Resources Connection Inc (RGP) 2003 Q1 法說會逐字稿

Welcome to this Resources Connection first quarter 2003 conference call. At this time for opening comments and introductions I'd like to turn the call over to the Chief Legal Officer, Miss Kate Duchene.

Thank you for participating in us today. Joining me are Don Murray, Chairman and Chief Executive Officer and Steve Giusto, our Vice President of corporate development and CFO. During this call we'll be providing you with comments on fiscal 2003.

By now you should have a copy of today's press release in front of you. If you need a copy or are unable to access it via our website, call can a Sandra Edwards, and she'll be able to fax a copy to you.

Before introducing Don Murray, I'd like to read an important announcement about certain statements we may make. Specifically, we may make make forward-looking statements, in other words, statements regarding future events. We wish to caution you that such statements are just predictions and actual events or results may differ materially. We refer you to our 10-K report for the year ended May 2002 for some of the risks uncertainties and other factors such as seasonal and economic conditions that may cause our business, results of operations, and financial condition to differ materially from results of operations and financial conditions expressed or implied by forward-looking statements made during this call.

I'll now turn the call over to Don Murray, our chairman and CEO to give you a overview of the quarter.

Thanks, Kate. Welcome to our conference call for the first quarter of fiscal 2003. For those of you new to our company, Resources Connection is an international professional services firm which provides primarily accounting and finance, human technology professionals to serve needs on a project-by-project basis. We serve them in 45 offices. Accounting and finance services represent the majority of our services, although our new service services continue to grow. That requires expertise that is not feasibly available from the company's internal staff. As a pace of change in the business world has accelerated the complexity of depths on corporate staff increases.

Resources Connection has capital live on our big five audit tank to build a company whose client service model helps them achieve the goal at cost substantially different from other alternatives. That, coupled with our cost-effective business model, have helped us develop a unique niche in the professional services environment recently in response to clients's needs and changes in the business world, we are expanded the company's service official.

Specifically, as I mentioned very briefly in our last call, we had formed two new subsidiaries that are focused primarily on assisting companies on risk assessment needs. The first, Resources Audit Solution, was launched June 1, 2002, to assist clients with internal audit and assist leads or out source basis or co-source. In light of today's corporate environment, we believe this offering has great potential. Our second subsidiary, Resources Consulting Group, was also launched June 1, 2002, to expand our existing executive compensation consulting practice. This group focuses on consulting projects for companies, board of directors and creditor committees in the areas of executive compensation and corporate governance. We believe that there's a great needs for this service offering from an independent experienced provider.

Today we'll discuss the operating results in our first quarter of fiscal 2003. We'll also give you our thoughts on the trends we see in our business specifically as well as those trends and events impacting the greater professional services industry. As indicated in our press release earlier today, revenues for the quarter were $43.5 million. This revenue is sequentially slightly higher than the prior quarter and less than the first quarter by 12%. Since the summer quarter has traditionally experienced weaker demand and a higher level of vacation that negatively impact revenues, and because this first quarter included two significant holiday weeks, the revenues results for the quarter were encouraging to us. In order for us to meet our internal gross margin target for the year, our business will need to show sustained revenue growth in the ninth, three-quarters of the year.

We experienced strong sequential growth in our UK practice and our IT practice. The company-wide accounting and business was flat sequentially as the economic slowdown experienced in July 2001 continues to impact demand for middle market companies. Demand from our larger clients has not been as severely impacted. Our offices report many pending businesses as fortune 1,000 type companies. The first quarter of fiscal 2003 included two major holidays. As with the winter holiday season last year, the summer holidays have a significant impact on gross margin. Therefore, the pricing improved slightly during the quarter gross margins would suggest the low 40 for the quarter.

Our last conference call we indicated our intersection to invest to provide the comprehensive risk management and internal add it solutions to our clients. We also announced resources consulting group that example expand our ability to provide human capital corporate growth as soon as and executive, and we'll continue our advertising efforts. These steps were taken to position services historically by big five firms but now these services may pose a conflict for the external auditors to provide to their clients. During the first quarter, these additional investments totaled approximately $500,000, or a little more than a penny a share. We are cautious about prospects for revenues until services have actually been delivered, but we're very enthusiastic about the reception our internal audit service is receiving in the marketplace. This is a business with less volatility than our core practice and one that is right on point with the issues companies are facing in today's challenging regulatory environment.

