Earnings Call Transcript - RGP Q1 2022

Operator, Operator

Good afternoon, ladies and gentlemen, and welcome to the Resources Connection Inc. Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session and instructions will follow at that time. As a reminder, this call is being recorded. At this time, I'd like to remind everyone that management will be commenting on results for the first quarter ended August twenty twenty one. They will also refer to certain non-GAAP financial measures. An explanation and reconciliation of the measures to the most comparable GAAP financial measures is included in the press release issued today. Today's press release can be viewed in the Investor Relations section of RGP's website and was 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. Predictions and actual events or results may differ materially. Please see the Risk Factors section in the RGP's report on Form 10-K for the year ended May twenty eight, twenty twenty one for a discussion of risks, 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, CEO

Thank you, operator. Welcome to our Q1 earnings call, and thank you for joining us today. I'll cover three topics, starting with a quick review of our strong first quarter performance. I'll then discuss progress against our digital agenda, followed by comments relevant to macro trends and original research we just completed within our current and target client base. On our Q4 call, we previewed stronger growth coming in Q1 and it did. Revenue was the highest achieved in over ten years during a fiscal first quarter, and that one hundred and eighty three point one million dollars exceeded our guidance and represented twenty five percent growth year-over-year. We also grew sequentially by eight point five percent. We're pleased by the strength across many markets and industry verticals, driven by sustained improvement in operational execution and delivery and macro trends such as workforce agility and digital transformation. Revenue in every major market was up double-digits and our strategic client accounts delivered twenty six percent growth. Disciplined account planning and client centricity are paying dividends. Adjusted EBITDA performance is a further highlight from Q1 results. As we expected, adjusted EBITDA margin improved to twelve point two percent, up five thirty basis points from the first quarter last year. This accomplishment is a result of operating with an improved fixed cost structure and strong gross margin performance. We've worked hard to increase the profitability of the business by achieving top line growth, lowering headcount and real estate expense and driving efficiency with technology and digital tools. We'll continue to do so. We're also focused on pricing the value and increasing bill rates appropriately. Consistent with our fiscal-year goal, this is the second quarter in a row we've achieved twelve percent plus adjusted EBITDA margin. The management team set this trajectory when we began working together three years ago. While COVID sidetracked our progress as clients put new projects on hold for a time, we have recovered to exceed Q1 fiscal twenty nineteen levels and remain optimistic about the path forward. This optimism is fueled by two fundamental macro trends. The first centers on digital transformation, both internally and throughout our client base. The second is a tangible and meaningful shift toward organizational agility and specifically, how work gets done. This trend equally impacts client strategy and talent preference. As I've shared many times, RGP's digital transformation is both internal and external. First, we are transforming how we deliver our services to clients and our gig opportunities to consultants through digital transformation initiatives. The best current example of this effort is HUGO, our soon-to-be-launched digital engagement platform to allow clients and talent to interact through a self-service marketplace for finance and accounting talent. Our differentiator is launching a technology platform with the trust, quality and high-touch experience of RGP and the safety net of employment benefits in community, which we believe professional talent wants. As evidenced by discussion