Kforce Inc (KFRC) 2012 Q4 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Kforce fourth quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session, and instructions will be given at that time. (Operator Instructions).

As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr. Michael Blackman, Chief Corporate Development Officer. Sir, you may begin.

Thank you. Good afternoon. Welcome to the Kforce fourth quarter earnings call.

Before we get started, I would like to remind you that this call may contain certain statements that are forward-looking. These statements are based upon current assumptions and expectations that are subject to risks and uncertainties. Actual results may differ materially from the factors listed in Kforce 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 this call over to David Dunkel, Chairman and Chief Executive Officer. Dave.

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

The firm continued to perform well in the fourth quarter reporting revenues of $269.8 million, and earnings per share of $0.24, after adjusting for the non-cash goodwill impairment charge. We have continued to see consistent demand for our services, and have been able to capitalize on this demand through both increases in revenue and improvements in operating margins. During the fourth quarter, we also shifted our strategy to focus on accelerating future revenue growth by adding a significant number of new sales associates, as we now believe we will remain in a positive environment for professional staffing for the foreseeable future.

This continued high demand environment for skilled talent in the preponderance of areas that we serve, which persisted throughout 2012, allowed us to grow full year technology in F&A revenues 8% over 2011 levels, and our HIM business over 12%. Additionally, we now have gained greater clarity around the future operating environment, due to the recent election, and the resolution of various tax and regulatory issues, many of which we believe will be favorable to the growth of our industry.

The positive operating environment and greater clarity have led us to recently change the mindset under which we have been previously operating. Over the past few years, we have conservatively focused on refining our operating platform and growing revenue through productivity improvements and measured incremental investments. We now believe that the confluence of competitive, regulatory, political and economic factors afford Kforce the opportunity to more aggressively pursue growth initiatives and leverage our operating platform.

We therefore took significant actions to realign our focus in Q4 to accelerate profitable revenue growth through a greater outbound focus, and a larger associate population. Indicative of this renewed outbound focus, we have visited seven markets and met with over 25 clients and with our operating teams since October. The client meetings very much reaffirmed our assumptions on the many structural shifts taking place across the employment landscape, particularly their desire to increase the component of their contingent workforce.

We believe the temporary staffing penetration, which has improved from 1.34% at the beginning of this economic cycle, and is currently about 1.9% of the workforce, may achieve historic highs in the US during this economic expansion. I would note that in many European economies which have long faced many of the concerns now part of the domestic landscape, the percentage of temp penetration is significantly higher. In addition, the percentage of jobs added through temp in this economic recovery cycle had been disproportionately high, reflecting clients increasing desire to migrate toward a flexible workforce. We believe strongly in the long term growth prospects in our Tech, FA, and Health Information Management businesses, where there continues to be an imbalance between strong demand and short supply.

As we transition into this new era for Kforce, we would once again like to thank Bill Sanders for his contribution to the firm, as he led Kforce to $1 billion in revenues, while building a world-class infrastructure that will serve as a platform to achieve the next billion and beyond. Under the leadership of Joe Liberatore, our firm will continue to focus on delivering profitable revenue growth as we emphasize a sales driven culture. Joe's legacy is in sales, as he started his career at Kforce in the sales organization where he rapidly progressed into a leadership role, and left a legacy of growing significant markets and leadership teams. Joe has also had the opportunity to serve as the firm's Chief Talent Officer and Chief Financial Officer among other roles, which will provide him valuable perspective on the business, and will serve him well in this new role. Joe has begun driving the philosophy of focus, simplicity and accountability in everything we do, but he is most relentless in applying those principles to generating profitable revenue growth.

All of this is against the backdrop of Kforce having only a 3% market share in a growing domestic staffing market. There are clearly significant opportunities for the firm. As I reflect on 2012, I am pleased with what we have accomplished, and believe that the firm is well-positioned for future success. In addition to improving full year earnings per share exclusive of impairment charges to $0.85, a 21.4% year-over-year increase, we also paid a special cash dividend on Kforce common stock in December of $1.00 per share. The total value of that dividend was approximately $35 million.

Looking forward, I am excited as we move into a new era for Kforce, and I am confident that the results will speak for themselves. I will now turn the call over to Joe Liberatore, President, who will provide commentary, Dave Kelly, Chief Financial Officer, will then provide additional insights on operating trends and expectations. Joe, Mr. President, the call is yours.

Thank you Dave, and thanks to all of you for your interest in Kforce. As Dave indicated in his opening comments, this is a new era for Kforce, focused on accelerating profitable revenue growth, and further enhancing our sales focused client-centric culture. I am confident Kforce is poised to win as we strive to take market share in 2013 and beyond. I am excited to be in a position to allocate a higher percentage of my time focused on direct client interactions, and working more closely with our revenue generation teams.

In the fourth quarter, I personally had the opportunity to meet with over 25 clients, as I visited seven markets which contribute one-third of our overall revenue. These conversations reinforce our belief, opportunity exists for us to significantly grow revenue within our existing clients. The platform has been set with a world-class and scalable infrastructure that will allow us to compete effectively and take market and customer share. As a firm, we will be looking for ways to focus more time and energy externally, to better meet the needs of our customers.

