Kforce Inc (KFRC) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kforce, Inc. second quarter 2015 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Michael Blackman, Chief Corporate Development Officer. Mr. Blackman, you may begin.

Great. Thank you. Good afternoon, and welcome to the 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.

You can also 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 the call.

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

Thank you, Michael. We're very pleased with our results, which represent our eighth consecutive quarter of double-digit year-over-year organic growth and the achievement of a significant operating margin benchmark on the path to our longer-term profitability goals.

Second quarter revenues of $337.4 million and earnings per share of $0.41 both exceeded our expectations and consensus estimates in our new records for the firm, and our operating margin this quarter of 6.1% confirms that our plan is working. Strong growth was seen across our staffing business lines, and profitability has also improved through both expanding gross margins and improving SG&A leverage.

Secular drivers continue to be key factors in flexible staffing growth against the backdrop of a nontraditional economic recovery. A disproportionate share of job growth continues to come from the temporary staffing sector, the temp penetration rates remaining above prior peak cycle levels.

Highly skilled specialty staffing demand in particular remains robust. Staffing industry analysts continue to predict 6% or greater annual growth for technology staffing through 2022, which represents approximately 70% of our business. This ranks among the fastest growing staffing segments in the US.

We are also seeing continued migration of traditional technology project-based work into statement of work opportunities as organizations look to reduce costs by utilizing a higher percentage of highly skilled, contract technology resources. F&A staffing is also expected to grow at 5% or greater annually over the same period.

Our domestic portfolio remains balanced with strong year-over-year growth to both tech and FA flex as well as direct hire, while our government division remains stable. The 9.6% year-over-year growth rate in tech flex, which accelerated from 8.3% in Q1, and the 21.2% growth rate of F&A flex, which accelerated from 15.9% in Q1, both suggest that we continue to take market share.

We are gaining productivity through our continued investments in revenue-generating talent over the past two years, while also seeing operating leverage from efforts to simplify and narrow our focus over that same period.

We have also enhanced shareholder value by returning essentially all operating cash flows to shareholders through stock repurchases and dividends. Year to date in 2015, we have repurchased 687,000 shares of common stock for $15.6 million and paid $6.2 million in cash dividends. We expect to continue this course of capital allocation for the foreseeable future.

We made a decision in 2013 to simplify and focus our firm around core tech and FA service offerings and established financial goals of sustained double-digit revenue growth coupled with significantly improved profitability. At the time, we believed that we could exceed prior peak operating margins with this simplified model as annualized revenues approached $1.6 billion. A key benchmark along that path was to reach at least 6% operating margin when $1.4 billion in annualized revenue was achieved.

This quarter represents the accomplishment of this benchmark a little sooner than we had anticipated. Kforce today operates a significantly different business model, with direct hire contributing approximately 4% of revenues versus 8% at the peak of the last cycle. In addition, Kforce has divested approximately $200 million of very profitable, noncore business units in the past three years and reinvested the proceeds in larger and faster growing markets, along with returning capital to shareholders.

Our results to date demonstrate our commitment to our original goals. Though there remains much work to do, we remain confident that the continued strong demand environment and the focus on execution by our exceptional associates and their leaders will enable us to reach our longer-term goals of 7.5% operating margin when $1.6 billion in annualized revenue is achieved.

In closing, recently there has been more discussion and questioning about the duration of the current business cycle and the implications for staffing. We believe that the secular catalysts, including the explosion of technology, current and proposed legislation, project durations, healthcare, economic uncertainty and employment risk, are now the principle growth drivers behind staff.

While there will certainly be cyclical effects, we believe they will be less significant than in the past, and muted GDP growth has many leading economists believing current trends will continue for an extended period.

I will now turn the call over to Joe Liberatore, President, who will provide further details on our Q2 operating results. Dave Kelly, Chief Financial Officer, will then add further color on our Q2 operating trends and financial results as well as provide guidance on Q3. Joe?

