Exponent Inc (EXPO) 2004 Q2 法說會逐字稿

Good afternoon. My name is Marcus, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Exponent second-quarter financial results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions). Thank you. Ms. Johnson, you may begin your conference.

Good afternoon, ladies and gentlemen. And thank you for joining us on today's conference call to discuss Exponent's second quarter of 2004. Please note that this call is being simultaneously Webcast on the Investor Relations section of the Company's corporate Web site at www.exponent.com. This conference call is the property of Exponent, and any taping or other reproduction is expressively prohibited without Exponent's prior written consent. Joining me on the call today are Mike Gaulke, President and CEO, and Rich Schlenker, CFO of Exponent.

Before we get started, I would like to remind you that the following discussion includes forward-looking statements, including statements about Exponent's market opportunities and future financial results that involve risks and uncertainties, 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 periodical filings with the SEC, including those factors discussed under the caption, "Factors Affecting Operating Results and Market Price of Stock" in Exponent's Form 10-Q for the quarter ended July 2, 2004. 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 the result of new developments or otherwise.

And now, I would like to turn the call over to Mike Gaulke, President and CEO of Exponent. Mike, please go ahead.

Hello, and thank you for joining us today as we report another strong quarter. We are pleased with both the revenue growth and margin expansion we have been able to achieve in the first half of the year. For the second quarter, revenues increased 14 percent over the same period last year to 39.6 million, while revenues net of reimbursables increased 12 percent to $35.6 million. Net income increased 26 percent over the second quarter of last year to 3.4 million, or 40 cents per share.

Our success in the quarter was the result of expansion in defense technology development and continued growth in our core practice areas, with particular strengths in our electrical, thermal sciences, and biomechanics practices. We're pleased to report a moderate improvement in our utilization rate, enabling us to bring more of our revenue growth to the bottom line.

In our defense technology development business, we continued the development of the Advanced Robotic Controller for the U.S. Army's Rapid Equipping Force, and conducted a successful demonstration in June. We expect the next phase of testing will take place in Afghanistan during the third quarter.

Our expertise and success with the ARC project has paved the way for additional opportunities with other military branches. We recently won an initial contract with the U.S. Navy, which is encouraging, as we continue to focus on diversifying our defense technology development portfolio.

During the quarter, we received notification that the Exponent, Booz Allen Hamilton, and Wexford team has been successful in our bid to provide engineering support services to the U.S. Special Operations Command. Booz Allen will be the prime contractor for our team on this indefinite delivery, indefinite quantity contract. In total, four teams were awarded five-year contracts with an aggregate ceiling value of $400 million. We believe that our unique expertise and rapid response approach to technology development are both well-suited to the Special Operations Command.

At this time, we have not received any specific task orders, and we do not expect this contract to significantly impact our financial performance during 2004. However, we believe this contract award is a vote of confidence for our business and will offer Exponent revenue opportunities over the long-term.

Turning to our environmental business, we made a strategic hire this quarter, adding Dr. Paul Boehm as group vice president. Dr. Boehm has 27 years of experience in environmental consulting, and is recognized internationally as an expert in environmental and marine science, environmental pollution, and environmental chemistry forensics. We believe that Paul's market recognition and leadership will help drive incremental growth in our business over time. I will now turn the call over to Rich for a detailed review of our financials.

Thanks, Mike. As Mike discussed, we are pleased with our strong financial performance in the quarter. Revenues for the second quarter were $39.6 million, up 14 percent over the second quarter of 2003. And net revenues were $35.6 million, up 12 percent over the same period a year ago. Net income increased 26 percent to $3.4 million or 40 cents per diluted share as compared to 34 cents per diluted share in the second quarter of 2003.

For the first half of 2004, revenues were $78.4 million, up 12 percent over 2003. And net revenues were $71.5 million, up 13 percent over the prior year. Net income increased 34 percent to $6.9 million or 82 cents per diluted share as compared to 65 cents per diluted share for the first six months of 2003.

Turning back to the second quarter -- as a result of strength in some of our key operating metrics, growth in revenues translated to strong net income performance. Our second quarter utilization increased to 68 percent from 67 percent in the prior year. While there is still room for improvement, we are pleased to have made some progress. We had 178,000 billable hours in the second quarter, an increase of 8.6 percent over the same period last year. Additionally, bill rates were up approximately 5 percent over the prior year.

