Kforce Inc. (KFRC) Q2 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Second Quarter 2011 Kforce Inc. Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I'll turn the program over to Michael Blackman, Chief Corporate Development Officer. Sir, the floor is yours.

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 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 from the factors listed in Kforce public filings and other reports and filings with the Securities and Exchange Commission. We cannot undertake any duty to update any forward-looking statements. I would now like to turn the call over to David Dunkel, Chairman and Chief Executive Officer. Dave?

Thank you, Michael. You can find additional information about Kforce in our 10-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. Overall, we are pleased with our record second quarter revenues of $274 million and earnings per share of $0.17, which represent year-over-year growth of 11.3% and 30.8%, respectively. We are pleased with the performance of our Tech Flex and HIM businesses and the continued strength in Search which performed well in both Technology and F&A. However, results for the quarter were mixed as we continued to experience headwinds, which negatively impacted a number of our businesses. Our Government business continues to be impacted by the challenging government contracting environment and the mortgage-related component of our F&A business continues to be negatively impacted by the slowdown in mortgage refinancing and foreclosure activity. Kforce Clinical Research also did not grow sequentially in the quarter as previously anticipated due to a slower than expected ramp at a major client project and some headcount reductions at 2 large customers. Management is focused on being flexible and constantly adapting to the changing landscape across each of our businesses, particularly those as experiencing challenges, to mitigate any negative external impacts and position the firm to take advantage of future opportunities. We have made progress, repositioning these business units and have confidence in our teams. Over time, we continue to believe that though all of our businesses rarely are performing at their peak at the same time, diversification in our revenue footprint provides the best platform for long-term success. We remain committed to our goal of surpassing prior peak earnings with a higher-quality revenue stream that is less dependent upon the Permanent Placement revenue. However, the challenge as mentioned, and the fact that margins particularly in our Tech Flex business are not expanding as quickly as in previous cycles, suggests that peak earnings will not be achieved as quickly as originally anticipated. As a result of these unexpected challenges and the significant changes that have taken place in the economic outlook since February, 2011 revenue and earnings growth targets previously discussed will likely not be achieved and long-term revenue and earnings growth targets will need to be assessed in the context of this uncertain global fiscal landscape. Since February 2011, the Q410, Q111 GDP have been revised downwards, 2011 GDP expectations have been significantly reduced, BLS employment data has been contacting and the macroeconomic environment remains uncertain due to the U.S. fiscal issues. However, despite the GDP backdrop, which historically correlates the declining temp staffing revenues, we have continued to see an environment where a disproportionate amount of private sector hiring has been created through the temp sector. Our thinking remains that this uncertain environment, which has persisted for more than 2 years, continues to drive our clients' increasing desire for a more flexible workforce. This is particularly true in high scale niches, as college-educated unemployment was just 4.4% in June. Talent shortages are particularly acute in tech, which is project driven by nature and constitutes over half of our revenues. In fact, we believe the decline in GDP expectation for the U.S. economy reinforce our client's desire to utilize flexible staffing, which allows them to quickly adjust to this constantly shifting economic environment and the significant uncertainties surrounding regulatory tax and healthcare reform. Many client meetings have confirmed that they are reluctant to go long human capital in this macro backdrop. We remain confident in our belief that there is a sustained secular shift toward a flexible staffing model and that temporary staffing penetration of the workforce may achieve historic highs in the United States. We also remain confident in our highly leverageable operating model and anticipate continued revenue and earnings growth both in the near term and over the long term. I will now turn the call over to Bill Sanders, Kforce's President, who we welcome back, who will provide additional insights and operating trends and expectations and then Joe Liberatore, CFO, will provide remarks and overall financial performance. Bill?