The end gauge. That we're winning will provide revenue throughout the year and have a potential of recurring revenue for years to come thus while the impact is not yet significant this service is providing us with a important new revenue source and we believe we'll continue growing at a robust rate for the foreseeable future. We've currently won engages it's at 20 companies and have many opportunities in the pipeline. We project by October that the RAS will be at a $3 million annual run rate.

In our accounting finances services the metrics we use to gauge the business continue to lead us to conclude that clients are satisfied. This since revenues from our 50 largest clients represented 42.7% of total revenues year to day. 69 clients contributed six tier% of revenue during the quarter and our largest client was less than 4% of revenues. Other than one client that's close to bankruptcy all of our top 50 clients from the previous year remain clients at the end of our first quarter. Although demand in the accounting and finance project business continues to be flat the demand seems to be better at fortune 1,000 type clients. In worse, at middle market companies.

We believe there is [inaudible] and companies deal with recession issues that demand will surface and drive growth over the balance of the year. There appears to be a reasonably robust pipeline of new work, and we're hopeful that this pipeline will help drive company-wide growth and create positive momentum for the remainder of the year. We remain committed to the development of our geographic footprint.

We have recently opened two new domestic offices offices and small markets in and second uk office to serve a client in the north of England. Numerous offices do not have a significantly significant impact on revenues but they boss our capabilities and they also provide the platform for growth in future years. The typically have only modest impact on our G&A cost. We continue to look optimistically at domestic expansion with a Target of four to six offices per year.

Here's Steve on additional information with results on the first quarter.

Thanks, Don.

Revenues during the first quarter were slightly above the final 2002 quarter, despite the impact of the holidays. Average weekly revenue during the first quarter was $3.35 million. Weekly revenues during Q1 were between 3.3 and $3.7 million, except for the Memorial Day and the 4th of July holiday weeks. Especially the July 4th week was down, as the fourth fell on a Thursday and we lost two full days of revenue. The remainder of the summer was flat. This is actually encouraging, as August tends to be a slow months even in strong economic periods.

The early weeks of the second quarter showed some positive results. Revenue was slightly to the upside, and in the first week of the quarter, we had the first year-over-year growth since December nine months ago. While this is encouraging, demand still remains choppy, and week to week trends are difficult to identify. To meet currents analysts' expectations for Q2, weekly revenues would need to average $3.7 million per week; the first week of the quarter revenues were over $3.7 million. The second week of the quarter included the Labor Day holiday, and was therefore substantially less, but on a normalized basis was in line with the first week. Because of the lower revenue in a Labor Day week, average revenues for the remainder of the quarter would need to be approximately $3.8 million to reach the current consensus. Although we have the potential to achieve this level of revenue, it seems more likely that revenue during the quarter would average between $3.5 to $3.8 million per week, which would result in revenues between $45.5 million and $49.4 million.

Our gross margin percent for the quarter was lower, consistent with our exec agencies sawing. Gross margin for the quarter was was 39.6%, compared with 40.7% in the year ago quarter. As we mentioned after the winter holidays, as the business model matures, more associates qualify for holiday and vacation pay, negatively impacting gross margins in those quarters that have many holidays. Adjusted for the holidays, gross margin would have been over 41%. Other than the holiday impact, the vast majority of a difference in gross margins year-over-year is attributable to lower conversion fees this year. Bill rates improved in every service line during the quarter. Associate head count at the end of the quarter was 1,044 compared to 1134 a year ago and 1,060 at the end of the 2002 fiscal year.

For the quarter, our spending levels were flat with the previous quarter, while we continued strategic spending in the marketing area, made investment in our newest services, and made some strategic hires. The overall impact of these investments was approximately $500,000 during the quarter ,a little more than a penny per share. Given the changes going on in the professional services industry, we believe it is important for us to make these types of investments now, and we expect to continue spending to improve our brand and to capitalize on new opportunities. We added a net of six higher level professionals in business development, our new resources audit solutions practice, and in our newest offices.

