Exponent Inc (EXPO) 2012 Q2 法說會逐字稿

Welcome to the Exponent second quarter fiscal 2012 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) This conference is being recorded today Wednesday July 18, 2012. I would now like to turn the conference over to Matthew Hunt of Investor Relations. Please go ahead, sir.

Good afternoon, ladies and gentlemen, and thank you for joining us on today's conference call to discuss Exponent's second quarter 2012 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 of stock in Exponent's Form 10-Q for the quarter ended June 29, 2012. 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. 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 second quarter 2012 results. For the second quarter, net revenues increased 13% to $68.3 million, and total revenues were up 14% to $74.5 million. Net income grew by 26% to $10.3 million, or $0.72 per share, compared with $0.55 per share a year ago. We are pleased with our second-quarter performance, having produced double-digit revenue growth and increased profitability. We continued to benefit from the strong demand across a broad range of our services, both proactive and reactive. We experienced high utilization, as we continued to benefit from new work in key areas, as well as a few major projects. In the 60% of our business that is reactive in nature, we continued to see a steady flow of new retentions related to litigation, insurance claims, and product recalls from a diverse set of clients.

In the 30% of the business that is proactive in nature, we continued to see an increase in new assignments related to design consulting, regulatory consulting, and engineering management consulting. Our defense technology development business saw an increase in activity supporting the US Army's rapid equipping force, which was offset by the winding down of our current US ground penetrating radar development contract. In our environmental and health segment, we had notable contributions from our environmental sciences, ecological sciences, chemical registration and food safety, and exposure assessment practices. In our engineering and other scientific segment, we had notable performances among Mechanics and Materials, electrical, biomedical, vehicle, and engineering management consulting practices.

This broad-based demand for our services, in addition to the continuation of a few large projects, led to a strong utilization of 76% in the quarter, which along with a moderate growth in expenses and lower share count resulted in 31% growth in earnings per share. While only 6% of our revenues are generated from our international offices, we continued to see good demand. In the UK and EU we are seeing increased demand for our chemical and pesticide registration services. In China, business remains strong. Driven by our work addressing clients' quality control issues from their suppliers and contract manufacturers.

We are pleased with our performance to date, and are optimistic about our ability to weather a difficult economic environment. Since our project work, both in the US and internationally, is in areas that we believe are less sensitive to the economic slowdown. Thus us, we are increasing our full-year expectations. I will now turn the call over to Rich for a detailed discussion of our financial results.

Thanks, Paul. For the second quarter, total revenues increased 14% to $74.5 million from $65.1 million in the same period last year. Revenues before reimbursements, or net revenues, as I will refer to them from here on, increased 13% to $68.3 million in the quarter, as compared to $60.6 million in the prior-year period. Net income for the second quarter increased 26% to $10.3 million, or $0.72 per diluted share, as compared to a $8.2 million, or $0.55 per diluted share reported in the prior-year period. EBITDA in the second quarter increased 22% to $18.3 million as compared to $15 million in the same period last year. For the first half of 2012, total revenues increased 6% to $146.4 million. Net revenues increased 8% to $134.8 million. Net income for the first half of 2012 improved 14% to $18.5 million, or $1.29 per diluted share. EBITDA in the first half of the year improved 13% to be $33.1 million.

Overall, we are quite pleased with our financial performance for the second quarter, which together with the first quarter has set us up to have a good year in 2012, especially considering the high hurdle established in 2011. In the second quarter of 2012, net revenues from our Defense Technology Development business were $4.5 million, as compared to $2.8 million in the same quarter last year. Net revenues from product sales in the second quarter of 2012 were $188,000, as compared to $105,000 in the same period last year. We have recently been awarded a new contract for surveillance system product sales, and believe we are going to get a second contract soon. If we receive both contracts, we expect net revenues from product sales to be approximately $250,000 in the third quarter, and $1.25 million in the fourth quarter.

