Computer Task Group Inc (CTG) 2002 Q3 法說會逐字稿

Good morning, my name is Judy, and I will be your conference facilitator. At this time, I would like to welcome everyone to the CTG third quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time simply press star then the number 1 on your telephone keypad. If you would like to withdraw your question, press star then the number 2 on your telephone keypad. Thank you. I would now like to turn the conference over to Mr. James Boldt, chairman and CEO of CTG. Mr. Boldt, you may begin your conference.

Thank you. Good morning, everyone. This is Jim Boldt. I want to thank you for joining us this morning for our third quarter 2002 earnings conference call. Joining us this morning is Greg Dearlove, our CFO. Before we begin, I want to mention that statements made in the course of this conference call that state the company's or intentions, hopes, beliefs, expectations, and predictions in the future are forward-looking statements. It's important to note that the company's actual results could differ materially from those projected. Additional information concerning factors that could cause actual results to differ from those in the forward-looking statements is contained in our press releases and, from time to time, in the company's Securities and Exchange Commission filings. With that out of the way, I'd now like to discuss our quarterly results. For the third quarter of 2002, CTG's revenues were 62.1 million, net income was 141,000, and net income per diluted share was 1 cent. Revenues from IBM were 12.2 million in the third quarter of 2002 versus 17.3 million in the third quarter of 2001. Revenues from our European operations were 8.9 million in the 2002 third quarter compared to 10.7 million in last year's third quarter. Our revenues and earnings for the quarter were within our revised guidance. It is clear that many development and integration projects continue to remain on hold as clients contain their expenditures, given the current economic situation. Somewhat surprisingly, application management outsource, the contract side, have also started to slide, despite the compelling benefits that they yield. There appears to be at least two causes of these delays. While AMOs reduce the client's cost over the life of the contract, there's often an incremental cost to the customer during the initial transition phase. Understandably, customers are trying to time that cost in a period when they can best afford it. Secondly, there's no doubt that IT departments have been significantly scaled back. Not only has the technical staff been reduced, but IT management has been stretched as well. In the initial stages of an AMO, there's a significant amount of client management time required until the AMO is operational. With responsibility for multiple projects, an AMO is generally not considered mission-critical, we're often put on the back burner until more urgent problems are addressed. While many of the AMOs that we're pursuing are being delayed, we're confident that our clients will eventually move forward with them, given the compelling financial benefit that the AMOs produce. Our perception of the staffing market is a little bit different from what we've heard from others in our sector. Comparing demand from customers that we had, both in the full second and third quarters, we would say that we say a modest quarter-to-quarter increase in demand in the U.S. Most of our customers have significantly cut back on their IT staffs, and many technical employees are already working overtime. As such, when a new change is required, customers often don't have anyone available to handle the added work and therefore go outside for additional staff. Why the difference in views in companies in our sector? We believe it's because we all have a significant difference in the mix of our customers and therefore may experience different demand trends from time to time. A significant part of our strategy for our staffing business is to sell new preferred vendor contracts. We've been successful in signing several new contracts and, as a result, our strategic staffing group, which has responsibility for most of our large U.S. staffing customers had a 4-percent increase in billable headcount during the third quarter of this year. Demand has remained strong in the first couple of weeks of the fourth quarter, and we continue to add to our recruiting staff in order to meet that demand. As mentioned in our press release, our health care business remains strong with more than a 20-percent increase in revenues for the first nine months of 2002. Most of our health care business is with providers who generally rely on packaged software solutions. While our HIPAA assessment and security business has exceeded our expectation, we've not done any significant work on remediation, as none of the major supplier of health care packages have released their HIPAA-compliant software. As the compliance date for the transaction process is now only a year away, we'd expect that much of that business is going to fall into 2003. As to Europe, demand remains weak, and while we have reduced our [inaudible] in the last quarter, it still remains higher than we would like. Unlike the U.S., we've not seen any signs that IT demand within the European market has reached a stabilization point. I'd just like to take a couple of minutes to talk about the impairment charge. Almost all the charge relates to our 1999 purchase of Elumen Solutions, now called CTG Healthcare Solutions. Although our health care group's revenue and profitability dipped with the rest of the industry in 2002 and 2001, it's revenue and profitability today were about the same as they were when we purchased the company in 1999. Unfortunately, the new accounting pronouncement essentially requires that we record acquisitions for no more than the amount that we could sell the business for today. In 1999 valuations of technology companies were relatively high compared to today's multiple. The NASDAQ, for instance, was approximately 2,500 when we acquired Elumen in 1999 and destined, a little over a year later, to reach 5,000. As you know, the NASDAQ today is around 1,300. The charge relates to the lower valuations for IT services companies, and reflects the fact that if we had to sell our health care group today, we would not receive the amount of money that we paid for it in 1999. As I mentioned before, the business itself is doing very well, with over a 20-percent growth in revenue this year. It's unfortunate that they've changed the rules, causing us to take this charge, but I'm glad that we have our health care business, as it has been a strong contributor to the company this year, and I believe that it will continue to be a significant contributor to the business moving forward. As to the fourth quarter, we're forecasting headcount to be flat to up modestly, for rates to stabilize, for a lower amount of vacation time, and, of course, for two additional billing days. Those assumptions produce a revenue forecast in the range of 63 million to 65 million and earnings per share of 1 cents to 3 cents. Before I open the call to questions, I know you need some additional information to complete your model. At the end of the third quarter our day sales outstanding stood at 68 days. Depreciation for the third quarter was 871,000, and our capital expenditures were 320,000. Total employment was, at the end of the third quarter, 2,800 - approximately 85 percent of which were billable. I might add that our total personnel was the same at the end of the third quarter as it was at the end of the second quarter and that our billable headcount was up just slightly. It's the first time that our billable headcount has increased since the fourth quarter of 2000. Our belief is that the business has stabilized. Now it's up to us to get it to grow. I would like to open the call for questions, if there are any. Operator, would you please manage our question-and-answer period?

