Fti Consulting, Inc Q2 FY2020 Earnings Call

Welcome to the FTI Consulting Second Quarter 2020 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Mollie Hawkes, Vice President of Investor Relations. Please go ahead.

Good morning. Welcome to the FTI Consulting conference call to discuss the company's second quarter of 2020 earnings results as reported this morning. Management will begin with formal remarks, after which they will take your questions. Before we begin, I would like to remind everyone that this conference call may include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21 of the Securities Exchange Act of 1934 that involve risks and uncertainties. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events, future revenues, future results, and performance, expectations, plans, or intentions relating to financial performance, acquisitions, share repurchases, business trends, and other information or other matters that are not historical, including statements regarding estimates of our future financial results and other matters. For a discussion of risks and other factors that may cause actual results or events to differ from those contemplated by forward-looking statements, investors should review the safe harbor statement in the earnings press release issued this morning, a copy of which is available on our website at www.fticonsulting.com, as well as, other disclosures under the heading of risk factors and forward-looking information in our annual report on Form 10-K for the year ended December 31, 2019, and updated in our quarterly report for the second quarter ended June 30, 2020, as well as, in our other filings with the SEC. Investors are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this earnings call and will not be updated. During the call, we will discuss certain non-GAAP financial measures such as total segment operating income, adjusted EBITDA, total adjusted segment EBITDA, adjusted earnings per diluted share, adjusted net income, adjusted EBITDA margin, and free cash flow. For a discussion of these and other non-GAAP financial measures, as well as, our reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures, investors should review the press release and the accompanying financial tables that we issued this morning, which include these reconciliations. Lastly, there are two items that have been posted to the investor relations section of our website this morning for your reference. These include a quarterly earnings presentation and an Excel and PDF of our historical financial and operating data, which have been updated to include our second quarter of 2020 results. Of note, during today's prepared remarks, management will not speak directly to the quarterly earnings presentation posted to the investor relations section of our website. To ensure disclosures are consistent, these slides provide the same details as they have historically, and as I have said, are available on the investor relations section of our website. With these formalities out of the way, I'm joined today by Steven Gunby, our President and Chief Executive Officer; and Ajay Sabherwal, our Chief Financial Officer. At this time, I will turn the call over to our President and Chief Executive Officer, Steve Gunby.

Thank you, Mollie, and thank you, everyone, for joining us today. I hope all is well with you and your loved ones during these challenging times. Ajay will soon provide details of the quarter, but I want to express how pleased we are with our second quarter results and acknowledge our teams for their outstanding efforts that contributed to these results. The work our teams have done over the past months to support our clients and each other from home, along with the groundwork laid in previous years, has positioned us to be seen as valuable resources for our clients even in tough times. Let's start with the results. A negative perspective might highlight that our adjusted EPS of $1.32 is significantly lower than a year ago. However, it's important to remember that we are comparing to an all-time record quarter for adjusted EPS, making this a tough comparison. More importantly, despite COVID's challenges, including low utilization in parts of our business due to travel restrictions and court closures, we still delivered our fifth-best adjusted EPS in the company's history and achieved the highest revenue quarter ever. I hope you share my optimism about these results. As discussed in the last quarter's earnings call, we anticipated this quarter would be slow. Some areas of our business were indeed very slow, but overall, we managed to generate solid results. This happens partly because markets can both take away and provide opportunities. While discretionary spending on consulting services has decreased, the COVID crisis has created new demands for restructuring, crisis communication, and litigation support, indicating a significant shift in client needs. What matters more for our long-term goals is the impact of our teams' incredible efforts during this time. We have successfully increased our positions in new areas and geographies while anticipating and addressing our clients' evolving needs. In Corporate Finance, for instance, we have remarkable second-quarter results, but that's not just because of favorable market conditions. It's crucial to understand that our success is not simply a reaction to the market but the result of our proactive measures and investments. Reflecting on our history, our Corporate Finance business was already thriving before the current market boom. During 2018 and 2019, we recorded revenue growth amidst challenging conditions. We've transformed our position from being a U.S.-focused business to achieving leadership in key global markets, including London and Hong Kong, and expanding our footprint in regions like Latin America. While we acknowledge market fluctuations, our focus is on the long-term impact of the proactive steps we've taken. Every segment of our business has undergone significant changes and improvements. For example, in Strategic Communications, we've seen growth in certain areas despite some components experiencing slowdowns. Similarly, our Economics segment has expanded globally, allowing us to maintain demand even amid challenging circumstances. Looking ahead, we recognize the heightened uncertainty surrounding COVID and its potential impact on bankruptcies, M&A, and litigation trends. While we reaffirm our guidance and believe that strong businesses will persist and weaker areas will gradually recover, we must remain conscious of the unpredictability in the current environment. Going forward, we are committed to making strategic decisions that prioritize the growth of our good businesses while understanding the distinction between those affected by temporary factors and those that need re-evaluation. It's critical to invest in talent, especially during slow periods, as this often presents an opportunity to attract exceptional people. Our core belief is that focusing on talent development—both recruited and homegrown—will enable us to create a professional services firm that continues to expand, adapt, and provide value to our clients while rewarding our shareholders. With this in mind, I will now turn it over to Ajay for a more detailed overview of the quarter. Ajay?

