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Edited Transcript of HCKT earnings conference call or presentation 7-Aug-18 9:00pm GMT

Q2 2018 Hackett Group Inc Earnings Call

MIAMI Aug 21, 2018 (Thomson StreetEvents) -- Edited Transcript of Hackett Group Inc earnings conference call or presentation Tuesday, August 7, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Robert A. Ramirez

The Hackett Group, Inc. - CFO & Executive VP of Finance

* Ted A. Fernandez

The Hackett Group, Inc. - Co-Founder, Chairman & CEO

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Conference Call Participants

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* Francis Carl Atkins

SunTrust Robinson Humphrey, Inc., Research Division - Associate

* Jason Michael Kreyer

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Jeffrey Michael Martin

Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst

* Vincent Alexander Colicchio

Barrington Research Associates, Inc., Research Division - MD

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Presentation

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Operator [1]

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Welcome to The Hackett Group Second Quarter Earnings Conference Call. (Operator Instructions) 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.

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Robert A. Ramirez, The Hackett Group, Inc. - CFO & Executive VP of Finance [2]

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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 4:05 p.m. Eastern Time. For a copy of the release, please visit our website at www.thehackettgroup.com. We will also place any additional financial or statistical data discussed on this call that is not contained in the release on the Investor Relations page of our website.

Before we begin, I would like to remind you that in the following comments and in the question-and-answer session, we will be making statements about expected future results, which may be forward-looking statements for the purposes of the federal securities laws. These statements relate to our current expectations, estimates and projections and are not a guarantee of future performance. They involve risks, uncertainties and assumptions that are difficult to predict and which may not be accurate. Actual results may vary. These forward-looking statements should be considered only in conjunction with the detailed information, particularly the risk factors contained in our SEC filings.

At this point, I would like to turn it over to Ted.

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [3]

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Thank you, Rob, and welcome, everyone, to The Hackett Group's second quarter earnings call.

This afternoon, we reported net revenues of $69.6 million, a 3% increase over the prior year; and pro forma EPS of $0.27, an increase over -- 8% increase over the prior year as well. As expected, our U.S. revenues were up 8% from last year with 20%-plus growth coming from our strategy and business transformation group, offset by a 5% decline in our ERP, EPM and analytics Oracle Group as we continue to aggressively migrate from on-premise to cloud implementations.

As a result of our focus on digital transformation initiatives, our strategy and business transformation group experienced strong growth across nearly all of the practices with strong performance from our eProcurement and IP as a Service offerings. While our Oracle ERP, EPM and analytics business was down, our cloud revenues exceeded our on-premise revenue this quarter. As you know, this is something that we planned and targeted over a year ago.

More importantly, when we look at our Q3 guidance, we expect this momentum to continue. And for the group to be flat to up in Q3. As expected, cloud revenue growth will more than exceed the expected on-premise decline.

To provide some context to the on-premise decline impact in our total company revenue growth. If our on-premises revenues were flat on a year-over-year basis, in Q3, our total company revenue growth would be approximately 7% higher than we reflected in our current Q3 guidance. The impact in Q2 was approximately 10%. This is why we look to our 2019 year with great promise. Since growth and scale will also mean margin expansion for the group. We know we are quickly getting closer to being able to realize the benefits of our transition if we continue to migrate at our current pace. Although we would like to be further along in our transition, we expect the benefits of cloud investments to become evident in 2019.

As expected, our European results were more tepid, but solid as we continue to benefit from the investments we made in EPM and RPA capabilities in Europe. Perhaps our most strategic action, as we look back at our transition over the last year, was to digitize all of our IP and start by launching Quantum Leap, our next-generation benchmarking platform, and to follow that up with the introduction of our proprietary Hackett Digital Transformation Platform. DTP, as we call it, allows us to lead with our IP in sales, delivery and continuous support initiatives.

Coupled with our investments at RPA, or robotics process automation technologies, these actions have allowed us to secure significant digital transformation engagements.

Additionally, by building one of our first versions of our Digital Transformation Platform around Oracle Cloud app's functionality, we were able to quickly demonstrate how we can digitally use our proprietary best practices IP to assess and optimize the configuration of Oracle Cloud applications to the Oracle sales channel as well as the clients'.

In fact, we were recently notified that, again, we've been recognized as the Oracle Cloud EPM Partner of the Year.

