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Resources Connection, Inc. (NASDAQ:RECN)

F2Q09 Earnings Call

January 6, 2009 5:00 pm ET

Executives

Kate Duchene - Chief Legal Officer & Executive Vice President of Human Resources

Thomas D. Christopoul - President and Chief Executive Officer

Nathan W. Franke - Chief Financial Officer

Anthony Cherbak - Chief Operating Officer and President, International Operations

Analysts

Kevin McVeigh - Credit Suisse

James Janesky - Stifel Nicolaus & Company

Andrew Steinerman - J.P. Morgan

Paul Ginocchio - Deutsche Bank Securities

Gary Bisbee - Barclays Capital

Mark Marcon - Robert W. Baird & Co.

Scott Schneeberger - Oppenheimer & Co.

Operator

Welcome to the Resources Global Professional second quarter fiscal year 2009 earnings results conference call. (Operator Instructions) At this time, for opening remarks and introductions I’ll turn the call over to Kate Duchene.

Kate Duchene

Good afternoon everyone and thank you for participating today. During this call we will be providing you with comments on our results for the second quarter of fiscal year 2009. By now you should have a copy of today's press release. If you need a copy and are unable to access a copy via our website, please call Patricia Marquez at 714-430-6314 and she will be happy to fax a copy to you.

Before introducing Tom Christopoul, our CEO, 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, 2008, 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'll now turn the call over to Tom Christopoul, our Chief Executive Officer.

Thomas D. Christopoul

Good afternoon everyone and welcome to the Resources Global second quarter conference call. Joining me today here in Irvine are Don Murray, our Executive Chairman, and our senior leadership team of Nate Franke, Kate Duchene, Tony Cherbak, and Karen Ferguson.

Let me begin by giving you a brief snapshot of our second quarter operating results. Total revenues for the second quarter of fiscal 2009 were $190.2 million, down 7.9% over the second quarter a year ago.

Net earnings were $9.5 million, or $0.32 per share, compared to $0.27 per share that we reported a year ago this quarter.

Our second quarter revenues came in approximately 3.5% below what our computed run rate was for the first four weeks of the quarter. But despite the high level of turmoil and uncertainty in the global economy, our average weekly client service hours, excluding the holiday weeks, were relatively consistent throughout the quarter.

However, within the quarter we experienced significant movements in foreign currency exchange rates which caused us to lose approximately $3.3 million in revenue from early in the second quarter through the end of the quarter as the U.S. dollar strengthened dramatically against a host of foreign currencies, most notably for us, the Euro and the pound.

Second quarter gross margin increased 50 basis points to 39% and that compares to 38.5% a year ago, which was flat sequentially with last quarter.

Aggregate SG&A dollars decreased 3.7%, primarily the result of exchange rate differences from the first quarter. Nate will provide more detail on our second quarter financial results later in the call.

As many companies struggle to find financing in a difficult credit market, Resources continues to generate cash based on the strength of our business model. Our business model, as you know, suggests that 70% of our cash costs are variable and that is self-regulatory and as our cost of revenue decreases our revenue levels become less volatile.

The variable nature of our business model dramatically decreases our risk profile. Through the first half of fiscal 2009 we have generated approximately $31.0 million in cash from operations and ended our second quarter with approximately $134.0 million in cash and investments and no debt.

Our ability to generate cash allows us to be opportunistic in returning cash to shareholders or taking advantage of attractive investment opportunities as they present themselves in the global market.

Business today for Resources is definitely more difficult than it was 12 to 18 months ago and it is obviously testing the strength of our business model as well as the resolve of our people. We are quite confident that we will pass these tests successfully.

As I have communicated to our people all over the world, extraordinary times require extraordinary effort. Everyone at Resources is working harder today to develop business and take advantage of every revenue opportunity that presents itself while at the same time working efficiently to control discretionary costs.

These efforts are reflected in our current operating results and will also serve to make us a much stronger company as we emerge from this phase of the current economic cycle. We will continue to stay focused on what we can control and not be distracted by extraordinary events in the capital markets.

And I would also like to take this opportunity to discuss with you some very recent organizational changes within Resources. These changes to our senior leadership team are not revolutionary by any means, but rather are designed to support the evolution of our enterprise in accordance with our long-term growth strategies and the execution of our unique value proposition, which is the foundation of our competitive advantage in the market place.

Given the high levels of uncertainty in the markets these days, I will mention that these changes all involve very straight-forward modifications to the accountabilities of the existing senior leadership of the company and in no way signals any significant restructuring or discontinuity of leadership at Resources.

First, Karen Ferguson will take on a new challenge as Executive Vice President and Chief Strategy Officer for Resources, reporting to me. In this role Karen will be focusing most of her time leading growth initiatives and assessing market opportunities for the company globally.

In connection with Karen moving to this new role, I will take direct accountability for operations in North America and accordingly the North American Regional Managing Directors will report to me.

Separately, as my recent travels visiting our operations around the world have reinforced, we are very well positioned to take advantage of growth opportunities in markets outside of North America. In order to provide appropriate management focus on these reasons, I have asked Tony Cherbak to accept the role of President, International Operations. In this capacity Tony will shift a significant amount of his focus to leading our international practices on a day-to-day basis.

