The Hackett Group's (HCKT) CEO Ted Fernandez on Q2 2016 Results - Earnings Call Transcript

| About: The Hackett (HCKT)

The Hackett Group, Inc. (NASDAQ:HCKT)

Q2 2016 Earnings Conference Call

August 9, 2016 5:00 pm ET

Executives

Robert A. Ramirez - EVP, Finance and CFO

Ted A. Fernandez - CEO and Chairman

Analysts

Jason Kreyer - Craig-Hallum Capital Group

Morris Ajzenman - Griffin Securities

Bill Sutherland - Emerging Growth Equities

Jeff Martin - Roth Capital Partners

Operator

Welcome to The Hackett Group Second Quarter Earnings Conference Call. Your lines have been placed on a listen-only mode until the question-and-answer session. Please be advised that the conference is being recorded. Hosting tonight's call are Mr. Ted Fernandez, Chairman and CEO, and Mr. Rob Ramirez, Chief Financial Officer. Mr. Ramirez, you may begin.

Robert A. Ramirez

Thank you, operator. Good afternoon everyone and thank you for joining us to discuss The Hackett Group's second quarter results. Speaking on the call today and here to answer your questions are Ted Fernandez, Chairman and CEO of The Hackett Group, and myself, Robert Ramirez, Chief Financial Officer.

A press announcement was released over the wires at 4.05 PM Eastern Time. For a copy of the release, please visit our Web-site 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 Web-site.

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.

Ted A. Fernandez

Thank you, Rob, and welcome everyone. As we ordinarily do, I will open the call by providing some overview or highlight comments. I'll turn it back over to Rob so that he could provide some detailed commentary on operating results, cash flow, and also provide our guidance as well. Rob will then turn it back over to me where I will make some market and strategic overview comments, and then we will open it up to Q&A.

So let me again welcome everyone to Hackett Group's second quarter earnings call. This was another very strong quarter. This afternoon we've reported revenues of $75.6 million, up 14%, and pro forma earnings per share of $0.24, which was up 26%. Both were above the high end of our guidance. The results are even more impressive when you consider that our pro forma EBITDA was up 32%.

Consistent with last year, strong U.S. revenue growth continued across virtually all of our Hackett practices. As expected, we also saw improving European results, which are expected to continue into the third quarter. Our strategy to more closely mirror our U.S. capabilities by investing in EPM capabilities in Europe is starting to pay off.

As I mentioned at year end, our growth in the U.S. is a direct result of several key strategies. The first one has been to continue to grow our wedge or as we refer to them, our benchmarking and best practice advisory offerings. These are the offerings which have the greatest intellectual capital and create strategic access to our leading global companies – that provide the strategic access to leading global companies. We have also made significant investments in the dedicated channel of both of these offerings.

These offerings have also been resulting in increased downstream opportunities for our business transformation and EPM consulting groups, which is reflected in the overall growth of the organization. Both the access provided by our IP and the downstream opportunity into the consulting revenue provide great examples on how strategic access when provided through highly differentiated IP and how strongly it can extend through our consulting offerings.

Second item was to increase revenue per client. As we've mentioned, the consolidation of several Hackett practices has improved in improved collaboration and cross-selling and is allowing us to serve clients more broadly. Last quarter we mentioned that our top 20% of our clients were providing a significant amount of our growth. This growth continued and is a strong indication of the fact that we are seeing larger engagements, which reflects our increasing influence as well as the growing opportunities with our clients.

Number three that we continue to add and upgrade talent and do that by building a more efficient resource pyramid. At our scale, we've always said we have a competitive disadvantage in that we don't get to leverage our most senior people the way some large organizations do. That continues to be a significant opportunity for us but our ability to just simply move the dial is resulting in improved gross margins, but are probably more visible within the Hackett Group rather than in our ERP Solutions group.

Lastly, we are identifying new channels through strategic partners that can use our benchmarking and best practice intellectual capital to introduce new recurring revenue, high margin offerings that could redefine our organizational model as the first true performance improvement IT-as-a-service business. I'll provide more details on those alliances and talk about new opportunities that we continue to pursue.

On a long term basis, we are also seeing that the rapid development of the emerging Cloud and Web technology and digitization of everyday activities may be creating a significant and sustained enterprise transformation period. I will expand on these thoughts a little later as well in the strategic overview section of our call.