Yes, sir. At this time, I would like to remind everyone, if you would like to ask a question, please press star, then the number 1 on your telephone keypad. We'll pause for a just a moment to compile the Q&A roster. Your first question comes from [Bill Sutherland] with Commerce Capital Market.

Hey, Jim.

Hey, [Bill], how are you?

I'm good. Can you hear me?

Yeah.

Okay. I've had trouble with the headset. How big was IBM in the quarter?

Our IBM revenues were 12.2 million.

How does that compare? I don't have that in front of me.

Last year it was 17.3 million and last quarter it was 12.9.

Okay. So as far as the preferred vendor trend being slightly positive, IBM is not participating in that?

Well, I wouldn't necessarily say that, because what often happens, as you well know, is during the summer months more of our employees take vacation than they do any other time of the year. So we get a dip in our revenues from IBM and everywhere in the third quarter versus the second, even if we hit the same number of employees. So the IBM trend, if you look at the number of employees, would be up versus flat.

Okay.

Can I just add a little bit to that? We did add a couple of new large contracts during the quarter, obviously, that helped us, and if you look at the company, in total, our billable employees are up just a little bit. Actually, billable employees in the U.S. increased by about 2 percent in total during the third quarter, and the employees in Europe dropped by about 7 percent, and we're still in the process of trying to reduce our billable employees in Europe. Unfortunately, we've got some statutory limitations that we have to deal with. But our sense is that the trend for staffing in the United States improved during the third quarter - probably improved each month with, clearly, September being the best of the three months.

So that's Q3 over Q2, right?

Yes.

Okay. In my model I noticed the gross margin was off a little bit, and I wanted to ask if that was third quarter utilization or more mix?

It's utilization in Europe. The utilization in the U.S. is back to what it's traditionally been. In Europe if you're severing a person, their severance is determined by statute, and it's often fairly expensive.

In terms of revenue, where were you internationally in the quarter?

Our revenues in Europe were 8.9 million. So it was about 14 percent of the total business.

Okay. What is the strategy for Europe as you look ahead a little bit?

Well, first we've got to stabilize the business over there. Our strategy is actually the same for the entire company, so they're pursuing application management outsourcing business. They're looking for new, large preferred vendor transactions, and we don't have a health care presence in Europe, unlike the U.S., because their health care is often controlled by the government. We've just elected not to [inaudible].

And the last thing, Jim, on HIPAA, if you can help us, or tell me if anything has happened to the deadlines that had been in place. Has there been any slippage that would have changed the - where revenues were likely to be realized in the next year or so?

Well, the slippage actually occurred almost a year ago. The government came out and said that they were going to stick with their original date. So, for instance, October 16th of 2002 was the original date for transaction processing, and I think it was last December they modified that and said that if a customer had a plan to do the remediation and become compliant, they would give them an additional year if they filed a request to do so with the plan. So I'm sure virtually everybody is filing for that extension, and that gave them until October 16th of 2003 to be compliant. That's forced most of their business, really in it.

And that category was the processing?

Print and processing - so, you know, sending information between the payors, from the hospitals or doctors to the Blues, for instance.

Is that the lion's share of what they have to do?

