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NAVIGANT CONSULTING INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) This Management's Discussion and Analysis of Financial Condition and Results of Operations relates to, and should be read in conjunction with, our unaudited consolidated financial statements included elsewhere in this report. Overview We are an independent specialized, global professional services firm that combines deep industry knowledge with broad technical expertise. We focus on industries and clients facing transformational change and significant regulatory and legal issues. We serve clients primarily in the healthcare, energy, construction and financial services sectors which represent highly complex regulatory environments. Our professional service offerings include strategic, financial, operational, technology, risk management, compliance, investigative solutions, dispute resolution services and revenue cycle management. The nature of our services, as well as our clients' demand for our services, are impacted not only by these regulatory and structural changes, but also by the United States and global economies and other significant events specific to our clients. Our clients' demand for our services ultimately drives our revenues and expenses. We derive our revenues from fees on services provided. The majority of our revenues are generated on a time and materials basis, though we also have engagements where fees are a fixed amount (either in total or for a period of time). We may also earn incremental revenues, in addition to hourly or fixed fees, which are contingent on the attainment of certain contractual milestones or objectives. We also recognize revenues from business referral fees or commissions on certain contractual outcomes. These performance-based and referral revenues may cause unusual variations in our quarterly revenues and results of operations. Revenue is also earned on a per unit or subscription basis. Regardless of the terms of our fee arrangements, our ability to earn those fees is reliant on deploying consultants with the experience and expertise to deliver services. Our most significant expense is consultant compensation, which includes salaries, incentive compensation, amortization of sign-on and retention incentive payments, share-based compensation and benefits. Consultant compensation is included in cost of services before reimbursable expenses, in addition to sales and marketing expenses and the direct costs of recruiting and training consultants. Our most significant overhead expenses are administrative compensation and benefits and office-related expenses. Administrative compensation includes salaries, incentive compensation, share-based compensation and benefits for corporate management and administrative personnel that indirectly support client engagements. Office-related expenses primarily consist of rent for our offices. Other administrative costs include bad debt expense, marketing, technology, finance and human capital management. Because our ability to derive fees is largely reliant on the hiring and retention of personnel, the average number of full-time equivalents (FTE) and our ability to keep consultants utilized are important drivers of the business. The average number of FTE is adjusted for part-time status and takes into account hiring and attrition which occurred during the reporting period. Our average utilization rate as defined below provides a benchmark for how well we are managing our FTE levels in response to changing demand. While hiring and retention of personnel are key to driving revenues, FTE levels and related consultant compensation in excess of demand drive additional costs that can negatively impact margin. From time to time, we hire independent contractors to supplement our consultants on certain engagements, which allows us to adjust staffing in response to changes in demand for our services, and manage our costs accordingly. In connection with recruiting activities and business acquisitions, our general policy is to obtain non-solicitation covenants from senior and some mid-level consultants. Most of these covenants have restrictions that extend 12 months beyond the termination of employment. We utilize these contractual agreements and other agreements to reduce the risk of attrition and to safeguard our existing clients, staff and projects. We periodically review and adjust our consultants' total compensation (including salaries, annual cash incentive compensation, other cash and share-based compensation, and benefits) to ensure that it is competitive within the industry and is consistent with our performance. We also monitor and adjust our bill rates according to then-current market conditions for our service offerings and within the various industries we serve. In addition to investing in human capital resources, we invest in technology-related tools to derive services to provide further value to current and future clients as our business models change. 23-------------------------------------------------------------------------------- Table of Contents Acquisitions On May 14, 2014, we acquired Cymetrix, a privately held revenue cycle management firm that specialized in providing services to hospital and healthcare networks. The acquisition added approximately 600 employees mainly to the Technology, Data & Process group within our Healthcare segment. Further information regarding the purchase price, purchase price allocation and other details of significant businesses acquired can be found in Note 2 - Acquisitions to the notes to our unaudited consolidated financial statements. Any material impact our acquisitions may have had on our results from operations or segment results for the periods presented have been included in our discussion below. Dispositions and Discontinued Operations During the year ended December 31, 2013, we had two dispositions. We sold the United Kingdom financial services advisory business within our Financial, Risk & Compliance segment. All significant cash flows from this business were eliminated, and we have no continuing involvement in the operations of this business. As such, in accordance with ASC Topic 205, all operations of this disposed business were reflected as discontinued operations. In addition, we sold a portion of the economics business within our Disputes, Investigations & Economics segment. In accordance with ASC Topic 205, we consider the economics business within this segment to be continuing. Additional information regarding these dispositions, including the required disclosures under ASC Topic 205, may be found in Note 3 - Dispositions and Discontinued Operations to the notes to our unaudited consolidated financial statements. Prior period results have been reclassified to reflect continuing operations only unless otherwise stated. Key Operating Metrics The following key operating metrics provide additional operating information related to our continuing business and reporting segments. These