Exponent Inc Q1 FY2023 Earnings Call

Good afternoon. And welcome to the Exponent First Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Joni Konstantelos with Investor Relations. Please go ahead.

Thank you. Good afternoon, ladies and gentlemen. Thank you for joining us on Exponent’s first quarter 2023 financial results conference call. Please note that this call will simultaneously be 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, Joni, and thank you everyone for joining us today. I will start off by reviewing our first quarter 2023 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. We are pleased to report another solid quarter, growing net revenues by over 9%, despite evolving macroeconomic challenges and uncertainty. Our results demonstrate the strength of our business with a diversified portfolio of offerings, serving a broad range of industries across the entirety of the product life cycle. Safety, health and the environment are increasingly important as companies deliver innovation and push the envelope with new technologies. Exponent remains uniquely positioned as a trusted adviser, harnessing the power of technical excellence, objectivity and disciplinary diversity to help our clients solve their toughest science engineering and business challenges. Increased demand for our reactive services, which have been foundational to Exponent from our inception, bolstered our growth in the first quarter. In the quarter, we saw an influx of litigation-related activity, as well as product safety and recall related work that spans multiple industries. On the proactive side, activity in the quarter was driven primarily by work in the consumer products, chemicals, utilities, automotive and life sciences sectors. Turning to our engagements in more detail. Within our reactive business, we saw strong demand for both our domestic litigation and international arbitration related work, particularly involving the transportation and energy sectors, as well as intellectual property disputes. We also saw increased engagements around product safety and recall across a number of end markets, including transportation and life sciences. Within our proactive business, engagements in the quarter were primarily driven by regulatory issues across multiple industries, product design consulting in the electronics and medical device spaces and asset integrity and risk related work. Engagements continued related to machine learning data collection and user research across a range of end markets. This work is reflective of ongoing demand from our clients as they seek differentiated data to improve user experience and advance product performance and reliability of their next-generation designs. Across the business, Exponent is well positioned to capitalize on macro trends, including escalation in safety, health and environmental concerns that will have a significant impact on our business over the next several years. We are excited about transformations related to energy storage, vehicle electrification and automation, consumer electronics and digital health, as the complexities associated with these innovations will continue to drive work for our services. We are intently focused on understanding what is on the horizon and are positioning ourselves with the talent, capabilities and relationships to grow our client base and expand our business. In the quarter, our headcount grew 12% year-over-year, driven by our ability to attract and retain top tier talent. We are an employer of choice for the best and brightest scientists and engineers who choose Exponent because of our esteemed reputation for technical excellence, objectivity, and disciplinary diversity. We are committed to growing our world-class team and are pleased with our accelerated recruiting efforts over the last year, which have strengthened our unique position to meet the complex and dynamic needs of our clients. As always, we will continue to balance strategically expanding our team with utilization to ensure that we are positioned correctly for any market environment to deliver value over the long-term for all of our stakeholders. Turning to our segments. Exponent’s engineering and other scientific segment represented 83% of our net revenues in the first quarter, increasing 11% as compared to the prior year period, with continued strong demand for our services across the transportation, utilities, consumer products and life sciences sectors. Exponent’s environmental and health segment represented 17% of our net revenues in the first quarter. Net revenues in this segment decreased 1% compared to the same period in the prior year. Excluding the impact of foreign exchange, net revenues for the environmental and health segment increased 2% in the first quarter as compared to the prior year period. Work in this segment was primarily driven by Exponent safety-related engagements, evaluating the impacts of chemicals on human health and the environment. Before I turn the call over to Rich to review the financials, I do want to highlight the recent launch of Exponent’s newly designed website, which underscores how we are helping clients create a safer, healthier and more sustainable world. We are incredibly proud to showcase our people and the diverse and impactful work of our team of experts who have helped assess some of the world’s biggest disasters and challenges, including building collapses, chemical spills, and high profile product failures. Exponent’s world-class team combines that experience with a vast array of scientific and engineering expertise to help our clients build future-focused solutions for their most profoundly unique, unprecedented, and urgent challenges. Overall, our first quarter results exemplify the strength of our adaptable business model, unique market position and depth of our client relationships. We will continue to position ourselves for the future, investing in our talent, knowledge base and skills to deliver increasing value to our clients and our shareholders. I will now turn the call over to Rich to provide more detail on our first quarter results, as well as discuss our outlook for the second quarter and the full year 2023.

