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Kforce Inc. (NASDAQ:KFRC)

Q2 2010 Earnings Call Transcript

August 3, 2010 5:00 pm ET

Executives

Michael Blackman – Chief Corporate Development Officer

David Dunkel – Chairman and CEO

Bill Sanders – President

Joe Liberatore – EVP and CFO

Analysts

Kevin McVeigh – Macquarie

Paul Ginocchio – Deutsche Bank

Kelly Flynn – Credit Suisse

Mark Marcon – R. W. Baird

Tobey Sommer – SunTrust Robinson Humphrey

John Healy – Northcoast Research

Operator

Good day, everyone, and welcome to the Kforce Incorporated second quarter 2010 earnings conference call. Today's call is being recorded. At this time, I would like to turn the call over to Mr. Michael Blackman, Chief Corporate Development Officer. Please go ahead, sir.

Michael Blackman

Thank you. Good afternoon and welcome to the Q2 Kforce conference call. Before we get started, I would like to remind you that this call may contain statements that are forward-looking. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results may differ materially because of factors listed in Kforce's public filings and other reports and filings with the Securities and Exchange Commission. We cannot undertake any duty to update any forward-looking statements.

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

David Dunkel

Thank you, Michael. You can find additional information about Kforce in our 10-Q, 10-K, and 8-K filings with the SEC. We provide substantial disclosure in our release and our hope is that this will improve the dissemination of information about our performance and the quality of this call.

We are very pleased with our firm’s performance for the second quarter of 2010. The significant upturn that began in March and April translated into one of our best sequential growth performances in the firm history. This is over a strong base, given the firm did not experience significant revenue fall-off over the past year.

Our Technology Flex results of 11.6% sequential growth were outstanding, with particular recognition to our west region team. I’d also like to acknowledge our F&A flex teams, which delivered 6.8% sequential growth, again led by our west team. Search also had an outstanding quarter with our search teams in all three regions performing exceptionally and delivering 25% sequential growth. Overall, an excellent quarter.

We’ve continued to see very strong activity levels in our technology and F&A services as we move into Q3 and are focused on meeting delivery targets firm-wide and particularly in the NRC. There has been extensive discussion and analysis centered on the economy and labor markets and the weak job creation relative to historic recoveries.

It appears that it may be different this time as the uncertainty created by new healthcare and financial reform regulations and uncertainties surrounding future tax policy has resulted in a strategic shift towards the use of contract and flexible labor. Since September 2009, the temp penetration percentage of the total workforce has increased from 1.33% to 1.6%.

Temporary jobs rose 19.6 % year-over-year in June, the largest gain on record and the sixth consecutive month of year-over-year gains. Discussion with our clients confirmed what the data suggests, as they express a preference for flexibility and a desire to shift unemployment risk to staffing firms. It is too early to say with certainty that this trend will continue, but we are encouraged about the prospects for accelerated growth, should that occur.

Throughout the second quarter, we continued our investment in our National Recruiting Center and Strategic Accounts teams and selectively added to our field delivery resources where appropriate. We are very pleased with our NRC teams as they surge committing to significant increase in demand in both Tech and F&A. We are also pleased that we are able to deliver exceptional earnings performance while continuing to invest for future accelerated growth.

We are continuing to see significant opportunities, as our Strategic Accounts team jewels [ph] and the timeline builds for future revenue growth. Our primary goal, however, remains to capture additional client share with our existing customers. We anticipate using cash flow for continued debt retirement, share repurchase and acquisitions that meet a very high hurdle.

We are continuing to see opportunities presented to us and recently absorbed the private valuations primarily in tech have increased substantially. We are maintaining our discipline and standards. Again, a great quarter with great results delivered by our great teams. We have diligently planned for this period with the goal surpassing prior peak revenue and earnings earlier in the cycle.

I’ll turn the call over to Bill Sanders, Kforce’s President, to provide his comment, and then Joe Liberatore, Kforce’s CFO, will then provide additional insights on operating trends and expectations, and I will conclude. William?

Bill Sanders

Thank you, David. And thanks to all of you for your interest in Kforce. We are indeed very pleased with our second quarter performance and in particular the continued strength in our Tech Flex and permanent placement business, as we continue to take advantage of a strengthening environment for professional staffing to deliver strong revenue and earnings growth.

Our second quarter revenues of $246.1 million, which grew 8.6% sequential, and improving bill pay rate spreads across all our businesses further suggests that demand for our services continued to increase. Our diversified revenue stream is concentrated in some of the areas of greatest anticipated demand, as the labor market for flexible and permanent professionals continues to strengthen.

We believe that Kforce is well positioned with great people and an operating platform that delivers exceptional results for both our clients and our shareholders. We are pleased to see that on a billing day basis, our Flex revenue trends improved sequentially each month and quarter and for both May and June for perm. In many respects, our clients are accelerating a flexible staffing model at a much faster pace than we have historically experienced.

