Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
Some of the statements in this Quarterly Report on Form 10-Q (this “Quarterly Report”) constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, as amended. These statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. In some cases, you can identify these statements by forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “should,” “will,” “would,” or similar words. You should read statements that contain these words carefully. The risk factors described in our filings with the Securities and Exchange Commission (the “SEC”), as well as any cautionary language in this Quarterly Report, provide examples of risks, uncertainties, and events that may cause actual results to differ materially from the expectations described in the forward-looking statements, including, but not limited to:
•Our dependence on contracts with United States (“U.S.”) federal, state and local, and international governments, agencies and departments for the majority of our revenue;
•Changes in federal government budgeting and spending priorities;
•Failure by Congress or other governmental bodies to approve budgets and debt ceiling increases in a timely fashion and related reduction in government spending;
•Failure of the presidential administration (the “Administration”) and Congress to agree on spending priorities, which may result in temporary shutdowns of non-essential federal functions, including our work to support such functions;
•Results of routine and non-routine government audits and investigations;
•Dependence of commercial work on certain sectors of the global economy that are highly cyclical;
•Failure to realize the full amount of our backlog;
•Risks inherent in being engaged in significant and complex disaster relief efforts and grants management programs involving multiple tiers of government in very stressful environments;
•Risks resulting from expanding service offerings and client base;
•Difficulties in identifying attractive acquisitions available at acceptable prices;
•Acquisitions we undertake may present integration challenges, fail to perform as expected, increase our liabilities, and/or reduce our earnings;
•Additional risks as a result of having international operations.
Our forward-looking statements are based on the beliefs and assumptions of our management and the information available to our management at the time these disclosures were prepared. Although we believe the expectations reflected in these statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report. We undertake no obligation to update these forward-looking statements, even if our situation changes in the future.
The terms “we,” “our,” “us,” and “the Company,” as used throughout this Quarterly Report, refer to ICF International, Inc. and its subsidiaries, unless otherwise indicated. The term “federal” or “federal government” refers to the U.S. federal government, and “state and local” or “state and local government” refers to U.S. state and local governments and the governments of U.S. territories. The following discussion and analysis is intended to help the reader understand our business, financial condition, results of operations, and liquidity and capital resources. You should read this discussion in conjunction with our consolidated financial statements and the related notes contained elsewhere in this Quarterly Report and our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed with the SEC on March 1, 2023 (our “Annual Report”).
16
OVERVIEW AND OUTLOOK
We provide professional services and technology-based solutions, including management, marketing, technology, and policy consulting and implementation services. We help our clients conceive, develop, implement, and improve solutions that address complex business, natural resource, social, technological, and public safety issues. Our services primarily support clients that operate in three key markets:
•Energy, Environment, Infrastructure, and Disaster Recovery;
•Health and Social Programs;
•Security and Other Civilian & Commercial
We provide services to our diverse client base that deliver value throughout the entire life cycle of a policy, program, project, or initiative. Our primary services include:
•Program Implementation Services;
Our clients utilize our services because we combine diverse institutional knowledge and experience with the deep subject matter expertise of our highly educated staff, which we deploy in multi-disciplinary teams. We believe that our domain expertise and the program knowledge developed from our research and analytics, and assessment and advisory engagements further position us to provide a full suite of services.
We report operating results and financial data as a single segment based on the consolidated information used by our chief operating decision-maker in evaluating the financial performance of our business and allocating resources. Our single segment represents our core business: professional services to our broad array of clients. Although we describe our multiple service offerings to clients that operate in three markets to provide a better understanding of the scope and scale of our business, we do not manage our business or allocate our resources based on those service offerings or client markets. Rather, on a project-by-project basis, we assemble the best team from throughout the enterprise to deliver highly customized solutions that are tailored to meet the needs of each client.
We believe that, in the long-term, demand for our services will continue to grow as government, industry, and other stakeholders seek to address critical long-term societal and natural resource issues due to heightened concerns about the environment and use of clean energy and energy efficiency; health promotion, treatment, and cost control; the means by which public health can be improved effectively on a cross-jurisdiction basis; natural disaster recovery and rebuild efforts; and ongoing homeland security threats.
We also see significant opportunity to further leverage our digital and client engagement capabilities across our client base. Our future results will depend on the success of our strategy to enhance our client relationships and seek larger engagements that span the entire program life cycle, and to complete and successfully integrate additional strategic acquisitions. We will continue to focus on building scale in our vertical and horizontal domain expertise, developing business with our existing clients as well as new customers, and replicating our business model in selective geographies. In doing so, we will continue to evaluate strategic acquisition opportunities that enhance our subject matter knowledge, broaden our service offerings, and/or provide scale in specific geographies.
Although we continue to see favorable long-term market opportunities, there are certain business challenges facing all government service providers. Administrative and legislative actions by the federal government to address changing priorities or in response to the budget deficit and/or debt ceiling could have a negative impact on our business, which may result in a reduction to our revenue and profit and adversely affect cash flow. Similarly, the very nature of opportunities arising out of disaster recovery means they can involve unusual challenges. Factors such as the overall stress on communities and people affected by disaster recovery situations, political complexities and challenges among involved government agencies, and a higher-than-normal risk of audits and investigations may result in a reduction to our revenue and profit and adversely affect cash flow. However, we believe we are well positioned to provide a broad range of services in support of initiatives that will continue to be priorities to the federal government, as well as to state and local and international governments and commercial clients. We believe that the combination of internally generated funds, available bank borrowings, and cash and cash equivalents on hand will provide the required liquidity and capital resources necessary to fund ongoing operations, potential acquisitions, customary capital expenditures, and other working capital requirements.
