Kforce Inc (KFRC) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kforce, Incorporated, Q4 2016 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded.

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

Good afternoon, and welcome to the Q4 call. The prepared remarks for this call are available on the Investor Relations page of the Kforce, Inc., website, in the Download Library under Shareholder Tools.

Before we get started, we would like to remind you that this call may contain certain statements that are forward-looking. These statements are based upon current assumptions and expectations and are subject to risks and uncertainties. Actual results may vary materially from the factors listed in Kforce's public filings and other reports and filings with the SEC. We cannot undertake any duty to update any forward-looking statements.

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

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

I'm going to spend a few minutes discussing Q4 and 2016, then turn to discuss market and industry dynamics and thoughts on 2017.

2016 was a year of considerable transformation for Kforce. Although we are disappointed with our full-year financial results, as revenues of $1.32 billion are roughly equal to prior-year revenues, we are encouraged about our prospects for 2017, and we are beginning to see the benefits of the actions we have taken in support of our longer-term strategy.

Key among the many changes we made was to consolidate and streamline our sales and delivery organization under a single leader. This change has allowed us to rapidly rebalance and deploy our talent to more effectively meet customer needs and also drive greater accountability for activities across the enterprise.

During the fourth quarter, we made a significant investment to enhance our sales methodology and train our sales associates to engage in more strategic conversations and shape solutions with our clients.

During the past year, we also made significant progress towards a 2017 rollout of our new customer relationship management system, which incorporates our sales methodology to reinforce execution. This rollout is a major piece of a multi-year effort to replace and upgrade our technology tools to equip our talented associates with significantly improved capability to deliver exceptional service to our clients, enhance productivity and accelerate associate ramp-up.

As we move into 2017, we believe these actions have laid a solid foundation for a reacceleration of revenue growth, improved associate productivity, and is very much aligned to our longer-term profitability objectives.

Revenue in the fourth quarter returned a year-over-year billing day growth, as anticipated. Our intra-quarter trends as well as the momentum we have carried into the beginning of the first quarter are providing encouraging signs about our ability to accelerate Tech Flex revenue growth in 2017.

Earnings per share in the quarter was $0.36, which exceeded the top end of our guidance by $0.03. Dave Kelly, our Chief Financial Officer, will elaborate on these trends and results further in his prepared remarks later in this call.

We continued to return capital to our shareholders in the form of share repurchases and dividends, totaling $56 million for the full-year 2016. Over the last three years, we have returned $221.4 million to our shareholders in the form of share repurchases and dividends.

Turning to market and industry observations, entering the fourth quarter, the Presidential election and expectations for a slowing period of economic growth caused uncertainty and hesitancy by our clients to make new commitments for 2017 investments. It was widely anticipated that we were approaching the end of the business cycle and the staffing industry was entering a recession.

The surprise election outcome and corresponding policy expectations had a tangible effect on optimism and brought greater clarity for economic prospects. As a result, and together with the impact of our previously mentioned initiatives, we began to experience improving trends later in the quarter.

Given the pace of reform under the Trump administration in large and complex areas such as immigration, healthcare, financial regulation and corporate taxation, we are closely monitoring the potential impacts, both positive and negative, on our business. To date, most of the details regarding the potential reform in these areas have not yet been communicated.

Skilled technology talent continues to be in high demand, with the potential tightening of immigration standards only exacerbating the supply shortages. The secular drivers of technology spend remain intact, with many companies now becoming increasingly dependent on the efficiencies provided by technology and the need for innovation to support business strategies and sustain relevancy in today's rapidly changing marketplace.

Technology investments -- in particular mobility, cloud computing, cybersecurity, e-commerce -- machine learning, digital marketing, advancements in the use of big data, and business intelligence have contributed to the demand landscape for technology resources. We expect that the ubiquitous nature of technology and continued advancements in these areas will continue to fuel demand as companies strive to remain competitive and meet evolving customer expectations.

We are confident in the structure and strength of our organization and believe the actions taken during 2016 position us well to maximize our market opportunities, and we remain on track to achieve our operating margin commitments of 6.3% at $1.4 billion and 7.5% at $1.6 billion in annualized revenue.

Our bias continues to be to invest in our business to generate long-term shareholder value. These investments include measured and balanced additions to our revenue-generating talent and enhancing and sustaining sales and delivery and training tools. We also plan to continue our technology-related investments while taking appropriate care to monitor opportunities that technological advancements might provide to enhance our operating model.

