Good day, and welcome to the Exponent Third Quarter Fiscal Year 2021 Financial Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to [ Joni Konstantelos ]. Please go ahead. .

Thank you, operator. Good afternoon, ladies and gentlemen. Thank you for joining us on Exponent's Third Quarter of Fiscal Year 2021 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. .

Joining me on the call today are Dr. Catherine Corrigan, President and Chief Executive Officer; and Rich Schlenker, Executive Vice President and Chief Financial Officer. .

Before we start, I would like to remind you that the following discussion contains forward-looking statements, including, but not limited to, Exponent's market opportunities and future financial results that involve risks and uncertainties that may cause actual results to differ materially from those discussed here.

Additional information that could cause actual results to differ from forward-looking statements can be found in Exponent's periodic SEC filings, including those factors discussed under the caption Risk Factor in Exponent's most recent Form 10-Q. .

The forward-looking statements and risks in this conference call are based on current expectations as of today, and Exponent assumes no obligation to update or revise them, whether as a result of new developments or otherwise. .

And now I will turn the call over to Dr. Catherine Corrigan, Chief Executive Officer.

Catherine?.

Thank you, [ Joni ], and thank you, everyone, for joining us today. I will start off by reviewing our third quarter 2021 business performance. Rich will then provide a more detailed review of our financial results and outlook, and we will then open the call for questions. .

In the third quarter of 2021, we continued to deliver exceptional results. For the quarter, net revenues grew 16% and while EBITDA margin increased to over 350 basis points from the prior year period.

We saw robust demand across our diverse business lines, in large part driven by our differentiated value proposition, which brings together high-quality data analytics with unrivaled subject matter expertise. .

Importantly, while momentum in litigation continued, the proactive side of the business continued to drive growth through a significant increase in user and machine learning data studies outpacing 2019 levels.

Additionally, the velocity of new starts over the last several months and the caliber of that talent underscores our ability to attract the best and the brightest talent to our team. .

Turning to our engagements in more detail. Our momentum continued into the third quarter as we won new assignments while reengaging projects on the reactive side of the business. As we highlighted last quarter, our litigation work has been in a mode of recovery, hovering near 2019 levels.

As the throughput of litigation in our United States courts continues to accelerate, we will be positioned to capture the stickiness and inertia around the backlog of trials making their way through the system.

Globally, delays in international arbitrations have the potential to recover with eased COVID restrictions facilitating more in-person meetings. .

Exponent is well positioned to capture these growth tailwinds, while also leveraging expansion into new end markets such as pharmaceutical and software litigation and increasing our brand recognition in the international arbitration arena.

Within our proactive business, we are seeing a strong increase in user studies spanning across various end markets, particularly as it relates to artificial intelligence and machine learning for wearables and other devices.

This increase is driven by rising demand as well as the accessibility of human participants and the ability to conduct on-site work as COVID restrictions eased over the year.

Overall, our proactive engagements remained robust and diverse, fulfilling complex customer requirements related to user experience, as well as product optimization and performance while leveraging data analytics to further mitigate risk for our clients. .

Our traction across our multidisciplinary offering continues to demonstrate the strength of our long-term strategy and our commitment to providing customers with the tools and analysis needed to drive optimal decision-making.

Utilization in the third quarter saw improvement year-over-year, supported by strong demand for human participant studies, increased litigation work and lower head count, which drove improved profitability.

However, as we have said over the last few quarters, we do expect utilization to normalize somewhat in the fourth quarter of 2021 as human participant studies moderate, head count grows and we see typical seasonality. .

Recruiting a world-class team remains a top priority for us, and we have accelerated our efforts during the second and third quarters of 2021.

While the market for engineering and scientific talent remains competitive and voluntary turnover has increased relative to last year, we are seeing exceptional candidates and adding depth and experience to our already world-class team. .

Turning to our segments. Exponent's engineering and other scientific segment represented 83% of our net revenues in the third quarter, increasing 20% year-over-year. Our growth was driven by strong demand for Exponent services across a broad range of the industries and use cases.

