The Hackett Group, Inc. (HCKT) Q2 2013 Earnings Report, Transcript and Summary

Welcome to The Hackett Group Second Quarter Earnings Call. [Operator Instructions] Please be advised that the conference is being recorded. Hosting tonight's call are Mr. Ted Fernandez, Chairman and CEO; and Mr. Rob Ramirez, Chief Financial Officer. Mr. Ramirez, you may begin.

Thank you, operator. Good afternoon, everyone, and thank you for joining us to discuss The Hackett Group's second quarter results. Speaking on the call today and here to answer your questions are Ted Fernandez, Chairman and CEO of The Hackett Group; and myself, Robert Ramirez, Chief Financial Officer Our press announcement was released over the wires at 4:27 p.m. Eastern Time. For a copy of the release, please visit our website at www.thehackettgroup.com. We will also place any additional financial or statistical data discussed on this call that is not contained in the release on the Investor Relations page of our website. Before we begin, I would like to remind you that in the following comments and in the questions-and-answer session, we will be making statements about expected future results, which may be forward-looking statements for the purposes of the federal securities laws. These statements relate to our current expectations, estimates and projections and are not a guarantee of future performance. They involve risks, uncertainties and assumptions that are difficult to predict and which may not be accurate. Actual results may vary. These forward-looking statements should be considered only in conjunction with the detailed information, particularly the risk factors contained in our SEC filings. At this point, I would like to turn it over to Ted.

Thank you, Rob. And welcome, everyone, to The Hackett Group's second quarter earnings call. First, let me review the agenda. I will open up by providing some highlights of our second quarter. I will turn it back over to Rob and ask him to comment on operating results, cash flow and also provide details on guidance. Rob will then turn it back over to me, where I'll be able to provide some market and strategic overview comments. And then, we will open it up for Q&A. So let me start with the highlights of the quarter. We were pleased to report revenues of $59 million and pro forma EPS of $0.13 in our second quarter of fiscal year 2013. As we mentioned on our first quarter call, the revenue ramp in the U.S. at the beginning of the year materialized a little later in the first quarter than planned. As expected, this momentum exiting the first quarter resulted in strong U.S. sequential growth in the second quarter, which totaled 14%. Internationally, revenues were down 11% sequentially as the expected European weakness came in better than planned. And international results also benefited from solid Asia Pac sequential growth. In the U.S., we experienced solid sequential improvement across nearly all of our practices led by the strong performance of our transformation and EPM or Enterprise Performance Management groups. Specific to our EPM groups, whose revenues are now in excess of 40% of total Hackett U.S. revenue, it's important to note that we're recently recognized as Oracle's #1 EPM influenced partner. When you consider our much larger consulting and technology competitors, this is a significant recognition. On the balance sheet side, our strong cash flow allowed us to pay down $5.5 million in our credit facility during the quarter, bringing the total outstanding to $15 million and our net debt position to $4 million. Given this accelerated pay down, the company also announced today that it intends to launch a modified Dutch Auction offering -- Dutch Auction tender offer, excuse me, to purchase up to $35.75 million in value of its common stock at a price ranging from $5.75 to $6.50. The tender offer would allow the company to repurchase approximately 17% of its outstanding common shares at the high end of the pricing range. The company intends to pay for the share repurchase from the expansion of its credit facility. On the investment front, we continue to develop and attract talent and expand our brand and intellectual property through the constant best practice research that we published that emanates from our proprietary benchmarking and performance study insight, as well as the development of our new Hackett Performance Exchange offering. I will comment about these opportunities in more detail in my strategic overview section of our call. I will also comment further on market conditions and specific go-to-market initiatives, but let me first ask Rob to provide details on our operating results, cash flow and also comment on guidance.

