Kforce Inc (KFRC) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kforce Incorporated second-quarter 2014 earnings conference call. (operator instructions) As a reminder, this conference call may be recorded.

I would now like to introduce your host for today's conference, Michael Blackman, Chief Corporate Development Officer. Please go ahead.

Thank you. Good afternoon. Welcome to the Kforce Q2 2014 earnings call.

Before we get started, I would like to remind you that this call may contain certain statements that are forward-looking. These statements are based upon current assumptions and expectations and are subject to risks and uncertainties.

Actual results may vary materially from the factors listed in Kforce's public filings and other reports and filings with the SEC. We cannot undertake any duty to update any forward-looking statements.

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

Thank you, Michael. You can find additional information about Kforce in our 10-Q, 10-K, and 8-K filings with the SEC. We also provide substantial disclosure in our release to assist in better understanding our performance and to improve the quality of this call.

We're very pleased with our performance, as both revenues and earnings per share met our higher-end expectations for the quarter and exceeded consensus estimates.

Q2 revenues increased 15.4% year over year to $327.4 million, as a result of growth in all of our business lines. Earnings per share of $0.33 increased 57.1% from $0.21 per share in Q2 of last year.

These results were driven by growth in all of our Flex staffing businesses, who collectively have grown 17.7% year over year.

Demand for our flexible-staffing services continues to be very strong. The temp-penetration rate continues to exceed all-time highs, now at 2.07% as of July, surpassing the previous peak of 2.03%.

In addition, college-educated unemployment of 3.1% remains at low levels, and temp-job growth remains a significant driver for overall job growth in 2014.

Staffing-industry analysts [estimates] revenue growth in the tech-staffing space, the largest component of domestic professional staffing, to be 8% for both 2014 and 2015.

A perfect storm has developed wherein technology has become increasingly embedded across our clients' business platforms, while development cycles are shorter, skill obsolescence has accelerated, and lack of immigration reform are contributing to further resource scarcity.

As the seventh-largest domestic tech-staffing firm, we believe our current mix of almost 70% Tech-Flex revenue and a significant global candidate shortage puts Kforce in an optimal position for further growth and expanding market share.

As announced this morning, today we completed the sale of our health-information-management business. As a general note, numbers cited during our call for Q2 will reflect operations inclusive of HIM unless otherwise noted.

HIM has been a successful part of Kforce for some time, and we are proud of all they have accomplished on their way to becoming one of the leading staffing and solutions providers in the sector.

As we look to simplify our business model and intensify the focus on our core businesses, it became clear to us that we could not sustain the level of investment needed to deliver exceptional service to our clients and equip our team with the tools they needed.

In the new era, we are narrowing our focus, simplifying our business model, and raising accountability. We believe that our Kforce stakeholders are better served by focusing on technology and finance and accounting to our commercial and government services.

We sought and found an acquirer that we believe will provide the HIM team with the opportunity they deserve to better leverage their existing capabilities and client relationships to grow and evolve with a more singular focus and less competition for investment dollars.

We extend our best wishes to the HIM team and thank them for their many contributions to Kforce over the years.

The consummation of this transaction allows us to dedicate our resources to exclusively provide technology and finance-and-accounting talent in the commercial and government markets through our staffing organization and KGS, our staffing-solutions provider.

The market for technology staffing is in excess of $24 billion, and the FA market exceeds $6 billion. We believe we can significantly improve upon our approximately 3% market share in each and better serve our current clients and consultants, leading to sustained revenue outperformance and improved profitability.

We expect to use the proceeds from this transaction to further enhance shareholder value, which could include significant share repurchases and potential acquisitions aligned with our core business lines.

It's now almost two years since we began our new era and embarked on a plan to accelerate revenue growth and improve operating margins with a focus on our premier clients and our consultants. We are now seeing that plan come to fruition.

We are confident in the business model we have built, and we plan to continue our investment in revenue-generating headcount with a goal of sustained revenue growth that exceeds industry averages and leads us to reaching $2 billion in revenues. In doing so, we still expect to reach target operating margins of 7.5%, $1.6 billion in annualized revenues.

I will now turn the call over to Joe Liberatore, Kforce President, who will provide further details on our Q2 operating results; (technical difficulty) Dave Kelly, Chief Financial Officer, will follow and add further color on our Q2 operating trends and financial results, as well as provide guidance on Q3 continuing operations and additional clarity and the longer-term financial expectations for the firm. Joe?

Thank you, Dave, and thanks to all you for your interest in Kforce.

In this new era of Kforce, we are striving to accelerate our business through simplicity, focus, and accountability.

