KELLY SERVICES INC - Quarter Report: 2013 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

      For the quarterly period ended September 29, 2013

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-1088

KELLY SERVICES, INC.

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(Exact name of registrant as specified in its charter)

999 WEST BIG BEAVER ROAD, TROY, MICHIGAN 48084

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(Address of principal executive offices) (Zip Code)

(248) 362-4444

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(Registrant's telephone number, including area code)

No Change

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(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).                                            Yes [X] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).                                                          Yes [  ] No [X]

At October 25, 2013, 33,902,577 shares of Class A and 3,452,585 shares of Class B common stock of the Registrant were outstanding.

KELLY SERVICES, INC. AND SUBSIDIARIES

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

 KELLY SERVICES, INC. AND SUBSIDIARIES

(UNAUDITED)

(In millions of dollars except per share data)

KELLY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements of Kelly Services, Inc. (the “Company,” “Kelly,” “we” or “us”) have been prepared in accordance with Rule 10-01 of Regulation S-X and do not include all the information and notes required by generally accepted accounting principles for complete financial statements. All adjustments, including normal recurring adjustments, have been made which, in the opinion of management, are necessary for a fair statement of the results of the interim periods. The results of operations for such interim periods are not necessarily indicative of results of operations for a full year. The unaudited consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the fiscal year ended December 30, 2012, included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 14, 2013 (the 2012 consolidated financial statements). The Company’s third fiscal quarter ended on September 29, 2013 (2013) and September 30, 2012 (2012), each of which contained 13 weeks. The corresponding 2013 and 2012 year-to-date periods each contained 39 weeks.

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated. During the third quarter of 2013, the Company determined that both cash and equivalents and accrued payroll and related taxes were understated by $4.8 million as of December 30, 2012. The Company determined that the impact of this error on the consolidated balance sheets and consolidated statements of cash flows was not material. As a result of correcting the error in the third quarter of 2013, changes in operating assets and liabilities and net cash from operating activities are both overstated by $4.8 million in the consolidated statements of cash flows for the 39 weeks ended September 29, 2013.

Earnings from discontinued operations in 2012 represent adjustments to the estimated costs of litigation, net of tax, retained from the 2007 sale of the Kelly Home Care business unit.

2. Fair Value Measurements

Trade accounts receivable, accounts payable, accrued liabilities, accrued payroll and related taxes and short-term borrowings approximate their fair values due to the short-term maturities of these assets and liabilities.

Assets Measured at Fair Value on a Recurring Basis

The following tables present assets measured at fair value on a recurring basis on the consolidated balance sheet as of third quarter-end 2013 and year-end 2012 by fair value hierarchy level, as described below.

Level 1 measurements consist of unadjusted quoted prices in active markets for identical assets or liabilities.  Level 2 measurements include quoted prices in markets that are not active or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 3 measurements include significant unobservable inputs.

KELLY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(UNAUDITED)

2. Fair Value Measurements (continued)

Money market funds as of third quarter-end 2013 and as of year-end 2012 represent investments in money market accounts, all of which are restricted as to use and are included in other assets on the consolidated balance sheet as of third quarter-end 2013 and prepaid expenses and other current assets as of year-end 2012. The valuations were based on quoted market prices of those accounts as of the respective period end.

Available-for-sale investment represents the Company’s investment in Temp Holdings Co., Ltd. (“Temp Holdings”), a leading integrated human resources company in Japan, and is included in other assets on the consolidated balance sheet. The valuation is based on the quoted market price of Temp Holdings stock on the Tokyo Stock Exchange as of the period end. The unrealized gain, net of tax, of $4.5 million for the 13 weeks ended 2013 and unrealized loss of $0.5 million for the 13 weeks ended 2012 was recorded in other comprehensive income, as well as in accumulated other comprehensive income, a component of stockholders’ equity. The unrealized gain, net of tax, of $28.3 million for the 39 weeks ended 2013 and unrealized gain of $9.8 million for the 39 weeks ended 2012 were recorded in other comprehensive income, as well as in accumulated other comprehensive income. The cost of this yen-denominated investment was $21.1 million as of the third quarter-end 2013 and $24.1 million at year-end 2012.