Thank you, Dave. We thanks to all of you for your interest in Kforce. We at Kforce are committed to revenues and earnings growth. We will accomplish this by quickly adapting to the dynamic issues facing our clients. We will provide exceptional service to our clients, which will accelerate growth. We also expect to continue to improve profitability through the leverage that exists in a highly advanced operating platform and by further evolving the NRC, which allows us to profitably serve certain clients and niches that would not be possible under our traditional staffing model. In Q2, we continued to have success in pursuit of these objectives. In our largest business unit, Technology Flex [Tech Flex], which represents 55% of total firm revenues, Q2 revenues increased 7.6% sequentially and 15.4% year-over-year. We have been successful allocating firm resources such as the NRC to our best performing verticals such as the Financial Services and Healthcare, are also taking advantage of the continued widespread strong demand for highly skilled tech professionals in the marketplace. Our key performance indicators such as job orders and client visits are stable, and fill ratios are improving, which reflects increased efficiency in prioritization of requisitions. However, the candidate pool is tight for skill sets and demand. Maintaining pipeline and finding candidates through passive recruiting and social media is a necessity. We expect sequential revenues for Tech Flex to increase in the third quarter. Revenues for our Finance and Accounting Flex business, which represents 17% of our total revenues, decreased 0.7% sequentially and increased 24.6% year-over-year. This business was again impacted by a larger than expected decline in activity and lower bill rate positions, inclusive of the mortgage refinancing and foreclosure space, which constitutes approximately 18% of our F&A business. This portion of our F&A business declined 14.7% sequentially, and we anticipate a flat to slightly declining revenue trend for this portion of our F&A business in Q3. Management is adapting to changes in this business to allocate resources to stronger performing sectors of our business. July performance indicators for FA Flex in total are up slightly from June levels, and we expect revenues for this units to be flat to slightly up in Q3. Both of our Tech Flex and FA Flex businesses benefit from the continuing maturation of our cost effective and highly elastic National Recruiting Center, coupled with our Strategic Accounts strategy, as well as a highly tenured workforce serving all of our clients. Currently, 27% of Technology and F&A revenue is being supported by the NRC. This percentage increased from 25% in Q1 and we expect this percentage to grow as our Strategic Accounts strategy gains further momentum and increasing tenure in the NRC leads to additional productivity improvements. We believe the continued evolution of these teams and their related success provides significant additional revenue in earnings leverage. Our HLS business segment, which represents 16% of total revenues in Q2 2011, is comprised of our Clinical Research and our Health Information Management businesses. HIM revenues increased 4.8% sequentially and increased 21.2% year-over-year. Our HIM revenue trends continue to be promising as hospital spend continues to improve particularly in the project services and remote coding areas. This business has performed nicely over the past 5 quarters as it continues to evolve its business model to better embrace the evolving technological changes in this space. We believe in the long-term demand for this profitable business and, in particular, the opportunities that should evolve for both HIM and Tech Flex, while the transitions to electronic medical records end with the October 2013 deadline for the adoption of ICD-10. We expect HIM revenues to be up again in the third quarter. During Q2, revenues in our Clinical Research business decreased 0.2% sequentially and 6.2% year-over-year. We experienced an unexpected decline in revenue during Q2 at 2 large clients, due to increased turnover as well as a slower than expected ramp of a significant project that was awarded in Q1. Management continues to monitor this changing space as many long-term drug patents are scheduled to expire shortly and industry consolidation continues. We will adapt to these changes as they occur and continue to position this business for success. We are expecting revenues to be flat in Q3. Revenues for Kforce Government Solutions, our prime government contracting business, decreased 6% sequentially and declined 19% year-over-year. This profitable business unit continues to see the negative impacts of the challenging federal procurement environment. We will remain focused on our key competencies and, consistent with our philosophy during difficult periods, are challenging all aspects of this business and its processes. We have recently made significant upgrades in our senior management and business development team so that we are fully prepared to take advantage of opportunities in niches where we excel as the external environment improves. As we look ahead to Q3, we anticipate revenues will be flat with a stable profit picture in this unit. Perm revenues from direct placements and conversions constitute 4.4% of total revenues, increased 20.6% sequentially and 23.5% year-over-year. We continue to make measured investments in our field and NRC search teams to support our high quality revenue stream, though our financial targets are not predicated on returning to prior peak Perm revenue levels. Perm revenues are very difficult to predict in Q3 since a significant portion of revenues are generated in September. Thus, we are projecting perm revenues to remain flat to slightly down in Q3. In terms of headcount trends. We continue to make selective investments in our sales headcount during Q2, while ensuring the allocation of existing headcount in areas of greatest demand. Sales headcount, inclusive of the NRC and Strategic Accounts, has increased 3.9% year-over-year. We continue to believe that continued development of our National Recruiting Center and our Strategic Account team provides a leverage to increase productivity well beyond historical highs and a cost of delivery well below historic levels, and therefore, we expect near-term headcount additions to remain selective. We began our diversified service offering fortified by our tenured field teams and our National Recruiting Center and Strategic Account executives will result in continued revenue growth as we move further through this economic recovery. We remain focused on adapting to the changing needs of all of our businesses to optimize performance to position the firm for long-term success. All this involves [ph] continuing relentless focus in retaining our great people and improving client satisfaction, while driving continued profitable revenue growth. I will now turn the call over to Joe Liberatore, Kforce CFO and Executive Vice President, who will provide additional insights on operating trends and expectations. Joe?