It's a pretty big share, and it's actually the very first of the dates. The other dates are for security and privacy and they actually were a little farther out. So they kind of get over this hurdle first. It may be very expensive for the hospitals to meet the privacy, for instance, but there's not much IT work in it. Most of the IT work is in the transaction processing and then security.

Are you guys going to try to get positioned for security?

Absolutely. We're actually doing a fair amount of security work now. That is something we've actually exceeded what we though we'd do by now.

Okay, great, Jim.

Okay, thanks.

Your next question comes from [Michael Keller] with [McDonald] Investments.

Good morning, Jim.

Hi, how are you?

Good. Just a few things to go over - the 4-percent increase in billable headcount in staffing, did that impact utilization this quarter a bit?

I think the utilization was probably about the same for our technical employees, other than they took more vacation time third quarter.

Okay, so the fourth quarter upside is based on, as you said, stable billing rates, probably some increase in headcount but not necessarily a move in utilization?

Well, the increase in utilization would be based upon there's less vacation taken in the fourth quarter. Often, for instance, from the second to the third quarter we could lose as much as 2.5 percent on the utilization just because people are taking their vacation during the summer months.

Okay. I know you don't specifically discuss bill rates on the staffing side, but I think in the past you've, at least, qualitatively discussed what bill rates are averaging for staffing along the lines of - well - I'm sorry - whether a bill rate is averaging in your health care group, in the staffing group, and in the development and integration side. I just wondered if you had any indication as to pricing or bill rates in those three divisions?

Sure. You know, our average bill rate at the moment is around $60. It's twice that for our health care group. The health care business has been very strong. They tend to be higher-end consultants versus perhaps programmers. The general business, if you will, for instance, development and integration, any projects or anything like that, the bill rates are probably $70 to $80 range and for staffing the rates tend to be on the lower side. So it's probably somewhere in the low 50s.

Right, okay. And continuing on the staffing for just a second, again, qualitatively in the last quarter, certainly, you discussed a little bit of the - you offered some color as far as vertical - forms in the various verticals, you know, you said telecom was notably weak last quarter; not surprisingly, financial services, you said it was actually leveling off a little bit, and then you talked about your IBM. I just wondered, you know, can you update us a little bit on any areas of things getting better, things getting worse among the verticals? I mean, I assume telecom is still rough. Financial services, you know, well, you told me I haven't seen much material change at the margin in terms of demand trends. Do you see any strength in any of the areas, specifically, or do you see further contraction on the flip side?

Well, we haven't come up with a good name for the group. Gartner refers to it as "service aggregators," I think they call it, which is the large companies who purchase some of their staffing needs - companies like IBM, EDS, et cetera. And the trend there would be up slightly, at least from the demand in the second quarter to the third quarter. The telecoms, when you look at it on a comparable basis, is still very weak. We're fortunate that we didn't have a big book of business in the telecom industry when the downturn hit in that sector, and financial services actually has been pretty good from an opportunity standpoint. A lot of it, though, has to do with the application management outsourcing. Like everybody else, they're looking for ways to cut their costs and I think, in general, there's a sense in the New York City area that some of that work should be at other locations.

Right. Do you have a sense of if there is some emerging positive demand trends among the staffing aggregators, any sense - at least your opinion, anyway, of what could be driving that at this moment?

I think a lot of it is - you know, I've met with several CIOs who told me that they were worried because their staff has been stretched so far that they're literally worried about some of them jumping out of a window. You know, all companies have tried to cut back. Often, the demand from users doesn't necessarily decline. Often it will go up when their staffs are cut - the user staffs are cut - if they get more IT support, obviously, it's easier for them to deal with it. And I think that they're just getting to a point that if something comes up that they have to do, they have no slack in their system, they have to go outside, and that's one of the reasons, I believe, that we're seeing demand start to pick up a little.

Yeah, so with both - with respect to both external and internal IT staff, this is sort of consistent with a few things I've been hearing, too - a lot of companies are just at the breaking point. I mean, they have - and it would seem that there would be some indication of a bottom as far as both internal and external staffing levels, broadly speaking.

That's right, and this is pretty consistent with what happened in other downturns. Our customers are telling us that when the uptick happens, they want to add more independent contractors rather than their own internal staff, partially because of the Wall Street problem. I mean, everybody kind of reports what their employment is to Wall Street but also to give them the flexibility. If the economy is a little bumpy, they can flex the additional staff that they hire somebody - it's much more difficult to let them go. So I suspect that if there is an uptick in demand, you're going to see most companies go outside versus they add to their own internal staffs. Right now, as you said, they are pretty stretched.

And they tend to like the liquidity in the staffing labor in that scenario, too.

