Resources Connection Inc (RGP) 2004 Q1 法說會逐字稿

Good day and welcome to the Resources Connection first quarter 2004 earnings conference call. This call is being recorded. At this time for opening comments and introductions, I would like to turn the call over to the Chief Legal Officer, Ms. Kate Duchene. Please go ahead.

Thank you, operator. Good afternoon everyone, and thank you for participating with us today. Adjoining me as usual are Don Murray, our Chairman and Chief Executive Officer of Resources Connection; and Steve Giusto, our Executive Vice President of Corporate Development and Chief Financial Officer.

During this call we will be providing you with comments on our results for the first quarter of fiscal year 2004. By now you should have a copy of today's press release in front of you. If you need a copy, and are unable to access it via our website, please call Margaret Porter at 714-430-6363, and she will be happy to fax a copy to you.

Before introducing Don, I would like to read an important announcement about certain statements that we may make during this call. Specifically, we may make forward-looking statements. In other words, statements regarding future events, or future financial performance of the Company. We need to caution you that any 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 31, 2003, for a discussion of some of the risks, uncertainties and other factors, such as seasonal and economic conditions, that may cause our business results of operations and financial conditions to differ materially from results of operations and financial conditions expressed or implied by forward-looking statements made during this call.

I will now turn the call over to Don Murray, our Chairman and CEO, to give you an overview of the quarter.

Thanks, Kate. Well welcome to our first conference call for fiscal 2004. Resources Connection is a professional services firm, originally founded as part of the Big 4 accounting firms. In the United States we are part of Deloitte & Touche, and in Europe we are part of Ernst & Young. We provide accounting and finance, human capital and information technology professionals to serve company's internal consulting needs on a project by project basis. Through our wholly-owned subsidiaries we also serve our clients with internal audit services, including outsourcing and co-sourcing, with consulting and compensation consulting.

We provide our services to clients through over 60 offices worldwide. And we're best known for accounting and finance services, and have added the additional service offerings to meet our clients' needs.

As we mentioned in our final fiscal 2003 conference call, we acquired two international businesses from the Big 4 during the first quarter of this year. So this'll be our first quarter that includes some results from the Dutch and Australian practices. The quarter also includes the partial impact of the acquisition of our internal audit software called policyIQ.

As a point of reference, Australian results are included for the entire quarter; the Dutch results are included for only seven weeks; and the policyIQ results for only the final four weeks of the quarter.

First, let me summarize the operating results in our first quarter for fiscal 2004. As indicated in our press release today, revenues for the quarter were 59.5 million. This revenue is higher than the first quarter of a year ago by 37 percent, and is slightly better sequentially. For comparability purposes, if we exclude revenues from the sources acquired during the last twelve months, revenue was higher by 17 percent than the year ago period. Steve will provide additional details of the revenue trends during the quarter in his review of operations, and a recap of the domestic and international revenue.

While we were generally pleased with the growth, we did experience a typical softening in the summer months, in particularly in our international locations. It won't be until later in the year that our revenues will be impacted by a fourth quarter from all of our acquisitions in periods that are typically stronger for them. Also the combination of the July 4th holiday, the effects of the East Coast blackout shorten billing days by about a day and a half.

From a strategic standpoint, we're pleased with our recent progress. Our domestic business is growing nicely. And we feel that many of the investments we made during the worst of the recession are paying off. Further, some of our well-known clients in United States have now used our services in the Netherlands and Australia. These sorts of multinational engagements are what we envision in becoming an alternative to the Big 4, and taking the Resources Connection business model worldwide.

We expect there is some transition time necessary for our European practice to adjust to the Resources model in a recessionary climate. And now that they are out of the Big 4 umbrella, they can focus on some of the same initiatives we did in the United States to help us cope with the recession.

While gross margins for the quarter were right at our 40 percent target domestically and about 35 percent internationally, overall gross margin was 39.4 percent.

Our Resources Audit Solutions practice continues to grow. Resources Audit Solutions, which provides comprehensive risk management and internal audit solutions to our clients, is a business particularly appropriate for the current issues facing corporate leaders, as they adjust to this new and more attentive corporate governance environment.

