Exponent Inc Q1 FY2021 Earnings Call

Good day. And welcome to the Exponent First Quarter and Fiscal Year 2021 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Whitney Kukulka. Please go ahead, ma’am.

Thank you, Operator. Good afternoon, ladies and gentlemen. Thank you for joining us on Exponent’s first quarter of fiscal year 2021 financial results conference call. Please note that this call will be 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 prior written consent. Joining me on the call today are Dr. Catherine Corrigan, President and Chief Executive Officer; and Rich Schlenker, Executive Vice President and Chief Financial Officer. Before we start, I would like to remind you that the following discussion contains forward-looking statements, including, but not limited to, Exponent’s market opportunities and future financial results that involve risks and uncertainties that may cause actual results to differ materially from those discussed here. Additional information that could cause actual results to differ from forward-looking statements can be found in Exponent’s periodic SEC filings, including those factors discussed under the caption Risk Factor in Exponent’s most recent Form 10-Q. The forward-looking statements and risks in this conference call are based on current expectations as of today and Exponent assumes no obligation to update or revise them, whether as a result of new developments or otherwise. And now, I will turn the call over to Dr. Catherine Corrigan, Chief Executive Officer. Catherine?

Thank you, Whitney, and thank you everyone for joining us today. I will start off by reviewing our first quarter 2021 business performance. Rich will then provide a more detailed review of our financial results and outlook, and we will then open the call for questions. Our business continued to gain momentum, driving strong quarterly results, which exceeded our prior expectations. In the first quarter, net revenues grew 10% and EBITDA margin increased 400 basis points from the prior year period. These results were bolstered by increased activity in human participant studies and litigation projects as pandemic-related restrictions were eased and vaccinations became more widely available. Exponent is winning new assignments daily, and at the same time, is gradually reengaging on projects that were paused due to Coronavirus restrictions and court closures. The pandemic has altered many aspects of our lives, but one trend that has not abated is the growing complexity of our world. Exponent continues to leverage its expertise to understand and enhance human-machine interactions for technologies, including wearables, medical devices, and advanced vehicles. Exponent advises industry and governments on their most pressing engineering and scientific challenges as society continues to raise expectations for safety, health, sustainability, and reliability. These long-term trends that existed prior to the pandemic are now only strengthening, driving increased demand for our services. Exponent continued its work related to physiological monitoring through wearable technology platforms for the U.S. Army and Navy and expanded the engagement to include a coordinated effort in the Department of Defense. Exponent is uniquely positioned to advise clients as they leverage technology to improve human health and enhance human performance. On the reactive side, we saw improvement in demand for Exponent’s support in litigation matters. As restrictions lift, there is more confidence in court cases proceeding and we expect to see a return to normalized levels as the year progresses. Exponent’s engineering and other scientific segments represented 81% of the company’s net revenues in the first quarter. Net revenues in this segment increased 11% in the first quarter as compared to the prior year period. Growth was driven by strong demand for Exponent’s proactive and reactive services across a broad range of industries and use cases. In addition to the steady increase in litigation support and human participant studies, our multidisciplinary battery team continues to see demand for its solutions in electric vehicles and energy storage. Our work in international arbitrations and integrity management advisory services continued at strong levels. Exponent’s environmental and health segment represented 19% of the company’s net revenues in the first quarter. Net revenues in this segment increased 7% in the first quarter as compared to the prior year period. This segment also benefited from increased activity in litigation-related projects and support of human participant studies. The chemical regulation and food safety practice continue to grow, as Exponent’s scientists evaluated the effects of chemicals and new products on human health and the environment. Society continues to raise its standards for safety, health, sustainability, and reliability, which has fueled our growth for over 50 years. I am incredibly proud of the way that Exponent’s employees have continued to deliver value to our clients and to our shareholders over the last year. While a degree of uncertainty remains, our strong reputation, diversity of engineering and scientific disciplines, world-class team of experts, and the durability of our market drivers all position us to deliver long-term value to our stakeholders. I’ll now turn the call over to Rich to provide more detail on our first quarter 2021 results, as well as discuss our outlook for the second quarter and the full year 2021.

