ICF International, Inc. (ICFI) Q3 2014 Earnings Report, Transcript and Summary

Welcome to the ICF International Third Quarter 2014 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded on Thursday, November 6, 2014, and cannot be reproduced or rebroadcast without permission from the company. And now I would like to turn the program over to Douglas Beck, Senior Vice President, Corporate Development. Please go ahead.

Thank you, operator. Good afternoon, everyone, and thank you for joining us to review ICF's third quarter 2014 performance. With us today from ICF International are Sudhakar Kesavan, Chairman and CEO; John Wasson, President and COO; and James Morgan, CFO. 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 November 6, 2014, 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 our CEO, Sudhakar Kesavan, to discuss the third quarter 2014 performance. Sudhakar?

Thank you, Doug, and good afternoon, everyone. We appreciate your participation in today's conference call to discuss our third quarter results and outlook for the rest of 2014, heading into 2015. This was an excellent quarter for ICF across all key metrics. Revenues were solidly ahead of last year, up 8.5%. And on an adjusted basis, operating income and diluted earnings per share increased 13.5% and 10.7%, respectively, significantly outpacing revenue growth. At the same time, we saw strong growth in our 2 major markets, which together accounted for 90% of total third quarter revenue. Revenues from health, social programs and consumer financial increased 13% year-on-year. And energy, environment and infrastructure was up 9%. These growth rates demonstrate ICF's competitive advantages, thanks to our recognized domain expertise, which we continue to build upon by adding to our senior leadership and leveraging our successful outcome. Domain expertise has also been a key differentiator for us in winning business and this was another highlight of our third quarter performance. Record contract awards, which totaled $618 million, were up 29% year-on-year, bringing sales wins for the first 9 months of this year to $1.04 billion, 10% ahead of the comparable period last year. Overall, our third quarter performance was strong, reflective of how much more diversified our revenue base has become over the last several years, even before including the Olson acquisition, which closed yesterday. Importantly, our year-to-date pro forma commercial revenue post the Olson acquisition represents approximately 36% of total revenue, which increases our exposure to a higher-margin commercial business. And U.S. federal, state and local and international government account for 45%, 10% and 9%, respectively, which gives us a considerable visibility and positions us well to benefit from additional government spending in the areas where we have a competitive edge. With respect to our federal government business, we are entering 2015 with substantial resources directed towards our areas of specialization, namely energy, environment, health and transportation infrastructure, where we have significant scale. Our backlog is quite substantial and federal contract wins account for about 60% of our 9-month booking. We are, therefore, cautiously optimistic that we can at least hold U.S. federal revenues at current levels next year. And with the addition of Olson, we will be offering commercial best practices in digital services to our government clients, particularly in the key areas of mobile and analytics, which will provide us with even better positioning in that market. Growth prospects for our international government business remain robust heading into 2015. Revenues more than doubled in the first 9 months of this year. The international government pipeline has been consistently increasing, which speaks to how well we've been able to integrate and grow this business subsequent to the acquisitions of GHK and Mostra. The Mostra acquisition in February of this year added a critical strategic communications element to our offering. Now that we have scale internationally, we'll focus on increasing the profitability of our European business. We are quite bullish on the 2015 growth potential of our commercial business. Commercial revenues increased 10.4% in the first 9 months of this year. And the Olson acquisition provides us with multiple cross-selling opportunities with ICF and Olson's existing commercial clients as well as in the government space. Combined, federal government and commercial, we have 1,600 professionals and over $300 million in revenue in digital services and strategic communications, which makes ICF a strong competitor in this fast-growing market. Olson complements our current digital services offering, which is already growing at a double-digit rate. The acquisition adds strategic advisory, creative services and proprietary technology and analytics that enable multichannel customer and stakeholder engagement and e-commerce with emphasis on mobile platforms. We intend to take these capabilities to our utility clients, who use these channels to increase energy efficiency; to our health care clients, who use digital services to influence consumer choices; and to our transportation clients for their transaction and loyalty programs, just to name a few. In our energy business area, we had a few key energy efficiency wins this quarter that John Wasson will talk about in a moment. And we see major intermediate term growth opportunities around proposed regulation of greenhouse gases related to Section 111B of the Clean Air Act and the continued changes in oil and gas markets. We've added several senior leaders to our commercial health advisory business to accommodate the demand we have seen from payers and providers. To sum up, our outlook for 2015 is quite positive. And I would like to ask John Wasson, ICF's President, to give you more details on our recent contract wins and our business development pipeline. John?

