CRA International Inc (CRAI) 2004 Q3 法說會逐字稿

Good day, and welcome, everyone to the Charles River Associates third-quarter fiscal 2004 conference call. Today's call is being recorded. A replay of today's call will be available beginning at 2 PM Eastern time today and will run through Wednesday, October 6th, at midnight. The rebroadcast dial-in number is 719-457-0820, and you'll be asked for the confirmation code, which is 844077. Again, that number is 719-457-0820 with a confirmation code of 844077. 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 the site for those you who did not receive it by e-mail or fax.

With us today are 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, Chris. 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, September 30, 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, the integration of InteCap 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.

Thanks, Phil. CRA reported strong top and bottom results in the third quarter, driven by robust performance in several of our practice areas, particularly finance, pharmaceuticals, and Energy & Environment, as well as a full quarter of InteCap revenue. In addition, continued strong demand for our services enabled us to maintain utilization rates at the second-quarter level of 81 percent.

For the quarter, revenue increased 50 percent to $74.2 million from $49.4 million in Q3 of fiscal 2003. Organic revenue growth, that is, revenue growth excluding revenue attributable to InteCap and reimbursables, was approximately 15 percent. Third-quarter revenue includes roughly $17 million attributable to InteCap offices, slightly ahead of expectations.

Looking at the bottom line, third-quarter net income was up 58 percent year-over-year to $5.4 million, or 52 cents per diluted share, compared with $3.4 million or 34 cents in Q3 of last year. CRA's finance process continues to perform strongly, with revenue growing well over 50 percent year-over-year and about 20 percent sequentially on a normalized quarter basis in Q3 over Q2. The finance process growth is attributable to increased demand for our services and general securities litigation, alleged accounting malpractice, and general finance-based litigation. And as you can tell by the level of growth in finance all year, year-over-year growth for the first three quarters was almost 50 percent. We continue to be the beneficiaries of this changing marketplace. We expect this market to continue to grow in the coming quarters as Sarbanes-Oxley becomes a more integral part of the way companies do business in the United States and the standards for financial reporting become more exacting.

Because of the timing of specific projects, revenue from our competition practice decreased modestly, approximately 5 percent from Q3 of last year. However, the practice was up over 10 percent on a year-to-date basis compared to the same period last year. The competition practice continues to work in a wide variety of engagements. For example, during the quarter, CRA Vice President James Mellsop recently provided expert testimony in a dispute between two lead processing companies in New Zealand. The dispute involves a claim of anti-competitive conduct against CRA's client, AFSCO (ph) New Zealand Ltd. On the basis of James' testimony, the court rejected the claim and AFSCO was successful in all aspects of the case.

The European Commission has issued a statement of objections, finding that Visa has acted not anti-competitively, and seeking to exclude Morgan's Stanley Dean Whitter from acting as a merchant acquirer for Visa credit cards in Europe. CRA continues to advise Morgan Stanley Dean Whitter on this matter.

Senior consultant and CRA board member, professor Carl Shapiro of Berkeley will testify on behalf of the FTC in a significant litigation matter that has important implications for gasoline prices in California and potentially for gasoline prices nationwide. Energy company, Unocal, asserts that it has patents covering most covering most gasoline sold in California. The FTC is challenging Unocal's rights to assert those patents on antitrust ground. The FTC versus Unocal trial is scheduled to start October 19th.

Our business consulting processes group revenue increased almost 20 percent year-over-year, driven by strengthen in Energy & Environment, pharmaceuticals and aerospace and defense. Q3 revenue in the Energy & Environment practice increased almost 50 percent year-over-year, and over 25 percent sequentially on a normalized basis. CRA continues to work in several large and complex bankruptcy-related cases for energy companies. These cases include analysis of the electricity and gas markets and contract and regulatory disputes. Clients include Enron, Morant (ph), and National Energy & Gas Transmission Inc. These engagements are likely to generate revenue well in the seven figures this fiscal year, and we anticipate the work to continue into the fiscal year '05.

