The Hackett Group, Inc. (HCKT) Q3 2018 Earnings Report, Transcript and Summary

Welcome to The Hackett Group Third Quarter Earnings Conference Call. [Operator Instructions] Please be advised 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 third 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, Rob Ramirez, Chief Financial Officer. A press announcement was released over the wires at 4:05 PM 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 question-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 our third quarter earnings call. As we normally do, I will open the call with some overview comments on the quarter. I will then turn it back over to Rob to comment on detailed operating results, cash flow as well as comment on guidance. We will then go over to our market -- I will then provide some market strategic overview comments and then we will open it up to Q&A. So, again on the overview side, let me again welcome everyone to our third quarter earnings call. This afternoon, we reported net revenues of 68.2 million, a 3.5% increase over the prior year with pro forma earnings per share of $0.27, a 4% increase over last year. As expected, our Hackett US revenues were up 9% from last year, led by a 20% plus growth coming from our strategy and business transformation group. Consistent with prior quarters, digital transformation initiatives continue to drive the growth of our strategy and business transformation practice. Our Oracle ERP, EPM and Analytics group was up 1% from prior year, as we continued to aggressively migrate from on-premise to cloud implementations. Total company US was up 4%, as our SAP group came in slightly weaker than we expected, down 19%, as we continue to feel the impact of SAP's transition to software-as-a-service applications and their impact on our channel alignment. International revenues were flat and lower than expected on a year-over-year basis due to weaker than expected performance from our working capital practice. Excluding working capital, international results were up over 20%. Given our strong focus on digital transformation as we head into 2019, we have decided to consider several options for this practice, which we plan to effect by year end. Our Oracle ERP, EPM and Analytics business continue to make progress, as I said, a strong cloud revenue growth outpaced the decline on the on-premise’s revenue. As expected, the group was slightly up in Q3, the first time we have had net revenue growth for the group since the first quarter of 2017. Although we don't expect this to continue in Q4 due to a very strong on-premises comp from our ERP, Oracle ERP group in Q4 of ’17, we continue to believe that we will see net revenue growth of 2% or higher in Q1 of ’19. Important to note that significantly lower on-premise revenue declines provide favorable comps in Q1 and will do so throughout 2019. This is why we look to our 2019 year with great promise since revenue growth and increasing cloud scale should also mean margin expansion for this group. We believe our strategic actions to fully digitized all of our IP and launching Quantum Leap, our next generation benchmarking platform followed with the introduction of our proprietary Hackett digital transformation platform or DTP highly differentiate our offerings and our go-to-market. DTP, as we call it, also allows us to lead with in our sales delivery and on our continuous support initiatives. Coupled with our investments in RPA, our smart automation, these actions have been key to our strategy and business transformation momentum. Additionally, by building one of our first versions of digital transformation -- of our digital transformation platform, specifically around Oracle cloud apps functionality, we were able to quickly demonstrate how we can digitally use our proprietary best practices IP to assess and optimize the configuration of Oracle cloud applications to the Oracle sales channel as well as prospective clients. This was further confirmed by Oracle's recent recognition of our digital transformation platform with their SaaS Innovation of the Year Award. Last but not least, our successful introduction of our IP as a service offerings through strategic partners as well as our expanding training and certification programs have further accelerated our positioning as a digital transformation and IP as a service leader. On the balance sheet side, we continue to generate strong profitability and cash flows from operation. This has allowed us to increase our dividend, buy back stock and fund acquisitions, while continuing to invest in our business. I'll also comment further on strategy and market conditions, but let me first ask Rob to provide details on our operating results, cash flow and also comment on outlook. Rob?

