Resources Connection, Inc. (RGP) Earnings Call Transcript & Summary

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 27, 2022. 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 28, 2022, for a discussion of risks, uncertainties and other factors that may cause the company's business, results of operations and financial conditions 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.

Thank you, operator. Good afternoon, everyone, and thanks for being with us. We're pleased to report sustained, robust performance in Q1. Specifically, Q1 revenue was 17% higher than prior year, excluding the taskforce business, which we divested at the end of May. Gross margin improved 190 basis points over prior year to 40.9%. Gross profit improved almost 17% quarter-over-quarter. Adjusted EBITDA margin improved 280 basis points over prior year to 15%. These results exceeded our guidance as we grew top line, improved pricing and maintained disciplined cost management. During our prior call, we outlined the strategic objectives for fiscal year '23. I will briefly comment on technology and digitalization initiatives as we are progressing on all fronts. We've launched our technology modernization project to support continued top line growth and drive greater operational efficiencies. This project will take approximately 24 months to complete globally. To remind you, we are replacing our core ERP systems, our core talent acquisition and management system and implementing a contract management product. These technology modernizations will help us automate and provide collaboration tools for the new ways of working. We believe it will allow us to continue to improve our financial performance as we replace manual process with technology-enabled workflows. During the quarter, we also advanced the development of our digital engagement platform, HUGO by RGP. We have expanded our reach into California and are on track with our strategy. The next regional focus for HUGO will be Texas, which we are planning to launch in the second half of this fiscal year. HUGO enables us to attract finance and accounting talent who are earlier in their careers and want to pursue their work life through a state-of-the-art professional staffing platform, which allows talent and clients to match skills and opportunity directly. We're pleased with the volume and quality of candidates published on this platform and continue to receive favorable client experience feedback. With respect to our brand development work and as announced during our Investor Day in April, we launched several initiatives to refresh our brand's position, including a new tagline, Dare to Work Differently. This tagline speaks to the business model we pioneered in the late '90s when we were first-to-market offering expert diverse professionals the ability to control their own career path. It acknowledges and affirms our consultants' decision to work differently and is a rallying cry, encouraging our clients to embrace more agility in their human capital strategy. Most importantly, it challenges us to own our position of strength in today's world of work as we amplify our brand. What you can expect to see in the coming months is a refreshed website as well as thought leadership based on RGP-led market research, offering perspectives on how organizations are managing their most mission-critical projects, particularly in the face of challenging economic times, talent shortages in a hybrid working world. We've also continued to expand our PR program, garnering earned media coverage in Bloomberg market, Yahoo! Finance, Chief Executive, NewsNation and other major outlets as well as appearances on prominent business podcasts. We will continue our efforts throughout the year to build brand recognition