Thank you, Dave, and thanks to all of you for your interest in Kforce. I'm pleased with our performance in Q2, as we delivered revenue that exceeded expectations across the spectrum of all offerings.

We are now two and a half years into the new era. The simplification of our business model continues to provide a platform focused upon execution to better serve and delight our clients, consultants and candidates. This has been and will continue to be critical to our success in delivering above-market revenue growth and improving profitability.

Year-over-year growth rates in tech flex, our largest business unit, accounting for 67% of total revenues, accelerated to 9.6% this quarter as a result of the 8.4% sequential improvement. Overall, our key performance indicators for technology continue to be at record high levels in Q2, and our pipeline remains strong.

Demand is strong across many industries, with our most significant being financial services, manufacturing, healthcare and insurance, which we continue to see outperformance related to our overall tech flex growth averages.

The ability to assess talent continues to be the most significant constraint in tech flex. Conversions have been elevated for the past year and are a reflection of this constraint against a strong demand environment. Though this has short-term impact on revenue growth, it is a positive indicator of strength in overall tech staffing demand and customer confidence as we look ahead. As we look forward into Q3, we expect to sustain similar year-over-year growth rates in this business.

Finance and accounting flex, which represents 22% of our total firm revenues, experienced an acceleration in its year-over-year growth rate to 21.2% year over year, as revenues grew 9.9% sequentially. This business is also experiencing all-time high KPIs. Growth by industry is diverse. The contributing drivers to the year-over-year success continue to be financial service and healthcare project revenue, both of which our national recruiting center positions us to maximize.

Our decision to invest in management and implement operating model adjustments have contributed to market share gains, client-based diversification and project opportunities. We expect Q3 flex revenues to increase sequentially and year-over-year growth to remain at high levels.

Our top 25 clients contributed 37.2% of total revenues, an increase of 90 basis points year over year from 36.3% in Q2 2014, suggesting that we've been successful in taking customer share within our largest clients. We continue to invest to further delight these key customers and leverage our national recruiting center to maximize our service capabilities. We also continued to experience growth in our medium and small customers, reflecting the diversity of our growth in Q2.

Revenues for Kforce Government Solutions increased 1.3% year over year. Services revenues, which is about 85% of this unit's total revenues, has been down slightly over the past year in an environment that remains difficult. However, total Government Solutions revenues have remained flat due to increases in this unit's product sales. We expect services revenues to improve slightly in Q3 and product revenues to decline from its elevated levels. Therefore, total revenues should be very stable sequentially and year over year.

Direct hire revenues from placements and conversions increased 14.7% year over year, and as with Q2 2014, remain slightly more than 4% of total firm revenues. We've made some select investments in direct hire over the past few quarters from which we're deriving benefit, and we will continue to do so as opportunities and productivity levels present themselves.

Our objective is to meet the talent needs of our clients through whatever means they prefer, and providing the highly skilled capability to deliver resources through direct hire remains important in meeting those needs. We expect a slight seasonal decline in Q3 in direct hire revenues. Year over year growth is expected to continue, though likely at a lower level than experienced in Q2.

Revenue-generating talent increased 7.7% year over year in Q2. We continue to invest in additional revenue-generating talent and will prospectively remain focused on the 10% year over year target we have communicated, realizing this will fluctuate to a degree within any given quarter.

The improving productivity of these new associations we have been consistently hiring over the past two and a half years have allowed us to grow staffing revenues at rates greater than hiring levels and generate improving bottom-line results, as we expect this to continue into the near future.

Each aspect of our business is executing well. We exceeded our expectations in Q2 2015 and remain committed to maintaining our focus and discipline in becoming a strategic partner to our clients.

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

Thank you, Joe. Total revenues for the quarter were $337.4 million, which represented a 7.9% sequential increase and an 11.4% increase year over year. Our flex staffing revenues collectively grew 12.2% year over year, and our government business increased 1.3% year over year. Direct hire revenues of $14.4 million increased 14.7% year over year.

