Kforce Inc (KFRC) 2015 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the today's Kforce Q3 2015 Earnings Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

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

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 and better understand 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. The third quarter marked another quarter of nearly 10% staffing revenue growth, driven by continued strength in our F&A business and significant progress toward our operating margin targets.

Total revenues of $341.6 million were slightly below our expectations, driven primarily by a deceleration in our year-over-year Tech Flex growth rates. Operating margins of 6.8% and earnings per share of $0.48 exceeded our expectations as we continue to demonstrate our ability to generate leverage as we scale. The deceleration of Tech Flex revenues is a result of customer-specific issues, not the result of any changes in market demand. Rather, demand for highly-skilled Tech resources remained strong and the many drivers in this space remained firmly intact.

Although we do not believe the slowdown in spend will be long-term in nature, we're going to take this opportunity to further diversify our portfolio and plan to immediately accelerate hiring of Tech Flex sales associates.

Given our progress in improving our operating margin, our expectation is that we can accomplish our hiring objectives without impacting our stated profitability goals. Joe will further address this issue later in the call.

The unprecedented rate of change that we're seeing in areas like mobility and data security as well as the project nature of technology itself are continuing to drive demand. Staffing industry analysts continue to believe that this segment will be one of the fastest growing segments in the US with projected growth rates of 6% for 2015, 2016 and beyond. We're very pleased with the exceptional performance of our FA team and the continued progress we're making in capturing customer share as demonstrated by our excellent growth rates.

We will be taking further advantage of our strong FA customer relationships to leverage further penetration and capture more of those customers' Tech spend. Across the whole staffing sector, the ever expanding regulatory requirements, particularly around employee classification, have created a higher-risk employment environment for clients. We believe this will continue to contribute the staffing firms increasingly being considered a solution of choice for human capital needs as witnessed by temp penetration rates remaining near record levels of 2.04%.

Our cash flow generation continues to be strong with operating cash flows for the third quarter of $29 million, allowing us to continue returning capital to our shareholders in the form of dividends and stock repurchases, which in the aggregate, were roughly $11 million for the third quarter. In addition, we announced today an increase of approximately 9% to our quarterly dividend, which is further confirmation of our belief in the strength of our business and operating cash flows.

I'll now turn the call over to Joe Liberatore, President, who will provide further details on our Q3 operating results; Dave Kelly, Chief Financial Officer, who will then add further color on our Q3 operating trends and financial results, as well as provide guidance on Q4. Joe?

Thank you, Dave and thanks to all of you for your interest in Kforce. Our top line performance in Q3 was lower than we anticipated, primarily as a result of the deceleration in year-over-year growth rates in our Tech Flex business. Tech Flex, our largest business unit, which accounts for 66% of total revenues, decelerated 6.6% year-over-year in the third quarter. Our key performance indicators such as job orders remain very strong, though slightly lower than the second quarter in a number of our larger clients.

We're seeing strong demand across many industries such as financial services, insurance services, computer manufacturing and retail, which all continue to outperform our overall Tech Flex growth rates.

The ability to access talent continues to be the most significant constraint in Tech Flex. As Dave mentioned, we experienced unforeseen revenue declines as the quarter progressed and several of our premier partner clients, resulting from their M&A activities and other business disruptions associated with near term strategic initiatives. We continue to capture additional share of these customers and are well positioned for when these issues pass.

Over the last several years, we benefited from considerable growth and significantly enhanced our relationship within these premier clients. We believe these issues are unique and short term in nature and we continue to look for ways to deepen our relationship with these customers. These longstanding relationships provide longer-term stability to our overall revenue base.

The broad strength in demand suggests we have additional opportunity to further penetrate our expansive client base by more aggressively adding to our Tech Flex sales associate population. Our hiring focus in the past two years has been disproportionately focused on recruiting resources to better manage the shortage of talent in the space. This in some cases been has been at the expense of adding sales associates.

We are confident capacity exists within our existing recruiting resources to support the additional sales resources we have begun to bring on board to allow further penetration within our broad portfolio of high quality clients. As we work through the client-specific issues, we expect that our year-over-year growth rate in Tech Flex may decelerate again in the fourth quarter of 2015.

