Kforce Inc (KFRC) 2006 Q2 法說會逐字稿

Good day, everyone, welcome to the Kforce second quarter 2006 earnings conference call. Today's call is being recorded. Now for opening remarks and introductions, I would like to turn the call over to Michael Blackman, Senior Vice President of Investor Relations. Please go ahead, sir.

Good morning and welcome to the call. Before we get started I would like to remind you that this call contains statements that are forward-looking. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results may differ materially because of the factors listed in Kforce's 10-K and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements. I would now like to turn the call over to David Dunkel, Chairman and Chief Executive.

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

The second quarter was a very strong quarter for Kforce with revenues once again up to historical highs. We are particularly pleased with our performance in our technology segment and our gross margin performance.

Over the past several weeks, economic sentiment has shifted to the belief that the U.S. economy is entering a mid-cycle slowdown. While we are not economists, we can draw on our extensive experience in managing through past economic cycles. Yesterday I completed my 26th year in staffing and, as such, have observed numerous business cycles. Here is how we see it -- the drivers for professional staffing are supported by both cyclical and secular trends, both of which remain favorable for the short and the long term. The demand for our services remains strong and skill shortages are prevalent in each of our service offerings for both Flex and Search.

Our KPIs, or key performance indicators, remain strong and do not suggest the economy is entering into a recession. Customers are investing, in particular, they are investing in enterprise-wide technologies to drive enhanced customer service and efficiencies. Accordingly, we have mapped our strategy to optimize returns at appropriate periods in the cycle. We believe that we are in a period similar to 1995, where the economy also experienced a mid-cycle slowdown and are managing accordingly. We would call this current phase the investment phase, whereby we increase investment and productive resources to accelerate future revenue and earnings growth. This phase is followed by an optimization phase where we seek to maximize our return on investments and drive significant operating leverage. Our goal remains operating margins of 10-plus percent in the optimization phase, a target we were able to reach post-1995.

I will now turn the call over to our CFO, Joe Liberatore, who will provide his comments. Bill Sanders, Kforce President, will then provide additional insights and operating trends and expectations. I will then conclude. Joe?

Thank you, Dave, and thanks to all of you for your interest in Kforce. We are excited to have delivered another quarter of record revenues in the second quarter, and operating earnings at their highest level since Q4 1998. Second quarter revenues of 234.4 million represent a 5.4% increase over Q1 and an 18.1 increase year-over-year. Revenue per billing day of 3.7 million reached an all-time high for the fourth straight quarter and continues to trend upward. We continue to drive improving bottom-line results as net income is increased 47.6% year-over-year to 8.4 million in Q2 2006 as compared to 5.7 million in Q2 2005.

EBITDA, an indication of the firm's strong cash flow, increased 51.8% year-over-year to 18.3 million, or $0.43 per share in Q2 2006 as compared to 12 million, or $0.30 per share in Q2 2005.

Q2 2006 earnings per share of $0.20 increased $0.06, or 42.9% year-over-year, and increased $0.05, or 33.3% sequentially. We are extremely pleased at being able to deliver strong profits while continuing to make significant investment in sales and recruiting as well as infrastructure improvements that should allow us to optimize operating results as top-line revenues continue to grow.

Total Search revenues of 17.7 million for Q2 were up 27.2% year-over-year, which represents acceleration in growth from Q1 and now represents 7.5% of total revenues as compared to 7% a year ago.

During the second quarter, the firm continued to invest in building our Search capabilities in order to position the firm to achieve our target of 10 to 15% of total revenues at peak of the cycle. We have continued to see positive results from our investments in Search, and our focus on repositioning the Flex portfolio to higher value, higher margin business. This focus has resulted in the continued increases in profitability and positions the firm to take advantage of the strong hiring environment as we move forward. We are very pleased with year-over-year earnings improvements and are optimistic these positive trends will continue.

We believe we continue to run an extremely efficient operating model that will continue to generate operating leverage and improved earnings as revenues increase. Operating income is at its highest level since 1998. Earnings before taxes of 14 million or 6% of revenues increased 53% from 9.1 million, or 4.6% of revenues in Q2 2005. We believe we are making excellent progress towards achieving our peak cycle target earnings before taxes of 10%+ of revenues.

A key driver contributing to the current positive trends continues to be our ability to manage gross margins. Gross profit percentages improved significantly over the past year across all business lines. Our gross profit percentage of 34.5% has improved 220 basis points year-over-year and 120 basis points sequentially. Our Flex gross profit percentage at 29.2% in Q2 2006 increased 140 basis points sequentially from Q1 2006 with approximately 70 basis points of the increase coming from the reduction in payroll-related taxes from Q1 and the remainder through improvements in the spread between bill rates and wage rates. Flex gross profit percentage has now improved 200 basis points year-over-year. We will continue to focus on this area of our business to drive improvements, though we don't expect the rate of improvement to be as great as experienced in 2005 since we have substantially completed the repositioning of our client portfolio. However, over the course of 2006, we will continue to expect an additional degree of pricing leverage.

We seek to balance current profitability with long-term investments. In Q2 operating expenses decreased 20 basis points from Q1 to 28.1% and have increased 70 basis points year-over-year. The increase in operating expense from last year is attributable to our commitment of building sales and recruitment teams and support infrastructure including technology improvements to take advantage of the increasing demand for our services across all business lines.

