KFRC

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2003, for Kforce Inc., a staffing and consulting firm incorporated in Florida. The company operates through three functional segments: Information Technology, Finance and Accounting, and Health and Life Sciences. As of May 13, 2003, the company had 30,876,845 shares of common stock issued and outstanding.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net service revenues decreased 6.0% year-over-year. This was driven by a 4.3% drop in Flexible Billings and a 24.6% drop in Search Fees. Management attributes these declines to unfavorable economic conditions and a realignment of the Health Care business model.
• Profitability Improvement: Despite lower revenues, the company returned to profitability, reporting net income of $0.3 million compared to a net loss of $1.6 million in the prior year. This turnaround was primarily due to a 15.0% reduction in Selling, General, and Administrative (SG&A) expenses.
• Expense Reductions: SG&A expenses fell to $36.6 million (down from $43.1 million) due to lower commissions, office consolidations, and reduced credit write-offs. Depreciation and amortization expenses dropped 59.5% to $1.1 million.
• Segment Performance: All three segments saw revenue declines. Health and Life Sciences Flexible Billings dropped 10.0%, while Search Fees declined significantly across all segments (e.g., Information Technology Search Fees fell 35.4%).

Outlook, Risks, and Management Commentary

• Liquidity and Capital Resources: The company holds $1.8 million in cash and has access to a $100 million credit facility, with $22 million currently outstanding. Approximately $20.4 million was available under the facility as of March 31, 2003. Management believes current resources are adequate for the next 12 months but notes that further economic deterioration could negatively impact liquidity.
• Debt Covenants: The company is currently in compliance with financial covenants. However, management disclosed that if they had borrowed sufficient funds to trigger these covenants, they would not be in compliance.
• Stock Repurchases: The Board has authorized up to $115 million in stock repurchases. The credit facility limits repurchases to $25 million per year. No shares were repurchased in the current fiscal year as of May 13, 2003.
• Interest Rate Hedging: To mitigate interest rate risk, the company entered into a new $10 million fixed interest rate swap in March 2003 and additional swaps totaling $12 million in April and May 2003. As of May 13, 2003, the notional value of swaps ($22 million) matches the outstanding debt, effectively fixing interest rates.
• Accounting Policies: The company maintains a valuation allowance on deferred tax assets due to recent operating losses. It continues to use the intrinsic-value method for stock-based compensation but discloses pro forma figures under SFAS 123, which would have resulted in a net loss of $0.4 million for the quarter.

Investor Verification Checklist

• Covenant Compliance: Verify the company's ability to maintain EBITDA projections required by the credit facility, given the disclosure that they would be non-compliant if borrowing levels increased.
• Revenue Mix: Monitor the continued decline in higher-margin Search Fees (down to 6.7% of revenue) versus Flexible Billings, as this mix shift pressures overall gross margins.
• Cash Flow Sustainability: Assess whether operating cash flow can sustain operations without further reliance on the credit facility, especially given the $1.8 million cash balance.
• Stock Repurchase Impact: Evaluate the potential cash drain from the authorized $115 million stock repurchase program against current liquidity levels.
• Deferred Tax Assets: Review the valuation allowance on deferred tax assets and the likelihood of future profitability to utilize these carryforwards.