The Hackett Group, Inc.
Q3 2008 Earnings Call Transcript

Published: 20 Nov 2008

[Operator:]

Welcome to The Hackett Group third quarter conference call. (Operator Instructions) Hosting tonight’s call are Mr. Ted Fernandez, Chairman and CEO, and Mr. Rob Ramirez, Chief Financial Officer.

[Robert A. Ramirez:]

Thank you for joining us to discuss The Hackett Group’s third quarter 2008 results. Speaking on the call today and here to answer your questions are Ted Fernandez, Chairman and CEO of The Hackett Group, and myself, Robert Ramirez, CFO. Our press announcement was released over the wires at 4

[Ted A. Fernandez:]

As we customarily do, I will start by providing some overview or highlight comments on the quarter. I will then turn it back over to Rob and ask him to comment on our operating results, also speak to cash flow, and provide some commentary on outlook. Rob will turn it back over to me. It will allow me a chance to provide some market perspective and talk about some of our strategic priorities and then we will open it up for Q&A. Let me start with the Q3 highlights and welcome everyone to our third quarter earnings call. We are pleased to report another strong quarter with pro forma earnings per share increasing 29%, led by the Hackett Group’s 11% revenue growth, 13% on a constant currency basis. Our strong operating results, coupled with improved DSO performance, resulted in over $12.0 million in cash flow from operations in the quarter. This allowed us to increase our cash balances during the quarter while returning over $6.0 million to our shareholders through our stock buyback program. On a year-to-date basis our operating income of $16.3 million has more than doubled from last year, which speaks to all aspects of our progress. Despite the economic turmoil and even though the sudden drop in foreign currencies are reducing our total company fourth quarter revenue guidance by nearly 4% and our EPS guidance by $0.01, we are poised to have another strong quarter to close out 2008. We have seen clients continue to seek our advice in implementation assistance. We know their need to better understand and manage their costs and working capital has only increased as the economy has slowed and as credit availability has become more difficult to obtain. The question is where they can do this for themselves or who they decide to turn to for assistance. Our job is to continue to ensure that our clients understand that our unique intellectual capital and implementation expertise enable them to make the necessary changes in a very targeted and timely manner. We are also pleased to report our first year-over-year growth in our technology solutions group since the first quarter of 2006. It is clear that the investment we have made in new leadership, our offshore facility, and in our best practice and industry solutions, are paying off for this group. As I have mentioned throughout the year, several changes have driven our improved performance. The introduction of our transformational benchmark has expanded our initial entry point with our clients. The improved performance by our REL team has been meaningful and the cross-selling opportunities to and from our other Hackett offerings still represent a significant growth opportunity that we have yet to capture. Lastly, our ability to sell other services into our executive advisory client base has been expanding but we are just starting to fully realize the power of this continuous and trusted relationship that we have with these clients. Let me elaborate just a little bit more on each of these items. As you will recall, at the beginning of last year we introduced the transformational benchmark that allowed us to sell our transformation planning, design and implementation services along with our benchmark. As a result, we have experienced an increase in the average revenue per client and we have improved the leverage of our intellectual property in our pricing, which is also evident in the increase in revenue per professional and also in gross margins. Along with this strategy, the improved REL performance, and the improved [REL] performance, have been the primary reasons for our increased growth and profitability since the beginning of 2007. On the REL front, we are seeing improved performance across all of our operating metrics and regions. This is a group that is benefitting from the credit crisis as clients seeks alternative ways to generate cash. Over the last two years we increased our investment in both resources and infrastructure across France, Germany, and the U.K. and we launched our line to the Nordic regions. Those investments continue to pay off with year-over-year international growth of 22% in Q3. Lastly, the investments in leadership and sales and marketing in our technology solutions businesses have started to pay off and this has been most evident in the improved performance of our Hyperion, or Oracle EPM, group. It is clear that our go-to-market execution has improved and our brand permission has expanding globally. At the same time, we recognize that there is much room for improvement and the opportunity provided by our brand and the unique best-practice intellectually property that we have is vast. We are creating a powerful, highly-recognized global professional services brand with services that help clients improve organizational effectiveness globally. Let me now ask Rob to provide details on our operating results, cash flow, and also comment on outlook.

