Hackett Group Inc (HCKT) 2007 Q1 法說會逐字稿

Good evening, and welcome to the Answerthink first quarter conference call. (OPERATOR INSTRUCTIONS) Please be advised that the conference is being recorded. Hosting tonight's call are Mr. Ted Fernandez, Chairman and CEO, and Mr. Grant Fitzwilliam, Chief Financial Officer. Mr. Fitzwilliam, you may begin.

Good evening, everyone. Thank you for joining us today to discuss Answerthink's first quarter results. Speaking on the call today and here to answer your questions are Ted Fernandez, Chairman and CEO, and myself, Grant Fitzwilliam, CFO. A press announcement was released over the wires at 4:08 p.m. eastern time today. For a copy of the release, visit our website at www.answerthink.com. We will also place any additional financial statistical data discussed on this call, not contained in the release, on the investor relations page on 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 might 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 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 filing. At this point, I would like to turn it over to Ted.

Thank you, Grant. As we normally do I will open up the call by providing some overview on the quarter. I will them it back over to Grant and ask him to comment on operating results, cash flow and comment on outlook. Grant will then turn it back over to me and I will update everyone on our strategic priorities and we will then open it up for Q&A. Having said that, let me go ahead with the overview comments. Today, we reported Q1 results with revenues and pro forma EPS in line with guidance. In early Q1, we made adjustments to our Hackett sales incentive structure so that we reward the sale of all of our offerings equally. We made the sale of our membership advisory programs a prerequisite for accelerator and club recognition.

Another key change for 2007 was to change the emphasis in our primary, go-to-market strategy to ensure we optimize client relationships and lead to cross all of our offerings. In order to do this in Q1, we introduced a new transformational benchmark that allows us to engage a client as strategically as possible at the onset of our relationship while fully exposing them to our proprietary benchmarking matrix, best practice implementation content and our advisors, which are at the heart of the membership advisory offering. Our goal is to ensure that our benchmarking and transformation services grow at normalized growth rates while continuing to grow our advisory services as aggressively as possible. We believe these adjustments will result in higher Hackett group sales and revenue per client and favorably impact profitability throughout 2007. In Q1, we started to experience the impact of our changes as we saw total Hackett revenues grow strongly on a sequential basis and expect that to continue into Q2.

On the revenue for client side, we had a large number of phase 1 million plus deals, in the quarter, and also a much higher volume of deals over $500,000 in this quarter and this would be, this quarterly activity was higher than in any single quarter in all of 2006. Specifically, our now transformational benchmark drove strong sequential growth in our benchmarking and transformation service line, membership advisory grew as expected, grew strongly, and REL was down slightly on a sequential basis. Relative to REL, we believe the dedicated sales channel focus we effected in Q3 of last year is allowing us to build a strong pipeline of opportunities in this business. And given the number of quality opportunities we're currently pursuing, we're planning for revenue growth momentum to start to rebuild in 2007. In our best practice solutions group, if you recall, in Q4 we completed the exit of our business applications and low margin staff augmentation contracts which made up our loss in practice as well as our SAP staff augmentation business. Excluding these revenues in Q4, our BPS group was up slightly, sequentially. That was also as expected. In the business application practices, we're experiencing improved demand in both Oracle and SAP. Relative to our Hyperion Group, we believe we can regain the growth momentum in our Hyperion practice in early last year as we increase our emphasis in the growing demand we're seeing in the Hyperion analytic and reporting areas.

On the SG&A front, we took several cost reduction actions in Q1which resulted in severance of other costs that totalled a penny and a quarter, but were part of our overall plan to reduce our total SG&A spend throughout 2007. Overall, the actions that we took during the quarter are providing the momentum we expected. Additional overall market demand remains healthy in the U.S. and has improved noticeably in Europe, which bodes well for our growth prospects for the remainder of the year. Those are my overview comments. Let me turn it over to Grant to provide details on our operating results, cash flow and comment on outlook.