17
Energy, Environment, Infrastructure, and Disaster Recovery
For decades, we have advised our clients on energy and environmental issues, including the impact of human activity on natural resources, and have helped develop solutions for infrastructure-related challenges. In addition to addressing government policy and regulation in these areas, our work focuses on industries that are affected by these policies and regulations, particularly in those industries most heavily involved in the use and delivery of energy. Significant factors affecting suppliers, users, and regulators of energy are driving private and public sector demand for professional services firms, including:
•Changing power markets, increasingly diverse sources of supply including distributed energy resources and an increased demand for more carbon-free sources of energy and/or energy storage;
•The changing role of the U.S. in the world’s energy markets;
•Ongoing efforts to upgrade energy infrastructure to meet new power, transmission, environmental, and cybersecurity requirements and to enable more distributed forms of generation;
•Changing public policy, regulations, and incentives (including those established by the Inflation Reduction Act) surrounding the modernization of and investment in an upgraded energy infrastructure, including new business models that may accompany those changes;
•The need to manage energy demand and increase efficient energy use in an era of environmental concerns, especially regarding carbon and other emissions; and
•The disruption of global energy markets and supplies, involving natural gas in particular, that have emerged as a result of the invasion of Ukraine by Russia.
We assist energy enterprises worldwide in their efforts to analyze, develop, and implement strategies related to their business operations and the interrelationships of those operations with the environment and applicable government regulations. We utilize our policy expertise, deep industry knowledge, and proprietary modeling tools to advise government and commercial clients on key topics related to electric power, traditional fuels, and renewable sources of energy. Our areas of expertise include power market analysis and modeling, transmissions analysis, flexible load and distribution system management, electric system reliability standards, energy asset valuation and due diligence, regulatory and litigation support, fuels market analysis, air regulatory strategy, and renewable energy and green power project implementation.
We also assist commercial and government clients in designing, implementing, and evaluating demand side management programs, both for residential and for commercial and industrial sectors. Utility companies must balance the changing demand for energy with a price-sensitive, environmentally conscious consumer base. We help utilities meet these needs, guiding them through the entire life cycle of energy efficiency and related demand side management and electrification programs, including policy and planning, determining technical requirements, and program implementation and improvement.
Carbon emissions have been an important focus of federal government regulation, international governments, many state and local governments, and multinational corporations around the world. Reducing or offsetting greenhouse gas (“GHG”) emissions continues to be the subject of both public and private sector interest, and the regulatory landscape in this area is still evolving. The need to address carbon and other harmful emissions has significantly changed the way the world’s governments and industries interact and continues to be one of the drivers of interest in energy efficiency. Moreover, how government and business adapt to the effects of climate change continues to be of global importance. We support governments at the federal and state and local level, including providing comprehensive support to the National Science and Technology Council’s Global Change Research Program. Additionally, we support ministries and agencies of the government of the United Kingdom (the “U.K.”) and the European Commission (the “E.C.”), as well as commercial clients, on these and related issues.
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We believe that demand for our services will continue to grow as government, industry, and other stakeholders seek to provide natural disaster recovery and rebuilding. In the wake of the major hurricanes (Ian, Harvey, Ida, Irma, Maria, Laura and Michael) that devastated communities in Texas, Florida, North Carolina, Louisiana, the U.S. Virgin Islands, and Puerto Rico, the affected areas remain in various stages of relief and recovery efforts. Our prior experience with disaster relief and rebuild efforts, including after hurricanes Katrina and Rita and Superstorm Sandy, puts us in a favorable position to provide recovery and housing assistance, and environmental and infrastructure solutions, including disaster mitigation, on behalf of federal departments and agencies, state, territorial and local jurisdictions, and regional agencies. We support ongoing disaster recovery and mitigation efforts in a variety of US states, territories, and local jurisdictions that have been affected by natural disasters including but not limited to hurricanes.
We also have decades of experience in designing, evaluating, and implementing environmental policies and environmental compliance programs for energy, transportation (including aviation), and other infrastructure projects. A number of key issues are driving increased demand for the services we provide in these areas, including:
•Increased focus on the proper stewardship of natural resources;
•Changing precipitation patterns and drought that is affecting water infrastructure and availability;
•Aging water, energy, and transportation infrastructure, particularly in the U.S.;
•The increasing exposure of infrastructure to damage and interference by severe weather events influenced by a changing climate, and therefore the need to become more resilient to those effects;
•Past under-investment in transportation infrastructure that was recently the center of the Infrastructure Investment and Jobs Act passed by Congress and signed by the President on November 15, 2021;
•Economic and policy incentives for the implementation of carbon-free energy sources that were the centerpiece of the Inflation Reduction Act passed by Congress and signed by the President on August 16, 2022;
•The increasing demand for businesses to respond to climate change and similar “ESG” priorities being championed not only by the public sector, but also by investors, financing sources, business organizations, ratings agencies, and proxy advisory firms; and
•Changing patterns of economic development that require transportation systems and energy infrastructure to adapt to new patterns of demand.
By leveraging our interdisciplinary skills, which range from finance and economics to earth and life sciences, information technology, and program management, we are able to provide a wide range of services that include complex environmental impact assessments, environmental management information systems, air quality assessments, program evaluation, transportation and aviation planning and operational improvement, strategic communications, and regulatory reinvention. Our acquisition of Blanton & Associates (“Blanton”) in September 2022 added to these skills and expanded our geographic reach. We help clients deal specifically with the interrelated environmental, business, and social implications of issues surrounding all transportation modes and infrastructure. From the environmental management of complex infrastructure engagements to strategic and operational concerns of airlines and airports, our solutions draw upon our expertise and institutional knowledge in transportation, urban and land use planning, industry management practices, financial analysis, environmental sciences, and economics.
