Resources Connection, Inc. (RGP) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Resources Global Professionals’ Fiscal 2019 Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instruction will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today’s call, Ms. Alice Washington, General Counsel. Ms. Washington, you may begin.

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; and Herb Mueller, our Chief Financial Officer. During this call, we will be commenting on our results for the second quarter of fiscal year 2019. By now you should have a copy of today’s press release. If you need a copy or are unable to access it on our website, please call Shannon McPhee at 714-430-6363. I would like to remind you 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 may cause our business, results of operations and financial conditions to differ materially from the 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.

Thank you, Alice. Good afternoon and welcome to RGP’s 2019 second quarter conference call. Here is a quick road map for my remarks. I will start with a brief overview of our operating results for the second quarter; next, I will update you on the progress of the businesses we acquired during fiscal 2018; third, I will discuss the primary growth drivers in the first half of the fiscal year; fourth, I will review our progress on the two enterprise objectives for fiscal year 2019, which I outlined during our last call; and fifth, I’ll share a few thoughts on the macro environment for our consulting services and what we are hearing from clients. First, to our operating results. Our total revenues for the second quarter of fiscal 2019 were $188.8 million, which represents an increase of 20.5% over the second quarter a year ago. We are pleased that all three regions again reported growth year over year. North America grew approximately 25%, Europe grew 1%, and Asia Pac grew 4.4%. This was the 12th straight quarter of growth for Europe. We’re also pleased by SG&A improvement this quarter. Year-over-year, SG&A improved by 120 basis points. Sequentially, the improvement was 250 basis points. We still have some transformation in severance costs in our Q2 numbers that will continue to reduce over the balance of the fiscal year. We achieved $20 million in adjusted EBITDA or 10.6% of revenue compared to $13.4 million, or 8.5% of revenue in the year-ago quarter. We intend to deliver more profit to the bottom line through a combination of careful headcount and compensation planning, expense management, improved pricing, and expanding our mix of business to higher-value services. Over the past two years, we’ve been focused on building capabilities beyond staff augmentation and fully into project execution and solutions deployment. We continue to make progress with this shift, which we believe will drive greater return to the bottom line. Herb will share further detail regarding our financial results during his discussion shortly. My perspective on our improving results is that top line growth is happening as we execute on our go-to-market initiatives. These initiatives include focusing our client service and technical sales teams to spend more time in front of clients, aligning our incentive compensation programs to sales growth and improved margin, and utilizing an energized business development team and sales practices to create velocity with new client acquisition and large client penetration. Next I want to share a quick update on the two acquisitions we completed in fiscal 2018. First, taskforce Management on Demand, the acquisition we completed in August of 2017 is growing ahead of plan. This business is the premier C-level interim and project management firm in Germany, focused on serving the middle market. Revenue continues to trend up in Q3. Accretive Solutions, the U.S.-based finance technology and business transformation firm serving the middle market, which we acquired just over a year ago, has performed in line with expectations. As we discussed previously, we now have completed the full integration of this team, so drawing a bright line through our revenue is no longer possible. We continue to develop meaningful revenue together, revenue that we would not have won as independent companies either because of expertise or global reach. The standalone business from the Accretive acquisition, Countsy, continues to grow and is trending positively in Q3. This business, which operates with a distinct brand and business model, serves as an outsourced finance and accounting and HR services partner for venture-backed start-ups and divested companies. Now I’ll provide an update on the growth drivers in the business that we discussed during our last call that are still relevant in the current quarter. First, our solutions practices, especially transaction services and technical accounting continued to produce strong results. Our solutions practices are up 36% year-over-year. The leading driver continues to be the technical accounting practice, where we are helping clients comply with new accounting standards, particularly the new lease accounting standards. We are working with clients large and small on data extraction, software implementation, and reporting compliance. Many of these projects have been won in competition with the Big Four. Since we have invested in partner-level subject matter experts, who provide