Kforce Inc. (KFRC) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q1 2018 Kforce Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Michael Blackman, Chief Corporate Development Officer. Sir, you may begin.

Good afternoon. Before we get started, I would like to remind you that this call may contain certain statements that are forward-looking. These statements are based upon current assumptions and expectations and are subject to risks and uncertainties. Actual results may vary materially from the factors listed in Kforce's public filings and other reports and filings with the Securities and Exchange Commission. We cannot undertake any duty to update any forward-looking statements. I would now like to turn this call over to David Dunkel, Chairman and Chief Executive Officer. Dave?

Thank you, Michael. You can find additional information about this quarter's results in our Earnings Release and our SEC filings. In addition, we have published our prepared remarks within the Investor Relations portion of our website. I will provide some high-level opening remarks on our first quarter results and operating environment and will then turn it over to Joe Liberatore, President, who will give greater detail into our operating results and trends and then Dave Kelly, CFO, who will add color on first quarter results and provide guidance on Q2. We are very pleased with our first quarter results, especially with the continued acceleration of growth in our Tech Flex business and the significant progress we are making towards meeting our previously stated profitability objectives. The actions to focus the efforts of our sales and delivery talent more broadly across our portfolio of clients is benefiting both revenue growth and margin stability more rapidly than we had anticipated, which contributed positively to our first quarter results. Flex gross profit margins in both Tech Flex and FA Flex improved on a year-over-year basis, which along with lower SG&A costs, resulted in a year over year improvement of 80 basis points in operating margin. Also, when combined with the lower effective tax rate, earnings per share increased 60% year-over-year. The demand environment continues to be very strong and we believe we are very well positioned to capitalize on this growth. Though the recent headline for GDP was slightly lower than anticipated, business spending is robust and many leading economists expect continued strong growth. We have seen some increase in spending since the passage of the recent tax reform legislation, but anticipate that this may accelerate going forward. Companies across virtually all industries and of all sizes are experiencing competitive dynamics requiring technology investments to enhance their customer experiences in this rapidly changing marketplace. We believe these secular drivers will actually transcend traditional cyclical patterns as business models are transformed. Big data, artificial intelligence and machine learning continue to be in high demand, as well as cloud computing, cybersecurity, mobility and digital marketing. Again, we expect that the need for increasing technology investments across all industries will continue for the foreseeable future. To meet this demand, companies are continuing to look to flexible solutions and partners that have the infrastructure to provide quality and timely talent and are also able to meet increasingly stringent compliance requirements. As we look to Q2, we look forward to achieving the first milestone in our objective of significantly improved profitability and accelerating revenue growth. We also expect to continue to invest in technology that equips our organization with improved capabilities to deliver exceptional service to our clients, candidates and consultants while increasing the productivity of our associates. I'll now turn the call over to Joe Liberatore, President to provide further details. Joe?