As Paul discussed, utilization in the second quarter was very strong at 76%, compared to 71% in the same quarter last year. This was driven by a 12% increase in billable hours, totaling $271,000. Based on scheduled holidays, vacations, our utilization will be lower sequentially in each of the third and fourth quarters. Additionally, we expect a step down in activity in some of our major assignments in the third and fourth quarters. Our average technical full time equivalent employees increased 5% to 685 from 652 in the same period last year. Headcount in the second quarter was flat on a sequential basis, but we currently have a number of recruits plan to start in the third quarter and expect sequential growth in FTEs of 1% to 1.5% per quarter for the remainder of the year. During the second quarter of 2012, we realized an average billing rate increase of approximately 2.5% over the prior year.

The percentages I will reference hereafter are on a percentage of net revenue basis. EBITDA margin for the second quarter improved 210 basis points to 26.8% from 24.7% in the same period last year as a result of strong utilization, and leveraging our infrastructure. For the second quarter, compensation expense after adjusting for gains and losses and deferred comp increased 8% to $41.9 million. This increase is the result of a 5% increase in headcount, accrued bonus due to higher profits, and annual compensation increases which took effect in April.

Included in total compensation in the second quarter is a loss in deferred compensation of $530,000, as compared to a $220,000 gain in the same quarter last year. As a reminder, deferred compensation gains and losses are offset in miscellaneous income, and have no impact on the bottom line. As a component of compensation, stock-based compensation expense for the second quarter increased to $2.7 million, compared to $2.1 million in the same period last year. This increase is related to the accrual of the stock portion of the bonus program. In 2012, we expect stock-based compensation to be approximately $12 million to $12.5 million for the full-year.

Other operating expenses for the second quarter increased 4% over the prior year to $6 million. As a component of other operating expense, depreciation was $1.2 million. For the remainder of the year, we expect other operating expenses to be in the range of $6 million to $6.5 million per quarter. G&A expenses in the second quarter increased 5% over the prior year to $3.1 million. We expect G&A expenses to be approximately $3.4 million in the third quarter and $3.8 million in the fourth quarter. This increased level of expenditure is related to our managers meetings scheduled for the end of the third quarter.

Interest income in the second quarter was $88,000. Our tax rate for the second quarter of 2012 was 40.1%, about flat compared to the same period last year. For 2012, we expect our tax rate to remain approximately 4.2%(sic). Turning to the balance sheet, cash, cash equivalents and short-term investments increased sequentially to $109 million. During the second quarter, we generated $20.8 million in cash from operations, and repurchased $14.4 million of common stock, bringing our year-to-date repurchases to $18.5 million. We still have approximately $26 million available for stock repurchase under our current authorization.

Capital expenditures for the second quarter were $650,000. DSOs were 91 days at the end of the quarter. So for the full-year 2012, we are increasing our outlook for growth and revenues before reimbursements to be in the middle single digits, and expect full-year EBITDA margins to be approximately flat over the prior year. This outlook reflects the strong utilization during the first half of the year, our expectation that a few major projects will step down in their level of activity in the next several quarters, and lower defense technology development product sales as compared to last year. Now, I will turn the call back to Paul for his concluding remarks.

Thank you, Rich. In summary, we are pleased to have delivered a strong second quarter of 2012. As we look ahead, we will continue to provide the expertise and experience to address our clients' important technology, health, and environmental questions. We will manage operating expenses and utilization to provide the foundation for continued growth in revenues and earnings. We will selectively add new talent to allow us to continue to expand our capabilities and strengthen our offerings. And finally, will generate cash from operations, maintain a strong balance sheet, and undertake activities such as repurchasing shares to enhance shareholder value. In summary, we remain optimistic that we can continue to drive growth in our business and leveraging our multi-disciplinary capability and expertise to capitalize on new market opportunities. Now, I will turn the call over to the operator for your questions.

