CRA International Inc (CRAI) 2010 Q2 法說會逐字稿

Good morning, everyone, and welcome to Charles River Associates second quarter fiscal year 2010 conference call. Today's call is being recorded. You may listen to the webcast on CRA's website located at www.CRAI.com. In addition, today's news release and prepared remarks from the Company's Chief Financial Officer are posted on the Investor Relation's section of the site. With us today are CRA's President and Chief Executive Officer, Paul Maleh, Chief Financial Officer, Wayne Mackie, and Vice President and Practice leader, Mason Kissell. At this time for opening remarks and introductions, I would like to turn the call to Mr. Mackie. Please go ahead, sir.

Thank you, Rob. Statements made during this conference call concerning the future business, operating results, estimated cost savings, and financial condition of the Company, and statements made using the terms anticipates, believes, expects, should, or similar expressions are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on 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, are included in the Company's filings with the Securities and Exchange Commission, and in today's news release, and prepared CFO's remarks which are posted on the Company's Web site.

The Company cannot guarantee any future results, levels of activity, performance or achievement. The Company undertakes no obligation to update any of it's forward-looking statements after the date of this call. Let me remind everyone that CRA's fiscal year typically operates on 13 four week cycles, producing unequal quarters, in terms of length. Q1, Q2 and Q4 are typically 12 weeks in length, and the third quarter being a 16 week quarter. In addition, let me remind everyone that we will be referring to some non-GAAP financial items on this call. I would encourage everyone to refer to today's earnings release for a full reconciliation of non-GAAP items to their GAAP equivalents. Our non-GAAP results exclude the results of our NeuCo subsidiary, expenses related to restructuring activities, and expenses related to the repurchase of our convertible bonds. Let me now turn it over to our CEO, Paul Maleh for his commentary. Paul?

Thanks, Wayne, and good morning, everyone. Thank you for joining us on today's call. The Company's momentum shifted favorably in the second quarter, as non-GAAP revenue and profitability improved from Q1 levels. However, given where we began, we recognize we have a ways to go before we will be satisfied with our performance. Although clients are still being cautious in their spending, the active lead flow we reported in the past two quarters resulted in sequential revenue growth in Q2. Looking at the top line performance, it was encouraging to see a return to growth this quarter, in both our litigation and management consulting service offerings. Revenue in each, and for the Company as a whole, were up approximately 15% on a non-GAAP basis from the sequential first quarter.

Some practices, most notably our competition practice, experienced solid revenue growth. Competition revenue reflected strong activity in both North America and Europe, driven by large merger and antitrust litigation matters. For example, in an antitrust matter, the analysis and testimony provided by one of our competition economists led to the denial of class certification, which had alleged that the merger of two hospitals had anti-competitively raised prices for healthcare services.

During the second quarter, the life sciences and finance practices also delivered solid utilization rates. For example, life sciences continued to work on a range of projects related to patent litigation damages, global policy issues, and new channel and pricing strategies. The transfer pricing and Marakon value management practices generated an increase in demand in their services. In addition, several of our smaller practices, including auctions and competitive bidding, financial economics, and labor and employment continued to perform well.

Our ability to achieve double digit revenue growth over Q1 is worth noting, considering that -- considering that we were deeply involved in restructuring activities during the second quarter. As we mentioned in our first quarter call, we closed our Houston office, and shifted key people to other locations. We restructured selective practices, and we better aligned staffing levels with our revenue. In addition, we reduced the size of our administrative staff by eliminating or not filling a number of positions, and made some investments in our operating infrastructure to pare costs and boost productivity. We expect these actions will yield annualized savings of approximately $9.3 million. As a result of these actions, and an increased demand for our services, utilization improved to 65% in the second quarter, from 60% in Q1. Although this remains below our target utilization range of the low 70s in the second half of fiscal 2010, several practices have responded positively to the challenging environment.

