Resources Connection, Inc. (NASDAQ: RGP) Q3 2022 earnings call dated Apr. 06, 2022
Kate Duchene — Chief Executive Officer
Tim Brackney — President and Chief Operating Officer
Jenn Ryu — Chief Financial Officer
Good afternoon, ladies and gentlemen, and welcome to the Resources Connection Inc. Conference Call. [Operator Instructions]
At this time, I would like to remind everyone that management will be commenting on results for the third quarter ended February 26, 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, 2021, for a discussion of risk, 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 — Chief Executive Officer
Thank you, operator. Good afternoon, everyone, and welcome to our call today. We will keep our remarks brief as we hope to see you at our Investor Day next week on April 12 at NASDAQ MarketSite.
We’re pleased to announce outstanding Q3 operating results. We’ve achieved record top-line Q3 revenue and well exceeded the high end of our guidance range. Q3 revenue was the highest attained during the same period since the company’s founding over 23 years ago with 32% growth year-over-year. Moreover, we achieved growth across all client segments, including strategic global accounts and regional accounts as well as all major geographies. We’ve also dramatically improved profitability year-over-year. Adjusted EBITDA more than doubled versus the prior year quarter to $22.5 million and adjusted EBITDA margin improved to 11%. This is a fantastic result for a holiday-impacted quarter. These financial accomplishments reinforced that our strategies are working.
We have successfully built a business model and consulting capabilities that are more relevant and essential than ever in today’s environment. Talent is in the driver seat. Today’s talent wants more flexibility and mobility. According to Forbes, 50% of the workforce will be agile or gig-oriented by the end of 2023. We pioneered a gig model for professional workers over 20 years ago. We know how to attract, deploy and nurture project-based agile professional talent. Given the powerful accelerating impact of the global pandemic, we’ve become a career destination for in-demand experts who desire to work with marquee clients to co-deliver on high-value impactful projects.
Our work model offers an attractive alternative to traditional role-based career paths or professional services pyramid models. Where those models often involves abdication of control of choice and flexibility and skill stagnation, we allow our employees to reclaim and own their careers to determine when and how much to work and what projects to work on. Modern professionals are bolder and clear-minded about what they want. For many, that’s no longer traditional employment, and we deeply understand what they’re looking for and how to provide it.
From the client perspective, the war for talent, retirement trends, immigration policy, wellness considerations, diversity priorities and other imperatives have led to significant talent shortages and gaps. To solve the growing challenges, clients are innovating their workforce strategies. Three trends are pre-eminent and all aligned to RGP’s sweet spots. First, clients are rapidly evolving how work gets done with full-time employees who are remote, hybrid or demand and improved experience to ensure retention. These talent innovation strategies create opportunity for digital transformation, project management and change management services as these projects often entail automation, collaboration and knowledge-sharing project initiatives. Veracity has increasingly focused its expertise on workforce experience consulting, delivering strategies through digital implementation.
Second, clients are rapidly increasing the use of innovative talent engagement models that bring on-demand experts into co-deliver on projects, providing greater speed, efficiency and agility. Strategy is one part of the puzzle, but execution is the game-changer. Alphabet was the early adopter of this business strategy and many others are now at last following this lead. According to a McKinsey survey, 85% of executives recently pulled, expect to increase the use of on-demand talent over the next 24 months.
This strategy also aligns with upskilling its objectives as RGP experts offer knowledge-sharing mentorship and industry cross-pollination when co-delivering with client teams. Beyond demand resourcing movement, provides excellent growth opportunity for RGP’s core capabilities, which align perfectly to the pressing business needs of today, including supply chain, risk management, talent innovation, digital and finance and data excellence consulting.
Third, the project-based economy is growing across the board and across the globe. The Project Management Institute projects that 25 million new project managers will be needed over the next eight years to meet global talent demands. CEOs report a preference to address today’s biggest business challenges involving cybersecurity risk, climate change, DE&I and supply chain disruption through a project-oriented framework to accelerate outcomes and bring independent thinking to the solutions. RGP is strongly positioned to thrive in this space given our blend of project management, change management and functional expertise.
