Kelly Services, Inc. and Subsidiaries
Results of Operations
1998 versus 1997
Sales for the 53 week fiscal year reached a record $4.09 billion in 1998, an increase of 6% compared to the $3.85 billion for the 52 week fiscal year in 1997. On a 52 week basis, sales increased 5% over 1997. Sales in the U.S. Commercial Staffing segment grew by 3%, while Professional, Technical and Staffing Alternatives (PTSA) sales grew by 8% compared to last year. International sales grew by 13% as compared to 1997. International sales represented 24% of total Company sales in 1998, as compared to 22% in 1997.
The 1998 gross profit rate averaged 17.9% versus 17.7% in 1997. The improvement was principally related to an increased mix of fee-based permanent placement income and an increase in the share of our international business as a percentage of total revenue. The international component carries a higher average gross profit rate than domestic commercial staffing.
Selling, general and administrative expenses increased 8% over 1997. Expenses expressed as a percentage of sales were 14.4% as compared to 14.2% last year. The rate of growth of expenses principally reflects increased spending for the year 2000 and information technology programs.
Earnings from operations totaled $140.6 million, a 4% increase from the $135.8 million reported last year. Earnings were 3.4% of sales as compared to 3.5% in 1997.
Interest income was $6.2 million, 41% higher than last year. Interest expense totaled $3.2 million, virtually unchanged from 1997. The increase in investment return related to an improved cash and investment position as compared to 1997.
Earnings before income taxes were a record $144 million, a 5% increase over 1997. As a percentage of sales, earnings before taxes were 3.5% compared to 3.6% in 1997. The effective income tax rate was 41.0% in both 1998 and 1997.
Net earnings totaled a record $84.7 million in 1998, a 5% increase over 1997. The rate of return on sales was 2.1%, consistent with last year’s 2.1% rate. Basic earnings per share were $2.24 or 6% over last year. Diluted earnings per share were $2.23 or 5% higher than 1997.
Results of Operations
1997 versus 1996
Sales totaled $3.85 billion in 1997, an increase of 17% over 1996. U.S. Commercial Staffing sales totaled $2.45 billion, reflecting 13% growth over 1996. PTSA sales were $546 million in 1997, a 31% increase over the prior year. International sales totaled $855 million and grew 20% as compared to 1996.
Cost of services, representing payroll and related taxes and benefits for temporary employees, increased 18%. Increases in pay rates and related taxes and benefits accounted for the change. Gross profit rates held steady through all four quarters of 1997 and averaged 17.7%. Gross profit rates in 1996 averaged 18.6%. While generally higher than 1997, the 1996 rates were declining through much of that year. As in 1996, reduced margins on large contracts and other competitive conditions worldwide were factors in the reduced level of gross profit.
Selling, general and administrative expenses increased 11% over 1996. The increase reflects continued worldwide expansion including the cost of opening new offices in international locations. As a percentage of sales, expenses decreased for the second consecutive year and reached 14.2%, down from 14.9 % in 1996.
Earnings from operations in 1997 were $136 million, an increase of 12% over 1996. These earnings were 3.5% of sales, compared to 3.7% in 1996.
Interest income was $4.4 million in 1997, an increase of 4% over 1996. An improved cash and investments position during the year which resulted from improved collections of accounts receivable contributed to the increase.
Interest expense increased to $3.2 million from $2.2 million in 1996. Short-term borrowings were used to finance continued business expansion in Europe.
Earnings before income taxes were $137 million, an increase of 11% over 1996. As a percentage of sales, earnings before taxes were 3.6% in 1997 and 3.7% in 1996. The effective income tax rate was 41.0% in 1997 and 40.6% in 1996.
Net earnings totaled $80.8 million in 1997, 11% higher than the $73.0 million reported in 1996. The rate of return on sales was 2.1% in 1997 and 2.2% in 1996. Basic earnings per share were $2.12 compared to $1.92 per share in 1996. Diluted earnings per share were $2.12 in 1997 compared to $1.91 per share in 1996.
Liquidity and Capital Resources
Cash and short-term investments totaled $72 million at the end of 1998, down from the $144 million at year-end 1997. The decrease was principally due to the $76 million utilized for the share repurchase program completed during the fourth quarter of 1998. Two negotiated share repurchase transactions were completed with the William Russell Kelly Trust and 2.5 million Kelly Class A shares were repurchased. This amounted to 6.5% of the then total outstanding common shares and was accretive to earnings per share during the fourth quarter of 1998.
Accounts receivable totaled $585 million at year end as compared to $572 million at year-end 1997. Strong accounts receivable management during the year reduced global days sales outstanding to 53 days, down from 54 days in 1997.
Short-term debt totaled $48 million, a decrease from $55 million at year-end 1997. During the fourth quarter the Company arranged a committed $100 million five-year multi-currency revolving credit facility. All short-term borrowings are foreign currency denominated and support the Company’s international working capital position.
The Company’s working capital position was $293 million at the end of 1998, a decrease of $70 million from 1997 and $43 million from 1996. The current ratio in 1998 was 1.7, 1.9 in 1997 and 2.0 in 1996. The current year decline was principally a result of the cash utilized in the share repurchase program.
Assets totaled $964 million in 1998, virtually unchanged from 1997. In 1996 assets totaled $839 million. The return on average assets was 8.8% in 1998 and 8.9% in 1997. In 1996 the return was 9.4%.
