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Edited Transcript of KFRC earnings conference call or presentation 6-Feb-19 1:30pm GMT

Q4 2018 Kforce Inc Earnings Call

Tampa Feb 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Kforce Inc earnings conference call or presentation Wednesday, February 6, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David L. Dunkel

Kforce Inc. - Chairman & CEO

* David M. Kelly

Kforce Inc. - Senior VP, CFO & Corporate Secretary

* Joseph J. Liberatore

Kforce Inc. - President

* Michael R. Blackman

Kforce Inc. - Chief Corporate Development Officer

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Conference Call Participants

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* Joseph Marberry Thompson

SunTrust Banks, Inc. - Head of SunTrust Private Wealth Management

* Kevin Damien McVeigh

Crédit Suisse AG, Research Division - MD

* Mark Steven Marcon

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Timothy John McHugh

William Blair & Company L.L.C., Research Division - Partner & Global Services Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Q4 2018 Kforce Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this conference call may be recorded.

I would now like to introduce your host for today's conference, Mr. Michael Blackman, Chief Corporate Development Officer. Sir, you may begin.

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Michael R. Blackman, Kforce Inc. - Chief Corporate Development Officer [2]

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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?

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David L. Dunkel, Kforce Inc. - Chairman & CEO [3]

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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 result 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 adviser 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 include -- 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, through 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 midpoint 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 macroeconomic environment, significant market volatility and political uncertainty has persisted. Contrary to the concern that we might be late in the cycle, however, the strength in 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. Nontraditional 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, cybersecurity, mobility and digital marketing. These rapidly changing technologies are also impacting staffing, as new tools become available and nontraditional 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 improved 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 to 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 in 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?

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Joseph J. Liberatore, Kforce Inc. - President [4]

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Thank you, Dave, and thanks to all you for your interest in Kforce. Our results in the fourth quarter, particularly in Tech Flex, reflect the 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, where 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 the year-over-year growth rate may accelerate and may exceed 10%, despite increasingly difficult comps.

We continue to make the necessary adjustments to align our sales and delivery talent within our client portfolios, which is contributing to both improved revenue growth rate 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 effort 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 the 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 the 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 set less susceptible to being disrupted by technology advancements. We're 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 high 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% to 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 the 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 pursuit and have positioned KGS for significant growth. It is clear, the time line of KGS new business pursuits have been delayed as a result of the federal government shutdown.

Last quarter, we disclosed KGS was awarded its largest contract in 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 the timing of the resolution is a bit uncertain, we expect it to be resolved favorably over the next 30 to 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 million to $40 million once fully ramped. Despite the impact of the shutdown on loss 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 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 the 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 to 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 investment, have led to improved productivity of our revenue-generating talent, which has improved greater than 10% each of the past 3 years. Our associate population by design was flat sequentially and would 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 to 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.

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

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David M. Kelly, Kforce Inc. - Senior VP, CFO & Corporate Secretary [5]

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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 and 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 was partially offset by higher Direct Hire and KGS product revenue mix.

Tech Flex margins of 26.6% declined 60 basis points year-over-year, and FA Flex margins of 28.7% increased 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 2 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 expenses 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 were $23 million and were quite strong. We ended 2018 with outstanding borrowings under our credit facility of $71.8 million, which equates to leverage of approximately 0.8x 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 and 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.

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 for 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 onetime 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 toward regulatory, legal or future tax law changes.

We are firmly on track to reach our next milestone of 7.5% operating margins where 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 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 were successful in accelerating revenue growth in our Tech Flex business, continuing to improve associate productivity, generating higher levels of profitability and significantly improving cash flows. We're 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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Tim McHugh from William Blair.

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Timothy John McHugh, William Blair & Company L.L.C., Research Division - Partner & Global Services Analyst [2]

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Just want to -- on the guidance, the gross margin commentary. I guess, as I listened to your comments, especially on the Tech Flex, it was mostly about a 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?

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David M. Kelly, Kforce Inc. - Senior VP, CFO & Corporate Secretary [3]

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Sure, Tim. This is Dave Kelly. Actually, yes, 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 on -- in cost of sales and increased payroll taxes. That's actually what's driving that sequential decline.

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Timothy John McHugh, William Blair & Company L.L.C., Research Division - Partner & Global Services Analyst [4]

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I was talking year-over-year decline. I guess, it still seems to be down quite a bit on that basis.

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David M. Kelly, Kforce Inc. - Senior VP, CFO & Corporate Secretary [5]

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So if you look, Tim -- so I did mention as well -- so in Q4, so we're talking about stable bill/pay spreads from Q4 to Q1. From Q3 to Q4 sequentially, we saw a decline, as I'd 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 '18 versus Q4 of '17 and will stay at those levels.

