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KELLY SERVICES INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) Executive Overview The Workforce Solutions Industry The staffing industry has changed dramatically over the last decade - transformed by globalization and competitive consolidation. The industry has also continued to evolve in terms of service line expansion and evolution from commercial into professional/technical and outsourced solutions. The broader workforce solutions industry has continued to transform to meet businesses' growing demand for total workforce or talent supply chain management ("TSCM") solutions. Global employment trends are reshaping and redefining traditional employment models, sourcing strategies and human resource capability requirements. Clients' workforce solutions strategies are moving up the maturity model as they take the full spectrum of talent into consideration. The TSCM concept seeks to manage all categories of talent (temporary, project-based, outsourced and full-time) and represents significant market potential. The global workforce solutions market has seen some acceleration during the second half of 2014, as the engine for economic growth has gradually shifted in favor of large developed economies in recent months. While the outlook for 2015 is encouraging, years of economic under-performance is tempering expectations. Despite recent cyclical challenges, strategic clients are increasingly looking for global, flexible and holistic talent solutions that encompass all worker categories, driving adoption of our TSCM concept covering temporary staffing, Contingent Workforce Outsourcing ("CWO"), Recruitment Process Outsourcing ("RPO"), independent contractor management and more. Near-term demand for traditional temporary staffing is now benefiting from improving labor market conditions in the U.S., while structural shifts toward higher-skilled, project-based professional/technical talent continue to represent long-term opportunities for the industry. Professional/Technical staffing is projected to steadily increase as a percent of the global market, with demand for specialty staffing projected to outperform commercial. Our Business Kelly Services is a global workforce solutions company, serving customers of all sizes in a variety of industries. Our staffing operations are divided into three regions, Americas, EMEA and APAC, with commercial and professional/technical staffing businesses in each region. As the human capital arena has become more complex, we have also developed a suite of innovative solutions within our global OCG business. OCG delivers integrated talent management solutions to meet customer needs across the entire spectrum of talent categories. Using talent supply chain strategies, we help customers manage their acquisition of contingent and full-time labor, and gain access to service providers and quality talent at competitive rates with minimized risk. We earn revenues from the hourly sales of services by our temporary employees to customers, as a result of recruiting permanent employees for our customers, and through our outsourcing activities. Our working capital requirements are primarily generated from temporary employee payroll and customer accounts receivable. The nature of our business is such that trade accounts receivable are our most significant financial asset. Average days sales outstanding varies within and outside the U.S., but is 58 days on a global basis. Since receipts from customers generally lag temporary employee payroll, working capital requirements increase substantially in periods of growth. Our Strategy and Outlook Our long-term strategic objective is to create shareholder value by delivering a competitive profit from the best workforce solutions and talent in the industry. To achieve this, we are focused on the following key areas: • Maintain our core strengths in commercial staffing in key markets; • Grow our professional and technical solutions; • Enhance our position as a market-leading provider of talent supply chain management in our OCG segment; • Capture permanent placement growth in selected specialties; and • Lower our costs through deployment of efficient service delivery models. 19-------------------------------------------------------------------------------- Although our objectives remain clear, ongoing economic, political and fiscal disruptions have been a persistent drag on the global recovery and our business. Recent economic and labor market trends have been more favorable and the outlook for the remainder of 2014 and beyond is encouraging, but the global recovery remains historically weak and uneven. Our industry is not experiencing the degree or patterns of growth typically seen at this point in the recovery cycle. Kelly's third quarter revenue increased 4% year over year, helped by improving conditions in the U.S. During the third quarter of 2014, we increased revenue in our OCG segment by 11% year over year, confirming that our direction aligns with increased market demand for outsourced solutions. Growth was particularly strong in RPO and the fee-based CWO portion of the business, which continue to be key drivers of our strategic and financial progress. We continued to execute our planned investments, including additional resources for OCG and Americas PT. As a result, total Company expenses increased as expected, underscoring our commitment to strategically drive long-term growth. At 0.5% for the third quarter of 2014, our return on sales ("ROS") is still well below our long-term goal of 4.0%. To make significant progress against our ROS goal and better leverage our business, we will need to see continued economic growth coupled with stronger demand for full-time and temporary labor in the sectors that Kelly supports. In the meantime, we remain focused on what we can control: executing a well-formed strategy with increased speed and precision, and making the necessary investments to advance that strategy. During the first nine months of 2014, we made aggressive, targeted investments