through learning opportunities for our clients and consultants. Our brand work has not come at a better time to align to the prevailing trends in the contingent workforce marketplace. Pandemics reorder society. This one is no different and has radically transformed how work gets done. We have been in this pandemic for over 900 days. There is no doubt new habits have formed. Talent is mobile and empowered with career control like never before and immigration policy and retirement trends warrant that professional talent shortages aren't going to resolve any time soon. According to a staffing industry analyst July 22 report, there are 6.7 million more openings in the job market than unemployed individuals available for full-time work. While the jobs report just yesterday from the Bureau of Labor Statistics indicated a 5% drop in job openings August-over-August, these numbers confirm that there remains a wide gap in talent need and talent supply. Therefore, it's no wonder employers are actively rethinking their talent strategies to compete in this new environment. In fact, many companies recognizing these trends as foundational and generational shifts are embracing a more hybrid talent strategy, whereby they allocate an increasing number of positions and roles to contingent rather than traditional permanent workers. According to a recent SIA research report, buyers expect that 22% of their workforce will be contingent by 2024. This is up from 12% in 2009. The trend toward embracing the shift in workforce model is still pronounced, SIA has finally given the movement a name, total talent strategy. According to SIA, because of critical talent shortages, many large organizations are actively accelerating workforce plan and innovation. While we remain mindful of current macroeconomic conditions and uncertainty, the trends I've just touched upon, presents continued opportunity for RGP. Our business model, which provides us mobility, flexibility and choice, aligns strongly to today's reordered world of work. We empower expert, diverse professionals with ultimate career control and work with clients every day to deliver support for mission-critical work and transformation initiatives that continue to progress even in the face of recessionary pressures. While we read and hear every day about high inflation, increased interest rates and growing recessionary pressures, we still see capital improvement and other business transformation work moving forward. These kinds of projects were delayed in COVID and are not being decommissioned even given market uncertainty. We believe this supports our point of view that the migration to agile talent models is real and will be increasingly important solutions in the evolving world of work. I'll close by highlighting an example of culture and innovation at RGP. In the face of 2 recent disasters, a serious earthquake in Mexico and the devastating Hurricane Ian in Florida, a creative and caring group of cross-functional employees came together to design and implement a new global disaster protocol. The driving force for the work was to ensure we could connect with our people quickly to offer the right level of response and personal support. Using a survey tool in Workday, this group launched an automated, standardized new process that enables us to check on the safety of our people as quickly as possible and deploy support as needed. The protocol has been incredibly well received by our employees and highlights the power of human at work at RGP. I want to recognize and thank this group of self-starters who exemplified the best of RGP, bringing empathy, creativity and drive to make an impact for each other and the world at large. I'll now turn the call over to Tim for an update on operations.