The sale of our HIM business aligns with this strategy, as we further simplified our operating model and can now focus exclusively in the Tech FA space through our commercial- and government-services offerings.

I'm very pleased to see another quarter of strong results delivered by our team. Our success continues to be broad-based with double-digit, year-over-year revenue growth rates in Tech Flex, FA Flex, and HIM Flex, and the second consecutive quarter of sequential growth in our government business.

Tech Flex staffing, our largest business unit, grew revenues 5.4% sequentially on a billing-day basis and 17.7% year over year. Our key performance indicators remain at high levels.

There continues to be very strong demand in this business, as our weekly job-order flow remains near all-time highs, and candidate supply remains tight, particularly in skill sets such as Java, [Epic], .NET, project and program management, and business analysis.

The strong demand is consistent across many industries, including our two largest commercial-industry verticals in healthcare and financial services.

The financial-services vertical is benefitting from continuing regulatory compliance and risk-management needs, along with competitive technology-enabled project initiatives.

Hospitals and healthcare organizations are driving growth in the healthcare vertical from system implementations that advance their platforms, in support of the evolving healthcare requirements, along with migration to more of a shared-services model.

We have experienced year-over-year and sequential gains in telecom, insurance, and the technology-service industries, as well.

Inter-quarter trends for Tech Flex revenues showed growth in April sequentially, some flattening in May, and accelerated growth in June. However, two large healthcare-technology projects ended at the conclusion of Q2, and as a result, the growth rate declined in July.

As we continue to gain client share at our large clients, we expect to see variability in year-over-year growth rates quarter to quarter, due to changes such as these.

Whereas year-over-year growth exceeded our 15% target the last three quarters, we anticipate Q3 revenues to be up on a billing-day basis sequentially and year-over-year growth to be in the low- to mid-teens.

At this level of growth, we will maintain growth rates of approximately double the rate that staffing industry analyst projection for Technology Flex in 2014. Our hiring practices and metrics are calibrated to achieve an average of 15% growth over long periods of time.

Revenues for our finance and accounting Flex business going forward represent 19.8% of total firm revenues. Q2 revenues increased 3.5% sequentially on a billing-day basis and 13.4% year over year.

Contributing drivers to the year-over-year success are expansion in healthcare-project revenues, which the National Recruiting Center positions to maximize, and client diversification.

Revenues remained steady through April and May, but increased in June and continue to increase in July.

Execution has been key to our success, as we are benefitting from management investment and operating-model adjustments made in this business over the past two years to capture market share.

KPI levels, particularly start volumes, are strong, and we expect Q3 FA Flex revenues to be up on a billing-day basis with year-over-year growth to remain growth to current levels.

Revenue increases for the second quarter for our Tech and FA Flex businesses were broad-based from a client-side perspective, and overall spread between bill and pay rates was stable, as bill-rate increases kept pace with the increase in pay rates.

We have a diverse and high-quality client base. A key to our success has been our strategy to prioritize the continued penetration of existing clients through refinement of territory management and the allocation of resources into these clients.

Our top 25 clients contribute 33.7% of total revenues, an increase of 190 basis points year over year from 31.8% in Q2, 2013.

Contributing to this growth is our success in taking customer share with our 25 largest clients in Tech Flex, which have grown in excess of 20% year over year.

This focus is expected to increase our ability to service and delight our largest customers and enhance our ability to shift quickly as their needs change.

This has been further enabled by our National Recruiting Center and the allocation of a portion of those resources in our west-region facility, which opened last week, enhancing support of our west-region clients.

Revenue for Kforce government solutions increased 3.3% sequentially on a billing-day basis for the second consecutive quarter and are now up 2.8% year over year.

We were pleased with this group's performance, as there remains continued uncertainty around funding levels of various federal-government programs and the environment for government services remains challenging. We continue to experience strong organic growth across our client base, and we anticipate revenues to be up again in the third quarter.

As we look forward to late Q3 and Q4, the recompete for our largest contracts has been accelerated into 2014. Given our longstanding relationship with this customer and the government's desire to bundle additional services into the new award, we believe this could provide significant opportunity for future revenue growth.

We have historically had excellent success in recompetes and are very well positioned with this customer. However, a loss of this contract could impact future revenues.

Flex revenue in HIM grew 6% sequentially, and year-over-year growth accelerated significantly to 30.2%. As Dave indicated, we wish this team the best of luck and continued success.

