Ted Fernandez - Chairman and CEO Rob Ramirez - CFO.
Morris Ajzenman - Griffin Securities Frank Atkins - SunTrust Jason Kreyer - Craig-Hallum Jeff Martin - Roth Capital Partners Vincent Colicchio - Barrington Research.
Good evening and welcome to The Hackett Group’s Third Quarter Earnings Conference Call. Your calls have been placed on a listed-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..
Good afternoon, everyone, and thank you for joining us to discuss The Hackett Group’s third quarter results. Speaking on the call today, and here to answer your questions, are Ted Fernandez, Chairman and CEO of The Hackett Group; and myself, Rob Ramirez, Chief Financial Officer. A press announcement was released over the wires at 4:14 p.m.
Eastern Time. For a copy of the release, please visit our website at www.thehackettgroup.com. We will also place any additional financial or statistical data discussed on this call that is not contained in the release on the Investor Relations page of our website.
Before we begin, I would like to remind you that in the following comments and in the question-and-answer session, we will be making statements about expected future results, which may be forward-looking statements for the purposes of the federal securities laws.
These statements relate to our current expectations, estimates and projections and are not a guarantee of future performance. They involve risks, uncertainties and assumptions that are difficult to predict and which may not be accurate. Actual results may vary.
These forward-looking statements should be considered only in conjunction with the detailed information, particularly the risk factors contained in our SEC filings. At this point, I would like to turn it over to Ted..
Thank you, Rob, and welcome, everyone, to our third quarter earnings call. I will start the call by trying to provide some overview or highlight comments relative to our quarter, then turn it back over to Rob and ask him to comment on our operating results, cash flow, and then provide some details on guidance.
Rob will then turn it back over to me to provide some market and strategic overview comments, and then we will open it up for Q&A. So, let me first start with our quarterly highlights. This afternoon, we reported gross revenues of $71.5 million and pro forma EPS of $0.26, both revenues and pro forma EPS came in at the high end of our guidance.
As expected, our U.S. revenues including our acquisitions, were down from last year. This was offset by strong European results and our small but emerging IP as a Service revenues.
As we discussed last quarter, the software market is rapidly moving to cloud, and we have aggressively started to transition our Oracle group from being primarily focused on the implementation of Oracle EPM on-premise software to the entire Oracle Cloud enterprise suite and we’ve done that through a series of actions.
As you know, we acquired an Oracle Enterprise Cloud implementation group in May which has allowed us to expand our Oracle addressable market four-fold. We then started to aggressively migrate our existing EPM on-premise resources to the rapidly growing Oracle cloud focus.
At the recent Oracle OpenWorld conference, we were recognized as the EPM cloud partner of the year, which demonstrates our ability to migrate our on-premise capabilities to cloud effectively.
We’ve also started to develop our Oracle Digital Transformation Platform, which aligns Oracle cloud functionality to Hackett’s best practices and specific configuration guidance which optimizes the use of the software.
We premiered the platform during a recent Oracle OpenWorld to very favorable feedback from both the prospective clients and Oracle sales channel. We believe, this as a highly differentiated capability which will prove successful for us as we go forward with Oracle and in the marketplace.
Lastly, we have fully aligned our capabilities to the Oracle go-to-market strategy and sales channel. As you know, Oracle had aligned its EPM and ERP sales channels at the beginning of the year.
And it was very important for us to expand our capabilities and aligned our capabilities with their go-to-market strategy and channels, and we believe we have so, effectively. These moves have allowed us to significantly increase the addressable market to cover the entire Oracle cloud implementation software suite.
Instead of just selling EPM cloud related software, we are now positioned to implement cloud related software for finance, EPM, HCM, supply chain customer experience, the entire suite.
As I mentioned last quarter, we believe that the expanded Oracle implementation capabilities and our ability to demonstrate to prospective clients and the Oracle channel that we can optimally configure Oracle cloud software by leveraging our best practice IP will allow us to move to their top tier status by early 2018.