Thank you, Catherine, and good afternoon, everyone. I want to mention that all comparisons will be year-over-year unless stated otherwise. In the first quarter of 2023, total revenues increased by 9.2% to $140.3 million, and revenues before reimbursements grew to $128.7 million, compared to the same period in 2022. The quarter's revenue growth was negatively impacted by 0.5% from foreign exchange. Net income for the first quarter dropped 1.6% to $29.1 million or $0.56 per diluted share, compared to $29.6 million or $0.56 per diluted share in the previous year. The tax benefit related to share-based awards in the first quarter of 2023 was $3.6 million or $0.07 per diluted share, down from $6 million or $0.11 per diluted share in the first quarter of 2022. With the tax benefit for share-based awards included, our consolidated tax rate was 18% in the first quarter, compared to 9.7% for the same period in 2022. EBITDA for the first quarter increased by 3.7% to $35.8 million, resulting in a margin of 27.8% of net revenues. Billable hours in the first quarter were around 385,000, a 3.1% rise over the previous year. The average number of technical full-time equivalent employees was 1,052, which represents a 12% increase year-over-year. This exceeded our expectations due to successful recruiting and improved retention. Utilization in the first quarter was 70.4%, down from 76.5% in the same period of 2022. We anticipated this decline from last year’s elevated level due to strong headcount growth. Despite lower utilization, we are pleased with the EBITDA margin as it meets our guidance. The realized rate increase was about 6% for the first quarter compared to a year ago. Adjusting for gains and losses in deferred compensation, total compensation expense rose 9.3%. This includes a deferred compensation gain of $3.9 million, compared to a loss of $4.7 million in the same period of 2022, which is an $8.6 million turnaround. It’s important to remember that these gains and losses are offset in miscellaneous income and do not affect the bottom line. Stock-based compensation expense in the first quarter was $7.1 million, up from $6.9 million in the previous year. Other operating expenses increased by 17.1% to $9.6 million, primarily due to heightened activity as employees return to the office. Included in this expense was a depreciation cost of $2 million. G&A expenses rose by 38.1% to $5.8 million for the first quarter due to increased marketing and recruiting activities as in-person engagements resumed. We saw interest income increase to $1.8 million for the quarter, driven by rising interest rates. Miscellaneous income, excluding the deferred compensation gain, was about $730,000 in the first quarter. Capital expenditures totaled $5.7 million, and we paid out $14.5 million to shareholders in dividends. We concluded the first quarter with $125.6 million in cash and short-term investments. Looking ahead, our full year 2023 outlook remains unchanged. For the second quarter, we expect revenues to grow in the high-single to low-double digits and an EBITDA margin between 27.5% and 28.5% of revenues before reimbursements. For the entire year, we anticipate similar revenue growth and an EBITDA margin of 28% to 28.5%. Our recruiting and retention efforts continue to yield positive results, and we project a sequential employee growth of 1% to 2% in each of the remaining quarters, translating to a year-over-year increase of 10% to 13% in full-time equivalent employees. We expect second quarter utilization to be between 69% and 72%, down from 76.6% in the same quarter last year, influenced by the increase in headcount. For the full year, we foresee utilization at 70% to 72%, contrasting with 73.8% in 2022. We remain confident that our long-term target of sustaining mid-70s utilization is within reach as we manage headcount and utilization strategically based on market needs. We project a realized rate increase of 4.75% to 5.5% for 2023, with similar rates expected for our annual salary increases beginning April 1. For the remaining quarters, stock-based compensation is estimated to be between $4.5 million and $5.2 million. Full-year stock-based compensation is anticipated to be between $22 million and $23 million. We estimate other operating expenses for the second quarter to fall between $10 million and $10.5 million, totaling $40.5 million to $41.5 million for the year as we continue growing headcount and returning to the office. We project G&A expenses for the second quarter to be between $6.4 million and $6.8 million, reaching between $27 million and $27.6 million for the full year. The growth in G&A expenses year-over-year relates to increased headcount, recruiting, business development, and travel, as travel was notably low in the first half of 2022. We expect interest income to range from $1.5 million to $1.8 million per quarter in 2023, while miscellaneous income is projected to be approximately $600,000 to $800,000 per quarter. For the remainder of 2023, we do not foresee any additional tax benefits from share-based awards, with the anticipated lower year-over-year tax benefit reducing net income by $2.2 million and earnings per diluted share by $0.04. For 2023, we expect our tax rate, excluding the benefit for share-based awards, to be around 28%, compared to 27% in 2022. Our tax rate for the second quarter of 2023 is expected to be approximately 28%, versus 28.3% in the same quarter last year. For the full year 2023, the tax rate, including the benefit from share-based awards, is projected to be 25.3%, compared to 22.6% in 2022. In closing, we delivered another solid quarter and are well positioned for continued profitable growth. I will now hand the call back to Catherine for her closing remarks.

