Good day, and welcome to the Exponent second quarter of fiscal year 2015 financial results conference call. [Operator instructions.] At this time, I would like to turn the conference over to Erica Abrams. Please go ahead, ma’am..

Thank you, operator. Good afternoon, ladies and gentlemen, and thank you for joining us on today’s conference call to discuss Exponent’s second quarter 2015 results. Please note that this call will be simultaneously webcast on the Investor Relation section on 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. Joining me on the call today are Paul Johnston, President and Chief Executive Officer; and Rich Schlenker, Executive Vice President and Chief Financial Officer of Exponent.

Before we start, I would like to remind you that the following discussion contains forward-looking statements, including statements about Exponent’s market opportunities and future financial results, that involve risks and uncertainties, and that Exponent’s actual results may vary materially from those discussed here.

Additional information concerning factors that could cause actual results to differ from forward-looking statements can be found in Exponent’s periodic filings with the SEC, including those factors discussed under the caption Factors Affecting Operating Results and Market Price of Stock in Exponent’s most recent Form 10-K.

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 Paul Johnston, President and Chief Executive Officer. Go ahead..

Thank you for joining us today for our discussion of Exponent’s second quarter financial results. For the quarter, net revenues increased 4% to $75.3 million from the same period a year ago. Net income for the quarter also increased 4% to $11.7 million, or $0.43 per share.

We are pleased with our results in the first half of the year, delivering revenue and profit growth along with improved margins and utilization, even as we increased headcount in order to drive long term progress in both our proactive and reactive services.

Our underlying business continued to grow in the high single-digits, but as expected, was partially offset by a decline in defense work.

We are pleased that during the quarter we continued to be retained to investigate the most significant accidents and failures, and we continued to see strong demand for our proactive services in consumer electronics and medical devices.

We had notable performances from our materials, biomedical, polymer science, structural engineering, thermal sciences, biomechanics, and construction consulting practices, as well as from our environmental group.

As we have previously indicated, we expected the last of our three major assignments, which had been approximately 4% to 5% of our revenues, to step down in the second half of 2015 to approximately half that run rate. However, as a result of a proposed resolution of this matter, our efforts going forward will be de minimis.

Rich will elaborate on the details of our forecast in a few minutes. During the second quarter, we continued to repurchase common stock on the open market and completed our two for one stock split. We also paid shareholders a dividend and will continue the payment of a dividend of $0.15 per share in the coming period.

We are focused on ways to continue to deliver shareholder value. Now, Rich will provide a more detailed review of our financial performance and outlook..

Thanks, Paul. For the second quarter of 2015, revenues before reimbursements, or net revenues, as I will refer to them from here on, were $75.3 million, up 4% from $72.3 million in the same period of 2014. Total revenues for the second quarter of 2015 were $79.9 million, up 4% over $76.6 million one year ago.

Net income for the second quarter increased 4% to $11.7 million, or $0.43 per share, as compared to $11.3 million or $0.41 per share in the second quarter of 2014. EBITDA for the second quarter increased 5% to $20.6 million versus $19.7 million last year.

For the first half of 2015, net revenues also increased 4% to $151.4 million and total revenues increased 5% to $160.2 million. Net income increased 8% to $22 million or $0.80 per share. EBITDA increased 7% to $39 million over the same period of last year.

In the second quarter of 2015, net revenues from defense technology development were approximately $800,000, as compared to $3.7 million in the same quarter last year. For the first half, net revenues from defense were $2 million, as compared to $6.9 million in the same period of 2014.

We continue to expect revenues from defense to be in the range of $500,000 to $1 million per quarter for the remainder of 2015. For the second quarter, billable hours in the second quarter increased 4% to $287,000, as compared to $276,000 in the second quarter of 2014. For the first half, billable hours increased 5% to $579,000 from $550,000.

Utilization in the second quarter rose to 74% from 72% one year ago. For the first half, utilization was 75%, up from 72% in the same period one year ago.

As we look to the second half of 2015 and considering the step down in revenue from the major project that Paul discussed, we expect utilization in the third and fourth quarters to be approximately down 3 to 4 percentage points compared to the same period in 2014.

This will result in the full year’s utilization being approximately 71% as compared to 72% in 2014. In the second quarter, the realized bill rate increase was approximately 1%, which is lower than normal, as the increased billable hours were a result of better leverage of lower level staff.

This rate increase was offset by six tenths of a percent from translating foreign currency for consolidated financial statements. For the second quarter, technical full time equivalent employees were up 2% to 750, as compared to the same quarter in 2014.

