Good day, ladies and gentlemen, and welcome to the Q4 2018 Kforce Incorporated 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 be given at that time. [Operator Instructions] As a reminder, this conference call maybe 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 morning. 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 Securities and Exchange Commission. We cannot undertake any duty to update any forward-looking statements. I would know like to turn the call over to David Dunkel, Chairman and Chief Executive Officer.

Dave?.

Thank you, Michael. You can find additional information about this quarter's 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.

As I reflect on 2018, and in particular, the strong results we delivered in the fourth quarter, I am immensely proud of what our team has accomplished. During the course of the year we made significant progress in building our Tech Flex business.

We have deepened client relationships, and, in many cases, we have become a trusted advisor in helping companies meet their ever-growing technology needs. We have also continued to invest in tools that should further strengthen our capabilities and generate additional productivity from our associates.

These investments included continued enhancements to our CRM and our Business Intelligence platform. A key technology initiative in 2019 will be the initial rollout of our Talent Relationship Management system, which we expect to go live late in the year.

We have also continued to incorporate other technologies into our processes, which could further enhance our capabilities. We expect the pace of change from a business model and technology standpoint to continue and we believe that we, like virtually every organization, need to maintain high levels of technology investment for the foreseeable future.

In addition to accelerating revenue growth, we have also significantly improved profitability and generated significant cash for our shareholders. Total revenue of $1.42 billion in 2018 grew 4% year-over-year.

We were also able to expand operating margins by 80 basis points and generate earnings per share of $2.30, which is a 46.5% improvement year-over-year.

Our strong cash flows in the year and positive outlook allowed us to not only continue to return cash to our shareholders through stock repurchases, but to also increase our quarterly dividend midway through the year to $0.18 per share.

All told, we returned $31 million to our shareholders through repurchases and dividends while also reducing debt by $45 million. Fourth quarter revenues of $358 million meaningfully exceeded our expectations and earnings per share of $0.65 exceeded the mid-point of our guidance by $0.08.

The demand environment continues to be very constructive and our outlook for 2019 is quite positive. As to the macro economic environment, significant market volatility and political uncertainty has persisted.

Contrary to the concern that we might be late in the cycle however, the strength and recent employment reports point to the increasing need for skilled talent. Trends in our business as well as others in our space support the notion that secular drivers in technology will transcend traditional cyclical patterns as business models are transformed.

Non-traditional competitors are entering new end markets, thus putting increased pressure on companies to invest in innovation and evolve. Big data, artificial intelligence and machine learning continue to be in high demand, as well as cloud computing, cyber-security, mobility and digital marketing.

These rapidly changing technologies are also impacting staffing as new tools become available and non-traditional competitors enter the industry.

At Kforce, our strategy is to embrace technologies that will enable our associates to focus on serving our customers with trusted relationships and where appropriate, selectively invest in these technologies.

We believe that technology will facilitate enhanced productivity and improve customer service in the sophisticated and complex world of professional and technical staffing.

In both the $30-plus billion market for technology staffing and the $100-plus billion market for IT solutions, where staffing companies are increasingly gaining a foothold there are limited providers with the infrastructure to not only provide quality and timely talent at scale, but who also meet increasingly stringent compliance requirements.

These represent significant competitive advantages in today's war for talent. It's people serving people. Before I turn the call over, I would like to share my deepest appreciation for the hard work done by all of our associates for the past year.

I am proud and humbled to work side-by-side with these talented people who are dedicated to daily meeting the needs of our clients and consultants. I'll now turn the call over to Joe Liberatore, President, who will give greater detail into our operating results and trends.

And then Dave Kelly, CFO will add further color on fourth quarter results and provide guidance on Q1.

Joe?.

Thank you, Dave, and thanks to all of you for your interest in Kforce. Our results in the fourth quarter, particularly in Tech Flex, reflect a continued strong demand environment and success from our efforts to optimize the alignment of our sales and delivery talent within our client portfolios.

Overall revenues in the fourth quarter meaningfully exceeded the top end of our guidance, driven primarily by Tech Flex, which grew 9% on a year-over-year basis. Our growth rate in Tech Flex continues to be more than double the industry average and is expected to continue or slightly accelerate into the first quarter.

In Tech Flex, we experienced fewer assignment ends than anticipated and an increase in average hours worked, as clients are looking to hold onto and maximize the availability of these highly skilled scarce resources.

An additional indicator of the strength of demand were the higher than normal levels of new assignment starts experienced later in the fourth quarter, which is typically a slow period for new activity.

