Good day, ladies and gentlemen, and welcome to the Kforce, Incorporated Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. And instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference Mr. Michael Blackman, Chief Corporate Development Officer. Sir, you may begin.

Great. Good afternoon and welcome to the Q3 call. Before we get started, we would like to remind you that this call may contain certain statements that are forward-looking. These statements are based upon current assumptions and expectations and are subject to risks and uncertainties. Actual results may vary materially from the factors listed in Kforce's public filings and other reports and filings with the SEC. We cannot undertake any duty to update any forward-looking statements. I would now like to turn the call over to David Dunkel, Chairman and Chief Executive Officer. Dave?

Thank you, Michael. You can find additional information about Kforce in our 10-Q, 10K and 8-K filings with the SEC. We also provide substantial disclosure in our earnings release to assist in better understanding our performance and to improve the quality of this call. We've published our prepared remarks within the Investor Relations portion of our website. Revenues in the third quarter of $336.5 million were largely as anticipated across all business lines as we continue to make progress in diversifying our client portfolio. We are encouraged by the late-quarter and early October trends in our Tech and FA businesses that are providing momentum heading into the fourth quarter and should allow us to return to positive year-over-year growth overall and in our Tech Flex business. We have largely completed our organizational realignment, which we began earlier this year when we consolidated and streamlined our field operations and certain revenue enabling support functions. We also made the decision during the quarter to onshore our support operations in Manila to our corporate headquarters in Tampa Florida. During the quarter we incurred $0.10 in severance and related costs relative to these organizational changes. This resulted in a reduction in earnings per share to $0.34. Exclusive of these costs earnings per share would have been $0.44 which was in excess of expectations for the quarter. We are confident that this streamlined organization will enable us to take advantage of solid market environment that continues to be in need of skilled technology resources. We are now nearing the end of the seventh year of an economic recovery for the average annual GDP growth has been approximately 2%, which is the lowest rate in any recovery since World War II. Since mid-2009 both our Tech Flex and FA Flex business have grown at an approximately…

Thank you, Dave and thanks to all of you for your interest in Kforce. A key component of the realignment effort that Dave mentioned has been to ensure we are putting our revenue-generating talent and position to succeed. This entails not only providing them the proper tools, training and direction, but also making sure they are supported by the best leadership and are working efficiently as a team. We've been focused over the last two quarters of rebalancing our talent to increase the ratio of sales talent to recruiters, particularly in our Tech Flex business. The intent of this plan was to reaccelerate our client facing activities and further diversify our client portfolio over a broader range of our largest client. We're making progress at seven of our top 25 Tech Flex clients in Q3 2016 our new to this customer segment as compared to a year ago. Our overall revenue generating talent is up 1.5% year-over-year while our Tech Flex sales talent is up 23.7% year-over-year. So aggregate year-over-year growth rate in our associate base have declined in recent quarters, we believe the shift in mix to more appropriate ratios will result in improving productivity and we believe significant capacity exist to grow revenue within the current talent population. We're seeing positive momentum in our leading indicators with four-week averages improving over 13-week averages, for client visits, job orders, submittals and send out, in both Tech Flex and FA Flex as well as recent momentum on billable consultants on assignment in both businesses, which is encouraging as we move into the fourth quarter. Let me get into a bit more detail with each business, Tech Flex our largest business unit, which accounts for 65% of total revenues, improved 0.4% sequentially and was down 2.7% on a year-over-year basis. We…

Thank you, Joe. Total revenue for the quarter of $336.5 million was in line with our guidance. Revenues grew 0.4% sequentially and declined 1.5% year-over-year. Total flexible staffing revenues, which exclude our government business grew 0.2% sequentially and declined 2.1% year-over-year as the year-over-year decline in Tech Flex narrowed slightly on improving trends in the quarter. Earnings per share of $0.34 in the quarter included $4.3 million in pretax severance costs related to realignment efforts which impacted GAAP earnings per share by $0.07. Excluding the impact of the severance related costs, earnings per share would have been $0.44, which exceeded the top end of our guidance. Our gross profit percentage in Q3 of 31.3% decreased 40 basis points sequentially and 90 basis points year-over-year. The year-over-year decline in gross profit margins was driven by a 60 basis point decline in Flex gross profit margins coupled with a reduction in the percentage of high-margin direct hire revenue as a percentage of total revenues. Our Flex gross profit percentage of 28.6% in the third quarter decreased 20 basis points sequentially and 60 basis points year-over-year. These declines are primarily due to compression in built pay spreads in both our Tech Flex and FA Flex businesses. We also had greater than anticipated health insurance expenses during the quarter, driven by a few large claim. Specific to our Tech Flex spread, the success we've had in growing revenues due to allocation of resources within our largest clients has created an increased concentration of revenues in this portfolio which in the aggregate have margins approximately 100 basis points lower than the rest of the portfolio. Flex revenues from our 25 largest clients now represent 47.2% of total Tech Flex revenue. These customers represented 41.7% of total Tech Flex revenues a year ago. In addition to…

[Operator Instructions] And our first question comes from the line of Kevin McVeigh of Deutsche Bank. Your line is now open.