Another key part of our digital transformation strategy has been the increasing consideration of robotics process automation and business transformation initiatives. To complement our capabilities, we made an acquisition in Europe and entered into an alliance agreement to quickly address these market changes.
We believe these moves along with the introduction of our new Quantum Leap benchmarking offering, our recently announced acquisition of our joint venture’s partner interest in CGBS training and certification program, as well as the new enterprise analytics training and certification program, accelerate our position as a digital transformation and IP as a Service leader.
On the balance sheet side, we continue to generate strong cash flow from operations. This has allowed us to increase our dividend, buy back stock and fund acquisitions. I will comment further on strategy and market conditions, but let me first ask Rob to provide details on our operating results, cash flow, and also comment on guidance.
Rob?.
Thank you, Ted.
As I typically do, I will cover the following topics during this portion of the call, an overview of our 2017 third quarter results, along with an overview of related key operating statistics, I’ll also provide an overview of our cash flow activities during the quarter, and I’ll conclude with a discussion on our financial outlook for the fourth quarter of 2017.
For purposes of this call, any references to The Hackett Group will specifically exclude SAP Solutions. Correspondingly, I will comment separately regarding the financial results of The Hackett Group, SAP Solutions, and the total company.
Please note that all references to gross revenues in my discussion represent revenues, including reimbursable expenses, and any references to net revenues, represents revenues excluding reimbursable expenses.
Additionally, references to pro forma results, specifically exclude non-cash stock compensation expense, intangible asset amortization expense, acquisition-related cash and stock compensation expense, and related transaction expenses and restructuring charges, and assumes a normalized long-term cash tax rate of 30%.
As Ted mentioned, for the third quarter of 2017, our net revenue or gross revenue excluding reimbursement expenses decreased by 1% to $65.9 million when compared to prior year and was at the high end of the guidance range provided.
The actual Q3 reimbursable expense ratio on net revenues, came in at 8.4% versus the 8% that we used in our gross revenue guidance. Reimbursable expenses are project travel and related expense pass through to client with no margin associated with them.
This resulted in total Company gross revenue of $71.5 million which represents a year-over-year decrease of 4%. Net revenues for the Hackett Group which excludes SAP Solutions was $56.1 million in the third quarter of 2017, a decline of less than 1% on a year-over-year basis. Hackett U.S.
net revenues were down by 7% as revenue declined in our EEA group as a result of the transition from on-premise software which were partially offset by our rapidly grown revenues, attributable to cloud based implementation services. This decline in U.S. revenues was offset by strong international growth of 36% led primarily by Europe.
Hackett Group annualized net revenue per professional was $297,000 in the third quarter of 2017 as compared to $321,000 in the third quarter of the prior year and $316,000 in the previous quarter.
It is important to note that in previous years, we reported annualized revenue per professional based on gross revenue, which included a growth of approximately 11% for reimbursable expenses. However, given the impact of the acquisitions on reimbursement expenses, we moved to reporting this statistic on a net revenue basis in Q2.
The reason for the decline is primarily due to lower revenue per professional related to our recent acquisitions. Additionally, our target cloud implementation model unitizes a much higher percentage of offsite resources, which will drive lower revenue per professional but at higher margins.
Net revenue from our SAP Solutions Group, which consists of our SAP reseller, implementation and application managed service groups, or AMS, totaled $9.8 million in the third quarter of 2017, a decrease of 6% on a year-over-year basis.
Total Company international net revenues accounted for 19% of total Company revenues in the third quarter as compared to 13% in the third quarter of 2016.
Our recurring revenues, which include our executive and best practice advisory as well as our AMS groups accounted for approximately 20% of our total Company net revenues and 27% of our total Company pretax practice profitability, in the third quarter of 2017.
Total Company pro forma cost of sales, excluding reimbursable expenses, stock compensation expense, and acquisition-related cash and stock compensation expense, totaled $39.8 million or 60.4% of net revenues in the third quarter of 2017 as compared to $40.6 million or 60.8% of net revenues in the previous year.
Total Company consultant headcount was 1,022 at the end of the third quarter as compared to 1,002 in the previous quarter and 942 at the end of the third quarter of 2016.