We are in the third leg of our plan to upgrade our IT systems, which have included upgrades of our hardware and front office IT systems. This third leg is focused on improvements in back office efficiencies and systems, which will continue into 2007. We expect these investments to drive both productivity and exceptional customer service.

Capital expenditures are expected to remain at comparable levels in 2006 as 2005. We expect to continue with these investments and for operating expenses as a percentage of revenue to be relatively constant in Q3.

A key to maintaining an increase in profitability is our ability to manage our accounts receivable portfolio, which maintained a very low DSO of 40.3 days as compared to 39.9 days in Q1 2006. Our disciplined management of receivables provides a platform to quickly and efficiently integrate acquisitions and is a key factor in our ability to generate strong cash flows.

Improvement in operating efficiencies coupled with careful management of sales performance metrics will allow us to continue the hiring of sales and sales support personnel with minimal effect on earnings.

Productivity levels in our sales force remain near all-time highs in Q2 2006 but were slightly below those in Q1 and down 9% from a year ago. This reduction is a reflection of the significant additions to headcount, which continued into the second quarter. We expect productivity levels to resume their upward momentum as productivity levels of new hires begin to ramp. The quality of the revenue stream continues to improve as we continue to gain leverage from our investments. Gross profit per person has improved 80 basis points over the past year despite the recent additions to our sales force.

Cash flow from operations for the firm in Q2 continues to be strong. EBITDA, an indication of cash flow, increased 51.8% year-over-year to 18.3 million in Q2 2006 as compared to 12 million in Q2 2005. During the second quarter, the firm was able to reduce its bank debt by 14.4 million and also fund 2.7 million in capital expenditures. At the end of the second quarter bank debt outstanding under our credit facility totaled 48 million. As our earnings increase, we expect cash flows to improve further and are very confident in our ability to pay down debt as well as invest in our growing business.

Looking forward to the third quarter, we expect to continue to make investments that will benefit the firm long term. We expect revenues may be in the 235 million to 240 million range and earnings per share of $0.20 to $0.23, which reflects continued investments in aggressive hiring and infrastructure and approximately 42.3 million weighted average diluted shares outstanding.

From a financial perspective, Q2 reflected a continuation of revenue and earnings growth as well as sustaining our long-term investment strategy to position the firm for prosperity through the current business cycle and beyond. Our balance sheet and cash flows remain strong. We remain optimistic and confident in the near term and long term strength in specialty staffing.

I would like now to turn the call over to Bill Sanders, our President.

Thank you, Joe, very nice report. This quarter's results continue last quarter's momentum of record revenues with good margin expansion. We are experiencing strong revenue growth in permanent placements, improved bill rates, and a client portfolio that places a high value on our superior consultant quality and exceptional service.

The technology Flex group's improvement of 30.7% year-over-year and technology perm growth of 45.1% year-over-year, which together constitute 52% of total revenues may indicate the anticipated recovery of tech that typically lags F&A staffing in an economic expansion.

We are pleased with another all-time record high quarterly revenues of 234.4 million and revenue per billing day of 3.7 million. Importantly, these record levels were achieved through a combination of both increases in bill rates and hours billed. This combination, we believe, is a sign of strong demand in our core service offerings of specialty skill set consultants. We have been able to couple this revenue growth with significant gains in gross profit percentages and operating profitability. Revenues were up 18.1% and gross profit increased $17 million, or 26% year-over-year. Staffing, higher gross profit business is our objective.

We continue to see the tangible results from our investments in perm associates as our direct-hire revenues are up over 27% year-over-year, and have accelerated over Q1 2006. We are also enjoying the efficiencies and leverage we have been able to extract from acquisitions and their sustained revenue and earnings contributions.

To provide further insights into the quarter results, overall demand for quality candidates remains strong across all service lines. Our key performance indicators point towards continuing strength, and we have not seen any slowdown in this demand. In fact, increased competition for candidates continues to require clients to accelerate their interviewing process and become more aggressive as candidates receive multiple offers in high demand skill sets in F&A, regional monitors and CRS, medical coding and HIM, and PeopleSoft, .NET, and senior level systems analysts and technology. We are also seeing some rotation in the nature of tech job orders, as more clients are focusing on larger-scale development projects and requesting longer contract periods.

Revenue growth for the quarter was led by our technology segment, which grew sequentially 10.6%. HLS revenues increased 2.2%, and financial and accounting revenues declined 1% as a result of typical seasonal effects and client selection.

As for revenue trends by month for our flexible staffing business, we saw improvements in each month of the second quarter led by the strength in technology. Perm exhibited strengthening throughout the quarter as well. We are very pleased in the growth of our perm business. Perm was up 5.3% sequentially and 27.2% year-over-year. Perm has now grown 10 of the last 11 quarters. The year-over-year growth of 27.2% marks acceleration in the growth trends over the 24.5% year-over-year growth in Q1. Perm has increased to 7.5% of total revenues. On a business unit basis, technology perm grew 13.8% sequentially while F&A perm increased 3.6% from Q1. Tech perm typically lags F&A perm in the economic cycle but accelerates quickly. We now have 73% more in headcount than a year ago in perm, and we continue to add capability, particularly in technology perm.

