Kforce Inc (KFRC) 2004 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2004 Kforce earnings conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to your host for today's call, Mr. Michael Blackman, Vice President of Investor Relations. Please proceed, sir.

Thank you. Good morning and welcome to the call. Certain of the above statements in this call are forward-looking statements that involve a number of risks and uncertainties. Such forward-looking statements are within the meaning of terms 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934 as amended. Factors that could cause actual results to differ materially include the following -- business conditions and growth in the staffing industry and general economy; competitive factors; risks due to ship send market demand, including without limitation shifts in demand for our Health and Life Sciences, finance and accounting, and information technology groups, as well as for the market; research and flexible staffing assignments in general, or the ability of the Company to complete acquisitions and the risk factors listed from time to time in the Company's reports filed with the SEC, as well as the assumptions regarding the foregoing. In particular, any statement related to Kforce's expected revenue or earnings or Kforce being well-positioned for future profitability and growth are forward-looking statements. The words should, believe, estimate, expect, intend, anticipate, foresee, plan and other similar expressions and variations thereof identify certain forward-looking statements which speak only as of the dates in which they are made. Additionally any statements related to the future improved performance and estimates of revenue and earnings per share are forward-looking statements. The Company undertakes no obligations to publicly update or revise any forward-looking statements. As a result, such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those indicated in these forward-looking statements as a result of the various risk factors. Listeners are cautioned not to place undue reliance these forward-looking statements.

I would now like to turn the call over to Derrell Hunter, our CFO.

Thank you, Michael. I will discuss our financial results and guidance for the third quarter, and then Bill Sanders and David Dunkel will provide insight and comments. As you know, you can find additional information about Kforce in our 10-Q, 10-K and 8-K filings with the SEC.

This morning's press release is posted on our Web site, www.Kforce.com. Our press release contains a summary of operations including selected cash flow and balance sheet information for the quarters ended June 30, 2004; March 31, 2004 and June 30, 2003, as well as supplemental pages of key statistical data about each of our business units for those same quarters.

Total revenue for the second quarter of 2002, which includes 18 billion days of revenue from the Hall Kinion and OnStaff businesses acquired, was $152.2 million, a sequential improvement of 16.9 percent from the 130.2 million in Q1 and a year-over-year increase of 23.5 percent compared to the 123.2 million in the prior year's second quarter. Since the acquired businesses have been integrated, their revenues are not separately disclosed. However, for this short postmerger portion of Q2, we estimate the revenue contribution related to the acquired businesses to be in the range of $9 to $11 million. This would then suggest that sequential revenue growth for the prior Kforce alone business was approximately 9 percent and year-over-year growth was approximately 15 percent.

Excluding the estimated revenues from the acquired businesses, Kforce's technology Flex grew sequentially by 8 percent, and FA Flex grew by 12 percent with year-over-year increases of 16 percent and 29 percent respectively. HLS Flex revenues, which were not impacted by the merger, grew by 7.8 percent sequentially and 4.6 percent year-over-year. Sequential and year-over-year increases in billable hours and quarter-end billable Flex consultants on assignment were also very positive.

Search revenues, which were only minimally impacted by the acquisition, increased 18.2 percent sequentially and 23.9 percent year-over-year. Both the number of permanent placements and the average placement fee were up. Total gross profit improved to 31.1 percent from 29.7 percent in the first quarter. We are particularly encouraged that Flex gross profit increased in the second quarter to 26.3 percent, a 140 basis point improvement over Q1 and down only 50 basis points year-over-year.

Our technology Flex business had the largest improvement, moving up 170 basis points from 23.1 percent in Q1 to 24.8 percent in Q2. After isolating an estimated 100 basis points of Flex gross profit improvement related to the expected reduced effects of payroll taxes from Q1 to Q2, the overall Flex gross margin improved sequentially about 40 basis points, and technology improved by 70 basis points.

SG&A expenses were 29.8 percent of revenues in Q2, up from 28.4 percent in Q1 and down from 29.9 percent in the prior year. Depreciation and amortization were also up slightly. Expenses in Q2 included non-recurring integration expenses, transaction-related charges, and temporarily duplicate expenses related to the acquisition, as well as the non-cash charge related to an economically beneficial sublease of one of our field offices.