Thank you, Catherine, and good afternoon, everyone. Let me start by saying all comparisons will be on a year-over-year basis unless otherwise noted. For the first quarter of 2021, total revenues and revenues before reimbursements, or net revenues as I will refer to them from here on, increased 10% to $116.5 million and $109.6 million, respectively, as compared to the first quarter of 2020. The divestiture of our German entity, which closed in April of 2020, was a 1% headwind in the first quarter. Net income for the first quarter increased to $30.8 million or $0.58 per diluted share, as compared to $26.3 million or $0.49 per diluted share. Exponent recognized a tax benefit from share-based awards of $8.8 million or $0.16 per share in the first quarter of 2021, which is the same as the one-year-ago period. As a reminder, most of the stock awards are granted annually in March as part of our compensation program and released four years later. As such, it is primarily a first-quarter event for us. The tax benefit from share-based awards is determined based on the change in the value between the grant date and the issuance date. EBITDA for the quarter increased 27% to $31.8 million, producing a margin of 29% of net revenues, which is an increase of 400 basis points as compared to the first quarter of 2020. Billable hours in the first quarter were 356,000, an increase of 2% year-over-year. The German entity accounted for approximately 3% of billable hours and 1% of revenue in the first quarter of 2020. Utilization in the first quarter was 75.7%, up from 71.4% in the same quarter of 2020. Utilization in the quarter was ahead of our prior expectations, as pandemic-related restrictions were relaxed and vaccinations increased, which accelerated the timing of human participant studies and litigation support. For the second quarter of 2021, we expect utilization to be 74% to 75%, as compared to 64% in the second quarter of 2020. The reason Q2’s forecasted utilization is expected to be slightly below Q1 actuals is that there will be more vacation days taken as we enter the summer and people are vaccinated. For the full year 2021, we expect utilization to be 71% to 72%, as compared to 67% for the full year of 2020. We do expect vacations to be higher than normal in the back half of the year as people take vacations that were deferred due to the pandemic. Technical full-time equivalent employees in the quarter were 906, approximately flat sequentially and a decrease of 3% as compared to the same period one year ago. The year-over-year decline in FTEs was primarily due to the divestiture of the German entity, which accounted for 3% of our headcount in the year ago period. We expect sequential headcount to be approximately flat in Q2 and to grow sequentially 1% to 2% in Q3 and Q4 as recruiting activities are strong. The realized rate increased approximately 7% for the quarter. The realized rate increase included a 3% benefit from the divestiture of the German entity. For the remainder of the year, we expect the year-over-year realized rate increase to be approximately 2% to 2.5%. As a result, the full year realized rate increase is expected to be 3% to 3.5%. Compensation expense after adjusting for gains and losses in deferred compensation increased by 7%. Included in total compensation expense is a gain in deferred compensation of $5.6 million, as compared to a loss of $14.6 million in the first quarter of 2020. As a reminder, gains and losses in deferred compensation are offset against miscellaneous income and have no impact on the bottom line. Stock-based compensation expense in the quarter was $6.3 million, as compared to $6.1 million a year ago. We expect stock-based compensation to be $3.9 million to $4.4 million in each of the remaining quarters. For the full year 2021, we expect stock-based compensation to be $18.5 million to $19 million. Other operating expenses were down 6% to $7.7 million. The primary reason these expenses declined is due to reduced activities in our offices. Included in other operating expenses is depreciation expense of $1.7 million for the quarter. For the second quarter, we expect other operating expenses to be $8.6 million to $8.8 million. For the full year 2021, we expect other operating expenses to be $34 million to $34.5 million, driven by a gradual return to our offices over the year. We do believe our office environment provides long-term value as it supports collaboration for our interdisciplinary teams and staff development, which results in higher value for our clients and retention of our employees. We anticipate associate expenses to be at historic levels as we exit the year. G&A expenses were down 41% to $3.3 million for the quarter. The decline in G&A expenses was primarily due to bad debt expense. We accrued for potential pandemic losses in the first quarter of 2020 that was released in the fourth quarter of last year, as well as lower travel and meal expenses related to marketing and recruiting. We expect G&A expenses to gradually scale as travel activities resume. For the second quarter of 2021, we expect G&A expenses to be $3.6 million to $3.8 million. For the full year 2021, we expect G&A expenses to be $16.2 million to $16.8 million, as a result of marketing and recruiting activities increasing during the year. Interest income decreased approximately $850,000 to $29,000 for the quarter. Lower interest income is due to a steep decline in interest rates. For 2021, we expect interest income to be approximately $25,000 per quarter or $100,000 for the full year. Miscellaneous income net of deferred compensation gain was $450,000. For 2021, we expect miscellaneous income to be approximately $750,000 per quarter or $2.7 million for the full year. Inclusive of the tax benefit for share-based awards, Exponent’s consolidated tax rate was negative 2.4% for the quarter as compared to negative 9.3% in the prior year period. For 2021, we expect our tax rate, exclusive of any tax benefit for the remainder of the year, to be approximately 27.5%. Moving to our cash flows, operating cash flow was $1.3 million for the quarter, as we paid prior year bonuses in March. Capital expenditures were $2.5 million for the quarter. In 2021, we expect CapEx to be approximately $10 million. In the first quarter, we distributed $11.9 million to shareholders through dividend payments. Today, we announced we will pay a $0.20 dividend in the second quarter as well. As of quarter end, the company had $214.5 million in cash and short-term investments. Looking forward, based on strong demand for our services in the first quarter and the encouraging trends with Coronavirus, we expect to maintain our positive momentum, but recognize that there may be unevenness along the way. The year-over-year improvement in staff utilization and the lower than normal operating and G&A expenses are resulting in significant margin improvements. As a result of the positive momentum across our business and the easier year-over-year comparisons, we expect second quarter 2021 revenues before reimbursements to grow in the low 20s and EBITDA margin to increase approximately 350 basis points to 400 basis points as compared to the same period in 2020. For the full year 2021, we expect revenues before reimbursements to grow in the high-single digits to low-double digits, and EBITDA margin to be up approximately 100 basis points to 130 basis points as compared to 2020. We delivered another quarter of sequential improvements across the business in the first quarter, and we are confident in our ability to continue to grow profitability. I will now turn the call back to Catherine for closing remarks.

