Kforce Inc. 2018 Third-Quarter Form 10-Q Summary
Business Context and Reporting Period
Kforce provides professional staffing and solutions through Technology (Tech), Finance and Accounting (FA), and Government Solutions (GS). Services include temporary staffing (Flex), permanent placements (Direct Hire), and GS product revenue. The unaudited report covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods. Kforce had nearly 2,400 associates and more than 11,000 consultants on assignment at quarter-end.
Financial Performance and Key Metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $355.5 million | $341.1 million | $1,060.4 million | $1,015.4 million |
| Gross profit | $104.4 million | $104.4 million | $312.1 million | $305.4 million |
| Gross margin | 29.4% | 30.6% | 29.4% | 30.1% |
| Income from operations | $22.7 million | $20.3 million | $59.3 million | $50.1 million |
| Net income | $16.2 million | $10.1 million | $41.6 million | $27.1 million |
| Diluted EPS | $0.64 | $0.40 | $1.65 | $1.06 |
| Adjusted EBITDA | $26.7 million | $24.2 million | $72.1 million | $62.1 million |
| Operating cash flow | Not separately provided | Not separately provided | $64.7 million | $5.6 million |
Q3 operating margin was 6.4% versus 6.0% in the prior-year quarter; nine-month operating margin was 5.6% versus 4.9%. Net margin increased to 4.6% from 3.0% for the quarter and to 3.9% from 2.7% for the nine-month period. The nine-month effective tax rate was 25.3%, compared with 41.3% in 2017, primarily reflecting the Tax Cuts and Jobs Act.
Flex revenue increased 4.2% in Q3 and 4.7% for the nine months. Direct Hire revenue decreased 13.7% and 8.2%, respectively, while product revenue increased 95.9% in Q3 and 35.9% for the nine months. Flex gross margin declined to 26.7% from 27.8% in Q3 and to 26.7% from 27.1% for the nine months.
Liquidity, Debt, and Capital Allocation
- Cash and cash equivalents were $0.5 million at September 30, 2018, compared with $0.4 million at December 31, 2017.
- Working capital was $157.2 million at quarter-end versus $161.7 million at year-end 2017.
- Credit Facility borrowings were $79.3 million, down from $116.5 million at December 31, 2017. The facility matures May 25, 2022 and has a $300 million maximum commitment, subject to potential expansion.
- Letters of credit totaled $3.2 million. Management stated that Kforce was not restricted from making distributions or repurchases at quarter-end.
- Nine-month capital expenditures were $4.0 million, producing reported free cash flow of $60.7 million.
- Kforce paid $10.4 million of dividends, or $0.42 per share, and repurchased $12.5 million of common stock during the nine months. The quarterly dividend was increased 50% to $0.18 per share.
- Management believes available cash, operating cash flow, and borrowing capacity will meet operating and capital requirements for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- Nine-month revenue rose 4.4%, led by Tech Flex growth of 8.9% and GS Flex growth of 13.5%; FA Flex revenue declined 9.7%.
- Tech represented 69.5% of nine-month revenue, up from 66.9%; FA declined to 22.3% from 25.7%.
- GS Flex gross margin fell to 22.0% from 27.8% for the nine months, reflecting a cost-competitive environment and lower-margin contracts.
- SG&A declined to 23.3% of revenue from 24.5%, reflecting performance-based compensation changes, productivity improvements, lower revenue-generating headcount, prior realignment actions, and expense discipline.
- Operating cash flow increased by $59.0 million, primarily from higher profitability, improved collections, a lower tax rate, and a $6.8 million tax refund.
- The company adopted ASC Topic 606 on January 1, 2018 using the modified retrospective method. The cumulative after-tax reduction to opening retained earnings was approximately $0.2 million, and management stated that the nine-month financial statements were not materially affected relative to the prior revenue standard.
- Prior-year results included a $3.3 million gain from the sale of Global’s assets; the 2018 comparison did not include that gain.
Outlook, Commentary, Risks, and Unusual Items
- Management expects Tech Flex growth to decelerate in Q4 2018 because Q3 new assignment starts were below expectations.
- FA Flex revenue is expected to increase slightly sequentially due to a large project beginning in Q4, but remain down year over year.
- GS Flex revenue is expected to be flat or slightly down year over year in Q4 because anticipated awards were delayed and billable headcount attrition affected lower-margin contracts.
- Direct Hire revenue is expected to decline seasonally and year over year as Kforce remains selective in this cyclical business.
- Management cited candidate constraints, bill-pay spread pressure, higher health insurance costs, contract profitability, delayed government awards, client demand, economic conditions, and interest-rate exposure as important operating risks.
- Kforce uses a $65 million-to-$25 million interest-rate swap through April 2022 to mitigate variable-rate debt exposure. The swap had a $1.6 million fair-value asset at September 30, 2018.
- Executive employment agreements could require approximately $32.4 million of payments following a change in control, or $13.4 million absent a change in control, if specified termination conditions applied to all covered executives.
- Ordinary-course litigation was not considered material by management, although adverse outcomes could materially affect results. Management reported no material changes to previously disclosed risk factors or off-balance-sheet arrangements.
Investor Verification Checklist
- Verify whether Tech growth decelerates and whether FA and GS revenue trends follow management’s Q4 expectations.
- Monitor GS contract economics and whether the significant recompete and other low-margin engagements improve.
- Assess sustainability of the 2018 tax benefit and the unusually large improvement in operating cash flow, including the $6.8 million tax refund.
- Review debt paydown, leverage and covenant compliance, particularly the fixed-charge coverage and total-leverage requirements.
- Track Flex gross margins, bill-pay spreads, consultant availability, health insurance costs, and Direct Hire placement volumes.
- Evaluate the effect of dividends and share repurchases on liquidity and future capital allocation.