ICF INTERNATIONAL, INC. FORWARD-LOOKING STATEMENTS
Some of the statements in this Quarterly Report on Form 10-Q (this "Quarterly Report") constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, as amended. These statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. In some cases, you can identify these statements by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plan," "potential," "should," "will," "would," or similar words. You should read statements that contain these words carefully. The risk factors described in our filings with theSecurities and Exchange Commission ("SEC"), as well as any cautionary language in this Quarterly Report, provide examples of risks, uncertainties, and events that may cause actual results to differ materially from the expectations described in the forward-looking statements, including, but not limited to:
• Our dependence on contracts with
local, and international governments, agencies and departments for the
majority of our revenue;
• Changes in federal government budgeting and spending priorities;
• Failure by
debt ceiling increases in a timely fashion and related reduction in
government spending;
• Failure of the Administration and Congress to agree on spendingpriorities, which may result in temporary shutdowns of non-essential
federal functions, including our work to support such functions;
• Effects of the novel coronavirus disease ("COVID-19"), or any other future
pandemic, and related national, state and local government actions and
reactions on the health of our staff and that of our clients, the
continuity of our and our clients' operations, our results of operations
and our outlook;
• Results of routine and non-routine government audits and investigations;
• Dependence of commercial work on certain sectors of the global economy
that are highly cyclical;
• Failure to realize the full amount of our backlog;
• Risks inherent in being engaged in significant and complex disaster relief
efforts involving multiple tiers of government in very stressful
environments;
• Difficulties in integrating acquisitions generally;
• Risks resulting from expanding service offerings and client base;
• Acquisitions we undertake may present integration challenges, fail to
perform as expected, increase our liabilities, and/or reduce our earnings;
• The lawsuit filed by the
million in alleged overpayments from the Road Home contract; and
• Additional risks as a result of having international operations.
Our forward-looking statements are based on the beliefs and assumptions of our
management and the information available to our management at the time these
disclosures were prepared. Although we believe the expectations reflected in
these statements are reasonable, we cannot guarantee future results, levels of
activity, performance, or achievements. You should not place undue reliance on
these forward-looking statements, which apply only as of the date of this
Quarterly Report on Form 10-Q. We undertake no obligation to update these
forward-looking statements, even if our situation changes in the future.
The terms "we," "our," "us," and "Company," as used throughout this Quarterly
Report, refer to ICF International, Inc. and its subsidiaries, unless otherwise
indicated. The term "federal" or "federal government" refers to the U.S. federal
government, and "state and local" or "state and local government" refers to U.S.
state and local governments and the governments of U.S. territories. The
following discussion and analysis is intended to help the reader understand our
business, financial condition, results of operations, and liquidity and capital
resources. You should read this discussion in conjunction with our consolidated
financial statements and the related notes contained elsewhere in this Quarterly
Report and our Annual Report on Form 10-K for the fiscal year ended December 31,
2019 filed with the SEC on February 28, 2020 (our "Annual Report").
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Impacts of the COVID-19 Pandemic
OnMarch 11, 2020 , theWorld Health Organization characterized the novel strain of coronavirus disease COVID-19 as a global pandemic. There is significant uncertainty as to the effects of this pandemic on the global economy, which in turn may impact, among other things, our operations, balance sheet, results of operations or cash flows. Adverse events such as health-related concerns about working in our offices, the inability to travel, the potential impact on our employees, clients, subcontractors and other suppliers and business partners, a slow-down in customer decision-making that affects procurement cycles, a reprioritization of client spending, and other matters affecting the general work and business environment have harmed, and could continue to harm, our business and delay the implementation of our business strategy. We cannot anticipate all the ways in which the current global health crisis, economic slowdown and financial market conditions could adversely impact our business in the future. Although we cannot predict with certainty the impact of the COVID-19 pandemic, the longer the duration of the event, the more likely it is that it could have an adverse effect on our business, financial position, results of operations and/or cash flows. We are primarily a service business, and our staffing, and that of our subcontractors, has been maintained, substantially on a work from home basis, fortunately with little COVID-19 illness among our staff. To date we have experienced continuity in the majority of our work for our government clients, which accounted for approximately 69 percent of our revenues for the nine months endedSeptember 30, 2020 . There have been postponements of events and challenges around some project work requiring travel, but overall, our government clients have continued to require our services. We are unable to predict whether, and to what extent, this trend will continue. It would be reasonable to expect some deterioration of certain client activities due to COVID-19, including the significant government spending directed at COVID-19 and its effect on health and the economy and government spending priorities, but there is also the possibility of additional demand from federal agencies such as theCenter for Disease Control and Prevention , theDepartment of Health and Human Services , and theFederal Emergency Management Agency , as well as state and local and international government agencies. Of the remaining 31 percent of our total revenue for the nine months endedSeptember 30, 2020 , the majority was generated from commercial energy markets and commercial marketing services, each of which represented roughly half of that total. In commercial energy, where we work primarily for utility clients, we have experienced trends similar to those with our government clients, although some aspects of energy efficiency programs have been put on hold as they involve direct interaction with consumers. In our commercial marketing services, a key component of our business is our industry-leading loyalty platform, where we have long-term implementation contracts, and we believe our clients, many of which are in the hospitality space, will continue to stay engaged with their most loyal customers. The other parts of commercial marketing services, which include public event management and marketing technology were impacted based on the restriction upon travel worldwide and the deferral or cancellation of marketing events. As a result, we are monitoring that business area closely. These elements of commercial marketing services represented less than 12 percent of our total Company-wide revenues for the nine months endedSeptember 30, 2020 . We are monitoring the evolving situation related to the COVID-19 pandemic and we continue to work with our stakeholders to assess further possible implications to our business and to take actions in an effort to mitigate adverse consequences. To protect employee health and safety while COVID-19 remains a threat, we plan to continue to deliver a majority of our services to clients remotely for the foreseeable future and continue to evaluate our return to office plans. While the Coronavirus Aid, Relief and Economic Security ("CARES") Act contains a provision that allows federal contractors to seek specified reimbursement for certain employeeswho are unable to perform their contract requirements due to government restrictions, we believe we have limited claims under the CARES Act, and reimbursements are also subject to limitations and do not extend pastSeptember 30, 2020 . Additionally, the Company exercised the option to defer payment of the employer portion of theSocial Security tax, with 50% to be repaid byDecember 31, 2021 and the remainder byDecember 31, 2022 . The Company deferred payment of approximately$13.5 million of employerSocial Security taxes during the nine months endedSeptember 30, 2020 . As part of management actions to counter the impact of COVID-19, we continue to align our costs with anticipated revenues. In theU.S. and in our international operations, we have used staff reductions, furloughs, and other temporary wage reduction programs in response to the pandemic. The Company is currently participating in several international government subsidy programs whose objective is to encourage eligible companies to keep employees on the payroll during the COVID-19 pandemic. A requirement of these subsidies is that the Company is to continue to employ the identified employeeswho might otherwise have been impacted by a reaction to COVID-19. The subsidies are limited in the amount and time in which payroll costs are covered.
OVERVIEW AND OUTLOOK
We provide professional services and technology-based solutions to government
and commercial clients, including management, marketing, technology, and policy
consulting and implementation services. We help our clients conceive, develop,
implement, and improve solutions that address complex business, natural
resource, social, technological, and public safety issues. Our services
primarily support clients that operate in four key markets:
• Energy, Environment, and Infrastructure;
• Health, Education, and Social Programs;
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• Safety and Security; and • Consumer and Financial Services.
We provide services to our diverse client base that deliver value throughout the entire life cycle of a policy, program, project, or initiative. Our primary services include:
• Advisory Services; • Program Implementation Services; • Analytics Services; • Digital Services; and • Engagement Services. Our clients utilize our services because we offer a combination of deep subject matter expertise, technical solutions, and institutional experience. We believe that our domain expertise and the program knowledge developed from our research and analytic, and assessment and advisory engagements further position us to provide a full suite of services. We report operating results and financial data as a single segment based on the consolidated information used by our chief operating decision-maker in evaluating the financial performance of our business and allocating resources. Our single segment represents our core business - professional services for government and commercial clients. Although we describe our multiple service offerings and client markets to provide a better understanding of our business operations, we offer integrated solutions, pulling from resources across our Company and, accordingly, do not manage our business or allocate our resources based on those service offerings or client market areas. Notwithstanding the impact of COVID-19 we believe that, in the long-term, demand for our services will continue to grow as government, industry, and other stakeholders seek to address critical long-term societal and natural resource issues due to heightened concerns about: clean energy and energy efficiency; health promotion, treatment, and cost control; natural disaster relief and rebuild efforts; and ongoing homeland security threats. In the wake of the major hurricanes (Harvey, Irma, Maria, and Michael) that devastated communities inTexas ,Florida , theU.S. Virgin Islands , andPuerto Rico , the affected areas remain in various stages of relief and recovery efforts. We believe our prior and current experience with disaster relief and rebuild efforts, including those from Hurricanes Maria, Katrina and Rita, and Superstorm Sandy, put us in a favorable position to continue to provide recovery assistance, housing, and environmental and infrastructure solutions on behalf of federal departments and agencies, state and local governments, and regional agencies. We also see significant opportunity to further leverage our digital and client engagement capabilities across our commercial and government client base. Our future results will depend on the success of our strategy to enhance our client relationships and seek larger engagements spanning all aspects of the program life cycle, as well as completely and successfully integrating strategic acquisitions. We will continue to focus on building scale in vertical and horizontal domain expertise, developing business with both our government and commercial clients, and replicating our business model in selective geographies. In doing so, we will continue to evaluate strategic acquisition opportunities, such as our recent acquisition ofIncentive Technology Group, LLC ("ITG"), that enhance our subject matter knowledge, broaden our service offerings, and/or provide scale in specific geographies. Although we continue to see favorable long-term market opportunities, there are certain business challenges facing all government service providers. Administrative and legislative actions by the federal government to address changing priorities or in response to the budget deficit could have a negative impact on our business, which may result in a reduction to our revenue and profit and adversely affect cash flow. Similarly, while disaster recovery work efforts are funded by the federal government, the very nature of opportunities arising out of disaster recovery mean they can involve unusual challenges. Factors such as the overall stress on communities and people affected by disaster recovery situations, political complexities and challenges among involved government agencies, and a higher than normal risk of audits and investigations, may result in a reduction to our revenue and profit and adversely affect cash flow. However, we believe we are well positioned to provide a broad range of services in support of initiatives that will continue to be priorities to the federal government, as well as to state and local and international governments and commercial clients.
Employees and Offices:
We have more than 7,000 full and part-time employees around the globe, including many recognized as thought leaders in their respective fields. We serve clients globally from our headquarters in theWashington, D.C. metropolitan area, our more than 75 regional offices throughout theU.S. and more than 15 offices in key regions outside theU.S. , including offices in theUnited Kingdom ,Belgium ,China ,India andCanada . 21
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion of our financial condition and results of operations is based on our consolidated financial statements prepared in accordance withU.S. generally accepted accounting principles ("U.S. GAAP"). The preparation of these consolidated financial statements requires us to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses and our application of critical accounting policies, including: revenue recognition, impairment of goodwill and other intangible assets, income taxes, and stock-based compensation. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Note 2 - Summary of Significant Accounting Policies" in our Annual Report and "Note 1-Basis of Presentation and Nature of Operations-Significant Accounting Policies" and "Note 1-Basis of Presentation and Nature of Operations-Recent Accounting Pronouncements" in the "Notes to Consolidated Financial Statements" in this Quarterly Report for further discussions of our significant accounting policies and estimates. We periodically evaluate our critical accounting policies and estimates based on changes inU.S. GAAP and the current environment that may have an effect on our financial statements.
It is our policy to test for impairment, at a minimum, on an annual basis or earlier when certain events or changes in circumstances indicate that goodwill may more likely than not be impaired. We are monitoring the impacts of COVID-19 on the fair value of goodwill. Although we currently do not anticipate any impairments to goodwill as a result of COVID-19, future changes in the expectations as to the impact on our operations, financial performance and cash flows related to the intangible assets and goodwill could cause these assets to be impaired. The Company reviews its long-lived assets, including property and equipment and amortizable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amounts of the assets may not be fully recoverable. If the total of the expected undiscounted future net cash flows is less than the carrying amount of the asset, a loss is recognized for any excess of the carrying amount over the fair value of the asset. The Company recognized impairment expense, included in indirect and selling expenses, of$1.7 million in the second quarter of 2019 related to an intangible asset associated with a historical business acquisition. There was no impairment recognized during the period endedSeptember 30, 2020 . If there are further, sustained financial impacts as a result of COVID-19 upon us or other unfavorable factors, we may be required to perform additional intangible asset impairment assessments, which may result in a recognition of intangible asset impairment that could be material to the consolidated financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
Recent accounting standards are discussed in "Note 1-Basis of Presentation and Nature of Operations-Recent Accounting Pronouncements" in the "Notes to Consolidated Financial Statements" in this Quarterly Report.
SELECTED KEY METRICS
In order to evaluate operations, we track revenue by key metrics that provide
useful information about the nature of our business. Client markets provide
insight into the breadth of our expertise. Client type is an indicator of the
diversity of our client base. Revenue by contract mix provides insight in terms
of the degree of performance risk that we have assumed. Significant variances in
the key metrics are discussed under the revenue section of the results of
operations. For further discussion see "Note 9-Revenue Recognition" in the
"Notes to Consolidated Financial Statements" in this Quarterly Report.
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RESULTS OF OPERATIONS
Three Months Ended
The table below sets forth certain items from our unaudited consolidated
statements of comprehensive income, the percentage of revenue for such items in
the periods provided, and the period-over-period rate of change and percentage
of revenue for the periods indicated.
Year-to-Year Change
Three Months Ended September 30, Three Months Ended
Dollars Percentages September 30, 2019 and 2020
(dollars in thousands) 2020 2019 2020 2019 Dollars Percent
Revenue $ 360,315 $ 373,918 100.0% 100.0 % $ (13,603 ) (3.6%)
Direct Costs 223,288 238,158 62.0% 63.7 % (14,870 ) (6.2%)
Operating Costs and
Expenses:
Indirect and selling
expenses 100,123 100,130 27.8% 26.8 % (7 ) -
Depreciation and
amortization 5,143 5,035 1.4% 1.3 % 108 2.1%
Amortization of intangible
assets 3,511 1,931 1.0% 0.5 % 1,580 81.8%
Total Operating Costs and
Expenses 108,777 107,096 30.2% 28.6 % 1,681 1.6%
Operating Income 28,250 28,664 7.8% 7.7 % (414 ) (1.4%)
Interest expense (3,488 ) (2,824 ) (1.0%) (0.8 %) (664 ) 23.5%
Other loss (223 ) (141 ) - - (82 ) 58.2%
Income before Income Taxes 24,539 25,699 6.8% 6.9 % (1,160 ) (4.5%)
Provision for Income Taxes 6,668 6,069 1.9% 1.6 % 599 9.9%
Net Income $ 17,871 $ 19,630 4.9% 5.3 % $ (1,759 ) (9.0%)
Revenue. Revenue for the three months ended September 30, 2020 was $360.3
million , compared to $373.9 million for the three months ended September 30,
2019 , representing a decrease of $13.6 million or 3.6%. The decrease in revenue
was attributable to a $12.7 million decrease in revenue from our commercial
clients and a $0.9 million decrease in government client revenue. Some of these
commercial clients perform work in travel-related markets and have been impacted
by the COVID-19 pandemic. The decrease in government client revenue was the
result of a $19.9 million decrease in revenue from our state and local
government contracts, primarily due to decreases in the energy, environment and
infrastructure client market in response to hurricane relief and recovery
efforts, and a $7.7 million decrease in our international government clients
partially offset by $26.7 million increase in revenue from our federal
government clients, including clients from our ITG acquisition.
Direct Costs. Direct costs for the three months ended September 30, 2020 were
$223.3 million compared to $238.2 million for the three months ended
September 30, 2019 , a decrease of $14.9 million or 6.2%. The decrease in direct
costs was attributable to a $21.1 million decrease in subcontractor and other
direct costs, partially offset by an $6.2 million increase in direct labor and
associated fringe benefits. Subcontractor and other direct costs for the three
months ended September 30, 2020 were 42.8% of direct costs compared to 49.0% for
the three months ended September 30, 2019 . The decrease in subcontractor and
other direct costs is primarily due to the decline in our state and local
government contracts and our commercial client revenue, and a general decline in
travel costs required to perform client work, offset by an increase in
subcontractor and other direct costs from our federal government clients. Direct
labor and fringe benefits for the three months ended September 30, 2020 was
57.2% of direct costs compared to 51.0% for the three months ended September 30,
2019 . The increase in direct labor and fringe benefits is primarily due to our
federal government clients, including clients from our ITG acquisition,
partially offset by a decline in direct labor and fringe benefit costs from our
state and local government contracts and our commercial clients. The direct
labor and fringe benefits from commercial clients declined both through the
client demands and by the use of foreign government subsidies. Direct costs as a
percent of revenue decreased to 62.0% for the three months ended September 30,
2020 , compared to 63.7% for the three months ended September 30, 2019 . Because
subcontractor and other direct costs do not yield a margin comparable to direct
labor and fringe benefits, the decline in subcontractor and other direct costs
and the increase in direct labor and fringe benefits resulted in a reduction in
direct costs as a percentage of revenue and an improvement in the gross margin.
Indirect and selling expenses. Indirect and selling expenses for the three
months ended September 30, 2020 was $100.1 million compared to $100.1 million
for the three months ended September 30, 2019 . Indirect costs were flat as
decreases in travel-related costs, the decline in our use of contract labor
costs and the decline in non-labor related administrative costs, partially
offset by an increase in indirect labor and fringe expenses, including our ITG
acquisition, to support the anticipated growth in revenue. Indirect and selling
expenses as a percent of revenue increased to 27.8% for the three months ended
September 30, 2020 , compared to 26.8% for the three months ended September 30,
2019 .
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-------------------------------------------------------------------------------- Depreciation and amortization. Depreciation and amortization was$5.1 million for the three months endedSeptember 30, 2020 compared to$5.0 million for the three months endedSeptember 30, 2019 . The increase in depreciation and amortization is the result of the depreciation of leasehold improvements acquired as part of the ITG acquisition, partially offset by the reduction in depreciation on leases that terminated during the three months endedSeptember 30, 2019 . Amortization of intangible assets. Amortization of intangible assets for the three months endedSeptember 30, 2020 was$3.5 million compared to$1.9 million for the three months endedSeptember 30, 2019 . The$1.6 million increase was primarily due to an increase in the amortization of the$47.3 million of intangible assets from the ITG acquisition, partially offset by reduced levels of amortization of intangible assets associated with prior acquisitions. Operating Income. Operating income was$28.3 million for the three months endedSeptember 30, 2020 compared to$28.7 million for the three months endedSeptember 30, 2019 , a decrease of$0.4 million or 1.4%. The decrease in operating income was largely due to an increase of amortization of intangible assets, offset by an increase in the gross margin of work performed. Operating income as a percentage of revenue increased to 7.8% for the three months endedSeptember 30, 2020 , compared to 7.7% for the three months endedSeptember 30, 2019 . Interest expense. For the three months endedSeptember 30, 2020 and 2019, interest expense was$3.5 million and$2.8 million resulting in an increase of$0.7 million , or 23.5%. The increase in interest expense was due to higher average debt balances, primarily due to the financing of the ITG acquisition, partially offset by lower average interest rates for the three months endedSeptember 30, 2020 compared to the three months endedSeptember 30, 2019 . Other income (expense). For the three months endedSeptember 30, 2020 , other expense was$0.2 million compared to other expense of$0.1 million for the three months endedSeptember 30, 2019 . Provision for Income Taxes. For the three months endedSeptember 30, 2020 , income tax expense was$6.7 million compared to$6.1 million for the three months endedSeptember 30, 2019 , an increase of$0.6 million . The effective income tax rate for the three months endedSeptember 30, 2020 and 2019 was 27.2% and 23.6%, respectively. The increase in the effective income tax rate was primarily due to a decrease in non-taxable income on certain investments in 2020 compared with 2019, partially offset by reduced expenses not deductible for income tax purposes in the three months endedSeptember 30, 2020 and 2019.
Nine Months Ended
The table below sets forth certain items from our unaudited consolidated
statements of comprehensive income, the percentage of revenue for such items in
the periods provided, and the period-over-period rate of change and percentage
of revenue for the periods indicated.
Year-to-Year Change
Nine Months Ended September 30, Nine Months Ended
Dollars Percentages September 30, 2019 and 2020(dollars in thousands) 2020 2019 2020 2019 Dollars Percent Revenue$ 1,072,540 $ 1,081,889 100.0% 100.0 %$ (9,349 ) (0.9%) Direct Costs 677,311 689,160 63.2% 63.7 % (11,849 ) (1.7%) Operating Costs and Expenses: Indirect and selling expenses 302,649 298,099 28.2% 27.6 % 4,550 1.5% Depreciation and amortization 15,386 15,392 1.4% 1.4 % (6 ) - Amortization of intangible assets 9,843 6,143 0.9% 0.6 % 3,700 60.2% Total Operating Costs and Expenses 327,878 319,634 30.5% 29.6 % 8,244 2.6% Operating Income 67,351 73,095 6.3% 6.7 % (5,744 ) (7.9%) Interest expense (10,921 ) (8,211 ) (1.0%) (0.7 %) (2,710 ) 33.0% Other income (expense) 316 (367 ) - - 683 (186.1%) Income before Income Taxes 56,746 64,517 5.3% 6.0 % (7,771 ) (12.0%) Provision for Income Taxes 14,607 14,958 1.4% 1.4 % (351 ) (2.3%) Net Income$ 42,139 $ 49,559 3.9% 4.6 %$ (7,420 ) (15.0%) Revenue. Revenue for the nine months endedSeptember 30, 2020 was$1,072.5 million , compared to$1,081.9 million for the nine months endedSeptember 30, 2019 , representing a decrease of$9.3 million or 0.9%. The decrease was attributable to a$24.3 million decrease in our commercial clients offset by a$15.0 million increase in government revenue. The decrease in commercial revenue was primarily due to a$25.4 million decrease in our consumer and financial services market clients as some of the commercial clients perform work in travel-related markets and have been impacted by the COVID-19 pandemic. The increase in government clients was the result of a$79.8 million increase in revenue from our federal clients, including clients from our ITG 24 -------------------------------------------------------------------------------- acquisition, offset by a$39.4 million decrease in our state and local government contracts, primarily because of decreases in the energy, environment and infrastructure client market in response to hurricane relief and recovery efforts, and a decrease of$25.4 million in our international government client work. Direct Costs. Direct costs for the nine months endedSeptember 30, 2020 was$677.3 million compared to$689.2 million for the nine months endedSeptember 30, 2019 , a decrease of$11.8 million or 1.7%. The decrease in direct costs was attributable to$39.8 million decrease in subcontractor and other direct costs partially offset by an increase of$27.9 million in direct labor and associated fringe benefits costs. The decrease in subcontractor and other costs is due to the decline in revenues of contracts reliant upon subcontractor and other direct costs, such as the hurricane relief and recovery efforts and marketing services. The direct labor and fringe benefits increase is the result of an increase in our federal government revenues, as discussed above, partially offset by the decline in direct labor due to declines in our international government clients and our commercial clients. Direct costs as a percent of revenue decreased to 63.2% for the nine months endedSeptember 30, 2020 , compared to 63.7% for the nine months endedSeptember 30, 2019 . Because subcontractor and other direct costs do not yield a comparable margin to direct labor and fringe benefits, the decline in subcontractor and other direct costs, partially offset by decrease in direct labor and fringe benefits from our international government clients and our commercial clients, resulted in a reduction in direct costs as a percentage of revenue and an improvement in the gross margin, Indirect and selling expenses. Indirect and selling expenses for the nine months endedSeptember 30, 2020 were$302.6 million compared to$298.1 million for the nine months endedSeptember 30, 2019 , an increase of$4.5 million or 1.5%. The increase in indirect and selling expenses was primarily due to an increase in indirect labor and fringe of$13.0 million , offset by a decrease in general and administrative costs of$8.5 million . The increase in indirect labor is due to the general increase in labor year over year, and additional severance from our internal restructuring. The decrease in general and administrative costs included a reduction of travel related expenses of$6.6 million in the current year expenses related to the$1.7 million impairment of intangible assets in the prior year, the decrease in our use of contract labor in the current year, and the decline in non-labor related administrative costs in the current year, partially offset by increased costs in the current year to invest in our internal infrastructure and processes and an increase in professional fees and insurance costs associated with our acquisition activities. Indirect and selling expenses as a percent of revenue increased to 28.2% for the nine months endedSeptember 30, 2020 , compared to 27.6% for the nine months endedSeptember 30, 2019 . Depreciation and amortization. Depreciation and amortization was$15.4 million for the nine months endedSeptember 30, 2020 compared to$15.4 million for the nine months endedSeptember 30, 2019 . Depreciation and amortization was flat due to an increase as a result of amortization of leasehold improvements acquired as part of the ITG acquisition which was offset by a decrease in depreciation and amortization as a result of accelerated depreciation of leasehold improvements on leases that terminated during the nine months endedSeptember 30, 2019 . Amortization of intangible assets. Amortization of intangible assets for the nine months endedSeptember 30, 2020 was$9.8 million compared to$6.1 million for the nine months endedSeptember 30, 2019 . The$3.7 million increase was primarily due to an increase in the amortization of$47.3 million of intangible assets related to the ITG acquisition, partially offset by reduced levels of amortization of intangible assets associated with prior acquisitions. Operating Income. Operating income was$67.4 million for the nine months endedSeptember 30, 2020 compared to$73.1 million for the nine months endedSeptember 30, 2019 , a decrease of$5.7 million or 7.9%. Operating income as a percentage of revenue decreased slightly to 6.3% for the nine months endedSeptember 30, 2020 , compared to 6.7% for the same period in 2019. The changes were largely due to an increase in indirect and selling expenses and an increase in amortization of intangible assets partially offset by an improvement in the gross margin on the revenue performed. Interest expense. For the nine months endedSeptember 30, 2020 and 2019, interest expense was$10.9 million and$8.2 million , an increase of$2.7 million or 33.0%. The higher interest expense for the nine months endedSeptember 30, 2020 was due to higher weighted average debt balances, primarily due to the financing of the ITG acquisition, partially offset by lower average interest rates for the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 . Other income (expense). For the nine months endedSeptember 30, 2020 other income was$0.3 million compared to other expense of$0.4 million for the nine months endedSeptember 30, 2019 . The change was primarily due to net unrealized and realized foreign currency gains, net of the change in the value of foreign currency swaps, for the nine months endedSeptember 30, 2020 compared to net unrealized and realized foreign currency losses, net of the change in the value of foreign currency swaps, for the nine months endedSeptember 30, 2019 . Provision for Income Taxes. For the nine months endedSeptember 30, 2020 , income tax expense was$14.6 million compared to$15.0 million for the nine months endedSeptember 30, 2019 , a decrease of$0.4 million , and the effective income tax rate for the nine months endedSeptember 30, 2020 and 2019 was 25.7% and 23.2%, respectively. The increase in the effective income tax rate was primarily due to a decrease in non-taxable income on certain investments in 2020 compared with 2019 partially offset by reduced expenses not deductible for income tax purposes in the nine months endedSeptember 30, 2020 and 2019. 25
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NON-GAAP MEASURES
Service Revenue
Service revenue represents revenue less subcontractor and other direct costs, which, among other things, include third-party materials and travel expenses. We believe service revenue is a useful measure to investors since, as a consulting firm, a key source of our profit is revenue obtained from the services that we provide to our clients through our employees. Service revenue is not a recognized term underU.S. GAAP and should not be considered an alternative to revenue as a measure of operating performance. This presentation of service revenue may not be comparable to other similarly titled measures used by other companies because other companies may use different methods to prepare similarly titled measures. The table below presents a reconciliation of revenue to service revenue for the periods indicated: Three Months Ended Nine Months Ended September 30, September 30, (in thousands) 2020 2019 2020 2019 Revenue$ 360,315 $ 373,918 $ 1,072,540 $ 1,081,889 Subcontractor and other direct costs (95,592 ) (116,710 ) (291,217 ) (330,990 ) Service revenue$ 264,723 $ 257,208 $ 781,323 $ 750,899 EBITDA and Adjusted EBITDA Earnings before interest and other income and/or expense, tax, and depreciation and amortization ("EBITDA") is a measure we use to evaluate operating performance. We believe EBITDA is useful in assessing ongoing trends and, as a result, may provide greater visibility in understanding our operations. Adjusted EBITDA is EBITDA further adjusted to eliminate the impact of certain items that we do not consider to be indicative of the performance of our ongoing operations. We evaluate these adjustments on an individual basis based on both the quantitative and qualitative aspects of the item, including their size and nature as well as whether or not we expect them to occur as part of our normal business on a regular basis. We believe that the adjustments applied in calculating adjusted EBITDA are reasonable and appropriate to provide additional information to investors. EBITDA and Adjusted EBITDA are not recognized terms underU.S. GAAP and should not be used as alternatives to net income as a measure of operating performance. This presentation of EBITDA and Adjusted EBITDA may not be comparable to other similarly titled measures used by other companies because other companies may use different methods to prepare similarly titled measures. EBITDA and Adjusted EBITDA are not intended to be measures of free cash flow for management's discretionary use as these measures do not include certain cash requirements such as interest payments, tax payments, capital expenditures and debt service. The following table presents a reconciliation of net income to EBITDA and Adjusted EBITDA for the periods indicated. Certain immaterial amounts in the prior year have been revised to conform with the current presentation of Adjusted EBITDA: Three Months Ended Nine Months Ended September 30, September 30, (in thousands) 2020 2019 2020 2019 Net income$ 17,871 $ 19,630 $ 42,139 $ 49,559 Other expense (income) 223 141 (316 ) 367 Interest expense 3,488 2,824 10,921 8,211 Provision for income taxes 6,668 6,069 14,607 14,958 Depreciation and amortization 8,654 6,966 25,229 21,535 EBITDA 36,904 35,630 92,580 94,630 Adjustment related to impairment of intangible assets (1) - - - 1,728 Special charges related to acquisitions (2) 11 - 1,953 - Special charges related to severance for staff realignment (3) 847 166 3,695 1,321 Special charges related to facilities consolidations, office closures, and our future corporate headquarters (4) - 194 - 263 Adjustment related to bad debt reserve (5) - - - (782 ) Total special charges 858 360 5,648 2,530 Adjusted EBITDA$ 37,762 $ 35,990 $ 98,228 $ 97,160
(1) Adjustment related to impairment of intangible assets: We recognized
impairment expense of
intangible assets associated with a historical business acquisition.
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(2) Special charges related to acquisitions: These costs consist primarily of
consultants and other outside third-party costs, as well as integration costs
associated with an acquisition.
(3) Special charges related to severance for staff realignment: These costs are
mainly due to involuntary employee termination benefits for our officers,
groups of employees
part of a consolidation or reorganization or, to the extent that the costs
are not included in the previous two categories, involuntary employee
termination benefits for employees
COVID-19.
(4) Special charges related to facilities consolidations, office closures, and
our future corporate headquarters: These costs are exit costs associated with
terminated leases or full office closures. The exit costs include charges
incurred under a contractual obligation that existed as of the date of the
accrual and for which we will continue to pay until the contractual
obligation is satisfied but with no economic benefit to us. Additionally, we
incurred one-time charges with respect to the execution of a new lease
agreement for our corporate headquarters.
(5) Adjustment related to bad debt reserve: During 2018, we established a bad
debt reserve for amounts due from a utility client that had filed for
bankruptcy and included the reserve as an adjustment due to its relative
size. The adjustment in 2019 reflects a favorable revision of our prior
estimate of collectability based on a third party acquiring the receivables.
Non-GAAP Diluted Earnings per Share
Non-GAAP diluted earnings per share ("EPS") represents diluted EPS excluding the
impact of certain items such as impairment of intangible assets, acquisition
expenses, severance for staff realignment, facility consolidations and office
closures, and certain adjustments to the bad debt reserve (which are also
excluded from Adjusted EBITDA, as described further above), as well as the
impact of amortization of intangible assets related to our acquisitions and
income tax effects. While these adjustments may be recurring and not infrequent
or unusual, we do not consider these adjustments to be indicative of the
performance of our ongoing operations. Non-GAAP diluted EPS is not a recognized
term under U.S. GAAP and is not an alternative to basic or diluted EPS as a
measure of performance. This presentation of Non-GAAP diluted EPS may not be
comparable to other similarly titled measures used by other companies because
other companies may use different methods to prepare similarly titled measures.
We believe that the supplemental adjustments applied in calculating Non-GAAP
diluted EPS are reasonable and appropriate to provide additional information to
investors.
The following table presents a reconciliation of diluted EPS to Non-GAAP diluted EPS for the periods indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
2020 2019 2020 2019
Diluted EPS $ 0.94 $ 1.02 $ 2.20 $ 2.58
Adjustment related to impairment of
intangible assets - - - 0.09
Special charges related to acquisitions - - 0.10 -
Special charges related to severance for
staff realignment 0.04 0.01 0.19 0.07
Special charges related to facilities
consolidations, office closures, and our
future corporate headquarters - 0.01 - 0.06
Adjustment related to bad debt reserve - - - (0.04 )
Amortization of intangibles 0.18 0.10 0.52 0.32
Income tax effects (1) (0.06 ) (0.02 ) (0.20 ) (0.12 )
Non-GAAP EPS $ 1.10 $ 1.12 $ 2.81 $ 2.96 (1) Income tax effects were calculated using an effective
27.2% and 23.6% for the three months ended
respectively, and 25.7% and 23.2% for the nine months ended
2020 and 2019, respectively.
Both Non-GAAP EBITDA and Adjusted EBITDA and Non-GAAP EPS do not reflect approximately$0.6 million of costs incurred by the Company that were the result of COVID-19. These costs included medical benefits and other fringe benefits provided to employees that are included with other fringe benefits and included in the fringe benefit allocation. Because fringe benefits are an allocation of costs based on the estimation of total fringe benefits during the interim periods, the full impact of these COVID costs is not fully realized within the quarterly periods and were therefore excluded as supplemental adjustments.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity and Borrowing Capacity. OnMarch 3, 2020 , we entered into the First Amendment (the "First Amendment") to the Fifth Amended and Restated Business Loan and Security Agreement with a group of 10 lenders (the "Credit Facility"). The First Amendment amended the Fifth Amended and Restated Business Loan and Security Agreement, entered into onMay 17, 2017 . As a result of the First Amendment, we increased our borrowing capacity by$200.0 million through the addition of a$200.0 million term loan to the Credit Facility. The First Amendment also made certain other changes to the Credit Facility as described in "Note 4-Long-Term Debt" in the "Notes to Consolidated Financial Statements" in this Quarterly Report. Additionally, we incurred additional loan fees of$2.1 million . 27
-------------------------------------------------------------------------------- We drew upon our Credit Facility to fund the ITG acquisition and to support our working capital needs. The improvement in cash flow from operations continues to be primarily driven by the timing of client billings and collections of our disaster relief and rebuild efforts. However, the timing of cash flow from disaster relief and rebuild efforts is more uncertain than from other clients due to factors such as political complexities and challenges among involved government agencies,. Moreover, the billing processes have complex reporting requirements and the funding processes have been slow to distribute funds once billed. Management continues to address the cash flows from the disaster relief and rebuild effort to bring the collections to a more current basis and reduce our need to draw upon our Credit Facility to fund operations. Short-term liquidity requirements are created by our use of funds for working capital, capital expenditures, debt service, dividends and share repurchases. We expect to meet these requirements through a combination of cash flow from operations and borrowings. Our primary source of borrowings is from our Credit Facility, as described in "Note 4-Long-Term Debt" in the "Notes to Consolidated Financial Statements" in this Quarterly Report. InMarch 2020 , theWorld Health Organization characterized the novel COVID-19 virus as a global pandemic. There is significant uncertainty as to effects of this pandemic on the global economy, which in turn may impact, among other things, our ability to generate historical levels of positive cash flows from operations and our ability to successfully execute and fund key initiatives. However, our current belief is that the combination of internally generated funds, available bank borrowings, and cash and cash equivalents on hand will provide the required liquidity and capital resources necessary to fund on-going operations, customary capital expenditures and acquisitions, quarterly cash dividends, share repurchases