Executives
Karl Bupp - Chief Financial Officer
Adam Gutstein - President and Chief Operating Officer
Analysts
Shlomo Rosenbaum - Stifel Nicolaus
Kevin Liu - B. Riley & Co. Inc
Analyst for Ed Caso - Wachovia Securities
Diamond Management & Technology Consultants, Inc. (DTPI) F1Q09 Earnings Call August 7, 2008 9:00 AM ET
Operator
Welcome to the Diamond Management & Technology Consultants first quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to Karl Bupp, Chief Financial Officer.
Karl Bupp
Also, with me today is Adam Gutstein, our President and CEO. Margaret Boyce, Diamond's Director of Investor Relations, is on maternity leave so I will be filling in for her on this quarter's call.
Adam and I will discuss our financial results for the first quarter fiscal year 2009 ended June 30, 2008 and then we will open up the call for questions. We have supporting slides available on our website that accompany our remarks today. You can advance the slides at your own pace and download them for future reference. I would also like you to note that the financial results we will discuss today are related to continuing operations of the Company unless otherwise noted.
As a reminder, during today’s call, we will make both historical and forward-looking statements in order to help you better understand our business. You should realize that our actual results may differ materially. Any forward-looking statements speak only as of today’s date, August 7, 2008, and we undertake no duty to update this information in the future. The risks and uncertainties associated with our business are highlighted in our filings with the SEC, including our quarterly report on Form 10-Q for the quarter ended March 31, 2007. During our call today, we will reference certain non-GAAP financial measures which we believe provide useful information for investors. You can find reconciliation of those measures to GAAP on the Investor Relations section of our website at DiamondConsultants.com. Finally, I wanted to share with you that we are presenting at the Kaufman Brothers Conference in New York City on September 3.
With that, I will turn the call over to our President and CEO, Adam Gutstein.
Adam Gutstein
We are pleased to report our first quarter results above our previous guidance. We delivered first quarter net revenue of $38.8 million, just above our previous guidance of $36 million to $38 million and at the high end of the range we preannounced on July 17. EPS came in at $0.03 per share including a $0.05 tax benefit which was also at the high end of the range we preannounced. Our clients recognize that the economic environment continues to be a challenging one. They are focused on projects that improve their cost structure and help them deliver products and services more efficiently.
Many of our clients are leaders in their industry and so not surprisingly, they also see the environment as one in which they can better differentiate themselves in the eyes of their own customers. They see this as the time in which they can improve their competitive position by delivering a better customer experience and by levering information and technology to their advantage as far as how they operate and how they interact with their customers. So, despite the dynamic environment and in some cases because of it, we are still seeing good opportunity.
Consultants must deliver value everyday and particularly in challenging economic environments because third parties are generally invisible, if not always put in place to look to reduce expense. We are pleased to report that despite this backdrop, the average duration of our client relationship has increased to over 31 months, compared with 23 months in the first quarter of last year. Our core client thus remains stable even if some of them are spending less. We work with all 20 of our top 20 clients from the March quarter in the June quarter and we are forecasting to work with 19 of the top 20 clients from the June quarter in the September quarter.
We believe the lengthening of our relationships and the stability of our top clients is directly related to the quality of our people and the value our teams deliver. We have also seen an improvement in our win rate in the first quarter where we were successful in initiating 24 new client relationships which is higher than we have had in recent quarters. The sizes of these new projects however are smaller than in the past as new clients similar to our existing client base are spending cautiously given the market environment. Then the last, we are pleased with both the quality and the quantity of our new clients.
In terms of the people side of our business, we are pleased to continue to receive recognition as one of the very best places to work. In July, we received the Workforce Chicago award which annually recognizes three companies with exemplary employee learning and development practices. Diamond was honored for its comprehensive and long term commitment to maintaining and growing the skills and careers of its workforce. The development and training of our people is crucial to our success as a firm and to that of our people as individuals. It is an honor to be publicly recognized.
Looking ahead to the September quarter, we are anticipating net revenue to be flat to up 4% over the June quarter.
