RECN Resources Connection Inc

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 consolidated financial statements and accompanying 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,” “remain,” “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 that could cause our actual results, levels of activity, performance or achievements and those of our industry to differ materially from those expressed or implied by these forward-looking statements. You are urged to carefully review the disclosures we make concerning risks, uncertainties and other factors that may affect our business or operating results, including those identified in Part II, Item 1A. Risk Factors below and in our Annual Report on Form 10-K for the year ended May 27, 2017 (File No. 0-32113). Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business or operating results. Readers are cautioned not to place undue reliance on the forward-looking statements included herein, which speak only as the date of this filing. We do not intend, and undertake no obligation, to update the forward-looking statements in this filing to reflect events or circumstances after the date of this filing or to reflect the occurrence of unanticipated events, unless required by law to do so. References in this filing to “Resources Connection,” “RGP,” “Resources Global Professionals,” the “Company,” “we,” “us,” and “our” refer to Resources Connection, Inc. and its subsidiaries.

Overview

RGP is a multinational consulting firm that provides agile consulting services to its global client base who are faced with disruption, business transformation and compliance issues. We bring functional competencies in the areas of accounting; finance; governance, risk and compliance management; corporate advisory, strategic communications and restructuring; information management; human capital; supply chain management; and legal and regulatory. We assist our clients with projects requiring specialized expertise in:

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We were founded in June 1996 by a team at Deloitte, led by our chairman, Donald B. Murray, who was then a senior partner with Deloitte. Our founders created Resources Connection to capitalize on the increasing demand for high quality outsourced professional services. We operated as a part of Deloitte until April 1999. In April 1999, we completed a management-led buyout in partnership with several investors. In December 2000, we completed our initial public offering of common stock and began trading on the NASDAQ Stock Market. We currently trade on the NASDAQ Global Select Market under the ticker symbol “RECN”. We operate under the acronym RGP, branding for our operating entity name of Resources Global Professionals.

We operated solely in the United States (“U.S.”) until fiscal year 2000, when we opened our first three international offices and began to expand geographically to meet the demand for project consulting services across the world. As of November 25, 2017, we served clients from offices in 21 countries, including 26 international offices and 43 offices in the United States. During the second quarter of fiscal 2018, we added two international offices as a result of our acquisition of taskforce – Management on Demand AG (“ taskforce ”) discussed below. Our global footprint allows the Company to support the global initiatives of our multinational client base.

The Company continues to make progress against its strategic initiatives announced in April 2017. During the second quarter of fiscal 2018 the Company continued to advance its initiative to cultivate a more sophisticated and robust sales culture. The Company launched a new learning and development program to enhance training and accountability across the organization – including providing training on new management techniques and processes. RGP continued the initiative to roll out new compensation programs to drive accountability and profitable growth. The Company has completed other facets of this initiative, including the alignment of the Company’s sales process and the establishment of an enterprise-wide Business Development function. Another initiative, the Company’s Strategic Client Program, with a dedicated account team for certain high profile clients with world-wide operations, is performing well with revenue of clients in this program up 8.0% since the beginning of the fiscal year. RGP expects to complete its sales culture transformation substantially by the end of the fiscal year.

In addition, the Company believes it made good progress on further building its national business development function targeting the middle market, where the Company sees significant growth opportunities. The Company has now completed deployment of Salesforce across all of its markets, and continues to leverage this platform to improve the organization’s ability to drive and coordinate business development globally. The acquisition of substantially all of the assets and assumption of certain liabilities of Accretive Solutions, Inc. (“Accretive”) in December 2017 and discussed further below will also enhance the Company’s capabilities in the middle market.

With regard to the second initiative to redesign the Company’s business model to enhance its client offerings, the redesign is close to completion, with a focus on building its integrated solutions capabilities and delivering multi-disciplinary offerings to its clients in three areas of focus –Transaction Services, Technical Accounting Services, and Data & Analytics. In the second quarter, the Company implemented the new operating model for sales, talent and integrated solutions within RGP for all of North America. We believe this effort has already delivered improved revenue growth and the Company expects this upward performance trend to continue throughout fiscal year 2018.

With respect to the cost containment initiative, the Company remains focused on improved leverage of its selling general and administrative expenses (“S, G & A”) as a percentage of revenue and cost synergies in the core business and with the Accretive acquisition. The impact of certain headcount reductions made in fiscal 2017 have been masked by one-time expenses during the first half of the fiscal year incurred for severance, acquisition and sales transformation. RGP remains committed to managing its cost structure to achieve improved S, G & A performance as measured against revenue.