The ramp-up of these new hires is a precursor to our future revenue growth expectations and continues to make us bullish on perm. During the peak cycle -- peak of the last cycle -- F&A perm and tech perm were at comparable levels as compared to today where F&A and perm is almost double tech perm. We continue to target permanent placement services at 10 to 15% of total firm revenues at the peak of this cycle.

For Flex, we continue to enjoy profitable revenue growth. We are particularly encouraged by the strong quarter in technology Flex, which grew each month of the quarter. We believe our diverse service offerings of technology, finance, and accounting, the industry specialties of HLS and our Kforce Government Solutions Group uniquely positions Kforce in the business segments that we will be in greatest demand for the foreseeable future.

We continue to have excellent results in balancing bill rates and wage rates as we continued to work with our clients. Bill rates have improved across all business units and have increased 16% on average year-over-year. Specifically, technology bill rates have increased 9.5%, F&A rates have increased 18.7%, and HLS rates are up 6.9% year-over-year. As a result, Flex gross margins have improved significantly across all business lines for a total of 200 basis points.

Given the reported mid-cycle position of the economic cycle, we believe margins will continue to improve upon this post-recession high. We expect all three segments to improve with our technology segment continuing to grow in Q3 and finance and accounting to improve. To further segment the performance of our HLS business units, CRS is now 43% of the HLS segment and is an $87 million annual business on a Q2 run rate basis. This business has grown 21% year-over-year and continues to impress. CRS is a highly project-based business that provides solutions to the clinical research areas that allow the FDA approval process to pharm, biopharm, and medical device clients. We expect CRS to continue to be stable in the third quarter.

Our Health Information Management Unit continues to outperform all other groups. Its growth and profitability is setting the pace for the Firm. Peter Alonso and Sam Farrell and her team have done an excellent job building this business. The demand for their services grew over 10.3% sequentially and 38.1% year-over-year due to more strategic sales of longer-term, multiple seat projects. HIM revenue is expected to be up sequentially in the third quarter.

Revenues for our Healthcare and Nursing Unit were down 4.5% sequentially in Q2. This unit represents 4% of total Firm revenues and continues to face a difficult climate. We are making significant progress towards longer-term contract assignments with placement of RNs to primary health facilities through our International Nurse Program, which now represents 35% of nursing revenue. We continue to manage these risks. We see improved gross profit percentages, and we'll be looking for more profitability from this group. We expect Q3 revenues to be flat to slightly up.

Our Scientific Unit continues to make progress moving its business to higher-margin customers, with Flex margins improving 210 basis points year-over-year. We expect the third quarter revenue to be up slightly.

Several federal government contract wins in our Kforce Government Services Group have occurred recently. Since their acquisition, this group has experienced a decline of approximately 8% in revenue run rate. They are now stable and have three important contract wins. In particular, the Project Eagle win was a significant potential for the future task orders for this group.

As Joe stated, as we add new sales associates, the overall field productivity levels have moderated slightly as anticipated and result from compensation, infrastructure, and training costs during the new-hire ramp-up period. We increased the size of our sales force by approximately 10% in the quarter and 32% year-over-year and plan to continue to add to and reinvest in our sales associates, particularly in perm with the objective of accelerating our profitable revenue growth.

We also continue to provide state-of-the-art systems and sales support to ensure we offer our clients the best candidate and the shortest time possible. Our formula is to hire and retain great people and provide them the highest quality training and tools in order for us to maximize productivity. Here I would like to note that the key to the success of our strategy is our seasoned CO management team. They are a focused team executing expansion and an operating model they had built. They are tested veterans and are the best management team, by far, that we have ever had.

In terms of revenues from the beginning of the third quarter -- despite the timing of the July 4th holiday, Flex revenues in July are up over 13% and perm is up 42% year-over-year. Though these intra-quarter trends are positive, it is difficult to draw conclusions for Q3 based on this limited data.

In conclusion, we are experiencing demand for both temp and perm placement services across all lines with a solid pipeline from job orders while candidate availability continues to be manageable as we remain focused on continuing profitability balance with investments. We have achieved record revenues and improved total gross profit margin 340 basis points over the last two years. As we look forward, we believe our recent aggressive hiring and intense focus on perm revenues, strong pricing discipline, and client selection will allow us to drive revenue growth with margin expansion. I am excited about the future of the firm and want to congratulate our field and support teams on the strong execution in the second quarter. I will now turn it over to our CEO, Dave Dunkel.

Thank you, Bill. In May Kforce was selected by "Business Week" magazine as a hot growth company based on three-year results in sales growth, earnings growth, and return on invested capital.

And on a personal note, Howard Sutter, Rich Cochiarro, and I, as founders of Kforce, were honored by Ernst & Young as Entrepreneurs of the Year for Florida. We would like to extend our appreciation to all of the great people of Kforce for making these special recognitions possible. It is truly an honor to serve with you.

Turning back to the quarter, we are pleased with our results and are aggressively investing in our team. Our goal is to accelerate profitable organic revenue growth. Productivity is a key measure, and we are managing to clear metrics even as we add significantly to our associate headcount.

While our primary focus is on organic revenue growth, we continue to evaluate acquisition prospects that will meet our stringent criteria. In the past five years, we have made a total of three acquisitions, which evidences our rigor and discipline. Additionally, we have developed a confidence in acquisition integration. Our acquisition goal is to derive a return for our shareholders, and that is reflected in EPS.

