Welcome to the ICF International Third Quarter 2018 Earnings Conference Call. My name is Vanessa, and I will be your operator for today's call. [Operator Instructions]. Please note this conference is being recorded on Thursday, November 1, 2018, and cannot be reproduced or rebroadcast without permission from the company. And now I would like to turn the program over to Lynn Morgen of AdvisIRy Partners. Please go ahead.

Thank you, Vanessa. Good afternoon, everyone, and thank you for joining us to review ICF's third quarter 2018 performance. With us today from ICF 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 1, 2018 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 over the call to ICF's CEO, Sudhakar Kesavan, to discuss third quarter 2018 performance. Sudhakar?

Thank you, Lynn, and thank you all for joining us this afternoon to review our third quarter results and discuss our business outlook. This was another quarter of solid execution for ICF, with total revenues up 9.1% year-on-year, consistent with our expectations and putting us firmly on track to achieve our full year 2018 revenue and earnings guidance. Our results continue to benefit from the diversified revenue sources inherent in our business, and the positive demand dynamics that align with ICF's domain expertise and implementation capabilities. Third quarter revenue performance reflected substantial year-on-year increases in both state and local and international government work, which more than offset slightly lower revenues from federal government clients. Growth in state and local government was closely tied to our recent contract to provide disaster recovery assistance in Puerto Rico. And international government revenue growth represented continued execution on the substantial backlog that we have built over the last several years. Our large commercial businesses, energy markets and marketing services, are both up year-on-year, more than offsetting the wind down of several infrastructure and aviation consulting projects. Adjusted EBITDA margin on service revenue rebounded sequentially by 190 basis points to 13.8% while we continued our investments. These results, along with a lower tax rate, enabled us to convert this quarter's high single-digit revenue growth into substantial double-digit increases in diluted earnings per share and non-GAAP EPS. The growth drivers that benefited our third quarter and year-to-date results have also set the stage for ICF's strong performance in 2019. First, we expect a significant pickup in federal government work next year. The dollar value of our year-to-date federal government contract wins is over 75% higher than the dollar amount of what we won all of last year, and our new business pipeline from federal work is…

Thank you, Sudhakar, and good afternoon, everyone. Third quarter results were in line with our expectations, supporting our decision to increase our guidance last quarter and positioning us for significant sequential growth in this year's fourth quarter. Revenues in our government business increased 14.1% in the third quarter and represented 65.1% of total year-to-date revenues. In the third quarter, revenues from federal government clients increased sequentially by just under 1% but declined by a little under 2% year-on-year. These results are consistent with what we anticipated and have spoken throughout the year about, given the issues associated with budgets going through the appropriations phase and then developing into RFPs. Also, in line with our expectations, we saw a pickup in RFP activity and contract awards in the third quarter, with awards from federal government agencies representing the lion's share of our record contract wins this quarter. As a result, we expect an acceleration in federal government revenue in this year's fourth quarter, representing a strong finish to this year and enabling us to achieve our guidance of flat revenues from federal clients for full year 2018. Federal government contract wins in the third quarter amounted to $522 million. In addition to our $200 million 5-year recompete with USAID to continue to implement its Demographic and Health Surveys Program, key federal contracts won in the third quarter included: a new $20 million task order from the U.S. Department of Justice to provide financial management and technical assistance; a new $35 million single-award IDIQ from the Environmental Protection Agency to support the National Water Program and EPA major water policy and regulatory actions; and the $20 million recompete contract with the U.S. Centers for Disease Control to support the BioSense Program, in which we were awarded significant additional funding to add new…

