Resources Connection, Inc. (NASDAQ:RGP) Q1 2024 Earnings Conference Call October 4, 2023 5:00 PM ET
Company Participants
Kate Duchene – CEO
Jenn Ryu – CFO
Conference Call Participants
Andrew Steinerman – JPMorgan
Marc Riddick – Sidoti
Operator
Good afternoon, ladies and gentlemen, and welcome to the Resources Connection, Inc. Conference Call. [Operator Instructions] 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 first quarter ended August 26, 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 also 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 the 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, everyone, and thanks for being with us.
We delivered solid performance during Q1 despite the continued uncertainty in the macro environment and despite Q1 traditionally being our most seasonally impacted quarter given summer holidays and consultant vacations. On both revenue and SG&A expense, we performed in the stronger half of our guidance range while also continuing to deliver strong free cash flow.
During Q1, Countsy delivered solid growth over prior year quarter. The Northern Californian market grew sequentially, showing movement in the tech sector after 12 months of a quiet buying environment. Regional performance in the rest of North America reflected the overall choppy operating environment with clients remaining cautious about new spend while extending current engagements. Our pricing initiative is progressing as planned with over a 2% increase in bill rate in the U.S. quarter-over-quarter and 4% in Europe, constant currency.
Turning to our operational metrics. Pipeline remains resilient. Engagement extension showed an uptick from the prior sequential quarter, continuing to demonstrate the stickiness of our consultants within the client environment.
In recent weeks, we are seeing numerous new opportunities being added to the growth pipeline in certain pockets of North America. In Europe, we’re growing the pipeline again as 2024 client budgets are being finalized and pent-up demand around technology transformation and transaction support are moving to the forefront. The Asia Pacific region, particularly in India and the Philippines, continues to show demand strength from our large global clients as they optimize their offshore service centers.
In Q2, we’re highly focused on revenue capture across all markets. And following the summer holidays, we have seen healthy meeting activity with in-person client connectivity on the rise globally. Based on many discussions with clients, we believe patterns are starting to break for the better. One of our largest clients reports that 10 months of uncertainty is coming to an end. Budget discussions have been renewed with recognition that there’s too much pain in the system that needs to be addressed.
Business resiliency is critical. Many organizations are now reaching out for support to unlock the value of prior technology implementations. For example, we have clients large and middle market in need of support implementing additional modules of S/4HANA, SAP’s modular cloud-based ERP. We’re also assisting and optimizing performance of previous S/4HANA implementations with business process redesign, project and change management, all capabilities in RGP’s sweet spot.
For such work, clients do not want to hire full time, but rather in-source talent to deliver the expertise with flexibility and agility. In addition, we see increasing demand for our expert solution offerings, including expansion of global shared services workflows, IT, audit and compliance as well as operational accounting and finance.
In our financial services practice, we see increasing needs in regulatory remediation. With these client conversations as the foundation, we’re cautiously optimistic that the buying environment will approve late this calendar year and into 2024.
In the near term, we will continue to expand our capabilities and engagement models, Agile consulting and managed services. This strategy will improve our ability to weather market cycles and dynamics to react more quickly to varying pockets of need. For example, tax and treasury services are nondiscretionary even in a challenged macro cycle, while PMO services related to a client’s market expansion are green lit with improving market cycles.
In addition to our core Agile Expert business, we’re also extending our total addressable market on both ends of the human capital and consulting continuum. HUGO is an engagement channel for an adjacent segment of the F&A market requiring more role-based support and lesser scope than team delivery. Digital transformation consulting expands the right side of the continuum with strategy to execution, UX to digital product development.
Looking further ahead, our business model is well aligned to the future of work. We support clients in more agile and flexible ways in the areas of finance transformation, operational excellence and digital transformation. We have the exceptional talent that clients want and need to execute critical project initiatives. We also know how to attract and retain that talent who is migrating toward our model.
As the Wall Street Journal reported two weeks ago, the labor crisis is here to stay. Retirement trends, lower birth rates and restrictive immigration policies around skilled talent suggests no improvement anytime soon. Thus, demand for agile talent, experts who can work on project teams and plug critical skill set gaps will increase opportunity for RGP over the long term.
