Exponent, Inc. (NASDAQ:EXPO) Q3 2023 Earnings Call Transcript

Exponent, Inc. (NASDAQ:EXPO) Q3 2023 Earnings Call Transcript October 26, 2023

Exponent, Inc. misses on earnings expectations. Reported EPS is $0.48 EPS, expectations were $0.49.

Operator: Good day, and welcome to the Exponent Third Quarter Fiscal Year 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] 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 of Investor Relations. Please go ahead.

Joni Konstantelos: Thank you. Good afternoon, ladies and gentlemen. Thank you for joining us on Exponent’s third quarter 2023 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.expone.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 and 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 — excellent 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?

Catherine Corrigan: Thank you, Joni, and thank you, everyone, for joining us today. I will start off by reviewing our third quarter 2023 business performance. Rich will then provide a more detailed review of our financial results and outlook, and we will now open the call for questions. During the third quarter, we once again delivered broad-based revenue growth and earnings with our diversified portfolio of services supporting growth across nearly all industries we serve. The deliberate investments we’ve made to expand capabilities and stay ahead of the pace of innovation, continue to pay off. Our ability to anticipate client needs throughout the product or assets or technology life cycle is and will continue to be a significant differentiator for Exponent.

Of course, uncertainty exists in the broader markets we serve, but our exceptional team of integrated experts and our expansive capabilities provide us the ability to remain nimble and adapt our business to align with these dynamic market trends. Turning to our third quarter in a bit more detail. Growth in the quarter was driven by continued strong demand for our reactive services. Our proactive engagements were driven by increased demand in the chemicals and life sciences sectors, offset by continued moderation in the consumer electronics sector. Overall, I am pleased with the strength we are seeing across the majority of the business. Within our reactive services, we continue to see robust demand for domestic and international dispute-related offerings involving large capital projects in the energy, utilities and transportation sectors spanning various geographic regions.

Additionally, consumer and automotive product liability and recall-related work increased in the quarter. Our proactive engagements were driven by increased demand for regulatory consulting work in the chemicals industry and engagements in the life sciences sector. This was offset by ongoing moderation in the consumer electronics industry due in part to the timing of product life cycles as well as ongoing macroeconomic headwinds. As a result, we saw declines in data collection and human subject research engagements as well as product development consulting. While we do expect this moderation to continue, we are optimistic about the long-term market drivers in this sector, and we remain well positioned to support our clients as these challenges begin to abate in 2024.

With regard to our segments, Exponent’s engineering and other scientific segment represented 83% of our net revenues in the third quarter, increasing 8% in the third quarter and 10% for the first 3 quarters compared to the prior year. Growth in the quarter was driven by strong demand for Exponent services across the transportation, energy and construction sectors. Exponent’s Environmental & Health segment represented 17% of our net revenues in the third quarter, increasing 13% in the third quarter and 7% for the first 3 quarters compared to the prior year. Evolving regulatory requirements drove increased safety-related engagements, evaluating the impacts of chemicals on human health and the environment, and we also saw increased activity in the life sciences sector.

As we close out the year, we remain focused on excellence and execution and expanding our differentiated capabilities to meet the dynamic needs of our clients. The investments I mentioned earlier will continue to be a priority to drive organic growth and development within Exponent and to foster the essential trust our clients place and our team of experts to address their most complex needs. Further, managing resources in line with the growth of the business remains top of mind. To that end, as we expected, full-time equivalent employees in the third quarter decreased 2.5% compared to the second quarter as we continue to strategically realign our resources with demand across the business. We are taking a two-pronged approach to ensuring our headcount is aligned with not only current demand but also with the longer-term demand and opportunities we are seeing.

First, we are focused on recruiting in areas of the business where resources are constrained, but where we see opportunity to meet current and future market demand. Second, we continue to focus on performance management to ensure that our retained consultants are on a strong development path that will contribute to the future growth of the firm. In summary, Exponent continues to position itself at the forefront of innovation as a trusted adviser to our clients across the product life cycle. Market drivers, including the increasing complexities around safety, health and the environment remain strong and continue to drive opportunity across our business. We remain focused on expanding our capabilities, strengthening our relationships and driving profitable growth and value for our shareholders.

I’ll now turn the call over to Rich to provide more detail on our third quarter results as well as discuss our outlook for the fourth quarter and the full year 2023.

