Resources Connection, Inc. (NASDAQ:RGP) Q2 2024 Earnings Call Transcript

Resources Connection, Inc. (NASDAQ:RGP) Q2 2024 Earnings Call Transcript January 3, 2024

Resources Connection, Inc. beats earnings expectations. Reported EPS is $0.1444, expectations were $0.11. RGP isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, ladies and gentlemen, and welcome to the Resources Connection, Inc. Conference Call. Currently, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. At this time, I would like to remind everyone that management will be commenting on results for the second quarter ended November 25, 2023. They will also refer to certain non-GAAP financial measures. An explanation and reconciliation of these measures to the most comparable GAAP financial measures are included in the press release issued today. Today’s press release can be viewed in the Investor Relations section of RGP’s website and filed today with the SEC.

Also during this call, management may make forward-looking statements regarding plans, initiatives and strategies and the anticipated financial performance of the company. Such statements are predictions, and actual events or results may differ materially. Please see Risk Factors section in RGP’s report on Form 10-K for the year ended May 27, 2023, for a discussion of risks, uncertainties and other factors that may cause the company’s business results of operations and financial condition to differ materially from what is expressed or implied by forward-looking statements made during this call. I’ll now turn the call over to RGP’s CEO, Kate Duchene.

Kate Duchene: Thank you, operator. Good afternoon and Happy New Year. Thank you all for joining us today. In Q2, we delivered solid performance across the enterprise despite a macro environment that continues to be sluggish and uncertain. This quarter can be characterized by green shoots and continued tenacity. Again, we have shown well with respect to engagement extensions and client retention, and our pipeline finished the quarter strong. As we shared last quarter, new project initiation has been slower to materialize and opportunities have pushed to the new calendar year. On revenue, we performed in the stronger half of our guidance range while also continuing to deliver strong cash flow this fiscal year. On SG&A and therefore, adjusted EBITDA, we’ve well exceeded our expectations as we continue to remain disciplined on cost in this environment.

Our balance sheet remains pristine. During Q2, Veracity delivered sequential revenue growth, earning new business from the sustained appetite for digital transformation services and capabilities. We also expanded Veracity’s digital presence across the Asia-Pac region through the acquisition of CloudGo, a digital transformation firm and elite ServiceNow partner. We’re excited about this acquisition, the exceptional talent this adds to our company and we are already beginning to see synergies between Veracity and CloudGo. The Northern California market, which I had mentioned last quarter, also grew sequentially. And again showing positive movement in the tech sector after more than a year of decline. Regional performance in rest of North America reflected the overall choppy operating environment with clients remaining cautious about new spend until there is greater clarity around interest rates and economic direction.

Our Mexico, India, Philippines and Switzerland practices all grew both sequentially and year-over-year as we delivered major projects for large strategic clients. Our pricing initiative in the U.S. is progressing well with a 1.3% increase in bill rate year-over-year. As you’ll hear more from Jen in a moment, Europe showed even stronger improvement in pricing. Turning to our operational metrics. We’re pleased that the pipeline remains steady through the quarter. And in post quarter December, more extension opportunities in the pipe were converted into close one engagements. In Europe, pipeline grew throughout Q2 as clients engaged in planning discussions for 2024 and pent-up demand around technology transformation and transaction support moved to the forefront.

Our Asia-Pacific business, particularly in India and the Philippines continue to show demand strength from our large global clients as they increasingly move more activity to offshore global business service centers. Across all geographies, we’re experiencing an uptick in in-person client meetings, which is a positive indicator that clients are engaging and planning for projects to get underway in the new calendar year. Given the areas in which we’re seeing consistent and rising demand for professional services, especially digital transformation and cloud technology support we believe we are well positioned to capture market share in 2024 and beyond. As mentioned last quarter, we closed more business related to cloud ERP implementations and optimization.

Our pipeline is heavy with opportunity at large and middle market companies to implement and unlock the value of technology and prepare for the implementation of AI with improved data governance and business process standardization. This is exactly the type of work for which RGP shines and can deliver significant value. In our financial services practice, we see rising demand for regulatory remediation, another area of strength for RGP. In health care, we’ve built an offering to support revenue cycle optimization and claims reimbursement capture and our large provider client base. These opportunities are significant longer term and allow us to get deeper into our A+ client set, which creates cautious optimism that revenue conversion will improve in 2024.

During Q2, we completed additional research around client decision-making to help us prepare for what’s next. We pulled 1,000-plus leaders from companies with at least $1 billion in revenue to understand what’s on the agenda and how our capabilities line up to that need. We found that transformation initiatives are a priority as large organizations are taking on an average of $21 million-plus transformation initiatives this year alone. They also report finding the right skill sets for critical transformation initiatives has become more complicated in an ever more disrupted world. Our research further uncovered that a hybrid workforce strategy that blends internal talent with skilled outsiders enables company to realize competitive advantages by building constant transformation into their core DNA.