Thank you, sir. (Operator Instructions) Matt Hill with William Blair & Company.

Hi. This is Matt Hill in for Tim McHugh today. I had a couple questions. Given the strong results you saw this quarter, specifically in regard to large cases winding down, it sounds like they're not rolling off as fast as you initially expected. I was wondering if you still expect the same amount of roll-off in the future, or if you think it's going to push a little bit longer now.

I think its fair to say that they have continued at a stronger level for longer than we had maybe originally thought. We expect -- the project lifecycle is such that they will step down here, it really is just a matter of the timing. As we look back on the last quarter, we actually began to see two of our larger projects step down in certain aspects of the activities that we are engaged with there. And we expect them to continue to do so over the next several quarters. It also turned out that one of our projects that is a large project actually stepped up in activity during the quarter, which masks what was happening with the other two. We still believe they're going to step down as Rich has discribed over the next several quarters.

Okay. And then in regard to recent hires, can you talk about how, over the past year, the heads you have added, how they are ramping up? And also, given your expectations for sequential headcount growth, what the current recruiting environment for the consultants looks like?

Let me talk about the recruiting environment, and Rich can add some data for you. From our perspective, the recruiting environment, we always break into two pieces. One is the more entry-level or junior staff, and at our firm, that's often typically a PhD level person coming out of a top school. That's where we recruit our entry-level people. And while the economic environment has made recruiting on college campuses in general a little easier, it hasn't really changed much for us. The top candidates we are looking for always have multiple offers, so it is still a competitive field. However, I don't think in terms of getting entry-level staff, we are restricted by supply per se. With regard to the more senior staff that we recruit, finding people who will fit in well to the firm, often having a book of business and so forth is always difficult in good times and in tough economic times because they control their own destiny. And that just continues to be a hard thing to do.

Related to the integration of staff and what we have seen around the ramp up there, again, breaking them off into these two buckets that Paul has mentioned here, clearly the ability to integrate staff at the more entry-level is made easier when the utilization of the firm is higher actually. There is more work to be done, and the demand levels on others is high. So the ability for people to naturally spin off work to others comes much easier in that environment. So, I would say that, from that standpoint, that has gone quite well over the last year.

At the more senior level, I think we continue to see the same level of timing around integration. It varies from consulting staff, who have been consultants in a prior life, where they have some clients that they have worked for. Those clients want to work with them in the future, and so when staff joins a different firm, you tend to find that those clients find them wherever they land on their feet. As such, their ramp up time is measured probably over a few months in time frame as they begin to ramp up, whereas staff that you hire either out of government, or academia, or industry, while over the long-term they may become a very successful consultant, the ramp up time is gradual, probably, over a period of a year that they are gradually building up into that and establishing themselves in the marketplace. I think we really haven't seen a change in that, that is just more natural behavior.

Okay, and if I can get in one more, I think in your prepared remarks, there was a comment about the macroeconomic environment wasn't having quite the impact you thought it was. Is this just a change in your clients' attitude with regards to proactive projects?

I think it is more a reflection on the nature of our business. We have consistently seen that our business seems to be quite resilient in tough economic times. We can reflect back, obviously, going through the end of 2008 and 2009, when our business held together very well. I think it's more a reflection of the kind of work we do on the reactive side, and the kinds of clients, and the specialty nature of our services on the proactive side. Clearly, in tough economic times, clients are maybe more cost sensitive, but the demand for our services, we have historically seen, and we believe we are continuing to see, remains good.

Okay, thank you.

Joseph Foresi with Janney Montgomery Scott.

Good afternoon, this is Jeff Rossetti in for Joe. Thanks for taking my question. Congratulations on the results. Paul, I just wanted to see if I could get a little more detail. I know you're just talking about proactive, but it seems like it may have grown at a faster pace than the reactive portion. Could you give a little bit more detail on what was maybe driving those design consulting, regulatory consulting, and engineering management consulting engagements you referred to?