On the balance sheet side, during the quarter we declared our semi-annual dividend which was paid in early July. In addition to the shares bought back from executives in mid-May, we also continue to buy back shares in the open market and from employees to satisfy withholding tax obligations.

On the investment front, we continue to develop new technology delivery platforms to help us further differentiate the leverage of our Benchmarking and Best Practice IP to our clients and to our new alliance partners. In the latter part of 2016, we plan to rollout our new benchmarking offering that will fully incorporate our Hackett Performance Exchange or HPE technology and other innovations into our benchmarking platform. That will improve and further differentiate the unmatched value delivered through these offerings.

In advisory, our alliance relationships are helping us invest in new technology and offerings that will improve our clients' access and leverage of our proprietary insight that we deliver through our existing and new best practice advisory programs.

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

Robert A. Ramirez

Thank you, Ted. As I typically do, I'll cover the following topics during this portion of the call. I'll go through an overview of our 2016 second quarter results along with an overview of related key operating statistics. I'll also cover an overview of our cash flow activities during the quarter, and I will then conclude with a discussion on our financial outlook for the third quarter of 2016.

For purposes of this call, any references to The Hackett Group will specifically exclude ERP, which consists of our SAP solutions group. Correspondingly, I will comment separately regarding the financial results of The Hackett Group, ERP Solutions and the total Company.

Please note that all references to gross revenues in my discussion represent revenues including reimbursable expenses. Additionally, references to pro forma results specifically exclude non-cash stock compensation expense, intangible asset amortization expense, acquisition related charges and gains, and assumes a 30% long-term cash tax rate.

As Ted mentioned, for the second quarter of 2016, total Company gross revenues were $75.6 million, and above our second quarter's guidance. This represents a year-over-year growth of 14%. The impact of foreign currency fluctuations on consolidated revenues was less than 0.5% and was immaterial to the quarter.

Gross revenues for The Hackett Group, which exclude ERP Solutions, were $65.7 million in the second quarter of 2016, an increase of 17% on a year-over-year basis. Strong Hackett U.S. growth of 23% more than offset international revenue declines which decreased 3.5%, or 2% in constant currency. The decrease was primarily due to revenue declines in our Asia-Pacific operations as our European revenues were essentially flat. Hackett Group annualized gross revenue per professional was $397,000 in the second quarter of 2016, as compared to $392,000 in the second quarter of the previous year and $376,000 in the previous quarter.

Gross revenue from our ERP Solutions group, which consists of our SAP reseller, implementation and Application Managed Services group or AMS, totaled $9.9 million, a decrease of 5% on a year-over-year basis.

Total Company international gross revenues accounted for 14% of total Company revenues in the second quarter of 2016, as compared to 16% in the second quarter of the previous year. Our recurring revenues, which include our AMS group as well as our Executive and Best Practice Advisory practices, now make up approximately 15% of our revenues and 17% of our pre-tax pro forma practice profitability.

Total Company pro forma cost of sales excluding reimbursable expenses and stock compensation expense totaled $41.9 million or 61.4% of net revenues, as compared to $36.4 million or 61.3% of net revenues in the previous year.

Total Company consultant headcount was 926 at the end of the second quarter, as compared to 861 in the previous quarter and 810 at the end of the second quarter of 2015.

Total Company pro forma gross margin was 38.6% of net revenues in the second quarter, as compared to 38.7% in the second quarter of the previous year. Hackett Group pro forma gross margins on net revenues was 39.2% in the second quarter of 2016, as compared to 38.8% in the second quarter of 2015, primarily due to increased revenue per professional and utilization when compared to the prior year.

ERP Solutions pro forma gross margins on net revenues was 30.7% in the second quarter, as compared to 37.8% in the previous year, primarily due to decreased revenues when compared to the prior year.

Pro forma SG&A was $15.1 million or 22.1% of net revenues in the second quarter of 2016, as compared to $14.7 million or 24.7% of net revenues in the previous year, a 260 basis point improvement that is primarily due to continued leverage on increasing revenues.

Pro forma EBITDA in the second quarter of 2016 was $11.9 million or 17.4% of net revenues, as compared to $9 million or 15.2% of net revenues in the second quarter of 2015, an increase of 32%.

Total Company pro forma net income for the second quarter of 2016 totaled $7.8 million or $0.24 per diluted share, which as Ted mentioned was above our second quarter's guidance. This compares to pro forma net income of $5.8 million or $0.19 per diluted share in the second quarter of 2015, an earnings per share increase of 26% on a year-over-year basis.

