Hackett Group, Inc. Q4 FY2020 Earnings Call

Welcome to The Hackett Group Fourth Quarter Earnings Conference Call. Your lines have been placed on a listen-only mode until the question-and-answer session. 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 fourth 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. 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 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, 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 that are contained in our SEC filings. At this point, I would like to turn it back over to Ted.

Thank you, Rob, and welcome, everyone, to our fourth quarter earnings call. As we normally do, I will open the call with some overview comments on the quarter, and I will then turn it back over to Rob to comment on detailed operating results, cash flow as well as comment on outlook. We will then review our market and strategy-related comments. After such, we will open it up to Q&A. I would like to start by continuing to acknowledge those dedicated individuals who continue to work nonstop and under very dangerous circumstances to support all of us during this pandemic. I also want to acknowledge our associates and clients that quickly and successfully adapted to the remote delivery requirements around the globe. This quarter is about progress, momentum, and how eagerly we're looking forward to 2021. Let me first start with our quarterly results. Since the end of Q2, we have experienced increased activity through the end of the year, and I am pleased to announce today that our quarterly results exceeded our expectations. This afternoon, we reported net revenues of $59.2 million and pro forma earnings per share of $0.23, which was up 35% sequentially. Net revenues were up 2.5% sequentially on lower available days. But as I said, pro forma EPS was up strongly from our COVID-disrupted Q3 results of the prior year and only $0.01 below the profitability in Q4 of last year, which obviously was not COVID impacted. U.S. sequential revenue growth was led by the continued bounce back of our strategy and Business Transformation Group and the double-digit year-over-year growth of our SAP, Oracle ERP, and OneStream practices. The pandemic has accelerated the deployment of digital technologies to support cloud enablement transformation, which has resulted in the growth in these practices. We are further encouraged that Q4 sales in the U.S. were ahead of prior year's sales for the first time in 12 months. On the international front, Europe was sequentially stable, which is very good news for us. The investments we have made to fully digitize all of our IP and the development of our IP-as-a-service platforms, which include Quantum Leap, our state-of-the-art global benchmarking platform as well as our proprietary Hackett Digital Transformation platform, or DTP, are highly differentiating our offerings and will continue to be important drivers of our growth for many years to come. Additionally, our partnerships with rapidly growing eProcurement, infrastructure and cloud analytics, and other workflow automation providers will also continue to be key to our digital transformation strategy and important future drivers of our growth. On the balance sheet side, our ability to generate strong cash flow from operations has allowed us to continue our dividend, buy back stock and fund acquisitions we identify while continuing to invest in our business. It is important to reiterate how critical it was to start the year with such a strong cash position and no outstanding debt, which has provided us with the ability to properly manage the demand disruption that we faced. 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 strategy and market conditions following Rob's comments.

