Exponent, Inc.
Q4 2020 Earnings Call Transcript

Published: 4 Feb 2021

[Operator:]

Good day, and welcome to the Exponent Fourth Quarter and Fiscal Year 2020 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Whitney Kukulka. Please go ahead, ma'am.

[Whitney Kukulka:]

Thank you, operator. Good afternoon, ladies and gentlemen. Thank you for joining us on Exponent's fourth quarter and fiscal year 2020 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.exponent.com/investors. This conference call is the property of Exponent and any taping or other reproduction is expressly prohibited without prior written consent.

[Dr. Catherine Corrigan:]

Thank you, Whitney, and thank you, everyone, for joining us today. I will start off by reviewing our 2020 business performance, Rich will then provide a more detailed review of our financial results and our outlook for 2021. We will then open the call for questions. In a year of worldwide challenge, we demonstrated the durability of Exponent's business model and the strength of our market opportunities. Our fourth quarter results exceeded our prior expectations and illustrate continued improvement across the business. For the quarter, we expanded EBITDA margin 200 basis points as compared to the same period last year. Net revenues in the quarter reflected a return to underlying growth, declining only 5% in the face of the 8% headwind from an extra week in the fourth quarter of 2019. Our successful execution demonstrates the resiliency of our business model, the dedication of our world-class team and the strength of our reputation. While we are encouraged by our results, COVID-19 continues to impact litigation and human-participant studies. Society is raising the bar for safety, health, sustainability and reliability, and clients are increasingly seeking Exponent's interdisciplinary proactive solutions. Exponent grew its annual revenues from proactive services in both business segments despite pandemic-related restrictions, one less week than the prior year and the divestiture of the German entity. Industry and government alike are advancing their missions in multifaceted ways, from designing novel products and navigating new regulatory challenges to innovating and evaluating new paradigms and processes. These dynamics are creating opportunities for Exponent, and we will leverage our nimble business model to capitalize on these opportunities to drive long-term growth and profitability.

[Rich Schlenker:]

Thank you, Catherine, and good afternoon, everyone. I will start by providing details of Exponent's financial results for the fourth quarter and full year 2020, and then we'll provide some insight into our expectations for the first quarter and full year 2021. All comparisons will be on a year-over-year basis, unless otherwise noted. For the 13-week fourth quarter of 2020, total revenues declined by 6% to $103.2 million, and revenues before reimbursements or net revenues, as I will refer to them from here on, declined by 5% to $97.3 million as compared to the 14-week fourth quarter of 2019. Having one less week in 2020 was an 8% headwind for the fourth quarter, in addition to the 1% headwind for the divestiture of the German entity that occurred in April of 2020. As a result, the fourth quarter, the underlying net revenue grew by approximately 4% year-over-year. Net income for the fourth quarter increased to $21.8 million or $0.41 per diluted share as compared to $19.1 million or $0.36 per share. Exponent recognized a tax benefit from share-based awards of $2.6 million or $0.05 per share in the fourth quarter of 2020 as compared to $700,000 or $0.01 per share in the same period one year ago.

[Dr. Catherine Corrigan:]

Thank you, Rich. While uncertainties related to the pandemic remain ahead of us, society will continue to raise the bar for safety, health, sustainability and reliability, and clients will continue to seek Exponent's interdisciplinary solutions. We remain focused on developing and retaining our exceptional talent, ensuring that we are ahead of the curve and increasing our value in the marketplace by solving our clients' most pressing problems. I am grateful to our team for their hard work dedication and resiliency throughout this challenging period. We are well positioned for long-term growth and will continue to deliver for all of our stakeholders. Operator, we're ready for questions.

[Operator:]

And we will take our first question from Tobey Sommer with Truist.

[Tobey Sommer:]

You gave us some good color on the trends in kind of litigation-related work and some variability in the most recent months. How would you describe that on a year-over-year basis, either in the quarter or in 1Q, whichever time period you wanted to say? Because you gave us color, but I kind of wanted to see what it was numerically as a reference to the prior year.