Search revenues from direct placement and conversions increased 29.5% sequentially but decreased 5.2% year over year. Our objective is to meet the talent needs of our clients through whatever means they prefer; and providing a meaningful capability to deliver resources through permanent placement will remain important in meeting those needs.

In Q2 2014, search was 3.9% of total revenues versus full Q2 last year. We expect search as a percentage of total revenues to continue to decline but be relatively stable on a dollar perspective as we move forward.

Revenue-generating headcount increased 12% year over year. We plan to continue to invest in headcount in order to sustain revenue growth at approximately 15% over time; and we expect revenue growth rates to continue to exceed hiring rates.

Contributing to the growth in overall headcount is continued low turnover in our most-experienced, most-productive tenure groups. Associate mix, however, remains highly weighted in a tenure of less than 2 years. So overall productivity levels have significantly room to improve, particularly in Tech Flex.

I'm pleased with our strong performance in the second quarter. Our priorities have been consistent -- evolving our premiere partnership with our clients, striving to be the employer of choice for our consultants and employees, and supporting revenue enablement with an agile customer-centric infrastructure.

The further focus on tech and F&A due to the sale of HIM should allow us to reduce complexity and capitalize on our strong relationships and diverse footprint.

I will now turn the call over to Dave Kelly, Kforce's Chief Financial Officer, who will provide additional insights on operating trends and expectations. Dave?

Thank you, Joe.

Total revenues for the quarter, inclusive of HIM, of $327.4 million increased 7.2% sequentially and 15.4% year over year. Our Flex-staffing revenues collectively grew 17.7% year over year, and our government business increased 2.8% year over year. Search revenues of $12.6 million increased 29.5% sequentially but decreased 5.2% year over year.

For the first 4 weeks of Q3 on a year-over-year basis, Tech Flex is up 14.2%, and finance-and-accounting Flex is up 16.3%. Search revenues are up 9.2% year over year for the first 5 weeks of Q3.

It is difficult to assess potential full-quarter results with this limited data, but we expect continued strong year-over-year growth in Q3.

Second-quarter net income [earnings] per share were $10.7 million and $0.33, respectively, compared to net income of $6.2 million, or $0.19 per share, in Q1 2014, and $6.9 million and $0.21 per share in Q2 2013.

Net income and earnings per share, which again were at the high end of our expectations, have grown over 50% on a year-over-year basis. These results provide confidence that our plan is working and reinforce our belief that we are on track to achieving our longer-term goals.

Gross margin in Q2 was 31.5%. The sequential increase in gross margins is primarily the result of a reduction in payroll taxes and an increase in the mix of search as a percentage of total revenues.

Flex gross profit percentage of 28.8% in Q2 increased 130 basis points sequentially and declined 60 basis points year over year. The sequential increase was the result of a reduction in payroll taxes and was consistent with prior-year improvements.

Bill-pay spreads have been stable in our Flex businesses during 2014. The year-over-year decline in Flex margins was the result of bill-pay spread declines at the second-half of last year.

Specifically, Tech Flex spread has declined 50 basis points year over year, and FA spread has declined 70 basis points year over year, driven by an increase in larger clients as a percentage of the portfolio. We expect Flex margins of Tech and FA to be stable in the near term.

Our government margins increased 160 basis points sequentially and declined 480 basis points year over year. Fewer holidays and a reduction in payroll taxes in Q2 drove the increased margins.

The year-over-year decline was driven by primarily by change in contract mix to a greater percentage of subcontract business, as well as the continued improvement toward new contracts based primarily on lowest price. Government margins are expected to be stable in Q3.

Q2 SG&A levels of 25.2% decreased 40 basis points from 25.6% in Q1 2014 and have declined 250 basis points from 27.7% in Q2 2013, as we realized the benefits from the recent infrastructure realignment that we initiated in the fourth quarter of last year. Payroll-tax decreases in Q2 impacted SG&A by 40 basis points relative to the first quarter.

As we look at our balance sheet in cash flows, our accounts-receivable portfolio continues to perform well. Write-offs remain at low levels, though [aging] has increased over the last year, as larger clients have become a more significant part of our portfolio.

Capital expenditures for Q2 were $1.9 million. Adjusted EBITDA for Q2 was $21.1 million, which is increased 43% year over year from $14.8 million in Q2, 2013.

Adjusted EBITDA per share has increased from $0.44 in Q2, 2013, to $0.65 this quarter, as shareholders continue to benefit from not only improving performance but also from our ongoing stock-repurchase activities.

During the quarter, the firm repurchased 1 million shares for a total of $21.7 million. Currently, $40.6 million is available under our board authorization for future stock repurchases.

