Resources Connection Inc (RGP) 2007 Q3 法說會逐字稿

Good day and welcome everyone to the Resources Global Professionals third-quarter fiscal year 2007 earnings results conference call. Today's call is being recorded. With us today from the Company are 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 Ms. Kate Duchene. Please go ahead, ma'am.

Thank you, operator. Good afternoon, everyone, and thank you for participating with us today. Joining me, as you know, are Don Murray, our CEO, and Steve Giusto, our CFO.

During this call we will be providing you with comments on our results for the third quarter of fiscal year 2007. By now you should have a copy of today's press release. If you need a copy and are unable to access one via our website, please call [Patricia Marques] at 714-430-6314, and she will be happy to fax a copy to you.

Before introducing 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 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 31, 2006 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 condition 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 third quarter.

Thanks, Kate. Good afternoon. The third quarter of fiscal 2007 was stronger than a year ago. The third quarter as usual was impacted by the holiday season in the United States and Europe, but even with the holiday impact, our revenue grew 17% over the comparable quarter a year ago and 3% sequentially to $187.5 million. And earnings per share before stock compensation for the quarter grew by 22% year-over-year. Steve will provide additional detailed revenue and earnings trends in his review of operations later in the call. It is our normal practice to give you an update on our core growth strategies.

Our first two strategies are to grow revenues from existing major clients and to add significant new clients. We have enjoyed considerable success with these strategies as the number of major clients we serve has grown consistently for many years. During the third quarter, we added 11 new Fortune 1000 clients, and we measure large clients as those from whom we generate annual revenues over $500,000. This year we have 309 clients on a $500,000 annualized run-rate after three-quarters of the year versus 244 at the same time a year ago. We believe our effectiveness in this area is enhanced by our global expansion and our client service model rather than the commission-based models of some of our competitors.

As we have said in the past, no one benefits from the wrong client solution as they could in a commission-based system. Revenues from our top 50 clients represented 36% of total revenues for the quarter, while 50% of our revenues came from 106 clients. Our largest client in the third quarter was less than 3% of revenue. In 2006 our largest client from three quarters was just under 5% of revenue. We believe our client service team approach is the differentiating factor that creates client continuity, even though our business appears to be temporary projects. Client continuity continues to be a focus during fiscal 2006. We served all of our top 50 clients from 2005 in 2006, and in 2007 we have served all 50 of the top 50 from fiscal 2006.

Looking back a number of years, over 80% of the top 50 clients from fiscal 2003, 90% of the top 50 clients from 2004 are clients in 2007. We think this illustrates the effectiveness of our client service approach. We are growing the total number of client served as well. At the end of the third quarter of fiscal 2007, we have served almost 2000 clients year-to-date compared to about 1800 in the prior year at this time. The major component of our growth strategy is to be relevant to our clients wherever they are in the world, and to execute on that strategy, we have been expanding our geographic footprint quickly. We did not open any new practices this quarter, but we have reached an agreement with a leader from Mexico City and look forward to opening there in the fourth quarter.

Offices that represent new markets over the last year and a half contributed $4.5 million in revenue during Q3. Further, during Q3 our overall revenue growth internationally was 36% on a year-over-year basis.

As we have expanded internationally, the percentage of revenues coming from international practices has grown. In this quarter our international practice contributed 24.2% of revenues, which is our highest ever.

Our fourth strategy is to diversify our scope of services end market the various services to our large clients. All of our service lines other than RAS grew sequentially and year-over-year in the third quarter. We provide services in six different professional areas, and we will continue to examine other potential professional services offerings that fit our model.

Consistent with our big four heritage, our most significant revenue continue to be generated from the accounting and finance and RAS service lines. One measure of the success of this strategy is the number of top clients who have engaged us in multiple service lines. In fiscal 2007 48 of our top 50 clients have used more than one service line, and 88% have used three or more service lines. We stated last quarter that we expected revenue from RAS to be down sequentially over the second quarter 2007, and this is what we experienced. RAS was approximately 19% of total revenues in the third quarter of fiscal 2007. It seems that demand from clients in the SOX area, including international companies who are filing requirements with the SEC, is becoming more seasonal. Although we believe RAS has good long-term growth prospects, the aggregate growth of revenues from other services we offer has continued to offset any decline in RAS revenue. The waxing and waning of client demand for our various service offerings is one of the reasons we have a broad service strategy to begin with.

Now Steve is going to provide a more detailed review of our financial results for the quarter.