to adjust our operating models and increase the resources responsible for driving growth in higher margin specialties - both in Americas PT and in our fast-growing OCG segment. Specifically, our investments are designed to: • Grow Americas PT staffing by: establishing nationally focused, product-specific recruiting centers for our IT, engineering, science and finance specialties in the U.S.; hiring additional PT recruiters and PT business development representatives in local U.S. markets; and leveraging our centralized large account delivery model to drive PT growth in large accounts across the Americas. • Target rapid expansion of our OCG solutions on three fronts: expanding our global supplier network to transform Kelly's delivery capabilities around the world; strengthening our talent supply chain analytics solution to meet the growing demand for workforce planning among our clients; and expanding our statement of work and independent contractor solutions to ensure we take full advantage of the trend toward project-based PT work. • Ensure our technology capabilities support our growth initiatives, including: improving the end-to-end ordering process for large accounts using OCG solutions; and revamping our front-office systems to increase efficiency and productivity in our operations. These investments are intended to achieve double-digit sales growth in 2015 in both OCG and our Americas PT segment, assuming continued growth in portions of the economy that rely on these services. As previously reported, we expect that revenue growth will lag these investments and, consequently, that our overall earnings in 2014 will be down on a year-over-year basis. On September 15, 2014, the Board of Directors of the Company approved a management simplification restructuring plan ("Plan") that was subsequently communicated to Kelly personnel in October 2014. We expect to complete this Plan during the fourth quarter of 2014. We began 2014 with a firm commitment to growth and a clear plan for accelerating Kelly's strategic priorities through significant investments in our PT specialties, our OCG practices and our centralized approach to servicing large customers. We have executed these investments on schedule, and the Plan now brings additional efficiency to our operating models across the organization by: • In the Americas segment: • Streamlining our local U.S. field operations through the closure or consolidation of approximately 50 branches • Simplifying our centralized large account delivery structure • Simplifying our U.S. management structure • Continuing to align OCG resources more efficiently against areas that deliver rapid growth and return on investment • Optimizing our headquarters operations 20 -------------------------------------------------------------------------------- Estimated headcount reduction related to the above actions is approximately 100 permanent positions across our global workforce, including several senior leadership positions that will be vacated at the end of December 2014. The headcount reduction related to the Americas segment is estimated to be 40 positions, OCG headcount is estimated to be reduced by 5 positions and corporate headquarters is estimated to be reduced by 55 positions. Related to this Plan, we reported restructuring charges of $3.7 million, consisting entirely of severance costs, in the third quarter of 2014. These severance costs include contract termination costs of $2.9 million and substantive plan costs of $0.8 million. Subsequent restructuring charges, to be incurred in the fourth quarter, are estimated to range between $5.3 million to $6.3 million and will include additional severance, as well as lease termination costs of approximately $2.0 million. We estimate restructuring charges to total between $9.0 million to $10.0 million, as detailed below, and will be recorded entirely in corporate selling, general and administrative expenses. The majority of these costs will result in future cash expenditures, starting in the fourth quarter of 2014. Severance Costs Lease Termination Costs Total (In millions of dollars) Range Range Range Americas $ 1.8 - $ 2.0 $ 1.9 - $ 2.1 $ 3.7 - $ 4.1 OCG 1.3 - 1.5 0.0 - 0.0 1.3 - 1.5 Headquarters 4.0 - 4.4 0.0 - 0.0 4.0 - 4.4 Total $ 7.1 - $ 7.9 $ 1.9 - $ 2.1 $ 9.0 - $ 10.0 Meeting the provisions of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, the "Acts") remains a challenge for the staffing industry. The Acts represent comprehensive U.S. healthcare reform legislation that, in addition to other provisions, will subject us to potential penalties unless we offer to our employees minimum essential healthcare coverage that is affordable and provides minimum value. In order to comply with the Acts, Kelly intends to begin offering health care coverage in 2015 to all temporary employees eligible for coverage under the Acts. In 2014, we are continuing to incur costs related to implementing the Acts in advance of future pricing designed to pass related costs on to our customers. Estimating the costs of complying with the Acts is difficult due to a variety of factors associated with our temporary employee population, particularly the percentage of eligible employees who will enroll for health care coverage. We are having conversations with customers aimed at increasing pricing for these implementation and ongoing costs, but there can be no assurance that we will be able to increase pricing to our customers in a sufficient amount to cover the increased costs, and the net financial impact on our results of operations could be significant. For the balance of the year, we anticipate steady improvement in the U.S. and global economies, and we are seeing increased confidence among our large customers - though it remains to be seen whether that confidence will translate into more meaningful job growth in the months to come. Longer-term, we believe the trends in the staffing industry are positive: companies are becoming more comfortable with the use of flexible staffing models; there is increasing acceptance of free agents and contractual