Hackett Group, Inc. Q2 FY2023 Earnings Call

Welcome to The Hackett Group Second 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.

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 4:15 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 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 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 that are contained in our SEC filings. At this point, I'd like to turn it over to Ted.

Thank you, Rob, and welcome everyone to our second 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 the detailed operating results, cash flow, as well as comment on the 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 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 at least $0.03 in each quarter of the prior year. By the middle of the year, the impact of interest rate increases started to disrupt economic growth, which has resulted in extended client decision-making. Relative to the second quarter, this afternoon we reported revenue before reimbursements of $75.6 million, which was above the high end of our guidance and adjusted earnings per share of $0.39, which was at the high end of our guidance. Although economic volatility is evident, so is the demand for our digital transformation solutions, which clients require to remain competitive and drive productivity improvement. Consistent with our comments on our previous earnings call, significant first quarter sales resulted in an 8% sequential revenue growth in the second quarter. This has allowed us to exceed the results from Q2 of last year. This was most pronounced in the swift turnaround of our Oracle Solutions segment. Our total company quarterly results continue to be driven by our Global Strategy and Business Transformation segment, which was up sequentially but down slightly on a reported basis when compared to last year's strong comp. Our recurring higher-margin Research Advisory and IPaaS offering sales grew sequentially and we expect strong sequential sales growth in Q3. If this momentum continues and we are able to close a couple of IPaaS pilots, we should be able to achieve an annual contract value growth of 20% in 2023. In Q2, we published our Customer-to-Cash Receivables Market Intelligence Report. In the third quarter, we intend to publish two additional market intelligence reports: first, we will analyze and compare the purchase-to-pay software companies such as Coupa, SAP, Ariba, and Oracle; the second market intelligence report, which evaluates service providers in finance and accounting outsourcing, will include companies such as Accenture, IBM, and TCS. What makes our market intelligence report essential is the unique approach to assess companies for both differentiated capabilities and measurable value delivered on our Hackett Value Matrix. Our unique insight is our ability to measure value realized through automation and service improvements that enhance customers' business performance. Our next one, Enterprise Performance Management, is a three-part report that will include specialized analysis of planning and budgeting, enterprise consolidation, plus an aggregate view of total enterprise performance management. By early 2024, we intend to issue six additional evaluations of software and services providers. Our market intelligence reports represent critical value to our providers – to the providers, the companies learn how they compare to competitors, strengths, and opportunities, as well as the measurable impact their solutions deliver. Our conclusions, which are depicted in our Hackett Value Matrix, help providers market and sell their solutions through licensing and the use of Hackett digital tools. We also advise how providers can adapt their solutions to perform better. Providers aren't the only ones to benefit. A large benchmarking and consulting and executive advisory customer base can apply the market intelligence report to inform software and services purchase decisions. All of these enhancements are critical to the launch of our new member platform Hackett Connect. This new state-of-the-art platform will allow all of our existing and new members to avail themselves of the proprietary benchmarking metrics as practices and research which is based on applied knowledge and proven implementation expertise delivered by practitioners, which highly differentiates our insight and expert advice. We are also building a community of users that can benefit from one another that we believe will result in a powerful expert network. This is one of our organization's most significant transformative efforts. The Oracle Solutions segment was up strongly on a sequential basis as expected this quarter. We started several engagements which we sold, as we completed the first quarter and continue to experience strong market demand and received strong support from the Oracle sales channel. Our SAP Solutions segment continued its momentum with higher-than-expected software sales activity. 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 Digital Transformation Platform or DTP, are paying off. These platforms are allowing us to highly differentiate all of our offerings and also develop new licensing and research relationships with software and service providers across the enterprise. The launch of our Hackett Connect platform provides members access to the IP and tools of these two platforms and also significantly improves their ability to engage with our experts and shortly our community of users in an ever-improving way. On the balance sheet side, you can expect us to use our cash flow from operations to accelerate the pay-down of our outstanding credit facility throughout the balance of the year. Longer term, 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. I will make additional comments on strategy and market following Rob's comments.

