Hackett Group, Inc. Q3 FY2021 Earnings Call

Welcome to the Hackett Group Third 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.

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 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 our 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 healthcare 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 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 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 improved demand across nearly all of our practice groups. We are encouraged by 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 additional workflow automation and process mining technology providers across all areas of the enterprise. We believe these new and potential relationships are key 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 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. 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 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 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 the total company consultant headcount 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 the 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 days 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 three 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 rights in 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.

Thank you, Rob. As we look ahead, I want to share our insights on the current and future demand landscape and the growth opportunities it presents for our organization. While the pandemic caused significant demand disruptions, it also increased awareness of digital technology and accelerated the need for digital transformation initiatives. This shift is dramatically changing how businesses compete and deliver services, as digital innovation in enterprise cloud applications, analytics and infrastructure, workflow automation, and process mining becomes crucial. Digital transformation is rapidly redefining all activities, prompting organizations to fundamentally adapt and adopt these new capabilities to remain competitive. We are seeing heightened client engagement and demand for our services, which has led to competition for experienced talent that we haven’t witnessed in a long time. We also believe that a flexible work-from-home model will evolve, enhancing our ability to attract and retain talent. This emerging service delivery model helps us tackle retention issues in our industry, particularly regarding the travel required to serve clients. The positive momentum we've seen since the end of Q2 last year has continued into 2021, positioning us well to close the year strong and return to our long-term growth and profitability targets. To boost our revenues in all IP-led offerings, we will keep investing in our IP platforms and expand our sales and marketing resources. This will include our IPS service offerings to partners looking to license our IP and use our brand as they develop their business cases and sales strategies, including delivery efforts. We currently have over 10 such opportunities, with formal proposals, pilots, or contract negotiations in progress, and we believe these will positively impact our future results. Our strategic focus remains the same: to continue strengthening our brand around new offerings and capabilities centered on digital transformation, leveraging our unmatched IP and intellectual capital platforms. This allows us to serve clients strategically, primarily in a remote capacity when possible. Specifically, we will enhance our leadership in global benchmarking through improvements in Quantum Leap, our digital benchmark Software-as-a-Service solution, which enables us to provide more information with significantly less client effort. Clients can also track their transformation initiatives over time using our IP. We believe this platform has no comparable competition in the market. Moreover, we are advancing our digital transformation platform to differentiate our unique IP and solution design capabilities, fully digitizing our IP and aligning verified software configurations and organizational solutions to drive transformational change. DTP is essential to our iPass digital transformation and our cloud implementation offerings. As I mentioned in the last call, we have added a 20-minute demo on our Investor Relations page to familiarize investors with these platforms' capabilities. Finally, while we believe we have the client base and offerings to grow our business, we are also looking for strategic acquisitions and alliances that can leverage our IP and increase our scope, scale, and capabilities to accelerate growth. I'll now close by encouraging our associates to stay safe and thanking them for their hard work, while reminding them to stay focused on our clients and our team during any short-term challenges we may face. That concludes my comments. I'll now turn it over to our operator for the Q&A section of our call.

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. 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, that the impact of them should be meaningful to our future results.

Okay. Great. And then as you exit the year at a 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 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 four 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.

I wanted to discuss the pro forma EPS for the third quarter, which exceeded expectations by $0.03 compared to the consensus of $29 million. It's usually typical to see a $0.01 beat. What were the main factors that contributed to such a significant outperformance this quarter?

When we look at it, it's clear that the demand continued at a slightly stronger pace than we anticipated. As a result, we experienced strong performance across the group. The activity from value-added sellers also contributed to this positive outcome. We are seeing more SAP-related deals, though not at the level we had in Q2, but at a somewhat higher pace than in the past year. This contributed positively to our results.

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 our Oracle EPM business performed very strongly this quarter. So as I mentioned also in the 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 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 our scope to make sure that if we see something we really like that culturally fits, it's in an area we believe is 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.