Thank you, Ted, and welcome, everyone. As I typically do, I will cover the following topics during our call, an overview of our 2013 second quarter results, along with an overview of related key operating statistics. I will also cover an overview of our cash flow activities during the quarter, and I will then conclude with the discussion in our financial outlook for the third quarter of 2013. For purposes of this call, any references to The Hackett Group will specifically exclude ERP Solutions. Correspondingly, I will comment separately regarding the financial results of The Hackett Group, ERP Solutions and the Total Company. Please note that all references to gross revenues in my discussion represent net revenues plus reimbursable expenses. As mentioned previously, we exit our Oracle ERP implementation practice during the first quarter of 2013. As such, historical information discussed on this call has been recast for comparability purposes. Additionally, references to pro forma results specifically exclude noncash stock compensation expense, intangible asset amortization expense, results of discontinued operations and assumed normalized tax rate of 40%. Now turning over to our second quarter results. For the second quarter of 2013, Total Company gross revenues were $59 million and above our second quarter's guidance. This represents a sequential increase of 8% and a year-over-year increase of 2%. Pro forma EPS was $0.13, which was also above our guidance and up 18% from prior year. Total Company international gross revenues accounted for 21% of Total Company revenues in the second quarter of 2013, as compared to 23% in the second quarter of 2012. International revenues were down 11% sequentially and 15% on a year-over-year basis. Gross revenues for The Hackett Group, which excludes ERP Solutions, were $47.7 million in the second quarter of 2013 representing a sequential increase of 9% and a year-over-year decrease of 5%, primarily due to lower revenue from our international groups and longer than expected ramp on U.S. client engagements at the beginning of 2013. Hackett Group annualized gross revenue for Professional was $358,000 in the second quarter of 2013, as compared to the $379,000 in the second quarter 2012 and $329,000 in the previous quarter. Gross revenue from our ERP Solutions group, which now consists of our SAP implementation group, totaled $11.3 million, up 5% sequentially and a year-over-year increase of 44%. ERP Solutions hourly gross realized billing rate per hour was $130 in the second quarter of 2013, as compared to $122 in the second quarter of 2012. This includes the impact of our offshore resources, which approximate 40% of our total ERP implementation resources. ERP Solutions consultant utilization was 83% for the second quarter of 2013, as compared to 71% in the second quarter of 2012. Total Company pro forma cost of sales, excluding reimbursable expenses and stock compensation expense, totaled $32.5 million or 62.1% of net revenues, as compared to $31.4 million or 61% of net revenues in the previous year. This was primarily attributed to European revenue declines and an increase of subcontractor use in our EPM technology and ERP practices. Total Company consultant headcount was 735 at the end of the second quarter of 2013, as compared to 719 in the previous quarter and 749 at the end of the second quarter of 2012. This year-over-year increase was primarily attributable to increased hiring activities and a higher level of utilization of subcontractors in our EPM technology and SAP groups, commensurate with market demand. Total Company pro forma gross margin was 37.9% of net revenues in the second quarter of 2013, as compared to 39% in the second quarter of 2012. Hackett Group pro forma gross margins on net revenues was 38% in the second quarter, as compared to 38.7% in the second quarter of the prior year, primarily due to the European revenue decline and a higher use of subcontractors in our EPM technology practice when compared to Q2 of the prior year. ERP Solutions pro forma gross margins on net revenues was 37% in the second quarter, as compared to 41% in the second quarter of the previous year due to headcount increases in our SAP group, as well as higher than expected use of subcontractors to service demand. Pro forma SG&A was $13 million or 24.8% of net revenues in the second quarter of 2013, as compared to $14 million or 27.2% of net revenues in the second quarter of 2012. This improvement is primarily due to cost-containment measures enacted during the latter part of fiscal 2012. Interest expense on borrowings under our credit facility was $125,000 during the quarter. This compares to $247,000 of interest expense in the prior fiscal year. This decrease is as a result of the debt repayments that we have made. Total Company pro forma net income for the second quarter of 2013 totaled $4.1 million or $0.13 per diluted share and was above our second quarter's guidance. This performance compares to pro forma net income of $3.5 million, and is up 18%, from the $0.11 per diluted share that was reported in the second quarter of 2012. As expected, second quarter 2013 results includes approximately $0.01 impact due to our development internal launch roll out of HPE, which is comparable to the prior year. Total Company pro forma net income for the second quarter of 2013 excludes