Kforce Inc (KFRC) 2021 Q1 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Kforce First Quarter 2021 Earnings Conference Call. (Operator Instructions) I would now like to introduce to your host of this conference call to David Dunkel, Chairman and CEO. You may begin.

Good afternoon. I would like to remind you that this call may contain certain statements that are forward-looking. These statements are based upon current assumptions and expectations and are subject to risks and uncertainties. Actual results may vary materially from the factors listed in Kforce's public filings and other reports and filings with the Securities and Exchange Commission. We cannot undertake any duty to update any forward-looking statements. You can find additional information about this quarter's results in our earnings release and our SEC filings. In addition, we have published our prepared remarks within the Investor Relations portion of our website.

I am incredibly proud of the continued outstanding execution by the entire Kforce team in delivering first quarter results that were at the high end of our elevated expectations and that improved as the quarter progressed. This extraordinary execution follows on the heels of a great 2020, where our largest business Technology demonstrated remarkable resilience against the backdrop of an unprecedented macro environment. The momentum we have built and increasing expectations of demand for Technology resources has significantly raised our expectations for the second quarter and our ongoing performance, which Dave Kelly will cover in some detail in a moment.

As I reflect on our strategic decision to focus our business on domestic Technology staffing and solutions, it's important to remember that prior to the great recession, the domestic technology staffing market was roughly $20 billion in size and the third largest staffing market segment behind industrial and clerical staffing. The most recent update from Staffing Industry Analysts noted that the domestic technology staffing market became the largest market segment in 2020, with spend of nearly $31 billion.

Over the same period, our Technology business grew in excess of 2x the market rate. Additionally, the Technology Professional Services market exceeds $100 billion. Companies have significantly increased their technology spend over the past decade, and the rate of growth in this market is accelerating. In fact, SIA currently anticipates the domestic technology staffing market will grow by 9% in 2021. This confirms the wisdom of our strategic decision to focus our energy and technology and complementary functional skills in FA and related skill sets. As we look to the future, there is no other single market segment where we would want to be focused, and we are incredibly excited about Kforce's future prospects.

The strength in the secular drivers of demand, coupled with improving corporate prospects across virtually every industry, allowed our talented team to deliver services to our blue-chip client portfolio at a level above our expectations with Technology in the first quarter growing more than 3% sequentially and 6% year-over-year on a billing day basis.

Additionally, we made nice progress in our objective of migrating our FA business toward higher-end skill sets for decision support and analytics in the quarter. Our FA results, excluding COVID revenues, also exceeded our expectations. This strategic shift, we believe, will provide an important complement to the Technology services we provide our clients, which Joe will elaborate on during his remarks.

We also continue to make great progress in positioning our firm to have a more flexible work environment post pandemic, through our reimagined initiative by leveraging many of our ongoing internal technology investments and utilizing available tools such that our employees will have a blend of in office and remote work.

We expect that this shift will result in fewer offices and a smaller physical footprint per office. This vision includes both the revenue-generating and revenue enabling components of our workforce. As for our release last week, we have entered into an agreement to sell our corporate headquarters and are actively seeking a new facility in Tampa Bay.

Our business continues to generate significant operating cash flows. And we were active in repurchasing approximately $16 million in stock in the first quarter. The strength in our balance sheet and availability under our credit facility allows us to be opportunistic with respect to deploying capital.

While we continue to evaluate potential acquisitions, we will apply our stringent, cultural and financial criteria to any potential transaction. In addition to the proceeds from the sale of our building, we expect to continue generating solid operating cash flows in the second quarter. Given the strength in our balance sheet and our belief in our future growth prospects, we expect to remain active in repurchasing our stock at current levels.

From a governance perspective, 4 years ago, we began in earnest, a mission to refresh our Board with individuals possessing necessary skill sets and backgrounds to lead Kforce into the future. Earlier in the quarter, we provided detail on 2 additions to our Board. Ms. Catherine Cloudman joined our Board of Directors in the fourth quarter of 2020, and Mr. Derrick Brooks joined the Board in the first quarter of 2021. Each of these extraordinarily accomplished individuals, both professionally and personally, bring diverse and valuable perspectives to our Board.

As we look ahead, we are very excited about our strategic position and ability to execute within what we believe will be a continued strong demand environment for our services. It's our belief that the pandemic has exponentially elevated the imperative for companies to rapidly digitize their businesses, transform business models and drive productivity gains through technology investment.

I will now turn the call over to Joe Liberatore, President, who will give greater insights into our performance, recent operating trends and other insights into our operating environment. Dave Kelly, CFO, will then give greater detail on our financial results and position as well as our financial expectations and guidance for the second quarter. Joe?

