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EXPO > SEC Filings for EXPO > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for EXPONENT INC

Form 10-K for EXPONENT INC


3-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

Exponent, Inc. is a science and engineering consulting firm that provides solutions to complex problems. Our multidisciplinary team of scientists, physicians, engineers, business and regulatory consultants brings together more than 90 different technical disciplines to solve complicated issues facing industry and government today. Our services include analysis of products, people, property, processes and finances related to litigation, product recall, regulatory compliance, research, development and design.

CRITICAL ACCOUNTING ESTIMATES

In preparing our consolidated financial statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, operating income and net income, as well as on the value of certain assets and liabilities on our consolidated balance sheet. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis we evaluate our assumptions, judgments and estimates and make changes accordingly. We believe that the assumptions, judgments and estimates involved in accounting for revenue recognition and estimating the allowance for doubtful accounts have the greatest potential impact on our consolidated financial statements, so we consider these to be our critical accounting policies. We discuss below the assumptions, judgments and estimates associated with these policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. For further information on our critical accounting policies, see Note 1 of our Notes to Consolidated Financial Statements.

Revenue recognition. We derive our revenues primarily from professional fees earned on consulting engagements, product sales in our defense technology development practice, fees earned for the use of our equipment and facilities, as well as reimbursements for outside direct expenses associated with the services that are billed to our clients.

Substantially all of our engagements are service contracts performed under time and material or fixed-price billing arrangements. For time and material and fixed-price service projects, revenue is generally recognized as the services are performed. For substantially all of our fixed-price service engagements, we recognize revenue based on the relationship of incurred labor hours at standard rates to our estimate of the total labor hours at standard rates we expect to incur over the term of the contract. Our estimate of total labor hours we expect to incur over the term of the contract is based on the nature of the project and our past experience on similar projects. We believe this methodology achieves a reliable measure of the revenue from the consulting services we provide to our customers under fixed-price contracts.

Significant management judgments and estimates must be made and used in connection with the revenues recognized in any accounting period. These judgments and estimates include an assessment of collectability and, for fixed-price engagements, an estimate as to the total effort required to complete the project. If we made different judgments or utilized different estimates, the amount and timing of our revenue for any period could be materially different.

All contracts are subject to review by management, which requires a positive assessment of the collectability of contract amounts. If, during the course of the contract, we determine that collection of revenue is not reasonably assured, we do not recognize the revenue until its collection becomes reasonably assured, which in those situations would generally be upon receipt of cash. We assess collectability based on a number of factors, including past transaction history with the client, as well as the credit-worthiness of the client. Losses on fixed-price contracts are recognized during the period in which the loss first becomes evident. Contract losses are determined to be the amount by which the estimated total costs of the contract exceeds the total fixed price of the contract.

Estimating the allowance for doubtful accounts. We make estimates of our ability to collect accounts receivable and our unbilled but recognized work-in-process. In circumstances where we are aware of a specific customer's inability to meet its financial obligations to us, we record a specific allowance to reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other customers we recognize allowances for doubtful accounts taking into consideration factors such as historical bad debts, customer concentration, customer credit-worthiness, current economic conditions, and aging of amounts due.

The following table sets forth, for the periods indicated, the percentage of revenues of certain items in our consolidated statements of income and the percentage increase (decrease) in the dollar amount of such items year to year:

                                            PERCENTAGE OF REVENUES                      PERIOD TO
                                               FOR FISCAL YEARS                       PERIOD CHANGE
                                        2013          2012        2011       2013 vs. 2012     2012 vs. 2011

Revenues                                 100.0 %       100.0 %     100.0 %             1.2 %             7.4 %

Operating expenses:
Compensation and related expenses         62.2          58.7        57.6               7.1               9.5
Other operating expenses                   8.5           8.1         8.5               7.3               1.4
Reimbursable expenses                      5.4           8.9         9.5            (38.2)               1.2
General and administrative expenses        5.0           4.6         4.8               8.5               3.4
                                          81.1          80.3        80.4               2.2               7.3
Operating income                          18.9          19.7        19.6             (2.9)               7.8

Other income, net                          2.7           1.4         0.5              93.7             203.8

Income before income taxes                21.6          21.1        20.1               3.6              12.6