In addition to the steady increase in litigation support and human participant studies for the consumer products segment, our work around wearable technologies and asset integrity and risk management for utilities was a core driver of growth over the period. .

On the automotive side, we continue to see strong reactive based demand for our unrivaled and state-of-the-art testing and analysis capabilities for Advanced Driver Assistance systems.

On the proactive side of automotive, we continued to engage clients in implementing safety frameworks in the automated, connected, electric and shared vehicle space, while also gaining traction on battery work for electric vehicles and energy storage systems. .

Exponent's environmental and health segment represented 17% of the company's net revenues in the third quarter. Net revenues in this segment were largely flat compared to the prior year period.

The pharmaceutical industry remains a significant opportunity for Exponent as we leverage our multidisciplinary approach and data landscape across the full product life cycle from pharmacoepidemiology and real-world evidence to health economics and outcomes research and market access.

As mentioned last quarter, our focused efforts in the pharmaceutical industry continue to materialize with an emphasis on recruitment and business development initiatives supporting new client engagements. .

Overall, we are very encouraged by the influx of new engagements and key hires across the business. We are already seeing our accelerated recruitment efforts materialize with a strong pipeline of high-quality talent, positioning Exponent for a record year of hiring to close out the year.

As we move through the remainder of fiscal year 2021, we remain confident that our strong reputation, multidisciplinary capabilities, industry-leading expertise and market-driven durability will propel Exponent forward towards sustained growth and increased scale. .

I'll now turn the call over to Rich to provide more detail on our third quarter 2021 results as well as discuss our outlook for the fourth quarter and the full year 2021. .

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 third quarter of 2021, total revenues increased 18% to $116.4 million and revenues before reimbursements or net revenues, as I will refer to them from here on, increased 16% to $108.5 million as compared to the third quarter of 2020. .

Net income for the third quarter increased to $24.6 million or $0.46 per diluted share as compared to $18.1 million or $0.34 per diluted share in the prior year period. EBITDA for the quarter increased 31% -- to $34 million, producing a margin of 31.4% of net revenues, which is an increase of 355 basis points as compared to the third quarter of 2020.

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Billable hours in the third quarter were 348,000, an increase of 13% year-over-year. Utilization in the third quarter was 76%, up from 66% in the same quarter of 2020.

Utilization in the quarter remained above expectations, driven by lower FTEs or full-time equivalents and strong demand for our human participant and machine learning studies as well as litigation support. Technical full-time equivalent employees in the third quarter were 883, down 2% as compared to the same period 1 year ago.

The realized rate increase was approximately 3% for the third quarter. .

Compensation expense after adjusting for gains and losses in deferred compensation, increased 9%. Included in total compensation expense is a loss in deferred compensation of $300,000 as compared to a gain of $3.2 million in the third quarter of 2020.

As a reminder, gains and losses and deferred compensation are offset to miscellaneous income and have no impact on the bottom line. Stock-based compensation expense in the third quarter was $4.4 million as compared to $3.7 million a year ago.

Other operating expenses were up 2% to $8 million, driven primarily by increased activities at our offices as our employees gradually return. Included in other operating expenses is depreciation expense of $1.6 million for the quarter. .

G&A expenses were up 48% to $4.2 million for the third quarter. The increase in G&A expense was primarily due to higher marketing and recruiting activities. Interest income decreased $300,000 to $13,000 for the third quarter. Lower interest income is a result of a steep decline in interest rates.

Miscellaneous income net of deferred compensation loss was approximately $300,000. Inclusive of tax benefit from share-based awards, Exponent's consolidated tax rate was 24.1% for the third quarter as compared to 26.6% in the prior year period. .

Moving to our cash flows. During the third quarter, we generated $24.9 million in cash from operations and capital expenditures were $1.2 million. In the third quarter, we distributed $10.4 million to shareholders through dividend payments. At quarter end, the company had $255 million in cash and short-term investments. .

