Kforce Inc. (NASDAQ:KFRC) Q1 2024 Earnings Call Transcript

Kforce Inc. (NASDAQ:KFRC) Q1 2024 Earnings Call Transcript April 29, 2024

Kforce Inc. reports earnings inline with expectations. Reported EPS is $0.58 EPS, expectations were $0.58. Kforce Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, everyone, and welcome to the Kforce First Quarter 2024 Earnings Call. Today’s call is being recorded. I would now like to turn the call over to Joe Liberatore, President and CEO. Please go ahead, sir.

Joe Liberatore: Good afternoon. Thank you for your time today. This call contains certain statements that are forward-looking and 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 SEC. We cannot undertake any duty to update any forward-looking statements. You can find additional information about our results in our earnings release and our SEC filings. In addition, we have published our prepared remarks within our Investor Relations portion of our website. Our first quarter performance was generally consistent with our expectations, and we were encouraged by March trends in our Technology business.

Operating trends over the past two quarters and discussions with our clients indicate to us that the current operating environment is more stable and constructive than it was throughout most of 2023. There remains uncertainty as to whether or not the U.S. economy will fall into a recession. The dialogue surrounding interest rate cuts has shifted from a discussion referencing the number of anticipated cuts and when we should expect cuts in 2024 to if there will be any cuts at all this year. Geopolitical concerns, including the war in Ukraine, the recent expansion of the war in Israel with Iran’s aggression, further complicate forward-looking visibility. Against this backdrop, our clients, broadly speaking, have continued to exercise a degree of caution initiating new technology investments.

Importantly, this restraint does not appear to be increasing but rather appears to be fairly stable. As we look beyond the current uncertainties, we continue to be encouraged by the backlog of strategic imperative investments that we expect to be high priorities for our clients once the macro uncertainties begin to clear. Technology investments are simply not optional in today’s competitive and disruptive business climate. Given the secular underpinnings, there is simply no other market we want to be focused in other than the technology talent solutions space. As we move throughout the upcoming second quarter and second half of 2024, we will closely monitor our performance indicators and trends and make any necessary adjustments to our business while continuing to invest in our long-term strategic priorities and retain our most productive associates.

As to our first quarter results, revenues and earnings per share were both within our range of guidance. The improvement in our leading indicators that we spoke about on our last call translated into reasonably robust new assignment growth in March 2024, which encouragingly is expected to lead to sequential growth in our Technology business in the second quarter at levels close to historic seasonal pre-pandemic levels. Dave Kelly will expand upon our operating trends in his remarks. Our message to our people is unchanged. During these uncertain times, we must control what we can, stay close to our people and our clients while maintaining a long-term view in our decision-making. We are blessed to have a tenured executive leadership team, who has been through multiple economic cycles together and is prepared to quickly adjust to changing market conditions, and we are equally blessed to have a high performing team that is tenured, dedicated, and passionate about what they do.

While all economic cycles behave a bit differently, what remains clear is that the broad and strategic uses of technology, including the most recent technology secular shift associated with AI, will continue to evolve and play an increasingly instrumental role in powering businesses. Over the long term, we believe that AI and other technologies will continue to drive demand for, rather than replace technology resources, and the pace of change will accelerate. We are ideally positioned to meet that demand. Our core competency is rooted in the ability to identify and provide critical resources, real-time and at scale, to help world class companies solve complex problems and help them competitively transform their businesses. Our operating model also allows us to be flexible in partnering with our clients to meet their needs across a broad spectrum of engagement forms, from direct hire, traditional staffing assignments to managed team engagements and managed projects.

Our decision to grow our business organically with a consistent, refined business model tailored to provide highly skilled technology talent solutions to world-class companies has been critical to our success over many years, and we remain confident that our firm is positioned well for improving market conditions. I am tremendously proud of our team as they continue to execute with incredible passion to serve our clients, candidates, and consultants cohesively as one Kforce. I remain confident and excited about the future of Kforce. Dave Kelly, our Chief Operating Officer, will now give greater insights into our performance and recent operating trends. Jeff Hackman, Kforce’s Chief Financial Officer, will then provide additional detail on our financial results as well as our future financial expectations.

Dave?