These trends provide us with good momentum going into the first quarter of 2019 and suggest that year-over-year growth rates may accelerate and may exceed 10%, despite increasingly difficult comps.

We continue to make necessary adjustments to align our sales and delivery talent within our client portfolio which is contributing to both improved revenue growth rates and associate productivity. Fortune 1000 companies continue to be the largest consumers of Flexible Technology talent.

Our revenue growth over the last several quarters has been largely a result of our broader diversification efforts beyond our largest clients and deeper into other Fortune 1000 customers where we have established relationships.

This focus on significant users of flexible staffing services has better enabled us to understand the technology issues and craft solutions for these sophisticated and substantial consumers of our services. From an industry standpoint, we experienced growth in 9 of our top 10 industries.

The growth was broad based, but strongest in Technology, Financial Services, Business Services and Manufacturing. Our FA Flex business, which represents roughly 20% of overall revenues performed consistent with our expectations. Revenues improved sequentially and declined 11.7% year-over-year.

The fourth quarter was inclusive of a project related to federal government disaster recovery, which does not carry into the first quarter of 2019.

We have frankly struggled in this business over the past year and are early in working to reposition it to place greater emphasis on higher bill rate opportunities within the skill sets less susceptible to being disrupted by technology advancements. We are using the same disciplined methodology we applied to our technology segment.

Bill rates within FA Flex have increased 5.3% on a year-over-year basis, which reflects our pursuit of a more balanced mix of higher skilled roles in FA as larger projects end.

The market for higher bill rate FA staffing continues to be strong and we believe our efforts in this area should lead to improving performance as we enter the second half of the year. We expect first quarter revenues to be down approximately 10%-12% on a year-over-year basis.

KGS services revenues declined 13.3% on a year-over-year due to a combination of award delays and refinement efforts to reduce the number of consultants on lower margin assignments as reflected in the year over year 50 basis point improvement within the services business.

Despite the instability in the political environment, KGS’ management team has done a nice job building a strong, qualified pipeline of new business pursuits and have positioned KGS for significant growth. It is clear the timeline of KGS’ new business pursuits have been delayed as a result of the Federal government shutdown.

Last quarter, we disclosed that KGS was awarded its largest contract in its history, with an estimated $150 million to $200 million value, which is expected to be recognized over a period of 5 years.

This contract award is currently under protest and, while timing of resolution is a bit uncertain, we expect it to be resolved favorably over the next 30-60 days and make a meaningful contribution to revenue growth beginning in late Q2. We would expect it to contribute annualized revenues of approximately $30 to $40 million once fully ramped.

Despite the impact of the shutdown on lost billable hours and award delays, we expect our KGS services business to be stable on a sequential basis. KGS product revenues, which are inherently more volatile than its services business, increased approximately 29% year-over-year in Q4.

Revenues annually ramp in this business with the strongest quarters typically in the second half of the year, to align with the buying patterns of the government fiscal year. The first quarter, we expect KGS product revenues to decline to typical seasonal first quarter levels.

Overall KGS revenues in the first quarter will decline approximately 9% year over year. Direct Hire revenues, which represent roughly 3% of overall revenues, increased 9.1% year-over-year. Our Direct Hire business continues to be an important capability in ensuring that we can meet the talent needs of our clients through whatever means they prefer.

We have been selective in our investments in this line of business to meet this evolving model. We expect sequential and year-over-year growth rates to be down in the mid to high single digits in Q1 after a stronger than expected fourth quarter.

Over the long term, we have built our model with the belief that Direct Hire will continue decline as a percentage of our entire business.

The stabilization of our team after several years of significant change, in combination with our technology and process investments, have led to improved productivity of our revenue generating talent, which has improved greater than 10% each of the past three years.

Our associate population, by design, was flat sequentially and we expect headcount levels to remain relatively constant in the near term.

As we refine our model, we continue to identify opportunities for improving productivity and, therefore, have not made material additions to associate headcount, beyond those areas where productivity levels warrant additions, as we believe significant capacity exists to continue grow revenue at our targeted levels.

I appreciate our team's effort in driving our firm forward in 2018 and look forward to 2019 and beyond. And I'll turn the call over to Dave Kelly, Kforce's Chief Financial Officer, who will provide additional insight on operating trends and expectations.

Dave?.

Thank you, Joe. Revenues of $358 million in the quarter grew 2.8% year-over-year and earnings per share of $0.65 improved 44% year-over-year, as adjusted for the $5.4 million impact in Q4 2017 of the revaluation of our deferred taxes stemming from the Tax Cuts in Jobs Act.