key operating metrics may not be comparable to similarly-titled metrics at other companies. Our Technology, Data & Process businesses are comprised of technology enabled professional services, including e-discovery services and data analytics, technology solutions and data services, revenue cycle management and insurance claims processing, market research and benchmarking businesses. • Average FTE is our average headcount during the reporting period adjusted for part-time status. Average FTE is further split between the following categories: • Client Service FTE - combination of Consulting FTE and Technology, Data & Process FTE defined as follows: • Consulting FTE - individuals assigned to client services who record time to client engagements; and • Technology, Data & Process FTE - individuals inbusinesses primarily dedicated to maintaining and delivering the services described above and are not included in average bill rate and average utilization metrics described below. • Non-billable FTE - individuals assigned to administrative and support functions, including office services, corporate functions and certain practice support functions. • Period-end FTE - represents our headcount at the last day of the reporting period adjusted for part-time status. Consulting, Technology, Data & Process and Non-billable criteria also apply to period-end FTE. • Average bill rate is calculated by dividing fee revenues before certain adjustments such as discounts and markups, by the number of hours associated with the fee revenues. Fee revenues and hours billed on performance-based services and related to Technology, Data & Process FTE are excluded from average bill rate. • Average utilization rate is calculated by dividing the number of hours of our Consulting FTE who recorded time to client engagements during a period, by the total available working hours for these consultants during the same period (1,850 hours annually). • Billable hours are the number of hours our Consulting FTE recorded time to client engagements during the reporting period. • Segment operating profit represents total revenues less costs of services excluding long-term compensation expense attributable to consultants. Long-term compensation expense attributable to consultants includes share-based compensation expense and compensation expense attributable to retention incentives. All FTE, utilization and average bill rate metric data provided in this report exclude the impact of independent contractors and project employees. 24-------------------------------------------------------------------------------- Table of Contents Results of Operations Results for the three and nine months ended September 30, 2014 compared to the three and nine months ended September 30, 2013 2014 over 2014 over For the three months 2013 For the nine months 2013 ended September 30, Increase ended September 30, Increase (Decrease) (Decrease) 2014 2013 Percentage 2014 2013 Percentage Key operating metrics: Average FTE -Consulting 1,567 1,522 3.0 1,557 1,517 2.6 -Technology, Data & Process 1,168 477 144.9 851 432 97.0 -Non-billable 601 529 13.6 572 534 7.1 Period end FTE -Consulting 1,592 1,534 3.8 1,592 1,534 3.8 -Technology, Data & Process 1,199 489 145.2 1,199 489 145.2 -Non-billable 604 529 14.2 604 529 14.2 Average bill rate $ 283 $ 278 1.8 $ 281 $ 277 1.4 Utilization 74 % 73 % 1.4 75 % 76 % (1.3 ) Overview. During the three months ended September 30, 2014 and 2013, we reported $16.3 million and $13.5 million in net income from continuing operations, respectively. Revenues before reimbursements (RBR) increased 10.2% for the three months ended September 30, 2014 compared to the corresponding period in 2013. The increase was mainly a result of the acquisition of Cymetrix in May 2014 within our Healthcare segment (see Note 2 - Acquisitions to the notes to our unaudited consolidated financial statements) partially offset by a year-over-year decline in our Financial, Risk & Compliance segment. In addition, we had a 24.1% and 77.5% increase in depreciation expense and interest expense, respectively, for the three months ended September 30, 2014 compared to the corresponding period in 2013. For the three months ended September 30, 2014 and 2013, we had other operating benefits related to adjustments to our deferred contingent acquisition liabilities of $0.8 million and $2.0 million, respectively. During the nine months ended September 30, 2014 and 2013, we reported a $49.2 million net loss from continuing operations and $40.9 million in net income from continuing operations, respectively. During the three months ended June 30, 2014, we recorded a goodwill impairment in other operating cost (benefit) of $122.0 million relating to our Disputes, Investigations & Economics segment. For further discussion regarding the impairment, see our segment discussion below and Note 5 - Goodwill and Intangible Assets, net to the notes to our unaudited consolidated financial statements. RBR and cost of services before reimbursements increased 1.9% and 4.1%, respectively, for the nine months ended September 30, 2014 compared to the corresponding period mainly due to the acquisition of Cymetrix. General and administrative expenses increased 2.4 % during the nine months ended September 30, 2014 compared to the corresponding period in 2013. The nine months ended September 30, 2014 and 2013 benefited from a $4.4 million and $2.0 million adjustment, respectively, to our deferred contingent acquisition liabilities. The nine months ended September 30, 2013 benefited from a $1.7 million gain from the sale of a portion of our economics business within our Disputes, Investigations & Economics segment (see Note 3 - Dispositions and Discontinued Operations to the notes to our unaudited consolidated financial statements). In addition, depreciation expense increased 20.3% while amortization expense decreased 10.7% and interest expense increased 19.7% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. Operating results and segment information are discussed in further detail below. Revenues before Reimbursements. For the three months ended September 30, 2014, RBR increased 10.2% compared to the corresponding period in 2013. During the three months ended June 30, 2014, we acquired Cymetrix (see Note 2 - Acquisitions to the notes to our unaudited consolidated financial statements). Including the impact of our acquisitions on a pro forma basis, RBR increased 1.0% for the three months ended September 30, 2014 compared to the corresponding period in 2013. For further discussion of RBR, see segment results below. RBR included $0.3 million of performance-based fees for the three months ended September 30, 2014, compared to $1.2 million in the corresponding period in 2013. 