SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended February 29, 2004
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the transition period from to |
Commission File Number: 0-32113
RESOURCES CONNECTION, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE (State or Other Jurisdiction of Incorporation or Organization) | 33-0832424 (I.R.S. Employer Identification No.) |
695 TOWN CENTER DRIVE, SUITE 600, COSTA MESA, CALIFORNIA 92626
(Address of Principal Executive Offices and Zip Code)
(714) 430-6400
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
As of April 7, 2004, 23,122,248 shares of the registrant’s common stock, $0.01 par value per share, were outstanding.
RESOURCES CONNECTION, INC.
INDEX
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PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
| February 29, 2004 | May 31, 2003 | |||||||
| (unaudited) | ||||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 28,769,000 | $ | 48,078,000 | ||||
Trade accounts receivable, net of allowance for doubtful accounts of $3,636,000 and $2,388,000 as of February 29, 2004 and May 31, 2003, respectively | 55,705,000 | 26,635,000 | ||||||
Prepaid expenses and other current assets | 1,108,000 | 2,035,000 | ||||||
Prepaid income taxes | — | 1,774,000 | ||||||
Deferred income taxes | 2,596,000 | 2,596,000 | ||||||
Total current assets | 88,178,000 | 81,118,000 | ||||||
Investments in marketable securities | 19,000,000 | 20,000,000 | ||||||
Goodwill | 74,501,000 | 47,876,000 | ||||||
Intangible assets, net | 5,509,000 | 1,203,000 | ||||||
Property and equipment, net | 5,931,000 | 4,341,000 | ||||||
Other assets | 958,000 | 1,399,000 | ||||||
Total assets | $ | 194,077,000 | $ | 155,937,000 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable and accrued expenses | $ | 14,574,000 | $ | 2,784,000 | ||||
Accrued salaries and related obligations | 16,916,000 | 17,899,000 | ||||||
Other liabilities, including income taxes payable | 2,679,000 | 258,000 | ||||||
Total current liabilities | 34,169,000 | 20,941,000 | ||||||
Deferred income taxes | 1,465,000 | 1,465,000 | ||||||
Total liabilities | 35,634,000 | 22,406,000 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock, $0.01 par value, 5,000,000 shares authorized; zero shares issued and outstanding | ||||||||
Common stock, $0.01 par value, 35,000,000 shares authorized; 23,099,000 and 22,251,000 shares issued and outstanding as of February 29, 2004 and May 31, 2003, respectively | 231,000 | 222,000 | ||||||
Additional paid-in capital | 97,571,000 | 86,676,000 | ||||||
Deferred stock compensation | (238,000 | ) | (480,000 | ) | ||||
Accumulated other comprehensive gain | 702,000 | 293,000 | ||||||
Notes receivable from stockholders | — | (55,000 | ) | |||||
Retained earnings | 60,480,000 | 46,876,000 | ||||||
Treasury stock at cost, 154,000 and 141,000 shares at February 29, 2004 and May 31, 2003, respectively | (303,000 | ) | (1,000 | ) | ||||
Total stockholders’ equity | 158,443,000 | 133,531,000 | ||||||
Total liabilities and stockholders’ equity | $ | 194,077,000 | $ | 155,937,000 | ||||
The accompanying notes are an integral part of these financial statements.
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CONSOLIDATED STATEMENTS OF INCOME
| Three Months Ended | Nine Months Ended | |||||||||||
| February 29, 2004 | February 28, 2003 | February 29, 2004 | February 28, 2003 | |||||||||
| (unaudited) | (unaudited) | (unaudited) | (unaudited) | |||||||||
Revenue | $ | 87,758,000 | $ | 49,237,000 | $ | 221,315,000 | $ | 142,974,000 | ||||
Direct cost of services, primarily payroll and related taxes for professional services employees | 54,353,000 | 30,153,000 | 135,828,000 | 86,363,000 | ||||||||
Gross profit | 33,405,000 | 19,084,000 | 85,487,000 | 56,611,000 | ||||||||
Selling, general and administrative expenses | 22,724,000 | 14,170,000 | 60,424,000 | 41,714,000 | ||||||||
Amortization of intangible assets | 514,000 | 298,000 | 1,212,000 | 455,000 | ||||||||
Depreciation expense | 507,000 | 328,000 | 1,327,000 | 955,000 | ||||||||
Income from operations | 9,660,000 | 4,288,000 | 22,524,000 | 13,487,000 | ||||||||
Interest income | 147,000 | 231,000 | 422,000 | 839,000 | ||||||||
Income before provision for income taxes | 9,807,000 | 4,519,000 | 22,946,000 | 14,326,000 | ||||||||
Provision for income taxes | 4,021,000 | 1,853,000 | 9,342,000 | 5,873,000 | ||||||||
Net income | $ | 5,786,000 | $ | 2,666,000 | $ | 13,604,000 | $ | 8,453,000 | ||||
Net income per common share: | ||||||||||||
Basic | $ | 0.25 | $ | 0.12 | $ | 0.60 | $ | 0.39 | ||||
Diluted | $ | 0.24 | $ | 0.12 | $ | 0.57 | $ | 0.37 | ||||
Weighted average common shares outstanding: | ||||||||||||
Basic | 22,763,000 | 21,934,000 | 22,607,000 | 21,764,000 | ||||||||
Diluted | 24,140,000 | 22,969,000 | 23,850,000 | 22,808,000 | ||||||||
The accompanying notes are an integral part of these financial statements.
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| Nine Months Ended | ||||||||
| February 29, 2004 | February 28, 2003 | |||||||
| (unaudited) | (unaudited) | |||||||
COMMON STOCK—SHARES: | ||||||||
Balance at beginning of period | 22,251,000 | 21,661,000 | ||||||
Exercise of stock options | 778,000 | 275,000 | ||||||
Issuance of common stock for the acquisition of The Procurement Centre | — | 116,000 | ||||||
Issuance of common stock under Employee Stock Purchase Plan | 70,000 | 86,000 | ||||||
Balance at end of period | 23,099,000 | 22,138,000 | ||||||
COMMON STOCK—PAR VALUE: | ||||||||
Balance at beginning of period | $ | 222,000 | $ | 216,000 | ||||
Exercise of stock options | 9,000 | 3,000 | ||||||
Issuance of common stock for the acquisition of The Procurement Centre | — | 1,000 | ||||||
Issuance of common stock under Employee Stock Purchase Plan | — | 1,000 | ||||||
Balance at end of period | $ | 231,000 | $ | 221,000 | ||||
ADDITIONAL PAID-IN CAPITAL: | ||||||||
Balance at beginning of period | $ | 86,676,000 | $ | 79,991,000 | ||||
Exercise of stock options | 9,514,000 | 1,666,000 | ||||||
Issuance of common stock for the acquisition of The Procurement Centre | — | 1,503,000 | ||||||
Issuance of common stock under Employee Stock Purchase Plan | 1,395,000 | 1,800,000 | ||||||
Forfeiture of restricted stock and stock options | (14,000 | ) | (112,000 | ) | ||||
Balance at end of period | $ | 97,571,000 | $ | 84,848,000 | ||||
DEFERRED STOCK COMPENSATION: | ||||||||
Balance at beginning of period | $ | (480,000 | ) | $ | (909,000 | ) | ||
Forfeiture of restricted stock and stock options | 14,000 | 112,000 | ||||||
Amortization of deferred stock compensation | 228,000 | 239,000 | ||||||
Balance at end of period | $ | (238,000 | ) | $ | (558,000 | ) | ||
ACCUMULATED OTHER COMPREHENSIVE GAIN (LOSS): | ||||||||
Balance at beginning of period | $ | 293,000 | $ | (51,000 | ) | |||
Translation adjustments | 409,000 | 89,000 | ||||||
Balance at end of period | $ | 702,000 | $ | 38,000 | ||||
NOTES RECEIVABLE FROM STOCKHOLDERS: | ||||||||
Balance at beginning of period | $ | (55,000 | ) | $ | (109,000 | ) | ||
Repayment of notes receivable | 55,000 | 54,000 | ||||||
Balance at end of period | $ | — | $ | (55,000 | ) | |||
RETAINED EARNINGS: | ||||||||
Balance at beginning of period | $ | 46,876,000 | $ | 34,334,000 | ||||
Net income | 13,604,000 | 8,453,000 | ||||||
Balance at end of period | $ | 60,480,000 | $ | 42,787,000 | ||||
TREASURY STOCK—SHARES: | ||||||||
Balance at beginning of period | (141,000 | ) | (101,000 | ) | ||||
Repurchase of shares | (13,000 | ) | (22,000 | ) | ||||
Balance at end of period | (154,000 | ) | (123,000 | ) | ||||
TREASURY STOCK—COST: | ||||||||
Balance at beginning of period | $ | (1,000 | ) | $ | (1,000 | ) | ||
Repurchase of shares | (302,000 | ) | — | |||||
Balance at end of period | $ | (303,000 | ) | $ | (1,000 | ) | ||
COMPREHENSIVE INCOME: | ||||||||
Net income | $ | 13,604,000 | $ | 8,453,000 | ||||
Translation adjustments | 409,000 | 89,000 | ||||||