Perm is also accelerating faster than historical economic cycles. We are pleased that we are prepared to provide our clients solutions to this surge in demand. Our largest business unit, Technology Flex, which represents greater than half of total perm revenues, increased 11.6% sequentially and 17.1% year-over-year.

Tech Flex revenue showed a consistent upward trend each month throughout the second quarter. Recent trends for Tech Flex were up from June levels and leading indicators continued to improve in July. We invested in our National Recruiting Center in Q2 to support this business as demand continued to be very broad-based. We continued to diversify our client base and are also seeing our large clients request greater numbers of consultants for projects. Both of these indicators are signs of a strengthening market.

We expect Tech Flex will have continued growth in Q3 and for the foreseeable future with a sustained increase in IT spending, providing a strong catalyst. Our Finance & Accounting Flex business, which now represents 16% of total revenues, also performed well in the quarter, where the revenue is increasing 6.8% sequentially and 2.7% year-over-year. Much like our Tech business, we are seeing broad-based growth across the entire bill rate spectrum.

This business unit continues to be enabled by our Strategic Accounts strategy and our National Recruiting Center, and we believe it is seeing the benefit of investments and leadership infrastructure that we have made over the past two years. F&A Flex revenue showed an upward trend throughout the second quarter. Recent trends and performance indicators for F&A Flex were up in July, and we therefore expect continued growth for this unit in Q3.

Our HLS business segment, which comprises 17% of total revenues, is made up of two businesses; Clinical Research and Healthcare. During Q2, our Clinical Research business increased 2.4% sequentially and was flat year-over-year. Healthcare increased 4.4% sequentially and declined 1.7% year-over-year.

While the sequential increase in Clinical Research was driven primarily by a ramp of a new project in a larger client, this dependence on these large projects can create fluctuations in quarterly revenues. In late Q2, we began to wind down of the large projects, which will negatively impact Q3 revenues. We therefore expect Q3 revenues for KCR to be slightly down.

Our Healthcare revenue trends are promising and margins remained strong and hospital spend continues to improve, particularly in the project services and remote coding areas. We believe in the long-term demand for this profitable business and expect revenues to be up again in the third quarter. Revenues for Kforce government solutions, our prime government contracting business unit, increased by 2.1% sequentially, but decreased year-over-year by 8.6%. This business is concentrated in some of the better funded areas of both defense and federal services such as healthcare, data integrity, finance and technology solutions.

And the long-term growth prospects remain strong. In the near-term, we continue to see the expected impacts of the challenging federal procurement environment and continue to be negatively impacted by the trend towards the government in-sourcing positions previously held by contractors. We remain focused on our key competencies and are making significant investments to improve our business development capability, which included bringing in a seasoned sales executive during Q2 to lead the function at KGS.

Margins improved in Q2, but continued to be under pressure due to government’s focus on cost reductions and fixed the assignments on re-competed contracts. As we look forward to Q3, we expect revenues to be flat to slightly down and to build our pipeline. We believe in the long-term prospect of this business and anticipate growth to resume in 2011.

Search revenues from direct placements and conversions increased 25% sequentially and 48.9% year-over-year, driven by both rate and volume increases. We believe this growth reflects continued rebuilding of core staff and our clients after significant reductions throughout the economic recession. This is the fourth consecutive quarter search revenues have increased.

Search revenues in July were trending upward – trending similarly to Q2 levels, and leading indicators suggest continued strong demand. Because a significant portion of our search business is centered in the Northeast and therefore typically slows during the summer months, search may be flat in Q3. The performance of our highly tenured sales associates continues to improve as a result of continued improvement in our internal KPI and feedback from our clients.

We increased the capacity in our field sales force and our National Recruiting Center. In addition, we made significant investments in our large volume Strategic Accounts team. Our KPI strengthened throughout the second quarter and into July at a faster rate than we have experienced in recent history. This is true particularly for job orders and placement in Tech and F&A Flex.

Total sales headcount is 3% greater than last quarter. Our NRC and Strategic Accounts sales teams have increased in size by 19% sequentially and have almost doubled over the past year. We believe these investments position us well to attain higher peak revenues and earnings levels than we experienced during previous up-cycles, and we are well prepared as demand continues to strengthen.

As we consider the quality of our revenue stream defined by a diversified business footprint and 3,000 clients to whom we provide service at any point in time, we believe we are well positioned to maximize both market and client share. Our revenue growth in the quarter was well distributed amongst client segments. Our 25 largest clients represent 41% of revenues, and demand remains strong in this segment.

We are performing well, as we have reached the halfway point of our three-year strategic plan, which we are calling to race for the Triple Crown and are on track to meet our goals. We have established a cost effective delivery model in our National Recruiting Center, and our Strategic Accounts strategy has enabled us to evolve our revenue footprint to take advantage of our nationwide geographic presence and take customer share, as large volume clients continued to consolidate vendor list.

