CRA International Inc (CRAI) 2004 Q2 法說會逐字稿

Good day and welcome, everyone, to the Charles River Associates second quarter fiscal 2004 conference call. Today's call is being recorded. A replay of the call will be available beginning at 2 p.m. eastern time today and will run through Wednesday, June 16th, at midnight. The rebroadcast dial in number is 719-457-0820 and you will be asked for the confirmation code which is 254273. Again, that number is 719-457-0820 with a confirmation code of 254273. You may also listen to the webcast on CRA's website located at www.CRAI.com. In addition, today's news release is posted on this site for those of you who did not receive it by e-mail or fax. With us today is CRA's President and Chief Executive Officer, Mr. James Burrows and Executive Vice President and Chief Financial Officer Mr. Phil Cooper. At this time, for opening remarks, I would like to turn the call over to Mr. Cooper. Please go ahead, sir.

Thank you, Jennifer. Statements in this conference call concerning the future business, operating results and financial condition of the company, are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements are based upon management's current expectations as of today, June 10, 2004, and are subject to a number of factors and uncertainties.

Information contained in these forward-looking statements is inherently uncertain and actual performance and results may differ materially due to many important factors. Such factors that could cause actual results to differ materially from any forward-looking statements made by the company, include, among others, dependence upon key personnel, attracting and retaining qualified consultants, dependence upon outside experts, intense competition and professional liability. Further information on potential factors that could affect the company's financial results is included in recent filings with the SEC. Jim?

Thank you, Phil. CRA's strong second quarter performance reflects year-over-year growth in nearly all of our litigation and business consulting practices. For the quarter revenue increased 13.5% to 45.7 million from 40.2 million in the second quarter of fiscal 2003. Q2 revenue includes approximately $2 million in revenue from our recently completed InteCap acquisition. Not including InteCap and reimburseables, revenues increased from 33.6 million to 37.6 million, an increase of 11.8%. In addition to being the 25th consecutive quarter of year-over-year revenue growth, Q2 also had the second highest level of quarterly revenue in CRA's history despite being only a 12-week quarter.

Second quarter net income was $4 million, up 42.7% year-over- year and EPS was 38 cents, including approximately one cent from InteCap, compared with 30 cents in Q2 of last year. Our finance and competition practices continue to drive CRA's performance. Revenues of the finance practice increased 16% from Q2 of '03. As in the past several quarters strength in our finance practice in Q2 was based on demand for our services in general securities accounting malpractice and finance-based litigation. We expect this trend to continue, particularly in view of the more difficult operating and regulatory environment related to Sarbanes-Oxley and related issues and other trends in the business environment. Revenues from the competition practice increased about 25% from Q2 of '03. Our competition practice continues to be fueled by general corporate litigation.

As I've noted in the past we cannot disclose most of our cases. However, it is public knowledge that CRA is helping IBM and its counsel, Cravath Swaine & Moore, that defend monopolization claims brought by Compuware, the leading producer of software tools for IBM's mainframe computers. We're also engaged in a number of merger cases, for example we're assisting Skadden Arps in obtaining anti-trust clearance for United Health Group's $4.7 billion acquisition of Oxford Health Plans. Turning to the performance of our other practices, Q2 revenues in the energy and environment practice increased 29% sequentially from Q1, but decreased slightly year-over-year as a result of a delay in revenue recognition of about $650,000 associated with a single large project. Without this delay energy and environment revenues would have increased from Q2 of 2003. CRA started a large electricity project in Q2 with Ireland's Electric Supply Board. This work is to functionalize and operationalize a market for electricity in the Republic of Ireland, delivering both the market rules and related documentation, as well as assistance requirement.

CRA expects this work will continue into calendar 2005 and may well generate revenues well into the millions of dollars if it continues the rates that are currently contemplated. CRA continues to work in several large and complex bankruptcy cases for energy companies. These cases includes analysis of the gas and electricity markets. Examples include Enron, Morant(ph) and National Energy and Gas Transmission Incorporated. Each of these engagements may generate revenues of more than $1 billion this fiscal year and each is likely to continue into fiscal year '05. The chemicals and petroleum practice grew 17% quarter-over-quarter and about 4% from Q2 fiscal 2003. Middle East revenues increased over 40% from Q1and returned to levels of about 5% below Q2 of '03, before the full impact of the Iraq War were felt.

