Resources Connection, Inc. (RGP) Q3 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Resources Global Professionals Third Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the call over to Kate Duchene, Chief Legal Officer.

Thank you, operator. Good afternoon, everyone, and thank you for participating with us today. Joining me on this call are Don Murray, our Chairman; Tony Cherbak, Chief Executive Officer; Tracy Stephens, our Chief Operating Officer; and Nate Franke, our Chief Financial Officer. During this call, we will be providing you with comments on our results for the third quarter of fiscal 2014. By now, you should have a copy of today's press release. If you need a copy and are unable to access one via our website, feel free to call Patricia Marquez at (714) 430-6314 and she'll be happy to fax copies to you. Before introducing Tony, I'd like to read an important announcement about certain statements that we may make during this call. Specifically, we may make forward-looking statements. In other words, statements regarding future events or future financial performance of the company. We wish to caution you that such statements are just predictions and actual events or results may differ materially. We refer you to our 10-K report for the year ended May 25, 2013, for a discussion of some of the risks, uncertainties and other factors, such as seasonal and economic conditions, that may cause our business, results of operations and financial condition to differ materially from results of operations and financial conditions expressed or implied by forward-looking statements made during this call. I'll now turn the call over to Tony Cherbak.

Thanks, Kate. Good afternoon, and welcome to the RGP Third Quarter Conference Call. I'm going to start by giving you a brief overview of our third quarter operating results. Total revenue for the third quarter of fiscal 2014 was $132.7 million, a 3.8% decrease over the comparable quarter a year ago. It's important to remember that quarter-over-quarter comparisons are impacted by the fact that Thanksgiving holiday fell in our third quarter this year but was in the second quarter a year ago. Other items impacting our third quarter results included severe weather in our Eastern markets which we estimate to have cost us approximately $1 million of revenue and continued weakness in our European revenues which declined by 12.3% quarter-over-quarter. As a result of the continued softness in Europe, we will take a charge which will be recorded in the fourth quarter, to further reduce our headcount in certain European practice offices. When complete, we anticipate incurring total severance cost of approximately $2.8 million, an impact of about 7% -- $0.07 per share to our fourth quarter results. These severance costs will be recorded as either cost of revenues or SG&A depending upon the role of the impacted employee. On an annualized basis, these headcount reductions will reduce our cost structure in Europe by approximately $4.5 million or $0.12 per share. This savings will begin primarily in the first quarter of fiscal 2015. Our European platform remains intact and is vital to us in serving multinational clients. However, these actions better align our cost structure to current revenue levels. Now on to other financial highlights. Third quarter gross margin was 36%, a decrease of 110 basis points from the comparable quarter a year ago. During the third quarter, our SG&A costs were $41.6 million, the same as the comparable quarter a year ago and a sequential decrease of $1.5 million. As Nate will expand on in a bit, our third quarter SG&A was lower than anticipated primarily resulting from lower compensation cost among other items. During the third quarter, we generated cash flow from operations and adjusted EBITDA of $5.2 million and $7.8 million, respectively. Additionally, we returned $10.1 million to shareholders during the third quarter in the form of share repurchases and dividends. Our pretax income on a U.S. GAAP basis was $4.9 million. Based upon an effective tax rate of 53.5% during the third quarter, our earnings per share was $0.06 versus $0.11 in the third quarter a year ago. As we reported in -- now on the revenue trends. As we reported in early January, non-holiday weekly revenues during the first 5 weeks of the third quarter averaged $11.6 million. As expected, we lost about 1 week of revenue during the 2 weeks comprising Christmas and New Year holiday weeks. Our weekly revenue following the New York -- New Year's week was volatile, ranging from $10.7 million during MLK week to $11.6 million. This weekly volatility was partly correlated to weather issues in the east during certain weeks in January and February. Our weekly consolidated revenue during the first 5 weeks of the fourth quarter is trending approximately 2.3% higher than the comparable non-holiday weeks a year ago. Now we'll go to Nate for a detailed review of our financial statements.

