Kforce CEO Discusses Q3 2010 Results – Earnings Call Transcript

Nov. 1.10 | About: Kforce, Inc. (KFRC)

KForce Inc. (NASDAQ:KFRC)

Q3 2010 Earnings Conference Call

November 1, 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

Evan McVeigh – Macquarie

Mark Markham – Robert W Baird

Paul Ginocchio – Deutsche Bank

Kelly Flynn – Credit Suisse

Tobey Sommer – SunTrust Robinson Humphrey

Operator

Good day, ladies and gentlemen, and welcome to your Q3 2010 KForce Incorporated Earnings Conference Call. (Operator Instructions). Now I would like to introduce your host for today, Michael Blackman, Chief Corporate Development Officer.

Michael Blackman

Great, thank you. Good afternoon and welcome to the Q3 KForce conference 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 on current expectations and assumptions that 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 filed 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.

Once again we’re very pleased with our firm’s performance for the Q3 of 2010, with revenues exceeding the EPS at the top end of guidance. It is now clear that this recovery is different than past recoveries in staffing. Historically, tepid GDP growth of 2% or less meant flat revenue performance and limited penetration. Since the beginning of the year, private sector jobs have increased by 602,000, with temp help jobs accounting for 217,600 of those net job ads – roughly 36% of the net job ads despite temporary staffing accounting for only 1.6% of total payroll dollars. We believe this is evidence of a secular transition to a flexible workforce, as our clients seek greater flexibility in an uncertain economic, regulatory, and tax environment.

KForce’s results have been strong throughout the downturn and now into the recovery. Recent staffing industry data and our KPIs suggest continued strength in our staffing business. During the Q3 we adjusted field and NRC delivery to align better with the very high demand from our strategic accounts and field clients, in finance and accounting and in particular, technology. This significant increase in demand that began in March and April has continued at levels we have not experienced in prior recoveries. On a sequential basis, flex revenue increased 5.7% in tech and 16.5% in F&A. Total firm revenue increased $31.2 million, or 13.7% on a year over year basis. Surge also had another outstanding quarter with our surge teams in all three regions performing exceptionally in delivering 7% sequential and 61% year over year growth. Overall, another excellent quarter for KForce.

We have continued to evaluate sales and delivery capacity against very high demand, in what we believe will be seen as the beginning of a secular shift towards the use of flexible resources. The backbone of our sales efforts is in our field sales force, and we are balancing productive capacity against forecasted demand, and adding to our team where appropriate. The balanced and widespread strong performance in nearly all of our geographical markets is encouraging, and we believe will provide operating leverage throughout the recovery. Our strategic accounts team is starting to gel and we are seeing opportunities for new clients, while our primary focus is further penetration and share in our current clients. Our NRC teams continue to perform very well, as our associates mature and ramp to productivity. Strong cash flows allowed us to make progress in our debt retirement as we reduced borrowings post-acquisition of our building. We anticipate using cash flow for continued debt retirement, share repurchase, and acquisitions that meet a very high hurdle. While we are seeing many opportunities, we are maintaining our discipline and standards, and we have not consummated a transaction since December, 2008. We are finalizing our plans for 2011, the last year of our triple crown, and have made substantial progress on our next three-year plan. We believe we will exceed prior peak earnings earlier in the cycle, and we are now very close to exceeding prior revenue peaks. Again, a great quarter with great results, delivered by our great teams.

I will turn the call over to Bill Sanders, KForce’s President, who will provide his comments. Joe Liberatore, KForce’s CFO, will then provide additional insights on operating trends and expectations and we will then entertain questions. Bill?

Bill Sanders

Thank you, Dave, and thanks to all of you for your interest in KForce. We are very pleased with our Q3 performance, and the continued strong environment for professional staffing as clients dare to be looking increasingly to our services to meet their hiring needs. In particular, our technology and finance & accounting flex businesses continued to show strong growth in the quarter; and the continued growth in our permanent placement business contributed to overall revenue growth and profitability. Our firm is well positioned to take advantage of our clients’ increasing desire for a more flexible workforce, driven by an uncertain economic environment in what we believe will be a secular shift towards flexible staffing.

