Everforth Inc (EFOR) FY 2022 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the other sections of this 2022 10-K, including the Special Note on Forward-Looking Statements and Part I, Item 1A. Risk Factors.

OVERVIEW

ASGN provides information technology and professional services in the technology and creative digital marketing fields across the commercial and government sectors. ASGN operates through its Commercial and Federal Government segments. Virtually all of the Company's revenues are generated in the United States.

The Commercial Segment provides IT services and solutions, digital and creative services to Fortune 1000 and large enterprise clients across the United States, Canada and Europe. The Federal Government Segment delivers advanced solutions in cloud and enterprise IT, cybersecurity, artificial intelligence, machine learning and digital transformation to meet the mission critical needs of defense, intelligence and federal civilian agencies.

Critical Accounting Policies and Estimates

Our financial statements are prepared in conformity with accounting principles generally accepted in the United States ("GAAP"), which require us to make certain assumptions and related estimates affecting the amounts reported in the consolidated financial statements. Actual results could differ from those estimates.

Critical accounting policies are those we believe are both most important to the portrayal of our financial condition and results and require our most difficult, subjective or complex judgments, often because we must make estimates about matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. We believe the accounting policies and estimates most critical in understanding the judgments involved in preparing our financial statements are goodwill and acquired intangible assets.

Recognition of Goodwill and Acquired Intangible Assets — Determining the fair value of goodwill and intangible assets requires management's judgment, the use of significant estimates and assumptions and, in some cases, the utilization of independent valuation experts. The most critical assumptions utilized in this determination are the future cash flow estimates associated with the acquired businesses, as well as discount rates and royalty rates applied to those cash flow estimates.

Recoverability of Goodwill and Acquired Intangible Assets — Goodwill is evaluated for impairment annually or more frequently if an event occurs or circumstances change, such as material deterioration in performance that would indicate an impairment may exist. We perform an annual impairment assessment as of October 31st for each of our reporting units. When evaluating goodwill for impairment, we may first perform a qualitative assessment (“step zero” of the impairment test) to determine whether it is more likely than not that a reporting unit is impaired. If we decide not to perform a qualitative assessment, or if we determine that it is more likely than not the carrying amount of a reporting unit exceeds its fair value, then we perform a quantitative assessment (“step one” of the impairment test), and calculate the estimated fair value of the reporting unit. If the carrying amount of the reporting unit exceeds the estimated fair value, an impairment charge would be recorded to reduce the carrying amount to its estimated fair value.

Given there were no impairment factors identified in the prior year, and there were no negative trends in the current year, we performed a qualitative assessment for the October 31, 2022 annual impairment evaluation for all reporting units. By review of macroeconomic conditions, industry and market conditions, cost factors, overall financial performance compared with prior projections, and other relevant entity-specific events, we determined it was more likely than not that the fair value of each reporting unit exceeded its carrying amount. Therefore it was concluded that there were no indicators of impairment.

RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2022 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2021

In this section, we discuss the results of our operations for the year ended December 31, 2022 compared with the year ended December 31, 2021. For a discussion of the year ended December 31, 2021 compared with the year ended December 31, 2020, please refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2021.

Revenues

Revenues for the year were $4.6 billion, up 14.3 percent from 2021 primarily as a result of double-digit organic growth of our Commercial Segment and the contribution of $158.0 million from acquired businesses. Excluding the contribution from acquisitions, revenues were up 10.3 percent. The table below shows our revenues by segment (in millions).

Commercial Segment — Revenues from our Commercial Segment (75.0 percent of revenues) were up 17.4 percent from 2021. Assignment revenues were $2.5 billion (72.1 percent of the segment's revenues), up 8.3 percent year-over-year. Consulting services revenues were $959.6 million (27.9 percent of the segment's revenues), up 49.7 percent year-over-year. Excluding the contribution of $69.0 million from acquired businesses, consulting services revenues were up 38.9 percent year-over-year.

From an industry perspective, Commercial revenues fall into five broad industry verticals: (i) Financial Services, (ii) Consumer and Industrials, (iii) Healthcare, (iv) Technology, Media and Telecom and (v) Business and Government Services. Four out of our five industry verticals achieved double-digit growth year-over-year, while our Business and Government Services vertical was slightly up over the prior year.

Within the Commercial Segment, IT services and solutions revenues, which accounted for 83.7 percent of the segment's revenues, were up 18.2 percent year-over-year, driven by high growth in consulting services, the contribution from acquired businesses, and high-single-digit growth in IT staffing services. Creative digital marketing and permanent placement revenues, which combined accounted for 16.3 percent of the segment's revenues, were up 13.4 percent over the prior year.

Federal Government Segment — Revenues from our Federal Government Segment (25.0 percent of revenues) were up 5.8 percent year-over-year. Revenues included a contribution of $89.0 million from acquired businesses. Excluding that contribution, revenues were slightly below 2021, which had benefited from higher spending levels under two cost reimbursable contracts and approximately $38.6 million in revenues from a low-margin web services contract that the segment elected to not renew in the third quarter of the prior year.