We expected to be highly selective in evaluating prospective targets with culture and valuation primary factors. We have three primary uses of capital -- debt retirement, acquisitions, and returning capital to shareholders in the form of dividends or share repurchase. We determine the use of capital based on the highest returns for long-term shareholder value. Looking forward, we are optimistic about the prospects for professional and technical staffing and once again we wish to express our appreciation to our field and corporate teams, our consultants, and our clients for allowing us the privilege of serving them. We'd now like to open up the call to questions.

[OPERATOR INSTRUCTIONS] Mark Marcon, Robert W. Baird.

I was wondering, with regards to IT, obviously, quite a solid performance there. Can you talk a little bit about two things -- one, the performance that you saw in the areas where you integrated Pinkerton and then in geographies where Pinkerton wasn't involved, could you tell us a little bit -- are there any differences and what can you tell us about that?

Well, Pinkerton had -- this is Bill, Mark -- Pinkerton had two business units. They had the Commercial Technology business unit, and they had the Federal Government Business unit, basically two-thirds commercial IT, one-third Federal Government. As you look at Pinkerton, we go through our normal process, we fully integrate those into the Firm and absorb those. They were primarily in the Northeast, particularly around the New York area, and two things happened. As we historically have done, we integrate those and then we run off those clients that -- while we have a runoff of the revenues from those clients, which do not meet our gross profit percentage objectives. And so that is what basically has occurred, so as you look at that revenue stream, it continues to grow in certain areas but certainly has a revenue runoff that is much more -- happens much more quickly than you would see growth in the revenue stream.

And so as I look at them, they helped in this second quarter to a certain extent, but they were offset by the runoff of two particular projects that were quite significant and were basically what we call "payrolling" type agreements where there is very little gross profit in them.

Okay, and how'd you do outside of the Northeast?

With Pinkerton?

No, in the areas where Pinkerton is not involved.

Generally, if you were to look at us at market-by-market, the individual markets are typical of what we are showing here, which is pretty significant growth in technology and a more conservative growth from the finance and accounting based upon the seasonal effect and our ability to choose staffing business with those clients at a much higher bill-rate level and at a much higher gross-profit level.

Okay. On the F&A side, it looked like the hours declined, and you've obviously been focusing on the higher bill rate and gross profit projects. On the flip side, Flex gross profits had a nice increase against a tough comp -- up 14.2% year-over-year. And I'm wondering if you can talk a little bit about the dynamics that you're seeing on the Flex F&A side. It certainly seems like you're focused on the best-paying accounts. So I'm wondering if you can give us a little bit of color there?

Well, you're exactly right. Our objective is to reach -- migrate upstream to a larger bill rate group, and we absolutely have done that. Bill rates are up 18.7% year-over-year with pay rates being up only 11% in finance and accounting. So we see several things -- the seasonal effect, total revenue is up 4.1%. For finance and accounting, on a billing-day basis, it's up 5.7%. We have moved to those clients, which are in our sweet spot and provide us a significantly higher GP level. Basically, it's up 390 basis points, and so that migration, I think, is nearly complete. First, we try to migrate to a certain level with our clients, and now it is to improve productivity or volume -- any of the words you like to use -- so you have that type of activity moving. I think we can move in productivity pretty substantially now as we focus on it, and I would say the last piece, to make sure that you understand our accounting, we have conversions, and our search -- we have conversions in Search and not in Flex, and because of that, we have -- finish for me, Joe.

Yeah, Mark, this is Joe, I'll pick up. Because all of our conversions basically go into our Search numbers, and so it doesn't dilute the margin whatsoever. So I think when you look at the F&A business, what also doesn't come to light often is with that margin expansion, the real significance there is in the actual dollars, meaning margin dollars, because when you're expanding margins at that rate with bill rates expanding the way that they've expanded, the amount of margin dollars is really even disproportional to that 390 basis-point improvement.

I'm back -- and as conversions occur, of course, that takes up the Flex revenue stream, and that's one of the negative factors that affects that. I would tell you, overall, we're very happy with the migration and the improvement in GP, and now we are after balancing that with higher productivity.

Would you expect that hours would -- on the Flex side of F&A, would stabilize and improve from here, or is there a continued migration toward higher-margin accounts?

Absolutely. We believe that we actually hit that bottom towards -- accomplished our objective, I guess, is the way I'd look at it. We accomplished that objective at the end of last quarter, and starting to see some of that moderation, and I expect that there will be an acceleration this quarter. In other words, Q2 was the bottom, and Q3 we expect to see an acceleration in hours.

Toby Sommer, SunTrust Robinson-Humphrey.

I wanted to ask you a couple of questions about the headcount additions that you've made internally. Could you give us some color as to whether those are evenly distributed among the different segments or perhaps seen a little bit faster growth in any particular segment?

Yes, this is Joe. We've continued to expand in Search pretty significantly, so there is a disproportional amount of headcount that's being added in Search. The Search headcount ramps up much faster, so we get a much quicker return on that investment as well as the market opportunity continues to present itself.

I would say from a Flex standpoint, pretty evenly distributed from a tech and an F&A standpoint on the Flex side of the business. It's 10% for the growth for the quarter at 32% year-over-year growth [helping].

