Kforce Inc (KFRC) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kforce Inc. First Quarter 2010 Earnings Conference Call. One note, that today's call is being recorded. At this time, I would like to turn the conference to Mr. Michael Blackman, Chief Corporate Development Officer. Please go ahead, sir.

Great, thank you. Good afternoon and welcome to the Q1 Kforce conference call. Before we get started I would like to remind you that this call may contain statements that are forward looking. These statements are based on current expectations and assumptions and are subject to risks and uncertainty. Actual results may differ materially because of factors listed in Kforce's public filings and other reports and filings with the Securities and Exchange Commission. We cannot undertake any duty to update any forward-looking statements.

I would now like to turn this call over to David Dunkel, Chairman and Chief Executive Officer. Dave?

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

We are pleased with our firm's performance for the first quarter of 2010. As the quarter unfolded, we experienced a good start, some unusual weather patterns in the middle, affecting our largest markets, and then a strong finish, particularly in our technology segment. In March and April we've seen a significant upturn in job requirements for tech that was abrupt and dramatic. The demand is across most markets and client sizes and may be the beginning of a sustained period of significant growth for our technology business.

As the quarter unfolded, we also saw stability in both our HLS business units and F&A with KGS declining slightly this quarter, as expected. As I have been doing for a while now, I personally traveled to multiple markets to meet with clients or field teams and investors. It is clear that the sentiment shift is real, as clients are accelerating investments and awakening to the abrupt demand change in tech. It is interesting to note that the severity of the downturn and the resulting cutbacks, together with uncertainty about the regulatory environment, have shifted client emphasis towards using flex consultants.

We may be beginning to experience the temp penetration increase some have anticipated. In addition, permanent hiring is stronger than we expected, as clients rebuild lean staffs cut deeply during the downturn.

Throughout the quarter we continued our investment in our national recruitment center and strategic counts teams and selectively added to our field delivery resources, where appropriate, this in preparation for many leading economist believe may be several years of increasing tech demand. We also made excellent progress in our back office projects aimed at improving associate performance and increasing operating efficiency throughout the up cycle.

As I mentioned in our last call, our objectives for 2010, the second year of our three-year plan, are to further penetrate existing strategic accounts, gain additional customer share and selectively target new accounts. We have diligently planned for this period with the goal of surpassing prior peak revenue and earnings earlier in the cycle.

We anticipate using cash flow for continued debt retirement, share repurchase and acquisitions that meet a very high hurdle. We are continuing to see opportunities presented to us but are maintaining our discipline and standards.

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

Thank you, Dave, and thanks to all of you for your interest in Kforce. The firm continued its solid performance in the first quarter, as we were able to balance maintenance of our revenue stream with selected investments to prepare for the up cycle.

Our first quarter revenues of $226.7 million, which grew 0.9% sequentially, and earnings per share of $0.07 reflect a continued strengthening of our business. Our diversified revenue stream is concentrated in some of the areas of greatest anticipated demand, both from a cyclical standpoint as the economy recovers and from a long-term secular perspective. We believe that Kforce is well positioned with great people in an operating platform that delivers exceptional results for both our clients and our shareholders.

During the first quarter, we continued to invest in our centralized national recruiting center and our strategic accounts group which, coupled with selective investments in our field sales force, position us to attain higher peak revenues and earnings levels and experience during previous up cycles. Our largest business unit, Technology Flex, which represents greater than half of total firm revenues, performed well relative to the market in 2009 returning to sequential growth in Q3 2009.

Q1 2010 revenues decreased sequentially by 0.3% from Q4 impacted by weather and early completion of a large project at a client but were 1.3% higher than Q1 2009. Tech Flex revenues recovered in January more quickly than in previous years from annual assignment ends, but were relatively flat in February and early March with an upward trend later in the quarter that strengthened in April.

Recent trends for Tech Flex are up from March levels as leading indicators continue to gain strong momentum in April. We therefore expect Tech Flex to have strong growth in Q2 and for the foreseeable future with a sustained increase in IT spending providing a strong a catalyst.

Our finance and accounting flex business, which now represents 16% of total revenues increased 0.8% sequentially and was down 0.7% year-over-year. We continue to see more demand in the lower rate, lower margin job classifications, which is impacting gross margins. However, this business has been enabled by a strategic accounts strategy and is supported by our low cost, centralized delivery function in the national recruiting center creating operating leverage.

FA flex revenues were relatively flat the first two months of the quarter and began to improve in late March. Recent trends for FA flex are up from March levels. We therefore expect FA flex to be up slightly in Q2.