Provision for income taxes                 8.5           8.4         8.1               3.2              10.8

Net income                                13.0 %        12.7 %      12.0 %             3.8 %            13.9 %

EXECUTIVE SUMMARY

Revenues for fiscal 2013 increased 1% and revenues before reimbursements increased 5% as compared to the prior year. The increase in revenues before reimbursements was due to an increase in billable hours, an increase in billing rates, and revenues of $1.4 million related to services performed in prior periods for a foreign client for which we deferred revenue recognition until receipt of payment. The increase in revenues before reimbursements was also due to fiscal 2013 having one additional week of activity than fiscal 2012. We experienced strong demand for our consulting services from a diverse set of clients for both reactive and proactive projects and received some follow-on activities related to several major investigations. This was partially offset by the expected decline in the level of activity for some of these major investigations and a decrease in product sales in our defense technology development practice.

During 2013, we experienced strong demand for our reactive services, where we investigated accidents ranging from the collapse of a major industrial facility to a home fire, evaluated potential product recalls including home appliances and food products, and assessed the health and environmental exposures for oil and gas operations.

We also experienced strong demand for our proactive services where we provided design consulting for products ranging from tablet computers to drug delivery systems, assisted clients with regulatory matters involving toilets and cosmetics, and worked with clients to develop risk management programs for gas distribution systems.

The increase in revenues before reimbursements resulted in a 4% increase in net income to $38,640,000 during fiscal 2013 as compared to $37,225,000 during the prior year. Diluted earnings per share increased to $2.76 per share as compared to $2.60 during the prior year due to the increase in net income and our ongoing share repurchase program.

We remain focused on selectively adding top talent and developing the skills necessary to expand upon our market position, providing clients with in-depth scientific research and analysis to determine what happened and how to prevent failures or exposures in the future, capitalizing on emerging growth areas, managing other operating expenses, generating cash from operations, maintaining a strong balance sheet and undertaking activities such as share repurchases and dividends to enhance shareholder value. We continue to expect some of our major investigations to step down from their elevated levels of activity as they move through their project life cycle. We also continue to expect a step down in the level of activity in our defense technology development practice due to the constraints on defense spending and reduction of forces in Afghanistan by the United States federal government.

OVERVIEW OF THE YEAR ENDED
JANUARY 3, 2014

Our revenues consist of professional fees earned on consulting engagements, product sales in our defense technology development practice, fees for use of our equipment and facilities, and reimbursements for outside direct expenses associated with the services performed that are billed to our clients.

We operate on a 52-53 week fiscal year with each year ending on the Friday closest to December 31st. The fiscal year ended January 3, 2014 included 53 weeks of activity. The fiscal years ended December 28, 2012 and December 30, 2011 included 52 weeks of activity. Fiscal 2014 will end on Friday, January 2, 2015.

During fiscal 2013, billable hours increased 3.3% to 1,087,000 as compared to 1,052,000 during fiscal 2012. The increase in billable hours was due to follow-on activities related to major investigations and continued demand for our proactive and reactive consulting services. The increase in billable hours was also due to fiscal 2013 having one additional week of activity than fiscal 2012. Total billable hours during the 53rd week of fiscal 2013 were 9,804 which contributed approximately $2.5 million to the increase in revenues before reimbursements.

Our utilization decreased to 71% for fiscal 2013 as compared to 73% during fiscal 2012 due to the anticipated step down in our elevated levels of activity on several major investigations, the anticipated step down in the level of activity in our defense technology development practice due to the constraints on defense spending and reduction of forces in Afghanistan by the United States Government, and due to our investment in hiring technical consultants. Technical full-time equivalent employees increased 3.9% to 719 during fiscal 2013 as compared to 692 during the fiscal 2012 due to our recruiting and retention efforts. We continue to selectively hire key talent to expand our capabilities.

Product sales in defense technology development decreased to $486,000 during fiscal 2013 as compared to $9,213,000 during fiscal 2012 due to lower sales of surveillance systems to the United States Army. We do not expect any additional sales of surveillance systems during fiscal 2014 as a result of the reduction of forces in Afghanistan.

