Exponent Inc (EXPO) 2012 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Exponent third-quarter fiscal 2012 earnings conference call. During today's presentation, all parties will be in a listen-only mode, and following the presentation, the conference will be open for questions.

(Operator Instructions)

This conference is being recorded today, October 17, 2012. I would now like the conference turn the conference over to Matthew Hunt with Blueshirt Group, investor relations for Exponent. Please go ahead.

Thank you, and good afternoon, ladies and gentlemen. Thank you for joining us on today's conference call to discuss Exponent's third-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 Richard 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 September 28, 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. And now, I'd like to turn the call over to Paul Johnston, President and Chief Executive Officer of Exponent. Paul, please go ahead.

Thank you for joining us today for our discussion of Exponent's third-quarter 2012 results. For the third quarter, total revenues were up 11% to $73.3 million, and net revenues increased 9% to $66.7 million. Net income grew by 17% to $10.2 million, or $0.72 per share, compared with $0.60 per share in the same period a year ago. We again delivered strong revenue growth and profitability in the third quarter and are pleased with our performance. Demand in our proactive and reactive businesses was strong, and activity levels on a few major projects remained high. As a result, utilization was 74%, which is an increase over the same period last year. We also grew our consulting staff by 5% over the past 12 months.

In the 60% of our business that is reactive in nature, we continue to support a steady flow of business related to litigation, insurance claims, and product recalls from a diverse set of clients, with significant assignments in the chemical, energy, and automotive sectors. In the 30% of the business that is proactive in nature, we assisted clients such as consumer electronics and medical device manufacturers in their design and manufacturing efforts. In our Environmental and Health segment, we had notable contributions from our environmental sciences, ecological sciences, and chemical registration and food safety practices. In our Engineering and Other Scientific segment, we had notable performances from our mechanics and materials, electrical, thermal, human factors, and engineering management consulting practices. Additionally, despite some expected surveillance system product sales pushing into the fourth quarter, Defense Technology Development also made a meaningful contribution from several projects related to the detection of improvised explosive devices.

In summary, we are pleased with our performance year-to-date, which positions Exponent for a strong 2012. As a result, we are increasing our full-year expectations for net revenue and EBITDA margin growth. We are encouraged about the business opportunities ahead and believe our unique scientific and engineering capabilities make us well-positioned to capitalize on them. I'll now turn the call over to Rich for a detailed discussion of our financial results.

Thanks, Paul. For the third quarter, total revenues increased 11% to $73.3 million, from $66 million in 2011. Revenues before reimbursements, or net revenues as I will refer to them from here on, increased 9% to $66.7 million in the quarter, as compared to $61.4 million in the prior-year period. Net income for the third quarter increased 17% to $10.2 million, or $0.72 per diluted share, as compared to $8.7 million, or $0.60 per diluted share, in the prior-year period. EBITDA in the third quarter increased 13% to $17.4 million, as compared to $15.4 million in the same period last year.

For the first nine months of 2012, total revenues increased 7% to $219.7 million. Net revenues increased 8% to $201.5 million. Net income for the first nine months of 2012 improved 15% to $28.8 million, or $2.01 per diluted share. EBITDA in the first nine months of the year improved 13% to $50.5 million. Overall, we are pleased with our third-quarter and year-to-date performance. This performance sets up for a strong 2012, which is especially noteworthy considering the high hurdle we established in 2011.

Turning back to the details of our third-quarter performance, net revenues from our Defense Technology Development business were $4.4 million, as compared to $3.6 million in the same quarter last year. We saw an increase in activities from our UK Ground Penetrating Radar program while we worked on completing the current round of development of the US GPR. Additionally, we continued to support the Rapid Equipping Force's new mobile labs in Afghanistan.

