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spk07: Good day, and welcome to the Exponent's second quarter earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the start key followed by zero. 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 Constantelos with Investor Relations. Please go ahead.
spk01: Thank you. Good afternoon, ladies and gentlemen. Thank you for joining us on Exponent's second quarter 2023 financial results conference call. Please note that this call will simultaneously webcast on the investor relations section of the company's corporate website at www.exponent.com backslash 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 Lenker, 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, exponents 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. Katherine Corrigan, Chief Executive Officer. Katherine?
spk02: Thank you, Joni, and thank you everyone for joining us today. I will start off by reviewing our second quarter 2023 business performance. Rich will then try to provide a more detailed review of our financial results and outlook, and we will then open the call for questions. We delivered solid second quarter results, growing net revenues by 10% and expanding earnings per diluted share. We continue to demonstrate the strength of our diverse and ever-evolving services portfolio, which anticipates and adapts to our clients' critical needs throughout their product life cycles. Growth in the quarter was driven by robust demand for our reactive offerings. The proactive side saw increased demand in the chemicals and life sciences sectors, offset by some moderation in the electronics sector. Overall, our strategic mix of capabilities across industries and the product lifecycle performed well despite specific headwinds that I will discuss in a moment. Turning to our engagements in more detail, within our reactive services, we saw strong increased demand for our disputes and litigation-related work, with particular strength in the transportation, construction, and consumer products sectors. On the automotive side, we are fielding more and more questions about the design and performance of advanced driver assistance and battery systems in accident scenarios as these technologies become more complex and more prevalent in the fleet and the decisions made by artificial intelligence algorithms are challenged. We also saw increased product safety and recall related engagements as clients leveraged our expert insights to understand the root cause of issues with their products. The proactive side benefited from increased demand in the chemicals and life science sectors, driven in large part by regulatory engagements. This was offset by some moderation in the electronics industry, associated with the timing of client product releases, coupled with the disruption caused by the actions the industry has taken to reduce staff. These factors impacted data gathering activities and human subject research, as well as product development consulting. as products moved through their life cycles out of the development stage and into the refinement stage. While we expect these trends within electronics to persist over the next few quarters, we are optimistic about the longer term opportunities in this sector. We are well positioned given the increasing role of artificial intelligence in product innovation and performance with our capabilities in curating data to drive AI algorithms as well as our experience analyzing the physical consequences of AI-driven decisions. Our diverse portfolio of proactive offerings positions us well to capitalize on the complexities associated with next-generation designs and increasing expectations around safety, health, and the environment. Improved retention, as well as our accelerated recruiting efforts over the last year, drove a 15% increase in headcount year over year, which reflects the strength of our employee value proposition. While these investments in our talent are critical for our future growth, we remain diligently focused on aligning our resources with the growth of the business and future opportunities. Rich will share some additional color on our expected headcount growth in a few moments. Turning to our segments, exponents engineering and other scientific segment represented 83% of our net revenues in the second quarter. increasing 10% in the second quarter and 11% in the first half compared to the prior year. Growth in the quarter was driven by strong demand for exponents services across the transportation and construction sectors. Exponents environmental and health segment represented 17% of the company's net revenues in the second quarter. Net revenues in this segment increased 10% in the quarter and 4% in the first half compared to the prior year. Growth was driven by regulatory consulting around the impacts of chemicals on human health and the environment, as well as activity in the life sciences sector. As we move into the back half of the year, we remain focused on strengthening our client relationships, managing resources in line with the growth of the business, and meeting the dynamic needs of our clients. Overall, I am pleased to see the power of our diverse portfolio delivering solid growth through economic cycles as we address our clients' most complex challenges. 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 2023.