Thank you, Kate, and good afternoon, everyone. During the first quarter, we saw strong revenue growth, operational metrics and margin performance. Pipeline build and closed deals were also robust, and the momentum we had noted at the end of the fourth quarter continued in Q1 and through September despite the return of traditional impacts related to summer vacation. When excluding taskforce, revenue increased by 17% over the prior year quarter on a same-day constant currency basis, and the demand profile for our services demonstrated strength throughout the quarter. Geographic performance in the quarter was solid across our core business with strategic accounts, Asia Pacific, North America, Healthcare, Countsy and Veracity are all performing well. Along with some turbulence related to the macro environment, Europe experienced significant vacation impact as anticipated. While we have performed well in the current economic environment and our operational indicators remain strong, we are cognizant of recessionary trends that could impact our customer base. Further, as we are setting the path, as companies continue to shift their focus to co-delivery of important initiatives, we have become more embedded in the fabric of our enterprise workforce plan. Also, as we have learned from the pandemic, the pace of change in our client base is not abating. We remain cautiously optimistic that despite necessary awareness in our client base related to macroeconomic trends, there remains opportunity for RGP as companies continue to fashion flexible solutions to forge ahead on important objects. One favorable trend that is increasingly prevalent is the importance that clients are pricing on value, which has long been our hallmark. As RGP provides experts to actually execute to work directly versus leveraging a pyramid structure that has common in a big consulting. As an example, a top-tier commercial and investment bank has utilized this consulting over the last couple of years to help them transform. As they evaluated their current and upcoming portfolio of initiatives, 2 things became increasingly evident: an overreliance on large consultant firms utilizing junior talent for much of the work product and the increasingly prohibitive cost of those relationships, particularly as they shifted in the project execution phase. As a result, our accounts team have given an opportunity to propose on a scope of services and we were successful in shifting several projects to RGP, including work to support a significant divestiture. There is also more opportunities beyond the horizon to shift work from the wallet share of larger competitors, a process we shorthand as shift-share. Another example of shift-share occurred in a large pharmaceutical client that was struggling with the user experience for Intranet with offering to their employees. The main charter of the site was to be a place where colleagues could quickly find answers so they could get back to the important work of making breakthroughs that change patients' lives. A larger firm had implemented this new technology. And as stakeholders began to use the platform, the client realized they do not provide the ease and utility they expected. Instead of turning back to the consultancy that had done the initial implementation, the client gave Veracity an opportunity to propose on an overall assessment with particular emphasis on user journeys and experience. Veracity won that proposal and the project has been so well received that we are proposing on significant additional work. On the candidate side of our business, the first quarter demonstrated continued strength in our ability to attract and retain premium talent to our platform. RGP is increasingly viewed as an attractive alternative to traditional employment both in professional services and in industry that talent is more drawn to the flexibility, career ownership and community that RGP provides. Despite current economic concerns, the labor market continues to be very tight, and our team [ talent ] with the attraction, engagement and deployment of talent are performing with excellence. Attrition has lowered sequentially and strong hiring trends have persisted as we have become the premier destination for professional talent that is daring to work differently. This strong trend continues despite some of the hiring freezes and layoffs that in previous periods of volatility may have created a sense of anxiety and perhaps reflects the traditional employment. In fact, hiring freezes and reductions in workforce helped to amplify the increasingly small chasm between traditional and agile employment. This realization, coupled with the shift in the way people desire to live and work makes RGP a very attractive employment destination. A clear example of this can be seen in the decision of one of our West Coast consultants. Working as an RGP consultant for over a year, the large technology company, who has approached numerous times for a variety of different job opportunities. We have repeatedly declined noting that we enjoyed the control of the hourly schedule and that is in position to help with client be successful without having the stress of project ownership. He admitted that the current macro environment made him think harder about our recent offer but that his desire for flexibility and love with the RGP community, along with headlines about layoffs in other technology companies, cemented his desire to remain an RGP'er. We also continue to see boomerang of an alumni who returned to us after leaving to work on other opportunities. These individuals are so important to our company as they are living embodiments of the agility that people seek and the experience that we work hard to provide for them. They are excellent ambassadors and can provide cautionary tales about leaving our platform. They help us cement the culture and community and cohorts of rejoiners, which is very important, particularly for those who are trying agile employment for the first time. A recent boomerang shared that she missed the culture and family environment at RGP, and lamented that sometimes you must leave to appreciate what you have. While that is true, we are committed to continue to build an environment that is hard to leave at all. Now let me turn back to our first quarter operations. During the quarter, we saw pipeline growth fueled by strong overall demand. We continue to make progress with respect to pricing, increasing bill rates by 3% on a constant currency basis compared to prior year quarter. We see pricing leverage as an opportunity across the enterprise even in a potentially more challenging macro environment as value is paramount to clients. While we are mindful of potentially broader impact based on economic conditions, early second quarter revenue and operational trends are in line with Q1 trends. Finally, let me touch on operational leverage. In Q1, we continued to focus on controlling fixed costs and operating efficiently. Adjusted EBITDA margin improved significantly over prior year quarter. We remain vigilant about discretionary spend and work diligently to continue to improve operating leverage. I will now turn the call over to Jen for a more detailed review of our first quarter results.

