CRA International Inc (CRAI) 2010 Q3 法說會逐字稿

Good morning, everyone and welcome to the Charles River Associates third 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 Relations section of the site. With us today are CRA's President and Chief Executive Officer, Paul Maleh, Chief Financial Officer, Wayne Mackie, and Life Sciences Practice Leader, Greg Bell. At this time, for opening remarks I'd like to turn the call over to Mr Mackie. Please go ahead, sir.

Thank you, Claudia. Statements made during this conference call concerning the future business, operating results, estimated cost savings and financial condition of the Company and statements using the terms anticipate, believes, expect, 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 remarks, which are posted on the Company's website. The Company cannot guarantee any future results, levels of activity, performance or achievement. The Company undertakes no obligation to update any of its 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 we are reporting on today 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 repurchase of our convertible bonds. In addition, we have provided normalized non-GAAP financial information for the third quarter of fiscal 2010 on a basis intended to convert the 16 week period to an as if 12 week period in order to provide an equivalent comparison to financial information for the 12 week second quarter of fiscal 2010. 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 today on today's call. In the third quarter we saw a continuation of many of the positive trends we experienced in Q2, and a continued rebound from the slow start to the year. Our results were driven by a pickup in larger projects and engagements, particularly on the management consultant side of the business. The activity we're seeing in our lead flows suggest that the underlying fundamentals of our business are improving. Our cost reductions and restructuring measures also proving to be effective. On a non-GAAP basis we delivered higher margins and improved our bottom line performance on both a year-over-year and normalized sequential basis. For the second consecutive quarter, we improved our utilization by several percentage points, achieving 68% utilization in Q3. Overall, we are encouraged with the progress we made during the quarter and are on track to achieve our fiscal year goals.

Looking at our top line performance, we clearly saw improvement in our management consulting business and expect this to continue. In particular, our global industrial consulting practice grew nearly 25% year-over-year, and equally as important, grew more than 30% from Q2 to Q3 on a normalized basis. While we need to temper our reaction to these results with a slower start to the year, we are starting to see signs of return to a more normal demand pattern to clients. The strategic and operational challenges have become more acute as a result of the economic downturn.

At the same time, Marakon continues to be a consistent performer. Marakon has experienced a steady flow of assignments during the past several quarters. Our management consulting had a good Q3, growing incrementally from Q2 on a normalized basis. Although our litigation portfolio was impacted due to the seasonality, we are pleased with our litigation lead flow. Our conversion rate of leads into new engagement was good and we saw signs of performance trending upward. We are continuing to be involved in a number of significant cases and have been retained to participate in many others. However, our primary challenge continues to be the uncertain economic environment which has the potential to limit near term client spending on major consulting projects and disrupt litigation related activities. From a geography perspective, our international operations performed well. For the second consecutive quarter, international revenues accounted for 28% of our total revenue.

As we noted in today's press release, the highlight of our Q3 results was our margin improvement which ultimately drove our increased profitability in the quarter. On a non-GAAP basis, we improved our gross profit and our operating margin on both a year-over-year and sequential normalized basis. This is even more impressive when you consider that we generated a lower level of revenue this quarter when compared to either period. Our non-GAAP gross profit margin for the third quarter of 2010 was 34.1%, as compared with 30.8% in the second quarter of this year, and 30.6% in the first quarter and 32.9% in the third quarter of fiscal 2009. We achieved the non-GAAP operating margin of 8% this quarter, compared with a 7.2% in Q3 of 2009. That 8% is a considerable improvement from the 6.5% operating margin we reported in Q2, and 3.2% in Q1.

We have focused on streamlining our entire organization during the past two years and channeling our resources toward the core components of our business. Our results confirm that our restructuring activity and cost reduction initiatives are working. And the leverage in our business model is increasing. When we compare Q2 to Q3 on a non-GAAP normalized basis, we grew our net income by 19% sequentially, even with revenues down 7% over the same period.

We are also in a strong financial position as we enter the final quarter of fiscal 2010. During Q3, we generated cash flow from operations of approximately $12 million. We increased our cash position during the quarter by nearly $7 million, and concluded Q3 with $86.6 million. Wayne will touch more on our capital structure and financial position in his remarks. But ultimately, we have considerable financial flexibility and the capital necessary to execute our growth strategy.

