ASGN Incorporated (NYSE:ASGN) Q3 2023 Earnings Call Transcript

ASGN Incorporated (NYSE:ASGN) Q3 2023 Earnings Call Transcript October 25, 2023

ASGN Incorporated beats earnings expectations. Reported EPS is $1.68, expectations were $1.56.

Operator: Greetings. Welcome to the ASGN Incorporated Third Quarter 2023 Earnings Call. [Operator Instructions]. I will now turn the conference over to your host, Kimberly Esterkin, Vice President of Investor Relations. You may begin.

Kimberly Esterkin: Good afternoon, and thank you for joining us today for ASGN’s Third Quarter 2023 Conference Call. With me are Ted Hanson, Chief Executive Officer; Rand Blazer, President; and Marie Perry, Chief Financial Officer. Before we get started, I would like to remind everyone that our commentary contains forward-looking statements. Although we believe these statements are reasonable, they are subject to risks and uncertainties, and as such, our actual results could differ materially from those statements. Certain of these risks and uncertainties are described in today’s press release and in our SEC filings. We do not assume any obligation to update these statements made on this call. For your convenience, our prepared remarks and supplemental materials can be found in the Investor Relations’ section of our website at investors.asgn.com.

Please also note that on this call, we will be referencing certain non-GAAP measures, such as adjusted EBITDA, adjusted net income and free cash flow. These non-GAAP measures are intended to supplement the comparable GAAP measures. Reconciliations between GAAP and non-GAAP measures are included in today’s press release. I will now turn the call over to Ted Hanson, Chief Executive Officer.

Theodore Hanson: Thank you, Kim, and thank you for joining ASGN’s Third Quarter 2023 Earnings Call. ASGN’s performance for the third quarter of 2023 was in line with our expectations with result slightly ahead of or within our guidance ranges. Third quarter 2023 revenues of $1.12 billion were above the midpoint of our guidance with IT consulting revenues reaching approximately 55% of the total ahead of our 2024 goals. Adjusted EBITDA margin was 12.3% for the third quarter, above the top end of our guidance range. We continue to see opportunities for margin expansion as our consulting revenues grow. With that as a background on our consolidated results, I’d like to turn to our industry performance. As we review our performance, 3 key things will be consistent throughout the discussion.

First, while the market for IT spend remains difficult, these headwinds will reverse and ASGN’s business is better positioned than it’s ever been to capture in-demand IT opportunities. Second, the strength of our business lies in our large domestic enterprise account base. Our diversified client base across 6 critical industry verticals provide stability throughout market cycles. Third, our business continues to evolve toward IT consulting with more than half of our consolidated revenues now in the higher end, higher value project and solution capabilities. This growth in consulting revenues along with the variable nature of our cost structure supports our margins. I’ll speak more on each of these topics as we review our quarterly performance, but let’s begin by discussing the 5 industry verticals that comprise our Commercial segment.

Our Commercial segment predominantly services large enterprise and Fortune 1000 companies. Commercial segment revenues for the quarter declined by low teens on a difficult year-over-year comparison. Revenues for the segment benefited from growth in our consulting business, offset by double-digit declines in the more discretionary areas of our assignment business. For the quarter, commercial consulting revenues increased 2.1% year-over-year. Commercial consulting bookings of $291 million translated to a book-to-bill of 1.1x for the quarter and 1.2x on a trailing 12-month basis. Of the consulting work won during the quarter, bookings were again weighted towards renewals on existing projects with a large portion of bookings coming in at the end of the third quarter, an indication that our clients remain cautious in their spend.

Sales cycles are slow and project duration continue to be elongated, but our retention rates on existing deals remain strong as our clients continue to recognize the high value of and need for ASGN services. We are seeing anything with an immediate return on investment specifically projects aimed at cost containment and those generating operational efficiencies, getting the green light from clients. I’ll speak more on the work won during the quarter shortly. Turning to our vertical performance. Our Consumer & Industrial and healthcare verticals saw low single-digit revenue declines year-over-year. Within Consumer & Industrial, consumer staples and utilities were bright spots, each experience seeing a low single-digit growth as compared to the third quarter of 2022.