Thank you, Tim, and good afternoon, everyone. We achieved another outstanding quarter, one of the best first fiscal quarters in the company's history. Revenue of $204.1 million exceeded the high end of our guidance. On same-day constant currency basis and excluding the impact of the taskforce divestiture, we grew revenue 17% year-over-year and 0.4% sequentially from the fourth quarter despite summer vacation in Q1. In addition to the strong top line growth, we also expanded our adjusted EBITDA margin by 280 basis points from the prior year quarter to 15%, a record first quarter margins and attained GAAP diluted EPS of $0.53 per share for the quarter. Overall, demand remains healthy despite uncertainties in the macro environment. Our strong revenue performance in Q1 was broad-based across all client segments in our core business, including strategic global accounts and regional accounts with 16%growth and 10% growth year-over-year, and was led by solution areas in finance and accounting, technology and digital, and business transformation. Revenue and profit consulting and on-demand talent both grew approximately 12% year-over-year. Geographically, North America and the Asia Pacific both performed well with 18% and 20% year-over-year growth on a same-day constant currency basis, while Europe declined slightly by 1% as a result of heavy summer vacation as we had anticipated. While we're anticipating to see some softness in pockets of the European client base, the growing recession in Europe did not have a material impact on our Q1 performance in the region. Gross margin in the first quarter was 40.9%, up 190 basis points over the same quarter a year ago, primarily driven by an improvement in the pay bill ratio of 230 points. We raised our average billing to $130 constant currency from $126 in Q1 of fiscal '22, a 3.2% improvement while U.S. average bill rate rose by 5.4%. Average pay rate was also favorable at $62 constant currency compared to $63 in the prior year quarter. Turning to SG&A. We remain disciplined with cost management and investment oversight in the business. Our run rate SG&A expense for this quarter was $53.1 million or 26% of revenue or 100 basis point improvement compared to the same period a year ago. As a reminder, run rate SG&A excludes noncash stock compensation, restructuring charges, contingent consideration and technology transformation costs. The 3 main levers for SG&A that we continue to focus on are management compensation, occupancy and business travel expenses. First, in the case of recessionary pressure, we will closely monitor our headcount investment to match the pace of demand and business activity while driving forward our growth strategy in key areas of the business. Second, we will continue to drive reduction in our real estate while reaping benefits from our previous efforts over the last 2 years. Occupancy costs in the current fiscal year is expected to be favorable by another $2 million or 17% over fiscal '22. Lastly, we will remain disciplined with the level of business travel and expect to sustain the cost reduction achieved in the previous fiscal year. Turning to our liquidity. As expected, we used approximately $5.3 million of cash in operations during the first quarter due to our annual bonus payout in the summer. We repaid $34 million of outstanding debt, lowering our debt leverage ratio from 0.6% to 0.2% and ended the fiscal quarter with $72.6 million of cash and cash equivalents. Now let me address the macroeconomic trends and how they impact our business. First, on inflation. Sharp inflation understandably creates some cost pressure on our business, primarily in the area of employee consulting rate and compensation, given that's the most significant cost in the business. We're focused on providing competitive pay to our employees while raising pay rates and have been successful in alleviating the margin pressure from wage inflation. And will continue to do so in the future. In a contractual economic environment, we believe our value proposition becomes more appealing compared to our competitors for optimal expenses leading to ample opportunities to continue driving billings upwards. Second on currency, particularly with respect to the strengthening U.S. dollar, while the transition of our operating results is subject to fluctuations in the exchange rate of foreign currency, we believe our economic exposure to such fluctuations is not material. Our foreign entities typically transact with clients and consultants in the respective local currencies and generate healthy cash flows to fund their own operations. There is a limited number of circumstances where we may be asked to transact with our client in one currency but are obligated to pay our consulting in another currency. Loss on interest rates, at the current debt level, we do not expect any material impact from rising interest rates nor our ability to service such debt. In the event of higher debt levels, our ability to generate cash will enable us to deleverage quickly. And always, we will remain prudent in how we leverage debt to grow the business, whether organically or strategically. I'll close with our second quarter outlook. Early second quarter weekly revenue trend has been stable. While there is more caution in general within our client base, critical projects are still being initiated and executed, albeit at a more deliberate pace. More than ever in the face of macro headwinds, our deep relationships with our clients and our expert talent base has positioned us to compete and win opportunities. Our second quarter revenue is estimated to be in the range of $196 million to $201 million, representing growth over the prior year quarter, excluding taskforce. Gross margin in Q2 is expected to be in the range of 40% to 41%, reflecting the impact on banks getting holidays. Finally, our run rate SG&A is expected to be in the range of $54 million to $58 million. We continue to make progress in our technology transformation project and expect cash outlays to be in the range of $3 million to $5 million in the second quarter, of which approximately 55% to be capitalized with the remaining to be recognized as nonrecurring operating expenses. With that, I will open up the call for Q&A.

