The Hackett Group, Inc.
Q2 2014 Earnings Call Transcript

Published: 6 Aug 2014

[Operator:]

Welcome to the Hackett Group Second Quarter Earnings Conference Call. Your lines have been placed on a listen-only mode until the question-and-answer session. Please be advised that 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.

[Rob Ramirez:]

Thank you, operator. Good afternoon, everyone, and thank you for joining us to discuss The Hackett Group's second quarter results. Speaking on the call today and here to answer your questions are Ted Fernandez, Chairman and CEO of The Hackett Group; and myself, Rob Ramirez, CFO. A press announcement was released over the wires at 4

[Ted Fernandez:]

Thank you, Rob. As I ordinarily do, I'll open off the call with some overview or highlight comments on the quarter. Then I'll turn it back over to Rob and ask him to comment on detailed operating results, cash flow and also cover our third quarter guidance. And Rob will then turn it back over to me, allow me to make some market and strategic related comments. Then we will open it up for Q&A. So first my highlight comments. Let me first welcome everyone to Hackett Group's second quarter earnings call. This afternoon, we reported revenues of $61 million and pro forma earnings per share of $0.16 in our second quarter of fiscal year 2014, both of which exceeded the high end of our guidance. As a result of our actions taken in Europe and the strong US momentum, we exceeded last year's Q2 results in spite of having only neutralized the European contribution impact during this quarter. In the US, Hackett grew at an 8% rate, 5% if you exclude the recent acquisition of our EPM AMS capability, with strong performance from our EPM and benchmarking groups. This quarter we also saw strong performance from our ERP group, which benefited from strong license sales activity. Internationally, Europe was down slightly more than we expected, but more importantly we're starting to see improving demand and shorter sales cycles, which will benefit our second half of the year operating results. On the balance sheet side, we continue to be active with our stock repurchase programs throughout the quarter. Subsequent quarter-end, the Board also approved an initial $5 million to our stock repurchase program. On the investment front, we're already seeing the complementary capability that we brought on board with our recent EPM AMS acquisition, which we closed in the first quarter. Since the acquisition, we have closed six AMS transactions and we continue to build the strong pipeline of opportunities. Rob will provide more color on exactly where those overall numbers and growth rates stand. Additionally, we continue to develop and attract talent, expand our brand and intellectual property through the development of our new Hackett Performance Exchange and our benchmarking and executive advisory offerings. I will comment about these opportunities in more detail in my strategic overview section of our call. I'll also comment further on market conditions and specific go-to-market initiatives, but first let me ask Rob to provide details on our operating results, cash flow and also cover outlook. Rob.

[Rob Ramirez:]

Thank you, Ted, and welcome, everyone. As I typically do, I will cover the following topics during the call

[Ted Fernandez:]