And across the Company, we are focused -- we are focused on maintaining the momentum gained during the second quarter. Our restructuring activities and ongoing cost containment initiatives have significantly reduced our SG&A costs as a percent of revenue, and have improved our operating margins compared with the first quarter. We essentially remained flat on non-GAAP SG&A costs in the second quarter, while adding $8.5 million of revenue. As a result, on a non-GAAP basis, SG&A as a percentage of revenue, declined approximately 300 basis points from Q1 to 22.2%. I would also like to note that our SG&A expense includes payments made to external consultants. For the second quarter, these payments represented approximately 1.9% of our revenue. We will continue to work at reducing our SG&A expense, while improving support services provided to our consultants.

Turning our, turning your attention to a specific area of our business, exactly one year ago today, CRA announced it's asset purchase of Marakon Associates. We have invited Vice President and Practice leader, Mason Kissell to provide you with further insights about the practice that has joined us. Mason has worked in a broad range of industries, with particular emphasis on financial services and insurance. He has been a practice leader since joining CRA, and was previously CEO of Marakon, and before then, head of it's North American operations. Mason?

Thank you, Paul. It is a pleasure to join all of you on today's call, and have a chance to introduce you to our practice. Marakon was founded in 1978, with a simple, yet powerful idea, that we could help executives of large corporations more effectively manage their businesses through a focus on shareholder value. Marakon is often referred to as a pioneer in the high-end management consulting segment, because of our work on strategic, organizational, and operational issues, always analyzed through a value lens, and customized to each client. Our ideas have given us the opportunity to advise management teams in some of the world's best-known companies at the corporate, business unit, and functional levels, and on the issues that most impact their value and performance.

Our clients consist of primarily large companies, in addition, to middle market companies, and private equity firms. Our work is focused in the US, and Europe, with our team based in New York, London, and Chicago. Although our focus on shareholder value is relevant across all industries, over the years we have accumulated substantial experience in financial services, industrials, consumer, retail, and healthcare, as well as chemicals and energy. The core members of our practice leadership team have been working together for more than 20 years. They have been instrumental in advancing our approach to art and science of business management, and helping our clients to identify and deliver improvements in their value.

With that overview as a backdrop, I would like to take a moment to describe how we came to team up with CRA. The severe economic downturn between 2008 and 2009 was the most challenging time in our history. We were fortunate to attract the attention of CRA, who was interested in building a larger presence in the management consulting space, to compliment it's litigation and regulatory work. The transaction has brought to us additional functional depth and breadth, access to leading industry expertise, and strong analytic capabilities, which has strengthened our offering to clients.

Before speaking to our combined synergies, I would like to briefly describe the current challenges in the marketplace. We are finding that clients are still not spending as much as they had in the past, and when they do spend, they are very cautious. Engagements are shorter, they are taking longer to close, and they are more tightly controlled. Market uncertainty has, in some cases, resulted in clients and prospects holding off from engaging consulting services, at least in the near term. For an example, we have three large clients and prospects in the middle of M&A transactions, which are taking longer than expected to close. While these M&A delays are reducing some near opportunities for our services, they may increase demand over the coming months.

Despite this business environment, we have seen a strengthening in our business, and revenue growth has been better than expected. We are starting to see signs of a return to a more normal demand pattern. For example, we have recently been retained by the CEO of a multi-billion dollar global industrial company to conduct a thorough analysis of the company's strategy, and management model, which will be presented to the Company's Board this fall. The goal is to substantially increase the growth and intrinsic value, as well as help the clients improve the pace and quality of it's strategic decision making. This involves constructing a new fact base that details where and how value is being created, by product, customer, and geography. And then developing a series of integrated alternative strategies, that will increase both returns and growth. Along the way, we will be working jointly with client teams to build capabilities, so that this type of work becomes part of their decision-making process.

