Exponent Inc (EXPO) 2010 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Exponent second quarter 2010 earnings conference call. (Operator Instructions.) This conference is being recorded today, Wednesday, July 21, 2010. I would now like to turn the call over to Miss Brinlea Johnson of the Blueshirt Group. Please go ahead, ma'am.

Good afternoon, ladies and gentlemen and thank you for joining us on today's conference call to discuss Exponent's second quarter 2010 results.

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/investors.

This conference call is the property of Exponent and any taping or reproductions is expressively 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 these factors that could cause actual results to differ from forward-looking statements can be found in Exponents periodic filings with the SEC including those factors discussed under the caption Factors Affecting Operating Results and Market Price of Stock, in Exponent's form 10Q for the quarter ended July 2, 2010.

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 the 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, Brinlea. Thank you for joining us today for our discussion of Exponent's second quarter 2010 results. We are pleased with our financial performance. With revenues before reimbursements increasing 5% to $55.1 million. Total revenues in the second quarter were $60.4 million. Net income was up 21% to $7.3 million, or $0.48 per share. EBITDA improved 22% to $13.4 million (sic - see Press Release).

Our strong operating performance was the result of improved utilization and careful management of expenses. In the second quarter we continued to receive a steady flow of projects. During the quarter we served more than 1,500 clients and worked on over 3,000 projects. This diversification resulted in our largest client being less than 4% of net revenues and only four projects being greater than 1% of net revenues.

During the quarter we continued to receive a steady flow of requests to answer the question, "what happened?" As is clear on a daily basis from the front page of any newspaper, accidents and failures involving products and processes continue to happen regardless of the state of the economy. These reactive projects make up approximately 65% of our revenues. In the 25% of our business that is related to more proactive services we did not see any indicators of a broad based increase in discretionary spending.

One of the areas we did see increased spending, though, was related to regulatory compliance pertaining to the registration of chemicals. This activity contributed to the strong performance in our health group. In defense technology development we continued our development of the Ground Penetrating Radar technology for the US Army.

In Europe we have one GBR program in the contract negotiation phase and another in the proposal phase. Additionally, we have continued to fill the order for surveillance systems which we discussed on last quarter's conference. In summary we are pleased to have delivered solid net revenues and strong earnings-per-share.

I will now turn the call over to Rich for a detailed discussion of our financial results.

Thanks, Paul. Revenues before reimbursements, or net revenues as I will refer to them from here on, increased 5% to $55.1 million as compared to $52.4 million in the prior year period. Total revenues for the second quarter of 2010 were $60.4 million as compared to $60.9 million in 2009. Net income for the second quarter increased 21% to $7.3 million or $0.48 per share. EBITDA in the quarter increased 22% to $13.3 million. In the quarter, net revenues from defense technology development business decreased to $3.7 million as compared to $4.9 million last year. This includes $800,000 of net revenues from product sales in the second quarter of 2010 and $1.5 million in 2009.

For the first half of 2010 net revenues increased 3% to $110 million as compared to last year. Net income for the first half improved 15% to $13.5 million or $0.90 per share. EBITDA in the first half improved 16% to $24.8 million. Our strong improvement in operating performance in the quarter was a result of solid revenue growth, higher utilization and management of expenses.

In the second quarter, billable hours increased 3.8% to 26,000 as compared to $218,000 in the same period last year. Our average technical full time equivalent employees for the quarter were down 3% to 611 as compared to 629 in the same period last year.

Based on our current level of accepted offers and ongoing recruiting activities, we expect FTEs to increase slightly in the second half of the year and we intend to selectively invest in additional talent to generate future revenue.

Utilization in the second quarter improved to 71% as compared to 67% in the same period last year. We expect the full year utilization to be between 67% and 68% as a result of the normal step down in utilization in the second half of the year due to increased holidays and vacations.

