Kforce Inc: Form 10-Q for the period ended Jun 30, 2023

EXECUTIVE SUMMARY

The following is an executive summary of what Kforce believes are highlights as of and for the six months ended June 30, 2023, which should be considered in the context of the additional discussions herein and in conjunction with the unaudited condensed consolidated financial statements and notes thereto.

• Revenue for the six months ended June 30, 2023 decreased 6.8% to $795.2 million from $853.5 million in the comparable period in 2022. Revenue decreased 3.7% and 28.1% for Technology and FA, respectively, primarily driven by the impact of the macro environment on our business and the result of our repositioning efforts for FA.
• Flex revenue for the six months ended June 30, 2023 decreased 5.8% to $774.0 million from $821.6 million in the comparable period in 2022. Flex revenue decreased 2.9% and 27.8% for Technology and FA, respectively.
• Direct Hire revenue for the six months ended June 30, 2023 decreased 33.6% to $21.2 million from $31.9 million in the comparable period in 2022.
• Gross profit margin for the six months ended June 30, 2023 decreased 170 basis points to 28.2%, compared to June 30, 2022, as a result of a decline in the mix of Direct Hire revenue and Technology Flex gross profit margins.
• Flex gross profit margin for the six months ended June 30, 2023 decreased 90 basis points to 26.2%, compared to June 30, 2022, primarily due to a tighter pricing environment, higher healthcare costs, and business mix changes within our client portfolio.
• SG&A expenses as a percentage of revenue for the six months ended June 30, 2023 decreased to 21.7% from 22.4% in the comparable period in 2022 primarily as a result of a decrease in performance-based compensation given lower revenues.
• Net income for the six months ended June 30, 2023 decreased 24.5% to $34.8 million, or $1.77 per share, from $46.1 million, or $2.22 per share, for the six months ended June 30, 2022. The termination of our interest rate swaps in the three months ended June 30, 2022 resulted in a benefit to earnings per share of $0.14.
• The Firm returned $38.0 million of capital to our shareholders in the form of open market repurchases totaling $24.0 million and quarterly dividends totaling $14.0 million during the six months ended June 30, 2023.
• Cash provided by operating activities was $40.4 million during the six months ended June 30, 2023, as compared to $70.8 million for the six months ended June 30, 2022.

RESULTS OF OPERATIONS

Business Overview

Kforce is a leading domestic provider of technology and finance and accounting talent solutions to innovative and industry-leading companies. Our corporate headquarters is in Tampa, Florida. As of June 30, 2023, Kforce employed approximately 2,000 associates and had approximately 9,000 consultants on assignment providing flexible staffing services and solutions to our clients. Kforce serves clients across a diverse set of industries and organizations of all sizes, but we place a particular focus on serving Fortune 500 companies and other large consumers of our services.

From an economic standpoint, total and temporary employment figures and trends have historically been important indicators of staffing demand. The national unemployment rate was 3.6% at the end of June 2023 compared to 3.5% at December 2022.

Operating Results - Three and Six Months Ended June 30, 2023 and 2022

The following table presents certain items in our Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income as a percentage of revenue:

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Revenue. The following table presents revenue by type for each segment and the percentage change from the prior period (in thousands):

Our quarterly operating results are affected by the number of billing days in a quarter. The following table presents the year-over-year changes in revenue, on a billing day basis, for the last five quarters:

Flex Revenue. The key drivers of Flex revenue are the number of consultants on assignment, billable hours, the bill rate per hour and, to a limited extent, the amount of billable expenses incurred by Kforce and billable to our clients.