Additionally, the strong performance of our Search business continues to complement our revenue footprint. We believe our clients are looking increasingly to our staffing solutions as a cost-effective way to acquire talent. Our immediate plans are to continue to have a relentless focus on retaining our great people and to improve client satisfaction while driving continued profitable revenue growth that will lead us back over the $1 billion mark in revenues and beyond.

I’ll now turn the call over to our Chief Financial Officer and Executive Vice President, Joe Liberatore. Joe?

Joe Liberatore

Thank you, Bill. The firm performed well during the second quarter of 2010, coming in at the high end of guidance for revenue and earnings per share. Revenues for the quarter of $246.1 million increased 8.6% sequentially and year-over-year growth turned positive with an 8.9% increase. Quarterly revenues were flat of $236.3 million increased 8% sequentially and 7.7% year-over-year. Search revenues of $9.9 million increased by 25% sequentially and were up 48.9% year-over-year.

Revenue trends for the beginning of the third quarter of 2010 are up from June levels, and key indicators continue to trend positively. For the first three weeks of July, Tech Flex was up 20.9% year-over-year, Finance and Accounting Flex was up 12.3% year-over-year, and HLS was down 3.3% year-over-year. Search revenues were up 75.7% year-over-year for the first four weeks of Q3 2010.

We caution that it’s difficult to draw conclusions for Q3 based upon this limited data. Net income of $5.1 million and earnings per share of $0.13 in Q2 2010 increased sequentially 90% and 85.7% respectively. These increases are largely the result of the increase in revenue coupled with the increase in gross margins.

Year-over-year net income and earnings per share increased 31.7% and 30.0% from $3.9 million and $0.10 in Q2 2009. Our overall gross profit percentage of 31.9% increased 180 basis points sequentially and 20 basis points year-over-year as a result of an increase in search revenue as a percentage of total revenue and an increase in Flex margins.

Our Flex gross profit percentage of 29% in Q2 2010 increased 150 basis points sequentially, due to an expansion in bill rate and pay rate spreads as well as a 60 basis point decrease in payroll tax expenses compared to Q1. Flex margins improved as we experienced sequential bill pay spread expansion in all of our business units. Of particular note is the improvement in Tech Flex margins, which are now 20 basis points higher than a year ago, reflective of the strong demand in this business.

Tech Flex margin expansion appears to have begun slightly earlier than in prior cycles and consistent with the strengthening demand. Consistent with historical results, we believe our focus in this area will allow us to continue to expand margins as demand increases even as the work for talent heats up in this candidate-constrained environment for highly skilled workers. We believe our centralized National Recruiting Center provides the firm with a competitive advantage in this area and has been a key contributor to our success in managing margins.

The firm continues to diligently manage operating expenses and in particular discretionary expenses so that we made balance our profitability goals with continued investments in such areas as our National Recruiting Center and Strategic Accounts, which we believe will be critical to sustain growth. Operating expenses were 28.2% of revenue in Q2 2010, which was flat with Q1 2010 and a decrease of 60 basis points from 28.8% in Q2 2009.

The majority of our cost structure is variable in compensation-related expense, which is highly correlated to gross profit, comprises over 75% of our operating expenses. A key benefit to investments in our National Recruiting Center and Strategic Accounts group is to improve the performance of our field sales associates, thereby reducing the cost of expensive turnover and the need for significant hiring as demand increases.

As this performance improves, we anticipate more productive delivery of our services that should improve operating leverage. We believe revenues can grow significantly without having to add significant sales headcount, though we will continue to invest in adding sales capacity as demand strengthens.

Our accounts receivable portfolio continues to perform very well. The percentage of receivable days over 60 days increased only slightly to 4.6% in Q2 as compared to 4.2% in Q1, and write-offs continued to be nominal. Our accounts receivable reserves are currently $6.2 million and we believe sufficient to account for the current risk in our portfolio.

EBITDA, an indication to the firm’s strong cash flow, was $13.7 million or $0.34 per share in Q2 as compared to $8.6 million or $0.21 per share in Q1. Year-over-year EBITDA increased 22.9% from $11.2 million in Q2 2009. Bank debt as of today of $37 million is up from $19.2 million at the end of Q1 2010 and up from $24.9 million at the end of Q2 2009.

This increase resulted from the acquisition of the firm’s corporate headquarters in May 2010 for $28.5, partially offset by the strong cash flows which were used to pay down debt. We believe the building purchase provides an excellent return on investment with pretax savings of approximately $1.5 million annually and doesn’t compromise our ability to make acquisitions or repurchase stock.

Borrowing availability under our credit facility, which expires in November 2011, is currently $55.9 million. Capital expenditures in Q2 were $31.3 million, inclusive of the building purchase. Excluding the firm’s corporate headquarters acquisition, we expect capital expenditures to be between $7 million and $9 million for the year. The firm made no significant repurchases of stock during the quarter and had $71.2 million available for future stock repurchases under the current Board of Directors’ authorization.

