SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-26058
Kforce Inc.(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: (813) 552-5000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) had been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
As of August 12, 2002 the registrant had 31,650,727 shares of common stock, $.01 par value per share, issued and outstanding.
ITEM 1. FINANCIAL STATEMENTS
KFORCE INC. AND SUBSIDIARIESUNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS(IN THOUSANDS)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITEDCONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
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KFORCE INC. AND SUBSIDIARIESUNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONSAND COMPREHENSIVE INCOME (LOSS)(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE UNAUDITEDCONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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KFORCE INC. AND SUBSIDIARIESUNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(IN THOUSANDS)
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KFORCE INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY(AMOUNTS IN THOUSANDS)(UNAUDITED)
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KFORCE INC. AND SUBSIDIARIESNOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NOTE A — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. The unaudited condensed consolidated financial statements include the accounts of Kforce Inc. and its wholly owned subsidiaries (the “Company”). All material transactions and balances have been eliminated in consolidation.
Interim Financial Information. The unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in management’s opinion, include all adjustments necessary for a fair presentation of results for the periods presented. Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by applicable SEC rules and regulations; however, the Company believes that the disclosures made are adequate to make the information presented not misleading.
Reclassification. Certain amounts reported for prior periods have been reclassified to be consistent with the current period presentation.
Revenue Recognition. Net service revenues consist of sales inclusive of billable expenses and net of credits, discounts and fallouts. The Company recognizes Flexible Billings based on hours worked by assigned personnel on a weekly basis. Search Fees are recognized when earned upon the successful completion of the assignment. The Company’s policy is to replace individuals who fail to continue employment (fallouts) for the period of time specified in the agreements for search placements, generally thirty to ninety days. Revenue from Search Fees is shown on the Consolidated Statements of Operations and Comprehensive Income (Loss) net of a reserve for candidates not fulfilling the contract requirements.
Allowance for Doubtful Accounts and Fallouts. The Company has established a reserve for expected credit losses and fallouts on trade receivables based on past experience and management believes the reserves are adequate. It is possible that the accuracy of the estimation process could be materially impacted as the composition of accounts receivable changes over time. We continually review and refine the estimation process to make it as reactive to these changes as possible. We cannot, however, guarantee that we will be able to accurately estimate credit losses on these accounts receivable.
Cash and Cash Equivalents. The Company classifies all highly-liquid investments with an initial maturity of three months or less as cash equivalents.
Self-insurance. The Company offers an employee benefit program for all eligible employees for which it is self-insured for a portion of the cost. The Company is liable for claims up to $150 per claim and aggregate claims up to a defined yearly payment limit. All full-time employees and full-time consultants are eligible to participate in the program. Self-insurance costs are accrued using estimates to approximate the liability for reported claims and claims incurred but not reported.
Income Taxes. The Company accounts for income taxes using an asset and liability approach for the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the carrying amounts and the tax bases of other assets and liabilities. The tax effects of deductions attributable to employees’ disqualifying dispositions of shares obtained from incentive stock options are reflected in additional paid-in capital. No valuation allowance has been recorded because the Company has determined that it is more likely than not that the deferred tax asset will be realized.
Earnings Per Share. Options to purchase 7,008 and 7,592 shares of common stock were not included in the computation of diluted earnings per share during the three and six months ended June 30, 2002 as compared to 4,765 and 5,286 for the same periods in 2001, because these options were anti-dilutive. Options to purchase 2,383 and 2,176 shares of common stock were included in the computation of diluted earnings per share during the three and six months ended June 30, 2001.
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Other Comprehensive Income (Loss). Other comprehensive income (loss) is comprised of foreign currency translation adjustments, which arise primarily from activities of the Company’s Canadian operations, and unrealized gains and losses from changes in the fair value of certain derivative instruments that qualify for hedge accounting under SFAS 133,“Accounting for Derivative Instruments and Hedging Activities”.