The firm had $81.7 million in bank debt at quarter end, compared to $61.2 million in debt at tend of Q1, 2014, and $50.1 million in debt at the end of Q2, 2013. This increase was driven by stock-repurchase activities.

As reported in today's press release, the sale of HIM resulted in an aggregate purchase price of $119 million, resulting in after-tax proceeds of over $70 million.

This business was grown entirely organically and therefore has virtually no tax basis. The cash proceeds will allow us to reduce debt in the near term, as well as finance future stock repurchases to generate EPS accretion and execute potential acquisitions.

Looking forward, our plans of achieving 7.5% operating margins and annualized revenue levels $1.6 billion remain intact. As we consider an intermediate [point to our] goal, we believe the firm can exceed 6% operating margins when annualized revenue reaches $1.4 billion.

Near-term operating margins will be impacted by both the loss of the relative profitability of HIM and the reduction in overall scale of the operation.

However, we are already working to recapture the loss of the roughly $1.5 million in quarterly operating margin through efficiency gains and reducing complexity, and expect to recapture to shortfall by Q2 of 2015.

Based on our recent success in improving operating margins while growing our business, we are confident in our ability to continue on our previous profitability roadmap and achieve our stated goals.

With respect to guidance on continuing operations, the third quarter of 2014 has 64 billing days, compared to 64 billing days in the second quarter of 2014.

We expect Q3 revenue may be in the $308-million to $314-million range and for earnings per share on continuing operations to be between $0.26 and $0.29.

Gross margins on continuing operations are expected to remain stable from Q2 to Q3. We expect gross margins to be between 31.1% and 31.4%. SG&A as a percent of revenue is expected to be between 25.5% and 25.8%. Operating margins are expected to be between 4.6% and 5%. Our effective tax rate in Q3 is expected to be 39.1%.

This guidance assumes weighted average diluted shares outstanding of approximately $32.7 million for Q3, though repurchasing in Q3 could possibly impact results.

This guidance does not consider the effect, if any, of charges related to the impatient of intangible assets; any one-time costs; costs related to the settlement of any pending legal matters; the impact on revenues of any disruption in government funding; or the firm's response to regulatory, legal, or tax-law changes.

We believe the HIM divestiture will enhance shareholder value through simplification of our operating model to better focus on our core business, and in particular, technology, which continues to experience positive secular drivers and some of the strongest demand in the professional-staffing space.

We expect continued investment in our growing business to sustain revenue growth rates well above industry averages and for increasing scale and efficiencies to drive operating-margin improvements at the faster pace than revenue growth.

Charlotte, we'd now like to turn the call over to questions.

(operator instructions) Mark Marcon from Baird.

I'm wondering if you could talk a little bit about the demand trends that you're seeing in the IT space. Obviously, there've been a few companies have been reporting recently. Some of them are going to get tougher comps.

But you also mentioned on your prepared remarks that you're gaining some share in your top 25 accounts. Can you talk about -- what are you seeing in terms of the -- how much of the growth that you're seeing on IT Flex is attributable to gaining share relative to market growth?

Hi, Marc, this is Joe. One point I'd like to start out with is -- actually, our growth rates started to significantly accelerate in Q3, so we're also dealing with tougher comps in Q3.

Relative to what we're seeing from a demand standpoint, I guess the best thing that I can look at is what's happening from a job-order standpoint.

So our job-order flow was up 3.3% sequentially in Tech Flex. We're seeing similar trends in FA, as well. We were up 3.2%. And this is off of really at or -- pretty much near all-time high job-order flows. So we've seen nothing but an improvement on that standpoint.

The same thing -- we're seeing Tech Flex starts improvement of about 4.2% sequentially. So we haven't really seen anything change from the client.

I think I've been in front of about 175 clients since stepping into this seat at this point in time. That pace has been pretty balanced, so we -- we were out in six different markets this past quarter; and the clients that I've been sitting in front of -- we're hearing the same thing that we've been hearing for the better part of the last six quarters.

Relative to our top 25, we're seeing, as I mentioned, about 20% growth in our top 25 clients within Tech Flex. They make up roughly about 42.9% of our Tech Flex revenue at this point in time.

And so that was part of our strategy. We actually started to deploy that strategy back, coming out of the dot-com bust. So we're very pleased with the progress we're making there.

Mark, I think you also asked about the impact on margins of that large client growth. As I mentioned, as we look year over year, the gross-margin decline that we've seen, and in particular in tech, is a result of that mix shift.

We have seen very stable spreads, however, at the client level. And over the course of the last two quarters, spreads overall has been stable, and we expect that to be the case as we move into Q3.