Last but not least, our successful introduction of our IP as a Service offerings through strategic partners as well as our expanding training and certification programs have further accelerated our positioning as a digital transformation and IP as a service leader.

On the balance sheet side, we continue to generate strong profitability and cash flow from operations. This has allowed us to increase our dividend, buy back stock, fund acquisitions while continuing to invest in our business.

I will also comment further on strategy and market conditions, but let me first ask Rob to provide details on our operating results, cash flow and also comment on our guidance. Rob?

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Robert A. Ramirez, The Hackett Group, Inc. - CFO & Executive VP of Finance [4]

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Thank you, Ted. As I typically do, I'll cover the following topics during this section of the call: An overview of our 2018 second quarter results, along with an overview of related key operating statistics; I'll also cover an overview of our cash flow activities during the quarter; and I will then conclude with a discussion on our financial outlook for the third quarter of 2018.

For purposes of this call, any references to The Hackett Group will specifically exclude SAP Solutions. Correspondingly, I will comment separately regarding the financial results of The Hackett Group, SAP Solutions and the total company. Please note that all references to gross revenues in my discussion represent revenues, including reimbursable expenses. And any references to net revenues represent revenues, excluding reimbursable expenses. Additionally, references to pro forma results specifically exclude noncash stock compensation expense, intangible asset amortization expense, acquisition-related compensation expense, acquisition earn-out adjustments and assumes a normalized long-term cash tax rate of 25%. Acquisition-related cash and stock compensation expense primarily relates to the portion of the purchase consideration for the 2017 acquisitions that contain service-vesting requirements, and as such, are reflected as compensation expense under GAAP.

For the second quarter of 2018, our net revenues, or gross revenue excluding reimbursable expenses, increased by 3% to $69.6 million when compared to the prior year and was within our revenue guidance range. The Q2 2018 reimbursable expense ratio on net revenues was 8.7% as compared to 8.6% for Q2 of the prior year. Reimbursable expenses are primarily project travel-related expenses passed through to a client and has no associated impact to our margin or profitability. Including reimbursable expenses, company gross revenues were $75.6 million in the second quarter of 2018, which represents a year-over-year increase of 3%.

Net revenues for The Hackett Group, which excludes SAP Solutions, were $61.3 million in the second quarter of 2018, an increase of 6% on a year-over-year basis. Hackett U.S. net revenues were up by 8%. International revenues, primarily from Europe, were up 1%.

Strong U.S. strategy and business transformation growth of approximately 20% was offset by slightly lower-than-expected ERP, EPM and analytics practice results.

It is important to note that our Oracle U.S. cloud revenues exceeded our Oracle U.S. on-premise revenues during the quarter, which occurred earlier than expected. This will continue into Q3 as our strong U.S. cloud growth rates will continue to offset a lower year-over-year on-premise decline.

As the U.S. on-premise year-over-year and sequential declines decrease and the absolute amount also decreases, we continue to get closer to reestablishing our ability to resume our 5% to 10% annual growth rate. This transition will become much more noticeable in 2019.

For example, in Q3 2018, we expect the U.S. Oracle Group to be flat to up on a year-over-year basis. This compares to a decline of 5% in the current quarter when compared to the prior year.

Net revenue from our SAP Solutions Group, which consists of our SAP reseller, implementation and Application Managed Services groups or AMS, totaled $8.3 million in the second quarter of 2018, a decrease of 17% on a year-over-year basis, as expected.

The decrease is primarily due to the impact of channel transition from on-premise to cloud-based offerings and the loss of the AMS contract that we have discussed in previous quarters. We expect this group to be down 1% to 2% sequentially in the third quarter of 2018.

Total company international net revenues accounted for 20% of total company revenues in the second quarter of 2018 as compared to 21% in the second quarter of 2017. Our recurring revenues, which include our executive and best practice advisory and AMS groups, accounted for approximately 20% of our total company net revenues and 29% of our total company pretax practice profitability in the second quarter of 2018.

Total company pro forma cost of sales, excluding reimbursable expenses, totaled $43 million or 61.8% of net revenues in the second quarter of 2018 as compared to $40.9 million or 60.5% of net revenues for the same period in the prior year. Total consultant headcount was 1,043 at the end of the second quarter as compared to 1,016 in the previous quarter and 1,002 at the end of the second quarter of the previous year. Our pro forma return on equity was 31% in the second quarter of 2018.

