The Hackett Group, Inc. (HCKT) Q2 2019 Earnings Report, Transcript and Summary

Welcome to The Hackett Group's Second 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.

Good afternoon, everyone, and thank you for joining us to discuss the Hackett Group's second quarter 2019 results. Speaking on the call today and here to answer your questions are Ted Fernandez, Chairman and CEO of Hackett Group; and myself, Robert Ramirez, CFO. A press announcement was released over the wires at 4:05 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’d like to remind you that in the following comments and in the Q&A 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 second quarter earnings call. As we normally do, I'll 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 strategy related comments, then we will open it up to Q&A. This afternoon, we reported net revenues of $68 million and pro forma earnings per share of $0.28, which was at the high end of our guidance. More importantly, both up strongly on a sequential basis. As expected, the momentum we developed during the back half of the first quarter continued into the second quarter and now consistent with our guidance will continue into the third quarter. Our increased demand was across both our Strategy and Business Transformation Group and our EEA or ERP, EPM and analytics group. Consistent with prior quarters, digital transformation and enterprise application cloud implementation initiatives continue to be the driving force for our organization. On the strategy and business transformation front, we had some client transitions during the quarter, which impacted our U.S. growth, but we expect the U.S. to be up 5% to 10% in Q3. However, our international revenues were down over 20% in Q2 and more than offset our U.S. growth in the second quarter and will continue to impact our growth in the third quarter. In our EEA group, we made great progress with strong growth in our Oracle Cloud application practices, which was offset by the decline in our on-premise related implementation, so essentially flat. Our SAP group, which is now reported within the EEA group came in better than expected, which allowed our overall EEA group to be up nicely in the quarter. It's been a while since we've been able to say that. The combination of our strong cloud implementation growth and the decreasing exposure to our on-premise revenue should allow the group to be up in Q3, and as you would expect should only improve as we move beyond the subsequent quarter. On the investment side, we believe the strategic investments we have made to fully digitize all of our IP launching which, what we believe is, a next-generation benchmarking platform, we named Quantum Leap in the introduction of our proprietary Hackett Digital Transformation platform, or as we refer to it DTP, highly differentiate our offerings and will continue to be important drivers of our growth. Additionally, our investments in smart automation along with strategic relationships with rapidly growing procurement and EPM software providers will also be key to our strategy in digital transformation momentum. Some of those relationships have yet to impact our revenue growth, but will impact the balance of the year and are important future drivers of our growth strategy. On the balance sheet side, we continue to generate strong profitability and cash flow from operation. This allows us to increase our dividend, buy back stock and fund acquisitions while we continue to invest in our business. I will 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 our outlook or guidance. Rob?