David Kelly: Thank you, Joe. Total revenues for the first quarter were $352 million, down 7.7% sequentially and 13.3% year-over-year. Our Technology business declined 6.9% sequentially and 11.4% year-over-year. As we mentioned on our last call, following a slower start to the year and higher year-end assignment ends, we experienced an improvement in our leading indicators in late January and believed that those higher activity levels would contribute positively to new assignment starts in our Technology business later in the quarter. As expected, we experienced a notable acceleration in our consultants on assignment throughout March, which should lead to sequential growth in Q2 within the range we saw before the pandemic. Our clients continue to undertake mission critical projects and also recognize the need to retain the highly skilled talent that we provide while they await a point of increased confidence to accelerate spending to address their increasing backlog of technology initiatives.

Overall average bill rates in our technology business have remained stable over the past few quarters and continue to reflect our focus on providing highly skilled talent on both traditional staffing assignments and as part of managed teams or managed projects. Our clients remain focused on critical technology initiatives in the areas of digital, data governance, AI, and ML, UI/UX, cloud, data analytics, business intelligence, project and program management, and modernization efforts. This represents a continuation of recent trends and reflects some of the foundational work required by companies to gain the eventual benefit of AI-related investments. Flex margins of 25.3% in our Technology business declined 10 basis points sequentially and 60 basis points year-over-year.

The sequential decline was less than expected, as lower healthcare claims helped to offset the traditional annual tax resets. Our bill pay spreads continued to be stable on a sequential basis, which is an encouraging data point given the cloudiness of the economic environment. We have continued to broaden our service offerings beyond traditional staffing to include managed teams and project solutions. Clients consider access to the right talent essential to their success and see our services as a cost-effective solution for their project requirements. Our integrated strategy capitalizes on the strong relationships we have with world-class companies by utilizing our existing sales, recruiters, and consultants to provide higher value teams and project solutions that effectively and cost efficiently address our clients’ challenges.

Our client portfolio is diverse and is comprised primarily of large, market-leading companies. Market leaders typically prioritize technology investments to maintain their competitive advantage. Our focus on addressing their needs continues to be critical in our ability to drive sustainable, long-term above-market performance. Given the seasonal resets we see at year-end, a number of our industry verticals declined sequentially in the first quarter, but we saw relative stability in our retail, transportation and manufacturing verticals and some headwinds in financial services after a steady performance in the fourth quarter. Looking forward to Q2, we expect Technology consultants on assignment to remain relatively consistent with the levels we ended with in the first quarter and for revenue to increase sequentially in the low single digits.

Year-over-year revenue declines will decelerate to the mid-single digits. Our FA business, currently 8.5% of our total revenues, declined approximately 16% sequentially and declined 27% year-over-year. The year-over-year decline reflects the impact of business we are no longer supporting due to our repositioning efforts and a more challenging macro-environment environment. Our average bill rate has continued to exceed $50 per hour as we continue to drive this business towards a higher skill set of business that is more synergistic with our Technology service offering. We expect Q2 FA revenues to be down year-over-year in the mid 20% range. Flex margins in our FA business decreased 70 basis points sequentially due to a lower margin project with a strategic client but have improved 130 basis points over the last five years as our mix of business has significantly improved.

We expect bill pay spreads to remain fairly stable at these levels in Q2. We’ve taken thoughtful measures to strike a balance between associate productivity and our revenue expectations. As we’ve done in prior economic downturns, we are focused on retaining our most productive associates and making targeted investments in the business to ensure that we’re well prepared to capitalize on the market demand when it accelerates. We continue to invest in our managed teams and project solutions capabilities and the integration of those offerings within the firm, which is progressing well. While the uncertainty in the macro environment has persisted longer than many expected, I remain excited about our strategic position and ability to continue delivering above market performance.

The success that we have as a firm doesn’t happen without the unwavering trust that our clients, candidates, and consultants place in us. We’ve been able to continue delivering with strong relative performance during this difficult period, but continuing to aggressively invest in the strategic initiatives that are critical to our long-term success and expect to continue to do so. I appreciate the dedication, creativity, and resilience displayed by our incredible team. I’ll now turn the call over to Jeff Hackman, KForce’s Chief Financial Officer.