Second quarter income and earnings per share from continuing operations were $11.6 million and $0.41, respectively, which represent 46% and 71% year-over-year improvements versus $8 million and $0.24 in Q2 2014. Earnings per share exceeded the top end of our guidance by $0.05.

Our gross profit percentage in Q2 of 31.4% increased 110 basis points sequentially and 20 basis points year over year The sequential increase in gross margins is primarily the result of an expected seasonal reduction in payroll taxes, which positively impacted flex margins, and an increase in the mix of direct hire as a percentage of total revenues.

Our flex gross profit percentage of 28.4% in Q2 increased 90 basis points sequentially and 20 basis points year over year. As it relates to the 20 basis points year over year improvement in flex gross profit percentage, we are beginning to see favorable trends in federal and state unemployment tax rates, which is the main driver to the year-over-year improvement. After years of very high costs, the states are beginning to lower their rates slightly.

These reductions coupled with increasing assignment lengths in our tech flex business are driving unemployment taxes down, and we expect to benefit from these prospectively in the form of slightly higher flex margins.

Bill pay spreads in our tech and F&A flex businesses are flat year over year. Prior to this quarter, spreads had been compressing slightly over the past year, driven by more rapid revenue growth in our larger clients, which have slightly smaller spreads.

However, as a result of the sequential spread improvement we experienced from Q1 to Q2 across the portfolio, inclusive of our strategic accounts and spot market clients in both tech and FA flex, spreads are now back to the same levels as a year ago. Looking forward, we expect pay bill spreads to remain constant and for margins to be stable at these slightly higher levels.

SG&A as a percentage of revenue was 24.7% in Q2 and represents a historical low for the firm. SG&A declined 120 basis points year over year, from 25.9% in Q2 of 2014. The decline was driven by continued expense disciplines as well as improvements in associate productivity.

The improving productivity, which we began to see last quarter and is a critical element in achieving our operating margin targets, is improving slightly faster than our financial models had anticipated. As we look forward, we expect productivity trends to continue to improve, though not at a rate seen this quarter, and for these improvements to be a key driver in meeting our profitability goals.

Q2 2015 operating margins of 6.1% improved 160 basis points from 4.5% in Q2 of 2014, driven by a combination of revenue growth, gross margin improvements and SG&A leverage achieved over the past year. We expect operating margins to continue to improve as we take advantage of scale and increasing productivity of our revenue-generating populations as they gain additional tenure with our firm.

As we look at our balance sheet and cash flows, our accounts receivable portfolio continues to perform well. Capital expenditures for Q2 were $2.4 million and remain at steady levels. Bank debt at the end of the quarter was $93.6 million, as compared to $94.3 million at the end of Q1 and $81.7 million at the end of Q2 2014.

The firm repurchased 412,000 shares in Q2 at a total cost of $9.2 million. This volume is now at levels approximating operating cash flows net of dividend payments. We expect to deploy our capital in this manner in future quarters. Our Board of Directors recently authorized an additional $60 million to be used for stock buybacks under our plan, bringing the total currently available to approximately $74 million.

With respect to guidance on continuing operations, the third quarter of 2015 has 64 billing days, which is the same as the second quarter of 2015 and the third quarter of 2014. We expect Q3 revenue to be in the $344-million to $349-million range, and for earnings per share to be between $0.45 and $0.47.

Gross margins are expected to be between 31.6% and 31.8%. SG&A as a percentage of revenue is expected to be between 243.5% and 24.7%. Operating margins are expected to be between 6.3% and 6.5%. Our effective tax rate in Q3 is expected to be 40.1%.

This guidance assumes weighted average diluted shares outstanding of approximately 28.2 million for Q3. The guidance does not consider the effect, if any, of charges related to the impairment of goodwill, 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.

Our strategy initiated two and a half years ago is delivering results. Revenue growth has exceeded 10% year over year for eight straight quarters. A narrowed focus on our core business lines and crisp execution, which is creating operating leverage, have us hitting our financial benchmarks and on track to achieve 7.5% operating margins when we reach $1.6 billion in annualized revenues. We laid out our plan and have remained steadfast in its execution and continue to deliver on our commitments.

