Resources Connection, Inc. (RGP) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Resources Global Professionals’ Fourth Quarter Fiscal 2016 Earnings 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 be given at that time. [Operator Instructions] Please note that today’s conference is being recorded. I would now like to hand things over to Kate Duchene, Chief Legal Officer. Please go ahead.

Thank you, operator. Good afternoon, everyone, and thank you for participating today. Joining me on this call are Tony Cherbak, our Chief Executive Officer; and Nate Franke, our Chief Financial Officer. During this call, we will be providing you with comments on our results for the fourth quarter of fiscal year 2016. By now, you should have a copy of today’s press release. If you need a copy and are unable to access a copy via our website, please call Patricia Marquez, at 714-430-6314, and she will be happy to fax a copy to you. Before introducing Tony, I would like to read an important announcement about certain statements that we may make during this call; specifically, we may make forward-looking statements, in other words statements regarding future events or future financial performance of the company. We wish to caution you that such statements are just predictions and actual events or results may differ materially. We refer you to our 10-K report for the year ended May 30, 2015 for a discussion of some of the risks, uncertainties, and other factors, such as seasonal and economic conditions, that may cause our business, results of operations, and financial condition 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 Tony Cherbak, Chief Executive Officer.

Thanks, Kate. Good afternoon and welcome to Resources Global fourth quarter conference call. I’m going to begin by giving you a brief overview of our fourth quarter and year-end operating results. Total revenue for the fourth quarter was $152.5 million, up 2.5% from our fourth quarter a year ago, and up 3.9% sequentially. Please note that approximately nine tenths of a percent of the quarter-over-quarter increase stems from the shift in the Memorial Day holiday to the first quarter of fiscal 2017. For the year revenue increased 1.3% to $598.5 million versus $590.6 million last year, in constant currencies revenues would have been $607.5 million, or 2.9% higher compared to the prior year. The aforementioned shift in the Memorial Day holiday impacted revenues by ten tenths of a percent. Fourth quarter gross margin was 39.9% representing a 250 basis point improvement from the third quarter and was 100 basis points higher than the fourth quarter a year ago. During the fourth quarter, our SG&A costs were $44.4 million. SG&A increased by $1.9 million quarter-over-quarter and by $1.1 million sequentially. The sequential increase stems from higher marketing expenses. During the fourth quarter, we generated cash flow from operations and adjusted EBITDA of $31.2 million from $17.8 million respectively. For the quarter, our pretax income was $15.7 million. Based upon an effective tax rate of 44.9%, our fourth quarter GAAP net income was $8.7 million, or $0.23 per share. During fiscal 2016, we returned $42.2 million of capital to shareholders in the form of dividends and share repurchases. Now let’s talk about revenue trends. As we reported in April, weekly revenues during the first four non-holiday weeks of the fourth quarter averaged $11.7 million. For the remaining weeks of the quarter, weekly revenues averaged $11.8 million. After adjusting for the Memorial Day holiday, which fell in Q4 of fiscal 2015 but in Q1 of fiscal 2017, U.S. revenues were up 2% quarter-over-quarter and international revenue was flat. Our non-holiday weekly revenues have averaged $11.5 million in the early weeks of our first quarter of 2017. In addition, while Nate will provide further details with respect to our international regions, I’m pleased with the continued progress that we’re seeing in Europe. With respect to revenue growth, Europe’s fourth quarter revenues increased 13.5% quarter-over-quarter and 11.7% sequentially. This increase offset a 6.5% quarter-over-quarter revenue decline in Asia Pacific. With that I will turn the call over to Nate for a detailed review of our financial results.

