Resources Connection Inc (RGP) 2006 Q2 法說會逐字稿

Good day and welcome everyone to the Resources Connection second-quarter fiscal year 2006 earnings results conference call. This call is being recorded. With us today from the Company is Ms. Kate Duchene, Chief Legal Officer; Mr. Steve Giusto, Chief Financial Officer; and Mr. Don Murray, Chief Executive Officer. At this time, I would like to turn the call over to Kate Duchene. Please go ahead.

Good afternoon everyone, and thank you for participating with us today. Joining me, as you know, are Don Murray, our Chairman and CEO, 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 second quarter of fiscal 2006.

By now, we hope you have a copy of today's press release in front of you. If you need a copy and you are unable to access that via our website, please feel free to call Patricia Marquez (ph) at 714-430-6314 and she will be happy to fax a copy to you. Before turning the call over to Don Murray, 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 remind 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 31, 2005 for a full 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 an overview of the second quarter.

Good afternoon and welcome to our second conference call fiscal 2006. We continue to experience excellent demand for our services in the marketplace. The revenues in the second quarter were our highest ever, and year-to-date, our revenues have grown in excess of our 20% targeted growth rate this year.

Our revenues have continued to grow in existing offices and service lines. In accordance with our stated strategy, we have used the strong revenue results to continue to invest for our future to build additional capabilities, which we expect to lay the foundation for our long-term growth.

For the second quarter of fiscal 2006, revenues were 158.1 million, up 6% sequentially and up about 15% over a very strong second quarter a year ago when we accomplished these results, despite the impact of three hurricanes that disrupted business in Houston and South Florida. We also incurred additional costs based on our decision to pay associates in those areas for lost work.

The second quarter includes Labor Day in the U.S. as well as a Thanksgiving week. These holidays had similar percentage impacts on our revenues as in prior years. Steve will provide additional data of revenue trends in his review of operations later in the call.

As is our normal practice, I will update you on the four key components of our growth strategy. Our first two strategies are to grow revenues from existing Fortune 1000 clients and to add significant new clients. We believe our effectiveness in this area is enhanced by our client service model rather than a commission-based models of some competitors. No one benefits at Resources for the wrong client solution as they would or could in a commission-based system.

Revenues from our top 50 clients represented 44% of total revenues during the quarter, while 15% of our revenue came from 73 clients. Our largest client year-to-date represents about 5% of revenues. Client continuity continues to be a focus. During fiscal 2005, we served 100% of our top 50 clients from 2004 and 94% of the top 50 clients from fiscal 2003. So far in fiscal 2006, we continue to do work with all of our top 50 clients from last year.

We currently have over 175 more clients after two quarters of this year than we had served at the comparable time last year, which demonstrates momentum in adding new clients. We also have a long-term strategy to expand our geographic reach and become a true, multinational professional services firm. We serve and target multinational companies, who have needs around the world. And thus, we need to be multinational. To achieve this, we are continuing to invest in new offices and in expanding our international capabilities.

During the second quarter, we started practices in Belgium, in Luxembourg, in Ireland, Beijing and Singapore. Working with our affiliated firm in China, we are already generating revenues on the Mainland and Beijing. We expect to complete the acquisition of our affiliate in India during the third quarter.

Our fourth strategy is to diversify our scope of services and market the various services to our larger clients. We're reaching new revenue highs in all of our service lines other than RAS. Our most significant revenues continue to be generated from the accounting and finance and the RAS service lines. We continue to experience a shift in revenue towards our accounting and finance area and away from RAS. As we have anticipated, we're done for clients, who initially engaged us to help with the Sarbanes compliance -- has led to several follow-on engagements in other areas. Further, it is sometimes difficult to precisely differentiate between accounting and financing engagements and RAS engagements. Because many of our RAS associates are easily redeployed on accounting and finance projects, and they prefer to view themselves as project specialists rather than just SOX or internal audit professionals.

Many of these engagements lead to other service opportunities and information management, human capital services, supply chain management and legal services. We now address clients' needs as one coordinated Company with six service lines. As you know, we sell a policy management software solution called policyIQ, which we use internally for our own SOX requirements.