As we are streamlining and leveraging our processes and tools to simplify how we do business with our clients, and we will leverage real-time data to hold our associates accountable to higher levels of performance and superior customer service. Our flexible staffing businesses, which is compromised of almost 70% Technology staffing, inclusive of those technology portions of our government and HIM businesses, continue to grow in the fourth quarter sequentially and year-over-year on a billing day basis. Permanent placement revenues decreased sequentially, but increased year-over-year.

Tech Flex is our largest business unit and represents 61% of total firm revenues. On a billing day basis, Q4 revenues increased 0.3% sequentially, and 2.7% year-over-year. Overall our key performance indicators for Technology remain at a healthy level. Job orders, external submittals, and send outs remain at high levels, and candidate supply remains tight, particularly for skill sets in high demand areas, such as EPIC, Java, .net, project management, data warehouse, business intelligence, and mobile computing.

We continue to improve in prioritizing the highest quality job orders. and our fill ratios for these orders are at all-time high levels, though we believe additional opportunities remain for improvement. Intraquarter trends for Tech Flex revenues showed declines in October and November, and an increase in December. January trends for Tech Flex are better than last year. The declines in January due to annual assignment ends were similar to last year, but we are already at 97.3% of normalized December headcount, which is more promising than last year. The better recovery and strong KPI volumes suggest continued solid demand in this business. We expect Q1 2013 revenues to be flat on a billing day basis for Tech Flex from Q4 2012 levels, but with an accelerated rebound relative to Q1 2012 that bodes well for the remainder of the year.

Revenues for our Finance and Accounting Flex business represent 19% of total revenues. On a billing day basis, Q4 revenues increased 2.1% sequentially, and 0.2% year-over-year. Revenues increased in October, decreased in November, and increased in December. Current trends for FA Flex revenue suggest a slight decline on a billing day basis, as this is recovering more slowly than last year, due to more significant Q4 project ends than last year.

Revenue growth for the quarter for our Tech and FA businesses was driven by our small and medium sized client base and some select strategic accounts. Our strategic accounts portfolio declined slightly as a percentage of the total revenue in the quarter. In aggregate, the firm provides consultants to approximately 3,000 clients at any time, with no one client constituting more than 3% of total revenues. We believe a key to our ability to accelerate revenue growth will be to more deeply penetrate our existing customer base, many of which provide substantial opportunities to increase share.

Our flexible model allows us to source consultants at scale in key areas of customer need. We are refining our processes in the NRC to more sharply focus on key skill sets that are in greatest need by our customers. Our national footprint and diversified service offerings also allows us to service clients in the industries with the greatest demand for Technology and FA professionals, such as healthcare. Four of our top 25 clients are Financial Services, and compromise approximately 7.3% of total revenues in Q4 2012, which has declined from 9.8% in Q4 of 2011. Financial Services represents 16% of Tech revenue which is flat to Q3 2012.

On a billing day basis, revenues for our HIM business increased 8.7% sequentially, and 2.6% year-over-year. We believe there is a strong demand for this profitable business unit, and its synergies with our Tech Flex business. As we continue to capitalize on the growing spend in healthcare around ICD-10 and electronic medical records. This business experienced significant ends at two clients in Q4, and we expect revenues in Q1 to be relatively flat as a result.

On a billing day basis, revenues for our Kforce Government Solutions increased 8.3% sequentially, and 2.1% year-over-year. Revenues for this unit have stabilized, but the overall market visibility for government contractors remains extremely limited. There remains continued uncertainty around funding levels for various federal government programs and agencies, as they await the outcome and potential impact of sequestration. KGS continues to strategically focus on opportunities within federal agencies that are less impacted by these fiscal concerns, such as the healthcare space, and expect less than 10% of its business to be impacted by sequestration. We anticipate a decline in revenues in Q1 due primarily to product sales that positively impacted Q4 to not recur in Q1.

Perm revenues for direct placement and conversions, which constitute 4.1% of total revenues, decreased 10.3% sequentially, but increased 9.2% year-over-year. The war for talent continues to create an environment of strong demand for highly-skilled candidates, and the pace of conversions has remained elevated for the past four quarters. Q1 has historically improved as the quarter progressed. Perm revenues are difficult to predict, but we expect perm revenues to be relatively stable in Q1. As I alluded to earlier, we have continued to increase investments in revenue responsible headcount from Q3 to Q4. Sales headcount inclusive of the NRC and strategic accounts increased 10% sequentially, and 20.9% year-over-year.

The demand for our services remains strong. Associate performance metrics remain near peak levels at certain tenure levels. Our most experienced performers are close to capacity, and we have seen contributions from our 2 to 4 year tenured performers increase nearly 45% year-over-year, and our 1 to 2 year population responsible for an additional 23% over the same period. Continuing improvements in performance from these tenured groups and ramping of newly-hired associates should positively impact revenue trends as we move further into the year. However, it typically takes six to nine months for new associates to ramp, and as a result we expect increased compensation costs relative to gross profit generated from this population over the next two quarters. We plan to continue to make additional investments in our sales associate headcount in geographies and industries we believe represent the greatest opportunity, though not at the accelerated pace of Q4.

We had solid performance in the fourth quarter, and have a very strong foundation for the future success. We will remain heavily focused on our clients needs and will leverage our platform of tenured field teams, the National Recruiting Center, and our strategic accounts model to adapt to changing market dynamics and client and industry trends. We believe that the current environment remains very attractive for professional staffing, and that our time is now. We will remain focused on driving profitable revenue growth by meeting our client needs and gaining market share. We will do this by maintaining our focus, executing with simplicity, and holding ourselves accountable for delivering great results.