Our HLS business segment, which comprises 18% of total revenues, is made up of two businesses, clinical research and healthcare. During Q1 our clinical research business increased 12.8% sequentially but decreased 9% year-over-year and healthcare decreased 1.8% sequentially and declined 14.7% year-over-year. The sequential increase in clinical research was driven by a combination of more billing days in Q1 and growth at a significant new client. We expect Q2 revenues to increase slightly as we see a ramp up of activity at this new client.

Our health care revenues have stabilized. Margins remain strong and hospital spend is beginning to improve. We believe in the demand for this profitable business and expect revenues to be up in the second quarter.

Revenues for Kforce Government Solutions, our prime government contracting business, decreased, as anticipated, by 4.4% sequentially and decreased year-over-year by 5.1%. This business is concentrated in some of the better funded areas above defense and civil federal services such as health care, data integrity, finance and technology solutions and its growth prospects remain strong. In the near term we continue to see the expected impact from in sourcing, as well as contracting delays and an increasing number of contract protests, which have let delay works on awarded contracts.

We are also still performing work on two of our larger contracts that had been under protest. Should these protests not be upheld or should we lose re-compete opportunities on these contracts, revenues could be negatively impacted.

I should also note that in addition to the Q1 SUTA impact, margins were negatively impacted by bill rate compression due the government's focus on cost reductions on re-competed contracts, as well as a decline in our utilization rates in Q4. We expect margins going forward to improve from Q1, as utilization ramp continued to be under pressure. We have make additional investments in business development in this unit, which we believe will ultimately mitigate some of -- much of the impact of these challenges and expect Q2 revenues to be flat in Q1 and then resume strong growth later in this year.

Search revenues from direct placements and conversions, which were 3.5% of total revenues in Q1, increased 6.6% sequentially. Search in Q1 2010 was increased 0.9% year-over-year. This is the second consecutive quarter search revenues have increased, though total revenues remain at low levels. Search revenues reflect an increase in conversions with placement fees stable to increasing. Q2 has started strong and we expect search to continue to grow.

We continue to diligently manage the performance of our sales associates, which are the most tenured in the firm's history, and look to our internal KPI as one of our primary near-term forecasting tools. Our KPI strengthened in March and significantly further in April as we have seen improvement in many of our flex leading indicators, particularly in Tech Flex job orders. As a result, we have increased pro forma head count in our sales, sales support and delivery teams, even as capacity exists in our existing work force.

Core field flex headcount was up 4% while core search headcount [increased] 5% sequentially. Total core field sales headcount is 2% greater than last quarter. All of our businesses are supported by our national recruiting center and strategic account sales teams, which add additional leverage and speed of execution to the capacity that exists in the field sales force. These corporate sales teams have increased in size by 21% sequentially and have almost doubled over the past year.

As we consider the quality of our revenue stream, defined by a diversified business footprint and 3,000 clients to whom we provide services at any point in time, we believe we are well positioned to maximize both market and client share as the economy rebounds. We have established a cost effective delivery model in our national recruiting center and our large strategic account strategy has enabled us to evolve our revenue footprint to take advantage of our nationwide geographic presence and take customer share, as large volume accounts continue to consolidate vender lists. Additionally we expect search to continue to complement our revenue footprint.

We are off to a solid start for the second year of our three-year strategic plan, which we are calling the "race for the Triple Crown." We understand that our clients believe our services are cost effective way to acquire talent. Our immediate plans are to continue to have a relentless focus on retaining our great people and to improve client satisfaction, while driving continued profitable revenue growth that will lead us back over the $1 billion dollar mark in revenues and beyond.

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

Thank you, Bill. The firm continued to perform well during the first quarter of 2010, coming in at the middle of guidance for revenue and at the high end of guidance for earnings per share.

Revenue for the quarter of $226.7 million increased 0.9% sequentially and decreased 2% year-over-year. Flex revenues of $218.8 million increased 0.7% sequentially and were down 2.1% year-over-year. Search revenues of $7.9 million increased for the second consecutive quarter by 6.6% sequentially and increased 0.9% year-over-year. This is the first year-over-year increase in search in seven quarters.

We estimate that the weather related impact on Q1 revenues to be between $900,000 and $1.2 million. Revenue trends for the beginning of the second quarter of 2010 are up from March levels and key indicators continue to trend positively.

For the first four weeks of April, Tech Flex was up 12.6% year-over-year, finance and accounting flex is up 1.8% year-over-year and HLS is down 3.3% year-over-year. Search revenues are up 58.6% year-over-year for the first four weeks of Q2 2010. We caution that it's difficult to draw conclusions for Q2 based upon this limited data.

Net income of $2.7 million and earnings per share of $0.7 in Q1 2010 decreased sequentially 23.4% and 22.2% respectively compared to Q4 2009. These declines are largely a result of the reduction in flex gross margins due to the increase in payroll taxes at the beginning of the each year, coupled with the continued investments in our national recruiting center, strategic accounts infrastructure and field sales associates.