employment by companies and candidates alike; and companies are seeking more comprehensive workforce management solutions that lend themselves to Kelly's talent supply chain management approach. This shift in demand for contingent labor and strategic solutions plays to our strengths and experience -- particularly serving large companies. Financial Measures - Operating Margin and Constant Currency Return on sales (earnings from operations divided by revenue from services) in the following tables is a ratio used to measure the Company's pricing strategy and operating efficiency. Constant currency ("CC") change amounts are non-GAAP measures. The CC change amounts in the following tables refer to the year-over-year percentage changes resulting from translating 2014 financial data into U.S. dollars using the same foreign currency exchange rates used to translate financial data for 2013. We believe that CC measurements are an important analytical tool to aid in understanding underlying operating trends without distortion due to currency fluctuations. 21 -------------------------------------------------------------------------------- Realignment of Segments Beginning in the first quarter of 2014, we realigned the project-based legal services business in our Americas PT segment to the OCG segment and recast the prior year amounts to conform to the current presentation. Staffing Fee-Based Income Staffing fee-based income, which is included in revenue from services in the following tables, has a significant impact on gross profit rates. There are very low direct costs of services associated with staffing fee-based income. Therefore, increases or decreases in staffing fee-based income can have a disproportionate impact on gross profit rates. 22 -------------------------------------------------------------------------------- Results of Operations Total Company - Third Quarter (Dollars in millions) CC 2014 2013 Change Change Revenue from services $ 1,396.4 $ 1,345.6 3.8 % 3.9% Staffing fee-based income 19.9 20.2 (2.4 ) (1.6) Gross profit 225.4 220.4 2.2 2.4 SG&A expenses excluding restructuring charges 214.3 199.7 7.3 Restructuring charges 4.0 0.5 NM Total SG&A expenses 218.3 200.2 9.0 9.1 Earnings from operations 7.1 20.2 (65.1 ) Gross profit rate 16.1 % 16.4 % (0.3 ) pts. Expense rates (excluding restructuring charges): % of revenue 15.3 14.8 0.5 % of gross profit 95.1 90.6 4.5 Return on sales 0.5 1.5 (1.0 ) Total Company revenue from services for the third quarter of 2014 was up 3.8% in comparison to the prior year. This reflected primarily an increase in hours worked in the Americas, EMEA and APAC regions, as well as increased revenue in OCG. Compared to the third quarter of 2013, the gross profit rate was down 30 basis points. This decrease was primarily due to a decline in the gross profit rate in the EMEA and APAC regions and OCG, which more than offset the improvement in the gross profit rate in the Americas, as more fully described in the following discussions. Selling, general and administrative ("SG&A") expenses excluding restructuring charges increased year over year primarily as a result of investments in our PT and OCG businesses, as described more fully in the Executive Overview above, as well as salary increases. Restructuring costs in the third quarter of 2014 include $3.7 million related to our Plan, also described in the Executive Overview above, combined with $0.3 million of costs incurred to consolidate back office functions in Australia and New Zealand. Restructuring costs in the third quarter of 2013 primarily related to severance costs incurred from the closure of EMEA commercial branches. Income tax expense for the third quarter of 2014 was $3.5 million, compared to $0.1 million for the third quarter of 2013. The increase in income tax expense is driven by expiration of the U.S. work opportunity credit at the end of 2013, making credits unavailable for employees hired in 2014. The credit, along with several other temporary income tax incentives, has previously expired and later been retroactively reinstated in what is commonly referred to as "extenders" legislation. While extenders legislation has been introduced in Congress that would retroactively reinstate the work opportunity credit, if or when such action would be taken is unknown. If extenders legislation is enacted, the retroactive reinstatement of the work opportunity credit would result in a significant benefit to income tax expense. Diluted earnings per share for the third quarter of 2014 were $0.03, as compared to $0.49 for the third quarter of 2013. 23 -------------------------------------------------------------------------------- Total Americas - Third Quarter (Dollars in millions) CC 2014 2013 Change ChangeRevenue from services $ 883.3 $ 856.9 3.1 % 3.4% Staffing fee-based income 8.2 7.2 12.7 13.1 Gross profit 131.3 125.6 4.5 4.8 Total SG&A expenses 110.8 100.2 10.6 10.9 Earnings from operations 20.5 25.4 (19.7 ) Gross profit rate 14.9 % 14.7 % 0.2 pts. Expense rates: % of revenue 12.5 11.7 0.8 % of gross profit 84.5 79.8 4.7 Return on sales 2.3 3.0 (0.7 ) The change in Americas revenue from services represents primarily a 3% increase in hours worked. Americas represented 63% of total Company revenue in the third quarter of 2014 and 64% in the third quarter of 2013. Revenue in our Commercial segment was up 4% and our PT revenue was up 1% in comparison to the prior year. The increase in revenue in Commercial was due to revenue from new customer wins in our educational staffing business as well as increases in our electronic assembly and light industrial products. These increases were partially offset by reductions in our office clerical product. In the PT segment, our revenue grew in our science, engineering and finance products, partially offset by a reduction in our IT product. The increase in the gross profit rate was primarily due to improved pricing, customer mix, increased staffing fee-based income and lower payroll taxes, partially offset by higher workers' compensation costs. SG&A expenses were up 11% in comparison to the prior year. This increase is attributable to last year's annual salary increases and planned investments in additional headcount in sales and recruiting staff, primarily for our PT segment. These investments are more fully described in the Executive Overview above. Restructuring costs related to Americas as disclosed in the Restructuring footnote are included in Corporate SG&A expenses. 