25 -------------------------------------------------------------------------------- Table of Contents Utilization levels for the three months ended September 30, 2014 and 2013 were 74% and 73%, respectively. Average bill rate increased 1.8% to $283 during the same period. Average FTE-Consulting increased 3.0% for the three months ended September 30, 2014 compared to the corresponding period in 2013 mainly due to hiring within the Healthcare, Financial, Risk & Compliance and Energy segments offset by planned and unplanned attrition within the Disputes, Investigations & Economics segment. Average FTE - Technology, Data & Process increased 144.9% mainly due to our May 2014 acquisition of Cymetrix, which added 595 Average FTE. We also made additional technology-related hires to support physician revenue cycle management engagements. For the nine months ended September 30, 2014, RBR increased 1.9% compared to the corresponding period in 2013. Including the impact of our acquisitions on a pro forma basis, RBR decreased 3.3% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. For further discussion of RBR, see segment results below. RBR included $0.3 million of performance-based fees for the nine months ended September 30, 2014, compared to $3.3 million in the corresponding period in 2013. The decrease was primarily associated with our Healthcare and Financial, Risk & Compliance segments. Utilization levels for the nine months ended September 30, 2014 and 2013 were 75% and 76%, respectively. Average bill rate increased 1.4% to $281 during the same period. Average FTE-Consulting increased 2.6% for the nine months ended September 30, 2014 compared to the corresponding period in 2013 mainly due to hiring within the Healthcare segment offset by planned and unplanned attrition within the Disputes, Investigations & Economics segment. Average FTE - Technology, Data & Process increased 97.0% mainly due to the acquisition of Cymetrix, which added 294 (due to partial period of ownership averaged over the nine month period) Average FTE. Cost of Services before Reimbursable Expenses. Cost of services before reimbursable expenses increased 11.2% for the three months ended September 30, 2014 compared to the corresponding period in 2013. The increase was mainly due to the acquisition of Cymetrix, an increase in wages and benefits relating to FTE hires within the Healthcare segment, and recruiting costs. These increases were partially offset by lower compensation costs associated with the Financial, Risk & Compliance segment, lower performance-based incentive compensation and lower share-based compensation (see Note 7 - Share-based Compensation to the notes to the unaudited consolidated financial statements). Severance expense relating to client service FTE for the three months ended September 30, 2014 and 2013 was $0.5 million and $0.3 million, respectively. Cost of services before reimbursable expenses increased 4.1% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. The increase was mainly due to reasons discussed above. Severance expense relating to client service FTE for the nine months ended September 30, 2014 and 2013 was $2.7 million and $3.7 million, respectively. General and Administrative Expenses. General and administrative expenses increased 0.5% for the three months ended September 30, 2014 compared to the corresponding period in 2013. The increase was mainly a result of incremental general and administrative costs relating to our acquisition of Cymetrix. In addition, bad debt expense for the three months ended September 30, 2014 and 2013 was $1.5 million and $0.8 million, respectively. The increase was partially offset by lower facilities and legal expenses and lower incentive compensation. Average non-billable FTE related to general and administrative expenses for the three months ended September 30, 2014 and 2013 was 545 and 474, respectively, due, in part to Cymetrix which added 46 non-billable FTE. General and administrative expenses were 16.6% and 18.2% of RBR for the three months ended September 30, 2014 and 2013, respectively, due to lower facilities, meeting, legal and incentive compensation expenses partially offset by higher bad debt expense and incremental general and administrative expenses relating to acquisitions. General and administrative expenses increased 2.4% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. The increase was mainly a result of incremental general and administrative costs relating to our acquisition of Cymetrix; higher acquisition-related costs which were $1.8 million and $0.5 million for the nine months ended September 30, 2014 and 2013, respectively; and higher information technology costs, accounting expense and bad debt expense. Bad debt expense for the nine months ended September 30, 2014 and 2013 was $4.3 million and $2.1 million, respectively. These increases were partially offset by a decrease in facilities expense, meeting expense, legal expense and lower wages expense due to the departure of certain senior corporate management personnel in 2013 and lower incentive compensation in 2014. The nine months ended September 30, 2013 also benefited from a large collection of previously reserved accounts receivable balances. Average non-billable FTE related to general and administrative expenses for the nine months ended September 30, 2014 compared to the corresponding period in 2013 was 519 and 478, respectively. General and administrative expenses were 17.9% and 17.8% of RBR for the nine months ended September 30, 2014 and 2013, respectively. Depreciation Expense. The increase in depreciation expense of 24.1% and 20.3% for the three and nine months ended September 30, 2014 compared to the corresponding periods in 2013 was primarily due to recent acquisitions and increased technology infrastructure spending. Amortization Expense. Amortization expense decreased 7.8% and 10.7% for the three and nine months ended September 30, 2014, respectively, compared to the corresponding periods in 2013. The decrease was due mainly to reduced amortization associated 26 -------------------------------------------------------------------------------- Table of Contents with certain intangible assets which became fully amortized as their useful lives came to term. Amortization expense for the three and nine months ended September 30, 2014 compared to the corresponding period in 2013 was also impacted by the acquisition of Cymetrix. Other Operating Benefit - Contingent acquisition liability adjustment. During the three and nine months ended September 30, 2014, we recorded benefits of $0.8 million and $4.4 million, respectively, relating to fair value adjustments to our deferred contingent acquisition liabilities. Similarly, during the nine months ended September 30, 2013, we recorded a benefit of $2.0 million relating to a fair value adjustment to our deferred contingent liabilities (see Note 12 - Fair Value to the notes to the unaudited consolidated financial statements). Other Operating Costs - Office consolidation. During the three months ended September 30, 2013, we recorded a benefit of $0.2 million for earlier-than-anticipated sublease income related to one previously vacated office space in 2013. During the nine months ended September 30, 2013, in addition to the benefit mentioned