[Robert A. Ramirez:]

I plan to cover the following topics

[Ted A. Fernandez:]

As we look forward, we continue to believe that the market demand for our services remains healthy. But we are cognizant that the recent market turbulence can impact behavior. As I mentioned in my opening comments, a growing number of companies now recognize the need to reduce costs and optimize cash. The key for us is to make sure that the clients understand the role we can play in helping them affect the necessary changes as their revenue growth prospects change. Geographically, we entered the year expecting that the U.S. economy would slow and we would see lower discretionary spending impact our U.S. business. In Europe we expected better demand, but tempered from the strong demand that we had experienced throughout 2007. The impact of the slowing economy is now clearly evident globally, and in our view, was only exacerbated by the global credit crisis. We expect clients to be more thoughtful about their discretionary spend during this period, but it is also clear that the cost reduction in cash flow improvement initiatives will receive increased attention from our client base and has resulted in a net increase in overall demand thus far. This is more evident when you look at our activity on a local currency basis. Despite the global economic slowdown, we remain optimistic that we continue to be net winners during this period. Given this activity, our prospects for strong EPS and EBITDA improvement in fiscal 2008 have remained unchanged, even though foreign currency changes will negatively impact our Q4 revenue and EPS results. Our Hackett Group, excluding Technology Solutions, long-term prospects of 50%+ growth remain unchanged. However, with the current level of economic uncertainty, we don’t know the impact we may experience in the short term. With that demand overview as a back drop, let me comment on our strategic priorities for 2008 and I will start with revenue growth. We continue to believe that the opportunity to grow by increasing our revenue per client with our current offerings is significant. Specifically, and some of these I covered in my opening remarks, the increased leverage that can come from further expanding the number of advisory clients utilizing our other services, meaningful. The ability to better integrate the REL capabilities with other Hackett opportunities is significant, and as I mentioned earlier, have been limited at this point. Another meaningful opportunity for us. And our ability to convert more of our transformational benchmarks into larger implementation initiatives continues to be very significant. We also continue to see a great opportunity to continue to expand internationally. We have seen our brand strongly resonate with both prospective clients and associates outside the markets that we currently serve. We want to expand out lines partner relationships in markets that we are not currently serving as a great way to expand our brand and offering and rive incremental growth very efficiently. I have previously noted the strong performance from our European Nordic region line and as I have mentioned previously, we would like to use this same strategy in other regions. During the third quarter we signed an alliance agreement with an organization in South Korea and we now expect to announce another alliance during the fourth quarter. During the quarter we also expanded our presence to Asia Pac with our new planned expansion, starting in Australia. Lastly, we continue to actively look for acquisitions that would enhance and strongly leverage our existing intellectual capital to drive and accelerate our growth. Let me comment further on the executive advisory leverage. As you know, our long-term goal is to be able to ascribe an increasing percentage of our total annual revenues to clients who are continuously engaged with us through our executive advisory program. Our clients use our executive advisory programs to track emerging issues and to support performance improvement initiatives that they are assessing or executing on their own. At the end of the quarter, gross membership counts approximated 770, while client counts approximated 235. Client count is basically flat with last quarter, but more importantly, an increasing number of advisory clients are driving a larger amount of our total revenues. We have seen this happen throughout the entire year, which is a validation of our strategy. We continue to believe that both the percentage of clients and the sales to that loyal client base should continue to expand. Correspondingly, expanding our member and client counts remains one of our key strategies. As I mentioned last quarter, given the success we are having leveraging our executive advisory entry point into broader relationships, we plan to increase the number of sales associates solely focused on executive advisory program growth through the balance of the year and into 2009. Those recruiting and hiring efforts are underway. Let me speak to the need to expand the leverage of our best-practice intellectual capital. We know that the reason we are distinct is because of the proprietary data we capture through our benchmarks and the applied knowledge that we have captured in our best-practices repository and implementation tools that help clients drive to a targeted solution very efficiently. A key element of our 2008 plan is changes to the product architecture, which determines how we avail our intellectual capital to clients. We believe we are continuing to improve how we do this and one of our key initiatives has been to fully integrate the access and automation of our best-practice implementation tools into our new global delivery methodology. We believe this will enhance the marketability, usability, and enhance data and IP capture. And lastly, talent management; as we continue to grow and fully recognize the potential of our business model, it has become increasingly evident that the only limit to our progress and opportunity will be our ability to attract, retain, develop, and energize our associates. Our associates are passionate about our organization and we must ensure that we nurture this sentiment. To this end, we have been developing a comprehensive global talent management program that will ensure that we have an opportunity to excel across all of these dimensions. Last quarter we rolled out the first phase of the talent management initiative at our expanded U.S. and European knowledge-share meetings, which were attended by all of our market-facing associates. We have now also rolled out a new performance management program and have set a very aggressive expansion of our training curriculum for all of our associates, going into 2009. We have, and will continue to, increase our investment in this very important area. In summary, the strategy we put in place several years ago, along with the changes we affected over the last couple of years, have been favorable to our growth and profitability. As I repeatedly say to our associates, the opportunity for our organization is truly boundless when you consider the power of our brand, the unique intellectual capital, along with the very talented associates, we know we have an opportunity to build one of the most admired and valuable professional services organization in the world. We believe this is applicable even during challenging economic times. Let me close by thanking all of our associates for their contributions and their tireless effort and congratulate them again for the great progress that we continue to make. Let me now open it up for Q&A.

