The Hackett Group, Inc.
Q2 2009 Earnings Call Transcript

Published: 12 Aug 2009

[Operator:]

Welcome to The Hackett Group second quarter earnings 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:]

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, Robert Ramirez, CFO. A press announcement was released over the wires at 4

[Ted A. Fernandez:]

Welcome, everyone, to our call. As I customarily do, I will start the call by making some overview comments relative to the quarter. I will then turn it over to Rob and ask him to comment on the detailed operating results, address cash flow details, and then also address our guidance for the following quarter. Rob will then turn it back over to me, I will make some comments relative to the market, and some of the strategic responses that we are focusing on, and then we'll open it for Q&A. So having said that, let me again start by welcoming everyone to the Hackett Group's second quarter earnings call. For the quarter we reported revenues of $34.6 million and pro forma EPS of $0.02, both in line with our guidance. As expected, our results reflect the impact from the volatile economic environment, which our clients are experiencing across the U.S. and international markets that we serve. However, as our Q3 guidance indicates, we now believe that revenues will stabilize, or be up, sequentially in the upcoming quarter, which will allow us to benefit from the cost management actions that we have taken to date. As we noted in early May when we provided our Q2 guidance, although our client pipeline activity is healthy, clients are simply taking longer to make decisions and in general, they are making smaller commitments. Initiatives that do not have credible ROI targets but with longer benefit-realization time frames, are more difficult to get approved. Accordingly, even though all of our practice groups were impacted by the current environment, our Hackett Technology Solutions projects, which typically have longer benefit realization time frames, were impacted more significantly in the quarter. However, based on current pipeline activity, as I mentioned before, we now expect both Technology Solutions and Hackett Group revenues to stabilize and be flat to up in the quarter. During the quarter we also started to see the benefits of our efforts to engage clients more strategically around the design and implementation of global operating platforms, or as we refer to it internal, our client service delivery models. This focus resulted in several large key wins that will benefit our results for the balance of the year. We are also encouraged by improving GDP figures in the markets that we serve, along with improved client decision making that we saw during the second quarter. Although we have had to take difficult cost-reduction actions, we are pleased that the actions we are taking are allowing us to continue to invest in our people, in our offerings, while maintaining an appropriate level of profitability and cash flow under difficult market conditions. This will allow us to reward high-performing associates while also protecting our shareholders' interest. We also believe that many of these actions provide sustainable operating leverage that we will be able to benefit from as our revenue growth re-emerges. As I mentioned last quarter, we will continue to ensure that our clients understand that our unique, best-practice intellectual capital and implementation expertise allows them to accelerate the change they must make to reduce costs and improve cash flows while improving operating excellence. This requires operating agility that many organizations simply do not have. Along with cost reduction and cash flow improvement, the ability to sustain these benefits as growth stabilizes and re-emergence is becoming an increasing area of focus for our clients. A lot of them are simply being questioned by their shareholders for the cost reductions and actions you have taken to create real operating leverage for the balance of the year and in 2010 and beyond. This type of change requires operating excellence, not just brute force. This is where we believe our offerings excel. Although we continue to plan for a challenging environment for the balance of the year, we are also making sure that we build on the great momentum we created over the last several years. Accordingly, we will continue to execute strategies that allow us to expand our brand permission and improve in all aspects of our go-to-market execution. I will comment further on market conditions and our specific go-to-market initiatives relative to revenue growth, but let me first ask Rob to provide details on our operating results, cash flow, and also comment on outlook.

[Robert A. Ramirez:]

As usual, I will cover the following four main topics this evening

[Ted A. Fernandez:]