And finally, consistent with our ongoing strategy to serve large, multi-national companies as growing clients of Resources, we have formed a strategic accounts team that will advance this important growth element of our strategy, led by Tom Schember.

I believe these changes will provide the right leadership support of our growth agenda globally and maintain focus and results in three important areas of our company’s activities, which are core to our success.

One, continued flawless execution of Resources practice fundamentals of our clients around the world; two, proactive and comprehensive account management of new and existing multi-national companies to support their global initiatives; and three, continued development of strategic initiatives including acquisitions and internal capabilities to deliver incremental growth.

With that I will turn it over to Nate for a detailed review of our financial results.

Nathan W. Franke

As mentioned, revenues for the quarter were $190.2 million, a 7.9% decrease from $206.6 million in the comparable quarter a year ago.

On a sequential basis, second quarter revenue declined 8.2% from $207.3 million in the first quarter of fiscal 2009. Approximately 40% of the sequential percentage decrease relates to foreign currency exchange rate changes.

While Tony will discuss our international operations in greater depth, let me discuss some highlights of our revenues geographically.

For the second quarter, revenues in the U.S. were $134.4 million, a decrease of 11% quarter-over-quarter. On a sequential basis, U.S. revenue decreased 8%.

For the second quarter, total revenues internationally of $55.9 million were approximately even with $55.6 million in the quarter a year ago and on a sequential basis international revenues decreased 8.6%. International revenue accounted for 29% of total revenues for the quarter versus 30% last quarter.

Europe’s second quarter revenues were flat quarter-over-quarter while the Asia Pacific region saw second quarter revenues up 2% quarter-over-quarter.

As you are aware, during the second quarter of 2009 the U.S. dollar strengthened against several foreign currencies. As Tom mentioned, based upon exchange rates from the first few weeks of second quarter, our second quarter revenues were reduced by $3.3 million.

Additionally, on a quarter-over-quarter basis the U.S. dollar strengthened against most of the currencies of our foreign locations and as a result, international revenues would have been higher by about $4.0 million in the second quarter using comparable fiscal 2008 conversion rates.

On a constant currency basis, and excluding acquired business revenue in the quarter, international revenue was essentially flat quarter-over-quarter, a gratifying result in the current environment which should not be overlooked.

Let me now discuss revenue trends for the third quarter of fiscal 2009. Weekly revenues for the first four weeks of the third quarter were $14.4 million, $14.1 million, $13.8 million, and $6.3 million, the latter of which includes the Christmas holiday period. While we are still compiling revenue data from last week, using the average of the most recent non-holiday weekly run rates over the remaining weeks of the first quarter, and adjusting for New Year’s and certain other holidays, we would achiever third quarter revenues of approximately $167.0 million.

Consistent with our historical practice and the operating philosophy of Resources, this computation is purely mathematical and does not consider increases or decreases and weekly run rates over the balance of the quarter, exchange rate changes, or other factors. As you also know, it is in no way reflective of any formalized budget or forecast.

Now, let me discuss gross margins. Gross margin for the second quarter was 39%, compared to 38.5% a year ago, a 50 basis point improvement. Excluding reimbursable expenses, our second quarter gross margin was 39.9%, which compares to 39.3% in the second quarter a year ago. The quarter-over-quarter improvement stems primarily from continued improvement and bill versus pay ratio.

The average billing rate for the second quarter was approximately $131 and represents a 1.3% increase from approximately $129 a year ago. The average pay rate for the second quarter was approximately $67, which represents a 1% increase from $66 a year ago.

On a sequential basis our second quarter gross margin was flat with the 39% experienced in the first quarter of fiscal 2009. Gross margin in the United States was 40.1% and our international gross margin was 36.2%.

In thinking about the third quarter of fiscal 2009, it is important to remember that we have historically experienced an approximate 150 basis point decrease in gross margin as a result of the winter holidays and the resetting of certain statutory payroll taxes at the beginning of the calendar year.

Now to headcount, for the second quarter average consultant FTE count was 2,938. This compares to 3,087 in the previous quarter and 3,234 in the year-ago quarter. Quarter end consultant headcount was 2,854 versus 3,319 a year ago. The total headcount of the company was 3,041 at quarter end.

Now to the other components of our second quarter financial results, total selling, general, and administrative expenses, including stock compensation for the second quarter were $54.4 million, or 28.6% of revenue compared to $55.5 million, or 26.9% in the second quarter of fiscal 2008. SG&A was $56.5 million, or 27.3% of revenue in the first quarter of fiscal 2009. The sequential improvement in SG&A primarily stems from foreign exchange rate changes.

As a percentage of revenue our SG&A expense leverage was less than that achieved during the first quarter of fiscal 2009, primarily due to the lower revenue base in the second quarter.

Stock compensation expense was $4.6 million, or 2.4% of total revenue versus $5.3 million, or 2.6% of total revenue in the second quarter of fiscal 2008.

While we continue to focus on our SG&A spending, excluding the impact of exchange rate changes, we would anticipate SG&A expenses to be relatively consistent with our second quarter of fiscal 2009 in the upcoming third quarter.

At the end of the second quarter our office count remains at 89, 56 domestic and 33 international.

Depreciation and amortization was $2.5 million for the quarter, up about $450,000 over last year’s second quarter, as the result of our increased asset base. Based upon our current asset base, we would expect similar levels of depreciation and amortization expense in the upcoming quarters.