During the second quarter of fiscal 2018, the Company completed its acquisition of taskforce , a German based professional services firm founded in 2007 that provides clients with senior interim management and project management expertise. The Company paid initial consideration of €5.8 million (approximately $6.9 million translated to U.S. dollars based on exchange rates at the date of acquisition) for all of the outstanding shares of taskforce in a combination of cash and restricted stock. In addition, the purchase agreement requires additional earn-out payments resulting from application of a formula based upon Adjusted EBITDA (as defined in the purchase agreement) for calendar years 2017, 2018 and 2019. The estimated fair value of these additional earn-out payments are recorded as contingent consideration at a discounted liability in the Company’s Consolidated Balance Sheet for €5.5 million (approximately $6.5 million translated to U.S. dollars based on exchange rates at the date of acquisition) as of November 25, 2017. The contingent consideration is subject to revision until ultimately settled and such adjustments are recorded through the Company’s Statement of Operations. For the twelve months ended December 31, 2016, taskforce revenues were approximately €12 million ($13.3 million). Results of operations of taskforce are included in the Company’s consolidated statement of operations in the quarter ending November 25, 2017, including revenue of $3.7 million and pre-tax income of $0.3 million.

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Subsequent to the end of the second quarter of fiscal 2018, the Company announced the completion of its acquisition of substantially all of the assets and assumption of certain liabilities of Accretive. Accretive is a professional services firm that provides expertise in accounting and finance, enterprise governance, business technology and business transformation solutions to a wide variety of organization in the U.S. and supports startups through its Countsy suite of back office services. The Company paid consideration of $19.4 million in cash subject to working capital adjustments and issued 1,150,000 shares of Resources Connection, Inc. common stock restricted for sale for four years. The Company expects EBITDA to increase after 9-12 months, driven by cost synergies that RGP expects to achieve by the end of calendar 2018, resulting from office consolidations, the elimination of redundant back-office functions and other specific cost reductions. Results of operations from this transaction will be included in the Company’s consolidated statement of operations beginning in the quarter ending February 24, 2018.

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 (“GAAP”). 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 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. There have been no material changes in our critical accounting policies, or in the estimates and assumptions underlying those policies, from those described in our Annual Report on Form 10-K for the year ended May 27, 2017.

Valuation of long-lived assets — We assess the potential impairment of long-lived tangible and intangible assets periodically or whenever events or changes in circumstances indicate the carrying value may not be recoverable. Our goodwill is not subject to periodic amortization. This asset is considered to have an indefinite life and its carrying value is required to be assessed by us for impairment at least annually. Depending on future market values of our stock, our operating performance and other factors, these assessments could potentially result in impairment reductions of this intangible asset in the future and this adjustment may materially affect the Company’s future financial results and financial condition.

Allowance for doubtful accounts — We maintain an allowance for doubtful accounts for estimated losses resulting from our clients failing to make required payments for services rendered. We estimate this allowance based upon our knowledge of the financial condition of our clients (which may not include knowledge of all significant events), review of historical receivable and reserve trends and other pertinent information. While such losses have historically been within our expectations and the provisions established, we cannot guarantee we will continue to experience the same credit loss rates we have in the past. A significant change in the liquidity or financial position of our clients could cause unfavorable trends in receivable collections and additional allowances may be required. These additional allowances could materially affect the Company’s future financial results.

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 and any such adjustment may materially affect the Company’s future financial results. If the ultimate tax liability differs from the amount of tax expense we have reflected in the Consolidated Statements of Operations, an adjustment of tax expense may need to be recorded and this adjustment may materially affect the Company’s future financial results and financial condition.

Revenue recognition — We primarily charge our clients on an hourly basis for the professional services of our consultants. We recognize revenue once services have been rendered and invoice the majority of our clients in the United States on a weekly basis. Some of our clients served by our international offices are billed on a monthly basis. Our clients are contractually obligated to pay us for all hours billed. To a much lesser extent, we also earn revenue if a client hires one of our consultants. This type of contractually non-refundable revenue is recognized at the time our client completes the hiring process.

Stock-based compensation — Under our 2014 Performance Incentive Plan, officers, employees, and outside directors have received or may receive grants of restricted stock, stock units, options to purchase common stock or other stock or stock-based awards. Under our Employee Stock Purchase Plan (the “ESPP”), eligible officers and employees may purchase our common stock in accordance with the terms of the plan.

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The Company estimates a value for employee stock options on the date of grant using an option-pricing model. We have elected to use the Black-Scholes option-pricing model which takes into account assumptions regarding a number of highly complex and subjective variables. These variables include the expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. Additional variables to be considered are the expected term, expected dividends and the risk-free interest rate over the expected term of our employee stock options. In addition, because stock-based compensation expense recognized in the Consolidated Statements of Operations is based on awards ultimately expected to vest, it is reduced for estimated forfeitures. Forfeitures must be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience. If facts and circumstances change and we employ different assumptions in future periods, the compensation expense recorded may differ materially from the amount recorded in the current period.

