Hackett Group Inc (HCKT) 2017 Q3 法說會逐字稿

Good evening, and welcome to The Hackett Group's Third Quarter Earnings 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. Rob Ramirez, Chief Financial Officer.

Mr. Ramirez, you may begin.

Good afternoon, everyone, and thank you for joining us to discuss The Hackett Group's third 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, Chief Financial Officer. A press announcement was released over the wires at 4:14 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.

Thank you, Rob, and welcome, everyone to our third quarter earnings call. I will start the call by trying to provide some overview or highlight comments relative to our quarter, then turn it back over to Rob and ask him to comment on our operating results, cash flow and then provide some details on guidance. Rob will then turn it back over to me to provide some market and strategic overview comments, and then we will open it up for Q&A.

So let me first start with our quarterly highlights. This afternoon, we reported gross revenues of $71.5 million and pro forma EPS of $0.26, both revenues and pro forma EPS came in at the high-end of our guidance. As expected, our U.S. revenues, including our acquisition, were down from last year. This was offset by strong European results and our small but emerging IP-as-a-Service revenues.

As we discussed last quarter, the software market is rapidly moving to cloud, and we have aggressively started to transition our Oracle Group from being primarily focused on the implementation of Oracle EPM on-premise software to the entire Oracle Cloud Enterprise Suite. And we've done that through a series of actions.

As you know, we acquired an Oracle Enterprise Cloud implementation group in May, which has allowed us to expand our Oracle addressable market fourfold. We then started to aggressively migrate our existing EPM on-premise resources to the rapidly growing Oracle Cloud focus. At the recent Oracle OpenWorld conference, we were recognized as the EPM Cloud Partner of the Year, which demonstrates our ability to migrate our on-premise capabilities to cloud effectively.

We have also started to develop our Oracle Digital Transformation Platform, which aligns Oracle cloud functionality to Hackett's best practices and specific configuration guidance, which optimizes the use of the software. We premiered the platform during the recent Oracle OpenWorld to very favorable feedback from both prospective clients and Oracle sales channel. We believe this is a highly differentiated capability, which will prove successful for us in the -- as we go forward with Oracle and in the marketplace.

Lastly, we have fully aligned our capabilities to the Oracle go-to-market strategy and sales channel. As you know, Oracle had aligned its EPM and ERP sales channels at the beginning of the year. And it was very important for us to expand our capabilities and align our capabilities with their go-to-market strategy and channels, and we believe we have done so effectively.

These moves have allowed us to significantly increase the addressable market to cover the entire Oracle Cloud implementation software suite. Instead of just selling EPM cloud-related software, we are now positioned to implement cloud-related software for finance, EPM, HCM, supply chain and customer experience, the entire suite.

As I mentioned last quarter, we believe that the expanded Oracle implementation capabilities, and our ability to demonstrate to prospective clients and the Oracle channel that we can optimally configure Oracle Cloud software by leveraging our best-practice IP will allow us to move to their top-tier status by early 2018.

Another key part of our digital transformation strategy has been the increasing consideration of robotics process automation in business transformation initiatives. To complement our capabilities, we made an acquisition in Europe and entered into an alliance agreement to quickly address these market changes. We believe these moves, along with the introduction of our new Quantum Leap benchmarking offering, our recently announced acquisition of our joint venture's partner interest in CGBS training and certification program, as well as the new enterprise analytics training and certification program, accelerate our position as a digital transformation and IP-as-a-Service leader.

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

I will 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 guidance.

Rob?

Thank you, Ted. As I typically do, I'll cover the following topics during this portion of the call: an overview of our 2017 third quarter results, along with an overview of related key operating statistics. I'll also provide 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 2017.

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 represents revenues excluding reimbursable expenses.

Additionally, references to pro forma results specifically exclude noncash stock compensation expense, intangible asset amortization expense, acquisition-related cash and stock compensation expense and related transaction expenses and restructuring charges and assumes a normalized long-term cash tax rate of 30%.

As Ted mentioned, for the third quarter of 2017, our net revenues or gross revenue excluding reimbursable expenses, decreased by 1% to $65.9 million when compared to prior year and it was at the high-end of the guidance range provided. The actual Q3 reimbursable expense ratio on net revenues came in at 8.4% versus the 8% that we used in our gross revenue guidance.