Now turning your attention to the specific area of our business, we have invited Greg Bell, our Life Sciences Practice Leader to tell you more about that practice. Greg joined CRA in 1993 after completing his PhD and MBA programs at Harvard to help CRA expand its work with litigation clients and grow our strategy consulting business. He focused on what initially was known as CRA's Pharmaceutical Services, which through the years has expanded and evolved into our life sciences practice. Greg?

Thank you, Paul. It's a pleasure to join you on today's call. As Paul alluded to, the life sciences practice addresses CRA's three areas of focus, strategy consulting, litigation, and public policy or regulatory consulting. We sell our services to companies in the pharmaceuticals, biotechnology, medical device and diagnostic industries focusing on Europe and North America. Our work in advising clients on their product launches and other strategy issues helps to establish credibility when providing expert testimony in litigation matters. Similarly, clients find our experience with policy issues valuable when determining the competitive positioning of their products. And our people appreciate the opportunity to work on a variety of projects.

I'd like to briefly tell you more about our work. In strategy consulting, we advise clients on a comprehensive range of strategic issues, including licensing and business development, pipeline and product positioning, and portfolio optimization. For more than a decade, we have helped companies assess global opportunities, develop therapeutic category strategies, launch products successfully, and build competitive advantage throughout the product life cycle. A particular area of current focus involves research and development portfolios and related therapeutic categories. We have begun to offer clients services in the economic management of research and development. More explicitly, tying investments and product development by therapeutic category to the related global commercial potential. We expect this service to capitalize on an ongoing evolution of business models in the pharmaceutical industry. Companies are focusing more on developing and positioning a portfolio of products to address a particular therapeutic category as the significance of blockbusters and individual brands are declining.

Our litigation consulting work spans the areas CRA is traditionally known for in working with law firms and providing expert witness testimony on litigation matters. Life sciences practice has advised on a broad range of disputes. Offering expert witness testimony and consultation regarding lost profits and reasonable royalty estimates and damage, and intellectual property cases, damage evaluations and breach of contract matters including global co-development and co-marketing agreements, cloud certification, liability and damages assessments regarding competition issues including the so-called pay for delay cases involving branded and generic manufacturers.

To bring the best talent to bear on an assignment, we tap into subject matter experts from CRA's other litigation consulting practices when appropriate. For example, we partner with the competition practice on antitrust issues. The intellectual property practice on patent issues and the transfer pricing practice on transfer pricing issues. Each area has seen high profile disputes in which the life sciences practice has been engaged. For instance, our team played a significant role on behalf of GlaxoSmithKline in one of the largest transfer pricing cases in US history. We have acted for Boston Scientific in a number of disputes involving stents, one of the largest sets of patent cases in US history. And we also act for the industry in three individual companies in the AWP litigation, which could be characterized as the biggest litigation issue for the pharmaceutical industry as a whole since the 1990s.

The third area of focus for the practice is public policy. We're not lobbyists or advocates in this regard. Instead, we provide clients such as industry associations, governmental bodies like the European Commission, and individual pharmaceutical companies with independent advice on public policy issues. Our white papers might evaluate the economic impact of a policy issue and our recommendations help companies structure their positions on policy issues. Currently, Health Technology Assessment is one of the most significant public policy issues that we are addressing. On both sides of the Atlantic, the industry's being challenged to work effectively with governments and payers regarding the news of Health Technology Assessments to make decisions on different products and treatments.

Our life sciences practice is able to create a unique synergy among all three of the major elements I just outlined. As the practice moves forward, we will continue to draw upon our experience and expertise in strategic business challenges, litigation disputes and policy issues to benefit our clients and to provide our consultants with rewarding assignments. That concludes my remarks. Now I'll turn the call back to Paul.

Thank you, Greg. Greg and his team offers a unique blend of experience and expertise and I want to thank the entire group for their efforts. As Greg reviewed, the life sciences industry is continually evolving and each change seems to generate a new set of complex issues. CRA is benefiting from the practice of these efforts in helping clients work through these challenges.