Gross Profit and Gross Margin

The table below shows gross profit and gross margin by segment (in millions).

Consolidated gross profit was up 19.9 percent on revenue growth of 14.3 percent. Gross margin was 29.9 percent, an expansion of 140 basis points from 2021. Both segments reported expansion in gross margin. The expansion in gross margin for the Commercial Segment was driven by double-digit growth of its high-margin services (commercial consulting, creative digital marketing and permanent placement services). The expansion in gross margin of the Federal Government Segment was driven by changes in business mix, including: (i) the contribution from acquired high-margin businesses; (ii) a lower contribution from cost reimbursable contracts, which carry a lower margin than other contract types; and (iii) the decision not to renew a low-margin web services resale program in the third quarter of last year.

Selling, General and Administrative Expenses

Selling, general and administrative ("SG&A") expenses were $895.0 million (19.5 percent of revenues), compared with $735.8 million (18.4 percent of revenues) in 2021. The increase was commensurate with the growth in the business, changes in business mix and investments to support the future growth of the business. These investments were mainly in headcount, employee compensation and IT applications and systems.

Amortization of Intangible Assets

Amortization of intangible assets was $65.1 million, up from $55.7 million in 2021. This increase reflects a full year of amortization from businesses acquired in 2021 and amortization from the two businesses acquired in 2022.

Interest Expense

Interest expense was $45.9 million, up from $37.5 million in 2021, primarily as a result of higher interest rates on the senior secured credit facility. Interest expense was comprised of $25.4 million of interest on the unsecured senior notes, $18.4 million of interest on the senior secured credit facility and $2.1 million in amortization of deferred loan costs. The weighted-average outstanding borrowings were approximately $1.0 billion for 2022 and 2021 and the weighted-average interest rate was 4.1 percent, up from 3.4 percent in 2021.

Provision for Income Taxes

The provision for income taxes was $96.7 million, up from $81.6 million in 2021, related to the growth in income before income taxes. The effective tax rate of 26.6 percent was slightly higher than the effective tax rate of 26.0 percent for 2021.

Income from Continuing Operations

Income from continuing operations was $266.9 million, up from $231.8 million in 2021, driven by the growth in the business and expansion of our gross margin.

Income from Discontinued Operations

Income from discontinued operations was $1.2 million, down from $178.1 million in 2021. In 2021, virtually all of the income from discontinued operations related to the gain, net of income taxes, on the sale of the Oxford business.

Net Income

Net income of $268.1 million in 2022 was comprised of income from continuing operations of $266.9 million and discontinued operations of $1.2 million. Net income of $409.9 million in 2021 was comprised of income from continuing operations of $231.8 million and income from discontinued operations of $178.1 million.

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Commercial Segment - Consulting Metrics

Commercial consulting bookings are defined as the value of new contracts entered into during a specified period, including adjustments for the effects of changes in contract scope and contract terminations. The underlying contracts are terminable by the client on short notice with little or no termination penalties. The book-to-bill ratio for our commercial consulting revenues is the ratio of our commercial consulting bookings to the commercial consulting revenues for a specified period. The average duration of commercial consulting projects is one year.

Federal Government Segment Metrics

Contract backlog for our Federal Government Segment represents the estimated amount of future revenues to be recognized under awarded contracts including task orders and options. These estimates are subject to change and may be affected by the execution of new contracts, the extension or early termination of existing contracts, the non-renewal or completion of current contracts and adjustments to estimates for previously included contracts. Changes in the funded contract backlog are also affected by the funding cycles of the government.

Contract backlog does not include potential value from contract awards that have been protested by competitors until the protest is resolved in our favor. Contract backlog does not include any estimate of future work expected under indefinite delivery, indefinite quantity contracts or U.S. General Services Administration schedules. Contract backlog is segregated into funded contract backlog and negotiated unfunded contract backlog, which together make up total contract backlog.

Funded contract backlog for contracts with U.S. government agencies primarily represents contracts for which funding has been formally awarded less revenues previously recognized on these contracts and does not include the unfunded portion of contracts where funding is incrementally awarded or authorized by the U.S. government even though the contract may call for performance over a number of years. Funded contract backlog for contracts with non-government agencies represents the estimated value of contracts, which may cover multiple future years, less revenues previously recognized on these contracts.

Negotiated unfunded contract backlog represents the estimated future revenues to be earned from negotiated contract awards for which funding has not yet been awarded or authorized and from unexercised priced contract options.

The book-to-bill ratio for our Federal Government Segment was 0.9 to 1.0 for the year ended December 31, 2022. The book-to-bill ratio was calculated as the sum of the change in total contract backlog during the period plus revenues for the period, divided by revenues for the period. The contract backlog coverage ratio (backlog at December 31, 2022 divided by trailing-twelve-months of Federal Government Segment revenues) was 2.9 to 1.0.

