ASGN Incorporated (ASGN) Q3 2012 Earnings Report, Transcript and Summary

Good afternoon. My name is Sade, and I will be your conference operator today. At this time, I would like to welcome everyone to the On Assignment Third Quarter Earnings Conference Call. [Operator Instructions] Thank you. Mr. Ed Harris. You may begin your conference.

Thank you. Before we begin, I'd like to advise everyone that our presentation contains predictions, estimates and other forward-looking statements. These include words such as forecast, estimate, project, expect, believe and other similar expressions. We believe these remarks to be reasonable, but they are subject to risk and uncertainties that could cause actual results to differ materially from the forward-looking statements. We describe some of these risks and uncertainties in today's press release and our filings with the Securities and Exchange Commission. We do not assume the obligation to update statements made in this conference call. I'll now turn the call over to Peter Dameris, our CEO and President, who will provide an overview of our third quarter results. Peter?

Thank you, Ed, and good afternoon. I would like to welcome everyone to the On Assignment 2012 Third Quarter Earnings Conference Call. With Ed and me today is Mike McGowan, COO of On Assignment and President of Oxford Global Resources, our high-end IT skill staffing group; and Jim Brill, our Chief Administrative Officer. During our call today, I will give a review of the markets we serve and our operational highlights, followed by a discussion of the performance of our operating segments by myself and Michael. I will then turn the call over to Ed for a more detailed review and discussion of our third quarter financial performance and our estimates for the fourth quarter of 2012. We will then open the call up for questions. Before we start today's call, I would like to remind everyone that today's results include a full quarter of contribution from Apex. Now on to our third quarter results. All markets we serve, including Nurse Travel and Physician Staffing, remained productive and stable during and exiting the quarter. Once again, we saw particularly strong growth and strength in the IT end markets. Our healthcare groups continue to make solid progress in improving their operating performance, and in the third quarter, we saw solid execution in our Physician Staffing group. In the Physician group, Physician days sold increased 4% in the third quarter over last year's third quarter and 15% over last quarter. During the third quarter, we also built on the increased end market demand in Nursing and Allied Healthcare. Based on days sold in the Physician group and our growth in professionals on billing in our healthcare group, we believe double-digit revenue growth will be achieved in 2012 for those groups. As we have mentioned many times in the past, we firmly believe…

Thanks, Peter. Let me first address Oxford Global Resources, where we had another solid quarter. Revenues for the third quarter of 2012 were $88.1 million, a 25.7% increase over the third quarter of 2011. This followed year-over-year quarterly increases for the 4 previous quarters of 34.9%, 31%, 31.4% and 47.7%, respectively. The increase in year-over-year quarterly revenue was due to increase in bill rates and a higher demand for consultant labor across all of our business units. Although revenue was flat from the second quarter due to the slowdown in August, demand picked back up again in September and continues to be strong until October. Our gross margin for the third quarter of 2012 remains strong at 35.5% compared to 35.8% for the same period last year. As we've mentioned on previous calls, we believe that Oxford's bill rates and gross margins continue to be among the highest in the staffing industry. Our Healthcare IT business continues to be Oxford's fastest growing area. Total revenue in Healthcare IT was $11.5 million for the third quarter of 2012 compared to $5.8 million in the third quarter of 2011, a 99% increase. Demand for our IT consultants was strong in the third quarter in financial services, retail trade and durable goods and slowed in food manufacturing and pharmaceuticals. On the engineering side, companies in the high-tech equipment, machinery manufacturing and pharmaceutical industries continue to add consultants, while demand declined slightly in medical equipment, appliance and electronic product manufacturing firms. Over the previous 10 quarters, we have seen progressive highs in terms of consultants on assignment, and this trend continued into the third quarter of 2012. Billable consultants hit an all-time high for Oxford during the quarter, surpassing the previous mark set during the second quarter. In fact, the third quarter of 2012…