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Timothy John McHugh, William Blair & Company L.L.C., Research Division - Partner & Global Services Analyst [6]

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Okay. Yes. And then can you talk a little bit more about the year-end? I guess, the comment, basically, you saw more engagements than normal, particularly in counsel engagements. And I get kind of the broad commentary that feels just like people are afraid to lose resources. But is there any more, I guess, specifics you can give in terms of what sectors you saw that in or what kind of feedback you're getting in terms of, I guess, why you're seeing that behavior, if there was in any particular areas that you saw it more pronounced than others?

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Joseph J. Liberatore, Kforce Inc. - President [7]

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Yes, Tim. This is Joe Liberatore. Yes, typically, on the back end of every year, we have contract ends, which then requires us to rebuild as we move through the force of Q1 with typically getting back to kind of pre-holiday levels, usually in that March time frame. What we experienced -- and 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 things 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 have to roll them off from a co-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, is this is all directly related to the war for talent, this -- supply-demand is as far out of balance as we've ever seen it for the highest demand skill sets. And people are looking to hold on to individuals.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [8]

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Tim, this is Dave. The other point that I think that we made in the prepared remarks was we had really never seen the acceleration going into the back end 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 back end of the year, which was 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.

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Timothy John McHugh, William Blair & Company L.L.C., Research Division - Partner & Global Services Analyst [9]

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Okay. 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 roll out? And what sort of impact could we watch for on the business as you do that?

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Joseph J. Liberatore, Kforce Inc. - President [10]

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Yes. As of right now, we're targeting it'll be the back end 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 individuals the best tools to go out and identify and then move people through the process, applying 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 back end and then as we move forward from there.

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Operator [11]

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Our next question comes from Tobey Sommer from SunTrust.

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Joseph Marberry Thompson, SunTrust Banks, Inc. - Head of SunTrust Private Wealth Management [12]

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This is Joseph on the line for Tobey 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?

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Joseph J. Liberatore, Kforce Inc. - President [13]

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Yes. 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.

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David M. Kelly, Kforce Inc. - Senior VP, CFO & Corporate Secretary [14]

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

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Joseph Marberry Thompson, SunTrust Banks, Inc. - Head of SunTrust Private Wealth Management [15]

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

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Joseph J. Liberatore, Kforce Inc. - President [16]

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Yes, I mean, actually, the strong external environment, I mean, those 2 things really are directly connected at the hip, so it's a combination of those 2. It's the productivity of our individuals are driving the growth against the backdrop of a very strong economic and robust hiring environment.

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Operator [17]

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Our next question comes from Mark Marcon from R.W. Baird.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [18]

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Just wanted to ask, Dave and Joe, you mentioned some of the clients waiving the Microsoft kind of era stipulations. How do they do that? And how much are you seeing that?

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Joseph J. Liberatore, Kforce Inc. - President [19]

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It's just really -- it's internal programs that all these organizations have put in place based upon 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. So in essence...

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [20]

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Are they actually in contract with you? In terms of how much the comp would end up being for -- I remember, those contracts pretty specifically and particularly as it related to benefits, options, et cetera. I mean, that's a great sign that they're doing it. I was just wondering if you could just elaborate a little bit about how widespread that is.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [21]

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Mark, this is Dave. The issue really relates more specifically to the term limits, you could call employment. So basically, what we're seeing, there's an evolving view about the relationship -- the employment relationship and the responsibility for the management and 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 relationship. So organizations in the past took a more conservative view of term limits have relaxed some of those, not really an impact on benefits per se because we're -- we actually are offering benefits across the whole term anyway. It really relates specifically to the co-employment issue.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [22]

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Yes, that's really encouraging. How widespread is that now?

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Joseph J. Liberatore, Kforce Inc. - President [23]

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I mean, we're hearing it more than -- I'm in -- I'm entering my 31st year in this industry and really had never experienced it prior, even when we went through the great imbalances during the dotcom era. So I would not say that it is broad-based. There's just -- there are certain organizations that you would not expect to see that coming from that are now waiving that. And by the way, they're not waiving it broad-based across all areas. It's really just more in those real very high-demand skill sets. So 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.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [24]

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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, okay, 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?

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Joseph J. Liberatore, Kforce Inc. - President [25]

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Yes. So I'll speak to 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.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [26]

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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 5 largest clients, actually, the concentration is less in those 5 largest. So the growth of that top 20, 25 is weighted towards clients 6 through 25. So this -- within that portfolio, Fortune 1000 clients, the focus here has been on large users of technology flex services where we don't have a significant -- as significant a relationship and growing those, and that is what is driving the double-digit growth in Tech Flex.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [27]

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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 the $400 million?