Total company pro forma gross margin was 38.2% of net revenues in the second quarter as compared to 39.5% in the second quarter of 2017. Hackett Group pro forma gross margins on net revenues was 38.8% in the second quarter of 2018 as compared to 40.2% in the second quarter of 2017, primarily due to lower international gross margins.

SAP Solutions pro forma gross margin on net revenues was 34% in the second quarter of 2018 as compared to 35.8% in the previous year. This decrease was primarily due to decreased revenues in the period when compared to the prior year.

Pro forma SG&A was $15 million of net revenues in the second quarter of 2018 as compared to $15.2 million of net revenues in the previous year. As a percentage of revenues, both periods were 22%.

Pro forma EBITDA for the second quarter of 2018 -- and '17 was $12.2 million, which represented 17.6% and 18.1% of net revenues, respectively. Total company pro forma net income for the second quarter of 2018 totaled $8.6 million or $0.27 per diluted share, which was at the midpoint of our second quarter's EPS guidance. This compares to pro forma net income of $8 million or $0.25 per diluted share in the second quarter of 2017. These results represent an increase of 7% and 8% on a year-over-year basis for pro forma net income and diluted earnings per share, respectively.

Total company pro forma net income for the second quarter of 2018 excludes an acquisition earn-out liability benefit of $4.6 million; cash and stock compensation expense of $1.5 million; and intangible asset amortization expense of $591,000. Pro forma results also assume a long-term cash tax rate of 25% or $2.9 million.

Consistent with our comments over the last 2 quarters, our pro forma results include a long-term cash tax rate of 25% as a result of the decrease in U.S. federal statutory rates. As we disclosed last quarter, we decided to use 2% of the 5% decrease in our pro forma rate with our associates by doubling our existing 401 contribution as well as to increase [product-related] bonus programs.

GAAP diluted earnings per share was $0.36 for the second quarter of 2018 as compared to GAAP diluted earnings per share of $0.15 in the second quarter of 2017. GAAP results included $4.6 million or $0.14 benefit due to the reduction of a contingent earn-out liability relating to the Jibe acquisition.

The company's cash balances were $13.3 million at the end of the second quarter as compared to $23.7 million at the end of the previous quarter. This cash decrease in the second quarter was primarily attributable to $5.5 million repayment of our debt under revolving line of credit.

Net cash utilized for operating activities in the second quarter of 2018 was $2.4 million, which was primarily driven by net income adjusted for noncash items, offset by increases in accounts receivable and payments of federal income taxes in the quarter.

Our DSO or days sales outstanding at the end of the second quarter of 2018 was 68 days as compared to 65 days at the end of the previous quarter and 61 days in the prior year. We continue to expect our DSO target to be below 65 days.

During the second quarter of 2018, the company had $2.8 million of capital expenditures, primarily related to investments in internal corporate systems and the global rollout of new laptops, which occurs every 3 to 4 years. We will spend approximately $8 million this year for our new systems and laptops as well as for our key digital initiatives, which include Quantum Leap, our Digital Transformation Platform and the Hackett Institute. We currently expect our capital expenditures to return to historical levels of $3 million to $4 million in fiscal 2019.

I am now going to discuss our guidance for the third quarter of 2018. Before I do, just consistent with seasonal third quarter trends, we expect the impact of the additional U.S. holiday and the typical increase in time-off due to summer vacation in the U.S. and even more meaningfully, in Europe, to unfavorably impact available days by approximately 3% to 5% on a sequential basis. As such, the company estimates total net revenue for the third quarter of 2018 to be in the range of $67 million to $69 million. At the high end of the guidance, this would represent a 5% increase from the previous year. We expect Hackett Group to be up 8% to 9%, and we expect SAP Solutions to be down between 15% and 17% on a year-over-year basis. As I mentioned previously, however, we expect SAP Solutions to be down only 1% to 2% sequentially despite the decrease in available days.

The company estimates gross revenue to be in the range of $73 million to $75 million. The gross revenue outlook includes an estimated 8% for reimbursable expenses.

We expect our pro forma diluted earnings per share in the third quarter of 2018 to be in the range of $0.26 to $0.28. The high end of the range will represent a year-over-year increase of approximately 8%.

Sequentially, we expect pro forma gross margins in the third quarter to benefit from the seasonal reductions in U.S. payroll-related taxes resulting from reaching FICO limits and the utilization of vacation accruals, offset by decreasing available days due to summer vacations. As a result, we expect pro forma gross margin under our net revenues to be approximately 39% to 40%.