We achieved record revenues in the Q3 for total firm flex revenue, tech revenue, and tech flex revenue. Our Q3 revenues of $259.5 million grew 5.4% sequentially and 13.7% year over year. Additionally, our operational performance metrics continued to trend positively into the Q4, further suggesting that demand for our services continues to increase. Our diversified revenue stream is concentrated in some of the areas of greatest anticipated demand. 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.

Flex revenue trends improved sequentially each month of the quarter, and perm. continued its growth trends in August and September after a typically slower July, which is always impacted by summer slowdowns in hiring. In many respects, our clients are accelerating a flexible staffing model at a faster pace than we have historically experienced. We are well prepared to provide our clients with solutions to surges in demand.

Our largest business unit, technology flex, which represents 53% of total firm revenues, increased 5.7% sequentially and 19.6% year over year. Tech flex revenue showed a continued upward trend through the Q3. Our operating model, which leverages the flexibility and scale of our national recruiting center to meet demand across the country, has contributed to strong growth in our strategic accounts, which has been one of the key drivers to success in our tech flex. However, the growth in tech has been very broad based, with all client segments showing strong growth trends. October trends for tech flex are up from September levels and performance indicators are improving. We expect tech flex to have continued growth on a billing day basis in Q4 and for the foreseeable future, with a sustained increase in IT spending providing a strong catalyst.

Our finance & accounting flex business, which now represents 17% of our total revenues, performed extremely well in the quarter, with revenues increasing 16.5% sequentially and 18.1% year over year. Much like our tech business, we are seeing broad based growth across the entire bell rate spectrum. This business continues to benefit from the investments in leadership that we have made over the past two years, and synergies between our strategic account strategy and national recruiting center capabilities. Of particular note was the strength in the lower bell rate mortgage refinancing and foreclosures space, which now constitutes approximately 20% of our F&A business and grew greater than 30% sequentially.

This business, which originated with the acquisition of the OnStaff division of Hall Kinion in 2004, benefits from a dedicated team in the national recruiting center to successfully service this lower margin business at a lower cost than our traditional F&A staffing model and we are especially prepared to meet surge opportunities presented by financial service companies with processing needs. This is a great example of how the NRC has provided KForce with a competitive advantage for addressing surge demand opportunities in a timely and cost effective manner. We expect the demand for these types of services to continue for the foreseeable future, and we expect to continue to take market share in this space. We also believe our NRC provides flexibility to take advantage of surge opportunities across all of our businesses and geographies in the future.

As I indicated, F&A flex revenues showed an upward trend throughout the Q3. Recent trends and performance indicators for F&A flex are up in October, and we therefore expect continued growth on a billing day basis for this unit in Q4. Our HLS business segment, which comprises 16% of total revenues, is comprised of our clinical research and health information management businesses.

During Q3, revenues in our clinical research business decreased 4.6% sequentially and 1% year over year. HIN revenues increased 7.1% sequentially and 7.3% year over year. As anticipated, the sequential decline in clinical research was driven primarily by a large project end. We anticipate Q4 revenue for clinical research to decline as a result of the full quarter impact of the project end, as well as Q4 seasonal billing day impacts, which significantly impacts KCR since its major clients close their operations over the holidays. However, we believe that revenue growth could resume its historical growth pattern in 2011.

Our HIM revenue trends continue to be promising and margins remain strong as hospital spend continues to improve particularly in the project services and remote coding areas. This business has rebounded nicely over the past two quarters as it continues to evolve its business model to better embrace the technological changes in this space. We believe in the long-term demand for this profitable business, and expect revenues to be up again in the Q4.

Revenues for KForce’s government solution, our (inaudible) government contracting business, decreased by 3.3% sequentially and 10.2% year over year. This profitable business unit continues to see the impact of the challenging federal procurement environment, and continues to be negatively impacted by the trend toward the government in-sourcing positions previously held by contractors. We remain focused on our key competencies and consistent with our philosophy during difficult periods. Our challenge at KGS management team is taking the opportunity to make investments to improve our business development capability and our operating processes, so we are fully prepared to take advantage of the government spending cycle. As we look ahead to Q4, we expect revenues to decline largely as a result of the reduction in billing days, which impact this business similarly to our clinical research business. We continue to believe in the long-term prospects of this business unit.

