Exponent - Q2 2024

Transcript

Operator (participant)

Please note, this event is being recorded. I would now like to turn the conference over to Joni Konstantelos, Managing Director, Riveron. Please go ahead.

Joni Konstantelos (Managing Director)

Thank you. Good afternoon, ladies and gentlemen. Thank you for joining us on Exponent's second quarter 2024 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.investors.exponent.com. 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. Now I will turn the call over to Dr. Catherine Corrigan, Chief Executive Officer. Catherine?

Catherine Corrigan (CEO)

Thank you, Joni, and thank you everyone for joining us today. I will start off by reviewing our second quarter 2024 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 delivered net income growth of 14% and expanded EBITDA margin in the second quarter, reflecting the results of efforts to align our operating model with market demand. As expected, revenue growth moderated during the quarter due to ongoing headwinds in the consumer electronics and chemical sectors and a tough comparison against 20% growth in our reactive work last year. Despite these challenges, our reactive business delivered mid-single digit growth, fueled by demand across the transportation, utilities, and medical device sectors. Our proactive business continued to experience softness in consumer electronics, partially offset by modest year-over-year growth in the utility sector.

Turning to our engagements in more detail, in our reactive work, we saw strong demand within transportation related to product liability and regulatory matters. These included evaluating the performance and safety implications of advanced driver assistance technologies and battery systems, as well as railway failure investigations. In life sciences, our team continued to leverage their expertise in engineering, manufacturing, and human factors to understand the root causes of medical device safety concerns. The energy transition continued to be a driver as we advised clients facing infrastructure disputes involving wind, solar, and large-scale energy storage. During the quarter, we continued to see headwinds in the chemical sector as some clients paused near-term litigation work. Within our proactive services, engagements in the quarter were driven by our asset integrity work in the utility sector. For example, evaluating ignition risks and mitigations for electrical infrastructure, and in transportation, evaluating vehicle emissions technologies.

While we continued to experience headwinds in the consumer electronics industry related to product lifecycle, timing, and broader industry impacts, we are seeing more signs of stabilization. Our product development consulting activities began to recover modestly in the quarter and were encouraged by an uptick in human subject research engagements. Turning to our segments, Exponent's Engineering and Other Scientific segment represented 84% of revenues before reimbursements in the second quarter. Revenues before reimbursements in this segment increased 4%, driven by demand for Exponent services across the transportation and energy sectors. Exponent's Environmental and Health segment represented 16% of revenues before reimbursements in the second quarter. Revenues before reimbursements in this segment decreased 4% due to ongoing headwinds in the chemical sector.

Looking ahead, accelerating transformation across industries will continue to create attractive market opportunities, from groundbreaking technology and data applications in life sciences to renewables and infrastructure resilience in the energy sector and electrification and automation of transportation. Exponent remains well positioned to support our clients with vital insights for current challenges while preparing the path toward the future. Considering our encouraging performance in the first half of 2024 and the outlook for the remainder of the year, we are raising our full year revenue and margin expectations. Rich will take us through the details of that. However, we still face headwinds in the chemical sector, as well as tough comparisons based on unusually strong prior year growth in our reactive services. Over the last several quarters, our incredible team has demonstrated agility in adapting to ongoing dynamics in both our consulting and our talent marketplaces.

Going forward, we will continue to leverage and build upon our diversified portfolio of talent and capabilities as we flex to meet market demands. I'll now turn the call over to Rich to provide more detail on our second quarter results, as well as discuss our outlook for the third quarter and the full year 2024.

Rich Schlenker (EVP and CFO)

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 second quarter of 2024, total revenues were approximately flat at $140.5 million, and revenues before reimbursements, or net revenues, as I will refer to them from here on, increased 2% to $132.4 million, as compared to the same period in 2023. Net income for the second quarter increased to $29.2 million, or $0.57 per diluted share, as compared to $25.7 million or $0.50 per diluted share in the prior year period.

