KFRC

Business Context and Reporting Period

Kforce Inc. is a provider of professional staffing services and solutions operating in four segments: Technology, Finance and Accounting, Health and Life Sciences, and Government Solutions. This Form 10-Q covers the quarterly period ended September 30, 2008. During this period, Kforce completed the sale of its Scientific and per-diem Nursing businesses, classifying their results as discontinued operations to focus on core growth areas.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net service revenues increased 1.8% for the quarter and 4.2% for the nine-month period compared to 2007, driven by growth in Flexible billings (up 3.9% and 5.3% respectively).
• Search Revenue Decline: Search fees decreased significantly, down 21.9% for the quarter and 8.4% for the nine-month period, reflecting economic uncertainty and reduced demand for permanent placements.
• Margin Compression: Gross profit margins decreased 260 basis points for the quarter and 140 basis points for the nine-month period. This was primarily due to the decline in high-margin Search fees and a contraction in the spread between bill rates and pay rates for Flexible staffing.
• Expense Increases: Selling, general, and administrative (SG&A) expenses as a percentage of revenue increased to 29.2% for the nine months ended September 30, 2008, from 28.0% in the prior year. This was driven by higher stock-based compensation (due to accelerated vesting), increased bad debt provisions, and higher benefit costs.
• Debt Reduction: Long-term debt under the Credit Facility was reduced from $50.3 million at year-end 2007 to $12.0 million as of September 30, 2008, utilizing proceeds from business dispositions and operating cash flows.

Guidance, Outlook, and Risks

• Economic Outlook: Management notes growing concerns regarding the U.S. macro-economic environment, including credit market turmoil and potential recession. A recession would likely have a significant adverse impact on clients and business operations.
• Discontinued Operations: The company sold its Scientific business (for $10.5 million plus a $1.5 million earnout) and per-diem Nursing business (for $1.5 million). These sales generated a pre-tax gain of $7.3 million included in discontinued operations.
• Stock Repurchases: Kforce repurchased 3.2 million shares for $28.0 million during the nine-month period. As of September 30, 2008, $36.8 million remained available under the repurchase authorization.
• Risk Factors: Key risks include the potential for a U.S. recession, increased bad debt exposure due to financial market instability, and the possibility that the Credit Facility may not be fully available if lenders face liquidity issues.
• Anti-Takeover Rights: On October 29, 2008, the Board declared a dividend distribution of stock purchase rights (poison pill) to shareholders of record, effective to deter unsolicited takeover attempts.

Investor Verification Checklist

• Bad Debt Provisions: Verify the adequacy of the allowance for doubtful accounts, which increased significantly due to exposure in the financial services sector and rising business failures.
• Discontinued Operations Impact: Confirm the classification of the Scientific and Nursing sales and the sustainability of earnings without these segments.
• Stock-Based Compensation: Review the impact of the $6.0 million acceleration of equity award vesting on Q2 2008 expenses and future compensation costs.
• Credit Facility Availability: Assess the risk that the $140 million Credit Facility may not be fully accessible given the broader credit market turmoil.
• Search Revenue Trends: Monitor the continued decline in Search fees as a leading indicator of economic health and future revenue mix.