CRA International Inc (CRAI) 2014 Q2 法說會逐字稿

Good morning and welcome to Charles River Associates second-quarter fiscal year 2014 conference call. Today's call is being recorded. 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, Mr. Paul Maleh; and Chief Financial Officer, Mr. Wayne Mackie. At this time for opening remarks and introductions, I would like to turn the call over to Mr. Mackie. Please go ahead, sir.

Thank you, Manny. Statements made during this conference call concerning the future business, operating results, tax rates, and financial condition of the Company, including statements regarding the quality of its portfolio, its project lead flow, its conversion rates, its financial position, the ability of its assets to grow profitably, and statements using the terms expects, balanced approach, long-term goal, objective, positioned, planned, target, 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 Securities and Exchange Commission and in today's news release and prepared CFO remarks.

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 we will be referring to some non-GAAP financial items on this call, including adjusted EBITDA. I would encourage everyone to refer to today's earnings release for a full reconciliation of these non-GAAP items to their GAAP equivalents as well as the calculation of adjusted EBITDA, based on GAAP and not GAAP results.

Let me now turn it over to Paul Maleh for his report. Paul?

Thanks, Wayne, and good morning, everyone. Our performance in the second quarter of fiscal 2014 reflected strong contributions across our portfolio. Company-wide utilization for the quarter was 78%, consistent with the sequential first quarter and up significantly from 67% a year ago, driving revenue growth on a non-GAAP basis of 20% year over year and 2.4% from the sequential first quarter.

In terms of improving our profitability, CRA delivered non-GAAP adjusted EBITDA margin of 16.8% in Q2 of 2014, up from 14% a year ago.

Before discussing other Q2 performance highlights, I want to briefly describe the path that led us to this stretch of strong performance. In July 2012, we announced a strategy to improve CRA's performance and better position the Company for growth.

We delivered a comprehensive restructuring plan and eliminated our chemicals practice, while maintaining our core expertise within Marakon, closed the Company's Middle East operations, and repositioned other underperforming assets. During the past 24 months, we have focused our portfolio on areas where we have a track record of profitable growth and committed significant investments towards enhancing our core offerings.

At the same time, we stabilized our cost structure by more efficiently managing our administrative services, eliminating excess office space, and lowering our administrative spend. Our objective was to set the stage for topline growth and then leverage that growth to ultimately achieve consistent revenue expansion.

Our results have demonstrated that this strategy is working well and that our core assets can grow profitably. Since implementing this strategy, revenues have grown 8% and adjusted EBITDA is up 35%. These non-GAAP metrics are based on the 12-month period ending June 28, 2014, measured against the 12-month period ending on June 30, 2012, which included the divested businesses.

These results demonstrate our ability to deliver solid performance even while overcoming the headwinds that originated from the divested practices. We restructured, we reinvested, we grew organically and through strategic new hires, and as a result, CRA is now positioned for further long-term growth. CRA's healthy financial position gives us the flexibility to pursue new hires and acquisitions that support the offering in our portfolio.

Through a balanced approach of organic investments and strategic acquisitions, and assuming a stable economy, our long-term goal is to consistently deliver topline growth in the mid-to-high single digits on an annualized basis.

We are focused on growing our current assets, with the antitrust and competition economics, finance, life sciences, and Marakon as our primary areas of investment. With that as a backdrop, let's move to some additional color around Q2 of fiscal 2014 year.

During the second quarter, revenues grew both sequentially and year over year, led by solid contributions from our litigation and regulatory and management consulting businesses. In the litigation and regulatory, our antitrust and competition economics practice had another strong quarter.

The market for large-scale M&A transactions is at a level not seen in several years. Our team of consultants are working on many of these high-profile projects, and their efforts are far-reaching, assisting clients across a range of sectors and regions around the globe.

For example, during the second quarter, we advised on a significant antitrust investigation involving advertising practices in North America. In Europe, we assisted ALSTOM in settling its UK lawsuit with National Grid over collusion in the delivery of electrical substations.

