Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(MARK ONE)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010

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 000-26058

 

 

KFORCE INC.

(Exact name of Registrant as specified in its charter)

 

 

 

FLORIDA   59-3264661

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

1001 EAST PALM AVENUE, TAMPA, FLORIDA   33605
(Address of principal executive offices)   (Zip Code)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (813) 552-5000

 

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

TITLE OF EACH CLASS

 

NAME OF EACH EXCHANGE ON WHICH REGISTERED

None   None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock, $0.01 par value

(Title of class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer    ¨      Accelerated filer    x
Non-accelerated filer    ¨ (Do not check if a smaller reporting company)      Smaller reporting company    ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.):    Yes  ¨    No  x

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of the last business day of the registrant’s most recently completed second fiscal quarter, June 30, 2010, was approximately $368,836,004. For purposes of this determination, common stock held by each officer and director and by each person who owns 10% or more of the registrant’s outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares outstanding of the registrant’s common stock as of March 3, 2011, was 43,112,641.

DOCUMENTS INCORPORATED BY REFERENCE:

 

Document

 

Parts Into Which Incorporated

Portions of Proxy Statement for the Annual Meeting of Shareholders scheduled to be held June 21, 2011 (“Proxy Statement”)   Part III

 

 

 


Table of Contents

KFORCE INC.

ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010

TABLE OF CONTENTS

 

PART I

  

Item 1.

   Business.      3   

Item 1A.

   Risk Factors.      10   

Item 1B.

   Unresolved Staff Comments.      18   

Item 2.

   Properties.      18   

Item 3.

   Legal Proceedings.      18   

Item 4.

   Reserved.      18   

PART II

     

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.      18   

Item 6.

   Selected Financial Data.      20   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations.      21   

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk.      37   

Item 8.

   Financial Statements and Supplementary Data.      38   

Item 9.

   Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.      69   

Item 9A.

   Controls and Procedures.      69   

Item 9B.

   Other Information.      69   

PART III

     

Item 10.

   Directors, Executive Officers and Corporate Governance.      70   

Item 11.

   Executive Compensation.      70   

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.      70   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence.      70   

Item 14.

   Principal Accounting Fees and Services.      70   

PART IV

     

Item 15.

   Exhibits, Financial Statement Schedule.      70   

SIGNATURES

     72   

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

References in this document to “the Registrant,” “Kforce,” “we,” “our” or “us” refer to Kforce Inc. and its subsidiaries, except where the context otherwise requires or indicates.

This report, particularly Item 1 Business, Item 1A Risk Factors, and Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), and the documents we incorporate into this report, contains certain statements that are, or may be deemed to be, forward-looking statements within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are made in reliance upon the protections provided by such Acts for forward-looking statements. Such statements may include, but may not be limited to, projections of revenue, income, losses, cash flows, capital expenditures, future prospects, anticipated costs and benefits of proposed (or future) acquisitions, integration of acquisitions, plans for future operations, capabilities of business operations, effects of interest rate variations, our ability to obtain financing and favorable terms, financing needs or plans, plans relating to services of Kforce, estimates concerning the effects of litigation or other disputes, estimates concerning our ability to collect on our accounts receivable, expectations of the economic environment, developments within the staffing sector including, but not limited to, the penetration rate and growth in temporary staffing, as well as assumptions as to any of the foregoing and all statements that are not based on historical fact but rather reflect our current expectations concerning future results and events. For a further list and description of various risks, relevant factors and uncertainties that could cause future results or events to differ materially from those expressed or implied in our forward-looking statements, see the Risk Factors and MD&A sections. In addition, when used in this discussion, the terms “anticipates,” “estimates,” “expects,” “intends,” “plans,” “believes,” “will,” “may,” “should” 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 cannot 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. Kforce 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.

 

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PART I

 

Item 1. Business.

Company Overview

We are a national provider of professional and technical specialty staffing services and solutions and operate through our corporate headquarters in Tampa, Florida as well as our 65 field offices, which are located throughout the United States, and two offices in Manila, Philippines. Kforce is a Florida corporation and was formed in August 1994 as a result of the combination of Romac & Associates, Inc. and three of its largest franchises. Kforce completed its Initial Public Offering in August 1995.

We provide our clients staffing services and solutions through four operating segments: Technology (“Tech”), Finance and Accounting (“FA”), Health and Life Sciences (“HLS”) and Government Solutions (“GS”). Kforce organizes and manages its Tech and FA segments on a regional basis: Atlantic, North and West. Our Tech segment includes the results of Kforce Global Solutions, Inc. (“Global”), a wholly-owned subsidiary, which has two offices in the Philippines. We believe this operational alignment supports a more customer-centric organization, leverages our best leaders, leverages client relationships across functional offerings, and streamlines the organization by placing senior management closer to the customer as well as achieving greater cost-efficiency. The HLS and GS segments are organized and managed by specialty because of the unique operating characteristics of each business.

The following charts depict the percentage of our total revenues for each of our segments for the years ended December 31, 2010 and 2009:

 

2010   2009
LOGO   LOGO

Tech

We provide both temporary staffing and permanent placement services to our clients focusing primarily on more sophisticated areas of information technology (i.e., systems/applications programmers and developers, senior-level project managers, systems analysts, enterprise data management and e-business and networking technicians). Our Tech segment provides service to clients in a variety of industries with a strong footprint in healthcare, financial services and government integrators. A recent report published by Staffing Industry Analysts (“SIA”) listed the information technology staffing market as one of the fastest growing sectors in 2010. The report anticipates that technology staffing growth will accelerate in 2011 and in 2012 will surpass the prior peak set in 2000 during the height of the dot-com boom. The U.S. Bureau of Labor Statistics (“BLS”) lists computer systems design and related services among the fastest-growing industries reflecting the continuing demand for the high-level skills that are needed to keep up with changes in technology.

We believe this segment continues to benefit significantly from our centralized and highly flexible National Recruiting Center (“NRC”) as well as our Strategic Accounts strategy, which we believe will also provide significant leverage in supporting future growth. Our Tech segment includes the results of Global, a wholly-owned subsidiary. Global provides information technology outsourcing solutions internationally through two offices located in the Philippines. Our international operations comprised approximately 2% of net service revenues for the three years ended December 31, 2010.

FA

Our FA segment provides both temporary staffing and permanent placement services to our clients in areas such as: taxation, budget preparation and analysis, mortgage and loan processing, financial reporting, cost analysis, accounts payable, accounts receivable, professional administrative, credit and collections, general accounting, audit services, and systems and controls analysis and documentation to support compliance work under Section 404 of the Sarbanes-Oxley Act of 2002. Our FA segment provides service to clients in a variety of industries with a strong footprint in financial services and government integrators.

We believe this segment continues to benefit significantly from our centralized and highly flexible NRC as well as our Strategic Accounts strategy, which we believe will also provide significant leverage in supporting future growth.

 

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HLS

Our HLS segment includes our Clinical Research and Health Information Management specialties and provides both temporary staffing and permanent placements services to our clients. These categories primarily consist of clinical research associates for the pharmaceutical industry and health information management professionals for hospitals and healthcare facilities. The HLS segment, generally and especially in Clinical Research, is characterized by contracts and relationships that are typically longer-term in nature as compared to our Tech and FA segments. A substantial portion of the sales, account management and recruiting functions for the HLS segment is provided out of our corporate headquarters. We have seen a trend, among larger pharmaceutical companies, to achieve greater efficiency and effectiveness through functional outsourcing, which allows larger pharmaceutical companies to reduce the number of facilities and streamline vendor management efforts. Consistent with the recent consolidation that has occurred within the pharmaceutical sector, a material portion of revenues within HLS is concentrated in a relatively small number of clients. For the year ended December 31, 2010, the single largest client within the HLS segment comprised approximately 29.7% of this segment’s total revenues while only representing 4.9% of total Kforce revenues.

GS

The Federal Government is one of the largest consumers of information technology, spending approximately $78 billion in 2010 and budgeted to spend approximately $79 billion in 2011. Our GS segment provides Tech and FA professionals to the Federal Government, primarily as a prime contractor. GS also serves as a subcontractor to prime contractors, and we believe that our ability to source professional candidates for assignments, in combination with our prime contractor relationships, will allow us to pursue additional opportunities in this sector. The acquisition of RDI Systems, Inc., d/b/a dNovus RDI (“RDI” or “dNovus”), in 2008 was an important milestone, as our GS segment then began to have annualized revenues in excess of $100 million, which we believe provides this segment with access to more significant government contracts. Substantially all GS services are supplied to the Federal Government through field offices located in the Washington D.C. and San Antonio, Texas areas.

Types of Staffing Services

Kforce’s staffing services consist of temporary staffing services (“Flex”) and permanent placement services (“Search”). The following chart depicts the percentage of total revenues for Flex and Search for the years ended December 31, 2010 and 2009:

 

2010   2009
LOGO   LOGO

Flex

We provide our clients with qualified individuals (“consultants”) on a temporary basis when it is determined that the consultants have the appropriate skills and experience and are “the right match” for our clients. Our success is dependent upon our employees’ (“associates”) ability to: (1) understand and acknowledge the clients’ needs; (2) determine and understand the capabilities of the consultants being recruited; and (3) deliver and manage the client-consultant relationship to the satisfaction of both our clients and our consultants. Proper execution by our associates and our consultants directly impacts the longevity of the assignments and increases the likelihood of being able to generate repeat business with our clients.

Flex revenues are driven by the number of total hours billed and established bill rates. Flex gross profit is determined by deducting consultant pay, benefits and other related costs from Flex revenues. Flex associate commissions, related taxes and other compensation and benefits as well as field management compensation are included in Selling, General and Administrative expenses (“SG&A”), along with administrative and corporate compensation. The Flex business model involves attempting to maximize the number of consultant hours and bill rates, while managing consultant pay rates and benefit costs, as well as compensation and benefits for our core associates. Flex revenues also include solutions provided through our GS segment. These revenues involve providing longer-term contract services to the customer primarily on time-and-materials, fixed-price, and cost-plus bases.

 

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Search

The Search business is a smaller, yet important, part of our business that involves locating qualified individuals (“candidates”) for permanent placement with our clients. We primarily perform these searches on a contingency basis; thus, fees are only earned if the candidates are ultimately hired by our clients. The typical structure for search fees is based upon a percentage of the placed individual’s annual compensation in their first year of employment, which is known at the time of placement. We recruit permanent employees from our Flex consultant population, from the job boards, from our associates’ networks, social media networks and from passive candidates we identify who are currently employed and not actively seeking another position. Also, there are occasions where consultants are initially assigned to a client on a Flex basis and later are converted to a permanent placement, for which we also receive a Search fee (referred to as “conversion revenue”). Kforce targets clients and recruits for both Flex and Search services, which contributes to our objective of providing integrated solutions for all of our clients’ human capital needs.

Search revenues are driven by placements made and the resulting fees billed and are recognized net of an allowance for “fallouts,” which occur when placements do not complete the applicable contingency period. Although the contingency period varies by contract, it is typically 90 days or less. This allowance for fallouts is estimated based upon historical experience with Search placements that did not complete the contingency period. There are no consultant payroll costs associated with Search placements, thus all Search revenues increase gross profit by a like amount. Search associate commissions, compensation and benefits are included in SG&A.

In order to achieve greater stability in our revenue stream, Kforce management has deemphasized the investment in Search revenues to total revenues over the last several years, primarily because of the highly volatile nature of the Search business. Search revenues comprised 4.0% of total revenues in 2010 in contrast to in excess of 20% in 2000.

Business Strategy

The key elements of our business strategy include the following:

Retain our Great People. A significant focus of Kforce, especially during the most recent economic cycle, is on the retention of our most tenured and productive associates. We ended fiscal 2010 with what we believe to be the most tenured field sales team in Kforce’s history, which we believe will significantly enhance our efforts to achieve future growth.

Continue to Optimize our NRC. We believe our centralized NRC offers Kforce a significant competitive advantage, and we believe that the NRC is particularly effective at meeting the demands of our Strategic Account clients as well as other demands for high volume staffing. The NRC identifies and interviews active candidates from nationally contracted job boards, Kforce.com, as well as other sources, then forwards qualified candidates to Kforce field offices to be matched to available positions. The NRC primarily supports our Tech and FA segments but is also expanding its support of our HLS segment. The optimization of the NRC in 2010 was a significant priority for the Firm, specifically around building an appropriate number of associates, aligning our geographical delivery and achieving dedicated market support. Given the significant investment in headcount within the NRC in 2010, the average NRC tenure is just over one year. As a result, a continuing focus is on training, ramping and development, which we expect will: (i) significantly enhance the performance of the NRC in meeting demand; (ii) enhance our efforts to support future growth and (iii) expand the NRC as our revenues increase.

Focus on our Strategic Accounts. A focus of Kforce is in cultivating relationships with large clients, both in terms of annual revenues and geographic dispersion. For each of our Strategic Accounts, Kforce assigns a Strategic Account Executive who is responsible for managing all aspects of our client relationship.

Encourage Employee Achievement. We have an intense focus on promoting and maintaining a quality-focused, results-oriented culture. Our field associates and corporate personnel are given incentives (which include competitions with significant prizes, incentive trips and internal recognition, in addition to bonuses) to encourage achievement of Kforce’s corporate goals and high levels of service. During 2010, we implemented and went live with a business intelligence tool referred to as AMP!, which is an acronym for Actions Maximizing Performance. This metrics-based system is designed to provide associates with current and historical performance measures relative to their Kforce peers, which we believe will fuel healthy competition and assist associates in reaching their highest performance levels.

 

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Focus on Value-Added Services. We focus on providing specialty staffing services and solutions to our clients. The placement of highly skilled personnel requires operational and technical skill to effectively recruit and evaluate personnel, match them to client needs, and manage the resulting relationships. We believe this strategy will serve to balance the desire for optimal volume, rate, effort and duration of assignment, while ultimately maximizing the benefit for our clients, consultants and the Firm. Of the areas of Tech, FA, HLS and GS, we concentrate resources in the areas of highest anticipated demand to adapt to the ever-changing landscape within the staffing industry. We believe our historical focus in these markets, combined with our staff’s operating expertise, provides us with a competitive advantage.

Build Long-Term, Consultative Relationships. We believe we have developed long-term relationships with our clients by repeatedly providing solutions to their specialty staffing requirements. We strive to differentiate ourselves by working closely with our clients to understand their needs and maximize their return on human assets. In addition, Kforce’s ability to offer flexible staffing services, coupled with our permanent placement capability, offers the client a broad spectrum of specialty staffing services. We believe this ability enables Kforce to emphasize consultative rather than just transactional client relationships, with the intent of expanding our share of our client’s staffing needs.

Achieve Extensive Client Penetration. Our client development process focuses on contacts with client employees responsible for staffing decisions. Contacts are made within functional departments and at different organizational levels within our client companies. Our associates are trained to develop a thorough understanding of each client’s total staffing requirements in order to expand our share of our clients’ staffing needs.

Recruit High-Quality Consultants. We place great emphasis on recruiting qualified consultants. We believe we have a recruiting advantage over our competitors who lack the ability to offer candidates flexible and permanent opportunities. We frequently place candidates seeking permanent employment in flexible assignments until a permanent position becomes available, as well as convert temporary candidates into permanent employees of our client companies.

Industry Overview

We serve Fortune 1000 companies, the Federal Government, state and local governments, local and regional companies, and small to mid-sized companies. Our 10 largest clients represented 23.5% of revenues and no single customer accounted for more than 4.9% of revenues for the year ended December 31, 2010. The specialty staffing industry is made up of thousands of companies, most of which are small local firms providing limited service offerings to a relatively small local client base. We believe Kforce is one of the 10 largest publicly-traded specialty staffing firms in the United States. According to a recent report by SIA, 94 companies reported at least $100 million in U.S. staffing revenues in 2009. Competition in a particular market can come from many different companies, both large and small. We believe, however, that our geographic presence, diversified service offerings, centralized NRC, Strategic Account team and focus on consistent service and delivery, all provide a competitive advantage, particularly with clients that have operations in multiple geographic markets. In addition, we believe that our diversified portfolio of service offerings is concentrated in areas with significant growth opportunities in both the short and long-term.

Based upon previous economic cycles experienced by Kforce, we believe that times of sustained economic recovery generally stimulate demand for substantial additional U.S. workers and, conversely, an economic slowdown results in a contraction in demand for additional U.S. workers. We also believe that Flex demand generally increases before demand for permanent placements increases given that companies tend to prefer a flexible staffing model in the early stages of an economic recovery to ensure its sustainability. From an economic standpoint, temporary employment figures and trends are important indicators of staffing demand, which saw significant increases in 2010. While we believe the macro-employment picture continues to be relatively weak with the unemployment rate at 9.4% as of December 2010, temporary employment has expanded by 495,000 jobs since reaching a low in September 2009. In addition, the penetration rate (the percentage of temporary staffing to total employment) has increased 15 consecutive months from its low of 1.32% in August 2009 to over 1.7% in November 2010. We believe that the penetration rate could surpass the prior peak of 2.0% achieved in the late 1990s. If the penetration rate of temporary staffing continues to increase, we believe that our Flex revenues can grow significantly even in a relatively modest growth macro-economic environment. Management remains cautiously optimistic about the growth prospects of the temporary staffing industry, the penetration rate and in particular our revenue portfolio.

According to an industry report, the United States temporary staffing industry generated estimated revenues of $96.7 billion in 2007, $94.5 billion in 2008 and $71.2 billion in 2009; with projected revenues of $78.8 billion in 2010 and $88.0 billion in 2011. Of course, no reliable predictions can be made about the general economy, the staffing industry as a whole, or specialty staffing in particular; which we believe will experience increasing demand in 2011.

 

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During 2006 and 2008, Kforce made several acquisitions in order to expand its presence in the Federal Government contracting space, primarily because the results of operations in the GS segment were anticipated to have better long-term growth stability during variable economic cycles. During 2010, our GS segment was significantly impacted by delays in the timing of project awards as well as a continuing trend by the Federal government to in-source certain functions and positions that were previously outsourced in an attempt to reduce expenditures. Continued political issues related to the federal budget may negatively impact the GS segment’s 2011 performance. Despite the near-term challenges, however, we remain optimistic concerning the GS segment’s long-term prospects.

Technology

A significant focus for Kforce is the continuous advancement of its front-end and back office technology infrastructure to improve efficiency and maintain a leveraged platform. We believe our continuous enhancement of our back office system software provides a competitive advantage through the enhancement of the efficiency and performance of our sales and delivery functions. While we continue to focus on our Enterprise Optimization Program (EOP), which is focusing on the continual improvement of our front-end systems and our back office systems, including our time collection and billing systems, the more significant investments in 2010 were as follows:

 

   

AMP! – this metrics-based system is designed to provide our field associates with current and historical performance relative to their Kforce peers, which we believe will fuel positive competition and assist our field associates in reaching their highest performance levels.

 

   

Incentive Compensation Enterprise (“ICE”) – we believe that this best-in-class compensation management software, which went live in January 2011, will efficiently manage the processes around all variable compensation within the Firm. We believe that this software will also provide the appropriate visibility to management to manage the performance of our associates and help to ensure that Kforce’s pay-for-performance philosophy is adhered to.

 

   

Contracts Management System (“CMS”) – we believe that this software will significantly improve the efficiency and effectiveness of the overall contract review and approval process both from a field and back-office perspective.

 

   

Time Entry 2.0 (“TE 2.0”) – this project represented a significant upgrade to the Firm’s time entry systems, which provided a sustainable and scalable technical solution to support the Firm’s future growth. We believe that this solution has already demonstrated significant efficiency gains for our consultants and back office operations.

We expect to make additional investments in our infrastructure over the next 12 months, though at lower levels than experienced in 2010, which we believe will provide for a sufficient return on capital and support the future growth in our business.

While we believe our technology systems are adequate to meet our current needs, there can be no assurance that they will not be subject to system outages or data loss caused by natural or man-made disasters. In addition, Kforce depends on certain third-party vendors whose reliability we cannot guarantee going forward. One or more of such events could negatively impact our ability to conduct our business in the ordinary course.

Trade Names and Trademarks

The Kforce trade names and the “Data Confidence” trademarks are important to our business. Our primary trade names and trademarks are registered with the United States Patent and Trademark Office.

Regulatory Environment

Staffing firms are generally subject to one or more of the following types of government regulations: (i) regulation of the employer/employee relationship between a firm and its flexible staff, (ii) registration, licensing, recordkeeping and reporting requirements and (iii) substantive limitations on their operations. Staffing firms are governed by laws regulating the employer/employee relationship such as wage and hour regulations, tax withholding and reporting, social security and other retirement, anti-discrimination, and workers’ compensation regulations.