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Health, and Social Programs
We also apply our expertise across our full suite of services in the areas of health, and social programs. We believe that a confluence of factors will drive an increased need for public and private focus on these areas, including, among others:
•Weaknesses in our public health and healthcare delivery systems exposed by COVID-19;
•Expanded healthcare services to underserved portions of the population;
•Rising healthcare expenditures, which require the evaluation of the effectiveness and efficiency of current and new programs;
•Rampant substance abuse and widespread social and health impacts of the opioid abuse epidemic;
•The emphasis on improving the effectiveness of the U.S. and other countries’ educational systems;
•The perceived declining performance of the U.S. educational system compared to other countries;
•The need to digitally transform and modernize the technology infrastructure underpinning government operations;
•The need for greater transparency and accountability of public sector programs;
•A continued high need for social support systems, in part due to an aging population, and the interrelated nature of health, housing, transportation, employment, and other social issues;
•A changing regulatory environment; and
•Military personnel returning home from active duty with health and social service needs.
We believe we are well positioned to provide our services to help our clients develop and manage effective programs in the areas of health, education, and social programs at the international, regional, national, and local levels. Our subject matter expertise includes public health, biomedical research, healthcare quality, mental health, international health and development, health communications and associated interactive technologies, education, child and family welfare needs, housing and communities, and substance abuse. Our combination of domain knowledge and our experience in information technology-based applications provides us with strong capabilities in health and social programs informatics and analytics, which we believe will be of increasing importance as the need to manage information grows. We partner with our clients in the government and commercial sectors to increase their knowledge base, support program development, enhance program operations, evaluate program results, and improve program effectiveness.
In the area of federal health, we support many agencies and programs within the U.S. Department of Health and Human Services (“HHS”), including the National Institutes of Health (the “NIH”), the Centers for Disease Control and Prevention (the “CDC”), and the Centers for Medicare and Medicaid Services (“CMS”) by conducting primary data collection and analyses, assisting in designing, delivering and evaluating programs, managing technical assistance centers, providing instructional systems, developing information technology applications, and managing information clearinghouse operations. Our 2021 acquisition of ESAC brought a strong team with deep expertise in bioinformatics to further extend our capabilities in this arena. Our 2022 acquisition of SemanticBits, LLC (“SemanticBits”) brought substantial expertise in technology applications used in CMS to oversee healthcare quality. Increasingly, we provide multichannel communications and messaging for public health programs. We also provide training and technical assistance for early care and educational programs (such as Head Start), and health and demographic surveys in developing countries for the U.S. Department of State (the “DoS”). In the area of social programs, we provide extensive training, technical assistance, and program analysis and support services for a number of the housing programs of the U.S. Department of Housing and Urban Development (“HUD”) and state, territorial, and local governments. In addition, we provide research, program design, evaluation, and training for educational initiatives at the federal and state level. We provide similar services to a variety of U.K. ministries, as well as several Directorates-General of the European Commission.
Security and Other Civilian & Commercial
We serve a number of other important government missions and commercial markets. These government missions range from Security (e.g., the Departments of Defense, Homeland Security, and Justice) to a variety of other civilian government departments and agencies; commercial markets include those we serve with our commercial marketing and communications services.
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Security programs continue to be a critical priority of the federal government, state and local governments, international governments (especially in Europe), and in the commercial sector. We believe we are positioned to meet the following key safety concerns:
•Vulnerability of critical infrastructure to cyber and terrorist threats;
•Increasing risks to enterprises’ reputations in the wake of a cyber-attack;
•Broadened homeland security concerns that include areas such as health, food, energy, water, and transportation;
•Reassessment of the emergency management functions of homeland security in the face of natural disasters;
•Safety issues around crime and at-risk behavior;
•Increased dependence on private sector personnel and organizations in emergency response;
•The need to ensure that critical functions and sectors are resilient and able to recover quickly after attacks or disasters in either the physical or cyber realms; and
•The challenges resulting from changing global demographics.
These security concerns create demand for government programs that can identify, prevent, and mitigate key cybersecurity issues and the societal issues they cause.
In addition, the U.S. Department of Defense (“DoD”) is undergoing major transformations in its approach to strategies, processes, organizational structures, and business practices due to several complex, long-term factors, including:
•The changing nature of global security threats, including cybersecurity threats;
•Family issues associated with globally deployed armed forces;
•The increasing use of commercial cloud computing infrastructure and services to support the DoD enterprise; and
•The increasing need for real-time information sharing and the global nature of conflict arenas.
We provide key services to DoD, the U.S. Department of Homeland Security (“DHS”), the U.S. Department of Justice (“DoJ”), and analogous Directorates-General at the European Commission. We support DoD by providing high-end strategic planning, analysis, and technology-based solutions around cybersecurity. We also provide the defense sector with critical infrastructure protection, environmental management, human capital assessment, military community research, and technology-enabled solutions.
At the DHS, we assist in shaping and managing critical programs to ensure the safety of communities, developing critical infrastructure protection plans and processes, establishing goals and capabilities for national preparedness at all levels of government in the U.S., and managing the national program to test radiological emergency preparedness at the state and local government levels in communities adjacent to nuclear power facilities. At the DoJ, we provide technical and communications assistance to programs that help victims of crime and at-risk youths. At the E.C., we provide support and analytical services related to justice and home affairs issues within the European context.