noncash stock compensation expense of $1.6 million, intangible asset amortization expense of $151,000, and assumes a normalized tax rate of 40% or $2.7 million. Pro forma EBITDA on net revenue in the second quarter of 2013 was $7.3 million or 14% of net revenues, as compared to $6.5 million or 12.7% of net revenues in the second quarter of 2012. GAAP diluted earnings per share were $0.09 for the second quarter of 2013, as compared to $0.12 in the second quarter of 2012. As previously discussed, we released the remaining balance of our U.S. Federal valuation allowances in the second quarter of 2012, which resulted in a GAAP tax benefit of $0.04 in that quarter. Excluding this valuation allowance release, we would be comparing the second quarter 2013 GAAP results of $0.09 to $0.08 in the second quarter of 2012. As previously stated, the GAAP book tax provision effective rate should approximate our current pro forma rate of 40% as we move forward. At the end of the second quarter of 2013, the company had approximately $26 million and $14 million of income tax loss carry forwards remaining in the U.S. and in foreign tax jurisdictions, respectively. As a result, for tax purposes, we will continue to have the ability to offset most of our U.S. and international tax liabilities until these net operating losses are fully utilized. Now turning to cash balances. The company's cash balances were $11.3 million at the end of the second quarter of 2013, as compared to $12 million at the end of the first quarter. This cash decrease in Q2 was primarily attributable to debt repayments, capital expenditures, stock repurchases and partially offset by cash -- and offset by cash generated from operations. During the second quarter of 2013, the company repaid $5.5 million of its existing credit facility, which now stands at $15 million. However, in light of the proposed modified Dutch auction that Ted mentioned, we'll be expanding the term loan under our facility to fund the tender transaction. Capital expenditures for the quarter were $563,000 for the second quarter of 2013, primarily related to the continued development of the Hackett Performance Exchange and other benchmark related offerings. During the second quarter, cash was utilized to repurchase approximately 124,000 shares of the company's common stock at an average price of $4.80, for a total cost of $594,000. This took our remaining repurchase authorization to approximately $5 million. Net cash generated from operating activities in the second quarter of 2013 were $5.7 million, which was primarily attributable to net income adjusted for noncash items, the timing of accounts payable and U.S. payroll cycles and payroll-related items and partially offset by an increase in accounts receivable. Our DSO, or days sales outstanding, at the end of the second quarter of 2013 was 55 days, as compared to 59 days at the end of the fourth quarter of 2012 and 56 days at the end of the previous quarter. I will now turn over to guidance. Before I discuss guidance, I want to make sure that everybody understands that consistent with seasonal third quarter trends, we expected the impact of the additional U.S. holiday and the typical increase in vacation utilized in both the U.S. and Europe to unfavorably impact available days by approximately 5% on a sequential basis as we head into the third quarter. We expect Total Company -- having said that, we expect Total Company gross revenues for the third quarter of 2013 to be in the range of $57 million to $59 million with a reimbursable expense estimate of 12.5% on net revenues. This compares to a prior year gross revenue amount of $55.6 million, which was reclassed to reflect the Oracle ERP divestiture, and had a reimbursable expense ratio of 12% on net revenues. We expect U.S. gross revenues to be up on a year-over-year basis by approximately 7% to 10% with Hackett U.S. estimated to be up strongly and ERP Solutions to be down. International revenues primarily derived from Europe, are expected to be down on a year-over-year basis by approximately 3% to 5%. As a result, we expect our pro forma diluted earnings per share in the third quarter of 2013 to be in the range of $0.11 to $0.13. Our pro forma guidance excludes amortization expense, noncash stock compensation expense, the impact of discontinued operations resulting from the sale of the Oracle ERP implementation practice, and includes a normalized tax rate of 40%. Sequentially, we expect pro forma gross margin in the third quarter to benefit from the seasonal reductions in U.S. payroll related taxes resulting from reaching FICO limits and the utilization of vacation accruals, offset by decreasing available days due to summer vacations. As a result of our revenue guidance, we expect pro forma gross margin on net revenues to be approximately 36% to 37% in Q3. We expect pro forma SG&A and interest expense for the third quarter to be approximately $12.5 million or down sequentially by approximately $500,000. We expect third quarter pro forma EBITDA on net revenues to be in the range of 12.5% to 14.5%. We expect our cash balances excluding the impact of debt repayments and share buyback activity to be up on a sequential basis consistent with our earnings guidance. At this point, I would like to turn it back over to Ted to review our market outlook and strategic priorities for the coming months.