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

Thank you Joe. The firm delivered solid results in the fourth quarter. Total revenues for the quarter were $269.8 million, which represented a billing day increase of 1.5% sequentially, and an increase of 2.4% year-over-year. Quarterly revenues for Flex were $258.7 million which represented a billing day increase of 2% sequentially, and a 2.2% year-over-year increase. Search revenues of $11.1 million decreased by 10.3% sequentially, and increased 9.2% year-over-year.

Superstorm Sandy had a direct billing impact of roughly $1 million in Q4, which was not as significant as we had anticipated. Q4 monthly revenue trends were relatively flat in October and November, and showed improvement in December. Flex revenue trends for the beginning of 2013 have declined from December levels, as is typical due to December assignment ends. For the first four weeks of January, Tech Flex is up 3.6% year-over-year, Finance and Accounting Flex is down 4.6% year-over-year, and HIM is up 2.6% year-over-year. Search revenues are up 3.8% year-over-year for the first five weeks of Q1.

It is difficult to assess potential full quarter results with this limited data. This is particularly true in Q1 due to the uncertainty of any holiday-related impact. Additionally, Q1 2013 has one less billing day than last year since 2012 was a leap year. Adjusted for the $2.5 million after tax non-cash goodwill impairment charge, fourth quarter net income and earnings per share from continuing operations were $8.4 million and $0.24 respectively. Net income decreased 9.7% sequentially, and EPS decreased 7.7% sequentially.

Year-over-year net income from continuing operations excluding the impairment charge increased 64.6%, from $5.1 million in Q4 2011, and earnings per share increased 71.4% from $0.14 in Q4 2011. Improvements in revenues and gross profit helped to offset the costs of the increase in revenue responsible headcount to drive strong bottom line results.

The $2.5 million impairment charge was recorded in Q4 to true-up the estimated impairment for our government reporting unit in Q2 after finalization of our procedures. No additional impairment was identified in Q4. Our overall gross profit percentage of 32.8% decreased 10 basis points sequentially, and increased 110 basis points year-over-year. Our Flex gross profit percentage of 29.9% in Q4 2012 increased 30 basis points sequentially, and 100 basis points year-over-year. Overall Bill pay spreads increased 20 basis points sequentially, and increased 100 basis points year-over-year.

Gross margins improved throughout 2012 reflecting consistent demand for our services. Tech Flex margins are now only 100 basis points from their previous peak, despite a significant increase in statutory costs from the last cycle. The following is a breakdown of year-over-year and sequential bill pay spread improvement by business unit. From a year-over-year perspective, Tech Flex improved 90 basis points, and FA Flex spread improved 70 basis points, while HIM spreads were down 120 basis points. From a sequential perspective, Tech and F&A spreads were stronger than anticipated in the quarter, despite the impact of Q4 consultant paid time off. Tech Flex spreads were flat, and F&A Flex spreads declined only 10 basis points, due to improvements in pricing and shift in the mix of clients. HIM spreads declined 110 basis points.

As we look to Q1, Flex margins in the first quarter will be negatively impacted by payroll taxes, which will be slightly greater than last year and could reduce Flex margins as much as 130 basis points. However, we expect to continue to see modest expansion in bill pay spread as we move through 2013, which should fully mitigate these increases as the year progresses, and should result in improved Flex margins overall. We believe we have a world-class back office infrastructure that will allow us to deliver operating leverage as we continue to expand revenue and take market share. Q4 SG&A levels of 26.9% have declined 40 basis points year-over-year despite the 21% increase in revenue responsible headcount. The overall result of improving revenue and gross margins along with declining SG&A is seen in our operating margin improvements.

Operating margins have improved from 3.2% in Q4 2011 to 5.1% in Q4 2012, and we anticipate continued improvements as we grow the top line. We are in the process of assessing the impact of healthcare reform. The rules are still being refined so there remains much uncertainty. However, the provisions that go into effect in 2014 will certainly increase the cost of employment for most companies. We believe this will have a positive impact on our revenues due to the potential increased demand for temporary staffing.

Relatively speaking, the cost of the law should have less impact on Kforce than many other companies because of the level of benefits we already offer, particularly to our Tech Flex consultants. We have always viewed our consultant benefit plan as a competitive advantage, and it may serve an even more meaningful attraction tool under the new law. We currently offer benefit plans that will likely exceed the minimum requirements to approximately two-thirds of our employees, of which slightly over half enroll in our plans.

Under the new law, the requirement for offering benefits to a larger population will likely increase, so there will be an impact. We believe we will be able to pass these incremental costs, which will be most significant in our FA business through to our clients over time. A positive implication of this law is the potential for increased demand from companies looking to better manage their employee healthcare costs, which is particularly relevant in project related disciplines such as technology. We believe Kforce is in a strong position to provide solutions to our clients to minimize the effects of the new rules.

As we look to our balance sheet and cash flows, our Accounts Receivable portfolio continues to perform well. Write-offs were down sequentially, and the percentage of Receivables aged over 60 days remains at very low levels. Our cash flow continues to be strong, EBITDA for Q4 2012 was $16.1 million, decreased 12.7% sequentially, but increased 10.2% year-over-year. We are now generating annual EBITDA over $60 million. The firm had $21 million in bank debt, and $1.4 million in cash at quarter end, compared to zero bank debt at the end of Q3 2012, and $49.5 million in debt at the end of Q4 2011.