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 2020 fourth quarter results along with an overview of related key operating statistics. I'll cover an overview of our cash liquidity during the quarter, and I will then conclude with a discussion on our financial outlook for the first quarter of fiscal 2021. For purposes of this call, I will comment separately regarding the financial results of our Strategy and Business Transformation Group for S&BT, 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 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 on 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 and growth trends. During our call today, we will reference certain non-GAAP financial measures, which we believe provides 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. As Ted mentioned, we continued to see an increase in client engagement throughout the quarter, which resulted in a sequential increase in net revenues of 2.5% to $59.2 million and a 7% decrease when compared to the prior year, which was above the high end of our revenue guidance range. The Q4 2020 reimbursable expense ratio on net revenues was 0.1% as compared to 8.4% in the prior year. Net revenues and reimbursable expenses were both affected by the economic disruption of the COVID-19 pandemic as we transition to a remote service delivery model throughout the U.S. and Europe. Net revenues of our S&BT Group were $23.4 million, a sequential increase of 5%, and a decrease of 12% when compared to the same period in the prior year, reflecting the improving demand for enterprise transformation initiatives. Net revenues for our EEA Solutions Group were $30.1 million, an increase of 1% on both the sequential and a year-over-year basis. This was driven by growth from our SAP, OneStream, and Oracle ERP practices offset by declines in our Oracle EPM practice, again, reflecting the broad demand for cloud enterprise applications. Our U.S. operations, which currently represent 90% of our total company net revenues for the fourth quarter, were up 3% on a sequential basis and down 5% when compared to the pre-COVID fourth quarter of the prior year. More importantly, we now believe that we have an opportunity to be flat in the U.S. when compared with the pre-COVID first quarter of 2020, which reflects the continued improvement in client engagement and demand. Net revenues for our International Group were $5.8 million, a decrease of 1% sequentially and a decrease of 22.3% on a year-over-year basis as expected. Total company international net revenues accounted for 10% of total company net revenues as compared to 10% in the prior quarter and 12% in the fourth quarter of the prior year. Our recurring revenues, which include our executive advisory, IP-as-a-service, and AMS groups, accounted for approximately 22% of our total company net revenues and approximately 32% of our total company pre-tax practice contribution in the quarter. Total company pro forma cost of sales, excluding reimbursable expenses, totaled $36.8 million or 62.1% of net revenues in the fourth quarter of 2020 as compared to $37.8 million or 65.4% of net revenues in the prior quarter and $38.6 million or 60.6% of net revenues in the previous year. Total company consultant headcount was 928 at the end of the fourth quarter of 2020 as compared to total company headcount of 923 in the previous quarter and 982 at the end of the fourth quarter of 2019. The year-over-year decrease was primarily as a result of the actions taken in the second quarter of 2020 to reduce our global workforce by approximately 10% in response to the ongoing disruption from the pandemic. Total company pro forma gross margin on net revenues was 37.9%, up sequentially from 34.6% and down as compared to the prior year of 39.4%, primarily driven by the comparison to pre-COVID-19 revenue levels. S&BT gross margins on net revenues was 44.8%, up sequentially from 42.4% and down as compared to the prior year of 48.9%. The year-over-year margin decrease was primarily driven again by the comparison to pre-COVID revenue levels. EEA gross margins on net revenues was 31.7%, up sequentially from 27.5% and down as compared to the prior year of 33.2% as we continue to see improved demand, resulting in improved utilization when compared to pre-COVID levels. International gross margins on net revenues was 42.7%, up sequentially from 40.7% and up as compared to prior year of 30.2%. The margin increase is primarily driven by the staff reduction actions taken over the last year. Pro forma SG&A was $12.5 million or 21.2% of net revenues in the fourth quarter as compared to $12.7 million or 22% of net revenues in the prior quarter and $14.8 million or 23.2% of net revenues in the previous year. The year-over-year absolute dollar increase of $2.2 million was primarily due to decreased travel-related selling and marketing activities due to the move to virtual sales and delivery models resulting from the pandemic. Pro forma EBITDA was $10.8 million or 18.3% of net revenues in the fourth quarter as compared to $8.2 million or 14.1% of net revenues in the prior quarter and $11.2 million or 17.6% from net revenues in the previous year. Total company pro forma net income for the fourth quarter of 2020 totaled $7.4 million or $0.23 per diluted share, which represents a sequential increase of 35% in pro forma diluted earnings per share and is above the high end of our earnings guidance range. This compares to pro forma net income of $7.7 million or $0.24 per diluted share in the fourth quarter of 2019. GAAP diluted earnings per share was $0.03 for the fourth quarter of 2020 as compared to earnings per share of $0.07 in the fourth quarter of the previous year. GAAP results for the fourth quarter of 2020 included a $5.5 million or $0.12 restructuring and asset impairment charge, primarily resulting from the reduction in office space as we have transitioned to a remote operating model. The transition resulted in the impairment of operating lease right-of-use assets, property, equipment, and leasehold improvements and other real estate-related costs. GAAP results for the fourth quarter of 2019 included a $4.5 million or $0.12 restructuring and asset impairment charge, primarily related to severance costs for the reduction of staff taken in Europe and Australia in the prior year. The company's cash balances were $49.5 million at the end of the fourth quarter of 2020 as compared to $43.2 million at the end of the previous quarter. Net cash provided by operating activities in the quarter was $12.9 million, which was primarily driven by net income adjusted for non-cash items and decreases in net accounts receivable. Our DSO or day sales outstanding at the end of the quarter was 54 days as compared to 57 days at the end of the previous quarter. Given our strong cash balances, the company's $45 million credit facility remained unused during the fourth quarter. During the quarter, we repurchased 40,000 shares of the company's stock for an average cost of $11.96 per share or at a total cost of approximately $483,000, including purchases from employees to satisfy income tax withholding triggered by the vesting of restricted shares. Our remaining stock repurchase authorization at the end of the fourth quarter was $4.3 million. In November 2020, the Board declared a quarterly dividend of $0.095 per share, which was paid in December 2020, making this the second dividend that was funded and paid in the fourth quarter. At its most recent meeting, the company's Board of Directors authorized a 5% increase in its annual dividend from $0.38 to $0.40 per share to be paid quarterly and also declared the first quarterly dividend of $0.10 per share for its shareholders of record on March 26, 2021, to be paid on April 8, 2021.