Thank you, Sudhakar, and good afternoon. We indeed had an excellent sales quarter driven by record federal government contract wins. Our U.S. government third quarter book-to-bill ratio was 3.4x, comprised of a high proportion of new business, which strengthened our backlog in key areas such as public health, environment and information and digital technology. In the area of digital services and strategic communications, we won an important engagement with the National Cancer Institute at the National Institutes of Health to provide comprehensive support for their tobacco cessation efforts, valued up to $100 million over 5 years. This work is a great example of combining our domain expertise, in this case, behavioral health and tobacco cessation specialties, with our communications and digital media capabilities to address highly targeted populations and their social networks, such as teen smokers, pregnant smokers and veterans. By engaging these hard-to-reach populations via social media, we are able to tap into community support structures to reduce smoking based on the latest behavioral research. This sizable contract demonstrates the importance of cutting-edge stakeholder engagement in fulfilling an agency mission. And we expect this approach to become an increasingly important part of federal programs in the future. Another key technology win in the federal space that highlights the important role of our health domain expertise is a $100 million 5-year blanket purchase agreement to continue our work with the National Institutes of Health in providing data collection and analysis and multichannel information dissemination and outreach initiatives to users throughout the federal government and medical community. Under this agreement, NIH depends on ICF for the development of important health-focused digital and IT initiatives in such areas as U.S. HIV/AIDS guidelines and the National Cancer Institute's cancer treatment summaries and to support the dissemination of rare and genetic disease information. In addition, in this most recent award, the client expanded ICF's global work to include data analytics, disaster preparedness and assistance in converting more quickly to mobile applications. A third major win was at the Department of Health and Human Services Children's Bureau, a new $78 million contract to help establish the National Capacity Building Center for Public Child Welfare Agencies. ICF will help the Children's Bureau transform assistance to state child welfare agencies for more strategic and evidence informed approaches, providing consulting to more than 52 jurisdictions, designing and delivering learning programs and executing national information dissemination strategies. Also, we won 4 new contract awards from the Centers for Disease Control, ranging from $10 million to nearly $15 million per engagement. One of these contracts support CDC's public health surveillance system, called BioSense, with data management and analytics. BioSense is a public health surveillance system that helps officials at all levels of government rapidly monitor and respond to harmful health effects of exposure to disease and hazardous conditions. Two new contracts with the CDC are to provide technical and management expertise to grant awardees to help reduce chronic disease rates and to evaluate progress with others. The fourth is to evaluate CDC initiatives designed to reduce diabetes, heart disease and obesity, and increase wellness in targeted communities. Finally, at HHS, ICF will support -- continue to support SAMHSA's suicide prevention branch in evaluating its suicide prevention programs on a national level, including the design, implementation and dissemination of findings for 2 of its largest funded programs, including the National Suicide Prevention Lifeline crisis hotline program. In sum, all of these wins underscore our continued leadership in addressing federal public health objectives with management, research, evaluation and technology expertise. Beyond the public health arena, we also had a spectrum of significant wins across our other major client agencies. At the Pension Benefit Guaranty Corporation, we won an engagement worth up to $25 million to help them modernize and implement the next generation of business operations and customer service through enhanced IT management. At the Agency for International Development, we won an $18 million engagement to continue our work on strengthening health information systems and enhancing variability to monitor diseases in developing countries. At the Environmental Protection Agency, where we have decades of experience, we won a new contract in the Office of Solid Waste and Emergency Response to provide technical and evaluation assistance around technological innovations and trends and remediation practices. Our international government business continued to execute on recently-won contracts with the U.K. government and the European Commission. And as Sudhakar mentioned, their pipeline continues to grow. We were pleased that Mostra was honored with 5 Dolphin awards for its work with several European clients. The awards were presented earlier this week at the Cannes Corporate Media and TV Awards gala. In the commercial space, we had more than 400 wins across all of our markets, including digital, energy, environmental, health, aviation and infrastructure. The largest and most notable were the 3 new contracts that we signed to extend our support for BG&E's EmPOWER Maryland energy efficiency programs. As our largest client in our energy efficiency business, BG&E programs are evenly divided between work in the residential and commercial industrial sectors. As we enter this third 3-year phase, we will continue to manage many of the same programs that have made us successful, and introduce some new initiatives as well. With respect to the medium-term outlook, the energy efficiency pipeline is now in excess of $400 million after the BG&E win, with a number of larger opportunities to be decided in the second half of next year. Despite the fact that we won $618 million in contract awards in the third quarter, our pipeline stood at $3.3 billion at the end of this period, slightly higher than a year ago this time and only down $400 million from this year's second quarter. Moreover, our large contract pipeline stands at 24 opportunities greater than $25 million and 64 opportunities greater than $10 million. Finally, our voluntary turnover for the quarter was 3.7% and this translates into 12.2% in an annualized rate. I'll now turn the call over to our CFO, James Morgan, for the financial review. James?