Thank you, Dave, and thanks to all of you for your interest in Kforce. The momentum across our business is accelerating. Total revenues for the first quarter grew 10.1% on a year-over-year billing day basis as the improvements we're seeing in our Technology business and strategic areas in FA are being complemented by the COVID business. I'm extremely pleased with the 3.1% sequential and 6.3% year-over-year billing day growth in our Technology business. This is the best sequential growth in first quarter we have on record and perhaps the best marked performance we've ever experienced at Kforce.

More typically, we experienced a sequential revenue decline on a billing day basis in the first quarter, given seasonal year-end assignment end. However, we have remarkably low assignment ends at the end of 2020 and very strong first quarter with respect to new assignment starts. In fact, we returned to preholiday levels of consultants on assignment by the end of January. Typically, it takes until the end of the quarter to return to these levels. For additional perspective, going back to the Great Recession, the range of sequential billing day declines in our Technology business is about 1% to nearly 6%, so this result is tremendously encouraged relative to that range. We believe that this speaks volumes as to the vital nondiscretionary, mission-critical work that we are performing across our client portfolio, which I'll refer and further elaborate on shortly.

Enhancing our growth rate is an improving bill rate trend. Bill rates have increased 4.4% year-over-year in Technology to $80 an hour. Volume, however, is the most significant driver to our growth. Billable consultants on assignments began increasing shortly after the inception of the pandemic and have grown sequentially for 3 consecutive quarters. Consultants on assignment are now at levels 21% greater than in June 2020. We're benefiting from a combination of solid new assignment activity as well as a continued lower level of assignment end. Both strong bill rates and volume increases have continued into the second quarter and provide us a solid foundation to meaningfully accelerate our sequential growth of the first quarter levels.

Job order flow has recently returned to pre-pandemic levels and new assignment activity in the month of March and thus far in April has significantly surpassed levels seen prior to the pandemic. We are also continuing to see higher fill ratios due to improved job order quality as clients are executing against an overall higher mix of critical technology initiatives. We also believe the trends we are experiencing are reflective of growing confidence in restarting projects that may have been deferred or delayed. The scarcity of high-end IT resources and securing resources for new transformative initiatives. We continue to see the acceleration of critical technology initiatives within our clients in areas such as cloud, mobile, data analytics, project and program management, with a strong focus geared towards improving the consumer's digital experience.

The investment we have made in the front-end technology and process over the last several years have matured our capability to efficiently provide these clients with highly diverse top talent at scale in a now boundaryless environment across the U.S. A significant accelerant to our overall technology growth has been the investments we've made in our managed team and solutions capabilities in order to provide higher value, differentiated offerings to our clients. This offering provides a strong complement to our traditional staffing business. We have been experiencing tremendous success bringing this offering to our clients due to the strong long-standing partnerships we have built and our reputation for delivering quality services. We intend on making further investments in this capability throughout 2021 and in the foreseeable future. We feel extremely confident in the positioning of our Technology business and the ability to continue expanding our market share. There remains broad strength in demand across virtually every industry.

We experienced growth sequentially in professional services, insurance and retail industries while nearly all the other key industry sectors experienced modest growth or stability. Financial services, insurance and professional services have shown relative resilience throughout the pandemic and have been significant contributors to our growth on a year-over-year basis.

Given the momentum we have carried into the second quarter, we expect revenues in our Technology business could increase in the mid-to-high teens on a year-over-year basis. This well above-market growth is compounding our success as Technology revenue significantly outperformed the market in the depths of the pandemic, only declining 3% in the second quarter last year. We are clearly continuing to take market share, which we would attribute to our team's execution against the backdrop of an acceleration of overall technology spend.

Our FA Flex revenues were up 26.4% year-over-year on a billing day basis in the first quarter, primarily as a result of the contribution of approximately $24 million of revenue from our support of government-sponsored initiatives tied to the economic fallout and recovery efforts from the COVID-19 pandemic. The COVID revenue stream remains fluid as we expect that revenues could be in the range of $28 million to $33 million in the second quarter.

Our non-COVID FA Flex business was stable sequentially and declined 12% year-over-year on a billing day basis. As we mentioned previously, we began to intensify our efforts to migrate our FA business towards more highly skilled assignments, such as analytics and decision support roles that are less susceptible to the technological change and automation and more synergistic with our technology footprint. We will continue to support lower end skill sets for certain clients where we have long-standing relationships and are strategically important to Kforce's ongoing success of our Technology business. We have seen natural assignment ends of lower skilled FA roles in the first quarter of 2021, where strategic client relationships do not exist and expect that to continue into the second quarter. We expect our non-COVID FA revenues to be up on a year-over-year basis as our repositioning gains traction.

When combined with the midpoint of the range of the COVID revenue, total FA Flex may be up sequentially in mid-single digits, but down slightly year-over-year on a billing day basis due to the expected decline of COVID revenue.

