RESOURCES CONNECTION, INC. quarterly report, Q2 FY2018

Resources Connection, Inc. — Q2 FY2018 Form 10-Q

Reporting period: Second quarter and six months ended November 25, 2017; each second quarter comprised 13 weeks. Amounts below are in U.S. dollars unless stated otherwise.

Business context

Resources Connection operates as RGP, a multinational professional services firm providing project-based consulting across finance, accounting, risk, technology, human capital, supply chain, and related areas. It operates in one segment and served clients from 69 offices in 21 countries.

Financial performance

Metric	Q2 FY2018	Q2 FY2017	Six months FY2018	Six months FY2017
Revenue	$156.7m	$147.6m	$297.9m	$290.9m
Gross margin	$59.4m; 37.9%	$56.5m; 38.3%	$113.1m; 38.0%	$111.0m; 38.2%
Operating income	$10.7m; 6.8% margin	$9.6m; 6.5% margin	$16.0m; 5.4% margin	$19.8m; 6.8% margin
Net income	$8.1m	$5.7m	$10.3m	$11.3m
Diluted EPS	$0.27	$0.16	$0.34	$0.31
Operating cash flow	Not separately presented for the quarter	$1.6m	$8.1m

• Q2 revenue increased 6.2% year over year, or 5.3% on a constant-currency basis. Excluding $3.7m from taskforce, revenue grew 3.7%; bill rates rose 3.4% and hours worked increased 0.1%.
• First-half revenue grew 2.4% reported and 2.0% constant currency; excluding taskforce, it increased 1.1%. Bill rates improved 2.5%, while hours worked declined 1.7%.
• Q2 Adjusted EBITDA, a non-GAAP measure, was $13.4m versus $12.3m, with margin of 8.5% versus 8.3%. First-half Adjusted EBITDA was $21.3m versus $24.5m, and margin was 7.1% versus 8.4%.
• Q2 effective tax rate was approximately 21%, compared with 41%; first-half rate was 33%, compared with 43%. Management attributed the decrease primarily to reversals of valuation allowances for certain foreign entities.

Financial position and liquidity

• At November 25, 2017, cash and cash equivalents were $56.3m, current assets $170.5m, and current liabilities $72.3m.
• Long-term debt was $48.0m under a $120m secured revolving credit facility; $1.0m of letters of credit was outstanding. The filing reports $41m remaining under the revolving loan and $30m under the reducing revolving loan. The company was in compliance with facility covenants.
• First-half operating cash flow fell to $1.6m from $8.1m. The company cited increased receivables and lower net income; receivables rose $8.4m in the operating cash-flow reconciliation.
• Cash declined $6.0m to $56.3m over the half-year. Investing activities used $4.2m, primarily for the taskforce acquisition; financing activities used $2.9m, including $6.8m in dividends paid.
• Management stated existing cash, operating cash flows, and facility availability should cover working capital and capital expenditure needs for at least 12 months.

Material changes and notable items

• Q2 revenue growth reflected taskforce, acquired August 31, 2017, as well as higher bill rates and hours worked. Taskforce contributed $3.7m of revenue and $0.3m of pretax earnings; its acquisition included $6.5m of estimated contingent consideration.
• Q2 direct costs were 62.1% of revenue versus 61.7%; management cited taskforce’s cost mix, higher medical coverage expenses, and unreimbursed expenses. The company’s stated target is 60%.
• Q2 SG&A was $47.5m, including $2.9m of severance, acquisition, and transformation/integration costs. First-half SG&A was $94.9m and included $6.7m of such costs. Management said first-half SG&A as a share of revenue increased to 31.9% from 30.8%.
• Q2 operating income improved year over year, but first-half operating income and net income declined. The first-half net income comparison also reflects the significantly higher prior-year income-tax provision.
• On December 4, 2017, the company completed the Accretive acquisition for $19.4m cash, subject to working-capital adjustments, plus 1.15m restricted shares. Results were expected to be included beginning in the quarter ending February 24, 2018. Management expected cost synergies by the end of calendar 2018 and EBITDA improvement after 9–12 months.
• The company declared dividends of $0.12 per share per quarter, up from $0.11 a year earlier. It made no share repurchases in the first half; $125.1m remained available under its repurchase authorization.

Outlook, risks, and contingencies

• No numerical revenue or earnings guidance is provided. Management said the sales-culture initiative was expected to be substantially complete by fiscal year-end, the North American operating-model rollout was complete, and it expected the recent revenue-performance trend to continue.
• Management identified continuing weakness in financial-services revenue and uncertainty about the timing of improved client penetration. Client engagements generally lack long-term commitments, making demand difficult to predict.
• Foreign currency movements affect reported results; approximately 24% of Q2 revenue was generated outside the U.S. The company said it did not use financial hedges for currency exposure.
• Taskforce contingent consideration is based on future adjusted EBITDA and requires subjective estimates; changes in fair value could affect future earnings. The purchase-price allocation was provisional.
• Tax reform enacted in late December 2017 was expected to benefit the tax position through a lower rate, partly offset by other provisions, and to cause a one-time reduction in domestic deferred tax assets and liabilities. The amount of the impact was not yet clear.
• Other disclosed risks include economic and discretionary-spending weakness, competition, consultant recruitment and retention, acquisition integration, client credit and collections, cybersecurity, variable-rate debt, and covenant compliance. Management reported no material legal proceedings and no material changes to previously disclosed risk factors.

Important facts for investors to verify

• Whether underlying revenue growth persists excluding taskforce, particularly given weak financial-services demand and first-half hours worked declining.
• Whether gross-margin performance improves toward the company’s 60% direct-cost target and whether SG&A leverage offsets transformation and acquisition costs.
• Whether receivables convert to cash and operating cash flow recovers from the first-half decline.
• Taskforce earn-out outcomes, final purchase-price allocation, and delivery and timing of Accretive’s expected synergies.
• The realized effects of tax reform, including the one-time deferred-tax adjustment, and the sustainability of the lower effective tax rate.
• Capacity under the secured credit facility, covenant headroom, and the effect of interest-rate and currency movements.