Thank you, Dave and thanks to all of you for your interest in Kforce. The results for the first quarter of 2018 reflect our continued efforts to bring consistency to our operating model and align our activities to the places of greatest value to our clients and consultants. We have made significant progress in our Tech Flex business, which is roughly two-thirds of overall revenues. The year-over-year growth rate in this business accelerated to 6.7% in the first quarter from 5.4% last quarter. After considering the loss of revenue from the divestiture of our Global business in the third quarter of 2017, our core Tech Flex business grew 8.1%, which is roughly twice the projected industry growth rate. This is due to an increase in start activity that allowed us to rebound from year-end assignment ends at the fastest rate in this economic cycle. This momentum has been carried into the early second quarter. We have been working diligently on better segmenting and diversifying our client portfolio and optimizing the alignment of our sales and delivery talent within our client portfolio. Fortune 1000 companies continue to be the largest consumers of flexible technology talent. Our revenue growth over the last several quarters has been largely a result of our broader diversification efforts beyond our few largest clients and deeper into other Fortune 1000 customers where we have established relationships. This focus on clients with whom we have established relationships, better enable us to understand the technology issues they are facing and to craft solutions. As a result, engagements structured under statements of work continue to be a key focus area within our portfolio. From an industry standpoint, we experienced growth in virtually all of our industries, so growth was broad-based. This strategy is well supported by our mature centralized delivery platform, which allows us to deliver consultants at scale across the United States. This capability, combined with improved execution and focus in our field offices, and the application of technology has also allowed us to increase productivity levels again this quarter. While we are certainly pleased with the productivity gains, we believe additional capacity exists. For the second quarter of 2018, we expect Tech Flex revenues to grow sequentially and for year-over-year growth rates to accelerate from Q1 levels. Our FA Flex business, which represents 22% of overall revenues, declined 7.9% year-over-year. While we anticipated certain larger project ends to present headwinds in the first quarter, these ends were greater than we anticipated. New assignment starts in FA Flex also were lower than anticipated. We believe the market for FA Flex remains strong and we are focused on accelerating activity levels that should result in improving trends. We have already seen improvements due to this focus and expect second quarter revenues to be stable to slightly down and year-over-year declines to approximate first quarter levels. KGS services revenues grew 24.5% year-over-year, which was primarily driven by the increase in revenues from the two strategic prime contracts that were awarded in the third quarter of 2017. KGS product revenues, which are inherently more volatile than its services business, declined 34% year-over-year. We referenced in our last call that a significant re-compete, representing 18% of our revenue base, was scheduled for award in the first quarter. We were successful in winning this re-compete as a subcontractor, however, as is common in this business, it is currently being protested and we expect the protest to be resolved in the second quarter of 2018. KGS continues to operate in a cost competitive environment and this re-compete is expected to put pressure on KGS' margins going forward. For the second quarter, we expect KGS revenues to grow double digits on a year-over-year basis and at a growth rate that exceeds the first quarter primarily as a result of an increase in product revenues, which are expected to roughly double the low Q1 levels. Direct Hire revenues which represents roughly 3% of overall revenues, declined 1% year-over-year. Our Direct Hire business is an important capability in ensuring that we can meet the talent needs of our clients through whatever means they prefer. We expect a seasonal increase in the second quarter, but expect a decline on a year-over-year basis. We continue to make targeted investments in training, technology and other business intelligence tools that are directed towards improving the experience of our clients and consultants as well as improving the productivity of our people. To that end, we have improved the productivity of our revenue-generating talent by approximately 11% year-over-year and we believe significant capacity exists to continue growing revenue. Associate headcount in the quarter grew slightly sequentially, but has declined 7.2% year-over-year. We expect associate headcount levels to be stable in the second quarter with first quarter levels as we further accelerate revenue growth. Our success is tied to our ability to consistently improve associate productivity by ensuring they are engaging with the right customers and arming them with the best tools and leadership. I will now turn the call over to Dave Kelly, Kforce's Chief Financial Officer, who will provide additional insights on operating trends and expectations.

Revenues of $346.3 million grew 3.7% year-over-year and earnings per share of $0.37 improved 60% year-over-year. Our gross profit percentage in the quarter of 28.9% declined 20 basis points year-over-year, though staffing flex margins have improved. The decline in gross profit margins was driven by a lower percentage of Direct Hire and KGS product revenues versus Q1 last year. Our Flex gross profit percentage of 26.3% improved 10 basis points year-over-year, which was driven by a 30 basis point improvement in both Tech and FA Flex margins, which offset a 50 basis point decline in our KGS service business. We have now seen a sequential improvement in bill pay spreads in three of the last four quarters in our staffing business, which reflects both strong demand and our success in pricing discipline and further penetrating higher margin accounts. As a footnote, shared initially last quarter, the sale of our low bill rate Global operations in second half of 2017 has resulted in a substantial improvement in our Tech Flex average bill rate, which has increased from $67 to $72. Not only is our core Tech Flex business growing at a faster rate, excluding the Global operations, as Joe mentioned, but the resulting higher rates will help drive more gross margin dollars as we grow. Technology bill rates, normalized for the Global divesture, have grown approximately 3% year-over-year. Gross margins will benefit sequentially from higher levels of direct hire and product revenues, which will offset slightly lower flex margins in KGS. Second quarter Flex margins are expected to be stable in our Tech and FA Flex businesses after taking into account the improvement in Q2 from Q1 of seasonal payroll taxes. Flex margins in our Government services business will see further compression as a result of a full quarter of revenues under the recent re-compete. SG&A expenses as a percent of revenue declined 100 basis points year-over-year to 24.4% in the first quarter of 2018. We continue to make progress in generating SG&A leverage by significantly improving productivity and controlling expenses. This has allowed us to significantly increase our investments in technology while continuing to improve operating margins. Looking forward into Q2, SG&A dollars spent should be essentially flat year-over-year on significantly greater revenues. We will continue to make additional investments in technology, with a focus on improving the candidate and consultant experience and further expanding our business intelligence capabilities. While these investments will have up-front costs, they are directly linked to generating additional productivity improvements. We are also aggressively pursuing opportunities to partner with leading technology firms to embrace applications that enhance our customer experience and improve productivity and relationships. First quarter 2018 operating margins of 3.9%, improved 80 basis points year-over-year. Our effective tax rate in the first quarter of 25.1% was slightly lower than we had anticipated as a result of higher anticipated tax credits and the vesting of share-based compensation awards. As it relates to our effective income tax rate on a go-forward basis, we expect this will track closer to 26% for the remainder of 2018. With respect to our balance sheet and cash flows, operating cash flows in the first quarter, which is typically our lowest cash flow quarter, were $10.3 million. Long Term debt under our Credit Facility at the end of March was $123.2 million. Capital Expenditures in the first quarter were $1.5 million. We repurchased roughly 318 thousand shares for $8.7 million during the quarter and paid approximately $3 million in dividends. We will continue to balance the utilization of this cash and other available capital between investing in the long-term growth of our business through technology investments, potential tuck-in and strategic acquisitions, investments in strategic partnerships, reducing debt levels and returning capital to our shareholders. The second quarter of 2018 has 64 billing days, which is equal to Q1 of 2018 and Q2 of 2017. With respect to guidance, we expect Q2 revenues to be in the range of $355 million to $360 million and for earnings per share to be between $0.62 and $0.65. Gross margins are expected to be between 30% and 30.2%, while flex margins are expected to be between 27% and 27.2%. SG&A as a percent of revenue is expected to be between 23% and 23.2%. As Dave noted in his opening remarks, our guidance for the second quarter reflects our expectation to achieve the first milestone in our commitment to improve our profitability. In the second quarter, we expect to exceed $350 million in revenues and operating margins are forecasted to be between 6.3% and 6.5%. Guidance assumes an effective tax rate of 26%. The high end of guidance also contemplates Tech Flex year-over-year growth rates that are approaching 10%. Weighted average diluted shares outstanding are expected to be approximately 25 million for Q2. This guidance does not consider the effect, if any, of charges related to the impairment of intangible assets, any onetime costs, costs related to any pending tax or legal matters, the impact on revenues of any disruption in government funding, or the Firm's response towards regulatory, legal or future tax law changes. We are pleased with the continued acceleration in our Tech Flex business and believe we have a solid foundation for sustained revenue growth and continued improvements in profitability. Sequentially, our operating margin is expected to benefit from the leverage gained from revenue growth, greater levels of more profitable Direct Hire and KGS Product revenues, lower seasonal payroll taxes, improved associate productivity and continued SG&A expense discipline. We expect to make continued incremental improvements in meeting our next milestone of 7.5% in a quarter, without seasonality impacts, where revenues reach $400 million. We continue to believe we are in businesses that will remain in significant demand and are excited about our future prospects. Victor, we'll now take questions.