In addition, our antitrust and competition economics and finance practices continue to team on matters involving investigations related to benchmarks in the financial services sector. In another significant engagement, the labor and employment practice played a key role, assisting the Association of Private Sector Colleges and Universities with a response to the gainful employment debate and proposed legislation by the Department of Education.

Within management consulting, Marakon delivered both sequential and year-over-year growth. From a demand perspective, Marakon has seen client needs shifting towards addressing strategy and growth questions again for both enterprise and business units.

Consistent with this shift, Marakon is actively working with several large players in the banking, insurance, and asset management sectors on how best to deploy their capital to grow. Marakon also continued to advise a large pharmaceutical consumer care business on its growth strategies in emerging markets and within its core US franchise.

Additionally, in the strategy area, during the quarter, the life sciences practice assisted clients with such areas -- such issues as therapeutic category positioning strategies, local market product implementation plans, patient-centric strategies, and project launch and evaluation work.

CRA's overall portfolio quality is high, project lead flow is strong, and project conversion rates continue to improve. Despite overall project inventory being healthy, we are mindful that the summer months typically impact both the demand and the supply side of the equation.

With that, I'll turn the call over to our CFO, Wayne Mackie. Wayne?

Thanks, Paul. As a reminder, a more detailed report of my remarks on the financial results can be found on the investor relations section of our website. Right now, I will cover a few key metrics.

In terms of headcount, we ended the fiscal second quarter with 424 consulting staff, which consisted of 331 senior staff and 93 junior staff. This is a decrease of 25 consultants from the 449 we reported at the end of Q1 of fiscal 2014.

It's important to point out that during Q2 2014, we had no departures of key revenue generators. Moreover, timing differences explain the headcount decrease in Q2, as many junior staff departed shortly before quarter end to return to school and new junior level hires began to arrive and will continue to do so throughout the third quarter.

Factoring in these considerations, Q2 headcount was relatively flat with Q1 of 2014 and we expect consulting headcount to return to approximately 450 by the end of Q3.

In terms of our operations, GAAP SG&A expenses for Q2 of fiscal 2014 decreased to 22.3% of revenue compared to 23.6% of revenue for the same period last year. Non-GAAP SG&A expenses, after adjusting for commissions to nonemployee experts of $2.7 million, decreased to 18% of revenue compared to 19.6% of revenue in the second quarter of last year.

The decrease in SG&A as a percentage of revenue was primarily due to our ability to continue leveraging our cost structure during revenue growth.

Q2 2014 non-GAAP gross margin grew to 32% compared to 30.2% in Q2 of fiscal 2013 and 31.4% in Q1 of fiscal 2014. These improvements in non-GAAP gross margin percentages reflect the high revenue in Q2 2014 compared with lower client reimbursables -- coupled with lower client reimbursable expenses, which are included in revenue but carry little or no margin, partially offset by an increase in consultant compensation.

In addition, adjusted EBITDA based on non-GAAP results increased to $12.9 million, or 16.8% of revenue, compared to $9 million, or 14% of revenues, for Q2 of fiscal 2013 and $12.1 million, or 16.1% of revenues, for Q1 of fiscal 2014.

The effective tax rate for the second quarter of fiscal 2014 on a non-GAAP basis was 49.3%, reflecting a non-cash tax expense of $750,000 or $0.08 per diluted share related to the correction of an error in the valuation deferred tax assets in our historical financial statements, which is unrelated to current operations.

Excluding this non-cash tax expense, our non-GAAP tax rate would have been 37.5%. For the full 2014 fiscal year, we estimate our non-GAAP tax rate to be in the low 40% range, including the effect of the $750,000 nontax cash expense. We expect our effective tax rate for the second half of 2014 to be in the high 30% range.

Turning to the balance sheet, our DSO at the end of the second quarter was 108 days compared to 100 days that we reported in Q1 of fiscal 2014. DSO in Q2 of fiscal 2014 consisted of 74 days of billed and 34 days of unbilled compared to 64 days of build and 36 days of unbuild in Q1 of fiscal 2014.

