Everforth Inc (EFOR) FY 2021 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 2021 10-K, including the Special Note on Forward-Looking Statements and Part I, Item 1A. Risk Factors.

OVERVIEW

ASGN Incorporated ("ASGN," "we," or "us") is one of the foremost providers of information technology (IT) and professional services and creative digital marketing across commercial and government sectors. We operate through two segments: Commercial and Federal Government. Our Commercial Segment provides assignment and consulting information technology and creative digital marketing services to Fortune 1000 and mid-market clients across the United States, Canada and Europe. Our Federal Government Segment delivers advanced solutions in cloud, cybersecurity, artificial intelligence, machine learning, application and IT modernization, science and engineering to departments and agencies in the federal government.

On August 17, 2021, we sold the Oxford Global Resources business unit (the "Oxford business"), see Note 4. Discontinued Operations. As a result of this disposition, the Oxford business has been classified as discontinued operations for all periods presented herein and all segment data has been recast to remove Oxford as a reportable segment.

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 and the discount 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 the low risk of impairment identified in the prior year, and no negative trends in the current year, we performed a qualitative assessment for the October 31, 2021 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, 2021 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2020

Revenues

Revenues for the year were $4.0 billion, up 14.5 percent from 2020 primarily as a result of double-digit organic growth of our Commercial Segment and the contribution of $124.4 million from acquired businesses. Excluding the contribution from acquisitions, revenues were up 10.9 percent. The table below shows our revenues by segment (in millions).

Revenues from our Commercial Segment were up 17.2 percent from 2020 as a result of double-digit growth in high-margin commercial consulting, creative digital marketing and permanent placement services and mid-single-digit growth in IT assignment services. The growth in our consulting revenues was due to a combination of factors, including broad-based industry demand, increase in technical capabilities, the expansion of our near-shore delivery center in Mexico and the contribution from acquired businesses. Revenues included a contribution of $40.5 million from acquired businesses (all commercial consulting services businesses) and excluding that contribution revenues were up 15.6 percent.

Within the Commercial Segment, IT services and solutions revenues, which accounted for 83.2 percent of the segment's revenues, were up 15.6 percent from 2020. Creative digital marketing and permanent placement revenues, which combined accounted for 16.8 percent of the segment's revenues in the period, were up 25.5 percent. All divisions in the segment (IT services and solutions, creative digital marketing and permanent placement) were up double-digits from 2020.

Commercial consulting services revenues (virtually all IT services), which accounted for 21.9 percent of the segment's revenues, were $641.2 million, up 68.3 percent from 2020. Assignment revenues, which accounted for 78.1 percent of the segment's revenues, were $2.3 billion, up 8.0 percent driven by double-digit growth in creative digital marketing and permanent placement revenues and mid-single-digit growth in IT assignment revenues. All five industry verticals: (i) financial services, (ii) consumer and industrials, (iii) healthcare, (iv) technology, media and telecom and (v) business and government services were up from 2020.

Revenues from our Federal Government Segment were up 7.8 percent from 2020. Revenues includes a contribution of $83.9 million from acquired businesses. Excluding that contribution, revenues were only slightly below 2020, which had benefited from higher spending levels under two cost reimbursable contracts and from a low-margin web services contract that the segment elected not to renew in the third quarter of 2021.

Gross Profit and Gross Margin

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

Gross profit is comprised of revenues less costs of services, which consist primarily of compensation for our contract professionals, allowable materials and consultant assignment expenses. Consolidated gross profit increased 20.6 percent on revenue growth of 14.5 percent. Gross margin was 28.5 percent, an expansion of 150 basis points from 2020 and both segments reported expansion in gross margin. The expansion for the Commercial Segment was the result a shift in business mix toward high-margin revenue streams, driven by the double-digit growth of the segment's high-margin IT consulting, creative digital marketing and permanent placement services. The expansion for the Federal Government Segment was also driven by changes in business mix, related to a lower level of revenues from certain lower-margin cost reimbursable contracts and from a low-margin web services project, the contribution from the high-margin businesses acquired after the third quarter of last year and higher profitability on certain firm-fixed-price contracts with initial contract terms that ended during the period.

Selling, General and Administrative Expenses

Selling, general and administrative ("SG&A") expenses consist primarily of compensation expense for our field operations and corporate staff, rent, information systems, marketing, telecommunications, public company expenses and other general and administrative expenses. SG&A expenses were $735.8 million (18.4 percent of revenues), compared with $615.0 million (17.6 percent of revenues) in 2020. The increase was commensurate with the growth in the business, the higher mix of high-margin commercial revenues (which carry a higher SG&A expense component than federal government services revenues), headcount investments to support the future growth of the business, higher incentive compensation and higher acquisition expenses.