24 -------------------------------------------------------------------------------- Total EMEA - Third Quarter (Dollars in millions) CC 2014 2013 Change Change Revenue from services $ 279.4 $ 269.6 3.6 % 3.6% Staffing fee-based income 7.7 8.5 (9.3 ) (6.9) Gross profit 44.5 44.7 (0.5 ) (0.1) SG&A expenses excluding restructuring charges 40.0 40.0 - Restructuring charges - 0.3 (100.0 ) Total SG&A expenses 40.0 40.3 (0.8 ) (0.5) Earnings from operations 4.5 4.4 1.6 Gross profit rate 15.9 % 16.6 % (0.7 ) pts. Expense rates (excluding restructuring charges): % of revenue 14.3 14.8 (0.5 ) % of gross profit 90.0 89.5 0.5 Return on sales 1.6 1.6 - The change in EMEA revenue from services reflected a 5% increase in hours worked, partially offset by a 1% decrease in average bill rates on a CC basis. The increase in hours was due primarily to Portugal and Ireland, countries with lower average bill rates, partially offset by a decrease, primarily in Germany, Switzerland and the U.K. EMEA represented 20% of total Company revenue in the third quarter of 2014 and 2013. The EMEA gross profit rate decreased primarily due to a decline in staffing fee-based income and a decline in the temporary gross profit rate. The decline in the temporary gross profit rate was primarily driven by unfavorable country mix. The declines in staffing fee-based income and temporary margins negatively impacted the gross profit rate by approximately 40 and 30 basis points, respectively. SG&A expenses excluding restructuring remain flat in comparison to the prior year. Restructuring costs recorded in the third quarter of 2013 reflect the adjustments to prior restructuring costs, primarily in France. 25 -------------------------------------------------------------------------------- Total APAC - Third Quarter (Dollars in millions) CC 2014 2013 Change Change Revenue from services $ 101.6 $ 96.7 5.0 % 3.4% Staffing fee-based income 4.0 4.5 (12.8 ) (14.2) Gross profit 15.0 16.1 (7.0 ) (8.5) SG&A expenses excluding restructuring charges 14.2 14.5 (2.5 ) Restructuring charges 0.3 0.1 410.5 Total SG&A expenses 14.5 14.6 (0.9 ) (2.7) Earnings from operations 0.5 1.5 (65.7 ) Gross profit rate 14.8 % 16.7 % (1.9 ) pts. Expense rates (excluding restructuring charges): % of revenue 14.0 15.1 (1.1 ) % of gross profit 94.6 90.2 4.4 Return on sales 0.5 1.6 (1.1 ) The change in total APAC revenue from services reflected a 7% increase in hours worked, partially offset by a 2% decrease in average bill rates on a CC basis. The increase in hours worked was primarily due to higher hours in India. The decrease in average bill rates was driven primarily by country mix, with bill rates in India lower than the region's average, and also customer mix in New Zealand and Singapore. APAC revenue represented 7% of total Company revenue in the third quarter of 2014 and 2013. The decrease in the gross profit rate was due to decreases in temporary margins and staffing fee-based income, which reduced the gross profit rate by approximately 70 and 80 basis points, respectively. Staffing fee-based income decreased by 10% in Singapore, due to regulatory changes, and by 28% in Australia, due to the weaker economic climate. These decreases were combined with the effect of a wage credit in Singapore, which was recorded in cost of services. The wage credit totaled $0.1 million in the third quarter of 2014 and $0.6 million in the third quarter of 2013. The year-over-year decline in the wage credit accounted for approximately 50 basis points of the decline in the APAC region gross profit rate in the third quarter of 2014. Restructuring charges in the third quarter of 2014 relate to costs to consolidate back office functions in Australia and New Zealand. SG&A expenses excluding restructuring costs decreased 2.5%. This change reflects the savings from consolidating Australia and New Zealand management in the prior year, partially offset by additional hiring in Singapore and India. 26 -------------------------------------------------------------------------------- OCG - Third Quarter (Dollars in millions) CC 2014 2013 Change Change Revenue from services $ 149.8 $ 135.3 10.7 % 10.9% Gross profit 35.8 34.8 2.9 2.8 SG&A expenses excluding restructuring charges 32.2 28.0 15.0 Restructuring charges - 0.1 (100.0 ) Total SG&A expenses 32.2 28.1 14.7 14.7 Earnings from operations 3.6 6.7 (46.0 ) Gross profit rate 23.9 % 25.7 % (1.8 ) pts. Expense rates (excluding restructuring charges): % of revenue 21.5 20.7 0.8 % of gross profit 89.8 80.3 9.5 Return on sales 2.4 5.0 (2.6 ) Revenue from services in the OCG segment increased during the third quarter of 2014 due primarily to growth in the RPO, BPO and CWO practice areas. Revenue in RPO grew by 30% year over year, revenue in BPO grew by 10% and revenue in CWO, which includes PPO, grew by 10% year over year. The revenue growth in RPO, BPO and CWO was due to expansion of programs with existing and new customers. OCG revenue represented 11% of total Company revenue in the third quarter of 2014 and 10% in the third quarter of 2013. The OCG gross profit rate decreased primarily due to customer mix in CWO and BPO. The CWO gross profit rate was impacted by customer rebates and customer mix changes in PPO. The BPO gross profit rate was impacted by costs in KellyConnect in advance of revenue, as well as a price decrease in one of our large accounts. The increase in SG&A expenses is primarily a result of costs associated with increased volume with existing customers, implementation costs of new customers in our CWO practice area and planned investments as more fully described in the Executive Overview above. Restructuring costs related to OCG as disclosed in the Restructuring footnote are included in Corporate SG&A expenses. 