The realized tax benefit associated with accounting for share-based awards in the second quarter of 2024 was $700,000, or $0.01 per diluted share, as compared to an immaterial impact in the second quarter of 2023. Inclusive of the tax benefit for share-based awards, Exponent's consolidated tax rate was 26.3% in the second quarter of 2024, as compared to 29% for the same period in 2023. EBITDA for the quarter increased 8% to $39.9 million, producing a margin of 30.2% of net revenues, as compared to $36.8 million, or 28.4% of net revenues in the same period of 2023. This year-over-year increase in margins was driven by an increase in utilization during the second quarter of 2024.

Billable hours in the second quarter were approximately 381,000, a decrease of 2% year-over-year. This decrease was primarily related to the year-over-year decline in machine learning data studies for consumer electronics clients. The average technical full-time equivalent employees in the second quarter were 975, which is a decrease of 9% as compared to one year ago, as we have strategically aligned our resources with demand over the past year. Utilization in the second quarter was 75%, up from 69% in the same period of 2023. As Catherine mentioned, our efforts to align our operating model to the market demand, while also selectively expanding our capabilities, drove utilization back to historical norms. The realized rate increase was approximately 4% for the second quarter as compared to the same period a year ago.

In the second quarter, after adjusting for gains and losses in deferred compensation expense, compensation was approximately flat. Included in total compensation expense is a deferred compensation gain of $875,000, as compared to a gain of $4.1 million in the same period of 2023. As a reminder, gains and losses and deferred compensation are offset in miscellaneous income and have no impact on the bottom line. Stock-based compensation expense in the second quarter was $5.6 million, as compared to $5.2 million in the prior year period. Other operating expenses in the second quarter were up 9% to $11.2 million, driven primarily by increased engagement at our offices and investment in our corporate infrastructure. Included in other operating expenses is depreciation and amortization expense of $2.5 million for the second quarter.

G&A expenses declined 9% to $6 million for the second quarter. This decrease was primarily due to decrease in travel and meals and bad debt expense. Interest income increased to $2.2 million for the second quarter, driven by an increase in interest rates. Miscellaneous income, excluding the deferred compensation gain, was approximately $800,000 in the second quarter. During the quarter, capital expenditures were $1.1 million, and we distributed $14.2 million to shareholders through dividend payments. Turning to our outlook. For the third quarter, 2024, as compared to one year prior, we expect revenues before reimbursements to be approximately flat and EBITDA to be 26.75%-27.5% of revenues before reimbursements. As Catherine mentioned, we are raising our revenue and margin expectations for the full year 2024.

For fiscal year 2024, we expect revenues before reimbursements to grow in the low- to mid-single digits, and EBITDA to be 27.5%-28% of revenues before reimbursements, as compared to 27.7% for fiscal 2023. Both our current and previous guidance are inclusive of the extra week in the fourth quarter, which occurs approximately every sixth year, which is estimated to contribute an additional 5% to net revenues in the fourth quarter or 1.25% for the year. We expect sequential revenue, sequential growth in headcount by the end of the third quarter. The average technical full-time equivalent employees in the third quarter of 2024 will be approximately 1% less than in the second quarter. As a result, average FTEs for the third quarter will be down approximately 8% year-over-year.

We expect headcount to grow sequentially in the fourth quarter and year-over-year average FTEs in the fourth quarter to be down 4%-5% on a year-over-year basis. We expect utilization in the third quarter to be 71%-73%, as compared to 70% in the same quarter last year. We expect the full year utilization to be 70.5%-72.5%, as compared to 69% in 2023. We still believe our long-term target of sustained mid-seventies utilization is achievable as we continue to strategically manage headcount and balance utilization based on market demands. We expect the 2024 year-over-year realized rate increase to be 4%-4.5% for the third quarter and full year. For the third quarter, we expect stock-based compensation to be $5.2 million-$5.5 million.

For the full year, we expect stock-based compensation to be $23 million-$23.5 million. For the third quarter, we expect other operating expenses to be $12.5 million-$13 million. For the full year, we expect other operating expenses to be $46.75 million-$47.75 million. It should be noted that on June 19, 2024, we exercised an option to early extend the lease for our testing and engineering center in Phoenix, Arizona. Although our current lease does not expire until 2028, we wanted to lock in the pricing at this time. Although we will not pay any higher rent until 2028, the lease accounting rules require us to recalculate the rent expense for the length of the new lease period.