Reimbursable expenses are project travel and related expenses passed through to a client with no margin associated with them. This resulted in total company gross revenues of $71.5 million, which represents a year-over-year decrease of 4%. Net revenues for The Hackett Group, which excludes SAP Solutions, were $56.1 million in the third quarter of 2017, a decline of less than 1% on a year-over-year basis. Hackett U.S. net revenues were down by 7%, as revenue declined in our EEA Group as a result of the transition from on-premise software, which were partially offset by our rapidly growing revenues attributable to cloud-based implementation services. This decline in U.S. revenues was offset by strong international growth of 36% led primarily by Europe.

Hackett Group annualized net revenue per professional was $297,000 in the third quarter of 2017 as compared to $321,000 in the third quarter of the prior year and $316,000 in the previous quarter. It is important to note that in previous years, we had reported annualized revenue per professional based on gross revenue, which included a gross-up of approximately 11% for reimbursable expenses. However, given the impact of the acquisitions on reimbursable expenses, we moved to reporting this statistic on a net revenue basis in Q2. The reason for the decline is primarily due to lower revenue per professional related to our recent acquisitions.

Additionally, our target cloud implementation model utilizes a much higher percentage of off-site resources, which will drive lower revenue per professional but at higher margins. Net revenue from our SAP Solutions Group -- which consists of our SAP reseller, implementation and Application Managed Services Groups, or AMS -- totaled $9.8 million in the third quarter of 2017, a decrease of 6% on a year-over-year basis. Total company international net revenues accounted for 19% of total company revenues in the third quarter as compared to 13% in the third quarter of 2016.

Our recurring revenues, which include our executive and best practice advisory as well as our AMS Groups accounted for approximately 20% of our total company net revenues and 27% of our total company pretax practice profitability in the third quarter of 2017.

Total company pro forma cost of sales, excluding reimbursable expenses, stock compensation expense and acquisition-related cash and stock compensation expense, totaled $39.8 million or 60.4% of net revenues in the third quarter of 2017 as compared to $40.6 million or 60.8% of net revenues in the previous year.

Total company consultant headcount was 1,022 at the end of the third quarter as compared to 1,002 in the previous quarter and 942 at the end of the third quarter of 2016. The year-over-year increase is primarily due to the acquisitions closed in the second quarter of 2017, partially offset by the rationalization of resources resulting from the migration from on-premise software to cloud-based resource requirements.

Total company pro forma gross margin was 39.6% of net revenues in the third quarter as compared to 39.2% in the third quarter of the previous year. Hackett Group pro forma gross margins on net revenues was 39.7% in the third quarter as compared to 39.1% in the third quarter of the previous year.

SAP Solutions pro forma gross margins on net revenues was 39.3% in the third quarter as compared to 39.6% in the previous year. Pro forma SG&A was $14.2 million or 21.5% of net revenues in the third quarter of 2017 as compared to $14.7 million or 21.9% of net revenues in the previous year. Pro forma EBITDA in the third quarter of 2017 was $12.5 million or 19% of net revenues as compared to $12.1 million or 18.2% of net revenues in the third quarter of 2016, an increase of 3%.

Total company pro forma net income for the third quarter of 2017 totaled $8.2 million or $0.26 per diluted share, which, as Ted mentioned, was at the high-end of our third quarter's guidance. This compares to pro forma net income of $8 million or $0.25 per diluted share in the third quarter of 2016. These results represent an increase of 3% and 4% on a year-over-year basis for pro forma net income and earnings per share, respectively.

Total company pro forma net income for the third quarter of 2017 excludes noncash stock compensation expense of $2 million, acquisition-related stock compensation expense of $794,000, acquisition-related cash compensation expense of $619,000, intangible asset amortization expense of $557,000 and acquisition-related transaction costs of $111,000.

Pro forma results also assume a long-term cash tax rate of 30% or $3.5 million. Acquisition-related cash and stock compensation expenses relate to the portion of the purchase consideration for acquisitions that contain service vesting requirements and, as such, are reflected as compensation expense under generally accepted accounting principles.

GAAP diluted earnings per share was $0.17 for both the third quarter of 2017 as well as the third quarter of 2016. The company's cash balances were $16.2 million at the end of the third quarter of 2017 as compared to $14.4 million at the end of the previous quarter. This cash increase in the third quarter was generated from net income adjusted for noncash items and net borrowings under our revolving line of credit offset by the payment of semiannual dividends, repurchases of common stock and capital expenditures.