Year-over-year net income and earnings per share declined 14.3% and 12.5% from $3.2 million and $0.08 in Q1 2009. Q1 results were positively impacted by a one-time true up related to foreign income taxes of approximately $300,000 resulting in a Q1 effective tax rate of 29.8%.

Our overall gross profit percentage of 30.1% decreased 100 basis points sequentially, primarily as a result of the increased payroll tax expense experienced in the first quarter, and decreased 110 basis points year-over-year, primarily as a result of changes in business mix in our F&A business and the margin impact in our government business, as described by Bill.

Our flex gross margin profit percentage of 27.5% in Q1 2010 decreased 120 basis points sequentially, largely due to the increase in payroll taxes payable at the beginning of each year. The increase in payroll taxes reduced flex gross margins by approximately 90 basis points. This is approximately 30 to 40 basis points greater than the 50 to 70 basis point impact we have seen historically, but less than we originally anticipated, which could have been as much as 100 basis points.

We believe we've done a good job passing much of the increased SUTA cost and this continues to be an area of focus. Additionally, there continues to be pressure on bill rates and pay rates spreads across our businesses. In general we've been very successful in passing a significant portion of pay increases of our billable consultants on to our clients, although there was typically a lag in bill rate compared to pay rate increases, as demand strengthened and supply tightens, leading to some margin compression.

We've been particularly successful balancing these spreads in our largest business, Technology Flex where margins were essentially flat year-over-year. Staffing bill rates have increased 1.8% sequentially but decreased 2.6% year-over-year and pay rates have increased 2.9% sequentially but decreased 0.9% year-over-year.

As we look foreword to Q2 we will continue to focus our efforts on managing bill rate/pay rate spreads, though we expect margins to continue to be under pressure as the war for talent heats up in the candidate constrained environment for highly skilled workers. We believe our centralized nationalized recruiting center provides the firm with a competitive advantage in this area and it's been the key contributor to the relative maintenance of our margins.

Historically we've seen margins begin to expand three to four quarters into an economic recovery. This would suggest margin expansion potentially in the second half of 2010. The firm continues to manage operating expenses, while continuing to make investments to improve operating leverage. Operating expenses were 28.2% of revenue in Q1 2010, a decrease of 10 basis points from Q4 2009 and a decrease of 50 basis points from 28.7% in Q1 2009.

The majority of our cost structure is variable and compensation related expense, which is highly correlated to gross profit, comprises over 75% of our operating expenses. A key benefit to the investments in our national recruiting center and strategic accounts group is to improve the performance of our field sales associates thereby reducing the cost of expensive turnover and the need for significant hiring as demand increases. As this performance improves we anticipate more productive delivery of our services that should improve operating leverage.

We believe revenues can grow as much as 25% without having to add significant sales headcount, though our selective investments in headcount during the quarter positioned the firm to better penetrate specific market opportunities and also add additional capacity in our high gross strategic accounts in national recruiting center. We continue to see improvements in our non-compensation based cost structure, as a result of the significant infrastructure investments made over the past four or five years. As we look forward, we expect these investments to allow operating efficiencies to evolve and produce corresponding leverage in earnings over the next few years as revenues grow.

Our accounts receivable portfolio continues to perform well. The percentage of receivables aged over 60 days decreased to 4.2% in Q1 and net write-offs were approximately $218,000 in the quarter. Our allowance for doubtful accounts is currently $6.8 million and we believe sufficient to account for the current risk in the portfolio.

EBITDA, an indication of the foreign strong cash flow, was $8.6 million, or $0.21 per share in Q1, as compared to $9.6 million, or $0.24 per share in Q4. Year-over-year EBITDA decreased 12.5% from $9.8 million in Q1 2009.

Bank debt at the end of Q1 2010 of $19 million is up from $3 million at the end of Q4 2009 but down from $44 million at the end of Q1 2009. This sequential increase was primarily the result in the increase in accounts receivable and the timing of payment of payroll and accounts payable items barring availability under our credit facility, which expires in November of 2011 with $70.5 million at the end of Q1 2010.

Capital expenditures in Q1 for normal business operations were $1.9 million and are expected to be $6 million to $8 million for the year. Additionally during April 2010 the firm entered into an agreement to acquire its corporate headquarters in Tampa, Florida for $28.5 million, which is expected to be funded under our credit facility. The acquisition is anticipated to close in May 2010. We anticipate 2010 expenses to be reduced by approximately $500,000 so the impact in Q2 will be nominal. Going foreword, savings resulting from the purchase should exceed $1.4 million annually.

The firm made no significant repurchase of stock during the quarter and has $71.2 million available for future stock repurchases under the current Board of Director's authorization.