[Rich Schlenker:]

Yes. For the -- what we experienced in the full year basis is the litigation work overall being down about 5% for the full year. The -- I think we saw that gap closed in the fourth quarter. It was probably down somewhere in the mid-single-digit percentage, 5% to 7%, somewhere in that range. So we did see it come up, but it's still down year-over-year.

[Tobey Sommer:]

Okay. How is the company positioned from a pricing perspective? And what is the hiring posture this year?

[Rich Schlenker:]

Maybe I'll start off there from talking about what we've seen around the pricing that we're going forward with in 2021, and then Catherine will pick up on the sort of demand environment and how it ties into recruiting. So we, as Exponet always does, we have one rate for each of our individual consultants. We evaluate the market demands for those each year in the fourth quarter and put forward our rate changes as of January 1. We've got some areas that had very strong demand for our people. As we've talked about, we've seen our proactive work growing and increasing we still believe that the demand is there in the litigation market because we're still getting those new engagements at a pretty good clip. It's just that the work hasn't picked up. But still with that, we have clients that are in some challenging situations with their market being down. So we were quite sensitive to that. As a result, when we -- our rates were about 1% less of an increase than they were a year ago for our staff. So what happens is that we see that our staff rates for this year increased between, let's call it, around 4.5% on a year-over-year basis for those employees. A year ago, that was closer to 5.5%, a little bit higher. So we -- those increases go through. Those are blended down by more junior staff that have been hired recently or into the next year, which gets us to the realized rate increases that we have laid out for the year of being between 2% and 2.5%. So a little bit lower, still price increases in the market, but we're being sensitive to certain areas.

[Dr. Catherine Corrigan:]

Yes. And I can pick up there, Tobey, with regard to sort of the talent and recruiting side. So we certainly feathered our foot on the gas pedal when COVID first hit back in Q2 and have seen steady gradual increases in our recruiting activity sort of through Q3 through Q4. And we're really looking at it continuing to accelerate that activity as we get into 2021. It's focused in the areas of business strength, right? It's about hiring the right people in the right area. So it's the same philosophy. Some of the areas that we're particularly focused on, we're focused on the pharma space, at both the junior and the senior level; we continue to focus in the human factors space with the opportunities there; the data sciences space, particularly when you think about our opportunities around wearables and our opportunities around life sciences as well as the integrity management side, all of these things require bringing on talent, more talent around the data sciences area; the engineering disciplines that are in our areas of strength. So think about battery-related engineering disciplines, think about the disciplines related to automated vehicles and vehicle safety. These are the areas that are driving the business where we're seeing the growth, and so we're focused on that. It's been interesting in the virtual space. We've been able to reach more grad students than ever before, quite frankly, through our virtual events. So as we move forward, we will certainly be returning to in person recruiting in terms of actually meeting our recruits in the flesh. But a lot of learnings that I think we'll be able to carry over in terms of really getting our messaging out there around the opportunities that we have and getting that out to that talent base because there's no doubt, based on what we're seeing that the demand for engineering and scientific expertise is there, and we're seeing that. And there are lots of very high-quality students that are coming out of those programs and being referred to us.

[Tobey Sommer:]

Last question for me. The accumulation of cash on the balance sheet would -- while great because it indicates you're very profitable, it's also dampening returns on equity and invested capital. Do you expect that to continue?

[Rich Schlenker:]

No. I mean we remain committed over the long term here or near term to reduce that cash balance. The goal still remains to work that down in a prudent way to something that might be in the $50 million to $70 million on the balance sheet that will likely through dividends and repurchases, be over still a 4- to 5-year period of time. But it is something that we as management and the Board remain committed to.

[Operator:]

We will take our next question from Andrew Nicholas with William Blair.

[Andrew Nicholas:]

Now that we're almost a year out from the start of the pandemic, I'm wondering if you could speak to any competitive disruption you've seen in your markets. I realize your competitive set is relatively fragmented, but is there anything you could say about kind of the strength of your competitors today versus pre-pandemic? I guess I'm just curious to what extent Exponent's relative scale has proven a competitive advantage in the current environment and what it could mean for future demand capture?

