Good day, ladies and gentlemen. And welcome to the Kforce Incorporated Q4 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 call 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.

Good afternoon. And welcome to the Q4 call. The prepared remarks of this call are available on the Investor Relations page of the Kforce, Inc. website in the Download Library under Shareholder Tools. 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-K, 10-Q 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 have published our prepared remarks within the Investor Relations portion of our website. I am going to spend a few minutes discussing Q4 and 2016, then turn to discuss market and industry dynamics and thoughts on 2017. 2016 was a year of considerable transformation for Kforce. Although, we are disappointed with our full year financial results, as revenues of $1.32 billion are roughly equal to prior year revenues, we are encouraged about our prospects for 2017 and we are beginning to see the benefits of the actions we have taken in support of our longer term strategy. Key among the many changes we made was to consolidate and streamline our sales and delivery organization under a single leader. This change has allowed us to rapidly rebalance and deploy our talent to more effectively meet customer needs and also drive greater accountability for activities across the enterprise. During the fourth quarter, we made a significant investment to enhance our sales methodology and train our sales associates to engage in more strategic conversations and shape solutions with our clients. During the past year, we also made significant progress toward a 2017 rollout of our new customer relationship management system, which incorporates our sales methodology to reinforce execution. This rollout is a major piece of a multi-year effort to replace and upgrade our technology tools to equip our talented associates with significantly improved capabilities to deliver exceptional service to our clients, enhance productivity and accelerate associate ramp up. As we move into 2017, we believe these actions have…

Thank you, Dave, and thanks to all of you for your interest in Kforce. We have been focused throughout 2016 on positioning our sales and delivery teams to operate with greater consistency and discipline to improve the intimacy with our clients, candidates and consultants. This included rebalancing our revenue generating talent between sales and delivery. We ended 2016 with a 9.1% increase in our sales talent while planned attrition within our delivery talent contributed to overall revenue generating talent declining 2.9% year-over- year. This rebalance is allowing us to reaccelerate our client facing activities and diversify our client portfolio over a broader range of our largest clients. In addition to the improving revenue trends, we are seeing this rebalancing and implementation of our sales transformation initiative we began in the fourth quarter is resulting in increasing strength in client visits, job orders, submittals and send outs in both Tech Flex and FA Flex. We are pleased to have returned to year-over-year revenue growth in Tech Flex and FA Flex. The improvements we experienced during the fourth quarter in both of these businesses is also translating into a solid start to our first quarter of 2017. Now for a bit more detail within each business. Tech Flex, our largest segment, which accounts for 65% of total revenues, improved 1.1% sequentially and 1.4% year-over-year on a billing day basis. As we noted on last quarter’s call, we began to see improvements in sequential revenue trends coming out of the summer months and into October. While the trends slowed a bit due to the Presidential election and usual seasonality around the holiday months, we are experiencing strength in recovery trends from year end assignment ends. Our activity levels have remained elevated and suggest continued strength in demand within technology. We are also continuing…

Thank you, Joe. Total revenue for the quarter of $326 million was in line with our guidance. Revenues grew 1.7% sequentially and 1.1% year-over-year on a billing day basis, as the fourth quarter of 2016 had one less billing day than Q4 2015. Total flexible staffing revenues, which exclude our Government business grew 3.0% sequentially and 1.6% year-over-year on a billing day basis. Earnings per share of $0.36 in the quarter exceeded the top end of our expectations as we continue to see the benefits of our streamlining activities. Our gross profit percentage in Q4 of 30.6% fell short of our expectations, decreasing 70 basis points sequentially and 100 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, as well as a reduced concentration of higher margin Direct Hire revenue, which represented 3.5% of revenues in the quarter versus 4.1% a year ago. Our Flex gross profit percentage of 28.1% in the fourth quarter decreased 50 basis points sequentially and 60 basis points year-over-year. The year-over-year decline in flex margins was driven primarily by compression in bill/pay spreads in our FA Flex business, due to a lower mix of project business in FA from a year ago and a 460 basis point decline in our Government business, which is realizing lower margins on some of its re-compete wins and had a lower mix of higher margin product business than a year ago. Tech flex margins are basically stable year-over-year, as we have seen some recent stability in bill/pay spreads, which are down only 10 basis points year-over-year. At a transaction level, bill rates and pay rates in Tech Flex and FA Flex increased in tandem during the quarter, though we have begun to see slight wage…

Thank you. [Operator Instructions] And our first question comes from Mark Marcon from R. W. Baird. Your line is open.

