Exponent, Inc. (EXPO) Q3 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Exponent Third Quarter Fiscal 2013 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, October 16, 2013. And I would now like to turn the conference over to Erica Abrams of The Blueshirt Group. Please go ahead.

Thank you. Good afternoon, ladies and gentlemen, and thank you for joining us on today's conference call to discuss Exponent's third quarter 2013 results. Please note that this call is being simultaneously webcast on the Investor Relations section of the company's corporate website at www.exponent.com/investors. This conference call is the property of Exponent, and any taping or any other reproduction is expressly prohibited without Exponent's prior written consent. Joining me on the call today are Paul Johnston, President and Chief Executive Officer; and Rich Schlenker, Executive Vice President and Chief Financial Officer with Exponent. Before we start, I would like to remind you that the following discussion contains forward-looking statements, including statements about Exponent's market opportunities and future financial results that involve risks and uncertainties, and that actual results may vary materially from those discussed here. Additional information concerning factors that could cause actual results to differ from forward-looking statements can be found in Exponent's periodic filings with the SEC, including those factors discussed under the captions Factors Affecting Operating Results and Market Price of Stock in Exponent's Form 10-Q for the September quarter of 2013. The forward-looking statements and risks stated in this conference call are based on current expectations as of today, and Exponent assumes no obligation to update or revise them, whether as a result of new developments or otherwise. And now I would like to turn the call over to Paul Johnston, President and Chief Executive Officer of Exponent. Paul, please go ahead.

Thank you for joining us today for our discussion of Exponent's third quarter of fiscal year 2013 results. As our press release indicates, we posted another solid quarter of revenue and EBITDA performance, which were better than expected. Net revenues increased 5% to $70.1 million. Total revenues increased 3% to $75.2 million. Net income increased 8% to $11.1 million or $0.79 per diluted share. EBITDA also increased 8% to $18.8 million. We continue to see high single-digit growth from our underlying business, which was partially offset by a reduction in the work from our major assignments, as well as lower revenues from our defense business. However, the tail-off in the work from our major assignments was slower than anticipated, which resulted in higher-than-expected revenue utilization and profitability for the quarter. During the quarter, we had notable performances in our polymer sciences, mechanical engineering, biomedical engineering, construction consulting and chemical regulation and food safety practices. We continue to see strong demand for our engineering and scientific consulting services to answer the question, "What really happened?" when our clients are faced with a litigation matter, an insurance claim, a potential product recall or a regulatory enforcement. We are also seeing more demand from clients who want in-depth knowledge so they can make their products and processes more reliable. Again, we are pleased to have delivered a solid third quarter. Now Rich will provide a more detailed review of our third quarter financial performance.