In the healthcare vertical, provider accounts maintained their strength and revenues were up double digits year-over-year. Technology, Media and Telecommunications or TMT, Business and Government services and Financial Services, our 3 remaining commercial industry verticals, all saw continued revenue declines year-over-year. Though each of these verticals displayed some resiliency in certain areas on a sequential basis. Within TMT, for example, media and entertainment account revenues remain relatively consistent with the second quarter of 2023 with the rate of decline slowing. Within our financials vertical, big bank revenues were relatively flat sequentially with small sequential revenue growth in diversified financials. Even in these more challenging macroeconomic conditions, as previously noted, our commercial bookings remain solid.

We continue to make progress on the AI front across the Commercial segment, with generative AI coming for many of the new opportunities in our pipeline followed closely by work in machine learning. The vast majority of the generative AI projects for clients are exploratory at this time, we expect larger AI programs to follow once use cases that demonstrate value creation have been identified for our clients. At the same time, this AI exploration work is taking place, we’re seeing strong demand for data engineering and data governance in support of AI use cases. These infrastructure needs are being driven by the desire to ensure that data is complete, accurate and timely for training, testing and deploying AI models in the future. One example of work is the consulting project we won during the third quarter with a leading North American tech supply companies.

Our team was brought on to build out an end-to-end freight management system for our clients, including the full cloud data platform for managing analytics and future AI and automation capability. We are responsible for ensuring the architecture, configuration, reporting and analytics are properly set up in the new freight management tool. At the same time, we must ensure that the data is extracted correctly from the old tool and ingested into the new tool. We’re using technology solutions such as Snowflake, Databricks and Google Cloud as part of this end-to-end architecture to ensure the best outcome for our clients. We also continue to excel in projects involving engineering robotics and machine learning capabilities. In another consulting project won during the third quarter, we were hired to provide services to a leader in e-grocery technology.

Under this contract, we’re helping to drive the deployment of our clients’ robotic grocery fulfillment systems, which are used to stock the warehouses of a major retailer nationwide. We are providing end-to-end provisioning, installation, quality assessment and support for each warehouse deploying the new e-grocery technology. Let’s now turn to our Federal Government segment, our sixth industry vertical, which provides mission-critical solutions to the Department of Defense, the intelligence community and fed civilian agencies. Federal segment revenues for the quarter were up 12.3% year-over-year on an as-reported basis and up 4% organically. Contract backlog was roughly $3.3 billion at the end of the third quarter or a healthy coverage ratio of 2.6x the segment’s trailing 12-month revenue.

New awards were approximately $501.2 million, which translates to a book-to-bill of 1.5x for the quarter and 0.9x on a trailing 12-month basis. As we continue to secure work during the third quarter, we recognized the potential for some disruption in the procurement process should the government shutdown occur following the end of Q3. Our government team proactively engaged in discussions with clients for several weeks leading up to October 1 and reconfirmed that the vast majority of our work is mission-critical. We believe that 10% or less of our Federal Government work to be impacted in the case of an extended government shutdown. We’re keeping track of budgetary developments. In the meantime, we remain heads down on providing leading IT solutions to our government client base.

Speaking of supporting our clients in the third quarter, we won a combination of new and recompete contracts. Amongst the new work secured, we won 2 new cybersecurity contracts with the U.S. House of Representatives and the Census Bureau. In addition, we’ve secured a 5-year data and AI contract to support the National Geospatial Intelligence Agency, the Chief Digital Artificial Intelligence Office or CDAO and the Army Research Laboratory. We also won a smaller contract from the CDAO to help establish a global AI innovation lab that will support academic research in artificial intelligence worldwide. Similar to the Commercial segment, much of our work in generative AI in the government space remains exploratory at present. But with excellent qualifications in traditional forms of artificial intelligence, our federal and civilian customers continue to look to us to identify use cases that will increase their operational efficiency.

In fact, on several DoD AI research and development programs, we are integrating generative AI and large language models into current solutions. With regards to project extensions, we won work with the U.S. Postal Service supporting several key areas, including advanced data management and cybersecurity and continue to support the Department of Veteran Affairs, while adding new work and strategic planning, cloud advisory services and AI technology implementation. The breadth of work just described is evidence of the countercyclical balance the government industry vertical provides to our overall account portfolio. With that, I’ll turn the call over to Marie to discuss the third quarter results and our fourth quarter 2023 guidance.