While we have a nice pipeline of new hires that will join over the next couple of quarters, but as we adjust to the impact of the sudden step down in a major project, we are likely to see our headcount remain flat. EBITDA margin was slightly up for the second quarter to 27.3% of net revenue, as compared to the same period of 2014.

For the first half, EBITDA margin was 25.8%, as compared to 25% in the same period one year ago. For the second quarter of 2015, compensation expense after adjusting for gains and losses in deferred compensation increased 4%.

Included in the total compensation is a loss in deferred compensation of $72,000, as compared to a gain of $2 million in the same quarter of 2014. 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 of 2015 was $2.7 million.

For the remainder of 2015, we expect stock based compensation to be between $2.3 million and $2.6 million a quarter. Other operating expenses in the second quarter increased 4% to $6.7 million. Included in other operating expenses is $1.3 million of depreciation.

For the remainder of 2015, other operating expenses are expected to be $7 million to $7.3 million per quarter. G&A expenses in the second quarter increased 9% to $4.1 million. For the remainder of 2015, G&A expenses are expected to be $4.2 million to $4.5 million per quarter.

Our income tax rate in the quarter was 39.4% as compared to 38.8% in the same period of 2014. For the full year of 2015, we expect our tax rate to be approximately 39.5%. For the second quarter, operating cash flow was $13.1 million. Year to date, operating cash flow was $14.8 million.

In the first half of the year, we repurchased $7 million of common stock. We still have $28.1 million authorized and available for repurchases. Also during the first half, we distributed $8 million to shareholders through dividends. We ended the quarter with $150 million of cash and short-term investments after repurchases and dividends.

Capital expenditures were $1.1 million in the second quarter and $1.7 million year to date. Turning to our outlook for the remainder of 2015, as Paul discussed, and we have previously indicated, we had expected a major project to step down in the second half of 2015 to approximately half its run rate.

But as a result of a proposed resolution of this matter, our efforts going forward will be very little. While our underlying growth remains in the high single-digits, it will be partially offset by the significant decline in this major project, as well as our defense work.

As a result, we expect full year 2015 growth in revenues before reimbursements to be in the low single digits, and EBITDA margin to be down approximately 50 basis points from the 25% we achieved in 2014. We remain optimistic about our business and our long term prospects. Now, I will turn the call back to Paul for closing remarks..

to produce strong organic revenue growth and improve profitability, which are expected to generate significant cash flow and allow us to continue to repurchase stock and pay dividends. Operator, we are now ready for questions..

[Operator instructions.] We’ll take our first question from Tim McHugh with William Blair..

First, just wanted to ask about the plans for headcount. You mentioned they’re probably pretty flattish as you adjust to the project, but would you cut back on headcount? Do you expect to just try and grow into this? And I guess more numerically, I’m trying to think about the 50 basis points of margin headwind this year that the half year impacts.

So trying to think about the following year, [unintelligible]..

I think it’s a bit of both of those. If you look forward realistically, the level of utilization that we had in the environmental side of our business was certainly beyond what we normally would be sustaining, but for the fact that we had a very large client, large matter, to investigate and provide services for.

So I think sort of steady state, when you have the right level of workflow and the right level of people, the utilization rate would come down some anyway, just because of the effect of the very large project. I think over time, we will tackle that from both sides.

There’s no question that what we would look to do is increase revenue from other projects. I think there’s some opportunity to do that already, just because there was so much demand on much of our staff, that there are other opportunities that maybe we could push forward with a little faster.

We will clearly be looking to fill gaps with new work and new opportunities, some of which we’re beginning to identify, some of which we haven’t identified. But inevitably, there would probably be some impact on staff over time. The reality is when a group is as busy as it is, the turnover rate tends to be smaller than when the group isn’t so busy.

So we would expect that there would be some change in headcount over time as well, as we’ve seen in other parts of the business where we’ve gone through some reasonably significant changes..

And then technology development, I think in the past year, you’ve signaled that it would be down, that there were some opportunities or at least some things you were trying to pursue.

So where does that [unintelligible]? Is there anything on the horizon that could reaccelerate the growth of that piece of the business? Or are we likely to stay in this range for a while?.

I think from the standpoint of defense work, we don’t see necessarily a lot of change. There are always some smaller, reasonable sized projects that we’re pursuing, investigating, whatever, that may come to fruition, but nothing of the magnitude that would put us back in the mode when we had combat troops in Iraq and Afghanistan.