Firm revenues from direct placements and conversions increased 7% sequentially and 61.2% year over year. We believe this growth reflects continued rebuilding of core staff at our clients after significant reductions throughout the economic recession. This is the fourth consecutive quarter perm revenues have increased. Over the last several years, we have aligned our perm business more closely with our flex business to more efficiently meet customer needs as well as reduce the overall costs that must be invested in establishing and maintaining the perm workforce. Q4 has started relatively strong. Though revenues are very difficult to predict, we expect perm revenues to continue to be relatively stable in Q4.

We are most happy with the productivity of our field sales force. They are the lifeblood of our firm. We continue to retain our tenured associates and now have the most tenured field team in our history. Performance of our sales teams continued to improved, as reflected in the 13.7% increase in revenue and 15.4% increase in gross profit year over year. In addition, we believe there are additional significant performance and leverage opportunities in both our strategic accounts team and national recruiting center, which we expect to be significant contributors to our future success.

As we consider the quality of our revenue stream defined by a diversified business footprint and 3000+ clients to whom we provide service at any point in time, we believe we are very well positioned to maximize both market and client share. Our 25 largest clients represent 38% of revenues and demand remains strong in this segment. We are performing well as we enter the final stretch of the second race in our three-year strategic plan, which we are calling the Race for the Triple Crown, and we are on track to meet our goals and win the race. Our service offerings, particularly tech and F&A, position us for revenue growth as we move further through this economic recovery. The strategic enhancements we have made to our sales and delivery platforms provide us significant flexibility and operating leverage, and our longstanding focus on performance management and team culture positions us well to compete in this marketplace. Additionally, the strong performance of our perm business continues to complement our revenue footprint. Our immediate plans are continuing 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 over the $1 billion mark in revenues and beyond.

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

Joe Liberatore

Thank you, Bill. The firm continued its strong performance in the Q3, exceeding the high end of guidance for revenue and coming in at the high end of guidance for earnings per share. Revenues for the quarter were up $259.5 million, increased 5.4% sequentially, and 13.7% year over year. Quarterly revenues for flex reached an all-time high of $249 million, and increased 5.4% sequentially and 12.3% year over year. Surge revenues of $10.6 million increased 7% sequentially, and are up 61.2% year over year. We continue to see momentum early in the Q4 as revenue trends are up from September levels and key indicators continue to trend positively. For the first three weeks of October, tech flex is up 19.8% year over year, finance & accounting flex is up 26.9% year over year, and HLS is up 3.5% year over year. Surge revenues are up 53.5% year over year for the first four weeks of Q4 2010. We caution that it’s difficult to draw conclusions for Q4 based upon this limited amount of data.

A combination of the increased revenue and gross margins, coupled with SG&A leverage, resulted in an increase in net income of $6.4 million and earnings per share of $0.16 in Q3 2010. These results represent sequential increase of 25.3% and 23.1 % respectively. Year over year net income and earnings per share increased 183.6% and 166.7% from $2.3 million and $0.06 in Q3 2009. Our overall gross profit percentage of 32.2% increased 30 basis points sequentially and 50 basis points year over year as a result of the increase in surge revenue as a percentage of total revenue and a sequential increase in flex margins. Our flex gross profit percentage of 29.3% in Q3 2010 increased 30 basis points sequentially and decreased 40 basis points year over year. Overall bill rate and pay rate spreads remained under pressure and were relatively flat from Q2 to Q3, largely as a result of declines in HLS margins.

On a business segment basis, tech flex and F&A flex margins increased sequentially 50 and 120 basis points respectively, and are now 60 basis points and 10 basis points higher than a year ago. Historical results suggest margins will continue to expand as demand increases and the war for talent heats up in this candid and constrained environment for highly skilled workers. However, flex margins in the Q4 could be negatively impacted as much as 100 basis points by holidays and paid time off, and are expected to decline sequentially. The firm continues to diligently manage operating expenses, and in particular discretionary expenses so that we may balance our profitability goals with continued investments in areas such as our national recruiting center and strategic accounts, which we believe will be critical to sustained growth. We believe our centralized national recruiting center provides the firm with competitive advantage and has been a key contributor to our success.