Thank you, Rich. Exponent stands at the cornerstone of engineering and scientific excellence, connecting the lessons of past failures with tomorrow's solutions to create a safer, healthier and more sustainable world. Our first quarter results demonstrate Exponent’s leading position in the market, as well as our financial strength. Backed by our world-class team, multidisciplinary capabilities and diverse client relationships, we remain confident in our ability to grow Exponent profitably and drive long-term value for our shareholders. Operator, we are now ready for questions.

Our first question is from Andrew Nicholas with William Blair. Please go ahead.

Hi. Good afternoon. Thanks for taking my question. I wanted to start with one on headcount growth. Just maybe more broadly, it seems like you hired a little bit stronger than even you had expected. Could you unpack why you think that was in the quarter, did attrition come in lower than you thought, is there particularly strong demand for working at Exponent now relative to previous quarters? Just any other color on the recruiting environment and what has driven your success there would be great?

Yeah. Why don’t I start off there and give you back. So, look, we knew that we were coming into what we thought was a strong quarter for headcount growth. We had good momentum in the back half of 2022 and part of that carries over to those people you already have lined up coming in. But what we ended up seeing is a couple of percentage point contribution from both sides of the net headcount equation and that included the fact that we were seeing strong acceptance rates and good access to top talent, which led to a little bit higher inbound level of people based on the quality of what we are getting on that side. And the same occurred in the retention sort of side, we saw that pulling back to levels that approximate the rate that we were seeing in the first quarter to now four months of 2019. So back to a more normalized level to pre-COVID than, obviously, what we saw, which was a new levels during 2021 and 2022, especially in those first four months as we pay out our bonuses in the middle of March and we provide reviews and communicate our salary increases that would take effect April 1. We had seen more higher turnover, and again, it’s been a short period of time. We will see how the next couple of quarters go, but we are optimistic that we are in a good position in both of these areas.

I would like to emphasize the strength of our employee value proposition, which has always been strong. Despite the current uncertain environment, I believe that talented engineering and scientific professionals view Exponent as a company with a solid foundation and a diverse portfolio of engaging and stimulating projects they want to be involved in. This aligns with the quantitative aspects that Rich mentioned, but it also highlights the overall value proposition that we are confident is robust.

Makes sense. Thank you. And then for my follow-up, I wanted to ask about the proactive business. It seems like, and correct me if I am wrong, that the reactive side was a bit stronger than the proactive side this quarter. If that is true and that was the case, what would you attribute that to and kind of related to the market uncertainty, has there been any change in demand from your proactive clients in the current environment?

Yeah. Thanks, Andrew, for that. Like you said, the reactive side of the business was very strong in the quarter, both internationally as well as domestically. This is our litigation portfolio. It’s our recall related work, some of the defect investigations very strong around automotive, life sciences, some of the toxic tort areas. On the proactive side, we are finding it to be pretty variable across clients. We have got a lot of critical work that we are doing around the regulatory environment. The regulations don’t go away when you have sort of uncertainty in the macroeconomic environment that need for innovation in industries like consumer electronics, or let’s say, medical devices, that’s still there. But what we are seeing with some clients is they are getting themselves oriented around the uncertainty. Maybe they have had some layoffs. Their teams are resetting themselves and saying, okay, look, we have got to do this work, but it’s going to be maybe next quarter, not this quarter. So we are seeing a little bit of that sort of behavior from some clients, but the reality is that, that critical work is still moving forward, right? So we have got a few areas where there may be a pause or we are going to start that in another month or two kind of thing, but we are seeing the workflow of those critical items continue to be part of that demand equation for us.