Thanks, Tony. As mentioned, total revenues for the quarter were $152.5 million, up 2.5% quarter-over-quarter and 3.9% sequentially. On a constant currency basis, the adjusted quarter-over-quarter increase was 2.6% and the sequential increase was 3.4%. For the 2016 fiscal year, revenues increased 1.3%, and were $598.5 million versus $590.6 million in fiscal 2015. Adjusted annual revenue growth on a constant currency basis was 2.9%. As Tony mentioned, the shift in the Memorial Day holiday had a $1.4 million or nine tents of a percent positive impact on our revenue growth quarter-over-quarter and a two tenths of a percent impact year-over-year. Highlighting certain geographies, for the fourth quarter, revenues in the U.S. were $124.4 million, up 3.1% quarter-over-quarter and up 2.8% sequentially. For the fourth quarter, total revenues internationally were $28.1 million, flat quarter-over-quarter and up 9.2% sequentially. International revenue accounted for approximately 18% of total revenues for the quarter versus 18% in the third quarter of fiscal 2016 and 19% in the prior year quarter. Europe’s fourth quarter revenues increased 13.5% quarter-over-quarter and 11.7% sequentially while the Asia Pacific region saw fourth quarter revenues decreased 6.5% quarter-over-quarter and increased 2.8% sequentially. On a quarter-over-quarter basis, the U.S. dollar was weaker against most of the major currencies in Europe and Asia Pacific. As a result, on a constant currency basis, Europe’s quarter-over-quarter revenue increase was 12.5%, while Asia Pacific’s quarter-over-quarter revenue decrease was 7.1%. Let me now discuss early revenue trends for the first quarter of fiscal 2017. Weekly revenues for the first six weeks of the first quarter, which included Memorial Day and the 4th of July holiday, aggregates to approximately $65.5 million, which is approximately 2% lower than the comparable weeks last year after factoring in the Memorial Day shift. On a weekly basis, revenues were $10 Memorial Day week, $11.6 million, $11.4 million, $11.6 million, $11.4 million, and $9.6 million the 4th of July holiday week. And thinking about the remainder of the first quarter, it is important to remember that we generally lose about 4% or 5% of weekly revenue due to vacations taken by our consultants in the U.S. and Europe during the mid July through August timeframe. Using 96% of the non-holiday weekly average achieved during the first four non-holiday weeks of the quarter, the weekly revenue computed for the remaining seven weeks of the first quarter would approximate about $11 million per week, which yields first quarter revenue of approximately $143 million. This computation is purely mathematical and does not consider potential increases or decreases in weekly run rates over the balance of the quarter. Labor Day will fall into the Second Quarter similar to fiscal 2016. Now, I’ll discuss gross margins. Gross margin for the fourth quarter was 39.9% versus 38.9% in the year ago quarter and 37.4% in the third quarter. The 250 basis point increase in sequential gross margin stems primarily from fewer U.S. holidays during our fourth quarter, and the reduced impact of FICA taxes. Additionally, our fourth quarter gross margin was 70 basis points better than anticipated at the beginning of the quarter, primarily due to lower than anticipated healthcare costs. Excluding reimbursable expenses, our fourth quarter gross margin was 40.6%, which compares to 39.7% in the fourth quarter a year ago. The average rounded billing rate for the quarter was approximately $122, up from $121 in the third quarter and $118 a year ago. The average rounded pay rate for the fourth quarter was approximately $61, up from $60 in third quarter and $58 a year ago. Please remember that these hourly rates are derived based upon prevailing exchange rates during each period given. For the first quarter of fiscal 2017, we would expect gross margin to approximate 38.5% slightly down from the year ago quarter. Due to the impact of the Memorial Day holiday shift offset in part by lower estimated healthcare costs. For the fourth quarter, gross margin in the U.S. was 41.4% and our international gross margin was 33.6%. Our consolidated gross margin for fiscal 2016 was 38.8% compared with 38.7% in fiscal 2015. For the fourth quarter, the average consultant FTE count was 2,478. This compares to 2,480 in the previous quarter and 2,528 in the year-ago quarter. Quarter-end consultant headcount was 2,511 versus 2,516 a year ago. The total headcount at the Company was 3,283 at quarter end. Selling, general and administrative expenses for the fourth quarter were $44.4 million or 29.1% of revenue versus $42.5 million or 28.5% of revenue a year-ago. Sequentially SG&A increased $1.1 million primarily due to higher marketing expenses. The quarter over quarter increase primarily results from higher marketing and compensation and benefit costs. We believe SG&A expenses in the first quarter of fiscal 2017 will approximate $43.7 million versus $44 million in the first quarter a year ago. Stock compensation expense was $1.3 million a 0.9 of a percent of total revenue down $200,000 from the third quarter and down to $1.4 million in the fourth quarter of fiscal 2015. We would anticipate first quarter fiscal 2017 stock compensation expense to approximate $1.3 million. At the end of the fourth quarter, our office count was 68, 45 domestic and 23 international. Related to other components of our financial statements, depreciation was $900,000 for the quarter, about the same as last quarter. We would expect depreciation expense for the upcoming quarters to approximate $900,000 per quarter. Our adjusted EBITDA or cash flow margin, which we define as EBITDA before stock compensation was 11.7% in the fourth quarter a 280 basis point increase from 8.9% in the third quarter and a 40 basis point increase from the year ago quarter. For fiscal 2016 our adjusted EBITDA percentage was 10.6% up from 10.3% in fiscal 2015. During the fourth quarter on a GAAP basis, we recorded a provision for income taxes of $7.1 million on pre-tax income of $15.7 million representing an effective tax rate of approximately 44.9%. Our fiscal 2016 effective tax rate was 43.6% an improvement from 45.4% in fiscal 2015. Our effective tax rate continues to be impacted by our current ability to offset income and tax jurisdictions in which we are profitable with losses in tax jurisdiction in which we are not. Our cash tax rate continues to approximate 42%. For the first quarter of fiscal 2017 we anticipate a tax rate approximating 44%. 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 mix of operating results between our U.S. and foreign locations each of which are taxed or benefited with different statutory rates, and the offset of the tax benefit of foreign losses in certain locations by valuation allowances. In summary, our GAAP basic and diluted per share income during the fourth quarter was $0.24 and $0.23 respectively. The diluted per share change represents an increase of $0.02 per share or 9.5% from the fourth quarter of year ago. For fiscal 2016 our GAAP basic per share income was $0.82 and on a diluted basis was $0.81. On a diluted basis this represents an increase of $0.09 per share or 12.5% from fiscal 2015. I'll now turn to the balance sheet. Cash and investments at the end of the fourth quarter were $116 million, up a $19.6 million from the third quarter. The increase results from cash generated from operations during the fourth quarter of $31.2 million, offset in part by share repurchases and dividends totaling approximately $11.8 million and capital expenditures of approximately $700,000 during the quarter. For fiscal 2017 we anticipate capital expenditures of approximately $3 million net of landlord reimbursements of which about $1 million should occur in the first quarter. For fiscal 2016 the generated cash flow from operations of $38.3 million. During the fourth quarter, we repurchased approximately 558,000 [ph] shares of our common stock at an aggregate cost of $8.1 million or $14.54 per share. During fiscal 2016 we repurchased a total of approximately 1.8 million shares at an aggregate cost of $28.1 million or $15.31 per share. The shares repurchased represent 4.9% of our outstanding shares as of the beginning of fiscal 2016. Our current stock buyback program has approximately $138.6 million remaining. We will continue to return cash to shareholders through our regular quarterly dividend and share repurchases while maintaining a balance between the capital requirements of our business and fiscal prudence. Our shares outstanding at the end of the fourth quarter were approximately 36.2 million. Receivables at quarter end were approximately $97.8 million compared to $100.5 million at the end of the third quarter. Days of revenue outstanding were approximately 59 days versus 61 days in the third quarter and 58 days in the comparable quarter a year ago. Now I will turn the call over to Tony for some closing thoughts.