Revenues outside of the Middle East grew about 10% from Q1and about 6% from Q2 of '03, representing a continuation of the strengthening of our strategic positioning in global non-Middle East oil and gas multi-nationals and chemicals and electric utilities. We remain encouraged by improving business prospects and continue utilization rates in the other regions in which the practice operates. We continue to believe the revenues from clients in North America and Europe will continue to grow and will offset any revenue losses from the Middle East should the military conflicts and terrorist activities increase in the future. Pharmaceutical practice revenues grew sequentially in Q2 and posted average sequential growth of 30% per quarter for the past year. This growth is based on continued work in our core areas of pharmaceutical pricing and a number of high profile pharmaceutical and medical device litigation matters concerning patent infringement and generic entry.

Collectively revenues from the small transportation and aerospace and defense practices were up from Q2 of '03. Revenues from our metals practice doubled from Q1 of '04 but were significantly off in Q2 of 2003 when the practice was engaged in a large restructuring for a multi-national corporation. Looking at our business from a geographic perspective, international revenue represented 12% of total revenue in Q2 compared with 11% in Q1 of fiscal 2004 and 15% in Q2 of fiscal 2003. These figures do not include about 2% of total revenues from overseas clients that are recorded as US revenues in our accounts. We expect revenues of the international offices to increase over the next year. NeuCo posted Q2 revenue of about $1.8 million including approximately $300,000 from the Department of Energy contract.

NeuCo revenue in Q2 of fiscal 2003, which did not include any daily revenues, was $943,000. We continue to expect that NeuCo's revenues will continue for the next several quarters at rates similar to the first half average and that NeuCo will operate in the black although I caution that NeuCo's revenues may continue to be more volatile then CRA's core consulting revenues. On the headcount front we continue to hire opportunistically to strengthen our head consultant base in Q2, adding oil and gas specialist Panos Cavoulacos and pharmaceuticals business strategy expert Mason Tenaglia to our roster. Total consultant headcount, excluding InteCap, was essentially flat from Q1. Q2 tends to be a quarter in which staff returning to graduate school begin to leave whereas Q3 tends to be a quarter in which newly hired entry level staff begin to arrive.

Turning to CRA's recent acquisition of InteCap, as we stated on the first quarter call, InteCap gives CRA an immediate leadership position in intellectual property and commercial damages consulting. It also provides us with a local presence in Chicago and New York, the two largest major markets in which we did not have an office prior to the acquisition. The acquisition closed on April 30 and our integration teams have been working diligently to insure a smooth transition for InteCap's staff and clients to the CRA culture. I'm happy to report that the integration is proceeding smoothly and on schedule. With InteCap we have added 129 consultants and we've had multiple client referrals both from CRA to InteCap and visa versa.

We have worked on multiple joint marketing (inaudible), as well, including a transfer price case where our joint team was retained and we are currently bidding on two IP strategy opportunities and one transportation opportunity. We've held our first joint marketing event and continue to develop a go-to-market strategy that will highlight the expanded scope of opportunities at CRA and InteCap together can provide to our clients. With that I will now turn the call over to Phil who will discuss the financials in more detail. Phil?