Other large Federal departments and agencies, such as USDA and Treasury, also face important challenges that motivate them to transform their business processes and to modernize the associated technology systems. ICF supports these organizations with a variety of technology and program support services.
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In the area of commercial marketing and communications, some of the long-term market factors that we believe will have an impact on our clients include:
•Increased use of interactive digital technologies to link organizations with consumers and other stakeholders in more varied and personalized ways, and less reliance on traditional print and television marketing;
•Changing industry structures in marketing and advertising services;
•The desire for greater return on marketing investments; and
•The continued elevation of data analytics as a business management and marketing tool, as well as the concomitant growth of concerns about, and regulation of, data capture and exploitation for marketing and other private and public sector purposes.
We combine our expertise in strategic communications, marketing and creative services, and public relations with our strengths in interactive and mobile technologies to help companies develop stronger relationships and engage with their customers and stakeholders across all channels, whether via traditional or digital media, to drive better operating results. We took steps in 2022 to exit our traditional advertising and marketing platform technology business lines and refocus on the core services of business transformation, loyalty, and integrated communications across several key verticals. Target customer areas include airlines, airports, electric and gas utilities, health care companies, transportation, travel, and hospitality firms.
Across all of the areas described above we assist our clients in their growing efforts to ensure equity in their program operations, whether it is with an environmental justice or a health equity focus, or some other perspective depending on the program being delivered.
Employees and Offices:
We have approximately 9,000 full and part-time employees around the globe, including many recognized as thought leaders in their respective fields. We serve clients globally from our headquarters in the Washington, D.C. metropolitan area, our 50 regional offices throughout the U.S. and more than 20 offices in key regions outside the U.S., including offices in the U.K., Belgium, India and Canada.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion of our financial condition and results of operations is based on our consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). The preparation of these consolidated financial statements requires us to make certain estimates, assumptions, and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses and our application of critical accounting policies, including revenue recognition, impairment of goodwill and other intangible assets, and income taxes. If any of these estimates, assumptions or judgments prove to be incorrect, our reported results could be materially affected. Actual results may differ significantly from our estimates under different assumptions or conditions. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Note 2 –Summary of Significant Accounting Policies” in our Annual Report and “Note 1 – Basis of Presentation and Nature of Operations” in the “Notes to Consolidated Financial Statements” in this Quarterly Report for further discussions of our significant accounting policies and estimates.
We periodically evaluate our critical accounting policies and estimates based on changes in U.S. GAAP and the current environment that may have an effect on our financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
Recent accounting standards are discussed in “Note 1 – Basis of Presentation and Nature of Operations—Recent Accounting Pronouncements” in the “Notes to Consolidated Financial Statements” in this Quarterly Report.
SELECTED KEY METRICS
In order to evaluate operations, we track revenue by key metrics that provide useful information about the nature of our operations. Client markets provide insight into the breadth of our expertise. Client type is an indicator of the diversity of our client base. Revenue by contract mix provides insight in terms of the degree of performance risk that we have assumed. Significant variances in the key metrics are discussed under the revenue section of the results of operations. For further discussion see “Note 7 – Revenue Recognition” in the “Notes to Consolidated Financial Statements” in this Quarterly Report.
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RESULTS OF OPERATIONS
Three Months Ended March 31, 2023 Compared to Three Months Ended March 31, 2022
The table below sets forth certain items from our unaudited consolidated statements of comprehensive income, the percentage of revenue for such items in the periods provided, and the period-over-period rate of change and percentage of revenue for the periods indicated.
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Three Months Ended March 31, |
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Dollars |
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Percentages of Revenue |
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Year-to-Year Change |
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(dollars in thousands) |
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2023 |
|
|
2022 |
|
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2023 |
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2022 |
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Dollars |
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|
Percent |
|
Revenue |
|
$ |
483,282 |
|
|
$ |
413,468 |
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|
|
100.0 |
% |
|
|
100.0 |
% |
|
$ |
69,814 |
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|
|
16.9 |
% |
Direct Costs |
|
|
312,565 |
|
|
|
258,158 |
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|
|
64.7 |
% |
|
|
62.4 |
% |
|
|
54,407 |
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|
|
21.1 |
% |
Operating Costs and Expenses: |
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|
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Indirect and selling expenses |
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123,733 |
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|
117,452 |
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25.6 |
% |
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28.4 |
% |
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6,281 |
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|
|
5.3 |
% |
Depreciation and amortization |
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6,309 |
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4,838 |
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1.3 |
% |
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1.2 |
% |
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1,471 |
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30.4 |
% |
Amortization of intangible assets |
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9,224 |
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5,317 |
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1.9 |
% |
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1.3 |
% |
|
|
3,907 |
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|
|
73.5 |
% |
Total Operating Costs and Expenses |
|
|
139,266 |
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|
|
127,607 |
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|
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28.8 |
% |
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30.9 |
% |
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|
11,659 |
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|
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9.1 |
% |
Operating Income |
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|
31,451 |
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|
|
27,703 |
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6.5 |
% |
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6.7 |
% |
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3,748 |
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13.5 |
% |
Interest expense, net |
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(9,457 |
) |
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|
(2,627 |
) |
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(2.0 |
%) |
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(0.6 |
%) |
|
|
(6,830 |
) |
|
|
260.0 |
% |
Other expense |
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|
(558 |
) |
|
|
(439 |
) |
|
|
(0.1 |
%) |
|
|
(0.1 |
%) |
|
|
(119 |
) |
|
|
27.1 |
% |
Income before Income Taxes |
|
|
21,436 |
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|
|
24,637 |
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|
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4.4 |
% |
|
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6.0 |
% |
|
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(3,201 |
) |
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|
(13.0 |
%) |
Provision for Income Taxes |
|
|
5,038 |
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|
|
6,775 |
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|
|
1.0 |
% |
|
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1.6 |
% |
|
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(1,737 |
) |
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|
(25.6 |
%) |
Net Income |
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$ |
16,398 |
|
|
$ |
17,862 |
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|
|
3.4 |
% |
|
|
4.4 |
% |
|
$ |
(1,464 |
) |
|
|
(8.2 |
%) |
Revenue. Revenue for the three months ended March 30, 2023 was $483.3 million, compared to $413.5 million for the three months ended March 30, 2022, an increase of $69.8 million or 16.9%. The increase in revenue was driven by our U.S. federal government and U.S. state and local government clients, increases in our U.S. and international commercial clients, as well as the favorable impact of our acquisitions of SemanticBits and Blanton & Associates in third quarter of 2022. These gains were offset by decreases from our international government work.