Mark, this is David. I think we just need to put a stake in the ground and say there's been no shift in demand in Tech Flex, period. And our footprint, I think, is pretty representative of customers across the US and across various industries.

Demand is very much intact, and there's still a shortage of candidates -- a significant shortage of candidates, particularly in the high-demand skillsets.

So from everything that we're seeing -- which we understand that other firms have different models than we do and are at different places in the integration process of transformational acquisitions that they've done -- but we've been very stable in our model, and we are seeing absolutely no change whatsoever in demand in our Tech Flex business, at all.

Great. And can you just give us a sense for the size of your ERP exposure? I don't it's (multiple speakers) material but --?

It's not. If we look at ERP collectively, all types of skillset, realizing we don't do project initiatives in and around ERP, so it's more supplemental staffing, it's probably 3.3%.

Great. And then can you give us a sense for the SG&A and how we should think about that in light of the announcement earlier today? And in particular, I just want to make sure I understood correctly, David, your comments with regard to -- by the second quarter of 2015 we should get back to margin levels -- did you mean that by the second quarter of 2015 we'll get back to the operating margin that we ended up seeing in the second quarter of 2014?

So I guess a couple points to that.

As we look at the business pre and post this divestiture, we were on a trajectory to attain 7.5% operating margins of $1.6 billion in annualized revenue. So HIM relative to the rest of the business was more profitable, relatively speaking, than the rest of the business incrementally.

So in order to regain that same type of operating margin, we've got to -- and we think we certainly can do so because this is a far less complex model without HIM here as part of our revenue footprint -- we can gain efficiencies here. And we need to drive about $1.5 million of efficiency gains out of our cost structure in order to be back to those operating-margin levels.

And as I've indicated, we expect as we go through the next three or four quarters that we will resume and get to those levels.

Mark, this is Joe. I think an important point here is -- you know, you're very familiar with the plan that we put in place on the back end of Q3 last year and the team focusing on operating efficiencies and alignment. So I think this management team has a demonstrated track record -- that we know what the targets are, we've put the stake in the ground that we're going to get to the same operating margins at the same revenue level.

So we're already getting after it, and I'm totally confident in the team's ability to make that happen.

Great. And then can you talk a little bit about the priorities in terms of the proceeds?

Sure. As we stated in our prepared remarks, use of proceeds would be retiring debt. We also indicated that we've significant share repurchases. And then we will be very selective in evaluating acquisition candidates, which would be targeted specifically at Tech Flex.

I will tell you that we have not done an acquisition since 2008, and that was dNovus, which was acquired and integrated into KGS. And in staffing we haven't done one since 2006.

We've been evaluating them for a long time. We've got a very, very high bar, obviously for lots of reasons, including regulatory reasons, and so forth, and compliance reasons.

So we'll be selective. It would be a tuck-in, not transformational, if we were to do one. But otherwise it'll be for debt retirement and share repurchase.

Okay. And so we should just -- first priority, basically, being the debt pay-down?

Yes. That's a [lay-down].

Okay, thank you.

Kevin McVeigh from Macquarie.

Thanks, and congrats on the disposition.

In terms of -- what would be -- just so we have a sense -- the EPS impact for all of 2014 from HIM? Is it fair to think that maybe the debt reduction, the savings on the debt service and/or buy-back would be enough to offset that EPS near-term? Or is it more of a couple quarters out based on the efficiencies you'll capture in the next four quarters, just through more -- tighter SG&A?

I think it's difficult -- if you look back, based upon how the accounting rules require it -- we've got some disclosures that we'll be putting out in a couple days that require some pro formas -- but as you look forward, certainly, Kevin, as we look at repurchase activities, certainly that might have an accretive benefit. But given interest-rate costs, debt retirement isn't going to get us there.

What gets us there is taking advantage of the environment for Tech Flex, growing there, as well as reduced complexity, additional efficiencies that we've identified. So we look to become a leaner, more efficient infrastructure, and that's what's going to drive the operating-margin improvement.

So we're not looking at gross-margin improvement to get there. Certainly that's why, as we look through this, it's going to take a couple quarters for us to get there.

Got it. And then real quick, what would be the impact, just for modeling purposes, in the Q3 of taking HIM out?

So in our -- we tried to give you a comparative look there. I think we had indicated in our earnings release, Kevin, that revenues would have been $302.8 million and then EPS [for their] contribution just a strict, simple accounting extraction would have yielded $0.24 relative to the guidance we provided of $0.26 to $0.29.

