Hackett Group, Inc. Q2 FY2024 Earnings Call

Welcome to the Hackett Group Second Quarter Earnings Conference Call. 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 second quarter results. Speaking on the call today, I’m here to answer your questions, alongside Mr. Ted Fernandez, Chairman and Chief Executive Officer of the Hackett Group, and myself, Rob Ramirez, Chief Financial Officer. A press announcement was released over the wires at 4:05 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 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 guaranteed 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 files. At this point, I would like to turn 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 outlook. We will then review our market and strategy-related comments, after which we will open it up to Q&A. This afternoon, we reported total revenues of $77.7 million and revenues before reimbursements of $75.9 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. Our results were driven by the overperformance of both our Oracle and SAP sectors. Oracle's overperformance is consistent with the momentum that it has experienced in the second quarter of last year. A recent important development is the notable increase in the demand we continue to experience in our historically strong Enterprise Performance Management offerings. Oracle has reemphasized its sales commitment to this area, and we are clear beneficiaries of this strategy. Our SAP solution segment also performed above our expectations as it closed several value-added reseller transactions which benefited the quarter. We are seeing some of the sales investments we made in this segment last year start to pay off. Our global strategy and business transformation segment was down 3% when compared to last year, as we have seen economic headwinds continue to result in extended decision-making. As I mentioned last quarter, that has been particularly noticeable in our e-procurement area. On the positive side, we are continuing to see increased activity from companies considering GenAI investments. We have conducted hundreds of meetings with Global 1000 organizations as a result of their interest in our recently launched GenAI ideation and design platform, AI Explorer (XPLR). These meetings have provided us with unique detailed exposure to these organizations' GenAI adoption plans, implementation concerns, as well as their limitations. Given this unique perspective, we have continued to make significant enhancements to our platform's version 1 capability and plan to release an AI Explorer version 2 this month. The most important enhancement is our ability to simulate enterprise use cases for our clients by utilizing Hackett IP and our strong business process knowledge. This can only happen because of our ability to identify task automation opportunities at a detailed level, which also enables us to design meaningful use cases using our AI Explorer's GenAI-assisted capabilities. Our AI projects have also exposed us to significant implementation assistance our clients require to successfully implement sophisticated GenAI use cases and solutions. Given the strategic access and the platform enhancements we think it is only natural for us to extend our AI implementations capabilities to be able to fully develop and implement GenAI use cases. Although the project conversions from our hundreds of meetings are still low at this point, we expect our sequential revenues in this area to continue to increase strongly. We also believe that our new AI Explorer version 2 capabilities will improve our conversion rate and also expand downstream opportunities on our existing engagements. There is no doubt that in just six months, our aggressive pivot to become the architects of our clients' GenAI journey is being well received and has extended our branding in GenAI. This has been enabled by our unique ability to identify meaningful AI use cases, determine their feasibility, and assess their benefit realization potential by utilizing our benchmarking database. On the Executive Advisory front, we continue to invest in our growing IP-based programs. We believe our move to fully integrate GenAI content into all of our advisory programs, which began in April, will be responsive to our clients' strong interest in this area. On the balance sheet side, you will hear from Rob that in the short term, you can expect us to use our strong cash flow and operations to continue to pay down our outstanding balance of our credit facility. Longer term, we plan to use our balance sheet 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 conditions following Rob's comments.