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

Thank you, sir. (Operator Instructions) Mark Marcon, R.W. Baird.

Good afternoon, and congratulations on a terrific quarter. I was wondering, can you talk a little bit more about the share gains that you're getting, particularly in tech flex, where you're actually experiencing an improvement with regards to the margins? What's the key driver behind the share gains, and what are you seeing in financial services? Because we've been hearing mixed things about that vertical.

Mark, this is Joe. I guess to start on the revenue side, the revenue growth has really been broad-based. I think six of our top seven industry verticals actually outgrew the total tech flex revenue number that you're looking at, so I would attribute that to the focus and the concentration and the alignment of our teams executing in and around those customers within those verticals, so it's broad-based.

Specific to financial services, we have a fairly diverse portfolio within financial services, and I would say as a whole, what we're seeing is we're seeing a little bit above market in terms of the growth that's happening within overall financial services, at least within those areas that we're playing with in the customers.

And so related to the margin profile, we're seeing a nice, balanced margin profile within our tech flex business. We're seeing the pay bill spread remain somewhat constant, and that's both within our large customers as well as within the spot market. So they both moved pretty much in concert this past quarter on a year-over-year basis, so very balanced from that standpoint as well.

That's great. And then with regards to your F&A business, can you talk a little bit about what you're seeing on the healthcare side, just a little more color there in terms of that particular vertical?

Yes, healthcare specifically we're seeing a lot of opportunity within rep cycle, which really plays well to our NRC alignment, because typically those types of projects are bulk hire type projects where we're gaining exclusive bulk needs within those clients, so there's usually a short duration for delivery because it's kind of crisis mode. And the NRC, the location that we have here in the East to service those clients, as well as the location we opened a little bit over a year ago in the West to service the West Coast clients, have really uniquely positioned us to be able to go after that business, so we continue to see exceptional growth in that area.

Can you talk a little bit more about the specific types of clients that you have in that healthcare business?

It's probably a little bit heavier on the provider side of the house, but we're actually working with clients both in the payer and on the provider side within that space.

Great. And then you made a comment about lengthening assignments. Can you give a little bit more color there just in terms of dimensionalizing that?

I mean, I would say we haven't seen anything materially change from lengthening the assignments. Historically, our average assignment duration has pretty much been in about that six-month window from a tech flex standpoint. We've seen that migrate here over the last several quarters closer to about a seven-month window, and that helps us from some of the statutory costs standpoint when we're holding onto those people longer.

Great. And then the margin guidance on the gross margins is, obviously, favorable. Where is the biggest level of increase that you would expect? Because you are expecting direct hire to come down a little bit as a percentage, so I was wondering if you could give just a little more color there.

Sure, Mark. This is Dave Kelly. So, really two areas -- I'd mentioned at some length our discussion around the reduction in (inaudible) costs. As we move into the year, in addition to that favorable trend that we've been seeing with the states reducing their rates to us, we continue to see as the year progresses a reduction in (inaudible) costs as a percentage of revenue, so we're going to get some benefit for that going from Q2 to Q3, just as we do every year.

And then we're expecting -- it fluctuates a bit, but we're expecting some mix changes in our government business to impact rates. So as Joe said, we're really expecting pretty stable spreads in tech and in F&A, and so those are really the two big drivers.

Great. And then a last question, and then I'll jump back in the queue. You're part of a big Pentagon contract. Can you talk a little bit about how we should think about government longer term, beyond the current quarter?

Sure. This is Dave again. Very much as we've been saying, the government procurement environment is a very difficult space and tough to gain any longer-term visibility. We've seen a relatively flat revenue stream here for a number of quarters. As we look out into the third quarter and beyond, I don't know that I would expect anything different from that.

As it relates to recompetes and some of the things that we've been talking about in the past, almost all of our recompetes are behind us this year, so we've got some pretty good visibility as we look into at least Q3 for that business. One of the larger contracts that we had talked about in the past has continued to get pushed to the right in terms of an award, so we're continuing to work on that contract. We've been a contractor there for many years, so it actually benefits us that the government hasn't made any decision on that, so that's where we are in that business.

