Good afternoon. My name is Krista and I'll be your conference operator today. At this time, I would like to welcome everyone to the Kforce Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, we will have a question-and-answer session. [Operator Instruction] I would now like to turn the conference over to Joe Liberatore, Kforce's President and CEO. You may begin your conference.

Good afternoon. This call contains 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 Securities and Exchange Commission. We cannot undertake any duty to update any forward-looking statements. You can find additional information about our results in our earnings release and our SEC filings. In addition, we have published our prepared remarks within the Investor Relations portion of our website. The Firm continues to operate effectively against a challenging macro environment. Our laser focus on growing our business organically with a consistent, refined business model tailored to provide highly skilled technology talent solutions to world-class companies has been critical to our success. Third quarter results were stronger than we anticipated and results in our Technology business continue to be at the top of our peer group. Further to this point, we saw notable improvements in consultant retention in the back half of the third quarter, which contributed significantly to our better-than-expected third quarter performance. We have experienced an improving trend in new assignment starts in October. Our strategic position is solid, and our prospects are excellent. With that said, tremendous uncertainties still exist in the macro landscape, though the improvements in our results over the last quarter leaves us cautiously optimistic. The prevailing view of economists continues to be that the US economy will fall into a recession in early 2024 following the aggressive monetary tightening by the Federal Reserve. The challenges in the geopolitical landscape continue to grow with the ongoing war in Ukraine, more recently with the war in Israel, along with US political uncertainties and many others. Against this backdrop, the labor markets continue to…

Thank you, Joe. Revenue for the third quarter meaningfully exceeded the top end of our guidance. The performance of our Technology business, which declined less than expected due to positive late Q3 trends, was the most significant driver. Overall revenues in Q3 declined 13.4% year-over-year with flexible revenues in our Technology staffing and solutions business declining about 11% off very difficult prior-year comps. As a reminder, our Technology business grew organically approximately 16% on a year-over-year basis in the third quarter of 2022 and nearly 30% in the third quarter of 2021. When you look at our Technology business from Q2 to Q3, revenue declines moderated sequentially to only 2% as compared to a nearly 4% decline from Q1 to Q2. As Joe mentioned, our consultants on assignment stabilized mid-quarter in Q3 and actually showed a very modest improvement at the end of the quarter. This trend has continued into October. The volume of new assignments and projects still remain at lower levels than a year ago, though assignment retention was significantly better than we anticipated, and new assignment starts have recently improved. We believe this may be indicative of clients reaching minimum staff levels necessary to perform required activities and execute on mission critical initiatives. Based on our conversations with clients, they recognize the need to retain highly skilled talent while they await a point of increased confidence to more aggressively address their increasing backlog of desirable and important technology investments. Overall average bill rates in our technology business remain near record levels at approximately $90 per hour, which improved slightly sequentially and 2.3% year-over-year. Even in this uncertain environment, highly skilled talent remains in short supply and high demand, which is reflective of the stability in bill rates. We are also benefiting from an increase in the proportion…

Thank you, Joe and Dave, for your support over the years and your comments. We are blessed to have the unwavering support and passion of the entire Kforce team in moving our firm forward. I appreciate the opportunity to provide some comments about our financial position and forward-looking expectations. In the third quarter, we recognized expenses related to actions to reduce our structural costs to better align them with the lower revenue levels, and also incurred expenses related to the executive realignment that we announced in September. These costs, as well as certain legal accruals for the expected settlement of outstanding legal matters, amounted to $8.4 million. As you remember, we included $5.5 million within third quarter guidance, so there was an incremental $2.9 million recognized in the quarter. These total costs, net of the related tax benefit, impacted GAAP earnings per share by $0.36. In my commentary, I will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the impact of these costs on our financial results. Our press release provides the reconciliation of differences between GAAP and non-GAAP financial measures. Third quarter revenues of $373.1 million declined 13.4% year-over-year. GAAP earnings per share was $0.54. As adjusted for the previously mentioned costs, earnings per share of $0.90 was at the high end of our third quarter expectations. Overall gross margins declined 60 basis points sequentially and declined 130 basis points year-over-year to 27.7% in the third quarter due to a combination of a lower mix of direct hire revenue and a decline in Flex margins. Overall SG&A expenses as a percentage of revenue, as…

[Operator Instruction] Your first question comes from the line of Mark Marcon from Baird. Please go ahead.