Liquidity and Capital Resources

Our working capital at December 31, 2022 was $539.2 million, and our cash and cash equivalents were $70.3 million. Our cash flows from operating activities have been our primary source of liquidity and have been sufficient to fund our working capital and capital expenditure needs. At December 31, 2022, we had $31.5 million outstanding under our $460.0 million revolving credit facility. We believe that our cash and cash equivalents on hand, expected operating cash flows and availability under our revolving credit facility will be sufficient to fulfill our obligations, working capital requirements and capital expenditures for the next 12 months.

Net cash provided by operating activities was $307.8 million in 2022, compared with $193.7 million in 2021. The year-over-year increase is mainly the result of income tax payments totaling $91.5 million in the prior year that related to the gain on the sale of the Oxford business.

Net cash used in investing activities in 2022 was $510.0 million and included $484.6 million used to acquire two IT consulting businesses and $37.5 million in capital expenditures. In 2021, investing activities generated net cash of $246.5 million and included cash proceeds (before income taxes) of $503.8 million from the sale of the Oxford business, as well as $222.8 million used to acquire three IT consulting businesses and $34.7 million in capital expenditures.

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Net cash used in financing activities in 2022 was $256.5 million and included $281.4 million to repurchase the Company's common stock, as well as net borrowings under the revolving credit facility totaling $31.5 million. In 2021, net cash used in financing activities was $184.4 million and primarily consisted of $181.3 million of stock repurchases.

Senior Secured Credit Facility — On November 22, 2022, the Company entered into the ninth amendment to its senior secured credit facility (the "facility'), which (i) increased the capacity of its revolving credit facility (the "revolver") to $460.0 million from $250.0 million; and (ii) replaced the LIBOR reference rate with the secured overnight financing rate plus a 10 basis points adjustment ("SOFR").

The facility consists of a term B loan and the aforementioned $460.0 million revolver. At December 31, 2022, the Company had $490.8 million outstanding under the term B loan and $31.5 million outstanding borrowings under the revolver. Borrowings under the term B loan bear interest at SOFR plus 1.75 percent, or the bank’s base rate plus 0.75 percent. Borrowings under the revolver bear interest at SOFR plus 1.25 to 2.25 percent, or the bank’s base rate plus 0.25 to 1.25 percent, depending on leverage levels. A commitment fee of 0.20 to 0.35 percent is payable on the undrawn portion of the revolver. There are no required minimum principal payments on the facility until maturity. The facility is secured by substantially all of the Company's assets and includes various restrictive covenants. The facility permitted the sale of its Oxford business in 2021 and the net cash proceeds (approximately $0.4 billion) were used for the acquisition of GlideFast on July 6, 2022 and other permitted investments within the required timeframe. At December 31, 2022, the Company was in compliance with its debt covenants.

Unsecured Senior Notes — The Company has $550.0 million of unsecured senior notes due in 2028, which bear interest at 4.625 percent payable semiannually in arrears on May 15 and November 15. These notes are unsecured obligations and subordinate to the senior secured credit facility. These notes contain certain customary limitations including, among other terms and conditions, our ability to incur additional indebtedness, engage in mergers and acquisitions, transfer or sell assets and make certain distributions.

Commitments and Contingencies — The following table sets forth, on an aggregate basis, the amounts of specified contractual cash obligations required to be paid in the future periods shown (in millions):

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(1) Long-term debt obligations include interest calculated based on the rates in effect at December 31, 2022.

(2) Represents the future minimum lease payments for non-cancelable operating leases.

(3) Purchase obligations are non-cancelable job board service agreements and software subscriptions, maintenance and license agreements.

For additional information about these contractual cash obligations, see Notes 5. Leases, 9. Long-Term Debt and 10. Commitments and Contingencies in Item 8. Financial Statements and Supplementary Data.

We have retention policies for our workers’ compensation liability exposures. The workers' compensation loss reserves are based upon an actuarial report obtained from a third party and determined based on claims filed and claims incurred but not reported. We account for claims incurred but not yet reported based on estimates derived from historical claims experience and current trends of industry data. Changes in estimates, differences in estimates and actual payments for claims are recognized in the period that the estimates changed or the payments were made. The workers' compensation loss reserves were $2.6 million and $2.4 million, net of anticipated insurance and indemnification recoveries of $10.2 million and $10.4 million, at December 31, 2022 and 2021, respectively. We have undrawn stand-by letters of credit outstanding to secure obligations for workers’ compensation claims and other obligations. The undrawn stand-by letters of credit were $4.0 million at December 31, 2022 and 2021.

We have a deferred compensation plan liability of $13.6 million and $15.6 million at December 31, 2022 and 2021, which was primarily included in other long-term liabilities. We established a rabbi trust to fund the deferred compensation plan (see Note 12. Stock-Based Compensation and Other Employee Benefit Plans in Item 8. Financial Statements and Supplementary Data).

Off-Balance Sheet Arrangements

As of December 31, 2022, we had no off-balance sheet arrangements.

Accounting Standards Updates

See Note 3. Accounting Standards Update in Item 8. Financial Statements and Supplementary Data for a discussion of new accounting pronouncements.

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