Thank you, Don. Revenues for the quarter were $187.5 million versus $160.3 million in the comparable quarter a year ago and $182.8 million in the second quarter of fiscal 2007. This represents year-over-year growth of 17% and sequential growth of 3%. Growing revenue sequentially by $5 million is encouraging considering the heavy holiday season that occurs in the third quarter. In the US and Europe, we lose approximately a week's worth of revenues between Christmas and New Year's, and the last two weeks of the quarter were impacted by the Presidents' Day holiday in the US. In Asia all our Chinese practices lost a full week's revenue in the last week of the quarter due to Chinese New Year's.

Now let me discuss revenues geographically. Revenues in the US were strong prior to the holidays and rebounded quicker than last year after the expected lull at the end of the year. There was a slight slowing during the last two weeks of the quarter as associates took off early for the Presidents' Day holiday and generally did not return until the following Tuesday. Since that time, our US practice has returned to strong levels of revenues that are slightly below all-time highs. As expected, RAS revenue fell off considerably as companies completed their SOX work for the calendar year. Due to demand across other service areas, we are able to redeploy most of the associates rolling off RAS projects on engagements in other service areas.

The overall revenue results from our international practices continued to be strong, and this was a good quarter in most international markets. But the last few weeks of the quarter were a little week. For the quarter international revenues were 24.2% of total revenues, the highest percentage yet. Netherlands revenues for the quarter on a dollar basis were up by 10% year-over-year and down 5% sequentially. Total revenues for the Dutch practice in Q3 were $17.5 million. It is normal for Dutch companies to end the contracts early in the calendar year and then reopen them. So, in the last few weeks of the quarter, the Dutch had a meaningful number of contracts end, but by the second week of Q4, they had opened new contracts that replaced all that had been completed. UK revenues were up 14% versus the prior year third quarter and 7% sequentially. We believe the UK market has substantial potential, and this was a good quarter of progress.

The Asia-Pacific region had another excellent quarter with revenues up 76% year-over-year but down 5% sequentially due to seasonality. Total revenues internationally were $45.4 million versus $33.4 million in the third quarter of fiscal 2006 and $43.8 million in the second quarter of this year. This represents year-over-year growth of 36% and sequential growth of 4%. While a portion of the international revenues increase was from currency exchange rates, international revenue grew year-over-year by 27% on a constant currency basis.

Let me now give you information about the first few weeks of Q4, which have been good. The first week of the quarter was approximately $15.4 million. The next week of the quarter was slightly better at $15.5 million, and the most recent week was about $15.3 million. Our offices report a strong pipeline of work that is encumbered in some markets only by the challenge of attracting the right number in quality of associates. At current run-rates and in a quarter when there were few holidays to impact our revenues, we are trending toward revenue in the fourth quarter just short of $200 million. If we achieved that revenue result in Q4, total revenues for the year would be approximately $735 million, representing annual growth of slightly over 15%.

Now to gross margins. Gross margins were up 10 basis points from the year ago quarter. Consolidated gross margins were 38.2% for the quarter, and last year's third quarter gross margins were 38.1%. Conversion fees were only a 0.5% of revenues, indicating to us the permanent hiring by companies remains somewhat soft. Conversion fees were half as much as the first quarter of this year. As a comparison, in 2000 conversion fees were 5% of revenues in some periods, indicative of the strong job market then.

Client reimbursements were about 2.3% of revenues during the quarter, the same percentage as Q1 and Q2. And, as we have previously described, the holiday effect during Q3 reduces gross margins during this quarter, so gross margins before converting them to the client reimbursements were 38.8%.

On an international basis, gross margins were 35.7% during the quarter versus 35.6% a year ago. The international practices have lower gross margins due to differences in work customs laws and regulations in those markets.

Headcount growth in the quarter was fairly consistent with revenue growth. For the third quarter, average associate FTE count was 3119. This compares to 3054 in the previous quarter and 2728 in the year ago quarter. Quarter-end associate headcount was 3142 versus 3195 at the end of Q2. As I mentioned earlier, the Netherlands had a temporary falloff in headcount at the end of the quarter, which has subsequently been recovered. The total headcount of the Company was approximately 3930 at quarter end.

Now to the other components of our third-quarter financial results. Selling, general and administrative expenses before stock compensation for the third quarter were $43.6 million or 23.3% of revenue. In last year's third quarter, SG&A was $38.4 million or 24.0% of revenue. SG&A was $42.0 million or 23% of revenue in the second quarter of fiscal 2007. Year-to-date our revenues are up 14.4% and SG&A is up 15.0%. So our goal of balancing SG&A growth with revenue growth this year is pretty much on track.