SG&A for the quarter was $13 million; this was a $140,000 more than a year ago quarter. SG&A as a percent of revenue was 29.9% for the quarter, reflecting the reduced levels coupled with growth investments. Our board is supportive of investing for future growth in newer service lines and new offices and new service lines. Depreciation and amortization were $346 thousand for the current year quarter, versus $288 thousand a year ago. Interest income was $338,000 for the first quarter versus $282,000 a year ago. Invested cash earned 2.5% during the quarter; we have no interest expense this year. Interest income was negatively impacted by the very low interest rates available in current market conditions. Our pretax margin for the quarter was 9.7%.

Now let me turn to our balance sheet. We again generated positive cash flow in the quarter. Cash and investments at quarter end was $57 million. Our net increase in cash during the quarter was $1.4 million. Receivables at quarter end were $21.5 million, reflecting good collection experience. Days of Sales outstanding at quarter end were 47 days, compared to 44 years at year end. Much of the increase in DSO is due to higher receivables and revenue a year ago, so if you used the most recent quarter results DSO's would be a few days lower at the end quarter and the end of the prior year. Therefore, while we're never content with DSO's above 40, I believe our performance on that measure is good.

Now let me return the call to Don for some final comments.

Thanks, Steve.

Starting with July of last year, we have experienced a period of difficult operating results. The last six months, it seems stable revenue results, we're optimistic that the remainder of this year and particularly the last year of the fiscal year will see the type of demand we have enjoyed historically, and therefore growth and revenue consistent with our plan for the rear. We're being opportunistic. We're making investments in people and services that today have a greater impact on short term earnings than when our revenues were growing rapidly. We need to be in a position to provide services that were traditionally provided by the big 5 audit firms, but in today's environment may not be appropriate for the auditors to provide. We must make those investments now to capitalize on these opportunities we see for the future. These investments are already providing some revenue, and our newest service lines are demonstrating the highest demand in this slack economy.

Our outlook for the next quarter is for modest growth sequentially as a foundation for higher anticipated growth after the end of the calendar year. This outlook is based on a presumption that there will be some improvement in U.S. economy that'll allow us to experience the growth and experiences we historically achieved in the third and fourth quarters previous to this recession.

As we mentioned in the first weeks of our second quarter, weekly revenues showed year-over-year growth for the first time in a long while. We're still unable to say this is a strong trend, but we're working hard to build positive momentum. We'll continue to look for new ways to improve and strengthen our business around the core principles of client service, superior talent, and extraordinary value that clients demand. We also continue to explore acquisition opportunities that could expand our scope of services in geographic reach. One of these is in the fast growing area of supply chain management.

We will continue the print advertising campaign in publications geared toward our buyer or influence our group. These ads position us as a truly independent solution to address the heightened awareness of risk issues that executives and boards are facing. We plan to continue this level of marketing to increase influencer and buyer awareness of resources connections.

The first quarter was a quarter of investments. These investments as mentioned are reflected in our operating results. We would not make them if we didn't think they'd result in growth. As we review the outlook for the remainder of the year we should continue to see returns interest these investments. As a company, we're committed using our cash to continue making appropriate investments for our future, including acquisitions or organic start ups.

We'd be glad to answer any of your questions now. Thank you.

Thank you, sir. Today's question question and answer session will be conducted electronically. If you'd like to signal to ask a question, please press star 1 on your touch-tone telephone. Once again, that is star 1 for a question. We'll pause for just a moment to give everyone a chance to signal. And we'll take our first question from Randy Mill with Robert W Baird.

Good afternoon, Don and Steve. A couple questions. First of all, what are the investments to come in the internal audit business? It sounds like your investing, trying to get that going. What can we expect for the next couple quarters? Or for the next year?

We are going to be investing in people, basically partner-level people with internal audit management experience, and we're looking at them in various regions around the country. Right now we have hired some, and, of course, they're helping us get these new clients that we're getting, but we'll be hiring in different regions ahead of the revenue curb. Most of these internal audit projects take a lot longer to close than our typical resource project. So those investments are going to be in the form of salaries, and we'll make them as we find the right people. So we have searches going probably in three or four different locations right now for a partner-like a person.