Mark, the other thing I would add on that front is, obviously, as you're aware, we brought Pat Moneymaker back in as CEO of that entity. Pat has a very long-standing track record of success, and I think he and the team have really done a lot of heavy lifting here over the course of the last 18 months on realignment of that as well as on pursuit of business, so I'd say their pipeline is building nicely, realizing that it is a very competitive landscape.

So I think the team has really made some nice progress on those fronts in terms of the quality of the pipeline and the focus of the business, and they're doing very similar things that we started down a path three years ago within our staffing businesses, which is really narrowing the focus, getting after execution, the blocking and the tackling, not looking for the shiny object and really going after customer share, and capturing and penetrating those customers.

That's great to hear. Thank you.

Sure.

Tobey Sommer, Suntrust.

This is actually Frank in for Tobey. I wanted to ask first about the hiring environment for recruiters and kind of your comfort level for where you stand in terms of capacity on that side.

Frank, I would say the hiring environment -- it's a competitive environment, but it's one of the top priorities of all of our leaders in the field, as well as we support them. It's a component within our centralized services to help from a hiring standpoint, so it's front and center. Every applicant that we bring in, the first thing that we look at is would they be a good quality talent acquisition for Kforce, so we haven't really seen any constraints on our ability to hire top talent from a recruiting or an account management standpoint.

And then I'd say relative to our plans as we look forward, as I mentioned in my comments, the target we had put out there was to pretty much target growing that population by roughly about 10%, realizing it's not a precise science, based upon turnover and other dynamics. So we've fallen a little bit short here on the last couple quarters, and we're hoping that here in the back half of the year, that we'll come in closer to that 10% target.

But one thing that I would give you just a little bit of awareness in and around when we're just talking pure percentages on a year-over-year basis is, actually, Q3 last year was a low water mark for us. I think our headcount growth was about 2.9%, so it is possible that we could be in the lower teens this quarter if we were to hit what our net hiring target is.

Frank, this is Dave Kelly. I'd add just a couple of other things to Joe's comments. You'd asked about capacity and productivity. So we have been hiring, although, as Joe mentioned, last year we didn't hire as many. We have been hiring consistently for a number of years now.

And so when we think about moving forward, we certainly have the resources and the capacity with our hiring plan and the people we have in place to sustain the revenue growth levels that we've established. It's all part of a longer-term plan, so it will fluctuate quarter to quarter. We continue to invest, but we've got the benefit of the people who've been here two years and they're really starting to hit their stride now, which actually gives us incremental capacity and productivity, so we think we're in a pretty good place right now.

Yes, and just to give you a statistic in and around that, if we were to look back eight quarters ago, we've seen our two-plus year population grow by about 41%, and those people are a much higher contributor when they get into those ranges. Likewise, what we did see here in Q2 is we saw our year-over-year -- both revenue and GP productivity levels moved up nicely on a year-over-year basis.

Thanks. That's helpful. I wanted to ask a little bit about kind of revenue by client size, particularly on the tech flex and F&A. Are you seeing a broad base of both large clients as well as the smaller clients build up that demand?

Yes, we are. We're seeing that demand across -- it's really across the spectrum, which is nice because of where we're concentrated within some of the larger clients to see those revenue growth levels being at or, in many cases, actually higher than even what we're seeing in the spot market.

It gives me confidence that the plan that we laid out, that the team is executing upon it and we are gaining customer share within those clients, because on average, when we look at just pure tech FA, if we look at top 25, the top 25 grow historically a little bit above average to what we're seeing in the spot market. And then when we look at our enterprise top 25 customers, we typically see them gapping the average growth rates even by a little bit more when we look at the collective top 25.

All right. Great. Thanks very much.

Sure.

Kevin McVeigh, Macquarie Capital.