Increasingly, talent itself is looking to lend its expertise to platforms like RGP who offer a different compelling career experience. RGP’s attractive proposition to this talent is especially apparent in the finance and accounting field, where the profession faces an existential crisis. There are two few CPAs for market demand with many of them exiting the profession because they do not want the partnership model.
RGP provides a career that values their skill set in a more dynamic model built on choice, flexibility and control. Especially given current market conditions, RGP is proud of the strong cash flow that so well reflects the underlying strength of our business model. As a result, we have a clean balance sheet and no debt. We have consistently paid a quarterly dividend for over 10 years with six annual increases during that period. And as much as ever, we’re staying disciplined on cost structure to ensure we continue to deliver value to shareholders.
Before I hand it over to Jenn, I want to leave you with my thoughts on how the new fiscal year will likely progress. We expect the current year’s annual revenue trends to reflect the opposite of fiscal ’23. Meaning last year, the first and second quarters were the strongest, reflecting the continued post-pandemic bounce back. This year, we believe the second half of the fiscal year will be stronger, given the nature of our solid pipeline and as the economy and buyer sentiment improve.
As noted in the CFO’s survey conducted by Duke University’s Fuqua School of Business and the Federal Reserve Banks of Richmond and Atlanta, which was released last week. CFO optimism around revenue, hiring outlook, and the economy in general has increased for 2024 which adds to our cautious optimism for this current fiscal year.
In closing, I’m pleased to share that Harvard Business Review published an article last week, co-authored by me and business strategist, Antonio Nieto Rodriguez, titled creating a cohesive team for corporate transformation projects. This piece, based on our recent research reinforces the benefits of building a blended team to deliver transformation work the highest impact and most successful outcomes. Please visit our website for a link to the article and the insights shared.
I’ll now turn the call over to Jenn.
Jenn Ryu
Thank you, Kate, and good afternoon, everyone.
This quarter, our revenue of $170.2 million and gross margin of 39.4% were both within our outlook range provided in July. While run rate SG&A of $55.5 million was better than the favorable end of our run rate SG&A outlook. Notwithstanding an uncertain macro environment, we produced solid adjusted EBITDA of $11.5 million, with a 6.8% margin, and we continue to generate strong free cash flow.
On a same-day constant currency basis, revenue declined by 17% year-over-year as our clients continue to work through challenges in their own business and hold back the pace of investments. Regional performance was reflective of the overall environment. North America, specifically in the U.S. market was the most impacted by clients’ hesitancy to spend as they manage their earnings through the elevated inflationary and interest rate environment resulting in a year-over-year decline of 19% in revenue. Our international business showed resiliency with a modest decline of 4% year-over-year on a same-day constant currency basis. While many international markets experienced similar macro and client trends as the U.S., albeit less severe, they were avoid by growing markets such as Switzerland, India and the Philippines.
Operationally, as Kate mentioned earlier, our growth pipeline remains resilient, illustrating healthy appetite from our clients to execute operational improvements and our strong client retention. However, conversion into engagement remains slower than normal in Q1, driven by more cautious budget planning on the part of our clients. While extensions on existing engagements have been healthy, new opportunities in the pipeline require more persistence and time to close. These opportunities represent real upside for our business as macro conditions improve.
Gross margin in the quarter was 39.4%, reflecting a heavier mix of business in Europe and Asia Pac, which typically carry higher pay bill ratio compared to North America. Gross margin in the first quarter was also impacted by less favorable leverage of indirect cost of services on lower top line revenue.
Next, I will provide an update on our pricing initiative through which we’ve made good progress raising bill rates across the majority of our regions. Our U.S. average bill rate rose 2% compared to the first quarter of fiscal 2023, and Europe was up 4% on a constant currency basis.
However, due to the shift in revenue mix to regions with lower bill and pay rate, enterprise average bill rate for the quarter was $124 constant currency, down from $128 a year ago. While average pay rate declined to $59 from $61 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. While we always approach cost management discipline, we have been even more judicious given the current environment. Our run rate SG&A expense for the quarter was $55.5 million, more favorable than our outlook range. We continue to identify opportunities to streamline our cost structure, including aligning resource levels to the demand environment, reducing travel, occupancy costs and other discretionary spend.