For the quarter, compensation expenses increased to $23.4 million or 65.7 percent of our net revenues from $20.7 million or 65.1 percent of net revenues in the same period last year. Salary increases, which averaged 4.5 percent, went into effect on April 1. Our full-time equivalent technical employees during the second quarter were 504, an increase of 6.6 percent year-over-year. In the second quarter, other operating expenses were $4.4 million, or 12.3 percent of net revenues, as compared to 14 percent of net revenues in the same period a year ago.

For the quarter, G&A expenses increased to $2.3 million or 6.5 percent of net revenues, which is the same percentage of net revenues as last year in the second quarter. Reimbursements were $4.1 million, as compared to $3.1 million in the same period of last year. These positive trends in business generated operating income of $5.5 million, an increase of 20 percent over $4.6 million in the second quarter of 2003.

Our operating margin improved to 15.4 percent from 14.4 percent in the same period of last year. Other income in the quarter was $246,000. Our tax rate in the quarter was 41 percent.

Shares used to count calculate net income per diluted share of 40 cents were 8,493,000. Due to options exercised, we expect shares used to increase approximately 200,000 in the coming quarter.

Turning to the balance sheet, we closed the quarter with cash and short-term investments of $39.6 million, slightly from $38.7 million at the end of the first quarter. The second half of the year is much stronger from a cash-flow perspective.

Accounts receivable were $47.6 million, and DSOs were 107 days. The increase in AR and DSOs is caused by the fact that at year end, we had $2 million in deferred revenues in technology development, and this quarter, we have $4 million unbilled in technology development. We expect to see this anomaly work itself out by year end. We also expect to improve our collections in the rest of our business. DSOs should be in the low to mid 90s by year end.

As we look ahead, we continue to be optimistic about our ability to grow net revenues. Due to the timing of vacations and holidays in the third and fourth quarters, we expect to see slight sequential decreases in net revenues while still experiencing high single-digit to low double-digit year-over-year growth. We want to remind you of this, since we had such a strong performance in the third quarter of 2003.

Now, I will turn over the call to Mike for closing comments.

Thanks, Rich. We're pleased with our success in continuing to grow our failure analysis business while leveraging this experience to help existing clients in product design and the military in technology development. Our health sciences consulting business continues to expand, and we're encouraged about the future of our environmental business with the addition of Paul Boehm. We will continue to make additions to our staff in order to address new market segments, enhance existing capabilities, and further our growth opportunities. With a good first half already behind us, we're optimistic about our ability to post solid growth in 2004. With that, I will turn the call over to the operator for your questions.

(Operator Instructions). Mike Crawford, B. Riley & Company.

First, on the SOCOM contract, the four teams that were awarded those were all of the four finalist teams -- each team was awarded a piece of the ID/IQ -- is that correct?

That's correct, Mike.

When was that award made?

I think the Army came out with an announcement in late June. Booz Allen is just in the process of getting their contract in place with the Army, and then our subcontract to them will follow.

Okay. And you don't care to venture at all what percent of your team's revenue would accrue to you over the five-year ID/IQ?

No. The problem is that at this state, we have not really had sat down with the customer yet following these awards. Secondly, hazarding a guess as to what the split out will be until we really see what the near-term priorities are would really only be that.

I guess what I can say and what I have said in the past is from our standpoint, this is a -- an ideal client, we believe, for the capabilities and the value that we can bring in this particular situation. The Special Operations Command historically has been one who has embraced new technology, doesn't need the technology in hundreds of thousands but relatively small quantities, and generally wants it yesterday. And those are all capabilities that play particularly well to the kind of services that we have been able to provide clients in the sector. So we are very encouraged with the award here of what I would describe as a hunting license to be able to go start selling to this client.

Okay. As to the other parts of your business, could you give the revenue and EBIT breakdown for the two reporting segments?

Yes, I can, Mike. The revenues for the other scientific and engineering segment for the quarter were 29 -- really 30 million, 29.965 for that segment, and 9,678,000 for the environmental and health segment. That's the revenues.