I'm wondering if you could -- I kind of tend to get a little too optimistic. Can you help us with the 6.1% margin? How should we think about that in the back half of the year and just as figure out the progress towards 7.5% of the $1.6 billion mark? Is there any type of seasonality we should think about, not getting too far out in terms of Q4, but just at least to think about that margin within the context of a great outcome?

Kevin, this is Dave Kelly. Again, just a couple of overarching comments, and then I'll talk about seasonality. So, yes, we're pleased with 6.1%. We think Q3 and our guidance is another good step towards our business goals and our operating margin goals.

As we look forward, we've historically targeted that $1.6 billion to be at 7.5%. We still think that is the right benchmark. We are in this and have been on a consistent plan on a sustained basis investing in our business. We expect to continue to do so, and making those investments is going to impact some of the cost structures, so we'll make our way from where we are today into that 7.5% level at that revenue level, and we don't believe that that has changed, and the plan is working that we've laid out.

In terms of any seasonality, as we look into the fourth quarter, as we historically do -- there's a lot of holiday that takes place in the fourth quarter, so it impacts some gross margins, and so you typically see a little degradation there, and because there are a little bit less billing days, the revenue growth trajectory that we see in the middle of the year gets stunted a little bit.

And then, of course, you've got Q1, as we did last quarter -- or two quarters ago now. We see every year the payroll tax impact pretty significantly impact margins again, because you start the year and you've got the rebuilds in particular in our tech flex business. The revenue stream, it takes some time, so, again, the revenue growth is kind of muted in the first quarter, so there is still that same seasonality effect that we've seen in years past.

Understood. And then just with the (inaudible) release, is that primarily tech right now, and would you expect that to expand into F&A next year, or is it pretty broad-based?

Kevin, the (inaudible) release -- and we had mentioned assignment lengths. In tech, of course, we benefit from the fact that the turnover isn't as great, and that helps us, but we're seeing broad-based in both tech and F&A and in our government business as well. All the states -- not all the states, but a fair amount of the states who have really gotten their unemployment pools in order were reducing their rates to us a little bit, so both in tech and in F&A, we are seeing the benefit of that.

And so I think we believe these types of (inaudible) that we've seen are something that are sustainable and we'll benefit from, and I think you'll probably see that across the space.

Awesome. Thanks, guys.

Thanks, Kevin.

Randle Reece, Avondale Partners.

This is Ben on for Randy Reece. Congrats on a good quarter. Just a couple things. On the contingent search side, how should we think about that going forward as part of the broader business?

I think Dave mentioned that in his opening comments. I mean, we've pretty much modeled in for that to stay somewhat constant on a percentage of revenue basis, and that's pretty much -- we've been tracking in this 4% range for quite some time, and we wouldn't anticipate anything materially changing from that one direction or the other at this point in time.

Okay, cool. And then on the -- within F&A, anything about your current book of business that could make for difficult comps next year?

The only thing that's going to make for difficult comps is at the rate we're growing. I mean, obviously that -- I don't know another way to answer that. But in terms of if you're asking if there's anything material that we see inside the business with major project ends that we have to overcome or things of that nature, not at this point. I mean, the pipeline is very deep, and we continue to build the pipeline, so we're pretty confident. The team has done a great job from an execution standpoint.

This is Dave. We only have 3% market share in both of our businesses, so we think that there's still a lot of runway ahead, and as we've said, we're starting to take market share, but the 800-pound gorilla in that space still has a lot that we'd like to have, so we'll keep going.

Gotcha. Thanks. And then just one last thing on the tech flex side. Can you just speak to kind of where you're seeing hot and cold spots and how you guys are doing addressing those particular segments of the market?

Yes, I'd say from -- as I mentioned in an earlier comment, from a vertical standpoint, I mean, six of our seven top verticals -- and that's from a revenue scale standpoint -- they outgrew our top-line tech flex of 9.6%, so we're seeing -- it's very broad-based. We're not seeing anything specific to geography. We're seeing it East Coast to West Coast, we're seeing it north to south, so it's pretty much across the spectrum.

