Highwoods Properties Q2 2024 Earnings Call Transcript

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January 3, 2024

There are 6 speakers on the call.

Operator

Good afternoon, ladies and gentlemen, and welcome to the Resources Connection, Inc. Conference Call. Currently, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

Operator

At this time, I would like to remind everyone that management will be commenting on results for the Q2 ended November 25, 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 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.

Operator

Such statements are predictions and actual events or results may differ materially. Please see Risk Factors section in RGP's report on Form 10 ks 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 operation 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.

Speaker 1

Thank you, operator. Good afternoon and Happy New Year. Thank you all for joining us today. In Q2, we delivered solid performance across the enterprise despite a macro environment that continues to be sluggish and uncertain. This quarter can be characterized by green shoots and continued tenacity.

Speaker 1

Again, we have shown well with to engagement extensions and client retention, and our pipeline finished the quarter strong. As we shared last quarter, new project initiation has been slower to materialize and opportunities have pushed to the new calendar year. On revenue, we performed in the stronger half of our guidance range, while also continuing to deliver strong cash flow this fiscal year. On SG and A and therefore adjusted EBITDA, we well exceeded our expectations as we continue to remain disciplined on cost in this environment. Our balance sheet remains pristine.

Speaker 1

During Q2, Veracity delivered sequential revenue growth, earning new business from the Sained appetite for digital transformation services and capabilities. We also expanded Brasby's digital presence across the Asia Pac region through the acquisition of CloudGo, a digital transformation firm and elite ServiceNow partner. We're excited about this acquisition, the exceptional talent this adds to our company, and we are already beginning to see synergies between Veracity and The Northern California market, which I had mentioned last quarter, also grew sequentially, again showing positive movement in the tech sector after more than a year of decline. Regional performance in the rest of North America reflected the overall choppy operating environment with clients remaining cautious about new spend until there is greater clarity around interest rates and economic direction. Our Mexico, India, Philippines and Switzerland practices all grew both sequentially and year over year as we delivered major projects for large strategic clients.

Speaker 1

Our pricing initiative in the U. S. Is progressing well with a 1.3% Increase in bill rate year over year. As you'll hear more from Jen in a moment, Europe showed even stronger improvement in pricing. Turning to our operational metrics, we're pleased that the pipeline remains steady through the quarter.

Speaker 1

And in post quarter December, more extension opportunities in the pipe were converted into closed won engagements. In Europe, pipeline grew throughout Q2 as clients engaged in planning discussions for 2024 and pent up demand around technology transformation and transaction support moved to the forefront. Our Asia Pacific business, particularly in India and the Philippines, continued to Show demand strength from our large global clients as they increasingly move more activity to offshore global business service centers. Across all geographies, we're experiencing an uptick in in person client meetings, which is a positive indicator that Clients are engaging and planning for projects to get underway in the new calendar year. Given the areas in which we're seeing consistent and rising demand for professional services, especially digital transformation and cloud technology support, we believe we are well positioned to cap As mentioned last quarter, we closed more business related to cloud ERP implementations and optimizations.

Speaker 1

Our pipeline is heavy with opportunity at large and middle market companies to implement and unlock the value of technology and prepare for the implementation of AI with improved data governance and business process standardization. This is exactly the type of work for which RGP shines and can deliver significant value. In our financial services practice, We see rising demand for regulatory remediation, another area of strength for RGP. In Healthcare, we've built an to support revenue cycle optimization and claims reimbursement capture in our large provider client base. These opportunities are significant longer term and allow us to get deeper into our A plus client set, which creates cautious optimism that revenue conversion will improve in 2024.

Speaker 1

During Q2, we completed additional research around client decision making to help us prepare for what's next. We pulled 1,000 plus leaders from companies with at least 1,000,000,000 In revenue, to understand what's on the agenda and how our capabilities line up to that need. We found that transformation initiatives are a priority as large organizations are taking on an average of 20 $1,000,000 plus transformation initiatives this year alone. They also report finding the right skill sets for critical transformation initiatives Has become more complicated in an ever more disrupted world. Our research further uncovered that a hybrid workforce Strategy that blends internal talent with skilled outsiders enables company to realize competitive advantages by building constant transformation into their core DNA.