The firm repurchased approximately 1.4 million shares of stock, at an average price of $13.08 in Q4. Additionally, last week our Board of Directors approved an increase of $50 million in authorization for stock repurchases. Currently $89.9 million is available for future stock repurchases. We will continue to evaluate additional repurchases as cash flow and market conditions warrant.

With respect to guidance, the first quarter of 2013 has 63 billing days compared to 62 billing days in the fourth quarter of 2012. We expect Q1 revenue may be in the $268 million to $274 million range. Earnings per share in the first quarter relative to the fourth quarter will be significantly impacted by both the increase in payroll taxes, and the incremental costs of our recent investments in revenue responsible headcount, and additional anticipated investments in Q1. We expect the increase in payroll taxes and cost of sales and SG&A to negatively impact EPS by $0.09 to $.010 relative to the fourth quarter. Additionally, the impact of recent revenue generating headcount investments and those anticipated in Q1 are expected to impact EPS by $0.03 to $0.04 as it typically takes six to nine months for our new associates to ramp.

Earnings per share may be $0.09 to $0.12 in Q1. Our effective tax rate in Q1 is expected to be 40%. We anticipate weighted average diluted shares outstanding to be approximately 35 million for Q1. This guidance does not consider the effect, if any, of charges related to the impairment of tangible assets, costs related to the settlement of any pending legal matters, the impact on revenues of any disruption in government funding, or the firm's response to regulatory, legal, or tax law changes. We are pleased with our fourth quarter results, and in particular the continued expansion and bill pay spreads that helped to offset some of our planned hiring costs.

We expect to continue making human capital investments to drive top line performance, with a goal of accelerating revenue growth in the second half of 2013. We remain confident in our near-term and long-term prospects, and expect to capitalize on the operating platform that we have built to grow revenue and generate operating leverage. We would now like to turn the call over for questions.

Thank you. (Operator Instructions). Our first question comes from Paul Ginocchio from Deutsche Bank.

Thanks for taking my question. Dave, maybe just help us think about the new idea, about it seems like it is a new idea, you are just going to hire more to accelerate growth, relative to your previous strategy. Can you talk about what that does to margins, or how we should think about incremental margins going forward? Thanks.

Sure, Paul in terms of margins, operating margins, obviously we had talked about the fact that we had hired significantly in Q4. In Q1, as I had said, the expectation is we would have a full quarter of those costs from those hires we had in Q4, as well as the fact we anticipate hiring additional headcount in Q1, so part of the guidance that we provided in Q1 was to give you some sense as to what the impact on margins would be for that hiring, and we anticipate Q1 specifically to have an impact of about $0.03 to $0.04 in EPS, and those costs predominantly are in the SG&A line.

Should we think about whatever your incremental margins were previously under this newer strategy, incremental margins going forward are going to be a little bit less in the hopes of getting more revenue growth? Is that the right way to think about it?

I think, Paul, the way to think about it, and Joe touched on it in his comments, as we hire these folks, it will take them as we mentioned, as he and I both mentioned, six to nine months to ramp, so as we work through that six to nine months, certainly there is going to be incremental costs until they turn the corner and start paying for themselves if you will, and we anticipate revenue growth obviously to accelerate as a result of that hiring, which is going to allow us to leverage the operating platform that we have, to generate some incremental operating margin improvements as we get to the back half of the year.

Paul, this is Joe. I will give you a little bit more color in and around the ramp. Because obviously, there was acceleration in Q4. We don't anticipate that we will be adding at the same levels of Q4. Back in 2010, we really started to refine our new hire ramp, put a bunch of programs in place on how we measure people with 30, 60, 90-day increments. And over the course of time what we've seen, is we have seen actually our performance of our less than one year people improve 65% from where we were on the back end of 2009, prior to putting in a lot of the programs.

Likewise, we have also seen the performance increase by 55% on our people as they move from one year to two years. We are getting nice performance out of those individuals and to kind of frame that, when we look at our greater than four year population, they are about 63% more productive than our 2 to 4 year population, and they are about 114% more productive than that 2 to 4 year population. Where we get our greatest leverage is when we move people from less than one year into our 1 to 2 year population. Those people are typically 200% more productive, and that is off of these higher levels that we have established, which gives us comfort that we are really building future revenue leverage opportunity that won't really manifest itself from really expanding SG&A by too much, as this group of people start to move through the pipeline.

Okay. If I could ask maybe one more, just to get a better understanding. Was there something that happened in the fourth quarter, an event or something that you looking at that changed your mind, or why weren't you just adding throughout 2012, and why was there such a big bubble of hires in the fourth quarter? Thanks.

Actually, we started back in Q3. We started to accelerate our hiring in Q3, and that was mainly because as we started to look at some of what was happening with productivity of our more seasoned people, we had noticed that they had started to plateau, which led us to believe that we had started to reach peak productivity levels, which really drove the need to start hiring in additional, and then in combination with that, Dave and I visited, as we mentioned, seven markets, and spent a lot of time with customers, and these are some of our largest customers that were giving us a lot of forward insight, in terms of what they had coming heading into 2013 and forward, and we saw a lot of projects that were being teed up, so there are a number of drivers there.