Flex revenue in our Technology business decreased during the three and six months ended June 30, 2023 by 7.8% and 2.9%, respectively, as compared to the same periods in 2022, primarily due to a decrease in consultants on assignment, which was partially offset by higher average bill rates. We continued to experience a softening in the demand environment in the second quarter as our clients continue to exercise restraint in initiating new technology initiatives and selectively pruning resources on existing programs against the backdrop of the current macroeconomic environment. Our average bill rates remained strong and increased 3.5% and 4.7% for the three and six months ended June 30, 2023, respectively, as compared to the same periods in 2022. We expect revenue in our Technology Flex business in the third quarter to decline sequentially in the mid-single digits and expect declines in the low double digits as we face more difficult comparisons on a year-over-year basis.

Our FA segment experienced a decrease in Flex revenue of 27.3% and 27.8% during the three and six months ended June 30, 2023, respectively, as compared to the same periods in 2022, primarily driven by the repositioning efforts of our business towards more high-skilled roles and the continued uncertainty in the macroeconomic environment. We continue to see indicators of success in this repositioning as our average bill rates continued to improve by 5.4% sequentially. In the third quarter, we expect the year-over-year decline in FA Flex revenue to approximate second quarter levels.

The following table presents the key drivers for the change in Flex revenue by segment over the prior period (in thousands):

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The following table presents total Flex hours billed by segment and percentage change over the prior period (in thousands):

Direct Hire Revenue. The key drivers of Direct Hire revenue are the number of placements and the associated placement fee. Direct Hire revenue also includes conversion revenue, which may occur when a consultant initially assigned to a client on a temporary basis is later converted to a permanent placement for a fee.

Direct Hire revenue decreased 36.3% and 33.6% during the three and six months ended June 30, 2023, respectively, as compared to the same periods in 2022, which was primarily driven by a decrease in placements stemming from the uncertainties in the macroeconomic environment.

Gross Profit. Gross profit is calculated by deducting direct costs (primarily consultant compensation, payroll taxes, payroll-related insurance and certain fringe benefits, as well as third-party compliance costs) from total revenue. There are no consultant payroll costs associated with Direct Hire placements; accordingly, all Direct Hire revenue increases gross profit by the full amount of the placement fee.

The following table presents the gross profit percentage (gross profit as a percentage of total revenue) by segment and percentage change over the prior period:

The total gross profit percentage for each of the three and six months ended June 30, 2023 decreased 170 basis points as compared to the same periods in 2022, primarily due to a decline in the mix of Direct Hire revenue and lower Technology Flex gross profit margins.

Flex gross profit percentage (Flex gross profit as a percentage of Flex revenue) provides management with helpful insights into the other drivers of total gross profit percentage driven by our Flex business, such as changes in the spread between the consultants’ bill rate and pay rate, changes in payroll tax rates or benefits costs, as well as the impact of billable expenses, which provide no profit margin.

The following table presents the Flex gross profit percentage by segment and percentage change over the prior period:

Our Flex gross profit percentage decreased 90 basis points for each of the three and six months ended June 30, 2023 as compared to same periods in 2022.

• Technology Flex gross profit margin decreased 100 and 90 basis points for the three and six months ended June 30, 2023, respectively, as compared to the same periods in 2022, primarily due to a tighter pricing environment, higher healthcare costs and business mix changes within our client portfolio. We expect Technology Flex gross profit margins for the third quarter to be stable with second quarter levels.
• FA Flex gross profit margins were flat for the three and six months ended June 30, 2023 as compared to the same periods in 2022.

The following table presents the key drivers for the change in Flex gross profit by segment over the prior period (in thousands):

SG&A Expenses. Total compensation, commissions, payroll taxes and benefit costs as a percentage of SG&A represented 85.6% and 85.1% for the three and six months ended June 30, 2023, respectively, as compared to 85.7% and 85.0% for the comparable periods in 2022, respectively. Commissions and bonus incentives are variable costs driven primarily by revenue and gross profit levels. Therefore, as those levels change, these expenses would also generally be anticipated to change.

The following table presents components of SG&A expenses, and expressed as a percentage of revenue (in thousands):

(1) Includes credit loss expense, lease expense, professional fees, travel, telephone, computer, and certain other expenses.