Total Company pro forma net income for the second quarter of 2016 excludes non-acquisition stock compensation expense of $2 million, acquisition related stock compensation expense of $315,000 and intangible asset amortization expense of $275,000. Pro forma results also assume a normalized tax rate of 30% or $3.3 million.

GAAP diluted earnings per share was $0.17 for the second quarter of 2016, as compared to GAAP diluted earnings per share of $0.12 in the second quarter of 2015. At the end of the second quarter of 2016, the Company had approximately $2.2 million of income tax loss carryforwards remaining in the U.S. relating to state taxes and approximately $6.3 million in foreign tax jurisdictions respectively. We believe that we will continue to have the ability to offset most of our international tax liabilities throughout the balance of the year.

The Company's cash balances were $15.6 million at the end of the second quarter of 2016, as compared to $12.6 million at the end of the previous quarter. This cash increase in the second quarter was primarily attributable to net cash provided from operations and net borrowings under our revolving line of credit, offset by cash utilized to repurchase common stock.

Net cash provided by operating activities in the second quarter of 2016 was $7.2 million, which was primarily driven by net income adjusted for non-cash items which amounted to $8.8 million, offset by a decrease in accounts payable of $4.5 million due to the timing of maintenance payments relating to our AMS business.

Our DSO or days sales outstanding at the end of the second quarter of 2016 was 57 days, as compared to 62 days at the end of the previous quarter and 61 days when compared to prior year.

During the quarter, we purchased 1.8 million shares of the Company's stock at a total cost of $25.8 million, or an average cost of $14.72 per share. This repurchase activity was comprised of repurchases of 1.5 million shares from Company executives for $22.2 million, as discussed in our previous quarter, and 220,000 shares repurchased in the open market for $3.2 million. Additionally, we utilized $422,000 to repurchase 29,000 shares of common stock from employees to satisfy employee net vesting related tax obligations Our remaining stock repurchase authorization at the end of the quarter was approximately $4.9 million.

This repurchase activity was funded from the Company's amended revolving line of credit. During the quarter, the Company borrowed $25 million and made payments totalling $3 million, for net borrowings during the quarter of $22 million. The $22 million is the balance of the Company's total debt outstanding at the end of the second quarter of 2016.

I'll now turn over to guidance for the third quarter of the fiscal year, and consistent with seasonal third quarter tends, we expect the impact of the additional U.S. holiday and the typical increase in time-off due to summer vacation in both the U.S. and Europe to unfavorably impact available days by approximately 4% to 5% on a sequential basis as we head into the third quarter.

We expect total Company gross revenues for the third quarter of 2016 to be in the range of $72 million to $74 million, with a reimbursable expense estimate of 11% on net revenues. On a total Company basis, at the high end of the guidance range, we expect revenues to be up approximately 11% on a year-over-year basis, with both Hackett U.S. and ERP expected to be up and international revenues to be slightly down on a reported basis.

As such, we expect our pro forma diluted earnings per share in the third quarter of 2016 to be in the range of $0.22 to $0.24. The high end of this range would represent a year-over-year increase in EPS of 20%, with EBITDA up in excess of 20%. Our pro forma guidance excludes amortization expense, total non-cash stock compensation expense and includes a long-term cash tax rate of 30%.

Sequentially, we expect pro forma gross margins in the third quarter to benefit from the seasonal reductions in U.S. payroll related taxes resulting from reaching FICA limits and the utilization of vacation accruals, offset by decreasing available days due to summer vacations. As a result, we expect pro forma gross margin on net revenues to be approximately 38% to 39% in the third quarter.

We expect pro forma SG&A and interest expense for the third quarter to be approximately $15 million or essentially flat on a sequential basis. We expect SG&A to decrease as a percentage of net revenues when compared to the previous year as a result of continued leverage on revenue growth.

We expect third quarter pro forma EBITDA on net revenues to be in the range of approximately 17% to 18%. We expect cash generated from operations to be up on a sequential basis.

At this point, I would like to turn it back over 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 take a moment to speak more broadly about the current demand environment as well as our future prospects. As I mentioned last quarter, the rapid development and move to cloud along with the extended mobile functionality being introduced into the marketplace by software and technology providers is dramatically influencing the way businesses compete and deliver their services.

This will disrupt the entire industry 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 on their functionality and performance promises.

