Computer Task Group Inc (CTG) 2003 Q3 法說會逐字稿

At this time, I would like to welcome everyone to the Computer Task Group third quarter 2003 earnings release conference call. (OPERATOR INSTRUCTIONS). Thank you. I would now like to turn the conference over to James Boldt, Chairman and CEO. Please go ahead, sir.

Good morning, everyone. This is Jim Boldt. I want to thank you for joining us this morning for our third-quarter 2003 earnings conference call. Joining me is our CFO, Greg Dearlove. (indiscernible) the call this morning, Greg's going to begin with a review of our financial results; after his review, I'll talk about trends we saw in the third quarter and what we anticipate in the fourth quarter of the year. And then we'll open the call up for questions. Greg, if you would start us off, please.

Thank you, Jim, and good morning. Before we begin, I want to mention that statements made during the course of this conference call that state the Company's or management's 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 SEC filings.

For the third quarter of 2003, CTG's revenues were $61.1 million. Net income was $340,000, and net income per diluted share was 2 cents. The third quarter sequential decrease in revenue was in line with our expectation, and reflected one less billing day and the seasonal impact of increased vacation and holiday time. Our net income and diluted earnings per share came in at the high end of our guidance due to our continued attention to controlling costs in all aspects of our business.

Our direct profit percentage declined to 26.8 percent in the third quarter from 27.2 percent in the same period last year. However, our operating profits increased to 1.3 percent during the current quarter, up from 0.8 percent in the comparable period last year.

Excluding the impact of our accounting change in 2002, this is the ninth consecutive quarter that the Company has reported profitability. SG&A decreased by over $800,000 in the third quarter versus the same quarter last year, and approximated 25.5 percent of revenue, an improvement of almost 1 percentage point from last year. Revenues from IBM were $13.1 million in the third quarter 2003 versus $12.2 million in the third quarter of 2002. Revenues from our European operations were $9.6 million in 2003, as compared to $8.9 million in last year's third quarter.

On the balance sheet, our days sales outstanding and receivables decreased to 66 days from 67 days in the second quarter of 2003, and from 68 days in the third quarter of 2002. Long-term debt continued to decrease, dropping to 6.9 million as of September 26, 2003, down from $7.6 million at the end of our second quarter and $13.2 million from a year ago. This is the lowest level of debt that the Company has had since the first quarter of 1999, when we acquired Elumen Solutions. We expect that long-term debt will continue to decrease during the fourth quarter of 2003.

Our cash flows reflect an increase in cash during the quarter of $961,000. After making $391,000 in capital acquisitions and recording depreciation expense of $838,000. Also, total employment in the third quarter continued at 2700, of which approximately 85 percent were billable employees.

Jim, that concludes my summary of the Company's financial results for the third quarter.

Thanks, Greg. In general, we're feeling better about our business and the market conditions than we have in some time. In the third quarter, we once again saw strong demand from our strategic staffing business. This is the fifth quarter in a row that we've reported increased demand for staffing. Since August of 2002, we've added 50 percent to the number of recruiters that are in our strategic staffing group. We did not add to recruiting in the third quarter of the year; but given the demand we are currently experiencing, we expect to add another 15 percent to that group's recruiting organization by year end.

As to our solutions business, we think we're seeing the very first signs of a recovery in that area. We're talking to more customers about larger development and integration projects than we have in years. The vendor allowance project that our retail group started in the third quarter of the year is a good example. It started with a small feasibility study in the second quarter of the year, and we are now into the larger development stage of the project, which will take a little less than a year to complete. I don't want to leave you with the impression that the floodgates are about to open, and there's going to a massive amount of D&I (ph) work to do. It doesn't appear that it's going to happen that way. It does seem, however, that some of our customers are starting to feel more comfortable with their business outlook going forward. And they're beginning to look at larger, multi-year IT investments. We think that the recovery in development and integration work will probably occur a lot like the improvement in our staffing business, which did not rebound all at once, but rather has been getting progressively better each quarter. We closed one new $5 million AMO in our health-care practice during the third quarter of the year, and we continue to engage in outsourcing discussions with a number of customers.

