Earnings Call: Q3 2022

Nov 8, 2022

Quarterly report

Welcome to The Hackett Group Third 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 3rd 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 4:0:5 p. M. Eastern Time. For a copy of the release, please visit our website at www.thehockettgroup.com. We will also place any additional financial or 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 a guarantee of future performance. They involve risks, Uncertainties and assumptions are difficult to predict and which may not be accurate, especially in light of COVID-nineteen. Actual results may vary. These forward looking statements should be considered only in conjunction with the detailed information, particularly the risk factors that are contained in our SEC filings. At this point, I would like to turn it over to Ted. Thank you, Rob, and welcome everyone to our Q3 earnings call. As we normally do, I'll open the call with some overview comments on the quarter. I will then turn it back over to Rob to review our detailed operating results, Cash flow and provide our quarterly guidance. We will then review our market strategy related comments, after which we will open it up to Q and A. This afternoon, we reported total revenues of $72,000,000 and revenues before reimbursements of 71,000,000 And adjusted earnings per share of $0.37 which was above our quarterly guidance and up 19% on a year over year basis. Our results were driven by 11% growth in revenues before reimbursements from our global SPT group, which also reported Year over year segment profit growth of 18%. This growth was driven by our strong SBT Consulting performance And by the growth and increasing revenue mix of our higher margin research advisory and IPS service offerings. This highlights the reasons why we have accelerated our investments in this area. The quarter benefited from the growth of our Ipass revenues As our contract we discussed last quarter continued to ramp. We also continue to be actively engaged in contract and pilot discussions with Other several large software and service companies that help them bolster their value selling and value realization efforts. Our results also benefited from the growth of our Research Advisory business. During the quarter, we launched our first of 3 new market intelligence programs that we plan to launch by year end. These programs allow us to compare the differentiating capabilities of software and services providers, which should help them strategically support their sales and marketing efforts. The Global SPT or Strategy and Business Transformation segment revenue growth Was partially offset by the results of our Oracle and SAP segments, which were down as expected in the quarter. Both groups have been rebuilding their pipelines after strong 2021 performance. We now expect year on year revenues for both segments to level off in Q1 and return to growth in Q2 of 2023. Our investments that we 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 starting to pay off. These platforms are allowing us to highly differentiate all of our offerings and also Develop new licensing and research relationships with software and services providers across the enterprise. On the balance sheet Side, our ability to generate strong cash flow from operations has allowed us to increase our dividend. And today, we announced the expansion of our credit facility And a $120,000,000 Dutch tender offer to acquire over 5,000,000 shares of our company's common stock. This tender offer should be strongly accretive, especially when you consider that the reduction of the dividend payment due to this buyback is As we have discussed on our last few calls, we wanted to be more aggressive with our balance sheet by expanding our credit facility to fund acquisitions and to 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. Rob? Thank you, Ted. As I typically do, I'll cover the following topics during this portion of the call. I'll go through an overview of our Q3 results along with an overview of related key operating statistics. I'll go over an overview of our cash flow activities in the quarter, and I'll conclude with a discussion on our financial outlook for the Q4 of 2022 as well as make some comments in relation to the Dutch. Before moving to our results, I'd like to comment on the Form 10 ksA that was filed this evening. Based on comment letters and discussions with the staff of the SEC, the company concluded that we had a material weakness in our internal control of financial reporting as it relates to segment disclosures. It is important to note that the omission of additional segment disclosures did not result in material misstatement of the company's financial statements. Effective in the Q3 of 2022, the company has reorganized its operating and internal reporting structure to better align with its primary market solutions. Due to this reorganization, the company is expanding its reporting to 3 segments. 