Kforce Inc. (NASDAQ:KFRC) Q4 2023 Earnings Call Transcript
Kforce Inc. (NASDAQ:KFRC) Q4 2023 Earnings Call Transcript February 5, 2024
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: Thank you for standing by and welcome to the Kforce Q4 2023 Earnings Conference Call. I would now like to welcome Joe Liberatore, President and CEO, to begin the call. Joe, over to you.
Joe Liberatore: Good afternoon. This call contains certain statements that are forward-looking, that are based upon certain 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. I'm tremendously grateful for the extraordinary efforts of the Kforce team who executed well in 2023, in an environment that proved to be more challenging than originally expected.
Our results driven by solid execution and a focused business model also allowed us to continue allocating significant capital towards strategic investments in our people and tools. As a result, we enter 2024 well positioned to take additional market share and create significant long-term returns for our shareholders. The investments we are making include a continuation of our efforts to transform the back office, implementing AI in certain areas to drive efficiency and productivity while further institutionalizing our one Kforce organizational design and operating principles. During 2023, we selected Workday as our future state enterprise cloud application for our HCM and financials which will complement our Microsoft front-end application and create a unified and streamlined technology suite for the Firm once fully implemented over the next few years.
We are incredibly fortunate to be partnering with Workday and Microsoft, 2 companies at the forefront of investing in AI which puts us in an ideal position to take advantage of these technologies as they become available. The foundational transformation will be a meaningful contributor to us meeting one of our long-term financial objectives of generating at least 10% operating margins. 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 in the domestic market has been critical to our success over many years and we remain confident that our firm is positioned well for improving market conditions. We experienced a decline in technology revenues in 2023 that closely resembled what we experienced in the Great Recession in 2009.
We believe the decline that we experienced in 2023 was due to an acceleration of strategic technology investments made during 2021 and '22, to address the implications of remote work and other digital transformation efforts, combined with the caution exercised by companies in a very uncertain environment. Companies remain cautious due to the continued economic and geopolitical uncertainties and we are encouraged to have grown our technology revenue sequentially in the fourth quarter of 2023 on a billing day basis in this difficult environment. We are blessed to have a tenured executive leadership team who has been through multiple economic cycles together and can quickly adjust to the changing market conditions. Our message to our people in 2023 was simple.
And frankly, it is no different as we begin 2024. There are many things that are uncontrollable. We must control what we can control, stay close to our internal associates, support our consultants and continue listening to our clients while maintaining a long-term view in our decision-making. We made some difficult adjustments in July 2023 to reduce our structural cost which mitigated the impact of lower revenues on the profitability levels. Our strategic position is solid and our prospects are excellent. With that said, tremendous uncertainty still exist in the macro landscape and there are conflicting views of economists on whether we will avert a recession, see a soft landing or slip into a recession in the U.S. economy in 2024 following the aggressive monetary tightening by the Federal Reserve.
The challenges in the geopolitical landscape continue to grow, with the ongoing war in Ukraine, the effects across the region of the war in Israel, including the loss of Americas service members, with dozens injured in the drone attack on their base in Jordan, along with the 2024 U.S. election uncertainties and many others. We will continue to closely monitor our performance indicators and trends and are prepared to make the necessary adjustments to our business without jeopardizing investments in our long-term strategic priorities. The strength of the secular drivers of demand in technology accelerated significantly coming out of both the Great Recession, with the advancement of mobility, cloud computing, among others and with the 2020 pandemic, with further digitization of businesses and the continued headlines around Gen AI technologies.
I have seen a lot of economic cycles in my 35-plus years in the business and each one behaves a bit differently. What remains clear to us though is that the broad and strategic use of technology, including AI technologies 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 that 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, at scale, to help world-class companies solve complex business problems and help them competitively transform their businesses.
Our operating model also allows us the flexibility in partnering with our clients to meet their needs across a broad spectrum of engagement forms, from direct hire, traditional staffing assignments to manage team engagements and manage projects. While clients have been acting with restraint over the last 12-plus months, the backlog of desired investments continues to grow. We expect these important technology investments to be high priorities once the macro uncertainties begin to clear. Technology investments are simply not optional in today's competitive and disruptive business climate. There are simply no other market we would want to be focused on other than the domestic technology talent solution space. We have built a solid foundation at Kforce.
