Q3 2023 Hackett Group Inc Earnings Call

Participants

Robert A. Ramirez; CFO & Executive VP of Finance; The Hackett Group, Inc.

Ted A. Fernandez; Co-Founder, Chairman & CEO; The Hackett Group, Inc.

Adam David Kelsey; Associate Analyst; Craig-Hallum Capital Group LLC, Research Division

Jeffrey Michael Martin; Co-Director of Research & Senior Research Analyst; ROTH MKM Partners, LLC, Research Division

Vincent Alexander Colicchio; MD; Barrington Research Associates, Inc., Research Division

Presentation

Operator

Welcome to The Hackett Group Third 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.

Robert A. Ramirez

Good afternoon, everyone, and thank you for joining us to discuss The Hackett Group's Third Quarter 2023 Results. Speaking on the call today and here to answer your questions are Ted Fernandez, Chairman and Chief Executive Officer of Hackett Group; and myself, Robert Ramirez, Chief Financial Officer.
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 the following comments and in the Q&A session, we will be making statements about expected future results, which may be forward-looking statements for the purposes of the federal securities laws. The 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 that are contained in our SEC filings.
At this point, I would like to turn it over to Ted.

Ted A. Fernandez

Thank you, Rob, and welcome, everyone, to our third quarter earnings call. As we normally do, I will open the call with some overview comments on the quarter. I will then turn it back over to Rob to comment on the detailed operating results, cash flow as well as comment on outlook. We will then review our market and strategy-related comments, after which we will open it up to Q&A.
This afternoon, we reported revenues before reimbursements of $74.6 million, which was above the high end of our guidance and adjusted earnings per share of $0.41, which was at the high end of our guidance. Consistent with our comments on our previous earnings call, the momentum we experienced in the second quarter continued and allowed us to exceed the results from Q3 of last year. This was most pronounced with the strong performance of our Oracle Solutions segment, which was up strongly at several engagements which we launched in the second quarter continued to ramp.
Equally important, we continue to experience strong market demand and received strong support from the Oracle sales channel during the quarter. Our global SBT (sic) [S&BT] segment was up over 5% when compared to last year. We saw most of the new client meetings now include thoughtful discussions on GenAI considerations. We have been working on a new series of AI offerings. We recently launched our new AI Explorer tool, which allows us to deliver a comprehensive GenAI opportunity assessment for clients and provides recommendations by function at the activity level.
We expect this activity to increase significantly in 2024. We are also seeing increasing activity in our enterprise performance management function, which is favorably impacting our Oracle and OneStream practices. Our SAP Solutions segment continued to perform strongly, but was down on a year-over-year basis as it comped against very strong software sales realized in the third quarter of last year.
We also continue to aggressively invest and grow -- and growing on IP-based programs. In Q3, we continued to enhance the product architecture and pricing of our existing executive advisory programs into a more powerful combination of highly focused IP and access to expert practitioners emphasizing our unmatched best practices and value realization tools. Benchmark metrics as well as applied knowledge research.
While our pipeline for these offerings continues to increase meaningfully, extended client decision-making has impacted our sales more than expected. Given this development, we expect to achieve annualized contract value growth closer to 5% to 10% in 2023. All of our executive advisory programs are delivered through our new member platform, Hackett Connect, which fully launched in October. This new state-of-the-art platform allows all of our existing and new members to avail themselves to our benchmarking and best practices IP, applied knowledge research and dedicated experts.
We are also building a community of users that we believe will result in a powerful extended expert network. These investments represent one of our organization's most significant transformative efforts. On the balance sheet side, you can expect us to use cash flow from operations to continue to pay down our outstanding credit facility through the balance of the year. Long term, we plan to use our balance sheet by using our current credit facility to fund acquisitions and to buy back stock while continuing to invest in our business.
With that said, let me ask Rob to provide details on our operating results cash flow and also comment on outlook. I will make additional comments on strategy and market conditions following Rob's comments. Rob?