Turning to the outlook for the fourth quarter and full year 2021. We now expect fourth quarter 2021 revenues before reimbursements to grow in the mid-single digits and EBITDA margin to decrease 175 to 225 basis points as compared to the same period in 2020.

For the full year 2021, we expect revenues before reimbursements to grow in the mid-teens and EBITDA margin to increase 290 to 310 basis points as compared to 2020. .

We expect utilization in the fourth quarter to be 67% to 69% as compared to 66% in the same quarter last year. As a result, we expect a full year utilization of 74% to 75% as compared to 67% in 2020. As a reminder, utilization is lower in the fourth quarter due to more holidays and vacations.

In particular, we expect more vacations in the fourth quarter as compared to last year even. .

In the fourth quarter, we expect full-time equivalent employees to reach approximately 910 to 920, which is a sequential growth of 3% to 4% from the third quarter of 2021. This will place us slightly ahead of where we were in the fourth quarter of last year. As we progress through 2021, we have accelerated our recruiting efforts.

While the job market remains highly competitive, which has resulted in increased voluntary turnover over prior year, we continue to demonstrate our ability to attract high-quality talent. We have had a significant number of new starts over the last several months, which will temper utilization slightly in the fourth quarter. .

In the fourth quarter, we do expect year-over-year realized rate increase of 2.5% to 3%. As a result, the full year realized rate increase is expected to be 4% to 4.5%. We expect stock-based compensation to be $3.8 million to $4.2 million in the quarter and $19 million to $19.4 million for the full year.

We expect operating expenses for the fourth quarter to be $8.4 million to $8.7 million. And for the full year, we expect other operating expenses to be $32.2 million to $32.5 million as we gradually return to the offices.

We believe our office environment provides long-term value as it supports collaboration for our interdisciplinary teams and staff development, which results in higher value for our clients and retention of our employees. .

We anticipate associated expenses to be at historic levels as we enter 2022. G&A expenses will also gradually scale as recruiting, business development and travel activities increase. For the fourth quarter of 2021, we expect G&A expenses to be $4.5 million to $4.8 million.

For the full year 2021, we expect G&A expenses to be $15.2 million to $15.5 million. For the quarter, we expect interest income to be approximately $10,000 and $60,000 for the full year. In addition, we anticipate miscellaneous income being approximately $500,000 for the quarter and $2.1 million for the full year. .

For the fourth quarter of 2021, we expect our tax rate to be approximately 27% as compared to 18.6% in the same quarter last year. As a result, we expect the full year 2021 tax rate to be 19% as compared to 14.8% in 2020. CapEx for the full year 2021 is expected to be $8 million to $9 million.

We are pleased to have delivered another strong quarter with significant margin improvement year-over-year, and we are confident in our ability to continue to grow. .

I will now turn the call back to Catherine for closing remarks. .

Thank you, Rich. For over 50 years, Exponent has partnered with thousands of clients to address their most complex challenges.

As society continues to raise expectations for safety, health, sustainability and reliability as our clients' needs evolve and increase in complexity, Exponent remains uniquely qualified to deliver groundbreaking solutions for the challenges of today and to help unravel the complexities of innovations for tomorrow.

We are confident that the increased level of new engagements across our broad-based portfolio as well as new hires across the business will support consistent profitable growth and will ultimately drive long-term value for our shareholders. Operator, we are now ready for questions. .

[Operator Instructions] We'll take our first question from Tobey Sommer of Truist Securities. .

I was hoping you could give us some more color about the sort of record headc ount and hiring additions that you've made and expect to continue to make this year.

And then maybe if you could frame that in the context of what you think you could achieve on an ongoing basis as we look to model future periods?.

Yes. Thanks, Tobey. So we've certainly accelerated our efforts around recruiting just in the last few months, and we're particularly encouraged by how we've been able to continue to attract the best and the brightest talent in the organization.

