Computer Task Group Inc (CTG) 2004 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the CTG first-quarter 2004 earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded. I would now like to turn the conference to over to our host James Boldt. Please go ahead.

Good morning, everyone. This is Jim Boldt. I want to thank you for joining us this morning for our first-quarter 2004 earnings conference call. Joining me is our CFO Greg Dearlove. As to the format of the call this morning, Greg is going to begin with the review of our financial results; after his review I will talk about the trends we saw in the first quarter and what we anticipate for the second quarter of 2004, and then we will open up the call for questions. Greg if you could start us off.

Thank you, Jim and good morning. Before I begin I want to mention that statements made in the course of this conference call that states 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 first quarter of 2004 CTG's revenues from continuing operations were 61.4 million. Net income from continuing operations was about $800,000 and net income per diluted share was 5 cents. We also incurred a loss from discontinued operations of approximately $4.3 million resulting from the disposition of our Dutch operating company.

This loss included $3.7 million related to the actual loss on the sale of the subsidiary, approximately half a million dollars relating to a foreign currency adjustment that was previously reported as a direct charge to shareholders equity. And approximately $100,000 in operating expenses which had been included in the Dutch holding company that will be eliminated because of the disposition.

Our first-quarter revenues from continuing operations were in line with our expectations. Our net income from continuing operations and diluted earnings per share slightly exceeded our expectations because of favorable March results. Our direct profit percentage increased to 27 percent in the first quarter, up about 6/10ths of a percent for the first quarter last year, and our operating profits increased from 1.2 percent last year to 2.3 percent in the first quarter this year. Excluding the impact of our accounting change in 2002 this is the 11th consecutive quarter that the Company has reported profitability from continuing operations.

SG&A decreased by over $469,000 in the first quarter versus the same quarter last year, and approximated 24.7 percent of revenue, an improvement of almost half a percentage point from last year. Revenues from IBM were 14.2 million in the first quarter of 2004 as compared to 13.1 million in the first quarter of 2003. Quarterly revenues from our European operations were $10.2 million in 2004, as compared to 7.9 million in last year's first quarter.

On the balance sheet our days sales outstanding and receivables increased to 71 days from 62 days in the fourth quarter of 2003 and from 64 days in the first quarter of 2003. Long-term debt was just under 9 million at quarters end, up from having no outstanding debt at year end but down from 15.6 million at the end of the first quarter of 2003.

Our cash flows after adjusting for the sale of our Dutch operation reflects an increase in cash during the quarter of approximately $700,000. This is after making $556,000 in capital acquisitions and recording depreciation expense of $732,000. Also total employment in the first quarter was 2500 of which approximately 85 percent were billable employees.

Jim, that concludes my summary of the Company's financial results for the first quarter of 2004.

Thanks, Greg. In general we are pretty pleased with the results from continuing operations in the first quarter. While demand and strategic staffing approximated that of the fourth quarter in January and early February, we experienced a delay in customers making decisions to hire candidates. We experienced that trend in (technical difficulty) before, and generally was associated with delays of budget approvals. By late February, we saw a reversal in the trend and customers not only resumed hiring in a more normal fashion but the number of requirements that we were receiving also noticeably increased. We have added about 70 percent of the number of strategic staffing recruiters since we started to see an increase in our staffing demand in the third quarter of 2002. We are currently adding an additional 10 percent to that group's recruiting staff given current demand.

As to our solutions business, we had several long-term projects that came to an end in the first quarter of the year. It is a normal part of the solutions business when you're engaged for a specific project, at some point that project is completed. As you know, the problem with the solutions business in the last couple of years has been more multi-year projects are being completed than started.

As we mentioned on last quarter's call, however, we think that we are seeing the very first signs of a recovery in our solutions business. We think that the increase in the solutions business will happen like the improvements in the staffing business, slowly over time versus a dramatic resurgence.

Our healthcare group had another good quarter and we continue to see a significant amount of demand for development in integration projects going forward. Two large projects that we'd originally expected to start up in the fourth quarter of last year are just beginning to ramp up now. As a result of those projects we expect we will have a double-digit increase in revenues in our healthcare business in 2004.

Our life science's vertical is performing extremely well, not only did we continue to work on 21 CFR Part 11 compliance, we'd begun to cross sell other services such as the AMO into that sector. Revenues from our financial services vertical declined in the first quarter of the year, both are the projects that I previously mentioned that ended in the first quarter were in the financial services sector. We are in the process of introducing new offerings into our financial services vertical which should benefit that group as the year progresses.

As you know we sold our Netherlands operating company earlier this month to the Dutch management. I would like to take a couple minutes to just explain the background behind this transaction. In the late 1990s the Netherlands was our largest and most profitable office. When the Y2K work ended in 2000 and the world entered into a prolonged recession, the European economy suffered more than the economy in the United States, and unfortunately the Dutch economy suffered a greater loss than any other country in Europe.

The unemployment rate in the Netherlands has been around 15 percent during the last couple of years; the IT services industry was particularly hard-hit and that has not been unusual to hear that our competitors had 2 to 3000 of their technical staff on the bench at any point in time. The last couple of years we have been trying to make the Netherlands profitable again, the downsizing, that we undertook in the United States in 2000 was not possible in the Netherlands. In the Netherlands, the government tells you how many people can be laid off in a quarter, and an administrative judge determines how much severance an employee will receive. Often, the ultimate amount paid is based upon the size of the Company, that is, larger companies usually pay significantly more than smaller companies.

For years we tried our best to get our Dutch operations back to at least a breakeven point by restructuring to the extent allowed by law each quarter, despite all of our efforts last year our operating loss for the Netherlands was $2.4 million dollars. As shutting down the operations in the Netherlands would have been very costly, we came up with an alternative transaction that we believe will benefit multiple parties. For CTG we no longer have an operation in the Netherlands and therefore will not be facing further operating losses there. The management group will end up with their own services company and given its smaller size, it should be able to operate efficiently under Dutch law.

