Kforce Inc. Form 10-Q Summary
Business context and reporting period
Kforce provides professional staffing and solutions through Technology, Finance and Accounting, and Government Solutions segments. Services are delivered through temporary Flex staffing and permanent Direct Hire placements. The unaudited results cover the three months ended March 31, 2017, compared with the same period in 2016.
- Nearly 2,800 associates and more than 11,000 consultants were on assignment at March 31, 2017.
- Net service revenue was 96.6% Flex and 3.4% Direct Hire.
Financial performance and key metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net service revenue | $334.0 million | $322.2 million | 3.7% increase |
| Gross profit | $97.1 million | $97.2 million | 0.1% decrease |
| Gross margin | 29.1% | 30.2% | 110 basis-point decrease |
| Income from operations | $10.4 million | $9.4 million | 10.6% increase |
| Net income | $5.9 million | $3.7 million | 61.7% increase |
| Diluted EPS | $0.23 | $0.14 | Increase |
| Adjusted EBITDA | $14.6 million | $13.7 million | 6.2% increase |
| Operating cash flow | $(10.5) million | $3.3 million | Decrease |
| Free cash flow | $(12.8) million | $2.0 million | Decrease |
Flex revenue increased 4.2% to $322.5 million, while Direct Hire revenue declined 8.4% to $11.5 million. Flex gross margin declined to 26.6% from 27.3%, primarily because of bill-rate/pay-rate compression and higher benefit costs. SG&A declined to 25.4% of revenue from 26.5%, reflecting lower relative variable compensation and reduced severance expense.
- Technology revenue increased 2.5%; Finance and Accounting increased 5.8%; Government Solutions increased 6.6%.
- Flex hours in Technology and Finance and Accounting increased 4.8% in aggregate; total Direct Hire placements declined 9.8% to 823.
- The effective tax rate was 36.0%, compared with 58.2% in Q1 2016. Adoption of share-based payment guidance reduced tax expense by approximately $0.2 million and increased diluted EPS by approximately $0.01.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $2.7 million at March 31, 2017, versus $1.5 million at December 31, 2016.
- Trade receivables increased to $227.6 million from $206.4 million.
- Working capital was $159.4 million, compared with $135.4 million at year-end 2016.
- Credit facility borrowings increased to $132.0 million from $111.5 million. Availability was $20.9 million at March 31 and $27.3 million at April 28, 2017; April 28 borrowings were $125.6 million.
- The facility has $170.0 million of borrowing capacity and a $50.0 million accordion option and expires December 23, 2019.
- The fixed-charge coverage covenant was not applicable at March 31, but liquidity was below thresholds that limited share repurchases and distributions. Management expected these limitations to be short-term.
- Kforce paid a quarterly dividend of $0.12 per share, or approximately $3.0 million. No open-market repurchases were made during the quarter.
Material changes versus the prior comparable period
- Revenue growth was led by Flex staffing, while Direct Hire activity weakened.
- Gross profit was essentially flat despite higher revenue because of margin compression and the lower mix of Direct Hire revenue.
- Operating profit and net income improved due primarily to SG&A leverage, lower relative variable compensation, lower severance costs, and the lower effective tax rate.
- Operating cash flow shifted from a $3.3 million inflow to a $10.5 million outflow, primarily because of delayed receivable collections following back-office function changes and delayed execution of a large Government Solutions contract.
- Debt increased by $20.5 million to fund working capital needs and offset weaker operating cash flow.
- Effective January 1, 2017, Kforce adopted new share-based compensation guidance and changed forfeiture accounting. It also early adopted guidance simplifying goodwill impairment testing; the latter had no financial statement impact.
Guidance, outlook, risks and unusual items
- Management expected Technology Flex revenue to increase sequentially and year over year in Q2 2017 at levels similar to Q1.
- Finance and Accounting Flex revenue was expected to decline marginally sequentially but increase year over year in Q2.
- Government Solutions revenue was expected to increase sequentially but remain flat year over year in Q2.
- Management remained optimistic about temporary staffing demand and growth in Technology and Finance and Accounting, but noted economic uncertainty and limited visibility.
- Bill-rate/pay-rate spreads could remain under pressure because of labor shortages, particularly in technology skill sets.
- On April 21, 2017, Kforce entered into an interest-rate swap at a 1.81% swap rate, effective May 31, 2017, with a $65 million notional amount for the first three years that amortizes to $25 million in years four and five.
- Kforce accrued $0.9 million of severance related to the resignation of its Chief Talent Officer.
- A putative class action alleges unpaid regular and overtime wages by telephone-dedicated workers. Kforce cannot estimate a loss range but believes an adverse outcome is unlikely to be material.
- Executive employment agreements could require approximately $40.8 million of payments following a change in control, or $16.7 million absent a change in control, if all covered executives qualified for severance.
- Future adoption of the lease standard is expected to materially increase reported assets and liabilities. The company selected a modified-retrospective approach for the revenue standard and expects timing changes for no more than the portion of revenue associated with certain Government Solutions fixed-price contracts.
Important facts for investors to verify
- Whether delayed receivable collections and the Government Solutions contract timing normalize as management expects.
- Progress in restoring credit-facility availability and removing restrictions on dividends and repurchases.
- Whether bill-rate/pay-rate compression and higher benefit costs continue to reduce Flex margins.
- The sustainability of the Q1 effective tax rate, including volatility from share-based compensation tax accounting.
- Q2 performance against management’s segment-specific revenue outlook.
- Potential exposure from the wage-and-hour litigation, executive severance obligations, and interest-rate movements before and after the swap becomes effective.