Our gross profit percentage in the quarter of 29.8% declined 20 basis points year-over-year as a result of a 30 basis point decline in our Flex gross profit percentage to 27%, which is partially offset by higher Direct Hire and KGS products revenue mix.

Tech Flex margins of 26.6% declined 60 basis points year-over-year and FA Flex margins of 28.7% increased to 20 basis points year-over-year.

Overall spreads in our Tech Flex business have been relatively stable over the course of 2018, but we experienced slight compression in the second half of the year as a result of strong growth in two of our largest clients that have a slightly lower margin profile.

As we look into 2019, we expect growth to be strongest in clients outside of those where we already have very significant relationships. This should result in reasonably stable Tech Flex spreads, since those very significant clients have a slightly lower margin profile than the rest of the portfolio.

As is the case every year, overall Flex margins will be negatively impacted sequentially by annual payroll tax resets, which occur in the first quarter. SG&A expenses as a percentage of revenue declined 100 basis points year-over-year to 23% in the fourth quarter of 2018.

We continue to make significant progress in generating SG&A leverage by improving the productivity of our associates and exercising solid control over discretionary expenses. These actions have allowed us to increase our investments in technology while also improving operating margins.

We expect to continue to reduce SG&A expense as a percentage of revenue as revenues grow. As a reflection of this trend and looking forward to Q1, we expect SG&A dollars to actually be down year-over-year despite higher levels of revenue and incremental investments in technology.

Fourth quarter 2018 operating margins of 6.2% improved 80 basis points year-over-year and were consistent with expectations at these revenue levels. During this economic cycle, our gross profit percentage has declined by 190 basis points. Despite this compression operating margins have actually improved by 430 basis points.

Our effective tax rate in the fourth quarter was 23.7%, which was lower than anticipated as a result of excess tax benefits from the vesting of restricted stock and higher income tax credits. With respect to our balance sheet and cash flows, operating cash flows in the fourth quarter of $23 million were quite strong.

We ended 2018 with outstanding borrowings under our credit facility of $71.8 million, which equates to leverage of approximately 0.8 times trailing 12-months EBITDA. Cash flows in 2019 could reach approximately $100 million based upon current trends.

Our healthy cash flows, minimal CapEx requirements, low debt levels, and $300 million credit facility collectively provide flexibility to execute quickly on strategic or tuck-in acquisitions or other ventures and strategic partnerships and also continue to return significant capital to our shareholders through both a healthy dividend and share repurchases.

Our billing days are 63 days in the first quarter, one less than the first quarter of 2018. Billing days for the rest of the year will be 64 days in the second quarter, 64 days in the third quarter, and 62 days in the fourth quarter. Revenue per billing day in the fourth quarter of 2018 was $5.8 million.

With respect to guidance, we expect Q1 revenues to be in the range of $351 million to $356 million and for earnings per share to be between $0.40 and $0.42.

Revenues in the first quarter will be impacted by the government shutdown which created delays in new contract awards and lost billable hours, primarily in KGS, but also our Tech Flex business, which provides staff on a subcontract basis to many government integrators.

The total impact of the shutdown in Q1 is expected to be approximately $3 million in revenues. Gross margins are expected to be between 28.2% and 28.4%, while Flex margins are expected to be between 25.7% and 25.9%. This includes an expected sequential impact from seasonal payroll taxes of 90 basis points.

SG&A as a percent of revenue is expected to be between 23.4% and 23.6% and operating margins should be between 4.1% and 4.3%. Guidance assumes an effective tax rate of 25.5%. Weighted average diluted shares outstanding are expected to be approximately 25.1 million for Q1.

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

We are firmly on track to reach our next milestone of 7.5% operating margins when quarterly revenues reach $400 million. We expect the progression in profitability improvements to be relatively linear absent seasonality impacts in the first and fourth quarters.

For the first quarter, the range of operating margins contemplated in our guidance of 4.1% to 4.3% includes a 220 basis point impact on cost of sales and SG&A combined from seasonality and payroll tax resets. Payroll taxes impact EPS by $0.15, thus, our profitability in the first quarter against our operating commitments is very much on track.

We are very pleased with our performance in the fourth quarter, especially with the continued above market performance in our Tech Flex business.

In 2018, we are successful and accelerating revenue growth in our Tech Flex business continuing to improve associate productivity generating a higher level of profitability and significantly improving cash flows.