Thank you, Rich. For more than 50 years, Exponent has been called upon to advise clients on the causes of failures, as well as how to produce safer, healthier, more sustainable, and more reliable products and processes. As our clients’ needs evolve and increase in complexity, our team of engineers and scientists positions itself ahead of the curve, utilizing deep knowledge and multi-disciplinary capabilities to deliver unique solutions. With strong market drivers and a world-class team, Exponent is primed to deliver long-term growth. Operator, we are now ready for questions.

Thank you. Our first question comes from Tobey Sommer, Truist Securities.

Thank you. My first question has to do with the potential for global supply chain reconfigurations post-pandemic, what you’re hearing from customers and to the extent you are actively helping some achieve this kind of goal or expect to? Thanks.

Yeah. Thanks, Tobey. So this is an area of concern across a number of our industries that we operate in, right? If you think about the automotive side, if you think about the consumer electronics side in particular, there is the opportunity for us that we’ve been seeing vis-à-vis consumer electronics in particular really relates to our presence in Asia and our ability to be on the ground for our clients in understanding what some of these supply chain impacts are when our clients in the U.S. are in a situation where they really can’t have their folks traveling as much. So we are seeing, to some extent, some demand drivers around being able to advise clients with respect to qualification of suppliers to the extent that they are reorienting. We are able to help them vis-à-vis understanding the quality implications on their product, some of the related data implications vis-à-vis their products, the likelihood of failure in terms of monitoring and auditing types of things. And so that’s primarily the area that we are seeing this is going to be around the consumer electronics and consumer products area. Our teams in Asia are being called in to advise clients with regard to some of those impacts, primarily around consumer electronics.