The year-over-year increase is primarily due to the acquisitions closed in the second quarter of 2017, partially offset by the rationalization of resources, resulting from the migration from on-premise software to cloud-based resource requirements.
Total Company pro forma gross margin was 39.6% of net revenues in the third quarter as compared to 39.2% in the third quarter of the previous year. Hackett Group pro forma gross margins on net revenues was 39.7% in the third quarter as compared to 39.1% in the third quarter of the previous year.
SAP Solutions pro forma gross margins on net revenues was 39.3% in the third quarter, as compared to 39.6% in the previous year. Pro forma SG&A was $14.2 million or 21.5% of net revenues in the third quarter of 2017 as compared to $14.7 million or 21.9% of net revenues in the previous year.
Pro forma EBITDA in the third quarter of 2017 was $12.5 million or 19% of net revenues as compared to $12.1 million or 18.2% of net revenues in the third quarter of 2016, an increase of 3%.
Total Company pro forma net income for the third quarter of 2017 totaled $8.2 million or $0.26 per diluted share, which as Ted mentioned, was at the high-end of our third quarter’s guidance. This compares to pro forma net income of $8 million or $0.25 per diluted share in the third quarter of 2016.
These results represent an increase of 3% and 4% on a year-over-year basis for pro forma net income and earnings per share respectively.
Total Company pro forma net income for the third quarter of 2017 excludes non-cash stock compensation expense of $2 million, acquisition-related stock compensation expense of $794,000, acquisition-related cash compensation expense of $619,000, intangible asset amortization expense of $557,000, and acquisition-related transaction costs of $111,000.
Pro forma results also assumed a long-term cash tax rate of 30% or $3.5 million. Acquisition-related cash and stock compensation expense relate to the portion of the purchase consideration for acquisitions that contain service vesting requirements and as such, are reflected as compensation expense under Generally Accepted Accounting Principles.
GAAP diluted earnings per share was $0.17 for both the third quarter of 2017 as well as the third quarter of 2016. The Company’s cash balances were $16.2 million at the end of the third quarter of 2017 as compared to $14.4 million at the end of the previous quarter.
This cash increase in the third quarter was generated from net income adjusted for non-cash items and net borrowings under our revolving line of credit offset by the payment of semi-annual dividends, repurchases of common stock and capital expenditures.
Net cash provided by operating activities in the third quarter of 2017 was $10 million, which was primarily driven by net income adjusted for non-cash items, amounting to $9.1 million as well as increases in accrued expenses partially offset by increases in accounts receivable.
Our DSO, or days sales outstanding, at the end of the third quarter of 2017 was 71 days as compared to 61 days at the end of the previous quarter. This increase was primarily due to the impact of acquisitions completed in the second quarter of 2017.
We fully expect DSO to come back down over next two quarters as we migrate the acquired companies to our billing processes and procedures. During the quarter, the Company paid $4.6 million for its semi-annual dividend. Additionally, we purchased 250,000 shares of the Company stock at a total cost of $3.5 million or an average cost of $14.21 per share.
During the quarter, the Company borrowed a net $2 million from our credit facility. The balance of the Company’s total debt outstanding at the end of the third quarter of 2017 is $22 million. I will now turn to our guidance for the fourth quarter, but before I do, I would like to remind everyone of the seasonality of our business.
Specifically, the increased holiday and vacation time that as historically taken the fourth quarter would decrease our available billing days by approximately 8% when compared to the third quarter. We will continue to use a lower estimate of reimbursable expenses, which will unfavorably impact year-over-year revenue compressions by approximately 3%.
The decrease in reimbursable expenses is primarily driven by lower expense ratios, resulting from the recent acquisitions and the increase in IP as a Service revenues, growth, which historically drive much lower levels of reimbursable expenses.
As such, the Company estimates total net revenues for the fourth quarter of 2017 to be in the range of $61.5 million to $63.5 million, slightly up from the previous year at the high end of the guidance range. Gross revenue will be in the range of $66.5 million to $68.5 million.