Thank you, Ted. I plan to cover four main topics. Firstly, and overall Q1, 2007 result review; second, a breakdown of Q1, 2007 revenue; thirdly, a review of some key operating statistics; and finally, we will conclude with a discussion of our financial outlook for the second quarter of 2007. Note that all references to revenue in my discussion will pertain to gross revenues, which is revenue including reimbursable expenses. From a Q1 result perspective, both revenue and EPS are in line with our quarterly guidance. For the first quarter, our revenues were $40 million, a 4% sequential increase. Excluding our revenues from the exit of our Lawson and SAP staff augmentation contract in Q4, our sequential growth was 9%. Our pro forma net loss was $639,000 or $0.01 per share. Pro forma loss excludes non-cash compensation of $1 million intangible asset amortization of $364,000, a net recovery of $167,000 from the UK misappropriation and includes a normalized tax rate of 40%. The pro forma loss does include approximately $700,000 of severance costs which relate to actions taken in Q1 as part of our cost reduction effort. On a GAAP basis for the first quarter, we had a net loss of $2.3 million or $0.05 per diluted share. This includes tax expense in the quarter of $67,000. As of the end of the first quarter of 2007, the company has approximately $70 million of U.S. federal loss carried forward.

Breakdown of Q1 revenues. As Ted mention mentioned earlier, along with our Hackett commission program realignment, our go-to-market strategy now focuses on ensuring we engage clients as broadly as possible before moving to more narrow alternatives. One of the key action items in making this happen was the introduction of our new transformational benchmark as our primary go-to-market offering. As a result, we will consolidate our Hackett revenue reporting service lines from 3 to 2. Benchmarking and transformation will now be reported as a single line-item and will continue to include our REL business.

Having said that, total Hackett revenue was up 10% sequentially to $22.9 million compared to $20.8 million in the previous quarter. Breaking down Hackett revenue, membership advisory revenue was $3.6 million, which is up 4% sequentially and 62% on a year-over-year basis. Annualized contract value for Hackett membership advisory business was $14.4 million at the end of the first quarter of 2007, up 4% sequentially and up 45% on a year-over-year basis. Benchmarking and transformation revenue was $19.3 million, which is up 11% on a sequential basis, but down 16% on a year-over-year basis. The primary reason for the year-over-year decrease was attributable to the REL business, which was down $2.6 million in that period. The go-to-market strategy of emphasizing a transformational benchmark is finally having a positive impact on revenue as we saw more million-dollar deals in Q1 than any single quarter of 2006.

Moving on to the best-practice solutions group, we will also be consolidating our revenue reporting from two line-items into a single line-item. This is driven by Oracle's recent acquisition of Hyperion. Our Hyperion group has been aligned with our Oracle group consistent with Oracle Corp.'s acquisition strategy. Together, our Oracle and Hyperion practices make up over 2/3 of our total best practice solutions group. The remainder is comprised of SAP and custom visits intelligence groups. Revenues for best practice solutions total $17 million, down from $17.4 million in Q4 and $24.6 million a year ago. The Q1 number does not include any loss in SAP staff augmentation contracts, which were wound down during 2006. In Q4, of last year, Lawson SAP (inaudible) augmentation contracts generated approximately $1.5 million in revenue. Excluding those revenues, the best practice solutions group was up slightly, as expected.

I would now like to discuss our key operating specifics. Consultant head count at quarter end was 563, a decrease of 21, compared to 584 at the end of last quarter. The decrease is primarily attributable to a reduction in the usage of subcontractors in best practice solutions group. Revenue for professional and Hackett group was $345,000, compared to $322,000 in Q4 of 2006, and $350,000 in the first quarter of last year. Revenue for professional was positively impacted in the current quarter by improved utilization of our business transformation consultant. Revenue for professional is calculated by dividing gross Hackett group revenues by the average number of consultants and subcontractors during the period. Our target revenue for professionals for all of the Hacketts continues to be in excess of $400,000 and we expect to make progress toward this goal in Q2.