The percentages I will reference hereafter are on a percentage of net revenue basis. EBITDA margin for the second quarter improved 24.1% from 20.9% in the same period last year. Total compensation expense for the quarter was $34.1 million. Annual compensation increases took effect in April and were approximately 3%. Including these raises compensation was up 2% after adjusting for deferred compensation, gains, and losses which do not impact the bottom line. As a component of compensation stock-based compensation expense for the second quarter was $2 million. For the full year we expect stock-based compensation to be $8.5 million to $9 million.

Other operating expenses for the second quarter increased slightly to $5.4 million. As a component of other operating expenses depreciation was $1.1 million. We expect other operating expenses to be $5.5 million to $5.6 million a quarter for the remainder of 2010. G&A expenses in the second quarter from $2.9 million, down from $3.2 million in the same period last year. Going forward we expect G&A to be $3 million to $3.4 million a quarter for the remainder of 2010 as a result of increased business development activities, a company-wide managers' meeting and professional services to assist us with entering the European defense business.

Interest income was $66,000 as compared to $200,000 in 2009 due to a lower interest rate environment. Our tax rate for the second quarter of 2010 was 40.7% as compared to 40% in the same period last year. This increased tax rate is primarily related to lower tax exempt interest income. Turning to the balance sheet we closed the period with $76.4 million of cash. During the quarter we repurchased $2.3 million of stock. This leaves us $15.8 million available under our current stock repurchase authorization.

Capital expenditures for the second quarter were $730,000. DSO's were 94 days. In summary, our performance in the first half of the year provided a foundation for us to grow revenues before reimbursements in the low to mid single digits for fiscal year 2010, and to improve EBITDA margins by approximately 150 basis points. Included in these expectations is net revenues from product sales of between $2 million and $2.5 million in the third quarter, and approximately $500,000 in the fourth quarter.

Now I will turn the call back to Paul for concluding remarks.

Thank you, Rich. We had a strong second quarter, which demonstrates the strength of our business model. As we look to the second half of 2010 we will remain focused on -- providing our clients with in-depth scientific research and analysis to determine what happened and how to prevent failures or exposures in the future, selectively adding new talent to allow us to continue to expand our capabilities and grow revenues, continuing to manage our other operating and G&A expenses and finally generating more cash from operations, maintaining a strong balance sheet and undertaking activities such as repurchasing shares to enhance shareholder value.

We are optimistic about our long term future as we continue to see our demand being driven by product and process safety, human health concerns and environmental issues. Our multidisciplinary team of over 300 PhDs and MDs, and over 40 years of experience provides us a differentiated market position to address the most complex engineering and scientific problems of the future.

Now I will turn the call over to the operator for your questions.

Thank you, sir. We will now begin the question and answer session (Operator Instructions). Our first question is from the line of Timothy McHugh with William Blair & Company. Please go ahead.

Yes. First I just want to ask about the updated revenue guidance for the year. Last quarter you were saying low single digits. You are now saying low to mid. Can you talk about what you're seeing that makes you more confident in that slight at that slight tweak upwards? You said you aren't seeing necessarily discretionary spending come back. Is it more of the trends you're seeing on the technology development side or something else that you can point to?

So, Tim, it's Paul. I think that from our standpoint obviously we had a very strong second quarter and as we look at that it was really generated by our continuous flow of these more reactive projects and I don't see that those have stopped. I mean they come and go much obviously, there is lots of different projects there, but we feel that based on the strength of that second quarter we believe that it's appropriate for us to have a tick up in our guidance for the year.

Okay. And then, Rich, can you help me walk through the impact of the deferred comp adjustments on the gross margin. The comp expense line and how to strip that out of the other income or (overlapping speakers.)

Yes. Tim, so in the second quarter of 2010 there was an $880,000 loss in that, so that would reduce -- that would have made compensation expense $880,000 lower than it actually was, okay? So you should add $880,000 to this year's. Last year there was a $565,000 gain in the portfolio so that would mean that compensation was overstated by that $565,000. So you should lower last year by $565,000, increase this year by $880,000 and that's how -- then you will get a 2% growth in year-over-year.