Paul, this is Dave, I want to add a couple of other points. If you look back over the last several years, coming out of 2008 and 2009, with the financial crisis that we had, the new President. There was a tremendous amount of uncertainty about what was going to happen with healthcare, regulation, and so forth. As we went into Q4, and the election was settled, the regulatory environment was settled, and even with the recent, at least temporary resolution of the fiscal cliff, when we combine all of those things together, and we take our feedback back from our clients, it became very clear to us that the opportunities for Kforce were significant.

We have seen a significant change in the competitive climate, many of our larger competitors have been acquired, so there have been a lot of factors that have really, really I think changed the landscape, and given us a pretty unique opportunity. So we considered all of those factors. This made a lot of sense for to us do.

Great. Promise this will be the last one. So obviously one of the factors is healthcare reform?

I wouldn't say healthcare reform was a catalyst. I would say the resolution fixed one of the variables that we are waiting for. I think the election was certainly another one, because one of the things that we have seen clearly is that in this highly regulated environment, many of our clients have made the decision to shift employment risk, and with the re-election of the current President, that kind of confirms that for the next four years at least, we can expect that our clients are going to continue to shift more of that employment risk to us, so that was confirmed, and together with the market opportunities, we believe that actually we are probably in one of the best positions we have been in, in the history of our firm.

Thank you very much.

Thank you.

Thank you. Our next question comes from Mark Marcon from Robert W. Baird.

Good afternoon. I was wondering, did you mention how many full-time employees you have within the organization at Q4 end?

No, we didn't talk about numbers, Mark. All of that information will be in our K when we release our K, that is typically when we put the number of employees, just so that we have a specific point in time.

Okay. I was just wondering if you wouldn't mind disclosing it now since it will be in the K shortly?

Yes, hold on a second, I want to make sure that we give you the right number.

Mark, this is Dave. In the aggregate, there's about 2,500 total employees in the firm, that is core employees, that is obviously exclusive of the 10,000 billable consultants that we have.

What is that number up relative to a year ago, or is it flattish?

Well when we think about, as Joe had mentioned, revenue responsible headcount is up 21% year-over-year, in the aggregate, the headcount is up less than 15%, so it gives you some perspective of the operating leverage and the shift in focus to more revenue and sales focus, and trying to capitalize on the operating leverage that has been built.

Great. And the SG&A, when we think about that and we think about our typical ratios, how much of the SG&A at this point is fixed and scalable? You did say just in answering Paul's question, that there were a few folks who are client facing or who were recruiters or plateauing, which if they are in fact plateauing, then it makes you wonder, where does this scale come from in terms of being able to drive higher productivity across the firm? So I am assuming that there is a percentage, a meaning percentage of SG&A that is fixed, and that could continue to be scaled?

Yes, depending upon how you define fixed. We have talked about the compensation for the firm is about 70% of SG&A, so the fixed costs is about that other 30%, and compensation, obviously, you have got salary, management salary, which you could deem as fixed as well.

Then there are also going to some back office folks.

That is exactly right. When I am talking about total SG&A, I am talking about that 30% that is not compensation that is fixed, then as I said, you have got management salaries that is a better part of that 70% that is also, obviously, fixed. So you are talking about a percentage certainly relatively sizeable in excess of 30%, 30% to 50% that is fixed if you want to define it that way.

Mark, just to give you a little additional color when we talk about that more seasoned population where they are producing at very high levels. We have improved performance of that 4-year plus population 45% from where we were when we really came out of the downturn last cycle, so we have gotten tremendous leverage there. Those people are just, you can only do so much, and we have implemented a lot of tools. That has allowed us to get this continued productivity, that is not to say that we don't believe we might still be able to get some additional productivity there, but it would have just been a high risk to bank on that to continue to happen.

Got it. Of the 2,500 employees, what percentage are recruiters or sales, as opposed to kind of back office?

As we think about it in terms of ratio, it is probably somewhere in the neighborhood of 65% to 70% focused on revenue generation.

Great. What are you seeing in terms of your retention rates among those folks?

Retention is really broken up by the tenure grouping, so our more seasoned people, 4 plus years, we have historically run low single digits, and we continue to stay in those areas, so we typically hold on to those individuals. As you move down to new hires, we have our greatest churn is in the people in the 0 to 6 month category, but we have gotten very disciplined about having 30-day and 60-day and 90-day checkpoints. Where we really evaluate how people are ramping, and also how things are going for them, because this is a sales environment, and there is no perfect formula. Sometimes people coming in the door are better at selling themselves than really what we needed them to do in terms of servicing our customers, and likewise sometimes they make a wrong decision, or we haven't evaluated them appropriately, so it is our responsibility to do what is right for them, and right for the firm.

Great. Then with regards to the government side, good performance during this quarter, and you did say it is going to be down a little bit sequentially in the first quarter. I am just wondering if you could put a little more color around that, in terms of how you are expecting it to go, and what would your game plan be if there is, in fact, sequestration?

We have gone through to the best of our ability and looked at the agencies where we are doing work and mapping that against what is out in the marketplace in terms of the agencies that will be impacted the most, and what our team has come back with is really anticipating less than a 10% exposure if things were to stay with what is known at this point in time to the whole revenue stream. Realizing a little bit over 35% of our business is wrapped up in the healthcare areas, which are not supposed to be impacted by sequestration, and we are in a number of other agencies that are supposed to be somewhat insulated.