Good afternoon, everybody. Really nice to see the same billing day growth rates inflect. I was wondering if you could talk a little bit about what you're seeing specifically with some of the efforts that you have made to target some new clients on the IT side, in terms of expanding the portfolio of clients that you have really good relationships with. And to what extent is that one of the drivers for the better than expected Q1 guidance for revenue?

Hi, Mark. It’s Joe. I would say it’s really, it’s a combination of targeting new clients, as well as going deeper and wider in existing clients, where we have placed a lot of our emphasis there. So, probably, the best way I could say that as we have seen our top 25 portfolio grow by about 450 basis points on a year-over-year basis. So, I think, where that really ties back one of the things is right larger customer, lower margin, I think, when you look at our margin profile pretty much staying flat on a year-over-year basis, we’ve been able to accomplish that, allow maintaining our margin.

That’s great. And on the FA side, you’re -- its sounds like you are seeing better trends than the largest player in this space. Can you talk a little bit about that in terms of what's driving that?

Yeah. I mean, it’s the same story that we've pretty much been consistent with over the better part, probably, last three or four years when up until last year, I think, we were really outperforming the overall marketplace and it really has a lot to do with going after more bulk type business, leveraging our ability from a centralized deliver to service that business. So last year we had a lot of projects that came to closure that we had trouble outrunning and we are seeing at this point in time projects coming back on board. We have a pretty good pipeline. So that's really what’s being reflected in our Q1 guidance.

Great. And then, question for, David, a couple of them. One would basically be with regards to the comment about potentially achieving the 6.3% operating margin target by as early as Q2. Can you just put a little bit of color around like what would we need to see in terms of revenue run rate or mix or are you -- is -- are you signaling that given the current trend, perhaps, by Q2 but certainly by Q3, how should we interpret comment?

Yeah. Mark, this is Dave Kelly. So, yeah, I think, you mailed it on the back half your comment. As we think about where trends are looking in the first quarter and we look historically as we rebuild revenues in the first quarter and the trend, sequential growth trends that we would typically see from Q1 to Q2, just a simple math suggests, as well as that the positive trajectory that we are seeing that that $350 million number is going to be in the ballpark there, so which is part of the reason why we made that comment. And then for us obviously all the planning that we have done, Joe, had mentioned in his commentary about productivity improvements. We have done a lot of conversation here around the realization of the full benefit of the streamlining activities that we undertook in the last half year, you combine all those things together with the reduction in payroll taxes and the bottomline again manifest itself which is growing gets us to in that $350 million revenue category, in that range of 6.3%, so pretty simple.

Great. And then, I am sure you’ve done this calculation. If the top corporate tax rate ends up declining by a 1000 basis points or 1,500 basis points or 2,000 basis points. How should we think about calibrating that to your actual cash tax liability?

Yeah. So, obviously, Mark, you are right, we don’t know what and when we will see changes in federal tax rate. But if we do, obviously the fact that we are entirely domestic company, we get minimal time issues, means that any reduction in tax rates is almost perfectly correlated to reductions in our obligation. So it’s a simple way to think about it because it’s a simple business that we have.

That’s what we thought. Thank you.

Thank you. Our next question comes from Kevin McVeigh from Deutsche Bank. Your line is open.