Robert A. Ramirez

Thank you, Ted. As I typically do, I'll cover the following topics during this portion of the call: an overview of our 2023 third quarter results, along with an overview of related key operating statistics, an overview of our cash flow activities during the quarter and I'll conclude with a discussion on our financial outlook for the fourth quarter of 2023.
For purposes of this call, I will comment separately regarding the revenues of our global S&BT segment, our Oracle Solutions segment, our SAP Solutions segment and the total company. Our global S&BT segment includes the results of our North America and international IP-as-a-Service offerings, our executive advisory programs, our benchmark services, our business transformation and our OneStream offerings. Our Oracle Solutions and our SAP Solutions segments include the results of our Oracle and SAP offerings, respectively.
Please note that we will be referencing both total revenues and revenue before reimbursements in our discussions. Reimbursable expenses are primarily project travel-related expenses pass through to our clients that have no associated impact to our profitability. During our call today, we will also reference certain non-GAAP financial measures, which we believe provide useful information to investors. We have included reconciliations of GAAP to non-GAAP financial measures in our press release filed earlier today and will post any additional information based on the discussions from this call to the Investor Relations page of the company's website.
As Ted mentioned, for the third quarter of 2023, our total revenue was $75.9 million, up 5% over the prior year. Our revenues before reimbursements were $74.6 million which was above the high end of our quarterly guidance, also up 5% over the prior year. The third quarter reimbursable expense ratio on revenue before reimbursements was 1.6% as compared to 1.9% in the prior period and 1.5% when compared to the same period in the prior year. Total revenues from our global S&BT segment were $43.8 million for the third quarter of 2023. Revenues before reimbursements for our global S&BT segment were $43.3 million for the third quarter of 2023, an increase of 5.3% when compared to the same period in the prior year.
Total revenues from our Oracle Solutions segment were $20.8 million for the third quarter of 2023. Revenues before reimbursements for our Oracle Solutions segment were $20.4 million for the third quarter, an increase of 16.9% when compared to the same period in the prior year. This reflects the momentum we started to build in the second quarter of 2023, as Ted had mentioned.
Total revenues from our SAP Solutions segment were $11.2 million for the third quarter of 2023. Revenues before reimbursements for our SAP Solutions segment were $11 million for the third quarter of 2023, a decrease of 12% when compared to the same period in the prior year, primarily due to the expected decreases in software sales in the quarter. Approximately 23% of our total company revenues before reimbursements consist of recurring multiyear and subscription-based revenues which includes our executive advisory, IP as a service, multiyear benchmarks and application managed services contracts.
Total company adjusted cost of sales, which exclude reimbursable expenses and noncash stock-based compensation expense totaled $42.9 million or 57.5% of revenues before reimbursements in the third quarter of 2023 as compared to $41.2 million or 58.1% of revenues before reimbursements in the prior year.
Total company consultant head count was 1,177 at the end of the third quarter as compared to total company consultant head count of 1,148 in the previous quarter and 1,133 at the end of the third quarter of the prior year. Total company adjusted gross margin on revenues before reimbursements which excludes reimbursable expenses and noncash stock-based compensation expense was 42.5% in the third quarter of 2023 as compared to 41.9% in the prior year period.
Adjusted SG&A, which excludes noncash stock-based compensation expense, was $15.3 million or 20.5% of revenues before reimbursements in the third quarter of 2023. This is compared to $13.8 million or 19.4% of revenues before reimbursements in the prior year. The year-over-year absolute dollar increase is primarily due to the incremental investments we're making in dedicated sales resources for our IP-led service offerings. These investments approximated $0.03 in the third quarter of 2023.
Adjusted EBITDA, which excludes noncash stock-based comp expense, was $17.3 million or 23.2% of revenues before reimbursements in the third quarter as compared to $16.9 million or 23.7% of revenues before reimbursements in the prior year. GAAP net income for the third quarter of 2023 totaled $9.4 million or diluted earnings per share of $0.34 as compared to GAAP net income of $10.4 million or diluted earnings per share of $0.32 in the third quarter of the prior year.
Adjusted net income, which excludes noncash stock-based comp expense for the third quarter of 2023, totaled $11.4 million or adjusted diluted net income per common share of $0.41, which was at the high end of our earnings guidance range. This compares to adjusted net income of $11.8 million or adjusted diluted net income per common share of $0.37 in the third quarter of the prior year.
Company's cash balances were $9.9 million at the end of the third quarter of 2023 as compared to $15.8 million at the end of the previous quarter. Net cash provided by operating activities in the quarter was $7.2 million, primarily driven by net income adjusted for noncash activity and increases in accrued expenses partially offset by increases in accounts receivable and decreases in contract liabilities. Our DSO or days sales outstanding at the end of the quarter was 75 days, as compared to 68 days at the end of the previous quarter. The increase in DSO is primarily due to extended terms and milestone deliverables on large multiyear client engagements that we've begun during the first half of the year. We expect a reduction in accounts receivables in the fourth quarter, which should benefit DSO by an estimated 3 to 5 days.
During the quarter, the company paid down $9 million on our credit facility. The balance of the company's total debt outstanding at the end of the third quarter was $44 million. Our plan is to continue to make pay downs through the balance of the year. Net interest expense for the quarter was $814,000.
During the quarter, we purchased -- repurchased approximately 3,000 shares of the company's stock from employees to satisfy income taxable holding triggered by the vesting of restricted shares for an average of $23.55 per share at a total cost of approximately $66,000. Our remaining stock repurchase authorization at the end of the quarter was $13.9 million. At its most recent meeting, subsequent to quarter end, the company's Board of Directors declared the fourth quarterly dividend of $0.11 per share for its shareholders of record on December 22, 2023, to be paid on January 5, 2024.
Before I move to guidance for the fourth quarter of 2023, I would like to remind everyone of the seasonality of our business. Specifically, the increased holiday indication time that has historically taken in the fourth quarter will decrease our available billing days by approximately 10% when compared to the third quarter. As such, the company estimates total revenues before reimbursements for the fourth quarter of 2023 to be in the range of $69 million to $70.4 million.
We expect global S&BT and Oracle segment's revenue before reimbursements to be up when compared to the prior year. We expect SAP Solutions segment revenue before reimbursements to be down on a year-over-year basis. We estimate adjusted diluted net income per share in the fourth quarter of 2023 to be in the range of $0.36 to $0.38, which assumes a GAAP effective tax rate on adjusted earnings of 28.6%. As Ted mentioned last quarter, the fourth quarter will reflect the continued incremental dedicated investments we are making in program development and in dedicated sales resources for our benchmarking, executive advisory, market intelligence and related IP-as-a-service offerings. These incremental costs are expected to impact our diluted net income per common share by approximately $0.02.
We expect adjusted gross margin on revenues before reimbursements to be approximately 43.8% to 44.4%. We expect adjusted SG&A and interest expense to be approximately $16.2 million in the quarter. We expect fourth quarter adjusted EBITDA on revenues before reimbursements to be in the range of 23% to 23.8%. Lastly, we expect cash from operations to be up strongly on a sequential basis.
At this point, I'd like to turn it over back to Ted to review our market outlook and strategic priorities for the coming months.