When we look at the business in terms of the guidance that we provided Q1 relative to Q4, is we have a product within our KGS unit by the name of MAT, which is really, they are utilized for the military in terms of different services, but we had a nice product mix there, and as we look into Q1, that business kind of moves in different cycles. So our pipeline has grown from about $7 million to $10 million over the course of the last year, but we are not expecting as many orders to be processed in Q1.

Got it. I missed the tax rate that you are expecting for the first quarter and for the year?

Mark, we are expecting an approximately 40% tax rate for 2013, including the first quarter.

Great, thank you.

Thank you. Our next question comes from Kelly Flynn from Credit Suisse.

First of all, in talking about your reinvestments in growth so to speak, a couple of times you referenced changing views on the competitive environment, and I think you said your competitors, many of them have been acquired, which is obviously true. So I was hoping you could more fully explain what you have observed competitively? Are you seeing it is getting less competitive, or what is going on there?

Hi Kelly, this is Dave. Actually, what we've seen is at the client front firsthand, that the clients are seeing issues related to pricing, turnover, margins, and so forth, particularly as some of the larger clerical firms have acquired the professional firms, and as they try to rationalize compensation, and the conflicting channels that they have had with those clients, there have been a lot of disruptions. One thing that has become clear to us is that staying as a pure-play independent professional and technical firm actually has given us opportunities that are very significant. We have been invited into many of those relationships as a result of the fact that the clients are not happy with the way that they are being serviced.

In addition to that, we have also received a number of people who have come to us from those firms who experienced compensation cuts, experienced pricing changes, and channel conflicts, and so forth. We benefited on both the client front and also on the associate front, and obviously we are going make measured investments because not all of them fit the Kforce culture, but in general I would say that particularly in the larger clerical firms where the acquisitions have taken place over the last couple of years, we have actually benefited both on the client front and on the associate front.

Kelly, I would add that while we did a lot of our heavy lifting, and I am very thankful for everything that Bill did while he was here at Kforce as we reengineered ourselves and our infrastructure, we worked very hard on building our culture. We haven't done a staffing acquisition in seven years now, so our culture is very solidified, and it just really provides us a unique opportunity, especially as many of these individuals with some of these competitive firms, they were really attached to those types of cultures, and the type of focus that we have here at Kforce, and we think it provides us a unique opportunity.

Okay, great, thank you. A couple of clarification questions on the guidance. You were talking about the gross margin, I think you said you expected to expand year on year I think for the year, but you also threw in some comments about the payroll taxes. What do you expect to do year over year the gross margin in the first quarter, then how will it play out as the year progresses?

Kelly, a couple of clarifications to those comments. The comment that I made was that we anticipate sequentially that the payroll tax impact from Q4 to Q1 could be as much as 130 basis points. What we were referencing in terms of expansion and margins has to do with the fact that we have seen pretty persistent gradual improvements in our bill pay spreads really over the course of the last eight quarters, and had in the fourth quarter continued success on that front, and anticipate that at a modest level to continue, such that year-over-year when we look at total margins, obviously those payroll tax costs normalize full year to full year, that Flex margins will improve over 2012 levels.

But that 130 bips, is that to be taken straight out of the gross margin sequentially, or are you saying that some of that--?

That is correct. That is correct. Every year in the first quarter we see an impact , because obviously the clock resets on payroll taxes on January 1st for all employees.

Great. Then on the KGS revenue decline, are you saying you expect year-over-year or just sequentially, a decline?

The commentary that we were making referred to a sequential decline.

Okay. Lastly, when were you talking about benefits, you said you have two-thirds of the employees that are offered benefits, but then you said slightly over half will do something else. I really couldn't understand what you were saying, so could you clarify the two-thirds versus one half, what you were intending to say there?

Sure. The healthcare reform law requires you to offer benefits to employees at some minimal level. The comments I made suggested that we believe our benefits exceed those minimum levels. About two-thirds of our employees are offered those benefits, two-thirds of our billable consultants, those are concentrated particularly in Tech Flex, and that they have an election, and about half of those who are offered benefits accept those benefits, the other half have other benefits, maybe from their spouse, or some other arrangement that they have.

Okay, perfect. Thank you very much.

Thank you.

Thank you. Our next question comes from John Healy from Northcoast Research.

I wanted to ask you guys a little bit more about the investments into the headcount. Could you maybe give us a little bit of color, in terms of where you are allocating these resources in terms of where you want them to go in the market? Is it a view to keep investing and growing the Tech business because you believe in the secular opportunity there, or do you look to have a more balanced split between the three verticals, or the four verticals that you are in today? In terms of the customer size you want to focus these individuals on, is there a thought process that you would like to highlight there?

Yes in terms of where we are directing the hires, the highest concentration is within Tech Flex. We are also hiring into FA flex, and we have done some hiring into our NRC, mainly within our NRC we have piloted, and we have been piloting for a little while, what we are calling the performers academy. We have had a lot of success with people ramping up in the NRC, and then going out into our field operations.

In fact, my son just left the NRC, and went to work in one of our operations. It is happening broad based, and what we have done is we've really organized around that more effectively, so we believe over time that is going to allow us to ramp our field associates even more effectively. In terms of how we are focusing the individuals, as I mentioned, we believe there is tremendous opportunity within our existing customer base, so we have actually started to align more new hires in and around existing customers, so that we can penetrate those existing customers more effectively, versus what I would say has more traditionally happened is they have been assigned to hard to break accounts, so we believe that will also provide us an opportunity.