Thanks, Paul. We're pleased to have delivered another quarter of good financial results. Revenues before reimbursements, or net revenues as I will refer to them from here on, were $70.1 million, up 5.1% from $66.7 million in the same period of 2012. Total revenues for the quarter were $75.2 million, up 2.6% as compared to $73.3 million 1 year ago. Net income for the third quarter was $11.1 million or $0.79 per share as compared to $10.2 million or $0.72 per share 1 year ago. Our diluted share count decreased to 14 million from 14.2 million in the same period last year as a result of our ongoing repurchase program. EBITDA for the third quarter was $18.8 million, an increase of 8% over $17.4 million 1 year ago. EBITDA margin for the quarter was 26.8% of net revenue, which is an increase of 75 basis points over the same period in 2012. In our Defense Technology Development business, net revenues for the quarter were $2.9 million, which is down from $4.4 million in the third quarter of last year. Defense product sales were 0 in the third quarter and are expected to be the same in the fourth quarter. As a reminder, this will result in a $2 million lower net revenues from product sales as last year had $2 million and this year, again, we're expecting it to be 0. Utilization in the third quarter was 72% as compared to 74% in the third quarter of 2012, reflecting a step-down in a few major assignments and a decline in our defense business. Year-to-date, utilization is 73%. We expect 2013 full year utilization to be approximately 71%, and the fourth quarter to be in the mid-60s as a result of our seasonally low fourth quarter. In 2012, the step-down in utilization from the third quarter to the fourth quarter was 5 percentage points. Additionally, the extra week we are picking up this year includes the New Year's holiday, so we expect the utilization to further -- to be further impacted. For the third quarter of 2013, billable hours increased 2% over the same period last year to 273,000. We had a year-over-year FTE or full-time equivalent employee growth of 4.6% to 726. We also realized a year-over-year bill rate increase of approximately 2.5%. We expect headcount to grow another 1% sequentially in the fourth quarter. For the third quarter, compensation expense, after adjusting for gains, losses and deferred compensation, increased 3%. Included in total compensation expense is a gain in deferred compensation of $1.9 million as compared to $1.1 million in the same quarter of 2012. Gains and losses in deferred compensation are offset in miscellaneous income and have no impact on the bottom line. Stock-based compensation expense in the third quarter was $2.5 million. We expect stock-based compensation for the full year to be approximately $13 million. Other operating expenses in the third quarter increased to $6.4 million as compared to $5.9 million in the same period last year. Depreciation was $1.3 million and is included in other operating expenses. We expect operating expenses in the fourth quarter to be in the range of $6.5 million to $6.8 million. G&A expenses in the quarter were $3.7 million as compared to $3.5 million in the same quarter 1 year ago. We expect G&A expenses in the fourth quarter to be in the range of $4.2 million to $4.5 million. Our income tax rate in the quarter was 36.7% as we benefited from a one-time tax deduction. We expect the tax rate for the fourth quarter to be approximately 40.5%. Turning to the balance sheet. Operating cash flow was strong at $17.4 million. Our cash and short-term investments were $135 million at quarter end. Year-to-date, stock repurchases are $21.2 million or 389,000 shares. We still have 38 -- $34.8 million authorized and available for repurchases under our current repurchase program. We also distributed almost $6 million to shareholders through dividends year-to-date and today, announced our fourth quarter dividend. Capital expenditures in the third quarter were $890,000. DSOs were 94 days. In the third quarter, we continue to execute well and are excited about future opportunities for growth. Considering our better-than-expected performance year-to-date, we now expect growth in revenues before reimbursements for the full year to be in the middle single digits. We are also improving our 2013 outlook on EBITDA margin by 100 basis points to now be down by only 50 to 100 basis points as compared to the previous year. This guidance reflects reduced revenues from a few major assignments and a decline in defense business, which are offset by increased revenues from the rest of the business and the extra week in 2013. I will now turn the call back to Paul for closing remarks.

Thank you, Rich. In summary, we are pleased with the level of activity in our underlying business during the first 9 months of the year. While last year presents a difficult comparison for this year's fourth quarter, we are encouraged by the fact that we continue to see an increasing demand for our multidisciplinary consulting services. We are adding talents that will ensure that we have the resources to address our clients' most important engineering and scientific business issues, now and into the future. Our top financial priorities continue to be generating substantial cash flow from operations, maintaining a strong balance sheet and enhancing shareholder value through stock repurchases and dividends. I will now turn the call over to the operator for your questions.

[Operator Instructions] Our first question is from the line of Tim McHugh with William Blair. Timothy McHugh - William Blair & Company L.L.C., Research Division: First -- but I guess just first question would be, can you -- I mean, at a high level simply, can you give us some more color on the underlying business trends and where the strength is coming from? I know you called out a few practices. But I guess more broadly, are you penetrating new clients? Are you seeing increased spending from your existing clients? I guess, can you help us understand what you're seeing that's driving the strength?

Yes, Tim, thanks. I think -- we talk about the underlying business, we believe, is growing in the high single digits, and I think it is fairly broad-based. I -- we certainly see, in the proactive side of the business, we certainly see the work in the consumer electronics area, the work in the medical device area, the regulatory work that we do in food and chemicals, all as something that are -- continue to grow stronger. A mix of more revenues from the same clients and some new clients, but I think that that's -- that area is particularly strong. But also, sort of across -- a fair number of the practices, the what I'll call more traditional reactive business, litigation, insurance claims and product recall business sort of continues. So I just think the underlying business is going, really, we feel quite nicely. There's been a definite pickup in the infrastructure area. You'll recall in previous calls, we've -- we talked about how the infrastructure area, along with the automotive area, were 2 areas that were very severely impacted back in 2009. And that infrastructure was taking kind of a long time to recover. We've seen, clearly, more work in that area, which I think has definitely helped us. Timothy McHugh - William Blair & Company L.L.C., Research Division: On that last point -- I'm sorry. Go ahead, Rich.

I mean, I think the other thing that we're seeing is that our clients are utilizing us more broadly as well. That as issues come up, they tend to be engaging us in a more broad sense of utilizing multidisciplines that we have. And we're also seeing growth, while it's still not a substantial part of our business, but utilizing our China -- the people that we have in China, to help them in getting on-site into their manufacturing environments, helping them understand what's going on with their products both in preproduction and then when they go live into production -- full production. Timothy McHugh - William Blair & Company L.L.C., Research Division: Okay. That's helpful. And then Paul, just the infrastructure comment, is that tied to -- you mentioned construction consulting in the press release. Is that -- are those the same things that you're talking about?

Yes, that's a part of it. But I would say, even more broadly across the infrastructure groups, where we have practices in civil engineering and buildings and structures, those are our -- haven't returned to what I'll call full strength that they get recognition but are clearly much stronger than they were some time back. Timothy McHugh - William Blair & Company L.L.C., Research Division: And that's still mostly reactive work, is that right? Am I right?

Yes. Yes. The construction consulting has got, well, I think you could say some proactive work associated with new construction projects. But certainly, the civil and structural and buildings work we do is mostly reactive. Timothy McHugh - William Blair & Company L.L.C., Research Division: And I guess on the proactive side, I mean, is it -- are you willing to change the percentage of the business you're saying at this point? From there, has it moved enough that we're now talking an even bigger percentage than you would have said before coming over there?

No. I mean, it's not that long ago that we changed from 25%. We used to be 65% reactive, 25% proactive, 10% government. And then we changed to 60% reactive, 30% proactive. I think we're inching above 30%, but we're not yet to 35%. Timothy McHugh - William Blair & Company L.L.C., Research Division: Okay. And then lastly, Rich, the nature of the tax credit. So obviously, you gave us guidance for Q4, but trying to think towards 2014. Is that some sort of annual tax credit that you might be able to grab next year or...

Yes, no, it's not going to be it. It's really just something that we were able to do relative to some of the product sales stuff that we did previously. So we would expect our tax rate to be about 40.5% in 2014.

Next question is from the line of Joe Foresi with Janney Montgomery Scott.

Rich, Paul, this is Jeff Rossetti on for Joe. I just wanted to check about the 3 major assignments. Just wanted to see if -- are we still thinking about those as about around the 3% range of revenue each? And is it -- should we expect maybe a one quarter push out before they get to a more normal level? I think perhaps last time, you mentioned you might be anticipating them getting to more normalized level by the end of this calendar year.

Yes, I mean, I think just to kind of go back over some of the sort of numbers that we've talked about in the past, we generally think that under normal circumstances, we have some large projects in the 2% to 3% of revenue, and these what we call major assignments have been more like in the 4%, 5% range. And that's what made them sort of different. They're in between those 2 now is the way I would describe it. They're more in the 3%, 4% range rather than the 4%, 5% range or the 2%, 3% range. And they've held there a little longer, quite frankly, than we had thought. And there was a fair amount of activity in that area in this particular quarter, and that's part of the reason why we performed where we did. We do expect them to continue to go down. But we've been -- we've always -- it seems to us being conservative or overestimated how quickly they would decline. But it is my sort of expectation that you would get them back into a normal large project range by the end of the year.

Okay. And then just some of the maybe the growth areas that you've talked about in the past. Just maybe an update in terms of, say, computer science and energy and health. I know you mentioned medical devices, but maybe an update on some of your investments there and what kind of activity you've been seeing?

Yes, well, I think that in terms of the computer science area and in terms of the health area, we've been focused on trying to do some senior-level recruiting in those areas. We've had some success in terms of hiring people, but not yet to the point that the revenue flows would really sort of have an impact on the business at this stage. But I think that the recruiting activity has certainly been moving forward, and we've had some good -- we've made some good hires.

Okay. And then in your headcount increases, is there any kind of breakout for, like, major hires that you would call out within the...

Yes, I don't see that we do. A lot of it -- the hiring has been around -- these stronger practices has really been also driving the hiring over the last year. And that's what you'd expect here is that we've said all along that we're going to keep recruiting, keep bringing in people and we've done that really around these growth areas that are happening in the business today. So -- and there's not -- it's been very strong at the junior level. We've had a few mid-senior-level people but nothing, let's say, of a leader coming in, in a particular area to make a significant difference at this point in time.

[Operator Instructions] Our next question is from the line of Tobey Sommer with SunTrust Robinson Humphrey.

I want to ask a question about the government shutdown. Is there anything that you're keeping an eye out on in terms of funding of the judicial system and the courts that we should be paying attention to in terms of potential impact on your business? How are you thinking about that?