Joe, I'm sorry, I'm sure you gave the growth in Search but, if you didn't, is that something you could share with us?

Sure, it was 73%.

Are you distributing those evenly in geographies or how do you think about that in terms of distributing that growth around the country?

As we had mentioned, I think, in one of our earlier calls, we're focused on what we're calling a "power center" concept, which is hiring in bulk in certain key markets where we have a good footprint. Search is a mass inertia type business, so when we hire in that mass, people feed off of each other, and so we notice productivity levels even jumping more. So we typically don't just drop in two Search people in a marketplace. If we're going to invest in Search, we're going to deploy a sizable team in that marketplace. So I'd say that's more so how we've been distributing.

From the hiring standpoint, our hiring has been heavier on the tech side in comparison to the F&A side, and I would really attribute that to if you were to go back in history and look at tech Search, tech Search has improved 346% off of the low, which was 1.4 million in Q3 2003. FA Search has improved about 125% off of the low, which was 4.5 million in Q3 2003. So typically, because of what happened in the last cycle with DotCom level and kind of that convergence of, really, everything hid in Y2K, it's just the overall technology space. As we've mentioned, at peak cycle last time, we were about 50-50 in terms of contribution from a tech standpoint and an F&A standpoint. F&A didn't fall as far as technology, likewise, F&A kind of came out earlier, and we're really noticing a lot of momentum on the tech side, which is why we've been driving more hires within that organization.

Thanks for all that color. If I could ask one more question on the headcount -- what's it like in terms of the recruiting market for you? Are you having to pull the trigger a little faster with people that are getting multiple offers, et cetera, and are you bringing people in primarily that do not have prior experience in the industry, or is it a combination of people with prior experience as well as newcomers? Thank you.

This is Joe. We have a pretty good legacy staff that's fairly well experienced, which provides us the luxury of being able to bring in non-experienced people -- individuals that might have a couple years of sales experience, and then we just really have to teach them the staffing business as well as maybe terminology. So it's a combination. We will bring in people that have industry experience if it's the right match as well as we will bring in people that are outside of industry. So we're really focused on both fronts. We're after the profile of the individual. We've spent quite a bit of capital as well as have done quite a bit of work in and around human capital studies to understand what type of profiles are most successful within Kforce by Flex, by Search, and so we really try and target the profiles that have the highest probability of success.

This is Bill. I would add to part of that -- the first part of your question is how are we hiring recruiters? About three years ago, we built up an internal staff, which goes out and does most of the work for us for hiring internal people. That group has grown pretty significantly as we've made these additional hires, and it brings a real professional sophistication to the hiring process within our own firm.

We have, at times, had to be pretty aggressive but, generally speaking, this group is on top of it. We have a well-defined process for hiring people internally, and it's worked very well for us. So we do not feel any undue pressure in trying to hire people.

In terms of the business model in the incremental profitability, is there a fundamental shift, perhaps, due to the focus on the power centers and the ability to drive more of that incremental revenue down to the bottom line -- this cycle versus in the prior expansion maybe when you didn't rely as heavily on the power centers?

This is Joe. The power centers are really just how you deploy the resources not the amount of resources that you necessarily need. What we typically see in cycles is when we come out of a recession, there is typically built-up operating leverage in terms of capacity within the people who made it through the downturn, which is typically why you start to see your operating expenses decelerate for a period of time, and then as the cycle starts to take hold, that's when the resources -- additional associates need to be injected in, which is really where you've seen us for probably the last four quarters or so, which is really hiring ahead of the curve. Because what we experience from an associate standpoint, and then you kind of get to the back end of the cycle, where you start to get all the operating leverage out of those volumes of individuals you brought in, because -- just to give you some simple statistics, a year-two person versus a year-one person in our environment is probably 100 to 150% more productive in year two than they were in year one. When they start to move into year three and four, that expansion versus a year-one person can be anywhere from 200 to 400% plus. So that's where we start to really get a lot of operating leverage out of those individuals.

Thank you, I'll ask one last question, and I'll get in the queue. David, things appear to be going pretty well. All your key operating metrics, et cetera, the market looks firm. What are you worried about these days?

I'm worried about making sure that we are balancing all of the aspects of the business. I would say that things are going very well, actually. When you get into this kind of an environment, which we've been in in the past, and we've had experience in managing through, the things that concern us, of course, are making sure that we're taking care of our people. Kforce is very focused on great people, and we have a great team. So we want to make sure that we do all the things necessary to keep our people and to provide them with the best tools.

In this environment, it's all about execution. We are somewhat amazed, frankly, at market perceptions about what's happening in the space. Historically, staffing firms have been looked to as leading indicators of what's going on in the economy. The leading firms have all consistently said that the market is strong for the services, and yet this time no one seems to be listening. So we're somewhat baffled by that.

Mark Derussy, Raymond James.

Dave, I wanted to ask you a little bit about the situation in the M&A environment. Obviously, we've had a contraction here recently in the valuations of public companies, and I was wondering if that's been having any noticeable impact on the opportunities you're seeing out there in terms of, a, pricing and in terms of maybe volume. Are there any more deals you're being presented with these days?

