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.

Thank you, Tesh. 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?

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 are 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 [inaudible], another indication of ICF's competitive positioning in areas of priority spending. Our trailing 12-month book-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 our IRA legislation. Lastly, we executed transactions that strengthened ICF's position in key growth areas and support our long-term growth strategy. Our energy environment, infrastructure and disaster recovery market, which spans our government and commercial client set, continue to be a standout performer in the second quarter. Revenues increased nearly 18%, primarily representing organic growth, and…

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 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 continue 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 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…

Thanks, Barry. We are pleased to reaffirm our full year guidance. We expect 2023 total revenue of $1.93 billion to $2 billion, and we anticipate subcontractor and other drug costs will be approximately 27% of total revenue. EBITDA is estimated to range from $210 million to $220 million and GAAP EPS is projected at $4.75 to $5.05, exclusive of special charges. Non-GAAP EPS is expected to range from $615 to $6.45. Operating cash flow is expected to be approximately $150 million in 2023. In the second quarter, we continue to invest in people and technology that enabled ICF to execute effectively on our existing contracts while positioning us to capture an even greater share of future growth opportunities. The sale of our commercial marketing group was a strategic decision to streamline our business and deploy our resources to support the key growth markets we have identified. And the acquisition of CMY fully aligns with the increased demand we anticipate from our commercial energy clients. Our industry-leading trailing 12-month book-to-bill ratio of 1.3, together with a record $10.3 billion business development pipeline point to continued growth ahead. Additionally, we are proud of the impact that ICF and its people are having on society through the services we provide clients in support of energy saving, carbon reduction and natural resource protection programs as well as health, education, development and social justice programs. I encourage all of you to review our recently released corporate citizenship report, which highlights our impacts in these areas. With that, operator, we'll open it up for questions.

[Operator Instructions] Our first question will be from Joseph Vafi from Canaccord Genuity.

Hey, everyone. Good afternoon. Everyone and once again, congratulations on the solid and steady results. I thought, John, I would just circle back to your -- some of your opening comments where you said that you expected a strong second half in bookings. And I know there's a lot of tailwinds out there relative to the environment and IIJA and the like. But unless the deals are signed, it's a little bit unlike you to say it's going to be solid. So just any color there, maybe perhaps some solid bookings already happened in July? And then I'll have a follow-up.

Sure, Joe. I appreciate the question. Well, first of all, I'd say, obviously, as you saw and heard in the results, we have a very strong pipeline, a record pipeline. As you know, the [inaudible] of our awards, Q3 is generally our far and away our strongest quarter for awards driven with the end of the government fiscal year, Q4, certainly last year and over the last couple of years has also been quite strong, again, with some wins in federal, but also across commercial and state and local. And so I think given the size of the pipeline and the significant amount of the pipeline that is in proposal submitted a leading award or is in final negotiation of the opportunity, I think we do have a high degree of confidence that the wins and the sales for Q3 and Q4 will be quite strong, much like last year, where Q3 and Q4, we were quite strong and obviously differ very strong results. And so I think that's what's driving the confidence. Again, I think we have clear visibility of how those awards should play out.

Got it. And then I know you kind of also mentioned about having the size and scale for a bigger bid, but it kind of feels like you've had that size and scale for a while. I mean you're kind of a scale player in a lot of verticals. So just wanted to drill down into those comments too, John, relative to your size and average deal size that you're seeing these days? And then I might sneak one more in.

Sure. I mean I think the area where the size and scale over the last several years is really helping us is on the IT modernization and the technology front. I mean, as you know, Joe, we've come a long way there. As I said in our remarks, we have 1,800 technologies. We have $500 million in round numbers of $500 million revenue technology business. And so I think that's an area where we are seeing larger opportunities, and we are increasingly able to pursue and capture larger opportunities. I think as we also talked about, with the SemanticBits acquisition, that really has given us scale in a position within CMS to bid larger opportunities and combine the technology capabilities that legacy ICF has on the low-code and no-code with the open source and bring deeper ICF capabilities into CMS. And then we can also leverage the SemanticBits open source capabilities into our broader civilian client base. And so I wouldn't emphasize to scale on certainly as with respect to technology. The only other thing I'd say is right now, I mean, I think as you saw in the second quarter results, I mean, our energy business is really coming to the fore here in terms of the growth. I think we grew all in 22% in commercial energy. And I think we -- so I think and we obviously have scale there and see large opportunities, continue to see a lot of opportunities on the energy efficiency area. And so I think that's what I would emphasize on the scale side.

Got it. And then just one more. I know that there are some puts and takes coming in the P&L here in the second half with M&A and divestitures. But with EPS kind of reiterated, started to drill down bit and ask if there was -- because you're going to lose some EPS from, I guess, the sale of marketing the acquisition of CMY's coming in, it could be a little accretive. Maybe the core business was doing a little better, and it would have been kind of upside to guidance without any M&A. But just I thought I'd ask if there's any more color to add on how we get to kind of reiterated EPS with those moving parts.