We're very pleased to welcome Randy Mehl to the Kforce Board of Directors. Randy has served as a lead investor and director for other companies in the areas of digital marketing, IT services, analytics and workforce management, as well as prior experience as a sell-side equity analyst. Randy is well-known in the staffing industry, and we are excited to have him join the Kforce team.

I'll now turn the call over to Joe Liberatore, President, who will provide further details on our Q4 operating results. Dave Kelly, Chief Financial Officer, will then add further color on our Q4 operating trends and financial results as well as provide guidance on Q1. Joe?

Thank you, Dave, and thanks to all of you for your interest in Kforce. We've been focused throughout 2016 on positioning our sales and delivery teams to operate with greater consistency and discipline to improve the intimacy with our clients, candidates and consultants.

This included rebalancing our revenue-generating talent between sales and delivery. We ended 2016 with a 9.1% increase in our sales talent, while planned attrition within our delivery talent contributed to overall revenue-generating talent declining 2.9% year-over-year. This rebalance is allowing us to reaccelerate our client-facing activities and diversify our client portfolio over a broader range of our largest clients.

In addition to improving revenue trends, we are seeing this rebalance and implementation of our sales transformation initiative we began in the fourth quarter is resulting in increasing strength in client visits, job orders, submittals and send-outs in both Tech Flex and FA Flex. We are pleased to return to year-over-year revenue growth in Tech Flex and FA Flex. The improvements we experienced during the fourth quarter in both of these businesses is also translating into a solid start to our first quarter of 2017.

Now, for a bit more detail within each business. Tech Flex, our largest segment, which accounts for 65% of total revenues, improved 1.1% sequentially and 1.4% year-over-year on a billing day basis. As we noted last quarter's call, we began to see improvements in sequential revenue trends coming out of the summer months and into October. While the trends slowed a bit due to the Presidential election and usual seasonality around the holiday months, we are experiencing strength in recovery trends from year-end assignment ends.

Our activity levels have remained elevated and suggest continued strength in demand within technology. We are also continuing to benefit from positive trends in the length of our average assignment, which we believe is driven by our client's desire to retain qualified, skilled IT talent.

In terms of performance by industry in Tech Flex, we experienced sequential billing date growth in six of our top ten industry verticals, which suggests to us that the demand environment is broad-based. Financial services, retail and communications were particular strengths sequentially and year-over-year.

Our Tech Flex sales talent is being allocated to the market and clients that have the greatest level of opportunity. From a sales set standpoint, our teams continue to focus on areas of greatest demand and high demand development skill sets, such as .NET, Java, as well as cybersecurity, project management and business intelligence.

We expect Tech Flex revenues to decline sequentially on a billing day basis in the first quarter due to seasonal year-end assignment ends. However, based upon our strong start to the quarter, we expect further expansion of our year-over-year growth rate.

Our FA Flex business, which represents 24% of total revenues, increased 8.5% sequentially and 2.1% year-over-year on a billing day basis. Our activity levels and assignment start volume were particularly strong in the fourth quarter, which has continued into the first quarter of 2017. From an industry perspective, nine out of our top ten verticals saw sequential billing day improvements, with financial services, business services and retail experiencing notable growth.

Following project end and elevated conversions in the first half of 2016, we experienced an encouraging trend in late Q3 and throughout Q4. Early first quarter 2017 finds are also encouraging, and while we expect to experience usual seasonal decline sequentially, we anticipate that our year-over-year growth rate will accelerate.

Revenues for Kforce Government Solutions declined 8.5% sequentially, but increased 4% on a year-over-year -- on a billing day basis, driven by both services and product revenue increases. We continue to see the majority of the awards on T4 Next Gen contract going to small, service-disabled, veteran-owned businesses, though we have been successful in a number of these awards as a subcontractor.

With the successful recompete on two projects in January, virtually 96% of KGS revenue base in 2017 is secure. This will allow KGS the ability to focus their efforts on maximizing the capture of opportunities under the T4 Next Gen contract as well as their other business development efforts. We expect revenue for KGS in Q1 2017 to be flat sequentially on a billing day basis, but to maintain a year-over-year growth rate at a level that approximates Q4 2016.

Direct-hire revenues from placements and conversions declined 8.8% sequentially and 14.5% year-over-year. This revenue stream is currently 3.5% of total firm revenues, though the fourth quarter is usually the low point due to seasonality. Our objective is to meet the talent needs of our clients through whatever means they prefer, and we will continue to provide this capability, though investment in our talent for our Tech Flex business remains our priority.