In order to accelerate demand, we have been building our senior level staff within the practice, and putting significant emphasis on the innovation of our service offering to clients. We have importantly, welcomed back a former senior colleague, and earlier this year one of our own was promoted to Vice President. In addition, two Vice Presidents from other CRA practices, who have expertise in global industrial and consulting, and risk management, respectively, have transitioned to our practice full time, to deepen our insights in those industries, and expand the scope of how we market our services to clients.

The stability that being part of CRA provides, has essentially allowed us to start building our practice again. In addition, we are developing new synergies, by collaborating with consultants from other practices on different assignments. As a result, we are winning new client work that our practices would not have won on their own. For example, we recently completed an extensive strategic review for a specialty chemical company, that had worked independently, with both CRA and Marakon in the past. In this most recent engagement, the joint team met with the client, who was impressed by the combination of CRA's chemical expertise and Marakon's strategy. We are engaged to do a complete review of the business, and develop a new corporate strategy, and the client's feedback has been very positive. In another example, a major integrated oil company was seeking a detailed analysis of part of it's US refinery system. The clients knew us, but needed experts in refinery economics, so colleagues from other practices were engaged on the assignment. The client has been delighted with the combination of our practice's analytic approach, and expertise in energy economics.

Over time, we expect to increase our penetration in the chemicals energy spaces through the combination of our value lens, and other practices functional in industry expertise. The good news for our practice is that company's strategic, organizational, operational problems have clearly gotten more acute in this downturn, so the potential need for our services is high. Corporate strategy and portfolio management issues have been top of mind to many companies recently, and our value perspective is highly relevant to addressing these needs. For many companies, returns and risks are getting more weight than growth, and this also plays to our strength.

In financial services, many companies have had to step back and rethink their strategies, which has been good for our business. In addition, many companies have reduced their internal staff so they have fewer people to do the work. The supply demand balance in the industry is also gradually being restored, which should improve price realization. These are positive signs that should point toward upward trends in our business. One year into our relationship with CRA, we have a lot to be proud of. We are building our practice with an outstanding team of people. We are looking forward toward leveraging our synergies further to benefit our employees and our clients. That concludes my remarks. I will now turn the call back to you, Paul.

Thank you, Mason. We appreciate your insights. We have gained benefits in a number of areas since our teams have come together, including a stronger global platform, deeper capabilities, and corporate strategy, transformation and transition, and the stronger market position in several industry verticals. Internally, we are also benefiting from the best practices that support the training and professional development of our people. On our next quarterly call, we will focus on the life sciences practice. We have invited Greg Bell, head of our life sciences practice to speak with you about the practice's work in both the litigation and management consulting areas.

Before turning the call over to Wayne for his remarks, I'd like to conclude with a couple of thoughts. First, I would like to express my appreciation to our shareholders on an important matter. Recruiting and retaining highly talented people, and rewarding them fairly for their success, and serving clients and generating revenue, is in no small measure a function of our ability to provide attractive and competitive compensation. Last year, in order to align the interest of our key revenue generators and our senior leaders with our growth strategy, and the interest of our shareholders, our Board of Directors approved the implementation of a new long term incentive program, or LTIP.

In order to continue funding the LTIP program, the Board recommended to shareholders to approve an increase of nearly 1.5 million shares of common stock available under our 2006 equity incentive plan. On behalf of the Board, I would like to extend my thanks to our shareholders for voting to approve this important tool, for driving profitable growth and strategic achievements at our recent annual meeting.

Second, we are encouraged by our results in the quarter. Perhaps most important for the long term, the activity we are seeing in our lead flow suggests that the underlying fundamentals of our business have improved from the slow start we experienced at the beginning of the fiscal year. Having said that, it is far from certain, that we will even see a modest level of global economic growth in the near term. Clients continue to be hesitant about spending on major consulting projects, and the pace of the litigation-related activity remains sluggish. Consequently, although we are encouraged by the dynamics we saw in our business in Q2, we are expecting to continue to face a challenging landscape in the second half of the year. With that said, I will now turn the call over to Wayne for his financial review. Wayne?

