Huron Consulting Group Inc. — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010, compared with the corresponding 2009 periods. Financial statements are unaudited and presented in accordance with GAAP. Huron provides operational and financial consulting services through Health and Education Consulting, Legal Consulting, and Financial Consulting.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Revenue | $145.4 million | $149.0 million | $408.8 million | $417.6 million |
| Operating income (loss) | $24.6 million | $(57.7) million | $41.6 million | $(29.2) million |
| Operating margin | 16.9% | (38.7)% | 10.2% | (7.0)% |
| Net income (loss) from continuing operations | $11.1 million | $(41.3) million | $17.2 million | $(30.0) million |
| Total net income (loss) | $7.5 million | $(64.0) million | $12.3 million | $(47.3) million |
| Diluted EPS from continuing operations | $0.53 | $(2.04) | $0.83 | $(1.50) |
| Adjusted EBITDA | $31.5 million | $31.8 million | $68.8 million | $78.5 million |
| Adjusted EBITDA margin | 21.6% | 21.4% | 16.8% | 18.8% |
Cash flow and liquidity: Operating cash flow was $10.9 million for the first nine months, down from $47.8 million in 2009. Investing cash flow was $(61.4) million, including $65.2 million for business acquisitions and additional purchase consideration. Financing cash flow was $49.7 million, reflecting $297.5 million of borrowings and $247.0 million of repayments. Cash and cash equivalents were $6.3 million at September 30, 2010, compared with $5.7 million at December 31, 2009; cash flow statements include cash classified in discontinued operations.
Debt and liquidity: Bank borrowings were $269.5 million at September 30, 2010, compared with $219.0 million at year-end 2009, at a weighted-average interest rate of 4.4%. The credit facility comprised a $180.0 million revolver and a $220.0 million term loan. Available borrowing capacity was $74.8 million after outstanding letters of credit of $6.2 million. Huron remained in compliance with its covenants, including a 2.58:1 fixed-charge coverage ratio and 2.40:1 leverage ratio. The credit agreement matures on February 23, 2012.
Balance sheet: Total assets were $732.8 million and stockholders’ equity was $349.3 million at September 30, 2010. Receivables from clients were $76.2 million and unbilled services were $50.2 million. Goodwill was $468.3 million, including $106.0 million of accumulated impairment losses related to prior periods.
Material changes versus the prior comparable period
- Revenue declined 2.4% in the quarter and 2.1% year to date, as lower demand, delayed client decisions, fewer full-time billable consultants, and lower average billing rates offset stronger demand for variable, on-demand professionals.
- Operating results improved sharply because Q3 2009 included a $67.0 million goodwill impairment charge. Q3 2010 also benefited from lower restatement expenses of $1.1 million versus $13.0 million and lower restructuring charges of $0.3 million versus $1.9 million.
- Adjusted EBITDA was essentially flat in the quarter but declined 12.3% year to date, reflecting lower revenue and increased compensation and contractor costs.
- Health and Education revenue decreased 10.7% in the quarter and 11.8% year to date; its operating margin declined to 35.9% from 38.8% in Q3 and to 32.8% from 37.7% year to date.
- Legal Consulting revenue increased 29.2% in the quarter and 25.8% year to date, driven principally by document review demand. Its Q3 operating margin increased to 30.9% from 18.3%.
- Financial Consulting revenue decreased 7.4% in the quarter but increased 6.3% year to date; its Q3 operating margin increased to 31.2% from 22.1%.
- Discontinued operations generated losses of $3.6 million in Q3 and $4.9 million year to date, substantially below the respective 2009 losses of $22.6 million and $17.3 million. Huron sold part of its Disputes and Investigations practice, exited Utilities, wound down Japan, and had previously sold Galt.
- Operating cash generation weakened primarily because of performance-bonus payments, other liability payments, and working-capital timing. Debt increased to fund operations, bonuses, and acquisition-related payments.
Outlook, commentary, risks, and unusual items
- Management expects internally generated liquidity, available revolver capacity, and external capital resources to fund growth, earn-out obligations, capital expenditures, and debt service, but future financing depends on profitability, receivable quality, leverage, and credit-market conditions.
- Management estimated 2010 capital expenditures of approximately $10.0 million and anticipated approximately $20.0 million of additional purchase consideration for the year. The filing states that earn-out obligations have no maximum aggregate amount and could be significant; $4.0 million remained payable at September 30, 2010.
- The June 2010 ninth credit agreement 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 add-backs for litigation and restatement costs. Without the amendment, Huron states it would not have met certain covenant obligations at June 30, 2010.
- Interest-rate exposure remains material: a hypothetical one-percentage-point change in borrowing rates would affect pretax income by approximately $2.7 million. A $100.0 million interest-rate swap fixes the LIBOR component at 1.715% through February 2012.
- Huron recorded a $4.8 million litigation settlement charge in Q2 2010 and $4.2 million of restatement-related expenses during the first nine months. The company is disputing insurance coverage for a portion of restatement costs.
- SEC investigations concerning the restatement and time allocation within a practice group remained ongoing. The U.S. Attorney’s Office requested documents. Huron states that potential fines, penalties, damages, or other liabilities could be material but cannot be reasonably estimated.
- A consolidated shareholder class action remained in discovery after the court denied a motion to dismiss. State derivative litigation was dismissed with prejudice on October 25, 2010; a federal derivative case was reopened after plaintiffs were permitted to file an amended complaint.
- A False Claims Act lawsuit alleging more than $30 million of inflated Medicare and Medicaid outlier payments was amended after an earlier dismissal without prejudice; Huron filed another motion to dismiss and said it believes the claims lack merit.
- Subsequent to quarter-end, Huron acquired Click Commerce and TRILANTIC International Limited; terms were not disclosed and management stated neither acquisition was significant. Huron also exited its San Francisco office and expected an approximately $2.5 million restructuring charge in Q4 2010.
- Goodwill impairment testing at April 30, 2010 found no impairment, but the Financial Consulting reporting unit’s estimated fair value exceeded carrying value by only 8.1%. Future declines in earnings or cash flows could produce impairment charges.
- Management reported that disclosure controls and procedures were effective as of September 30, 2010, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile reported GAAP earnings with adjusted EBITDA and adjusted EPS, particularly the treatment of restatement costs, restructuring, amortization, share-based compensation, litigation, and discontinued operations.
- Assess debt-service capacity and refinancing risk before the February 2012 credit facility maturity, including the $74.8 million remaining capacity and covenant requirements.
- Monitor operating cash flow, receivables, unbilled services, bonus payments, and acquisition-related earn-outs, which materially affect liquidity.
- Track the status and potential financial impact of the SEC and USAO matters, shareholder class action, derivative litigation, and False Claims Act litigation; the filing does not provide a reliable loss estimate.
- Evaluate whether the decline in Health and Education revenue and margins is temporary or reflects sustained demand, pricing, utilization, or client-spending pressure.
- Review the sustainability of Legal Consulting growth, reliance on variable full-time-equivalent work, and increased independent-contractor costs.
- Consider goodwill concentration and sensitivity to valuation assumptions, especially in Financial Consulting.