But regardless of these delivery limitations, the mere threat or opportunity promise will lead to one of the most significant enterprise transformation periods of our lifetime. This will redefine traditional sequential and linear based business models and activities to fully network the dynamic automated workflows and events with enhanced analytics that will finally deliver on the promise of predicted analytics as well as artificial intelligence, as promised years ago.

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

On a near-term basis, we expect continued growth in Q3 from our U.S. businesses across nearly all of our groups. In Europe, we expect our revenues to be sequentially flat to slightly down on a year-on-year basis on a reported basis. As we have previously mentioned, a key driver of our growth strategy has been to continue to expand our market-leading Enterprise Performance Management or business analytics business. At the heart of the digital transformation era I just referenced is business analytics, which now represents approximately 50% of our Hackett U.S. revenues.

We were fortunate to have invested heavily in this area for many years and it has been one of the major reasons for our improved results. Our ability to define the right metrics, configure the software and provide full application and infrastructure, post-implementation support, driven by our unique IP allows us to deliver a highly credible and differentiated solution.

Our long term strategy is to continue to build our brand by building new offerings and capabilities around our unmatched best practice intellectual capital in order to serve clients strategically and, whenever possible, continuously. We believe that clients that leverage our IP are more likely to allow us to serve them more broadly. IP based services enhance our opportunity to serve clients remotely, continuously and more profitably.

Our goal is to use our unique intellectual capital to establish strategic relationships with our clients directly or through strategic alliances and channels and to further use that entry point to introduce our business transformation and technology capabilities.

Our long term goal is to be able to ascribe an increase in percentage of our total annual revenues to clients who are continuously engaged with us through our Executive and Best Practice Advisory programs, and eventually through our Hackett Performance Exchange.

At the end of the quarter, our Executive and Best Practice Advisory members totaled 985 across 330 clients. These numbers exclude the new clients that we have been adding from our new IP-as-a-service alliances. Over 40% of our Hackett sales also came from Advisory clients, which continue to support the leverage of this entry point or IP-wedge offering.

As we announced last year, we are now seeing opportunities through our new alliances and channels to use our IP to help others sell and deliver their offerings. In the fourth quarter of 2015, we launched a dedicated Hackett Best Practices advisory program for ADP's Vantage HCM or Human Capital Management solution. All early indications from the ADP sales force as well as our clients continue to be very favorable. During the second quarter, we continued to add new clients at an increasing pace.

Our original contract value guarantees from ADP have now been achieved. Given this early success, we are now developing plans with ADP that would expand our offering beyond Vantage to include additional platforms that they expect to migrate to Vantage as well as programs into a targeted part of their existing installed base.

Relative to our new Certified GBS Program's alliance with CIMA, the Chartered Institute of Management Accountants, we believe this relationship will allow us to build an entirely new professional development business that provides globally recognized certifications for shared services and global business service professionals.

We launched our initial sales efforts with an entry-level program with clients and all indications continue to be very favorable. During the quarter, we announced the completion and launch of our executive level program and we expect to complete and launch the managerial level program during the third quarter. At that time, we will have our complete curriculum fully rolled out.

We continue to sign up new companies at an increasing pace and continue to build our pipeline with major global organizations with significant GBS or shared service organizations. We now have over 75 companies who are using our entry and executive level course for their assessment. We believe this ability to ramp will continue to accelerate as we roll out the remaining managerial level program during this quarter and clients complete initial pilot programs. We continue to expect the ADP and CGBS alliance with CIMA activities to build throughout the year and become noticeable to our 2017 results.

Our new joint marketing plan with Oracle that includes the sale of HPE along with the sale of Oracle's new Business Intelligence Cloud Service also continues to develop. This program has few clients and we believe this activity will increase as Oracle becomes more familiar with both their new cloud solution as well as the integrated value of HPE.

Our Benchmarking and Best Practice IP leverage strategy allows us to increase our client base, profitability and also increase revenue per client. It would also represent an increase in recurring revenue at much higher margins due to the way these services are provided and contracted.

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

In summary, we reported another strong quarter. More importantly, we are seeing that the improvements and investments we are making in our IP, our people and expanded EPM as well as IP service alliance focus will enhance our ability to drive sustainable structural growth.

