Hackett Group, Inc. Q2 FY2021 Earnings Call

Welcome to the Hackett Group Second Quarter Earnings Conference Call. 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 second quarter results. Speaking on the call today and here to answer your questions are Ted Fernandez, Chairman and CEO of the Hackett Group and myself, 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 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, 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 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. 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 strategy and related comments, after which we will open it up to Q&A. Given the recent rise in Delta variant infections, I would like to continue to acknowledge those dedicated healthcare providers who continue to work nonstop and selflessly to support us all during this pandemic. Consistent with our comments since the end of the second quarter of last year, we continued to experience increased client engagement and demand for our services throughout the quarter. It is evident that organizations have recognized the need to embrace digital transformation as a requirement to remain competitive. Correspondingly, this afternoon, we reported net revenues of $73 million and pro forma earnings per share of $0.39, both in excess of guidance. Of note is a $5.3 million SAP software sale transaction, which also increased our pro forma EPS by $0.09. Excluding this software sale, our net revenues exceeded the high end of our guidance and were up a strong 7% sequentially and up 29% when compared to the COVID-impacted second quarter of last year. The results are consistent with the strong demand recovery we have been experiencing since the end of the second quarter of last year. It is also important to note that we are now operating above pre-pandemic revenue and profitability levels. U.S. sequential revenue growth, excluding the software sale, was up 7% sequentially and up 28% when compared to the second quarter of last year. The results were driven by the continued recovery of our S&BT group, our strategy and business transformation group, and 10% sequential growth in our EEA group, excluding the impact of the SAP software sale. All groups within EEA were up sequentially. Of special note was the sequential improvement we experienced in our Oracle EPM practice. As many of you know, this group has adversely impacted our year-over-year growth over the last several years as we transitioned that group from on-prem to cloud implementations. We believe that our Oracle on-prem to cloud transition is now behind us, which should result in improving revenue growth for our organization. Just to put that transition in perspective, we have lost an excess of $60 million in Oracle on-prem revenue and replaced it with a much broader base of Oracle Cloud ERP and EPM revenues and with a rapidly growing OneStream business. I would be remiss if I didn’t also comment on the strong performance of our SAP group, which again, we can attribute to that $5.3 million transaction as a result of the incredible expertise they have in life sciences and specifically in pharma and biotech, which allowed that transaction to be facilitated and realized by our organization. The pandemic has accelerated the deployment of digital technologies to support cloud-enabled transformation, which has resulted in the growth in these practices. We’re also further encouraged with the increasing activity in the U.S. and with the sequential growth that we experienced in Europe during the second quarter. The investments we have made to fully digitize all of our IP and the development of our ideas as a service platforms: Quantum Leap, our state-of-the-art global benchmarking platform and our proprietary Digital Transformation Platform, or DTP, are highly differentiating our offerings and continue to be important drivers of our long-term growth. Additionally, as I mentioned last quarter, our partnerships with rapidly growing e-procurement, EPM, and cloud and workflow automation providers also continue to be key in our digital transformation strategy and are important future drivers of growth as well. On the balance sheet side, our ability to generate strong cash flow from operations has allowed us to increase our dividend and our buyback program. We also continue to have strong cash balances and a 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.

