CRA International Inc (CRAI) 2012 Q3 法說會逐字稿

Good morning and welcome to Charles River Associates third-quarter fiscal year 2012 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 Financial Officer, Paul Maleh, and Chief Financial Officer, Wayne Mackie. At this time for opening remarks and introductions I would like to turn the call over to Mr. Mackey. Please go ahead, sir.

Thank you, Lewis. Statements made during this conference call concerning the future business; operating results; anticipated, expected or intended impact of restructuring actions in key hires; estimated cost savings and financial condition of the Company and statements using the terms anticipates, believes, expects, should, prospects, target, on track or similar expressions are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

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 performance and results to differ materially from any forward-looking statements made by the Company are included in the Company's filings with the SEC and in today's news release and prepared CFO remarks.

The Company cannot guarantee any future results, levels of activity, performance or achievements. The Company undertakes no obligation to update any of its forward-looking statements after the date of this call.

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 these non-GAAP items to their GAAP equivalents. Let me now turn it over to Paul Maleh for his report. Paul.

Thanks, Wayne, and good morning, everyone. Our third-quarter results reflect the initial benefits associated with our previously announced restructuring actions combined with solid performance by a number of our practices. Let me first update you on our restructuring activity and then talk about the quarter and outlook for our markets.

As previously announced, during the third quarter we eliminated two underperforming businesses and restructured select practices, all with an eye towards intensifying the focus of our portfolio, increasing the cohesiveness of our services and how we market them, enhancing our margins and profitability and ultimately improving the long-term prospects of the Company.

Within our management consulting business we closed our Middle East operations and eliminated our chemicals practice while maintaining some sector expertise with a core team of individuals within our broader management consulting business. We expect these actions will enhance profitability on a margin percentage and dollar basis going forward and lessen the drag on our overall tax rate, which Wayne will discuss in further detail.

As part of our plan we also repositioned select underperforming practices. In total our restructuring activity resulted in a reduction of more than 60 consulting staff. As previously announced, we expect the reduction in consulting staff will reduce net revenue on an annual basis by approximately $8 million to $10 million while generating an annualized cost of service savings of approximately $17 million.

We're also taking significant actions to lower our SG&A costs. In Q3 we reduced our administrative staff, lowered administrative spending on outside contractors and professional fees and eliminated excess office space. We continue to expect the majority of these SG&A savings will be completed by the end of fiscal 2012 and will generate an annualized cost savings of approximately $8 million.

We expect the shedding of these lines of business, the repositioning of select underperforming practices and the SG&A initiative to improve overall profitability by approximately $15 million to $17 million annually. We are on schedule with our plan and we expect these restructuring efforts to enhance our performance in future quarters.

With that I would like to turn to our results in the quarter. Our performance in the third quarter demonstrates one result of the restructuring, the beginning of a positive effect on our margins. Our Q3 restructuring activities helped increase our non-GAAP operating margin to 8.1% in the quarter from 5.9% in Q2.

From a top-line perspective we delivered solid results with $64.7 million in non-GAAP revenue. In addition, we generated from operations for the quarter -- we generated cash from operations for the quarter of $4.2 million.

The performance of the litigation and regulatory business was led in the quarter by strong contributions from our intellectual property, competition and labor and employment practices among others. In particular, our intellectual property practice won several large projects that resulted in more than a 50% revenue increase for the third quarter on both a year-over-year and sequential basis.

In addition, our European competition group continued to perform well, growing more than 50% in the quarter relative to a year ago and more than 30% on a year-to-date basis. Overall our litigation and regulatory business produced good Q3 results and a comparable performance level to Q2 despite some industry headwinds.

During the quarter demand for our management consulting services continued to improve from its slow start at the beginning of the year led by our Marakon practice which achieved year-over-year growth in the third quarter. Although clients remain cautious about undertaking large consulting engagements with the current economic uncertainty, we are continuing to take on new engagements.

We continue to focus on growing organically, supplemented by new senior hires. Throughout Q3 and in recent weeks we have issued a number of press releases announcing key senior hires who joined CRA in competition, finance, energy and environment, international arbitration and intellectual property.

CRA remains an attractive destination for top-tier consultants within our service areas. We expect as these consultants get fully up to speed at CRA, they will more meaningfully contribute to our revenue and operating profitability going forward. We intend to remain aggressive in recruiting additional rainmakers as well as pursuing broad-based growth across our portfolio.