Assets Measured at Fair Value on a Nonrecurring Basis

We evaluate long-lived assets, including intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable, based on estimated undiscounted future cash flows. During the second quarter of 2013, a triggering event for the evaluation of certain long-lived assets for impairment occurred as the Company made the decision to exit the executive search business operating in an asset group within Germany that was associated with the OCG business segment. Based on the Company’s estimates as of the 2013 second quarter end, a $1.7 million reduction in the carrying value of OCG intangible assets was recorded. The resulting expense was recorded in the asset impairments line on the consolidated statement of earnings.

KELLY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(UNAUDITED)

3. Accumulated Other Comprehensive Income

The changes in accumulated other comprehensive income by component, net of tax, during the 39 weeks ended 2013 are included in the table below. Amounts in parentheses indicate debits. There were no reclassification adjustments out of accumulated other comprehensive income during the 13 and 39 weeks ended 2013.

 KELLY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(UNAUDITED)

4. Earnings Per Share

The reconciliation of basic and diluted earnings per share on common stock for the 13 and 39 weeks ended 2013 and 2012 follows (in millions of dollars except per share data):

Stock options representing 0.2 million and 0.4 million shares, respectively, for the 13 weeks ended 2013 and 2012, and 0.3 million and 0.4 million shares, respectively, for the 39 weeks ended 2013 and 2012 were excluded from the computation of diluted earnings per share due to their anti-dilutive effect.

KELLY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(UNAUDITED)

5. Other Expense, Net

Included in other expense, net for the 13 and 39 weeks ended 2013 and 2012 are the following:

6. Contingencies

The Company is continuously engaged in litigation arising in the ordinary course of its business, typically matters alleging employment discrimination, alleging wage and hour violations or enforcing the restrictive covenants in the Company’s employment agreements.  While there is no expectation that any of these matters will have a material adverse effect on the Company’s results of operations, financial position or cash flows, litigation is always subject to inherent uncertainty and the Company is not able to reasonably predict if any matter will be resolved in a manner that is materially adverse to the Company.

During the first quarter of 2013, the Company agreed to a settlement related to its unclaimed property examination by Delaware, its state of incorporation, for $4.5 million. Types of property under exam included payroll and accounts payable checks and accounts receivable credits, covering all reporting years through and including 2012. Accordingly, the Company recorded an additional reserve of $3.0 million in the first quarter of 2013. The Company paid this settlement during the second quarter of 2013.

7. Segment Disclosures

The Company’s segments are based on the organizational structure for which financial results are regularly evaluated by the Company’s chief operating decision maker to determine resource allocation and assess performance. The Company’s seven reporting segments are: (1) Americas Commercial, (2) Americas Professional and Technical (“Americas PT”), (3) Europe, Middle East and Africa Commercial (“EMEA Commercial”), (4) Europe, Middle East and Africa Professional and Technical (“EMEA PT”), (5) Asia Pacific Commercial (“APAC Commercial”), (6) Asia Pacific Professional and Technical (“APAC PT”), and (7) Outsourcing and Consulting Group (“OCG”).

The Commercial business segments within the Americas, EMEA and APAC regions represent traditional office services, contact-center staffing, marketing, electronic assembly, light industrial and, in the Americas, substitute teachers. The PT segments encompass a wide range of highly skilled temporary employees, including scientists, financial professionals, attorneys, engineers, IT specialists and healthcare workers. OCG includes recruitment process outsourcing (“RPO”), contingent workforce outsourcing (“CWO”), business process outsourcing (“BPO”), payroll process outsourcing (“PPO”), executive placement and career transition/outplacement services. Corporate expenses that directly support the operating units have been allocated to the Americas, EMEA and APAC regions and OCG based on a work effort, volume or, in the absence of a readily available measurement process, proportionately based on revenue from services.

KELLY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(UNAUDITED)

7. Segment Disclosures (continued)

The following tables present information about the reported revenue from services and gross profit of the Company by segment, along with a reconciliation to consolidated earnings from continuing operations before taxes, for the 13 and 39 weeks ended 2013 and 2012. Asset information by reportable segment is not presented, since the Company does not produce such information internally nor does it use such data to manage its business.

KELLY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(UNAUDITED)

7. Segment Disclosures (continued)

KELLY SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(UNAUDITED)

8. New Accounting Pronouncements

In March 2013, the FASB issued amendments to address the accounting for the cumulative translation adjustment when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. The amendments are effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013 (early adoption is permitted). The adoption of this guidance is not expected to have a material effect on our results of operations, financial position or liquidity.