Sure. I think on the design consulting side, we are seeing very strong demand in the consumer electronics area. We are seeing growing demand in the medical device area. So those areas are definitely very strong or hot right now. I think from the regulatory standpoint, the work we do in our chemical registration and food safety practice, in terms of registering new products and so forth, that continues to be very strong. It's those kinds of projects that I think have really made the proactive work come through so well for us.

Jeff, I would just add that I think on both of those areas, it's very broad-based, a lot of different projects, and quite diverse in the disciplines that it is drawing upon.

Okay. And just on the defense side. Rich, you said maybe you were anticipating a decision on two contracts within the next few months, is that correct?

This is just related to the product sales of the surveillance systems that we have sold before. One of them we already have in hand, just in the last day or two, and the other we would expect probably even in the next few weeks, and as such, those are built into the estimates that provided relative to the product sales parts.

Okay, great. And final question, just on the balance sheet, it looks stronger. Any plans outside of the share repurchase program that you talked about for uses of cash? Thanks.

Yes. I think we have expressed previously that on the two other real uses here, one is on acquisitions, that we continue to have a primary growth of organic growth, but we believe that, and continue to look for the opportunity for some key seed acquisitions in important areas for us to expand in, in particular in the computer science and software consulting area, and in the pharmaceutical consulting area, in particular. While we haven't found the right match in those areas, in the meantime we will continue to do recruiting in those areas, and try to build it out as we have done with some others over the last decade. Over time, we will do something, because otherwise we shouldn't be spending our time looking. I don't expect that to be anything major, but it will make a major difference on a long run.

We have also indicated to the market that we -- earlier in the year, late last year had discussions with our Board about our dividends. The conclusion from those discussions was that we should wait until out into 2013, when we see what has happened with the tax regulations after the election. It is clearly an option out there, it is something we will revisit when there is better clarity about where the tax regulations are going.

Thank you.

Tobey Sommer with SunTrust.

Thank you very much. Rich, I was wondering if you could give us a breakdown of revenue by segment.

Yes. Revenues before reimbursements, or net revenues, were for the second quarter in other engineering and scientific, it was $48.3 million, and for the environmental and health segment, it was $20 million.

Okay, thanks.

And on a gross revenue, GAAP revenue basis, engineering and scientific was $54 million, and the environmental and health was $20.5 million.

Okay, thank you. In terms of the medium-term outlook for the defense business, you've got some visibility into the surveillance system sales, this quarter next. But with a potential wind down of operations in Afghanistan, and at least for now, not another theater emerging, do you anticipate that over the next couple of years that your sales in that area to diminish?

Yes. I will break it down into -- I think this is an important topic, even though it's 6% or 7% of our business, I think it's good to talk about here. First of all, in response around the product sale, let's call it the surveillance system product sales, I would -- based on the numbers that I just gave for the third and fourth quarter, that will put us somewhere around $2.5 million, maybe we will have a little but more come in, maybe we'll be $2.5 million to $3 million in net revenues from product sales this year. That will end up being down from the $4.2 million that we did last year. It is our expectation that over the next couple of years, during the wind down in Afghanistan, that we will continue to get some sales, but it would probably diminish some in that area. So we are in -- I think that's what you should expect around the surveillance system product sales.

There may be other things that we do, as I talk here about how our activities have been picking up with the rapid equipping force, that has been an area that has generated new product requirements that the Army has, and as such could generate other opportunities. But we don't have that identified at this point in time. What we have been seeing happen is that we were brought back in last year fourth quarter for the rapid equipping force. That work has been gradually picking up over the last three quarters. And now, not only are we supporting two fixed labs in Afghanistan, but we have just begun supporting the rapid equipping force's first mobile lab.