Thanks, Paul. To remind everyone, today's news release and prepared CFO remarks are posted on the Investor Relation's section of the Company's website. As I have done in the past two calls, I want to discuss some key metrics and factors you may want to consider when assessing our performance for the remainer of 2010. First, we entered the quarter with a consulting head count of 554, of whom 431 are senior staff, and 123 are junior staff. Second, we raised our utilization to 65% in Q2, from 60% in Q1. Our goal continues to be to achieve utilization in the range of 70% during the second half of fiscal 2010. Our recent head count reductions and uptick in business should help us achieve this goal.

On our last quarter call, I discussed the steps we are taking to improve our tax rate. In Q2 our tax rate was 42.7% on a non-GAAP basis, compared to 47.1% for Q2 of fiscal 2009, and 57.6% for Q1 of fiscal 2010. We are pleased with the better results, which reflect improved performance in our Europe and Middle East regions. If we are able to continue this international operating performance in the second half of fiscal 2010, we should maintain or improve the non-GAAP tax rate we recorded in Q2. International revenue represented 28% of the second quarter of fiscal 2010, compared to 26% of the first quarter, and 24% of the second quarter of 2009.

Efforts to reduce our square footage requirements in leasing costs will continue in the coming quarters. We have a number of long-term leases for offices and facilities and facility space that are up for renewal over the next several years, and we are taking proactive steps with our landlords, to reconfigure our space, and negotiate lower rents for the space we continue to require. In order to gain efficiencies and further reduce our cost structure, we have decided to implement a new financial information system. This system will be the backbone of our financial information, and much of our business information systems. We are in the process of selecting and negotiating with vendors at this time, and expect it to be some time before the implementation of the new system is fully completed.

Currently we are looking at our capital structure. During Q2, we bought back $15 million of our bonds at a slight discount to face value, even though for accounting purposes, we recorded a non-cash loss of $425,000. After the Q2 bond repurchase and payment of the majority of our fiscal 2009 consultant bonuses, we concluded the second quarter with approximately $80 million in cash and short term investments. We also have a $60 million credit facility which we have yet to access, that provides us with additional flexibility. At the end of the quarter, our remaining principle balance of bonds was approximately $47.5 million, which is redeemable in approximately one year. At the end of the third quarter, we anticipate our outstanding bonds will be reclassified as a short term liability. In the coming months, we will look at what makes the most sense for our capital structure, and how we ultimately manage our debt obligations. As we have noted in the past two calls, we have adopted a new accounting standard, related to our convertible bonds. For the full-year of fiscal 2010, we expect to see a non-cash interest expense of approximately $1.2 million, and we accounted for $609,000 of this through Q2. That concludes my remarks. Rob, we would now like to open the call up for questions. Rob

Thank you.

(Operator Instructions).

Thank you. Our first question is coming from the line of David Gold of Sidoti & Company. Please proceed with your question.

Hi, good morning.

Morning.

Morning.

I was hopeful you can give a little more color on plans from here by way of head count adds, and or cuts, sort of on a go forward basis, or are we basically done with that?

We are hopeful that we are done with that. We are starting to see some positive signs of our business, so we would like these restructuring activities to be behind us, with respect to head count. With respect to expansion of that head count, right now our utilization is still somewhere in the 60s, and thus we have capacity to take on more work without adding head count. With that said, we are still actively pursuing recruiting opportunities, and group hires, and acquisitions, revenue generating assets. So our focus right now is on the top line, and as we start seeing our capacity tying up, we will re-examine whether we need to expand the pyramid.

Okay, are there particular practices, like say competition where you've seen strength, where you may need to add some folks, or is there excess capacity sort after across the board still?

Are you -- I'm sorry, David, I am just going to ask you a clarifying question there. Are you asking what practice areas we are going to be focused on with our hiring?