Direct Hire revenues in the first quarter increased nearly 1% sequentially and 5% year-over-year on a billing day basis. Direct Hire remains an important part of our service offering to clients, though, we have not allocated significant investment here due primarily to the sensitivity to economic cycles. We expect Direct Hire revenues may see slight growth sequentially and increase approximately 50% year-over-year in the second quarter as clients demonstrate a high degree of confidence in the recovery through the addition of full-time staff.

We are continuing to invest in strategic initiatives to better position our firm for long-term sustainable profitable growth. Our most recent significant investment in our talent relationship management system, which went fully live in the first quarter. Both our CRM and TRM systems are cloud-based and seamlessly integrate with other Microsoft product offerings, thus providing us significant efficiencies. Our team has also significantly advanced efforts in the evolution of a fully integrated hybrid operating model to enhance the online experience of our internal team and the interaction with our clients, candidates and consultants. The sale of our corporate headquarter building announced last week, positions us to build out a state-of-the-art facility with a smaller real estate footprint, aligned with how work will be performed in the future, deploying a high-tech, high-touch hybrid operating model. These and many other efforts will position us for the continued evolution of an operating model that provides maximum flexibility regardless of what lies ahead.

Productivity metrics continue to improve across our experienced associated base. We are very bullish in our long-term prospects and also began making selective investments to increase the number of associates in our Technology business late last year, so to be able to take advantage of what we believe will be sustained strong growth in the technology staffing market for years to come. Overall capacity currently remains sufficient to support above-market growth rates and should improve due to our continued investments in Technology and greater enablement of communication and collaboration tools and processes that have been so successful for us during this transition to remote work. This allows us the opportunity to continue to invest in growing our resources to address growth beyond 2021.

We have supported and retained our best people, structurally reduced our fixed costs, and are refining a more leverageable model that we expect will result in positive leverage as growth accelerates as we reimagine the future. Our customers and employee satisfaction levels are at an all-time high. We continue to carry the highest Glassdoor rating among our peers and maintain a world-class net promoter score from our clients and consultants, and are the most recognized firm by Technology consultants per SIA. I greatly appreciate the trust our clients, consultants and candidates have placed in Kforce, and I couldn't be prouder of our team's attitude and efforts executing in a fully remote capacity while operating under the circumstances of the past year.

I will now turn the call over to Dave Kelly, Kforce's Chief Financial Officer. Dave?

Thank you, Joe. First quarter revenues of $363.2 million were near the high end of our guidance and the positive trends we are seeing across our business, especially in our Technology business, lead us to provide second quarter guidance that significantly exceeds our previous expectations.

Earnings per share of $0.62 in the first quarter grew 47.6% year-over-year. We are also significantly increasing our EPS expectations for the second quarter due to the strength of our revenue growth.

Our gross profit percentage in the quarter of 27.2% decreased 100 basis points year-over-year primarily as a result of a decrease in overall Flex gross profit margins, which also declined by 100 basis points to 25.2%.

Specific to Technology Flex margins, we experienced a 70-basis-point decline year-over-year. This decline was partially related to spread compression, which is driven by year-over-year growth in some of our largest clients with the margin profile, slightly lower than the average of our Tech business as a whole. I should note that as we grow our business with these lower margin -- gross margin clients, we're able to continue to expand operating margins as the benefits of scale more than offset the lower gross margins. We also experienced higher payroll taxes in Q1 as states began to raise rates and also slightly higher health care costs versus the first quarter last year.

Sequentially, spreads in our Technology business expanded from Q4 as we continue to have success growing our higher-end managed solutions offering.

Flex margins in FA declined 200 basis points year-over-year with our lower-margin COVID project portfolio being the primary contributor to this decline. As we look forward to Q2, we expect spreads in both our technology and FA businesses to be relatively stable. Should we begin to see wage inflation within our consultant population, we are confident in our ability to work with our clients to appropriately align bill rates, so that they can retain these valuable resources. We believe rising wages are a sign of strengthening demand for our Technology resources and is a long-term net positive for our business.

We also continue to experience success in growing our Managed Teams and Solutions business, which carries roughly 400 basis point higher margins than our technology staffing business. We expect this offering to help stabilize overall Technology spreads and over the longer term, create leverage to increase margins and overall profitability.

Flex margins should improve by 150 basis points approximately relative to Q1, principally due to the seasonal alleviation of payroll tax resets that occur in Q1.

Overall SG&A expenses decreased as a percentage of revenue by 210 basis points year-over-year due to operating leverage provided by our revenue growth, significantly improved associate productivity, lower costs in areas such as travel and office expenses and improving credit trends. These reductions are offsetting higher performance-based pay due to our strong results. SG&A expenses as a percentage of revenue in the second quarter will decline from first quarter levels due primarily to the alleviation of payroll tax costs in Q2 and the $2 million gain on sale of our headquarters.

Our first quarter operating margin was 5.4%. We believe the improving quality of our revenue stream, continued productivity improvements, and ongoing lower structural operating costs, will collectively drive continued improvement in profitability levels. Our effective tax rate in the first quarter was 27%.