Now, the guidance for the third quarter. We expect revenues may be in the $252 million to $258 million range. Earnings per share may be between $0.14 and $0.16. Our effective tax rate in Q3 is expected to be approximately 38%, with approximately 40.5 million weighted average diluted shares outstanding. This guidance contemplates strengthening in our business driven by continued growth in Tech and F&A Flex, somewhat offset by the full quarter impact of the 3.2% headcount growth mainly within the NRC and Strategic Accounts.

Achievement of the low end of guidance would result in sequential total firm revenue growth of 2.5% and the high end assumes 4.8% growth. The third quarter of 2010 has 64 billing days, which is the same as the second quarter. We are very pleased with second quarter results. We continue to invest in our business to take advantage of the increased demand for professional staffing and believe we are well positioned to achieve a high level performance.

We have a quality revenue stream and balance sheet, as well as the strongest management team and most tenured associate population in our history. And we expect to capitalize on the capacity that exists in our current employee base to increase leverage and accelerate earnings, which will position the firm to attain prior peak earnings earlier in the cycle.

Elizabeth, we’d like to now open the call up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question today comes from Kevin McVeigh with Macquarie.

Kevin McVeigh – Macquarie

Great. Thank you. Hey, guys, great job on the quarter.

David Dunkel

Thanks, Kevin.

Bill Sanders

Thank you, Kevin.

Kevin McVeigh – Macquarie

Dave, there has been a lot of talk obviously about the secular shift in temporary health, and it has been pretty consistent across the board. And I know we are not economists. But the thing I’m certain with is, given the growth you had, it seems like you are going to be able to continue to grow even if we get a slower GDP trajectory over the next couple quarters. Is that feasible kind of given the trends you are seeing in the business now, particularly given the GDP hasn’t been as robust as past cycles?

David Dunkel

Well, I sure hope you’re right. And you’re right, we’re no economists. It’s interesting having just finished 30 years here. So unfortunately again, starting at 12 and being only 42 today.

Kevin McVeigh – Macquarie

Happy birthday.

David Dunkel

Thank you. Actually we’ve seen a lot over the last several cycles. I would say to you that this one in unlike anything that I’ve seen in the past for exactly the reason we stated. And that is that even without significant GDP growth, we are seeing robust demand, if you will, for Flex and for Search. We’ve also seen an earlier Search recovery and a more robust Flex recovery. All of those things would suggest that the theory on the secular trend is accurate. We’ve actually talked to our clients. We’ve asked them, and it would appear at this point that that is in fact the case.

As I mentioned in my opening remarks, the healthcare reform, the financial reform, the uncertainty with regard to the tax packages, there is a desire on the part of our clients and many in the market to keep flexibility. And as far as we are concerned, if you look at Europe and you look at other markets and other economies that deal with highly regulated economies that tend to shift more employment risk, the staffing firms, that would suggest that there is still a lot of room to go. So that’s a hypothesis that we are operating under, and that’s where we are going.

Joe Liberatore

Yes. Kevin, I’d also just give a little bit of color because I went back and looked at some of our trends last time around in comparison to this time, realizing unemployment much higher at this point in the recovery than where we were at this point last time around. I mean, the Tech Flex gains that we are experiencing really a year from trough at this point, last time was 8.4%, this cycle we’re at 17.1% growth from that point. And also in F&A, our recovery last time around began about three quarters after the trough and this cycle began about two quarters after the trough. And likewise, Search being up 48.9% year-over-year really from the trough in the current cycle is much stronger in comparison to what we experienced last time where we almost had really a double dip in search.

Kevin McVeigh – Macquarie

That’s helpful. And the other thing is, if you have any thoughts around – obviously if you look at your growth relative to industry, I mean, you’re clearly outperforming the industry by a fair amount. Is that a function of the tenure of the sales force? Is it a mix, kind of small to medium versus large clients? Is there anything you can kind of attribute to just the tremendous outperformance?

David Dunkel

I would say it’s a lot of it. It’s tenured leadership team, management team, as Joe said, tenured sales force. I think the strategy, some of the things that we’ve been working on, we’ve been adding for ten-plus years. The NRC, as I mentioned in the last call, really came with an outgrowth of our interactive strategy in the late ‘90s, early 2000, and it has evolved culturally under Bill’s leadership and the President’s leadership the level of trust that exists between the field and corporate resources is really what makes that work. So I think all of those pieces coming together.

I think the maturation of our Strategic Accounts teams, we have not yet really even seen the contribution. We’ve tripled that staff basically over the last 18 months, and we’ve only seen a nominal contribution from the new folks that have joined our team and we expect as we go into ’11 that we will start to see even more contribution from them. So that’s why we’ve been increasing the headcount in both of those groups. So I would really attribute it to the culture and the people in the firm that have all come together and the level of trust that exists. And I really take hats off to Bill and Joe on our leadership team because they make it happen.

Kevin McVeigh – Macquarie

Great, thanks. I’ll get back in the queue. Thanks.