We believe that most, but not all, of the duplicate costs in acquisition-related costs are now behind us. Our operating structure is efficient. We believe this structure and our discipline will allow us to realize in excess of the cost synergies anticipated from the transaction and will cause the SG&A percentage to decline as those synergies are realized and revenues grow.

Net income for this quarter was $251,000 or 1 cent per share compared to $1,067,000 or 3 cents per share for the first quarter and 686,000 or 2 cents per share for the prior year. We are pleased that the firm was able to remain profitable for the quarter even with the non-recurring negative impacts on operating costs.

The firm issued approximately 5.7 million shares with evaluation of $51 million to former Hall Kinion shareholders and incurred cash transaction costs at or near closing of approximately 13.2 million. The accounting for the acquisition is substantially complete, although the independent appraisal of identifiable intangibles is pending and we will consider that and any other information which might warrant further adjustment to the purchase price allocation year-end. Goodwill from the acquisition will be initially recorded at slightly less than $70 million. This is, however, exclusive of potential reductions in goodwill of up to approximately $23 million from the future reversal of the valuation reserve on the acquired deferred tax asset. This deferred tax asset relates to the estimated future tax benefit of Hall Kinion's approximately $30 million of federal net operating loss carryforwards, aggregate state NOLs of approximately 35 million, and future tax deductions. The acquired company NOLs, which are limited to a maximum tax return usage of less than $3 million per year, can be combined with Kforce's $38 million federal NOL and $58 million of state NOLs to eliminate cash taxes on around $70 million of future pretax income.

As discussed in previous quarters, Kforce also has had a valuation reserve on its deferred tax asset, which is $21.5 million at June 30. The firm will continually assess the need for these reserves. If we continue to be profitable as currently expected, some or all of the valuation reserves may be reversed in the fourth quarter of this year. While the reversal of the reserve on the acquired deferred tax asset would be recorded as a reduction to goodwill, any reversal of the reserve related to the Kforce asset would result in an income tax benefit, an increase to net income.

Cash of 10.2 million at the end of Q1 had declined prior to the merger closing because of the second-quarter growth in Kforce's business. Therefore, we utilized available borrowing capacity under our $100 million line of credit to pay transaction costs and to pay off Hall Kinion's debt of approximately 10.6 million. As a result, our debt balance was $40.6 million at the end of the quarter, up from the 22 million balance outstanding for several quarters. Additional borrowing capacity is currently over $20 million.

Gross receivables, which provide the basis for the firm's borrowing capacity, exceeded $100 million at quarter-end. DSOs remain strong at 42 days, even with the effects of acquiring approximately $18 million in receivables. Kforce's balance sheet is healthy, with current assets exceeding current liabilities by over $40 million, and even with the effects of the merger, EBITDA, an indication of cash flow, remained positive at $2 million in Q2.

We continue to expect the merger to be net accretive to EPS in the third quarter, even though there will be some minimal integration-related expenses impacting that quarter. We affirm our previously provided guidance that revenue for Q3 may be in the range of $170 to $180 million and EPS may be between 9 and 15 cents. We believe this guidance continues to be appropriate at this time. Although if current trends were to continue, we believe it is more likely that revenues and EPS may be at the upper end of the ranges.

Thank you very much for your attention and your continued interest in Kforce. Bill?

Thank you, Derrell. We are pleased with our broadbased growth during the second quarter. The estimated increase of total revenues before considering the acquisition for the technology group of 8 percent, FA by 12 percent and HLS of 7.9 percent sequentially is strong. We are very pleased to see this performance, which is among the highest in the professional staffing industry and that the distraction to all our sales associates of the acquisition was kept to a minimum. We now operate for more than 80 offices with 9000 consultants, serving more than 3000 clients.

On a billing day basis, Flex revenue in April and May continued to improve the March pace with accelerated growth in June. July Flex revenue is continuing at the improved post-merger June rate. This is particularly noteworthy as historically we see declines at the beginning of each quarter.

Additionally strong Search revenues did not have the usual significant decline in the first three weeks of July as in prior quarters.

Total revenue for technology, which is our largest business unit comprising more than 46 percent of revenues, increased sequentially 17.6 percent for the quarter or an estimated 8 percent without the acquisition. Technology Flex revenue is up sequentially for the fifth straight quarter. Technology Search was up 23.3 percent with only nominal acquired Search revenues, but remains volatile month-to-month with limited visibility. Gross billable hours were up sequentially with Flex margins increased from 23.1 to 24.8 percent.