In terms of guidance for the second quarter, we expect revenues may be in the $238 million to $245 million range. Earnings per share may be between $0.10 and $0.13 with approximately $40.4 million weighted average diluted shares outstanding.

Our effective tax rate each of the next three quarters is expected to be approximately 39%. This guidance contemplates a strengthening in our business driven by continued growth in Tech Flex. Achievement of the low end of guidance would result in sequential total firm revenue growth of 5% and the high end assumes 8.1% growth including continued improvement in search.

The second quarter of 2010 has 64 billing days versus 62 billings in the first quarter. We are pleased with first quarter results. We continue to invest in our business to take advantage of the economic upturn and believe we are well positioned to out perform as the economy recovers. We have quality revenue stream and balance sheet and the strongest management team and most tenured and talented associate population in our history and we expect to capitalize on the capacities that exist in our current employee base to increase leverage and accelerate earnings as the economy rebounds positioning the firm to attain prior peak earnings earlier in the cycle.

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

(Operator Instructions). We'll go first to Kevin McVeigh.

Hey, great execution in the quarter. I wondered, Dave or whom ever it makes sense, could you help us understand? It seems like traditionally the light industrial recovers and then some of the more professional services will lag by two to three quarters. But, given your first quarter results and second quarter guidance, it seems like that's narrowed pretty significantly and I'd just love to get your thoughts on what's driving that. I mean you've done a great job through the downturn. Is it the NRCs at the sales force? And just, in addition to that, can you talk about the leverage because your SG&A as a percentage of revenue, the leverage was even better than in the fourth quarter, which is seasonally weaker. So you've got a lot of real positive dynamics and I would just like to understand a little bit more.

I'll give you some commentary of the market and then Joe can comment on the SG&A leverage. It's interesting because this recovery is not like the ones that I've experienced in my 100 years of staffing. The interesting thing is we're seeing, as evidenced by our permanent placement we're seeing hiring happening earlier in the cycle and coincident with the improvement, particularly in tech.

We think this is predominantly due to the fact that many of our clients -- it's been corroborated by our meetings with clients -- cut very, very deeply. In fact, cut the positive cash flow and, as the stability returned they found themselves really shorthanded, so they've been doing direct hiring and also converting consultants so we're benefiting on the search side but losing to some degree on the consultant billings in the flex side. And I would say this is predominantly in the tech area.

Can't really speak to why the traditional relationship with the labor categories is happening the way that it is. I have watched and seen that many of the manufacturing firms are beginning to hire again and I think I would attribute it predominantly to the really unusual nature of this downturn, the severity of it and you think about the catastrophic impact of the Lehman bankruptcy and the fear that gripped the markets and all of those things I think accentuated a lot of the cuts that people made and what we're seeing now is an element of stability.

And I mentioned in my prepared remarks there's no question that we are seeing also the clients choosing to use our flex consultants rather than beefing up their own internal staff and that's directly related to the pain that they've suffered and the cutting that they had to go through during the downturn and the uncertainty related to the regulatory environment, so I think we're benefiting in that regard.

Joe, do you want to comment on SG&A?

Yes, Kevin, from an SG&A standpoint we're really seeing the benefit of our tenured work staff. We worked very hard on retention of our employee base. That's not just our field based associates but that's also our back of the house, so we really pick up a lot of efficiency because of that tenured work force from a compensation commission standpoint out in the field and then from a lack of need of really expanding our back office operations to get a lot of things done because these people have worked together for so many years and they're just so efficient.

The other items are we're -- this is a byproduct of a lot of the investments we've made over the past five to six years on our infrastructure and gaining leverage from that infrastructure, so we've really taken down our what I would consider fixed cost infrastructure. We're getting leverage off of that and we continue to plan on continuing to gain leverage off of that and so, even albeit while we're getting improvements from an SG&A standpoint, we believe we still have significant capacity and actually, as we move from Q4 into Q1 we added to our sales support infrastructure. Bill mentioned some of those numbers in terms of the NRC and our strategic accounts group, so I mean we are adding the sales capacity as well.

That's super helpful and let me just sneak one more in and I'll get back in the queue. In terms of the Healthcare Bill, how does that impact relationship with the temps, number one? And then number two, how does that impact the HLS segment?

Yes from a healthcare reform I think the way that I would categorize it, and I'll talk about Kforce specifically, I don't think anybody is excited about the potential increase in cost to do business but we believe on a relative basis that we'll feel less of an impact than many of our competitors. We have plans in place for over 75% of our population, which really will not put us in that difficult spot of having to make a decision of do we want to offer those employee benefits or do we want to pay the excise tax because those plans are not really going to be affected by the healthcare plan.