We expect pro forma SG&A and interest expense for the third quarter to be approximately $15.5 million. We expect third quarter pro forma EBITDA on net revenues to be in the range of 18% to 19%. We expect cash generated from operations to be up on a sequential basis.

At this point, I'd like to turn it back over to Ted to review our market outlook and strategic priorities for the coming months.

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [5]

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Thank you, Rob. As you've heard me comment here over the last, probably 2 years, the opportunities that are available to us and in our industry relative to digital transformation, cloud and analytics are just significant. And it's -- probably everything that I'll say is in that context. More specifically, the rapid development in machine learning, cloud applications, artificial intelligence, along with improving mobile functionality and enhanced user experience is dramatically influencing the way businesses compete and deliver their services. This is redefining entire industries at an accelerated pace, forcing organizations to fundamentally change and adopt these new capabilities in order to remain competitive.

Traditional sequential and linear-based business models are changing the fully networked and dynamic automated workflows and events with enhanced analytics. It doesn't matter which industry or which company, everyone is looking at digital as a way of remaining competitive and improving the way they sell their products and serve their customers.

In the U.S., these transformative technologies are resulting in increased activity as companies determine how to respond to the quickly changing competitive environment. We are seeing the growth in cloud and digital transformation improve our growth prospects. As our digital transformation and cloud engagements continue to grow and the decline in the on-premise revenue slows and becomes a smaller part of our total company revenues, the complete benefits of our transition will become increasingly clear.

In Europe, demand continues to be strong, but growth is expected to be more tempered too to strong prior year comps. Europe has benefited from improved market conditions as well as from EPM and BPO and RPA investments in that region.

We believe we have taken the necessary actions to both optimize short-term performance and, more importantly, be strongly positioned for the high-growth digital transformation opportunities. Our long-term strategy is to continue to build our brand by building new offerings and capabilities around our fully digitized and unmatched benchmarking and best practice intellectual capital in order to serve clients strategically and whenever possibly -- possible, continuously.

Specifically, let me review just some of the actions. We redefined our global benchmarking leadership by launching Quantum Leap, our new digital benchmarking Software-as-a-Service solution. The new platform allows us to deliver more information with significantly less client effort. It also allows us to leverage our IP and track and -- leverage our IP and track the clients' transformation initiatives over the life of their respective effort.

We launched our Digital Transformation Platform to further differentiate our unique IPA capabilities. Our ability to fully digitize our IP and align proven technology and organizational solutions, to help clients drive transformational change, allows us to highly differentiate all of our offerings. In many ways, we believe our new platform and the way we go to market is redefining how consulting services are sold and will be delivered in this digital era.

Leveraging our Digital Transformation Platform to further attract new alliance partners that can leverage our unique capabilities to help them differentiate and sell their software and service solutions will also allow us to further expand our IP as a Service offering solutions.

And lastly, to successfully grow and further expand our Hackett Institute, training and certification offerings that allow us to expand the way we use our IP to help serve our clients in new and powerful ways to grow our business.

At the end of the quarter, we have 300 executive best practice advisory clients. But this excludes hundreds of new clients that we now serve through our IP as a Service alliance or training solutions. At some point here, I will let you know what the total of all of these 3 groups, total 1,000 clients, but it's a goal that we have set.

Last year, we expanded our ADP offerings by launching our new ADP Workforce Now program. And we added another pilot program during the first quarter of this year that is testing our ability to help them sell and differentiate their comprehensive outsourcing solutions. These programs expanded our opportunities with ADP and are continuing to grow in 2018.

Relative to the Hackett Institute, we now have fully transitioned to state-of-the-art learning system, which we believe is better aligned with our client demands. We did launch our Enterprise Analytics training programs. We are developing an expanded RPA curriculum to, again, to complement or to be delivered on a standalone basis our CGBS offering. Given the unique nature of our best practice content and the favorable market reaction, we believe that the continuing education provides a significant high-margin growth opportunity for our organization.

Lastly, even though we believe we have the client base and offerings to grow our business, we continue to look for acquisitions and alliances that strategically leverage our IP and add scope and scale or capability, which can accelerate our growth and improve our margins.

In summary, in the second quarter, we continued our aggressive focus on cloud and digital transformation initiative while reporting solid operating results. More importantly, we believe the investments we're making in Digital Transformation Platform, expanded cloud capability, RPA capabilities, expanded IP-as-a-Service offerings and alliances will allow us to resume the long-term growth and profitability targets that we have set long term.

