Ladies and gentlemen, thank you for standing by. And welcome to the Q3 2019 Kforce Inc. Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Mr. Michael Blackman, Chief Corporate Development Officer. Thank you. Please go ahead.

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 now like to turn the call over to David Dunkel, Chairman and Chief Executive Officer. Dave?

Thank you, Michael. You can find additional information about this quarter's results in our earnings release in our SEC filings. In addition, we have published our prepared remarks within the Investor Relations portion of our website. Unless otherwise indicated, our commentary relates to results from our continuing operations. We are very pleased with our third quarter results, as both revenues and earnings per share exceeded the top end of our guidance. The better than expected results were driven primarily by an acceleration in new assignment starts in our technology business as the quarter progressed. We are excited about our focused footprint with technology now comprising almost 80% of overall revenues. Our business is now completely dedicated to meeting our clients' domestic needs in Technology, and Finance and Accounting, which are 2 of the largest and fastest growing segments. Clients, particularly in Technology, are looking for partners that are able to provide resources at scale with multiple skill sets across multiple geographies and with a focus on compliance. We have built a business that is able to do just that without distraction, and it is helping us increase clients and market share. Growth in our technology business has now outpaced the market for the eighth consecutive quarter. We continue to look to deepen relationships within our existing client portfolio, which is comprised of predominantly Fortune 500 companies. These companies are increasingly looking for their partners, such as Kforce to provide the resources necessary to execute on critical projects and to also assume a greater role in more complex technical projects that require managed services and solutions. Our clients have increasingly expressed the desire to engage with us to serve as an effective, more cost-efficient alternative or complement to the larger scale integrators, as evidenced by our success and recently winning several…

Thank you, Dave. And thanks to all of you for your interest in Kforce. Our technology service offerings continue to be the engine that is fueling our growth. This business saw meaningful improvements and starts activity in the second half of the quarter, which drove an improvement in year-over-year growth rates to 6.5% in the quarter. However, both our FA Flex business, which grew sequentially and our Direct Hire business, which has seen improvement in growth rates for 4 consecutive quarters, were important contributors to exceeding our expectations in the quarter. Collectively, we have excellent service offerings that set the firm up versus same growth at rates exceeding the market. Let me provide some details about the performance in each of our service lines. We continue to take a larger share of business at existing clients and technology. The increase in billable consultants on assignment at clients where we have our longest and deepest relationships is driving our growth, which has now exceeded the market for eight consecutive quarters. We believe our continued focus on furthering deepening relationships with existing clients is the right path given our enviable client portfolio. We have established the relationships with roughly 70% of the Fortune 500, many of which are long standing. These companies continue to be the largest consumers of technology talent. We are aligning our service offerings and operating model to best fit with how these clients purchase our services. We have made a concerted effort to align our teams by industry and size of relationship to drive enhanced customer intimacy. Overall, technology bill rates have increased modestly by 2.9% over last year and 1% sequentially. Our strong relationships, coupled with the quality of skilled technology talent, we provide our clients is contributing to an increase in the average duration of consultant…

Thank you, Joe. Revenues of $345.6 million in the quarter grew 4.2% year-over-year and earnings per share from continuing operations of $0.68 grew 21.4% year-over-year. Our gross profit percentage in the quarter of 29.8% increased 40 basis points year-over-year as a result of a higher mix of Direct Hire revenues and a higher Flex gross profit percentage. Our Flex gross profit percentage increased 10 basis points year-over-year. While we are seeing an increase in rebates and discounts from our largest clients, we're having success growing revenues at other clients, where our share of client spend is not quite as significant, and the margin profile is more attractive. Additionally, revenue from managed services projects, which also have a more attractive margin profile is increasing. The 30 basis point improvement in Tech Flex margin, which is 26.8% in the third quarter was driven by some favorable pricing adjustments. We expect margins, subject to seasonal impacts, to remain closer to Q2 levels, prospectively. Our portfolio is well diversified. No single client represents more than 4.2% of total revenues, and our 25 largest clients represent only 40.2% of total revenues. SG&A expenses increased as a percentage of revenue by 10 basis points year-over-year as a result of increased accruals for variable compensation costs related to improved full year performance. Absent these costs, we continue to make progress generating SG&A leverage as our revenues grew. This leverage has been achieved while also significantly increasing our technology investments. We expect to continue to make incremental technology investments to improve productivity and drive operating efficiencies while continuing to improve profitability. Our third quarter operating margin of 6.4% was in line with expectations and on track with our operating margin objectives. During this economic cycle, our gross margins have declined by approximately 200 basis points due to a…

[Operator Instructions] And our first question comes from Tobey Sommer with SunTrust. Your line is now open.