Okay. When you're saying 150 basis point increase, is that adjusting for that?

That nets out in EBITDA because the gains -- the offsets to that compensation are down in miscellaneous income and when you go to our EBITDA statement, that is washed out.

Okay, yes, the way you're talking, okay.

Yes.

Okay. And then last question quickly would be the repurchases. You purchased some here but clearly you have the nice problem that you continue to build more and more cash. You know, are there acquisition opportunities that make you maybe not be quite as aggressive there or are you -- would you otherwise expect to have to get more aggressive to deploy that capital that's building up?

Well, Tim, I think that we do have some acquisition opportunities that we're looking at. Again, we have generally found those to be hard to do and as you know the last one was in 2002. So we're not fundamentally changing our approach and strategy with regard to that. So I do think that we will need to continue to push the share repurchases as a way of returning the cash to shareholders.

Okay. Thank you, guys.

Thank you. Our next question is from the line of David Gold, with Sidoti & Company. Please go ahead.

Hi. Good afternoon.

Hi David.

I wanted to delve a little bit more into the decline in compensation expense year to year. So I understand that some of that was overstated last year, maybe understated a little this year but even adjusting for that you have pretty aggressive pull back as percentage of revenues. I'm just curious if you could give some color. Presumably some of that is the utilization improvement, but anything else going on there? Is there mix to it or are you adjusting comp a little bit or what's happening there?

yes. So, David, the first thing is we -- as I stated earlier on a year-over-year basis we're down 3% in FTEs, so if there were no raises or anything else changes compensation would be down 3%. That was offset by raises that were about that same amount plus other mixes that go on. Clearly our profitability is up as we've talked about before, our bonus pool is driven by profitability so that adds to it, so that's why we ended up when you adjust for deferred comp our total comp is up 2% overall and I think based on headcount being down slightly that's why it's a low single digit number. And then the relativeness to revenue if that's what you're referring to...

Yes.

Is driven by utilization. You've got that as your base number. Utilization, billable hours are up as well as pricing is up which generated the 5% to 5.5% increase in revenues.

Yes. Okay. All right. So it's really right there. It's really all about utilization?

That's correct.

Okay. Got you. And then can you speak a little bit to attrition? The headcount, the lower headcount. Was that all voluntary or did you pare some back?

Yes. So with regard to the retention issue we continue to look at that in sort of two buckets. One is sort of looking at our senior staff. You know, we've talked before about retention levels at the principal level and they represent the main rainmakers of the firm and we obviously are very focused on that. We continue to have great success in retaining our principals. I believe we've lost just one this year so far. So that -- we have over 100 principals. So that's very good. We have seen a higher level of turn over of staff below the principal level this year. It is really -- there's not a particular trend of that. We obviously are always looking at our staff with regard to how well the staff fits with the firm and peoples' careers are advancing. But I would say that the majority of the turn over this year is not based on that.

Okay.

It's just based on a number of individuals over time deciding that their careers might be better in some different field or moving on to something else. So it's just a turn over that happened and at the same time that that's been going on we've had a desire as we've talked on these calls over a period of time to have our utilization pickup a little bit and we're pleased that that's happening here.

Okay. Perfect. And then just one last if I might. Last quarter you had -- (inaudible) spoke about some new contracts. I am I just curious on progress for other potentials that presumably you might be working on.

You're talking in particular in the defense area?

Yes.

Yes. So I think what we talked about at that time is one that we had gotten a new contract or new task by the rapid equipping force for this development of the GBR technology. This was a contract that was about $14.7 million in gross revenues, for which we had about $4.7 million of that funded. That still today remains the level of funding on that so there's still more available for that.

