Hackett Group: Beneath-The-Radar Inventory With Sturdy Fundamentals (NASDAQ:HCKT)

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This is a company that has been flying under the radar over the last years given that the most recent Seeking Alpha article about it was out in 2016. Radio silence since then. We are talking about The Hackett Group, Inc. (NASDAQ:HCKT).

That said, we decided to dive into its fundamentals and check whether this stock has significant upside potential from today’s price levels.

Brief Overview

Supply chain issues, retention and higher wages place a lot of pressure on the companies around the world. As such, the companies need to implement technology and workflow automation in an effort to address these issues and improve their operating performance. And this is HCKT’s job. HCKT offers technology and organizational changes, which can be implemented to help its clients remain competitive.

Specifically, HCKT is an intellectual property-based strategic consultancy to global companies, offering a comprehensive range of services, including executive advisory programs, benchmarking, business transformation and technology consulting services. With strategic and functional knowledge in finance, human resources, information technology, procurement, supply chain management, corporate services, customer service, and sales and marketing, its expertise extends across the enterprise. HCKT has completed successful engagements in a variety of industries, including automotive, consumer goods, financial services, technology, life sciences, manufacturing, media and entertainment, retail, telecommunications, transportation and utilities. On that front, HCKT’s clients include the world’s most respected brands, representing a broad range of industries and businesses, as illustrated below:

Logos

Source: HCKT’s website

The Strong Balance Sheet And More

HCKT was not the exception to the rule, so its business was not immune to COVID-19. The COVID-19 pandemic negatively impacted its top and bottom lines in 2020, so the company had to take measures on several fronts, as quoted below:

As a response to the ongoing COVID-19 pandemic, we have implemented plans to manage our costs and preserve cash. We have significantly limited the addition of new employees and third party contracted services, eliminated all travel except where necessary to meet customer needs, and limited discretionary spending. In addition, at the end of June 2020, we reduced our global workforce by approximately 10% of our global workforce and recorded a $5.0 million restructuring charge”.

However, things began to change for the better in 2021. Actually, HCKT was off to a spectacular start in Q1 2021 and the strong momentum continued into the remainder of the year. As a result, revenue in 2021 returned to pre-pandemic levels while profitability far exceeded pre-pandemic levels thanks to high operating leverage and significant margin expansion, as illustrated below (in thousands):

Year Ended

December 31,

January 1,

December 27,

2021

2021

2019

Revenue:

Revenue before reimbursements

$

277,583

$

234,810

$

260,837

Reimbursements

1,226

4,672

21,635

Total revenue

278,809

239,482

282,472

Costs and expenses:

Cost of service:

Personnel costs before reimbursable expenses

(includes $6,766, $7,319 and $4,785 of stock compensation

expense in 2021, 2020 and 2019, respectively)

171,920

161,696

164,044

Reimbursable expenses

1,226

4,672

21,635

Total cost of service

173,146

166,368

185,679

Selling, general and administrative costs

(includes $3,356, $2,421 and $2,931 of stock compensation

expense in 2021, 2020 and 2019, respectively)

59,187

53,984

62,074

Restructuring charges and asset impairments

10,488

4,514

Acquisition-related contingent consideration liability

(1,133

)

Total costs and operating expenses

232,333

230,840

251,134

Operating income

46,476

8,642

31,338

Other expense:

Interest expense

(95

)

(126

)

(311

)

Income from continuing operations before income taxes

46,381

8,516

31,027

Income tax expense

4,829

2,871

7,744

Income from continuing operations

41,552

5,645

23,283

Loss from discontinued operations (net of taxes)

(7

)

(172

)

(6

)

Net income

$

41,545

$

5,473

$

23,277

Despite the strong revenue YoY growth in 2021, customer concentration was not high. Actually, customer concentration has never been high over the last years, as quoted below:

We focus on developing long-term client relationships with Global 2000 firms and other sophisticated buyers of business and IT consulting services. During 2021, 2020 and 2019, our ten most significant clients accounted for 22% of total revenue in each year. In addition, during 2021, 2020 and 2019, our largest client generated 4%, 5% and 4% of total revenue, respectively. We have achieved a high level of satisfaction across our client base. We receive surveys from a significant number of our engagements which are utilized in a rigorous process to improve our delivery execution, sales processes, methodologies and training.

Another positive thing is that revenue are almost equal weighted to the Strategy & Business Transformation segment (S&BT) and the ERP, EPM & Analytics (EEA) segment, as illustrated below (in thousands):

Year Ended

December 31,

January 1,

2021

2021

S&BT

$

108,244

$

88,655

EEA

145,631

122,618

International

23,708

23,537

Revenue from continuing operations before reimbursement

$

277,583

$

234,810

However, HCKT has limited international presence and has been heavily reliant on North America, as illustrated below (in thousands):

Year Ended

December 31,

January 1,

December 27,

2021

2021

2019

Revenue:

North America

$

254,107

$

208,329

$

221,823

International (primarily European countries)

23,476

26,481

39,014

Revenue from continuing operations before reimbursement

$

277,583

$

234,810

$

260,837

Outlook

Outlook is positive, based on the recent CEO’s statements below:

More importantly, the strong demand for our digital transformation services continues into the new year which bodes well for 2022.

and:

The increasing client demand we have experienced since the end of the second quarter of last year has continued throughout 2021. More importantly, we believe this momentum should continue into fiscal 2022.