Thanks, Jim. As always for those of you not familiar with CRA, I would like to start my comments by reminding you that CRA's fiscal year operates on 13 four-week cycles producing quarters unequal in length. Q1, Q2 and Q4 typically are 12 weeks each, while Q3 is a 16-week quarter. Turning to the financial results. As Jim said, Q2 revenue increased 13.5% to 45.7 million from 40.2 million in Q2 of fiscal '03. Q2 revenue includes about $2 million in InteCap revenue. Organic growth of revenue net of reimbursable and InteCap was close to 12%. Second quarter gross margin was 41.8%, it's 460 basis point increase from the 37.2% in Q2 of fiscal 2003 and a 120 basis point sequential decline from 43% in Q1 of this year. The year-over-year increase was due to higher utilization and lower reimbursable expenses. The sequential decline was primarily due to higher reimbursable expenses and compensation which offset improved consult utilization. Total reimburseable expenses were 6.4 million for Q2 '04 or 13.9% of revenues compared with 5 million or 13.1% of revenues for Q1 '04 and 6.6 million or 16.5% of revenues in Q2 of '03. Total consult utilization in Q2 was 81%, up substantially from 74% in Q1 of fiscal '04 and 73.5% for the comparable period of fiscal '03. Excluding InteCap staff for the last two weeks of the quarter, utilization was 80%. We have not seen utilization at the 80% level since 1999, a clear indication of the strong demand we are experiencing right now. The increase reflects not only growth in nearly all of our practices, but also CRA's judicious approach to hiring. Based on our Q2 performance we now expect full year fiscal '04 utilization to be at 76 to 78%, above the 74 to 76 target range that we had indicated earlier. SG&A expense for the second quarter was 12.3 million or 27% of total revenue compared with 10.3 million or 25.7% of revenue in Q2 of fiscal '03 and 11.6 million or 30.2% of revenue in Q1 of fiscal '04. Second quarter SG&A expense includes approximately $200,000 in Sarbanes-Oxley section 404 compliance costs and a $550,000 write-off associated with moving CRA's Los Angeles office to Pasadena. In the long run we expect that the lower rent at the new Pasadena location will offset this write-off. Second quarter operating income increased 46.2% to $6.8 million compared with 4.6 million in Q2 of fiscal '03. Operating margin was 14.8% compared with 11.5% in the second quarter of fiscal '03 and 12.7% in the first quarter of this year, reflecting the improvement in utilization. Net income grew 42.7% year-over-year to 4 million or 38 cents per diluted share from 2.8 million or 30 cent per diluted share in Q2 of fiscal '03. Q2 fiscal '04 EPS includes approximately one cent from InteCap. EPS in Q2 fiscal '04 was calculated using 10.7 million weighted average diluted shares outstanding compared with 9.3 million shares outstanding in Q2 of fiscal '03, an increase in the fully diluted share count of more than 14%. During the quarter we recorded a foreign exchange benefit of approximately $330,000 related primarily to the strength of the dollar against pound Sterling. We have begun more actively managing our foreign exchange exposure through more frequent settling of intercompany account balances and by self-hedging our foreign dollar position. Professional headcounts stood at 477 at the end of Q2, including 129 professional staff who joined CRA from InteCap. This is up from 350 at the end of Q1. Our current junior to senior staff breakdown, including InteCap, is 164 junior consultants and 313 senior consultants. Of the 129 InteCap professionals we consider 83 as senior consultants and 46 as junior consultants in CRA's nomenclature. Legacy CRA net headcount declined by two professionals sequentially in Q2. For the full year we expect net headcount positions of approximately 10% over fiscal '03 year-end levels by the end of this fiscal '04, apart from acquisition-related growth. Looking at the balance sheet, billed and unbilled receivables increased sequential to $70.4 million at the end of Q2, from 51.9 million at the end of Q1. The increase primarily reflects the addition of InteCap's accounts receivable to our balance sheet. Current liabilities increased to 39.8 million at the end of Q2 from 37.3 million at the end of Q1, again, related to the InteCap acquisition. Total DSOs were 101 days in Q2 down from 108 in Q1reflecting the success we've had in escallating the billing of work-in-process and collecting the resulting receivables. This is down from 108 days at the end of the first quarter. This consists of 43 days of unbilled and 58 days of billed in Q2 compared with 45 days of unbilled and 63 days of billed in the sequential first quarter. With only two weeks to measure InteCap's average daily sales we have excluded their accounts receivable and sales in this calculation, although based on two small samples, directionally inclusion of InteCap results in the calculation would have lowered the DSO figure further. We continue to have a DSO target in the 95 to 100 day range. Cash equivalents and long-term investments stood at 26 million at the end of Q2 down from 65.9 million at the end of Q1, reflecting the InteCap acquisition. Turning briefly to our results for the first two quarters of fiscal '04, total revenue was 84.2 million up 12.2% from75 million in the first two quarters of fiscal '03. Operating income in the first two quarters of fiscal '04 of 11.7 million was 38% higher than the 8.5 million reported in the comparable period in fiscal '03. Net income increased 31.3% to 6.6 million from 5 million in the comparable period last year. Earnings per diluted share totaled 62 cents compared with 54 cents a year earlier. EPS in the first two quarters of fiscal '04 was calculated using 10.7 million shares outstanding compared with 9.3 million shares outstanding for the first two quarters of fiscal '03, an increase of 15.6%. Now, back to Jim.