I will now turn it over to Karl to take you to the financials for the quarter.
Karl Bupp
Entering our fiscal year 2009, the environment is clearly very different than it was a year ago. As we mentioned during our May call, last year was a year of two parts with a strong first half and weaker second half. Since the market we are operating today is more similar to last quarter of last year, I will give primarily sequential comparisons as we go through the various aspects for the business.
Over the past year, we have continued to manage our expenses and now many of those actions are beginning to take effect. In the June quarter, the quarterly expense level of our business decreased over $2 million from the prior quarter and we expect our quarterly expense level to decrease more than $1 million again in the September quarter. Turning to the first quarter results, as Adam said, net revenue for the first quarter was $38.8 million compared with $42.4 million reported in the prior quarter primarily driven by declines in our financial services and healthcare verticals.
Project personnel costs before reimburseable expenses were $30.4 million in the first quarter down slightly from $30.8 million last quarter. Gross margin was 21.6% in the first quarter compared with 27.2% in the fourth quarter of last year. Total other operating expenses were $9.6 million in the June quarter down from $11.3 million in the March quarter due to expense management efforts and not conducting an exchange event during the quarter.
The company reported a loss from operations before taxes of $1 million in the June quarter compared with the income from operation before taxes of $1 million in the prior quarter. Pre tax margin was a negative 2.7% compared with positive 2.4% reported in the prior quarter. Income after taxes in the first quarter was $720,000 including the reversal of the $1.5 million international tax valuation allowance. This compares with income after taxes of $576,000 reported last quarter.
Diluted earnings per share was $0.03 in the first quarter including the reversal of the international tax valuation allowance which provided a benefit of $0.05 per diluted share compared with $0.02 reported in the March quarter. These EPS results exclude any impact from discontinued operations. Our effective tax rate in the first quarter was a benefit of 169% reflecting the reversal of the international tax valuation allowance compared with a 44% effective tax rate last quarter and a statutory tax rate of 42%.
We remained active in the market during the first quarter as we purchased over 1 million shares at an average price of $5.25 per share or payout of $5.4 million. Our stock repurchase authorization was just over $34 million as of June 30, 2008 and we will continue to remain active in our stock buyback program. Diluted rated average shares outstanding decreased 17% to 27.3 million shares from 33 million as of June 30 last year.
Common shares outstanding as of June 30, 2008 stood at 26.5 million, down 15% from 31.3 million on June 30, 2007. This decrease was a result of our stock buyback program and a reduced stock price during the quarter. We ended the quarter with a cash and cash equivalents balance of $48.1 million and no borrowing. Free cash flow was negative $3.2 million in the first quarter reflecting the payout of $4.6 million in annual cash bonuses during April.
Days billing outstanding was 29 days in the June quarter compared with 26 days in the March quarter but still below our target of 30 days. Turning to our client metrics, we served 69 clients in the first quarter compared with 63 clients served in the prior quarter. We added 24 new clients in the first quarter representing 8% of revenue, up from 14 new clients added in the prior quarter and an average of 16 new clients added during each of preceding four quarters. Our top five clients represented 34% of revenue, down from 39% in the prior quarter.
We ended the first quarter with 469 consultants compared with 510 in the prior quarter. Revenue per professional was $317,000 compared with $332,000 in the prior quarter. Chargeability was 59% in the first quarter compared with 60% in the prior quarter. Our annualized voluntary attrition was 25% in the first quarter compared with 12% in the prior quarter and 19% in the first quarter last year. This is a seasonal increase in employee turnover we see essentially every June quarter following the payout of annual variable compensation.
We expect to end the second quarter with 480 to 490 consultants as the majority of our campus hires join us during the September quarter. As we look at our revenue by industry practice, the mix by industry in the quarter was as follows; financial services represented 28% of revenue, insurance 22%, healthcare 21%, enterprise 21%, telecom 4% and public sector 4%. As we discussed in our last earnings call, we will begin to provide adjusted EBITDA data as supplemental information to help investors evaluate our business performance.