27 -------------------------------------------------------------------------------- Results of Operations Total Company - September Year to Date (Dollars in millions) CC 2014 2013 Change Change Revenue from services $ 4,137.7 $ 4,027.3 2.7 % 3.1% Staffing fee-based income 58.5 60.9 (4.1 ) (2.4) Gross profit 675.8 658.0 2.7 3.1 SG&A expenses excluding restructuring charges 650.7 611.3 6.5 Restructuring charges 5.8 1.3 351.8 Total SG&A expenses 656.5 612.6 7.2 7.5 Asset impairments - 1.7 (100.0 ) Earnings from operations 19.3 43.7 (56.4 ) Gross profit rate 16.3 % 16.3 % - pts. Expense rates (excluding restructuring charges): % of revenue 15.7 15.2 0.5 % of gross profit 96.3 92.9 3.4 Return on sales 0.5 1.1 (0.6 ) Total Company revenue from services for the first nine months of 2014 was up 2.7% in comparison to the prior year. This reflected primarily an increase in hours worked in the EMEA and APAC regions. The gross profit rate was flat on a year-over-year basis. An increase in the Americas gross profit rate was offset by decreases in the EMEA and APAC regions and OCG, as more fully described in the following discussions. SG&A expenses excluding restructuring costs increased 6.5% year over year as a result of investments in our PT and OCG businesses, as described more fully in the Executive Overview above, as well as salary increases. Included in SG&A expenses for the first nine months of 2013 is $3.0 million for a settlement with the state of Delaware related to an unclaimed property examination. Restructuring costs in the first nine months of 2014 include $3.7 million related to the Plan described in the Executive Overview above, $0.8 million of costs incurred for exiting the staffing business in Sweden, and $1.3 million related to closing branches in Australia and consolidating back office functions in Australia and New Zealand. Restructuring costs in the first nine months of 2013 primarily relate to severance costs incurred from exiting the OCG executive search business operating in Germany. Asset impairments in the first nine months of 2013 represent the write-off of the carrying value of long-lived assets related to the decision to exit the executive search business operating in Germany. Income tax expense for the first nine months of 2014 was $8.4 million, compared to a benefit of $1.9 million for the first nine months of 2013. The increase in income tax expense is driven by expiration of the U.S. work opportunity credit at the end of 2013, making credits unavailable for employees hired in 2014. Diluted earnings per share for the first nine months of 2014 were $0.17, as compared to $1.09 for the first nine months of 2013. 28 -------------------------------------------------------------------------------- Total Americas September Year to Date (Dollars in millions) CC 2014 2013 Change Change Revenue from services $ 2,638.2 $ 2,637.8 - % 0.7% Staffing fee-based income 22.1 20.6 7.4 8.4 Gross profit 398.4 390.6 2.0 2.6 Total SG&A expenses 332.9 310.6 7.2 7.9 Earnings from operations 65.5 80.0 (18.3 ) Gross profit rate 15.1 % 14.8 % 0.3 pts. Expense rates: % of revenue 12.6 11.8 0.8 % of gross profit 83.6 79.5 4.1 Return on sales 2.5 3.0 (0.5 ) Americas represented 64% of total Company revenue for the first nine months of 2014 and 66% for the first nine months of 2013. Revenue in our Commercial segment was up 1% and our PT revenue was down 1% in comparison to the prior year. The increase in revenue in Commercial was due to increased revenue in our educational staffing business due to new customer wins, partially offset by revenue decreases in our office clerical, light industrial and electronic assembly products. In the PT segment, we continued to see declines in revenue in our IT and finance products, partially offset by growth in revenue in our science and engineering products. The increase in the gross profit rate was due to a combination of improved pricing, customer mix and lower payroll taxes and employee benefit costs, partially offset by higher workers' compensation. We regularly update our estimates of open workers' compensation claims. As a result, we reduced our estimated costs of prior year workers' compensation in the Americas region by $1.4 million for the first nine months of 2014. This compares to an adjustment reducing prior year workers' compensation claims by $4.6 million for the first nine months of 2013. SG&A expenses were up 7.2% in comparison to the prior year. This increase is attributable to last year's annual salary increases and planned investments in additional headcount in sales and recruiting staff, primarily for our PT segment. These investments are more fully described in the Executive Overview above. Restructuring costs related to Americas as disclosed in the Restructuring footnote are included in Corporate SG&A expenses. 29 -------------------------------------------------------------------------------- Total EMEA - September Year to Date (Dollars in millions) CC 2014 2013 Change Change Revenue from services $ 835.7 $ 777.0 7.5 % 6.0% Staffing fee-based income 24.7 26.6 (7.0 ) (5.7) Gross profit 134.3 130.8 2.6 1.5 SG&A expenses excluding restructuring charges 124.2 122.1 1.7 Restructuring charges 0.8 0.1 327.7 Total SG&A expenses 125.0 122.2 2.2 0.8 Earnings from operations 9.3 8.6 8.1 Gross profit rate 16.1 % 16.8 % (0.7 ) pts. Expense rates (excluding restructuring charges): % of revenue 14.9 15.7 (0.8 ) % of gross profit 92.5 93.3 (0.8 ) Return on sales 1.1 1.1 - The change in EMEA revenue from services reflected a 7% increase in hours worked, partially offset by a 1% decrease in average bill rates on a CC basis. The increase in hours was due primarily to Portugal, reflecting improved volume with existing customers, as well as new customers. EMEA represented 20% of total Company revenue for the first nine months of 2014 and 19% for the first nine months of 2013. The EMEA gross profit rate decreased primarily due to a decline in the temporary gross profit rates and a decline in staffing fee-based income. These declines negatively impacted the gross profit rate by approximately 40 and 30 basis points, respectively. The decline in the temporary gross profit rate was driven by unfavorable country mix and, to a lesser extent, customer mix, as well as the reversal of previously accrued training costs for temporary employees in the Netherlands in the second quarter of 2013. The effect of this reversal accounted for approximately 15 basis points. SG&A expenses were up slightly, as some investments, primarily in France and Portugal, have been partially offset by a reduction in headquarters costs throughout the EMEA region. Restructuring costs recorded in the first nine months of 2014 reflect costs incurred for exiting the staffing business in Sweden. Restructuring costs recorded in the first nine months of 2013 reflect favorable adjustments to prior restructuring costs, primarily in France. 