This gross revenue outlook includes an estimated 8% for reimbursable expenses. Relative to pro forma diluted earnings per share, we expect the unfavorable impact of decreased available billing days to be partially offset by the corresponding utilization of vacation accruals and lower U.S. payroll taxes, resulting from reaching U.S. FICO limits.
As such, we expect our pro forma diluted earnings per share in the fourth quarter of 2017 to be in the range of $0.25 to $0.27. The high end of this range will represent a year-over-year increase in pro forma EPS of 4%.
Our pro forma guidance excludes amortization expense, total non-cash stock compensation expense, acquisition-related cash and stock compensation expenses, acquisition-related transaction costs, restructuring costs and includes a long-term cash tax rate of 30%.
Sequentially, we expect the pro forma gross margins on net revenues to be approximately 42% to 43% in the fourth quarter. We expect pro forma SG&A and interest expense for the fourth quarter to be approximately $14.7 million. We expect fourth quarter pro forma EBITDA on net revenues to be in the range of approximately 19% to 21%.
We expect cash generated from operations to be up on a sequential basis consistent with earnings. At this point, I would like to turn it back over to Ted to review our market outlook and strategic priorities for the coming months..
Thank you, Rob. As we look forward, let me reiterate our thoughts on the transitioning demand environment and more importantly on the high growth opportunities which are emerging.
As I’ve been saying for quite a while now, the rapid development and move to cloud applications and infrastructure along with improving analytics, mobile functionality and enhanced user experienced being introduced into the marketplace by technology providers is dramatically influenced in the way the businesses compete and deliver their services.
This will disrupt entire industries at an accelerated pace, forcing organizations to fundamentally change and adopt these new capabilities in order to remain competitive. The speed of change will only be limited by the ability of technology providers to deliver the required functionality and performance.
But regardless of these limitations, the mere threat and promise will lead to significant enterprise transformation opportunities, and we believe this will be generational.
This will redefine for additional sequential and linear-based business modeled and activities to fully network and dynamic automated workflows and events with enhanced analytics that will ultimately deliver on much anticipated predictive analytics as well as artificial intelligence expectations.
This so called digital transformation era is very attractive to our organizations since we believe clients will increasingly turn to us to provide them with best practice insight on what technology can deliver and what changes in business models work and justify significant investments and transformational change.
Specific to Europe, we expect our revenues to continue to be up strongly. Europe has benefited from improved market conditions as well as from our EPM investments and our recent BPO and RPA advisory acquisition.
We believe we have taken the necessary actions to both optimize current year performance and more importantly, be strongly positioned for the emerging digital transformation opportunities as we look forward.
To reap the benefits of our investments as we finish 2017 and head into and 2018, specifically, we have redefined benchmarking with our recently launched Quantum Leap benchmarking and continuous improvement Software as Service solution. We have already seen several clients commit o multiyear assessments due to the new solutions offering.
It’s been both more dollars as well as the multiyear commitment. We are developing and launching our digital transformation platform to further differentiate our unique IP and capabilities across all of our offerings. It helps differentiate our advisory transformation, cloud implementation and analytic offerings.
Our ability to fully digitized our IP and align proven technology and organizational solutions that help clients drive transformational change, allows us to highly differentiate our offering.
We’re also leveraging the digital transformation platform to expand and attract new alliance partners that can leverage our unique benchmarking and best practices IP to help them differentiate and sell their software or service solutions which will allow us to further expand our IP as a service solutions.
You have seen the success that we have had with ADP, and with its software offering, we believe we will see similar solutions in the future.
We have also successfully now grown and further expanded our Hackett Institute training and certification offerings that will allow us to expand and use our IP to serve our clients in new and powerful ways to grow our business.
Our long-term strategy is to continue to build our brand by building new offerings and capabilities around our fully digitized and unmatched benchmarking and best practices intellectual capital, and use this to serve clients strategically and whenever possible continuously.
At the end of the quarter, our executive and best practice advisory members totaled 1,070 across 327 clients. These numbers exclude the new clients that we’ve been adding to our new ADP and CGSB IP as a Service alliances. We’ve expanded our ADP offerings and recently launched the ADP Workforce Now platform.