On our Q2 call, we announced a large electricity project with Ireland's electricity supply board. We completed a major piece of work on Ireland's electricity market in the third quarter of 2003, and had expected the project to continue into FY 2005. As of right now, the government has suspended its consideration of new regulatory structures and the work on the project is stopped. However, we are continuing work with ESPNG (ph) in Ireland, and are pursuing further opportunities in that arena. The work in other areas of the Energy & Environment practice remains robust, and we expect expanded work in a number of areas, especially work related to the Federal Energy Regulatory Commission's various rule makings and proceedings with regard to composite electricity markets.

Revenue from the chemicals and petroleum practice declined modestly from the prior year. Safety and security issues in Saudi Arabia resulted in suspending work for a major energy corporation in the region. We do, however, anticipate renewed work as the securities situation improves in the region.

In the third quarter, we continued to work on major corporate restructuring programs in the specialty chemicals sector. We also performed a variety of major performance improvement initiatives for major oil and gas producers. For example, for a large specialty chemical company that was facing eroding prices, increased production costs, and commoditization of parts of its product portfolio, CRA identified and implemented a cost reduction strategy that aligned with its overall business strategy and yielded sustainable benefits. We performed a detailed profitability analysis at the customer product and client level. We identified new asset options and helped the client choose the best one. Then we developed a detailed implementation plan and loaded (ph) the restructuring effort, working with the client's transition teams and monitoring performance.

In the area of performance improvement, we led a process to improve the operational effectiveness fairly maintenance supply chain activities of a major integrated oil company. This involved a deep analysis of their global spending, a resegmentation of their spending based on like economic characteristics, and a development of cost reduction priorities. We developed a road map with $100 million in savings targeted on approximately $2 billion in spending.

As we mentioned last quarter, within our CMP practice, we are encouraged by improving business prospects and utilization rates outside of the Middle East region, and believe that revenue from clients in North America and Europe will continue to grow.

Pharmaceutical, aerospace and defense and transportation revenue all grew on a yearly-over-year basis, reflecting deepening relations with existing and selected new clients and continuing growing client needs within those industries.

Looking at our business for a geographic perspective, revenue recorded by our non-U.S. subsidiaries represented 10 percent of total revenue in Q3, compared with 12 percent in Q2 of fiscal '04 and 14 percent in Q3 of fiscal '03. The addition of InteCap with a largely domestic presence lowered the percentages of international revenue by about 3 percentage points in Q3 and 1 percentage point in Q2. We are actively evaluating opportunities to strengthen our presence and boost revenues overseas. In particular, we are continuing to invest in our client relationships and recruiting complementary staff to build our brand and help accelerate our growth, as well as seeking select acquisitions that can leverage our existing London resources to pursue opportunities in the UK and continental Europe.

Turning to NeuCo, our neural network software subsidiary posted Q3 revenue of about $1.4 million, including approximately $400,000 from the Department of Energy contract compared with 1.5 million in Q3 of '03 and 1.8 million in Q2 of this year, which it included $300,000 from the DOA contract. As we had previously stated, we expect NeuCo revenues to grow over time, but with near-term volatility, which was the case in the third quarter. While we're disappointed with NeuCo's revenue in Q3, demands remain high for technology solutions that enable electric power generators to improve efficiency and reduce emissions.

On the head count front, we made progress toward our full-year growth initiative, adding 19 consultants in Q3. We continue to expect head count by the end of FY 2004 to be at least 10 percent above FY '03 year end levels, in addition to acquisition-related growth.

Of particular note on the recruiting front in this quarter, we hired Tom Blake, an expert in corporate finance valuation and damages estimation, and is joined as a CRA vice president within the firm's finance practice. Tom comes to CRA from Ernst & Young, where his 33 years of experience, included 24 as a partner. For the past 14 years, he was managing partner of Ian (ph) Wise New England investigative and dispute services practice, and also led the firm's securities, mergers and acquisitions and bankruptcy litigation practices.

Also during the quarter, we brought on board Samir F. Barakat as a senior consultant to the firm's Energy & Environment practice. Sam's expertise is in litigation economics, valuation studies, regulatory policy and pricing, and strategic planning and he has worked extensively for electric utilities, other energy companies, and solid waste firms. Sam comes to CRA having previously worked as a vice president for consumers (ph) for customer strategies at PG&E Energy Services.