We expect technology revenues to continue to improve for the third quarter. The legacy HK technology footprint includes approximately $4 to $5 million of revenues per quarter, which do not meet our profitability requirements. These low profit activities will be restructured or discontinued in the third and fourth quarter.

The performance of our finance and accounting business unit improved during the second quarter. Finance and accounting Flex was strong with 26.7 percent sequential growth or 12 percent before the acquisition, and Search grew almost 17 percent. Gross billable hours were up 32.4 percent, and Flex margins improved by 30 basis points.

The demand drivers for our FA business remain strong. Sarbanes-Oxley work is approximately 10 percent of FA revenues, and we believe the Sarbanes-Oxley work will be sustained the remainder the year. The Kforce OnStaff group will continue to grow and has recently won a major contract with a World Bank that will continue their diversification away from interest-sensitive clients.

Lastly is the Health and Life Sciences business unit, which represents 26 percent of revenues. Clinical research staffing or CRS, which we formally call pharmaceutical, now is 36 percent of the HLS segment. We changed the name of this business unit to reflect the services that this team delivers, which is providing staffing solutions to the clinical research areas of the FDA approval process to pharm, bio-pharm and medical device clients to include clinical research analysts, clinical monitors, drug safety, data management and clinical programming. CRS is a highly project based business.

Flex revenue was flat from Q1 to Q2 due to the timing of a large project end. We have recently been awarded a major exclusive project with a very large pharma company. As this project ramps late in the third quarter and along with the effect of two other large projects wins, we project that CRS sequential Flex revenue in Q3 to be flat and to have significant growth in Q4. These large projects and volume clients will have an adverse effect on GP percentage. However, we will recover this with a significant increase in GP dollar growth as we grow Kforce consultant headcount in the fourth quarter and in 2005.

The scientific staffing group showed both sequential and year-over-year Flex revenue growth for the first time since Q1 2002. This is a positive sign that the scientific and lab professionals' demands are firming. However, we are cautiously optimistic. Scientists and lab professional employment is initiating its recovery from the highest historical unemployment rate which occurred in 2003 for the 2003 American Chemist Society Employment Survey. Thus, growth may be choppy here at first.

Scientific Flex revenue should be stable in Q3 after the explosive growth in Q2. Healthcare nonnursing, which is the health information management group, provides medical record staffing solutions to include medical coders and cancer registry professionals to hospitals, GPOs and clinics. They had the highest Flex revenues sequential growth in the firm for Q2, which was 18.6 percent.

HIM (ph) experienced both sequential and year-over-year growth for the first time since Q4 of '01. The demand is steady and promising. HIM Flex revenue is projected to grow sequentially in the third quarter. Healthcare nursing had its second consecutive up quarter with Flex revenues up 5.5 percent sequentially. We continue to focus our nursing business towards longer-term contract assignments with placements of RNs to primary healthcare facilities. We believe we're making progress in repositioning this business and in the utilization of international nursing and continue to believe in the long-term dynamics of nurse staffing.

The summer season is historically weak, and we expect third-quarter revenues to be stable. As we look forward, we are continuing our emphasis on acquiring and retaining great people. We continue the hiring and training of field management and sales associates in order to have the team with the most talent in the industry. The current emphasis of our business model is on growing our Search capacity and expertise and innovating the OnStaff service offerings across our office network. We are making excellent progress in both areas. Our field operating model is shifting to more emphasis on our strong heritage, which is recruitment and delivery. As the war for talent begins, we are prepared to bring great people to our clients.

The integration of our field teams has been excellent. The day of closing of the transaction and throughout that first week we brought together in Tampa all Kforce and Hall Kinion and OnStaff field management and all Hall Kinion and OnStaff field associates. By the end of the week, each person knew which team they were on, the team leadership, the individual roles and responsibilities, their compensation, the rules of engagement with clients and candidates, and how to succeed in the Kforce culture. It was a great welcome aboard week.

As of today, we are essentially complete with all of our colocations of offices and a technology refresh of those offices not colocating. We have had a few voluntary terminations. In general, we have quickly responded to issues that arose and are being very efficient and effective in obtaining our integration objectives. While we are addressing a few lingering issues, it is fair to say the integration is substantially complete and we are one team.