We are excited about our prospects in 2019 as the market for our services remains quite strong and we remain confident that we've built a solid foundation for sustained revenue growth and continued improvements in profitability. Crystal, we'd now like to open up the call for questions..

Thank you. [Operator Instructions] And our first question comes from Tim McHugh from William Blair. Your line is open..

Thanks. Just wanted to follow on the guidance gross margin commentary, I guess, I listened to your comments specially on the Tech Flex – it was mostly about the revenue mix and it seemed like you thought that would normalize but yet the Q1 seems to imply a decent-sized decline in the Flex gross margin.

So can you talk about what's impacting that?.

Sure, Tim. This is Dave Kelly. Actually, what I did say is we think spreads between bill and pay rates are going to be stable. In Q1, every year we've got a significant impact in cost of sales of increased payroll taxes. That's actually what's driving that sequential decline..

I was talking year-over-year decline.

I guess, it still seems to be down quite a bit on that basis?.

So if you look Tim, so I did mention as well – so in Q4, we're talking about stable bill/pay spreads from Q4 to Q1. From Q3 to Q4 sequentially we saw a decline as I mentioned in spreads. So we expect those spreads to be stable from Q4 levels.

So part of that year-over-year decline is because they were lower Q4 of 2018 versus Q4 of 2017 and will stay at those levels..

Okay. Can you talk a little bit more about the year end? I guess, the comment basically you saw more engagements than normal typically and counseled engagements. And I get kind of the broad commentary that feels just like people are afraid to lose resources.

But is there anymore, I guess specifics you can give in terms of what sectors you saw that in or what kind of feedback you were getting in terms of I guess why you're seeing that behavior if there was any particular areas that you saw it more pronounced than others?.

Yeah. Tim this is Joe Liberatore. Typically, on the back end of every year we have contract ends which then requires us to rebuild as we move through the forest of Q1 with typically getting back to kind of pre-holiday levels usually in that March timeframe.

Where we experienced it on? We experienced it to a certain extent last year as well, not quite as many year-end assignment ends taking place and people carrying those individuals into the beginning of the year.

One of the other thing that we're hearing from the end clients is there were a lot of clients that have put in term limits where they can only keep consultants on assignment for 18 months and then you'll have to roll them off. From a core employment standpoint, just this goes back to the Microsoft days.

We're seeing those guidelines being waived by more and more large organizations as well. So our belief is as this is all directly related to the war for talent. Supply demand is as far out of balance as we've ever seen in front of the highest demand skill sets and people are looking to hold on to individuals..

Tim this is Dave. The other point that I think that we've made in the prepared remarks was we had really never seen the acceleration going into the backend of the year November and December historically that we saw this year.

So we saw lower attrition, we saw increased hours and increased starts all happening at the backend of the year, which is kind of unusual. But as Joe said, I think it really reflects the war for talent as organizations are looking to move quickly to identify that talent, retain that talent because there's a lot of work yet to be done..

Okay, thanks. And then last question, just the comment that the major focus this year is the talent relationship management system.

Can you talk about I guess when during the year, do you expect that to rollout? And what impact could we watch for on the business as you do that?.

Yeah. As of right now we're targeting -- it'll be the backend of the year, so no material impact to 2019.

Again these are investments really for the future, taking our platforms through the digital transformation to allow our individual the best tools to go out and identify, and then move people through the process, flying a lot of the more advanced technologies that we're seeing in the marketplace, artificial intelligence bots various other things.

So we're integrating all these things within that platform. So I think we'll see the benefits of that as we start to move through 2020 probably more so on the backend and then as we move forward from there..

Okay, great. Thank you..

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

This is Joseph [ph] on the line for Toby this morning. My first question is about KGS. Was the effect of the government shutdown on KGS dampened at all by the shutdown occurring around the holidays, and if so, about how much? Thank you..

Yeah. I would say I don't think holidays had really any impact there, it's more so the shutdown because you don't have the contracting officers available for approval of those new engagements that we had in process, so there was a real drop in the award of various things that we were bidding on.

And then we also experienced some billable hour deterioration by people not being able to go to work..

Yeah. So Joseph the impact in Q4 was nominal. I think it was $250,000 give or take, I think is what we estimated. Joe's point is right on. It's these delays and actually lost billable hour not only in our KGS business but in our Tech Flex in business in Q1, which even despite that is going to grow north of 10% that is being impacted..

Got you. And looking at Tech Flex, how growth is being -- or how much of 4Q's growth is being driven by an increase in productivity of your sales staff versus strong external environment? Thanks..