I haven't seen any noticeable change, frankly. We've got our very disciplined model and stringent criteria that we're focused on, and I wouldn't say that we've seen more opportunities presented as a result of the recent contraction. We have specific target areas that we're after. We evaluate a lot of opportunities and processed them through the funnel. Howard Sutter believed that program, is very experienced at that, and knows exactly where we're going with this program, so I would say that the contraction really hasn't changed the pipeline in any material respect.

Moving on to the clinical business -- obviously, it's been a great sort of growth track for you guys, up significantly year-over-year. On a sequential basis, I'm just wondering if I should read into -- is that business slowing down at all or is there maybe some seasonal factors there? Any change in your outlook for the clinical business, going forward?

The clinical business is a little bit unusual in that it is made up of a small number of the large accounts, and those particular accounts are project-oriented business, so it historically has been very lumpy or volatile, whichever word you like to use, Mark, that -- and we'll continue to see that. I think the trend continues to be up. Whether, on this scale, they continue to grow at that growth rate, we will see. Next quarter, I think, is going to be just a stable quarter for them, but I do believe in future quarters they will continue their trend and over any given year, it's time we expect significant growth from them.

Mike Carney, Aperion

A couple of questions -- Bill, you said 32% year-over-year sales associates -- was that just Flex or was that combined perm and Flex?

That was both.

Okay. And then also you talked many times about the power centers and then there being, I believe, five. Is that something that you -- maybe there's seven now -- or now that you've really decided to enter into an investment strategy, that there's more centers out there for perm rather than just the five?

Well, there's five power centers. That doesn't mean that's exclusive of our Search groups. There are certainly Search people in a number of other locations. Those five power centers, we are in process of expanding that -- analyzing and expanding that group, and so we want to make sure that we cover all of the major markets where we have good brand recognition, and we want to do it in a very effective and efficient way, and power centers happens to be our name for doing that.

So when you talk about, I guess, the considerable increase in headcount the last couple of quarters, is that primarily in the power centers?

Yes, it is, primarily, yes.

Okay. And then also -- Bill, you also talked about -- I guess -- was I correct in hearing that the project wins that you got in Government Tech kind of offset the projects that ended in the most recent months?

Well, yes, there's been a rolloff of about 8% of the revenue rate up to this point in time. The three wins, which are -- two of them are good wins, and one is a huge win. Those are contract wins. Now, that basically gives you a hunting license with several other firms to go out and achieve or acquire certain task orders. That's a very limited group that goes out to be able to do that. That should, in our opinion, allow us to rather significantly accelerate some growth in the -- what we call KGS Group or Kforce Government Solutions Group. So we are very optimistic in what that group can begin to do over the next year. But that's a longer sales cycle, and it takes time to ramp that up.

So when you talk about you're seeing longer durations on the tech side, you're really talking about those large-scale projects being in the private world?

Exactly.

The Government Solutions space, as we've indicated previously, we made a strategic decision to get into this area. The government, as a whole, is facing very significant talent shortage. It's been well documented. The retirement rate of the government workers is significant and accelerating, and the government has, in many respects, outsourced key functions, and we believe there is an outstanding opportunity in the specialty staffing area to further develop that with significant growth, and it fits perfectly with our existing footprint. So we're actually quite bullish on the government space, and obviously thrilled at the recent wins.

Right, and then you mentioned price increases, I think, Dave, in your remarks, maybe in the release, at the first of the year, is that right?

I'm not sure I'm with you, Mike. Price increases -- do you mean generally, rate -- well, let's take it a different way. Rate per hour is up for us -- our rate per hour, if that's what you're suggesting, a rate per hour in finance and accounting is up 18.7%, technology is up 9.5%, and HLS is up 6.9%. So rate per hour is up substantially, a total of 15.3%, while wage pay per hour is up 12.4%, and that basically is what contributes to our significant improvement and gross profit percentage.

Okay. I may have messed that up, but you've had price -- I'm sorry -- you've had bill rate increases starting significantly primarily from finance/accounting in the third quarter of '05. So would we expect those increases to -- the growth to start decelerating in the third quarter of '06?

Yes, I would expect in the second half that we would have a moderation in the increasing -- it would -- the spread will continue to increase and bill rates, I think, will continue to increase but not at the same pace -- they will begin to moderate.

Right, okay. And last question, back to recruiting -- every quarter for the last three or four, I guess, you've added more and more people. Would we expect that year-over-year increase in headcount to continue to move upwards in the third quarter, in the fourth quarter, or are we probably at a peak in terms of growth and that would decelerate also?

This is Bill -- we would not expect that we are at the peak in terms of growth. We may be at the peak in terms of percentage of growth because, obviously, that's a rather rapid percentage of growth. We continue to -- it's not a linear growth pattern; that is, we bring people on, we expect them to ramp up and be productive, we try to balance that investment with what the P&L can absorb at any one point in time. However, we expect to continue to hire and to continue to build our sales force as well as we can keep this balance.

Dave talked about this investment phase that we think we are in now, and it probably will last for some period of time before we go into the actual return on investment phase or maximum return on investment phase. And so I think we're going to continue to hire for some time here, and we're going to, however, be very deliberate so that we can continue to maintain an improving bottom line.

And you're comfortable with operating expenses as a percentage of revenue remaining stable for the next few quarters until these consultants become relatively productive?