We have built this practice organically, and our revenue run rate for this business continues growing. There still remains much opportunity to assist companies' efforts to comply with Sarbanes-Oxley. And as of last week, the annualized run rate for RAS was over $30 million. The majority of our biggest engagements continue to be the result of changes, like the bankruptcies, Sarbanes, corporate governance changes. And the companies are now dealing with issues that they had postponed, rather than a pickup from the economy.

Now let me update you on our feel of our client statistics. Revenues from our 50 largest clients represented 46 percent of total revenues during the quarter. And our largest client was about 7 percent of revenues. Of our top 50 clients for the previous fiscal year, all were still clients during the first quarter. Forty-five of these 50 have already spent at least $100,000 with us this year. We believe that as companies began to feel more comfortable about their own business, this type of demand will continue. Eight of our ten largest clients have been clients for over three years. We believe this reflects on our value added model and our level of client service.

One change that will be occurring this next quarter concerns our Resources Consulting Group. It appears that eight of the salaried consultants of Resources Consulting Group will be leaving our business within the next two weeks. Revenues and operating earnings from this group have not been material to our consolidated results, and many of the types of services provided by this group can be provided by our core human capital associates. This changes is expected to reduce annual revenues by less than $1 million, and have no significant impact on our earnings.

Now here is Steve with additional information on the results of the first quarter.

Thanks, Don. Revenues totaled $59.5 million for the quarter, versus $43.5 million in the year ago quarter, and $59 million in the previous quarter. These results represent year-over-year growth off 37 percent, and a small sequential improvement. In evaluating sequential growth investors should consider the following three facts. First, the fourth quarter of fiscal '03 included an extra week of revenue. Second, the most recent quarter includes only a partial impact of the acquisitions over the summer. And third, the summer quarter it is seasonably weak.

To help put this in context, let me give you some information on how weekly revenues progressed during the quarter. The following weekly amounts exclude the Dutch practice. The average weekly revenue in the first quarter of 2004 was $4.2 million per week. Revenue during the quarter ranged from $3.6 million per week to $4.6 million per week. Average weekly revenue during the fourth quarter of fiscal '03 was also $4.2 million. The average in the first quarter a year ago was $3.3 million. The average for all of last year was $3.8 million. That means that the just completed quarter is on average almost 1 million a week better than one year ago, and $400,000 better than the average of all of last year.

Since the end of the first quarter we had seen a bit of a pickup, consistent with the expectation that the fall months are generally stronger. In the weeks after Labor Day our revenue run rate improved to 4.5 to $4.6 million a week, excluding the Dutch practice. If we were to continue at recent run rates, revenue during the second quarter, excluding the Dutch practice, would be between 56 and $60 million.

Now let's discuss Dutch revenues. Revenues from our Dutch practice were seasonably soft during the quarter. The seven weeks that include our Dutch practice were the last two weeks of July and all of August. European operations are typically more seasonal than our domestic business as extended summer holidays are the norm.

Results from Europe were somewhat less than we expected due to the combination of a soft European economy and the summer slowdown. Much of the focus of the senior management in the Netherlands was on closing the transaction in June and July, rather than on growing revenue. Now that the holiday season is finishing, management's attention is focused on growing the business in a ecomony. Nevertheless, revenues per week in total internationally were more than $1 million during the weeks that all of our international operations were consolidated. Revenues from the Dutch practice average approximately $700,000 per week during the seven weeks after the acquisition.

Since the quarter end, the summer slowdown in the European markets has extended into early September. The vacation period for the continent tend to extend through mid-September. So the weeks we've seen so far would normally be soft. We currently expect revenues from the Dutch practice to total between 10 and $11 million in Q2. This could lead to breakeven, or slightly positive, operating results from the Dutch for that period. These results are at the low-end our expectations, and arise from a combination of a slowing Dutch economy, and to a lesser extent transitioning issues, as our Dutch colleagues get refocused on the marketplace.