Yeah. I mean, actually the strong external environment, I mean those two things really are directly connected at the hip, so it's a combination of those two. It's the productivity of our individualists are driving the growth against the backdrop of a very strong economic and robust hiring environment..

Thanks. I’ll jump back in the queue..

Thank you. Our next question comes from Mark Marcon from R. W. Baird. Your line is open..

Good morning everybody. I just wanted to ask Dave and Joe, you mentioned some of the clients waving the Microsoft era stipulations.

How do they do that? And how much are you seeing that?.

It's internal programs that all these organizations have put in place based on whatever their legal is guiding them towards. So it's embedded in the actual contracts that we enter into them with the master service agreement..

And that's in contract with you? In terms of so much the comp would end up being for -- I remember those contracts pretty specifically and particularly as it related benefits options etcetera. I mean that's a great sign that they're doing it.

I was just wondering if you could elaborate a little bit about how widespread?.

Mark, this is Dave. The issue really relates more specifically to the term limits, if you call employment. So basically what we're seeing, there is an evolving view about the relationship, the employment relationship and the responsibility for the management, the supervision of the technology resources.

So the market, if you will, is viewing it a little bit differently than they have in the past. Part of that is a result of the supply shortages, part of that is a result of the evolving regulatory environment.

I think certainly the administration's view and the new look at some of the regulations and the definition of 1099 employees, all of those things are affecting the view of the employment relationships.

So organizations in the past that took a more conservative view of term limits and have relaxed some of those, not really an impact on benefits per se because we actually are offering benefits across the whole term anyway. It really relates specifically to the core employment issue..

Yes that's really encouraging.

How widespread is that now?.

We're hearing it more than -- I'm entering my 31st year in this industry, really have never experienced that far even when we went through the great imbalances during Dot Com era. So I would not say that it is broad-based. There are just certain organizations that you would not expect to see that coming from that are now waving that.

And by the way they're not waving it broad-based across all areas. It's really just more in those real very high demand skillsets. As Dave mentioned, it's playing into a number of areas because we're seeing it in some of the larger consumers. Again realizing the majority of the work that we do is within the Fortune 1000..

Got it.

And then with regards to the color, with regards to expanding beyond the top clients and seeing success in terms of expanding significant clients, could you dimensionalize that a little bit further? Like could you give us some stats in terms of like, percentage of revenue that came from top 25 clients or top 10 clients was blank last year and it's moving to blank this year.

However you choose to do it? But could you put some meat on the bones?.

I'll speak to our Tech Flex specifically. So Tech Flex for example, our top 25 in Q4 on a year-over-year basis, the concentration was 230 basis points higher than it was in Q4, 2017 and in combination with that, we basically had about 28% of that overall top 25 population were new to the top 25.

So that really kind of gives you a feel for the rotation..

So let me add a little bit more color to that, Mark, so although it's a little soft. To Joe's point, a higher concentration in the top 25 revenues, but if you look at our five largest clients, actually the concentration is less in those five largest. So the growth of that top 20, 25 is weighted towards clients six through 25.

So within that portfolio of Fortune 1000 clients, the focus here has been on large users of technology Flex service where we don't have as significant a relationship and growing those and that is what is driving the double-digit growth in Tech Flex..

Great. That's terrific. And then can you talk a little bit about the SG&A leverage? Because you're basically putting in place this new talent relationship management solution, you're making investments behind that, but it sounds like we're still anticipating good SG&A leverage.

What revenue level or what revenue growth rate would you need in order to be able to continue to achieve that SG&A expense leverage, other than just getting to $400 million?.

Yes. So Mark, as I think I've mentioned, the progression in profitability for us as we grow has been and I expect will continue to be relatively linear, right? So we've said at $7.5 million and $400 million in revenue, 7.5% operating margin of $400 million, we've said at $350 million we will be 6.3% or better. So it will be linear from there.

That is a result of the efficiencies that we have gained through a lot of things, including technology investments. So we've ramped technology spend significantly. Joe mentioned TRM, but that is on the heels of a CRM. It's on the heels of BI investments and those are driving efficiencies.

We continue to expect to continue to invest in those things to improve efficiency both in front of the house and the back of the house and allow us to actually continue to invest in technology. So this is a path we've been on for quite some time and are well on the road that we thought we would be..

Yes. Mark, this is Dave Dunkel. Another point is that the way that the solutions are being delivered today, the cloud solutions, it's more of a direct expense as opposed to capitalized software. And so as our older technology has been fully amortized, our new expenses are coming on as an operating expense versus an amortized expense.