and research shared at the SIA Conference on collaboration in the gig economy, platforms are coming to all corners of this industry. While we've seen such marketplaces like Aya Healthcare, Upwork, and JobStack for nursing, creative, coding, light industrial and hospitality gig work, we've not seen a dominant player in the professional gig arena. We intend to be the dominant player for knowledge workers engaging with enterprise business. I'm very pleased to share that HUGO will go live the week of October eighteen in the tri-state market of New York, New Jersey and Connecticut. We're launching with a pilot for a designated set of clients and finance and accounting rules. The team is ready, the product is ready for MVP launch and we believe the macro environment is now conducive. Following our launch in the tri-state, we will extend the capabilities to the Dallas market and in Northern California within the next fiscal year. We'd hope to share more about the functionality of the product during an in-person Investor Day at NASDAQ on October thirteen. However, given continued restrictions at NASDAQ due to the COVID delta variant, we've decided to move the Investor Day to April twelve, twenty twenty two. We look forward to engaging in person and sharing client experience with HUGO at that time. Externally, the trend toward digital transformation in our client base continues to accelerate. We added Veracity's capabilities to our suite of services at just the right time two years ago. Clients continue to fund the projects to digitize core processes for automation and collaboration and create digital tools to drive growth. The need spans our client base from healthcare providers to technology to big pharma. We know this concrete shifting corporate priorities is real as Veracity grew by an impressive forty five percent year-over-year with nice growth in revenue and pipeline coming from RGP's core client base. Please review our updated investor deck for new case studies and further color around Veracity's project work. As an important tailwind for our business, the macro trends creating today's opportunity rich environment come from both the demand and supply side. These trends have been confirmed by original research we've recently gathered from our current and target client base. We will be releasing the human agility research this month prominently on our website as it confirms how post-pandemic behavior is favorable to our business model are here to stay. On the demand side, clients are committed to operating in a different paradigm with agility at the core. This means companies are building more distributed leadership, nimble finances and new workforce strategy centered on agile talent. We're increasingly engaged with clients who want RGP formally on the org chart as a talent provider to match critical project based skill set to business imperatives. Decisions can then be made throughout the business to achieve speed and resiliency. On the talent side, our research confirms that control, choice and diversity of experience matter more in a changed world. Where to work, when to work and on what to work are increasingly vital considerations for professionals. Talent also wants to align with organizations on shared values, empathy and flexibility. Our business model beautifully meets the preferences of today's modern professional. While other firms are facing the harsh realities of the great resignation, we are increasingly an employer of choice. In closing, I want to express my enthusiasm about a new executive appointment we announced this week. Bhadresh Patel has been named our new Chief Digital Officer effective immediately. As the CEO of Veracity, Bhadresh has been consulting on our digital and technology transformation efforts informally. We're now ready to formalize his role and remit. During the next year, he will stay close to Veracity's sales and strategy, while developing his leadership role over our enterprise digital roadmap, priorities and alignment. We're delighted to welcome him into the C-suite and further bond Veracity and RGP as we pursue digital transformation work in all corners of the business. I'll now turn the call over to Tim for an update on operations.