Thanks, Phil. Our Q2 performance representing what we believe is a turning point for CRA. We achieved 81% consult utilization and 80% for legacy CRA staff, a level we haven't approached since 1999. We raised operating margin to 14.8% despite a sizable office lease write-off. We also completed the acquisition of InteCap bringing to CRA top-notch intellectual property and commercial damages consulting experts and expanding our U.S. footprint. Our finance practice continues to grow as does our competition practice. In addition our business consulting practices are benefiting from the uptick in the economy and they appear poised for additional growth in coming quarters. For the full year we now expect consult utilization to be in the range of 76 to 78% above our earlier target of 74 to 76%. Based on these factors and including the impact of InteCap, we now expect fiscal 2004 revenue growth to be in the high end of the 25 to 30% range and income from operations growth to be in the high end of the 35 to 40% range. We expect EPS for the year to grow between 20 and 25% year-over-year. With that I will ask the operator to open the call for questions. Operator? Jennifer, are you on?

Thank you, sir. Today's question and answer session will be conducted electronically. If you would like to signal for a question at this time, you may do so by pressing the star button followed by the digit one on your touchtone telephone. A reminder, if you are using a speakerphone today, please make sure your mute button is turned off to allow your signal to reach our equipment. Again that is star one on your touchtone telephone. We will pause for a moment to allow everyone a chance to signal. Our first question will come from Sandra Notardonato of Adams Harkness & Hill.

Hi, thank you. A couple of questions on Intecap. I know you said that directionally the DSOs would have improved even more with InteCap. What were the DSOs at InteCap or what do you expect them to be?

Hi, Sandy this is Phil. We hesitate to put a number given the sample, but it could drop another five or six days. On the other hand we're still learning about the quarter-to-quarter fluctuation in this kind of variable at their company versus our company. But right now we would have expected it to be more in the 95 day range.

Okay, great. So that could get you to your target a little bit faster than you would have been able to do on your own?

Yes.

Okay. Are there any client concentration issues or anything that we need to know about it at InteCap?

Their clientele is very diversified. Their largest client is probably Enron. I guess we are now working for the (inaudible) for Enron, I'll see what I can find for them. Outside of that, their clientele is quite diversified.

Is Enron more than 10% of revenue.

I believe it was for the trailing quarter or year.

It was for the trailing quarter and it was, I believe, in their last fiscal year.

Okay. And just the bill rates that InteCap is getting.

Their bill rates are of the order of about 15% less than ours. They are, however, out of sync with us and they will be, I believe, had planned a bill rate increase for July 1st of this year.

Do you know what percentage increase we could see in July of this year?

That's currently being worked on, but it will be at least as high as what CRA has been doing in recent years.

Right.

Okay.

So I would look for something north of 7%.

Okay. A couple of other questions. The 2 million in revenue that you saw, it sounds like it's for the month of May because the deal closed April 30th.

Actually, it's two weeks Sandy.

Two weeks of revenue. So should we be assuming that about 10 million of revenue will show up in August from InteCap?

In August?

In the August quarter?

Oh, in the August quarter.

Right.

Their revenues for their last fiscal year, I think, was a December fiscal year were --

On a pro forma basis, they were about $52 million. So you should be thinking that if $1 million a week would not be unexpected.