Earlier this week, we commenced a reduction of our U.S. management and administrative workforce intended to reduce costs and streamline operations. We expect approximately $10 million to $12 million of reduction in our annual SG&A run rate.
Turning to liquidity. We are proud of our ability to continue to generate robust free cash flow despite the macro environment, which came in at $81 million or 130% of EBITDA over the last 12-month period. We ended the fiscal quarter with $112.6 million of cash and cash equivalents and zero outstanding debt. We distributed $4.7 million of dividends during the quarter, with total available financial liquidity of $287 million, we plan to invest in the most critical areas in the business to drive long-term growth and profitability. While continuing to return cash to shareholders through dividends and by opportunistically buying back stock through our share repurchase program, which has $50 million available at the end of the quarter.
We continue to push forward our multiyear technology transformation project. We incurred $5 million of costs in the quarter, of which $3.1 million was capitalized with the remaining $1.9 million included as non-run rate operating expense. Post go-live, we anticipate the new technology platform will drive long-term value by improving our operating efficiency, enabling scale and enhancing even further the stickiness of our talent platform.
I’ll now close with our second quarter outlook. The early second quarter revenue trend has been stable compared to the end of the first quarter. We anticipate timing challenges related to deal closes and project starts to continue through the second quarter. With early Q2 daily revenue trending slightly below the first quarter daily run rate and after giving effect to less business days in Q2, we project revenue to be in the range of $160 million to $165 million. We anticipate Q2 gross margin to be similar to Q1, currently estimated to be in the range of 39.2% to 39.7%, reflecting the global revenue mix and the lower top line projection.
We expect our run rate SG&A to improve to a range of $53 million to $55 million. Non-run rate and noncash expenses for the second quarter will consist of $1.5 million to $2.5 million of technology transformation costs $2 to $2.5 million of restructuring costs and $1 million to $2 million of stock compensation expense. Fully capitalized costs related to the technology implementation in the second quarter is estimated to be around $3 million.
In closing, I want to reiterate what Kate stated earlier. As we navigate through a changing economic environment, during the first half of this fiscal year, quarterly comparisons over the prior year may not be indicative of our underlying annual performance. Based on the opportunities we’re seeing in the pipeline, we believe the pace of revenue conversion will improve as the macro conditions start to recover, and we’re ready to execute and excited about our business model and longer-term outlook. With a durable variable cost model, a pricing balance sheet and ample liquidity, we believe we are well positioned to continue driving long-term value for our shareholders.
This concludes our prepared remarks, and we will now open the call for Q&A.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Andrew Steinerman with JPMorgan. You may proceed.
Andrew Steinerman
Hi. I have two questions. The second one could probably be harder than the first, but I’ll give it a try. On HUGO, could you give us any sense of scale and success like how many active users you have in your database or anything quantitatively. The second one is talk about the current uncertain macro and clients hesitancy to spend. But economists tell us that we’re not in a recession currently. Do you feel like that label might be misappropriated. Maybe your belief is we are in a mild recession that we’re going to recover from. And obviously, that you’re also suggesting that the recovery of the macro will help your second half. Is that really coming from your economist view your main views that economists of that or your clients?
Kate Duchene
Yes. Thank you, Andrew. Let me take both of those, and then Jenn could add some color. So on HUGO, this year is about our commercialization efforts in three markets. And we’re very pleased with the talent inflow into the platform, and we’ve exceeded our goals there, and we are working to increase client registration and offerings.
We’ve presented HUGO as an option for some larger enterprise clients, too. So we are optimistic about the reception we have received. We’re not prepared at this stage given how small HUGO is to give you more specifics than that, but we are on track.
With respect to the broader question, and that is a hard one. I think I read Jamie Dimon’s interview yesterday in terms of his comments. I don’t think we’re in a recession. I think that his comments about just a muted economic environment stagflation is probably more likely right now. And that means that we’re all going to have to work harder and pursue every opportunity. I’ll tell you, we are very focused on sales motion right now and ensuring that our people spend time with clients talking about the initiatives they have and where our capabilities measure up.
Our comments about the second half of the year are not so much based on what the economists are saying because that has been a I would say, a bumpy road, but more on the conversations that we’re having with clients and what we’re hearing them tell us about their budgeting process and what they expect in 2024.