Okay. Thank you, Rob. As we look forward, consistent with reported and future estimates of global GDP, economic recovery and related demand for our client services continue to be slower than desired. Our strategy is to ensure that we continue to expand our capabilities and intellectual capital in order to serve our clients strategically, and allow us to continue to improve our profitability and cash flow regardless of economic environment. In the U.S., we are seeing solid demand for our services. As Rob mentioned, our U.S. business is expected to be up nicely, sequentially, with Hackett U.S. up strongly and our SAP or ERP business down, but only after a very strong first half of the year. It is worth noting that our SAP group was also recognized as integrator of the year by SAP in 2012. These acknowledgments validate our strategy to focus on technology integration areas, where we can highly differentiate and distinguish ourself. Relative to Europe, activity remains good, but volatile. Overall, we expect to be down sequentially as we are impacted by the traditional summer vacation period, but down low-single digits on a year-over-year basis, as Rob mentioned. Overall, our activity remains healthy as clients continue to value our benchmarking and transformation expertise and unique intellectual capital that it generates to quickly respond to the complexity of the global business environment. With that demand overview as a backdrop, let me now comment on some of our strategic priorities. We continue to work hard to innovate new ways to develop continuous relationships that leverage intellectual capital as well as create an opportunity to serve clients more broadly. IP-based services enhance our opportunities to serve clients remotely, continuously and more profitably. The goal is to use our unique intellectual capital to establish a strategic relationship with our clients that have a high profitability and predictability and to further use that entry point to introduce our business transformation and technology consulting capabilities. This strategy should allow us to increase our client base, profitability as well as increase revenue per client. The best example of this strategy has been the revenue leverage that we've experienced from the executive advisory client base. Speaking of our desire to have continuous client relationships, our long-term goal continues to be, to be able to ascribe an increasing percentage of our total annual revenues to clients who are continuously engaged to our executive advisory programs and eventually, to our Hackett Performance Exchange. At the end of the second quarter, our executive advisory members totaled 825 across 242 clients. Consistent with prior quarters, approximately 45% of our Hackett quarterly sales were also advisory clients, continuing to show its strong relationship leverage. To give you an idea of the strategic touch points that come from those relationships, year-to-date, we are responding to approximately 400 inquiries per month from our advisory clients, which is up from last year. On the Hackett Performance Exchange front, we have nearly completed our planned enhancements for both the Oracle and SAP offerings. We are finalizing some key algorithms and presentation alternatives to our dashboard, and are now fully engaged in testing and feedback with clients. Our plan is to increase the client participation in this process through the balance of the year to ensure that our offerings are working as intended by no later than the beginning of next year. In addition to our fully automated CFO Ops dashboard, which is the key component of our Hackett Performance Exchange, we are also developing functionality that will allow our clients to complete and upload cost and full-time equivalent data, similar to our existing functional benchmarks in less than half the time it currently takes them. We call this capability CFO Ops Plus. This new offerings will allow us to offer unmatched data capture capability, which complements our unmatched benchmarking database. As I repeatedly mentioned, this is an ambitious new offering, but if successful it could enhance our business model by creating a powerful and possibly continues relationship with our clients. Although we continue to learn about how best to sell and leverage our HPE offerings, we believe it could represent a new way to monitor and benchmark a client's performance, which could result in a new revenue stream and a significant increase in data capture and operating insight, which we know our clients value. Lastly, even though we believe we have the client base offerings and market coverage to grow our business, we will continue to look for acquisitions and alliance that can add scope, scale and capability to accelerate our growth. In summary, we reported solid quarterly results that provided us with improved momentum going into the second half of the year. We also believe that our unique ability to combine proprietary intellectual capital with terrific clients -- for terrific talent, I'm sorry, to help our clients optimize the performance in this complex environment we're operating in, allows us to remain top of mind with leading global companies and bodes well for our prospects. As always, let me close by thanking our associates for their tireless efforts and always urge them to stay highly focused on our clients, our people and the exciting opportunities available to our organization. This concludes my comments. I will now turn it back over to the operator to start our Q&A. Operator?