the right insights and quality control, we’re well-positioned to deliver this work. We have also built strategic alliances with two of the leading lease software providers and are referring business to one another. The trends in this solution area remains strong as we enter Q3. The deadline for public company compliance with the new lease accounting standards is January 2019. But we foresee a tale of need with public and private company compliance through the balance of calendar 2019, because compliance is more onerous than clients expected and the accounting disclosures more robust. Another notable area of strength for our business is project management services for large companies. I’ve discussed this trend on the last few calls, but it remains relevant as most of our large clients are executing transformational change projects: Technology, automation transactions that are global in scope and need to be delivered with a co-execution partner. This means that clients no longer want to outsource execution, but want to maintain control of the initiatives with the help of a partner. At RGP, we are now even better prepared to deliver this work, because over the last 18 months, we have built our own customizable project management and change management frameworks for project execution. We have fully trained approximately 1,000 consultants in North America and have additional training underway in all regions. We continue to differentiate ourselves by the level of expertise we bring around the globe, delivered by an integrated, dedicated client account team. In Q2, we also saw double-digit growth in our Strategic Client Program, which we refer to as SCP. The strategy behind the SCP program is to grow by enabling a global team to penetrate deeper into a client, delivering seamless service and depth of knowledge. This strategy is paying off as we continue to expand our opportunities to new buyers and new categories of work within these designated clients. Our investment in technology infrastructure was important to this strategy as before we did not have the ability to work as efficiently and seamlessly for the clients’ benefit. Finally, I’ll update you on our priority enterprise objectives that I laid out during our Q1 call. The first is a focus on gross margin improvement. As I mentioned earlier, we are expanding our mix of business to deliver higher-value work in our client base through project and solutions delivery. Since these engagements are led by partner-level talent, the associated bill rates are significantly higher than staff augmentation engagements. We are also implementing an institutional pricing approach, ensuring our bill rates for project and solutions work are appropriate and ensuring our bill rates for staff augmentation work reflect the caliber of talent we deliver. In the first six months of this fiscal year, we have seen bill rates improved year-over-year and sequentially in North America and Europe. Our efforts have not had real impact yet to our financial results, but we believe they will in calendar 2019, as we remain focused on our enterprise pricing strategies. The second priority initiative is a focus on cost containment and driving down SG&A as we continue to evolve. We’ve made progress in lowering our cost structure this quarter and we’ll continue to focus on driving better leverage amongst our revenue delivery and talent functions. We also have reviewed and reconstituted certain positions in our client service and talent teams to onboard talent with a lower-cost basis and the runway to grow in the senior positions. As we embark on 2019, we are hearing more talk about business slowdown globally. For example, China has reported slower growth in 2018, the UK economy has been disrupted by Brexit, the U.S. business environment faces uncertainty due to trade tensions, talent shortages and Fed policy. These are macro challenges that we’ll continue to monitor. However, we believe we are positioned to grow despite such news and potential disruptions. We are different today as an organization than we were during the last recession. We have a stronger sales and client service foundation across the globe. We have exceptional human talent to partner with clients on project initiatives like automation, procurement and process strategies to improve the bottom line, even if the top line slows in our client base. We know how to operate seamlessly for global clients on cross-border initiatives. We’ve proven ourselves as a more attractive value proposition versus the Big Four. We know that clients are shifting workforce strategies towards more agile models. And as a result, we are more motivated as a team around the agility and positive impact of our business model than I have experienced in my nearly 20 years at RGP. Our market share as a consulting provider is small. And given our investment in people and improved in expanded capabilities, our value proposition is stronger than ever in our client size. In closing my remarks, I want to wish everyone a very Happy New Year. In December, we held our Global Management Meeting in Nashville, Tennessee. And I can confidently say that we have a grateful group of employees, who are very energized about our business and the opportunities in the year ahead to serve clients the RGP way. I will now turn the call over to Herb for a more detailed review of our second quarter.