This is Joe. As I mentioned in my remarks, we anticipate that to be constant into Q3, and that's mainly being driven by the continued aggressive hiring as well as the investments that are required with that hiring in terms of training and ramping the individuals up. One of the other things that I mentioned in my comments that I want to make sure was not met is we've been able to maintain or actually increase slightly what we call GP per employment month, so that's, on a monthly basis, the gross profit produced by the average associate in the field. So when you consider the volume of hiring that we've been doing and to hold that number constant, that should give you some indication of where the operating leverage exists because of how less productive the new individual is versus the individuals they start to move into year two. So that's when you start to look out into '07 and in '08, that's where you really start to see that leverage. So we'll continue to hire into the marketplace, and we're constantly looking at balancing that. We're not going to let that GP per employment month drift too low because that would have a significant ramification on the P&L. So we're balancing these things.

That's gross profit per person, Joe, is that what you're --

Yes.

And then is that firm-wide or is that just in Flex, just in perm, or is that firm-wide?

What I was referencing is firm-wide.

John Mahoney, BB&T Capital Markets.

Good morning, guys, great quarter. Just a quick question on the quarter. The revenues were very near the high end of the range, yet the earnings were a little close to the bottom end of the range. What happened within the quarter -- it's two questions -- that caused that? Was it the investments? And, secondly, in the third quarter, you know, if you were to fall towards the high end of the range at 240, wouldn't we expect you to be a $0.23 in the third quarter? Or what are the kind of factors that could happen during the quarter that might cause you to invest more or what happened basically?

John, this is Joe. You know, as we've continued to mention, we've continued to make investments in various areas during the quarter and anticipate those investments to continue into Q3. A lot of that's in and around the additions to headcount, the training, as well as sales support, as well as we continue to make investments in our technology infrastructure, continue to provide the tools. Because as I was just referencing in the last comments to Mike, when you look at that gross profit per associate and holding that constant on a year-over-year basis with the volume of hiring, a lot of that's attributed to the continued things that we do to drive efficiency in our operating model, and that's through the tools that we're providing the individuals and the overall sales support infrastructure that we're providing.

When you first gave the guidance for the second quarter, I think that if you had -- if you said, "Well, we're going to do $235 million of revenue," you would have assumed you would have done $0.22? Right? But you guys just continued to invest because things continued to look good?

Yes, as I mentioned, operating expenses, as a percentage of revenue, are going to remain constant as we head into Q3 because of the balancing of what we're looking at from an investment standpoint as well as driving future top-line revenue.

Okay. Let me ask one more question -- I think I'm allowed to because you tend to give the monthly perm revenue growth as for growing forward. You said it was up over 40% in July. That's correct?

That was perm.

Right.

There was 13% for Flex and 42% for perm.

13 and 42? Now, during the June quarter, what does the -- how do those months look in perm? I mean, I remember -- I think I remember they were up also similar rates, which was fantastic, but for the full quarter, you know, Search was up 27, so did -- was June a little softer than April and May? Is there something that has to do with the timing of your -- how you pay out the perm or the Search employees that it affects the timing of how fast quarters ramp?

John, this is Bill. Basically, what I have -- would like to tell you is that for Flex, year-over-year, April, May, June, and for the first month of July -- all up year-over-year. Perm -- same thing -- all up year-over-year. For technology -- same thing -- Flex and perm, month over month, and for the month of July -- up. Same thing for finance and accounting -- up. The only difference I have, really, is in HLS, where perm is -- the mix is down in April and May, up in June and July. So for the most part, we continue to see an acceleration. Now, whether each one of those percentages tells you in a given story, that I think we'd rather not disclose that. I'm not sure that would give any true view. But the true view is, for the month of July, up 13% Flex, 42% perm.

I guess what I'm getting at is there a normal pattern within your quarters where the first month of the quarter, the rate of growth -- I know and appreciate what you said that each month -- that April, May, June, and July were all up -- but is the rate of growth greatest in the beginning of the quarter? Does there seem to be a pattern? Because I think the rate of growth in April was greater than it was for the full quarter -- for perm and Search?

John, this is Joe. The best way that you can look at Search is on a year-over-year quarter basis. You can't compare the first month of a Q1 to the first month of a Q2 to the first month of a Q3 just because of how holiday impact and start of year ramp-up happens. So you have to look at the year-over-year. I don't believe we're prepared on this call to discuss what the first month of Q1 was versus the first month of Q1 last year, the first month of Q2 this year versus the first month of Q2 last year. What I can share with you is when you look at Q1 year-over-year, it was up 24.9%. When you look at Q2 year-over-year, it was up 27.2%. When you look at Q3, quarter to date, it's up about 42%. So there's a continued acceleration that's taking place.

Okay, thank you very much. Congratulations again.

Mark Marcon, Robert W. Baird.

Just a few follow-ups -- first of all, on the IT side, it sounds like things are going quite solidly, and I was wondering what particular areas are you seeing strength on? Either from verticals or skill sets on the IT side?

I think I said a few of those, but they're primarily PeopleSoft, .NET, and I would say enterprise-wide systems, certainly, senior systems analysts and developers, Web-oriented people. I think you can see all of that activity is pretty strong but certainly the large enterprise-type projects are now coming back onstream, and those longer contracts give a good annuity for our revenue stream.

