Kelly Services, Inc. — 2013 Second-Quarter Form 10-Q
Business context and reporting period
Kelly Services is a global staffing and workforce-solutions company operating across the Americas, EMEA, APAC, and Outsourcing and Consulting Group (OCG). The filing covers the 13 weeks and 26 weeks ended June 30, 2013, compared with the periods ended July 1, 2012. Results are unaudited.
Key financial metrics
| Metric | Q2 2013 | Q2 2012 | Year-to-date 2013 | Year-to-date 2012 |
|---|---|---|---|---|
| Revenue from services | $1,366.9 million | $1,366.1 million | $2,681.7 million | $2,720.9 million |
| Gross profit | $220.7 million | $223.2 million | $437.6 million | $446.9 million |
| Gross profit margin | 16.1% | 16.3% | 16.3% | 16.4% |
| Earnings from operations | $16.4 million | $23.8 million | $23.5 million | $38.5 million |
| Operating margin | 1.2% | 1.7% | 0.9% | 1.4% |
| Net earnings | $10.0 million | $15.0 million | $22.9 million | $24.6 million |
| Diluted EPS from continuing operations | $0.26 | $0.40 | $0.60 | $0.64 |
- Q2 revenue was essentially flat year over year, while first-half revenue declined 1.4%.
- Q2 earnings from operations fell 30.9%; first-half operating earnings fell 38.9%.
- Return on sales was 0.7% in Q2, below management’s long-term goal of 4.0%.
- Operating cash flow was negative $14.2 million in the first half of 2013, versus positive $5.9 million in the prior-year period.
- Capital expenditures were $7.7 million, producing negative investing cash flow of $7.9 million.
- Financing activities generated $15.3 million, primarily from a $19.1 million increase in short-term borrowings, partially offset by $3.8 million of dividends.
- Cash and equivalents were $70.3 million at June 30, 2013, versus $76.3 million at December 30, 2012.
- Trade receivables were $1.04 billion, and global days sales outstanding increased to 54 days from 53 days in the comparable prior-year quarter.
- Short-term borrowings were $83.2 million, compared with $64.1 million at year-end 2012. Debt-to-total capital increased to 9.7% from 8.0%.
Material changes versus comparable periods
- Staffing hours declined 4% in Q2 and 6% year to date, partly offset by higher average bill rates. Management attributed weaker volumes principally to economic uncertainty and selected exits from low-margin Indian business.
- Americas Q2 revenue declined 2.4% and operating earnings declined 18.0%; higher SG&A reflected investments in professional and technical recruiting, centralized operations, and technology.
- EMEA Q2 revenue increased 3.0%, but operating earnings declined 17.3% because of lower fee-based income and a weaker gross profit rate.
- APAC Q2 revenue increased 0.7%, and the region returned to $0.9 million of operating earnings from a $1.2 million loss, primarily through expense reductions and business-mix changes. First-half APAC revenue declined 4.5%.
- OCG revenue grew 20.2% in Q2 and 17.3% year to date, driven primarily by business process outsourcing and contingent workforce outsourcing. OCG nevertheless recorded a Q2 operating loss of $2.5 million and a first-half loss of $0.8 million due to growth-related costs, lower margins, a $1.7 million impairment, and $0.8 million of restructuring costs.
- The company recognized a $3.0 million charge related to settlement of a Delaware unclaimed-property examination; the $4.5 million settlement was paid in Q2.
- First-half tax results benefited from retroactive reinstatement of work opportunity credits, resulting in a $2.0 million tax benefit versus $13.2 million of tax expense in the prior-year period.
- Other comprehensive income included a $23.8 million year-to-date unrealized, after-tax gain on the Temp Holdings investment, partly offset by a $9.4 million foreign-currency translation loss.
Outlook, commentary, risks, and unusual items
Management described global economic growth as uneven and below the level typically associated with a recovery. It expects near-term hiring demand to remain constrained in the United States and does not anticipate significant improvement in European economic conditions. Long-term priorities include expanding professional and technical staffing, growing OCG, increasing selected permanent-placement activities, maintaining commercial staffing strength, and reducing service-delivery costs.
Kelly intends to offer health coverage to eligible temporary employees under the Affordable Care Act. Because employer-penalty and reporting provisions were delayed until 2015, the company did not intend to expand employer-subsidized coverage in 2014. Management plans to seek customer price increases to offset related costs, but warned that recovery of those costs is uncertain and the financial impact could be significant.
- Liquidity depends on operating cash flow, cash balances, receivables securitization, and credit facilities. At quarter-end, the company reported $150.0 million of availability on its revolving credit facility and $11.0 million of availability on its $150.0 million securitization facility.
- The company stated that it met applicable debt covenants and expects existing facilities to cover near-term working-capital needs, but significant deterioration in operating conditions could require additional funding.
- European receivables totaled $297.5 million, or 29% of net trade receivables; receivables from Italy, Portugal, and Ireland totaled $42.7 million.
- Ordinary-course litigation includes employment discrimination, wage-and-hour, and restrictive-covenant matters. Management does not expect current matters to have a material adverse effect, but acknowledges inherent uncertainty.
- Key risks include economic and staffing-demand volatility, pricing pressure, customer concentration or contract loss, foreign-exchange movements, workers’ compensation and employment claims, technology execution, financing and covenant compliance, regulatory changes, and impairment risk.
- Disclosure controls and procedures were deemed effective, with no material changes to internal control over financial reporting.
Investor verification checklist
- Verify whether OCG growth converts into sustainable operating profit after implementation and support costs.
- Monitor staffing hours, bill rates, fee-based income, gross margins, and SG&A leverage by region.
- Assess receivable aging, days sales outstanding, and the resulting need for securitization-facility borrowings.
- Review liquidity headroom, standby letters of credit, debt covenants, and available credit capacity.
- Evaluate the ultimate cost and customer-pricing recovery of Affordable Care Act compliance.
- Check the effect of foreign currency movements and the Temp Holdings investment on comprehensive income and equity.
- Confirm the resolution and remaining exposure from restructuring, German executive-search exit costs, Delaware unclaimed-property matters, and ordinary-course litigation.