Michael R. Blackman - Chief Corporate Development Officer David L. Dunkel - Chairman and CEO Joseph J. Liberatore - President David Kelly - CFO.

Kevin D. McVeigh - Macquarie Mark S. Marcon - Robert W. Baird Anjaneya Singh - Crédit Suisse Randle Reece - Avondale Partners Ato Garrett - Deutsche Bank.

Good day, ladies and gentlemen, and welcome to the Kforce Inc. Third Quarter 2014 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, Michael Blackman, Chief Corporate Development Officer. You may begin..

Thank you. Good afternoon. Welcome to the Kforce Q3 2014 earnings call. Before we get started, I 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 CEO.

Dave?.

Thank you, Michael. You can find additional information about Kforce in our 10-Q, 10-K and 8-K filings with the SEC. We also provide substantial disclosure in our release to assist in better understanding our performance and to improve the quality of this call.

We are very pleased with our performance in the third quarter as revenue and earnings per share, excluding non-recurring charges, were at the high end of our expectations. Strong growth across all of our business lines contributed to Q3 revenues of $313.8 million which is a 12.1% increase year-over-year.

Earnings per share from continuing operations of $0.25 included $2.4 million of non-recurring charges related to identified efficiencies that will benefit the firm's future earnings. Adjusted for these items, earnings per share from continuing operations was $0.30 which is a 30.4% increase from Q3 2013 earnings per share of $0.23.

Against the backdrop of tempered economic growth, demand for flexible staffing in both Technology and Finance and Accounting continues to be robust. We continue to see a disproportionate share of job growth coming from the temporary staffing sector as evidenced by another record high of 2.1% in September for the BLS temp penetration rate.

Staffing industry analysts expects the market for Tech Flex to grow 7% in both 2014 and 2015, and Finance and Accounting market to grow 5% for both years.

Our strategy over the past two years has been to simplify our business to focus on our core offerings and accelerate investment in revenue generating resources to build the model that drives sustained double-digit revenue growth.

We have accomplished this organically with our last acquisition occurring in December 2008, thus avoiding integration related distractions. At the same time, we have made significant progress in optimizing our infrastructure through identification of efficiencies that have significantly improved operating margins.

Shareholders also continue to benefit from our aggressive stock repurchase activity. During the third quarter, we repurchased an additional 1.9 million shares for $38.5 million and are on track to deploy the roughly $70 million of net cash proceeds from the HIM divestiture by the end of Q4.

The activities in Q3 to reduce future costs coupled with our share repurchase efforts should allow us to roughly recapture the EPS lost through the divestiture of HIM by the end of Q4, two quarters ahead of our target.

We continue to execute on our strategy and remain on track to achieve operating margins of 7.5% at $1.6 billion in annualized revenue.

I will now turn the call over to Joe Liberatore, Kforce's President, who will provide further details on our Q3 operating results, while Dave Kelly, Chief Financial Officer, will follow and add further color on our Q3 operating trends and financial results as well as provide guidance on Q4 expectations.

Joe?.

Thank you, Dave, and thanks to all of you for your interest in Kforce. I'm very pleased to see another quarter of strong results delivered by our team. All our businesses are contributing to our success.

Tech and FA Flex has grown well in excess of industry averages, Search remained stable, and our Government business has now achieved three consecutive quarters of sequential growth and is a contributor to the firm's year-over-year growth, a trend that we expect to continue in Q4. Our priorities have been consistent in this New Era of Kforce.

Developing our premier partnership with our clients, striving to be the employer of choice for our consultants and employees, and enhancing and optimizing our revenue enablement support, these efforts are gaining traction and I believe we've laid the foundation for continued success.

Tech Flex staffing, our largest business unit, grew revenues 3% sequentially and 12.4% year-over-year and in line with our expectations. New starts activity and job order flow remain at high levels and strengthened significantly in September.

Demand is strong across most industries with our top five being financial services, communications, health services, insurance, and computer manufacturing, which continued to outpace our average 12.4% year-over-year Tech Flex growth rate.