In addition, the services provided by our HLS Clinical Research business involve participation in clinical trials of pharmaceutical compounds using human subjects. This is a highly regulated field subject to oversight and inspection by the U.S. Food and Drug Administration.

In providing staffing services to the Federal Government, we must comply with complex laws and regulations relating to the formation, administration, and performance of Federal Government contracts. These laws and regulations create compliance risk and affect how we do business with our federal agency clients, and may impose added costs on our business.

For more discussion of the potential impact that the regulatory environment could have on Kforce’s financial results, please see Item 1A. Risk Factors below.

 

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Competition

We operate in a highly competitive and fragmented specialty staffing services industry within each of our operating segments. Within temporary staffing and permanent placement services, one of the more significant barriers to entry is that significant working capital is needed because most employees are paid on a bi-weekly basis and customers may take 30 to 45 days to pay. A number of our competitors have substantially more resources than we possess. We face substantial competition from large national firms and local specialty staffing firms. The local firms are typically operator-owned, and each market generally has one or more significant competitors. We also face competition from national clerical and light industrial staffing firms, and national and regional accounting firms that also offer certain specialty staffing services.

In addition, many companies utilize Vendor Management Systems (“VMS”) for the purchase of staffing services. Generally, VMS are systems that allow companies to manage service providers. Industry data shows that larger, more sophisticated companies are more likely to add VMS. Approximately 63% of these companies used VMS during 2009, up from 51% in 2008, and this usage is expected to increase to 81% in 2011. Typically, VMS providers charge staffing firms administrative fees of 1% to 3% of total service revenues, and these fees are usually recorded by staffing firms as a cost of services, thereby compressing their profit margins. While Kforce does not currently provide VMS directly to its clients, its strategy has been and is expected to continue to be to work with VMS providers to enable us to extend our Flex staffing services to the widest customer base possible within the sectors we serve.

In the United States, there are 94 staffing firms with more than $100 million in U.S. staffing revenues in operation; and thousands of smaller organizations compete to varying degrees at local levels. Several similar companies – global, national, and local – compete in foreign markets. Our peer group for 2010, which is composed of some of our largest competitors, included: AMN Healthcare Services, CDI Corporation, Ciber, Inc., Kelly Services Inc., On Assignment Inc., Resources Connection, Inc., Robert Half International Inc., SFN Group, Inc., and Volt Information Sciences Inc.

Kforce believes that the availability and quality of personnel, level of service, effective monitoring of job performance, scope of geographic service, and price are the principal elements of competition in our industry. We believe that availability of quality personnel is especially important. In order to attract candidates, we place emphasis upon our ability to provide competitive compensation and benefits, quality and varied assignments, scheduling flexibility, and permanent placement opportunities. Because personnel pursue other employment opportunities on a regular basis, it is important that we respond to market conditions affecting these individuals. Additionally, in certain markets and in response to economic softening, we have experienced significant pricing pressure from some of our competitors. Although we believe we compete favorably with respect to these factors, we expect competition and pricing pressure to continue, and there can be no assurance that we will remain competitive.

Seasonality of Operating Results

Our quarterly operating results are affected by the number of billing days in a quarter and the seasonality of our customers’ businesses. The majority of our operating segments, especially HLS and GS, are significantly impacted by the increase in the number of holidays and vacation days taken during the fourth quarter of the calendar year. In addition, we experience an increase in direct costs of services and a corresponding decrease in gross profit in the first fiscal quarter of each year, as a result of certain annual U.S. state and federal employment tax resets that occur at the beginning of each year.

Insurance

Kforce maintains a number of insurance policies including general liability, automobile liability and employers’ liability; each with excess liability coverage. We also maintain workers’ compensation, fidelity, fiduciary, directors and officers, professional liability, and employment practices liability policies. These policies provide coverage subject to their terms, conditions, limits of liability, and deductibles, for certain liabilities that may arise from Kforce’s operations. There can be no assurance that any of the above policies will be adequate for our needs, or that we will maintain all such policies in the future.

Financial Information about Foreign and Domestic Operations

Substantially all of Kforce’s revenues are derived from domestic operations with customers located in the United States and substantially all long-lived assets are located in the United States for the three years ended December 31, 2010. One of our subsidiaries, Global, provides outsourcing services internationally through two offices in Manila, Philippines. Our international operations comprised approximately 2% of net service revenues for the three years ended December 31, 2010.

 

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Financial Information about Business Segments

We provide our clients staffing services and solutions through four operating segments: Tech, FA, HLS and GS. For segment financial data see Note 16 – “Reportable Segments” to the Consolidated Financial Statements.

Operating Employees and Personnel

As of December 31, 2010, Kforce employed approximately 2,000 associates and had approximately 10,400 consultants on assignment (“Flexible Consultants”) providing flexible staffing services and solutions to our clients. Approximately 80% of the Flexible Consultants are employed directly by Kforce (“Flexible Employees”); the balance consists of individuals who are employed by other entities (“Independent Contractors”) that provide their employees as subcontractors to Kforce for assignment to its clients. As the employer, Kforce is responsible for the operating employees’ and Flexible Employees’ payrolls and the employer’s share of applicable social security taxes (FICA), federal and state unemployment taxes, workers’ compensation insurance, and other direct labor costs relating to our employees. We offer access to various health, life and disability insurance programs and other benefits for operating employees and Flexible Employees. We have no collective bargaining agreements covering any of our operating employees or Flexible Employees, have never experienced any material labor disruption, and are unaware of any current efforts or plans to organize any of our employees.

Availability of Reports and Other Information

We make available, free of charge, through the Investor Relations page on our website, and by responding to requests addressed to Michael Blackman, our Chief Corporate Development Officer, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements on Schedule 14A and amendments to those materials filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically submit such materials to the SEC. Our corporate website address is http://www.kforce.com. The information contained on our website, or on other websites linked to our website, is not part of this document. In addition, the SEC’s website is http://www.sec.gov. The SEC makes available on its website, free of charge, reports, proxy and information statements, and other information regarding issuers, such as us, that file electronically with the SEC. Information provided on the SEC’s website is not part of this Annual Report on Form 10-K.

 

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Item 1A. Risk Factors.

Kforce faces significant employment-related legal risk.

Kforce employs people internally and in the workplaces of other businesses. Many of these individuals have access to client information systems and confidential information. An inherent risk of such activity includes possible claims of errors and omissions; intentional misconduct; release, misuse or misappropriation of client intellectual property, confidential information, funds, or other property; discrimination and harassment claims; employment of illegal aliens; criminal activity; torts; or other claims. Such claims may result in negative publicity, injunctive relief, criminal investigations and/or charges, payment by Kforce of monetary damages or fines, or other material adverse effects on our business. To reduce our exposure, we maintain insurance coverage for professional malpractice liability, fidelity, employment practices liability, and general liability in amounts and with deductibles that we believe are appropriate for our operations. Our insurance coverage, however, may not cover all potential claims against us or continue to be available to us at a reasonable cost. In this regard, we face various employment-related risks not covered by insurance, such as wage and hour laws and employment tax responsibility. U.S. Courts in recent years have been receiving large numbers of wage and hour class action claims alleging misclassification of overtime eligible workers and/or failure to pay overtime-eligible workers for all hours worked. In addition, declining tax revenues in the current economic environment have heightened state and federal scrutiny of independent contractor relationships.

Kforce may be adversely affected by immigration restrictions.

Our Tech business utilizes a significant number of foreign nationals entering the U.S. on work visas, primarily under the H-1B visa classification. The H-1B visa classification enables U.S. employers to hire qualified foreign nationals in positions that require an education at least equal to a bachelor’s degree in the U.S. Immigration laws and regulations are subject to legislative and administrative changes, as well as changes in the application of standards and enforcement. Immigration laws and regulations can be significantly affected by political developments and levels of economic activity. Current and future restrictions on the availability of such visas could restrain our ability to import the skilled professionals we need to meet our clients’ needs, which could have a material adverse effect on our business. In 2009, the United States Customs and Immigration Service (“USCIS”) significantly increased its scrutiny of companies seeking to sponsor, renew or modify H-1B visas, including Kforce and Kforce’s subcontractors. On January 8, 2010, the USCIS issued internal guidance to its field offices that appears to narrow the eligibility criteria for H-1B visas in the context of staffing services. In addition to immigration restrictions, certain aspects of the H-1B visa program are subject to regulation by the U.S. Department of Labor, which has recently hired additional personnel and stepped up enforcement activities in a number of areas, including immigration. The scope and impact of these changes on the staffing industry and Kforce remains unclear, however a narrow interpretation and vigorous enforcement could adversely affect our ability to obtain foreign national labor and/or renew existing foreign national consultants on assignment, and could subject us to fines, penalties and sanctions. There can be no assurance that we will be able to keep or replace all foreign nationals currently on assignment, or continue to import foreign national talent at the same rates as in the past.

Kforce may be adversely affected by government regulation of the staffing business, and of the workplace.

Our business is subject to regulation and licensing in many states. There can be no assurance that we will be able to continue to obtain all necessary licenses or approvals or that the cost of compliance will not prove to be material. If we fail to comply, such failure could materially adversely affect Kforce’s financial results.

Part of our business entails employing individuals on a temporary basis and placing such individuals in clients’ workplaces. Increased government regulation of the workplace or of the employer-employee relationship could have a material adverse effect on Kforce.

Any failure by our HLS Clinical Research business to comply with certain regulations, policies and procedures specific to that business could harm our operating results and/or reputation.

The services provided by our HLS Clinical Research business involve participation in clinical trials of pharmaceutical compounds using human subjects. This is a highly regulated field subject to oversight and inspection by the U.S. Food and Drug Administration (“FDA”). Any failure on our part to comply with the regulations, policies, or procedures established for a trial, or to comply with good clinical research practices, could result in the termination of the trial or the disqualification of data for submission to the FDA. This could subject us to regulatory sanctions and penalties, create substantial contractual or other legal liability to our client(s), harm our reputation, harm our ability to win or participate in future business, and harm our operating results.

 

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We face certain risks in collecting our trade accounts receivable.

We generate a significant amount of trade accounts receivable from our customers. Delays or defaults in payments owed to us could have a material adverse effect on our financial condition and results of operations. Factors that could cause a delay or default include business failures, turmoil in the financial and credit markets, sluggish or recessionary U.S. economic conditions, our exposure to customers in high-risk sectors such as the financial services industry, and declines in the credit worthiness of our customers. See Note 1 – “Summary of Significant Accounting Policies” to the Consolidated Financial Statements for further details.

Kforce may not be able to maintain sufficient cash flow or borrowing capacity to support operations.

On October 2, 2006, Kforce entered into a Second Amended and Restated Credit Agreement with a syndicate led by Bank of America, N.A. (the “Credit Facility”). Kforce’s maximum borrowings under the Credit Facility are $140 million, which includes a revolving loan tranche of up to $125 million (the “Revolving Loan Amount”) and a $15 million sub-limit for letters of credit.

Kforce’s liquidity may be adversely impacted by covenants in our Credit Facility. Borrowings under the Credit Facility are limited to 85% of eligible accounts receivable of which unbilled receivables can be no more than 40% of billed receivables, less certain minimum availability reserves. Under the Credit Facility, Kforce is required to maintain a minimum fixed charge coverage ratio in the event that it is unable to maintain minimum availability under the Credit Facility of $15.0 million. As of December 31, 2010, Kforce had availability under the Credit Facility of $89.3 million; therefore, the minimum fixed charge coverage ratio was not applicable. Kforce believes that it will be able to maintain the minimum availability requirement; however, in the event that Kforce is unable to do so, Kforce may fail the minimum fixed charge coverage ratio, which would constitute an event of default. The Credit Facility expires in November 2011. If we are not able to enter into or if there is a significant delay in the timing of our entering into an extension of the existing Credit Facility, a new credit facility or an alternative financing vehicle, our financial condition and liquidity may be materially adversely impacted.

At no time during the existence of the Credit Facility have we failed to meet the minimum availability and fixed charge coverage ratio requirements. If we did not comply with these financial covenants, such a breach of the Credit Facility could materially adversely affect our liquidity and financial condition and could result, among other things, in the acceleration of all amounts borrowed under the Credit Facility. See the “Liquidity and Capital Resources” portion of the MD&A in this annual report.

The financial markets may experience significant turmoil, similar to the turmoil of 2008 and 2009, which may negatively impact our liquidity and our ability to obtain financing.

Our liquidity and our ability to obtain financing may be negatively impacted if one of our lenders under our Credit Facility, or another financial institution, suffers liquidity issues. In such an event, we may not be able to draw on any of the amounts available under our Credit Facility, or a substantial portion thereof. This could limit Kforce’s ability to make strategic acquisitions and/or selective repurchases of its common stock.

Also, when we attempt to extend our Credit Facility, or if we attempt to obtain future financing in addition to, or as a replacement of, our Credit Facility, the credit market turmoil could negatively impact our ability to obtain such financing or at favorable terms.

Kforce’s temporary staffing business could be adversely impacted by recent health care reform.

The Health Care and Education Reconciliation Act of 2010 that was signed into law in March 2010 could have an adverse effect on Kforce by increasing the cost of providing temporary staffing services. If such an increase occurs, we could experience a reduction in our Flex gross profit if there is a delay in or inability to increase bill rates charged to our customers.

We are exposed to intangible asset risk which could result in future impairment.

A significant and sustained decline in our stock price and market capitalization, a significant decline in our expected future cash flows, a significant adverse change in the business climate, or slower growth rates could result in the need to perform an impairment analysis in future periods. If we were to conclude that a future write down of our goodwill is necessary, we would then record the appropriate charge, which could result in material charges that are adverse to our operating results and financial position. See Note 6 – “Goodwill and Other Intangible Assets” to the Consolidated Financial Statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” for further details.

Inflation may adversely affect our business operations in the future.

Given the current macroeconomic environment, the U.S. government has and may attempt in the future to provide additional monetary stimulus, a fiscal stimulus, or both, to the U.S. economy. Such actions may lead to inflationary conditions in our cost base, particularly resulting in an increase in the compensation, commissions, and benefits components of our SG&A expenses. This may harm our margins and profitability if we are unable to increase prices or cut costs enough to offset the effects of inflation in our cost base.

 

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Significant legal actions could subject Kforce to substantial uninsured liabilities.

Professional service providers are subject to legal actions alleging malpractice and other legal theories. These actions may involve large claims and significant defense costs. We may also be subject to claims alleging violations of federal or state labor laws. In addition, we may be subject to claims related to torts, intentional acts, or crimes committed by our full-time employees or temporary staffing personnel. In some instances, we are contractually obligated to indemnify clients against such risks. A failure of any of our employees or personnel to observe the applicable standard of care, relevant Kforce or client policies and guidelines, or applicable federal, state, or local laws, rules, and regulations could result in negative publicity, payment of fines, significant damage awards, or settlement expense. To reduce our exposure, we maintain insurance coverage for professional malpractice liabilities, fidelities, employment practices liabilities, and general liabilities in amounts and with deductibles that we believe are appropriate for our operations. Our insurance coverage, however, may not cover all claims against us or continue to be available to us at a reasonable cost.

Kforce may not be able to recruit and retain qualified personnel.

Kforce depends upon the abilities of its staff to attract and retain personnel, particularly technical, professional, and cleared government services personnel, who possess the skills and experience necessary to meet the staffing requirements of our clients. We must continually evaluate and upgrade our base of available qualified personnel to keep pace with changing client needs and emerging technologies. We expect competition for individuals with proven technical or professional skills for the foreseeable future. If qualified personnel are not available to us in sufficient numbers and upon economic terms acceptable to us, it could have a material adverse effect on our business.

Kforce’s success depends upon retaining the services of its management team and key operating employees.

Kforce is highly dependent on its management team and expects that continued success will depend largely upon their efforts and abilities. The loss of the services of any key executive for any reason could have a material adverse effect upon Kforce. Success also depends upon our ability to identify, develop, and retain qualified operating employees; particularly management, client servicing, and candidate recruiting employees. Kforce expends significant resources in the recruiting and training of its employees, as the pool of available applicants for these positions is limited. The loss of some of our key operating employees could have a material adverse effect on our business, including our ability to establish and maintain client and candidate, professional, and technical relationships.

Kforce depends on the proper functioning of its information systems.

Kforce is dependent on the proper functioning of information systems in operating its business. Critical information systems are used in every aspect of Kforce’s daily operations, most significantly, in the identification and matching of staffing resources to client assignments and in the customer billing and consultant payment functions. Kforce’s information systems are vulnerable to natural disasters (we are headquartered and our leased data center are located in a hurricane-prone area), fire or casualty theft, technical failures, terrorist acts, power loss, telecommunications failures, physical or software intrusions, computer viruses, and similar events. If our critical information systems fail or are otherwise unavailable, we would have to accomplish these functions manually, which could prove difficult or impossible, causing a material adverse effect on our business. In addition, we depend on third-party vendors for certain functions, whose future performance and reliability we cannot warrant.

Significant increases in payroll-related costs could adversely affect Kforce’s business.

Kforce is required to pay a number of federal, state, and local payroll and related costs, including unemployment taxes, workers’ compensation and insurance premiums and claims, FICA, and Medicare, among others, related to our employees. Significant increases in the effective rates of any payroll-related costs would likely have a material adverse effect on Kforce. Recently, many of the states in which Kforce conducts business have significantly increased their state unemployment tax rates in an effort to increase funding for unemployment benefits. Costs could also increase as a result of health care reforms or the possible imposition of additional requirements and restrictions related to the placement of personnel. We may not be able to increase the fees charged to our clients in a timely manner and in a sufficient amount to cover these potential cost increases.

If Kforce becomes subject to material liabilities under our self-insured programs, our financial results may be adversely affected.

Kforce provides workers’ compensation coverage through a program that is partially self-insured. In addition, we provide medical coverage to our employees through a partially self-insured program. If we become subject to substantial uninsured workers’ compensation or medical coverage liabilities, our financial results may be adversely affected.

 

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Adverse results in tax audits could result in significant cash expenditures or exposure to unforeseen liabilities.

Kforce is subject to periodic federal, state, and local tax audits for various tax years. Although Kforce attempts to comply with all taxing authority regulations, adverse findings or assessments made by taxing authorities as the result of an audit could have a material adverse effect on Kforce.

Due to inherent limitations, there can be no assurance that our system of disclosure and internal controls and procedures will be successful in preventing all errors and fraud, or in making all material information known in a timely manner to management.

Our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Kforce have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

The addition of offices and entry into new geographic markets may not occur on a timely basis or achieve anticipated financial results.

Kforce’s growth depends in part on our ability to enter new vertical or geographic markets successfully. This expansion is dependent on a number of factors, including our ability to:

 

   

develop, recruit, and maintain a base of qualified professionals within a new geographic market;

 

   

initiate, develop, train and sustain corporate client relationships in each new vertical or geographic market;

 

   

attract, hire, integrate, and retain qualified sales and sales support employees; and

 

   

accurately assess the demand in a new market.

The addition of new offices and entry into new vertical or geographic markets typically results in increases in operating expenses, primarily due to increased employee headcount. Expenses are incurred in advance of forecasted revenue, and there is typically a delay before our new employees reach full performance potential. Additionally, demand for our services in new markets that we enter might also be less than we anticipate. If we are unable to enter new vertical or geographic markets in a cost-effective manner or if demand for our services in new markets does not meet or exceed our forecasts, our business, operating results and financial condition could be negatively impacted. Historically, we have closed and consolidated offices to improve efficiency, and further closures or consolidation may occur depending on market and competitive conditions.

Our business is dependent upon maintaining our reputation, our relationships, and our performance.

The reputation and relationships that we have established and currently maintain with our customers are important to maintaining existing business and identifying new business. If our reputation or relationships were damaged, it could have a material adverse effect on our operations. In addition, if our performance does not meet our customers’ expectations, our revenues and operating results could be materially harmed.

We rely on short-term contracts with most of our clients.

Because long-term contracts are not a significant part of our business, other than in our HLS and GS segments, future financial results cannot be reliably predicted by considering past trends or extrapolating past results. Further, our reliance on short-term contracts exerts continued pressure on us when we try to renew contracts with existing clients who may seek better terms upon renewal.

 

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Our “offshore” outsourcing solutions are limited.

Many staffing customers are now seeking an offshore solution to support their technology and business process function and, as a result, a significant amount of technology and financial staffing may be replaced by offshore resources. We provide a limited technology staffing solution through two offices in the Philippines to certain clients whose contracts were acquired in conjunction with the 2006 acquisition of PCCI. There can be no assurance that we will be able to compete successfully against other offshore solution providers or that we will not lose significant market share and revenue.

We do not provide a VMS solution.

