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CRA International (NASDAQ:CRAI)

Q2 2014 Earnings Call

July 24, 2014 9:00 am ET

Executives

Wayne D. Mackie - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Paul A. Maleh - Chief Executive Officer, President, Director and Member of Executive Committee

Analysts

Jeffrey Rossetti - Janney Montgomery Scott LLC, Research Division

David Gold - Sidoti & Company, LLC

Timothy McHugh - William Blair & Company L.L.C., Research Division

Operator

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.

Wayne D. Mackie

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 non-GAAP results. Let me now turn it over to Paul Maleh for his report. Paul?

Paul A. Maleh

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 of 2012, we announced the 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 top line 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 top line growth in the mid- to high-single digits on an annualized basis.

We are focused on growing our current assets with the Antitrust & Competition Economics, Finance, Life Sciences and Marakon as our primary areas of investment. With that as the 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 & Regulatory and Management Consulting businesses. In the Litigation & Regulatory, our Antitrust & 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 U.K. lawsuit with National Grid over collusion in the delivery of electrical substations. In addition, our Antitrust & 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 & 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 had seen client needs shifting towards addressing strategy and growth questions again for both the 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 U.S. 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 plan, patient-centric strategies and product launch and evaluation work. CRA's overall portfolio quality is high. Project lead flow is strong, and project conversion rates continued to improve. Despite overall project inventory being healthy, we are mindful that the summer months typically impact both the demand and supply side of the equation. With that, I will turn the call over to our CFO, Wayne Mackie. Wayne?

Wayne D. Mackie

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 '14. It's important to point out that during Q2 '14, we had no departures of key revenue generators. Moreover, timing difference has explained 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 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. This -- 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 higher revenue in Q2 '14 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 '13 and $12.1 million or 16.1% of revenues for our Q1 of fiscal '14.

The effective tax rate for the second quarter of fiscal 2014 on a non-GAAP basis was 49.3%, reflecting a noncash 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 noncash 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 '14. DSO in Q2 of fiscal '14 consisted of 74 days of billed and 34 days of unbilled compared to 64 days of billed and 36 days of unbilled in Q1 of fiscal '14. While we're not happy with the growth in DSO, decline primarily attributable -- is primarily attributable to the timing of receivables related 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 '14. Principal drivers of the reduction of cash in 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.

Question-and-Answer Session

Operator

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

Jeffrey Rossetti - Janney Montgomery Scott LLC, Research Division

This is Jeff Rossetti in for Joe. Just to start out, I just wanted to see if you could tell, Paul, maybe describe which practices maybe surprised you in the quarter. I know you'd mentioned there was strength across the portfolio, but was there any particular areas that drove the strong growth for the quarter?

Paul A. Maleh

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'll take the kind of superb performance of competition any day.

Jeffrey Rossetti - Janney Montgomery Scott LLC, Research Division

And you mentioned that conversion rates and project lead flows isn't continuing to improve? 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're doing for banks?

Paul A. Maleh

We're 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 good qualifications to clients, we more often than not get retained on those engagements. And that's pretty much across the entire portfolio that we're 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 -- it's in its infancy and those have not been disclosed in terms of our involvement or lack thereof.

Jeffrey Rossetti - Janney Montgomery Scott LLC, Research Division

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?

Paul A. Maleh

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

Wayne D. Mackie

Yes, 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 1 month or 2 off before they enter a grad school, which is what most of the individuals involved have done.

Jeffrey Rossetti - Janney Montgomery Scott LLC, Research Division

Okay. And then last for me, I think 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 in terms of free cash flow?

Wayne D. Mackie

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've improved our cash flow for the quarter by about that amount. So we, as I said, are very convinced that this has got nothing to do with the deterioration in the AR. And in fact, in a way, it's a good thing with the increased revenue and there was a good clip of work and revenue generation going on during the last month or so for 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.

Operator

The next question is from David Gold of Sidoti & Company.

