CRA International, Inc. (CRAI) Q2 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Charles River Associates Second 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 Executive Officer, Paul Maleh; and Chief Financial Officer, Wayne Mackie. At this time, for opening remarks and introductions, I will turn the call over to Mr. Mackie. please go ahead, sir.

Thank you, Donna. Statements made during this conference call concerning the future business; operating results; anticipated, expected or intended impact of restructuring actions; estimated cost savings and financial condition of the company and statements using the terms: anticipates, believes, expects, should, prospects, targets 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 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. 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 the call over to Paul Maleh for his report. Paul?

Thank you, Wayne. Our performance in the second quarter of fiscal 2012 reflected strong contributions by select core practices, notably the Competition and Marakon practices. However, our second quarter results were below expectations as several underperforming practice areas affected CRA's overall performance. In response to this performance, we are taking decisive actions intended to bring CRA back on track. Before discussing our Q2 results, I will provide some context and describe the actions we are taking. Let me first say our core business is healthy. The Litigation and Regulatory business led by our Competition and Finance practices produced a solid profitability and is an attractive platform for leading talent in the economic, finance and accounting, consulting space. Our lease flow and project startups have held steady over the last several quarters. The Management Consulting business, while occasionally susceptible to greater swings in quarterly performance, has demonstrated solid annual contribution and also continues to see an active pipeline of work. Underperforming practice areas in both lines of business, however, have overshadowed the performance of the core portfolio. Firmwide utilization declined to 70% for the second quarter of this year, relative to 74% for the second quarter a year ago. If we were to adjust for the restructuring actions that we announced today, the firmwide utilization for the second quarter of fiscal 2012 would have increased to 73%, demonstrating the continued health of our core assets. We are focused on 3 goals, which should improve performance and better position the company for growth. First, greater focus of our portfolio on areas where we have a track record of growth and profitability. Second, an increase in the cohesiveness of our services and how we market that. And third, significant improvements in margins and profitability. To achieve this, we have worked with our leadership group to develop a comprehensive restructuring plan and we are now in the process of eliminating 2 underperforming business units while restructuring others. In the Management Consulting business, we are taking 2 steps. First, we are eliminating our Chemicals practice. The sector expertise remains in a core team of individuals within our broader Management Consulting business. Second, we are closing our Middle East operation. The Middle East operation and the Chemicals practice have substantially underperformed and created a drag on both our top and bottom line results. We expect these restructuring actions will improve the performance of our portfolio going forward. Our overall restructuring plan also includes repositioning other select underperforming practice areas. The combination of all of these restructuring actions will result in a reduction of approximately 55 consulting positions. Some of this began in Q2 as we ended the quarter with a headcount that was about a dozen lower as compared with Q1. Based on the 6-month year-to-date 2012 performance of the total restructured operations, we expect that these reductions will reduce net revenue on an annual basis by approximately $8 million to $10 million and generate annualized cost savings of approximately $17 million. Commensurate with these consulting staff reductions, we are also taking significant actions to lower our SG&A cost by reducing our administrative staff, eliminating excess office space capacity, better rationalizing remaining office space and lowering administrative spending, particularly related to outside contractors and professional fees. We expect the majority of these actions to be completed during the third and fourth quarters of fiscal 2012 and to generate annualized savings of approximately $8 million. We expect that once completed, the consulting staff reductions and the lowering of SG&A costs will improve our operating profitability on an annualized basis by approximately $15 million to $17 million and will put us on track to achieve double-digit non-GAAP operating margins by the fourth quarter of fiscal 2012. This restructuring should have even a larger effect on margin performance as its cost savings are realized over time. As a result of the organizational changes, the company expects to take a third quarter restructuring charge of approximately $3.5 million to $4.5 million. These actions are always difficult because of their direct impact on our most important assets, our people. However, the net result will be a more focused and cohesive CRA, which should benefit our clients, our employees and our investors. Let me turn to a recap of our second quarter performance. Looking at the performance of our 2 business lines, revenue within our Management Consulting business rebounded from a slow Q1. In particular, the Marakon practice showed strong improvement with Q2 revenue nearly doubling from Q1. However, Management Consulting overall remains below its historical levels, largely due to the performance of the Chemicals practice and Middle East operations. With regards to other Q2 performance highlights. Our Litigation business did not repeat the high level of revenue it achieved in Q1. While the Competition practice had a great second quarter with its revenue representing the third highest quarterly level since fiscal 2008, it was down from Q1 in which it delivered its highest revenue total in nearly 5 years. Overall, non-GAAP revenue for the company in Q2 of fiscal 2012 decreased 2% sequentially and 17% on a year-over-year basis. On a positive note, we were active during Q2 in recruiting and pursuing acquisition opportunities that can help drive growth. We have been successful in attracting leading academics to our Litigation and Regulation business as evidenced by a number of announcements of noteworthy senior professionals joining our core practices. This included renowned economist Professor Kevin Murphy, widely regarded as one of the top economic minds in the world who has entered into an agreement to become a senior consultant to our Antitrust & Competition Economics practice. Along with Professor Murphy, we announced that Professor Mark Zmijewski, a leading authority on Financial Accounting & Valuation matters, entered into an agreement to become a senior consultant to our Financial and Accounting Valuation practice. In addition to these professors, who we expect to begin working with CRA in May 2013, we hired other revenue generators in the quarter across core practice areas in, Competition, Energy and Environment, International Arbitration and Life Sciences. We expect that they will be strong contributors to growing these offerings in the years ahead. Looking ahead, we expect that the comprehensive actions that we announced today will put CRA in a stronger operational, financial and competitive position and will continue to contribute to our prospects for profitable growth. The underlying demand for CRA's services remains intact, and we believe sizable opportunities remain for our core practices. We continue to see a reasonably strong pipeline of committed and highly probable engagement. In addition, we remain active in the recruiting marketplace. We are seeing a healthy talent pipeline and we expect to continue to announce new senior talent additions to the firm. As Wayne will highlight in his remarks, we are well capitalized and have the financial flexibility to pursue new hires and strategic acquisitions that support the offering in our portfolio. With that, I will now turn the call over to Wayne for a review of some financial metrics.