Thank you, Ted. As I typically do, I’ll cover the following topics during this portion of the call, an overview of our 2018 third quarter results along with an overview of related key operating statistics, an overview of our cash flow activities during the quarter and I will then conclude with a discussion on our financial outlook for the fourth quarter of 2018. For purposes of this call, any references to The Hackett Group will specifically exclude SAP solutions. Correspondingly, I will comment separately regarding the financial results of The Hackett Group, SAP Solutions and the total company. Please note that any references to gross revenues in my discussion represent revenues including reimbursable expenses and any references to net revenues represents revenues excluding reimbursable expenses. Additionally, references to pro forma results specifically exclude non-cash stock compensation expense, intangible asset amortization expense, acquisition related compensation and non-cash compensation expense, acquisition related costs and earn-out adjustments and assumes a normalized long term cash tax rate of 25%. Acquisition related cash and non-cash compensation expense primarily relates to the portion of the purchase consideration for the 2017 acquisitions that contain service vesting requirements and as such are reflected as compensation expense under GAAP. In terms of our third quarter results, for the third quarter, our net revenues or gross revenues executing reimbursable expenses increased by 3.5% to 68.2 million when compared to the prior year and was within our revenue guidance range. Reimbursable expense ratio on net revenues for the third quarter above 2018 and 2017 was 8%. Reimbursable expenses are primarily project, travel related expenses, past due to a client and has no associated impact to our margin or profitability. Including reimbursable expenses, company gross revenues were 73.8 million in the third quarter of 2018, which represents a year-over-year increase of 3.3%. Net revenues for The Hackett Group, which excludes SAP Solutions were 60.3 million in the third quarter of 2018, an increase of 7% on a year-over-year basis. Hackett US net revenues were up by 9%, led by strong US strategy and business transformation growth of 25%. International revenues primarily from Europe were essentially flat. As Ted mentioned in his comments, this was primarily due to weak performance from our European working capital practice. Excluding this practice, international revenues would have been up by 20% and pro forma earnings per share would have been up $0.01 to $0.02. Given the results of this practice, we will be evaluating all available alternatives during the quarter. Our Oracle ERP, EPM and Analytics business continued to make progress, as strong cloud revenue growth exceeded the decline in on-premise revenues. As a result, Oracle EEA revenues were up 1% in Q3 as compared to the 5% decline reported in the previous quarter. As Ted mentioned, we don't expect this trend to continue in Q4 due to strong on-premise comps from our ERP group in Q4 of 2017. However, our cloud revenue growth continues to be in excess of 60% on a year-over-year basis, resulting in improved mix of cloud to on-premise revenue. We expect to regain year-over-year net revenue growth in Oracle EEA in Q1 of 2019. Net revenue from our SAP Solutions Group, which consists of our SAP reseller, implementation and application managed services groups or AMS totaled 8 million in the third quarter of 2018, a decrease of 19% on a year-over-year basis, slightly higher decrease than expected. The decrease is primarily due to the impact of channel transition from on-premise to cloud based offerings and the loss of the AMS contract that we have discussed in previous quarters. We expect this group to be down approximately 2% sequentially in the fourth quarter of 2018. However, we expect a year-over-year decline to be less than 10% as a result of stabilizing revenues and improved comps. Total company international net revenues accounted for 18% of total company net revenues in the third quarter of 2018 as compared to 19% in the third quarter of the previous year. Our recurring revenues, which include our executive and best practice advisory and AMS groups accounted for 18% of our total company net revenues and 26% of our total company pretax practice profitability in the third quarter of 2018. Total company pro forma cost of sales, excluding reimbursable expenses, totaled 41.4 million or 60.6% of net revenues in the third quarter of 2018 as compared to 39.8 million or 60.4% of net revenues for the same period in the prior year. Total company consultant headcount was 1046 at the end of the third quarter as compared to 1043 in the previous quarter and 1022 at the end of the third quarter of 2017. Total company pro forma gross margin was 39.4% of net revenues in the third quarter as compared to 39.6% in the third quarter of 2017. Hackett Group pro forma gross margins on net revenues was 40.1% in the third quarter of 2018 as compared to 39.7% in the third quarter of 2017, primarily due to higher US gross margins. SAP solutions pro-forma gross margins on net revenues was 34.7% in the third quarter of 2018 as compared to 39.1% in the previous year. This decrease was primarily due to decreased revenues in the period when compared to the previous year. Pro forma SG&A was 15.1 million of net revenues in the third quarter of 2018 as compared to 14.2 million of net revenues in the previous year. As a percentage of net revenues, both periods were 22%. Pro forma EBITDA in the third quarter of 2018 was 12.4 million as compared to 12.5 million in the same period of the previous year, which represented 18.2% and 19% of net revenues respectively. Total company pro forma net income for the third quarter of 2018 totaled 8.7 million or $0.27 per diluted share, which was at the midpoint of our third quarter’s guidance. This compares to pro forma net income of 8.2 million or $0.26 per diluted share in the third quarter of 2017. These results represent an increase of 6% and 4% on a year-over-year basis for pro forma net income and diluted earnings per share respectively. Total company pro forma net income for the third quarter of 2018 excludes an acquisition earn-out liability expense of 803,000, cash and stock compensation expense of 2.8 million and intangible asset amortization expense of 585,000. Pro forma results also assume a long-term cash tax rate of 25% or 2.9 million. Consistent with our comments over the last two quarters, our pro forma results include a long term cash tax rate of 25% as a result of the decrease in US federal statutory rates. As we disclosed last quarter, we decided to use 2% of the 5% decrease in our pro forma rate with our associates by doubling our existing 401(k) contribution as well as to increased practice related bonus programs. Our pro forma return on equity was 30% for the third quarter of 2018. GAAP diluted earnings per share were $0.16 for the third quarter of 2018 as compared to $0.17 in the third quarter of the previous year. GAAP results include an 803,000 or $0.02 expense due to additional adjustments to the contingent earn-out liability, relating to the Jibe acquisition. The company's cash balances were 13.2 million at the end of the third quarter of 2018 as compared to 13.3 million at the end of the previous quarter. The slight decrease in the third quarter was primarily attributable to strong cash flow from operations, which was more than offset by the payment of our semiannual dividend, debt repayments and capital expenditures. Net cash provided by operating activities in the third quarter was 9.5 million, which was primarily driven by net income adjusted for non-cash items. Our DSO or days sales outstanding at the end of the third quarter was 70 days as compared to 68 days at the end of the previous quarter and 71 days in the prior year. We continue to target DSO to be below 65 days. During the third quarter of 2018, the company had 2.1 million of capital expenditures, primarily related to the investments in internal corporate systems, key digital initiatives which include Quantum Leap and our digital transformation platform, The Hackett Institute and the global rollout of new laptops, which occurs every 3 to 4 years. We expect to spend approximately 9 million this year, but currently expect our capital expenditures to return to our historical levels of $3 million to $4 million in 2019. During the quarter, the company paid down a net 2 million from our credit facility. The balance of the company's total debt outstanding at the end of the third quarter was 11.5 million. Subsequent to the end of the third quarter, the company has made additional debt repayment of 3 million. During the third quarter of 2018, the company paid its semiannual dividend to shareholders, which totaled 5.4 million. At its most recent meeting, the board declared the next semiannual dividend of $0.17 per share, which will be paid in January of 2019. I’ll now turn to our guidance for the fourth quarter. Before I move to the guidance, I would like to remind everyone of the seasonality of our business, specifically the increased holiday and vacation time that is historically taken in the fourth quarter will decrease our available billing days by approximately 8% when compared to the third quarter. As such, the company estimates total net revenues for the fourth quarter of 2018 to be in the range of 61.5 million to 63.5 million. At the end of the -- at the high end of the guidance, this will represent a 1% decrease from the previous year. This includes the 5% unfavorable impact of the year-over-year decline of the working capital practice, which represents 3% and the Oracle EEA group, representing 2%. The company estimates gross revenue to be in the range of 66.5 million to 68.5 million. The gross revenue outlook includes an estimated 8% for reimbursable expenses. Relative to pro forma diluted earnings per share, we expect the unfavorable impact of decreased available billing days to be partially offset by the corresponding utilization of vacation accruals and lower US payroll taxes, resulting from reaching US FICO limits. As such, we expect our pro forma diluted earnings per share in the fourth quarter of 2018 to be in the range of $0.25 to $0.27. At the high end of the range, total company would be flat on a year-over-year basis. It is important to note that the decline in the working capital practice equates to $0.01 to $0.02 unfavorable impact to the fourth quarter. We expect pro forma gross margin on net revenues to be approximately 40% to 41%. We expect the pro forma SG&A and interest expense for the fourth quarter to be approximately 14.4 million. We expect fourth quarter pro forma EBITDA on net revenues to be in the range of approximately 19% to 20%. We expect cash generated from operations to be up on a sequential basis. 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.