For the best practice solutions group, consultant utilization was 63% which, is up from 60% from last quarter and down compared to 76% in Q1 last year. This was driven by low utilization levels at the beginning of the quarter, but showed improvement as the quarter continued. We expect this percentage to show improvement in the second quarter to through a combination of better demands and the Hyperion adjustments made in Q1, 2007. For the best practice solutions group, our per hour realized billing rate was $171.00 this quarter, up from $161.00 last quarter and $150.00 in Q1 of last year. This improvement was anticipated as we have now exited all low-margin staff augmentation contracts. Our pro forma gross margins which, excludes stock compensation expense were 37.4% in the first quarter comparable to 37.4% in previous years first quarter. Our pro forma SG&A as a percentage of revenue was 40.7% in the first quarter, compared to 32% in the first quarter of last year. This reflects our continued investment in the REL and Hyperion sales channel to allow these practices to regain their sales momentum as well as severance-related costs, which were incurred in Q1 as part of our cost reduction effort. Our cash balances, including restricted cash and marketable investments were $24.2 million at the end of the first quarter, compared to $20.2 million in the fourth quarter of last year. The primary reason for the increase in cash is due to a 14-day reduction on our DSO from 85 days to 71 days. 71 days of DSO is a more normalized level of DSO for us, but we're motivated to get DSO into the 60s. We did not repurchase any stock in Q1 and at the end of the first quarter, we have $6.1 million available for future purchases of common stock.

Finally, I would like to discuss guidance. For the second quarter for all of Answerthink, we expect second quarter revenues to be in the range of 42 to $44 million. Diluted pro forma earnings per share in the second quarter should be in the range of $0.02 to $0.04, this pro forma estimate includes a normalized tax rate of 40%. From the Hackett revenue perspective, we expect Hackett to be up strongly sequentially with both membership advisory and benchmarking transformations showing strong sequential growth. We expect business applications, best practice solutions to be flat to up slightly sequentially. We expect SG&A expense to remain flat compared to Q1, even though we expect to spend nearly $1 million between our U.S. and European annual Hackett best practice conferences, as well as the annual Hyperion and SAP software conferences. Accordingly, our cost reduction efforts affected in Q1 will be more evident in Q3 of this year. We expect our cash balance, excluding any potential stock buyback to be up during the quarter, benefiting from improving operating income and partially offset by the timing of our U.S. payroll cycle. At this point, I would like to turn it back to Ted to cover our market outlook and strategic priority.

Thank you Grant. As we look forward, we continue believe the market demand for our services remains healthy. Geographically, we continue to expect slower but solid GDP growth and related business spending reflected in our U.S. demand. In Europe, we're clearly seeing improved demand across all markets that we serve. With that as a backdrop, let me comment further on our strategic priority.

Let me first start by addressing revenue growth. We believe the best way to take advantage of our expanded brand permission and business model is strongly tied to the way we initially engage with a client. We understand that clients come to us for our unique ability to evaluate how efficiently they operate their company and for our ability to bring proven best practices to bear in their business as quickly and as efficiently as possible. They strongly value our imperical data-based approach and, therefore, the objectivity that we bring to critical business decisions. As I mentioned in my opening comments, we did see an increasing number of large deals in Q1. We believe this is a combination of both the way we initially engage clients and also the improved demand in Europe, and I believe continuing brand expansion in our Hackett group. If we continue to improve on how best to expose our clients to the broadest leverage of our best practice content and tools at the onset of our relationship without defaulting to a more narrow offering prematurely, we believe we will be able to ensure that we develop the broadest revenue relationship with the client while having a great opportunity to establish a continuous relationship through our advisory programs. The key is to avail the client to our intellectual capital and our associates in a way that best suits their needs but to ensure that we have not sub-optimized our opportunity with that client.

