Resources Connection, Inc. (RGP) on Q2 2021 Results - Earnings Call Transcript
Operator: Good afternoon, ladies and gentlemen, and welcome to the Resources Connection Inc. Conference Call. At this time, 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 now like to remind everyone that management will be commenting on results for the Second Quarter Ended November 28, 2020. They will also refer to certain non-GAAP financial measures. An explanation and reconciliation of these measures to the most comparable GAAP financial measures is included in the press release issued today. Today's press release can be viewed in the investor relations section of RGP's website and was also filed today with the SEC.
Kate Duchene: Thank you, operator. Good afternoon, everyone, and thank you for joining us. With me today are Tim Brackney, our Chief Operating Officer and Jen Ryu, our Chief Financial Officer. I will start with an overview of the second quarter, including the ongoing progress we are making to overcome COVID-19 impact. Then I'll share updates on our two most significant priorities this fiscal year, our digital transformation and evolving our delivery model to be more flexible, virtual and borderless to drive growth within our client base -- existing and new geos client programs and health care. This evolution also supports our focus on EBITDA improvement. I'll then share client continuity statistics to reinforce our stickiness in a blue-chip core client base and improving continuity quarter-over-quarter. Finally, I will close by touching on a few highlights from our new investor deck added to our website today. From a revenue perspective, we saw steady improvement in top line results as we move through the quarter, the impact of the global pandemic notwithstanding. In Q2, our revenue at $153.2 million with a 4% sequential improvement over Q1 and grew 6.4% when comparing revenue based on the same number of billing days in constant currency. Excluding our restructuring charges, SG&A also improved as expenses were reduced 4.7% sequentially. Adjusted EBITDA margin increased 120 basis points sequentially to 8.1% as a result of our cost reduction initiatives and expense discipline. We are continuing to pursue bottom line growth through operational efficiencies, lowered real estate investment and headcount management. In his remarks next, Tim will discuss some of the positive revenue trends that are emerging as well as steps we're taking to maximize opportunity in our core geographies, client programs and health care industry practice as we continue to position the Company for sustained success in the coming years.
Tim Brackney: Thank you, Kate, and good afternoon, everyone. During the quarter, we continued to embrace our de facto operating model of virtual delivery and utilization of borderless talent. We saw positive movement in revenue and operating metrics as well as an appreciable increase in project teams working on large client initiatives. As the overall macro environment began to improve, our weekly revenue and pipeline also gained strength. As Kate touched on, sequential revenue trended up 6.4% on a same-day constant currency basis, buoyed by increased client spend on project initiatives and some seasonal tailwind tied to year-end activities. Project management and communication became even more important with rising demand as we continue to operate mostly virtually traversing time zones to deliver projects. We've seen this demonstrated on numerous occasions, whether it be assisting and operational transformation for a West Coast entertainment client, leveraging talent from Honolulu, Miami and Houston, or assisting a Pacific Northwest Healthcare client transformed their delivery in operations with talent from Atlanta, Orange County and the San Francisco Bay Area. This more seamless matching of supply and demand has allowed us to operate with greater efficiency which was increasingly important as demand continued to rebound during the quarter. Our ability to successfully deliver in a remote fashion provides a critical qualification, which will impact the buying decisions of clients in a post-COVID environment. We believe the successful evolution of project delivery, coupled with our clients' increased leverage of the distributed workforce has permanently changed our commercial environment. It opens up our ability to fashion solutions using a mixture of traditional and virtual delivery models, bound together by our strength in Agile Co delivery, project management and commitment to holistic communication. This new market dynamic will provide a strong foundational underpinning as we enter into the second half of the fiscal year and initiate planning for FY '22, which will include expansion of client programs, leveraging broader market talent for virtual delivery and increased focus on account penetration.