As to our health-care group, our business remains strong. We continue to see a lot of opportunities for development and integration projects going forward. Our newly launched life sciences vertical is performing well. As we mentioned in our press release, we are working on 21 CFR Part 11 compliance work at several large pharmaceutical companies.

Our retail vertical is getting a good response from customers looking for vendor allowance and customer relationship management work. Revenue from our financial services vertical was stable in the last quarter.

As to business in Europe, business in Belgium continues to pick up. Luxembourg and the UK remain stable. And the Netherlands is the only remaining Company in Europe where we have an excess bench (ph) issue. We changed our approach to managing the excess bench in Europe since our last call. After reducing the European bench to a more manageable level earlier in the year, we elected to try and place the remaining excess versus for the last. That approach has been working, but it will take a considerable amount of time to get the remaining bench back to a normal level. We therefore decided in the third quarter of the year to lay off some of the staff that had been on the bench for all of this year. And the severance associated with those layoffs in the third quarter of the year reduced earnings per share by approximately 1 cent. We plan to further reduce the bench in Europe in the fourth quarter of the year, and cost to do so, which also approximates 1 cent per diluted share, is reflected in our fourth quarter EPS guidance.

For the fourth quarter of 2003, we're forecasting revenues in the range of 63 to 65 million. While there are 66 billing days in the quarter, as typical in the industry, we anticipate the normal slowdown during the holiday season. Given the revenue forecast, we expect earnings to be in the 2 to 4 cent per share range in the fourth quarter of the year.

As to the future, we continue to remain guardedly optimistic. Staffing demand has increased for five quarters now. We are seeing increased interest in AMOs, and the very first signs of a recovery in development and integration work. All in all, we believe that the worst of times are behind us.

With that, I would like to open the call for the questions if there are any. Operator, would you please manage our question and answer period?

(OPERATOR INSTRUCTIONS). We will pause for just a moment to compile the Q&A roster. Your first question comes from Rick D'Auteuil of Columbia Management.

Good morning.

Hey, Rick. How are you?

Hey, just -- I wanted to get at the margins a little bit and sort of the leverage to the model. Today, I think if we kind of crank through -- and this probably includes your severance expand embedded in there -- but it looks like the operating margins are fairly steady at say 1.3 percent. Again, that embeds probably a little bit of severance, so maybe not an operating kind of number; but in the ballpark, right?

Right, that's correct.

Okay. What do you think if -- if you look back at history -- what do you think is sort of a normalized operating margin in more normalized times?

We think normal operating margins for CTG would be between 7 and 8 percent. If you look back to the early '90s, that's pretty much what the industry was doing before the Y2K run-up in the latter part of the '90s. And it depends on what your mix is between staffing and solutions work. We are assuming that ours is going to be about 50-50. Staffing should be at least be able to get a 5 percent operating margin. And solutions work (ph), we should be able to get 10 percent. So what we see going forward is the margins going up to about 7.5 percent. If I were to have to predict I guess where that would be in terms of direct profit and SG&A, our direct profit should go up to probably 28, 29 percent. The severance that you mentioned -- the unusual severance from Europe -- actually had reduced the direct profit by about 0.4 of a percent. So right now, it's around 27.3, kind of on a normalized restated basis. And if Europe were performing more normally, in other words, if we didn't have as much bench etc., we'd probably be around 28 percent. We think as the solutions business starts to grow in terms of our mix. we'll probably go up to more 29 percent.

And then in terms of the SG&A, currently, we are running about 25.5 percent. We have run, in the past, and I believe we can in the future, run at a 21 to 22 percent ratio. So that's how you get it to the 78 percent operating margin.

Okay. And given what you've done to overhead, today, roughly 250, 255 in million in revenues kind of run rate -- how much to get to -- I assume a lot of that margin is going to be revenue driven. We've kind of got through the breakeven point and there's leverage to the model. What level of revenues, say on a 50-50 mix, staffing and solutions, do we start seeing numbers -- margins -- like 7 and 8 percent?

I think it would have to be something over 300 million in revenue? It's probably going to take us 2 to 3 years in a normal market, perhaps, to get back to that.

Okay. Thank you.

Okay. Thank you.

Your next question comes from Michael Keller of McDonald Investments.

Hi, Jim.