As always, let me close by thanking our associates for their tireless efforts, and as always, to urge them to stay highly focused on our clients, our people and the exciting opportunities available to our organization.

Those conclude our formal comments. Let me turn it back over to the operator and start our Q&A. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Frank Atkins with SunTrust.

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Francis Carl Atkins, SunTrust Robinson Humphrey, Inc., Research Division - Associate [2]

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First question is on the ADP relationship. Can you give us just an update of how you're feeling that's progressing, and some of the new offerings, how you're seeing traction develop there?

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [3]

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We continue to make great progress, and everything that we are currently discussing with them is to expand either the platforms or the access that our -- how our program is offered to their client base. So I would say that our prospects there continue to go very well.

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Francis Carl Atkins, SunTrust Robinson Humphrey, Inc., Research Division - Associate [4]

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Okay. And as a second question. I wanted to ask about the Oracle on-prem decline. Are you seeing any signals that, that is slowing relative to prior decline rates? And are the new cloud offerings integrating well with the remainder of the business? And how do you see that kind of balance between the 2, shaking out as we approach the end of the year?

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [5]

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Well, first, let me speak to the on-premise decline. We are expecting -- the on-premise decline has clearly decreased from 2017 to 2018. We're expecting it to increase in the -- continue to decrease, I'm sorry, the declines continue to decrease in Q3 and Q4 of this year. When we look at the fact that our -- just consider that the cloud growth rate is increasing at multiples of the on-prem decline decrease. And that is why I wanted, Frank, to highlight the fact that if and when year-over-year on-prem numbers flatten out and if our cloud growth rates remain at numbers that are well in excess of 50% here for just even just the foreseeable few quarters and beyond, that we would expect what has been for -- on a growth perspective, and even profitability because it's important to note that the -- until we scale that cloud business properly, we're never going to fully realize the offsite benefits that come from the investments that we've made. So 2 things happen or are happening. One, it was important that we -- that the cloud revenues exceeded the on-prem revenue in Q2 for our Oracle business. Two, that, that delta is only increasing in Q3 as cloud growth continues and the on-prem decline slows. If you model that out in any way, shape or form at any shape you want, if it continues to be if one is changing at a multiple of the other and the on-prem number continues to decline, so the declines aren't lower absolute numbers, the impact at FY '19 is, let's call it, double digit and greater growth opportunities. Even if we maintain some on-premise number that we continue to serve over the next, well, it could be around for 5 or 10 years, I mean these are -- many clients are continuing to build out on-premise solutions and completing some investments that they started from previous years. So for us, what the math tells us, based on the current pace, and the current pace has had no, if you want to call it, inflection point, for us, an inflection point would be a significant cloud win, $10 million-plus win, of which we continue to pursue several. And we think the opportunity for us are only improving because of simply our tenure now continues to extend beyond the 1-year anniversary of our acquisition last May. When we look at all of those things, we would expect our -- what we refer to as our ERP EPM and analytics business, which includes both our cloud and on-prem businesses, to be primary contributors to our growth in FY '19. And as you just heard Rob say, in the current quarter, that entire group was down 5% year-on-year. It goes to flat to slightly up in Q3, and we think that then continues into something much more favorable in '19 if we just stay at the current pace. If we get some inflection point, all of that gets accelerated to something more significant. You know that's what we've been targeting. We hope it happens sooner rather than later.

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Francis Carl Atkins, SunTrust Robinson Humphrey, Inc., Research Division - Associate [6]

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Okay, great. And last one for me, can you just talk a little bit about the talent environment? You've done some positive things on that side, but what are you seeing and what are you doing to attract and retain good talent?

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [7]

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Well, we're kind of a unique animal in that, as you know, we compete with multibillion dollar businesses, which, I think, a lot of people -- some people desire to work there, but there are many others that love the idea of being able to work with a company like ours where you're able to work with these large global 2,000 companies. But in a smaller company, you play a much more significant role as you do within The Hackett Group. So we have had no problems continuing to retain our talent and attract new talent. And I think it's because we are a unique alternative to the sector that we compete with day-to-day where some of their scale and size may actually work against them for somebody who's looking for an alternative.