We refer to this approach as the dynamic workforce model, and we believe it is becoming increasingly more prevalent in business today. Adoption of the dynamic workforce model is being accelerated by transformation overload as our research uncovered that only four in 10 organizations reported they had enough internal talent to staff all their planned initiatives. This research matches with the Manpower Group Employment Outlook Survey reported in December. In that survey, which included an even bigger pool of 40,000 plus employers across 41 countries 75% of respondents reported they’re struggling to find the skill sets they need. These skills shortages have wide-ranging impacts on transformation initiatives, ranging from project delays, missed critical goals and more difficulty in achieving operational change.

Thus, based on our research, the proportion of outside talent on transformation teams grew to 45% in 2022 and is expected to reach 48% this calendar year. Connecting this research to our business model, we are highly encouraged. The global pandemic proved once and for all that highly skilled talent can collaborate effectively regardless of location or FTE status. C-suite leaders recognize the power of hybrid talent models, and we’re seeing more CEOs and CFOs work with HR leaders to adjust talent strategy accordingly. The talent side of the equation is equally embracing these ships. Expert talent is actively choosing to pursue their professional passions in a more independent way. In fact, we’ve consistently seen our retention rates increase in recent years, now even exceeding those reported by the traditional partnership models.

The choice, transparency and control and client engagements, we offer our consultants is a key differentiator. These attributes also serve to create a client experience that is differentiated for the good. Experts who choose their projects feel more empowered, engaged and committed to the client’s success. In short, we may have been ahead of our time when we launched the first agile professional services business model 20 plus years ago when we spun off from Deloitte. We are now emboldened to see that today’s clients and talent and like are eager to embrace what we have built and perfected. Our focus for the rest of the fiscal year is on the execution of three strategies: First, we will continue our diversification path, expanding consulting services, especially in digital and technology transformation.

As we have earned trust with our clients, they have asked us to deliver more strategic advice, including assessments, tools, methodologies and expert talent. We acquired Veracity in 2019 and the start of this strategy, and it has been a successful combination. We most recently added CloudGo to continue the expansion of this strategy globally. We will also continue to scale such targeted consulting services with our Agile Expert business. Second, we will execute our talent strategies to build in-demand pools of talent around the world that can be used to quickly assemble blended delivery teams. These teams can be built to grow our consulting assets faster and we’ll improve our win rates by offering clients blended rates and intellectual arbitrage.

We’ve established two centers of excellence this year in Manila and India and have made good progress in growing these talent hubs. Finally, we will continue to push forward our technology transformation initiative to drive even greater operational efficiency and financial performance as one global enterprise. We’ll soon launch the first wave of the technology transformation initiative benefiting our global talent function. We’re excited that this enhanced software will improve our supply and demand match and enhance our global service to our clients. Jen will share more detail in her remarks. In sum, we’re working hard throughout our organization to close every business opportunity with creativity and grip. At the same time, we are retaining the best consultants and improving operations with streamlined process, improved technology and global connectivity.

The macro environment is not easy, and far from standing still, we are aggressively optimizing our business to quickly capitalize when conditions improve and to deliver long-term value. We have what business needs today. I’ll now turn the call over to Jen.

Jennifer Ryu: Thank you, Kate, and good afternoon, everyone. This quarter, we achieved $163.1 million of revenue, which was in the upper half of our outlook range provided in October. Our run rate SG&A of $47.4 million was significantly better than the favorable end of our run rate SG&A outlook of $53 million to $55 million. Notwithstanding an uncertain macro environment, we produced solid adjusted EBITDA of $16.1 million or 9.8% adjusted EBITDA margin and have delivered $54 million of free cash flow in the last 12 months. On a same-day constant currency basis, revenue declined by 19% year-over-year as our clients continue to be cautious with the pace of spending in the face of the uncertain macro conditions. Regional performance was reflective of the overall environment.

In North America, although certain pockets such as Northern California, Atlanta and Veracity have started to show signs of recovery compared to the beginning of the fiscal year. Many major markets were still affected by the broader economic environment. Our Europe and Asia-Pacific regions performed relatively better with more modest declines of 9% and 10% year-over-year on a same-day constant currency basis. Markets such as Switzerland, India and the Philippines grew over the prior year quarter as well as sequentially, primarily attributable to project opportunities with our large strategic clients. Operationally, our growth pipeline remained resilient during the quarter, while the velocity of converting new opportunities in the pipeline to actual engagement remains slow, extensions on existing engagements have been healthy.