Thank you for that. And what’s the environment like for recruiting? You did mention that you’re active expect to be for the balance of the year. Has it changed as a result of the pandemic and the relative attractiveness of Exponent as an employer?

We are currently very focused on recruiting and have made significant adjustments during the pandemic. We've effectively utilized the virtual space for sourcing candidates through various channels, including our university recruiting efforts. This virtual environment has allowed us to reach a broader and more diverse pool of candidates, as we can host virtual events instead of relying on in-person campus visits. As we ramp up our recruiting efforts, we've established a robust pipeline of candidates. Interestingly, many individuals are reconsidering their career paths due to the pandemic, which has opened up opportunities for us to attract those who may be seeking change from our competitors. We're also prioritizing senior recruiting by leveraging the networks of our senior leaders across different sectors, including environmental and health sciences. We're staying attuned to potential candidate sources and are optimistic about accelerating our headcount growth as we move further into the year. While we had moderated our hiring in 2020 to focus on profitability and retain our exceptional talent, we now have a positive outlook on recruiting. The competition is fierce as candidates have many opportunities, but we are seeing Exponent recognized as a top choice for many of them.

Thanks. You mentioned real estate and increasing travel expenses in your prepared remarks. Is there any noticeable cost difference in the business now, as we hopefully exit the pandemic, compared to pre-pandemic levels?

I believe that our facility profile will remain similar to what it was before. Exponent has consistently managed to achieve better margins by building critical mass at our locations, and we expect to continue this trend in the coming years. We are on a path to optimize our shared spaces and enhance collaboration. Regarding travel expenses, I expect to see some reduction since certain conferences and meetings have transitioned to virtual formats. We are currently evaluating whether this will result in net cost savings or if those expenses will simply be redirected towards marketing and recruiting efforts to maintain our effectiveness. We still see opportunities for reduced travel to be both efficient and effective for our business, but we recognize the necessity to invest in other communication methods to strengthen our market position.

And last question from me, as courts’ throughput kind of slowed last year, we weren’t sure whether all projects would sort of be deferred and/or maybe parties would settle. What’s your perspective now on the degree to which some of those projects kind of went away or really just accumulated in, for lack of a better word, some sort of backlog?

Yeah. Yeah. Thanks, Tobey. I’ve been spending a fair bit of time engaged with our clients on the litigation side, both the outside counsel, as well as the in-house folks, who make a lot of the decisions around how they handle their litigation portfolios. And I will tell you, they have not changed their posture around wanting to fight the battles on the merits of the case. They’re really making their decisions based on the merits. I’m finding we didn’t really see waves of settlements when things started to decline in terms of the macroeconomic impact. Of course, you get a settlement, you get settlements here and there. And at the end of the day, the vast majority of these matters do settle, but what tends to happen is they get fully worked up, full expert reports, depositions, you’re almost to the courthouse steps before those settlements tend to happen. And we really have seen that our clients are just as committed to their cases as they have been whether you’re on the plaintiff side or you are on the defendant’s side. They’ve been willing to wait it out, is what I’ve seen and just kind of push the dates. But what we see now is the dates are becoming real. The reality of bringing a jury in for an in-person trial in even the summer or the fall of this year is very real, and that is pushing demand back toward us for things like the preparation of expert reports and doing these deep analyses and preparing for depositions. And so, that’s been a part of the driver really here for the activity in the quarter, where we continue to see this improvement in matters that are being brought back to life if you will.

Thank you very much.

You’re welcome.

Our next question comes from Andrew Nicholas, William Blair.