Thank you, Kate, and good afternoon, everyone. I will start by giving detail on our fiscal second quarter financial results and will then discuss the trends we’re seeing in the third quarter. I’ll also give further detail on the financial impact of our recent acquisitions. Starting with an overview of our second quarter results. Total revenue for the second quarter of fiscal 2019 was $188.8 million, a 20.5% increase from the comparable quarter a year ago. Sequentially, revenue was up 5.7%. On a constant currency basis, revenue increased 21.3% year-over-year and 6% sequentially. Our second quarter gross margin was 38.9%, up 100 basis points from the prior year second quarter, primarily as a result of focus on internal pricing initiatives, as well as lower medical costs. SG&A expenses were $55 million, or 29.1% of revenue, compared to $47.5 million, 30.3% of revenue in the fiscal second quarter a year ago. Our net income improved to $10.6 million, or $0.33 per diluted share, compared to $8.1 million, or $0.27 per diluted share in the prior year quarter. In Q2, adjusted EBITDA was $20 million, or 10.6% of revenue, compared to $13.4 million, or 8.5% of revenue in the year-ago quarter. Now, let me discuss some of the highlights of our revenues geographically. As Kate mentioned, our U.S. performance strengthened in the quarter, with revenue increasing 25% year-over-year, reflecting the Accretive acquisition, as well as estimated organic growth in the 6% to 7% range. We have fully integrated Accretive into our offices, so we can no longer definitively breakout results on a standalone basis. Sequentially, revenue in the U.S. increased 5.4% as a result of the initiatives we have discussed. For the second quarter, total revenues internationally were $39.9 million versus $37.3 million in the second quarter a year ago, an increase of 7% year-over-year, 10.6% constant currency and an increase of 6.9% sequentially, 8.1% constant currency. Europe’s second quarter revenue increased 1% year-over-year and 12% sequentially, 4.2% constant currency year-over-year and 13.1% sequentially. Europe’s growth slowed this quarter from the trend of the last three years, especially in the UK, where economic conditions are mixed bag. The sequential increase was a result of fewer holidays in the second quarter compared to the first quarter. Turning to early revenue trends for the third quarter of fiscal 2018. Weekly revenues in Q3 are trending approximately 6% to 7% ahead of last year. If the current trend continues, revenue would be in the range of $181 million to $186 million. Kate mentioned earlier, we’re seeing some encouraging trends in top line revenue for the quarter ahead. North America is continuing to grow, while Europe and Asia Pac appears stable. North America is strong throughout the geography, especially in Atlanta more than California, Chicago, Dallas, Denver and Mexico City. Tri-State is continuing its transformation. They are focused on getting the right team in place. Revenue was essentially flat year-over-year, however, they were up 3% sequentially in Q2. Financial services revenue is improving, however, much of that additional revenue is occurring outside of the Tri-State area, as they build their operations globally. We are very pleased the turnaround we’re seeing in Southern California. Los Angeles and Orange County combined were up 10.6% year-over-year, 8.4% sequentially. Europe up slightly overall had excellent results in Germany with taskforce leading the way. Asia Pac’s growth is being driven by China. As mentioned above, revenue is trending in the $181 million to $186 million range in the third quarter, compared to $172.4 million a year ago. The high-end of the range is dependent on maintaining the trends we’re currently seeing. Turning to gross margins. Gross margin for the second quarter was 38.9%, increasing 100 basis points from the prior year equivalent period and increasing 70 basis points sequentially. The year-over-year range is related to slightly improved bill pay ratio, driven by internal initiatives to improve pricing, as well as lower medical costs in the quarter. For the second quarter, our gross margin in the U.S. was 39.7%, compared to 39.1% in the second quarter last year and our international gross margin was 35.9%, compared to 34% a year ago. For the third quarter, we expect gross margin to be in the 36.6% to 37.3% range, compared to 36.3% a year ago. The drop sequentially is primarily a result of higher payroll taxes beginning in January. We have been making progress improving bill rates and gross margins in new deals sold. We expect to see the full impact in calendar year 2019. The average hourly bill rate for the quarter was approximately $124, which compares to $124 in the first quarter and $123 in the year-ago quarter. The average pay rate for the second quarter was approximately $62, compared to $63 last quarter and $62 last year. We are having strong growth in lower-cost regions, such as China, India and Latin America that offset some of the bill rate increases that we’re having in other regions. As a reminder, these hourly rates are derived based on prevailing exchange rates during each given period. Now, looking at the components of our second quarter financial results. Selling, general and administrative expenses were $55 million, or 29.1% of revenue. This compares to SG&A of $47.5 million, or 30.3% of revenue in the second quarter of fiscal 2018 and $56.4 million, or 31.6% of revenue in the first quarter of fiscal 2019. The year-over-year percentage decrease from last year’s second quarter relates to improved leverage from revenue growth, with decreases in operating expenses in the quarter somewhat offset by $1 million in severance in quarter two versus $400,000 a year ago. SG&A was down $1.4 million sequentially, resulting from lower benefit expenses in the quarter, primarily payroll taxes and transformation integration costs, offset by increases in severance of $900,000 and the bonus commissions related to revenue growth. Stock compensation expense was $1.7 million, or just under 1% of total revenue. In the third quarter, we expect SG&A to be in the range of $54.5 million to $55 million. Sequentially, severance will be lower, however, we’ll have increased payroll taxes, as well as slightly higher compensation expense. Turning to the other components of our financial statements, depreciation was just under $1.2 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 defined as EBITDA before stock compensation and contingent consideration adjustments, was 10.6% in the second quarter, up from 8.5% a year ago and 7.4% in the first quarter of fiscal 2019. Our pre-tax income was $15.7 million in the second quarter. During the quarter, we recorded a provision for income taxes of $5.1 million, representing an effective tax rate of 33%. 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 U.S. and foreign locations, each of which are taxed or benefited 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%, and we expect that rate to be in that range going forward. Finally, our GAAP net income was $10.6 million, or $0.33 per share during the second quarter. Now let me turn to the balance sheet. Cash and investments at the end of the second quarter were $40.8 million, a $13.7 million increase in the first quarter of fiscal 2019. Receivables at quarter-end were approximately $146 million, compared to $138 million at the end of the first quarter. Days of revenue outstanding were approximately 64 days, compared to 62 days in the first quarter of fiscal 2019. Dividends for the quarter were approximately $4.1 million. Capital expenditures were $3.4 million during the quarter, as we have multiple office relocations occurring. We are transitioning to an open office footprint requiring new office furniture. We expect CapEx to be in the $5 million to $6 million range in Q3. We are moving three of our largest offices this year, including two of the New York Tri-State – in the New York Tri-State area, as well as our San Francisco office. In the second quarter, we repurchased $5.5 million in stock. Our stock buyback program still has $107 million remaining. Our shares outstanding at the end of the second quarter were approximately $31.7 million. We’ll continue to return cash to shareholders through our quarterly dividend, while balancing debt repayment, the capital requirements are growing our business organically and strategically and fiscal prudence. Now I’d like to turn the call back over to Kate for some closing comments.