Thank you, Ted. I’ll cover several topics during this part of the call, including a summary of our second quarter results for 2021, key operating statistics, an overview of cash flow activities for the quarter, and our financial outlook for the third quarter of 2021. I will provide separate commentary regarding the financial results from our strategy and business transformation group, our ERP, EPM, and Analytics solution group, our international group, and the overall company. The strategy and business transformation group includes results from our North America IP-as-a-service offerings, executive advisory programs, benchmarking services, and business transformation practices. The ERP, EPM, and Analytics solutions group covers results from our North America Oracle, SAP, and OneStream practices. The international group’s results are based primarily in Europe. Please note that all references to net revenues translate to revenues without reimbursable expenses, which are mostly related to project travel costs passed on to clients and do not affect our margins or profitability. Given the lack of business travel during the pandemic, we suggest investors focus on net revenues to evaluate revenue growth and margin trends. We will mention some non-GAAP financial measures that we believe provide valuable insights to investors, and we included reconciliations of GAAP and non-GAAP measures in our earlier press release. My comments will focus on outcomes from continuing operations. For the second quarter of 2021, our net revenues rose to $73 million, representing a 15% increase compared to the previous quarter and a 39% increase year over year, which exceeds the high end of our revenue guidance. This growth includes a software sales transaction worth $5.3 million. Excluding that transaction, our net revenues were $67.7 million, an increase of 7% quarter over quarter and 29% year over year, driven by increased client engagement throughout the quarter. The reimbursable expense ratio for the second quarter was 0.3%, compared to 0.1% the previous quarter and 0.2% the same time last year. These expenses have significantly decreased due to COVID-19, which led to a shift to remote service delivery. Our U.S. operations, which accounted for 92% of our total net revenues in the second quarter, saw a 16% sequential increase and a 39% increase compared to the second quarter of the prior year. Excluding the software sales transaction, total U.S. revenues were up 7% sequentially and 28% year over year. Net revenues for our strategy and business transformation group were $26.4 million, a sequential increase of 3% and a 51% increase year over year, indicating strong demand for enterprise transformation. For the ERP, EPM, and Analytics solutions group, net revenues were $40.5 million, a 26% sequential rise and a 32% increase compared to the previous year. Excluding the software sales transaction, EEA revenues were up 10% sequentially and 15% year over year, driven by growth in our OneStream, Oracle, and SAP practices. Our international group net revenues reached $6 million, with a 9% sequential increase and a 36% year-over-year increase. International revenues accounted for 8% of total company net revenues, a slight decrease from 9% in the prior quarter and matching 8% from the second quarter last year. Recurring revenues, excluding the SAP transaction, were around 19% of total net revenues, contributing approximately 22% to company-wide practices in the quarter. The pro forma cost of sales, excluding reimbursable expenses, was $41.4 million, comprising 56.8% of net revenues in the second quarter, down from $39.3 million or 62% in the previous quarter and $38.7 million or 73.4% in the previous year. Total company consultant headcount stood at 1,001 by the end of the quarter, compared to 943 in the previous quarter and 908 at the end of the second quarter last year. This year-over-year growth was largely due to increased hiring and greater utilization of subcontractors due to rising demand. The gross margin on net revenues for the total company was 43.2% in the second quarter, improving from 38% sequentially and from 26.6% a year ago. Excluding the SAP software transaction, our gross margin was 38.9%. The strategy and business transformation gross margins were 45.3%, slightly down from 46.5% sequentially and significantly up from 25.3%. The sequential decline is mainly due to higher incentive compensation linked to better performance. The EEA gross margins were 42% in the second quarter, up from 31.2% sequentially and from 30.4% the same period last year. This increase reflects both the software sales transaction and improved revenue growth, while EEA margins excluding the transaction were 33.5%. International gross margins stood at 42.2%, increasing sequentially from 38.2% and from 5.1% year-over-year, largely due to the noted increase in revenues. Pro forma SG&A was $14.4 million or 19.7% of net revenues, up from $12.4 million or 19.5% in the prior quarter and from $11.4 million or 21.7% in the previous year. The absolute dollar increases for both sequential and year-over-year figures were primarily driven by increased sales commissions and incentive compensation due to better company performance. Our pro forma EBITDA was $18 million or 24.6% of net revenues, compared to $12.6 million or 19.8% in the prior quarter and $3.4 million or 6.6% from the previous year. Excluding the software sales transaction, EBITDA was $13.9 million or 20.5% of net revenues. The total pro forma net income for the second quarter of 2021 was $0.39 per diluted share, showing a 44% sequential increase, exceeding the upper range of our earnings guidance. Excluding the software sales transaction, earnings per share were $0.30, compared to $1.9 million or $0.06 per diluted share in the second quarter of 2020. GAAP diluted earnings per share for the second quarter was $0.32, compared to $0.19 in the first quarter and a net loss of $0.13 a year prior. The prior year's GAAP results accounted for a $5 million or $0.13 per share restructuring expense related to staff reductions in the U.S. and Europe. The company's cash balances were $52.5 million at the end of the quarter, up from $51.1 million in the previous quarter. Net cash from operating activities was $13.8 million, largely due to net income adjusted for non-cash items and an increase in accrued expenses, somewhat offset by rising accounts receivable. Our days sales outstanding at the end of the quarter was 59 days, compared to 55 days at the end of the previous quarter and 64 days in the second quarter of the prior year. Our $45 million credit facility remained unused during this quarter. We repurchased 491,000 shares of our stock for an average price of $17.58, totaling approximately $8.6 million. The remaining authorization for stock buyback at the end of the quarter was $13.6 million. At its recent meeting, the board declared the third quarterly dividend of 2021 at $0.10 per share for shareholders on record as of September 24, to be paid out on October 8, 2021. Now, I will discuss our outlook for the third quarter. We expect that the seasonal trends typical of the third quarter will negatively affect available working days by approximately 3% sequentially due to additional U.S. holidays and increased time off during the summer, especially in Europe. As Ted indicated, economic uncertainties related to the pandemic persist. We currently estimate that net revenue for the third quarter of 2021 will range from $66 million to $68 million, excluding the previously mentioned software sales transaction. We anticipate flat to upward movement in EEA revenues, an increase in S&BT revenues, and a decrease in international revenues. We expect diluted earnings per share for the third quarter to be between $0.28 and $0.30, with pro forma gross margin on net revenues projected at around 39% to 40%. We also anticipate pro forma SG&A and interest expenses to be approximately $13.7 million. Our forecast for third quarter pro forma EBITDA on net revenues is likely to be in the range of 19% to 20%. We expect cash balances, aside from share buybacks, to remain stable or increase slightly due to anticipated U.S. federal tax payments during the quarter. I will now turn it back 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 short and long-term demand environment and on the growth opportunity it offers our organization. Although the pandemic created unprecedented demand disruption, it is now clearly evident that it has also created heightened awareness and has accelerated demand for digital transformation initiatives. This means that digital innovation and enterprise cloud applications, analytics, 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. Consistent with our comments since the end of Q1, during the second quarter, 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 most challenging retention issue in our industry has always been the amount of travel required to serve clients. Specifically, the increasing momentum since the end of Q2 last year has continued into 2021. This has positioned us well for the balance of the year and should allow us to return to our target long-term growth and profitability levels. In addition to improved digital transformation demand, we continue to see an increase in interest from potential partners that desire to license our IP and brand permission and leverage our Quantum Leap and digital transformation platforms to bolster their business case development and value selling, as well as their delivery efforts. We closed a meaningful relationship during the quarter and have plans to launch additional pilots this quarter. We also continue to have over 10 opportunities, several of which have formal proposals, near-term pilots launching, or are in contract negotiations. We believe the newly signed and in-process opportunities should further benefit our 2021 results. 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 fully digitized and unmatched IP and benchmarking and best practices intellectual capital platforms that should allow us to serve clients strategically, increasingly, remotely, and whenever possible, continuously. Specifically, we will continue our global benchmarking leadership to enhance those in Quantum Leap. Our digital benchmarking Software-as-a-Service solution allows us to deliver more information with significantly less client effort. It also allows clients to leverage our IP and track 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. DTP allows 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 IPaaS digital transformation and cloud application implementation offerings. As I mentioned on our last call, we have added a 20-minute demo to our investor relations page of our website so that investors can become more familiar with the capabilities of our 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 in that scope, scale, or capability, which can accelerate our growth. We are also encouraged to see the power of our brand and the focus of our offerings along with our sound financial position, allow us to serve the world’s largest organizations as well as manage the most challenging macroeconomic events. As always, let me close by asking our associates to remain safe and to thank them for their tireless efforts and always urging them to stay highly focused on our clients and people, especially in light of the short-term challenges that we may continue to encounter. That concludes my comments. Let me then turn it over to our Operator and let’s move on to the Q&A section of our call.