1, Global Strategy and Business Transformation or Global SMBT 2, Oracle Solutions and 3, SAP Solutions. As a result, I will comment separately regarding the revenues of our Global SMBT, our Oracle Solutions Group, our SAP Solutions Group and the total company. Our global SMBT group includes the results of our North America and Our research advisory programs and benchmarking services, our OneStream offerings and our business transformation, Our Oracle Solutions and our SAP Solutions segments include the results of our North America Oracle and SAP offerings respectively. Please note that we will be referencing both total revenues and revenues before reimbursements in our discussion. Reimbursable expenses Our primarily project travel related expenses passed into our clients and have no associated impact to our profitability. During our call today, we will also reference certain non GAAP financial measures, which we believe provide useful information to investors. We included reconciliations of GAAP to non GAAP financial measures in our press release filed earlier today 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 Q3 of 2022, Our total revenue was $72,000,000 Our revenues before reimbursements were $71,000,000 which was in line with our quarterly guidance. The 3rd quarter reimbursable expense ratio on revenues before reimbursements was 1.5% as compared to 1.6% in the prior quarter And 0.7% when compared to the same period in the prior year. Post COVID, as we've said, we have experienced increased client Related travel, however, given our transition to a remote delivery model, we do not expect these project related travel expenses to return to pre COVID levels. Revenues before reimbursements for our Global SmbT segment were $41,100,000 An increase of 11% when compared to the same period in the prior year, reflecting the continued year over year growth since the Q2 of 2020 and the continuing demand for digital transformation investments. The U. S. SMBT revenue before reimbursements growth was 13.2% and international SMBT was 1.6%, but was 16% utilizing the same foreign currency rates in the Q3 of the prior year. Revenues before reimbursements for our Oracle Solutions Segment were $17,400,000 a decrease of 16% when compared to the same period in the prior year. We experienced extended client decision making during the quarter as clients reconsider their spending priorities. As we exited the quarter, however, several large opportunities closed, which is further evidence that the digital transformation demand remains healthy. Revenues before reimbursements for our SAP Solutions segment was $12,500,000 a decrease of 10% when compared to the same period of the prior year. As we have stated previously, SAP Solutions is coming off of strong 2021 results and continues We built this pipeline after the completion of some large SAP engagements late in 2021. SAP results benefited from strong VAR activity at the end of the quarter. Approximately 21% of our total company revenues before reimbursements Consistent with current and subscription based revenues, which includes our research advisory, IP as a service, multiyear benchmarks and application managed service contracts. Total company adjusted cost of sales, which exclude reimbursable expenses and non cash stock based compensation expense, totaled $41,200,000 We're 58.1 percent of revenues before reimbursements in the Q3 of 2022 as compared to 43,600,000 or 61% of revenues before reimbursements in the prior year. Total company consultant headcount was 121 at the end of the third quarter as compared to total company consultant headcount of 11 22 in the previous quarter And 10.75 at the end of the Q3 of 2021. The year over year increase was primarily a result of hiring activities and increased utilization of Total company adjusted gross margin on revenues before reimbursements, which excludes reimbursable expenses and non cash stock based compensation was 41.9% in the Q3 of 2022 as compared to 39% in the prior year period. The 290 basis point gross margin improvement was primarily driven by the relative mix of higher margin global SMBT revenues as well as higher margin VAR sales during the quarter. Adjusted SG and A, which excludes non cash stock based compensation expense, Intangible asset amortization and restructuring activity was $13,800,000 or 19.4 percent of revenues before reimbursements in the 3rd quarter. This is compared to $13,600,000 or 19.1 percent of revenues before reimbursements in the prior year period. Adjusted EBITDA was $16,900,000 or 23.7 percent of revenues before reimbursements in the Q3 of 2022 as compared to $15,100,000 or 21.1 percent of revenues before reimbursements in the prior year. GAAP net income for the Q3 of 2022 totaled $10,400,000 or diluted earnings per share of $0.32 for the Q3 of 2022 As compared to GAAP net income of $8,100,000 or diluted earnings per share of $0.25 in the Q3 of the previous year. Adjusted net income, which excludes non cash stock based compensation expense and restructuring activity in the Q3 of 2022, Both $11,800,000 or adjusted diluted net income per common share of $0.37 which is above the high end of our earnings guidance range. Our adjusted