Hi, Mike; how are you?

Good. Actually, Greg, I missed the CapEx number. If you have that one,. that would be helpful.

The CapEx was $391,000.

Okay. So you said you added 961 -- net increase in cash. Do you have the operating cash flow number?

The operating cash flow should be, for the quarter, is $2,022,000.

Okay. Thank you. If you could, Jim, we've talked in the past a little bit in a qualitative fashion, anyway, about the impact of the -- of the competitive impact -- of the offshore model. Maybe you could just give us a brief update -- I think it's maybe been a couple of quarters since we've talked about this -- but maybe as far as what you're hearing from customers, at least anecdotally, about their desire to move work offshore -- about what they're willing to send over their versus what they are not willing to send over there. And maybe also as it regards to the AMO business, in particular?

It's a pretty mixed bag, actually, depending on the size of the customer in their appetite for risk. Clearly, we have seen a lot of the larger companies send their development and integration work over there. And anybody who has ever programmed knows that if you are doing development and integration work, in particular in the software business, where there is a very specific specs that you are working off of, once the specs are developed, you should be able to make a program or program into those specs anywhere. So that's kind of at one end of the spectrum. The other end of the spectrum that we've seen people try to send over is the application management business. And a lot of that is interacting with the users -- making various short, quick change, kind of on demand. And in the case of the leasing (ph) back (ph) sending offshore has not worked particularly well. So obviously, the Indian firms are promoting it.

Our strategy, as you now, is to go after the large staffing opportunities in the United States, but particularly from the technology service providers. And then go to market in verticals where the business expertise that you bring is probably more valuable than the cost of the programs, where you know exactly how to do a vendor allowance program, for instance. So you can bring best practices to the customer. In the AMO area, we have changed, actually -- this goes back to July of 2001 -- and we targeted our AMO efforts to mid-tier companies where we don't see that much of an appetite go into India. If you have a relatively small IT department, they have part of it working in India just doesn't function as well; they just don't get the payback. And also, to do transitional outsourcing, for instance, if a customer wants to go to SAP, needs to move their programmers over to work on the new implications, we will back them -- behind them. And often, if it is a fixed project, it's often scoped out to only last for a year. We have some AMOs that were only supposed to last for a year. It started eight years ago and we're still working on them. So, the transition period can be a fairly long period of time. In the smaller companies and in the transitional outsourcing, we don't see the offshore activity, really at all. -- because -- for instance, when you're doing a transitional outsourcing, the cost of the transition to move it over to India is often fairly high (inaudible).

Right. Kills the (indiscernible) on the labor, right?

Right.

Okay, that's helpful. Just to shift gears, any update on the timing as far as when we are going to hear from IBM on the vendor list?

I suspect that will be certainly before the end of the year. As we've told you before, I think we expect this to be a normal renewal. We have gone through this with IBM many times in the past.

Okay. And finely just on the tax rate -- I guess it's been 42 percent now a couple quarters in a row. What is the right way to look at that going forward? I mean, maybe it's a little bit above historical and/or peer averages. Is this related to the European business? Or is there something else (indiscernible) that number? Or basically, just what should I look for in the next couple of quarters?

I'm going to ask Greg to answer that one.

We -- it will go down as our income goes up, obviously. Right now, it's being driven, along with European influence, also, a heavy state influence. So it might look a bit high. I think you mentioned it might be running a little bit high. It will run high as we stay closer to the income levels that we are at. It should decrease as we improve income as the years go forward.

I think if you look back Mike, historically, we generally run between 39 and 40 percent -- once the income is up to a more realistic level.

Okay. That's all I had. Thank you.

Okay. Thank you.

Your next question comes from Jay Wigdale (ph) of Lakefront Partners.

Good morning. In your press release, you talked about this health care win being, you know, a multiyear contract. Can you -- did you actually generate revenue in the quarter on this contract? And can you disclose or discuss roughly the parameters of the size, and how that would ramp?

There is probably a full-year (ph) contract if I recall correctly, and probably hit about half, I think, of the staff on board during the quarter. So we definitely are adding to the staff in the fourth quarter of the year; so we will get some benefit in that quarter.

Can you disclose the size of the contract?

It was 5.5 million.