If we look at what we did in going from last year to this year is we knew we’d have a significant drop in defense revenues, but we also thought there was an opportunity to reposition part of that group. We did have a fairly significant change in headcount throughout last year in that group, recognizing that these changes were coming.

I think the part of that group that is moving to what I’ll call commercial technology development projects have had some success, and we’ve had some good projects. But probably not running at a level where we would say we’ve completely settled that group into a new diet of commercial technology development projects. But we’re still optimistic.

The projects we’ve been involved in have been successful projects. I think we’re starting to get some recognition in that space. But certainly, that is not going to be at the size that it was during the time period when there were combat troops in Iraq and Afghanistan..

And just to be clear, the numbers that I provided around defense were just the change in defense revenues. It doesn’t include any commercial work that may have come in that partially offset that. That would be in the underlying growth numbers..

We’ll go next to Joseph Foresi with Janney Montgomery Scott..

I was curious about the ending of the large project.

Can you bring us up to speed on what’s left out there for large projects? And maybe you could talk a little bit about anything that might be in the pipeline that could reach that level?.

So, just as sort of a recap here on some of the history, setting aside defense, which is a different thing, you know, we’ve talked for quite a few years now actually about three large assignments, which over time got identified as being the activities regarding the oil spill in the Gulf, unintended acceleration with Toyota and a large PG&E gas explosion.

And this is the last of those three to step down from what I would call an abnormal level to back into a normal range.

So we’ve described in the past that each of these three projects have been in the 4% to 5% of revenue of the entire firm, and that what we’ve also described is normally, our large projects, that would last from a few quarters to a year or so, might be of the order of 2% to 3%, 2.5% of revenue, let’s say, and then they would step down into something lower.

And so it was because these ones were above that let’s call it 2.5%, were up in the 4.5% to 5%, we felt it appropriate to share with shareholders the potential impact of a slowdown in those.

So we’d previously indicated that two of those matters, which have been identified as the unintended acceleration matter and the gas explosion matter, have indeed moved out of being what we call a major assignment, out of the 4% or 5% of revenue down to below 2% of revenue.

Now, those are a little different in the sense that it doesn’t mean that revenue from those clients necessarily isn’t still fairly significant. Both of those are clients we’ve had for a long time, and we do various other projects for them.

But the projects related to those two events have fallen out of what we would call a major assignment into what we’d call our normal mix of business. So the only one that was remaining was the matter that’s been identified as being in the Gulf, and that’s what we have indicated was sort of this 4.5% of the company’s revenues.

Now, that one we had explained earlier in the year, based on when court deadlines were and so forth, based on the information we had, we’d explained earlier in the year that we expected the second half of the year, that would drop it roughly in half. Well, it turns out that a major settlement was announced.

That has to be approved by the court and so forth, and it’s not completely over, but the result of that is that this project has essentially ended. It’s actually abnormal for us. Normally, large projects step down over time, and they tend to have long tails.

We’ve talked about that in the context of previous large projects, like Exxon Valdez, or we’ve talked about where there were rollover issues with regard to SUVs that had a very long tail on them and so forth. This one has ended more abruptly than we would have expected.

And there may be a few little things we’re still working on to finish up, but they’re truly little in comparison to the original size. It’s not like dropping in half, it’s much more like just disappearing. So in that sense, it’s been more dramatic.

And therefore, we’ll take a little bit of time here in the back half of the year for us to adjust to that in terms of filling other work in and dealing with headcount and so forth.

Whereas normally, we say these step downs occur in a more gradual way, and as a result, just have an effect of being a headwind against our organic growth over time, but don’t really cause anything beyond that..

It sounds like what you’re saying is that this effectively ends our conversations about headwinds from large deals slowing down and not going forward, although the numbers will correct themselves. You don’t have any other large deals, effectively..

That’s correct. We don’t have other projects that represent more than this sort of 2% to 2.5% maybe 3% of revenue that we identify, and so that’s not the mode that we’re in.

We’ve obviously got large clients we do a diversified portfolio of work for and things, but we don’t have anything that fits in this category that we have been talking about for some time in terms of either the three major assignments or the defense work..

And then if we look at the present customer base and projects, we’ve been surprised in the past by the strength that you did in defense. Obviously, there was a step up of these contracts when they came into the business.

Is there anything in the current client or customer base or project base that you think has the ability to step up and be a catalyst now that you’ve seen the tail end of the larger projects you were working on?.

I’m going to give kind of a yes and no answer to that. If I would specifically put on narrow blinders and I said do we have other projects today that we think could grow to the 4% or 5% of revenue, the answer would be no on that. But we do have new matters coming in, but we don’t see that they’re going to be of that size.