Thank you, Steve. Good morning, everyone. In my comments today, I will summarize our company and segment results and discuss our full-year guidance, starting with the second quarter results. As Steve mentioned, we achieved record quarterly revenues, and our performance exceeded our expectations from the last earnings call. Given the challenges posed by the COVID-19 pandemic for our clients and employees, we are thankful for these results. Our revenues reached $607.9 million, a slight increase of $1.7 million or 0.3% from $606.1 million in the same quarter last year. Year-over-year revenue growth was mainly driven by record performance in our corporate finance and restructuring segment due to heightened demand for our restructuring services. GAAP earnings per share were $1.27 in the second quarter, down from $1.69 in the same quarter last year. Adjusted EPS for the quarter was $1.32, compared to $1.73 in the previous year. The difference between our GAAP and adjusted EPS in this quarter reflects $2.3 million of non-cash interest expense related to our convertible notes, contributing to a $0.05 decrease in GAAP EPS. Our convertible notes had a potential dilutive impact on EPS of about 507,000 shares, with weighted average shares outstanding for the quarter at an average share price of $121.03, which was above the conversion threshold price at maturity. Notably, the trigger for conversion of our convertible notes prior to maturity was not met in this quarter. Our net income for the second quarter was $48.2 million, down from $64.6 million in the same quarter last year. This decrease was mainly due to increased compensation, resulting from an 18.2% increase in billable headcount and higher variable compensation, though partially offset by lower selling, general, and administrative expenses and a reduced tax rate. SG&A expenses for the second quarter were $126.9 million, which accounted for 20.9% of revenues, compared to $129.9 million or 21.4% of revenues in the previous year’s second quarter. The decline is mainly due to reduced travel and entertainment expenses due to COVID-19 travel restrictions, partially offset by increased bad debt. Adjusted EBITDA for the second quarter was $75.8 million or 12.5% of revenues, down from $97.2 million or 16% of revenues in the same period last year. Our effective tax rate for the second quarter was 23.1%, compared to 24.8% in the prior year, with the decline largely due to a favorable discrete tax adjustment related to share-based compensation. For the remainder of 2020, we expect our effective tax rate to be between 25% and 27%. Billable headcount grew by 715 professionals or 18.2%, compared to the prior year. Sequentially, we added 65 professionals or 1.4%. It's important to highlight that during the quarter, 66 professionals from our forensic and litigation consulting segment transitioned to our corporate finance and restructuring segment. Now, I'll discuss some insights by segment. In corporate finance and restructuring, we achieved record revenues of $246 million, an increase of 29.5% compared to last year. This significant growth occurred despite a decrease in success fees compared to the extraordinary previous year and lower revenues from business transformation and transaction services. The strong demand and realization of our restructuring services, including revenues from our acquisition of Andersch AG in August 2019, contributed to this notable increase in segment revenues. We undertook some of the largest restructuring mandates, especially in the retail, energy, automotive, airline, telecom, and financial services sectors. Adjusted segment EBITDA was $76.3 million or 31% of segment revenues, compared to $50.5 million or 26.6% in the previous year, as increased revenues more than offset higher compensation from the 34.7% increase in billable headcount. Sequentially, corporate finance and restructuring revenues rose by $38.3 million or 18.4%, driven by our restructuring practice, even as demand for business transformation and transaction services declined. In FLC, revenues declined by 27.1% to $106.4 million compared to the prior year, primarily due to reduced demand for investigations and dispute services, partly because some matters were deferred due to travel restrictions, court closures, and delays. Adjusted segment EBITDA was a loss of $9 million, compared to $28.2 million or 19.4% of segment revenues in the previous year. This decline was attributed to lower revenues, reduced staff utilization, and higher compensation from a 9.4% increase in billable headcount, though somewhat offset by lower SG&A expenses. Sequentially, FLC revenues decreased by $41.2 million or 27.9% due to declines in investigations, disputes, and data analytics services. Additionally, a few large investigations concluded during the quarter. Our economic consulting segment saw revenues of $151.5 million, down by 2.6% year-over-year. Despite COVID-19 effects, we continued work on significant M&A-related antitrust cases and saw higher realization; however, demand for non-M&A related services declined. Adjusted segment EBITDA was $21.7 million or 14.3% of revenues, down from $23.3 million or 15% of segment revenues last year, primarily due to lower revenues and increased SG&A expenses linked to bad debt, although partly offset by reduced variable compensation. Sequentially, economic consulting revenues rose by $19.4 million or 14.6% due to higher demand for M&A-related antitrust services. In technology, revenues of $47.1 million decreased by 15.4%, mainly due to reduced demand for litigation and global cross-border investigation services, impacted by delays and lower revenues from our transition services after the Ringtail divestiture. Adjusted segment EBITDA was $6.4 million or 13.7% of revenues, down from $12.9 million or 23.1% last year, due to lower revenues and increased compensation linked to a 19.5% increase in billable headcount. Sequentially, technology revenues fell by $11.6 million or 19.8% from diminished demand. In the strategic communications segment, revenues of $56.9 million fell by 3.8%. Excluding the FX impact, the revenue decline was mainly due to a $1.9 million drop in pass-through revenues, such as travel and entertainment costs, client event expenses, and media buys, though this was partially offset by stronger demand for public affairs and financial communications services. Adjusted segment EBITDA was $10 million or 17.6% of revenues, compared to $10.5 million or 17.7% last year, with the decrease mainly from higher compensation and an increase in billable headcount, mitigated by reduced SG&A expenses. Sequentially, revenues in strategic communications decreased by $1.5 million or 2.6%, primarily due to lower pass-through revenues but improved demand for urgent communication projects related to restructuring and financial issues. Now, discussing key cash flow and balance sheet items, we generated $153 million in net cash from operating activities and $147.3 million in free cash flow for the quarter. Our total debt, net of cash, fell by $100.1 million year-over-year from $147.1 million at June 30, 2019 to $47 million at June 30, 2020. During the quarter, we repurchased 470,853 shares at an average price of $108.41, costing $51 million total. In the last 12 months, we repurchased 1.27 million shares at an average price of $107.78 for $137.1 million total. On July 28, 2020, our board approved an additional $200 million for share repurchases. By that date, we had bought back 8.2 million shares under the repurchase program at an average price of $54.90, totaling about $450.4 million. We have approximately $249.5 million left available for share repurchases under this program. Regarding our guidance, we've previously noted that small revenue changes can significantly impact EPS due to our business's relatively fixed cost structure and margins. This was evident this quarter, positively for our corporate finance segment and negatively for FLC. Our decision to reaffirm guidance for the year, even amid uncertainty, is based on our results thus far and several assumptions for the remainder of the year. First, we anticipate sustained demand for restructuring services for the rest of the year, particularly in sectors such as oil and gas, automotive, financials, telecom, healthcare, airlines, and entertainment. Second, while we expect gradual improvement in utilization for many segments, particularly for FLC, we caution that the situation remains fluid as most client sites are still closed, and travel restrictions persist. Certain work may also shift to next year due to court delays. Third, we foresee the pandemic leading to new types of disputes and investigations that our experts will be well-equipped to handle. Fourth, the stoppage of business travel is leading to a decline in both billable and non-billable travel expenses. Fifth, our guidance applies to the next two quarters, and we typically see lower utilization in the fourth quarter, with many professionals taking holiday time off, which may be even more pronounced this year. Before I conclude, I want to highlight some key themes reflecting the resilience and potential of our business. Our diverse group of services demonstrated strength this quarter. Despite the global pandemic, we achieved record revenues and maintained our guidance. We continue attracting top talent as our colleagues work on high-profile engagements globally, and we believe our investments in talent will drive profitability through increased utilization. Over the years, we've both deepened our capabilities in core markets and expanded into adjacent sectors. We are confident these areas will thrive as we navigate beyond this pandemic. Our strong cash flow has allowed us to significantly reduce net debt while repurchasing shares and making strategic acquisitions. Additionally, we have the financial strength to create shareholder value in various ways. Notably, we completed the acquisition of Delta Partners on July 1, 2020, which strengthens our position in the technology, media, and telecom consulting space. We also announced a $200 million increase to our share repurchase authorization. With that, let's open the call to your questions.