Our philosophy continues to be to work with clients that see the value of our services and recognize the shortage of supply of technology talent and we don't believe we need to compromise pricing to reaccelerate growth.

Finance & Accounting Flex, which represents 22% of total firm revenues grew 19.4% year-over-year. This business continues to experience all-time highs in KPIs, growth by industry is broad, but significant drivers to the year-over-year success had been in financial services and healthcare industry, both of which are National Recruiting Center positions us well to maximize.

Our decision to invest in talent, diversify our client base and (inaudible) operating model adjustments in this segment have contributed to market share gains. We expect Q4 Flex revenues to increase sequentially and year-over-year growth to remain at high levels.

Revenues for Kforce Government Solutions decreased 1.8% year-over-year. Services revenues, which make up approximately 85% of this business's total revenues have 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 product sales. We expect total revenues to be fairly stable sequentially.

Direct Hire revenues from placements and conversions increased 13.1% year-over-year and as with Q2 2015, remains 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'll 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 seasonal decline in Q4 in direct hire revenues though we expect the year-over-year growth rates to be stable for Q4.

Revenue generating talent increased 10.1% year-over-year in Q3, though a disproportionate amount of this time was concentrated within our expanding FA Flex service offering. We expect to refocus our efforts and accelerating growth in Tech Flex sales talent, which may result in year-over-year talent growth exceeding 10% over the next several quarters.

Profitability improvements occurring more quickly than anticipated position us to accelerate hiring in Tech sales resources without compromising our longer-term financial objectives. We continue to expect greater levels of productivity from the associates we've hired over the past 2.5 years, which should also benefit revenue growth trends and improved operating leverage.

Overall, the firm has performed well, despite the short-term client-specific softening impact trends. Finance & Accounting and direct hire remain strong while government remains stable. We continue to focus on our clients, consultants and core associate relationships to drive results and expect to drive forward with momentum as we head into 2016.

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

Thank you, Joe. Total revenues for the quarter were $341.6 million, which represented an 8.8% increase year-over-year. Our Flex staffing revenues collectively grew 9.6% year-over-year and our government business declined 1.8%. Direct Hire revenues of $14.1 million increased 13.1% year-over-year.

Third quarter net income and earnings per share were $13.5 million and $0.48 respectively and earnings per share exceeded our top end of guidance. After normalizing Q3 2014 for non-recurring charges that negatively impacted results last year. Third quarter net income and earnings per share represents 43% and 60% year-over-year improvements versus Q3 2014 results of $9.4 million and $0.30.

Our gross profit percentage in Q3 of 32.2% increased 90 basis points year-over-year. The year-over-year increase is a result of both improvements in staffing Flex margins and higher product mix within our Government business which carries higher margin profile and a slightly greater mix of direct hire revenues.

Our Flex gross profit percentage of 29.2% in Q3 increased 70 basis points year-over-year. We're seeing continued stability in pricing spreads in our Tech Flex business and our FA Flex spreads have improved 60 basis points year-over-year.

Looking forward, we expect pay bill spreads to remain relatively stable. Also of note, we continue to experience favorable trends in federal and state unemployment tax rates. 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 this to continue the benefit Flex margins prospectively.

SG&A as a percentage of revenue was 24.6% in Q3 and represents a historical low. SG&A declined 90 basis points year-over-year from 25.5% in Q3 2014. The decline was driven by ongoing expense discipline as well as improvements in overall associate productivity as this population continues to mature.

The improving productivity is a critical element in achieving our operational margin targets. As we look forward, we expect productivity trends to continue to improve as associate tenure increases. The improvements we are seeing in operating expenses should mitigate some of the cost of an acceleration in associate growth.

Q3 2015 operating margins of 6.8% improved 170 basis points from 5.1% in Q3 of 2014 driven by a combination of revenue growth, gross margin improvement and SG&A leverage achieved over the past year. This improvement exceeded our expectations, and along with providing the flexibility to invest in our business, it should allow us to meet or exceed our 7.5% operating margin target on $1.6 billion in annualized revenues reached. We now also believe we will attain operating margins of at least 6.3% as annualized revenues reach $1.4 billion and as we continue to invest in the business.

