Perficient, Inc. (NASDAQ:PRFT) Q3 2022 Results Conference Call October 27, 2022 11:00 AM ET
Company Participants
Jeff Davis – Chairman and CEO
Paul Martin – CFO
Tom Hogan – President and COO
Conference Call Participants
Mayank Tandon – Needham
Surinder Thind – Jefferies LLC
Jonathan Lee – Morgan Stanley
Puneet Jain – JP Morgan
Vincent Colicchio – Barrington Research
Maggie Nolan – William Blair
Operator
Good day, and thank you for standing by. Welcome to the Q3 2022 Perficient Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded.
I would now like to hand the conference over to your speaker today, Chairman and CEO, Jeff Davis. Please go ahead.
Jeff Davis
Thank you, and good morning, everyone. With me on the telephone today is Paul Martin, our CFO; Tom Hogan, our President and COO. I’d like to thank you again for your time this morning. We have about 10 to 15 minutes of prepared comments, after which we’ll open up the call for questions.
Before I proceed, Paul, would you please read the safe harbor statement?
Paul Martin
Thank you, Jeff, and good morning, everyone. Some of the things we will discuss in today’s call concerning future company performance will be forward-looking statements within the meaning of the securities laws. Actual results may materially differ from those discussed in these forward-looking statements, and we encourage you to refer to the additional information contained in our SEC filings concerning factors that could cause those results to be different than contemplated in today’s discussion.
At times during this call, we will refer to adjusted EPS and adjusted EBITDA. Our earnings press release including a reconciliation of certain non-GAAP financial measures to the most directly comparable financial measures prepared in accordance with Generally Accepted Accounting Principles, or GAAP, is posted on our website at www.perficient.com. We have also posted a slide deck, which includes a reconciliation of certain non-GAAP guidance to the most directly comparable financial measures prepared in accordance with GAAP on our website under Investor Relations.
Jeff?
Jeff Davis
Well, thanks, Paul. It’s good to be with you today as we discuss our third-quarter performance and our continued growth and profitability. Adjusted earnings per share increased 26% during the period with revenue up 18%. North American average bill rates were up 4.4% year-over-year, accelerating to an all-time high. Gross margin also reached an all-time high at 40.1% or 41.3% on an adjusted basis. The pipeline remains strong, in fact, larger than ever, and we’re pursuing several 8-figure deals. And now we are seeing a modest increase in sales cycles with some customers deliberating a little longer given the macroeconomic inputs. But because our work primarily involves mission-critical projects in which enterprises must invest and do prioritize, we’re not overly concerned at this point.
The breadth and depth of our portfolio, ensure Perficient delivers material value and environments of strength or weakness, whether our clients are investing in growth or seeking to reduce cost by leveraging efficiency, Perficient is the answer.
Organic growth revenue — organic offshore revenue grew 32% in the quarter and overall offshore revenue grew 72%. On an apples-to-apples basis, that component of our business is growing as fast as anyone in the industry. Our fully integrated global delivery model continues to resonate with clients who value the combination of our local and global approach. We continue to scale in both Latin America and in India. In fact, the Q3 acquisition of Inflection Point Systems in Mexico and the acquisition closed earlier this month of Ameex Technologies in India, increased our headcount in those regions by more than 600 colleagues.
As we’ve long discussed, we’re uniquely positioned due to our 2 decades of presence and strength in the United States. We’ve now built and continue to build meaningful global depth in Latin America and India with tremendous talent. Our teams in those regions are not bolt-on staff augmentation and resources. They are true experts, peers on par with our senior leaders in the United States. And our fully integrated approach is what customers want and ensures we can deliver meaningful value from anywhere in the world.
We’ve also discussed many times that this mix shift in the near and medium term will expand margins but also pose a modest headwind to our overall top-line growth. Eventually; however, it will prove an accelerant to both. We just reported adjusted earnings per share of $1.11 for the third quarter. 3 years ago, in the third quarter of 2019, we reported $0.56, with essentially a doubling of earnings while the world entered and emerged from the pandemic. Just for perspective, revenue was up 57% during that same time period. So clearly, investors who value earnings, continued profitability growth and strong margins, will continue to appreciate Perficient as a consistent best-in-class performer.