Impairment. In accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which became effective for the Company as of January 1, 2002, the Company periodically reviews the carrying value of long-lived assets to determine if impairment has occurred. Impairment losses, if any, are recorded in the period identified. Significant judgment is required to determine whether or not impairment has occurred. The determination is made by evaluating expected future cash flows or the anticipated recoverability of costs incurred and if necessary determining the amount of the loss, if any, by evaluating the fair value of the assets. During the quarter ended June 30, 2002 the Company identified impairment losses of $807 relating to the write off of capitalized software which will not be implemented by the company.
Foreign Currency Translation Adjustments. For the period ended June 30, 2001 the results of operations from the Company’s Canadian operations, which were sold in June 2001, were translated into U.S. dollars using the weighted average exchange rates during the period, while assets and liabilities have been translated using current or historical rates depending upon the related assets. Resulting foreign currency translation adjustments have been recorded in Other Comprehensive Income (Loss).
Accounting for Derivatives. The Company accounts for derivatives under SFAS 133, as amended by SFAS 137 and 138, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. It also requires that all derivatives and hedging activities be recognized as either assets or liabilities in the balance sheet and be measured at fair value. Gains or losses resulting from the changes in fair value of derivatives are recognized in net income (loss) or recorded in other comprehensive income (loss), and are recognized in the statement of operations when the hedged item affects earnings, depending upon the purpose of the derivatives and whether they qualify for hedge accounting treatment. The Company’s policy is to designate at a derivative’s inception the specific assets, liabilities, or future commitments being hedged and monitor the derivative to determine if it remains an effective hedge. The Company does not enter into or hold derivatives for trading or speculative purposes.
In April 2001, the Company entered into two fixed interest rate swap contracts in relation to a portion of its Credit Facility for a total notional amount of $22,000 with terms expiring no later than May 2003. Effective October 24, 2001, the Company obtained a lower interest rate and extended the expiration date to October 2003 on $12,000 of the swaps contracts. The contracts, which have been classified as cash flow hedges, effectively convert a portion of the Company’s outstanding debt under its Credit Facility to a fixed rate basis, thus reducing the impact of interest rate changes on future income. The differential between floating rate receipts and fixed rate payments is accrued as market rates fluctuate and recognized as an adjustment to interest expense. Consistent with SFAS 133, the Company recorded the fair value of the interest rate swap contracts, approximately $315 and $373 net of income taxes of $210 and $248, in other liabilities and accumulated other comprehensive income (loss) as of June 30, 2002 and December 31, 2001, respectively.
Recent Accounting Pronouncements.
In August 2001, the Financial Accounting Standards Board issued SFAS 143, “Accounting for Asset Retirement Obligations”. SFAS 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it occurred. The standard is effective for fiscal years beginning after June 15, 2002. The Company has not yet determined the impact that SFAS 143 will have on its financial statements.
In October 2001, the Financial Accounting Standards Board issued SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which replaces SFAS 121, the accounting model for long lived assets, including discontinued operations, and replaces the provisions of APB Opinion No. 30, “Reporting Results of Operations — Reporting the effects of Disposal of a Segment of a Business”, for the disposal of segments of business. SFAS 144 requires that those long-lived assets be measured at the lower of the carrying amount or fair value less cost to sell, whether reported in continuing operations or discontinued operations.
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SFAS 144 also broadens the reporting of discontinued operations to include all components of an entity with the operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. The provisions in SFAS 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001 and, generally, are to be applied prospectively. Effective January 1, 2002, the Company adopted SFAS 144. There was no impact on the Company’s financial position or results of operations as a result of adopting this standard.
Effective January 1, 2002, the Company reclassified billable expenses to revenue based on the Emerging Issues Task Force, Issue No 01-14, “Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred. Historically the reimbursements were classified as direct costs of services in the Consolidated Statements of Operations and Comprehensive Income (Loss). All prior period information has been adjusted to comparably reflect the effects of this reclassification. Billable expenses were $2,713 and $3,973 for the three months ended June 30, 2002 and 2001 and $5,504 and $7,644 and for the six months then ended, respectively.
NOTE B — INTANGIBLE ASSETS
Effective July 1, 2001 the Company adopted SFAS 141, “Business Combinations”. SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. The adoption of SFAS 141 did not have an impact on the results of operations, financial position or liquidity of the Company.