Thanks, Tony. As mentioned, revenues for the quarter were $132.7 million, a decrease of $5.3 million or 3.8% from $138 million in the third quarter of fiscal 2013. On a sequential basis, revenues decreased 9.1%. On a constant currency basis, the quarter-over-quarter decrease was 3.4% and, sequentially, 9%. As Tony mentioned, our third quarter revenues are not directly comparable, as the prior year quarter did not include the Thanksgiving holiday. We estimate that revenue impact of the holiday shift was about $3.3 million. Adjusting solely for this impact, our consolidated quarter-over-quarter revenue decrease would've been approximately 1.5%. I'll now discuss some highlights of our revenues geographically. For the third quarter, revenues in the U.S. were $103.4 million, down 2.4% quarter-over-quarter and -- down 8.4% sequentially. Adjusting for the previously mentioned shift in the Thanksgiving holiday, on a pro forma basis, our U.S. revenue would have increased by slightly less than 1% quarter-over-quarter. For the third quarter, total revenues internationally were $29.3 million, down 8.7% quarter-over-quarter and 11.5% sequentially. International revenue accounted for approximately 22% of total revenues for the quarter, down from 23% in the second quarter. Europe's third quarter revenues decreased 12.3% quarter-over-quarter and 12.4% sequentially while the Asia Pacific region saw a third quarter revenues decreased 1.8% quarter-over-quarter and 12.1% sequentially. On both a sequential and quarter-over-quarter basis, the U.S. dollar was weaker against the euro but stronger against most Asia Pac currencies. As a result, on a sequential constant currency basis, Europe's revenue decrease would have been 13.6% and Asia Pac's revenue decrease would've been 9.9%. On a quarter-over-quarter basis, Europe's revenue decrease would have been 14% and Asia Pac's revenue would have increased 6.1%. Let me now discuss early revenue trends for the fourth quarter of fiscal 2014. Weekly revenues for the first 5 weeks of the fourth quarter were $11.6 million, $11.4 million, $11.4 million, $11.2 million and $11.4 million. Using the most recent average weekly run rate of $11.4 million over the remaining weeks of the fourth quarter and adjusting for Memorial Day and Easter-related holidays, for which we typically lose an aggregate of 2 days of revenues, we would achieve fourth quarter revenues of approximately $155 million. This computation is purely mathematical and does not consider potential increases or decreases in weekly run rates over the balance of the quarter. Please remember our fourth quarter includes a 14th week this fiscal year. On to gross margins. Gross margin for the third quarter was 36%, a 110 basis point decrease from 37.1% a year ago and down 330 basis points from 39.3% in the second quarter. While we anticipated a 270 basis point decrease in sequential gross margin, we experienced compression and bill/pay spreads primarily in international markets and a slight loss of leverage on benefit costs from lower revenues. These 2 factors reduced our margin by an additional 60 basis points. The average billing rate for the quarter was approximately $125 compared to $126 in the second quarter and $127 a year ago. The average pay rate for the third quarter was approximately $64, up from $63 in the second quarter and $63 1 year ago. Please remember these hourly rates are derived based upon prevailing exchange rates during each given period. Excluding reimbursable expenses, our third quarter gross margin was 36.6%, which compares to 37.7% in the third quarter a year ago. In thinking about gross margin, in the fourth quarter of fiscal 2014, including a 30 basis point impact of estimated European severance costs allocated to cost of revenues, we would expect gross margin to improve sequentially by approximately 230 basis points primarily due to the reduction of compensated holidays and reduced payroll taxes. The dollar amount of severance we expect to record as cost of revenue is approximately $500,000 or about $0.01 per share. For the third quarter, gross margin in the U.S. was 34.7% and our international gross margin was 31.1%, representing a quarter-over-quarter decrease of 80 basis points in the U.S. and 250 basis points internationally. I'll just repeat, gross margin in the U.S. was 37.4%. For the third quarter, the average consultant FTE count was 2,233. This compares to 2,293 in the previous quarter and 2,254 in the year-ago quarter. Quarter-end consultant headcount was 2,346 versus 2,254 a year ago. The total headcount of the company was 3,064 at quarter-end. Now on to other components of our financial statements. SG&A expenses for the third quarter were $41.6 million, similar to the year-ago quarter, or 31.3% of revenue. SG&A was $43.1 million or 29.5% of revenue in the second quarter of fiscal 2014. While we anticipated a $700,000 sequential increase in SG&A for the third quarter due primarily to the reset of payroll taxes, we benefited from reductions in compensation costs and marketing as well as several other SG&A expense categories. We believe SG&A expenses in the fourth quarter of fiscal 2014 will increase approximately $2.7 million from the third quarter level. This increase in fourth quarter SG&A stems primarily from the 14th week occurring during this quarter. This estimate also excludes the European severance estimate of $2.3 million or $0.06 per share which we expect to record as SG&A expense during the fourth quarter. As Tony mentioned, on an annualized basis, these reductions will result in annualized cost savings of approximately $4.5 million or $0.03 per share per quarter beginning in the first quarter of fiscal 2015. Stock compensation expense which is included in the SG&A amounts I just disclosed was consistent with the second quarter at $1.6 million or 1.2% of revenue, down from $1.8 million or 1.3% of total revenue in the third quarter of fiscal 2013. We would anticipate quarterly stock compensation expense in the upcoming quarter to decline by approximately $100,000 from the third quarter's level. At the end of the third quarter, our office count was 71, 46 domestic and 25 international. Depreciation and amortization was $1.3 million for the quarter, the same as last quarter. And we would expect depreciation and amortization expense for the upcoming quarter to approximate the same amount. Our adjusted EBITDA or cash flow margin, which we define as EBITDA before stock compensation, was 5.8% in the third quarter versus 8.3% in the third quarter of fiscal 2013 and 10.9% last quarter. During the third quarter, on a GAAP basis, we recorded a provision for income taxes of $2.6 million on GAAP pretax income of $4.9 million, representing an effective tax rate of approximately 53.5%. As a result of recording the European severance charge which will not be benefited under U.S. GAAP reporting, we anticipate a fourth quarter effective tax rate of approximately 58%. Our effective tax rate is impacted by our current inability to offset income in tax jurisdictions in which we are profitable with losses in tax jurisdictions in which we are not profitable. Our tax rate continues to -- our cash tax rate continues to approximate 42%. 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 and benefited at different statutory rates and the offset of the tax benefit of foreign losses in certain locations by valuation allowances. In summary, our per share income was $0.06 per share for the third quarter. On a non-GAAP basis, utilizing a cash tax rate of 42%, our per share income would have been $0.07 per share. On to the balance sheet. Cash and investments at the end of the third quarter were $107.3 million, a $3.2 million decrease from the end of the second quarter. The decrease stems primarily from cash generated from operations of $5.2 million offset by share repurchases and dividends totaling approximately $10.1 million during the quarter. Capital expenditures were $449,000 during the quarter. During the third quarter, we repurchased approximately 522,000 shares of our common stock at an aggregate cost of $7.4 million or $14.14 per share. On a fiscal year-to-date basis, we have repurchased approximately 1.6 million shares at an aggregate cost of $21.6 million or $13.18 per share. The shares repurchased represent 4.1% of our outstanding shares as of the beginning of the year. Our current board authorization for our stock buyback program has approximately $50.9 million remaining. We will continue to return cash to shareholders through our regular quarterly dividend and share repurchases while maintaining a balance between the capital requirements of our business and fiscal prudence. Our shares outstanding at the end of the third quarter were approximately $38.7 million. Receivables at quarter-end were approximately $89 million compared to $93.1 million at the end of the second quarter. Days of revenue outstanding were approximately 59 days, the same as the comparable quarter a year ago, and down from 61 days in the second quarter. I'll now turn the call over to Don for some closing thoughts.