Thank you, Bill. Total revenues for the quarter are $274 million, increased 4.4% sequentially and increased 11.3% year-over-year driven by continued growth in our Technology Flex, HIM and Search businesses. Quarterly revenues reflect a $261.8 million, increased 3.8% sequentially and increased 10.8% year-over-year. Search revenues of $12.2 million increased 20.6% sequentially and 23.5% year-over-year. Overall revenue trends improved each month within the quarter, though results by segment were mixed. Sequential monthly revenues for Tech Flex improved April to May and again, May to June, though rate of improvement slowed in June. Sequential revenue trends for FA showed improvement in June after sequential declines in April to May. HLS revenues declined from April to May and then remained flat in June. Search was strong in April and May, though slowed in June as typical entering the summer months. Flex revenue trends for the beginning of the third quarter of 2011 are up slightly from June. For the first 3 weeks of July, Tech Flex is up 18.2% year-over-year, Finance and Accounting Flex is up 13.5% year-over-year and HLS is up 4.9% year-over-year. Search revenues were up 2.2% year-over-year for the first 4 weeks of Q3 2011. We caution that early quarter trends do not necessarily accurately reflect potential full quarter results. We also note that in 2010, revenue trends strengthened significantly late in Q3. Net income of $6.8 million and earnings per share of $0.17 in Q2 2011 increased sequentially, 40.2% and 41.7% respectively compared to Q1 2011. Year-over-year net income and earnings per share increased 31.9% and 30.8% from $5.1 million and $0.13 in Q2 2010. Our solid bottom line results, despite an environment in which gross margin expansion, particularly in our Tech Flex business has been proven difficult as a result of discipline related to controllable cost and improving cost efficiencies from our operating platforms, as well as increased use of our cost efficient National Recruiting Center. Our overall gross profit percentage of 31.6% increased 170 basis points sequentially, but decreased 30 basis points year-over-year. This sequential increase was driven by a combination of mix shift, a decrease in payroll, tax-related costs and slight improvement in bill/pay spreads. The year-over-year decrease is the result of a combination of compressed bill/pay spread and increased payroll taxes. Our Flex gross profit percentage of 28.4% in Q2 2011 increased 130 basis points sequentially due primarily to 110 basis point reduction in payroll taxes from Q1. Year-over-year Flex gross profit percentage decreased 60 basis points primarily as a result of decreased bill/pay spreads and the increased payroll taxes. Bill/pay spread and Tech Flex are essentially flat sequentially and year-over-year, and FA Flex spread have improved 40 basis point sequentially and 30 basis points year-over-year. Over the past two years, the U.S. economy has been growing at a relatively slow rate. Though we've had success in growing revenue, it remains very challenging to improve bill/pay spreads across our business lines. We continue to be highly focused in this area and believe that the current supply/demand environment suggests that pricing power will improve over time, but not at a rate previously anticipated. Impacting the improvement in bill/pay spreads, particularly in our Tech Flex business, is the continued growth of our Strategic Accounts, which typically have lower margins and where spreads are more difficult to expand. In order to continue to expand operating margins in this environment, management continues to reinforce its use of the NRC in particular to the support Strategic Account portfolio. This significantly lowers the cost of delivery and results in highly profitable business despite lower gross margins. Additionally, we continue to have a relentless focus on all controllable costs. Overall, we anticipate continued moderate improvements in bill/pay spread across all our staffing businesses into Q3 and into 2012, though at a slower pace than originally anticipated. We're very pleased with the declining trend in operating expenses over the past two years. Operating expenses were 27.5% of revenue in Q2 2011, which increased 60 basis points from Q1 2011, but decreased 70 basis points from 28.2% in Q2 2010. The sequential increase was driven largely by a full quarter of headcount additions made in late Q1 and incentive-based compensation related to the pay for performance plans. In addition, as we continue to adapt our changing environment, we are incurring some onetime costs during Q2 and Q3, related to the relocation of our back office functions for our Government business to Tampa, Florida. We expect to realize long-term savings as a result of this centralization effort. The continued year-over-year reductions in our operating expenses as a percentage of revenue are a reflection of our diligent management of operating expenses and the expansion of our National Recruiting Center. The NRC currently services approximately 27% of our Tech and F&A revenue yet comprises only 12% of compensation related to these businesses as compared to servicing only 6% of Tech and F&A client 3 years ago. Another key benefit from investments in our National Recruiting Center and Strategic Accounts group is to improve the performance of our field sales associates, thereby improving retention and reducing the cost of expensive turnover. Field associate turnover continues to be low. As the percentage of NRC usage increases across the firm, we anticipate additional operating expense leverage. Additionally, as revenues increase, we continue to see operating leverage from the technology investments made over the past 7 years. Our Accounts Receivable portfolio continues to perform very well. Write-off continue to be small and the percentage of receivables days over 60 days remain at low levels, increasing slightly to 4.1% on June 30, as compared to 3.5% on March 31. The firm's cash flow continues to be strong. EBITDA was $17.3 million or $0.43 per share in Q2 as compared to $14.1 million or $0.34 per share in Q1. Year-over-year EBITDA increased 25.8% from $13.7 million in Q2 2010. Bank debt at quarter end of $18.9 million is down from $25.3 million at the end of Q1. Borrowing availability under our credit facility, which expires in November of 2011, is currently $88 million. We have actively been in discussions with various parties for a replacement facility and expect to finalize the transaction in Q3. The firm repurchased approximately 425,000 shares of stock for a total of $5.6 million in Q2. There's currently 54 million available for future stock repurchases under the current Board of Directors' authorization. We will continue to be opportunistic in the future repurchases as cash flow and market conditions warrant. With respect to guidance, the third quarter of 2011 has 64 billing days, same as the second quarter. We expect revenues may be in the $276 million to $283 million range. Earnings per share may be $0.17 to $0.19. Our effective tax rate in Q3 is expected to be approximately 37.7% with approximately $40.5 million weighted average diluted shares outstanding. This guidance reflects flat to modest gross margin improvement and continued SG&A leverage. This guidance does not consider the effect, if any, of charges related to the impairment of goodwill, acceleration of equity incentives or the firm's response to regulatory, legal or tax law changes. We continue to be confident in our long-term success as we strive to adapt to the changes to the external environment in our businesses. Our mix of service offerings particularly in Tech, FA and HIM, position us well as we see continued secular shift towards flexible staffing. Our gross margin profile is already one of the most attractive in the industry, but the capability to cost effectively meet customer needs with speed and quality allows us to drive EBIT both through increased gross margins and through operating efficiencies and flexible compensation structures. We have a high quality revenue stream and balance sheet, a highly tenured associate population as well as the strongest management team in the firm's history. We expect to capitalize on the capacity that exists in our associate base to grow revenues and improve earnings. Operator, we'd now like to open up the call for questions..

[Operator Instructions] Our first questioner in queue is Mark Marcon with Robert W. Baird. Mark Marcon - Robert W. Baird & Co. Incorporated: I was wondering if you could talk a little bit about the SG&A, the sequential jump that you saw. You mentioned that there was a portion of that, that was due to shifting over some of the back office functions from KGS over to Tampa. Can you quantify how much that was? And once those steps are done, what sort of savings should we see?

Yes, Mark, this is Joe. Really, there were really 3 main things that impacted that 60 basis point increase. One of those being the back office nominal impact in Q2 associated with that. We'll feel a little bit more of the impact in Q3 because we'll be running almost completely redundant operations for that period of time. And then, the people in San Antonio and Fairfax, will be exiting the organization and so we'll get some of those pick up as we head into Q4. We also had added some headcount in our NRC on the back end of Q1. So we had the full quarter impact of that headcount addition in the quarter. And then also when I was referencing our performance based plans, that really hit us from 3 points. Search performed very well so we get some increase in SG&A while that helps us from a bottom line standpoint. It does show up with a little increase in SG&A because of that mix. As well as we have people moving through our Flex ladders because of their performance and then management having an extremely good quarter because of the way that we do our current quarter based upon the average of the prior 2 quarters. Mark Marcon - Robert W. Baird & Co. Incorporated: So how much of an increase are we going to see sequentially going into Q3 because of the shift in terms of KGS?