Great. Then along those lines, you may have mentioned it earlier and I missed it. Any color on how much of your customer base right now is being serviced by the NRC?

Yes. Actually, the NRC has improved about 450 basis points on a year-over-year basis, in terms of the percentage of revenue that they are servicing. Currently they are servicing about 33.1% of revenue.

Great. The other thing you mentioned on the HLS business, some ramp down with two projects there for ICD-10. Any thoughts in terms of what inning we are at in terms of the opportunity there, and maybe how you would see that opportunity kind of trending as maybe we go out through 2013?

Yes, I would say just in general, I would say healthcare providers aren't ready for healthcare reform, that is inclusive of HIPPA high-tech, EMR, and ICD-10, so we believe there is still opportunity. We saw a slowdown last year in terms of ICD-10 assessments, we have noticed and been awarded a number of contracts here in Q1, so we have seen a pick up there, but we believe we are going to see more of the volume associated with remediation around ICD-10 as we move into the back half of this year and then as we move into 2014, as people prepare for that October of 2014 date.

Great, thank you, guys.

Sure.

Thank you. Our next question comes from Tobey Sommer from SunTrust.

Just a follow-up on the distribution of your headcount additions. Could you comment on the proportion between the NRC and the field? Just curious in this climate how the productivity is advancing in the NRC on a go-forward basis, and what you think about where the upper bounds of that may be?

Yes, much higher. The majority of the headcount was field-based hiring and recruitment oriented, or in account or handed roles. Relative to the NRC and performance, we have a much higher percentage now within the NRC that are moving across that 2-year level, so we believe we will continue to see performance there. The big thing with the NRC, I think we have mentioned this before, we were the victims of our own success with the NRC, we were very fragmented in terms of how we were leveraging the NRC. We really started on the back half of last year refining the focus and narrowing our focus and concentration. We believe that will pay dividends over time as well, in fact, we have already seen some performance aspects in the areas where we have had them focus, such as the high demand skill areas, specific demand areas in certain industry verticals, where we know there is a gross misbalance. In fact, in some of these areas if you were to go out and do an assessment, you would find that there are ten jobs for one candidate, so we are really after the identifying and the building of the pipelines on those ends.

One of the other areas is our business development area, which we actually saw an increase by about 70%, in terms of the client visits that they are setting for more experienced people, providing leverage for field operations on that front.

Thank you. What was the contribution in terms of revenue in EPS from product sales in the fourth quarter?

In terms of the total, certainly we don't have the data on EPS.

Nominal.

It was a small, couple million dollars in revenue for the firm as a whole on that product sales and KGS.

Okay. Is that what causes the sequential decline in revenue in the first quarter?

That is correct. That is correct. The service business we expect to be stable and to slightly up in KGS from Q4 to Q1.

In the fourth quarter itself, the gross profit in KGS, that gross profit margin was up almost 500 basis points. Is the preponderance of that related to product sales?

Yes, there's really three pieces to that. Actually that is a small piece of it, but only about 50 basis points is being driven by the product sales. Actually the biggest driver is increased rate on some new and existing business in our service business as we have managed to improve profitability there. I am talking sequentially about 170 basis points. The rest was really one-time true-ups. If you think about margins for that business, the service business contribution of 170 basis points was the key there.

What kind of bill rate growth are you seeing in the Tech Flex business?

As far as bill rates are concerned, as we think about bill rates year-over-year, they are modest. They have modestly continued to increase pretty consistently. Pay rates, obviously, have kept step not quite as quickly as we have been able to manage both the bill rate and the pay rate side, so we think that is reflective of continued good demand in the space.

Okay. Two last questions for me. One, a housekeeping one. Could you give us the number of billing days by quarter if you happen to have them for 2013? Then, I was interested if you could comment on, are you lapping anything in Tech Flex relative to some big industry project that ended in the May-April timeframe last year that may facilitate growth optically looking faster as we enter the second half?

First of all, I will answer your billing day question. Q1 63 days, Q2 64 days, Q3 64 days, and Q4 62 days.

Relative to Tech Flex, the best way that I could answer that question, are we aware of any big projects that we have coming to an end? The answer is no to that question, but when we look at our firm sponsored accounts, the strategic accounts portfolio makes up roughly about 30% of our revenue stream. However our firm sponsored accounts as I mentioned had decreased from 9.8% to 7.3% in some of the financial services areas, so we did experience some trail off through the course of 2012, but in fact, in Q4 is the first time in four quarters where we actually saw growth within our firm sponsored accounts. They were up about 4.7% sequentially, and here even heading into Q1, we have seen job flow demand coming out of those clients has been at a healthier pace.

Thanks, Joe, I was actually referring to big projects ending last year that might have hampered comparison? Thank you.

That is what I am saying. I wouldn't call them large projects ending, but some of the firm sponsored accounts where we were doing business had various aspects of their business that they were decelerating in terms of their use of billable consultants, so it wasn't like a big project of 100 people ended, or 300 people ended. It was more of a constant bleed, as they were bringing down their contingent workforce.

Thank you very much.

Thank you. Our next question comes from Randy Reese from Avondale Partners.

I was wondering about what corporate expense looked like in 2012, and how you think it will compare in 2013?

If you are talking about corporate expense in terms of infrastructure to support the revenue responsible population in 2012, I think we did an excellent job in managing those costs, and they were stable throughout the course of the year, which obviously you can see is driving a lot of that operating margin improvement, and a focus as Joe has talked a lot about and Dave, in driving revenue growth, it's going to be important for us and are committed to scrutinizing all of those costs and don't expect expansion of those costs as we move into 2013 either.

