Kforce Inc (KFRC) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Kforce, Inc.'s third quarter 2013 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 call is being recorded. I would now like to introduce your host for today's conference, Michael Blackman, Chief Corporate Development Officer. Sir, you may begin.

Great, thank you. Good afternoon. Welcome to the Kforce third 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 and are subject to risks and uncertainties. Actual results may differ materially from 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 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 filings 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. We are very pleased with our performance in the third quarter as Kforce achieved record high quarterly revenues of $299.7 million and earnings per share of $0.27, driven by Tech Flex, our largest business segment, which accelerated the double-digit growth of 14.2% year-over-year.

We continue to invest in our growing Tech Flex businesses, given the positive opportunities that we see going forward. All of our businesses grew sequentially for the second consecutive quarter, driving year-over-year revenue growth above 10%. The talent investments we have made are taking hold, demand is strong, we expect an acceleration of year-over-year growth in Q4.

Interactions with our clients and consultants continue to affirm our belief about the secular shifts taking place in the employment marketplace. US GDP growth continues to be below 3%, translating to a slow and steady overall job growth rate where we continue to see a disproportionate amount of job growth coming from the staffing sector.

Temp penetration, which is temporary workers as a percentage of the total labor force, grows 2 basis points to 2.02%. This is higher than last cycle's 1.96% peak and is closing in on the all-time peak of 2.03% achieved in April of 2000. We expect IT staffing to continue to outperform other staffing sectors, in part due to secular shifts, but also driven by our client's desire to fully leverage the benefits of staffing in this largely project-driven sector. Candidate supply remains tight in this market and we are working proactively with our clients to align process and pricing to help them win in this heated war for technology talent.

As I highlighted last quarter, we have intensified actions to improve operating margins as we move into the new era of simplicity, focus, and accountability. In recent weeks, we have taken steps to streamline our leadership and support structure to align a higher percentage of roles closer to the customer and speed our ability to turn decisions into action. This new organizational design will provide improved accountability and will enable the firm to move at an accelerated pace in our efforts to service our clients, consultants, and core personnel. These changes, coupled with our excellent operating platform, should allow us to accelerate operating margin improvements and continue to fuel our revenue growth, allowing Kforce to achieve prior peak earnings levels at a faster pace.

As a result of our realignment, a number of roles within the firm have been eliminated. Words cannot express how thankful I am for the effort of the individuals who will not be moving forward with the firm. Kforce would not be the firm it is today without the efforts and valuable contributions of these individuals.

As demonstrated by our Q3 results and Q4 guidance, we are building meaningful momentum in what remains a very positive operating environment for the firm, particularly in Tech Flex. We remain confident in our strategic direction and believe there are significant opportunities with Kforce having only a 3% market share in a growing domestic professional staffing market.

I will now turn the call over to Joe Liberatore, President, who will provide operating insights; Dave Kelly, Chief Financial Officer, will then provide additional insights on operating trends and expectations, as well as provide some perspective around the impact of our realignment on Q4 results and the impact over the coming quarters as we execute our plan. Joe?

Thank you, Dave, and thanks to all of you for your interest in Kforce. I'm excited about the new era for Kforce, as we continue to align our focus to better meet the needs of our customers.

Throughout the third quarter, I've continued to spend a significant amount of my time visiting with our customers, our consultants, and our associates. I have now visited 33 of our markets, met with over 100 clients, and over 500 consultants. These interactions and the success of our hiring efforts have reinforced my belief in the opportunity to accelerate revenue growth through an expanded presence in existing clients and by selectively adding new clients. We continue to evolve our processes and tools to simplify and improve how we do business with our clients and consultants. This focus was critical to the widespread productivity gains of our associates at all tenure levels and a key to our success in the quarter.

Tech Flex, our largest business unit, represents 63% of total firm revenues. Q3 revenues increased 7.8% sequentially and 14.2% year-over-year. Overall, our key performance indicators for technology remain at high levels for job orders, external submittals and send-outs, with fill ratios at an all-time high. Candidate supply remains tight, particularly for skill sets in high demand, such as .NET and Java developers, business analysts, and project managers.

The industries that performed best in Q3 were telecom, computer hardware, retail, and financial services. Technology services within healthcare remain very healthy as hospitals and healthcare organizations implement systems and transition their platforms to more of a shared services model. Inter-quarter trends for Tech Flex revenue showed steady growth in both July and August, followed by further acceleration in September. Tech Flex revenue trends have continued to strengthen in October and we expect revenues to show further increases in the fourth quarter on a billing-day basis, which should result in overall revenue growth, despite the impact of the holidays falling mid-week.

Revenues for our Finance and Accountant Flex business represent 18% of our total revenues. Q3 revenues increased 3.5% sequentially and 6.1% year-over-year. Revenues were basically stable during July and August and returned to growth in September. We expect Q4 F&A Flex revenues to increase on a billing-day basis, though gross revenues may be down slightly due to the holiday impact. Revenue increases for the quarter for our Tech and FA businesses benefitted from the continued strong growth in some of our larger clients, whose overall growth rate was stronger than our smaller clients in aggregate. We expect a mix of growth to be more balanced across all client sizes in Q4.