Speaker 1

We refer to this approach as the dynamic workforce model, and we believe it is becoming increasingly more prevalent in business today. Adoption of the dynamic workforce model is being Accelerated by transformation overload as our research uncovered that only 4 in 10 organizations reported they had enough internal talent to Staff all their planned initiatives. This research matches what the ManpowerGroup Employment Outlook Survey reported in December. In that survey, which included an even bigger pool of 40,000 plus employers across 41 countries, 75% of respondents reported they're struggling to find the skill sets they need. These skills Shortages have wide ranging impacts on transformation initiatives ranging from project delays, missed critical goals and more difficulty in achieving operational change.

Speaker 1

Thus, based on our research, the proportion of outside talent on transformation teams Grew to 45% in 2022 and is expected to reach 48% this calendar year. Connecting this research to our business model, we are highly encouraged. The global pandemic proved once and for all that highly skilled talent can collaborate effectively regardless of location or FTE status. C suite leaders recognize the power of hybrid talent models, and we're seeing more CEOs and CFOs work with HR leaders to adjust talent strategy accordingly. The talent side of the equation is equally embracing these Expert Talent is actively choosing to pursue their professional passions in a more independent way.

Speaker 1

In fact, we've consistently seen our retention rates increase in recent years, now even exceeding those reported by the traditional partnership models. The choice, transparency and control in client engagements we offer our consultants is a key differentiator. These attributes also serve to create a client experience that is differentiated for the good. Experts who choose their projects feel more empowered, engaged and committed to the client's success. In short, we may have been ahead of our time when we launched The first agile professional services business model 20 plus years ago when we spun off from Deloitte.

Speaker 1

We are now emboldened to see that today's clients and talent alike are eager to embrace what we have built and perfected. Our focus for the rest of the fiscal year is on the execution of 3 strategies. First, we will continue our Expanding Consulting Services, especially in digital and technology transformation. As we have earned trust with our clients, they have asked us to deliver more strategic advice, including assessments, tools, methodologies and expert talent. We acquired Veracity in 2019 as the start of this strategy and it has been a successful combination.

Speaker 1

We most recently added CloudGo to continue the expansion of this strategy globally. We will also continue to scale such targeted Consulting services with our Agilexpert business. 2nd, we will execute our talent strategies to build in demand pools of talent around the world that can be used to quickly assemble blended delivery teams. These teams can be built to grow our consulting assets faster and will improve our win rates by offering clients blended rates and intellectual arbitrage. We've established Two centers of excellence this year in Manila and India and have made good progress in growing these talent hubs.

Speaker 1

Finally, we will continue to push forward our technology transformation initiative to drive even greater operational efficiency and financial performance as one global enterprise. We'll soon launch the 1st wave of the technology transformation initiative benefiting our global talent function. We're excited that this enhanced software will improve our supply and demand match and enhance our global service to our clients. Jen will share more detail in her remarks. In sum, we're working hard throughout our organization to close every business opportunity with Creativity and grit.

Speaker 1

At the same time, we are retaining the best consultants and improving operations with streamlined process, improved technology and global connectivity. The macro environment is not easy And far from standing still, we are aggressively optimizing our business to quickly capitalize when conditions improve and to deliver long term value. We have what business needs today. I'll now turn the call over to Jen.

Speaker 2

Thank you, Kate, and good afternoon, everyone. This quarter, we achieved $163,100,000 of revenue, which was in the upper half of our outlook range provided in October. Our run rate SG and A of 47,400,000 dollars was significantly better than the favorable end of our run rate SG and A outlook of $53,000,000 to $55,000,000 Notwithstanding an uncertain macro environment, we produced solid adjusted EBITDA of $16,100,000 or 9.8% adjusted EBITDA margin and have delivered $54,000,000 of free cash flow in the last 12 months. On a same day constant currency basis, revenue declined by 19% year over year as our clients continue to be cautious with the pace of Spending in the face of the uncertain macro conditions. Regional performance was reflective of the overall environment.