Jen Ryu: Thank you, Tim, and good afternoon, everyone. Starting with an overview of our second quarter results, revenue notably improved this quarter compared to the first quarter. Gross margin was in line with our expectation given typical seasonality with Thanksgiving holidays. SG&A continues to benefit from our restructuring initiatives as well as our increasingly virtual operating model. As a result, we delivered a solid 8.1% adjusted EBITDA margin despite the ongoing pandemic. Our balance sheet remains strong, with an increase in available liquidity during the quarter and we continue to generate positive cash flow from operations. Now let me provide more color on our operating results, starting with revenue. We generated $153.2 million of revenue, a 4% increase sequentially and a 17% decrease from the comparable quarter a year ago. After adjusting for business day and currency impact, revenue increased 6.4% sequentially and decreased 15.6% year-over-year. Same-day constant currency revenue increased sequentially by 5% in North America, 14.3% in Europe and 10.2% in Asia Pac. Compared to the prior year quarter, same-day constant currency revenue decreased 16.8% in North America, 7.9% in Europe and 13% in Asia Pac. Our second quarter gross margin was 38%, down 130 basis points sequentially and down 230 basis points from the prior year quarter. The reduction in gross margin was largely due to more holiday pay as a result of Thanksgiving as well as a decline in the bill pay spread. Compared to the first quarter of fiscal '21, lower payroll taxes toward the end of the calendar year mitigated a portion of the gross margin decline. The average hourly bill rate for the quarter was approximately 124 compared to $1.23 in the prior year quarter and 1.24% in Q1 of fiscal '21. The average pay rate for the quarter was 63 compared to 61 in prior year quarter and 62 in the prior quarter sequentially. SG&A expenses for the quarter were $47.8 million after excluding $6.8 million of restructuring charges, a meaningful improvement of $6 million compared to the prior year quarter. We continue to realize more cost improvements this quarter as we make progress executing our restructuring initiatives. Management compensation costs were reduced by $2.5 million, and occupancy costs were reduced by $0.8 million compared to Q2 of fiscal '20. General business expense also improved, down $1.8 million due to reduced travel and reduced discretionary spend. Turning to the other components of our financial statements. Income tax provision was $2.3 million for the second quarter, representing an effective tax rate of 178.5% compared to 30.2% in the prior year quarter. The effective tax rate for the current quarter was driven by higher international losses, largely resulting from the restructuring costs incurred in our European entities, and our inability to realize any tax benefits due to the required valuation allowances. Adjusted diluted EPS for Q2 of fiscal '21, which excludes the net of tax impact of restructuring charges, stock compensation and contingent consideration, was $0.21 per share compared to $0.42 per share in the prior year quarter. Next, let me provide an update on our progress in executing the restructuring plan. We have substantially completed the reduction in force, including those carried out under the European plan in Q2. We set out to exit from 22 real estate locations under the restructuring plan, of which 11 have been completed. To date, we incurred total restructuring charges of $12.8 million, of which $7.8 million was incurred in the first half of the fiscal 2021. We expect between $2 million to $4 million of additional charges before completing the remaining actions, mostly related to real estate. The timing of the planned real estate exits will depend on a number of factors, some of which are not within our control, but we are committed to executing on our plan. As I mentioned earlier, we have already realized significant cost reductions in the current fiscal year as a result of these actions. We anticipate additional savings in the remainder of the fiscal year as the benefits from the European plan take full effect. Longer term, we expect to continue to rationalize our real estate footprint. Beyond what's planned under restructuring and continue to control our discretionary and travel spend by taking a blended approach between traditional and virtual methods of client engagement and delivery. Now let me turn to our balance sheet and liquidity. Our balance sheet remains strong. We ended the quarter with cash and cash equivalents of $97.2 million, up slightly since the end of fiscal '20. We generated approximately $30 million of positive cash flow from operations in the first half of the fiscal year and paid down $20 million of outstanding debt under the amended credit facility. The Board of Directors maintained a $0.14 per share quarterly dividend in the second quarter. We remain vigilant in managing our liquidity, considering the ongoing pandemic, the near-term restructuring-related cash obligations as well as other cash requirements to fund our digital transformation efforts. In the long term, we continue to evaluate our capital allocation strategy and expect to return cash to shareholders through both dividends and share repurchases. While balancing debt repayment and the capital requirements of growing our business, both organically and strategically. I'll close with our recent change in segment reporting and a discussion of third quarter trends. The execution of the European plan in the second quarter resulted in changes to our internal management structure and our reporting structure of financial information used to assess performance and allocate resources. Effective second quarter, our businesses are organized and managed in three operating segments: RGP's, Taskforce's and Citrix. RGP is over 90% of our business and drives the trends of our consolidated enterprise. Please refer to our press release and Form 10-Q for additional disclosure regarding segments. Now we'll get ahead to Q3. Average weekly revenues for the first three non-holiday weeks for the quarter was $13.3 million, we expect typical seasonality in the third quarter around our revenue as well as gross margin. From an SG&A perspective, while we anticipate cost savings from restructuring to continue, we typically experience higher SG&A in Q3 due to the reset of payroll taxes at the start of the calendar year. Lastly, consistent with our approach last quarter, we will not issue any specific revenue or earnings guidance for the third quarter of fiscal '21, given the ongoing uncertainty as it relates to the pandemic. Now we're happy to take questions.