The first question comes from Andrew Nicholas with William Blair. Please go ahead.

Hi, good morning. Thanks for taking my questions. First, I just wanted to touch on CFR and the bankruptcy environment. I realize market and economic conditions are evolving pretty rapidly, but I just want to get your take on the runway for this level of demand in CFR. How do you see the bankruptcy market kind of evolving over the rest of this year and into next? And then relatedly, if you could speak to the length of the typical engagement in the current environment, obviously, recognizing that each case is unique, that would be helpful.

Let me address this, Ajay, and feel free to add your thoughts. The current global landscape is quite complex and dynamic, as you know, Andrew. Our understanding in Corporate Finance suggests that we could be in for a prolonged cycle, although there may be uncertainties along the way. The unpredictability of government actions can influence this. In various countries, governments have put a hold on bankruptcies for some time, but that won’t last indefinitely. Events like this can occur unexpectedly and could significantly affect your business. Looking at the broader macroeconomic trends, there has been an extended period of easy money, allowing many companies that would have otherwise restructured to continue operating for now, but eventually, this situation will normalize. Our team is quite optimistic about the ongoing need for our restructuring services over an extended timeframe. However, this doesn’t guarantee that each quarter will resemble the current one; idiosyncratic factors will definitely play a role. In the medium term, we're confident about that business, but predicting the exact trajectory is challenging. Ajay, do you want to add anything regarding the duration? I’m not sure if we should label the duration as conservative since many assignments vary in length. Perhaps you could clarify that.

Yes, I will do my best. To be clear, Andrew, we have chosen our words very carefully in my script. We expect the strength in corporate finance to continue at least for the remainder of this year. We'll provide guidance for next year in February, but for now, we're focused on the rest of this year. Additionally, if I were to estimate, the average duration for an assignment is about six months.

Got it. That's helpful. And then, the next question I had is looking at some of the mandates that you won throughout the quarter, we saw a handful of examples where you were also tasked with helping in another area kind of alongside a restructuring win. Have you seen an uptick in your ability to cross-sell services in the current environment, specifically? I know that's been a trend over the past several years more broadly. But just curious on the cross-sell opportunity in that environment and progress there.