spk03: 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 2023, total revenues increased 7.6%, to $140.2 million. And revenue before reimbursements, or net revenues as I will refer to them from here on, increased 9.7% to $129.7 million as compared to the same period of 2022. Net income for the second quarter was 25.7 million, or 50 cents per diluted share, as compared to 25.8 million for $0.49 per diluted share in the prior year period. The realized tax benefit associated with accounting for share-based awards was immaterial in the second quarters of 2023 and 2022. X-Funded's consolidated tax rate was 29% in the second quarter, as compared to 27.3% for the same period of 2022. EBITDA for the second quarter decreased less than 1% to $36.8 million, producing a margin of 28.4% of net revenues as compared to $37.1 million, which was a margin of 31.4% in the same period of 2022. The year-over-year step-down in margins was anticipated as expenses normalized post-pandemic. Billable hours in the second quarter were approximately 388,000, an increase of 4.4% year-over-year. The average technical full-time equivalent employees in the second quarter were 1,077, which is an increase of 15% as compared to one year ago. This exceeded our expectations as recruiting has been very successful and retention has improved. Utilization in the quarter was 69%, down from 77% in the same period of 2022. While we expected utilization to decline from the elevated level it was in the second quarter of last year, Our higher than anticipated headcount resulted in lower utilization in the quarter. As Catherine mentioned, we are diligently focused on strategically balancing our resources with the growth of the business and our pursuit of future opportunities. The realized rate increase was approximately 5.3% 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 expense increased 12.6%. Included in total compensation expense is a deferred compensation gain of $4.1 million as compared to a loss of $11.3 million in the same period of 2022. This is a $15.4 million swing. As a reminder, gains and losses in deferred compensation are offset in miscellaneous income and have no impact on the bottom line. Stock-based compensation expense in the second quarter was $5.2 million as compared to $4.6 million in the prior year period. Other operating expenses in the second quarter were up 17.7% to $10.3 million, driven primarily by increased employee activity at our offices. Included in other operating expenses is depreciation and amortization expense of $2.2 million for the second quarter. G&A expenses were up 15.6%. to $6.6 million for the second quarter. The increase in G&A expenses was primarily due to increased travel as employees returned to in-person engagement with clients and professional development. Interest income increased to $1.6 million for the second quarter, driven by an increase in interest rates. Miscellaneous income excluding the deferred compensation gain, was approximately $700,000 in the second quarter. During the quarter, capital expenditures were $5.4 million, and we distributed $13.2 million to shareholders through dividend payments. We ended the second quarter with $148.2 million in cash and cash equivalents.
spk04: Turning to our outlook. Our full year 2023 outlook is unchanged.
spk03: For the third quarter, 2023, as compared to one year prior, we expect revenues before reimbursements to grow in the high single to low double digits and EBITDA margin to be 27.5 to 28.5% of revenues before reimbursements. For the full year, 2023, as compared to one year prior, We are maintaining our guidance and expect revenues before reimbursements to grow in the high single to low double digits and EBITDA margin to be 28% to 28.5% of revenues before reimbursements. As mentioned, we remain focused on strategically aligning our headcount with the growth of the business. These actions include reducing hiring and increasing performance management. As a result, in each of the next two quarters, we expect technical full-time equivalent employees to decline sequentially 2% to 3%. Over the next quarter or two, our hiring will be surgical in nature to address areas of high utilization and strategic growth. We have also increased performance management, which will increase turnover. Performance management is ongoing in our firm, as we evaluate each employee's career trajectory towards determining if they are on a path to principal or if their career skills are better aligned with a career in industry, government, or academia. Performance management tends to be less when resources are constrained and turnover is high, such as in 2021 and 2022. We expect utilization in the third quarter to be 68 to 70% as compared to 73% in the same quarter last year. Utilization in the third quarter will continue to be tempered by increased headcount as well as seasonally higher vacation and holiday time during the summer months. Our expectations for full year utilization is 69 to 70% 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 demand. We expect the 2023 year-over-year realized rate increase to be 4.75% to 5.5%. For the remaining quarters, we expect stock-based compensation to be $4.8 to $5.2 million. For the full year, 2023, we expect stock-based compensation to be $22 to $22.8 million. For the third quarter, we expect other operating expenses to be $10.7 to $11 million. For the full year, we expect other operating expenses to be $41.7 to $42 million as in-office activities continue to pick up. G&A expenses are increasing as post-pandemic travel increases for business and professional development. For the third quarter of 2023, we expect G&A expenses to be $7.3 to $7.7 million. For the full year, we expect G&A expenses to be $26.7 to $27.2 million. We expect interest income to be approximately $1.8 million per quarter for the remaining quarters of 2023. In addition, we expect miscellaneous income to be approximately $750,000 per quarter. For the remainder of 2023, we do not anticipate any additional tax benefit associated with share-based awards. So, the year-over-year tax benefit associated with share-based awards will be $2.4 million, less than it was in 2022, which is five cents per diluted share impact to EPS. For 2023, we expect our tax rate exclusive of the tax benefit for share-based awards to be approximately 28.5% as compared to 27.0% in 2022. For the third quarter of 2023, we expect our tax rate to be approximately 29% as compared to 27% in the same quarter a year ago. For the full year 2023, the tax rate inclusive of the tax benefit for share-based awards is expected to be 26.1% as compared to 22.6% in 2022. In closing, our second quarter results continue to underscore the strength of our business model and financial position. As we look to the back half of the year, we remain positioned to continue our profitable growth. I will now turn the call back to Katherine for closing remarks.
spk02: Thank you, Rich. Exponent continues to advance science and engineering to empower our clients with solutions to their most critical challenges. We are uniquely positioned to advise them as they navigate the complexity of society's increasing expectations around safety, health, and the environment. Supported by the strength of our world-class team and our ever-evolving services portfolio, we remain confident in our ability to drive profitability and shareholder value over the long term. Operator, we are now ready for questions.