Great. Hey. Thank you, and great, great job. I want to just talk couple of things just directionally, if I heard the comment right, it sounds like you are sourcing more towards revenue generators as opposed to sourcing candidates. And now just given how tight IT spend, just a real impressive ability to do that, I mean, is that just, what enables you to do that given, just how tight IT demand is and obviously, you have been really, really impressed and been able to source that talent at -- the fewer people and ultimately just how do we do that?

Yeah. Kevin, we have gone a little bit ahead of ourselves in terms of the amount of staffing we were doing on the delivery side of that. So we were over weighted on that side of the equation, especially in light of as tools and technologies still continue to improve and so we are seeing more efficiencies on those front. So our objective is to get more of an appropriate balance of sales and delivery to be able to service the need. So I don’t think we are doing anything special there. I mean, we really put that back on our leadership and more effectively driving activities and driving focus in and around the right requirements. So it's really part of our overall leadership playbook that’s allowing us to do that. So I don't think we are special relative to anybody else in the marketplace from that standpoint.

Got it. And then, as you think about, obviously, tax reform, one of the things had been in the press a lot is H1B Reform. And my experience has always been companies don’t wait for the law, they start to change their patterns and quite frankly even if the law doesn't change, I'd imagine they would want to take maybe some of that risk off the table, are those conversations starting to be had?

Yeah. Actually, surprisingly enough, there hasn’t been a whole lot of conversation up to this point in time, I mean, certain people are starting to think it through, but we haven't seen anybody reacting at this point in time. We look at all of the proposed regulations that are out there as they stand right now. We don't see anything on the horizon that really, probably, doesn't play to a benefits of who we are, I mean, most of this appears that it’s going to come back and it’s going to hit really the heavy foreign national entities that are bringing in a lot of H1Bs. Most of the -- any of the H1B work that we do here is really U.S. based. So most of was out there and being posted at this point in time doesn’t appear that it creates more opportunity for us at this point than threat, specific to us. I would say, if it were to play through the way that some of its being articulated, I mean, it's going to create a little bit more constrained then already challenging supply environment, which again, with recruitment being, what I believe is one of our strength, I think, it placed our favor.

Got it. And then one more, just because it really, really nice job. You’ve seen in a lot earlier and Mark alluded to this that basically all your peers in terms of the reacceleration. Is that organic, is that just kind of the client mix that you're dealing with or just any thoughts around that, I mean, it’s just -- it’s pretty dramatic?

Yeah. I mean, we are completely organic. I think the last acquisition we did…

Okay.

… on the commercial side was 2006. So this is really, I would say, we’ve reengineered disciplined and focused within the firm and that’s where a lot of our efforts were in and around, and it also dials into our sales transformation to drive greater consistency. So this is an execution business and our team has done a really nice job on embracing and driving the execution and to be candid I think we are just on the start of that path at this point.

Awesome. Thanks, guys.

Thank you. Our next question comes from Randy Reece from Avondale. Your line is open.

Good afternoon.

Good afternoon, Randy.

First question I had, you discussed how many vertical markets had seen sequential growth in, I guess, it was the hours billed per day from third quarter to fourth quarter? And is there a point in time in this year where you expect more of those and industry verticals to start clicking into some growth?

Yeah. So, I think, what I put out there was six out of 10 from a Tech Flex standpoint, nine out of 10 on FA. So I am assuming the question is more specific to Tech Flex.

Yeah. I would say, when I look at the industry verticals where we didn't experience on the growth, it's really more client specific versus any particular dynamic going on within those vertical. So, I think, there's -- absolutely there is opportunity across the board, because we are seeing demand broad-based even in those industry verticals where we didn't experience the year-over-year growth, the dynamics are healthy and the demand is there.

When we -- you discussed CRM system implementation, is there any affecting on D&A spend as we go through the year?

Yeah. So, Randy, a little bit, right. A lot of, I think, we have mentioned this in the past. So as we move to subscription-based, you are going to see actually a lot of the work that we are doing in technology inclusive of this CRM is going to be in manifesto of SG&A and we are seeing some of that already in our cost structure. So, no, the D&A line isn’t expected to move significantly.

