Kelly Services, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Kelly Services is a global workforce solutions company providing commercial and professional/technical staffing, outsourcing, consulting, recruitment process outsourcing, business process outsourcing, and related services. The filing covers the 13 weeks and 39 weeks ended October 2, 2016, compared with the periods ended September 27, 2015. Results are unaudited.
On July 4, 2016, Kelly transferred its Asia-Pacific staffing operations and certain APAC outsourcing and consulting businesses to TS Kelly Asia Pacific, a joint venture with Temp Holdings. Kelly retained a 49% interest and received cash at closing.
Financial Results and Key Metrics
| Metric | Q3 2016 | Q3 2015 | Change |
|---|---|---|---|
| Revenue from services | $1,247.8 million | $1,351.0 million | Down 7.6% |
| Gross profit | $215.1 million | $228.2 million | Down 5.8% |
| Gross profit rate | 17.2% | 16.9% | Up 0.3 percentage points |
| SG&A expense | $196.3 million | $211.6 million | Down 7.3% |
| Earnings from operations | $18.8 million | $16.6 million | Up 13.1% |
| Earnings before taxes | $105.6 million | $16.6 million | Includes $87.2 million gain |
| Net earnings | $80.9 million | $9.1 million | Up substantially |
| Diluted EPS | $2.06 | $0.23 | Up substantially |
| Return on sales | 1.5% | 1.2% | Up 0.3 percentage points |
| Conversion rate | 8.7% | 7.3% | Up 1.4 percentage points |
| Metric | 39 Weeks 2016 | 39 Weeks 2015 | Change |
|---|---|---|---|
| Revenue from services | $3,972.4 million | $4,056.6 million | Down 2.1% |
| Gross profit | $678.3 million | $670.8 million | Up 1.1% |
| Earnings from operations | $43.4 million | $40.2 million | Up 7.9% |
| Net earnings | $101.0 million | $19.6 million | Up substantially |
| Diluted EPS | $2.58 | $0.51 | Up substantially |
| Operating cash flow | $26.1 million | $(1.5) million | Improved |
Quarterly operating results benefited from lower SG&A, including a one-time $7.5 million reduction in performance-based compensation expense. Year-to-date SG&A included $3.4 million of restructuring charges and $1.8 million of one-time costs related to the APAC joint venture expansion.
Liquidity, Cash Flow, Debt, and Balance Sheet
- Cash and equivalents were $27.6 million at October 2, 2016, compared with $42.2 million at January 3, 2016.
- Operating activities generated $26.1 million of cash during the first 39 weeks, versus cash usage of $1.5 million in the prior-year period.
- Investing activities generated $10.6 million, including $18.8 million of net cash related to the TS Kelly Asia Pacific transaction. Capital expenditures were $7.8 million.
- Financing activities used $55.1 million, primarily because of a $47.8 million reduction in short-term borrowings and $7.7 million of dividend payments.
- Short-term borrowings declined to $8.7 million from $55.5 million at year-end 2015. Debt-to-total capital was 0.8%, compared with 5.8% at year-end 2015.
- Working capital was $430.0 million and the current ratio was 1.6 at quarter-end. Global days sales outstanding was 56 days.
- The company reported $199.0 million of available capacity under its $200.0 million revolving credit facility and $101.6 million of available capacity under its $150.0 million securitization facility. It met applicable debt covenants and intended to refinance both facilities in the fourth quarter of 2016.
Material Changes and Segment Trends
- The APAC transaction reduced reported revenue and eliminated consolidated APAC operating results for the third quarter. The retained investment was recorded at $104.2 million, and Kelly recognized an $87.2 million pretax gain.
- Americas third-quarter revenue declined 1.8%, while earnings from operations increased 1.0% to $24.1 million. The region benefited from lower expenses and a higher gross profit rate.
- EMEA revenue declined 1.4% and earnings from operations declined 17.8% to $4.4 million, primarily due to lower gross profit rates and unfavorable customer mix in Switzerland and the U.K.
- OCG revenue increased 3.7% and gross profit increased 8.5%, but operating earnings declined 7.0% to $7.7 million because of investments in headcount and sales resources.
- For the first nine months, OCG revenue rose 7.0% and operating earnings rose 22.8%. Americas operating earnings rose 7.0%, while EMEA operating earnings rose 30.5% following cost controls.
Outlook, Risks, Contingencies, and Unusual Items
Management expects growth in professional and technical staffing and OCG, continued commercial staffing as a core business, disciplined cost control, and further improvement in the conversion rate. Management noted that the U.S. staffing market softened in the second quarter and showed signs of stabilization in the third quarter, while demand for skilled workers and flexible workforce models remains a long-term opportunity.
- The $87.2 million TS Kelly Asia Pacific gain is a significant nonrecurring item and drove most of the increase in pretax and net earnings.
- Operating results exclude the joint venture’s third-quarter operations; Kelly will account for its interest under the equity method on a one-quarter lag.
- The company expects a $4.5 million post-close cash true-up from Temp Holdings in the fourth quarter and expects to transfer its TS Kelly Workforce Solutions interest to the joint venture.
- A nationwide Fair Credit Reporting Act class action settlement remains subject to court approval. Kelly recorded a $4.1 million accrual in the fourth quarter of 2015.
- Management cited increased litigation volume, including potential class actions, employment-related claims, foreign currency exposure, economic and labor-market uncertainty, customer concentration, cyber and data privacy risks, and the ability to maintain financing covenants.
- Restructuring accruals totaled $1.2 million at quarter-end, with most expected to be paid by the end of 2016.
- Management stated that there were no material changes to previously disclosed risk factors, contractual obligations, or commercial commitments.
- Several new accounting standards, including those covering revenue recognition, leases, credit losses, equity investments, share-based payments, and cash-flow classification, were under evaluation. The company expects to adopt the new revenue standard beginning January 1, 2018, using the modified retrospective approach.
Most Important Facts for Investors to Verify
- Separate underlying operating performance from the $87.2 million TS Kelly Asia Pacific transaction gain and related $23.5 million tax expense.
- Assess the comparability of 2016 revenue and segment trends after the APAC operations were deconsolidated.
- Monitor whether U.S. professional and technical staffing growth accelerates, particularly in centralized delivery accounts.
- Evaluate whether OCG investment spending converts its revenue and gross profit growth into sustained operating-profit growth.
- Confirm completion and terms of the planned refinancing of the revolving and securitization facilities.
- Track cash balances, receivables, days sales outstanding, and borrowing needs because temporary payroll obligations precede customer collections.
- Review the valuation and future equity-method results of the 49% TS Kelly Asia Pacific investment.
- Monitor court approval of the Hillson settlement and developments in other employment-related and class-action litigation.