Andrew Steinerman
Perfect. Thank you.
Kate Duchene
You’re welcome.
Operator
Thank you. One moment for the question. Our next question comes from Andre Childress with Baird. You may proceed. Andre, your line is now open.
One moment for our next question. Our next question comes from Marc Riddick with Sidoti. You may proceed.
Marc Riddick
Hi Good evening. I wanted to ask maybe sort of a couple of questions that are more along the lines of sort of controlling the controllables, I guess. I was wondering if you could talk a little bit about where you finish with consultant count at the end of the quarter. Maybe you could sort of talk a little bit about some of the thoughts as to sort of your own needs going forward, whether we are looking to maintain that level, pay at that level and kind of how we feel about that? And then also maybe if you could give a bit of an update. I know that there had been some mentions to sort of relooking at the organizational structure following the announcement of resignation. Maybe you can talk a little bit about maybe where you are with that or maybe some hiring trends or anything like that, that we should be aware of? Thank you.
Jenn Ryu
Mark, this is Jenn. I can take the first question and maybe Kate can comment on the second one. Our consultant count at the end of the quarter did decrease, as you can imagine, due to the demand environment. We do have – for our bench consultants, we are doing everything we can to deploy them and to keep them engaged. We’re putting in a number of measures to share available consultants with our entire sales team and talent team globally and also proactively approach clients to see if there’s a need there. I think our consultant count, as you know, fluctuates based on our demand environment, and that’s also part of our overall variable cost model. That is unique to our business.
Kate Duchene
Yes. So I’ll jump in. I think, Marc, correct me because you got a little soft. So I hope I heard all of your question if I didn’t just please ask it again. I think you asked about organizational structure and how we’re continuing to build the business going forward. As we’ve talked about, we really have three components kind of our business currently. We have our agile model, which is the core of RGP, meaning we provide expert talent to work on project initiatives in our client environments or to fill role or skill set gaps at a professional level in our client base.
We also have certain assets in our portfolio that are consulting soup to nuts veracity is the perfect example. We want to do more this year in setting up CFO advisory at the true consulting unit. And this is all about making us easier to buy and easier to sell in our client base.
And then the third component is Countsy, which is our managed services business in an outsourced solution for finance and HR services more in the start-up environment. And we’re also looking at how we can provide services to divested assets of businesses. That don’t want to stand up their own full financial function, especially in light of today’s lack of accounting and finance talent.
So those are kind of the three segments we see continuing to pursue that as we grow. And again, it’s about making us easier to buy and easier to sell in our client base.
Marc Riddick
Okay. Then I was just sort of wanted to also follow up then on the – I think there were some of the commentary in the press release a couple of months ago that you’re considering adding a couple of people to replace TIM or maybe some things might be, I just wasn’t sure if there’s an update available there as to as to adding to the leadership bench there?
Kate Duchene
Yes. So I think that we will, through the balance of this fiscal year, reposition what we need in senior leadership positions. I think that the future of the COO role will look different than it has in the past for good reason as we build real leadership of the segments that we’re talking about. And we continue to improve what role and function that COO position can deliver across the enterprise.
One of our initiatives this year too, Jenn talked about pricing, that’s important, but also to do a better job of cross-selling across our assets into this client base. And as we determine what we need in that regard, we’ll be sharing more about the roles that we’ll put in place. And I don’t necessarily think, Marc, these are going to be new roles. We have some really talented people that are ready to step up. And so it may be reproposing or repositioning some of the existing talent we have.
Marc Riddick
Excellent. Thank you.
Kate Duchene
You’re welcome.
Operator
Thank you. [Operator Instructions] Our next question comes from Andre Childress with Baird. You may proceed. Andre, you maybe on mute, your line is now open.
And I’d now like to turn it back to Kate Duchene for any closing remarks.
Kate Duchene
Yes. Thank you, operator. And Andre, if you have a question, please feel free to give us a call off-line. But I want to thank everyone for attending this call. I can assure you we are focused and motivated to serve clients with excellence and value as we all learn to work differently in today’s environment. We look forward to reporting again after Q2, and we’ll talk with you in January. Thank you very much.
Operator
Thank you. This concludes today’s conference call. Thank you for participating. You may now disconnect.
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