Turning to InteCap, performance was strong in Q3, our first complete quarter with InteCap as part of CRA. Revenue was at a run rate of slightly more than about $1 million per week, as expected. I should also point out that in accordance with InteCap to start a practice, billing rates for InteCap consultants were increased in July, although the full-rate increase was not effective immediately for our clients. We expect to see the full impact of the rate increase in Q4. The integration of InteCap continues smoothly, and we continue consolidating office locations. Integration of our financial, HR, and IT systems and infrastructure has been completed. The staff members of the two companies have begun to blend together and are already working together on a number of projects, including new engagements in transfer pricing, commercial damages, and intellectual property disputes and strategy. As a result of this continuing integration, we may not be able to separately identify InteCap revenue after this fiscal year. With that, I'll now turn the call over to Phil, who will discuss the financials in more detail. Phil.

Thanks, Jim. As always, for those of you who are not familiar with CRA, I'd like to start my comments by reminding you that CRA's fiscal year operates on 13 four-week cycles and produces quarters unequal in length. Q3 is a 16-week quarter, while Q1, Q2, and Q4 typically are 12 weeks each. When we describe some Q3 results as normalized, we have prorated the results from the actual 16-week Q3 quarter to represent a 12-week quarter.

Turning to the financial results, as Jim said, Q3 revenue increased 50.2 percent to $74.2 million. Of that amount, InteCap contributed $17.3 million to CRA's Q3 revenue. We are sharing this information this quarter to give investors some insight into a full quarter's contribution of InteCap as part of CRA. But going forward, especially next year, we do not expect to break out InteCap's performance as its staff becomes more deeply integrated into the overall Company and projects are not as clearly delineated.

Third-quarter gross margin for all of CRA was 38.6 percent, a 60 basis-point decrease from the 39.2 percent in Q3 of fiscal 2003, and a 320 basis-point sequential decline from the 41.8 percent in Q2 of this year. As I will elaborate later, the lower gross margin in Q3 is more than offset by a decrease and SG&A expense as a percentage of revenue. Totally reimbursable expense was $10.6 million for Q3 2004 or 14.2 percent of revenue compared with $7.5 million or 15.1 percent of revenue for Q3 2003, and $6.4 million or 13.9 percent of revenue in Q2 of 2004.

Total consultant utilization in Q3 was 81 percent, consistent with the 81 percent reported in Q2 of fiscal 2004, and a dramatic increase from the 72 percent reported in the comparable period of fiscal 2003. We are particularly pleased with our ability to maintain utilization at the Q2 level, especially since it's better than 80 percent, despite the normal seasonal drop we might experience in Q3. Our finance practice is firing on all cylinders, and we have been steadily allocating staff to the practices data-intensive projects while still keeping utilization strong. InteCap's staff also achieved a high utilization rate in Q3. Based on our Q3 performance, we now expect full-year fiscal 2004 utilization to be at 78 to 80 percent, above the 76 to 78 percent target range that we had indicated earlier.

SG&A expense for the third quarter was $17.2 million, or 23.2 percent of total revenue, compared with $13.3 million or 27 percent of revenue in Q3 of fiscal 2003, and $12.3 million, or 27 percent of revenue in Q2 of fiscal 2004. The year-over-year and sequential improvements in SG&A are the result of lower performance payments to outside consultants compared with prior periods, as well as CRA's continued success in carefully managing its operating expenses. In addition, virtually all of InteCap's revenue is sourced by full-time employees. The bonuses related to this are accrued in cost of services. In contrast, in legacy CRA, 20 to 30 percent of revenue is sourced by non-employee consultants. Performance payments to these consultants are included in SG&A. As a result, other things being equal, the merged entity will have a tendency for both lower gross margin and lower SG&A expense ratios.

Third-quarter operating income increased 89.1 percent to $11.4 million compared with $6 million in Q3 of fiscal 2003. Operating margin was 15.4 percent compared with 12.2 percent in the third quarter of fiscal 2003, and 14.8 percent in the second quarter of this year. As many of you know, we have been driving to increase our operating margins to 15 percent or better. We are quite pleased that in this quarter and last, we have been operating in this neighborhood, and would hope to be able to sustain operating margins at this level or better.