In July 2001, the FASB issued SFAS 142, “Goodwill and Other Intangible Assets”. The Company has adopted SFAS 142 as of January 1, 2002. SFAS 142 requires goodwill and intangible assets with indefinite useful lives to no longer be amortized, but instead to be tested for impairment on an annual basis.
SFAS 142 provides a six-month transitional period from the effective date of the adoption for the Company to perform an assessment of whether there is an indication that goodwill is impaired. To the extent that an indication of impairment exists, the Company must perform a second test to measure the amount of the impairment. In the first step the Company identified its reporting units and determined the carrying value of each by assigning the Company’s assets and liabilities, including existing goodwill, to them as of January 1, 2002. The Company identified its reporting units as Information Technology, Finance and Accounting, Health and Life Sciences and Human Resources. The Human Resources business line is part of the Information Technology reporting segment but based on analysis under SFAS 142 the Company has determined that the business line meets the criteria for a reporting unit. The Company then determined the fair value of each reporting unit utilizing an independent appraiser, by using a combination of present value and several earning valuation techniques and comparing it to the carrying value of each reporting unit. The Company completed the first step, as of June 30, 2002, which indicates that impairment may exist in the Information Technology and Human Resources units. The potential impairment of existing goodwill, if any, could range from a nominal amount to an amount exceeding a majority of total existing goodwill for the units of approximately $59,378 for Information Technology and approximately $11,136 for Human Resources.
In the second step the Company will compare the implied fair value of the affected reporting units’ goodwill to its carrying value to determine the amount of the impairment. The fair value of goodwill will be determined by allocating the reporting unit’s fair value to all of its assets and liabilities in a manner similar to a purchase price allocation in accordance with SFAS 141, “Business Combinations”. The Company must complete the second step as soon as practicable and no later then December 31, 2002.
Conditions contributing to the goodwill impairment are negative industry and economic trends which have lowered profits and cash flows over the last 18 months and which continue to impact earnings forecasts.
In accordance with SFAS No. 142, the Company discontinued the amortization of goodwill effective January 1, 2002. At December 31, 2001, goodwill, net of accumulated amortization, was $95,804. Goodwill amortization expense was $1,036 and $2,082 for the three and six months ended June 30, 2001. A reconciliation of previously reported net (loss) income and earnings (loss) per share to the amounts adjusted for the exclusion of goodwill amortization, net of the related income (loss) tax effect follows:
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Acquired intangible assets are summarized as follows at:
The Company’s estimated amortization expense related to these acquired intangible assets is $419 for each of the four fiscal years beginning in 2002. Amortizable intangible assets are included in Other assets, net on the Unaudited Condensed Consolidated Balance Sheets.
The $183 reduction in gross carrying amount of goodwill between June 30, 2002 and December 31, 2001 is attributable to a change in the allocation of the purchase price for those acquisitions completed in December 2001.
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NOTE C — CREDIT FACILITY
On November 3, 2000 the Company entered into a $90,000 Amended and Restated Credit Facility with Bank of America (“the Credit Facility”). This Credit Facility has an initial term of three years. The Credit Facility provides for a maximum revolving credit facility of $90 million (not to exceed 85% of our “Eligible Receivables” as such term is defined in the Credit Facility). Borrowings under the Credit Facility are secured by all of the assets of Kforce and its subsidiaries. Amounts borrowed under the Credit Facility bear interest at rates ranging from Prime to Prime plus 0.75% or LIBOR plus 1.75% to LIBOR plus 3.25%, pursuant to certain financial performance targets as set forth in the Credit Facility. As of June 30, 2002, one-month LIBOR was 1.84%. Pricing is changed quarterly based on the previous four quarters’ performance. Under the terms of the Credit Facility, we are prohibited from making any dividend distributions. The terms of the Credit Facility also include certain financial covenants should the total amount borrowed under the Credit Facility exceed specified amounts. These financial covenants include measurement of quarterly EBITDA as compared to our EBITDA projections. The amount available under the credit facility as of June 30, 2002 was $31,895. The amount available without triggering debt covenants as of June 30, 2002 was $11,895. We currently would not be in compliance with such financial covenants if such covenants were applicable and at certain times we have borrowed amounts that put us within approximately $1,000 of triggering these covenants. If we were subject to such financial covenants, we fail to comply with such covenants, and a default is declared under the Credit Facility, such default could result, among other things, in the acceleration of amounts borrowed under the Credit Facility. The Credit Facility also contains certain limitations on investments and acquisitions, and repurchases of our stock.