Right. I guess I was thinking -- would have be pretty consistent, Dave, with Q3 and Q4, just for trying to think about how we should adjust the model?

Well, I think it's dependent upon how quickly we get after the efficiencies that we expect, which we've already begun to undertake. But I think Q3 is certainly a good starting point.

Great. Thanks so much.

Tobey Sommer from SunTrust.

Thanks very much. I'm just curious, within Q2, how much in terms of EPS do you think you gained versus what your goal was stated to be several quarters back? Are you within that $0.03 to $0.05 contribution from the streamlining effort already in Q2?

Hi, Tobey. This is Dave Kelly. Certainly -- and I think [within] the last quarter we've realized the benefits and actually -- as we think about expectations when we put out that roadmap a few quarters ago, I think we actually exceeded some of that expectation.

So we're very comfortable with where we were, which is why I think, as Joe mentioned, as we look forward, our confidence in obtaining these efficiency gains that we also have -- one thing I didn't mention as we're talking about this transaction, one of the things that is a part of this is, we are required as part of this transaction to provide services under a transition-service agreement to the acquirer of HIM.

That is going to be a break-even for us, so we'll be reimbursed from that. So I don't want to forget to mention that, as well.

So is that to say that -- for example, in Q2, maybe you got $0.06 from the streamlining effort? How much did it contribute?

I didn't go back and specifically calculate it. We said $0.03 to $0.05. I think it's safe to say -- as I said, we were at or probably slightly exceeded that number. So that's probably a good benchmark, that $0.05, or so.

Okay. Curious about the accretion that you talked about in terms of share repurchase. I understand you sold the business and you lose some of the scale and profitability associated with that. So is this transaction accretive at a certain point when you have been able to streamline and transition those back-office functions to the new owner of the business? I'm just trying to get a sense for -- over what time period it is accretive. Thanks.

I think the investment of the proceeds and share repurchases certainly could affect that accretion if you just do simple math. We talked about after-tax proceeds, that would be, at today's share price, 3-plus-million shares. So you can kind of do the math of what impact that would be.

But as we move forward, certainly HIM was a, relatively speaking, incrementally more profitable business, and we were more profitable with that business.

So as we look out, however, as I mentioned, you reduce the complexities of this business over time, increasing efficiencies, which we're confident that we're going to attain. We're probably looking a year out, and -- yes, I think we're looking at a transaction that gets accretive.

Tobey, this is Joe. What I'd also add is -- I think we've been very consistent in this messaging.

We're looking at operating the business from a long-term perspective, and so this creates greater transparency for us. Because as we assess the landscape, as we were looking at all of our businesses strategically, while this is a business that has performed well for us and the team there has done a tremendous job, we concluded that there were going to have to be some rather significant investments in this business to position this business to be able to compete long term; and that would have been at the expense of investments being made into our technology and FA businesses. So that was a big part of driving this. So I just wanted to make you aware of those dynamics, as well.

Okay, that is helpful. I appreciate that addition. Just so I further understand, with the simplification of the operations, do you think that contributes to a faster top-line growth of the Tech and F&A businesses on a go-forward basis somehow? In other words, is there that element in addition to foregoing the need to make investments to grow the HIM business for the long term?

Tobey, this is Dave. Our target is 15% for the firm as a whole. Staffing would be 15%. KGS, as you know, has been a drag. As they now continue to see sequential growth, they'll be less of a drag. But our target has been and will continue to be 15% for staffing.

So can we do better than that? The answer is yes; we have been. But our model is predicated based on investment and headcount, etc, to get to that 15%.

So as we continue to look at this business going forward now, we would expect that the sustained growth rates over the longer term, particularly given what we consider to be true secular drivers, here -- a lot of the decisions that we've made strategically are predicated on the assumption that the model for our clients has changed permanently, meaning that they are now looking at staffing firms as a primary source of supply for their talent, given the shorter development cycles, and so forth.

And we've seen that through the temp penetration rate. So we believe that with a 3% customer share in a $6-billion F&A market and a $24-billion tech market, we're better off placing those investments into those businesses.

And not that HIM is a bad business, but that market size is significantly smaller than even F&A. So we believe that be setting them free to be able to focus, they can continue to dominate their market, and we can take greater share faster in a much larger market, which really facilitates much longer-term growth for us.

Thank you very much. If I can sneak in a little question regarding your prepared remarks. I think you said perm dollars flat and maybe declining as a percentage of revenue. Is that all the way up to the 1-point -- to the longer-term goal, or is that just meant to be kind of a near-term commentary?