We believe that the longer average assignment length that we are experiencing in our Flex business may be an indication of our clients' reluctance to convert these consultants. January direct-hire revenue is off to a slower start, and we expect revenues to decrease in Q1 2017 sequentially and year-over-year.

From a talent perspective, we have been focused on providing our revenue-generating talent with the necessary tools to be more effective and efficient when performing their roles, put them in a better position to collect more relevant business intelligence, to enable better evaluation of business opportunities, and allow us to evaluate the value that we bring to our clients and consultants.

As it relates to this, we completed the initial rollout of our sales transformation initiative in the fourth quarter, and have also made solid progress on ingraining our enhanced sales process and methodology into our new front-end customer relationship management system that will be deployed in 2017. We believe these investments will generate a significant return by improving how we consistently engage with and deliver services to our clients and enhance our effectiveness and efficiency.

Looking ahead to the first quarter, we expect to continue to make selective investments in revenue-generating talent, but overall talent levels may be flat with the fourth quarter as we focus on full adoption and integration of our sales transformation efforts. We believe significant capacity exists to grow revenue with the current mix of tenure within our talent population, coupled with improved productivity levels as a result of the investments we've made.

I'll now 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. Total revenue for the quarter of $326 million was in line with our guidance. Revenues grew 1.7% sequentially and 1.1% year-over-year on a billing day basis, as the fourth quarter of 2016 had one less billing day than Q4 2015. Total flexible staffing revenues, which exclude our government business, grew 3% sequentially and 1.6% year-over-year on a billing day basis. Earnings per share of $0.36 in the quarter exceeded the top end of our expectations, as we continue to see the benefits of our streamlining activities.

Our gross profit percentage in Q4 of 30.6% fell short of our expectations, decreasing 70 basis points sequentially and 100 basis points year-over-year. The year-over-year decline in gross profit margins was driven by a 60-basis-point decline in Flex gross profit margins as well as a reduced concentration of higher margin direct-hire revenue, which represents 3.5% of revenues in the quarter versus 4.1% a year ago.

Our Flex gross profit percentage of 28.1% in the fourth quarter decreased 50 basis points sequentially and 60 basis points year-over-year. The year-over-year decline in Flex margins was driven primarily by compression in bill pay spreads in our FA Flex business due to a lower mix of project business in F&A from a year ago and a 460-basis-point decline in our government business, which is realizing lower margins on some of its recompete wins and had a lower mix of higher margin product business than a year ago. Tech Flex margins are basically stable year-over-year, as we've seen some recent stability in bill pay spreads, which are only down about ten basis points year-over-year.

At a transactional level, bill rates and pay rates in Tech Flex and F&A Flex increased in tandem during the quarter, though we have begun to see slight wage inflation in both Tech Flex and FA Flex, which will continue to put pressure on spreads. Specific to our Tech Flex spreads, we've had particular success in growing revenue within our 25 largest clients, which now represent approximately 47% of total Tech Flex revenues. Most of these significant users of flexible resources are increasingly looking to consolidate spend with fewer providers, and for that, gain escalating discounts based upon volume increases.

In addition, financial services, our largest industry vertical, has become a larger presence within our overall portfolio, now representing approximately 20% of total Tech Flex revenues. This business tends to have a lower margin profile than the overall average. As we look forward into the first quarter, we expect margins, exclusive of the impact of annual payroll tax resets, to be stable.

SG&A as a percentage of revenue was 25.2% in Q4 2016, versus 24.6% in Q4 last year. The year-over-year increase is due primarily to a 60-basis-point impact from the investment we made in the fourth quarter to significantly enhance our sales methodology and train our sales associates. The investments we continue to make in technology enhancements and revenue-generating talent are being largely offset by the benefits we're deriving from our streamlining activities.

Additionally, the firm recognized the benefit of 20 basis points in the quarter for the true-up of performance-based compensation costs as a result of lower-than-anticipated full-year performance expectations.

Q4 2016 operating margins were 4.7%, as compared to 6.2% in Q4 2015. We take a longer view of our business and expect to continue to make measured investments in additional revenue-generating talent and technology enhancements. Our goal is to significantly improve the productivity of our associates and also capitalize on the efficiencies we gained from servicing large customer engagements to create SG&A leverage and improve operating margins.

