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Resources Connection Inc (NASDAQ:RECN)
Q4 2019 Earnings Call
Jul 18, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Resources Global Professionals Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions].

I would now like to introduce your host for today's conference, Ms. Alice Washington, General Counsel. You may begin.

Alice J. Washington -- General Counsel

Thank you, operator. Good afternoon, everyone, and thank you for participating on this call. Joining me here today are Kate Duchene, our Chief Executive Officer; Herb Mueller, our Chief Financial Officer; and Tim Brackney, our Chief Operating Officer. During this call, we will be commenting on our results for the fourth quarter and the year ended May 25, 2019. By now, you should have a copy of today's press release. If you need a copy and are unable to access it on our website, please call Shannon McPhee at (714) 430-6363.

I would like to remind you that we may make forward-looking statements during this call. Such statements regarding future events or future financial performance of the Company are just predictions and actual events or results may differ materially. Please see our report on Form 10-K for the year ended May 26, 2018 for a discussion of risks, uncertainties and other factors such as seasonal and economic conditions. Such factors might cause our business, results of operations and financial conditions to differ materially from results of operations and financial conditions expressed or implied by forward-looking statements made during this call.

I'll now turn the call over to our CEO, Kate Duchene.

Kate W. Duchene -- Chief Executive Officer

Thank you, Alice. Hello, everyone, and welcome to RGP's 2019 fourth quarter conference call. To begin, we delivered a very strong financial year in fiscal '19. I am pleased by the headway we made this year in driving growth, but also improving gross margin and bottom line profitability. Tim and Herb will provide specific color and details around revenue and gross margin during their remarks in a few moments. They'll also discuss operational priorities for fiscal '20 and trends we are experiencing in the first quarter of the current fiscal year.

I want to focus my opening remarks on two broader topics. These topics are core to RGP's strategic plan over the next three years. First, I will discuss our plan to become a more digital business. Second, I will discuss recent investments in brand refreshment and brand development and why we believe they are vital for the future of RGP. The first important element of our strategic plan centers on digital innovation. In June, we consolidated our digital innovation efforts within RGP to be led by Tracey Figurelli, Executive Vice President, Digital Innovation. This function will be focused on three core priorities. First, building commercialize a digital engagement platform for RGP. Second, enhance our consulting capabilities to serve clients in the digital transformation and user experience category. And third, building commercialized digital product offerings for our clients and for use within RGP.

The critical objectives of this group are fourfold, to drive volume, improve profitability by lowering cost of sales metrics, and driving product revenue, elevate customer experience and enable us to support our clients on their own digital transformation journeys. I'll now address each of those digital priorities with more specificity.

The digital engagement platform initiative is under way and the team is on track to deliver a minimum viable product or MVP using development vernacular by the second half of fiscal 2020. This human cloud platform is an online digital marketplace where talent and those looking to hire talent can find and engage one another in a work arrangement. Our vision is to create a human cloud tool in the professional services space to allow our devoted client base to self serve staff augmentation needs with greater transparency, speed and control. We also expect this tool to attract new clients looking for a reputable, reliable staffing tool given that the growth in business-to-business human cloud platform adoption is up 19% year-over-year, according to a 2018 update from staffing industry analysts in their report, The Human Cloud, The Gig Economy and the Transformation of Work.

We believe we can be successful with this new engagement model because clients trust us and they're asking us for more speed, seamless connectivity and efficiency.

In addition, in today's tightening labor market, early career and more seasoned talent both want more control and transparency in their career progression and development. This platform will deliver for both critical constituencies. Initially, the plan is to launch the platform to drive our own talent match process for the internal team using AI built into the matching algorithm. The next step will be to commercialize the product in limited markets with specific job competency that are roles to optimize further the matching algorithm and onboard clients with high touch.

Eventually, we envision digital engagement becoming an important part of all client talent interactions. Throughout the year, we commit to providing updates on our digital engagement, deployment progress and plans. The second priority I want to talk about is adding consulting capability to serve our clients' needs around digital transformation and user experience. We're looking to build this both organically and through a targeted acquisition strategy which will accelerate pace. In its recent research, Gartner found that 87% of senior business leaders say digitalization is a company priority. Further, 62% of CEOs say they have a management initiative or transformation program under way to make their business more digital. So at RGP, we're not alone. We know that client need exists and we know that client budgets exist to support consulting work in this arena. We therefore are committed to building a new element within our solutions business to serve the growing market demand.