But if you ask the question in terms of more broadly do we see a very strong flow of good activity out there both in the reactive and proactive space, the answer is absolutely yes.

We’ve talked for some time about how we’ve tried to be careful in describe this each quarter, about what’s going on in the underlying business versus these three large projects and events. And we’ve always tried to separate that.

And we’re still in that exact same mode we’ve been pretty much constantly over this time period, over this time period, which is that the underlying growth, separated from that, is in the high single-digits. We had this bump from that coming in and it’s gone away here. So we still feel very good about the underlying flow.

The proactive part of the business is clearly growing from our standpoint. We see that running at probably about 40% of the business today.

And the reactive side, I mean, you know, if you listen to the news over sort of recent times, there’s a variety of different fairly significant events that have made national news involving what I would call sort of engineering related projects.

And because of confidentiality, I can’t go into all of them, but basically, we still feel very much that if it’s on the national news, we’re retained. And I think we feel as good about that today as we’ve ever felt about that..

As you look at the proactive versus the counter-cyclical, can you give us any sense of the growth rates that you expect in those businesses and the size of them? Is one going to complement the other and grow faster? We’ve talked about historically this usual mid to high single digit growth rate.

Is there anything that might cause that to tweak up once we get to better comps?.

Yes, our expectation long term remains to be a high single to low double digit organically grown firm. We think history plays that out. You can play out the last 10 years, the last five years, 20 years, whatever it may be. On average, we’ve been right around 10% as the growth.

What we are definitely seeing is that we see here over the next several years to maybe even much longer, that the proactive work will be a double digit grower. We think we are making good progress, but we are still very early in our development there.

It is a huge market opportunity when you look across the different industries and services we have to offer, from design consulting to regulatory consulting, to risk management type of matters. All of those play out across almost all of the what I will call industrial businesses. People who make things and either you’re processing or selling products.

It fits across that spectrum. So we have a long term optimism here around our ability to be able to grow in that area. The reactive business for which we’ve been in for 50 years almost now, we think we’ve got a leading position there, but it’s one that we’re likely to be growing sort of middle single digits.

Certain matters and things clearly we get the great visibility on, but that that’s sort of a mid to high single-digit growth area for us..

We’ll go next to Tobey Summer with SunTrust..

On the headcount for the balance of the year, headed into next year, I just want to make sure I understood, because I think I missed part of it. You kind of conveyed flattish, even though you have some new people slated onboard.

So does that imply that some people associated with the large project will be leaving the firm? Or maybe you could just give some color on whether all that work was being done with full time staff, or there might have been some contractors involved or something..

First of all, the work that we were doing was almost entirely done by our staff. The net revenues are not focused on other staff. So it is our staff. As I indicated, they were running at a much higher utilization that would be maybe normal for a group in that marketplace, and so some of that will just get taken care of from that standpoint.

Look, I think with regard to staff, usually for one reason or another, when there’s a significant change in the workflow, there does end up being some change in staff. We’re always looking for new opportunities. We’re not going to stop hiring in that area.

But needs change, and so the people you hire in one subspecialty that you think is sort of important and maybe you’ve got too much staff in another specialty. And I think it’s sort of offsetting all those effects that Rich indicated that staff outlook going forward might be overall, more flat..

And then I wanted to expand on the implications of slightly faster growth over a period of time in the proactive side of the business.

What metrics that we’re used to talking about for the business might change? And if so, how? And as an example, does leverage of folks go up and maybe the bill rate growth slow because of that? Those just being examples, I’ll let you speak as to which metrics..

Let me describe a few things that are going on there, and this runs a fairly broad range.

One aspect of it is that we’ve talked before about the challenges associated with growth in parts of, particularly in our design consulting area, where our clients are very focused on confidentiality, it’s very difficult to market to new clients in a sense because they don’t know what you’re doing, because you’ve got to be confidential about the work you’re doing.

Over time, I think that tends to open up a little bit, in part because people who’ve worked with you at one company move and go to another company, and there just becomes more knowledge out there that Exponent is a major player in certain areas.

And so we think that that is sort of accelerating, in a sense, some of the opportunities for growth, and from that standpoint, I think we’re optimistic about that aspect of it.

I think we have gone through a time period -- this kind of goes back to sort of the billing rates and the issue with regard to that change in rate that Rich had talked about, the fact that our average billing rate has not gone up much. It’s because in the proactive space, there is probably greater leverage.

Both proactive and large project reactive tend to have the most leverage in the business.