Thank you, Ted. As I typically do, I'll cover the following topics during this portion of the call: an overview of our 2024 second quarter results, an overview of our 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 2024. For the purposes of this call, I will comment separately regarding the revenues of our global S&BT segments, our Oracle solution segment, our SAP solution segment, and the total company. Our global S&BT segment includes the results of our North America and international benchmarking and business transformation offerings, Executive Advisory, and iPaaS programs, and our OneStream and Coupa implementation offerings. Our Oracle solutions and our SAP solution sections 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 and have no associated impact on their 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 we'll post any additional information based on the discussions from this call on the investor relations page of the company's website. As Ted mentioned, for the second quarter of 2024, our total revenue was $77.7 million. Our revenues before reimbursements were $75.9 million, which was above the high end of our quarterly guidance. The second quarter reimbursable expense ratio on revenues before reimbursements was 2.3% compared to 1.9% in the prior quarter and the same period in the prior year. Total revenues from our global S&BT segment were $42.3 million for the second quarter of 2024. Revenues before reimbursements for our global S&BT segment were $41.6 million for the second quarter of 2024, a decrease of 3% when compared to the same period in the prior year. As Ted mentioned, the segment has been impacted by extended decision-making in our business transformation engagements, particularly affected by our e-procurement offerings. Total revenues from our Oracle solution segment were $23 million for the second quarter of 2024. Revenues before reimbursements for our Oracle solution segment were $22.2 million for the second quarter of 2024, an increase of 9% when compared to the same period in the prior year. These results continue the momentum we've experienced since the second quarter of 2023 with strong growth over the last five quarters when compared to prior year periods. Total revenues from our SAP solutions segment were $12.3 million for the second quarter of 2024. Revenues before reimbursements for our SAP solution segment were $12.2 million for the second quarter of 2024, a decrease of 2% when compared to the same period in the prior year. Approximately 22% of our total company revenues before reimbursements consist of recurring, multi-year subscription-based revenues, which includes our research advisory, IP as a service, multi-year benchmarks, and application managed services contracts. Total company adjusted cost of sales, which exclude reimbursable expenses and non-cash stock-based compensation expense, totaled $43.8 million in both the second quarter of 2024 and 2023, representing 57.7% and 57.9% of revenues before reimbursements respectively. Total company consultant headcount was 1,145 at the end of the second quarter of 2024, as compared to 1,154 in the previous quarter and 1,148 at the end of the second quarter of 2023. Total company adjusted gross margin on revenues before reimbursements, which exclude reimbursable expenses and non-cash stock-based compensation expense, was 42.3% in the second quarter of 2024 as compared to 42.1% in the prior year. Adjusted SG&A, which excludes non-cash stock-based compensation expense, was $16.8 million or 22.1% of revenues before reimbursements in the second quarter of 2024. This is compared to $16.3 million or 21.5% of revenues before reimbursements in the prior year. Adjusted EBITDA, which excludes non-cash stock-based compensation expense, was $16.3 million or 21.5% of revenues before reimbursements in the second quarter of 2024 as compared to $16.4 million or 21.6% of revenues before reimbursements in the prior year. GAAP net income for the second quarter of 2024 totaled $8.7 million, or diluted earnings per share of $0.31, as compared to GAAP net income of $8.7 million, or diluted earnings per share of $0.32 in the second quarter of the previous year. Adjusted net income, which excludes non-cash stock-based compensation expense for the second quarter of 2024 totaled $10.9 million, or adjusted diluted net income per common share of $0.39, which is at the top end of our earnings guidance range. This compares to adjusted net income of $10.8 million, or adjusted diluted net income per common share of $0.39 in the second quarter of the prior year. The company's cash balances were $19.1 million at the end of the second quarter, as compared to $13 million at the end of our previous quarter. Net cash provided from operating activities in the quarter was $13.7 million, primarily driven by net income adjusted for non-cash activity, increases in accrued expenses, and income taxes payable, partially offset by an increase in other assets and decreases in accounts payable and contract liabilities. Our DSO, or days sales outstanding, was 68 days at the end of the quarter, as well as at the end of the previous quarter and the prior 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 $22.94 per share at a total cost of approximately $144,000. Our remaining stock repurchase authorization at the end of the quarter was $12.9 million. During the second quarter, the company paid down $4 million on its credit facility. The balance of the company's total debt outstanding at the end of the second quarter was approximately $27 million. During the third quarter of 2024, the company has paid down an additional $5 million. At its most recent meeting, subsequent to quarter-end, the company's Board of Directors declared the third-quarter dividend of $0.11 per share for its shareholders of