The net revenues off of that $4.7 million are probably about $3 million. We did about two thirds of that in the second quarter. Most of the remaining will happen during the third quarter, a little bit may spill over to the fourth quarter, and there's still an opportunity for those additional tasks under that to be funded. As far as the other opportunities we had indicated that we were in the final throes of a sort of technology assessment area over in Europe. That, as Paul indicated in his comments, we've got one of those contracts that's in negotiation at this time. So I can't provide details of it or talk about it in that sense, but it is something that looks promising for us in this technology area and breaking in with a new client and then we have additional European, one or two, clients who are also now in the technology review phase of their evaluation and are asking us -- one of them has already asked us for a proposal for going forward. So, again, I think things are firming up and looking pretty good as far as some of those future opportunities for us. In the product area in defense it's really been more recently around the surveillance systems or RDISS.

We announced that we had a gross revenue contract of about $9.6 million that we got somewhere early in the second quarter. Net revenues of that were about $3 million to $3.5 million. We did about $700,000 or $800,000 thousand dollars of that in the second quarter of that net revenues. As I indicated, we expect $2 million to $2.5 million to come through in the third quarter and the remainder out into the fourth quarter. I would say that we are receiving -- or there are out in the marketplace further requests for surveillance technologies. We've turned in some proposals for those but do not have back any indication of where that is, but we would hope that over the next quarter or two, you know, there seems to be a continued demand for that particular technology out there and I think we're in a pretty good market condition to capture some of that on a going forward basis.

Got you.

So that's where those things stand.

Perfect. That's all helpful. Thank you both.

Thank you David.

Our next question is from the line of Tobey Sommer, with SunTrust. Please go ahead.

Thank you. I had a question for you kind of about margins both with the EBITDA and operating line. What do you think is the right margin range for this business over time?

Well, I still -- this is Rich. I think that last year we did EBITDA margin on net revenues of about $19.8 million. As indicated earlier in my comments I think that we can improve that approximately 150 basis points this year which comes with this step up in utilization as well as leveraging the infrastructure that we have in place. You know, I think that one of the goals that we have over time is to continue to improve our utilization so that our full year utilization can get up around the 70% level and I think that we have demonstrated over the last decade that if we can be growing revenues in the sort of low double digits, high single digits, low double digits, we can tend to grow other operating and G&A slightly slower than that in a sense to get a little bit of leverage out of it that way over the long term.

So I view that there still is some room out into the future. I would expect that is going to have to come with utilization improvement and sort of solid top line growth, but if it is in that range we're able to march forward on improved utilization and we can steadily grow, I would hope that we can improve sort of the EBITDA margin in the 30 to 50 basis points a year. You know, that's going to depends on those key factors, but those are the expectations we have over the, let's say the next three to five years.

Thanks, Rich. That was helpful. In the quarter itself could you give us the numbers that would let us know kind of what the impact was of product and defense related higher margin sales in the second quarter as well as maybe the year ago or the first quarter just so we can get a sense of what the underlying margin was versus the contribution from those other areas? Thank you.

Yes. Well, as we have stated before, in the defense product sales when you look at it on a gross revenue basis, the margins are really no different than the rest of our business. We don't really have a difference in the margins. Where it sort of skews the margin sum is when we take a net revenue because there is a lot of third party costs involved in those and that's what we've talked about before. So relative to that just to indicate -- and in the second -- focusing on the second quarter first. In the second quarter of 2009 we had just about $1.5 million of net revenues from product sales and that was around $800,000 here in the second quarter of 2010. I think that when you take that sort of $700,000 swing there, it had just a little bit of improvement in it. It's probably ten to 20 basis point improvement in that area, potentially 25 basis point help in that.

When you look at the first quarter, product sales were about the same in both years and again, one was at -- 2009 had just about $400,000 in net revenue from product sales, and in Q1 of 2010 it was $200,000.

So we've said our margins are not really affected at sort of $0.5 million of product sales in a quarter. It's really when we exceed that $0.5 million a quarter that we see some impact. So I would say in the first half of the year we haven't had a significant impact from that product sale margin here in the first half of the year.