Amortization of Intangible Assets

Amortization of intangible assets was $55.7 million, up from $51.0 million in 2020. This increase reflects a full year amortization on businesses acquired in 2020 and amortization on the three businesses acquired in 2021.

Interest Expense

Interest expense was $37.5 million, down from $39.7 million in 2020, primarily resulting from the reduction of LIBOR. Interest expense was comprised of $25.4 million of interest on the unsecured senior notes, $9.7 million of interest on the senior secured credit facility, $1.8 million in amortization of deferred loan costs and $0.6 million related to amendments to the senior secured credit facility. The weighted-average borrowings outstanding was approximately $1.0 billion for 2021 and 2020 and the weighted-average interest rate was 3.4 percent, slightly down from 3.6 percent in 2020.

Provision for Income Taxes

The provision for income taxes was $81.6 million for 2021, up from $63.9 million in 2020, related to the growth in income before income taxes. The effective tax rate of 26.0 percent was slightly lower than the effective tax rate for 2020.

Income from Continuing Operations

Income from continuing operations was $231.8 million, up from $177.6 million in 2020 driven by the growth in the business and expansion of our gross margin.

Income from Discontinued Operations

Income from discontinued operations was $178.1 million. This included approximately $168.8 million gain on sale, net of income taxes related to the sale of the Oxford business.

Net Income

Net income of $409.9 million was comprised of income from continuing operations of $231.8 million and income from discontinued operations of $178.1 million.

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RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2020 COMPARED WITH THE YEAR ENDED DECEMBER 31, 2019

Revenues

Revenues for the year were 3.5 billion, an increase of 2.5 percent from 2019, which was achieved despite lower demand from our commercial customers related to the COVID-19 pandemic. Our operating performance was driven by the high growth of our Federal Government Segment and the growth of our Commercial Segment off trough-level revenues experienced in May of 2020. Revenues from our Commercial Segment, which accounted for 71.3 percent of total revenues, were down 4.6 percent year over year. Revenues from our Federal Government Segment, which accounted for 28.7 percent of total revenues, were up 25.8 percent year over year reflecting increased volume on certain existing programs, new contract awards and the contribution from acquired businesses. The table below shows our revenues by segment (in millions).

Revenues from our Commercial Segment were down 4.6 percent year-over-year, resulting from lower customer demand attributable to the COVID-19 pandemic. Within the segment, IT services and solutions (84.3 percent of the segment's revenues) were slightly down from 2019. Consulting revenues (virtually all IT services and solutions) were up 15.7 percent from 2019, reflecting our increased focus on expanding our high-end consulting offerings. Creative digital marketing and permanent placement revenues (15.7 percent of the segment's revenues) were down 21.9 percent from 2019. Four of our five industry verticals were down from 2019, while financial services, our largest industry vertical (25.8 percent of commercial revenues), was up 10.6 percent.

Revenues from our Federal Government Segment were up 25.8 percent year over year. The increase was driven by a number of factors, including increased volume on certain existing programs, new contract awards and the contribution from the businesses acquired.

Gross Profit and Gross Margin

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

Consolidated gross profit was down 2.5 percent year over year. Our consolidated gross margin compressed approximately 140 basis points related to changes in business mix. This included a higher mix of revenues from the Federal Government Segment, which carries a lower gross margin than commercial revenues. Gross margin for both segments were down from 2019 related to changes in business mix. Gross margin on commercial revenues was down due to lower revenues from high-margin revenue streams (mainly creative digital marketing and permanent placement), partially offset by the higher mix of consulting revenues, which carries a higher margin than assignment revenues. Gross margin on federal government revenues was down due to a higher mix of revenues from certain programs under cost reimbursable contracts, which have lower margins than other contract types.

Selling, General and Administrative Expenses

SG&A expenses were $615.0 million (17.6 percent of revenues), down from $645 million (18.9 percent of revenues) in 2019. This improvement related to effective expense management and cost containment in response to the COVID-19 pandemic, which included lower incentive compensation and travel and entertainment expenses.

Amortization of Intangible Assets

Amortization of intangible assets was $51.0 million, up from $50.3 million in 2019. This increase reflects a full year amortization on business acquired in 2019 and amortization on the four businesses acquired in 2020.

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Interest Expense

Interest expense was $39.7 million, down 25.0 percent from $52.9 million in 2019. This improvement was the result of (i) a reduction in LIBOR, (ii) a 25 basis point reduction in the spread on our senior secured credit facility resulting from our debt refinancing in the fourth quarter of 2019, (iii) lower amortization of deferred loan costs and (iv) lower average borrowings outstanding in 2020. Interest expense was comprised of $25.4 million of interest on the unsecured senior notes, $12.6 million of interest on the senior secured credit facility, and $1.7 million in amortization of deferred loan costs. The weighted-average borrowings outstanding were $1.0 billion and $1.1 billion for 2020 and 2019, respectively. The weighted-average interest rate in 2020 was 3.6 percent, down from 4.3 percent in 2019.