Total comprehensive income | $ | 14,013,000 | $ | 8,542,000 | ||||
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CONSOLIDATED STATEMENTS OF CASH FLOWS
| Nine Months Ended | ||||||||
| February 29, 2004 | February 28, 2003 | |||||||
| (unaudited) | (unaudited) | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 13,604,000 | $ | 8,453,000 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 2,539,000 | 1,410,000 | ||||||
Amortization of deferred stock compensation | 228,000 | 239,000 | ||||||
Bad debt expense | 1,207,000 | 783,000 | ||||||
Changes in operating assets and liabilities, net of effect of acquisitions: | ||||||||
Trade accounts receivable | (21,532,000 | ) | (3,728,000 | ) | ||||
Prepaid expenses and other current assets | 1,263,000 | (193,000 | ) | |||||
Income taxes | 4,051,000 | 2,623,000 | ||||||
Other assets | 850,000 | 147,000 | ||||||
Accounts payable and accrued expenses | 521,000 | 209,000 | ||||||
Accrued salaries and related obligations | (983,000 | ) | 806,000 | |||||
Other liabilities | 144,000 | (87,000 | ) | |||||
Net cash provided by operating activities | 1,892,000 | 10,662,000 | ||||||
Cash flows from investing activities: | ||||||||
Redemption of marketable securities | 28,000,000 | 18,000,000 | ||||||
Purchase of marketable securities | (27,000,000 | ) | (6,000,000 | ) | ||||
Purchase of Executive Temporary Management BV, net of cash acquired and including transaction costs | (27,643,000 | ) | — | |||||
Purchase of policyIQ, including transaction costs | (2,056,000 | ) | — | |||||
Purchase of Deloitte Re:sources Pty, including transaction costs | (1,078,000 | ) | — | |||||
Purchase of The Procurement Centre, net of cash acquired and including transaction costs | — | (7,957,000 | ) | |||||
Purchases of property and equipment | (1,922,000 | ) | (431,000 | ) | ||||
Net cash (used in) provided by investing activities | (31,699,000 | ) | 3,612,000 | |||||
Cash flows from financing activities: | ||||||||
Proceeds from exercise of stock options | 9,523,000 | 1,669,000 | ||||||
Proceeds from issuance of common stock under Employee Stock Purchase Plan | 1,395,000 | 1,801,000 | ||||||
Repurchase of treasury stock | (302,000 | ) | ||||||
Repayment of notes receivable from stockholders | 55,000 | 54,000 | ||||||
Net cash provided by financing activities | 10,671,000 | 3,524,000 | ||||||
Effect of exchange rate changes on cash | (173,000 | ) | — | |||||
Net (decrease) increase in cash | (19,309,000 | ) | 17,798,000 | |||||
Cash and cash equivalents at beginning of period | 48,078,000 | 31,745,000 | ||||||
Cash and cash equivalents at end of period | $ | 28,769,000 | $ | 49,543,000 | ||||
The accompanying notes are an integral part of these financial statements.
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ITEM 1. (CONTINUED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Nine months ended February 29, 2004 and February 28, 2003
1. Description of the Company and its Business
Resources Connection, Inc. (“Resources Connection”) was incorporated on November 16, 1998. Resources Connection provides professional services to a variety of industries and enterprises through its subsidiaries, Resources Connection LLC (“LLC”), RECN of Texas, LP (“Texas”), Resources Audit Solutions, LLC (“RAS”), and seven foreign subsidiaries (collectively the “Company”). Prior to its acquisition of LLC on April 1, 1999, Resources Connection had no substantial operations. LLC, which commenced operations in June 1996, and Texas, which was formed in May 2002, and the various foreign subsidiaries, provide clients with experienced professionals who specialize in accounting, finance, information technology, human resources and supply chain management services on a project basis. RAS commenced business formally in June 2002 and assists its clients with their internal audit and risk assessment needs on a project or co-sourced basis. The Company has offices in the United States, Australia, Canada, Hong Kong, Japan, the Netherlands, Taiwan and the United Kingdom. Resources Connection is a Delaware corporation. LLC and RAS are Delaware limited liability companies. Texas is a limited partnership formed in Texas.
The Company’s fiscal year consists of 52 or 53 weeks, ending on the last Saturday in May. The actual quarter end dates for the third quarter of fiscal 2004 and 2003, each consisting of 13 weeks, were February 28, 2004 and February 22, 2003, respectively. For convenience, all references herein to years or periods are to years or periods ended May 31, February 29, 2004 or February 28, 2003, respectively.
2. Summary of Significant Accounting Policies
Interim Financial Information
The financial information for the three months and nine months ended February 29, 2004 and February 28, 2003 is unaudited but includes all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair presentation of the financial position at such dates and the operating results and cash flows for those periods. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to SEC rules or regulations; however, the Company believes the disclosures made are adequate to make the information presented not misleading.
The results of operations for the interim periods presented are not necessarily indicative of the results of operations to be expected for the fiscal year. These condensed interim financial statements should be read in conjunction with the audited financial statements for the year ended May 31, 2003, which are included in the Company’s Annual Report on Form 10-K for the year then ended (File No. 0-32113).
Investments in Marketable Securities
The Company accounts for its marketable securities in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities”. Accordingly, securities that the Company has the ability and positive intent to hold to maturity are carried at amortized cost. Cost approximates market for these securities. All held-to-maturity securities have remaining maturity dates greater than one year. To secure a slightly higher interest rate on its investment in government bonds, the $19 million in investments classified as long-term as of February 29, 2004 are callable at the discretion of the issuer although their stated maturity dates are greater than one year from the balance sheet date.
Stock-based Compensation
On December 31, 2002, the FASB issued SFAS No. 148, “Accounting for Stock Based Compensation Transition and Disclosure,” which amends SFAS No. 123.“Accounting for Stock Based Compensation”. SFAS No. 148 requires more prominent
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and frequent disclosures about the effects of stock-based compensation, which the Company has adopted as of the year ended May 31, 2003. The Company will continue to account for its stock-based compensation according to the provisions of APB Opinion No. 25.
If the Company had recognized compensation cost at the date of grant using the fair value method, our pro-forma net income and pro-forma income per share would have been as follows:
Three months ended February 29, 2004 and | Nine months ended February 29, 2004 and | |||||||||||||||
| 2004 | 2003 | 2004 | 2003 | |||||||||||||
Net income, as reported | $ | 5,786,000 | $ | 2,666,000 | $ | 13,604,000 | $ | 8,453,000 | ||||||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (2,152,000 | ) | (2,285,000 | ) | (4,857,000 | ) | (6,019,000 | ) | ||||||||
Pro forma net income | $ | 3,634,000 | $ | 381,000 | $ | 8,747,000 | $ | 2,434,000 | ||||||||
Net income per share: | ||||||||||||||||
Basic-as reported | $ | 0.25 | $ | 0.12 | $ | 0.60 | $ | 0.39 | ||||||||
Basic-pro forma | $ | 0.16 | $ | 0.02 | $ | 0.39 | $ | 0.11 | ||||||||
Diluted-as reported | $ | 0.24 | $ | 0.12 | $ | 0.57 | $ | 0.37 | ||||||||
Diluted-pro forma | $ | 0.15 | $ | 0.02 | $ | 0.37 | $ | 0.11 | ||||||||
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although management believes these estimates and assumptions are adequate, actual results could differ from the estimates and assumptions used.