The operating income for those -- other scientific and engineering was 7,466,000, and environmental and health was 1,545,000.

Great. And then, could you talk, finally, about any new business or contracts during the quarter in some of these practice areas that you mentioned in the release?

Yes. The challenge for us is most of our work in our core engineering practices are litigation in nature, or sort of regulatory in nature. And we can't go into the details of those in public. So it does constrain us somewhat. What we can say is that both -- in the electrical practice, we have been able to grow in the failure analysis area. But we are also in the process and have been working with several firms in the electronics industry, where we are helping them in their product design cycle. So they are moving us forward in their development cycle to help them eliminate the problems that they are seeing on the back end. That is one area. In the biomechanics segment, we've seen growth both in our sort of accident reconstruction area -- this would be automobile accidents, slip-and-falls and such, where we're working on litigation matters. We're also working in biomechanics on the medical device product development cycles. So we're advising clients in that development cycle, as well.

Richard Hyon, Roth Capital Partners.

My first question is about the Advanced Robotic Controller. I know the last quarter, you had mentioned that phase six would range in between for revenues you can see from that opportunity of between 1.5 to 1.8 million. How much was awarded from that phase six program, and how much do you expect from phase seven?

Phase six, I continued to run just about on budget. So that estimate that we gave in the call at the end of the first quarter is accurate. And phase seven is a task that is just about the same size. We've recognized the majority of those revenues during the first and second quarters. We have only about 10 to 15 percent remaining on each of them.

And also, depreciation and amortization for the quarter?

Yes -- 820,000.

Mike Niehuser, The Robbins Group.

Just a kind of a follow-on question about the phase six and seven. A few years ago, when Land Warrior kind of ran out, there was a reduction in revenues and I guess what I'm seeing with the SOCOM ID/IQ is that your revenues from technology are much more durable, or better diversified, now than they were a year or two years ago. Is that right?

Yes. I would describe it as such, Mike. I think if you look back to when we got first involved with Land Warrior, that really was the only contract that we at that point in time called defense technology development or technology development. If you look at the revenues today, there is more activity there, for sure. The Advanced Robotic Controller is the principal project with the Rapid Equipping Force. But there are other projects that we're working with the REF, and we continue to pursue other work there with them. Of course, we have the defense manpower data agency, contract we've got a contract with Army night vision labs. We've got the SOCOM award now, and of course, expanding here to now the U.S. Navy. So it is more broadly based then it was, and that is good

Did the other teams that were also winners in the -- with the SOCOM hunting license -- are they complementary, or are they competitive to what services you provide?

We have not had the opportunity to look at all our submissions, in terms of the contract. Those other players are folks like SAIC, Patel (ph), and ITT. I mean, they are very capable organizations. The history of procurement, as I understand it, in SOCOM, is that they tend to take 100 percent of what they want with one of those contractors. And so, it will be -- we will end up ultimately having to compete with them. But the nature of the procurements is typically is because of the very fast reaction cycle, it's not something that they competitively lay out there for each procurement. So they will make their selection. They can go to any one of us and engage that contractor for the perceived need.

I think that's interesting that there is smaller quantities and rapid turnaround. It seems like now, they are fitting most of your other customers.

But, lastly, with the guidance -- again, it's resembling prior quarters, where its low double digit, high single digits. Would you still be looking for a 50 basis point improvement in operating margins if you're able to have that revenue growth?

We do see that we should be able to achieve that. Probably the exception to that is just the third quarter, where last year we had real strong revenues and very strong operating margin. That would probably -- the third quarter would probably be more flat in a margin expansion area. But probably for the overall year, or even the back half of the year, we should be able to see growth in our operating margin.

Okay, that helps. Thank you.

John Gruber, Gruber and McBaine Capital.

I'm confused on the Booz Allen prime contract. How much do you know you're going to get -- is it -- how much do you think you'll get (technical difficulty) get of the, what, 400 divided by four, in the first 12 months?

John, I'm only guessing -- it's impossible to guess. There are four players. And obviously, if we divide it by four, you get a number that I would say there is extremely high probability won't happen. So, it is indefinite delivery, indefinite quantity and until we know more about what it is that they really want to procure, it's hard to venture a guess as to whether or not we think that we are going to be preferred over other vendors here. This is a five-year support contract, and I just cannot give you any guidance right at the moment until we get closer to the customer.