David Dunkel

Thank you.

Operator

Our next question will come from Paul Ginocchio with Deutsche Bank.

Paul Ginocchio – Deutsche Bank

Thanks. On the SG&A line, there was quite a big sequential increase. And I know that you are investing in Strategic Accounts and NRC. Just you talked about a lot of excess capacity a few quarters ago, maybe even last quarter. Just wondering where you are in the capacity and how you think about managing that capacity as you move through this part of (inaudible).

Joe Liberatore

Yes. Paul, I’m assuming you’re talking dollars, not percentage.

Paul Ginocchio – Deutsche Bank

Correct.

Joe Liberatore

Yes. The dollars are – the majority of that is wrapped up in compensation on some of the investments we’ve talked about on the 3.2% increase in headcount, as well as what’s taking place. Because of the accelerated performance in Q2, all of our field-based management comp structures are very performance-based based upon revenue and profitability growth. So when we have an exceptional quarter like this, that drives a lot more compensation into – in the management team as well.

Paul Ginocchio – Deutsche Bank

And on the capacity, has it changed at all or are you trying to keep the excess capacity at the same level you’re trying to compress it as we move through? How should we think about that?

Joe Liberatore

Yes. I would say based upon some of the activities here over the course of the last year with the significant expansion within NRC and Strategic Accounts specifically and then some of the growth that we’re experiencing especially in some of the better performing units such as at Tech Flex where we’ve been adding people as well, capacity in the field is still about the same, which means we have about 25% capacity off of where we were in the early part of 2008. But with the additions in NRC as well as Strategic Accounts, that’s – that much more capacity into our overall sales force.

Paul Ginocchio – Deutsche Bank

Great. If I could just sneak one more in on the gross margin, what do you think is driving it? It just seems like again the bill pay rate spreads widening sooner than we would have thought. Is there any – particularly in Tech Flex, is there any scarcity of labor that we should be thinking about that’s driving that or is it something else?

Joe Liberatore

I’d say it was broad-based across all of our service lines in terms of the margin expansion that we saw. The demand is absolutely tightening, or I should say, supply is tightening up. And we haven’t really – even to this point, we haven’t seen a significant movement in terms of bill rate expansion. So a lot of this has been pricing discipline internally.

Paul Ginocchio – Deutsche Bank

Great. Thank you.

David Dunkel

Thank you.

Operator

We’ll now hear from Kelly Flynn with Credit Suisse.

Kelly Flynn – Credit Suisse

Hey, guys. I’m sorry, I think I might be asking you to repeat something you said on the call, but you covered a lot. Can you go over the month-to-month trends again, year-over-year revenue growth by months in the quarter and then early in the third quarter? And then also if you could kind of comment on what we should be thinking about in terms of the year-over-year growth in the third quarter for perm versus flex, given the strength in perm? I guess I’m just unclear on how sustainable that is.

Joe Liberatore

Yes. Kelly, it’s Joe. Related to the sequential – the first question you had I think was really what I consider like inter-quarter revenue trends. What we experienced during Q2? So search was down in April, it was up in May and it was up in June, and then it was slightly down in July.

Kelly Flynn – Credit Suisse

I’m talking about the year-over-year growth by month. So over 8-ish percent for the quarter, what was it by month?

Joe Liberatore

I don’t have the percentages by month. I can give you directionally, but we historically haven’t quoted what percentages are by month as you have a billing day dynamic that come into play. So we look at it more on a billing day basis and directionally what’s happening on a year-over-year basis, and then we quote where the quarter is on year-over-year. But we don’t break it out by month.

Kelly Flynn – Credit Suisse

Okay. Just as broadly, I’m just trying to get an idea of – obviously the year-over-year growth accelerated a lot in the second quarter versus the first. And if that acceleration – I guess accelerated throughout the quarter and continued into the third quarter, did you see any slowdown at all in any month?

Joe Liberatore

No. That was what I – in my opening comments, I guess this is what you’re asking, where I stated Tech Flex for July for the first three weeks was up 20.9% year-over-year; Finance & Accounting was up 12.3% year-over-year; HLS was down 3.3% year-over-year. So that gives you a feel directionally of where we are heading. In fact, in both F&A and in Tech, those are accelerations over what we experienced year-over-year on a billing day basis for Q2 year-over-year comps.

Kelly Flynn – Credit Suisse

Okay, great –

Joe Liberatore

And likewise, service was up 75.7% year-over-year based upon the first four weeks of July, which is an acceleration also on a year-over-year basis.

Kelly Flynn – Credit Suisse

Okay. Great. And then, yes, what about for the third quarter? I mean, I think what you said about Search, so to speak to this, but should we be modeling an acceleration in Search in the third quarter?

Joe Liberatore

What Bill had stated in his opening comments is, we have a high concentration of our Search business in the Northeast. The Northeast is typically impacted by the state card [ph] phenomena. And so you typically have a little bit of slowing in the summer months. So we had pretty much guided that Search potentially could be flat on a quarter-over-quarter basis.