SG&A as a percentage of revenue decreased 70 basis points for each of the three and six months ended June 30, 2023, as compared to the same periods in 2022, primarily due to a decrease in performance-based compensation given lower overall revenue and gross profit levels, and lower professional fees.

Despite the uncertainties in the macroeconomic environment, we are continuing to prioritize investments in our strategic initiatives, including our integrated strategy and multi-year efforts to transform our back office, but are exercising tighter discretionary spend control, taking certain actions to align our costs with the lower revenue levels and generating other cost efficiencies, where appropriate.

Depreciation and Amortization. The following table presents depreciation and amortization expense and percentage change over the prior period by major category (in thousands):

Other Expense (Income), Net. Other expense, net for the three and six months ended June 30, 2023 was $0.3 million and $1.4 million, respectively. Other income, net for the three and six months ended June 30, 2022 was $2.7 million and $1.2 million, respectively. This line item primarily includes interest expense related to outstanding borrowings under our Amended and Restated Credit Facility and our proportionate share of losses related to our equity method investment prior to the sale of our noncontrolling interest in WorkLLama in February 2023, as discussed below.

During the three and six months ended June 30, 2023, our proportionate share of losses related to our equity method investment was nil and $0.8 million, respectively. During the three and six months ended June 30, 2022, our proportionate share of losses related to our equity method investment was $1.0 million and $1.8 million, respectively. On February 23, 2023, Kforce sold its 50% noncontrolling interest in WorkLLama to an unaffiliated third party. Refer to Note A - “Summary of Significant Accounting Policies” in the Notes to Unaudited Condensed Consolidated Financial Statements, included in Item 1 of this report, for more details.

During the three and six months ended June 30, 2022, Other income, net also includes a $4.1 million gain recognized as a result of the termination of an interest rate swap agreement in May 2022. Refer to Note J - “Derivative Instrument and Hedging Activity” in the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data, for a complete discussion of the interest rate swap derivative instruments.

Income Tax Expense. Income tax expense as a percentage of income from operations, before income taxes (our “effective tax rate”) for the six months ended June 30, 2023 and 2022 was 27.5% and 26.6%, respectively. The primary differences between the U.S. statutory rate and our effective tax rate are related to state taxes and other nondeductible items such as Internal Revenue Code Section 162(m).

Non-GAAP Financial Measures

Free Cash Flow. “Free Cash Flow,” a non-GAAP financial measure, is defined by Kforce as net cash provided by operating activities determined in accordance with GAAP, less capital expenditures. Management believes this provides an additional way of viewing our liquidity that, when viewed with our GAAP results, provides a more complete understanding of factors and trends affecting our cash flows and is useful information to investors as it provides a measure of the amount of cash generated from the business that can be used for strategic opportunities, including investing in our business, repurchasing common stock, paying dividends or making acquisitions. Free Cash Flow is limited, however, because it does not represent the residual cash flow available for discretionary expenditures. Therefore, we believe it is important to view Free Cash Flow as a complement to (but not a replacement of) our Unaudited Condensed Consolidated Statements of Cash Flows.

The following table presents Free Cash Flow (in thousands):

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**Adjusted EBITDA. “**Adjusted EBITDA,” a non-GAAP financial measure, is defined by Kforce as net income before depreciation and amortization, stock-based compensation expense, interest expense, net, income tax expense, loss from equity method investment, gain from swap termination, and certain other items as specified in the table below. Adjusted EBITDA should not be considered a measure of financial performance under GAAP. Items excluded from Adjusted EBITDA are significant components in understanding and assessing our past and future financial performance, and this presentation should not be construed as an inference by us that our future results will be unaffected by those items excluded from Adjusted EBITDA. Adjusted EBITDA is a key measure used by management to assess our operations including our ability to generate cash flows and our ability to repay our debt obligations and management believes it provides a good metric of our core profitability in comparing our performance to our competitors, as well as our performance over different time periods. Consequently, management believes it is useful information to investors. The measure should not be considered in isolation or as an alternative to net income, cash flows or other financial statement information presented in the consolidated financial statements as indicators of financial performance or liquidity. The measure is not determined in accordance with GAAP and is thus susceptible to varying calculations. Also, Adjusted EBITDA, as presented, may not be comparable to similarly titled measures of other companies.