And are there any other ones where we -- contracts coming down where we know what we're going to get if we win them?

Well, most of the other contracts are not what are called ID/IQs -- indefinite delivery, indefinite quantity. And so when we bid them, we know at the outset reasonably what we're going to get, because most of -- nearly all the work that we have done to date has been fixed-price. And so we've got a reasonable idea of what the contract size those are.

So, for example, we had an initial small contract to -- sort of a concept development with the Navy this quarter. That is leading to further discussions of that idea which, unfortunately, we cannot share publicly. But the development of that -- and then in doing that, we would end up signing up for a fixed-price contract with them. It would not be something where it's just a contract vehicle to go out and get work over a long period of time. It would actually be more of a fast-burn project, similar to what we've done for the Department of Defense to date.

And the SOCOMs will be fast-burn if and when they happen. I think it is -- I'm very optimistic that we will be doing work there. But I just -- I don't know what size or shape it will take yet. Sorry for the seeming vagueness here, but ID/IQ in some sense perfectly describes what this is.

Jon Hickman, Halpern Capital.

Two questions. One is, as you get a task from the SOCOM contract, will you press release those? Or tell us about those individual tasks and what they might -- maybe you can't talk about the nature, but you can talk about the dollars?

It will depend -- I mean, most likely not. We don't come out and announce every project that we get. From time to time, if the client believes that it's appropriate to announce it publicly, we will put out a press release if it is material and the client will allow it. Otherwise, we will probably talk about the progress we've made on our quarterly conference calls.

We will give you a sense of the size or the importance. It's not like it's going to be a total mystery.

Okay. Then, the other thing is -- I got on the called just a little late. Did you say anything about your construction dispute business and how that has progressed?

Yes -- no, I actually didn't mention anything. But actually, during the quarter, we had several construction dispute projects going on. A couple of them are actually in our top 20 projects in our company. I will say that the area has been strong, but -- and we've continued to do recruiting. Some of the individuals that we have brought in are coming up to speed right away. Others have developed a little bit slower than we would have expected. But overall, we're continuing to make progress, and recruiting and bringing in new projects in this area. The biggest project still remain -- that we're working on is the MTA project back in -- or the Big Dig in Boston.

Jerry Heffernan (ph), Lord Abbott.

Thank you for a very nice report here. If I could ask you just a couple of questions here, you made a comment on DSOs and the accounts receivable increasing -- Rich did during the opening remarks. And if I could beg your forgiveness or patience here, if you could just review that whole thing again?

Yes -- we ended up with $47.6 million of AR. There were two drivers to that increase in accounts receivable then ultimately driving DSOs. One is really a shift in technology development. At year end, we had $2 million of deferred revenue. So we were in advance in our billings there, or ahead of our revenue recognition at year end. And at this point, we have $4 million unbilled in technology development. Those will end up, actually, getting billed here within the next 30 days. But it just happens to be about a $6 million shift in moneys in advance versus moneys that we're billing towards the end of doing the work.

The other areas -- the fact that we've seen nearly a $6 million increase in the revenues that we have versus fourth quarter to second quarter. So when you look at it, that makes up the 12 -- the $13 million increase in DSOs. We believe that by year end, we will get more into a normal operating mode in the technology development area. And we feel that we can make some improvements in our collections in the rest of business that will allow us to bring the DSOs down into the low to mid 90s by year end.

And last year, with all of the deferred revenues, we had said at the interview that we didn't expect to be performing long-term in the low 80s, at least as long as we have the mix of business we had today.

Does that help out?

Yes. Just wanted to get -- low 80s is not a norm.

Yes. That was really because we had deferred revenues there instead of some actual billings. We would expect the government work to traditionally help our DSOs versus our typical client, where we bill to a law firm, they send it onto a corporate client who pays the law firm who pays us back. They're -- good credit there. Our write-offs are in the 1.5 to 2 percent. But it just takes a long time to get paid.

Okay. Thank you. If I could just switch topics now -- your treasury shares, that balance decreased, I guess, would be the appropriate term here.

Yes.

If you could just review that $3 million there?