[Dr. Catherine Corrigan:]

Yes. Thanks, Andrew. As you know, the competitive landscape for our services is fragmented. So we are seeing different things in different spaces. But there's no doubt that as we have engaged with folks in the technical community, we engage with our competitors as we are out at conferences. These are being done virtually. But we are definitely finding opportunities from the standpoint of, let's say, the senior recruiting side. And we've capitalized on a number of those opportunities this year in terms of being able to hire principal level talent that is coming out of some of our competitors. And so we've been successful in attracting those. That's not an easy thing to do. I think there are multiple contributors to that. But I think, for sure, that Exponent's relative success and the strength of the company and the forward-looking opportunities that we have are a big part of the conversations that we're having with those folks as we talk to them. And so I do think that there's been an opportunity for us to gather talent and simply represent the durability and the resilience of the business. This is -- we've been in business for over 50 years. We continue to have strong market drivers, and we've really been putting out that message. And I think that our competitors are seeing that, and we've been able to capitalize on some of those trends.

[Andrew Nicholas:]

And then for my follow-up, you talked in the release about seeing growth in your proactive business this year despite having one less week in the calendar and divestiture, obviously, that's quite encouraged. I'm wondering on the proactive side, what's your sense of where client budgets sit for this type of work heading into next year? Any sense of kind of increased wave of R&D investment in 2021, now that some of your larger clients are presumably passed a lot of the COVID-related uncertainty? And then relatedly, is the expectation that proactive will materially outperform reactive in 2021?

[Dr. Catherine Corrigan:]

Yes. Thanks. It varies to some extent across industries, right? When you think about the impact that COVID had and then what the sort of forward-looking outlook is. So if I think about the utility industry, we're pretty independent of the COVID situation, right? That's kind of a one extreme example where the drivers are around -- drivers around asset integrity, drivers around climate uncertainty, drivers just around safety and reliability of power delivery, right? So you're not seeing an impact there. But you can look to, let's say, the life sciences side of the equation, and early on there in the pandemic, there were real pullbacks around things like elective surgeries and things like that. And so we saw those budget cycles really have an impact somewhat early on, but what we're seeing as we go forward is to some extent, the release of that, those elective surgeries are happening again to a large extent, that is driving the usual issues around regulatory requirements, regulatory strategy and things like that, the growing -- the impending deadline around medical device regulation in Europe, looking at real-world evidence around the pharma space as these technologies in life sciences become more and more complex. So those drivers are beginning to really take over again and we're not seeing nearly the sort of impact of those budget cycles. So -- and you think about electronics, they are -- we were prevented from doing a lot of that work in the laboratory early on. There were some budgetary impacts there. But as they look forward to their next-generation of innovation and devices, we are seeing a return to kind of the level of activity around the design consulting. This is something we do in the electronics space as well as the medical device space. So all in all, these are some strong drivers that are coming back in on the proactive side. In terms of that sort of balance of growth between proactive and reactive, there's no doubt that there's increasing -- there are trends that are going to drive the litigation side further along, sort of independent of COVID. Some of these things are advanced driver assistance systems in the automotive arena. You can think about the toxic tort and environmental arena where they're looking at things like the fluorinated substances and a variety of different things that impact that. We are positioning ourselves and seeing increased inquiries and retentions around those kinds of varies on the litigation side. So the COVID effect we will continue to grow with that reactive side of the business. But the proactive side, for sure, grew faster during 2020. We believe, over time and on average, that is likely to continue to grow at a faster rate for reasons that I've mentioned, but really both sides of the house, we anticipate continuing to grow long term.

[Operator:]

We will take our next question from Sam England with Berenberg.

[Sam England:]

And the first one, do you see any opportunities in the government space under the new Biden administration? I know government's been a small portion of revenues for you historically, but do you think there's any opportunities in areas like environmental work under that administration?