When I look at what we have ahead of us in the third quarter, though, I think that while we would expect utilization to come down in the third quarter as we get more vacation, which would typically bring margins down, one of the factors offsetting that will be this $2 million to $2.5 million in net revenues from product sales that we will have there and I think that will have -- even on the third quarter probably close to a 150 basis point benefit to the margin in that quarter on a net revenue basis. At $0.5 million in the fourth quarter, again, I don't see a lot of difference.

We had about $800,000 in 2009 in the fourth quarter so I would expect those margins to be more equal between the year-over-year. So a little bit -- or a good impact here in the third quarter from it, but not really a change in the margins for the fourth quarter.

Thanks. Paul, could you describe the hiring environment? Thank you very much for answering my questions.

Sure. I think the hiring environment continues to make a little bit of difference whether you're talking about senior rainmaker principal type hires or we're talking about more entry level type hires. At the most senior level the hiring environment it's always difficult and continues to be difficult. People who are very talented have a book of business, have a client list and so forth.

First of all, usually happy where they are and it's difficult to get movement there but we work on it and we get a few of those every year and that works out very well, but there's not really a change in that I think right now. With regard to the more entry level hires, there's no question that there is a lot more talent out there that is available than normal because the hiring -- it's still a very difficult economy for many people coming out of school.

Having said that we usually find that the people we make offers to are in a mode of receiving multiple offers. The top talent always seem to have a lot of opportunities, but we're not -- I would describe it at the entry level we're not restricted in how many people we can hire in terms of the availability of talent that would meet our needs. It really is more a matter of at what stage do we hire and I think it would be fair to say that we always have a certain amount of turn over and we've probably replaced some of that slower than we might have but, again, we have wanted to increase the utilization.

Thank you very much.

(Operator Instructions). Our next question is from the line of Joseph Foresi with Janney Montgomery Scott. Please go ahead.

Hi, guys.

Hi.

I guess my first question here is, you talked a little bit about hiring at the end there and I know that you are doing some campus recruiting, but is there any specific skill set that you're in the market for right now that you see in demand in your present client base?

Well, I certainly think we've got some practices that we probably are looking stronger at than some others but let me just start with kind of a baseline. Essentially just about all our practices recruit people every year because there's always a certain amount of turn over. So we're always in that marketplace, but clearly you can look at some areas like electrical, electronic sort of things that we've in recent years wanted to -- we've needed to kind of grow a little bit faster there and we continue to be bullish about where things are in health so we want to grow there but the hires are very much across the board.

Okay. So but I mean then specifically you're looking more in health and electronics or is that just kind of in general?

I am I just saying that those are areas that I think we're looking to hire at a faster rate than we might be in some other areas.

Okay and then I know in your opening remarks you were pretty clear that you're not seeing a pickup in discretionary spending and litigation. Can you give us just a little bit more color on what is any reason for that or are pipelines building, do you see it happening in a quarter or two, anything you can give. I know we've kind of gone maybe a year without this sort of picking up.

It continues to be a difficult issue, I think, and I think we really see things pretty much the same as we've seen them for the last couple of quarters, which is we talk about we haven't seen any indicators of a broad based increase, which is what we referred to, but previously I talked about it being very client-specific. We have individual clients in different industries that just are moving forward and doing well and some of those could be in consumer electronics, some of those could be in medical devices or in registration of chemicals and thing like that, but it's just not across the board. You continue to have good clients who are just holding back compared to where they have been in the past and yet some others are moving forward. So it really is just that very selective kind of situation.

Okay. I think -- maybe you could just give us an update on sort of the auto industry. I know you have done some work there in the past. Has that come back to full speed? Are there some projects that have just stopped and what part of the -- how do you see that progressing sort of going forward?

I think that going forward the -- our business in that area is very robust, is moving forward just fine. I think that when we had the bankruptcies we had two of our clients who basically got a lot of their cases wiped clean and the case load was kind of starting to build over. We have started to see some of those new cases in small amounts come back, but that's taking a while to come back. At the same time there's other issues that have come up. Obviously it's been public that we've been assisting Toyota on some of their issues. So on balance the auto industry and our work for that industry continues to be pretty robust.