Interest income decreased by about $1.2 million to $380,000 in the second quarter versus $1.6 million a year ago. Interest income decreased due to lower average interest rates earned on our invested cash in the second quarter of fiscal 2009.

Our adjusted EBITDA, or cash flow margin, which we define as EBITDA before stock comp expense, was 12.8% in the second quarter compared to 14.2% a year ago and to 14.1% in the first quarter of fiscal 2009.

Earnings for the quarter, including stock compensation expense, was $9.5 million, or $0.21 on a diluted per share basis versus $13.0 million, or $0.27 per share a year ago.

In the second quarter the non-cash pre-tax charge for stock compensation was $0.08 per share versus $0.09 per share in the comparable quarter a year ago.

As we have discussed previously, the cash treatment of our incentive stock options under FASB 123(NYSE:R) will likely cause continued volatility in our GAAP tax expense. During our second quarter we experienced a decrease in the number of ISOs exercised, thereby decreasing the tax benefit related to ISOs for which we reported compensation expense of $1.9 million. As a result, our GAAP tax rate was 46.1% for the quarter versus 44.8% in the comparable quarter a year ago.

On a cash basis we will get a real tax deduction for all ISOs when they are exercised and ultimately sold. Our tax rate before the impact of stock comp expense was approximately 40.5% for the second quarter.

Now let me turn to our balance sheet. Cash and investments at the end of the second quarter were about $134.0 million, a $27.0 million increase from the end of fiscal 2008. During the first six months of fiscal 2009 we have generated approximately $31.0 million in cash flow from operations.

We purchased 392,000 shares of our stock for approximately $6.3 million at an average price of $16.04. Our current Board authorization for our stock buy-back program has approximately $41.6 million remaining. Throughout the balance of fiscal 2009 we will continue to assess additional share repurchases in connection with the other capital requirements of growing our business.

Our shares outstanding at the end of the second quarter were approximately 44.9 million.

Receivables at quarter end were $103.0 million, down by about $14.0 million from the previous quarter. Days of revenue outstanding were approximately 48 days, down three days from the prior year’s comparable quarter and one day lower than the first quarter of fiscal 2009.

Now let me turn the call over to Tony for some additional commentary.

Anthony Cherbak

I would like to take a moment to provide a bit more detail on our international operations. Total revenues for the Netherlands practice in Q2, excluding Dominica, were $16.9 million, down 13% quarter-over-quarter. U.K. revenues were down 31% quarter-over-quarter. Approximately one half of these percentage decreases were attributable to foreign currency changes as the dollar strengthened against the pound and the Euro. Dominica’s revenues during the second quarter were $4.7 million.

Despite the economic issues impacting some of our practices in Europe, we continue to see encouraging signs from our north regions as well as our offices in France, Italy, and Germany.

In November we acquired [Copen and Smusen], a small human resource consulting business located in Sweden. This acquisition adds a much expanded portfolio of human capital services towards Swedish practice and presents cross-selling opportunities for all practice areas within our collective Swedish client base. We paid approximately $1.3 million for this company, with additional consideration payable upon the achievement of certain future operating results. [Copen and Smusen] currently has annual revenues of approximately $3.0 million.

In Asia we continue to be encouraged by the progress we are making in Japan through our offices in Tokyo and Nagoya. We are also committed to growing our newer practices in China through our offices in Hong Kong, Beijing, and Shanghai, where we see significant opportunities with both our multi-national clients as well as domestic enterprises.

Let me talk for a moment now about our clients. In fiscal 2008 we had 340 clients for whom we provided services exceeding $500,000 in fees. Through the end of our second quarter, on a run rate basis, we served the same number of clients at this level as of the end of the second quarter a year ago.

Revenues from our top 50 clients represented 36% of total revenues, while 50% of our revenues came from 113 clients. This is consistent with our past experience and validates our strategy to target large companies with whom we can develop sustainable and repeatable client relationships.

Our business with financial services companies decreased 13.5% quarter-over-quarter. While demand from these clients has decreased from a year ago, we continue to enjoy significant client relationships in the financial services sectors, ten of which exceeded $1.0 million in revenue for the quarter. Our largest client for the quarter was approximately 3% of revenues.

Client continuity continues to be solid. Through our second quarter we served all our top 50 clients from fiscal year 2008 and fiscal year 2007. Our loyal client following is reflective of our client service approach and our basic principle of always doing the right thing for our clients.

Through the second quarter 48 of our top 50 clients have used more than one service line and 80% of those top 50 clients have used three or more service lines. This service line penetration reflects the diversity of relationships we have within our clients’ organizations.

I would like to turn the call back to Tom for some closing remarks.

Thomas D. Christopoul

That concludes our remarks that are prepared and we are happy to answer your questions at this time.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kevin McVeigh - Credit Suisse.

Kevin McVeigh - Credit Suisse

On the revenue guidance, assuming $167.0 million, I would be interested in your thoughts on the SG&A just from a travel perspective. Obviously there is a pretty significant run off in revenue. Why the flat SG&A? Are there levers you could pull? It sounds like you are obviously going to keep the office footprint intact at this point. But your thoughts around SG&A would be helpful.