Great. Thanks. Hey and thanks for all the detail. Just wanted to understand still little more what kind of drove the decision to invest? And then how does this ultimately impact the go-to-market strategy of the NRC if at all?

Yes Kevin I am Joe. So when you said to invest and invest in sales headcount and the training I'm assuming along with that.

Yeah, that's right and just because it sounds like obviously across the group there has been some concern about the duration of the cycle but to me it feels like this one starting to feel little bit longer and that's what the fundamentals would suggest and really the actions you're taking support that. But we're just trying to figure out is it -- does it tweak the NRC strategy at all Joe or is this going to be investments more pushed down at the local level or how should we think about just at a higher level. I understand it makes total sense, but just where did those dollars go if you would?

Yeah, it's really, it's really aligning strength for strength based upon what client volume buying models are and the most effective way to service and deliver those. So there is not one-size-fits-all. So that's really what we're doing. We're looking at our overall portfolio and where it makes sense to deliver that in a decentralized fashion, leveraging our field operations we're doing that. Work it makes sense to centralize that we're doing that. As we mentioned starting about a year ago, we've been ramping up our sales headcount so that we get deeper and wider in those 3,000 technology Flex customers that we service on an annualized basis and we're starting to get some traction there. What that really led us to and you heard my statistic with that headcount being up 23.7% on a year-over-year basis, we were getting to the point here where we're about ready to get into requirements definition on our CRM and it really made sense to tighten up our processes, our methodology, our go-to-market messaging, because there's nothing more powerful than when you implement technology and the technology supports your overall methodology and your processes. So in essence by engaging this third party to help refine all of that, it will provide us with a more effective means so that all of our people market-to-market are communicating in the same way, bring the same value proposition, supported by the technology. So that helps with our existing population with getting everybody on the same day and then as we on board and bring on new individuals as we continue to ramp up that population, we believe that will allow us to more effectively ramp them more quickly. Does that help give you some color on that backdrop?

It does and there kind of without getting too specific and any sense in terms of goals on what the client mix looks like going forward, large versus small to medium?

Yeah, we're working through those things at this point in time. So more to come on that front. The first place that we're doing is we're stepping back and we're looking at our existing client base and where we should going deeper and wider and then we ultimately have to start putting together some pro formas on how we view we can grow those various client base. So no, at this point in time for me to give you an absolute percentage it's just wouldn't be right. So we're just going to look at the overall picture, because by the way and Dave Kelly covered this in some of his comments when we look at the continued landscape in and around the Fortune 1000. The Fortune 1000 continue to get more sophisticated and in terms of how they procure resources, in terms of escalating rebates based upon volume, continued consolidation of vendor servicing those customers and that's incumbent upon us, which is why we're making these investments we are in methodologies and training and technologies because we have a responsibility to be able to bring down our cost structure. If I am sitting in one of their procurement offices, if I'm giving you more business, you need to figure out how to do it more effectively, so we're being proactive on all those fronts.

Got it. And then one more just on if you said this I missed it, how are we thinking about buyback in the quarter and then just the stock along with the rest of the goose been under some pressure, any thoughts on user buyback as we get it working for Q4.

So obviously we continue to buy back stock in the third quarter. We spend over $9 million in the third quarter alone. I think we spent $28 million or $29 million, which is in excess of the cash that we generated as a firm year-to-date and additionally we continue to do pay a quarterly dividend. So we continue to believe that those avenues to return cash are extremely beneficial to us, to our shareholders and so as we look forward, cash flow in the fourth quarter we expect it will be very strong. We've got ample availability on the board authorization. As a matter of fact, we've got $65 million left on the board authorization. Plenty of resources under our credit facility and so we think that's an efficient way to use the balance sheet absolutely.

Super. Thanks.

Thank you. And our next question comes from the line of Randle Reece of Avondale Partners. Your line is now open.

Good afternoon.

Good afternoon.

You've had a little bit of bouncing around in the Tech Flex gross margin this year. I was wondering what changed from 2Q to Q3?