HIM Flex revenues grew 3.6% sequentially and increased 8.4% year-over-year. This space continues to be impacted by cost management initiatives as healthcare organizations prioritize available spend toward technology projects, such as ICD-10 and EMR implementations. However, revenue trends improved late in the third quarter and demand continues to strengthen. We expect HIM revenues to be up sequentially in Q4 on a billing-day basis and flat to slightly up on a gross basis.

Revenues for Kforce Government Solutions increased 3.6% sequentially, despite the impacts of sequestration, and increased 6.3% year-over-year. Our government unit continues to have success in growing revenues organically on some of its more profitable existing contracts. There remains continued uncertainty around the funding levels of the various federal government programs and the environment for government services remains difficult. We anticipate Q4 revenues to be flat in the fourth quarter.

Perm revenues from direct placements and conversions, which constitutes 4.1% of total revenues, decreased 8% sequentially and 1% year-over-year. Perm revenues are difficult to predict, but we expect them to decline in Q4 from Q3, which is a typical pattern heading into the holiday season.

Against an increasingly strong demand environment, we accelerated hiring above anticipated levels during the third quarter. The hiring was focused primarily in Tech Flex sales and delivery. Revenue responsible headcount in Q3 increased 8.3% sequentially and 21% year-over-year, driven not only by greater than anticipated investments, but also better than expected retention levels as a greater proportion of our newer associates are having success than historic models would have anticipated.

Our Q3 performance also benefitted from increased contribution from all tenure populations. We continue to have an associate mix highly weighted in less-than-year category, however, so overall productivity levels have significant room for improvement. We plan to make continued investment in our sales associate headcount, while balancing operating margin improvements as the demand environment dictates.

As Dave mentioned, over the last few weeks, we have finalized a number of significant actions that we believe will position the firm to take better advantage of our strengths to improve customer and market share. These changes have included a reorganization of our sales and delivery teams to better leverage our resources and geographical presence and improve coordination of activities around our clients.

We have also realigned our support infrastructure to streamline services and improve our speed to market through a greater emphasis on activities most critical to meeting our client's needs. The immediate impact of this reengineering is the approximate 50 individuals, primarily back office personnel, were released from service within Kforce over the past few days. It is important to note that approximately 300 individuals have been hired to perform functions in the field and other services directly interacting with our clients and consultants over the last 12 months.

Though the full impact of these changes will not be fully realized until the second quarter of next year, we are confident we have taken a significant step that will benefit both our customers and our shareholders alike.

I am pleased with our strong performance in the third quarter and I'm confident we have built a solid foundation for continued success. As we transition into our new alignment, we are now positioned to operate in a more agile space, allowing us more rapid adaptation to the ever-changing operating climate. We remain focused on driving profitable revenue growth by meeting our clients and consultant needs and gaining market share.

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

Thank you, Joe. Total revenues for the quarter of $299.7 million increased 5.6% sequentially and 10.9% year-over-year. Quarterly revenues for Flex were $287.4, which represented an increase of 6.3% sequentially, and an 11.5% year-over-year increase. Search revenues of $12.2 million decreased by 8% sequentially and 1% year-over-year.

We are seeing continued strength in the October weekly revenue trends. For the first three weeks of October, Tech Flex is up 15.3% year-over-year, Finance and Accounting Flex is up 4.3% year-over-year, and HIM is up 12.8% year-over-year. Search revenues are up 6.4% year-over-year for the first 4 weeks of Q4. It is difficult to assess potential full quarter results with this limited data, though recent activity is encouraging and continued year-over-year growth acceleration is expected.

Third quarter net income and earnings per share were $9 million and $0.27, respectively, compared to $6.9 million and $0.21 per share in Q2, 2013 and $9.3 million and $0.26 per share in Q3 2012. Our overall gross profit percentage of 32.5% decreased 20 basis points sequentially and 40 basis points year-over-year as our Flex revenue acceleration has led to our high margin search business declining as a percentage of total revenues.

Our Flex gross profit percentage of 29.6% in Q3 increased 20 basis points sequentially and was flat year-over-year. Overall spreads experienced slight compression sequentially as a result of changes in the mix of business, however, at the transaction level we are still seeing slight improvements in spread as bill rate increases are slightly outpacing increasing pay rates.

Flex spreads in our tech business were flat sequentially but down 60 basis points year-over-year. FA Flex spreads were down 70 basis points sequentially and are down 50 basis points year-over-year. Both segments are experiencing a year-over-year increase in revenue from large clients, which typically have smaller spreads and is the key driver to this trend.

Our government spreads improved 50 basis points sequentially and 290 basis points year-over-year. This business unit, as Joe said, has done a nice job growing organic revenues on some of its larger, more profitable projects.

HIM spreads still remain high, relative to our other businesses, but were down 180 basis points sequentially and have declined 570 basis points year-over-year, due to a combination of increased compensation costs for our consultants to enhance retention and cost pressures on healthcare providers that is making it difficult to improve bill rates. We expect these trends to continue for the foreseeable future.

