Kforce Inc. 2019 Q3 Form 10-Q Summary
Business context and reporting period
Kforce provides temporary (Flex) and permanent (Direct Hire) staffing services through its Technology (Tech) and Finance and Accounting (FA) segments. This unaudited Form 10-Q covers the three and nine months ended September 30, 2019. Kforce had nearly 2,300 associates and 10,400 consultants on assignment at quarter-end.
During 2019, Kforce sold its Government Solutions segment, comprising Kforce Government Solutions and TraumaFX. Those businesses are presented as discontinued operations, and continuing operations now focus on commercial technical and professional staffing.
Financial performance and key metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Revenue | $345.6 million | $326.6 million | $1,011.2 million | $973.6 million |
| Gross profit | $102.8 million | $96.0 million | $297.0 million | $288.8 million |
| Gross margin | 29.8% | 29.4% | 29.4% | 29.7% |
| Income from operations | $22.2 million | $19.9 million | $55.3 million | $53.5 million |
| Income from continuing operations | $15.9 million | $14.2 million | $40.0 million | $37.3 million |
| Net income | $14.9 million | $16.2 million | $116.7 million | $41.6 million |
| Diluted EPS | $0.64 | $0.64 | $4.81 | $1.65 |
| Adjusted EBITDA from continuing operations | $25.6 million | $23.6 million | $67.0 million | $64.9 million |
- Q3 revenue increased 5.8%; nine-month revenue increased 3.9%.
- Tech revenue increased 8.3% in Q3 and 7.5% year to date. FA revenue declined 2.6% in Q3 and 7.6% year to date.
- Flex revenue increased 5.6% in Q3 and 3.7% year to date; Direct Hire revenue increased 13.6% and 8.0%, respectively.
- Nine-month Flex gross margin declined to 26.7% from 27.1%, while total gross margin declined to 29.4% from 29.7%. Q3 Flex gross margin improved to 27.2% from 27.1%.
- SG&A was 23.0% of revenue in Q3 and 23.4% for the first nine months, compared with 22.8% and 23.6%, respectively, in the prior-year periods.
- Nine-month income from continuing operations increased 7.2%, while reported net income benefited substantially from the Government Solutions divestitures.
Cash flow, balance sheet, debt and liquidity
- Cash provided by operating activities was $46.5 million for the first nine months, compared with $64.7 million in 2018. Management attributed the decline principally to the prior-year $6.8 million tax refund and the timing of receivable collections.
- Free cash flow was $38.8 million, compared with $60.7 million in the prior-year period, after $7.7 million of capital expenditures.
- Cash provided by investing activities was $108.0 million, including $123.3 million of net proceeds from the Government Solutions sales and a $7.5 million investment in WorkLLama.
- Cash used in financing activities was $113.3 million, including $91.9 million of share repurchases, $12.7 million of dividends and $6.8 million of net credit-facility repayments.
- At September 30, 2019, cash and cash equivalents were $41.3 million, working capital was $180.7 million, and credit-facility borrowings were $65.0 million. Management reported net debt of $23.7 million.
- The credit facility has a maximum borrowing capacity of $300.0 million, potentially expandable by $150.0 million, subject to conditions. Kforce was in compliance with its covenants and was not restricted from dividends or repurchases at quarter-end.
- Kforce stated that existing cash, operating cash flow and available borrowing capacity should be adequate for operating and capital requirements for at least the next 12 months, subject to economic conditions and potential strategic uses of capital.
Material changes versus the prior comparable period
- Tech continued to outperform FA. Tech Flex revenue growth was driven primarily by more consultants on assignment, while FA Flex revenue declined because of lower assignment volume despite higher bill rates.
- Nine-month Tech Flex margin declined 40 basis points, primarily from bill/pay spread compression among larger clients. FA Flex margins were broadly stable.
- Kforce sold KGS on April 1, 2019 for $115.0 million and TFX on June 7, 2019 for $18.4 million. The transactions produced aggregate pretax gains of approximately $79.6 million, reported in discontinued operations.
- Share repurchases increased materially: approximately $91.3 million for the first nine months of 2019 versus $12.5 million in cash repurchases in the prior-year period. Approximately $70.8 million remained authorized at September 30, 2019.
- Kforce adopted the new lease standard in 2019, recognizing operating lease right-of-use assets and liabilities. Operating lease liabilities totaled $20.1 million at September 30, 2019.
- In June 2019, Kforce entered a 50% joint venture investment in WorkLLama. The investment balance was $8.6 million, and Kforce recorded a $0.4 million loss from the investment. Up to $15.0 million of future contingent contributions may be required; $1.5 million was accrued as probable at quarter-end.
Guidance, outlook, commentary and risks
- Management expected Q4 Tech Flex revenue growth to approximate Q3 levels on a billing-day basis and expected Tech Flex margins to remain at or near year-to-date levels.
- Management expected FA Flex year-over-year revenue growth to decline further in the high single digits, partly because of a large project in Q4 2018, while continuing to reposition FA Flex toward higher-skilled roles.
- Management cited favorable technology demand, low unemployment in relevant professional skill sets and continued client technology spending. These conditions are not a guarantee of future performance.
- Key risks include economic or staffing-market deterioration, client demand changes, consultant and candidate shortages, competition, margin pressure, receivable collections, interest-rate exposure, covenant limitations, and the execution of the FA repositioning.
- Kforce is a defendant in a putative class action alleging violations of the Fair Credit Reporting Act concerning applicant disclosures and authorizations. The company stated that the outcome and potential loss could not yet be estimated, but believed a material adverse effect was unlikely.
- Executive employment agreements could require approximately $33.4 million of payments following a change in control if applicable termination conditions were met, or approximately $16.5 million without a change in control.
- The interest-rate swap, designated as a cash-flow hedge and maturing in April 2022, had a $0.3 million liability fair value at September 30, 2019.
Most important facts for investors to verify
- Whether Tech growth offsets continued FA Flex declines and whether the stated Q4 outlook is achieved.
- Whether Flex gross-margin pressure, particularly in Tech, stabilizes or worsens.
- The sustainability of operating cash flow after the one-time divestiture proceeds are exhausted.
- Future capital allocation among share repurchases, dividends, debt repayment, acquisitions and WorkLLama funding.
- Compliance with credit-facility covenants and the effect of interest rates on borrowing costs.
- Developments, potential damages and insurance coverage related to the FCRA litigation.
- The effect of discontinued operations and divestiture-related gains when assessing recurring earnings and valuation.