30 -------------------------------------------------------------------------------- Total APAC - September Year to Date (Dollars in millions) CC 2014 2013 Change Change Revenue from services $ 289.7 $ 286.1 1.3 % 4.1% Staffing fee-based income 11.7 13.7 (15.1 ) (11.9) Gross profit 45.1 47.3 (4.6 ) (1.7) SG&A expenses excluding restructuring charges 43.3 45.5 (4.7 ) Restructuring charges 1.3 0.3 373.4 Total SG&A expenses 44.6 45.8 (2.3 ) 1.1 Earnings from operations 0.5 1.5 (76.8 ) Gross profit rate 15.6 % 16.5 % (0.9 ) pts. Expense rates (excluding restructuring charges): % of revenue 15.0 15.9 (0.9 ) % of gross profit 96.2 96.2 - Return on sales 0.1 0.5 (0.4 ) The change in total APAC revenue from services reflected a 10% increase in hours worked, partially offset by a 4% decrease in average bill rates on a CC basis. The increase in hours worked was due to higher hours in India. The decrease in average bill rates was mainly due to country mix, with bill rates in India lower than the region's average. APAC revenue represented 7% of total Company revenue for the first nine months of 2014 and 2013. The decrease in the gross profit rate was due to decreases in temporary margins and staffing fee-based income, which reduced the gross profit rate by approximately 80 and 70 basis points, respectively. Staffing fee-based income decreased by 14% in Singapore, due to high staff turnover, and by 21% in Australia, due to the weaker economic climate. The reduction in temporary margins is due to the increasing proportion of international and national large accounts that have lower margins. These decreases were partially offset by the effect of a wage credit in Singapore, which totaled $2.0 million in the first nine months of 2014 and $0.6 million in the first nine months of 2013. This amount, which was recorded in cost of services and represents additional credits received for 2013 and 2014, partially offset the year-over-year decline in the APAC region gross profit rate by approximately 50 basis points. Restructuring charges in 2014 relate to costs for exiting branches in Australia and consolidating back office functions in Australia and New Zealand. SG&A expenses excluding restructuring costs declined 4.7%. This change was the result of consolidating the Australia and New Zealand management in the prior year and lower country headquarters costs across the region, partially offset by investments in Singapore, Malaysia and India. 31 -------------------------------------------------------------------------------- OCG -September Year to Date (Dollars in millions) CC 2014 2013 Change Change Revenue from services $ 422.1 $ 361.0 16.9 % 17.3% Gross profit 101.3 91.7 10.5 10.6 SG&A expenses excluding restructuring charges 94.7 81.6 16.0 Restructuring charges - 0.9 (100.0 ) Total SG&A expenses 94.7 82.5 14.9 15.0 Asset impairments - 1.7 (100.0 ) Earnings from operations 6.6 7.5 (13.1 ) Gross profit rate 24.0 % 25.4 % (1.4 ) pts. Expense rates (excluding restructuring charges): % of revenue 22.4 22.6 (0.2 ) % of gross profit 93.4 88.9 4.5 Return on sales 1.6 2.1 (0.5 ) Revenue from services in the OCG segment increased during the first nine months of 2014 due primarily to growth in the CWO, KellyConnect and RPO practice areas. Revenue in CWO, which includes PPO, grew by 22% year over year, RPO increased by 21% and KellyConnect revenue grew by 11% year over year. The revenue growth was due to expansion of programs with existing and new customers. OCG revenue represented 10% of total Company revenue for the first nine months of 2014 and 9% for the first nine months of 2013. The OCG gross profit rate decreased primarily in CWO and BPO. CWO experienced growth in PPO, a lower margin business. The BPO gross profit rate declined due to a price decrease in one of the large accounts and customer mix in our legal managed project business. The increase in SG&A expenses is primarily a result of costs associated with increased volume with existing customers, implementation costs of new customers and planned investments as more fully described in the Executive Overview above. Restructuring costs related to OCG as disclosed in the Restructuring footnote are included in Corporate SG&A expenses. 32 -------------------------------------------------------------------------------- Financial Condition Historically, we have financed our operations through cash generated by operating activities and access to credit markets. Our working capital requirements are primarily generated from temporary employee payroll and customer accounts receivable. Since receipts from customers generally lag payroll to temporary employees, working capital requirements increase substantially in periods of growth. Conversely, when economic activity slows, working capital requirements may substantially decrease. As highlighted in the consolidated statements of cash flows, our liquidity and available capital resources are impacted by four key components: cash and equivalents, operating activities, investing activities and financing activities. Cash and Equivalents Cash and equivalents totaled $51.6 million at the end of the third quarter of 2014 and $125.7 million at year-end 2013. As