Depreciation and amortization was $1.9 million for the quarter, up about 43% over last year's third quarter as the result of a higher asset base. Interest income was $2.4 million for the third quarter versus $1.3 million a year ago. Our tax rate before the impact of stock compensation expense was 40%, the same rate as the first two quarters of this year but up 75 basis points from last year's third quarter. Our operating margin before stock compensation expense for the third quarter was 14.9%, an increase of 80 basis points from the comparable quarter a year ago. This compares to 16.8% in the second quarter of this year.

Earnings for the quarter before stock compensation were $17.1 million or $0.33 per share versus an $13.8 million and $0.27 per share a year ago. We began recording stock compensation costs in accordance with FASB statement 123R during the first quarter of this year. The pretax charge for stock compensation in Q3 was $5.0 million, up a little over Q1 and Q2 due to our incumbent option awards effective in February. As we have previously described, the tax treatment of our incentive stock options causes volatility in our GAAP tax expense. During Q3 we were unable to record the full tax benefit related to ISO for which we recorded compensation expense of over $2.5 million. Therefore, our GAAP tax provision was 44.2% for the quarter. The after-tax impact of FAS 123R third quarter amounted to $0.07 per share, and to be clear, the impact of 123R has no impact on the cash flows of our business.

On a GAAP basis, net income for the quarter was $13.1 million or $0.26, down $0.01 versus the year ago quarter due to the impact of 123R.

Now let me turn to our balance sheet. Cash and investments at quarter end were $223 million. Our board management continued to examine all relevant uses of cash to achieve solid returns on capital while maintaining a balance sheet that has superior strength and liquidity to protect the Company and its shareholders through good and bad business climates. We're still evaluating some potential acquisitions that may be made using a meaningful amount of cash, and we, therefore, did not buy back any of our stock during the quarter.

Receivables at quarter end were $108 million, up by about $3 million from the previous quarter. Day sales outstanding were 52 days, the same as the previous quarter. As our business with large companies continues to expand, the overall collection risk of our receivable portfolio falls, but the time it takes us to get paid is getting a little longer, and it's a trend we still aim to reverse. Despite this modest lengthening, we're comfortable with the overall security of our receivables portfolio.

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

Thank you, Steve. Well, we were happy that the momentum experienced in the first half of this year continued after the holidays. We recognized some signs of slowing economic growth in some of the world's major economies, and we have been preparing by carefully monitoring our internal headcount and other administrative cost. We continue to enjoy a solid demand environment, but there are some specific geographic markets and service lines where we are working hard to improve our execution. We believe that global demand for professional talent will outstrip supply for many years to come, and Resources is well positioned to fill that void. But we must continue to execute by hiring the best available talent and serving our clients very well.

We continue to experience a good demand environment where we are also looking for additional geographic and service capabilities that could supplement our current practice. Most of our past growth has been organic. As we mentioned last quarter, we are seeking professional service acquisitions that provide a competitive advantage to addressing new markets and services that fit culturally into our business. We're currently exploring the best way of expanding into Asia and Europe. Geographic areas that we're currently investigating for the best ways to expand include European countries like Germany and Italy and in China and Asia. Additional service lines we seek include regulatory consulting and government financial consulting.

We're pleased with the way the Company has been executing, and our focus continues to be on executing our business model well. It starts with recruiting. That means identifying high-quality associates who have the right skills and experiences to help our clients and retain them. As I have said in the past in my visits to clients, I continue to hear that our people differentiate us. We strive to exceed our clients' expectations, and we work hard everyday 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 talented associates and serving high visibility clients is key to our circle of quality. We believe the potential for the next five years is attractive as our reputation, capabilities and strong performances continue to position us well in the rapidly evolving professional services market.

We would be glad to answer your questions at this time. Thanks.

(OPERATOR INSTRUCTIONS). Brandt Sakakeeny, Deutsche Bank.

A question for you. First, Steve, you talked about I guess the revenue run-rate coming in close to $200 million for the fourth quarter. Given the $0.05 spread in the third quarter on the street estimates, can you just give us maybe a little more color around what you would expect SG&A and just some color around margin activity either gross or EBIT as we progress in the fourth quarter?

Well, certainly the third quarter is a difficult quarter from a margin standpoint because of the holidays, and the fourth quarter alternatively is generally a strong quarter from a margin standpoint. So I would expect that if we achieve our revenue goals that you should see a return to operating margins similar to what we saw earlier in the year.