With respect to our balance sheet and cash flows, our accounts receivable portfolio continues to perform well, though operating cash flows in the fourth quarter of $10.1 million were lower than expected. As we noted last quarter, we brought certain back-office functions onshore from Manila to our Tampa headquarters in the fourth quarter, which impacted the timing of cash flows this quarter, so we expect this timing issue to resolve itself in the first quarter of 2017. Capital expenditures for Q4 were approximately $3 million in the quarter.

We continue to maintain significant borrowing capacity under our $170-million credit facility. Long-term debt at the end of the quarter was $115.5 million, which is an increase of $10.5 million from Q3 2016.

We repurchased roughly 680,000 shares for $15 million during the fourth quarter, and returned approximately $56 million to our shareholders in 2016, $44 million of which was through share repurchases and $12 million in dividends.

We continue to believe that our strong balance sheet and cash flows provide ample resources to continue to invest in the growth of our business while returning the cash we generate to our shareholders using these mechanisms. However, the first quarter is typically our lowest cash flow quarter as a result of the timing of cash outlays.

With respect to guidance, the first quarter of 2017 has 64 billing days, which is the same number of days of the first quarter of 2016. We expect Q1 revenue to be in the range of $330 million to $335 million and for earnings per share to be between $0.22 and $0.24. This includes the combined impact to Flex margins and SG&A of annual payroll tax resets in Q1, which is expected to be approximately $0.13 per share.

Gross margins are expected to be between 29.3% and 29.5%. Flex margins are expected to be between 27% and 27.2%, which assumes a 110-basis-point negative sequential impact from payroll tax resets. SG&A as a percentage of revenue is expected to be between 25.5% to 25.7%. Operating margins are expected to be between 3% and 3.3%. This guidance assumes an effective tax rate of 38%, which is a bit lower than 2016, as we continue to see an increased benefit from work opportunity tax credits from improved diligence in this area. Weighted average diluted shares outstanding are expected to be approximately $26 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 related to any pending tax or legal matters, the impact on revenues of any disruption in government funding, or the firm's response for regulatory, legal or tax law changes.

As we noted on last quarter's call, there will be certain changes in the accounting for equity-based awards beginning in the first quarter, one of which results in excess tax benefits and tax efficiencies recognized on the vesting of equity awards being recorded in our income statement for income tax expense. The impact of this change depends upon the valuation of our common stock investing dates. Assuming the current valuation for Kforce stock, the impact is expected to be insignificant.

We believe the actions taken in 2016 to realign our leadership, rebalance our sales and delivery talent, refine our sales strategy and streamline our operations set us up to take advantage of a strong, sustained market for highly-skilled talent during 2017 and beyond. We believe the combination of these actions will enhance our ability to accelerate revenue growth and create additional operating leverage as the firm grows and the productivity of our associates improves.

We intend to supplement our capabilities with selective additions to our revenue-generating talent and technology enhancements, and believe that this collective strategy will lead to longer-term success. The actions we've taken reinforce our confidence in honoring our longer-term commitment to shareholders to achieve an operating margin of at least 7.5% at $1.6 billion in annualized revenue. We also still expect operating margins to be in excess of 6.3% at $1.4 billion in annualized revenue, which we may see as early as the second quarter of this year.

Crystal, we'd now like to turn the call over for questions.

Thank you. (Operator Instructions). Mark Marcon, R.W. Baird.

Really nice to see the same billing date growth rates in Flex. I was wondering if you could talk a little bit about what you're seeing specifically with some of the efforts that you've made to target some new clients on the IT side in terms of expanding the portfolio of clients that you have really good relationships with, and to what extent is that one of the drivers for the better-than-expected Q1 guidance for revenue?

Mark, it's Joe. I would say it's really -- it's a combination of targeting new clients as well as going deeper and wider in existing clients, where we've placed a lot of our emphasis there. So probably the best way I could say that is we've seen our top-25 portfolio grow by about 450 basis points on a year-over-year basis, so I think where that really ties back, one of the things is, right, larger customer, lower margin. I think when you look at our margin profile pretty much staying flat on a year-over-year basis, we're being able to accomplish that while maintaining our margin.

That's great. And on the F&A side, it sounds like you're seeing better trends than the largest player in this space. Can you talk a little bit about that in terms of what's driving that?

Yes, I mean, I think it's the same story that we've pretty much been consistent with over the better part of the, probably, last three or four years when -- up until last year, I think we were really outperforming the overall marketplace, and it really has a lot to do with going after more bulk-type business, leveraging our ability from a centralized delivery to service that business.