The Credit Facility contains a provision that limits the dollar amount of its common stock the Company may repurchase. On August 5, 2002, this limit was increased by an additional $5 million. As of June 30, 2002 and August 12, 2002, $2,473 and $6,394 were available under the authorization.
NOTE D — STOCKHOLDERS’ EQUITY
During the first quarter, the Company issued restricted stock to executive management, inside directors and certain other employees who voluntarily reduced their salary and cash bonus potential for fiscal 2002 in exchange for the restricted stock. Approximately 224 shares were issued under this program. The shares vest over a five-year period and have a vesting acceleration clause if certain Kforce common stock price thresholds are met. Upon issuance of stock under the plan, unearned compensation of $1,201, which is equivalent to the market value at the date of grant, was charged to shareholders’ equity. Due to the time acceleration clause, the Company must make a determination at each reporting date whether it is probable that the performance criteria will be met for acceleration. If it is determined that, based on information available, it is probable the performance criteria will be achieved, the Company will recognize compensation cost over the shorter period. If it is determined that, based on information available, it is not probable the performance criteria will be achieved, the Company will continue to recognize compensation cost over the service period. This amount is currently being amortized over the five-year vesting period and approximately $110 was expensed during the six months ended June 30, 2002.
NOTE E — SEGMENT ANALYSIS
The Company reports segment information in accordance with SFAS 131, “Disclosures about Segments of Enterprise and Related Information”. SFAS 131 requires a management approach in determining reportable segments of an organization. The management approach designates the internal organization that is used by management for making operation decisions and addressing performance as the source of determining the Company’s reportable segments. The Company’s internal reporting follows its three functional service offerings: Information Technology, Finance and Accounting, and Health and Life Sciences.
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In January 2002, the Company reviewed the management of service revenue and determined that flexible billings and search services should be reported separately by segment. All prior period information has been adjusted to comparably reflect the effects of this change.
In January 2002, the Company reclassified billable expenses to revenue based on Emerging Issues Task Force Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred. Historically the reimbursements were classified as direct costs of services in the Consolidated Statements of Operations and Comprehensive Income (Loss). All prior period information has been adjusted to comparably reflect the effects of these changes.
The Company only generates revenue and gross profit information on a functional basis. As such, asset information by segment is not disclosed. Substantially all operations and long-lived assets are located in the U.S.
For the three months ended June 30,
For the six months ended June 30,
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Report and prior period SEC reports can be obtained free of charge in the “About Us” section of the Company’s website at www.kforce.com.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements, particularly with respect to the Liquidity and Capital Resources section of Management’s Discussion and Analysis of Financial Condition and Results of Operations. Additional written or oral forward-looking statements may be made by the Company from time to time, in filings with the SEC or otherwise. Such forward-looking statements are within the meaning of that term in Section 27A of the Securities Act of 1933 and Section 21 E of the Securities Exchange Act of 1934. Such statements may include, but may not be limited to, projections of revenue, income, losses, cash flows, capital expenditures, plans for future operations, the effects of interest rate variations, financing needs or plans, plans relating to products or services of the Company, estimates concerning the effects of litigation or other disputes, as well as assumptions to any of the foregoing. In addition, when used in this discussion the words “anticipate”, “estimates”, “expects”, “intends”, “plans”, and variations thereof and similar expressions are intended to identify forward looking statements.