Q3 SG&A levels of 26.5% decreased 120 basis points from Q2, as we began to see the initial benefits in the ramp of our recent hires. SG&A is 50 basis points higher than Q3 2012, however, as a result of the additions made to our revenue responsible associate population over the past year.

As we look at our balance sheet and cash flows, our accounts receivable portfolio continues to perform well. Write-offs and the percentage of receivables aged over 60 days remain at low levels. Capital expenditures for Q3 were $2.4 million. EBITDA for Q3 of $18.3 million increased $3.6 million sequentially and was down slightly year-over-year. EBITDA growth should continue to improve proportionally to net income growth.

The firm had $53.4 million in bank debt at quarter end, compared to $50.1 million in debt at the end of Q2 2013, and no debt at the end of Q2 2012. The firm repurchased 300,000 shares of stock for $5.8 million during the third quarter. Over the past 7 quarters, we've repurchased 5.2 million shares for $70.9 million. Currently $63.3 million is available under board authorization for future stock repurchases. As cash flows improve, we will continue to evaluate the opportunity to return earnings to our shareholders through share repurchases and dividends.

With respect to guidance, the fourth quarter of 2013 has 62 billing days, compared to 64 billing days in the third quarter of 2013. We expect Q4 revenue may be in the $300 million to $304 million range. Gross margins are expected to decline from Q3 to Q4, due to revenue declines we typically experience with search and the impact on Flex margins of increased paid time off to our consultants around the holidays.

We expect gross margins to be between 32% and 32.3%. SG&A, as a percentage of revenue, is expected to be between 25.7% and 26.3%, excluding charges related the realignment, which were between $6 million and $7 million. We will only see partial SG&A savings in Q4 as a result of the realignment activities. Excluding the $6 million to $7 million charge, Q4 earnings per share may be $0.27 to $0.29.

Looking beyond Q4, we expect to see a $0.03 to $0.05 quarterly improvement in earnings per share with the recent streamlining actions once the benefits are fully realized.

Our effective tax rate in Q4 is expected to be 40.6%. We anticipate weighted average diluted shares outstanding to be approximately $33.3 million in Q4. This guidance does not consider the effect, if any, of charges related to the impairment of intangible 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.

Though we expect the realignment activities to positively impact SG&A, the magnitude of impacts will not be clear until all actions are complete. We plan to provide an update and additional refinements to the expected impact during our presentation at the JPMC Business Services Conference, a Reg FD compliant event, on November 13th.

Third quarter revenue and earnings represent historical highs for the firm. As we look forward, we believe sustained revenue growth and a strong environment for our services, coupled with the operating leverage that exists in our operating platform, the recent organizational changes we have made, and the significant productivity that exists in our revenue-responsible team, will allow us to accelerate operating and margin improvements and exceed prior peaks more quickly.

The confluence of the macro environment driving a secular shift to a greater use of temporary staffing, the growing prominence of technology which is our largest business as a percentage of the overall economy, and the changes we have made over the past 9 months to accelerate revenue and rationalize our cost structure position Kforce better than any time in our history. We're just getting started and are excited about the future.

Sam, we'll now take questions. Thanks.

(Operator instructions). Mark Marcon of Robert W. Baird.

Good afternoon and congratulations on the results, particularly in terms of the top line acceleration in Tech Flex. I was wondering if you could talk a little bit more about that in terms of what's going on under the surface in terms of you did ramp up your hiring, people have become more productive, but are you seeing that in terms of any regions? You mentioned a few verticals but if you could go a little bit further in depth there, and then I have a follow up as it relates to the margin implications for next year due to the cost actions.

Yeah, Mark, relative to the ramp-up of our new people now I'd say it's broad-based. We've put a lot of programs in place and we've made tremendous progress here. In fact, as we were moving through the quarter, we've been able to retain approximately 70% of our new hires, the hires that we made earlier in the year, which is a little bit higher than the normal historic trends. We're aligning people more on existing accounts to further our penetration into those accounts, which I think is aiding in the ramp-up of individuals. Also, when we look at the hiring, realize probably 70% of the hiring we've been doing has been within Tech Flex where we're getting most of our growth. Likewise, it's disproportionately balanced on the hiring on the delivery side versus the sales side.

When we look to the industry verticals, as I had mentioned, I mean we're seeing nice growth, really, across 5 of our top 6 industry verticals -- in double-digit growth on a year-over-year basis, so I'd say that's pretty broad-based growth as well, and across all geographies.

That's great and it looked like the bill rates are going up as well. Can you talk a little bit about how you would expect paid bill spreads to unfold as we go into next year? I know you've been going out and talking to a lot of clients about the need to pay a little bit more in order to get the fill rates up.