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Operator [8]

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(Operator Instructions) George Sutton from Craig-Hallum.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [9]

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It's Jason on for George. First of all, congratulations on the turning the corner with cloud revenue exceeding premise revenue. I know that's been a big focus for some time. On that point, Rob, I think you had mentioned and, I think, Ted, you just touched on it a little bit, the slowdown in ERP and EPM in Q2. I think I heard that right. Can you help break that down? I mean, cloud growth is increasing, premise is decelerating. Help me in the context of a slowing ERP, EPM environment.

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [10]

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Well, let's make sure that you understand. Slowing as it relates to on-premise business, not cloud. So we're talking about the fact that the slope of the decline in our on-premise revenues is starting to slow, meaning becoming more and more stable. So obviously, our goal is for that, at a minimum, to simply flatten out on a year-over-year basis. And we believe that opportunity comes to us. If it doesn't come to us in FY '19, okay, so let's just call it over the next 3 to 4 quarters, it won't matter because those absolute numbers become immaterial to our total number. But to add some perspective, our cloud revenues in Q2 and Q3 are going to go well in excess of 50% and our on-premise decline is, let's just call it, it's a fraction, 1/2 to 1/4 of that over those 2 quarters. So you apply math to our numbers to that. If they continue to grow at any multiple of one another, especially since we've crossed over and since those numbers, the on-premise numbers, have gotten much smaller, so those declines have a smaller impact each and every sequential quarter and the cloud revenues are now larger numbers and those are growing at a faster pace so they are all -- they're coming in at -- and having a higher sequential impact. There is a point here, if you model that out, where, instead of negative 5%, you would see double-digit growth or better in that group. So the question -- we know, we've never known the slope of either one, and I come back and say that. We've done that with, what I call it, kind of, a very linear kind of planned transition. If we're able to -- and I just believe it, again, I know I'm going to continue to jinx myself. I've been saying this for a couple of quarters, but if because of tenure reputation within Oracle, relationship with our clients, we're able to get some significant engagements like the ones we have bid on and we're continuing to bid on and compete for today, we will transition through that prism, for lack of a better term, at a much quicker and profitable pace.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [11]

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Okay. And it was the slowing reduction -- I mean, it was the double negative that I missed in the last (inaudible)

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [12]

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Yes, the double negative. I'm sorry.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [13]

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Okay, we've got that straight, now moving on. You mentioned a couple of times the strength of the IP as a Service offering. I'm just wondering if you can break that down into where you saw the pockets of strength, and if you think there's -- if there's any timeline around adding any more services there.

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [14]

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The answer is that timeline -- look, it's a -- for the existing clients that are in the offering, those revenues increase as, one, you continue to build your client base and they give you access to more opportunity. Secondly, we have added a client at the beginning of the year and it was more data-centric and more limited access to the full, kind of, transformation platform offering that we support and provide ADP with. And I continue to say that we continue to get increasing inquiries and we continue to speak to other strategic alliance partners that are looking for ways to leverage that strategy within -- for themselves. And we believe that adding additional customers of scale could also be an inflection point. Everything that we discuss or plan would be just progress based on known and existing transition. I consider a new IP as a Service client or a very significant win in cloud, whether it's Oracle or SAP, inflection points from our current, if you want to call it, progress.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [15]

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Okay. One more because we don't want to leave out Rob. The change in contingent consideration that flowed through the P&L, I think that's related to Jibe. Help me just understand exactly what that means. Are you -- is this an indication that you're expecting a lower earn-out related to Jibe?

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Robert A. Ramirez, The Hackett Group, Inc. - CFO & Executive VP of Finance [16]

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That's correct. The earn-out relating to Jibe -- that was estimated at the beginning as less than we expect.

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Jason Michael Kreyer, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [17]

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Is there a particular reason?

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [18]

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Well, yes. The profitability from that cloud acquisition is lower than the cap, which we established for them. We negotiated a number with a cap. We believed that they would hit that cap. If they would have hit that cap, then obviously, you would see very different numbers throughout '18. When you look at '18 for us, the surprising things to us, just so that we can address that and others, one is that the transition of cloud to on-prem, and especially the cloud transition has happened slightly slower and because it's more limited in scale, we're getting lower margin and returns on it. That has been more than fully offset by the strength of the strategy and business transformation performance in the U.S., which we just said was up 20% on a year-over-year basis. And then the real surprise that we didn't have at the beginning of the year that we, kind of, obviously found out as we reported Q1, is that SAP was down as much as it was on a year-over-year basis when we lost that one AMS client and we saw some channel transition as they started to -- start aggressively positioning SaaS over what they call purchase. They use the term purchase for on-prem and they use the term SaaS for cloud just to compare this to Oracle. So in their world, that disruption, which Rob said we think that we understand what we have to do and have started to do, is being reflected in the fact that we see stable revenues in SAP from Q2 to Q3 with lower available days. I don't know if that's more than you wanted, but -- so yes, the liability take-down is the opportunity we now estimate from the cap that was established at the beginning that we believe will not be earned.