Tim Brackney, COO

Thank you, Kate, and good afternoon, everyone. During the first quarter, we saw continued strong progress in our revenue and operating metrics despite pandemic flare-ups and the typical vacation effects of the summer months. Larger deal sizes and longer project durations exemplified the commercial environment as clients continue to take on significant and transformational initiatives. The momentum noted at the end of Q4 relative to revenue and pipeline continued. Enterprise revenue increased by twenty five percent over the prior year quarter and eight point five percent sequentially, while top of the funnel activity was strong, leading to increases in qualified opportunity and ultimately to the highest level of closed deals since twenty nineteen. Revenue growth and pipeline strength was consistent across our core business in Asia Pacific, Europe, North America, Veracity, and Countsy. Operational effectiveness, our strengthening economy, and macroeconomic trends favoring co-delivery provide a powerful combination for growth. As Kate noted, our first quarter results exceeded the high end of our revenue guidance. We have seen growth in both project staffing and professional consulting that is part of a broader market shift away from a traditional fixed workforce to a more fluid workforce that can be marshaled quickly and molded instantly in fit-for-purpose solutions. As companies start new initiatives or resume and accelerate existing ones, the utilization of agile core delivery is becoming a potent force. Clients are prioritizing flexibility and labor is demanding it. While elements of this dynamic started before the outset of COVID, the last eighteen months have provided a significant and meaningful acceleration, leading to a palpable tightening of the traditional labor market and a high reliance on more fluid workforce solutions. We continue to see more candidates seeking non-traditional employment and have seen declines in attrition rates and increases in hiring in our variable employee base over the last three quarters. As opportunities rise, project durations lengthen and the ability to work unconstrained by locality becomes more prevalent. We are seeing more talent attracted to our platform. We continue to work seamlessly as one RGP, providing a diverse portfolio of experience for our consultants and demonstrating durability in employment opportunities for new applicants. While we recognize that a tight labor market could impact us more broadly in the future, we believe that as more professionals assess their career objectives and opt for more flexible work, our ability to offer a blue-chip client roster, career control, borderless delivery, and a professional community will continue to be an attractive proposition for a more mobile workforce. As an example, a new West Coast consultant wanted an opportunity to lead strategic projects as his traditional role was not providing challenging growth opportunities. He chose to come to RGP as a project lead for one of our premier healthcare clients. His positive experience with us proved to be the impetus to refer his sister to RGP. She was enduring a reorganization and felt like her current employer had misaligned values from her own. After hearing about RGP's model and culture, she came aboard and is now also working remotely in project management transformation at another healthcare client. Over time, we see workforce desires and our ability to meet them leading to more employment stickiness to RGP and an upward trend in our existing tenure of approximately three years, which is a strong statistic given industry trends and our flexible employment model. While we feel that general workforce shifts are already favorable to our model, we will continue to focus on operational discipline and providing an excellent consulting experience. As we've noted in previous quarters, a hybrid return to work continues with companies embracing distributed employee bases and utilizing a blend of on-site and virtual teams to drive projects. This shift is very much in line with RGP's value proposition of fast-tracking the right composition skill set within teams to deliver successful outcomes. In fact, the blend of on-prem and off-site resources allows for better matching of supply and demand and improved operational efficiencies when responding to client opportunity. The pandemic has educated the market about the virtues of remote delivery and a tight labor market with distributed workforces means that hybrid and modular resourcing is likely a permanent shift. We see some increased call for on-premise engagement, but significantly less requiring a full-time on-site presence, as most companies are utilizing a hybrid workforce themselves and are comfortable engaging with us in the same manner. As an example, we are currently engaged with a technology company that is working on several initiatives concurrently as the rapid growth has begun to strain their infrastructure. They recognized early on that the scope of work contemplated would require a high reliance on external talent to help deliver the desired outcome. Noting the difficulty attracting traditional employees and recognizing the competition for variable resources, they made a significant commitment to retain RGP talent knowing they have both immediate and future gaps to fill. Our team will work on-premise and remotely as required and will be staffed for multiple locations. We are in discussions with other clients who are interested in ensuring they have access to capture talent pool for immediate and future initiatives. Now let me turn back to our first quarter operations. During the quarter we saw continued strength in pipeline and top of the funnel activity. Average weekly revenue grew by approximately four percent from the first weeks of the quarter to the last. In fact, average daily revenue rates ended the quarter at the highest they've been since FY twenty nineteen and pipeline and booked revenue continued to demonstrate pre-pandemic quality. The majority of markets demonstrated growth over the prior year quarter, while several markets, strategic client account, healthcare, Veracity, and Countsy demonstrated growth, both sequentially and over the prior year quarter. Lead generation and opportunity identification continue to be strong into Q2 as clients grappled with the pace of change coupled with the tight labor market. The early weeks of Q2 have shown a strong continuation of positive trends in both revenue and pipeline. In fact, the early-quarter revenue trends are some of the highest we've seen in twenty nineteen. While the holidays starting this quarter, we don't expect to be inordinately impacted. Revenue expansion is a core objective. However, we continue to target profitable growth through increased operational leverage. As in prior quarters, in Q1 we've continued to make strides in controlling fixed costs and focusing on efficiency yielding an over five hundred basis point improvement in enterprise EBITDA margin. We understand the importance of in-person meetings and will not shy away from face-to-face interaction. However, the lessons learned during the last eighteen months have stayed with us as we transition into a new normal. To that end, we will continue to sell, deliver, and operate in a more hybrid fashion, look for opportunities to reduce real estate and utilize technology to extend and strengthen the experience of our clients and consultants and our quest to increase shareholder value. I will now turn the call over to Jenn for a more detailed review of our first quarter result.