So with that, I’ll turn the call back to Paul for some more color on the numbers.
Paul Martin
Yes. Let me turn to the third quarter results. Services revenue, excluding reimbursed expenses, were $224.9 million in the third quarter, an 18% increase over the prior year. The year-over-year organic services revenue growth was 12%. Services gross margin, excluding reimbursed expenses and stock compensation was 41.3% in the third quarter compared to 40.3% in the prior year. SG&A expense was $44.3 million in the third quarter compared to $39.3 million in the prior year. SG&A expense as a percentage of revenue decreased to 19.5% from 20.4% in the prior year. Adjusted EBITDA was $53 million or 23.3% of revenues in the third quarter compared to $41.5 million or 21.5% of revenues in the prior year. Amortization expense was $6.1 million in the third quarter compared to $4.3 million in the prior year. The increase in amortization expense was primarily due to the additional intangibles from acquisitions in 2021 and 2022.
Net interest expense for the third quarter decreased to $0.6 million from $3.5 million in the prior year, primarily as a result of adopting a new accounting standard for comfortable debt in the first quarter of 2022. Our effective tax rate was 29.4% for the third quarter compared to 28.1% in the prior year. Net income increased 32.3% to $23 million for the third quarter from $17.4 million in the prior year, primarily as a result of higher revenues, higher gross margins and lower SG&A as a percent of revenue.
Diluted GAAP earnings per share increased to $0.64 a share for the third quarter from $0.48 a share in the prior year. Adjusted earnings per share increased to $1.11 or 26% from the third quarter from $0.88 a share in the prior year. You can see the press release for a full reconciliation to the GAAP earnings.
I’ll now turn to the year-to-date results. Services revenue, excluding reimbursable expenses, were $664.2 million for the 9 months ended September 30, 2022, a 24% increase over the prior year. Year-over-year organic services revenue growth was 16%. Services gross margin, excluding reimbursed expenses and stock comp for the 9 months ended September 30, ‘22, was 40.1% compared to 39.8% in the prior period. SG&A expense for the 9 months ended September 30, 2022, was $127.4 million compared to $110.7 million in the prior year. SG&A expense as a percentage of revenue decreased to 18.9% from 20.3% in the prior year. Adjusted EBITDA for the 9 months ended September 30, 2022, was $151.5 million or 22.5% of revenues compared to $115.1 million or 21.1% of revenues in the prior year. The 9 months ended September 30, 2022, included amortization of $18.1 million compared to $17.7 million in the prior year.
Net interest expense for the 9 months ended September 30, 2022, decreased to $2.3 million from $10.1 million in the prior year, again, primarily as a result of adopting the new accounting standard for convertible debt in the first quarter of 2020. Our effective tax rate was 25.2% for the 9 months ended September 30, 2022, compared to 25.3% in the prior year.
Net income for the 9 months ended September 30, 2022, was $77.9 million compared to $47.6 million in the prior year, increasing primarily as a result of higher revenues, gross margins and lower SG&A expense, as a percent of revenues. Diluted GAAP earnings per share increased to $2.17 for the 9 months ended September 30, 2022, compared to $1.39 in the prior period. Adjusted earnings per share increased to $3.14 for the 9 months ended September 30, ‘22 from $2.49 in the prior year. Again, you can see the press release for a full reconciliation to GAAP earnings.
Our ending global headcount at September 30, 2022, was 5,959, including 5,605 billable consultants and 354 subcontractors. And the SG&A headcount was 886. Our outstanding debt, net of deferred issuance costs at September 30, 2022 was $394.1 million. We also had [$24.8] million in cash and cash equivalents as of September 30, 2022, and $199.8 million of unused borrowing capacity on our credit facility. Our balance sheet continues to leave us very well-positioned to execute against our strategic plan.
I’ll now turn the call over to Tom Hogan for a little more commentary. Tom?