Thank you, Ted. As I typically do, I'll cover the following topics during this portion of the call: An overview of our 2019 second quarter results along with an overview of related key operating statistics. I'll also cover an overview of our cash flow activities during the quarter. And I'll then conclude with a discussion on our financial outlook for the third quarter of 2019. For purposes of this call, I will comment separately regarding the financial results of our Strategy and Business Transformation Group, or S&BT and our ERP, EPM and analytics solutions group or EEA, and the total company. Our S&BT Group includes the results of our IP as a service offerings, which include our executive advisory programs and benchmarking services as well as our business transformation practices. Our EEA solutions group includes the results of our U.S. Oracle, EEA and SAP solutions practices. Please note that this differs from how we have commented in the past, whereas we previously discussed SAP solution separately from the other practices that were grouped under Hackett. In addition, please note that all references to gross revenues in my discussion represent revenues including reimbursable expenses and any references to net revenues represent revenues excluding reimbursable expenses. As previously discussed, we exited our European-based REL working capital practice at the end of 2018, which was accounted for as discontinued operations in our financial statements. All historical information discussed on this call has been recast to exclude discontinued operations for comparability purposes. All recast historical financial information that excludes our European-based REL working capital practice is posted on the Investor Relations page of our website. Additionally, references to pro forma results specifically exclude noncash stock compensation expense, intangible asset amortization expense and nonrecurring adjustments and assumes a normalized long-term cash tax rate of 25% as detailed on the accompanying tables of our press release. Acquisition-related compensation expense, adjustments or cash and noncash items relating to the portion of the purchase consideration for acquisitions that contain vesting requirements, which are reflected as compensation expense under GAAP. For the second quarter of 2019, our net revenues from continuing operations decreased by 1.1% to $68 million when compared to the prior year and is at the midpoint of our revenue guidance range. The Q2 2019 reimbursable expense ratio on net revenues was 8.2% as compared to 8.5% for the second quarter of the prior year. Reimbursable expenses are primarily project travel-related expenses passed through to our clients and have no associated impact to our margin or profitability. Including reimbursable expenses, company gross revenues worth from continuing operations were $73.5 million in the second quarter, which represents a year-over-year decrease of 1.3%. Net revenues for our S&BT Group were up 7.4% on a sequential basis to $35.7 million in the second quarter, but down 5.6% on a year-over-year basis. The decrease was due to weaker-than-expected international revenues, which were down 21% as the uncertainty surrounding Brexit appeared to have impacted client decision-making. Net revenues for our EEA solutions group were $32.3 million in the second quarter, an increase of 4.4% on a year-over-year basis and up 10.9% on a sequential basis. This was driven by strong Oracle cloud revenue growth, offsetting our Oracle on-premise declines and better-than-expected growth from our SAP practice. Specific to our U.S. Oracle practice within EEA, our cloud revenue growth was in excess of 30% on a year-over-year basis resulting in the improved mix of cloud to on-premise implementation revenue, which is now approximately 69%. Total company international net revenues accounted for 16% of total company revenues in the second quarter of 2019 as compared to 19% in the second quarter of the previous year. Our recurring revenues, which include our executive and best practice advisory and AMS groups accounted for approximately 19% of our total company net revenues and approximately 25% of our total company pretax practice profitability in the second quarter of 2019. Total company pro forma cost of sales, excluding reimbursable expenses, totaled $40.8 million or 60.1% of net revenues in the second quarter of 2019 as compared to $42.1 million or 61.3% of net revenues for the same period in the prior year. Total company consultant headcount was 999 at the end of the second quarter as compared to 979 in the previous quarter and 1,020 at the end of the second quarter of 2018. The year-over-year headcount reduction is primarily due to rationalization of resources resulting from the migration from on-premise software to cloud-based resource requirements and lower utilization of subcontractors in the quarter. Total company pro forma gross margins was 39.9% of net revenues in the second quarter of 2019 as compared to 38.7% in the second quarter of the previous year. S&BT gross margins on net revenues were 44% in the second quarter as compared to 44.7% in the second quarter of the prior year. This decrease is primarily due to the decrease in European revenues previously discussed. EEA gross margins on net revenues was 35.4% in the second quarter of 2019 as compared to 31.3% in the second quarter of the prior year, primarily driven by improved revenue growth of the group. Pro forma SG&A was $15.2 million in the second quarter as compared to $14.8 million in the previous year. As a percent-to-net revenues both periods were 22%. Pro forma EBITDA in the second quarter of 2019 was $12.8 million as compared to $12.4 million in the same period of the prior year and represented 18.9% and 18.1% of net revenues, respectively. Total company pro forma net income for the second quarter of 2019 totaled $8.9 million or $0.28 per diluted share, which was at the high-end of our second quarter's guidance. This compares to pro forma net income of $8.7 million or $0.27 per diluted share in the second quarter of 2018. Our pro forma return on equity was 26% for the second quarter of 2019. GAAP diluted earnings per share was $0.22 for the second quarter of 2019 as compared to $0.36 in the second quarter of 2018. This decrease is due to the fact that previous year GAAP results included a $4.6 million or $0.14 benefit due to additional adjustments to the contingent earn-out liability relating to the Jibe acquisition. The company's cash balances were $16.7 million at the end of the second quarter of 2019 as compared to $10.7 million at the end of the previous quarter. This cash increase in the second quarter was primarily attributable to strong cash provided by operations, partially offset by debt repayments and repurchases of common stock. Net cash utilized by operating -- net cash generated from operating activities in the second quarter of 2019 was $11.3 million, which was primarily driven