Jennifer Ryu, CFO

Thank you, Tim, and good afternoon, everyone. During the first quarter, the continued rise in demand coupled with successful go-to-market execution fueled substantial growth in revenue, reaching the highest level in any first quarter in the last ten years. We also improved average fill rates, driving above guidance gross margin. Furthermore, we remain disciplined in SG&A spend, increasing leverage significantly and enabling us to deliver twenty two point four million dollars of adjusted EBITDA or a twelve point two percent adjusted EBITDA margin, which is also the highest margin in any first quarter in the last decade. Now, let me provide more color on our operating results starting with revenue. With quarterly revenue of one hundred and eighty three point one million dollars, we well exceeded the high end of our revenue guidance of one hundred and seventy seven million dollars. After adjusting for business day and currency impact, Q1 revenue represents growth of twenty five percent year-over-year and five percent and two percent over the pre-pandemic first quarter periods of fiscal twenty twenty and twenty nineteen, respectively. In addition, notwithstanding summer vacation impact, our performance in Q1 exceeded the sequential quarter by eight point five percent on a same-day constant currency basis. Revenue growth in the first quarter was across most of our core markets, key client accounts solution areas as well as industry. Strategic client accounts grew twenty six percent year-over-year and nine percent sequentially. In addition, macro trends accelerated by the pandemic, including increased use of contingent talent and a shift towards a more agile workforce model, continue to be a tailwind in driving top-line growth. Professional staffing revenue grew thirty six percent year-over-year and eight percent sequentially. In North America, revenue improved twenty eight percent year-over-year and eleven percent sequentially on a same-day constant currency basis. Most core markets in North America experienced double-digit growth year-over-year with tri-state and California leading the growth at forty one percent and thirty percent. In addition, Veracity grew forty five percent year-over-year, which continues to evidence increased demand in projects that enhance employee experience through digitization and automation of processes, a trend we believe is likely permanent. Europe continues to perform well, achieving ten percent growth compared to the first quarter of fiscal twenty twenty one on the same-day constant currency basis. Excluding revenues from markets we exited as part of the restructuring initiative, year-over-year revenue growth was eighteen percent. Sequentially, revenue was down seven percent in Europe due to more summer vacation taken in the first fiscal quarter and was relatively stable in Q1 of last year. Asia Pacific also experienced broad-based expansion in revenue across most markets. First-quarter revenue grew seventeen percent year-over-year and eight percent sequentially on a same-day constant currency basis. Gross margin in the first quarter was essentially flat to prior year, thirty nine percent compared to thirty nine point three percent a year ago. We effectively elevated our average bill rate and held pay/bill ratio flat from last year. There was one additional holiday in the U.S. and the impact of heavier summer vacation as COVID-related restrictions eased in some parts of the world. Compared to the fourth quarter, we improved our pay/bill ratio by seventy basis points as a result of achieving a higher average bill rate. The tight labor market has not yet had a significant impact on our pay rate. However, we intend to be a step ahead of any impending rise in pay rate by pricing our engagements to market appropriately. We continue to see opportunities to achieve higher bill rates across several solution sets, including digital transformation services. Emerging from our restructuring initiatives, we are positioned with a more nimble cost structure; run rate SG&A expenses for the quarter were forty nine point four million dollars after excluding non-cash stock compensation, contingent consideration expense, and restructuring charges, representing twenty seven percent of revenue, a five seventy basis point improvement compared to the same period a year ago. Now, turning to the other components of our financial statement, the effective tax rate was twenty nine percent compared to forty six percent in the prior year quarter. The improvement in effective tax rate resulted primarily from better operating results in the European entities, enabling us to utilize the benefit from historical net operating losses. We expect the improved profitability in Europe will continue to cause future effective tax rates to be more favorable. Adjusted diluted EPS for Q1 rose significantly to zero point four three dollars per share compared to zero point one four dollars in Q1 of fiscal twenty one. We generated positive cash flow from operations in the first quarter, which is typically cash flow negative due to our annual bonus payout. Our balance sheet remains strong and we paid down an additional ten million dollars of outstanding debt under our credit facility in the first quarter. As we look ahead, assuming the macro environment remains stable, we plan to invest in new ERP and talent management systems that will allow us to achieve more efficiency in our back-office operations and position us to scale as we continue to grow our top line. As a result, the CapEx is expected to be elevated beginning in the second half of the fiscal year. We're currently assessing the scope and cost of such investment. We regularly evaluate our capital allocation strategy, taking a balanced approach between investing in the business and returning value to our shareholders through a combination of dividends and share buybacks. At the end of Q1, eighty five million dollars remained available under our share buyback program. I'll close with our second quarter outlook. We remain optimistic and anticipate continued growth in the business. Revenue in Q2 is expected to be in the range of one hundred eighty six million dollars to one hundred ninety million dollars, which at the high end of the range would be an estimated twenty four percent increase compared to Q2 of last year. We expect gross margin to be within the range of thirty eight percent to thirty eight point five percent, reflecting the impact of Thanksgiving holidays in the U.S. We expect run rate SG&A to be in the range of fifty million dollars to fifty three million dollars.

Operator, Operator

Our first question comes from Andrew Steinerman of JP Morgan. Your line is open.