Nathan W. Franke

As we mentioned earlier in the call and as we mentioned last quarter, approximately two-thirds of our SG&A is the people costs that make up our offices. And then another 10% or so is the actual office footprint, the real estate costs, and related costs to that.

So, I think what we have to remember is when you look at that revenue run off, a big portion of that is the two weeks in Christmas and in New Year’s where we basically lose probably a little over a full week in revenue. We are always looking at SG&A and that is something that has continued focus, but we are not at the point where we are making drastic cuts or significant headcount reductions, which is ultimately where any significant SG&A dollars would come from, based on the components of our SG&A.

Clearly, we continue to monitor discretionary spend wherever it exists. But keep in mind that revenue run off is something that is related obviously to the holiday weeks here.

Kevin McVeigh - Credit Suisse

Have you seen any pick up in work around bankruptcy at this point or is that still in the relatively early stages?

Thomas D. Christopoul

For us, it’s still in the early stages. But there is no question that we are seeing lots of work coming to us. And I would call it in the category of just generally distressed activities. Some of that is in the form of bankruptcy and restructuring inquiries that we have gotten. Some of it is related to, as we have said in past quarters, the restructuring work that has been going on, as an example, in the financial services sector, for several months now. That has turned into opportunity for us.

We have seen that in the money center cities where the disproportionate impact has been felt. So we are starting to see that. The conversion of that is a much less predictable type of work than the progressive change that we typically see in an up market, but I would say it’s more than just a trickle at this point and we’re involved in those conversations.

I would add, perhaps not in the category of distressed opportunities, but certainly consistent with what we see in the market place. We are also responding to requests and presenting our business model to organizations who are taking advantage of the TARP program that the federal government has promulgated and we think that is probably going to continue.

Although, again, how those opportunities convert and the rate at which they convert, is a much less, let’s call it visible, type of activity than we would typically see in a normal environment.

Kevin McVeigh - Credit Suisse

Nate, a tax rate for the third quarter? I know it’s difficult given the volatility in share price but do you have a range you can give us?

Nathan W. Franke

I think a lot obviously is going to depend on, where it all depends is the number of ISOs that are exercised. And if you just look at the share price during the second quarter, to the extent the share price stayed the same, I think you would probably see a roughly equivalent tax rate to what we experienced in the second quarter.

Again, on a cash basis, that 40.5% we expect to remain fairly consistent.

Operator

Your next question comes from James Janesky - Stifel Nicolaus & Company.

James Janesky - Stifel Nicolaus & Company

When you look at the, first of all, the fourth week being down more than about 50% versus the third week of the quarter, last year when you reported you only had given us the outlook for the first three weeks because it was earlier on the report date. Is this the order of magnitude that you generally see from the third week to the fourth week of the third fiscal quarter?

Nathan W. Franke

Yes, it’s consistent with the week that Christmas falls on.

James Janesky - Stifel Nicolaus & Company

But taking that into account, you still expect revenues to be down somewhere around 18% to 20%. Could you talk a little bit around what your clients are telling you now? Are folks more or less just frozen in terms of pulling the trigger on using outside professional services? And if you could also just kind of add to that, have your clients given you any indication for the upcoming audit season? Do you feel that they will be turning to you as much as they had in the past or are they going to focus more on using internal resources?

Thomas D. Christopoul

I don’t think we indicated that our revenues are going to be down 18% to 20% and if that is your take away, based on the computation, we will just remind you what we always do, which is that with a reasonable question to ask as to how the beginning of the current quarter looks, so what we do is we report the facts. But I wouldn’t tell you that is either a trend or reliable in terms of a forecast. And any number of factors could change the weekly revenue in our business, as it ordinarily does.

But responding to your question, which is an important one, on clients pulling the trigger, yeah, absolutely, we are continuing to see what we have been seeing over the last at least 60 days, as especially as the calendar year has turned, a significant contraction of capital spending in business across the country and across most segments of commerce in the country.

Again, that reduces visibility for us. It may reduce immediate opportunity but it doesn’t necessarily reduce opportunity within clients or with clients that we haven’t worked with yet.

And your second point, actually I think is a compelling one, and that’s ultimately the value proposition that we are talking about with our clients multiple times a day, every day, around the world, and that is that the value proposition of resources compared and contracted to, as an example a Big Four type of engagement resource is a compelling one and we expect that our clients will continue to see value in that differential. All of that wrapped up in a package, they will like put the bow on it, that uncertainty.

Uncertainty seems to be the order of the day and lots of clients, as you have probably read, not only in the paper everyday but at the close of market every day, lots of contraction and lots of infrastructure cutting, ahead of what many of our clients expect to be a contracted revenue environment for some period of time.

James Janesky - Stifel Nicolaus & Company

Stock buy-back, what are your thoughts at the current levels?

Nathan W. Franke

As I mentioned in the prepared remarks, I think it is something that we would continue throughout the year. We would continue to try to be opportunistic but I think we feel we have the capital structure that would continue to allow us to be in the market, obviously on a judicious basis.

Operator

Your next question comes from Andrew Steinerman - J.P. Morgan.

Andrew Steinerman - J.P. Morgan

You mentioned what a typical gross margin decline is in a third quarter versus a second quarter. I think you said 150 basis points and you gave the reason why. Are we in a typical environment? And if you could, just go through gross margins in the quarter again. I know you gave bill rate, pay rate. You did a great job in managing that in the second quarter. Do you think those strong management capabilities could continue into the third quarter?