On that front, the three key growth drivers in 2022 and beyond are (emphasis added):

Well to us, the ones that – one – the one that we’ve been working very hard, and we expect – we expect that to contribute in ’22 has been the iPaaS related relationships which as I had mentioned, we have many – I’ll use the word percolating, but they’re in all stages. So that’s why we continue to speak to the fact that we expect those relationships to start materializing in 2022.

The second one that – that I think it’s important to note, which was – I think, rather new commentary. Our Research Advisory business has been focused on corporate or enterprise clients historically. And if you recall, we had a significant relationship with one of the large cloud infrastructure companies, which came in, in the latter part of the year. And as a result of the feedback we got from that very significant client, which was, they wanted our help with research and support with client related initiatives.

Their feedback was that, they believe that our ability to provide research to support vendor related initiatives to evaluate technology and competencies and take them to the marketplace is really very significant. So, you will see us make a very – we are and have started to make an investment in hiring individuals. And you’ll see us launch a series of new programs in that vendor intelligence space throughout 2022, which we believe could be very significant as I mentioned in my comments. I would say those are two.

Our third one could be the fact that we continue to add some cloud implementation partners, I think you may have seen in our release the announcement of a relationship with Anaplan, that is new. We’re also evaluating a couple others, some on the strategic enablement side, some on the implementation side. So just think about it, we got two – two sides of our business.

Valuation

Based on the outlook above, we estimate that revenue and adjusted EBITDA in 2022 will be about $280 million and $63 million, respectively.

Meanwhile, with zero debt and $46 million in cash, HCKT’s Enterprise Value currently is about $700 million.

Therefore, EV-to-2022 Revenue and EV-to-2022 adj. EBITDA are about 2.5 times and 11 times, respectively, at the current price of $23 per share, so we believe that HCKT is fairly valued.

These projections do not include any acquisitions, which seem to be on the horizon, as quoted below:

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 and at scope scale and capability, which can accelerate our growth.

and:

We’d also plan to expand our current credit facility to fund acquisitions we identified and to buy back stock, while continuing to invest in our business.

Dividend

HCKT is not new in paying dividends. HCKT has been paying dividends since 2012, as quoted below:

In December 2012, we announced an annual dividend of $0.10 per share. In 2019, 2020 and 2021, the Board of Directors approved an increase in the annual dividend to $0.36 per share, $0.38 per share, and $0.40 per share, respectively. During 2020, the Board of Directors approved the increase in the frequency of dividend payments from semi-annual to quarterly. During fiscal 2021, we paid the quarterly dividend to shareholders of record on March 26, 2021, June 25, 2021, September 24, 2021, and December 17, 2021, totaling $12.9 million. Our credit agreement contains restrictions on our ability to declare dividends and repurchase shares. Subsequent to fiscal year end, the Board of Directors increased the annual dividend to $0.44 per share and declared the first quarterly dividend of 2022.”

As also quoted above, HCKT has raised the annual dividend more than once since 2019. This was largely the result of the rock-solid balance sheet and consistently positive operating cash flow and free cash flow, as illustrated below:

Year Ended

December 31,

January 1,

2021

2021

Cash flows provided by operating activities

$

46,353

$

44,061

Cash flows used in investing activities

$

(3,242

)

$

(1,893

)

Cash flows used in financing activities

$

(46,739

)

$

(18,715

)

Based also on the company’s news and outlook, we project that operating cash flow will be at least $40 million in 2022.

Meanwhile, HCKT has a low CapEx business model, which is a key starting point when it comes to dividend sustainability. Specifically, annual CapEx has been less than $5 million over the last years, as illustrated below (in thousands):

Year Ended

December 31,

January 1,

2021

2021

Cash flows provided by operating activities

$

46,353

$

44,061

Cash flows used in investing activities

$

(3,242

)

$

(1,893

)

Cash flows used in financing activities

$

(46,739

)

$

(18,715

)

And this low CapEx business model is not going to change in 2022, as quoted below:

Capital Expenditures: There were no material commitments for capital expenditures as of December 31, 2021. Our capital expenditures primarily consist of investments related to the continued development of our Quantum Leap benchmark technologies and laptop purchases. During the years ended December 31, 2021, and January 1, 2021, our capital expenditures were $3.2 million and $1.9 million, respectively. We expect capital expenditures for the year ended December 30, 2022, to approximate the capital expenditures in 2021.

As a result, we estimate that free cash flow will be at least $35 million in 2022, while the annual dividend of $0.44 per share translates into about $14 million. In other words, the margin of safety is high and we estimate that free cash flow will far exceed the dividend payments in 2022, so we project that its dividend is sustainable in 2022 and the foreseeable future, barring unforeseen events.

