Business Context and Reporting Period
Kelly Services, Inc. is a global workforce solutions company providing branch-delivered 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 unaudited Form 10-Q covers the 13 weeks ended April 2, 2017, compared with the 13 weeks ended April 3, 2016.
Effective in the first quarter, Kelly realigned its operations into three reportable segments: Americas Staffing, Global Talent Solutions (GTS), and International Staffing. Prior-period segment information was recast. The company’s APAC staffing operations were transferred to the TS Kelly Asia Pacific joint venture in 2016, affecting year-over-year comparisons.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue from services | $1,289.7 million | $1,349.1 million | Down 4.4% |
| Gross profit | $231.6 million | $232.7 million | Down 0.5% |
| Gross profit rate | 18.0% | 17.3% | Up 70 basis points |
| SG&A expense | $215.2 million | $218.0 million | Down 1.3% |
| Earnings from operations | $16.4 million | $14.7 million | Up 11.2% |
| Earnings from operations, excluding restructuring | $18.8 million | $14.7 million | Up 27.2% |
| Operating margin | 1.3% | 1.1% | Up 20 basis points |
| Net earnings | $12.2 million | $11.2 million | Up 8.9% |
| Diluted EPS | $0.31 | $0.29 | Up $0.02 |
| Cash flow from operations | $24.3 million | $20.2 million | Up $4.1 million |
The company reported a 7.1% conversion rate, compared with 6.3% in the prior-year quarter; excluding restructuring charges, the conversion rate was 8.1%. Staffing fee-based income declined to $13.5 million from $16.5 million.
Cash and equivalents were $46.0 million at quarter-end, compared with $29.6 million at 2016 year-end. Trade accounts receivable were $1.16 billion, and global days sales outstanding was 55 days. Working capital was $444.2 million and the current ratio was 1.5.
Kelly reported no debt at quarter-end and a debt-to-total-capital ratio of 0.0%. Available funding capacity included $150.0 million under a revolving credit facility and $149.6 million under a $200.0 million securitization facility. The securitization facility had no borrowings and $50.4 million of standby letters of credit related to workers’ compensation.
Material Changes Versus the Prior Comparable Period
- Americas Staffing revenue increased 3.4% to $573.1 million, while earnings from operations increased 24.0% to $21.2 million. Average bill rates increased 6%, partly offset by a 2% decline in hours volume.
- GTS revenue declined 0.7% to $487.3 million, but gross profit increased 6.1% to $90.5 million and earnings from operations increased 11.6% to $15.3 million.
- International Staffing revenue declined 24.4% to $233.6 million, primarily because APAC staffing was transferred to the TS Kelly Asia Pacific joint venture. Excluding the transferred APAC operations, management reported revenue growth in Europe.
- Gross profit rate improvement reflected lower workers’ compensation and employee-related costs, favorable pricing and customer mix in GTS, and a one-time French payroll tax benefit. Americas Staffing also recorded a $1.2 million favorable adjustment to prior-year workers’ compensation estimates, compared with a $0.1 million benefit in 2016.
- Operating cash flow increased to $24.3 million from $20.2 million. Financing cash use declined to $3.0 million from $18.3 million because the prior-year period included repayments of short-term borrowings.
- Other comprehensive income increased to $24.6 million from $3.5 million, mainly due to an $18.9 million after-tax unrealized gain on the company’s Temp Holdings investment, compared with an $8.1 million loss in the prior-year quarter.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management did not provide specific quantitative revenue or earnings guidance. Its stated objectives are to grow professional and technical specialty staffing and outsourced solutions, maintain locally delivered staffing, control costs, improve service delivery efficiency, and continue improving the conversion rate. Management expects demand for skilled workers, flexible staffing models, free-agent and contractual employment, and comprehensive workforce management solutions to support its strategy.
- The company recorded $2.4 million of restructuring charges, primarily severance, including $2.0 million in GTS and $0.4 million in Americas Staffing. The remaining restructuring accrual was $2.2 million, with most payments expected during 2017.
- Management completed goodwill testing following the segment realignment and identified no impairment. Goodwill remained $88.4 million.
- A potential income tax benefit of approximately $6 million could arise in the near term if future taxable income supports releasing valuation allowances on deferred tax assets.
- The Hillson nationwide class action lawsuit alleges violations of Fair Credit Reporting Act background-screening disclosure requirements. A $4.1 million accrual was recorded in 2015; court consideration of settlement approval was scheduled for August 2, 2017. The company also reported increased litigation volume, including potential class actions, although it did not expect current matters to have a material adverse effect.
- Effective May 10, 2017, Carl T. Camden retired as President and Chief Executive Officer and George S. Corona was appointed to succeed him. The retirement resulted in forfeiture of approximately 141,000 performance shares and 130,500 unvested restricted shares.
- Key risks include economic and labor-market conditions, pricing and competitive pressures, foreign currency fluctuations, customer concentration and demand changes, availability of qualified workers, employment-related claims, cybersecurity and privacy risks, dependence on third parties, workers’ compensation claims, tax matters, impairment risk, and compliance with debt covenants.
- The company is evaluating several new accounting standards, including revenue recognition, leases, credit losses, financial instruments, cash-flow classification, and goodwill impairment. The lease standard is expected to have a material balance-sheet impact because the company primarily operates from leased facilities.
Important Facts for Investors to Verify
- Determine the underlying year-over-year performance excluding the APAC deconsolidation and quantify the sustainability of European growth.
- Assess whether the improved gross profit rate and conversion rate can persist after the one-time workers’ compensation and French payroll tax benefits.
- Monitor whether GTS restructuring produces the expected recurring cost savings and whether additional restructuring charges arise.
- Review liquidity needs as staffing growth increases payroll and receivable funding requirements, despite zero reported debt and substantial unused facilities.
- Track the Temp Holdings investment because changes in its market value affected comprehensive income and accumulated other comprehensive income.
- Follow the Hillson settlement approval, other employment-related litigation, and potential exposure from class-action claims.
- Evaluate the impact of the planned accounting standards, particularly lease accounting and revenue recognition, on reported assets, liabilities, revenue, and timing of earnings.