In addition, although we excluded amortization of stock-based compensation expense because it is a non-cash expense, we expect to continue to incur stock-based compensation in the future and the associated stock issued may result in an increase in our outstanding shares of stock, which may result in the dilution of our shareholder ownership interest. We suggest that you evaluate these items and the potential risks of excluding such items when analyzing our financial position.

The following table presents a reconciliation of net income to Adjusted EBITDA (in thousands):

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LIQUIDITY AND CAPITAL RESOURCES

To meet our capital and liquidity requirements, we primarily rely on our operating cash flows and borrowings under our credit facility. At June 30, 2023 and December 31, 2022, we had $24.6 million and $25.6 million outstanding under our Amended and Restated Credit Facility, respectively, and the borrowing availability was $174.2 million and $173.1 million, respectively, subject to certain covenants.

Cash Flows

We are principally focused on generating positive cash flows from operating activities, investing in our business to sustain our long-term growth and profitability objectives, and returning capital to our shareholders through our quarterly dividends and common stock repurchase program.

Cash provided by operating activities was $40.4 million during the six months ended June 30, 2023, as compared to $70.8 million during the six months ended June 30, 2022. Our largest source of operating cash flows is the collection of trade receivables, and our largest use of operating cash flows is the payment of our associate and consultant compensation. The year-over-year decrease in cash provided by operating activities was primarily driven by lower profitability levels and the timing of payments.

Cash used in investing activities during the six months ended June 30, 2023 was $0.8 million and primarily consisted of the proceeds from the sale of our joint venture interest of $5.1 million, partially offset by cash used for capital expenditures of $5.0 million. Cash used in investing activities was $6.0 million during the six months ended June 30, 2022, and primarily consisted of cash used for capital expenditures and contributions to our joint venture.

Cash used in financing activities was $39.6 million during the six months ended June 30, 2023, compared to $131.8 million during the six months ended June 30, 2022. The change was primarily driven by the repayment of $100.0 million outstanding on our Amended and Restated Credit Facility in the prior period.

The following table presents the cash flow impact of the common stock repurchase activity (in thousands):

During the six months ended June 30, 2023 and 2022, Kforce declared and paid quarterly dividends of $13.9 million ($0.72 per share) and $12.2 million ($0.60 per share), respectively, which represents a 20% increase on a per share basis. While the Board has declared and paid quarterly dividends since the fourth quarter of 2014, and intends to in the foreseeable future, dividends will be subject to determination by our Board each quarter following its review of, among other things, the Firm’s current and expected financial performance as well as the ability to pay dividends under applicable law.

We believe that existing cash and cash equivalents, operating cash flows and available borrowings under our Amended and Restated Credit Facility will be adequate to meet the capital expenditure and working capital requirements of our operations for at least the next 12 months and give us the flexibility to continue returning significant capital to our shareholders. However, a material deterioration in the economic environment or market conditions, among other things, could adversely affect operating results and liquidity, as well as the ability of our lenders to fund borrowings. Actual results could also differ materially from these indicated as a result of a number of factors, including the use of currently available resources for capital expenditures, investments, additional common stock repurchases or dividends.

Credit Facility

On October 20, 2021, the Firm entered into the Amended and Restated Credit Facility, which has a maximum borrowing capacity of $200.0 million, and subject to certain conditions and the participation of the lenders, may be increased up to an aggregate additional amount of $150.0 million. As of June 30, 2023, $24.6 million was outstanding and $174.2 million was available on our Amended and Restated Credit Facility, and as of December 31, 2022, $25.6 million was outstanding. As of June 30, 2023, we were in compliance with all of our financial covenants contained in the Amended and Restated Credit Facility as described in the 2022 Annual Report on Form 10-K, and currently expect that we will be able to maintain compliance with these covenants.

