CRA International Inc (CRAI) 2005 Q3 法說會逐字稿

Good day and welcome to the CRA International third-quarter fiscal 2005 conference call. Today's call is being recorded. You may listen to the web-cast on CRA's website located at www.crai.com. In addition, today's news release is posted on the site for those of 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 Vice President and Chief Financial Officer, Mr. Wayne Mackie. At this time, for opening remarks, I would like to turn the call over to Mr. Mackie. Please go ahead, sir.

Thank you. These statements are based upon management's current expectations 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, changes in the Company's effective tax rate; share dilution from the Company's convertible debt offering; dependence on key personnel; attracting and retaining qualified consultants; dependence on outside experts; utilization rates; risks associated with acquisitions; risks inherent in the international operations; NeuCo's performance; changes in accounting standards, rules and regulations; potential loss of clients; dependence on growth of the Company's business consulting practice; the ability of the Company to integrate successfully new consultants into its practice; intense competition; and professional liability. Further information on these and other potential factors that could affect the Company's financial results is included in the Company's filings with the Securities and Exchange Commission. Jim?

Thanks. In Q3, we increased revenue 25% to $95 million compared with Q3 of last year. We achieved net income of $7.9 million, up approximately 47% from Q3 2004, and EPS increased to $0.66. The tax rate was 40.5% for the quarter compared to 44% for Q2. Organic growth, excluding acquisitions of reimbursable revenues, was about 13% for the quarter and about 33% year to date as a result of continued growth and demand for our core services, particularly our chemicals and petroleum and pharmaceutical practices.

Discuss with (technical difficulty) the improved operation are reflected in our international results in the third quarter. The acquisitions of Lee & Allen and the former Lexecon Limited business, both of which are headquartered in London, significantly expanded our overseas consulting capabilities. This contributed to the improved performance for our London office, which coincided with positive contributions from our other international locations. The improved international performance directly impacted our tax rate, resulting in an effective tax rate for the quarter of 40.5%, which lowers our year-to-date tax rate to approximately 43%.

Our utilization this quarter was 74%. Utilization was adversely affected by the summer vacation cycle, a 4% organic growth in headcount in Q2, integration activities in connection with our two recent acquisitions, one of which occurred just two weeks prior to the quarter, and the second about one month later, and a significant increase in the number of summer interns was (technical difficulty) sense of investment to support long (technical difficulty) recruiting.

Our litigation revenues grew approximately 27% over Q3 of last year. Revenues of the competition (technical difficulty) practice increased 69% on a year-to-year basis. Organic growth in this practice was 25%.

M&A work continues to be an important driver of the growth in the competition practice. The M&A component of the practice grew approximately 200% from Q3 2004 and accounted for nearly 12% of CRA's third-quarter revenues. This compares with approximately 5% of total revenues in Q3 2004. Some notable examples of our M&A assignments include the Sprint-Nextel merger, the P&G-Gillette merger and the $9.4 billion Harrah's and Caesars Entertainment merger, which created the world's largest casino gaming company. We also assisted Federated Department Stores with its $11 billion acquisition of the May Company.

Outside the United States, CRA has been working on a number of mergers, including the Sasol-Exel merger in the South African oil industry. Selective (technical difficulty) of our non-merger-related work in this practice were the following cases. In our (technical difficulty) work with Telstra Corporation to provide advice regarding the pricing of unbundled access to its last mile (ph) telecommunications network.

Also in (technical difficulty) staff and academic senior consultants have been engaged to provide economic analysis in connection with an antitrust matter currently at trial in federal court in Sydney, Australia. The matter involves a Seven Network allegation surrounding the (technical difficulty) channel C7 after C7's failure to obtain (technical difficulty) rights to Australian football and rugby in late 2000. The Australian subsidiary’s damage was approximately $1 billion Australian.

In the United States, CRA argued on behalf of the Scotts Company, which recently won a favorable verdict in its multiyear antitrust litigation against Aventis Environmental Health Science regarding Scotts' agreement to become Monsanto's exclusive sales and marketing agent for its consumer Roundup business.