This resulted in an immediate increase in our non-cash rent expense of $150,000 during the second quarter, and an increase of $1.1 million during each of the third and fourth quarters. We are very excited to secure this facility as we believe it will continue to be an integral part of our growth. For the third quarter, we expect G&A expenses to be $5.5 million-$6 million. For the full year 2024, we expect G&A expenses to be $23.5 million-$24.5 million. We expect interest income to be $2 million-$2.5 million per quarter for the remainder of 2024.

In addition, we anticipate miscellaneous income to be approximately $500,000-$600,000 for the third quarter of 2024, and $100,000-$200,000 in the fourth quarter. This includes an expected sequential decrease in rental income in the third and fourth quarters due to the loss of a tenant in our Menlo Park building, which we own. For the remainder of 2024, we do not anticipate any additional tax benefit associated with share-based awards. For the third quarter of 2024, we expect our tax rate to be approximately 28%, as compared to 27.9% in the same quarter one year ago. For the full year, 2024, the tax rate is expected to be 26.7%-26.9%, as compared to 25.1% in 2023.

The increase in the tax rate is due to less tax benefit from share-based awards in the first quarter.... In closing, we are pleased with the expanded profitability this quarter and remain focused on growing and maintaining the balance between our operating model and market demand. I will now turn the call back to Catherine for closing remarks.

Catherine Corrigan (CEO)

Thank you, Rich. Exponent thrives in the complexity that abounds in products, technologies, and regulations. In this environment of relentless innovation and safety-critical applications, we are focused on fueling the growth engines of the future through expanded capabilities, recruitment of top talent, and development of our exceptional team. Looking forward, we will maintain our strategic positioning on the cutting edge of innovation and remain steadfast in our ability to deliver sustained profitability and long-term shareholder value. Operator, we are now ready for questions.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Andrew Nicholas with William Blair. Please go ahead.

Andrew Nicholas (Equity Research Analyst)

Hi, good afternoon. Thank you for taking my questions. I wanted to first ask about kind of the second half outlook. It looks like you're expecting maybe a bit better growth than we had thought previously in the third and fourth quarter. And I'm just wondering, you know, what's driving that? Is it specific momentum in any specific practice? Is it some increased optimism on the consumer product side? Is it increased visibility in consistent conditions? Just any more color on what gives you more conviction in growth in the back half of the year, that'd be great.

Catherine Corrigan (CEO)

Yeah. Yeah. Thank you, Andrew. I'll start, and Rich can, of course, add on here. But thinking about the electronic side, that is certainly part of the equation here. You know, we're very pleased to have seen sequential improvements in the last, you know, really in Q1 and Q2, around our user research work and our machine learning data studies in electronics. You know, we continue to be in close conversations with that client group and talking to them a lot about what the back half of the year looks like. You know, we're getting some more visibility into Q3. We're seeing signs of that sort of continuing trend of some sequential improvement. And on the other side of the house, in electronics, that's more of the hardware-related work and the product development consulting work.

This is another area where we've seen, you know, some upticks, some modest sort of improvement there. So there is, you know, there are good signals coming from that side of the market. So we're pleased with that, and that's, you know, certainly part of the equation. You know, we are encouraged by the general outlook on the market drivers as well in our reactive business when you look at the work we're doing in Advanced Driver Assistance Technologies, and other areas of automation and electrification and transportation and, you know, work around wearables that we're doing as well. You know, this has given us some encouragement, I would say, you know, as we look into the back half of the year.

Rich Schlenker (EVP and CFO)

Yeah, I would just add, you know, we clearly knew that, yes, there were, you know, some areas that we needed to work through relative to the consumer electronics and still some headwinds in chemicals. But the biggest thing that we had a real, you know, question of trying to forecast is how strong we would—where we'd end up being able to come out relative to a really exceptional growth rate that we had last year in the reactive business. You know, something we've been doing for 57, 58 years here now, 57 years, I guess.