Write-off of Loan Costs

As a result of the 2019 amendment to our senior secured credit facility, we wrote-off $18.9 million of deferred loan costs.

Provision for Income Taxes

The provision for income taxes was $63.9 million for 2020, up from $54.7 million in 2019. The effective tax rate for the year was 26.5 percent, which was slightly lower than the effective tax rate for 2019.

Income from Continuing Operations

Income from continuing operations was $177.6 million, up from $149.7 million in 2019. Income from continuing operations for 2019 included a charge of $18.9 million ($13.9 million after income taxes) related to a write-off of deferred loan costs on our credit facility resulting from our debt refinancing in the fourth quarter of 2019.

Income from Discontinued Operations

Income from discontinued operations was $22.7 million.

Net Income

Net income of $200.3 million was comprised of income from continuing operations of $177.6 million and income from discontinued operations of $22.7 million.

Federal Government Segment Contract Backlog

Contract backlog is a useful measure of potential future revenues for our Federal Government Segment. Contract backlog represents the estimated amount of future revenues to be recognized under awarded contracts including task orders and options. 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.

Contract backlog 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.

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Federal Government Segment Book-to-Bill Ratio

The book-to-bill ratio for our Federal Government Segment was 1.1 to 1.0 for the year ended December 31, 2021. 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, 2021 divided by trailing-twelve-months of Federal Government Segment revenues) was 2.6 to 1.0.

Liquidity and Capital Resources

Our working capital at December 31, 2021 was $858.5 million, and our cash and cash equivalents were $529.6 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, 2021, we had full availability under our $250.0 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 $193.7 million in 2021, compared with $424.8 million in 2020. Operating cash flows in 2020 benefited from lower working capital requirements related to the decline in business activity stemming from COVID-19 and the deferral of $85.7 million in federal payroll taxes as provided by the CARES Act. The year-over-year decrease in net cash provided by operating activities is mainly the result of (i) investment in working capital to support growth in the business, (ii) the payment of taxes totaling $91.5 million related to the gain on the sale of the Oxford business and (iii) the payment of half of the deferred federal payroll taxes from 2020.

Net cash provided by investing activities was $246.5 million in 2021 and included $503.8 million in net cash proceeds (before income taxes) from the sale of the Oxford business. Significant uses of cash in 2021 included $222.8 million used to acquire three IT consulting businesses and $34.7 million in capital expenditures. Net cash used in 2020 was $219.0 million and included $186.2 million used to acquire four IT consulting businesses and $32.6 million in capital expenditures.

Net cash used in financing activities was $184.4 million in 2021, compared with $29.0 million in 2020. Net cash used in 2021 consisted primarily of $181.3 million to repurchase the Company's common stock compared with $27.9 million in 2020.

Senior Secured Credit Facility — The senior secured credit facility consists of a term B loan and a $250.0 million revolving credit facility. At December 31, 2021, the Company had $490.8 million outstanding under the term B loan and no outstanding borrowings under the revolver. Borrowings under the term B loan bear interest at LIBOR plus 1.75 percent, or the bank’s base rate plus 0.75 percent. Borrowings under the revolver bear interest at LIBOR 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. In July 2021, the Company amended its facility to, among other things, permit the sale of its Oxford business and allow the net sale proceeds (approximately $0.4 billion) to be used for future acquisitions and other permitted investments, provided the Company enters into binding commitments by August 2022 and completes those transactions by February 2023.

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):

_______

(1) Long-term debt obligations include interest calculated based on the rates in effect at December 31, 2021.

(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 Part II, Item 8. Financial Statements and Supplementary Data.

Certain acquisitions completed in 2021 and 2020 contained provisions requiring the Company to pay contingent consideration in cash based on the achievement of certain specified earnings results in 2021 (see Note 6. Acquisitions in Part II, Item 8. Financial Statements and Supplementary Data). At December 31, 2021, the fair value of the contingent consideration liability was $15.1 million.

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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 $2.4 million and $2.2 million, net of anticipated insurance and indemnification recoveries of $10.4 million and $10.9 million, at December 31, 2021 and 2020, 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, 2021 and 2020.

We have a deferred compensation plan liability of $15.6 million and $14.4 million at December 31, 2021 and 2020, which was primarily included in other long-term liabilities. We established a rabbi trust to fund the deferred compensation plan (see Note 16. Fair Value Measurements in Part II, Item 8. Financial Statements and Supplementary Data).

Off-Balance Sheet Arrangements

As of December 31, 2021, we had no off-balance sheet arrangements.

Accounting Standards Updates

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