Thank you, Rob. As we look forward, let me share our thoughts on the short-term and long-term demand environment, and on the growth opportunity it offers our organization. It goes without saying that the pandemic created an unprecedented period where demand disruption necessitated ensuring our safety, which required extreme measures, but it is now clearly evident that the digital transformation era has also been rapidly accelerated by the pandemic, which will further improve what we believe are the long-term prospects for our business. This means that digital innovation and emerging enterprise cloud applications, analytics and infrastructure, workflow automation, process mining, and artificial intelligence, which 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. On the demand side, the short-term environment continues to improve as our clients now understand they must continue to transform and that the virus will continue to disrupt our lives until the vaccine and herd immunity are able to protect all of us. This means all organizations must adapt to this new normal while we sort through the changes that will result from the pandemic. Broadly speaking, we believe the acceleration means demand improvement, and on the expense side, the virtual delivery and sales model reduces our overall delivery cost, both should benefit future results. Specifically, the increasing momentum we experienced in Q4 is continuing into the new year as our clients and our sales and service delivery model acclimate to this next normal market requirement. This should position us well in 2021 and should allow us to return to pre-pandemic levels of target growth and profitability. Additionally, we continue to see an increase in interest from potential partners that desire to license our IP and brand permission to our Quantum Leap and digital transformation platforms to bolster their business case development and value selling efforts. We have over 10 opportunities with more than half of them now with formal proposals, near-term pilots launching, or in contract discussions. Strategically, our focus will remain the same, which is to continue to build our brand with our new offerings and capabilities focused on digital transformation around our fully digitized and unmatched IP, benchmarking, and best practice intellectual capital platforms. This should allow us to serve our clients strategically, increasingly remotely, and whenever possible, continuously. Specifically, we 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 our clients to leverage our IP and track transformation initiatives over the life of their respective efforts. We believe there is no comparable platform in the market. As I have previously mentioned, we have been experiencing increased interest from potential strategic partners in leveraging our platforms and IP. We also continue to refine and improve our digital transformation platform to further differentiate our unique IP and related solution design capabilities. DTP allowed us to fully digitize our IP and align proven software configuration and organizational solutions to help clients drive transformational change. DTP is a core asset of our digital transformation and cloud applications implementation offerings. As I mentioned on our last call, we have added a 20-minute demo to our Investor Relations page on our website so that investors can become more familiar with the capabilities of both of these market-leading platforms. Lastly, even though we believe we have the client base and the offerings to grow our business, we continue to actively look for acquisitions and pursue these strategic alliances that will leverage our IP at scope and scale and capability which can then accelerate our growth. In summary, we continue to believe we are well positioned to resume our growth as the demand disruption subsides. We're also encouraged to see the power of our brand and the focus of our offerings along with our sound financial position allow us to positively address the most challenging economic events such as the ones we have faced almost this entire year. This validates our focus and the investments we are making. As always, let me close by thanking our associates by asking them to remain safe for their tireless efforts and always urge them to stay highly focused on our clients and our people regardless of the short-term challenges we encounter. I think it's really easy to look at our overall results and see that we're down obviously meaningfully on a year-over-year basis and just ignore the fact that it has taken an extraordinary effort from the entire organization to maintain and transition as flawlessly as I believe we have, allowing us to exit the year with such momentum and a terrific balance sheet, and also look at the cash flow generation capabilities of the organization, even through these difficult times. Those conclude my comments, let me turn it over to our operator, and let's move into the Q&A section of our call.