We're particularly excited about the opportunities we are already uncovering in the healthcare and financial services client base. The third priority of the digital innovation group is to build products as part of our service offerings to automate both front office and back office functions. We intend these products to be repeatable and drive improved profitability. One of the products, for example, is a robotic process automation tool to drive account reconciliation faster and more efficiently. In Gartner's 2018-19 annual report on Top Insights for the C-suite, they assert that robotics is key to any finance organization's success. They also report that only 19% of corporate controllers operate RPA today. This figure is expected to quadruple over the next several years with more than 220 potential use cases for RPA in a typical back office. We also intend to deploy relevant products in our own front and back offices to increase efficiency and productivity without adding headcount for a growing business. As referenced previously, we're currently working with several clients on automation projects and this work serves as the initial foundation for our digital product development.

Next, I'd like to spend a few minutes talking about brand. In mid-June, we launched a refreshed RGP brand to celebrate the humans and humanity of how we serve our clients and engage with our consultants. From our 20 plus years of helping clients solve problems, we know that technology alone cannot address today's complex business challenges. Human experience and ingenuity remain critical elements of successful transformation, and today's top talent wants to work differently; discrete projects, not roles, impact without bureaucracy, a portfolio-driven career. Thriving companies know that the future of work is still about people.

This brand launch capped a six month research project with a boutique brand consulting firm does it to discern the exclusive and desirable idea embedded in RGP. We believe our refresh brand has the power to change perception, influence preference and command loyalty. And that's what this work was about. The brand launch included the debut of our new website at rgp.com, which articulates our brand promise and better reflects the firm's capabilities given our evolution and acquisitions. This website represents our new digital home. RGP to the power of human. If you've not visited the site yet, I encourage you to do so.

We help clients every day with technology, digital and other initiatives by putting the right people on the project team to drive execution. Like the power of hydrogen, PH, we have the unique ability to bind attracting elements together to deliver transformation and our elements are our people. That is what our RGP means by PH to the power of human. Coupling RGP power of human with the migration of client buying patterns toward project based talent and not role based talent, the opportunities for our business model remain robust. We are perfectly positioned to become the preferred future of work partner for our clients, global and local alike. We have client buyers and a talent base who actively seek expertise, agility and flexibility. RGP was built to deliver all three. We will continue to activate this brand throughout fiscal '20 and beyond through strategic investments in research, public relations and targeted marketing.

In wrapping up my opening remarks, I lead you with a research reference on one perspective about the market opportunity ahead. In its most recent July report, Staffing Industry analysts estimates that the gig economy totaled $1.3 trillion in the US in 2018, including 53 million gig workers. The figure is roughly $3.7 trillion in the global gig economy. Their definition of gig includes all contingent workers, temporary workers assigned by a staffing agency, people working via the humans cloud, other independent contractors, temporary employees sourced directly by companies and salaried employees of consulting firms on engagement with clients. This market opportunity is large and mushrooming. We aspire to own a greater share of the gig economy related to professional services everywhere we operate in the world. We are actively evolving our business to better align and deliver on this opportunity.

I'll now turn the call over to Tim for more color around our operational achievements in fiscal '19 and the priorities for the current fiscal year.

Timothy L. Brackney -- President and Chief Operating Officer

Thank you, Kate, and good afternoon everyone. I will highlight three operating initiatives that impacted our results and operations for the fourth quarter and the fiscal year, as well as provide a view into our fiscal '20 priorities. As noted by Kate in previous calls, we have been embarking on operational improvements in sales productivity, cost containment and delivery efficiency. We are proud of the results we've achieved to-date from our initiatives around sales productivity. Global revenue increased 11.4% to $729 million on an annual basis.

In North America, there are increases in average outreach, average pipeline and revenue per salesperson year-over-year. This was largely accomplished through a combination of efforts, improved sales leadership and discipline, and focused on pricing governance and aligned incentives. Note that Europe and Asia Pacific only began their sales transformation efforts in earnest during fiscal '19 and progress is nascent. We recognize that our transformation into a true sales organization is not yet complete and there is more work to be done. But we are certainly pleased with the progress we've made to-date.