Kelly Flynn – Credit Suisse

So year-over-year or sequentially flat?

Joe Liberatore

That’s sequentially.

Kelly Flynn – Credit Suisse

All right. Okay.

Joe Liberatore

Year-over-year – it would be growth on a year-over-year basis.

Kelly Flynn – Credit Suisse

Okay, got it. And then likewise, you made some comments about KCR and KGS, some of the, I guess, sort of timing issues influencing trends there. When you talked about KCR revenue being down, are you talking about sequentially or year-over-year?

Joe Liberatore

Sequentially.

Kelly Flynn – Credit Suisse

Okay. And same thing as for KGS?

Joe Liberatore

KGS would be down sequentially and year-over-year potentially.

Kelly Flynn – Credit Suisse

Okay. Thanks a lot.

Operator

We’ll now take a question from Mark Marcon with R. W. Baird.

Mark Marcon – R. W. Baird

I want to tell my congratulations. It’s a terrific performance.

David Dunkel

Thank you, Mark.

Mark Marcon – R. W. Baird

Can you talk a little bit about – on the Tech Flex side, clearly terrific performance there. You also mentioned the West. Can you talk a little bit about what you’re seeing in terms of share gains? It seems like your NRC is giving you the potential of filled positions faster, and as a result, you’re getting the sense that you can take more share, which is why you are adding to your national account team. Am I sensing that correctly?

Bill Sanders

Yes, you are sensing that correctly. One, the West was an outperformer. There is no doubt about it. That’s a very strong group out there led by Jeffrey Neal, and we’re very proud of the West and the work that they have done. And we continue to expect great things from them.

Mark Marcon – R. W. Baird

Great. Can you talk a little bit about where you are adding to your strength in terms of national accounts, in terms of what sort of verticals, what areas are you going after?

Bill Sanders

It’s primarily geographic. We are looking for the very best people in those individual markets, whether they are within Kforce or outside of Kforce. And we are placing those because they integrate very closely with the field offices. They are an empirical part of the sales efforts in those particular offices. So it’s much more oriented towards a geographic presence because we would like those strategic account executives to be very close to our eyes.

Mark Marcon – R. W. Baird

So in which geographies would you be adding?

Bill Sanders

All geographies. Again, we tripled in size over the last 18 months. So it’s – and all of our large markets and where we have great sales teams.

Mark Marcon – R. W. Baird

Great. And what sort of excess capacity would you say you have now in tech?

Bill Sanders

In Tech? Well, I don’t know that we could break down the capacity by associates. Joe said 25%, generally speaking. And when you talk about Strategic Accounts, you have about 90% capacity because that’s a longer sales cycle dealing with those large volume customers although we are very pleased that while we target specific clients, that group has already brought in 12 proposals recently and three that we believe we should hear about his quarter. So it has begun. I think it will ramp up quickly in 2011. And that is primarily tech, although that team sells all of our products through all of our products.

Mark Marcon – R. W. Baird

Great. And what I was referring to was just – if we take a look at you recruiters and account managers and back office combined as it related to IT services, we heard that the 25% excess capacity at this point. But I’m just trying to narrow it down in terms of the areas that you are seeing the strongest growth, particularly tech.

David Dunkel

Mark, when we’re talking about expansion of NRCs, I think Bill said in some of her comments, I mean, we’ve been adding to that aimed to drive additional delivery capability. And a lot of that has been in tech because it’s been one of the highest demand products and it came out of the recovery faster. So that percentage that I gave you is pretty proportional because that’s how we continually are rebalancing our workforce internally and where the additions are taking place. We really protect – we really search because the demand has increased dramatically. And particularly as the Strategic Accounts grow 60% of delivery on the Strategic Accounts come from the NRC, when you combine the power of our investments in strategic account executives and the NRC delivering on that, that teaming effect between those two along with the local office, I mean, we have – we blow through 25% capacity. We have much more capacity because of the flexibility in the way we search to satisfy our clients’ needs.

Mark Marcon – R. W. Baird

Great. And then if you see the KPIs continue to increase at the rate that they have been increasing, should we assume that there will be additional capacity increases on a proportional basis to what we’ve seen going into the second quarter?

Bill Sanders

Well, there is always some ramp-up, but I would tell you as the teams, particularly the NRC, all of these groups continue to mature and the integration processes continue to be refined, then I would think that we have made a significant part of the investment that is necessary for what we would see in the next year to 18 months unless things really take off beyond our original planning and expectations.

Mark Marcon – R. W. Baird

Great. And then –

Bill Sanders

So basically the answer is no. There will not be a growth in expense at the same trend line as the growth in revenues.

Mark Marcon – R. W. Baird

Great. And then can we talk about F&A? I mean, over there it sounds like you must be gaining share in a material way because we haven’t see F&A pick up at some of the other players to the same extent that we’ve seen with you. Can you give a little commentary in terms of where you are seeing that growth come from?