[Operator Instructions] Our first question comes from Mark Marcon with Baird.

Really nice to see the strong first quarter results. Wondering, can you talk a little bit about the progress that you're seeing with HUGO? You're expanding that to California and then Texas. What have you seen so far in New York in terms of the take-up? And how meaningful is it in terms of revenue and stability?

Yes. Mark, thanks for the question. So we have launched in the Tri-State area as we talked about in the last fiscal year, and we've just launched in California, both Northern California and Southern California. So we're on track with our strategy. We've hired some additional sales personnel to support the platform. And we've been building talent pools in the particular geographies where we're expanding. So as we return to more hybrid or on-site work, we'll have talent available to fill the need. So far, we're on track, but it's early days. And the budget for HUGO is not material this year in light of our overall results.

Okay. But it is meeting expectations in terms of what you were expecting out of the Tri-State area in terms of the kind of the initial stages?

Yes, we're on track. We feel good about where we are. I mean migrating to this alternative channel is something that will take some time, especially as we're targeting more digitally native buyers. And so that takes some time. As we -- I think we shared on a previous call, Mark, we had a client who loved the experience, went through the digital engagement, but came out the other end saying don't let me lose the connection to my client service personnel as well. So I think still going through a stage where we're learning new behaviors and new channels and the efficiency of it. And I -- as we've said before, this will be a learning year as we bring this platform to life.

Great. And then the 17% growth that you ended up experiencing on a constant currency basis when we strip out taskforce, that was terrific. I'm wondering how is the growth split between project consulting and managed services versus on-demand talent and professional search.

Yes. Mark, on-demand talent and project consulting, both segments grew by 12% year-over-year. And when I say 12% there, it's not constant currency and same day. So I would say that the growth is evenly split between the 2 segments.

Okay. Great. And then with regards to Europe during the last quarter, obviously, taskforce came out. It still seemed a little bit softer than what we were looking for. I'm wondering, was that broad-based across Europe? Or was it 1 country or 2 countries specifically that may have been a little bit softer? And any sort of projects that, that would have been associated with?

Mark, well, I would say it was fairly broad based. Remember our largest practice in Europe is in the U.K. And a lot of the reasons had to do with a full complement of vacation of some of the royals in the markets and then there are all types of things that happened with the queen and other things there. So generally, it wasn't -- I don't think it was solely unexpected. There are some things that occurred, obviously, that were out of our control that are a little bit unexpected. And we had some timing of projects -- remember, it's a smaller European practice than it's been in the past, and we're focusing really on large projects and have larger clients. So some of the timing of those projects can impact where they hit in the quarter.

Great. And then the gross margin improvement was impressive. Can you talk a little bit about the sustained ability to continue to raise the bill rates in excess of the pay rates and how you're doing that? And are there specific practices where you're seeing a greater ability to do that?

Yes. Let me address the bill rates. I think -- I'll talk about the pay rates in a second because our approach around pay rates hasn't really changed, but our approach around bill rates really has over the last few quarters as we've been talking about it. Some of this kind of comes down to -- we always talk about having both mindset and mechanics. And I think we've had -- we've done a pretty good job of shifting people's mindset, few of these concepts of pricing to value. I mean, prior to this year, prior to last year, we hadn't really focused. We've been more of a cost plus as opposed to pricing the value. So we've made some of those strides. We brought in some assets to help us around strategic pricing. So we've put folks through training, we've tightened up the governance. And so that mechanic -- both of mechanics of helping to enforce the mindset and the market can take it. I mean the reality of it is, is that we've been on the market for many years. So our ability to continue to raise pricing. But I still think there's plenty of upside there. So with respect to pay rates, our pay rate has been fairly consistent, but we price to market. We don't negotiate against our consultants. We want to pay them -- we want to pay a fair wage to come and work for us and pay them for every hour that they work. And the result of that is we're in the market a lot, both for using external surveys, but also just in our own experience to make sure that we're paying the right amount to our folks. And so the reality of it is, is that, that muscle in our business is a little further ahead than our muscle on pricing, and we'll really look to flex the pricing muscle now.