I mean over the years, as healthcare costs have continued to rise, we've absorbed these costs and they're basically embedded in our operating costs as part of doing business. In comparison we've seen quite a few of our competitors over the years really drive to plans that are more fully funded by the employees and these are the plans that really it's targeted after, so we're very comfortable where we stand from our perspective realizing over 75% of our population is really not going to be impacted by this.

This is Bill, Kevin. On the healthcare side, business side of healthcare, there are a number of rules that are already in place for healthcare. In the coding area there's some new coding activities that are going on, or coming into place in 2010, which were quite significant for the coding aspect of what we do. On the other side of that, the electronic records is going to be quite significant as well, so that will affect our IT group quite a bit, so we have a specialized vertical addressing those issues and so we look forward to that piece of it for our business.

Super, thanks.

Mark Marcon, R.W. Baird.

Terrific execution, particularly in terms of managing the SG&A and seeing leverage come through. Can you talk a little bit more about the -- you used the words, "sudden, abrupt, dramatic" in terms of the pickup, in terms of IT. Was that truly across the board or does it have something to do with some of the contracts that you've been going out and visiting and maybe making a little bit more progress with regards to getting some larger accounts or can you just give us a little more color there?

Yes those words were chosen carefully because we have really, as we monitor very closely our KPIs, I mean it has been significant and the interesting this is it is across markets and it's across client sizes so, while we've certainly seen an impact from our strategic account initiative and benefited substantially from that, as we look at the marketplaces we're really seeing it across different client sizes, different industry groups and different marketplaces. The west has been particularly strong for us this quarter and has had a great start to the second quarter as well so I would attribute it predominantly to what we're seeing in the press about the massive investment in technology and all aimed at increasing productivity and the result of catch up and delayed projects from the last several years.

Great and are you seeing any impact with regards to a couple of your competitors that are recently going through some corporate transitions?

We've seen to some people that have come to us from some of those accounts. I can't attribute any revenue to it but at this point in the game I would say that it's still muted and still in a period of transition.

Great and then you mentioned that bill rates are still under some pressure. With demand picking up as much as it is, at what point do you think bill rates could actually start improving on a year-over-year basis?

Yes, as I mentioned in the comments, I mean when we look back at our historic data, Mark, I mean we typically see a lag of three to four quarters, so it's based upon when you would peg you believe this has begun to turn, whether it was Q4 or Q1. Really the back end of 2010 is when we would anticipate that potential would be there if we follow some of the historic trends that we've observed.

We basically have contracts that are annual in nature and as those contracts renew, that's when we would start seeing the improvement in spreads as well.

Yes because I was really answering to spreads. Now I believe you specifically asked about bill rates. We -- bill rates were actually up on a sequential basis so--

Right I noticed that. Just that you're, as I look at it, it looks like the current bill rate is relative to the middle of last year still a little bit down, so then obviously in Q4 it came down a little bit more and then so relatively easy sequential compare but I was just thinking about at what point does it start trending up year-over-year and you answered that. And then, in terms of the pay rates, can you -- do you have enough flexibility to manage those within the bill rate context or are a lot of the contracts spread based?

No I mean the bulk of our business I mean that will have an opportunity to move as the bill rates adjust, so historically we price it on both sides and supply/demand just drives so much of that. and based upon how severe this demand increases, I mean that's going to -- it's going to more quickly and you've seen some of the press out there already in terms of what's happening with what pay and some of the anticipated increases there. And we're dealing with the predominantly the college educated, which never hit the same unemployment rates as the general population, so one would translate to that that you would see it a little bit exponentially impacting that population, so that's the area that we focus on.

Got it; thank you.

Tobey Sommer, SunTrust Robinson Humphrey.

I had a question for you related to one of your prepared remarks saying that potentially peak margin and EPS could happen earlier in the cycle. Is it fair that potentially GP could be, percentage, could be lower but we would get more SG&A leverage in terms of reaching that goal earlier in the cycle or should we think about it differently in terms of the composition of getting to that outcome?

No I think you should think about it as total firm GP absolutely being lower than it was in the prior cycle just because of the mix of where we are from a search contribution versus flex. I mean, that just inherently drives down the margin and yes we are focused on controlling SG&A and gaining leverage from that front.

And just I had a question for you about compensation of the field staff and recruiters, both in the field offices as well as your focused efforts, your centralized efforts. Are you doing anything to tweak the compensation, whether it's favoring margin or favoring volume of sales and sales growth, exiting the recession I know sometimes there may be certain priorities you have in the depths of recession and different ones as we exit and wondering if that's manifested itself in a changing compensation.