Many staffing customers are seeking to consolidate their use of staffing services through the use of a VMS solution. Kforce provides consultants to these clients through other staffing companies who utilize a VMS solution, but we do not currently provide this service directly to our clients. There can be no assurance that we can continue to effectively compete with those companies that provide a VMS solution. If we must provide a VMS solution, we could incur significant costs.

Kforce’s current market share may decrease as a result of limited barriers to entry for new competitors and discontinuation of clients outsourcing their staffing needs.

We face significant competition in the markets we serve, and there are limited barriers to entry for new competitors. The competition among staffing services firms is intense. Kforce competes for potential clients with providers of outsourcing services, systems integrators, computer systems consultants, temporary personnel agencies, search firms, and other providers of staffing services. A number of our competitors possess substantially greater resources than we do. From time to time, we experience significant pressure from our clients to reduce price levels. During these periods, we may face increased competitive pricing pressures and may not be able to recruit the personnel necessary to fulfill our clients’ needs. We also face the risk that certain of our current and prospective clients will decide to provide similar services internally. There can be no assurance that we will continue to successfully compete.

Competition for acquisition opportunities may restrict Kforce’s future growth by limiting our ability to make acquisitions at reasonable valuations.

Kforce has increased its market share and presence in the staffing industry through strategic acquisitions of companies that have complemented or enhanced its business. We have historically faced competition for acquisitions. In the future, this could limit our ability to grow through acquisitions or could raise the prices of acquisitions and make them less accretive or possibly non-accretive to us. In addition, Kforce may be limited by its ability to obtain financing to consummate desirable acquisitions.

Kforce may face significant risk arising from acquisitions.

Kforce may face difficulties integrating future acquisitions into existing operations and acquisitions may be unsuccessful, involve significant cash expenditures, or expose Kforce to unforeseen liabilities.

These acquisitions involve numerous risks, including:

 

   

potential loss of key employees or clients of acquired companies;

 

   

difficulties integrating acquired personnel and distinct cultures into a single business;

 

   

diversion of management attention from existing operations; and

 

   

assumption of liabilities and exposure to unforeseen liabilities of acquired companies.

These acquisitions may also involve significant cash expenditures, debt incurrence, integration expenses, and exposure to unforeseen liabilities that could have a material adverse effect on our financial condition, results of operations, and cash flows. Any acquisition may ultimately have a negative impact on our business and financial condition.

Decreases in patient occupancy at healthcare clients’ facilities may adversely affect the profitability of Kforce’s business.

Demand for temporary healthcare staffing services is significantly affected by the general level of patient occupancy at healthcare clients’ facilities. When a hospital’s occupancy increases, temporary employees are often added before full-time employees are hired. As occupancy decreases, clients may reduce their use of temporary employees before undertaking layoffs of their regular employees. Kforce may also experience more competitive pricing pressure during periods of occupancy downturn. This reduction in occupancy could adversely affect the demand for services and Kforce’s profitability.

 

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Future changes in reimbursement trends could hamper our clients’ ability to pay Kforce.

Many of Kforce’s healthcare clients are reimbursed under the federal Medicare program and state Medicaid programs for the services they provide. In recent years, federal and state governments have made significant changes in these programs that have reduced government rates. In addition, insurance companies and managed-care organizations seek to control costs by requiring that healthcare providers, such as hospitals, discount their services in exchange for exclusive or preferred participation in their benefit plans. Future federal and state legislation or evolving commercial reimbursement trends may further reduce, or change conditions for, our clients’ reimbursements. Limitations on reimbursement could reduce our clients’ cash flow, hampering their ability to pay us. This situation could have a significant impact on our cash flow.

Provisions in Kforce’s articles and bylaws and under Florida law may have certain anti-takeover effects.

Kforce’s articles of incorporation and bylaws and Florida law contain provisions that may have the effect of inhibiting a non-negotiated merger or other business combination. In particular, our articles of incorporation provide for a staggered board of directors and permit the removal of directors only for cause. Additionally, management may issue up to 15 million shares of preferred stock, and fix the rights and preferences thereof, without a further vote of the shareholders. In addition, certain of our officers and managers have employment agreements containing certain provisions that call for substantial payments to be made to such employees in certain circumstances upon a change in control. Certain of these provisions may discourage a future acquisition of Kforce, including an acquisition in which shareholders might otherwise receive a premium for their shares. As a result, shareholders who might desire to participate in such a transaction may not have the opportunity to do so. Moreover, the existence of these provisions could have a negative effect on the market price of our common stock.

Kforce’s stock price may be volatile.

Kforce’s common stock is traded on The NASDAQ Global Select Market under the symbol “KFRC.” The market price of our stock has fluctuated substantially in the past and could fluctuate substantially in the future, based on a variety of factors, including our operating results, changes in general conditions in the economy, the financial markets, the employment services industry, or other developments affecting us, our clients, or our competitors; some of which may be unrelated to our performance.

In addition, the stock market in general, especially The NASDAQ Global Select Market tier, along with market prices for staffing companies, has experienced volatility that has often been unrelated to the operating performance of these companies. These broad market and industry fluctuations may adversely affect the market price of our common stock, regardless of our operating results.

Among other things, volatility in our stock price could mean that investors will not be able to sell their shares at or above the prices they pay. The volatility also could impair our ability in the future to offer common stock as a source of additional capital or as consideration in the acquisition of other businesses.

 

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RISKS RELATED TO OUR GOVERNMENT BUSINESSES

In 2006, Kforce acquired PCCI and Bradson, which were both merged during 2007 into Kforce Government Solutions (“KGS”). In 2008, Kforce acquired RDI, which was merged into KGS during 2009. KGS is substantially dedicated to contracting with and serving U.S. Federal Government agencies (the “Federal Agency Business”), primarily as a prime contractor. In addition, Kforce supplies services to the Federal Government, primarily as a staffing services provider to federal prime contractors. Federal contractors, including KGS and Kforce face a number of risks, including the following:

Our failure to comply with complex federal procurement laws and regulations could cause us to lose business, incur additional costs, and subject us to a variety of penalties, including suspension and debarment from doing business with the Federal Government.

We must comply with complex laws and regulations relating to the formation, administration, and performance of Federal Government contracts. These laws and regulations create compliance risk, affect how we do business with our federal agency clients, and may impose added costs on our business.

If a government review or investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, harm to our reputation, suspension of payments, fines, and suspension or debarment from doing business with Federal Government agencies. On December 15, 2009, the United States Department of Interior (“DOI”) suspended KGS from seeking new Federal business or renewing existing business, and proposed to debar KGS, for failure to follow procurement regulations relating to conflicts of interest. The suspension and proposed debarment was withdrawn on December 29, 2009, pursuant to the terms of a three-year Administrative Agreement entered into between KGS and DOI. The Administrative Agreement imposes training requirements, oversight and controls on KGS for a period of three years. While we believe that we have remained in compliance with the Administrative Agreement, the failure of KGS to comply with the Administrative Agreement during this period could have a material adverse impact on KGS and Kforce, including suspension and debarment from doing business with the Federal Government.

The Federal Government also may reform its procurement practices or adopt new contracting rules and regulations, including cost accounting standards, that could be costly to satisfy or that could impair our ability to obtain new contracts. A failure to comply with all applicable laws and regulations could result in contract termination, price or fee reductions, or suspension or debarment from contracting with the Federal Government; each of which could lead to a material reduction in our revenues, cash flows and operating results.

Unfavorable government audit results could force us to refund previously recognized revenues and could subject us to a variety of penalties and sanctions.

Federal agencies can audit and review our performance on contracts, pricing practices, cost structure, and compliance with applicable laws, regulations, and standards. An audit of our work, including an audit of work performed by companies Kforce has acquired or may acquire, or subcontractors we have hired or may hire, could force us to refund previously recognized revenues.

If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or debarment from doing business with Federal Government agencies. In addition, we could suffer serious harm to our reputation if allegations of impropriety were made against us, whether or not true.

If we were suspended or debarred from contracting with the Federal Government generally or with any specific agency, if our reputation or relationships with Government agencies were impaired, or if the Government otherwise were to cease doing business with us or were to significantly decrease the amount of business it does with us, our revenue, cash flows and operating results could be materially adversely affected.

The failure by Congress to approve budgets on a timely basis for the federal agencies we support could delay or reduce spending and cause us to lose revenue.

On an annual basis, Congress must approve and the President must sign the appropriation bills that govern spending by each of the federal agencies we support. When Congress is unable to agree on budget priorities and is unable to pass the annual budget on a timely basis, Congress typically enacts a continuing resolution authority (“CRA”). A CRA allows government agencies to operate at 75% of spending levels approved in the previous budget cycle. When government agencies must operate under a CRA, it may delay funding we expect to receive from clients on work we are already performing and will likely result in any new initiatives being delayed, or potentially cancelled.

 

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Changes in the spending policies or budget priorities of the Federal Government could cause us to lose revenue.

Changes in Federal Government fiscal or spending policies could adversely affect our government agency business. For example, the Federal Government began in 2009 to in-source certain functions. If this trend continues, it could adversely affect our business. In addition, our business could be adversely affected by decreases in Federal Government spending.

Our Federal Agency Business is dependent upon maintaining our reputation, our relationships and our performance.

The reputation and relationships that we have established and currently maintain with government personnel and agencies are important to maintaining existing business and identifying new business. If our reputation or relationships were damaged, it could have a material adverse effect. In addition, if our performance does not meet agency expectations, our revenues and operating results could be materially harmed.

Competition is intense in the Federal Agency Business.

There is often intense competition to win federal agency contracts. Even when a contract is awarded to us, competitors frequently challenge such awards. If we are unable to successfully compete for new business or win competitions to maintain existing business, our revenue growth and margins may decline. Many of our competitors are larger and have greater resources, larger client bases, and greater brand recognition than we do. Our larger competitors also may be able to provide clients with different or greater capabilities or benefits than we can provide.

Loss of our General Services Administration (“GSA”) Schedules or other contracting vehicles could impair our ability to win new business.

GSA Schedules constitute a significant percentage of revenues from our federal agency clients. If we were to lose one or more of these Schedules or other contracting vehicles, we could lose revenues and our operating results could be adversely affected. These Schedules or contracts typically have an initial term with multiple options that may be exercised by our government agency clients to extend the contract for successive periods of one or more years. We can provide no assurance that our clients will exercise these options.

Our failure to obtain and maintain necessary security clearances may limit our ability to perform classified work for government clients, which could cause us to lose business.

Some government contracts require us to maintain facility security clearances and require some of our employees to maintain individual security clearances. If our employees lose or are unable to timely obtain security clearances, or we lose a facility clearance, a government agency client may terminate the contract or decide not to renew it upon its expiration.

Our employees may engage in misconduct or other improper activities, which could harm our business.

Like all government contractors, we are exposed to the risk that employee fraud or other misconduct could occur. Misconduct by our employees could include intentional failures to comply with Federal Government procurement regulations, engaging in unauthorized activities, seeking reimbursement for improper expenses, or falsifying time records. Employee misconduct could also involve the improper use of our clients’ sensitive or classified information, which could result in regulatory sanctions against us and serious harm to our reputation. It is not always possible to deter employee misconduct, and precautions to prevent and detect this activity may not be effective in controlling such risks or losses, which could adversely affect our business.

Security breaches in sensitive government information systems could result in the loss of our clients and cause negative publicity.

Many of the systems we develop, install, and maintain involve managing and protecting information used in intelligence, national security, and other sensitive or classified government functions. A security breach in one of these systems could cause serious harm to our business, damage our reputation, and prevent us from being eligible for further work on sensitive or classified systems for Federal Government clients. We could incur losses from such a security breach that could exceed the policy limits under our insurance. Damage to our reputation or limitations on our eligibility for additional work resulting from a security breach in one of our systems could materially reduce our revenues.

 

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Item 1B. Unresolved Staff Comments.

None.

 

Item 2. Properties.

On May 27, 2010, we acquired our corporate headquarters in Tampa, Florida, which we previously leased and which is approximately 128,000 square feet of space, for a purchase price of $28.5 million. Leases for our field offices, which are located throughout the U.S., range from three to five-year terms although there are a few month-to-month arrangements and one 10-year lease term. We also lease approximately 24,000 square feet of combined space in two offices in Manila, Philippines.

Although additional field offices may be established based on the requirements of our operations, we believe that our facilities are adequate for our current needs, and we do not expect to materially expand our facilities in the foreseeable future.

 

Item 3. Legal Proceedings.

As disclosed in our previous filings with the SEC, Kforce is a defendant in a California class action lawsuit alleging misclassification of California Account Managers and seeking unspecified damages. The tentative settlement referred to in our Quarterly Report on Form 10-Q for the period ended September 30, 2010 has been preliminarily approved by the Court in the adjusted amount of approximately $2.5 million, which has been recorded within accounts payable and other accrued liabilities in the accompanying consolidated balance sheets. A hearing on the final approval is scheduled to take place in May 2011.

In the ordinary course of its business, Kforce is from time to time threatened with litigation or named as a defendant in various lawsuits and administrative proceedings. While management does not expect any of these other matters to have a material adverse effect on the Company’s results of operations, financial position or cash flows, litigation is subject to certain inherent uncertainties. Kforce maintains liability insurance in such amounts and with such coverage and deductibles as management believes is reasonable. The principal liability risks that Kforce insures against are workers’ compensation, personal injury, bodily injury, property damage, directors’ and officers’ liability, errors and omissions, employment practices liability and fidelity losses. There can be no assurance that Kforce’s liability insurance will cover all events or that the limits of coverage will be sufficient to fully cover all liabilities.

Other than as described above, we are not aware of any pending legal proceedings that are likely to have a material adverse impact on Kforce.

 

Item 4. Reserved.

None.

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our common stock trades on the NASDAQ Global Select Market under the symbol “KFRC.” The following table sets forth, for the periods indicated, the high and low intra-day sales price of our common stock, as reported on the NASDAQ Global Select Market. These prices represent inter-dealer quotations without retail markups, markdowns or commissions, and may not represent actual transactions.

 

     Three Months Ended  
     March 31,      June 30,      September 30,      December 31,  

2010

           

High

   $ 16.04       $     16.25       $ 14.51       $ 17.10   

Low

   $ 12.32       $ 11.92       $ 9.80       $ 13.04   

2009

           

High

   $ 8.31       $ 11.20       $ 12.65       $ 14.43   

Low

   $ 5.44       $ 6.69       $ 8.05       $ 10.34   

From January 1, 2011 through March 3, 2011, the high and low intra-day sales price of our common stock was $19.23 and $16.00, respectively. On March 3, 2011, the last reported sale price of our common stock on the NASDAQ Global Select Market was $18.06 per share.

 

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Holders of Common Stock

On March 3, 2011, there were approximately 206 holders of record.

Dividends

Since our initial public offering in 1995, we have not paid any cash dividends on its common stock and has no current intention to do so. Kforce is not restricted under its currently existing Credit Facility from paying dividends.

Securities Authorized for Issuance under Equity Compensation Plans

The following table provides information about our common stock that may be issued under all of our existing equity compensation plans as of December 31, 2010:

 

Plan Category

   Number of Securities
to be Issued Upon
Exercise of
Outstanding Options,
Warrants and Rights
(a) (1)
     Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights
(b) (2)
     Number of Securities
Remaining Available
for Future Issuance
Under
Equity Compensation
Plans (excluding
securities reflected in
column (a)) (c) (3) (4)
 

Equity compensation plans approved by shareholders

        

Kforce Inc. 2006 Stock Incentive Plan

     853,920       $ 9.64         2,939,013   

Kforce Inc. 2009 Employee Stock Purchase Plan

     N/A         N/A         3,000,000   
                          

Total

     853,920       $ 9.64         5,939,013   

Equity compensation plans not approved by shareholders

     —         $ —           —     

 

(1) In addition to the number of securities listed in this column, 1,897,511 shares of performance accelerated restricted stock and restricted stock granted under the Kforce Inc. 2006 Stock Incentive Plan have been issued and are unvested as of December 31, 2010.
(2) The weighted-average exercise price excludes unvested performance accelerated restricted stock and restricted stock because there is no exercise price associated with these equity awards.
(3) All of the shares of common stock that remain available for future issuance under the Kforce Inc. 2006 Stock Incentive Plan may be issued in connection with options, warrants, rights and restricted stock awards. Each future grant of options or stock appreciation rights shall reduce the available shares under the Kforce Inc. 2006 Stock Incentive Plan by an equal amount while each future grant of restricted stock shall reduce the available shares by 1.58 shares for each share awarded. In order to maximize our share reserves, the prevailing practice over the last few years has been for Kforce to issue full value awards as opposed to options and stock appreciation rights.
(4) There are 3,000,000 shares of common stock that remain available for future issuance under the Kforce Inc. 2009 Employee Stock Purchase Plan (“2009 ESPP”). As of December 31, 2010, there were options outstanding under the 2009 ESPP to purchase 8,979 shares of common stock at a discounted purchase price of $15.37.

Purchases of Equity Securities by the Issuer

There were no repurchases of Kforce common stock during the three months ended December 31, 2010.

 

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Item 6. Selected Financial Data.

The information set forth below is not necessarily indicative of the results of future operations and should be read in conjunction with the information within Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data.

 

     Years Ended December 31,  
     2010      2009      2008 (1)     2007      2006  
     (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)  

Net service revenues

   $     990,807       $     910,136       $     997,017      $     972,781       $ 868,001   

Gross profit

     312,414         285,979         344,651        352,023         304,749   

Selling, general and administrative expenses

     265,183         251,268         415,884        272,335         241,503   

Depreciation and amortization

     12,611         11,673         13,824        14,487         11,551   

Other expense, net

     1,296         1,145         2,136        4,422         3,701   

Income (loss) from continuing operations, before income taxes

     33,324         21,893         (87,193     60,779         47,994   

Provision for income taxes

     12,690         9,020         1,928        23,856         18,550   

Income (loss) from continuing operations

     20,634         12,873         (89,121     36,923         29,444   

Income from discontinued operations, net of income taxes

     —           —           5,013        3,444         3,075   

Net income (loss)

   $ 20,634       $ 12,873       $ (84,108   $ 40,367       $ 32,519   

Earnings (loss) per share – basic, continuing operations

   $ 0.52       $ 0.33       $ (2.26   $ 0.90       $ 0.73   

Earnings (loss) per share – diluted, continuing operations

   $ 0.51       $ 0.33       $ (2.26   $ 0.87       $ 0.70   

Earnings (loss) per share – basic

   $ 0.52       $ 0.33       $ (2.13   $ 0.98       $ 0.81   

Earnings (loss) per share – diluted

   $ 0.51       $ 0.33       $ (2.13   $ 0.95       $ 0.77   

Weighted average shares outstanding – basic

     39,480         38,485         39,471        41,308         40,189   

Weighted average shares outstanding – diluted

     40,503         39,330         39,471        42,294         42,012   
     As of December 31,  
     2010      2009      2008 (1)     2007      2006  
     (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)  

Working capital

   $ 64,878       $ 57,924       $ 60,302      $ 95,348       $ 64,425   

Total assets

   $ 391,044       $ 339,825       $ 350,815      $ 476,136       $ 442,618   

Total outstanding borrowings – credit facility

   $ 10,825       $ 3,000       $ 38,022      $ 50,330       $ 86,435   

Total long-term liabilities

   $ 36,904       $ 33,887       $ 59,528      $ 78,102       $ 94,664   

Stockholders’ equity

   $ 253,817       $ 226,725       $ 205,843      $ 312,468       $ 261,925   

(1)        Kforce recognized a goodwill and intangible asset impairment charge of $129.4 million during 2008. The tax benefit associated with this impairment charge was $14.2 million, resulting in an after-tax impairment charge of $115.2 million.

Acquisitions were made in our fiscal years ended December 31, 2008 and 2006. The results of operations for these acquisitions were included in our Consolidated Financial Statements from the respective acquisition date. See Note 7 – “Acquisitions” to the Consolidated Financial Statements for more detail on acquisitions made in 2008. During the three months ended June 30, 2008, Kforce sold its Scientific and per-diem Nursing business and completed efforts to wind down the remaining operations of its non per-diem Nursing business. As a result, the results of operations of Scientific and Nursing have been presented as discontinued operations for the years ended December 31, 2008, 2007 and 2006. See Note 2 – “Discontinued Operations” to the Consolidated Financial Statements for more detail.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand Kforce, our operations and our present business environment. MD&A is provided as a supplement to - and should be read in conjunction with - our Consolidated Financial Statements and the accompanying notes thereto contained in Item 8. Financial Statements and Supplementary Data of this report as well as Item 1. Business of this report for an overview of our operations and business environment. This overview summarizes the structure of our MD&A, which includes the following sections:

 

   

Executive Summary – a summary of our 2010 results.