As always, let me close by thanking our associates for their tireless efforts and always our attempt to stay highly focused on our clients, our people and the exciting opportunities available to our organization. Congratulations on another strong quarter. Operator, those conclude my comments. Let me turn it back over to you and open up for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from George Sutton with Craig-Hallum Capital Group. Your line is now open.

Jason Kreyer

It's Jason on for George. It seems like you're making really good progress on these IP-as-a-service opportunities with ADP, CIMA and Oracle. I'm just wondering if you can talk a little bit about the pipeline for new opportunities and if those three existing opportunities are at a point where they are referenceable for new clients or at what point those become referenceable and help you add additional capabilities?

Ted A. Fernandez

I'm sorry, I had to un-mute. Back to your question, one, let me first comment on ADP, Jason, one, the original ADP alliance obviously has referenceable clients as we've been adding clients at an increasing pace quarter on quarter and we now are developing plans with ADP to not only continue that relationship but to expand the sale of our IP to other platforms in their product base and to do that through a number of different initiatives. So, we think that obviously we are seeing that that is referenceable, the value that clearly the sales and delivery teams are seeing by including our capabilities as part of the sale of their software.

On the CIMA side, the reason I'm a little bit more cautious of our CGBS alliance side is because it's important to remember that we launched with the entry-level course only, and it wasn't only until the second quarter that we launched the second of three programs, which was the executive level course. So we have quite a bit of feedback coming back from clients that we signed up in the latter part of last year and in the first quarter who are now utilizing our course syllabus, course prep and are taking the exam. We're just starting to get some initial feedback on the course we just launched in the second quarter, and as I mentioned in my comments, our managerial level course will be launched in the third quarter.

So the level of reference capability of feedback relative to all of those courses will just increase as we roll out the courses and the clients have a chance to actually go through the entire product suite and actually take the exam, and all of that is happening. But at this point there is nothing that we believe would get in the way of us not having a very successful launch across the two and obviously have learned from the first two and expect that to carry into the third level program as we head into the second half of the year.

And then lastly, as you know, I've been very tempered about anything I've said around Oracle and the HPE product because there the product is simply sold with Oracle's new product and doesn't go to market on a standalone basis. So there the feedback of our product has been very good. Oracle's sales feedback to us relative to how it enhances their ability to present the capabilities of their offerings have also been favorable, but the activity there has been much more limited than in the other two where we fully control either the sales or both the sales and delivery of those offerings. Did that answer your question, Jason?

Jason Kreyer

Yes, it does. Thank you. And one more, so you talked about the opportunity as we kind of adopt more Cloud-based solutions and in the transition to mobile. Just wondering if you can lay out maybe if this change is the long-term opportunity for Hackett in the market and what additional changes would you have to see externally to increase your opportunity to penetrate that further?

Ted A. Fernandez

Look, we think the changes that are happening as a result of Cloud and Web technology are fundamental, and I'm not sure that our clients fully appreciate just how significant their business models will change as they adopt new technology. We believe it's significant. We believe that to adopt these technologies and realize the benefits require you to really reorganize and re-think the businesses in many ways. It drives tremendous operating efficiencies to the users of this technology and we believe that both the ability to interact with clients and their constituencies are significantly enhanced and the level of analytics also enhances.

So when it comes to a client, simply understanding the opportunity to leverage this new technology we think we really have a bird's eye seat to help a client understand where the exact – how to sequence or how to develop a strategy to start leveraging that technology and the impact on organizational change, which is half of our business.

When you then look at the other half of our business, which is business analytics and enterprise performance management, we love the fact that we have a very well branded and very strongly positioned analytics business and we think that it will expand to enterprise analytics that clients really learn to leverage analytics as new technology and new information is available to them.

So as I mentioned last quarter, we like the changes that are happening in the marketplace and we think that they bode very well for the demand on our services, and we believe that the improved performance we've had now for the last several years, I think reflects on the fact that clients are undergoing that fundamental change and that our products and our credibility with clients is well aligned to the things they have to consider.

So, having said that, we continue to look for any and all ways to then leverage and participate in this digital transformation era more broadly, and we think our way to do that is to try to embed more and more of our IP into client offerings and to help them position and differentiate the value of their offerings. If that third leg of the stool continues to grow through our existing alliances and we add new alliances, we think then the power of the entirety of our model will only show just how highly differentiated we really are.

Jason Kreyer

Okay. And then last for me, Ted, I always appreciate your commentary on the macro backdrop and I was a little surprised to hear your thoughts on looking out to Q3, the stability that you expect in Europe considering Brexit and what's going on over there, so just curious if you could add any additional detail on why you're seeing that stability overseas?