Net cash provided by operating activities in the third quarter of 2017 was $10 million, which was primarily driven by net income adjusted for noncash items, amounting to $9.1 million as well as increases in accrued expenses, partially offset by increases in accounts receivable.

Our DSO, or days sales outstanding, at the end of the third quarter of 2017 was 71 days as compared to 61 days at the end of the previous quarter. This increase was primarily due to the impact of acquisitions completed in the second quarter of 2017. We fully expect DSO to come back down over the next 2 quarters as we migrate the acquired companies to our billing processes and procedures.

During the quarter, the company paid $4.6 million for its semiannual dividend. Additionally, we purchased 250,000 shares of the company's stock at a total cost of $3.5 million or an average cost of $14.21 per share. During the quarter, the company borrowed a net $2 million from our credit facility. The balance of the company's total debt outstanding at the end of the third quarter of 2017 is $22 million.

I will now turn to our guidance for the fourth quarter. But before I do, I would like to remind everyone of the seasonality of our business. Specifically, the increased holiday and vacation time that is historically taken in the fourth quarter will decrease our available billing days by approximately 8% when compared to the third quarter. We will continue to use a lower estimate of reimbursable expenses, which will unfavorably impact the year-over-year gross revenue comparisons by approximately 3%. The decrease in reimbursable expenses is primarily driven by lower expense ratios resulting from the recent acquisitions and the increase in IP-as-a-Service revenues, both which historically drive much lower levels of reimbursable expenses.

As such, the company estimates total net revenues for the fourth quarter of 2017 to be in the range of $61.5 million to $63.5 million, slightly up from the previous year, at the high-end of the guidance range. Gross revenue will be in the range of $66.5 million to $68.5 million. This gross revenue outlook includes an estimated 8% for reimbursable expenses.

Relative to pro forma diluted earnings per share, we expect the unfavorable impact of decreased available billing days to be partially offset by the corresponding utilization of vacation accruals and lower U.S. payroll taxes resulting from reaching U.S. FICA limits. As such, we expect our pro forma diluted earnings per share in the fourth quarter of 2017 to be in the range of $0.25 to $0.27. The high-end of this range would represent a year-over-year increase in pro forma EPS of 4%. Our pro forma guidance excludes amortization expense, total noncash stock compensation expense, acquisition-related cash and stock compensation expenses, acquisition-related transaction costs, restructuring costs and includes a long-term cash tax rate of 30%.

Sequentially, we expect pro forma gross margin on net revenues to be approximately 42% to 43% in the fourth quarter. We expect pro forma SG&A and interest expense for the fourth quarter to be approximately $14.7 million. We expect fourth quarter pro forma EBITDA on net revenues to be in the range of approximately 19% to 21%. We expect cash generated from operations to be up on a sequential basis consistent with earnings.

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

Thank you, Rob. As we look forward, let me reiterate our thoughts on the transitioning demand environment and, more importantly, on the high-growth opportunities which are emerging. As I've been saying for quite a while now, the rapid development and move to cloud applications and infrastructure, along with improving analytics, mobile functionality and enhanced user experience being introduced into the marketplace by technology providers is dramatically influencing the way businesses compete and deliver their services. This will disrupt entire industries at an accelerated pace, forcing organizations to fundamentally change and adopt these new capabilities in order to remain competitive. The speed of change will only be limited by the ability of technology providers to deliver the required functionality and performance.

But regardless of these limitations, the mere threat and opportunity promise will lead to significant enterprise transformation opportunities, and we believe this will be generational. This will redefine traditional sequential and linear-based business models and activities to fully network and dynamic automated workflows and events with enhanced analytics that will ultimately deliver on much anticipated predictive analytics as well as artificial intelligence expectations.

This so-called digital transformation era is very attractive to our organizations, since we believe clients will increasingly turn to us to provide them with best practice insight on what technology can deliver and what changes in business models work and justify significant investments in transformational change.

Specific to Europe, we expect our revenues to continue to be up strongly. Europe has benefited from improved market conditions as well as from our EPM investments and our recent BPO and RPA advisory acquisition. We believe we have taken the necessary actions to both optimize current year performance and, more importantly, be strongly positioned for the emerging digital transformation opportunities as we look forward to reap the benefits of our investments, as we finish 2017 and head into 2018.