Operator: Our first question comes from Josh Vogel with Sidoti. You may proceed with your question.
Josh Vogel: My first question, we saw some modest bill pay spread on in the quarter. And I think with regard to bill rates, when you're at the table and you try to win and deliver projects remotely, it doesn't seem affected pricing at all. I'm curious where you think that is?
Tim Brackney: Josh, it's Tim Brackney, Happy New Year. Well, we're -- a lot of the projects that we take on when you think about it, it's most -- there's outcome orientation to it. So if you think about the -- since we don't have to deliver locally, it's really about kind of what expertise do you need to deliver and how is it delivered. So theoretically, we should be able to get some actual arbitrage from that if we're able to locate from other parts of the country, and we're starting to see some of that. But the reality of it is that, we're basing our bill rates on the project itself versus the locality of the delivery resource.
Josh Vogel: Understood. And on the other side, though, with your consultants no longer having the constraint of geofencing, couldn't we assume maybe give you some leverage over time on the pay side?
Tim Brackney: Yes. That is -- and we anticipate that. And just -- it kind of comes down to you like this is still a world that everybody is a little bit getting used to. But as we sort of open up the catalog that allows us to really match talent efficiently, irrespective of locality, as you pointed out, no geofencing of talent, then we will have the ability to think about labor costs in a different way. One of the advantages that we had, I think, through this is that we didn't really -- we really erred on the side of being fair to our consultants. So as our -- we didn't negotiate downwards, and that was intentional because we want to keep our best talent with us, and we want our platform to be sticky. And so as a result of that, as demand picks up, that will be an advantage for us as we move forward.
Josh Vogel: All right. Great. And with the vaccine rollout and getting back to a normal life, hopefully, in the next few months or quarters, do you think that you can and will still have success in selling and delivering remotely. Is that going to remain the new de facto model? Or do you expect it to revert back at all?
Tim Brackney: Well, I think I definitely think there'll be modulation. But I think the most important thing about this is, when you think about the environment we went to was largely on-prem. And then we went to an environment that was all off-site. And what we've learned in that move is that there are parts of engagements and access to talent that we could that we can utilize from a virtual perspective. That doesn't mean we need to go all one way or the other. In fact, we'll start to see, I believe, teams where we'll have some on-site delivery and that will be supplemented by folks who are on-site for part of the time, and some folks who aren't on-site at all just depend on the composition of the team and the project itself.
Josh Vogel: Sure. Sure. And last quarter, you talked about some challenges on-boarding at new clients due to like some hardware and software constraints. I'm curious if that's eased at all.
Tim Brackney: It has -- those constraints are still there, but it has eased a bit. I mean, people -- we have a couple of clients to the hardware element of it was a real challenge, and they've been able to kind of get a handle on their own supply chain. But as more people are working remotely, I think everybody's found this, even in the consumer world, the access to some technology is not as efficient as it once was. It's better than it was in the second quarter, but we still have challenges.
Josh Vogel: Okay, great. If I could just sneak in two, I know I have a lot of questions. Thank you. You referenced how you're seeing good traction from your most significant client accounts and the health care client base. So I was just curious how much those clients represent the pay and maybe what that looked like a year ago and even from Q1?
Kate Duchene: Josh, I can take that. Our client program revenue represents about roughly around 30% of our revenue -- or our consolidated revenue. And it's grown sequentially to Q1, our client program revenue on a same-day basis grew almost 7%. And health care, health care is roughly around 20% of our North America revenue. And we've also seen similar growth in health care clients as well, comparing sequentially.
Josh Vogel: Okay. Great. And just last one, maybe for you, Jen. I just want to make sure I'm calculating the workdays for Q3 and Q4. Do you have that hand?
Jen Ryu: For which quarter, Josh?