I'd now like to make a few comments about our tax rate. You'll notice in our news release that CRA's effective tax rate for the third quarter was 51.5 percent and 47 percent year-to-date, up from 43 percent last year and in our two earlier quarters this year. The change in our tax rate for the quarter is due to operating losses which we are in incurring in some of our international subsidiaries, primarily in the UK. The extra 4.5 half percentage points in this quarter's effective tax rate over the total-year expected rate of 47 percent, generated an increase in taxes for Q3 of almost $500,000. As we mentioned earlier, our UK business consulting operation is dependent in part upon the chemicals and petroleum consulting engagements originating in the Middle East. Because of the continued instability in the region, we have been unable to capitalize on work that's there, and as a result, have incurred operating losses that we are unable to deduct against U.S. profit. We are taking steps to diversify the revenue base in London, which as Jim said, includes targeting rainmaker consultants and select acquisitions that will accelerate our growth and allow us to apply some currently underutilized assets.

During the quarter, we incurred a foreign exchange loss of about $200,000 versus a gain of about $300,000 for Q2. Year-to-date, we have incurred a net loss of about $200,000. The swings in the currency movement are largely due to movement between U.S. dollars and pounds sterling. As mentioned in the Q2 call, we have begun to manage our foreign exchange exposure more actively through frequent setting of intercompany account balances and by self-hedging our foreign dollar position.

Net income grew 58 percent year-over-year to $5.4 million or 52 cents per diluted share from $3.4 million or 34 cents per diluted share in Q3 of fiscal 2003. EPS in Q3 was calculated using 10.4 million weighted average diluted shares outstanding, compared with 10 million shares outstanding in Q3 of fiscal 2003. If not for the higher tax rate in Q3, net income and EPS would have been considerably higher in the quarter.

Professional headcount stood at 498 at the end of Q3. This compares with 479 at the end of Q2. Our current junior-to-senior staff breakdown is 173 junior consultants and 325 senior consultants. We continue to expect net headcount additions by the end of fiscal 2004 of at least 10 percent over fiscal 2003 year-end levels, apart from acquisition-related growth, and we have some hiring initiatives that may push this figure even higher.

Looking at the balance sheet, billed and unbilled receivables remain consistent on a sequential basis at $70.5 million. Current liabilities are up to $46.9 million at the end of Q3 compared to 39.8 million at the end of Q2, due primarily to timing of bonus payments.

Total DSOs, days sales outstanding, were 101 days in Q3, consistent with Q2. This consists of 34 days of unbilled and 67 days of billed in Q3 compared with 43 days of unbilled and 58 days of billed in the sequential second quarter. We continue to target DSOs in the 95 to 100-day range, but are pleased that we have been able to bring down the unbilled component of DSOs from 43 to 34, because that is the component that is more under our management control.

Cash and equivalents and long-term investments stood at approximately $63 million at the end of Q3, up from about $26 million at the end of Q2, reflecting our convertible bond issuance, which I will be discussing in greater detail later. Depreciation and amortization expense was $1.8 million, following our acquisition of InteCap. We had preliminarily booked $6.5 million in amortizable intangibles. This past quarter, we engaged an outside appraiser to determine the appropriate level of amortization and goodwill. Our Q3 results reflect lower amortizable intangibles for InteCap, in line with the recommendations of the independent appraisal. InteCap also had approximately $17 million of net deferred tax assets that were fully reserved at the time of the acquisition. If we determine that the reserve on these tax assets is not needed, the allocation of the purchase price will be adjusted in the future. CRA has not completed the evaluation and allocation of the purchase rights associated with these assets.

Turning briefly to our results for the first three quarters of fiscal 2004, total revenue was $158.4 million, up 27.3 percent from $124.4 million in the same period of fiscal 2003. Operating income in the first three quarters of fiscal 2004 of $23.1 million was 59.3 percent higher than the 14.5 million reported in the comparable period in fiscal 2003. Net income increased 42 percent to $12 million from a 8.4 million. EPS totaled $1.13 compared with 88 cents a year earlier. EPS in the first three quarters of fiscal 2004 was calculated using 10.6 million shares outstanding compared with 9.6 million shares outstanding for the first three quarters of fiscal 2003, a diluted share count increase of greater than 10 percent.