In Q3, actually as I just mentioned, Q3 will have more expense in our Q3 than we had in Q2 because the KGS, because we added people in Tampa throughout the quarter. And so we'll have the full impact of that in Q3 as well carrying those people in San Antonio from a transition standpoint. However, as I mentioned, I mean, all this is contemplated in our guidance so we do anticipate that SG&A will decrease as we move from Q2 to Q3. Mark Marcon - Robert W. Baird & Co. Incorporated: SG&A will decrease as you go from Q2 to Q3?

On a percentage basis, yes, it will, even in spite of the KGS redundancy. Mark Marcon - Robert W. Baird & Co. Incorporated: And just can you quantify how much that KGS redundancy will be?

We're really not going to break that out at this point in time. Mark Marcon - Robert W. Baird & Co. Incorporated: Can you talk a little bit about what the savings might be later on?

Our initial transition is focused on the compliance aspects and making sure that we do no harm to the business. As part of our assessment, we've been looking at this for quite some time. We do believe once we get that in Tampa and stabilized because of the leverage we'll get from communication standpoint and various other aspects, that we will get SG&A pick up, but we haven't broken out what percentage of that's SG&A because that's within the KGS. Mark Marcon - Robert W. Baird & Co. Incorporated: And can you talk a little bit about the anticipation with regards to the Flex gross margins going into the third quarter just sequentially?

Flex gross margins in guidance, I mean, we're being conservative so we're anticipating flat to slight improvement from a Flex gross margin standpoint. Albeit that we're tracking this on a weekly basis and we have continued to see week-over-week improvements early in the quarter. Mark Marcon - Robert W. Baird & Co. Incorporated: And then are you anticipating that government stabilizes here? Or given all the headlines that are out there, does it make sense to just assume that we're going to continue to see some deterioration with regards to the top line?

Mark, this is Bill. Certainly, the government's not going anywhere. In the areas that are sweet spot for ourselves, we believe that there will be continued funding, although the funding at different times and different places are certainly unpredictable compared to prior periods. So we think that we are in the right spot. Technology, primarily, it's about 50% of our prime government business, and we think that we will continue to see growth in that area. We have reorganized our management team, we have brought in -- we've upgraded our senior management team, we have upgraded substantially our business development team. So we think it's a good diversification of our revenue stream. It's good solid risk management for us. And as confident as you can be in this very uncertain environment that we will have a flat third quarter, for us, fourth quarter for the government, and we expect to take market share. We expect to grow this business over time. Mark Marcon - Robert W. Baird & Co. Incorporated: In terms of the change, in terms of the KGS management team, are you talking about more recently or are you talking about what happened awhile ago?

No, I mean, it's basically in the second quarter, but we've brought in some top people from some of the larger groups around here. As you know, Glenn Shaffer retired. He's now Chairman of the Board of KGS and he, with Admiral Pat Moneymaker is the Vice Chairman of that board. So we believe we have built an excellent team. It's time for them to produce, I agree with you, but they're somewhat new. We brought in a number of different people and we're pleased with what we see today.

Our next questioner in queue is Kevin McVeigh from Macquarie.

Dave, I wonder if you could give us just a little perspective on the core, what I'll call more cyclical businesses like IT, as opposed to the Government and Clinical Research where it seems like we're seeing some slowing there as well as F&A side. Just kind of your thoughts on that, in terms of where we were, expectations into Q2, and then how that progressed particularly given revenue coming in below, well under the range.

I would say that Tech actually performed well. It was up 15% year-over-year and 7.6% sequentially. So Tech is actually performing well for us, and we believe that reflects what's happening in the market. We expect it to continue to perform well. HIM, as you know, performed well. Search performed well. If there were areas that didn't fit our expectation in Q2, it was certainly in the government space, it was in the clinical space. And we saw a decline and a slowdown in the orders in the mortgage-related, in the real-estate related activities within F&A. So as we have gone through and done our modeling and given our guidance for Q2, it's those 3 units really that did not come to meet our expectations for our second quarter numbers. So the rest of our business has remained strong. We're still very confident. In Tech, I think the marketplace overall for Tech remains very strong. What we're hearing from our clients and what we're seeing in our KPIs is that Tech is strong. And as is typically the case, it's having a diversified revenue stream works for you sometimes or works against you sometimes. And today, everybody would say, "Boy, you should be 100% Tech." And a year are from now, they'll say, "Boy, we're really glad that you have a diversified revenue stream when things change." So we've done what we've done with the 4 legs of the stool intentionally. Certainly, 3 or 4 years ago, we couldn't have foreseen what would have happened in the government space or even in the clinical space, and when you look at what's happening with biopharma. But with that being said, we're playing the cards we're dealt, we're making the adjustments. And most importantly, I have confidence in our team. We've got a great team. And our team is used to winning, particularly in those 3 units, and they are working aggressively and fighting aggressively to make the adjustments necessary to accomplish what we set out to do there. So overall, Kforce performed well. We're up 11.6% year-over-year in revenue. We expect to continue to grow revenue year-over-year and we're confident in our team. Although, we certainly have a couple of challenges in those businesses.

On the mortgage side, was that more kind of the processing in the application because I know it's kind of full circle in terms of doing some work on the foreclosures as well? Or is it just generally across the whole sector on the mortgage side?