In terms of skill set, it's the standard skill sets where we're seeing demand. We continue to still see a lot of opportunity in the app dev areas as well as the project and program management areas.

And then, needless to say, one of the things that we've been seeing a little bit more here more recently is we continue to see more business come down out of the solutions space into the statement of work space, and I think this is really playing well with our larger customer strategic account focus, where we have a seat at the table and we have deep relationships, because it's giving us an opportunity to capture a greater share of that business. And we like that business, because that business is typically more exclusive in nature, so we have a higher probability of outcome.

So when we get those requirements, we know when our people are working hard and they find the right people, we're going to get the placement because we're not competing with other firms for that business. And that space that's coming down is -- I mean, in reality, I've heard things as large as it's five times the size of the general staffing space.

And I've been out in the markets meeting with top-level executives inside these organizations, and they're saying it. I mean, I can't put it any other way -- they're basically narrowing those vendor lists to work on what they say are the C-suite exposure projects. So if they're going to major ERP implementation, that's still going to the solutions provider, but a lot of the other business that they used to push to the solution providers that don't have that visibility, they're driving it down into the statement of work business, and that's an area that we're very well equipped to play in, and our teams are organized and going after that business.

Perfect. Thank you so much. Thanks, guys.

(Operator Instructions). Ato Garrett, Deutsche Bank.

Most of the questions I have have already been asked. I just had one quick one regarding your strong results within tech on search and direct hire. Are you starting to see any scarcity coming up out of that, just given the strong perm results you've had for the last two quarters?

I mean, well, that business has been a knife fight, and I would say actually we're seeing the same thing from a candidate demand standpoint on the FA side of the house. I mean, it's been tight, tight candidate pools for quite some time now, so we see counter-offers up. Fortunately, we have some very tenured people working both within the tech side as well as the FA side that really button down the process and work very good on the matching of the right people with the right clients and orchestrating that through, but -- yes, it's going to continue to be a challenging environment, but it's been challenging for quite some time at this point.

Actually, just one more quick one, on just how to think about SG&A expense going forward. With the about 7% increase in revenue-generating headcount this year -- or this quarter, excuse me, you're maintaining your target for 10% for the year. It sounds like you're going to have a ramp in the back half of the year. I want to think about how that fits with your SG&A guidance for the third quarter and what kind of implication that might have as a percent of revenue in the fourth, if you have any comments you can make on that.

This is Dave Kelly again. So as it relates to the third quarter -- and I would say as it relates to the third quarter, our plan has been no different than it has been for the last couple years, so it's very much baked into the whole model. We look to hire -- we hired at 7.7% in the second quarter. It'll be approximately that or slightly more in the third quarter. So when we think about incremental costs, it is not a big incremental cost.

When we think about SG&A prospectively, we've indicated to you in our guidance that we expect to gain some additional SG&A leverage. Big drivers of that -- and again, this is all part of the plan that we've been talking about for a long time -- is we've done consistent hiring, we found efficiencies in our model, but the productivity improvements that we see in the associates that we've had onboard and continue to hire and as they ramp drive down the cost of compensation as a percentage of gross profit that we generate.

So that really is the key to the model, and so as you look forward from where we are today to that 7.5%, we've mentioned a number of times gross margin expectations are flat, so the benefits that we're going to get here as we move from where we are to the revenue levels that get us to 7.5% are going to come from scale and they're going to come from productive, so, therefore, SG&A.

But I want to clarify what Dave is saying from a productivity standpoint. We're not saying we're going to do anything that history has not proven we're capable of doing from a productivity standpoint, so this is really the portion of people that are in the ten-year bucket, which is the comment that I made earlier.

As we continue to see our two-plus year population expand, we're modeling that they're going to perform at the same levels that we've historically performed. If we get any productivity lift on that population on a per-person basis, that would actually be in addition to, but we are not banking on any of those things happening in our models.

Got it. Thank you.

Anj Singh, Credit Suisse.