Well, to the extent there's hiring necessary, yes. So in other words, are there -- do you still have capacity in sort of all of the practices? Or are there any practices that, to the point of pick up, might require --are there any of them that are doing so well, that with we might need to add some folks?

Sure. I believe we have capacity right now in the firm. If I were to say areas that are potentially tight, would have to do with our smaller practices that are highlighted during our call. For those, the way we have been trying to meet demand is really utilizing the capacity that exists in CRA. There is fungibility across a number of these practices. So all of our practice leaders are doing their best to make sure we use that unused capacity before going to the external market.

Got you. And just one last if I might. I think in the last call, you spoke about you put through a modest price increase, at the beginning of the year. I am just curious, to the extent that you can tell, if that is sticking, or if there's push back from that?

The price increase has stuck, there is push back, in that clients are price sensitive, and they want to make sure they are receiving value for the services that we are providing. So it is not as much on the actual per-hour charge. But the, the insistence on delivering value for dollars -- aggregate dollars spent,.

Got you. Perfect. That's helpful. Thank you.

Our next question is from the line of Tim McHugh with William Blair & Company. Please proceed with your question.

Yes, just a quick numbers question to start here, reimbursable expenses, do you have what those were?

Sure, Tim. Reimbursables for the quarter Q2 were $8.7 million, or roughly 13.2% of revenue.

Okay. Wayne, the health claims that you mentioned as impacting the gross margin, can you help quantify that? I just want to -- I view that as somewhat, hopefully not a recurring issue, trying to unanimous what the base gross margin might have looked like at this utilization rate.

No, we actually don't view this as a recurring item. It was a spike that occurred for some unforeseen and unpredictable claims. The amount that's in the cost of sales area related to that, is approximately $600,000 above what would be the normal level.

Okay. And then on the demand environment, I may be reading too much into it, but it kind of sensed you were highlighting a bit more, the litigation-related practices of competition, and financial economics is showing improvement. I know you said business consulting was up I think sequentially, but was it up less than those other areas? Can you just maybe give a little more color on what you are seeing on that side of the business?

Yes, I apologize if I wasn't clear on that, Tim. If I look at our service offerings into those two buckets, litigation being one bucket, and management consulting being the other, they both increased by approximately 15% over Q1 performance. So we were pleased to see, sort of all ships rising here at the firm. There were some practices that, of course, performed better than other practices, and we just wanted to highlight those, one being competition and Marakon. Our value management group had a very strong quarter.

Okay, and then one more if I could, the restructuring, the incremental restructuring here, was much of the cost savings reflected in the second quarter, or is that more something we will see in the run rate going into Q3?

Well, in terms of the actual costs, of course, they were all in Q2. In term of the savings that we would anticipate starting to kick in, that should be rolling along nicely now, principally in Q3 and Q4. But most of the activity was dealt with earlier in Q2, a third to half way through Q2.

Okay. Thank you.

Thank you.

(Operator Instructions).

Our next question is coming from Joseph Foresi of Janney Montgomery Scott. Please proceed with your question.

Hi, guys.

Hi, Joe. Good morning.

I was just first curious about utilization. I know it went up 5%. Could you -- was that purely driven by an increase in work, or was that a mix of, kind of getting rid of some the restructuring charges, if you can give us an idea of where that is driven from?

Sure. It is, of course, a little bit of both, any time you out source or out place individuals with low utilization rates, your average utilization will increase. But what we were pleased about, is the increase in utilization also came with an increase in revenue, the increase in the billable hours in aggregate, which signaled to us that the demand for our services has increased. This wasn't just a numbers game of playing with a denominator here.

And do you expect it -- to sort of move up from this level going forward? I know you gave 70% in the back, in the back half of the year, but is that -- have we started to set maybe a new base on the utilization side?

I sure hope so. We are seeing positive signs. Our hesitancy here is, I have seen some of these positive signs over the past two years, where we start seeing signaling, in terms of, lead flow has increased, in terms of billable hours has increased, utilization, but yet we hit a wall going into the proceeding quarter. But here are a lot of positive signs, and we are just trying to counter balance that with the cautiousness of our clients on aggregate spent.