This is Bill, Kevin. We certainly were very lucky to have the NRC employees when the mortgage refi business really started. There were some large companies putting out anywhere between 300 and 600 orders at a time. Because of our NRC, we were able to capture a significant portion of that, that we would not have been able to capture before. So it's a little bit of a sugar high. You take advantage of some things and, of course, when it declines, it comes down a little bit. But I mean, we've gone from mortgage refinancing to now foreclosures, mitigations, some reconciling. You know what the industry is -- the financial services industry is going through. And we're kind of moving a little bit with that, but certainly the mortgage refi business alone was really cranked up last year. And still the comps for us was a little tough, but year-over-year we're up, as Dave just said, 24%, but sequentially, pretty flat.

And Kevin, that business as a percentage of F&A in one quarter declined from 23% to 18%. Our core F&A business is still performing and still growing. And as you'll see looking ahead, as Bill said, we expect it to be flat to slightly up. And that component of that F&A business, we expect will be the more traditional core business, even as some of the larger financial services firms have reduced their expectations on refinancing and also have slowed down their foreclosure activities and some of their other activities. You're very familiar with this space so, as Bill said, the comps became more difficult for us as that space changed.

The regulatory environment changed, too. You got the Safe Act, you got the Dodd-Frank bill, the banks are sitting back and waiting to see. So there's a lot of things that are dynamic in that group, and we're very fortunate to have the NRC that can move quickly from vertical to vertical.

Our next questioner in queue is Paul Ginocchio with Deutsche Bank.

Just on -- maybe talking about smaller accounts. Is your revenue that's outside the NRC up year-on-year? Or however you look at it? I'm just wondering how the smaller accounts are doing within Kforce.

A year ago, Strategic Accounts was 22.9% of our business, and in second quarter it was 22.6%. So as we have grown, I mean, it's been pretty stable of what the Strategic Accounts and the other, what should we call it, basically the spot market or the transition market has stayed pretty constant. So when you consider all the things that we have talked about, I mean, we have been quite strong in that market and will continue to be.

Just by looking at maybe some of your competitors, it seems like the spot market gross margin is doing a little better than you would imply from the third quarter. So I'm just trying to note, is it just that your Strategic Accounts gross margin is declining year-on-year that much and it's not being made up for the smaller accounts?

Yes, I would say, from a Tech Flex standpoint, Paul, that'd be very accurate. I mean, we were noticing nice margin improvement in the spot market and somewhat flat in our Strategic Account portfolio. In fact, from a Tech Flex standpoint, we did notice a nice improvement and then slight decline in spot. From an FA standpoint, very similar. I would say that on the FA front, we're really seeing actually some improvement in our higher volume accounts in terms of margin. And actually, a little bit more flat in the spot market. And a lot of that just has to do with the nature of the business that we're focused on.

I want to correct a stat that Bill gave you. He gave you 22% of total Tech business or total revenue being in our Strategic Accounts is 32%.

Basically flat at 32%?

That's just Tech. My percentage was total revenue of the firm. I will add a little bit to what Joe just said. In Strategic Accounts, we have longer-term contracts and as we replace people, pay rate increases. So there's some lag between pay rate and bill rate from Strategic Accounts. Now that gap will close as we renew contracts and as these clients find that they can attract the people at these kinds of rate. So it's much more gradual because of the mix that you see within Strategic Accounts versus the spot market.

And then just maybe talking about long-term guidance, you talked about gross margin is not going up sort of as much as planned. So you sort of changed your guidance or your longer-term guidance. Was there any certain events or contracts or things that took place that kind of changed your opinion? Can you help us what happened between -- over the last 3 months?

No, I wouldn't say anything contract wise had really changed from that front. It's more so, we very much look at what's happened in historic cycles and then map that to the current cycle. And we were having experience that was very similar and we've noticed a tempering of that so that was really why we had raised the awareness. So obviously, this cycle is very different than anything else that we've experienced in the past when we look all the dynamics that are coming at us whether it be from when we look at healthcare reform, lack of job creation, as Dave referenced, the GDP environment. So just with all those dynamics coming into play, we just tempered that back a little bit.

Paul, I would comment also that in Tech Flex specifically, as we've picked up the additional volume in Strategic Accounts, the more efficient delivery of the NRC actually lowered our SG&A and the comp related to that, as Joe said and as we've modeled this out and frankly, strategically, when you look at the industry, the adoption of VMS tools and VOP is continuing to accelerate not only in large accounts, but middle market accounts as well. So we expect over the long term, that the more efficient delivery system is going to gain us additional share and actually, give us a little bit more leverage on the SG&A front. So what we're doing isn't a quarter by quarter thing, it's really a part of a much longer term strategy to address what we think are macro trends in the industry.

It's tough to see this quarter because of the spike in SG&A and the gross margin, which was at least versus my expectations, a little bit below. So unless we can size the impact of the changeover in KGS, just very hard to see that you're gaining in efficiencies.

I mean, if you look at it quarter by quarter at a point in time, that it's very difficult because you have different events and dynamics that's happen in a given quarter. I think the best thing to reflect upon is look at what's happening on a year-over-year basis and what type of improvements are taking place because I think our SG&A has been continuing to come down. I mean, just to give you an example, from a Tech margin standpoint, during the last cycle, our Tech Flex margins improved about 450 basis points off the trough to the peak levels that we hit at 29.4. This time around, we only declined 240 basis points at the trough which was in Q4 2009. So for comparison purposes, margins troughed at 24.9% in the last cycle and Tech Flex as compared to 27% this cycle. And then we've improved 10 basis points off of the trough here. My point being is this has a lot to do with this shift into these more stable, larger customers. It reduces the risk of the firm. So for example, in the downturn, our Tech Flex business decreased 11.2% whereas most of the sector was decreasing 25% to 30%. So when you start to look at those impacts, that our Tech Flex business has grown 35% off of that trough level, had we decreased like the rest of industry, we would've had to grow 60% to get back to the $150 million Tech Flex business where we are today.