Yes I mean we've -- compensation is near and dear to us and we spend quite a bit of time understanding the competitive landscape. In fact, we have an office, which is our Chief Talent Officer office, which reports directly into me, which actually is the seat that I sat in prior to stepping into the CFO seat because this is such a cost component of our business, as well as it's a revenue driver. Our plans are all performance based, totally confident in virtually every acquisition that we've looked at. Our top performers make top pay in the industry and those that are under performing make a lot less here and typically don't stay around here very long, so I believe that our compensation structure drives the behaviors that we're looking to get after, which is capturing customers market share.

And just had a question for you on the government side, I think you mentioned some re-competes that you're continuing to do work on. When do you expect to hear back on those re-competes and how meaningful are they for the segment?

This is Bill. They are quite meaningful. We expected to hear at the end of the last year. We expected to hear in the first quarter. We expect to hear in the second quarter. The government has really slowed down significantly with the administration change and so there's a lot of issues that need to be resolved and until -- and certainly the government is getting to a position they're going to have to speed some of this up but it's, at the moment on those two, it's working to our advantage. There are other contracts that's not working to our advantage so the task orders are not being let but, at the moment, it would be significant to that unit not overly significant to the firm, as a whole.

Thank you. There's two kind of detailed questions if I could. How many billing days in the third quarter and the fourth quarter of this year? And then how should we think about incremental margin because if I do -- if I am doing my math correctly for guidance it implies I think something above 20%. Is that a reasonable way to think about the business?

Yes, Tobey, so for Q3 we'll have 64 billing days and for Q4 we'll have 61 billing days and restate your margin question.

If I am doing my math correctly, relative to 2Q guidance in the 1Q results, that incremental operating margin, EBIT margin seems to be kind of in the mid 20s. Is that a reasonable way to thinking about it if, again, if I am making my calculations correct?

I'm not sure what, when you're talking incremental operating margin. I mean, but certain -- well, we can say this. Certainly, as revenues improve, which we anticipate, there will continue to be a better EBIT and a bottom line margin percentage, if that's what you're referring to.

I think you mean SG&A don't you, Tobey, that the SG&A would be in the mid 20s? Is that what you're saying?

No, no. I'll handle it off line. I am talking about the incremental operating margin per revenue dollar. Thanks.

Okay, all right thank you.

Paul Ginocchio, Deutsche Bank.

On investments you talk about the 2Q versus 1Q. Any way to size that? I mean, obviously SG&A was flat Q-on-Q. What's the kind of growth look like into the second quarter? Thanks.

Yes I would say from an SG&A standpoint it's fairly stable and, similar to what we saw last year in terms of margins. We had about an 80-basis point margin and improvement sequentially from Q1 to Q2. This year with the dynamics associated with where we are in the cycle from a potential compression, we don't have anything aggressive for margin expansion built into our guidance at this point.

Okay so, in that case, if the SG&A is pretty flat it does look like on a Q-on-Q basis it would seem like you're, unlike last year where your gross margin, your overall gross margin, tech and flex combined, was up, this quarter it's probably going to be at least on a Q-on-Q basis 2Q versus 1Q be actually down. Is that right?

No it would be up on sequential basis, maybe not to the quite the same extent as what we experienced last year and, again, we like to model from a conservative standpoint.

Understood thank you.

Jim Janesky, Stifel Nicolaus.

Yes a couple questions, Joe, just to clear up the question on peak margins, you would before you bought your Government Solutions practice you achieved peak margins overall when perm was growing 25%, 35%, so I understand that that's going to affect the mix but to say that that's going to occur earlier in the cycle I, perm aside, I assume that it's still the majority would come from SG&A leverage, unless you expect the change outside of perm in the gross margin profile of some of your businesses going forward. Is that the way to look at it?

Yes I mean you have to understand we're a very different firm today than we were in the last cycle in terms of the makeup of our population in terms of the infrastructure and the leverage capabilities that we have. We spent an inordinate amount of time building out our shared services function, building out our national recruiting center and things we're doing from a strategic accounts standpoint to really allow and enable our field associates to be more productive, so operating leverage is really what it's all about. So, to answer the question, we don't need the 10% mixture of perm to get back to those same operating margins that we experienced last time around. We've completely re-engineered the firm and that's basically how we're operating.

Okay great that's helpful. Shifting to finance and accounting, if you can help us understand the flex revenues were roughly flat sequentially, up a little bit. The perm, the search revenues jumped in the fourth quarter over the third quarter of 2009 but then were flat into the first quarter of 2010. Can you -- I think that you explained that the majority of the search, of course, movement and the early hiring is happening in the tech segment. Dave, can you comment on the F&A segment, what are the trends there outside of the comments that you made about billing and where the business is?