Later, Herb will provide more detailed color around bill rate and gross margin in his remarks. With respect to cost containment, we are committed to unlocking operational leverage by doing more with the same. Global adjusted EBITDA increased by more than 50% on a full year comparative basis. This gain was led by North America and Asia Pacific, offset by a decline in Europe. Largely, this increase was accomplished in productivity gains, but also through a commitment to discipline hiring coupled with improved transparency and governance around discretionary spend. We remain committed to prudent investment and cost containment in all three theaters of operations. Finally, this quarter, we reorganized our advisory and project services function. A team of stellar doers whose primary responsibility is to shepherd sales pursuits and engagement delivery on our more complex projects. This group is tasked with providing improved scoping and opportunity identification at the point of sale, client stakeholder management throughout the course of the project and ultimate accountability for engagement, deliverables and results.

They will principally sell and deliver within our four main solution groups: technology and digital, business strategy and transformation, risk and compliance, and finance and accounting. This is another step in our stated goal of becoming more client-centric and providing a more seamless customer experience. In fiscal '20 we remain focused on five main priorities. The first is a global commitment to operating a world-class sales organization and making meaningful strides in the relentless continuum of demand generation and pipeline management.

Next, in Europe, we will focus on go-to-market productivity, profitable growth and cross-border pursuits. Let me quickly share a few other points on Europe. We are actively recruiting a new senior leader in Europe whom we expect to have in place in Q2. Mark Campbell, SVP and Head of Europe for the past five years, will retire in October. We have also hired a new revenue leader for the Dutch business who will join in Q2. In addition, we are currently working to refresh our German practice under the leadership of Jens Christophers, one of the founders of taskforce, who will harmonize our existing practice with that of our fast growing taskforce business, which grew nearly 40% -- 46% quarter-over-quarter. Returning to our FY '20 operational priorities, the third is increased focus on improving alignment of our supply and demand curve, which is paramount for operational efficiency. The fourth is to continue to better serve our clients around the world, a truly global remit starting with our strategic client program. Finally, delivery excellence remains a top priority as we continue our efforts to increase our mix of projects and advisory work.

I will now turn the call over to Herb for a more detailed review of our fourth quarter and year-end results.

Herbert M. Mueller -- Executive Vice President and Chief Financial Officer

Thank you, Tim, and good afternoon, everyone. I'll start by giving detail on our fiscal fourth quarter financial results and we'll then discuss the trends we're seeing in the first quarter of fiscal 2020. Starting with an overview of our fourth quarter results. Total revenue for the quarter for fiscal -- in 2019 was $182.1 million, a 0.9% decrease from the comparable quarter a year ago but increased 1.5% sequentially. On a constant currency basis, revenue increased 0.4% year-over-year and increased 1.5% sequentially. Our fourth quarter gross margin was 40.1% up 180 basis points for the prior year fourth quarter, primarily due to the improvement in our pay rate to bill rate ratio as a result of the impact of internal pricing initiatives, slightly lower payroll taxes and business expenses.

SG&A expenses for the quarter were $56.9 million or 31.2% of revenue compared to $58.9 million, 32% of revenue last year and improvement as a percentage of revenue of 80 basis points. Our net income improved to $9.4 million or $0.29 per diluted share compared to $4 million or $0.12 per diluted share in the prior year quarter. In Q4, adjusted EBITDA was $17.5 million or 9.6% of revenue compared to $13.1 million or 7.1% of revenue in the year ago quarter.

Now let me discuss some of the fourth quarter highlights of our revenues geographically. Our US revenue decreased 0.6% year-over-year and increased 0.5% sequentially. We had significant improvements in the Southeast, Chicago and the Northwest, offset by drops in Tri-State and Southern California during the quarter. Tri-State's results continue to be impacted by the trend of financial services companies moving work out of the area. For the fourth quarter, total revenues internationally were $39 million versus $39.8 million in the fourth quarter a year ago, a decrease of 1.8% year-over-year. On a constant currency basis, international revenues increased by 4.3%. Sequentially, revenues increased by 5.3%, 5.5% constant currency. Europe's fourth quarter revenue decreased 7.9% year-over-year, but increased 3.3% sequentially. However, on a constant currency basis, Europe's revenue decreased 0.6% year-over-year and increased 4% sequentially.

Turning to the early revenue trends for the first quarter of fiscal 2020. Revenue -- weekly revenues in Q1 are trending down 3% to 4% compared to last year. If the current trend continues, revenue would be in the range of $170 million to $175 million compared to a $178.5 million last year. As Kate mentioned earlier, we're positive about our forward prospects, however, there is some uncertainty in the market short term, especially in Europe. Lease accounting work is slowing. Q4 was down just under $3 million compared to our peak in quarter two. However, private companies are required to be in compliance beginning in 2020, so we still expect significant business for the next year, though at reduced levels from our Q2 peak. We expect to offset this decline with other finance and accounting projects. However, those have been slower to materialize than anticipated.