Joe, thanks for the question. I think as I stated that we are strong on reaffirming the non-GAAP EPS guidance for this year. We think that given the divestitures and all the different moving parts, including the tax strategies that we've implemented will certainly help offset any of the lost EPS that we would have from the divestiture. So we feel like that we're solidly there for this year.

I just would add on the -- well, I think Barry gave guidance on exactly how the revenues would shift given the divestiture of the commercial marketing and the CMY acquisition on the revenue front. I would just say from the bottom line earnings and EPS perspective, how we look at it is commercial marketing business, we divested that. Its margins were at the low to mid end of our federal business. And CMY, which is a smaller business than what we're divesting with CMG and why the revenues are coming down, what we say, $13 million to $14 million. It is a commercial energy business. The margins are at the high end of our kind of commercial energy, what we'd expect for commercial energy. So at the end of the day, from an EPS perspective, I would say, kind of more or less a loss given the relative margins and the revenues.

We have Tobey Sommer from Truist Securities.

Thanks. If you look at your expectation for pretty strong contract towards in the back half of this year. If you look at the composition source of those, are they related to the IIJA and/or climate bill and sort of like that -- is that what makes them strong? Or from your vantage point, is it the regular way of budget spending by your customers?

Yes. I guess I'd say at a high level, Tobey, that, I mean, I think we're seeing the growth in the pipeline and the awards. I would expect to see them across the 5 growth areas. And so I would -- and so -- and the pipeline is expanding across federal, commercial, state and local. And so it's broad-based across those 5 growth drivers. Having said that, I do think that as I said, actually I said in my remarks and I said in response to Joe's question on our commercial energy business is showing acceleration here. I think that across -- in a broad way across that business from advisory to utility programs to climate, to environment and planning. And in the second quarter, our total pipeline, we have reported our pipeline for IIJA opportunities here in our awards. I think we're approaching about $270 million pipeline for IIJA opportunities. I think we're up to about 70 million awards here. And so we are seeing some positive momentum on the IIJA front, which we said we thought we would see in the second half of the year. I think the IRA, we're seeing a lot of interest and a lot of impact on that on the market, particularly around the economics of solar wind and investment activities with utilities, developers, which is a very positive time for our pipeline. And so as I've said, I think we -- there's not a significant amount of built into our contents for 2023 from those areas. I just would say that the momentum we're seeing from IIJA and IRA remains positive. And I think as I've said before, it's a positive indication that it's -- things are playing out in a positive way. And I think it potentially sets us up even further growth as we go into 2024.

Okay. What does your guidance assume from a fiscal federal 2024 budget or CR. I know you don't have a particular crystal ball and you can't predict it, but curious what sort of assumption you have as you get into the fourth calendar quarter.

I mean I think we're -- I mean, we haven't given guidance per se for 2024 yet. Obviously, we do have our long-term goal we articulated at our Investor Day around high single-digit organic growth and the potential for double-digit growth with leveraging the balance sheet over time through 2024. I think generally, our assumption is that we'll have a budget. Ideally, we'll have a budget. Certainly, we would expect to have a continuing resolution. And I think with either of those, I think, given the momentum in our markets, so on the federal side, the fact that public health and IT modernization has tended to be bipartisan, it's remained a very high priority that those areas will do better than the average budget increase in civilian and frankly, given the strong momentum we have with contract awards and backlog we have in place in those areas. That's what we're assuming to continue to deliver the results we've discussed through 2024. Obviously, if there's unexpected -- I mean, obviously, a government shutdown or unexpected cuts are not what we're expecting. But generally, I think we're assuming there will either be a budget or there will be a continuing resolution.

We will have our next question from Kevin Steinke, Barrington Research Associates.

Good afternoon. I just wanted to ask about with the divestiture of the commercial marketing group. You mentioned that they helped with the growth of some of your engagement and communication services that you provide to your government utility clients. Do you still retain some of those capabilities within the company, even after the divestiture that are going to serve you going forward to serve that -- those key client bases?

Yes. Let me be very clear, Kevin. It's a good question. I mean, so within our government business, we have a separate group that provides the marketing and communication services to our federal clients. That's north of $100 million business. That business resides within our federal business, and that business is staying with ICF. There's no that's going to make a key part of ICF and our ICF next sub brand. We also have a core set of people that support our commercial energy business with communication in the market, in particular, our energy efficiency and other utility programs. Those people are embedded in our commercial energy business, they are all staying with ICF, and we'll continue to do that work. And then we have an international marketing communications business out of Brussels. And that's also remaining with us. So all of those businesses remaining in the firm, they've been operating on a stand-alone basis. There's a little bit of interaction with the commercial marketing group, but it's de minimis. And so we'll keep all those capabilities and all the skills and all that -- all those people. The thing we're selling is kind of the core commercial marketing services business, which included the hospitality, innovative marketing, some business transformation consulting we do really for retail, hospitality, travel, the super packaging good clients, which today are not a core part of our business, a core part of more broadly who we serve. And so that's what we're kind of divesting with this transaction.

