ICF International : Q2 2023 ICF Earnings Conference Call

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EDITED TRANSCRIPT

Q2 2023 ICF International Inc Earnings Call

EVENT DATE/TIME: AUGUST 03, 2023 / 8:30PM GMT

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AUGUST 03, 2023 / 8:30PM GMT, Q2 2023 ICF International Inc Earnings Call

CORPORATE PARTICIPANTS

Barry M. Broadus ICF International, Inc. - Senior VP & CFO

John M. Wasson ICF International, Inc. - Chairman of the Board, President & CEO

CONFERENCE CALL PARTICIPANTS

Joseph Anthony Vafi Canaccord Genuity Corp., Research Division - Analyst

Kevin Mark Steinke Barrington Research Associates, Inc., Research Division - MD

Marc Frye Riddick Sidoti & Company, LLC - Business and Consumer Services Analyst

Tobey O'Brien Sommer Truist Securities, Inc., Research Division - MD

Lynn Morgen AdvisIRy Partners

PRESENTATION

Operator

Welcome to the Second Quarter 2023 ICF Earnings Conference Call. My name is Tess and I will be your operator for today's call. (Operator Instructions) I will now turn the call over to Lynn Morgen of Advisory Partners. Lynn, you may begin.

Lynn Morgen AdvisIRy Partners

Thank you, Tess. Good afternoon, everyone, and thank you for joining us to review ICF's second quarter 2023 performance. With us today from ICF are John Wasson, Chair and CEO; and Barry Broadus, CFO. Joining them is James Morgan, Chief Operating Officer.

During this conference call, we will make forward-looking statements to assist you in understanding ICF management's expectations about our future performance. These statements are subject to a number of risks that could cause actual events and results to differ materially, and I refer you to our August 3, 2023 press release and our SEC filings for discussions of those risks.

In addition, our statements during this call are based on our views as of today. We anticipate that future developments will cause our views to change. Please consider the information presented in that light.

We may, at some point, elect to update the forward-looking statements made today, but specifically disclaim any obligation to do so. I will now turn the call over to ICF's CEO, John Wasson, to discuss second quarter 2023 performance. John?

John M. Wasson ICF International, Inc. - Chairman of the Board, President & CEO

Thank you, Lynn, and thank you all for joining us to review our Q2 results, the transactions we announced this afternoon and our business outlook. As there's a lot to discuss today, I will focus on the highlights of the second quarter and then quickly move on to recent developments and comment on the growth initiatives underway at ICF.

There were key -- several key takeaways from our second quarter performance. First, this was an excellent quarter for ICF. Revenues increased 18%, indicative of how well aligned our services and capabilities are with market demand. Second quarter revenue growth was led by strong year-on-year comparisons in our key growth markets and represented 10% organic growth, together with the SemanticBits' acquisition we completed in mid-2022.

Second, contract awards were up 28% year-on-year, and we expect second half contract wins to be quite strong. Over 80% of our second quarter wins represented new business in contrast to recompetes, another indication of ICF's competitive positioning in areas of priority spending. Our trailing 12-monthbook-to-bill ratio of 1.3 is among the highest in the industry and supports our expectations for significant revenue growth this year and into 2024.

Third, we ended the quarter with a record business development pipeline of $10.3 billion, which represents almost 20% growth compared to year ago levels. This growth is attributable to our expanded capabilities, our ability to bid on larger contracts thanks to our increased scale and the opportunities that are emerging from the IIJA and IRA legislation.

Lastly, we executed transactions that strengthen ICF's position in key growth areas and support our long-term growth strategy.

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AUGUST 03, 2023 / 8:30PM GMT, Q2 2023 ICF International Inc Earnings Call

Our Energy, Environment, Infrastructure and Disaster Recovery market, which spans our government and commercial client set, continued to be a standout performer in the second quarter. Revenues increased nearly 18%, primarily representing organic growth, and this market accounted for slightly over 40% of second quarter revenues.

Commercial Energy represents a large part of that market and includes advisory work for utilities, renewable energy developers and investors, implementation of energy efficiency and distributed energy programs for utilities, and environmental services for utilities and other energy providers. Commercial energy revenues increased 22% in the second quarter and are up 20% year-to-date. We expanded our energy efficiency programs for several large utility clients and saw greater demand for advisory expertise and our environmental and planning services, as clients plan their renewable projects in light of funds and tax credits made available through the IIJA and IRA.

This was also a strong quarter of new contract awards in the commercial nergy arena. There was particular strength in multiple innovative pilot programs, focusing on electrification, financing and energy equity. A material portion of the new work that we won is to provide services necessary to analyze, finance, permit, construct, connect, monitor and operate renewable projects across the country and offshore. The Federal Energy Regulatory Commission issued an order last week that should expedite interconnection of new wind, solar and storage resources to the grid, which should drive additional demand for our advisory work.