Yes so Randy. This is Dave Kelly. So I think a couple things and I mentioned it. One of them is somewhat discrete and that's health insurance costs. So we had a couple large claims. So that negatively impacts margins in the third quarter relatively speaking, but I think more fundamentally, is as we've seen the growth of these large clients. And as Joe I think just alluded to the sophistication of those large clients and the fact that they're looking to consolidate their spend with fewer providers, there is an increasing trend for them to look to you and for the vendors to provide escalating discounts based upon volume and frankly that Ross is a great place to be given the design of our organization if frankly is the place where I think we see a significant amount of money continue to be spent because of the technology and demands of those providers. So those are the two drivers really to where we've seen some margin compression frankly over the last year and certainly from Q2 to Q3.

And I would say there was a third area specific to Q2 that to Q3 not as material, but it is in there. We had a client that rotated certain resources and we have a pretty large population of international resources, which we carried the paperwork on. So we had to carry a little bit more bench in the quarter, associated with redeploying some of those individuals, which shows up in margin as well.

So from Q3 to Q4 should we expect an improvement -- modest improvement in the Flex gross margin or is it going to be similar?

So Randy no, you should actually typically see from Q3 to Q4. You'll see a decline in Flex margins with that driven not by an expectation of the transaction level spread compression, but rather the fact that we've got more paid time off, we paid this is not anything that we would typically expect to be any different than what we see on an annual basis. As a matter of fact, I think I quoted gross margin to be 30.9% to 31.1% and part of the reason that we expect gross margins to go down is that our direct hire business as a percentage of the whole will go down. So I wouldn't expect any different characteristics in Flex margins than we see in prior years.

All right. Thank you.

Thank you. And our next question comes from the line of Mark Marcon of Baird. Your line is now open. [Operator Instructions] And our next question comes from the line of Tobey Sommer of Suntrust. Your line is now open.

Thanks could you maybe refresh me on the gross margin expectations and percent of PERM associated with your longer-term goals of operating margin?

Sure. Hi Tobey. This is Dave Kelly. So right now and then it of course varies by basis points quarter-to-quarter, our direct hire revenue is\ about 4% of total revenues and that's a 100% gross margin business. As we model our expectations prospectively, we expect that percentage to remain relatively constant. It may trickle down a little bit as we think about the growth in the Flex business but it certainly is not expected to be in excess of where it is today.

And our Flex gross margin is expected to be as they were in the quarter or is there a different expectation? So I was trying to get a sense for overall gross margin.

Sure. And I think it's an important question Tobey because it relates to a lot of the things that we've talking about in doing as a firm to make sure that we're prepared to take advantage of market opportunities where they exist while still ensuring that we're going to meet the profitability goals that we've established the bottom line goals. So as I look forward in some of the measures that we put out specifically an expectation of being at 6.3% operating margin at that $1.4 billion in annualized revenue and that of course 7.5% and $1.6 billion the model that we have currently built we're able to realize those operating margin at gross margins that exist as they were in the third quarter, which is as I've mentioned lower than they were previously a year ago. So that's how we're thinking about it right now. We're not planning in those target to see an expansion of those gross margins or Flex margins therefore.

Okay. A couple of questions from your prepared remarks if I could, when we talk about contract value in KGS is that funded or unfunded could you describe that in a little bit more detail?

Yes so Tobey what we're effectively talking about funded value in this in the business and so as we look at KGS as we look forward Dave alluded to frankly I think what was our largest contract that we won the re-compete on in the fourth quarter and there were two significant contracts. So as we look into and you may be curious as we look into 2017 it's a very low re-compete year. As a matter of fact I think only about 10% of the base is up for re-compete in 2017. So fundamentally that business is well set in terms of the current revenue base and can focus obviously on new opportunities in Q4 in other places.

And Tobey to give you a little perspective there, if you were to go back to '16 we had about 25% of the business to re-compete and if you were to go back to '15 we had about one third of the business that re-competed. So that's why we're pretty optimistic in terms of new contract acquisition opportunities while as we look out.

Okay. And then on the revenue or excuse me, the talent growth being in the low single digits is terms of headcount, when did you shift your thoughts thinking that that would be sufficient to generate the revenue growth that you're hoping to achieve because I can recall not too long ago, we were targeting a faster rate of headcount growth. When did that shift and how might you be offsetting that to drive productivity gains through your investments either in training or technology thanks?

And I referenced it in my remarks, we see a comparable year on the back end of Q4, but as we start to look forward providing market dynamics stay intact, we will migrate back towards that 10% year-over-year growth. So we've been just working on rebalancing our overall workforce in terms of the amount of salespeople to delivery people and aligning those in and around customers. So what's been happening as we go through that, as I mentioned, our sales population is up 23.7%. We've brought down some of our unproductive recruiting resources, as I mentioned also in my comments are submittals and our send-outs are actually all up. So we've actually improved productivity on the front-end indicators with those populations. So we're very pleased with the progress that we're making on that front.