Massive disruption has happened in the world of work. Talent supply and preferences have significantly changed and services demand has been permanently altered. These disruptions are not ephemeral or retreating. To the contrary, they are growing. So what is RGP doing to own our position of strength and sustain growth and improve profitability for our shareholders? During our Investor Day next week on April 12 at NASDAQ MarketSite, we will be sharing deeper insights about macro trends, highlighting the growth and profitability opportunities across our offerings and outlining how they address different pain points in today’s world of work challenges.
We will also discuss our internal initiatives to execute more efficiently against opportunity trends, including our important initiative to achieve greater brand clarity in the marketplace. We will also help attendees visualize how the interconnectivity of services within the RGP ecosystem will drive further growth and profitability. Whether we describe the client success stories from Countsy, Veracity, RGP or HUGO, we are building and growing a set of capabilities that deliberately and powerfully reinforce each other to solve client problems. Investors will leave with a better understanding of how RGP is uniquely positioned to address the macro trends that are converging to fundamentally change the way work is accomplished.
In closing, I want to share an employee story. This story happens to also tie to the tragic geopolitical events happening in the world today. While RGP does not have business exposure to Russia or Ukraine, we do have people within our organization who have loved ones in the region. For them, we take a stand and denounce Vladimir Putin’s unjustified military invasion of a sovereign country. We also encourage expressions of kindness and support for the people of Ukraine.
Specifically, we applaud one of our own who converted her Employee Recognition Award to tickets travel anywhere in the world to tickets to fly strangers in need out of Ukraine. Those two Ukrainian citizens, a mother and young son, are now staying with our RGP employee until safe and affordable housing can be found. I share this story of human kindness because it is a beautiful example of the soul of our company, empathetic, human-first and problem-solving. Thank you team RGP for your heart, energy and enthusiasm in delivering the exceptional results we are presenting today. We are a collaborative culture and strongly committed to continuing to deliver excellent results for each other, our clients and our shareholders.
I will now turn the call over to Tim for an update on operations.
Tim Brackney — President and Chief Operating Officer
Thank you, Kate, and good afternoon, everyone. During the third quarter, we saw continued revenue growth, strong operational metrics and margin performance despite the seasonal impacts of the holiday season. In fact, this marked the sixth consecutive quarter of sequential growth. Pipeline and deal size demonstrated continued strength, led by penetration into existing accounts coupled with new logo acquisition. The momentum noted at the end of Q2 relative to revenue and closed deals sustained throughout Q3, such that we saw the highest levels of closed deals in over a decade. Enterprise revenue increased by 32% over prior year quarter and 4% sequentially on a same-day constant currency basis, while top of the funnel activity was robust, especially when taking into account holiday effects for both Christmas and New Year’s Day.
Geographic performance in the quarter was consistently strong across our core business with strategic accounts, Asia Pacific, Europe, North America, healthcare, Countsy and Veracity all demonstrating solid performance. Demand trends across the portfolio continue to rise as business has been buoyed by our operational focus and tenacity and the macro trends that are driving the commercial aspects of our business, in particular, clients’ heightened desire for co-delivery on key initiatives.
As we have previously noted, this shift to the use of more agile resources is really a permanent lens through which companies are reimagining their overall workforce plans and is very much in line with our core value proposition of impact through agility. Illustrative of this shift is a project we are doing with a large technology company in the west who is undergoing a transformation which includes the carve-out and stand-up of an entity and the setup and maintenance of the Transitional Services Agreement or TSA.
We initially started with approximately 10 consultants working out a team comprised of client and RGP personnel at the functional and program level focused on the carve-out. That quickly morphed to additional work streams covering the new entity to help implement systems and processes and finance, which would free them from the TSA. The team doubled its initial size and the project is scheduled to be ongoing through most of FY ’23 with other co-delivery opportunities expected on the horizon.
Similarly, at a new medical device client, we proposed and won a significant projects around the integration of a major acquisition. Our initial scope focused on managing the IT integration work stream where we were delivering functional and program management expertise. Subsequently, our scope is expanding to a good program and change management working with Immigration Management Office.