Before turning the call back to Jim, I'd like to mention some aspects of our contingent convertible debt offering. CRA completed a $90 million convertible bond offering in Q3. $75 million of the bonds were sold on June 21st and on June -- July -- 1st, an additional 15 million were sold pursuant to the full exercise of the over allotment option or greenshoe. The bond is a 30-year bond and has a coupon of 2.875 percent. Although we may be required to pay contingent interest after 7 years if certain conditions are met, we may be able to realize a corresponding tax and cash flow benefit in the meantime. The bonds have a 7-year, no call, no put provision and have a conversion price of $40 per share. The bonds may be converted only if certain contingencies are met, for example, when CRA's stock exceeds $50 per share for a specified period of time. CRA used the $90 million proceeds for a $20 million share repurchase, a pay down of the nearly $40 million revolving credit line we have with Citizen's Bank, and after paying financing fees this left approximately $27 million for general corporate purposes, including potential future acquisitions.

Turning to the accounting aspects of this, at its early July meeting, the Emerging Issues Task Force, that is EITF, of the Financial Accounting Standards Board, or FASB, reached a tentative conclusion that the contingently issuable shares guidance in Statement 128 does not apply to convertible debt. As a result, the dilutive effect of contingently convertible debt should be included in the calculation of diluted earnings per share immediately upon issuance of the instrument, generally using the so-called if-converted method. However, the EITF's proposed accounting treatment does not affect our ability to use the treasury method of accounting because it is CRA's policy and intent to settle the par value in cash, which would generate a much less dilutive impact on earnings per share. To enable this, we had structured the bond debenture so that we can unilaterally amend it to commit contractually or hardwire the settlement of the par value of the bond debenture with cash.

The current state of the accounting treatment of contingent convertible bonds is not yet entirely clear. And in fact, there was an EITF webcast on the subject earlier this morning. Still, as previously stated, CRA qualifies for the treasury stock method of accounting, in which there will be no share dilution until its stock price exceeds $40 per share because we have the flexibility I've mentioned to elect on a timely basis to hardwire cash settlement of the par value of the bonds. Indeed, there is also an outside possibility that CRA will not have to report dilution, and even then, only to the extent that shares are in the money, until our share price exceeds the higher so-called cocoa trigger price, our $50 contingent conversion price, which CRA's share price must exceed for a specified period of time before a bondholder could actually request conversion. In addition, there remains a further possibility that FASB may conclude that issuers will still be able to retain the treasury method of accounting even without electing to hardwire the cash settlement provision.

CRA is keeping its options open to make the hardwire election. Pending final FASB conclusions on the accounting treatment, consistent with current accounting standards, we report today our third-quarter financials without any dilutive share count impact from the issuance of convertible bonds. Jim.

Thanks, Phil. Just to recap, overall, we believe in our excellent Q3 performance as we've talked to the benefits of our strategy of growing both organically and through acquisitions. We recorded organic revenue of about 15 percent, while at the same time management resources were focused on the integration of InteCap. The integration of InteCap continues nearly seamlessly, and is extremely encouraging from the perspective of pursuing additional acquisitions. Operating margins in the quarter were strong as we continue to manage our costs effectively. Our net income growth is substantial despite the higher federal (ph) tax rate. I mentioned last quarter that we believed Q2 was a turning point for CRA and our Q3 results validate that statement.

Based on our performance in Q3, we are once again raising our full-year fiscal 2004 guidance. We now expect the full-year fiscal 2004 revenue growth will be in the range of 30 to 35 percent, up from our previous guidance of 25 to 30 percent over fiscal 2003. Our new expectation reflects a forecast of continued strength in both our legacy CRA practices and InteCap, as well as an anticipated full-year utilization rate of 78 to 80 percent. We are increasing our expected annual growth in income from operations from the 35 to 40 percent range to 40 to 50 percent. As a result, we now anticipate that annual earnings per diluted share will increase in the 30 to 35 percent range, up from our previous EPS guidance of 20 to 25 percent over fiscal 2003. With that, I will ask the operator to open the call for questions. Chris.

Thank you, sir. (Operator Instructions). We'll take today's first question from Matt Litfin with William Blair & Co.

Hello. Congratulations on a strong quarter, obviously. Question on the full-year guidance, which I guess you could now boil down to fourth-quarter guidance. Just a little clarification -- what is the tax rate that you're assuming going forward? We've obviously seen some movement there.

47 percent.

So 47 percent in the fourth and then also, as you move forward, you would expect that to be kind of the Company's general tax rate?