Yes, part of what we're hearing from the clients, and I'll have Dave add a little bit more of the numbers behind this, but given I've met with over 100 clients this year, what we're really seeing from the clients is a focus on how they win the war for talent, so you know, the 25 years that I've been doing this business, I haven't seen clients as receptive as they are right now on refinement of their hiring processes, streamlining it, so that they can get the candidates that they're looking for. We've yet to see the pressure of meeting clients -- every organization that I've been in, virtually, they're feeling a lot of financial pressure, so they're obviously passing that along to the vendors, so that's probably why, in this cycle, unlike other cycles, we haven't seen the bill rates expand at the rate that we normally would see, based upon where we are in supply-demand, so I'd say it's healthy, meaning they're inching up but we're not seeing it gap as I've seen in other cycles.

Yes, Mark, this is the other Dave. The better Dave, right. I would say just to further Joe's comments, so we've been seeing this quarter much what we've been seeing the last few quarters. Pay rates, as we are in a supply constraining environment, continue to inch up and a transaction level for us, we've been pretty successful in improving spread -- as a matter of fact when we look at spreads relative to historical peaks, we're almost there. We've got some higher regulatory costs but on a transaction by transaction basis -- as you pointed out the education to our clients is paying off, and I'm talking primarily in tech, and so I think as we kind of look forward, our view really is pretty much unchanged to where it has been.

We expect continued high margins, which are, today, pretty close to where our peaks were. I don't think we anticipate significant improvement from here because they have been pretty stable for the last couple quarters but that, I think, goes both ways. We're having success inching them up. I don't see them really going down at any point in time, so pretty stable right now.

Yes and we're continuing to see more penetration in what we call our strategic account portfolio, which are the large clients, making up about, close to almost 35% of our Tech Flex revenue now. So that's continued to grow on a sequential basis and within that population, we actually, in the quarter, did see about a 30 basis point improvement on margins, so we are seeing those high consumers starting to move a little bit.

That's great and can you talk a little bit about the cost savings? It looks like at the mid-point in terms of the changing of the SG&A, it looks like, roughly, about $2 million per quarter, roughly speaking, and I know that won't go into full effect until the second quarter of next year but at the same time you're going to continue to hire -- I'm wondering, can you give us a little bit of a feel for, like, of your revenue producers, what the pace of hiring would be and how we should think about the incremental margins as we go through the year next year, how we should think about that?

Yes, so Mark a bit more color on these savings, so what we're talking about this improvement in SG&A, and the change that we've made in redirecting our resources to revenue production versus support, that's what we're talking about on an ongoing basis, $0.03 to $0.05 as I said. We'll be refining those estimates over the course of the next couple weeks. As a matter of fact, some of those actions took place as recently as today, so we're still working through those, waiting for those things to settle. So as we think about on a go-forward basis, what that means, and we've talked a lot in the past about our infrastructure being very stable and creating additional opportunities for leverage, this is something that we see as layering on top of that versus where we were before, that's going to create additional opportunity for margin improvement as we move forward so that we can really direct investment decisions specifically into the revenue responsible area to continue accelerating revenue growth and generate incremental leverage there. So I'll end with that.

Okay. Can you give us a sense for how you would think about the incremental margins going forward with these savings or is that too difficult to do right now, because I know you are at an early stage?

Hey Mark, this is Dave. Yeah, we're still going through that process, so we'll add more color, obviously, as it becomes clearer and also with our report of our Q4 earnings, so we'll be able to give you a lot more color at that point, but I think the best thing to do is to go with what we've given you, which is we estimate $0.03 to $0.05 per share per quarter as we go into 2014.

Got it, thank you.

Paul Ginocchio, Deutsche Bank.

Thank you. I appreciate the color around the 30 basis point expansion in gross margins in your strategic accounts. What was it last quarter and then does that imply that your smaller account gross margin in the third quarter was down year-on-year? And then second question, how much of the cost saves of that $0.03 to $0.05 do you have embedded in your fourth quarter guidance? Thank you.

This is Dave. You asked a number of questions. So just to clarify the spread discussion, Joe mentioned the 30 basis point increase in strategic accounts was, and this mix shift is, part of what's driving those flat spreads. We did see an improvement in the smaller clients, just at a lesser extent than our strategic accounts. I don't know if you wanted to add anything to that, Joe.

Well, now in terms of the trending, so I think I had mentioned it on last quarter's call. When we were comparing sequential Q1 to Q2 within that same portfolio, we had about a 20 basis improvement in the strategic account and then this quarter we had a 30 basis improvement. So yes, we are seeing more of a flattening at the spot market. In certain regions, we're seeing some slight improvements, 10 or 20 basis points, but in aggregate, I'd say that population is really more on a flat basis.

Yes, and I think the last question, Paul, you had was the impact in the fourth quarter itself on these savings. Hard to estimate for us. Hard to estimate because these activities are taking place throughout the quarter certainly far less than that $0.03 to $0.05 that we were talking about. It's a relatively small impact. Still trying to get our arms around that in the aggregate but a small number.

And Joe, maybe go back to just as you look out to next year, when you just look at wage rates or revenue per billing hour, this year's kind of muted. Would you expect 2% to 4% next year from that line or do you think that's still going to be held back by a mix shift or other things? Thanks.

Paul, this is Dave. Yes, I think on your range, 2% to 4%, if I think about this this year and historically, if we think about a consistent environment to what we've seen it's on the lower end of that range based upon what we've seen this year.