Jeffrey Hackman: Thank you, Dave. First quarter revenues of 352 million declined 13.3% year-over-year, and earnings per share of $0.58 were at the midpoint of our expectations. Overall, gross margins in the first quarter declined 20 basis points sequentially due to seasonal payroll tax resets, which was partially offset by lower healthcare costs. Margins declined 100 basis points year-over-year to 27.1% due to a combination of a lower mix of direct higher revenue and a decline in flex margins. Overall SG&A expenses as a percentage of revenue was 22.2%, which is an increase of 20 basis points year-over-year. Our variable-based compensation structure, the adjustments we made in July 2023 to reduce our structural costs to lower revenue levels, and disciplined cost management have significantly mitigated the impact of lower revenue and gross profit levels on our profitability.

With that said, we are continuing to prioritize investments in retaining our most productive associates and advancing our enterprise initiatives, both of which are expected to significantly contribute to our long-term financial objectives. Our operating margin of 4.5% was toward the high end of our expectations. Our effective tax rate in the first quarter was 27.1%, which was higher than we anticipated due to greater non-deductible expenses and adjustments to certain tax credits. Operating cash flows were approximately $13 million, and our return on invested capital was nearly 40%. We have prudently managed our business by driving solid organic growth over many years, which has resulted in consistently strong results and a pristine balance sheet with minimal debt.

Our pattern of returning significant capital to our shareholders has been consistent over many years and continued in Q1, with a total of approximately $9 million returned through dividends and share repurchases. All in, we have returned slightly more than $900 million in capital to our shareholders since 2007, which has represented approximately 75% of the cash generated, while significantly growing our business and improving profitability levels. We remain committed to returning capital regardless of the economic climate, and our threshold for any prospective acquisitions remains very high. Our strong balance sheet and the flexibility we have under our credit facility provides us with the opportunity to get more aggressive in repurchasing our stock if there is a dislocation between expected future financial performance and the valuation of our shares.

The second quarter has 64 billing days, which is the same as the first quarter of 2024 and the same as the second quarter of 2023. We expect Q2 revenues to be in a range of $352 million to $360 million, and earnings per share to be between $0.68 and $0.76 cents. Our guidance does not consider the potential impact of any other unusual or non-recurring items that may occur. We remain excited about our strategic position and prospects for continuing to deliver above market results over the long term while continuing to make the necessary investments to help drive long-term growth and enable us to achieve our longer-term profitability objective of attaining double-digit operating margins at slightly greater than 2 billion in annual revenues. On behalf of our entire management team, I’d like to extend a sincere thank you to our teams for all of their efforts.

We would now like to turn the call over for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions]. We’ll take our first question from Mark Marcon with Baird.

Mark Marcon: Hi, good afternoon, and thanks for taking my question. You mentioned that you did see some, you know, improvement in terms of your leading indicators in late January and believe those higher activity levels would contribute positively. Can you just talk a little bit more about that? Like, what exactly-which areas are you seeing the strength in? How broad-based is it? And in your client discussions, what do you think would end up resolving some of the uncertainty that they’re facing? I know the geopolitical is not within their control, but are there domestic things that they’re looking for? Thank you.

David Kelly: Yes, Mark, I’ll start. This is Dave Kelly. Yes, as you mentioned, and we actually mentioned this on the call in January, you know, we’ve seen activity levels that the front-end indicators that we typically look at, client visits, the amount of submittals. We saw a lot of increasing activity, and as a matter of fact, some of the job order flow, a lot of those activity levels were at levels that we had seen prior to the pandemic, so that was promising. And as we had indicated, you know, the expectation is the flow-through would lead to some increase in new starts activity, and that actually did occur in March. As a matter of fact, in each week in the month of March, we did see an increase. So, it is pretty typical of what we had historically seen.

Now, I’ll point out, we saw that a couple times, right? At the end of last year, we saw that in September, October. As we look into, as I commented in the prepared remarks, into the second quarter, we’re still seeing, you know, a little bit of unevenness there. So, I think clearly, as Joe said, you know, there’s certainly a fair amount of uncertainty still that we’re seeing. So, it’s probably, from our perspective, too early to call those increases a trend, per se. We want to be cautious about that. But certainly, it’s clear that things have become quite a bit more stable than they have been, and there have been some, obviously, some periods of actually greater amounts of success in activity. And I would say, I think you’d ask about where we’re seeing that.