Yes and no. The yes part is it's certainly our expectation for the fourth-quarter at this time. We have -- we are in the process, however, of engaging outside consultants to help us work out a transfer pricing policy for the Company, which we hope will reduce the so-called trapped losses problem reducing our effective tax rate next -- certainly for next year.

Okay. Question on NeuCo as well. You know, what are you assuming there in terms of either revenue contribution or maybe even profitability as you move forward? And maybe you could give a little qualitative discussion of pipeline there.

As we move forward, we do anticipate that we will see continued growth. And we are assuming for planning purposes, it will be roughly breakeven, simply because NeuCo is continuing to reinvest as it grows. So, I don't have a precise growth number for you, but we do -- we do anticipate that we will continue to see growth similar to what we've seen in recent two or three years, but basically a breakeven basis.

Okay.

In terms of qualitatively, activity in NeuCo has been very strong. They were quite busy during the quarter in terms of new clients coming in and installing their product. So NeuCo is, from a underlying business point of view and with the momentum, is in actually fairly strong shape in spite of the fact that the quarter results were a little bit disappointing.

Got it. A final question if I could. You saw a little seasonality in the legacy CRA consultant utilization rate, as you'd indicated last quarter. Have you seen that pick back up in September toward the high 70s toward 80 percent? I'm talking excluding InteCap here.

The experience to date has been more or less consistent with what we saw in Q3, but I would caution that you can't really extrapolate much from a couple of weeks, which is all the information we have.

Okay. Thanks again.

Jim Janesky, Ryan Beck.

Yes, thank you. Going back to Matt's question on the tax rate, Phil, if you assume -- and Jim commented that, you know, the business in Europe and the Middle East, you expect the pipeline to be better and for it to get better, so wouldn't you assume that the tax rate would go back to 43 percent once the losses turn into profits in Europe?

Yes, I would, when it happens.

Right, when it happens. So you're obviously still expecting losses in the November quarter, right?

Yes.

Okay, great. Thanks for clearing that up. Thanks. When you look at utilization again, Jim, where do you think that starts to comps out, and, you know, either a level that you couldn't go higher or that you would feel uncomfortable with running at?

Well, I guess as I've said before, we have operated in the past fairly consistently in the 85 to 90 percent range, but the mix of business today is a little bit different than it has been historically going back 5 or 10 years. So I think we're still looking at mid-80s as a reasonable run rate that we would like to get to.

Okay. And, you know, you had talked about in the past how, you know, the Sarbanes Act just has created additional litigation type of work, etc. But do you expect that once the act, you know, companies are expected to comply by the end of 2004, once that's in place and, you know, some companies are found to have material deficiencies in their accounting systems and processes, do you think that that could spur, you know, additional work for you, and when will we start to realize that type of work?

Well, if those events happen, I think, and it's likely that some of them would lead to shareholder suits (ph) and that will eventually lead to more business for us. So the line (ph) for that kind of stuff is really in the years. The more immediate effect of Sarbanes-Oxley on us is that there is a diversion of work going on away from accounting firms towards non-audit firms like us in the litigation area. Sarbanes-Oxley has resulted in clients generally not wanting to use their own audit firms for non-audit consulting work. The accounting firms are major providers of litigation services, and -- but there definitely is a trend for that to move away from the accounting firms.

Okay. And, you know, I know you've been hiring some people from those firms. Are you finding that you are having to "pay up" for them, or are they coming with pretty reasonable compensation expectations?

No, we're not out there paying ransoms to get people, if that's what you are applying. I think we're bringing people on at pretty much what our cost structure is in line with our compensation arrangements.

Okay.

Yes, Jim, we essentially represent a excellent opportunity for people to continue their career growth. You know, as there are high conflict ratios and Sarbanes-Oxley related limitations within the accounting firms.

Okay, good. Thank you.

(Operator Instructions). We'll go next to Brett Manderfeld with Piper Jaffrey.

Good morning, guys. My congratulations as well. I guess kind of digging a little bit further on the UK operations, just hopeful that you can give us a little more meat on the bones related to stemming (ph) the losses there. I think you mentioned diversify away from some of the things that you're doing right now in the Middle East. Can you dig in a little bit deeper there, please?