Another measure of client penetration is the number of top clients, who have engaged us in multiple service lines. Of our top 50 clients, 49 have used more than 1 service line and 39 have used more than 2 service lines. The percentage of revenue from RAS was approximately 31% of total revenues in the second quarter. During the second quarter of last year, RAS was 43% of revenue.

We are still seeing demand from clients in the SOX area. We have seen various surveys about expected spending levels for SOX during the coming year as well as some broad estimates for 2007. While only time will tell if any of these estimates are accurate, our experience is that clients we serve who have been satisfied with our work related to SOX are inclined to engage us for future work both for SOX and other project needs.

We see SOX compliance as one component of a larger opportunity in the internal audit market. We also expect that clients will be working on corporate governance, risk assessment and control, and operational audits. We believe we are well-positioned to help them with those sorts of initiatives.

Our investments include the rollout of a new operating system in the United States, the expansion of an Internet-based companywide recruiting ability through our National Service Center, the continued expansion of our Resources Academy, and the development of a Shared Services Center in Europe. These each require upfront investments and have impacted our costs over the short-term. But we expect these investments to improve efficiency and allow us to grow over the long-term.

Now Steve will provide a more detailed review of our financial results for the quarter.

Revenues for the quarter were $158.1 million versus 137 million in the comparable quarter a year ago and $149.6 million in the first quarter of fiscal '06. We had strong weekly revenue results through the quarter, despite the impact of the hurricanes. After a fast start to the quarter, with weekly revenues accelerating from $11.8 million at the end of Q1 to $12.1 million in the first week of Q2 to $12.6 million in the third week of the quarter, we maintained those levels through the middle of the quarter and weekly revenues stayed in a range of 12.6 to $12.8 million.

During the quarter, as we had mentioned in our last call, we were impacted by the hurricanes that hit the United States. Not only did we lose revenue in our Houston and South Florida offices, but we also paid associates in those markets for time lost. The Company also matched contributions made by our employees to hurricane relief efforts. We lost estimated revenues of about $450,000, paid associates impacted by the hurricanes over $200,000, and matched contributions of almost $200,000.

In the last few weeks before Thanksgiving, our revenues continued their upward trend. Our last two full weeks of the quarter before Thanksgiving were successive new highs with the final full week of the quarter over $13 million for the first time. Revenues in that week were about $13.1 million. The Thanksgiving week was the last week of the quarter and was lower than the week before by a similar percentage as last year's Thanksgiving week.

Now let me discuss revenues geographically. Revenues in the U.S. were strong. The U.S. practice was operating at weekly run rates above $10 million as the quarter ended and has accelerated in the first few weeks of Q3 to just over $11 million. International revenues were stronger than expected in the first quarter, and revenues for the second quarter maintained the levels similar to the first quarter and were flat on a sequential basis.

For the quarter, international revenues were 21% of total revenues. Netherlands revenues for the quarter on a dollar basis were up 14% year over year. UK revenues were 60% greater than in the prior-year second quarter. And elsewhere, our Asia-Pacific practices grew 52% year over year.

Total revenues internationally were $33.1 million versus $24.2 million in the second quarter of fiscal 2005. Total revenues for the Dutch practice in Q2 were $15.2 million. Revenue growth internationally in total was 37% year over year. Due to a strengthening of the dollar, year-over-year growth was higher on a local currency basis.

Let me now give you information about the first few weeks of the third quarter. We are off to a strong start in Q3. The first week of Q3, the week ended December 2, was another record week for the Company. Revenues for that week were about $13.6 million. In that week, the Dutch hit an all-time high week in their local currency and we also experienced new highs in a number of our Asian practices. The second week of the quarter was also $13.6 million and our highest week ever for hourly revenue.

It is difficult to predict the impact of the coming holiday weeks. Generally, we lose 1 week's revenue during the holidays. With that in mind, we are trending towards revenues in Q3 that could be flat or up slightly from Q2, a good result in the holiday period. At current run rates, we would also be well-positioned to achieve the necessary revenue growth in our fourth quarter required to achieve our 20% revenue growth target for the year.

