RESOURCES CONNECTION, INC. quarterly report, Q1 FY2013

Business context and reporting period

Resources Connection, Inc. is a multinational project-based professional services firm operating as Resources Global Professionals. This unaudited Form 10-Q covers the 13 weeks ended August 25, 2012 (fiscal 2013 first quarter); comparisons are with the 13 weeks ended August 27, 2011. Dollar amounts below are in millions unless noted.

Financial performance and liquidity

Gross margin improvement reflected a more favorable bill-rate/pay-rate ratio and lower zero-margin reimbursable expenses. The effective tax rate was approximately 50%, versus 62% a year earlier; the company cited jurisdictional losses without tax benefits and stock-option-related tax effects as drivers of rate variability.

At August 25, cash and cash equivalents were $112.9 and short-term investments were $10.0, or $122.9 combined. No funded debt is disclosed. The company had a $3.0 unsecured revolving facility expiring November 29, 2012; approximately $1.3 remained available after $1.7 of letters of credit, and the company intended to renew it. It reported compliance with facility covenants. Total liabilities were $61.8.

Investing activities provided $12.4, principally from net redemptions of short-term investments; capital expenditures were $0.6. Financing activities used $8.7, including $8.9 for repurchases of 764,700 shares and $2.1 of dividends paid. The quarterly dividend declared was $0.06 per share; approximately $2.5 was accrued at quarter-end and paid in September. About $97.8 remained under the $150 million repurchase authorization.

Material changes versus the prior comparable period

• Revenue was nearly flat overall, but performance diverged by region: North America increased 3.7% to $107.9; Europe declined 18.3% to $19.0; and Asia Pacific declined 6.5% to $10.0.
• Hours worked increased about 1.9%, while average bill rates declined about 2.3%, partly due to currency movements. The stronger U.S. dollar reduced reported international revenue; at prior-year exchange rates, Q1 FY2013 international revenue would have been about $2.7 higher.
• Direct cost of services fell to 61.0% of revenue from 62.2%. SG&A decreased 1.2% to $42.1, and administrative headcount fell to 675 from 720.
• Net income and EPS rose substantially despite slightly lower revenue, aided by improved service economics and lower amortization and depreciation. Weighted-average basic shares declined to 41.7 million from 45.2 million, in part reflecting repurchases.
• Cash from operations increased to $3.7 from $1.6. Cash and short-term investments together totaled $122.9 at quarter-end, versus $128.1 at the May 2012 year-end.

Outlook, commentary, risks and unusual items

The filing gives no formal revenue or earnings guidance. Management expected the direct-cost percentage to improve in Q2 as summer vacations ended and operating leverage recovered. It said existing cash and anticipated operating cash flows should cover working capital and capital expenditures for at least 12 months. Management cautioned that demand is difficult to forecast because clients generally do not sign long-term service contracts.

Management attributed international weakness particularly to continuing economic uncertainty in Europe and unfavorable currency movements. Sequentially, revenue declined 5.9% from Q4 FY2012; billable hours fell 4.2%, with seasonal vacations and foreign exchange cited as factors. The company does not hedge foreign-currency exposure; 23.4% of Q1 revenue was generated outside the U.S.

The Sitrick Brincko acquisition earn-out liability was zero at quarter-end. The company considered a payment in November 2013 more unlikely than likely, based in part on average EBITDA of $6.5 over the first two annual measurement periods, below the $11.3 threshold. Estimates depend on subjective future-performance assumptions and could change. Separately, a $2.25 contractual cash payment to Mr. Brincko may be due if no earn-out is paid, subject to his continued good standing; the filing says this amount is recognized as SG&A over the remaining service period.

Key risks include global economic weakness and lower demand, pricing and consultant-retention pressures, currency fluctuations, client credit and collection risks, quarterly seasonality, and possible impairment of goodwill. The company reported no material change in previously disclosed risk factors, no material legal proceedings, and no off-balance-sheet arrangements. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

• Whether North American growth can offset continued weakness in Europe and Asia Pacific, and how hours, bill rates and utilization evolve.
• The effect of foreign exchange on reported revenue, margins and cash, given the absence of hedging.
• Whether the expected Q2 service-cost leverage improvement materializes and how the unusually high, variable tax rate affects earnings.
• Renewal and terms of the $3.0 million credit facility before its November 2012 expiry, and the adequacy of liquidity for planned operations and capital allocation.
• Progress on the Sitrick Brincko earn-out assessment and accounting for the separate conditional $2.25 million payment.
• The sustainability of repurchases and dividends relative to operating cash generation and investment needs.