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Operator [19]

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Our next question comes from Jeff Martin with Roth Capital Partners.

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Jeffrey Michael Martin, Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst [20]

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Could you talk about -- speak to the competitive dynamics and the overall landscape in cloud, and how that -- your competitive position has evolved over the course of the 12 months, it's now more aggressively positioning and strategizing to approach that market?

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [21]

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Yes. The competitive landscape is that there's 2 distinct groups. There's the -- an enterprise group for larger companies and majors group, which is the middle-market companies. We continued because it was kind of -- if you want to go back if Jibe came out of the majors or more middle-market-centric world, and we were obviously serving both in EPM and in our business transformation, some of the larger enterprise clients. And competitively, you will see more regional organizations, slightly lower rate environments, smaller engagements in that majors group and you will see higher rate, much larger engagements that would include your typical competitors, the Big 4, Accenture, IBM and the like, which are no different than the ones we compete with in our EPM cloud business. Our standing in that group, we believe that the acquisition first was the first step. It told Oracle that we're serving Oracle Cloud broadly, enterprise-wide versus just staying to EPM, a very important first step. And then secondly, last year at OpenWorld, we attended that and wanted to make sure the channel was fully aware of our Digital Transformation Platform that we built to specifically support and optimize Oracle, kind of, platform. That introduction of that Oracle Digital Transformation Platform capability has allowed us to establish, I think, a very -- a strong unique relationship with the Oracle channel at both levels, the higher and the, if you want to call it, enterprise and majors clients. And one is probably competes a little bit more on price if you go lower end. And the upper one competes a little bit more on scale and relationship that, as you would imagine, we believe, since we do business, we compete for all of our business in the upper market that, for us, it's just a matter of time when we start getting the kind of engagements in that upper stream that are directly aligned with the client base that we have historically served. And we think that, over the last year, that relationship and capability with Oracles and the clients has continued to expand, and it's giving us visibilities to opportunities and hopefully, it will result in us being able to close those and accelerate the pace of everything we're doing.

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Jeffrey Michael Martin, Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst [22]

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Okay. And if I recall correctly, the sales cycle is longer in cloud than it was in on-prem. Is that accurate? And how has the pipeline build progressed over the course of the last 3 to 6 months?

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [23]

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First, the sales cycles are not longer. It's just a matter of whether the cloud -- it's longer only if the client is trying to -- is taking a little longer to understand what that transition to cloud is for them. And that could delay it for some clients. Because of pricing cash flow benefits and the like, it actually facilitates it. So I'm going to say that the timeline is not changed and the pipeline activity for us has continued to improve as our reputation and standing have continued to improve.

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Jeffrey Michael Martin, Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst [24]

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Okay. That's helpful. And then on the Hackett Institute side, I would imagine you're expecting that to really start to ramp in 2019, wondering if you could speak to that.

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [25]

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Yes. Our -- we -- it's increasing quarter-on-quarter. We continue to add clients. We've had to make sure that clients understand that -- make sure that they understand that we have fully transitioned to a new platform because I think some of the issues we ran in -- with some of our pilot clients is that they did not like the technology that CIMA had really developed for the joint venture, which we fully replaced at the beginning of this year, but we're seeing increasing activity. We saw -- the biggest uptick actually happened because we highlighted the Institute, I think, in a more meaningful way during our U.S. Best Practice Conference, and it led to a pretty significant increase in volume into that group. So we would expect that. If you recall, that group was accretive. We then took over all of the costs of our joint venture partner, which then made it -- it was then -- it became slightly dilutive. We believe now that it is back to slightly accretive and we would expect that contribution. It's very small at the moment, but we expect that contribution to expand through the balance of the year and into '19 and beyond.

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Jeffrey Michael Martin, Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst [26]

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Okay. And then your 20% growth rate in strategy and business transformation, is that a rate that you see as sustainable? Help us kind of get our arms around what the impact to the overall growth rate that means.