Before turning the call over to Wayne for his brief remarks, I'd like to conclude with a couple of thoughts on our outlook. As I mentioned earlier, we're encouraged by our results for Q3 and our ability to deliver growth and additional momentum over Q2. We have recently assembled an experienced four person business development team to ensure the value of our litigation consulting services is fully realized in the marketplace. Our four new vice presidents will focus on deepening and broadening our client relationships with law firms and general counsels, ensuring that both existing and potential clients have access to CRA's broad array of services, as well as helping to bring the best talent to bear on any given assignment.

In conclusion, let me just say that the underlying fundamentals of our business have improved for the second straight quarter. Despite the stalled global economic recovery, we are encouraged by the dynamics of our business and the trends we're seeing. Overall we're entering Q4 cautiously optimistic. With that, I will now turn the call over to Wayne for his financial review. Wayne?

Thanks, Paul. To remind everyone, today's news release and my prepared remarks are posted on the IR section of our website. What I'll focus on this morning are the key metrics and factors you should consider when assessing our performance for the remainder of 2010 and beyond.

First, in terms of consulting headcount, we entered the quarter with 555, of whom 420 are senior staff and 135 are junior staff. While that's essentially flat with the 554 we reported at the end of Q2, it's a decrease of 11 senior members and an addition of 12 junior staff, which is consistent with the typical hiring pattern at the junior level during the Summer season. We raised our utilization to 68% in Q3, up from 65% in Q2, and 60% in Q1. I should note that the Q3 utilization continued to trend higher as the quarter progressed. This gives us confidence that we can achieve our goal of utilization in the range of 70% in the fourth quarter. Our tax rate, which was 42% in Q3 on a non-GAAP basis, reflected the improved performance in our international operations. Our non-GAAP Q3 tax rate was essentially flat with our Q2 2010 tax rate, and down substantially from 58% we reported in Q1. Based on our outlook, our goal for Q4 is a tax rate in the low to mid-40s.

In terms of the new -- looking forward, our primary challenge continues to be the uncertain economic environment which has the potential to limit near term client spending on major consulting projects and disrupt litigation related activity. However, we have substantially lowered CRA's overall cost structure during the past two years and created a leaner, more leverageable business model in the process. As reported in our 8-K filing this morning, we are making small adjustments to consulting headcount in some practices. While we will continue to align our cost structure with revenue, particularly in the area of office leases, our primary focus now is on generating profitable growth and deepening our client relationships.

We are continuing our efforts to lower our office leasing costs. As we have resized our consulting and support staff through restructurings and divesting practices during the past two years, our square footage requirements have changed. Our goal is not merely to cut down on our square footage, but in addition, we are re-evaluating our space use standards and ways to further optimize the utility and efficiency of the office space we occupy. We have a number of long-term leases that are up for renewal over the next several years. As I mentioned on our last call, we are proactively reaching out to our landlords to not only negotiate lower rents for the space we require, but to also better reconfigure much of our existing space.

In terms of the new accounting standards related to our convertible bonds that we've noted on several past calls, we still expect to see a non-cash interest expense of approximately $1.2 million for all of fiscal 2010, and have now accounted for $941,000 of this through Q3.

Our capital structure remains an area of focus for the Company. During Q3, we spent approximately $4 million to repurchase 210,000 shares of our stock as part of our ongoing buyback program. We added to our cash and short-term investment position during the quarter, closing with nearly $87 million. We also have a $50 million credit facility that provides additional flexibility. At quarter end our remaining principal balance on bond was approximately $47.5 million, which is redeemable next June. The key take-away for investors is that our existing cash and capital position will allow us to retire that entire bond obligation and we also have the $60 million credit facility to access if we choose. We will continue to update you on our capital plans in the months ahead. Please note on the balance sheet for Q3 that we have reclassified those bonds as a short-term liability.

Lastly, before we open the call to questions, we have just received $10.3 million of cash that have been placed in escrow in connection with a business acquisition we made in 2006. The $10.3 million was reflected as a current asset at the end of Q3 of 2010 as we had anticipated in near term repayment. That concludes my remarks. Claudia, would you now like to open up the call for questions?

Certainly. Ladies and gentlemen, we will now be conducting the question-and-answer session. (Operator Instructions). Our first question is coming from the line of Tim McHugh with William Blair. Please state your question.