[Dr. Catherine Corrigan:]

Yes. With regard to the government asset client, I mean we certainly, as I mentioned, have seen, for example, the wearables work with the Army and Navy. We believe that, that actually -- we've delivered -- we've been delivering well on that and are seeing opportunities for potential expansion and are actually engaged with that client in discussions about that. In terms of, let's say, the environmental space or the regulatory space, those are areas where we are typically our client base is typically sitting within the industry, as you said, as opposed to the government side. So I think what we will see and we're already seeing is a raising of the bar from a regulatory perspective, whether that's around environmental regulation, whether that's around safety-related regulations or, let's say, things like automated vehicles or pharmaceuticals. I mean we just had news this morning about potential metallic contaminants in baby food. I mean there are a number of things that are going to drive that regulatory bar higher and higher. So that, of course, creates opportunity for us. But in terms of the government per se as a client, we don't like to anticipate that, that is going to grow in a way nearly in the way that we would see the opportunities on the industrial side.

[Sam England:]

Great. And then I was just wondering what you're seeing in Asia at the moment? You've obviously talked about the opportunity over there, and they've been a lot quicker in many of the Asian countries to come out on the other side of the pandemic. So do you see a bigger opportunity there over the next couple of years?

[Dr. Catherine Corrigan:]

Yes. So Asia has been -- was part of the strength in the fourth quarter. And we think, to some extent, that will certainly continue going into 2021. Part of what's been going on very recently with the strength there, really relates to -- in some sense, our clients in -- our U.S. clients' inability to travel. That's work in the consumer electronics space, for example, in terms of qualification around issues with suppliers and a variety of sort of advisory level activities. And so we do think there's an opportunity to continue that sort of advisory level service that we're providing, yet even going past the coped pandemic, like we think we're really demonstrating our value with regard to that, and that's an opportunity for the clients to really continue to leverage that. Another thing I'll bring up with regard to Asia, is sort of the diversification there. There are opportunities internationally that we've talked about with regard to some of the major infrastructure projects and things like that. Some of that work is, in fact, centered around our Asia. There's some activity there. So I think that will be -- continue to be a growth driver, not only in Asia, but really for our broader sort of global operations in addition to our domestic operations.

[Sam England:]

Great. And then maybe just one more for Rich. You noted that costs will ramp up as people begin to return to the office. But do you there's any sustainable improvement that you can hold on to in areas like travel, facilities expenses?

[Rich Schlenker:]

I do think that it's likely that people will decide to do some of their activities on a remote basis or virtually going forward. But I think that where we might save in travel and meals in an area at the same time, we're looking at how do we make sure that we have the best technology and platforms for be successful in those virtual environments as well. So I view that at this point in time that the cost will balance out that we will make some investments to get higher returns on the virtual environment that might be able to be offset by reductions in costs in the physical environment. But overall, I think I'm viewing that there isn't a major long-term savings to come out of it, but I think there is an improvement in the return on our investment that we should be able to get over that time.

[Operator:]

We'll take our next question from Marc Riddick with Sidoti.

[Marc Riddick:]

I wanted to touch a little bit on a couple of things that you mentioned. I wanted to circle back on the user studies and how we should think about maybe how social distancing, it being relaxed in certain jurisdictions and locations? And maybe what your thoughts are around the effectiveness of vaccine rollout? How that return might play out if there's kind of a bit of a road map that you currently have in mind? Or what we should be looking for as to what could open up the return of user studies?

[Rich Schlenker:]

Yes. I think there is some optimism that as we look forward, that we will be able to move forward with a number of the studies that we have lined up. But what I would say is that is in its early development. I think things will change over the next several weeks to a month or two, and things should be getting better as -- hopefully, as we go into late first quarter but into the second quarter. But at this time, just breaking out of these stay-at-home orders, it still remained in a limited level early in the first quarter, but things are lining up on a positive basis going forward.

[Marc Riddick:]

So it seems as though the interest in user studies from your customers is there, it's just a matter of when you get to get started with it. Is that a fair congestion?