above, we recorded $0.5 million of additional depreciation expense relating to the consolidation of two office spaces. On October 1, 2014, we took possession of our new office space located in New York, New York. Due to construction time, we will have duplicate rent as we continue to occupy the existing offices which are to be consolidated into the new space upon completion of the build-out. Other Operating Benefit - Gain on disposition of assets. During the nine months ended September 30, 2013, we recorded a $1.7 million gain relating to the January 31, 2013 sale of a portion of our economics business within our Disputes, Investigations & Economics segment. The gain reflected proceeds of $15.6 million in cash, net of selling expenses, and a reduction of $6.5 million of working capital and $7.4 million of goodwill (see Note 3 - Disposition and Discontinued Operations to the notes to our unaudited consolidated financial statements). Other Operating Costs- Goodwill impairment. During the nine months ended September 30, 2014, we performed our annual goodwill impairment test. Based upon the results of the two-step test, a pretax goodwill impairment of $122.0 million was recorded. For further details see Note 5 - Goodwill and Intangible Assets, net to the notes to our unaudited consolidated financial statements. Other Operating Costs - Other impairment. During the nine months ended September 30, 2014, we recorded a $0.2 million impairment on software that is no longer being utilized by our consultants for client engagements. Interest Expense. Interest expense increased 77.5% or $0.8 million and 19.7% or $0.7 million for the three and nine months ended September 30, 2014 compared to the corresponding period in 2013, respectively. The increase was mainly due to the incremental imputed interest relating to the contingent acquisition liability for Cymetrix recorded at net present value and higher average borrowings partially due to the Cymetrix acquisition for the three and nine months ended September 30, 2014 compared to the corresponding period in 2013. Our average borrowing rates under our credit facility, including the impact of our interest rate derivatives (see Note 10 - Derivatives and Hedging Activity to the notes to our unaudited consolidated financial statements), were 2.2% and 2.6% for the three months ended September 30, 2014 and 2013, respectively, and 2.3% and 2.5% for the nine months ended September 30, 2014 and 2013, respectively (see Note 11 - Bank Debt to the notes to our unaudited consolidated financial statements for further information on borrowings under our credit facility). Income Tax Expense. Our effective income tax rate fluctuates based on the mix of income earned in various tax jurisdictions, including U.S. state and federal and foreign jurisdictions, which have different income tax rates as well as various book-to-tax permanent differences. It is also affected by discrete items which may not be consistent from year to year. The effective tax rate from continuing operations for the three months ended September 30, 2014 and 2013 was 41.6% and 46.9%, respectively. The decrease in rates between periods is due to increased earnings in certain foreign jurisdictions where the statutory rates are significantly lower than the U.S. Federal statutory rate and the utilization of certain foreign deferred income tax valuation allowances established in 2013, which primarily drove the higher tax rate in the prior year. The effective tax rate for the nine months ended September 30, 2014 is not comparable to the prior period due to the impact of a goodwill impairment of approximately $122.0 million related to both tax deductible and non-tax deductible components of goodwill. The impairment reduced income tax expense for the nine months ended September 30, 2014 by approximately $35.1 million. 27-------------------------------------------------------------------------------- Table of Contents The effective tax rate excluding the goodwill impairment from continuing operations for the nine months ended September 30, 2014 and 2013 would have been 41.0% and 44.1%, respectively. The decrease in rates between periods is attributable to increased earnings in certain foreign jurisdictions, including the utilization of foreign deferred income tax valuation allowances. Income (loss) from Discontinued Operations, net of tax. Income from discontinued operations, net of tax was zero for the three months ended September 30, 2014 compared to a loss of $3.3 million for the corresponding period in 2013. Income from discontinued operations, net of tax was $0.5 million for the nine months ended September 30, 2014 compared to a loss of $2.9 million for the corresponding period in 2013. During the year ended December 31, 2013, we sold the United Kingdom financial services advisory business within our Financial, Risk & Compliance segment. In connection with the sale, during the nine months ended September 30, 2014, we received payment in full for a holdback receivable which we had partially reserved for possible working capital adjustments (see Note 3 - Dispositions and discontinued operations to the notes to our unaudited financial statements for further details on our discontinued operations). 28-------------------------------------------------------------------------------- Table of Contents Segment Results Based on their size and importance, our operating segments are the same as our reporting segments. Our performance is assessed and resources are allocated based on the following four reporting segments: • Disputes, Investigations & Economics • Financial, Risk & Compliance • Healthcare • Energy The following information includes segment revenues before reimbursements, segment total revenues and segment operating profit. Certain unallocated expense amounts related to specific reporting segments have been excluded from the calculation of segment operating profit to be consistent with the information used by management to evaluate segment performance (see Note 4 - Segment Information to the notes to our unaudited consolidated financial statements). Segment operating profit represents total revenues less cost of services excluding long-term compensation expense related to consultants. Long-term compensation expense attributable to consultants includes share-based compensation expense and compensation expense attributed to retention incentives (see Note 8 - Supplemental Consolidated Balance Sheet Information to the notes to our unaudited consolidated financial statements). Key operating metric definitions are provided above. The information presented does not necessarily reflect the results of segment operations that would have occurred had the segments been stand-alone businesses. Prior period segment data has been reclassified to be consistent with the presentation in the current period. Disputes, Investigations & Economics 2014 over 2014 over For the three months 2013 For the nine months 2013 ended September 30, Increase ended September 30, Increase (Decrease) (Decrease) 2014 2013 Percentage 2014 2013 Percentage Revenues before reimbursements (in 000s) $ 79,862 $ 75,366 6.0 $ 232,188 $ 228,693 1.5 Total revenues (in 000s) $ 85,518 $ 81,144 5.4 $ 250,046 $ 247,430 1.1 Segment operating profit (in 000s) $ 27,264 $ 25,738 5.9 $ 78,195 $ 76,948 1.6 Key segment operating metrics: Segment operating profit margin 34.1 % 34.2 % (0.3 ) 33.7 % 33.6 % 0.3 Average FTE - Consulting 516 539 (4.3 ) 521 550 (5.3 ) Average FTE - Technology, Data & Process 202 192 5.2 197 191 3.1 Average utilization rates based on 1,850 hours 72 % 68 % 5.9 72 % 72 % - Average bill rate $ 370 $ 353 4.8 $ 365 $ 349 4.6 The Disputes, Investigations & Economics segment provides accounting, financial and economic analysis, as well as discovery support, data management and analytics, on a wide range of legal and business issues including disputes, investigations and regulatory matters. The clients of this segment are principally companies, along with their in-house counsel and law firms, as well as accounting firms, corporate boards and government agencies. As a result of reducing the growth assumptions and lowering margin expectations in this segment, our annual goodwill impairment testing performed as of May 31, 2014 indicated that the fair value of the segment was less than its carrying value by 1%. After performing the second step of the goodwill impairment test (see Note 5 - Goodwill and Intangible Assets, net to the notes to the unaudited consolidated financial statements), we determined that a goodwill impairment of $122.0 million was necessary and recorded such amount during the three months ended June 30, 2014. Although growth assumptions have been reduced, we still expect modest RBR growth in the future albeit with lower margins. RBR for this segment increased 6.0% for the three months ended September 30, 2014 compared to the corresponding period in 2013. The increase in RBR was mainly a result of higher demand for financial services dispute engagements, increased activity in global construction, technology and new business from a third quarter 2013 acquisition in healthcare disputes (see Note 2 - Acquisitions to the notes to our unaudited consolidated financial statements). Including the impact of the segment's acquisitions on a pro forma basis, RBR increased 4.4% for the three months ended September 30, 2014 compared to the corresponding period in 2013. 29 -------------------------------------------------------------------------------- Table of Contents Average FTE-Consulting decreased 4.3% for the three months ended September 30, 2014 compared to the corresponding period in 2013 due to planned and unplanned attrition. For the same period, average FTE - Technology, Data & Process increased 5.2%. Average bill rate increased 4.8% to $370 for the three months ended September 30, 2014 compared to the corresponding period in 2013, mainly due to higher global construction, economics and dispute engagement rates. Utilization increased 5.9% for the same period. For the three months ended September 30, 2014, segment operating profit increased $1.5 million while segment operating profit margins were flat compared to the corresponding period in 2013 mainly due to RBR growth while maintaining similar cost structure to the prior year. RBR for this segment increased 1.5% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. The increase in RBR was mainly due to reasons discussed above as well as increased demand for international arbitration, data breach and tax controversy work partially offset by a decline in economics and the completion of certain large dispute engagements. Including the impact of the segment's acquisitions on a pro forma basis, RBR decreased 1.3% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. Average FTE-Consulting decreased 5.3% for the nine months ended September 30, 2014 compared to the corresponding period in 2013, due to planned and unplanned attrition. For the same period, average FTE - Technology, Data & Process increased 3.1%. Average bill rate increased 4.6% to $365 for the nine months ended September 30, 2014 compared to the corresponding period in 2013. Utilization was flat for the same period. For the nine months ended September 30, 2014, segment operating profit increased $1.2 million and segment operating profit margin was flat compared to the corresponding period in 2013. 30 -------------------------------------------------------------------------------- Table of Contents Financial, Risk & Compliance 2014 over 2014 over For the three months 2013 For the nine months 2013 ended September 30, Increase ended September 30, Increase (Decrease) (Decrease) 2014 2013 Percentage 2014 2013 Percentage Revenues before reimbursements (in 000s) $ 37,251 $ 40,227 (7.4 ) $ 100,855 $ 117,965 (14.5 ) Total revenues (in 000s) $ 44,878 $ 48,668 (7.8 ) $ 121,100 $ 142,936 (15.3 ) Segment operating profit (in 000s) $ 17,246 $ 16,959 1.7 $ 44,255 $ 47,897 (7.6 ) Key segment operating metrics: Segment operating profit margin 46.3 % 42.2 % 9.7 43.9 % 40.6 % 8.1 Average FTE - Consulting 282 227 24.2 265 220 20.5 Average utilization rates based on 1,850 hours 78 % 83 % (6.0 ) 81 % 82 % (1.2 ) Average bill rate $ 276 $ 268 3.0 $ 277 $ 274 1.1 The Financial, Risk & Compliance segment provides strategic, operational, valuation, risk management, investigative and compliance consulting to clients in the highly regulated financial services industry, including major financial and insurance institutions. This segment also provides anti-corruption solutions and anti-money laundering, valuation and restructuring consulting, litigation support and tax compliance services to clients in a broad variety of industries. The financial services advisory business based in the United Kingdom was sold on July 8, 2013 (see Note 3 - Dispositions and Discontinued Operations to the notes to our unaudited consolidated financial statements), and as such, the results of this disposed business for the prior year are presented in discontinued operations. RBR for this segment decreased 7.4% for the three months ended September 30, 2014 compared to the corresponding period in 2013. RBR for the current period reflected decreased RBR from one large anti-money laundering engagement, mortgage servicing review engagements and restructuring-related services partially offset by new compliance work within the financial services sector. Average FTE - Consulting increased 24.2% for the three months ended September 30, 2014 compared to the corresponding period in 2013 due to on-going demand for anti-money laundering and compliance work partially offset by fewer restructuring-related professionals. Use of project employees are not reflected in the Average FTE - Consulting metric. Average bill rate increased 3.0% to $276 for the three months ended September 30, 2014 compared to the corresponding period in 2013. Utilization decreased 6.0% for the three months ended September 30, 2014 compared to the corresponding period in 2013. Segment operating profit marginally