Thanks, Paul. I'd like to walk you through our key financial metrics and other factors that you should consider when assessing our Q2 2012 performance and our outlook going forward. One, in terms of consulting headcount, we entered the quarter with 511, which consisted of 383 senior staff and 128 junior staff. This is a reduction of about a dozen consultants from the end of Q1 and reflects 11 consulting staff who left CRA in connection with our in-process restructuring actions. Two, our utilization of Q2 of fiscal 2012 was 70%. This is up from the 68% we reported in Q1 but lower than the 74% we reported in Q2 of fiscal 2011. Many of the restructuring actions that Paul detailed in his remarks are expected to improve our utilization rate going forward. In terms of our operations, non-GAAP SG&A declined by approximately $750,000 compared with Q2 of fiscal 2011. However, on a percentage basis, the non-GAAP SG&A increased in Q2 to 23.8% compared to 20.8% in fiscal -- in Q2 of fiscal 2011 as a result of the low revenue we reported in this quarter. The $750,000 reduction on an absolute dollar basis reflected our low revenue, as well, but also reflects our continued emphasis on expense management. We also recorded an approximately $1.4 million pretax restructuring charge, including $1.7 million associated with the surrender of one floor of our office space in London at the end of the second quarter of fiscal 2012, partially offset by approximately 350,000 reserve adjustment associated with the reopening of a portion of our Houston office space. Turning to our international revenue tax rate. Our international revenue contribution for the quarter was approximately 25%, which was above the 20% we recorded in Q1. However, we recorded overall losses in our international operations this quarter, which includes the effect of the restructuring of our London office space. A portion of the London office restructuring cost is not tax-deductible. This resulted in an unusually high tax rate of 71% on a GAAP basis and 45% on a non-GAAP basis. These high GAAP and non-GAAP tax rates drove down our quarterly -- drove our quarterly profitability further down. Turning to the balance sheet. Our DSO was essentially unchanged at the end of Q2 as compared to Q1. DSO were 115 days in the quarter compared to 114 days we reported in Q1. Our conversion to a new enterprise-wide financial reporting system that we announced earlier this year is now complete. Our transition to this new system should assist us in our efforts to return DSO to a more normalized level in the quarters ahead. We continue to target a DSO level below 100 days. In terms of our cash position, we concluded the quarter with approximately $42 million in cash, cash equivalents and short-term investments. As expected, this is down from the $51 million we reported at the end of Q1 as we paid the remainder of our annual bonus compensation to our staff for fiscal 2011 performance. In addition, during the second quarter, we purchased approximately 130,000 shares of our common stock at a cost of approximately $2.6 million. I'll conclude my remarks by stating we continue to be in a strong capital position as we move forward with our restructuring activities. We have essentially no long-term debt and more than $40 million in cash, cash equivalents and short-term investments on our balance sheet and continue to have access to a $60 million credit facility as needed. With this substantial flexibility, we remain confident that we can execute our corporate strategy going forward. That concludes my remarks. Donna, we would now like to open up the call for questions.