Yes, can you just give us a little more color on the improvement in the demand trends, and kind of reconcile that versus the sequential down tick in revenue, at least on a normalized basis. How did you -- is there something about how you saw the quarter progress, or is it just the improvement in the utilization rate that you mentioned? Can you just help us kind of reconcile those two data points?

Sure. Good morning, Tim.

Good morning.

I think a large part of the uptick in business that we talked about did come from the close in some of these larger management consulting opportunities that we mentioned during our Q2 call. Those cases were closed, and work was ongoing throughout Q3 and into Q4.

On the litigation side, as we mentioned, we did see a continuation of lead flow come in, and engagements closing. On a sequential basis, it was really impacted by two things. Really, one is the seasonality of summer months, and not dealing with the court systems. And two, the [fringe] time, typically in Q3 is much higher than that of Q2.

Okay. And I guess, are you at a point where you're expecting to get towards positive year-over-year revenue growth over the next couple quarters, and then have you seen enough from it to feel good about that?

Well, Tim, this is Wayne. Certainly, as I said in my comments, with the improving utilization that we've had over the last couple of quarters, and we feel good about it, and we feel reasonably good about the fourth quarter, we're expecting to continue to move along the path that the first -- the progress of Q2 and now Q3 has us on. We are, in terms of number of people, smaller than we were, and you're right, the absolute revenue numbers are slightly down from what they were. But the operating income, I think, speaks well to the management of resources and the expenses and headcount in connection with revenues we are generating.

Okay. And then can you -- you mentioned the new business development team. I think that's a -- certainly a shift from many years ago for the Company. Can you give a little more color on that, and how it compares to the last couple of years in terms of business development strategy?

Sure. In prior years, the revenue generating burden rested entirely on the shoulders of our consultants. So, they were out in the marketplace. They were creating the opportunities. They were carrying through on the work. In this more competitive marketplace, and also consistent with our goal to try to deepen our client relationships that we currently have, we brought on a team of professionals to help us with that outreach to the marketplace.

These professionals will be working with both our existing client network, and with client networks that they personally have developed through the years. Their job is to identify opportunities in the marketplace, and then come to CRA and to see what is the best talent we can bring to each and every assignment.

So, in a way, you can say they're acting as a middleman for the Corporation, but they're really teaming with each of our practices. They are not practice-specific resources. They are working with each and every one of the litigation practices. I think probably in the short period of time that they've been with us, they might have generated leads for each and every one of our litigation related practices. So, we are providing opportunities to all of our consultants.

Okay. And then the last topic, can you talk about the capital structure, and uses of cash? Are the repurchases lightly assigned, that's where you're going to direct more of the capital. And then I guess related to that, how you think about the capital structure relative to acquisitions and repurchases?

Tim, the way we've looked at the capital structure, I think you may generally know, we've considered a number of different avenues. We've repurchased back end number of our bonds over the last year or so, because we could do it at a discount and that made sense. And we've considered other subordinated debt deals, excuse me, convertible debt deals. We've considered expanded bank facilities, and a number of other derivatives of that type. We haven't yet decided, for a number of reasons, we wish our stock price was a little higher, in terms of doing a convertible type of deal.

We also are thinking very hard about whether or not, instead of having a large amount of cash which we've had on our balance sheet for the last number of years, that in hindsight we haven't really utilized, although we've looked at many, many deals and opportunities, we haven't utilized it. So, we're considering whether we should, frankly, have less cash on the balance sheet, and seek out and use debt when we need it, and pay the interest and the debt service on that.

The answer to those questions is, also in this very choppy market that we're looking at, it seems every other week there's a different swing in which way the markets seem to be going, we're continuing to evaluate and consider it. But I guess the underlying point I want to make is that today we have and we expect to have very handily on hand, sufficient resources to retire the bond obligation next June, assuming that's what occurs, without any additional financing. But we, frankly, don't expect to stay where we are, but as to what we'll do exactly, we're not sure. But we feel very comfortable that we control our destiny on this.

The other thing I would like to add is, our current capital resources are in no way limiting any kind of growth initiatives that we would like to undertake. In fact, our financial health and flexibility has been an asset to us in recruiting new talent, and discussing potential initiatives throughout the firm, and outside the firm.