Net revenues from product sales in the third quarter of 2012 were $48,000, as compared to $253,000 in the same period last year. We now expect net revenues from product sales to be approximately $2 million in the fourth quarter. We have secured both of the surveillance system product contracts we discussed last quarter. As Paul discussed, utilization in the third quarter was strong at 74%, as compared to 72% in the same quarter last year. This was driven by a 7% increase in billable hours, totaling 267,000. We expect our utilization in the fourth quarter to step down to 68% to 70%, as there are more holidays and vacations in the period, as well as the impact of a gradual step-down in some major assignments.

Growth in FTEs was 4.5% to 694 from 664 in the same period last year. We expect FTEs to grow 1% to 1.5% sequentially in the fourth quarter. During the third quarter of 2012, we realized an average billing rate increase of approximately 2.5% over the prior-year period. We expect to realize a billing rate increase of about the same for the full year.

The percentages I will reference hereafter are on a percentage of net revenue basis. EBITDA margin for the third quarter improved 90 basis points to 26.1%, from 25.2% in the same period last year, as a result of strong utilization. For the third quarter, compensation expense, after adjusting for gains and losses in deferred compensation, increased 8% to $42.6 million, as compared to $36.1 million last year. This increase is the result of headcount growth and annual compensation increases, which took effect in April. Included in total compensation in the third quarter is a gain in deferred compensation of $1.1 million, as compared to a loss of $2.5 million in the same quarter last year. As a reminder, deferred compensation gains and losses are offset in miscellaneous income and therefore have no effect on the bottom line. As a component of compensation, stock-based compensation expense for the third quarter increased to $2.7 million, as compared to $2.3 million in the same period a year ago. For the full year, we expect stock-based compensation to be approximately $12.5 million.

Other operating expenses for the third quarter were about flat with the prior year at $5.9 million. As a component of other operating expense, depreciation was $1.1 million. We expect other operating expenses to be in the range of $6 million to $6.5 million in the fourth quarter. G&A expenses in the third quarter increased to $3.5 million from $3 million a year ago. This increase was the result of a firm-wide managers' meeting that was held at the end of the third quarter of 2012. We expect G&A expenses in the fourth quarter to be $3.8 million to $4 million. Interest income in the third quarter was $80,000. Our tax rate for the third quarter of 2012 was 37.4%, down from 39.3% in the same period last year due to a nonrecurring benefit of about $420,000. For 2012, we now expect our tax rate to be approximately 39.3%. As we look forward to 2013, we estimate our tax rate to be at 40.3%.

Turning to the balance sheet, cash, cash equivalents, and short-term investments increased slightly over the prior quarter to $110 million. During the quarter, we repurchased about $1 million of common stock, bringing our year-to-date total to $19.4 million. We still have $25 million available under our current authorization for stock repurchases. Capital expenditures for the third quarter were $1.5 million. This was higher in the quarter because we had a couple of tenant improvement projects that we were paying for. DSOs were 103 days at the end of the quarter. This is higher than usual due to a couple of Defense Technology Development contracts that were structured to bill near the completion of the project and as a result, remain outstanding at the close of the quarter. Given our strong year-to-date performance, we are again increasing our fiscal-year 2012 outlook. We now expect growth and revenues before reimbursement to be in the high single digits and full-year EBITDA margin to increase between 80 and 100 basis points over the prior year. Our growth expectations are particularly significant given the strong 2011 comparable. Now I will turn the call back to Paul for concluding remarks.

Thank you, Rich. In summary, we are pleased to have again delivered strong results in the third quarter of 2012. As we look forward, we will continue to provide the expertise and experience to address our clients' important technology, health, and environmental questions. We will selectively add new talent to allow us to continue to expand our capabilities and strengthen our offerings. We will manage operating expenses and utilization to provide the foundation for continued growth in revenues and earnings. And finally, we will generate cash from operations, maintain the strong balance sheet, and undertake activities such as repurchasing shares to enhance shareholder value. Exponent is well-positioned to deliver long-term organic growth and profitability, which in turn will create more value for shareholders. 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)

Tim McHugh, William Blair.