Looking forward, alto in 2008 we performed highly in an increasingly difficult economic environment, it is clear that 2009 is a more challenging environment than what we experienced in 2008, but regardless of the length and extent and the current economic cycle, we know that it will pass, and more importantly that the long-term prospects for our organization remain unchanged. We continue to believe that the market demand for our services remains favorable. Companies clearly recognize the need to reduce costs and optimize cash during this period of economic uncertainty. They are also starting to realize that in the near term, revenue gains may be difficult to come by so operating excellence, which allows them to sustain the operating leverage that they have achieved, will be important in 2010. We continue to believe that as GDP improves gradually in the markets that we serve, that the pressure on discretionary spending will start to ease and clients will start to address how they can maintain productivity gains that they have achieved while improving, or maintaining, acceptable service levels throughout their businesses. As a result, we expect to see gradual improvement in the U.S. and international markets in the second half of the year. We also believe that the European recovery will lag the U.S. recovery by a quarter or two. With that demand overview as a backdrop, let me now comment on some of our strategic priorities, and specifically address revenue growth. Although we have been in a defensive posture over the last, really, two quarters, we now expect revenues to stabilize in the third quarter. Long term we understand our largest opportunity to grow will come by extending our special market permission from being the premiere global benchmarking organization to our global implementation capabilities across all of our offerings. Our clients must know that we are every bit as good as helping them implement the outcome as we are at identifying the opportunity to improve, using our benchmarking capabilities. To that point, one of our biggest investments has been in sales training and ensuring that our market-facing associates continue to improve their skills at presenting our key go-to-market messages and engaging clients strategically. This effort, which has been ongoing in the first couple of quarters, will continue in Q3. In fact, we've got a pretty significant meeting in the U.S. actually at the end of this week. The other key training area has been focused on the integration of our best practice implementation content and tools into our global delivery methodology, specifically in one of our key service areas, which is in architecting service delivery strategies and implementing global G&A operating platforms for our clients. Let me know speak to our executive advisory leverage. As I repeatedly mentioned, 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. At the end of the quarter, our membership counts approximated 690 across 215 clients, which are down slightly from last quarter. In Q2 over 50% of our total Hackett sales came from just over 10% of our advisory client base. At the beginning of the year we started to increase our investment in an advisory-dedicated sales team in both the U.S. and in Europe. During the quarter we decided to further increase the number of dedicated sales resources focused on our advisory program and we plan to do that during the third quarter. And it's important to note, as I mentioned last quarter, that all of our client touch points, executive briefings, client inquiries, the research we produce, the Web casts that are attended by our clients, continue to be highly read and attended and this has been consistent over the last several quarters. These touch points are important in expanding our market permission and staying top of mind with our client base as we help them address strategic issues. We also continue to see a great opportunity to expand internationally. We continue to look for alliance relationships as the most efficient way to make this happen throughout 2009. This is an area where we see how valuable our intellectual property is to potential partners across the globe. Last quarter we mentioned a new industry alliance with a shared service and outsourcing network. This quarter we executed an alliance agreement with IQ Business Group in South Africa that will help us introduce our brand in that marketplace. You can expect this kind of activity to continue across both industry groups and with specific consultancies in markets that we don't serve continued through the balance of the year. Additionally, we also continue to actively look for acquisitions that would enhance and strongly leverage our existing intellectual capital to drive and accelerate our growth. In summary, the strategy we put in place several years ago has been favorable to our brand expansion growth and profitability. Regardless of the short-term impact that we may experience, and have experienced, from the current global economic crisis, we are certain that the opportunity for our organization remains boundless. We have a powerful brand, proprietary and unmatched intellectual capital, a terrific group of talented associates, and a strong balance sheet with ample cash balances, and no debt. We have proven that these attributes are extremely valuable during increasingly challenging economic times and we believe they will allow us to optimize our market opportunity as the global economic conditions improve. Let me close by thanking our associates for their numerous contributions and their tireless efforts and urgence to stay highly focused on our clients and our people. This is an important time for our clients and our associates understand that our clients will strongly value those organizations that help them manage through this challenging economic cycle. Let me now open it up for Q&A.

[Operator:]

(Operator Instructions) Your first question comes from George Sutton – Craig-Hallum Capital.

[George Sutton:]

So last quarter, Ted, and I think in a couple of the previous quarterly calls, you have suggested a negative free to a positive free GDP is the ideal environment for you, and I'm not a GDP tracker, but I think we're about there. And I was just wondering, wouldn't this be the ideal time for the relevance of your offering as you're out pitching this offering?

[Ted A. Fernandez:]

We do. We do believe that when productivity is important to clients, which I believe it's within that spectrum you mentioned of kind of broad economic performance, that our services should be in the highest demand. And we would expect that to happen. Clearly you are dealing with clients in essence getting a little bit further away from what I'll call the economic crash of the latter part of 2008, so we know that clients are sensitive to any level of discretionary spend. But we also know that it is critical for clients to sustain all the productivity improvements they've put in place, and when I tell you that some of them have done it through brute force, I'm not exaggerating. We know, because we speak to many of these clients, that they will have to come back and make structural change to retain some of those productivity improvements. And we believe they will benefit us. So as things continue to get further away from what I call the economic crash, I would expect the overall demand for our offerings to improve.