We have higher expectations for the Dutch practice later in the fiscal year, both in terms of revenue and operating process. We do believe the Dutch practice positions us well for future growth in Europe, that will be essentially evident with any type of European economic recovery.

The combination of revenue estimates from the Dutch and the rest of the practice would lead us to expect total revenues for the quarter of between 66 and $71 million. Based on that estimated revenue, we're comfortable with estimates of earnings in the second quarter of 16 to 17 cents per share.

Now let me give you some gross margin data. Once again, I will first discuss gross margins on a basis comparable with prior disclosures, and then margins in our international operations. Gross margins domestically were right on our 40 percent target. Conversion fees, which have a disproportionate impact on gross margins, continue to be very low, less than 1 percent of revenues during the quarter.

We would consider an increase in conversion fees a sign that economy is strengthening. Also, the summer quarter is negatively impacted by the July fourth holiday. Therefore, achieving our targets showed good pricing discipline. A year ago our gross margins were 39.6 percent during the quarter, so we improved a little bit this year.

Our international offices have historically maintained lower gross margins. Gross margins for these practices were just over 35 percent during the quarter, and our blended gross margin percentage was 39.4 percent.

Associate headcount at the end of the quarter was 1,468, including 286 associates in the Netherlands and Australia, compared to 1,044 associates a year ago, and 1,175 last quarter. While we have been able to improve billing rates throughout most of the recession, growth in headcount is the primary driver of revenue growth. Accordingly, we're pleased that associate headcount is improving.

Now to the other components of our first quarter financial results. SG&A for the quarter was $17.2 million. This was $4.2 million more than the year ago quarter. SG&A as a percent of revenue was 28.9 percent for the quarter. Increases in SG&A are primarily the result of internal headcount increases from our newly acquired businesses, and in domestic offices where demand is the strongest.

Depreciation and amortization were $693,000 for the current year quarter versus 346,000 a year ago. The increase is due to the amortization related to the acquisitions previously described, including an estimate of the amount that will be recorded relating to our Dutch and Australian purchases. The purchase price allocation related to these acquisitions is not yet complete. And when it is, we may need to adjust the amount we're recording for amortization from these transactions.

Consistent with our disclosures during the year-end conference call, we've included an estimate $120,000 in this quarter. Interest income was $172,000 for the quarter versus $338,000 a year ago. Invested cash earned 1.4 percent during the quarter. Interest income was negatively affected by the very low interest rates available in current market conditions, and by lower cash balances as a result of the cash used in acquisitions.

Our pretax margin for the first quarter was 9.6 percent compared to 9.7 percent in the year ago quarter. Earnings for the quarter were $3.4 million, or 15 cents per share, versus $2.5 million and 11 cents per share a year ago. Our newly acquired international operations are expected to be accretive for the year, but due to the slack summer, we are collectively about breakeven on an operating basis during the quarter.

Additionally, as previously disclosed, we expensed an option purchased to hedge the purchase price of the Netherlands acquisition, which was in which was in euros. Included in SG&A is approximately $319,000 of non-recurring expense related to this hedging transaction.

Now let me turn to our balance sheet. Cash and investments at quarter end was $38 million, demonstrating continued strong cash flow performance. We used over $30 million during the quarter for acquisitions. Receivables at quarter end were $34.3 million, including $8.7 million of Dutch and Australian receivables.

Days sales outstanding at quarter end, excluding the Dutch practice, were 41 days compared to 42 days at the end of the year. Even after a significant strategic deployment of our cash, we have a very strong balance sheet.

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

Thanks, Steve. Well, in summary, we enjoyed good revenue growth in the last few quarters. We have taken opportunistic risks to improve our international footprint; to grow our business; to launch our new services. And we think we're not in a position to capitalize on our larger scale and broader service offerings.

The improving demand for health, implementing Sarbanes-Oxley, and the additional breadth of services we have developed over the course of the recession position us relatively well. We have focused on capitalizing on that positioning to continue our revenue progress of the last few quarters.

Our objective has been to capitalize on the opportunity presented in these unique times, and to make us a viable alternative to the Big 4 for internal professional projects. We're pleased with our operating results for this quarter, as our earnings improved by almost 40 percent. It is been a very difficult last three years. Our resources have made good progress during the recession. And with a little help from the economy, we may be entering a period of solid revenue growth and improved profitability. Now we would be glad to answer your questions.

(OPERATOR INSTRUCTIONS). And we will have our first question from Andrew Steinerman with Bear Stearns.

When you look out to the types of projects that your clients are engaging you for, do you feel like there's a change going on? Is there more growth initiatives going on as elements of change where they're bringing you in? Or is it still just primarily sort of cost initiatives? And if you could comment about your work with bankrupt clients?

Let me just talk about some of our bigger projects. Right now our two biggest projects -- one is with a healthy company that is in bankruptcy, but they are financially healthy, and they're coming out of it. And they have a very, very large project that was postponed that had to be done. So it wasn't a growth initiative, it was more of cleanup initiative.

The second very large client we have right now is a very fast-growing financial services company. And we're helping them with systems changes throughout the organization to permit them to grow very rapidly in the future. So that would be a growth initiative.

We still haven't seen a lot of growth types of projects. Most of them still seem to be maintenance projects, Sarbanes work, and cleanup of things that need to be fixed.

That is very helpful. How about M&A type of activity? Do you see any increase in that type of work for Resources?

I haven't. No. How about you, Steve?

I wouldn't say that M&A has been substantial to date. Let me add one thing though to what Don said about the bankrupt clients. We continue to serve a relatively significant number of bankrupt companies, but it is not traditional bankruptcy work. We're not doing restructuring type work. A lot of it is, as Don described, special projects work that happens to be inside companies that are bankrupt. And then from an M&A standpoint, as I just said, we just haven't seen much yet.

And the work with bankrupt clients, which you were very specific on just now, you expect to continue forward for the next couple quarters, business as usual?

Yes. I think the large projects we're on now, which has been growing over the last few quarters, is not expected to finish before the springtime.

Last question. What is the largest engagement you have been working on as measured by number of associates at a given time?

We haven't disclosed that, Andrew. We have disclosed in this call about our largest client during the quarter was 7 percent of revenue. And based on that and our average rate, you can probably extrapolate.

I think our largest project, Andrew, right now is approximately 70 associates.

Thanks for all the comments. I appreciate it.

Our next question will come from Adam Waldo, Lehman Brothers.

Good afternoon, Don and Steve. How are you all? A few questions on the numbers side. Based on your comments both with respect to second quarter guidance, and also trends over the course of the quarter and the early part of the second quarter, it would seem that your sort of counseling those of us building sell side models more into the, let's say, 70 to 75 cents in FY '04, EPS versus the current Street consensus in the 83 cent range.

While I know you historically haven't given guidance on an annual basis, I wonder if you could give some commentary around what you would expect for the year, if trends that you're seeing so far in the second quarter were to continue, given the timing benefit of acquisitions during the back half of the fiscal year?

Adam, let me see if I can cover that. First of all, given that we're still pretty cautious about the economy, we're kind of going quarter to quarter with thoughts around where our revenues and earnings might be. And in this quarter we have given more guidance than we have historically, primarily because there's been a substantial change in the business that occurred when we bought the Dutch practice. And with all of the sell side analysts, I think there was a wider breadth of expectations during this past quarter.

So we're trying to give you a baseline, just to all the investors and to all analysts, so that as the year progresses, you will have a good starting point for looking at how our business is progressing.

Okay. Fair enough. You all granted a fair amount of options last year in your compensation plans. And I wonder if you could speak a little bit about your option grant plans in FY '04 as compared with cash comp plans. Should we expect a similar mix in FY '04 to the option cash/comp mix that you showed in FY '03 in your recent 10-K filing?

Yes, you can. It is very similar. Though I'm not sure, compared to a lot of plans, that they would be termed, I guess, a lot of options, compensation. I'm not aware that we have a very rich option plan.

Okay. Your EPS would have been 19 cents, right, had option grants been expensed last year rather than 55. That's why I was trying to really get at that issue, and whether we should expect a similar relationship this year?