increased $0.3 million while segment operating profit margins increased 4.1 percentage points mainly as a result of new engagements with higher profitability and higher use of independent contractors included within reimbursable expenses. RBR for this segment decreased 14.5% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. RBR for the current period reflected decreased RBR from mortgage servicing review engagements and restructuring-related services partially offset by new compliance work. Average FTE - Consulting increased 20.5% for the nine months ended September 30, 2014 compared to the corresponding period in 2013 due to the reasons discussed above. Average bill rate increased 1.1% to $277 for the nine months ended September 30, 2014 compared to the corresponding period in 2013. Utilization decreased 1.2% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. Segment operating profit decreased $3.6 million and segment operating profit margins increased 3.3 percentage points mainly as a result of project mix. 31 -------------------------------------------------------------------------------- Table of Contents Healthcare 2014 over 2014 over For the three months 2013 For the nine months 2013 ended September 30, Increase ended September 30, Increase (Decrease) (Decrease) 2014 2013 Percentage 2014 2013 Percentage Revenues before reimbursements (in 000s) $ 62,964 $ 48,088 30.9 $ 162,145 $ 138,485 17.1 Total revenues (in 000s) $ 69,035 $ 53,721 28.5 $ 179,877 $ 155,295 15.8 Segment operating profit (in 000s) $ 18,726 $ 17,967 4.2 $ 48,230 $ 51,881 (7.0 ) Key segment operating metrics: Segment operating profit margin 29.7 % 37.4 % (20.6 ) 29.7 % 37.5 % (20.8 ) Average FTE - Consulting 438 445 (1.6 ) 444 432 2.8 Average FTE - Technology, Data & Process 915 238 284.5 602 195 208.7 Average utilization rates based on 1,850 hours 74 % 75 % (1.3 ) 75 % 78 % (3.8 ) Average bill rate $ 260 $ 265 (1.9 ) $ 256 $ 257 (0.4 ) The Healthcare segment provides strategic, operational, performance improvement and revenue cycle management solutions to clients across the healthcare landscape including health systems, physician practice groups, health insurance providers, government and life sciences companies. We assist clients on issues such as the shift to an outcomes and value-based reimbursements model, ongoing industry consolidation and reorganization, and the required implementation of a new medical coding system. RBR for this segment increased 30.9% for the three months ended September 30, 2014 compared to the corresponding period in 2013. RBR for the current period reflected the second quarter acquisition of Cymetrix (see Note 2 - Acquisitions to the notes to our unaudited consolidated financial statements). Including the impact of the segment's acquisitions on a pro forma basis, RBR decreased 2.1% for the three months ended September 30, 2014 compared to the corresponding period in 2013. The 2.1% decrease for the period reflects decreased RBR within the performance improvement area due to competitive challenges as well as the delay in anticipated project work relating to the implementation of ICD10 (regulatory codification update). Additionally, strategy related services declined as certain large projects wound down during the second half of 2013 and were replaced by smaller engagements. Performance based fees were $0.3 million and $1.0 million for the three months ended September 30, 2014 and 2013, respectively, also contributing to the decrease. These decreases were offset by the growth of our combined existing physician revenue cycle outsourcing capabilities and our revenue cycle management business. The growth will potentially allow us to incorporate more data analytics products, technology-enabled solutions, and operations outsourcing within this segment. Organic growth within our life sciences business also offset a portion of the overall RBR decline in the segment. Average FTE - Consulting decreased 1.6% for the three months ended September 30, 2014 compared to the corresponding period in 2013, while utilization decreased 1.3% for the same period, due in part to delayed start up of certain projects and acquisition integration for Cymetrix. Average FTE - Technology, Data & Process increased 284.5% for the three months ended September 30, 2014 compared to the corresponding period in 2013 due to the acquisition of Cymetrix which added 595 Average FTE as well as new hires in our physician revenue cycle outsourcing group. Average bill rate decreased 1.9% for the same period. For the three months ended September 30, 2014, segment operating profit increased $0.8 million, and segment operating profit margin decreased 7.7 percentage points compared to the corresponding period in 2013 reflecting mix of engagements, lower utilization and increased wages and training expense for new hires as well as additional technology-related expense. RBR for this segment increased 17.1% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. As previously mentioned RBR for the current period reflected the acquisition of Cymetrix (see Note 2 - Acquisitions to the notes to our unaudited consolidated financial statements). Including the impact of the segment's acquisitions on a pro forma basis, RBR decreased 0.4% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. The decrease is due to similar reasons discussed above. Performance based fees were $0.3 million and $2.3 million for the nine months ended September 30, 2014 and 2013, respectively. Average FTE - Consulting increased 2.8% for the nine months ended September 30, 2014 compared to the corresponding period in 2013, while utilization decreased 3.8% for the same period, also due to reasons discussed above. Average FTE - Technology, Data & Process increased 208.7% for the nine months ended September 30, 2014 compared to the corresponding period in 2013 due to the acquisition of Cymetrix which added 294 (due to partial period of ownership averaged over the 9 month period) Average FTE as well as additions relating to our physician revenue cycle outsourcing group. For the nine months ended September 30, 2014, segment operating profit decreased $3.7 million and segment operating profit margin decreased 7.8 percentage points compared to the corresponding period in 2013 due to mix of engagements and increased costs relating to acquisitions, training, strategic investments and segment meetings. In addition, severance expense for the nine months ended September 30, 2014 and 2013 was $1.2 million and $0.3 million, respectively. 