by net income adjusted for noncash items, decreases in accounts receivable, offset by net decreases in accrued expenses. Our DSO or day sales outstanding at the end of the second quarter of 2019 was 68 days as compared to 76 days at the end of the previous quarter. During the second quarter of 2019, we repurchased 93,000 shares of the company's stock at a total cost of approximately $1.5 million. Our remaining stock repurchase authorization at the end of the quarter was $3.9 million. During the quarter, the company repaid $3 million on its credit facility. The balance of the company's total debt outstanding at the end of the second quarter was $4.5 million. Consistent with seasonal -- I will now turn to guidance for the third quarter. Consistent with seasonal third quarter trends, we expect the impact of the additional U.S. holiday and the typical increase in time-off due to summer vacation in the U.S. and even more meaningfully in Europe to unfavorably impact available days by approximately 3% to 5% on a sequential basis. The company estimates total net revenues for the third quarter of 2019 to be in the range of $66.5 million to $68.5 million. On a year-over-year basis, we expect S&BT to be flat, as strong U.S. revenue growth of 5% to 10% will be adversely affected by lower international revenues of approximately 20%, primarily from Europe as we expect Brexit concerns to continue. For the EEA group, we expect revenues to be flat up 2% when compared to the prior year. The company estimates gross revenue to be in the range of $72 million to $74 million. The gross revenue guidance includes an estimated 8% for reimbursable expenses. We expect our pro forma diluted earnings per share in the third quarter of 2019 to be in the range of $0.27 to $0.29. At the high end of the range, this would represent a year-over-year increase of approximately 4%. Sequentially, we expect pro forma margins in the third quarter to benefit from the seasonal reductions in U.S. payroll-related taxes resulting from reaching FICA limits and the utilization of vacation accruals, offset by decreasing available days due to summer vacations. As a result, we expect pro forma gross margin on net revenues to be approximately 39% to 40%. We expect our pro forma SG&A and interest expense for the third quarter to be approximately $15 million. We expect third quarter pro forma EBITDA on net revenues to be in the range of 18.5% to 19.5%. We expect cash generated from operations to be up on a sequential basis. And 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 on the growth opportunity it offers our organization. As I have been repeatedly mentioning the rapid development in digital transformation along with the emerging enterprise cloud applications, RPA, artificial intelligence is dramatically influencing the way businesses compete to deliver their services. Traditional sequential, sequential and linear-based business models are changing to fully digital and dynamic automated workflows and events with enhanced intelligence. Digital transformation is redefining entire industries at an accelerated pace, forcing organizations to fundamentally change and adopt these new capabilities in order to remain competitive. We think this creates a very good environment for our organization. In the U.S., these transformative technologies are resulting in increased demand 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 our on-premise revenue or legacy revenue becomes a smaller part of our total company revenue, the complete benefit of our transition will become increasingly clear. We believe that we're getting very close to the point where that crossover is significant enough to be fully reflected in the organic growth that we have been targeting for several years. Our long-term strategy is to continue to build our brand with our new offerings and capabilities focused on digital transformation around our fully digitized and unmatched benchmarking and best practice intellectual capital. This should and is allowing us to serve our clients strategically and whenever possible, continuously. Specifically, we redefined global benchmark -- global benchmarking leadership with the launching of Quantum Leap, our new digital transformation software as a service solution. This new platform has allowed us to deliver more information with significantly less client effort. It also allows our clients to leverage our IP and track transformation initiatives over the life of their respective effort. We believe that we're just starting to see the benefits of the state-of-the-art platform, but we all -- but we feel strongly that as that platform continues to pick up clients and momentum and grow the way it has been that it reflects very good on the transformation opportunities available -- both technology and organizational transformation opportunities available to both of our service groups. We also launched our Digital Transformation Platform, or as we call it internally DTP, to further differentiate our unique IP and related capabilities. DTP allowed us to fully digitize our IP and align proven software configuration and organization solutions to help clients drive transformational change. In many ways, we believe our new platform is redefining how consulting services will be delivered in the digital era. We also believe that the benefits of this platform, we're just starting to scrape the surface. 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. As I mentioned last quarter, we now have nearly 1,000 clients with access to our IP platforms across our executive advisory and other IP as a service offerings, which include our benchmarking platform, Quantum Leap. Given the success of our current client initiatives and the improved functionality we continue to add to Quantum Leap and our Digital Transformation Platform, we believe we will attract other strategic partners to similar 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 have strategically leveraged our IP and have scope, scale or capability, which can accelerate our growth. In summary, Q2 allowed us to reestablish our momentum, which should allow us to resume our growth in the second half of the year. It also demonstrates that the investments we're making in our very strategic platforms are expanding our cloud and RPA applications capability and software partners as well as our IP as a service offerings, providing us with highly differentiated offerings and strategic access to most of the leading global companies. A very strong proof of that, not only is the strength of the Quantum Leap growth rate, which was -- has been significant in the first half of this year, but also the fact that we continue to grow our Oracle cloud offerings in excess of 30% the way Rob just mentioned, which again bodes well for our future. 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. Those conclude my comments. Let me turn it over to our operator, and let's move on to the Q&A section of our call.