As we look at our balance sheet and cash flows, our accounts receivable portfolio continues to perform well.

Operating cash flows in the third quarter was $29.2 million as a result of greater than anticipated profitability as well as positive collection trends throughout the third quarter. Capital expenditures for Q3 were $4.3 million, which is higher than prior quarters, but does not represent the new trends and should return to more normal levels of approximately $2 million to $2.5 million for quarter in Q4.

Bank debt at the end of the quarter was $80.9 million as compared to $93.6 million at the end of Q2 2015, a reduction of $12.7 million. The firm repurchased 297,000 shares in Q3 2015 at a total cost of $7.9 million, there is approximately $66 billion available for repurchases under current Board authorization.

As we have now increased our dividend for the second consecutive year, we will continue to evaluate future stock repurchases and pay quarterly dividends as cash flows warrant.

With respect to guidance for the fourth quarter of 2015, we have 62 billing days, which is two days less than the third quarter of 2015 and is the same number of days as the fourth quarter of last year. We expect Q4 revenue to be in the $333 million to $338 million range, which represents a slight increase on a billing day basis, and for earnings per share to be between $0.43 and $0.45.

Gross margins are expected to be between 31.7% and 31.9%. SG&A as a percentage of revenue is expected to be between 24.8% and 25%. Operating margins are expected to be between 6% and 6.2%. Our effective tax rate in Q4 is expected to be 38.8%. This guidance assumes weighted average diluted shares outstanding of approximately 27.8 million for Q4. This guidance does not consider the effect, if I any, of charges related to the impairment of intangible assets, any one-time costs, cost related to the settlements of any pending tax or legal matter, the impact on revenues of any disruption in government funding or the firm's response to regulatory, legal or tax law changes.

Despite revenue growth falling short of guidance this quarter, the firm exceeded expectations on profitability, both through gross margin improvement and operating leverage. We continue to return significant amount of capital to our shareholders in the form of dividends and share repurchases which is further confirmation of our belief in the strength of our business.

We expect the client-specific challenges to be resolved over the next few months and remain focused on the execution of our plan. The acceleration in hiring along with a resolution of these client issues should allow us to re-accelerate revenue growth in the first half of 2016 while generating profitability at or above our previous targets.

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

(Operator Instructions) Kevin McVeigh, Macquarie.

I wonder if you could give us a sense in terms of the additional hires, how many and where they sit in terms of more focus on larger or small type clients?

Yes, Kevin, this is Joe. We've been targeting the 10% growth, which we've had out there for a while. So we believe that we're going to go up on that a little bit, because we're going to continue to, obviously, fuel FA Flex and we'll have to add some delivery resources, but not proportional to what we've been doing in the past.

Really the intent with the Tech sales people that we're adding is we're going to be aligning those Tech sales people throughout our existing portfolio. I mean, sure, there will be some new account penetration that will go on, but we're very confident that we have a premier portfolio of high-quality clients that we have an opportunity to go deeper and wider with beyond our strategic accounts and that's what the intent we'll be aligning those individuals.

And the same type of buildup, Joe, in terms of six months to nine months kind of scale or these more seasoned folks?

It will really be a combination. Our intent is to go into market and look for seasoned individuals, which would probably have a faster ramp up. But in general, on average, that ramp up will be pretty consistent. Also we get some leverage when we're aligning them with this existing accounts, so that also helps with some of the acceleration of ramp up.

And then, is there any way you could bracket how much those accounts just impacted you by revenue? And then, obviously, great job on the margins, is it fair to say that's probably lower margin business that came off?

No, it's not lower margin business that came off. Actually, these are some of the marquee customers that are in the marketplace. They are customers that anybody in the industry would want in their portfolio. I think if anybody looked out there and you look at the amount of M&A transactions that have taken place in the last 21 months, there's been over $8 trillion of deals that are done. I think with the last count as of this week was about 1,409 transactions. So it's pretty tough to be in the marketplace and not experience customers that deal with those dynamics. I will tell you, one of the things as we went into the new era, we spend a lot of time on evaluating the customers that we wanted to get aligned with, and go deeper, and pick who we believe are going to be the winners in various industry verticals. I will tell you, at this point in time, we're batting a thousand.