Additionally, as revenues increase, we continue to see operating leverage from technology investments made during the past seven years. Operating expenses were 28% of revenue during the Q3 2010, which decreased 20 basis points from Q2 2010 and decreased 180 basis points from 29.8% in Q3 2009. The majority of our cost structure is variable and compensation related expense, which is highly correlated to gross profit, comprises over 75% of our operating expenses. A key benefit to the investments in our national recruiting center’s 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 revenue can grow significantly without having to add significant head count, but we will continue to selectively invest in adding sales capacity as demand strengthens.

Our accounts receivable portfolio continues to perform very well. The percentage of receivables aged over 60 days decreased to 3% in Q3 as compared to 4.6% in Q2, and write offs continue to be very small.

Our accounts receivable reserves are currently $5.5 million and we believe sufficient to account for the current risks in the portfolio. The firm’s task load continues to be strong. EBIDTA was $15.7 million, or $0.39 per share in Q3, as compared to $13.7 million or $0.34 per share in Q2.

Year over year, EBIDTA increased 36.1% from $11.5 million in Q3 2009. Bank debt as of today of $20 million is down from $38 million at the end of Q2 2010 due to a combination of strong cash flow and the timing of certain payments, and was up from $12.8 million at the end of Q3 2009.

Borrowing availability under our credit facility, which expires in November, 2011, is currently $77.7 million. Capital expenditures in Q3 were $3.3 million and remain only a small portion of our cash flow, but we continue to enhance our technology platform with selective investments that we believe will enhance the capabilities of our sales associates. Excluding the firm’s corporate headquarters acquisition, we expect capital expenditures to be less than $10 million for the year. The firm made no significant repurchases of stock during the quarter, and has $71.2 million available for future stock repurchases under the current board of director’s authorization.

With respect to guidance, the Q4 has 61 billing days versus 64 billing days in the Q3 of 2010. We expect revenues may be in the $253 million to $259 million range, which represents between 2.3% and 4.7% growth on a billing day basis. Earnings per share may be between $0.14 and $0.16.

Our effective tax rate in Q4 is expected to be approximately 38.6%, with approximately 40.4 million weighted average diluted shares outstanding. This guidance contemplates a continued strengthening in our business driven by continued growth in tech and F&A flex, adjusted for the billing day impact as well as sequential margin compression resulting from the holidays and paid time off. Our guidance does not consider the effect for any acceleration of equity incentives nor for the firm’s response to regulatory, legal, or tax law changes.

We are very pleased with Q3 results. We continue to invest in our business and take advantage of the increased demand for professional staffing, and I believe we are well-positioned to achieve a high level of performance by delivering exceptional service for our customers through speed and quality. We have a high quality revenue stream and balance sheet, as well as the strongest management team in the firm’s history and a highly tenured associate population. We expect to capitalize on the capacity that exists in our associate base to increase leverage and accelerate earnings, which will position the firm to obtain prior peak earnings earlier in the cycle. John, we’d like to now open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions.) And our first question is coming from Evan McVeigh from Macquarie. Evan, please go ahead.

Evan McVeigh – Macquarie

Great, thanks. Great, great job; just continued really good execution overall. I wonder if you could, David if you have any sense on early indication of 2011 budget shifts specifically within IT. And just if you could help us understand, obviously the tech flex and just flex overall has been really, really strong but just the strength in perm seems really, really intriguing, particularly at this point in the cycle. So if you could just talk about those two things that’d be great.