Thank you, Rob. As we look forward, we expect continued growth from our US Hackett business across nearly all of our groups through the balance of the year. We also expect activity to improve internationally even if it comes with more volatile decision making when compared to the US. We continue to believe that some of the international volatility may be a result of our limited solution offering when compared to the US. A key part of our solid US activity is due to our very strong enterprise performance management and business intelligence capability, which now represents over 40% of our total US Hackett revenues. Our plan is to expand into this area in Europe during 2014, as I've covered in our previous call. We believe by more closely marrying our US activities in Europe and building on our EPM and BI strength globally, we can improve our ability to grow in Europe and also further strengthen our global delivery capabilities, which are important to large multinational engagements. Beyond our immediate focus on Europe, our strategy is to continue to build our brand by building dedicated skill around unmatched intellectual capital in order to serve our clients strategically and whenever possible continuously. We believe that our clients that leverage our intellectual property are more likely to allow us to serve them more broadly. IP-based services enhance our opportunities to serve clients remotely, continuously and more profitably. Our goal is to use our unique intellectual capital to establish a strategic relationship with our clients and to further use that entry point to introduce our business transformation and technology consulting capabilities. This strategy would allow us to increase our client base profitability and increase revenue per client. The best example of this strategy continues to be the revenue leverage we're experiencing from executive advisory client base and also the strategic entry points provided by our benchmarking capability. Specifically to benchmarking, we're seeing increased demand for our services, which we believe will enable greater downstream opportunities for all of our consulting services. Specific to executive advisory and its client base, 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 one of our executive advisory programs. Eventually, we hope to have the same kind of relationship with those who would use our Hackett Performance Exchange on a continuous basis. At the end of the quarter, our executive advisory members totaled 900, the first time we've reached that mark across 280 clients. In the quarter, we also had our highest relationship leverage ratio for the group with over 50% of our Hackett Q2 sales coming from clients that use our advisory services. On Hackett Performance Exchange front, we continue to build our pipeline. We believe these efforts will allow us to build the client base during the year and help validate the value of our offering. As I repeatedly mentioned, this is an ambitious offering, but if successful, it could enhance our business model by creating a powerful and continuous relationship with our clients. And although we continue to learn how best to sell and leverage this capability, we clearly believe that this new platform will become a critical component of all of our benchmarking offering over the next several years. Lastly, even though we believe that we have the client base, offerings and market coverage to grow our business, we continue to look for acquisitions and alliances that can add scope, scale or capability to accelerate our growth. We would also like to add that given our efficient access to debt, we're encouraged to pursue this focus. In summary, we reported strong quarterly results, especially given our weakness in Europe. However we are optimistic that the changes of investments we've made in Europe will lead to improving results in the second half of the year. More importantly, we continue to believe that our unique capability to combine proprietary intellectual capital with terrific talent to help our clients optimize their performance in this complex demand environment allows us to remain top of mind with leading global company and bodes well for our prospects. As always, let me close by thanking our associates for their tireless efforts and as always urge them to stay highly focused on our client, our people and the opportunities available to our organization. Those are my comments. Let me then ask the operator to move on to the Q&A section of our call.

[Operator:]

(Operator Instructions) And Mr. George Sutton, your line is open.

[George Sutton:]

Ted, Europe has been costing you several cents a quarter previously. I'm curious is it still in that range and how much impact do you think some of the changes you've made there, how much can that help you in the next few quarters.

[Ted Fernandez:]

We actually neutralized it and made that impact in the quarters marginally positive. Obviously we would like to see that improve in Q3 and further improve into Q4. But as Rob mentioned, we expect growth in Europe, this is excluding the Technolab acquisition, meaningful, nice, especially given the results we've had over the last year. So we would expect that to be favorable. How much, I don't know.

[George Sutton:]

If we look at Technolab, which has just been a great acquisition, do you see other potential concepts out there that you could either acquire and/or simply replicate organically what you're seeing at Technolab?

[Ted Fernandez:]

The good thing about Technolab is it's allowing us to talk more broadly about also the same AMS capability that exists within SAP. We've always felt that we've made significant improvements and enhancements in our SAP AMS capability. But I really think the Technolab acquisition has just great, great potential, George, when you consider the strength of our EPM and BI capabilities, especially in the Oracle EPM area. So our belief when we mentioned that we signed six new clients and we're literally just learning how to integrate and sell this capability into our business, we hope that it's a significant contributor to our growth in the future and profitability as well. Are there things like that that are similar? The answer is they're harder to find than you think. But we clearly believe that there is capability that we can acquire that we've leveraged in the US that we clearly have not taken advantage in Europe. And this is not only the EPM capabilities we're trying to build in Europe, but internationally there's just capabilities on the transformation side that we think give us a great opportunity as well. So we do like this recent acquisition and the prospects for it. And yes, there is prospects for similar opportunities globally as we look around.

[George Sutton:]

You and I have talked over a period of time about branding, and I've looked at some initiatives on branding and potentially enhancing the Hackett brand or paging some of the imagery. Can you give us any update on sort of where you're thinking from that perspective?