Thank you, Herb. Looking ahead, we’re committed to top line growth, improving our pricing to increase gross margin results and bringing our cost structure down as a percentage of revenue. We are excited about our prospects through the balance of the fiscal year. Before turning to questions, as always, I’ll review our client continuity statistics for Q2. Client continuity remains strong. During our second quarter, we served all of our top 50 clients from fiscal 2018 and 48 of our top 50 clients from 2017. In the quarter, we have 296 clients for whom we provide services at a run rate exceeding 500,000 in fees, up from 267 in fiscal 2018. In addition, our top 50 clients for the quarter represented 36% of total revenues, while 50% of our revenues came from 105 clients. Our largest client for the quarter was approximately 2.5% of revenue. At the end of the second quarter, 86% of our top 50 clients have used more than one type of service or functional expertise. This penetration reflects the diversity of relationships we are building within our clients’ organizations and reinforces the opportunity for growth. That concludes our prepared remarks, and we’re now happy to answer any questions.

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

Hi. So you talked about the year-over-year improvement you’ve made in bill rates, and I definitely quote the comment that some trends are growing, lower bill rate regions are also growing quickly. So there’s probably more underlying bill rate improvement. My question is sort of twofold. One, do you expect continued improvement in bill rates year-over-year and what’s your thought on wage rates which seem to have been holding? And kind of going forward, what do you expect there?