[George Sutton:]

Could you give a little more detail in terms of where some of these cost cuts have been made and then the counter-thought process with respect to hiring more advisory sales people in Q3.

[Ted A. Fernandez:]

Well, it's been across the board. I think it really doesn't matter by industry, clients have really taken a very hard look at their entire operating platforms, and I'm talking soup-to-nuts, and looked at any way to improve both the efficiency and effectiveness of their platforms. Having said that, we know that many did this very quickly and they didn't do it as thoughtfully as they would have liked but that's what was demanded by the market. And they know that if they want to try to sustain those productivity gains, they're going to have to do more work. And I believe that in order to do, they will have to turn to outsiders for that level of assistance. So the question is only when and how does that really tie in with obviously their goals to try to maintain the highest level of profits through 2009, but I also think it will become a very significant part of the 2010 budget cycles.

[George Sutton:]

As you look out to 2010, so getting out a couple of quarters from now, where do you have the most concern, where do you have the most enthusiasm?

[Ted A. Fernandez:]

I think the most enthusiasm for us is, as I said, that clients, I think, will try to drive 2010 EPS growth by trying to sustain most of the operating leverage that they've been able to achieve in the first half of this year. But to do that, they're going to have to make investments in both their businesses processes across the business, and again, soup-to-nuts, and they're going to have to look at the underlying technology that makes that work. I think, to date, clients have done it, I'll call it the old-fashioned way, which is simply take costs out regardless of the ramifications, just because the revenue compression was so swift. But I would expect our services broadly to benefit from the way the clients try to deal with any kind of slow growth environment which I believe we will see somewhat in 2010, which requires them to really sustain all of the productivity gains that they have worked so hard to put in place in 2009.

[George Sutton:]

This $1.0 million in cost of sales savings that you mentioned sounds like it should fall to the bottom line, which suggests about $0.015 of EPS improvement alone. Am I reading that the right way?

[Robert A. Ramirez:]

You are. You're reading $1.0 million on a wide select basis from Q2 to Q3 and an additional incremental $1.0 million from Q3 to Q4.

[George Sutton:]

Oh, an additional from Q3 to Q4.

[Ted A. Fernandez:]

A penny and a half, as you said, from Q3 to Q4.

[Robert A. Ramirez:]

That is correct.

[Operator:]

Your next question comes from William Sutherland - Boenning & Scattergood, Inc.

[William Sutherland:]

Ted, maybe you could give us a little color on these new wins that you mentioned. To the degree that you can.

[Ted A. Fernandez:]

Well, we've worked very hard over the last 18 months to engage clients more strategically so that they don't just come to us for what I think they used to come us for, which is help them identify their performance improvement opportunity and in many cases either try to execute this on their own or turn to others for assistance. There is no doubt that over the last two years our revenue per client has increased and that's directly attributed to the fact that clients are staring to figure out that there's quite a bit more that they should do with us, that our expertise in actually implementing the opportunities for improvement we identify is absolutely core to our skills. So what we saw in the latter part of Q2 is we saw some very significant wins with exactly that, where we're seeing our brand permission expand, our associates just doing a better job at making sure clients understand how broadly we can serve them, and we were able to sign up some what we call significant clients. Multi-million dollar clients, and there were several of them. What we would have loved to see, in addition to that, is great volume. Because we know from great volume then come more of these opportunities. We still would love to see more volume relative to clients quickly identifying and moving through the pipeline. But we clearly can see that we are getting better and better at making sure clients understand that if they turn to us for simply just some high-level advice, or just to help them to identify and gap the opportunity using our benchmark, they're really, really foregoing some of the most valuable skills that we have, and that's actually implementing the solution, which we do very, very well.

[William Sutherland:]

So these are all benchmark transformations, I think you called them?

[Ted A. Fernandez:]

They were clients that were utilizing our intellectual capital either through an executive advisory program or that leveraged some of our benchmarking capabilities in order to, as we call it, size the prize. So yes, and they've now become a broader transformation client.

[William Sutherland:]

So with one or more goals, as far as transformation. But you're saying you would like to have seen more volume. Do you just mean they're starting up more slowly than ideal.