Thank you.

Tobey Sommer of SunTrust.

Thank you. You had mentioned a couple of sequential trends in the fourth quarter and I just didn't quite keep up with what you were describing. From a same-day basis, did you say you have an expectation for Tech Flex to grow sequentially?

Yes, actually Tech Flex is expected to be up on a billing day basis and on a gross basis.

Okay. Are there any of the segments that will be down sequentially either typical with fourth quarter seasonality or is that a uniform comment across the segment?

Well on a billing-day basis, we expect all segments to be up on a billing-day basis. I did mention the KGS, we expect that to be flat, realizing they're impacting much heavier on a billing-day basis, so KGS flat on a gross basis.

Okay and was there an impact in KGS relative to the government shutdown or was the fourth quarter kind of unscathed by that?

Actually, based upon the client mixture that we're in and the areas where we're doing business with the government, we weathered that fairly well. Our estimates are we were impacted by about a $0.5 million in the quarter.

Dave, from a broad perspective over the last decade or so, you've had a couple of multi-year plans and targets, goals for financial performance, but do you envision sharing a set of goals similar to those plans with us at some point, perhaps after you've refined the impact of the quarterly streamlining?

I think we're going to stay with what we're doing. We'll give it to you one quarter at a time right now and maybe we'll give you the Big Papi and we'll point to the fences and at another time, because it's, as you know, the operating environment that we're in is very volatile. The actions that we've taken over the last year, year-and-a-half, were a direct result of the conclusions that we reached about the environment that we were already operating in over the next several years.

With that being said, there are a number of things that have changed. We know the Affordable Care Act has now been implemented. We also know that the government funding is still a large question mark as we get into next year, so we're going to take it one quarter at a time. If at some point, we're more confident and comfortable going longer, we'll do that but right now, we're going to take it one quarter at a time and as Dave said, we'll give you more color on the impact of some of the changes that we've made but understand that the objective is to accelerate the improvement in operating margins while at the same time accelerating growth rates and revenue. So we're kind of bringing those two things together in lock step and of course we would expect the operating margins and operating profitability to improve at a greater percentage than revenue growth as we get leverage.

Thank you, that's really helpful. In terms of the opportunity in Tech Flex, in I guess Tech Perm, too -- in the perm side, are you performing in line with the market there or are you still trying to kind of de-emphasize that in the mix relative to prior cycles?

We haven't really de-emphasized it. The way that I would more so categorize it is we haven't tried to time the cycle as we have in the past, so we are adding selectively where we're hitting capacity levels onto some of our pure search teams. Much more of our tech search business now is done in a blended model, where it's being, that contribution is coming through our Flex performers. I believe it's roughly about 50% of our tech search business, now, is coming through our Tech Flex service line.

Okay, my last question has to do with the NRC and if you could give us an update on metrics in productivity versus the field sales office and kind of which one you're experiencing better growth with. Thanks.

Well, our NRC contribution increased, it's up about 21.6% year-over-year. So they're contributing to about 32.4% of our revenues being contributed by the NRC. So we don't really measure the NRC and our field performers on the same metrics because they're doing a little bit different pieces of the job, outside of when we're selectively employing them, such as at our firm-sponsored accounts, where that type of role is a little bit more similar to a field-based role. The way that I really look at delivery as a whole -- and this is part of why we've ramped up our field delivery by 33% year-over-year -- is delivery is a hub and spoke game.

So we have something very special with the NRC. We've probably swung the pendulum a little bit too far in terms of moving away from the candidate at the local market, so I really think of our overall delivery model as more of a hub and spoke delivery model, especially in times like today where talent is scarce. You have to be close to the people to build the relationships. You also have to get into the networks. You have to get into a lot of different events where you can access the individuals. It's not all just by the Web and magically happens.

So we're actually -- one of the things that we've been very focused on to broaden our net is really going more after the passive candidates and building the relationships with passive candidates and doing that with feet on the ground in the local markets.

So overall, we've been very pleased with the continued progress we've been making in the NRC. We've continued to narrow the focus and exert more of our energy where we're having the greatest successes.

Thank you very much.

Randle Reece of Avondale Partners.

Previous three quarters, you had some pretty substantial increases in non-compensation SG&A and I was wondering what that looked like this quarter.

In terms of non-compen-, well, most of our investments and increases in SG&A are driven by compensation as we look from Q2 to Q3, Randy. So you see the aggregate increase there of SG&A as a whole is less than $1 million, and we've added, as we've mentioned but we're not 21% year-over-year headcount of revenue responsibles, so non-compensation related SG&A is down sequentially.

You still made progress on the leverage over comp expense versus the previous few quarters, though, didn't you?

We did. So we talked about that, and as we were thinking about where the third quarter was going to end up, that we were going to start to see some -- as we started to see at the end of June -- a ramp, continued ramp in the new hires, and that certainly contributed to some of the operating leverage that we saw in the third quarter relative to the second quarter, certainly Randy, yes.