Andrew Steinerman, Analyst

Just one quick clarification and then a question. So, Jenn, what did you just mean when you said fifty million dollars to fifty three million dollars of run rate SG&A? Do you mean SG&A for the quarter? I just didn't know what SG&A run rate meant. My other question is about HUGO and the launch. How much is this going to affect SG&A? And when do you feel like HUGO could be contributory to revenues and profits?

Jennifer Ryu, CFO

Sure. Hi, Andrew. When I talk about run rate SG&A, I'm really talking about SG&A excluding stock compensation, restructuring cost, and contingent consideration. So SG&A that is part of our run rate business, that's what I meant by that, fifty million dollars to fifty three million dollars.

Andrew Steinerman, Analyst

Got it. Okay. And then about HUGO?

Jennifer Ryu, CFO

Regarding HUGO, we anticipate that following its launch in the coming weeks, the level of capitalization will decline. This will lead to an increase in SG&A for the remainder of the year. We expect to see returns related to HUGO, but it's still too early to accurately forecast what that revenue will look like until we conduct our pilot in the tri-state area.

Andrew Steinerman, Analyst

And just to be clear that, fifty million dollars to fifty three million dollars of run rate SG&A includes the HUGO launch, right?

Jennifer Ryu, CFO

That's right. Yes.

Operator, Operator

Thank you. Our next question comes from Mark Marcon of Baird. Your line is open.

Mark Marcon, Analyst

Hi. Good afternoon, everybody. Nice job on the quarter, it's great to see. Can you share some details about Veracity, which has shown significant growth? Also, could you remind us of Veracity's size?

Kate Duchene, CEO

Yes, Veracity currently accounts for approximately five percent of our overall enterprise revenue.

Mark Marcon, Analyst

Great. And then it sounds like across North America you ended up seeing really strong growth, particularly strong growth in the tri-state area of over forty percent. To what extent do you think it's being driven in part by increased deal flow, deal activity, whether it's IPOs specs or private equity transactions?

Tim Brackney, COO

Hey, Mark, it's Tim. First of all, we’re really excited about the growth in the tri-state area and several other key markets this quarter. Overall, we are experiencing some positive momentum from transaction deal flow, particularly concerning mergers and acquisitions as well as some SPAC activities. There was likely more SPAC activity towards the end of the fourth quarter and early summer, which tapered off a bit, but that doesn’t mean there aren't various transactions happening. Tri-state has been actively involved as well, but much of this stems from the efforts made over the last three or four quarters. We have a new leader and team in place that have been focused on reconnecting with the financial services market and diversifying beyond it. While some of the transaction activity played a role, it wasn’t the only factor contributing to our success.

Mark Marcon, Analyst

Great. And then can you talk a little bit about what your expectations are with regards to pricing on a go-forward basis? You mentioned that you're going to be a little bit more proactive and obviously, it's a tight labor market and we're seeing all sorts of signs of wage inflation. So how should we think about bill rates on a go-forward basis?

Tim Brackney, COO

Mark, I believe the bill rate presents a significant opportunity for our business. I've mentioned this in the past few quarters, and I feel we've made some progress with our pricing discipline. It's a concerted effort for us. In the latter half of this year, I anticipate we will be able to extend our pricing. While it's challenging for existing engagements, our main focus is on new opportunities and reversing any pricing arrangements established during COVID. As I have highlighted before, this represents an opportunity for us to adjust our pricing to better align with the market. Given the tight labor market, it's the right moment for us to implement these increases, and we are taking proactive steps to do so.

Mark Marcon, Analyst

And how much do you think you could end up pushing through? And it would seem like almost everybody would be accepting a higher bill rate. So how much can you push through, do you think?

Tim Brackney, COO

It's a bit of a complicated question because each client is unique, and I want to emphasize that no client is eager to accept a price increase unless absolutely necessary. I believe you are asking about the specific circumstances. People recognize that the labor market is tight and that we offer a quality product, which makes them more amenable than they might otherwise be. However, it still requires careful negotiations. While it's difficult to provide a precise estimate, I do believe we have the opportunity to raise our prices by a few percentage points.

Mark Marcon, Analyst

Okay. Jenn, regarding the revenue guidance for the second quarter, could you elaborate on that? When we look at the historical trend from Q1 to Q2, it seems like your expectations may be somewhat conservative. I'm trying to understand the normal sequential pattern. I realize you're coming off your strongest first quarter in ten years, which makes forecasting challenging. Are you anticipating some normalization, and what do you see as the driving factors?