Speaker 2

In North America, although certain pockets such as Northern California, Atlanta and Veracity have started to show signs of recovery compared to the beginning of the fiscal year, Many major markets were still affected by the broader economic environment. Our Europe and Asia Pacific regions performed relatively better with more modest declines of 9 percent and 10% year over year on a same day constant currency basis. Markets such as Switzerland, India and the Philippines grew over the prior year quarter as well as sequentially, primarily attributable to project opportunities with our large strategic clients. Operationally, our growth pipeline remained resilient during the quarter. While the velocity of converting new opportunities in the pipeline to Actual engagements remain slow.

Speaker 2

Extensions on existing engagements have been healthy. Our solid pipeline suggests that demand in fact exists And it's a matter of when, not if, clients will move forward with the execution of their initiatives. These opportunities represent real for our business as macro conditions improve. Gross margin in the quarter was 38.9%, reflecting a heavier mix of business in Europe and Asia Pacific, which typically carry higher pay bill ratio compared to North America. Gross margin in the second quarter also reflected a 90 basis adverse impact from a spike in healthcare costs.

Speaker 2

As a sponsor of a self insured medical program, we know the number of medical claims can spike from time to time. But in general, we do not believe the trend this quarter is indicative of our healthcare costs in the foreseeable future. Next, I want to provide an update on our pricing initiatives. We're seeing more competitive pricing pressure in the current environment. Even against this backdrop, Our U.

Speaker 2

S. Average bill rate rose more than 1% compared to the Q2 of fiscal 2023, and Europe was up 5% on a constant currency basis. Average bill rates in both regions also improved on a sequential basis from Q1. However, due to the shift in revenue mix To regions with lower bill and pay rate, enterprise average bill rate for the quarter was $121 constant currency, down from $1.28 a year ago, while the average pay rate was $58 down from $60 a year ago. Strategic pricing will a continued point of emphasis and expansion for the rest of fiscal 2024 and beyond.

Speaker 2

Turning to SG and A. Our run rate SG and A expense for the quarter was $47,400,000 which as I noted was significantly better than our outlook range. Variable compensation expense was favorable in the Q2, aligning with the company's overall financial performance this fiscal year. In addition, the reduction in force we executed at the start of the second quarter contributed approximately $2,000,000 of SG and A savings in the quarter. Restructuring costs associated with this effort was $2,300,000 and we expect $10,000,000 to $12,000,000 of annual savings on a go forward basis.

Speaker 2

Effective tax rate this quarter was 43%, largely attributable to an outsized amount of stock option expiration and the capitalization of acquisition costs for tax purposes. Turning to liquidity. We're proud of our ability to continue to generate robust free cash flow Despite the macro environment, we distributed $4,700,000 of dividends during the quarter and repurchased $5,000,000 worth of common stock at a weighted average price of $14.13 per share, leaving $45,000,000 available in our share repurchase program at quarter end. Pursuant to our stated strategy to expand our digital consulting business, both organically and inorganically, on November 15, we closed the acquisition of Calgo, a digital transformation firm and an elite ServiceNow partner in the Asia Pacific region. Calgo's strategic capabilities and regional positioning will play a key role in our growth plan.

Speaker 2

Together with Veracity, this combination will position us better to support our clients globally. Initial cash consideration of $7,700,000 was paid during the quarter, while remaining consideration of up $12,000,000 will be determined by Clogos performance against a set of target performance metrics over a 2 year earn out period. Cargo did not contribute significant revenue or EBITDA to our 2nd quarter results. We ended the fiscal quarter With $95,800,000 of cash and cash equivalents and 0 outstanding debt, with total available financial liquidity of 2 $69,000,000 at the end of the second quarter. Our capital allocation will be focused on investing in the most impactful areas of the business, including completing our technology transformation project and continuing to pursue a disciplined M and A strategy to accelerate long term growth and profitability, while continuing to return cash to shareholders through dividends and by opportunistically repurchasing shares.