Yes I would say that, looking at F&A, what we see is a consistency but no major catalyst to accelerate the revenue. There's been a lot of discussion about IFRS and so forth but the reality of it is that the drivers for F&A are growth. M&A activities and regulatory change and, from our perspective, we don't see any of those things happening. However, we are benefiting from our strategic account relationships and because of our tenure in the market we expect that we'll continue to take market share. So this isn't going to be for F&A like it was in the last cycle, where there was a Sarbanes Oxley impact, there was a lot of M&A activity. We believe that this cycle for M&A will probably be somewhat muted. We can grow it. We will grow it but this one is going to be a tech recovery.

And so you're not -- so you're finding within search that folks are a little bit more conservative or hesitant about making permanent hiring decisions there than they certainly are within the tech segment, right?

That's true. Jim, this is Bill. That's true but we would also say that I would emphasize what Dave just said, that our investment is in tech so, for example, an F&A search year-over-year the people we have in F&A search are down 48% versus being down 23% in tech. We're continuing to maintain our search team in tech because that's where the cash is.

Right, right, so down headcount in F&A but year-over-year the revenues are roughly flat so I mean you're getting -- I mean these must be pretty tenured seasoned people that are extremely productive. Is that accurate?

Yes these are the tenured people. That's who we wanted to hold onto and those are the people that have stayed and we've supported them with the national recruiting center from a delivery standpoint and, of course, the other side of it is there's still capacity because these are our top performers. These are people who in historical cycles have performed significantly better than they are even now. They are very important to our firm. They're very important to us from a client servicing standpoint, so we've worked hard to make sure that we give them the support they need. Unlike in past cycles where they might be working with a junior recruiter in the field, which would affect overall GP and would be -- would skew the headcount, we've taken a different approach this time in servicing them from a delivery standpoint.

Okay great thanks.

Josh Vogel, Sidoti & Company.

I just have a couple quick ones here. I missed what you said why the tax rate was lower in the quarter. Can you just go over that?

Yes we had -- it was a foreign tax true up that we did in the quarter as we drove that rate down.

Okay so then we should expect a near 40% range for Q2 and going forward?

Yes in my opening comments, basically 39% for the remainder of the year.

Okay great and can you just talk about your typical tech or IT client? Are these mostly small and medium sized businesses or do you have relationships with some of the bigger players because we've seen a lot of reports that the tech giants are adding head count and I wanted to know if you were playing in that market.

Absolutely we are playing in that market. We think we have a very nice mix between the different segments in size but 23% of our revenues come from our strategic account clients and they are very active in the Tech Flex area, particularly in April as Dave was talking about, as our other clients are. But the giant clients are very aggressive right now and they're -- the job order flow I think, as David is suggesting, Tech Flex job order flow has increased dramatically. In some weeks it's as much as up 35% sequentially.

Okay great. Thank you.

[John Haley], North Coast Research.

Question for you regarding acquisition activity, I was hoping you could revisit what maybe some of your goals were in terms of hurdle rates and how you looked at deals. And when you look at kind of the portfolio of the Company today, it seems like you're most upbeat about the tech component of the business and maybe you could try to prioritize for us what areas of the portfolio would be of highest priority to make acquisitions in and if there's a certain percentage of the portfolio you want to keep tech. Thanks.

John, this is Dave. The number one consideration is culture. It's always culture. If the culture doesn't fit, free is too much so we walk away from a lot of transactions on the basis of that alone. The primary consideration after that is whether or not it will be additive to us. Tech has been a focal point for us, as KGS has as well. When we look at tech today we're looking at acquisitions that will be additive to our markets, strengthening our markets and helping us to gain additional share in our clients.

As we have discovered over the years, the more significant we are to a client the greater the share we have, the better opportunity we have to be their partner. When we're entrenched become and, frankly from our standpoint, that gives us a more stable revenue stream and an opportunity to grow our business over the long term, so there was a specific strategic effort that we made.

As far as hurdle rates and those kinds of things, we have a number of different considerations. We certainly wouldn't want to tip off any of our guys and what it is that we're willing to pay and what our hurdle rates are. Activity has been good. We've seen a number of acquisition prospects. The good news is that, based on where we are today from our business, we don't have to do anything. However, it would be from our standpoint desirable to do one earlier in the cycle versus later because we are focused on achieving peak earnings and peak revenue earlier in the cycle, so we're head down and executing and that's our focus right now.

I appreciate it. Thank you.

Mark Marcon, R.W. Baird.

I just had a follow-up with regards to the discussion around peak margins. Last time around we ended up seeing peak margins on a quarterly basis but on the EBITDA side approach 9.7%. How much higher do you think you can get if this ends up being a normal length in cycle? I mean, obviously nobody really knows how that's going to unfold but if this were to go on for another four or five years?

Yes, Mark, we had our goal out there last time. We were chasing 10%. We've been there before. That still remains the goal, so that's as we look at our business planning and our three-year strategic planning. We're building plans that allow us to get to those levels. Once we get there, then we'll set the next target but that's the target that we have in our sights.