Where do you think you are the rebalancing effort, so when can we reasonably think about starting to increase the headcount towards that 10% growth target?

We'll probably have a little bit more guidance as we get on the Q4 call, but based upon now in our models, we're looking at a re-acceleration in that in Q1 if everything were to remain intact economically.

Okay. Thank you for your help.

Thank you. And our next question comes from the line of Mark Marcon of Baird. Your line is now open.

Good afternoon. Can you give us a little bit of color with regards to how quickly you can get the SG&A associated with some of the larger Tech Flex accounts down even further than what you have and then obviously we've gotten a partial impact thus far from some of those new build rates, but how do you think that it is going to evolve over the next year to two years in terms of those large accounts.

Sure Mark. So this Dave Kelly. I'd give you a couple data points to think about to reinforce some of the comments that I made in the prepared remarks. So I think we've started to see some of that in the third quarter as SG&A itself was less that is a reflection of some of the refinements that we saw a little bit earlier than we expected in the third quarter. As we look ahead to the fourth quarter, I'll reflect back on the comment that I made giving you some thoughts around the impact of the revenue declines and the cost of the sales enhancement, the work that we're doing. You strip those things out and I think you'll realize that we're going to expect to see some additional operating leverage and that's driven in a large client space even in the fourth quarter, which leads us to high degree of confidence that as we get to that $1.4 billion even at these lower gross margins that we'll still attain 6.3% or better operating margins. And then as we look forward, there still -- obviously it takes a little bit of time with the changes that we're making to settle we think we'll fully realize these benefits as we're in the second quarter and we believe we're well-positioned as I think Dave and I both stated continue to get to that 7.5% levels. So we're already seeing if and we expect more over the course of next couple quarters.

Great and then can you just talk a little bit more about the anticipation in terms of further volume increases with some of those larger players. Can you just give us a little more scope with regards to the pairing back of their approved vendor lists and how much of a volume bump you could potentially get?

As I mentioned, we've seen pretty broad-based demand across eight of our 10 largest industry verticals and so within those articles typically is where our larger customer sit within those verticals and so we’re continuing to push on those customers. Some of the newer customers that we're bringing on that are just cracking into our top 25 we have just tremendous upside and by the way even customers that were in our existing top 25, we still have tremendous client share opportunities that exist with them. And that's not to mention that those customers that have migrated out of our top 25 is not necessarily because they've decreased, it's because ones have outgrown them and jumped into the top 25. So we still have that client portfolio that we're going after. So, our customer' share within anyone given customers is so nominal that it’s all about execution and implying more resources in those customers to capture greater share.

And is that primarily going to be a function of widening the sales funnel with those particular clients or are you also hoping to increase the number of orders through increased or improved recruiting efforts?

Yes and yes. So the reality is as we like most organizations when you're inside these Fortune 1000 you typically have successes in given areas. We're looking to parlay those successes and take that messaging across into other departments where we haven't done quite the volumes of business. And as I mentioned earlier in my comments we view it’s our responsibility with the volume of business and the amount of reps that we're getting with each one of these clients in terms of submittals and taking people through the interview process and ultimate start process. It's incumbent upon us to become more effective and efficient for those customers. They expect it from us, but to be honest with you, they don’t need to put the pressure on us. We put more pressure on ourselves on that front than they place on us. In many of these customers that’s one of their score carding of how they view our effectiveness. It's not just on output, on placements, or revenue, there is compliance aspects, there is productivity aspects. So I think it's a really balanced approach and we're aligned with our customer needs.

Okay. And then can you just give a little more color with regards to either geography or industry in terms of the areas where you are seeing, reduction in terms of the level of demand.

Yes, probably the one industry which we're still seeing a lot of choppiness is the manufacturing. We still haven’t seen manufacturing turn back around. That's probably the biggest outlier from an industry. When I talk about really any other industries, I would really say like in the ninth industry then I'm not talking about because eight out of 10 were up that I would say is more specific to us versus any dynamics going on within the industry, it's just the nature of the client mix that we have within that industry.

Great. Thank you.

Sure. Thanks Mark.

Thank you. [Operator Instructions] Our next question comes from the line of Anj Singh of Credit Suisse. Your line is now open.

Hi. This is Anj Singh from Credit Suisse. Thanks for taking my questions. I guess first off on your commentary regarding the larger clients giving more volume or spend and compressing spreads as an offset. I guess could you walk us through why we aren't seeing the uptick in revenue but we are seeing the gross margin and spread compression what would be the lag time to see that revenue uptick?