The Company uses its historical volatility over the expected life of the stock option award to estimate the expected volatility of the price of its common stock. The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of our employee stock options. The impact of expected dividends ($0.12 per share in the first and second quarter of fiscal 2018 and $0.11 per share in each quarter of fiscal 2017) is also incorporated in determining the estimated value per share of employee stock option grants. Such dividends are subject to quarterly board of director approval. The Company’s expected life of stock option grants is 5.7 years for non-officers and 8.2 years for officers. The Company uses its historical volatility over the expected life of the stock option award to estimate the expected volatility of the price of its common stock. The Company reviews the underlying assumptions related to stock-based compensation at least annually.

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.

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We also assess the results of our operations using EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin. EBITDA is defined as earnings before interest, taxes, depreciation and amortization. We define Adjusted EBITDA as EBITDA plus stock-based compensation expense. Adjusted EBITDA Margin is calculated by dividing Adjusted EBITDA by revenue. These measures assist management in assessing our core operating performance and the Company believes they are also useful to investors as an alternative measure of our operating performance. The following table presents EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin for the periods indicated and includes a reconciliation of such measures to net income, the most directly comparable GAAP financial measure:

The financial measures and key performance indicators we use to assess our financial and operating performance above are not defined by, or calculated in accordance with, GAAP. A non-GAAP financial measure is defined as a numerical measure of a company’s financial performance that (i) excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the comparable measure calculated and presented in accordance with GAAP in the Consolidated Statements of Operations; or (ii) includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the comparable measure so calculated and presented.

EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin are non-GAAP financial measures. We believe EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin, which are used by management to assess the core performance of our Company, provide useful information to our investors because they are alternative financial measures investors can also use to assess the core performance of the Company and compare it to the Company’s peers. EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin are not measurements of financial performance or liquidity under GAAP and should not be considered in isolation or construed as substitutes for net income or other cash flow data prepared in accordance with GAAP for purposes of analyzing our profitability or liquidity. These measures should be considered in addition to, and not as a substitute for, net income, earnings per share, cash flows or other measures of financial performance prepared in conformity with GAAP.

Further, EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin have the following limitations:

Due to these limitations, EBITDA, Adjusted EBITDA and Adjusted EBITDA Margin should not be considered a substitute for performance measures calculated in accordance with GAAP.

Three Months Ended November 25, 2017 Compared to Three Months Ended November 26, 2016

Percentage change computations are based upon amounts in thousands.

Revenue . Revenue increased $9.1 million, or 6.2%, to $156.7 million for the three months ended November 25, 2017 from $147.6 million for the three months ended November 26, 2016. On a constant currency basis, revenue increased 5.3%. Revenue in the second quarter of fiscal 2018 includes $3.7 million in revenue resulting from taskforce since its acquisition on August 31, 2017. Absent the taskforce revenue, revenue increased $5.4 million, or 3.7%. We deliver our services to clients, whether multi-national or locally based, in a similar fashion across the globe. Excluding taskforce for comparison purposes, bill rates improved 3.4% (2.5% on a constant currency basis) and hours worked increased 0.1% between the two periods. The Company experienced an upswing in revenue in certain industries and markets during the quarter; however, consistent with recent trends, the Company’s revenue in the financial services industry was down quarter-over-quarter. The timing of the result of efforts to improve our client penetration in the financial services industry is uncertain.

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As presented in the table below, revenue increased in the second quarter of fiscal 2018 compared to the same quarter of fiscal 2017 in Europe and North America but declined in Asia Pacific. A portion of the European increase is due to the acquisition of taskforce discussed above (dollars in thousands):

Our financial results are subject to fluctuations in the exchange rates of foreign currencies in relation to the United States dollar (“U.S. dollar”). Revenues denominated in foreign currencies are translated into U.S. dollars at the monthly average exchange rates in effect during each period. Thus, as the value of the U.S. dollar strengthens relative to the currencies of our non-United States based operations, our translated revenue (and expenses) will be lower; conversely, if the value of the U.S. dollar weakens relative to the currencies of our non-United States based operations, our translated revenue (and expenses) will be higher. Using the comparable fiscal 2017 second quarter conversion rates, international revenues would have been lower than reported under GAAP by approximately $1.3 million in the second quarter of fiscal 2018. Using these constant currency rates, which we believe provides a more comprehensive view of trends in our business, our revenue increased in Europe and North America by 35.7% and 1.9%, respectively, while decreasing in Asia Pacific by 0.8%.