We define adjusted EBITDA as income from continuing operations before interest, taxes, depreciation, amortization and stock base compensation expense. We believe adjusted EBITDA is a useful indicator of the Company's financial and operating performance and our ability to generate cash flows from operations that are available for share repurchases and capital expenditures. Adjusted EBITDA of the first quarter was $3 million.
Looking ahead for the second fiscal quarter of 2009, we are expecting our revenue to be flat to up 4% over the June quarter, pretax income of $1 million to $ 1.75 million, stock base comp expense of $3.8 million, depreciation and amortization expense of $500,000, other income of $300,000, adjusted EBITDA of $5 million to $6 million and GAAP EPS of $0.0 to $0.02 per share.
We expect our reported tax expense to be in the range of $1 million to $1.25 million. The second quarter weighted average share account is expected to be approximately 27 million shares. Free cash flow is expected to be $4 million to $6 million in the quarter. Going forward, in order to remain free cash flow positive for fiscal year 2009, our revenue needs to be above $34 million per quarter for the remainder of the fiscal year. Adam?
Adam Gutstein
We feel good about our performance in the first quarter and we are pleased with the outlook for our second quarter especially given the current market environment. We have talked in the past about expanding our execution offerings to improve the leverage of the firm and we have made good progress on that front. We also continued to work on diversifying the sources of our revenue focusing on industry such as healthcare, enterprise and public sector and markets outside of United States including the UK and India.
Our international operations reached just over 10% of our revenue in the June quarter which is an increase sequentially over the March quarter. The growth largely came from our UK regions specifically in the insurance vertical. We continue to invest in those areas where we can provide the greatest value to our clients, developing and executing strategies to create a significant economic value. In our case, that means focus on helping clients create an information advantage, mobilize and execute transformational strategies across their operations and improve the experience of their own customers.
Looking at our business by vertical, we saw declines in both our financial services and healthcare practices in the June quarter but we are encouraged by some positive trends. In healthcare, we had spoken in the past about expanding our base beyond payers. Over the past two years, we have diversified our client base from more than 75% payers to a healthy mix across payers, pharma, biotech, device manufacturers and providers. Today the environment in healthcare is challenging but generally stable.
In financial services, clients continue to be cautious in an environment in which assets are difficult to value and whose value are often falling. Consumer credit quality is deteriorating and their stock market performance is under pressure. Clearly this is as dynamic in environment as we have seen while revenue in our financial services practice decline as a percent of revenue overall, the environment is far from idle. We continue to have meaningful conversations and opportunities to help clients in performance improvement, risk management and compliance and we have recently added a few new clients in banking and payments.
Both our insurance and enterprise practices grew sequentially in the June quarter. In our insurance practice, we have leveraged our deep insurance expertise and intellectual capital to grow our insurance practice outside of United States. Insurance companies are primarily investing in cost initiatives and while we have seen sale cycles lengthen our first quarter revenue was up from the prior quarter and that strength looks like it should continue through the next quarter.
Finally, the demand in our enterprise practice also continues to be relatively strong. We see good demand as it relates to ERP and the information analytics to make ERP more successful. Enterprise clients are also focusing on ways to improve revenue performance as well as profitability and slowing down in the past. There is no doubt that we are operating in a dynamic environment. We must and we will remain nimble relative to bringing the best that we have in each opportunity.
In addition, we will continue to work to diversify our industry and geography base practices and to manage our expense as appropriate. If I had to characterize how I feel, I would say that we are cautiously optimistic about the short term and confident in the long term opportunities for our business. People at Diamond are exceptionally skilled at improving the practice of management for our clients through the use of information and technology and we look forward to capitalizing on those opportunities before us.
With that, we will open up the call for questions.
Question-and-Answer Session
Operator
(Operator Instructions) Our first question comes from Shlomo Rosenbaum - Stifel Nicolaus.
Shlomo Rosenbaum - Stifel Nicolaus
I just have a few questions just in terms of the environment. Can you just go over the activity that you are seeing in your top clients, maybe the top three to top five, are they all in financial services verticals and if you could just talk about what is going on there?
