Exponent, Inc. (NASDAQ:EXPO) Q2 2019 Earnings Conference Call July 18, 2019 4:30 PM ET Company Participants Whitney Kukulka – Investor Relations Catherine Corrigan – President and Chief Executive Officer Rich Schlenker – Executive Vice President and Chief Financial Officer Conference Call Participants Joseph Thompson – SunTrust Drew Kootman – Cantor Fitzgerald Tim McHugh – William Blair Sam England – Berenberg Marc Riddick – Sidoti Operator Good day, and welcome to the Exponent’s Second Quarter of Fiscal 20 ...

Exponent, Inc. (NASDAQ:EXPO) Q1 2019 Earnings Conference Call April 18, 2019 4:30 PM ET Company Participants Whitney Kukulka - Investor Relations Catherine Corrigan - President and Chief Executive Officer Richard Schlenker - Executive Vice President and Chief Financial Officer Paul Johnston - Executive Chairman Conference Call Participants Timothy McHugh - William Blair & Company L.L.C., Tobey Sommer - SunTrust Robinson Humphrey Joseph Foresi - Cantor Fitzgerald Securities Samuel England - Berenberg Capital ...

[Part I](index=4&type=section&id=PART%20I) [Business](index=4&type=section&id=Item%201.%20Business) Exponent is a science and engineering consulting firm with two operating segments serving diverse industries - Exponent is a science and engineering consulting firm with a multidisciplinary team covering over **90 technical disciplines**[11](index=11&type=chunk) - The company operates through two reportable segments: **Engineering and Other Scientific**, and **Environmental and Health**, with 18 distinct practices[15](index=15&type=chunk) - Key client industries in fiscal 2018 were consumer products (**27% of revenue**), transportation (**16%**), and energy/utilities (**15%**)[13](index=13&type=chunk) - As of December 28, 2018, the company employed 1,122 staff, including 886 engineering and scientific personnel, of whom **584 hold a Ph.D., Sc.D., or M.D.**[63](index=63&type=chunk) [Services](index=4&type=section&id=Item%201.%20Business%23Services) The company's services are structured within its Engineering and Environmental & Health segments - The Engineering and Other Scientific segment provides a wide range of services, including biomechanics, structural analysis, electrical engineering, human factors, materials science, mechanical engineering, and vehicle analysis[15](index=15&type=chunk)[17](index=17&type=chunk) - The Environmental and Health segment focuses on chemical regulation, food safety, ecological sciences, environmental and earth sciences, and health sciences, addressing risks to human health and the environment[18](index=18&type=chunk) - The company is actively engaged in emerging technology areas, including **Advanced Driver Assistive Systems (ADAS)**, automated vehicles, and evaluating fire risks of lithium-ion batteries[31](index=31&type=chunk)[48](index=48&type=chunk) [Competition](index=12&type=section&id=Item%201.%20Business%23Competition) The company operates in a fragmented and competitive market, differentiating on technical capability and reputation - The marketplace is fragmented, and the company believes barriers to entry are low, resulting in **increasing competition**[60](index=60&type=chunk)[62](index=62&type=chunk) - Key competitive factors include technical capability, breadth of services, timely delivery, professional reputation, and knowledge of litigation/regulatory processes[61](index=61&type=chunk) [Executive Officers](index=13&type=section&id=Item%201.%20Business%23Executive%20Officers) The executive team consists of experienced leaders with advanced degrees in science and engineering - Dr. Catherine Ford Corrigan was named **Chief Executive Officer in May 2018**, succeeding Dr. Paul R. Johnston, who became Executive Chairman of the Board[67](index=67&type=chunk)[68](index=68&type=chunk) - The executive team comprises individuals with extensive experience within the company and the industry, holding advanced degrees (primarily Ph.D.s) in various engineering and scientific fields[66](index=66&type=chunk) [Risk Factors](index=15&type=section&id=Item%201A.%20Risk%20Factors) Key business risks include service unpredictability, talent retention, client concentration, and cybersecurity threats - Business is unpredictable and reactive, with engagements being terminable at any time, making **backlog an unreliable indicator** of future revenue[80](index=80&type=chunk) - Success is highly dependent on attracting and retaining key technical and managerial personnel in a competitive labor market[82](index=82&type=chunk) - The company faces risks from client concentration and financial instability, with the bankruptcy of PG&E noted for its **$6.0 million in outstanding receivables**[84](index=84&type=chunk)[86](index=86&type=chunk) - International operations expose the company to risks including currency fluctuations, regulatory burdens, and compliance with laws like the **FCPA and GDPR**[102](index=102&type=chunk) - Cybersecurity is a risk, as security breaches could disrupt operations and lead to unauthorized disclosure of confidential client or employee data[98](index=98&type=chunk)[99](index=99&type=chunk) [Unresolved Staff Comments](index=20&type=section&id=Item%201B.