and organic growth. Additionally, we continuously analyze our capital structure to ensure we have capital to fund future strategic acquisitions. We monitor the state of the financial markets on a regular basis to assess the availability and cost of additional capital resources from both debt and equity sources. We believe that we will be able to access these markets at commercially reasonable terms and conditions if, in the future, we need additional borrowings or capital. Financial Condition. There were several changes in our consolidated balance sheet as ofSeptember 30, 2020 compared to the consolidated balance sheet as ofDecember 31, 2019 . Cash and cash equivalents increased to$8.2 million as ofSeptember 30, 2020 , from$6.5 million onDecember 31, 2019 . These changes are further discussed in "Cash Flow" below. Contract receivables, net of allowance for doubtful accounts, as ofSeptember 30, 2020 decreased to$230.3 million compared to$261.2 million onDecember 31, 2019 , primarily due to improved collections from both the disaster relief and rebuild efforts and receivables overall. Contract receivables are a significant component of our working capital and may be favorably or unfavorably impacted by our collection efforts, including timing from new contract startups, and other short-term fluctuations related to the payment practices of our clients. Contract assets and contract liabilities, on a contract by contract basis, represent revenue in excess of billings, and billings in excess of revenue, respectively, both of which generally arise from revenue timing and contractually stipulated billing schedules or billing complexity. AtSeptember 30, 2020 , contract assets and contract liabilities were$139.9 million and$36.5 million , respectively, compared to$142.3 million and$37.4 million , respectively, atDecember 31, 2019 . We evaluate our collections efforts using the days-sales-outstanding ratio, or DSO, which we calculate by dividing total accounts receivable (contract receivables, net and contract assets, less contract liabilities), by revenue per day for the three months endedSeptember 30, 2020 . The decrease in contract receivables is primarily due to improved collection related to our disaster relief and rebuild efforts as well as in our international business, as evidenced by the decrease in DSO from 94 days for the quarter endedSeptember 30, 2019 to 83 days for the quarter endedSeptember 30, 2020 . Days-sales-outstanding remained constant at 83 days for each of the quarters endedDecember 31, 2019 andSeptember 30, 2020 . We continue to be impacted by disaster relief and rebuild efforts which have complex reporting and billing requirements and have been slow to pay our invoices. The DSO, excluding disaster relief and rebuild efforts, was 69 days for the quarter endedSeptember 30, 2020 compared to 70 days for the quarter endedDecember 31, 2019 . We do experience seasonality with respect to DSO, in that our first quarter typically has a higher DSO as compared to other quarters. We did see an improvement for the quarter endedSeptember 30, 2020 as compared to the quarter endedSeptember 30, 2019 as the DSO, excluding disaster relief and rebuild efforts, was 69 days for the quarter endedSeptember 30, 2020 and 76 days for the quarter endedSeptember 30, 2019 . However, with the onset of COVID-19, we anticipate that the current business environment could result in increases to our DSO, as customers continue to consolidate their cash and try to extend their payment of outstanding receivables. Property and equipment, net of depreciation and amortization, increased due to capital expenditures primarily related to increases in leasehold improvements, as part of the ITG acquisition, and in capitalized software and computer equipment, as we invest in our infrastructure, offset by depreciation and amortization expense.Goodwill and other intangible assets, as discussed in "Note 3-Goodwill " and "Note 14 - Business Combinations" in the "Notes to Consolidated Financial Statements" in this Quarterly Report, increased due to the acquisition of ITG and the impact of foreign currency translation. OnJanuary 31, 2020 , we acquired ITG, for the purchase price of$255.0 million (subject to post-closing and working capital adjustments). The acquisition resulted in the recording of$188.3 million in goodwill and$47.3 million in intangible assets. 28 -------------------------------------------------------------------------------- Total current liabilities, exclusive of the current portion of long-term debt, current portion of operating lease liabilities and contract liabilities, consists of: accounts payable, accrued salaries and benefits, accrued subcontractors and other direct costs and accrued expenses and other current liabilities, which we call our operating liabilities. These operating liabilities were$225.7 million atSeptember 30, 2020 , a decrease of$42.4 million from$268.1 million atDecember 31, 2019 . The net decrease in these liabilities was due primarily to timing of payments which shifted into the first quarter of 2020. Long-term debt (exclusive of unamortized debt issuance costs) increased to$375.0 million onSeptember 30, 2020 from$165.4 million onDecember 31, 2019 , primarily due to net draws on our Credit Facility of$209.6 million , primarily fund the acquisition of ITG for approximately$253.1 million , dividends, common share repurchases, and capital improvements. The average debt balance on the Credit Facility for the three and nine months endedSeptember 30, 2020 and 2019 was$439.6 million and$286.6 million and$422.4 million and$273.7 million , respectively. The average interest rate on the Credit Facility, excluding any fees and unamortized debt issuance costs, for the three months endedSeptember 30, 2020 and 2019 was 2.1% and 3.6%, respectively, and for the nine months endedSeptember 30, 2020 and 2019 was 2.5% and 3.7%, respectively. We generally utilize cash flow from operations as our primary source of funding and turn to our Credit Facility to fund temporary fluctuations such as increases in accounts receivable, reductions in accounts payable and accrued expenses, purchase of treasury stock, dividends and to meet funding requirements for capital expenditures and acquisitions. Other long-term liabilities as ofSeptember 30, 2020 consists primarily of$15.3 million of deferred compensation plan liabilities,$13.5 million of deferred Company payroll taxes under the CARES Act,$12.2 million of liabilities related to the fair value of outstanding hedges and commitments under purchase agreements of$1.2 million . The increase in other long-term liabilities is primarily due to the deferral of Company payroll tax liabilities of$13.5 million under the CARES Act and a$8.4 million increase in the fair value of outstanding hedges. We have explored various options for mitigating the risk associated with potential fluctuations in the foreign currencies in which we conduct transactions. We currently have forward contract agreements ("currency hedges") in an amount proportionate to work anticipated to be performed under certain contracts inEurope . We recognize changes in the fair value of the