The first question in the queue is from George Sutton with Craig-Hallum.

Nice results. Ted, you talked about, on one side, acceleration going into the year due to demand improvement. On the other hand, you talked about your sales model being more efficient in this new environment. Can you put a little bit more meat on both of those components?

The pandemic has undeniably pushed organizations to evaluate their use of digital transformation technology. This has accelerated the already significant demand we were seeing as we entered 2020. Consequently, the necessity for clients to consider changes and engage with companies like ours is only expected to grow. However, we still experience some disruption due to vaccine concerns and safety issues for our associates and communities. It's important to remember that this situation has prompted further acceleration, which I believe is influencing economic activity and stock market trends, even as we continue to face challenges due to ongoing shutdowns. I'm currently in an office that typically houses 35 to 40 people, yet only 4 or 5 of us are present, and the building feels quite empty. I doubt this will be the case for the remainder of 2021. In parallel, client engagement and discussions about how to leverage emerging technology are on the rise. On the other hand, we've adapted our sales and delivery models to remote virtual capabilities. People often inquire about our most significant achievement of 2020, and for me, it's how well everyone has adapted to remote work under the constraints we have encountered in both our personal and professional lives. Consulting and technology deployment usually require close interactions with clients, often in person with senior executives. The fact that this activity is still happening at high levels gives me confidence regarding our future opportunities. Despite improvements in demand, it's important to note that clients typically allocate between 8% and 15% of their budgets to travel and other engagement expenses; however, these costs have now dropped to nearly 1%, which is astounding. Nevertheless, we are still able to serve and engage our clients effectively. This shift means that everyone has become more comfortable conducting meetings and executing work virtually, which has implications for our business. Demand for digital solutions will likely continue to grow at a rapid pace, and as our delivery models remain predominantly virtual, this offers significant operating advantages. Additionally, for a company like ours that heavily relies on intellectual property and insights, success isn't just about the number of people we deploy; it’s about the quality of our ideas, which are increasingly supported by our unique benchmarking capabilities. In this virtual environment, it feels like we are larger, and our size is less critical. I believe these factors will positively impact our business moving forward.

So Barron's had a wonderful article on Oracle, talking about how they're making the shift very effectively to the cloud. You're obviously very well aligned with Oracle. I wondered if you could talk about the progress that you're seeing in terms of that specific relationship? And then any other thoughts on other partners, folks like SAPs and Coupas and OneStreams?

That Oracle article highlights two key aspects. Firstly, it discusses how Oracle is attempting to compete more aggressively with cloud infrastructure providers like AWS, Microsoft Azure, Google, HyVM, and themselves. They believe this is a substantial market and intend to participate and compete more robustly. Secondly, this relates to how applications are supported and efficiently deployed and maintained after customization for clients. Currently, 95% of our pipeline is cloud-based, indicating a decline in work related to on-premise engagements. This signifies a major transition for us, allowing us to promote our new cloud application offerings to clients, many of whom have yet to fully migrate from their on-premise setups. We view this as a positive development. The activity in the NASDAQ, along with tech companies like Oracle competing in these dynamic areas, bodes well for them and for us as well.

Next question in the queue is from Jeff Martin with ROTH Capital Partners.

A question for Rob, I guess, or Ted, you can comment on it as well. But relative to your guidance for Q4, you beat the high end of it by a couple of million. I was wondering if there were any specific drivers of that, things came in better-than-expected, trends developing more quickly than you thought? Some insight there would be helpful.

The main factor behind our strong performance was the strength of several application groups. The SAP Group, particularly the S/4 HANA cloud product in the healthcare market we target, performed exceptionally well. Additionally, the Oracle ERP segment also exceeded expectations. Our OneStream Group continued to show significant growth, although from a smaller base. Moreover, the transformation initiatives we mentioned earlier were supported by technology advancements. This positive trend was evident in both the EEA side of the business and contributed to our strategy and business transformation efforts.

Okay. And then wanted to get some insight on the digital transformation acceleration, essentially a lot of spend being pulled forward. How does that flow through to Hackett? Is there a long lead time with that? Do you expect that to eventually bring the business in and of itself back to organic growth relative to kind of the levels you were doing in 2019, the comparisons, obviously, in Q2, Q3 of last year, not all that relevant?