In summary, revenues continued to improve. We believe we have a very talented team that has integrated the acquisition and expanded our business model and that our market penetration and service offerings have been enhanced and will provide the anticipated growth trends. We look forward confidently to a bright second half of 2004 and achieving our quest for 2005.

And now to David Dunkel, our CEO.

Thank you. I will just make a few brief comments. During the second quarter, the staffing recovery continued to build momentum and to broaden, and it appears that we are entering a period of accelerating growth within the labor markets. We expect Kforce will benefit from this growth, and it is very gratifying to see the fruits of our efforts manifested in the performance of each of our business units. We have worked hard to develop a diversified platform of services for sustained growth and profitability, and while we were certainly not finished, we have made great progress.

Having finally closed the Hall Kinion transaction, we were able to action our integration plans and get a sense for the opportunities ahead for the combined firms. The integration has gone well thus far, and we are very pleased with how our people have come together quickly to form a team. Looking forward we expect increased utilization of Flexible Staffing across all of our service lines, as well as an increased demand for our Search Services, particularly in FA and IT. While the third quarter is typically a slower quarter for Search due to summer vacations, we are optimistic about our Search business as we move into the fourth quarter and 2005. Search has now been up for the past three consecutive quarters after 11 down quarters.

Shortages of skilled professionals in FA and IT are now on the horizon, and we're making adjustments to our delivery model to address it. With the increased demand, we're beginning to see an improved pricing environment. However, we are coming out of an economic slowdown with a relatively low 3 percent unemployment rate among college-educated where we focus.

The competitive climate has changed in that there are now far fewer firms with national platforms focused exclusively on staffing. Kforce is one of the few pure-play professional staffing firms with a national footprint and the ability to serve customers across diverse segments offering both permanent and Flexible Staffing. Kforce does, indeed, offer unique value proposition to our customers, and we believe Kforce is well-positioned going forward.

We are focusing on achieving our vision and are executing well. While the market remains highly competitive, we're confident in our ability to execute and deliver the right match through exceptional service for our customers.

In staffing there is no cope formula, there is no proprietary software that gives one firm an advantage over another. Our culture of exceptional service and disciplined process delivering the right match is our differentiator in the marketplace. And the result is great people delivering great results for our customers.

Once again, our thanks to all of the Kforce associates. You kept delivering exceptional service to our customers as we went through the integration process, and also our thanks to our consultants and customers. Operator, we will open up the call to questions.

(OPERATOR INSTRUCTIONS). John Mahoney, Raymond James.

Good quarter, guys. Can you give me some feel for where the Flex gross margin will be going next quarter? Should we see continued improvement? Is that possible?

John, this is Bill. We have a number of mix issues. Certainly from a Flex standpoint, Hall Kinion Legacy group brings a lower GP percentage to the table, and therefore, a full complement or full quarter of those revenues will certainly have some dampening effect upon our gross profit percentage.

At the same time, we are experiencing some uptick, and so there will be some offset to that. But generally speaking, I would not count on an increase in the GP percentage.

Because the Hall Kinion carries a slightly lower one?

Yes.

Okay. Can you give us some dollar amount or range as to what the onetime costs were? How about the leads, start there?

The leads? Yes, we had estimated on the leads that we would have approximately $800,000 hit in Q2, and the number came in just slightly less than that. A portion of it is in SG&A, about 570,000, and a portion of it, which is the unamortized portion of leasehold improvement and some fixtures and furniture that we wrote off, is in the depreciation and amortization line. That is about 215,000. So the total is about 780 compared to the 800 we estimated. It came through just as we expected.

Let me go at the SG&A a different way. Last quarter Q1 SG&A was 27.9 percent of revenues. This quarter it was 29.8. Would SG&A as a percentage of revenues, will it be the down? When will you get back to that sub 28 percent range? Next quarter? What would it have been this quarter I guess?

We believe that in Q3 we can indefinitely make a major step in driving that percentage back toward the mid-20s. You know the lowest I believe that we have been is in December when we were in that 27 percent range I believe -- 27.3 in the fourth quarter. We were actually at 28.4 in Q1. So somewhere in the midst of those kind of numbers is certainly our direction and our belief that we can drive the GP percentage -- I mean the SG&A percentage, John, and I think we will make a major step in that regard in Q3.