So in the face of all of the other improvements we've made, we've also seen a significant increase in our technology spend, which is a direct hit to operating expense. So that leverage is starting to manifests itself and will even more in the future.

So we've kind of worked both of those things together, operating leverage together with significantly increased technology spend..

Yes. So just to state what we've said before, as revenues grow and as Joe said, we expect to see a trail up in Direct Hire revenues. That's actually going to be stable or slightly reduced gross margins as we grow. Operating expense is going to continue to improve, because of what is Dave was talking about through further reductions in SG&A expense.

We're down 1% year-over-year operating margins are up 400 basis points since the beginning of this economic cycle, despite the GP compression..

Great. And there's two more questions. Just on the direct hire, can you talk a little bit about, like, how expensive would it be just to stabilize that? Number one.

And number two, can you just talk on the F&A side, how long do you think it will take to reposition to some of the higher value added positions? And how achievable is that given your current market position?.

So, yes, on the Direct Hire, the reality is if you look back over the course of the last eight quarters at the quarterly revenue contribution Direct Hire, it has been fairly stable probably within $1 million $1.5 million quarterly. So, I think we are at that stabilization in terms of an absolute dollar.

That's why I stated it will shrink as a percentage of revenue; we continue to outpace the growth with Tech Flex and such.

Does that answer your question?.

Yes, but on an absolute basis, it will be -- it will hold here?.

And Mark, this is Dave. We are making selective investments in that area, but we're also saying that that business has changed significantly. See Contract-to-Hire, which is a service that we offer as well. So, there's lots of different things that are happening within that Direct Hire space. We are making selective investments.

But at this percentage level with the growth rate of our other businesses, it will just decline as a percentage, but not dollars per se..

Okay.

And then [ph] on the F&A?.

Yes, I'll just wrap it up. As always with Direct Hire in any given quarter, I mean it will bounce around, so it's not an absolute flat business. From an FA standpoint, we've really started to dissect that. Our teams are aligned. We've repositioned and the majority of our markets are now -- it's is a lot of the client-pursued activities.

So, we've already started down the path. I think I said in my comments while we expect to see some of those improvements starting to realize themselves as we move into the back end of the year as we reposition the business.

And similar to what I had mentioned on a year-over-year basis, bill rate in this business was up 5.3% as we had started some of that work last year..

Mark this is Dave. If you look at what's happening in that space more and more of the lower skill areas are being automated. And so there's a converge with the technology and the FA skillsets where the FA -- the analysis that's being done using BI tools and so forth is kind of a blending of technology and F&A.

So, as we have looked to position this business strategically looking over the long-term, we're migrating it up the skill areas.

It doesn't mean we're abandoning the lower skills, but our focus and development is on the higher skill areas because we believe in the long-term that's where the real growth is going to be and the opportunities are going to be and also by the way plays well with our portfolio of customers..

If you're seeing that through RPA and also through some of the various other automations that are hitting some of those skill areas which by the way are areas where we really benefited from if you go back several years -- three, four years ago when our -- when this business was performing well into mid to upper double-digit growth we were benefiting in those areas, mainly attributable to our ability to deliver through our centralized delivery centers to capture bulks of those business, but we've seen that space change rather quickly..

So, the comps become relatively easy by the time we get into the second half or even the second quarter do you think? At what point do we think we could actually get back to growth in F&A?.

Yes, I mean when we look at our models if everything were to go as planned with repositioning with obviously the caveat being the customer penetration because we're having to enter into we're -- while we're leveraging relationships within existing customers, we're having to move into other areas to capture the business that we're targeting.

So, our hope would be that we'll turn the quarter in terms of year-over-year as we move in the second half..

Great. Thank you..

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

Great.

Could you just frame out that F&A a little different in terms of what percentage of the business has real potential versus secular risk to it? And is there a way to think about that in terms of skill sets and then client mix? Like if you have opportunity to kind of upsell it versus maybe stuff that's going to run off, is there any way to have 100% thinking about what the opportunity is there?.

Yeah, in terms of runoff, most of our bulk projects have started to filter out and filter out as we move into the first half of this year. And so we're -- we haven't -- we have not been on-boarding the volume of bulk business at lower bill rates that we had experienced in the past. So I wouldn't say that we would really see much there.

In terms of the secular dynamics, I mean, the overall F&A space has been very strong and remains very strong. I think SIA has it performing right in the same ZIP code as where they have Tech roughly 4%. So the market is there. This is not a market problem. I mean, this is a -- we benefited from our model by design.

