The Hackett Group, Inc. (HCKT) Q3 2021 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.

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 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 the in 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, especially in light of COVID-19. 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'll open the call with some overview comments on the quarter. I will then turn it back over to Rob to comment on the detailed operating results, cash flow as well as comment on outlook. We will then review our market strategy related comments, after which we will open it up to Q&A. Although it appears that COVID-related activity is truly tapering, I would like to continue to acknowledge those dedicated health care providers who continue to work nonstop and under difficult circumstances in many cases to support all of us during this pandemic. Consistent with our comments since the end of the second quarter of last year, we continue to experience increased client engagement and demand for our services throughout the quarter. It is clearly evident that organizations have recognized the need to embrace digital transformation as a requirement to remain competitive and at a rate -- and the rate of digital innovation and related change is truly unprecedented. Correspondingly, this afternoon, we reported net revenues of $71.4 million and pro forma earnings per share of $0.32, both above our quarterly guidance and up strongly on a year-over-year basis. Excluding our large SAP software sale in Q2, revenues were up 5% sequentially. The results are consistent with the strong demand recovery that, as I said, we've -- we have been experiencing throughout the year. And it's also nice to note that it's above prepandemic levels. U.S. sequential revenue growth, including the large Q2 software sales was up 7% sequentially and up 27% when compared to the third quarter of last year. The results were driven by the strong performance of both our strategy and business transformation as well as our EEA or ERP and analytics group across nearly all of our U.S. practices. Of special note was the continued sequential improvement of our Strategy and Business Transformation Group, which has now grown sequentially for five quarters in a row, reflecting the accelerated demand for digitally enabled transformation. Without a doubt, the COVID pandemic has accelerated the deployment of digital technologies to support cloud-enabled transformation, which has resulted in the improved demand across nearly all of our practice groups. We are encouraged with the increasing activity in the U.S. and the prospects in Europe. The investments we have made to fully digitize all of our IP in the development of our digital platforms, including Quantum Leap, our state-of-the-art global benchmarking platform and our proprietary Hackett Digital Transformation Platform, or DTP, allow us to highly differentiate and expand our offerings and are important drivers of our long-term growth. We also continue to explore add workflow automation and process mining technology providers across all areas of the enterprise. We believe these new and potential relationships are key to digital to our digital transformation strategy and are important components of our growth strategy. On the balance sheet side, our ability to generate strong cash flow from operations has allowed us to increase our dividend and buyback -- and our buyback program. We also continue to have strong cash balances and fully available credit facility to fund acquisitions we identify while continuing to invest in our business. With that said, let me ask Rob to provide details on our operating results, cash flow and also comment on outlook. I will make additional comments on the strategy and market conditions following Rob's comments. Rob?