record on September 20, 2024, to be paid on October 4, 2024. I will now discuss our guidance for the fourth quarter, consistent with seasonal trends for the third quarter. We expect the impact of the additional U.S. holiday and the typical increase in time off due to summer vacations in the U.S. and in Europe to unfavorably impact available days by approximately 2% on a sequential basis. The company estimates total revenues before reimbursements for the third quarter of 2024 to be in the range of $74.5 million to $76 million. We expect global S&BT segment revenue before reimbursements to be down compared to the prior year, but up on a sequential basis. We expect both Oracle solutions and SAP Solutions second revenue before reimbursements to be up when compared to the prior year. We estimate adjusted diluted net income per common share in the third quarter of 2024 to be in the range of $0.39 to $0.41, which assumes a GAAP effective tax rate on adjusted earnings of 27.7%. We expect the adjusted gross margin as a percentage of revenues before reimbursements to be approximately 43% to 44%. We expect adjusted SG&A and interest expense for the third quarter to be approximately $17 million. We expect the third-quarter adjusted EBITDA as a percentage of revenues before reimbursements to be in the range of approximately 22% 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. Although demand for digital transformation remains strong, it continues to be impacted by extended decision-making as organizations assess competing priorities created by high interest rates and the demand disruption. This is intended to affect digital innovation across all areas of enterprise. Cloud applications, analytics, and workflow automation are dramatically influencing the way businesses compete and deliver their services. However, there is a clear, major change which is rapidly emerging, and that is the demand for GenAI solutions. Its unlimited potential will define an entirely new level of what we describe as GenAI-enabled digital world-class performance standards, driving all software and service providers to extend the value of their existing offerings. We believe this will result in unprecedented innovations, which all organizations will have to consider. Strategically we continue to focus on recurring, high-margin IP-related services. What is new is the accelerated focus and investment we are making in our GenAI capabilities. The most significant investments have been the development of our AI Explorer platform and the training and development of our associates. Although they are consuming our organization, I’m also very proud of the way we are making this pivot in a highly efficient way, whether you look at profitability, cash flow, or any other aspect of our performance. This could only be done because of our IP and the talented individuals we continue to attract and retain. We are utilizing the AI Explorer platform as the vehicle to integrate the GenAI impact across all of our offerings. We also continue to hire and upgrade our skills and critical data and depth tech architecture resources to further support our efforts. These efforts will allow us to become key architects, advisors, and consultants of our clients' GenAI journey. We also continue to see strong downstream revenue from our benchmarking and executive advisor clients to our business transformation and cloud application consulting services. This table effect, which has been approximately 40% over the last several years, continues. We believe that this will only be expanded by our AI Explorer offering and the broad and strategic access it provides. Organizations that rely on our IP, AI assessment solutioning, and marketing intelligence platforms are also more likely to utilize our advisory and consulting services. We also continue to publish our market intelligence reports. We have started to publish our research reports on GenAI and key solution providers in the space, which are important for the content of AI Explorer and our Executive Advisory programs. On the talent side, competition for experienced executives continues. Overall, we saw turnover continue to moderate and remain low during the quarter, and we expect that 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 to attract and retain talent. We also continue to explore strategic partnerships that will allow us to extend our AI capabilities and sell our IP through new channels that will allow us to reach beyond the current Global 1000 focus in an efficient manner. We also continue to redefine our global benchmarking leadership through enhancements in Quantum Leap, which has not been entirely integrated, but obviously all the benefit realization capabilities of Explorer are fully enabled through Quantum Leap and some of the benefit case assessments that exist within our digital transformation platform. These platforms 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 the integration of these platforms with AI Explorer significantly enhances the value of our IP; it fully aligns with our perspective on the emerging GenAI world-class performance standards that will be achieved due to these new AI technologies. As I have mentioned on previous calls, we are adding videos of our platforms on the investor relations page of our website. You can expect to see more of that in a new website before the end of the quarter. Investors will be able to utilize these videos and access we are providing through the investor portal to become more familiar with our new capabilities. 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 I always urge them to stay highly focused on our clients and our people, no matter what challenges they may encounter. Those conclude my comments, let me turn it over to our operator and move on to the Q&A section of our call.