Second item is our desire to have trusted and continuous relationships with our clients. Our goal continues to be 1,000 members and 500 clients as quickly as possible. Our long-term goal is to be able to ascribe and predict an increasing percentage of our total annual revenues to our Hackett, to our advisory program members and clients. Our clients use our programs to support performance improvement initiatives that they are assessing, executing or to remain current on best practice changes that can drive sustainable improvements in their business. At the end of Q1, gross membership counts exceeded the 800 mark over 60% from a year ago with client counts now approaching 270 or approximately a 26% increase from a year ago. Members per client are just over three members per client. In Q1, we set out to grow our benchmarking and business transformation business, as we have commented, to what we believe is their normalized growth rates while continuing to grow our membership advisory business as aggressively as possible. One of the key aspects of our adjustments was to supplement our strategic account sales team who cover our largest client relationships with a geographic sales team that would primarily pursue advisory program sales. We expect this team to be an increasing part of our advisory sales as the year progresses.

Third item is to expand and leverage our imperical capital. Our organization has always been distinct because of the proprietary data we capture through our benchmarks and our best practices repository and tools that help clients drive to an outcome. During the year, we continue to look for ways to expand our ability to capture and create performance improvement data and insight. During the year, we also continued our ability to expand and refresh our best practice repository and implementation tools as well. While we continue to develop the strategies that allow us to broaden the data capture and sharing across the organization of clients, in addition to our benchmarking offerings, we have the ability to capture data through a series of new benchmark and data analysis tools so that we can expand the number of customized benchmarking studies we can execute during the year. At our most recent best practices conference, we used one of such studies to focus on talent management which was very well received. In our last earnings call, we mentioned we're seeing our Oracle group reposition itself around the leverage of Hackett and our best practices implementation intellectual capital. With the alignment of our Hyperion group, now of Oracle group, we expect to see an acceleration of this effort in our Hyperion group as well.

Let me comment on the expanding leverage of our India team also. This quarter we further expanded the resources of our Hyderabad facility by launching a new research team that supports our globalization practice effort, part of our transformation and advisory efforts. We increased the number of resources that support our Oracle team's application delivery efforts. We believe we're in the early stages and how we use our India team to support many of our global delivery and back office efforts. In summary, the early indication of the changes that we effected heading into 2007 have been favorable to our growth and profitability prospects in our business. We understand that the key will be to maintain this momentum throughout Q2 and strongly position the organization for the balance of the year. As always, it's important to recognize the outstanding contribution of our associates during this very strategic transformation of our entire business model. I want to thank them and recognize their outstanding efforts in spirit. Those are my comments. Let me turn it back over for Q&A.

Thank you. (OPERATOR INSTRUCTIONS) The first question comes from George Sutton with Craig-Hallum..

Hi, guys. First question with respect to how you are getting some of these larger contracts that you're beginning to see. You are engaging the customer differently, obviously, the Hackett brand is improving and you have changed the compensation plan. Can you try to break down where business is coming from, why you're starting to see a little bit of improvement when you look at those three variables?

It's a couple of things. We clearly did see improved demand, George, but I think one of the things that we learned in 2006 was that if we were to properly package the introduction of our benchmarking and transformation as one offering, that our ability to engage that client more broadly would clearly improve. We also know that when our transformation team is engaged with a client in any phase one initiative, that our ability to continue with that client is probably two out of three. So we did it for a number of reasons. One is because we thought it was logical as we saw our offerings develop. We saw clients asking us for more feedback from benchmarks and we really believe that we were now getting very close to offering something that was more comprehensive, but also we believe the introduction of transformation not only strengthens the benchmark delivery but allows us to enter more strategically and have a much higher conversion rate from phase 1 to phase 2. There was a lot of good reasons, but I think changing the sales incentive structure so the sale of a Hackett offering is rewarded equally, then I think also eliminated any skew that we may have had in 2006 in terms of the way one of our sales executives engaged the client.

