Kforce Inc. Q2 2017 Form 10-Q Summary
Business Context and Reporting Period
Kforce provides professional and technical staffing services through Technology, Finance and Accounting, and Government Solutions segments. Services are delivered through temporary Flexible staffing and permanent Direct Hire placements. This unaudited Form 10-Q covers the three and six months ended June 30, 2017, compared with the same periods in 2016.
- As of June 30, 2017, Kforce employed nearly 2,700 associates and had more than 11,000 consultants on assignment.
- The company operated 59 U.S. field offices and an office in Manila, Philippines.
Financial Performance and Key Metrics
| Metric | Q2 2017 | Q2 2016 | Six Months 2017 | Six Months 2016 |
|---|---|---|---|---|
| Net service revenues | $340.3 million | $335.0 million | $674.3 million | $657.2 million |
| Gross profit | $103.9 million | $106.3 million | $201.1 million | $203.5 million |
| Gross margin | 30.5% | 31.7% | 29.8% | 31.0% |
| Income from operations | $19.4 million | $18.6 million | $29.8 million | $28.0 million |
| Net income | $11.1 million | $10.9 million | $17.0 million | $14.5 million |
| Diluted EPS | $0.44 | $0.41 | $0.67 | $0.55 |
| Adjusted EBITDA | $23.3 million | $22.6 million | $37.8 million | $36.3 million |
- Q2 revenue increased 1.6%; six-month revenue increased 2.6%.
- Six-month Flex revenue increased 2.8% to $648.9 million, while Direct Hire revenue declined 3.0% to $25.4 million.
- Six-month SG&A declined to $167.2 million from $170.9 million, and SG&A as a percentage of revenue improved to 24.8% from 26.0%.
- Six-month effective tax rate decreased to 37.4% from 45.2%, benefiting partly from the adoption of new share-based compensation accounting guidance.
Cash Flow, Liquidity, Debt and Capital Allocation
- Cash provided by operating activities was $5.5 million for the six months ended June 30, 2017, compared with $16.0 million in the prior-year period.
- Capital expenditures were $4.3 million, producing reported free cash flow of $1.2 million, versus $12.8 million in the prior-year period.
- Cash and cash equivalents increased to $3.5 million from $1.5 million at December 31, 2016.
- Trade receivables increased to $225.4 million from $206.4 million at year-end, and management attributed the increased borrowing partly to higher days sales outstanding and lower-than-anticipated operating cash flow.
- On May 25, 2017, Kforce entered into a new secured revolving credit facility with borrowing capacity of $300.0 million, expandable by up to $150.0 million subject to conditions.
- Credit facility borrowings were $124.1 million at June 30, 2017, with $172.4 million available subject to covenants. The facility matures May 25, 2022.
- The facility requires a fixed charge coverage ratio of at least 1.25 to 1.00 and a total leverage ratio of no more than 3.25 to 1.00. Kforce reported that it was not restricted from making distributions or repurchases at quarter-end.
- Kforce paid $6.1 million of dividends during the first six months, or $0.24 per share, and retained $50.7 million under its authorized share repurchase program.
Material Changes Versus the Prior Comparable Period
- Revenue growth was positive but modest, led by Tech and Finance and Accounting Flex revenue. Government Solutions revenue declined 0.2% for the first six months and 6.4% in Q2.
- Flex gross margin declined to 27.1% for the first six months from 28.1%, primarily because of compression between bill rates and pay rates and higher benefit costs.
- Gross profit declined despite revenue growth, reflecting lower Flex margins and revenue mix.
- Lower SG&A, improved operating leverage, and a lower effective tax rate more than offset gross-margin pressure, increasing six-month net income by 17.4%.
- Operating cash flow and free cash flow declined substantially, while credit facility borrowings increased by $12.6 million from year-end.
- The company entered into a forward-starting interest rate swap with a 1.81% swap rate, covering a $65.0 million notional amount for the first three years and decreasing to $25.0 million for years four and five.
Guidance, Outlook, Risks and Unusual Items
- Management expected Tech and Finance and Accounting Flex revenue to increase sequentially and year over year, adjusted for billing days, in Q3 2017. Government Solutions revenue was expected to increase sequentially and remain stable year over year on a billing-day-adjusted basis.
- Management remained optimistic about temporary staffing demand and cited a record temporary-staffing penetration rate of 2.07% in June 2017, but cautioned that economic conditions and industry performance remained uncertain.
- Bill-pay spread pressure could continue because of client pricing pressure, talent shortages, and potential consultant wage inflation.
- The company launched a pilot of a new customer relationship management system in April 2017 and expected full deployment during Q3 2017.
- Kforce disclosed a putative class-action wage-and-hour lawsuit involving Kforce Flexible Solutions. The company stated that the outcome and potential loss could not currently be estimated, while believing a material adverse effect was unlikely.
- Executive employment agreements could result in approximately $40.8 million of obligations following a change in control, or approximately $16.3 million absent a change in control, if specified termination conditions applied.
- The company expects the future lease accounting standard to have a significant balance-sheet impact by recognizing substantially all operating leases as right-of-use assets and lease liabilities.
- Management stated that existing cash, operating cash flow, and available credit were expected to meet operating and capital requirements for at least the next 12 months, subject to economic conditions, acquisitions, repurchases, and lender funding availability.
Important Facts for Investors to Verify
- Whether gross-margin compression stabilizes or worsens, particularly in Tech and Finance and Accounting Flex operations.
- Whether accounts receivable growth and days sales outstanding normalize sufficiently to restore operating cash flow.
- Compliance with the credit facility’s leverage and fixed-charge coverage covenants as debt and interest rates change.
- Q3 performance against management’s qualitative expectations for Tech, Finance and Accounting, and Government Solutions.
- The ultimate exposure and progression of the wage-and-hour litigation.
- The effect of the interest rate swap and future interest-rate movements on financing costs.
- The impact of upcoming lease and revenue-recognition standards, including the review of Government Solutions fixed-price contracts.