Hey, good afternoon, and thanks for taking my questions. David, Jeff, congratulations on the well-deserved promotions. Joe or David, can you please talk a little bit more about what you were seeing intra-quarter and, you know, the stabilization/slight upturn with regards to the demand that you're seeing in Tech Flex? How broad-based was that? How pervasive is that? How confident are you that, you know, that may end up continuing? And to what extent does the guidance contemplate, you know, potential furloughs, you know, at the very end of December as you have gone through multiple cycles? Typically, end of the year, we do see some companies that do pull back and decide to send all the consultants home. So, wondering, you know, to what extent is there a pad for that to occur?

Yeah. Yeah, Mark, this is Dave. I appreciate the kind words. Thank you. So, you asked a number of questions there so [Technical Difficulty]. So I think maybe a good place to start when we look at Q3 is how we thought about it when we gave guidance about 90 days ago. As we had indicated, we really took a mathematical approach to third quarter guidance, because if you recall, we've been seeing some consistent, albeit small declines in the number of consultants on assignment in the first couple of months for the quarter and or like I should say, the last couple of months of the quarter and then the first month of this quarter. And so our guidance contemplated that to continue. So, we really have experienced some stabilization in the number of consultants on assignment in Technology that really began midway through the third quarter and we saw that continue through the rest of the quarter. You know the number of new assignments and projects that we had during the quarter also was pretty stable. Obviously, new starts activity being lower than it was, you know, during the pandemic. But I think the point here is, the demand as we got into the midpoint of the quarter was very stable versus what we have seen for the, I would say the two quarters prior to that or so, which was a decline. I think also notable, a lot of this stability is coming from clients retaining consultants on assignment. So we saw a very low level of attrition during the quarter. As I think Joe made a comment, they're really indicative of clients we think reaching staffing levels that are kind of minimum levels required to execute on contracts that are really critical. I think increasingly encouraging…

That's great. Thanks for the clarity there, David. And then just shooting a little bit ahead, I'm not asking for guidance, but just, you know, in terms of, you know, broadly speaking, when you think about the pipeline and how it seems to be building out and then thinking about kind of the normal seasonal variations, you know, when people go from Q4 to Q1, typically there is a little bit of a slower start in terms of Q1. We obviously have the payroll reset. What are some of the things that, you know, investors should think about as they think about, you know, modeling ahead beyond the fourth quarter?

Yeah, I think -- Mark, this is Dave again. I'll let Joe and Jeff have any other comments. But, you know, as you rightly point out, right, we typically see at the end of the year project ends that impact the business. I think this year, based upon what we're hearing, I've given you some view of Q4 and what we have seen typical -- typically. I don't think we're seeing anything exceptional relative to a -- I'll say, you know, normal year, so not pandemic years where we saw really net increases. So I think we're contemplating a more typical year-end end picture based upon the visibility we have right now.

And Mark, this is Jeff. I appreciate your comments at the front end of this. The only thing I'd add to that is, when you look at our typical year-end assignment ends in our Technology business over the last three years, and that we were actually going into 2023, they were actually lower in the number of consultants that we lost at the end of the year than they were if you go back to the pre-pandemic period, and then, this is not a crystal ball, you know, trying to forecast that, Mark, we'll get some visibility and clarity as the fourth quarter goes on here. But I think, fair to say, just given the criticality of the technology consultants to these resources and the projects themselves, that the last three years has been lower than what we've historically seen pre-pandemic as far as consultants we retained through the end of the year.

Great. And then, can you talk a little bit about Flex gross margins and just how the discussions are going with regards to, you know, pay bill ratio? And what are you seeing in terms of the pay ratios? Because, you mentioned year-over-year roughly 2% growth, you know, which is slightly below inflation. How are the pay rates going? What is the competition like for the consultants? Do you have more flexibility with regards to managing those? How should we think about the gross margins on the Flex side going forward?