Rich Schlenker: 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 third quarter of 2023, total revenues increased 4.8% to $133.3 million and revenues before reimbursements or net revenues, as I will refer to them from year on increased 8.5% to $125 million as compared to the same period of 2022. This includes a decline of approximately $8 million in our consumer electronics business, which created a 6% to 7% headwind as compared to the third quarter of 2022. Net income for the third quarter was $24.5 million, or $0.48 per diluted share as compared to $24.4 million or $0.47 per diluted share in the prior year period. Exponent’s consolidated tax rate was 27.9% in the third quarter as compared to 27.0% for the same period in 2022.

EBITDA for the quarter was $34.5 million, producing a margin of 27.6% and of net revenues as compared to $34.6 million or 30% of net revenues in the same period of 2022. This year-over-year decline in margins was anticipated as expenses normalize post-pandemic, and utilization was lower due to the growth in headcount. Billable hours in the third quarter were approximately $380,000, an increase of 4.1% year-over-year, which is significant considering the headwinds in electronics. The average technical full-time equivalent employees in the third quarter were 1,050, which is an increase of 9.6% as compared to 1 year ago. This was the result of successful recruiting efforts in the second half of 2022, coupled with improved retention in 2023. As Catherine mentioned, full-time equivalent employees decreased 2.5% compared to the second quarter of 2023, reflecting our progress on strategically aligning our resources with the current and long-term demand opportunities.

Utilization in the third quarter was 70%, down from 73% in the same period of 2022. The realized rate increase was approximately 4.4% and for the third quarter as compared to the same period a year ago. In the third quarter, after adjusting for gains and losses and deferred compensation expense, compensation expense increased 13.4%. Included in total compensation expense is a loss in deferred compensation of $2.8 million as compared to a loss of $4.9 million in the third quarter of 2022. As a reminder, gains and losses in deferred compensation are offset to miscellaneous income and have no impact on the bottom line. Stock-based compensation expense in the third quarter was $4.9 million as compared to $4.6 million in the prior year period. Other operating expenses in the third quarter were up 24.7% to $11 million driven primarily by increased employee engagement at our offices.

Included in other operating expenses is depreciation and amortization expense of $2.4 million for the third quarter. G&A expenses declined 10.6% to $6 million for the third quarter. This decrease was due to a reduction in the use of outsourced personnel and a smaller annual company meeting. Interest income increased to $1.9 million for the third quarter, driven by an increase in interest rates. Miscellaneous expenses, excluding deferred compensation loss was approximately $1 million. During the quarter, capital expenditures were $3.3 million, we distributed $13.2 million to shareholders through dividend payments and repurchased $17 million in common stock. We ended the third quarter with $137.1 million in cash and cash equivalents. Turning to our outlook.

For the fourth quarter of 2023 as compared to 1 year prior, we expect revenues before reimbursements to grow in the middle single digits and EBITDA margin to be 26% to 27% of revenue before reimbursements. For the full year 2023 as compared to 1 year prior, we expect revenue before reimbursements to grow in the high single digits and EBITDA margin to be 27.4% to 27.8% of revenues before reimbursements. This assumes approximately the same headwinds of 6% to 7% from consumer electronics business in the fourth quarter as we experienced in the third quarter. The full year margins remain at or above pre-pandemic levels. As Catherine mentioned, we are taking actionable steps to strategically align our resources with the current and long-term demand trends within our business through targeted recruiting and ongoing performance management.

As a result, we expect our average technical full-time equivalent employees to decline sequentially 2% in the fourth quarter. We expect utilization in the fourth quarter to be 66% to 68% as compared to 69% in the same quarter last year. As a reminder, utilization is seasonally lower in the fourth quarter due to more holidays and vacations compared to other quarters. Our expectations for full year utilization is in the range of 69% to 69.5% as compared to 73.8% in 2022. We still believe our long-term target of sustained mid-70s utilization is achievable as we continue to strategically manage headcount and balance utilization based on market demands. We expect the 2023 year-over-year realized rate increase to be 4.75% to 5.25%. For the fourth quarter, we expect stock-based compensation to be $4.5 million to $5 million.