Ted A. Fernandez

Thank you, Rob. As we look forward, let me share our thoughts on the near and long-term demand environment and the growth opportunity it offers our organization. Although demand for digital transformation remains, it is being impacted by extended decision-making as organizations assess competing priorities created by the increasing interest rates and the demand disruption, which is intended to affect.
Digital innovation and enterprise cloud applications, analytics and artificial intelligence as well as workflow automation are dramatically influencing the way businesses compete and deliver their services. Digital transformation is redefining all activities at an accelerated pace, forcing organizations to fundamentally change and adopt these new capabilities to remain competitive and to realize targeted productivity gains.
When the year started, we believe the clients would become more comfortable with the economic headwinds as the year progressed, and we would see behavior improve in the second half of the year. Although we have seen many clients adjust to the higher rate inflationary environment, the prolonged rate increase uncertainty continues to result in headwinds for new initiatives, which we expect to persist through the balance of the year.
On the talent side, competition for experienced executives continues. Overall, we saw the turnover continue to moderate and improved during the quarter and expect that trend to continue. Longer term, we have transitioned to a hybrid sales and delivery model, which provides us with an effective access to our clients and their respective teams. This hybrid model provides our associates with greater personal flexibility to perform their defined responsibilities remotely, which is very valuable to them. This should allow us to attract and retain talent that we have struggled to retain because of the demanding historical travel requirements of our industry.
Strategically, we have accelerated our focus on our recurring high-margin IP-related services by increasing the development of new programs and sales and marketing resources dedicated to this area. Additionally, we will continue to invest on our new Hackett Connect member platform, with plans to introduce further GenAI capabilities beyond the AI Explorer throughout 2024.
It is also important to note that we continue to see strong downstream revenues from our benchmarking and research advisory clients through our business transformation and cloud application consulting services. The sale effect has been approximately 40% over the last several years. Simply put, organizations who rely on our IP, research and benchmarking services are also more likely to utilize our consulting services.
We also published our inaugural and second market intelligence reports with the most recent report focus on purchase to pay software providers such as Coupa, SAP Ariba, Oracle, and others. We will soon publish our third market intelligence program, which evaluates service providers in the finance and accounting outsourcing space, including companies such as Accenture, IBM and Capgemini. Our unique insight is our ability to measure value realization and provide implementation insight that accelerates a customer's business performance.
Our next one, Enterprise Performance Management is a 3-part report that includes specialized analysis of planning and budgeting enterprise consolidation as well as close in addition to an aggregated view of total [EPM]. By early 2024, we intend to issue 6 additional evaluations of software and services providers. Our market intelligence reports represent critical value to the providers, the companies learn how they compare to competitors as well as the measurable impact their solutions deliver.
Our large benchmarking and consulting and executive advisory customer base can also acquire the market intelligence reports to inform software and service purchasing decisions. We're also exploring strategic partners -- partnerships that will allow us to sell our IP through new channels and that will allow us to reach beyond our current Global 1000 focus in an efficient manner.
We executed our first agreement of our IP and content on April 1, we continue to evaluate new channels for our IP and platforms. We also continue to redefine our global benchmarking leadership through enhancements in Quantum Leap, our digital benchmarking Software-as-a-Service solution along with our digital transformation platforms. These platforms allow us to deliver more information with significantly less client effort. It also allows clients to leverage our IP to create compelling benefit case assessments, accelerate process flows and software configuration decisions and track the value realization of transformation initiatives over the life of their respective effort. We believe there are no comparable IP-led platforms in the marketplace.
As I have mentioned on previous calls, we have a 20-minute demo on the Investor Relations page of our website that investors can utilize to become more familiar with the capabilities of our platforms. We will also be updating our demo with our newly launched Hackett Connect platform.
Lastly, even though we believe that we have a client base in the offerings to grow our business, we continue to look for acquisitions and alliances that strategically leverage our IP and adds scope, scale or capability, which can accelerate our growth. As always, let me close by congratulating our associates on our performance and by thanking them for their tireless efforts and always urge them to stay highly focused on our clients and our people no matter what challenges we may encounter.
Those conclude my comments. Let me turn it over to the operator, and let us move on to the Q&A section of our call. Operator?