Yes. The treasury shares were used for option exercises, ESPP plan payouts that we normally have quarterly, and the payout of our -- we moved to a restricted stock as part of our bonus, and substituting restricted stock for option to be able to reduce the shares that we're putting out on an annual basis and the long-term impact to shareholders. We did that in the first quarter. And in the second quarter, we had a large set of options that were going to expire that had been issued just under 10 years ago. And those were expiring at the end of June. So we saw more option exercises during the second quarter than we would typically have.

And those options are being exercised due to expiration?

Yes. They had a ten-year expiration. These were issued back in '94.

Okay. Certainly, the first and second quarters when -- they are your bigger growth periods -- if you're going to have a cash usage that would be during that period -- you actually on a -- from year end, have used some cash. However, you didn't build cash from first quarter to second quarter. And one would imagine if things continue on, you have another step-up in cash balance in -- through the third and fourth quarter here, which brings the ever-asked question as to your plans for the cash balance.

It has been a question that investors , potential investors, have asked this year as we have gotten up to the $40 million mark. We continue to look at it as a funding source for acquisitions. And we continue to look at acquisitions. We will continue to consider repurchase of our own equity. And we continue to assess other alternatives -- paying a dividend is one of those. At this point in time, we're not -- we have not made a decision to do the latter, to pay a dividend. We certainly are continuing to look at acquisitions, and do have a Board authorization for repurchase of shares.

And what is the Board authorization, if you would remind me, please?

The Board authorization is currently at about $4 million remaining on that authorization.

But if it made sense, we will go -- that's something that can be refreshed or expanded.

Okay. And, if I could just follow-up, then, on the comment on acquisitions -- if you could just tell us how you see the current acquisition environment, what -- is the candidate list out there increasing or decreasing, sellers' thoughts as to the worth of their business -- is that increasing or decreasing? And how many people are on the buy side today?

Well, the acquisition environment today from our perspective looks better than it has over the last -- certainly, over the last five years. The last couple of years has become much more sane than it was in the '99-2000 period. Valuations appear to be more realistic. We continue to pursue a strategy here that is not attempting to do large acquisitions, but rather find acquisitions that complement the business that we have and accelerate what would otherwise be organic growth or internal growth by being able to acquire multiples of that kind of talent that we need in the long-term for our growth. We have several areas staked out, where we're looking specifically for growth. We have been talking about those in terms of strategic growth opportunities. Health is really the area that we think is most promising. We would be looking both in this country, and potentially to do something in Europe, with health. And that may be internal or through an acquisition to have a bigger stake in the EU on some of these critical health issues.

Okay, very good. And as I said, I complimented you on the quarter, but we always have to find something to complain about. The G&A expenses -- I see it at 5.9 percent of the total revenue number, consistent with what was on a year-over-year basis and even on a six-month, we seem to be flat. However, revenues were up a pretty good clip during that one-year basis. What am I missing when I'm thinking about G&A expenses? I would think you would be able to leverage the number somewhat. Why am I mistaken there, or what's going on that's causing us not to realize the leverage on that level?

Well, G&A -- first of all, I think if you look back over the last several years, we have just made significant improvement in this area as far as holding the cost down and growing the revenues faster. I think that with the change in the operating environment, that public companies are working in today with Sarbanes-Oxley and other government directives that are coming down, the cost of doing corporate governance and having a qualified board, as well as our focus on recruiting and growing the firm -- those two areas are really ones that are driving us to maintain that sort of operating level as a percentage of revenues.

Okay. And you'd made a comment in the opening remarks initially regarding the -- utilization has been better, which has transpired into our better margins. Can you give us any more metrics on utilization rate? You did give us the statement that full-time employees were up to 504 -- I guess that's a 6 percent increase year over year. But just some of the metrics that you look at to grade yourselves when you review the quarter?

The metrics that we actually mentioned on the call today, both where are we as far as growing our full-time equivalent technical employees -- ultimately in the long run, you can -- we're not there yet. But you can cap out on the utilization. And ultimately, if you're not growing in people, you're not going to grow in this business. So we watch that number. And with that up 6.6 percent over last year, for us, we feel that's solid growth. And then, we turned to our utilization and look at that. With us growing and our ability to improve the utilization, we view that as a positive -- at least a movement in the right direction. If we can keep recruiting and bringing in new talent and expanding the platform we have with an improved utilization, we find that to be a real positive. We know we can slow down recruiting and tighten up and get the utilization up. But in the long run, we think the best is to keep both of those moving in the right direction.