Okay. Great. Just a question on the conversion fees, I am still amazed that they are where they are. Is that a function -- I think, Don, perhaps you said, or Steve, that it was a function of still some conservative hiring among your clients. Could it also be a function of lack of desire among your associates to go to full-time permanent positions as well? Maybe which is the bigger force?

Well, I think we have put into place a lot of programs to help our retention. So I think that is part of it, but the decrease is so dramatic from 2000 that I think more of it is economic driven. We would hope that our programs and our associates are happy to be here, and they like all the different things we have done, but I don't think it would account for over 5% to under 0.5%. That is so dramatic.

How about, Don, perhaps that figure was somewhat inflated by the dot-com bubble. Anything there?

Yes, it was. The 5% was definitely the height of the e-business and dot-com wave with a giant strong job market especially on the West Coast and the East Coast. So you are right. That was part of the driving force. That created the demand.

Okay. I guess finally it sounds like you're keeping powder dry potentially for a sizable acquisition. Can you just discuss is there anything specifically in the pipeline for which you're doing due diligence, or is this more of a theoretical exercise in case something does materialize?

We have three or four opportunities that have not done due diligence, but we're hoping to be in a position to do due diligence. So yes, we have some specific targets that we're looking at that would enhance our abilities that we don't have already. Of the three or four that we're looking at, only one is of any I would say significant size at all. The others are more boutique-oriented.

Mike Fox, JPMorgan.

Could you talk a little bit about the pricing environment and then also your ability to continue to hire qualified personnel? And then finally, you mentioned you are seeing some strengths and some weaknesses in certain geographies. Is that continuing to be strength on the Coast and a little weakness on the middle of the country?

I would say that your last question your answer is, it is generally correct. We continue to see economic strengths in the two coasts and in the Chicago area and soft for us in the South and the majority of the Midwest, and our hiring environment basically mirrors that. So our hiring environment is tougher on the East Coast and the West Coast and easier in the Midwest and the South. But we're moving our associates around and getting them opportunities outside their geographic areas if their particular skills are not in demand in that area at that time. So we're doing a better job in mobilizing our associate strength.

We also I think are really working hard to try to take advantage of our presence in India by getting talented India associates out on assignments in countries other than India especially where there is demand problems like in some parts of Europe. So we are working on that to develop that as a strategic almost separate business line within our business.

From a pricing standpoint, we continue to have good pricing. Our rates were up again in this quarter. They were up a couple of dollars over the quarter just before it. So while there is pressure to continue to find the right talent, when we are able to find that talent, we're able to price appropriately to get those sorts of margins that we aim for. So we mentioned that in this quarter gross margins are impacted by the holidays, but in a normal environment, our gross margins are at or above the 40% target that we have set, which means that we are able to pass that along (technical difficulty)-- to our clients the incremental cost of finding this new talent.

Okay. Great. Just one quick follow-up. On the hiring, given the strong demand on the closed and it sounds like it's a little bit tougher to hire, are you seeing wage inflation, and if so, is it minor, or you are starting to see it move up? Do you think that is more to come, and do you think that that could impact your margins or that should be offset by further price increases?

I would say we don't anticipate our margins being affected, and we do have regional areas where there has been wage inflation, and we handle that with increases in the pay rates and increases in the billing rates. So I think because our margins are fairly constant and when our come clients compare us to the big four, the big consulting firms on average, we are a lot less. So we have I think less pricing pressures than we would have if we had that kind of salary multiple in our bill rates.

Gary Bisbee, Lehman Brothers.

SG&A was a little higher quarter-over-quarter, and I guess my understanding after last quarter you had had the onetime branding spend was that it might come in a little bit. Was there anything in particular involved with that, and how do you expect that to trend over the next quarter?

Well, our branding initiatives were less costly in Q3. They were about half of what they were in Q2, and we would expect that they will be at similar levels in Q4. I would consider the amount that we are investing in that area pretty reasonable spend for a company of our size, and that the positioning is an important initiative.

In terms of overall G&A spending, I would say that we're pretty comfortable that the goals we set earlier in the year of balancing SG&A growth with revenue is, as I said, pretty much on track, particularly since we have just gone through the seasonally most difficult period for us, and the holiday impact of that season gets reflected in the SG&A percent. So we are still in our view being pretty careful about where we spend our SG&A, and as revenue accelerates towards the end of the year, we're hopeful that that will have a complete balance in terms of SG&A and revenue growth by the end of the year.