In Europe, CRA was retained by AstraZeneca to undertake a detailed and critical analysis of market definition in the pharmaceutical sector and to assist AstraZeneca in its appeal against the European Commission's findings that the client abused its dominant position. In both these (technical difficulty) involved in a number of price-fixing matters in the chemicals industry.

On a year-to-date basis, revenues for the finance practice increased approximately 27%, but declined during the quarter by 25% from an unusually busy Q3 in the prior year as a result of timing issues we expect with some of our long-running cases. The volume of cases that the finance practice is working on has continued to grow both sequentially and year over year, and we continue to expect this practice to be an important driver of CRA's growth.

The flow of new business in the finance area remains strong. For example, CRA has an active pipeline of work relating to certain states investigating business practices within the insurance industry and to (technical difficulty) scrutiny (technical difficulty) fund industry, and we have been retained in several significant new cases in recent weeks.

During the third quarter, CRA was instrumental in helping obtain a favorable verdict for Thane International in a securities class-action case that actually went through a full trial, which happens only infrequently.

Revenues of our intellectual property practice increased slightly from an unusually busy quarter in the prior year. As an example, numerous active IP cases, we've been working with Boston Scientific for more than a year in connection with the damages phase of its litigation versus Johnson & Johnson company involving coronary stents. Both parties asserted patents against the other and both of them found they infringed the other patents.

Turning to business consulting, overall revenue increased approximately 18% in Q3. This growth was driven by our chemicals and petroleum and pharmaceuticals practices. The strong growth more than offset modest declines in other business consulting practices. Within our environment and energy practice, we benefited from ongoing work on several large mergers, as well as other sizable energy litigation and consulting engagements.

During the quarter, we continued our ongoing work on three large electric utility mergers -- Exelon and PSEG, Duke Energy and Cinergy, and MidAmerican and Pacific Corp. The energy practice also continued to act as long-running consulting engagements for Merant and Enron. In addition, we've been engaged by (technical difficulty) and Enron on proceedings related to the litigation that resulted from the California energy crisis. The practice continues working on various regulatory matters relating to ensuring competitive electricity markets and litigation.

An important development during the quarter was the signing in August 2005 of the Energy Policy Act of 2005. This act repealed the Public Utility Holding Company Act of 1935 and is expected to result in increased transaction action activity, including investments in the U.S. electric utility industry by non-utility buyers and foreign investors.

Revenues of the chemicals and petroleum practice increased by about 50% in Q3. Higher revenue for the Middle East accounted for nearly 70% of the rise in C&P revenues in Q3, and includes business strategy work in Saudi Arabia, Jordan and Kuwait. As we had (technical difficulty) call, we have been able to get our consultants back to work in the area and generate significant billings.

For example, we're working with a major oil company to develop a strategy for obtaining a viable long-term sustainable oil and gas resource position in the Middle East region. We're also working with the government of another Middle East country to develop a strategy for the encouragement of sustainable high employment in manufacturing sectors outside of the oil and petrochemicals industries.

Our experts are using their skills in strategy, economics, materials chemistry and industrial development to assist in allocating resources to prioritize job-creating economic activity.

In Europe, CRA has been working for the past (technical difficulty) for the International Air Transport Association on the European Commission's DG competition review of Regulation 1617, which governs tariff conferences that enable passengers to interline between airline networks.

Also in the year, CRA provided a range of services to one of the bidders for Tupras, which is a Turkish (technical difficulty) company that is being privatized. In the United Kingdom, CRA's London financial economics teams provided assistance (ph) in the prosecution of a company that was charged with criminal market abuse. Two directors of ASE Group were found guilty of recklessly making a misleading statement to the London Stock Exchange. CRA has demonstrated to the jury the market impact of four announcements made by directors. CRA believes that this case was the first of a number of prosecutions reflecting the UK Financial Services Authority's commitment to tackle (technical difficulty) abuses.

Our international assets performed well in the third quarter following steady growth in Q2. This resulted in a reduced effective tax rate as we reduced the impact of so-called (technical difficulty) overseas for which we previously received no tax benefit in our consolidated financials. Wayne will cover this in more detail.

Revenue for the quarter by our non-U.S. subsidiaries represented approximately 21% of total revenue in Q3 compared with 14% in Q2 and 10% in Q3 of last year. Of the 7-percentage-point sequential increase, acquisitions accounted for approximately 5% and legacy operations generated about 2%. As we have said on previous calls, our primary non-U.S. focus is on surrounding (technical difficulty).