North America has continued to grow in many markets, though at a slower rate than the last several quarters. We have seen excellent growth in Atlanta, Chicago, Denver and Seattle to name a few standouts. Northern California slowed after the Christmas holidays after several years of strong growth, however, is currently rebounding. Southern California, however, continues to lag. Europe continues to struggle, though taskforce has been a brightspot as Tim highlighted earlier. Asia Pac's growth is being driven by nice progress in China and Japan.

Turning to gross margins. Gross margin for the fourth quarter was 40.1%, increasing 180 basis points from the prior year equivalent period and increasing 230 basis points sequentially. The year-over-year progress is related primarily to improved bill pay ratio driven by internal initiatives to improve pricing as well as lower payroll taxes and business expenses. The sequential increase is primarily due to improved bill pay ratio and lower costs in the company's self-insured medical program. For the fourth quarter, our gross margin in the US was 41.7% compared to 39.7% last year and our international gross margin was 33.9% compared to 33.2% a year ago. For the first quarter, we expect our gross margin to be in the 38.4% to 39% range compared to 38.2% a year ago. We've been making significant strides in improving bill rates, gross margin and new deals sold. As expected, we're seeing the impact now.

The average hourly bill rate for the quarter was consistent at approximately $124 in the third and fourth quarter of fiscal 2019, as well as fourth quarter of fiscal 2018. Bill rates are improving, however, the overall average is staying constant as a result of mix. Europe, which has the highest bill rates, had a decline in revenue, whereas Asia Pac, which has the lowest rates, had increased revenue. In North America alone, bill rates in Q4 increased 5.5% year-over-year. The average pay rate for the third and fourth quarter was approximately $62 and $64 last year. As a reminder, these hourly rates are derived based on prevailing exchange rates during each given period.

Now, looking at other components of our fourth quarter financial results. SG&A expenses were $56.9 million or 31.2% of revenue. This compares SG&A of $58.9 million or 32% of revenue in the fourth quarter of fiscal 2018 and $55.6 million or 31% of revenue in the third quarter of fiscal 2019. The year-over-year percentage improvement from last year's fourth quarter relates to lower severance, acquisition transformation integration costs in the quarter, partially offset by slightly higher payroll and benefits due to increase in headcount to support revenue growth, including approximately $500,000 of comp benefits related to the loan forgiveness of our recently appointed Chief Operating Officer. The sequential increase of $1.3 million is related to these factors. Stock compensation expense was $1.6 million or 0.9% of total revenue. In the first quarter of fiscal 2020, we expect SG&A to be in the range of $57 million to $57.8 million. We will incur onetime costs of approximately $800,000 related severance and a management retention bonus. At the end of the fourth quarter, our office count was 73, 48 domestic and 25 international.

Turning to the other components of our financial statements. Depreciation was just under $1.3 million and amortization was just under $1 million. As a result of the improvements noted above, our adjusted EBITDA or cash flow margin, which we define as EBITDA before stock compensation and contingent consideration adjustments was 9.6% in the fourth quarter, up from 7.1% a year ago. Our pre-tax income was $13.4 million in the fourth quarter, up from $8.9 million in the year ago quarter. During the quarter, we recorded a provision for income taxes of $4 million, representing an effective tax rate of 30%. Our GAAP tax rate for each of the upcoming quarters is difficult to predict and could be volatile as the rate will be dependent on several factors, including the operating results of our US and foreign locations, each of which are tax or benefit at different statutory rates and the offset of the tax benefit of foreign losses in certain locations by valuation allowances. On a cash basis, our tax rate was about 31%. Finally, our GAAP net income was $9.4 million or $0.29 per share during the fourth quarter.

Now let me turn to the balance sheet. Cash and short term investments at the end of the fourth quarter were $49 million, receivables at quarter end were approximately $133.3 million compared to $138.5 million at the end of the third quarter. Days of revenue outstanding were approximately 66 days compared to 63 days in the prior year and 66 days in the third quarter of fiscal 2019. Dividends for the quarter were approximately $4.1 million. Capital expenditures were $1 million and $6.9 million during the fourth quarter and fiscal year respectively. Three of our largest offices moved during the past year, including two in the New York Tri-State area, as well as our San Francisco office.