These new programs will expand our opportunities with ADP in 2017 and do so more significantly in 2018. We’ve also launched the Hackett Institute and acquired our partner’s interest in the CGBS training and certification program.
As a result, we will fully transition the programs to state of the art learning platform system, which we believe will better align -- will be better aligned to our client demands. At the end of the quarter, we have over 175 clients piloting one of our training and certification programs.
We also have launched our enterprise analytics training and certification program, given the unique nature of our best practice content and the recognized value we have experienced with our CGBS offering, we now believe that continuing education provides a significant growth opportunity for our organization.
Lastly, even though we believe that we have the client base and offerings to grow our business, we continue to look for acquisitions and alliances that strategically leverage our IP at scope, scale or capability which can accelerate our growth.
In summary, we reported solid results while aggressively transitioning our offerings to focus on the rapidly growing cloud applications and digital transformation opportunities.
More importantly, we believe the investments we are making in our digital transformation platform, our expanded cloud application capabilities and our RPA expanded capabilities as well as our IP as a service offerings and alliances will allow us to continue to drive sustainable structural growth.
As always, let me close by thanking our associates for their tireless efforts, and as always urge them to stay highly focused on our clients, our people, and the opportunities available to our organization. Those conclude my comments. Let me now turn it back over to the operator, and ask us to commence the Q&A.
Operator?.
[Operator Instructions] Our first question comes from the line of Morris Ajzenman with Griffin Securities. Your line is open..
You’ve given clarity over the past year, as you transitioned from on-premise to cloud-based platform and you’ve been very, very clear about how that has played out and will play out. In the guidance for Q4, it will be the third straight quarter year-over-year where revenues will be down.
I know you don’t like looking out beyond one quarter’s guidance, but can you give us any sort of thoughts on when the year-over-year decline on a quarterly basis will end, how that plays out beyond Q4 as best as you can?.
Well, first of all, as you know, there are two pieces. One is the decrease in the EPM on-premise revenue and how we offset that with the cloud implementation revenue.
I would say that in the quarter, both -- the on-premise EPM software accelerated a little bit more than we thought and our cloud revenues also accelerated, its growth accelerated at a higher pace than we thought, but it came in exactly as we thought.
We expect the cloud implementation revenue to continue to accelerate since as you know, we would only -- this is only sixth months since the close of our Oracle cloud implementation of capability.
And we believe we have made tremendous strides in both influencing the way we go to market with the organization as well as making sure that the Oracle channel understands both our expanded capabilities and then the unique capabilities that Hackett brings with the digital transformation platform.
So, no, we continue to believe that -- and I think I’ve been saying this throughout the year, we believe that 2017 would be a year where if we thought we could be flat to up on earnings and continue to generate strong cash flows, while migrating our capabilities from the on-prem to the cloud opportunities that we should see our growth accelerate into 2018 into its more traditional long-term growth range that we’ve always had.
So, but, basically said, we expect the acceleration of cloud implementation revenues to outpace EPM declines as each quarter plays out and we expect to see -- I’ll call it, that crossover line to happen sometime in early 2018..
Thank you.
Just as the comment, give us the rational SAP on net basis down year-over-year 6%; what’s happening there and how does it look going to Q4 and beyond?.
Nothing meaningful. As you go back and look at it historical, that group has quite a bit of volatility, partly because that has a value added reseller business which influences the quarter and then it drives some kind of spotty starts and stops.
But if you look at it on a year-over-year basis, SAP for the year is going to be probably flat to slightly up when we look at Q4.
So, no, we think it is a transitioning to the cloud implementation opportunities within that SAP group and it still has a very strong, both implementation and AMS capability that we expect should grow with the long-term prospects of the company in 2018?.
Last question, and I’ll get back in queue. Hackett Institute, you’ve now bought out that portion of CIMA.
My question there is, you’ve formed these relationships, these affiliates, so that you can maximize growth about having to I guess put yourself as an operator but here you are going to the flip side where now you will be an operator by now I guess owning and offering CIMA.