Now to gross margins. Gross margins were slightly lower than the comparable quarter a year ago, partially because of the impact of the hurricanes. We paid associates impacted by loss of revenue during the hurricanes, and this reduced gross margins. Domestic gross margins were 40.4% for the quarter, conversion fees were less than 0.5% of revenues, and client reimbursements stayed at about 3% of revenues during the quarter.

International gross margins were 37.4% during the quarter. The international practices have slightly lower gross margins due to differences in work, customs, laws and regulations in those markets. Consolidated gross margins were 39.8% for the quarter. Without the impact of conversion fees and client reimbursements, which we do not manage, gross margins would have been 40.8% during Q2. Last year's second-quarter gross margins were 40.3%.

For the second quarter, Everett Associates' FTE count was 2,733. This compares to 2,509 in the previous quarter and 2,419 in the year-ago quarter. Quarter-end associate headcount was 2,882 versus 2,645 a year ago.

Now to the other components of our second-quarter financial results. Selling, general and administrative expenses for the second quarter were $36.8 million, or 23.3%, of revenue. In last year's second quarter, SG&A was 20.6% of revenue. SG&A was $28.2 million in the prior-year second quarter and was $34.1 million in the first quarter of fiscal 2006. The largest component of the increase in SG&A is investment in people needed to continue our growth strategy with the service lines internationally and with major clients. We continue to add internal headcount as we bolstered our management team to address the ongoing demands we see in the business and to invest in new services and offices. The total headcount of the Company was just over 3,500 at quarter end. We expect to continue adding internal headcount throughout fiscal 2006 to fuel future growth, and this may continue to impact short-term operating margins.

We have also begun the rollout of a new operating system to our offices. This effort is expected to improve efficiencies in both our front and back office operations. Most of the capital expenditures for this system have already been made, and we have completed the rollout to about one-third of our U.S. practices. We will continue to incur certain incremental operating costs for training and transition of data during the remainder of fiscal 2006 and potentially into fiscal 2007 as the U.S. rollout continues.

We have also been developing a European Services Center to consolidate back office functions across Europe. We expect this effort to not only lower long-term operating costs as a percentage of revenues but also improve our internal controls. The initial transition costs and training in fiscal 2006 are an investment. The combination of these two initiatives will cost approximately $0.01 per quarter for the remainder of the year. All of the costs I just mentioned are part of the investments Don described earlier in the call.

Depreciation and amortization was just less than $1 million for the quarter, identical to last year's second quarter. We completed the purchase of an office building in Irvine, California during Q2 and have begun planning to move our corporate office and Domestic Service Center to that location. The purchase price for the building was $9.3 million. We anticipate making some leasehold improvements and moving our people in over the next 2 years as our corporate lease expires. Part of the building is leased to others and thus provides a current cash return on our investment.

Interest income was $1.1 million for the second quarter versus $411,000 a year ago. Interest income is growing due to our higher cash balances and slightly higher interest rates than in a prior year.

Our tax rate was 39% during the quarter, lower by 50 basis points than the first quarter, as our projection of our annual tax rates have come down to 39.25% for the year. Our operating margin for the second quarter was 16.5% compared to 16.6% in the first quarter of this year and 19.7% a year ago. Earnings for the quarter were $16 million, or $0.31 per share, versus 15.6 million and also 31 per share a year ago.

Now let me turn to our balance sheet. Cash and investments at quarter end were $153 million. Receivables at quarter end were $87.6 million, up by about 4 million from the previous quarter and up about 20% from a year ago. Day sales outstanding were 49 days, up 2 days from the previous quarter.

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

Our results so far this year are in line with our expectations and our plan entering the year. The quarterly financial results demonstrate strong, ongoing demand for our services and the continued measured level of investments to achieve our long-term growth and profit objectives. This is the approach to managing the business that we have employed since inception.

As Steve mentioned, revenues entering the third quarter have improved, and our practice leaders report a pipeline of significant new opportunities coming in January. The next 2 to 3 weeks are expected to be seasonally weak as most of the world celebrates holidays. We hope to see a strong rebound after the holidays, as clients use their new budgets to address needs in their businesses. The strong demand for services has created a tight market for talent. This is particularly challenging on both coasts in the United States and in Asia. We believe that we're doing an effective job but are implementing strategies to increase our recruiting and retention. We could be growing faster, but it is critical to remain disciplined in hiring in order to serve our clients well.