further described below, we used $109.0 million of cash for operating activities, used $20.2 million of cash for investing activities and generated $55.1 million of cash from financing activities. The cash and equivalents balance at the end of the third quarter of 2014 was negatively impacted by $20.0 million related to payments we received at year-end 2013 from our OCG customers, most of which we paid out to suppliers during the first quarter of 2014. Operating Activities In the first nine months of 2014, we used $109.0 million of net cash for operating activities, as compared to generating $21.9 million in the first nine months of 2013. This change was primarily due to year-to-date growth in trade accounts receivable, along with the negative impact of the $20.0 million related to the timing of payments to suppliers noted above. Included in operating assets and liabilities and net cash from operating activities for the first nine months of 2013 is an increase of $4.8 million related to the correction of an error from prior periods. Trade accounts receivable totaled $1.2 billion at the end of the third quarter of 2014. Global days sales outstanding were 58 days at the end of the third quarter of 2014 and 56 days at the end of the third quarter of 2013. The increase in DSO is primarily due to the timing of our month-end cut-off as well as extended terms and invoicing complexities for certain large customers. Our working capital position was $450.7 million at the end of the third quarter of 2014, a decrease of $23.8 million from year-end 2013. The current ratio (total current assets divided by total current liabilities) was 1.5% at the end of the third quarter of 2014 and 1.6% at year-end 2013. Investing Activities In the first nine months of 2014, we used $20.2 million of cash for investing activities, as compared to using $11.7 million in the first nine months of 2013. Capital expenditures in both years relate primarily to the Company's technology programs. Investment in equity affiliate in the first nine months of 2014 primarily represents cash contributions to TS Kelly, our equity affiliate in which we have a 49% ownership interest. Financing Activities In the first nine months of 2014, we generated $55.1 million of cash from financing activities, as compared to using $11.5 million in the first nine months of 2013. The increase in cash from financing activities was caused by additional short-term borrowing. Debt totaled $88.7 million at the end of the third quarter of 2014 and $28.3 million at year-end 2013. Debt-to-total capital (total debt reported on the balance sheet divided by total debt plus stockholders' equity) is a common ratio to measure the relative capital structure and leverage of the Company. Our ratio of debt-to-total capital was 9.7% at the end of the third quarter of 2014 and 3.3% at year-end 2013. The net change in short-term borrowings in the first nine months of 2014 was primarily due to additional borrowings on our securitization facility, used to fund our everyday operations. The net change in short-term borrowings in the first nine months of 2013 was primarily due to payments on our U.S. securitization facility as a result of lower working capital needs. We made dividend payments of $5.7 million in the first nine months of both 2014 and 2013. 33-------------------------------------------------------------------------------- New Accounting Pronouncements See New Accounting Pronouncements footnote in the Notes to Consolidated Financial Statements of this Quarterly Report on Form 10-Q for a description of new accounting pronouncements. Contractual Obligations and Commercial Commitments There are no material changes in our obligations and commitments to make future payments from those included in the Company's Annual Report on Form 10-K filed February 13, 2014. We have no material, unrecorded commitments, losses, contingencies or guarantees associated with any related parties or unconsolidated entities. Liquidity We expect to meet our ongoing short and long-term cash requirements principally through cash generated from operations, available cash and equivalents, securitization of customer receivables and committed unused credit facilities. Additional funding sources could include public or private bonds, asset-based lending, additional bank facilities, issuance of equity or other sources. We utilize intercompany loans, dividends, capital contributions and redemptions to effectively manage our cash on a global basis. We periodically review our foreign subsidiaries' cash balances and projected cash needs. As part of those reviews, we may identify cash that we feel should be repatriated to optimize the Company's overall capital structure. At the present time, these reviews have not resulted in any specific plans to repatriate a majority of our international cash balances. We expect much of our international cash will be needed to fund working capital growth in our local operations. The majority of our international cash is concentrated in a cash pooling arrangement (the "Cash Pool") and is available to fund general corporate needs internationally. The Cash Pool is a set of cash accounts maintained with a single bank that must, as a whole, maintain at least a zero balance; individual accounts may be positive or negative. This allows countries with excess cash to invest and countries with cash needs to utilize the excess cash. We manage our cash and debt very closely to optimize our capital structure. As our cash balances build, we tend to pay down debt as appropriate. Conversely, when working capital needs grow, we tend to use corporate cash and cash available in the Cash Pool first, and then access our borrowing facilities. As of the 2014 third quarter end, we had $200.0 million of available capacity on our $200.0 million revolving credit facility and $9.0 million of available capacity on our $150.0 million securitization facility. The securitization facility carried $86.0 million of short-term borrowings and $55.0 million of standby letters of credit related to