 

   

Critical Accounting Estimates – a discussion of the accounting estimates that are most critical to aid in fully understanding and evaluating our reported financial results and that require management’s most difficult, subjective or complex judgments.

 

   

New Accounting Standards – a discussion of recently issued accounting standards and their potential impact on our Consolidated Financial Statements.

 

   

Results of Operations – an analysis of Kforce’s consolidated results of operations for the three years presented in our Consolidated Financial Statements. In order to assist the reader in understanding our business as a whole, certain metrics are presented for each of our four operating segments.

 

   

Liquidity and Capital Resources – an analysis of cash flows, off-balance sheet arrangements, stock repurchases and contractual obligations and commitments and the impact of changes in interest rates on our business.

During 2008, Kforce sold its Scientific and per-diem Nursing businesses. See Note 2 – “Discontinued Operations” to the Consolidated Financial Statements for a more detailed discussion. The results presented in the accompanying consolidated statements of operations and comprehensive income (loss) for the year ended December 31, 2008 include activity relating to the Scientific and Nursing businesses as discontinued operations. Except as specifically noted, our discussions below exclude any activity related to the Scientific and Nursing businesses, which are addressed separately in the discussion of income from discontinued operations, net of income taxes.

EXECUTIVE SUMMARY

The following is an executive summary of what Kforce believes are important 2010 highlights, which should be considered in the context of the additional discussions herein and in conjunction with the Consolidated Financial Statements and notes thereto. We believe such highlights are as follows:

 

   

Net service revenues increased 8.9% to $990.8 million in 2010 from $910.1 million in 2009. Net service revenues increased 15.1% for Tech and 14.9% for FA and decreased 1.8% for HLS and 9.9% for GS.

 

   

Flex revenues increased 7.9% to $951.4 million in 2010 from $881.7 million in 2009.

 

   

Search revenues increased 38.6% to $39.4 million in 2010 from $28.4 million in 2009.

 

   

Flex gross profit margin decreased 50 basis points to 28.7% in 2010 from 29.2% in 2009. Flex gross profit margin increased 50 basis points for Tech, decreased 110 basis points for FA and 360 basis points for GS, and was flat for HLS.

 

   

SG&A as a percentage of revenues for the year ended December 31, 2010 was 26.8% compared to 27.6% in 2009.

 

   

Net income increased 60.3% to $20.6 million in 2010 from $12.9 million in 2009.

 

   

The total amount outstanding under the Credit Facility increased $7.8 million to $10.8 million as of December 31, 2010 from $3.0 million as of December 31, 2009. As a result of the expiration date of the current Credit Facility, we have classified outstanding borrowings under the Credit Facility as a current liability in our Consolidated Financial Statements as of December 31, 2010.

 

   

Diluted earnings per share increased 54.5% to $0.51 in 2010 from $0.33 in 2009.

 

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CRITICAL ACCOUNTING ESTIMATES

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

Our significant accounting policies are discussed in Note 1 - “Summary of Significant Accounting Policies” to the Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain.

 

Description

  

Judgments and Uncertainties

  

Effect if Actual Results

Differ From Assumptions

Allowance for Doubtful Accounts, Fallouts and Other Accounts Receivable Reserves

     
See Note 1 - “Summary of Significant Accounting Policies” to the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K, for a complete discussion of our policies related to determining our allowance for doubtful accounts, fallouts and other accounts receivable reserves.   

Kforce performs an ongoing analysis of factors including recent write-off and delinquency trends, changes in economic conditions, a specific analysis of material accounts receivable balances that are past due, and concentration of accounts receivable among clients, in establishing its allowance for doubtful accounts.

 

Kforce estimates its allowance for Search fallouts based on our extensive historical experience with the actual occurrence of fallouts.

 

Kforce estimates its reserve for future revenue adjustments (e.g. bill rate adjustments, time card adjustments) based on our historical experience.

  

We have not made any material changes in the accounting methodology used to establish our allowance for doubtful accounts, fallouts and other accounts receivable reserves. As of December 31, 2010 and 2009, the allowance was 2.6% and 5.1% as a percentage of gross accounts receivable, respectively.

 

We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our allowance for doubtful accounts. However, if our estimates regarding estimated accounts receivable losses are inaccurate, we may be exposed to losses or gains that could be material. A 10% difference in actual accounts receivable losses reserved for at December 31, 2010, would have impacted our net income for 2010 by approximately $0.4 million.

 

Although we do not believe that there is a reasonable likelihood that there will be a material change in the actual occurrence of fallouts, a 10% difference in our actual fallout experience reserved for at December 31, 2010, would have impacted our net income for 2010 by less than $0.1 million.

 

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Description

  

Judgments and Uncertainties

  

Effect if Actual Results

Differ From Assumptions

Goodwill Impairment

     

We evaluate goodwill for impairment annually or more frequently whenever events and circumstances indicate that the carrying value of the goodwill may not be recoverable. See Note 6 - “Goodwill and Other Intangible Assets” to the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a complete discussion of the valuation methodology employed.

 

We completed our annual assessment of goodwill impairment as of December 31, 2010 using the methodology described therein and determined there was no impairment.

 

The carrying value of goodwill as of December 31, 2010 was $138.1 million.

  

We determine the fair value of our reporting units using widely accepted valuation techniques, including discounted cash flow, market multiple analyses and market transactions analyses. These types of analyses contain uncertainties because they require management to make significant assumptions and judgments including: (i) an appropriate rate to discount the expected future cash flows, (ii) the inherent risk in achieving forecasted operating results, (iii) long-term growth rates, (iv) expectations for future economic cycles and (v) market multiples.

 

It is our policy to conduct impairment testing based on our current business strategy in light of present industry and economic conditions, as well as future expectations.

  

We have not made any material changes in our goodwill impairment assessment methodology during the past three fiscal years.

 

Impairment was not indicated for any of our reporting units based on the results of the first step of the goodwill impairment assessment as of December 31, 2010. The fair value for Tech, FA, HLS and GS reporting units exceeded their carrying values by 59%, 107%, 58% and 17%, respectively.

 

As a result of the 17% gap between the fair value and carrying value of our GS reporting unit, we performed a sensitivity analysis by independently modifying the discount rate, long-term growth rate and forecasted operating results, each of which did not indicate impairment. Given this, we do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to test for impairment losses on goodwill and other intangible assets. However, if actual results are materially inconsistent with our estimates or assumptions, we may be exposed to impairment charges that could be material.

Accounting for Business Combinations

     

In accordance with accounting for business combinations, we allocate the purchase price of an acquired business to its identifiable assets and liabilities based on estimated fair values. The excess of the purchase price over the amount allocated to the assets and liabilities, if any, is recorded as goodwill.

 

We use all available information to estimate fair values and we adjust the preliminary purchase price allocation, as necessary, up to one year after the acquisition closing date as we obtain more information regarding asset valuations and liabilities assumed.

 

During the last three fiscal years, we have completed one acquisition.

  

Our purchase price allocation methodology contains uncertainties because it requires management to make assumptions and to apply judgment to estimate the fair value of acquired assets and liabilities. Management estimates the fair value of assets and liabilities based upon quoted market prices, the carrying value of the acquired assets and widely accepted valuation techniques, including discounted cash flows and market multiple analyses.

 

Unanticipated events or circumstances may occur which could affect the accuracy of our fair value estimates, including assumptions regarding industry economic factors and business strategies.

  

See Note 7 - “Acquisitions” to the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for the purchase price allocation calculations as well as a description of the methods used to value the identifiable intangible assets.

 

We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to complete the purchase price allocation and estimate the fair value of acquired assets and liabilities. However, if future results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.

 

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Description

  

Judgments and Uncertainties

  

Effect if Actual Results

Differ From Assumptions

Self-Insured Liabilities

     

We are self-insured for certain losses related to health insurance and workers’ compensation claims. However, we obtain third-party insurance coverage to limit our exposure to these claims.

 

When estimating our self-insured liabilities, we consider a number of factors, including historical claims experience, plan structure, internal claims management activities, demographic factors and severity factors. Periodically, management reviews its assumptions to determine the adequacy of our self-insured liabilities.

 

Our liabilities for health insurance and workers’ compensation claims as of December 31, 2010 were $3.5 million and $1.7 million, respectively.

   Our self-insured liabilities contain uncertainties because management is required to make assumptions and to apply judgment to estimate the ultimate total cost to settle reported claims and claims incurred but not reported as of the balance sheet date.   

We have not made any material changes in the accounting methodology used to establish our self-insured liabilities during the past three fiscal years.

 

We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate our self-insured liabilities. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.

 

A 10% change in our self-insured liabilities related to health insurance and workers’ compensation as of December 31, 2010 would have impacted our net income for 2010 by approximately $0.5 million.

Stock-Based Compensation

     

We have stock-based compensation plans, which includes options, stock appreciation rights and unvested share awards and an employee stock purchase plan. See Note 1 - “Summary of Significant Accounting Policies,” Note 12 - “Employee Benefit Plans,” and Note 14 - “Stock Incentive Plans” to the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a complete discussion of our stock-based compensation programs.

 

We determine the fair value of our stock option awards and stock appreciation rights (“SARs”) at the date of grant using widely accepted option-pricing models such as Black-Scholes. We determine the fair market value of our restricted stock (“RS”) and performance accelerated restricted stock (“PARS”) based on the closing stock price of Kforce’s common stock at the date of grant. We also utilize a lattice model to determine the derived service period for our SARs and PARS, which contain a market condition.

  

Option-pricing models and generally accepted valuation techniques require management to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the future volatility of our stock price, expected dividend yield, risk-free rates, future employee turnover rates and future employee stock option exercise behaviors. Changes in these assumptions can materially affect the estimate of fair value.

 

RS and PARS require management to make assumptions regarding the likelihood of achieving any performance conditions as well as employee turnover rates.

 

SARs and PARS also have certain market conditions, which are inherently difficult to estimate but are modeled using a Monte Carlo simulation model.

  

We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to determine stock-based compensation expense. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to changes in stock-based compensation expense that could be material or the stock-based compensation expense reported in our financial statements may not be representative of the actual economic cost of the stock-based compensation.

 

A 10% change in our stock-based compensation expense would have impacted our net income for 2010 by approximately $0.6 million.

 

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Description

  

Judgments and Uncertainties

  

Effect if Actual Results

Differ From Assumptions

Defined Benefit Pension Plan – U.S.

     
We have a defined benefit pension plan that benefits certain named executive officers, the Supplemental Executive Retirement Plan (“SERP”). See Note 12 - “Employee Benefit Plans” to the Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a complete discussion of the terms of this plan.    When estimating the obligation for our pension and postretirement benefit plans, management is required to make certain assumptions and to apply judgment with respect to determining an appropriate discount rate, bonus percentage assumptions and expected future compensation increases for the participants in the plan.   

We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate our obligation. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.

 

A 10% change in the discount rate used to measure the net periodic pension cost for the SERP during 2010 would have had an insignificant impact on our net income for 2010.

Accounting for Income Taxes

     
See Note 4 - “Income Taxes” to the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for a complete discussion of the components of Kforce’s income tax expense as well as the temporary differences that exist as of December 31, 2010.   

Our consolidated effective income tax rate is influenced by tax planning opportunities available to us in the various jurisdictions in which we conduct business. Significant judgment is required in determining our effective tax rate and in evaluating our tax positions, including those that may be uncertain.

 

Kforce is also required to exercise judgment with respect to the realization of our net deferred tax asset.

  

We do not believe that there is a reasonable likelihood that there will be a material change in our liability for uncertain income tax positions or our effective income tax rate. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses that could be material.

 

A 0.50% change in our effective income tax rate from continuing operations would have impacted our net income for 2010 by approximately $0.2 million.

NEW ACCOUNTING STANDARDS

In November 2008, the SEC issued for comment a proposed roadmap regarding the potential use of financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”). IFRS is a set of standards and interpretations adopted by the International Accounting Standards Board. Under the proposed roadmap, Kforce would be required to prepare its financial statements in accordance with IFRS in our fiscal year ending December 31, 2015. Kforce is currently assessing the potential impact of IFRS on its financial statements and will continue to follow the proposed roadmap for future developments. In February 2010, the SEC released a policy statement confirming the continuous movement towards a vote during 2011 on whether or not to move ahead with a mandate for the required use of IFRS for U.S. public companies as well as an estimated timeline.

In October 2009, the FASB issued guidance related to multiple-deliverable revenue arrangements. This guidance requires entities to allocate revenues in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenues to be allocated using the relative selling price method. This guidance should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on our future Consolidated Financial Statements.

 

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RESULTS OF OPERATIONS

Net service revenues for the years ended December 31, 2010 and 2009 were $990.8 million and $910.1 million, respectively, which represents an increase of 8.9%. The increase was primarily due to our Tech (which represents approximately 54% of our total net service revenues) and FA segments (which represents approximately 19% of our net service revenues), which had year-over-year increases in net service revenues of 15.1% and 14.9%, respectively. Net service revenues for HLS declined 1.8% primarily as a result of cost-cutting initiatives of large pharmaceutical companies and delays in hiring activity resulting from several mergers. Our GS segment experienced a 9.9% decline in net service revenues, which was primarily attributable to continued delays in the timing of project awards as well as the trend by the Federal Government to in-source certain functions in an attempt to reduce expenditures.

Flex gross profit margins decreased 50 basis points to 28.7% compared to 29.2% for the years ended December 31, 2010 and 2009, respectively. Kforce experienced declines in Flex gross profit margins across all segments with the exception of Tech, which increased 50 basis points on a year-over-year basis. The decreases experienced in most segments were primarily attributable to the compression in the spread between our bill and pay rates as well as higher payroll taxes, particularly unemployment taxes. SG&A expenses as a percentage of net service revenues were 26.8% and 27.6% for the years ended December 31, 2010 and 2009, respectively.

From an economic standpoint, temporary employment figures and trends are important indicators of staffing demand, which increased during the year ended December 31, 2010 as compared to 2009 based on data published by the Bureau of Labor Statistics (“BLS”). While we believe the macro-employment picture continues to be relatively weak with the unemployment rate at 9.4% as of December 2010, temporary employment has expanded by 495,000 jobs since reaching a low in September 2009. In addition, the penetration rate (the percentage of temporary staffing to total employment) has increased 15 consecutive months from its low of 1.32% in August 2009 to over 1.7% in November 2010. We believe that the penetration rate could surpass the prior peak of 2.0% achieved in the late 1990s. If the penetration rate of temporary staffing continues to increase, we believe that our Flex revenues can grow significantly even in a relatively modest growth macro-economic environment. Management remains cautiously optimistic about the growth prospects of the temporary staffing industry, the penetration rate and in particular our revenue portfolio.

Although there can be no assurance that historical trends will continue, Search activity and Flex gross margins historically decrease heading into the troughs of an economic cycle, increase after economic conditions have shown sustained improvement, and are the strongest during the peak of an economic cycle. Consistent with this trend, we have seen recent increases in Search activity. Search revenues increased 38.6% for 2010 compared to 2009. We believe these increases reflect clients rebuilding staff after significant reductions during 2008 and 2009. We expect this growth trend may flatten in the near term, which may be reflective of the completion of the initial stage of our clients rebuilding their full-time staff and a secular shift to a flexible staffing model.

We have utilized the most recent economic downturn to undertake several significant initiatives including (i) further developing and optimizing our NRC and Strategic Accounts teams in support of our field population, (ii) restructuring both our back office and field operations under our Shared Services program, (iii) upgrading our corporate systems (primarily our front end and time collection systems) and (iv) making other technology investments designed to increase the productivity of our field associates. We believe that these investments have increased our operating efficiency and enabled us to be more responsive to our clients as well as provided for a better operating platform to support the expected future growth. We believe our field operations model, which allows us to deliver our service offerings in a disciplined and consistent manner across all geographies and business lines, as well as our highly centralized back office operations, are competitive advantages and keys to our future growth and profitability. We also believe that our diversified portfolio of service offerings, which are primarily domestic, will also be a key contributor to our long-term financial stability.

 

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Net Service Revenues. The following table sets forth, as a percentage of net service revenues, certain items in our consolidated statements of operations for the years ended:

 

     December 31,
             2010                   2009                   2008        

Revenues by Segment:

            

Tech

       54.4 %       51.4 %       52.1 %

FA

       18.9         17.9         21.2  

HLS

       16.3         18.1         19.0  

GS

       10.4         12.6         7.7  
                              

Net service revenues

       100.0 %       100.0 %       100.0 %
                              

Revenues by Time:

            

Flex

       96.0 %       96.9 %       93.4 %

Search

       4.0         3.1         6.6  
                              

Net service revenues

       100.0 %       100.0 %       100.0 %
                              

Gross profit

       31.5 %       31.4 %       34.6 %

Selling, general and administrative expenses

       26.8 %       27.6 %       41.7 %

Income (loss) from continuing operations, before income taxes

       3.5 %       2.4 %       (8.7 )%

Income (loss) from continuing operations

       2.1 %       1.4 %       (8.9 )%

Net income (loss)

       2.1 %       1.4 %       (8.4 )%

The following table details net service revenues for Flex and Search revenues by segment and changes from the prior year.

 

(in $000’s)

   2010      Increase
(Decrease)
     2009      Increase
(Decrease)
     2008  

Tech

              

Flex

   $ 522,220         14.1%        $ 457,544         (7.2)%       $ 493,282   

Search

     16,346         59.0%          10,280         (61.3)%         26,585   
                                

Total Tech

   $ 538,566         15.1%        $ 467,824         (10.0)%       $ 519,867   
                                

FA

              

Flex

   $ 165,831         13.4%        $ 146,186         (16.0)%       $ 174,039   

Search

     21,365         28.2%          16,670         (55.2)%         37,220   
                                

Total FA

   $ 187,196         14.9%        $ 162,856         (22.9)%       $ 211,259   
                                

HLS

              

Flex

   $ 160,247         (2.0)%       $ 163,481         (12.8)%       $ 187,486   

Search

     1,666         14.7%          1,452         (33.4)%         2,180   
                                

Total HLS

   $ 161,913         (1.8)%       $ 164,933         (13.0)%       $ 189,666   
                                

GS

              

Flex

   $ 103,132         (9.9)%       $ 114,523         50.2%        $ 76,225   

Search

     —           —             —           —             —     
                                

Total GS

   $ 103,132         (9.9)%       $ 114,523         50.2%        $ 76,225   
                                

Total Flex

   $ 951,430         7.9%        $ 881,734         (5.3)%       $ 931,032   

Total Search

     39,377         38.6%          28,402         (57.0)%         65,985   
                                

Total Revenues

   $ 990,807         8.9%        $ 910,136         (8.7)%       $ 997,017   
                                

 

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While quarterly comparisons are not fully discussed herein, certain quarterly revenue trends are referred to in discussing annual comparisons. Our quarterly operating results are affected by the number of billing days in a quarter, which is provided in the table below. This 2010 quarterly information is presented for this purpose only.

 

     Three Months Ended  

(in $000’s, except Billing Days)

   December 31      September 30      June 30      March 31  

Billing Days

     61         64         64         62   

Flex Revenues

           

Tech

   $ 138,467       $ 137,326       $ 129,961       $ 116,466   

FA

     47,512         44,437         38,152         35,730   

HLS

     38,145         41,007         41,066         40,029   

GS

     23,313         26,190         27,091         26,538   
                                   

Total Flex

   $ 247,437       $ 248,960       $ 236,270       $ 218,763   
                                   

Search Revenues

           

Tech

   $ 4,402       $ 4,604       $ 4,130       $ 3,210   

FA

     5,937         5,733         5,282         4,413   

HLS

     719         222         455         270   
                                   

Total Search

   $ 11,058       $ 10,559       $ 9,867       $ 7,893   
                                   

Total Revenues

           

Tech

   $ 142,869       $ 141,930       $ 134,091       $ 119,676   

FA

     53,449         50,170         43,434         40,143   

HLS

     38,864         41,229         41,521         40,299   

GS

     23,313         26,190         27,091         26,538   
                                   

Total Revenues

   $ 258,495       $ 259,519       $ 246,137       $ 226,656   
                                   

Flex Revenues. The primary drivers of Flex revenues are the number of consultant hours worked, the consultant bill rate per hour and, to a limited extent, the amount of billable expenses incurred by Kforce.

Flex revenues for our largest segment, Tech, have been strong compared to the beginning stages of previous economic recoveries, which we believe is primarily a result of the candidate skill sets that are in demand, our great people and our operating model. A recent SIA report projected 10% growth in 2010 for the information technology staffing market while our Tech segment grew 15.1%. We believe that our operating model allows us to deliver our service offerings in a disciplined and consistent manner across all geographies and business lines. This operating model includes our NRC, which we believe has been highly effective in increasing the quality and speed of delivery of services to our clients, particularly our Strategic Accounts. We also believe that unlike the late 1990s and early 2000s, our customers generally did not over-hire during the most recent economic expansion. We also do not believe that an exaggerated technology bubble similar to that which occurred prior to the economic downturn in the early 2000s, which decreased demand for our Tech segment, developed prior to the most recent downturn. We expect to see continued growth in 2011 within our Tech segment.

