CRAI International: Despite Stock Decline, Still On Track For Growth

| About: CRA International,Inc. (CRAI)

CRA International (NASDAQ:CRAI), formerly Charles River Associates, is a global provider of legal, regulatory, business consulting, and other expert services through its more than 720 consultants. The company's staff of economists, business professionals, engineers, and other industry leaders provides original, authoritative advice to support various customer activities across 22 areas of functional expertise and 13 vertical industries.

CRA International's consultants combine economic and financial analysis with expertise in litigation and regulatory support, business strategy and planning, market and demand forecasting, policy analysis, engineering, and technology strategy. The company also owns 36% of NeuCo, which provides network software tools and application consulting services to electric utilities. We believe the company s main competitive advantage is its solid reputation in complex litigation and regulatory proceedings.

The company's senior employee consultants are highly educated, with the vast majority holding advanced degrees, and recognized as experts in their respective fields. Given the company s solid reputation and quality of work, the company generates a high level of repeat business from its existing relationships. Most of the company's senior employee consultants are also able to apply their skills across multiple practice areas, which provide the company with flexibility in staffing engagements.

We believe the company's strong reputation, and the flexibility and expertise of its workforce, has led to solid utilization rates for the company. Utilization, or the total hours worked divided by the total hours available in the period, increased from 69% in fiscal year 2002 to 78% in fiscal year 2005 nd in fiscal 2006.

CRA International has also utilized an aggressive acquisition strategy for geographical expansion, to broaden its existing service offerings, and expand into new practice areas. We note that the company's international revenue accounted for 27% of total company revenue in the first quarter 2007, compared to 19% in the prior year period. Most recently, the company built out its European businesses via acquisitions.

In June 2005, CRA International acquired Lexecon Ltd., a provider of competition economics consulting in Europe with offices in the U.K., Germany, and Belgium. This follows the acquisition of Lee & Allen in April 2005, a provider of forensic accounting and dispute resolution services in the U.K. The deals solidified the company s position as the largest, independent litigation support practice in Europe, with additional opportunities for expansion into South Africa. In addition to an expanded presence in Europe and potential in South Africa, the company also acquired an Australian economic and regulatory consulting firm.

Closer to home, CRA International acquired a U.S.-based energy and utility consulting firm, Pegasus Technologies (optimization software for the power industry), and further built out its domestic transfer pricing practice via the acquisition of The Ballentine Barbera Group. We expect the company to continue to benefit from strong demand for its services.

We expect organic revenue growth of approximately 15% in fiscal year 2007, following a similar growth rate in fiscal years 2005 and 2006. This includes a 6% increase in billing rates and an 8% increase in headcount. We expect the company s European operations to continue to benefit from increased demand in the U.K., acquisition activity, and key headcount additions. The international business is further benefiting from increasing activity in the Middle East. Given favorable near and long-term catalysts for CRA International, we maintain our Buy rating.

INDUSTRY OUTLOOK

Our outlook for the business services industry is neutral. Companies in this broadly characterized industry provide consulting, information and data, information technology [IT], marketing, payment processing, staffing, and other outsourcing services to businesses. The industry is generally tied to the economy, and is related to growth in business spending. We expect spending on equipment, consulting, staffing, and outsourcing services to continue to increase in 2007, as corporations look to deploy record cash balances to support top and bottom line growth.

We expect strong growth in the outsourcing industry over the next three-to-five years, as it allows corporations to focus more on their core businesses. This also reduces the growing costs associated with in-house systems. Outsourcing has advanced from running software and data centers to a growing trend toward business-process outsourcing [BP], where a company takes over the back-office functions for clients, such as human resources, payroll, travel services, and accounting.

In addition, companies are increasingly relying on technological and business innovations to improve efficiency, thus increasing the importance of strategically analyzing their businesses and developing and protecting new technology. As a result of increasingly competitive and complex business environment, companies must constantly gather, analyze, and use available information to enhance their business strategies and operational efficiencies.

Furthermore, as the general business and regulatory environment becomes more complex, corporate litigation has also become more complicated, protracted, expensive, and important to the parties involved. As a result, companies are increasingly relying on sophisticated economic and financial analysis to solve complex problems and improve decision-making. We believe that there are significant growth opportunities in the various outsourcing markets, yet competition is fierce and pricing remains very competitive.