It’s pretty broadly based. You know, we obviously do business with predominantly very large companies across effectively every industry. And I couldn’t point to any one particular industry driver or client type of a driver. You know, large companies, as we said, are big spenders in technology, and they continue to spend money on mission-critical projects. So, it’s really a client-by-client type of an evaluation you want to do. I mentioned a number of industries, but even in financial services, where I said we saw some headwinds, we actually had clients there that actually had pretty robust increases in spend. So, again, it’s an execution game for us. We’ve got the benefit of being in many clients, many market-leading clients, and execution for us in those clients in our portfolio, the strength of it across geographies has really led us to some success here over the last couple quarters, frankly.

Mark Marcon: Great. And then can you talk a little bit about, you know, pay bills spread, and specifically what are you seeing with regards to pay rates? Notice that, over the last two quarters, we’ve had a, if we’re looking at TxFLEX, you know, the hourly bill rate has come down very modestly relative to Q3 in 2023. And I’m wondering, is there some mixed change, or is there, just with a caution maybe and some overcapacity in the industry, slight price pressure?

Jeffrey Hackman: Yes, and Mark, this is Jeff Hackman. Good to talk with you. I think we talked about this last quarter. I think the relatively modest decline in the average bill rate, I wouldn’t read too much into that. I think it’s still roughly $90 an hour, very modest, I think, sequential decline Q3 to Q4 of last year. Q4 to Q1 of this year was a very, very slight, tick down. For the very large part of 2023, and that largely has continued in the Q1 of this year, the average bill rate’s been actually quite stable. And in this environment, I think that’s a good dynamic and an encouraging sign for us. I think as it relates to spread, I think the comment that I would give you is early on in 2023, we certainly saw some pricing pressures early on in the year.

And for the large part of the second half of ’23, our spreads in our Technology business actually were quite stable. When you look at Q4 to Q1 trend and overall margins, I think in our technology business, they’re rolling down 10 basis points. And typically in a Q4 to Q1, you see that a little bit more of a decline. And part of what Dave mentioned in his script is we saw some favorable healthcare costs that came in a little bit lower than we expected there. But I think to answer your two questions, Mark, I would say spreads are continuing to be quite stable. And as it relates to our average bill rates, it’s still roughly $90 an hour. So it’s also quite stable as well.

David Kelly: Yes, the only other thing, Mark, that I would add to this, right, so you’d ask in terms of supply, supply continues to be tight here, right? Even in a slower time, they have the marginal change in bill rates. It’s really been almost inconsequential. And that is true with pay rates as well. Suggests, again, even in slower periods of technology spend, to find the right talent is going to require us to pay the market rates. And our clients, obviously, understanding that continue to understand that. And that’s why bill rates haven’t moved either. So much like it’s been for many years, right, a supply of highly skilled talent in particular continues to be very difficult to find.

Mark Marcon: Right. And then if I could squeeze one more in, just with regards to current capacity, you did mention, hey, if we get into the $2 billion mark from a revenue perspective, we’re going to have significant expansion with regards to the margins. How much excess capacity do you have in your field sales and recruiting force? How should we think about the incremental margin trajectory from here? Is it going to be a fairly straight line or smooth line in terms of the uptick or would we end up having some fairly significant increases in terms of personnel as we get back towards 2 billion?

David Kelly: Yes, Mark, this is Dave again. I think, first off, and you’ve heard this often from us in slower periods, maintaining our critical resources is very important. So we’ve always made sure that we’ve carried enough capacity. One, because those are the people who are going to lead you out of the recession. And two, obviously, when things break, we don’t want to be shorthanded. So we certainly have ample capacity. We have mentioned, I think, in the past, obviously, in terms of focus, we actually have more sales-related associates than we did a year ago, right? So there’s always a bit of a mix shift here to ensure that we’ve got appropriate total capacity. So clearly, additionally, we continue to invest in technology and things like that, process improvements that creates additional productivity opportunities for us.