3. Net Income Per Share
The Company follows SFAS No. 128, “Earnings Per Share,” which establishes standards for the computation, presentation and disclosure requirements for basic and diluted earnings per share for entities with publicly held common shares and potential common shares. Basic earnings per share are computed by dividing net income by the weighted average number of common shares outstanding. In computing diluted earnings per share, the weighted average number of shares outstanding is adjusted to reflect the effect of potentially dilutive securities, consisting solely of stock options.
Potential common shares totaling 1,405,000 were not included in the diluted earnings per share amounts for the three months ended February 28, 2003, as their effect would have been anti-dilutive. There were no anti-dilutive potential common shares for the three months ended February 29, 2004. For the three months ended February 29, 2004 and February 28, 2003, potentially dilutive securities consisted solely of stock options and resulted in potential common shares of 1,377,000 and 1,035,000, respectively.
Potential common shares totaling 538,000 and 1,569,000 were not included in the diluted earnings per share amounts for the nine months ended February 29, 2004 and February 28, 2003, respectively, as their effect would have been anti-dilutive. For the nine months ended February 29, 2004 and February 28, 2003, potentially dilutive securities consisted solely of stock options and resulted in potential common shares of 1,243,000 and 1,044,000, respectively.
4. Acquisitions
During the first quarter of fiscal 2004, the Company completed three separate cash acquisitions as follows:
| • | On July 15, 2003, the Company acquired the outstanding capital shares of Ernst & Young’s subsidiary, Executive Temporary Management BV in the Netherlands for $29.4 million. The Company completed the acquisition to |
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provide a foundation in continental Europe and believes the acquisition will allow it to market to current and prospective multinational clients with significant international operations. This operation has been renamed Resources Connection.NL BV (“RC.NL”).
| • | On June 1, 2003, the Company acquired the operations of Deloitte Re:sources Pty Ltd. operating in Australia from Deloitte Touche Tohmatsu for $1 million. This operation has been renamed Resources Connection Australia Ltd. . |
| • | On July 30, 2003, the Company acquired policyIQTM, a web-based solution for internal controls documentation and content management for $2 million. |
In accordance with SFAS No. 141, “Business Combinations,” the Company allocated the purchase price of the three entities based on the fair value of the assets acquired and liabilities assumed. The Company considered a number of factors in performing this valuation, including a valuation of the identifiable intangible assets. During the third quarter of fiscal 2004, this valuation was completed.
The following table presents revenue, net income and diluted earnings per share for the nine months ended February 29, 2004 and February 28, 2003 as if the acquisition of RC.NL had occurred on June 1, 2003 and 2002, respectively:
| Resources Connection, Inc. Nine Months Ended February 29, 2004 | RC.NL Pre- Acquisition Results | Pro Forma Adjustments Increase (Decrease) | Pro Forma Combined | |||||||||||
Revenue | $ | 221,315,000 | $ | 5,233,000 | $ | — | $ | 226,548,000 | ||||||
Income before income taxes | $ | 22,946,000 | $ | (82,000 | ) | $ | (117,000 | ) | $ | 22,747,000 | ||||
Net income | $ | 13,604,000 | $ | (53,000 | ) | $ | (70,000 | ) | $ | 13,481,000 | ||||
Diluted earnings per share | $ | 0.57 | $ | 0.57 | ||||||||||
| Resources Connection, Inc. Nine Months Ended February 28, 2003 | RC.NL Nine Months Ended March 31, 2003 | Pro Forma Adjustments Increase (Decrease) | Pro Forma Combined | ||||||||||
Revenue | $ | 142,974,000 | $ | 45,754,000 | $ | — | $ | 188,728,000 | |||||
Income before income taxes | $ | 14,326,000 | $ | 802,000 | $ | (1,107,000 | ) | $ | 14,021,000 | ||||
Net income | $ | 8,453,000 | $ | 527,000 | $ | (653,000 | ) | $ | 8,327,000 | ||||
Diluted earnings per share | $ | 0.37 | $ | 0.37 | |||||||||
The net pro forma adjustments reflect estimated amortization on amortizable intangibles allocated in the purchase, reduction in interest income from the use of cash in the purchase and the related impact on income taxes.
The components of the purchase price and allocation of the acquisition of RC.NL are as follows:
Tangible assets acquired | $ | 572,000 | |
Identifiable intangible assets acquired | 4,668,000 | ||
Goodwill | 24,160,000 | ||
Total | $ | 29,400,000 | |
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5. Intangible Assets and Goodwill
The following table presents details of our intangible assets, related accumulated amortization and goodwill:
| As of February 29, 2004 | As of May 31, 2003 | |||||||||||||||||||
| Gross | Accumulated Amortization | Net | Gross | Accumulated Amortization | Net | |||||||||||||||
Customer relationships (2 – 4 years) | $ | 4,849,000 | $ | (854,000 | ) | $ | 3,995,000 | $ | 1,050,000 | $ | (171,000 | ) | $ | 879,000 | ||||||
Associate and customer database (1 – 5 years) | 1,742,000 | (743,000 | ) | 999,000 | 580,000 | (318,000 | ) | 262,000 | ||||||||||||
Non-compete agreements (1 – 4 years) | 630,000 | (630,000 | ) | — | 630,000 | (568,000 | ) | 62,000 | ||||||||||||
Developed technology (3 years) | 520,000 | (87,000 | ) | 433,000 | — | — | — | |||||||||||||
Trade name and trademark (indefinite life) | 82,000 | — | 82,000 | — | — | — | ||||||||||||||
Total | $ | 7,823,000 | $ | (2,314,000 | ) | $ | 5,509,000 | $ | 2,260,000 | $ | (1,057,000 | ) | $ | 1,203,000 | ||||||
Goodwill (indefinite life) | $ | 79,118,000 | $ | (4,617,000 | ) | $ | 74,501,000 | $ | 52,493,000 | $ | (4,617,000 | ) | $ | 47,876,000 | ||||||
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” which became effective January 1, 2002, goodwill and other intangible assets with indeterminate lives are no longer subject to amortization but are tested for impairment annually or whenever events or changes in circumstances indicate that the asset might be impaired. Intangible assets with finite lives continue to be subject to amortization, and any impairment is determined in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
The Company recorded amortization expense for the three and nine months ended February 29, 2004 of $514,000 and $1,212,000, respectively. The Company recorded amortization expense for the three and nine months ended February 28, 2003 of $298,000 and $455,000, respectively. Estimated intangible asset amortization expense (based on existing intangible assets) for the years ending May 31, 2004, 2005, 2006, 2007 and 2008 is $1,715,000, $1,647,000, $1,613,000, $1,269,000 and $362,000, respectively.
The following is a rollforward of our goodwill balance:
| Gross | Accumulated Amortization | Net | ||||||||
Goodwill, as of May 31, 2003 | $ | 52,493,000 | $ | (4,617,000 | ) | $ | 47,876,000 | |||
Acquisitions | 26,458,000 | — | 26,458,000 | |||||||
Impact of foreign currency exchange rate changes | 167,000 | — | 167,000 | |||||||
Goodwill, as of February 29, 2004 | $ | 79,118,000 | $ | (4,617,000 | ) | $ | 74,501,000 | |||
6. Segment Reporting
In accordance with the requirements of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”, the Company discloses information regarding operations outside of the United States. The Company operates as one segment. The accounting policies for the domestic and international operations are the same as those described in Note 1 of the Company’s 2003 Annual Report on Form 10-K. Summarized financial information regarding the Company’s domestic and international operations is shown in the following table for the three months and nine months ended February 29, 2004. Amounts for the three months and nine months ended February 28, 2003 were not material.
| Revenue for the three months ended February 29, 2004 | Revenue for the nine months ended February 29, 2004 | Long-Lived Assets as of February 29, 2004(1) | |||||||
United States | $ | 68,616,000 | $ | 179,070,000 | $ | 4,239,000 | |||
The Netherlands | 13,415,000 | 30,592,000 | 1,153,000 | ||||||
Other | 5,727,000 | 11,653,000 | 539,000 | ||||||
Total | $ | 87,758,000 | $ | 221,315,000 | $ | 5,931,000 | |||
| (1) | Long-lived assets are comprised of computers and equipment, furniture and leasehold improvements. |
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7. Recent Accounting Pronouncements
In December 2003 the SEC issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition”. SAB No. 104 revises and rescinds certain sections of SAB No. 101 in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. Accordingly there is no impact to our results of operations, financial position or cash flows as a result of the issuance of SAB No. 104.