Looking ahead, we remain on track to achieve our established target of double-digit non-GAAP operating margins in Q4. We believe our Q3 performance is an early indicator in demonstrating that our actions will be effective in enhancing our margins and better positioning the Company for long-term profitable growth. With that I will turn things over to our CFO, Wayne Mackie. Wayne.

Thanks, Paul. Our fiscal Q3 over Q2 improvement in non-GAAP operating income as a percentage of revenue reflects the initial impacts of the Q3 restructuring. This improvement of over 2 percentage points represents only a portion of the cost savings we expect to realize from the full impact of the restructuring.

As Paul noted, we expect to see the non-GAAP operating income increased into the double-digit range next quarter with further improvements in 2013. Moreover, the 8.1% Q3 non-GAAP income from operations includes the effect of an operating loss from our discontinued Middle East operation.

Not only did these Middle East operating results pull down our Q3 GAAP and non-GAAP operating income performance, they pushed our GAAP tax rate to an extraordinary level of nearly 170%. Our non-GAAP tax rate of 48% would have been under 40% without the impact of the Middle East operation. With the negative earnings impact of our Middle East operation behind us we expect a more normalized tax rate in Q4 and beyond.

Let me provide some other factors that you should consider when assessing our Q3 2012 performance and our outlook owing forward. In terms of consulting headcount, we ended the quarter with 485, which consisted of 351 senior staff and 134 junior staff.

We eliminated more than 60 consultants as part of our restructuring, the new influx of senior hires that Paul mentioned, along with targeted additions to our junior ranks within our practices resulting in a net decline of only 26 consultants in Q3 from the 511 we reported at the end of Q2.

Our leverage ratio of junior staff to senior staff improved during the quarter, an indicator of the progress we are making towards achieving one part of our strategy to increase overall profitability of the Company.

Our company-wide utilization for Q3 of fiscal 2012 was 67%. However, when you exclude the consultants involved in our workforce reduction that rate would have risen to 71%. This is lower than the 73% we reported in Q2 of fiscal 2012, but the number reflects the transitional effects of the restructuring activities which reduced Q2 headcount very slightly but more fully impacted Q3.

In addition, the ramp up of several of our key hires likely affected Q3 utilization. We are maintaining our target utilization in the low to mid 70s going forward.

Our non-GAAP SG&A was approximately $600,000 lower in Q3 2012 compared to Q3 2011 and essentially flat compared to Q2 2012. Commissions to non-employee experts, which are included in SG&A expenses, were a proximately $600,000 higher in Q3 2012 versus Q3 2011 and $400,000 higher as compared to Q2 2012.

If these commissions were excluded from SG&A expenses our Q3 2012 non-GAAP SG&A expenses would have been 21.4% of revenue versus 21.9% for Q2, 2012. A reduction in SG&A expenses reflects our restructuring efforts and our ongoing emphasis on expense management in order to enhance our margins.

Turning to our international operations, our international revenue contribution for the quarter was approximately 22%, which was below the 25% we reported in Q2. Despite economic conditions in that region, several of our European practices, specifically the larger competition in the Marakon practices, had a good quarter which partially offset the performance of other smaller practices in the Middle East operation.

Turning to the balance sheet, DSOs were 115 days in the quarter, flat with the 115 days we reported in Q2. We are disappointed that we did not lower DSO during the quarter. We have increased our efforts related to our DSO and expect it to return to historical levels.

DSO in Q3 consisted of 77 days of billed and 38 days of unbilled as compared to 69 days of billed and 46 days of unbilled in Q2. We anticipate that the third-quarter increase in billed DSO and decrease in unbilled DSO should translate into a stronger cash flow during the fourth quarter.

In terms of our cash position, we concluded the third quarter with approximately $42 million in cash, cash equivalents and short-term investments which is essentially flat with the end of Q2. However, I should note that during Q3 we repurchased approximately 214,000 shares of our common stock at a cost of approximately $3.4 million and paid a majority of the approximately $4.4 million of restructuring charges.

That concludes my comments with respect to Q3. I also want to cover an accounting measurement we are required to make each year that may impact our Q3 -- excuse me our Q4 non-cash GAAP results.

Each year in the fourth quarter we are required by GAAP to perform a test of the value of our intangible assets, principally goodwill or impairment. The test indicates if the value of CRA as determined under GAAP is less than the book value an impairment right down is then calculated.

If a write down is required in Q4 it may be material to our financial statements as reported under GAAP. However, any such write down would have no affect on cash or non-GAAP results of operations. Lewis, we now would like to open up the call for questions.