As mentioned in our earnings call last quarter, we are transitioning to an open office footprint to increase the collaboration of our teams and the change in concept requires an investment in new office furniture. We expect capex to be in the $1 million to $2 million range in Q1. We repurchased $7.6 million and $29.9 million in stock during the fourth quarter and fiscal year ended 2019. We are continually evaluating uses of cash to reduce debt and/or facilitate our growth both organically and strategically. During fiscal 2019, we paid down our revolver by $20 million. Our stock buyback program has $90.1 million remaining. We will continue to return cash to shareholders through our quarterly dividend while balancing debt repayment, the capital requirements of growing our business organically and strategically and fiscal prudence. Our shares outstanding at the end of the fourth quarter were approximately $31.6 million.

Now, I'd like to turn the call back to Kate for some closing comments.

Kate W. Duchene -- Chief Executive Officer

Thank you, Herb. In closing, while we made tangible progress in improving our financial fundamentals, we recognize that there is more work to do. Our strategy is to evolve the mix of business from staff augmentation, moving into project execution and advisory services are making a positive difference. In addition, the evolution of our sales organization and delivery model and our approach to incentive compensation are paying off. While these are ongoing initiatives, I am pleased to see they're already making impact.

We have operational changes we are implementing in Europe, which we just discussed and in certain markets in North America, including Tri-State, Southern California and Houston. We will have new leadership in Europe over the next 60 days and we're optimistic about the impact that Jens Christophers' leadership can have in the German marketplace. He is a proven builder and a disciplined leader. In certain other markets, we are making management changes in fiscal '20 and refocusing our sales and delivery capabilities to better align with client needs. We believe these changes will lead to improved performance and we'll be updating you during our next call regarding progress. Pardon me.

Before turning to questions, as always, I'll share our client retention and continuity statistics for the fourth quarter of '19 as they do reinforce the trusted relationships we have with our great clients. Our client continuity does remain strong. During our fourth quarter, we served 49 of our top 50 clients from fiscal '18. In the quarter, we have 278 or we had 278 clients for whom we provided services at a run rate exceeding $500,000 in fees. This was down from 316 in fiscal fourth quarter of '18. However, on a year-to-date basis, the comparison is 281 in fiscal '19 versus 266 in fiscal '18.

In addition, our top 50 clients for the quarter represented 37.3% of total revenues, while 50% of our revenues came from 99 clients. Our largest client for the quarter was approximately 2.9% of revenue. At the end of the fourth quarter, 92% of our top 50 clients have used more than one type of service or functional expertise. This penetration reflects the diversity of relationships we continue to build within our clients' organizations and reinforces our opportunity for growth. We look forward to growing a more profitable business in fiscal '20 as we evolve our offerings in the digital space and in how we engage with our clients and talent. We're excited about the initiatives we've shared on this call and the impact we believe they will have on our financial performance throughout the year.

Okay, so that concludes our prepared remarks. And we're now happy to answer any questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Michael Cho with JPMorgan. Your line is now open.

Michael Cho -- JPMorgan -- Analyst

Hi. Thanks for taking my question. Kate, like I just want my first question, I want to start with some of the digital initiatives that you laid out earlier in your prepared commentary. I guess you threw out some I guess market statistics or size of the market around why you're going approaching the digital innovation initiatives. But I guess because is there a revenue opportunity that Resources is specifically going after in terms of the commercial products that you're thinking of? I'm specifically interested in your commentary about the external human cloud platform?

Kate W. Duchene -- Chief Executive Officer

Yes. So in recent research from the same study that I referenced, I mean that marketplace is paid right now to be about $63 billion in revenue. And while there's competition already in the freelancer marketplace and for what I would call non-professional services, there's a real opportunity for a company to step forward that can drive a human cloud platform broadly across professional services. And that's what we believe we can do. So if you think about the Zappos model, for example, with regard to selling shoes, they developed a very robust digital marketplace, but they wrapped, high touching client service around that. And that was their secret sauce to become successful. And that's the vision we have for our product in the global marketplace. And I think that really sets are our opportunity apart, Michael, is the fact that we have trusted client relationships already. And that's going to matter in terms of developing a new way of engaging for talent on projects that matter to an organization.

Michael Cho -- JPMorgan -- Analyst

Thanks. And then if I just ask a follow-up to that, Kate and do you get the sense today from your clients that there's a notable segment of Resources' existing clients that want this health service?