Okay. Any early response that you have seen from the branding initiatives, or is it the kind of thing that is just helping reinforce the brand but it is tough to really get a gauge as to what that is doing for you?

My perception and expectation is that the branding initiative, it is a long-term value building program. It is not going to have measurable short-term effects. Yes, we have gotten some calls from companies who saw one of our advertisers and called and liked it, and we actually may have gotten a new engagement or two from it. But it is really a long-term building process, and the most important thing is it makes our people internally feel good about themselves. When they see an ad or a client sees an ad that basically shows another client that they recognize the name of and talking about the great experience that that client had, I think that really makes people feel good about Resources and using us. So it is definitely a longer-term approach to what we're doing. We're not a consumer retail business that would get immediate impact from advertising. We are much more I think long-term value building.

Okay. And then, Don, I think you mentioned a comment that you are seeing economic growth decelerate in some markets. Can you give us a little more color on where that may be and how exactly you expect that to impact your business as we look out over the next six to nine months?

Well, the Midwest, a lot of the Midwest area is driven partly by the auto industry. It is no surprise to anybody the issues that the auto industry are having, on a short-term impact, it creates an environment where they don't want to hire anybody outside right away to help them with projects and problems. On a longer-term and maybe a medium-term, it does create issues internally in the companies where they are going to need help to get through and as they do these layoffs, etc. So we think there is opportunity in the mid-term to help a lot of these companies with their projects.

In the oil and gas industry, we see a lot of hesitancy from a lot of the major clients that we have to increase their G&A. Even though it seems like it is a very robust economic environment for the major oil companies, they seem to be very cautious on spending money on new projects and G&A. So we continue to work with them, but like I said, we see some hesitancy on their part.

In California, Southern California, they have been dominant with these lending -- these subprime and other types of lending institutions of which we have had large clients in the past. We probably have transitioned most of that work out over the last 18 months. But that is going to affect the economies in Southern California, so we see that as again we have experienced it and probably from our Company standpoint have rolled through most of that. But those are the types of things we're talking about.

Okay. So you were not necessarily referring to anything international? As far as you can tell, the international demand continues to be a really robust picture at this point?

Yes, we think international demand is -- in Europe it is stronger than it has been since we have been involved in Europe. We see it growing. We're looking at how to get into Germany because Germany seems to be growing now where in the last few years they were either flat or shrinking. Japan seems to be growing again. We all know the story is in China. So that is a lot of where our attention is, in those areas.

Okay. And then just one last one. You have talked about acquisitions. Obviously we are hearing a lot about private equity interest in almost any kind of assets that generates good cash flows. Are the things you are looking at largely below the radar, or is this a situation where you would love to do a deal but there is so much activity out there that you may not find something that you can do at the price that you would like to do it?

Well, for us most of what we're looking at is below the radar of a private -- especially the well-known private equity funds. One of them is on the radar of the private equity funds, and that is probably who we're competing with. So for us the important thing is culture. Once we have a price range that we can live with, then the important thing for us is culturally will this fit into our business and not create additional problems for us when we are trying to mesh two disparate cultures.

So I would say when we had deals negotiated where we have walked away, it is because the cultural fit did not work for us when we did our due diligence.

Jim Janesky, Stifel Nicolaus.

Steve, is the fourth fiscal quarter of 2007 a 13 or a 12-week quarter?

It is a 13-week quarter.

Okay. So you in essence are expecting that recent trends in revenues will just continue throughout the rest of the quarter, is that correct?

It is normally our practice that we take whatever has happened early in the quarter and extrapolate it for the rest of the quarter. If we get some strength or some incremental growth from there, we can do better than we suggested, and alternatively if there were some slowing, we would do somewhat less than what I predicted. But it is pretty simple math, and it is our best guess from what we know today.

And with the fact that you said that the economy might be -- might have an effect on permanent hiring a bit, do you think that you might -- and you said that there still is a shortage of professionals in some markets. Do you think that you might be able to attract more people, and therefore, the revenue momentum could accelerate throughout the quarter? Is that a possibility, or is that just too short of a period of time?

Well, it is a possibility. We're always looking to find as many talented people as we can and to match that with the demands from our clients. And, as we mentioned, even with the macroeconomic underpinnings that Don mentioned, the underlying demand for our services continues to be strong.

And you expect the same idea status quo in terms of the economic environment for at least the rest of the quarter in your outlook as well? Would that be accurate?

Yes.

Okay. To clarify a statement that you made that the branding was half of last quarter and you expect next quarter to be half of this quarter or in line --?