Yes. I think, I’ll answer and then Herb can answer with a little more detail, Andrew. I think, we’re very committed to bill rate improvement. So, I think that we’ll continue through the balance of the calendar year. It’s a very focused initiative in the company as an enterprise, and I think our wage rates, you know there are concerns out there. And I know in your recent report on staffing, you recognized labor shortages and talent shortages, so there has been some pressure. I think what we’ve shown through our disclosures this quarter is that, they are holding steady. We want to be a fair payer with our talent, and we’ll continue to assess it on a monthly basis to ensure that we have the right talent to offer to our clients, but right now I think that’s holding steady.

Okay. Thank you.

Thank you. And our next question comes from Mark Marcon with R W. Baird.

Good afternoon, and happy New Year. I was wondering if you could talk a little bit about some of the macro comments that you alluded to earlier, Kate. Can you just provide a little bit more color, specifically with regards to what you’re actually hearing from clients by geography, because there’s obviously different crosscurrents?

Right. So, I think probably the most impactful comment that we’re hearing from clients that I think really provides opportunity for our business model is that the change environment, even in a downturn will remain. And while the changes have been focused in, I’d say, the past five years on topline growth activity, if they shift to bottom line and cost structure initiatives, I think, we’re perfectly positioned to still support a client. I think many of our largest global clients are really, for the first time as enterprises, attacking the idea of workforce strategy and how do we ensure that we have the right talent to achieve the objectives – the business objectives that change in these large organizations we’ve seen, and I’ve heard it directly from clients in my client meetings that they want to move away from a full-time equivalent kind of resourcing model to a more agile model, which I believe will continue to provide opportunity. The kinds of conversations we’re having with clients now are ones that I felt we’d have 20 years ago that we didn’t at the same level. And now clients, I think, really understand that the gig economy, the democratization of knowledge is changing the way organizations will get work done. And I think that at the macro level, that provides a lot of opportunity for us if we’re in front of our clients in the right ways and really understanding what the business objectives are for the current year, so that’s one that I really pay attention to. I also think that we’re now better positioned to delivering competition to the Big Four and other consulting firms in a way that we weren’t 10 years ago, and that provides encouraging information for me as well. And I think that we’ve been able to attract talent in our organization that maybe we couldn’t attract 10 years ago given some of the changes we’ve made. Talent is attracted to a more agile model, too. So I think all of those factors can provide some tailwind for us, even as we enter what’s becoming increasingly choppy water again.

Great. I appreciate all the comments specific to RGP. I was just wondering specifically, you mentioned Brexit and London and we see a little bit of the deceleration. I’m just wondering if you could just elaborate a little bit in terms of what you’re actually hearing from them in terms of – are there any pockets of softness or – and you also mentioned China, and it sounds like you’re actually seeing good growth there?

Yes. So let me put those in order. So I’ve been in front of some clients in the fourth calendar quarter of last year. And they were sharing with us that they didn’t really feel there’d be much impact from Brexit. There’s certainly some uncertainty and there is political upheaval. But when it comes to our clients really migrating a lot of their operations to different locations, we have not heard that yet. I think what has happened in our business really is, we were so focused on serving our clients as we grew over the last three years. We didn’t have enough capacity to focus on pipeline development and new client acquisitions. So as some of the big projects we had have naturally wound down, it’s just a matter of continuing to focus on pipeline now and getting that pipeline robust again and hiring. I mean, our UK practice, we need to hire, and that’s been a challenge in finding the right people, because as you know, in our business, it’s all about the people and that isn’t going to change. Now as it relates to China, and I know the news is choppy and the Apple news today was not good for the market, but our practices in China are growing, and I’m very optimistic about what’s in front of us in China. We have a new regional leader in China. We’ve just added a new leader in Hong Kong, and we’re about to add a new leader in Japan. I think a lot of our Strategic Client Program or SCP clients have needs in China. We see a lot of interest from our pharma clients in China, so I continue to be optimistic about what’s ahead there.

Great. And then can you talk a little bit about lease accounting in terms of – that sounds like it’s going really well, how big is that at this point in terms of North America?