Yes. So, Mark, good. This is Dave again. I think I'd start out by saying in a very positive way, same story, different day, right. So, as you pointed out, bill rates continue to hold up well, still north of $90, as you point out, up a couple of percent. We think that continues to be reflective of a low supply, high demand for highly skilled talent, which is obviously reflective of our bill rate. I made a specific comment, and this has been a consistent comment over the course of the last many quarters, there clearly is an upward bias over the -- in the longer term for increased bill rates given the dynamics in the marketplace and the need for this talent. As it relates to margins and spreads, the spread between bill and pay rates continues to be very consistent. In this slower environment, you know, we did actually see, you know, a slight decline, but as I'd mentioned, that's Healthcare cost related predominantly. So, that spread between bill rates and pay rates continues to be very stable. And the last comment I would make is kind of a reiteration of my prepared remarks is, you know, in the longer term, not atypical in a slow environment as things improve, although sometimes you might see lags, we would typically see some expansion in the longer term. So again, the dynamics are playing out as they have historically here.

Appreciate the comments. Thank you.

Your next question comes from the line of Trevor Romeo from William Blair. Please go ahead.

Hi. Good afternoon. Thanks so much for taking the questions. I will also congratulate Dave and Jeff on their new roles. First, you know, I was just wondering if you might have any insights from client conversations on how IT budgets are trending as we kind of move into the year-end budget cycle and what that might mean for IT project spending for your clients next year?

Yes, Trevor, this is Joe Liberatore. I'd say most of our clients are still in the early terms of locking down 2024 budgets. However, as a whole, what we're really hearing about is kind of flat to slightly increasing budgets over 2023, with an emphasis on projects that are focused to gain efficiencies both internally and externally. Needless to say, there is industries and client-specific drivers which we believe play to our favor with the quality, the diversity of our overall portfolio. But we're seeing budget discussions being allocated a little bit differently than prior years. There seems to be a focus on stretching the dollar to get more out of it. I would say on our end, the good news is, that's really opening up more opportunities for us as clients are no longer exclusively looking at traditional consulting firms due to, you know, the cost differential between with those firms who engage versus a Kforce or firms like Kforce. So, we believe that that provides a lot of opportunity for us with a more efficient options to staffing and solutions within those clients. Does that give you a feel for what you're looking for?

Yes. Thanks, Joe. That was helpful. And then, I guess, you know, to the team's credit, I think Kforce's revenue on the Tech side continues to hold up better than a lot of companies in the peer set. Just wondering from your perspective, are you seeing any notable changes in, you know, market share or competitive behavior across the market? Do you see further opportunity to take market share in this type of environment?

Yes. I think, you know, we've seen some of our competitors are performing well in this, you know, challenging environment as much as we are. And what I would say is probably, you know, we like to see our competitors do well because that's an indication of the overall opportunities in the market. I would say probably not just us, but probably them as well. I think probably more of the market there is coming from the more localized and regional operators than those that have very expanded platform, and, you know, because we continue to see our opportunity pipeline build. As we were moving through Q3 and into the early part of Q4, our existing projects and our strongest pipelines, they've really been in and around application development, around digital transformation initiatives, which often focus on those customer and internal experiences, realizing much of that work also touches our cloud practices which we really like and we're also seeing a lot of things happening from a data standpoint, which also often have cloud requirements within there. Existing projects and pipeline opportunities in the data side are really more traditional. Although, you know, we are starting to see some of the front-end aspects as customers are experimenting with and exploring AI and really setting themselves up to take care of that. So, I think with all that said, we believe we're really focused on those areas where demand is there. Application development, cloud, data, and digital, all continue to be robust areas and really position us well near-term and long-term. So I would say, part of the driver I believe is, we've honed our focus so much over the years and we're focused in those areas where there is so much mission-critical stuff that's taking place, I'm not inside competitors,…

All right. Thanks, Joe. I appreciate the comments.