We feel very comfortable that when things return I think to a trajectory of growth in technology spend, we’ll be able to take advantage of that. Doesn’t mean we won’t need to add resources, we expect to be able to do so. But certainly productivity improvements are what’s driven a lot of the profitability, if not all of the profitability improvements that we’ve seen in the past. That is certainly the biggest driver to get to the operating margins that we had expected. In terms of how that plays out, obviously, nothing is purely linear. As things start to improve, we are going to see a gradual improvement in operating margins, but we’ve got some other big opportunities as well. So it’s going to be a bit uneven, Mark. There are pieces that are linear.

There are pieces that are not. So I would say still our thought process and thesis has not changed. When we get to something a little over $2 billion, 10% is where we expect to continue to be from an operating margin standpoint.

Joe Liberatore: Yes, Mark. The only other thing that I would add to everything that Dave just shared with you is throughout 2023 and here into 2024, we’ve continued to build our sales capacity. Because needless to say, to ramp up sales people relationship, getting entry points into clients is a much longer process. So we’ve actually increased our headcount from a sales standpoint within our technology area. From a recruiting standpoint, we have capacity to service existing needs as well as market terms. And there’s a ramp up in job orders coming in to service those job orders. Also, our team has clearly demonstrated, because we’ve invested a lot in technologies and automation on the delivery front, that we can turn that dial very quickly if and when necessary.

But we have plenty of capacity to address anything for quite some period of time. But then as we needed to accelerate that, we’d be able to do that. Likewise, I would say, especially here over the course of the last 24 months, we’ve continued to add a lot of capacity within our KCS, our consulting solutions organization, bringing on a lot of industry expertise, subject matter expertise. And they’re really making a difference in terms of elevating our game, taking our conversations and the work that we’re pursuing within clients to a whole other level. So we’ve been making a lot of investments on those fronts, which I think all these things are just building greater capacity as well.

Mark Marcon: Perfect. Appreciate the answers. Thank you.

Joe Liberatore: Thank you, Mark.

Operator: We’ll take our next question from Kartik Mehta with Northcoast Research. Please go ahead.

Kartik Mehta: Thank you. Joe, you mentioned something about AI and obviously having a positive impact on the company in the long run. But I’m wondering in the short run, is it causing any pause for your clients as they figure out maybe how to implement it, maybe how to use it internally, what resource they need from an external perspective? And could that be causing any delays in orders or jobs?

Joe Liberatore: Yes, I kind of the way I would characterize what we’re experiencing within our clients is they’re all in, I would say, preparatory efforts in areas such as building out their infrastructure and data to take advantage of Gen AI as well as large language models, for example. We’re supporting clients with the integration work to ensure that their segmented systems are talking more seamlessly with each other. And in many instances, that also means moving things to the cloud. And then likewise, from a data standpoint, there’s major massive data efforts going on, whether that be they’re addressing data structure, governance, data cleansing efforts. So we’ve been successful at winning engagements in these areas and also have been assisting our clients with what I’ll call the exploratory efforts, understanding the Technology and evolving their strategies and potential use cases.

So no, I don’t believe that it’s pausing anything. We’re seeing a lot of energy in those areas as organizations organize themselves so that they can take advantage of things. And by the way, I don’t think this is something that’s going to change anytime in the near-term future, meaning for entities such as a Kforce who’s not a strategy firm like a McKinsey, this is where the sweet spot and where the true revenue is going to be generated. It’s going to be in these infrastructure areas. It’s going to be in the cloud. It’s going to be in the data areas for the foreseeable future. I mean, I would say that it’s highly probability that the application of generative AI and the use of large language models will ultimately prove to be beyond powerful and widespread accelerator for our business for a long time to come.

So we’re really excited about how we’re positioned, where our focus already was. It kind of everything played to our favor on those fronts. So hopefully that gives you a little bit of a backdrop.

Kartik Mehta: Yes, it does. And I just wanted to make sure I understood your commentary on margins. And I think if we continue to see a sequential increase in revenue, do you think that portends well for margins? Or as you’re adding capacity, could there be just some volatility in margins for the rest of the year?

David Kelly: Yes, I think, Kartik, generally speaking, as revenues improve, margins are going to improve. Right. So that has been consistently how we’ve been managing the business. The capacity that we talked about, obviously, some of that will get absorbed. We’ll continue to invest, but we’ll be prudent to make sure that we return appropriately the revenue to the bottom line. So I expect margins will expand as revenue expands.

Kartik Mehta: Thank you very much. I appreciate it.