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [27]

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The answer is we don't know, but since I have a long-term growth rate of 5% to 10%, I guess the answer will be no. We really believe that both the strategy and business transformation group and our ERP and EPM and analytics group, if that -- once we have year-on-year comps on, on-prem that are either -- the year-on-year comps become immaterial or the declines are very small, we believe that given the digital transformation demand, it's double-digit growth opportunity for both groups. So at least in the near term, if we can eliminate the on-premise anchor, I mean, for lack of a better term.

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Jeffrey Michael Martin, Roth Capital Partners, LLC, Research Division - Director of Research & Senior Research Analyst [28]

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Right. And then I noticed your single customer, top 5 and top 10, as a percentage of revenue increased pretty significantly, well, sequentially and year-over-year. I was wondering if you could help provide some detail around that.

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [29]

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I mean, it's a long-standing client, but we are continually working with 5 or 10 clients on some major transformation or technology initiative. So if you want to call it, this is a client that's had a combination of both. But we have others. If you look at that top 5 or 10 that are at or near that same scale, especially when you look at the mix of work and the profitability it contributes and the like. But it's a [global] 50 company as probably the other top 5 are.

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Operator [30]

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Vincent Colicchio from Barrington Research.

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Vincent Alexander Colicchio, Barrington Research Associates, Inc., Research Division - MD [31]

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Most of mine has been asked. Just a couple here, Ted, just what needs to happen to hit the high end of expectations in the Q3 period?

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [32]

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We need -- well, first of all, let me -- you're asking a very good question since you're accustomed to, and our investor base is accustomed to, us hitting the high instead of the mid. So it is important to realize that, for us, it's not what we like to do. And obviously, we consider that as we guided Q3. But I think the answer is just not have any different, any greater volatility than we currently see primarily in that Oracle business, all right. It's just the on-premise decline surprise us in any way, the cloud increase supposed -- seems to be pretty strong. We expect it to slow, and we expect it to continue to slow. So hopefully, each and every quarter, that is only increasing.

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Vincent Alexander Colicchio, Barrington Research Associates, Inc., Research Division - MD [33]

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Are there any changes that you're considering or need to make in the SAP business to better position yourself with the growth of the cloud?

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [34]

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It's a great question. And it's important to make sure that we characterize the SAP transition for us to be dramatically different than the Oracle transition. That is because, one, our focus is on small and medium markets and a great 80% -- 75%, 80% of our business is in life sciences. We're just a highly recognized SAP life science provider. Our capabilities extend to either on-prem or cloud. Our capabilities in S/4 are just exceptional. It doesn't matter to us whether the client decides to go on-prem or cloud, which is entirely different than the capabilities that we had in Oracle. Our capabilities in SAP extend throughout the entire, if you want to call it, SAP suite, the entire ERP suite, which is more stable and obviously a lot harder to transition from than just a simple EPM Oracle business that we had. So it's been a combination really from 2 sides. One, that SAP, clearly, at the beginning of the year, clearly stepped on the gas on the incentives and its desire to sell cloud versus purchased, to use their term, or sell SaaS, instead of purchased, to use their term. And both sales force, if you want to call it, confusion as -- if it change any channel. And our -- we needed to also quickly adapt and clearly understand that at the end of the day, depending on who is facilitating the client mind share, we need to follow the client script. If the client wants to go purchased or instead of SaaS, they will do that. We -- we're able to serve both. If the client wants to go fully hosted, private or public cloud, we need to be able to do that. And we needed to make sure that SAP knew that even though we had been predisposed to selling and maintaining the software, we're able to do everything for a client. So we needed to make sure that any confusion for the channel was clarified and any confusion, certainly for us, was clarified. The only thing I can tell you about our activity there is that the early year activity that we first had experienced in Q1 relative to the activity in pipeline that we're now seeing as we go into second half is significantly improved. So we expect us -- we expect to deal with it dramatically differently than we dealt with any of the Oracle transitions.

Vince, to you and anyone else that always expect us to be at the high, we understand. That's where we want to be, and I understand the question. Our goals have not changed. Any other questions?

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Operator [35]

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

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Ted A. Fernandez, The Hackett Group, Inc. - Co-Founder, Chairman & CEO [36]

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Okay, then, let me thank everyone for participating in our second quarter call, and look forward to updating everyone when we report the third quarter. Thanks, again.

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Operator [37]

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And thank you, this concludes today's conference call. You may go ahead and disconnect at this time.