Yes, I think that first of all I think in terms of the top 25 clients we are seeing some benefit here. We have seen some sequential growth in those 25 clients than are a 47% of our revenues I have been called so but as we see it the way that this will typically work is we will win new business and it will take some time to grow those gradually and they will build in the discounts that are based upon volume and the increase will hit additional markers so, is there a lag, there is a growing trend of these discounts when there is a slight lag.

Okay. Got it and then on direct hire, I know it's not a huge priority for you guys, but in light of it impacting the gross margin outlook, wanted to just get a little bit more color. We haven't seen this trend of declines in this business in a long time. I think last time you had this trend of down year-over-year was early '08. So, what's driving this are you losing market share or you walking away willingly from some of the direct hire business or is just lower demand could just walk us through some of the puts and takes there.

Yes, I think if you listen to anybody else that has commented on direct hire, I think everybody is experiencing a little bit more challenging fourth quarter. I mean if there is an election year and we've gone back and looked historically during election year's, there is a little bit more uncertainty. So, you see a little bit more pause. And similar I think what some of our competitors have said on earlier calls, specific to direct hire because by the way we’re not seeing this on the Flex side of the business, clients are very selective, they are being more cautious, they are asking for more candidates, they are looking for a higher degree of fit or the roles that they have because they're trying to use those wisely, so all those things are stretching out the process. By the way the top candidate it is a highly competitive marketplace. So often clients are moving slow and that candidate is going somewhere else and we also are seeing people accepting many more counteroffers in this client.

Got it. And just I have a couple questions on the T4 NexGen, when do you expect the next cycle of these task orders to come and any sense of what your win rate was on the task orders that you were eligible to submit responses as a prime contractor for?

Yes, this is David Dunkel. The orders are continuing to flow. The issue comes down to what the mix of the orders are and who is allowed to bid on them as prime because there is 12 large and 12 small. And so the nature of the task orders really determines who gets to bid on them. So there is a constant flow. There are still pending task orders that we're awaiting awards on that are pending now for the balance of this quarter and that will continue throughout the balance of the contract period. So we expect that we'll see more of those awards and will have more to say about that in the first quarter. In addition to T4 by the way we also have other customers and we're working within other departments and there are other still substantial opportunities that as we move in '17 that we're awaiting on as well. So, we’ll hopefully have more to say about that in Q1. In terms of percentage you want to comment on that Dave?

Hi, Anj. It was a lower percentage that was even let out to large in this initial round of task orders that we had anticipated somewhere in the neighborhood I think of 10% or 20% was all in terms of the volume of contracts that were full and open and the rest were better and owned small disadvantaged businesses. The other thing I would say to Dave's point and this is true for us as being well positioned in the VA, though we in some cases aren't eligible to bid on some of the contract, that doesn’t preclude us from taking advantage of our relationship with the small businesses that do bid and the relationship we have with VA they also subcontract on those. So there is some of that for us as well. So it’s not an all or nothing type of thing for us which is part of the reason why we still think and continue to think as a prime and as a sub to T4 and the amount of money that the VA is allocated under this IDIQ is an important contract vehicle for us.

Okay. Got it. That’s super helpful. I just one quick follow-up for me what is the timeframe to recognize the re-competes that you spoke to the $60 million we just trying to understand what you know what number of years that we recognized over, thanks.

So Anj, to recognize this, first of all obviously recomplete it means we’re sustaining the revenue that we have already had and that as we would typically see as contract dependent of course you see an average contract length of about four or five years. So again we got 10% recomplete that makes 90% of our base at KGS it’s not up for a already in 2017.

Perfect, really appreciate the time. Thank you.

Thank you and I’m showing no further questions at this time. I would now like to turn the call over to Mr. David Dunkel, Chairman and CEO for closing remarks.

Okay. Great. Thank you, Shennel. First of all I want to say thanks to our folks, our field leaders, our team. They did a fantastic job during this quarter, where there was quite a bit of change going on with the realignment activities and in the process they were still able to execute and deliver on revenue and actually position us for growing fourth quarter and we're excited about what we've set the table for in 2017. There is a lot of good things that have come together and our team has just done a great job. So I just want to tell you guys I am proud of you and I also want to thank the rest of you for your interest and support of Kforce and our corporate teams have done a great job and finally to our consultants and our clients, thank you for allowing us the privilege of serving you. We look forward to talking with you again in Q1 and maybe we'll know who won this crazy election by then. Thank you very much.

Ladies and gentlemen, thank you for participation in today's conference. This concludes today's program. You may now disconnect. Everyone, have a great day.