Thank you very much. I wonder if you could start out by giving us a little bit of color regarding your decision to, kind of, offer us a preliminary outlook at 2020. Historically, most companies in the industry only give a look out 1 quarter and it's after half the quarter is done. So how did you arrive at that choice?

Yeah, Tobey, this is Dave Kelly. So I think a couple of things. Obviously, we've done a lot of work over the last few years, and there's been a lot of, I guess, effect on our income statements, and I think it becomes increased -- it has become difficult to -- for you guys, in particular, to say where are we going. Now that we've completed the divestitures. We've got a couple of quarters ahead of us. And frankly, we had finalized the deployment of all the cash and looking at where the public and the analyst base is in terms of models, there's a lot of differentiation there. So we thought since we finished that work, we'd give you a look at: Number one, how things look on a clean basis; and number two, there seem to be quite a few questions from time to time on the seasonality impacts of the business. So we wanted to provide, although we verbalized that in quarters past, we wanted to provide you a little bit more easily understandable look at that. So I think those are really the drivers as well as, I mean, obviously, reiterating our belief that the market for 2020 for tech, in particular, is going to be strong.

Thank you. [Operator Instructions] Our next question comes from Greg Mendez with Baird. Your line is now open.

Hi. Thanks for taking the question. It's Greg on for Mark Marcon. I was wondering, just -- could you talk a little bit about - within the - how you're thinking about 2020 -- the Flex IT gross margins? I mean, you improved here, normalized a little bit in Q4. But I mean, is the expectation that maybe we can hold those stable? Or would larger crown still be a little bit of pressure? And could you offset that with some of the stuff you're seeing with statement work?

Yes, Greg, this is Dave Kelly. Yes, to your point, we have seen some nice stability in margins in general. I think we've done a very good job in managing our business, looking for opportunities to drive improved margins and increase our clients here, as we mentioned. I think as we look forward, I think we look at relatively stable margins going forward. Clearly, it's a competitive environment out there and growing client share in some respects requires us to -- obviously, put some pressures on bill pay spreads. But I think we do look for stability. I would say if there is any degradation, it would be along the lines of what we've seen, our ability to grow revenues and drive at least as good operating margin unit, those declining margins because we're taking client share and being more efficient is, it's been very beneficial for us. So I think gross margin stability, even if there's a degradation, I think our operating margin expectations continue to be very solid.

Okay, thanks. And just also thinking, with the productivity gains you're seeing, we've done a lot from a technology perspective here. I know you had the talent management system rolling out. I mean, what else is on the road map to help drive further productivity gains. If you could just talk a little bit more about that?

Yeah, Greg, this is Joe Liberatore. I would say, even from a technology standpoint, we've yet to realize what we truly believe the productivity gains could be there from technology. So we're in the early innings there. So we think there's a lot of opportunity, especially when we look at the activities from candidate acquisition through match, where we're seeing the majority of investment being made in the marketplace, really addressing opportunities in those areas. So I'd say that's one - one leg of the stool. This is ongoing technology. This is going to continue to provide opportunities, and we haven't realized what we believe the opportunities are there just yet. The other, I would say, is that the consistency of our team's execution. We've been really relentlessly focusing on the business to drive a greater consistency into our overall operating model, which has a by-product effect of allowing us to ramp people faster, improve our retention of individuals. So it all, kind of, dovetails together with our technology strategy and our -- really our human capital talent strategy, putting those two things together, and then the overall operating environment.

Okay. So I mean, you still think there's more room within the headcount that you have?

Yes. No, we're very comfortable. We've continued to see our productivity levels, especially in our more tenured people move up on there -- they're actually at all-time highs right now, and we still see room there when we look at metrics such as average amount of placements that somebody is making on a weekly or monthly basis, the amount of billable consultants that we have for associate. We see plenty of runway there. And then when we get into our less tenured populations, just a real -- a lot of opportunities continue to move those up.

Great, thanks. I’ll hop back in the queue.

[Operator Instructions] Our question - next question comes from Tobey Sommer with SunTrust. Your line is now open.

Thanks. It seems like your assignment lengths in Techs -- in Tech have elongated quite a bit. Could you talk about that? And to elaborate on kind of what's driving that?