Tom Hogan
Thanks, Paul, and good morning, everybody. We booked 37 deals greater than $1 million during the third quarter of 2022, which compares to 40 in the third quarter of 2021. As Jeff already mentioned, we did see some client stress negotiation cycles as they navigate the plan internally. The deals aren’t going way though. They’re just taking a bit longer to close. Our net pipeline weighted — unweighted is larger than it’s ever been, and it continues to grow daily. A couple of recent wins to highlight for the quarter. We have entered into a new phase of our work with the Global Architectural Corporation to approve their existing cloud platform. This win is an extension of our work to modernize the client supply chain technology. As part of the ongoing partnership, our trusted global team of experts are consolidating 12 legacy applications into a single software service cloud with primary focus to continue building [indiscernible] clients’ formulation product.
We recently won work with a new client that provides information management services to deploy ERP and supply chain management platform throughout Asia Pacific, South America, Europe, the Middle East and Africa. Our proven track record of delivery of similar projects and our reputation of quality, talent and our ability to support the deployment onshore and offshore prompted the enterprise to switch from their previous provider to Perficient. Just a great example of our trifecta of the United States, Lat Am and India team, it was all perceived as superior alternative to their incumbent.
We continue to remain well diversified from a customer, industry and platform perspective. Health care and financial services remain the strongest industries during the quarter. Automotive also remained strong as well. I’ve talked in recent quarters about the internal and external investments we’ve made to improve our colleagues work lives, but also making increased impacts in the global communities where we operate. And we’re seeing our colleagues value these investments more and more with an already below industry average attrition slowing even further. And our feedback about the colleague experience is as high as it’s ever been.
In our most recent all colleague engagement survey, nearly 90% of our colleagues responded and 90% of them expressed that they recommend Perficient as a great place to work. For the first time ever, we engaged an external partner to administer our engagement survey, is well-known partner, was able to provide us with cross-market benchmark data and data specific to our industry, enabling us to glean additional insights from our colleagues feedback. Their findings were that Perficient server results materially exceeded the benchmarks across virtually every category surveyed.
Our colleagues are telling us that they value the investments we’ve made and will continue to make in total rewards programs and community efforts, like Bright Paths into the innovative internal products we’ve built and into the internal initiatives like our Women in Technology [indiscernible], employee resource groups. They love collectively and individually Perficient and its colleagues are making so many positive differences in the world.
And most of all, what they value is the collaborative culture that built the Perficient and without silos or borders based on geography. At Perficient each and every day, the vast majority of our colleagues are working across time zones, countries and continents to deliver world-class solutions for our customers, which results in a world-class experience for our colleagues.
And with that, I’ll turn things back over to Jeff to discuss the fourth quarter and the remainder of 2022.
Jeff Davis
Thank you, Tom. Perficient expects its fourth quarter 2022 revenue to be in the range of $233 million to $239 million. Fourth-quarter GAAP earnings per share is expected to be in the range of $0.69 to $0.74. Fourth quarter adjusted earnings per share is expected to be in the range of $1.11 to $1.16. Perficient is updating its full-year ‘22 revenue guidance to a range of $905 million to $911 million, updating its ‘22 GAAP earnings per share guidance to a range of $2.85 to $2.90 and narrowing its 22% adjusted earnings per share guidance to a range of $4.25 to $4.30.
And with that, we can open up the call for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Mayank Tandon of Needham.
Mayank Tandon
Jeff, I just wanted to first start with — last quarter, you had mentioned the impact from cancellations and delays. Did that play a role in your revised guidance? I see a little bit of a downtick in terms of organic growth embedded in your 4Q numbers. So maybe if you could just speak to that. And then on a related note, if you could also just give us the organic growth numbers for 4Q that you’re building into your expectations.
Jeff Davis
Yes, sure. Yes, I would say that the cancellations we experienced have still impacted the quarter carried over into Q3, and you’re seeing that reflected somewhat in the Q4 guidance as well. It was really a matter of how quickly we’re able to build that back. And also keep in mind, everybody knows we had that one large health care account that we exited this year. That represented about $30 million in revenue last year. It’s about $5 million this year. So that was a headwind, again, that I think is a unique situation, and that’s now lapsed.
And of course, Q4 was a tough comp. Obviously, we had a really, really strong Q4 last year. So that’s factored in as well. On the organic growth for the fourth quarter, I want to say the midpoint is at about 8%. Paul, is that right?
Paul Martin
Yes, it is 7%, 8% at the midpoint.
