Hackett Group, Inc. Q1 FY2023 Earnings Call

Welcome to the Hackett Group First 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 first quarter 2023 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 4:24 PM 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 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. 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 first quarter earnings call. As we normally do, I will open the call with some overview comments on the quarter. I will then turn it back over to Rob to comment on detailed operating results, cash flow as well as comment on outlook. We will then review our market and strategy-related comments, after which we will open it up to Q&A. Before I move to our quarterly results, let me start by mentioning our 2022 results and the comps that they will provide to our 2023 performance. In 2022, we had a very strong first half of the year with operating results exceeding our guidance in Q1 and Q2 by $0.03 in each quarter of that prior year. By the middle of the year, the impact of Fed interest rate increases started to disrupt economic growth and resulted in extended client decision-making. Also, to our first quarter, this afternoon, we reported total revenues of $69.8 million and adjusted earnings per share of $0.37, both at the midpoint of our quarterly guidance range. Broadly speaking, the economic volatility is evident, but some of the demand for digital transformation solutions required to remain competitive and drive productivity improvements for our clients. As the quarter progressed, we saw clients increasingly moving forward with significant engagements, which should allow us to be up sequentially from Q1 to Q2. This was most pronounced in the swift turnaround of our Oracle Solutions Segment. Our quarterly results continue to be driven by the global SBT segment, which was down slightly on a reported basis and down 1% on a local currency basis. Our recurring higher-margin research advisory and IPaaS offering revenue continue to grow and we continue to expect the annual contract value for these offerings to grow over 20% in 2023. The quarter benefited from the growth of our IPaaS revenues and we continue to add new pilot participants as we exited the quarter. We also continue to engage with large software and service companies to help them bolster their value selling and value realization efforts. During the quarter, we launched our second and third market intelligence programs and we plan to launch additional programs throughout 2023. These programs allow us to compare the capabilities of software and services providers, which is valuable to our large Hackett benchmarking and consulting end-user client base considering procuring these capabilities. The programs also allow us to work with the solution providers to strategically support their sales and marketing efforts. We have also continued to add new content and IP to our existing functionally focused executive advisory programs, improvements in our existing programs, along with the new market intelligence programs, the launch of our new member platform, Hackett Connect along with our aggressive sales hiring should allow us to continue to grow our higher-margin recurring revenues and related annual contract value throughout the year. The Oracle Solutions Segment was down 22% as expected this quarter. However, we are pleased to say we have a number of significant contract wins in the latter part of the quarter, which will more than offset the large project loss that we experienced at the end of Q4. This will allow the segment to be up strongly from Q1 and into Q2. This was an exceptional response by the team through its year-end challenge and has accelerated the return to growth, which is now expected by Q3 of this year. Our SAP Solutions Segment delivered as expected with flat revenues before reimbursements and improved segment profits. We expect that segment to be up sequentially as well as on a year-over-year basis in the second quarter. The investments we have made to fully digitize our IP and the development of our digital platforms, which include Quantum Leap, our state-of-the-art global benchmarking platform and our proprietary Hackett and Digital Transformation Platform, or DTP, are starting to pay off. These platforms are allowing us to highly differentiate all of our offerings and also develop new licensing research relationships with the software and services providers across the enterprise. We also expect to launch our Hackett Connect platform in Q2, which will significantly improve our research and IPaaS member clients' ability to avail themselves all Hackett IP as well as the virtual expertise which supports those programs. On the balance sheet side, in our first quarter, we funded our previous year's annual performance bonuses, bought back shares to fund investing, and funded our prior quarter's dividend. For the balance of the year, you should expect to see us continue to pay down our credit facility. As we have discussed on our last few calls, we want to be more aggressive with our balance sheet by using our current credit facility to fund acquisitions and buy back stock 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. Rob?