Kate W. Duchene -- Chief Executive Officer

Yes, I can tell you that directly. I had one on one conversations with clients about it in the research phase regarding the development of this tool. And part of that, Michael, is when you think about the shifting client buyer and the demographic of client buyer, we are selling to many more millennials today than we ever did, and they are much more inclined to want to engage with us in super efficient ways that don't involve waiting until 9 o'clock in the morning or 8 o'clock in the morning and placing a telephone call. If they're up at 2 A.M, they want to send their need and they want to know that somebody is responding to it as quickly as possible. And we all know that the drivers today in the marketplace are speed and efficiency. And so we have to keep up with that. And that's really why these initiatives are, I think, critical and will be impactful for our business over the next three to five years.

Michael Cho -- JPMorgan -- Analyst

Okay, great. Thanks for the color. Just one more for me and I'll hop off. I think last quarter you had mentioned some slower client decision making or putting off project, that I think it's both in the US and in Europe. I'm just curious has that tone of conversation with your clients changed at all through this quarter?

Timothy L. Brackney -- President and Chief Operating Officer

Yes, Michael, thanks for the question. I would still say there's cautious purchasing out there. I think at the end of the last quarter, what we were seeing was definitely some of the macro trends were -- with the trade war Brexit, some of the other things that are still out there but people have sort of pushed through them a little bit and have recognized that. They can't delay some of their critical initiatives. So some of the things that got resequenced from Big Bang into something that's more modular. They're going now, and we feel a little bit more optimistic about how they're buying patterns will be in the future quarters.

Michael Cho -- JPMorgan -- Analyst

Okay, great. Thank you.

Operator

Thank you. [Operator Instructions] And our next question comes from the line of Mark Marcon with Baird. Your line is now open.

Mark Marcon -- Robert W. Baird -- Analyst

Good afternoon, everybody. I was wondering if you could talk just a little bit more about just the digital transformation strategy and just wondering if you could give some commentary with regards to how that's being received internally? Because it does -- you've always been a solution company, but it seems like culturally it's a bit of a transformation as well, both in terms of the interface as well as also some of the projects that you're working on, where it's more -- it appears more IP-centric versus F&A/audit-centric. So could you talk a little bit about that?

Kate W. Duchene -- Chief Executive Officer

Sure. And Mark, thank you for the question, and I will also start by saying this is a purposeful move. And, strategically, as we talk about the future and how we need to be able to compete more effectively and really grow this platform, we have to get more capability in technology in the digital space. You're absolutely right that the kind of talent we're bringing in now to provide digital transformation support is more design thinking talent, which clients really want in the innovation space, more solution architecture and programing support. So it is a different talent base, but we've done a lot of change management work with our existing employee group and to get them ready for this, and to understand the why behind the importance of this.

And I would say, in the early days, I think there was some hesitancy about, well, aren't we really at the core finance and accounting operations support shop? And the answer is no, we can be more. And the other answer -- comment I would give to you is that, we're being asked by many clients to help them in the digital space. There's one particular large healthcare client in -- that's out of Europe, and we're helping them with one of their most strategic digital transformation projects because they trust our way of client service. They trust the humanity we bring, which for us means our listening skills going elbow to elbow with our clients to problem solve with them and our approach to give the client credit for the successful result. We've always said and Mark, I think you know this because you know as well, RGP operates with a lot of humility and we are motivated every day to make our clients look better. So when we have a client base that is asking us to help in this arena, in my opinion, we have an obligation to start broadening our perspective, getting the right talent in our organization so we can deliver.

Mark Marcon -- Robert W. Baird -- Analyst

That's great. And then can you talk a little bit about the timeline that you're envisioning with regards to the various initiatives, because it seems like there's multiple facets to the transformation?

Kate W. Duchene -- Chief Executive Officer

Yes, I think this is, honestly, a three to five year transformation. It's not going to -- we're not going to be talking about lots of impact next quarter. But as you know, when you're building this, and I think your initial question suggested this. It takes time to transform. So, I laid out three specific priorities of the group. The digital engagement platform is well under way. So I think we'll see that product coming to market by the end of this fiscal year. Excuse me. Our product development in the RPA space will see impact this year. We already have, I would say two really viable products in the automation space. And that group is targeting to develop three to five more during the calendar year. I think in terms of really building out a consulting team that can have more immediate impact in the next 12 to 24 months, it will take targeted M&A to and we're engaged in a specific strategy to do that. So -- and we'll be reporting further on that as we make progress.

Mark Marcon -- Robert W. Baird -- Analyst

That's great. With regards to the digital engagement platform, how close are you to launching it internally because it sounds like that's the first step?