Jennifer Ryu, CFO

Yes, compared to the previous period, we're up about six percent. We have the Thanksgiving holidays in Q2, and with the world reopening more, we have included a bit of caution in our projections as we are not fully sure how the holiday will impact us. Additionally, the tight labor market could worsen, which might affect our growth slightly. These are the two main factors that could lead to a smaller sequential increase than we have typically experienced.

Mark Marcon, Analyst

Great job managing SG&A and addressing CapEx. However, I'm curious about the reduction in management compensation and how it contributes to your overall expense reductions. Specifically, how much of the remaining expense structure can you consider permanent compared to temporary? Also, what should we anticipate beyond the next quarter, particularly in light of the expected increases in SG&A related to technology initiatives?

Jennifer Ryu, CFO

Yes. I think this year, if I consider SG&A as a percentage of revenue, it will likely be between twenty-eight percent and twenty-nine percent for the remainder of the year. Q1 was quite favorable because we anticipated an increase in travel, which didn't quite materialize. However, as the world opens up, we expect travel to increase a bit. Additionally, as our revenue grows, variable compensation will also rise. These factors should be taken into account regarding SG&A.

Mark Marcon, Analyst

Okay. I have one more question. We saw a significant increase in headcount, rising from twenty-four forty-four to thirty-one forty-one over the past year. I'm curious about how much of that growth is sustainable and how much was just a temporary bounce-back. How quickly did you manage to scale it back?

Kate Duchene, CEO

Yes, hi Mark, it's Kate. I believe most of that is due to a bounce-back and an increase in consultant engagement and employment. We anticipate, as we have mentioned before, that the business will continue to grow, and we've provided some guidance on that. So I expect this trend to persist, although the bounce may stabilize somewhat.

Tim Brackney, COO

I would add to that. The hiring trends for us during the quarter were the highest we’ve seen in a while, and we believe the macro forces will continue to push things our way even in a tight labor market. That represents a significant recovery. As noted, we think that will normalize over the latter half of the year.

Mark Marcon, Analyst

Okay. And then two final questions. One is, you mentioned that retention of the consultants is improving. Can you elaborate on how much longer they are staying? And then the second question, which is probably related, is what percentage of the positions you are currently selling were staffed virtually instead of on-premise? How do you expect that trend to develop as things normalize?

Tim Brackney, COO

Yes, the first question is a bit challenging to answer precisely. Our average tenure is around three years, fluctuating slightly. If you consider three years as a baseline, we've noticed some variation over the years. However, over the past three quarters, our overall attrition rate has decreased. Typically, when new employees join our company, they spend their initial year getting acquainted with our model and appreciating the culture and experiences we offer. During this period, we usually see higher turnover. In this specific segment, attrition has dropped significantly. Looking forward, as we progress through the year with our combination of increased hiring and lower attrition, we expect to see average tenure continue to rise. The second point I want to emphasize is about the current state of on-site versus off-site work. In the last eighteen months, nearly everything was conducted off-site, resulting in a ratio of roughly ninety percent off-site to ten percent on-site. Now, we are likely closer to around sixty-fifty or maybe thirty-five percent. Given the unique nature of the pandemic, moving forward, the focus will not be strictly on what is done off-site versus on-site, but rather on how frequently people are working on-site compared to remotely. This dynamic will reflect the traditional workforce as well. I believe the most common pattern will be two days working on-site and three days remote, or the opposite, depending on client needs.

Kate Duchene, CEO

Yes, Mark, I want to provide some additional context. I recently attended the FIA conference focused on the gig economy. During that event, they presented a McKinsey report that analyzed employment models before and after COVID. The findings indicate a significant shift, with a twenty-five percentage point decrease in on-site work and a twenty-two percent increase in hybrid models. This aligns well with what we're observing among our clients. As mentioned in our prepared remarks, we truly believe this world has changed, and we are adapting by engaging with consultants and talent to foster this flexibility. We think our flexible approach will help us attract top talent in the future. Additionally, as we progress through fiscal twenty-two, our focus will be on nurturing our consultants so they can appreciate that this more agile working style is not just feasible but enjoyable. This is the kind of experience we aim to create for our people.

