Kelly Services, Inc. 2017 Third-Quarter Form 10-Q Summary
Business Context and Reporting Period
Kelly Services is a global workforce-solutions company providing temporary and direct-hire staffing, recruitment process outsourcing, contingent workforce outsourcing, business process outsourcing, payroll outsourcing, career transition, executive placement and advisory services. The company reports three segments: Americas Staffing, Global Talent Solutions, and International Staffing.
The third quarter ended October 1, 2017 and included 13 weeks, compared with 13 weeks ended October 2, 2016. Year-to-date periods each included 39 weeks. Results are unaudited.
Financial Performance and Liquidity
| Metric | Q3 2017 | Q3 2016 | Change |
|---|---|---|---|
| Revenue from services | $1,328.8 million | $1,247.8 million | Up 6.5%; 5.3% constant currency |
| Gross profit | $230.7 million | $215.1 million | Up 7.3% |
| Gross profit rate | 17.4% | 17.2% | Up 0.2 percentage points |
| SG&A expense | $212.5 million | $196.3 million | Up 8.3% |
| Earnings from operations | $18.2 million | $18.8 million | Down 2.9% |
| Net earnings | $23.0 million | $80.9 million | Down $57.9 million |
| Diluted earnings per share | $0.58 | $2.06 | Down $1.48 |
| Operating conversion rate | 7.9% | 8.7% | Down 0.8 points |
| Return on sales | 1.4% | 1.5% | Down 0.1 points |
Net earnings in the prior-year quarter included an $87.2 million pretax gain related to the formation of the TS Kelly Asia Pacific joint venture. Q3 2017 also benefited from a $5.1 million tax benefit from releasing a German valuation allowance. The prior-year quarter included a $23.5 million tax charge related to the joint-venture gain.
For the first 39 weeks of 2017, revenue was $3,952.1 million versus $3,972.4 million, gross profit was $691.1 million versus $678.3 million, operating earnings were $54.9 million versus $43.4 million, and net earnings were $53.9 million versus $101.0 million. Year-to-date diluted EPS was $1.37 versus $2.58. The year-to-date operating conversion rate improved to 7.9% from 6.4%.
Segment Results
- Americas Staffing: Q3 revenue increased 7.1% to $554.8 million, while operating earnings declined to $13.3 million from $14.3 million. Hours were flat; higher bill rates drove revenue, but mix and increased investment reduced margins.
- Global Talent Solutions: Revenue increased 1.6% to $503.0 million. Gross profit rose 7.9% to $93.0 million and operating earnings increased 30.3% to $20.8 million, supported by favorable practice and customer mix, lower workers’ compensation costs and service-delivery efficiencies.
- International Staffing: Revenue increased 15.2% to $275.6 million, or 10.4% in constant currency, and operating earnings increased 57.0% to $7.2 million. European hours volume increased 8%, but gross profit rate declined because of customer mix.
Cash Flow, Debt and Liquidity
- First-nine-month operating cash flow was $32.9 million, compared with $28.2 million in the prior-year period.
- Investing activities used $51.3 million, including $37.2 million for the acquisition of Teachers On Call and $14.7 million of capital expenditures.
- Financing activities provided $13.4 million, primarily from $23.9 million of short-term borrowings, partly offset by $8.7 million of dividend payments.
- Cash and equivalents were $22.2 million at October 1, 2017, compared with $29.6 million at January 1, 2017.
- Short-term borrowings were $23.9 million versus zero at year-end 2016. Debt-to-total capital was 2.1% versus zero.
- Available capacity was $126.8 million on the $150.0 million revolving credit facility and $149.3 million on the $200.0 million securitization facility. The company reported compliance with applicable debt covenants.
- Trade accounts receivable were $1.27 billion and global days sales outstanding was 58 days, compared with 56 days at the prior-year quarter-end.
Material Changes, Transactions and Unusual Items
- On September 5, 2017, the company acquired Teachers On Call, a U.S. educational staffing firm, for a stated purchase price of $41.0 million and cash paid at closing of $39.0 million. The preliminary allocation included $18.7 million of goodwill and $18.3 million of intangible assets.
- The company incurred $2.4 million of restructuring costs during the first nine months of 2017, primarily related to service-delivery optimization. The remaining restructuring accrual at quarter-end was $0.5 million.
- SG&A included a $2.8 million third-quarter benefit and a $1.4 million year-to-date benefit from correcting prior-period expense overstatements. Management stated the errors were not material to the affected periods.
- The company recognized $28.8 million of after-tax unrealized gains on its Persol Holdings investment in Q3 and $48.6 million year to date in other comprehensive income.
- The Hillson litigation settlement was approved in August 2017, and the final payment, previously accrued in 2015, was made in September 2017.
Guidance, Outlook and Risks
Management expects to grow professional and technical staffing and outsourced solutions, maintain locally delivered staffing as a core business, leverage Kelly Educational Staffing and Teachers On Call, control expenses and improve the conversion rate. Management cited expected demand for skilled workers, flexible staffing models and comprehensive workforce-management solutions, but provided no specific quantitative revenue or earnings guidance.
Key risks include competitive pricing and technology disruption, changing economic and labor-market conditions, execution of the business strategy, acquisition integration, foreign currency fluctuations, customer concentration or loss, availability of skilled employees and temporary workers, employment-related litigation, privacy and cybersecurity incidents, workers’ compensation and benefit claims, tax changes, goodwill impairment, and compliance with financing covenants. The filing states that no material changes occurred to the risk factors disclosed in the 2016 Form 10-K.
The company is evaluating several accounting standards, including revenue recognition, leases, credit losses, equity investments and goodwill impairment. Adoption of the new revenue standard is expected January 1, 2018 using a modified retrospective approach; management preliminarily expects contract-cost deferrals and expanded disclosures, with the final impact subject to change. The new lease standard is expected to have a material balance-sheet impact.
Important Facts for Investors to Verify
- Whether revenue growth continues after adjusting for currency effects and the Teachers On Call acquisition.
- Whether operating conversion and return-on-sales metrics improve as management expects.
- The sustainability of GTS margin gains and the margin effects of mix changes in Americas and International Staffing.
- Integration performance and contribution from Teachers On Call, including the final purchase-price allocation.
- Receivables growth, days sales outstanding and resulting working-capital funding requirements.
- Use of short-term borrowings, facility availability and continued compliance with debt covenants.
- Volatility in the Persol Holdings investment and the potential effect of future accounting changes, particularly revenue recognition, leases and equity-investment accounting.
- Developments in employment-related litigation, arbitration matters, cybersecurity, data privacy and other contingencies.