spk07: We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Josh Chan from UBS. Please go ahead.
spk05: Hi. Good afternoon, Catherine and Rich. Thanks for taking my questions. Hi there. Hello. I guess maybe I can start with a two-part question on demand. I guess first on the reactive side, it seems like that business is growing above what it normally grows at, and Catherine, you brought up some points on what's driving that, but I guess do you feel like that above normal growth is sustainable going forward? And then secondly, on the proactive side, it's hard to tell whether that business maybe decelerated a little bit in Q2. It sounds like it might have, but if there's a way you can kind of ballpark for us how broad-based the choppiness has been, that would be really helpful.
spk02: Yeah, thanks. Thanks, Josh. So, you know, first on the reactive side, look, I mean, we see the increasing complexity that is coming around products as a real driver of that reactive work. You know, I did give the example around advanced driver assistance systems As artificial intelligence is incorporated even more into products and making those decisions, it could be an automated vehicle. It could be a wearable device that's giving signals about human health. It could be an AR or VR or mixed reality device that's making decisions as well, whether that's around employee training or various things. we are positioning ourselves at the forefront of those questions, you know, through our research and through the professional development of our teams. And so, you know, we don't think this is necessarily a blip in the growth and our reactive work. We think that portfolio has very, very strong market drivers, you know, that in addition to, you know, the opportunities for expansion internationally around disputes, changes in the landscape in the EU around, product recalls and those frameworks. And so, you know, we really are optimistic about the growth potential for that side of the portfolio. You know, on the proactive side, we did talk about, you know, some of the moderation that's happened. You know, we've got strength in a number of areas. Growth around the regulatory side in agricultural chemicals, for example. Growth on the pharma side in life sciences. But the electronics industry, that is a place where there is some moderation. And a couple of factors that are weighing into that. There was some disruption caused by the layoffs that impacted the flow of work in electronics layoffs in the industry. This is groups that are having to reconfigure and stabilize. That takes a couple of quarters to sort of work its way through. We're seeing signs of that stabilizing that workflow starting to come back through. But some of our data collection work, our human subject work, these are impacted in the near term by the product lifecycle. It's where our clients are in that product lifecycle. There can be a big push in the development phase and a big product launch, and then that goes into the refinement phase, and it can ebb and flow. Because of that, you know, we see these clients also managing their budgets a little more tightly which isn't surprising So, you know, we're seeing we're expecting that over the next couple of quarters, you know, we saw it in q2 And and probably we'll see it over a couple more quarters, but you know long term you know this focus that society has on the quality of the data that's driving and training AI algorithms and the quality of the decisions it's making and the competitive landscape in that industry. Um, that all makes us feel, feel good in the longterm about these kinds of, uh, offerings that we have. And of course we'll continue to evolve those offerings to really capture, um, you know, what we think is a, is a good longterm opportunity.
spk05: Thanks, Catherine. That's a really good color there. I appreciate that. Um, And then I guess like my second question on margins this quarter, just conceptually, it seems like utilization kicked down from Q1 going to Q2, but somehow you were able to deliver stronger margins this quarter. So could you talk about what's driving that kind of sequential margin improvement, even though you didn't have the utilization help there?
spk03: Yes. So the margin improvement there is coming from the balance on the compensation line. So we do tend to have higher compensation costs in the first quarter on a stock-based basis. So in the first quarter, that was about $7 million. In the first quarter, we had about $5.2 million in stock-based compensation in the second quarter. And that's all around the timing of when we issue our grants and the accounting for those that pushes through. In addition to that, a lot of our hiring has been very much at the entry level. So when you balance that with where the rates are on bill rates versus the change in the compensation area, you get the benefit of that also pushing through.
spk05: Okay. Thanks for that, Rich. And I guess lastly... how are you seeing the impact between revenue per billable hour growth and wage inflation? I think you gave some color on what you expect for revenue per billable hour for the year, but just wondering how you're thinking about that balance. Thank you.
spk03: Yeah, so on a per consultant basis, what we've seen, or a per dollar basis there, we haven't, we've seen our rate increase on, even though we gave pretty substantial raises to our existing staff effective April 1, and all those raises were there and in place in the second quarter. That was blended down to basically a flat to 1% sort of rate increase that we saw across because of the mix of employees that we had coming in. So the mix of employees that we had generated a flat to slightly up wage increase at the same time that that mix generated approximately 5.3% increase in the billing rates.
spk05: Great. Thank you for that, and thanks for your time.
spk07: The next question comes from Toby Sommer from Truist. Please go ahead.
spk06: Thanks. I wanted to follow up on sort of the broad headcount in revenue and expense growth. Are you comfortable with this amount of headcount growth and the near-term demand picture so that you can continue to maintain a bottom-line growth rate sort of in excess of your revenue growth?