Yes, sir. [Operator Instructions] And our first question comes from the line of Tobey Sommer from Suntrust. You may begin.

Revenue growth, you mentioned productivity improvements and see continued opportunity for that, but I'm curious to what degree are you increasing the headcount of your revenue generating staff or maybe in addition to that question, when might you have to if you were able - if the market will let you kind of have this relatively elevated rate of revenue growth.

Yeah, Tobey, it's Joe. I would say we have a long to go in terms of productivity opportunity within our existing population. We've been rebalancing sales delivery and also the alignment of our various associates within our portfolio realignment and we think through those activities that we have ample capacity. So we'd stated back in the beginning of the year that our objective was keep pay count flat through the first half of the year. We remain consistent with that approach and then we'll evaluate where we are coming out of the back end of the year, but even if we were to ramp up headcount, I don't see us significantly ramping it up through this second half of the year.

Okay, that's helpful. Could you give us a little bit more color about the product business at KGS and maybe extend - do you have visibility as to what that will look like in the back half of the year or it's really kind of a quarter-to-quarter as far as the timing?

Yeah, I would say, as I stated in my opening comments, we're expecting to basically double that revenue in the second quarter. And I think as we look out through the remainder of the year, we look at that being pretty consistent in the second half of the year at those rates. It's just - it's tough to say how it might balance between Q3 and Q4.

Okay and in the Tech Flex business were there any large projects or anything that might have helped to contribute to the improvement in growth that we should keep an eye or have in mind as we model out the next several quarters?

Yeah, it was widespread, so, no, in the quarter it was really across all geographies. A lot of concentration within what we call our major portfolio, which are the up incomer accounts, so I would attribute it to the team just as - I mean they're just executing. They're hitting on all cylinders and its pure execution.

Yeah, Tobey, this is Dave Kelly. I would add to that as Joe talks about that success we have in our major accounts as we've touched on earlier. It also has provided us a bit of a lift as we think about the distribution of the growth that we've seen across the portfolios. We move beyond those first couple of clients which happen to be slightly lower margin and broadened us and further penetrated these major clients is providing us part of that lift we're seeing in gross margins in Tech Flex and in FA Flex, so it's got that dual benefit.

Okay, thank you. Is the bill rate momentum that you've seen in the reported quarters including the last four [ph], are you seeing signs that that momentum can continue?