Sure.

Your next question comes from the line of Kartik Mehta from Northcoast Research. Please go ahead.

Thank you. Good afternoon. So, I was wondering, Joe, just on assignments, you know, if you looked at three months ago, I think you and others had talked about, assignments were just being delayed and not canceled, which was a positive sign. And I'm wondering if you're seeing some of those assignments that, you know, were delayed coming back on, or is it just that your existing customers are feeling a little bit better and spending more money?

Yes, I would say it's probably the latter. We haven't seen any major changes from what we've been seeing earlier in the year in terms of your question. What we're really more so seeing, and Dave and Jeff touched upon this, the retention that we've seen with our consultant base, we have seen a noticeable difference as we move through the third quarter. I would say one of the other things that we've been observing is that our conversions have actually come down. I mean, on a year-over-year basis, our conversions are down roughly 55%. So, what those things really point to me is, you know, in this industry, in every recession or cycle that I've been involved with, the first thing that happens is clients start to exit consultants. Then the next segment is, they start to tighten up on their FTEs and start to align their full-time workforce. And then the third stage is, they start to bring flexible consultants back on while they're waiting for certainty that the economy is off to the races. And -- so we could be seeing some of those earlier dynamics, right. We experienced this last year, I think we had three sequential quarters of negative sequential growth in our Tech Flex business. Historically, if you were to go back to the financial crisis and you would go back to the pandemic, we had two down sequentially. And if our stabilization holds as we put in within our Wall Street guidance, basically here in Q4, we would start to turn positive on a sequential basis. And then what would typically happen after that is, you start to see the expansion as customers start to bring on more and more Flex consultants. So, I mean, I don't have a crystal ball. I don't know where the ultimate economy is going, but, I mean, I'm just looking at history versus the [Technical Difficulty]. So, we kind of see this cycle has started to play out similar to prior cycles.

No, that's helpful. You know, the last quarter or three months ago, you know, you weren't the only Company, almost every company that was in temporary staffing and others talked about the uncertainty in economy and I don't think that uncertainty has gone away, at least not from some of the comments you've made. But just out of curiosity, based on your experience, what do you think -- what changed do you think that where companies are feeling a little bit better about spending money or is it the type of projects? What do you think has changed from three months ago when you gave guidance to today where you do sound a little bit more positive?

Yes, I would say and again, you know, just in listening to our people and what they are experiencing inside the clients and the client feedback, you know, and again, I've seen this every cycle, people cut too far and now they can't get the mission-critical work done that has to be done. And we could be seeing some of those things that are unfolding here, which is why, and this isn't just Kforce, I mean, if you listen to our competitors that have announced prior to us, you are hearing about a general stabilization on the technology front and that's typically what happens when they go a little bit too far, because you got to realize, the amount of backlog of projects and it's not the nice to have projects, it's the must-do project. And when you start to cut, those things start to now get impacted on those projects that have to be moved forward. So, I think that that's what really creates this stabilization that's going on. So if anything were to change, I would say basically it's the pain points that organizations are feeling on having to get some of these projects moving and some of them over to gold line.

Thank you very much. I really appreciate it.

Sure.

Your next question comes from the line of Marc Riddick from Sidoti. Please go ahead.

Hi. Good evening, everyone.

Good evening, Riddick.

I wanted to first say congratulations, Dave and Jeff, as others have said, congratulations on the roles, and certainly looking forward to continuing to move forward there. I just wanted to follow up, piggyback on one of your comments earlier, Joe, about the, you know, the customer behavior that you had and I really appreciate all the color that you've already given. I was wondering if you're seeing from a sense of, are there sort of industry customer segment leaders that are kind of further along that process of sort of making that turn that you're seeing or are you generally seeing that across the board?