This is a concept that we developed with them, and that I think both they and we think is very strategic for the longer-term. The idea between these mobile labs is that they can be dropped wherever the Army wants them to be. And the strategy for the rapid equipping force going forward is that they will follow the Army as requirements come upon, including out on humanitarian missions and other development missions that come out over the next several years. They're in the process of moving forward with a couple more of these labs, and as such, we hope that we are able to play a role with them, not only in Afghanistan, but longer-term. Nothing is guaranteed there.

Obviously, defense spending, where demands are, there isn't really a lot of activity, then there will be less for us to do there. At least over the next year or two, we hope that we have moved back into a strong role with the rapid equipping force. And only time will tell much they are needed. But as of right now, our work has been picking up with them over in Afghanistan.

As it ties into our US PPR program, we are winding down or completing our recent development contract there that we have been working on for the last three quarters. We have a little bit more to do in the third quarter, and then that contract will be complete. We are looking at what other opportunities are out there in the future. But we don't have the next follow-on contract, nor have we put in a proposal on the next follow-on contract there. The Army is looking at doing a larger procurement around ground penetrating radar. They have an existing contract with Niitek in that area. And if that comes out -- and when it comes out, we will evaluate if we think we should compete for that or not. In addition to that, our guys will continue to pursue additional development contracts with the Army or other parts of the Department of Defense around ground penetrating radar.

Lastly, we have activity related to the administrative defense for the UK. That work actually has picked up recently, as we are doing an uplift for the technology we delivered last year that we are doing some new technology development in insertions for them. That work will come here mainly in the third quarter, a little bit into the fourth, but we are planning on continuing to do a sustained level of support for them that we were back in the first of second quarters, as we look out over the next year or two.

Beyond that, our feeling is that the expertise that we have developed in ground penetrating radar is important for the long-term. IDs are going to be a challenge for the US, the UK, and other nations, allied nations out there, regardless of the environment they are in. That's just part of what they have to deal with today. So hopefully we can continue to offer our expertise in this area long-term, and we look at it as an area that should continue to get funding in one way or another, regardless of the cuts that come down in defense. But when we get those dollars from somebody else, that we'll have to be determined by the clients.

Thank you very much. I had another question about your proactive services. I am just wondering, in your perspective, you've had good progress there, increasing traction. And I'm just wondering if you have noticed, or have an opinion that your customers may not have the capabilities resident inside their firms to deal with the matters at hand, and if there is something kind of structural changing there, where they are increasingly more reliant on a firm like Exponent for their product development.

I think there are a number of things at play here. And there is certainly no question that most of our clients, or basically our clients in general, don't have the range of capability that we have. Their capability is more focused in certain areas, and when they run into problems that fall outside their area, they clearly need to go outside. But I think that a significant reason for the gains we are seeing on the proactive side do relate to the concern that clients have over putting projects in the marketplace that end up needing to be recalled or taken back in some way. It's not just a costly activity, it's a very significant issue for their reputation. And so I think some of the best names in the business want to spend a little bit more up front to make sure they really have the best product, and so we find that there's just a very good flow business. As a result of that, while we have been growing as a firm, this part of our business has been growing faster than the firm as a whole.

Last question. Rich, do have an expectation for what share repurchase is going to look like for the year as a whole?

We continue to be of a mind that we would like to be able to buy back in the $40 million to $50 million range. As we've discussed before, we buy more when there is some pullback in the stock, and a little bit less on the -- as it advances. And sometimes you get caught where you have a 10b5-1 plan in or something, and it moves beyond even the price you have. But our current feeling is that we would like to be in that $40 million to $50 million range if the circumstances allow us to be there.

How does that $40 million or $50 million compare to your cash flow expectations in '12?

At the low end of that, it is probably in line. At the high end of that range, it will allow us to bring down the cash balance slightly.

Thank you very much.

(Operator Instructions) David Gold with Sidoti & Company.

Good afternoon.

Good afternoon, David.