David Gold - Sidoti & Company, LLC

A little bit of follow-up on a couple of other questions. First, obviously, clearly just 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're picking up, how long these might run for?

Paul A. Maleh

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're cautiously optimistic as we look at Q3 and beyond in terms of the workflow from those opportunities.

David Gold - Sidoti & Company, LLC

Got you. Okay. And maybe it would help -- can you give a little bit of a sense of the 20% top line? 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 2 segments, what growth looks like?

Paul A. Maleh

We're always to happy to report a 20% top line growth. But the other thing we have to take into 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% top line growth year-over-year was the continued sequential improvement that we're having to 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 offerings, 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 in second quarter of 2013, and they have far surpassed that performance. But I can say that for Marakon, I can see 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.

David Gold - Sidoti & Company, LLC

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.

Paul A. Maleh

I'm looking for revenue growth to come from an expansion of headcount. Okay? We're going to be active in the labor markets to bring on new talents 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 utilization has been pretty constant at that 78%, 79% clip for the last year, it's 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.

David Gold - Sidoti & Company, LLC

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

Paul A. Maleh

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 5 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 strive for those growth levels.

Operator

[Operator Instructions] And the next question is from Tim McHugh of William Blair.

Timothy McHugh - William Blair & Company L.L.C., Research Division

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

Paul A. Maleh

No. Competition in the antitrust practice has been the largest practice at CRA for as long as I have been a part of the organization. And I've been here 25 years. So it is clearly the leader of the portfolio, and it is probably the largest practice, like close to a factor of 2, relative to the second largest practice in the firm. But the great thing that we're seeing now is we're seeing a lot of collaboration from our competition practice with a lot of other practices that are enabling us to bring sort of the best talent there for various client assignments. I know we've highlighted numerous times the work we're doing for the financial institutions, that wouldn't have been possible without the brands and market presence of the competition units. So they are our largest practice, but the exciting thing for me is I don't think they're near capped in terms of what their growth opportunity is in the marketplace.

Timothy McHugh - William Blair & Company L.L.C., Research Division

Okay. And 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.

Paul A. Maleh

It's an interesting question, and 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 offerings. 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 the valuation 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.

Timothy McHugh - William Blair & Company L.L.C., Research Division

Okay. You made some comments about large projects and I think, quickly moving once 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 and you haven't even started on. But are these particularly large, I guess, that we need to be cognizant of when they step down it'll be a headwind? Or I guess, how do we think about the grow over at some point on this? How challenging or not challenging will it be?

Paul A. Maleh

Sure. I mean there 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's 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 is 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 to your question is, I do not envision during Q3 having the ending of one assignment to play a significant role on the overall corporate performance.

Timothy McHugh - William Blair & Company L.L.C., Research Division

Okay. Well, I guess, even if we load out the next 4 quarters, any of them of the magnitude that -- when they end is it going to be?

Paul A. Maleh

Very few. Very few of these merger cases really goes on much past 1 or 2 quarters. They're usually very high-intensity matters, but they're usually relatively short-lived. So it's clearly not going to have an impact of 4 quarters out.

Timothy McHugh - William Blair & Company L.L.C., Research Division

And the headlines we saw just in the last 3, 4 months about major acquisitions, that's -- I guess, I'm trying to understand -- just make sure I understand the pace of 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?

Paul A. Maleh

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.

Timothy McHugh - William Blair & Company L.L.C., Research Division

Okay. And then, can you talk about recruiting? I mean, I know you said, basically, you expect at this point to -- you hope to grow mainly through growing headcount, given how high utilization is. And I know, I guess, when you explained why it was down sequentially but it will bounce up a little bit even, but you'll still -- it sounds like you're kind of relatively flat in Q3. So it seems like 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, I mean, 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 3 or 4 quarters from now might you hope to be seeing?

Paul A. Maleh

I think we'd like to see headcount growth in the mid-single digits across the firm. I mentioned the 4 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 desks, 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're enjoying that benefit right now. We're 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 marketplace.

Operator

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

Paul A. Maleh

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.

Operator

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.

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