Yeah, Marc, so that's a bit of a difficult one. Obviously, we mentioned, there are a number of industries, right, Financial Services, for example, or Healthcare, Retail that have got some headwinds, right. But again, to Joe's point, those mission-critical activities are what market leaders need to do to stay leading in the marketplace. Obviously, there are other industries maybe a bit more conducive in a more positive environment. I'd mentioned Transportation, right? You're hearing about what's happening with Travel, Utilities. Those are industries that we've had, relatively speaking, better performance in. But I don't know that there is any specific industry or industries that are notably different from any other, right. As I said, the market leaders of every industry are thinking critically about what is necessary to maintain -- stay on top.

Okay. And then the last one for me, actually, is just around, I wonder if you could sort of share some thoughts on candidate availability and maybe what you're seeing, if there are certain pockets where that's starting to loosen up a little bit, or, you know, versus maybe some others where it's extraordinarily, you know, about I guess maybe it's the same or maybe more difficult to find the type of candidates that you're looking for. Thanks.

Yes. I would say that, again, you know, and especially in the technology areas that we play in, which are the highest demand areas, you know, candidates are always hard to come by. They've been hard to come by for as long as I've been in this industry. The segments have changed, the skill sets have changed, but we've always focused in those areas of highest demand. So, I mean, again, this is why I go back to [Technical Difficulty) if somebody ever asked me what is your number one core competency? It is the ability to go out and identify the best candidates available in the market, bring them to our clients in a timely fashion, and engage them. So, you know, that's one I -- that's one that really doesn't change for us over time. I will say one of the dynamics that has changed over the course of the last year is probably the amount of competing offers those individuals have on their table, you know, obviously. So that helps a little bit in terms of when we do have a client that's interested, our ability to engage that consultant with that client because we're not dealing with competing offers, right. If you were to go back into that very robust 2021, 2022 time period, there were a lot of individuals that our customers wanted to engage, but they elected to pursue another opportunity just because there was so much demand out there. You do see less of that. We also see people more probably considerate in terms of those opportunities they'll want to look at in these types of clients, which means, when you do engage with consultants that are in the marketplace and they're looking to make a move, they're much more serious about it because they're not going to take risks in a little bit more of an uncertain climate. Those are the kind of dynamics that we deal with more versus availability of candidates.

The other thing I -- the only other thing I would add, right. So, it always comes out in the numbers, right, being a former CFO, both Joe and I, bill rates and pay rates continue to rise, right. So, if there was a dislocation in an availability of talent, you would see it in what clients are willing to pay and what candidates are willing to accept.

Great. Thank you very much.

Sure.

Your next question comes from the line of Josh Chan from UBS. Please go ahead.

Hi, good afternoon, and congrats to Dave and Jeff as well. I guess my first question may be a bigger-picture question. So, it sounds like you are -- you sound better and are guiding for some improvement into Q4. At the same time, you mentioned that economists expect a recession next year. So, how do you think Kforce would perform, hypothetically, if there is a recession coming, are we at a bottom anyways from a needs perspective and therefore a recession won't really impact you that much from here on?

Yeah, and it's, right, and again, going back to, you know, every one of these cycles is different. Every one of them is unpredictable, they react differently. Probably to answer that question, it would be what type of a recession? Meaning if it was short and shallow, been in this industry before where we've been experiencing things like we have been, which is revenue deterioration and recessions hadn't been called. And by the time a recession is called, actually, our Flex business was moving in a positive direction by the time a recession is called. By no means am I saying that is what's going to happen this time, but we have seen that in prior cycles. So, it really just depends upon the nature of what that recession is, you know, how deep, how long, how short, how shallow. It's that equation that's going to give us the answer to the question that you're asking, which we don't have a crystal ball. And again, we get economists information from some of the highest respected economists on a weekly basis and we pay attention to those dynamics. It's a matter of, hopefully, this will be a soft landing. If it's a soft landing, absolutely, we might have seen the worst behind us. If there is a second step to this because of how the economy reacts and how clients react, you know, there could be another leg down and I really honestly do not know the answer to that question or I probably wouldn't be sitting here on this call, I'd be sitting on an island somewhere. But at the end of the day, it comes down to the confidence in our management team to navigate. Irrespective of which one of those scenarios played out, we are positioned and we will navigate through it.