[Operator Instructions] Our first question is coming from Joseph Foresi of Janney Montgomery Scott.

So I guess, maybe you could give us a little color on what caused the underperformance of the consulting groups that you're moving away from? Were they demand based, were they consultant specific? And then within the same sort of thought process, maybe you can give us some color around your vision of the realignment.

Sure. The underperformance, as we mentioned in our discussion here, had a lot to do with the Chemicals and the Middle East practice. That's not to say it had everything to do with those 2 units. With the Chemicals and Middle East practice, what was frustrating for everyone, for CRA and the individuals in those practice, is the inconsistent performance of those business units across the last several years. We thought we took a significant step forward in 2011 as they return to more average levels of profitability. But we took a big step back in the first quarter of 2012. We began taking actions to try to reposition them. We did not see any improvements in the performance as a result of those actions, and thus proceeded to the restructuring that were described. Both units in 2012 struggled to even cover the labor costs and that's even though it's always difficult to say goodbye to colleagues, it was clearly the right decision for the organization. With respect to the other business units, there were a handful of underperforming practices. And what we did is we tried to adjust the supply side or the consulting numbers to the demand that we're observing in the marketplace and to see if we can better position those assets for success in the marketplace. But the majority of the headcount reductions that we talked about and the anticipated cost savings, probably ballpark about 2/3 for both, relates to the Chemicals and the Middle East operations.

Okay. And just your vision sort of on the realignment, where you're planning on focusing and how you came up with that strategic plan?

Sure. The realignment, for me, I've been in this area now for 23 years, is really going back to our strength of what we do best. CRA is a leading name in the litigation and regulatory space and has been throughout its history. And those business units have performed incredibly well during my entire tenure here. And in fact, continue to perform very well in this challenging marketplace. The Management Consulting segments that we've decided to keep are segments that closely aligned with our core belief of superior analytics and functionally-led services. And we believe that the business units that exist within auction, Life Sciences and the Marakons are true to CRA's core beliefs. So it's just going back to what we do best. We believe we can reduce the volatility that we've observed in our performance over the past several quarters. And not just reduce the volatility, but improve the level of profitability that we have experienced at CRA.

Okay. And maybe you could talk a little bit about -- you've talked about the large cash balance. Any particular targets as far as the deployment of that acquisitions, Managing Directors and what are you looking for in the characteristics of those acquisitions?