No, no, the amount that we will spend in Q4 is comparable to what we spent in Q3.

Right. When do you think that will -- when do you think that we could expect that SG&A will start to grow at less than revenues? Is that more into -- is that a 2008 type of timeframe?

I would say that is more an issue of revenue than it is expense. We are consistently investing in the business, and there are two parameters that drive the percentage of SG&A -- growth in revenue and growth in SG&A. Our goal is to keep -- our goal, as we stated this year, is to keep SG&A growth in balance with revenue growth. We are not talking yet about fiscal '08, but our goal for the coming year will be to grow our revenues as quickly as possible and to support that with an appropriate level of investment in SG&A.

Part of that is dependent on what type of investments we make. If we invest in new service lines or we invest in another country without doing an acquisition, all of that startup expense goes right to the G&A line before we have revenue. And if we find an appropriate acquisition, say, in the service line that we don't have or in a country that we are not in, we hit the ground with revenue and with a net profit basically that relieves G&A. So a lot of it depends on how we do the investments over the next 12 months if we can find appropriate acquisitions.

Okay. And then, as a final question, since the percentage of your international business has increased over time, we should probably think about it in the first fiscal quarter, the August quarter, that European vacations tend to be longer than US vacations. So there will probably be more pronounced seasonality as your mix goes more towards international. Is that a good way to look at the business?

Potentially. I mean we also have a growing Asian practice where that impact is not as great. So certainly as the percentage of our revenues that comes from Europe has increased, the impact of the summer in Europe has also increased. But it is not that much different than the US. In August you should see some vacation time in the US as well. So clearly our first quarter and our third quarter tend to be the most seasonably impacted.

Mark Marcon, Robert W. Baird.

You mentioned in Southern California you saw some impact from the mortgage lending business falling off a little bit. Can you describe what level of exposure you have now? It sounds like in Southern California despite that that you were still able to grow. Is that correct?

Yes. I would say that the subprime clients were much larger for us two years ago. And so, as of today, we may have some associates helping some of them over there with their issues because they have laid off staff, and they don't have the internal help to get them through their issues. But the numbers and the dollar significance is nowhere near what it was, say, two years ago.

We have no incremental exposures from a bad debt standpoint. It was not appropriately reserved, and frankly if some of these companies end up going bankrupt, then likely we would see an increase in work as opposed to a decrease.

That was going to be my follow-up question. Are there any potential opportunities for greater scrutiny that might occur across different portfolios that might end up including some of these securities or anything else that might --

Yes, I would say that on balance change creates demand for our services, and this unfortunately for those companies is negative change. But negative change creates demand as well as positive change does. Some of our thinking around how we build relationships includes how do we help companies through difficult times as well as good times. So we will have to wait and see, but it could be positive.

Okay. And then with regards to the practice areas and the potential for growth there, obviously in the non-RAS business you were up roughly 30% year over year and on the RAS business down roughly about 17%, but that continues to decline as a percentage of revenue. Do you think that you had mentioned during the last quarter that we were going to see the seasonality from the external auditor crowd-out phenomenon that is going to come through? How do you think that plays out, the RAS business plays out throughout the rest of the year? And then can you give us some color with regards to your non-RAS practices and what you're seeing there?

I would say the RAS business has basically become routine when you're talking about Sarbanes-Oxley. So Sarbanes-Oxley has now become a process. Major companies are doing everything they can to keep the costs down and make it just part of their normal quarterly and normal closing procedures. It appears to peak -- the business appears to peak right before the fiscal end of the years as they are getting ready for their auditors to come in or their auditors are already in looking at what they are doing. So it has become much more, say, a predictable process.

What we are looking to do, and we have had some success, is expand our RAS outside of just Sarbanes-Oxley and look on other types of projects or clients around the internal audit function and their own duties to protect their assets and also to monitor royalty agreements, etc. So that is where a lot of our emphasis is in RAS in promoting it, etc.

Last week we cosponsored with University of Southern California a corporate governance seminar, and it was only the second year, but it got very wide coverage from the media, as well as a lot of board members and CEOs attending. And our lead speaker that the conference got was Commissioner Cox from the SEC. So things like that we hope are going to help us brand RAS and get us into areas of RAS that we are not currently in in a major way.

The other service lines are growing well. We continue to expect them to grow well. One of the nice things about our business model is our associates are not necessarily internal auditors or necessarily SOX experts. They do have SOX expertise, there are certificates in SOX compliance, but they are also foremost experienced accountants and financial people. So the majority of our people that work on SOX can transition into other accounting and finance jobs which helps the other service lines grow.