Thank you, John. Good afternoon, everyone. I'm pleased to report on our third quarter financial performance and provide you with additional insight into our thinking for the remainder of 2018. Third quarter revenue was $333 million, up 9.1% from the $305.3 million that we reported in last year's third quarter. This growth was driven by a 14.1% increase in total government revenues, which reflected double-digit increases in revenue from work for state and local and international government clients, which more than offset a 1.9% year-over-year decline in revenue from federal government clients. Pass-through revenues increased 21.8% year-on-year and accounted for 30.5% of third quarter revenues. This is related in part to the disaster recovery work in Puerto Rico as well as our increased communications and events work with the European Commission, for which subcontractors account for more than 50% of the revenue. Service revenue increased 4.3% to $231.3 million, up from $221.8 million in the third quarter of 2017. Gross profit increased 4% to $119.9 million from $115.3 million, driven by higher revenue. Due largely to a shift in client mix and higher pass-through revenues that yield lower margins, we reported a 180 basis point decline in gross margin to 36% in the third quarter of 2018 as compared to the third quarter of last year. However, our gross margin on service revenue was 51.9%, down a more modest 10 basis points year-on-year mostly due to lower revenues from certain higher-margin aviation projects. Indirect and selling expenses for the third quarter amounted to $89 million compared to $84.6 million in the third quarter of last year--but as a percentage of service revenues and after exclusion of special charges, it stayed essentially flat at 38.1%. Bid and proposal activities, which had accelerated in the first half of this year, eased in…

Thank you, James. To sum up, the third quarter was another period of strong performance for ICF and supports our guidance for solid double-digit earnings growth this year. Additionally, higher backlog, record contract wins and a business development pipeline of close to $5.5 billion all set the stage for strong growth in 2019. Vanessa, I would now like to open the call to questions.

[Operator Instructions]. And we have our first question from Tobey Sommer with SunTrust.

With respect to the disaster recovery work stemming from the storms in 2017, the company's had some success winning some contracts. I'm trying to get a sense for the remaining sort of addressable market in terms of those Community Development Block Grant funds sort of yet to be allocated and paying it off to a consulting firm to assist with. Or perhaps, you could even quantify the addressable market available to consulting firms.

Sure, Tobey. It's John Wasson. I guess I would - so let's do that geography by geography. I would just remind folks, as we've talked about in the past, that Congress has appropriated $35 billion of funds under the Community Development Block Grant program to help Puerto Rico, Texas, Florida and the U.S. Virgin Islands respond to the damage from the storms. And so - and we've indicated that, that money has been allocated by HUD such that Puerto Rico has gotten about $20 billion of CDBG funds; Texas, about $10 billion; and Florida and the U.S. Virgin Islands, $2.5 billion each. So the largest opportunity, obviously, remains in Puerto Rico. No contracts have been awarded yet to undertake CDBG-related implementation yet in Puerto Rico. We are in capture and in proposal stage on opportunities there and expect awards going forward. And into next year, that remains a very significant opportunity, certainly, the largest opportunity for us. Second largest opportunity is Texas. Texas was allocated $10 billion. We noted that we've been awarded a couple of contracts. We've been notified of intent to award us a couple of contracts in Texas to help support CDBG opportunities that are about $50 million potential value to us. There's certainly more to come and more opportunity in Texas, and we expect that to also play out throughout the rest of this year and into next year. And so I would say that in the two areas with the most - have been allocated the largest resources, there's still significant opportunity, and that will play out here in the next months and quarters.

Okay. With respect to Puerto Rico, is the - if you're successful in winning additional work, is the most likely path for that to transpire by applying additional funds to your existing FEMA contract? Or would it be a separate sort of contract vehicle?

I mean, my expectation is it would be a separate contract vehicle. I mean, the CDBG requirements and rules are specific for programs that - to that program. They are different than FEMA programs. And so I would certainly expect it will be different - separate contracts and that there will be a set of contracts awarded to support CDBG activities in Puerto Rico.

Okay. With respect to the cash flow guidance for this year, could you give us some color, without giving specific numbers if you're not prepared to, but is there some sort of catch-up that we should expect next year, at least, based on what we know now in the business?

Yes, you would. This is James, Tobey. We certainly would expect that there would be a little bit of a catch-up into the beginning of next year, in the first quarter. So that would help to benefit the 2019 cash flow.