So every one of these situations that we're dealing with, we came out on the right side of the equation, and as we all know, when organizations go through this, there is a pause that takes place. This has provided us an opportunity to actually go deeper and wider in those customers. In fact, we've heard directly from a number of these customers, the way that we handle things through the processes that they've been working for have even further entrenched us in those clients. So we're really excited as these things will turn back up, because some of these customers we've been doing business with for the 27 years that I've been around here. So these are brand names out there.

And then just last one, I'll jump back in. Is there any way to think about the mix dividend versus buyback as it relates to free cash flow or does it -- a function of where the stock is?

Yes. So Kevin, this is Dave Kelly. So in terms of the dividend, as we put the dividend in place, and I guess we're just finishing about the last, second biggest -- the second full-year of dividends. This is the second increase we've seen when we put the dividend in place, we were targeting a yield of about 2%. And so we've, of course, over the last couple of years, seen some pretty good appreciation in our stock price, and we've been pretty active in the marketplace repurchasing the stock and we've got, as you well know, very predictable cash flows in this business, and feel very good about our business and felt it appropriate to make sure that we maintain consistency with our original thought process. That's really the driver behind that.

An Singh, Credit Suisse.

Hi, this is Mark in for An. Thanks for taking my question. So just on the increasing your operating margin targets to 6.3%. Previously you had pointed the few buckets that would drive that margin expansion, which included cost realignment efficiencies, scale and associate productivity. Just wondering, if you can delve in and tell a little bit of detail on your expectations and how they've changed in each of these buckets?

Sure. I would say, generally, with respect to expectations, they've been high because we performed, I think, from our perspective, better than we'd anticipated the last couple of quarters. In terms of our thought process today, really where we are going to reap the benefits in our plan continues to really be the same as we've been talking about the last few quarters. We've done a lot of work over the course of the last couple of years in making sure that we're investing in the right places and aligning efficiencies and cost and really, the big driver to where we are today -- from where we are today to where we're going is going to be driven by one scale certainly as we continue to grow, we're going to benefit from the scale -- the efficiencies that we achieved with scale, but the biggest driver is in the area of associate productivity as it relates to the increase in tenure of our associates and the expectations of those associates as they have (inaudible) and that really hasn't changed. So the thought process here is, we're doing quite well in that regard and given the opportunities we see impact Flex, taking some of that productivity and reaccelerate growth in the business, so kind of a pretty simple story. Same story, bit better than we had anticipated and we're going to take advantage of it.

Got it. That's helpful. And on just on the broader Tech market, which I understand is still pretty healthy. So over the past few quarters, we've seen some weakness in the Tech Flex bill rates and that has accelerated a little bit. Can you break down for us what the moving pieces over there and how should we think about that going forward?

Actually -- this is Joe, our Tech bill rates actually increased from Q2 to Q3. So while there's been -- if you were to look at it on a year-over-year basis, there's been a slight decrease in bill rates, that's really mix driven, not skill driven. So we haven't experienced any pressures in terms of deceleration on bill rates for given skill sets. In fact, they've been, I would say moving up.

I'd say pretty consistently really kind of over a prolonged period of time, right?

Tobey Sommer, SunTrust.

Wanted to talk a little bit more about the client-specific issues. You had referenced, I believe if I heard correctly, growth potentially being slower year-over-year in the fourth quarter, but then re-accelerating in a period of months. Is that driven by your internal changes, the sales people, additional recruited heads et cetera, or is there a line of sight to alleviation of the customer issues?

Hi Tobey, this is Dave Kelly. So just to make sure that we are precise on what we said, so we said we anticipated Tech Flex revenues year-over-year growth to potentially slow in the fourth quarter. And then as we get into the first half of the year that we expect a re-acceleration of that growth, drivers primarily being, yes, we expect that the issues that are being seen at these specific clients will alleviate themselves over the course of a few months. Additionally, as we get a little bit farther into the year, we're going to start to see some of the benefits of the people that we have. So it really is a combination of things overlaying what we see is still a very strong market for Tech Flex.