FISCAL YEARS ENDED JANUARY 3, 2014, AND DECEMBER 28, 2012

Revenues

(In thousands except                    Fiscal Years           Percent
percentages)                         2013          2012        Change

Engineering and Other Scientific   $ 215,972     $ 213,304         1.3 %
Percentage of total revenues            72.9 %        72.9 %
Environmental and Health              80,196        79,349         1.1 %
Percentage of total revenues            27.1 %        27.1 %
Total revenues                     $ 296,168     $ 292,653         1.2 %

The increase in revenues for our Engineering and Other Scientific segment was due to an increase in billable hours and an increase in billing rates partially offset by a decrease in reimbursable expenses and a decrease in product sales in our defense technology development practice. During fiscal 2013, billable hours for this segment increased by 5.4% to 778,000 as compared to 738,000 during fiscal 2012. The increase was due to strong demand for services in our polymer science, mechanical engineering, biomedical engineering, engineering management, and construction consulting practices. The increase in billable hours was also due to fiscal 2013 having one additional week of activity than fiscal 2012. Utilization decreased to 74% for fiscal 2013 as compared to 75% during fiscal 2012 due to the anticipated step down in our elevated levels of activity on several major investigations. Technical full-time equivalents increased 4.6% to 496 for fiscal 2013 from 474 for fiscal 2012 due to our recruiting and retention efforts. Product sales in defense technology development decreased to $486,000 during fiscal 2013 as compared to $9,213,000 during fiscal 2012 due to lower sales of surveillance systems to the United States Army.

The increase in revenues from our Environmental and Health segment was due to an increase in billing rates, revenues of $1.4 million related to services performed in prior periods for a foreign client for which we deferred revenue until receipt of payment, and fiscal 2013 having one additional week of activity than fiscal 2012, partially offset by a decrease in billable hours. During fiscal 2013, billable hours for this segment decreased by 1.6% to 309,000 as compared to 314,000 during fiscal 2012. Utilization decreased to 65% for fiscal 2013 as compared to 69% for fiscal 2012. The decrease in billable hours and utilization was due to a step down from the elevated levels of activity on a number of major investigations that engage consultants across many of our environmental and health practices and centers. The decrease in utilization was also due to our investment in hiring experienced consultants. Technical full-time equivalents increased by 2.3% to 223 during fiscal 2013 as compared to 218 for fiscal 2012 due to our recruiting and retention efforts.

Revenues are primarily derived from services provided in response to client requests or events that occur without notice and engagements are generally terminable or subject to postponement or delay at any time by our clients. As a result, backlog at any particular time is small in relation to our quarterly or annual revenues and is not a reliable indicator of revenues for any future periods.

Compensation and Related Expenses

(In thousands except                     Fiscal Years           Percent
percentages)                          2013          2012        Change

Compensation and related expenses   $ 184,084     $ 171,809         7.1 %
Percentage of total revenues             62.2 %        58.7 %

The increase in compensation and related expenses during fiscal 2013 was due to an increase in payroll, bonuses, fringe benefits and a change in the value of assets associated with our deferred compensation plan. Payroll increased $5,719,000 and fringe benefits increased $730,000 due to a 3.9% increase in technical full-time equivalent employees, the impact of our annual salary increases, and fiscal 2013 having one additional week of activity than fiscal 2012. Bonuses increased $992,000 due to a corresponding increase in profitability. During fiscal 2013, deferred compensation expense increased $3,886,000 with a corresponding increase to other income (expense), net, as compared with the prior year due to the change in value of assets associated with our deferred compensation plan. This increase consisted of an increase in the value of the plan assets of $6,044,000 during fiscal 2013 as compared to an increase in the value of the plan assets of $2,158,000 during fiscal 2012. We expect our compensation expense, excluding the change in value of deferred compensation plan assets, to increase as we selectively add new talent.

Other Operating Expenses

(In thousands except               Fiscal Years          Percent
percentages)                     2013         2012       Change

Other operating expenses       $ 25,299     $ 23,574         7.3 %
Percentage of total revenues        8.5 %        8.1 %

Other operating expenses include facilities-related costs, technical materials, computer-related expenses and depreciation and amortization of property, equipment and leasehold improvements. The increase in other operating expenses was primarily due to an increase in occupancy expenses of $579,000, an increase in computer expenses of $359,000, an increase in technical materials of $275,000, an increase in depreciation and amortization of $241,000, and an increase in office expenses of $223,000. The increase in occupancy expenses, computer expenses, technical materials, depreciation and amortization, and office expenses were due to costs associated with the increase in technical full-time equivalent employees and the extra week of activity during fiscal 2013. We expect other operating expense to grow as we selectively add new talent and make investments in our corporate infrastructure.