Now, the corresponding issue of the plan changed that you recognized could be an issue as a slowdown in membership advisory. Can you just give us a little more sense there?

Well, two things. We said we didn't expect it to grow at the same rate that we did last year because, obviously, we had skewed our attention and skewed the incentives to make sure we grew that as aggressively as possible, but it was coming at a significant expense to our other larger and very profitable offerings. But the two things that we did was, one, in the sales incentive for our strategic account managers, we made sure that we, all of our accelerators that our accelerators and club incentives included a certain level of advisory sales and we have also supplemented that team with a geographic-based team to -- that would focus primarily on the advisory sales. But if -- I get this question asked a lot. If I had to compromise our advisory -- our advisory growth rates some in order to allow Hackett in total to grow over 20%, the way we believe the company should, then we believe that is the right tradeoff. Our desire is to obviously keep those, but we know we're engaging clients in a way where many times the client makes the choice. So, we know we skewed it the way we engage clients today, but we believe that is the right number when we look at total revenue growth and the level of profitability that we believe the company should be, should achieve in '07 and as we look into '08.

Okay, a question for Grant. Your gross margins year-over-year gross margin percentage was flat. And you eliminated the staff augmentation business during 2006, why would we not see gross margins improve year-over-year?

I think the primary reason, George, is that we had excess capacity and lower utilization at the beginning of the quarter and if you look at, particularly in the best practice solutions, the utilization rate in Q1 of last year was 76% whereas in Q1 of this year, it's 63%. So, that excess capacity in the beginning of the quarter clearly cost us on the margin perspective.

We exited, George, we exited '05 with more momentum and it probably had higher utilization across the board for almost all of our team when we compare it to the first half of this quarter as compared to the first half of 2006.

Okay and then I know you don't give guidance for the back half of the year but if you could give us the sense given the fact that you're seeing a little bit better large deal environment, you're going to start to see some of the benefit from the comp plan changes, should we start to see some acceleration in the back half of 2007?

George, I think last quarter we said for the year we expected Hackett to grow north of 15% and that was assuming that REL would not contribute to that growth. So on an overall basis, we continue to believe that and that we also believe that our business applications and business intelligence groups should grow throughout the year. When you look at the combination of both of those things with, as Grant mentioned, the fact that you should expect to see the SG&A leverage increase throughout the year, it won't be noticeable in Q2 because of the significant expenses that we have in marketing specific to the conferences that we hope to participate in the quarter. Yes, it would -- it should mean that that growth with higher SG&A leverage and the benefit of lower operating taxes should give us an opportunity to kind of improve results throughout the year.

Just to clarify one thing. When you say lower operating taxes, you mean you have in Q1 to be effective early-year taxes?

Yes, if you remember as you get into the second half of the year, your social security and other taxes decrease, which give you some benefit in that second half of the year.

Okay, thanks, guys.

Thank you. (OPERATOR INSTRUCTIONS) Our next question comes from William Sutherland with Boenning & Scattergood.

Thank you. Hi, Ted and Grant.

Hello.

Would you mind reviewing a couple of numbers, I didn't quite keep up with. Where are you with members and clients?

Members, 803. Clients, right under 270.

And the percentage change in those numbers?

Year-over-year over 60% on members and over 25% on client counts with an increasing member per client count.

Does this include all of facets of Hackett or is this only reflective of the advisory?

This corresponds only to membership advisory.

Uh-huh.

The membership advisory service line.

Okay.

Yes.

And you're not seeing on a couple of the best practices kind of consultants, they're seeing a little bit of customer fatigue or priority shift. You're actually seeing sort of an improved interest it sounds like?

Clearly when we combine Europe and U.S., we're clearly seeing increased demand. When we look at U.S. alone, I believe that demand in U.S. has been unchanged now for 18 to 24 months. When I -- my strategic comments -- I always comment on the fact that slower GDP should mean slower demands somewhere down the roads. We have not seen any change in client behavior.