Our FA segment experienced an increase in net service revenues of 14.9% during the year ended December 31, 2010 compared to 2009. According to a recent SIA report, the overall finance and accounting segment was to expect modest growth of 4% in 2010 with accelerated growth of 8% in 2011 and 2012. Consistent with Tech, we believe that the success of our FA segment has been enabled by our NRC, which has been particularly effective in meeting the demand within the mortgage, refinancing and foreclosure space that has seen significant growth in 2010. We expect to see continued growth in 2011 within our FA segment.

Net service revenues for our HLS segment decreased 1.8% for the year ended December 31, 2010 compared to 2009. The Clinical Research business, which comprised approximately 64% of our HLS segment in 2010, experienced a 3.6% decrease in net service revenues during the year ended December 31, 2010 compared to 2009, which we believe reflects the wind down of a large project and also the cost-cutting initiatives of large pharmaceutical companies and delays in hiring activity resulting from several mergers within this sector. We expect that our Clinical Research business may experience modest growth as a result of the continued impact of these items; however, we believe in the long-term growth prospects of this business. The Health Information Management (“HIM”) business, which comprised approximately 36% of our HLS segment in 2010, consists primarily of professionals providing medical coding and transcription services to hospitals and other healthcare facilities. Net service revenues within HIM increased 1.5% in 2010 as hospital census and spending continued to increase. We expect to see continued growth in 2011 within HIM.

 

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Our GS segment experienced declining results for the year ended December 31, 2010 compared to 2009, which we believe is primarily a result of the macro-economic environment and political landscape. Since the change in the administration took place, our GS segment has been impacted by delays in the timing of project awards as well as a continuing trend by the Federal Government to in-source certain functions. The majority of our GS contracts contain an initial one-year term with four option years, which are typically exercised. At the end of this term, the contract award typically goes through a competitive bidding process to retain the contract. During 2009, approximately 60% (expressed as a percentage of 2009 revenues) of our GS segment’s contracts were subject to the re-compete process. Historically, we have been successful in retaining contracts subject to the re-compete process although there can be no assurances that we will be as successful in the future. In 2010, management refocused its efforts on business development activities as the number of re-competes and the resources consumed related to the re-compete process have returned to normal levels. Management cannot predict the outcome of efforts to reduce federal spending and whether these efforts will materially impact the budgets of federal agencies that are customers of our GS segment. We expect net service revenues within our GS segment to be flat in 2011 as a result of the continuing trend of the Federal Government to in-source functions and Federal Government budgetary delays and cutbacks. We continue to believe in the long-term prospects of our GS segment.

The following table details total Flex hours for each segment and percentage changes over the prior period for the years ended December 31:

 

(in 000’s)

   2010    Increase
(Decrease)
  2009    Increase
(Decrease)
  2008

Tech

       8,333          14.1 %       7,304          (4.0 )%       7,606  

FA

       5,037          15.1 %       4,378          (9.5 )%       4,840  

HLS

       1,971          5.2 %       1,873          (12.0 )%       2,129  

GS

       1,114          (12.5 )%       1,273          51.4 %       841  
                                        

Total hours

       16,455          11.0 %       14,828          (3.8 )%       15,416  
                                        

The changes in billable expenses, which are included as a component of net services revenues, are primarily attributable to increases or decreases in project work. Flex billable expenses for each of our segments were as follows for the years ended December 31:

 

(in $000’s)

   2010    Increase
(Decrease)
  2009    Increase
(Decrease)
  2008

Tech

     $ 4,126          3.6 %     $ 3,983          57.1 %     $ 2,536  

FA

       374          98.9 %       188          (39.7 )%       312  

HLS

       13,723          (2.1 )%       14,016          (32.3 )%       20,695  

GS

       538          (53.7 )%       1,163          315.4 %       280  
                                        

Total billable expenses

     $ 18,761          (3.0 )%     $ 19,350          (18.8 )%     $ 23,823  
                                        

Search Fees. The increase or decrease in Search fees is primarily attributable to the increase or decrease in the number of placements as well as the average fee earned on each placement. Search fees also include conversion revenues (conversions occur when consultants initially assigned to a client on a temporary basis are later converted to a permanent placement). Our GS segment does not make permanent placements.

As previously mentioned, Search activity historically decreases heading into the troughs of an economic cycle, increases after economic conditions have shown sustained improvement, and is the strongest during the peak of an economic cycle. We cannot provide any assurances, however, that historical trends will continue. Search revenues increased 38.6% for the year ended December 31, 2010 compared to 2009. In addition, Search revenues increased sequentially each quarter during 2010. We believe these increases reflect our clients rebuilding their staff after significant reductions during 2008 and 2009. We expect this trend may subside in the near term after the initial increase but may still grow if the economic growth continues. Over the last several years, Kforce has aligned its Search business more closely with its Flex business to more efficiently meet customer needs and reduce the impact of the volatile nature of the Search business, as well as reduce the overall costs that must be invested in establishing and maintaining the Search workforce.

Total placements for each segment were as follows for the years ended December 31:

 

     2010    Increase
(Decrease)
  2009    Increase
(Decrease)
  2008

Tech

       1,118          51.3 %       739          (55.6 )%       1,665  

FA

       1,820          26.1 %       1,443          (48.3 )%       2,792  

HLS

       88          (12.0 )%       100          (30.6 )%       144  
                                        

Total placements

       3,026          32.6 %       2,282          (50.4 )%       4,601  
                                        

 

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The average fee per placement for each segment was as follows for the years ended December 31:

 

     2010      Increase
(Decrease)
     2009      Increase
(Decrease)
     2008  

Tech

   $ 14,615         5.1%       $ 13,911         (12.9)%       $ 15,972   

FA

     11,742         1.7%         11,549         (13.4)%         13,329   

HLS

     18,948         30.5%         14,524         (4.0)%         15,131   
                                

Total average placement fee

   $ 13,013         4.6%       $ 12,444         (13.2)%       $ 14,341   
                                

Gross Profit. Gross profit on Flex billings is determined by deducting the direct cost of services (primarily flexible personnel payroll wages, payroll taxes, payroll-related insurance, and subcontract costs) from net Flex service revenues. In addition, consistent with industry practices, gross profit dollars from Search fees are equal to revenues, because there are generally no direct costs associated with such revenues.

The following table presents, for each segment, the gross profit percentage for the year as well as the increase or decrease over the preceding period, as follows:

 

     2010      Increase
(Decrease)
     2009      Increase
(Decrease)
     2008  

Tech

     29.7%         3.8%          28.6%         (7.7)%         31.0%   

FA

     37.8%         (0.5)%         38.0%         (15.9)%         45.2%   

HLS

     29.9%         0.0%          29.9%         (5.1)%         31.5%   

GS

     32.2%         (10.1)%         35.8%         (4.0)%         37.3%   
                                

Total gross profit percentage

     31.5%         0.3%          31.4%         (9.2)%         34.6%   

Changes in the amount of Search fees as a percentage of total revenues can significantly impact total gross profit percentage because Search revenues contribute 100% to gross profit, as described previously. Given this dynamic, Kforce monitors the gross profit percentage as a percentage of Flex revenues, which is referred to as the Flex gross profit percentage. This provides management with the necessary insight into the other drivers of total gross profit percentage such as changes in volume evidenced by changes in hours billed for Flex and changes in the spread between bill rate and pay rate for Flex.

The increase in Search gross profit from 2009 to 2010 was $11.0 million, composed of a $9.4 million increase in volume and a $1.6 million increase in rate. The decrease in Search gross profit from 2008 to 2009 was $37.6 million, composed of a $30.9 million decrease in volume and a $6.7 million decrease in rate.

The following table presents, for each segment, the Flex gross profit percentage for the years ended December 31:

 

     2010      Increase
(Decrease)
     2009      Increase
(Decrease)
     2008  

Tech

     27.5%         1.9%          27.0%         (1.1)%         27.3%   

FA

     29.8%         (3.6)%         30.9%         (7.8)%         33.5%   

HLS

     29.2%         0.0%          29.2%         (4.9)%         30.7%   

GS

     32.2%         (10.1)%         35.8%         (4.0)%         37.3%   
                                

Total Flex gross profit percentage

     28.7%         (1.7)%         29.2%         (2.3)%         29.9%   

The increase in Flex gross profit from 2009 to 2010 was $15.4 million, composed of a $26.0 million increase in volume and a $10.6 million decrease in rate. The decrease in Flex gross profit from 2008 to 2009 was $21.1 million, composed of a $10.3 million decrease in volume and a $10.8 million decrease in rate.

In general, as economic conditions begin to improve and revenues begin to increase, there is typically a lag in our ability to raise average bill rates as quickly as pay rates increase, thereby negatively impacting margins. In addition, the increase in payroll taxes, particularly unemployment taxes, has impacted our Flex gross profit percentage in recent years, which we expect may continue to rise. Our Tech segment experienced an increase in the Flex gross profit percentage for the year ended December 31, 2010 compared to 2009, which was primarily the result of an improvement in the spread between our bill and pay rate and a decrease in payroll taxes resulting from the Hiring Incentives to Restore Employment Act (“HIRE Act”). The decrease in the Flex gross profit percentage for our FA segment for the year ended December 31, 2010 compared to 2009 was also impacted by a shift in Flex hours to clients with higher volume and lower gross margins offset by a decrease in payroll taxes which was primarily the result of the HIRE Act. The Flex gross profit percentage decline for our GS segment for the year ended December 31, 2010 compared to 2009 was primarily impacted by a shift in the type of contract from a time-and-materials to fixed fee and cost plus arrangements, which generally carry a lower margin, as well as reduced pricing resulting from the Federal Government’s efforts to reduce spending.

 

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A significant continued focus for the Firm is on optimizing the spread between bill rates and pay rates, which will focus on providing our associates with tools, economic knowledge and defined programs to drive improvement in the effectiveness of our pricing strategy around the staffing services we provide. This strategy will serve to balance the desire for optimal volume, rate, effort and duration of assignment, while ultimately maximizing the benefit for our clients, consultants and the Firm. We anticipate that our Flex gross profit margin will increase in each of our segments in 2011.

Selling, General and Administrative (“SG&A”) Expenses. For the years ended December 31, 2010, 2009 and 2008, total commissions, compensation, payroll taxes, and benefit costs as a percentage of SG&A represented 83.6%, 82.1%, and 55.8% (81.1% excluding the goodwill and intangible asset impairment charge), respectively. Commissions and related payroll taxes and benefit costs are variable costs driven primarily by revenues and gross profit levels, and associate performance. Therefore, as gross profit levels change, these expenses are also generally anticipated to change but remain relatively consistent as a percentage of revenues.

The following table presents these components of SG&A along with an “other” caption, which includes bad debt expense, lease expense, professional fees, travel, telephone, computer and certain other expenses; as an absolute amount and as a percentage of total net service revenues for the years ended December 31:

 

(in $000’s)

   2010    % of
Revenues
  2009    % of
Revenues
  2008    % of
Revenues

Compensation, commissions, payroll taxes and benefits costs

     $ 221,602          22.4 %     $ 206,315          22.7 %     $ 232,189          23.3 %

Other

       43,581          4.4         44,083          4.8         54,286          5.4  

Impairment charges

       —                    870          0.1         129,409          13.0  
                                                               

Total SG&A

     $     265,183          26.8 %     $     251,268          27.6 %     $     415,884          41.7 %
                                                               

SG&A as a percentage of net service revenues decreased 80 basis points in 2010 compared to 2009. This was primarily attributable to the following:

 

 

Decrease in compensation and benefits cost of 0.4% of net service revenues, which was primarily related to: (i) an overall decrease in compensation as a result of the Firm’s continued efforts to align pay for performance; (ii) a decrease in the cost of providing health insurance to our employees as a result of a decline in claim volume and severity during the year ended December 31, 2010; (iii) an increase in the amount of capitalized labor related to our significant technology projects and (iv) a decrease in stock-based compensation resulting from a $3.6 million charge incurred from the acceleration of the vesting of certain equity awards during September of 2009. These decreases were partially offset by an increase in compensation within our Strategic Accounts and NRC teams, which is reflective of the investments made by the Firm.

 

 

Decrease in lease expense of 0.3% of net service revenues, which was primarily attributable to the acquisition of our corporate headquarters during May 2010, which eliminated any future lease expense relating to this location.

 

 

Decrease in bad debt expense of 0.2% of net service revenues, which was primarily attributable to the reduction of our allowance for doubtful accounts to reflect the positive experience as it relates to our accounts receivable portfolio and increased clarity with respect to the macro-economic environment.

 

 

Increase in professional fees of 0.2% of net service revenues, which was primarily attributable to an accrual for the expected settlement of a class action lawsuit and related legal fees.

Depreciation and Amortization. The following table presents depreciation and amortization expense by major category for the years ended December 31, 2010, 2009 and 2008 as well as the increases (decreases) experienced during 2010 and 2009:

 

(in $000’s)

   2010      Increase
(Decrease)
     2009      Increase
(Decrease)
     2008  

Fixed asset depreciation

   $ 3,777         19.3%         $ 3,167         14.0%        $ 2,777   

Capital lease asset depreciation

     1,781         (14.5)             2,084         (21.0)            2,638   

Capitalized software amortization

     4,925         11.3              4,426         (6.2)            4,720   

Intangible asset amortization

     2,128         6.6              1,996         (45.9)            3,689   
                                

Total depreciation and amortization

   $     12,611         8.0%         $     11,673         (15.6)%       $     13,824   
                                

Fixed Asset Depreciation: The $0.6 million increase in 2010 primarily relates to the acquisition of Kforce’s corporate headquarters in May 2010. The $0.4 million increase in 2009 was primarily related to increases in the purchases of computer hardware, furniture and leasehold improvements, which were primarily for expansions in our business and the number of field office lease renewals.

Capital Lease Asset Depreciation: The $0.3 million and $0.6 million decrease in 2010 and 2009, respectively, were primarily related to the reduction in costs associated with certain capital leases in 2010 and 2009, and decisions to purchase certain computer equipment in 2008 as opposed to leasing such assets.

 

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Capitalized Software Amortization: The $0.5 million increase in 2010 primarily related to the commencement of amortization on several technology initiatives implemented during 2010. The $0.3 million decrease in 2009 is primarily related to certain software becoming fully amortized during late 2008 and 2009.

Intangible Asset Amortization: The $1.7 million decrease in 2009 is primarily related to the completion of amortization of certain identifiable intangible assets acquired in the 2004 acquisition of Hall Kinion and the 2005 acquisition of VistaRMS, Inc.

Other Expense, Net. Other expense, net was $1.3 million in 2010, $1.1 million in 2009 and $2.1 million in 2008, and consists primarily of interest expense related to Kforce’s Credit Facility. The decrease of $1.0 million in 2009 was primarily due to Kforce’s continued emphasis on paying down outstanding debt during 2009 and 2008, and the reduction of Kforce’s weighted average borrowing rate.

Income Tax Expense. Income tax expense as a percentage of income from continuing operations before income taxes (our “effective rate for continued operations”) for each of the three years ended December 31, 2010, 2009 and 2008 was 38.1%, 41.2%, and (2.2)%, respectively. The decrease in Kforce’s effective rate for 2010 is primarily a result of higher pre-tax net income for 2010 and the impact of unrealized foreign exchange gains and losses attributable to our operations in the Philippines. The change in the effective tax rate for 2009 was primarily related to the largely non-deductible goodwill impairment charge that occurred in 2008.

Income from Discontinued Operations, Net of Income Taxes. Discontinued operations include the consolidated income and expense of Kforce’s Scientific and Nursing businesses. During the three months ended June 30, 2008, Kforce completed the sale of its Scientific and per-diem Nursing businesses resulting in a pre-tax gain of $7.3 million for the year ended December 31, 2008. Included in the determination of the pre-tax gain is $2.1 million of goodwill that was allocated to the carrying value of these businesses upon disposition, and transaction expenses which primarily included commissions, legal fees and transaction bonuses totaling $1.4 million.

Income tax expense as a percentage of income from discontinued operations, before income taxes, for the years ended December 31, 2008 and 2007 was 41.0% and 39.3%, respectively. The increase in the effective income tax rate of discontinued operations for the year ended December 31, 2008 is primarily related to the non-deductibility of a portion of the goodwill that was allocated to the carrying value of the per-diem Nursing business upon its disposition.

Adjusted EBITDA. Adjusted EBITDA, a non-GAAP financial measure, is defined as net income before discontinued operations, non-cash impairment charges, interest, income taxes, depreciation and amortization and amortization of stock-based compensation expense. Adjusted EBITDA should not be considered a measure of financial performance under generally accepted accounting principles. Items excluded from Adjusted EBITDA are significant components in understanding and assessing our past and future financial performance, and this presentation should not be construed as an inference by us that our future results will be unaffected by those items excluded from Adjusted EBITDA. Adjusted EBITDA is a key measure used by management to evaluate its operations including its ability to generate cash flows and, consequently, management believes this is useful information to investors. The measure should not be considered in isolation or as an alternative to net income, cash flows or other financial statement information presented in the unaudited condensed consolidated financial statements as indicators of financial performance or liquidity. The measure is not determined in accordance with generally accepted accounting principles and is thus susceptible to varying calculations. Also, Adjusted EBITDA, as presented, may not be comparable to similarly titled measures of other companies.

Some of the items that are excluded also impacted certain balance sheet assets, resulting in all or a portion of an asset being written off without a corresponding recovery of cash we may have previously spent with respect to the asset. In addition, although we excluded stock-based compensation expense (which we expect to continue to incur in the future) because it is a non-cash expense, the associated stock issued may result in an increase in our outstanding shares of stock, which may result in the dilution of our stockholder ownership interest. We encourage you to evaluate these items and the potential risks of excluding such items when analyzing our financial position.

 

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The following table presents Adjusted EBITDA results and includes a reconciliation of Adjusted EBITDA to net income for the years ended December 31:

 

     Years Ended December 31,  
      2010      Per Share      2009      Per Share      2008      Per Share  

Net income (loss)

   $ 20,634       $ 0.51       $ 12,873       $ 0.33       $ (84,108)       $ (2.13)   

Income from discontinued operations, net of taxes

     —           —           —           —           5,013          0.13    
                                                     

Income (loss) from continuing operations

     20,634         0.51         12,873         0.33         (89,121)         (2.26)   

Intangible assets impairment, pre-tax

     —           —           870         0.02         129,409          3.28    

Depreciation and amortization

     12,611         0.31         11,673         0.30         13,824          0.35    

Acceleration of PARS and SARs

     —           —           3,624         0.09         6,009          0.15    

Amortization of stock options and SARs

     —           —           127         0.00         2,363          0.06    

Amortization of RS and PARS

     6,036         0.15         2,620         0.07         3,372          0.09    

Interest expense and other

     1,254         0.03         1,338         0.03         2,258          0.06    

Income tax expense

     12,690         0.31         9,020         0.23         1,928          0.05    

Earnings per share adjustment (*)

     —           —           —           —           —            (0.03)   
                                                     

Adjusted EBITDA

   $ 53,225       $ 1.31       $ 42,145       $ 1.07       $ 70,042        $ 1.75    
                                                     

 

(*) This earnings per share adjustment is necessary to properly reconcile net loss per share on a GAAP basis to Adjusted EBITDA per share. Reconciling items within the table above are based on basic weighted average shares outstanding, as the inclusion of dilutive securities such as stock options and stock awards would have an anti-dilutive effect on loss per share.

LIQUIDITY AND CAPITAL RESOURCES

To meet our capital and liquidity requirements, we primarily rely on operating cash flow as well as borrowings under our existing Credit Facility. At December 31, 2010, Kforce had $64.9 million in working capital compared to $57.9 million in 2009. Kforce’s current ratio (current assets divided by current liabilities) was 1.6 at the end of 2010 and 1.7 at the end of 2009. As a result of the expiration date of the current Credit Facility, we have classified $10.8 million of outstanding borrowings under the Credit Facility as a current liability in our Consolidated Financial Statements as of December 31, 2010, which has impacted the above measures. As a result of the increase in Kforce’s long-term debt, which was driven primarily by the acquisition of its corporate headquarters in May 2010, our percentage of borrowings under our Credit Facility to equity increased to 4.3% as of December 31, 2010 from 1.3% as of December 31, 2009.