Bill Sanders

Well, it’s very broad-based growth across our entire bill rate spectrum. So in fact when you look at it, it’s certainly a lower level mortgage specialist and the mid-tier and the higher levels. It is, I believe, the only area that we had bill rate increases. So it is very broad based. The job orders are coming from everywhere. Accounts receivable, accounts payable, tax, accounting expertise, CPAs, GAAP, SEC, risk management, internal audits, it is growing after all of that, as well as a very strong NRC growing not only after the local markets, but light space, in an area that we are not in. So it’s – we have a strong team with some strong leadership we’ve put in place as a leadership in the last two years. So we are pleased. And of course, we expect our Strategic Accounts executives to continue to sell that as well. It’s better than the rest of the industry. It’s primarily because of execution of the entire team.

Mark Marcon – R. W. Baird

Great. And last question and I’ll jump back in the queue; can you talk about the impact on SG&A and D&A in terms of buying the corporate headquarters?

Joe Liberatore

Yes. Related to SG&A, I think I said that in my opening comments. I mean, we anticipate about $1.5 million positive impact on an annualized basis.

Mark Marcon – R. W. Baird

I guess what I was wondering is that – did you see any of that, Joe, in the second quarter?

Joe Liberatore

Pretty nominal in Q2 because we had some expense associated with it, Mark. Pretty nominal in Q2. And that lease expense obviously comes out of SG&A and the depreciation goes down in depreciation and amortization. So it has a little bit of a financial engineer impact as well.

Mark Marcon – R. W. Baird

Got it. Thank you.

Operator

(Operator instructions) We’ll now hear from Tobey Sommer with SunTrust Robinson Humphrey.

Tobey Sommer – SunTrust Robinson Humphrey

Thank you. I had a question about Flex trends in July. If I just do some math on the segment detail that you gave, I netted out at about kind of 14% year-over-year growth. Is that about right for the first few weeks of July?

David Dunkel

For Tech Flex?

Tobey Sommer – SunTrust Robinson Humphrey

No. If I kind of net out the impact on a consolidated basis of all flex?

David Dunkel

I don’t have the consolidated number. So I’d hesitate to tell.

Tobey Sommer – SunTrust Robinson Humphrey

Okay. I’m just wondering to get a sense for your commentary that the company is going to be able to achieve prior peak margins earlier in the cycle. Is it relative to the time that lapses in the cycle or are you trying to make a comment relative to sort of revenue levels or run rates or something like that? If you could provide a little bit more color, that would be great.

Joe Liberatore

Yes. I’d say the way that we are characterizing that is we believe we will be able to exceed peak quarterly revenues, which we peaked at $265 million in the last cycle, and quarterly EBITDA percentage, which we peaked out at 9.2%. We will (inaudible) both of those earlier in this cycle. Last cycle, it took us 20 quarters from trough to reach those levels, which would equate to approximately Q2 2014 if you were to take the trough of this cycle. At this point in the cycle, we are tracking about eight quarters ahead of that. In fact, on an EBITDA percentage, where probably we recaptured almost 61% of where we were at peak last time.

David Dunkel

That also, Tobey, had scientific and though we are seeing there, which are discontinued hours [ph] but of course we replaced that.

Tobey Sommer – SunTrust Robinson Humphrey

So it is based on kind of time lapsing relative to last cycle. Okay. Given some of your headcount additions, do you think it’s possible that you may kind of pass the revenue level but not quite be at the EBITDA level because those people are ramping up or something like that? Because I’m just thinking your guidance for the third quarter is very healthy, but not that far away from a 265 quarterly run rate.

David Dunkel

There is a lead in lag effect, and it takes time for these folks to ramp. And as we look forward, one of the considerations is looking at particularly the Strategic Accounts investments; we want to make sure that we have the capacity to deliver on that and also respond to the current demand. So it doesn’t walk in lock step. But I wouldn’t tell you that you would expect that revenues are well ahead of our EBITDA performance by any number of quarters. I think that they will probably be relatively close. But again, it’s going to be throttled based on demand. If we see a huge spike demand, we’re certainly not going to walk away from it. We’re going to go after it, because dollars are still better than percents.

Joe Liberatore

Yes, exactly, because those two things are not going to think of precisely like they did last cycle. Last cycle, it was a very different makeup. Because when we hit peak revenues, we were at also peak margin. So our Flex margins were very high percentage because of where we were in the cycle when we hit these revenues as well as our mixture of our percentage of Search business was very different when we hit 265. So it wasn’t by any means implying that 265 equates to 9.2%. What we are saying is, we work at each of those metrics earlier in the cycle.

Tobey Sommer – SunTrust Robinson Humphrey

Right. Thank you very much. And then just couple of housekeeping questions. How many billing days do you have in the fourth quarter?

David Dunkel

61 billing days.