And if they're partner-like people, are they bringing business? You mentioned that the closure rate take a bit longer but are they bringing business with them to you, and, you know, is there a way we can quantify what you might expect as far as the investment for the next few quarters?

For the most part, the people we have hired have brought us sort of a network that has not resulted yet in any of the internal audit work. Most of the internal audit work we're getting right now is coming from Resource clients and the Resource network. Eventually the people we hire will bring us business. So we're not counting on them for immediate business, like we're acquiring a practice. It's really for their expertise in managing the business and responding to the leads that we're getting right now, which have really been very surprising and encouraging to us. And I would think -- and Steve, you can correct me. I would think that the level of investment we're going to make is probably similar for the rest of the quarter to this quarter.

Yeah, I mean, our goal, Randy, is to have a reasonable balance of SG&A spending and investment coupled with revenue, and we're trying to keep it as close to our existing business model as possible while continuing to make appropriate people investments to grow the business. So as we mentioned, demand for this service seems to be as high as we expected, and we're -- it's necessary, therefore, for us to build the management team to address that demand and while some of it may come slightly ahead of revenues we're hopeful to match it up pretty closely.

Sounds like --

There's two ways of making an investment. One is to buy a company and put on your balance sheet as goodwill. The other is to do the way we're doing it which is organically, which we've always done ,that we feel really has the best return for ourselves and our shareholders.

It sounds very encouraging; and then just want to ask about the gross margin below 40% in the quarter, and the holidays, obviously, would not be, shouldn't be a reason for a year on year decline just because they occur in both periods. But, Steve, could you break out how you get to the 41%, and what that comparable number would have been in the prior year?

The comparable number would have been slightly higher. We have conversion fees that, year-over-year, have shrunk pretty considerably, and that's the major reason for the year-over-year is he decline in gross margins. Also, you know, part of the reason for the more impactful component of the holidays is just the business is maturing, and we have people who've stayed with us longer and, therefore, more people qualify. So it's not exactly apples and apples, Randy, so you can't just say last year was exactly the same as this year. But I think it's fair to say that we expect gross margins to be 40% or higher for the remainder of the year.

And for the full year?

For the full year, you know, we'll have the same type of pressure that we did last year during the holiday periods, but we expect gross margins in excess of 40% for the year.

Great. Thank you very much. Appreciate it.

We'll take our next question with Thatcher Thompson from CIBC World Markets.

Good afternoon. I'm wondering on the internal audit side you mentioned you thought by the end of next quarter you'd have about a $3 million annual revenue run rate.

Right.

And those most of these clients are calm you going from existing Resource clients. How much have you seen of turn over of the internal audit groups within the big four, I guess, where clients are looking to shift that work somewhere else? How much is coming your direction? How many of those conversations are you having, and also those employees?. Are they seeking to get out of their situation they're in now?

It's a multifaceted question, so let me see if I can answer it and cover everything. Number one, we have seen and, in fact, we've hired some people that have left the big five internal audit groups. Number two, I have spoken to the CEO's of -- the people running two of the big four groups, and they believe that they're going to keep the majority of their work because they're just going to switch clients.

So do the same level of revenue, but it may be a different client they're doing it with?

That's what they believe; right. What we see is that the Sarbaine's act and as clients, as companies become aware of all the ramifications of these certifications required that it's going to increase the amount of internal audit work, number one. Number two, as the big four firms try to switch clients around, the clients may not be amenable, especially a, say, two to $3 billion public company may not be amenable to having two big four firms in there working, because when they do that they exclude them from doing something else. So I think the fortune 100 companies will continue to use big four firms for out sourcing internal audit, but it may not necessarily be true for the majority of the public companies.

And Don, has that process started? Are those discussions already happening?