Nathan W. Franke

You have a couple of questions embedded in there. The gross margin in the second quarter was 39% and that was basically consistent with the gross margin in the first quarter. Now, when we look at the third quarter, what has tended to happen over prior years and it’s because of the number of holidays that occur in the quarter, despite our efforts that I think we have proven out of really being able to hit our target gross margin, we do hit periods where we have the number of holidays that tends to reduce leverage to a certain extent and therefore has historically diluted that gross margin up that 150 basis points that I gave.

But I think going back, just in terms of that typical bill versus pay rate spread, again, that is something our 89 offices continue to be very focused on, pricing new engagement. We feel that target gross margin is a very fair one and it remains competitive in the market place.

Thomas D. Christopoul

If I got the essence of your question, while I would never characterize this environment as anything like normal, we would expect that same level of impact in sequential gross margin, barring any other management actions that we took. And that’s something we have been managing closely. You will continue to see us manage closely and you will continue to see the results of that.

So I believe the final part of your question is, yes, we expect to be able to maintain that management focus on those levers in the business. If we see continued pressure or if there is additional pressure, let’s call it incremental pressure, on bill rates, we will be responsive to that and do the appropriate things with respect to pay rates.

But right now, I wouldn’t say that, in spite of the environment, that we’re planning for that or we’re seeing disproportionate pressure, understanding that every day in this market is basically the rules being re-written again.

Andrew Steinerman - J.P. Morgan

So it sounds like you are trying to target 37.5%, if I was going to pick a number in the quarter, but what I’m surprised you didn’t say, I mean, I remember part of your gross margin had some fixed costs in it and on a lower revenue base I thought there would be some deleveraging. I don’t remember exactly what they are but I do remember in some quarters citing revenue getting tied to gross margins.

Nathan W. Franke

I think what you might be referring to is turning the clocks back probably a little bit over a year was the gross margin clawing back some of the extra vacation that was given. And then there is clearly, again, part of it is, as you said, given the holiday pay where our consultants are given holiday pay where you have no revenue and you have associated benefits as well, like the health care.

But I think that, again, if you just look at the historical basis, that that is the basis for that 150 basis points.

Andrew Steinerman - J.P. Morgan

But I’m just saying, if you have that holiday pay, if you have those types of costs, you end up with a lower revenue base, it could be a bigger than normal drag.

Nathan W. Franke

Again, all we’re giving you is not necessarily a forecast, we’re kind of stating that historically we have experienced an approximate 150 basis points decrease.

Thomas D. Christopoul

If you recall from last year same time frame, we gave you the same historical information and we were able to do a little bit better than that. So again, as Nate said, it is just what we have seen on a historical basis.

Operator

Your next question comes from Paul Ginocchio - Deutsche Bank Securities.

Paul Ginocchio - Deutsche Bank Securities

Could you give me quarter end corporate headcount? And then, it doesn’t look like the bill pay rate spread helped your gross margins. I’m wondering where that 50 basis points came from? Was it lower reimbursements from percent of revenues?

Nathan W. Franke

The total headcount at the end of the quarter was 3,741. Tom said I might have mis-stated that during the prepared remarks. That was the total headcount.

As to the second part of your question, number one, those bill and pay rate numbers are rounded so the biggest component is that. That really is the biggest component. The rest, when we look at it is pretty inconsequential stuff. Because what we give as the bill and pay rate are the rounded numbers.

Paul Ginocchio - Deutsche Bank Securities

So you did get it from that spread?

Nathan W. Franke

There is just under 50 basis points from that.

Operator

Your next question comes from Gary Bisbee - Barclays Capital.

Gary Bisbee - Barclays Capital

Let me start on the SG&A. It sounds like you are obviously being careful of costs and you’ve slowed up office openings but it also sounds like, given the guidance, you’re not looking to take a real aggressive knife to the amount of overhead. If we are in a situation here where revenues continue to deteriorate for several quarters, how aggressively are you going to look to cut SG&A and I guess I’m sort of curious that you haven’t done it yet, so what would trigger you to do it? Or are you more likely just to say we’re building for the long term and leave the SG&A base relatively untouched, even if we have several more weak revenue quarters.

Thomas D. Christopoul

So you’re asking a hypothetical question, right?

Gary Bisbee - Barclays Capital

Yes.

Thomas D. Christopoul

I just wanted to be clear. Because I would tell you that we are managing costs as closely as you would expect us to in this environment and your analogy of a knife is a good one, and the reason I say it is a good one is because at the moment it doesn’t appear necessary to us to consider taking costs out with that kind of an instrument.

Now, on the other hand, we have to respect the environment that we’re in and we feel like we’re doing that. We are not taking what I would call disproportionate actions. Your hypothetical question is one that we think about. The reality is that we believe what we say on the call and we believe what our value proposition is in the market place. And what we have seen, although clearly a revenue deceleration in the business is not surprising, but also what isn’t surprising is that we’ve been able very, very quickly, as this market has changed significantly, to shift our work from what we call progressive change to regressive change, very, very appropriately and that is important to understand, because that is the selling proposition that goes on in the office.