[Ted Fernandez:]

It's interesting because you're one of the big proponents that believes so strongly in the brand, that believes that there is a way for us to further leverage and promote the brand. It's amazing how well our capability and our brand is known globally, especially given our size. Having said that, as I've also shared with you, especially for those of us who've been through some cycles, we know that you can spend quite a bit of money promoting something and it must be meaningful and sustainable. And we're just not (inaudible) as to put significant sustainable dollars into a branding promotion yet. It doesn't mean we don't think about it all the time, but it's not something we're currently considering.

[Operator:]

And we have another question over the phone from Mr. Morris Ajzenman.

[Morris Ajzenman:]

Just to follow up on the question on Europe, I think you stated that Europe would be, I guess, the [quotient to God] even though you had declining revenue of approximately 13% and 20% organically. I think what you stated that it aided in a couple of cents per share, and I presume that's the action you took earlier in the year. Is that correct?

[Ted Fernandez:]

No, not at all. The contribution in the quarter fully loaded was margin. So I call it neutral to earnings. And no, it you recall, the charge we took was $3.6 million and that was in Q1.

[Morris Ajzenman:]

What I'm trying to understand, was there any benefit from that restructuring, the charge you took in this quarter from the expense basis?

[Ted Fernandez:]

Yeah, there was a reduction in cost, yes. There was a reduction in cost, absolutely.

[Morris Ajzenman:]

And can you quantify that or not?

[Ted Fernandez:]

I'm going to say $0.02 to $0.03.

[Morris Ajzenman:]

Then the question is going forward into the third quarter and fourth quarter, I presume that takes more attempts to really ramp up when we see a greater contribution by a low cost overhead, let's say, for Europe and will that be further accentuated by topline growth now?

[Ted Fernandez:]

The answer is yes. Those cost benefits should be sustainable. And yes, that allows then the revenue growth on top of that then to lead to truly incremental contribution.

[Morris Ajzenman:]

And would you care at this point or is it too early to some sort of guesstimate of what topline revenue can be sequentially year-over-year in Europe?

[Ted Fernandez:]

Well, I think Rob said it's strong. So we're hoping that it's something that can approach 10%. That's a meaningful transition for us. That's why in my comments, Morris, I'd really like to say that it should help us through the balance of the year. Second half of the year, I think, is what I said. So I was trying to talk like you're saying that if we can have some revenue growth on top of the cost reductions that we've made, and Rob just reminded me it's a couple of pennies, $0.02, instead of $0.02 to $0.03, that yes, we should see Europe start to contribute. Having said that, for those of you who've covered us long enough, you know that Europe is nowhere near its contribution level or it'll be nowhere near its historical contribution level in this upcoming quarter.

[Morris Ajzenman:]

Switching gears to Technolab closed during the first quarter, was there any accretion into the second quarter from that acquisition on EPS basis?

[Ted Fernandez:]

No, this contribution in Q1 was not better than Q2. It doesn't mean we're not building a pipeline, but remember that AMS revenue is something you sell into a client at selling cost and then it comes in continuously over a multi-year period. So just keep that in mind.

[Morris Ajzenman:]

Ted, I know when you make acquisition, you like it to be accretive.

[Ted Fernandez:]

You just asked me if it was more accretive, and the answer is no. It was not more accretive in Q2 than it was in Q1.

[Morris Ajzenman:]

So the question is do you expect that to gain traction over the next couple of quarters as far as being more accretive?

[Ted Fernandez:]

No, having said that, if you listen to Rob's comments that the comment is on application managed services revenue, he did say that he expects the growth rate in AMS, which was approximately 10%, to double into Q3. So we should see improving benefit as we (technical difficulty) new clients. How is that?]

[Operator:]

Our next question over the phone comes from Mr. Bill Sutherland.

[Bill Sutherland:]

Rob, the gross margin guidance for the Q3, do you expect further software sales in the quarter?

[Rob Ramirez:]

It does, but lower. The software sales, especially if you track our SAP growth, Bill, can spread out or can accumulate. So it has a certain amount of volatility. So I would say that this next quarter, it's expected to be a more normalized level. And I would say that the previous two to three quarters have actually been lower than historical levels. And that was probably consistent with the revenue growth you saw in that group over the last few quarters.