Thank you, Ted. As I typically do during this portion of the call, I'll cover the following topics: an overview of our 2023 second quarter results along with an overview of related key operating statistics; an overview of our cash flow activities during the quarter; and I will then conclude with a discussion on our financial outlook for the third quarter of 2023. For purposes 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 OneStream 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 discussion. Reimbursable expenses are primarily project travel-related expenses passed through to our clients that have no associated impact on our profitability. During our call today, we will also reference certain non-GAAP financial measures, which we believe provides useful information to investors. We've included reconciliations of GAAP to non-GAAP financial measures in our press release filed earlier today and we'll post any additional information based on the discussions from this call to the Investor Relations page of the company's website. For the second quarter of 2023, our total revenue was $77.1 million. Our revenues before reimbursements were $75.6 million, which was above the high end of our quarterly guidance. The second quarter reimbursable expense ratio on revenue before reimbursements was 1.9% as compared to 2% in the prior quarter and 1.6% when compared to the same period in the prior year. Total revenues from our global S&BT segment were $43.6 million for the second quarter of 2023. Revenues before reimbursements for our global S&BT segment were $43 million for the second quarter of 2023, a decrease of 2.4% when compared to the same period in the prior year. This was consistent with guidance as extended client decision-making impacted business transformation engagements. Additionally, the comparisons were against accelerated post-COVID demand we experienced throughout the first half of the prior year. Total revenues from our Oracle Solutions segment were $20.8 million for the second quarter of 2023. Revenues before reimbursements for our Oracle Solutions segment were $20.3 million for the second quarter of 2023, an increase of 3.8% when compared to the same period in the prior year, as well as a sequential increase of 21.6%. The momentum we discussed when we provided guidance last quarter continued to accelerate and drove earlier-than-expected second quarter year-over-year revenue growth and strong sequential growth. Total revenues from our SAP Solutions segment were $12.7 million for the second quarter of 2023 and also exceeded expectations due to the sale of a number of cloud license deals. Revenues before reimbursements for our SAP Solutions segment were $12.4 million for the second quarter of 2023, an increase of 10.7% when compared to the same period in the prior year. Approximately 22% of our total company revenues before 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 excludes reimbursable expenses and noncash stock-based compensation expense, totaled $43.8 million or 57.9% of revenues before reimbursements in the second quarter of 2023 as compared to $43.2 million or 57.8% of revenues before reimbursements in the prior year. Total company consultant headcount was 1,148 at the end of the second quarter, as compared to total company consultant headcount of 1,128 in the previous quarter and 1,125 at the end of the second quarter of 2022. Total company adjusted gross margin on revenues before reimbursements, which excludes reimbursable expenses and non-cash stock-based compensation expense, was 42.1% in the second quarter of 2023, as compared to 42.2% in the prior year period. Adjusted SG&A, which excludes non-cash stock-based compensation expense and intangible asset amortization, was $16.3 million or 21.5% of revenues before reimbursements in the second quarter of 2023. This is compared to $14.8 million or 19.7% 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 dedicated sales resources for our benchmarking, executive advisory, market intelligence, and our IP-as-a-Service offerings. These investments approximated $0.03 in the second quarter of 2023. Adjusted EBITDA, which excludes noncash stock-based compensation expense, was $16.4 million or 21.6% of revenues before reimbursements in the second quarter of 2023, as compared to $17.6 million or 23.6% of revenues before reimbursements in the prior year. GAAP net income for the second quarter of 2023 totaled $8.7 million or diluted earnings per share of $0.32 and compares to GAAP net income of $10.2 million or diluted earnings per share of $0.32 in the second quarter of the prior year. Adjusted net income, which excludes noncash stock-based compensation expense and intangible amortization for the second quarter of 2023, totaled $10.8 million or adjusted diluted net income per common share of $0.39, which was at the high end of our earnings guidance range. The second quarter of 2023 results were negatively impacted by $0.01 due to unfavorable movements in foreign currency. This compares to adjusted net income of $12.1 million or adjusted diluted net income per common share of $0.38 in the second quarter of the prior year. The company's cash balances were $15.8 million at the end of the second quarter as compared to $16.9 million at the end of the previous quarter. Net cash provided by operating activities in the quarter was $7.7 million, primarily driven by net income adjusted for non-cash activity and increases in accrued expenses, partially offset by increases in accounts receivable. Our days sales outstanding at the end of the quarter was 68 days as compared to 66 days at the end of the previous quarter. This increase in DSO is primarily due to slightly unfavorable terms on large client engagements that we've begun during the first half of the year. During the quarter, we repurchased 6,000 shares of the company's stock from employees to satisfy income tax withholding triggered by the vesting of restricted shares for an average of $19 per share at a total cost of approximately $119,000. Our remaining stock repurchase authorization at the end of the quarter was $13.9 million. During the quarter, the company paid down $5 million on our credit facility. The balance of the company's total debt outstanding at the end of the second quarter was $53 million. Our plan is to further accelerate debt paydowns through the balance of the year. Net interest expense for the quarter was $921,000. At its most recent meeting subsequent to quarter-end, the company's Board of Directors declared the third quarterly dividend of $0.11 per share for its shareholders of record on September 22, 2023, to be paid on October 6, 2023. I'll now move to our guidance for the third quarter. The company estimates total revenues before reimbursements for the third quarter of 2023 to be in the range of $72.8 million to $74.3 million. We expect global S&BT segment revenue before reimbursements to be up when compared to the prior year. We expect Oracle Solutions segment revenue before reimbursements to be up strongly when compared to the prior year. We expect SAP Solutions segment revenue before reimbursements to be down on a year-over-year basis, primarily due to expected decreases in cloud license sales. We estimate adjusted diluted net income per common share in the third quarter of 2023 to be in the range of $0.38 to $0.41, which assumes a GAAP effective tax rate on adjusted earnings of 27.5%. As Ted mentioned last quarter, the third quarter will reflect the continued incremental dedicated investments we are making in program development, adding 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 by approximately $0.04. We expect adjusted gross margin on revenues before reimbursements to be approximately 43% to 44%. We expect adjusted SG&A and interest expense to be approximately $16.7 million. We expect third quarter adjusted EBITDA on revenues before reimbursements to be in the range of approximately 23% to 24%. 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. As I repeatedly say, the demand for digital transformation is being impacted by extended decision-making as organizations assess competing priorities created by the increasing interest rates and the demand disruption, which 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. As we mentioned at the beginning of the year, we believe clients use the year-end planning process and the beginning of the 2023 year to assess their 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 that 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 the demand disruption until late in Q2 of last year, and will be more challenged by the strong year-over-year — or have been more challenged by the strong year-over-year comparisons 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 behavior improvement, which we expect when we look at the second half when compared to the first half of 2023. On the talent side, competition for experienced executives continues. Overall, we saw turnover continue to moderate during the quarter and expect the trend to continue. Longer term, we have transitioned to a hybrid sales and 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 and is allowing 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, those which we detailed on the market intelligence comments I made previously, and aggressively adding to our sales and marketing resources dedicated to this area. The investment will decrease our Q3 results by $0.04. Additionally, on the CapEx side, we will continue our investment in our new Hackett Connect member platform and plan to introduce generative AI functionality in 2024. It is also important to note that we continue to see strong downstream revenues from our benchmarking and research advisory clients through our business transformation and Oracle OneStream and Coupa Consulting Services. This halo effect has been in excess of 40% over the last several years. Simply put, organizations who rely on our IP research and benchmarking services are more likely to utilize our consulting services. We are also exploring strategic partnerships, which will allow us to syndicate our IPs through new channels and that will allow us to reach beyond the Global 1000 focus in an efficient manner. We launched our first syndication agreement of our IP and content on April 1. We continue to evaluate new channels for our IP and our platforms. We also continue to redefine our global benchmarking leadership through enhancements in Quantum Leap, our digital benchmark software-as-a-service solution along with our digital transformation platforms. These platforms allow us to deliver more information with significantly less client effort. It also allows our clients to leverage our IP to create compelling benefit case assessments, accelerate process flow and software configuration decisions, and track the value realization of the transformation initiatives over the life of their respective effort. We believe that there are no comparable IP-led platforms in the market. As I have mentioned on previous calls, we have a 20-minute demo on our Investor Relations page of our website so that investors can become more familiar with the capabilities of our platform. 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, and 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 urge them to stay highly focused on our clients and our people no matter what challenges we may encounter. That'll conclude my comments. Let me turn it over to our operator and let us move on to the Q&A section of our call.