For us, we're having a lot of discussions around that. And -- but it does take longer. Some of the companies that we are bidding on the work, you know, the other bidders are two of the big five, or two of the big four, so that's who we're seeing right now in the marketplace. Now what helps is all of our backgrounds and resources came out of the big five. A lot of people came out of the audit practice. You know, I had an internal audit group at delight working for me, so I'm aware of what this stuff works and what we need to do it to market it and sell it, so we're working hard to do that. I think you had one other question which is, are we seeing a lot of companies switch yet from one big five internal audit group? I don't think we're seeing a lot of it. We're seeing some of it, but, frankly, in some of the speeches that some of our people have gone to these Sarbaine act seminars, the big four partner indicated they wouldn't going to give up to the internal audit work until the SEC actually publishes regulations that says they have to. They actually said that in public.

I would think that it's a board level decision not the internal audit service company decision. And I just wonder what it is that's going to kick the boards into high gear to start making the change.

That's one of the reasons we've really increased our marketing and advertising, and we're advertising to board members. I mean that's really where a lot of advertising is going: to audit members and board members. And I think you're right. It's sort of like a wind and as this wind grows, this trend is growing, that board members will become more aware of their responsibilities, more aware of the requirements under the Sarbaine's act, and this would be a group of changes that occurs, and we're trying very hard to position ourselves to be, you know, a really professional preferred provider for them.

Okay. Good. Thank you.

You're welcome.

Our next question comes from Andrew Steinerman with Bear Stearns.

Hi, Don and Steve. If I think back to my big six accounting days, I recall big business for accountants is heating up and it's great that you were able eke out some sequential growth during an unseasonably unhealthful time of the summer. Don't you think -- or if you could give us insight into what your client are saying as we look at current quarter there's, you know, a fair bit of work that comes on that is sort of less discretionary in nature?

We're seeing a lot of, right now, in our core business, opportunities, and I don't believe a lot of those have to do with that kind of work. Steve and I made some rounds and met with some of the big four audit PIC's to talk to them about, well, as you get a new Anderson client, they probably require a lot of work to switch them over to your auditor.

Sure.

And the answer we got back is we got plenty of staff right now in the summer to do that.

I see.

So they were -- we've gotten some of that work I would say. I'm aware of a few projects, but the majority of that work is I think is being driven by this demand that has sort of had a lid on it because of the cost restraints in fortune 1,000 companies, and some of this stuff is bursting out and they need help.

What about just normal accounting busy season, do you think that we're going to get a benefit from that?

Andrew let me see if I can add. I think first of all, that we generally expect some benefit during this period of time, and we're hopeful that we'll see it. I would say that my last couple weeks in travels to offices the sole source of concern among our client base and amongst target base is internal controls, risk assessments, Sarbaine's actually asked, "How am I going to comply?" and the reason it's difficult to estimate when that demand will arrive is that there's a lot of uncertainty around how to deal with it. So we're dealing with a likely improvement in demand because of that, but it's difficult to know when exactly it will happen because you have decisions being made, first of all, at a very high level. Either at the board or a very high level in those organizations, and you have people who are trying to make decisions without a whole lost information to make it from. So there's a little bit of a catatonia associated with that that, but that's going to have to break because compliance with that law will be coming down the track pretty quickly.

One more clarification, I think you talked about 20 contracts or something like that in your prepared remarks. Could you be more a little more specific? Is that from 20 new clients or a combination of new and existing clients, and if you could just give us a sense of where they're coming from.

These are 20 internal audit assign.

Oh, I see.

And they range from -- this is from our RAS group, and they range from 20 different companies, and they range from complete outsourcing of an internal audit to in sourcing where we're working for their chief internal auditor doing either a set of internal audits or just projects, but this is a new RAS organization that picked up the 20 clients.

That is clear but if you could just point out the other thing to me. When we're seeing some sequential growth here, is it coming from your our existing client or a new client wins as well?

It's mostly coming from our existing clients from fortune 1,000 company base.

Thanks for your help. Okay.

Our next question comes from Greg Capelli with CSFB.

Hi, guys. I wanted to go back to the gross margin and just clear something up. Steve, if we were to assume that you are associate pool continues to mature, is 40% plus in the gross margin still realistic?

