FTI Consulting, Inc. (NYSE:FCN) Q3 2023 Earnings Call Transcript
FTI Consulting, Inc. (NYSE:FCN) Q3 2023 Earnings Call Transcript October 26, 2023
FTI Consulting, Inc. beats earnings expectations. Reported EPS is $2.34, expectations were $1.84.
Operator: Welcome to the FTI Consulting Third Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please also note that this event is being recorded today. I would now like to turn the conference over to Mollie Hawkes, Head of Investor Relations. Please go ahead.
Mollie Hawkes: Good morning. Welcome to the FTI Consulting conference call to discuss the company's third quarter 2023 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 related to financial performance, acquisitions, share repurchases, business trends, ESG related matters 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 quarterly report on Form 10-Q for the quarter ended September 30th, 2023, our annual report on Form 10-K for the year ended December 31st, 2022, and 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 accompanying financial tables that we issued this morning, which include the reconciliations. Lastly, there are two items that have been posted to the Investor Relations section of our website 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 address our third quarter 2023 results and changes to certain historical information.
Of note, effective July 1st, 2023, 127 billable professionals in the health solutions practice within the company's Forensic and Litigation Consulting business segment were transferred to the Corporate Finance and Restructuring business segment. 83 billable professionals within the Health Solutions practice remained in the Forensic and Litigation Consulting segment. Prior period information for these two segments included in the quarterly report on Form 10-Q for the quarter ended September 30th, 2023, and the financial tables in this morning's press release have been recast to reflect the modified composition of these segments. Additionally, the unaudited summary financial information and other select financial and operating data for the Corporate Finance and Restructuring and Forensic and Litigation Consulting segment included in the historical financial statements posted on our website have been recast for each of the previously reported years ended December 31st, 2020, December 31st, 2021, and December 31st, 2022, and the previously reported quarters in each such year and the first and second quarters of 2023 to conform to the current period presentation reflected in FTI Consulting's quarterly report on Form 10-Q for the quarter ended September 30th, 2023.
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 our exposures are consistent, these slides provide the similar details as they have historically, and as I've 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.
Steve Gunby: Thank you, Mollie. Welcome everyone and thank you once again for joining us this morning. I have one main message that I'd like to convey this morning about this quarter, which is this is a quarter where we got our earnings back on track. And I'm focusing on the word earnings because as I hope everyone on this call will remember, our revenue has been terrifically on track all year. In the first half of this year, our revenues were up 13%. This quarter, we delivered 15% topline growth. Those are numbers that I would be proud of most years, but particularly so given this year has been an environment where it's been particularly challenging for many professional services firm. I like focusing on revenues. To me, that sort of revenue growth is one of the best predictors of long-term success.
It is a validator of whether your teams are doing something right. When you have that sort of growth that shows the power of your teams and relevance in the market for their competitive position, perhaps most important impact they are delivering for and with your clients. I believe, in this case, it also reflects our team's dedication to and continuing success in attracting supporting sort of talent that aspires to make that sort of difference for clients. So, we have been extraordinarily gratified this year that it has been yet another year where we have delivered terrific revenue growth. What was not so great in the first half of the year was translating the terrific revenue growth into earnings growth. In general, in most companies and in professional services, over time, earnings end up roughly tracking with revenues.
And that's what we, of course, have seen for much in the last five years. But for periods of time, earnings and revenues can, of course, deviate. And that's what we saw for the first half of the year. And we've discussed on prior calls, some of the causes of that, some of the causes of the lag and bottom line results. Two of the causes that we discussed were externally driven, inflation. It's taken us a while to adjust for the impact of inflation. And second, we, like many professional services firm this year have ended up with lower attrition than we expected, lower attrition than we've had in prior years and lower attrition than we had budgeted for. So, two of the factors for the lag and bottom line results were externally driven. The third factor, however, was not an external factor.