On December 23, 2003, the FASB issued SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88 and 106, and a revision of FASB Statement No. 132 (“FAS 132 (revised 2003)”)”. This Statement revises employers’ disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans required by SFAS No. 87, “Employers’ Accounting for Pensions”, SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits”, and SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”. The new rules require additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. The required information should be provided separately for pension plans and for other postretirement benefit plans. The new disclosures are generally effective for 2003 calendar year-end financial statements of public companies, with a delayed effective date for certain disclosures and for foreign plans. The Company is currently evaluating the effect of this pronouncement on its financial statement disclosures.
In December 2003, the FASB issued Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46R”). FIN 46R requires the application of either FIN 46 or FIN 46R by Public Entities to all Special Purpose Entities (“SPE”) created prior to February 1, 2003 as of December 31, 2003 for calendar year-end companies. FIN 46R is applicable to all non-SPEs created prior to February 1, 2003 at the end of the first interim or annual period ending after March 15, 2004. For all entities created subsequent to January 31, 2003, Public Entities were required to apply the provisions of FIN 46. The adoption of FIN 46 did not have a material impact on our consolidated financial position, results of operations or cash flows. The adoption of FIN 46R for SPEs did not have an impact to our consolidated financial position, results of operations or cash flows, and we do not believe the adoption of FIN 46R for non-SPEs will have a material impact to our consolidated financial position, results of operations or cash flows.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes. This discussion and analysis contains “forward-looking statements”, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements relate to expectations concerning matters that are not historical facts. Such forward-looking statements may be identified by words such as “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should,” or “will” or the negative of these terms or other comparable terminology. These statements, and all phases of our operations, are subject to known and unknown risks, uncertainties and other factors, some of which are identified herein and in our report on Form 10-K for the year ended May 31, 2003 (File No. 0-32113). Readers are cautioned not to place undue reliance on these forward-looking statements. Our actual results, levels of activity, performance or achievements and those of our industry may be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. We undertake no obligation to update the forward-looking statements in this filing. References in this filing to “Resources Connection”, the “Company,” “we,” “us,” and “our” refer to Resources Connection, Inc. and its subsidiaries.
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Overview
Resources Connection is an international professional services firm that provides experienced accounting and finance, risk management and internal audit, information technology, human resources and supply chain management professionals to clients on a project basis. We assist our clients with discrete projects requiring specialized expertise in accounting and finance, such as mergers and acquisitions due diligence, financial analyses (e.g., product costing and margin analyses), corporate reorganizations and tax-related projects. In addition, we provide human resources management services, such as compensation program design and implementation, information technology services, such as transitions of management information systems, and internal audit services, such as documenting internal controls. We also assist our clients with periodic needs such as budgeting and forecasting, audit preparation, public reporting and assisting clients with their compliance efforts under the Sarbanes-Oxley Act of 2002 (“Sarbanes”).
We began operations in June 1996 as a division of Deloitte & Touche and operated as a wholly owned subsidiary of Deloitte & Touche from January 1997 until April 1999. In November 1998, our management formed RC Transaction Corp., renamed Resources Connection, Inc., to raise capital for an intended management-led buyout. In April 1999, we completed the management-led buyout in partnership with, among others, an investor, Evercore Partners, Inc. In December 2000, we completed our initial public offering of common stock and began trading on the Nasdaq National Market.
Growth in revenue through fiscal 2003 was generally the result of establishing offices in major markets. We established nine offices during fiscal 1997, our initial fiscal year, all in the Western United States. In fiscal 1998, we established nine additional offices, which extended our geographic reach to the Midwest and Eastern United States. For the year ended May 31, 1999, we opened ten more offices and established a new service line in information technology. In fiscal 2000, we established four more domestic offices, established a new service line in human resources management and also began operations in Toronto, Canada; Taipei, Taiwan; and Hong Kong, People’s Republic of China. In fiscal 2001, we established nine additional domestic offices. In fiscal 2002, we began operations in London, England and opened two more domestic offices. To date, the information technology and human resources management service lines have been introduced in a limited number of our offices.
During fiscal 2003, we commenced operations for Resources Audit Solutions, LLC (“RAS”), an entity focused primarily on providing internal audit services and we acquired The Procurement Centre, LLC (now operating as our Resources Connection Supply Chain Management subsidiary (“SCM”)), a Texas based provider of supply chain management services to companies on a project basis. In addition to SCM’s office in Houston, Texas, we opened six offices domestically during fiscal 2003 and an office in Birmingham, England.
During fiscal 2003, we also started a practice named Resources Consulting Group, LP (“RCG”). This entity focused on expanding our executive compensation consulting practice. In October 2003, the employees of RCG left Resources Connection to work for another employer and their office was closed. The services provided by RCG will continue to be provided by the other operating units of Resources Connection. No material impact on operations is expected from this change.
In the first quarter of fiscal 2004, we completed three transactions to enhance our international presence as well as our ability to assist clients with the compliance efforts under Sarbanes. The largest of the three transactions was the all-cash acquisition for $29.4 million of the outstanding capital shares of Ernst & Young’s subsidiary, Executive Temporary Management BV (“ETM”) in the Netherlands on July 15, 2003. ETM, renamed Resources Connection.NL BV (“RC.NL”), is considered a market leader in the interim management industry in the Netherlands. We believe this acquisition provides a foundation in continental Europe and will allow us to market to our current and prospective multinational clients seeking an alternative to the Big Four firms, particularly in light of concerns about auditor independence. RC.NL has seven offices in the Netherlands and contracted with, or employed, over 270 professional service associates on assignment as of February 29, 2004.
In addition to the international expansion driven by the acquisition of RC.NL, we also acquired the operations of Deloitte Re:sources Pty Ltd. from Deloitte Touche Tohmatsu in Australia in an all-cash deal for $1 million on June 1, 2003. The subsidiary, renamed Resources Connection Australia Pty. Ltd., was originally launched in 1998 by us on behalf of the Deloitte Australia firm. The acquisition presented the opportunity to expand our Asia Pacific presence.
Finally, in July 2003, we acquired the company that developed policyIQTM, a web-based solution for internal controls documentation and content management. The purchase included upfront cash and provision for contingent payments based on sales volume. policyIQTM is a tool that our clients can use to assist in complying with Sarbanes, among other things.
During the third quarter of fiscal 2004, we opened an office in Tokyo, Japan, continuing to expand our operations in Asia Pacific. We have also opened two domestic offices during the current fiscal year. As of February 29, 2004, we served our clients through 51 offices in the United States and 15 offices abroad.
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Critical Accounting Policies
The following discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
The following represents a summary of our critical accounting policies, defined as those policies that we believe: (a) are the most important to the portrayal of our financial condition and results of operations and (b) involve inherently uncertain issues that require management’s most difficult, subjective or complex judgments.
Valuation of long-lived assets—We assess the potential impairment of long-lived tangible and intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Under the new accounting standard effective June 1, 2001, our goodwill and certain other intangible assets are no longer subject to periodic amortization over their estimated useful lives. These assets are now considered to have an indefinite life and their carrying values are required to be assessed by us for impairment at least annually. Depending on future market values, our operating performance and other factors, these assessments could potentially result in impairment reductions of these intangible assets in the future.