And in terms of management compensation, what kind of leverage are you going to get in 2013 since you have made some changes to management comp?

You are obviously alluding to some of the disclosures that we have on modifications that were being considered by the Comp Committee. Those were actually determined at the end of 2012 on top of some of the change that was already instituted in 2012. Certainly, the result of those changes is going to be a reduction in overall executive pay. As we think about that, again, we think that only enhances our ability to invest in accelerating revenue growth. It is opportunity for us.

Do you have the numbers for operating cash flow for either fiscal 2012 or the fourth quarter?

Yes, sure. Fourth quarter cash from operations is going to be about $28 million, and for the year about $56 million, Randy.

Okay. Very good. Thank you very much.

Thank you. Our next question comes from Morris Ajzenman from Griffin Securities.

Let's take another stab at this headcount increase that is staffing up the next three quarters. Clearly, you guys are optimistic looking out over the next year or so, and on the flip side, when you make an announcement like this, Wall Street's reactions initially for the first quarter or two going out is, what is it going to be the impact to earnings. You give us some antidotal evidence earlier, talking about post-elections and things improving, but can you put a little bit more meat on the bone? Give us some sort of story. I presume you are optimistic because you have gone to your different corporate customers and one by one, you have kind of listened and strategized with them. What can you help us understand your optimism of how you are going forward now, having increased staff by what you have been told or been hearing from your customer base?

Morris, I think we kind of said it. It is a confluence of several factors coming together. If you look at the environment that we have been operating in, there has been an enormous amount of uncertainty throughout the entire last term of the current President, the question was whether or not healthcare reform was actually going to be passed, and then whether it was going to sustain the Supreme Court. That was resolved. The issue of who was going to be the next President, obviously was a significant issue because of the clear regulatory environment, and tax policy, and so forth. That was another issue that has now been resolved.

As you know, uncertainty, in our industry, is clearly a relatively issue. Our clients have now come to the point where they have said, okay, now we know what we are going to operate in. It is beyond a year. We are looking past the year and saying that we now believe that over the next several years, what we have experienced over the last several years is what we will experience over the next several years, and our clients have confirmed it, and that is the point. We have been talking to our clients not just during the fourth quarter but throughout, but we have placed a major emphasis on it.

It is clear to us that the opportunities for us as a firm now with the resolution of some of these political factors, as well as some of the competitive issues that we have already talked about, we are actually in probably the best position as a, firm having maintained our independence, having a solid corporate culture, and the ability to leverage a fixed infrastructure, we believe that this is our time. As Joe said, this is our time now, and we want to take full advantage of it, and therefore, we have made the decision to make the investments in the additional headcount. The impact on SG&A is marginal for the incremental headcount and the risk/reward, we believe, is significantly weighed towards reward, particularly towards the back end of this year and accelerating revenue growth even into 2014.

All very well thought out, all very well calculated, all very well executed, and we are confident that as we get into the back end of the year that we are going to see more of that, and we are going to continue to invest as we go forward to accelerate the revenue growth. We have got a great platform. As Joe said, Bill has done a phenomenal job in honing the culture, building out a great infrastructure, and actually all of these factors coming together put us in a great place right now, and we are actually excited about our future, and we think that based on these conversations, I will give you an interesting status.

We went through our plans of attack for our field offices. We could actually triple the size of the firm and not add another client, so just to give you an idea of the level, the scope, and the success that we have had with these clients. The new people that are coming in, as Joe said, are largely going to be targeted at existing clients to further penetrate them, and to gain more share from them as we move up in the share of those customers, and take additional market share. I know you are looking for something more than that, probably something more specific, but it is a management call, and management has made the call and we believe you will see as we get to the back end of the year that there is going to be an accelerated revenue growth.

I just wanted to make sure then, basically, what I am hearing, the majority of this call of the risk going forward is not something that you are hoping happens, but what you are hearing from your clients, your customer base, is that correct?

Correct. Morris, I have met with the majority of our largest customers in the last quarter. There is one thing that is crystal clear. Everybody is looking at overall human capital staffing strategies, and what balance of the mixture of their population is going to be in contingent, and the use of contingent on an ongoing basis. I think part of that is what Dave has mentioned, what we have seen manifest itself here over the last several years because of all of the uncertainty.

With healthcare reform, and all of the uncertainties there, there is no question, people are not looking to go long on human capital and now they are building in contingent workforce as a staple of their overall, not just for projects but even ongoing maintenance. There is another big point that Dave didn't mention. It is the quality of our leadership. We have a very stable leadership team. We have built a team over time, they have been in their seats, they are ready to go, they have good infrastructure, the training aspects, the ramp-up aspects of some of the things that I mentioned earlier, in terms of proof in the pudding of some of the results and how we have been ramping up new people, so we are very confident in our leadership's ability to integrate these teams and make things happen, and our ability to our capture market share at the client front.

Thank you.

Alright, thank you.

Thank you. This concludes our question and answer session. I would like to hand the conference back over to Mr. David Dunkel for any closing remarks.

Alright. Thank you. We appreciate your interest and support for Kforce. And once again, I would like to say thanks to each and every member of our field and corporate teams, and also to our consultants and our clients for allowing us the privilege of serving you. Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect, and have a wonderful day.