Ted A. Fernandez

Look, at the very highest level, we believe Brexit brings some uncertainty to that market, and uncertainty is never good for business. Having said that, we also are very optimistic that the roll that the U.K. plays within the region and globally may change but it won't change the need and the roll they have played historically. So we hope that it's more of a distraction than a fundamental change in demand for the services in that market.

Having said that, when you look at why we're seeing improved results and why we've carried that into the third quarter, it's the fact that we have finally seen the pay-off from the investments we started making in our business analytics or EPM business two years ago. We've been on this call now for probably eight or nine quarters and every time we've been talking about the fact that European revenues have continued to decline. The reason that they did decline is because the EPM capabilities that we have been investing and building are having success in the marketplace.

So we think we are stronger in Europe now as a result of that investment which was our attempt to mirror U.S. capabilities, and we don't know whether this will be just a pure add-on where we just get the benefit from that growth, or in a worst-case scenario it will offset any volatility that comes from any indecision from Brexit related – if you want to call it Brexit related impact. Too early to tell, but at least for Q2, we saw improvement in results with Q2 and guidance into Q3 is that we would expect it to be stable into Q3. So, at least for the foreseeable future, obviously improving prospect for us.

Jason Kreyer

Okay, great. Thanks for the color and congratulations on the results.

Operator

[Operator Instructions] Our next question is from Morris Ajzenman with Griffin Securities. Your line is now open.

Morris Ajzenman

Just a quick follow-up from the previous question, the improving results in Europe, is that sequential or also year-over-year?

Ted A. Fernandez

I said we expect to be flat sequentially and flat to slightly down on a year-over-year basis. And actually on a constant currency basis, we actually think it would be a little bit better than that, but we do expect FX to be slightly negative in Q3. So, relatively speaking, we are carrying Q2 activities, we believe they will carry over into Q3 the same level of performance.

Morris Ajzenman

I'm sorry, I meant to say improving results Q2, was that sequential year-over-year or both?

Robert A. Ramirez

Year-over-year.

Ted A. Fernandez

Year on year. When we said 14% growth and 26% EPS improvement and 32% EBITDA improvement, those were all year-over-year improvements.

Robert A. Ramirez

So, Morris, international year-over-year decreased 3.5% but only 2% in constant currency.

Morris Ajzenman

Okay, and it was up sequentially then?

Ted A. Fernandez

Did we comment sequentially?

Robert A. Ramirez

We didn't comment sequentially.

Ted A. Fernandez

Let him take a look at that, Morris, and we'll comment as soon as he has that.

Morris Ajzenman

Thank you. Okay, let's move back to the alliances. Third quarter revenue guidance, $72 million to $74 million, is anything in that number from the alliances at this point?

Ted A. Fernandez

Little to none. So, yes, we have new clients, they are starting out, it's starting to come in, right, but immaterial. So we'll continue to push to say that if we continue to build them the way we have build them, we are building them, and the products continue to have the acceptance we've seen, it becomes noticeable in 2017.

Morris Ajzenman

I'm not trying to pin you down but when do you think in 2017 it would be something that you could talk about?

Robert A. Ramirez

We would have to do it in Q1.

Ted A. Fernandez

I would expect us to be able to speak to it with more color in Q1, only to be limited by restrictions provided by our alliance partners.

Morris Ajzenman

Understand. And on the alliances, I know you always talk about looking to fund another strategic partner. Is anything in the works there that might be happening?

Ted A. Fernandez

Yes, we continue to work very closely on several ideas and I'll stand by our comments that we would be disappointed if we didn't added a couple of new alliances by the end of the year.

Morris Ajzenman

Okay. And last question and I'll get back in queue here, you mentioned in the second quarter Hackett U.S. was up 23%. You talk about guidance in the third quarter Hackett U.S. being up. You didn't put a number on it. Would you want to try to put a number on that for us?

Ted A. Fernandez

It will be in the teens, but don't forget two things. Probably the most significant thing would be the fact that we lose 4% to 5% available days in that quarter, and we are comping on slightly higher numbers. But Hackett, we expect both ERP and – ERP to be up some and Hackett U.S. to be up in the teens.

Operator

Our next question is from Bill Sutherland with Emerging Growth Equities. Your line is now open.