Thank you, Nate. Whereas we enter our fourth quarter, I am pleased with the traction we continue to experience in the U.S. On a comparable non-holiday weekly basis, our U.S. revenues are trending 4.4% ahead of last year. It is interesting that our weekly revenues in the U.S. during the first week of our fourth quarter was our highest weekly revenue since the third quarter of fiscal 2009. The successive weeks have been slightly impacted by spring breaks and negative weather, but we are pleased with the growth we are seeing in the U.S. Our U.S. growth results from the continued addition of consultants to some of our clients' initiatives that we had previously described last quarter as well as the start of some new assignments. And over time, we believe certain of these assignments will expand internationally. Our global footprint remains strategically important to us as we continue to serve our Fortune 500 type client base with their global initiatives. However, as Tony described, we recently concluded it is time to more closely align our cost structures in Europe with the current kind of reality revenue levels. With respect to Asia Pac, after adjusting for currency, it's nice to see their quarter-over-quarter revenue growth of 6.1% in the third quarter. Now I'll share some additional statistics which we believe reflect the continuing health and strength of our core business. The client continuity remains outstanding. In the third quarter, we served all of our top 50 clients from fiscal 2013 and 49 from fiscal 2012. Through the third quarter of fiscal 2014, on a run rate basis, we have served 220 clients with fees exceeding $500,000. Compared to fiscal 2013, we had 216 clients for whom we provided services at that level. Our top 50 clients represented 39.8% of total revenues, and 50% of our revenues came from 82 clients. Our loyal client following is reflective of our client service approach and the quality of the work performed by our consultants. Our largest client for the quarter was approximately 1.8% of revenues. Through the third quarter, 96% of our top 50 clients have used more than 1 service line and 76% of those top 50 clients have used 3 or more service lines. And this service line penetration reflects the diversity of relationships we have within our clients' organizations. Now this concludes our prepared remarks and we'll be happy to answer your questions at this time.