So last year, we had a lot of projects that came to closure that we had trouble outrunning, and we're seeing, at this point in time, projects coming back onboard, and we have a pretty good pipeline, so that's really what's being reflected in our Q1 guidance.

Great. And then a question for David -- a couple of them. One would basically be with regards to the comment about potentially achieving the 6.3% operating margin target by as early as Q2. Can you just put a little bit of color around like what would we need to see in terms of a revenue run rate or a mix or -- are you signaling that given the current trends, perhaps by Q2, but certainly by Q3? How should we interpret the comment?

Yes, Mark, this is Dave Kelly. So, yes, I think you nailed it on the back half of your comment. As we think about where trends are looking in the first quarter and we look historically as we've built revenues in the first quarter and the trends, the sequential growth trends that we would typically see from Q1 to Q2, just the simple math suggests -- as well as the positive trajectory that we're seeing -- that that $350 million number is going to be in the ballpark there, which is part of the reason why we made that comment.

And then for us, obviously, all the planning that we've done. Joe had mentioned in his commentary about productivity improvements. We've had a lot of conversation here around the realization of the full benefit of the streamlining activities that we undertook in the last half of the year. You combine all those things together with the reduction in payroll taxes, and the bottom line, again, manifests itself, which is growing -- gets us in that $350 million revenue category and that range of 6.3%, so it's pretty simple.

Great. And then I'm sure you've done this calculation. If the top corporate tax rate ends up declining by 1000 or 1500 or 2000 basis points, how should we think about calibrating that to your actual cash tax liability?

Yes, sure. So obviously, Mark, you're right, we don't know what and when we will see changes in the federal tax rates, but if we do, obviously the fact that we're an entirely domestic company, we've got minimal timing issues means that any reduction in tax rates is almost perfectly correlated to reductions in our obligations, so it's a simple way to think about it because it's a simple business that we have.

That's what we thought. Thank you.

Kevin McVeigh, Deutsche Bank.

Great. Thank you, and just great, great job. I want to just talk a couple things just directionally. If I heard the comments right, it sounds like you're sourcing more towards revenue generators as opposed to sourcing candidates, and just given how tight IT has been, that's just a real impressive ability to do that. I mean, is that just -- what enables you to do that given just how tight IT demand is? Obviously, you've been really, really impressed in being able to source that talent at the fewer people. Ultimately, just how do we do that?

Yes, Kevin, we've -- I think we've gotten a little bit ahead of ourselves in terms of the amount of staffing we were doing on the delivery side of the house, so we were overweighted on that side of the equation, especially in light of as tools and technologies still continue to improve, and so we're seeing more efficiencies on those fronts.

So our objective was to get to more of an appropriate balance of sales and delivery to be able to service the need, so I don't think we're doing anything special there. I mean, I would really put that back on our leadership and more effectively driving activities and driving focus in and around the right requirements. So it's really part of our overall leadership playbook that's allowing us to do that, so I don't think we're special relative to anybody else in the marketplace from that standpoint.

Got it. And then as you think about, obviously, tax reform, one of the things that's been in the press a lot is H-1B reform, and my experience has always been companies don't wait for the law. They start to change their patterns. And quite frankly, even if the law doesn't change, I would imagine they would want to take maybe some of that risk off the table. Are those conversations starting to be had?

Actually, surprisingly enough, there hasn't been a whole lot of conversation up to this point in time. I mean, certain people are starting to think it through, but we haven't seen anybody reacting at this point in time. When we look at all of the proposed regulations that are out there as they stand right now, we don't see anything on the horizon that really probably doesn't play to a benefit to who we are.

I mean, most of this appears that it's going to come back and it's going to hit really the heavy foreign national entities that are bringing in a lot of H-1Bs. Most of any of the H-1B work that we do here is really US-based, so most of what's out there and being proposed at this point in time doesn't appear that -- it creates more opportunity for us at this point than threat specific to us.

I would say if it were to play through the way that some of it's being articulated, I mean, it's going to create a little bit more constraint in an already challenging supply environment, which, again, with recruitment being what I believe is one of our strengths, I think it plays to our favor.

Got it. And then one more, just because it's -- really, really nice job. You're seeing it a lot earlier, and Mark alluded to this, in basically all your peers in terms of the reacceleration. Is that all organic? Is that just kind of the client mix that you're dealing with, or just any thoughts around that? I mean, it's just pretty dramatic.