David Dunkel

Yeah, I’ll comment on the tech flex budgets, and basically, Kevin, I’ll just say that it’s probably a little early. The indications are that tech is continuing to be strong as we go into Q4. Last year we saw an acceleration in November and December which resulted in a much lower fall off than we typically experience in December. So as we look at this year we’ll be monitoring it to see if that trend continues. We have several client trips coming up over the next few weeks – myself, Michael, Joe, and several of our senior team will be out meeting with clients and our investors out at some of the conferences, so during that time we’ll certainly be asking about 201 budgets. But at this point we don’t see any indication of a tail off but it’s too early to say how much of a fall off we’ll see at our normal year end. And as far as perm’s concerned, we’re delighted with how we’ve done. We still believe that most of the hiring today is a reflection of the deep cuts and adjustments in staff levels, so we don’t believe it’s the beginning of a great perm cycle, and if we look back historically at our prior peaks I would say that certainly we’re far away from where we’ve been previously. So as far as we’re concerned right now we’re very pleased with how perm is doing, we’re proud of our team. But we’re not ready yet to declare the beginning of a great perm cycle. Thanks.

Evan McVeigh – Macquarie

Great. Thanks, Dave.

Operator

Thank you. Our next question is coming from Mark Markham from Robert W Baird. Please go ahead.

Mark Markham – Robert W Baird

Hi, it’s Mark, congratulations. I was wondering if you could talk a little bit more about what you’re seeing on the F&A side. That was a pretty impressive sequential jump. Was it due to any individual projects coming on or really big client demand in one particular area? How would you describe that? It looks like you’re outperforming the other players in the space.

Bill Sanders

Mark, this is Bill. It was very broad based. Of course we moved our mortgage related foreclosure business from 18% to 20% of our overall F&A model, so we had some staffing and bunches in that particular area. But I would say to you it’s very broad based, the skill sets are the skill sets that you hear about all the time, from accounting specialists to accounts receivable people, controllers, auditors, tax people. So it’s broad based, there’s nothing really to single out other than we did see the mortgage related activity grow 30% over the quarter.

Joe Liberatore

Yeah Mark, this is Joe. The other thing that I would reference is it’s very balanced across different industries as well, so it’s not just all concentrated just in the mortgage industry. It’s in the banking/credit unions as well as the mortgage industry as well as the insurance, as well as some of the securities and brokerage areas. So it’s pretty balanced across those types of industries.

Mark Markham – Robert W Baird

And it sounds like you’re basically saying as we look out towards the Q4 we should see revenue per billing day continue to increase, which would suggest that you’re continuing to see more and more new orders come in in that area.

Joe Liberatore

Yeah, this is Joe. I would say as I mentioned in some of my earlier comments, some of our early indicators on the quarter are very positive. That’s a pretty big number that F&A was up on the first three flex weeks of the quarter, so we hope that that’ll continue through the quarter.

Mark Markham – Robert W Baird

And the gross margins are pretty strong. I mean you mentioned there’s an excessive or a greater share that’s coming from the mortgage side, which typically would be viewed as being lower margin. And yet your margins are up year over year and sequentially. Can you talk a little bit about that?

Joe Liberatore

Yeah. I would say from a margins standpoint, which is really the spread from the pay bill, while that business is a little bit lower bill rate from an absolute margin standpoint, on a percentage basis it’s somewhat constant although albeit the dollars are a little bit less.

Mark Markham – Robert W Baird

That’s terrific. And can you talk a little bit more about, do you feel like you’re gaining share in that area as well? Or do you think that F&A in general is starting to pick up?

Bill Sanders

Well, I think F&A in general is picking up a little bit. I think we are also gaining market share through our strategic accounts group. And so I think all that is a positive and so yeah – we’re gaining both market share and client share in our different clients. So we’re pleased with what the team is doing and as I said, in some clients, especially that come through this mortgage financing, there’s staffing in bunches where it’s 100 or 200 or 300 people at a time.

Mark Markham – Robert W Baird

Great. Thanks. I’m going to jump off and come back on.

Bill Sanders

Thanks, Mark.

Operator

Thank you. And our next question is coming from Paul Ginocchio from Deutsche Bank.

Paul Ginocchio – Deutsche Bank

Thanks. My question, you talked a bit about field sales reorder and the NRC, is that just a continuation of the optimization of the NRC? Or is that something specific that happened in the quarter?