Yes, thank you. First, I want to ask about the utilization that you're able to sustain. Can you give us a little more color? I think usually you see somewhat of a seasonal impact during the third quarter from summer vacations and so on. Is it fair to say you just didn't see that normal-type activity because demand was so strong? Any more color on that?

Yes, Tim, I think you've pretty accurately presented that. The fact is we do have -- see a normal step-down in utilization by a couple percentage points as we go into the summer. We continued to see strong demand as we went through the quarter, and it was pretty broadly based. While we continued to see strong activity in several major projects, we also continued to see a good flow of new projects during the quarter as well. So, things -- utilization stayed strong, while people were still taking pretty much a normal level of vacations and holidays.

And on those large projects, is there any more visibility in terms of the risk of them winding down? I know it's something you've been careful about all year, but you just haven't seen it yet. Is there any more visibility in terms of when that -- those will slow down, or is it still hard to tell?

I'll make first comment, and Paul may have some additional. I think clearly we've been involved in a number of these issues over a few years. We're clearly at a point that we're seeing that our clients are either -- if it's a litigation matter, those litigation activities are occurring if they're depositions or other moving through the litigation process. So that is moving along. If it is more of a regulatory matter, or also includes that, we're clearly seeing that the regulatory hearings are happening, or interchanges between the parties are occurring. So I would say that we are seeing progress along the project lifecycle.

Tim, I would say that it's a couple of things. One, in this particular quarter, the larger projects were very strong. Some of the earlier signs of cutting back a little bit didn't materialize at all at this time, and it continued very, very strong. But the reality is that there are more and more dates that are on the calendar when trials are starting and things like that. There are efforts with regard to settlement on some parts of them -- parts of these cases. So we know for sure these things can't go on forever, and we're obviously closer to the end than we were before.

As we think about 2013, and I know it's a little early for you usually to give guidance. But is the larger-than-normal contribution from the cases -- still, is it a couple percentage points the right way to think about that as we go into next year?

You're right in the sense that Exponent has a pretty regular process to planning for the following year in the sense that we work with all of our practice leaders during the fourth quarter and spend time with them putting together plans for the following year. And we're just at the beginning of that process now, so we don't have the outcome from that. But I think responding to your question about the larger projects, I do think that -- look, we've got three or four of these on the commercial side.

We've also got the larger project for the US in the federal government side where we -- these projects are running, especially on the commercial side, a couple of percent larger than what we've seen large projects run in the past. And as such, that headwind that we see going into 2013 is probably something like 4% to 6%. It's a couple of percent per engagement there that, until we prove out this over the long term that we're going to get engagements that are of this size consistently, we continue to rely on the path engaging that really we ought to expect the replacement type of projects to be more or less call it a 2%, 3% than a 4%, 5% size engagement. We view this [at] headwind that we have is probably in that 4% to 6% relative to these commercial engagements.

But it sounds like at least for this past quarter, were they actually up a little, or -- ?

No, I would say when we looked at Q2 to Q3, they were pretty flat with that in essence as we look at that. A few of them were, as we had mentioned, the second quarter was strong when we had that. We had seen some pick-up in a few of them, and that sustained through the third quarter. I think as Paul has indicated, a number of these are working towards some definite dates. They may last for quite a while, and we do think it will be hopefully a gradual step down. We view that the headwind ahead of us is strong, but the underlying business is strong as well. We're just going to have to -- we've been talking about it for a long time. We're just going to have to work hard to bring in other engagements and deal with it as it comes on.

Okay, great. Thank you.

Joseph Foresi, Janney Montgomery Scott.

Hi, guys. My question here first is it seems like by the tone of the earlier part of the call that -- are you seeing a pick-up in the demand environment on both sides of the business? And has there been a change in the decision making on that front? Maybe you could just provide some color, because it seems like both parts of the business, both reactive and proactive, seem to be running pretty well.