Reimbursable Expenses

(In thousands except               Fiscal Years          Percent
percentages)                     2013         2012       Change

Reimbursable expenses          $ 16,125     $ 26,091      (38.2) %
Percentage of total revenues        5.4 %        8.9 %

The decrease in reimbursable expenses was primarily due to a decrease in project-related costs in our defense technology development practice in our Engineering and Other Scientific segment. The amount of reimbursable expenses will vary from year to year depending on the nature of our projects.

General and Administrative Expenses

(In thousands except                      Fiscal Years          Percent
percentages)                            2013         2012       Change

General and administrative expenses   $ 14,714     $ 13,559         8.5 %
Percentage of total revenues               5.0 %        4.6 %

The increase in general and administrative expenses during fiscal 2013 was primarily due to an increase in legal expense of $857,000 and an increase in recruiting expenses of $259,000. The increase in legal expenses was due to an increase in costs associated with legal claims during fiscal 2013 as compared to the same period last year. The increase in recruiting costs was due to our efforts to hire experienced consultants. We expect general and administrative expenses to increase as we selectively add new talent, expand our business development efforts, and pursue staff development initiatives.

Other Income (Expense), Net

(In thousands except               Fiscal Years         Percent
percentages)                     2013        2012       Change

Other income and expense, net   $ 7,999     $ 4,129        93.7 %
Percentage of total revenues        2.7 %       1.4 %

Other income (expense), net, consists primarily of interest income earned on available cash, cash equivalents and short-term investments, changes in the value of assets associated with our deferred compensation plan and rental income from leasing excess space in our Silicon Valley facility. During fiscal 2013, other income (expense), net, increased $3,886,000 with a corresponding increase to deferred compensation expense as compared to fiscal 2012 due to the change in value of assets associated with our deferred compensation plan. This year-over-year increase consisted of an increase in the value of the plan assets of $6,044,000 during fiscal 2013 as compared to an increase in the value of the plan assets of $2,158,000 during fiscal 2012.

Income Taxes

(In thousands except               Fiscal Years          Percent
percentages)                     2013         2012       Change

Income taxes                   $ 25,305     $ 24,524         3.2 %
Percentage of total revenues        8.5 %        8.4 %
Effective tax rate                 39.6 %       39.7 %

The increase in income taxes was due to a corresponding increase in pre-tax income. During fiscal 2011 our effective tax rate was 40.4%. The decrease in our effective tax rate for fiscal 2012 was primarily due to a change in estimate associated with the Company's apportionment of income between the states. Our effective tax rate for fiscal 2013 remained below our historical average due to manufacturing deductions claimed. Both the change in apportionment between the states and the manufacturing deductions were non-recurring. As such we expect our tax rate to increase during 2014 and approximate our historical average.

FISCAL YEARS ENDED DECEMBER 28, 2012, AND DECEMBER 30, 2011

Revenues

(In thousands except percentages)        Fiscal Years           Percent
                                      2012          2011        Change

Engineering and Other Scientific    $ 213,304     $ 199,772         6.8 %
Percentage of total revenues             72.9 %        73.3 %
Environmental and Health               79,349        72,674         9.2 %
Percentage of total revenues             27.1 %        26.7 %

Total revenues                      $ 292,653     $ 272,446         7.4 %

The increase in revenues for our Engineering and Other Scientific segment was due to an increase in billable hours. During fiscal 2012, billable hours for this segment increased by 6.5% to 738,000 as compared to 693,000 during fiscal 2011. The increase was due to strong demand for services in our mechanics and materials, electrical, thermal and engineering management consulting practices. Utilization increased to 75% for fiscal 2012 as compared to 73% for fiscal 2011 due in part to elevated levels of activity on a number of major assignments that engaged consultants across many of our engineering and other scientific practices and our management of headcount to align resources with anticipated demand. Technical full-time equivalents increased 3.5% to 474 for fiscal 2012 from 458 for fiscal 2011 due to our recruiting and retention efforts. Product sales in defense technology development decreased to $9,213,000 during fiscal 2012 as compared to $12,300,000 during fiscal 2011 due to lower sales of surveillance systems to the United States Army.