The number of consultants on assignment as of November 25, 2017 was 2,746 compared to 2,649 consultants engaged as of November 26, 2016. The number of consultants on assignment as of November 25, 2017 includes 60 consultants from the taskforce acquisition.

We operated 69 (26 abroad) offices as of November 25, 2017 and 67 (23 abroad) as of November 26, 2016; the change between the two years is the result of the addition of two offices acquired in the taskforce transaction and the formal establishment of offices in Zurich, Switzerland and Guangzhou, China since the end of the second quarter of fiscal 2017; these additions were offset by two office closures in the United States and one office closure in Canada.

Our clients do not sign long-term contracts with us. As such, there can be no assurance as to future demand levels for the services we provide or that future results can be reliably predicted by considering past trends.

Direct Cost of Services . Direct cost of services increased $6.3 million, or 6.9%, to $97.3 million for the three months ended November 25, 2017 from $91.0 million for the three months ended November 26, 2016. Direct cost of services includes consultant costs of $2.6 million related to the taskforce acquisition. Excluding the impact of taskforce , the increase in the amount of direct cost of services between the periods was primarily attributable to an increase of 3.4% in the average pay rate per hour between the two quarters and an increase in benefit costs of 3.5%; hours worked increased 0.1% between the two quarters. Currency fluctuations between the quarters increased direct cost of services by $0.9 million.

Direct cost of services as a percentage of revenue was 62.1% and 61.7% for the three months ended November 25, 2017 and November 26, 2016, respectively. The increase in the direct cost of services as a percentage of revenue between the two quarters was driven principally by the impact of taskforce’s higher direct cost of services percentage and to higher medical coverage expenses and unreimbursed “out of pocket” expenses, such as travel, in the fiscal 2018 quarter.

Our target direct cost of services percentage is 60% for all of our offices.

Selling, General and Administrative Expenses . S, G & A as a percentage of revenue was 30.3% and 31.2% for the quarters ended November 25, 2017 and November 26, 2016, respectively. The improved current quarter percentage is the result of leverage from the higher revenue in the second quarter of fiscal 2018. S, G & A increased to $47.5 million for the second quarter of fiscal 2018 from $46.1 million for the same period in the prior year. The second quarter of fiscal 2018 S, G & A includes $2.9 million of expenses as follows: approximately $0.4 million related to severance expenses, $0.7 million of acquisition related costs and $1.8 million related to costs of the Company’s on-going transformation and integration in accordance with its strategic initiatives to drive revenue growth and improve cost containment. The prior year S, G & A included approximately $1.1 million in severance and $0.4 million in costs related to accelerated vesting of options previously granted to a senior executive in connection with his departure from the Company. Absent these costs in each period, S, G & A spend was approximately the same in each quarter. However, the second quarter of fiscal 2018 also includes S, G & A associated with the operations of taskforce of approximately $0.8 million.

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Management and administrative headcount was 783 at the end of the second quarter of fiscal 2018 (including 17 from the taskforce acquisition) and 782 at the end of the second quarter of fiscal 2017.

Sequential Operations . On a sequential quarter basis, fiscal 2018 second quarter revenues increased approximately 11.0% (10.6% constant currency), from $141.2 million to $156.7 million. Revenue for fiscal 2018 includes $3.7 million from the acquisition of taskforce . Absent the taskforce revenue, revenue increased $11.8 million or 8.4%. Excluding taskforce , hours worked increased 7.8% while average bill rates improved 0.8% between the first and second quarter. The Company experienced consistent revenue growth during the Company’s second quarter compared to the first quarter; some of this growth is attributable to fewer consultants on holiday during the second quarter compared to the first quarter, which included the traditional summer vacation period. The Company’s sequential revenue increased in North America (5.6%), Europe (51.6%) and Asia Pacific (12.1%). On a constant currency basis, using the comparable first quarter fiscal 2018 conversion rates, sequential revenue increased in North America (5.6%), Europe (48.0%) and Asia Pacific (11.6%).

Direct cost of services as a percentage of revenue was 62.1% and 62.0% in the second and first quarters of fiscal 2018, respectively; the higher direct cost of services percentage in the second quarter is primarily the result of a 1.7% increase in average pay rate per hour, offset by a decrease in the amount of Company payroll tax expense typically experienced toward the end of the calendar year.