I don't know if this is the environment. I think you're right, Andrew, that what's happened is our firm has gotten to know each other a lot better over the last few years and our leadership team has gotten to know each other a lot better. And where it's made sense for teams to collaborate, we're just doing it a lot more. That's been a general trend over the last few years, whether this environment creates new opportunities. I mean, look, what does happen in this environment, challenging economic conditions, as I've been educated, tends to reveal big frauds for example, and big frauds tend to be associated with big bankruptcies. And so, those sorts of macro forces tend to tee up big joint efforts between our FLC business and our bankruptcy business. But I think what I've been seeing more is the general increase of collaboration across our firm rather than anything I can point to for COVID. Do you see something different, Ajay? Or would you agree with that?

No questions. I completely agree with you. The one thing that I might add is our strategic communications practice, especially this quarter, benefited significantly from allying itself with the corporate restructuring practice.

That's good. Yes. Does that answer your question, Andrew? Or at least give you…

Yes, that's helpful. If I could ask one last question about FLC, you've mentioned several times that both travel restrictions and the closure of court systems have had an impact. I'm curious about how this might evolve as we progress through the year. Which of these factors has a bigger influence, or can we rank them in terms of impact? I expect that improvements in travel over the year could affect the business, and I want to understand what that might mean for us.

The travel seems to be the larger issue at the moment. We're able to conduct virtual depositions, but in the court system, we're facing delays due to the limited number of judges, which is pushing some matters into next year. While that's manageable as long as we don't lose business, the travel restrictions are detrimental, especially affecting business development.

Thank you, Andrew.

The next question comes from Tobey Sommer with SunTrust. Please go ahead.

Thank you. I wanted to get your perspective on the hiring environment. And here, how you're thinking about kind of utilizing the throttle that you control with respect to that? And if you could also comment on the opportunity to hire people, particularly, in EMEA, in the U.K. Given some of the scrutiny and perhaps, disruption among traditional consulting and auditing competitors there.

Thank you, Tobey. I hope you're well and your family too. You raised an important point about our approach to hiring. Naturally, the instinct is to avoid bringing in too many people when business is slow, waiting for performance to improve. Conversely, there's a strong urge to seize talent when it becomes available since great talent isn't always on the market. Such availability often stems from disruptions, whether in the industry or among competitors. Right now, we're witnessing a fair amount of disruption globally, partly due to regulatory scrutiny affecting some competitors and also due to financial pressures from COVID. We discuss these factors actively. It's important not to overhire at junior levels in slow businesses, but we also have to honor commitments made to candidates nine months ago who are just starting their careers. Those individuals are essential for our long-term plans, so we focus on their development and keep them engaged, without overextending our hiring. When we assess a slow business, we ensure it's one we believe in for the long haul. If so, we tend to adopt a conservative approach, recognizing that hiring often happens several months ahead. Additionally, we aim to capitalize on opportunities resulting from competitor displacements. Even in a challenging market, if we can acquire great talent, we will make that investment, even if it impacts our earnings in the short term. It's about building for the future. I can't comment on specific competitors right now, but I hope that clarifies our thinking on hiring.

It does. With respect to the opportunity in the U.K. rather than talk about a specific competitor, would you say it's improving, staying the same, or worsened?

Europe has been a very fruitful area for us to attract senior talent for several years. I would say that nothing in the environment there has made it less favorable. In fact, all the scrutiny we've discussed has only increased the number of resumes from highly skilled individuals we are receiving, particularly in the U.K., but also across the continent. Does that help?

It does. With respect to the balance sheet and the convert, could you give us a little bit kind of color of how you're thinking about that? Whether you've kind of liked having an equity-linked instrument or may eventually look to replace that with an alternative source of finance?

Ajay?

A wise man once said, hindsight is 20/20. At this point, we are very optimistic about our stock and our company’s future compared to when we issued the convert. It is a low interest-bearing instrument, and we have been actively buying back stock to counteract any potential dilution. We do not need to raise additional debt at this time under any circumstances that I can foresee.

Could you explain the differences in the economic segment regarding your exposure to antitrust work linked to M&A and that which is not related to M&A? Investors often find it challenging to grasp the significance of these two aspects within the segment. Thank you.