Allowance for doubtful accounts—We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of our clients to make required payments for services rendered. We estimate this allowance based upon our knowledge of the financial condition of our clients, review of historical receivable and reserve trends and other pertinent information. If the financial condition of our clients deteriorates or we note an unfavorable trend in aggregate receivable collections, additional allowances may be required.
Income taxes—In order to prepare our consolidated financial statements, we are required to make estimates of income taxes, if applicable, in each jurisdiction in which we operate. The process incorporates an assessment of any current tax exposure together with temporary differences resulting from different treatment of transactions for tax and financial statement purposes. These differences result in deferred tax assets and liabilities that are included in our Consolidated Balance Sheets. The recovery of deferred tax assets from future taxable income must be assessed and, to the extent recovery is not likely, we will establish a valuation allowance. An increase in the valuation allowance results in recording additional tax expense. If the ultimate tax liability differs from the amount of tax expense we have reflected in the Consolidated Statements of Income, additional tax expense may need to be recorded.
We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.
Three Months Ended February 29, 2004 Compared to Three Months Ended February 28, 2003
The comments discussed below for the three months ended February 29, 2004 include the results of operations for a full quarter for Resources Connection Australia Pty Ltd, RC.NL and policyIQ. The acquisitions in the first quarter of fiscal 2004 are referred to in the comments below as “the acquisitions”.
Revenue. Revenue increased $38.5 million, or 78.2%, to $87.8 million for the three months ended February 29, 2004 from $49.2 million for the three months ended February 28, 2003. The acquisitions contributed $14.4 million to the growth in revenues. Without the additional revenue from the acquisitions, revenues increased 49.0%. This increase was triggered by the continued expansion of our scope of services, resulting in more billable hours for our associates and an improvement in rate per hour. We believe our services expanded in finance and accounting, information technology and Sarbanes related engagements by increasing market awareness of our ability to provide those types of services. Bill rates improved by 10.0% compared to the prior year average bill rate. The increase in revenue is also reflected by the increase in the number of associates on assignment from 1,181 at the end of the third quarter of fiscal 2003 to 1,980 at the end of the third quarter of fiscal 2004 (including 297 associates working for the Australia and Netherlands practices as of February 29, 2004). Overall, the Company billed approximately $8.0 million per week in non-holiday impacted weeks in the third quarter of fiscal 2004.
We operated 66 offices during the third quarter of fiscal 2004 compared with 55 offices during the third quarter of the previous fiscal year. Nine of the additional offices operated in the third quarter of fiscal 2004 were from acquisitions. We
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opened a new office in Tokyo, Japan during the third quarter of fiscal 2004 in an effort to continue to expand our presence in the Asia Pacific region. Last year, we opened three offices in the United States in the third fiscal quarter.
Direct Cost of Services. Direct cost of services increased $24.2 million, or 80.3%, to $54.4 million for the three months ended February 29, 2004 from $30.2 million for the three months ended February 28, 2003. The increase in direct cost of services was attributable to the previously described expansion of the scope of services resulting in more chargeable hours for our associates at higher average pay rates as well as the full quarter of results of the acquisitions included in the third quarter of fiscal 2004; overall, the average pay rate per hour increased by 15.5% year-over-year. The direct cost of services as a percentage of revenue increased from 61.2% for the three months ended February 28, 2003 to 61.9% for the three months ended February 29, 2004. Among the factors contributing to this increase were: 1) the increase in volume of zero margin client expense reimbursements as the Company’s projects requiring associate travel increased significantly; 2) the decrease in conversion fees (non-refundable fees recognized when one of the Company’s professionals accepts an offer of permanent employment from a client) in the current year compared to the prior year; 3) the greater impact of the international operations with a higher direct cost of services percentage; and 4) the incremental increase in pay rate per hour compared to bill rate per hour.
Historically, the cost of compensation and related benefits offered to the associates of our international offices has been greater as a percentage of revenue than our domestic operations. Thus, the direct cost of services percentage of our international offices has usually exceeded our domestic operation’s targeted direct cost of services percentage of 60%.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $8.6 million, or 60.4%, to $22.7 million for the three months ended February 29, 2004 from $14.2 million for the three months ended February 28, 2003. This increase was primarily attributable to the acquisitions. In particular, compensation and related benefit expenses increased as management and administrative headcount grew from 341 at the end of the third quarter of fiscal 2003 to 455 at the end of the third quarter of fiscal 2004. Excluding the management of companies acquired, management and administrative headcount was 347 at the end of the third quarter of fiscal 2004. The increase in dollars spent (apart from the acquisitions) was attributable to the increase in salaries and benefit costs driven by the larger headcount and occupancy and related costs from new offices opened. In addition, marketing and advertising expenses increased in the quarter, primarily related to the Netherlands practice, and bonus expense increased as a result of the Company’s improved revenue results. However, selling, general and administrative expenses decreased as a percentage of revenue from 28.8% for the three months ended February 28, 2003 to 25.9% for the three months ended February 29, 2004 as a result of improved leverage.
Amortization and Depreciation Expense. Amortization of intangible assets increased to $514,000 in the third quarter of fiscal 2004 compared to $298,000 in the prior year’s third quarter. The increase is related to the acquisitions in the first quarter of fiscal 2004. During the third quarter of fiscal 2004, the Company completed its allocation of the purchase price of the acquisitions, and considered a number of factors in performing this valuation, including a valuation of identifiable intangible assets. As a result, approximately $5.5 million of the purchase price was assigned to amortizable intangible assets related to contractually based customer relationships, the acquired database of potential associates and technology related to the policyIQ software. These intangibles will be amortized over one to five years. The amortization charge expected in the fourth quarter of fiscal 2004 is $503,000. The Company is also amortizing intangible assets related to the SCM acquisition through fiscal 2006. In the prior year third quarter, amortization expense related primarily to the amortization of the SCM intangibles assets.
Depreciation expense increased from $328,000 for the three months ended February 28, 2003 to $507,000 for the three months ended February 29, 2004. This increase reflects the impact of a full quarter of depreciation related to the acquisitions, the other offices opened since February 2003 and investments in information technology.
Interest Income. The Company has invested available cash in money market and commercial paper investments that have been classified as cash equivalents due to the short maturities of these investments. In addition, as of February 29, 2004, the Company has $19 million in government-agency bonds with maturity dates in excess of one year from the balance sheet date. The bonds mature through February 2006 and have coupon rates ranging from 1.5% to 2.4%. These investments have been classified in the February 29, 2004 consolidated balance sheet as “held-to-maturity” securities.
During the third quarter of fiscal 2004, interest income was $147,000 compared to interest income of $231,000 in the quarter ended February 28, 2003. The decrease in interest income is a combination of a lower average cash balance available for investment in the third quarter of fiscal 2004 and the lower interest rates available year over year. The cash balance available for investment decreased from the third quarter of fiscal 2003 to the third quarter of fiscal 2004 as funds of approximately $30 million were used in the first quarter of fiscal 2004 to complete the acquisitions. The Company earned approximately 1.3%, annualized, on its money market, commercial paper and marketable securities investments during the quarter.
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Income Taxes. The provision for income taxes increased from $1.9 million for the three months ended February 28, 2003 to $4.0 million for the three months ended February 29, 2004 as a result of the increase in the Company’s pre-tax income. The effective tax rate was approximately 41.0% for both the three months ended February 29, 2004 and February 28, 2003, which differs from the federal statutory rate primarily due to state taxes, net of federal benefit. There can be no assurance that the Company’s effective tax rate will not increase in the future.
Nine Months Ended February 29, 2004 Compared to Nine Months Ended February 28, 2003
The comments regarding the consolidated results of operation discussed below for the nine months ended February 29, 2004 include the results of operations for the following periods: for SCM and Resources Connection Australia Pty Ltd, a full nine months of results of operations; for RC.NL, results of operations from July 15, 2003 through February 29, 2004; and for policyIQ, results of operations from July 30, 2003 through February 29, 2004. The results of operations for the nine months ended February 28, 2003 include operating results of SCM from October 11, 2002 onward. Collectively, the acquisition of these businesses are referred to in the comments below as “the acquisitions”.