Are you -- trying to understand these client issues, did you see some of this develop? Was it late in the quarter, or early in the quarter, or are they telling you that they will be resolved and be kind of back into resuming increased demand within a short period of time?

Yes. So let me back up a little bit because whenever, especially, if you talk about M&A, everything we're talking about here, it's not like we had a run-up because of M&A situations going on within clients and now we're seeing a tail-off as they're working through that. We haven't benefited from any M&A dynamics within these particular customers we're talking about. Their businesses were tracking along and they were making considerable investments mainly on customer-facing type applications where we do a lot of work.

And as they started to go through their integration, they just paused things, which is very normal for any organization to do. And what we're also hearing is the pipelines are building as now those things are starting to move behind them. And so, as we move into the first half of the year, we are hearing direct from the client that there is going to be a loosening and they're going to get back to a normal course of business and getting after their key applications to drive customer interaction, which again is, an area that we focus quite a bit of in and around.

So from your perspective, the wallet share among those customers remains good, and in fact, some of your commentary suggests maybe you entrench yourself even further?

Yes. Within those customers, we're not hearing that they are decreasing their budgets over time, so if anything, let's just say, in the scenario their budgets are staying constant, we've been capturing our customer share within every one of those customers we've been basically capturing a greater percentage of their spend as well.

Maybe kind of shifting gears, if I could ask a question or two in the government space, for example, where it looks like we're about to have a scenario with the budget in place for a while that has not been the norm. Could you give some comments as to what you think that might imply for the business going forward?

Sure, Tobey. This is Dave. We're 18 months into Pat Moneymaker's tenure, we've gone through a significant positioning of the business, focusing on two primary areas within services, DSS and CSS. As you know, our sequestration has caused a lot of difficulties in the way that they manage their budgets, and their spend, and the trend toward low-cost technically acceptable has really gotten traction.

The good news is that as we've gone through this, we've managed through most of the recompetes and have resolved nearly all of them. So the revenue at risk within there is very low. At the same time, we've also been actively pursuing, through the RFP process, some fairly significant contracts. The budget resolution theoretically should allow for those contracts to be less according to their normal schedule. And of course, with the government, everything is up in the air, but not having sequestration looming and having the budgets resolved for a couple of years ought to be favorable for us as we move into Q1.

And as we mentioned, in the commercial side, we have heard things that would suggest that there are favorable developments there. We've also had quite a bit of success in the product part of that business and that too is continuing to prosper. So we could actually be looking at a favorable 2016 for government if trends continue and things develop the way we talked about.

Yes, and I would add in addition to that, Tobey, just to give you a little bit of color. We had five re-competes in Q3 of which we won five for five on, so I mean the team has done a really nice job on that front as well.

Let me jump in -- a little bit finer point on the recompete question, those 5 recompetes as Dave mentioned are significant portion of their base. So as we look forward into 2016, relatively speaking, it's a very light recompete year for KGS. So the work that they had previously been doing in keeping the business that they had with their resources are certainly fully dedicated to new pursuit. So we feel good about where we are in that business.

Yes, it would be nice too, they have been contributing to growth instead of the depending. And I take my hat off to those guys. They've done a great job in a very difficult climate in going through this transition. So they're highly committed and they're actually excited to start contributing favorably to our growth as well.

My last question, if I may is, the investments that you're going to be making in sales and additional recruiters, does that change at all, the incremental margin profile as we look into next year in the income statement?

Tobey, this is Dave. So certainly as they ramp, the cost of those hires impact the incremental margin of the business. So and you can kind of think about where we are today and think about some of the guidance that we provided you in terms of where we think we will be at $1.4 billion in annualized revenue being at 6.3% operating margin, you obviously see the results for this quarter and get some sense as to the fact that that reinvestment does have an impact on margins and the incremental margins in the near term.

In the longer term, note that the -- on a per-person basis, the productivity that we expect from them is going to come the same way it has in the past. So it is a really shift, a little bit to the right for those folks as they ramp in the population as a whole.