Okay. And then I wanted to ask a question on the commercial side, and I'll get back in the queue. You mentioned some energy projects winding down. Could you just provide a little bit more color about the nature of those projects in - whether that was anticipated, a natural phenomenon? Or any other color you could provide?

Sure. I mean, the environmental work, it tends to be environmental - support environmental permitting or construction monitoring for large energy infrastructure projects, so electric transmission lines - primarily electric transmission lines. We've had several large projects that had been winding down, and I think we expected them to wind down. I think as I noted, we do expect our commercial business to grow in the mid-single digits for the year, and that's, I think, what we've been guiding for the year. And so I think we've - this is factored into our guidance, and think it was not a surprise.

We have our next question from Lucy Guo with Cowen and Company.

I wanted to just follow up on Tobey's question about the disaster recovery funding situation, just to clarify maybe. It doesn't seem like you have received any chunky awards this quarter. Would you characterize that there may be postponement and - or at least, prolonged adjudication pace in terms of the getting the awards done?

I mean, I wouldn't say that there's been a prolonged adjudication or delay. I mean, I think we've - our experience has generally been it takes a year from time of the storms and the appropriation to kind of run the process out, to design programs, get out approval, run the RFPs and select one or more firms that will help support the implementation. And so I think we're - so I don't think there's been - I would not characterize it as delayed. I would expect that over the next - through the end of this year and into early next year, these will play out. And we should have clarity. There certainly are, as you note, chunky opportunities still out there that were certainly in capture or bidding and awaiting decision.

Okay. And the opportunities that you had named, over $25 million, some of those are clearly related to disaster recovery. Is that right?

That's correct, yes. And some of the largest in that category would be related to disaster recovery.

Okay. That's great. And then you had mentioned in your prepared comments there are some Q4 potentials on the federal government side. Are there any besides the opioid opportunity that was mentioned? Or just any color you can give there.

I mean, I would say that I think we've been pretty consistent in our commentary on the federal civilian budgets that we expected, given the increase in budget from Trump two year budget for 2018 and 2019, that the time it will take for that money to flow and we'd start seeing real opportunities and awards and start impacting our growth will start to occur as we go into Q4 and ramp into early next year. I think the opportunities we're seeing and our expectation is they'll be pretty broad-based. I think as Sudhakar noted in his commentary, I mean, Department of State, including AID, Department of Justice, EPA, Homeland Security, HHS, we're seeing opportunities across all those clients. I guess, what I would say is that the money associated with increase in the civilian budgets, we're starting to see that flow. And as expected, and we expect it'll ramp up our growth here in the fourth quarter and into next year on federal. I mean, as we noted in the commentary, we were slightly under 2%, a decline in federal through the first three quarters. We're saying we're going to be back to flat at the end of the year. So that obviously implies a ramp-up in growth, and we think it'll continue into next year.

Got it. And then just going to the commentary that James made about the revenue mix on some of the higher-margin, aviation-related consulting projects, do you expect to do more of those going forward? Just there's hardly - maybe the mix getting better there.

Yes. I mean, our aviation business, I mean, it's a cyclical business. It goes up and down. It's dependent. We can win very large strategy opportunities that can really drive the margins and drive the growth. We had some of those last year. This year, we haven't had quite those set of projects. And so it's a volatile business. It is a very profitable business, one of our most profitable businesses. And so it's a small business. It's less than 2% of our revenues. But when it's cranking, it can really help drive our earnings. This has been a challenge year for that business. I don't think there's a broad kind of industry trend that would lead us to believe that will. I think it should show improvement, and we're cautiously optimistic for next year. But when that business is strong, it can really drive earnings. It is very profitable.

Make sense. Lastly, just on the commercial side, which is you typically have very good seasonality in Q4. Is there any reason why that wouldn't be the case this year?