There's no doubt that we're seeing a competitive marketplace for that talent as we always have, but we feel very good about what we've been able to do in terms of bringing them on board and getting them into the flow of engagements quickly so that they can be contributing and having an impact relatively quickly in their tenure.

So we've got our foot on the pedal there. We intend to keep our foot on the pedal there with a goal really, as we come back into sort of a more normalized type of situation to be growing head count annually in -- with sort of a goal of 4% to 7% range. .

That really has not changed in terms of what we're looking to do in a steady state over the long term. What we're dealing with now is still some transients that are in the system. We've demonstrated our ability to ramp up and really surge in order to meet client demand, so that's been great.

But over the long term, we need these folks that are coming on board to be able to make their investments in professional development and business developments and all of those things that require their time.

So as we get back on a more long-term normalized basis, we do expect that the utilization will moderate a bit as we increase the head count and sort of balance those things out. .

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

The first question I wanted to ask was just on the proactive and reactive businesses as kind of a component of mix here. It sounds like proactive has been gaining momentum for some time post pandemic.

So I was wondering if you can kind of help us think about the growth rates for those 2 pieces, both immediately following the pandemic and maybe how it's progressed over the course of the past couple of quarters. .

Yes, thanks. And things are a little bit different depending on which side of the business you're looking at.

When we look at reactive and particularly litigation, we're continuing along what I would call a fairly steady, gradual path in terms of the pace of the engagements, right? It's -- there's an increasing rate of activity that's going on through the domestic court system. There are still some impacts related to restrictions.

There are still some challenges that they're seeing in the courts in terms of in-person engagements, bringing juries in and that sort of thing. But it's getting there. We're continuing to see this sort of steady increase. .

As we look forward, we certainly see activities in the reactive space for growth. Although as I look forward, I really do believe that the proactive side will grow faster.

If I think about the drivers on the proactive side, there are lots of drivers around the regulatory frameworks that things like chemical regulatory work, that continued to grow through the pandemic, and we expect it to continue to grow as we kind of get away from the pandemic.

Think about the design related and reliability-related consulting that we're doing for the consumer products industry. That's something that's been a very strong driver lately. .

And if you look at the kinds of innovation that are happening, things like virtual reality, augmented reality, consumer electronics, these are all important drivers. We're doing a lot of work around machine learning, data curation and data collection studies that's being driven by that sort of innovation landscape.

Climate change is driving work for the utilities industry and around infrastructure in general. Assessing the vulnerability of our infrastructure, we're seeing work there. Our work in batteries and energy storage. .

If you just think about the demand sort of tipping point that we're getting to around electric vehicles. General Motors announced additional expenditures over the last month. Ford is building a couple of extra battery plants.

I think even Lamborghini is announcing they're going to electrify their fleet, right? So there are lots of drivers for this proactive sort of safety-driven and complexity driven work on that proactive side. So the reactive will grow as well.

We mentioned pharmaceutical litigation, software litigation, international disputes is an area where we continue to build our brand. So we've got good drivers on -- really on both sides of the house. .

That's really helpful. Actually, Catherine, you made note of the second question I was going to ask, which is around software litigation. I don't know if that's a new name for a practice that -- or a new reference to a practice that you've had for some time. But I don't believe that's something that you've called out in prior calls.

Can you talk a little bit about that opportunity? It certainly makes sense as the world gets eaten by software.

I was just wondering what that opportunity looks like, how new that is and maybe what the ramp schedule looks like for a practice like that, particularly given I would imagine sourcing talent and adding new people to be able to service that is incredibly tough in this environment. .

Yes. Yes, thanks. And so this is work that we have been doing but are seeing some stronger growth drivers. So some of it is in the intellectual property type of space. Other software litigation is around embedded systems in particular.

We've had a lot of expertise in embedded systems within our electrical engineering and computer science practice for many years. Think about the systems that are driving control systems for automotive electronics. That's a big area or control systems around advanced manufacturing. These types of areas can lead to either IP litigation.