Okay. So what type of -- okay, that's fine. I will do the math and figure that out. My last question, the target senior to junior ratio that you're looking for in 2004, I'm trying to understand, of the 10% increase in headcount what types of people you will be hiring, more junior people or more senior people?

It's a mix.

Right now, I guess the ratio is about two, I guess one to two, one senior to two juniors. Is that where we should see it going forward?

Right now the ratio, I believe, is between three -- well, actually, in terms of officers. In terms of junior staff - .

I think you said 164 junior, 313 senior, so two senior to one junior?

Yeah that's about right.

Okay. And is that what we can expect for the year or do you anticipate that changing?

On an annual basis that's not bad but understand that a lot of our junior staff comes on in the summer quarter.

Uh huh.

I think that there will be some increase in that ratio in terms of the additions.

On the junior side?

Right now in terms of the known additions the ratio is a little bit higher junior to senior than the average going into the year.

Okay. So if I look at some historical quarters you were close to two and a half, three to one senior to junior. Is that the longer term target?

Yes.

Okay. All right, Great. I will let somebody else ask questions and then I will circle back. Thank you.

Our next question comes from Matt Litfin of William Blair & Company.

Well, good morning. Just start with a headcount question, and I think the total headcount came in a little bit lower than what I had modeled and you mentioned that you have a lot of people going back to graduate school and things like that on the junior consultant front. I guess, the main question I have there is what trends are you seeing, if any, in employee turnover and especially within the more senior consultant ranks.

There's very little turnover at the senior levels. At the junior levels many of the staff are on a two to three-year cycle where they're going back to graduate school and that's the same as it has always been.

Okay, that's helpful. Phil, what does the guidance that you guys have provided assume regarding this foreign exchange issue that's raised its head the last couple of quarters and you mentioned some of it is hedged. I'm interested in how much actually is hedged at this point.

Well, it's hard to exactly quantify it in terms of this day or this week, but let me answer it the following way. As you know we had a loss last quarter and $330,000 gain this quarter. If we hadn't hedged we would have had a higher gain. We started actively hedging in the last third of our second quarter and did not benefit from some of the increase in dollar against foreign currencies. In going forward and giving guidance, we essentially assumed neutrality with respect to foreign exchange gains and losses.

Okay. And related to that, can you give a little more color on what you are seeing demand-wise for your consulting services internationally, and maybe talk about Middle East versus Europe and contrast or compare the two?

Well, we think that the trends, actually, are positive in all the regions. We are focusing our marketing efforts out of the London office on Europe as opposed to the Middle East, but we are seeing an increasing trend in business in the Middle East as well.

Okay. And on a final question here, could you speak to the typical seasonality that you might expect in the August quarter and does InteCap change that in any way? And then what have you been seeing on the utilization front over the past three weeks since the end of the second quarter.

I don't believe we usually comment on the utilization on a weekly basis. As you know, it can fluctuate significantly as litigation projects begin and end. But let me assure you that the guidance that we give today is based upon all of the data available to us today. In terms of Q3, there are two factors that will affect the actual financial results that we will report. One is that it's a 16-week quarter versus a 12-week quarter. On the other hand it's summer and our vacation and use of fringed benefits is substantially higher during this quarter and we're able to observe going back in time that on an equal quarter basis, the first and third quarters, those two quarters are our weak quarters and the second and fourth quarters are our stronger quarters. I would also want to point out that we have a couple events going on that are actually Q3 events that will actually affect negatively what's happening in our business. We believe that we have lost revenues this week in DC. We haven't quantified it exactly, but based on assumptions that, let's say, over three days in D.C and the Democratic National Convention in Boston, where most of the arteries and the public transportation will be shut down for significant parts of four days, so assume that we'll lose some revenue over those four days plus the three days associated with President Reagan's funeral in DC that could cost us 2 cents that we might otherwise have in the third quarter of this fiscal year. Revenue, probably, of the order of 800 to $900,000.

Matt, I believe in the last call I said that Q3, other things equal, has about a 4 cent negative swing from norm because of holidays and vacations and the Q2 actually has about a 3 cent uptick. We haven't had enough experience with InteCap but I believe that they would have roughly the same swings. I suspect they take their vacations at more or less the same time our people take their vacations so that would have to be adjusted upwards for the proportional effect at InteCap. And then Q4 tends to have a 3 cent swing the other direction.