Tobey, this is Joe. I just want to clarify one comment that you made just so that there is no confusion. You'd mentioned the addition of recruiting resources, where actually we stated we're hiring on the sales side of the house. Because by hiring on the sales side of house, the candidates that we're recruiting today are mainstream skill set and historically, because of our concentration within these premier partners, we've had a place to put those individuals. And now while we have this dampening that's going on there, given these are mainstream skill sets, we're looking to deploy those same resources into our broader customer base through these additional sales people that we're bringing on.

Mark Marcon, R. W. Baird.

I was wondering, could you talk a little bit about the Flex gross margins because you did have a really strong improvement there. What's really seeing that, what's driving that?

Hi. Mark, this is Dave. It comes from actually a couple of different places and a bit different in a couple businesses. So as we look in our staffing businesses in Tech and F&A, specifically I made a comment that spreads -- in the bill pay spreads in the Tech are really stable year-over-year, actually it's slightly improved. So there is a positive bias, I would say to spreads although they've been relatively stable. I'd mentioned at length and this is true across all of our businesses that the (inaudible) cost that we've incurred over the course of the last five years as a percentage of the pay has come down because there have been many states who have lowered rates and net pay back to federal loans and income tax, there are only five states now that have yet to repay the federal loans, unfortunately, that state on the West Coast, the biggest one is still one of the outlier there. But nonetheless, the fact that rates have come down and for us, obviously, that has significant impact on our cost, especially in the first quarter, but we get a sustained benefit throughout the course of the year, because of course, depending upon the taxes all year. And those are really the big drivers.

In Tech and F&A, spreads have actually been quite a bit stronger. I mentioned 60 basis point improvement in spreads between bill and pay, and F&A I think it's a reflection really of the strength of the market there. That's the biggest one. In government, we talked about the product business. So it's a number of different things.

Mark, one thing, just to give you a little bit of flavor, because I know this may have been where you were trying to go there. We're seeing strength across both the spot market and across our strategic account portfolio, it's been very consistent with NFA in both of those and actually in Tech we've seen a slightly more of a margin expansion within our strategic account portfolio versus spot, albeit they are both up.

I really appreciate that additional commentary. And with regards to just on the Tech Flex side, where there were some client disruptions, can you talk about how broad-based that was and in what specific verticals that may have been?

Yes, I mean, it was not broad-based, so it wasn't something across the entire portfolio as we mentioned in the comments. A very client-specific and in a number of --.

I meant like how -- is it like five or six clients or three-year?

Yes, I mean just for competitive purposes, we're not going to go to that level of detail, Mark. It's not broad-based. I mean, whether it's three or whether it's five, does not change the dynamics of what we're talking about in terms of what happened, and where we're going.

Okay, but I mean, it's just a handful.

Correct.

And then, with regards to the addition of the sales associates, just to understand it better, it sounds like you're going to target the existing accounts, which you've already penetrated fairly deeply. Is it because of the M&A activity that they might have some parts of those accounts that were acquired that you aren't touching on that you can now touch on?

Well, if we were to partition our portfolio, where we've been concentrating the majority of our effort has been within the Top 25 within Tech Flex. We have 1,000 customers that we do business with, at any given point in time within Tech Flex and so what we're really looking at is getting deeper and 26 through X number of our clients. So we're not going to the thousand customer but that next layer customers where just through sheer number of people, we didn't have enough resources to go deeper and wider within those customers and there is additional market opportunity and customer share opportunity to penetrate at those client where we already have established track records.

And then just to clarify with regards to the 6.3% operating margin target on $1.4 billion. Is that, I mean if you just end up growing your revenue by 6% next year, you get to $1.4 billion. Shouldn't we then therefore assume that the EBIT margin would get to 6.3% at that revenue run rate or is there something I'm misunderstanding?

I'm not sure that I understand the question entirely, Mark. Is it possible for you to restate for us?

Sure. I just want to -- so on an earlier question you mentioned how the SG&A was going to increase and help potentially with the addition of the new sales associates. So I'm trying to make sure I understand the commentary around the $1.4 billion revenue run rate, these will be the 6.3%?