Specifically, we have redefined benchmarking with our recently launched Quantum Leap benchmarking and continuous improvement Software as a Service solution. We have already seen several clients commit to multi-year assessments due to the new solution offering. It's been both more dollars as well as the multi-year commitment.

We have developed -- we are developing and launching our Digital Transformation Platform to further differentiate our unique IP and capabilities across all of our offerings. It helps differentiate our advisory, transformation, cloud implementation and analytic offerings. Our ability to fully digitize our IP and align proven technology and organizational solutions that help clients drive transformational change allows us to a highly differentiate our offerings.

We're also leveraging the Digital Transformation Platform to expand and attract new alliance partners that can leverage our unique benchmarking and best practices IP to help them differentiate and sell their software or service solutions, which will allow us to further expand our IP-as-a-Service solutions. You have seen the success that we have had with ADP and with its software offerings. We believe we will see similar solutions in the future.

Since we have also successfully now grown and further expanded our Hackett Institute training and certification offerings that will allow us to expand and use our IP to serve our clients in new and powerful ways to grow our business. 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 practices intellectual capital and use this to serve clients strategically and, whenever possible, continuously.

At the end of the quarter, our executive and best practice advisory members totaled 1,070 across 327 clients. These numbers exclude the new clients that we've been adding to our new ADP and [CGSB] IP-as-a-Service alliances. We have expanded our ADP offerings and recently launched the ADP Workforce Now platform. These new programs will expand our opportunities with ADP in 2017, and do so more significantly in 2018.

We've also launched the Hackett Institute and acquired our partner's interest in the CGBS training and certification program. As a result, we will fully transition the programs to a state-of-the-art learning platform system, which we believe will better aligned -- will be better aligned to our client demand. At the end of the quarter, we have over 175 clients piloting one of our training and certification programs.

We also have launched our enterprise analytics training and certification program. Given the unique nature of our best practice content and the recognized value we have experienced with our CGBS offering, we now believe that continuing education provides a significant revenue growth opportunity for our organization.

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

In summary, we reported solid results while aggressively transitioning our offerings to focus on the rapidly growing cloud applications and digital transformation opportunities. More importantly, we believe the investments we are making in our Digital Transformation Platform, our expanded cloud application capability and our RPA expanded capabilities as well as our IP-as-a-Service offerings and alliances will allow us to continue to drive sustainable structural growth.

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

Those conclude my comments. Let me turn it back over to the operator and ask us to commence the Q&A. Operator?

(Operator Instructions) Our first question comes from the line of Morris Ajzenman with Griffin Securities.

You've given clarity over the past year as you transitioned from on-premise to the cloud-based platform, and you've been very, very clear about how that has played out and will play out. In the guidance for Q4, it will be the third straight quarter, year-over-year, where revenues would be down. And I know you don't like looking out beyond one quarter's guidance, but can you give us any sort of thoughts on when the year-over-year decline on a quarterly basis will end? How that plays out beyond Q4, as best as you can?

Well, first of all, as you know, there's 2 moving pieces. One is the decrease in the EPM on-premise revenue and how we offset that with the cloud implementation revenue. I would say that in the quarter, both the on-premise EPM software accelerated a little bit more than we thought; and our cloud revenues also accelerated, its growth accelerated at a higher pace than we thought, but it came in exactly as we thought. We expect the cloud implementation revenue to continue to accelerate, since, as you know, we've only -- this is only 6 months since the close of our Oracle Cloud implementation capability. And we believe we have made tremendous strides in both influencing the way we go to market with the organization as well as making sure that the Oracle channel understands both our expanded capabilities and then the unique capability that Hackett brings with the Digital Transformation Platform.

So, no; we continue to believe that -- and I think I've been saying this throughout the year, we believe that 2017 will be a year where if we thought we could be flat to up on earnings and continue to generate strong cash flows while migrating our capabilities from the on-prem to the cloud opportunities, that we should see our growth accelerate into '18 into its more traditional long-term growth range that we've always had. So basically said, we expect the acceleration of cloud implementation revenues to outpace EPM declines as each quarter plays out. And we expect to see, I'll call it, that crossover line to happen sometime in early 2018.

Just a comment, give us the rationale in SAP on net basis, down year-over-year 6%. What's happening there? And how does that look going into Q4 and beyond?