No, I don't expect anything unusual with our seasonality. I think we'll see the typical seasonality. And again, we've certainly indicated our commercial business will be mid-single-digit growth this year, and we think we'll experience growth in the fourth quarter. I think we're - and certainly are positive on energy and marketing services.

Our next question comes from Kevin Steinke with Barrington Research.

I believe you talked about some incentive payments or fees that you expect to come through in the fourth quarter. I assume those are higher-margin opportunities. And I'm just curious about how secure those are in terms of the timing that they're going to hit the fourth quarter, if you've already received them. Or is there any potential for slippage on those?

Kevin, this is James Morgan. Majority of those payments relate to our energy efficiency work incentives. And certainly, we have very - they're paid based on us achieving certain metrics, success metrics on those contracts. We manage it very tightly. We have very good insight as to what we expect at year-end, and so I don't see that there is going to be any significant slippage of those in the fourth quarter.

Okay. And that ramp-up in margin you're expecting in the fourth quarter, I guess, relates to gross margin and - but how are proposals and bid and proposal expenses trending? I think you expected them to tick down in third quarter and further in the fourth quarter, so is that kind of the trend you've been seeing?

Yes. With regard to our proposal expenses, certainly, it's eased in Q3. And we expect it to be little bit less in Q4. But I will also say, depending on the timing of some of these opportunities that come out with regard to disaster recovery, that could have a little bit of impact on spending. And that will - that's going to drive our investments. If those come out, we have to do what's necessary to go after it.

Right. Okay. You talked about a potentially significant pickup in federal government growth in 2019. I was just wondering if there's any way to frame that in terms of maybe relative to some of your best years historically in terms of growth in your federal government business. I mean, would you say that, that would be - this could potentially be one of your best years or - I'm just trying to get a - or could trend above your longer-term targets for the federal government business growth?

Kevin, I think that basically, what we see, it's a very substantial part of our business. The federal business is between 40% and 45%. So I think traditionally, it's been flat to low single digits. I think it'll certainly increase from there, and we will certainly give you a better sense of it. But it will be much better. Now I don't recall what our best years were, but we've had - after ARA, we had 13%, 14% growth. I wouldn't expect that. But I think it'll be, certainly, good growth. And given the size of our business, relative to the rest of our businesses, I think it will make a significant difference to our profitability going forward.

Okay. That's helpful. And any more detail on the We are Vista acquisition in terms of size or the strategy there with the rest of your commercial marketing business?

Sure. I think that the - it's 100-person firm based in London and - in the U.K. and 1 or 2 of the other locations. I think that the strategy - our strategy has been quite consistent over the last many years. We have had an ICF here in North America. We've had a strong set of federal government-type business. But on top of that, we build our commercial businesses. Similarly, in Europe, both in the U.K. and in the European continent, we've had a strong federal-like business, the European Commission and the U.K. government business. And we are doing the same analog here. We have commercial clients there, which are serviced out of the London office. And we have government clients. And as we get more need for engagement services, we want to make sure that the resources available for that kind of activity for our clients. And it's just an analog of what we've done here. So I think we are going to just build a business in Europe, which is an economy which is very large and has lots of data and has need, which is similar to us, in a similar way to what we did - what we are doing here. So that's basically the strategy.

Our next question comes from Tim McHugh with William Blair.

First, I want to follow up on a question on seasonality in the commercial business. I think last year, in the fourth quarter, you had a big - kind of a spike in revenue that, if I look years prior to that, really wasn't - it was much more pronounced. And I know you also had a spike in pass-through costs last year. Is that - I guess, when we think about the normal seasonality is what, I guess - the heart of the question I'm trying to get to and how much pass-through expenses impact that growth for the commercial in the fourth quarter.