The expense was still a little bit more than I expected but it sounds like that this is driven almost completely by what you're doing in the field. Is that accurate or is it (inaudible)?

Yes, I think -- just to kind of get, and we alluded to, I think Joe did in his remarks, as we went through the third quarter, certainly in the third quarter demand that we continued to see actually was stronger than we had anticipated, so as we have been doing, we certainly don't want to get behind the curve, we actually hired a bit more aggressively than we had originally anticipated in the third quarter to take advantage of what we see as a strong environment going forward. So that certainly contributed to some of that cost that you're referring to, but we think it's a prudent investment for us as we look out to the opportunities, in particular in Tech Flex as Joe said.

Well part of what happened is, we hire at a given pace based upon what we know are historic turnover levels to make sure that we keep netting on a positive basis. Our teams have done a better job of ramping people up and holding onto people, so while we were hiring at the same pace, we ended up with more people at the back end of the quarter because retention improved at -- hiring's not a spigot that you can just turn on and off, so I actually view -- I'm actually excited that our hiring ramped up in Q3 because that was not what our game plan was but the byproduct of why it happened is a very good outcome.

It looks like -- if I just look at your growth rates in hours billed by segment, exclude government for a little bit, it looks like that you've been improving, you improved in the second quarter, improved in the third quarter -- are those comparisons meaningful or is there something else I should take into account?

I'd say, really, hours are relevant, rate's relevant and hours per individual, meaning the number of consultants on, I mean, all three of those are key in getting to what's really happening in revenue, so the nice thing is we're seeing it really across all areas. The only place where we're really not seeing any, really, degree of improvement is the amount of hours worked on a weekly basis. So we're actually seeing it on a per-consultant basis versus the amount of hours each consultant's working. Now it really benefits you when you can start moving that number as well.

Is that some other kind of mix issue or is that comparison pretty much straight up in similar assignments?

Assignment length has remained pretty constant. We haven't seen much movement in assignment length.

All right. Thank you very much.

John Healy of Northcoast Research.

Thank you. Dave, I wanted to ask a big picture question. It's exciting to hear that you guys are putting some efforts in place to recalibrate the cost structure but I was hoping to get some more background on the jettison of this initiative. What makes you decide to do it now and how long this has been on the drawing board and some of the other factors that might've went into this decision.

John, actually this is Joe and then I'll let Dave add any additional color. As I mentioned, I mean I've been spending quite a bit of time in our field operations with our people listening to what our clients are saying, listening to what our consultants are saying, and we just have a lot of opportunity to simplify how we're interacting with those populations to really focus our energy on the high value-add areas. So it's really a byproduct of the heavy outbound focus. I believe as I stepped into the role, I had mentioned that on one of the early calls is we've built an incredible infrastructure at Kforce. I mean, when Bill was here and I was working with him as CFO and many of the others here, we just built an incredible, incredible platform and it's time to leverage that platform and that's really what we're doing now.

So as we've been going through, we're identifying areas where we may be doing things that are of value, but not the highest value and we're contemplating how do we redirect more of those dollars closer to the customer, so I'd say from a backdrop, that's really the genesis of everything.

And I would comment, John, that from a performance standpoint, our desire has been and continues to be to accelerate revenue growth and to generate additional operating leverage and operating margin. So as we have gone through and really evaluated all of the different elements, as Joe said, we have identified ways to gain efficiency while at the same time, accelerating the revenue growth and as those revenues are layered on against this platform, we think that the firm is very well-positioned to take advantage of what, as I mentioned earlier, is just an incredible market condition for us, particularly in Tech Flex, which happens to be our long suit.

So we're very focused on Tech Flex. We're very focused on investing there and accelerating that revenue growth. We think there's a chance for us to take market share. Many of our competitors over the years have been acquired and become distracted and we see a real opportunity for ourselves and a couple of other firms to really gain share here and to take advantage of the market conditions.

With that said and the desire to gain share on the technology side, how do you feel about acquisitions at this point? I mean is that something you could see yourself maybe more active with in 2014? I know it hasn't really been in the playbook this far in the recovery, but interested in your thoughts there.

The last acquisition that we did was actually a government business in 2008. We actually have been evaluating many acquisitions and we run into a few problems. Number one is always culture. If they don't fit, it doesn't matter what the price is. And the second, now, is really in compliance because there's a taint if that firm is not as compliant in areas like 1099 or in some of the foreign workers, so were we to make an acquisition of a firm that wasn't as compliant, then we're taking on significant risk and actually affecting our clients as a result of that.

Wall Street Journal today had an article on a firm that wasn't as compliant and you could see some pretty significant implications there and over the years, we've had a very, very tight compliance policy and have enjoyed some very high marks from the regulators in that respect and we don't want to do anything to jeopardize that.

With that said, we are going to evaluate opportunities and will and if we do find one that fits culturally and also from a compliance standpoint, meets our standards, then we would certainly evaluate it. Of course, expectations today are high, so we've got to rationalize whether or not it's more, a better investment than buying our own stock or investing in our own people but I would say we wouldn't dismiss it but it is not priority one for use of capital.