Thanks, Nate. Overall, I'm pleased with our fiscal 2016 operating results. On a constant currency basis revenues increased 2.9%. We improved our gross margin to 38.8% just shy of our goal of 39%, which includes the impact of zero margin receivable. We increased our earnings per share to $0.81 in fiscal 2016 from $0.72 in fiscal 2015 a 12.5% increase. Our operating performance has allowed us to return $42.2 million to shareholders during fiscal 2016. Our Board of Directors will evaluate increasing our dividend at our upcoming board meeting. As we enter fiscal 2017 our field personal remained focused on serving our clients and undoubtedly Britain’s recent vote to exit the European Union has raised many questions regarding its impact on the global economy. Approximately 10% of our consolidated revenue is derived from services provided in Europe. And less than 2% of our revenues are in the U.K. Consequently I believe our direct exposure to the U.K. is relatively small but how the uncertainty over Brexit impacts initiative based spending in multi-national companies is currently unknown. As reflected in the recent choppiness of our most recent weekly revenues and from what we hear from our client’s service teams certain companies particularly in financial services are taking a fairly cautious approach to initiative based spending. Over the longer-term organizational change typically drives demand for our services and we’ve helped several companies in the past with change in their schedules including corporate relocations providing project management and operational support. Specifically to the U.K. our current sense is that most U.K. based companies are taking a wait and see approach to the potential impact of the U.K.’s exit from the European Union. We continue to believe that implementing the revenue recognition standard will be a significant demand driver. We are just beginning to see an up-tick in activity in this area and believe the majority of the companies have not commenced significant efforts to comply with the standard. Related to clients, I’m pleased to report the following statistics for fiscal 2016. Client continuity remains outstanding. During fiscal 2016 we served all of our top 50 clients from fiscal 2015 and 2014. In fiscal 2016 we served 245 clients exceeding $500,000 in fees, compared to 229 clients served at this level in fiscal 2015. During fiscal 2016, our top 50 clients represented 39% of total revenues while 50% of our revenue came from 92 clients. Our loyal client following is reflective of our client service approach and the quality of work performed by our consultants. Our largest client for the year was approximately 2.2% of revenues. For fiscal 2016, 94% of our top 50 clients have used more than one of our practice areas, and 80% of those top 50 have used three or more practice areas. This practice area of penetration reflects the diversity of the relationships that we have within our client’s organizations. That concludes our prepared remarks, and we would now be happy to answer your questions.