Sure. The one thing that I'm hoping is not lost on many of our actions on the announcements of the professionals who have decided to join CRA is the fact in the past couple of years, we have worked really hard to make our platform more attractive to our existing consultants and to make it more attractive to potential recruits. It's not that CRA was necessarily the highest bidder when you're talking about the names and the reputation of the people we recruited. Quite frankly, they can extract similar rents at other organizations. But it was the platform and their confidence that our platform can deliver success for them and the team that will support them going forward. So with that, that gives us a wonderful launching point to use our capital effectively because we can continue to recruit the best and brightest into this organization. We are going to begin with, as you turn Managing Directors or revenue generators first on those recruiting efforts, and then fill out their team afterwards. Given what the utilization is within the firm even within the core assets, we have the capacity that enables us to fill in the pyramid afterwards as opposed to having to lead with larger teams at this stage.

Okay. And then just lastly, any commentary you might have on any particular catalyst in the business that may help buoy, I guess, revenues as we go through the transition?

There's necessarily no new catalyst. While we've been very impressed with despite the economic uncertainty and turmoil that's existing in Europe, our larger European practices are performing exceptionally well and our Competition Practices is having one of their better years in recent history. The Marakon practice in Europe, during Q2, is performing comparably to what they did a year ago. So there are clearly opportunities that they're taking advantage of within the litigation market. We haven't seen any large changes to, say, in terms of outside new catalysts. But we're continuing to position this firm for success in the market.

Our next question is coming from Tim McHugh of William Blair & Company.

First, I want to ask the $8 million to $10 million of kind of revenue impact from the departures you highlighted, what is that $8 million to $10 million relative to? I'm assuming these businesses were lower than normal in the last couple of quarters. But is that relative to even first half of this year or is that relative to last year?

Yes. I apologize for not being more clear then in the press release or in the discussion piece. What we did is we looked at the impacted individuals or practices during the first 6 months of 2012, so that's quarters 1 and 2. We've looked at what the actual realized revenue was during those 2 quarters and annualized it.

Okay. So I mean, relative to what it was in 2011, would that have been a bigger number? Is that fair to...

If you looked in 2011, there was a significant decline by those assets from 2011 to 2012.

Correct.

Okay. And then, as you look forward now, what is the mix between kind of the Litigation and the business consulting or Management Consulting look like going forward? And how much of that Management Consulting is now basically Marakon given the changes?

Right now, in terms of the overall balance, it's probably shifted a little more towards Litigation. We'll have a better idea coming out of Q3 as to what that balance is. But going forward, this is not necessarily deemphasizing of Management Consulting. Within that space, we still have other practices. Like as I mentioned with auctions and competitive bidding or our Life Sciences work at some space in the Energy space and all those are in addition to Marakon. But Marakon is clearly a major piece of the overall offering.

Tim, I don't think I mentioned in my comments but in Q2 of 2012, the business consulting was about 24% of our revenue and the balance was in the Litigation and Regulatory.

Okay. And what -- do you, I guess, I was going to say, I was going to ask what it was in the year ago. But I think you give us the year-over-year change in that. And the last question is just some of the new hires you've made. Can you talk about the cost of those? I know you said it was competitive but you paid similar rates to what others paid, but how expensive was it for some of these new hires and then how much kind of cash is earmarked to pay for those when those individuals join you?

I think those individuals continue to do what they've done in the past several years. We'll create a very attractive returns for CRA. These aren't lost leaders by any means that they are profitable as a standalone basis, and we expect to see much more benefit beyond then as a standalone basis given the reputation that they bring with them. We're not going to reveal specifics of their deals. But what I can say is that their deals are consistent with that we've paid to other senior revenue generators on a rate basis and consistent to what we've observed in the marketplace for senior revenue generators.

[Operator Instructions] Our next question is coming from David Gold of Sidoti & Company.

A couple of things. First, walk me through a little bit the planned annualized savings. I think in the release, you spoke about $17 million from cutting 55 consultants and then you spoke about $8 million from closing some of the offices.