Intra-quarter trends for Tech Flex revenue showed a decline in July driven by the end of two large projects at the end of Q2. August was generally flat. It was followed by growth acceleration in late September and into early October.

We anticipate Q4 revenues to be up on a billing day basis sequentially and year-over-year growth to be in the low double-digits. Based upon our current pipeline, we're confident that this year-over-year growth rate will be sustained into Q1, at which point year-over-year revenue trends could reaccelerate towards our 15% target.

Revenues for our Finance and Accounting Flex business represent 20.5% of total firm revenues. Q3 revenue growth accelerated to 7% sequentially and 17.3% year-over-year. This business is also experiencing strong starts volumes and job order flow.

Contributing drivers to the year-over-year success are expansion in healthcare project revenue and increasing financial services revenues, both of which in the National Recruiting Center position us to maximize. Finance and Accounting is also seeing a diverse mix of large and medium sized clients contribute to the current success.

Intra-quarter revenues grew in July, flattened in August and then accelerated late in September and into early October.

We're benefiting from investments in management and our operating model adjustments made in this business over the past two years to diversify our customer base and capture market share, and we expect Q4 Flex revenues to be up on a billing day basis with year-over-year growth to maintain and possibly grow from current levels.

Revenue increases for the third quarter for our Tech and FA Flex businesses were driven from the diverse blend of clients. Our top 25 clients contributed 35.9% of total revenues, an increase of 150 basis points year-over-year from 34.4% in Q3 2013.

Our well above market growth rate suggests that we have been successful in taking customer share within our largest clients as we continue to invest to further delight these key customers.

Our service capability is firmly enabled by our National Recruiting Center including recently opened location in Phoenix which is better situated to serve our Western U.S. client needs. Revenue for Kforce Government Solutions increased 3.5% sequentially in Q3, up for the third consecutive quarter and are now up 2.7% year-over-year.

We're proud of this team's success in both the service and product spaces as it works through the ongoing challenges within the federal government.

We anticipate revenues to be up again in the fourth quarter sequentially and to further acceleration in year-over-year growth with steady performance in services revenues assumed and a delivery of a large order in Q4 that will significantly increase product revenue in the quarter.

Looking forward into 2015, we expect our Government business to positively contribute to the firm's revenue growth as we have a solid base of both services revenue and product order backlog. Year-over-year growth in the low double digits is a possibility though the mix between services and product revenue may vary.

The award on the re-compete of our largest contract has been delayed until early 2015 and should therefore not impact forecasted revenues in Q4.

As we stated last quarter, our long-term relationship with this customer and the government's desire to bundle additional services into the new award may provide significant opportunity for future revenue growth when this contract is awarded.

We have historically had success in the re-competes and we believe we are very well positioned with this customer. However a loss of this contract could impact future revenues. Search revenues from direct placement and conversions declined 0.7% sequentially but increased 2.9% year-over-year.

Our objective is to meet the talent needs of our clients through whatever means they prefer and providing a meaningful capability to deliver resources through permanent placement will remain important in meeting those needs. In Q3 2014, Search was 4% of total revenues versus 4.3% in Q3 of last year.

We expect Search as a percentage of total revenue to continue to decline but be relatively stable from a dollar perspective as we move forward. Q4 is typically a slower quarter for starts, so we expect a slight decline sequentially but revenue level similar to last year. Revenue generating headcount increased 2.6% year-over-year in Q3.

We continue to invest in additional revenue-generating performer growth and anticipate year-over-year growth rates to accelerate in Q4 to more recent levels, though they continue to be below revenue growth rates.

63% of our revenue-generating population remains in the tenure range of less than two years, so we believe capacity exists and significant opportunity to improve productivity remains as our new hires become more experienced.

The results being delivered by our New Era strategy are aligned with our expectations and we remain excited about our prospects for future revenue growth well in excess of market trends and attainment of our operating margin objectives.