And maybe you can just talk a little more about that, it sounds like there has been a couple of different starts and stops. What has caused the starts in the past, and what has caused the stops? And maybe just if you can relate that what happened historically, versus what you are seeing now, and if you are more positive or less positive?

The, it 's hard to compare over time, because there some times the mix of the practices that are driving, the performance. Is very different. What is promising to me, is again, we have been spending a lot of time looking at lead flow, we have been spending a lot of time focused on how do we better leverage the client relationships that we do have. And they seem to be paying off. Our consultants are gaining traction, are gaining traction with their clients. So for me, the first indicator is lead flow. And I have not seen the lead flow dip over the past three months or so, since that slow start in Q1. So hopefully that lead flow is enough to get us through the summer, and to end the fiscal year on a strong note.

So is has there been a -- a general pick up in litigation? Do you think it could be the beginning of the trend, I don't want to put words in our mouth. It seems like you are probably encouraged, but not necessarily ready to say, okay, things have totally improved.

That's right. It is -- I don't want to lose sight, and we haven't lost sight of the fact that utilization for Q2 was 65%. This is not an acceptable performance level for this firm. We know it, our consultants know it. So say that litigation has returned to days of old is a little premature, but we are seeing an increase in activity.

And two more quick questions. Maybe you can bring us up to speed in the practice in the Middle East, and the contribution and how it performed, and what you are expecting going forward?

The practice and the lead flow has been very lumpy since the high that we experienced during Q4 of 2009. We have started seeing a little pick up in activity, now prior to the summer months of closing, of new leads. And we are hoping those closings will translate into revenue the coming months. Other than that, in Europe, our management consulting offering has been very strong. A lot of that has been driven by the contribution of my Marakon value management colleagues, where we are just hoping that momentum continue.

And do you expect the currency -- any kind of currency head wind making way in Europe?

So far, we have been able to manage it well. Depending on where the euro, and other currencies continue to go, we will stay on top of it. But we have managed it reasonably well to this point. And our goal is to stay on top of, if you will, our net monetary position, so that doesn't hurt us in any significant way.

What percentage of revenue comes from European denominated currencies?

Well, the international was 28% this quarter. The portion that comes from Europe and Middle East is probably -- and most of that I would say 25% or so.

You are getting paid in the local currencies in that 25%?

It is a mixed bag, Joe. Some we get paid in dollars, much of the Middle East work is denominated in dollars effectively, some is euros, and some is in pounds.

All right. Thank you, guys.

Thank you.

(Operator Instructions).

Thank you. We have a follow up question from the line of Joseph Foresi of Janney Montgomery Scott.

I wasn't expecting it to be that quick. But -- just wanted to get some idea on, which way you guys might be leaning on the cash side, as far as uses of cash, and where you stand with the debt?

I think what I heard, it was a little garbled, but I think what you said is, what are our planned uses of the cash?

Yes.

Well, as I said one thing we are doing is we are evaluating, of course, the capital structure of the Company, the bonds that we have in place are likely going to be redeemed within, basically a year from now. And so we are looking at a number of different alternatives in that area. But we also want to very much stay in a position, that between the cash balance that we have in our debt line, that if an opportunity of the right nature comes along, that we have the ability to capitalize on it. So, what we don't want to do, is get into a situation where we cannot, or we are perceived as not being able to acquire or do a transaction that would be in the best interest of the Company in the future.

All right. Thank you.

Thank you. At this time we have reached the end of the Q&A session. I will now turn the conference back over to management for any closing or additional remarks.

Great, thank you, Robert. Again, thanks, thank you to everyone for going us this morning. We appreciate your time and attention, and look forward to updating you on our third quarter conference call later this year. This concludes today's call.

This concludes our conference call, thank you for joining us today.