And now we're having to pivot our model. So the market is there..

Yes. And I'll add a couple of things, Kevin. I think if you look at the market potential, the addressable market if you will, we look at Tech there's $130 billion addressable market being, $30 billion of staffing, $100 billion of solutions. I mentioned in my remarks that we're being pulled up into that solution space more and more.

We offer cost advantage and greater flexibility. So we believe that that brings an element of stability to it. And frankly I think if you look at where we are in the transformation of business models and the digitization of all of these models, we're still early on.

There's a lot of organizations that are -- have yet to fully address the transformation. And then there are others that have longer-term plans. So one of the reasons that we made the decision to go even more aggressively into Tech was that we see that there's a much longer-term play there strategically.

And frankly I haven't seen anything that would tell us that the investment in technology is going to stop anytime soon, I mean even related to business cycles. So we believe that the underpinning of our business today is secular and driven predominantly by technology..

Understood.

And then just as you see the mix of all in terms of F&A towards the Tech, how do we think about that within the context of the longer term margin targets you folks have set out the $1.4 billion? Are we still able to achieve those, or do we need to revisit them?.

Yeah. We'll, I mean, obviously, what Dave had just mentioned, we made a decision many, many years ago to double down in Tech and that's where we've exerted a lot of our energy. So we do believe that we'll continue to outperform the market in terms of capturing market from a Tech standpoint.

So we would anticipate that our Tech business would outgrow on a percentage basis our FA business. So if you take that math into account, I mean FA will become a smaller percentage of total revenue..

Yes. So, Kevin, this is Dave Kelly. So your question about margins, I said -- I would tell you this fits quite nicely into exactly what we would have expected. You think about Tech and you think about F&A there are other differences. Bill rates are much higher. Length of assignments are much higher.

The number of people on assignment per client is much higher which brings a lot of efficiencies to placing Tech consultants relative to F&A consultants which reduces the cost of that. So though there's a slight Flex margin difference, the incremental profitability of Tech consultants on the assignment relative to F&A is very positive.

So I think we can feel very good about this plan and our ability to meet these goals. As a matter of fact the further acceleration in Tech growth relative to F&A will probably help us..

Great. Thank you..

Thank you. And we do have a follow-up from Mark Marcon from R.W. Baird. Your line is open..

You said a couple of things on the last comment that was kind of interesting.

Dave I was wondering could you expand a little bit about being pulled up into the solutions part of the business in terms of exactly how you're doing that? Are you doing solutions light? Are you putting project managers out there? How are you structuring the contracts from a deliverable perspective? Are you staying on time and materials? Anything that you can say there in terms of how we think about the evolution of the business?.

Okay. Mark. I'm going to let Joe answer that question because he is infinitely more qualified to answer that than I am..

Yes. Mark actually pursuing just about everything that you had mentioned so no yes, the majority of where we're focused is we're being pulled off remains time and materials. Albeit, I would consider them more bulk arrangement.

So yes, we're putting engagement managers on site which allows us to have a little bit more involvement with the overall customer. It's a higher-value offering.

But this really plays into what I would consider our staff aug business extremely well because the staff aug allows us to build a relationship, earn credibility which then gives us a seat at the table to basically be able to go upstream.

So we've identified those areas that map very well especially into our most strategic customers where we can bring these offerings and services. And we've been building out the team. I think the team has done a really nice job on building out our methodologies, our processes getting the right people on board.

But we are very early on in our evolution on that front..

Yes there's a couple of other pieces to that too Mark. The way that projects are being done now with the agile methodologies being adopted a lot of that stuff is being on-shored for the speed at development.

And so when you think about it in that context, the large-scale integrators that are moving a lot of that stuff offshore that has changed somewhat as the organizations have moved. The sprint team is back onshore and into smaller sprint teams and into projects that are smaller in general in size overall.

So as a result, we get to participate in those a lot more. And the nature of the projects that they're doing tend to be more customer-focused as opposed to the large-scale ERP system. So these are unique technologies. There are separate teams.

And so, it plays very well with our ability to deliver local resources with the skills that they need bringing project management in. So it's a result of those long-term relationships and where the customers are going. There's another aspect to it as well. We bring a big cost advantage. The large-scale integrators have significantly greater overhead.

We have much greater flexibility and we don't have the unbilled resources loading overhead onto these projects. And we hear this from customers. They love the flexibility as well because they give us – it gives them the ability to ramp up fast or slow down. And so others have said the same in the space and I would echo their comments.