Our next questioner in queue is Giri Krishnan with Credit Suisse. Giridhar Krishnan - Crédit Suisse AG: I guess a question on Tech Flex. You addressed some of what's going on in Tech, but when you look at the GP and how it's taken longer this cycle for it -- it's not risen as much, is any of that also due to sort of the mix shift of assignments you're servicing at all or not?

I don't believe -- our bill rate's been pretty constant. So it's really -- it's not driven by the mix if we were to compare this cycle to last cycle. It's really the points that I've mentioned. It's the focus on the customers that we're going after, which are the more stable, longer-term contracts. Now the downside with stable, longer-term contracts is it's not like the spot market where it's repricing itself every four months on their longer commitments. But again, as I think it proved through the downturn, it protected our revenue stream more effectively and we're seeing the opportunities in the upcycle here as well. So that will start to change over time as those clients have to adjust to what the market demands are in terms of bill rate expansion. Giridhar Krishnan - Crédit Suisse AG: And on the F&A business, clearly, the mortgage refis we've seen that impact for more than a quarter, but given some positive commentary on F&A from some of your competitors and looking at -- I think you expect a modest growth in Q3. Could you talk about how the rest of your F&A business drill down into what sort of trends you're seeing and any implied bill/pay spreads for Q3?

That's a 2-part question and I'll handle one part and Joe will handle the other part. [ph] Again, we don't overreact to a short one quarter result. We are up 24.6%, and I said I believe that's the number year-over-year. And that's very important to us. That is our core business, and F&A continues to grow and we continue to invest in that group. So I would tell you we expect that core business to continue to grow. KPIs are strong in July so we expect things to continue. Joe, you want to talk about bill rates?

From a bill/pay spread standpoint, FA Flex spread improved 30 basis point on a year-over-year. It improved 40 basis points sequentially. So we saw bill rate -- basically the bill rates increased 0.9% sequentially while pay rates increased 0.2% sequentially, just to give you a feel on the actual numbers.

[Operator Instructions] And our next questioner in queue is Tobey Sommer with SunTrust.

Could you review the percentage of revenue from Strategic Accounts? I got a little confused with the sets of numbers that were given. How much in a year ago period and how much now? And then I think you gave a separate Tech number specifically as well.

Dave mentioned the Tech number, which was 32%, Strategic Accounts and Tech. As a full revenue, total revenue of the firm one year ago a quarter, it was 22.9%. This quarter, 2011 that's 22.6%.

How long are the contracts typically in national accounts? Or maybe asking the question in a different way, what percentage of those accounts will have contract renewals over the next year or so?

It's approximately, if you wanted to take a general number, they're a 3-year contract. It depends, obviously, everybody is a little bit different, but I would say that would be the median, if you were to pick it. And I would say that I mean, I don't have a real clear view of that, but I would say that it's pretty equal, over time, depends on -- as I said, if it's a stable amount of our total revenues, you would have anticipate the churn would be somewhat equally year-over-year.

So about 7.5% of total revenue. In terms of --

Remember that I mentioned, clients are having, some of these large clients with these contracts are also having a hard time finding the quality of people that they need at those rate. And therefore, we are experiencing some increases from these clients already and this will continue, especially in the Tech side, where finding the right skill sets and high demand is difficult for them at lower rate. And so, you have more than just contracts, and that will accelerate as time goes on if there is continued strong demand.

Yes, because to add on to that, we saw a 2.1% sequential increase in Tech Flex pay rates. That's a very healthy increase. And having been in the Tech Flex business for going on 25 years at this point in time, while it's painful when that first starts to happen because you can't move bill rates immediately overnight, especially in these larger customers, it's a great indicator of supply/demand in terms of what opportunities are available to these individuals. And over time, bill rate does open, at least start to gap, from that pay rate. So they don't move in concert. I mean, there's lead lag effects that have always taken place from that standpoint. So I would say the front end indicators are what we want to see in terms of where the opportunity exists for expansion of bill rate and hence, margins.

Joe, what was the figure you gave? Was that 2.1%?

Yes, 2.1%.

And that was sequential?

That's on a sequential basis.

If I was to look at billing days, which you give for the whole firm, do they vary by industry as well? Or is it pretty much comparable segment to segment?

They do vary little bit. They do vary a little bit segment by segment just because where the government has typically more holidays than the commercial business, the pharma entities can get in that mix. The only time that we really start to break that out and differentiate it is in Q4 because it becomes more material in Q4 especially on the government side and on the KCR side, or how long they shut down with holidays. But in any given quarter, yes, in fact, we technically would have more or less billing days in KGS than we might have in some of our commercial businesses.

In terms of the -- I think you touched on this in your prepared remarks a little bit, Joe. The gross margin, if you were to isolate and try to segment the impacts of the bill/pay rate spread compression and the payroll taxes, how would you allocate it?

Basically, as I mentioned, about 110 basis points of that improvement was because of payroll tax pick up. Is that what you're looking for? And then I would say 10 basis points would be associated with spread, and then 10 basis points would be associated with kind of there's a number of other things that go into the makeup of the margin benefit and various other things go into play there, which fluctuate on any given quarter.

Could you guys comment on the Clinical Trials business? We do have, I guess, from a general sense, you've got a bunch of generics coming online. And I just wondered what your longer-term outlook is there particularly, I think in the second quarter, it looks like Pfizer announced they were going to try to consolidate their vendors.