The greatest acceleration, Jeff, as you know, happened from the work-from-home and virtual increases that were immediately necessary to continue to conduct business. So you saw the infrastructure-as-a-service companies like AWS, Microsoft, Oracle, and others benefit from that activity. You saw that also in anything that dealt with the execution side. So the Zooms and Teams products exploded throughout the use. And then you then saw that then follow into the application environment. But if you said what was pulled forward in my mind, what was pulled forward was the infrastructure side of the business that had to be put in place to facilitate the virtual operations of all of these businesses, which was necessitated basically within weeks. I don't believe that on the application side, there was much pull forward. I do believe, though, that it should follow. It should follow the significant investments in infrastructure should be followed by the enterprise app space continuing to be, I'll call it, not only strong but improving. Because I still think that the work from home and some of the distractions it creates did prevent some of that natural activity from happening. So I do believe that the pull forward was infrastructure related; I believe that on the enterprise apps and on organizational change-related, which is core to our business. There wasn't pull forward. I would say that there was some disruption, but that you should see that accelerated activity now follow in '21 as the pandemic subsides.

Okay. Great. And then last question, I didn't catch it if you gave it, but did you give an Oracle Cloud growth number for the quarter? And then could you also comment on average deal size and maybe average deal size within the pipeline?

We did not provide details on Oracle Cloud growth. However, we mentioned that Oracle ERP was performing strongly, while our EPM was experiencing a decline. The current ratio of ERP to EPM on the Oracle side is likely around 55 to 60 compared to 40 to 45 for ERP. What we're observing in Oracle is that the multi-tenant deals are driving the growth. The main factor contributing to Oracle's success is ERP. We still aim to enhance that capability on the East Coast, and we are exploring several options that we anticipate will be available to us in 2021.

Okay. And then what about comment on average deal size?

Oh, do you have something, Rob?

It depends on this particular...

Yes, there hasn't been any significant change. We are clearly seeing larger multi-tenant deals. Overall, we've had some large clients progressing with ERP, EPM, and HCM deals, which are definitely larger than what we experienced a year ago when we approached the market with those offerings separately. The multi-tenant deals are helping to increase the deal sizes. I don’t have a detailed list right now, but I can provide that later.

Next question is from Vincent Colicchio with Barrington Research.

I know your Oracle backlog was run down pretty much. You are in the process of rebuilding that, Ted. You had a decent Oracle quarter. Where do we stand now at the end of the quarter?

Significant pipeline activity. As I just told Jeff, with ERP continuing to take the lion's share now and EPM still underperforming. So we have ERP overperforming, EPM underperforming because the standalone EPM deals that we would traditionally have simply aren't there; you're just seeing the combination of deals being together. Our success becomes increasingly dependent on broadening out our ERP capability.

And then the U.S. outlook is flat for Q1. Curious if you could give us some differentiation between SBT and EEA?

Rob, why don't you...?

We said that S&BT...

They're both expected to be up.

Internationally, yes.

That will allow us to be flat. Therefore, if we're flat and our service delivery model is more efficient, that provides the opportunity for us to exceed last year's results in Q1.

I'm sorry. So they're both expected to be up, you said?

Both expected to be up with Europe down.

Correct.

Ted, what gives you the confidence that the business will improve as we progress through the year? Is it based on the nature of your conversations, the types of discussions you are having, and the opportunities you see in the pipeline?

Yes, client activity, which is pipeline as well as just a number of conversations and the way clients are engaging in a broader sense. Even some of the industries that have been hardest hit are reengaging; that to me is a very positive sign. So it's really just activity that we're experiencing along with a more efficient delivery model. Both of those things really allowed us to think 2021's prospects are that we could return to long-term growth and profitability, long-term targets, as I mentioned in my opening comments.

So the overall spend was broader this quarter. Would you say that was in both SBT and EEA?

Yes. Absolutely. When we said the total activity in the U.S. was up versus a year ago, and that's the first time in 12 months, that was across both groups, yes.

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

Thank you, operator. Let me thank everyone for participating in our fourth quarter earnings call, and I look forward to updating you again when we report the first quarter.

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