%20Unresolved%20Staff%20Comments) The company reports no unresolved comments from regulatory staff - None[116](index=116&type=chunk) [Properties](index=20&type=section&id=Item%202.%20Properties) The company owns and leases various office, laboratory, and testing facilities across the US and internationally - The company owns its **153,738 sq. ft. Silicon Valley facility** and an adjacent 27,000 sq. ft. warehouse in Menlo Park, CA[117](index=117&type=chunk) - A new **60,480 sq. ft. building** is under construction on 2.9 acres of land purchased in Natick, Massachusetts during Q1 2018[119](index=119&type=chunk) - Aggregate lease expense for all leased properties in fiscal 2018 was **$7,488,000**[120](index=120&type=chunk) [Legal Proceedings](index=20&type=section&id=Item%203.%20Legal%20Proceedings) The company is not currently involved in any material legal proceedings - Exponent is not engaged in any material legal proceedings[121](index=121&type=chunk) [Mine Safety Disclosures](index=21&type=section&id=Item%204.%20Mine%20Safety%20Disclosures) This section is not applicable to the company's operations - Not applicable[123](index=123&type=chunk) [Part II](index=21&type=section&id=PART%20II) [Market for Common Equity, Stockholder Matters, and Issuer Purchases](index=21&type=section&id=Item%205.%20Market%20for%20Registrant's%20Common%20Equity%2C%20Related%20Stockholder%20Matters%20and%20Issuer%20Purchases%20of%20Equity%20Securities) The company's stock trades on NASDAQ under 'EXPO' with an active share repurchase program in place - The company's common stock is traded on the NASDAQ Global Select Market under the symbol **'EXPO'**[124](index=124&type=chunk) - On January 31, 2019, the Board of Directors authorized an additional **$75,000,000** for the repurchase of the Company's common stock[126](index=126&type=chunk) Share Repurchases for Q4 2018 (in thousands, except price per share) | Period | Total Shares Purchased | Average Price Paid | Remaining Authorization | |---|---|---|---| | Sep 29 - Dec 28, 2018 | 562 | $49.63 | $17,462 | [Selected Financial Data](index=23&type=section&id=Item%206.%20Selected%20Financial%20Data) A five-year summary of financial data highlights steady growth in revenues, net income, and total assets Selected Financial Data (2014-2018, in thousands, except per share data) | Metric | 2018 | 2017 | 2016 | 2015 | 2014 | |---|---|---|---|---|---| | **Revenues** | $379,523 | $347,799 | $315,076 | $312,832 | $304,704 | | **Operating Income** | $91,456 | $72,051 | $61,911 | $68,933 | $63,549 | | **Net Income** | $72,254 | $41,305 | $47,480 | $43,599 | $40,701 | | **Diluted EPS** | $1.33 | $0.77 | $0.87 | $0.80 | $0.74 | | **Cash Dividends per Share** | $0.52 | $0.42 | $0.36 | $0.30 | $0.25 | | **Total Assets** | $468,936 | $439,589 | $403,744 | $387,507 | $365,299 | | **Total Stockholders' Equity** | $313,909 | $289,088 | $273,346 | $262,804 | $244,288 | [Management's Discussion and Analysis (MD&A)](index=23&type=section&id=Item%207.%20Management's%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations) Revenues grew 9% in 2018, with net income surging 75% primarily due to a lower U.S. corporate tax rate - Revenues for 2018 **increased 9%** year-over-year, and revenues before reimbursements increased 8%, driven by increased billable hours and billing rates[139](index=139&type=chunk) - Net income for 2018 **increased 74.9% to $72.3 million**, and diluted EPS rose to $1.33 from $0.77 in 2017, significantly impacted by U.S. tax legislation[138](index=138&type=chunk)[141](index=141&type=chunk) - Strong growth was noted in the human factors, materials & corrosion engineering, thermal sciences, polymer science & materials chemistry, mechanical engineering, and chemical regulation & food safety practices[140](index=140&type=chunk) - Total billable hours **increased by 5%** to 1,274,000 in 2018, while utilization decreased slightly to 73% from 75% in 2017[147](index=147&type=chunk) [Results of Operations](index=26&type=section&id=Item%207.