Kelly Services, Inc. 2016 Second-Quarter Form 10-Q Summary
Business context and reporting period
Kelly Services is a global workforce-solutions provider offering commercial staffing, professional and technical staffing, outsourcing, consulting, recruitment process outsourcing, contingent workforce outsourcing, business process outsourcing, payroll outsourcing, executive placement, and career transition services. The filing covers the 13-week quarter and 26-week year-to-date period ended July 3, 2016, compared with the periods ended June 28, 2015.
Financial performance and key metrics
| Metric | Q2 2016 | Q2 2015 | YTD 2016 | YTD 2015 |
|---|---|---|---|---|
| Revenue from services | $1,375.5 million | $1,385.0 million | $2,724.6 million | $2,705.6 million |
| Gross profit | $230.5 million | $222.3 million | $463.2 million | $442.6 million |
| Gross profit rate | 16.8% | 16.1% | 17.0% | 16.4% |
| Earnings from operations | $9.9 million | $11.5 million | $24.6 million | $23.6 million |
| Net earnings | $8.9 million | $6.8 million | $20.1 million | $10.5 million |
| Diluted EPS | $0.23 | $0.18 | $0.51 | $0.27 |
- Q2 revenue declined 0.7% reported but increased 0.6% on a constant-currency basis. YTD revenue increased 0.7% reported and 2.5% constant currency.
- Q2 gross profit increased 3.7%, while the gross profit rate expanded 70 basis points. YTD gross profit increased 4.6%, with a 60-basis-point rate improvement.
- Q2 operating earnings declined 13.9% because of $3.4 million of restructuring charges. Excluding restructuring, operating earnings were $13.3 million versus $11.5 million, and the conversion rate was 5.8% versus 5.2%.
- YTD operating earnings increased 4.2%. The reported Q2 return on sales was 0.7%, versus 0.8% in the prior year; the YTD return on sales was 0.9% in both periods.
- Lower income tax expense, primarily from reinstatement of the U.S. work opportunity tax credit program and a more favorable income mix, contributed to higher net earnings and EPS.
- Q2 OCG revenue increased 5.4% and operating earnings increased 38.2%. YTD OCG revenue increased 8.8% and operating earnings increased 61.3%, driven primarily by BPO and CWO growth.
Cash flow, debt, liquidity, and balance sheet
- YTD operating cash flow was $41.2 million, compared with cash used of $26.5 million in the prior-year period. The improvement reflected lower receivables growth, improved days sales outstanding, and higher earnings.
- YTD investing cash outflow was $4.7 million, including $4.3 million of capital expenditures. Financing cash outflow was $33.7 million, including $29.1 million of net debt repayments and $4.8 million of dividends.
- Cash and equivalents were $33.3 million at July 3, 2016, compared with $42.2 million at January 3, 2016. The reported cash balance excludes $18.1 million reclassified to assets held for sale.
- Short-term borrowings were $26.9 million, down from $55.5 million at year-end. Debt-to-total-capital declined to 2.8% from 5.8%.
- Available capacity was $187.2 million under the $200.0 million revolving credit facility and $93.6 million under the $150.0 million receivables securitization facility. The company reported compliance with related debt covenants.
- The securitization facility expires December 9, 2016; management intends to refinance it on or before maturity.
- Trade accounts receivable were approximately $1.1 billion, and global days sales outstanding improved to 53 days from 56 days at the prior-year quarter-end.
Material changes, outlook, risks, and unusual items
- The U.S. staffing market softened in Q2. Americas revenue declined 2.3%, including a 3% decrease in hours volume, although operating earnings increased 3.6% and the gross profit rate improved.
- EMEA revenue increased 0.7% reported, while operating earnings increased to $2.6 million from $1.7 million. APAC revenue declined 3.5% and operating earnings declined 31.4%, partly because of lower bill rates and reduced Singapore wage credits.
- Management expects growth in professional and technical staffing and OCG, continued commercial-staffing support, disciplined cost control, operating leverage, and continued improvement in the conversion rate. Management cautioned that goals may change with economic and business conditions.
- Q2 restructuring actions in the Americas and Italy generated $3.4 million of charges, consisting primarily of severance and lease termination costs. The remaining restructuring accrual was $2.8 million, most of which was expected to be paid in 2016.
- On July 4, 2016, Kelly completed the TS Kelly Asia Pacific joint venture with Temp Holdings. Kelly received $36.5 million in cash and retained a 49% equity interest; Temp Holdings owns 51%. Kelly expects to record a material gain in Q3 2016 and will subsequently account for the interest under the equity method.
- Asia Pacific assets of $94.0 million and liabilities of $48.0 million were classified as held for sale at quarter-end. The disposal group was not classified as discontinued operations.
- A pending nationwide Fair Credit Reporting Act class action settlement remains subject to court approval. Kelly recorded a $4.1 million accrual in Q4 2015. Management also noted increased litigation volume, including potential class actions, although it does not currently expect a material adverse effect.
- Principal risks include staffing demand and pricing pressure, foreign currency exposure, customer concentration or loss, availability of qualified workers and leaders, employment-related claims, workers’ compensation trends, cybersecurity and data privacy, regulatory and tax changes, debt covenant compliance, and execution of outsourcing and joint-venture strategies.
- The company’s investment in Temp Holdings was carried at a fair value of $156.5 million at quarter-end. A $15.6 million after-tax unrealized gain was recorded in other comprehensive income during Q2.
Facts investors should verify
- Completion accounting, fair value, and the expected material gain from the TS Kelly Asia Pacific transaction in Q3 2016.
- Refinancing or renewal terms for the securitization facility before its December 9, 2016 expiration.
- Whether the softer U.S. staffing market persists and whether professional and technical staffing growth accelerates.
- The sustainability of OCG growth, gross-margin expansion, and management’s targeted conversion-rate improvement.
- Final court approval and ultimate cost of the Fair Credit Reporting Act settlement and other employment-related litigation.
- The effect of restructuring actions, one-time benefit and litigation costs, and future operating expenses on reported margins.
- Exposure to foreign-exchange movements, Temp Holdings share-price volatility, and changes in wage credits or tax benefits.