32 -------------------------------------------------------------------------------- Table of Contents Energy 2014 over 2014 over For the three months 2013 For the nine months 2013 ended September 30, Increase ended September 30, Increase (Decrease) (Decrease) 2014 2013 Percentage 2014 2013 Percentage Revenues before reimbursements (in 000s) $ 25,457 $ 22,763 11.8 $ 71,906 $ 71,501 0.6 Total revenues (in 000s) $ 30,708 $ 28,074 9.4 $ 84,961 $ 85,100 (0.2 ) Segment operating profit (in 000s) $ 8,766 $ 6,968 25.8 $ 22,262 $ 23,839 (6.6 ) Key segment operating metrics: Segment operating profit margin 34.4 % 30.6 % 12.4 31.0 % 33.3 % (6.9 ) Average FTE-Consulting 331 311 6.4 327 315 3.8 Average FTE-Technology, Data & Process 51 47 8.5 53 46 15.2 Average utilization rates based on 1,850 hours 76 % 74 % 2.7 74 % 76 % (2.6 ) Average bill rate $ 191 $ 189 1.1 $ 189 $ 191 (1.0 ) The Energy segment provides management advisory services to utility, government and commercial clients. We focus on creating value for our clients by assisting in their implementation of new business models and creating sustainable excellence on issues ranging from asset investment management, integrated resource planning, renewables, distributed generation, energy efficiency and outage management and restoration. RBR for this segment increased 11.8% for the three months ended September 30, 2014 compared to the corresponding period in 2013. RBR for the current period reflects the ramp up of energy efficiency, governmental policy and research engagements as well as business strategy related services as a result of new senior hires. Utilization increased 2.7% for the three months ended September 30, 2014 compared to the corresponding period in 2013. Average FTE - Technology, Data & Process increased 8.5% for the three months ended September 30, 2014 compared to the corresponding period in 2013 as demand for the segment's benchmarking and research services strengthened. For the three months ended September 30, 2014, segment operating profit increased $1.8 million and segment operating profit margin increased 3.8 percentage points compared to the corresponding period in 2013 due to improved resource alignment. RBR for this segment was relatively flat for the nine months ended September 30, 2014 compared to the corresponding period in 2013. This reflects a decrease relating to fewer engagements in market analysis and pricing services and a slowdown within energy efficiency due to competitive pressure and clients' timing of report requirements offset by increases in governmental policy engagements and research. Utilization decreased 2.6% for the nine months ended September 30, 2014 compared to the corresponding period in 2013. Average FTE - Consulting increased 3.8% relating to hires within energy efficiency and business strategy offset by attrition within the market analysis and pricing business. Average FTE - Technology, Data & Process increased 15.2% for the nine months ended September 30, 2014 compared to the corresponding period in 2013 as demand for the segment's benchmarking and research services strengthened. For the nine months ended September 30, 2014, segment operating profit and segment operating profit margin decreased $1.6 million and 2.3 percentage points, respectively, due to strategic hires and the delay of renewing certain engagements. Severance expense for the nine months ended September 30, 2014 and 2013 was $0.7 million and $1.2 million, respectively. 33-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Our cash flow activities were as follows (in thousands) for the nine months ended September 30: 2014 2013 Net cash provided by operating activities $ 26,893 $ 50,638 Net cash (used in) provided by investing activities $ (105,395 ) $ 947 Net cash (used in) provided by financing activities $ 80,799 $ (49,069 ) Generally, our net cash used in operating activities is funded by our day to day operating activities and augmented by borrowings under our credit facility. First quarter operating cash requirements are generally higher due to payment of our annual incentive bonuses while subsequent quarters' cash requirements are generally lower. Our cash equivalents are primarily limited to money market accounts or 'A' rated securities, with maturity dates of 90 days or less. We calculate accounts receivable DSO by dividing the accounts receivable balance, net of reserves and deferred revenue credits, at the end of the quarter, by daily revenue. Daily revenues are calculated by taking quarterly revenue divided by 90 days, approximately equal to the number of days in a quarter. DSO was 77 days at September 30, 2014, compared to 81 days at September 30, 2013. DSO is reported on a historical basis and is inclusive of discontinued operations. As DSO increases, we have less operating funds available for operating activities and our borrowings under our credit facility may increase. Operating Activities Net cash provided by operating activities was $26.9 million for the nine months ended September 30, 2014 compared to $50.6 million for the corresponding period in 2013. The decrease in cash provided by operating activities was primarily due to higher accounts receivable balances compared to the prior year, higher sign-on and retention bonus payments in 2014 compared to 2013 and deferred revenue received in 2013 with no similar amount in 2014. Investing Activities Net cash used in investing activities was $105.4 million for the nine months ended September 30, 2014 compared to cash provided by investing activities of $0.9 million for the corresponding period in 2013. During the nine months ended September 30, 2014, we paid $78.3 million, including selling costs, in cash for Cymetrix, paid $9.3 million for three other small acquisitions and paid $1.5 million for software. The acquisitions were funded by borrowings under our credit facility. This compares to acquiring one small business during the nine months ended September 30, 2013 (see Note 2 - Acquisitions to the notes to our unaudited consolidated financial statements for further information on our acquisitions). Higher capital expenditures in 2014 primarily associated with increased technology investment further contributed to the increase in cash used in investing activities for the current period. We expect to have further capital expenditures in the near term relating to leasehold improvements and technology for our new New York office lease. During the nine months ended September 30, 2013, we received $15.6 million in proceeds from the sale of a portion of our economics business (see Note 3 - Dispositions and Discontinued Operations to the notes to our unaudited consolidated financial statements). Financing Activities Net cash provided by financing activities was $80.8 million for the nine months ended September 30, 2014 compared to cash used in financing activities of $49.1 million for the corresponding period in 2013. The increase in cash provided by financing activities was primarily due to higher borrowings under our credit facility due to the acquisition of Cymetrix discussed above. Borrowings were also higher due to higher accounts receivable balances in the current period as well as higher capital expenditure requirements in 2014. During the nine months ended September 30, 2014, we purchased 1,204,124 shares of our common stock in the open market for $20.8 million compared to 1,719,905 shares for $22.3 million during the nine months ended September 30, 2013. Debt, Commitments and Capital For further information regarding our debt, see Note 11 - Bank Debt to the notes to our unaudited consolidated financial statements. 