Mayank Tandon
Got it. And then maybe I could just piggyback off that, Jeff and Paul. So I know you’re not going to give guidance for next year. But just given what you’re seeing in the market right now, I’m sure clients are going through the budgeting process and then the 4Q organic growth expectation that you just laid out, is that a good baseline on how we should think about at least the early part of 2023 as we’re building our model to set realistic expectations in this current uncertain macro?
Jeff Davis
Yes, I think that’s fair. We’ll — I think a lot would be revealed between now and the end of the year on a macro sense without — so there’s no crystal ball. So — but yes, I think that’s a good starting point.
Mayank Tandon
Just one housekeeping item. So just in terms of the revenue contribution in the fourth quarter from your 2 recent acquisitions, could you just size that for us? So again, we have a good handle on the impact.
Jeff Davis
Yes. I think it’s about somewhere between $8 million and $9 million.
Operator
Our next question comes from Surinder Thind of Jefferies LLC.
Surinder Thind
Jeff, I’d like to start with a question around the demand environment. And more specifically, it seems like there’s increasing desire for continued offshore work relative to onshore work. And that seems to be impacting the top line. Can you talk about that? Is that explicitly being driven by clients concerned about cost and so they’d rather continue with current projects, but rather have them offshore? Or are there just other considerations here because it just seems like that’s a continuing headwind at this point for the top line?
Jeff Davis
Yes, I think that’s right. And it’s a combination of both. So we have — our top 50 accounts have an average tenure of 10 years. So we have a lot — we’ve evolved a lot over that long period of time, as have they. And in particularly, our offshore and nearshore capabilities have evolved a lot around the digital space. We’re completely digitally native in our offshore and nearshore delivery centers. And that really didn’t exist anywhere for the most part 5 years ago. So all of these things have evolved to definitely a higher pace growth for offshore, nearshore. And certainly, a lot of the motivation for that is the value that it brings. So it is definitely a cost factor. I don’t know clients that aren’t always cost sensitive when it comes to services.
Surinder Thind
Fair enough. And then is there, what I would call, internal realignment with the clients as well. In that sense, I’m assuming most of the new work is that primarily offshore and then what about existing projects? Are clients transitioning existing projects offshore as well? Or is that — or is it generally when there’s a new cycle for a new project that the work shifts to offshore?
Jeff Davis
Yes, it’s a good question. It’s generally a new cycle. And there’s still a number of clients who prefer the onshore experience. So there are still clients that are sticking with 100% onshore. But most clients have transitioned. I mean a great example on an industry basis is health care. So I kind of mentioned the 5-year cycle, 5 years ago, no health care companies that we work with would touch offshore. And now I can’t think of one that isn’t leveraging it in some way or another. And that’s just a competitive necessity.
Surinder Thind
Got it. And then one more related question to the offshore. At this point in time about what percentage of revenues are generated by your offshore teams?
Jeff Davis
It’s approaching 30%. It’s probably a little below 30%. With these latest acquisitions, though, it should be right around 30%.
I’m looking forward to us getting to what I refer to as a tipping point of 50%, by the way. I think that’s the point where we’ll really see offshore and nearshore helping to contribute to accelerated top-line growth in addition to the contributions they’re already making to the gross margin.
Surinder Thind
Understood. And then my final question here is your earlier comment about the increase in the sales cycle. Any color on that? Is that client simply delaying existing projects? Or are they starting to maybe change the nature of the types of projects that they’re asking you to focus on? We’ve heard commentary from, let’s say, competitors about, well, maybe there’s a bit more focus on cost. But how does that impact you? Or what are you guys particularly seeing?
Jeff Davis
Yes. I wouldn’t say that the mix of the drivers has really changed much. It’s still primarily customer acquisition, new products and services, customer support, et cetera. Of course, there’s a lot of work around efficiency gains as well. I don’t think that mix has changed much so far. And in terms of the sales cycles extending, I do think it’s the climate that we’re in, oversimplification to say maybe they’re waiting for the midterm. So do you think there’s a factor there as well. So I think we’re just at a stage in this year’s evolution where people are taking a little more cautious approach. We do know of some clients that are going through reprioritization. In those cases, the projects that we’re working on tend to move forward. And I expect that will continue, but they do still have to go through that prioritization process, which introduces some delay.