%20Management's%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations%23Results%20of%20Operations) Revenue growth of 9.1% and a significantly lower effective tax rate drove a 74.9% increase in 2018 net income - The effective tax rate dropped to **22.6% in 2018 from 49.9% in 2017**, with the 2017 rate including a one-time expense of $16.5 million from new U.S. tax legislation[158](index=158&type=chunk)[159](index=159&type=chunk) Revenue by Segment (2018 vs. 2017, in thousands) | Segment | 2018 | 2017 | % Change | |---|---|---|---| | Engineering and Other Scientific | $306,265 | $277,603 | 10.3% | | Environmental and Health | $73,258 | $70,196 | 4.4% | | **Total Revenues** | **$379,523** | **$347,799** | **9.1%** | Key Expense and Income Changes (2018 vs. 2017) | Item | 2018 (% of Rev) | 2017 (% of Rev) | % Change (Dollar) | |---|---|---|---| | Compensation & Related | 56.7% | 60.5% | 2.3% | | Operating Income | 24.0% | 20.7% | 26.9% | | Provision for Income Taxes | 5.5% | 11.8% | (48.9)% | | Net Income | 19.0% | 11.9% | 74.9% | [Liquidity and Capital Resources](index=33&type=section&id=Item%207.%20Management's%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations%23Liquidity%20and%20Capital%20Resources) Operations are financed by cash flows, with liquidity deemed sufficient for the upcoming year - Cash, cash equivalents, and short-term investments totaled **$208.5 million** at the end of 2018, up from $196.4 million at the end of 2017[172](index=172&type=chunk) - Significant investing activities in 2018 included a **$5.2 million land purchase** in Natick, MA, and $5.3 million in associated construction costs[176](index=176&type=chunk) - As of December 28, 2018, the company had total contractual commitments of **$43.1 million**, including $30.8 million in operating leases and $12.3 million in purchase obligations[180](index=180&type=chunk) Summary of Cash Flows (in thousands) | Activity | 2018 | 2017 | 2016 | |---|---|---|---| | Net cash provided by operating activities | $91,188 | $67,838 | $66,946 | | Net cash used in investing activities | $(25,820) | $(17,722) | $(27,443) | | Net cash used in financing activities | $(62,500) | $(41,261) | $(49,166) | [Non-GAAP Financial Measures](index=36&type=section&id=Item%207.%20Management's%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations%23Non-GAAP%20Financial%20Measures) The company utilizes non-GAAP measures like EBITDA and EBITDAS to evaluate its operating performance - **EBITDA as a percentage of revenues before reimbursements** increased to 27.3% in 2018, compared to 26.5% in 2017 and 24.9% in 2016[186](index=186&type=chunk) Reconciliation of Net Income to EBITDA and EBITDAS (in thousands) | Metric | 2018 | 2017 | 2016 | |---|---|---|---| | Net Income | $72,254 | $41,305 | $47,480 | | Add: Income taxes | $21,063 | $41,204 | $21,642 | | Add: Deprec. & Amort. | $6,292 | $6,285 | $6,131 | | Subtract: Interest income, net | $(2,751) | $(1,294) | $(683) | | **EBITDA** | **$96,858** | **$87,500** | **$74,570** | | Add: Stock-based comp. | $16,993 | $16,155 | $13,333 | | **EBITDAS** | **$113,851** | **$103,655** | **$87,903** | [Quantitative and Qualitative Disclosures About Market Risk](index=37&type=section&id=Item%207A.%20Quantitative%20and%20Qualitative%20Disclosures%20About%20Market%20Risk) The company is primarily exposed to market risks from interest rate fluctuations and foreign currency exchange - The company is exposed to interest rate risk on its portfolio of cash, cash equivalents, and short-term investments, though a **100 basis point change** would not have a material impact[190](index=190&type=chunk)[191](index=191&type=chunk) - Foreign currency risk exists from revenues and expenses denominated in British Pounds, Euros, and Chinese Yuan, with net assets in these currencies each at approximately **$5.4 million**[192](index=192&type=chunk)[193](index=193&type=chunk) - The company **does not use derivative financial instruments** or foreign exchange contracts to hedge its market risks[191](index=191&type=chunk)[195](index=195&type=chunk) [Financial Statements and Supplementary Data](index=38&type=section&id=Item%208.%20Financial%20Statements%20and%20Supplementary%20Data) This section incorporates by reference the financial statements and data found in Item 15 - The required financial statements and supplementary data are located in Part IV, Item 15 of this Form 10-K[197](index=197&type=chunk) [Changes in and Disagreements with Accountants](index=38&type=section&id=Item%209.%20Changes%20in%20and%20Disagreements%20with%20Accountants%20on%20Accounting%20and%20Financial%20Disclosure) No changes in or disagreements with the company's accountants on financial disclosure are reported - None[198](index=198&type=chunk) [Controls and Procedures](index=38&type=section&id=Item%209A.