Thanks, John, and good afternoon, everyone. As mentioned previously, we reported solid year-on-year comparisons in the third quarter. Total revenue was $264.8 million or 8.5% above last year's third quarter. Organic revenue growth, which is total revenue excluding acquisitions completed within the last 12 months, was up 3.2% year-on-year, the highest organic revenue performance we have had all year. This growth was primarily driven by our work supporting Hurricane Sandy recovery efforts and revenues from commercial digital services in energy business areas. Third quarter 2014 gross profit margin was 37.3% an increase over the 36.9% reported in the third quarter of last year. Indirect and selling expenses for the third quarter were $74.7 million. The $7.1 million increase in indirect and selling expenses was primarily due to the additions of Mostra and CITYTECH, and included approximately $800,000 in acquisition costs related to the Olson transaction. Operating income was $18.5 million for this year's third quarter, up 8% year-over-year. Adjusted to exclude acquisition and severance costs related to staff realignments that were announced last quarter, operating income was $19.6 million, 13.5% above the similar period last year and significantly ahead of our revenue growth rate for the third quarter. Reported EBITDA was $24 million for the quarter, 7.3% higher than the $22.4 million reported in last year's third quarter. Adjusted EBITDA, which excludes severance and acquisition related costs, was $25.1 million for the quarter or 11.6% higher than the $22.5 million of adjusted EBITDA reported in last year's third quarter. Adjusted EBITDA margin increased to 9.5% from 9.2% in the third quarter of 2013. Depreciation and amortization expense was $3.2 million, up from $2.8 million in 2013's third quarter, primarily due to the acquisition of Mostra and CITYTECH earlier this year. Amortization of intangibles was $2.3 million for the third quarter of 2014, down from $2.5 million in 2013's third quarter, primarily due to reduced amortization of intangible assets related to the acquisition of Ironworks and Macro, partially offset by the impact of our recent acquisitions of Mostra and CITYTECH. The effective tax rate was 33.6% for the quarter, as compared to 33.8% reported in the third quarter of 2013. In both periods, the effective rate benefited from a positive impact of our federal return to provision true-up, mostly driven by foreign tax credits and compensation-related deductions. Reported net income was $11.6 million or $0.59 per diluted share. Adjusted EPS, which excludes acquisition severance costs, was $0.62 for the third quarter, an increase of 10.7% over the prior year. Looking briefly at the first 9 months of 2014. Revenue was $773.7 million, up 7.5%. On a reported basis, EBITDA increased 1.5% to $68.7 million. On an adjusted basis, EBITDA increased 5.9% to $72 million. Adjusted earnings per share for the first 9 months was $1.68, up from $1.58 last year. Reported earnings per share was $1.56 compared to $1.57 for the first 9 months of last year. In the third quarter, we generated cash from operating activities of $27.4 million, resulting in year-to-date cash flow from operating activities of $19.5 