Kforce Inc. 2018 Form 10-K Summary
Business Context and Reporting Period
Kforce provides professional staffing and solutions through Technology (Tech), Finance and Accounting (FA), and Government Solutions (GS). Services are delivered primarily on a temporary “Flex” basis, with smaller Direct Hire and GS product businesses. The filing covers the fiscal year ended December 31, 2018, with comparisons to 2017 and 2016. Substantially all revenue is generated in the United States. Kforce had approximately 2,400 associates and 11,400 consultants on assignment at year-end.
- Tech represented 69.8% of revenue; FA represented 22.1%; GS represented 8.1%.
- The 10 largest clients generated approximately 25% of revenue; no single client exceeded 5%.
- Approximately 96% of revenue was Flex, 3.2% was Direct Hire, and 1.2% was GS product revenue.
Financial Performance and Key Metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $1.418 billion | $1.358 billion | +4.4% |
| Gross profit | $418.6 million | $408.1 million | +2.6% |
| Gross margin | 29.5% | 30.0% | -50 bps |
| Operating income | $81.7 million | $68.6 million | +19.0% |
| Operating margin | 5.8% | 5.1% | +70 bps |
| Net income | $58.0 million | $33.3 million | +74.2% |
| Diluted EPS | $2.30 | $1.30 | +76.9% |
| Cash flow from operations | $87.7 million | $29.3 million | +199.1% |
| Free cash flow | $82.6 million | $23.5 million | +251.4% |
| Adjusted EBITDA | $98.7 million | $85.2 million | +15.8% |
SG&A declined to 23.2% of revenue from 24.4%, reflecting improved associate productivity, performance-based compensation changes, lower revenue-generating headcount, prior restructuring benefits, and expense discipline. Flex gross margin declined to 26.8% from 27.2%, primarily because of lower GS profitability.
Segment and Other Material Changes
- Tech: Revenue increased 9.1% to $990.1 million, including 9.4% growth in Tech Flex revenue. Tech gross margin was 28.0%, compared with 28.3% in 2017.
- FA: Revenue declined 9.3% to $313.8 million, driven primarily by lower volumes of lower-bill-rate assignments and a shift toward higher-skill opportunities. FA gross margin improved to 34.8% from 34.2%.
- GS: Revenue increased 9.7% to $114.4 million, but gross margin declined to 28.1% from 31.1%. GS Flex gross margin fell to 22.7% from 27.0% because of bill/pay spread compression, higher benefit costs, and lower profitability on newer contracts.
- Direct Hire revenue decreased 4.2% to $45.7 million, while placements declined 10.8% to 3,116; the average fee per placement increased 7.4% to $14,662.
- GS backlog declined to $47.4 million from $59.3 million and excludes renewal options and unfunded work.
- Kforce adopted ASC 606 using the modified retrospective method. The adoption reduced opening retained earnings by approximately $0.2 million, net of tax, and did not materially affect 2018 consolidated results.
- The 2017 sale of Kforce Global Solutions was completed before the current period; 2017 included a $3.3 million gain on sale.
Liquidity, Debt, Capital Allocation, and Outlook
- Working capital was $158.1 million at December 31, 2018, compared with $161.7 million in 2017. Cash and cash equivalents were only $0.1 million.
- Credit facility borrowings declined to $71.8 million from $116.5 million. The facility has $300 million of capacity, matures May 25, 2022, and had $225.0 million of availability at year-end, subject to covenants and letters of credit.
- The company maintained compliance with its fixed-charge coverage and leverage covenants and was not restricted from repurchases or distributions at year-end.
- Kforce repurchased 553,000 shares on the open market for approximately $15.7 million and had $92.9 million remaining under its repurchase authorization at year-end.
- Dividends increased to $0.60 per share for 2018 from $0.48, including a quarterly increase from $0.12 to $0.18 during the second half of the year.
- Management stated that existing cash, operating cash flow, and available borrowings should meet operating and capital requirements for at least the next 12 months, subject to economic conditions, acquisitions, and additional repurchases.
- Management expected continued Tech growth, FA revenue to remain stable or decline slightly, and GS revenue to grow in 2019. A GS subcontract awarded in October 2018 with an estimated value of $150 million to $200 million was protested; on February 21, 2019, the protest was sustained, creating uncertainty regarding the award and related revenue.
Risks, Contingencies, and Unusual Items
- Demand is sensitive to U.S. economic and employment conditions, client project decisions, billing days, seasonality, and consultant availability.
- Key risks include competition and pricing pressure, wage and payroll cost inflation, worker classification, employment claims, immigration restrictions, cybersecurity and privacy incidents, information-system failures, and difficulty recruiting qualified consultants.
- Government business is exposed to federal budget reductions, shutdowns, sequestration, procurement changes, contract protests, audits, funding delays, security-clearance requirements, and potential suspension or debarment.
- Legal proceedings arise in the ordinary course. Management does not currently expect existing matters to have a material effect, although litigation outcomes are inherently uncertain.
- Executive employment agreements could require approximately $32.6 million of payments if all covered executives were terminated without cause or resigned for good reason following a change in control; the comparable estimate absent a change in control was $14.1 million.
- The company maintains an interest-rate swap with a $65.0 million notional amount for the first three years, declining to $25.0 million thereafter, to mitigate variable-rate debt exposure. A hypothetical 10% increase in interest rates would have increased annual interest expense by less than $0.2 million based on year-end debt.
- No goodwill impairment was recorded in 2018. Future impairment remains possible if operating results, economic conditions, or valuation assumptions deteriorate.
- Kforce expected to recognize approximately $17.6 million of right-of-use assets and $21.0 million of lease liabilities upon adopting the new lease standard on January 1, 2019.
Important Facts for Investors to Verify
- Whether Tech growth offsets continuing FA declines and whether GS margin compression stabilizes.
- The outcome and revenue impact of the sustained protest involving the estimated $150 million to $200 million GS subcontract.
- Accounts receivable collection trends, given $234.9 million of net receivables and minimal cash on hand.
- Compliance with credit facility leverage and fixed-charge coverage covenants as debt, dividends, and repurchases continue.
- The sustainability of 2018 earnings growth after considering the lower effective tax rate of 24.9%, compared with 48.1% in 2017, largely due to the Tax Cuts and Jobs Act.
- The effect of new lease accounting, ongoing technology investments, consultant wage and benefit costs, and potential goodwill impairment on future margins and cash flow.