Josh Vogel: Q3 and 4.
Jen Ryu: The upcoming Q3, and for Q3, Q3, our North America workdays is going to be officially 63 days. But remember, due to the timing of the Christmas and year's holiday, we do have some adjacent impact of those holidays as well as MLK Presidents Day, even though we're not officially counting them as holidays. So Q3's holiday impact will definitely be more significant than Q2.
Kate Duchene: I mean, let me just jump in there, Josh, because we don't have the day off as our roots come from accounting firms. We don't have MLK and President's day off. Many of our clients do. So we always debate should we count that as a working day or not. I think you err on the side of count - not counting it as a working day, even though we're open because so many of our clients take the day off. Yes.
Jen Ryu: And Josh, Q4 in North America, you're looking at 65 days.
Operator: Your next question comes from Mark Marcon with Baird. You may proceed with your question.
Mark Marcon: Good afternoon and Happy New Year. Wondering, can you talk a little bit about the improvement that you're seeing with regards to TRI States, California, Dallas, that all sounds like a marked improvement. Just what are you seeing exactly? Is it better execution, better leadership or is just the orders are they starting to really increase as you've repositioned?
Tim Brackney: Hey, Mark, and Happy New Year. It's -- first of all, let me just say, I mean, we have new leadership in both those markets, and we have focused teams. And so I would start there. I would say we have -- I think we've got the right people in place, and we're definitely executing better. I would also say, particularly in the Tri-State market, we are seeing some market rebound in financial services, which is nice. In the California markets, we thought we were going to see more impact in the entertainment space there. And what we've seen is that actually with some of the reorganizations and pivots that, that industry is doing, we're actually getting some tailwind from that and Northern California, where you've got a lot of technology that market, while it kind of paused a little bit, we're definitely starting to see that the tailwind related to technology is strong again. The Texas markets sort of three distinct markets. You have Houston, Dallas and you have Central Texas. Dallas and Central Texas have really been strong. And Houston, we have got new leadership there, and we are very hopeful that we'll start to see some pretty good momentum there, but out of all those markets, really with Tri-State and Northern California, starting to see some substantial steps forward in terms of revenue velocity.
Mark Marcon: That's great. And can you talk a little bit more about this kind of the cadence in terms of orders and how they built up through the quarter and then early into this quarter. Has there been any sort of pause with regards to the surge in COVID or any hesitancy? Or does it seem like, hey, we've all gotten used to the -- this environment and this uncertainty and people are continuing to build.
Tim Brackney: Go ahead, Kate.
Kate Duchene: I'll share a few thoughts, and then Tim can add some specific color. But it feels to us, and our pipe and our revenue trend is telling us that the initial panic and kind of standstill of COVID has given way to decision-making now. So the decisions may look different than they did a year ago, but we are starting to see opportunity open up. Clients moving forward on large projects, and we don't see a regional distinction. It seems like that's happening across the board with our core client base. And remember, our core client base or the larger organizations that tend to have more budget and firepower, if you will, to move their business forward.
Mark Marcon: Great. Can you talk a little bit about the size of Veracity that continues to do really well? How big is it now?
Kate Duchene: Veracity hit record revenue, and there -- I don't have that calculation right in front of me, but are, they've had -- on a year-to-date basis, there -- compared to last year, they grew, I think, roughly 8.5%. So it's pretty substantial that improvement.
Mark Marcon: Great. I mean, roughly speaking, what percentage of revenue is veracity now?
Tim Brackney: I mean, it sounds like HUGO.
Kate Duchene: I got it. It's roughly 4%. I got to do the math really quick.
Mark Marcon: Okay, all right, great. And then, HUGO, it sounds like you've got the talent management capabilities up and running. You're going to obviously test it, make sure it works exactly as you anticipate. What's the next step that you need to, to get to -- just from a technical perspective in terms of being ready for launch? I know you're waiting also for the economy to be in a good position as well so that the launch really has a meaningful impact. But just wondering where are we from a technical perspective?