Thanks, Mike. As Peter mentioned, net income for the quarter was $17.4 million or $0.33 per share on record revenues of $388.3 million. This performance was driven by the inclusion of Apex Systems for a full quarter and the 14.3% combined year-over-year revenue growth rate of the other business segments. Apex accounted for $202.7 million or 52.2% of total revenues for the quarter compared with $98.5 million or 34.8% of revenues in the preceding quarter. There were approximately 62.5 billing days in the quarter, 1 less than the preceding quarter and 1.5 less than the third quarter of 2011. Our consolidated average bill rate for the quarter was down approximately 3% year-over-year primarily due to the inclusion of Apex, whose average billing rate is lower than the combined average billing rate for the other business segments. The consolidated bill pay spread also contracted year-over-year as Apex operates at a lower spread than our other business segments. While Apex's gross margins are lower, its operating margin are comparable to our other business units due to its scale and the efficiency of its operating model. Conversion and direct hire revenues for the quarter were $7.4 million or 1.9% of total revenues, down from 2.1% in the preceding quarter and 3% of revenues in the third quarter of 2011. Foreign currency translation adversely affected revenues $2.3 million year-over-year and $400,000 sequentially. Net income was $17.4 million or $0.33 per share, up from $8.5 million or $0.19 per share in the preceding quarter. Excluding acquisition-related cost of $0.8 million in Q3 and $6.6 million in Q2 and the reduction in the HCP earn-out obligation, net income for the quarter was $17.5 million or $0.33 per share, compared with $12 million or $0.26 per share for the preceding quarter. SG&A expenses for the quarter were…

Thanks, Ed. We believe that we are well positioned to continue to take advantage of what we believe will be historical -- historic secular and cyclical growth for the staffing industry over the next 3 to 5 years. While the entire On Assignment team is very proud of our performance, we remain focused on continuing to profitably grow our business. We'd like to once again thank our many loyal, dedicated and talented employees, whose efforts have allowed us to progress to where we are today. I would like to now open the call to participants for questions. Operator?

[Operator Instructions] Your first question comes from Kelly Metzler of Bank of America Merrill Lynch.

This is Kelly Metzler for Sara Gubins. Gross margin for Apex was up nicely sequentially, which you attributed to more permanent placement. Is this a trend that you expect to continue going forward?

Yes. So I'll address part of the question and turn that part over to Ed. Our focus has always been on stable to expanding gross margins. I wouldn't forecast that the margin would go up considerably from here, but we do believe that there's a little bit of room. Ed will break out for you what allowed us to grow at 70 basis points from the prior quarter. Ed?

There are 2 pieces. One is an improvement in the permanent placement mix. In the second quarter, it was 1% of total revenues. This quarter, it was 1.3%. The other is that the contractor gross margin increased sequentially by about 40 basis points. So it's almost evenly split between the two.

And just a follow-up. What sort of trends are you seeing in bill/pay spreads? Are there other any particular segments that stand out?

The higher you go on the skill set, the better negotiating power we have with the customer as it relates to bill/pay spread. I will tell you that the mid-tier skill sets, Life Sciences and in Nursing, it's pretty tight on demands for pay rates. And so there's not a lot of negotiating power right now, because unemployment rates are pretty low in most of the skill sets that we have.

Your next question comes from Edward Caso with Wells Fargo Securities.

Question is around the government market or the companies that support the federal and state government market. Just can you remind me how much work you do into that sector and what you might be seeing given all the sequestration noise?

Yes. So Ed, we'll have to get back to you on a precise percentage, but it's single digits. And as we said in our prepared remarks, there was a noticeable slowdown with some of the prime government contractors that we sub to, but that started to lighten up a little bit. The constraints started to lighten up a little bit in September and in October, but we're not expecting the same type of purchasing behavior in 2013 as we did in let's say 2009 or 2010.

The Apex, I think you indicated it was 14% year-over-year growth in Q3. My memory is the growth rate used to be meaningfully above that. Is there a transition that brings you down to these new levels? Or is this just sort of the new normal level here for Apex, sort of low teens, this is what we should be thinking about?

Your memory is correct. I think in 2011, their growth rate was about 29%. And the growth rate at around 14% this year is just a reflection of what the entire IT staffing industry is facing, which is a dramatic slowdown in spending by financial services, large money center banks. At its peak, large money center bank, IT staffing work represented 29% of total revenues for Apex, and that number is below 20% right now. So we've done -- we've taken advantage of the slowdown in financial services to build up some of our other industry verticals, like healthcare and IT, but financial -- the financial services industry will always be one of the most important end markets for us, because they're the biggest spenders and earliest adopters. We're still growing about 400 basis points faster than the stated industry growth rate, and we're just -- we're getting what we think is real demand out in the marketplace currently and not getting distracted. And we firmly believe when you get normalized GDP growth and normalized spending from the financial services industry, which is so important to IT staffing, that we can grow at 20% plus again.