Bill Sanders

This is Bill. Nothing particularly happened in the quarter in the NRC. We built that up, dramatically doubled the staff through the first two quarters of the year. We think we have it at the optimum size for the current demand that our clients are asking of us. So we really didn’t grow that, in fact it was down slightly quarter over quarter. We’re very pleased with the NRC and how it’s coming together, but certainly when you ramp something so quickly there’s a lot of existing capacity in that group, and we expect that to really work well with our tenured staff in the field. So you put those two together and that’s very dynamic for our firm.

Paul Ginocchio – Deutsche Bank

Great. If I could just follow up with SG&A Q on Q, with revenues sort of flattish Q on Q because of the fewer billing days, would we expect the same for SG&A? Thanks.

Joe Liberatore

Yeah, from an SG&A standpoint, obviously when we look at guidance and we contemplate some of the margin compressions that’s taking place, that would actually imply that SG&A, we’d have to get a little bit of that SG&A leverage in Q4 to deliver the EPS numbers that I put out.

Paul Ginocchio – Deutsche Bank

Thank you.

Operator

Okay, thank you. Our next question is coming from Kelly Flynn from Credit Suisse.

Kelly Flynn – Credit Suisse

Thanks. My question relates to Q4 guidance. It looks like on a year over year growth basis you’re forecasting kind of a plateauing or even a slight deceleration in your rear growth versus Q3, so I wanted to dig into that. First of all, on the billing days, you said that there were 61 in Q4, I just want to double check, is that the same year over year?

Joe Liberatore

Yes, that would be the same on a year over year basis. So Kelly, maybe did you mean from a sequential revenue standpoint on an absolute basis, that would be correct. The top end of guidance would be flat on an absolute basis of (inaudible).

Kelly Flynn – Credit Suisse

I’m talking- sorry, I was talking year over year so it’s sort of in the 13-ish percent year of year growth range is what your forecasting for Q4 to be the same roughly as the growth rate in Q3?

Joe Liberatore

Yeah, I’m sorry, I thought you were talking on an absolute number basis and that’s why I was a little bit confused. That would be correct on a growth rate year over year, pretty much in the same type of ballpark.

Kelly Flynn – Credit Suisse

Okay, so I just want to clarify. I think you said, I think Joe you said in talking about the early quarter trends that the year over year growth for both tech and accounting finance was higher so far in the quarter than in Q3. Is that right? I’m talking year over year growth.

Joe Liberatore

Yeah, that’s first three weeks of Q4 in comparison to the first three weeks of Q4. So typically what happens, if the quarter start out stronger in Q4 and then you start to get post-Thanksgiving, things start to slow down, you start to get a little bit of a tailing off effect going on. So we have sorted out the quarter very strong, but you know especially when we, you know, we have government and HLS that when you bring that into the mix, they start to drag those things down.

Kelly Flynn – Credit Suisse

Yeah, that’s kind of what I was getting at. And first of all, did you give the early quarter trends for KGS? And what is that…

Joe Liberatore

Those businesses are much more difficult to kind of give a week over week comparison like they are in more the Tech Flex and F&A business because they’re more very project based, so when you look at those short period of times to do year over year comparisons, it can be very misleading in one direction or the other. But however I will mention we’re not seeing anything that’s alarming us in either of those businesses.

Kelly Flynn – Credit Suisse

Okay, I guess what I’m getting at is it seems like if it weren’t for those two businesses, Health and Gate TVS, I mean you’d be forecasting a continued acceleration in year over year growth, is that fair?

Joe Liberatore

Very fair statement. But you know this goes back to really what I think we share on a regular basis. We’re very comfortable with the four legs of the stool that we have our businesses with them no different than during the recessionary times. You know, KGF and HLS were the stellar performers that allowed us to hold onto more of our field performers in tech and F&A during recession and vice versa. You know, now we’re in a situation where we’re virtually in what I would consider a government recession when it comes to the contracting business, no different than a commercial recession.

David Dunkel

Kelly, this is Dave. I also want to remind you that the, on a billing day basis and then also because of holidays and paid time off, KGS and HLS are impacted much more significantly than a traditional staffing business. In a government they’ll typically take the last week of the year off and in our case, see our business, the last two weeks of the year. So those two are more significantly impacted than the traditional staffing business.