Kate Duchene: Yes. So, the next element of the platform will be the client side. So that's what we're working to finish right now, Mark. And when we're done with that, we'll be ready to bring the product to market. That will be our minimum viable product, and we'll continue then from there to make certain enhancements. So you're right. There are two things at play here in terms of our time line. One is our own internal product development, and that is a lot of software development and perfecting the match algorithm. And the second is an assessment of the macro environment and is the environment ready. Because remember, we're going to launch HUGO in an adjacent market. Not where we operate right now. It's a level or two down from where we operate primarily in finance and accounting. And that kind of work may require more on-premise delivery. So we want to make sure when we launch that the market is healthy and ready for that, if that makes sense.
Mark Marcon: It totally does. And then with regards to -- obviously, this is fairly recent. But when we think about solar winds and the implication as it relates to cyber, and your push on digital transformation, what sort of impact are you seeing there? Are you seeing more audit opportunities? Is that meaningful? Is there any sort of slowdown or pause from clients in terms of any sort of initiatives until they get a better handle? What are you seeing from that perspective?
Kate Duchene: I mean I'm not aware we're seeing any pause, Tim, are you?
Tim Brackney: No.
Kate Duchene: I think we have opportunity there in terms of assessment work and audit work.
Mark Marcon: Great. And then in terms of the gross margins, how much was the health care, the increased health care utilization, a function of the lower gross margin?
Kate Duchene: It's roughly about 25%.
Mark Marcon: Okay. And so do you anticipate that continuing, Jen? Or do you think that, that was just kind of a blip?
Jen Ryu: Yes. I mean the health care trend is a bit unpredictable to a certain extent. I mean, we saw the our health care costs come down right when we entered into COVID, and it started ticking back up in Q1 and Q2 so just depending on where COVID stands and participant behavior, that's a little bit -- that's somewhat hard to predict. But I think that we've seen some kind of pent-up demand coming back in Q1 and Q2. So I don't know that it's going to materially go up going forward, but it's possible.
Mark Marcon: Okay. How should we think about the gross margins for this current quarter obviously, there's holidays, there's also going to be the reset in terms of payroll taxes. So how should we think about that relative to this past quarter?
Jen Ryu: Given the holiday impact, it's going to be more significant. So I think Q3's gross margin is going to be relatively lower compared to this past quarter compared to and if you take into consideration the payroll tax reset, so all of those are contributing factors to a lower -- to a lower gross margin percentage in Q3?
Mark Marcon: Yes. I mean, would it be in line with historical seasonal patterns in terms of.
Kate Duchene: Correct.
Mark Marcon: Okay. And then how -- and then you said SG&A is going to go up a little bit sequentially, obviously, again, because of the payroll reset and then any sort of new compensation structures but then obviously, the offset is we should have some benefits from the restructuring. How -- I mean, roughly speaking, how much of a delta should we see in terms of SG&A from a short term perspective?
Kate Duchene: Yes. I think the impact of payroll taxes. I'll just give you kind of a reference point. Normally, in Q3, our payroll taxes run about 10% and of our payroll costs versus 7.5% in Q2. So I think roughly, you're looking at -- excluding restructuring costs, you're probably looking at a couple of million or more maybe higher from payroll taxes increase.
Mark Marcon: Terrific, and then it sounds like in Europe, can you just talk a little bit about how you're able to maintain the revenue while doing the significant restructuring. It sounds like there was a really good performance there.
Tim Brackney: Yes, Mark, I would definitely say that was the case, and we have a couple of large clients over there where we have been working on both existing projects and expanding our footprint there. And again, candidly, we have a very engaged and dedicated team there that kind of soldiered through a tough situation and managed to keep our clients happy and make sure that our consultants felt connected to us. So it was, as you pointed out, it's a story of good performance.
Operator: Our next question comes from Andrew Steinerman with JP Morgan. You may proceed with your question.
Andrew Steinerman: Happy New Year, everybody. I just wanted to focus on the $13.3 million, which was the kind of the three weeks in December trend year-over-year. What kind of percentage change would that be on a year-over-year basis? And I'm asking on a same-day constant currency basis, thinking about weekly $13 million versus the year ago?
Kate Duchene: Based on the first few weeks' trend compared to a year ago, we're roughly down about 9%.
Andrew Steinerman: Okay. And that's same-day and constant currency, right, total company?
Kate Duchene: That's right.
Operator: Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Kate Duchene for any further remarks.
Kate Duchene: I just want to thank everyone for attending with us today, and we look forward to reporting after our third quarter of fiscal '21. Happy new year, everyone.
Operator: Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.