[Operator:]

(Operator Instructions) Your first question comes from Bill [Detillio] – Boenning & Scattergood.

[Bill [Detillio]:]

Could you give us more color on the sales cycle, specifically the differences, if you are seeing any, between the United States and Europe and between the Hackett Group and REL.

[Ted A. Fernandez:]

First of all, sales cycles generally, we are seeing all kinds of different behavior. One behavior is clients now realizing that their demand, or their revenue growth opportunities, are in fact changing or will be more volatile, so we see them taking a more comprehensive look at all aspects of cost and cash. That can lead to a slight delay in that decision-making process, but we also recognize that if they do it thoughtfully the opportunities for us will be more significant. Having said that, so far we have seen an equal number of clients then turn to us with more urgency and simply say they would like to get started on an initiative. On the REL front, specifically, there is no doubt that the credit crisis has led to an increased activity in both our European and U.S. teams and the prospects for that team just remain very, very strong. As I said in our overall comments, thus far we have been net winners of the behavior we have seen from clients and we will continue to track it closely and hope that it stays that way.

[Bill [Detillio]:]

Could you also talk about what are your pricing plans going into next year? Do you foresee changing them at all?

[Ted A. Fernandez:]

We do not. As you have seen over the last 18 months, our revenue for professional and gross margins have expanded very nicely. We believe that the opportunity that it is currently providing for us is meaningful. So for us, it’s really just positioning our intellectual capital in the most strategic way. It is what allows us to drive better pricing leverage and drive better margin performance. If we simply engage a client with just that we have people who do something really well instead of making sure clients understand that in addition to having very talented people, we have intellectual capital both in terms of benchmark metrics and best-practice execution, which is unique to us, and that allows them to get to an answer in a more targeted fashion and more quickly, our pricing works out very nicely and we don’t intend to change that. I think for us, as you can see by my comments on the talent management program, our focus is just making sure that all of our associates are better, or are getting better, at explaining how they can leverage our IP and how well we can help them affect change. We think that’s where the best opportunity for improved pricing and margin expansion lie.

[Bill [Detillio]:]

You had mentioned utilization, you are currently meeting those target levels overall. Could you give us an idea, are you meeting that target utilization specifically within the Hackett Group?

[Ted A. Fernandez:]

Actually, in the target group, we have been, on an overall basis, slightly below our target for the entire year so it’s funny because we know we have achieved very high levels of revenue for professional and improved gross margin, but we know that not all of our teams within our Hackett Group are at target utilization. On the tech side we have clearly seen improved utilization, especially it’s being reflected in our improved Hyperion performance so we have seen that in some aspects of tech as well.

[Bill [Detillio]:]

Can you give us an idea where attrition stands? Are you seeing any slowdown in that or is it kind of the same?

[Ted A. Fernandez:]

We have seen a slowdown in attrition. If anything, we are seeing an increased number of opportunities to hire people over the last several months than we saw in the first half of the year. So from a resource perspective, although we are working very diligently and investing more dollars to see if we can improve the performance of all of our people, we do see an opportunity to bring in new and very good talent in some areas that we are targeting.

[Bill [Detillio]:]

And is this the junior level or senior level or both?

[Ted A. Fernandez:]

My comments are really more about some of the more senior or impact people. Our ability to hire overall has remained very good throughout the last couple of years and I think it will remain unchanged.

[Bill [Detillio]:]

Regarding your goals for 2009, could you give us some color as far as where maybe your productivity client goals. And then given the impact of exchange rates, would you still think a 4% impact would be appropriate for 2009?