Great. Can you tell us a little bit more about things like legal and what you are seeing there?

Legal from Q2 to Q3 sequentially had about 24% growth over a very small base, and so we are looking to expand legal into other major Metropolitan areas. Because right now it is really only in two major Metropolitan areas. So we are looking to expand it into two other Metropolitan areas. Accounting & Finance, which is our largest service line, had very strong sequential growth for that. Human capital service line was in double digits. Legal service line again I said was double digits. Supply chain management sequentially was double-digit. So we continue to expect that those service lines will grow faster because they are coming off a smaller base, and we are introducing them into more geographic locations.

Terrific. Thank you.

Andrew Steinerman, Bear Stearns.

Here is a tricky one. Steve, could you take a guess at a tax rate in the fourth quarter?

A real tax rate or a GAAP tax rate?

Could you guess at both for us? We are not tax accountants here.

Well, the answer is no, it is hard to take a guess because of the volatility that comes from how the ISOs get exercised, which -- and I sympathize with you guys because we cannot give you guidance on it. Other than to suggest it certainly is my view that the street has underestimated our GAAP tax expense for a number of quarters.

Yes, I did.

The tax rate pre-123R we expect to continue to be at 40%. The tax rate on a GAAP basis after 123R is difficult to predict. But I would tell you that it is likely to be considerably higher than 40% based on our three quarters of experience. I just cannot be precise about it because it is completely dependent on things outside of our control in terms of how people exercise their options, and I would hope so for those investors who are listening that they recognized that it is really a non-economic event when it comes to how we run the business and irrelevant to how the business is actually operating or how our cash flows come in. But I recognize that it is the front page number when it comes to earnings per share. We would expect that the pretax expense will be higher in Q4. We gave our incumbent grants in February. So late in Q3 those grants will have a full quarter's worth of effect in Q4, and so the pretax expense will be probably $0.5 million or a little bit more than that higher in Q4.

That is helpful. How about a shot at gross margin? I heard you say a few times February quarter gross margin hindered by seasonality; normal quarter would be 40; I think you even said maybe sometimes higher. Is there anything abnormal about the May quarter, or should it be in the normal gross margin range?

Well, the third quarter is abnormally low, so I would expect that the fourth quarter would get back to normal, and I would expect it would be after taking into account emergencies and client reimbursement at or above our 40% target.

Right. How about because international keeps growing faster, obviously they have lower gross margins?

I would still think that in the aggregate we will be pretty close to our 40% target after taking into account those two non-managed components of the calculation.

We have lower gross margins typically in continental Europe with higher gross margin in Asia.

All right. We should charge as much as we can. Thanks for the help. Appreciate it.

Michel Morin, Merrill Lynch.

I just wanted to drill a bit further if possible on the earlier question on SG&A which increased a bit more than what we had expected in the quarter. Given the decline in the ad spend, what were some of the things that drove that line? It does not seem like the administrative headcount really rose that much, and you did not open any new offices.

Well, the significant changes are salaries because there is on a sequential basis a modest increase in a number of people that we have in the Company, and occupancy, which is going up as we get bigger. There is nothing magical about it, and I am surprised that anyone would think it would have been much different than what it actually was.

If we lose about a week or so of revenue because of the holidays, our salary expense and rental expense is still the same. So the percentage of G&A is going to be a little bit higher.

And then on the topic of occupancy, can you update us on your move to the new corporate headquarters?

Yes, we are moving forward with that and expect to be there in the next couple of quarters.

Okay. And then finally you mentioned that you signed I think the number was 11 new clients among the Fortune 1000. How are you getting in the door there? Is it still primarily through financial accounting and RAS, or is it through the other service lines that are helping you get in increasingly?

Well, I think we get in as Resources, and whether it is in any particular service line depends on the particular needs of those clients. So I don't have the list in front of me to know exactly how we entered. But if the relationship fell and if the professional level fell, we go to market as one company with a variety of different service offerings. My perception is that investors continue to look at us as if we have got silos of different service lines when, in fact, it is one consolidated company with a variety of different services. So we can get into new clients in many different ways and through many different service lines. Of course, we are best known for accounting and finance, so it is likely that that might be the entry point. But it could be in all kinds of different ways. I think some of those we are guiding also, we started with supply chain management projects, which is logistics is a hot button around the world.

Great. Thank you. That is really helpful. And then just one finally, can you remind us, Steve, the gross margin number a year ago, I know you reported 40.1. But if you exclude the two elements that you don't control, what was that number?