And really that’s the reason why we wouldn’t be motivated, at least at this point, to go and take any assertive, or overly aggressive I should say, action with respect to our costs. Our business model allows us the luxury of doing the right thing for the business, long term, by both investing in it as well as giving us a pretty clear connection and coupling of our variable costs to our variable revenue.

Having said that, I don’t know what 2009 holds. We’re not economists. But we’re not contemplating a robust economy anywhere in the future so it’s something that we look at pretty much on a daily basis.

Gary Bisbee - Barclays Capital

I appreciate how you’re coming at this thing hypothetical, but I would point out that while it’s not guidance, the $167.0 million is an 18% year-over-year drop relative to 8% this quarter. So I would argue unless things change wildly, we’re in that environment, where it’s happening. But I appreciate the color.

Can you give us any sense, it sounded like things overall, ex the currency, actually were still hanging in there pretty well in international and maybe more so in Europe than I would have guessed. Does part of that run rate we’re seeing through the first month of the third quarter include a bigger fall-off in Europe, given all the data we’ve seen over there? Is that an appropriate thing to think is included in that?

Anthony Cherbak

I think we mentioned, related to Europe, we did see a little bit of a decrease in our practices in the Netherlands and also in the U.K. Obviously a very tough economic situation in the U.K., like we’re experiencing in the U.S.

But that was offset to some degree by pretty good performances in France, the Nordic states, good revenue growth in some our newer practices in Italy and Germany. So all in all, on a trend-line basis, Europe would probably be down a little bit in the third quarter but it depends on the pocket of offices that you’re looking at relative to specific performance.

Gary Bisbee - Barclays Capital

Is it right to say that you haven’t seen too many projects get cancelled at this point? There just continues to be what you talked about last quarter, sort of a hesitation?

Anthony Cherbak

You’ve got a couple of different things at play and when we look at practices, and this is both the U.S. and in Europe, some of the newer projects that we are seeing could possibly be a little bit shorter in duration. Clients are looking at things more with fixed budgets. Again, as Tom said, very cautionary spending, capex budgets being monitored more significantly than they have in the past.

It’s been taking clients a little bit longer to make decisions. Some projects are being deferred when possible. Some anticipated projects, that otherwise would have occurred, are being cancelled.

However, that is offset by some instances in which we have companies realizing that they have made pretty deep cuts in their organization and they don’t have the resources to now help with the year-end close and are getting us back involved.

So again, it’s a little bit of a mixed bag. As we mentioned last quarter, it’s going to take a little while for clients to sort out this new economy but we will be there when they are ready.

Thomas D. Christopoul

I would say avoid, as we do, the trap of thinking about this as a binary management lever, meaning you can control costs or you can’t, you can cut heads or you hire, right? We should not leave you with the impression that we are ignoring the environment, we are being very, very cautious and we are sharpening our pencils, as you would expect us to.

But looking back to the example of the financial services client that I addressed earlier who called us about a week and a half ago, and in connection with the massive lay-off that happened at this particular client, they were looking for between eight and ten of our consultants to come in and help them do some audit and book-closing work.

That is exactly the type of call that we are prepared to take. And to the extent that there is nobody in the office to take that call, that’s a bad outcome for us, it’s a bad outcome for our shareholders, and it’s a bad outcome for our clients.

Operator

Your next question comes from Mark Marcon - Robert W. Baird & Co.

Mark Marcon - Robert W. Baird & Co.

Could you talk a little bit about the bill rates and how you think they’re going to trend? I was noticing the change relative to last quarter. Is there anything that is occurring from a geographic perspective that is impacting the mix? Or how should we think about that?

Anthony Cherbak

A couple of comments. Number one, keep in mind that the bill rate, quarter-to-quarter, related to the international piece, is affected by the currency exchange rates. As we have pointed out in the past, we have that natural hedge while we lose revenues our expenses are typically in the local currency. So we did not go through and recomputed bill rates on a constant currency basis but if you look at it on a sequential basis, clearly the bill rates were impacted by currency.

As I mentioned earlier in response to a question, we remain very focuses on achieving our gross margin target and I think Tom had mentioned that obviously there is what you might call some pricing pressure out there in certain clients.

That said, what we continue to find is that our rates are very competitive versus the competition we see out there, which are the other professional services firms. And again, because of our variable model, and this is really the third attribute, on any new project we are able to kind of renegotiate pay rates.

So when you look at all of those pieces, it really has enabled us to maintain that gross margin despite what I think we would share as a very difficult last three months.

Mark Marcon - Robert W. Baird & Co.

You have absolutely done a great job maintaining the margins, given the environment. I was just trying to get a little bit of a sense. It sounds like it is primarily FX.

Anthony Cherbak

And again, you can do the FX every which way but sideways but that’s a huge chunk of the impact this quarter.

Mark Marcon - Robert W. Baird & Co.

Can you talk a little bit about the consultants and how you’re managing the relationships with them during this period in terms of if somebody comes off an assignment and there isn’t something for them to do immediately, how do you keep them in the loop?

Thomas D. Christopoul

There are two pistons, as you know, in the resources engine. There’s the client services piston and the recruiting piston. And in an environment like this, where as you would expect, there is not a ton of recruiting activity, or there is not a disproportionate amount of recruiting activity, because there still is much recruiting activity around the enterprise, it’s that part of the engine that really maintains the relationship with the client.