Joe, I think that's correct. They are running pretty well. We have a good flow of new projects coming in on the proactive side. Certainly, the depth and breadth of them continues to be very strong. Bigger assignments from -- not the same as we were talking about some of the reactive cases, but assignments seem to be getting bigger. Stronger relationships with a number of clients. So certainly do think that the proactive side is definitely building in spite of where the economy is. We're in a fortunate position that most of the clients that were serving on that side are clients that are actually performing very well, even in this economy. (multiple speakers) Go ahead, Rich.

Joe, one comment on that I would say is these are clients who are faced with either a strong regulatory environment demand that is pressing them to really get it right the first time, or if they don't, they'll need our help as well there. But we really are seeing that. And it's clients that are -- a lot of the focus is around the design. And then there is offshore manufacturing that goes on that we're able to help them in getting better reliability out of those things. I think those are two big drivers that we're seeing from clients on the proactive side.

Okay. If you could just characterize it, are you seeing some pent-up demand? Are you seeing a return to normal steady state? Or are you seeing even an increase in demand because of some of the regulatory stuff that you were talking about, Rich?

I think on the proactive side, I think it is getting stronger. Remember, I think we've talked in the past about how over time, we see the proactive side of our business growing faster than the reactive side. And I think that's part of what we're seeing here. We're seeing more new growth in those areas, which is very consistent with what we expect to be the long-term direction of the company.

Okay. On 2013, I know -- I'm not asking for guidance, but is it -- the Company in the past has talked about a desire to expand margins and to continue to push to move that utilization rate higher. How should we think about those longer-term goals in the face of that 4% to 6% headwind that you were talking about from the larger contracts?

I think that when we think longer term, as a steady state out in the, let's call it the three to five years, I think that this is a firm that can run in the mid-70%s here. This year will probably be whatever, 72%, 73% overall, and I think that as we see good performance from bigger groups. On the other hand, as we've indicated before, I think as we see a step-down in the level of revenues from some of these larger assignments, we would expect that in the short term, we would see a step-down in utilization by a couple of percentage points. Clearly, in the short term, that will have some potential impact to margins. I think fundamentally, what we're proving out is that our larger groups where we've got more critical mass, as we build the ability to offer more disciplines to clients on each initiative, we're able to effectively get a higher utilization. I think the short-term expectations, as we look out into 2013, or more importantly, as these projects begin to step down, we may see utilization step down a couple of percentage points, which, in the short term, will mean we have to grow through that.

Okay. One last question from me on the products business. It seems like it's coming in a little stronger than what we expected for the fourth quarter. Could you give us an update on what the pipeline looks in that business heading into 2013? And thank you.

At this point, we have no additional orders that would -- first, surveillance systems, this is really what it's related to. These have all gone in the past into Iraq originally and then into Afghanistan. There are surveillance systems allow them to deploy efficiently, systems in forward operating bases and places like that, where the more traditional heavy systems were more cumbersome to set up. We've had a consistent -- we didn't know what quarter they'd come in and such. But when you look back over the last couple years, it's been pretty consistent.

This year will be a little bit lower. I think we did about $4.4 million of -- $4.3 million of net revenue from product sales in 2011. This year, we'll probably be in the low $3 millions from this. But next year, we'll have to see. We don't have a read right now on what the needs will be. Clearly there's, I would say, going to be downward pressure against this as the US begins to pull out of Afghanistan over time. So this is an area that we've got our defense technology development team trying to get some better intelligence on, but I think we've seen some downward pressure as far as step-down in revenues this year. And it would -- it may be further again when we look to 2013.

Okay. Thank you.

Tobey Sommer, SunTrust Robinson Humphrey.

Thank you very much. Just a housekeeping question that I'll ask and then get in a little more substantial stuff. Do you have a segment revenue detail?

Yes. So total revenue numbers?

Sure.