Forward-looking statements are inherently subject to risks and uncertainties, some of which can not be predicted. Future events and actual results could differ materially from those set forth in or underlying the forward looking statements. Readers are cautioned not to place undue reliance on any forward looking statements contained in this report which speak only as of the date of this report. The Company undertakes no obligation to publicly publish the results of any adjustments to these forward looking statements that may be made to reflect events on or after the date of this report or to reflect the occurrence of unexpected events.
CRITICAL ACCOUNTING POLICIES
In December 2001, the SEC requested that all registrants list their most “critical accounting policies” in MD&A. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of the Company’s financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We believe that our following accounting policies fit this definition:
Revenue recognition
Net service revenues consist of search fees and flexible billings inclusive of billable expenses and net of credits, discounts and fallouts. Flexible Billings are recognized based on hours worked by assigned personnel on a weekly basis. Search Fees are recognized when earned upon the successful completion of the placement assignment. Kforce’s policy is to replace individuals who fail to continue employment (fallouts) for the period of time specified in the agreements for search placements, generally thirty to ninety days. We have attempted to estimate credits, discounts and fallouts based on our analysis of current data and historical experience.
Allowance for doubtful accounts and fallouts
The Company has established a reserve for expected credit losses and fallouts on trade receivables based on our past experience and believe our reserves to be adequate. As a result of an ongoing analysis of factors including recent write off trends, changes in economic conditions, and concentration of accounts receivables among clients, we have increased the allowance as percentage of gross accounts receivable by 1.3% from 7.1% as of December 31, 2001 to 8.4% as of June 30, 2002. No single client has a receivable balance greater than 2% of the total accounts receivable balance. It is possible that the accuracy of our estimation process could be materially impacted as the composition of accounts receivable changes over time. We continually review and refine the estimation process to make it as reactive to these changes as possible. We cannot, however, guarantee that we will be able to accurately estimate credit losses on these accounts receivable.
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Income taxes
The Company’s losses have resulted in net operating loss (NOL) carryforwards and other temporary differences for which the Company has recorded a deferred tax asset. Accounting principles generally accepted in the United Sates of America require that we record a valuation allowance against the deferred tax asset if it is “more likely than not” that we will not be able to utilize it to offset future taxes. We have not recorded a valuation allowance against our deferred tax asset because we believe it is more likely than not that we will be able to utilize our deferred tax asset to offset future taxes.
Accrued commissions
The Company pays commissions to its associates for successful placement of personnel. Commissions vary based on the expected annual production achieved by placement specialists and on the actual cash collections from the customer. We have estimated accrued commissions based on our analysis of actual data and historical experience of cash collections.
Impairment
In accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which became effective for the Company as of January 1, 2002, the Company periodically reviews the carrying value of long-lived assets to determine if impairment has occurred. Impairment losses, if any, are recorded in the period identified. Significant judgment is required to determine whether or not impairment has occurred. The determination is made by evaluating expected future cash flows or the anticipated recoverability of costs incurred and if necessary determining the amount of the loss, if any, by evaluating the fair value of the assets. During the quarter ended June 30, 2002 the Company identified impairment losses of $807,000 relating to the write off of capitalized software which will not be implemented by the Company.
Goodwill
Effective January 1, 2002, the Company adopted SFAS 142, “Goodwill and other Intangible Assets”. Accordingly, as of January 1, 2002, the Company discontinued amortizing goodwill. SFAS 142 also provides specific guidance for testing goodwill annually for impairment beginning with an initial transitional goodwill impairment test that is required to be completed within six months of the year of the initial adoption of SFAS 142. The Company has completed the initial transitional goodwill impairment test as of June 30, 2002. In the first step the Company identified its reporting units and determined the carrying value of each by assigning the Company’s assets and liabilities, including existing goodwill, to them as of January 1, 2002. The Company then determined the fair value of each reporting unit utilizing an independent appraiser, by using a combination of present value and several earning valuation techniques and compared it to the carrying value of each reporting unit. The first step indicates that impairment may exist in the Information Technology and Human Resources units. The potential impairment of existing goodwill, if any, could range from a nominal amount to an amount exceeding a majority of total goodwill for the units of approximately $59.4 million for Information Technology and approximately $11.1 million for Human Resources.