This year's performance comes on the heels of two strong years before it. We have consistently predicted 20 to 30% long-term growth. And if we finish this year where we expect, our 5-year compound growth rate in revenues and earnings will be at the top of that range. Our focus continues to be on executing our business model well. It starts with identifying high-quality associates, who have the right skills and experience to help our client. I visit major clients as I visit our offices. And I believe from these client visits that our people do differentiate us in the marketplace.

We strive to satisfy our clients, and we work very hard every day to maintain their trust in us and in our business model. That in turn allows us to offer interesting assignments to our people. And this relationship between finding the talented associates and serving high visibility clients is key to our circle of quality.

We believe the potential for the next 5 years is attractive as our reputation, capabilities and strong performance continue to position us well in the rapidly-evolving professional services market. So we would be glad to answer your questions at this time. Thanks.

(OPERATOR INSTRUCTIONS). Greg Capelli, Credit Suisse First Boston.

The first question just maybe if we get back into the G&A just for a second, Don, you brought up investing more in this area. I know you guys have talked about this in the past. Can you be more specific where the spending is? You mentioned you are investing in people. Is that in the geographic regions and offices or is it at corporate? Maybe a little more color there for us.

The majority of our investment is in the offices. And when we start either a new client service director or we start a brand-new office with a managing director, there is going to be a lead-time before that person is actually going to generate any revenue and a longer lead-time before they actually generate any profit. So those are the types of investments we're making, where we have been increasing our footprint for supply chain management services by hiring client/server directors in supply chain management around the country as well as internationally.

I mentioned the new offices that we opened. We have incurred the cost of opening an office in Singapore, training people, etc. But the training is all done in the United States or in Hong Kong. Those people haven't really generated any revenue yet; that is a cost. So the majority of our costs are in future revenue-producing people.

Got it. On the hiring environment itself, the supply-side here, what do things look like on the recruitment front? Can you give us some color on the bill rate, pay rate? I think, Steve, did you say you guys had 8 or 9% sequential growth in that associate headcount number on a FTE basis?

I think that sounds right. We had -- let me just make certain I give you the right number again. We had 22,000 -- on a FTE basis, 2,733 versus 2,509 in the previous quarter. So we are continuing to make good progress in adding associates to our Company.

On the bill rate, pay rate topic?

Bill rates were flat sequentially, up about 6.5% year over year. And pay rates are similar when you look at our gross margins; our gross margins are similar year over year.

So in line with your expectations I am guessing?

Yes.

One more quick one. In the RAS division, can you talk a little bit about how demand is shifting within that -- maybe the types of clients or the types of work that you're getting asked to do right now?

Yes. First of all, when you calculate the changes in our business, when RAS sounds like it is drastically dropping more than it really is -- because as a percentage it is going down but only because some of the other service lines are growing at a much more rapid rate. But we did an analysis; we looked at our top 10 clients to give you a feel. And only 21% of the work at the top 10 clients is Sarbanes related. The biggest area that we're helping the top 10 clients with are accounting issues that they're trying to reconcile and fix. Does that help?

Yes, that definitely helps. Thanks a lot guys.

Brandt Sakakeeny, Deutsche Bank.

A couple of questions for you. Steve, I think you said your conversion ratios were still less than 0.5%. I guess I'm still surprised by that number, given clients' sort of demand for full-time professional staffing and their expression that they'd be interested in hiring people. Is it just they can't convince your people to convert full time or are they not asking? Can you just give a little more color there?

I would say that our clients are trying to hire more people internally. Whether we're doing a really good job convincing them to stay or whether a number of them have already had the experience of working in those types of environments and don't want to go back, another big concern of our associates is they like being project specialists. They like the idea of they are the SWAT team that goes in and helps clients. And Sarbanes or internal audit projects are merely part of their repertoire.

They feel that if they go in full time into a SOX role or full time into an internal audit role, that is the label that's on them. And so a lot of associates don't want that label.