The organic growth in the quarter sequentially, excluding Hall Kinion as you mentioned, was roughly 9 percent. The 170 -- at 175 million at the midpoint of the range, I think that assumes like 2 percent sequential growth on an organic basis. Does that speak to the conservative nature of the guidance because you mentioned you could be at the higher end? I guess the high-end would assume about 5 percent organic growth.

Yes, I think you're reading it correct, John. Certainly we don't have a trend and we don't have a full quarter behind us, and so to maintain credibility, we are staying on the conservative end when we are putting out this range. Therefore, if there was overall sequential growth, you are probably modeling it fairly correctly.

Okay. I guess the economy has not shown any signs or your headcount has not really softened such that you see a dramatic drop-off in sequential growth?

That is correct, and I would suggest to you, though, remember I mentioned $4 to $5 million of nonprofitable business from Legacy HK that will either make profitable or we will drop that revenue stream. And so profits will remain strong, but there may be some net effect on revenue.

Okay. And a positive impact on gross margins, though?

Exactly.

Toby Sommer, SunTrust Robinson-Humphrey.

Good morning. A couple of questions. I wanted to dig into that 4 or 5 million in more modest margin business that you may decide to prune. Is that for one customer, or is it several smaller customers? And kind of what was your thought process in terms of deciding to look at that particular business a little bit closer now? Is it a change in what kind of margin you're willing to accept, or are they looking to negotiate down the prices?

That is primarily one customer, but there are a couple of other small customers. It is not a change. We disclosed the transaction June 7th. We knew that was there. That was considered in the transaction price, and it was an action we contemplated all along that we would take. We are discussing the outcome with a client, and so we certainly want to do the right thing by the client. At the same time, it needs to be a profitable business, or it would not be the type of business that we would like to do.

Fair enough. Regarding the second-quarter results and the expenses, I may have missed this because I joined the call just a touch late. The specific expenses in the quarter related to the acquisition that might be non-recurring, what was the total impact in the quarter?

We have not disclosed those amounts. Frankly, as you go through the integration, things become quite fungible. Our focus has been on completing the integration, getting us to one team.

We did incur some costs. There is different ways to estimate that. You can look at indirect costs. You can look at specific costs. We felt like that we ran the risk of confusing more than helping if we focus there. Our focus has been on looking at the base where we are today. We know how many people we have. We know where our office costs are. We are substantially integrated. So we would point you towards the guidance for Q3 as a basis for concluding that where we are today as opposed to trying to dissect where we went during the period of the integration.

Okay. Are there any -- is there anything else that you can hang around that in terms of any other level of detail, even the corporate headquarters, for example, which you referred to that is now closed?

It is closed. That is correct. We had that open for most of the period from the acquisition to June 30. It closed right around June 30, and a majority of the people were gone before June 30.

And then I had two other questions. One of them regarding the pharma business, it sounds like you have a couple of nice projects that are coming online toward the end of the year. I wanted to see if you could maybe speak to that just a little bit more and maybe what the pipeline and what your early sense is for '05 in terms of opportunity there?

And then Sarbanes-Oxley is a relatively small proportion of revenue in S&A. You commented that you think it is sustainable through the year-end. Just maybe want to get your sense for where this goes on an ongoing basis if that 10 percent of revenue maybe where that translates into '05 and '06 in terms of customer relationships or new business that you are able to generate because of those relationships and client engagements.

Sure, this is Bill. First, the CRS group, they had three significant wins during the quarter. One of them was an exclusive win with a very large company. All of those wins will start in the September timeframe, and of course, they ramp up over time.

In addition to that, CRS is a large project oriented type of business. So you put all that together, the way we look at the pipeline, we look for very good growth in the fourth quarter and especially in 2005 for this group, so we are quite bullish on the group. They have performed exceptionally well in the past, and we believe that they will continue to do so.

Sarbanes-Oxley. We believe Sarbanes-Oxley will continue. I think as you know companies will have to continue their compliance into future years as they begin this year, which changes processes and infrastructures. There are a large numbers of companies that did not even have to comply this year that they first have to comply next year. And so we continue to believe that there will be a carryover effect for years to come in Sarbanes-Oxley.