Makes sense and just last question. I know sometimes the government business can be sometimes choppy, but as you look to next year, are there any decent-sized contracts or renewals that you have to be successful with that might be able to move the needle forward or backward a little bit?

Yes, John this is Dave. I would say the government space, as we look into next year, is still a very uncertain place, so generally speaking, I think that will be the case for the foreseeable future. As far as a [outsize], the amount of recompetes or anything like that, no. It is a relatively normal year for us.

I would actually compliment our team. I think they've done a phenomenal job. You know if you look competitively and what's happening with some of the other, larger players in the space, they've been declining at a pretty significant rate and our team is not only not declining, they're actually growing, which I consider to be remarkable. So hats off to those guys.

And you also have to realize 40% of our KGS revenues are within healthcare, which is fairly insulated and the nature of how we've aligned the KGS business is it's a high concentration, so our top 10 customers in KGS make up almost 90% of the revenue stream, so it's highly focused and highly concentrated, so to Dave's point without big recompetes coming our way, we feel we have a good basis of business and our services businesses have been performing.

Got you, thank you guys.

Paul Ginocchio, Deutsche Bank. Paul, please check your mute button.

Sorry about that. What exposure in HIM do you have to ICD-10? Do you have any rough approximation of what percentage of revenue is being generated from that? Thank you.

Actually, our HIM business is predominantly coders, so that business is transitioning. ICD-10 actually presents an opportunity for us. We've been, for quite some time now, investing in the reengineering and retraining of 9 coders into 10 and putting retention programs in. That's part of why you've seen some of the margin compression in that business over the course of the last several quarters. So actually 10 presents an opportunity for that business because many of the clients that we're interacting with are more than likely going to run dual for periods of time, so it gives us an opportunity to actually have 9 coders in there and 10 coders in there, so it's not from the, necessarily, the technology side of it or the assessment and remediation aspects. That's not within our HIM business.

Thank you.

Mark Marcon of Robert W. Baird.

I appreciate you're only giving guidance for the coming quarter, but as most people are going to set expectations for the first quarter, are there any sort of, I mean aside from a normal [SUDA] increase, is there any sort of thing that we should take into consideration as it relates to Q1 expenses or gross margins? Thank you.

I think, first of all, off the top of my head, no. Certainly SUDA is something that always impacts Q1 and it will certainly, at least to the extent that it did last year and has in prior years. We're going to continue to refine our estimates as to what we've done this quarter and we'll give you a better sense of it in the next couple weeks, but other than that, I don't know that there's anything that I would look forward to that changing.

Mark, this is Dave. I would say the operating assumption now is that the gross margins are going to be relatively consistent, relatively flat, so increased operating margin's going to come from operating leverage efficiency, revenue growth, so that's where we're focused and as I said, I know it's difficult for you guys to model and I'd love to be able to give you more color and more specificity, but we can't at this point. But as I said, we will give you more color at the JPMC Conference and also with reporting the Q4 results.

And realize part of the realignment of our support infrastructure was to align that infrastructure, so we've scaled back that infrastructure. That's the byproduct of what Dave was talking about, the $0.03 to $0.05. We believe we have an infrastructure that remains that we will be able to scale on top of without really much incremental adds there. We do have certain roles that are very linear, but that's a much smaller percentage of that overall infrastructure.

In terms of the revenue producers, what was the pace of the growth of the revenue-producing headcount in this quarter?

We gave you, the year-over-year number this quarter, Mark, is 21%, a producer increase.

8.3% sequentially, predominantly in Tech Flex.

Does that seem like a good rate or would you think of that -- if you're seeing demand trends as you're currently seeing them, would you expect that that would be, that's a good way to think about it or how should we think about that going forward, just roughly?

I would say when we look at our sequential Q2 to Q3, it's higher than we had modeled in and anticipated because of the earlier comments that I had mentioned.

Right.

Which is we held onto more of the newer hires, so we didn't turn as many of those over, so we hired at the same pace, which left us on the back end with more population. So no, I would say that's a little bit higher than what we would anticipate on a normal basis, but you have to understand. You try and mark these things on a quarterly basis but these are humans and they make decisions and things happen, so it's not a precise science but yet, we have a pretty robust plan associated how we're going to be incrementally adding.

Mark, the only other thing I would add is as you think about this and we talk about this quite often is as tenure improves, as these individuals mature within the firm, they become increasingly more productive, so that we're at a point where we won't have to hire at the rate that we are today to continue to grow revenue at the pace that we are today. So that percentage over time of your earlier hires goes down.

And actually, we're seeing productivity increases in each of the pools, which suggests that we're actually getting better traction than we've ever experienced, so a lot of the things that we're doing training and tools, territory management, focus, direction, we're actually starting to see some of the fruit of the efforts and so actually we're quite optimistic about our ability to hire and ramp these folks, particularly in the tech business, although I will say that F&A has also made significant progress in fill rates and so forth.

That's great.