[Rich Schlenker:]

Absolutely is -- that is the case, and we have adapted and been able to do certain activities in the areas, but moved being forward with more community, higher volume out in the community interactions on them have been more limited over the last couple of months. And -- but are planned and expected to be able to move forward within a few months.

[Marc Riddick:]

Okay. That's good. And then one thing I was sort of curious about, I mean, I know that you've made mention about some of the things that are tied to the buyers, and I'm not sure if it's I'm not sure if it's easy to necessarily parse this out. But I was wondering if there was sort of a ballpark way we should think about how the -- what the things that you're working on that are related to the virus as a percentage of revenue, is this sort of a -- I know that could be a little tricky, but maybe a general ballpark?

[Rich Schlenker:]

Yes. So yes, we've seen an increase across the three quarters. We were seeing just over 1% back in Q1. We saw revenues related to it. This includes our work for the Army and Navy on wearables, but it's worked in disinfectants as well as contact tracing programs and occupational health and safety and across the board testing programs, all of those things we test. In the fourth quarter, that was about 2.5% to 3% of revenues. So it has been increasing over that period of time. A big step function came with that wearables project in the fourth quarter, which made up maybe about half of that revenue. So we did make a little progress on the others and then layer that on top. And so it brought the full year about 1% of our revenues in 2020 were some way related to the pandemic.

[Marc Riddick:]

Okay. And then one last one for me, I guess. I was wondering if you could talk a little bit about going back to the litigation front. I think -- Catherine, I think you had mentioned in prior calls before about sort of how that sort of lays out when you -- whether things are being put on the docket or what have you? I was wondering if you sort of just maybe give a broad overview as to maybe what you're seeing and that process? And maybe if it's just certain types of courts or certain passengers? You mentioned international, which is really helpful. But I just want to see if there's sort of any little you could add as far as -- so how we can sort of how -- see how that plays out going forward?

[Dr. Catherine Corrigan:]

Yes, yes. So there's sort of -- there are a few things to sort of mention. I mean, this type of -- what we're seeing is consistent with the fact that this type of work tends to come in kind of in boluses. That's the way these litigation projects work. So for example, when you first get brought on, there's a bolus of activity when you do your initial workup in your inspection, right, and then you might kind of ease back. And then you've got a big bolus when you're doing your analysis and putting your expert report together, that -- we saw that. We saw a number of those types of activities unlock for some pretty substantial matters and multi-district litigation and things like that when we were in Q4 because they were anticipating trial dates in sort of the early 2021 time frame. And as we saw the increases in COVID cases that came later in the year and given what people were anticipating relative to COVID in January, then we saw those dates push, have a tendency to push again. The judges are working really hard to try to hold the trial dates, but so it unlocks the bolus of activity, and then they have to push the date. They simply have to because they can't bring a jury in, right? And so this is part of what we're seeing in these fits and starts. But it does vary to some extent across geographies, as you mentioned, even within the domestic litigation portfolio. States where there -- they tend to be more conservative with regard to the stay-at-home orders, the courts are generally closed. States where there are a bit more -- where things are a bit more open, you might see an occasional jury trial go forward. So it's variable. A lot of our work that we do is at the state court level. So we've definitely had folks who have had to be out there. But we continue to sort of see these boluses of activity and then the date gets pushed again. I personally have trials now put back into the fall, and we all know the type of uncertainty that exists around the vaccine at this point. They're doing their best on the rollout side of that. But there are still uncertainties vis-à-vis, how quickly that can be rolled out, the new virus variance, solicit the restrictions, et cetera. So we're tracking it closely. If we kind of look at the trend line over time from Q2 to Q3 to Q4, we're having that steady increase. We think that Q1 can kind of continue on that path and our best hope and what we truly believe is that, that line will continue to move upward as we move through the year.

[Operator:]

And that does conclude today's question-and-answer session. We thank you for your participation and for joining today's call. Have a wonderful day. You may now disconnect.