(Operator Instructions). Tim McHugh, William Blair & Co.

First wanted to ask if you can give us a little more clarity on how much of the cost savings were impacted or reflected in the Q3 and then as we go into Q4? It seems like you are still expecting some cost to come out of the business, so I'm trying to understand how you are getting to the double-digit margin next quarter -- just how much is revenue versus the costs coming down further?

Sure. I think when we talked about our savings we tried to break apart those savings estimates into things that impact our cost of services and things that impact our SG&A. The third bucket, which I will get to at the end, is the expected reduction in revenue. So let me begin with the cost of service estimate.

We believe that in Q3 we realized about 50% of the expected savings on a quarterly basis associated with the staff reductions. We also believe that the majority of the remainder of that savings should be realized during Q4.

With respect to the SG&A, we are probably a little less than the expected -- than 50% on the cost of service. Those savings will probably be fully materialized through Q4 and Q1 of 2013.

With respect to the expected reduction in revenue, it is probably also in the magnitude of about 50% of the $8 million annual run rate that was experienced in Q3. So let me break that down a little bit.

It is $8 million to $10 million in revenue reduction that we announced during Q2. On a quarterly basis that translates into about $2 million to $2.5 million. So in terms of what we felt during Q3 is about 50% of the revenue reduction of $2 million to $2.5 million.

Okay, that is very helpful. And then, Wayne, what is a normalized tax rate once you get past the Middle East wind down? You said 40%, is that a number we can use going forward?

Tim, that should be a reasonable number. There is opportunity for the rates to be even lower than that across the Company depending on the mix of profitability between North America and Europe. Right now the European tax rates -- UK, for example, is 25%.

Our rates here, depending on what happens following the election, when you add state taxes in at least 40%. So that's a pretty substantial differential in the tax rates. So depending on the mix of taxable income it could drop below 40%. 40% is probably a good rate to think in terms of -- as we go forward.

Okay. And then can you talk about -- you referred to some of the new hires. I think there is a large group of them that are scheduled to start middle of next year. Can you talk about the impact that those would have as well as their speculation in terms of the cost of hiring those people and what the impact on margins would be as you bring them in?

Yes, we are not prepared to reveal what the revenue impact is for those parties. There are some very significant additions that we are looking forward to having join CRA. In terms of the relation between what we paid and what we expect the impact is, they are all positive NPV projects, they are all going to be accretive in the year they join us. So we don't anticipate any margin compression through the addition of these new colleagues.

Okay. And one more on the market, you talked about -- there was comment in the press release about the litigation business was flat even though the market was tougher. Can you tell us a little bit how the market was tougher? I guess what got tougher?

I think if you look at a number of the surveys, you talk to the law firms there has clearly been an increasing headwind as 2012 has progressed. So our ultimate clients are becoming a little more hesitant to undertake large consulting engagements. They are delaying the retention of some experts.

So we have seen all these impacts, say the opportunities that we are being presented, we are converting on a great rate of those opportunities, but it is just again general headwinds that we are experiencing. With that, many of the large practices that you would expect to be impacted really have performed exceptionally well in some of those that I highlighted during the call.

Okay, great. And my last one and I will turn it over. Wayne, cash flow for the year, will you be able to be positive for the year given -- I don't know how much of an improvement in DSOs and cash flow you are hoping for.

Cash flow from operations we are hopeful will be positive for the year. It -- I guess -- well, let me actually step back. Cash flow through -- from operations through the -- through Q3 for the full year is actually $22 million negative, Tim, so I would say frankly we are not going to close that gap in Q4, although we certainly expect to be positive cash flow in Q4.

Okay, thank you.

Joseph Foresi, Janney Montgomery Scott.

This is Jeff Rossetti in for Joe. Paul, just to follow up on Tim's last question about demand. I know you had mentioned IP competition and labor and employment being healthy in the quarter. Just any commentary on the finance practice and the life sciences practices?

The finance practice performed just fine, it wasn't of the extraordinary levels that we experience when we are talking about 30% to 50% sequential year over year growth. They're maintaining the pace that they have realized throughout the year. So there is no concerns there.

With respect to life sciences, a lot of those efforts have been more on the management consulting side as opposed to the litigation side. And we also seeing improvements in life sciences as the year is progressing, but again, not to the magnitude of the exceptional performances that we are seeing in competition in Europe, IP and labor.