Yes, it would be a similar number of grants.

Okay. And then my last question is, historically guys had been extremely financially disciplined through this downturn in terms of how you allocate surplus capital, using it principally for financially disciplined, diversifying acquisitions. And historically, have held the trigger, so to speak, on share buybacks, given the elevated share price for much of the last year, year and a half. I wonder how you are thinking about hierarchy of use of surplus capital these days, as between acquisitions and share buybacks, given your current surplus capital position and current share price valuation?

I would say, Adam, my position hasn't changed. If the share price appear to us to be beneficial for us to do share buyback, our Board has authorized us to do that. However, we think it is currently, in this environment, a much better allocation of our resources to keep them for any strategic opportunities that arise. So at this current -- in this economic environment and price of our stock, we don't have a current plan to buy back stock.

Okay. Thanks. It sound like a good plan for use of resources, no pun intended, Don. Take care.

We will have our next question from Greg Capelli, CS First Boston.

Hi, it is Greg and Josh at CSFB. Just to follow on the -- a little bit below -- it was your expectations as you communicated on the Dutch side. I just would love a little bit more color in terms of how you look at that market going forward. You talked about bringing the Resources' disciplined operating in a tough market from a cyclical standpoint, a little bit more color on that. And when you look at the performance there, was it just a mix on how seasonal that business was, or is it also that there is some core softness there that surprised you?

First of all, we closed the transaction later than we originally planned. So we originally had planned to close the transaction July 1st or prior to that, which would have given us a chance to get some growth programs going before the vacation all hit in Europe. So we closed in July 15, and it was in the midst of their school break. So it is very hard to get acquisition type of initiatives launched in that time period. So that was number one.

Number two, we knew the European economy is soft and in a recession, and I think that was probably reflected in our negotiated purchase price with Ernst & Young. So we didn't buy it at the high part of the market. We bought at the the low part of a market, and I think we have some comfort there.

The environment is soft. We expected it to be soft. And we think that the fact that we were able to grow through this recession over the last few quarters because of things that we had done over the last few years, we think that those techniques that we use will also help our Dutch colleagues, because they haven't had a recession since 1992ish, so in this is a new environment for them, just like it was for us when we went into it.

And so they have a similar client base that we do. They have the opportunity to get back into large Ernst & Young audit clients that they are precluded from doing work for. They're very focused on getting their people refocused in the market in a correct way. And so I'm very optimistic. I mean for us this is not a one year acquisition, it is a very long-term strategic acquisition for us to grow with Europe. We're going to start marketing more internationally to our U.S.-based multinationals. So we have a lot of things that we're doing to try to spur growth.

Okay. I'm getting a little feedback.

No, that was it.

My phone has a little feedback. I apologize for that. On the Resources Audit Solutions business line, you talked about a $30 million annualized run rate there. Just curious as to the sustainability of that in terms of how much of that would be more onetime project oriented, and how much of that would be something that we could look as sustainable?

I would say that right now the majority of the projects -- the majority of the projects are helping companies figure out how to comply with a new corporate government environment. Somewhat out of Sabanes, however, we're doing proposals for companies that are private, very large foundations, etc., that still want to implement the same type of corporate governing structure, including periodic internal audits, periodic reporting on internal controls back to the management etc.

So a portion of that work will be, we hope, sort of an annuity type work at a client. And some of it clearly is one time to get Sarbanes implemented. One of the things that we have done very well as a Company is, once we are in a large company, is proving our value to them so that we stay there and do more projects. But I think one of the statistics I said was that eight of their ten largest clients today had been clients for more than three years. Which means once we are in these accounts, we can help them fix their issues. It is not because we're selling them stuff that they don't need. It is because we are really helping with their critical tasks that they have to get done.

Corporate governance and all the related increases in internal audits, and watchdog type activities, I think is really going to increase. But certainly it has increased internally in own Company. So I think part of it will be an annuity.

Thanks a lot.

We will have our next question from Randy Mehl with Robert W. Baird.