Thank you, Ted. As I typically do during this portion of the call, I'll cover the following topics: an overview of our 2023 first quarter results along with an overview of related key operating statistics, an overview of our cash flow activities in the quarter, and I'll then conclude with a discussion on our financial outlook for the second quarter of 2023. For the purpose of this call, I will comment separately regarding the revenues of our global S&BT segment, our Oracle Solutions Segment, our SAP Solutions Segment and the total company. Our global S&BT segment includes the results of our North America and international IP as a Service offerings, our research advisory programs, our benchmarking services, our business transformation, and our onstream offerings. Our Oracle Solutions and our SAP Solutions segments include the results of our Oracle and SAP offerings respectively. Please note that we will be referencing both total revenues and revenue before reimbursements in our discussions. Reimbursable expenses are primarily project travel-related expenses passed through to our clients and have no associated effect from our profitability. During our call today, we will also reference certain non-GAAP financial measures, which we believe provide useful information to investors. We have included reconciliations of GAAP to non-GAAP financial measures in our press release filed earlier today and will post any additional information based on the discussions from this call to the Investor Relations page of the Company's website. For the first quarter of 2023, our revenue was $71.2 million. Our revenues before reimbursements were $69.8 million, which was in line with our quarterly guidance. As we discussed last quarter, during the first half of fiscal 2022, we experienced stronger-than-expected post COVID pent-up demand that drove strong results in the prior year. The Q1 2023 reimbursable expense ratio on revenues before reimbursements was 2% as compared to 1.9% in the prior quarter and 0.7% when compared to the same period in the prior year. Post COVID, we have experienced increased client-related travel. However, given the market's transition to a remote delivery model, we do not expect these project-related travel expenses to return to pre-COVID levels. Total revenues from our global S&BT segment were $42.3 million for the first quarter of 2023. Revenues before reimbursements for our global S&BT segment were $41.7 million for the first quarter of 2023, a decrease of 1.7% when compared to the same period in the prior year, but down 1% on a local currency basis utilizing the same foreign currency rates in Q1 of the prior year. Total revenues from our Oracle Solutions Segment were $17.2 million for the first quarter of 2023. Revenues before reimbursements for Oracle Solutions Segment were $16.7 million for the first quarter, a decrease of 22% when compared to the same period in the prior year as we expected and as we guided per our last quarter. Oracle Solutions was coming off of solid 2022 results and was rebuilding its pipeline in light of unfavorable macroeconomic conditions as we entered the first quarter. However, given a number of significant engagements, which closed towards the end of the first quarter, we now expect Oracle will be up strongly on a sequential basis as we move into Q2. Total revenues from our SAP Solutions Segment were $11.7 million for the first quarter of 2023. Revenues before reimbursements for our SAP Solutions Segment were $11.5 million for the first quarter, an increase of 1.3% when compared to the same period in the prior year. Approximately 23% of our total company revenues for reimbursements consist of recurring multiyear and subscription-based revenues, which include our research advisory, IP as a service, multiyear benchmarks and application managed services contracts. Total company adjusted cost of sales, which exclude reimbursable expenses and noncash stock-based compensation expense totaled $41.6 million or 59.6% of revenues before reimbursements in the first quarter of 2023 as compared to $45.7 million or 60.8% of revenue before reimbursements in the prior year. Total company consultant headcount was 1,101 at the end of the first quarter as compared to a total company consultant headcount of 1,120 in the previous quarter and 1,141 at the end of the first quarter of 2022. Total company adjusted gross margin on revenues before reimbursements, which excludes reimbursable expenses and noncash stock-based compensation expense was 40.4% in the first quarter of 2023 as compared to 39.2% in the prior year period. The 120 basis point gross margin improvement was primarily driven by the relative mix of higher-margin global S&BT segment revenues. Adjusted SG&A, which excludes noncash stock-based compensation expense and intangible asset amortization was $14.5 million or 20.8% of revenues before reimbursements in the first quarter of 2023. This compares to $13.3 million or 17.7% of revenues before reimbursements in the prior year. The year-over-year absolute dollar increase is primarily due to incremental investments we are making in program development and dedicated sales resources for our benchmarking, executive advisory, market intelligence, and our IP service offerings. These investments approximated $0.03 in the first quarter of 2023. Adjusted EBITDA, which excludes noncash stock-based compensation expense and intangible asset amortization was $14.5 million or 20.8% of revenues before reimbursements in the first quarter as compared to $17 million or 22.6% of revenues before reimbursements in the prior year. GAAP net income for the first quarter of 2023 totaled $8.2 million or diluted earnings per share of $0.30 as compared to GAAP net income of $10.5 million or diluted earnings per share of $0.33 in the first quarter of the previous year. Adjusted net income, which excludes noncash stock-based compensation expense and intangible asset amortization for the first quarter of 2023 totaled $10 million or adjusted diluted net income per common share of $0.37, which is in line with our earnings guidance range. This compares to adjusted net income of $12.6 million or adjusted diluted net income per share of $0.39 in the first quarter of the prior year. In Q2 of 2022, we moved to an actual GAAP effective tax rate for adjusted net income reporting purposes. For those of you reconciling to the prior year reported results in Q1, we reported adjusted diluted income per common share of $0.38 when utilizing a non-GAAP effective tax rate of 25%. The Company's cash balances were $16.9 million at the end of the first quarter of 2023 as compared to $30.3 million at the end of the previous quarter. Net cash used in operating activities in the quarter was $3.1 million, primarily driven by decreases in accrued expenses due to the payment of 2022 performance bonuses and increases in accounts receivable, partially offset by net income adjusted for noncash activity. Our DSO or days sales outstanding at the end of the quarter was 66 days as compared to 63 days at the end of the previous quarter. During the quarter, we repurchased 199,000 shares of the Company's stock for an average of $21.23 per share at a total cost of approximately $4.2 million, driven by purchases from employees to satisfy income tax holding triggered by the vesting of restricted shares as well as for share repurchases. Our remaining stock repurchase authorization at the end of the quarter was $14 million. During the quarter, the Company paid down $2 million on our credit facility. The balance of the Company's total debt attending at the end of the first quarter is approximately $58 million. At its most recent meeting, subsequent to quarter end, the Company's Board of Directors declared the second quarterly dividend of $0.11 per share for shareholders of record on June 23, 2023, to be paid on July 7, 2023. Now moving to the second quarter of 2023 and our guidance. The Company currently estimates total revenue before reimbursements for the second quarter of 2023 to be in the range of $72.5 million to $74 million. We expect global S&BT segment revenue before reimbursements to be slightly down when compared to the prior year as we expect slowing economic growth to result in extended client decision-making and business transformation engagements. We expect Oracle Solutions Segment revenue before reimbursements to be up strongly on a sequential basis and to be only slightly down when compared to the prior year. We expect SAP Solutions Segment revenue before reimbursements to be up on a year-over-year basis. We estimate adjusted diluted net income per common share in the second quarter of 2023 to be in the range of $0.36 to $0.39, which assumes a GAAP effective tax rate on adjusted earnings of 27%. As Ted mentioned last quarter, the second quarter will reflect the continued incremental investments we are making in program development and dedicated sales resources for our benchmarking executive advisory, market intelligence, and our IP as a service offerings. These incremental costs are expected to impact our diluted net income per common share for approximately $0.04 when compared to the prior year. We expect adjusted gross margin on revenues before reimbursements to be approximately 42% to 43%. We expect adjusted SG&A and interest expense for the second quarter to be approximately $16.7 million. We expect second quarter adjusted EBITDA on revenues before reimbursements to be in the range of approximately 21% to 23%. Lastly, we expect cash flow from operations to be up on a sequential basis. 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 the growth opportunity it offers our organization. Demand for digital transformation is being impacted by extended decision-making as organizations assess competing priorities created by increasing interest rates and the demand disruption that it is intended to affect. However, it continues to be a clear strategic priority for our clients. Digital innovation and enterprise cloud applications, analytics and artificial intelligence, cloud infrastructure and workflow automation 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 to remain competitive and to realize targeted productivity gains. We believe clients use the year-end planning process at the beginning of the year to assess industry risk, make headcount and spend reductions, and rebalance their spending with productivity and strategic cost reduction efforts, which are also core to our offerings. We believe the clients will become more comfortable with the economic headwinds and we will see their behavior improve throughout the year. Similar to us, many of our clients did not experience demand disruption until late in Q2 of last year, and will be more challenged by the strong year-over-year comps of the first half of the year. However, most will face more favorable comps in the second half of the year. If we are correct, this will further support the behavioral improvement we expect from the first half to the second half of the year. On the talent side, competition for experienced executives continues, but we saw turnover continue to moderate during the quarter and expect that trend to continue. Longer-term, we have transitioned to a hybrid sale of delivery model, which provides us with effective access to our clients and their respective teams. This hybrid model provides our associates with greater personal flexibility to perform their defined responsibilities remotely, which is very valuable to them. This should allow us to attract and retain talent that we have struggled to retain because of the demanding historical travel requirements of our industry. Strategically, we are accelerating our focus on recurring high-margin IP-related services by increasing the development of new programs and sales and marketing resources dedicated to this area. This investment will decrease our Q2 results by approximately $0.04. Additionally on the CapEx side, we will continue our investment in our new Hackett Connect member platform and introduce AI functionality in 2024. It's also important to note that we continue to see strong downstream revenues from our benchmarking and research advisory clients through our business transformation and technology consulting services. This halo effect has been in excess of 40% over the last several years. Simply put, organizations that rely on our IP, research, and benchmarking services are more likely to utilize our consulting services. We have been exploring or continue to explore strategic partnerships that will allow us to syndicate our IP through new channels and reach beyond our Global 1,000 focus in an efficient manner. We launched our first syndication agreement of our IP and content on April 1. Like our other licensing efforts, we expect new recurring high-margin revenue to slowly build from this relationship as new markets and segments are offered our IP. We also continue to redefine our global benchmarking leadership through enhancements in Quantum Leap, our digital benchmarking Software-as-a-Service solution along with our digital transformation platform. These platforms allow us to deliver more information with significantly less client effort. They also allow clients to leverage our IP to create compelling benefit case assessments, accelerate process flow and software configuration decisions, and track the value realization of transformation initiatives over the life of their respective efforts. We believe that there are no comparable IP-led platforms in the market. As I have been mentioning in previous calls, 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. We will also be updating our demo with our newly launched Hackett Connect platform in the next few months. Lastly, even though we believe that we have the client base and offerings to grow our business, we continue to look for acquisitions and alliances that strategically leverage our IP and add scope, scale, or capability, which can accelerate our growth. As always, let me close by congratulating our associates on our performance and by thanking them for their tireless efforts and always urge them to stay highly focused on our clients and our people, no matter what challenges we may encounter. Those conclude my comments. Let me turn it over to our operator and let's move over to the Q&A section of our call.