Thank you. We will now begin the question-and-answer session. Our first question comes from Jeff Martin with Roth MKM. Your line is open.

Thanks. Good evening, Rob, and Ted. How are you?

Great. How are you?

Good. Thanks. Ted, you mentioned generative AI, a product launch in 2024. Could you give an early peek under the hood what that might look like?

We are focusing on two main areas regarding GenAI. First, we want to assist our clients in identifying the most beneficial use cases as soon as possible. To do this, we are conducting a comprehensive evaluation of all our business process areas, which we have identified as 130 within the enterprise. We are also exploring how specific GenAI capabilities can provide advantages to our clients in the near term. This will help them prioritize their initiatives. Additionally, we are exploring various methods to develop our own large language model, whether independently or in partnership. We believe this will enable us to interact with clients much more efficiently than we currently do. One example we discussed recently revolves around the Hackett concept. We recognize that individuals frequently seek to access content in a more efficient manner without necessarily using a mobile device or laptop. Hence, we are examining the type of training and data we can provide, considering the data we currently have. Our goal is to offer our clients and members the valuable intellectual property of Hackett by allowing them to pose questions and receive detailed information relevant to their inquiries throughout the day, especially as they evaluate their strategic or productivity initiatives. These represent our approaches from a client perspective and how we intend to enhance our capabilities and deliver them to our client base more proactively in 2024.

Great. And then wanted to ask what kind of reaction you're getting from the initial market intelligence launch? And what do you think the sales cycle in that might be? And what timing of engagements you might start to expect? And then finally what would be considered an average contract size related to market intelligence?