And as a result of that, you tend to get a higher proportion of more junior people working on the program, so that while that’s not a problem at all obviously from a profitability standpoint, but nevertheless, when you look at it from the standpoint of growth in our bill rates, you kind of end up concluding wait, the bill rates aren’t going up, even though we are going up much, even though we’re increasing them each year.

So I think there’s an effect there. And then the final area, I think, is just continuing to expand the breadth of what we do in the more proactive spaces. I think one of the things that makes us really valuable in that space is the range of technologies that are involved.

Whether it’s in polymer science or it’s in electrical engineering or battery technology or whatever, we’ve got a very broad range. And part of that range we’re continuing to work on, continuing to try to build upon. We see some opportunities in data analytics. We’re just scratching the surface at the moment.

So the range of opportunity out there beyond just what we’re in right now, this firm has always got part of its growth by expanding the range of what we do, and we still see opportunities to do that, both in the health arena, for example, and the pharmaceutical area, but also in the engineering space as it gets more into some of these sort of analytical areas that we can provide solutions to clients on..

One numerical question for Rich. Just want to make sure I caught it.

The amount of share authorization you have remaining at this stage?.

Yes, that is just over $28 million..

[Operator instructions.] We’ll go next to David Gold with Sidoti..

Rich, you commented that you have a strong pipeline of professionals coming in. And you talked a little bit about expecting flattish headcount. And so just curious there, on the professional management.

One, can you speak to which practices you’re likely adding to? And then to just how one manages that balance, or has some management of the balance already taken place?.

I think that we’ve certainly had certain areas of the firm that are growing faster, that we expect more headcount growth. And I would include that as being on the health side in the chemical regulation and food safety area. There’s a strong pipeline there.

I think if you look to the engineering side, the practices that tend to provide services to these more proactive growth areas we’ve talked about. That includes materials, it includes polymer science, it includes biomedical. Those would be examples of some of the areas that would be growing at a faster rate.

And was there a second part, David?.

Just as far as managing the headcount that goes in, versus that goes out..

I think the other aspect I would say about that, in addition to the comments I’ve already made, I think you’re all aware that we’re not a what I’ll call a traditional project engineering firm, that hires and fires people because they have certain projects. We hire and develop staff over a long period of time. We attract very qualified staff.

More than half of our people have PhDs.

And so one of the effects of that is that when there are significant changes in the marketplace, whether it be in what happened in defense or whether it might be what happened here recently with this project, there’s going to be a little bit of time to digest that and make what I’ll call appropriate adjustments, considering where we want to go and where we’ve got strength in staff and so forth.

It would be easy for me if it was a situation where I could say yes, we’re going to make exactly this change, but that’s not really the way the business works.

Having said that, you can look back over time, whether you look at the challenges in 2009 or whether you look at how we’ve handled the situation in defense, we do find a way to make the adjustments that need to be made.

And again, we will do that here, but it’s in this broader context that I’m describing of having a very high end workforce, and so those matters have to satisfy that body of constraints..

Can you speak to at this point uses of the cash position builds and repurchases obviously a little bit during the quarter, but is that still high on your list? And is there anything else we should be thinking about there?.

I think really three areas that we’ve talked about. We’ve been conservative probably over the long term on all three, but really look to, over the next four to five years, to be able to see that our cash balance is coming down into the $50 million to $70 million range.

And we expect to get there really across our continual look for acquisition opportunities that would be a growth into one of these adjacent areas, as Paul has discussed earlier, where we continue to look at that. It’s clear that we haven’t done anything since 2002.

That doesn’t mean that we don’t continue to look and evaluate things, but we feel that it’s a matter of identifying the right opportunity that we think is of good value to shareholders in that process.

So we’ll continue with that, but outside of that, it is our intent to continue to grow the dividends at a rate that is a little faster than earnings growth here, at least in the near term, and to complement that with a repurchase program that takes advantage of step backs in the stock.

And over time, we think that hopefully that will achieve the long term goal of delivering good return on equity to shareholders..

We’ll take a follow up from Tobey Summer with SunTrust..

Rich, I think you gave a billable hours number.

Could you repeat that, and the comparison?.

Yes, the second quarter billable hours increased 4% to $287,000 as compared to $276,000 in the second quarter of last year. This brings the year to date billable hours up to $579,000 versus $550,000 last year..

[Operator instructions.] And it appears there are no further questions at this time. This does conclude today’s conference. A replay will be available later today. To hear the conference, dial 1-888-203-1112 and enter the passcode 6997907. Thank you for your participation..