Yeah, yeah, I think it is. We have -- I think the effect you're seeing is about the effect that you will see, meaning that it's not going to get any worse than it is. It's kind of gotten to the point where we have a handle on it, and it impacts an individual quarter, but our pricing is strong enough that over the course of the year, we still, even in a market where kind of the hundred percent gross margin that comes from conversion fees is not really happening, even in that type of market we expect over time to have 40% gross margins.

The other thing that it impacts the gross margins is up through July last year, we were growing. When we grow we add new associates on that don't automatically qualify for all the benefits and have to work a certain amount of time to earn their PTO which is their personal time off. And as we've contracted and we basically aren't adding a lot of new associates, the associates doing the work, basically, already have their PTO earned and everything else. So we would also see the gross margin probably go up a little bit as we start to grow again and add new associates.

That makes sense. And then, Steve, on the DSO's that you talked about, you know, where would you expect -- where would you hope to end the year, you know, given what you've seen here in the quarter and what you're expecting going forward?

I would tell you that there were a lot of encouraging things in the quarter. The fact that DSO's were up a few days was not one of those, and I'm not particularly pleased about it. I think that we still have DSO's that are better than those. My expectation over time is low 40s, and we have specific actions in place to return to the low 40s.

Okay. One more. You mentioned, you know, I think you said you spent $500,000. Was that mostly on branding and advertising, that $500,000, or was that split?

It was sort of like half and half, .

And then are you planning on continuing at that level for the rest of the year?

Yes.

Okay. Just final question. You know, for you, Don. Just in terms of the attitude of your larger clients, you know, not even perhaps what they actually did with you in the quarter, but just give us a idea, you know, from the beginning and then versus coming out of the quarter, did anything change meaningfully ? Did it -- did it get worse or was it about the same?

Yeah, I don't want like be hiding anything. I would say that just to say that we're much more optimistic today than we were, you know, three months ago with our large client base, and their attitudes. We, you know, we're actually feeling, you know, better, so --

That's helpful. Thanks a lot.

And just a reminder for everyone: It is star one for a question. Our next question comes from Adam Waldo with Lehman Brothers.

Yes, good afternoon, Don and Steve, thanks for taking my questions, and I apologize. I joined late, so you may have covered some of these already. Don, on the last quarterly conference call you signed the company up for 15% growth although admittedly you would say that would count on the big second half of the year. Are you still comfortable with that 15% top line growth target?

The 15% is our internal plan that we are working hard to get to. And I tried to clarify that last time that it wasn't really the guidance we were giving, but it was our internal plan that our people are committed to working as hard as they can to make it. Steve and I talked about the type of guidance, and I'll let him answer that.

Adam, I think that what Don has said with I agree with completely is we have a target to get to 15%. We have a plan to get there. We gave guidance during our prepared remarks about revenue for this coming second quarter, and I would tell you that if we are not towards the top end of that, then it becomes very difficult for us to get to the 15% target that we've set. So, you know, the street has us growing slower than that, and, you know, I've looked at where you and other people have revenues estimated for the year, and while we certainly can't guarantee it, we think that we have a reasonably good shot at getting to those revenue levels, particularly given as the inclemently better revenues we saw toward the beginning of our second quarter. But I think that it's still difficult in this environment which has continued to be very challenging to look out much further than a quarter. So we've estimated as best we can revenues for this quarter. We're going to, you know, work hard to get there first, and if we're towards the top end of that range we'll be in good shape to make bigger numbers obviously for the rest of the year. If for some reason the economy continues to put a drag on demand, and we're unable to get to the top end of the range, we will have to give you guys additional thoughts on where we think the year will come out at that times.

That is fair, Steve. As we look at the EPS consensus for the street, the street consensus I think was around 70 cents going in the quarter, and with a 11 cent quarter here and the perspective brands spend for the remainder of the year, are you comfortable with the street consensus at 70 cents, or are you more comfortable down in the 50 to 55 cent range?