And, to be able to last year, you know, the second quarter, having reactive growth that was 20%, the third quarter, being even higher than that, into the low 20s%, and continuing, to be in the high teens%, even in the, in the fourth quarter. You know, the fact that we, you know, we realized that we had some a plethora of good-sized jobs during that period of time, and what was that to mean for going forward? And I think we're very encouraged by the fact that we were able to grow, on a year-over-year basis here, in that area in the second quarter. Not modest, you know, we, we don't, even 6% growth there, we want to see it be better.

We realized that the overall guidance here, performance of 2% net revenues in Q2 and flat in Q3 are not, you know, inspiring on the surface. But when you look at the market that we're in and the growth we've been getting over the last several years, and last year's growth was not over negative circumstances the prior year. That had strong growth, too. So we're just very, you know, yeah, there's always timing. It's, you know, we're a public company. We know we're held accountable to the quarters, but the underlying demand that this is demonstrating is encouraging for the long term. We've got to work through these periods, but I think long term, we're very encouraged.

Andrew Nicholas (Equity Research Analyst)

Very helpful. Thank you. Then maybe as a follow-up to that commentary, if you could just talk to us a little bit about headcount and ambitions on the hiring front. It certainly seems like things are turning around and improving enough to wanna lean back into headcount growth. If you could just kind of talk about whether or not that aligns with how you're thinking about it, or if you're hesitant to do that, absent maybe a multi-quarter recovery, would appreciate it. Thank you.

Catherine Corrigan (CEO)

Yeah. Thanks, Andrew. So we are, we are absolutely in recruiting mode, but it is strategic based on the areas of the market where we see, you know, the key growth opportunities. And this has always been our philosophy, as you know, that we target our recruiting in those areas because, you know, it's those individuals, as they develop, who truly are the engines of growth for the future. And so, you know, we are still getting through some of the ripples in headcount, and, you know, we've been able to balance that to get our utilization back where we would like it to be. And we are hiring. You know, we are coming into the fall recruiting season at the universities. That is a really important time of year for us.

Not the only time of year that we hire new PhDs, but it's a really important one. And so we are already those engines are running, you know, and we are interviewing in those key areas, you know, vehicle automation and batteries and sensor technology, and over on the health side, you know, toxicologists and epidemiologists. These are all areas of, you know, disciplines where we need those, those growth engines. So for sure, we are in that mode.

Rich Schlenker (EVP and CFO)

Yeah, I think it's, you know, it's always, you know, you gotta turn it back around. You know, it's recruiting in PhDs, and that is a longer game. And, you know, we didn't let up on that, keeping our market recognition and doing those things, but it's there, that was there. You know, I just, you know, it's important for all of us to remember, you know, we got ourselves into it, but the last year, in the second quarter, headcount growth year-over-year in Q2 of 2023 was 15%. And, yes, you know, that came from low turnover and high acceptance rates and, and lots of other things, but we, we were there.

We did need to gradually make an adjustment to that, which we've tried to do in a prudent way, as Catherine described in the performance management and moderating recruiting. But, you know, that led to, I think, a really sort of healthy place that we are now, where we came down 9% off of that. But we, you know, we didn't take it all back. We, we are built, and I think with that 75% utilization in the second quarter, which is slightly better than first quarter, when you adjust for holidays and vacations. There's more holidays and vacations in the second quarter than the first, and then it takes another, you know, a couple point step down in the third quarter, and then again in the fourth because of the timing of holidays and vacations.

But that equal utilization in Q2 means it's a slight tick-up in utilization. Now, that came because the headcount was slightly down, but overall, I think it's getting into a good balance and gives ourselves a position where our business units can be more comfortable leaning into the recruiting and hiring process.

Andrew Nicholas (Equity Research Analyst)

Thank you very much.

Operator (participant)

The next question is from Josh Chan with UBS. Please go ahead.