Yes. Let me just add something else on pay rate, which is, in some parts of the business, we are hiring offshore talent. And so that definitely is the favorability that you're seeing in this quarter in pay rates, some of it comes from that as well. And that's something that we're going to continue to focus on going forward to expand that offshore.

That's really helpful and really illuminating. Can you talk a little bit about the 17% constant currency ex taskforce growth that you ended up seeing, how did that vary over the course of the quarter? And how are you seeing that translate? Or how are you thinking about that translating into the guidance that you basically provided for the second quarter, what areas might potentially slow down? Obviously, we're all aware of the macro headwinds. And so it's natural to assume that there would be some slowing. But just wondering if you can be specific about where you're seeing it.

Yes. First of all, overall, when I think about the velocity of the business, we're actually fairly consistent through the quarter with some -- in the latter part of the quarter with some of the holiday impact in Europe impacting us towards the latter 1/3 of the quarter. And what we've seen is real consistency and stabilization as we moved into the second quarter. And so when I look at both kind of the trends from a velocity standpoint, but then also looking into where our pipeline is and some of our operational metrics, those are still strong. What you -- what we begin to think about is that the things that aren't -- things will get a little bit harder, we know that. But our overall demand profile is still really strong. So some of that kind of comes down to how quick -- how hard are we willing to grind to get that extra bit of revenue, which I can tell you that we're willing to do that. And the second bit is just understanding that there may be some things, some choppy waters that are outside of our control. And we are putting ourselves in the best position to help our clients. And we'll -- depending on kind of the wariness or the impact that they're feeling from the macroeconomy, we'll adjust as we move through.

Yes. Mark, I'll just add one thing. I was on the phone today with one of our major market leaders talking about the environment and what he's seen. And one comment he made, which I think has been echoed in with a variety of our clients is in these economic times, they don't want -- clients don't want to be paying for a lot of advice right now. They really want to be paying those firms that can help them execute the projects that are already on the agenda or underway. And that tells me that we are the right solution for today because we are all about locking on for their clients and executing those initiatives. And I think that's really what clients are looking for in today's environment.

Okay. That makes a lot of sense. One last one for me, and then I'll jump into the queue. But with regards to one of the questions that we're getting from investors is this -- how companies might end up reacting with regards to if the macro environment significantly slows down to what levers you would have in order to reduce expenses if need be Obviously, you've got a variable cost structure. But I'm wondering if you can just discuss that a little bit just in terms of like what the game plan would be if things do get a lot choppier over the next 3 to 9 months?

Right. Well, I'll start by saying we've highlighted that we have a variable cost structure already. It's built into our model, and that makes us more agile than many of our competitors. The other thing I'd say is with the work we've done internally over the last 5 years, we do have much greater visibility to our data and to the investments we're making and whether that's paying off and what the trend lines we see in our client buying behaviors, so we can adjust sales or pull levers more quickly than I think we used to be able to do. Keep in mind the 2 most fundamental elements of our cost structure, our headcount and real estate and we'll continue to look very carefully. I mean, Tim is running our operations with a very careful eye on headcount, replacement or additions, and we will continue to stay very disciplined. And Jen and her group are continuing to look at our real estate needs and continuing to trim those where appropriate. As a firm, we're still operating largely in a hybrid model. That seems to be working for our people. We recognize that in today's environment, we are in a new world of work with new behaviors and in order to attract the very best that can drive growth and profitability, we need to be listening to what talent wants.

[Operator Instructions] Our next question comes from Marc Riddick with Sidoti.

So I wanted to follow up on the travel side -- the business travel side of things and what you're seeing there, it seems as though you're expecting that to be steady. Are there any particular areas where you're seeing any type of pickup as far as folks looking to -- clients looking to engage more face-to-face or any type of visibility that you might have and having that pick up going forward?