In today's release, we announced the acquisition of CMY Solutions, which will expand our addressable market within the electrical sector. CMY Solutions is a power and [energy] (added by company after the call) engineering firm that provides next-generation technology solutions and data analytics that drive more informed decision-making on grid modernization and investments. CMY has a team of about 50 electrical engineers who work with utilities and developers across the U.S., Europe and Asia, including investor-owned utilities, electric municipalities and electric cooperatives. We have successfully partnered with CMY on several projects and together have an excellent track record of delivering positive results for our clients, which made this a compelling transaction for us. CMY expands our addressable market by giving us the ability to support client needs for renewables interconnection, substation and distribution upgrades and grid resilience, and providing us new technology and data management capabilities that we can offer our commercial energy clients as well as our government clients.

In addition to commercial energy, we also experienced strong demand in the second quarter for our climate and environmental services, which, as you know, cut across all of our client categories. Second quarter growth in our climate business was driven by new or expanding projects at NASA, EPA, DOE, USAID and 3 large East Coast utilities. ICF has one of the leading, if not the leading climate practice in the country, and we are seeing strong demand resulting from funding for decarbonization programs, including assessment, disclosure and management of risk in the private sector and large-scale programmatic funding by government, including the IIJA and IRA.

Our environmental planning and monitoring services and disaster management account for over 80% of our state and local revenues, which in total increased over 27% in the second quarter. Pent-up demand post-COVID and the IIJA and IRA are driving significant new infrastructure planning and investment, and environmental scopes of work that are required at the front end of such projects are increasingly considering climate risk, energy equity, resilience, fire, flood and sea level rise, which is another example of the growing interconnections that play to ICF's competitive advantages.

Revenues from our disaster recovery market continued to grow at a double-digit rate in the second quarter. We continued our recovery work in Puerto Rico and just announced a new $32.1 million contract with a U.S. territory to provide disaster management consulting services to accelerate federally funded recovery efforts across the territory.

Our other large market is Health and Social Programs, which is where our public health and the majority of our IT modernization services reside. This market is primarily comprised of work for the federal government, with a small part representing services to state and local and international government clients and a minor contribution from commercial clients. In the second quarter, its revenues were up 30%, reflecting both organic growth and the acquisition of SemanticBits, and this market accounted for 41% of total second quarter revenues.

We continued to see strong year-on-year growth in public health and IT modernization in the second quarter. Public health and IT

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AUGUST 03, 2023 / 8:30PM GMT, Q2 2023 ICF International Inc Earnings Call

modernization are 2 areas that historically have garnered bipartisan support and have been well funded. We see significant runway to increase our market share at the Department of Health and Human Services, resulting from specific opportunities for revenue synergies tied to the SemanticBits acquisition, which we expect to bid over the next 6 to 9 months.

Also, our greater scale is opening more and larger opportunity for us at HHS and across our federal government client set. Similarly, our social programs pipeline is very strong, and we have seen material growth in this area in the past and expect to see more in the future.

Our pipeline and federal government opportunities increased 21% from the similar period last year and 6% sequentially, supporting our outlook for continued growth in the federal arena.

Further, with regard to federal government opportunities, we are seeing increased interest in the use of AI amongst our federal government clients, and ICF is well positioned to benefit from this trend. In fact, we have been deploying AI and machine learning for years with our federal clients. As a leader in the shift to low-code/no-code platforms and to open source solutions, our 1,800 technologists have been and will continue to take advantage of the AI capabilities embedded in these platforms, including developing novel generative AI approaches to automate code generation and enhance developer productivity, and leveraging AI to enable more efficient migration of technology to modern platforms.

At the same time, we see generative AI as a way to improve the productivity and experience of our own employees and streamline various corporate functions at ICF. In fact, at the beginning of this year, we established a generative AI enablement team to identify and develop use cases for how Gen AI can be utilized to increase productivity for both client-related work and efforts internally within ICF.

Lastly, in today's earnings release, we announced that ICF recently signed a definitive set of agreements to sell our Commercial Marketing Group. Included in the sale were our commercial loyalty programs and integrated communication services for consumer and financial clients. This group has brought ICF important capabilities that have provided and contributed to the growth of the engagement and communication services we provide to our government and utility clients. As we have increased our focus on key growth markets and mission-related areas within our government and commercial energy client sets, however, this group has become less core to what we do and thus the decision was made to divest the business. We are especially pleased that the group's senior leadership and staff have been offered positions by the acquirer. The transaction is expected to close in the third quarter, and Barry will provide additional details on the net effect of this divestiture and the CMY acquisition in his remarks. With that, I'll turn the call over to our CFO, Barry Broadus for a financial review. Barry?