We've made significant progress with this objective recently with the acquisition of the former Lexecon Limited business. The acquisition of the former Lexecon company, which CRA acquired for a purchase price of approximately $15.3 million, consisting of $11.5 million in cash and $3.8 million in loan notes, provided CRA with a stronger foundation for growth in the expanding economic consulting market and additional opportunities in South Africa.

Between our acquisitions and our legacy practices, CRA now has an extremely significant presence in the European litigation and regulatory market.

Turning to headcount, on a net basis, CRA added 43 new consultants in Q3, including the 55 consultant employees that were part of the former Lexecon Limited acquisition, which also added a number of academic consultants to CRA's roster, bringing total consulting staff employee headcount to 657. The organic growth rate in headcount in Q3 was about 10% compared to Q3 of the prior year and about 4% compared to the prior quarter.

Year to date, we've had organic headcount growth of about 7% from the end of FY '04. We are continuing to actively recruit at all levels, and we expect to achieve our planning target of 10% organic headcount growth for the year.

Turning to our NeuCo subsidiary, revenue in the quarter nearly doubled to nearly $2.8 million from $1.4 million in Q3 of last year. NeuCo achieved net income of (technical difficulty) in the quarter compared with a loss of approximately (technical difficulty) a year ago. We continue to anticipate quarter-to-quarter volatility in NeuCo's results, but we also continue to be optimistic about NeuCo's growth prospects.

With that, I will turn it over to Wayne for the financial review.

Thanks, Jim. Let me start my finance review by reminding everyone that CRA's fiscal year operates on 13 four-week cycles, producing quarters unequal in length. Q3 is the longer 16-week quarter, while Q2, Q4 and Q1 typically are 12 weeks in length. Briefly recapping our results, Q3 free revenue, as Jim highlighted, increased 25% to $92.5 million, compared with $74.2 million for the third quarter of fiscal 2004. This total includes a full quarter contribution from Lee & Allen, which we acquired late in Q2, and a partial quarter from the former Lexecon Limited business, which we acquired early in Q3.

Third-quarter gross margin increased 40.7%, compared to 38.6% in Q3 of last year. Reimbursable expenses were 11.9% of revenue, compared to 14.2% of revenue for Q3 2004. This level of reimbursable expenses is consistent with our past several quarters.

Total consultant utilization in Q3 was 74%, down from 81% reported in both Q2 2005 and Q3 2004. Third-quarter operating margin was 14.9%, compared to 15.4% in the third quarter of fiscal 2004 and 15.4% in the second quarter of this year. Q3 SG&A expenses were 25.8% of total revenue, compared to 23.2% of revenue in Q3 last year and 25.1% of revenue in Q2 of this year. This higher SG&A percentage in Q3 is partly due to additional rent and depreciation from office expansion and moves.

CRA's tax rate decreased to 40.5% in the third quarter, compared to 44% for the second quarter of 2005. As Jim mentioned, the healthier performance in our UK operations helped drive the improved tax rate as we were able to reduce the need to reserve for trap losses overseas. In addition, profitability in the UK is taxed at only 30%, well below our U.S. tax rate. We anticipate the tax rate for fiscal 2005 -- for fiscal '05 -- for the fiscal '05 year to be close to the Q3 year-to-date rate of approximately 43% and below our previous fiscal year '05 guidance of 44 to 45%.

Our results for the third quarter included a GAAP-related foreign exchange gain of approximately $103,000, versus a loss of $158,000 during Q2 2005. We continue to mitigate our foreign exchange exposure through frequent settling of intercompany account balances and by hedging our foreign (indiscernible) position. Interest income was approximately $660,000 for Q3, compared to $334,000 for Q2. After taking into account that Q3 is a 16-week quarter in contrast to Q2, which is a 12-week quarter, the normalized growth of interest income due to higher -- was due to higher cash balances from both operations and the follow-on securities offering and a higher yield on investments.

Our Q3 net income grew 47% year over year to 7.9 million or $0.66 per diluted share. In addition to higher operating profits, we benefited from our reduced tax rate, an improvement in the GAAP-related foreign exchange gains and the increase in interest income. Shares used to calculate Q3 EPS were 12 million, compared to 10.4 million shares outstanding in Q3 fiscal 2004.

Based on an average price in the quarter of $52.39, approximately 532,000 shares included in the calculations for Q3 fiscal 2005 were due to dilution from CRA's convertible bonds issue. This average share price, by exceeding the bonds' conversion price of $40, lowered Q3 EPS by approximately $0.03.

Our current staff breakdown is 223 junior consultants and 434 senior consultants, which includes both Lee & Allen and the formerly named Lexecon Limited staff.

Turning to the balance sheet, billed and unbilled receivables decreased to $87.8 million, compared to $92.5 million at the end of Q2. Current liabilities were 68.4 million at the end of Q3, compared to 61.2 million at the end of Q2.

We improved DSO in the quarter. Total DSO were 103 days in Q3, down from the Q2 level, 108 days. This consists of 37 days of unbilled and 66 days of billed versus 38 days of unbilled and 70 days of billed in the second quarter of 2005. We continue to target total DSO to be lower than 100 days.

Cash and equivalents and short-term investments stood at $104.4 million at the end of Q3, up from 51.7 million at the end of Q2, reflecting (technical difficulty) net cash provided from operations, stock option exercises and the successful follow-on offering we conducted during the quarter, offset by the acquisition of the former Lexecon Limited business. Included in the 29.8 million net cash provided from operations is 4.9 million from income tax savings associated with the exercise and sale of stock options.

Capital expenditures were approximately 6.1 million for the quarter, compared to 4.4 million in Q2 and 4.1 million for Q3 of last year, reflecting some recent office moves, expansions and consolidations. Depreciation and amortization expense was approximately 2.6 million for Q3, compared to approximately 1.7 million in the sequential second quarter.

During the third quarter, our closing stock price did not exceed $50 for at least 20 of the last 30 consecutive trading days. Pursuant to the terms of the indenture governing our 2.875% convertible debenture, the coco trigger was not satisfied, and these debentures cannot be converted during our fiscal fourth quarter. The test will be repeated each quarter. To date, no bonds have been converted.

Lastly, on June 29, CRA successfully completed a public offering of approximately $1.59 million shares of its common stock at a price of $53.75 per share. Of the approximately 1.9 million shares sold, 710,000 shares were offered by CRA International and about 1.2 million came from selling stockholders. CRA received proceeds of approximately $35.9 million after deducting the underwriting discount and estimated offering expenses. As part of the offering, CRA received additional net proceeds of approximately 2.6 million from the exercise of options by selling shareholders. Now back to Jim.

Thanks, Wayne. Turning to the outlook, utilization during the first week of Q4, which included the Labor Day holiday, was a little below the Q3 rate. However, since then, utilization has been increasing and is now at a Q3 run rate on a normalized basis, adjusting for the effects of our annual staff training and the impact of Hurricane Rita on our Houston office.

During Q3, the flow of new business opportunities for legacy CRA was significantly greater than during the year-earlier period, and these opportunities are already starting to be converted into new projects in Q4, including several very large assignments in the finance practice. We believe that Q4 utilization will trend higher for the remainder of the quarter.

As we announced in today's press release, based on year-to-date financial results, the acquisitions that occurred earlier in the year and the continued flow of new business, we anticipate the revenue growth of the full year 2005 will be at the low end of the 35 to 40% range.

Taking into account the June stock offering, we anticipate that the growth in full-year EPS in 2005 will be in the 32 to 40% range. This is based on approximately 12.2 million average diluted shares for Q4 and assumes a stock price of approximately $47.18, which is the average closing price for 10 trading days through September 27, 2005. Deviations from this stock price will cause our earnings per share to vary based on share dilution from our stock options and convertible bonds. The above estimates are also based on a tax rate for the year of approximately 43%, utilization in the low end of the 78 to 80% range and annual organic headcount growth of approximately 10%.

With that, I will ask the operator to open the call for questions. Operator?

(Operator Instructions). Jim Janesky, Ryan Beck & Co.