Please help me understand why that would work better than just working in the partnership format?.
Well, the big, big difference is our go to market versus them was very different. They were an organization that focused on individual training and certification kind of relationships.
And as you know, we believe that the way you rapidly grow this program is by using a B2C channel, going to our existing clients, demonstrating -- first, leveraging the fact that they believe we have unique IP and information that they currently use, drive that into training into solutions and certification solutions and becoming part of the clients’ annual professional development programs and getting a portion of those very meaningful budgets.
In order to do that, we needed to respond, as we got from feedback from clients, we needed to respond to some very specific and demanding client needs. But with it comes sizeable student populations.
And we believe that by understanding those clients so well as we do and now having a couple of years under our belt and learning how to develop and support these professional development solutions and leveraging a state of the art that we’ve moved to or aggressively moving to right now that we will able to support the client opportunities, sell the programs more aggressively, and will be very honest with you.
As the scales, we love the idea of keeping the profitability opportunity to ourselves and that having to share it with some.
So, since we were driving -- since we were contributing IP and since we were driving the majority of those sales through our client channels, we believe that taking on the additional operating responsibility by acquiring and leveraging a learning management system that we -- impacts at the cloud-based system that could easily support the things we were trying to do, was well worth the risk..
Thank you. [Operator Instructions] Our next question comes from the line of Frank Atkins with SunTrust. Your line is open..
I wanted to ask about, European results were very strong.
Can you give us a little bit more color in terms of either functional area or industry vertical that’s contributing to some of that strength outside the U.S.?.
Well, first, the number that Rob quoted, which was 36%, that also benefited from the Aecus acquisition but the organic growth was in excess of 20%.
But, if you look at it -- if look at where we’re seeing, as I said on our call, the investments that we made in the EPM area over the last three years, continues to drive a significant part of that growth.
But, we believe that the acquisition that we have will allow us to accelerate the growth in some of the transformation work we do for large GBS and shared service centers that will also give us an opportunity to grow, RPA-related opportunities and BPO advisory opportunities.
So, we know and believe that the market is healthier relative when we see overall activity, but we also believe we’re benefiting from the investments in prior years and the recent investment in the acquisition..
And could you comment a little bit on the pricing environment in the U.S.
as well as outside U.S.?.
I would say, the pricing environment remains stable.
I think the biggest transition for us for example that goes with the cloud implementation capabilities is as you know or as I think I’ve commented in previous calls, the implementation of cloud software versus on-prem, which comes with obviously without the customization that on-prem comes, allows us to deliver capabilities offsite, the proportion of offsite and therefore offshore resources.
The proportion of each changes pretty significantly. So, pricing on those resource is also stable as well. The blend is different and the margin is higher. But pricing overall, stable..
Thank you. Our next question comes from the line of George Sutton with Craig-Hallum. Your line is now open..
It’s Jason on for George. Ted, can you talk a little bit about the ERP opportunity? We haven’t covered that a whole lot.
Just wondering your progress in that environment and really what you are seeing in the market?.
Well, we still stand by the fact that we’ve expanded our capabilities for four-fold by expanding our capabilities beyond EPM and aggressively migrating to cloud. So, we believe that the size of the technology group that we are able to build will be four times as largest the one that we are basically migrating from.
So, overall, the ERP opportunities are absolutely core and the bedrock of the Oracle cloud application. We are seeing meaningful opportunities in that space.
We’re also seeing that the size of the opportunities since we’re now pursuing opportunities across the entire Oracle suite instead of just EPM are also significantly larger than the ones that we previously pursued. So, overall, we think the opportunity for us to -- it’s painful to have your -- to wean yourself up off something that was so successful.
But, when we look at the fact that we are moving to a four-fold opportunity in a market that was previously growing single digits to one that Oracle is still growing ex-acquisitions in the mid-to-high-20s, we think that bodes very well for our growth prospects. And just it’s just kind of tide to a previous question.