Kelly Flynn – Credit Suisse

Okay, but that’s more of a sequential phenomenon than a year over year, is that fair?

David Dunkel

Well depending on whether you look at where they were last year and then the declines throughout the year primarily as a result of the government in-sourcing. So the comps become a little more difficult.

Kelly Flynn – Credit Suisse

Okay, and just one more. Sorry to beat a dead horse. On the health business, can you go back to what you were saying about clinical research and I guess the question is what’s going to disappear in Q4 that was in there in Q3 from a revenue perspective?

Joe Liberatore

In Q4 KCR, our clinical research group, their large customers, they closed down the last week and sometimes last two weeks in the year. And so that’s sequentially is adverse effect on our firm. I’d also point out that, adding to what you were talking about earlier, the pharmaceutical industry is second behind the government in the most layoffs of any business segment in the United States this year. So when you really look at that, you will see that. I think the last piece of it to tell you about is we had a major project in in Q3 and we won’t get the full effect of that in Q4.

However I would tell you that I’m real pleased that KCR is beginning to spread its wings more for major accounts and they’re working with a number of smaller accounts to diversify that revenue stream. So we’re working on that but that is certainly the case for this quarter.

Kelly Flynn – Credit Suisse

Okay, great. Thanks for taking all those. I appreciate it.

Joe Liberatore

Okay, thank you Kelly.

Operator

Thank you. And we’ll take our next question from Tobey Sommer from SunTrust Robinson Humphrey.

Tobey Sommer – SunTrust Robinson Humphrey

Thanks. I was wondering if you could comment on the sequential growth in your recruiter headcount. Because I seem to remember that was a pretty decent figure maybe 2% or 3% in Q2 and I’m wondering what kind of editions you made in the third.

Bill Sanders

This is Bill. Now when we talk about revenue responsible activities of our people so we include our NRC as part of our recruiter base. And so when you look at that as a total and even if you split it apart, it’s about the same, which is it is flat to down very little in Q3 of the year.

Tobey Sommer – SunTrust Robinson Humphrey

Okay, were there any other expenses in Q3? Because, at least by my calculations, incremental margin was a little bit lower than in Q2. Was there anything else that may kind of thrown off the proportion of incremental revenue that slowed down operating income?

Joe Liberatore

Toby, this is Joe. I mean in any given quarter we have things going in both directions. You know, we had a couple things that were favorable in the quarter as we did our workers come true-up as well as some of the things we’re experiencing from a credit standpoint in terms of our bad debt reserve. And also as we referenced in our 10-K and 10-Q, we had a suit in California as a pending legal matter. I’ve been advised not to discuss that matter in great detail, but I will share with you that we don’t expect that to have any material impact at the firm. So nothing major in one direction or the other.

Tobey Sommer – SunTrust Robinson Humphrey

Okay that makes sense then. Over time, what kind of incremental margin range should we expect, do you think, in this kind of top line growth environment? Thanks.

Joe Liberatore

Yeah, where we are is, and I believe I’ve referenced this before in terms of our tenured workforce, that the bulk at this point in time is our fixed infrastructure. We’re very comfortable with where our fixed infrastructure. So it’s gotta come through performance management and we’re very confident that we’re doing all the right things and we’re starting to see some of that leverage from the NRC in our overall sales population. Our number of two plus tenured associated continues to grow as well as performance of those individuals continues to grow.

This all goes back to, based upon Q3 data for example, our most productive group this population, they on average produce 50% more than our other less than two year populations. So there’s a lot of leverage there and everything we’ve build and invested is to continue to drive performance management. Based upon our calculations, we still have 25% in field capacity from where we were prior (inaudible) and then when you look at the NRC with doubling that over the course of the last year, very, very less tenured population there so our expectations are to get a lot of leverage from those investments as well.

Tobey Sommer – SunTrust Robinson Humphrey

Okay, thanks. My other question’s been answered; I’ll just end with one. You mentioned, I think, in terms of your guidance that it doesn’t include any acceleration of equity. Is there any other color you could offer there? Is there something that could be accelerated here at some point?