I have an active set of decisions on our portfolio. Decisions that we have made year after year after year, which we continue to make this year, which is that we committed -- continue to commit to be acquired, to acquire and support great talent whenever that talent is available, even if it's in a business that happens to be running at a lower utilization at quarter than we aspire to the longer term. And we've continued to do that in the first half of the year, even some businesses that were slow because we were in a fortunate position. This year, like we have been in many of the prior years that some terrific talent was available and wanted to join us. So, that was the reason for the lax, net of all of that was that all revenues were up 13% in the first half of the year.
Our cost structure was up 14%. And no matter how impressive 13% growth is your cost structure is up 14%. You're going to have some pressure on earnings. I think that's the way math works, Ajay. If I remember right, and that's where we were. In this quarter, we did not make a dramatic change to how we manage the business. Some of the factors started to normalize a bit. We had, as we discussed another great quarter in terms of revenue growth. But unlike the first two quarters, our cost structure did not grow quite as fast. We continue to make progress against inflation. We also had an uptick in attrition, both voluntarily and performance related, and we tightened hire as we normally do in places where we had low utilization. We continued on the path of being willing to hire exceptional talent regardless of whether it has slower businesses.
But overall, we throttled hiring back a little bit. In a radical change. We continued to grow headcount. This quarter was up 8% year-on-year. That growth was a little bit slower than the 11% headcount growth we had in the first half of the year, and therefore, translated into cost structure that unlike in the first half of the year was up a little bit less than revenue. If you have 13% growth in revenue and 14% growth in your cost structure as we did in the first half of the year, you have pressure on earnings. When you have revenue growth, that is 1% higher than the increase in your cost structure, the earnings benefit. And that's essentially what happened this quarter, not a radical change in strategy and normalization of factors that allow the underlying power of the results to show up in earnings.
For the most part, this quarter, therefore, essentially worked out much like Ajay and I and the management team expected. I do want to point out something that Ajay will detail a little bit more, which is that, in fact, this quarter, the actual results actually exceeded our expectations a bit, not because of any of the factors I just described. But because in addition to those underlying core drivers of earnings, we also had is -- sometimes do random factors that can cut one way or another in a quarter. And this quarter, a number of those has become positively like FX and higher success fees. So, the underlying movement you see this quarter back towards strong revenue growth translating to higher earnings growth was expecting the actual results this quarter -- in total, we're actually higher than we expected.
I hope that's a helpful framing, Ajay will for sure give you more details. Let me therefore close my remarks by instead of going from details, trying to tie this quarter and the year some of the broader dialogue that we've been having for some time. We have, I think, frequently talked about the fact that there are so many factors that can cause zigs and zags, and underlying earnings of this business over any short period of time. And the fact that -- in fact, those things could happen not just for a quarter, but for multiple quarters or a year or two for individual businesses. Our view has always been that when you have a you have a zag, you have to look at carefully, you have to look at it hard. You have to make sure it's not reflecting a permanent change in the market or a permanent change in our competitive position.
Because if you have one of those, you have to react to that. We also have the firm view where we come to believe it's neither of those. It is critical to withstand the pressure at, just on short-term factors. In those circumstances, rather than overreacting, we believe it's critical to ignore the short-terms act. To focus on the core elements that help you build a great business and professional services, the focus on getting great questions, supporting their development, supporting their ambitions, investing behind them, make sure we're all thinking through the most critical issues facing the clients and make sure we have the best teams who can grow into those lead professions and support them actually making difference for clients. Our belief, and I think by now, our experience is we focus on those core elements, and you do not -- if you do not overreact to the zags, you have a chance that your firm can get into the virtuous loop of professional services.
We have terrific teams delivering great work, building client relationships. To churn and helps you attract and keep the sort of people who get motivated by that and deliver that sort of work. And who will reinforce those relationships, and we'll build others who can build those relationships. And in turn, even create a powerful growth engine. Growth mentioned that yes, may, have, orders to lead zigs and zags. One that can ultimately become an institution that delivers powerfully for your clients, powerfully from the great individuals in your firm, the ones were committed to delivering for those clients and are committed to building others who can do that and ultimately, around the noise of the Zig-Zag line and also deliver powerfully for investors.