And we’re eager, right to have that cloud implementation line, the new implementation outgrow any of the on-prem decline that we have experienced throughout the year. And e believe that we will see that in early 2018, as I previously commented..
And just one more, if you can maybe walk through the IP opportunity. So, I know you talked a little bit about the CIMA acquisition and last quarter we talked about [Workplace Now].
But if you can give any other updates on the progress and other channels?.
Well, probably the best way to answer that question is just to spend a little bit more time talking about the digital transformation platform that we have been developing and just recently demoed at Oracle OpenWorld.
So, we have now -- since we have expanded our footprint in Oracle from EPM to the entire suite, we have fully digitized our content across the entire enterprise. And we’re aligning that for both, transformation opportunities that we would do -- that would not include a software provider.
And in Oracle’s case, we have been building that platform to allow it to tie our best practice and organizational decision frameworks to Oracle functionality. So, by -- think of it as follows. It’s been -- it will be two years ago in December I think when we originally launched the ADP opportunity.
And we used that very small and narrow HCM opportunity to kind of demonstrate to potential alliance partners how we could align IP to a software or a service to demonstrate how to help differentiate that capability.
By now, digitizing our entire enterprise IP in order to align with the enterprise opportunities of Oracle software, it allows us to demonstrate the capability of our IP across a broader set of opportunities.
So, we believe that by doing that in order to differentiate the way we to go to market with Oracle and to demonstrate that unique capability there, we are going to be able to demonstrate and show other potential alliance partners or solution providers how our IP can be aligned to any service or software solution to differentiate and help them sell their product.
We believe that that investment will give us increased opportunities across, as I mentioned with software and service solutions providers, and we expect to see additional alliances emerge in 2018..
Thank you. Our next question comes from the line of Jeff Martin with Roth Capital Partners. Your line is now open..
Ted, I was wondering if you could help us get a sense of the growth rate, either on a sequentially basis might be more relevant and on a year-over-year basis, of the cloud business? And then, in addition to that, what kind of progress you’ve had in the quarter in terms of working with integrators? Obviously, the award is a big step, but some detail around kind of the progress you’re making is also very helpful.
.
I think probably the best way to comment is to say that we started 2016 with virtually zero cloud capabilities, implementation capability and revenues. And first on the EPM business, the business that we had previously owned, we now just won the EPM cloud partner of the year award.
That means -- in order to do that that means that we’ve been rapidly growing that capability both -- the year-on-year numbers are, as Rob would say, not reasonable to mention but even sequentially, they are very significant increases.
How significant? Well, significant enough that if we’re correct, in early 2018, our cloud implementation revenues will exceed the legacy on-prem revenues. So, one for us was to exceed the decline in that revenue; the other one is to simply exceed the revenues in total.
So, we would expect -- we expect the growth of that cloud implementation revenue to probably exceed that decline sometime here as we exit the year and we would expect -- again, I’ll go back, we would expect the number in early 2018 cloud revenues to exceed our legacy EPM on-prem revenues in early 2018.
So, we don’t want to quote those numbers, because that’s getting down to a level of detail. But, the reason our revenues staying flat is because we are doing two things. We are transitioning our EPM on-prem revenues aggressively and we are helping our recent acquisition do that as well with their ERP revenues, Oracle ERP revenues.
And so, in effect, we’re transitioning two businesses. The only difference is that the ERP on-prem revenues of the acquired company are more stable because to take out any operating system is much harder than to simply migrate off a EPM kind of solutions which allows the client to use EPM as an area where they can try cloud.
Therefore the migration from on-prem to cloud and EPM has been much quicker than in other areas and therefore, much quicker than we thought in the year.
But overall, as we kind of pointed it out when we did the acquisition and developed our plans and reported the second quarter, we continue to believe that cloud revenues will outpace on-prem -- EPM on-prem revenues sometime in the latter part of this year as we exit 2017 and that we cross over sometime in early 2018..
I recall on last quarter’s call, you mentioned in terms of getting back to a 5% growth rate next year, is that still your expectation on a revenue basis?.
Yes, it is..