Got it. I mean, Toby, as you're well aware, I mean, this is an interesting time when you have every organization across every industry competing really for the same type of talent. We're seeing trends in the marketplace that, personally, I haven't seen prior in my career. We're seeing a lot of organizations looking at extending their tenure limits, in fact, I just met with the client last week that was talking about moving their tenure limits from 2 years to 4 years. And mainly, the reason that they're doing this is because they see the ongoing need for these skill set. And also they're battling to get the skill sets on board. And so they're -- by the time they're getting these people oriented and ramped up and productive in their environments, they're having to turn them over from a tenure standpoint. So we're seeing expansion in tenure limits is one driver of it. The other is the statement of work business. When we look at the different ways that we're engaging in statement of work, whether it's through managed teams, managed services solutions. These types of initiatives usually have a multiyear facet associated with them. So as that continues to be a higher percentage of our overall business, that's also extending out those contract durations. So Toby, the last piece that I would add, and I don't know if you saw the Wall Street Journal article a couple of weeks ago, where they talk about Tech employment, currently, 7.6% of overall employment in the U.S., and they're projecting that to go into double digits in the coming years. So I think customers are really seeing the demand for these technology people, especially on these front-end customer-facing systems. It's not going away.

And this is Dave. I would add that it's going cross-functional as well. So you see F&A people are becoming more information analysts, and so they're taking on additional technology skills. So technology is clearly driving business models, productivity and really transformation in moving into the digital realm for a lot of these non-traditional competitors as they are moving into new space. So I don't see that ending anytime soon.

Great. I appreciate the answer. You talked about investment in Tech in, kind of, new tools. Could you - just for a second talk to us about whether these are proprietarily developed or you're buying, kind of, industry off-the-shelf things and maybe doing some customization to them?

Yes. It's a great question. Actually, what we've done is we've got -- we've componentized all of our front-end systems. So that allows us an opportunity to basically plug-and-play as different technologies are evolving. So we all see it. I mean, today, XYZ search engine might be the best search engine, somebody might be developing a better search engine in their garage tomorrow. And so when we went through our system re-architecture, basically, we broke everything apart so that we'd have ultimate flexibility in plugging and playing. So we're really doing both. I'd say it's a combination of partnering with organizations that are very focused in specific areas, because here's the reality. I mean, Kforce is not going to help technology on the massive technology providers and everybody's after human capital in one way or the other. So we're partnering. We're acquiring SaaS-type licensing. And then we're also bringing in platforms and customizing to a certain extent. So it's really a combination of all the above.

Last question for me. In your 2020 outlook, you gave us a little bit of color on Tech and F&A, about Direct Hire, what would the assumption be for 2020?

Yes. So again, yes, we're trying to give you an illustration here of how 2020 might look. I think, obviously, the Direct Hire market has been -- is very good. Joe talked about, and you were talking about average duration of assignment, right, to strengthen the Direct Hire market probably reflective of the same thing, trying to identify talent. And I think we're looking at a very good year for '19. And as I look forward here, a relatively stable good outlook for Direct Hire for 2020. But again, I wouldn't read too much into specific numbers here, Tobey, this is for illustrative purposes.

Yes, from a per Direct Hire standpoint as well, Tobey. I think it's important to note, it was probably about 3 years ago, we saw our conversion levels really move up. And we've seen those stay at elevated levels. So it's clear, the end clients are utilizing staff augmentation as also a means to accommodate their full-time hiring, more in the try and buy. So we're seeing really a lot of right to hire being executed within our contracts. Once those consultants become proven, they see an ongoing need. It's a right fit for the consultant. It's a right fit for the organization. So that's another means where Direct Hire. And we don't really, in many instances, derive revenue in our Direct Hire line item associated with that because after certain duration of assignment, basically, those consultants can convert, and there's no fees associated with that. So that employment space in tech has been very healthy.

Okay. Thank you very much.

Thank you. And we have a follow-up from Greg Mendez with Baird. Your line is now open.

Thanks. Just one more follow-up. I was wondering if you could just talk a little bit more on the growth with managed services in the quarter. And then how we're thinking about that next year? I mean, obviously, you continue to grow, but I think previously, we're at about 5% of revenue. So just thoughts there and for next year would be helpful?

I remember one of our previous calls, I believe, Dave had managed the expectations, our objective over the course of the next 5 years is to really evolve this service offering to be roughly 20% of our overall revenue mix or better hopefully. And so we're continuing to make the investments. The pipelines continue to build that we're building out the teams. I am also refining our processes and methodologies. We've aligned our more dedicated people to focus on these efforts. So we're very comfortable with staying on track to hit those objectives that Dave put out there.

Okay. Thank you.

Thank you. And I'm showing no questions in the queue at this time. I'd like to turn the call back to David Dunkel, Chairman and CEO, for any closing remarks.

All right, great. Well, thank you for your interest and support for Kforce. While we always have much more to do. I'd like to again say thank you to each and every member of our field and corporate team and also to our consultants and our clients for allowing us the privilege of serving you. We look forward to speaking with you again soon. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.