Operator
Our next question comes from Jonathan Lee of Morgan Stanley.
Jonathan Lee
Last quarter, you signaled some of the softness given change in client priorities, it’s not necessarily the macro environment. And I want to build on some of the prior questions. So how has that evolved over the last few months? What’s contemplated in your outlook from a macro perspective?
Jeff Davis
Yes. We’ve definitely taken a little more conservative approach on guidance understandably, I think, given the current climate. And yes, I would also say that what we saw as primarily kind of macro in Q2, I think, admittedly, is revealing itself to be a little more macro than we thought. And as I’ve alluded to earlier in the prepared comments. So I do think it’s a little softer environment. Not dramatic, though, like I said. We’re still putting up a good result. I think the guidance is really solid, although I will say that we’ve tried to be quite conservative in this guidance and feel very confident at hitting that midpoint.
Jonathan Lee
That’s helpful color. And then one more, if I may. Can you talk us through the current pricing environment, just given some of the macro headwinds that you may be seeing? And sort of what’s contemplating your outlook as it relates to you being able to take up price?
Jeff Davis
Yes, that’s pretty interesting that in spite what intuition I tell you, we’ve managed to move rates up pretty nicely. We mentioned in the earlier part of the call, 4.4% for U.S., North America, and the fact of the matter is, actually, nearshore has been about 15% and India has been similar. So we’ve got decent, I’d say, quite good pricing power, and that’s really just based on results. So once clients make the decision to move ahead and make those commitments, we successfully negotiate what we believe is an appropriate price for what the market will bear. And again, I think the fact that we’ve been able to move — been able to move rates up as much as we have supports that.
Now if moving forward into the — maybe medium term, I don’t know, mid — late next year, that might change. But as of right now, I think that momentum looks like it’s going to continue.
Operator
Our next question comes from Puneet Jain of JP Morgan.
Puneet Jain
I wanted to ask about margins. Given like the 2 recent acquisitions, how should we think about pro forma margins for the entire company on a going forward basis?
Jeff Davis
I think the 2 acquisitions are going to be somewhat neutral, and that’s not uncommon. We — I mentioned the price improvement that we’ve made nearshore in particular. But as we drive more demand from our existing client base into those newly acquired businesses, I expect that the margins will expand. So I think we’re going to see similar results next year, this year. When I started this year saying, gosh, I think it’s going to be maybe 50 basis points in gross margin. And I’d probably say the same thing about next year, depending what the macro environment holds in store.
But I want to reiterate, we’re not trying really to drive higher gross margins. In terms of margin expansion, we’re really more focused on EBITDA. So I want to see the price increase is going to offset cost increases, right, wage inflation and also us being able to leverage that offshore to maintain and drive competitive pricing versus letting it all flow through. And I think the results that we’re seeing right now are exactly the result of that. I’m very pleased with — we may end up closer to 100 bps on gross margin, but we’re going to put up a couple of hundred bps of EBITDA expansion this year. And I think that’s what I’d encourage investors to focus on.
Puneet Jain
Got it. Got it. And then how should we think about use of cash priorities given rising interest rate environment, specifically as it relates to M&A, potential M&A to further increase that offshore mix to 50% of revenue over medium term?
Jeff Davis
Yes, absolutely. So the 2 primary uses of cash for us of course, are M&A and stock buyback. So on the M&A front, we do have some things still in the pipeline that we’re going to continue to work on. We may slow the pace a bit as we, again, keep a close eye on that macro primarily here over the next couple of months. And again, I do think the midterms may determine some direction there.
But in terms of buyback, I think it was in our press release that we actually just expanded — the Board just approved an expansion to the buyback program of additional $60 million. So I want to say with that, we’ve got about $70 million in dry powder approval for buybacks. So we’ll certainly be pursuing that, certainly at these levels of the stock price. I think it’s a great use of cash and certainly accretive.
Puneet Jain
Got it. And let me quickly follow up on that. How often you adjust the cut-off rate for organic investments or for M&A, whether it’s buyback internally for your internal models?
Jeff Davis
I didn’t quite catch that. I don’t know, Paul, did you get that?
Paul Martin
Would you mind repeating that please?