Thank you, Ted. As I typically do, I'll cover the following topics during this portion of the call. I'll cover an overview of our 2021 third quarter results, along with an overview of related key operating statistics. I'll cover 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 2021. For purposes of this call, I will comment separately regarding the financial results of our Strategy and Business Transformation Group, or SMBT; our EPM ERP and Analytics Solutions Group, or EEA; our International Group and the total company. Our S&BT group includes the results of our North America IP-as-a-Service offerings, our executive advisory programs and benchmarking services and our business transformation practices. Our EEA Solutions group includes the results of our North America Oracle, SAP solutions and OneStream practices. Our International Group includes the results of our S&BT and our EEA resources that are based primarily in Europe. In addition, please note that all references to net revenues represent revenues excluding reimbursable expenses. Reimbursable expenses are primarily project travel-related expenses passed through to our clients and have no associated impact to our margin or profitability. Given the limited amount of business travel due to the pandemic, we encourage investors to focus on net revenues to assess revenue growth and margin trends. During our call today, we will reference certain non-GAAP financial measures, which we believe provide useful information to investors. We included reconciliations of GAAP to non-GAAP financial measures in our press release filed earlier today. Additionally, my comments today are based on results from continuing operations. For the third quarter of 2021, our net revenues increased to $71.4 million, up 24% when compared to the prior year, which is above the high end of our revenue guidance range. We continue to see an increase in client engagement throughout the quarter. This is also up 7% when you compare it to the pre-COVID third quarter of 2019. The Q3 reimbursable expense ratio on net revenues was 0.7% as compared to 0.3% when compared to the prior year. Reimbursable expenses have been significantly reduced in 2020 and 2021 due to COVID-19, which required the transition to a remote service delivery model. Our U.S. operations, which represented 92% of our total company net revenues in the third quarter of 2021 were up 27% when compared to the third quarter of the prior year. Net revenues for our S&BT Group were $27.6 million, an increase of 24% when compared to the same period in the prior year, reflecting the continued demand for enterprise digital transformation initiatives. Net revenues for our EEA Solutions group were $38.2 million, an increase of 29% when compared to the third quarter of the prior year. The year-over-year increase was driven by growth across all of our EEA practices. Net revenues for our International Group were $5.6 million, a decrease of 5% on a year-over-year basis as expected. Total company international net revenues accounted for 8% of total company net revenues as compared to 10% in the third quarter of the prior year. Our recurring revenues which include our executive advisory, IP as a service, multiyear benchmarks and AMS groups, accounted for approximately 19% of our total company net revenues and approximately 23% of our total company practice contributions in the quarter. Total company pro forma cost of sales, excluding reimbursable expenses, totaled $43.6 million or 61% of net revenues in the third quarter as compared to $37.8 million or 65.4% of net revenues in the previous year. Total company consultant headcount was 1,049 at the end of the third quarter as compared to total company consultant head count of 1,001 in the previous quarter and 923 at the end of the third quarter of 2020. The year-over-year increase was primarily a result of hiring activities and increased utilization of subcontractors resulting from higher demand. Total company pro forma gross margin on net revenues was 39% in the third quarter, up when compared to the prior year of 34.6%. S&BT gross margins on net revenues were 44.3% in the third quarter of 2021, up as compared to 42.4% in the third quarter of the prior year. The margin increase is primarily due to increased revenues partially offset by increased headcount and increased incentive compensation accruals commensurate with improving demand. EEA gross margins on net revenues were 34.9% in the third quarter up as compared to 27.5% in the third quarter of the prior year. The margin increase is primarily due to increased revenues, partially offset by incremental use of subcontractors and increased headcount commensurate with improving demand. International gross margins on net revenues were 41.4%, up as compared to prior year of 48.7%. The pro forma SG&A was $13.6 million or 19.1% of net revenues in the third quarter as compared to $12.7 million or 22% of net revenues in the prior year. The year-over-year absolute dollar increase is primarily due to increased sales commissions and incentive compensation accruals associated with increased company performance. Pro forma EBITDA was $15.1 million or 21.1% of net revenues in the third quarter as compared to $8.2 million or 14.1% of net revenues in the previous year, primarily resulting from increasing revenues. Total company pro forma net income for the third quarter of 2021 totaled $10.7 million or $0.32 per diluted share, which represents a year-over-year increase of 88% in pro forma diluted earnings per share and is above the high end of our guidance range. This compares to pro forma net income of $5.4 million or $0.17 per diluted share in the third quarter of 2020. Pro forma diluted earnings per share in the third quarter is up 19% when compared to the pre-COVID third quarter of 2019. GAAP diluted earnings per share was $0.25 in the third quarter of 2021 as compared to $0.09 in the third quarter of the previous year. The company's cash balances were $52.9 million at the end of the third quarter as compared to $52.5 million at the end of the previous quarter. Net cash provided by operating activities in the quarter was $6.8 million, which was primarily driven by net income adjusted for noncash activity, partially offset by increases in accounts receivable and decreases in accrued expenses and deferred revenues. Our DSO or day sales outstanding at the end of the quarter was 63 days as compared to 59 days at the end of the previous quarter. The company's $45 million credit facility remained unused during the third quarter of 2021. During the quarter, we repurchased 121,000 shares of the company's stock for an average of $18.74 per share at a total cost of approximately $2.3 million. Our remaining stock repurchase authorization at the end of the quarter was $11.5 million. At its most recent meeting, the company's Board of Directors declared the third quarterly dividend of $0.10 per share for shareholders of record on December 17, 2021, and to be paid on December 30, 2021. Before I move to guidance for the fourth quarter, I'd 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 Ted mentioned in his comments, although economic uncertainty from the pandemic continues, the company's current estimates suggest that net revenue for the fourth quarter of 2021 will be in the range of $64.5 million to $66.5 million. We expect year-over-year total revenues to be up 9% to 12%, with all 3 practice areas also up. We estimate pro forma diluted earnings per share in the fourth quarter of 2021 to be in the range of $0.28 to $0.30. We expect pro forma gross margin on net revenues to be approximately 39% to 40%. We expect pro forma SG&A and interest expense for the fourth quarter to be approximately $13.5 million. We expect fourth quarter pro forma EBITDA on net revenues to be in the range of approximately 20% to 21%. We expect cash balances to be down sequentially, primarily due to net vesting activities associated with the expected settlement of outstanding stock appreciation rights, which expire in February of 2022. The company is settling these stock appreciation rates and equity and net vesting to satisfy the related tax obligations will result in the repurchase of approximately 1 million shares and will reduce the company's outstanding weighted average shares by approximately 3% in 2022 and will require approximately $21 million to $23 million of available cash balances. 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 share our thoughts on the near and long-term demand environment and on the growth opportunity it offers our organization. Although the pandemic created unprecedented demand disruption, it also created heightened awareness for digital technology and has resulted in an accelerated demand for digital transformation initiatives. This means that digital innovation in enterprise cloud applications analytics and infrastructure, workflow automation and process mining are dramatically influencing the way businesses compete and deliver their services. Digital transformation is redefining all activities at an accelerated pace, forcing organizations to fundamentally change and adopt these new capabilities in order to remain competitive. We continue to experience increased client engagement and demand for our services. This increased demand is resulting in competition for experienced talent unlike we have seen in a very long time. With that said, we also believe that a new more flexible work-from-home delivery model will evolve, which will enhance our ability to attract and retain resources for our organization. The emerging service delivery model helps us address our more challenging retention issue of our industry, which is the amount of travel required to serve clients. The increasing momentum since the end of Q2 of last year has continued throughout 2021. This positions us well to finish the year and should allow us to return to our target long-term growth and profitability levels. In order to increase our revenues across all of our IP-led offerings, we will continue to invest in our IP platforms and to increase our sales and marketing resources. This will include our IPS service offerings to partners that desire to license our IP and brand permission to bolster their business case development and value selling as well as delivery efforts. We continue to have over 10 such opportunities with formal proposals, pilots launching or in contract negotiations. We also continue to believe these opportunities should further benefit our future results. Strategically, we will focus -- our focus will remain the same, which is to continue to build our brand around our new offerings and capabilities focused on digital transformation around our fully digitized and unmatched IP and benchmarking and best practices intellectual capital platforms. This should allow us to serve clients strategically, increasingly remotely, and whenever possible, continuously. Specifically, we will continue to redefine our global benchmarking leadership through enhancements in Quantum Leap, our digital benchmark Software-as-a-Service solution, this 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 believe there is no comparable platform in the market. We also continue to enhance our digital transformation platform to further differentiate our unique IP and related solution design capabilities allowed us to fully digitize our IP and align proven software configuration and organization solutions to help us drive transformational change. DTP is a core asset to our iPass digital transformation as well as our cloud implementation practices and offerings. As I mentioned on our last call, we have added a 20-minute demo to our Investor Relations page on website so that investors can become more familiar with the capabilities of both of these platforms. 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 add scope, scale and capability with which we can accelerate our growth. As always, let me close by asking our associates to remain safe and thank them for their tireless efforts and always urge them to stay highly focused on our clients and our people, especially in light of the short-term challenges, which we may encounter. 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] Our first question comes from Jeff Martin from Roth Capital Partners.