On the other hand, we do have associates that may leave and go to work for a Big Four firm or headhunters contacted them. So it is kind of unusual. I would have expected our conversion rate to pick up as clients are hiring more of our people. But we're not seeing it in the marketplace.

That's interesting. Can you remind me, back in '99/2000 I remember that being in the mid-3s. Is that right, 3 or 4%?

I think April of 2000 was our highest, and that was 5%.

5%. Okay. I guess questions is around Steve, you said $0.01 a hit in the investment. Is that $0.01 relative to your last year's EBITDA margins, or how should we frame that $0.01 impact? Or is it just that is sort of what it is?

I'm not quite certain how to answer that (indiscernible). Because I'm not sure that I understood the question but I will try. What we're trying to remind people and we have been reminding investors for the last few quarters is that there is a general level of investments that has to go on in the business to continue to lay the foundation for future growth. We are describing those investments in some detail today just to make certain that we're giving some transparency on that. And we are estimating -- and it is only an estimate of what the cost of some of those investments might be.

But as Don said, the ones that I'm describing are effectively the startup costs for our new system and for the service center and those costs will go away. The costs that are long-term revenue generators are in the people that we're hiring, and that also adds to SG&A. So the reason that we gave an estimate of the service center and the rollout is that those costs are transient, while the costs of people are more long-term.

Got it. Okay. I understand that now. With respect to I guess margins as we look out to the February quarter, historically, that is your low gross margin quarter because of the holidays. Would you expect sequential gross margins to be down then in February?

Yes.

Okay. Finally, I guess, acquisition front. Anything interesting or is there a lot of deal volume out there?

Currently, we're not looking at any acquisitions. We have not seen anything interesting. We have been trying to close our transaction in India since July. It is a difficult legal environment to do an acquisition. But we're hopefully getting close to the finish line there. So that is the only thing.

Andrew Steinerman, Bear Stearns.

My question is for Stephen; it is a geeky SG&A question. So I calculated $0.01 is about $850,000 of SG&A cost-affected a $0.01 on the bottom line. This past quarter, SG&A came up sequentially a couple of million dollars. It came up sequentially 8%; revenues are up 6%. If I am going to interpret your $0.01 comment for the increased spending, does that mean the increases in the coming quarters sequentially will be much less than the couple of million dollars that had just came up sequentially? And do you think that could be contained within the context of what revenue grows sequentially?

This is Don just to give you a non-geek answer, and then Steve can be the geek answer. The 850,000 your calculation, I think the $0.01 that Steve related to had to do with more the infrastructure -- changes with the service center and the software and things like that. Where the majority of our increase in G&A (multiple speakers) is with people, who we expect to generate income and revenue to start paying for themselves over time. It is our expansion geographically and in the United States and our existing markets in the service lines that has always been our greatest G&A investment.

That is a good reminder, Don. It did combine the two quickly to catch that. You're right.

I don't know if there's any better answer than that. We are -- I guess what I would say as Don said and as I said to Brandt, we are identifying for you those costs that are not people related because that is different than the people-related issues. We clearly believe that the cost of streamlining our operating systems and streamlining the systems in the European markets will ultimately drive better margins, but they are not revenue-generating issues. The people that we higher generate revenue. The costs that we're incurring to put in systems and to develop the service center are to make those people more efficient.

Maybe if you let me restate my question just more simply. SG&A came up sequentially $2.7 million; that is 8% sequential growth. Do you feel like we did a lot of catching up in that, or do you feel like the type of sequential increases when you think about both the infrastructure and the people cost might really be more representative by how much we came up with in November quarters? So thinking forward, does a $2.7 million sequential increase in the November quarter seem like a lot of catching up, or does it feel like that is sort of the rate that we're increasing for a couple of quarters?

I looked at the last 4 years. And in the last 4 years, the change from the first quarter to the second quarter in SG&A is just about the same as it was this year. So there was certainly some catching up, but it was mostly catching up with the very, very strong revenue growth we have seen over the last 2 years. And we are continuing to see strong revenue growth. It is not at the 16% (ph$) pace that we saw in the last 2 years. But continuing to target a 20% growth rate this year is in our view something we're quite proud of.