[Ted A. Fernandez:]

We'd just like to see more clients get through that decision making process quickly. But it's a tricky transition for us because we saw significant wins, it gives us strong visibility into the quarter, but we also want to be very measured because we know the clients are still trying to do—my sense is that clients are trying to do what they can to constrain spending and keep the productivity gains that they've achieved in the first half of the year. But we also know, because we speak to many of them, we estimate that without taking more structural change, the productivity gains that many of our clients achieved, that nearly half of those gains they will not be able to sustain in the long term, which we believe creates an opportunity for us. It creates an opportunity for them as well. They know that making change quick may get you a quick return but to sustain that takes more work and we hope that that's where they turn to us because we do that very well.

[William Sutherland:]

How many folks do you have in this advisory dedicated force now?

[Ted A. Fernandez:]

Not enough. That dedicated group is going to a fist by the end of the third quarter, in the U.S. and Europe, so it's really nominal. When we looked at our advisory results, even though they were impacted, just like all our other business lines, when we look at the year-over-year decline some of our competitors experienced, here as they report in Q2, we don't feel too bad about our results. But we know long term if we're getting this kind of loyalty from our executive advisory client base, 10% of these clients drove 50% of our sales in Q2, we'd like to have more of that and we would like to continue to expand that base. As you remember, my long-term goal was to bring that client base up to 500 clients. And that that would really provide just a great opportunity for growth, if we could leverage that client base the way we are now leveraging it. So we would like to see that client count start to grow and hopefully we can do that. By making the investment now maybe we can see that happen in 2010.

[William Sutherland:]

So I'm not if I understood. You said five?

[Ted A. Fernandez:]

Six in total. And then obviously the rest of our sales force will sell that but the obviously sell all of our other offerings. But we wanted to start making a dedicated investment because we know the leverage from that client base has been pretty substantial for us over the last 12 to 18 months.

[William Sutherland:]

Are these alliances, you announced a new one in South Africa, are you starting to see them move the needle a little bit?

[Ted A. Fernandez:]

The South Africa alliance will not get kicked off until this quarter. We just signed it. It took us quite a bit to get that signed. And we've got a couple of others where we expect them to have some impact on volume in the second half of the year. So we believe that's a very efficient way for us to expand our benchmarking as well as our executive advisory volume. And you will see more.

[William Sutherland:]

I know you're always looking around at the acquisition environment, how do you characterize kind of what you've got in the pipeline right now? Does it feel like some things feel more realistic than in the past?

[Ted A. Fernandez:]

We've been working hard at this, as you know, really for the last 12 to 18 months, as the value in the stock market has really put a big question mark as to what assets are really worth. It simply just takes longer to try to come agreement with any organization that would be interested in becoming part of Hackett. But our hope is that the opportunity is compelling enough and that if we put enough time that sooner or later we will be able to add some acquisitions to our organization.

[Operator:]

Your next question comes from Mickey Schleien – Ladenburg Thalmann & Co.

[Mickey Schleien:]

Ted, I wanted to follow up on a comment you made in terms of Europe. You said you thought growth there would lag the U.S. by a quarter or two and I wanted to understand your thoughts behind that. And also whether you're doing anything to protect your revenue streams from Europe, given the volatility in the currencies that we're seeing.

[Ted A. Fernandez:]

From a foreign currency perspective we've done everything we can to hedge that exposure. And when I say hedge it, I mean from an operating perspective, not actual financial hedges. So making sure that whether we execute a contract or the time to settle, all of those things are being dealt with something we believe is manageable. So beyond foreign currency, if you call it exposure management, Europe went into the economic decline later but boy when it hit, it hit them harder. We saw that. If you recall back from our fourth quarter call, where we experienced the more significant stall happen in Europe in the late part of 2008. We have seen that same, if you want to call it compression of the economic cycle impact their decision making more severely than we've seen our U.S. businesses. Having said that, we have seen some improvement in the European behavior here over the last 30 to 60 days. Whether or not that sustainable becomes a little tricky because you know we now are going into a little bit of the European summer stall, which is a little bit disappointing for us, especially given some of the activity we started to see over the last 60 days. But with that backdrop in mind, we've seen the way the U.S. behavior has just improved slightly and gradually and clients just becoming a little bit more comfortable with what they're going to accomplish in 2009 and what they have to start looking for in 2010. So we believe, just based on that anecdotal feedback from clients and the clients that we're talking to, that we would expect the European recovery to lag a couple of quarters. So that's our hope. We're not planning for Europe to help us as much in the second half of the year, as we're expecting, I'll call it our U.S. businesses, to participate in that. It would sure be nice to see it happen and we're doing everything we can from a marketing perspective to position those businesses to do that, but too early to tell.