Well, first as I've said on the call, the actual published report was our C2C side, we're publishing procure-to-pay software assessment here in the next week or so. And we'll follow that up with finance and accounting outsourcing and hope to get that out before the end of the third quarter. So we're still trying to first put out a number of these as quickly as we possibly can. The engagement both on the participation side and post has been favorable. The important thing for us is to complete the programs that we do want to go out in this if you want to call it first tranche to make sure that everyone both participants as well as clients know exactly how we're weighing in and both the influence that we have and the insight that we can provide that is valuable to them, so that's really where we see the benefit coming. To be more specific, when I think of meaningful monetization of all those programs both in terms of numbers and engagement, we would like to see that start materializing in the beginning of 2024, just like we would like to see the impact of the significant sales resource investments that we've been making to increase the number of our sales executive within our IP service ranks to have what we hope is a meaningful impact in the middle of 2024. If – as I said on my call, if we see the sequential growth from the sales that we're currently expecting improve as strongly as we expect from Q2 to Q3, we saw a good improvement from Q1 to Q2. We expect stronger sequential improvement from Q2 to Q3. If that kind of cadence continues, then you will see the impact on market intelligence programs both on the rollout and the sales of them as well as the impact of just the sales resources across all of our executive advisory programs which are already in place.

Great. And then you mentioned a $0.04 impact in Q3 from the investments and program development and sales personnel or sales resources. What might we expect in Q4? I know it was a $0.03 impact in Q2. That's up to $0.04 in Q3. What do you think it might look like in Q4?

We would expect it to be similar. We have no reason to expect it to be any different. We thought it was going to be $0.04 in Q2 but it actually ended up being $0.03 and that's just when the resources came in and impacted the quarter. We're seeing that roll into the next quarter. We know what that spend is expected to be so we would expect it to be $0.04. I have no reason to believe that it won't be $0.04 in Q4.

Great. And then in terms of the headcount addition on the consultant side what areas are you adding more aggressively than others?

Well, it's hard to ignore the incredible performance that we're getting from our Oracle Solutions group. So, even though we went through that volatility at year-end since that latter part of Q1 we've been aggressively hiring both onshore and offshore resources to handle the kind of demand that we've been experiencing. So, that would be the primary area. And then I'm going to say the second largest area is the hiring of all these additional sales resources. Those will be the two primary hiring areas in both Q2 and continue into Q3.

Great. Thank you for your time.

Our next question comes from Vincent Colicchio with Barrington Research. Your line is open.

Yes. Rob, on GS&BT and Oracle Solutions I didn't hear in your prepared remarks the growth outlook for Q3. Could you repeat that please?

Sure. What we said was that S&BT would be up, Oracle would be up strongly, and that SAP would be down.

And that's year-over-year?

That's year-over-year.

Okay. Thank you for that. Ted, the $0.02 cost less than expected, was that because hiring salespeople was taking longer than expected?

Yes. We had some changes, but yes, some of the resources came in later in the quarter.

Are you finding the right people you need, at least folks from companies that are already doing research type of work?

Yes. Yes. We're finding them. And we find their interest in what we're trying to do to be extremely high. We don't expect that to change.

Okay. And I know you've said you expect that you're looking for meaningful revenue from the market intelligence programs early next year. Is it too early to ask? And the first programs were launched in December of last year. Has revenue come in with plan or is it just too early for that to even be meaningful?

It's still too early to assess the impact of the C2C program, which was published about five weeks ago. However, the key measurement we're focusing on is the productivity of the new salespeople and their progress. We saw improvement from Q1 to Q2, and we anticipate even stronger gains from Q2 to Q3 based on their activity. It's important to note that we have existing programs, and we aim to expand the number of member or subscription-based programs for our market intelligence initiatives. Essentially, we're looking to more than double the programs we offer. The primary focus remains on the productivity of our sales force with the significant existing programs we have. As I've mentioned to investors since the beginning of 2022, our goal has been to quadruple the sales force and double the programs by the end of 2023, and we are still working toward that objective.

And how many salespeople do you have now? And how many do you plan to have by year-end?

In this group that we brought onboard, it's around 30 and counting.

Okay. And one last one for me. The strength in Oracle Solutions, are there any particularly large deals there or is it balanced in terms of the business you're ramping now and also in the pipeline?

We have seen an increase in the number of deals we've closed, including some significant contracts from previous clients who have returned for Oracle support and assistance. Additionally, new clients are also coming on board, which I attribute to the excellent collaboration we are experiencing with the Oracle sales channel.

Okay. Thanks, Ted.

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

Well, thank everyone for participating in our second quarter's earnings call. And we look forward to updating everyone when we report the third quarter. Thank you.

Thank you for your participation in today's conference. You may disconnect at this time.