I don't know that I want to get too granular on the call about what -- what the dollar amount of SG&A growth might be between the second and the third quarter. But I think that if you look back over the last 3 or 4 years in terms of trends, we have tended to grow SG&A slower in the third quarter than we did in the second quarter.

Just to elaborate, our return on investments for offices that we start ourselves has always been very strong once we execute the office correctly. We are opportunistic, looking for the right opportunities to start geographic new locations. When we find the right person and get say, a potential assignment in a foreign country outside the United States, we try to take advantage of that and jump on it. We are opportunistic in where we start in trying to get as many factors to help us with success as possible.

Sometimes, you cannot predict when the situation is going to present itself. But when it does present itself, we'd like to be opportunistic and take advantage of it.

That makes a lot of sense. Thank you.

Gary Bisbee, Lehman Brothers.

A couple questions. You have talked about -- not to beat this one to death -- it probably already has been, but I will have to ask my one question as well. The infrastructure investments you made in the SG&A line, can you give me a sense as to how much of that sort of ends at the end of fiscal '06? Or should we expect those to continue? And also are there any other infrastructure projects that you're planning that could happen in '07?

Our expectation is that most of those costs will be complete by the end of '06. There will be some that will stretch into the first or second quarter of '07, depending on the efficiency with which we roll out systems and the efficiency with which we implement the new service center in Europe. But most of the costs will be completed in this fiscal year.

Can you give some color on how the areas beyond the core finance and accounting practice are doing? I guess you don't necessarily give the percent of the business. But any sense as to the scale of those and how they have been growing relative to the F&A business?

I think in my remarks, I mentioned that we had growth in the quarter of every service line other than RAS. We are seeing growth in every service line -- supply chain management, information management, legal services, our human capital practice, and as well as the accounting and finance. We are getting positive momentum in all the service lines.

Are they growing, given that a lot of them are off a smaller base, are they growing faster than finance and accounting or not?

The answer to that is some are and some are not. The answer is that this is an analysis that Wall Street seems to want to do, which we tend not to do. But if you were to look at the growth rate for the Company without RAS is beyond the long-term growth rate that we have set for the Company of 20 to 30%. Having said that, we look at the Company as one Company that happens to do six different things and we have always expected that there would be a waxing and waning of demand from our clients for particular services. And that is what is happening right now is we are seeing strong demand in certain areas of the Company and slightly lower demand in an area that was very -- in high demand the last 2 years. That is essentially exactly what we have predicted for the last 6 to 9 months.

Just one last one. Using this FTE, or full-time equivalent, associate number you have been giving us, if we look at the revenue per full-time equivalent, it was only up 2% which is a pretty dramatic slowdown from the last few quarters. Is there some mix shift going on that would explain that? Or is that more of an anomaly?

I don't think there's much of a mix shift. The rates in our various service lines are not identical, but they are fairly comparable. And so differences between where we see revenues doesn't necessarily imply any lack of productivity. We only recently began giving the FTE numbers, and it was primarily to give you two different ways to look at the trends in headcount. The way I would look at it is the ended quarter number was significantly higher than the FTE number for the quarter, which suggests that as we -- and it is clear in the revenue numbers is that as we were trending towards the end of the quarter, revenues were growing fairly quickly. The goal is not to give you guys incredibly precise ways to define productivity but instead to give you a good way to assess the trajectory of the business.

And just to give you a specific -- some specifics answers on your question. In looking at the service lines, we market them with a group of professionals that don't differentiate themselves to the client that we only are selling the IM services or accounting and finance. So we do go to market as one Company with the six service lines. But if I look at our service lines, for the sequential growth, our fastest -- our highest sequential growth between quarters was supply chain management. Our second-highest was human capital; now they also had the smaller basis.

Percentage-wise, our IM practice and legal practices both grew close to the same percentages. And then our accounting and finance had -- of the ones I mentioned -- had the least percentage growth -- of course, a lot of dollars. And then our RAS did not grow. So as I said, we grew in every service line other than RAS.

Mark Marcon, Robert W. Baird.