Please see the accompanying Consolidated Statements of Cash Flows for each of the three years ended December 31, 2010 in Item 8. Financial Statements and Supplementary Data. for a more detailed description of our cash flows. Kforce is principally focused on achieving the appropriate balance in the following areas of cash flow: (i) achieving positive cash flow from operating activities; (ii) reducing the outstanding balance of our Credit Facility; (iii) repurchasing our common stock; (iv) investing in our infrastructure to allow sustainable growth via capital expenditures; and (v) making strategic acquisitions.

We believe that existing cash and cash equivalents, cash flow from operations, and available borrowings under our Credit Facility will be adequate to meet the capital expenditure and working capital requirements of our operations for at least the next 12 months. However, further deterioration in the economic environment and market conditions, among other things, could negatively impact operating results and liquidity as well as the ability of our lenders to fund borrowings. There is no assurance that: (i) our lenders will be able to fund our borrowings; or (ii) if operations were to deteriorate and additional financing were to become necessary, we would 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.

Actual results could also differ materially from those indicated as a result of a number of factors, including the use of currently available resources for possible acquisitions and possible additional stock repurchases.

 

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The following table presents a summary of our cash flows from operating, investing and financing activities, as follows:

 

     Years Ended December 31,  

(in $000’s)

   2010      2009      2008  

Cash provided by (used in):

        

Operating activities

   $ 28,590        $ 42,696        $ 89,328    

Investing activities

     (35,768)         (6,039)         (39,442)   

Financing activities

     5,421          (34,505)         (50,309)   
                          

Net (decrease) increase in cash and cash equivalents

   $ (1,757)       $ 2,152        $ (423)   
                          

Discontinued Operations

As was previously discussed, Kforce sold its Scientific and its per-diem Nursing businesses on April 29, 2008 and June 29, 2008, respectively. The accompanying Consolidated Statements of Cash Flows have been presented on a combined basis (continuing operations and discontinued operations). Cash flows provided by discontinued operations for all prior periods, including the year ended December 31, 2008, were provided by operating activities and were not material to the capital resources of Kforce. In addition, the absence of cash flows from discontinued operations is not expected to have a significant effect on the future liquidity, financial position, or capital resources of Kforce.

Operating Activities

The significant variations in cash provided by operating activities and net income (loss) are principally related to adjustments to net income (loss) for certain non-cash charges such as the goodwill and intangible asset impairment charge, depreciation and amortization expense, stock-based compensation and the gain on sale of discontinued operations. These adjustments are more fully detailed in our Consolidated Statements of Cash Flows for the three years ended December 31, 2010 in Item 8. Financial Statements and Supplementary Data. Our largest source of operating cash flows is the collection of trade receivables and our largest use of operating cash flows is the payment of our employee and consultant populations’ compensation, which includes base salary, commissions and bonuses. The decrease in cash provided by operating activities in 2010 primarily resulted from the increase in trade receivables, net due to the increase in net service revenues and the timing of collections.

Investing Activities

Capital expenditures have been made over the years on Kforce’s infrastructure as we anticipate growth in our business. Capital expenditures during 2010, 2009 and 2008 were $37.7 million, $3.8 million and $8.5 million, respectively. The increase in cash used for capital expenditures during the year ended December 31, 2010 as compared to 2009 and 2008 was primarily a result of the acquisition of our corporate headquarters in May 2010 for a total purchase price, including acquisition related costs, of $28.9 million. Capital expenditures during 2009 were below the levels of 2008 primarily as a result of: (i) the significant investments in our technology infrastructure in previous years; (ii) prioritizing the uses of cash during the economic recession; and (iii) taking time to strategically plan for future investments.

We expect to continue to selectively invest in our infrastructure in order to support the expected future growth in our business. Kforce believes it has sufficient cash and availability under its Credit Facility to make any necessary capital expenditures in the foreseeable future.

Cash proceeds from the dispositions of our Scientific and per-diem Nursing businesses were $12.0 million for the year ended December 31, 2008. We continually review our portfolio of businesses and their operations in comparison to our internal strategic and performance objectives. As part of this review, we may acquire other businesses and further invest in, fully divest and/or sell parts of our current businesses.

 

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Financing Activities

There were no open market repurchases of common stock in 2009 or 2010. During 2008, open market repurchases of common stock were $36.7 million.

Credit Facility

Borrowings under the Credit Facility are limited to 85% of eligible accounts receivable, of which unbilled receivables can be no more than 40% of billed receivables, less certain minimum availability reserves, and bear interest at a rate of LIBOR plus 1.25% or Prime. Fluctuations in the ratio of unbilled to billed receivable could result in material changes to availability from time to time. Letters of credit issued under the Credit Facility require Kforce to pay a fronting fee equal to 0.125% of the amount of each letter of credit issued plus 1.25% per annum of the total amount of letters of credit outstanding. To the extent that Kforce has unused availability under the Credit Facility, an unused line fee is required to be paid equal to 0.25% of the average unused balance on a monthly basis. Borrowings under the Credit Facility are principally secured by our accounts receivable but are also secured by substantially all of the assets of Kforce. Under the Credit Facility, Kforce is required to maintain a minimum fixed charge coverage ratio in the event that it is unable to maintain minimum availability under the Credit Facility of $15.0 million. As of December 31, 2010, Kforce had availability under the Credit Facility in excess of the minimum requirement; therefore, the minimum fixed charge coverage ratio of 1.25 to 1.00 was not applicable. Kforce believes that it will be able to maintain the minimum availability requirement; however, in the event that Kforce is unable to do so, Kforce could fail the fixed charge coverage ratio, which would constitute an event of default.

On September 15, 2009, and effective as of September 16, 2009, CIT Group, Inc. (“CIT”) assigned rights and obligations under the Credit Facility together with a corresponding portion of each of its outstanding committed loans and letter of credit obligations in an amount equal to $20.0 million to Wachovia. After giving effect to this assignment, the commitments of Wachovia and CIT under the Credit Facility are now $50.0 million and $15.0 million, respectively. Kforce Inc. incurred no fees in conjunction with this assignment and there was no impact to the maximum borrowings or other provisions within the Credit Facility.

The Credit Facility expires in November 2011. Kforce is currently undergoing an evaluation of various financing alternatives, including an extension of the existing Credit Facility, a new credit facility and alternative financing vehicles. As a result of the expiration date of the current Credit Facility, we have classified outstanding borrowings under the Credit Facility as a current liability in our Consolidated Financial Statements as of December 31, 2010. Kforce cannot provide any assurance that it will be able to secure alternative financing prior to the expiration of the existing Credit Facility. Kforce believes that cash generated from operating activities would be sufficient to fund operations if such an event occurs.

As of December 31, 2010, $10.8 million was outstanding and $89.3 million was available under the Credit Facility. During the three months ended December 31, 2010, maximum outstanding borrowings under the Credit Facility were $22.6 million. The increase in the cash provided by financing activities for the year ended December 31, 2010 as compared to 2009 was primarily the result of the acquisition of our corporate headquarters in the second quarter of 2010 for a total purchase price, including acquisition related costs, of $28.9 million. As of March 3, 2011, $36.0 million was outstanding and $69.0 million was available under the Credit Facility.

Off-Balance Sheet Arrangements

Kforce provides letters of credit to certain vendors in lieu of cash deposits. At December 31, 2010, Kforce had letters of credit outstanding for workers’ compensation and other insurance coverage totaling $2.7 million and for facility lease deposits totaling $0.2 million. Kforce does not have any additional off-balance sheet arrangements that have had, or are expected to have, a material effect on our Consolidated Financial Statements.

Stock Repurchases

As of December 31, 2009, our Board of Directors had authorized $75.0 million of repurchases of our common stock, and $72.5 million remained available for future repurchases. During the year ended December 31, 2010, Kforce repurchased approximately 0.2 million shares of common stock for minimum income tax withholding on the exercising of stock options and SARs and the vesting of restricted stock awards at a total cost of $3.6 million. There were no open market repurchases during 2010. As of December 31, 2010, $68.9 million remains available for future repurchases.

On December 30, 2010, Kforce filed a Form 8-K with the SEC announcing that it had entered into a corporate stock repurchase plan in accordance with Rule 10b5-1 of the Exchange Act, which was effective from January 6, 2011 through February 11, 2011. This corporate stock repurchase plan was subject to certain price, market, volume and timing constraints which were specified in the plan. Pursuant to this plan, Kforce repurchased 0.1 million shares at a total purchase price of $1.7 million. Also, Kforce repurchased 0.2 million shares at a total purchase price of $3.4 million from February 12, 2011 through March 4, 2011.

 

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Contractual Obligations and Commitments

The following table presents our expected future contractual obligations as of December 31, 2010:

 

     Payments due by period

(in $000’s)

   Total    Less than
1 year
   1-3 Years    3-5 Years    More than
5 years

Operating lease obligations

     $ 13,189        $ 5,785        $ 6,611        $ 793        $ —    

Capital lease obligations

       4,275          1,871          2,158          246          —    

Credit facility (a)

       10,825          10,825          —            —            —    

Interest payable – credit facility (b)

       148          148          —            —            —    

Purchase obligations

       14,344          6,548          7,024          772          —    

Liability for unrecognized tax positions (c)

       —            —            —            —            —    

Deferred compensation plan liability (d)

       20,678          967          1,094          310          18,307  

Other (e)

       —            —            —            —            —    

Supplemental executive retirement plan (f)

       41,933          —            10,383          —            31,550  

Supplement executive retirement health plan (f)

       8,543          —            17          86          8,440  

Foreign defined benefit pension plan (g)

       23,780          —            404          22          23,354  
                                                      

Total

     $ 137,715        $ 26,144        $ 27,691        $ 2,229        $ 81,651  
                                                      

 

(a) The Credit Facility expires in November 2011. Kforce is currently undergoing an evaluation of various financing alternatives, including an extension of the existing Credit Facility, a new credit facility and alternative financing vehicles. As a result of the expiration date of the current Credit Facility, we have classified all outstanding borrowings under the Credit Facility as a current liability in our Consolidated Financial Statements as of December 31, 2010.
(b) Kforce’s weighted average interest rate as of December 31, 2010 was 1.64%, which was utilized to forecast the expected future interest rate payments. These payments are inherently uncertain due to interest rate and outstanding borrowings fluctuations that will occur over the remaining term of the Credit Facility.
(c) Kforce’s liability for unrecognized tax positions as of December 31, 2010 was $0.2 million. This balance has been excluded from the table above due to the significant uncertainty with respect to expected settlements.
(d) Kforce has a non-qualified deferred compensation plan pursuant to which eligible highly-compensated key employees may elect to defer part of their compensation to later years. These amounts, which are classified as other accrued liabilities and other long-term liabilities, respectively, are payable upon retirement or termination of employment. Amounts payable upon the retirement or termination of employment may become payable during the next five years if covered employees schedule a distribution, retire or terminate during that time.
(e) Kforce provides letters of credit to certain vendors in lieu of cash deposits. Kforce currently has letters of credit totaling $2.8 million outstanding as security for workers’ compensation and property insurance policies as well as facility lease deposits. Kforce maintains a sub-limit for letters of credit of $15 million under its Credit Facility.
(f) There is no funding requirement associated with the SERP or the SERHP. Kforce does not currently anticipate funding the SERP or SERHP during 2011. Kforce has included the total undiscounted projected benefit payments, as determined at December 31, 2010, in the table above. See Note 12 – “Employee Benefit Plans” to the Consolidated Financial Statements for more detail.
(g) Kforce has included the total undiscounted projected benefit payments, as determined at December 31, 2010 in the table above. There is no funding requirement associated with this plan.

Kforce has no material unrecorded commitments, losses, contingencies or guarantees associated with any related parties or unconsolidated entities.

Income Tax Audits

Kforce is periodically subject to U.S. Internal Revenue Service audits as well as state and other local income tax audits for various tax years. Although Kforce has not experienced any material liabilities in the past due to income tax audits, Kforce can make no assurances concerning future tax audits.

 

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Registration Statement on Form S-3

On March 18, 2009, Kforce filed a Registration Statement on Form S-3 that allows the issuance of up to $250 million of common stock and other equity, debt and financial instruments for general corporate purposes which may include capital expenditures, the repayment or refinancing of debt, investments in our subsidiaries, working capital, or the financing of possible acquisitions or business opportunities. Such filings are referred to as “Shelf Registrations”. No issuance of securities has been made under this registration statement as of December 31, 2010. There is no assurance that the existence of the Shelf Registration will assist Kforce in registering its securities in connection with future efforts to raise capital or for other purposes.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

In addition to the risks inherent in its operations, Kforce is exposed to certain market risks, primarily changes in interest rates. The sensitivity analysis presented below for our Credit Facility is based on a 10% change in interest rates. This change is a hypothetical scenario and is used to calibrate potential risk and does not represent our view of future market changes.

As of December 31, 2010, we had $10.8 million outstanding under our Credit Facility. Our weighted average effective interest rate on our Credit Facility was 1.64% at December 31, 2010. A hypothetical 10% increase in interest rates in effect at December 31, 2010 would not have a significant effect on Kforce’s annual interest expense.

We do not believe that we have a material exposure to fluctuations in foreign currencies because our international operations represented approximately 2% of net service revenues for the year ended December 31, 2010, and because our international operations’ functional currency is the U.S. Dollar. However, Kforce will continue to assess the impact which currency fluctuations could have on our operations going forward.

 

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Item 8. Financial Statements and Supplementary Data.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Kforce Inc.

Tampa, FL

We have audited the accompanying consolidated balance sheets of Kforce Inc. and subsidiaries (“Kforce”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, and comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2010. Our audits also included the financial statement schedule listed in the Index at Item 15. We also have audited Kforce’s internal control over financial reporting as of December 31, 2010, based on Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Kforce’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on internal control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedule and an opinion on the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kforce as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ Deloitte & Touche LLP

Certified Public Accountants

Tampa, Florida

March 4, 2011

 

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KFORCE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

 

     YEARS ENDED DECEMBER 31,  
     2010      2009      2008  

Net service revenues

    $   990,807         $   910,136         $   997,017    

Direct costs of services

     678,393          624,157          652,366    
                          

Gross profit

     312,414          285,979          344,651    

Selling, general and administrative expenses, excluding impairment

     265,183          250,398          286,475    

Goodwill and intangible asset impairment

     —            870          129,409    
                          

Selling, general and administrative expenses

     265,183          251,268          415,884    

Depreciation and amortization

     12,611          11,673          13,824    
                          

Income (loss) from operations

     34,620          23,038          (85,057)   

Other expense (income):

        

Interest income

     (20)         (99)         (73)   

Interest expense

     1,274          1,437          2,331    

Other expense (income)

     42          (193)         (122)   
                          

Income (loss) from continuing operations, before income taxes

     33,324          21,893          (87,193)   

Income tax expense

     12,690          9,020          1,928    
                          

Income (loss) from continuing operations

     20,634          12,873          (89,121)   

Income from discontinued operations, net of income taxes

     —           —           5,013    
                          

Net income (loss)

     20,634          12,873          (84,108)   

Other comprehensive (loss) income:

        

Pension and postretirement plans adjustments, net of tax

     (267)         (1,602)         389    
                          

Comprehensive income (loss)

    $ 20,367         $ 11,271         $ (83,719)   
                          

Earnings (loss) per share – basic

        

From continuing operations

    $ 0.52         $ 0.33         $ (2.26)   

From discontinued operations

     —            —            0.13    
                          

Earnings (loss) per share – basic

    $ 0.52         $ 0.33         $ (2.13)   
                          

Earnings (loss) per share – diluted

        

From continuing operations

    $ 0.51         $ 0.33         $ (2.26)   

From discontinued operations

     —            —            0.13    
                          

Earnings (loss) per share – diluted

    $ 0.51         $ 0.33         $ (2.13)   
                          

Weighted average shares outstanding – basic

     39,480          38,485          39,471    
                          

Weighted average shares outstanding – diluted

     40,503          39,330          39,471    
                          

The accompanying notes are an integral part of these consolidated financial statements.

 

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KFORCE INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

 

     DECEMBER 31,  
     2010      2009  
ASSETS      

Current Assets:

     

Cash and cash equivalents

    $ 1,055         $ 2,812    

Trade receivables, net of allowances of $4,021 and $6,604, respectively

     148,507          123,144    

Income tax refund receivable

     5,675          246    

Deferred tax asset, net

     4,950          6,011    

Prepaid expenses and other current assets

     5,014          4,924    
                 

Total current assets

     165,201          137,137    

Fixed assets, net

     38,130          11,407    

Other assets, net

     32,941          32,914    

Deferred tax asset, net

     8,907          10,380    

Intangible assets, net

     7,787          10,075    

Goodwill

     138,078          137,912    
                 

Total assets

    $     391,044         $     339,825    
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY      

Current Liabilities:

     

Accounts payable and other accrued liabilities

    $ 30,602         $ 25,437    

Accrued payroll costs

     54,461          50,690    

Current debt – credit facility

     10,825          —      

Other current liabilities

     4,185          2,807    

Income taxes payable

     250          279    
                 

Total current liabilities

     100,323          79,213    

Long-term debt – credit facility

     —            3,000    

Long-term debt – other

     2,103          1,784    

Other long-term liabilities

     34,801          29,103    
                 

Total liabilities

     137,227          113,100    
                 

Commitments and contingencies (see Note 15)

     

Stockholders’ Equity:

     

Preferred stock, $0.01 par; 15,000 shares authorized, none issued and outstanding

     —            —      

Common stock, $0.01 par; 250,000 shares authorized, 66,542 and 63,281 issued, respectively

     665          633    

Additional paid-in capital

     355,869          338,890    

Accumulated other comprehensive loss

     (1,480)         (1,213)   

Retained earnings

     61,979          41,345    

Treasury stock, at cost; 24,823 and 24,176 shares, respectively

     (163,216)         (152,930)   
                 

Total stockholders’ equity

     253,817          226,725    
                 

Total liabilities and stockholders’ equity

    $     391,044         $     339,825    
                 

The accompanying notes are an integral part of these consolidated financial statements.

 

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KFORCE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(IN THOUSANDS)

 

     YEARS ENDED DECEMBER 31,  
           2010                  2009                  2008        

Common stock – shares:

        

Shares at beginning of period

     63,281          61,866          60,919    

Exercise of stock options and stock appreciation rights

     1,212          615          371    

Issuance of restricted stock

     2,049          800          576    
                          

Shares at end of period

     66,542          63,281          61,866    
                          

Common stock – par value:

        

Balance at beginning of period

    $ 633         $ 619         $ 609    

Exercise of stock options and stock appreciation rights

     12                    

Issuance of restricted stock

     20                    
                          

Balance at end of period

    $ 665         $ 633         $ 619    
                          

Additional paid-in capital:

        

Balance at beginning of period

    $ 338,890         $ 325,187         $ 310,165    

Exercise of stock options and stock appreciation rights

     8,626          5,944          2,591    

Income tax benefit from stock-based compensation

     2,337          1,243          416    

Stock-based compensation expense

     6,036          6,371          11,744    

Employee stock purchase plan

     —            153          277    

Issuance of restricted stock

     (20)         (8)         (6)   
                          

Balance at end of period

    $ 355,869         $ 338,890         $ 325,187    
                          

Accumulated other comprehensive (loss) income:

        

Balance at beginning of period

    $ (1,213)        $ 389         $ —      

Pension and postretirement plans adjustments, net of tax of $170, $1,051 and $310, respectively

     (267)         (1,602)         389    
                          

Balance at end of period

    $ (1,480)        $ (1,213)        $ 389    
                          

Retained earnings:

        

Balance at beginning of period

    $ 41,345         $ 28,472         $ 112,580    

Net income (loss)

     20,634          12,873          (84,108)   
                          

Balance at end of period

    $ 61,979         $ 41,345         $ 28,472    
                          

Treasury stock – shares:

        

Shares at beginning of period

     24,176          23,850          19,365    

Open market repurchases of common stock

     —            —            4,395    

Shares tendered in payment of the exercise price of stock options

     420          195          52    

Shares repurchased for minimum tax withholding on restricted stock, stock option exercises and stock appreciation rights

     227          212          134    

Employee stock purchase plan

     —            (81)         (96)   
                          

Shares at end of period

     24,823          24,176          23,850    
                          

Treasury stock – cost:

        

Balance at beginning of period

    $ (152,930)        $ (148,824)        $ (110,886)   

Open market repurchases of common stock

     —            —            (36,712)   

Shares tendered in payment of the exercise price of stock options

     (6,705)         (2,171)         (578)   

Shares repurchased for minimum tax withholding on restricted stock awards, stock option exercises and stock appreciation rights

     (3,581)         (2,368)         (1,220)   

Employee stock purchase plan

     —            433          572    
                          

Balance at end of period

    $ (163,216)        $ (152,930)        $ (148,824)   
                          

The accompanying notes are an integral part of these consolidated financial statements.