Okay. So, let me see if I can give you a bunch -- a kind of a way to think about it. So when we talk about annualized revenue, what you might think about it in the context of in a quarter where we might have $350 million in revenue, the expectations would be for operating margins to be at 6.3% or better. Did that answer your question?

Paul Ginocchio, Deutsche Bank.

Hi, good afternoon. This is Ato Garrett on for Paul. Just a couple quick questions about your 4Q guidance. It looks there's a bit of a revenue slowdown that's implied by guidance. Wondering if that's concentrated to the persistence of those client combined specific issues at Tech Flex representing a more broad base there? And also just looking at your gross margin guidance for the fourth quarter, if you had any comments you'd like to make by division on gross margin expectations?

This is Dave Kelly. So the key thing to know Q3 to Q4 that impacts revenue most significantly is the fact that there are two less billing days. So when you think about the sequential percentage growth by billing day from Q3 to Q4, that actually suggest that revenues are going to grow on a billing day basis Q3, so on a daily basis. So it's (inaudible) part of your question. The other question you had was relating to, I think, gross margin. The gross margin in Q3 and Q4, we typically see Q3 to Q4 a slight decline in gross margin, predominantly because of the fact that we've got less billing days and yet we have some people or they -- for the full calendar quarter and have paid time-off. So it's not a reflection of bill pay spread compression, it is a dynamic of basically the holiday season.

If there's any comment you want to make for Tech versus F&A? Is there any (inaudible) differentiation to be material?

Yes. No, I mean, I think that is a dynamic, generally speaking that we see across our business inclusive of government.

And then part of -- because the other part that Dave didn't really touch upon explicitly, just to give you some flavor. Given we didn't experience this slowdown in these clients at the beginning part of the quarter, it happened more mid-quarter. So ultimately what happened is typically in our industry, you're going to see a softer August. What we didn't see our typical rebound as we moved into September. So yes, that's why Tech Flex, based upon the numbers that we shared in guidance, will come down on a year-over-year basis in Q4. And it's because we're going to feel that full quarter impacting Q4 as well.

So you say that's coming down in 4Q, but it's more of a -- it's a lower year-over-year growth rate, you won't actually see a revenue decline, will you?

Correct, that's right. The deceleration in year-over-year growth.

I was talking year-over-year.

(Operator Instructions) Randy Reece, Avondale Partners.

I was wondering, if you could detail a little bit how you saw Tech Flex trends change in September and October?

Yes. So as I think, Joe just mentioned, typically September itself, as you come off the summer months, and it's a five-week month for us in our accounting calendar, has historically been a strong month. It's a month that we typically look to as a key month to make that quarter because the summer is always going to be slow, as Joe mentioned, because of the client dynamics that we've talked about that bounce in growth that we typically saw, we did not see. And as we've moved into the month of October, again is reflective of our guidance of a deceleration in growth again, more specifically because of those clients, just because of the sheer size of those clients, we're not seeing that further acceleration. So again that's kind of the same story that we've been talking about.

Yes, Randy, one other piece that I would add to that is on the front end indicator KPI front. So what we experienced is we had a very strong beginning of August at the high levels that we had been seeing in Q2 and then we saw a deceleration in KPIs such as job order flow and those -- things of that nature. And that ran through September and in the beginning part here of Q4, we have seen a rebounding of that.

And the strong gross margin because of product and government solutions in the third quarter, do you expect some of that to persist in the fourth quarter?

This is David Kelley again. So it continues to be a highlight of that business, certainly, but I think our expectation as we move into the fourth quarter, then the strength in the third quarter may slide a little bit, but it's still going to be a good quarter, not quite as good. So March -- in total, we think it's going to be flat.

Thank you. At this time I'm showing no further questions. I would like to turn the call back over to Mr. David Dunkel for closing remarks.

Okay. Thank you very much for your interest and support of Kforce, I'd like to again say thanks to each and every member of our field and corporate teams and to our consultants and our clients for allowing us the privilege of serving you. Thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now all disconnect.