While we're not happy with the growth in DSO, the client primarily attributable -- is primarily attributable to the timing of receivables rated to large, quick moving projects during Q2, and we are comfortable that there has been no deterioration in the collectibility of our accounts receivable. We continue to target a DSO level of 100 days or less and expect to return to this level in Q3 of 2014.

In terms of our cash position, we concluded the second quarter of fiscal 2014 with approximately $27.6 million in cash and cash equivalents. This is down from the $32.5 million we reported at the end of Q1 of fiscal 2014. Principal drivers of the reduction in cash from Q1 were the payment of 2013 bonuses to employees, the repurchase of 157,000 shares of common stock, and the increase in DSO I mentioned.

That concludes my remarks, Manny. We would now like to open the call for questions.

(Operator Instructions) Joseph Foresi, Janney Montgomery Scott.

Hi, good morning, this is Jeff Rosetti in for Joe. Thanks for taking my questions. Just to start out, just wanted to see if you could tell, Paul, maybe describe which practices maybe surprised you in the quarter? I know you had mentioned there was strength across the portfolio, but was there any particular areas that drove the strong growth for the quarter?

I can't really call it a surprise, but competition continued on its exceptional ways. They have a very strong position in the marketplace and are getting their fair share and more of these mergers that you've seen announced over the past several months.

So clearly they were the leader of the pack in terms of our portfolio performance. But again, we are not achieving these kind of high rates of utilization and profitability by only one practice or one segment of the portfolio thriving. But we will take the kind of superb performance of competition any day.

And you mentioned the conversion rates and project lead flows and is it continuing to improve -- and am I just assuming that that's broad across the portfolio? Are there any kind of new catalysts that might be coming up, like, say, high-frequency trading in your work with -- that you are doing for banks?

We are real pleased with the improvement in the conversion rates. And when we talk about the quality of our portfolio, that addresses the improvement in productivity. That addresses the lead flow that we've been having, but even more importantly for me, it also addresses the high conversion rate.

We have top people and when we have opportunities to present our qualifications to clients, we more often than not get retained on those engagements. And that's pretty much across the entire portfolio that we are seeing this improvement.

Our relationship with the financial sector on the legal regulatory side continues to build and we're getting brought in to all of their most pressing legal regulatory matters. I won't comment on the high-frequency trading, since it's sort of in its infancy, and those have not been disclosed in terms of our involvement or lack thereof.

Okay. And I think Wayne addressed the headcount on the junior side. Just saw there was a slight downtick on the senior side. Are there -- could you maybe discuss if there are any plans for hiring in the back half of the year on the senior side? Any particular areas that you're focusing on?

I guess we're looking to fill out the entire staffing pyramid. So we would like to hire more junior staff. We would also like to hire more senior staff. The revenue demand remains strong and we would like to continue to fill out that pyramid. So we are active in the marketplace, looking for talent to help bolster our service offering.

Jeff, as I mentioned, no key revenue generator was -- left the Company in the last many months and so that was clearly not part of this. This is really at the lower level and it's truly timing in terms of folks going back to school and I think wanting to depart earlier, which is a trend that many folks tend to want to take a month or two off before they enter grad school, which is what most of the individuals involved had done.

Okay. And then last for me -- I think you may -- on the cash flow side, when you discussed the DSO, but is there any kind of deviation from maybe what you had previously thought about for 2014 for free -- in terms of free cash flow?

No, I think the blip in DSO, I think I touched on in the CFO report, was roughly $7 million to $7.5 million. Had we kept our DSO where it was at the end of Q1, we would have improved our cash flow for the quarter by about that amount. So we, as I said, have -- are very convinced that this has got nothing to do with a deterioration in the AR.

And in fact, it's, in a way, it's a good thing. With increased revenue and there was a good clip of work and revenue generation going on during the last month or so of the quarter -- as you noted or probably noted, the unbilled actually went down a couple of days.

So it wasn't a matter of getting bills out, it's just that when you get bills out towards the latter part of the month, they don't necessarily get collected in just a few days. So we think that this will turn this around very quickly here in Q3.