million. In this year's first 9 months, operating cash flow was reduced by additional working capital requirements associated with our Mostra and CITYTECH acquisitions and temporary delays in the collection of accounts receivable due to administrative billing issues on certain new contracts. We are successfully addressing the temporary billing delays as is evident by our $21.3 million decrease in unbilled accounts receivable and a decrease of 3 days in days sales outstanding as of the end of the third quarter as compared to the second quarter of 2014. As a result, we continue to expect cash flow from operating activities for the full year 2014 to range from $60 million to $70 million. Days sales outstanding as of the end of the third quarter were 77 days, which is within our expected range as discussed in Q2. As a reminder, we anticipate the DSO for the year will be in the 72 to 77 day range, including the impact of deferred revenue. Capital expenditures for the first 9 months of 2014 were $10.6 million and in line with our expectations. In the third quarter, we repurchased approximately 139,000 shares, which will allow us to achieve our goal of offsetting the dilution caused by our employee incentive programs, and maintain a fairly flat year-over-year diluted share count. Yesterday, we completed the acquisition of Olson, which we announced on October 21. The purchase price was $295 million in cash with no earnouts. Given our preliminary fourth quarter projections of cash flows for ICF, inclusive of Olson, on a pro forma basis, we expect our net debt-to-EBITDA ratio to be between 3 and 3.1 at the end of this year. Going forward into 2015, we expect the cash flow from operations for ICF, inclusive of Olson, will annualize at more than $90 million. We reaffirm that the Olson transaction will be neutral to this year's reported fourth quarter earnings and accretive beginning in the first quarter of 2015. However, it is important to note that if you deduct the financial impact of Olson's related intangible amortization of $1.8 million and the associated integration and personnel retention expense of about $800,000, the transaction is expected to be approximately $0.08 accretive to this year's fourth quarter earnings per share. Inclusive of the Olson transaction, we expect full year 2014 depreciation and amortization expense to be in the $13.3 million to $13.8 million range, amortization of intangibles to be in the $10.3 million to $10.8 million range and interest expense to be in the $4 million to $4.5 million range. Capital expenditures are anticipated to be between $14 million and $14.5 million for 2014. We'll provide guidance on certain line items for 2015 when we release our fourth quarter results. However, for modeling purposes, our preliminary estimate of intangibles related to the Olson acquisition is roughly $67 million, which will be amortized on an accelerated basis over 10 years. For 2015, the amortization expense associated with Olson is expected to be approximately $12 million. Additionally, we are issuing about $15 million of equity related instruments to help ensure employee retention, which will be expensed over a 4-year period. With that, I'd like to turn the call back over to Sudhakar.