Josh Vogel, Analyst

Thanks. Good afternoon, everyone. The results are certainly impressive, which is great to see. You addressed many of my questions, but I would like to expand on a few of them. Can you clarify how much of your business in the quarter was related to digital transformation services, excluding Veracity?

Jennifer Ryu, CFO

Hey, Josh, it's Jenn. Yes, it's about ten percent of our business beyond Veracity that is in digital and technology.

Josh Vogel, Analyst

So ten percent, I'm sorry, beyond Veracity or including Veracity?

Jennifer Ryu, CFO

Yes. Beyond Veracity. So total, we're looking at about fourteen percent to fifteen percent. Yes.

Josh Vogel, Analyst

Okay. So when we consider that fourteen percent or fifteen percent of the business, what is the margin profile on digital transformation related services compared to the other eighty-five percent?

Jennifer Ryu, CFO

The bill rates for digital transformation services are generally a bit higher than our average enterprise bill rate, which stands at one hundred and twenty-six dollars. For digital transformation services specifically, the rate is in the mid-fifties. Overall, the bill rate tends to be a little bit higher. While the gross margin profile may be slightly higher, it is not significantly different from other solution families.

Josh Vogel, Analyst

Okay, great. And shifting gears, I know there is a bunch of questions on SG&A. I was just curious, what would you say is the breakdown today following the restructuring initiatives and operating efficiencies that resulted, what's the breakdown today between fixed and variable cost structure of the business relative to where you're running prior to the pandemic?

Jennifer Ryu, CFO

Overall, our variable cost structure, full cost is still roughly about seventy percent and fixed cost is about thirty percent. And variable, when I say variable cost that includes cost of service as well.

Josh Vogel, Analyst

Okay, great. I want to follow up on your guidance regarding Q1 to Q2. Looking at the quarter, should we anticipate a return to more seasonal patterns, such as the usual decline in the third fiscal quarter? In fiscal twenty twenty, that decline was approximately nine percent sequentially before the pandemic. Can we expect a similar trend, or do you believe that there's enough pent-up demand that would result in a less noticeable decline, considering the current pipeline and sales cycle?

Tim Brackney, COO

I think it's a bit difficult to say for certain. However, I do anticipate some seasonality, especially with two holidays in the third quarter. I hope we experience a real Christmas and New Year this year. If so, we may see a slight decline. Nonetheless, I believe the market is very strong right now, and we could see a scenario similar to the summer when work continued even as people took time off. Our pipeline is currently robust, but it's too early to determine if one factor will impact the other. Each quarter we discuss a return to normalcy, and I believe the holidays are significant for our clients. Consequently, I expect some decline for everyone in our client base during that quarter, but we will continue to push forward vigorously.

Josh Vogel, Analyst

Okay, great. Appreciate this insight. And last one for me. I saw the recent announcement with the Kotter alliance. I was just curious, when we look at an alliance like that, should we expect these types of partnerships going forward when you want to combine forces with someone or is this another way of not necessarily doing any M&A activity or is M&A still on the table? And then just speaking of M&A, what does that pipeline look like in the valuations you're seeing today? Thank you.

Kate Duchene, CEO

We are interested in mergers and acquisitions and are pleased with our recent progress. Taskforce and Veracity have brought unique capabilities that are helping us achieve our current results. We believe there are areas where we can accelerate growth through the right acquisition instead of pursuing organic growth. Our pipeline is focused on increasing our technology and digital capabilities by ten percent and enhancing the types of projects we can deliver to our clients. We see further opportunities in healthcare, particularly in supporting payers and providers with revenue integrity initiatives. We recognize that valuations vary depending on the sector, and digital and technology sectors tend to have higher multiples, so we will approach those opportunities with caution. Regarding the Kotter partnership, we are optimistic about the importance of change management for our transformational projects. Kotter has a stellar reputation, and we are excited to collaborate with them, which we believe will strengthen our relationship and capabilities moving forward.

Josh Vogel, Analyst

I appreciate all those insights. And thanks for taking my questions, and everyone have a good night. Thank you.

Kate Duchene, CEO

Well, I want to thank everyone for listening in today. We really appreciate your support and we look forward to talking to you after Q2. Everyone have a great fall. Bye-bye.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.