The program — the project teams combined client and RGP expertise with a sole focus of an efficient and successful integration. Given the scope and complexity of the project, we anticipate additional work before the integration is complete. On the candidate side, we continue to see more candidates attracted to our employment brands who are seeking control of their personal portfolio of experience, while retaining the community, learning, progression and protections that have been the hallmark of traditional employment, a combination RGP has always provided.
Despite an overall employment environment, rise with employment change and constricting supply, hiring and total consultant count are the highest they’ve been in several years and our attrition rate has declined to a low not seen in recent memory. Labor trends have transformed broadly and a much larger contingent of the overall workforce are daring to work differently.
We continue to be confident in our demonstrated ability to attract and retain professional talent that is demanding flexibility and control despite a competitive labor market, which has more broadly impacted traditional employment. In fact, the positive experience engendered in our hiring process generates morality, which is crucial for highly personal decisions such as employment.
As an example, one of our exceptional talent acquisition team members did a cold outreach to a potential applicant to speak about an opportunity for which he was a good match. After the initial call, the prospect decided that this opportunity wasn’t a good fit for him at this time and he was happy in his current position. However, he said it would be a perfect fit for his wife. In short order, his wife was on an FP&A project with RGP. In fact, she was so delighted at the speed, personalization and professionalism of the process that she raved to her husband in that work. Given her overall experience with our company, her husband then decided to make the leap despite his initial reluctance and now is a candidate for a couple of other opportunities, and we expect them to start shortly.
These examples show how the desire for flexibility and control permeate both our commercial and employment model and demonstrate compelling future opportunity as the market continues to evolve. We are competing with traditional employers for talent and are winning at increasing rates. Over time, we expect that more roles within more functions and organizations will increasingly become the province of an agile workforce. We remain keenly focused on overall consultant experience and are committed to investing in pathways driven by workforce desires ultimately leading to enhanced employment stickiness to RGP.
Now let me turn back to our third quarter operations. During the quarter, we saw continued pipeline growth and strong velocity. Average daily revenue grew throughout the quarter and ended at the highest rate in over a decade. Additionally, pipeline and book revenue are the strongest they’ve been in many years. In terms of upside, we continue to see pricing leverage as an opportunity across all of our business and remain focused on increasing bill rates. Lead generation and opportunity identification continue to be strong into Q4, and the early weeks of the quarter have shown strong positive trends in revenue, pipeline and closed deals. In fact, the early quarter weekly revenue trends sustained rates that we saw in the last weeks of Q3, which were very strong.
Finally, let me touch on operational leverage. As in prior quarters, in Q3, we continue to focus on controlling fixed cost and operating efficiency. Adjusted EBITDA margin improved significantly from prior year quarter and was especially strong given seasonal impacts of the quarter. We will continue to operate in a hybrid fashion, but we’ll be opportunistic and utilize in-person meetings to cultivate and solidify relationship.
I will now turn the call over to Jenn for a more detailed review of our third quarter results.
Jenn Ryu — Chief Financial Officer
Thank you, Tim, and good afternoon, everyone. We achieved record third quarter revenue and further improved our SG&A leverage, which led to $22.5 million of adjusted EBITDA or an 11% adjusted EBITDA margin, a 490 basis point increase from the prior year quarter. Third quarter revenue of $204.6 million exceeded the high end of our revenue guidance. After adjusting for business day and currency impact, Q3 revenue represented growth of 32% year-over-year and was up 4% sequentially.
The sustained sequential growth over an already robust second quarter revenue performance speaks to the strength in our business despite typical adverse seasonality. We continue to see broad-based growth across most of our core markets, client segments, solution areas as well as industry. As the labor market continues to tighten, our clients are turning to us more to fill their workforce gaps and to co-execute their projects.
Professional staffing revenue increased 43% year-over-year, while project consulting revenue increased 25%. We continue to drive healthy growth in our strategic client accounts. Revenue from this client segment increased 23% over the prior year quarter. Our solution offerings and finance and accounting and business transformation grew 42% and 36% year-over-year. Taking a look at industries, healthcare, financial services and technology industry revenues expanded by 49%, 43% and 35% compared to the prior year quarter.