Josh Chan (Executive Director and Equity Research Analyst)

Hi, good afternoon. Thanks for taking my questions. Maybe on the headcount topic, how do you feel like your Q4 projected exit rate will position you for any growth that you expect in 2025? I guess you're exiting the year possibly in low 70s% utilization already. So just kind of curious how you're thinking about headcount versus growth going into next year again.

Rich Schlenker (EVP and CFO)

Yeah, first of all, I'll address the utilization, you know, part of that, because obviously that you're trying to keep that model. You know, I think what we're expecting is utilizations that are give or take around what we're guiding here in the third quarter, adjusted for what we have in additional vacations and holidays that occur in the fourth quarter. That's what we would expect in it. Yes, it's lower, but it's because only of that adjustment, so we're not... You know, we're expecting that. Secondly, on the exit, I would expect us to be, again, having momentum moving in the sequential growth area....

We will have to see where that's progressing, how far we've gotten along on that, and where we are in our 2025 planning that we'll do this. We're just gonna get started on here this fall, about where we are. Because we've still got a lap where we were in Q1 and Q2 that have stepped down. I'm based on those sequential step downs, at this time, I'm not prepared to predict that it will, you know, where it'll be relative to, you know, it will still be a little bit down year-over-year, early in the year, because of still trying to catch up, or will we have brought that even or up?

I think, we need, you know, we need a few more months, to be able to see what we've got lined up to come out of the year and what we've got lined up for early, acceptances into 2025, and we probably won't have that until we get into the fourth quarter.

Josh Chan (Executive Director and Equity Research Analyst)

Okay, perfect. Thanks for that color, Rich. And maybe my second question is on the Q3 growth guidance. Is there any reason why growth slows down in Q3 versus Q2? I know that you mentioned the reactive comp gets a little tougher, but yeah, I wonder if there's any other reasons behind the slightly more moderate growth in Q3 than Q2. Thank you.

Rich Schlenker (EVP and CFO)

Yeah, it really is about... Well, first of all, I think it is two things. One, it is the comp comparison here. If you look at what we did, I talked about the fact that Q3's growth rate in reactive business was in the low 20s% growth rate a year ago in the third quarter versus 2022 there. And overall, as a company, we grew 10% including the fact that we had a 5% drop in consumer electronics as an overall business. So that area had a negative 5%. So ex consumer electronics, a year ago, we had that sort of 15%. So very strong, a lot of litigation stuff, lot of other activities that were very, very strong in that period. So those comparisons.

In addition to that, we, we do have a few, you know, good projects that we had in a couple of areas in the second quarter that are stepping down in the third quarter. And so we have a little bit of headwind, you know, a little bit of step up of those activities, and we've accounted for that in the guidance that we provided as well.

Josh Chan (Executive Director and Equity Research Analyst)

Thanks for the color there, and congratulations on the group.

Rich Schlenker (EVP and CFO)

Thank you.

Operator (participant)

Again, if you have a question, please press star, then one. The next question is from Tobey Sommer with Truist. Please go ahead.

Tobey Sommer (Managing Director)

Thanks. I was interested in getting your updated perspective on AI-related projects. Maybe how often that is coming up in your new business and how it might compare to, you know, 2, 3, 4 quarters ago, if it's increasing or decreasing? And what your expectation is for the, the relevance of that as a, as a topic and driver for your business.

Catherine Corrigan (CEO)

Yeah. Thanks, Tobey. So we continue to see AI coming in in different ways. You know, and we've talked about some of these before. One is our traditional failure analysis work, but oriented toward a system that is making decisions using, you know, artificial intelligence. So this is our Advanced Driver Assistance Technologies in transportation. That is an area that continues to grow as the questions of, you know, whether you equipped your vehicle with that, transition into even more complex question of: did your vehicle systems perform properly now that they had it? And we're seeing, you know, early signs of encouraging trends around testing in that area. We have been developing some very novel test methodologies that are drawing, you know, business around that, the litigation side for that.