Yes. I mean, I think - Tim, so I'd say a couple of things. I think we do expect a significant amount of pass-through revenues on the commercial side in 2018, like we had in 2017. Those are media buys associated with several of our commercial clients who, for business reasons, make those investments in the fourth quarter. So I would expect that to certainly be the case in 2018. I also think that certain parts of our business do ramp up in the fourth quarter, particularly our - on Olson side around advertising, marketing services associated with the holidays. And so that drives it. And then as we've talked about, we do get these incentive payments from energy efficiency programs in the fourth quarter. And we expect them to be particularly high this year. So I think those are the things that are really driving higher fourth quarter service revenue and total revenue that we'll see in 2018, much like we saw in 2017.

Okay. And have you - I don't know, did you give a number for reimbursable or pass-through expenses this year? They're what you expect at this point?

As far as the full year - for the full year estimate?

Yes. Yes.

We have in total. I mean, we've said that on a Q3 basis, we were running at 30%. I would say that as we move forward, certainly for subcontract activity, there's going to be a higher level. If you think about the disaster recovery work we do, there's quite a bit of subcontract activity that goes with that. So I would suspect as we move forward into future quarters that - in the past, we used to run closer to 25%, 26%. I think in the future, we'll be 30% or a little bit more.

Okay. And seasonally higher in the fourth quarter? Or is that...

Yes, it's seasonally higher in the fourth quarter. That's correct.

Okay. The hurricane - I apologize. I joined the call slightly late, but could you quantify at all the impact from hurricane work? And is this as simple as thinking about the growth in the state and local business mostly related to that?

I think we reported on the growth in the state and local business today. Obviously, that has been driven over the last quarter, a couple of quarters by our significant Puerto Rico contract, which, I guess, I'll remind everybody, it was an award of $189 million over three years. And so if you did the math on an average basis, you'd get a sense of the growth. And we've talked about there's potential upside on that contract. And then I - we also described the small contract we've won in the U.S. Virgin Islands, the opportunities in Texas where we've had a notice of award for up to $50 million of CDBG-related work over a couple of years. And so I mean, those are the activities that are - that we have in hand that will continue to drive that business. And then we've talked about the robust opportunity and pipeline in Puerto Rico and Texas. That needs to play out here over the next months and quarters.

Let me ask maybe one other way. I guess, if we look at the third quarter in terms of the contracts you've won, are you - does this reflect a ramped up run rate from those? Or such that we need additional contracts to drive growth from hurricanes? Or I guess, are you still on the ramp stages...

No. Well, I would say that in Puerto Rico, we've come a long way on the ramp-up. I would not say that we're fully ramped up yet. I think there's more ramp - we're still ramping up fully on that contract, certainly, in the fourth quarter. And once we get going on this Texas work, we'll need to ramp that up. And so there's still - we're still ramping up the work. We're not at full capacity here at the end of the third quarter.

Our next question is from Joseph Vafi with Loop Capital.

On that Texas, I guess, down-select or notice of award - first of all, congratulations on that. But secondly, do you have a feel for, if there's been some other down-selects that you haven't gotten there yet, that you haven't gotten? Or do you think this is kind of the first notice of award coming out from Texas? And then I have a follow-up.

I think this is the first - there's an initial set of contract awards in Texas from multiple jurisdictions. I would say that we've won - so this is an initial set of wins for us. We've won our fair share. We weren't the only winners, and there's more to come. I mean, I think there still remains significant opportunity in Texas.

Okay. And then just as Puerto Rico starts to ramp, can you just kind of remind us what the margin profile is overall on that business? And then just finally, could you just remind us again how you're differentiated in some of the cyber work you say is starting to ramp?

Joe, this is James Morgan. I'll cover the margin piece. I think as we've said in the past, the Puerto Rican work, it is disaster recovery work. Typically, it's government-type work. But it's at the upper end of our government profitability spectrum typically. So yes, you can picture that to be - we've said in the past that our government work can run anywhere from, say, 7% to 10% or so. It's certainly near that upper end from a profitability perspective. John?