Kate W. Duchene -- Chief Executive Officer

Yes. Next quarter, I mean, I'd love to say tomorrow, Mark, and my colleagues would step on my foot right now. But I've seen the product. Our development team is hard at work. We're continuing to perfect it, I mean to get this right. There's art in the matching algorithm. So we are actively testing it as we speak right now. And I'm excited that in the next quarter, we'll be using it internally.

Mark Marcon -- Robert W. Baird -- Analyst

Great. And then with regards to the RPA product, what are the two viable products specifically do?

Kate W. Duchene -- Chief Executive Officer

So the first is a reconciliation tool, we're calling it recon bots and we sold it to some marquee brand name clients. And so now we're in the process of marketing it to several other large clients, and it's about the efficiency of the reconciliation project for a process for large organizations. The second one...

Mark Marcon -- Robert W. Baird -- Analyst

Is it specific to one area of reconciliation? Is there some specific areas that it's optimized for?

Timothy L. Brackney -- President and Chief Operating Officer

It's mostly in the finance area. It mostly, I mean, if you think about the number of reconciliations that quite large -- especially large finance, that organizations have to do using humans and also using sort of what we will call RPA lite there. There are software packages out there that help and aid in that process. What we've done is develop a product that will help reduce the need for human intervention in the reconciliation process, but also can work in harmony both with a server reduced human contingent as well as an RPA lite platform. So it's a flexible tool depending on what -- and kind of how mature the finance organization is and kind of what their desired efficiency outcome is.

Mark Marcon -- Robert W. Baird -- Analyst

Great. And then, sorry, Kate, you were mentioning another one.

Kate W. Duchene -- Chief Executive Officer

Yes, I think the other product that and I don't want to -- I don't want to get ahead of our thesis[Phonetic] on this one is more in the internal audit and compliance arena. So stay tuned. We'll be talking more about that as we're ready to speak publicly.

Mark Marcon -- Robert W. Baird -- Analyst

Okay. Great. And then with regards to just the numbers, can you talk a little bit about some of the trends, like specifically, what are you seeing? You mentioned Europe was a little bit softer as we're looking out to the first fiscal quarter of '20. Is it specific to any geography? Is there an impact from Brexit that you're seeing? We're starting to hear a little more chatter on that. So I was just wondering if you're seeing the same.

Kate W. Duchene -- Chief Executive Officer

Yes, I think, let me make a couple of comments about Europe just broadly and then maybe Tim or Herb want to add to this too, Mark. I'd say the first thing that we're seeing in Europe and this is going to hit in the UK, it started in the government sector and now it's coming to the commercial sector is a change in labor and tax regulation that is negatively impacting our business a little bit with respect to the use of independent contractors. And so we are developing and then we'll be implementing a strategy that tries to lessen that negative impact. I think it's the legislation is something, 35, I can't remember. Sorry, I [Indecipherable] thank you, Alice, our General Counsel is in the room, so she's helping me. And that legislation passed about 24 months ago, I think, in the Netherlands. And so we talked about that a little bit. So, those European countries are starting to try and claw back certain taxes that they've lost by allowing the independent contractor marketplace to get so robust. So that's one thing. And that doesn't have anything to do with us. But it does impact our business.

With respect to Brexit, there continues to be some chatter, but I actually I'm starting to hear perhaps about some opportunities related to Brexit. They haven't totally materialized, but I don't think that gives us a path to think we can't continue to pursue especially work for our largest clients that the good news, Mark, in Europe is that our largest client, which is our second largest client for the firm that comes out of Europe, is very much embracing its future of work philosophy and understanding that they want work to get done and what they're calling the open talent economy. And so we're developing a bigger and bigger relationship with them in order to deliver. And this is a global diversified consumer products business. Now, I don't know if you all have other colors, sorry.

Mark Marcon -- Robert W. Baird -- Analyst

Great. And then with regards to the US, you mentioned at least accounting, was running around $3 million. Where does that peak out?

Herbert M. Mueller -- Executive Vice President and Chief Financial Officer

No, it was running $3 million less than what it was in Q2. It was just under $10 million in Q2. So we had a pretty high run rate and then it's slowed down. We're still seeing pretty good activity. As I mentioned, the private companies that have to be compliant beginning in next year for fiscal years after December 15, 2019 are working on it. The other thing that's interesting is with some of the larger companies, some that decided not to automate their processes, they are really struggling right now to get it done as they have just gone through their Q2 and now Q3 after adoption. So we still think there's going to be a fair amount of work in both the public and private, but certainly, Q2 was a huge peak for us. As a point of reference, we're still up year-over-year in Q4 despite the decline that we had over the last couple of quarters.