 

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KFORCE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

 

     YEARS ENDED DECEMBER 31,  
           2010                  2009                  2008        

Cash flows from operating activities:

        

Net income (loss)

    $ 20,634         $ 12,873         $ (84,108)   

Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:

        

Goodwill and intangible asset impairment

     —            870          129,409    

Deferred income tax provision (benefit), net

     2,534          1,281          (16,389)   

Gain on sale of discontinued operations

     —            —            (7,330)   

(Recovery of) provision for bad debts on accounts receivable and other accounts receivable reserves

     (2,996)         (319)         5,135    

Depreciation and amortization

     12,611          11,673          13,824    

Stock-based compensation

     6,036          6,371          11,744    

Pension and postretirement benefit plans expense

     4,025          2,002          2,860    

Alternative long-term incentive award

     1,563          2,467          —      

Amortization of deferred financing costs

     151          151          —      

Tax benefit attributable to stock-based compensation

     2,337          1,243          416    

Excess tax benefit attributable to stock-based compensation

     (1,519)         (899)         (57)   

Deferred compensation liability increase (decrease), net

     2,431          3,136          (5,261)   

(Gain) loss on cash surrender value of company-owned life insurance

     (1,246)         (2,179)         6,168    

Loss on asset sales

     110          220          158    

Other

     172          (197)         (24)   

(Increase) decrease in operating assets, net of acquisitions:

        

Trade receivables, net

     (22,366)         9,453          31,748    

Income tax refund receivable

     (5,429)         241          (110)   

Prepaid expenses and other current assets

     (199)         (57)         (236)   

Other assets, net

     (155)                 476    

Increase (decrease) in operating liabilities, net of acquisitions:

        

Accounts payable and other current liabilities

     5,688          (2,758)         (318)   

Accrued payroll costs

     3,771          (7)         (3,798)   

Income taxes payable

     (30)         (3,853)         1,413    

Other long-term liabilities

     467          978          3,608    
                          

Cash provided by operating activities

     28,590          42,696          89,328    
                          

Cash flows from investing activities:

        

Capital expenditures

     (37,747)         (3,847)         (8,505)   

Proceeds from borrowings against cash surrender value of company-owned life insurance policies

     4,959          —            —      

Premiums paid for company-owned life insurance policies

     (3,331)         (3,345)         (4,594)   

Acquisitions, net of cash received

     —            (109)         (38,404)   

Proceeds from disposition of businesses

     —            —            12,036    

Proceeds from escrow

     —            1,170          —      

Other

     351          92          25    
                          

Cash used in investing activities

     (35,768)         (6,039)         (39,442)   
                          

Cash flows from financing activities:

        

Proceeds from bank line of credit

     448,490          284,482          395,232    

Payments on bank line of credit

     (440,665)         (319,504)         (407,540)   

Payment of capital expenditure financing

     (1,752)         (2,052)         (2,706)   

Short-term vendor financing

     (523)         259          563    

Proceeds from exercise of stock options, net of shares tendered in payment of the exercise price of stock options

     1,933          3,779          2,017    

Excess tax benefit from stock-based compensation

     1,519          899          57    

Shares repurchased for minimum tax withholding on restricted stock awards, stock option exercises and SARs

     (3,581)         (2,368)         (1,220)   

Open market repurchases of common stock

     —            —            (36,712)   
                          

Cash provided by (used in) financing activities

     5,421          (34,505)         (50,309)   
                          

Change in cash and cash equivalents

     (1,757)         2,152          (423)   

Cash and cash equivalents at beginning of year

     2,812          660          1,083    
                          

Cash and cash equivalents at end of year

    $ 1,055         $ 2,812         $ 660    
                          

The accompanying notes are an integral part of these consolidated financial statements.

 

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KFORCE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

1. Summary of Significant Accounting Policies

Organization and Nature of Operations

Kforce Inc. and subsidiaries (“Kforce”) is a provider of professional staffing services and solutions to its customers in the following segments: Technology (“Tech”), Finance and Accounting (“FA”), Health and Life Sciences (“HLS”) and Government Solutions (“GS”). Kforce provides flexible staffing services and solutions on both a temporary and full-time basis. Kforce operates through its corporate headquarters in Tampa, Florida as well its 65 field offices, which are located throughout the United States. One of our subsidiaries, Kforce Global Solutions, Inc. (“Global”), provides information technology outsourcing services internationally through two offices in Manila, Philippines. Our international operations comprised approximately 2% of net service revenues for each of the three years ended December 31, 2010 and are included in our Tech segment.

Kforce serves clients from the Fortune 1000, the Federal Government, state and local governments, local and regional companies and small to mid-sized companies.

Basis of Presentation

The consolidated financial statements of Kforce have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and the rules of the Securities and Exchange Commission (“SEC”).

Principles of Consolidation

The consolidated financial statements include the accounts of Kforce Inc. and its wholly-owned subsidiaries. References in this document to “Kforce,” “the Company,” “we,” “our” or “us” refer to Kforce Inc. and its subsidiaries, except where the context indicates otherwise. All intercompany transactions and balances have been eliminated in consolidation.

In addition to its wholly-owned subsidiaries, the consolidated financial statements of Kforce also include its 49% interest in a joint venture, which was acquired in the 2008 acquisition of RDI Systems, Inc., d/b/a dNovus RDI (“RDI” or “dNovus”). This joint venture is recorded as an investment in an unconsolidated entity and is accounted for under the equity method of accounting. Kforce’s equity in the earnings of its equity method investment is recorded as income with a corresponding increase in the investment with distributions received reducing the investment. This investment had an insignificant effect on the accompanying consolidated financial statements in all years presented.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most important of these estimates and assumptions relate to the following: allowance for doubtful accounts, fallouts and other accounts receivable reserves; accounting for goodwill and identifiable intangible assets and any related impairment; self-insured liabilities for workers’ compensation and health insurance; stock-based compensation; obligations for pension and postretirement benefit plans and accounting for income taxes. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.

Cash and Cash Equivalents

Kforce classifies all highly liquid investments with an original initial maturity of three months or less as cash equivalents. Cash and cash equivalents consist of cash on hand with banks, either in commercial accounts, or overnight interest-bearing money market accounts and at times may exceed federally insured limits. Cash and cash equivalents are stated at cost, which approximates fair value due to the short duration of their maturity.

 

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Accounts Receivable Reserves

Kforce establishes its reserves for expected credit losses, fallouts, early payment discounts and revenue adjustments based on past experience and estimates of potential future activity. Specific to our allowance for doubtful accounts, which comprises approximately 70% of our accounts receivable reserves, Kforce performs an ongoing analysis of factors including recent write-off and delinquency trends, a specific analysis of significant receivable balances that are past due, the concentration of accounts receivable among clients and higher-risk sectors, and the current state of the U.S. economy. Trade receivables are written off by Kforce after all collection efforts have been exhausted.

Accounts receivable reserves as a percentage of gross accounts receivable were 2.6% and 5.1% as of December 31, 2010 and 2009, respectively.

Revenue Recognition

We earn revenues from two primary sources: Flexible billings and Search fees. Flexible billings are recognized as the services are provided by Kforce’s temporary employees, who are Kforce’s legal employees while they are working on assignments. Kforce pays all related costs of such employment, including workers’ compensation insurance, state and federal unemployment taxes, social security and certain fringe benefits. Search fees are recognized by Kforce when employment candidates accept offers of permanent employment and are scheduled to commence employment within 30 days. Kforce records revenues net of an estimated reserve for “fallouts,” which is based on Kforce’s historical fallout experience. Fallouts occur when a candidate does not remain employed with the client through the contingency period, which is typically 90 days or less.

Net service revenues represent services rendered to customers less credits, discounts, rebates and allowances. Revenues include reimbursements of travel and out-of-pocket expenses (“billable expenses”) with equivalent amounts of expense recorded in direct costs of services.

Our GS segment generates its revenues under contracts that are, in general, greater in duration than our other segments and which can often span several years. GS provides these services under time-and-materials (which account for the majority of this segment’s contracts), fixed-price, and cost-plus contracts. Our GS segment does not generate any Search fees. Except as provided below, Kforce considers amounts to be earned once evidence of an arrangement has been obtained, services are delivered, fees are fixed or determinable, and collectability is reasonably assured.

 

  ¡  

Revenues for time-and-materials contracts, which accounts for approximately 65% of this segment’s revenue, are recorded based on contractually established billing rates at the time services are provided.

 

  ¡  

Revenues on fixed-price contracts are recognized on the basis of the estimated percentage-of-completion. Approximately 28% of this segment’s revenues are recognized under this method. Progress towards completion is typically measured based on costs incurred as a proportion of estimated total costs or other measures of progress when available. Profit in a given period is reported at the expected profit margin to be achieved on the overall contract.

Direct Costs of Services

Direct costs of services are composed primarily of payroll wages, payroll taxes, payroll-related insurance for Kforce’s flexible employees, and subcontractor costs. Direct costs of permanent placement services primarily consist of reimbursable expenses. Direct costs of services exclude depreciation and amortization expense, which is presented on a separate line in the accompanying consolidated statements of operations and comprehensive income (loss).

Income Taxes

Kforce accounts for income taxes using the asset and liability approach to the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the financial statement carrying amounts and the tax basis of assets and liabilities. Unless it is “more likely than not” that a deferred tax asset can be utilized to offset future taxes, a valuation allowance must be recorded against that asset. The tax benefits of deductions attributable to employees’ disqualifying dispositions of shares obtained from incentive stock options, exercises of non-qualified options, and vesting of restricted stock are reflected as increases in additional paid-in capital.

 

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Kforce evaluates tax positions that have been taken or are expected to be taken in its tax returns, and records a liability for uncertain tax positions. Kforce uses a two-step approach to recognize and measure uncertain tax positions. First, tax positions are recognized if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon examination, including resolution of related appeals or litigation processes, if any. Second, tax positions are measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement. Kforce recognizes interest and penalties related to unrecognized tax benefits in the provision for income taxes in the accompanying consolidated financial statements.

Fixed Assets

Fixed assets are carried at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The cost of leasehold improvements is amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the terms of the related leases, which generally range from three to five years.

Fair Value Measurements

Kforce uses the framework established by the Financial Accounting Standards Board (“FASB”) for measuring fair value and disclosures about fair value measurements. Kforce uses fair value measurements in areas that include, but are not limited to: the allocation of purchase price consideration to tangible and identifiable intangible assets; impairment testing of goodwill and long-lived assets; share-based compensation arrangements and capital lease obligations. The carrying values of cash and cash equivalents, accounts receivable, accounts payable, and other current assets and liabilities approximate fair value because of the short-term nature of these instruments. The carrying value of our debt under our Credit Facility approximates fair value due to the variable nature of the interest rates under our Credit Facility (as defined below). Using available market information and appropriate valuation methodologies, Kforce has determined the estimated fair value measurements; however, considerable judgment is required in interpreting data to develop the estimates of fair value.

Goodwill and Other Intangible Assets

Goodwill

Kforce performs a goodwill impairment analysis, using the two-step method, on an annual basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The recoverability of goodwill is measured at the reporting unit level, which Kforce has determined to be consistent with its operating segments; by comparing the reporting unit’s carrying amount, including goodwill, to the fair market value of the reporting unit. Kforce determines the fair market value of its reporting units based on a weighting of both the present value of projected future cash flows (the “income approach”) and the use of comparative market multiples (the “market approach”). The income approach is based on assumptions that are consistent with Kforce’s estimates of future cash flows. The market approach compares each of Kforce’s reporting units to other comparable companies based on valuation multiples to arrive at a fair value. Factors requiring significant judgment include, among others, assumptions related to forecasted operating results, discount rates, long-term growth rates, and market multiples. Changes in economic or operating conditions that occur after the annual impairment analysis and that impact these assumptions, may result in a future goodwill impairment charge, which could be material to Kforce’s consolidated financial statements.

As is more fully described in Note 6, Kforce completed its annual goodwill impairment test as of December 31, 2010 for each of its reporting units and recorded no impairment for the year ended December 31, 2010. No impairment charge was recorded for the year ended December 31, 2009 and an impairment charge of $128,429 was recorded for the year ended December 31, 2008.

Other Intangible Assets

Identifiable intangible assets arising from certain of Kforce’s acquisitions include non-compete and employment agreements, contractual relationships, customer contracts, trademarks and trade names. For definite-lived intangible assets, Kforce has determined that the straight-line method is an appropriate methodology to allocate the cost over the period of expected benefit, which ranges from one to 15 years.

The impairment evaluation for indefinite lived intangible assets, which for Kforce consist of trademarks and trade names, is conducted on an annual basis or more frequently if events or changes in circumstances indicate that an asset may be impaired. As is more fully described in Note 6, Kforce recognized impairment charges of $870 and $980 for the years ended December 31, 2009 and 2008, respectively, which are included in goodwill and intangible asset impairment in the accompanying consolidated statements of operations and comprehensive income (loss). No impairment charge was recorded for the year ended December 31, 2010.

 

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Impairment of Long-Lived Assets

Kforce reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of long-lived assets is measured by a comparison of the carrying amount of the asset group to the future undiscounted net cash flows expected to be generated by those assets. If such assets are considered to be impaired, the impairment charge recognized is the amount by which the carrying amounts of the assets exceed the fair value of the assets. Other than the impairment charges discussed in the preceding section, there were no other impairment charges recorded during the three years ended December 31, 2010.

Capitalized Software

Kforce purchases, develops, and implements new computer software to enhance the performance of our Firm-wide technology infrastructure. Direct internal costs such as payroll and payroll-related costs, and external costs incurred during the development stage of each project, are capitalized and classified as capitalized software. Kforce capitalized development-stage implementation costs of $4,504, $1,832 and $1,776 during the years ended December 31, 2010, 2009 and 2008, respectively. Capitalized software development costs are classified as other assets, net in the accompanying consolidated balance sheets and are being amortized over the estimated useful lives of the software, which range from one to five years, using the straight-line method.

Commissions

Our associates make placements and earn commissions as a percentage of actual revenues or gross profit pursuant to a calendar-year-basis commission plan. The amount of commissions paid as a percentage of revenues or gross profit increases as volume increases. Kforce accrues commissions for actual revenues or gross profit at a percentage equal to the percent of total expected commissions payable to total revenues or gross profit for the year, as applicable.

Stock-Based Compensation

Kforce accounts for stock-based compensation by measuring the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period in which the employee is required to provide service in exchange for the award, which is usually the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. For awards settled in cash, we measure compensation expense based on the fair value of the award at each reporting date, net of estimated forfeitures. Total compensation expense recognized during the years ended December 31, 2010, 2009 and 2008 was $7,599, $8,838 and $11,744, respectively. The related tax benefit for the three years ended December 31, 2010 was $2,989, $3,491 and $4,991, respectively.

Workers’ Compensation

Kforce retains the economic burden for the first $250 per occurrence in workers’ compensation claims except: (i) in states that require participation in state-operated insurance funds and (ii) for its GS segment which is fully insured for workers’ compensation claims. Workers’ compensation includes ongoing healthcare and indemnity coverage for claims and may be paid over numerous years following the date of injury. Workers’ compensation expense includes insurance premiums paid, claims administration fees charged by Kforce’s workers’ compensation administrator, premiums paid to state-operated insurance funds and an estimate for Kforce’s liability for Incurred but Not Reported (“IBNR”) claims and for the ongoing development of existing claims.

Kforce estimates its workers’ compensation liability based upon historical claims experience, actuarially determined loss development factors, and qualitative considerations such as claims management activities.

Taxes Assessed by Governmental Agencies – Revenue Producing Transactions

Kforce collects sales tax for various taxing authorities and it is our policy to record these amounts on a net basis; thus, sales tax amounts are not included in net service revenues.

Health Insurance

Except for certain fully insured health insurance lines of coverage, Kforce retains liability of up to $270 annually for each health insurance plan participant. For its partially self-insured lines of coverage, health insurance costs are accrued using estimates to approximate the liability for reported claims and IBNR claims, which are primarily based upon an evaluation of historical claims experience, actuarially-determined completion factors and a qualitative review of our health insurance exposure including the extent of outstanding claims and expected changes in health insurance costs.

 

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Business Combinations

Kforce utilizes the acquisition method in accounting for acquisitions whereby the amount of purchase price that exceeds the fair value of the acquired assets and assumed liabilities is allocated to goodwill. Kforce recognizes intangible assets apart from goodwill if they arise from contractual or other legal rights, or if they are capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged. Assumptions and estimates are used in determining the fair value of assets acquired and liabilities assumed in a business combination. Valuation of intangible assets acquired requires that we use significant judgment in determining fair value, whether such intangibles are amortizable and, if the asset is amortizable, the period and the method by which the intangible asset will be amortized. Changes in the initial assumptions could lead to changes in amortization charges recorded in our financial statements. Additionally, estimates for purchase price allocations may change as subsequent information becomes available.

Accounting for Postretirement Benefits

Kforce recognizes the overfunded or underfunded status of its defined benefit postretirement plans as an asset or liability in its consolidated balance sheets and recognizes changes in that funded status in the year in which the changes occur through other comprehensive income. Kforce also measures the funded status of the defined benefit postretirement plan as of the date of its fiscal year-end, with limited exceptions.

Amortization of a net unrecognized gain or loss in accumulated other comprehensive income is included as a component of net periodic benefit cost and net periodic postretirement benefit cost if, as of the beginning of the year, that net gain or loss exceeds 10% of the greater of the projected benefit obligation or accumulated postretirement benefit obligation. If amortization is required, the minimum amortization shall be that excess divided by the average remaining service period of active plan participants.

Earnings (Loss) per Share

Basic earnings or loss per share is computed as earnings or loss divided by the weighted average number of common shares outstanding during the period. Basic weighted average shares outstanding do not include unvested shares of restricted stock (“RS”) or performance-accelerated restricted stock (“PARS”). Diluted earnings or loss per common share is computed by dividing the earnings or loss attributable to common shareholders for the period by the weighted average number of common shares outstanding during the period plus the dilutive effect of stock options and other potentially dilutive securities such as non-vested stock grants using the treasury stock method, except where the effect of including potential common shares would be anti-dilutive.

The following table sets forth the computation of basic and diluted earnings or loss per share for the three years ended December 31, 2010:

 

     Years Ended December 31,  
     2010      2009      2008  

Numerator:

        

Income (loss) from continuing operations

   $ 20,634       $ 12,873       $ (89,121)   

Income from discontinued operations, net of tax

     —           —           5,013    
                          

Net income (loss)

   $ 20,634       $ 12,873       $ (84,108)   
                          

Denominator:

        

Weighted average shares outstanding – basic

     39,480         38,485         39,471    

Common stock equivalents

     1,023         845         —      
                          

Weighted average shares outstanding – diluted

     40,503         39,330         39,471    
                          

Earnings (loss) per share – basic:

        

From continuing operations

   $ 0.52       $ 0.33       $ (2.26)   

From discontinued operations

     —           —           0.13    
                          

Earnings (loss) per share – basic

   $ 0.52       $ 0.33       $ (2.13)   
                          

Earnings (loss) per share – diluted:

        

From continuing operations

   $ 0.51       $ 0.33       $ (2.26)   

From discontinued operations

     —           —           0.13    
                          

Earnings (loss) per share – diluted

   $ 0.51       $ 0.33       $ (2.13)   
                          

For the years ended December 31, 2010, 2009 and 2008, the total weighted average awards to purchase or receive 74, 2,078, and 5,401 shares of common stock were not included in the computations of diluted earnings (loss) per share, respectively, because these options would have had an anti-dilutive effect on earnings (loss) per share.

 

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Treasury Stock

Kforce’s Board of Directors (“Board”) may authorize share repurchases of Kforce’s common stock. Shares repurchased under Board authorizations are held in treasury for general corporate purposes, including issuances under various employee share-based award plans. Treasury shares are accounted for under the cost method and reported as a reduction of stockholders’ equity in the accompanying consolidated financial statements.

Comprehensive Income (Loss)

Accumulated other comprehensive income (loss) represents the net after-tax impact of unrecognized actuarial gains and losses related to (i) the supplemental executive retirement plan and supplemental executive retirement health plan, both of which cover a limited number of executives, and (ii) a defined benefit plan covering all eligible employees in our Philippine operations. Because each of these plans is unfunded as of December 31, 2010, the actuarial gains and losses arise as a result of the actuarial experience of the plans as well as changes in actuarial assumptions in measuring the associated obligation as of year-end, or an interim date if any re-measurement is necessary. This information is provided in our consolidated statements of operations and comprehensive income (loss).