And in our model we do our level best to ensure that that consultant is helping us help them by exploiting business opportunities with relationships that they have at other places that they may have worked or at other clients that they may have worked with us for. So it’s really that side of the organization that continues to keep the continuity with the consultant base.

And that has been very typical of our model and how it has operated through cycles in the past and one of the things that obviously we like about it in both, as I like to call it, a rising tide and a receding tide environment.

Mark Marcon - Robert W. Baird & Co.

Is it your sense that the consultant engagement is remaining fairly healthy? Is there a length of time under which if this downturn, which is global in nature, continues to a certain point where some of the consultants might get a little bit insecure and decide to go for something on a permanent basis?

Thomas D. Christopoul

Sure. In this environment anybody in that position would feel that that’s a rational response. Now, the reality is those opportunities don’t seem to be available in the market place so there is sort of a natural hedge against the risk. We’re not particularly pleased that that is case but it is what it is. If the environment were different I would be more worried.

Again, you have to remember, our consultants are not the kind of individuals who are going to be compelled to go to work typically at one of our traditional competitors if that work was available. So in this environment, we do our best to ensure that they are maximally, let’s call it marketed, to our clients or to clients that we worked with in the past, or we haven’t worked with thus far.

But I would be remiss if I didn’t say it was a challenge and that the current environment was testing our model. That would be irrational for me to say so. But I feel like we have done a pretty good job managing it and I feel confident that we will continue to manage it in the future. And we, like everyone else, feel like the right way to get through this is not to shrink our way, as I say it, through prosperity but to grow it to the extent that we can in a very uncertain environment.

Mark Marcon - Robert W. Baird & Co.

And there are probably some new associates or new consultants who are approaching you that haven’t worked with you in the past, I would imagine, as well.

Thomas D. Christopoul

Sure. Absolutely. On the balance this is a robust recruiting environment.

Mark Marcon - Robert W. Baird & Co.

Can you talk a little bit about the management responsibility changes and how we should, as investors, think about what the goals of the changes are and how that will change the client interface? In particular, I am curious about the heading of the account management and how that would interface, geographically. Would an account manager who is in charge of a global account drive the sales engine and then Tony would work on an operational basis internationally? How does that all fit?

Thomas D. Christopoul

I’ll just give you some color here. To me, this is a realignment of resources, no pun intended, that is pretty consistent with how we already manage our business and so I look at it as a realignment in that regard.

The offices are still managed the way they were before. There is a managing director structure. There is a regional manager structure and then there is an executive structure. That hasn’t changed. And the development of the client, or what we call our business development functionality, is also not new. It has been in place since inception of the company, it just requires at this point what we believe is a bit more focused management. And this is Tom Schember’s organization.

So as you can imagine, a client’s request to field, I’m going to make up the numbers, 26 consultants in six different countries in 14 different offices, requires a fair amount of coordination. We have always coordinated that type of work in the past. What we’re saying through the development of this structure is that we are going to respond to the growth in that type of business because a) it’s been growing and b) we expect it to grow that way.

Meaning, we expect to grow our global client base over time and we expect that global client base to require additional coordination as we put more consultants in more of their locations around the world.

Naturally, the functionality of that group, and it’s the development of those clients and the tending to those clients, as they become large and more global and complex, that is really a supplemental function to the management of the operations of the company, which have neither changed in structure nor tenor nor scope.

Really, the leverage, then, international, is one I was seeking based, candidly, on my visits around the world as I’ve gone to most of our locations outside of North America. I’ve noticed two things. One, as I’ve said before on this call, there is no question that this contraction is global, and two, there remains huge amounts of opportunity for us outside of North America and so we would like to develop that business with more management focus and the idea here was to leverage Tony, not only over his existing accountabilities, but to really focus on developing large global clients, who happened to be domiciled outside of the United States.

And the way I think about this company developing over time, is having those large global accounts that, not only U.S. domiciled-companies but companies that are domiciled in Asia and Europe who happen to have operations elsewhere. So that’s really the thought process there.

The thought process with the strategy group is really being a little bit more, in my opinion, let’s call it direct and focused on the development of particular capabilities around our practice areas, around opportunities in the market place that I’ve discussed earlier, such as compliance. And then specific focuses on certain industry groups or categories, like health care, aerospace, financial services, technology, entertainment.

As we become a more mature, global enterprise, this is an appropriate, it seems to me, focus of our management team. So no change in the individuals. You know them all, they are the same people. Slight changes in accountability but certainly no changes to the model and no signal at all that we are changing our view of how we should grow or our fundamental approach to the business or the model that we have come to rely on and are very thankful we have.

Mark Marcon - Robert W. Baird & Co.

Can you give a little color on the practice areas? How did the [inaudible] side do, how did RAS do, how are things looking [inaudible] management, etc.

Anthony Cherbak

Sure. Just to give you a little color on RAS, RAS was down 23% quarter-over-quarter, or about 17% sequentially. For the second quarter it made up approximately 13% of our revenue. I would say that the other service lines, supply chain management, obviously in this environment, continues to be a pretty in-demand practice area, just because it involves helping companies take costs out of their business.

Finance and accounting still our number one core competency and continues to do quite well. If you took RAS out of the mix relative to the other practice areas, the other practice areas in aggregate would have been down about 5% compared to the 8% overall decline in revenues.