Question and Answer Session

Operator

(Operator Instructions) Our first caller is Jeff Martin with ROTH MKM.

Jeffrey Michael Martin

Ted, I was hoping to get an update from you regarding -- you've made some significant investment in sales resources really since the beginning of 2022, but it's accelerated this year. Just kind of looking for an update there on progress tracking relative to your expectation, and what do you see as a potential benefit as we head into 2024?

Ted A. Fernandez

While we continue -- first, we've made significant investments and enhancements to all of our offerings. And specifically, the investments in the sales team have been very significant. We've assembled a great group of individuals. We've been aggressively training and building our pipeline. And I would say that although our conversions this quarter were a little lower than we expected, we continue to believe that the investments we're making on this team and the impact that they will have on our -- the sale of our high-margin IP-based offerings will be significant.

Jeffrey Michael Martin

Great. And then with respect to the market intelligence rollouts, would you say you're on track relative to your thoughts going into the year or maybe even ending after the second quarter? And then secondly, did I hear you correctly that you are seeing rate uncertainty as kind of a headwind to some of these new initiatives taking off initially?

Ted A. Fernandez

We've really seen it across the board. So it's impacted these services as well. I would say that when we look at the overall activity, it's incredibly high. When we look at conversion, we know that we'd like to convert at a faster pace. We expect it to convert the pipeline at a faster pace in Q3. But we saw that extended client decision-making extend into all offerings, and it impacted the sales of the IP-based offerings as well. I think it's probably easier for a client to extend the decisions of a new offering from a new individual, but we think that when we look at the kind of traction and relationships and knowledge of the products that they are building, the capabilities of the team, we think it's only a matter of time.
Is it extending beyond where we hoped? Yes. But did we also believe that the second half of this year would be without headwinds or with significantly, I'll call them less headwinds. But the fact of the matter is, is that as the prolonged interest rate environment -- as the interest rate environment took longer to hopefully hit its peak, and I say hopefully, and now the decision on whether or not to extend that, there's no doubt that the intended impact that it's intended to have to kind of slow down economic growth is being felt. So I want to make sure that it is not isolated to those offerings.
I think when we look at the results for the year, under those environments -- under those conditions as well as the investments we're making and the progress they're making. Yes, would I like to have higher numbers across the Board that I want to in this quarter, expected it to, even though this quarter was strong and also in the next quarter. Look, we're feeling it. But does that determine or dampen the expectations of the returns that we expect to get from those investments? Absolutely no.

Operator

(Operator Instructions). Our next caller is George Sutton with Craig-Hallum.

Adam David Kelsey

This is Adam on for George. Ted, I would love to hear if you have any early feedback on AI Explorer. And additionally, you mentioned in your remarks that you're going to be investing beyond that as well. Would love some further details on what exactly you're thinking about.