The issue with Sarbanes-Oxley that drives most of us today is this is a candidate shortage environment for this type of expertise, and so that is the offsetting effect. But we believe it will continue, and it, in fact, does increase our visibility to clients, and it certainly did have a positive effect for this quarter and will for next quarter and for 2005 for that matter.

Okay. Two last questions and then I will let someone else get in the queue. I don't want to monopolize the call. In the health segment, the nursing, I am curious. We've seen a couple of reports out of the hospital companies that admissions don't seem to be ramping up maybe as high as some had expected. I am curious what your thoughts are in the nurse staffing space for the second half of the year? And then I was curious what the acquisition market looks like currently and sort of where your thoughts are in terms of where you would like to potentially add or bolster your current offerings?

I will answer the nursing one, and then I will turn it over to Dave to answer the acquisition one. Nursing, well it certainly has been improving for us. There has been significant input into that area that comes from our global services group, which is international nurses that we brought over here, and they work in the hard to fill shifts. So there's plenty of work for them, and that has really bolstered our presence in that marketplace.

At the same time, our presence is primarily in California, Arizona, Florida, and because of that presence, we are subject to a summer seasonal decline or at least stability, and we expect that for the third quarter, that there will be some continuance of the current rates. But because of the seasonal decline elective surgeries, we probably will not pick up growth again until we get into the fall months.

With that, I will turn it over to Dave to talk about the acquisition environment.

Thanks, Bill. A quick comment on that. First of all, as we mentioned, the Hall Kinion transaction, one of the things that we were focused on in that was to really document and prefect a process for being exceptional at doing integrations. The industry as a whole has historically not been successful or highly successful in integrations, and we have made a determination that we are going to do them and we are going to do them exceptionally well, and we're holding ourselves accountable to doing that.

So the Hall Kinion process lead to a little bit more of an investment in making sure that we documented all the processes and had everything ready to go, if you will, for future acquisitions. We had external consultants involved and so forth. And to date I think while we have certainly learned a lot, I think the execution has been excellent.

With regard to future acquisitions, as we have stated clearly in the past, we will reiterate, we are constantly evaluating opportunities. We believe that there are still opportunities out there, while at the same time, we are going to maintain our discipline. The Hall Kinion transaction was the first that we had done in a couple of years. At the same time, we believe that we have an opportunity today with a great platform to do future acquisitions and that we are going to maintain the discipline and we are going to continue to evaluate opportunities.

Thank you very much.

Randy Mehl, Robert W. Baird.

Good job on the quarter. Obviously a lot of work was done here. I wanted to pursue a couple of items. First of all, just clarification on the Flex and perm growth trends going into the second quarter or through the second quarter and into July. Bill, I think you had mentioned those. Could you please repeat those and mention whether you're talking about year-over-year or sequential?

Actually what I am really looking at is week over week. I have all the weeks actually in front of me here. Usually at the end of a quarter, as we have discussed with you before and I know you are well aware of, we have a drop-off at the end of any quarter because of projects, and then it takes a while to build that up over the months. And for this -- actually it happened also last quarter -- we're seeing some pretty strong growth continuing from months in over into the quarter end over into the following months while it usually declines quite a bit. While we may have some decline in Flex, it has been nominal, and therefore we're very pleased with that.

From a Search standpoint, it almost always has a pretty significant decline in the following weeks. And this time we are not seeing anywhere near the decline that we saw before. While it may be down 20 percent off of the high, which is the months before, it is only 20 percent, and at times we have historically experienced a 50 to 70 percent drop.

So Search is coming through again sequentially. Week by week is what I am looking at, and I have the first three weeks of July in front of me. Of course, it has got holidays in it, so you have to do some normalization there. But it looks positive to us, and we are encouraged by that, and I think that is why Derrell was in the position to make the statements he did about current brands.

Okay. Is it fair to say that year-on-year growth in the month of July might be up or accelerated from year-over-year growth in the month of June, or is that just -- are you not looking at it that way?

I am not trying -- I would say from historical trends that would be true. From June stand-alone because the last month is always -- is generally much better than the previous two months. I would not say that. But I would say it did not decline to the extent that it normally does, and therefore, I would expect a better trend that would provide I would say a better quarter than normal. But I would not go that July is higher than June.

That is a pretty big statement, and remember we only have three weeks of the combined groups in June anyway. It makes it a little tough. You have got the holiday of July 4th. It is so many assumptions in there. It is hard to make that credible statement.