Speaker 2

Now let me provide an update on our technology transformation project. We have made tremendous progress and plan to go live with a set of new Talent Management and Contract Management Systems in North America during the 3rd fiscal quarter, followed by our financial systems go live planned for later in the calendar year. The new platforms will not only improve the efficiency of our business processes and enhance data visibility for better decision making, They will also provide a much more favorable experience for our clients, consultants and employees. We incurred $4,400,000 of implementation costs in the quarter, of which $2,800,000 was capitalized with the remaining $1,600,000 included as non run rate operating expense. I'll now close with our Q3 outlook.

Speaker 2

While it has certainly been a challenging year, we are encouraged that our weekly revenue has been stable We expect the pace of revenue conversion from opportunity to close to remain sluggish in the 3rd quarter. After giving effect to the holiday impact in Q3 and including Clougo, we project revenue to be in the range of $150,000,000 to 150 $5,000,000 Gross margin in Q3 will be compressed by the typical seasonality during the holidays, including the reset of employer payroll taxes at the start of the new calendar year as well as the current global revenue mix with a higher proportion of revenue coming from Europe and Asia Pacific. We estimate gross margin in Q3 to be in the range of 35.5 percent to 36%. We expect our run rate G and A expense to be in the range of $51,000,000 to $53,000,000 which includes CAGO's SG and A expense and again reflects the increase in employer payroll taxes at the beginning of the calendar year. Non run rate and non cash expenses for the 3rd quarter Will consist of approximately $2,000,000 of technology transformation costs and $3,000,000 of stock compensation expense.

Speaker 2

In closing, while we acknowledge the headwinds presented by the prolonged market uncertainty, we also see compelling opportunities ahead as macro conditions start to recover and we're ready to execute and excited about our business model and long term outlook. With a durable variable cost model, a pristine balance sheet and ample liquidity, we believe we are well positioned to continue driving long term value creation for our shareholders. This concludes our prepared remarks and we now will open the call for Q and A.

Operator

Thank you. Our first question comes from Stephanie Yih with JPMorgan. You may proceed.

Speaker 3

Hi, good afternoon. Could I ask for the revenue guide that you gave for the 3rd quarter? What is the implied revenue decline on a constant currency same day basis?

Speaker 2

Hi, Stephanie. The full year guidance at the top of the range at $155,000,000 is approximately a 17% year over year decline On a same day constant currency basis.

Speaker 3

Okay, great. And then could you help us understand how much of Cloudgo was included in the 3rd quarter outlook. And I guess how much on an annual basis Cloudgo is expected to contribute to RGP?

Speaker 2

Yes. We don't expect very material immediate impact on our financials from this acquisition. This acquisition is more Strategic in nature, we believe that this is going to enhance our capabilities to serve more clients and there's a lot of tremendous amount of synergy to drive future value. So given the size of the acquisition, we're not disclosing their financials.

Speaker 3

Okay. Sounds good. Thank you.

Operator

Thank you. One moment for questions. Our next question comes from Mark Marcon with Baird. You may proceed.

Speaker 4

Hey, this is Andre Childress on for Mark. Appreciate You're taking the questions and happy New Year's everyone. So Kate, last quarter you talked about some green shoots and you Talked about those same green shoots as well this quarter, with regards to the pipeline. As we get to the end of the year and we ended the year, What are you seeing and hearing from your clients with regards to their expectations for calendar 2024 now that budgets are set?

Speaker 1

Yes. I still think that we're seeing more opportunity around digital transformation, as I said in our prepared remarks, and Continued optimization of cloud ERP opportunity. In fact, today, Andrew, I got another request from a client to introduce our services around cloud ERP, both system selection And implementation services. And there's a lot of wraparound work tied to that, which is around data governance, data cleanup, and process improvement. So that's really where we're still seeing opportunity in our conversations with clients.

Speaker 1

I do expect in Europe that we might see some uptick around transaction work, especially around decisions to divest business. And we're in conversation with a couple of large clients about how we could Support some divestiture strategy.

Speaker 4

That makes sense. And last quarter, you also laid out in terms of a softer first half for the calendar 2024 year and then the back half stronger. As things have progressed over the past 3 months, how have those expectations changed or how should we think about that?