This year, to me, is simply another example of that truth. It is an example of the path we have sought to be on and the path that we are very much committed to stay on. With that, let me turn this over to Ajay to take you through the quarter in more detail. Ajay?
Ajay Sabherwal: Thank you, Steve. Good morning everybody. In my prepared remarks, I will take you through our company-wide and segment results and discuss guidance for the full year. Beginning with our third quarter results. We reported record revenues this quarter with all business segments growing year-over-year. 15.1% revenue growth outpaced the 14.4% increase in direct costs and SG&A expenses, and earnings per share grew by 8.8%, setting a new record at $2.34. Growth in revenues resulted from higher demand and higher realized bill rates. Utilization remains steady as we welcomed our new class of graduates while moderating other hiring. Overall, we are pleased with the strong results, especially after a weaker-than-expected first half of the year.
Year-to-date, our performance is more modest. While 3Q 2023 adjusted EBITDA of $118.7 million is up 20% from $99 million in 3Q 2022 year-to-date adjusted EBITDA of $297.4 million is only -- is up only 12% compared to $265.6 million in the prior year period. And earnings per share have increased only 3.4%, primarily because of a higher tax rate this year and FX remeasurement losses compared to the prior year period. Now, turning to our third quarter results in more detail. Record revenues of $893.3 million increased $117.4 million or 15.1% compared to revenues of $775.9 million in the prior year quarter. The increase in revenues was primarily due to higher demand in Corporate Finance and Restructuring, Forensic and Litigation Consulting, or FLC, Strategic Communications and Technology segments.
Net income of $83.3 million compared to $77.3 million in the prior year quarter. The increase in net income was due to higher revenues, which was partially offset by an increase in direct compensation, which includes the impact of a 7.8% increase in billable headcount. Higher SG&A expenses, a higher effective tax rate and a decline in FX remeasurement gains compared to the prior year quarter. Earnings per share of $2.34 in 3Q 2023 compared to $2.15 in the prior year quarter. SG&A of $186.1 million were 20.8% of revenues. This compares to SG&A of $159.2 million or 20.5% of revenues in the third quarter of 2022. The year-over-year increase in SG&A was primarily due to higher compensation and bad debt. Third quarter 2023 adjusted EBITDA of $118.7 million or 13.3% of revenues compared to $99 million or 12.8% of revenues in the prior year quarter.
The year-over-year increase in adjusted EBITDA was primarily due to higher revenues. Our third quarter effective tax rate of 22.6% compares to 17% in 3Q 2022. As a reminder, we had an unusually low tax rate in the prior year quarter because we utilized foreign tax credits against the licensing of our intellectual property or our brand to additional foreign subsidiaries. For the full year, we expect our effective tax rate to be between 24% and 26%. Our 2% convertible senior notes matured on August 15, 2023, and were fully settled on August 17, 2023. We settled the principal amount of $315.8 million in cash, and $280.3 million of premium in shares of our common stock based on a share price of $191.89, resulting in 1.46 million additional shares being added to our total shares outstanding this quarter.
As a reminder, our weighted average shares outstanding are WASO numbers in prior quarters already included the then estimated impact of our 2023 convertible notes premium, if converted in stock. Fully diluted WASO of 35.7 million shares in 3Q 2023 decreased by 262,000 shares compared to 35.9 million shares in 3Q of 2022. We remain steadfast in our commitment to attract talented professionals. Billable headcount increased by 467 professionals or 7.8%, and non-billable headcount increased by 104 professionals or 6.9% compared to the prior year quarter. Sequentially, billable headcount increased by 247 professionals or 4%, which included 316 new joiners from university campuses. Our largest class ever. Non-billable headcount decreased by 11 professionals or 0.7%.
Now, I'll share some insights at the segment level. In Corporate Finance and Restructuring, revenues of $347.6 million increased 23.2% compared to the prior year quarter. The increase in revenues was primarily due to higher realized bill rates and demand for restructuring and business transformation and strategy services, as well as an increase in success fees. Adjusted segment EBITDA of $68.1 million or 19.6% of segment revenues compared to $53.5 million or 19% of segment revenues in the prior year quarter. The year-over-year increase was due to higher revenues, which was partially offset by higher compensation, including the impact of a 9.8% increase in billable headcount and higher SG&A expenses. Restructuring represented 46% of segment revenues.
Business transformation and strategy represented 33% of segment revenues and transactions represented 22% of segment revenues this quarter. This compares to 41% for restructuring, 33% for business transformation and strategy and 26% of segment revenues for transactions in 3Q of 2022. On a sequential basis, revenues increased $29.6 million or 9.3%, primarily due to higher demand for business transformation and strategy and restructuring services, which was partially offset by a decline in demand for transaction services. Restructuring revenues grew 6%. Business transformation and strategy revenues grew 26% and transactions revenues declined 2%, compared to 2Q of 2023. Adjusted segment EBITDA increased $22.6 million compared to 2Q of 2023. Industries where we have been helping clients with restructuring, where we saw sequential increases in revenues include energy, utilities, health care, retail, real estate, and technology, among others.
Worth noting, on July 1st, 2023, we transferred 127 billable professionals from our health solutions practice within our FLC segment, who focus on business transformation in the health care and life sciences sector into the business transformation and strategy practice within our Corporate Finance & Restructuring segment. This change is reflected in the recast historical financials document and other documents filed with the SEC which, as Mollie said, we shared on our Investor Relations website this morning. Turning to FLC. Revenues of $166.1 million increased 15.9% compared to the prior year quarter. The increase in revenues was primarily due to higher demand for our investigations, data and analytics and construction solutions services. Adjusted segment EBITDA of $21.5 million or 12.9% of segment revenues compared to $16.2 million or 11.3% of segment revenues in the prior year quarter.
The increase was due to higher revenues which was partially offset by higher compensation and SG&A expenses compared to the prior year quarter. Sequentially, revenues were essentially flat, and adjusted segment EBITDA decreased compared to 2Q of 2023, primarily due to a $4.5 million increase in segment SG&A expenses, largely related to higher bad debt. Our Economic Consulting segment's revenues of $193.9 million were essentially flat compared to the prior year quarter. Excluding FX, Economic Consulting revenues decreased $3.5 million or 1.8%. The decrease in revenues was due to a decline in non-M&A-related antitrust revenues which was partially offset by an increase in international arbitration and M&A-related antitrust revenues compared to the prior year quarter.
As a reminder, in the third quarter of last year, our Economic Consulting segment recognized $21.4 million of previously deferred revenues from one large client, which resulted in higher realized bill rates in the prior year quarter. Adjusted segment EBITDA of $27.8 million or 14.3% of segment revenues compared to $32.9 million or 17% of segment revenues in the prior year quarter. The decrease was primarily due to higher SG&A expenses which was partially offset by lower compensation compared to the prior year quarter. Sequentially, revenues decreased $8 million or 3.9% and adjusted segment EBITDA decreased $7.8 million. As a reminder, in the second quarter of this year, our Economic Consulting segment recognized $7.6 million of previously deferred revenues from 1 large client.
If you look at Economic Consulting's performance for the first nine months of 2023, compared with the first nine months of 2022, the fluctuations we have seen in recent quarters as a result of deferred revenues are normalized. Year-to-date, the Economic Consulting segment's revenues increased $42.1 million or 8% compared to the prior year period. Primarily, due to higher demand for international arbitration, M&A-related antitrust and non-M&A related antitrust services. Year-to-date, adjusted segment EBITDA increased $1.7 million or 2.3% as higher revenues were partially offset by an increase in compensation, including the impact of an 8.7% increase in billable headcount and higher SG&A expenses. In Technology, revenues of $98.9 million increased 16.4% compared to the prior year quarter.