Our first call is George Sutton with Craig Hallum.

Ted, I wondered if you could walk through the Oracle wins that you saw late in the quarter that you mentioned. Just give us any sort of quantification particularly relative to what I believe was a high seven-figure loss late last year.

Thank you for the question, George. There were several wins, not just a couple. We had at least one win that matches the size of the loss we experienced late in Q4, in addition to four or five multimillion-dollar wins that position us well for the next quarter and the rest of the year. What we are most pleased about is that it showcases our relationship with Oracle and the Oracle channel, along with our capability to deliver a uniquely valuable message on how we configure Oracle, which is appealing in the market. Despite facing competitive challenges, we were able to achieve this. I must commend our Oracle team for their outstanding performance over the last 60 days.

Could you give us an update on the three programs that you've now launched under the Market Intelligence program? Just give us a sense of the demand relative to what you might have been anticipating? And any further thoughts on the scale of that program?

We published our first program, focusing on receivables management, at the start of the quarter. We also launched two additional programs in procure to pay within software and finance and accounting outsourcing services. Vendor participation in both areas has been strong, and we will ensure our comparisons and rankings include all involved. Our aim is to broaden our perspective on as many providers in these segments as possible. We reviewed our upcoming programs for the year, planning to transition to EPM software and expand into HCM and HR outsourcing in the next two programs. We also plan to explore procurement and GBS areas for the remainder of the year, potentially concluding with a broad ERP software assessment. Our goal is to launch eight or nine programs by year-end. Although it is taking longer to complete the first few, we believe our aim to distinguish ourselves in the marketplace and provide clear guidance on the value derived from these investments is worthwhile. While we may be running at least one quarter behind, we are confident in the quality of the product, vendor participation, and the number of planned programs, which we believe will have significant impact. These nine programs will match the nine existing functionally-focused executive advisory programs we currently have. Our objective is to at least double the number of programs from the beginning of the year. Each program represents multimillion-dollar opportunities for us in the long term, based on our ability to assist software and service providers seeking our marketing or strategic support. More critically, our large end-user client base, which includes benchmarks for over 25,000 clients, gives us extensive coverage and the potential to influence this space significantly. Our vision is to capture the client’s voice in value realization, hoping it resonates in software and services like J.D. Power does in the automotive sector. We have high expectations for these programs.

Our next call is from Jeff Martin with Roth MKM.

I wanted to get a sense with respect to the delayed extended decision-making. Are you getting feedback from clients that there are other reasons other than the difficult comparisons in the first half of the year, that second half may open up? Just curious if you have anything tangible from clients that you're hearing?