Tobey Sommer – SunTrust Robinson Humphrey

61, okay. And Joe, what’s your expectation for a full year tax rate?

Joe Liberatore

A little bit over 38% for the full year.

Tobey Sommer – SunTrust Robinson Humphrey

Okay. And then one last – I'm sorry. Do you have an operating cash flow number for the quarter?

Joe Liberatore

For Q2?

Tobey Sommer – SunTrust Robinson Humphrey

Yes. And if you don’t, I can get it offline.

Joe Liberatore

We’ll get it for you.

Tobey Sommer – SunTrust Robinson Humphrey

Thank you very much.

David Dunkel

Thank you.

Operator

We’ll now take a question from John Healy with Northcoast Research.

John Healy – Northcoast Research

Thanks. Just wanted to talk a little bit about the government business. For a couple of quarters you’ve been talking about the pipeline building there and the last quarter you’re little bit optimistic about activity in the second half of the year. And it appears like I might be dragged out a little bit. I was hoping to get your thoughts on the activity you are seeing there, maybe your expectations for 2011 and maybe how you are seeing maybe deals finally be awarded.

Bill Sanders

John, this is Bill. Same on me. I was optimistic – more optimistic than I should have been last quarter. And so I’ll outline a little bit. Yes, there are headwinds out there for us. The in-sourcing, the protest, the small business focus of award delays, budget freezes, we under estimated the headwinds that we were running into. So as we have done with the rest of the firm over the years, we’ve been running that type of activity. First, we made sure that we can see that all of our people are being maximized in their productivity and then we worked very hard to build a strong business development group. So basic rates, the way I look at as we are preparing our firm should be ready for game day.

And so in the next one or two quarters, we continue to grow very dramatically on our – on the proficiency of our business development team. In fact, this year – in some of the things that we can measure, proud of the team, they had won little over 66% of their RFPs. They have captured 82% of the prime work that they have done. They have a total backlog of $160 million. So some things are there that we are turning the headwinds into trailing winds. But at the same time, there is still going to be a difficult period this next six months before we roll into 2011. I will say we are very pleased with that management team and the work that they are doing, and we are very pleased with KGS and we stand behind them. And we look forward to them turning things around. It’s a little bit, as you look at it, a part of a very diversified high quality revenue stream. And they have produced greatly in the past and they will in the future.

David Dunkel

John, this is Dave. We are entering into a period with the government that has probably not been anything that we’ve experienced or anyone else has experienced in the past. So, as a result, as with many other market conditions, we are adjusting. As we looked at it and made our plans and assumptions based on activity to some degree, we drill in past performance. Unfortunately, we’ve seen a number of things that we expected to happen didn’t happen. We’ve talked about some of the procurement issues and getting the contracts laid out. We’ve seen in-sourcing. We’ve seen other things. But as Bill said, we’re not going to wine about it. We’re going to adjust, and that’s what we are doing. And our team is adjusting now and they will win in 2011. That’s the way they want to go.

John Healy – Northcoast Research

That’s encouraging. Thank you. A question on the cost side of things, when you think about top line growth in a more normalized environment or maybe just a better proxy, maybe gross profit dollar growth in a normalized environment, could you help us think about how we should expect SG&A to grow relative to maybe GP dollars from a longer term target?

Joe Liberatore

Well, SG&A percentage, if our model executes the way that we’ve been evolving the model over the course of the last ten years based on where we are from our belief on a capacity standpoint, actually SG&A percentage will start to come down as the population continues to mature because we started to get all that productivity out of all those individuals.

John Healy – Northcoast Research

So maybe you could give us some thoughts on maybe where maybe tenure is in terms of the recruiters today maybe compared to where it lies two or three years ago or maybe tenures of salespeople compared to maybe in the past?

David Dunkel

Sure. I mean, we have the most tenured population than we’ve ever had in the history of the firm, and that would be in my 22 years or days now slightly over 30 years.

John Healy – Northcoast Research

70 years.

David Dunkel

But now over 50% of our population has been with us for great than four years now. And I mean, I’ve said this on some of the past calls. Our people that have been here over four years, they are over two times as productive as people that have been here two years. So we get a lot of leverage out of those individuals in terms of their contribution.

John Healy – Northcoast Research

Okay. That’s helpful. Thank you.

David Dunkel

Thank you.

Operator

And with no questions remaining, I’d like to turn the call back over to Mr. Dunkel for any additional or closing comments.

David Dunkel

Thank you, Elizabeth. So again, we just want to thank everyone for your interest and support for Kforce. And once again, congratulations to our team. They have just done a fantastic job and we’re very proud of them. So for our field teams our corporate teams, our consultants and our clients, once again we always we thank you for the opportunity and the privilege of serving. So we thank you and we look forward to speaking with you again in the third quarter. Good evening.

Operator

Ladies and gentlemen, that does conclude today’s conference call and we thank you for your participation.

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Source: Kforce Inc. Q2 2010 Earnings Call Transcript
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