Marie Perry: Thanks, Ted. It’s great to speak with everyone this afternoon. As Ted noted, our results for the quarter were in line with or exceeded our expectations. The third quarter revenue of $1.12 billion were down 6.8% year-over-year. Revenues for the Commercial segment were $782.4 million, down 13.1% compared to the prior year quarter. Revenues from commercial consulting the largest of our high-margin revenue stream totaled $274.2 million, up 2.1% year-over-year on a tough comparison of 43.2% growth in the third quarter of 2022. Growth in commercial consulting revenue was offset by 19.5% year-over-year decline in assignment revenues, reflecting the continued softness in more discretionary and cyclical parts of our business.

On a same Billable Day basis, adjusting for 1.5 fewer Billable Days in Q3 of 2023 compared to the prior year quarter, assignment revenues declined 17.6%. Revenues from our Federal Government segment were $334.4 million, up 12.3% year-over-year, including a $24.6 million contribution from Iron Vine. The growth in our Federal Governance segment, our sixth vertical speaks directly to the benefits of maintaining a diverse client base across industries. Turning to margins. On a consolidated basis, gross margin was 28.9%, down 110 basis points over the third quarter of last year and flat sequentially. The year-over-year compression in gross margin was mainly related to business mix, including a lower mix of certain high-margin revenues within our Commercial segment and a higher mix of revenues from our Federal Government segment, which carry a lower gross margin than Commercial segment revenues.

Gross margin for the Commercial segment was 32.5%, down 60 basis points year-over-year, primarily due to the lower mix of certain high-margin assignment revenue stream, mainly creative digital marketing and permanent placement revenues, which was partially offset by a higher mix of high-margin IT consulting revenues with a year-over-year expansion in gross margin. Gross margin for the Federal Government segment was 20.4% and down 10 basis points year-over-year. SG&A expense for the third quarter were $206 million or 18.4% of revenues as compared to $232.6 million or 19.4% of revenue in the prior year period. SG&A expenses included $1.1 million in acquisition, integration and strategic planning expenses; and a $2.7 million tentative legal settlements, both of which were not included in our guidance estimates.

As expected, interest expense increased year-over-year related to rising interest rates and our recent refinancing. At the end of August, we completed a successful transaction that upsized and extended the maturity of our revolving credit facility and Term Loan B. Our revolving credit facility is now $500 million with a 5-year maturity extending to 2028, our Term Loan B is also $500 million and extends 7 years maturing in 2030. Post transactions, our net leverage remains low at 2x adjusted EBITDA. Ted will speak further about this transaction shortly. Income from continuing operations was $59.4 million. Adjusted EBITDA was $137.5 million, and adjusted EBITDA margin was 12.3%. At quarter end, cash and cash equivalents were $145.6 million, and we had full availability under our new $500 million Senior Secured revolver.

Free cash flow for the quarter was $137.7 million, an increase of 73.2% year-over-year. We deployed $91.3 million in cash on the repurchase of 1.1 million shares during the third quarter at an average price of $79.63 per share. We have roughly $349.1 million remaining under our share repurchase authorization. With strong free cash flow generation and full availability under our revolver, we have ample dry powder to make strategic acquisitions once the M&A market improves. Turning to our guidance. Our financial estimates for the fourth quarter of 2023 are set forth in our earnings release and supplemental materials. These estimates are based on current market conditions and do not take into account any possible revenue declines associated with the potential government shutdown in November.

Our estimate assumes 60 Billable Days in the fourth quarter, which is the same as the year ago period and 2.5 fewer Billable Days than Q3 of 2023. Guidance also takes into account seasonality, with the fourth quarter traditionally the second lowest quarter after the first quarter. We expect macro conditions to remain challenging in the fourth quarter. In our Commercial segment, we anticipate revenues to remain soft across both assignments and consulting. These declines are expected to be partially offset by growth in our Federal Government segment. We are expecting gross margins will decline year-over-year due to business mix similar to the more recent trends including a greater mix of federal government work and continued softness in our more cyclical and discretionary Commercial businesses.