Well, a couple of things are going on. One is that we do believe we will be able to send some people back to Saudi Arabia in the fourth quarter. We do actually have backlog there that we haven't been able to work off. We have some clients that have deposits that we could continue to get work from if we had some teams on the ground. We're being pretty cautious. Obviously, we're not going to ask anybody to go against their will; it would be strictly voluntary. But we do have plans afloat to start scaling back up. And that should start helping us immediately in the fourth quarter, although since we're already several weeks into the quarter, we won't get a full quarter's benefit of that.

Secondly, we've had a very active direct business development campaign with some of the big major international companies we deal with, primarily in chemicals and petroleum. We do have good client relationships with some of the household (indiscernible) industry, and we're working on deepening those connections and getting more business. And there's been some progress on that front.

Finally, we are actively recruiting. We have some senior individuals that are fairly advanced in the pipe -- recruiting pipeline. We are considering small acquisitions. So we're looking at a variety of ways of keeping up the operations and moving forward. We do have a beachhead in Brussels, and that's actually doing quite well, so we expect that that will continue to contribute also.

Okay. That's a great explanation. And related to that utilization, if you can't comment on hard numbers, maybe anecdotally, what the utilization looks like there relative to U.S. operations?

It's definitely lower. That's what's causing the problem. I don't have a number to give you, but. Their utilization in the foreign offices in general has been lower than the U.S. operations; it's just a different mix of business. But utilization there has been lower than our plan.

Okay. And switching gears, in terms of hiring expectations, you know, obviously, just a few months away from your next fiscal year. Would you expect to kind of continue the trend here that you've seen or will expect looking into the fourth quarter? I think you mentioned about 10 percent increase; but almost all of that, I believe, is coming here in the last quarter, in the fourth quarter. Would that, you know, kind of 20 percent for a full year be a number that we should target, looking out to next year?

We haven't really -- we're in the middle of our business planning for next year, so we're -- it's a little premature to be setting targets. But the baseline target we would like to see over the firm long-term would be at least 10 percent head count growth on average year-to-year. Obviously, we're going to try to do above that. And those are the kinds of -- we're trying to be in that range or higher for the planning process for next year.

We're also doing what we can to make the hiring more smooth over the course of the year. But the difficulty there is the entry-level hiring tends to be summer or late summer because of the school year effects. So there's a good percentage of our staff that's going to be bunched in August/September no matter what. So some of the growth will be back-end loaded.

Okay, so that's seasonal?

Right.

Brett, let me add a little bit to that. As we mentioned, we expect to exceed 10 percent for year-over-year in '04 over '03, and while we've gone to 19 in Q3, you know, we expect to bring it up to a number that's -- that gets that in Q4. Again, because of the seasonal effect, I wouldn't double that growth rate and apply that to the whole year. But we are looking to add a considerable number of people next year. And, you know, we're talking about a number in excess of 60 consultants.

Just to elaborate a bit, we have our normal planning process, where we try to build in a built-in momentum of 10 percent or more headcount per year. In addition, hiring seems to happen in spurts on top of that because when we bring in one or several senior individuals in the business area, that allotment generates some hires after that as they develop business or as they need people to do the business they have. So the historical pattern is that we plan for 10 percent or more in terms of business as usual, and then there eventually may happen during the course of the year, might lead to spurts above that.

Okay, great. And final question, Phil, I think you did a nice job of kind of explaining the changing mix in expenses related to InteCap. Should we expect kind of similar types of margins, you know, between kinds of services and SG&A going forward, given now that InteCap is fully integrated? Thanks.

Brett, the answer is yes. I think we are directionally correct. In other words, I believe that gross margins will be down somewhat of the kinds of movements we observed in Q3 from what we've seen in the past. At the same time, it will be more than offset by a reduction in SG&A expense ratios, so that our overall operating margin, hopefully, will be in the range that we're targeting, which is 15 percent or better.

Okay, great. Thank you, guys.

We will take our next question from Don Lacovon (ph) with Adams Harkness and Hill.

I'm sitting here for Sandy. I've got a couple of questions -- some have been answered. On the reimbursable expenses front, is that a trend that's going to continue? It's up on a dollar basis, slightly down on a percent basis. How much of that is from InteCap in what is the trend that you expect going forward?