I mean we as technology staffing and solutions providers are right in the sweet spot of where we want to be to address to full $130 billion market as opposed to just the staffing market of $30 billion.

And then of course the final thing is where is the talent and who has the ability to deliver the talent at scale? And so the large-scale centralized delivery capabilities that we have our recruiting resources in the field 50 years of relationships and brand all of those things come into play..

Great. And then I was wondering, if you could – two other questions. One, would just basically be on KGS.

How should we think – if we have another budget impasse and we have another shutdown how do you think that ends up impacting the contracts on a go-forward basis? Hopefully, you're getting them all set now while the window is open and then you can continue.

But I'm wondering if you could comment on that? And then secondly, how was the commentary from an economic macro perspective business confidence perspective 40 days ago? And how does that contrast to like, what you're hearing now? Obviously, the market has had a big shift in sentiment, but wondering what you're hearing actually from clients..

Yeah. Related to – if we have another government shutdown, I guess, the positive about this shutdown at least for the bulk of our business is it wasn't in areas where we're heavily concentrated. So the majority of our people still were able to go to work still get paid.

So given we're heavily involved in things such as the VA that we're not impacted realizing I believe the VA makes up a little bit over 45% of our total revenue. So that's the positive side of it. Where we really feel it Mark is the contracts that we're bidding on that are awaiting award get delayed in terms of that award.

So now you have this ripple effect, because the award gets delayed then your ability to start on the project and start staffing the project gets impacted it just pushes – it pushes everything to the right.

So, I can't give you an answer on if we were to go into another shutdown, and if it were this length what would happen with that, because I mean there's way too many components to give you unfortunately a solid answer on that. So the business would stay stable in terms of the business that we're doing today.

It just it starts to hurt the revenue growth as we start to look out into the back half of the year, because of those contracts ramping up..

Yeah. If you watched the State of the Union last night it certainly doesn't appear as though there's any movement towards the ability to resolve, if you will the budget impasses and the issues related to immigration. So we're going to watch this. Maybe it gets picked down the road a little bit further.

But the impact is in the contracting offices getting clearances done and so forth. And all of those things are just things that we can't do anything about. The good news is the demand is there. So the RFPs have been put out I mean there's contract awards awaiting some that we've already won which Joe indicated that need to be resolved.

But if you can call this one then I would like to know what the answer is because I certainly don't know either..

Yes, even those contracts where they're bringing people on to Dave's point that people have to go through the clearance process that whole thing has been pushed out as well which again prevents us from getting somebody on assignment and starting to bill..

Got it.

And then just -- can you talk a little bit about whatever sort of macro commentary you're hearing from clients?.

Yes. I would say we're hearing from our people that are very close to the clients as well as those that we've been engaged with is, the demand remains strong. We haven't seen anybody reacting to anything negative.

I mean there's more work to be done than people have resources to do especially in these high-demand skill areas that -- where everybody is competing for the same talent..

Yes. If you look at the back end of last year with all the concerns about the Fed and the moves of the Fed, we saw zero impact in demand.

I mean here we were entering into the fourth quarter with the expectation that there might be a little bit slower period and even with the overhang of the Fed's comments on bond sales and rates we saw zero impact to demand. Some of these things are just things you've got to do. The digital transformation model changes and so forth.

And it's the old adage. Let me ask you a simple question.

Is Baird spending more or less money on technology?.

Obviously more..

Yes. Unfortunately the analysts' increases in compensation this year might be a little less because of technology but....

It's not optional..

Yes, it's not..

It's not an option. Everybody has to spend more..

And from a competitive standpoint you have to. You have it coming at you from both sides right? You have the traditional competitors that people are keeping up with.

And then you have the non-traditional competitors that are coming at every space in -- on the planet that people are having to ramp up and leverage their existing platform to go against the non-traditional competitors. I mean it's a perfect storm for technology..

And if you look at FinTech and all the things particularly on the larger banks, I mean it's amazing to see it. And it's a race to improve the technology. So that's one of the big reasons we think the underpinning is secular as opposed to cyclical. We hopefully won't have to test that anytime soon, but that's still our belief. Thank you Mark..

Great, thank you..

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

Well, thank you very much. And thank you for your interest and support of Kforce. The results that we're experiencing is really the result of a lot of hard work and tough decisions by our team and I'm grateful for their tenacity. But we have much more to do.

I'd like to say, thank you, 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 you. Thank you very much and we look forward to talking with you soon..

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