Business Context and Reporting Period
Kelly Services, Inc. filed this unaudited Form 10-Q for the 13 and 26 weeks ended July 1, 2012, compared with July 3, 2011. The company provides temporary staffing, professional and technical staffing, outsourcing, consulting, recruitment, payroll, and career transition services through Americas, EMEA, APAC, and Outsourcing and Consulting Group segments.
Management cited a slowing U.S. labor market, the Eurozone recession, and continued global uncertainty. The company acquired Brazil-based Tradição in the fourth quarter of 2011; its purchase-price allocation remained preliminary.
Key Financial Metrics
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue from services | $1,366.1 million | $1,405.8 million | $2,720.9 million | $2,744.9 million |
| Gross profit | $223.2 million | $222.1 million | $446.9 million | $433.3 million |
| Gross profit rate | 16.3% | 15.8% | 16.4% | 15.8% |
| SG&A expense | $199.4 million | $200.8 million | $408.4 million | $410.4 million |
| Earnings from operations | $23.8 million | $21.3 million | $38.5 million | $22.9 million |
| Operating margin | 1.7% | 1.5% | 1.4% | 0.8% |
| Net earnings | $15.0 million | $18.8 million | $24.6 million | $19.9 million |
| Diluted EPS from continuing operations | $0.40 | $0.53 | $0.64 | $0.56 |
Q2 revenue declined 2.8% reported but was flat on a constant-currency basis. Fee-based income increased 9.4% to $38.9 million. Six-month fee-based income increased 12.1% to $75.6 million.
Q2 income-tax expense increased to $8.3 million from $0.6 million, producing a 35.5% effective tax rate versus 3.3% in the prior-year quarter. The increase primarily reflected reduced tax credits, including the absence of HIRE Act retention credits available in 2011.
Segment Performance
- Americas: Q2 revenue increased 1.4% to $931.0 million, gross profit increased 6.3% to $137.4 million, and operating earnings increased 14.7% to $38.4 million. The operating margin improved to 4.1% from 3.6%.
- EMEA: Q2 revenue declined 16.2% to $255.3 million and operating earnings declined 32.9% to $5.4 million. Management attributed the decline primarily to fewer hours worked and weak economic conditions.
- APAC: Q2 revenue declined 16.2% to $97.1 million and operating loss widened to $1.2 million from $0.4 million. The company exited certain low-margin customers in Australia and India.
- OCG: Q2 revenue increased 23.4% to $91.4 million, and operating results improved to earnings of $0.9 million from a loss of $0.8 million. Growth reflected BPO, PPO, RPO, and CWO programs.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash and equivalents were $65.2 million at July 1, 2012, down from $81.0 million at January 1, 2012.
- Operating activities generated $5.9 million in the first six months, compared with a use of $6.8 million in the prior-year period.
- Investing activities used $9.8 million, including $9.8 million of capital expenditures.
- Financing activities used $11.6 million, including $7.8 million of net short-term borrowing repayments and $3.8 million of dividends.
- Trade accounts receivable were $985.0 million; global days sales outstanding increased to 53 days from 52 days.
- Short-term borrowings were $88.5 million, compared with $96.3 million at year-end. Debt-to-total capital improved to 11.1% from 12.5%.
- The company reported $150 million of available capacity under its revolving credit facility and $6 million under its securitization facility. It complied with applicable debt covenants.
- Working capital was $443 million and the current ratio was 1.6 at quarter-end.
Material Changes and Unusual Items
- Revenue was pressured by an 11% Q2 decrease in hours worked, partially offset by a 10% constant-currency increase in average bill rates.
- Six-month hours worked declined 9%, while constant-currency average bill rates increased 8%.
- Gross margins benefited from higher fee-based income, lower payroll taxes, lower benefits and workers’ compensation costs, and improved mix. The company reduced estimated prior-year workers’ compensation costs by $4 million in the first six months.
- Restructuring costs were a $2.2 million credit in Q2 and for the first six months, compared with a $0.6 million credit in Q2 2011 and $3.4 million of expense for the first six months of 2011. The remaining restructuring accrual was $1.5 million, expected to be paid primarily through 2016.
- Vendor-management and technology costs were reclassified from SG&A to cost of services beginning in 2012; prior periods were revised. The reclassification reduced prior-year gross profit and SG&A by $2.5 million in Q2 and $5.0 million for the first six months.
- On July 24, 2012, Kelly and Temp Holdings announced a North Asia joint venture, TS Kelly Workforce Solutions, expected to become effective in October 2012.
Outlook, Risks, and Contingencies
Management stated that demand for staffing and workforce solutions was increasing gradually and emphasized growth in professional and technical, fee-based, outsourcing, and consulting offerings while controlling service-delivery costs. The filing does not provide quantitative revenue or earnings guidance.
- Key risks include economic weakness, Eurozone conditions, pricing pressure, customer concentration or contract losses, availability of qualified temporary workers, foreign-currency fluctuations, and execution of expansion and technology initiatives.
- The company is exposed to employment-related litigation, wage-and-hour claims, discrimination claims, workers’ compensation and benefit costs, and potential data-security liabilities. Management does not expect current litigation to have a material adverse effect but noted that outcomes remain uncertain.
- European receivables totaled $276 million, or 28% of total net receivables. Receivables from Italy, Portugal, and Ireland totaled $42 million, with no significant deterioration reported during the quarter.
- Approximately $6 million of unrecognized tax benefits and related interest and penalties could reasonably reverse within the next twelve months.
- Management identified risks related to maintaining debt covenants and financing access, sustaining critical information systems, regulatory and tax changes, expiration of the U.S. work opportunity credit program, and the Patient Protection and Affordable Care Act.
Investor Verification Items
- Verify whether Americas growth and OCG expansion offset continuing weakness in EMEA and APAC.
- Monitor hours worked, average bill rates, fee-based income, and gross profit rates for evidence of sustainable margin improvement.
- Assess the effect of elevated tax rates after the loss or limitation of 2011 tax credits.
- Review receivables aging, working-capital needs, and available capacity under the securitization and revolving facilities.
- Track the remaining restructuring accrual, workers’ compensation estimates, tax contingencies, and ordinary-course litigation.
- Evaluate the Tradição acquisition, including the preliminary purchase-price allocation and contribution to reported results.
- Confirm the October 2012 launch and expected financial impact of the TS Kelly Workforce Solutions joint venture.