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David M. Kelly, Kforce Inc. - Senior VP, CFO & Corporate Secretary [28]

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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 at $400 million in revenue, we -- 7.5% operating margin at $400 million, we've said at $350 million, we would be at 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 approve -- improve efficiency, both in the 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.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [29]

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Yes, Mark. I think -- 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 a 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 manifest 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.

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David M. Kelly, Kforce Inc. - Senior VP, CFO & Corporate Secretary [30]

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Yes. So just to state what we've said before, as revenues grow, as Joe said, we expect to see a trail-up in Direct Hire revenues. That's actually going to breed the 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.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31]

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Great. There's 2 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? 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?

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David M. Kelly, Kforce Inc. - Senior VP, CFO & Corporate Secretary [32]

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Yes. So on the Direct Hire, the reality is if you look back over the course of the last 8 quarters at the quarterly revenue contribution in 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 revenues as we continue to outpace the growth with Tech Flex and such. Does that answer your question on...

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [33]

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

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David L. Dunkel, Kforce Inc. - Chairman & CEO [34]

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Mark, this is Dave. We are making selective investments in that area. But we're also saying, that business has changed significantly. We've seen 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.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [35]

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Okay. Is it on F&A?

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Joseph J. Liberatore, Kforce Inc. - President [36]

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Yes. Well, let me -- I'll just wrap up. As always, with Direct Hire, on 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 had 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.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [37]

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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 convergence with the technology and the FA skill sets, 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.

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Joseph J. Liberatore, Kforce Inc. - President [38]

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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, 3, 4 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.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [39]

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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?

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Joseph J. Liberatore, Kforce Inc. - President [40]

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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.

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Operator [41]

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(Operator Instructions) And our next question comes from Kevin McVeigh from Crédit Suisse.

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Kevin Damien McVeigh, Crédit Suisse AG, Research Division - MD [42]

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Great. Can you just frame out that F&A a little different in terms of what percentage of the business has kind of real potential versus secular risk to it? And is there a way to think about that in terms of skill sets and then kind of 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?

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Joseph J. Liberatore, Kforce Inc. - President [43]

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Yes, 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.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [44]

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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.

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Kevin Damien McVeigh, Crédit Suisse AG, Research Division - MD [45]

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Understood. And then just as you see kind of the mix evolve, 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, kind of the $1.4 billion? Are we still able to kind of achieve those? Or do we need to revisit them?

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Joseph J. Liberatore, Kforce Inc. - President [46]

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Yes. 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 our -- 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.

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David M. Kelly, Kforce Inc. - Senior VP, CFO & Corporate Secretary [47]

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Yes. So Kevin, this is Dave Kelly. So my -- 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.

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Operator [48]

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And we do have a follow-up from Mark Marcon from R.W. Baird.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [49]

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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.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [50]

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

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Joseph J. Liberatore, Kforce Inc. - President [51]

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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 up on remains time and materials. Albeit, I would consider them more bulk arrangements. 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.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [52]

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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 of 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. They're 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. So -- 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're -- we, as technology, staffing and solutions providers, are right in the sweet spot of where we want to be to address the 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.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [53]

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Great. And then I was wondering if you could -- 2 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's had a big shift in sentiment, but wondering what you're hearing actually from clients.

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Joseph J. Liberatore, Kforce Inc. - President [54]

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Yes. 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 were 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 contract 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 get 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.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [55]

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Yes. 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 kicked 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.

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Joseph J. Liberatore, Kforce Inc. - President [56]

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Yes, because 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.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [57]

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

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Joseph J. Liberatore, Kforce Inc. - President [58]

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Yes. I would say what 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.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [59]

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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 0 impact on 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 0 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?

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [60]

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Obviously, more.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [61]

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

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Joseph J. Liberatore, Kforce Inc. - President [62]

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It's not optional.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [63]

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Yes, it's not.

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Mark Steven Marcon, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [64]

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It's not an option. It's -- we've -- everybody has to spend more.

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Joseph J. Liberatore, Kforce Inc. - President [65]

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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 nontraditional 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 nontraditional competitors. I mean, it's a perfect storm for technology.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [66]

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And if you look at FinTech and all the things, particularly on the larger banks, I mean, it's just -- 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.

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Operator [67]

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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.

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David L. Dunkel, Kforce Inc. - Chairman & CEO [68]

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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.

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Operator [69]

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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.