Okay.

So there is still a pronounced seasonality in the business which is not going to go away.

Right I assume all of this has been captured with your updated guidance in the press release.

Yes.

Yes that's correct.

Thank you very much.

Thank you, Matt.

And once again that is star one for any questions at this time. Our next question comes from James Janesky of Ryan Beck & Company.

Yes, good morning. Jim, this question has to do with Sarbanes-Oxley and it's pretty much a two-part question. The first is do you expect that after Sarbanes goes into effect officially in November, that there will be increased litigation driven from putting that into effect? And what time period would you expect that that would occur and where would the biggest growth potentially be for you from that act?

Our work on litigation tends to lie considerably when events happen. I'm sure that Sarbanes-Oxley will provide yet another reason for people to bring lawsuits. We would expect us to have a lag of a couple years before it shows up a lot in our business. That sector of our business is growing rapidly, anyway. So this is just another log on the fire that I think will continue the momentum in that area.

I would also add that we're not associated with doing the kind of work of, for example, installing section 404 controls in companies. We're not doing that kind of consulting work. Where we will benefit, really two areas. One is from the ultimate litigation, as Jim said, that will result from the higher bar that financial reporting will have to go over and the second aspect is that people from accounting firms, to some extent, are recognizing that there are serious impediments to their continuing some of their litigation support work within the framework of an accounting firm. So that we will continue to attract some staff and referrals from those areas.

Well, that was the second part of my question, when you look at your headcount growth estimates for 2004 have you worked into that equation at all the ability to hire individuals or a group from within the litigation practices at the big four?

Well, events like hiring groups come along from time to time and that's not in those numbers. This is just a normal recruiting and hiring activities that are reflected in those kinds of data. At any given time we have a lot of recruiting efforts going on. We can't always predict the exact timing of when those will come to fruition. We think given where we are in the year that the guidance we gave will be roughly right for this year but six months is a long time. So there's nothing to say that there wouldn't be some event sometime in that six months that could change that number.

Okay. That's very helpful. Thank you.

And we'll return to Sandra Notardonato for a followup.

Thanks. I just wanted clarification on Matt Litfin's question. The 4 cent swing you said that you see in August, that's separate from the 2 cent impact you're expecting from the Reagan funeral and the Democratic National Convention, is that right?

Yes.

That will be separate. I would say that the 2 cent swing in connection with those two events is somewhat unknown.

Sure.

We're just (inaudible) horseback guess on that because what's going to happen, it's going to be hard to get in and out of the Washington office for three days this week, this is one of those days, and then four days at the end of July it's going to be very difficult to get into and out of Boston. To the extent that staff takes those days as vacation days instead of days in August that may have no impact or if they work at home and still do the billings, it will have no impact, but on the other hand, my experience is that there will be some lost billings. So that will be on top of any normal seasonal impact.

Okay. Am I pushing to ask what type of revenue and earnings you expect to see for the August quarter? I know you gave the full year picture. Is there any way that we can get a little perspective on what the next quarter is going to look like?

Other than the directional discussion that we have about seasonals, Sandy, we would rather not get into quarterly guidance.

Okay. Okay. Let me ask a little differently then. Is the organic growth in August going to look like the organic growth we saw in May? Or do you think it's going to be down a little bit? Because of the summer seasonality?

Apart from the seasonality, I wouldn't expect to see much difference, however, we do expect and have identified net staff additions that will be arriving in the third quarter.

Mm-hmm

And we would presume that since most of those are at the junior ranks, we believe that they would become productive quickly.

Okay. All right, that's very helpful. Thank you.

And gentlemen, we have no further questions at this time. I would like to turn the call back over to Mr. Burrows for any additional or closing remarks.

Thank you, Jennifer, and thanks everyone for sitting in on the call. We look forward to speaking with you next quarter. This concludes today's call.

Thank you.

Once again that does conclude today's conference. You may disconnect at this time.