I don't have that in front of me, but it would be a little bit higher than that.

T.C. Robillard, Bank of America Securities.

Just real quick, can you give us what cash from ops were and CapEx in the quarter?

Cash flow from ops were a little bit north of $16 million, and CapEx was -- hang on. CapEx was 5.5.

Okay. Great. Just a quick follow-up on an earlier question with respect to looking at the non-SOX work in the RAS segment, can you give us an idea for the work that you're doing now how we should look at seasonality for any of that non-SOX work, or should that trend with the same type of seasonality that Sarbanes-Oxley stuff does?

I would think that non-SOX work -- I mean, our goal is to make it less seasonality in RAS, and SOX definitely has a seasonality to it with Fortune 1000 companies. And the auditors typically have to buy off on the numbers usually before they actually do their earnings release. So you're talking about most of that auditors buyout proportion for Fortune 1000 companies is done by February 1. So that is their seasonality.

The other things are internal audit type projects or compliance type projects that go year-round, and a lot of those are international in scope. So the more we build that business, the less seasonal RAS will be.

Great. Sorry, just one tag-on to that. What is your next biggest practice in RAS outside of Sarbanes-Oxley? Is it the internal audit work?

Yes, it is co-sourcing internal audit work.

Christina Woo, Morgan Stanley.

I was hoping you could give me an update on your Shanghai office. You had mentioned expecting for that to open during the quarter. What is the progress there?

The progress is we are actually still searching for the right person.

Okay.

We had identified somebody and made them a job offer, and actually they had accepted, and their current employer then offered them a lot more money to stay, which was a Western multinational company. So we're -- in fact, one of our managing directors for the international area is over in the China area right now working on the recruiting process with our people there.

And are you still -- do you have any work in the area that you're handling from remote locations?

Yes, we have a lot of work actually in China itself, but that work is basically being generated outside of China by multinational clients who need work done. We actually have a great group of associates already in China, and I got an email from Bob this morning telling me he went to some of the associate meetings, and the associates are fabulous. They want us to start building our presence so we start getting local clients.

Okay. And what areas might we look at for further expansion once you resolve the Shanghai office?

We're actually looking at Shanghai and next will be Shenzhen, and focus on those two areas as well as Beijing. And that task is critical. If you know any Mandarin speaking professionals who would like an exciting opportunity, then Shenzhen or Shanghai just please forward them to us.

I will keep that in mind. Any update on your progress in India? You had mentioned last quarter that you were also looking to expand there?

In India? No, we're in India. What we're working on is trying to make it more successful outside of India. So we're working on being able to source our associates, say, in Mumbai, and getting them to work on assignments, say, in the UK or in Japan or in Canada, etc.

Okay.

That is really where we're looking to leverage it. We also have a number of assignments for Indian companies internally in Mumbai, and that is just a whole different structure than it is working outside of India.

[Jeff Kardon], Wasatch Advisors.

I just wanted to ask a little bit of a clarified question. I think you implied that the last two weeks were a little bit weak during the quarter, and I think you also in your commentary just implied that there is a weak economy in certain geographic areas of the country. And then when you added up the first three weeks of this quarter and you came up to like a $200 million revenue number, which looks to me like an acceleration if you look -- you grew at 17% this quarter -- and if you kind of plug that number in, it looks like revenues are accelerating. So I'm just trying to connect all those dots. Can you kind of help me out with that?

I will try. We had -- the last two weeks of the quarter were impacted by the Dutch being a little bit down very temporarily. And just the last holiday of this holiday infused quarter is Presidents' Day, and we find that our people tend to leave early on Friday just before the weekend and not come back until a little later. So there was not really anything economically impacting us in those last two weeks. It was more just a couple of circumstances.

I would say that our view is that demand continues to be pretty good, which is what we have implied and what we have said. We're just trying to be smart about it, and certainly there are some signs around the economy that things might not be perfectly rosy. So we're not sanguine about the economy, but we're pretty comfortable with the trajectory of our business.

Okay. That helps.

Yes, I think the last two weeks that Steve referred to in the quarter were impacted by those factors, not by the number of associates not having assignments.

All right. Okay. That helps a lot. Thanks.

And I think we also had a major weekend holiday in Asia.

That does conclude our question-and-answer session. At this time I would like to turn the call back over to Mr. Murray for any closing remarks.

Well, as always, we thank you for your continuing interest in Resources, and we look forward to speaking to you again after our May quarter which will be our year-end. Thanks.

This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.