Your first question in the queue is from George Sutton with Craig-Hallum. Your line is now open.

Thank you. This is Adam on for George. Ted, great to hear about the closing of the first IP customer, I was hoping you could provide a little more detail on how that deal came to be and what you expected to become in the future?

Well, without providing too many details that haven’t been publicly disclosed by the client, simply to say that it’s taking us into a new area. I had a client in the infrastructure space that believes that the brand permissions and the performance data that they will utilize to go to market with will significantly enhance their ability to close deals at an accelerated pace. So for us, it's a great new opportunity, incredible brand, and really enhances our data capture reach in entirely different areas. So very meaningful in different ways.

And then one follow-up for me, you also mentioned at the beginning of the call how companies are beginning to really recognize the need for digital transformation. Any thoughts or insight you could offer, just specifically what you’re hearing from clients and how do you think the opportunity set has changed for the Hackett Group when you compare it to before the pandemic?

Without a doubt, the clients are aggressively engaging in conversations on what is the best path for them to prioritize their digital transformation efforts that allows us to engage clients then in evaluating those opportunities, sizing the performance improvement opportunities that would come from those initiatives as well as then implementing, helping them implement them, if our scale and capability fits. So we look at our clients and we see just how engaged they are, how broad the questions are, how they’re prioritizing and funding these initiatives. We just see that – we see it moving, we see velocity, we see decision-making engagement, all of it at an incredibly high level.