Okay. And is there any way to sort of quantify -- Paul, I think you mentioned that the conversion rates were improved from say a year ago. Is there any additional detail you could provide on that?

Yes, we don't provide the actual percentages. When I am talking about conversion rates, clearly CRA gets business opportunities. So these are leads that we have. And when we talk about conversion rates it is our ability to take one of those opportunities they've converted into a revenue generating project.

So we track how we do on converting opportunities into revenue. And the Firm has done really well in those situations. We track it because, one, it's an indication of the market we are facing; but two, it is also one of the best indicators of how we are doing relative to our competitors, whether we are winning competitive assignments and how our share is looking as the market as a whole.

We have not seen any negative trends on those ratios over time. So we are pleased with that, we would love to have more opportunities, but we are happy with our conversions.

All right, thanks. And, Wayne, I think you had mentioned in your comments that the recent hires had impacted utilization for the quarter. Was there any revenue contribution from the recent hires and how do you see maybe utilization heading into Q4 given that there is going to be -- it is seasonally weak given the holidays?

Go ahead, Paul.

Let me start with utilization. I guess we are going to maintain our utilization goal of low to mid-70s utilization in Q4 and beyond. We believe there is no reason why our portfolio shouldn't be able to deliver those results going forward.

With respect to the new hires, to date they have met our expectations. With any new hire there is always a ramp-up period. We are pleased with the opportunities they are presenting and also pleased with the conversions they have had year to date. There has been a positive contribution on the revenue line from these new hires, but really nowhere near what we anticipate to be their full capacity contribution.

Thank you.

(Operator Instructions). David Gold, Sidoti & Company.

A couple of things, one -- the easy one, Wayne, I think you gave a number of 485 for headcount at quarter end. I was curious if you can also give an average number?

Well, the quarter started with 511, David; the 485 obviously has a number of things in it. It has the over 60 consultants who had left the Company as part of the restructuring, as well as the seasonal new hires that come in.

We don't have an exact average that we have calculated for it, but clearly it swings. I would say the restructuring, as I think you know, occurred -- was announced at the end of July. Obviously everybody didn't leave that day so it took a little bit of time for those folks to roll out. The new hires, again, start arriving during the July, August and even September time frame. So it is very much a blended rate that would occur between that 511 and 485 (multiple speakers).

I mean, if you wanted to think of it in terms of an average, the fact is that many of the impacted -- our impacted colleagues who left as a result of the restructuring left towards the end of August into September with our new hires happening earlier on. So if I were to look at an average headcount it's probably north of the 485. But we don't necessarily compute that number.

Okay, that is helpful. And on that topic, can you speak a little bit about -- obviously we've seen some of the hiring which you've done. But practice areas where you still basically are seeing either strong enough demand or not enough talent, were you are still hiring?

I like my portfolio. And right now I am not hesitant to hire across any of the practice areas that comprise my portfolio. And that goes from our smaller practices; we are looking for opportunities all the way to our largest practice competition. Competition has enjoyed a wonderful year on recruiting ranks.

And I think that speaks to the fact that there is still room in the marketplace for that practice to grow significantly and it is about as attractive a destination as professionals out there in the marketplace see. So we believe there are opportunities for expansion across all these practice areas.

Okay. And then on Marakon management consulting returning to growth. Obviously an easier comp last year. But I think you also commented in the release a pickup in demand there. And was curious if you can also give some color on that I guess given some of your commentary that folks are a little slower to spend yet you have seen some success there.

I think, you know, let me talk a little more broadly about management consulting and not necessarily only specifically about Marakon. I think our management consulting practice received quite a bit of negative press in the beginning of the year, but to a consultant across this organization they took responsibility and have largely reversed that slow start. And that is by finding new opportunities in the marketplace, by doing an exceptional job on converting those opportunities and maintaining margins through that whole process.

So we have had a lot of pick up that has occurred through the year. They are working hard. Is it a tougher environment? Yes. I don't think there is any way else to say that when you look at the global economic uncertainty that we are seeing in Europe and in North America. But the quality of the work is speaking for itself, the referral network is paying dividends and we continue to see new opportunities and conversions all the way into October here.

Perfect. Thank you both.

There are no further questions at this time. I would like to hand the floor back over to Mr. Maleh for closing comments.

Again, I want to thank everyone for joining us today. As always, we do appreciate your time and interest in CRA and we look forward to updating you on our year-end conference call in early 2013. This concludes today's call.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.