Okay. Understood. That's helpful. Just also wanted to ask about service revenue, although you mentioned that it's not going to be part of your investor communications anymore. Is that going to be a metric you continue to look at internally to monitor the progress of the business and margins and overall health of the business?

Yes, Kevin, this is Barry. Thanks for the question. And the answer to that question is yes. We do think that it's an important metric. And we look at that as we think it's a very good representation of how the core business is performing. So we will continue to look at that, and we'll provide the Street information on subcontractors and ODCs so that if you'd like to be able to calculate that number, you certainly will be able to -- and you'll see that in the 10-Q when we file that, you'll see how we break that down in the MD&A section. So I appreciate the question. And yes, we do think it's important.

And I show our next question comes from the line of Marc Riddick from Sidoti.

Hi, good evening, everyone. So I wanted to jump in on to -- one of the things I wanted to circle back on in the prepared remarks that you made regarding some of the commentary around AI and some of those capabilities and some of the progress that you're making there, which is actually somewhat refreshing this season as a lot of folks are kind of -- it's a little too early for a lot of folks, but certainly, it's encouraging to see that it's an area that you're encouraged by. I was wondering if you could spend a little time sort of discussing some of the opportunities there as well as any talent needs that may arise, not just specifically within AI, but overall for the entire enterprise as well.

Sure. So I think as I said in the prepared remarks, obviously, we have a significant technology business on IT modernization. I think with that business, honestly, that business has been doing machine learning and for these forms of AI for years as part of their work for clients in the federal sector. And as I also indicated, are looking and experimenting with generative AI [inaudible] AI for clients as we go forward. And it's certainly our expectation that AI has been embedded in these platforms for many years and a generative AI will become part of what is embedded and used in these platforms. And so we continue to look at that, take a hard look at that, work with our clients and evaluate how internally how to best utilize those products to meet -- and those capabilities to meet client needs and to improve productivity. And we've also used -- more broadly, our domain client staff over the years have used machine learning and predictive AI for clients and things like literature searches and looking for patterns and data that to understand what might -- causes of diseases, how to avoid [inaudible] at least fraud abuse based on patterns and data. And so that's certainly been part of what we've done on the domain side. We're also looking at how we can -- how come we can use generative AI to improve our product internally in our corporate services and have created sandboxes to test and experiment with use cases to try to improve how we do our marketing, our business development review of contracts and then things of those -- of that nature. In terms of the talent, I think certainly, we obviously finding the talent in our technology business is quite important. As I say, we'll -- it's been part of our business, and we'll continue to look for that talent. It is -- that is an area where it's highly competitive and challenging to find that talent. But I think we generally -- we've made significant investments in recruiting; I think we'll be able to find the talent we need to support our business.

Great. And then the last one for me, I was wondering if you could talk a little bit about the pricing environment and as far as putting through price increases when rules come up? And are there any areas that are a little more price sensitive due to economic changes or given the funding environment that most areas where you play that you're not really running into that?

No, I wouldn't say there's been a significant change in the pricing environment. I mean, all of our business is competitive. And with the federal business and with regulated utilities, you're writing proposals, you have to compete for the business. But I wouldn't say there's been a change. And I think as we've talked about generally in the past, certainly in our client civilian client areas we've not seen over the years the kind of lowest price technically acceptable by concepts. Price is important, but the quality of your capabilities, your past performance, your people is most important. In terms of passing costs on, I would say that like many companies, we've given significant increases in salaries and pay the tension that we stated market on the compensation side I think, and we give those raises in March each year. So we did give material increases in races in March. I think as we've talked about, with cost plus, you can more or less pass those on quickly. Only about 15% of our work is cost plus 40 -- I don't know, period 40% is T&M, 45% of fixed price. Now the T&M, we can raise those rates on a yearly basis. We can move people up categories when they -- with more experience. And so those are things we do to address the cost of challenges on the fixed price. We have built in escalators. They're not always enough to cover the raises and there the strategies you can use over time to make sure that you pass those along as best as you can. We'll deploy all those strategies. I think it's -- and they tried two strategies. They don't happen overnight depending on the type of contract, but we're -- we remain focused on that and managing that, I think, generally well.

I'm showing no further questions in the queue. At this time, I'd like to turn the call back over to John for closing remarks.

Okay. Well, thank you for participating in today's call, and we look forward to connecting with you at future conferences and events. Have a good rest of the summer. Take care.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.