All right. And on the subject to permanent placement, I was wondering how you would compare, what you are doing with, what the markets doing and how you expect the search to go through the rest of the year and I know you are not putting a huge priority on trying to grow search necessarily, but I would like to get a little bit of more of an understanding of how that might play out this year?

That’s -- relative to us specifically, not talking about the competitive landscape. We look at how we service the technology sector differently than how we service the finance and accounting sector. Because within technology we’re operating with very similar skill sets to what our Flex footprint is. So we’ve blended most of our technology search. So we have some dedicated technology search, but the bulk of what we do is in a blended model. One other thing that we experience and it was kind of -- it was woven into some of my comments, where we have really seen convergence slow in the fourth quarter. I think our conversions were down 13% year-over-year in the fourth quarter which to us really tell us that the clients are looking to hold onto that talent more, still maintain flexibility. So we are going to continue to go after search, I mean, it’s our heritage, it’s really what the company was originally founded upon. We view that we are highly capable and competent in delivering those services and our client did look to acquire services from a Direct Hire standpoint, we are going to continue to focus and service them.

Okay. Good. Nice quarter. Thanks a lot.

Thank you.

Thanks, Randy.

Thank you. Our next question comes from Tobey Sommer from Suntrust. Your line is open.

Thank you. I want to follow-up on that last point you are talking about the lengthening of average assignment? Is -- are you conveying kind of the trends here early in the year that that both the changes to the sales force in recruiter mix, as well as the average assignment length are contributing to the positive financial performance of the topline…

Yeah.

Could you try to parse out the size of the impact of that change in assignment length?

Yeah. Sure. Well, we have been commenting on assignment length elongating for the last couple quarters now. Historically, we typically had about a six-month on average and over the better part of last 18 months we have seen that extending closer to the eight months so that placed our waiver. In terms of our sales transformation, we are very early on. So when we are looking at Q1 and Q2 impact, we don't have a lot faith in there, because it’s going to take a while to drive the full implementation, full execution. One of the things that we are seeing as we come into the beginning of this year is our rebuild is happening at a much faster pace than we've seen over the better part of last four years. So we didn't have the same degree of falloff that we typically see on the back end of the year, which gave us a little bit higher baseline. So at this point if things were to stay consistent we would get back to pre-holiday headcount at a much faster pace than where we have historically been, which so give us the higher jumping off point.

Hey, Randy. I am, sorry, Tobey, this is Dave. What we are seeing activity wise in addition to the elongated assignment length suggest the strength in the market as well. So one of the funnel KPIs, for example, orders, number of A orders, the submittals, those kind of things suggest the strengthening as well, so it's more than just the assignment length that were starting up a higher base, it’s also the activity coming into the year and that would -- I would say that it’s predominately as a result of the skills that we are focus on. These are sweet spot skills of technology. We are in the higher skill areas. This is the customer facing developments stuff that everyone has to do now. So, I think, the clarity that came as a result of the Presidential election and the potential for some of the policy changes have given a greater confidence to the clients that have given a sense of at least now directionally will invest and that’s why we are seeing these things start to happen.

Thank you. That’s right. My next in -- among the financial services customers, have you started to see conversations change as a result of higher rates and expectation for higher rates, as well as potential regulatory relief, are they going to turn that into investments for growth and IT to support the growth?

Yeah. I mean, we have been starting to hear some of the conversations taking place. So, yes, I would say, there is a tonality that both of those scenarios are highly favorable to financial services from -- especially from a regulation standpoint. And needless to say not only does the rate impact hit within financial services but a lot of in the insurance industry at this point in time, they are impacted pretty heavily from a rate standpoint, so we're hearing it on that front as well. Because last year we saw quite a bit of contraction taking place as people were expecting rates and then there was the pause and so no one is, I wouldn’t say anybody is reacting to it as of yet, but conversations are taking place.