I'm not certain given what I just said about how far out we can see that I could give you particular advice on what earnings will be for the year. You know, our plan, once again, and our target would be more or less in the range of what the street has. But that relies on a lot of things that are yet to happen. And which depend upon first of all, having a reasonably strong second quarter. I think for the second quarter the street was at 16 cents. I think that that is possible, but that's likely a little high, given where the economy has been. But I'm not completely prepared to say exactly what we think earnings will be for this quarter. We're more comfortable with our revenue guidance, then we'll see how the investments turn out in this quarter, and we'll give additional guidance at the end of second quarter.

Okay. If we just quickly you may have said this in your prepared remarks, Steve. Are you still earning about 2.5% effective interest rate on your surplus cash.

Yes.

If we could return to the buy back topic again. Stock buy back obviously looks a lucrative here. You've got about $60 million of cash. What does it take to buy back your own stock versus other internal investment projects given where the shares are trading relative to both the 501 pricing and the IPO pricing?

That is a topic that we'll discuss at our board meeting next week. We have a scheduled board meeting on Thursday.

Okay.

And we have some probably some sophisticated board members, so that will be one of our topics of discussion.

Okay. Thanks very much.

We'll take our next question from Stephan Micktook with Pipe Place Capital.

Good evening. A question on the -- when you talked about the internal audit service, it sounded like you were talking about managers of engagements or something. I'm just wondering as internal audit becomes a real, you know, a material revenue source to the company, are the economics of that business going to be similar to your kind of core accounting services, or is there going to be kind of another layer of oversight between yourselves and the associates out in the field that might, you know, make it lower margin than otherwise?

I don't anticipate it being a lower margin. Initially there may be an investment made to get clients, but as the business matures I do not anticipate it's going to be a lower margin. The economics of the business I'm familiar with from being at Beloit, and we're certainly not bidding the work to get lower margins.

Okay, I guess what I was getting at is will it look -- the kind of the beauty of your core business today is that you have -- that these associates are out there, you don't pay bench time and you don't have kind of a layer of management watching over what they're doing. And so I'm wondering, is internal audit going to have those same characteristics, or is it just that the fees that you get will be -- make up for kind of those other factors?

It's sort of a blend of both models. So the majority of the internal audit work that's done in the field -- and this has been to date even clients where we've actually done work now around the world, has been done by associates which are basically the variable model -- and the work itself is reviewed and is -- an oversaw by someone who is a partner like person who is not variable cost. So it's sort of a blended model and we build that into our pricing.

Okay.

The majority of the work should be on the variable side.

Okay. Terrific.

Which is why we think we have an advantage over the big four trying to do this work.

Next we'll take a follow-up question from Adam Waldo from Lehman Brothers.

Appreciate the follow-up opportunity. A couple clean up items, if I may, and you may have covered these in your prepared remarks, so I apologize. Did you give out ADA reserve balance at the end of the quarter?

No, but we can.

Okay. Thanks.

It is $2.3 million.

Okay.

Same percentage as it was at the end of the year.

Okay. And did you give out conversion fees either dollars or a percent of revenue?

Conversion were less than 2% of revenues.

And did you give out the pass through revenue line of -- that you started reporting in your financial reporting last quarter?

No, we didn't, but it is -- I wasn't sure what you were talking about, but it is $400,000 for the quarter.

Just right around 400?

Yea.

And then finally, if we can step back a second. I guess the bigger picture, give us a sense, if you can, and I know historically you've provided this sporadically, but how big is the human capital in IT practice in round numbers to give us a sense for maybe a leading indicator on where the new audit business and the new consulting group might go in a couple of year's time?

Well, Steve, you know the numbers.

We have been, you're right, some what adverse to break out the service lines and we have not disclosed this publicly. I think that we've tried to get some sense of the size of the various practices by discussing the relative growth rates, and certainly our IT practice has been kind of a shining star in a difficult year, and so it would be safe to say that IT as a percentage of our revenue has grown considerably, but we're not at this point prepared to disclose separately what the actual percentages are. With regards to the audit service, we see it as a very substantial opportunity and one that could become be a very substantial revenue driver for us, and because it is set up as a separate subsidiary and because it has a slightly different business model it may be something that we would report as it becomes material.