I just wanted to hit on the productivity that you were referencing earlier. As we think about productivity on your revenue-generating headcount, you talked a little bit about it being a little bit better than what you had anticipated at this stage. Now, is that a result of the NRC? Is it more just that the cycle is at a point where the revenue is, frankly, easier to generate? I guess if you could help us put that into context of how productivity for those headcounts fares versus -- or looks like versus prior cycles and how we should be thinking about it going forward.

Yes, I would say the best advice that I could give there is to be following what Michael and Dave are talking about in terms of the forecast that we've put out there, the 7.5% at $1.6 billion, and not to try and get too sophisticated in terms of productivity, because it's complex.

I mean, we're in the bowels of the system, and based upon how people are moving through ten-year gates and what's happening with productivity, so we are from time to time in a given quarter going to have some people that -- a bigger population that transitions into one of those ten-year categories, which will artificially move productivity for that period of time. So that's really the guidance that I would have, is to not try and decipher all those productivities, because it's a complex science.

Okay, fair enough. And then earlier on the call, you mentioned that there's chatter on the uncertainty about where the cycle is currently. Could you just give us some context around that with regards to how your client conversations are proceeding? Is this something your clients are even mentioning or bringing up at this stage, or is it generally glossed over in light of the longer assignment lengths you're seeing and the secular trends you pointed to?

This is Dave. Actually, the clients are saying anything about the cycle. They're saying -- can you hurry up and get us some people? It's a -- from our perspective, it's been business as usual. The demand is very high for our services.

I think it's pretty clear what's happening in technology. Technology in the 1970s, 1980s, 1990s was relegated really to support functions, and now it is the product. It's how most of our clients are interfacing with their customers. You've seen macro trends of mobility and business intelligence, and you've got security and all these drivers that are continuing to increase demand. So I would say that the technology explosion is one of the principle reasons for the underpinning of the secular drivers.

When you add to that uncertainty about government regulations and a lot of the chatter that's going on there, healthcare and all of those kinds of things, I think what you're seeing is a shifting of resources towards the flexible staffing firms, which ultimately I think is going to be sustained. We hear clients talking about target percentages of their staff, and that's going up.

So at this point, which we've been saying for several years now, we would say that the secular drivers have really overtaken the cyclical drivers for the industry -- not that the cyclical won't impact it, because it will, but it won't be as dramatic as in the past because these clients are still having to invest in their service offerings and in their support infrastructure, so we think that we're actually in the best time ever in the history of staffing.

Yes, and the piece that I would add to that is I'd say what we're seeing is disciplined growth, is what we're hearing from the client. So unlike back in the dot-com eras, where people were willing to spend money without any clear ROIs on that, that's not what's happening within the majority of the entities out there outside of if you're doing some business with a BC-based entity or somebody who's getting ready to IPO or things to that nature, where they don't have quite the same cost constraint.

But cost is something that we hear on these hiring authorities' minds, so they're looking for how they can gain efficiencies, how they can gain leverage, which is why we continue to see a significant vendor consolidation going on around the industry, because they're looking to concentrate their revenues and get some leverage associated with that.

And I think if you were to look at our portfolio over time, I think we've done a very nice job of balancing the ability to capture those greater revenues while maintaining our margin profile and not having to give away the farm to basically buy that business.

Got it. Okay, that's interesting. I appreciate the thoughts there. Thank you.

At this time, I show no further questions in the queue. I'd like now -- I would now like to turn it back over to Dave Dunkel, Chairman and CEO, for closing remarks.

Well, thank you very much for your interest and support of Kforce, and in closing, I'm proud to share that we will be recognizing our 20th anniversary as a public Company on Thursday, August 6th, and we'll be ringing the closing bell at NASDAQ to mark the occasion.

I'd also like to say thanks to each and every member of our field and corporate teams and our leaders. You guys crushed it, and we want you to do it again, so when -- it's time for you to get back to work after you get off this call.

And also, we want to say thanks to our consultants and our clients for allowing us the privilege of serving you and helping us to reach this milestone. Thank you very much. We look forward to talking with you soon.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Good day.