I will now turn the call over to Dave Kelly, Kforce's Chief Financial Officer, who will provide additional insights on operating trends and expectations.

Dave?.

Thank you, Joe. Total revenues for the quarter of $313.8 million increased 3.7% sequentially and 12.1% year-over-year. Our Flex staffing revenues collectively grew 13.5% year-over-year and our Government business increased 2.7% year-over-year. Search revenues of $12.5 million increased 2.9% year-over-year.

For the first three weeks of Q4 on a year-over-year basis, Finance and Accounting Flex is up 19.8% and Tech Flex is up 12.4%. Search revenues are up 8.1% year-over-year for the first four weeks of Q4. It's difficult to assess potential full quarter results with this limited data but we expect continued strong year-over-year growth in Q4.

Third quarter net income and earnings per share were $65 million and $2.06 respectively. These results were impacted by the $56.1 million net gain on the sale of our HIM business.

Income from continuing operations was also impacted by $2.4 million in pre-tax non-recurring charges related to determination of post-retirement healthcare obligations, severance related to organizational changes that will improve future operating efficiencies and an inventory adjustment related to the KGS product business.

Adjusted for these three items, Q3 2014 net income and earnings per share from continuing operations were $9.4 million and $0.30 respectively compared to $8 million and $0.24 per share in Q2 2014 and $7.6 million and $0.23 per share in Q3 2013.

Gross margin in Q3 was 31.3%, which is up 10 basis points sequentially and down 120 basis points year-over-year. Flex gross profit percentage of 28.5% in Q3 increased 30 basis points sequentially and declined 100 basis points year-over-year. This sequential increase was primarily due to a reduction in payroll taxes.

Bill pay spreads have been stable in 2014 and the year-over-year decline in Flex margins is primarily due to a change in client mix as larger clients which have slightly lower margins have grown at a faster pace than the rest of the portfolio over the past year.

Specifically, Tech Flex spreads have declined 60 basis points year-over-year while FA Flex spreads have generally been flat over the same period. Looking forward, we expect Flex spreads to continue to be stable.

Q3 SG&A excluding the previously mentioned non-recurring charges decreased 40 basis points to 25.5% of revenues from 25.9% in Q2 and it declined 140 basis points from 26.9% in Q3 2013.

The non-recurring charges taken in Q3 are the result of an accelerated effort to identify roughly $1.5 million in future quarterly SG&A savings to ensure we maintain progress towards our operating margin objectives. As of September 30, we have already identified all necessary savings to meet our target.

Q4 should benefit by approximately $400,000 in savings and Q1 by over $1 million, and we expect to fully realize the entire amount of savings by Q2 2015. As we look at our balance sheet and cash flows, our accounts receivable portfolio continues to perform well and write-offs remain at low levels. Capital expenditures for Q3 were $1.7 million.

Bank debt at the end of the quarter was $12.7 million as compared to $81.7 million at the end of Q2. The decrease was attributable to the cash derived from the sale of HIM. However, we were extremely active in the repurchasing of our stock during Q3 and into Q4.

Total stock repurchases in the third quarter were 1.9 million shares for a total cost of $38.5 million. We've repurchased an additional 800,000 shares for approximately $16.2 million so far in Q4 and are on target to deploy all net cash proceeds from the HIM transaction for stock repurchases by the end of Q4 based upon current volume.

Our repurchase activity contributed approximately $0.01 to earnings per share in Q3 and is expected to contribute an additional $0.02 to earnings per share in Q4.

Once the Q4 repurchases are complete, we will have deployed approximately $79 million in the second half of 2014 to repurchase 3.9 million shares which represents approximately 12% of shares outstanding. This should improve annual EPS by approximately $0.16.

With the combination of our share repurchases and the additional operating efficiencies we've identified, we will recapture roughly 100% of the $0.28 of annual EPS lost from the HIM transaction by Q1, and are on track to meeting our long-term operating margin targets.