In July 2013, the FASB amended its guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or a tax credit carryforward exists. This guidance is effective for fiscal periods beginning after December 15, 2013, and is to be applied prospectively to all unrecognized tax benefits that exist at the effective date (retrospective and early adoption are also permitted). The amendments only affect gross versus net presentation and the adoption of this guidance is not expected to have a material effect on our results of operations, financial position or liquidity.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Executive Overview

The Staffing Industry

The worldwide staffing industry is competitive and highly fragmented. In the United States, approximately 100 competitors operate nationally, and approximately 10,000 smaller companies compete in varying degrees at local levels. Additionally, several staffing companies compete globally. Demand for temporary services is highly dependent on the overall strength of the global economy and labor markets. In periods of economic growth, demand for temporary services generally increases, and the need to recruit, screen, train, retain and manage a pool of employees who match the skills required by particular customers becomes critical. Conversely, during an economic downturn, demand drops, leading to competitive pricing pressures. Accordingly, the on-going economic crisis in the Eurozone and slow recovery from recession in the U.S. have impacted staffing firms of all sizes over the last several years.

Our Business

Kelly Services is a global staffing company, providing innovative workforce solutions for customers in a variety of industries. Our staffing operations are divided into three regions, Americas, EMEA and APAC, with commercial and professional and 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. We are forging strategic relationships with our customers to help them manage their flexible workforces, through outsourcing, consulting, recruitment, career transition and vendor management services.

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 and consulting 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 56 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:

Although our objectives remain clear, sluggish global economic growth continues to impact our business, and Kelly’s third quarter revenue was down 1% year over year. However, even with the challenging global economic backdrop, we delivered solid operational performance in two key areas. During the third quarter of 2013:

At 1.4% for the third quarter of 2013, 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 stronger, more sustained economic growth accompanied by growing demand for full-time and temporary labor in the sectors that Kelly supports. In the meantime, we will continue to focus on what we can control: executing a well-formed strategy with increased speed and precision.

Looking ahead, although the U.S. unemployment rate is currently below 8%, one of the primary drivers of the lower rate has been a shrinking labor force, rather than a growing demand for labor. Though modest job growth is occurring, we are not experiencing the corresponding across-the-board uplift in our industry that was typical in previous recoveries. Instead, the improvement in temporary employment in the U.S. as reported by the Bureau of Labor Statistics has primarily been driven by hiring in the construction, retail and hospitality sectors -- areas in which Kelly is not generally engaged. In Europe, we do not anticipate any significant changes to the current economic conditions that continue to take their toll on demand for our services.

An additional challenge for us will be to meet the provisions of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (collectively, the “Acts”). 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 minimal essential 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. While we intend to pass related costs on to our customers, 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, either in total, or in the period in which costs are incurred, and the net financial impact on our results of operations could be significant.

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 searching for more comprehensive workforce management solutions. This shift in demand for contingent labor plays to our strengths and experience -- particularly serving large companies.

Financial Measures – Operating Margin and Constant Currency

Operating margin (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 2013 financial data into U.S. dollars using the same foreign currency exchange rates used to translate financial data for 2012. We believe that CC measurements are an important analytical tool to aid in understanding underlying operating trends without distortion due to currency fluctuations.

Fee-Based Income

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 fee-based income. Therefore, increases or decreases in fee-based income can have a disproportionate impact on gross profit rates.

Results of Operations

Total Company revenue from services for the third quarter of 2013 was flat in comparison to the prior year. This reflected a 4% decrease in hours worked, partially offset by a 2% increase in average bill rates on a CC basis. Hours decreased in our staffing business primarily in the Americas. The improvement in average bill rates was primarily due to the mix of countries.

Compared to the third quarter of 2012, the gross profit rate was down 40 basis points. The gross profit rate decreased in all regions and OCG.

Selling, general and administrative (“SG&A”) expenses decreased year over year as a result of continued efforts in controlling expenses, and continued to offset our investments in PT, centralized operations and technology infrastructure.

Restructuring costs in the third quarter of 2013 primarily relate to severance costs incurred from recently closed EMEA Commercial branches.