net income for the Q3 of 2022 was favorably impacted by approximately $0.01 Due to the utilization of a GAAP effective tax rate on adjusted earnings, which was 26% as compared to the 28% that was utilized For our Q3 2022 guidance, in Q2 of this year, we moved to an actual GAAP effective tax rate for adjusted net income reporting purposes. This compares to adjusted net income of $10,300,000 or adjusted diluted net income per common share of $0.31 in the Q3 of the prior year. Adjusted net income for the prior year included an effective tax rate of 27.8% on a GAAP basis. The company's cash balances were $67,000,000 at the end of the Q3 of 2022 as compared to $61,700,000 at the end of our previous quarter. Net cash provided by operating activities in the quarter was $9,800,000 Primarily driven by net income adjusted for non cash activity and increases in income tax liabilities, partially offset by increases in accounts receivable and decreases in accrued expenses and contract liabilities. Our DSO or day sales outstanding at the end of the quarter was 66 days as compared to 59 days at the end of the previous quarter, primarily due to quarter end SAP license related sales. Our remaining stock repurchase authorization at the end of the quarter was $10,600,000 Subsequent to the quarter, The company's Board of Directors authorized a $120,000,000 increase in the company's share repurchase authorization. Additionally, the Board declared the 4th quarterly dividend of $0.11 per share for its shareholders of record On December 23, 2022 to be paid on January 6, 2023. Before I move to guidance for the Q4 of 2022, I would like to remind everyone of the seasonality of our business, specifically Decreased holiday and vacation time that is historically taken in the 4th quarter will decrease our available billing days by approximately 8% to 10% when compared to the 3rd quarter. The company estimates total revenue before reimbursements for the Q4 of 2022 to be in the range of 66 to $68,000,000 We expect global SMBT revenue before reimbursements to be up on a year over year basis And we expect Foraker Solutions and SAP Solutions to be down on a year over year basis. We estimate Adjusted diluted net income per common share in the Q4 of 2022 to be in the range of $0.33 to $0.35 which assumes an effective tax rate on adjusted earnings of 28%. It's important to note that GAAP results for the Q4 of the prior year Included a $7,700,000 or $0.23 per diluted share tax benefit Related to the exercise of our outstanding share appreciation rights, which will impact year over year comparisons. We expect adjusted gross margin and revenues before reimbursements to be approximately 44% to 45%. We expect adjusted SG and A interest expense in the 4th quarter to be approximately $15,000,000 We expect 4th quarter adjusted EBITDA on revenues The company announced today its plan to launch a tender offer to purchase up to $120,000,000 in value of its common stock at a price not greater than $20.50 nor less than $23.50 We expect to launch the tender offer tomorrow, which would mean it would expire on December 8, 2022. We plan to conduct a tender offer through a procedure commonly known as a modified Dutch auction. This procedure allows stockholders Select the price within the specified price range set by the company at which stockholders are willing to sell their shares. The company will select the single lowest purchase price within the range that will allow the company to purchase $120,000,000 in value of shares at such price based on the number of shares tendered. All shares purchased in the tender offer will be purchased at the same price. The tender offer will only be made pursuant to the offer to purchase The related letter of Transmital and the other tender offer materials, which the company will file tomorrow with the Securities and Exchange Commission. Any specific questions should be addressed directly with the dealer manager or the information agent for the tender offer. Their contact information will be included in the press release we will issue tomorrow, announcing the tender offer and in the tender offer materials being filed with the SEC tomorrow. Additionally, subsequent to the end of the Q3, the company entered into a New 5 year $100,000,000 credit facility with Bank of America and U. S. Bank. Under the credit agreement, these banks We have agreed to lend the company up to $100,000,000 from time to time pursuant to a revolving line of credit. The loans under the credit facility will bear interest Based on the Bloomberg Short Term Bank Yield Index or BISB plus an applicable margin which ranges between 1.5 and $2.25 per annum. The proceeds of the credit facility will be used along with cash on hand For the purchase of the shares and the tender offer along with the related fees associated with the offer and the credit facility. Lastly, We expect our cash balances to be down from the Q3 as we plan to use approximately $50,000,000 in cash to fund the tender offer as well as costs associated with the tender offer and credit facility. At this point, I would