workers' compensation. Together, the revolving credit and securitization facilities provide the Company with committed funding capacity that may be used for general corporate purposes. While we believe these facilities will cover our working capital needs over the short term, if economic conditions or operating results change significantly, we may need to seek additional sources of funds. As of the 2014 third quarter end, we met the debt covenants related to our revolving credit facility and securitization facility. We monitor the credit ratings of our major banking partners on a regular basis. We also have regular discussions with them. Based on our reviews and communications, we believe the risk of one or more of our banks not being able to honor commitments is insignificant. We also review the ratings and holdings of our money market funds and other investment vehicles regularly to ensure high credit quality and access to our invested cash. 34 -------------------------------------------------------------------------------- Forward-Looking Statements Certain statements contained in this report are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements which are predictive in nature, which depend upon or refer to future events or conditions, or which include words such as "expects," "anticipates," "intends," "plans," "believes," "estimates," or variations or negatives thereof or by similar or comparable words or phrases. In addition, any statements concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible future actions by us that may be provided by management, including oral statements or other written materials released to the public, are also forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about our company and economic and market factors in the countries in which we do business, among other things. These statements are not guarantees of future performance, and we have no specific intention to update these statements. Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. The principal important risk factors that could cause our actual performance and future events and actions to differ materially from such forward-looking statements include, but are not limited to, competitive market pressures including pricing and technology introductions, changing market and economic conditions, our ability to achieve our business strategy, our ability to retain the services of our senior management, local management and field personnel, our ability to adequately protect our intellectual property rights, including our brand, our ability to successfully develop new service offerings, our exposure to risks associated with services outside traditional staffing, including business process outsourcing, the risks associated with past and future acquisitions, exposure to risks associated with investments in equity affiliates, material changes in demand from or loss of large corporate customers, risks associated with conducting business in foreign countries, including foreign currency fluctuations, availability of temporary workers with appropriate skills required by customers, liabilities for employment-related claims and losses, including class action lawsuits and collective actions, liability for improper disclosure of sensitive or private employee information, our ability to sustain critical business applications through our key data centers, our ability to effectively implement and manage our information technology programs, our ability to maintain adequate financial and management processes and controls, impairment charges triggered by adverse industry or market developments, unexpected changes in claim trends on workers' compensation, disability and medical benefit plans, the net financial impact of the Patient Protection and Affordable Care Act on our business, the impact of changes in laws and regulations (including federal, state and international tax laws and the expiration and/or reinstatement of the U.S. work opportunity credit program), the risk of additional tax or unclaimed property liabilities in excess of our estimates, our ability to maintain specified financial covenants in our bank facilities, our ability to access credit markets and continued availability of financing for funding working capital. Certain risk factors are discussed more fully under "Risk Factors" in Part I, Item 1A of the Company's Annual Report on Form 10-K. Item 3. Quantitative and Qualitative Disclosures About Market Risk. We are exposed to foreign currency risk primarily due to our net investment in foreign subsidiaries, which conduct business in their local currencies. We may also utilize local currency-denominated borrowings. In addition, we are exposed to interest rate risks through our use of the multi-currency line of credit and other borrowings. A hypothetical fluctuation of 10% of market interest rates would not have had a material impact on 2014 third quarter earnings. Marketable equity investments, representing our investment in Temp Holdings, are stated at fair value and marked to market through stockholders' equity, net of tax. Impairments in value below historical cost, if any, deemed to be other than temporary, would be expensed in the consolidated statement of earnings. See the Fair Value Measurements footnote in the Notes to Consolidated Financial Statements of this Quarterly Report on Form 10-Q for further discussion. We are exposed to market risk as a result of our obligation to pay benefits under our nonqualified deferred compensation plan and our related investments in company-owned variable universal life insurance policies. The obligation to employees increases and decreases based on movements in the equity and debt markets. The investments in mutual funds, as part of the company-owned variable universal life insurance policies, are designed to mitigate, but not eliminate, this risk with offsetting gains and losses. Overall, our holdings and positions in market risk-sensitive instruments do not subject us to material risk. 35 -------------------------------------------------------------------------------- |