Revenue. Revenue increased $78.3 million, or 54.8%, to $221.3 million for the nine months ended February 29, 2004 from $143.0 million for the nine months ended February 28, 2003. Growth in revenues of $36.0 million is attributable to additional revenues from the acquisitions. Without the additional revenue from the acquisitions, revenues increased 29.6%. This increase was triggered by the continued expansion of our scope of services resulting in more billable hours for our associates and an improvement in rate per hour. We believe our services expanded in finance and accounting, information management, and Sarbanes related engagements by increasing market awareness of our ability to provide those types of services. Overall bill rates improved by 9.0% compared to the comparable prior year period average bill rate. The increase in revenue is also reflected by the increase in the number of associates on assignment from 1,181 at the end of the third quarter of fiscal 2003 to 1,980 at the end of the third quarter of fiscal 2004 (including 297 associates working for the Australia and Netherlands practices as of February 29, 2004).
We operated 66 offices during the first nine months of fiscal 2004 (including the office of Resources Consulting Group closed in the second quarter of fiscal 2004) compared with 55 offices during the first nine months of the previous fiscal year. Nine of the additional offices operated in the first three quarters of fiscal 2004 were from the acquisitions.
Direct Cost of Services. Direct cost of services increased $49.5 million, or 57.3%, to $135.8 million for the nine months ended February 29, 2004 from $86.4 million for the nine months ended February 28, 2003. The increase in direct cost of services was attributable to the previously described expansion of the scope of services resulting in more chargeable hours for our associates at higher average pay rates as well as the results of the acquisitions completed in the first quarter of fiscal 2004; overall, the average pay rate per hour increased by 13.5% year-over-year. The direct cost of services as a percentage of revenue increased from 60.4% for the nine months ended February 28, 2003 to 61.4% for the nine months ended February 29, 2004. Among the factors contributing to this increase were: 1) the greater impact of the international operations with a higher direct cost of services percentage; 2) the increase in volume of zero margin client expense reimbursements as, due to client requirements, the Company’s projects involving associate travel increased significantly; 3) the decrease in conversion fees in the current year compared to the prior year; and 4) the incremental increase in pay rate per hour compared to bill rate per hour.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $18.7 million, or 44.9%, to $60.4 million for the nine months ended February 29, 2004 from $41.7 million for the nine months ended February 28, 2003. This increase was primarily attributable to the acquisitions. In particular, compensation and related benefit expenses increased as management and administrative headcount grew from 341 at February 28, 2003 to 455 at February 29, 2004. Excluding the management of companies acquired, management and administrative headcount was 347 at February 29, 2004. Apart from the acquisitions, the increase in dollars spent was attributable to the increase in salaries and benefit costs driven by the larger headcount and occupancy and related costs from new office opened. In addition, marketing and advertising expenses increased in the first nine months of fiscal 2004, primarily related to the Netherlands practice, and bonus expense increased as a result of the Company’s improved revenue results. However, selling, general and administrative expenses decreased as a percentage of revenue from 29.2% for the nine months ended February 28, 2003 to 27.3% for the nine months ended February 29, 2004 as a result of improved leverage.
Amortization and Depreciation Expense. Amortization of intangible assets increased to $1.2 million in the first nine months of fiscal 2004 compared to $455,000 in the comparable prior year period. Amortization related to the intangible assets of the acquisitions triggered the increase over the prior year. In the prior year period, amortization expense related primarily to
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the amortization of the cost of the non-compete agreement entered into when the Company acquired LLC and intangible assets acquired in the SCM acquisition.
Depreciation expense increased from $955,000 for the nine months ended February 28, 2003 to $1.3 million for the nine months ended February 29, 2004. This increase reflects the increased depreciation from assets acquired in the acquisitions completed in the first quarter of fiscal 2004, the other offices opened since February 2003 and our investment in information technology.
Interest Income. During the first nine months of fiscal 2004, interest income was $422,000 compared to interest income of $839,000 in the nine months ended February 28, 2003. The decrease in interest income is a combination of a lower average cash balance available for investment during the first nine months of fiscal 2004 and the lower interest rates available year over year. The cash balance available for investment decreased from February 28, 2003 to February 29, 2004 as the funds were used to complete the acquisitions.
Income Taxes. The provision for income taxes increased from $5.9 million for the nine months ended February 28, 2003 to $9.3 million for the nine months ended February 29, 2004, as a result of the increase in the Company’s pre-tax income. The effective tax rates were approximately 40.7% and 41.0% for the nine months ended February 29, 2004 and February 28, 2003, respectively, which differ from the federal statutory rate primarily due to state taxes, net of federal benefit. The Company raised its effective rate in the third quarter of fiscal 2004 to 41.0% after completing an analysis of its state tax obligations.
Comparability of Quarterly Results. Our quarterly results have fluctuated in the past and we believe they will continue to do so in the future. Certain factors that could affect our quarterly operating results are described below in the section of this report entitled “Risks Related to Our Business.” Due to these and other factors, we believe that quarter-to-quarter comparisons of our results of operations are not meaningful indicators of future performance.
Liquidity and Capital Resources
Our primary source of liquidity is our existing cash and cash equivalents, marketable securities, cash provided by our operations, cash provided by financing activities and, to the extent necessary, available commitments under our revolving line of credit. On an annual basis, we have generated positive cash flows from operations since inception.
The Company’s original August 2001 $10.0 million unsecured revolving credit facility with Bank of America has been replaced effective March 26, 2004 with a new $10.0 million unsecured revolving credit facility with substantially the same terms (the “Credit Agreement”). The Credit Agreement allows the Company to choose the interest rate applicable to advances. The interest rate options are Bank of America’s prime rate, a London Inter-Bank Offered (“LIBOR”) rate plus 1.5% or Bank of America’s Grand Cayman Banking Center (“IBOR”) rate plus 1.5%. Interest, if any, is payable monthly. There is an annual facility fee of 0.25% payable on the unutilized portion of the Credit Agreement. The Credit Agreement expires December 1, 2005 As of February 29, 2004, the Company had no outstanding borrowings under the revolving credit facility and is in compliance with all covenants included in the Credit Agreement.
Net cash provided by operating activities was $1.9 million for the nine months ended February 29, 2004 compared to $10.7 million for the nine months ended February 28, 2003. The net decrease in cash provided by operations was caused primarily by the increase in accounts receivable during the third quarter from the rapid increase in revenue growth, especially in the month of February 2004. In addition, the Company’s increased revenue in fiscal 2003 over fiscal 2002 resulted in higher obligations for the Company’s incentive bonus plan as compared to the prior year; the required payments were made in fiscal 2004. The Company’s working capital includes $28.8 million in cash and cash equivalents at February 29, 2004.
Net cash used in investing activities was $31.7 million for the first nine months of fiscal 2004 compared to cash provided by investing activities of $3.6 million in the first nine months of fiscal 2003. The Company used approximately $30.8 million in cash in the first and second quarters of fiscal 2004 to complete the acquisitions as well as related transaction costs. In addition, the Company spent approximately $1.9 million on leasehold improvements, office equipment and information technology upgrades in the first nine months of fiscal 2004, up from $431,000 in the previous year’s first nine months. The Company also had a net change in long-term investments of only $1 million in fiscal 2004, compared to $12 million in 2003. These investments, classified as long-term investments as of February 29, 2004 and February 28, 2003, were obligations of various United States government programs that contained a “call” feature at the discretion of the issuer of the bonds.
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Net cash provided by financing activities totaled $10.7 million for the nine months ended February 29, 2004 compared to $3.5 million for the nine months ended February 28, 2003. The increased volume of stock options exercised in fiscal 2004 caused this change.
Our ongoing operations and anticipated growth in the geographic markets we currently serve will require us to continue making investments in capital equipment, primarily technology hardware and software. In addition, we may consider making additional strategic acquisitions. We anticipate that our current cash, existing availability under our revolving line of credit and the ongoing cash flows from our operations will be adequate to meet our working capital and capital expenditure needs for at least the next 12 months. If we require additional capital resources to grow our business, either internally or through acquisition, we may seek to sell additional equity securities or secure additional debt financing. The sale of additional equity securities or the addition of new debt financing could result in additional dilution to our stockholders. We may not be able to obtain financing arrangements in amounts or on terms acceptable to us in the future. In the event we are unable to obtain additional financing when needed, we may be compelled to delay or curtail our plans to develop our business, which could have a material adverse affect on our operations, market position and competitiveness.