Thank you, James. We expect our fourth quarter comparisons to benefit from similar trends to those of the third quarter and the fact that last year's fourth quarter had the impact of the federal government shutdown. Also, we will have a roughly 2-month contribution from our Olson acquisition, which should add between $20 million and $25 million in revenue. For the year, we are reaffirming our diluted EPS guidance range of $2.12 to $2.20, exclusive of additional acquisition-related charges. On an adjusted basis, excluding acquisition -- Olson acquisition expenses and year to date severance costs, adjusted earnings per share for 2014 are anticipated to be between $2.19 and $2.27 on revenues of between $1.04 billion and $1.06 billion. As you know, we believe we are entering 2015 with positive momentum in terms of revenue and earnings growth. Higher-margin commercial business will account for a significantly greater percentage of our total revenues. And the Olson acquisition alone is expected to add from 80 to 100 basis points to our EBITDA margins beginning in the first quarter of 2015. We will be more precise in providing full year 2015 revenue and earnings per share guidance when we release our full year 2014 figures by early next year. At this point, operator, I would like to open the call to questions.

[Operator Instructions] And our first question comes from Bill Loomis with Stifel. William R. Loomis - Stifel, Nicolaus & Company, Incorporated, Research Division: Just on the Olson acquisition, any -- what other costs besides the $12 million in amortization and the higher expense should we be factoring into '15, when we try and figure out accretion? Is there going to be any -- what's the retention, for example, cost going to be for 2015?

I think the way to think about it, I mentioned that we have roughly $15 million, Bill, in total retention costs. And those will be amortized or expensed over a 4-year period. So you can, for estimate purposes, I think you can kind of straight-line that for the most part. William R. Loomis - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. And then on an earlier comment, you mentioned the focus is going to be -- Sudhakar said the focus is going to be on improving profitability on international. Can you talk a little more about that, what you're going to do and how quickly that could come about?

Sure, Bill. This is John Wasson. I think it's I'd say 2 things. I think we're expecting it to make improvement for 2015. And I think it will occur in 2 ways. One is we expect to improve utilization in the Europe and Asian business as we continue to grow. And as you know, we've had quite robust organic growth there. So part of it is raising the utilization as we go into next year with the larger longer-term contracts we've won. I think we've also closed down several offices that were unprofitable or in challenging environments, Russia and other locations. And so part of the strategy is to shut down small offices where we don't have scale. And the third thing I note is that we've had several expats over in Europe for the last 2 or 3 years under expat agreements that we'll be bringing back at some point in 2015. And so we won't be incurring those costs. We have -- we do believe we hired and trained a strong executive team in Europe. So we don't -- we can bring those expats back. And so I think those are the 3 things we're doing to raise profitability for 2015.

Our next question comes from Tim McHugh with William Blair. Timothy McHugh - William Blair & Company L.L.C., Research Division: Just on the federal government side, given the size of the contract awards, I guess -- I know you made the statement you're confident it won't decline next year. But just anecdotally, how different do you feel today versus -- it was just a quarter or 2 ago that the revenue was really coming in much lower than you thought. And so did the environment really change that much? Is it the difference between contracting activity versus your ability to recognize revenue on your contracts? I guess can you just bridge the message or I guess overall view of the federal government today versus 3 to 6 months ago?

Yes, Tim. I think that over this past year, we basically have certainly won a lot of work in our main areas. And over this past year, we had -- where we had certain marginal contracts, especially at DHS, where we didn't have scale, we didn't have major positioning in certain offices, we either got small business set-aside contracts, which therefore we lost some -- half the revenue, or we basically just lost the contract based on LPTA. So I think that we believe that our marginal contracts have declined significantly. And therefore, going forward, a lot of our work is in areas where we have scale and where we have domain expertise and where we have knowledge. And the backlog we built up now in these areas is fairly substantial. So the reason we think that we can maintain our revenues going forward is that it depends a lot on, obviously, government spending next year. Looking at the backlog, though, you would think that you would increase your federal government revenue, which could potentially happen. But given the uncertainty in spending patterns, we believe that we have enough backlog that we can maintain, at least, the revenue going forward for federal government in [indiscernible]. Timothy McHugh - William Blair & Company L.L.C., Research Division: Okay. And then just secondly, the -- can you give some comments on the reaction, as you've heard from Olson, I guess now -- the Olson employees beyond the kind of -- I'm sure -- your reaction would be from the senior people that you've been involved with along the way. But I guess maybe the good and the bad that you've heard as people have heard the news of being acquired by ICF in the last couple of weeks here?