Stockholders’ equity was $538 million in 1998, which was 4% below 1997. In 1997 stockholders’ equity grew 8% over 1996. The return on average stockholders’ equity was 15.4% in 1998, 15.0% in 1997 and 14.7% in 1996. Dividends paid per common share were $.91 in 1998, an increase of 5% over 1997. Dividends in 1997 were $.87 per share, also 5% more than 1996.
The Company’s financial position remains very strong. The Company continues to carry no long-term debt and expects to meet its growth requirements principally through cash flow from operations.
Year 2000 Systems Update
The year 2000 problem is an issue regarding computer programs and non-information technology systems that use embedded computer chips such as microcontrollers. Many of these programs are unable to distinguish between a year that begins with "20" instead of the familiar "19" and therefore could fail or produce incorrect results.
In 1995, the Company embarked upon a global Year 2000 Project. The project scope includes hardware, software and embedded chip technology. A formal Project Office was established with complete executive sponsorship and funding in February 1997. This initiated a global business system strategy that included a wide-scale Oracle implementation of business and financial systems, plus major enhancements to branch automation systems. Included in these initiatives is the remediation of year 2000 non-compliant systems.
The Company’s State of Readiness
Plans for remediation of year 2000 non-compliant systems are divided into the following major initiatives: mainframe, client server, domestic and international subsidiaries. The common project phases consisted of: inventory all hardware, software and embedded systems; prioritize systems based on business criticality; complete a risk assessment based on interviews with business users and subject matter experts, analysis of date functionality, and vendor documentation; test and decide to upgrade, replace or retire, as appropriate;
internal certification; and a return to production. As a part of the risk assessment process, contingency plans will be developed in the event of system failure. Compuware Corporation was selected to assist in the inventory remediation and testing process.
The inventory and assessment phase is 100% complete for all business areas. Remediation and testing is 100% complete for some of the Kelly business units. Overall completion is approximately 70% when all countries and business units are considered. The Company is 100% remediated of all mission-critical customer support systems at year-end 1998. Testing will continue throughout 1999 with planned completion during the third quarter of 1999. Testing teams are in place for mainframe, client server and international. The testing process includes a detailed risk assessment to determine the necessity and scope of testing. In some instances internal certification is recommended without testing, based on the risk assessment. This process will ensure resources remain focused on areas of greatest risk.
External communications and readiness assessments have been distributed to all customers, landlords, vendors, suppliers and facilities for North America. International communications and assessments were 100% complete at year end 1998. First quarter 1999 analysis of responses received will determine follow-up action including additional contingency planning.
The Costs to Address the Company’s Year 2000 Issues
The total cost of the Year 2000 project is expected to be at least somewhat offset by the benefits to be realized by the Company. These include: enhanced functionality at the branch level; a worldwide inventory of information technology and systems; a high-level documentation of business processes used by strategic business units; rationalization and standardization of diverse information systems; upgrades and standardization of desktop computing; upgrade of wide area network to remote business units; improved software quality assurance; and clean-up and documentation of older program code.
Total cost of the Year 2000 remediation project is estimated to be approximately $21 million. The total amount incurred to date is $9 million, of which $1 million was expended in 1997 and $8 million expended in 1998. Approximately $4 million of the total cost has been incurred for remediation (code remediation, project management compliance and risk assessment), nearly $3 million for testing, and the balance for contingency development.
The estimated future cost of completing the Year 2000 project is approximately $12 million to be incurred throughout 1999 and early 2000. Of these future costs the Company estimates approximately $4 million will relate to remediation, over $5 million for testing and the balance for contingency activities. Funds for the project are budgeted separately from other Information Technology initiatives. These costs are being expensed as an element of Selling, General and Administrative expense and are funded from cash provided by operations.
The Risks of the Company’s Year 2000 Issues
The failure to correct a material Year 2000 problem could result in an interruption, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company’s results of operations, liquidity and financial condition. It is believed the most significant of risks concern the Year 2000 readiness of third party customers and suppliers. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-party suppliers and customers, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company’s results of operations, liquidity or financial condition. The Year 2000 Project is expected to significantly reduce the Company’s level of uncertainty about the Year 2000 problem and through, in particular, the Year 2000 readiness of its internal systems and processes and its assessment of third-party preparedness.
In general, the Company believes all reasonable steps possible have been taken or are in process to ensure operations will continue without disruption. Additionally, in the event of circumstances resulting from the failure of a third party, all reasonable steps possible will have been taken to ensure appropriate contingency plans exist or are being developed to minimize the impact of these failures.
Market Risk Sensitive Instruments and Positions
The market risk inherent in the Company’s market risk sensitive instruments and positions is the potential loss arising from adverse changes in foreign currency exchange rates and interest rates. Foreign currency exchange risk is mitigated by the availability of the Company’s multi-currency line of credit. This credit facility can be used to borrow in the local currencies that can effectively hedge the exchange rate risk resulting from foreign currencies weakening in relation to the U.S. dollar.
The Company’s holdings and positions in market risk sensitive instruments do not subject the Company to material risk exposures.
Adoption of the Euro
A segment of the global business system implementation is devoted to changes necessary to deal with the introduction of a European single currency (the Euro). The transition period for implementation is January 1, 1999 through January 1, 2002.
The Company does not expect that introduction and use of the Euro will result in any material increase in costs.
Except for the historical statements and discussions contained herein, statements contained in this report relate to future events that are subject to risks and uncertainties, such as: competition, changing market and economic conditions, currency fluctuations, changes in laws and regulations, the Company’s ability to effectively implement and manage its information technology programs, including the Year 2000 project, and other factors discussed in the report and in the Company’s filings with the Securities and Exchange Commission. Actual results may differ materially from any projections contained herein.