For the full year, we expect stock-based compensation to be $21.5 million to $22 million. For the fourth quarter, we expect other operating expenses to be $11.2 million to $11.7 million. For the full year, we expect other operating expenses to be $42 million to $42.5 million as we — as in office activities continue to pick up. For the fourth quarter of 2023, we expect G&A expenses to be $6.6 million to $7 million. For the full year, we expect G&A expenses to be $25.1 million to $25.5 million. We expect interest income to be approximately $1.8 million for the fourth quarter. In addition, we expect miscellaneous income to be approximately $750,000 in the fourth quarter. For the remainder of 2023, we do not anticipate any additional tax benefit from share-based awards.

So the year-over-year tax benefit associated with share-based awards are expected to be $2.4 million lower than they were in 2022, which is a $0.05 per diluted share impact to EPS. For the fourth quarter 2023, we expect our tax rate to be approximately 28.2% as compared to 26.2% in the same quarter a year ago. For the full year 2023, the tax rate, inclusive of the tax benefit from share-based awards is expected to be 25.7% as compared to 6% in 2022. In closing, we continue to be confident in the strength of the business and our ability to drive further profitable growth. I will now turn the call back to Catherine for closing remarks.

Catherine Corrigan: Thank you, Rich. For many years, Exponent has been a trusted adviser in supporting our clients throughout the product life cycle. As the complexities of innovation create new challenges, Exponent will leverage our world-class team of experts and diversified services portfolio to guide our clients through the dynamic changes in their industries. We remain confident in our ability to drive long-term profitability and value for our shareholders. Operator, we are now ready for questions.

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Q&A Session

Operator: We will now begin the question-answer session. [Operator Instructions] First question comes from Tobey Sommer from Truist.

Tobey Sommer: Thank you. What sort of run rate do you think that the company may be on in terms of billable headcount growth as you exit the fourth quarter into next year?

Rich Schlenker: Yes. I anticipate that we will end the year with a headcount that puts us right around, give or take, around 1,025 is where we’ll end the year at. And then we will continue to — I would expect that, hopefully, that puts us in a good position to be able to grow throughout 2024. We are still in our planning phase. We’re sort of in the middle of that part where our business units are working on their 2024 plans. And the executive team will be meeting with each of those business units later on this quarter. And — but our expectations is based on the demand environment that we have across a number of our industries that, that will set us up in a good position to be able to really grow in those areas where the demand is increasing.

Tobey Sommer: And Catherine, the company doesn’t often miss expectations. And I was wondering if you could describe changes in demand throughout the quarter, whether it was just sort of a bit at a time in each of the months and into perhaps October as well? Or was there sort of an episode or a month at which many things changed and then sort of levelled off from there.

Catherine Corrigan: Yes. Thanks, Toby. It’s important to sort of look at this from a portfolio perspective. And when I do that, we’re very much focused in terms of the headwinds in the consumer electronics sector, as Rich described, and even more granularly around some of that human subject type of work that we’ve been doing around data collection, machine learning and things like that. It’s very much related to the product life cycle timing that we’ve been seeing and also by some of those macroeconomic headwinds. But I think the — as I look across the business, what I’m seeing is a portfolio that is performing well and as designed because what we’ve done is really design a portfolio that is diverse across industries, right?

And so we’re seeing growth in just about every one of those other industries, whether that’s transportation, which is very strong, whether that’s the life sciences side, whether that’s the energy side or the construction side, and being up 8.5% despite the headwinds, I think really exemplifies the strength of that portfolio and being able to deliver profitability that’s at or above where we were pre-pandemic without — with all of those expenses layered back in. So it is a focused area where there is some moderation. And we expect that to continue in Q4, but we also are seeing some nice activity in the pipeline. We’ve got requests coming in for scopes of work and proposals. And so that pipeline is filling and that’s why we feel like these headwinds are going to start to abate once we hit Q1 of 2024 and then progress even further into 2024.

Rich Schlenker: Yes. And Toby, I’d just add a little bit of granularity on to those numbers. As I mentioned there, we had about $8 million headwind. I think we thought that, that would probably be closer to $6 million in July when we put together the quarter. And in addition to that, we thought that would be slightly less, again, in the fourth quarter instead of holding at that level, we — based on what we understood, of timing of some projects coming in. We expected those projects to start in Q4 that are now going to come the first quarter, at least that’s what we expect now. So those — that provided that additional sort of headwind in the fourth quarter.