Yes. On the cyber side, I mean, I would say that we - I'd say a couple of things. We have a long history of supporting the Air Force on cyber-related activities - I'm sorry, the Army, Army. I'm sorry, the Army Research Lab on cyber-related opportunities. And so we have deep relationships there, and so we're leveraging those. And then we have - obviously, we have a variety of clients on the cyber side in civilian arenas. And we obviously have deep relationships into our civilian clients, and so we're able to leverage those relationships to pull through some of the cyber work. And so I would say that's the primary drivers. I mean, we do first-rate work in that area, and we're leveraging the relationships, both at the Army and on the civilian side.

And we also won a contract, Joe, based on the Army work with the Air Force, which does want similar work done. So I used to have TS clearance. I don't have it any longer. So they will shoot me if they tell me what they do. But I think whatever they're doing is interesting enough that a lot of the services are also seeking Army assistance, and the Air Force contract we won was also very similar to what we are doing for the Army.

Okay. But just to kind of - just drill down on that just a little more, it's not a really kind of IT cyber. It's more process and kind of workflow sites? It's not just pure IT cyber, if I recall. Just a little more clarity there would be great.

Yes. It's quite sophisticated cyber in that it's pattern recognition cyber, that is, they look at ways in which potentially there's incoming cyber-attacks and what patterns you can detect. So it requires some really highly trained people who look at the patterns which are emerging and, therefore, figure out ways in which we can perhaps respond. So I think that there are - it is - I don't know what you'd call that, but it is not processed. And that is not - I don't know exactly what the process aspect you're referring to but it's [indiscernible]

Yes, that's right. So in defensive cyber...

Defensive cyber, I mean. And we have folks working on site 24/7 who are doing defensive, protective measures. So I do think we have some real technology capability here.

Our next question comes from Marc Riddick with Sidoti & Company.

I wanted to touch base on some of the preparation for disaster recovery contracts. And I was - I guess, maybe taking a step back to - from the standpoint of looking at it historically, what you're doing now versus what you've seen historically, are you finding yourself now spending more to prepare for these, given - it seems as though from the outside looking in, there are more opportunities. The number of opportunities are more. How should we be thinking about sort of that initial investment in preparing for disaster recovery and then what that may be portend to for just sort of being more of a steady-state going forward?

I mean, I think from the 2017 storms, I think we've been pretty clear that there's significant opportunity there. The two quarters prior to this, we made significant investments to build the pipeline and position for the opportunities. Those are playing out. I think we continue to invest. With the investments coming down here in Q3 related to the 2017 storms, we would expect it to come down even further in Q4 although we'll still be investing. I think we'll see decisions on many of those 2017 storm opportunities on the CDBG front in the coming months and early - and into next year. I then would say that we've had two storms this year, and I would expect that there'll be appropriations in response to those storms to address the recovery. And as we get into later next year, as we get nine months into a year after those storms, there'll be a set of opportunities. And we'll need to invest in that, and we'll reflect that in our guidance. But I think there's a cycle to this. And I think we're - from the 2017 storms, we're kind of getting deep into that cycle in terms of investments coming down. We think we're at a point out now where proposals are being written and awards are going to shake out here. And then we'll - as I say, we'll bake into our 2019 guidance the investments we need to make later in 2019 in response to the storms this year, depending on what amounts that Congress ultimately appropriates.

Okay. I was wondering, as far as overall, how we should be thinking about overall head count expectations going into next year, not just around disaster recovery of course, but just overall, what you're thinking may be necessary in order to take advantage of total opportunities, given the increased backlog.

Yes. I mean, I think we're a people business and we - and so if we're going to grow, we're going to need additional people. I would say that generally, our philosophy is if we're growing - let's pick a number - 8%, we would look to add 7% additional - but we'd look to get some leverage and leverage our existing staff as much as possible and then add additional staff over time. I mean, we would hope the utilization would go up with existing staff as the firm grows and we have more opportunity. But at the end of the day, if we're growing 8%, we're going to have to add...

Staff...

A lot of staff to get that work done.

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

Well, thank you for - all for participating in today's call. Here's wishing you all a very happy holiday season, and we'll see you next year. Thank you.