Okay. And then you also talked about a significant engagement on the retail side. Can you also just give an idea on the start date of that, as well as the size and length?

Sure. There was a small feasibility study which was probably a couple hundred thousand dollars in the second quarter of the year. The project itself is going to be a little less than 2 million. It started up in the third quarter of the year. And will probably end in the first quarter of next year.

Okay. And then -- in the staffing business -- I guess, you commented five quarters in a row of improved demand there. Can you comment about the pricing now that, you know, clearly, you've seen a trend there? Has pricing improved at all?

Unfortunately, I wouldn't call it improved. Last year, we were under tremendous pricing pressure. And most companies, I think, had to reduce their prices. Unfortunately, we also had to lower our employees' salaries generally when we did that. We had a little bit of pressure in the first quarter part of this year. But in the second and third quarter, pretty much abated. We are not hearing any large customers saying that they want significant reductions in their bill rights. And conversely, there's little to no opportunity to raise rates either. But as I mentioned before, we pretty much have been adjusting people's salaries in tandem with that. So the margins at least stay about the same.

And can you maybe just -- you commented that your debt is at the lowest level it's been in for quite a while. Strategically, should we anticipate you getting back in the acquisition game? Or what is your philosophy going to be at this point, as regards to that?

Well, we are reaching that point. We would like to get our debt virtually paid off before we actually do an acquisition. And at the rate that we've been going, that's going to be in the next couple of quarters. Most likely (indiscernible). We think it's very possible that we will get down to zero between now and the middle of next year. We do plan on doing acquisitions going forward. But as you know, the Elumen one was fairly large; it was $90 million. And we borrowed about $44 million. So we wanted to pay that debt down first.

We have areas in our verticals now that we would like to augment for an acquisition. And we still have other vertical areas where we don't currently have any expertise where we'd like to perhaps buy a smaller company just to see the vertical, to get it going. But we've -- it's been a big change for us, because for probably two or three years, if somebody had approached us and said, are you interested in buying us? We said no, we are working on getting our debt down. Since the beginning of the third quarter, we are starting to look at the acquisition targets and selectively saying, "Okay, we'd like to sit down and talk to you on this one."

Okay. Thank you.

Thank you.

(OPERATOR INSTRUCTIONS). Your next question comes from Rick D'Auteuil of Columbia Management.

Just a follow-up to the last point. I know the banks, to-date, have had, I think, covenants that have prevented you from looking at buybacks. But as you move and eliminate the debt or come close to eliminating it, I would think as you renegotiate the covenants on these things -- is that something that you would bring to the table? It seems to me like, at your valuation, 25 cents on the revenue dollar, you're on the inexpensive side of sort of the peer group today. And, is that something that would be put on the table in addition to I guess bolt-on acquisitions?

Absolutely. The stock is at a very attractive price. As I mentioned, we are not 100 percent excluded from making any repurchases of our own stock. But it is very restrictive at the moment. Once we get the debt down so we are essentially kind of in a mode of being zero to a slight amount of debt, the covenants will dramatically change and we will have more flexibility. It's at an incredibly attractive price right now. And we think it would be accretive to earnings per share to repurchase stock.

Thank you.

Okay.

Your next question comes from Jay Wigdale of Lakefront Partners.

If I could just follow on to that, what is the debt level to where the bank has you tied up? And why have you not chosen to go and get that waved at this point?

Well, I'm not sure there is a magic number. I think that if we were to sit down with the banks today that we would get a lot different covenant than we got a year ago or to two years ago, certainly. I think that the existing bank agreement goes back two years. We do have the ability to make some repurchases under the existing agreement. When we did the loan agreement, we didn't feel that it was imperative that we have a free hand or a relatively large number. I think that if we approached even our existing bank group today and said hey, we want to increase the number, that they would sit down and allow us to do more. We just haven't done it because, I guess, we have been striving to get the debt down to a relatively low number, so we kind of continue in a normal mode of occasionally buying our stock or doing acquisitions.

And I'm sorry, you may have said this earlier. What percentage of revenue right now is coming out of Europe?

It generally runs around 15 percent -- I think in the last quarter, actually.

At this time, there are no further questions.

I would 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 now disconnect.