They can lead to sort of product quality-related litigation. It could lead to the types of litigation where OEMs are trying to recover from their suppliers. It sort of comes in a lot of different forms. But it's something we've been seeing more of. It is that as well as pharmaceutical litigation are areas where we're getting more traction.

And so that, along with the -- with all of the other areas of litigation, like product liability, like human health-related litigation, like environmental litigation, we see the ability to continue increasing sort of across this broad portfolio as we go forward. .

[Operator Instructions] We'll take our next question from Sam England with Berenberg. .

The first one I had, could you talk a bit about which end markets have bounced back most strongly over the last couple of quarters? And then which end markets are still below pre-pandemic levels and where there's sort of a recovery opportunity over the next few quarters?.

Yes. Thanks, Sam. One area that I mentioned that I would highlight in this context is our proactive work around consumer products and consumer electronics being a significant part of that.

This is a lot of the motivation for the human participant work, for the machine learning data type of studies that we've been doing for our user experience capability where we're doing research, really understanding the sort of cognitive effects of the use of technologies like virtual reality and augmented reality. .

That end market is quite strong. The utility sector is another one where we're really bringing our subject matter expertise in engineering and marrying that with our sophisticated data analytics capabilities in a very unique way.

Not only can we sort of run the algorithm and crunch the numbers to utilize sort of that artificial intelligence, but we also have the engineering expertise to lay over that. And we're finding that to be very valuable as we're assessing asset integrity, as we're looking at climate vulnerability and resilience in the utility sector.

And so those are some of the stronger ones. .

Some of the ones where we're seeing maybe a little more slowness, if I go back over to the reactive side, the litigation markets are sort of recovering at different paces. One of them that's maybe slower than the others is around transportation and product liability. This is one that got hit particularly hard back in 2020. .

And part of the reason for that, I believe, is because of its dependence not only on the court system, but also on our ability to travel to do site inspections, to do vehicle inspections, to bring people on site to do vehicle testing.

There's a lot of that type of work in that arena, and so -- not to mention the impact that the pandemic had on the client base in that area being very dramatic. And so it's taking some time, but we're absolutely sort of on that path.

But that, for example, has been slower than if you look at sort of the health and environmental-related litigation, which was stronger through 2020, wasn't impacted as much. So a little bit of variability there that we're still looking to kind of bring that transportation work back in litigation. .

But part of what's doing that right now is the work in Advanced Driver Assistance systems.

That is a -- in terms of prospects for recovery, that is a particular litigation area where we are being sought out for a really unique set of expertise that we've got, both around how these systems have been deployed and also how to test them in real sort of limit type of environment.

So we are seeing a lot of encouraging trends in that particular sector. .

Okay. Great. And the next one I had, you touched in your remarks on the higher staff attrition you've seen.

I think firstly, how much of that do you think is just driven by the fact that you had lower attrition in 2020? And then what are you doing as a business to try and improve staff retention in light of the business in those market?.

Yes. Yes. Thanks, Sam. I think there is definitely a piece of this that is sort of pent up from 2020. I don't think it explains everything, but I do think it explains some.

You're in an environment in 2020 where folks are maybe less certain about wanting to sort of change course, whereas as we started coming out in 2021, they see sort of more opportunity for that. .

As a company, one of the things that is so incredibly important to the retention of our consultants is our emphasis on professional development.

When we hire folks in, especially the junior staff, which is a big percentage of our hiring, we want to put them on a path that is going to help them to publish, help them to become famous, help them to find a niche and be engaged with clients and ultimately become a lead consultant someday.

So our efforts around retention are very much focused on those types of programs. They're focused on mentoring. They're focused on sponsorship. They're focused on ensuring that we are creating opportunities for those staff to have client engagement directly and really be able to see the impact of the work that they're doing. .

These are things that we always do. That's been part of our growth paradigm as a company for many years.