In the second step the Company will compare the implied fair value of the affected reporting units’ goodwill to its carrying value to determine the amount of the impairment. The Company must complete the second step as soon as practicable and no later then December 31, 2002.
The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States of America, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. See our audited consolidated financial statements and notes thereto included in Item 8 of our Annual Report on Form 10-K which contain accounting policies and other disclosures required by accounting principles generally accepted in the United States of America.
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RESULTS OF OPERATIONS
The following table sets forth certain items in the Company’s condensed consolidated statements of operations, as a percentage of net service revenues, for the indicated periods:
Results of Operations for each of the Three and Six Months Ended June 30, 2002 and 2001.
Net service revenues. Net service revenues decreased 26.8% and 29.8%, respectively, to $129.5 million and $261.1 million for the three and six months ending June 30, 2002 as compared to $176.9 million and $372.2 million for the same periods in 2001. The decrease was comprised of a $14.7 and a $36.7 million decrease in Search Services and a $32.8 and a $74.3 million decrease in Flexible Billings for the three and six months ending June 30, 2002, as described below.
Flexible Billings decreased 21.7% and 23.7%, respectively, to $118.6 million and $239.3 million for the three and six months ending June 30, 2002 as compared to $151.3 million and $313.6 million for the same period in 2001. Search Fees decreased 57.3% and 62.7%, respectively to $10.9 million and $21.9 million for the three and six months ended June 30, 2002 as compared to $25.6 million and $58.6 million for the same period in 2001. The decrease resulted from a 63.5% decrease in the number of placements made and a 9.1% decrease in the average fees for placements versus the same period in 2001. The changes by segment and revenue type are as follows:
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We believe the decreases in all Search revenues and in Flexible revenues for Information Technology and Finance and Accounting are primarily due to unfavorable economic conditions. The net increase in Flexible revenues for Health and Life Sciences is partially attributable to business acquisitions and disposals made in December 2001 which contributed an approximate $5.4 million and $10.5 million net increase in revenue for the three and six months ended. In addition, during 2001, the Company closed or sold various businesses in its Information Technology segment that contributed $.9 million and $4.2 million in revenues for the three and six months ended June 30, 2001.
Beginning in the first quarter 2002, the Company reclassified billable expenses to flexible billings based on the issuance of the Emerging Issues Task Force, Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred”. Historically the reimbursements were classified as direct costs of services in the Consolidated Statements of Operations. Results for the same period in 2001 have been adjusted for comparability. Billable expense reclasses were $2.7 million and $4.0 million for the three months ended June 30, 2002 and 2001, respectively and $5.5 million and $7.6 million for the six months ended June 30, 2002 and 2001, respectively.
Gross profit. Gross profit decreased 37.1% and 41.5% respectively, to $43.4 million and $87.2 million during the three and six months ended June 30, 2002 as compared to $69.1 million and $149.2 million for the same periods in 2001. Gross profit as a percentage of net service revenues decreased to 33.6% and 33.4% for the three and six months ended in 2002 as compared to 39.1% and 40.1% for the same periods in 2001. The decrease was primarily attributable to the decrease in higher margin Search Services as a percent of total revenues from 14.4% and 15.8% for the three and six months in 2001 to 8.4% for the same periods in 2002 and a change in the segment mix due to a decrease in higher margin Financial and Accounting flex revenues to lower margin Health and Life Sciences flex revenues which relate to fourth quarter acquisitions.
Selling, general and administrative expenses. Selling, general and administrative expenses decreased 31.4% and 35.2% to $41.4 million and $84.4 million for the three and six months ended June 30, 2002 as compared to $60.3 million and $130.3 million for the same periods in 2001. Selling, general and administrative expenses as a percentage of net service revenues decreased to 31.9% and 32.3% for the three and six months in 2002 compared to 34.1% and 35.0% for the same periods in 2001. The decrease in selling, general and administrative expense for the periods ended June 30, 2002 as compared to the same period in the prior year is primarily due to a decrease in commissions, other compensation and bad debt expense relating to the decrease in revenue; the benefits obtained from initiatives taken by management to re-engineer and streamline back-office operations; the realignment of the field management organization; and reductions in other selling, general and administrative expenses to better align expenses with revenue.