The ratio of S, G & A to revenue improved from 33.6% for the quarter ended August 26, 2017 to 30.3% for the quarter ended November 25, 2017. The ratio changed favorably because of improved leverage in the second quarter on a higher revenue base. Total spend in the second quarter of fiscal 2018 increased slightly to $47.5 million from $47.4 million in the previous quarter. The second quarter of fiscal 2018 S, G & A includes $2.9 million of expenses as follows: approximately $0.4 million related to severance expenses, $0.7 million of acquisition related costs and $1.8 million related to costs of the Company’s on-going transformation and integration in accordance with its strategic initiatives to drive revenue growth and improve cost containment. The first quarter of fiscal 2018 S, G & A includes approximately $3.8 million of expenses as follows: approximately $1.4 million in severance expenses, approximately $0.7 million of acquisition related costs and approximately $1.7 million related to costs of the Company’s on-going transformation and integration in accordance with its strategic initiatives to drive revenue growth and improve cost containment. Absent the S, G & A of taskforce of approximately $0.8 million in the second quarter fiscal 2018, spend was approximately the same in each quarter.

Amortization and Depreciation Expense. Amortization of intangible assets was $0.3 million in the second quarter of fiscal 2018 as a result of commencing amortization related to identifiable assets acquired in the August 31, 2017 purchase of taskforce . Those assets include: $1.9 million for customer relationships (amortized over 3 years), $2.0 million for tradenames (amortized over 10 years), $0.8 million for the database of potential consultants (amortized over 3 years) and $0.6 million for non-competition agreements (amortized over 3 years). The Company had no amortization expense in the second quarter of fiscal 2017. Based upon identified intangible assets recorded at November 25, 2017, the Company anticipates amortization expense related to identified intangible assets to approximate $1.0 million during the fiscal year ending May 26, 2018.

Depreciation expense was $0.9 million and $0.8 million in the second quarter of fiscal 2018 and 2017, respectively.

Interest Expense (Income) . The Company entered into a $120 million secured revolving credit facility (“Facility”) with Bank of America in October 2016. The Facility consists of (i) a $90 million revolving loan facility, which includes a $5 million sublimit for the issuance of standby letters of credit (“Revolving Loan”), and (ii) a $30 million reducing revolving loan facility, any amounts of which may not be reborrowed after being repaid (“Reducing Revolving Loan”). The Facility is available for working capital and general corporate purposes, including potential acquisitions and stock repurchases. Our obligations under the Facility are guaranteed by all of the Company’s domestic subsidiaries and secured by essentially all assets of the Company, Resources Connection LLC and their domestic subsidiaries, subject to certain customary exclusions. Borrowings under the Facility bear interest at a rate per annum of either, at the Company’s option, (i) a LIBOR rate defined in the Facility plus a margin of 1.25% or 1.50% or (ii) an alternate base rate, plus a margin of 0.25% or 0.50%, with the applicable margin depending on the Company’s consolidated leverage ratio. The alternate base rate is the highest of (i) Bank of America’s prime rate, (ii) the federal funds rate plus 0.50% and (iii) the Eurodollar rate plus 1.0%. The Company pays an unused commitment fee on the average daily unused portion of the Facility at a rate of 0.15% to 0.25% depending upon on the Company’s consolidated leverage ratio. The Facility expires October 17, 2021.

Total interest expense for the second quarter of fiscal 2018, including commitment fees, was approximately $0.4 million. During the second quarter of fiscal 2017 the Company incurred $0.1 million in total interest expense, as the Facility was only utilized for a portion of the quarter. As of November 25, 2017, the interest rate on the Company’s borrowings was 2.9% on one tranche of $24.0 million based on a 3-month LIBOR plus 1.50% and 2.8% on a second tranche of $24.0 million based on a 3-month LIBOR plus 1.50%. The Company’s interest income was $32,000 in the second quarter of fiscal 2018 compared to $40,000 for the same period of fiscal 2017. Interest income declined between the two periods as a result of the use of cash in the Dutch auction tender offer in November 2016, reducing amounts available for investment.

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Income Taxes. The Company’s provision for income taxes was $2.1 million (effective tax rate of approximately 21%) and $3.9 million (effective tax rate of approximately 41%) for the three months ended November 25, 2017 and November 26, 2016, respectively. The Company records tax expense based upon an actual effective tax rate versus a forecasted tax rate because of the volatility in its international operations which span numerous tax jurisdictions.

The provision for income taxes in both the second quarter of fiscal 2018 and 2017 resulted from taxes on income in the United States and certain other foreign jurisdictions, no benefit for losses in jurisdictions in which a full valuation allowance on operating loss carryforwards had previously been established and a lower benefit for losses in certain foreign jurisdictions with tax rates lower than the United States statutory rates. The effective tax rate decreased for the three months ended November 25, 2017 due to the reversal of valuation allowances that offset the deferred tax assets of certain foreign entities. Periodically, the Company reviews the components of both book and taxable income to analyze the adequacy of the tax provision. There can be no assurance the Company’s effective tax rate will remain constant in the future because of the lower benefit from the United States statutory rate for losses in certain foreign jurisdictions and the limitation on the benefit for losses in jurisdictions in which a valuation allowance for operating loss carryforwards has previously been established.

