Kforce Inc. 2014 Q3 Form 10-Q Summary
Business context and reporting period
Kforce provides professional staffing and solutions through Technology, Finance and Accounting, and Government Solutions segments. The filing covers the three and nine months ended September 30, 2014, with comparisons to the corresponding 2013 periods. Kforce operated 62 U.S. field offices and an international technology outsourcing office in Manila; international revenue represented approximately 2% of net service revenues.
Effective August 3, 2014, Kforce sold Kforce Healthcare, Inc., which operated the former Health Information Management segment, for $119.0 million in cash, subject to a $96 thousand working-capital adjustment. HIM is presented as discontinued operations.
Financial performance and key metrics
| Metric | Q3 2014 | Q3 2013 | First nine months 2014 | First nine months 2013 |
|---|---|---|---|---|
| Net service revenues | $313.8 million | $280.0 million | $898.6 million | $791.7 million |
| Gross profit | $98.3 million | $91.1 million | $276.2 million | $255.0 million |
| Gross margin | 31.3% | 32.5% | 30.7% | 32.2% |
| Income from operations | $13.6 million | $13.2 million | $34.6 million | $25.9 million |
| Income from continuing operations | $8.0 million | $7.6 million | $20.3 million | $15.0 million |
| Net income | $65.0 million | $9.0 million | $82.0 million | $19.0 million |
| Diluted EPS from continuing operations | $0.25 | $0.23 | $0.63 | $0.44 |
| Diluted EPS | $2.06 | $0.27 | $2.52 | $0.56 |
| Adjusted EBITDA | $16.9 million | $16.1 million | $44.0 million | $34.2 million |
Q3 net income included $57.0 million of after-tax income from discontinued operations, primarily the gain on the HIM sale. For the nine-month period, discontinued operations contributed $61.6 million after tax, including a $94.3 million pretax sale gain, net of approximately $11.0 million of transaction costs.
- Flex revenue increased 12.5% in Q3 and 14.4% for the first nine months, while Search revenue increased 2.9% in Q3 but declined 5.7% year to date.
- Technology revenue increased 12.4% in Q3 and 15.4% year to date; Finance and Accounting increased 14.7% and 12.3%, respectively; Government Solutions increased 2.7% and 1.8%.
- Flex gross margin declined to 28.5% in Q3 and 27.9% year to date from 29.5% and 28.9%, respectively, primarily due to a greater mix of larger, lower-margin clients and higher benefit costs.
- SG&A declined to 26.2% of revenue in Q3 and 26.0% year to date from 26.9% and 28.0%, respectively, primarily due to the 2013 organizational realignment.
- The effective tax rate on continuing operations was 39.4% for the first nine months, compared with 40.1% in 2013.
Cash flow, liquidity, debt and capital allocation
- Cash provided by operating activities was $3.7 million for the first nine months of 2014, compared with $3.8 million in 2013. Trade receivables used $38.3 million of operating cash.
- Investing activities provided $114.3 million, including $117.9 million of proceeds from the HIM disposition. Capital expenditures were $4.8 million versus $6.0 million in 2013.
- Financing activities used $117.8 million, including $58.6 million for share repurchases, $9.6 million for dividends, and net repayments on the bank line of credit.
- Cash and cash equivalents were $1.1 million at September 30, 2014, versus $0.9 million at December 31, 2013. Working capital was $87.4 million and the current ratio was 1.7.
- Credit-facility borrowings were $12.7 million at September 30, 2014, down from $62.6 million at December 31, 2013. Availability was $107.1 million, and the facility expires September 20, 2016. As of October 24, 2014, borrowings were $22.8 million and availability was $97.0 million.
- The credit facility had a weighted-average effective interest rate of 2.3%. A hypothetical 10% increase in interest rates would have increased annualized interest expense by less than $0.1 million based on September 30 borrowings.
- Kforce repurchased approximately 3.0 million shares for $60.5 million during the first nine months and had $72.1 million remaining under its repurchase authorization at September 30. The Board increased authorization by $70.0 million in September.
- Kforce declared dividends of $0.10 per share in Q3 and $0.30 per share year to date. Management expected quarterly dividends of a similar amount, but future dividends remain discretionary.
Material changes, outlook, risks and unusual items
- The HIM divestiture materially increased reported earnings and cash inflows, reduced debt, and shifted the company’s portfolio toward Technology, Finance and Accounting, and Government Solutions.
- Management expected Technology and Finance and Accounting revenue growth to continue through the remainder of 2014 and into 2015. Government Solutions revenue was expected to remain broadly stable for the remainder of 2014, while Search revenue was expected to remain stable.
- Management expected Flex gross margins to remain stable for the remainder of 2014 and into early 2015, although margins were already below the prior-year levels.
- Management believed existing cash, operating cash flow, and available credit capacity would satisfy capital and working-capital needs for at least the next 12 months. Liquidity could be affected by economic deterioration, market conditions, lender funding capacity, acquisitions, or further share repurchases.
- The company disclosed a qui tam and whistleblower lawsuit alleging False Claims Act, accounting, employment, and defamation violations. Kforce’s motion to dismiss was awaiting decision, and the U.S. government declined to intervene. Management did not expect a material effect, but litigation outcomes remain uncertain.
- Sale-related indemnification exposure was generally capped at $8.925 million for specified losses, subject to a $1.19 million deductible in certain cases; no liability was recorded because material exposure was considered remote.
- Kforce paid $3.2 million to terminate its supplemental executive retirement health plan, recording an $847 thousand settlement loss in Q3. The related postretirement obligation was eliminated.
- Employment agreements could require approximately $36.1 million of payments if all covered executives were terminated following a change in control, or $16.0 million absent a change in control; no liability was recorded.
- Letters of credit totaled $3.3 million at September 30, 2014. Management reported no other material off-balance-sheet arrangements.
Important facts for investors to verify
- Separate continuing-operations performance from the substantial, nonrecurring HIM sale gain when evaluating earnings, EPS, margins, and valuation.
- Confirm the sustainability of Flex revenue growth and whether lower spreads, benefit costs, and client mix continue to pressure gross margins.
- Monitor operating cash conversion, receivables growth, and the effect of staffing payroll requirements on liquidity.
- Review credit-facility availability, borrowing levels, covenant requirements, and the potential impact of changes in unbilled and billed receivables.
- Assess ongoing share repurchases and dividends against operating cash flow and the company’s low reported cash balance.
- Follow the qui tam litigation, HIM indemnification obligations, and any post-closing sale adjustments.
- Consider that quarterly staffing results are affected by billing days, seasonality, and annual employment-tax resets.