How was the OnStaff earnout treated?

What we did right at the culmination of the transaction as it ultimately closed and it was being finalized is we bought out the future earnout. You may have seen that disclosed in Hall Kinion's first quarter 10-Q. That is about the time or we did it right before that. We bought it for $2.5 million.

If we had gone forward and paid earnout dollars, they would have simply been an addition to goodwill at the time they were paid. The net effect of paying the $2.5 million upfront is that we, in fact, did have additional goodwill starting out. So that is really the net effect of it. And that was the 2.5 million was for a potential earnout that could have been as high as 8.7 million.

Now you had mentioned -- I know you are being careful about this item, but I think you had mentioned something along the lines of 10 to 15 million in potential non-recurring costs of integration. And I guess I am just wondering where that went? It clearly did not fall into this quarter. It does not sound like it is falling into next quarter. Was a lot of the non-recurring costs, did they end up being capitalized?

Well, I think we may be confusing two different things. Back when we originally announced acquisition, we said that we would have significant transaction costs that would be over time paid in cash in addition to the stock for stock deal. We estimated early on that that would be in the high-teens. We then came back, and I believe this was at our end of January call, and we felt that we were doing better on those transaction costs than we had originally expected, and we said we feel like they are more likely to be in the midteens. I think that is what you're referring to.

The number I gave you a moment ago of 13.2 million was the transaction costs that we paid out at or near the closing date. That actually in the original estimates never include the 2.5 million. It was expected that would be a future event, not a closing event. The 13.2 million actually includes the 2.5, but it does not include probably 1.5 million of costs that were incurred during the course of the deal. So if you add the 1.5 million and you subtract the 2.5, we came in we believe at about 12 to 12.5 million on transaction costs that we originally estimated at high-teens and then adjusted that to midteens. So we feel like we did well relative to those estimates. Those estimates were always of capitalized transaction costs, not period costs.

Okay. That is helpful. You have a nice improvement in the technology Flex margin in the quarter relative to the March quarter. I know there is a little bit of a payroll tax effect there. But the improvements seem bigger than that. So I'm wondering how much of it was related to maybe folding in the Hall Kinion technology business relative to core improvement in Flex margin if you can get to that difference?

Well, the first part of the answer, then I will Derrell expand on it, the Hall Kinion technology group, because of an approximate -- well $4 to 2 $5 million of that amount was at almost zero gross profit. It had a negative effect upon our combined gross profit percentage for the quarter for the technology division.

Okay. The Hall Kinion you're saying the Hall Kinion -- the Hall Kinion technology gross margins that contributed to the second quarter were lower than the Kforce gross margin?

Yes. And I will refer you back to the numbers some of the numbers that I presented. We do estimate that somewhere around 100 basis points is because payroll taxes are lower in Q2 than in Q1. You saw from our disclosures that technology went up 170 basis points, and from what Bill has said, you can conclude that the underlying business was growing at something in excess of the 70 basis point difference.

So the Hall Kinion piece for the 18 billion days diluted that a little bit, but we have not refined exactly how much that would be. But we would say we are very pleased with the upturn in our gross margin from our technology business.

Just one more question and I apologize for the number of questions. But, Bill, the 4 million, if you were to shut that off, would that finance itself from a P&L perspective, meaning would the immediate savings offset the whatever costs would be involved in turning that off?

Yes.

Mike Warner, Kennedy Capital.

The share count was a little bit lower than what I had thought. Is that the right number for what you are using for the third quarter or even the year?

Well, keep in mind the share account for the second quarter is a weighted average. So we issued 5.7 million shares in the transaction on June the 7th. So those only impacted the share count for part of the quarter. That is why you get a lower average. Our currently outstanding shares are about 36 -- slightly over 36.7 million, and a reasonable number to use for a Q3 is that the diluted would be a couple of million shares above that. So 38.7, in that kind of range.

Okay.

The 34 million is low, but it is low because it is a weighted average not a point in time.

That is what I thought. Now you showed organic growth in the quarter, and if I heard you correctly, on a consolidated basis, you would expect somewhat of a seasonal slowdown in the third quarter. Did I hear that correctly?

In a couple of areas, we would. Nursing and because Search is so lumpy, it is not absolutely clear to us whether we will have a slowdown or not, but we are after that. Other than that, no, we don't expect a slowdown.