A quick question for Ed. The 25% to 29% EPS in Q4, what does the math work out to then being what's the 2012 estimate on that equivalent basis, the first call it equivalent number?

Let us do that for you real quick and get that to you as they pull it off of the spreadsheet and answer some more questions, Ed.

Your next question comes from Tim McHugh with William Blair & Company.

Yes. Peter, I just want to follow up on something you were just talking, which was the financial services sector and some of the challenges there. It sounds like though based on your comments, you feel better about that. So I was wondering if you could just give a little more color on if you think that's a market turn, if you think that's an internal execution and kind of where you're seeing better demand for Apex out of the financial services sector during the last couple of months.

Yes. Some of it is specific to us, but I do think that some of the banks that had stalled on Dodd-Frank are really starting to look hard at the business intelligence data mining initiatives they have to engage in to appropriately represent the value of the assets that they hold. As it relates to other things that have allowed us to have a little bit faster demand than say the first and second quarter, we do have some customers that may be specific to our company that aren't shared with other publicly traded IT staffing companies that engaged in acquisition activity later in the cycle that are going through integration work now versus, for instance, to give you -- like JPMorgan Chase and Bear Stearns, which were at the beginning of the cycle. So -- but we're seeing a slight improvement. And it's stability.

Okay, good. And then on Oxford, Mike, you made the comment about August being slower. Was that just normal seasonal slowdown? And -- or was there something you saw different from clients as you got late in the quarter?

Well, it was a couple of things. One is we had a very strong second quarter, so that was one thing. Our perm revenue, actually, from the second quarter down to third was down by $0.5 million. And then I had mentioned, we actually had an all-time high in terms of the consultants on assignment. But when we look actually at hours worked not only here in the United States but especially in Europe, it was considerably down just in the number of hours worked. So some of that thing's seasonal stuff but really, generally, not much more than that. As we've seen, as I mentioned, September started increasing, and October now is increasing as well. So nothing really out of the ordinary.

Okay, great. And then last, just on the integration of Apex with Oxford, can you talk about any crossover synergies you've seen? I mean, can you quantify it at all or give any additional color on how you might -- the 2 businesses might be benefiting from each other at this point?

It's actually playing out along the lines we expected. We are starting to see some better coordination on some perm placement, where Apex has been requested to do it and Oxford's acting as the fulfillment center. Actually, we're seeing a lot of really productive activity out of the Life Science customer base as much as we're seeing opportunities to jointly bid on work, Oxford and Apex together, where we give a broader spectrum of service offerings. So it's going along the lines we expected.

Would we see that more in Apex revenue or Oxford's or kind of both at this point?

You'll see it on the perm side at Oxford and on the contract assignment only revenue side at Apex. And operator, before you take the next call, I think Ed Pierce has the answer for Ed Caso.

Ed, as it relates to projected EPS for the full year, it would be, at the low end of what we're protecting for Q4, $0.93 and at the high end, $0.97.

Your next question comes from the line of Tobey Sommer with SunTrust.

I was wondering if you could comment on what assignment links are like as -- on the new orders over the last couple of months? Any changes there in terms of visibility of -- and asset in the context of some of the dimensions of uncertainty that you cited in your prepared remarks?

Thanks, Tobey. We really have not seen any appreciable change in the length of assignments. I'll give you one caveat. One large money center bank has -- the actual assignment is ending up still being around 6 months, but they're kind of giving themselves the flexibility for it to be a 3-month assignment and then they renew it. But as an industry trend or a customer trend, we haven't seen any change.

Okay. And I -- just a numbers question that I may have missed. Perm as a percentage of revenue was 1.3% in the quarter?

For Apex, it was.

Oh, for Apex. Do you have a consolidated number?

Yes.

1.9%.

And how does that compare to either the year ago or the prior quarter, whichever you think is the relevant comparison?

Well, the prior quarter it was 2.1%, and the same quarter in the prior year, it was 3%.