[Operator Instructions] The first question comes from Kevin McVeigh from Macquarie.

Looks like you guys did a nice job managing the SG&A. Tony or Nate, can you just help us understand kind of the components of -- was it kind of bonus, some discretion that was maybe reversed or just not accrued or advertising? Just any thoughts on what drove the uptick.

Sure, Kevin. I would say the significant portion of it is, what I would label, some incentive comp. And with the falloff and then the revenue decline in -- particularly in Europe, there was a lack of accrual and a reversal of some accruals that we thought would be paid during the earlier part of the year. So that it -- the results now would not be paid. We deferred a little bit of marketing cost. And then I would tell you the remainder is just kind of a whole host of just different areas that, singularly, they're not that significant but they add up -- they added up to a reasonable amount.

Got it. And then just on the severance charge, just given the variability of the workforce, it seems -- how many people does that impact, number one? And then just number two, given where we are, I feel like we're getting a little late in the cycle. Is this just kind of adjusting the business for a different run rate in Europe going forward from a structural perspective or is it just anything kind of country-specific or -- just any thoughts around that will be helpful.

It's about 15% of workforce over there, Kevin. We just decided -- we've been thinking each quarter that their revenues would get better. It hasn't happened, so we decided it was time to kind of get the cost structure in line with the revenues. So that's where we came out on it. And it's going to produce some cost savings for us in 2015 and, hopefully, that can get the revenue going at the same time.

The next question comes from Andrew Steinerman from JPMorgan.

My question is, when I look at the $155 million number that you gave, and I guess if I wanted to do a 13-week quarter, I just subtract 11.4% (sic) [ $11.4 million ] that's quite a mighty sequential pickup from the $133 million that we just reported. And my question to you is, do you consider that a normal sequential pickup or how would you just described the cadence of the $155 million minus the $11.4 million to make it kind of a same-week basis comparison of where we stand right now?

I think, Andrew, one of the things you got to remember is, in the third quarter, we've had 3 major holidays. And going into the fourth quarter, we don't have really any major holidays other than Easter. And that's -- that pales in comparison to like a Thanksgiving or a Christmas or a New Year's. So that's one of the factors.

Andrew, did you -- I just also want to make sure you caught that the fourth quarter -- you had, in your question, had mentioned that the 13 weeks -- one of the drivers of that is the fourth quarter has a 14th week in it this year. That happens every 4 or 5 fiscal years for us.

Right. So if I want think about it as a 13-week quarter, I take the $155 million and subtract $11.4 million, right?

That's exactly right. I'm sorry, then I misunderstood your question. That's exactly right. It's all just built on that current run rate during the early weeks of March, which averaged $11.4 million.

Right. And then just one more thing about the normal seasonal pickup. Obviously, the spring quarter usually is one of the strongest sequential quarters for you. Does that usually happen because of weeks late in the quarter or does that usually happen because weeks early in the quarter like the weeks that we've already seen? Why does it -- why is the May quarter usually a strong seasonal pickup? When does that usually happen in the quarter?

Well, again, Andrew, it can -- it happens all throughout the quarter because, again, we don't have any holidays that are burdening it like we do in the third quarter. I would say, you can look more at the fourth quarter kind of like at Q2 where we averaged $11 million per week over an extensive period of time. I think we're going to do the same thing in the fourth quarter.

Okay. And then last question, sort of just the same question. If I total up the 5 weeks that we already saw, the $57 million, how does that compare to a year ago? Is that already in a kind of growth situation?

You really can't compare them because a year ago, in the first 5 weeks, we have Easter holiday in there. And because this Easter holiday is out a little bit, they're not really comparable. But if you looked at it on a non-holiday week basis, it's about 2.3% ahead.

Right. So you really do feel like we are in growth mode already?

Absolutely.

The next question comes from Jeff Silber from BMO Capital Markets.

I just wanted to follow up about the headcount reductions in Europe. I know this is a sensitive issue. I'm assuming they've already been announced internally?