So for the quarter, that is for Other Scientific and Engineering, it's $53.1 million. And for Environmental and Health, it is $20.3 million -- or $20.2 million.

Thanks. And I wanted to ask a question on the business that may be driven by government investigations and so forth. Are you seeing much in the way of a pause at all when it comes to government-driven business? I don't mean government as your end customer. I mean government as the catalyst for a private corporation engaging you.

My comments here don't refer to technology development. That's obviously a different business, where we get money directly from government agencies to do certain work.

Sure.

But if we look at the parts of our business that are driven by regulatory matters, for the kinds of things that we're involved in, I don't really see a pause. I think a lot of the regulations take a long time to get into place and reside for a long time. The kinds of things that we're dealing with there I don't think anybody waiting for next year or election results or something like that, just on the nature of the kind of evaluation of chemicals and things like that that we do through that process.

Thanks. That's helpful.

Tobey, I would say because they're more health and safety driven, they tend to again, like a lot of our business, not quite have as much of the cyclical nature to them.

Right.

If you're going to get a medical device through or a drug through and you're developing it, you got to still deal with it. If you had an explosion at a plant, then you've got to deal with the regulatory side. If you -- if there's been regulations in for many years for a matter, well then it's ongoing, and it's not stepping back.

I wanted to ask a question about your headcount growth, which at a touch under 5% even is pretty good. Where do you -- is that the sweet spot for the rate of growth of consultants, or do you feel that you could sustain a higher level of growth over a period of time?

I think that our view is that we would like to see that number higher. I think that we've been in a mode here over the last couple of years where -- last few years where we felt that we were running the company with utilization levels that were lower than we should be running the company with. And so some of our growth got channeled into higher utilization, and some got channeled into increasing headcount. I think with the gains on utilization that we've made, that the ratio of how much of the new revenue will go into, as it were, new headcount versus further increases in utilization will tilt more toward more headcount. We would like to see that 5% move. It's always going to vary some, but we'd like to see if we could move that up some.

I understand. So to achieve the same growth in EBITDA and EPS, given the potential pressures on utilization, the headcount engine is an area that you are looking to expand?

Yes, I think that as Paul said, if you're going to grow the billable headcount or the billability there, then we're going to have to add the headcount in the let's call it the 5% to 8% range instead of the 4% to 5% range.

Right. Could you comment about supply and the competitive market for talent, particularly new graduates? Are you able to attract talent more easily, or is the market as competitive as it has been recently?

I think for us, it hasn't changed that much. Certainly, there are a lot of people coming out of school that give you a lot of choice from that standpoint. But our experience has been the people we recruit out of school are mostly Ph.D.-level people. They're mostly from top schools. The people that we make offers to invariably have multiple offers. Do we feel like we can get our share? Yes, we do. We're not -- we don't feel like we're blocked from growth by not going able to find people. But the market is competitive for the top talent, and it continues to be very much that way.

When you look at the other end of recruiting and you look at the more experienced people, people who might join the firm for the transfer in from other places that are established consultants, those individuals are always difficult to find, and very difficult to predict when you will be successful in attracting a few more principals versus when you're not. It's just a matter of staying connected to people and capitalizing on opportunities when they appear. But it's difficult to set out a program and know exactly how many of those kinds of people you can recruit, whereas at the university level, you can say, okay, we want to recruit this many, and we can. It's just that the people we're getting, it's top talent, and they're going to be priced like top talent, but we're happy with the share we're getting.

Thank you. Last question from me. Do you have an expectation for free cash flow this year?

I think that -- we're expecting here, but if we can get these [teched-out] projects billed and collected in the year, get that -- if that comes back to a more normalized level, which it's going to be closest to if we get paid in December or January on those. That's why I'm hedging little bit here. But if we do, I think that this will return -- we'll be able to be in the mid-$30 millions here.

Thank you very much.

Thank you.

(Operator Instructions)

David Gold, Sidoti.