Income tax expense for the third quarter of 2013 was $0.1 million (0.3% effective tax rate), compared to $6.7 million (28.9%) for the third quarter of 2012. U.S. work opportunity credits provide a significant reduction to income tax expense and delivered $5.8 million (-30.8%) of benefit in the third quarter of 2013, compared to $1.8 million (-7.8%) in the third quarter of 2012 when the credits were generally not available for new hires. The work opportunity credit program is currently available for employees hired through 2013, and extension into 2014 is uncertain. Other items that favorably impacted the third quarter 2013 income tax rate as compared to the third quarter of 2012 include tax-free return on investments in company-owned variable universal life insurance policies that are used to fund non-qualified retirement plans, and the mix of income between jurisdictions. The Company is reviewing Mexico income tax law changes that, if enacted, could favorably impact income taxes in the fourth quarter of 2013 from the adjustment of deferred tax balances.

Diluted earnings from continuing operations per share for the third quarter of 2013 were $0.49, as compared to $0.43 for the third quarter of 2012.

The change in Americas revenue from services represents a 5% decrease in hours worked, partially offset by a 1% increase in average bill rates on a CC basis. Americas represented 64% of total Company revenue in the third quarter of 2013 and 67% in the third quarter of 2012.

Revenue in our Commercial segment was down 4% and our PT revenue was down 5% in comparison to the prior year. The decrease in revenue in Commercial was due to revenue decreases in our office clerical and electronic assembly products, somewhat offset by increased revenue in our educational staffing business due to new customer wins. In the PT segment, we continued to see declines in revenue in our IT and finance products, partially offset by slight growth in revenue in our science product.

The decrease in the gross profit rate was due to lower adjustments to prior year workers’ compensation costs and higher employee benefit costs. We regularly update our estimates of open workers’ compensation claims. As a result, we reduced our estimated costs of prior year workers’ compensation claims for the total Company by $1.5 million for the third quarter of 2013. This compares to a reduction of $4.3 million for the third quarter of 2012. The majority of these adjustments relate to the Americas Commercial and PT segments.

Although SG&A expenses were flat in comparison to the prior year, we continued to invest in PT, our centralized operations staff to support our largest customers and our technology infrastructure. These increased costs were offset by lower incentive-based compensation in the quarter.

The change in EMEA revenue from services reflected a 3% increase in average bill rates on a CC basis in most of the countries in the EMEA region, partially offset by a 1% decrease in hours worked. This change was due to strong performance in Switzerland, Portugal, Russia and Hungary. EMEA represented 20% of total Company revenue in the third quarter of 2013 and 19% in the third quarter of 2012.

The EMEA gross profit rate decreased due to unfavorable customer mix, with revenue from large customers increasing by 5% on a CC basis and revenue from retail customers with higher margins remaining flat in comparison to the prior year. Additionally, the gross profit rate was impacted by the decline in fee-based income. The effect of these decreases, which accounted for 100 basis points, was partially offset by the effect of the CICE tax credit in France. The CICE tax credit is related to a law which was introduced in 2013 to enhance the competitiveness of businesses in France. This credit of $1.3 million, which was recorded in cost of services, improved the reported gross profit rate by approximately 50 basis points.

The change in SG&A expenses was primarily due to bringing variable expenses more in line with the level of activity in specific countries. Restructuring costs recorded in the third quarter of 2013 reflect the adjustments to prior restructuring costs primarily in France.

The change in total APAC revenue from services reflected a 5% increase in average bill rates on a CC basis, combined with a 1% increase in hours worked. Excluding the 2012 results from the North Asia operations which were deconsolidated in the fourth quarter of 2012, APAC revenue increased 6% on a CC basis. The improvement in average bill rates was primarily due to higher bill rates in Singapore. APAC revenue represented 7% of total Company revenue in the third quarter of both 2013 and 2012.

Excluding the North Asia operations from 2012 results, the APAC gross profit rate decreased 70 basis points. As a result of the challenging economic environment in the APAC region, fee-based income decreased 10% on a CC basis excluding the North Asia operations, and reduced the gross profit rate by 90 basis points. Fees in most countries in the APAC region decreased compared to the prior year. This was partially offset by the effect of a wage credit related to a new law enacted in Singapore to promote the training and development of its citizens and incentivize companies to increase employee wages. The year-to-date credit of $0.6 million added 50 basis points to the APAC region gross profit rate in the third quarter of 2013.

SG&A expenses declined 6% on a CC basis, excluding the North Asia operations from 2012 results. This change was the result of the restructuring of the Australia and New Zealand management and lower country headquarters costs across the region.