Thanks and congratulations on the results.

David Gold, Sidoti & Company.

A little bit of follow-up and then a couple of other questions. First, obviously, clear that you've seen the benefit of the robust M&A environment and second quarter was a particularly strong one for transactions announced. But curious if you can add some color there as to your outlook in the large assignments that you are picking up -- how long these might run for?

It's always hard to predict, particularly in the M&A. It all depends on the regulatory process. What I can say is we have both the active portfolio in terms of current cases and new retentions continue to come in that we haven't started billing on. So we are cautiously optimistic as we look at Q3 and beyond in terms of the workflow from those opportunities.

Got you, okay. And maybe it would help -- can you give a little bit of a sense of the 20% topline -- a little bit of a sense of the breakdown in that? Maybe how much of it was M&A driven, if you will, or maybe just which -- between the two segments and what growth looked like?

We are always happy to report a 20% topline growth, but the other thing we have to take in consideration -- and I'm sure our investors are, too -- is the second quarter of last year was quite disappointing, where the portfolio underperformed. So the fact is we expected to deliver significant improvement over that and we have.

I think what is equally or even more exciting than that 20% topline growth year over year was the continued sequential improvement that we're having. Roughly 2.4%, 2.5% on a quarter-over-quarter basis will yield a nice annual revenue expansion there.

With respect to what parts of the portfolio, if I were to go through our service offering, it's really hard to point to a practice that has not had a revenue expansion year over year. And competition really had a very respectable solid quarter and second quarter of 2013 and they have far surpassed that performance.

But I can say that for Marakon, I can say that for finance, for life sciences, and all of the other practices. And in addition, also across our geographies. So we're very pleased with the way the portfolio is contributing.

Got you, okay. And then shifting for a second to utilization -- running at a nice clip. Presumably you want to bring some heads on, but thoughts there as to sustainability and is there potential upside from here?

I'm looking for revenue growth to come from an expansion of headcount. We're going to be active in the labor markets to bring on new talent here. Is there opportunity for within a quarter to see utilization above 78%? Yes, of course there is.

But quite frankly, a lot of things are working well to deliver that kind of utilization. What's been encouraging is even though the utilization has been pretty constant at that 78%, 79% clip for the last year, it is different practices that have had sort of high points in those various quarters.

But going forward, it's through headcount expansion. We were able to enjoy revenue growth over the last 12 months year over year because of the improvement in productivity or utilization. I don't think that's going to be the case going forward.

Got you, okay. And then one other thing -- in the release, you noted a plan to profitably deliver topline growth in the mid-to high single-digit range. And I guess the comment in there was it's organic and acquisition. Can you give a little bit more color on the organic component of that and what your expectation would be long term?

You know, I would always like to see a nice mix. If I can get anywhere near a equal contribution between organic and inorganic expansion, I think that's good for the portfolio. It's good for the integration of those assets, and I think it's also good for our shareholders. Purely acquisitive strategies are difficult to implement and difficult to enjoy the benefits of, so that is not our plan.

When I talk about mid-to-high single digits growth, if I look at this portfolio that I have today over the last five years, the fact is they've delivered a high single-digit growth. And thus, it gives us confidence to continue to reinvest in those assets and to thrive for those growth levels.

Perfect. Perfect. Thank you.

(Operator Instructions) Tim McHugh, William Blair.

Can you give us a relative size or rough size of how big the competition and antitrust practice is at this point?

No (laughter). Competition and the antitrust practice has been the largest practice at CRA for as long as I've been a part of the organization. I've been here 25 years. So it is clearly the leader of the portfolio and it is probably the largest practice by close to a factor of two, relative to the second largest practice in the firm.

But the great thing that we're seeing now is you are seeing a lot of collaboration from our competition practice with a lot of other practices that are enabling us to bring the best talent to bear for various client assignments. I know we've highlighted numerous times the work we are doing for the financial institutions that wouldn't have been possible without the brands and market presence of the competition unit.