Thank you, Rob. As we look forward, let me reiterate our thoughts on the demand environment and more importantly on the significant growth opportunity it offers our organization. The rapid development in smart automation, cloud applications and artificial intelligence along with improving mobile functionality enhanced user experience is dramatically influencing the way businesses compete and deliver their services. This is redefining entire industries at an accelerated pace, forcing organizations to fundamentally change and adopt these new capabilities in order to remain competitive. Traditional, sequential and linear based business models are changing to fully networked and dynamic automated workflows and events with enhanced analytics. In the US, these transformative technologies are resulting in increased activities as companies determine how to respond to the quickly changing competitive environment. We are seeing the growth in cloud and digital transformation engagements improve our growth prospects. As our digital transformation and cloud engagements continue to grow and the decline in on-premise revenue slows and becomes a smaller part of our total company revenues, the complete benefits of our transition will become increasingly clear. In Europe, demand continues to be solid as Europe has benefited from our digital transformation initiatives and our EPM and BPL as well as RPA investments. We believe we have taken the necessary actions to both optimize short term performance and more importantly to be strongly positioned for the high growth digital transformation opportunities. Our long term strategy is to continue to build our brand by building new offerings and capabilities around our fully digitized and unmatched benchmarking and best practices intellectual capital in order to serve clients strategically and whenever possible continuously. Specifically, we redefined our global benchmarking leadership by launching Quantum Leap, our new digital benchmarking software as a service solution. The new platform allows us to deliver more information with significantly less client effort, it also allows clients to leverage our IP and track the transformation initiatives over the life of their respective effort. We launched our digital transformation platform to further differentiate our unique IP and related capabilities. Our ability to fully digitize our IP and align proven technology and organizational solutions to help clients drive transformational change allows us to highly differentiate all of our offerings. In many ways, we believe our new platform is redefining how consulting services will be delivered in the digital era. We are leveraging our digital transformation platform to expand and attract new alliance partners that can utilize our unique benchmarking and best practice IP to help them differentiate and sell their software or service solutions, which should allow us to further expand our IP as a service offerings. Last year, we expanded our ADP offerings by launching our new ADP workforce now programs. These programs increased our opportunities with ADP and are continuing to grow in 2018. Given the success of this program, we continue to believe we will attract other strategic partners to similar programs. We are expanding our Hackett Institute training and certification offerings to allow us to use our IP and to serve our clients. We just found out we've served over 300 plus clients that have been part of our pilot or have used our training courses and over 4500 students have now had a chance to work with our new e-learning solutions. Given the unique nature of our best practices content and the favorable market condition to our CGBS offering, we believe that continuing education provides a significant high growth, high margin growth opportunities for our organization. At the end of the quarter, we had 289 executive and best practice advisory clients and 990 members, but this excludes the hundreds of new clients that we have both in our institute as well as in our new IP as a service solutions that we now serve through those alliance or training programs. Lastly, even though we believe that we have the client base and the offerings to grow our business, we continue to look for acquisitions and alliances that strategically leverage our IP and have scope, scale or capability which can accelerate our growth. In summary, in the third quarter, we continued our aggressive focus on cloud and digital transformation initiatives while reporting solid operating results. More importantly, we believe the investments we're making in our digital transformation platform, our expanded cloud applications capability, our RPA capability and our IP as a service offerings will allow us to resume the long term growth and profitability targets. 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 organizations. Those conclude my comments. Let me then turn it over to our operator and let us move on to the Q&A section of our call. Operator?