Our first question comes from George Sutton with Craig Hallum.

Thank you, Ted. You mentioned you've had hundreds of meetings relative to the Explorer offering, and you have thus far had low project conversions but expect that to increase strongly. I wondered if you could put a little bit more detail around those comments.

Well, I think what we're seeing is that the education side of our clients, which appear to be driving half of the calls that we were executing over the first three months since launching AI Explorer, are really now changing clients. We're now engaging clients who have dedicated some capabilities to AI, may have made some commitment to some GenAI development platform to develop their use cases, and try to identify areas of the business which they want to pursue. But the overwhelming majority is simply, I'll say, testing or trying to develop their capabilities in very narrow areas in order to prove both their capabilities and then also the value realization from this effort. So we now believe we've moved from primarily education, if you take, say, the first couple of hundred calls, to then more meaningful client conversations, let's say the next 200 calls. The conversations now include a more complete discussion about both ideation, design, development of the solution, and full deployment. That is why AI Explorer was built: to be responsive to a couple of things that we saw were critical to the clients. One, they wanted a better indication of the opportunities available to them, since many of them were highly focused on some narrow areas, or favored areas, and we have been a strong proponent that they should consider making these investments with a much broader context, which means understanding what their enterprise opportunity is. That's what led to the simulation capability that we're now introducing in Version 2. So what does that mean? It means that instead of talking, educating a client about how we ideate and design solutions, we will now be engaged in an M1 with a full simulation of their opportunity, fully utilizing what we're using as industry process flows and all the client information we have available before meeting with that client. We find that engagement where we are able to speak to specific numbers of opportunities across areas of the business and speak not only to how they are identified and how they're designed but also developed skills around making sure that the handoff—meaning functional requirements, data sources, both public and private—are addressed at a more detailed level. We believe all of that is more highly responsive to the issues that the clients are facing, and because of all the things I’m discussing, where they were starting, where they are now moving to, relative to understanding their commitment to time and dollars. We believe we can be more compelling and engaging clients. We believe we do that by presenting them with a broader use case number and opportunities that have been assimilated inside of our AI Explorer platform. All of these changes, we believe, will allow us now to walk into a client opportunity, no matter whether they're starting or sophisticated, discussing where they are relative to the ability to assess enterprise opportunity, define their use cases, and also talk about some of the deployment and implementation considerations. As they've developed capabilities, we've developed capabilities. The engagement of the clients, I'm going to say, with the exception of a maximum of 20% of those clients where maybe there was not a direct fit relative to the requirements they were seeing versus where we were developing capabilities are. We believe those are clients that understand the Hackett capability and how it's changing. So I believe not only do we have a more complete way and a new way to serve clients, but I believe that our opportunity to go back to these clients and now reengage them with more capability will make our offering competitive, and so it’s all of the above. And yes, when you mentioned that we believe revenues are going to be strong, the dollar amounts of our entry points have changed because they become more customized to the client reaction or request. By the way, with more customized or higher amounts also come longer times to validate the opportunity and close those engagements. But we've had enough success in what we call Phase 2 that our revenues will continue to increase strongly sequentially.

One other question, relative to implementations. You mentioned strength in the Oracle practice, and I believe that's because of a push in part from their sales force. And I just want to confirm that. And then relative to the IPO of OneStream and your success in growing that practice. Can you just give us an update there? Do you benefit from the IPO and the focus there? And then lastly, you called out e-procurement, which is, I believe, predominantly Coupa, they've pulled back on their sales resources. Is that what's driving that area? That's a bit of a challenge.

Well, I'll simply say that excluding the performance of that group, our S&BT practice was probably up 3% or better instead of down 3%, just to give you some perspective and respond to that question without providing individual numbers about that practice. So I agree with your observations. How do we benefit? Look, we benefit when both OneStream is successful and Oracle is successful. We believe they are the top two EPM or CPM providers in the marketplace, and we have this very strong capability in the EPM, both in the transformation as well as the software implementation side, and that relationship emanates from the very strong relationship we have with the CFO community. So we really like the fact that Oracle's reemphasized that area and we're benefiting from it. And yes, we also believe that the OneStream IPO only benefits and creates an opportunity for OneStream to continue to grow its business, and if they do so, we're going to be an active participant in that growth.

Our next question comes from Jeff Martin with ROTH Capital.

Ted, I wanted to dive a little deeper on AI Explorer 2.0. You mentioned that'll be available later this month. How much do you think the new features, particularly a simulation, make a difference in open-close conversions?

I believe it's two-fold, Jeff. I believe that clients are listening to our capabilities that are considering them within the context of their plans, and they're becoming more informed. The more detail we provide on how, I think, how strong we are in that ability to identify and design, which includes driving all the way through functional requirements and data sources, we believe extends our capability and provides more value and capability that we're offering our clients. So one of those two things is important. I think also we’re extending our capabilities all the way through to proof of concept and validation, and again, the more we extend our capabilities and directly respond to what the clients need help with. We believe, for example, some of the things that are in the pipeline now are clients that we made early presentations to, and we didn't hear much from. We thought they were educational. They picked up the phone and called us back. When they called us back, we were demonstrating greater credibility. That greater credibility has given us a chance to present a larger scope, which they now accept. So you’ve got to consider this somewhat of a startup. Clients are learning how to do the work, engage the services, compare the capabilities, and we're aggressively building capabilities where we believe the client limitations and capabilities are. So you can just expect us to continue to extend those capabilities, and we just believe that all of the above will give us a chance to compete for that work further. And I still don't know if anybody has had the volume of calls we've had with clients and the detailed level of discussions around GenAI adoptions and the underlying GenAI development platforms they're considering. Again, some of their issues and limitations and we're trying to go back and respond to it all through both platform and internal capabilities. You'll see us continue to do that aggressively.