The Company can only recognize a potential tax benefit for employees’ acquisition and subsequent sale of shares purchased through the ESPP if the sale occurs within a certain defined period. As a result, the Company’s provision for income taxes may fluctuate from these factors for the foreseeable future. The Company recognized a benefit of approximately $0.2 million and $0.5 million related to stock-based compensation for nonqualified stock options expensed and for disqualifying dispositions under the ESPP during the second quarter of fiscal 2018 and 2017, respectively. The proportion of expense related to non-qualified stock option grants (for which the Company may recognize a tax benefit in the same quarter as the related compensation expense in most instances) is significant as compared to expense related to disqualifying dispositions under the ESPP. However, the timing and amount of eligible disqualifying transactions under the ESPP cannot be predicted. The Company predominantly grants nonqualified stock options to employees in the United States.

Six Months Ended November 25, 2017 Compared to Six Months Ended November 26, 2016

Percentage change computations are based upon amounts in thousands.

Revenue . Revenue increased $7.0 million, or 2.4%, to $297.9 million for the six months ended November 25, 2017 from $290.9 million for the six months ended November 26, 2016. On a constant currency basis, revenue increased 2.0%. Revenue in the first half of fiscal 2018 includes $3.7 million in revenue resulting from taskforce since its acquisition on August 31, 2017. Absent the taskforce revenue, revenue increased $3.3 million or 1.1%. Excluding taskforce for comparison purposes, bill rates improved 2.5% (no difference in constant currency on a rounded basis) and hours worked decreased 1.7% between the two periods. During the first half of fiscal 2018, the Company experienced an upswing in revenue in certain industries and markets; however, consistent with recent trends, the Company’s revenue in the financial services industry was down year-over-year. The timing of the results of efforts to improve our client penetration in the financial services industry is uncertain.

As presented in the table below, revenue increased in the first six months of fiscal 2018 compared to the first six months of fiscal 2017 in Europe and North America but declined in Asia Pacific (dollars in thousands):

Our financial results are subject to fluctuations in the exchange rates of foreign currencies in relation to the U.S. dollar. Revenues denominated in foreign currencies are translated into U.S. dollars at the monthly average exchange rates in effect during each period. Thus, as the value of the U.S. dollar strengthens relative to the currencies of our non-United States based operations, our translated revenue (and expenses) will be lower; conversely, if the value of the U.S. dollar weakens relative to the currencies of our non-United States based operations, our translated revenue (and expenses) will be higher. Using the conversion rates of the comparable fiscal 2017 period, international revenues would have been lower than reported under GAAP by approximately $1.1 million in the first half of fiscal 2018. Using these constant currency rates, which we believe provides a more comprehensive view of trends in our business, our revenue increased in Europe and North America by 22.3% and 0.1%, respectively, while decreasing in Asia Pacific by 4.5%.

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Direct Cost of Services . Direct cost of services increased $4.9 million, or 2.7%, to $184.8 million for the six months ended November 25, 2017 from $179.9 million for the six months ended November 26, 2016. Direct cost of services includes consultant costs of $2.6 million related to the taskforce acquisition. Excluding the impact of taskforce , the increase in the amount of direct cost of services between the periods was primarily attributable to an increase in the average pay rate per hour of 3.4% (no difference on a rounded constant currency basis), an increase in benefit costs of 2.4% and an increase in reimbursable expenses of 8.3%. These increases were offset by a decrease in hours worked of 1.7%.

Direct cost of services as a percentage of revenue was 62.0% and 61.8% for the six months ended November 25, 2017 and November 26, 2016, respectively. The higher percentage in fiscal 2018 was primarily due to increased medical coverage expenses and a slight decrease in the bill rate/pay rate ratio.

Our target direct cost of services percentage is 60% for all of our offices.

Selling, General and Administrative Expenses . S, G & A as a percentage of revenue was 31.9% and 30.8% for the six months ended November 25, 2017 and November 26, 2016, respectively. The higher current quarter percentage is the result of higher spend in the first half of fiscal 2018 compared to the prior year. S, G & A increased to $94.9 million for the first half of fiscal 2018 from $89.7 million for the same period in the prior year. The first half of fiscal 2018 S, G & A includes $6.7 million of expenses as follows: approximately $1.8 million related to severance expenses, $1.4 million of acquisition related costs and $3.5 million related to costs of the Company’s on-going transformation and integration in accordance with its strategic initiatives to drive revenue growth and improve cost containment. The first half of fiscal 2017 S, G & A includes approximately $1.5 million of severance related expenses. Absent these costs in each period, S, G & A spend was approximately the same for each six month period. However, the fiscal 2018 period also includes S, G & A associated with the operations of taskforce of approximately $0.8 million.