I was wondering with regards to Europe, you did mention that the revenues were about 33.1 million. Is that correct?

That was for all of international.

Right. I meant all of international. During the last quarter, you had mentioned that you had a couple of big Sarb-Ox/RAS projects that came into play. Did those end or did they carry over into this quarter?

No, they are still going on. Some of those might be a year plus project. These are not things that can start and stop very quickly because these companies are so large.

Because in prior years, you had experienced pretty good sequential growth in international revenues going from Q1 to Q2. This time, it looks a little bit more flat. I was wondering if part of that wasn't maybe some of those big projects had wound down, or is there a different way to think about that?

I would suggest that Q1 was stronger than we had expected. So when you get stronger than expected results in Q1, then it makes sequentially between Q1 and Q2 maybe a little difference. I would say that our performance in Europe was fine in Q2.

As we think about the overall revenues that you have achieved during the first 2 weeks of this quarter, would a fair way to think about the overall quarters is to think about 12 weeks at that rate in terms of being conservative?

I don't know if that would be conservative; that is one way to look at it. When we look at the third quarter, we tend to look at it as effectively a 12-week quarter. I don't know that you can necessarily conclude that the revenues in the first couple weeks of the quarter are a proxy for the rest of the quarter because one of the things that we talked about on the prepared comments is we hope to see a strong rebound out of the holidays, and that is the most difficult thing to predict this quarter.

We hear from our field strong demand going into January. But we are going to be consistently conservative about expectations around that. If we see very strong demand in January, then the metric you just used might be reasonable.

How has the historic relationship been between your revenues in the first couple of weeks of December relative to the remainder of the quarter ex the holiday period been historically? And what might be different this time?

That is a simple question but a little complicated to answer because it changes from year to year. Last year for instance, we rocketed out -- or excuse me 2 years ago, we rocketed out of the holidays because of the first year of Sarbanes. Last year, we were already well into that dynamic and so we didn't come out quite as quickly out of the holidays. You're asking us to predict something that is as we have said probably the most difficult thing for us to predict. And what we have tried to do is give you factual data around what has occurred in the quarter so far, some thoughts around what might happen after the holidays. And we will just have to wait and see.

I was just trying to ascertain the historical past relationship to the extent that that is possible. And you also did mention during your prepared remarks that the pipeline was as robust as -- it sounded like it was quite robust.

That's what we see, yes.

The hard thing for us to predict year over year is when the business starts ramping up after the holidays. Sometimes, it has been the second week of January. And last year, it wasn't until the third week of January. Part of that I guess is more of what people are doing for -- around the holidays and vacations, when the fall holiday falls, etc.

With regards to RAS, obviously it has fallen off the last couple of quarters and you're not -- you're clearly doing exceptionally well in your non-RAS business. How should we think about that, the RAS business progressing? Or what would be your best guess in terms of how it should progress through the balance of this year?

For the balance of this year?

Yes.

My best guess is it is going to be approximately dollar-wise going to probably look as we are doing now with some incremental increases with the client's ramp-up is for their busy season to get through their year-end financial audits and SOX certification. On a longer-term basis, we are looking at ways that we can enhance and expand the service lines to be a lot more than just RAS -- a lot more than just SOX but have RAS be more applicable to more co-sourcing of internal audit projects as well as helping with corporate governance initiatives.

I will let somebody else ask a question.

Jim Wilson, JMP Securities.

I think pretty much all my questions have been hit on. But I guess I would ask one -- or actually I have two that I can think of. The competitive framework, obviously you continue to ramp pretty nicely. Do you see changes? Do you see Big Four more or less competitive or about the same? Are there any other players or smaller players starting to step up on any of your new practices?

Again, our competition tends to be more regional. On some of the names that you associated on a national basis with our competitors, it is not across the board strong competitors. It is really regionally -- and depending on how strong their teams are. The Big Four -- right now, I'm not aware that we have had any really large competitive issues with any of the Big Four on any of my visits so far. I think the Big Four are probably taking a breather since they got through Sarbanes and really stressed out a lot of their staff.

As far as major competitors, we really don't see one that we can say across the board we're dealing with. But there is new startups all the time that are trying to emulate us; that we see.