The increase in revenues from our Environmental and Health segment was due to an increase in billable hours. During fiscal 2012, billable hours for this segment increased by 9.0% to 314,000 as compared to 288,000 during fiscal 2011. The increase in billable hours was due to strong demand for services in our environmental sciences, ecological sciences, and chemical regulation and food safety practices. Utilization increased to 69% for fiscal 2012 as compared to 68% for fiscal 2011 due to elevated levels of activity on a number of major assignments that engage consultants across many of our environmental and health practices and centers. Technical full-time equivalents increased by 7.4% to 218 during fiscal 2012 as compared to 203 for fiscal 2011 due to our recruiting and retention efforts.

Compensation and Related Expenses

(In thousands except percentages)        Fiscal Years           Percent
                                      2012          2011        Change

Compensation and related expenses   $ 171,809     $ 156,853         9.5 %
Percentage of total revenues             58.7 %        57.6 %

The increase in compensation and related expenses during fiscal 2012 was due to an increase in payroll, bonuses, fringe benefits and a change in the value of assets associated with our deferred compensation plan. Payroll increased $6,387,000 and fringe benefits increased $841,000 due to a 4.7% increase in technical full time equivalent employees and our annual salary increases. Bonuses increased $4,102,000 due to a corresponding increase in profitability. During fiscal 2012, deferred compensation expense increased $2,431,000 with a corresponding increase to other income (expense), net, as compared to the prior year due to the change in value of assets associated with our deferred compensation plan. This increase consisted of an increase in the value of the plan assets of $2,158,000 during fiscal 2012 and a decrease in the value of the plan assets of $273,000 during fiscal 2011.

Other Operating Expenses

(In thousands except percentages)       Fiscal Years          Percent
                                      2012         2011       Change

Other operating expenses            $ 23,574     $ 23,238         1.4 %
Percentage of total revenues             8.1 %        8.5 %

Other operating expenses include facilities-related costs, technical materials, computer-related expenses and depreciation and amortization of property, equipment and leasehold improvements. The increase in other operating expenses was primarily due to an increase in occupancy expenses of $509,000 partially offset by a decrease in technical materials of $240,000. The increase in occupancy expenses was due to planned maintenance activities for our owned facilities and costs associated with the increase in technical full-time equivalent employees. The decrease in technical materials was due to a decrease in development activities for our defense technology development practice.

Reimbursable Expenses

(In thousands except percentages)       Fiscal Years          Percent
                                      2012         2011       Change

Reimbursable expenses               $ 26,091     $ 25,779         1.2 %
Percentage of total revenues             8.9 %        9.5 %

Reimbursable expenses for fiscal 2012 remained relatively consistent with fiscal 2011. The amount of reimbursable expenses will vary from year to year depending on the nature of our projects.

General and Administrative Expenses

(In thousands except percentages)         Fiscal Years          Percent
                                        2012         2011       Change

General and administrative expenses   $ 13,559     $ 13,116         3.4 %
Percentage of total revenues               4.6 %        4.8 %

The increase in general and administrative expenses during fiscal 2012 was primarily due to an increase in travel and meals of $689,000 partially offset by a decrease in legal fees of $336,000. The increase in travel and meals was related to a bi-annual firm-wide managers' meeting that was held at the end of the third quarter of 2012. The decrease in legal fees was primarily due to legal claims in the prior year.

Other Income (Expense), Net

(In thousands except percentages)      Fiscal Years         Percent
                                     2012        2011       Change

Other income and expense, net       $ 4,129     $ 1,359       203.8 %
Percentage of total revenues            1.4 %       0.5 %

Other income (expense), net, consists primarily of interest income earned on available cash, cash equivalents and short-term investments, changes in the value of assets associated with our deferred compensation plan and rental income from leasing excess space in our Silicon Valley facility. During fiscal 2012, other income (expense), net increased $2,431,000 with a corresponding increase . . .

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