Our credit agreement currently prohibits us from declaring or paying any dividends or other distributions on any shares of our capital stock other than dividends payable solely in shares of capital or the stock of our subsidiaries.
In October 2002, our board of directors approved a stock repurchase program, authorizing the repurchase of up to 1.5 million shares of our common stock. As of February 29, 2004, we had not repurchased any shares of our common stock under this program.
Recent Accounting Pronouncements
In December 2003 the SEC issued Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition. SAB No. 104 revises and rescinds certain sections of SAB No. 101 in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. Accordingly there is no impact to our results of operations, financial position or cash flows as a result of the issuance of SAB No. 104.
On December 23, 2003, the FASB issued SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88 and 106, and a revision of FASB Statement No. 132 (“FAS 132 (revised 2003)”)”. This Statement revises employers’ disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans required by SFAS No. 87, “Employers’ Accounting for Pensions”, SFAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits”, and SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”. The new rules require additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. The required information should be provided separately for pension plans and for other postretirement benefit plans. The new disclosures are generally effective for 2003 calendar year-end financial statements of public companies, with a delayed effective date for certain disclosures and for foreign plans. The Company is currently evaluating the effect of this pronouncement on its financial statement disclosures.
In December 2003, the FASB issued Interpretation No. 46R, Consolidation of Variable Interest Entities (“FIN 46R”). FIN 46R requires the application of either FIN 46 or FIN 46R by Public Entities to all Special Purpose Entities (“SPE”) created prior to February 1, 2003 as of December 31, 2003 for calendar year-end companies. FIN 46R is applicable to all non-SPEs created prior to February 1, 2003 at the end of the first interim or annual period ending after March 15, 2004. For all entities created subsequent to January 31, 2003, Public Entities were required to apply the provisions of FIN 46. The adoption of FIN 46 did not have a material impact on our consolidated financial position, results of operations or cash flows. The adoption of FIN 46R for SPEs did not have an impact to our consolidated financial position, results of operations or cash flows, and we do not believe the adoption of FIN 46R for non-SPEs will have a material impact to our consolidated financial position, results of operations or cash flows.
RISKS RELATED TO OUR BUSINESS
This section highlights specific risks affecting our business, operating results and financial condition. The order in which the risks appear is not intended as an indication of their relative weight or importance.
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We must provide our clients with highly qualified and experienced associates, and the loss of a significant number of our associates, or an inability to attract and retain new associates, could adversely affect our business and operating results.
Our business involves the delivery of professional services, and our success depends on our ability to provide our clients with highly qualified and experienced associates who possess the skills and experience necessary to satisfy their needs. Such professionals are in great demand, particularly in certain geographic areas, and are likely to remain a limited resource for the foreseeable future. Our ability to attract and retain associates with the requisite experience and skills depends on several factors including, but not limited to, our ability to:
| • | provide our associates with full-time employment; |
| • | obtain the type of challenging and high-quality projects which our associates seek; |
| • | pay competitive compensation and provide competitive benefits; and |
| • | provide our associates with flexibility as to hours worked and assignment of client engagements. |
We cannot assure you that we will be successful in accomplishing each of these items and, even if we are, that we will be successful in attracting and retaining the number of highly qualified and experienced associates necessary to maintain and grow our business.
The market for professional services is highly competitive, and if we are unable to compete effectively against our competitors our business and operating results could be adversely affected.
We operate in a competitive, fragmented market, and we compete for clients and associates with a variety of organizations that offer similar services. The competition is likely to increase in the future due to the expected growth of the market and the relatively few barriers to entry. Our principal competitors include:
| • | consulting firms; |
| • | employees loaned by the Big Four accounting firms; |
| • | staffing firms; and |
| • | the in-house resources of our clients. |
We cannot assure you that we will be able to compete effectively against existing or future competitors. Many of our competitors have significantly greater financial resources, greater revenues and greater name recognition, which may afford them an advantage in attracting and retaining clients and associates. In addition, our competitors may be able to respond more quickly to changes in companies’ needs and developments in the professional services industry.
An economic downturn or change in the use of outsourced professional services associates could adversely affect our business.
During the recent downturn in the U.S. economy, our business was affected. As the general level of economic activity slowed, our clients delayed or canceled plans that involve professional services, particularly outsourced professional services. Consequently, we have experienced fluctuations in demand for our services. In addition, the use of professional services associates on a project-by-project basis could decline for non-economic reasons. In the event of a non-economic reduction in the demand for our associates, our financial results could suffer.
Our business depends upon our ability to secure new projects from clients and, therefore, we could be adversely affected if we fail to do so.
We do not have long-term agreements with our clients for the provision of services. The success of our business is dependent on our ability to secure new projects from clients. For example, if we are unable to secure new client projects because of improvements in our competitors’ service offerings or because of an economic downturn decreasing the demand for outsourced professional services, our business is likely to be materially adversely affected.
We may be legally liable for damages resulting from the performance of projects by our associates or for our clients’ mistreatment of our associates.
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Many of our engagements with our clients involve projects that are critical to our clients’ businesses. If we fail to meet our contractual obligations, we could be subject to legal liability or damage to our reputation, which could adversely affect our business, operating results and financial condition. It is likely, because of the nature of our business, that we will be sued in the future. Claims brought against us could have a serious negative effect on our reputation and on our business, financial condition and results of operations.
Because we are in the business of placing our associates in the workplaces of other companies, we are subject to possible claims by our associates alleging discrimination, sexual harassment, negligence and other similar activities by our clients. We may also be subject to similar claims from our clients based on activities by our associates. The cost of defending such claims, even if groundless, could be substantial and the associated negative publicity could adversely affect our ability to attract and retain associates and clients.
We may not be able to grow our business, manage our growth or sustain our current business.
We grew rapidly from our inception in 1996 until 2001 by opening new offices and by increasing the volume of services we provide through existing offices. We experienced a decline in revenue in fiscal 2002 to $181.7 million but then rebounded in fiscal 2003 to revenue of $202.0 million. Although revenue has increased in the first nine months of fiscal 2004 compared to the same period in the prior year (not including revenues from acquisitions), there can be no assurance that we will continue to be able to maintain or expand our market presence in our current locations or to successfully enter other markets or locations. Our ability to successfully grow our business will depend upon a number of factors, including our ability to:
| • | grow our client base; |
| • | expand profitably into new cities; |
| • | provide additional professional services lines; |
| • | hire associates; |
| • | maintain margins in the face of pricing pressures; and |
| • | manage costs. |
Even if we are able to continue our growth, the growth will result in new and increased responsibilities for our management as well as increased demands on our internal systems, procedures and controls, and our administrative, financial, marketing and other resources. Failure to adequately respond to these new responsibilities and demands may adversely affect our business, financial condition and results of operation.
The increase in our international activities will expose us to additional operational challenges that we might not otherwise face.
As we increase our international activities, we will have to confront and manage a number of risks and expenses that we would not otherwise face if we conducted our operations solely in the United States. If any of these risks or expenses occurs, there could be a material negative effect on our operating results. These risks and expenses include:
| • | difficulties in staffing and managing foreign offices as a result of, among other things, distance, language and cultural differences; |
| • | expenses associated with customizing our professional services for clients in foreign countries; |
| • | foreign currency exchange rate fluctuations, when we sell our professional services in denominations other than U.S. dollars; |
| • | protectionist laws and business practices that favor local companies; |
| • | political and economic instability in some international markets; |
| • | multiple, conflicting and changing government laws and regulations; |
| • | trade barriers; |
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| • | reduced protection for intellectual property rights in some countries; and |
| • | potentially adverse tax consequences. |
We have acquired, and may continue to acquire, companies, and these acquisitions could disrupt our business.