Okay. And finally, I have a question just regarding your quarter report relative to your expectations. Now if I am correct, I thought you said that when you were guiding for the second quarter maybe two to three months ago that you expected the Kforce to be between, was it 3 to 6 cents, and then that was before the effect of Hall Kinion and integration expenses?

Yes, that is the number we guided for revenue and we guided for Kforce on Kforce alone. What we said was and we pointed out the lease at that point. We had separately identified some direct integration related expenses in Q1, so we did provide some guidance on the fact that that had been deducted in determining that 3 to 6 cents. We thought we carefully pointed out that this does not reflect the effects of the merger itself. It does not reflect the duplicate costs. It does not reflect the costs that would have to be charged to expense related to closing the transaction because we realized back then that that was going to be very difficult to separate in a meaningful way. So what we said was 3 to 6 cents before the effect of the transaction if it closes as generally is expected.

We actually, and again we're not going to identify detail costs, but we can tell you that we are very pleased with the way the second quarter came out based on our expectations of how that 3 to 6 cents would be impacted by the closing and the duplicate costs associated with that. So we view the 1 cent as being as well or better than we had hoped to do given the transaction closing in Q2.

Okay. I have heard from that that you would have been towards the higher end of your range if you just were Kforce alone?

Again, we have not tried to define those costs that would make up that reconciliation.

And you're going to have some additional costs from the transaction in the third quarter, is that right?

We will but the transaction and the big parts of the transaction are behind us now, and we feel very good about that. We think that there will be some costs certainly, but we think those will be minimal.

Rick Nagul (ph), Columbia Management.

My questions relate to the same question that the prior caller was trying to drill down on. One, is your guidance in the third quarter does it or does it not include whatever you expect to incur in Q3?

It does include that. We don't have any items that we want to put forth in Q3 that we believe would be nonrecurring or extraordinary. We believe that is our best estimate together with our directional feeling about where we are trending at the current time for Q3.

Just on this related to the non-recurring expenses again, I can understand why you did not necessarily break them out in the release. I don't understand. It sounds like you know what the number is even though it might not be or at least a range -- a fairly tight range. You felt good. Everything felt good in the quarter. The revenues were fine, the margins were fine, and yet all you have laid out here is this penny against the 6 cent estimate that is out there. I think you're getting unduly punished today and an ugly taste because of that and you know people not being able to drill down.

You know it helps to have you say that we feel good internally, but to feel good internally you must have a real sense of what the difference is. I guess I am scratching my head on why you cannot at least quantify it with a range.

Dave, do you want to try that one?

Well, there are so many things that are involved in those. We have got rebranding issues, literally taking down signs. We are flying people around. We had training meetings. I will give you another example. We had our incentive trip that we had previously planned that we then combined the Hall Kinion folks and the OnStaff folks that were their top performers with ours on those trips. And do you make the decision and say the costs related to having them join us on the trip then become merger and integration costs? The exercise in going through and trying to track every line item and every expense to make a determination, is it recurring? Would have it happened from a Hall Kinion stand-alone, or would it have happened from a Kforce stand-alone, or was it a cost directly related to the merger? It really becomes an exercise in futility.

We believe that the guidance that we issued for Kforce alone and the combined results for the company speak volumes with respect to the very positive revenue trends and the fact that we made money on a transaction that was closed on June 7th where the integration process took place in a very rapid period of time that involved expensive costs related to office closing, technology closing, technology refresh, termination and severance and so forth. So we believed very strongly and still believe that going through and trying to track those where there is an extensive amount of judgment involved and estimates involved frankly was not worth it. We felt very strongly that looking forward that it was of greatest interest to the market and to our shareholders is what now have we got in terms of revenues and earnings capability in the combined companies, and that is where we have focused our attention. I believe that the information we have provided today does that and suggests that we have a very positive outlook for the combined companies.

I hear the words, and unfortunately we take a longer-term prospective than many do, and as you know, we are a very large shareholder here. I just hate to lose the game because of communication, and I think that is partially why we are losing the game today. That is all I have. Thanks.

John Mahoney.

My question has been answered. Thank you.

There are no other questions in queue.

Very good. We wish to thank you all again for your interest in Kforce, and we will look forward to speaking with you again at the end of the third quarter. Thank you.

Thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect.