Exponent, Inc. (EXPO) Q1 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Exponent First Quarter Fiscal 2014 Financial Results Conference Call. [Operator Instructions] This conference is being recorded today, Tuesday, April 23, 2014. And I would now like to turn the conference over to Erica Abrams.

Thanks, Nikatya. Good afternoon, ladies and gentlemen, and thank you for joining us on today's conference call to discuss Exponent's first quarter 2014 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 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 of 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 Exponent's 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 caption Factors Affecting Operating Results and Market Price Stock in Exponent's most recent Form 10-K. The forward-looking statements and risks 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. Thank you for joining us today for our discussion of Exponent's first quarter 2014 results. For the quarter, we increased net revenues by 6% to $73 million and net income by 15% to $9.2 million or $0.66 per share. We are pleased to have delivered solid financial results in the quarter with continued revenue and net income growth. For the quarter, we had notable performances in several practices. In our polymer science practice, we evaluated materials for medical devices, consumer electronics and textiles. In our biomedical engineering practice, we assisted clients with addressing issues of compatibility between their devices and MRI and RF equipment. In our environmental practice, we continued our work on assessing the impact of an oil spill. And in our construction consulting practice, we helped clients manage significant capital projects. During the quarter, 2 of our 3 major assignments stepped down into the normal range for large projects of 2% to 3% of revenues, with the remaining major assignment being in the 3% to 4% of revenues. In summary, we delivered a solid first quarter. We are focused on returning more value to shareholders through share repurchases and the continuation of a quarterly dividend of $0.25 per share. We remain optimistic about our long-term ability to build upon our differentiated market position as a leading multidisciplinary engineering and scientific consulting firm. Now Rich will provide a more detailed review of our financial performance.

Thanks, Paul. For the first quarter of 2014, revenues before reimbursements, or net revenues, as I will refer to them from here on, were $73 million, up 6% from $69 million in the same period of 2013. Total revenues for the quarter were $76 million, as compared to $72.7 million 1 year ago. Net income increased 15% to $9.2 million or $0.66 per share, as compared to $8 million or $0.56 per share in the same quarter last year. EBITDA for the first quarter was $16.6 million versus $14.6 million in 2013. Diluted share count decreased to 13.9 million from 14.1 million in the same period last year as a result of our ongoing repurchase activity. Turning to more details of the quarter. Defense technology development had net revenues of $3.2 million and no product sales. In comparison, in the first quarter of 2013, net revenues were $3.9 million, of which $200,000 was product sales. For the full year of 2014, we continue to expect revenues from defense to be lower than in 2013 due to constraints on defense spending and the reduction of forces in Afghanistan. Utilization was 72%, which is equal to the same quarter last year. For the full year of 2014, we expect our utilization to be slightly lower than in 2013 as we continue to see a step-down in major assignments in defense business. For the quarter, billable hours increased 3.5% to 274,000. Technical full-time equivalent employees on a year-over-year basis were up 3.4% to 732. For the full year of 2014, we expect year-over-year headcount growth to be approximately 3%. Our realized rate increase was approximately 2.5%. For the full year of 2014, we expect to realize a rate increase of 2% to 2.5%. EBITDA margin for the quarter was 22.8% of net revenue, as compared to 21.2% in the first quarter of 2013. For the quarter, compensation expense, after adjusting for gains and losses in deferred compensation, increased 4%. Included in total compensation expense is a gain in deferred compensation of $700,000, as compared to $2.1 million in the same quarter of 2013. Gains and losses in deferred comp are offset in miscellaneous income and have no impact on the bottom line. Stock-based compensation expense was $5.3 million, which is flat with the same quarter last year. For the full year of 2014, we expect this to be approximately the same as 2013 at $13 million. Other operating expenses increased 3% to $6.3 million, as compared to $6.1 million in the same quarter of 2013. Included in other operating expenses is $1.3 million of depreciation. For the remainder of 2014, other operating expenses are expected to be $6.5 million to $7 million per quarter. G&A expenses increased 8% to $3.7 million, as compared to $3.4 million in the same quarter in 2013. For the remainder of 2014, G&A expenses are expected to be $3.9 million to $4.2 million per quarter. Our income tax rate was 40.4%, as compared to 40.9% in the same quarter in 2013. For the full year of 2014, we expect our tax rate to be approximately 40.5%. At quarter end, our cash and short-term investments were $137.5 million. As a reminder, we pay out our prior year accrued bonuses in the first quarter of the year. In the first quarter, we repurchased $7.6 million of our stock for a total of 103,000 shares. We still have $23 million authorized and available for repurchases under our current repurchase program. Additionally, during the quarter, we distributed $3.3 million to shareholders through dividends. Capital expenditures in the quarter were $915,000. For 2014, we continue to expect growth in revenues before reimbursements to be in the low single digits and EBITDA margin to be down approximately 100 basis points from 24.6% in 2013. As a reminder, fiscal 2013 was a 53-week year and, as such, included an extra week of activity. For the second quarter and full year, growth in revenues before reimbursements will be reduced because of a step-down in a few major assignments and lower defense spending. Additionally, in the second quarter of last year, we recognized $1.75 million in revenues related to a contract in our health and environmental segment, of which $1.4 million of work was performed in the fourth quarter of 2012 and $350,000 of work was performed in the first quarter of 2013. Due to concerns about collectability, we waited to recognize revenue until we received cash, which occurred during the second quarter of 2013. This incremental revenue contributed $1.75 million to revenues before reimbursements, $1.2 million to EBITDA, $700,000 to net income, $0.05 to EPS and 2 percentage points to utilization. An additional challenge for the second quarter comparison is the fact that this year's second quarter includes the July 4 holiday and associated vacations, while last year, this part -- this was part of the third quarter. This will further depress utilization 2 to 3 percentage points. Altogether, this will result in the second quarter's utilization being down 4 to 5 percentage points from 75% in the same quarter last year. As a result, revenues in the second quarter will be slightly lower than last year. I will now turn the call back to Paul for closing remarks.

Thank you, Rich. In summary, we posted a solid first quarter. While we have a difficult comparable ahead in 2014 and particularly in the second quarter, we will continue to hire talented professionals in order to strengthen and diversify our consulting practices and address our clients' most important engineering and scientific business issues. We remain focused on generating cash flow, maintaining a strong balance sheet and enhancing shareholder value through stock repurchases and dividends. Operator, we are now ready for questions.

[Operator Instructions] Our first question comes from the line of Tim McHugh with William Blair & Company.

This is Matt Hill in for Tim this afternoon. Well, I won't specifically ask about the large auto recall going on. Just kind of setting the scene, do you -- talking to the clients, is there any concerns out there of regulators and lawmakers taking a more stringent approach to some of these recalls that maybe that could generate some incremental work going forward for you guys?

Well, I think that, that sort of already happened, to some degree, with what happened with the unintended acceleration issues with Toyota. So I do think there is what one might call a sort of a change in the level of a -- of scrutiny, oversight, whatever you might want to call. Either it has happened or is happening as a result of this. That, by itself, doesn't necessarily immediately lead to additional work. It really just depends on the auto manufacturers deciding that they want to hire us to look at a particular problem or to assist them on a particular litigation. But it's certainly -- I think it's fair to say that the regulatory environment is stiffening.

Okay. And then on the recruiting front, just wondering if you can give an update on any changes you're seeing in the market. And then specifically, maybe a little bit more detail on kind of building out your -- the software piece of the business.

Yes. So let me sort of describe the recruiting as kind of how we see it. We typically divide the recruiting activity into what we call sort of senior recruits and people that are more junior to that, with senior recruits typically being principals or sort of very close to principal level and the balance scaling down from that point. The majority of our more junior recruits are people coming out of Ph.D. programs that we hire into the firm. I'd say that program is continuing to move forward well, particularly in the engineering side of our business. We continue to have a very active university recruiting program. We find that the environment is certainly competitive out there, but we're still in a position of being able to get well over 50% of the people we make offers to accept positions here. So I think from that standpoint, we feel that we can handle the kind of the improvement in the outlook there from the standpoint of graduates coming out of Ph.D. programs. At the more senior level, there are a number of areas that we are continuing to try to focus and try to identify some recruits in. One is in the computer science area that you mentioned. That is one of our longer-term sort of goals, to improve that area. We haven't found what I will call a lead for that area here. We've made some recruits in that area but not a lead. A couple of other areas, we have found more senior people to lead them, one in the engineering management consulting practice and another in the health sciences area, but we will continue to work to build out these areas that we believe represent good opportunities for growth for the firm.

And our next question comes from the line of David Gold, CFA, with Sidoti & Company.

Was curious, if we go over a little bit, where you were seeing upside in this first quarter by way of presumably -- I guess, from a revenue perspective, revenue is pretty much in line, but presumably, where you were picking up the upside was perhaps some of the higher-margin practices and which helped the bottom line. So I was just hopeful you could speak about some of the practices that are seeing the benefit there and where presumably you're able to get some better margins and better rate.

Well, I think, when I look at the first quarter, I would say, David, that, first of all, I think the underlying growth that we've talked about, for example, on the last call, as being in sort of the high single-digit level. We believe that's continuing. Obviously, we're stepping down from that with regard to the large projects we've talked about in defense and so forth, but we still feel that, that's there. We think that the -- particularly on the proactive side, we feel that the demand is very solid in the consumer electronics area, the medical device area. We talked about our biomedical engineering practice being strong in the quarter but also on the regulatory front, where we talk about our food and chemicals practice on the regulatory front also being fairly strong. So I think those continue to be some of the lead areas from the standpoint of growth.

Perfect. And then on these 3 larger projects that, I guess, it sounds like, if I remember right, we finished the year and the run rate was about 10-ish percent, and it sounds like we're now running about 8%. Is that -- is the tail-off there in line with what you were expecting? Or just might it be just a touch faster in your -- what you were thinking a quarter or so ago? But I thought my memory could be off.

No. I think it's actually pretty much in-line, David. I mean I think your memory is right about the sort of the step down, "a couple of percent" step down, from where we were when we talked last. And we think that, that's sort of consistent with what we expect as we kind of came into this year. I think we felt like that there were sort of maybe 3 more points to step down to get those projects into -- those assignments into the sort of the normal level for large projects. And we haven't gotten them all down into that level, but 2 of them are at this stage. And so I think that's pretty consistent with what we had expected.

Our next question comes from the line of Joseph Foresi with Janney Montgomery Scott.

My first question is just on the hiring. I think you said there was a 3% increase to headcount. Can you be more specific in what particular verticals and/or businesses that you're looking to add those 3%?

Yes, well, I mean I think, if we're looking back, the 3% this year over last year that you were describing there, that's the headcount increase in the first quarter. I mean I think that the areas where we've seen sort of the majority of the growth is clearly being in the engineering practices we've talked about. That's the area that we are most successful in being able to attract people out of Ph.D. programs and grow them from there. So I think that the largest focus of hires, by numbers, are clearly in that area, Joe.

Okay. Was there any specific skill set you were looking for, like was it health care oriented or auto, as you compare to last year?

And so I would say, in -- on the engineering side, it's essentially materials, mechanical engineering, electrical engineering, computer science, biomedical, all of those, less so in the auto area, I would describe. And in the health sciences, among the regulatory people, it's a sort of growth kind of what I'll call more across-the-board, but outside of the regulatory part, I think we're really looking for more strategic senior hiring in that particular area. As we've talked before, on the engineering side, we tend to get most of our principals by hiring them and growing them up through the organization, whereas in the health side, we tend to get most of our principals by hiring-in at the senior level. And so the numbers aren't so high, but that tends to be what we are going to be a bit more focused on.

Got it. So I think I just want to make sure that we're clear about this. I mean given all the auto regulatory changes and stuff that we've seen in the news, it would probably be unfair to think of that business as accelerating dramatically for you as these changes take place.

Yes, well, I think that's a good observation, Joe, because let me sort of basically sort of describe it the way -- perhaps the way I see it. Over a number of years here, what's happened is that the auto industry as a whole has, if anything, had sort of lower case counts of their typical litigation cases. However, there have been some major events that have, as it were, kept the volume up, if I could describe it that way. So things like the unintended acceleration issues or some of these major issues do bring a sort of a flurry of cases in a particular area, but the underlying number of cases that most of the auto industry seems to have has been declining over the years.

Okay, that's fair. I'm glad that's clear. Just 2 more quick ones from me. On -- from a headwind perspective, with 2 of the 3 large deals becoming more normalized, is it fair to say that -- once we exit tough comps this year, that you think the majority of that headwind is behind you?

Yes, I do. I mean, as we -- as Paul laid out, I think 2 are moving into that 2% to 3% range. 1 is a little bit larger than that still. And again, we expect that these will continue to have long tails to them, obviously, at lower levels. The 1 other area that we've talked about that will -- that has stepped down and will continue to step down through the year is in the defense area. But we believe that the underlying business here is -- been growing in the high single digits. We continue to believe that -- if we're growing in the high single digit to low double digit that we can improve our margins 30 to 50 basis points and be able to continue to grow the bottom line faster than top line. It's just the headwinds that are there. So as we look out beyond 2014, we continue to be positive about the drivers of our business, sort of the fact that society, as we've been talking about here on this call, is really pressing for higher and higher standards for health, safety and the environment, and technologies keep getting more and more complex that drive our business. And we think those things are positive. We think we're in a good market position. It does take good execution to achieve all this, but we're encouraged about the long term and our ability to grow both the top line and the bottom line here.

Okay. And then the last one I want to sneak in just on the defense side: Are we hitting more normalized level as we head into 2015? And how do you feel about the products business at this side? What should we -- at this point, what should we -- I know we're not assuming anything going forward, but have you seen any signs of life in that business?

First of all, I think that we are likely to sort of get to a normalized level by 2015 because I actually think that we're looking, at this point, in a drawdown in Afghanistan through the end here in the back half of 2014. So our expectation is that our work, relative to that, will have normalized at that point time. Related to the topic of products, again, you're right. We don't -- we're not building anything in there. The only thing going on at this point in time is -- that long term could provide some upside at a certain point in time is really around ground penetrating radar and really, in particular, around IED, mine detection that obviously, throughout the world, there's a lot of issues and focus around. And how -- the technology and methods that we've applied and integrated with the U.K. Ministry of Defense over the last several years and is becoming part of their core program, how that spreads into the future, that will depend if there's a greater opportunity around products around IED detection. It may be just that we're doing consulting in the area, but there are opportunities.

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

This is Frank in for Toby. Wanted to ask if you had the break down between engineering and scientific, and environment and health?

Yes, sure. I can give the metrics here as well as the revenues. So for the -- for billable hours, we had 77,000 hours in environmental health segment and 197,000 hours for the engineering segment. For -- the utilization was 66% in the environmental health and 75% in the engineering. The FTEs were 224 in environmental health and 508 in the engineering. On a net revenue basis, the net revenues for environmental health were $19.7 million and the net revenues for engineering were $53.3 million. And the gross revenues or reportable revenues were $20.1 million for environmental and health and $55.8 million for the engineering.

Could you just update us on the percentage of the business at this point that is kind of proactive versus reactive? And what do you see in that proactive portion?

Yes. So this is something that we don't have a -- it's not easy to get a very precise measure. This is something that we do track over time but then we don't spit out a sort of a quarterly number on it. We're still in that mode where we would say that our proactive revenues are something a little north of 30%; reactive, about 60%; and government, including defense but including other governments, somewhat less than 10%. So we're still in that mode. I do believe that the proactive revenues are -- continue to grow faster than the reactive, but we haven't got to the point where we've changed it to a sort of a 55:35 ratio yet. So that's probably about as good as I could give. In terms of the areas that are strong proactively, it's what I've talked about earlier in terms of consumer electronics and medical devices and the health regulatory area for chemicals.

Okay, that's helpful. And this is just a quick one. Is -- was there any significant weather impact during the quarter in any of your clients?

No, I don't think that we did. I mean, like everybody else, we -- as a consulting firm in preparing for these things, we try to -- which a lot of it did impact the people ability to get into the office, but you hope that they can work from -- remotely and continue to serve clients. So we did not see it impacting the workflow from clients to us and I think we managed through it, from our staff standpoint, pretty well.

Okay. And my last question is on G&A. As we look forward, I guess you guided to $3.9 million to $4.2 million. Is that impacted in any way by the step-down of the large projects? Or what levers do you have to change that SG&A going forward? And do you expect some incremental margins from that?

So first of all, I don't -- I think, in the -- let's say, the short term, sure, there are things you can turn down. I think there are things that we wouldn't want to turn down because our G&A expenses include recruiting costs and marketing costs. And those are -- and then of course, you have audit fees and legal and insurance and all those other things, but what I would call variable costs are things like marketing, recruiting, professional development, all things that we think are important to developing people, getting out there and marketing and getting new talent. So I think that what you'll see with us is that, that will continue to gradually grow over time. I think we've demonstrated over a very long period of time, though, that what you can expect from us is that expenses -- if we're growing the top line in the high single to low double digits, that the other operating and G&A together will end up growing a little slower than revenues. And we've been able to do that over a substantial time period. And we still believe that we have leverage and getting leverage out of building more critical mass in our offices, by the fact that we're a small public company and you can get leverage out of that infrastructure cost. Those things can come along and allow us to improve margins over the long term.

And that does -- ladies and gentlemen, that does conclude our conference for today. If you would like to listen to a replay of today's call, please dial (303) 590-3030 or 1 (800) 406-7325, with access code 4677897. Thank you for your participation. You may now disconnect.