34-------------------------------------------------------------------------------- Table of Contents At September 30, 2014 we had total contractual obligations of $326.3 million. The following table shows the components of our significant commitments at September 30, 2014 by the scheduled years of payments (in thousands): Contractual Obligations Total 2014 2015 to 2016 2017 to 2018 Thereafter Deferred acquisition liabilities (a) $ 32,006 $ 4,148 $ 27,858 $ - $ - Purchase agreements (b) 2,348 - 2,348 - - Revolving credit facility (c) (d) 158,017 - - 158,017 - Lease commitments (e) 133,922 6,107 44,222 33,157 50,436 Total contractual obligations $ 326,293 $ 10,255 $ 74,428 $ 191,174 $ 50,436 a) At September 30, 2014, we had $32.0 million in liabilities relating to deferred acquisition liability obligations (reflected in the table above). Of this balance, $23.4 million is in the form of contingent acquisition liability obligations which were recorded at estimated fair value and discounted to present value. Settlement of the liabilities is contingent upon the particular acquired business meeting certain performance targets. Assuming each of these acquisitions reach its maximum target, our maximum deferred acquisition liability would have been $47.5 million at September 30, 2014. b) We have obligations recorded in other current liabilities of approximately $2.3 million (reflected in the table above) relating to costs associated with information technology purchases associated with our Technology, Data & Process businesses. c) Interest incurred on amounts we borrow under our credit facility vary based on relative borrowing levels, fluctuations in the variable interest rates and the applicable margin we pay over those interest rates. As such, we are unable to quantify our future obligations relating to interest on borrowings under our credit facility (see Note 11 - Bank Debt to the notes to our unaudited consolidated financial statements for further information on our credit facility). d) At September 30, 2014, we had $8.1 million of unused letters of credit under our credit facility, which have been included as a reduction in the available borrowings. The letters of credit are primarily related to the requirements of certain lease agreements for office space. e) During the three months ended June 30, 2014, we entered into a new lease for office space located in New York, New York which increased our contractual obligations relating to lease commitments by $40.7 million. In conjunction with the new lease, we anticipate future expenditures for leasehold improvements, technology and double rent while the new space is under construction. On October 25, 2011, our board of directors extended until December 31, 2014 its previous authorization to repurchase up to $100.0 million of our common stock in open market or private transactions. On February 11, 2014, our board of directors increased the stock repurchase authorization by approximately $50.0 million and extended the authorization to December 31, 2015. As increased and extended, we are authorized to repurchase up to $100.0 million in shares of our common stock during the two year period ending December 31, 2015. During the nine months ended September 30, 2014, we repurchased 1,204,124 shares for $20.8 million. As of September 30, 2014 we have $79 million remaining under the authorization. We believe that our current cash and cash equivalents, future cash flows from operations and borrowings under our credit facility will provide adequate liquidity to fund anticipated short-term and long-term operating activities. However, in the event we make significant cash expenditures in the future for major acquisitions or other unanticipated activities, we may require more liquidity than is currently available to us under our credit facility and may need to raise additional funds through debt or equity financing, as appropriate. In addition, if our lenders are not able to fund their commitments due to disruptions in the financial markets or otherwise, our liquidity could be negatively impacted. As we further develop our margin improvement goals, we anticipate taking certain actions which may include compensation and staffing alignment, improved practice cost management, real estate consolidation and targeted general and administrative cost reductions. Such actions may result in additional severance expense. We continue to evaluate under-performing practice areas and are considering various options to improve our overall financial results. Off-balance Sheet Arrangements We do not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future impact on our financial condition or results of operations. 35 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies There have been no material changes to our critical accounting policies and estimates from the information provided in Part II, Item 7- "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in our 2013 10-K. Recent Accounting Pronouncements In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09 -Revenue from Contracts with Customers (Topic 606). This update is intended to improve the financial reporting requirements for revenue from contracts with customers by providing a principle based approach. The core principle of the standard is that revenue should be recognized when the transfer of promised goods or services is made in an amount that the entity expects to be entitled to in exchange for the transfer of goods and services. The update also requires disclosures enabling users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. This standard will be effective for financial statements issued by public companies for annual reporting periods beginning after December 15, 2016. Early adoption is not permitted. We are currently evaluating the potential impact of this guidance on our consolidated financial statements. In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360) - Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This update includes amendments that change the requirements for reporting discontinued operations and require additional disclosures about discontinued operations. Under the new guidance, only disposals representing a strategic shift in operations that has (or will have) a major effect on the entity's operations and financial results should be presented as discontinued operations. Examples include a disposal of a major geographic area, a major line of business, a major equity method investment, or other major parts of an entity. Additionally, the revised guidance requires expanded disclosures in the financial statements for discontinued operations as well as for disposals of significant components of an entity that do not qualify for discontinued operations presentation. This guidance is effective for financial statements issued by public companies for annual reporting periods beginning after December 15, 2014. |