EBITDA in Q1 was $24.1 million, which represents a 32.1% increase from the first quarter last year. Operating cash flows were $22.4 million in the first quarter. We returned approximately $21 million in capital to our shareholders in the first quarter through $16.2 million in share repurchases and $4.8 million in dividends. We ended the quarter with $1.3 million in no -- in net cash.

As we look forward to the second quarter, there are 2 items I'd like to discuss in some detail that are assumed in our guidance. First, as we announced last week, we entered into an agreement to sell our corporate headquarters facility for $24 million. This transaction is expected to close in mid-May and generate a roughly $2 million pretax gain that will be recorded in SG&A in the second quarter. The agreement includes a leaseback of the building for a period of 18 months. This transaction monetizes an underutilized asset on our balance sheet. While we expect a negative impact to SG&A of roughly $300,000 per quarter during the brief leaseback period due to increased occupancy costs as a tenant, it is expected to provide $1.5 million to $2 million in annual savings thereafter, as we identify a smaller, more technology-enabled footprint in the Tampa Bay Area.

The second discrete item impacting second quarter results is an approximately $2 million charge resulting from the termination of our supplemental Executive Retirement plan, which is expected to be recorded in other expense. Our Compensation Committee and Board of Directors made the decision to terminate this plan and eliminate a component of executive compensation not directly linked to performance. The termination will also reduce P&L volatility and eliminate unnecessary expense given its cost to maintain. In addition to the $2 million charge, our expected effective tax rate in the second quarter of 29.5% reflects the loss of a previously anticipated $750,000 tax benefit related to the SERP. Excluding the tax impact, the SERP charge and gain on sale of the building largely offset each other. Our expected normalized tax rate in Q2, excluding the SERP impact, would have been 26.7%.

The higher levels of revenue we are generating and the unpredictability of our COVID revenue stream leads us to continue providing a broader range in our guidance. Our billing days are 64 days in the second quarter, which is 1 more day than the first quarter and the same number of days as the second quarter of 2020. We expect Q2 revenues to be in the range of $387 million to $397 million and earnings per share to be between $0.87 and $0.95. Gross margins are expected to be between 28.4% and 28.6%, while Flex margins are expected to be between 26.6% and 26.8%. SG&A as a percent of revenue is expected to be between 20.2% and 20.4% and operating margins should be between 7.7% and 8.1%. Weighted average diluted shares outstanding are expected to be approximately 21.4 million for Q2 and as noted, the anticipated effective tax rate is expected to be 29.5%.

Our guidance does not consider the potential negative impact on the demand environment from a significant increase in COVID-19 variant cases, the effect, if any, of charges related to any onetime costs, costs or charges related to any pending tax or legal matters, the impact on revenues of any disruption in government funding or the firm's response towards regulatory, legal or future tax law changes.

Overall, we believe we are in an exceptional place. The strategic decision to focus our business in domestic technology, which is expected to grow organically in Q2 at 15% or greater, positions us for very strong overall revenue growth in Q2 and the foreseeable future. As our revenue mix evolves, we expect COVID-related revenues to decline through Q3 and Q4 and to reach minimal levels by the end of the year. We expect to enter 2022 with 85% of our revenues, focused in Technology, which permeates every aspect of business and society, and an FA business that is directly focused on complementing those technology efforts.

Our shareholders continue to benefit from strong performance and efficient capital allocation as exhibited by a return on invested capital in excess of 30%. Our predictable cash flows, supplemented by the proceeds from our building sale provides significant future flexibility to continue making investments in our business and remain active repurchasing our stock at current levels.

On behalf of our entire management team, I'd like to extend a sincere thank you to our teams for their efforts in outperforming market expectations through the adversity of 2020 and continue to build on that success in 2021.

Operator, we'd now like to open up the call for questions.

(Operator Instructions) And our first question comes from Mark Marcon from Baird.

It's Mark Marcon. First of all, congratulations on the strong progress that you're exhibiting. I'm wondering if you can talk a little bit more on the Tech Flex side. It's apparent across the board that the economy is improving, and that the market is growing and that the secular trends in terms of digital technology are continuing to gain steam. But what I'm wondering about is Joe and Dave, you both made comments with regards to share gains. And I'm wondering if you could elaborate a little bit there in terms of where are you seeing the share gains, how pronounced are they? Is it geographic? Is it by vertical? Relative to who do you think you're gaining share? How should we think about that going forward? How sustainable is it?

Yes, Mark, this is Joe. Very good question. I would say from a broad standpoint, the reference to share gain is really just benchmarking ourselves at a high level against what SIA is saying is taking place in staffing as a whole in terms of growth. So I think it's important to note that what we're seeing specific to clients that we're involved with is we are continuing to see vendor consolidation. And knock on wood, fortunate to this point in time, we've had very good outcomes when going through vendor consolidation and our opportunity to be a winner on that front and actually pick up more share associated with that. I could kind of give you one example. Large client had about probably about 8 or 9 vendors working on engagement that had roughly about 100 consultants on that engagement. They wanted to consolidate it down into one vendor. We won that assignment. We actually had about 50% of that share at that point in time, and now we have 100% of the share. So we see that going on broad-based within clients. So I'd say it's really -- it's client-specific where we're doing business, and then it's the overall market.