spk02: Yeah, thanks, Toby. So, look, we are looking to slow that headcount growth. You know, there are – to make sure that we're aligning that with the near-term and longer-term demand and the opportunities that we're seeing. You know, there are two – really two prongs to that approach, right? I mean, we've got the recruiting side – You know, so we've got a number of areas, many areas in the business. In fact, most of them are growing and strong, right? And so, you know, we need to be recruiting in those areas. And we're very focused on surgically recruiting strategically to make sure, you know, when our resources are constrained that we can meet the market and meet that demand. So, for example, the reactive side of the business and like that advanced driver assistance area, this is a place where we want to be recruiting to capture that. But the other side of managing that headcount and working to bring that down is through performance management. Rich mentioned a little bit about this. We're always looking for that best talent. That's what we're all about. We have this rigorous process of acquiring them a paradigm that puts them on a growth path from day one, but making it all the way to principal at Exponent as a consultant, it's hard. It's not for everyone. And so, you know, many employees can reach a point in their career where there are better opportunities for them elsewhere, right? And so we can counsel them about that, and that's what our performance management process is all about. So as Rich said, you know, sequentially bringing that head count down by two to 3% per quarter over the next couple of quarters is what we're doing in order to bring those two things back into balance again.
spk06: I appreciate that. Could you speak to artificial intelligence and all its forms and what you think it means internally for your company, how you engage with your customers and ultimately how it may impact demand for your services?
spk02: Yeah, yeah. I mean, we are engaged and have been engaged sort of across the life cycle of artificial intelligence algorithms. So you start with the data that you feed into them in order to create them, right, the training data sets. It's very important to make sure that those have the right diversity demographics, you know, the curation of those data sets is an important part of that first step. We talk to clients about that. You know, we talk about the sort of ontologies that are used and the cleaning of the data because real-world data are messy, right? We all know that an exponent has a history of being able to take real-world data and and gain insights from that because of our subject matter expertise. So the theme, Toby, when we're talking to clients is really about this is where AI meets the laws of physics. Exponent has a long history of applying their understanding of the laws of physics to understand the consequences of all kinds of different decisions. and that design decisions for products, decisions around the management of assets for a utility, whatever the case may be. And so it's that combination of the data you're using to drive the algorithm, the laws of physics that you are applying to make it real, and then the decision that is coming out the other end. And we have opportunities at every stage of that process, you know, because of the foundation we've laid in, you know, working around the product life cycle for many, many years. And so, you know, the key is where it meets the laws of physics, where it meets human behavior, and our ability to cross industries with that, with those assessments, I think is an incredible value proposition that positions us really well to capture growth there.
spk03: And so, you know, as Catherine had said earlier, you know, where we've already done this work and are gaining top recognition in the marketplace by key players over the last even year or two is in the automated vehicle or really actually in the ADAS systems, the subsystems within those vehicles. You don't need to be fully autonomous to have a braking decision or a steering decision or those other things. It's been in the risk models and decision models that utilities out here on the West Coast are doing to make a decision about the resiliency of their system or particular lines in making a decision at what wind speed or what environment to make a decision and do that, and to have that happen real-time as the weather is changing, as those inputs are coming in, and have that model built in an engineering environment basis so that you can rely upon those decisions you're doing. Or over into what we're seeing our clients develop in their health applications and wearable technologies where they want their customers to ultimately be able to rely upon the feedback coming from that wearable device to understand when they really need to seek medical attention and do such. And then finally, As we're moving into the AR and VR area, clients who want to have a true real-world experience and deal with the safety and reliability and quality of those experiences are wanting to make sure that they're utilizing curated data to have those experiences. So those are examples of what we've already done. I think the future is quite significant for us going forward.
spk06: Thanks. If I could sneak a last one in, can you update us on the large contract exposure or opportunity should there not be kind of classically defined large contracts. And my question comes in the context of having observed all the news around legacy telco cables with lead, which at least bond and stock markets are assuming represents pretty significant liabilities and exposures for those firms.
spk03: Yeah, I think so. We have not had a single project recently that is of that 4% to 5% of revenues. We've had collections of different areas, some of that in this data collection area that accumulate up near there, but not a single engagement around it. But you are right in the history of our history, a few of those projects that have achieved that four or five percent of revenues have been around health exposures and environmental contaminants. If you recall back in the mid-2010s here, we had our work for BP related to Deepwater Horizon fit in that. and such. So issues, we haven't had a project of this size, but we've done a lot of work over the past two decades related to asbestos and talc and other exposures there. So we have some of the leading experts in environmental and health exposure. and the consequences of that. And we'll see where this issue for industry goes.
spk07: Thank you. This concludes our question and answer session. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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