%20Controls%20and%20Procedures) Management concluded that disclosure controls, procedures, and internal controls over financial reporting were effective - Management concluded that the company's disclosure controls and procedures were **effective** as of the end of the fiscal year 2018[200](index=200&type=chunk) - Management concluded that the company's internal control over financial reporting was **effective** as of December 28, 2018, based on the COSO 2013 framework[201](index=201&type=chunk) - KPMG LLP, the independent registered public accounting firm, audited and provided an **unqualified opinion** on the effectiveness of the company's internal control over financial reporting[199](index=199&type=chunk)[220](index=220&type=chunk) [Other Information](index=38&type=section&id=Item%209B.%20Other%20Information) No other information is reported for this item - None[203](index=203&type=chunk) [Part III](index=38&type=section&id=PART%20III) [Directors, Executive Officers and Corporate Governance](index=38&type=section&id=Item%2010.%20Directors%2C%20Executive%20Officers%20and%20Corporate%20Governance) Required information is incorporated by reference from the 2019 Proxy Statement - Information is incorporated by reference from the company's 2019 Proxy Statement[205](index=205&type=chunk) [Executive Compensation](index=39&type=section&id=Item%2011.%20Executive%20Compensation) Required information is incorporated by reference from the 2019 Proxy Statement - Information is incorporated by reference from the company's 2019 Proxy Statement[207](index=207&type=chunk) [Security Ownership and Related Stockholder Matters](index=39&type=section&id=Item%2012.%20Security%20Ownership%20of%20Certain%20Beneficial%20Owners%20and%20Management%20and%20Related%20Stockholder%20Matters) Required information is incorporated by reference from the 2019 Proxy Statement - Information is incorporated by reference from the company's 2019 Proxy Statement[208](index=208&type=chunk) [Certain Relationships, Related Transactions, and Director Independence](index=39&type=section&id=Item%2013.%20Certain%20Relationships%20and%20Related%20Transactions%2C%20and%20Director%20Independence) Required information is incorporated by reference from the 2019 Proxy Statement - Information is incorporated by reference from the company's 2019 Proxy Statement[209](index=209&type=chunk) [Principal Accounting Fees and Services](index=39&type=section&id=Item%2014.%20Principal%20Accounting%20Fees%20and%20Services) Required information is incorporated by reference from the 2019 Proxy Statement - Information is incorporated by reference from the company's 2019 Proxy Statement[210](index=210&type=chunk) [Part IV](index=40&type=section&id=PART%20IV) [Exhibits and Financial Statement Schedules](index=40&type=section&id=Item%2015.%20Exhibits%2C%20Financial%20Statement%20Schedules) This section includes the consolidated financial statements, auditor's report, and a list of exhibits [Report of Independent Registered Public Accounting Firm](index=41&type=section&id=Item%2015.%20Exhibits%2C%20Financial%20Statement%20Schedules%23Report%20of%20Independent%20Registered%20Public%20Accounting%20Firm) KPMG LLP issued unqualified opinions on both the consolidated financial statements and internal controls - KPMG LLP issued an **unqualified (clean) opinion**, stating the financial statements are presented fairly in all material respects and conform with U.S. GAAP[220](index=220&type=chunk) - KPMG also opined that the Company maintained **effective internal control** over financial reporting as of December 28, 2018[220](index=220&type=chunk) [Consolidated Financial Statements](index=43&type=section&id=Item%2015.%20Exhibits%2C%20Financial%20Statement%20Schedules%23Consolidated%20Financial%20Statements) The financial statements detail strong 2018 performance with $379.5 million in revenue and $72.3 million in net income Consolidated Statement of Income Highlights (FY 2018, in thousands) | Line Item | Amount | |---|---| | Revenues | $379,523 | | Operating Income | $91,456 | | Net Income | $72,254 | | Diluted EPS | $1.33 | Consolidated Balance Sheet Highlights (As of Dec 28, 2018, in thousands) | Line Item | Amount | |---|---| | Cash and cash equivalents | $127,059 | | Total Current Assets | $326,612 | | Total Assets | $468,936 | | Total Liabilities | $155,027 | | Total Stockholders' Equity | $313,909 | Consolidated Statement of Cash Flows Highlights (FY 2018, in thousands) | Line Item | Amount | |---|---| | Net cash provided by operating activities | $91,188 | | Net cash used in investing activities | $(25,820) | | Net cash used in financing activities | $(62,500) | [Notes to Consolidated Financial Statements](index=49&type=section&id=Item%2015.