With respect to guidance on continuing operations, the fourth quarter of 2014 has 62 billing days compared to 64 billing days in the third quarter of 2014. We expect Q4 revenue may be in the $316 million to $322 million range and for earnings per share on continuing operations to be between $0.30 and $0.32.

Gross margins on continuing operations are expected to be between 31% and 31.2%. SG&A as a percentage of revenue is expected to be between 25.4% and 25.6%. Operating margins are expected to be between 4.7% and 5%. Our effective tax rate in Q4 is expected to be 39.3%.

This guidance assumes continued share repurchases in the quarter resulting in weighted average diluted shares outstanding of approximately [29.4 million] (ph) in Q4.

This guidance does not consider the effect, if any, of charges related to the impairment of intangible assets, any one-time costs, costs related to the settlement of any pending legal matters, the impact on revenues of any disruption in government funding, or the firm's response to regulatory, legal or tax law changes.

We plan continued investments in revenue generating headcount and secular drivers in professional staffing to remain positive in our core business lines. Our targets for operating margin appear to be within reach and we continue to explore opportunities for driving shareholder value. Nicole, we'll now open the call for questions..

(Operator Instructions) Our first question comes from the line of Kevin McVeigh of Macquarie. Your line is now open..

Really nice job in the quarter.

Wanted to get a sense, you're holding the 7.5% EBITDA and obviously having sold the HIM business that was more profitable, where is the target relative to the [delta] (ph), is that the stronger [indiscernible] margins or mix of business or can you help us understand that?.

Sure, Kevin, this is Dave Kelly. As we look forward, our expectation as we stated is for our Flex margins to be stable. We've seen that to be the case for the last three quarters.

So the key to our ability to drive those improved margins is really two-fold, it's related to the leverage in our infrastructure and the operating efficiencies that we continue to identify as we continue also to reallocate resources toward revenue generating activities, as well as, as we move forward leverage in our model around our tenured performers as they continue to gain tenure in our system, their productivity improvements and therefore the effective commission rate that we pay will continue to decline.

So it's really those two pieces that are both in the SG&A line..

Got it.

And then would there be any benefit from kind of lower shooter as we think about 15 into 16, or would that be incremental upside as opposed to how we should think about modeling the business?.

So, Kevin, about 70% of our business is in Tech and as we talked about in the past, supply is pretty low in that and unemployment is very low. So our expectation here is that opportunity in [indiscernible] is very minimal.

The other thing I'd add is we look forward because in the Tech business offering major medical insurance is important, it's something we have offered for years, the impact for us in the healthcare law changes, Obamacare, is not also expected to have a negative impact either. So we're looking at a stable gross margin profile unless things change..

Interesting. And then just one another if I could. It's pretty impressive how some of your larger clients seem to be expanding the type of projects that they are doing.

Any sense of scope of projects and is it just incremental step-up of existing budget or is it just more budget coming on, is it you're feeling better about things or just any thoughts on kind of small versus your larger client base?.

Kevin, I'd say there's really two dynamics that are happening. I think our growth, the most significant impact to our growth is capturing greater share of our client spend.

Where we're seeing them really invest is broad-based, and kind of the way I put it, we're seeing a little bit more investment in systems of engagement which are the ones that are really reaching and touching the customer, versus the systems of record which are your traditional ERP type applications.

So we're seeing a little bit more disproportional spend on those system of engagement side which happens to be the area where we've participated and played extensively for a number of years now..

Awesome.

Then my last question and I'll jump off, the incremental SG&A pickup, is that from legacy HIM cost or is that in other parts of the organization where you were able to find some incremental synergies?.

It's really an investigation of the model that considers that change, so really both. Because we're simplifying the business and getting rid of HIM, there's opportunities to simplify the infrastructure there.

And additionally as I said, we're always challenging what we're spending and the value it's adding to driving revenue and we're identifying opportunities there as well generally..

Awesome. Thanks guys. Nice job..