Hi, good afternoon. Couple things. One, Rich, picking up on the free cash flow question, one area that you spoke about, or have been active throughout the year using that, has been repurchases. Third quarter a little slower. So was curious there if you can give insight on how you're thinking about that on go-forward?

What we did was we had an active program. We had put in a 10b5-1 trading plan, and the price moved through that in the quarter there. We weren't -- we didn't end up buying as much as we would have expected during the quarter, because when we had the purchase plan in place, it had -- it then moved up. The price moved up pretty well. We continue to think that -- I can't predict from quarter to quarter, but what I would say is that it's still our philosophy that if you look out over the next 12 months, we would expect to buy back $40 million to $50 million in stock. We're going to be a little above or below that from time to time, sure. But that right now is there. As we've said, in addition to that, hopefully we can get more clarity to the tax situation as we move into 2013. And as we do that, we will also look to evaluate if we should put in place a dividend program, but we are waiting to see if there can become some more clarity around taxation on dividends and capital gains.

Perfect. And then one of the things, since we're all trying to get some clarity on -- sounds like you guys as well -- basically, it's just real difficult to time the run-off on some of the larger projects. Could you give us a sense from where you sit, how are you managing that process? Translation, seems like things have run off a little more slowly than expected. Yet you sort of have to be ready on a dime to move people off and on to other jobs. Are folks out aggressively selling already in anticipation? Or how do you manage that to make sure we don't get a big step-down in utilization?

I think that that's not the easiest thing to do in a firm like ours. I think you know, David, that in our firm we don't hire and fire people for projects. That's not the way we manage the professional staff here. I think that if these projects step down slowly, then everything will work fine. As new work comes in, people will stay utilized, and we'll have a nice smooth transition. If it turns out that several of these larger projects all take significant steps down at the same time, there inevitably will be a few points change in utilizations for a period of time as we work through it. Over time, we absolutely have the ability to manage our staffing, manage our recruiting, managing our counseling and staff and so forth to make the business model work well over time, as we've proved in the past. But in the short term, when you get -- if you get a rapid change in business over a short period of time, that will show up in the numbers.

Got you. From where you sit now, I think a year ago at this time, your thinking was the two larger projects that were good for maybe 10% of revenue last year would halve this year. Do you still see the tail-off as gradual?

I still see it as gradual in part because that's always been our history. It's just the history is that large cases don't completely go away. And the reason they don't is because the fact that they're large means they have many different aspects to them. They have certain regulatory aspects to them. They have certain litigation aspects to them, sometimes with different sets of parties. Certain classes of individuals, certain states, or the federal government, or state governments and so forth that may be involved in it. And so as a result, there are -- these large events result in issues having to be resolved in multiple jurisdictions. And so that's why our history is that they don't just go away.

Furthermore, there are often long tails that are either associated in the environmental area with continuing to monitor the environment over a period of time, or with other matters where there are other similar facilities that need to be monitored to evaluate what they might do. In the auto industry, when there's a major event, there is a very long tail of individual litigation associated with that particular alleged defect. We do expect all of these matters that we're involved in to have significant tails, but where they take the steps as they move down that tail is what is very difficult to predict.

Got you. Got you. Fair enough. One last. The product sales, I think when you spoke about them a quarter ago, the expectation was that a little bit of it would run into first quarter. Given the delay, is there an entire catch-up now in the fourth quarter, or do we still have -- do we have some additional run-off into the first quarter?

There could be some. Right now, I think most of this will happen -- that we have right now will happen this quarter. I don't have at this point in time an estimate for the first quarter.

Got you. Got you. All right. That's helpful. Thank you both.

And ladies and gentlemen, that is the final question. This does conclude our conference for today. If you'd like to listen to a replay of today's conference, please dial 1-303-590-3030, or toll-free, 800-406-7325, and enter the access code 4568755. We'd like to thank you for your participation, and you may now disconnect.