Yes, I mean, we're completely organic. I think the last acquisition we did on the commercial side was 2006. This is really -- I would say we've reengineered discipline and focus within the firm. That's where a lot of our efforts were in and around, and it also dials into our sales transformation to drive greater consistency. So this is an execution business, and our team has done a really nice job on embracing and driving the execution, and to be candid, I think we're just on the start of that path at this point.

Awesome. Thanks, guys.

Randy Reece, Avondale.

First question I had, you had discussed how many vertical markets had seen sequential growth in, I guess it was, hours billed per day from third quarter to fourth quarter, and is there a point in time in this year where you expect more of those industry verticals to start clicking into some growth?

Yes, so I think what I put out there was six out of ten from a Tech Flex standpoint, nine out of ten on FA. So I'm assuming your question is more towards the Tech Flex. Yes, I would say when I look at the industry verticals where we didn't experience the growth, it's really more client-specific versus any particular dynamic going on within those verticals, so I think there is -- absolutely there's opportunity across the board, because we are seeing demand broad-based. Even in those industry verticals where we didn't experience the year-over-year growth, the dynamics are healthy and the demand is there.

When we -- you discussed CRM system implementation. Is there any effect on D&A expense as we go through the year?

Yes. So, Randy, a little bit, right? A lot of -- I think we've mentioned this in the past. So as we move to subscription-based services, you're going to see actually a lot of the work that we're doing in technology, inclusive of this CRM, is going to be and manifest itself in SG&A, and we're seeing some of that already in our cost structure. So, no, the D&A line isn't expected to move significantly.

All right. And on the subject of permanent placements, I was wondering how you would compare what you are doing with what the market is doing and how you expect search to go through the rest of the year. I know you're not putting a huge priority on trying to grow search necessarily, but I'd like to get a little bit more of an understanding of how that might play out this year.

So relative to us specifically, not talking about the competitive landscape, we look at how we service the technology sector differently than how we service the finance and accounting sector, because within technology, we're operating with very similar skill sets to what our flex footprint is, so we've blended most of our technology search. So we have some dedicated technology search, but the bulk of what we do is in a blended model.

One of the things that we experienced, and it was kind of -- it was woven into some of my comments -- were we've really seen conversions slow in the fourth quarter. I think our conversions were down 13% year-over-year in the fourth quarter, which to us really tells us that the clients are looking to hold onto that talent more, still maintain flexibility.

So we're going to continue to go after search. I mean, it's our heritage. It's really what the Company was originally founded upon. We view that we're highly capable and competent in delivering those services, and our clients that look to acquire services from a direct-hire standpoint, we're going to continue to focus and service them.

Very good. Nice quarter. Thanks a lot.

Thank you.

Tobey Sommer, SunTrust.

I just want to follow up on that last point, where you were talking about the lengthening average assignment. Are you conveying kind of the trends here early in the year that both the changes to the salesforce and recruiter mix as well as the averaging assignment length are contributing to the positive financial performance at the top line? I'm trying to parse out the size of the impact of that change in assignment length.

Yes, sure. Well, we've been commenting on assignment length elongating for the last couple quarters now. Historically, we typically had about a six month on average, and over the better part of the last 18 months, we've seen that expanding closer to eight months, so that plays to our favor. In terms of our sales transformation, we're very early on, so when we're looking at a Q1 to Q2 impact, we don't have a lot baked in there, because it's going to take a while to drive the full implementation, full execution.

One of the things that we're seeing as we come into the beginning of this year is our rebuild is happening at a much faster pace than we've seen over the better part of the last four years, so we didn't have the same degree of fall-off that we typically see on the back end of the year, which gave us a little bit higher baseline. So at this point, if things were to stay consistent, we would get back to pre-holiday headcount at a much faster pace than where we've historically been, so it gives us the higher jumping off point.

Tobey, this is Dave. What we're seeing activity-wise in addition to the elongated assignment length suggests a strength in the market as well. So the front-of-the-funnel KPIs, for example, orders, number of AO orders, the submittals, those kinds of things suggest a strengthening as well, so it's more than just the assignment length and starting off a higher base. It's also the activity coming into the year, and I would say that it's predominantly as a result of the skills that we're focused on.