Hi, Don and Steve. Can you hear me okay? I don't have a great connection here. Just a couple of follow-up questions. Don, you mentioned RCG, and I was wondering if you could elaborate. I think you said eight salaried consultants will be leaving. What is happening there? How much of this is intentional and refocus on your part versus voluntary departure?

I would say RCG has not filled our expectations over the last few years, and we were searching for a way to try to make them more successful. And so this is sort of an agreed-upon voluntary separation with them and us. And a lot of the project work that they have been doing with the internal salaried people. We can still do at our clients with our associates in human capital.

And that under $1 million that you threw out, that is an annualized number?

Yes.

And then one other follow-up on ETM. What is the currency assumption in the guidance, is that $1.15?

For the quarter we used $1.10, so we're a little under where the market is right now.

For the next quarter?

Yes.

Okay. Thank you very much. I appreciate it.

(OPERATOR INSTRUCTIONS) We will have a follow-up from Adam Waldo, Lehman Brothers.

Just a couple of quick numbers questions. Can you give us a sense for specifically how much revenue you realized in the quarter from the supply chain management TPC business versus international operations in the aggregate?

International operations in the aggregate were just under $8 million, Adam. And the TPC number was $2.5 million.

Okay. And then if you could, Steve, the 40.5 percent tax rate, is that down 50 basis point sequentially just because of the increased international mix, or is there something going on with your tax planning that would affect tax rate guidance going forward?

We have implemented some tax planning strategies which we expect to improve our effective rate over an extended period of time. We have begun to see some small benefit from those tax planning strategies that we get to see this quarter. I would expect our tax rate to remain in the 40.5 to 41 percent range for the remainder of this year, and then perhaps get better after that.

And by order of magnitude, are we talking about maybe 100 basis points going into FY '05? Is that a reasonable expectation?

We are just getting into international tax planning, so we really can't projects right now.

Fair enough. And then the last question is just, can you give us a little bit of a sense for what kind of year on year trend you saw in local currency revenue in the Dutch ETM business during the quarter in the seven weeks it was consolidated? What kind of growth in were you seeing, or a decline in euros, I should say.

I am not certain I understood your question, Adam.

I'm sorry. Steve, let me try that again. The Dutch ETM business you had consolidated for seven weeks of the quarter, correct?

Yes.

Okay. If you look at its results in euros during the quarter, what rate of year on your decline in revenue would it have posted in the latest quarter, relative to the comparable seven week period a year earlier, if you have a handle on that?

We do have that available during the call.

Okay, thank you.

We will go next to Brandt Sakakeeny, Deutsche Bank.

Actually it is Ben Lee (ph) for Brandt. But Adam just asked our question, so thanks.

Okay, thanks, Ben.

We will have a follow-up from Randy Mehl, Robert W. Baird.

Just a couple of follow-ups. Don, historically you have had pretty good growth among your big clients, and just driving additional revenue, additional services. You mentioned some of the splits with the top fifty. Did you see growth in the top 50 on a year-over-year basis, looking at it on a same client basis?

Without having the specifics statistics in front of me, the answer off the top of my head is definitely. Our two largest clients are on track to be our biggest clients ever; they are growing so much. It presents a risk to us too, if for some reason these projects stop. But our bigger clients seem to be growing with us faster than the middle market by far.

And then, Steve, you, in your gross margin commentary it sounds like bill rates, pay rates, sprags (ph) you are managing well. Are we seeing those continue to go up, and roughly at what pace?

We saw bill rate expansion of about 6 percent during the quarter without the Dutch, and 7.5 percent with the Dutch. As we mentioned last quarter, the Dutch practice tends to have a slightly higher rate than our average, so that helped us a little bit. So the short answer is, yes, we continue to see rate expansion.

Thank you very much.

(OPERATOR INSTRUCTIONS). At this time we have no further questions in the queue. I would like to turn the conference back over to Mr. Don Murray for any additional or closing remarks.

I would like to thank you again for your time today and the continuing interest in Resources. We look forward to chatting with you after the conclusion of our next quarter. Thanks.

That does conclude today's Resources Connection first quarter 2004 earnings conference call. You may disconnect at this time. We do appreciate your participation.