Adam Gutstein
First, our top clients are not all in financial services. They are spread across financial services, healthcare, even enterprise and what we are seeing really does vary by industry. As I suggested in financial services, the market is certainly a challenging one. I think we all saw the results. They came out this morning and we know that folks are not yet seeing a bottom at it relates to housing and asset valuations and that sort of thing. So, it is clearly a cautious environment.
Having said that, we continue to work at those clients and we continue to work on important initiatives around risk management, compliance, technology and operations integration and so we feel good about the work that we are doing and I am convinced that are clients feel that what we are doing is pretty darn important to where they are. In healthcare, the work really has not changed much overtime. It is still about improving things like claims processing, improving things like the member experience, and improving the payers’ ability to integrate various operations and acquisitions that have been done overtime.
In pharma, it still continues to be around regulatory issues and insurance as I said earlier, the focus tends to be around cost base initiatives. But overall I would say that our top clients in fact as I mentioned earlier, our top client was stable. It has been last quarter into this quarter we anticipate the same going forward to next quarter.
Shlomo Rosenbaum - Stifel Nicolaus
Are they paying at the same rate? Is there any slowdown at all of that? I know you guys have really good DSO but is there anything that you are noticing on that front?
Adam Gutstein
We are not noticing that but then again, I would also say that you have to remember our clients tend to be top management and so we have a bit of an edge, I would say, as far as our ability to arrange the work properly and to collect it and frankly, as long as we are working on critical initiatives, that is not going to be an issue for us. We obviously do look carefully at the clients we serve and we want to be sure that they are, I hate to use this word but credit worthy. But our clients are industry leaders and generally speaking, they do not have that kind of an issue.
Shlomo Rosenbaum - Stifel Nicolaus
Can you talk a little bit about what you are doing to support the profitability of the business, just talk about some of the cost what was going down last quarter and then again this quarter and with the revenue falling which is one that given the environment seem what else is left out there for you guys to do? Describe what you have done in the last four quarters and what else is left for you to do to sort of focus on that cost base?
Karl Bupp
There are couples of things we are looking at. First, in the June quarter, you saw practice headcount decline nearly 10%. That was largely seasonal turnover. We moderated our hiring and expectation of the revenue decline and anticipation of our campus recruits joining us here in the September quarter but what you are seeing is as we have some turnover and some change out, more junior people are replacing senior people who are leaving so there are some cost pickup there. We have also looked at a number of our internal expenses.
We recently renegotiated the lease on our Chicago office which will provide significant savings for us this year and into the future. We have also looked at all our vendors and all our activities and either cutback, reduce or even replace providers. So, I think we have taken a pretty good look at that. As I have said, we have cut our expenses to $2 million in the June quarter over the March quarter. We expect to see at least a million dollar reduction here in September while we are increasing practice headcount and there may even be a little bit more left to do.
But one of the things we look at is we want to make sure that we have capacity available and we think there is a lots of upside in the business if the chargeability last quarter was 59%, we do not see any reason to take more dramatic actions.
Operator
Our next question comes from Kevin Liu - B. Riley.
Kevin Liu - B. Riley & Co. Inc
First question just on the financial services, just curious what your customers are seeing in terms of how quickly the projects currently in discussion might go, might become implemented. Are there budgets for the current calendar year and are they likely to spend against those budgets or will we kind have to wait for them to start to see a bottom in terms of their asset evaluations?
Adam Gutstein
I think there is certainly ample budget available for the project work that we are involved in both the current work as well as work that is being discussed in the future. Frankly, we like to sure that the work we are doing has a good business case to it so that it is well justified by those who have to make the decision to spend, it makes it easier for them inside their own organizations. So, I do not think it is an issue around the budget and the work that we are currently forecasting as well as further out sort of looking at, we do not believe there is an issue relative to budget.