I would say, directionally, that would be what you should use from a modeling perspective. That's somewhat consistent perm dollars. I mean, obviously they're going to fluctuate to some extent on a quarter-to-quarter basis. And as our Flex businesses continue to grow, that's why the percentage is coming down.

Perfect. And then I think Flex margin was a comment -- was that that would be stable. I was just curious, is that a sequential or a year-over-year comment?

Tobey, that was a sequential. It's been stable for the last -- the spread has been stable the last two quarters. Absent the payroll-tax impact, the gross margin -- the Flex margins would have been stable. But we look sequentially for it to continue to be stable.

Perfect. That's it for me. Thank you very much.

Hamzah Mazari from Credit Suisse.

Hi. This is Anj Singh dialing in for Hamzah Mazari. My first question is just on headcount growth. This quarter, it was double digit, well above last quarter and above your 10% target. Part of the job-order growth commentary you cited earlier -- is it safe to assume that you may continue to grow above 10% in the near term?

I would say that part of the driver -- when we put the 10% out there, that's an average. I think we're a little bit, right around 7% in Q1, and so here 12% in Q2. So when you look at year-to-date, we're pretty much hitting the target. So it can't be precise when you're looking at performance management and those dynamics, so that's really what the driver was.

Got it. And one other question, on the recompete that you cited for your government business, how have margins generally fared on these recompetes? And what sort of pressure, if any, do you see if you were to win this contract again?

It's pretty difficult to say what happens with margins on recompetes because sometimes -- yes, absolutely the government is much more focused on price than they have been -- lowest-cost, technically acceptable procurements is much more commonplace, which have been a driver to the margin declines in that business.

But on a particular procurement -- this one, for example, or some procurements might be a subcontractor arrangement where you have an opportunity to be a prime contractor. So to say that margins, just because you're going on lowest price are going to go down, it would be false.

So it's difficult to make a general comment about this. I think as we look forward, based upon what we're seeing, the margin profile in KGS is expected to be stable.

Okay, great. And one last one, if I could. The tax rate that you guys guided to at Q1, it ended up being a little bit higher this quarter. Can you just explain what were the drivers behind that?

So just the magnitude of some [true-ups] and temporary differences and permanent differences that we had -- we, of course, have to estimate the effective tax rate throughout the course of the year. And so we true that up every quarter.

So you mentioned there was a bit of a change, but it's not a significant change. I think last quarter it was 39.5% -- I can't remember; 39.1% is what we're talking about here. It's a pretty tight band.

Okay, thank you so much.

(operator instructions) Ato Garrett from Deutsche Bank.

Good afternoon. I have one more question on the divestiture. Just looking at the timing of divestiture of the healthcare-information business, was there anything in particular that drove the timing to happen now, or is this just part of the timing that shook out of your strategic review and how to focus the business going forward?

It's a great question. We've actually -- we go through a process and evaluate our business to determine whether or not it's going to fit long term strategically.

We've looked at that business. And it's being impacted, as Joe said, by a number of developments, including remote coding, computer-assisted coding, and other tools, which will ultimately, we think, have a significant impact on that business.

In order for us to continue to sustain these growth rates and maintain the share, we would have had to developed a lot of these tools and given these tools to our people.

So we believe that the optimal time was now, particularly given the timing of ICD-10. We believe that this will facilitate to them an opportunity to make the investments necessary to be successful and for us to narrow our focus.

So we believe actually the timing was optimum. We believe that we actually achieved better than we had originally expected in pricing, so the timing was very good.

Great. Also then just looking at the year-over-year change in gross margin implied by guidance, I was wondering if there was any other factors impacting that beyond the mix shift towards larger -- or the outsized growth from larger clients and flat perm dollars, as you mentioned before.

No, nothing significant. It is, as I've said -- and the important point to note -- when we look at spread at the transaction level, it's been very stable. No, it's a pretty simple story.

It's flat spreads. We've got some mix shift, both in terms of the composition of perm versus Flex. And then we've got a little bit of mix shift in terms of the composition of the client size. But that really is all there is.

Okay, great. And then finally, just looking -- and we've heard some comments around wage increases across all the skilled disciplines. And some of your competitors have mentioned that as being a boost to gross margin as they pass those costs and a little bit more on to clients. I was wondering how that's going with your business as you're facing those same kind of wage increases.

So we've seen proportional pay-rate and bill-rate increases pretty well mirrored. We're looking at the optimal passing through of those costs with revenue growth.

So we think we've got a very nice mix of strong revenue growth. If you look at our gross-margin profile, Flex margins in particular -- our Flex margins, relatively speaking, are amongst the highest in the industry. So we think it's a good mix, and so we're very pleased.