[Operator:]

Your next question comes from Morris Ajzenman - Griffin Securities, Inc.

[Morris Ajzenman:]

I was going to ask the same question on the international versus the domestic revenues. I mean, clearly, you can see the revenues internationally has declined and with the down draft in revenues, you can see how steep it's been internationally. You kind of touched on it but you're giving guidance of $34.0 million to $36.0 million versus $34.6 million, so if you get lucky and you get some conversion of the interest by [inaudible] customers, you can have sequential revenues up. Would that mean that domestically we're going to see potentially a stronger pickup or is there a risk to the international side dragging that down? It sounds like domestically there is some traction there. Am I reading that right into this current quarter?

[Ted A. Fernandez:]

We think we've risk abated the international side properly. Yes, we have seen more volatility from international operations, and specifically Western Europe, in the first half of the year. Having said that, some of the significant wins that I commented on earlier, our prospects are better. We just know that clients are just being incredibly thoughtful and they're trying to do everything they can to protect 2009 EPS, which normally means 2009 comp for many of these executives, so don't forget that. We've very aware of that. So we're making sure the clients understand what we can do to help them with 2009, both cash or cost. But we're also spending a lot of time making sure these clients understand. That the cost reductions that have allowed them to report these—I'll call them—75% of the Dow that has reported so far, has beat expectations. They've done it on cost reduction. The productivity numbers reported this morning were incredibly strong. I'm just here to tell you that for those productivity gains to be sustainable, clients will have to make more structural change. If not, they will give some of that back. And we believe that most of our clients are planning on trying to improve their EPS prospects for 2010 by being able to improve their operating margins. When they compare that to a 2007 and 2008 number. So you can only do that with productivity. If you want to sustain productivity gains, they're going to have to make more structural change, they're going to have to invest and hopefully we'll get a chance to participate in that.

[Morris Ajzenman:]

Let me ask the question differently. This year international was 34% of revenues. I think last year you said it was 40%. So if you did the math, we can get whatever the domestic revenues were. In this guidance, second quarter to third quarter, if we exed out international revenues, are we talking about sequential improvement, single digits, mid, low high? Can you comment on that?

[Ted A. Fernandez:]

We could possibly see sequential improvement in the international operations this quarter. Yes, that's possible.

[Morris Ajzenman:]

I'm talking about domestic. If you exed out the international.

[Ted A. Fernandez:]

Oh, no. When we look at the business broadly, flat to up, there are aspects of our European operations that are operating strongly. Let me take that back. We would expect some small erosion in Europe from Q2 to Q3, I'm thinking of the businesses on a global basis. If you ex out European operations, we would expect sequential increase in the U.S. operations, yes.

[Morris Ajzenman:]

And would that be low single digits as a percent increase? Would you want to venture that.

[Ted A. Fernandez:]

I don't have that so I'd hate to. I'm probably moving beyond where I should. Rob will probably strangle me here soon.

[Morris Ajzenman:]

Cash flow. Your company has always been able to generate free cash flow. Clearly the last quarter or two it's been difficult. You had a modest burn. Second half, third quarter, fourth quarter, do you go back to cash flow generation?

[Ted A. Fernandez:]

We should expect to generate cash flow. The only reason we didn't this quarter was because of the DSO increase, because we really weren't that active in the marketplace. We didn't find people that wanted to exit with large volumes at the prices that we were looking for. But we expect a cash flow in the third quarter. We expect a DSO loss. If you say the increase of 7 days that we lost from Q1 to Q2, we expect to get most of that back, from Q2 to Q3. So if you take the midpoint of our guidance, if you add then the improvement and if you take us back to a more normalized DSO target, which you have closer to 50, you would see net cash flow from our business, net of any stock buyback activity during the quarter.

[Operator:]

There are no further questions in the queue.

[Ted A. Fernandez:]

Let me thank everyone again for participating in our second quarter earnings call and look forward to updating everyone again when we report our third quarter.

[Operator:]

This concludes today’s conference call.