I think Q3 -- as you've observed in the past, there is almost random volatility within a narrow band. I really would not be able to offer you a forecast of either increase or decrease at this time. You know, it depends upon the specific mix of projects. And so I would -- if I were preparing my own -- your own forecast for this, I'd basically not offer any trends or expect any trends plus or minus.

Okay. And then as far as turnover, what have you been seeing as far as turnover at the senior level versus junior level?

Turnover continues to be very low, other than for the junior level, where they're basically on a 3-year program in many cases.

Okay. Any notable departures from the InteCap group?

No.

No, I'm not aware of any.

Okay. And then, could you give a little color on the bill rate -- if you saw an increase, what was it? And also what you expect on the future?

We haven't -- doing our -- gone through our processes of bill rates for next year. The normal cycle for that is bill rates being changed effective December 1st. There was an InteCap billing rate increase in July, so for that part of our business, there may not be much of an increase in December.

Okay.

Compared with last quarter -- you know, with prior quarters, the CRA legacy bill rate is of the order -- effective billing rate -- is of the order of, you know, $325 per hour. InteCap is less than that, but again, that doesn't show the effect of, you know, merging our sort of billing systems and also, the bill rate increase that went into effect there on July 1st, and which hasn't permeated most accounts yet.

Okay. And one final question for now. Utilization in the business consulting area versus litigation?

We typically don't provide, you know, a sort of segment analysis. But as Jim had said, the litigation consulting, which is more like CRA 10 years ago, runs in normal times at a much higher utilization rate than the business consulting. Business consulting has to market; they also have to -- and generally bill in terms of 8-hour days, whereas when we're on a litigation project, 12-hour days are not unusual, and often we're retained on the very first phone call from a law firm or general counsel to access the work on a case. But I'd say if the firm's average is of the order of say 80, 81 percent, we'd expect business consulting in steady-state to be of the order of 70 percent and the litigation consulting practices to be of the order of 85 percent. And because litigation is now about three-quarters of CRA, the 85 times the three-quarter weight brings the weighted average up to the neighborhood of 80, 81.

Okay. Got you. All right, great. Thanks, guys.

Next, we will take a follow-up question from Matt Litfin with William Blair & Co.

Hi. A couple of clean-up questions. One is, what was the cash from operations in the quarter?

Cash from operations was about $10.4 million. CapEx was about a little over $2 million, so to quote the non-GAAP free cash flow figure, about $8 million in the quarter, which is actually higher than the year-to-date number because there are certain payments that are -- cash payments -- that are very large in the early quarters of the year, such as bonuses and so on.

Okay. And one more if I might. Looking at and thinking about modeling share count, now that you have this convertible debt outstanding, and I'm trying to take a conservative view of it and thought I'd run something by you and get your comments, given the sort of complicated and changing picture. Assuming that the, well the November 30 year-end period, your fourth quarter, would not land you under the proposed new rules, and assuming that the rules are changed and so, therefore, dilution begins at, when the stock hits $40 a share, at about say half a percent for every dollar per share above that, -- are we supposed to sort of make our own assessment of where the stock price is going to be and therefore add say, if you say mid-40s stock price, maybe 2 or 300,000 shares to the early-year share count, and just sort of incorporate that now? Or how would you recommend that those of us in our shoes model this out?

I mean, one answer is, Matt, is you're the security analyst, and I'm not. But you have it right. At $1 above the $40 conversion price, that's about 55,000 shares addition per $1 over the $40. So you know, my assumption would be that you need to predict the stock price and then calculate the extra shares and then adjust your EPS. But as you pointed out in your question, it's about a half percent per share price, and it's a half percent for each $1 of share price over $40, and, you know, if -- I can't predict share price.

I wouldn't ask you to do that. But I just wanted to make sure that the parameters that I was laying down were at least on the conservative side and within reason, so -- (multiple speakers) --

Yes, Matt you're right on point with that. You've got the metric correct.

Okay. Thanks and congratulations again.

Thank you.

This does conclude the question-and-answer session of today's conference. At this time, I'd like to turn the call back over to Mr. Burrows.

Thanks, everyone. We look forward to speaking with you the next quarter, and this concludes today's call.

Thanks.

Once again, this does conclude today's conference call. We thank you for your participation. You may now disconnect.