like to turn it back over to Ted to review our market outlook and strategic priorities for Cremovus. Thank you, Rob. As we look forward, let me share our thoughts on the near and long term demand environment and on the growth opportunity it offers our organization. Digital Innovation and Enterprise Cloud Applications, Analytics and Infrastructure, Workflow Automation and Process Mining are dramatically Forcing organizations to fundamentally change and adopt these new capabilities in order to remain competitive. Clients understand that that payback from Digital transformation projects are critical to their long term competitiveness and as they evaluate the Fed's aggressive attempts to slow down the economy and the impact on their respective businesses as well. With that said, although digital transformation demand remains strong, It is being impacted by extended decision making as organizations assess competing priorities created by the increasing interest rates. During the quarter, we experienced a disruption of a meaningful project and noticed clients reassessing their spending priorities. However, we also saw other large projects go forward as we exited the quarter. During the quarter, we also saw some of our clients rebalance their spend with productivity and Strategic cost reduction efforts, which are also core to our offerings. On the talent side, competition for experienced talent continues, But we saw turnover moderate during the quarter and expect that trend to continue. Long 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, which is very valuable to them. This should also 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 our recurring high margin IP related services by increasing the content development and the sales and marketing resources dedicated to this area. Additionally, we have increased our investment in our research advisory member platform and expect to have a new version launched in early 2023. As I previously mentioned, we have also started to launch a series of new market intelligence programs that will help assess and highlight the unique capabilities of software and services providers across selected categories. Our goal is to launch 3 programs by year end And then further accelerate the number of new programs launched in 2023. We are absorbing these increased costs in our current results, but believe that they can add high margin recurring revenue. It is also important to note that we continue to see increasing downstream revenues From our benchmarking and research advisory clients to our Business Transformation and Technology Consulting Services. Over the last 2 years, over 40% of our consulting services have come from our research advisory and benchmarking client base. Simply put, organizations who rely on our IP, research and benchmarking services are also more likely to utilize Our consulting services. We are also exploring strategic relationships that will allow us to syndicate our IP through new channels That will allow us to reach significantly beyond the current Global 1,000 focus in a very efficient manner. We expect to launch the first of these relationships, which should result in new high recurring margin revenue prior to the end of the year. We will also continue to 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 effort. They are also the underpinning technology for our IP as a service offering. It also allows our clients to leverage RFP 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 effort. We believe there is no comparable IP led platforms in the market. As I've been mentioning on our calls, we have added a 20 minute demo of our Investor Relations page on our website So that investors can become familiar more familiar with the capabilities of our platforms. We plan to refresh those as well as we enter 2023 For those of you who have been exposed to it before and just want to continue to see our innovation. Lastly, even though we believe that we have client base and the offerings to grow our business, we continue to look for acquisitions and alliances that strategically leverage our IP and at scope, scale and capability, which As always, let me close by congratulating our associates on our performance and by thanking them for their tireless efforts And always urge us 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 Let us move into the Q and A section of our call. Operator? Thank you. Please ensure that your phone is unmuted. Our first question is from Jeff Martin with ROTH Capital Partners. You may go ahead. Thanks. Good afternoon, Ted and Rob. Hope you're doing well. Thanks, Jeff. Hey, Jeff. Ted, I wanted to see you mentioned the disruption of a meaningful Contract with an SNBT in the quarter. I was curious if that was a temporary disruption or if that's going to continue to Impact Q4 and if that was part of the consideration within your guidance for the quarter? It was clearly part of our consideration. There's a difference between an actual project stopping, which by the way impacted Q3 by probably $0.01 or $0.02 and impacts Q4 by $0.01 or $0.02 But