Okay great and then can you talk a little bit about the in sourcing dynamic with regards to KGS and how are you approaching that? I mean, it sounds like there's a lot of cross currents there.

We are approaching it with a tear I guess. In sourcing by the government is -- has affected us pretty significantly. We are somewhere between 8% and 10% of the activity is from in sourcing. In sourcing has two pieces to it. It's not only just the actual in sourcing of the clients for the -- or of our consultants, there's also a de facto in sourcing where task orders are not renewed and basically the government takes our people and does all the business itself. So we're looking at 8% to 10% currently. We believe that this will run its course, as the administration becomes more confident in numbers it really costs to take people over and the training and the benefits and all the additional things that go on with having a permanent sales force. So that's important to us.

On the other side of that, of course, we just have to have more wins on the proposal side and we have pretty dramatically increased our win percentage new proposals to 63%. We have 28 RPs out that we have responded to today and so we look forward to probably a flat second quarter but some strong improvement in the second half of this year for KGS.

Bill, I appreciate the color. Can you talk a little bit how you're thinking about just the longer-term trajectory of that business, given everything that's been occurring?

I would say we certainly are bullish. We think over -- we think we have an outstanding team there with Larry Grant and [Glen Shaffer] and that team, so we are looking for strong growth over time. We have set a bar for organic growth that we think that should be achievable and that's 15% and so, of course, things have to settle down in the government. The government has to get the contracting officers in place. We have to do something about all these protests that are delaying activities but we have beefed up our sales, our business development team. Of course, there's longer sales cycles in this business but we believe we have put together a team that should achieve that 15% growth over a long period of time.

Great and then lastly, just on the clinical research sub-segment within HLS it sounds like things have stabilized there and we're starting to see a pick up. How do you -- I mean there's been all sorts of news that's been occurring in big pharma land. How are you thinking about the longer-term growth rates over there?

Well, yes it isn't just stabilized in the first quarter. It had a 12.8% growth, which was pretty significant growth and so we believe we are in the right place. Functional outsourcing and monitoring site management of clinical trials is, we think, is very important. We believe we will be a strong player in this no matter how the integrations of these major clients come out. We have a very strong presence in large clients. We are building a very nice presence in mid-size and smaller clients and so we believe there's a lot of opportunity to do things here and we -- this is a great team we have and we will continue to expand that business.

Great. Thanks for the color.

[Gary Krishnan], Credit Suisse.

Just have a couple real quick ones. I think last quarter you provided a growth in the number of strategic accounts I believe. Do you have the data this quarter?

This quarter it looks like it's going to be somewhere around 2% to 3% growth over last quarter. Last quarter it was pretty significant and growth this year -- this quarter has been less. Obviously there is less billing days and there's the weather things that are involved. I would say to you though over the last year we have almost doubled that group. They are ramping up and we believe that they will achieve pretty significant growth for the firm. We're certainly looking for growth to ultimately get us to somewhere around 30% of the revenues that we have in the firm would come from our strategic accounts.

And, as you think about the composition of your sales associates or sales force, and you look at the areas that are attractive, any talks around how the mix of skills or domain knowledge, etcetera, might change looking ahead?

Well, as we've mentioned, Tech Flex and tech in general is the hot area. In the NRC, for example, we are surging that team to address the significant influx of job orders that we've seen. I mentioned earlier the 35% sequential growth in job orders for the firm that we have seen so, as the mix continues, we will be after the Tech Flex area predominantly, although tech search has also improved pretty dramatically. So there will be a shift and it's really -- and that's why we built this, the NRC, which is very elastic in the way that it can respond to client demands and that's working out very well for us.

From a sales standpoint, Gary, the focal point our teams are pretty flexible and able to move to where the skill set demand is but we also have verticals. We have a federal vertical, as you know. We also have healthcare vertical. We have financial services and we will continue to pursue those verticals, have opportunities, as Bill mentioned earlier, where we can take healthcare technology and combine it with our healthcare billing systems capabilities. So those are all things that we look at, as we look at industry verticals. So we're comfortable with our domain knowledge and domain expertise and if we look at our technology revenue footprint, as a whole, it's quite diverse actually.

Okay that was helpful. Thank you.

And there are no further questions at this time. Mr. Dunkel, I'll turn the conference back over to you for any closing or additional comments.

All right that's great. Thank you very much. I want to first of all say thank you to each of you for your interest and support for Kforce and, once again, thanks to our team for performing very well and for winning it on the field. Thanks to each and every member of our field and corporate teams. Corporate teams do a lot to support our folks in the field and also to our consultants and our clients for allowing us the privilege of serving them.

So thank you very much. We'll look forward to speaking with you in our second quarter call. Good evening.

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation. Have a great day.