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The Hackett Group, Inc. (NASDAQ:HCKT), a strategic advisory and technology consulting firm, has had a tough second half of calendar 2022. Growth is slowing down from the weakening economic environment and lack of visibility heading into 2023, which is causing companies to re-prioritize spending allocation.
While The Hackett Group, Inc.’s Global S&BT or Strategy and Business Transformation segment has had strong growth momentum, its Oracle and SAP Solutions has slowed down; partially from comps, but also from weaker sales.
Since June 2021, the company has struggled to break out of a tight revenue range and is likely to continue to grow incrementally at best until the negative effects of the current weak economic environment are resolved; that isn’t likely to happen at earliest until the second half of 2023.
In this article, we’ll look at its recent numbers and how performance in 2023 appears to be forming.
Some of the numbers
Revenue in the third quarter was $72 million, basically the same as it was in the third quarter of 2021. Revenue in the first nine months of 2022 was $223.6 million, up from the $209 million in revenue generated in the first nine months of 2021.
Its Global S&BT segment produced over half the revenue in the reporting period, ending the third quarter at $41.1 million, up 11 percent year-over-year.
Revenue from its Oracle Solutions segment was $17.4 million, down 16 percent from the third quarter of 2021. The drop in revenue was attributed to clients prioritizing its spending decisions.
Its SAP Solutions segment generated revenue of $12.5 million, down 10 percent year-over-year. A major part of this was tough 2021 comps after the unit completed several large pieces of business in the latter part of 2021. Since then, it has been working on rebuilding its pipeline.
Of total company revenues in the reporting period, approximately 21 percent of it came from recurring and subscription-based revenue.
Cost of sales in the third quarter of 2022 was $41.2 million or 58.1 percent of revenues, not including reimbursements or non-cash stock-based compensation.
Gross margin in the reporting period was 41.8 percent, up from the 39 percent of gross margin in the third quarter of 2021. The improvement of 290 basis points over the third quarter of 2021 was attributed to an increase in revenue from its higher-margin Global S&BT segment, along with more high-margin VAR sales.
Adjusted EBITDA was $16.9 million in the third quarter, up from the $15.1 million in adjusted EBITDA in the third quarter of 2021.
GAAP net income in the third quarter of 2022 was $10.4 million or $0.32 per diluted share, compared to net income of $8.1 million or $0.25 per diluted share in the third quarter of 2021.
At the end of the third quarter of 2022, the company held $67 million in cash, up from the $61.7 million in cash it held at the end of the prior quarter.
The company also entered into a five-year $100 million credit facility with Bank of America (BAC) and US Bank where the banks will lend up to $100 million from time-to-time during that time period.
Taking into account the decline in billing days of in the fourth quarter, which will be down in a range of 8 percent to 10 percent, along with clients re-prioritizing spending, the HCKT guided for revenue in the quarter to be from $66 million to $68 million.
It expects for Global S&BT revenue to be up in the fourth quarter compared to the fourth quarter of 2021, but revenue from Oracle Solutions and SAP Solutions are expected to be down again as measured against the fourth quarter of 2021.
With plans to fund its tender offer with approximately $50 million, it means its cash holdings will be much less at the end of the fourth quarter.
Economic headwinds
A major challenge for HCKT going forward is concerning high-level management having brought decision-making concerning spend further up the hierarchy, which is resulting, in many cases, with much tighter control and delays in spending.
The problem comes from lack of visibility concerning the global economy in 2023, which has made it difficult for business leaders to model their performance over the next 12 months or so. Until there is more clarity, this is probably going to result in subdued spending in the foreseeable future.
This suggests at minimum, that the first half of 2023 will be a hard environment for HCKT to operate in, with sales probably coming in lower than they have in the last couple of years, at least in the first half.
That said, I also think it’s premature to assume the second half is going to improve. Most analysts and companies think that’s how it’s going to play out, but there is still a hesitancy in making decisions based upon that assumption. At earliest I think it’ll be near the end of the second calendar quarter before we have a clearer picture of the second half of the 2023 economy.
As for how that has an impact on HCKT, I think its Global S&BT should continue to grow unless the recession goes deeper for longer. Concerning its Oracle and SAP segments, they are probably going to continue to struggle, providing at best growth at the very low end of the spectrum if the economy remains weak but doesn’t get worse.
Conclusion
While I agree with management that digital transformation remains strong, re-prioritizing of spending by senior management at a growing number of companies is going to delay a significant amount of spend in that transition until there is confirmation the global economy is turning around.
I think at earliest that’s going to come in the second half of 2023, but there is no certainty that it’s going to play out that way. The assumption is the Federal Reserve will stop raising interest rates by that time, which would provide more clarity on the economic environment in the near future.
I’m one of those in the camp of thinking that’s how it’s likely to play out because of the limitations the Federal Reserve faces on how high it can raise rates before being a huge problem for the U.S. government to pay down its extraordinary $31 trillion-plus debt load. I think somewhere around 5 percent is where interest rates are probably going to end up, with it being slightly above or below that level.
At this time the story for HCKT is the macro-economic headwinds it faces, and I tend to think management commentary on Oracle and SAP Solutions having an upturn by the second quarter of calendar 2023 as being too optimistic. If it were to happen, it would be, in my opinion, the best-case scenario. A lot of things would have to align right for it to play out that way.
When asked about his confidence in the turnaround by the second quarter of 2023, CEO Ted Fernandez said it was primarily from “the activity that we’ve seen even in the third and what we see in the pipeline going into the fourth quarter.” He added that there were some sizable engagements the company signed near the end of the third quarter and in the early part of the fourth quarter of 2023 that makes him believe demand remains in place in regard to digital transformation.
He also pointed out that clients during COVID and times of geopolitical challenges continued to invest in digital transformation initiatives, and he thinks that is probably going to continue on in 2023.
While he maintains demand will continue on, at the same time he acknowledges there will be headwinds in relationship to spending decisions in the current economic environment.
This may appear to be contradictory by the CEO, but what he is apparently trying to communicate is in the long term, demand in the sector is going to continue to grow, while in the short term headwinds are going to be in play as far as delay in spending goes.
As he concluded, “it will impact pipeline velocity and conversion,” and I agree with him. Demand at this time isn’t the issue, but the timing of spend for the ongoing digital transformation is what the issue is.
As mentioned above, I think the momentum in its Global S&BT should continue, while momentum in the Oracle and SAP segments could slow down further over the next two to three quarters. I would be surprised for them to have any meaningful upturn in the second quarter of calendar 2023.
I think The Hackett Group, Inc. has promise over the long term and is worth watching, but in the near term it is probably going to struggle to maintain momentum, and it should offer better entry points in the next quarter of two for those investors looking to take a position in the company.
The major thing to watch is how business leaders are responding to the economic headwinds in regard to spend in the sector The Hackett Group, Inc. competes in.
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