Very helpful. Thank you.

You are welcome.

The next question is from Tobey Sommer with Truist Securities. Please go ahead.

Thanks. I want to start with a question about pricing. What was the nominal rate increase in January and how has the realized rate affected the model? I’m curious if there are any nuances related to the improved retention and acceptance rate and how that contributes to the situation.

Yeah. So our rate increase for our employees who were here on the January 1 timeframe was approximately 10% that the realization of that was approximately 6% that we realized out of that and that is based on mix and what you mentioned there. So we have always had this in our portfolio. It’s not because we are having. As you are quite aware, Tobey, each of our employees have a single rate for the calendar year, each of them individually based on their experience and credentials and position in the marketplace is how that’s set for all clients in all work and that remains that way and we have been able to continue to push that through in 2023. But as we are hiring in new people, which we had a lot of in the first quarter here, that is blended down and is why I have that stepping down a little bit further as we move through the year and it provided that guidance on where the rate would be. But we are quite pleased with where that realization is, realize that a little higher headcount, especially because we are hiring in typically at the entry level, which is for us, typically, a new PhD out of a top school, bringing them in and then growing them up over their career to hopefully achieve the level of principal in our organization. So that is what we are seeing at this time.

Great. I am curious, do you see a connection in demand for EXPO services when we have seen in recent months, layoff announcements either in TMT, consumer electronics, I guess, it’s not uniquely in those verticals, but they are sort of top of mind these days?

The hiring landscape for engineering and scientific talent has changed due to broader trends in the tech sector and beyond. We're constantly competing with other companies for this talent. This relates back to the employee value proposition I mentioned earlier. We can attract talent, but we've previously experienced situations where our demand for consultants was affected when clients faced hiring challenges or layoffs. While we haven't observed significant impacts in the technology sector yet, we are noticing shifts in our talent acquisition efforts. It's still early in this process, and teams are adjusting after a wave of layoffs in the tech industry. We will continue to build those relationships and develop our workforce to meet their needs in innovation.

And I am curious if based on the better retention and higher acceptance rate, does it change your assumptions for those metrics throughout the year, and if so, do you tap the brakes on gross external hires based on how you see the marketplace and the opportunity to grow revenue?

Yeah. Thanks, Tobey. So it’s really all about the portfolio and hiring strategically where we are seeing the need and the demand in the marketplace, right? So it’s less about, okay, we are going to take a flat cut in our efforts across the board, right? We have got to be looking at every one of our business units, every one of our capabilities and industries. For example, electric vehicles is a great example. This is an area where we are looking to acquire more talent because of the opportunity that we see and so we are not tapping the brakes there. But in other areas where there is more softness, we can do different things, right? So I have got multiple dials on my dashboard that I can say, all right, we have got to ramp up here, we have got to pull back and it’s very strategic according to the market.

Thanks. It may be too soon to tell, but since the banking turmoil began, is that enough time to evaluate its impact on the marketplace? If it did have an effect, I would expect it to be more proactive. Does this represent a significant point in the year-to-date calendar before and after SVB?

We haven’t noticed any change related to that event, and most of Exponent’s engagements are not with startup organizations. While SVB had mature entities as clients, we haven't seen any impact from this situation. I've spoken with our employees who work in the tech sector, and the clients we see that are moving a bit slower do not appear to be waiting on funding or lacking resources; that hasn’t been our market historically. However, it’s still early, and we will see how things develop. I suspect that for our mature clients, who represent the majority of our revenues, this situation may actually create more opportunities for them.

Okay. Last question for me. Rich, any change in the composition of big projects versus last time we heard from you in the portfolio and in the P&Ls?

No. We sort of have what I will call a more normalized portfolio at this point in time. The large projects are 2% of revenue or such and going on across quarters and such and we will expect it to be more normal in that range. No outsized projects like we have had in prior years where something might be in that 4% or 5% of revenue range. So right now no.

This concludes our question-and-answer session and the conference is also now concluded. Thank you for attending today’s presentation. You may now disconnect.