I hope you're doing well. Ted, I wanted to dive into the IP of the service. Are you -- do you have line of sight for what the benefit could be in 2022 from some of these relationships? It sounds like they continue to mature in advance here.

The answer is yes, we do. And we believe that, as we said when we started and brought on our first client in that the impact of them should be meaningful to our future results.

Okay. Great. And then as you exit the year at double-digit net revenue growth rate, how should we be thinking about 2022 in terms of net revenue growth? Is double-digit growth sustainable? Or are we kind of still thinking in that 5% to 10% organic growth range?

Well, we've always used the 5% to 10% reference. I think we stay with that. We believe we're in a demand environment that should allow us to operate towards the high end of that. Probably the most meaningful information that I could share is that when we look back at our business over the last 4 years and fully exclude the impact of our Oracle on-prem business, we believe that our compounded annual growth rate was, again, towards the high end of that range that we provide. So that's what we're targeting.

Okay. And then I wanted to touch on the EPS or the pro forma EPS in the third quarter here, a $0.03 beat relative to what I think was consensus of $29 million. Is an outsized usually come in $0.01 or so ahead? What were the primary contributing factors to that type -- that size of outperformance in the quarter?

When we look at it, it's obviously we had stronger -- the demand continued at a slightly stronger pace than we expected. So we had pretty strong performance across the group. We also saw the value-added seller activity help us with part of that, if you want to call it, beat for lack of a better term. We're continuing to see more of those SAP-related deals, not in an amount that's anywhere near the one we had in Q2, but at a little higher pace than we've had in the past year. So that helped us a little bit.

Okay. Great. And then last one for me is I missed the first part of the call. I don't know if you already gave this in your prepared remarks, but in terms of your East Coast expansion strategy, particularly with the cloud business, I was curious if you could provide an update there?

Well, as you know, the ones that we targeted, one was acquired and the other one deferred any decision. We continue to look for an opportunity in the East Coast. I think it's worth noting that the -- our Oracle EPM business performed very strongly this quarter. So as I mentioned also in second quarter, even without the acquisition, our pace has picked up across the country, including the East Coast. So the urgency is not quite the same. It does not mean that if we saw -- if we had a group that we thought culturally fit and the value was reasonable to both sides that we would aggressively pursue a transaction like that. I can tell you that we are continuing to look for Oracle related acquisitions, whether or not they end up specifically addressing the East Coast Gap. So we're expanding -- let's put it, we're expanding our scope to make sure that if we see something we really like that culturally fits, it's in an area we believe it's of high growth. We will attempt to acquire it.

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

Thank you, operator. I know that we had a couple of analysts that said that they would have trouble making it tonight. So we'll hope that you will join us next time. But let me thank everyone for participating in our third quarter earnings call, and we look forward to catching up again when we report the fourth quarter and fiscal year. Thank you.

Thank you. That does conclude today's conference. You may disconnect at this time, and thank you for joining.