I guess I would adjust a little additional color there.

So when we look at spread, we are seeing spread dollars increase, and we're seeing bill-rate expansion. So even if you're moving dollar per dollar on that, you're going to see slight margin compression take place there.

And so we're seeing very much similarities between our [spot-]market business, as well as our strategic-account business, as Dave had mentioned.

Great. Thank you.

John Healy from Northcoast Research.

Thank you. I wanted to ask a little bit about the divestiture and your thoughts regarding around keeping some of the technology business. As you think about things about ICD-10, is there any type of relationship in place to work with the new partner to make sure some of those projects or some of that project work that might borderline of technology, that might borderline on healthcare is in place and you can continue to grow with those customers? Any thoughts on just if there's any potential linkage on the tech side of the business as a result of the divestiture of that HIM business.

John, this is Dave. Let me make this very clear. No technology went with this business.

We are as a result of this transaction only selling the coding part of the business. So any healthcare-technology work that we're doing with these clients, any finance-and-accounting work that we're doing with these clients, we retain those. And we actually have the opportunity to continue to work with them in the future.

Okay, that's helpful. And I wanted to ask about the expected competition for the government side of the business. When you started your comments, to me, my ear heard optimism and positive thought process. And I felt like you guys hedged a little bit at the end. Is there anything to read into -- how should we read into your confidence in terms of retaining that business? And is there a way to size how big that customer is for you guys as it relates to the government business?

Obviously, with recompetes, you're recompeting it. I mean, we're one of the incumbents there. We've been working with this particular entity for approximately 9 years at this point in time.

We're significant. We have longstanding relationships. We have respect. I think there's a lot of trust in the work that we're performing for them.

But whenever you're recompeting -- I mean, there's obviously a risk associated with that, especially in the landscape where we're operating. So we have to put everything out there.

Okay. Is there a thought (multiple speakers) -- go ahead (multiple speakers) I was going to ask if there's a --.

I was just going to make a general comment to your point. That business, as you look the last couple quarters, has grown the last couple quarters relatively well. It's now up year to year. They're going a nice job.

So we think we're doing a good job executing in a difficult space, which is why, as I think Joe mentioned, we feel good about our prospects in that business for Q3.

We also feel that we've evolved some unique delivery capability, because approximately 60% of our government business now is delivered through the NRC. That's up from 40% a year ago.

So we've made great strides on leveraging our staffing capability to really provide our government unit a differentiator in the marketplace from a talent-attraction standpoint.

So I think this is part of what Dave is talking about, where we've had incremental gains, even with this particular customer. But that's more broad-based across other KGS customers.

Okay, great. And is there a way to think about the timing of this that you might learn in the third quarter or fourth quarter what the expectation is?

It's possible we'd hear something in third quarter, more than likely some point in the fourth quarter. But in today's environment -- you know, we've been down these paths before. This very likely could push into next year very easily, with what's happening with the contracting offices, and such.

So that's really the best guidance that we can give.

And we've seen contests of awards. There's all kinds of things. So at this point, we really can't tell you exactly when it's going to happen.

Okay. Well I appreciate that. Thank you.

Tobey Sommer from SunTrust.

Thank you. Just a quick followup on the KGS segment. Is that business still have a lot of security-cleared IT people? And is reason I ask that is I'm wondering whether it might even simplify the organizational structure even more to have that as part of Tech, even though it serves government customers. Thank you.

Tobey, yes, there are a lot of cleared Tech skills in there. And we do report it separately, although you're right -- I mean, technically within the government vertical, the businesses and the services that we offer are tech and F&A. So if we were to combine the two, you would see a very, very different picture.

But we can't, for lots of different reasons. So we have combined it into the government vertical. But the services they offer -- and by the way, some of the leverage points, including servicing from the NRC, and so forth, do add value for KGS specifically as a vertical. But if we were to report it as a skill, you would see that our Tech business is much larger, as is our F&A business.

Okay. That's exactly what I was getting at. So the percentages of revenue exposed to Tech and F&A would both bump up as a result of looking at it from that perspective?

That business is a pure Tech FA business short of a smaller segment, which is product-based.

Perfect. Thanks a lot for your help.

Thank you. And we're going to go ahead and conclude. And we want to again thank you for your interest and support for Kforce. And again I'd like to say thanks to each and every member of our field and corporate teams and for their hard work, and also for our consultants and our clients for allowing us the privilege of serving you.

Thank you very much. We look forward to talking with you on our Q3 call.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.