Hi. Good afternoon.

Hi, Andrew.

I was hoping you could speak to the outperformance that you saw in the quarter relative to your guidance, where in particular you saw upside? And then somewhat relatedly, when you look at that outperformance, is there any way to describe how much of it was a function of maybe pent-up demand flowing into the pipeline versus what might otherwise be described as more a normal course of business? I realize that that’s maybe a difficult thing to obtain, but just curious if you have any thoughts on pent up versus normal course? Thanks.

Sure. Let me begin with this. When we initially provided guidance for the first quarter, we were in the midst of several human participant studies as clients were eager to proceed once restrictions eased and vaccinations ramped up. Reflecting back on January, it wasn’t too long ago, and we were coming off a challenging post-holiday period. Vaccinations were starting, but we were uncertain about how soon we would see positive effects. Fortunately, by early February, restrictions began to lift, allowing us to fully engage in our human participant studies for the last eight to nine weeks of the quarter. This was a significant factor in our results. I’ve discussed with the team, and I estimate that around one-third of the activity this quarter consisted of work that might have been completed earlier, in the late third or early fourth quarter, while the remaining two-thirds was new work that would have occurred no earlier than this quarter in the product life cycle. Overall, this contributed approximately 5% to 7% of our quarterly revenues, with some activity starting in January but accelerating in February. On the litigation support side, if you recall, we saw substantial growth in the fourth quarter. Clients recognized that vaccinations were becoming available, which led to increased court activity, including depositions and expert reports. Although there was some slowdown in late December and January, engagement levels surged again from late January into early February. We are experiencing a continued increase in new engagements year-over-year. Most of this work aligns with what we expected for the first quarter, with about 10% to 20% of our ongoing projects being deferred work that is now resuming. Moreover, litigation represents 50% of our business, and while we’re seeing some additional work, the majority falls in line with what we anticipated during the height of the restrictions.

Really helpful color. Thank you. Maybe with as a follow-up to that and with your answer as context or a precursor, I was hoping you could maybe walk us through in a little bit more detail how you’re thinking about the revenue cadence throughout the remainder of the year? If I look at the implied guide for the second half, it seems like you’re baking in consistent sequential step down through year end? And so I’m wondering if there’s anything else to call out besides typical seasonality and vacations or it’s just maybe being a bit conservative given how much uncertainty there is in the world at large? Thank you.

I believe there are several factors at play. Firstly, we have easier comparisons for Q2 and Q3 compared to the fourth quarter. As I mentioned earlier, the utilization in the fourth quarter has been strong; it was a solid quarter for utilization. We also experienced a slight increase in headcount during that time, along with notable rate realization. Given the work mix and positive project realizations, the rate was the highest of the year. Therefore, we see Q4 as a significantly different comparison moving forward, and we don't anticipate seeing a large rate realization then, instead expecting a small one due to the unusually high rate last year in that quarter. We believe underlying utilization might be slightly better than last year in Q4, though we recognize that vacations will affect us during that time. It's true that our expectations for year-over-year growth in the fourth quarter on the top line are modest due to these factors. However, this doesn't mean we don't see the business returning to a normal growth rate in 2022. We are actively recruiting, bringing in PhDs and similar talent, which takes time to have an effect. We expect to see some results in the fourth quarter, but much of it will carry over into the first quarter of next year and beyond. We anticipate headcount growth returning to the 4% to 7% range in 2022. We generally experience favorable rate increases with the current demand environment, as we're observing inflation and strong GDP growth, which should enable us to achieve a good rate increase as we enter 2022. Furthermore, we expect utilization this year to be in the 71% to 72% range, with the potential to gradually increase into the mid-70s over the next four to five years. We believe there is opportunity for improvement as we progress through the year, positioning us well for 2022 and beyond.

Makes sense. Very helpful color. Thank you.

Our next question comes from Marc Riddick, Sidoti.

Hi. Good afternoon.