Subsequent Events

Kforce considers events that occur after the balance sheet date but before the financial statements are issued to determine appropriate accounting and disclosure for those events. We evaluated all events or transactions that occurred subsequent to December 31, 2010 and through the time of filing this Annual Report on Form 10-K. We are not aware of any significant events that occurred subsequent to December 31, 2010 but prior to the filing of this report that would have a material impact on our consolidated financial statements.

New Accounting Standards

In November 2008, the SEC issued for comment a proposed roadmap regarding the potential use of financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”). IFRS is a set of standards and interpretations adopted by the International Accounting Standards Board. Under the proposed roadmap, Kforce would be required to prepare its financial statements in accordance with IFRS in our fiscal year ending December 31, 2015. Kforce is currently assessing the potential impact of IFRS on its financial statements and will continue to follow the proposed roadmap for future developments. In February 2010, the SEC released a policy statement confirming the continuous movement towards a vote during 2011 on whether or not to move ahead with a mandate for the required use of IFRS for U.S. public companies as well as an estimated timeline.

In October 2009, the FASB issued guidance related to multiple-deliverable revenue arrangements. This guidance requires entities to allocate revenues in an arrangement using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenues to be allocated using the relative selling price method. This guidance should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on our future consolidated financial statements.

2. Discontinued Operations

Scientific

On April 29, 2008 (the “Scientific Closing Date”), Kforce entered into an Asset Purchase Agreement (the “Scientific APA”) pursuant to which it sold its Scientific business, a non-core business within its HLS segment, to Aerotek Scientific, LLC (the “Scientific Buyer”) for $10,500 in cash plus additional earnout of $1,500, which was earned in the third quarter of 2008. In connection with the closing of the sale, Kforce entered into certain ancillary agreements with the Scientific Buyer, including a Transition Services Agreement (the “Scientific TSA”). Through the Scientific TSA, Kforce provided various temporary support services. The fees for these services were generally equivalent to Kforce’s cost. Kforce had no significant continuing involvement in the operations of its Scientific business and, as such, classified such operating results as discontinued operations beginning in 2008.

In accordance with the Scientific APA, Kforce was obligated to indemnify the Scientific Buyer for certain losses, as defined, in excess of $50. Kforce’s obligations under the indemnification provisions of the Scientific APA ceased, with the exception of certain limited items, on October 29, 2009. Kforce believes the likelihood of any future exposure is remote.

 

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Nursing

On June 29, 2008 (the “Nursing Closing Date”), Kforce entered into an Asset Purchase Agreement (the “Nursing APA”) pursuant to which it sold its per-diem Nursing business, a non-core business within its HLS segment, to Realtime Services, Inc. (the “Nursing Buyer”) for $1,500 in cash, which was paid at closing and a subordinated secured promissory note in the amount of $500 (the “Note”). The Note bears interest at a fixed rate of 6.0% and is due on June 30, 2011. During 2010, Kforce received a payment on the Note of $200, which is included in selling, general and administrative expenses in the accompanying consolidated statements of operations and comprehensive income (loss) due to its insignificance. The remaining balance as of December 31, 2010 has been fully reserved. In connection with the closing of the sale, Kforce entered into certain ancillary agreements with the Nursing Buyer, including a Transition Services Agreement (the “Nursing TSA”). Through the Nursing TSA, Kforce provided various temporary support services. The fees for these services were generally equivalent to Kforce’s cost. Kforce had no significant continuing involvement in the operations of the per-diem Nursing business sold to the Nursing Buyer and, as such, classified such operating results as discontinued operations beginning in 2008.

In accordance with the Nursing APA, Kforce was obligated to indemnify the Nursing Buyer for certain losses, as defined, in excess of $50. Kforce’s obligations under the indemnification provisions of the Nursing APA ceased, with the exception of certain limited items, on June 29, 2009. Kforce believes the likelihood of any future exposure is remote.

The financial results of Scientific and Nursing have been presented as discontinued operations in the accompanying consolidated statements of operations and comprehensive income (loss). The following summarizes the results from discontinued operations for the year ended December 31:

 

     2008  

Net service revenues

   $ 23,604   

Direct costs of services and operating expenses

     (22,437
        
     1,167   

Gain on sale of discontinued operations

     7,330   
        

Income from discontinued operations, before income taxes

     8,497   

Income tax expense

     (3,484
        

Income from discontinued operations, net of income taxes

   $ 5,013   
        

Included in the gain on sale of discontinued operations for the year ended December 31, 2008 are transaction expenses, which primarily include commissions, legal fees, and transaction bonuses totaling $1,437. As of December 31, 2008, there were no assets related to discontinued operations. Kforce utilized the cash proceeds from the sale of our Scientific and per-diem Nursing businesses to reduce outstanding borrowings under our Credit Facility as well as to repurchase common stock.

Acceleration of Equity Awards

Kforce granted 361 Stock Appreciation Rights and 575 shares of Performance Accelerated Restricted Stock on January 2, 2008 to Kforce’s Chief Executive Officer, Chief Financial Officer and the next three highest compensated executive officers (collectively, “Named Executive Officers” or “NEOs”). These equity awards included a provision whereby vesting could be accelerated at the discretion of the Compensation Committee should there be a sufficient gain on the disposal of a portion of Kforce’s business. As a result of the dispositions discussed above, Kforce’s Compensation Committee approved the acceleration of the vesting of these equity awards on June 30, 2008, which resulted in the acceleration and recognition of $6,009 of compensation expense during the quarter ended June 30, 2008. This expense has been classified in selling, general and administrative expenses in the accompanying consolidated statements of operations and comprehensive income (loss).

 

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3. Fixed Assets

Major classifications of fixed assets and related useful lives are summarized as follows:

 

            DECEMBER 31,  
         USEFUL LIFE          2010      2009  

Land

       $ 5,892        $ 1,310   

Building and improvements

     5-40 years         24,995         —     

Furniture and equipment

     5-7 years         7,261         6,981   

Computer equipment

     3-5 years         5,162         4,148   

Leasehold improvements

     3-5 years         3,914         6,914   

Capital leases

     3-5 years         6,114         6,922   
                    
        53,338         26,275   

Less accumulated depreciation and amortization

        15,208         14,868   
                    
       $     38,130        $     11,407   
                    

On April 6, 2010, Kforce entered into a purchase and sale agreement to acquire its corporate headquarters for a purchase price of $28,500. This transaction closed on May 27, 2010 and was funded under the Credit Facility. Kforce incurred $382 of costs that were directly attributable to the acquisition of its corporate headquarters, which were capitalized as part of the purchase price. In addition, Kforce decreased the purchase price by $373 for certain balances that arose as a result of its previous operating lease, which included a rental obligation that represented the difference between the straight-line rent expense and the sum of actual cash payments made and certain rent prepayments. The resulting aggregate purchase price of $28,509 was allocated between land and building and improvements in the amounts of $4,581 and $23,928, respectively. The estimated useful lives of the building and improvements range from 5 to 40 years. Upon the closing of the transaction, all lease agreements and amendments related to our corporate headquarters were immediately terminated.

Depreciation and amortization expense during the years ended December 31, 2010, 2009 and 2008 was $5,558, $5,251 and $5,415, respectively.

4. Income Taxes

The provision for income taxes from continuing operations consists of the following:

 

     YEARS ENDED DECEMBER 31,  
             2010                      2009                      2008          

Current:

        

Federal

    $     9,062        $ 7,192        $ 14,951    

State

     1,094         547         2,233    

Deferred

     2,534         1,281         (15,256)   
                          
    $ 12,690        $ 9,020        $ 1,928    
                          

The provision for income taxes from continuing operations shown above varied from the statutory federal income tax rate for those periods as follows:

         YEARS ENDED DECEMBER 31,      
             2010                     2009                     2008          

Federal income tax rate

     35.0     35.0     35.0

State income taxes, net of Federal tax effect

     3.8        2.6        0.4   

Non-deductible goodwill impairment

                   (37.6

Other

     (0.7     3.6          
                        

Effective tax rate

     38.1 %       41.2 %        (2.2 )% 
                        

 

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Deferred income tax assets and liabilities are composed of the following:

 

     DECEMBER 31,  
         2010              2009      

Deferred taxes, current:

     

Assets:

     

Accounts receivable reserves

    $     1,580         $     2,611    

Accrued liabilities

     3,721          2,327    

Federal net operating loss carryforwards

     —            386    

Deferred compensation obligation

     378          412   

Other

     19          986    
                 
     5,698          6,722    

Liabilities:

     

Prepaid expenses

     (748)         (711)   
                 

Deferred tax asset, net – current

     4,950          6,011    
                 

Deferred taxes, non-current:

     

Assets:

     

Deferred compensation obligation

     7,814          7,220    

Stock-based compensation

     3,911          3,944    

Pension and post-retirement benefit plans

     5,349          3,605    

Other

     1,352          1,012    
                 
     18,426          15,781    

Liabilities:

     

Fixed assets

     (2,790)         (2,651)   

Goodwill and intangible assets

     (6,729)         (2,750)   
                 

Deferred tax asset, net – non-current

     8,907          10,380    
                 

Net deferred tax asset

   $ 13,857        $ 16,391    
                 

At December 31, 2010, Kforce has approximately $10,272 of state tax net operating losses (“NOLs”) which will be carried forward to be offset against future state taxable income. The state tax NOLs expire in varying amounts through 2029.

In evaluating the realizability of Kforce’s deferred tax assets, management assesses whether it is more likely than not that some portion, or all, of the deferred tax assets, will be realized. Management considers, among other things, the ability to generate future taxable income (including reversals of deferred tax liabilities) during the periods in which the related temporary differences will become deductible. As a result of this evaluation, no valuation allowance was recorded against deferred tax assets as of December 31, 2010 or 2009.

Kforce is periodically subject to U.S. Internal Revenue Service audits as well as state and other local income tax audits for various tax years. As of December 31, 2010, Global, a wholly-owned subsidiary of Kforce Government Holdings, Inc., had an ongoing audit of its 2008 tax return filed with the Philippines Bureau of Inland Revenue. No assessments related to this audit have been proposed as of December 31, 2010. Although Kforce has not experienced any material liabilities in the past due to income tax audits, Kforce can make no assurances that this will continue.

Uncertain Income Tax Positions

In July 2006, the FASB clarified the accounting for uncertainty in income taxes recognized in an entity’s financial statements, and prescribed a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. The impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, the FASB provided guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

 

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A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31, 2010, 2009 and 2008 is as follows:

 

     December 31,
     2010    2009    2008

Beginning balance

       $238           $200           $517  

Additions for tax positions of prior years

       53          80          6  

Reductions for tax positions of prior years – lapse of applicable statutes

       (76 )        (42 )        —     

Settlements

       (24 )        —             (323 )
                                

Ending balance

       $191           $238           $200  
                                

The entire amount of these unrecognized tax benefits as of December 31, 2010, if recognized, would impact the effective tax rate. Kforce does not expect any significant changes to its uncertain tax positions in the next 12 months.

Kforce recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. During the years ended December 31, 2010 and 2009, interest and penalties recognized and the cumulative amount accrued as of each year-end were not significant.

Kforce and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states. Global files income tax returns in the Philippines. With a few exceptions, Kforce is no longer subject to federal, state, local, or non-U.S income tax examinations by tax authorities for years before 2005.

5. Other Assets

 

     DECEMBER 31,  
     2010      2009  

Cash surrender value of life insurance policies, net of policy loans of $3,924 and $0, respectively

    $     20,096        $ 20,478   

Capitalized software, net of amortization

     11,982         10,650   

Deferred loan costs, net of amortization

     126         277   

Prepaid rent – headquarters, net of amortization

     —           631   

Other non-current assets

     737         878   
                 
    $ 32,941        $     32,914   
                 

The cash surrender value of company-owned life insurance policies relates to policies maintained by Kforce on certain participants in the deferred compensation plan, which could be used to fund the related obligations (Note 12). Guidance regarding accounting for purchases of life insurance, which addresses the amount that can be reported as an asset under a company’s life insurance policies based upon the amount that can be realized under the contractual terms on a policy-by-policy basis, was adopted in the first quarter of 2007, and it did not have any impact on Kforce’s consolidated financial statements.

Kforce capitalized software purchases as well as direct costs associated with software developed for internal use of approximately $6,258 and $2,705 during 2010 and 2009, respectively. Accumulated amortization of capitalized software was $22,080 and $17,449 as of December 31, 2010 and 2009, respectively. Amortization expense of capitalized software during the years ended December 31, 2010, 2009 and 2008 was $4,925, $4,426 and $4,720, respectively.

 

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6. Goodwill and Other Intangible Assets

Goodwill

The following table contains a disclosure of changes in the carrying amount of goodwill in total and for each reporting unit for the two years ended December 31, 2010:

 

     Technology      Finance and
Accounting
     Health and
Life Sciences
     Government
Solutions
     Total  

Balance as of January 1, 2009

   $ 16,898        $ 8,006        $ 10,397        $ 104,818        $ 140,119    

Adjustment to dNovus (a)

     —            —            —            (2,207)         (2,207)   
                                            

Balance as of December 31, 2009

   $ 16,898        $ 8,006        $ 10,397        $ 102,611        $         137,912    

Adjustment to PCCI

     136          —            —            30          166    
                                            

Balance as of December 31, 2010

   $         17,034        $         8,006        $         10,397        $         102,641        $ 138,078    
                                            

 

(a) This adjustment is the result of the finalization of the dNovus purchase price allocation. The assumptions used in the purchase price allocation are more fully described in Note 7.

Kforce performed its annual impairment assessment of the carrying value of goodwill as of December 31, 2010 and 2009. We compared the carrying value of each of our four reporting units to their estimated fair value. For the December 31, 2010 impairment assessment, Kforce estimated the fair value of HLS and GS reporting units based on a weighting of both the income approach and the market approach while the fair value of Tech and FA reporting units were carried forward from the December 31, 2009 annual impairment assessment. For the December 31, 2009 impairment assessment, Kforce estimated the fair value of each of our four reporting units based on a weighting of both the income approach and the market approach.

Discounted cash flows, which serve as the primary basis for the income approach for applicable reporting units, were based on discrete financial forecasts which were developed by management for planning purposes and were consistent with those distributed within Kforce. Cash flows beyond the discrete forecast period of five years were estimated using a terminal value calculation, which incorporated historical and forecasted financial trends for each reporting unit and also considered long-term earnings growth rates for publicly-traded peer companies, as well as the risk-free rate of return. A terminal value growth rate of 3.0% was used for each reporting unit. For each calculation of fair value of HLS and GS reporting units for the 2010 impairment test, the income approach valuations included reporting unit cash flow discount rates, representing each reporting unit’s weighted average cost of capital, of 15.0%. For the calculation of fair value of HLS and GS reporting units for the 2010 impairment test, the market approach applied pricing multiples derived from publicly-traded guideline companies that are comparable to the respective reporting unit to determine its value. Kforce utilized invested capital/revenue multiples ranging from 0.30 to 1.30 and invested capital/EBITDA multiples ranging from 7.0 to 11.0 in order to value each of its reporting units under the market approach. Kforce assigned a weighting to each of the invested capital ratios for each reporting unit based on the ratio that is predominately used in the marketplace to value those types of businesses. Publicly available information regarding the market capitalization of Kforce was also considered in assessing the reasonableness of the cumulative fair values of our reporting units.

No goodwill impairment charges resulted from the December 31, 2010 or 2009 annual impairment analyses. As of December 31, 2010, Kforce determined that the fair value of our Tech, FA, HLS and GS reporting units exceeded their carrying amounts by 59%, 107%, 58% and 17%, respectively. Because no indicators of impairment existed for the reporting units, the second step of the test to determine the implied fair value of goodwill for each reporting unit was not required.

Although the 2010 annual goodwill impairment analysis for HLS and GS utilized assumptions we believe to be reasonable and financial forecasts we believe to be achievable, we performed a sensitivity analysis by independently modifying the discount rate, long-term growth rate and forecasted operating results; none of which indicated impairment.

Kforce recorded an impairment charge of $128,429 ($116,669 for Tech and $11,760 for FA) in the three months ended December 31, 2008 as a result of its annual impairment assessment, which represented 87.3% and 59.5% of the Tech and FA goodwill prior to the impairment charge, respectively, as their carrying values exceeded their respective fair values. Consistent with the approach in the 2010 and 2009 annual impairment assessments, Kforce utilized the income approach and market approach to calculate fair values. The impairment charge in 2008 was primarily a result of the impact that the depressed economic environment, including the turmoil in the financial markets, illiquidity in the credit markets, and increasing jobless claims and unemployment rates, had on overall equity values as well as our operations, forecasted cash flows and market capitalization experienced during 2008.

 

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The following table contains a disclosure of the gross amount and accumulated impairment losses of goodwill for Tech and FA reporting units for the two years ended December 31, 2010:

 

     Technology      Finance and Accounting  
     Gross Amount      Accumulated
Impairment
Losses
     Carrying Value      Gross Amount      Accumulated
Impairment
Losses
     Carrying Value  
                 

Balance as of January 1, 2009

   $ 156,255       $ (139,357)       $             16,898       $             19,766       $         (11,760)       $             8,006   

Balance as of December 31, 2009

   $ 156,255       $ (139,357)       $ 16,898       $ 19,766       $ (11,760)       $ 8,006   

Balance as of December 31, 2010

   $             156,391       $             (139,357)       $ 17,034       $ 19,766       $ (11,760)       $ 8,006   

There have been no impairment charges recognized for our HLS and GS reporting units. As a result, the carrying values of goodwill for each of the two years ended December 31, 2010 represents the gross amount of goodwill attributable to these reporting units.

Other Intangible Assets

During the three months ended June 30, 2009, Kforce performed a review of a trade name that was acquired in the 2004 acquisition of Hall, Kinion and Associates, Inc. which indicated a lack of market recognition and penetration of this trade name. We determined that the trade name’s carrying value was no longer recoverable. The fair value of the trade name was based on a relief-from-royalty model, which is considered a Level 3 input by Kforce. As a result, an impairment charge of $870 was recognized. The impairment charge is classified in goodwill and intangible asset impairment in the accompanying consolidated statements of operations and comprehensive income (loss). There was no impairment charge recorded during the year ended December 31, 2010.

As of December 31, 2008, Kforce assessed the recoverability of the carrying value of certain of its indefinite-lived trade names and trademarks as a result of a significant change in the manner in which certain of the trade names and trademarks were being utilized. Based upon this evaluation, Kforce determined that the carrying value of certain of its trade names and trademarks acquired in the January 2006 acquisition of PCCI Holdings, Inc. (“PCCI”) was no longer recoverable. As a result, an impairment charge of $980 was recognized. The impairment charge in 2008 has been classified in goodwill and intangible asset impairment in the accompanying consolidated statements of operations and comprehensive income (loss).

As of December 31, 2010 and 2009, intangible assets, net in the accompanying consolidated balance sheets consists of non-compete agreements, employment agreements, trade names, patents, trademarks, customer relationships, and customer contracts. Indefinite-lived intangible assets, which consist of trade names and trademarks, amounted to $2,240 as of December 31, 2010 and 2009. Customer relationships, customer contracts and other definite-lived intangibles, net of accumulated amortization, amounted to $5,547 and $7,835 as of December 31, 2010 and 2009, respectively.

Amortization expense on intangible assets for each of the three years ended December 31, 2010 was $2,128, $1,996 and $3,689, respectively. As of December 31, 2010 and 2009, accumulated amortization of intangible assets was $22,903 and $20,628, respectively. Amortization expense for 2011, 2012, 2013, 2014 and 2015 is expected to be $2,269, $1,110, $943, $752 and $634, respectively.

7. Acquisitions

On December 2, 2008, Kforce Government Holdings Inc., a Florida corporation (the “Purchaser”), a wholly-owned subsidiary of Kforce Inc., acquired all of the issued and outstanding common stock of RDI, through a Stock Purchase Agreement (the “Agreement”), that was effective as of November 30, 2008, between the Purchaser, Kforce, RDI, each of RDI’s shareholders and an individual representative of RDI’s shareholders.

Pursuant to the terms of the Agreement, Kforce acquired all of the outstanding stock of RDI for a total cash purchase price of $39,145 (the “RDI Purchase Price”). The cash consideration paid by Kforce was composed of Kforce’s cash on hand and borrowings under Kforce’s Credit Facility. On the closing date, Kforce placed $3,000 of the total RDI Purchase Price into escrow to secure RDI’s indemnification obligations and to satisfy certain adjustments to the RDI Purchase Price, which was recorded as part of purchase price.

 

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The following table summarizes the total purchase price, net assets acquired and intangible assets recorded in conjunction with the acquisition:

 

Goodwill

   $         29,773   

Acquisition intangibles

     5,335   

Net tangible assets acquired

     4,037   
        

Total purchase price