Now, having said that, if the work takes a very dark turn which we do not see that at the moment but if it does, we might have to revisit just what that looks like but today, from where we sit, we have good visibility into our second quarter and business feels like it is in a reasonable place.
Kevin Liu - B. Riley & Co. Inc
Okay and I know the headcount is expected to go up with the campus recruits coming in for the next quarter but as you look out to the remainder of the year, would you expect that hiring that you do would be enough to offset that normal seasonal attrition you might see?
Adam Gutstein
We will not have an issue relative to capacity. We, as Karl has mentioned, are planning to moderate our non-campus hiring and basically that is one way in which can manage our cost.
Kevin Liu - B. Riley & Co. Inc
And then lastly, just on some of the new relationships discussion, you mentioned that they were smaller in size and perhaps some new relationships in the past, I am just curious to kind of what the scope of the work there is particularly as it relates to what you guys have done previously. I mean, what kind of opportunities do you have to think about the scope for those relationships?
Adam Gutstein
Yes, you raised two good questions. First, I would say the new starts are actually similar in terms of the type of work. They tend to be assessments or they tend to be plans which is good for us because that means coming out of that, there is typically something to do, some sort of design or some sort of more detailed strategy work and then ultimately some kind of implementation design to deliver real economic value. So, we are getting the right kinds of new starts. They tend to be smaller so for example, instead of asking us to do an assessment in a plan, we might be asked to do simply the assessment and then as a result of the assessment then we would go forward to do the plan.
The second question you raised of course is what opportunities follow and that is the trick. The key here is to be able to take those new opportunities, those small starts and convert them to meaningful substantive client relationships where our clients accrue tremendous value and we have the opportunity to help create that value. And so that is what we have to focus on.
Operator
The next question is a follow-up question from Shlomo Rosenbaum - Stifel Nicolaus.
Shlomo Rosenbaum - Stifel Nicolaus
Why is the tax spend going to be so high in the next quarter?
Karl Bupp
It goes back to the point we talked about in the past where we have valuation allowances in the UK and India. And if we have operating losses there, we do not get any reported tax expense benefit on those, so in fact our reported tax rate will probably be a close to probably slightly below a 100%. But I think overtime as we maintain or sustain profitability in all our international regions, the rate should hedge back down towards statutory rate of about 42%.
Shlomo Rosenbaum - Stifel Nicolaus
Okay and in the UK, do the revenue stay flat over there? It is typically been I think around $4 million. Was it flat or down in this last quarter?
Karl Bupp
It was actually up this past quarter. So, both India and UK were up but we have more expenses there and looking ahead, we just as we forecast out, we will probably see a little dip in India, such a small amount of our revenue. It is not a huge number overall.
Shlomo Rosenbaum - Stifel Nicolaus
Can you remind me how many people do you have in India?
Karl Bupp
About 25 to 30, 27 actually.
Shlomo Rosenbaum - Stifel Nicolaus
And that is for India to India primarily?
Adam Gutstein
It is primarily India to India but we also have, Shlomo, we have got a handful of folks that are supporting the practice in an information analytics center and they support our practice in North America as well as in Europe and actually, also in India.
Operator
Our next qeustion comes from Analyst for Ed Caso - Wachovia.
Analyst for Ed Caso - Wachovia Securities
I believe you previously mentioned that you had seen some positive activity in the enterprise segment specifically CPG and I believe logistics. Can you provide an update on that?
Adam Gutstein
Yes, we continue to see strength amongst consumer products companies and principally it is focused in the area getting the most value out of, if you will, their ERP initiatives. So, we are making sure that they actually extract the cost that they plan to extract, being sure that they get the inventory turns they like to get, being sure that they actually get the data they want about their customers and their suppliers and being able to make appropriate pricing and purchasing decisions.
Operator
There are no more questions.
Adam Gutstein
Well, thank you operator and thank you all for taking the time to join us today. We are especially pleased with the stability of our client lists as well as the many new starts. This past quarter, we feel very good about the quality of our people, the quality of client work and the client relationships and we look forward to speaking with you next quarter. Thanks everybody.
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