But we're placing particular emphasis on that sort of development path for our team as well as some of the simple things when we're in a virtual environment, ensuring that we're checking in on our teams, ensuring that we're focused on their mental health and well-being, because they're very busy.

Our utilization is sort of hitting records here, right? And so there are those aspects as well, where we're really looking to our leadership, our directors, our managers all the way down to our supervisors to really find ways to foster engagement with the staff directly. .

We'll take our next question from Tobey Sommer of Truist Securities. .

Sorry about my technical difficulty.

Could you talk about what you would expect realized pricing to be if inflation broadly in wage inflation kind of up and down the labor market picks up and persist for a period of time? How would you realize pricing react?.

Yes. Thanks for the question. Tobey. Look, we, at Exponent have seen our pricing increases on a year-over-year basis sort of range in that 2% to 3.5% level over a couple of decades here as we've moved through different economic cycles and, in particular, the demand environment for high-end engineering and scientific talent.

Probably, the most important thing that goes on in our sector is what is that demand for that -- those engineers and scientists, what are our clients, who tend to also hire engineers and scientists, realizing in the employment market that the price for talent is going up. It will increase and do that.

So I think right now, we're in a strong demand environment and as such, and we may get some inflation here in things. But I'm expecting us to be in the upper part of that range in the rate that we realized as we go into 2022. .

And I apologize if I missed something. But could you expand on your utility work and the resiliency? And I'm kind of interested not just in the current work, but whether or not other utilities and other geographies are building out projects as well. .

Thanks, Tobey. Yes. So we are seeing sort of expansion of the work that we're doing in the utility sector. Of course, the Western utilities have a big driver around wanting to prevent wildfires. That has been an important driver for the work that we've done around risk related to electrical assets over the last -- certainly over the last several years.

And so that has been a strong area of growth. But there are -- what's wonderful about what we're doing is that the methodology and algorithms that we have developed to apply diverse data sources and engineering to look at the probability of failure, you can do this not only for wind knocking down transmission lines.

You can apply the same paradigm to vegetation risk. You can apply the same paradigm to bird strike risk. You can apply this paradigm to flooding risk, the sort of basin updating concept that's used statistically in this overall framework. .

And so what's exciting to me about this is that we have an opportunity to really broaden beyond and are already broadening beyond simply the peril of wind and electrical transmission lines into a broader set of assets that include gas infrastructure, that includes water-related infrastructure, et cetera.

So there's a nice set of opportunities, I think, for us as we build out our capabilities that marry these data analytics with that subject matter expertise. .

Last question for me. Of the multiple appropriations bills being juggled in Congress currently from the regular way budget, eventually the soft and hard infrastructure packages.

Is there anything that we should watch for in terms of the potential inclusion in those bills as being relevant for growth in your marketplace, understanding that you're typically working with commercial clients? But these government initiatives can be so big as to influence trends in the commercial markets, too. .

Yes, Tobey I think you're right there in the sense of trends. We -- historically, we have not seen a sort of immediate impact come from a 1-year budget. But I will bring your attention to some areas that we've been talking about here.

First of all, the funds that are going in, it sounds like around climate change and energy and all that are focusing along incentivizing electric vehicles, which obviously Exponent has a lot of expertise around and incentivizing the increased demand -- driving more demand about that.

That would be very -- continues to be positive for us and any encouragement of that would be good. .

The other area is alternative energy as you move into, I think, currently, the least what's out there is a lot around wind and technology.

We do a lot around the technologies and reliability of those wind systems, both turbines as well as blades and other things that come into your traditional engineering, but more volume and energy into that would be positive.

Focus around really the understanding in the health care area around real-world data, and real-world data evidence and the drive in that direction to have the accountability for the value being delivered there. That's very much centered to what we are trying to build in our go-to-market for the pharmaceuticals industry and such.

So those are a couple that I at least have. .

Thank you. At this time, we have no further questions in queue. This concludes today's call. Thank you for your participation. You may now disconnect..