It's important to know that almost, slightly less than 50% of our total performer population is less than 1 year, so we're carrying a lot of expense in those individuals, but we're seeing the right things happen. For example, we've seen our 2-plus population expand. It grew about 290 basis points, sequentially, which those are the gates that we want to get these people through because of the way that, disproportionally, their performance increases as they go through these different gates. So all the right things are happening, all the indicators, but we believe we're just continuing to build capacity to capture more market share because the objective is, I mean you see where the performance has gone. I believe if you go back to Q1, I think our Tech Flex performance in Q1 was 1.5% year-over-year growth. We're sitting here 2 quarters later at 14.2%. So we have the right team, we have the right leadership. Our people are hungry. They want to service their customers and we're going after it.

Great, thank you.

Jordan [Macca] of Macquarie.

It's actually Kevin. Of the $0.03 to $0.05, how should we think about that in terms of the way that layers into '14? Is that kind of a Q2, or is it kind of settle in pretty evenly on a quarterly basis?

You're going to see that each quarter for all of 2014, beginning in Q1, rolling through the quarters. So the range we gave you is because as Dave said, it's a little difficult right now to see the full effect of all of those things. So you should model in for 2014, as we get further on Q2, so you should model in $0.03 to $0.05 each of the quarters, probably less in the first as more as the (inaudible).

Got it. And then, as you think about, it sounds like it's primarily in the SG&A, any sense of whether there's a gross margin impact there and then ultimately is it coming out of kind of the NRC or at the field and just any thoughts on kind of the structure, the cost efficiencies?

Kevin, this is Dave. So a couple points. This will all come out of SG&A and we've been very careful about how we're thinking about this and so we don't anticipate it having any impact on our ability to grow revenue, as Mark has said. And you asked about the NRC, this is all out of the support infrastructure, not the NRC.

Got it and then just real quick, with obviously the glitches around Obamacare, is there any incremental opportunity for you folks on the tech side to kind of help undo some of the -- I mean it sounds like there's a lot of miscues there, but.

I'm putting my KFI hat back on and getting in there. Actually, I don't think that's one that we want to play with, nor do we have to play with, nor have we played with. I believe we're going to see the ripple. You know I've met with a number of clients that are building the connection points on the other side that are connecting to the government and that's where we're focusing our energy is working with those clients that are going to have to deal with it.

Yes, their description was it's like digging a tunnel through a mountain and they're drilling from each side and they're hoping that they meet in the middle. So that's the kind of -- I know that's kind of frightening to many of us, particularly taxpayers, but it's as bad as advertised. There's issues with the data engines, there's issues with the website, there's issues with the middleware, so the tech guys are all sitting around and of course now, there's been a lot of discussion in bringing in the giants and heavyweights but there are some things that just take time and there's another issue and that is the interdependencies with the different agencies and the connectivity to them. So this story has not been played out and I don't think that I could get Joe or Larry Grant or anybody else to get within a 100 miles of that thing.

I knew you weren't involved because it would've been done right if you were, but congrats anyway. Good luck.

Yes, if we had done it you would also probably have seen it in the revenue stream with about $800 billion that they spent on it.

Tobey Sommer of SunTrust.

Thank you, Dave I wanted to see which factor, external factor you see as helping the tech business the most? You cited some historical competitors have been acquired and distracted and on a prior call, we talked about how staffing and flexible labor may be taking share from outsourcing and consulting as CIOs kind of look at staffing as an attractive alternative to get projects done. Thanks.

Yes, I would say on the consulting side, given the scale of consulting, which by the way, is quite a bit larger than staffing, so God help us if we were ever successful in doing that. You'd see some pretty significant growth rates in staffing. I would say that there may be some firms that are experiencing success there. We certainly are seeing some but I wouldn't say that we're really harming or denting any of them. In fact, some of them are our clients, so I think that there's still somewhat of a symbiotic relationship but yes, we are benefiting from the ability to bring talent in at a lower cost where clients elect to self-manage projects and, in fact, they are obviously cost-conscious today and looking at ways to save money. So that is a factor.

Another factor is the project nature of work. It's a shorter term development cycle now. Many clients have actually pegged the percentage of flexible workers that they want of use and contract workers they want to use relative to core, so that's another factor.

So when you look at it, in context, I would say it's not one thing, it's everything but the one thing that is clear is that in this environment, that the opportunities for Kforce, particularly in tech but F&A as well, because of the model that we have and the way that we're executing it are significant. We think we are gaining share with customers. We think we're gaining share in the market and we think that we're finally at a point where we can see as we look down the road, assuming the same kind of a backdrop, where we're going to start performing at the levels that we've wanted to perform at.

Thank you very much.

Thank you and at this time, I'm not showing any further questions. I'd like to turn the call back to David Dunkel, Chairman and CEO, for any closing comments.

Okay and once again, we want to say thank you to all of you for your interest in and support for Kforce and again, I want to say thanks to each and every member of our field and corporate teams, to our consultants and our clients, for allowing us the privilege of serving you.

As I mentioned, we'll have more commentary at the JPMC Conference coming up in November and we'll provide more color on our Q4 call in January. We're very interested in sharing more with you and we're grateful for your support. Thank you.

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