The Energy, Environment, Infrastructure and Disaster Recovery client market increased $18.4 million or 10.9% over the same period last year and was driven by:
•Increases in our U.S. based commercial and international commercial businesses which grew by $10.5 million and $2.9 million, respectively;
•Growth in our U.S. state and local government and U.S. government business which increased by $5.7 million and $2.9 million respectively;
•Reduction of our international government business which decreased by $3.5 million.
The Health and Social Programs client market increased $47.6 million or 30.5% over the same period last year and was driven by:
•Growth in our U.S. government and U.S. state and local government businesses which increased by $44.6 million and $3.1 million, respectively;
•Increases in our U.S. based commercial business which grew by $6.5 million;
•Reductions in our international government and commercial businesses which decreased $5.9 million and $0.7 million, respectively.
The Security and Other Civilian & Commercial client market increased $3.8 million or 4.3% over the same period last year and was driven by:
•Growth in our international government and U.S. government businesses which increased by $2.7 million and $1.2 million, respectively;
•Increases in our international commercial business which grew by $1.7 million;
•Reductions in our U.S. commercial businesses which decreased $1.8 million.
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Direct Costs. The increase of $54.4 million in direct costs was driven by increases of $31.3 million in our direct labor and associated fringe benefit costs and $23.1 million in our subcontractor and other direct costs, which was driven, in part, by the acquisitions of SemanticBits and Blanton in the third quarter of 2022, as well as the growth in the business. Our direct labor and associated fringe benefit costs as a percentage of direct costs were 57.8% for each of the three-month periods ended March 31, 2023 and 2022, respectively. Our subcontractor and other direct costs as a percentage of direct costs was steady at 42.2% for each of the three-month periods ended March 31, 2023 and 2022, respectively. The increase in our direct costs was also due to additional work performed during the three months ended March 31, 2023 compared to the same period in 2022, partly due to our recent acquisitions previously noted. Our direct costs as a percent of revenue were 64.7% for the three months ended March 31, 2023, compared to 62.4% for the three months ended March 31, 2022. Our direct labor and associated fringe benefit costs as a percentage of revenue were 37.4% and 36.1% for the three months ended March 31, 2023 and 2022, respectively, and our subcontractor and other direct costs as a percentage of revenue were 27.3% and 26.3%, for the three months ended March 31, 2023 and 2022, respectively.
Indirect and selling expenses. For the three months ended March 31, 2023, our indirect and selling expenses increased $6.3 million, or 5.3%, compared to the prior year, primarily due to additional indirect labor and associated fringe costs of $3.8 million and to general and administrative costs of $2.5 million. The increase in our indirect labor and associated fringe costs was a result of additional headcount from our recent acquisitions in 2022 as well as additional labor resources to support our growth. The increase in our general and administrative costs were primarily from impairment of $0.9 million of intangible asset related to a prior acquisition, an increase of $0.9 million in travel expense, and additional credit losses of $0.7 million in 2023 compared to 2022. Although we saw our overall indirect and selling expenses increase in 2023, our indirect and selling expenses as a percent of revenue decreased to 25.6% for the three months ended March 31, 2023 compared to 28.4% for the three months ended March 31, 2022 as we continue to implement efficiency measures and reduce our operating expenses while supporting our revenue growth.
Depreciation and amortization. The increase of $1.5 million in our depreciation and amortization was from $0.9 million of additional depreciation expense and $0.6 million of additional amortization expense resulting from additional capital expenditure in the three months ended March 31, 2023 as compared to 2022.
Amortization of intangible assets. The increase of amortization of intangible assets was primarily due to the amortization of intangible assets acquired in our acquisitions of SemanticBits and Blanton in the third quarter of 2022.
Operating Income. Our operating income increased by $3.7 million for the three months ended March 31, 2023 compared to the prior year due to higher gross profit offset by higher operating costs to support our growing operations.
Interest expense, net. The increase of $6.8 million in interest expense, net, was primarily due to higher average debt balance of $634.3 million during the three months ended March 31, 2023 as compared to $461.2 million during the same period in 2022, as a result of our acquisition activities. We utilize floating-to-fixed interest rate swap agreements (the “Swaps”) to hedge the variable interest portion of our debt. For the three months ended March 31, 2023, settlements of the Swaps provided a reduction of $1.4 million to our interest expense, net, compared to $0.9 million in additional interest for the same period in 2022. Our average interest rate on borrowings, inclusive of the impact of the Swaps, was 5.5% for the three months ended March 31, 2023 compared to 2.1% for the three months ended March 31, 2022.