Speaker 1

Yes. I think unfortunately, the close of 2023 calendar 2023 has still been sluggish. And it's a crystal ball to say exactly when we'll see the shift occur. I think every client is Looking for a little more macro certainty and getting more clarity around economic conditions, especially around interest rate Decision making. So that continues to be a little sluggish.

Speaker 1

As Jen said in her prepared remarks, We believe it's a matter of when, not if, and so we stay very ready to support these initiatives that our clients are talking to us about. It's just getting them to pull the trigger. And that is all business decision makers getting a little more comfort and a little more about where the economy is headed.

Speaker 4

That makes a lot of sense. And then one more for me and then I'll hop back in the queue. Jen, you had some commentary about competitive pricing dynamics. Could you just explain a little bit more about what you're seeing in the market from a pricing perspective, particularly in

Speaker 5

the U. S? Thank you.

Speaker 2

Yes, sure. I mean the pricing environment has gotten tougher as like all of the Professional services firms are competing for in general a smaller pool of work. When we compete against the big four, they'll often have off Sure, operations and blended teams, and that averages down the rate and making it tougher to win the work. And that is another reason I think Kate I alluded to or talked about in her remarks, this is another reason why we're building our offshore talent pool to stay competitive. And on the other side, when we're competing against staffing firms and they've been racing to the bottom on pricing to win work.

Speaker 2

So that's where kind of the competitive pressure is coming from. With that said, I think new work is getting more challenging on pricing, but we are still working through to catch up on pricing on our existing MSAs. So far, we haven't really had much pushback from our clients with this regard. So I think we've done a really great job over the last Multiple quarters, 6 to 8 quarters to raise our pricing, and I think there's still probably some room to go there.

Speaker 4

Sorry, just one more follow-up, Given you touched on it, so the center of or the centers of excellence that you're building out internationally, could you just talk a little bit more about Strategy and how you think about that building out over the next few quarters and integrating that and blending that with your other talent pools, as we think about that going forward? Thank you.

Speaker 1

Yes. Andre, I'll jump in here. I talked about a little bit in my prepared remarks. We, for example, just won a big piece of work With veracity for our financial services client that's continuing their digital transformation. And the reason we won the work is because we are, blending not only rates, but we have tapped into A very strong talent pool in India around ServiceNow capability.

Speaker 1

So it's not just being able To bring labor arbitrage and the cost of labor down, it's also finding the talent that the world needs today. I mean, as I mentioned, our own research and the manpower, outlook from December still highlights That finding the right skill sets is one of the biggest challenges as every company is continuing to digitize and Introduce more and more technology and AI into what we do. And so it's not just about cost anymore, it's about finding The right talent pools that can offer our clients and especially on these consulting engagements what they need. We're very excited about what we're building in India, and we're doing the same thing around Finance talent finance and accounting talent in the Philippines. I mean, we're all reading the Stories about finance and accounting talent exiting the profession in North America for a variety of reasons.

Speaker 1

And so needing to Find these talent pools that exist in other parts of the world, I think will be increasingly important to remain Not only competitive financially, but also competitive in terms of winning the work.

Speaker 4

Great. Thank you so much for that color.

Speaker 1

You're welcome. Thank you and Happy New Year.

Operator

Thank you. One moment for questions. Our next question comes from Marc Riddick with Sidoti. You may proceed.

Speaker 5

Hey, good evening.

Speaker 2

Hi, Mark. Hi, Mark.

Speaker 5

So I wanted to start with thanks for all the color that you've already provided. I wanted Start with, if you could give some thoughts and commentary around sort of where you finished The quarter on headcount and kind of where you comfort level as to maybe what you're seeing maybe for the next Couple of quarters if you're kind of where you want to be or if you feel as though there are other adjustments that need to be made or some areas that you would need to shore up or how should we think about Sort of where we ended the quarter versus where you might want to be 6 to 12 months from now?

Speaker 2

Mark, are you referring to consultant headcount? I just want to make sure I'm answering. Yes. So our consultant headcount at the end of the quarter, it didn't really All that much from the end of last year around the same time. One reason is because we added A pool of consultants or talent from Clouso from this acquisition.