The increase in revenues was primarily due to higher demand for investigations and litigation services, which was partially offset by lower demand for M&A-related second request services. Adjusted segment EBITDA of $14.9 million or 15% of segment revenues compared to $13.2 million or 15.6% of segment revenues in the prior year quarter. The increase was primarily due to higher revenues, which was partially offset by higher compensation, including the impact of a 14.8% increase in billable headcount and higher SG&A expenses. Sequentially, revenues increased $1.4 million or 1.5%, primarily due to higher demand for litigation services. Adjusted segment EBITDA decreased $5.2 million sequentially, primarily due to higher SG&A expenses, largely related to higher bad debt and compensation compared to 2Q of 2023.
Revenues in Strategic Communications segment of $86.8 million increased 19.9% compared to the prior year quarter. The increase in revenues was largely due to higher demand for corporate reputation and public affairs services compared to the prior year quarter. Adjusted segment EBITDA of $13.5 million or 15.5% of segment revenues compared to $12.9 million or 17.9% of segment revenues in the prior year quarter. The increase in adjusted segment EBITDA was primarily due to higher revenues, which was partially offset by an increase in compensation which includes the impact of a 6.2% increase in billable headcount and higher SG&A expenses. Sequentially, revenues in Strategic Communications increased $4.2 million or 5.1%, primarily due to higher demand for corporate reputation services.
Adjusted segment EBITDA increased $1.2 million. Let me now discuss key cash flow and balance sheet items. Net cash provided by operating activities of $106.7 million for the quarter compared to $128.3 million of net cash provided by operating activities for the prior year quarter. The year-over-year decrease in net cash provided by operating activities was primarily due to cash collections not keeping pace with the increase in revenues and not sufficiently offsetting the increase in salaries and other employee cash compensation, largely related to headcount growth as well as higher operating expenses. We generated free cash flow of $92.5 million in the quarter. Total debt, net of cash and short-term investments of $59.4 million at September 30th, 2023, compared to a negative debt position of $10.8 million at September 30th, 2022, and $137.2 million on June 30th, 2023.
The sequential decrease in total debt, net of cash and short-term investments was primarily due to the $315 million repayment of our 2023 convertible notes at maturity which was partially offset by an increase in net borrowings of $285 million under our senior secured bank revolving credit facility. Turning to our guidance. With the passage of three quarters and a stronger-than-expected third quarter, we are narrowing and raising the lower end of our revenue and EPS guidance ranges. We now expect revenues will range between $3.35 billion and $3.4 billion which compares to our previous range of between $3.33 billion and $3.4 billion. We now expect EPS to range between $6.70 and $7.20 which compares to our previous range of between $6.50 and $7.20.
Our updated guidance is shaped by several key considerations. First, we are an event-driven large jobs firm and our intake of and success rate in winning new business may moderate. Second, our business is in the short term, a fixed cost business where small swings in revenue can cause significant swings in earnings per share. Third, as Steve said, we have and will continue to invest aggressively in talent when the right people become available such investments typically negatively impact EBITDA in the short-term. Lastly, the fourth quarter is usually a weaker quarter for us because of a seasonal business slowdown as professionals may take time off during the holidays. Before I close, I want to reiterate five key themes that underscore the strength of our company.
First, our key differentiating factor is the expertise of our people, their relationships, and the impact they deliver for our clients. Second, we continue to find opportunities to attract strong professionals and grow our reach globally. Though such growth at the outset can and typically does adversely impact EBITDA, we have demonstrated our continued commitment to seize such opportunities. Third, we are able to both grow at a double digit rate and optimize staff utilization and bill rates. Four, our scale and diversity of services reduce risk. And finally, our balance sheet remains exceptionally strong. We have the ability to boost shareholder value through share buybacks, organic growth, and acquisitions when we see the right ones. With that, let's open the call up for your questions.
Operator: We will now begin the question and answer session. [Operator Instructions] At this time, we will take our first question, which will come from James Yaro with Goldman Sachs. Please go ahead.
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