INDUSTRY POSITION
CRA International competes with a broad range of public and private consulting firms. The closest publicly traded peers to CRA International include FTI Consulting (NYSE:FCN), Huron Consulting Group (NASDAQ:HURN), LECG Corporation (OTCPK:XPRT), and Navigant Consulting (NYSE:NCI).

We believe the company's main competitive advantage is its solid reputation in complex litigation and regulatory proceedings. The company's senior employee consultants are highly educated, with the vast majority holding advanced degrees, and recognized as experts in their respective fields. Given the company's solid reputation and quality of work, the company generates a high level of repeat business from its existing relationships.

In addition, we believe the company's significant name recognition, which developed as a result of the work on many high-profile litigation and regulatory engagements, has enhanced the development of its business consulting practice. We believe the company s strong reputation, and the flexibility and expertise of its workforce, has led to solid utilization rates for the company.

RECENT NEWS
On March 22, CRA International reported financial results for the first quarter of fiscal year 2007. Revenue increased 15% from the prior year to $83 million and was slightly below our $85 million expectation. Top line growth benefited strong demand for the company s business consulting services. The company s gross margin was flat with the prior year period at 38%. Operating margin increased 90 basis points year-over-year to 13.9%. Reported diluted EPS of $0.56 was up compared to the $0.47 reported in the year ago period.

The EPS results were $0.01 above our expectation. During the third quarter of 2006, CRAI announced that its board of directors authorized a multi-year stock repurchase program of up to a total of 500,000 shares. The company currently has approximately 12.5 million diluted shares outstanding.

The company stated that primary purpose for the repurchase plan is to offset the dilutive impact of stock options and restricted stock grants. The repurchase is to be funded with available cash. While the company did not make any repurchases during the first quarter of 2007, management does expect to make repurchases throughout the remainder of the year.

VALUATION
Using a P/E ratio, the shares of CRA International are currently trading at a discount to the peer group average. Following robust earnings growth and with momentum expected to continue, we believe the multiple will continue to expand. Therefore, our six-month target price is $60.00, which implies a P/E multiple of 22x our 2007 EPS estimate.

We believe this multiple is reasonable considering our expected long-term earnings growth rate of 20%. RISKS Earnings per share may experience volatility due to the rising share price. A higher average share price increases the company's fully diluted share count, as a larger number of stock options will be in the money.

The convertible component of the company's debt also has a dilutive effect on earnings. SFAS 123R, accounting for stock-based compensation, will negatively impact earnings going forward.

RISKS

  • Earnings per share may experience volatility due to the rising share price. A higher average share price increases the company's fully diluted share count, as a larger number of stock options will be in the money. The convertible component of the company's debt also has a dilutive effect on earnings.
  • SFAS 123R, accounting for stock-based compensation, will negatively impact earnings going forward.

  • INSIDER TRADING AND OWNERSHIP

    Insiders own 10% of the company s common stock. Institutional Investors own 95% of the common shares outstanding. Institutional holders with greater than 5% ownership of common shares outstanding include Transamerica Investments (9% of common shares outstanding), Artisan Partners (9%), and Oak Ridge Investments (5%). Industry Comparables Ticker Company Market Cap P/E (Billions) (2007) CRAI CRA International 0.6 18.4x Group Average 20.9x FCN FTI Consulting 1.5 19.6x NCI Navigant Consulting 1.1 17.3x HURN Huron Consulting 1.2 30.0x XPRT LECG Corporation 0.4 16.6x.

    KEY POINTS

  • We maintain our Buy rating for CRA International.
  • We expect the company to continue to benefit from strong demand for its services. In particular, we expect M&A activity to remain robust, while the litigation practice should continue to benefit from large securities-related litigation cases.
  • In addition, we are encouraged by acquisitions, which have expanded the company's global operations and existing service offerings.
  • OUTLOOK
    We maintain our Buy rating for CRA International following the release of inline Q1 results. We expect the company to continue to benefit from strong demand for its services, both domestically and in international markets. We are also encouraged by ongoing acquisition activity, which has expanded the company s European presence and existing service offerings. We consider the approximate 6% decline in the stock price last week following the release of Q1 results to be unwarranted, and we reiterate our Buy rating on share of CRAI.

    CRAI 1-yr chart: