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FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

For the quarterly period ended October 1, 2004

OR

For the transition period from              to             

Commission File Number 0-18655

EXPONENT, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (650) 326-9400

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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EXPONENT, INC.

FORM 10-Q

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

EXPONENT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

October 1, 2004 and January 2, 2004

(in thousands, except share data)

(unaudited)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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EXPONENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

For the Quarters and Nine Months Ended October 1, 2004 and October 3, 2003

(in thousands, except per share data)

(unaudited)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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EXPONENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the Quarters and Nine Months Ended October 1, 2004 and October 3, 2003

(in thousands)

(unaudited)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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EXPONENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended October 1, 2004 and October 3, 2003

(in thousands)

(unaudited)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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EXPONENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Fiscal Quarters and Nine Months Ended

October 1, 2004 and October 3, 2003

Note 1: Basis of Presentation

Exponent, Inc. (referred to as the “Company” or “Exponent”) is an engineering and scientific consulting firm that provides solutions to complex problems. The Company operates on a 52-53 week fiscal year ending on the Friday closest to the last day of December.

The accompanying condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. All significant intercompany transactions and balances have been eliminated in consolidation. In the opinion of management, all adjustments which are necessary for the fair presentation of the condensed consolidated financial statements have been included and all such adjustments are of a normal and recurring nature. The operating results for the fiscal quarters and nine months ended October 1, 2004 and October 3, 2003, are not necessarily representative of the results of future quarterly or annual periods.

Reclassifications. Certain prior period balances have been reclassified to conform to the current period presentation.

Note 2: Revenue Recognition

The Company derives its revenues primarily from professional fees earned on consulting engagements and fees earned for the use of its equipment and facilities, as well as reimbursements for outside direct expenses associated with the services that are billed to its clients.

Exponent reports revenues net of subcontractor fees. The Company has determined that it is not the primary obligor with respect to its subcontractors because:

Reimbursements, including those related to travel and other out-of-pocket expenses, and other similar third-party costs such as the cost of materials, are included in revenues, and an equivalent amount of reimbursable expenses are included in operating expenses. Any mark-up on reimbursable expenses is included in revenues.

Substantially all of the Company’s engagements are performed under time and material or fixed-price billing arrangements. On time and material and fixed-price projects, revenue is generally recognized as the services are performed. For substantially all of the Company’s fixed-price engagements, it recognizes revenue based on the relationship of incurred labor hours at standard rates to its estimate of the total labor hours at standard rates it expects to incur over the term of the contract. The Company believes this methodology achieves a reliable measure of the revenue from the consulting services it provides to its customers under fixed-price contracts given the nature of the consulting services the Company provides and the following additional considerations:

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Gross revenues and reimbursements for the quarters and nine months ended October 1, 2004 and October 3, 2003 are as follows:

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

All consulting contracts are subject to review by management, which requires a positive assessment of the collectibility of contract amounts. If, during the course of the contract, the Company determines that collection of revenue is not reasonably assured, it does not recognize the revenue until its collection becomes reasonably assured, which is generally upon receipt of cash. The Company assesses collectibility based on a number of factors, including past transaction history with the client and project manager, 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.

Note 3: Net Income Per Share

Basic per share amounts are computed using the weighted-average number of common shares outstanding during the period. Diluted per share amounts are calculated using the weighted-average number of common shares outstanding during the period and, when dilutive, the weighted-average number of potential common shares from the exercise of outstanding options to purchase common stock using the treasury stock method.

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The following schedule reconciles the shares used to calculate basic and diluted net income per share:

There were no options excluded from the diluted per share calculation for the fiscal quarters ended October 1, 2004 and October 3, 2003. Common stock options to purchase 8,938 and 8,663 shares were excluded from the diluted per share calculation for the nine months ended October 1, 2004 and October 3, 2003, respectively, due to their antidilutive effect. Weighted average exercise prices for the antidilutive shares were $24.83 and $15.34 for the nine months ended October 1, 2004 and October 3, 2003, respectively.

Note 4: Stock-Based Compensation

During the first quarter of fiscal 2004, the Company implemented certain changes to its employee compensation designed to continue to attract and retain employees, and to better align employee interests with those of the Company’s stockholders. Up to 30% of a select group of principals’ and officers’ fiscal 2003 bonus was settled with fully vested restricted stock unit awards. Under these fully vested restricted stock unit awards, the holder of each award has the right to receive one share of the Company’s common stock for each fully vested restricted stock unit four years from the date of grant. On March 12, 2004, fully vested restricted stock unit awards representing 43,273 shares of the Company’s common stock were granted to a select group of principals and officers as a part of their bonus distribution for fiscal 2003. The value of these fully vested restricted stock unit awards as measured on March 12, 2004 was $984,000.

Each individual who received a fully vested restricted stock unit award was also granted a matching number of unvested restricted stock unit awards. These unvested restricted stock unit awards will vest on March 12, 2008, at which time the holder of each award will have the right to receive one share of the Company’s common stock for each restricted stock unit award provided the holder of each award has met certain employment conditions. Unvested restricted stock unit awards representing 43,273 shares of the Company’s common stock were granted to a select group of principals and officers on March 12, 2004. The value of these unvested restricted stock unit awards as measured on March 12, 2004 was $984,000 and was recorded as deferred stock-based compensation. This deferred stock-based compensation is being amortized over the four-year vesting period of the awards.

The Company uses the intrinsic value method of accounting for its Employee Stock Purchase Plan and Stock Option Plans, collectively called “Options.” The Options are granted at exercise prices equal to the fair value of the Company’s common stock on the date of the grant. Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure,” requires the Company to disclose pro forma information regarding net income and net income per share as if the Company had accounted for its options under the fair value method. Under the fair value method, compensation expense is calculated for options granted using a defined valuation technique. The Company uses the Black-Scholes option pricing model to calculate the fair value of its options. In calculating the fair value of an option at the date of grant, the Black-Scholes option pricing model requires the input of highly subjective assumptions. The Company used the following weighted-average assumptions for the periods ended October 1, 2004 and October 3, 2003:

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Had the Company determined compensation cost based on the estimated fair value at the grant date for its options under SFAS No. 123, the Company’s net income would have been adjusted to the pro forma amounts indicated in the following table:

Note 5: Short-Term Investments

Short-term investments consist of debt securities classified as available for sale and are carried at their fair value as of the balance sheet date. Short-term investments generally mature between three months and three years from the purchase date. Investments with maturities beyond one year are classified as short-term based on their highly liquid nature and because such marketable securities represent investment of cash that is available for current operations. The amortized cost of securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains or losses are determined on the specific identification method and are reflected in miscellaneous income. Net unrealized gains and losses are recorded directly in stockholders’ equity except for unrealized losses that are deemed to be other than temporary, which are reflected in net income.

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Note 6: Supplemental Cash Flow Information

The following is supplemental disclosure of cash flow information:

Note 7: Accounts Receivable, Net

At October 1, 2004 and January 2, 2004, accounts receivable, net was comprised of the following:

Note 8: Segment Reporting

The Company has two operating segments based on two primary areas of service. One operating segment is a broad service group providing technical consulting in different practices primarily in the areas of impending litigation and technology development. The Company’s other operating segment provides services in the area of environmental, epidemiology and health risk analysis. This operating segment provides a wide range of consulting services relating to environmental hazards and risks and the impact on both human health and the environment.

Segment information for the quarters and nine months ended October 1, 2004 and October 3, 2003 follows:

Revenues

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Operating income

The Company derived 12% of revenues from agencies of the federal government for the quarter and nine months ended October 1, 2004. No single customer comprised more than 10% of the Company’s revenues for the quarter and nine months ended October 3, 2003.

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Note 9: Related Party Transactions

The Company has a contract for software licensing from Durango Software LLC. The husband of Dr. Barbara Peterson, a practice director in the Exponent organization, owns Durango Software. Exponent recorded software licensing expenses related to this contract for the quarter and nine months ended October 1, 2004 of approximately $25,000 and $75,000, respectively. For the quarter and nine months ended October 3, 2003, Exponent recorded approximately $24,000 and $72,000, respectively, in software licensing expenses related to this contract.

Note 10: Goodwill and Other Intangible Assets

At October 1, 2004 and January 2, 2004, goodwill and other intangible assets were comprised of the following:

Intangible assets subject to amortization are included in other assets in the accompanying condensed consolidated balance sheets.

Amortization expense for intangible assets for the quarter and nine months ended October 1, 2004 was $15,000 and $44,000, respectively. Amortization expense for the quarter and nine months ended October 3, 2003 was approximately $15,000 and $45,000, respectively.

Below is a breakdown of goodwill, net of amortization, reported by segment as of October 1, 2004:

There were no changes in the carrying amount of goodwill for the quarter ended October 1, 2004.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto and with our audited consolidated financial statements and notes thereto for the fiscal year ended January 2, 2004, which are contained in our fiscal 2003 Annual Report on Form 10-K.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain “forward-looking” statements (as such term is defined in the Private Securities Litigation Reform Act of 1995, and the rules promulgated pursuant to the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended thereto) that are based on the beliefs of the Company’s management, as well as assumptions made by and information currently available to the Company’s management. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. When used in this document and in the documents incorporated herein by reference, the words “anticipate,” “believe,” “estimate,” “expect” and similar expressions, as they relate to the Company or its management, identify such forward-looking statements. Such statements reflect the current views of the Company or its management with respect to future events and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, the Company’s actual results, performance, or achievements could differ materially from those expressed in, or implied by, any such forward-looking statements. Factors that could cause or contribute to such material differences include the possibility that the demand for our services may decline as a result of changes in general and industry specific economic conditions, the effects of competitive services and pricing, the absence of backlog related to our business, our ability to attract and retain key employees, the effect of tort reform and government regulation on our business and liabilities resulting from claims made against us. Additional risks and uncertainties are discussed in our Annual Report on Form 10-K under the heading “Factors That May Affect Future Operating Results and Market Price of Stock” and elsewhere in the report. The inclusion of such forward-looking information should not be regarded as a representation by the Company or any other person that the future events, plans, or expectations contemplated by the Company will be achieved. The Company undertakes no obligation to release publicly any updates or revisions to any such forward-looking statements.

Business Overview

Exponent, Inc. is an engineering and scientific consulting firm that provides solutions to complex problems. Our multidisciplinary team of scientists, physicians, engineers and business consultants brings together more than 70 different technical disciplines to solve complicated issues facing industry and business today. Our services include analysis of product development, product recall, regulatory compliance, discovery of potential problems related to products, people or property and impending litigation, as well as the development of highly technical new products.

CRITICAL ACCOUNTING ESTIMATES

In preparing our condensed 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 the accounting for revenue recognition, estimating the allowance for doubtful accounts, accounting for income taxes and valuing goodwill have the greatest potential impact on our consolidated financial statements, so we consider these to be our critical accounting policies. We discuss below the critical accounting 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 the critical accounting policies, see Note 1 of our Notes to Consolidated Financial Statements contained in our fiscal 2003 Annual Report on Form 10-K.

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Revenue recognition. We derive our revenues primarily from professional fees earned on consulting engagements and 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 performed under time and material or fixed-price billing arrangements. On time and material and fixed-price projects, revenue is generally recognized as the services are performed. For substantially all of our fixed-price 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. 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 revenue recognized in any accounting period. These judgments and estimates include an assessment of collectibility 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 consulting contracts are subject to review by management, which requires a positive assessment of the collectibility 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 is generally upon receipt of cash. We assess collectibility based on a number of factors, including past transaction history with the client and project manager, 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 must make estimates of our ability to collect accounts receivable and our unbilled 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 based upon historical bad debts, customer concentration, customer credit worthiness, current economic conditions and changes in customer payment terms.

Accounting for income taxes. In preparing our condensed consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions where we operate. This process involves estimating actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our condensed consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent that we believe that recovery is not likely, we must establish a valuation allowance.

Significant judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance against our deferred tax assets, such as current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. In the event that actual results differ from these estimates or the estimates are adjusted in future periods, then we may need to establish a valuation allowance, which could materially impact our financial position and results of operations. Based on our current financial projections and operating plan for fiscal 2004, we currently believe that we will be able to utilize our deferred tax assets.

Valuing goodwill. We assess goodwill for impairment annually and whenever events or changes in circumstances indicate that the carrying amount may be impaired. Factors that we consider when evaluating for possible impairment include the following:

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When evaluating our goodwill for impairment, based upon the existence of one or more of the above factors, we determine the existence of an impairment by assessing the fair value of the applicable reporting unit, including goodwill, using expected future cash flows to be generated by the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, then an impairment loss is recognized.

RESULTS OF CONSOLIDATED OPERATIONS

Overview of the Quarter Ended October 1, 2004

During the third quarter of fiscal 2004 we had growth in several of our practice areas, resulting in a 6.7% growth in revenue as compared to the same period in fiscal 2003. Total billable hours were 168,000 for the third quarter of fiscal 2004 and 2003. Our revenue growth was the result of higher billing rates and an increase in billable hours for our other scientific and engineering segment. This segment has a higher average billing rate than our environmental and health segment. Technical full-time equivalents increased 6.1% to 503 for the third quarter of fiscal 2004 as compared to 474 during the same period last year. Utilization was 64% for the third quarter of fiscal 2004 as compared to 68% during the same period last year. Through the management of our operating expenses we were able to leverage this revenue growth to improve operating income by 8.5% and net income by 11.4% as compared to the third quarter of fiscal 2003.

Fiscal Quarter Ended October 1, 2004 compared to Fiscal Quarter Ended October 3, 2003

Revenues

The increase in revenues for our other scientific and engineering segment was the result of an increase in billable hours and higher billing rates. During the third quarter of fiscal 2004 billable hours for this segment increased by 6.7% to 127,000 as compared to 119,000 during the same period last year. This increase in billable hours was due to an increase in technical full-time equivalents to 363 during the third quarter of fiscal 2004 as compared to 332 during the same period last year. Utilization was 67% for the third quarter of fiscal 2004 as compared to 69% during the same period last year. The decrease in utilization for this segment was primarily due to the timing of the 4^th of July holiday, which fell in our third fiscal quarter during 2004 versus our second fiscal quarter during 2003.

The decrease in revenues for our environmental and health segment was primarily due to a decrease in billable hours partially offset by higher billing rates. During the third quarter of fiscal 2004 billable hours for this segment decreased by 16.3% to 41,000 as compared to 49,000 during the same period last year. Technical full-time equivalents for this segment during the third quarter of fiscal 2004 were 140 as compared to 142 for the same period last year. Utilization was 57% for the third quarter of fiscal 2004 as compared to 66% during the same period last year. The decrease in utilization for this segment was due to a decrease in demand for our services and the timing of the 4^th of July holiday.

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Compensation and Related Expenses

The increase in compensation and related expenses was due to the effects of our annual salary increase, an increase in full-time equivalents, higher fringe benefits and an increase in bonuses. Our annual salary increase, which was approximately 5%, took effect at the beginning of April 2004. Technical full-time equivalents increased 6.1% during the third quarter of fiscal 2004 as compared to the same period in fiscal 2003. Fringe benefits increased $583,000, due primarily to increases in workers compensation, payroll taxes, health insurance and employer 401(k) contributions. Bonuses are based on profitability and increased by $244,000 during the third quarter of fiscal 2004 as compared to the same period in fiscal 2003. We expect compensation and related expenses to continue to increase due to the anticipated hiring of additional staff, the impact of our annual salary increases, and an increase in bonuses, which are based on profitability.

Other Operating Expenses