Amortization and Depreciation Expense. Amortization of intangible assets was $0.3 million in the first half of fiscal 2018 as a result of commencing amortization related to identifiable assets acquired in the August 31, 2017 purchase of taskforce . The Company had no amortization expense in the first half of fiscal 2017. Depreciation expense was $1.9 million for the six months ended November 25, 2017 compared to $1.6 million for the six months ended November 26, 2016.

Interest Expense (Income) . As described further below under the caption Liquidity and Capital Resources, the Company entered into a $120 million Facility with Bank of America in October 2016. Total interest expense for the first half of fiscal 2018 was approximately $0.7 million, compared to $0.1 million in the first half of fiscal 2017 when the Facility was only accessed for a short period of time. The Company’s interest income was $60,000 in the first half of fiscal 2018 compared to $110,000 for the same period of fiscal 2017. Although rates have generally improved in the first half of fiscal 2018 compared to the same period in the prior year, interest income declined between the two periods as a result of the use of cash in the Dutch auction tender offer in November 2016, reducing amounts available for investment.

Income Taxes. The Company’s provision for income taxes was $5.1 million (effective tax rate of approximately 33%) and $8.5 million (effective tax rate of approximately 43%) for the six months ended November 25, 2017 and November 26, 2016, respectively. The Company records tax expense based upon an actual effective tax rate versus a forecasted tax rate because of the volatility in its international operations which span numerous tax jurisdictions.

The provision for income taxes for the six months ended November 25, 2017 and November 26, 2016 resulted from taxes on income in the United States and certain other foreign jurisdictions, no benefit for losses in jurisdictions in which a full valuation allowance on operating loss carryforwards had previously been established and a lower benefit for losses in certain foreign jurisdictions with tax rates lower than the United States statutory rates. The effective tax rate decreased for the six months ended November 25, 2017 due to the reversal of valuation allowances that offset the deferred tax assets of certain foreign entities. Periodically, the Company reviews the components of both book and taxable income to analyze the adequacy of the tax provision. There can be no assurance the Company’s effective tax rate will remain constant in the future because of the lower benefit from the United States statutory rate for losses in certain foreign jurisdictions and the limitation on the benefit for losses in jurisdictions in which a valuation allowance for operating loss carryforwards has previously been established.

The Company can only recognize a potential tax benefit for employees’ acquisition and subsequent sale of shares purchased through the ESPP if the sale occurs within a certain defined period. As a result, the Company’s provision for income taxes may fluctuate from these factors for the foreseeable future. The Company recognized a benefit of approximately $0.6 million and $1.0 million related to stock-based compensation for nonqualified stock options expensed and for disqualifying dispositions under the ESPP during the halves of fiscal 2018 and 2017, respectively. The proportion of expense related to non-qualified stock option grants (for which the Company may recognize a tax benefit in the same quarter as the related compensation expense in most instances) is significant as compared to expense related to disqualifying dispositions under the ESPP. However, the timing and amount of eligible disqualifying transactions under the ESPP cannot be predicted. The Company predominantly grants nonqualified stock options to employees in the United States.

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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 in Part II, Item 1A.—Risk Factors. Due to these and other factors, we believe quarter-to-quarter comparisons of our results of operations may not be meaningful indicators of future performance.

Liquidity and Capital Resources

Our primary source of liquidity is cash provided by our operations and, historically, to a lesser extent, stock option exercises and ESPP purchases. On an annual basis, we have generated positive cash flows from operations since inception. Our ability to continue to increase cash flow from operations in the future will be, at least in part, dependent on continued improvement in global economic conditions. As of November 25, 2017, the Company had $56.3 million of cash and cash equivalents.

In October 2016, we entered into a $120 million Facility with Bank of America. The Facility is available for working capital and general corporate purposes, including potential acquisitions and stock repurchases. The Facility allows the Company to choose the interest rate applicable to advances. See Note 6 – Long-Term Debt in the Notes to the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further information on the Facility. As of November 25, 2017, the Company had borrowings of approximately $48.0 million under the Facility and approximately $1.0 million of outstanding letters of credit for the benefit of third parties related to operating leases and guarantees. As of November 25, 2017, the Company was in compliance with the financial covenants in the Facility.