[Operator Instructions] And the first question comes from Morris Ajzenman with Griffin Securities.

Well, I'll applaud you on the Dutch Auction again. I think that's right thing for shareholders. My question, let me start with your Europe. Sequentially, I think it was sequentially -- yes, were down 11%. And on the previous call, I think you inferred you might be down 20% or so. Not that we should be happy with down 11%, but what's happening in Europe? Is there a change for the better -- again, 11% decline is nothing to jump up and down about, but just give us some sort of a handle on what's happening there. Again, I think you guided 3% to 5% decline, but I think that's year-over-year for third quarter, is that correct?

Let me start with your first question, Morris. First of all, the 11% you're quoting is total international, which includes both Europe and Asia Pac, which is really Australia for us, primarily Australia. So Europe was down approximately 15%, instead of the -- if you want to call it, 18% to 20% that we were expecting. So yes, it did, come in better than planned, and I mentioned that on my comments. And their 15% was further offset by strong sequential growth in Asia Pac, which then bought that number to 11%. Now relative to the third quarter guidance, yes, we're saying, look, we expect that same number to be about 3% to 5%. So in essence, what we're saying is, look, if anything 2 things. The quarter played out a little better than we thought for Europe and secondly, the negative, if you want to call it, impact on a go-forward basis is going to be cut by at least half going into the third quarter.

Is it any one country or any one company that stands out or is it just an overall European moderating integrated decline?

No. Really the -- if you remember I characterized the volatility of client decision making, no I really can't characterize it to 1 country or another. Generally speaking, I will say right now, we feel that Germany is performing a little strong -- let's call it, stronger than the U.K., France and the Netherlands, which are the primary countries in Western Europe, which we operate in.

Okay. And lastly, the revenue improvements for U.S., is that a year-over-year 10% or sequential improvement? The 7% to 10% guidance you gave us.

You're talking about Q2 or are you talking Q3?

Q3, you gave us guidance, I'm not sure if that was year-over-year or sequentially.

It's a sequential improvement from Q2 to Q3, and it's 6% to -- I forget. Rob, go ahead and -- I think it's 6% to 8% for total U.S. So we're saying that the strong Hackett U.S. momentum, it will be offset by the SAP finally slowing down from just impossible growth numbers if you want to characterize it -- we characterize it that way.

And the last question, and I'll get back on queue. HPE is it still a target, the first quarter 2014 to start getting paid for the service?

Well, we actually hope to get paid by some clients before the end of the year. And we actually have some clients who have some contracts that are getting down some pre-period that will trigger -- that will go into a paid relationship now if the product performs as intended here before the end of the year. But we need that feedback to know whether or not, as you know, we would provide any extension or the like. But our goal now, as I mentioned on the call, have the product fully embedded, tested and in full commercial use by no later than the beginning of next year.

And how many paid customers you think you will have by first quarter of '14?

I don't know. I don't even -- I don't want to guess. Let's complete the product. Let's get the feedback and then let's allow that to happen and for us to comment as we actually have the facts, Morris.

[Operator Instructions] George Sutton with Craig-Hallum.

This is Charlie Grande filling in for George Sutton. I just had a few questions. First off, Ted, can you give us a sense how the linearity of the quarter came in for revenues?

It was pretty solid across the board. It started with nice momentum and that momentum is carried across through the quarter and that's why you're seeing then the sequential guidance comments that I made relative to Q3. I would say that, that would apply to the Hackett U.S. business. I would say stable for Europe and then the piece that is going to be sequentially down would be SAP. So the sequential trend in SAP was pretty solid throughout the quarter, but that revenue run rate, which has a 44% year-to-date growth rate is just will not be sustainable into Q3. So it will be harder sequentially in Q3.