This is Bill. True, there is a significant consolidation in the pharma industry, 6 of the top 10 selling drugs are coming off patent in the near future. And therefore, you're seeing great pressure on expense reduction results from those companies. And they're looking for more global providers as part of that expense reduction. So I would say, certainly, there's more uncertainty in that particular industry. But in the next 2 years, we don't see that great a change to us. Again, there's huge uncertainty here. Yes, you mentioned the Pfizer operation. That continues to be something that is getting worked out over time. We continue to be a large vendor there. We expect to continue through time to have some exposure there, but we are diversifying and adapting. The word that we've been using a lot, adapting, by growing our smaller and medium-size businesses. So in conclusion, I would say, there's risk. We are adapting to that risk, and we will continue to work very closely with all of our clients.

What percentage of revenue, Bill, is derived from Pfizer?

Total revenue is less than 5%.

And just maybe just one final question, just kind of an overview, how do you feel -- you're a big player in tech. You're sizable in finance and accounting as well. But relative to standalone CROs or government services companies, you're not as large. Do you feel strategically that you need to get bigger in those areas in order to compete more effectively?

If you look at the government space, this is Dave, I would say that, that was a part of the opportunity that we saw, that we would be able to command and take advantage of the staffing delivery capabilities in our Technology and F&A footprint. And in fact, we're quite successful in doing so until the current administration came in, in which we've seen a significant change in terms of in-sourcing, the awarding of contracts to 8(a) firms, which you're familiar with. So with those things and now with the government debt situation, it certainly -- it's a challenging environment to say the least. With that being said, we have very, very minimal market share. So the disruption that's happening in the government space actually creates a very significant opportunity if we're able to adapt to it. For example, the larger firms that are entrenched, they're going to have to adjust margins, they're going to have to adjust footprint. So competitively, if the smaller firms like ours are able to adapt and adjust and take advantage of the areas that we have a confidence and expertise, we actually believe that we can win business where these other firms are unable to adjust. So that's the theory. We've had some success with it, and time will tell whether or not that works. And certainly, those are considerations as we look and say, "Okay, over the long term, how are we doing strategically in that space?" The Clinical business, clearly, we've got major challenges there and question marks, but with that said our team is adapted and adjusted. We've made quite a bit of progress actually in going after smaller and middle market clinical firms. As that space evolves, we've seen more of the new research and development for drug development shifting to some of the smaller firms. We think the industry is kind of evolving where the larger firms will actually be in manufacturing and distribution, smaller firms and even private equity firms will be taking more of the development risk. So as we look at what's happening in that space, it's still uncertain. There may be significant opportunities, but at this point it's too early to tell.

And I would also add on the government side, especially where it's really easy to isolate. We like the areas where we're operating and the agencies that we are working with, especially when you look at any of the proposed budget cuts there that are out there, being in Veterans Affairs and the Defense Threat Reduction agency, TRICARE, Defense Logistics Agency, U.S. Coast Guard, Customs and Border Protection. I mean, those are all areas that we feel very comfortable in terms of a lot of the talk about the big reductions are on the big block items, the $180 million plane, the very large carriers and those types of areas where a lot of that is going to come out. So we do like the agencies where we'd penetrated and we think we have opportunity to capture additional market share.

Our next questioner in queue is Josh Vogel with Sidoti & Company. Josh Vogel - Sidoti & Company, LLC: I was just curious, you mentioned that the reduction in payroll taxes was at 110 basis points sequentially. Do you have an idea of what that would be Q2 to Q3?

It will be nominal in comparison, most of it would be burned off from Q1 to Q2. So when I talk about any margin improvement Q2 to Q3, I'm really talking about the spread improvement, not just something that we're naturally going to get from a payroll tax standpoint. Historically, it's been 20 basis points, somewhat in that range. Josh Vogel - Sidoti & Company, LLC: And now just looking at KGS, outside of the back office relocation, are there any other levers there that you can pull to get margins higher?

Well, this is Bill. Margins in KGS are the highest in the firm. And so are we reducing management -- or not management, core employees? Yes. Are we making sure that we have a utilization and realization on our existing billable employees? Yes. But to me, this really is an issue of the right leadership team, and I think we have built a very significant team. There are a lot of new people, very happy with it. In fact, my best example I'll give props to the guys that may be on the call. A few years ago, we really put together -- had to do a lot of reorganization in our Midwest markets. And the market of the quarter was our Detroit and Cleveland market. Wow, and so it shows the right leadership team in the right organization, it doesn't matter where the economics are going. We are such a small percentage of what's happening in the government, and we have confidence in that team. They can do the same thing. They can grow this business, and we are looking forward to them growing the business.

Yes, what Bill is really referencing is the profitability of the unit. I mean, our government unit is, on a percentage basis, one of our highest profit contributors to the bottom line. If you are also looking from a Flex margin standpoint, what opportunities exist there? The dynamic in the government space has really shifted in terms of -- it's really moved from quality to prices probably the number one driver. And you see this in a lot of recompetes, I think. As we had discussed on our Q1 call, we had about $1.2 million impact on a sequential basis of recompete that we had won, but that recompete was at a lower bill rate level across all of those billets. So those are the types of things that you've also seen happening in the government space. It's a very different operating environment and landscape than where it traditionally has been. Josh Vogel - Sidoti & Company, LLC: And then one last one, if I may. In Clinical Research, you talked about the large project you won in Q1. It's been a little bit slower than expected to ramp. I was just curious if you had a status update as of today?

It is ramping. Yes, the people are now being put in place. We're still fighting some turnover, but we believe that we should have a stable third quarter in KCI.

We do have time for one final questioner. Our final question comes from Mark Marcon with Robert W. Baird. Mark Marcon - Robert W. Baird & Co. Incorporated: On the Tech Flex side, could you talk about the verticals that you're seeing the strongest strength out of? And what are some of the areas that have flattened out a little bit?