Great. And then can you talk about the uniformity this from a regional perspective in terms of the growth that you're seeing? I mean, you're talking about high mid-teens, mid-to-high teens in terms of Q2 growth. Is that across the board? Or are there any specific drivers to that as it -- as it looks -- as we look at Tech Flex?

I would say the market as a whole -- what we saw in the beginning of the year is we saw our enterprise clients come screaming right out of the blocks in terms of ramping up their hiring for critical project initiatives that they were looking to get after, part of why we referenced that we saw a little bit more growth in our enterprise clients versus what we call our market-based clients in Q1. I will tell you we've entered the early part here of Q2. It's much more balanced.

We're seeing gross broad-based. So we've really seen it across our top 5 industries, with 4 or 5 of those being in the double digits. And we're seeing it across all geographies. So pretty much, it's broad based, large companies, small companies, medium-sized companies, I mean, Technology. The impact, kind of the best example that I could give on the imperative for organizations to adjust from a digital standpoint is if we look at online retailing and the impact of those that weren't prepared for online retailing when the pandemic hit.

Online retailing was growing at about 1%, grabbing about 1% market share since the early days of dot com. In the first 8 weeks of the pandemic, online retailing captured close to 10% additional spend. So that's just one example in one industry that's happening, but that's happening within all sectors and all industries. So we're very confident in terms of what the ongoing prospects are. So it's not a single client. It's not a single vertical. It's not a single region. It's basically broad-based.

Great. And then can you talk a little bit -- just staying on revenue, can we talk about F&A and the special COVID projects that you're doing. You gave the guidance here for the second quarter with regards to the anticipated spend, that's well ahead of what we were previously anticipating. How do you think the balance of the year is going to go? And what caused your change in terms of guidance for the second quarter in terms of the projected spend? You had previously been conservative in terms of assuming it was going to fall off.

Yes. Mark, this is Dave Kelly. Yes, you're right. We've been talking about that last quarter that we thought things would drop off and excited actually because it continues to give us an opportunity to invest in the business, so that we can make those things -- make those investments that we think are going to help us in the long term, especially with respect to our Tech business, which we still think is going to be exiting this year about 85% of total revenues.

But basically, what happened is we've talked about the strategic partners that have come to us and asked for us to participate with them. We actually had another project, government request with one of these partners. And as a result, we had a little bit stronger growth in the second quarter than we had anticipated.

And a matter of fact, as we look forward into the third quarter, I think I'd indicated, second quarter, we think, $30-ish million in revenue in the second quarter, probably about those levels now in the third quarter. Pretty unpredictable business, I still would say, are still -- our planning assumptions here are that it will tail off and be relatively minimal at the end of the year, but we will get a little bit revenue lift for both in the second quarter and in the third quarter.

So for us, it's been a great bridge. And as I said, it's been a great opportunity for us to take advantage of and invest further in our core business, in particular Technology.

Great. And then can you just talk about the margin implications here with regards to you're guiding to a nice improvement with regards to the EBIT margins here for Q2. And obviously, that's complemented by some of the government business, the COVID business that's coming in. But how should we think with the divestiture of the corporate headquarters with moving to more online work. What are the long term implications? How should we think about the metrics that you've historically given us from a revenue and margin perspective and the targets?

Sure. Yes, no problem, Mark. Good question. So we had said last quarter -- we provided some updated guidance as to what we thought operating margins would be at certain revenue levels, have not changed those expectations. Certainly, when we were talking about that, it was not with the expectation that some of this COVID revenue, which frankly, is a little bit lower margin than the rest of the business, and we're doing it, because we think it's the right thing to do, would impact us. So as we look into the second quarter, certainly, that's having a slight operating margin impact as it is Flex margin impact. The corporate headquarters that I'd mentioned, we are going to be leasing that back for 1.5 years. It will cost us about $300,000 incrementally, because, again, obviously, as a tenant versus being an owner, there are costs, but we still expect that we're going to save $1.5 million, $2 million a year for the foreseeable future and also give our people a very exciting new space to take advantage of the hybrid model that we've been really focused on.

So it is really a great opportunity, we think, for us there. So I would say all in all, haven't changed our expectation as we grow operating margins, we still expect to improve at the levels we had said before, approaching 8%, certainly as we get past the $400 million market, more pure technology in our core F&A business. So really haven't changed our posture, but just trying to try to manage through this environment and take advantage, frankly, of some of this COVID revenue to even better prepare ourselves for the future.