The Share Buyback Program

Aside from the dividend, HCKT has returned money to its shareholders thanks to the ongoing share buyback program. Specifically, HCKT repurchased 748,995 shares in 2021 at an average price of $17.41 per share, as illustrated below:

Total Number

Maximum Dollar

of Shares Purchased

Value of Shares That

Total Number

Average

as Part of Publicly

May Yet Be Purchased

of Shares

Price Paid

Announced

Under the

Period

Purchased

per Share

Program

Program

Balance as of January 1, 2021

$

4,284,275

January 2, 2021 to April 2, 2021

136,627

$

15.45

136,627

$

2,173,933

April 3, 2021 to July 2, 2021

489,469

$

17.58

489,469

$

13,570,988

*

July 3, 2021 to October 1, 2021

112,550

$

18.68

112,550

$

11,468,188

October 2, 2021 to December 31, 2021

10,349

$

21.64

10,349

$

11,244,241

748,995

$

17.41

748,995

*

During the second quarter of 2021, the Company’s Board of Directors approved an additional share repurchase authorization of $20.0 million.

The share buyback program has not been completed yet and the company’s remaining share repurchase program authorization was $11.2 million, as of the end of the fourth quarter of 2021.

Insider Ownership

Insiders own 15.4%, so their interests are aligned with shareholders’, as illustrated below:

Name of Beneficial Owner

Amount and Nature of Beneficial Ownership(#) Percent of Class(%)

Ted A. Fernandez

3,233,586 10.2

David N. Dungan

1,267,584 4.0

Robert A. Ramirez

235,589 0.7

Maria Bofill

4,744 *

Richard N. Hamlin

50,274 *

John R. Harris

48,833 *

Robert A. Rivero

3,744 *

Alan T .G. Wix

16,559 *

All current directors and current named executive officers as a group (8 persons)

4,860,913 15.4

*

Represents less than 1%.

Risks

From an operational standpoint, we believe that the key risks are:

1) The consulting business will remain very competitive in the next years and HCKT is not going to be the only girl in town, as quoted below (emphasis added):

The strategic business advisory and technology consulting marketplace continues to be extremely competitive. The marketplace will remain competitive as companies continue to look for ways to improve their organizational effectiveness. Our competitors include international accounting firms; international, national and regional strategic consulting and systems implementation firms; and the IT services divisions of application software firms. Mergers and acquisitions throughout our industry have resulted in higher levels of competition. We believe that the principal competitive factors in the industries in which we compete include: skills and capabilities of people, innovative services and product offerings, perceived ability to add value, reputation and client references, price, scope of services, service delivery approaches, technical and industry expertise, quality of services and solutions, ability to deliver results on a timely basis, availability of appropriate resources, and global reach and scale. We acknowledge that many of our competitors are larger, however we believe very few, if any, of our competitors have proprietary intellectual capital similar to the benchmarking-based performance metrics QL delivers and the insight within the Hackett DTP that supports our Transformational Benchmark, Best Practices Advisory and Business Transformation and Technology offerings.

Despite our size relative to our competitor group, we believe our competitive position is distinct. With Hackett’s best practice intellectual capital and our QL and DTP platforms, we believe we can empirically and digitally assist our clients. Our ability to apply best practices and benchmarking metrics to client operations via proven techniques is at the core of our competitive standing.

Similarly, we believe that Hackett is the definitive source for best practice performance metrics and strategies. Hackett has conducted nearly 20,000 benchmark and performance studies over 28 years at over 7,000 clients, generating proprietary data sets spanning multiple performance metrics and correlating best practices with superior performance. The combination of Hackett benchmark data, along with deep expertise and knowledge in evaluating, designing and implementing business transformation strategies leveraging our proprietary Best Practices Repository and other accelerators within DTP, delivers a powerful and distinct value proposition to our clients.

Our culture of client collaboration leverages the power of our cross-functional and service line teams to increase revenue and strengthen relationships. We believe that this culture, along with terrific talent and with our intellectual capital-centric approach, gives us a distinct competitive advantage.”

2) To strengthen its ability to compete and expand its IP, HCKT has admitted that a deal is likely, as quoted above. However, there are several things that could go wrong and the deal could end up being a failure. For instance, HCKT may not be able to successfully integrate the acquired business without substantial expense or delays. Additionally, the acquired business could fail to generate anticipated revenue or earnings.

Takeaway

As always, we are going off the beaten path to find outperformers for the subscribers to our research. This is how we unearthed dividend-paying HCKT in December 2020, when we advised them to buy it at $14 per share for their income portfolio.

HCKT has performed very well since our buy recommendation while maintaining a fortress balance sheet. On top of this, its proven business model generates profitability, positive operating cash flow and positive free cash flow. What not to like? The answer is: The valuation.

At the current price of $23 per share, the stock is not a bargain, so we advise investors to stay on the sidelines. There are much cheaper undiscovered names with pristine balance sheets out there.

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