[Operator Instructions] The first question comes from George Sutton with Craig-Hallum.

This is Adam on for George. Thanks for taking my question. I was curious with Oracle OpenWorld ending two weeks ago, I was wondering if there's any notable insights you could share, specifically anything towards the channel would be helpful.

Let me restart my comments I said. The more important part of the Oracle OpenWorld effort for us was the fact that we were recognized both for our cloud, for our Oracle Cloud EPM related work and the SaaS Innovation of the Year award that we got around our digital transformation platform. When you consider, if you say insight, look, the opportunity for both Oracle SAP and anyone that has a large installed base and is trying to move individuals either from purchased or on-premise software with cloud applications is to be able to clearly articulate and demonstrate the value that that transitioned to that new application architecture and capability provides the clients. So for us, our focus has been to use that -- our IP and intellectual capital to help clients do that as quickly and as efficiently as we can and that's either to help the channel or to help clients understand that is a way of us competing for business. Hopefully that answers your question.

And then one more follow up, I know it's a small portion right now, but how much is RPA adding to your average deal size currently?

It is small in terms of the total strategy and business transformation revenues, however it is an important part of virtually every engagement. There is no such thing as a significant digital transformation initiative that would not have to consider the impact that RPA would have on that overall initiative. So although revenues today are relatively small but growing and the number of engagements are growing, the importance of the ability to assess the client's RPA opportunity and articulate and frame that for them is very critical.

[Operator Instructions] The next question comes from Frank Atkins with SunTrust.

Wanted to first ask on international revenue, can you talk about some of the areas of strength that drove the kind of up 20% percent ex-working capital and then a little bit about the weakness in the working capital practice and your thoughts going forward for that.