These are sweet spot skills of technology. We're in the higher-skilled areas. This is the customer-facing development stuff that everyone has to do now. So I think the clarity that came as a result of the Presidential election and the potential for some of the policy changes have given a greater confidence to the clients, that it has given them a sense of, at least now directionally, where to invest, and that's why we're seeing these things starting to happen.

Thank you. That leads right into my next question. Among financial services customers, have you started to see conversation change as a result of higher rates and an expectation for higher rates, as well as potential regulatory relief? Are they going to turn that into investments for growth and IT to support the growth?

I mean, we've been starting to hear some of the conversations taking place, so, yes, I would say there is a tonality that both of those scenarios are highly favorable to financial services, especially from a regulation standpoint. And needless to say, not only does the rate impact hit within financial services, but with a lot of the -- in the insurance industry at this point in time, they're impacted pretty heavily from a rate standpoint, so we're hearing it on that front as well, because last year, we saw quite a bit of contraction taking place as people were expecting rates and then there was the pause, and so no one -- I would say anybody is reacting to it as of yet, but the conversations are taking place.

Thank you. If there is an impact from changes to visas, et cetera, what industry vertical do you serve that would kind of see an impact potentially first?

We don't believe we would see an impact within the industry verticals that we serve. I think you would really see it more hitting the foreign national companies as things are being articulated at this point in time. So if we're working with any foreign national companies as a sub into them, that would be where we would feel it first, but that's a very small percentage of our business.

Okay. And could you just kind of size up on the Richter scale of systems implementation your project here in 2017 and how you feel managing the risk of a systems migration? Thanks.

So Tobey, I think we feel very comfortable. We've got a great team. There's been a lot of legwork, as Dave, I think, maybe mentioned in his comments. We've been after this for a number of quarters, and we've done -- and so we feel very good about the process there.

Now, I'll give you a little bit of flavor on that. The nature of our selection of Microsoft dynamics, the adoption and the ease of use to the end user is -- they're already trained on look, feel and usability. In fact, here over the course of the last several weeks, we've been out in markets with our sandbox, putting it in front of the end users and having them go in without any training, and it's intuitive. So we view that the tool is going to be such an enhancement to where we are currently, that our people will embrace it, and the use of the tool, we don't have any concerns.

And the only other thing I would mention to Joe's comment is the work we've done in terms of sales methodology and the transformation. We've got the builds right into the CRM, so the timing on this is great.

Yes. In essence, when we went down our sales transformation route, we were building out the requirements definition for the actual tool, so as we're training people on our sales transformation methodology, they're actually being integrated into the tool ahead of the tool being put in front of them.

Got it. Two last questions from me. Just a numerical one -- how big was the timing issue on cash flow? And will that probably be recouped in the current quarter, or will it take a little longer? And then could you update us on your expectations for KGS? It seems a little slow after the big contract win, so I just kind of want to get your, I don't know, call it two-year view on that business. Thanks.

Yes, Tobey, I'll take the first question on cash flow. So I think the preponderance of the timing issue will get resolved in the first quarter. There may be a little (inaudible) into the second quarter. So when you think about the size, in the aggregate, it was in the upper single digits of millions of dollars in terms of the timing issue. So as we've talked about, we size, for example, our repurchases based upon cash flows that we expect in the quarter, and so you saw the debt increase here from a timing perspective as a result of it. So, again, I think it is a timing thing that we feel we're already starting to see resolution.

Let me turn to the question on KGS. Interesting things happening in there. So first of all, the proposed new VA secretary is up for approval -- it should be within the next week or so. What we're hearing is that the small business primes are experiencing some difficulty in execution under T4 Next Gen, so within VA, there are some concerns about their ability to deliver on a project of this scope, which may invite a reconsideration of the sub, the rules that they're following currently. There's also been a change in the LPTA, the low price technically acceptable, that's come out of Congress. That has given them some relief to focus more on those that can deliver as opposed to just the LPTA. So there are some interesting things happening in that area.

Another factor within KGS is the product business, which we've experienced tremendous success with that we have fulfilled under those contracts predominantly in 2016, so this is going to be a little bit of a slower product here at the beginning of the year. The expectation is that new vehicles will come at the back end of the year, which could set us up for 2018, which is a much longer procurement cycle. And we have some new products that are coming out in that space, which should be a help to KGS as we move into next year.