Next question in the queue is from Vincent Colicchio with Barrington Research. Your line is now open.

Yes. And just to follow up on what you just said, Ted. So are you seeing sales cycles improved versus last quarter?

Well, when you look at 7% sequential, excluding that large software transaction, the answer is no; we were happy just to have them right where they’re at. In fact, to some extent, the demand is outstripping resource capability. So for the first time, as long as I can remember, having the resources are in place are as important as having capability and credibility in those capabilities.

You mentioned the tight labor market, the incremental increase in headcount this quarter. Were those wages up versus what you had to pay in recent quarters?

The answer is the wages are increasing. And in fact, for us going into the third quarter, since we have some movements, if you recall, from what we did in 2020, we actually have compensation increases kicking in this quarter which were planned. But I think they’re also responsive to the market conditions.

And Rob, in terms of the guidance, I think you said that excluding the SAP sale, you expect EEA revenue to be flat to up. Can you give me a little more color on where the strength is and where the drag is?

Look, it’s across the board. It’s across the board, Vince. And it comes back to how do you build on – in their case, let’s go back 10% sequential increase. So when you consider that we’re coming off a 10% sequential increase, you lose 3% available days in the quarter. Sequential increase in EEA would be pretty strong for us.

And then lastly, any color on the international? It finally started growing. Now it’s down again; do you have any color on what’s going on there?

A small number now.

Well, it’s 8% of our revenues, but that doesn’t mean it’s not something we expect to grow. I think they’re still experiencing more volatility than we have in the U.S., both in the impact of the pandemic as well as their ability and willingness to put in some of the actions to support some of the recovery-related issues. So I think it just results in more volatility. I think it’s also impacted by the fact that our scale is smaller. So we’re relying on fewer clients and fewer people and limited offerings given the size as it compares to the U.S. I mean, when you look at the growth in the U.S. – year-on-year in the U.S. in the second quarter, I mean, those are just – we haven’t seen numbers like that in a long time. And that’s the growth excluding the large software deal.

One more, if I may. Please remind us, what’s your long-term target growth goal? I haven’t heard that number in a while.

Never changed it. 5% to 10% top line results and 15% to 20-plus percent bottom line growth.

Thank you. Nice quarter.

Thank you, Vince.

Next question in the queue is from Jeff Martin with Roth Capital Partners. Your line is now open.

Thanks. Hi, Rob. Hi, Ted. I apologize for getting on the call a little bit late. I did come on right at the end of your prepared remarks. So I apologize if this is repetitive. But could you give us an update on the efforts to establish an East Coast presence?

They continue. As I mentioned last quarter, we were aggressively pursuing a couple of acquisitions, one which differed and one which went to another party. We continue to talk to the organizations to see if we can find both cultural and strategic fit with that geographic location. So the efforts continue. And I guess, I’ll leave it at that. I don’t know if you have something more specific than that, Jeff.

No. That’s helpful. And then you mentioned last quarter that EPM seeing an increased demand sequentially in Q2. I was curious how that flowed through the balance of the quarter and what you’re seeing so far in the third quarter there?

Well, I mean that’s an important follow-on to the other question, because if you recall, the primary reason for that East Coast acquisition target was to strengthen the combination ERP, EPM capabilities in the East Coast, which we thought we were not leveraging anywhere near the capability that we have. With that said, we did see nice sequential growth in that group, including the East Coast part of the business in Q2. And we are expecting those groups to grow sequentially from Q2 to Q3 in spite of the 3% available days loss from Q2 to Q3.

Right. Okay. And then with respect to your partners on the non-Oracle side, I’m curious if you could give us an update there? Are we nearing critical mass with some of the newer technology implementers out there that you might start to score separately?

Well, in some of them, like OneStream, we clearly are approaching critical mass, and we’ve become one of the leading OneStream implementers globally for that organization. So there we are in the Coupa space; we are leading there. Now in some of the other areas that we’re now exploring, some of the workflow automations that relate to ServiceNow or Microsoft, they are very early stages.

Okay. That’s helpful. Thanks, Ted.

Thanks, Jeff.

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

Well, again, let me thank everyone for participating in our second quarter call and look forward to updating everyone again when we report the third quarter. Thank you for participating.

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