Thank you. If there is an impact from changes to visas et cetera, what industry vertical do you serve that would kind of see an impact potentially first?

We don't believe we would see an impact within the industry verticals that we serve. I think, we -- you would really see it more hitting the four national companies as things are being articulated at this point in point time. So before working with any foreign national companies as serving to them that would be where we would feel it first but that’s a very small percentage of our business.

Okay. And could you just kind of size up on the Richter scale systems implementation your project here in ‘17 and how you feel managing the risk of systems migration? Thanks.

Yeah. So, Tobey, I think, we feel very comfortable. We have got a great team. There is no lot of [ph] leg work (43:24), as Dave I think maybe mentioned in his comments, we have been after this for a number of quarters and we have done and so we feel very good about the process.

Yeah. I will give you a little bit of flavor on that. The nature of our selection of Microsoft Dynamics, the adoption and the ease of use to the end-user is they are already trained on look, feel and usability. In fact here over the -- of the course over the last several weeks we've been out markets with our sandbox, putting it in front of the end-users and having them go in without any training and it's intuitive. So we view that the tool is going to be such an enhancement to where we are currently that our people will embrace it and the use of the tool we don't have any concerns.

The only thing I would mention to Joe’s comment is the work we have down in terms of sales methodology and the transformation we have to build right into the CRM, so we think this is great…

Yeah. That since when we work down our sales transformation route we were building out the requirements definition for the actual tools. So as we’re training people on our sales transformation methodology they are actually being integrated into the tool, a head of the tool being put in front of that.

Got it. Two last questions for me, just a numerical one. How big was the timing issue on cash flow and will that probably be recouped in the current quarter or will take little longer and then could you…

Yeah.

… update us on your expectations for KGS, seems little slow after the big contract wins, so I just kind of want to get your call two-year view on that business? Thanks.

Yeah. So, Tobey, I will take the first question on cash flow. So, I think the preponderance of the timing issue will get resolved in the first quarter. They may be a little trail into the second quarter. But so when you think about the size, in the aggregate it was in the upper single digits of millions of dollars in terms of timing issue. So as we have talked about, we size, for example, our repurchases based upon cash flow that we expect in the quarter and so you saw the net increase here from a timing perspective as a result of it. So, again, I think, it is a timing thing that we feel. We are already starting to see the resolution.

Tobey, I will answer the question on KGS. Interesting things happening, and first of all, the proposed new VA secretary is up for approval, should be within the next week or so. What we are hearing is that the small business clients are experiencing some difficulty in execution on the T4 Next Gen. So within VA there are some concerns about their ability to deliver project of this scope which may invite a reconsideration of this the rules that they are following currently. There has also been a change in the LPTA, the low price, technically acceptable, it’s come out of Congress that has given them some relief to focus more on those that can deliver as oppose to just the LPTA. So there's some interesting things happening in that area. Another factor within KGS is the product business, which we have experienced tremendous success with and we have fulfilled under those contracts predominantly in 2016, so this is going to be a little of the bit slower product here at the beginning of the year. The expectation is that new vehicles will come at the back end of the year which set us up great team which is a -- it’s a much longer procurement cycle and we have some new products that are coming out of that space which should be a help to KGS as we move into next year. In addition to what we are already doing in T4 Next Gen, we do have other perspective prime contracts that we are pursuing that. At this point we are not in position to comment on. As Joe said earlier, we are pretty comfortable now with our base for this year. We have already re-competed 96% of the base. So any of the opportunities that come forward now should be additive, but we are going to be conservative in KGS given the fact that that we are dealing with a couple of significant unknowns as it relates to T4 Next Gen and then the timing of some of these awards. But I would say in general the Government contract and environment is more favorable now with the administration change.

Thank you very much.

Thank you. [Operator Instructions] And our next question comes from Anj Singh from Credit Suisse. Your line is open.