Our next question comes from the line of Mark Marcon of RW Baird. Your line is now open..

Good afternoon and let me add my congratulations.

With regards to the IT Flex gaining a greater share of wallet, can you talk a little bit about some of the enhancements that you've put in place and what you're seeing with regards to fill orders and enhanced recruiting capabilities?.

Mark, this is Joe. Really it's been broad-based and this isn't a model that we've just changed overnight.

We've been evolving our model for the better part of last 12 years and I would say I would attribute a lot of it to the stability of the leadership infrastructure that we have in play, that's where we're really starting to see the by-products come about right now in terms of just the focus, the execution, the accountability driving through the narrowed focus of our customer base to go deeper and wider and those customers will realign well from a partnership standpoint, coupled with our ability to move out into just the general staff [indiscernible] business, I mean into the statement of work because we're seeing that space expand as things are moving away from more turnkey solutions, so that's playing very well to our footprint as well..

Great.

And then can you talk on the KGS side, you had a really nice sequential increase, what drove that?.

KGS, what we're seeing in KGS is our services side of our business has been stabilized. So the teams have done a really nice job there.

We had some pickup in some of our larger contracts with some additional resources going on those contracts, so we saw the benefit of a little bit of that in the quarter and then we saw some product revenue increases in the quarter on a sequential basis..

Okay.

And then if you could provide a little more color just in terms of how we are thinking about the level of revenue growth that we would need in order to achieve the 7.5% in EBITDA margin target, can you give us a little more color there just as we think about that, because you've had some pretty nice – it clearly is going to come as a result of SG&A leverage, how much of that is a function of some new initiatives that you've put in place to reduce the SG&A versus how much of it is going to be just getting some additional leverage and what sort of incremental EBITDA margins are you looking at?.

So, Mark, a number of questions there, so as we stated before, we expect to get to that 7.5% still at about $1.6 billion in annualized revenues. Along the way we've stated the belief that 6% plus operating margins at $1.4 billion is attainable. We still believe that is in fact the case.

I think the efforts that we undertook in the quarter really accelerating those things puts us ahead of our targets in terms of timing. So we're very confident that as we look at the infrastructure here, that we're well on the path to getting there..

Great, thank you..

Our next question comes from the line of An Singh of Crédit Suisse. Your line is now open..

I was wondering if you can talk a little bit about your revenue generating headcount. I know you expect it to increase in the back or in the remainder part of the year.

I'm just wondering with regards to the Q3 growth that was in the low single digit range, is there anything that you're seeing that ended up in the low single-digit range and do you still anticipate the full year to roughly end around 10% growth that you guided to?.

Our goal remains the 10% on a year-over-year basis, and I think as I mentioned on last quarter because we were on the other side of that equation last quarter because our headcount was up 12.4%, I mean unfortunately it's not a precise game, so our objective is we're constantly focused on the attraction and the retention of our people.

So over time we do believe we will hover in that 10% range. So that's what I was really referencing in my opening comments as we see moving back closer to that 10% range in Q4..

Got it. And then I know you cited bill pay spreads to be stable in the quarter.

I was wondering if you can give us any insight as to how the bill pay spreads at the large clients are trending say over the past four or five quarters versus the rest of your business, is it rather similar or are there any differences that you can call out?.

I would say what we've seen over the course of the last eight quarters is we've actually seen a migration towards the mean. What I mean by that is, we've seen bill rates accelerate at a little faster rate at our larger clients moving closer to the spot market rates.

I think we're only dealing with about 5% difference in bill rate between our spot market business and our strategic account business at this point in time. And we've seen similar dynamics with pay.

We've actually seen some of the pay accelerate at a little bit faster rate at those strategic accounts as well bringing those people more into competitive pay ranges..

Got it. And one final one, if I may, I was wondering if we can get some insight on the average assignment length that you've seen in this cycle.

I know the project oriented nature of Tech Flex specifically tempers the perm growth, I'm wondering if you're seeing more employer confidence translate into longer assignment plans and if that's giving you any more visibility in your business?.