Thank you. [Operator Instructions] Our first question is from Tim McHugh. Go ahead, your line is open.

Yes. Thanks. Just wondering if you could elaborate on Europe in terms of what you're seeing, is it client not engaging? Are they deferring all work? I guess this is a particular type of work. Just any more color, just -- particularly trying to understand, I guess, how long that might continue?

Well if you recall, in the second quarter, we actually added a pretty significant client -- global client that impacted both Europe and the U.S. business in Q2, and will, for several quarters to come. But what we saw is simply clients deferring decisions at an abnormal pace. So we're assuming that until there's a little clarity, we should expect the revenue growth there to be more limited. I think for us, I would say, not the positive part, but Q3, it hurts us as it did in Q2 pretty strongly. But if we were to remain sequentially flat, which is pretty close to what we're doing from Q2 to Q3 in Europe, we run up to a comp where it will actually allow us to be flat to up in Europe in Q4. Now whether that will continue, whether things in Europe improve or deteriorate, we don't know. But what we do know is that the comp alone allow Europe not to drag us into beyond Q4 and into 2020. Hopefully, whether it's some closed-door agreement with Europe or a hard Brexit, I think the clarity either way will help everyone tremendously.

Okay, thanks. And just a follow-up. The cloud growth that you continue to see with the Oracle platform. You talked just about the size and the engagements, I guess, that you're seeing, is that increasing? Is it just the number of engagements?

No, the size has clearly increased. I've got to say, if you remember, Tim, when we first did the ERP acquisition to really expand our Oracle footprint, one of the things we needed to do, we were a little bit of a mismatch with the access and size of clients that Hackett had versus the team that came on board to help us grow our ERP business. But no, with a little time in grade and our calls, we clearly improved in all aspects. So now it's important to note that, in fact, that our ERP business is growing, in fact, at a higher pace than our EPM business, which you know is a market-leading group, which I think is very positive for us.

Great, thank you.

[Operator Instructions] Our next question is from George Sutton. Go ahead, your line is open.

Good evening. This is Adam on for George. Can you discuss the progress that you're making with any non-Oracle EPM providers such as OneStream?

Well, we said we were launching that capability and announced our partnership, and we will see a nice revenue growth in that business into Q3. So I think it's progressing as we thought. As you know, Adam, we are a very strong EPM, both transformation and technology, partner for many of these large clients, so this provides another meaningful channel opportunity for us, which we think we'll exploit properly.

Great. Thank you. And then just in terms of the longer view, 3 to 5 years, what would you expect the growth rate to be once you see some more progress on on-prem?

I'm sorry, on-prem or on.....

Once you see more progress on on-prem, and it's not as big of a factor.....

We believe that it doesn't take many quarters for us to be, right, to have that EEA group, right, in that 5% to 10% long-term growth rate, which you know gives us a 12% to 25% bottom line impact. So no, we're getting close.

Great. And then just one final question. Obviously, Brexit has been a big deal, but is there any other geopolitical events that you're worried about looking forward?

I hate to speculate because I don't want to jinx us. I really believe that Brexit -- Brexit has really not been much of an event as all of the planning and the ramp-up into the last year took place. But I don't think anyone expected this kind of deadlock. But obviously, one way or another, we think October 31 is the deadline either way. So I think in my -- in our point of view, clearly whichever way that exit or Brexit takes place, will be good news for all industries.

Great. Thank you.

Our next question is from Jeff Martin. Go ahead, your line is open.

Hi, this is Sarra Schuster on behalf of Jeff Martin. You mentioned last quarter that the recently launched Digital Transformation Platform is helping Hackett differentiate in the marketplace. Can you provide an update on the impact this is having on the business and how you see that affecting the model over the next few years?