Operating Activities

Operating activities for the six months ended November 25, 2017 provided cash of $1.6 million compared to $8.1 million for the six months ended November 26, 2016. Cash provided by operations in the first six months of fiscal 2018 resulted from net income of $10.3 million and non-cash items of $4.7 million. These amounts were partially offset by net unfavorable changes in operating assets and liabilities of $13.3 million due primarily to the increase in the balance of accounts receivable as of the end of the second quarter of fiscal 2018. In the first six months of fiscal 2017, cash provided by operations resulted from net income of $11.3 million and non-cash items of $4.6 million, partially offset by net unfavorable changes in operating assets and liabilities of $7.8 million. The primary driver of the change in cash provided by operations between the two periods was the increase in accounts receivable during fiscal 2018 combined with the decrease in net income in fiscal 2018, both of which negatively impacted cash. Non-cash items in both fiscal 2018 and fiscal 2017 include depreciation and stock-based compensation expense. These charges do not reflect an actual cash outflow from the Company.

Investing Activities

Net cash used in investing activities was $4.2 million for the first six months of fiscal 2018, compared to a source of cash of $17.8 million in the comparable prior year period. The primary use of cash in fiscal 2018 was cash used to acquire taskforce of approximately $3.4 million, net of cash acquired. In the first six months of fiscal 2017, redemptions of short-term investments were $20.0 million as the Company accumulated cash from maturing investments in preparation for its November 2016 tender offer. The Company did not have money invested short-term during the first half of fiscal 2018. Purchases of property and equipment decreased approximately $1.5 million between the two periods as the Company had limited office relocation/refurbishment activities in the current year.

As described in Note 3 to the financial statements – Acquisitions - the purchase agreement for taskforce requires earn-out payments to be made. Under accounting rules for business combinations, obligations that are contingently payable to the sellers based upon the occurrence of one or more future events are recorded as a discounted liability on the Company’s balance sheet. The Company is obligated to pay the sellers in Euros as follows: for calendar year 2017, Adjusted EBITDA times 6.1 times 20%; and for calendar years 2018 and 2019, Adjusted EBITDA times 6.1 times 15% (Adjusted EBITDA as defined in the purchase agreement). The Company estimated the fair value of the obligation to pay contingent consideration based on a number of different projections of the estimated Adjusted EBITDA for each of the calendar years. The Company recorded this future obligation using a discount rate of approximately 11.0%, representing the Company’s weighted average cost of capital. The estimated fair value of the contractual obligation to the contingent consideration recognized at the date of acquisition was $6.5 million, of which the Company estimates $2.4 million will be payable based upon calendar year Adjusted EBITDA in March 2018.

Financing Activities

Net cash used in financing activities totaled $2.9 million and $57.4 million for the six months ended November 25, 2017 and November 26, 2016, respectively. Net cash used in financing activities for the six months ended November 25, 2017 included dividends paid on the Company’s common stock of $6.8 million, approximately $0.8 million lower than in the comparable period of the prior year. The Company’s dividend rate was $0.12 per common share in the first half of fiscal 2018, compared to $0.11 per common share in the first half of fiscal 2017. The Company’s board of directors declared a quarterly cash dividend of $0.12 per common share on July 27, 2017. The dividend of approximately $3.6 million, paid on December 14, 2017, is accrued in the Company’s Consolidated Balance Sheet as of November 25, 2017. The dividend paid in fiscal 2018 was lower because of the reduced number of outstanding shares of common stock after the Company’s modified Dutch auction tender offer in November 2016.

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Net cash used in financing activities for the six months ended November 26, 2016 included $104.2 million, excluding transaction costs, used to purchase shares of our common stock in the modified Dutch auction tender offer, with $58.0 million of this amount borrowed under the Facility and the remainder funded from the Company’s existing cash balances. The Company also used $6.6 million to purchase an additional 443,256 shares of common stock on the open market during the first six months of fiscal 2017. The Company did not repurchase any shares during the six months ended November 25, 2017. Proceeds from the exercise of employee stock options and issuance of shares via the ESPP were approximately $0.4 million lower in the first half of fiscal 2018 as compared to the comparable period of fiscal 2017.

Our ongoing operations and anticipated growth in the geographic markets we currently serve will require us to continue to make investments in office premises and capital equipment, primarily technology hardware and software. In addition, we may consider making strategic acquisitions. We currently believe our current cash, ongoing cash flows from our operations and funding available under our Facility 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 to increase our use of our Facility. In addition, if we decide to make additional share repurchases, we may fund these through existing cash balances or use of our Facility. The sale of additional equity securities or certain forms of 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 or to pay dividends on our capital stock, which could have a material adverse effect on our operations, market position and competitiveness.

Recent Accounting Pronouncements

Information regarding recent accounting pronouncements is contained in Note 13- Recent Accounting Pronouncements in the Notes to the Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements.

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