[Bill Sutherland:]

Another margin question. As AMS becomes more significant, should we think about that helping the blended gross margin?

[Rob Ramirez:]

Yes, we do, even though we would like to see our total Hackett, let me be specific, Hackett margins we still think have significant room for improvement as we build out the capability. Yes, we do expect our AMS margins, especially given the way we blend that in and provide that service, to be at least equivalent to current or higher than current margins.

[Bill Sutherland:]

So it's not materially different than your consolidated margins?

[Rob Ramirez:]

It's not materially different today, no, not materially different, correct.

[Bill Sutherland:]

Are you to the point of expanding your capabilities in Europe with more EPM obviously? I'm just asking how are you trying to get that done. Are you hiring or are you bringing in folks from North America?

[Ted Fernandez:]

Well, remember that we brought in a European leader who has dedicated experience within this enterprise performance management area. So start that our European leader's primary capabilities is in this EPM space. Secondly, we moved one of our senior guys from the US into Europe to help build out the technology side, as they're both hiring around the capability. We're currently going to market in that capability. And hopefully soon, we'll be able to announce our first significant EPM engagement in Europe. Not yet, but hopefully soon.

[Bill Sutherland:]

The AMS deals were all North America?

[Ted Fernandez:]

When we mention AMS deals, they could be a European client, but we think of it more as not the traditional EPM, which is the data and the implementation of the software around EPM. Technolab did have European clients as part of the client base that we acquired. And no, we have not added. All the six deals that we're sold at AMS were all US or North American-based transactions.

[Bill Sutherland:]

The quarter-over-quarter expectation for international revenue growth, what was that?

[Rob Ramirez:]

About 10%. Fully blended about 10%.

[Bill Sutherland:]

And then the pro forma income tax effective rate stay in the 32% going forward?

[Rob Ramirez:]

We're starting to present for this guidance number, that's correct.

[Bill Sutherland:]

And should we think about that as more of the baseline?

[Rob Ramirez:]

No, we expect it to continue to decrease further, Bill, directly impacted by how quickly we return to historical profitability in Europe. As European profitability comes back, we would benefit from the significantly lower European rates than the ones we currently enjoy in the US.

[Bill Sutherland:]

Nothing about inversion?

[Rob Ramirez:]

What we're doing is perfectly fine with us.

[Bill Sutherland:]

And then finally, I have to ask HPA question, another quarter under your belt. Can you just give us whatever color you can in terms of how that's developing for you guys?

[Ted Fernandez:]

Continuing to build the pipeline, have added a few clients, have a target for year-end that we keep to ourselves, what we'd like to see us achieve by the end of the year. And also at the same time, knowing that you could see it either as an integrated benchmarking and monitoring tool, but you could also see it as a very powerful business intelligence and cloud tool. We're continuing to reengage with software vendors to see if we could open up those channels, because we think that they could be helpful to us as well. We are currently selling the product directly through a very small dedicated group.

[Bill Sutherland:]

And when you say selling the product, are you selling it as an integrated benchmarking tool?

[Ted Fernandez:]

Well, we sell it as either both a benchmark or measurement and monitoring. You could use it single as an advanced benchmark, the way we would describe it, or you could use it continuously. Our belief is that if you see it in a single event that you'll like how rich the data is and you'd want to see that data on a monthly or quarterly basis. And then you'll become a continuous user of our product.

[Bill Sutherland:]

Just so I'm clear, Ted, you've added a few paying clients?

[Ted Fernandez:]

Yes, we do have a few paying clients, that is correct. And we've got a pretty nice pipeline, but obviously we want to do more. So we're looking for multiple channel strategies as we continue to build this capability and build our client base.

[Operator:]

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

[Ted Fernandez:]

I'd like to thank everyone for participating in our second quarter call and look forward to updating everyone again next quarter when we report our third quarter. Thank you again.

[Operator:]

Thank you for participating in today's conference call.