Nothing meaningful. If you go back and look at it historical, that group has quite a bit of volatility partly because it has a value-added reseller business which influences the quarter and it drives some kind of spotty starts, stops. But if you look at it on a year-over-year basis, SAP for the year is going to be, probably, flat to slightly up when we look at Q4. So no, we think it is transitioning to the cloud implementation opportunities within that SAP Group. And it still has a very strong both implementation and AMS capability that we expect should grow with the long-term prospects of the company in 2018.

Last question, and I'll get back in queue. The Hackett Institute, you've now bought out that portion of CIMA. My question there is, you've formed these relationships, these affiliates so that you can maximize growth without having to, I guess, put yourself as an operator. But here you're going to the flip side, where now you will be an operator by now, I guess, owning and offering CIMA. Please help me understand why that would work better than just working in the partnership format?

Well, the big, big difference is our go-to-market versus them were very different. They were an organization that focused on individual, training and certification kind of relationships. And as you know, we believe that the way you rapidly grow this program is by using a B2C channel. Going to our existing clients, demonstrating, first -- leveraging the fact that they believe we have unique IP and information that they currently use, drive that into training solutions and certification solutions and becoming part of the clients' annual professional development programs and getting a portion of those very meaningful budgets.

In order to do that, we needed to respond, as we got feedback from clients, we needed to respond to some very specific and demanding client needs, but with it comes sizable student populations. And we believe that by understanding those clients so well as we do and now having a couple of years under our belt and learning how to develop and support these professional development solutions and leveraging a state-of-the-art platform that we've moved to and are aggressively moving to right now that we will be able to support the client opportunities, sell the programs more aggressively.

And we'll be very honest with you, as this scales, we love the idea of keeping the profitability opportunity to ourselves and not having to share it with someone. So since we were driving -- since we were contributing the IP, and since we were driving the majority of those sales through the -- through our client channels, we believe that taking on the additional operating responsibility by acquiring and leveraging a learning management system that we've -- in fact, it's a cloud-based system that could easily support the things we were trying to do, was well worth the risk.

(Operator Instructions) Our next question comes from the line of Frank Atkins with SunTrust.

Wanted to ask about European results were very strong. Can you give us a little bit more color in terms of either a functional area or industry vertical that's contributing to some of that strength outside the U.S.?

Well, first, the number that Rob quoted, which was 36%, that also benefited from the Aecus acquisition, but the organic growth was in excess of 20%. But if you look at it -- if you look at what we're seeing, as I said on our call, the investments that we made in the EPM area over the last 3 years continues to drive a significant part of that growth. But we believe that the acquisition that we have will allow us to accelerate the growth in some of the transformation work we do for large GBS and shared service centers that will also give us an opportunity to grow RPA-related opportunities and BPO advisory opportunities. So there is -- we know and believe that the market is healthier relative to when we see overall activity, but we also believe we're benefiting from the investments in prior years and the recent investment in the acquisition.

Okay, great. That's helpful. And could you comment a little bit on the pricing environment in the U.S. as well as outside the U.S.?

I would say, the pricing environment remains stable. I think the biggest transition is, for us, for example, that goes with the cloud implementation capabilities is, as you know, whereas I think I've commented in previous calls, the implementation of cloud software versus on-prem, which comes with -- obviously without the customization that on-prem comes, allows us to deliver capabilities offsite, the proportion of offsite. And therefore, offshore -- [off-shelf] resources, the proportion of each changes pretty significantly. So pricing on those resources is also stable, as well; the blend is different and the margin is higher. So -- but pricing overall, stable.

Our next question comes from the line of George Sutton with Craig-Hallum.

It's Jason on for George. Ted, can you talk a little bit about the ERP opportunity? We haven't covered that a whole lot. Just wondering, your progress in that environment and really what you're seeing in the market?

Well, we still stand by the fact that we've expanded our capabilities fourfold by expanding our capabilities beyond EPM and aggressively migrating to cloud. So we believe that the size of the technology group that we're able to build will be 4 times as large as the one that we're basically migrating from. So overall, the ERP opportunities are absolutely core and the bedrock of the Oracle Cloud application. We're seeing meaningful opportunities in that space.