What kind of earnings leverage do you believe you can generate….
Well, the earnings leverage, if the -- remember, it’s a combination of a few things.
But, if our IP as a Service revenues continue grow and we are somewhere in that 5% to 10% range, pick any number, pick the low end or the middle range, we believe that that creates a 12.5%, if we are at the low end to 25% if we are at high end of our 5% to 10% revenue growth rate in 2018..
Okay. And I think that the bulk of that would come in the back half of the year in 2018….
We would expect to increase as the year goes on because several things happen.
One, the decrease in the on-prem business will decrease, so you will -- since we are working off a much smaller number as we start the year in 2018 versus 2017 and our cloud revenues we expect to accelerate and the IP as a Service revenues we also expect them to accelerate..
And then, in terms of….
That assumes - -I’m sorry. That would assume just Europe growing within the same range, not having to outgrow the U.S. business, sometime, let’s just say by the time we get to middle of 2018..
Okay. And then, in terms of your cash flow. I mean, you should be generating more cash next year than you’re this year, I would assume. What are your priorities for use of cash, is it to pay down debt, is it acquisitions, is it continue with the dividend and keep buying back the stock? Some help there would be useful..
All of the above. But, you know we prioritize it as -- we expect to continue to pay the dividend and to increase it with the expected cash flow changes for that subsequent year. We would love to find strategic accretive acquisitions, but as you know, easier said than done. And lastly, we will continue to buy back stock opportunistically as we see.
And when we’re not doing any of those things, we love to aggressively pay down debt, you’d seen us do that a couple of times..
Thank you. Our next question comes from the line of Vincent Colicchio with Barrington Research. Your line is open..
Ted, is there any change in your expectations as far as IP as a Service revenue growth for next year?.
It’s pretty significant right now. So, I guess the answer is no. The answer is, do I think that the opportunities to expand the current expectations exist, yes. But have I changed the expectations which are pretty meaningful just with what we’ve got in place? No..
And then, top-five and top-ten clients went down quite a bit year-over-year.
Could you give us some color on that?.
I really have not reviewed that in detail. I don’t see Rob here jumping to response to the question. So, I will go back and try to -- and give you that when we catch up for you, hopefully tomorrow. But generally, there has been no change in the way we’re serving clients. We normally have some large clients initiating projects, other changing.
Probably the most meaningful thing that I can say is something I said several quarters ago that continues to happen, the overwhelming majority of the revenues comes from clients that are using our IP or benchmarking and advisory offerings and expand that into consulting relationship.
But, as you know, we work with hundreds of companies, leading global 2,000 companies a year. And those that materialize into that top-10 category, migrate from -- I mean differ from time to time as clients are in some -- just initiating or just completing projects..
And then, was the increase in -- this is for Rob.
Was the increase in DSO was a surprise or was that expected and bringing that into a more normal level via simpler process?.
No. The growth of the 10 days surprised me somewhat. I expected to be up and I didn’t expect it to be up that much. But, we will work very strongly to make sure that comes down in Q4 and beyond..
We knew we have structural part of it that came with the acquisition but the number itself came and larger. So, as Rob said, we want to see it back down at historically levels very quickly..
Our target, as I said, over the next two quarters will -- we will make sure, get it back to the mid 60s on a minimum..
One last question, Rob.
What was capital spending in the quarter?.
About $1.9 million..
Thanks guys, that’s it for me. Good quarter..
By the way, Vince, just so you know, since that is a large number for us, we generally spend somewhere between $3 million to $3.5 million in CapEx annually on a historical basis.
But, as you can imagine, the amount of build-out that we are doing across the Quantum Leap, digital transformation offering are just monumental, but we believe the investments will pay off very strongly..
Thank you. I’m showing no further questions in queue at this time. I would now like to turn the conference back over to Mr. Fernandez for closing remarks..
Thank you, operator. Let me again thank everyone for joining us on our third quarter earnings call. We look forward to updating everyone again when we report the fourth quarter results and the results for the year, sometime in mid-February. Thanks again for participating..
Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Everyone, have a great day..