And our next question comes from Tim Mulrooney from William Blair.

Okay. You can hear me okay. All right. So I just want to stick on that for a second. I mean, I appreciate all the color you guys gave for the second quarter, but noticed you didn't update full year guide that you gave last quarter. Are you still comfortable with that annual guidance range you gave previously? Or is that just no longer relevant given how -- I mean I think you said in your prepared remarks, even things are coming in better than you expected?

Yes. Tim, yes, this is Dave Kelly. I guess a couple of things. So just the primary reason we wanted to make sure we provided some perspective was to share with you how the business post-COVID was going to change and still feel that, frankly, our technology footprint with the pace that it's growing, right, 15% or more in the second quarter is certainly going to eclipse some of the thought process that we had. And so yes, overall, obviously, the revenue trends that we're seeing and the bottom line trends that we're seeing are positive. But we didn't expect that we would look at that and say, we're going to provide an update to that. But clearly, here, things are going quite a bit better, both from a top line and bottom line perspective than we had thought. Our Tech business growing certainly at a much stronger clip than we had expected. And frankly, we provided that. As I said, it's really a courtesy to make sure you understood how the business was going to change, rather than giving you guidance for the full year.

Yes. No, I appreciate that. I figured that was the case, but just wanted to clarify that for anyone that was not sure. So appreciate that.

Sure.

On -- let's see what else. Yes. So one of your competitors, they recently talked about having a layer some costs back into the business over the coming quarters in anticipation of hiring more folks ahead of the strong demand for IT staffing. This may somewhat limit margin expansion on their side of their tech business for a little while. Should we expect a similar dynamic with your company and maybe temper expectations around Tech Flex margins a little bit over the next several quarters?

Yes, Tim, this is Joe. You asked that question in 2 different ways, and I want to make sure I give you the right answer. Because part of it, you were talking about the Tech Flex margins and then with layer in head count, really ripples to operating margins. So are you looking for more around the operating margins?

I am looking specifically for operating margin. Sorry to confuse things.

Yes. I just want to make sure I answered your question appropriately. Yes. I guess for starters, and David mentioned this, we're committed to the operating margin targets that we've put out there. Irrespective of what we experience and what changes go about. As we all know, as everybody comes out of the pandemic, a lot of expenses have come out of the P&L, other certain expenses have gone into the P&L. As we come out of this, that's going to move around. Certainly, those expenses. You're going to have more travel expense come in. You're obviously going to have more headcount, wage expense is going to come in as you start to ramp up headcount. And that's going to be offset in other areas with things like what we're doing from a real estate footprint and various other things, leveraging technology for productivity improvement. As I mentioned, we just completed the final rollout of our overall dynamics platform for our front office. We have high expectations in terms of productivity gains on that front.

So as I mentioned on the call last quarter, our intent here, as we move through 2021 is we will be incrementally adding to headcount where productivity levels and capacity warrant that, so that we can continue to fuel the business beyond 2021 into the future. As I mentioned in my opening comments, we're also continuing to add headcount into our Managed Teams and Solutions area, which is outpacing even our overall Technology growth. That's been a big contributor to that growth. So -- but all of those things are built into -- we are going to obtain and hit the operating margin targets that we put into the marketplace.

Okay. Okay. Maybe sticking on that Managed Services since you mentioned it. I know this is an important growth driver for you. But if I just step back and think about how that's evolved over the last -- maybe last 12 to 18 months. I mean, was that -- how did that perform during the pandemic? Was there disruption to that type of work? Or did it hold up better than you had expected, the Managed Services work? And then are you seeing an acceleration in this type of work as we emerge from the pandemic?

Yes. I would say, I would start with probably a broader answer to that question, which is our Technology business was down 3% at the trough of the pandemic. I mean if you compare that to other sectors within staffing and then going back into the financial crisis, our business was down, I think it was 6.5%. So there's no question, Technology isn't the cyclical play that it used to be back when I got into this business 33 years ago. There is a secular shift that has taken place. I mean you can't do anything without touching Technology at this point in time. And with everything going more consumer facing.

So our business in Managed Teams and Solutions performed well, just as the overall Technology business did during the pandemic. I would say one of the things that we did experience that we did not anticipate, realizing most of that work is really teams of people. We thought it would be a little bit more complex to be able to staff and manage that work in a remote environment. Actually, we found it to be very seamless. In fact, some of our clients saw productivity gains on the teams that were being put in and installed in remote versus even when we had those teams fully physical. So that business performed well during the downside of the pandemic. It outperformed the overall Technology business. So it was actually up on a year-over-year and sequential basis throughout the pandemic, and it's continued to perform.