Our balance sheet is clean which allowed us to be opportunistic in repurchasing over $67 million of our stock in 2023 and we expect to continue to generate strong cash flows in 2024. Our Board of Directors recently approved an increase in our quarterly dividend and share repurchase authorization to support our ongoing objective in returning capital to our shareholders. Before transitioning the call to Dave, I wanted to reiterate how proud I am of the performance and resiliency of our collective Kforce team. Together, we thought through a challenging operating environment, made some difficult decisions and met each and every challenge. We are blessed to have a high-performing team that is tenured, dedicated and passionate at Kforce. I am excited about the future of Kforce, as our team continues to advance our office occasional model, in combination with our integrated strategy, resulting in an overall team's ability to operate even more consistently as one firm.
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. Revenue for the fourth quarter came in just above the midpoint of our guidance. We were encouraged to see overall revenues increased sequentially by 0.6%, led by sequential growth in our technology business. For fiscal 2023, overall revenues were down 10%, while Flex revenues in our technology business were down approximately 7%. As a reminder, our Technology business significantly outperformed the market in 2022 and 2021, growing 43.5% over that 2-year period. The Q4 sequential growth in our Technology business is reflective of the stability in the number of consultants on assignment we began to see beginning in mid-Q3 which was followed by a modest increase through the fourth quarter. As we look into early Q1 trends, year-end assignment ends in our Technology business were slightly greater than prior year levels, as clients were generally slower than usual to approve 2024 IT budgets which resulted in fewer redeployments of our consultants as projects were completed at year-end within the existing clients.
This also contributed to a slightly later start in the typical acceleration of new orders from our clients at the beginning of the year. With that said, over the last 2 weeks, we've seen an improvement in our leading indicators. And as a result, we believe that the level of new assignment starts could improve from current levels as we get later in the quarter. This suggests we may see a more traditional pattern of growth in the number of technology consultants on assignment albeit beginning slightly later in the quarter than usual. Our clients recognize the need to retain the highly skilled talent that we provide while they await a point of increased confidence to address their increasing backlog of critical technology initiatives more aggressively.
Overall average bill rates in our technology business remained near record levels at approximately $90 per hour. While bill rates have been stable over the past few quarters, we expect them to increase over the longer term as highly skilled talent will remain in short supply as demand improves. In addition, we're continuing to benefit from an increased mix of managed teams and project engagements within our overall Technology business which carries an average higher bill rate. Our clients remain focused on critical technology initiatives in the areas of digital, UI/UX, cloud, data governance, data analytics, business intelligence, project and program management and modernization efforts. This represents a continuation of recent trends and reflects some of the front-end work needed by companies to take advantage of planned AI-related investments.
Flex margins of 25.4% in our Technology business saw a seasonal decline of 10 basis points sequentially and 70 basis points year-over-year. As we've mentioned on prior calls, the year-over-year declines in Technology Flex margins that we've seen recently are typical of what we see -- have seen in prior slowdowns and we normally see margins recover as the macroeconomic environment stabilizes. As we look forward to Q1, we expect bill pay spreads in our Technology business to continue to be stable, though overall Flex margins will be lower due to seasonal payroll tax resets. We've 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, as demonstrated by more than the 90% of managed teams and project solutions being executed within existing clients.
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 includes large market-leading customers. 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. While short-term disruption may occur within certain clients or industries, our diverse client base provides an outstanding platform for consistent long-term growth.
We experienced stabilization in some of our larger industry verticals in Q4, including financial services and technology services. Elsewhere, we saw a quarter-over-quarter improvement in transportation and retail trade and some headwinds in manufacturing. Looking forward to Q1, we expect technology revenue to decline between 10% and 12% year-over-year which is consistent with Q4 2023. Our FA business grew approximately 2% sequentially but declined 28% year-over-year as the prior year period included a project to support hurricane relief efforts. The year-over-year decline also reflects the impact of business we are no longer supporting due to our repositioning efforts in a more challenging macro environment. We expect revenues to be down approximately 25% year-over-year, our average bill rate has continued to exceed $50 per hour, reflecting our success in repositioning this business towards a higher skillset set of business which is more synergistic with our technology service offering.