My first question has to do with gross margin in the quarter. It came in higher than I had anticipated. Was there a mix issue going on, and was this -- or was gross margin at the level that you anticipated?

I can handle -- well, I can say -- the acquisitions we made are companies that don't make heavy use of outside consultants. So, as we've explained in the past, that means a higher -- business that uses outside consultants ends up being lower gross margin and higher SG&A. So I think it's been affected by that, and the other were just mix effects.

Okay. And when you look at how many things you were juggling in the quarter, you were integrating two acquisitions, you brought a new CFO onboard, you're trying to view how that is going to affect your utilization by getting an acquisition in the UK. I mean, in hindsight, -- this is a two-part question -- I mean, in hindsight, do you question the advice you got on the timing of your secondary transaction?

And then as a follow-up to that, as you look forward, is the focus going to be on organic growth and -- or could we expect to see more acquisitions this year?

Well, the focus going forward is going to be in organic growth. And I think that the slight downtick we experienced in the quarter was just a confluence of a number of factors. It was not -- the acquisitions were not the significant component of that. There were just a lot of things coming together at the same time.

Matt Litfin, William Blair.

Wayne, let me ask you again to repeat the -- what was the cash flow from operations in the quarter? I thought I heard two different numbers there.

I think I misstated it. It's 29.8 million.

Okay. I wonder if you guys could talk about your utilization assumption in Q4 in this guidance. It's kind of a wide range of bottom-line guidance, you know, in the implied fourth quarter. You said you assume that it will trend higher. I guess the question is how high do you expect it to trend and what's baked into that forecast?

It's early in the quarter, so it's difficult to give a precise point estimate. The bulk of the business, close to 90%, is time and materials, where we're responding to assignments on a daily or weekly basis, so you can't just plan out a quarter ahead of utilization. There have been some favorable developments, particularly in the finance area and in some other places. So we do anticipate an improvement from the Q3 level. Exactly how high it will go, I can't give you a point estimate of that.

Okay. One final one, if I might. If you exclude acquisitions and stock-based compensation and those types of things, what do you consider your long-term earnings growth rate?

I think what we've said historically is that the -- our underlying business model we think is for organic growth in the 15 to 20% range, depending on circumstances during the year. And we do expect margins to rise gradually over time, reflecting scale economies. So I would suggest low end of midteens for revenues, high end for margins and EPS. In addition, we will have acquisitions over time that should boost that number. I don't think anything's changed in terms of the underlying business model.

Actually, I lied; I'm going to ask one more, if I can. On the acquisition pipeline, Jim, you just mentioned you're going to focus on internal growth. How does that pipeline look, and do you see anything out there that looks exciting, and what is pricing doing in the acquisitions in the industry?

We don't have a lot of things that are late stage. We are always in some level of discussions with a number of people. There is one potential acquisition that's in the small to modest size. It could happen. It's not likely in the near-term future. There are some very small involvements that might happen. And then there's really nothing in a very rough stage. So we are focusing on organic growth. That's where we're putting most of our management attention for the next six months.

Colin Gillis, Adams Harkness.

Jim, could you talk a little bit about any differences you're seeing in the environment for the legal and regulatory piece versus the business consulting? And is it possible to break out the percentage of revenue for each piece?

We see favorable trends in both. We think that the finance activity will continue to grow. There's no letup in opportunities there -- leads. We've had a significant increase in leads across the board in the litigation area during Q3. Those generally show up in projects over this -- the slots (ph) have been three to six months. And in the business consulting area, we're very excited about the prospects in our chemicals and petroleum business, which has been strong in North America and has a good flow of business opportunity in Europe and the Middle East.

So I think we feel optimistic on both. In terms of the overall split, by practice area, it's about a little bit over 60% for the practices we count as litigation and around 35% or so for the ones we call business consulting, but some of the business consulting practices have litigation in them. I don't know what the most recent split is, but it would be -- it would still be -- it would be a number that still would be higher for litigation than the numbers I've just cited.

So no real significant change from prior splits?

No.

On the (multiple speakers)

Actually, the two acquisitions we made just at the beginning of Q3 are both primarily litigation companies. So that actually tilts the balance a little bit more towards litigation than was the case prior.