They have. And they have, and it's very much on its way -- or it's very much underway. We've had, Jeff, our COO has been spending plenty of time over in Europe making sure that as these headcount cuts get made, that we're not risking some of the revenue that would be associated with those people. So we're trying to do this in a very methodical order and not lose any revenue, but adjust our cost structure to the revenue run rate.

All right. That's great to hear. Can you tell us a little bit more about where specifically, which countries you're focusing on for these headcount reductions?

It's really all across the board. It's just across the board. Probably a little bit more so in Sweden than anywhere else, but it -- really, there's people coming out of the practice all across the European operations.

So should we infer from that, that the weakness you've been seeing in Europe is also really across the board?

I'd say outside of the U.K. and outside of Italy, of all places, that's correct. But the U.K. and Italy are doing very well in this environment.

All right, that's helpful. And just looking at the balance sheet, can you remind us, is there a minimal cash level that you need to operate the business under?

Yes. Jeff, we get asked that a lot. We don't really have a set balance. I think as you've seen over the last numerous quarters, we've been bringing that cash down as we've returned cash to shareholders. We're not working towards a magic number, but I think we'll also continue the track record of returning capital as the company does generate cash flows typically more than we need to invest in the business. So...

And a great part about our business model is we do generate a lot of cash. I guess if you had to pin us down to a number, we'd probably say roughly $25 million, but -- and that would give us a little bit of cushion. But we like retaining a fair amount of additional cash over and above the $25 million so that if we see any type of acquisition that we believe would improve our business for the long term, we could hop on it.

And what -- I mean, again, I know you're not going to disclose specific things, but are there specific holes in your portfolio that you are looking to fill via acquisition?

No. But we are always open to something new that might improve our business.

[Operator Instructions] The next question comes from Mark Marcon from Robert W. Baird.

Just wondering if you could talk a little bit about any sort of anticipated revenue impact from the reduction in terms of the European headcount. Were any of them productive or do you anticipate any revenue shortfall or...

Yes. Mark, I say mentioned, our Chief Operating Officer has been spending a lot of time to make sure that, that very thing doesn't happen. So there could be some minor revenue impacts, but we're hoping to achieve this headcount reduction without impacting revenue.

Okay. But I mean like all the remaining offices in Europe will continue to be pretty well staffed. It's not like any of them are going down to skeleton crews or...

Oh, yes. Like I said, I think that -- if you look at it as a percentage of our overall staff, it's about 15% reduction. So yes, in all of our offices, we have a critical mass, I think, of people that can continue the business. So...

Okay, great. And then can you talk a little bit about the revenue? You talked a little bit about U.S. trends, exclusive the holidays over the first few weeks. How should we think about international?

Well, like we said, the international, and if you take Europe and Asia Pac individually, Europe was down about 12% for the quarter. It's trending -- it's staying about even to a down a little bit.

What I was asking is, was it a little bit -- is it a little bit worse or is it about the same?

Well, we've always expected it to improve, and we've been wrong in that regard over the last several quarters and that's why we took the charge. But on an ongoing basis, if you look at it going into Q4, it's -- they're hanging in there, kind of about their previous levels in the third quarter.

So meaning you're still down around 12%, 13%, 14% on a constant...

Probably a little bit less than that, probably trending down about 9% to 10%.

On a constant currency basis?

We don't look at currency on a weekly basis.

So on a dollar basis is what you're saying in terms of that 9% to 10%?

Yes, correct.

Okay. And then in Asia Pac, are you continuing to see growth?

Yes, yes. On a -- and especially there, on the current -- on the -- the currency has hurt us in Japan. The constant currency has kind of been backwards there for us. But yes, we're seeing some good -- Japan's business is coming back. They're up over $300,000 a week. And in China, we're still getting some good growth out of Shanghai and Hong Kong starting to come online, so -- and we just hired a new MD in Beijing. So I'm confident in the Asia Pac practice.

Great. And then can you talk a little bit about, in the U.S., the practices and the specific areas where you're seeing growth?

Well, the primary area is certainly information management. We're seeing a lot of data governance work. We're seeing security privacy issues, in A&F, kind of the regulatory compliance side. Dodd-Frank has still been a big winner for us especially on the East Coast. Supply chain management is strong and our legal practices has been going great guns since Kate Duchene took over the leadership of that practice.

I am showing no further questions. I would now like to turn the call back over to Don Murray.

Well, I'd like to thank you all for your interest in Resources and we look forward to our next update after our year-end of fiscal 2014. Thank you.

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.