Mark Marcon -- Robert W. Baird -- Analyst

Okay, great. And then you mentioned both Tri-State as well as South Cal. And then you also mentioned Houston. What's the -- what are the prospects there?

Herbert M. Mueller -- Executive Vice President and Chief Financial Officer

I think the prospects are, I mean, look, our large markets are -- our most important markets that we have if I think about this year we had sort of mixed results there. And so what we're -- I think what we've decided to do is have renewed focus from a sales leadership perspective in those markets. So some of our -- some of the sales leadership teams who are managing the larger regions are going to spend a fair amount of time in market and some of those what we call out big muscles to try to make sure that we can get those things private[Phonetic]. So we still feel very positive about the prospects there, but we know that we need to have renewed focus there, especially from the leadership perspective.

Mark Marcon -- Robert W. Baird -- Analyst

Okay. And then it sounds like you did a great job with regards to managing the pay bill spread. In terms of the gross margins, how much of it was just was also just a factor of medical costs and what are the prospects in terms of looking forward for that?

Herbert M. Mueller -- Executive Vice President and Chief Financial Officer

Yes. Looking forward on it is difficult to do because you can see some fluctuations there though. We've done a lot of initiatives to try to control that as best we can. But you never know, what you can even run into. But, it's roughly about 25% of the improvement was related to that.

Mark Marcon -- Robert W. Baird -- Analyst

Okay. I mean, was it just unusually lower number of incidents and severity? Or is it because of plan design changes?

Herbert M. Mueller -- Executive Vice President and Chief Financial Officer

It was both. And, it's -- the amount, I'd say a little bit less on the plan design, but certainly that had an impact. But -- and it's hard to equate, and some of the things with the plan design, how that affects actually your participation rates and other things, so it's hard to actually quantify that exactly.

Kate W. Duchene -- Chief Executive Officer

I'd just say one other thing about medical. And I agree with Herb completely that, it's just hard to know in any given period when you're going to get a big claim or get a group of claims that you don't anticipate. But I will say, since I joined the firm 20 years ago where we had a demographic that was almost all older personnel and experienced hire, we now, Mark, are blending in more millennial talent and more junior talent and the demographic of our workforce across the board is growing younger. And that will have an impact on our health experience.

Mark Marcon -- Robert W. Baird -- Analyst

All right. I appreciate that. And then -- and then with regards to the investments, in terms of all the initiatives, you gave us the SG&A for this coming quarter, how should we think about it as the year unfolds? I'm not looking for the specific number guidance, but just directionally how we should think about it? Because you did a really nice job in terms of increasing the margins. And just wondering if we're...

Herbert M. Mueller -- Executive Vice President and Chief Financial Officer

Right. And we'll be continuing to focus on that. But one of the key things is that you report on the development costs for the automation tools, much of that is capitalized. So even with that, I expect my overall capex to still be under $10 million. And -- but roughly, that's a good number to think about in total about what we're doing digital on an annual basis.

Mark Marcon -- Robert W. Baird -- Analyst

Great.

Kate W. Duchene -- Chief Executive Officer

But, talking about SG&A overall, Mark, we still have a goal to drive it below 30%. So while Q1 is going to be a little tough because we have them, retention and severance obligations, we know we're coming up that we'll talk more about next quarter. That's our goal is to still stay very disciplined on the expense line.

Mark Marcon -- Robert W. Baird -- Analyst

Great. Terrific. I'll follow up offline. Thank you.

Kate W. Duchene -- Chief Executive Officer

You're welcome. Thank you.

Operator

And thank you, ladies and gentlemen. This concludes today's Q&A session. I would now like to turn the call back over to Kate Duchene, CEO, for any closing remarks.

Kate W. Duchene -- Chief Executive Officer

Well, thank you, operator. And again, thank you everyone for attending the call and for your continued interest in RGP. We'll look forward to talking with you next after the close of our first quarter of fiscal '20. Have a good day.

Operator

[Operator Closing Remarks]

Duration: 51 minutes

Call participants:

Alice J. Washington -- General Counsel

Kate W. Duchene -- Chief Executive Officer

Timothy L. Brackney -- President and Chief Operating Officer

Herbert M. Mueller -- Executive Vice President and Chief Financial Officer

Michael Cho -- JPMorgan -- Analyst

Mark Marcon -- Robert W. Baird -- Analyst

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