Yeah, Tobey, Dave, just further to that, to the extent that we continue to execute on the strategy that we're successfully executing on, yeah, I think we see opportunity. We're on a good run here, we feel good about where the second quarter has started. With the start we said that we see a relatively stable gross margin environment and I would say, we said a gross margin environment in Tech and FA Flex that is stable maybe with a downer bias. I would say right now as it relates to our execution, I would take away that comment negative bias frankly in the near term.

Thank you very much, very helpful.

And our next question comes from the line of John Healey from Northcoast. You may begin.

Thank you. You might have mentioned this earlier in the call, I might have missed it, but could you guys give me some color about maybe what the storms might have cost you, the harsh amount of weather on the East Coast, was it a headwind in the quarter and was it material in maybe the performance have been even better as far as we don't have mother nature working against us.

Hey, John, Dave Kelly, certainly we're highly concentrated on the East Coast, but nominal, not a huge impact, not more than any particular year really.

Okay, great. And if I'm kind of thinking about some of the moving parts that you talked to for the government business in terms of how they're performing in 2Q [ph] as well as the F&A performance. It's kind of like a high single digit organic growth rate for the Flex businesses, am I backing into that kind of the right way and just if you could help us there a little bit.

So John, I would say first of all, hard to predict the government business because these are big wins that have led to 25% growth rates in the fourth quarter and the first quarter. So to the extent we've won big contracts and we continue to - if it tends to steer step up, certainly our expectation because of the wins that we had in continuation of those contracts points a year of high single digit growth certainly for our government business for the year in 2018 relative to '17 in the service business certainly.

And John, this Dave Dunkel. I think you're asking about the Tech Flex business. Yeah, high single digits and as Dave mentioned in his prepared remarks and our high level of guidance approaching 10% and we've seen the acceleration which is I think as Joe said earlier the result of a really disciplined execution. Our team's done a great job.

Yeah, this is Joe and I'll close out on the last piece of that. You were asking about the FA Flex business. As I mentioned in opening remarks, very project specific, the team is organizing in and around that and execution has gone to another level, so we're very confident as we look to the back half of the year that will turn positive from a growth standpoint there as well.

Great, thank you for that. I apologize I chimed in a few minutes late.

Not to worry.

Thank you. [Operator Instructions] And we have a follow up from Tobey Sommer. You may begin.

Thanks. I was wondering just if you could update us on the way the company is utilizing the national recruiting center currently and how it - if that usage and value has changed at different points of this expansion, just kind of frame your thoughts if you could kind of - how you see that adding value to the firm now versus three or seven years ago? Thanks.

It's a great question, realizing. We've been after the methodology going back to the better part of about 18 years now with the national recruiting center really being a byproduct of our Dotcom initiatives as we saw technology really coming into the business. So there's been a lot of lessons learned and a lot of refinement. I want to be a little bit careful here because we have a lot of people looking to replicate what we've done. Although replication is not as simple as just standing it up because a big part of it is the adoption and the teamwork and the buy in, so that's probably the biggest thing that's changed in the last three years is just the cultural aspect and the alignment in and around very specific clients where we have a lot of deeper relationships now and very stable teams. So I'd say the stability the teams focused on key customers and how that all interacts with our field operations is really the main driver.

Okay, in terms of the Tech Flex landscape, do you have an opinion about how IT staffing and Tech Flex is performing relative to other methods that your customers can execute their IT projects. In other words, are there any - do you have an opinion about kind of share that IT staffing maybe either gaining or losing relative to consulting, offshore and outsourcing, those other kind of alternative methods.

Yeah, Tobey, this is Dave. I would say that there's a couple of things that we're seeing. Number one, the demand is so far exceeding supply and the availability of the project resources that clients are actually looking at lots of different ways to address those needs. As Joe mentioned, we've seen an increase in the statement of work business, we're actually delivering teams of people to bring resources to benefit some purely substantial clients and substantial projects. So I would say, it's really a balance. Certainly there's been a lot of political pressure if you will, to keep those resources onshore, so I think many of the customers are very cognizant of that as they're evaluating where they're going to put the talent. But in general I would say that they're using a mix of services and we have not seen any indication whatsoever of a shift out of IT staffing and in fact if anything I would say that that demand is greater than it's ever been and morphing now into the statement of work businesses we've mentioned. So our customers are bringing us there as a result of their needs and because of our capabilities in bringing these large scale projects and the teams together, it's actually worked to our advantage.

Great, thank you very much.

Thank you. And I'm showing no further questions at this time. I'll now like to turn the call back to Mr. David Dunkel, Chairman and CEO.

Thank you very much and thank you for your interest and support for Kforce. I like to again say thank you to each and every member of our field and corporate teams and to our consultants and our clients for allowing us the privilege of serving you. Great job this quarter guys, thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.