Business Context and Reporting Period
Kforce Inc. provides professional staffing and solutions in Technology, Finance and Accounting, and Government Solutions, through flexible staffing and direct-hire services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods. Kforce had nearly 3,000 associates and more than 11,000 consultants on assignment.
Key Financial Metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net service revenue | $336.5 million | $341.6 million | $993.7 million | $991.5 million |
| Gross profit | $105.4 million | $109.8 million | $308.9 million | $310.6 million |
| Gross margin | 31.3% | 32.2% | 31.1% | 31.3% |
| Income from operations | $15.4 million | $23.1 million | $43.1 million | $53.5 million |
| Net income | $9.0 million | $13.5 million | $23.5 million | $30.9 million |
| Diluted EPS | $0.34 | $0.48 | $0.89 | $1.09 |
| Adjusted EBITDA | $18.8 million | $27.0 million | $54.9 million | $64.7 million |
Q3 net income margin was 2.7%, compared with 4.0% in the prior-year quarter. Nine-month net income margin was 2.4%, compared with 3.1% in 2015. Nine-month Flex revenue increased 0.4% to $954.6 million, while Direct Hire revenue declined 3.8% to $39.1 million.
- Segment revenue, nine months: Technology declined 1.7% to $666.7 million; Finance and Accounting increased 5.3% to $251.8 million; Government Solutions increased 1.0% to $75.2 million.
- Cash flow: Operating cash flow was $29.3 million versus $55.2 million in the prior-year period. Capital expenditures were $9.4 million, producing reported free cash flow of $19.9 million versus $47.4 million.
- Liquidity: Cash and cash equivalents were $0.9 million at September 30, 2016. Working capital was $136.3 million. Trade receivables were $209.4 million.
- Debt: Credit-facility borrowings were $101.3 million, up from $80.5 million at December 31, 2015. Availability was $52.1 million at September 30 and $63.9 million at October 28, 2016; October 28 borrowings were $89.5 million.
- Capital returns: Kforce paid $9.4 million in dividends, or $0.36 per share, and repurchased approximately 1.6 million shares for approximately $29.1 million during the first nine months. The remaining repurchase authorization was $65.7 million at September 30.
Material Changes Versus the Prior Comparable Period
- Revenue was essentially flat for the first nine months, but Q3 revenue decreased 1.5% year over year.
- Gross profit declined 0.6% for the first nine months, with Flex gross margin decreasing 10 basis points to 28.3%, primarily because of higher benefit costs. Q3 Flex gross margin declined 60 basis points to 28.6%, also reflecting client concentration and spread compression in Technology.
- SG&A increased to 26.1% of revenue from 25.2% for the first nine months. The increase was primarily attributable to approximately $6.0 million of severance costs related to organizational realignment, along with investments in information technology and revenue-generating personnel.
- Nine-month net income decreased 23.9% and diluted EPS decreased 18.3%. Management attributed the decline primarily to the severance costs, which had an estimated $3.6 million after-tax impact, and approximately $1.7 million of tax adjustments. Excluding the stated one-time tax adjustments, the effective tax rate would have been 38.8% rather than 42.9%.
- Operating cash flow declined substantially, primarily because of the timing of compensation payments, severance payments, technology investments, personnel investments, and tax adjustments.
- Debt increased by $20.8 million, principally funding dividends and share repurchases totaling $38.5 million.
Guidance, Outlook, Risks and Unusual Items
Management expected Q4 2016 Technology Flex revenue to increase sequentially on a billing-day basis and year over year; Finance and Accounting Flex revenue to increase sequentially on a billing-day basis but be flat to slightly down year over year; and Government Solutions revenue to decline sequentially but increase year over year. Q4 was expected to have 61 billing days versus 64 in Q3.
Management remained optimistic about temporary staffing demand, citing technology trends such as cloud computing, data analytics, mobility and cybersecurity, and expected opportunities under the Government Solutions T4 Next Gen contract vehicle. The contract has a stated program ceiling of $22 billion over 10 years, but the filing does not provide a company-specific revenue estimate or guarantee of task orders or funding.
- Key business risks include economic uncertainty, client demand changes, candidate supply and retention, pricing and pay-rate spread compression, staffing-industry cyclicality, healthcare and employment costs, and reliance on collections of accounts receivable.
- The credit facility has a $170.0 million maximum borrowing capacity and a $50.0 million accordion option. Availability-based restrictions could limit dividends or repurchases, and a fixed-charge coverage covenant could become applicable if availability falls below specified thresholds.
- Kforce disclosed a putative class action alleging unpaid regular and overtime wages by telephone-dedicated workers. The company believes the matter is unlikely to be material, but stated that the outcome and any potential loss cannot currently be estimated.
- Executive employment agreements could require approximately $44.7 million after a qualifying change in control, or $20.2 million without a change in control, if all covered executives were terminated under specified circumstances. No liability was recorded because no triggering events had occurred.
- The filing reports no material changes to previously disclosed risk factors, off-balance-sheet arrangements, contractual obligations or market-risk disclosures.
- Management stated that existing cash, operating cash flow and credit-facility availability should meet operating and capital requirements for at least the next 12 months, subject to economic conditions, acquisitions and additional repurchases.
Investor Verification Items
- Verify whether Technology staffing demand and spending by previously reduced large clients continued to recover after Q3.
- Monitor Flex gross margin, benefit costs, client concentration and bill-rate/pay-rate spreads.
- Assess whether severance and other realignment costs were nonrecurring and whether SG&A leverage improved.
- Reconcile operating cash flow and free cash flow with receivables growth, compensation timing and tax payments.
- Track credit-facility borrowings, availability and covenant headroom as dividends and repurchases continue.
- Review developments in the wage-and-hour litigation and any potential impact from executive employment commitments.
- Confirm the conversion of the T4 Next Gen contract vehicle into funded awards and revenue; the filing does not establish the timing or amount of such revenue.