Moving on to geographic revenue trends. Our revenue in North America improved 36% year-over-year and 6% sequentially on a same-day constant currency basis. Most geographic regions across North America grew by double-digits over the prior year quarter as well as beating the sequential quarter. In Europe, same-day constant currency revenue grew 6% year-over-year, while there was a 6% deceleration compared to Q2 of the current fiscal year. The overall demand environment in Europe remains healthy. APAC also experienced broad-based expansion in revenue across most markets over prior year. Third quarter revenue grew 24% on a same-day constant currency basis and held flat sequentially.
Gross margin in the third quarter was up 110 basis points over the prior year to 37.5%, in line with expectation in the third fiscal quarter, which is typically lower due to the holiday. We made solid progress in raising average bill rate by 2.4% and improving pay/bill ratio by 120 basis points from the prior year quarter. Sequentially, average bill rate increased by 1.6% and pay/bill ratio remained flat. Third quarter enterprise average bill rate was 128 compared to 125 in the prior year quarter and 127 in Q2. We will continue to drive revenue growth and margin expansion through pricing and believe there are abundant upside opportunity.
Building on the structural improvement in our SG&A, run rate SG&A expense for the quarter was $54.4 million after excluding non-cash stock compensation, contingent consideration, restructuring charges and technology transformation costs, representing 26.6% of revenue, a 380 basis point improvement compared to the same period a year ago. SG&A dollars increased from the prior year quarter, primarily driven by higher variable compensation as a direct result of our strong business performance in the current fiscal year. Also included in the third quarter SG&A expense was a one-time foreign currency gain of $1 million related to the dissolution of our France entity.
Now turning to the other components of our financial statements. Our effective tax benefit rate for the quarter was 12.7%. With sustained profitability in our European entities, we recognized a discrete tax benefit of $7.5 million in the third quarter, specifically in the Netherlands related to both the reversal of its valuation allowance as well as a current quarter tax deductions related to the dissolution of the France entity.
Adjusted diluted EPS for Q3 rose significantly to $0.65 per share compared to $0.14 in Q3 of fiscal ’21. The discrete tax benefit during the quarter favorably impacted adjusted diluted EPS by $0.22 per share. We finished the quarter with $82 million of cash and cash equivalents and generated $23 million of cash from operations. We maintained our $0.14 per share quarterly dividend in Q3 and repurchased 20 million of common stock. We expect to engage in share repurchases opportunistically under our existing share buyback program, which has $65 million remaining at the end of the quarter. Our technology transformation project is progressing. Related cash expenditures for the third quarter were approximately $600,000 a portion of which was capitalized.
I’ll now close with our fourth quarter outlook. We’re proud of achieving sequential revenue growth over the last six consecutive quarters as we not only recover from the pandemic, but are approaching our all-time record. Consistent with market trends, we anticipate sequential revenue growth to start to normalize. While the fourth quarter will be impacted by spring break, we believe the overall strength in our business remains solid. Fourth quarter revenue is expected to be in the range of $211 million to $215 million. Gross margin in Q4 is expected to be in the range of 38.7% to 39.5%. And our run rate SG&A, which will exclude stock compensation and technology transformation costs, to be in the range of $58 million to $61 million. Before we turn to Q&A, I’d like to remind everyone about our Investor Day next week on April 12 at NASDAQ MarketSite. We look forward to hearing more about our business.
With that, we’re happy to take questions.
Questions and Answers:
Thank you. [Operator Instructions] And I’m not showing any questions at this time. I would now like to turn the call back over to Kate Duchene for any further remarks.
Kate Duchene — Chief Executive Officer
Thank you, operator, and thank you, again, everyone, for joining us today. I hope you’ve saved your questions because you intend to participate with our Investor Day event. To remind you, it’s next week, April 12 in the morning at NASDAQ MarketSite. And we hope to see you there for a more fulsome discussion of our business and our trends. Thanks so much, everyone, and we’ll see you there.
[Operator Closing Remarks]
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