You know, this is part of our investment in our Phoenix facility that Rich mentioned. So we're seeing it there. We're still fairly early in the curve around the medical device side of questions around AI in terms of the reactive business. But that is, I think, coming. This is, you know, the wearable that is, or the glucose monitoring system or what have you, that is making decisions about health-related aspects using an artificial intelligence algorithm. There are also places where we are seeing more and more opportunities to leverage machine learning in the way that we solve problems for clients.

So they come to us with a question about the durability of their packaging during shipping, and we can use machine learning to take massive amounts of data about the exposure of that packaging during its journey and make decisions about what testing that packaging needs to be exposed to in order to, you know, be robust in that application. So, you know, creating great efficiencies for our clients. So we're using the tools and developing the tools to answer the questions. And then there are also, of course, just the fundamental questions about the algorithms themselves and, you know, software as a medical device and, and areas like that. So still relatively early days on some of those more proactive areas.

But I am encouraged by, you know, the continued development of our capabilities and our increasing use of machine learning in our applications to solve problems.

Rich Schlenker (EVP and CFO)

Yeah, I think one other, one or two other things to add on there. I really think that the real questions that are coming back, and increasingly coming back around our studies are really about, help us benchmark, and understand, how our, our health applications, algorithms are, and applications are performing versus a medical device or versus a gold standard in what they're doing. And what we need to do-- what the client-- what we can do to help the client in gathering enough data in the training and doing it. So benchmark and then augment so that you can continue to get, that improvement out of it. Is it improve the hardware and the sensor, or is it improve, the algorithm machine learning tool, that you're doing there? So that's a big area.

And the other one, and we've been deep in that one in multiple clients, multiple applications. The other one is really as our clients in the utility sector are building and relying upon risk models here to make decisions about, you know, the reliability and the decision of when to shut power off in their systems in extreme weather events. And what is happening is we're able to help them in validating the data and the algorithms here so that they can build more robust and reliable decision models in that environment.

Tobey Sommer (Managing Director)

Thank you very much. Hey, in your conversations with customers and in, when you're hearing from, you know, senior consultants, what are you hearing about any impact that global elections are having? And I guess I tailor the question a bit more towards proactive, is my assumption, but I'll let you respond. 'Cause we've already had globally some surprise snap elections with unanticipated outcomes, and now we're in the middle of our own relatively unusual election process.

Catherine Corrigan (CEO)

Yeah. Yeah, thanks, Tobey. You know, certainly always paying attention to, you know, these sorts of things. Historically, the company has not, you know, there hasn't been a time when we've seen significant swings, you know, with administrations changing and things of that nature. Of course, you know, changes of administration around the globe can absolutely have an impact on regulatory frameworks, and, but, but we find that they don't change overnight. And we also find that even, even efforts to perhaps ease on regulation, you know, tend to be counterbalanced over time with society's increasing expectations around safety, health, and the environment. And we're also able to, you know, because of different parts of the portfolio, you know, let's say there is a deep pullback in regulations, and there's more building of, of pipelines.

You know, that can increase some of our opportunities on the reactive side around construction disputes. Whereas, if you're driving, you know, more, you know, higher bars in regulation, then we get more work around our chemicals area, and human exposure and things of that nature. So we've found there to be a balancing aspect there. And, you know, it hasn't been any different so far. But another question, related question that we're getting asked and absolutely tracking is the potential impact of the Chevron decision by the Supreme Court. The Chevron case, in overturning that case, it really empowers regulated entities to challenge some of the regulations based on how they're grounded in science and in engineering.

And so, look, we haven't seen a step change or anything like that, but we're tracking closely. We're engaged with our clients and wouldn't be surprised to see increasing questions over time about the scientific foundations of these regulations. And when regulations get complicated, and there are those kinds of questions, and they're about health and safety and the environment, we'll certainly be well positioned to capitalize on that, you know. But again, no, no material change in a step function kind of way.

Tobey Sommer (Managing Director)

I appreciate you leading right into Chevron, 'cause that's where I was going next. Thank you very much.

Catherine Corrigan (CEO)

You're welcome.

Operator (participant)

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.