Let me stop you there, Dave. Let me stop you there because I want to make sure that the information we gave, everyone understands. And I'm particularly concerned given the question we just got from Tim is all of the measures that we are providing, the $8 million, the $8 million to $10 million, $17 million savings in cost of service savings and the $8 million in SG&A, are all relative to that experience during the first 6 months of 2012. So it is on an apples-to-apples basis. I'm not mixing prior years' saving with this years' revenues. All 3 components are what we experienced, annualized for the first 2 quarters of 2012. I apologize for interrupting, but I just wanted to make sure that was clear.

No, no, it's definitely, I would say, not that clear to me. But I guess, part 2 and maybe I'm missing something obvious. But when we talk about -- we're taking out 55 heads and that will be a cost of service savings of $17 million. Then we talk about closing some offices and that will get you annualized savings of $8 million, right? We put those together but at the end of the day, we're looking for an annualized savings of $15 million to $17 million, right? What am I missing there? The $17 million and $8 million are not additive?

So the way we can do the simple math here and I'm going to write it out just to make sure that I'm providing you the right answer. So I have an $8 million to $10 million potential reduction in revenue. I have a $17 million cost of service savings and I have an $8 million SG&A saving. So if I just add my cost of service savings and my SG&A savings on an annualized basis, I get $25 million. But, of course, there's a cost associated with that $25 million and that is fewer revenue dollars coming in. So if I subtract the $8 million from the $25 million, I get at the upper range of $17 million and I subtract the $10 million, the upper range of the revenue loss from $25 million, I get $15 million. And that's how we derive that impact, potential impact, on operating income of $15 million to $17 million.

Got you, got you. Okay, so on the $8 million to $10 million of revenue that you're giving up basically, assuming there's a dollar-for-dollar cost there plus, okay. All right.

We need to execute. But we believe that it is a very achievable number for savings, it's substantial and could significantly improve our existing profit picture.

Got you. Okay. And so on a consulting piece of that, presumably that's either done or will be done this quarter. And the office closings, I think, you said third and fourth quarter, is that a good way to think about when the savings come in?

There may be -- some of the staff reductions may stretch over the third and fourth quarter and even some of the cost savings. So if I were to tell you we would hope that the majority of these savings are the actions taken to achieve the savings are in Q3. But we still believe that there will be tails across all 3 segments into Q4.

Got you, got you. Okay. And then just one other. I think prior questioner tried to get out but just to hit it another way. I wanted to get some sense as to how things really, I guess, developed over during the second quarter. I mean, I guess, from the distance, what we know is that on the first quarter call, the plan loosely was still to see that 11% margin. And you still sort of pointing to that 6% annual revenue growth. Now we know during the quarter, obviously, Chemicals became an issue. But broadly speaking, I mean, is it really just that simple or was it just -- were there just a number of things that happened between, say, April, I don't know, whatever it was, 26 and 3 weeks a month ago when you announced the revenue target was no good anymore?

Well, we began the year with a very disappointing Q1. We had -- we reported a large revenue shortfall that fell to the bottom line. I'm going to take you through the timeline. I don't want to miss a step here. We met with the leadership across all of our practices, even despite the hole that we had in Q1, we felt that we can still rebound and achieve our annual targets. About 4 to 8 weeks into the second quarter, as we took actions to try to get us back on track, we started feeling less comfortable with our ability to achieve the revenue target. Our confidence in achieving the profitability target really didn't waiver. As we began taking those actions, that's where the repercussions associated with Chemicals started to be realized.

Got you, got you. Okay. And then just one last, I'm not sure -- I don't think I still have the number for reimbursables, but if you happen to have it handy, that would be useful.

The reimbursables for the quarter 2 are $8.8 million, David.

At this time, I would like to turn the floor back over to Mr. Maleh for any additional or closing comments.

Again, I want to thank everyone for joining us today. As always, we really do appreciate your time and interest in CRA and look forward to updating you on our progress in the second half of 2012. With that, this concludes today's call. Thank you, everyone.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.