Okay. Well, firstly, the demand there is really around large scale digital transformation initiatives that where we’re executing those engagements across global teams. So specifically, we've got some engagements that expands from North America into Western Europe that are benefiting both the US as well as the European groups. Specifically to the impact of working capital, I would say look, the working capital group for us is and the impact on our performance and specifically in the third quarter and fourth quarter is a little bit of a surprise. It’s a group that has volatility from time to time just because of the nature of the engagements. But for us, we're so focused on 2019 and the prospects of what the growth of our digital transformation business as well as our cloud applications business is as our on-premise comps continue to significantly decline, which allow us to set up ‘19 for growth opportunities. That's why we’ve made the comment relative to the working capital group that given our focus in that digital transformation focus, we've decided to explore all strategic and other options available to us and to make a decision relative to that group by the end of the year.

And then could you give a quick update on the ADP relationship and where that practice stands?

As a matter of fact, I just saw, as this call was about to take on, I just saw a brand new set of marketing documents that they're putting out with their clients right now. So specifically, the Vantage program which we know we launched several years ago continues to grow consistent with the growth of that business for them and the Workforce Now program that we now have expands across both their, what they call national, which is their enterprise business as well as majors, which is the middle market business and those programs are expanding in 2018 and part of their -- some of their strategic offerings and we hope to be able to grow our business along with their growth, similar to that we've been able to do with the managed program we launched two years ago.

And last one from me, you spoke a little bit about dynamics on the margin expansion side in terms of 4Q and into ’19, but could you just maybe back up a little bit high level, talk about the major levers that you can pull to drive margin expansion as we look to 2019.

Yeah. The largest lever that we have is the fact that as you grow -- as your cloud engagements grow in that the offshore leverage that come from those cloud engagements are leveraged more significantly. We’ve made investments to be able to support those engagements offshore and a combination of cloud engagements in terms of the size of those clients, continuing to grow along with us being able to fully deploy the investments that we've made offshore or even offsite, but onshore is a part of the expanding margin opportunity that we see in 2019.

The next question comes from Jeff Martin with ROTH Capital Partners.

Ted, could you give us an update on the progress that you’re having with Quantum Leap, are you seeing it translate to client engagements and are you monetizing that to the extent that you expect it?

The answer is that we are continuing to grow that offering. It clearly is being very well received and highly differentiates all of our benchmarking offerings. It doesn't mean that we get to move everyone to use Quantum Leap, even though that's our goal, as we continue to benchmark clients. But with that said, the percentage of clients that we are signing using -- the reactions of Quantum Leap first is incredibly favorable and highly differentiating. When you then consider the number of clients who are instead of signing on to a, let's call it, a 12-week benchmarking event versus what we're now seeing where we're getting an increasing number of those clients using Quantum Leap, finding multi-year benchmarking and transformation tracking engagements, which are part of the total platform. For us, we'd always like for it to ramp quicker, but look, the accolades and the number of clients that are moving from a 12-week engagement to a 2 to 3-year commitment to utilize the platform is meaningful and has significant prospects for us.

How does the annual revenue contribution per client translate when you go from shorter engagement to a multi-year engagement?

Well, we sign a total contract and then we allocate a portion of that to that initial effort that happens and then we actually, similar with our executive advisory that subscription revenue, there is a portion of that total revenue then that is then received over that 1, 2 or 3 year period depending on the contract terms. So part of it still is somewhat front-loaded and then of course and then comes in over the life of the Quantum Leap contract, depending on the specific scope that that client hangs on to.

And then could you update us on your comfort in terms of getting back to your targeted growth rate in 2019?

Well, look, we were concerned that the Q4 guidance and the impact of the working capital group in the fourth quarter and third and fourth quarter would be of concern, but from our perspective, our growth prospects and profitability prospects for 2019 remain unchanged and that's a simple fact that if our digital transformation business just continues to compete as effectively as it is and that we continue to grow our cloud business at a rate of, let's say, 50% plus, we're running higher than that right now. And then you couple that with the fact that just to give you a high level number, the best estimate that we have on the decline, the on-premise decline in 2019 will be half of the number that we had in 2018, which by definition mathematically sets up some very favorable comps when we compare the two years. The comments that we've made around the fact that we think that we can return to our long term growth -- revenue range as well as the profitability range remains intact.

And then are you able to quantify on an annual basis what that European working capital group does in terms of revenue?

The answer is it's small, but the profitability impact has been significant the last two quarters. So the answer is, I'd rather not get into those details, Jeff. I’d want to -- my goal is to one say what the impact was and then make sure that it was clear that our plans are to address it by year end.

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

Let me close by thanking everyone for participating in our third quarter earnings call and look forward to updating everyone on both our fourth quarter results and full year fiscal results when we report those results sometime in mid-February. Thank you again for participating.

This concludes today's conference. Thank you for your participation. You may disconnect at this time.