We are seeing clients engage more on that type of work, really because what they're looking for are the right partners that can take on a little bit more responsibility. They're lean from a staff standpoint. So any leverage that they can get from additional leadership on their teams as well as to offload on certain engagements, so that they have the bandwidth to be able to take care of the overall increase of projects that are coming their way, has really demonstrated -- I would say, we've seen more engagements coming in here in the last quarter than what we were seeing on the back end of the year. So it's accelerating as overall technology spend is accelerating. It's a great value relative to solutions providers and everybody is looking at how to best manage their overall SG&A line items. There's a -- all the momentum is in the right places for that business to continue to prosper.

Okay. I appreciate all the color there. Congrats on a great quarter.

And our next question comes from Josh Vogel from Sidoti.

First question, obviously, seeing strong reception in the marketplace in Managed Teams, Managed Services and Solutions practice. I was curious, is there an opportunity to roll out this offering to FA clients, especially to continue to migrate FA towards higher end assets that are more close signed with your Tech wins?

Yes. David kind of touched upon that a little bit in his opening remarks. It's really one of many drivers of our migration of our traditional FA footprint, really into those type of skill sets that fit much more closely with what we're bringing to the market from a Technology standpoint. So that absolutely is directionally where we're headed. And we believe we've engaged already on certain types of projects where those 2 blend together. We view that, that is a great opportunistic space to leverage what our historic core competencies are, both from the FA standpoint as well as Technology and bring those together from a Managed Teams and Solutions standpoint, especially when you look at all the momentum in and around the data-driven type projects, which have a technology component. They have a decision support type component and around analyzing the data, so it fits really well. So yes, you are spot on.

Okay. Great. And I apologize because I was bouncing back and forth between a couple of calls, although I did miss some of the prepared remarks. As this business matures more, I'm just curious, is there a material difference in the margin profile or profitability versus traditional Flex work?

Yes. I think -- yes, go ahead, Joe.

No, go ahead, Dave.

Yes, I was going to say -- and we had mentioned this, as Josh, to your point. So we've seen -- and this is a great complement to our Technology business. But what we're seeing right now, margins in this business are about 400 basis points, gross margins, I should say, are about 400 basis points higher in this business, this Managed Services -- Managed Teams business than in the rest of our technology business. And so that's certainly one of the reasons why we've got a fair amount of confidence that our margins are going to be pretty stable as we move forward, even as we grow business with some of the larger clients. So it's a wonderful complement to the business, both in terms of meeting client needs as well as bringing stability and greater opportunity in maintaining our margin profile.

All right. Great. It sounds like I missed all the juicy details in your prepared remarks, sorry about that, which actually kind of leads into my next question because I know you did discuss it, but can you just tell me what the expected COVID contribution is for Q2 and the balance of the year?

Yes, sure, sure. No problem, no problem, Josh. So as we had indicated, we had actually a pretty good Q1, certainly, and our Q2 expectations have been raised as a result. I think we've indicated between $28 million and $33 million, so roughly $30-ish million in the second quarter. Part of that is the result of a new project and one of our partners came to us and ask that we assist in. So as we look forward to the third quarter, those revenue levels, we think, will sustain, I still think that they'll tail off near the end of the year and that revenues only minimal from that business as we go into '22.

Okay. Yes, that kind of led into my next question because it does seem like COVID is around to stay, whether it becomes the new flu and we potentially see yearly or biannual vaccination schedules. And I was just curious, do you think there's an element of these government-sponsored initiatives that could long-term or permit?

Yes. Again, I think we continue to see this as pretty fluid, pretty volatile. And clearly, the circumstances surrounding the country are a big driver -- certainly a driver to the new opportunity that we have. So hard for us to predict. I think we can plan with an expectation that it isn't here, and we're going to take advantage if it is here for us.

Yes, and I would add Josh, this is Joe. I would add on to that, just so that it's crystal clear. The businesses has come our way here through long-standing relationships. So we've supported this business really for 2 main reasons. One in support of our partners, who have depended upon us in the past. 2, given the nature of what the overall U.S. economy was going through and the impact of people is the right thing to do, because we had a capability to staff these engagements at scale, which few have the capability. So it was morally the right thing to do. This is not business that we are pursuing from a long-term standpoint. We're -- it's for those really 2 drivers. As Dave had mentioned, we're 85% Technology as we exit, we've migrated our FA footprint upstream to align much more closely with our Technology footprint. That is the future of Kforce. It is not in this space. I just want to make sure we're crystal clear on that.

Yes, totally understood. And lastly, a lot of talk on supply constraints, especially scarcity of high end IT resources to higher level, what are you seeing today? And what's being done on your end to improve candidate engagement to meet current and potential order flow and/or take share?

It's a great question. I mean it really never slowed down. I would say it dulled a little bit during the thick of the pandemic, because everybody was trying to reset and figure out. We -- our delivery transformation initiative, which we've been after for the better part of 3 years now, which our TRM is a subcomponent of that overall strategy, has been an area that we've made great investments.