Just a couple of questions for you. First on the utilization at 76%. Aside from I guess the natural seasonality we will see the next couple of quarters, what is the thinking there as to the sustainability in the mid-70s?

Yes. Naturally, just out of the fact that, vacations and holidays, we would expect a 76% in the second quarter would look like 73%, somewhere in the 73% range in the third quarter, and approach 69%, 70% in the fourth quarter. So that is without taking into any account any step down in the level of activity relative to the larger project. So I think we will see the impact by a percent or two from a stepdown in level of activity. I think that provides a range for each of the next couple of quarters. I think I will leave us for the full year still above our full-year performance of last year. But we will definitely be stepping back from our level right now.

I mean, long-term, I think when you look at what 76% in the second quarter looks like, we have always said long-term, as we build out the critical mass in practices and in offices, we expect that our utilization over the long-term could grow into that 73%, 74%, 75% for the full year, and that would leave you at a 75%, 76% UT in the second quarter. But we are clearly getting some of the benefit right now from a few of the larger projects, and hopefully over the long term, we can build that out across the business and be able to perform at this level on a regular basis.

Got you. Okay. And then Rich, if you can speak a little bit about the changing guidance. I'm looking at it from a couple of different angles. One, obviously you have stepped it up to the higher side of the range. We saw some good strength, certainly, as we came through the second quarter and the first half. At the same time, maybe we do have some run-off from those projects, the larger projects. I guess broadly speaking though, it suggests -- granted, you get some seasonality, it suggests a little bit of slowdown in the second half of the year, versus the first half, say. Is that entirely seasonal? Is it -- the runoff probably does start to affect us? Is it both, or has something else happened?

Look, I think when you start looking at year over year, the seasonality is somewhat taken out of it. But I think the fact is that we expect that the growth on a year-over-year basis in the second half of the year is going to be below, obviously, the 8% net revenue growth that we have to date for the first half of the year. The reason for that is, basically, we think that a lot of this core activity is going to continue to be strong. But we think that, one, the high hurdle that we created last year, where utilization went up from the Q2 to Q3, and we saw high utilization in the fourth quarter, those levels are more like the level we just performed at in the second quarter, relatively. Adjusted for seasonality. Our expectation is that we are going to see a step down in that level relative to some of the larger projects, and the fact that that is going on.

It is just a matter of saying, high hurdle last year, utilization already last year for the third quarter was 72%. I think that's a very good utilization. I just said 76% would be a 73%. We would have to literally hold at where we were to beat that out on a UT basis, and I said we probably have come down a percentage point or two. If we are down in the 71%, 72% range, and you got a headcount growth in the mid single digits, you're looking at something that puts you in that range there, that's growing year over year in the middle single-digits for both the third and fourth quarters. And that's why I think you see a little drawdown on the 8%. Our general feeling is, we weren't going to do better in the second half than we did in the first half, and as such, we couldn't really come out and say, we are going to be in the mid to high single digits, because that would draw us up above that number. At least at this point in time, we don't see that happening.

And one last one if I can. A couple of new contracts that you had referenced, that seem to ramp up for fourth quarter versus third. Can you give a sense for how the entire value of the contracts and the terms of them? I presume not just for the third and fourth quarter only.

They primarily will be for the third and fourth quarter, there's a little bit of that that will roll out probably to the first quarter, but it is primarily a third and fourth quarter -- it might end up being the same amount that we are seeing in the third quarter out into the first quarter.

I see. Okay. And just one more, I said that was my last but it won't be. On the buyback, can you give a sense for average -- number of shares or average share prices?

We repurchased 302,000 shares during the quarter for an average price of $47.75.

Perfect. That's all I have, thank you both.

Okay, thank you.

Thank you. There are no further questions at this time. Ladies and gentlemen, this does conclude the Exponent second-quarter fiscal 2012 earnings conference call. If you would like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030 and enter the access code of 4551395. Thank you for your participation. You may now disconnect.