In addition to what we're already doing with T4 Next Gen, we do have other prospective prime contracts that we're pursuing that at this point we're not in a position to comment on. As Joe said earlier, we are pretty comfortable now with our base for this year. We've already recompeted 96% of the base, so any of the opportunities that come forward now should be additive. But we are -- we're going to be conservative in KGS given the fact that we're dealing with a couple of significant unknowns as it relates to T4 Next Gen and then the timing of some of these awards, but I would say, in general, the government contracting environment is more favorable now with the administration change.

Thank you very much.

(Operator Instructions). Anj Singh, Credit Suisse.

For my first one, I wanted to follow up on some earlier Q&A. As it relates to some of the commentary from your peers in the staffing world, it seems that while they're also seeing the same optimism from their customers and leading indicators and KPIs, you guys seem to be a little bit more optimistic in that actually turning into revenue, particularly as it relates to your commentary around Q2. So are you seeing a little bit more tangibility of that optimism as it relates to revenue versus the others? I'm just trying to understand that a little bit better. Thanks.

Yes, I'm not inside anybody else's business, so all we're doing is we're communicating what we're seeing based upon our operating model in combination of what we're seeing with our metrics and how our metrics translate from a ratio standpoint to an output standpoint, so I really can't comment on anybody else.

Okay. Okay, that's fair. With regards to your headcount additions going forward, how should we expect that to trend? Should it return to sort of in line with revenue growth? How would you characterize the composition of your revenue-generating headcount now? Would you describe that as balanced at this stage?

So that's a great question. As I mentioned, I would say here in Q1, I think we'll stay fairly constant with where we were in Q4, because we're really focused here in Q1 of driving integration and adoption of a lot of the things that we've started. We will start to resume net headcount growth in the second quarter.

And based upon some of the plans that we're looking at now, I would say by the time we get to Q4, our year-over-years will be probably more mid-single digits, maybe slightly above that -- 7% to 8%. I don't think we'll resume back to a 10%, because we believe with the investments we're making in the technology, the investments we're making in the sales transformation methodology and other things we're doing on the delivery front, that that will yield itself from a productivity standpoint.

And also, to circle back, because I don't -- I'm not trying to be difficult on the first question, but everybody plays in different skill sets and has a different focus. We believe we're playing in the right skill sets within the right clients, which is probably a reflection of maybe where some of our optimism might be.

We're not a heavy mid-market player, where a lot of that business is done offshore, into the cloud, where the larger organizations are much more on the front end, customer-facing technologies, which is where our people are really focusing their efforts. So this isn't just about activity. It's also about footprint and focus and where you're playing within the tech space.

Understood. That's helpful. A couple housekeeping questions. On the six out of ten verticals that you mentioned as seeing sequential growth inside of Tech Flex, what are the other four doing? Are they flat? Are they declining? Just some color there. And it's nice to see the sort of success you guys have had with your top 25 clients or your largest clients, but I'm just also wondering, with regards to sort of revenue concentration, what is your largest Tech Flex client now comprised of your revenue? Or if you could just update us on what client concentration looks like for perhaps the largest client. Thanks.

Yes, so I'll start with your first question in terms of the industry verticals. So, yes, we're talking about the ones where we saw sequential nice improvement. None of the industry verticals we're in are, per se, down 10% on a sequential basis. I mean, some of those verticals are down 0.2% sequentially, so meaning they're all performing well and some of them we just have higher concentrations, given the makeup of the clients in that based upon activities that they had in Q4, could move that needle to a certain extent, which is part of why we're saying it's more broad-based and we're comfortable from that standpoint in terms of we're seeing demand across all the industry verticals that we participate within.

Yes, so in terms of client concentration, we've talked quite a bit about this -- pretty diversified even within our large clients. The largest clients that we have in terms of percentage of total revenue is less than 6% of total revenues, so it's pretty diverse still.

Okay, great. That's super helpful. I appreciate the time.

And I'm showing no further questions from our phone lines. I would now like to turn the conference over to Dave Dunkel for any closing remarks.

All right, great. Thank you very much, and thank you all, too, for your interest in support of Kforce. And I'd like to say thank you to each and every member of our field and corporate teams. 2016 was a year of significant change, and I'm really proud of how they handled it. It far exceeded my expectations, and they just did a fantastic job, so I want to take this opportunity to thank them. They were awesome.

I also want to thank our consultants and clients for allowing the privilege of serving you, and we appreciate your support, and our investment community as well. And as Dave said earlier, we're committed to delivering on our commitments to you earlier and honoring those commitments, and we're certainly going to do the very best that we can.

So thank you, and we look forward to talking with you again at the end of Q1.

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