currency hedges in our results of operations. We may increase the number, size, and scope of our currency hedges as we analyze options for mitigating our foreign exchange risk. Management views the current impact of the currency hedges to the consolidated financial statements as not material. OnFebruary 20, 2020 , we entered into a floating-to-fixed interest rate swap for an aggregate notional amount of$100.0 million to hedge a portion of our variable rate indebtedness. We designated the swap as a cash flow hedge. The swap requires us to pay a fixed rate of 1.294% per annum on the notional amount fromFebruary 28, 2020 toFebruary 28, 2025 . The floating-to-fixed interest rate settles monthly during this period and the realized gains and losses from the swap are recognized as a component of interest expense. On a quarterly basis, management evaluates the swap to determine its effectiveness and record the change in fair value as an adjustment to other comprehensive income or loss. Management intends that the swap remain effective. Share Repurchase Program. InSeptember 2017 , the board of directors approved a share repurchase program that authorizes share repurchases in the aggregate up to$100.0 million . Our total repurchases are also limited by the Credit Facility as described in "Note 16-Share Repurchase Program" in the "Notes to Consolidated Financial Statements" in this Quarterly Report. Our overall repurchase limit is the lower of the amount imposed by our board of directors and by the Credit Facility. Previously, purchases under the repurchase program would be made from time to time at prevailing market prices in open market purchases or in privately negotiated transactions pursuant to Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance with applicable insider trading and other securities laws and regulations. OnMarch 13, 2020 , we terminated the Rule 10b5-1 element of the share repurchase program out of an abundance of caution given uncertainties associated with the COVID-19 pandemic. Purchases under Rule 10b-18 will be funded from existing cash balances and/or borrowings, and the repurchased shares will be held in treasury and used for general corporate purposes. The timing and extent to which we repurchase our shares will depend upon market conditions and other corporate considerations, as may be considered in our sole discretion. During the nine months endedSeptember 30, 2020 , we repurchased 206,820 shares under this program at an average price of$80.41 per share. The Credit Facility permits unlimited share repurchases, provided the Company's Leverage Ratio, prior to and after giving effect to such repurchases, is not greater than 3.50 to 1.00. As ofSeptember 30, 2020 ,$51.4 million remained available for share repurchases under the Credit Facility.
Dividends. Cash dividends declared thus far in 2020 are as follows:
Dividend Declaration Date Dividend Per Share Record Date Payment Date
February 27, 2020 $ 0.14 March 27, 2020 April 13, 2020
May 5, 2020 $ 0.14 June 12, 2020 July 14, 2020
August 4, 2020 $ 0.14 September 11, 2020 October 13, 2020
November 5, 2020 $ 0.14 December 11, 2020 January 12, 2021
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-------------------------------------------------------------------------------- Cash Flow. We consider cash on deposit and all highly liquid investments with original maturities of three months or less to be cash and cash equivalents. The following table sets forth our sources and uses of cash for the nine months endedSeptember 30, 2020 and 2019: Nine Months Ended September 30, (in thousands) 2020 2019 Net Cash Provided by Operating Activities$ 95,171 $
6,364
Net Cash Used in Investing Activities (266,000 ) (24,255 ) Net Cash Provided by Financing Activities 172,707
12,631
Effect of Exchange Rate Changes on Cash, Cash Equivalents, and Restricted Cash (123 ) (274 ) Increase (Decrease) in Cash, Cash Equivalents, and Restricted Cash$ 1,755 $ (5,534 ) Our operating cash flows are primarily affected by the overall profitability of our contracts, our ability to invoice and collect from our clients in a timely manner, and the timing of vendor and subcontractor payments in accordance with negotiated payment terms. We bill most of our clients on a monthly basis after services are rendered. Operating activities provided$95.2 million in cash for the nine months endedSeptember 30, 2020 compared to$6.4 million for the nine months endedSeptember 30, 2019 . The increase in cash flows from operations for the nine months endedSeptember 30, 2020 compared to the prior year was primarily due to a decrease in contract receivables being offset by a decrease in accounts payable and other operating liabilities due to timing of payments, a decrease in net contract assets and liabilities and the decrease in net income. The increase in other liabilities is primarily due to the deferral of employer payroll taxes under the CARES Act of$13.5 million . The decrease in contract receivables is primarily due to improved collection related to our disaster relief and rebuild efforts as well as in our international business, as evidenced by the decrease in DSO from 94 days for the quarter endedSeptember 30, 2019 to 83 days for the quarter endedSeptember 30, 2020 . The DSO, excluding disaster relief and rebuild efforts, was 69 days for the quarter endedSeptember 30, 2020 compared to 76 days for the quarter endedSeptember 30, 2019 . Investing activities used cash of$266.0 million for the nine months endedSeptember 30, 2020 , compared to$24.3 million for the nine months endedSeptember 30, 2019 . Our cash flows used in investing activities consists primarily of payments for business acquisitions, net of cash acquired, and capital expenditures for property and equipment and capitalized software. The cash used in investing activities for the nine months endedSeptember 30, 2020 include payments for the ITG acquisition of$253.1 million , and capital expenditures of$12.9 million . The cash used in investing activities for the nine months endedSeptember 30, 2019 included payments for business acquisitions of$3.6 million and$20.7 million of capital expenditures. Our cash flows provided by financing activities consists primarily of debt and equity transactions. For the nine months endedSeptember 30, 2020 , cash flows provided by financing activities was$172.7 million . This was largely attributed to cash provided by net advances on our Credit Facility of$209.6 million to fund the ITG acquisition, partially offset by cash used for net payments for stock issuances and buybacks of$23.2 million , primarily representing shares repurchased under our share repurchase program, payments of cash dividends totaling$7.9 million , and payment of debt issuance costs of$2.1 million . For the nine months endedSeptember 30, 2019 , cash flows provided by financing activities was$12.6 million . This was largely attributable to net advances on our Credit Facility of$44.6 million , partially offset by cash used for payments for stock issuances and buybacks of$24.3 million and payments of cash dividends totaling$7.9 million .
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