Puneet Jain
So the cutoff rate that you use for use of cash decisions internally, like do you — how often you adjust those rates?
Paul Martin
We look at those annually based on the environment, based on interest rates, based on the macro, we evaluate that annually really as part of our budget process.
Operator
Our next question comes from Vincent Colicchio of Barrington Research.
Vincent Colicchio
Yes. So Jeff, with the year-over-year decline in million-dollar-plus deals, I’m curious, the pipeline you said, which is healthy, are deal sizes declining in the pipeline?
Jeff Davis
Actually, the deal sizes are pretty consistent. There was the number of deals. And I’d kind of chalk that up more to just the lumpy nature of the business. That’s how bookings tends to flow. But again, that’s why we talked about the fact that we had seen some delays. We expect we’ll be able to pick some of those up again still in the fourth quarter. And — but I think it does reflect some of the slower decision time frames that we’re experiencing.
Vincent Colicchio
And I’m curious, the nearshore deals you did in ‘21, Talos and Overactive. Are you hitting on the cross-sell objectives there with your existing base?
Jeff Davis
Yes. Yes, they’ve been really, really strong. The customers are, I’d say, nearshore is the component that’s highest in demand right now. And I don’t think that’s going to end anytime soon. Just the time zone alone is such a benefit.
Vincent Colicchio
And maybe one last one. You had a sequential decline in health care, which you’ve had for the reason you mentioned year-over-year declines with a big client. When do you expect that to return to sequential growth?
Jeff Davis
We’ve got a lot of deals out there. I do think that it’s probably going to take the better part of at least the first half of next year for us to kind of rebuild that. But we do have a lot of new opportunities, new logos in the pipeline and in the works. And so I think we’ll see that turn again sometime in the first half of next year. The good news is we’ve got a lot of — a big head of steam coming on in other industries, particularly financial services.
Operator
Our next question will come from Brian Kinstlinger of Alliance Global.
Unidentified Analyst
This is Sherman on for Brian. At the very beginning of the call, you mentioned that your pipeline still remains strong and that you’re pursuing multiple 8-figure deals. Could you allude to these 8-figure deals? What industry they’re in, whether it’s health care, financial services, et cetera?
Jeff Davis
It’s both.
Unidentified Analyst
Do you see like any sort of this heavy shift in one direction?
Jeff Davis
Yes. I would say there’s not a heavy shift other than like I mentioned, certainly, financial services is accelerating, probably beyond in terms of demand, probably beyond are close similar to health care right now. But it’s a good cross-section, I would say, across a number of industries. Those 2 in particular stand out. But we still have a lot of great relationships and work going on in automotive and manufacturing as well.
Operator
[Operator Instructions] Our next question comes from Maggie Nolan of William Blair.
Unidentified Analyst
I’m [indiscernible] on for maybe Maggie Nolan. And so I wanted to just start off talking a little bit more about the offshore growth. Was it stronger than expected for the quarter? And was it a factor in the guidance change? Or was — or were the sales cycle increases a bigger factor?
Jeff Davis
Yes. I would say it was a big contributor, but I think the sales cycle increase is probably the major factor. But it was probably in line, maybe a little bit accelerated again, beyond our expectations, which, of course, I think, is a positive. So it’s been strong and looks to be strong going forward.
Unidentified Analyst
And then you expected hiring originally to ramp up in the second half. Does that still hold true as we look to year-end?
Jeff Davis
Certainly, it’s a little slower in the U.S. as we — with this mix shift going on. So I think we’re up a couple percent organically on hiring in the U.S., but we’re definitely hiring a lot faster than that, both offshore and nearshore. I want to say, do — Paul, you or Tom have the net on that? What was the net organic on the offshore nearshore headcount?
Tom Hogan
Yes, this has the acquisition in it but without — it was definitely up sequentially, I think, 3% or 4%, maybe a little bit higher than that.
Operator
At this time, I would like to turn the conference back over to Jeff Davis for closing remarks.
Jeff Davis
All right. Well, thank you all once again. Another great quarter for Perficient, and appreciate your time today and look forward to speaking to you in about 120 days about what I’m confident will be a great quarter of the fourth quarter.
So thank you all for your time.
Operator
Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.
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