Depreciation and amortization expense. Depreciation and amortization expense decreased 45.6% and 39.16% to $2.5 million and $5.2 million for the three and six months ended June 30, 2002 compared to $4.6 million and $8.6 million for the same periods in 2001. The decrease is due primarily to the discontinuation of amortization of goodwill in accordance with SFAS 142, a new accounting pronouncement that the Company implemented on January 1, 2002. Goodwill amortization for the three and six months ended June 30, 2001, was $1.0 and $2.1 million, respectively ($.6 million and $1.3 million net of tax).
Other expense, net. Other expense, net, decreased 18.5% and 42.7% for the three and six months ended June 30, 2002 compared to the same period in 2001. The decrease in other expense was primarily due to a decrease in interest expense as a result of a reduction in long term debt.
Income (loss) before taxes. Income (loss) before taxes for the three and six months ended June 30, 2002, decreased to a loss before taxes of $1.0 million and $3.4 million for the three and six months ended, as compared to income before taxes of $3.5 million and $8.5 million for the same periods in 2001, primarily as a result of the decrease net service revenues, as discussed above.
Provision for (benefit from) income taxes. The income tax benefit for the three and six months ended June 30, 2002 was $0.3 million and $1.1 million, compared to a tax provision of $1.7 million and $3.9 million for the same periods in 2001. The effective tax rate was 32.8% for the six months ended June 30, 2002 compared to 38.0% for the same period in 2001. The difference was primarily the result of non-deductible goodwill amortization in 2001.
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Net income (loss). The Company incurred a net loss of $.7 million and $2.3 million, respectively, in the three and six months ended June 30, 2002 as compared to a net income of $1.8 million and 4.7 million for the same periods in 2001 primarily as a result of the factors discussed above related to net service revenues.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2002, the Company’s sources of liquidity included $3.3 million in cash and cash equivalents, and $40.7 million in additional net working capital. In addition, we have approximately $22.0 million outstanding under the $90 million Amended and Restated Credit Facility with Bank of America (“the Credit Facility”).
Credit Facility
This Credit Facility, which was entered into on November 3, 2000, has an initial term of three years. The Credit Facility provides for a maximum revolving credit facility of $90 million (not to exceed 85% of our “Eligible Receivables” as such term is defined in the Credit Facility). Borrowings under the Credit Facility are secured by all of the assets of Kforce and its subsidiaries. Amounts borrowed under the Credit Facility bear interest at rates ranging from Prime to Prime plus 0.75% or LIBOR plus 1.75% to LIBOR plus 3.25%, pursuant to certain financial performance targets as set forth in the Credit Facility. As of June 30, 2002, one-month LIBOR was 1.84%. Pricing is changed quarterly based on the previous four quarters’ performance. Under the terms of the Credit Facility, we are prohibited from making any dividend distributions. The terms of the Credit Facility also include certain financial covenants should the total amount borrowed under the Credit Facility exceed specified amounts. These financial covenants include measurement of quarterly EBITDA as compared to our EBITDA projections. The amounts available under the credit facility as of June 30, 2002 and August 12, 2002 were $31.9 million and $30.5 million respectively. The amount available without triggering debt covenants as of June 30, 2002 and August 12, 2002 were $11.9 million and $10.5 million, respectively. We currently would not be in compliance with such financial covenants if such covenants were applicable and at certain times we have borrowed amounts that put us within approximately $1.0 million of triggering these covenants. If we were subject to such financial covenants, we fail to comply with such covenants, and a default is declared under the Credit Facility, such default could result, among other things, in the acceleration of amounts borrowed under the Credit Facility. The Credit Facility also contains certain limitations on investments and acquisitions, and repurchases of our stock.
The Credit Facility contains a provision that limits the dollar amount of its common stock the Company may repurchase. On August 5, 2002, this limit was increased by an additional $5 million. As of August 12, 2002, for the period subsequent to June 30, 2002, the Company has repurchased an additional 235,100 shares. As of June 30, 2002 and August 12, 2002, $2.5 million and $6.4 million were available under the authorization.