Okay. Yes. I appreciate the color, Joe, that makes a lot of sense. For my second question, normally this doesn't have a big impact, but it looks like the Tech Direct Hire softened sequentially. Was that a function of the macro environment or your restructuring actions? You know, what's driving that?

Yes, just, yes, the simple answer is, absolutely it was the macro environment, right. When you -- Joe touched on it earlier, right, direct hire is typically as we go through these cycles, the part of our business that will suffer most. It's quite frankly that volatility is part of the reason why we are now 97% Flexible in project solutions because of the volatility there. But yes, it is a macroeconomic impact that's driving it.

And Josh, I think, you know, part of the reason why Joe went through the history of what we typically see in the cycles, I think that's part and parcel to where Joe was just going, not only from a conversions and what we were seeing within our Flex revenue base, but also the trends that we were seeing on the hiring of permanent staffing versus the trends that we saw in our Flex business and Technology being very stable mid-quarter through the end of the quarter and actually starting to improve, albeit modestly, but improve to start October. That's directly in line with where Joe went about it in the last couple of economic cycles.

That makes a lot of sense, Jeff. Thank you very much for you guys' and time.

Thanks, Josh.

Thanks, Josh.

[Operator Instructions] Your next question comes from the line of, I'm sorry, we have no further questions in our queue. I will now turn the call -- I'm sorry, we do. Your next question comes from the line of Tobey Sommer from Truist Securities. Please go ahead.

Hi. This is Jack Wilson on for Tobey. Just when we think about AI as a long-term driver, is that mostly going to show up in demand for cloud and data work or do you have a direct exposure to sort of AI demand?

Yes, it's a great question, and obviously one that everybody is paying attention to. In fact, I think it was the International Data Corp Group, they just came out with, you know, basically predicting $16 billion of worldwide GenAI solutions in 2023, you know, which is really in and around software, related infrastructure, hardware, and IT business services. And by the way, they expected that to reach $143 billion in 2027. What we're seeing from our customers is, we're very much in the early innings where clients are preparing and experimenting and have yet to really make any substantial investments. I mean, there remains also, by the way, much to resolve around pricing, privacy, security, and government interventions. You know, in fact, as we heard today, right, with the US government's first action with a -- an AI executive order. But at the end of the day, yes, you cannot do AI if you haven't addressed the data aspects, and that's why data has been front and center. It's one of our four core offerings. So, that's where we are seeing things. Everybody is working on cleaning up their data because you are not getting anywhere with AI if you don't have pristine and pure data. You know, it's the old garbage in, garbage out. And obviously with everything moving towards the cloud, they both play, which is another one of our core service offerings. So we like how we're positioned. As AI investments continue to ramp up, we think our teams are very well-positioned to take advantage of that.

Yes, thank you for that color there. That's very helpful. Then just sort of more from a modeling perspective, is that $14 million in annual cost savings achievable, sort of regardless of what the economic picture looks like in 2024?

Yes, I think, Jack, the point we gave is, you know, obviously, in our second quarter call, so you know, we're sitting here in an economic environment that's a bit challenging. The structural cost reductions that we implemented back in July started to benefit the third quarter. We anticipated that when we issued third quarter guidance. The full amount of the quarterly benefit in the fourth quarter would be realized. So you got, effectively, one-third additional benefit that would be realized in the fourth quarter compared to the third. But the short answer, Jack, is yes. Irrespective of the economic environment, you know, we would expect those annualized benefits.

Perfect. Thank you so much. I'll turn it over.

Thank you, Jack.

We have no further questions at this time. I will now turn the call back over to Joe Liberatore for closing remarks.

Thank you for your interest in and support of Kforce. I'd like to say thank you to every Kforcer for your effort and to our consultants and clients for your trust in Kforce in partnering with you and allowing us the privilege to serve you. We look forward to talking with everyone again on -- after our fourth quarter of 2023. Have a great evening. Thank you.

This concludes today's conference call. Thank you for your participation and you may now disconnect.