Okay. Okay. Second, can you give us some more color on any key takeaways you had on your best practices conference?

Well, I think the most significant thing that we're seeing with clients is just, it's just watching our strategy play out. I mean these are clients that are there for different reasons. So a large number are there because they're executive advisory members. But when we look at those executive advisory members as you've seen the report quarter-on-quarter, an increasing number of them have now gone from initiating an executive advisory relationship into a significant transformation or technology consulting relationship. So for us, the big takeaway is the value and the uniqueness of our IP is absolutely recognized by leading global companies, and when we deliver that well and we established a strategic relationship, it allows us to expand that relationship beyond intellectual capital, beyond benchmarking, beyond research, into a meaningful consulting relationship. So it's really kind of watching these comments that I try to make throughout -- on each call and they are kind of hard to visualize. We can run into clients who say, "Well, I started with this relationship, it's moved to this." Or "I now supplement my consulting relationship when I'm not doing consulting with you, I'm utilizing some of your advisory, executive advisory support." Or clients who simply come to us and say, "Please size the price." They come to us because they know our benchmarking capability is second to none. They come in with that mindset, not with the intention of extending their relationship beyond that, realize that our capabilities in implementing these solutions are every bit as good as they are in benchmarking, and then allow us to participate in these significant transformation and technology relationships. So a combination of all of the above. And thank you for allowing me the commercial.

Last question, with interest rates starting to pick up a little bit. At what point would we see a REL benefit?

That's a great question. RELs business in Europe stabilized during the quarter. It was also stable throughout the U.S. But yes, they -- it'd be nicer if they would work the higher interest rate environment to just increase the number of at bats that they get. But I would say that it would have to increase significant for that specific impact to be noticed in their business. So we've always said, in that business, it's a business where we work with about 25 to 30 clients a year and serve a number of them then very meaningfully. So we'd love to have broader increase at bats, but I always remind our REL leadership that the opportunity that we need to hit and exceed our plan, relative to number of clients, is not significant. It should never be an excuse for that group not performing where it should be.

[Operator Instructions] Bill Jones with Singular Research.

Obviously, the numbers are pretty good for the quarter, top and bottom line. So I'm going to focus more on the announced Dutch tender offer. $35 million is obviously pretty significant vote of confidence for the stock. Maybe you can give us some color on why that amount? Why Dutch tender versus more traditional buyback? Any color on that would be appreciated. It's a good move, by the way.

Yes. I would say 2 things. Look, I think we've been very consistent in saying that we want to make sure that we're utilizing our balance sheet given the credit facility and terms that we have. And we believe this was an appropriate time to return capital to shareholders given the alternatives that we had in front of us. It doesn't preclude us from doing acquisitions. I believe we've got an increase in stock price, provides us both the ability to use credit as well as equity, which as you know, we really have not wanted to use in prior years. But it doesn't preclude us from doing that as we move forward. So no, look, we want to make sure that we're actively trying to create value for shareholders. And we believe, when we looked at our alternatives, this was a great opportunity to do that. And we thought the price would be meaningful for shareholders. And then when we looked at the overall percentage of stock that we would like to acquire, one of the great things that we found out is that our trading activity, post our initial Dutch, has actually improved when most people thought that it could actually hurt us. So I think, generally, by being active, by putting the dividend in place at the end of last year, there's just more attention in our stock. There's more of us to talk about. Shareholders know we're actively engaged in share value creation. And we think those are the things that we should be doing in addition to, as you said, making sure that we're continuing to grow our business, grow cash flow and grow profitability.

Excellent. I think the share price will reflect the quarter and in the offering tomorrow. But earlier in the call, I think you had talked about your NOL and I missed the balance.

Yes. In the U.S. we have $26 million of NOLs remaining, and we've got $14 million internationally which are comprised of, obviously, various different countries across Europe.

At this time, I show no further questions. I would now like to turn the call back over to Mr. Fernandez.

Thank you, operator. And let me again thank everyone for participating in our second quarter call. We look forward to updating you once we complete the third quarter. Thanks again.

Thank you.

Thank you for your participation in today's conference call.