Hi, Marc.

Hey, Marc.

So I wanted to sort of piggyback on that and I really appreciated the way you kind of laid out how the cadence worked out around the recovery and positive performances that you saw, both on the litigation side and the user study portion. I was wondering if you could sort of take a similar dive at what you may be seeing, what the automated vehicles and some of those types of efforts, given the focus on what would may be coming as far as increased demand and production in that space?

The automotive sector, particularly advanced vehicles, is currently a significant focus for us. This impacts both the proactive and reactive aspects of our business. Recently, there has been an increase in regulatory activities related to advanced vehicles. We are noticing a demand for safety frameworks as various manufacturers envision deploying these vehicles on roadways. This is where Exponent plays a crucial role, transitioning from lab tests to real-world scenarios involving heavy vehicles driven by computers at high speeds and the associated safety considerations. On the proactive side, there's also substantial interest in electric vehicles, with pledges from companies like General Motors to have their fleets fully electric by 2030. Our expertise in battery technology for transportation is increasingly sought after, especially as the industry scales up battery production to meet market demands and regulatory requirements. However, this ramp-up brings challenges, reminiscent of the issues faced with the Samsung Galaxy Note 7. We see opportunities to engage in quality, performance, and reliability assessments, as well as evaluating crashworthiness. Vehicle fires are a concern for both gasoline and electric vehicles, although the methods for extinguishing them and the safety issues differ due to their propulsion systems. Additionally, we are seeing litigation related to advanced driver assistance systems, which include technologies like emergency braking and lane-keeping currently in use. The increasing litigation risks around vehicle safety highlight the aggressive stance of the plaintiff's bar. We have made investments to stay ahead in this area, developing advanced testing capabilities and closely analyzing performance data of these systems. The automotive sector, in both proactive and reactive contexts, has driven demand over the past quarter and is expected to continue as these technologies advance toward deployment and the challenges of performance and failure management arise on the roads.

Thank you for the information. I was curious about the regulatory aspect. Is there a typical timeframe or framework for new technologies in terms of state and local involvement? Can you anticipate these regulations so that you can prepare accordingly? Which jurisdictions are likely to be the first to implement these changes?

The regulatory environment is a significant factor. You accurately pointed out that this involves not only federal regulations but also state and local ones. At the state level, they are responsible for licensing human drivers, which raises important questions about how to determine whether an automated vehicle should be allowed on public roads. This process can vary greatly from state to state, and that's where Exponent can provide valuable assistance. Our focus has been on supporting the industry rather than pursuing the states as clients. We aim to facilitate the introduction of vehicles onto roadways and clarify what that entails in terms of required demonstrations. A key issue is how to prove safety and determine what constitutes "safe enough," which is a challenge that the entire manufacturing community is striving to address. Our goal is to stay ahead of regulators by showcasing best practices, which is a major area of focus for us.

Okay. And then I just one more and I promise I’ll be done. Can you talk a little bit about the expansion of the wearables within DoD and sort of how that came to be? And was there something that accelerated that pace or how should we think about that opportunity going forward? Thanks.

We initially conducted our work at the Army and Navy levels, primarily focused on COVID-related proximity monitoring and contact tracing. However, we are now expanding to a more integrated solution as a joint program across the Department of Defense. We are analyzing sensor data from wearables from various perspectives, including data security, hardware quality, and the sensors' ability to detect physiological signs. The structure and flow of this data are critical, along with how we address human factors related to displaying and managing information. Our goal is to present this information on wearable devices in a robust, reliable manner, offering insights into health and readiness for armed forces personnel. This initiative is about transitioning from experimental conditions to operational management, optimizing data flow to glean real insights. This is where the expansion into a unified solution as a joint program in the Department of Defense has emerged.

That’s great. Thank you very much.

You’re welcome.

With no more questions in the queue, we will be ending the call. Thank you, ladies and gentlemen. This concludes today’s teleconference. You may now disconnect.