The point I was trying to get at was that simulation seems like it's a huge value add for the client. I was just curious how long it might take to do a simulation for a client, and what all does that entail in terms of pulling data from their systems?

Well, first, the first thing is to get them to believe that we can. So we've just started doing our first demos, and their reaction is, how are you doing it? It may be hard for you to believe, but Explorer and the capabilities inside of Hubble when we provide Explorer with the right level of information that correlates to that client's industry, and more specific client information that we may get publicly or as a result of setting up the call is allowing us to get in front of the client. I apologize for the fact that we did this without any direct involvement from them or direct information in the areas we're going to cover. But we think it's incredibly compelling for us to be able to turn to most areas of the business and have a conversation about the use cases that are available and what we believe is the feasibility of the use cases. We break down use cases as breakthrough, transformative, and incremental. We also correlate to the benefit. To some extent, I think that we're catching some of our clients a little bit off guard with the capability we've developed as quickly as we have, but I think that the conversations we've had and we're having are clearly extending our branding, and if we continue to build capabilities, whatever opportunities emerge in this space will be very conducive to our approach.

Okay, one more for me, if I could. You mentioned strategic partnerships. Just curious if you could help us understand the overarching strategy there. Is that to penetrate more than the middle market? You mentioned you're intending to extend reach beyond the Global 1000, just curious if you could kind of give us the strategic viewpoint of how you're approaching this.

Well first, beyond the Global 1000, as you know, we also have had vendor strategies in our iPaaS program, so we've had an initial conversation where we're trying to determine whether we can take some of those relationships and support their AI either extended or offerings by sharing our capabilities with their channel. So the answer is, yes, we've initiated those conversations, so we'll see where they go. So relative to extending capabilities because of the success of AI Explorer and the fact that all the work that we pay by giving these clients these one hour, or in some cases more than one session and review of AI Explorer and discussion around GenAI adoption and related issues, it has attracted some of the firms that are now trying to transition their skills or build some new skills in the AI implementation area. And as we walk into clients, sometimes we get introduced to some providers, so we're kind of developing a good understanding of the ecosystem that's out there in figuring out the best way to work with them.

Our next question comes from Vincent Colicchio with Barrington Research.

Yes, Ted, shifting gears here a bit. With your heavy focus on the AI consulting. Is there less emphasis currently on the market intelligence programs?

No, we just don't believe that you obviously can separate our existing capabilities with the new capabilities. But when you engage a client more strategically or broadly, and when you look at how we believe the spend dollars will shift over time, we don't believe that you can separate our existing capabilities with the new capabilities. So what we've done is we've enveloped all of our traditional capabilities with AI Explorer or GenAI capabilities so that any conversation can result in either an AI consulting opportunity or a more traditional or legacy opportunity. To me, it’s the ability to turn left or right as the client needs your assistance. I just believe that the trend and the demand that will build around GenAI is so significant that not to emphasize it and use it as a primary go-to-market, as we look out several years would not benefit our organization the same way.

And then SAP, you said you closed some business towards the end of the quarter. Is this momentum shift sustainable? What are your thoughts on SAP?

Look, both Oracle and SAP have performed pretty well throughout this, if you want to call it an economic cycle, right? And now you've got to call it an economic and emerging GenAI cycle. So now you've got two cycles going at the same time. So Oracle is obviously outperforming the other groups. The SAP group is performing well, and we think both have an opportunity to continue to perform where they're at or better, just given how successful they've been through what I believe is not the best economic cycle. And when you also consider the new distraction that clients have now because everyone is offering them to implement some use case or presenting some new AI embedded opportunity for them to consider, there's a lot of competing wins, and it all leads to the deployment of technology and change, which is good for our business.

And lastly, what is driving the strong growth in your top client? I see some impressive growth there.

Well, obviously it was a very meaningful Oracle implementation, but it's probably expanded into four of our groups, including our AI group.

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

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

Thank you for your participation. Participants, you may disconnect at this time.