Both are very important drivers for us. We traditionally focused on M&A antitrust, but we are now also in a leading position in non-M&A antitrust. This quarter, considering the overall context, M&A activity is down, especially large M&A, yet our economic consulting practice performed quite well. This is one reason our earnings have surpassed our initial expectations for the quarter. We have both M&A and non-M&A related work, with significant cases continuing on the M&A side. We're also observing numerous mergers being considered that could not have been contemplated before, involving vertical and horizontal integration that requires antitrust scrutiny, making it relevant for our firm. On the non-M&A side, major technology and other firms are facing antitrust scrutiny, which is widely reported in the news. Therefore, both segments are performing well. Did I address your question?

You did. And as a follow-up, and then, I'll get back in the queue. Could you give us a sense for how far in advance of an M&A transaction being reported on and out in the public domain, the company is retained and/or utilized by customers as they think about and plan for potential M&A?

So I joke about this. Every morning, I look at all the cases we are picturing in the conflicts database around the world. It's the first thing I do in the morning and it feels like I'm reading the Financial Times, the Wall Street Journal, and the South China Morning Post three weeks before publication. Certainly, on major cases, we get hired in advance of the cases, whether it's three weeks or two months, I can't say for sure, but it's in that zip code.

Thank you very much.

The next question comes from Marc Riddick with Sidoti & Company. Please go ahead.

Hi, good morning, gentlemen.

Good morning, Marc. How are you?

Thank you for the detailed information provided on the call. I wanted to discuss the court closures and related activities. Could you elaborate on the actions you are observing and their impact? Are some jurisdictions performing better than others in terms of virtual testimony? Additionally, how do you respond to these changes? It would also be helpful if you could indicate whether certain jurisdictions are progressing more quickly than others. Thank you.

Fortunately, the bankruptcy courts in North America remained operational. The Delaware courts and the Southern District did not shut down, which allowed for virtual depositions and related activities to continue. This was a positive development. On the other hand, countries like Australia and Germany have implemented moratoriums affecting director liability and court filings. There is a wide range of situations across different regions. In FLC, particularly in economic consulting, we experienced significant delays in the court systems, which created a backlog. Now that virtual depositions are in use, the main challenge we face is the continuing logjam.

Okay, that's helpful. Thank you very much.

Thank you, Marc.

Next, we have a follow-up call or a follow-up question from Tobey Sommer with SunTrust.

Thank you for taking the follow-up. With respect to the court system and the logjam or slowdown in kind of throughput broadly, how do you think of that in terms of demand deferral versus potentially, in some cases, demand destruction? Thanks.

I think that's a valid question, and the answer is that we really don't know. Initially, it all starts as demand deferral. The court date gets pushed back, and when people return to their offices, they realize they are already booked for the second half of the year. So they reschedule for June of next year because that is the first available date. This results in what appears to be a deferral. The concern is whether people will settle before June of next year or if circumstances change in a way that the case no longer exists. We currently lack solid data on that. My judgment is that it will be a mix; a substantial portion is likely to manifest next year since many of these cases have lingered for years without settlement until now. However, some will certainly vanish due to the deferral, and we don't have empirical data to provide any percentages on this at the moment. I assume that aligns with your intuition that some will probably go away.

Correct. My last question is about government investigations as a driver for your business. Could you provide some insights on what you are observing in that area? The government has certainly supported various bankruptcy matters and has somewhat hindered the market's natural progression. Additionally, could you comment on how government investigations have historically impacted the business under different political administrations, especially with the upcoming Presidential election in November? Thank you.

In my remarks, I mentioned that this situation is likely to lead to a new category of disputes and investigations. A portion of this may involve the government, considering its increasing role as a participant and owner. It's not necessary for this to follow a precedent, and while I cannot guarantee it will, experience suggests it probably will. With significant investments being made across various sectors globally, there are bound to be issues to some extent. Our firm, combining our corporate finance and FLC practices, is uniquely positioned to assist in this area. I am not entirely clear on how previous political administrations responded during past recessions in this context, so I'm unable to provide an answer to that.

Okay. We'll take it up in 90 days. Thank you.

This concludes the question-and-answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.