Okay. Grant, the initiatives on the SG&A front, just real simple math, it looks like since you're going to be flat, Q2 over Q1, with the extra million plus or minus for all the conference expense, did you take out almost a million and a quarter?

Yes, because the absolute dollars will be the same. The revenue will be up as a percentage of revenues, it will be a lower percentage and yes, that is the offset.

Okay. And that was just -- that was mostly what kinds of savings did you get? In what areas did you find those savings?

Primarily in the SG&A personnel costs.

Okay. I am kind of wondering where you think your model can take you now as you have further refined your offerings and kind of look ahead at the mix of business. I don't know to what degree you have talked about targets for whatever sort of margin line you would like to refer to. You talked about where you think the group can grow but if you, have you spoken to that and if you have, or could you?

We didn't in Q1, George. Grant's nodding his head saying no. In Q1, I think we spoke to revenue growth and we thought that was a great indication as well as trying to provide you SG&A guidance. I would say in general we continue to expect Hackett margin to expand throughout the year and we're counting on basically flat gross margin from the BPS business. Even though we know we have gross margin opportunity, clearly in our Hyperion group, we have run higher gross margins there. That would be some color as to what we see, but I think the other indicator is Grant commented on the fact that our revenue per professional, which we continue to believe that our Hackett total target should be revenue for professional excess of $400,000, I would say that is another indicator of how we see the Hackett margin expanding, even though we haven't provided gross margins, specific guidance.

You have never actually given any indication of where the business runs on any margin basis, have you?

We do have -- we do provide a kind of a target model that we use frequently and we haven't changed that and we both said it's subject to the mix of the business at the time. But we believe that it's 12 to 15% operating margin, that is achievable on a target basis when we look out 18 to 24 months and that is significantly driven by the mix. Obviously, the -- we have also commented on -- that we believe the Hackett business on a standalone basis is the business that we believe has an operating margin opportunity in the 20% range and we have always commented that we thought the BPS margin opportunity was in the 10% range. Those would be kind of the trend comments that we provided generally.

And that hasn't changed at all now that you reformulated things on both sides of the business?

No, we haven't gone back and exchanged it because just the -- we haven't had a need to. We think we're obviously have margin expansion opportunity and as we get closer to some of those targets, we will expand it accordingly.

I know you're not breaking out benchmarking at this point, but I was curious if you did see sequential improvement quarter-over-quarter, since obviously we have prior quarter number?

Did we, Grant? He's looking at that, looking that up what, I do know, because it's the number that I'm closer to myself is that we're expecting strong sequential growth in benchmarking from Q1 to Q2. But let Grant see if he can give you some indication of Q4 to Q1 number. Did we have sequential growth in benchmarking Grant?

And is that partly, while he's looking, Ted, is that partly a function of some of those catch-up studies?

No, no. We still think that the multi-year opportunity, which this year the bigger numbers for the multi-year benchmark sales that were done are fallen to the biggest portion falls in '08, but there is some amount in '07. We have seen some movement in that space but the amount of the total backlog that we actually expect to realize in '07 from a scheduled basis was actually less than less than 10% of the total backlog. The number is significantly greater in '08. We still see that as an opportunity.

The answer to your question on benchmarking, it was down slightly on a sequential basis.

Okay. All right. Well, thanks. I'll be back.

Thank you,Bill.

Uh-huh.

Thank you, at this time, I show no further questions. I will turn the conference back over to the speaker.

Let me, since there are no questions, let me thank everyone for participating in -- and I -- I will apologize for the hold music that was on. We started a minute earlier because I couldn't tolerate it another minute but, thank you again for participating and I look forward to updating everyone when we report the second quarter sometime in the latter part of July or early August. Thank you again.

Thank you for participating in today's conference call. You may disconnect at this time.