In June 2023, Kforce entered into the First Amendment to the Amended and Restated Credit Agreement, among Wells Fargo, as administrative agent, and the lenders and financial institutions from time to time party thereto, to replace the LIBOR-based benchmark interest rates with the SOFR Rate. Refer to Note G - “Credit Facility” in the Notes to Unaudited Condensed Consolidated Financial Statements, included in this report, for a complete discussion of our Amended and Restated Credit Facility.

In April 2017 and March 2020, Kforce entered into two forward-starting interest rate swap agreements to mitigate the risk of rising interest rates. As of June 30, 2023 and 2022, the Firm did not have any outstanding interest rate swap derivative instruments. Refer to Note J - “Derivative Instrument and Hedging Activity” in the Notes to Unaudited Condensed Consolidated Financial Statements, included in this report, for a complete discussion of our interest rate swaps.

Stock Repurchases

In February 2023, the Board approved an increase in our stock repurchase authorization, bringing the total authorization to $100.0 million. During the six months ended June 30, 2023, Kforce repurchased approximately 422 thousand shares of common stock on the open market at a total cost of approximately $24.0 million and $84.9 million remained available for further repurchases under the Board-authorized common stock repurchase program at June 30, 2023.

As a result of the newly enacted IRA, the Company recorded a 1% nondeductible excise tax on certain repurchases of stock, net of issuances. The IRA is not expected to have a material impact on our cash flows, results of operations or financial position. Refer to Note A - “Summary of Significant Accounting Policies” in the Notes to Unaudited Condensed Consolidated Financial Statements, included in Item 1 of this report, for a complete discussion of the new excise tax related to the IRA.

Contractual Obligations and Commitments

Other than the changes described elsewhere in this Quarterly Report, there have been no material changes during the period covered by this report on Form 10-Q to our contractual obligations previously disclosed in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2022 Annual Report on Form 10-K.

CRITICAL ACCOUNTING ESTIMATES

Our unaudited condensed consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of our unaudited condensed consolidated financial statements, we are required to make assumptions and estimates about future events and apply judgments that affect the reported amount of assets, liabilities, revenues, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our unaudited condensed consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, estimates, assumptions and judgments to ensure that our unaudited condensed consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

NEW ACCOUNTING STANDARDS

Refer to Note A - “Summary of Significant Accounting Policies” in the Notes to Unaudited Condensed Consolidated Financial Statements, included in Item 1. Financial Statements of this report for a discussion of new accounting standards.

With respect to our quantitative and qualitative disclosures about market risk, there have been no material changes to the information included in Part II, Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in our 2022 Annual Report on Form 10-K.

Evaluation of Disclosure Controls and Procedures

As of June 30, 2023, we carried out an evaluation required by Rules 13a-15 and 15d-15 under the Exchange Act (the “Evaluation”) under the supervision and with the participation of our CEO and CFO, of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15 and 15d-15 under the Exchange Act (“Disclosure Controls”). Based on the Evaluation, our CEO and CFO concluded that the design and operation of our Disclosure Controls were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is: (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms; and (2) accumulated and communicated to management, including the principal executive officer and the principal financial officer, as appropriate, to allow timely decisions regarding disclosure.

Changes in Internal Control over Financial Reporting

Management has evaluated, with the participation of our CEO and CFO, whether any changes in our internal control over financial reporting that occurred during our last fiscal quarter have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on the evaluation we conducted, management has concluded that no such changes have occurred.

Inherent Limitations of Internal Control Over Financial Reporting

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

CEO and CFO Certifications

Exhibits 31.1 and 31.2 are the Certifications of the CEO and the CFO, respectively. The Certifications are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section 302 Certifications”). This section contains the information concerning the Evaluation referred to in the Section 302 Certifications and this information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.