We have acquired several companies and may continue to acquire companies in the future. Entering into an acquisition entails many risks, any of which could harm our business, including:
| • | diversion of management’s attention from other business concerns; |
| • | failure to successfully integrate the acquired company with our existing business; |
| • | failure to motivate, or loss of, key employees from either our existing business or the acquired business; |
| • | potential impairment of relationships with our employees and clients; |
| • | additional operating expenses not offset by additional revenue; |
| • | incurring significant non-recurring charges; |
| • | incurring additional debt with restrictive covenants or other limitations; |
| • | dilution of our stock as a result of issuing equity securities; and |
| • | assumption of liabilities of the acquired company. |
Our business could suffer if we lose the services of one or more key members of our management.
Our future success depends upon the continued employment of Donald B. Murray, our chief executive officer, and Stephen J. Giusto, our chief financial officer. The departure of Mr. Murray, Mr. Giusto or any of the other key members of our senior management team could significantly disrupt our operations. Key members of our senior management team include Karen M. Ferguson, an executive vice president, John D. Bower, our vice president, finance, and Kate W. Duchene, our chief legal officer and executive vice president of human relations. We do not have employment agreements with Mr. Bower or Ms. Duchene.
Our quarterly financial results may be subject to significant fluctuations.
Our quarterly financial results have fluctuated in the past and we believe they will continue to do so in the future. Factors that could affect our quarterly operating results include:
| • | our ability to attract new clients and retain current clients; |
| • | the mix of client projects; |
| • | the announcement or introduction of new services by us or any of our competitors; |
| • | the expansion of the professional services offered by us or any of our competitors into new locations both nationally and internationally; |
| • | the entry of new competitors into any of our markets; |
| • | changes in demand for our services by our clients; |
| • | the number of associates eligible for our offered benefits as their average length of employment with us increases; |
| • | the number of holidays in a quarter, particularly the day of the week on which they occur; |
| • | changes in the pricing of our professional services or those of our competitors; |
| • | the amount and timing of operating costs and capital expenditures relating to management and expansion of our business; and |
| • | the timing of acquisitions and related costs, such as compensation charges which fluctuate based on the market price of our common stock. |
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Due to these and other factors, we believe that quarter-to-quarter comparisons of our results of operations are not meaningful indicators of future performance. It is possible that in some future periods, our results of operations may be below the expectations of investors. If this occurs, the price of our common stock could decline.
We may be subject to laws and regulations that impose difficult and costly compliance requirements and subject us to potential liability and the loss of clients.
In connection with providing services to clients in certain regulated industries, we are subject to industry-specific regulations, including licensing and reporting requirements. Complying with these requirements is costly and, if we fail to comply, we could be prevented from rendering services to clients in those industries in the future.
It may be difficult for a third party to acquire our company, and this could depress our stock price.
Delaware corporate law and our second restated certificate of incorporation and bylaws contain provisions that could delay, defer or prevent a change of control of our company or our management. These provisions could also discourage proxy contests and make it difficult for you and other stockholders to elect directors and take other corporate actions. As a result, these provisions could limit the price that future investors are willing to pay for your shares. These provisions:
| • | authorize our board of directors to establish one or more series of undesignated preferred stock, the terms of which can be determined by the board of directors at the time of issuance; |
| • | divide our board of directors into three classes of directors, with each class serving a staggered three-year term. Because the classification of the board of directors generally increases the difficulty of replacing a majority of the directors, it may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of us and may make it difficult to change the composition of the board of directors; |
| • | prohibit cumulative voting in the election of directors which, if not prohibited, could allow a minority stockholder holding a sufficient percentage of a class of shares to ensure the election of one or more directors; |
| • | require that any action required or permitted to be taken by our stockholders must be effected at a duly called annual or special meeting of stockholders and may not be effected by any consent in writing; |
| • | state that special meetings of our stockholders may be called only by the chairman of the board of directors, our chief executive officer, by the board of directors after a resolution is adopted by a majority of the total number of authorized directors, or by the holders of not less than 10% of our outstanding voting stock; |
| • | establish advance notice requirements for submitting nominations for election to the board of directors and for proposing matters that can be acted upon by stockholders at a meeting; |
| • | provide that certain provisions of our certificate of incorporation can be amended only by supermajority vote of the outstanding shares, and that our bylaws can be amended only by supermajority vote of the outstanding shares or our board of directors; |
| • | allow our directors, not our stockholders, to fill vacancies on our board of directors; and |
| • | provide that the authorized number of directors may be changed only by resolution of the board of directors. |
The Company’s board of directors has adopted a stockholder rights plan, which was described in the Company’s May 31, 2003 Report on Form 10-K. The existence of this rights plan may also have the effect of delaying, deferring or preventing a change of control of our company or our management by deterring acquisitions of our stock not approved by our board of directors.
We may be unable to adequately protect our intellectual property rights, including our brand name. If we fail to adequately protect our intellectual property rights, the value of such rights may diminish and our results of operations and financial condition may be adversely affected.
We believe that establishing, maintaining and enhancing the Resources Connection brand name is essential to our business. We have obtained U.S. registrations on our service mark and logo, Registration No. 2,516,522 registered December 11, 2001, and No. 2,524,226 registered January 1, 2002 and No. 2,613,873, registered September 3, 2002. We have been aware from time to time of other companies using the name “Resources Connection” or some variation thereof. There could be potential trade name or service mark infringement claims brought against us by the users of these similar names and marks and those users
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may have service mark rights that are senior to ours. If these claims were successful, we could be forced to cease using the service mark “Resources Connection” even if an infringement claim is not brought against us. It is also possible that our competitors or others will adopt service names similar to ours or that our clients will be confused by another company using a name, service mark or trademark similar to ours, thereby impeding our ability to build brand identity. We cannot assure you that our business would not be adversely affected if confusion did occur or if we are required to change our name.
Our clients may be confused by the presence of competitors and other companies that have names similar to our name.
We are aware of other companies using the name “Resources Connection” or some variation thereof. The existence of these companies may confuse our clients, thereby impeding our ability to build our brand identity.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk. At the end of the third quarter of fiscal 2004, we had approximately $47.8 million of cash, highly liquid short-term investments and long-term marketable securities. These investments are subject to changes in interest rates, and to the extent interest rates were to decline, it would reduce our interest income.
Foreign Currency Exchange Rate Risk. Prior to fiscal 2004, our foreign operations were not significant to our overall operations, and our exposure to foreign currency exchange rate risk was low. However, as our strategy to continue expanding foreign operations progresses, more of our revenues will be derived from foreign operations denominated in the currency of the applicable markets. As a result, our operating results could become subject to fluctuations based upon changes in the exchange rates of foreign currencies in relation to the U.S. dollar. Although we intend to monitor our exposure to foreign currency fluctuations, including the use of financial hedging techniques when we deem it appropriate, we cannot assure you that exchange rate fluctuations will not adversely affect our financial results in the future.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of third quarter of fiscal 2004, the Company’s management, including its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of February 29, 2004 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. There was no change in the Company’s internal controls over financial reporting during the Company’s quarter ended February 29, 2004 that materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.
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PART II
OTHER INFORMATION
We are not a party to any material legal proceedings.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
None.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
| 31.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* | |
| 31.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.* | |
| 32 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* | |
| * | Filed herewith |
b) Reports on Form 8-K
The registrant filed or furnished the following current reports on Form 8-K during the quarter covered by this report:
Form 8-K (item 12), furnished on January 7, 2004, covering a press release announcing the Company’s financial results for the quarter ended November 30, 2003.
Form 8-K (item 9), furnished on January 8, 2004, covering a press release announcing the appointment of a new board member, Julie A. Hill.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
RESOURCES CONNECTION, INC. | ||||||||
Date: April 12, 2004 | By: | /s/ DONALD B. MURRAY | ||||||
Donald B. Murray President and Chief Executive Officer | ||||||||
Date: April 12, 2004 | By: | /s/ STEPHEN J. GIUSTO | ||||||
Stephen J. Giusto Chief Financial Officer, Executive Vice President of Corporate Development and Secretary (Principal Financial Officer) | ||||||||
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