Other expense. Other expense did not materially change for the three months ended March 31, 2023 as compared to 2022.
Provision for Income Taxes. Our effective income tax rate for the three months ended March 31, 2023 and 2022 was 23.5% and 27.5%, respectively. The decrease in the effective income tax rate was primarily due to the impact of windfall tax benefits relating to equity-based compensation that vested during the quarter and non-taxable income on insurance investments partially offset by non-deductible executive compensation and additional valuation allowance on foreign tax credits generated during the quarter.
NON-GAAP MEASURES
The following tables provide reconciliations of financial measures that are not calculated in accordance with generally accepted accounting principles in the U.S. to their most comparable U.S. GAAP measures (“non-GAAP”). While we believe that these non-GAAP financial measures provided additional information to investors and may be useful in evaluating our financial information, they should be considered supplemental in nature and not as a substitute for financial information prepared in accordance with U.S. GAAP. Other companies may define similarly titled non-GAAP measures differently and, accordingly, care should be exercised in understanding how we define these measures as similarly named measures are unlikely to be comparable across different companies.
Service Revenue
We compute Service Revenue as U.S. GAAP revenue less subcontractor and other direct costs (which include third-party materials and travel expenses, excluding any associated margins), which we believe represents the service we provide to our customer for directly contracting with and managing the activities of subcontractors. We believe Service Revenue is a useful measure to investors that best represents services that we provide to clients through our own employees.
24
The table below presents a reconciliation of U.S. GAAP revenue to Service Revenue for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(in thousands) |
|
2023 |
|
|
2022 |
|
Revenue |
|
$ |
483,282 |
|
|
$ |
413,468 |
|
Subcontractor and other direct costs |
|
|
(131,978 |
) |
|
|
(108,898 |
) |
Service Revenue |
|
$ |
351,304 |
|
|
$ |
304,570 |
|
EBITDA and Adjusted EBITDA
Earnings before interest, tax, and depreciation and amortization (“EBITDA”) is a measure we use to evaluate operating performance. We believe EBITDA is useful in assessing ongoing trends and, as a result, may provide greater visibility in understanding our operations.
Adjusted EBITDA is EBITDA further adjusted to eliminate the impact of certain items that we do not consider to be indicative of the performance of our ongoing operations. We evaluate these adjustments on an individual basis based on both the quantitative and qualitative aspects of the item, including their size and nature, as well as whether or not we expect them to occur as part of our normal business on a regular basis. We believe that the adjustments applied in calculating Adjusted EBITDA are reasonable and appropriate to provide additional information to investors.
EBITDA and Adjusted EBITDA are not intended to be measures of free cash flow for management’s discretionary use as these measures do not include certain cash requirements such as interest payments, tax payments, capital expenditures and debt service.
The following table presents a reconciliation of net income to EBITDA and Adjusted EBITDA for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(in thousands) |
|
2023 |
|
|
2022 |
|
Net income |
|
$ |
16,398 |
|
|
$ |
17,862 |
|
Interest, net |
|
|
9,457 |
|
|
|
2,627 |
|
Provision for income taxes |
|
|
5,038 |
|
|
|
6,775 |
|
Depreciation and amortization |
|
|
15,533 |
|
|
|
10,155 |
|
EBITDA (1) |
|
|
46,426 |
|
|
|
37,419 |
|
Impairment of long-lived assets (2) |
|
|
894 |
|
|
|
— |
|
Acquisition-related expenses (3) |
|
|
803 |
|
|
|
1,319 |
|
Severance and other costs related to staff realignment (4) |
|
|
2,495 |
|
|
|
1,226 |
|
Facilities consolidations and office closures (5) |
|
|
359 |
|
|
|
— |
|
Expenses related to the transfer to our new corporate headquarters (6) |
|
|
— |
|
|
|
1,882 |
|
Total Adjustments |
|
|
4,551 |
|
|
|
4,427 |
|
Adjusted EBITDA |
|
$ |
50,977 |
|
|
$ |
41,846 |
|
(1)The calculation of EBITDA for the three months ended March 31, 2022 has been revised to conform to the current period calculation of EBITDA. Specifically, interest income of $0.1 million was reclassified from “Other expense” to “Interest, net” on the consolidated statements of comprehensive income.
(2)We recognized impairment expense of $0.9 million in the first quarter of 2023 related to impairment of an intangible asset related to a prior acquisition.
(3)These costs consist primarily of consultants and other outside third-party costs and integration costs associated with our acquisitions and/or potential acquisitions.
(4)These costs are mainly due to involuntary employee termination benefits for our officers, and/or groups of employees who have been notified that they will be terminated as part of a consolidation or reorganization.
(5)These costs are exit costs associated with terminated leases or full office closures. The exit costs include charges incurred under a contractual obligation that existed as of the date of the accrual and for which we will (i) continue to pay until the contractual obligation is satisfied but with no economic benefit to us or (ii) we contractually terminated the obligation and ceased utilizing the facilities.
(6)These costs represent incremental non-cash lease expense associated with a straight-line rent accrual during the “free rent” period in the lease for our new corporate headquarters in Reston, Virginia. We took possession of the new facility during the fourth quarter of 2021, while also maintaining and incurring lease costs for the former headquarters in Fairfax, Virginia. The transition to the new corporate headquarters was completed in the fourth quarter of 2022.