Okay. And then last -- actually if I could slip one more in. Turnover, can you give an update on that, particularly the senior level, vice president, above type of turnover metrics?

Sure. As you know, our turnover metrics on the junior staff ranks are typically high because our analysts, associates, consulting associates typically turn over every three years on average. So you typically expect about a 30% per annum turnover in those ranks, and that's about exactly what we're experiencing now. Our senior staff turnover is still in the single digits.

Okay. Thank you.

(Operator Instructions). Our next question is coming from Joseph Foresi with Janney Montgomery Scott.

Hi, good morning. This is Jeff Rossetti calling on behalf of Joe Foresi. Just wanted to see if I could ask a question on the litigation side. You had mentioned, Paul, that the conversion rate and the lead flow was improving. Just wanted to see if the recent pick-up in M&A has impacted the competition practice, and maybe your outlook for that practice?

Sure. Any time we see an increase in M&A activity, it really impacts -- positively impacts a number of our practices, because a large part of what we do on the management consulting side is transaction related. But I can say throughout the volatility in the M&A market, our competition practice has really excelled during that entire time. They are maintaining market share on their cases, might even be gaining some. So their performance has been very steady throughout. I have not seen the kind of volatility one would expect when you're seeing M&A activity fluctuate.

Okay. And a follow-up just on, Wayne, in your comments in the 8-K filing, you had mentioned 15 positions that would be cut in the next quarter. Just wanted to see if that's on the litigation side, if you might provide any more color as to which -- if those are senior level consultants, and maybe what practices those might be taking place in?

Sure. The 8-K, as I'm sure you read, Joe, does talk about approximately 15 positions, and due to some regulatory issues, those -- that process is ongoing. And, although the individuals involved are aware of the expectation and the discussions, they're not finalized. So, I'm a little reticent to give out much more info than that until it actually is an accomplished event, which will happen shortly over the next I'd say couple of weeks.

The only other thing we can add is, the actions being taken and reviewed impact both sides of the business.

Okay. Appreciate that. And just also, you mentioned in the filing about -- on the SG&A side, that picked up a little bit this quarter as a percentage. Just wanted to see if that was primarily attributed to some recruiting, and whether it's related on the junior side or senior side?

It's a combination of things, although there were -- I think we mentioned in maybe the CFO remark section, there is a little bit more in recruiting, and there was a little more in travel. The real, I think, story is the percentage, although it may be slightly up, it's the slight difference in revenue that it's being measured against. On an absolute basis, I think we are happy with the control level we have over our SG&A costs, and as I think you know, they include what we call performance payments, which are the payments we make to outside consultants for referring work.

Many companies, maybe most, classify those types of costs as direct costs of revenue up above. We've had them down in that category for a while. So, when you take those out, and we often talk about SG&A without those in it, it does -- the SG&A costs come down to, frankly, as we get compared to others in the industry, pretty positive comparisons.

And as we've talked about in the past, we think we're positioned with very modest revenue growth. We experience much more significant earnings growth. So, I don't see our SG&A creeping up or beginning to become larger [as a good scale].

Okay. Are there any areas though where you might be recruiting for senior level positions or senior level consultants? Maybe give some insight on where you're seeing the best opportunities to pick up some of the hiring, or maybe replace some of the lost headcount from the 15 positions.

Sure. The majority of our hiring right now is, we're in the middle of our junior staff recruiting, and also our sort of MBA recruiting. So, we're on campuses now, recruiting across all of our practices. That is just sort of part of the normal calendar process.

In terms of the senior staff ranks, the focus there is really on rain-makers. We have enough capacity here at the firm, and are not currently looking to add to the middle ranks of our pyramid. The majority of the rain-making opportunities we are seeing, and there are a few on the litigation side, and I can't really say they're predominantly in one sector versus another.

Okay. Thank you very much.

Thank you.

(Operator Instructions). At this time, we have reached the end of the Q&A session. I'll now turn the conference back over to management for any closing or additional remarks.

Thank you, Claudia, and again, thank you to everyone for joining us this morning. We appreciate your time and attention, and look forward to updating you on our fourth quarter and year-end conference call. This concludes today's call. Thank you, again.

Ladies and gentlemen, that does conclude our conference call. Thank you for joining us today.