And then, for us, we set our bill rates at the beginning of the year. We charge of our clients the same bill rate for an individual who works in our firm. So we look at their place in the market at beginning of the year, and set a bill rate for them. And they bill that client at that same rate throughout the year. So we do look at that at the beginning of the year, look at the increase we've been able to achieve and how we're doing -- is that having an impact on people's ability to sell business? And we feel pretty good about that at this point in time, too. We've been able to realize the approximately 5 percent increase that we raised bill rates this year.

So those are the key drivers for us. And then ultimately, it is looking back at the -- how we're doing as far as leveraging the organization and the expense structure that we have. Can we leverage up the facilities we have, the corporate infrastructure that we have in place? And to date, we've been able to do that. And we foresee out over the next several years that we can continue to improve utilization. We believe our position in the marketplace will allow us to continue to increase bill rates at approximately that same level annually, and that we do have a solid infrastructure in place to be able to build upon. So all of that put together is why we have communicated to the marketplace that we think we can continue to improve our margins over the next several years.

All right. Thank you very much for time. I will get back in queue.

Eric Miller, Heartland Advisors.

Congratulations on the progress, guys. Actually, my question was on how, Rich, was -- are you fully picking up that 5 percent price increase -- and it sounds like you are.

Yes. We on average -- it varies across the board as far as what we ended up raising rates. We look at each individual within each practice, and make an evaluation of where we should go. So there is a lot of thought that goes into them. Sometimes, it ultimately results in someone sort of capping out in the marketplace. But overall, we raised them 5 to 6 percent, and we've been getting approximately 5 percent net out of it.

How about turnover? What are the statistics there?

Yes. Our turnover for our consulting staff has been running in the low teens, sort of 12 to 14 percent for the last two years. And that, we feel, is sort of a healthy level. Part of that is people that we have determined are not made out to be consultants. It takes a lot more than being a smart engineer or scientist. It takes some real communication skills and real-time thinking to be able to operate in this environment. And so with the natural turnover that you get in any business, plus some of it that we move along, we find that to be a healthy rate.

Jeff Meyers, Intrepid Capital.

Just within the receivables balance, what percent of that -- or, I guess, absolute dollar figure -- how much of that is unbilled at the end of the quarter?

Just one second. (multiple speakers) It's just under -- it's just about approximately 25 percent, without having the number right in front of me. But its approximately 25 percent. So you're looking at around 11 to $12 million.

I've got you. And how does that compare to the usual ratio?

It's a little bit higher, because -- I mentioned that we had more unbilled in technology development than we have had historically. (multiple speakers) So actually, I have just reviewed -- yes, it's normally running about 12 to 13, and we've got the extra $4 million in there for technology development. So it's actually at 18 million, with the other 31 million being in billed.

Okay. And then you mentioned margins being the same, I guess, next quarter. Was that the same sequentially, or was that the same year over year?

At that point in time, I was talking about the margins compared to last year that, because of the strong quarter that we had last year in the third quarter, that making improvement beyond that would be more challenging.

I've got you. So that's down about 90 basis points? Is that right, or am I thinking about that the right way?

Yes. That would compare out to last -- yes.

(Operator Instructions). Mike Niehuser, The Robbins Group.

Just on the shares -- you're seeing that they would increase a couple of hundred thousand next quarter. And that's pretty much to take care of options, and then pretty much flat from there on out, do you think?

We would expect to continue to see, as all companies do, some exercise of options, employee stock purchase shares put out. And then as -- depending on where the stock price is, if that is increasing, then that counts into your diluted calculation and weighs there. So we would expect to see more of a gradual increase that we have seen over the past couple of years versus the more of a spike (ph) that we've seen in the last couple of quarters.

So next quarter will be a little bit unusual, but not by a huge margin, then?

Yes.

Thank you. At this time, there are no further questions. And this does conclude today's Exponent second-quarter financial results conference call. You may now disconnect.