We have a lot of innovation going on. So we're still -- we're after technology tools to improve our people's capability to access candidates quickly and move them through the process efficiently, and we're going to continue to make investments from that front, no different than what we announced a while back with our relationship with Work Lama from our Kforce Connect, which is our referral platform as well as many other technologies that we're starting to deploy that they have in their suite of services.

All coupled with, I think the best measurement that's out there is what our NPS scores are telling us. And we continue to have world-class from a client and consultant standpoint. So we're going to continue to invest in technology to drive performance and give our people a competitive edge on ultimately being able to access candidates more rapidly than anybody else in the marketplace. But it is a war out there for talent.

And our next question comes from Tobey Sommer from Truist Securities.

This is Jasper Bibb on for Tobey. I wanted to circle back to your comments on capacity during prepared remarks. How are you thinking about growing recruiter headcount versus revenue going forward given the productivity gains you're seeing there?

Yes. It's a good question. I would say for starters, we have capacity to do more across all of our 10-year groups. So we're very comfortable in terms of where we are. We think we're in a great spot from a capacity standpoint. Mainly driven by some of the things that we just spoke about because of all the technology enablement investments. We spent a lot of time also looking at enhancing our overall processes.

And the -- really the ongoing strengthening of our culture. I believe our culture has become stronger through these trying times, which is just -- and I can't tell you how proud I am with our teams in terms of what they've demonstrated in terms of teamwork, working across the country because one of the things we also have to realize is the world has changed drastically in terms of how you source and identify candidates for the end client.

You're no longer constrained by geographical boundaries. That also provides productivity opportunities for our people to leverage candidates that are willing to go out of market and work with our teams across the country. So all those things play in our productivity. I mean, pre-pandemic, we were successfully driving 10% productivity gain with our technology associates, and that has picked right back up where it left off.

So from a hiring standpoint, the hiring that we're doing here in 2021 is not going to impact 2021. That is really the fuel of 2021 forward. So we feel very comfortable with where we are in terms of capacity currently to support the business and then what we're doing to continually support the business on an ongoing basis.

Yes, I would -- well, I was just going to add to Joe's comments. So he talked about the technology investments, and we're in a really great place to be able to do that, right? So we, as a firm, we generate a lot of cash. We think the right thing to do is invest in the future of the business. We're sitting here and as we move into the second quarter, we've had additional cash, right? We're going to sell the building. We're going to generate proceeds, we're going to generate significant cash to invest in the business and think about ways that benefit shareholders best, right, in deploying that capital, inclusive of thinking about our stock. So I think, frankly, can't be in a much better place from the ability to invest in this business.

Thanks for that. Last question for me. I was hoping you could comment on the perm business. And should we expect the company to, I guess, fully participate in a full rebound in that market given that you have, I guess, strategically shifted more resources towards temp and Tech in recent years?

I would say -- and again, I touched upon this a little bit in my opening comments, we expect that business to perform pretty comparable on a sequential basis, obviously, drives year-over-year up substantially given the big impact on the full-time hiring was in Q2 of last year. It's a very important part of the service offerings that we bring to our clients. From a tech standpoint, realizing 85% of our revenue stream exiting this year will be Technology focused. We service that business in a blended model. So it's not dedicated Direct Hire permanent placement teams within our tech offering, then that's so that our people can provide the right employment opportunity for the candidate as well as service that client-based upon what their need is there.

So we view that, yes, we will participate. But unlike some of our competitors that might be out there that have very dedicated practices in and around this. We view it as an integrated component of our overall, especially on the technology side, the offerings that we're bringing to the clients. So many of our clients in today's day and age, they really look at bringing on resources with conversion opportunities, which, again, I think I've stated this multiple times.

I don't think there's a higher acknowledgment of us doing a good job for our clients and the candidates, and we put somebody on an engagement from a contracting standpoint and then that turns into a full-time. So a lot that is not really seen because many of those, when they convert, do not have fees associated with them. But -- and they ultimately are a full-time hire, and that is a reasonable percentage of our population end up converting into full-time opportunity.

So that's an indirect way that we're participating in that overall permanent market. But we prefer to go this route. Having grown up in this business, starting as a search consultant 33 years ago, and then being on the Flex side of the business and then running operations, there is no question that a blended model of this nature is much more client-centric and candidate centric than when you partition these 2 types of offerings in the marketplace.

And I am showing no further questions. I would now like to turn the call back to David Dunkel, Chairman and CEO, for closing remarks.

Thank you, Justin. I appreciate it. Well, let me just say thank you for all of your interest and support for Kforce. As we continue to persevere during these unprecedented times, I especially want to say thank you to each and every member of our field and corporate teams, just an extraordinary effort in very difficult circumstances. And also to our consultants and our clients, and thank you for your trust in Kforce and allowing us to partner with you and allowing us the privilege of serving you. We delivered another quarter of exceptional results, and are very excited about how we're beginning 2021. We look forward to speaking with you again at the end of the second quarter. Thank you very much.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.