So, Steve, you'd want us being quite conservative in terms of forecasting revenue ramp on those new service lines given the early stage nature of them and the ramp path of the human capital and IT businesses to date?

Yeah, I think it's fair to say that we gave guidance early on in our call that the audit service was tracking at about $3 million so far. And we're -- even though that is not terribly substantial to our revenue we're pleased with that. It's kind of a startup and it's gotten to that run rate in a very rapid amount of time. But I think you're right that it would be probably wiser to kind of estimate the growth of that practice conservatively, and that's always been our bent is to be pretty conservative about the revenue until there is evidence that we can report that it is getting bigger.

Thank you very much.

Okay.

And we have a followup question from Randy Mill with Robert W Baird.

Just a couple quick follow-ups here: When you look at your top five clients, maybe top 10, what are the sources of business, generally, among the client? In other words, what are the projects that are happening?

Randy, interestingly two of our top 10 are bankrupt clients. So, you know, as you would expect in a downturn to kind of bare market issues that come with this down market have created some revenue opportunity. Others, you know, are not that much different from what we have had historically. Various restructuring, various other things going on that create change that require a substantial amount of resources to make that happen. I guess I would just say that the only, in my view and maybe Don has some additional thoughts on it, but from my view the item of note that bankruptcy is a bigger part of the largest components of our revenue this year.

If I look at our largest clients for the quarter, they're substantially the same as the largest clients for last year. You know, the dollar amounts may have changed and the things we do change, but all these companies have gone through significant change. One of them, you know, we're working on three different continents for them, helping them implement some cost-control measures, helping them with some control measures around the country, around the world. As Steve said, two of them, two of them are in bankruptcy and we've been helping them with, you know, bankruptcy filings, all the reconciliations, all the cleanup that's needed, and we think these things go on for years at these big bankruptcies. So one of them's a large healthcare client that's been probably our largest client from the day we started Resources and we helped them with a myriad of things. If they have a problem in the geographic location they call on us to go in and help them. If they're doing a disposal of a company, they want to bring the financial statements in a certain way to market that. So we do a lot of things, and a lot of these clients are using all three service lines at one time or another during the year.

Okay. And then London, maybe a little status there? Were you profitable in the quarter despite second office opening? And then, you know, what roughly would be the run rate there?

We are basically slightly profitable for the quarter. We didn't lose money. But we're slightly profitable for the quarter which for a big marketplace and an expensive marketplace, we're very happy with and as well as integrating the Ernst & Young people that joined us. Run rate? Steve, --

Randy, we are -- we have not disclosed the breakout of international, but I would say that the run rate is encouraging. And it's kind of similar in encouragement to our IT practice. We see the type of ramp up in revenues that we had hoped for, and we are hopeful that that is not just the number it's going to be but it continues to glow pretty rapidly, and that's why we've added another office. So --

We're waiting for international operations to become big enough so we have to break them out.

Is it fair to say that overseas, at least while you're spending you're investing in the business, you're showing -- you're on the upswing in terms of margins, you know versus the majority of the business where you're investing? You're not seeing revenue ramp and the manner margins are under pressure. Is that fair to say about the overseas?

I would say -- the UK we're definitely seeing the pay back on our investment. You know, I think we're very, very pleased with that. Our other international offices are not that large either in the number of people in them or the work being generated, and we're working hard to try to grow those. But by far, the UK dwarfs the other three.

Thank you very much. I appreciate it.

Sure.

And just as a reminder it is star one for a question or comment. We'll take a follow-up question from Adam Waldo.

One last question. Did you all give any guidance for expected balance of your office openings and what you would think in terms of fiscal '04? Should we think about a typical, you know, office quarter for the balance of this year and similar maybe five or six next year?

Yeah, we talked about in the range of four to six this year, four to six next year.

Okay.

I believe we've opened through this today we probably opened three.

Okay. Terrific, thank you.

This does conclude today's question-and-answer session. I'd like to turn the conference back over to our panel for any additional or closing remarks.

Well, I want to thank everybody again. I know it's a tough environment we're in and thank you for your continued interest in resources and we look forward to chatting with you after the next quarter. Thanks.

This does conclude's conference call. You may now disconnect.