Bill Sutherland

That was a pretty impressive revenue beat for Hackett Group in the second quarter. What kind of happened there after the mid part of the quarter that took it so far above your expectations?

Ted A. Fernandez

I'm glad you mentioned that because all the questions are always kind of couched in the opposite direction. So I'll take a second to remind everyone that our results in 2014 were up 37% on a year-over-year basis, in 2015 were up 34% on that 37%, and in the first couple of quarters here we're up in the mid-20s on those very significant increases. And you're right, it's coming off a higher revenue increase.

We've always said that our business would grow 5% to 10%, and at the 10% level we'd grow bottom line by 20% or better. But when we have a chance to grow over 10%, the way we have here for several quarters, you're seeing EPS results obviously in the mid-20s. And as we've said, they were only impacted slightly down from the EBITDA growth because of the higher weighted average share count, which we do get a chance to improve it by some of the buyback activity impacting Q3. But no, it's just the strength of the U.S. business across all practices strong and the EPM business very strong, and it's been a consistent message for us now for a couple of years.

Bill Sutherland

But, Ted, did you – at mid quarter when you [indiscernible] second quarter guidance, I mean kind of what kind of surprised you guys because it is [$0.25 million] [ph] higher on the Hackett Group side?

Ted A. Fernandez

No, we are slightly above the high end of our guidance, and as you know, we like to stay towards the high-end of that, if you look at that historically.

Bill Sutherland

So it's a little bit more [indiscernible] than usual, all right.

Ted A. Fernandez

Yes, so we got a little bit more than usual. It dropped right, we then beat the bottom line by some as well, and we are strongly positioned into Q3.

Bill Sutherland

Okay. Rob, the gross margin in ERP, the margin was down how many points?

Robert A. Ramirez

It was down about 7% on a year-over-year basis.

Bill Sutherland

7%. In other words, year-over-year decline in the number not the margin?

Robert A. Ramirez

No, it was in the margin.

Ted A. Fernandez

In margin, at least that lower revenue from the implementation side of the business. The AMS side of the business pretty constant, the implementation side came in a little short on revenue, and obviously more than exceeded by beats in all the other practices and that impacted the margin unfavorably.

Bill Sutherland

Okay. I was just trying to understand whether it was also a mix issue. So implementation, when that's light, it hurts your…?

Robert A. Ramirez

On that SAP side, it was lighter than we expected in the second quarter. It was 30.7%, as I said in my script, this quarter versus 37.8% a year ago.

Ted A. Fernandez

That group normally runs around 35%.

Bill Sutherland

And the recurring revenue is still at 15%, which was where it was prior quarter. Is that being driven mostly by the contracts, [indiscernible] acronym for them?

Ted A. Fernandez

The Application Management Services contract, that's both SAP and EPM, and our executive advisory business. So the way we [indiscernible] that, Bill, would be for our IP-as-a-services alliances to start to kick-in in 2017 and for the relative percentage on both margin and revenue, but more importantly on margins, to be the drive for us to impact that favorably.

Bill Sutherland

Okay. And last one for me on CIMA, that's impressive, you've got 75 sign-ups already. Based on the first two courses, do you feel like you're likely to get uptake on, when you finally have the managerial out, all three? Is that more likely than just taking one course or another by a client?

Ted A. Fernandez

Our goal is to continue to add clients to, if you want to call it, try-me phase, pilot phase, all being paid though. [Indiscernible], they are all being paid. But the idea would be, our goal is that you get a chance to look at one or all three, but our hope is that it is all three, and that we then going into 2017 or throughout 2017 we would convert those, hey, I took a look at your course, I liked it, and that we would develop a complementary strategy to the training programs that those organizations have.

So our goal with this relationship is that we become a core complement to their training and that the students and the client then highly value the certification that is achieved by the student from the courses that they take from us. So it can be, as an example, it could be a relationship with a center because one of the entry points could have been through a center. We've had conversations with somebody who said, if we really like this, we would have all of our new hires then put through this curriculum as a matter of course.

Everyone is looking at it differently. We've had people look at the courses and said, would you be willing to license some of the IP to help us complement some of the training or development programs we currently have. And the fact of the matter is that we are going to work with these large organizations to try to develop an integrated continuous relationship with them. We want to have the continuity of relationship with the organizations and we also want to have the continuity of the relationships with the individuals as they value that certification and want to maintain it on an annual basis.