Speaker 2

And then the other piece to remember is the Consultant count that you're looking at the end of the period is at one point in time. And so it depends on the talent that we're adding to serve our, for example, large Clients in the Philippines and we had some kind of a one time ad there, a group of independent consultants that's working on that. So Overall, if you look at the average, our consultant count, I would say, decreased about anywhere between 300 to 400, If you look at the average year over year, yes.

Speaker 5

Okay. And then I was wondering if you could shifting gears, I appreciate the commentary on I wonder if you could talk a little bit about, you did briefly touch on uses of cash and certainly there's another 5,000,000 or so on share repurchase during the quarter. I wonder if you could talk a little bit about the acquisition pipeline that you're currently seeing, whether That look has changed, valuation has changed or maybe how you're looking at the current pipeline today versus maybe 3 to 6 months ago?

Speaker 1

So let me just comment on M and A and pipeline activity, and then I'll hand it to Jen to talk about, our uses of cash In capital structure, but we continue, as I've talked about, we are building more diversification in our business to follow Higher margin and higher growth businesses. We see consulting as an opportunity for us to also scale with our agile business. And the Veracity and Cloud Go Business is exactly a testament to that strategy. And so as we continue to do that, we're going to look at additional consulting assets that can drive that strategy forward. We're also in the process of analyzing and mapping what our consulting capabilities have been in our PCS business And bringing them closer together with what Veracy does in their strategy practice, especially around user experience.

Speaker 1

So we bring both user experience and functional expertise closer together. Again, that is a part of Strengthening the consulting part of our business and then being able to scale those practices with our agile talent. And M and A will play a role in that. Jen, now I'll hand it to you.

Speaker 2

Yes. So from a capital allocation standpoint, Mark, we have a number of areas in the business as we want to continue to invest in to drive long term growth. One area, as I said in my remarks, is to complete our digital transformation project. And for the remainder of the year, we're still looking at about anywhere between $8,000,000 to $10,000,000 of And as I also said, we're going to we're looking at our Acquisition pipeline and continue to assess the deals in the pipeline and that's an area we could deploy some cash. And just as a reminder, right, on a year to date basis, we have spent around $15,000,000 on shareholder return via dividend and share buyback so far.

Speaker 2

I think given the uncertain environment and just overall lower expected earnings in this fiscal year, We are going to remain prudent on our capital allocation strategy.

Speaker 5

Great. And then the last one for me. In your prepared remarks, You may have mentioned around a couple of client verticals, financial services was mentioned, I believe. You mentioned some of the geographic footprints around some Northern Cowen versus the rest of North America, that kind of thing. So I wanted to talk a little bit, were there any other sort of areas that might be of interest, things like Pharma, healthcare, and anything that kind of stood out, any particular, either positive or negative as far as recent activity?

Speaker 5

Thanks.

Speaker 1

Yes. I'd say and this isn't new, but I'd say as we've talked about before, the healthcare industry overall is behind in terms of their Digital transformation, and so we continue to see opportunity there. And there have been some big transactions in our client base that we're hoping to get work from in the pharma space. So I see that as some green shoots coming up. Financial Services is still around Regulatory remediation as there are a focus on consent orders and Cleaning up, I think, both compliance reporting, but also a lot of data issues in financial services, especially as you connect the front of the house to the back of the house and there's still a lot of work to do because in These huge financial banking, environments, the systems are often very disparate and there's still a lot of work ahead For these organizations, to address some of the problems.

Speaker 1

So we're staying very close to this client set. And our financial services practice, I've been very pleased with their performance, and I see that that's continuing to strengthen a bit as we move through the rest of the fiscal year.

Speaker 5

Excellent. Thank you very much.

Speaker 1

Thank you, Mark.

Operator

Thank you. I would now like to turn the call back over to Kate Duchene for any closing remarks.

Speaker 1

Well, again, I want to thank everyone for continuing your interest in RGP. We're working hard, and we'll look forward to Talking with you after the end of our Q3. Thank you again and Happy New Year.

Operator

Thank you for your participation. You may now disconnect.

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