Thank you. Actually, the significant of both the Quantum Leap platform and the Digital Transformation Platforms are becoming significant and critical to our success. I can't emphasize enough how much it differentiates our ability to engage our clients with all of the capability, intellectual capital that comes from our benchmark and executive advisory business, the best practice insights that the clients try to gain when they engage The Hackett Group. So I would say that across our strategic and business transformation business, across the Oracle Fusion Cloud growth engagements where we have an Oracle Digital Transformation platform, specifically with an Oracle capability view as well as the way we believe that it's currently being leveraged or can be leveraged by additional strategic partners and alliances, we believe it's a significant component of our growth strategy over the next 3 to 5 years.

Thank you. Can you please provide an update on some of your newer procurements -- speech impediment, procurement relationships such as Coupa, as I believe you expect them to be meaningful drivers in 2H '19 revenue growth?

The Coupa relationship has been very significant to us. We continue to believe that we're one of the top handful of partners that they have. So both the relationship with the channel, our understanding of the capability and the success they're having has been significant. With that said, we're having also success with the SAP Ariba product as well. So procurement overall for us has been a real strength that we -- in an area we expect will continue to grow across both transformation, advisory and the technology parts of our business.

Another question. With the addition of the more multiyear contracts, you've mentioned in the past that those often come with follow-on opportunities. Can you give us a sense of how meaningful those are? And is there any common percentage to the follow-on opportunities that represents a percentage of the original contract?

The answer is, we've never provided that special -- that multiple information, but I would say that when those entry points emerge through Quantum Leap or a significant benchmarking exercise, our ability to transition that into a significant transformation of technology engagement is probably somewhere in the 25% to 50% range. So it's very significant.

Okay. Thank you. And finally, can you provide us with a sense of the monthly revenue cadence during the quarter?

Other than to say that our momentum from the back half of Q2 led to significant sequential growth in Q2 -- into Q2. And that now we've guided basically, call it flattish sequential growth against a quarter where we lose 3% to 5% available days, that should give you an idea of the momentum from quarter-to-quarter.

Okay, thank you very much.

Thank you.

Our next question is from Vince Colicchio from Barrington Research. Go ahead, your line is open.

Yes, thanks for taking my questions. Ted, with the SAP better-than-expected performance, was that one big client? Can you give us more color on what that looks like?

No just improved activity across both the consulting, value-added reseller and AMS part of the business. So no, the improvement in SAP for the first half of the year has surprised us a little bit. We thought that, as you remember, as you can recall, Vince, we thought that it would still be a year-over-year decline in '19. And now, obviously, SAP will -- that business will grow nicely throughout 2019. So no, that's been very good news for us.

And then within EEA, what was the year-over-year change in Oracle and SAP, respectively?

Within EEA, I'm going to say approximately 70% oracle, 30% SAP to give you kind of a broad sense. And I'm having Rob look at that as I make that statement, and he's pulling out the documents. But they both grew sequentially in the quarter. So the mix didn't change very much.

Okay. And what is your expectation for year-over-year growth for the EEA group in the Q3?

Flat -- it will be flat to up slightly, which means that the on-prem number is still hitting us pretty strongly as we go into Q4. Again, I'll speak more broadly. So beyond EEA, so I'll say, S&BT and the Strategy and Business Transformation group, if that momentum continues, as you look into Q4, our growth prospects start to improve Q4 and beyond. I don't want to get ahead of ourselves, we had a false positive in Q3 of last year. But what do we know that the on-premise revenue is significantly lower than it was a year ago. What do we also know that we're growing our Oracle Fusion Cloud strongly on bigger numbers. So in excess of 30% across ERP and EPM and that SAP is surprising us. So all of those things are favorable to us as we go into the latter part of the year and into 2020.

And Rob, what was capital spending in the quarter?

$1.3 million.

I'm sorry?

$1.3 million.

Okay. And I missed what you said on pro forma total adjusted gross margin. Could you repeat that please?

I said that pro forma for Q3 would be 39% to 40%.

No. What was the number in the quarter?

In Q2?

Oh, in Q2, for S&BT or for the business?

For one of the groups or for total?

I missed S&BT and total.

So S&BT, the margin was 44% and total was 39.9%.

And the year ago?

The year ago for S&BT was 44.7% and the year ago for total was 38.7%.

Thank you very much. I’ll go back in the queue.

By the way, Vince, Rob also said that the estimate I provided you of 70% is actually 69.5%. So I stand corrected.

Thank you.

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

Well, let me thank everyone for participating in our second quarter's earnings call. We look forward to updating everyone as we report the third quarter. Thank you.