Bill Sutherland

Great. Needles to say, nice quarter. Thanks guys.

Operator

Our last question comes from Jeff Martin with Roth Capital Partners. Sir, you may begin.

Jeff Martin

Could you give us a sense of what you expect to be the impact of rolling HPE into the offering by year-end? Do you expect that to be material updraft to your engagement size or your client base? Maybe give us kind of what you're thinking internally from an expectation standpoint?

Ted A. Fernandez

We obviously make the investment believing that it will do two things. It will allow clients to engage us, first for us to deliver the product with more ease, capture the client information with more ease, and then also encourage the client to utilize our benchmarking offering on a more recurring basis instead of a once every three or four year event. So we think if we improve the user interface in how easily a client can populate, receive the information, update the information, it would do that.

Do we have anything embedded in our program right now for that specific improvement? The answer is, we do not, but we believe, as we refer to it, that this is quantum leap for us and that at a minimum as we – no different than we demo HPE today, when a client looks at their ability to engage us in our benchmarking services, that there should be no one that would provide that level of capability, innovation and obviously our database is unmatched.

So hopefully, it further differentiates, it means the clients will use more of these benchmarking services. You know if the client used these services to understand, as we call it, the art of the possible to improve, that then that leads to both transformation and EPM engagement.

So look, we are incredibly hopeful that it will simply continue to strengthen what we believe is a global leadership position in benchmarking further, and that will allow clients to use us more frequently, and hopefully in some cases on a more continuous basis instead of more event driven the way it is today.

Jeff Martin

Does it shorten the timeframe in terms of a project size if someone wants to benchmark, i.e., does it speed up the revenue recognition cycle, does it affect the margin profile of the business at all?

Ted A. Fernandez

Our goal was to decrease the time and client involvement by 50%. So the answer is, yes, it will be a more – hopefully it's not only a better product, it's a more efficient product. And then the question then becomes right strategically, do you share, do you keep the margin that you get from this innovation.

Jeff Martin

Okay. And then the second question that I wanted to touch on was, you mentioned larger engagements, so I was just curious if you'd give some detail around that, what specifically are you doing that makes those engagements larger and do you think that's a recurring thing?

Ted A. Fernandez

We're seeing our opportunities for large engagements clearly improve and we've seen that throughout the last 24 months. So we believe that simply expanded permission in a certain number of our client base, but we still think it's early on.

When you look at the number of our total clients that we serve, both through benchmarking and advisory or some level of what we'll call it blueprinting, and you consider the opportunity, that our wallet share to these really large clients is really we think minuscule today. We think that revenue per client increase. So to use us more broadly across more functions or to use us both across the entire enterprise and to include transformation as well as analytics on a combined basis should only increase.

So we think it's a strong indicator again allowing us to play a broader and more strategic role with clients, and at our scale, that's pretty important. And I think some of the reason that we are clearly growing beyond this sector is that our permission and influence is expanding. So we hope it continues.

Jeff Martin

Okay. And then just to touch on a little bit in the past, in terms of the U.S. Hackett Group having grown at great attractive pace over the past year or so, at what point do you start to worry that you're something up against difficult comps and you may not be able to continue a double-digit growth rate there?

Ted A. Fernandez

We've never changed our – we've never said more than 5% to 10%. So if the demand continues the way it is and our permission with clients expand, we hope we stay at the high end of that. Obviously if we stay at the high end, if we stay around 10%, we're going to make 20% plus. But we also say that if it's somewhere in between, we could also live with 15 plus percent long term growth rate.

What we hope influences our profitability and really changes the value of the entity is that if in addition to these results whatever range we settle into, and obviously we're performing above what we would define our historical range, that if we complement those core businesses with these new IP-as-a-service alliances, that both expanded value margin expansion and multiple expansion comes from the higher gross margin recurring revenues coming through new channels. So our bet is that it's a combination thereof.

I know you're asking about what we are now calling base, but if it's true that transformational change in this digital era will be very transformative, then we would hope that historical growth rates will increase for service providers that are well-positioned and for software and technology providers that are well-positioned. We think we are part of that mix and we hope the IP-as-a-service opportunity is icing on the cake.

Jeff Martin

Great. Great to see you doing well. Keep up the good work.

Operator

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

Ted A. Fernandez

Thank you, operator. Let me thank everyone for participating in our second quarter call. We look forward to updating you again when we support the third quarter. Thanks again.

Operator

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

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