Okay. And then just lastly are we back to maybe a new normal -- I know that you typically want low double digits, high single digits. We are not back to that level yet obviously this year. Maybe you could talk about what you think needs to come back, and this is my final question, what do you think needs to come back to get you back to those levels?

Well, I think that really is related to the economy.

Okay.

You know, I think as you can see from our guidance we have picked that up a little bit, but we're still not in where we want to be in the high single digit to low double digit, which long term we still believe we can be there, and when the economy turns around a little bit we think we will be there, but in order for that to run at that level we need for the reactive side of our business to be moving along strongly and we need for the more proactive services to be moving stronger and growing faster than they are now. At the time -- if we kind of predate the recent troubles that started at the end of 2008 when we had our growth in the double digits, at that time our feeling was that the more proactive work was growing faster than the more reactive work and we are just not in that mode today.

Thank you. Our next question is from the line of Rob Ammann with RK Capital. Please go ahead.

Yes, thank you. Given the FTE count at 611 and I think the expectation was closer to flat, would you expect the hiring in the second half to maybe have a little bit of a catch up there or do you just expect modest growth off of this level?

Yes, I think it's modest growth off of this level. I think that's where it is at this point in time, to be able to sort of maintain the performance and be able to do that. I don't see -- while I think that -- to be honest I mean we'll tell you we sort of have a backlog of accepted offers and that's at probably its highest level of the year and things of that type, I just think that we tend to not just get some big leap upward in anything we do. So I don't expect it to be -- I expect it to be a gradual growth over time versus something different.

Just to understand this a little better. If you had expected to be flat sequentially and then seeing growth off of that, that would put you at 621 this quarter if you had hit the target and going probably -- I don't know -- to the high 620, 630 or so.

Yes.

Is it that the demand environment has changed, or do you just think you can size it better to run higher utilization or an acceptance that you're willing to have higher attrition or maybe just a little more color there would be helpful.

Yes. I think a couple of things. We had a little -- and, again, we're talking single digit numbers probably -- but we had a little higher attrition in the quarter than maybe we thought coming in. Hiring might have been a couple people short of what we were thinking, just timing and things because as I say the backlog looks pretty good now, but not as much as we would have thought in the quarter. So those two combined maybe get you ten heads less or such. I think we were able to get the work done, obviously, that's with the improved utilization. I think on a going forward basis I think we're building off of the space. I think that will leave us, you know, probably high teens to low 20s at the end of the year would be what you would be expecting out of a gradual growth.

Okay, high teens.

Yes. High meaning if we're at 611 now, we're in 615 to 620 sort of range sort of being the fourth quarter FTEs or end of the year FTEs.

Got you. That's helpful. And then can I just get a breakdown between the two practice areas of revenues, billable hours, FTEs.

Yes. So on total gross revenues for the second quarter is -- on the gross revenue basis it was $44 million in the Other Scientific and Engineering and $16.4 million to $16.5 million in the Environmental. If you do that on a net revenue basis, that was $39.2 million to $39.3 million in the Other Scientific and Engineering and $15.9 million in the Environmental and Health. Did you ask for FTEs and billable hours?

Did yes.

Billable hours for the Other Engineering and Scientific were 161,000 and they were 65,000 for the Environmental and Health, and the FTEs for Other Scientific and Engineering were 436 and for Environmental and Health were 175 and the utilization was 71% in Other Engineering and Scientific and 72% in Environmental and Health.

Okay. Thank you.

Yes.

Management, I show there are no further questions at this time. Please continue with any closing remarks you may have.

That's okay. We can end the call.

Ladies and gentlemen, this concludes Exponent's second quarter 2010 earnings conference call. This conference will be available for replay after 3.30 PM Pacific Standard Time today through July 28, 2010, at Midnight Pacific Standard Time. You may access the replay system at any time by dialing 1-800-406 -7325 or 303 -590-3030 and entering the access code 4328776 followed by the pound. Thank you for your participation. You may now disconnect.