Any particular verticals where you're seeing strength?

Financials would be certainly -- be a strong -- and we're certainly -- now that we -- with the acquisition of Vista, we're seeing a lot of activity in cleared personnel in our subcontracting for the government space -- federal government space.

Mark, this is Joe. What we're seeing is if you were to look at bill rate acceleration, we are seeing greater bill rate expansion happening on the coast, and when you look at the coast really map to certain verticals from a financial standpoint, the pharma space, and then you get out onto the West Coast you have a lot of biotech and a lot of technology out on that front. So we are seeing the greatest bill rate expansion happening on the coast.

Great, and then are you seeing -- with regards to your bill rates moving up as much as they are, with the clients that you still have, you know, kind of these larger contracts, are you seeing a movement away from either the VMS systems or trying to get around it through statements of work in order to get people who are in high demand?

Yes, that is to say, VMS is still in place, it's still strong, however, because of the need for quality talent and the ability to obtain that talent, we are finding it much easier to get around the VMS systems with statements of work.

Okay, and then with regards to the -- in terms of the SG&A as a percentage of revenue, you indicated it's probably going to be constant for the third quarter. Would you anticipate that that's going to be basically be constant for the entire year, just as we try to think about that? Or how should we think about that line item as a percentage of [reps] longer term?

Mark, this is Joe. You know, our practice is to provide forward-looking guidance on a quarter basis. So I'm not prepared to comment on Q4.

Okay. Let me ask sort of a related question, which is -- right now everything looks pretty darn good. Obviously, there's been a disconnect with regards to the way the market's been reacting not just with your stock but with virtually every employment-related stock relative to what you're currently seeing. So there are some investors out there who are anticipating a slowdown. What are the things that would trigger you to pull back with regards to your investments in terms of new personnel? Would it be a decline in orders or are there certain macro factors that you would look towards that would say, "You know what? Maybe we ought to leverage the investments that we currently have?"

Mark, this is Dave. I remember back to the second quarter of 2000. It was the new human capital era. It was different then. On that call we indicated that we were scaling back our Search hiring as our forward-looking KPI suggested that the market was starting to roll over. I remember on that call we were criticized sharply for that because it was, in fact, a new era. Two quarters later the evidence hit the market, and it was very clear that we were entering a slowdown in Search and hiring in the tech bubble that burst.

We rely heavily on a couple of factors -- KPIs are very important to us. They suggest what's happening currently in the near-term future with our customers. The other things that we look at are the way that we communicate with our customers and understanding their staffing plans. As a part of our meetings with customers, we actually sit down with them and go through staffing plans for the year. We understand where they're going. A lot of these plans are capital in nature, so they transcend one year to the next. Technology certainly fits that picture at 52% of the revenue; clinical does as well. So our revenue streams have, in many cases, a much longer view to them, so we are able to see further into the future. And the net of it is, after being in the industry for 26 years, having been through these cycles, you tend to get a sense for what's happening and, as I mentioned in my prepared remarks, this is a lot more like 1995 than it is like 2000. In 2000 we, as I mentioned, saw the rollover. We didn't see it in '95, and we're certainly not seeing it now, and we have a high degree of respect for our peers in this space, and none of our peers are seeing it either, so when you add all of those things up, there is clearly a disconnect between what has been considered to be leading indicators of staffing and what the market perceives.

Can you also comment a little bit -- I think one thing that's a little different now relative to back, say, in 2000 is maybe the variability with regards to your cost components. Can you talk a little bit about that?

One of the things that we've attempted to do is obviously keep as much variability as possible. That includes lease investments and other variable cost elements. We are not doing the same things that we did in the last cycle. One of the things we've done is centralize, for example, substantially in recruitment support and sales support. Leases -- lease terms, we're managing very carefully for yield; and seats, we are utilizing virtual models, and so there's a lot of things that we are doing differently. There are some things that we cannot control, but this time around we're certainly being much smarter about keeping our costs as variable as possible to adjust.

Josh Vogel, Sidoti & Company.

How much did the headcount increase on the perm side last quarter?

Seventy-three percent. I'm sorry, that's a -- you said quarter or year?

Both, actually.

Okay, 73% year-over-year; 10% wasn't it?

Ten percent total headcount for the quarter.

Total headcount for the quarter, 73% year-over-year.

Okay, and can you just comment on the state of the acquisition pipeline and what geographies you may be targeting right now?

Josh, I mentioned my earlier comments -- I'll just say that we have very specific criteria that we're after. We had mentioned previously certain geographies, so I would say that those things haven't changed since the first quarter.

Okay, great, and just a housekeeping question -- how much was capex in the quarter?

Capex for the quarter was 2.7 million.

Okay, and you expect for full year '06, it will be on par with '05 levels?

Correct.

With no further questions in the queue, I'd like to turn it back over to Mr. Dunkel for any closing remarks.

Okay, great. We want to thank you all for your interest in Kforce. We are very pleased with our performance this quarter. As I mentioned previously, we believe that the economy is shifting towards, really, a knowledge-based economy, and that the specialty and the tech space are where the action is going to be for the foreseeable future. We'll look forward to talking with you again at the end of our third quarter call. Thank you.

This does conclude today's conference, ladies and gentlemen. We thank you for your participation, and you may now disconnect.