Thank you. [Operator Instructions] Our first question comes from the line Andrew Steinerman from JPMorgan.

Hi guys this is Michael Chill calling in for Andrew Steinerman.

Hi.

Hi how you doing? Just a question on the gross margin impact from Memorial Day again, I think you gave us the guidance for Q1 – but what – and some of the impacts on the gross margin in Q4. What was the impact from that in Q4?

Yes I’m sorry I didn’t quite understand what you’re saying the impact from…

How was impact that you were – yes on the margin, yes.

Well since Memorial Day fell into Q1 of 2016 we basically benefit from a margin shift of about 50 basis points give or take.

Okay so in other words, the 38.5 in 1Q is also benefited from the 50 basis points as well is that the way to think about it?

Well again, any time there’s a shift in the holiday the impact of the holiday is about 50 basis, so if you think about what we said about Q1 there’s a portion of that decrease is the holiday offsetting it is anticipated lower healthcare cost so that’s driving the 20 basis points decrease in Q1.

Year-over-year, okay got it.

Yes.

Okay got it and if I could just squeeze one more in. On SG&A, the one first quarter guidance seems to indicate just the higher levels that we saw in Q4 so should we expect that kind of as a new normal or is that supposed to drop back down?

I think that if you look out over the coming quarters of fiscal 2017, I think that it’s going to probably range in that $43 million to $44 million time – $43 million to $44 million range give or take some of the seasonal impacts that we have.

Okay got it. Thank you.

Thank you. And our next question comes from the line Mark Marcon from Robert W. Baird.

Good afternoon. Thanks for taking my question. I was wondering if you could elaborate a little bit more on the weekly trends as they compare on a year-over-year basis, just for the last few weeks, and just a little bit more in terms of what you were saying with regards to the post Brexit stance that you have in some of your clients in terms of those Financial Services clients, can you talk about the magnitude of the impact you’re seeing recently – or – and then also in terms of the multinationals that might be outside of Financial Services what you’re seeing there. Thank you.

We’re just seeing a little bit of uncertainty creating very cautious spending environment. We’re still doing quite a bit of work for the Financial Services clients. There’s still a lot of regulatory compliance, we’re doing a lot of data, data solutions work for them, but with Brexit, it just – it’s kind of created just one additional level of uncertainty for multinationals that kind of goes along with the low interest rate environment, kind of the lower trading revenues, banks are obviously struggling with their own top line growth and concentrating on saving costs and that obviously impacts consulting spend.

Sure.

Mark one thing I would just add to that, if you think back when we commented last quarter about the trend comps starting at the beginning of the calendar year, we saw somewhat of a decline in demand in the Financial Services and then as we got into the Spring, it started bouncing back. So they are still facing, I think, quite a bit of regulatory pressure in different avenues. So I think as Tony said that our team still feels demand, it’s not like a cliff or anything like that, but there’s clearly cautiousness. And I think that’s why we’re seeing if you look at the first non-holiday weeks of the quarter were trending about 2% down.

And so, I mean when we are getting that 2% down on a consolidated basis I was wondering in the Financial Services vertical which is if I remember correctly about 20% of the revenues.

Correct.

Is that trending down more like 5% to 10% or is it too early to tell…

Mark it’s about 9% off in Q4, 2% for the year.

Okay. And then what are you seeing in terms of the energy [ph] vertical?

The what? The energy vertical? Sequentially, that actually improved. Sequentially was up about 5.5%, quarter-over-quarter, still down about 13%, but again, sequentially gives us some optimism there.

Well that’s good to hear. And then I appreciate the clarification with regards to the UK that’s being 2%, can you talk a little bit about what you’re seeing just in terms of some of the reaction on the continent, particularly in terms of your Dutch office, your Swedish office, are you continuing to see improvement there?