25
Non-GAAP Diluted Earnings per Share
Non-GAAP diluted earnings per share (“Non-GAAP Diluted EPS”) represents diluted U.S. GAAP earnings per share (“U.S. GAAP Diluted EPS”) excluding the impact of certain items noted above, as well as the impact of amortization of intangible assets related to our acquisitions and income tax effects of these exclusions. While these adjustments may be recurring and not infrequent or unusual, we do not consider these adjustments to be indicative of the performance of our ongoing operations. We believe that the supplemental adjustments applied in calculating Non-GAAP Diluted EPS are reasonable and appropriate to provide additional information to investors.
The following table presents a reconciliation of U.S. GAAP Diluted EPS to Non-GAAP Diluted EPS for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2023 |
|
|
2022 |
|
U.S. GAAP Diluted EPS |
|
$ |
0.87 |
|
|
$ |
0.94 |
|
Impairment of long-lived assets |
|
|
0.04 |
|
|
|
— |
|
Acquisition-related expenditures |
|
|
0.04 |
|
|
|
0.07 |
|
Severance and other costs related to staff realignment |
|
|
0.13 |
|
|
|
0.06 |
|
Facilities consolidations and office closures |
|
|
0.02 |
|
|
|
— |
|
Expenses related to the transfer to our new corporate headquarters |
|
|
— |
|
|
|
0.10 |
|
Amortization of intangibles |
|
|
0.49 |
|
|
|
0.28 |
|
Income tax effects on amortization, special charges, and adjustments (1) |
|
|
(0.17 |
) |
|
|
(0.14 |
) |
Non-GAAP Diluted EPS |
|
$ |
1.42 |
|
|
$ |
1.31 |
|
(1)Income tax effects were calculated using the effective tax rate of 23.5% and 27.5% for the three months ended March 31, 2023 and 2022, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity and Borrowing Capacity. Short-term liquidity requirements are created by our use of funds for working capital, capital expenditures, debt service, dividends, and share repurchases. We expect to meet these requirements through a combination of our cash and cash equivalents at hand, cash flow from operations, and borrowings. Our primary source of borrowings is from our Credit Facility with a syndicate of multiple commercial banks, as described in “Note 6 — Long-Term Debt” in the “Notes to Consolidated Financial Statements” in this Quarterly Report. As of March 31, 2023, we had $499.6 million, or $403.5 million after taking into account the financial and performance-based limitations, available under the Credit Facility to fund our ongoing operations, future acquisitions, dividend payments, and share repurchase program. We believe that our cash balances, expected cash flows from operations, and access to our Credit Facility will be sufficient to meet our working capital needs, debt servicing commitments, share repurchase, and dividend payment requirements for the next twelve months and beyond.
We have entered into floating-to-fixed interest rate swap agreements (the “Swaps”) for a total notional value of $275.0 million to hedge a portion of our floating rate Credit Facility. The Swaps expire in 2023, 2025, and 2028, respectively, and we may consider entering into additional hedges as these existing hedges expire. For additional details on the Swaps, see “Note 8 — Derivative Instruments and Hedging Activities” in the “Notes to Consolidated Financial Statements” in this Quarterly Report.
There are other conditions, such as the ongoing war in Ukraine and the recent increase in inflation, both in the U.S. and globally, that create uncertainty in the global economy, which in turn may impact, among other things, our ability to generate positive cash flows from operations and our ability to successfully execute and fund key initiatives. However, our current belief is that the combination of internally generated funds, available bank borrowings, and cash and cash equivalents on hand will provide the required liquidity and capital resources necessary to fund ongoing operations, customary capital expenditures and acquisitions, quarterly cash dividends, share repurchases and organic growth. Additionally, we continuously analyze our capital structure to ensure we have capital to fund future strategic acquisitions.
The recent closures of Silicon Valley Bank (“SVB”) and Signature Bank (“Signature”) in March 2023 and First Republic Bank (”Republic”) in May 2023 have raised significant concerns about bank-specific risks, broader financial institution liquidity risks, and the stability of the banking system in the United States. We did not hold any of our funds in, or have any banking relationship with SVB, Signature, or Republic. To date, we have not experienced any issues with the banks where we do maintain our accounts or have other banking relationships. We hold our funds in large commercial banks and our intent is to maintain account balances at a reasonably low level to reduce our risk of loss from a sudden failure at any individual bank. Our Credit Facility is supported by a syndicate of multiple commercial banks, and each bank in the syndicate provides a pro rata percentage of our total available borrowings and commitments independently of the others. No member of the bank syndicate is responsible for providing more than fifteen percent of the total available borrowings and commitments.
We continue to monitor the state of the financial markets to assess the continuing availability of borrowing capacity under the Credit Facility and the cost of additional capital from both debt and equity markets. At present, we believe we will be able to continue to access these markets at commercially reasonable terms and conditions if we need additional capital in the near term.
26
Financial Condition. There were several changes in our consolidated balance sheet as of March 31, 2023 compared to the consolidated balance sheet as of December 31, 2022. Significant changes are discussed below.
Cash and cash equivalents decreased to $5.4 million as of March 31, 2023, from $11.3 million on December 31, 2022 and restricted cash increased to $3.6 million as of March 31, 2023 from $1.7 million on December 31, 2022. These balances and the changes to the balances of cash and cash equivalents and restricted cash are further discussed in “Cash Flow” below and in “Note 2 — Restricted Cash” in the “Notes to Consolidated Financial Statements” in this Quarterly Report.