Interest Rate Swaps
In April 2001, the Company entered into two fixed interest rate swap contracts in relation to a portion of its Credit Facility for a total notional amount of $22 million with terms expiring no later than May 2003. Effective October 24, 2001, the Company obtained a lower interest rate and extended the expiration date to October 2003 on $12 million of the swaps contracts. The contracts, which have been classified as cash flow hedges, effectively convert a portion of the Company’s outstanding debt under its Credit Facility to a fixed rate basis, thus reducing the impact of interest rate changes on future income. The differential between floating rate receipts and fixed rate payments is accrued as market rates fluctuate and recognized as an adjustment to interest expense. Consistent with SFAS 133, the Company recorded the fair value of the interest rate swap contracts, approximately $315,000 and $373,000 net of income taxes, in other liabilities and accumulated other comprehensive loss as of June 30, 2002 and December 31, 2001, respectively.
Restricted Stock Issuance
In January 2002, we announced that executive management, inside directors and certain other employees voluntarily reduced their salary and cash bonus potential in 2002 in exchange for restricted stock. Approximately 224,000 shares, valued at approximately $1.2 million, were issued under this program. The shares vest over a five year period with an acceleration clause if certain Kforce common stock price thresholds are met.
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Registration Statement on Form S-3
On May 24, 2002, the Company filed a Registration Statement on form S-3 that will allow the issuance of up to $250 million of common stock and other equity and financial instruments for the financing of various corporate activities to potentially include funding for acquisitions and other business expansion opportunities, as well as compensation arrangements. No issuance of securities has been made under this registration statement as of August 12, 2002.
Cash Flows
During the six months ended June 30, 2002, cash flow provided by operations was $9.3 million resulting primarily from non-cash adjustments for depreciation and amortization, a decrease in trade receivables; a decrease in income tax receivables due to cash received during the period, a distribution from deferred compensation plan assets, and an increase in payroll related liabilities. These items are partially offset by a decrease in accounts payable, bank overdrafts and other liabilities.
For the six months ended June 30, 2002, cash flow used in investing activities was $0.3 million resulting from capital expenditures net of proceeds on disposals.
During the six months ended June 30, 2002, cash flow used by financing activities was $5.9 million, primarily from the repayment of $6.2 million of borrowings under the Company’s Credit Facility.
The Company’s Board of Directors has authorized the repurchase of up to $115 million of its common stock on the open market, from time to time, depending on market condition. As of June 30 and August 12, 2002, the Company had repurchased approximately 17.4 million shares, 17.6 million shares respectively. Approximately $17.7 million and $16.7 million was available under current board authorization and $2.5 million and $6.4 million was available under the current Credit Facility limitations as of June 30, 2002 and August 12, 2002, respectively. Additional stock repurchases may have a material impact on the Company’s cash flow requirements.
The Company believes that cash flow from operations and borrowings under our credit facility will be adequate to meet the working capital requirements of current operations for at least the next twelve months. However, further deterioration in the business environment and market conditions could negatively impact operating results and liquidity. There is no assurance (i) that we will be able to obtain financing in amounts sufficient to meet operating requirements or at terms which are satisfactory and which allow us to remain competitive, or (ii) that we will be able to meet the financial covenants contained in the Credit Facility. If we currently had borrowed sufficient funds to trigger the financial covenants in the Credit Facility, we would not be in compliance with such covenants. Our expectation that existing resources will fund working capital requirements is a forward-looking statement that is subject to risks and uncertainties. Actual results could differ from those indicated as a result of a number of factors, including the use of such resources for possible acquisitions and the announced stock repurchase plan.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to a variety of risks, including changes in interest rates on its borrowings. As of June 30, 2002 and August 12, 2002, the notional value of outstanding interest rate swap agreements of $22 million is equal to the amount outstanding under the Credit Facility. Therefore changes in interest rates will currently not affect the Company’s interest expense. The Company does not engage in trading market risk sensitive instruments for speculative purposes.
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PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
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