Yes, in the Netherlands the business is going well, Sweden is doing well, Ireland is doing well, France is doing well and actually this last quarter, the UK did fairly well. I think as it relates to Brexit, nobody really knows at this point in time there’s a lot of speculation on what might happen, but it’s so fresh and there’s so many things for the UK to do to actually exit the European Union. I don’t think they understand really what’s going to ultimately be the case in terms of the change. But one thing that I know is that our business thrives on organizational change and we hope that we can help companies deal with whatever issues they face in terms of, for example, if a bank needed to move their headquarters out of London to Brussels, we could certainly help them with doing that because we’re doing it right now with a big automotive company we’ve also done it with a big defense contractor. So we’re going to try to do whatever we can to help in whatever change comes about from Brexit.

Great, and then can you talk a little bit about Rev Rec and what you’re hearing from clients. Because we did some checks and from what we can tell, FASB is still on track with the deadlines but it doesn’t sound like there’s as much action popping up as one would think when those deadlines are starting to approach.

Yes we’re still – right now we’ve seen kind of an uptick in activity in terms of proposals. We still have the belief that companies are kind of dragging their feet a little bit on this and the majority of companies have not really started the effort to comply with the standard. So we believe that it’s coming, and like I said, we’re encouraged by the recent State of proposal activity that we’ve had. We hope that we can now convert those proposals into wins and projects.

Can you just, I mean, talk a little bit more about that proposal process, I’m assuming it’s your clients are coming to you and saying, we are looking at this…

Yes, you bet. It’s all over the…

Can you just elaborate a little more in terms of…

It’s all over the board Mark, anything from like full on assessments, limited assessments, reviews of contracts that are applicable to the standards, design and implementation of systems around it or just project management and execution of the actual process of complying with the standard and actually across a very broad base of industries: telecom, technology, manufacturing, consumer projects, consumer products and logistics, energy, you name it. So it’s very broad based as you would expect because it’s applicable to every public company and then after that the private companies, but we’re encouraged.

Great. And so I mean based on what you're currently seeing, when do you think it would translate to some results that would be noticeable from a revenue perspective?

We're hoping over the next couple of quarters over the balance of 2017.

Okay, great. And then with regards to your gross margin, I appreciate the Memorial Day clarification. As we look towards the balance of the year, are you seeing any signs of requirements from some of your consultants for higher pay rates? We're starting to see some signs of wage inflation come through. I'm not sure if you're seeing it or if you think that that's going to have any sort of impact?

Mark, I think, we feel when we look at gross margin and you look at the bill and pay rates and you look at the data I gave, the pay rates have crept up a little bit, but the bill rates have improved as well. So I think there's that pressure out there, I think our teams have done a good job with bill rates. And I think it's something that we’ll be able to continue to manage. As Tony said, I think, our goal was to be able to report a 39% annual gross margin. We came just shy of that. And so, I think we'll be able to manage through that. I've heard it maybe some of the lower ends of intellectual capital that that might be a bigger issue.

Yes. And that's what we were seeing it.

Yes.

With regards to this planned investments for this coming year, how should we think about CapEx? And any sort of incremental SG&A plans?

I would tell you, currently, I think as I had said in the prepared remarks with kind of anticipating CapEx of about $3 million. Now that can be net of some of the landlord reimbursement we get. And then I think as I commented earlier from an SG&A standpoint, as we sit here today, I think a run rate and it will bounce around a little bit, but in that $44 million per quarter range on an average basis is probably reasonable. We’ll see as things go on as things like rev rec as that ramps up, we may make some investments there, but we've also done a fair amount of hiring in that space to position ourselves. So…

Okay, great. And then from a board perspective, it's obviously the board’s decision, but what feels comfortable in terms of a payout ratio assuming that revenue is somewhat flattish given the environments where we have some puts and takes in terms of exit versus rev rec?

I think, as we said, our longer term goal is to continue to increase that net dividend on an annual basis. So, I think, we'll talk to the board about that in the next few weeks. But I would say, we're necessarily targeting to a specific payout ratio. Clearly, the cash flows and the like suggest that there's room, but we'll go through that with the board.

Great. And then Nate, we've enjoyed working with you. I'm wondering any chance that you'll hang with us for a little bit longer in terms of or are there some announcements or progress that's being made on that front?

Mark, we're going to be in a position probably to announce the new CFO for the Company within the next couple of weeks.

Okay.

So as much as we would like Nate to hang around, I think that he's got other ideas and he is going to be off the retirement, so we wish him well.

Absolutely.

Absolutely, long-time.

Thank you very much. I appreciate it. Nate, all the best.

Thanks.

Thanks, Mark.

Take care, Mark.

Take care.

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to Tony Cherbak for any closing comments.

Thank you, operator. Well, thanks everybody for your continued support and your interest in Resources and we'll look forward to catching up with you on the next update for the first quarter of fiscal 2017. Thank you.

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone, have a good day.