Contract receivables, net of allowance for expected credit losses, as of March 31, 2023, decreased to $221.1 million from $232.3 million on December 31, 2022 due to the timing of our billings and collection of client invoices. Contract receivables are a significant component of our working capital and may be favorably or unfavorably impacted by our collection efforts, including timing from new contract startups, and other short-term fluctuations related to the payment practices of our clients. We also utilize our MRPA with MUFG Bank, Ltd. to sell certain eligible billed receivables and sold $28.6 million in receivables during the first quarter of 2023. See “Note 3 — Contract Receivables, Net” in the “Notes to Consolidated Financial Statements” in this Quarterly Report
Contract assets and contract liabilities represent revenue in excess of billings and billings in excess of revenue, respectively, both of which generally arise from revenue recognition timing and contractually stipulated billing schedules or billing complexity. At March 31, 2023, contract assets and contract liabilities were $188.1 million and $25.8 million, respectively, compared to $169.1 million and $25.8 million, respectively, at December 31, 2022.
We evaluate our collections efforts using the days-sales-outstanding ratio (“DSO”), which we calculate by dividing total accounts receivable (contract receivables, net and contract assets, less contract liabilities), by revenue per day for the trailing 90-day period. Our DSO improved to 71 days at March 31, 2023, from 79 days at March 31, 2022, due, in part, to the utilization of our MRPA and improved collection efforts. Excluding collections relating to the Puerto Rico disaster relief and rebuild efforts (which include unusually long invoice payment cycles due to complex customer reporting and billing requirements), DSO was 68 days at March 31, 2023 compared to 74 days at March 31, 2022.
Accounts payable decreased to $109.9 at March 31, 2023 from $135.8 million at December 31, 2022, and our accrued expenses totaled $171.6 million at March 31, 2023 as compared to $209.5 million at December 31, 2022. The changes in our accounts payable and accrued expenses are primarily due to the timing of invoices from our vendors and subcontractors for services rendered and our subsequent payments of those invoices.
Long-term debt (exclusive of unamortized debt issuance costs) increased to $602.7 million on March 31, 2023 from $561.4 million on December 31, 2022, primarily due to the net advance on our Credit Facility of $41.4 million to fund short-term working capital needs. The average debt balances on the Credit Facility for the three months ended March 31, 2023 and 2022 were $634.3 million and $461.2 million, respectively. We deploy cash flow from operations as our primary source of funding and utilize our Credit Facility to fund any temporary cash requirements.
Inflation. Our business and results of operations have not been materially affected by inflation and changing prices during the period presented and we do not expect to be materially affected in the future due to the nature of our business as a provider of professional services with contracts that can be negotiated with new prices.
Share Repurchase Program. The objective of our share repurchase program has been to offset dilution resulting from our employee incentive plan. Our share repurchase program is described in “Note 14 — Share Repurchase Program” in the “Notes to Consolidated Financial Statements” in this Quarterly Report. The timing and extent to which we repurchase our shares will depend upon market conditions and other corporate considerations, as may be considered in our sole discretion. The purchases will be funded from our existing cash balances and/or borrowings, and the repurchased shares will be held in treasury.
During the three months ended March 31, 2023, we repurchased 180,000 shares under this program at an average price of $100.70 per share. As of March 31, 2023, $93.7 million remained available for share repurchases.
Dividends. We pay quarterly cash dividends to our shareholders of record at $0.14 per share. Total dividend payments during the three months ended March 31, 2023 were $2.6 million.
Cash dividends declared thus far in 2023 are as follows:
|
|
|
|
|
|
|
|
|
Dividend Declaration Date |
|
Dividend Per Share |
|
|
Record Date |
|
Payment Date |
February 28, 2023 |
|
$ |
0.14 |
|
|
March 24, 2023 |
|
April 13, 2023 |
May 9, 2023 |
|
$ |
0.14 |
|
|
June 9, 2023 |
|
July 14, 2023 |
27
Cash Flow. We consider cash on deposit and all highly liquid investments with original maturities of three months or less to be cash and cash equivalents. The following table sets forth our sources and uses of cash for the three months ended March 31, 2023 and 2022:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(in thousands) |
|
2023 |
|
|
2022 |
|
Net Cash Used in Operating Activities |
|
$ |
(16,831 |
) |
|
$ |
(7,055 |
) |
Net Cash Used in Investing Activities |
|
|
(6,900 |
) |
|
|
(6,454 |
) |
Net Cash Provided by Financing Activities |
|
|
19,688 |
|
|
|
2,674 |
|
Effect of Exchange Rate Changes on Cash, Cash Equivalents, and Restricted Cash |
|
|
11 |
|
|
|
(525 |
) |
Decrease in Cash, Cash Equivalents, and Restricted Cash |
|
$ |
(4,032 |
) |
|
$ |
(11,360 |
) |
Our operating cash flows are primarily affected by the overall profitability of our contracts, our ability to invoice and collect from our clients in a timely manner, and the timing of vendor and subcontractor payments in accordance with negotiated payment terms. We bill most of our clients on a monthly basis after services are rendered.
Net cash used in operating activities increased by $9.8 million primarily due to an additional payroll cycle that increased the use of cash by $25.2 million during the first quarter of 2023 and the timing of vendor payments, partially offset by higher proceeds from sale of receivables.
Net cash used in investing activities increased by $0.4 million primarily due to payments for prior business acquisitions.
Net cash provided by cash flows from financing activities increased by $17.0 million primarily due to net lower cash payments against restricted contract funds of $12.2 million and higher borrowing against our Credit Facility of $3.3 million.
28