Yes, I mean, I think -- our view is that sort of what I'll call a short-term government shutdown, I mean, there's some promising news perhaps out of Washington, maybe it's going to get back to normal here sometime soon. A sort of a short shutdown, we don't expect to have a significant impact on our business. If you got into a longer shutdown where it could impact -- certainly, a longer impact on the courts -- on the federal courts or a longer impact on some of the regulatory agencies that we do a lot of work related to, then it certainly could have an impact. But given the sort of relatively short-term nature, we don't expect this to have a significant impact.

A question for you, Rich. In looking at 2014, in the number of weeks in the year, how do we think about how that will impact the financials as we look into next year?

Yes, I think the extra week that we're picking up here in 2013 is probably a week that is maybe the equivalent of half a week, maybe a little bit more. But sort of -- puts us at revenues that might be $3 million to -- somewhere in the $3 million to $4 million in revenues in that week. We'll have to see when we march through it. But that's what I would expect the sort of bogey to be relative to that extra week.

And then I wanted to ask a question about what you think you are, as you exit this year and look into next, you've got the large projects, I guess, eventually moderating here to 4 [ph] holding up. What do you think in terms of headcount growth over the next 4, 5 quarters?

Well, I think -- this is our -- we're starting our fourth quarter here, where we go through a pretty detailed planning process for next year. Well, that's just got underway. And in terms of looking into next year, we build that up, practice by practice, based on their needs, demands and so on. And so we will obviously have a much more complete idea with regard to where we expect that to go when we talk again at end of January, beginning of February next year for the next quarter announcement. But at this stage, I think it's very difficult for us to talk about where recruiting will be next year. We know that we are having a good recruiting year this year. We have obviously started making offers and getting acceptances for next year. We generally like to start the new year with sort of 25 acceptances already there, and it's my hope we will do that as well. But looking more throughout the whole year for next year, I think it's too early for us to say.

[Operator Instructions] We do have a follow-up from the line of Tim McHugh with William Blair. Timothy McHugh - William Blair & Company L.L.C., Research Division: Yes, just one follow-up on the large projects that you said kind of that you had more activity. In terms of the nature of the activity, is it the type that might endure? Or is it just kind of a shorter-term burst and you would still expect it to wind off? And then a follow-up to that is, I guess I'm trying to think towards 2014. And is there still a grow-over challenge and how much related to these large projects? Or if maybe now you think they can stay at a higher level for a longer period?

Well, I think that we've always talked about there being a kind of a long tail here. We still very much believe that. I just think that there were a number of things going on in the third quarter, including some trials that made the level of work a little higher than we anticipated. But I don't think we have changed our view that we expect these projects to, by and large, still be major activities -- major -- sorry, more typical large projects next year, that they're not -- we don't expect them to disappear. We just think it will continue to step down a little bit. Timothy McHugh - William Blair & Company L.L.C., Research Division: Okay. I guess if they went back to being normal large projects, I guess I'm trying to get a sense for just, I guess, what that means for next year.

[indiscernible]

Yes, I mean, I think that as we've spoken before, we have seen these projects step down both from Q4 to Q1 and Q1 to Q2. We saw somewhat of a plateau. It's not like they picked up in the third quarter. It was more of a plateau at that point in time. As Paul indicated earlier, these are projects that are running somewhere probably in the 3% to 4% range now, will probably drift down from that into the 2% to 3% range here by year end. And then we'll have to see where they go from there. But I think that we've been tapering them down from the 4% to 5% level last year into -- by the year end into that, call it, 2.5% range on average by year end. And that will create some hurdle as we look forward to next year. I mean, they've been tapering off across the year and as such, there's going to be some headwind there. But what that will exactly be, it will depend on their level of activity next year for each of the projects. But I would expect that there will be just some headwind by the fact that they've tapered down throughout the year. Timothy McHugh - William Blair & Company L.L.C., Research Division: Okay. And I guess just saying if they go back to -- I know you don't know what they will be next year. But the math, if they go to your normal large project size, like 2 to 3 percentage points is...

So headwind overall? Timothy McHugh - William Blair & Company L.L.C., Research Division: Yes, for the full year.

Yes, actually it's probably in that -- it's somewhere in the 2% to 4%, 2% to 3%, somewhere in there, yes.

And that was the last question. Ladies and gentlemen, if you would like to listen to a replay of today's conference, please dial (303) 590-3030 or (800) 406-7325 and enter the access code 4644191. We'd like to thank you for your participation, and you may now disconnect.