David Dunkel

No, I mean just I think we’re all well aware there’s unknowns right now in terms of what’s going to take place between now and the end of the year from a number of aspects, so we’re constantly evaluating what the impacts to the firm are going to be and make decisions accordingly.

Bill Sanders

I maybe can build on that a little bit. As you know, we’ve tried to incentivize management only by performance, and part of that performance is based on stock price. So we issue, instead of stock options we issue often performance-based restricted stock. So those pars have to reach a certain stock price, which is 50% higher than when the pars were granted. So basically the next traunche, when the stock price gets in the $18.90 plus, that’s when we hit the next traunche. So if we were to hit that, that would result in a larger expense number. And so we’re just trying to make sure that we don’t have to go out and do a press release and say EPS is down because stock is up so much. So we think it’s aligned management and our shareholders very well, so that’s the number – $18.90.

Tobey Sommer – SunTrust Robinson Humphrey

Thank you very much.

Operator

Okay, thank you. And our next question is coming from Mark Markham from Robert W Baird.

Mark Markham – Robert W Baird

Just to go back to KGS, how should we think about that for next year in terms of what you’re hearing?

Bill Sanders

That’s a very good question, Mark.

Mark Markham – Robert W Baird

Or how are you planning for it given there’s lots of uncertainties out there.

Bill Sanders

Well, we’re trying to stay very light footed I guess. But I would say certainly most competitors in this space are being impacted by contract protests, low funding for the new projects, continued resolutions, uptick in-sourcing. They have all this kind of activity going on. At the same time, our KGS unit has a record amount of contract bids outstanding, has very solid $170 million total backlog. So we have a lot of things going for us but at the same time we want to do better. So as we normally do in these difficult times, we have a philosophy that we really rebuild for when and how we can do better. And I think as we mentioned on the last call we’ve hired a new person in charge of our business development efforts and he’s building a very strong A-team around him as well as all the other activities we have focused on that particular group. I would say if we guessed, and I’m going to tell you it’s somewhat of an informed guess but it’s a guess, I would look at the- It certainly depends on what happens in this election, and we look at the latter half of next year to see it start to really move if that’s when it’s going to move.

Joe Liberatore

Hi Mark, this is Joe. I would also add, I mean the pipeline continues to build. It is a very profitable business at the levels it is and it’s providing us a lot of opportunity, no different than when our core businesses go through recessionary times, to really work on the business and enhance the overall operating model, some of what Bill had mentioned in his open comments. So we’re very confident with the team that’s in place and with the things that we’re doing. So we’re doing everything within our power.

Mark Markham – Robert W Baird

Great. And then can you talk a little bit more about the capacity that you have on the IT side? You’ve already surpassed prior peak revenue there, margins continue to look good. Can you talk about how much capacity you have there, how you think that’s going to unfold next year?

Joe Liberatore

Yeah, from a capacity standpoint I would say in all of our populations it’s pretty balanced, so the numbers I put out there, you can pretty much apply those to most of our operating units, because we’re always balancing and rebalancing our head count. So I mean that’s the best that I can answer on that question specific to IT.

Mark Markham – Robert W Baird

There’s no big step up in terms of investment that you need to make. We should continue to see continued leverage on the SG&A there despite the fact that you’re already past peak.

Joe Liberatore

That’d be correct.

Mark Markham – Robert W Baird

Great, thank you.

Operator

Okay, thank you. And I’m showing no further questions in the queue at the moment. I’d like to turn the conference back to your host.

David Dunkel

Okay, well thank you very much. We appreciate your interest and your support for KForce. And once again, we want to take the opportunity to congratulate our team for performing very well and for really going out and winning on the field. So thanks to each and every member of our field and corporate teams, and also again to our consultants and our clients for allowing us the privilege of serving you. So we appreciate it very much. We hope you all enjoy your Thanksgiving and Christmas holidays, and we’ll look forward to speaking to you next year. Thank you.

Operator

Okay, ladies and gentlemen, this does conclude your conference. You may now disconnect and have a great day.

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