Right.

One final thing - what are - I haven't heard the number of office locations in a while. I'm just wondering if you have, you know, any consolidation opportunities on that side to sort of drive out any SG&A?

Well, we've actually done a fair amount of that. We still have nearly 50 offices in this quarter that I can think of closed in. We're right now focused more on how we can get the top line up. We think we've done a fairly good job at managing our SG&A quarter-to-quarter, given what revenues we have. And we do look at consolidating offices, but pretty much in 2001 we did a lot of that.

Okay, terrific. Thanks.

Thanks, Mike.

Again, if you have a question at this time, please press star then the number 1 on your telephone keypad. The next question comes from [John Daysher] with [Royce].

Good morning.

Good morning, [John].

Following up on the prior question - the offices now - how many did you have at the peak, say, a couple of years ago?

Oh, well, I would guess it was probably over 60 at the peak. I'd have to go back and look. That would have been in '98.

Okay. It looks like you're tracking at about $260 million a year in revenues, which translates to 5 to 10 cents a share in earnings power. What you're telling us is that the earnings aren't going to go up unless sales go up. In other words, there's no major cost-reduction opportunities that could be put into place?

Well, I'm hoping I didn't convey that. It's a question of what do you do, going forward? Most of our cost is variable, so we should be able to further reduce cost, particularly if the business doesn't expand. At the moment, what we're looking at is a fairly significant increase in demand, and the area where we don't have enough people, really, to respond to it is in recruiting. So we have plans - we actually put something in the third quarter, though. If you looked at our SG&A, quarter-to-quarter, it obviously dropped. It was about 17.9 in the first quarter, 17.3 in the second, and it was down to 16.14 in the third. If demand really is coming back, in order to respond to that demand, we have to add recruiters and we also believe it would be beneficial to add salespeople as well. Obviously, they're a component but not the largest component of our SG&A in total. It's kind of a question of has the industry bottomed out and is it starting to pick up? Certainly, if you were to look at our demand by month and look at September and the first part of October, you'd say that there were indications of that. Or is demand going to remain flat, and therefore we should continue to cut costs. And, at the moment, unless the demand changes, we're inclined to see if we can't grow the top line.

Okay. If, by chance, it does remain flat, though, what, specifically, can you do to reduce costs?

We obviously, when we booked our offices, for instance, we shut the ones that we thought - or combined. Actually, we usually let another city take care of that business -- there would be more room for office consolidation. We've cut back a fair amount in our corporate office. We actually, if you go to every department except for sales, we cut back in the last year. Our sales department is the only one that we increased, this is a pretty variable business. The problems that we have where we can't react in a quarter or so tend to be more leases, they tend to go out for a few years, and the capital expenditures you kind of sunk into - once you get beyond the two of those, most of your cost is really variable. Now, we usually figure that our cost of personnel is probably at least 75 percent of our total cost. So we vary the number of people.

So the 50 offices - that's kind of your critical mass. If you were to consolidate or close further, you might impair your ability to capture contracts?

Right, this additional demand that we're seeing currently, that's right. But if the demands are not there, we'll take a different course.

Okay, so you could consolidate or close additional offices?

Sure.

Okay. On the balance sheet, I know you took the write-off - the other assets number of 40.3 million in '02, what does that include in terms of additional intangibles or goodwill?

There's 37.3 million of goodwill in that number.

The other 3 million or so is what?

It's just longer-term assets if we have anything that is of value more that is over a year. It would go into that category.

And the goodwill - is that vulnerable to write-offs as you do your tests annually, going forward?

You know, it certainly is - you have to test at least once a year for the value of the business that you bought, but, quite frankly, our health care business is showing an uptick. We think that we've recorded a relatively conservative amount for what we could get the business for, and because we've taken the adjustment now, we're not - at least at the moment - expecting to have to take one again. We think we've got it pretty fairly valued, and if it continues to grow at the current rate, then it shouldn't be an issue, going forward. I've been thinking about it - I don't have the list - but the other thing in other assets, I think, is some long-term deffered taxes.

Okay. So the 37.3 that remains, that's all related to Elumen?

Yes, it is.

And so you just did the test, so you have another year before you do that again?

Well, actually, we have to do it, I believe, at December 31st of this year, but, certainly, if we were to do the test today, we won't have a charge this year. The first test we had to do was as of January 1st of this year.

Great, thank you.

At this time, there are no further questions. I will now turn the call back over to Mr. Boldt for closing remarks.

I'd like to thank you for your continued support and for joining us this morning. Have a great day.

This concludes today's conference call. You may disconnect at this time.