Yes. So excuse me, Tobey. The third quarter 2011 had no Apex revenue in it. So I think, really, it's going to take a while to get apples-to-apples comparisons, because even the second quarter of 2012 only had 6 weeks of Apex revenue in it, and that's why the 2.1% was slightly higher.

Understood. And just a comment about how you plan to perhaps strategically drive a slightly greater percentage of revenue from perm. The organizational structure that you have now across the different segments, are you operating with a dedicated staff? Or is -- are staff consultants performing perm assignments and filling them on an ad hoc basis?

It's on a case-by-case basis. We have dedicated teams for Physician Staffing, for IT and clinical research. We, on a highly restricted basis, allow our Life Science and Allied Travel -- our Allied Healthcare groups to do it with the same recruiter doing contract and do perm.

Okay. And then in order to get up to a 4% or 5% threshold over time, does that require a change to the organizational structure and more emphasis on dedicated teams? Or can you do it as is?

We would have to do more on the IT side.

Okay. Do you have an expectation for the disruption -- labor disruption revenue in the fourth quarter? And I think -- I guess there's something planned for the 1st of November at this point that I see.

Yes. It's within that range that we usually have, somewhere over $1 million for this one client for a one-week period.

Your next question comes from the line of A.J. Rice with UBS.

A couple of questions, if I could ask. First of all, I understand the commentary around the economy and how that ripples through the business lines. I guess I just want to a step back and wonder is the message that -- because of that uncertainty, that's reflected on the guidance that you're giving us to the fourth quarter. Or is the message about those comments that there's maybe a little more volatility around the guidance than normal because of the economic uncertainty? I guess just flesh that out a little more for me.

Yes. Thank you, A.J. So we think based on our -- a month completed, so to speak and what we see on our booked business that the numbers we gave you, we have visibility into. What we don't have visibility into is if the elections go a particular way or the rhetoric about the fiscal cliff gets incredibly heated, that a large number of large corporations say, "You know what? We're shutting down for 2012." And we're telling our full-time employees to flush their PTO. And we're telling contractors we're going to finish these projects in 2013, but we're not incurring any more expense in 2012. And we don't have -- we don't expect that, but if that occurred, that's not baked into our estimates. Does that make sense to you?

That make sense. Obviously, the leverage target came down nicely in the -- I mean, the leverage came down nicely in the quarter. Can you just remind us of what your goal for that leverage ratio is. And also, comment, if you would, about getting back on the buyback trail at some point, when that might make sense.

Right. So the way I would respond to that is we thought that we could get to about 3x leverage by the end of 2012. We got to that by the end of the third quarter. We think maybe if trends continue the way we expect, maybe we can get around 2 3/4 by the end of 2012 and maybe to 2.5 some time in 2013. And at that point, 2.5x leverage based on our cash generation capabilities, based on the cost of our debt being under around 4.6%, which we'll probably, at that point, want to refinance, we need to seriously look at what's best for our shareholders and either to return capital to shareholders or to look at some appropriate strategic niche acquisitions. But paying the debt down to 0 just doesn't make a lot of sense based on our cash generation capabilities and the cost of debt.

Okay. These are in the smaller divisions, but on the Nurse Travel side, you mentioned the EMRs transitions, and a lot of hospitals are doing it. That's helping demand. Can you sort of give us a flavor for how big that is at this point and where you think we are in terms of is that something that'll continue to be a tailwind for 2013? Are we sort of seeing that peak out here? Or any thoughts along those lines?

I think you can pretty much rely on it for 2013. I don't want to go out much further than that, and it typically will be something like 20 to 40 nurses per project.

And if you were to look at your entire business at this point, is it moving the needle on the entire business?

On the growth rate of the Nurse Travel group, yes.

Yes, okay. And then finally, just the strength in the Allied business year-to-year sequentially, any interesting thing to call out there? I know that's a small unit for you, but anything interesting?

It's actually bigger than our Nursing group now. And it's just -- actually, the end market dynamics of Allied Healthcare, healthier than nurse end market. There are a lot more points of purchase. And it's projected to be a $4 billion market versus a $1.5 billion market, and we're just seeing a nice recovery from a very, very steep falloff. I think the Allied Healthcare market in 2008 was $8.8 billion, and it dropped to $4 billion in 2011 or 2010. So there's a lot of room to grow, but we're seeing a lot more consumption of healthcare services out of the -- outside of the acute care hospital setting.