Yes, the increase in rates is expected to reduce economic demand, which is affecting our client services. Clients are needing to reassess their priorities because they have to put in more effort to achieve the revenue growth they experienced in 2022 and wish to replicate in 2023. Despite the challenges we see across the industry, clients recognize the importance of advancing their digital transformation initiatives to enhance client engagement and improve service sales. Additionally, they aim to leverage emerging technologies for productivity gains. Clients are trying to find a balance, and we anticipate this trend will persist for the remainder of the year. People are becoming more aware of the implications of interest rates for the rest of the year. With better comparisons, we believe the demand environment could improve, and we hope that will be the case.

Great. And then with respect to the investments that are being made, obviously, $0.04 a quarter is a significant investment for you. Are those primarily investments in sales personnel? And curious how much of that is within the Market Intelligence strategy? And what are you seeing or what are you expecting in terms of the sales cycle of the Market Intelligence platforms in various programs?

Well, first, at least 75% of the investment has been building that sales group. We were lucky and successful to attract a new global leader for that group. We joined just April 1, but we think is a terrific addition to our senior team. We're not narrowing the scope of these new sales resources just to Market Intelligence. Market Intelligence is intended to double the number of programs that these teams will take to market. So as those programs roll out, they'll have a chance then to drive revenue through those new programs. But for now, they can focus on the existing functionally-focused executive advisory programs. Some resources are highly focused on the IPaaS related activities. So I would characterize the team as being responsible for the growth of high-margin recurring revenues regardless of program. Just to make sure, Market Intelligence will just add inventory to what they sell. So we'd like to give them twice as much product by the time we enter 2024. Yes, I wish we were a little further ahead on that inventory we had given them earlier in the year. But they've got plenty of products to sell to our clients. We lack a lot of market coverage from these programs in many regions. So we will continue to add the resources as we planned. It is a significant investment, but we believe there's a significant payback.

Great. And then one more, if I could. You mentioned an artificial intelligence offering launch in 2024. Curious how that plays into your existing strategy?

We are in the process of developing our new Hackett Connect member portal, which serves as the main access point for our members and users of our IPaaS, research advisory, and Market Intelligence services. At the beginning of Q1, we began assessing our priorities and potential changes. Our primary goal is to ensure that we do not compromise any of the intellectual property available to our clients. A significant amount of foundational work has been completed. Our plan for 2023 focuses on detailed features for the Hackett Connect portal. We have a dedicated team exploring opportunities to prioritize throughout the year and begin utilizing some of these capabilities in 2024.

And our next call is Vincent Colicchio with Barrington Research.

Yes. Ted, it's good to hear you're making some progress on the Oracle Solutions side. Just curious how the SAP pipeline is progressing and when you may expect that to return to sequential growth?

Well, I want to notice. I don't know if you caught the comments on the call, but SAP will be up both sequentially and year-over-year in Q2. So solid progress on both the Oracle and SAP sides, which again is something that we wanted to address as early in the year as possible, I think we're ahead of schedule on both.

Are delays or cancellations still a factor in the Oracle and SAP businesses?

The answer is yes. I can't sit here and give you a specific example in this quarter. We were really focused on converting pipeline that took a little bit longer at the end of last year that really came through very strongly for us, especially in the latter part of the quarter. But yes, look, I'm assuming that in this environment, you need to expect clients to be more judicious with their decisions. And in certain cases, depending on what they encounter, they could second guess themselves. But I don't expect it to be anything that would be any different in any year.

And could you provide an update on your IPaaS pipeline, maybe negotiations that are close to coming out in the right way?

We are launching a few more pilots in the second quarter and hope that as we progress through the year, some of these will turn into more significant opportunities. We are still adding companies that are considering a more substantial multiyear relationship. The key question for us has been whether we require an introductory period before a client can transition to a more significant multiyear relationship. We are assessing this on a partner-by-partner basis, but the activity and discussions in this area remain positive.

And last for me, could you remind us of your current M&A priorities and if valuations are improving?

I don't know if valuations are improving, but our priority has been focused on trying to identify unique research-related businesses, those are very hard to combine and identify. But people have a way of reaching out to us. So we continue to stay actively involved in conversations with those that could be a good fit for us.

And at this time, we're showing no further questions. I will now turn the call back to Mr. Fernandez.

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

And this concludes today's conference. Thank you for participating. You may disconnect at this time and have a great rest of your day.