Is there any -- do you think there might be a pickup on the petroleum consulting side just related to, you know, the Katrina and Rita hurricanes?

Yes, we do think there could well be a pickup. In fact, we've been having some internal discussions of things we need to do to position ourselves. There will undoubtedly be a lot of litigation; there will be a lot of insurance claims with this, as well as litigation. There will be contract disputes, all kinds of things.

Okay then, great. And just on some of the Sarbanes-Oxley, obviously, the firms that are involved are in control of you (ph). But are you seeing any demand yet coming out of litigation support related to Sarb-Ox lawsuits?

I wouldn't say related to specific Sarb-Ox lawsuits. It's just part of the general regulatory environment that's leading to lots of cases involving securities issues, accounting fraud types of issues, and that business is very healthy.

And then just is a 5% bill rate increase for next year -- does that still seem like a reasonable target? Anything changing in terms of that outlook?

We haven't -- we're in the middle of the process for setting bill rates for next year. As you probably know, we have done it at the 5% level just about every year, sometimes a bit higher. That's the kind of range we're looking at. But until we've gone through the process, we won't know exactly.

And then I just wanted -- a couple of housekeeping items, if I could. Do you have the organic growth from a year ago -- the prior August? And then any comment on stock option expense in '06?

(multiple speakers) but if we can find it before the call is over, I'll give it to you.

(Operator Instructions). Brett Manderfeld, Piper Jaffray.

I have a couple of questions related to utilization. Jim, I think you mentioned several things that were impacting utilization, but if you look at it at a practice segment level, would you think that -- or do you think that most of the utilization drop was tied to the financial sector ending some longer deals?

That was certainly a major component. What happened was we didn't -- we actually had an increase in the number of big long-running cases we're working on, but there were no deadlines in the deadlines, and if you know much about litigation business, a lot of what we do is responsive to an upcoming deadline of some kind. And basically, there were a lot of deadlines in Q2 and then nothing in Q3.

So the work -- the potential for work actually increased, but utilization of the staff in that area decreased. We do expect a significant uptick in that for the fourth quarter and going forward. We have large numbers of very, very large cases which are expected to go on for a long period of time. These are not cases that are likely to settle. So we have a lot of prospective work to do that tends to be responsive to the needs of the case in terms of the timing. So we just basically went through a timing issue in the summer. It was not actually any decline in the number of cases we were working on.

Okay, that's helpful. And related to the summer, in your experience, I guess, and now looking at more European or international business, is it reasonable to assume, all things being equal, that the August quarter would be down a couple points in utilization, all things being equal, relative to the rest of the other quarters?

Yes, that's actually a good point. It didn't find its way into my prepared remarks, but there is an aspect of -- summer there is a more focused vacation period in Europe than it is in the United States. And if you're familiar with the way Europeans work, Europe pretty much shuts down in August, which is really not the case in this country, obviously. People do go on vacation, but you don't tend to have people taking whole months off. So as the percentage of our labor force located here goes up and as the percentage of our clients that are located in Europe goes up, we will probably see a more pronounced seasonal swing than we have in the past.

Okay, great. And my final question is just if you look back over the last five quarters before this one, utilization overhaul has kind of trended in the high 70s to 80, 81% range. I guess a couple of thoughts on that. Jim, do you still think you can get to kind of the mid-80% longer term, and what it really has to happen here looking out to '06 to kind of get it back into the 79 to 80% range for '06? Thanks.

Well, I think we have -- we are in a position to get back to the 79 to 80% ranges or higher. Really nothing has changed in the underlying business. Getting higher just means (technical difficulty) all the time. I think getting more scale in the business actually helps because if there's anything that turns down in one area, if you have more things going on, you can move people around. So we haven't reduced our long-term targets.

By the way, in answer to an earlier question, the organic growth rate for Q3 of '04 versus Q3 of '03 was about 16% in terms of net revenue and about 15% in other reimbursables, so actually very similar to what it was this quarter.

(Operator Instructions). It appears there are no further questions at this time. Mr. Burrows, I would like to turn the conference back over to you for any additional closing remarks.

Well, thanks, operator. We look forward to speaking with everyone on our fourth-quarter conference call in January. That concludes today's call.

That concludes today's conference. And we thank you for your participation.