Yes. We haven’t talked about the exact number on it, but it’s been growing. But as I’ve talked before, one of the things is it tends to replace some of the more fundamental finance and accounting work as they shift out of that into a specific project. But it has been hot, and what it’s also done for us is really open up new clients. To us, that has been exciting. We’ve seen that continue to grow year-over-year and still a lot of interest, where you think that it would be waning a little bit right now. There’s still a lot of public companies that have a fiscal year starts a little bit later than January 1, obviously, ourselves included and then the private companies that are coming in. So it’s still a driver, but I just always caution that it tends to offset some of the other finance and accounting projects that you have.

But it sounds like, I mean, in general, just in terms of technical accounting and project work, you’re feeling pretty good about the initiatives there in terms of driving that as a bigger percentage of overall revenue taking more leadership for the project that you’re spearheading?

Yes. Let me answer this in a slightly different way. I’m not going to give you a firm number on lease accounting. But what this has allowed us to do as an organization is to really understand how do we build capabilities around trending regulations. So, while we’re delivering lease accounting now, we’re already starting to think ahead around IFRS 17, and what is our offering there, what is our sweet spot vis-à-vis the Big Four that will help clients with more of the opinion aspect of compliance and what’s ahead in terms of CECL, et cetera, and now that we have an enterprise function that is dedicated to technical accounting capability. I think we’re better positioned than we’ve been in the past to address what’s next. And that’s what I think about when I make comments like we’re building better foundations at RGP for the future.

Great. And then it sounds like you’ve made really good project – progress in terms of both Chicago and Southern Cal in terms of the leadership. New York sounds like it’s baselining. Can you talk a little bit about how you’re feeling about the leadership in that office, or how far along you are in that in terms of that transition?

I think, one of the challenges – Herb, I’ll start and then you can add. I think, one of the challenges in Tri-State is, as we’ve said before, their client base was very much financial services, right? And as many of the financial services companies started moving their spend away from the controller’s office, I think, we’ve admitted that we did not focus on that fast enough and get into compliance or risk management areas quickly enough. But also, as they moved operations out of Tri-State that really hurt the client base there. I feel good about our leadership. I mean, our Senior Vice President, who is overseeing the transformation in Tri-State is very strong, very well-respected. I feel good about his leadership and what he’s bringing, but it is turning a big ship. That was our biggest practice in the company. So I expected that it would take sometime. I think we all did, and we’re starting to see that. They really do feel like they’re stabilizing and moving forward. Their new logo acquisition is increasing, and we’ve made personnel changes that we probably needed to make. So I feel good about that. And as we said Chicago and Southern California are moving forward nicely.

Yes, and I’ll add in on Tri-State, whereas looking – when you look at the numbers on the sales and productivity per person, those are actually up. We’re getting better performance out of our people. But we have gone through the transition and we have not filled a fair number of open positions there that we are just recently been filling them. So they’re not up to full speed. So we’re encouraged with what we see looking at the pipeline for them for quarter three, that’s up, I mentioned quarter two was up sequentially from quarter one. So I think all the trend lines are in the right direction. I was there a few weeks ago and very pleased with the new team that we’re building a lot of new faces, and I think, they’re going in the right direction. Los Angeles, I’m very excited about. Again, I was there last month, and and they’re showing the results. It’s been, again, kind of putting some new people in place that are doing really well. We’ve got good leadership there now, and it’s definitely moving in the right direction. And Chicago really stabilized about six months, nine months ago and continuing to grow. In fact, they just said a new weekly record a few weeks ago as well. So we’re really proud of what’s happened there.

Terrific. I’ll follow up more offline. Thanks.

Thank you, Mark.

Thank you. Ladies and gentlemen, thank you for participating in the question-and-answer portion of today’s call. I would now like to turn the call back over to Ms. Kate Duchene.

Thank you, operator. And again, thank you, everyone, for joining our call and your interest in RGP. We look forward to updating you after our third quarter of fiscal 2019. Happy New Year.

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may all disconnect, and have a wonderful day.