overall, what we're seeing is the demand and activity for the digital transformation initiatives remain Unchanged. But we're seeing clients being challenged in new ways and other ways, which forces them to reprioritize and rethink their spend. And we know we're not unaffected by it. We are benefiting some by some of our benchmarking and strategic cost reduction activity, Which comes with some of those clients reassessing their spending priorities. But look, We're expecting these extended decision making to continue until we see it change. So that's what's reflected in our guidance. Okay, great. And then with respect to process mining, could you give us Maybe a progress report on what's been done this year to position the business For that market and if that's contributing to revenue and profitability yet or if that is more the 2023 and beyond sort of impact Driver? No, it continues to be an area where we believe is high potential to our business model. But when we looked mid year, when we looked At the opportunities we had with iPass Growth, with the Content development and launching of new market intelligence programs, syndicating of our IP, all of which we controlled. We actually stopped the strategic joint venture efforts that we had launched earlier in the year and moved Our time and attention to these other areas, which again, we totally controlled and we really like the prospects of what we were seeing. Okay. And then with respect to your target model, which is 5% to 10% revenue growth, I think 15% to 25% Earnings growth. I would imagine you'd be at the low end of that range initially in terms of setting an expectation for 2023. Just curious if you could comment around that. Well, if you if we were trying to just crystal ball, we'll just assume that the if you want to call it slowing economy will impact This 4th quarter an impact perhaps the first half of the year. With that said, we would expect if Demand remains unchanged. And for the concerns around the economic slowdowns to abate That, we would go back to a pretty strong second half of twenty twenty three and that the investments that we're making Across all of our new programs and that increased sales investments we're making around our research advisory programs, all of those things to then to contribute To what we would consider our normal long term growth rate, but what we're seeing is that If we continue this growth, it would come at higher margins. So you're seeing that our operating margins, EBITDA margins are all improving, and we would expect that to be on an increasing recurring basis. So We believe that that's where the prospects of our business have its greatest potential. And then just let's go back and talk about our Oracle and SAP Solutions, even though it was it's been a rough 2021 I'm sorry, 2022 for that group off a Pretty decent 2021. Look, we're seeing good activity in those groups. We believe that they should continue to at least contribute growth At the low end of our long term growth rate in any environment and we also believe that their margin profiles as we continue To leverage offshore more, which we didn't mention, but if you'll see, we're managing wage increases are being nicely offset By the continued increase of offshore resources across all of our three segments, all of those things are contributing and creating a Margin profile at if you said, if you were to operate anywhere near the high end of our revenue growth rate with that new margin profile, The profitability profile for the business is clearly increasing, which you've seen throughout all of 2022. I mean, it's easy to forget because we're all getting when I say all of us, our clients and ourselves are getting impacted These increasing rates along with some of the other challenges that other industries face, But when you consider the very strong first half of the year that we had, even with this, let's call it, slowing second half compared to that first half, We still expect our 2022 results to be in excess of our historical record 2021 results. That's helpful. I'll pass it off. Thanks. Thank you. Our next question is from Vincent Colicchio with Barrington Research. You may go ahead. Yes. Ted, first question is, what gives you confidence in upturn in on the Oracle and SAP side? I think you said The Q2 of next year? Just the activity that we've seen even in the third and what we see in the pipeline going into the 4th quarter And some of the sizable engagements that we said that we signed as we exit Q3 and entered Q4 Impacted one of those two groups. So it's just the activity. That's why I didn't back off On the activity or demand around digital transformation, but we know that there are clients are facing other considerations and it will impact Pipeline velocity and conversion and we should plan for it. But the activity itself, it remains very strong. In fact, we've seen clients In industries that have been incredibly affected by Some of both the COVID and geopolitical issues that they faced not only in 2021 but in through 2022 continue To invest in these digital transformation