Your next question comes from Jeff Silber of BMO Capital Markets.

Peter, you mentioned earlier about the low unemployment rate in some of your end markets. I'm just wondering is there an issue in terms of finding supply. Is it getting worse? Also, the same question about your staffing consultants. How easy is it to find staffing consultants these days?

So it's easier to find internal staff than it is billable temps. Especially with our profile right now, we're having a good run of hire and our business model, Jeff, which is we hire a lot of people straight out of college with no experience and do some intense training. So we're hiring very attractive people both on academics and competitive spirit. They played for football, baseball, lacrosse teams at Division 2 and 3A schools, and that's continuing to go very well for us. As it relates to technical resources, I'd say that it's tightened somewhat.

Any specific one of your verticals is getting worse?

I would tell you across the board.

Across the board it's tightening. Okay, great. Just a couple of numbers questions. I know you're not going out to 2013, but roughly what should we expect for capital spending next year?

I think for this year, we're talking about roughly $13 billion to $14 billion in total.

It's kind of less than 1% of total revenue.

Okay. That's fine. And then Eddie, you mentioned in your remarks something an HCP earn-out. I missed that. Can you just go through the dynamics of that?

The HCP earn-out under -- will you tell them about the acquisition accounting rules [indiscernible] with every quarter?

We remeasure the earn-outs, obligations every reporting period. And just based on the of current trends, we determined it was appropriate to reduce that obligation by roughly $1 million in the quarter, and net of tax, that's roughly $620,000.

All right. And when is that earn-out to be paid?

In -- well, it -- the measurement period is from August 1 of this year until July 31 of next year. So it would be paid probably some time in September maybe of the following year, September of 2013.

It's a small earn-out. To give you a little more perspective about it, not accounting treatment but Jeff, classically, when you have these conversations with entrepreneurs, they always are very optimistic about how much they can grow. And so in this particular earn-out, there were kind of 2 stages to the earn-out. What I thought was a realistic at or slightly higher than industry growth rate and then there was a second tier to it, which was if they continue to grow what was their historical growth rate, which was twice the industry growth rate. And we said if you can continue to do it, we'll pay you. Well, they're growing closer to industry growth rates than their historical growth rate, which means they're probably not going to hit the second tier.

The full amount.

For the full amount. That's right.

We're still assuming that there's going to be an earn-out payment.

Did I explain that?

Yes. No, no, I got it. I understand. It's okay. All right.

Your next question comes from Ato Garrett from Deutsche Bank.

I wanted to go back to IT staffing and trends that you've seen. You've already spoken to -- for the trends within financial services clients. I was wondering is there anything else that might be happening there either by a client vertical or another way to slice that apart?

There's nothing different in the financial service vertical than what we've described. We are continuing to see a nice robust growth in the healthcare vertical. And then we're seeing, in the consumer cyclicals, a little fluctuation based on how their fortunes on revenue growth are going, but it's pretty much steady state. As we said in our prepared remarks, Ato, we're not really seeing a dramatic difference in purchasing behavior in the fourth quarter than what we saw at the beginning of the third.

Your next question comes from Mark McKinney with RW Baird.

It's Mark Marcon [indiscernible]. Can you talk about Apex just in terms of the bill -- the number of billable days, the comparison relative to a year ago? Is it going to be roughly the same?

Let us look through our spreadsheets. It may be 1 day or 1.5 days down.

The reason why I'm asking is because you went from 12.8% growth in the second quarter to 14% growth, but you're guiding to 10%. And it sounded like things were getting a little bit better in financial services. So I was just wondering if there was a bill rate difference, I mean a billable day difference.

Well, we did say there's 1.5 fewer days in the fourth versus the third.

Right. I'm talking about year-over-year.

Year-over-year, I think it's, in the fourth, 1.5 -- in the fourth, it's -- yes, it's actually about the same this year as it was last year. Apex, just, Mark, to remind you, they were on a 4-4-5 before we purchased them. So we'll need to look at what Apex did last year. That's a different world because of the 4-4-5 versus the calendar.

