Kelly Services, Inc. — 2014 Third-Quarter Form 10-Q
Reporting period: The quarter ended September 28, 2014, comprising 13 weeks; year-to-date figures cover 39 weeks. Comparative periods ended September 29, 2013. The filing is unaudited.
Business Context and Results
Kelly is a global workforce-solutions provider operating through commercial and professional/technical staffing businesses in the Americas, EMEA and APAC, plus its Outsourcing and Consulting Group (OCG). Management cited improving but uneven economic and labor-market conditions, with increasing demand for professional/technical staffing and outsourced talent-supply-chain solutions.
| Metric | Third quarter 2014 | Third quarter 2013 | Year-to-date 2014 | Year-to-date 2013 |
|---|---|---|---|---|
| Revenue from services | $1,396.4 million | $1,345.6 million | $4,137.7 million | $4,027.3 million |
| Gross profit | $225.4 million | $220.4 million | $675.8 million | $658.0 million |
| Gross profit rate | 16.1% | 16.4% | 16.3% | 16.3% |
| Earnings from operations | $7.1 million | $20.2 million | $19.3 million | $43.7 million |
| Return on sales | 0.5% | 1.5% | 0.5% | 1.1% |
| Net earnings | $1.4 million | $18.8 million | $6.7 million | $41.7 million |
| Diluted EPS | $0.03 | $0.49 | $0.17 | $1.09 |
Cash Flow, Liquidity and Capital Structure
- Operating cash flow was negative $109.0 million year to date, compared with positive $21.9 million in the prior-year period, primarily because of growth in trade receivables and timing of supplier payments.
- Investing cash outflow was $20.2 million, including $15.0 million of capital expenditures and a $5.4 million investment in an equity affiliate.
- Financing cash flow was positive $55.1 million, principally from a $60.4 million increase in short-term borrowings. Dividends paid were $5.7 million.
- Cash and equivalents declined to $51.6 million from $125.7 million at year-end 2013. Trade receivables were $1.158 billion, and global days sales outstanding increased to 58 days from 56 days.
- Short-term borrowings were $88.7 million versus $28.3 million at year-end 2013. Debt-to-total capital increased to 9.7% from 3.3%.
- The company reported $200.0 million of available capacity under its revolving credit facility and $9.0 million under its securitization facility. It stated that it met applicable debt covenants at quarter-end.
- Total stockholders’ equity was $825.6 million, compared with $822.6 million at year-end 2013.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue increased 3.8%, while year-to-date revenue increased 2.7%.
- OCG was the strongest growth area, with third-quarter revenue up 10.7% and year-to-date revenue up 16.9%. Growth was led by recruitment process outsourcing, contingent workforce outsourcing, business process outsourcing and related services.
- Americas third-quarter revenue rose 3.1%, but regional operating earnings declined 19.7% as SG&A increased 10.6% due to planned investments and compensation costs.
- EMEA revenue increased 3.6% in the quarter and 7.5% year to date, while operating earnings were broadly stable.
- APAC revenue increased 5.0% in the quarter, but operating earnings declined 65.7% because of lower margins, reduced staffing fee-based income and country mix.
- Company SG&A excluding restructuring charges increased 7.3% in the quarter and 6.5% year to date. Management attributed the increase primarily to investments in professional/technical and OCG operations and salary increases.
- Income tax expense increased to $3.5 million in the quarter from $0.1 million and to $8.4 million year to date from a $1.9 million benefit. Management cited expiration of the U.S. work opportunity tax credit.
- Foreign-currency translation reduced other comprehensive income by $13.2 million in the quarter and $11.0 million year to date. The Temp Holdings investment generated an unrealized after-tax loss of $1.9 million in the quarter but an $8.6 million gain year to date.
Guidance, Outlook, Risks and Unusual Items
- Management expected overall 2014 earnings to decline year over year because revenue growth was expected to lag strategic investments. It targeted double-digit 2015 sales growth in OCG and Americas professional/technical, assuming continued economic support.
- The company’s long-term return-on-sales goal is 4.0%; third-quarter return on sales was 0.5%.
- A management-simplification restructuring plan is expected to close or consolidate approximately 50 U.S. branches and reduce the global workforce by approximately 100 positions, including approximately 55 headquarters positions. Third-quarter restructuring charges were $3.7 million, with total charges estimated at $9.0 million to $10.0 million, including $5.3 million to $6.3 million expected in the fourth quarter.
- Kelly planned to begin offering healthcare coverage in 2015 to eligible temporary employees under the Affordable Care Act. Management stated that the financial impact remains difficult to estimate and that customer pricing may not fully offset the costs.
- Risks include weak or uneven economic conditions, pricing pressure, dependence on large customers, foreign-currency exposure, staffing and employment-related claims, workers’ compensation trends, technology execution, access to financing, debt-covenant compliance and changes in tax laws, including possible reinstatement of the work opportunity credit.
- In a Louisiana litigation matter, Kelly paid $0.25 million of a $1.0 million settlement amount previously accrued; a tentative agreement involving the excess insurer was expected to leave Kelly with no additional obligation, but had not yet been finalized.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Whether planned restructuring actions produce the estimated $9.0 million to $10.0 million of charges and deliver sustainable cost savings.
- Whether OCG and Americas professional/technical investments achieve the targeted double-digit 2015 sales growth and improve operating margins.
- The effect of negative operating cash flow, rising receivables and increased reliance on short-term borrowings on liquidity.
- The ultimate cost of Affordable Care Act compliance and the company’s ability to recover those costs through customer pricing.
- The final resolution and any remaining exposure in the Louisiana litigation matter.
- Whether the U.S. work opportunity tax credit is retroactively reinstated and, if so, the resulting tax benefit.
- The filing text reports a current ratio of “1.5%” at quarter-end and “1.6%” at year-end; based on the balance-sheet figures, these appear to represent approximately 1.5x and 1.6x, respectively, and should be verified against the filed financial statements.