We're also seeing that the size of the opportunities, since we're now pursuing opportunities across the entire Oracle suite instead of just EPM, are also significantly larger than the ones that we previously pursued. So overall, we think the opportunity for us to -- it's painful. It's painful to have your -- to wean yourself off of something that was so successful. But when we look at the fact that we're moving to a fourfold opportunity in a market that was previously drawing single digits to one that Oracle's still growing, ex acquisitions, in the mid- to high-20s, we think that bodes very well for our growth prospects.

And just to kind of tie to a previous question, and we're eager, right, to have that cloud implementation line, the new implementation outgrow any of the on-prem decline that we have experienced throughout the year. And we believe that we'll see that in early 2018, as I previously commented.

And just one more. If you can maybe walk through the IP opportunities? So I know you've talked a little bit about the CIMA acquisition. And last quarter, we talked about Workplace Now (sic) [Workforce Now], but if you can give any other updates on the progress in other channels?

Well, probably the best way to answer that question is to just to spend a little bit more time talking about the Digital Transformation Platform that we have been developing and just recently demoed at Oracle OpenWorld. So we have now -- since we have expanded our footprint in Oracle from EPM to the entire suite, we have fully digitized our content across the entire enterprise. And we're aligning that for both transformation opportunities that we would do that would not include a software provider; and in Oracle's case, we have been building that platform to allow it to tie our best practice and organizational decision frameworks to Oracle functionality.

So by -- think of it as follows: It's been -- it will be 2 years ago in December, I think, when we originally launched the ADP opportunity. And we used that very small and narrow HCM opportunity to kind of demonstrate to potential alliance partners how we could align IP to a software or a service to demonstrate how to help differentiate that capability. By now, digitizing our entire enterprise IP in order to align with the enterprise opportunities of Oracle software, it allows us to demonstrate the capability of our IP across a broader set of opportunities.

So we believe that by doing that in order to differentiate the way we go to market with Oracle and to demonstrate that unique capability there, we're going to be able to demonstrate and show other potential alliance partners or solution providers how our IP can be aligned to any service or software solution to differentiate and help them sell their product. We believe that, that investment will give us increased opportunities across, as I mentioned, with software and service solutions providers. And we would expect to see additional alliances emerge in 2018.

Our next question comes from the line of Jeff Martin with ROTH Capital Partners.

Ted, I was wondering if you could help us get a sense of the growth rate either on a sequential basis -- it might be more relevant than on a year-over-year basis -- of the cloud business? And in addition to that, what kind of progress you've had in the quarter in terms of working with integrators? Obviously, the award is a big step, but some detail around the kind of the progress you're making is also very helpful.

I think probably the best way to comment is to say that we started 2016 with virtually 0 cloud capability, implementation capability on revenues in -- first, on the EPM business, the business that we had previously owned. We now just won the EPM Cloud Partner of the Year Award. That means -- that in order to do that, that means that we've been rapidly growing that capability both -- the year-on-year numbers are, as Rob would say, not reasonable to mention. But even sequentially, they're very significantly increases. How significant? Well, significant enough that, if we're correct, in early 2018, our cloud implementation revenues will exceed the legacy on-prem revenues. So one for us was to exceed the decline in that revenue. The other one is to simply exceed the revenues in total.

So we would expect -- we expect the growth of that cloud implementation revenue to probably exceed that decline sometime here as we exit the year. And we would speak -- again, I'll go back -- we would expect the number in early 2018 cloud revenues to exceed the -- our legacy EPM on-prem revenues in early 2018. So we don't want to quote those numbers because that's getting down to a level of detail.

But the reason our revenues are staying flat is because we are doing 2 things: we're transitioning our EPM on-prem revenues aggressively; and we are helping our recent acquisition do that as well with their ERP revenues -- Oracle ERP revenues. And so we're -- in effect, we're transitioning 2 businesses. The only difference is that the ERP on-prem revenues of the acquired company are more stable. Because to take out an ERP system is much harder than to simply migrate off an EPM set of solutions, which allows the client to use EPM as an area where they can try cloud. Therefore, the migration of -- from on-prem to cloud in EPM has been much quicker than in other areas; and, therefore, much quicker than we thought in the year.

But overall, as we kind of pointed it out, when we did the acquisition and develop our plans and reported the second quarter, we continue to believe that cloud revenues will outpace on-prem -- EPM on-prem revenues sometime in the latter part of this year as we exit '17 and that we cross over sometime in early '18.