Barry M. Broadus ICF International, Inc. - Senior VP & CFO

Thank you, John, and good afternoon, everyone. I will now share additional details of our financial performance in the second quarter of 2023.

As John noted, we had strong second quarter revenue performance, which was a result of our 10% organic growth, coupled with the acquisition of SemanticBits in July of last year, and drove our year-over-year revenue increase of 18.2% to $500.1 million. Revenue growth was broad-based, reflecting double-digit increases from federal, state and local government and commercial energy clients, which together accounted for 88% of our second quarter revenue.

Subcontractor and other direct costs of $137.7 million represented 27.6% of total revenue, which is in line with last year's second quarter.

Gross margin for the second quarter was 34.9%, a decline of 150 basis points as compared to the same period last year. Several factors contributed to the decrease, including last year's acquisition of SemanticBits, which generates a lower gross margin but higher EBITDA margins, and the timing of certain projects and contract ramp-ups. We expect to see sequential progressive improvement in gross margins in the second half of this year.

Year-over-year adjusted indirect expenses declined 140 basis points to 24.6% of revenue due to greater scale and the effective management of our indirect expenses. As we continued to make investments in people and technology to support our long-term growth, our indirect and selling expenses increased 10.6% year-on-year to $126.5 million, which was at a significantly slower pace than our

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AUGUST 03, 2023 / 8:30PM GMT, Q2 2023 ICF International Inc Earnings Call

revenue growth.

Second quarter EBITDA increased 19.2% to $47.5 million, and adjusted EBITDA increased 15.3% to $51 million year-over-year.

Interest expense for the second quarter was $10.2 million, an increase of $6.1 million from last year's level. The second quarter acquisition of CMY, which was not embedded in our prior forecast, coupled with the increase in interest rates, drove our interest expense to be higher than we anticipated. The second quarter EPS impact of the higher interest expense was more than offset by the benefit from our tax optimization strategies we implemented. We expect this additional benefit from our tax optimization strategies to mitigate the forecasted year-over-year higher interest expense for the remainder of this year.

Net income was $20.3 million or $1.07 per diluted share in the second quarter, inclusive of $3.5 million or $0.13 per share of tax-affected M&A and severance charges. Our second quarter net income and diluted EPS included a $0.21 per share incremental tax benefit beyond the full year estimated tax rate from which our year-end ETR guidance was based upon. Second quarter of 2022 net income was $18.4 million or $0.97 per diluted share.

Non-GAAP EPS increased 18.8% to $1.57 per share, which also includes the benefit of the company's long-term tax strategies.

We're very pleased with our second quarter and year-to-date cash flow generation. Our second quarter cash flow from operations was $36.7 million and $19.9 million on a year-to-date basis, significantly ahead of our results in the first half of 2022. Our ongoing cash management initiatives were a key driver of the favorable cash generation performance and also contributed to our improved days sales outstanding of 73 days as compared to the 82 days in last year's second quarter.

Year-to-date capital expenditures primarily related to technology investments totaled $13.2 million as compared to $11 million in the first half of 2022.

Our debt at the end of June was $601.8 million, similar to our debt balance at the end of the first quarter. Our second quarter debt is inclusive of the funding of the purchase of CMY Solutions. The acquisition was largely executed through the cash flow generation from operations during Q2.

Our adjusted net leverage ratio was 3.11 at quarter end compared to 3.09 at the end of the first quarter. Assuming no additional acquisitions this year, we expect our year-end leverage ratio to be down approximately 1 turn, inclusive of the expected net proceeds from the divestiture of our Commercial Marketing Group.

In addition, during the second quarter, the company executed an additional $100 million of interest rate swaps, which increased our fixed rate debt to be approximately 60% of total debt. With the addition of these new swaps, our all-in average interest rate now stands at 5.25%.

In addition to debt reduction, our capital allocation priorities include making investments to support organic growth, paying dividends, repurchasing shares to offset the impact of employee incentive programs and continuing to consider strategic acquisitions. We used $18.1 million in the first half of this year to repurchase 180,000 shares. We have $93.7 million remaining under the current stock repurchase authorization plan. We also announced today a quarterly cash dividend of $0.14 per share, payable on October 13, 2023, to shareholders of record on September 8, 2023.

Now to help you with your financial models, I want to emphasize that our second half revenues will be essentially flat as compared to the first half due to the divestiture of our Commercial Marketing Group, which is offset in part by the revenue generated from the CMY acquisition. The net effect of the divestiture and the acquisition in the second half of this year will lower our revenue by approximately $15 million, weighted towards the latter part of this year.

As John previously stated, we are reaffirming our revenue and non-GAAP EPS guidance for 2023, which is inclusive of both the CMY acquisition and the pending divestiture of our Commercial Marketing Group. In addition, any potential gain associated with the

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