initiatives in spite of those, I'll call it, headwinds that they're facing. So that's what that's why I continue to say, the demand is going nowhere. Look, we're just going to have some headwinds as clients decide How it's impacting their respective businesses and we'll have to manage through that. We think we'll do so successfully. Can you give us an update on how many IP as a service deals you're currently in negotiations with? Actually in contracting pilot and the like, we're probably got another 2 to 4 That are active right now. So hopefully, we'll have some of those some sign here before the end of the year. And then As I said previously, we would hope that we're able to see additional ones in 2023. And is are you seeing increased demand for more offshore in the software implementation side, Given the economic pressures and could that be a headwind to revenue for those businesses? No. But anyone who is going to be delivering technology related services has to have an appropriate blend Of offshore resources to compete, I mean, I will bet well, I'm not going to bet I've got Rob Sid in front of me, But our offshore resources are probably approaching 50% of our total resource on our Oracle and SAP groups and they continue to increase. So not only are they helpful for us in leveraging offsetting wage increases For all, really across the globe, that mix change. But they're making sure that we Very competitive with any rate related or pricing related issues clients may bring. Thanks, Ted. Thank you. The next question is from George Sutton with Craig Hallum. You may go ahead. Thank you. Guys, I'm stunned that the question hasn't been asked yet. Very bold move with the Dutch At this time in the economy and this time in the market, so can you just give us some perspective of why now versus, say, Why not 6 months ago? What are you seeing that's given you the increased conviction? And by the way, I love it. Okay. First, it's been a consideration throughout the entire year. So it's something that we launched in the year That's something that we knew was going to be a strategic alternative as we considered other strategic alternatives. With that said, We weren't able to get it all done maybe as timely as we hope. But When we consider the fact when we look at the cash flow that we're generating, we've looked at the volatility of our shares. We thought that just continued to sit on our balance sheet, especially when you consider, I'm going to repeat the comment that I made That the interest expense that we're incurring will be significantly offset By the elimination of the dividends on the shares that are being repurchased and the, if you want to call it the tax effect interest expense. So our net of dividend and tax interest expense will remain very low for us. So when we took all of those things into consideration, we said we sat on it. I thought I personally sat on it as we looked at other strategic considerations, including acquisitions throughout 2021. I did want to let the year go by. Like the strength of our operations, strength of our earnings, cash flow we're generating. So we decided to go forward with So in other words, you've actively looked at strategic opportunities from an M and A perspective and found that Your own shares are the best investment. I guess that would be the logical summary? That is correct, especially when you look What we believe are the growth prospects from our research related offerings, iPass licensing, All of the above, we think it's a great investment. So You mentioned a new research advisory platform to launch in early 2023. Can you just give us some sense of What the incremental ads might be there? What's different about that platform? Well, I'm embarrassed to say that The existing member portal has taken our platform has taken a back seat to the significant investments That we made in Quantum Leap and digital transformation over the last 3 to 4 years. It's something that we probably should have and did start earlier, But it took a backseat to these other platforms that you know, George, have turned out to be very important to our current offerings. With that said, when we look at the amount of money we're spending now to grow programs and to grow the sales force around those research programs, We said we better get a state of the art member platform in place As we do that throughout 2023, so knock on wood, let's see if we get that first version out early in 2023. Clearly, our members deserve it. Superb. Thanks guys. Appreciate it. Thanks George. Thank you. And at this time, I show no further questions. I will now turn the call back over to Mr. Fernandez. Well, I'd like to thank everyone for participating in our Q3 earnings call. We look forward to updating all of you when we report The Q4, as Rob said, you will see press releases that will be going out tomorrow along with the details of our Dutch tender offer that will go out before the market opens. Thank you again for participating. Thank you. That does conclude today's conference. Thank you all for participating. You may disconnect at this