Huron Consulting Group Inc. quarterly report, Q2 FY2010

Huron Consulting Group Inc. — Form 10-Q Summary

Business Context and Reporting Period

Huron provides operational and financial consulting services to healthcare, education, legal, corporate, and financially distressed clients. This unaudited filing covers the three and six months ended June 30, 2010, compared with the corresponding 2009 periods. Effective January 1, 2010, the company reorganized into Health and Education Consulting, Legal Consulting, and Financial Consulting segments.

Japan operations were wound down effective June 30, 2010, and Galt was sold on December 31, 2009. Their results are presented as discontinued operations.

Financial Performance and Key Metrics

Metric	Q2 2010	Q2 2009	Six Months 2010	Six Months 2009
Revenue	$143.7 million	$154.4 million	$282.6 million	$305.6 million
Operating income	$9.2 million	$17.9 million	$17.1 million	$32.2 million
Operating margin	6.4%	11.6%	6.0%	10.5%
Net income from continuing operations	$3.3 million	$7.8 million	$6.2 million	$13.5 million
Net income	$2.4 million	$9.6 million	$4.9 million	$16.7 million
Diluted EPS from continuing operations	$0.16	$0.38	$0.30	$0.66
Adjusted EBITDA	$23.3 million	$25.4 million	$37.4 million	$50.4 million
Adjusted EBITDA margin	16.2%	16.5%	13.2%	16.5%

Q2 revenue declined 7.0%; first-half revenue declined 7.5%. Q2 net income from continuing operations declined 58%, while first-half continuing-operations net income declined 54%. Discontinued operations produced a $0.9 million net loss in Q2 and a $1.3 million net loss for the first half, versus income of $1.8 million and $3.3 million, respectively, in the prior-year periods.

Health and Education Consulting revenue decreased 8.4% in Q2 and 12.4% in the first half; segment margins were 34.4% and 31.0%, respectively.
Legal Consulting revenue increased 8.7% in Q2 and 23.9% in the first half; segment margins improved to 27.4% and 24.9%.
Financial Consulting revenue decreased 18.2% in Q2 and 19.3% in the first half; segment margins improved to 18.1% and 17.2%.
Total consultant headcount declined to 1,197 at June 30, 2010 from 1,372 at June 30, 2009. Overall utilization was 69.2% in Q2, compared with 68.7% in the prior-year quarter.

Cash Flow, Liquidity, Debt, and Balance Sheet

Cash used in operating activities was $14.0 million in the first half of 2010, compared with $29.7 million of operating cash flow in the prior-year period. The decline primarily reflected payment of 2009 performance bonuses and timing of accounts-payable payments.
Cash used in investing activities was $61.4 million, including $63.2 million of business acquisition payments and $2.5 million of capital expenditures. Management estimated approximately $10.0 million of 2010 capital expenditures.
Financing activities provided $73.0 million, including $232.0 million of borrowings and $158.0 million of repayments.
Cash and cash equivalents were $4.0 million at June 30, 2010, including $0.9 million classified within discontinued operations, compared with $6.5 million at December 31, 2009.
Bank borrowings were $293.0 million at June 30, 2010, up from $219.0 million at December 31, 2009. The weighted-average interest rate was 4.5%, compared with 4.0% at year-end 2009.
Available borrowing capacity under the credit agreement was $58.4 million after consideration of outstanding letters of credit. Letters of credit totaled $4.6 million.
The credit agreement matures February 23, 2012. The company was in compliance with its covenants at June 30, 2010, with a fixed-charge coverage ratio of 2.68:1 and leverage ratio of 2.51:1.
The June 30, 2010 ninth amendment increased pricing to 3.50% over LIBOR or 2.50% over the base rate through delivery of the December 31, 2010 compliance certificate and permitted specified litigation and restatement costs to be added back to Consolidated EBITDA for covenant purposes.
A $100.0 million interest-rate swap fixes the LIBOR component of that debt at 1.715% through February 23, 2012. A one-percentage-point change in borrowing rates would affect annualized pre-tax income by approximately $2.9 million.

Material Changes, Unusual Items, and Outlook

Revenue pressure reflected weaker economic conditions, lower client discretionary spending, delayed engagement decisions, reduced full-time consultant headcount, and lower average billing rates.
A cost-reduction program initiated in the third quarter of 2009 was expected to reduce annualized expenses by approximately $30 million. Selling, general and administrative expense declined 8.6% in Q2 and 9.1% in the first half.
Q2 included a $4.8 million litigation settlement charge related to the Saint Vincent Catholic Medical Center matter, a $2.4 million restatement-related expense, and a $1.2 million restructuring charge for consolidating two offices.
Q2 2009 included a $2.7 million gain from releasing employee non-solicitation agreements and settling contractual obligations; no comparable gain was recorded in 2010.
The company recorded $1.1 million of data-processing revenue in Q2 that related to services performed in Q1. Management concluded that the timing adjustment was not material, but Q2 continuing-operations net income was approximately $0.7 million higher than it would have been absent the adjustment.
Management expected approximately $25.0 million of additional acquisition consideration to be earned for 2010, with no contractual maximum on the aggregate potential earn-outs. The company paid $62.3 million of 2009 earn-out consideration during the first half of 2010.
Management stated that projected operating results were expected to support future covenant compliance and that internal liquidity, available revolver capacity, and external capital resources should fund expected growth, earn-outs, capital expenditures, and debt service. The filing provides no formal revenue or earnings guidance.

Risks and Contingencies

SEC investigations concerning the prior restatement and allocation of time within a practice group remained ongoing. The United States Attorney’s Office requested related documents, which Huron voluntarily provided.
Consolidated shareholder class actions and state and federal derivative actions related to the restatement were pending. Huron stated that it could not predict the outcome or reasonably estimate any potential liability, which could be material.
A separate False Claims Act qui tam action alleged more than $50 million of inflated Medicare and Medicaid outlier payments related to Saint Vincent. The United States declined to intervene; Huron’s motion to dismiss was pending.
The company disputed with its primary insurance carrier the scope and timing of coverage for certain restatement-related costs and had not recorded an insurance receivable for the disputed portion.
Goodwill totaled $464.2 million at June 30, 2010. The Financial Consulting reporting unit had the smallest excess of fair value over carrying value, at 8.1%, creating sensitivity to declines in earnings or cash flows.
Substantial variable-rate debt, limited cash, covenant requirements, refinancing needs in 2012, client demand variability, consultant retention, acquisition integration, and potential additional earn-outs remain significant risks.

Investor Verification Checklist

Verify the company’s ability to generate positive operating cash flow after bonus payments, earn-outs, and working-capital requirements.
Monitor debt balances, revolver availability, interest expense, covenant headroom, and the February 2012 maturity profile.
Assess whether revenue weakness in Health and Education and Financial Consulting is offset by sustainable Legal Consulting and full-time-equivalent demand.
Separate recurring operating performance from litigation, restructuring, restatement, discontinued-operations, and out-of-period revenue items.
Track the outcome and potential financial exposure of the SEC investigations, related shareholder and derivative litigation, and the False Claims Act case.
Reassess goodwill impairment sensitivity, particularly for Financial Consulting, if operating performance or market valuations deteriorate.