%20Exhibits%2C%20Financial%20Statement%20Schedules%23Notes%20to%20Consolidated%20Financial%20Statements) Notes detail accounting policies, the impact of tax legislation, and risks from the PG&E bankruptcy - The company adopted the new revenue recognition standard (ASU 2014-09) in fiscal 2018 with **no material cumulative effect adjustment**[267](index=267&type=chunk) - The 2017 Tax Cuts and Jobs Act resulted in a one-time income tax expense increase of **$16.5 million in 2017**[300](index=300&type=chunk) - As a subsequent event, PG&E filed for bankruptcy on Jan 29, 2019, posing an uncertain collectability risk to **$6.0 million in accounts receivable**[350](index=350&type=chunk) - On Jan 31, 2019, the Board declared a quarterly dividend of $0.16 per share and authorized an additional **$75 million for share repurchases**[349](index=349&type=chunk) - One client accounted for **12% of revenues in 2018** and 14% in 2017[338](index=338&type=chunk)

Financial Data and Key Metrics Changes - In 2018, the company grew net revenues by 8% to $355 million and expanded EBITDA margin by 77 basis points to 27.3% of net revenues, delivering earnings of $1.33 per diluted share [8][23] - For Q4 2018, net revenues increased by 3% to $85 million, with earnings per diluted share at $0.30, reflecting strong performance in several business areas [10][21] - Net income for 2018 was $72.3 million or $1.33 per diluted share, compared to $41.3 million or $0.77 per diluted share in the prior year [24] Business Line Data and Key Metrics Changes - The engineering and other scientific segment represented approximately 80% of the company's Q4 and 2018 net revenue, with net revenues growing 4% in Q4 and 8% for the fiscal year [14][16] - The environmental and health segment accounted for approximately 20% of the company's Q4 and 2018 net revenue, with revenues flat in Q4 and growing 4% for the fiscal year [16][17] Market Data and Key Metrics Changes - The company experienced strong demand in the consumer electronics industry, particularly in design consulting services, as clients faced manufacturability challenges [12] - There was increased reactive work in the U.S. regarding health effects of substances in consumer and agricultural products, indicating a focus on human health and environmental concerns [17] Company Strategy and Development Direction - The company aims to continue strategic market expansion in various industries and geographies, focusing on high-growth areas such as human factors and design consulting [8][11] - The management expressed confidence in the long-term financial performance and commitment to delivering increasing value to shareholders through actions like dividend increases and stock repurchase programs [9][41] Management's Comments on Operating Environment and Future Outlook - Management acknowledged challenges in the first half of 2019 due to the conclusion of a large human factors project but expressed confidence in achieving mid to high single-digit revenue growth by year-end [51][44] - The company expects utilization to decline in 2019 but anticipates long-term growth as it builds critical mass in its offices and practices [30][44] Other Important Information - The company announced a 23% increase in its quarterly dividend from $0.13 to $0.16 per share and an additional $75 million for share repurchases, increasing the total authorization to approximately $92.5 million [41] - The company reported that Pacific Gas and Electric (PG&E) accounted for approximately 6.6% of total revenues in 2018, with ongoing engagements despite PG&E's bankruptcy filing [42][43] Q&A Session Summary Question: How does the company plan to manage the impact of the large project rolling off? - Management expressed confidence in transitioning staff from the large project to other practices, noting that the team had a baseline level of work to engage in [50] Question: What is the initial margin guidance for 2019? - The management indicated that utilization is expected to step down due to the large project impact, with a focus on gradually improving utilization throughout the year [53] Question: How does the company react to economic volatility? - Management noted that while clients may tighten budgets during downturns, demand for proactive services in design consulting remains strong, particularly in consumer electronics and medical devices [56][58] Question: Can you provide insights on hiring trends? - The company is focused on university recruiting, primarily hiring Ph.D. graduates for high-growth areas, with a strategy to develop talent internally [63][64] Question: What are the expectations for PG&E revenue in 2019? - Management expects PG&E revenue to remain stable in the short term, with some areas potentially increasing while others may decrease [70][72]