[Ted A. Fernandez:]

Relative to foreign currency, you guess is as good as mine so I would love to add to that, to be honest with you, we were surprised at just the sudden drop, especially those first couple of weeks in October were just steeper than anything we have experienced. So my hope is that as some of the Bank of England and European community bank rates come down that maybe we will see some improvement in that relative relationship than what we have seen lately. But that’s a personal hope. We will track them closely and we will provide more perspective on that as we guide Q1. Productivity goals remain unchanged because if anything, again we like the gross margin performance of both of our teams so the relative pricing we have been able to get and the relative gross margins resulting, we think it’s very healthy so our hopes are to keep it very close to current levels. Relative to client expectations, it’s too early to tell. I tried to provide as much color as I could. I think what we can say is we have been net winners thus far and we understand why our business model could continue to have some success during this transition, but we’re also cognizant of the fact that things could change depending on just how difficult the economy gets in certain regions and for certain clients. We wanted to provide that perspective and tried to be as open as we can about it, but we will add a lot more color as we guide Q1.

[Operator:]

Your next question comes from George Sutton - Craig-Hallum Capital.

[George Sutton:]

The thing that I was really pleased with this quarter was the cash flow and I wondered if you could address that in more detail. We don’t have all the numbers from the press release. Was a lot of the cash flow driven by the continued reduction in DSOs?

[Robert A. Ramirez:]

Actually got some pleasant news as we were researching. Our DSO is actually the lowest in the company’s history, at this particular juncture. So the decrease of 9 days in a quarter was an extreme benefit, as well as the timing of our payroll cycles. We have one cycle that falls outside the quarter so that had a positive impact, as well. And of course the most important thing is just the strong operating earnings in the quarter.

[George Sutton:]

You mentioned you felt you might be able to further improve DSOs.

[Robert A. Ramirez:]

That is our goal.

[George Sutton:]

I’m curious, can you give us a sense of how significantly you could improve them from here?

[Robert A. Ramirez:]

We have a pretty aggressive target that we are aiming towards. If you look at other of our competitors you will see some outliers that are in the 30s and 40s and we continue to think that we can head toward those levels.

[George Sutton:]

Ultimately you can use your own DSO success in selling REL.

[Ted A. Fernandez:]

They have helped us, by the way. Our internal target has been 45 days. Our COO has been all over this. Rob and his team along with our practice leaders, and David Dungan’s leadership have really driven this number down pretty significantly. Broadly speaking, our results probably drove $7.0 million to $8.0 million of the money. The cash flow improvements probably drove another $4.0 million to $5.0 million and the other delta is a couple of items. The payroll is probably another $2.0 million.

[George Sutton:]

Your expectations for Q4 look to be almost like there’s almost no real change in the environment other than FX and I think when you addressed on the call last quarter, you suggested Europe might remain relatively strong vis-à-vis the U.S. and I think that has changed in the quarter and your guidance really remains fairly robust. So can you give me a sense of whether or not anything really has changed or not?

[Ted A. Fernandez:]

Clearly things have changed so I think for us to say we don’t recognize what everyone is going through and the type of conversations we have with our clients would not be appropriate. Now, relative to our own business, and relative to Europe—it’s interesting, during the third quarter we get the August holiday impact so we wondered whether in the middle of the third quarter we were seeing some impact in activity or any lull of activity because of the holiday period or if it were something more significant. But we were pleased with some of the activity we saw in September and have seen so far in October. So when we look at that activity on a constant currency basis we are saying we are holding up pretty nicely. And as I also say, knock on wood. So we look at that. And when you couple in with Europe, what we believe is probably improving opportunity for REL, which is a nice piece of that entire European story, it still paints a healthy picture for us. So the real question for us is whether the economic impact on clients becomes so severe that they take more severe actions. When clients are hit very hard, what we see sometimes is that they decide to be less thoughtful and then just decide to make unilateral cuts, which may be very bold and may make them feel a lot better in the short term, but long term they will see that those kinds of changes do not drive sustainable, continuous improvement. So our goal out there is to make sure we are making sure clients understand that they need to do this in a thoughtful way, we’re one of those people that really can them. We have unique intellectual capital to do that and hope that continues to show up in our demand.

[George Sutton:]

Could you just give the share count at the end of the quarter? You did give a weighted average in the press release.

[Robert A. Ramirez:]

It’s approximately 42.0 million. I will give you the exact number later.

[Operator:]

There are no further questions.

[Ted A. Fernandez:]

Let me thank everyone for participating in our third quarter earnings call. We look forward to updating you further when we report the fourth quarter and our annual results.

[Operator:]

This concludes today’s conference call.