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Architectural firms showing signs of recovery, but much improvement is still needed

Overall revenue levels are flat, billing rates are down and the utilization rate for architecture and engineering (A&E) firms is just 61.5%—yet the industry is beginning to show signs of recovery from the biggest downturn in recent history.

During the 2011 A&E Summit sponsored by DiCicco, Gulman & Company (DGC), we revealed industry trends for an industry that continues to struggle.

It is clear that not every firm will conclude that “flat is the new growth,” as co-presenter Ian Rusk ASA, of Rusk O’Brien Gido + Partners, put it. Some firms will find ways to grow despite current conditions.

One reason for optimism is that the direct labor billing multiple for 2010 was 3.23. Historically, a multiple of 3.0 or higher has been large enough to produce a reasonable rate of return. However, the 2010 multiple was slightly lower than the 2009 multiple of 3.28, and in both cases the multiple was artificially inflated by salary reductions.

Overall, as Rusk reported, revenue for the top 500 firms nationwide was flat in 2011, totaling just less than $80 billion. Although more than 100,000 firms are in the A&E sector, the top 500 represent about 80% of revenue. Overall, revenue from U.S. work declined, but many firms made up for the deficit by seeking more work abroad.

However, backlog levels are increasing for many firms, and billings and inquiries are rising.

Although a DGC survey of 34 client firms found that the utilization rate is just 61.5%, that’s still a slight improvement from the 2009 rate of 58.9%. To improve profitability, firms must boost the utilization rate significantly, especially for firm principals, who had a rate of just 42% in 2010.

The average billing rate for firms is flat at $108 an hour and is expected to stay around that level through 2011, while net-fee income per full-time employee is up modestly from $137,000 to $139,700. However, net-fee income per employee varies widely from one firm to another, with an overall range of $110,000 to $192,000.

Although income has increased slightly, costs have decreased slightly. Overhead per direct hour dropped from $73.11 to $66.64, and each employee’s average hourly cost rate was $36.28, down slightly from $36.94. The drop reflects the improvement in the utilization rate. The overhead rate of 2.02—down from 2.14—is still not good, but it is well below the break-even rate of 3.02. A rate of 1.75 to 1.85 would be a sign that the industry is returning to a healthy level.

The DGC survey found that firms are operating at a profit of about 7.5% of their net fees, compared with a profit averaging just 0.4% last year. That comes out to a profit of $8.15 per direct labor hour, which is low, but up significantly from $1 an hour in 2009.

To survive and grow, firms must focus more on working capital (receivables + cash – short-term debt), which should be approximately 20% to 25% of net fees; otherwise, they’ll end up relying too heavily on bank financing.

More consolidation is coming

Although current staffing is in line with industry backlogs, it is likely to take four more years before the industry fully recovers, according to co-presenter George Christodoulo, Esq., of Lawson & Weitzen.

Christodoulo noted that as of March 2011, construction nationwide stood at a seasonally adjusted annual rate of $768.9 billion, which is just half of the $1.5 trillion pace that economists consider to be healthy.

The industry is struggling with too much debt, high accounts receivable, bad real estate and poor morale. It is also hindered by project cancellations, unavailability of financing, high unemployment, poor cash flow and heavy competition for few projects. These factors, along with a significant number of firm principals nearing retirement age, will result in increasing consolidation.

“In a slow-growth economy, many realize that growth comes from taking market share away from penetrating new markets and adding new clients,” Christodoulo said. “Acquisitions are a faster way to achieve growth.”

For acquisitions to take place, though, sellers need to set realistic valuations that are well below 2007 valuation levels.

Sidebar: Getting past “flat”

With many architectural and engineering (A&E) firms downsizing or even closing, it may not seem like a good time to think about growth.

However, some will see opportunity in the current economic climate. If the prevailing mood among A&E firms is to ride out the current climate, those that concentrate on growth may be able to succeed if they plan carefully. It may, for example, be a good time to consider acquiring other firms or merging.

The keys to growing successfully include:

• Extensive planning
• Having the right people in the right positions
• The ability to make decisions quickly and move forward as an organization
• The ability to execute as a group

Execution is key. If a firm can’t execute a strategic plan as a group, meeting the other criteria for growth won’t matter.

David M. Sullivan CPA is a partner in the A&E group at DCG in Woburn, a CPA and business consulting firm specializing in the A&E industry. He can be reached at