I've heard from a lot of the employees. I mean, they all are quite excited, I think, generally about it. I haven't -- I don't, if any are concerned, but they don't tell me any bad news, but I haven't heard anything negative from anyone. I even heard from an Olson client, who basically uses one of their Loyalty Programs, who was quite impressed with the way they implement it, because it turns out that I know someone he knows and when he read the press release, he decided to call me. So I think we -- my general sense has been very positive and they are all very excited. If you looked at the Olson press release, when we issued it about 2 weeks ago, the head of Olson, John Partilla, used the word thrilled, which you will never see me use, so -- in any press release. So he is really thrilled about being part of us. So I think that's been infectious across the whole company. So I think that generally we are feeling quite good about the acquisition. And I think we've had some situations where even as we speak, we are bidding jointly for a utility for some digital agency work. And we are also working on some projects in California for a client in the transportation arena. So I think that there's a lot of enthusiasm and it's been really quite, quite good. All the -- all hands meetings which we had, where we visited all the offices, are very positive. I was in Minneapolis, John was in Chicago and Isabel was in Toronto and David Speiser, our head of strategy, went to Austin. And they're all very enthusiastic. We had this multi-video link to all the offices. It was all very technologically sophisticated and exciting. So I think generally, it was very positive.

[Operator Instructions] And our next question is from Tobey Sommer with SunTrust.

This is actually Frank in for Tobey. I wanted to ask a little bit about energy efficiency opportunities in California, kind of what you're seeing there, the progression of what may develop and any timeline or framework you could give?

Sure.

Go ahead.

Okay. This is John Wasson. I think we're still expecting a wave of energy efficiency RFPs in California. I think it's going to be second half towards the late -- latter part of 2015. We have north of $120 million of opportunities in California in our pipeline for energy efficiency. And so I think we're still quite opportunistic -- optimistic. I think there's significant opportunity there. It is going to be more of a second half of 2015 going into 2016 play in California.

Okay, that's helpful. And then also wanted to ask, there are nice bookings in the quarter and it was great to get the breakout of commercial. Can you talk a little bit about the seasonality of kind of commercial versus government and bookings going into Q4, and maybe a little bit longer term, in terms of what seasonality, you think there's any changes there?

Let me just -- these -- I don't know that I can address the seasonality of bookings. And I can tell you the seasonality of the business. Our seasonality of the business traditionally has been Q1 is low, Q2 is higher, Q3 is the highest and Q4 is like Q2. And we found that Olson also has a very similar seasonality. So I think that the seasonality for Olson is going to be similar to what [indiscernible] where Q1 is traditionally slower, Q2 up, 3 and then down. So -- and as you know, the third quarter with the government is always the highest, because the government fiscal year ends September 30. So I think that in terms of just the overall seasonality, it doesn't change very much with the acquisition.

Okay, that's helpful. And then lastly, I apologize, could you just repeat what you said about amortization and depreciation in 2015?

Yes. What I was referring specifically to Olson or referring to the entire company as a whole?

Olson and the entire company as a whole.

Okay. So what I had said is that for the remaining part of 2014, depreciation and amortization expense of $13.3 million to $13.8 million and then having amortization of intangibles of $10.3 million to $10.8 million. That's for the remaining part of 2014, inclusive of Olson. And then the comment I made regarding Olson in 2015 is that we expect to have roughly $12 million of amortization expense associated just with Olson in 2015.

We have no further questions at this time. I will now turn the call over to management for closing remarks.

Well, thank you. I just -- before closing, I just wanted to answer a question, which I don't -- someone asked at the last call, on the Olson call, which was, in the top 10 Olson clients, how many are agency of record clients, et cetera. So I just wanted to clarify that. In the top 10 clients of Olson, 4 we have general agency of record for 4 of the top 10 clients, and 2, an additional 2 clients with the agency of record for loyalty and CRM. So we have 6 agency of record relationships in the top 10 clients. I just want to clarify that. And thank you for participating in today's call. We look forward to keeping you up-to-date on our progress and we will talk to you early next year. Thank you.