Flex margins in our FA business decreased 70 basis points sequentially due to a lower margin project with a strategic client but have improved 330 basis points since the first half of 2020 as our mix of business has significantly improved. We expect bill pay spreads to remain fairly stable at these levels now that the significant majority of business that we are no longer pursuing has run off. However, overall FA margins will decrease sequentially due to seasonal payroll tax resets. We've taken the necessary and 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 in making targeted investments in the business to ensure that we are 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. We are fortunate to have one of the most recognized brands in the market for providing technology talent solutions. Our reputation has been established over our 60-plus year operating history and we continue to carry the highest overall Glassdoor rating within our peer group. I'm tremendously excited about our strategic position and the ability to continue delivering above-market performance. The success that we have as an organization doesn't happen without the unwavering trust that our clients, candidates and consultants place in us and 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. In my commentary, I will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the impact of these costs on our financial results. Our press release provides the reconciliation of differences between GAAP and non-GAAP financial measures. Overall revenues in 2023 of $1.53 billion decreased approximately 10% year-over-year. GAAP earnings per share in 2023 was $3.13 which declined 15% year-over-year. As adjusted for the third quarter charges associated with actions to reduce our structural costs and the settlement of outstanding legal matters, EPS was $3.49 in 2023.
This represents a decrease of 18% over the prior year period, as adjusted for a fourth quarter 2022 impairment charge related to a previous joint venture. Fourth quarter revenues of $363.4 million declined 13.4% year-over-year, while earnings per share of $0.82 was at the top end of guidance due to lower-than-expected SG&A costs. Overall, gross margins declined 40 basis points sequentially and declined 120 basis points year-over-year to 27.3% in the fourth quarter, due to a combination of a lower mix of direct hire revenue and a decline in Flex margins. Overall, SG&A expenses as a percentage of revenue was 21% which is a decrease of 150 basis points year-over-year, or a decrease of 100 basis points after normalizing for the joint venture impairment charge.
SG&A costs were lower than anticipated in the fourth quarter of 2023 due to lower performance-based compensation, lower health care costs and lower professional fees stemming from the settlement of outstanding litigation. We also continue to exercise greater discretionary spend control in this macro environment and generate leverage from our real estate portfolio, given our office occasional work environment. Our operating margin of 6% and exceeded the high end of our expectations of 5.8%. Our effective tax rate in the fourth quarter was 26.6% which was 160 basis points higher than we anticipated, due to adjustments to certain tax credits. Operating cash flows were $22 million and our return on invested capital was approximately 40% in the fourth quarter.
We generated $116 million in EBITDA in 2023. Operating cash flows were $91.5 million for 2023 and we've returned nearly $95 million in capital, in excess of 100% of operating cash flows, to our shareholders via dividends and open market repurchases. We have prudently managed our business by driving solid organic growth over many years, that has resulted in consistently strong results and a pristine balance sheet with minimal debt. As Joe indicated in his opening remarks, our Board of Directors approved an increase to our dividend, the fifth consecutive annual increase and an increase in our share repurchase authorization to $100 million. These actions again demonstrate our financial strength and continued confidence in our business. Our pattern of returning significant capital to our shareholders has been consistent over many years, not just in this operating environment.
In fact, since we initiated our dividend in 2014, we have increased at nearly 400%. And since 2007, we have reduced our weighted average shares outstanding from 42.3 million to 19.5 million. 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, whilst 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 acquisition remains 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 first quarter has 64 billing days which is 3 more than the fourth quarter of 2023 and the same as the first quarter of 2023. We expect Q1 revenues to be in the range of $351 million to $359 million and earnings per share to be between $0.54 and $0.62. Our guidance does not consider the potential impact of any other unusual or nonrecurring items that may occur. Looking beyond what we expect may be short-term macroeconomic uncertainties, we remain extremely excited about strategic position and prospects for continuing to deliver above-market growth while continuing to make the necessary investments in our integrated strategy and the ongoing transformation of our back office, that will help drive long-term growth and profitability improvements.
Joe mentioned our longer-term financial objective of obtaining double-digit operating margins. We believe the key contributors are increased scale, productivity improvements, including, through our back-office transformation program and advancements in AI technologies, driving a greater mix of managed teams and solutions business and further reducing our fixed costs such as real estate. As a point of reference, in 2022, our operating margin was approximately 7% at $1.7 billion in revenue. As we look forward, the anticipated benefits associated with our back-office transformation program are about 100 basis points compared to the current level of investment. When you combine this benefit with the benefit of scale, we believe a reasonable revenue level for us to attain double-digit operating margins is slightly more than $2 billion in annual revenues.
We offer this data point as our confidence in achieving these profitability levels, has further increased due to the returns we have seen in our front office technology investments and our progress with our transformation efforts. On behalf of our entire management team, I'd like to extend a sincere thank you to our teams for their efforts. We would now like to turn the call over for questions.
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