Our solid pipeline suggests that demand, in fact, exists, and it’s a matter of when, not if clients will move forward with the execution of their initiatives. These opportunities represent real upside for our business as macro conditions improve. Gross margin in the quarter was 38.9%, reflecting a heavier mix of business in Europe and Asia-Pacific, which typically carry higher pay bill ratio compared to North America. Gross margin in the second quarter also reflected a 90 basis point adverse impact from the spike in health care costs. As a sponsor of a self-insured medical program, we know the number of medical claims can spike from time to time. But in general, we do not believe the trend this quarter is indicative of our health care costs in the foreseeable future.

Next, I want to provide an update on our pricing initiative. We’re seeing more competitive pricing pressure in the current environment, even against this backdrop, our U.S. average fill rate rose more than 1% compared to the second quarter of fiscal 2023, and Europe was up 5% on a constant currency basis. Average bill rates in both regions also improved on a sequential basis from Q1. However, due to the shift in revenue mix to regions with lower bill and pay rates enterprise average bill rate for the quarter was $121 constant currency, down from $128 a year ago, while the average pay rate was $58, down from $60 a year ago. Strategic pricing will be a continued point of emphasis and expansion for the rest of fiscal ’24 and beyond. Turning to SG&A.

Our run rate SG&A expense for the quarter was $47.4 million, which, as I noted, was significantly better than our outlook range. Variable compensation expense was favorable in the second quarter, aligning with the company’s overall financial performance this fiscal year. In addition, the reduction in force we executed at the start of the second quarter contributed approximately $2 million of SG&A savings in the quarter. Restructuring costs associated with this effort was $2.3 million, and we expect $10 million to $12 million of annual savings on a go-forward basis. Effective tax rate this quarter was 43%, largely attributable to an outsized amount of stock option expirations and the capitalization of acquisition costs for tax purposes. Turning to liquidity.

We’re proud of our ability to continue to generate robust free cash flow despite the macro environment. We distributed $4.7 million of dividends during the quarter and repurchased $5 million worth of common stock at a weighted average price of $14.13 per share, leaving $45 million available in our share repurchase program at quarter end. Pursuant to our stated strategy to expand our digital consulting business, both organically and inorganically, on November 15, we closed the acquisition of CloudGo, a digital transformation firm and an elite ServiceNow partner in the Asia Pacific region. CloudGo’s strategic capabilities and regional positioning will play a key role in our growth plan. together with Veracity, this combination will position us better to support our clients globally.

Initial cash consideration of $7.7 million was paid during the quarter while remaining consideration of up to $12 million will be determined by CloudGo’s performance against a set of target performance metrics over a two-year earn-out period. CloudGo did not contribute significant revenue or EBITDA to our second quarter results. We ended the fiscal quarter with $95.8 million of cash and cash equivalents and zero outstanding debt, with total available financial liquidity of $269 million at the end of the second quarter, our capital allocation will be focused on investing in the most impactful areas of the business, including completing our technology transformation project and continuing to pursue a disciplined M&A strategy to accelerate long-term growth and profitability while continuing to return cash to shareholders through dividends and by opportunistically repurchasing shares.

Now let me provide an update on our technology transformation project. We have made tremendous progress and plan to go live with a set of new talent management and contract management systems in North America during the third fiscal quarter, followed by our financial systems go-live planned for later in the calendar year. The new platforms will not only improve the efficiency of our business processes and enhance data visibility for better decision-making, they will also provide a much more favorable experience for our clients, consultants and employees. We incurred $4.4 million of implementation costs in the quarter, of which $2.8 million was capitalized with the remaining $1.6 million included as non-run rate operating expense. I’ll now close with our third quarter outlook.

While it has certainly been a challenging year, we are encouraged that our weekly revenue has been stable over the last 13 weeks. We expect the pace of revenue conversion from opportunity to close to remain sluggish in the third quarter. After giving effect to the holiday impact in Q3 and including CloudGo, we project revenue to be in the range of $150 million to $155 million. Gross margin in Q3 will be compressed by the typical seasonality during the holidays, including the reset employer payroll taxes at the start of the new calendar year as well as the current global revenue mix with a higher proportion of revenue coming from Europe and Asia Pacific. We estimate gross margin in Q3 to be in the range of 35.5% to 36%. We expect our run rate SG&A expense to be in the range of $51 million to $53 million, which includes CloudGo’s SG&A expense and again, reflects the increase in employer payroll taxes at the beginning of the calendar year.

Non-run rate and noncash expenses for the third quarter will consist of approximately $2 million of technology transformation costs and $3 million of stock compensation expense. In closing, while we acknowledge the headwinds presented by the prolonged market uncertainty, we also see compelling opportunities ahead as macro conditions start to recover. And we’re ready to execute and excited about our business model and long-term outlook. With a durable variable cost model, a pristine balance sheet and ample liquidity, we believe we are well positioned to continue driving long-term value creation for our shareholders. This concludes our prepared remarks, and we now will open the call for Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions]. Our first question comes from Stephanie Yee with JPMorgan. You may proceed.