On the other hand, there are some modest change proposals to Sarbanes-Oxley legislation out there floating around, such as potential for smaller cap companies not having the external auditors have to sign off anymore. Anything you see affecting your business other than the slowdown it might have seen the same pattern anyway?

No, not so far. I would expect that there will be some incremental revenue loss from the companies that have market caps less than 125 million. Because they are not going to have to, I don't think, do Sarbanes. But that is a very, very small percentage of our revenue -- a very small percentage. For the market caps where the auditors don't have to sign off but the CEO and the CFO have to sign off, we haven't seen any changes yet. But I would guess that they're going to want to do some internal procedures so that legally they have support for their sign offs.

Would that even lead to even more potential for you conceivably, given that greater responsibility on the CEO and CFO's part?

No, I don't think it would be more because under Sarbanes, the CEO and CFO have to sign off. And the law was written, it was meant to be a management function. So the management had to evaluate tests and conclude on their internal controls and form this opinion and then certify it to them. And then for the big companies, the auditors had to sign off as to whether they thought the opinion was adequate or not. What occurred, of course, was that more work was done than anybody had anticipated. But that sort of leads to what is the best practice.

If you are the CEO and the CFO of a company and you have a $500 million market cap and you have to sign off on Sarbanes, the ones that are legally astute are going want to have a best practice type of support. So I would assume that that would mean close to the same types of procedures they would have done if their auditors were signing off on them. But again, are sweet spot has always been the Fortune 1000-type companies.

Steven Shin (ph), AmTrust.

I would like to ask a question from 30,000 feet. Over the last three quarters, you kind of averaged about $0.30 in earnings per quarter. And if you look at into the fiscal third quarter, that is roughly where the analysts are expecting you to be as well. Would you say that this indicates that your current asset base and your current labor pool allows you to earn at that $1.20 per year rate? Is your earning power from your current base higher than that level?

Let me attempt to answer your question. We have always said that we're trying to run the Company for a balanced approach of adequate profit, revenue and cash flow, and investment for the future. When we went public and since we went public, we have always really stated that we believe a 15% operating margin was a good target for us to be able to keep investing for the future, as well as providing a good return right now as we grow. For the last year plus, we have been operating well above the 15% and it looks like we're probably continue to be operating in that 16% range.

If we decided we were a mature business and we had no really good growth areas to invest in, we could manage the business to be 20% plus operating margin. And we could manage the business to really drive the earnings per share, but we don't think we are anywhere near close to mature. All we see are opportunities for us in the future that we need to keep investing in to achieve.

The answer is, we think our customer base, our base of business right now -- last year, we had I think a 19% operating margin. You can do the math and say what would our earnings per share have been if we did a 19% operating margin this year. But we're not managing the business that way. We are managing the business to continue to invest. And I mentioned all the new geographies that we're investing in, and we're quite excited about the prospects 3 years down the road for some of those locations.

What is the full return on investment that you are targeting?

We always try to invest at a higher than our cost of capital. Our cost of capital is about 12%. So we try to get the 12% return. We have operated well above that since going public. We have as Don said, a number of initiatives that don't immediately return that sort of return. But that is what we aim for. I don't know that we would want to continue to have a philosophical discussion on a quarterly conference call, but I think that is how we philosophically run the Company.

Our typical new office we would expect to break even in about 18 months. That becomes influenced by when you are going into a different country, the customs of the country, the economies of the country, etc. But we do try to get to an 18-month breakeven for a new office.

Brett Manderfeld, Piper Jaffray.

Is the composition of the RAS revenue still heavily weighted towards year 1 work today? Or has that kind of mix shifted? Is it more even between year 1 and year 2? Thanks.

No, I think the majority of our RAS revenue is year 2 and year 3. I don't think we're doing much of year 1 other than maybe in Europe.

We have no further questions in queue. I will turn the conference back over to Don Murray for closing comments.

Again, as always, I thank our investors and for having the faith in us. We appreciate your support and are doing the best we can to build a great Company. Thanks.

That does conclude today's conference call. We appreciate your participation. You may now disconnect your lines. Have a great day.