Well, certainly, the strongest area is our Healthcare. When you talk about electronic medical records and just the general activity in Tech Flex is very, very strong. The skill set and demand, the job [indiscernible], program managers, [indiscernible], it goes on and on. I mean, there's even need for COBOL people as you look at this. So it's a strong sector and we expect it to continue to be strong, Mark. Mark Marcon - Robert W. Baird & Co. Incorporated: Any areas where you're seeing any sort of flattening from a vertical perspective for any of the large clients?

Well, obviously, we've talked about the mortgage refi, and that particular area, which was quite big for us in the F&A vertical financial services. But I wouldn't point out any particular ones. Joe, you got any in particular?

Not from a tax standpoint. I mean, we're seeing stability to growth really across every vertical that we're operating in from a tax standpoint. We haven't seen anybody.

And I would add, every geography. There isn't a geography in the United States that isn't having significant skill shortages in Tech. As Bill and Joe mentioned earlier, it's a prioritization game now as opposed to a coverage game. So we're have to go back and reprioritize and really across the United States. So demand on the Tech side is certainly way, way greater than supply.

I guess from a geography standpoint, the best example I can give you is our top performer from Q1 to Q2 was in the Chicago and Detroit marketplace, which we obviously all know in terms of the economic climate that they're operating, it's not real optimal, but I mean, that just gives you a feel for how broad based it is. Mark Marcon - Robert W. Baird & Co. Incorporated: So with that level of supply/demand imbalance, how are you -- how is that impacting the way that you internally prioritize the clients? I've been to the NRC a few times and seen how you've done some of that prioritization, would you shift a little bit away from the Strategic Accounts if they don't take the bill rates up?

Client selection certainly is important to us, and we are not the right match for every client. That's true, Mark. I would say from a prioritization standpoint, when we talk about our infrastructure we call it world class, we now have electronic names and large screens in every office, where we prioritize it in that office and in the NRC. Our requisitions, and so we are using technology to its highest and best advantage here and prioritization is becoming quite a science in Kforce rather than the art that it used to be.

Mark, before we go further, I would say that the primary driver now is speed. And if the client responsiveness isn't there, we're moving on to the next client. So ultimately, Strategic Account pricing is going to be impacted by the market, and we expect that pricing will come up. So ultimately, the consultant makes the decision who he wants to go to work for. So to the extent that we get a response faster, to the extent that we get more realistic market pricing, those are the clients that are going to get prioritization in our servicing. And all of those things, by the way, are done against a larger backdrop of who are firms, the firm-sponsored accounts that we have targeted that we want the longer-term relationship for all the reasons that Joe mentioned; for stability, for diversification and so forth. Because the day will come when Tech will turn down, and we don't know when it's coming, hopefully not until after I'm long gone and buried. But the day will come, and we'll be glad we have a diversified revenue stream. For the meantime, we're going to grab as much as we can and we're going to balance not only our service portfolio but also our Tech client portfolio and that's really what we're trying to do.

It is important to note when you're dealing with these large consumers, what they've done with their vendor list, the way that they're narrowed their vendor list, it's not just -- I mean, we're spending a lot of time here talking about the margin exchange for stability and for volumes of business. But the part that really isn't referenced enough is the strategic nature of that relationship. That is a very different relationship and there's much more dependency in that relationship than there is in a spot market relationship. Again, I go back to the proven, and the facts associated with that is when you look at what happened to our Tech Flex revenue during the downturn, in comparison to the general market and that's because that is a much more strategic relationship, it's not just as a transactional relationship. So there's exchanges here, and these are long -- much longer-term relationships as well.

I would say we got it pretty easy formula, Mark, as we look at that. That's volume, rate, duration and effort. We look at those things and that's how we prioritize it. Mark Marcon - Robert W. Baird & Co. Incorporated: And can you talk just a little bit about the -- when you would expect SG&A leverage to come through in a more significant way? You mentioned there are a couple of onetime-ish things that are occurring in the third quarter. But as we go out towards the fourth quarter, at that point should we see a resumption in terms of the SG&A leverage that you were showing progress towards?

As I mentioned, SG&A based upon our models, barring a surprise of a carve out item, SG&A in our models, our operating models and our forecasting models, SG&A as a percentage of revenue will come down as we head into Q3. It will come down further as we head into Q4. So this isn't going to be some big bang type of event where you're just going to see some big tranche down. You're going to see a continued march down, and yes, there might be independent quarters, no different than here in Q2, where it bumps back up a little bit. But if you look at that trending, in all of our models, if we look at that trending out over the next 8 quarters, that's trend, linear, it's on a downward path. Mark Marcon - Robert W. Baird & Co. Incorporated: What I was speaking to was that on the first quarter, SG&A as a percentage of revenue was down 130 bps year-over-year. Here in the second quarter, we were down basically 60 bps year-over-year. Based on the way [ph], I think what you're saying, it sounds that we're closer to like 20, 30 bps in the third quarter. So I was just wondering if we were going back to expanding that leverage?

No, the way that I would look at it, Mark, is Q1 was probably a little bit lower on a normalized basis because we didn't have a lot of performance-based compensation that went out. So if you want to look at the comparison of Q1 to Q2, Q1 is probably, was probably a little lower if you just look at all of the fixed aspects of it. And Q2 performance is extremely well when we start to look at year-over-year comps and some of the stellar performance in some of our operations. And Search is performing real well so that's why you get that little bump up. But you know, as we move through the year, those things stabilize typically a little bit more. The beginning of the year is a little bit choppier, so like I said I believe you'll see that come down in Q3 and continue to come down in Q4.

And with that, I'd like to turn the program back over to Mr. David Dunkel for any closing comments.

Well, thank you very much for all of you and your interest in Kforce. Once again, we want to give thanks to our people, our consultants and our customers for allowing us the privilege of serving them. Thank you very much. We look forward to talking with you again at the end of Q3.

Thank you. Ladies and gentlemen, this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may disconnect at this time.