I think it hasn't materially changed. Historically from a Tech Flex standpoint, the average duration has roughly been about six months on average, Finance and Accounting it's typically a 13 week type assignment on average.

I would say, as this cycle has continued to mature, we have seen a little bit of expansion on average assignment in our Tech Flex product line but I think that's just indicative of the nature of the project..

Okay, that's all for me. Thank you..

Our next question comes from the line of Randy Reece of Avondale Partners. Your line is now open..

Beautiful numbers. Let me specifically drill down on Finance and Accounting. What on earth is going on in the world? Seems like demand has really taken off and it feels like it's coming from more than a couple of sources..

Randy, I think what you said is true. I mean we were seeing what we consider the transactional accounting, your typical APA, our collections we've seen an increase in that space as well as we've seen an increase in our project business specifically within healthcare and financial services.

We're more excited about the expansion in those areas because they really align well with our national recruiting model and allow us to maximize those opportunities..

So when you have FA taking off the way it has, how does that affect your internal resource allocation and your need to change hiring plans if at all?.

We have a philosophy, we feed the strong.

So the operations that perform, those are the operations that we are allocating additional headcounts, and when we look at our projected annual net increases, as you see FA disproportionately outperformed, we are pushing a little bit more of our hiring needs into that area because again our objective is to drive sustainable 15% year-over-year growth model, so that's both in Finance and Accounting and Technology..

So it looked like in Tech that perm was stronger than I had anticipated.

Have you – you've generally had a philosophy if I'm not misspeaking to kind of let that follow the market without you trying to push it especially, but was there a reason why Search was particularly strong in Tech this quarter?.

It's actually the reason – after doing this for 26 years, I'll tell you there's only one thing that's more satisfying than really completing the right match for a contract assignment, and it's actually completing the match from a contract assignment that leads to permanent employment.

So we actually had a little bit of increase in conversions in the quarter, which is part of our model, which is why we basically blended the model together from a perm and from a flexible standpoint specific to the technology area because the skill areas and the individuals we work with are very similar, so we just had more friends at Kforce go to work at our clients..

Very nice. Thank you very much..

Our next question comes from the line of [Paul Pinocchio] (ph) with Deutsche Bank. Your line is now open..

This is actually Ato Garrett on for Paul. So looking at the results that were just mentioned about the strong trends you have for Search within Technology, just thinking about how that might play into pay rates themselves.

Previously you mentioned that bill pay rate spreads are pretty constant, but can you talk about just the growth rates of pay rates themselves?.

I mean we're seeing them move kind of in concert especially here in the last couple of quarters. So we don't anticipate any major divergence at this point in the cycle that we're going to see pay rates accelerate faster than bill rates are moving up now.

As those move up, the one thing that I don't want to fall short on is, when those two things stay constant, the GP dollars per hour are going up as well which again plays into our 7.5% operating mark..

Right, but are they growing I guess closer to 2% or closer to 5%, is it more of a low single-digit or a mid single-digit growth rate, if you could get that specific?.

From Tech or Finance and Accounting?.

For Tech please..

So Tech average bill rate when we look at the sequential up about 5.1%, and when we look at the average pay rate up 6.1%..

So that, Ato, is actually a little bit greater than we saw the last quarter and the quarter before that, and that is a year-over-year number actually..

Great. Thank you very much..

Thank you. I'm showing no further questions. I would like to hand the call back to Mr. David Dunkel, Chairman and CEO, for any closing remarks..

Thank you. I want to first of all say it's the first time in my career I have not had to answer a question, and so that's a real tribute to these guys, they've done a fantastic job. So, Joe and Dave, thanks for that. I get the rest of the night off.

So for all of you on the call, we appreciate your interest and support for Kforce and I would again like to say thanks to each and every member of our field and corporate teams and to our consultants and our clients for allowing us the privilege of serving it. Thank you very much..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Have a great day everyone..