Ted A. Fernandez

Well, we actually started all of our GenAI-related offering development at the tail end of last year. So we did a very extensive study to look and develop a significant inventory of use cases by at -- by function at the activity level. So what AI Explorer does is it allows the client to do a very efficient and comprehensive assessment of their opportunities. And determine priorities and understand the related business changes they would have to make.
We just rolled it out in October. And I know that the first thing I had is that we had 10 clients already requested. We're going to be offering it as aggressively as we can throughout our client base. So as I mentioned on the call, we expect this activity to increase not only through the balance of the year, but to be significant in 2024. Now there is no doubt that everyone that is considering any kind of digital transformation effort to do that without considering the significance of GenAI and the with and without GenAI is no longer appropriate. So we think that kind of activity will follow and will build throughout the year.
As it relates to other offerings, we expect to have an executive advisory program, a horizontal program that will be -- that will extend to all of our functional programs. We've actually started doing client briefings on those, and we'll formalize that program either latter part of this year or no later at the beginning of the year. We've also incorporated then all GenAI-related consulting services that will accompany or follow the AI Explorer, I'll call it, opportunity identification assessment that it intends to make.

Adam David Kelsey

And in terms of the M&A market, I'd love to know if you're seeing anything improve, are more people coming to the table or pricing -- is pricing improving? Any type of feedback would be great.

Ted A. Fernandez

I can't really make many comments other than to simply say that on the financing side, obviously, it's a lot harder to finance a deal. It's definitely more costly. So I think that, that continues to be constrained. And yes, it's going to take a little bit for people to really reconsider what normalized pricing is. It's just part of the process. So no. Have we seen any difference in pricing? No. Have we seen significantly less activity on the financial buyer side and financials and those who play in that space? Yes.

Adam David Kelsey

And a final question for me. With respect to the sales force build-out for market intelligence, I believe in the past, you mentioned you wanted to grow that to about 30. How far along are you on that just from a head count perspective?

Ted A. Fernandez

Well, we were in high 20s throughout this quarter. So the 30 number is still the target. So unchanged I think at this point, it's around the conversion of the existing opportunities because we accelerated and built our team in that first half of the year.

Operator

And our next caller is Vincent Colicchio with Barrington Research.

Vincent Alexander Colicchio

Yes, Ted, on the market intelligence program side, has the performance been lower than expected because you rolled out less programs than expected as well as seeing less demand than expected?

Ted A. Fernandez

Well, first, I think I said this on the last earnings call. So let's make sure that we understand the increase in the sales resources were built to sell our existing executive advisory researchers with focus on our functional buyers. As you know, we've got depending on how do you count [8 to 12] programs, that is where the overwhelming amount of our time has been. The time on market intelligence, yes, it's taken us longer to make sure the programs have the kind of content and impact that we'd like. But they were never intended to be the sales of revenue-producing effort in 2023, they are and were expected to have the impact in 2024. We still believe we're going to have several new programs out through the balance of the year and in early 2024. So we think that the complementary market intelligence programs will come out.
But just to make sure we're clear. The 2023 projections were based on the sale of our executive advisory programs, not the market intelligence programs, we expected them to start contributing in an incremental basis, which they have. And yes, we wanted to roll out more. But as you may recall, we made a change from the market intelligence leader that we made at the middle of the year. I think it was the June time frame. So that led to some just a slowdown on approach and the effort we were making. However, it is back on full force with our effort to get out the targeted number as early in 2024 as we can.

Vincent Alexander Colicchio

Thanks for the clarification there. On the SBT, GSBT and the Oracle businesses, looking for sequential growth here in Q4. Curious what the sales pipelines look like there? And to what degree do you feel that there's enough pipeline to continue to grow sequentially into early next year?

Ted A. Fernandez

Well, the answer is you take the 10% less available dates that we have in the quarter when you consider the sequence from Q3 to Q4 and you look at our guidance and you will see that with the exception of SAP which our guidance includes, I'll call it, a more conservative number on the software sales out of the activity, the others are all expected to grow sequentially, including the 10% pure available days that we've had.

Vincent Alexander Colicchio

Yes, got that. But I'm just curious, the sales pipeline of potential new clients. What does that look like for the GSBT and Oracle businesses?

Ted A. Fernandez

Again, out of that extended decision making, the activity with those clients remains unchanged. [Interaction with clients] remained strong. GenAI conversations on virtually every conversation. So no, that's unchanged. But is it taking longer for people to make decisions or weigh some of those new initiatives against or as part of a broader GenAI opportunity, yes, we're seeing those kinds of, if you want to call it, extended decision-making.

Operator

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

Ted A. Fernandez

I'd like to thank everyone for participating in our third quarter earnings call and look forward to updating you again when we report our fourth quarter and full year results.

Operator

And this concludes today's conference. Thank you for participating. You may disconnect at this time, and have a great rest of your day.