Okay. That's helpful. I recall on last quarter's call, you mentioned in terms of getting back to a 5% growth rate next year. Is that still your expectation on a revenue basis?

Yes, it is.

What kind of earnings leverage do you believe you can generate?

Well, the earnings leverage -- if the -- remember it's a combination of a few things. But if our IP-as-a-Service revenues continue to grow and we're somewhere in that 5% to 10% range, pick any number, pick the low-end or the middle range, we believe that, that creates a 12.5%, if we're at the low-end to 25% if we're at the high-end of our 5% to 10% revenue growth rate in 2018.

Okay. I take it the bulk of that would come in the back half of the year in 2018?

We would expect it to increase as the year goes on because several things happen. One, where the decrease in the on-prem business will decrease. So you will -- since we're working off a much smaller number as we start the year in '18 versus '17 and our cloud revenues, we expect to accelerate. And the IP-as-a-Service revenues, we also expect them to accelerate.

And then in terms of plans for -- I'm sorry, go ahead.

That assumes -- I'm sorry, that would assume a -- just a Europe growing at -- within the same range, not having to outgrow the U.S. business. Sometime, let's just say, by the time we get to the middle of 2018.

Okay. And then in terms of your cash flow, I mean, you should be generating more cash next year than you are this year, I would assume. What are your priorities for use of cash? Is it to pay down debt? Is it acquisitions? Is it continuing with the dividend and keep buying back stock? But some help there would be useful.

All of the above. But you know we prioritize it as -- we expect to continue to pay the dividend and to increase it with the expected cash flow changes for that subsequent year. We would love to find strategic accretive acquisitions. But as you know, easier said than done. And lastly, we will continue to buy back stock opportunistically as we see. And when we're not doing any of those things, we love to aggressively pay down debt. You've seen us do that a couple of times.

Our next question comes from the line of Vincent Colicchio with Barrington Research.

Ted, is there any change in your expectations as far as IP-as-a-Service revenue growth for next year?

It's pretty significant right now, so I guess the answer is no. The answer is, do I think that the opportunities to expand the current expectations exist? Yes. But have I changed the expectations, which are pretty meaningful just with what we've gotten in place? No.

And then top 5 and top 10 clients went down quite a bit year-over-year. I'm just -- can you give us some color on that?

I really have not reviewed that in detail and I don't see Rob, here, jumping to respond to the question. So I'll go back and try to give you that when we catch up with you, hopefully, tomorrow. But generally, there's been no change in the way we're serving clients. We normally have some large clients initiating projects, others changing.

Probably the most meaningful thing that I can say is something I said several quarters ago that continues to happen, the overwhelming majority of the revenues come from clients that are using our IP or wedge benchmarking and advisory offerings and extend that into a consulting relationship. But as you know, we work with hundreds of companies, leading Global 2000 companies, a year. And those that materialize into that top 10 category migrate from -- they differ from time to time if clients are in some -- just initiating or just completing projects.

And then was the increase in -- this is for Rob. Was the increase in DSO a surprise? Or was that expected and will bringing that into a more normal level be a simple process?

No. The growth of the 10 days surprised me somewhat. I expected it to be up, but I didn't expect it to be up that much. But we will work very strongly to make sure that comes down in Q4 and beyond.

We knew we had some structural part of it that came with the acquisitions but the number, itself, came in larger. So as Rob said, we want to see it back down to historical levels very quickly.

Our target, as I said, is, over the next 2 quarters, we'll make sure to get it back to the mid-60s at a minimum.

One last question, Rob. What was capital spending in the quarter?

About $1.9 million.

By the way, Vince, just so you know, since that is a large number for us since we generally spend somewhere between $3 million to $3.5 million in CapEx annually on a historical basis. But as you can imagine, the amount of build out that we are doing across the Quantum Leap digital transformation offerings are just monumental and -- but we believe the investments will pay off very strongly.

Thank you. I'm showing no further questions in queue at this time. I would like to turn the conference back over to Mr. Fernandez for closing remarks.

Thank you, operator. Let me, again, thank everyone for joining us on our third quarter earnings call. We look forward to updating everyone again when we report the fourth quarter results and the results for the year sometime in mid-February. Thanks, again, for participating.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, you may now disconnect. Everyone, have a great day.