This should be partially offset by an improvement in our year-over-year cash SG&A expense margin. With this as background, for the fourth quarter, we are estimating revenues of $1.04 billion to $1.06 billion. We are estimating net income of $46.2 million to $49.1 million. Adjusted EBITDA of $115.5 million to $119.5 million and adjusted EBITDA margin of 11.1% to 11.3%. Thank you. I’ll now turn the call back over to Ted for some closing remarks.

Theodore Hanson: Thanks, Marie. ASGN’s business is very well positioned with IT market demand and the overall economy improves. Consistent with our peer set and our clients, we remain cautious about the near-term market demand given the uncertain macroeconomic condition. Nevertheless, with great qualifications that are across sought after IT solutions and skill sets, ASGN is ready to leverage growth in IT spend in the future. As we proactively position our company for the future, as Marie noted, in the third quarter, we successfully completed a transaction to upsize and extend the maturities of our revolving credit facility and Term Loan B. This transaction increased our financial flexibility and provided us with significant dry powder for acquisitions as the M&A market strengthen.

We continue to believe M&A is the best use of and highest return on our capital. Both the revolver and Term Loan B were oversubscribed, which we can attribute to the strength of our underlying business. The success of this refinancing was also due to the efforts of our treasury team, led by Jim Brill. Jim has been an integral part of the ASGN family for the past 16 years, but we knew the day would come when Jim would retire. Jim, it has been a pleasure to work alongside you all these years. And on behalf of our entire company, I want to thank you for your exceptional leadership and dedication to ASGN. You will be missed, and we wish you the very best in your well-deserved retirement. Transitioning into Jim’s role as Treasurer, we welcome Chris Donnini, who has served a VP of Finance and Treasury role at ASGN since July.

Chris has been shadowing Jim since day 1. With an extensive background in finance and treasury for publicly traded companies, Chris brings a wealth of experience to ASGN. We’re excited to have Chris on board and hope that many of you have the opportunity to meet him in the near future. That concludes our prepared remarks. I’d like to thank our entire ASGN team for your continued efforts this past quarter. Our ability to remain in the fast current of where IT spend is today and in the future is the result of your dedication and unwavering commitment to our clients. Thank you again for joining our third quarter call. Operator, please open the call to questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question comes from the line of Tobey Sommer with Truist Securities.

Tobey Sommer: I was wondering if you could give us a little bit more color on what you’re seeing in the commercial consulting arena in terms of the elongation of decision-making and maybe the size, the projects? Are they are diminishing outright? Or are customers piecemealing them out in modules or phases as opposed to signing up for the whole end-to-end period for you?

Theodore Hanson: Yes. So thanks for the question, Tobey. I’ll let Rand kind of jump in here, too. But I’ll tell you, I think in general, what we’re seeing is their solid bookings, a little bit more renewals than new work but what I would call very solid bookings for this quarter, it was $291 million. We were at a 1.1 book-to-bill, which Q3 is always seasonably a little lighter. So I think we were generally pleased with that. We’re definitely seeing clients elongate those that reduces their spend, if you will, and our revenue. It’s not a bill rate or a margin issue. It’s mostly embedded in that. And Rand, size of project is generally similar, right?

Randolph Blazer: Yes. Except for the AI work, which you noted, Ted, tends to be smaller, but the normal flow of our consulting work is the larger now 7-figure projects that have a 9- to 12-month duration. And Tobey, to your question of, is the client piecing it out, if you will, to us? I think it’s more as on the go scenario. In other words, as projects mature, they come to different milestones. I think the clients, generally, and some of this is seasonal, is not in a rush to finish, if you will. I’m not suggesting that they don’t think it’s a priority. But it’s just being cautious, which they’ve been for some time now in the last quarter or two. So it’s not so much the way it’s contracted. It’s more the way it’s executed. Did that answer your question?

Tobey Sommer: Sure. That provides helpful color. And then as a follow-up on the same theme, within that rate of bookings, and I understand most of it is renewals, do you think you’re holding serve, gaining share? How do you think you’re doing relative to the market in the areas that you play?

Theodore Hanson: Rand?

Randolph Blazer: Ted, I’ll take a first shot. And we’ll wait for our peer group to report Tobey, over the next days and weeks. But I mean, I feel like we’re holding court if not expanding just a bit. Most of the work that we’re seeing, by the way, is a lot in that data that Ted mentioned in the notes, the data area. Data aggregation, data consolidation, data cleansing, data mapping, these are fundamental steps you take in any kind of systems development, if you will. And I think a lot of clients are recognizing that this data work is — takes time, has to be pulled together, have to be meticulous. And guess what? This all sets the stage for AI technology when it comes in. And Tobey, one other thing we watch is the technology that supports data mapping and data cleansing, they are beginning to pop up on the horizon, new pieces of technology to support that effort.

But for the most part, it’s still methodology and labor-intensive. And its prep work — important prep work for AI implementation to come.

Tobey Sommer: If I could ask a question about M&A. I think you said in your prepared remarks when M&A, when sort of markets reopen, resume, revive, something like that. Did — what do you mean by that? Because certainly, it seems based on your financing, you have the capital and appetite. Is it a question of multiples or fewer assets available out in the market? From many perspectives one might think this would be a good time for you to lean in a bit.

Theodore Hanson: Well, I would agree with that. I would say, Tobey, we still see that high-quality assets are not stepping into the market because they still have it in their own mind, maybe reconcile to solve the valuation question. So you — while we see things flowing through the pipeline and we’re prosecuting all of it. It’s lesser quality, I would say, more and lesser quality assets than we would typically see. So I think it’s more that than anything else. For a company that has great IT solution capabilities in some high-demand areas that we want to be in. They’re performing, maybe not as good as they were, but they’re performing well, and I think they can afford to wait here. I think it’s mostly around that.

Tobey Sommer: That makes perfect sense. Last question for me. Could I get you to maybe give us a history lesson in how the government business performed and what the impacts were to top line, contract awards and book-to-bill as near as you could isolate those in the last shutdown in 2018 that straddled into ’19 because that may be informative as we perhaps experience some sort of volatility in government staying open over the next several months?

Theodore Hanson: Yes. Well, Tobey, that’s pretty far back. So I couldn’t clearly give you an answer on that, but let us follow up with you offline on that, if that’s okay.

Operator: And our next question comes from the line of Maggie Nolan with William Blair.

Maggie Nolan: My first one is on the commercial consulting side of things. Can you share your initial impressions about the clients’ budgeting processes for 2024? And what that might mean for spending potential next year?

Theodore Hanson: Well, we’re in the middle of that right now. I will tell you on a macro basis, not client by client, but I mean if you kind of follow Gartner, they’re lowering IT spending growth here in this year, they’re kind of down to 3% or 4% now, and they’re expecting a higher number next year, right? So I think that’s an overall market comment. Rand, are we really kind of into that on the client side here enough to make a comment?

Randolph Blazer: Well, I would say there’s two levels of client here. The technical client that runs the projects and has to get things accomplished and the executive team that has to make a decision relative to their financials and their own outlook for the future. I can tell you the technical client level, Maggie, let’s talk about it. Let’s get the next stage going. As I just mentioned, a lot of the work is in what I call the prep phase for AI before use cases get layered on. So there is a lot of discussion at the technical level. I think the executive level, I can’t speak to that, but I would sense if I were an executive of some of these businesses, if I’m a provider, it’s full steam ahead, if I’m a big bank, earnings are looking up.

Maybe I’m thinking positively, if I’m technology, the ad money and the results we’re seeing now that are coming out in the market are kind of giving us an indicator that earnings are moving up. So we — our thesis, as you know, has always been that IT spend is a function of earnings to the company. So I think executives are watching what happens with, I’m sure, the continuing resolution with what’s going on in the house. There’s obviously going to be money spent on aid for — in the foreign world. And I mean, I just think it’s too early quite to tell, but we’re optimistic, I would say. The bookings give us an indicator, Maggie, a little bit, right? I mean, we’ve had pretty solid bookings. And even as Ted said, the Q3 bookings were quite good.

Usually, it’s our lowest commercial quarter. The government side also had great bookings in the third quarter, so.

Maggie Nolan: That’s helpful. And then I think it was Ted, in your prepared remarks, you mentioned maybe some opportunities for more margin expansion. Is that anything incremental to some of the opportunities that you’ve laid out in the past like at your Investor Day? Or was that a comment on expected mix shift over time? Or any comments you would have there over a multiyear time frame would be helpful.