So they are our largest practice, but the exciting thing for me is I don't think they are near capped in terms of what their growth opportunity is in the marketplace.

Okay. I don't know if I missed it, but just the general securities litigation piece -- I understand competition is driving good growth on kind of the overall litigation practice, if you will, but the bread and butter securities litigation, has that environment improved or how would you describe it? Steady, improving, I don't know.

It's an interesting question in that for a good part of my career, when I was within the finance practice, securities litigation was sort of like, as you said, the bread and butter of much of our finance offering. There's been a shift in that marketplace. I think filings are down or the level of litigation is down in those arenas.

Our finance-related work has been much more focused to devaluation disputes and also assisting the financial institutions on these various investigations. But our success has not been driven by the security side of the equation.

Okay. You made some comments about large projects and I think quickly moving ones, even. I guess -- I know that's always part of the business. I know earlier you made a comment about there's some new work coming in you haven't even started on, but are these particularly large?

I guess that we need to be cognizant of when they step down that it will be a headwind or how do we think about the [grove] or at some point on these -- how challenging or not challenging will it be?

Sure. They are sizable projects with respect to what our typical experience is here at the Firm. But what we've been able to do is to keep -- again, when we referenced our lead flow and project inventory, that is sort of an indicator of our confidence on our ability to replace cases that are winding down.

Is there a little bit of volatility as that happens? Of course. If you have a large team of people working on one engagement and the case goes away, there's a transition period. But that's where the importance of getting contributions from across that portfolio to sort of cover up that temporary weakness.

But to directly answer your question is I do not envision during Q3 having the ending of one assignment to play a significant role in the overall corporate performance.

Okay. Oh, I guess even if we look out the next [four quarters], are any of them of the magnitude that -- when they end, is it going to be --

Very few of these merger cases really goes on much past one or two quarters.

Okay.

They're usually very high intensity matters, but they're usually relatively short lived. So it's clearly not going to have an impact four quarters out.

And the headlines we saw just in the last three, four months about major acquisitions -- that's -- I guess I'm trying to -- just make sure I understand the pace at which that converts to work for you. Those are the sorts of projects you're most likely working on already or is there -- how much of a lag would there be?

I think that's pretty safe to say. I mean pretty much the headlines that you're seeing with respect to the merger work and the investigations are what's really fueling our work and has been, for that matter, over the last 12 months.

Okay. And then can you talk about recruiting -- I know you said basically you expect at this point to or you hope to grow mainly through growing headcount, given how high utilization is. And I know you -- Wayne, you explained why it was down sequentially, but -- and it will bounce up a little bit even -- but, you will still, it sounds like, be kind of relatively flat in Q3, so it seems like you have to really crank up the recruiting engine as you go into next year, or late this year going into next year, I guess.

Where are you -- can you give us more color on the strategy or how you're going to do that or if you're doing anything differently to try and ramp that up. And I guess what type of headcount growth might -- three or four quarters from now might you hope to be seeing?

I think we would like to see headcount growth in the mid-single digits across the Firm. I mentioned the four practice areas where I think the focus is going to be on. But you're exactly right -- we need to crank up all phases of our recruiting cycle, given the fact that the benefit of the 2013 recruiting cycle has already really hit the Company right now.

A lot of our interim efforts are going to be in the secondary marketplace. What's great about that is the opportunities that are crossing our desk, not just for group hires but also the individuals, is really rather healthy.

You bring smart people into an organization, you're going to be able to recruit other very talented individuals and we are enjoying that benefit right now. We are working on the most interesting matters and we really have very talented colleagues here. So I'm hoping that will translate to success in the secondary market for us.

Okay. Well, thank you.

Thank you. At this time, we have reached the end of the question-and-answer session. I will now turn the conference back over to Mr. Maleh for any closing or additional remarks.

Okay. Thank you, Manny. And thank you to everyone for joining us today. As always, we appreciate your time and interest in CRA and look forward to updating you on our progress next quarter.

With that, this concludes today's call. Thank you.

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