Stephanie Yee: Hi. Good afternoon. Can I ask for the revenue guide that you gave for the third quarter, what’s the implied revenue decline on a constant currency same-day basis?

Jennifer Ryu: Hi, Stephanie. The full year guidance at the top of the range at $155 million is approximately a 17% year-over-year decline on a same-day constant currency basis.

Stephanie Yee: Okay. Great. And then could you help us understand how much of CloudGo was included in the third quarter outlook. And I guess how much on an annual basis, CloudGo is expected to contribute to RGP.

Jennifer Ryu: Yeah. We don’t expect very material immediate impact on our financials from this acquisition. This acquisition is more strategic in nature. We believe that this is going to enhanced our capabilities to serve more clients, and there’s a lot of tremendous amount of synergy to drive future value. So given the size of the acquisition, we’re not disclosing their financials.

Stephanie Yee: Okay. Sounds good. Thank you.

Operator: Thank you. One moment for questions. Our next question comes from Mark Marcon with Baird. You may proceed.

Andre Childress: Hey. This is Andre Childress on for Mark. I appreciate you taking the questions and Happy New Year, everyone. So Kate, last quarter, you talked about some green shoots and you talked about those same green shoots as well this quarter with regards to the pipeline. As we get to the end of the year, we ended the year, what are you seeing and hearing from your clients with regards to their expectations for calendar 2024, now that budgets are set?

Kate Duchene: Yeah. I still think that we’re seeing more opportunity around digital transformation, as I said in our prepared remarks and continued optimization of cloud ERP opportunity. In fact, today, Andrew — Andre, I got another request from a client to introduce our services around cloud, ERP, both system selection and implementation services. And there’s a lot of wraparound work tied to that, which is around data governance, data cleanup, and process improvement. So that’s really where we’re still seeing opportunity in our conversations with clients. I do expect in Europe that we might see some uptick around transaction work. especially around decisions to divest business, and we’re in conversation with a couple of large clients about how we could support some divestiture strategy.

Andre Childress: That makes sense. And last quarter, you also laid out expectations in terms of a softer first half for the calendar 2024 year and then the back half stronger as things have progressed over the past three months, how have those expectations changed or how should we think about that?

Kate Duchene: Yeah. I think unfortunately, the close of 2023 — calendar 2023, has still been sluggish. And it’s a crystal ball to say exactly when we’ll see the shift occur. I think every client is looking for a little more macro certainty and getting more clarity around economic conditions, especially around interest rate decision-making. So that continues to be a little sluggish. As Jen said in her prepared remarks, we believe it’s a matter of when, not if. And so we stay very ready to support these initiatives that our clients are talking to us about. It’s just getting them to pull the trigger. And that is all business decision-makers getting a little more comfort and a little more optimism about where the economy is headed.

Andre Childress: That makes a lot of sense. And then one more for me and then I’ll hop back in the queue. Jen, you had some commentary about competitive pricing dynamics. Could you just explain a little bit more about what you’re seeing in the market from a pricing perspective, particularly in the U.S.

Jennifer Ryu: Yeah. Sure. I mean the pricing environment has gotten tougher as all of the professional services firms are competing for, in general, a smaller pool of work. When we compete against the big four, they’ll often have offshore operations and blended teams, and that averages down the rates and making it tougher to win the work. And that is another reason I think Kate alluded to or talked about in her remarks, is this another reason why we’re building our offshore talent pool to stay competitive. And on the other side, when we’re competing against staffing firms and they’ve been racing to the bottom on pricing to win work. So that’s where kind of the competitive pressure is coming from. With that said, I think new work is getting more challenging on pricing, but we are still working through to catch up on pricing on our existing MSAs. So far, we haven’t really had much pushback from our clients with this regard.

So I think we’ve done a really great job over the last multiple quarters, 6 to 8 quarters to raise our pricing, and I think there’s still probably some room to go there.

Andre Childress: Sorry, just one more follow-up, just given you touched on it. So the center — the centers of excellence that you’re building out internationally. Could you just talk a little bit more about that strategy and how you think about that building out over the next few quarters and integrating that and blending that with your other talent pools as we think about that going forward? Thank you.

Kate Duchene: Yeah. Andre, I’ll jump in here. I talked about it a little bit in my prepared remarks. We, for example, just won a big piece of work with Veracity for a financial services client that’s continuing their digital transformation. And the reason we won the work is because we are blending, not only rates but we have tapped into a very strong talent pool in India around ServiceNow capability. So it’s not just being able to bring labor arbitrage and the cost of labor down. It’s also finding the talent that the world needs today. I mean as I mentioned, our own research and the manpower outlook from December still highlights that finding the right skill sets is one of the biggest challenges as every company is continuing to digitize and introduce more and more technology and AI into what we do.