Operator

Your next question comes from Scott Schneeberger - Oppenheimer & Co.

Scott Schneeberger - Oppenheimer & Co.

You mentioned last quarter in conversations with executives at financial services companies that they, and obviously a lot had happened at that time and a lot has happened since, but they had said stand by, stand by, we have a lot coming. Just curious, how open is your dialogue with them right now? Do you see anything coming down the pike or is it very paralyzed at the moment?

Thomas D. Christopoul

I describe it as the same to similar. Still having the discussions, still expecting. I gave the example of one that ultimately turned into an assignment. We continue to monitor that on a, if not daily, hourly basis in those places. And as I say, it will take some time for these changes to cycle through. Once an organization lets go a significant amount of their infrastructure, there is a period of time that the remaining individuals in that organization adapt then the work that is not getting done demonstrates itself and then presumably we have an opportunity to go in and help them accomplish that.

Scott Schneeberger - Oppenheimer & Co.

On a different subject, after we were on the use of cash, had made some share repurchases and are still open to that over the balance of the year, what’s the acquisition appetite right now and geographically could you discuss how you are thinking about that as well?

Thomas D. Christopoul

Well, the world is our oyster. We think that there are opportunities. Tony addressed two small ones that we’ve made, outside the United States. We don’t have a specific disproportionate view that we need to do deals one way or the other, one place of the other. I wouldn’t say that we have increased our appetite or we decreased our appetite. We’ve been very, very circumspect in our approach to acquisitions and that’s what you should continue to expect from us.

On the other hand, because of what’s happened in the market place, there are probably more opportunities for us to look and we are going to continue to look and see what makes sense to us, both strategically and geographically. But there is no strategy in place here. As you know, we have been opportunistic and will continue to be that way.

Scott Schneeberger - Oppenheimer & Co.

And how cautious would you be around doing something large right now in this credit environment with the cash balance you have? Obviously being opportunistic but not too big a bit right now.

Thomas D. Christopoul

I wouldn’t expect us to take on any leverage to do any deals.

Scott Schneeberger - Oppenheimer & Co.

Updates on IFRS, anything regulatory you may see coming out of the new administration? Just kind of an open question on anything coming along that may be an opportunity for you?

Thomas D. Christopoul

My own view is that we could probably help the SEC do what they’re supposed to be doing, but that’s a different issue. I think the reality is we are expecting a more regulatory-intense environment. I have no predictions on that.

One thing that isn’t, we don’t think, really impacted by the current situation is the IFRS environment, significantly. We think that’s still coming. It’s not something that gets talked about a lot because it’s been pushed off of most people’s list, given the current environment in the news.

But on balance, we are expecting what most people are, which is a more intensely regulated environment and on balance we think that is better for us than worse.

Operator

Your next question is a follow-up from Paul Ginocchio - Deutsche Bank Securities.

Paul Ginocchio - Deutsche Bank Securities

Just looking at your quarter-end headcount, year-on-year, it’s down about 14%. Typically your associates would be off on the holidays, just wondering if you could give any indication about when companies have come back the last couple of days, when do you expect to know how the beginning of the year started out? Is it next week? Is it typically yesterday or two days ago that you would sort of find out and get a good feel for the beginning of the year?

Anthony Cherbak

We’ll know next week because it will be the first full week that everybody is back at work outside of the holidays. So next week will be a pretty good barometer for us.

Paul Ginocchio - Deutsche Bank Securities

Year-on-year your quarter-end headcount for your associates was down 14%. That’s sort of is not too far off the minus 18 that some people were talking about. So it seems like at least your associate count at the end of November sort of was suggesting what the $167.0 million number was also looking like. Do you think we should be looking at that?

Thomas D. Christopoul

As a leading indicator?

Paul Ginocchio - Deutsche Bank Securities

Yes.

Nathan W. Franke

Again, when you look at that $167.0 million it’s purely a mathematical computation and I would leave it to you to look at the different data points and obviously derive your models. I think we tried to give you a certain color and certain data points of what’s going into the business, but we really don’t, as we have historically not done, given forecasts or anything that would become trend-type information.

Thomas D. Christopoul

I think the way the business works, I wouldn’t call it necessarily a spurious calculation, I wouldn’t call it an indicative one, either.

Paul Ginocchio - Deutsche Bank Securities

Just looking at your international gross margin, I would have thought with branches starting to mature a little bit, do you think it’s possible to get that international gross margin up? It seems to be sort of stuck at the 36% level for the last few years.

Anthony Cherbak

That’s absolutely the goal. When we talk about some of the things we’re going to focus on on international, it’s going to be the basics of our practice. It’s going to be revenue growth, gross margin improvement, and operating margin improvement. So I think it’s absolutely possible and I think we’ve talked before, as our mix changes a little bit, more towards our Asian practice, our Asian practices generally have gross margins that are a little bit in excess of our U.S. practice, on Europe we have the opposite. So I think the big opportunity is to see what we can do with the European gross margin.

Operator

There are no further questions at this time.

Thomas D. Christopoul

Thanks for joining us. We look forward to talking to you at the conclusion of next quarter. Happy New Year.

Operator

This concludes today’s conference call.

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Source: Resources Connection, Inc. F2Q09 (Qtr End 11/29/08) Earnings Call Transcript
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