Hi. Thanks for taking my questions. My first one, I wanted to follow-up on some earlier Q&A. And as it relates to some of the commentary from your peers and the staffing world, it seems that while they are also seeing the same optimism from their customers and leading indicators and KPIs, you guys seem to be a little bit more optimistic and that actually turning into revenue, particularly as it relates to your commentary around Q2? So are you seeing a little bit more tangibility of that optimism as it relates to revenue versus the others, just trying to understand that a little bit better? Thanks.

Yeah. I am not inside anybody else's business and so all we are doing is we are communicating what we are seeing based upon our operating model in combination of what we're seeing with our metrics and how our metrics translate from a ratio standpoint to an output standpoint. So, I really can't comment on anybody else.

Okay. That’s fair. With regards to your headcount additions going forward. How should we expect that the trend should return sort of in line with revenue growth? How would you characterize the composition of your revenue generating headcount now? Would you describe that as balanced at this stage?

Yeah. So, it’s a great question. As I mentioned that, I would say here in Q1, I think we will stay fairly constant with where we were in Q4, because we are really focused here on Q1 of driving integration and adoption of a lot of things that we have started. We will start to resume on net headcount growth in the second quarter. And based upon some of the plans that we are looking at now, I would say by the time we get to Q4 our year-over-year will probably more mix single digits maybe slightly above that 7% to 8%, I don’t think we will resume back to a 10%, because we believe with the investments we are making in the technology, the investments we're making in the sales transformation methodology and other things we are doing on the delivery front, other that will yield itself from a productivity standpoint. And also to circle back, I don’t, I am not trying to be difficult on the first question, but everybody plays in different skill set and has a different focus. We believe we are playing in the right skill sets within the right client, which is probably a reflection of maybe where some of our optimism might be, we are not a heavy midmarket player, where a lot of that business has gone offshore into the cloud, where the large organizations are much more on the front end customer facing technologies, which is where our people are really focused in their efforts. So this isn’t just about activity, it’s also about footprint and focus and where you are playing within the text base.

Understand. That’s help. A couple housekeeping questions. On the six out of 10 verticals that you mentioned, we are seeing sequential growth inside of Tech Flex. What are the other four doing, are they flat, are they declining, just some color there and it’s nice to see that sort of success you guys had with your top 25 clients, your largest clients. But just also wondering with regards to sort of revenue concentration, what is your largest Tech Flex client now comprised of your revenue or if you could just update us on one client concentration looks like for perhaps the largest client? Thanks.

Yeah. So I will start with your first question in terms of the industry vertical. So, yeah, we are talking about the one where we saw sequential nice improvement. There none of the industry vertical in our per se down 10% on a sequential basis. I mean, some of those verticals are down 0.2% sequentially. So meaning they are all performing well and some of we just have higher concentration. So given the makeup of the clients in that based upon activities that they had in Q4 could move that needle to a certain extent which is part of why we are saying it’s more broad based and we are comfortable from that standpoint in terms of we are seeing demand across all the industry verticals that we participated in.

Yeah. So, in terms of client concentration, we have talked quite a bit about this, pretty diversified even within our large client. The largest client that we have in terms of percentage of total revenues is less 6% of total revenue, so pretty diversified.

Okay. Great. That’s supper helpful. I appreciate the time.

Thank you. I am showing no further questions from our phone lines. I would now like to turn the conference over to David Dunkel for any closing remarks.

All right. Great. Thank you very much. And thank you all to for your interest in support of Kforce and I would like to say thank you to each and every member of our field and corporate teams. 2016 was a year of significant change and I am really proud of how they handled it, far exceeded my expectations, they just did a fantastic job. So I want to take this opportunity to thank and they were awesome. I also want to thank our consultants and clients for allowing the privilege of serving you and we appreciate your support our investment community as well and as Dave said, we are committed to delivering on our commitments to you earlier and honoring those commitments and we are serving as very best that we can. So thank you and we look forward to talking with you again at the end of Q1.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may now disconnect. Everyone have a wonderful day.