Got it. Got it. Okay, that -- and then in terms of Oxford, it looks like we're going to see some slight acceleration based on the way the guidance is worded. Are there particular areas where you're thinking that maybe the bill rates are going to improve?

No. As Peter mentioned, the biggest increase which we commented on was really in the Healthcare IT market. We're continuing to see growth and expansion there. And then also, as I commented in some of the specific industries within the engineering group, a lot of regulatory and compliance stuff, we're doing a lot more. And in fact, even in some ways, we look a little closer to the Apex model, we have 10 or 15 consultants on a particular client project versus the onesie-twosies that you're used to hearing us talk about. So those 2 areas are probably our biggest growth areas right now.

Mike, on top of it, we're just not budgeting or forecasting to see a monthly performance like August.

Correct.

In the fourth quarter.

Correct.

So we -- our guidance does assume that even though there's a fewer -- there are fewer billable days, that Oxford will be up on an absolute dollar basis fourth over third.

Correct.

Great. And then in terms of the SG&A guidance, what's the major area of the increase in sequential spending for the fourth quarter relative to the third?

Mark, bear in mind there was some one-time items, like the HCP obligation reduction. Okay. So you're not going to have anything similar to that going forward.

And we do have some increased investments as we broadened the senior management team and things like that.

In addition, there are normal seasonal increases for things like annual audit, fees, so that sort of thing.

Just how the cycle spend spreads.

Right.

Okay. I was just looking at it relative. But there's no -- aside from those sort of normal things, there's nothing really major that's occurring?

No.

No.

Your next question comes from Randy Reese with Avondale Partners.

I don't know if there's more hype than reality here, but I've been asked frequently by investors about the online contractor staffing businesses that are charging in the neighborhood of 8% to 15% markups to provide 1099 in payroll contractors on kind of a centralized online delivery method. And I was wondering if you have seen this out in the competitive marketplace at all, if customers have said anything to you about it and what you think of the business model.

The answer's no, and we're just -- we don't compete with clearinghouses, Randy. So it -- just we have not seen that. We haven't lost a single piece of business to a clearinghouse.

Is it accurate to say that there's a fundamental difference here in recruiting for yourself versus going to somebody who can recruit for you?

That -- we do a lot of passive recruiting, a lot of -- especially on people who can legitimately qualify as an independent contractor. Those people are even harder to discover than somebody that will work through you as a W2.

Do you believe that your business has gotten at least -- gotten some staffing business in the areas that may be used to be filled with independent contractors because of employers' increasing reticence about the legal implications of using independent contractors?

The answer is absolutely, yes, specifically in the clinical research side. It used to be that a PhD could go directly as an independent as a medical writer to one of those major pharmaceutical companies. And legal and HR have just shut them down and said, "I don't care how valuable this resource is. We're not taking that risk of an IRS audit for misclassification." So if you want that person, you're going to either have to may pay more for them, or you're going to have to find them in a place where we're not bearing the risk for misclassification. So we think that that's one of the big secular drivers as the U.S. government continues to look for revenue. The biggest places that the U.S. government can increase their revenues without increasing taxes is narrowing the classification and having more people working as W2s versus independents, because there's a big number of people in today's society that continue to work in a non-employee classification status. And that's a big driver for the entire staffing industry.

[Operator Instructions] Your next question comes from Tobey Sommer with SunTrust.

Just a couple of quick follow-ups. The staffing consultant sequential growth in the third quarter was pretty good, a little under 3%. Do you anticipate continuing to add to those ranks in the fourth quarter?

Tobey, as long as we continue to see appropriate demand and it's not diluted to the -- our targeted operating leverage, the answer is yes.

Okay. And in the IT world, I was wondering if you've evaluated taking on more solutions work and actually developing a bench-type business.

The answer's hell, no. We will look at benched employees to do staff augmentation on Healthcare IT just because of how tight the inventory is. But trying to compete with Accenture or HP on a fixed fee basis and having to do solutions determination and avoid scope creep. We don't have to do that, and we're not going to.

You have no further questions at this time.

We appreciate your time and attention and look forward to reporting our fourth quarter results in the future. Thank you so much for your attention today.

This concludes today's conference call. You may now disconnect your lines.