For our customers, they won't see a disruption in service and will continue to be serviced by the Dutch management and consultants who know their business and their needs. Also want to point out that this transaction in no way reduces our commitment to the European market; our current forecast indicates our continued operations in Europe should grow this year and our operations there should turn profitable again. As to the second quarter of 2004 we are forecasting revenues in the range of 61 to 63 million.

As you know we had 66 billable days in the first quarter of the year and we will have 64 billable days in the second quarter of the year. As many of our technical staff took vacation on January 2nd, the first billable day of the year, and we lost billable hours in the first quarter due to inclement weather. The true loss is closer to one day when comparing the first to the second quarter. Our business didn't change quarter to quarter; the losses of a day would put our expected revenues in the second quarter at approximately 60 million.

Given that our guidance is 61 to 63 million for the second quarter it is obvious that we are expecting a pickup in business in the second quarter of the year. As to the earnings forecast, we know that we need to improve our margins, and we believe we will be able to increase our direct profit percentage and continue to lower our SG&A expense as a percentage of revenue over time. In the short-term, however, we see three areas that we need to invest in to further drive revenue growth in the second half of this year.

First, we need to add recruiters to our strategic staffing in healthcare groups as currently we have more demand than we can handle with the existing staff. Generally, when you add a new recruiter they have to become accustomed to your systems and the needs of their customers, so it usually takes a couple months for them to become productive. Second area of investment is also in our healthcare group, for the last couple of years we have been able to find people in the marketplace that are experienced in the packages that hospitals use.

Unfortunately, the market is changing and individuals with knowledge of certain packages are becoming very hard to find. We therefore will need to begin to hire people who have worked in the hospital and train them in certain packages as needed. But we have now recently had the need to do this to any great extent; it’s fortunately something that we have done throughout our entire history and therefore are very good at it.

The third area for investment is in information security. We have a small information security group that was originally formed to address the security needs of HIPPA. We are experiencing more and more demand for information security services from companies who are beginning their Sarbanes-Oxley assessments. We believe that information security will be a good market for us going forward and that the demand is there today and therefore we are ramping up our staff accordingly.

All the investment we are making are expected to bring us returns in the second half of 2004, unfortunately, in most areas as we ramp up we expect that there will be more cost than revenue in the second quarter although we are forecasting an increase in revenues in the second quarter versus the first quarter. With the additional investments we believe earnings per share from continuing operations to be in the 3 to 5 cent per share range in the second quarter of this year.

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

(OPERATOR INSTRUCTIONS) Bill Sutherland from Boenning & Scattergood.

Good morning, Jim. Any currency impact in numbers?

When comparing it to last year revenues would have increased by about one million and a half dollars. In the first quarter versus the first quarter of last year because of the currency increases, if you compare it to the fourth quarter it is about $500,000 of an increase. Even if you use a constant exchange rate though, the European revenues from continuing operations grew at about 10 percent year-to-year without currency fluctuations and actually about 6 percent versus the fourth quarter.

So they increased in international revenue which was 10.2 over 7.9, just one and a half of that was currency?

Yes, that's right.

On the cash flow, Greg said CAPEX was 500,000?

That is correct.

On headcount, I didn't get that, if you can repeat.

It is 2500 people, 85 percent billable.

I would just like to point out in the CAPEX; it is more obviously in the fourth quarter. If you go back and look at last year we had that same trend. We spent about 600,000 in the first quarter; we usually tend to long (inaudible) projects in Q1.

What is the viewpoint on the working cap needs this year? Do you think you will continue to need a line are will you start to build up cash balance at this point?

Well, it's going to vary quarter to quarter. Depending on whether we're on one of our biweekly payrolls or between them. The effect that we have and in tipping (ph) those every year that I've been here, the fourth quarter December 31st, is always our best collection period. We always have the lowest DSO. At the end of the first quarter it's always our highest DSO, so I suspect the DSO will come down some. The debt probably will move around a little bit, I don't think at the end of the quarter it will be any higher than it is now, it should actually drop by the end of the year. Unfortunately, the end of this year is a payroll date so we are not going to get as much of a favorable benefit as we did last year between the payroll dates. But we are kind of a company that's just starting to get out of debt, I mean, we can have a day when we will be out of debt. The end of March was probably the high water point I think for the year.

DSOs were 71 in the quarter, what was it fourth quarter? I don't have it in front of me.

Was 62 days, Bill.

This was a bigger jump than usual when I look back at '03.

That's true.

Just timing?

It's just timing, there is nothing particularly unusual other than just timing.

The projects that are ramping up and I guess primarily financial services, are they implementations of various kinds?

One was, and one was a development and integration project on a suite of applications that actually went for three years, and it is just ending. The other was what we call a transitional involvement, when the client comes to us and says they would like us to take over the maintenance of some of their applications but tells us right from the beginning but after -- in that case it was three years -- we are planning on doing something different. Often that is bringing them back in or they are moving over to SAP and they want us to maintain the legacy systems. So originally this was a three-year AMO that actually went five years, the client finally reached the point that they were ready to switch to something else.

When you look at the pipeline, I know outsourcing deals are starting to get signed again. Are you starting to see that kind of indication, too?

Yes, absolutely.

And is there a component of offshore in a lot of your deals now?

We have some now that we do offshore, we have two offshore partners, one is in India and the other one is in Russia. Depending on the type of work and the domain experience that's needed we will use them for part of the work. I would say that it is pretty rare actually that we bid on an AMO now that at least some of it, at least the development and integration portion of the work don't go offshore.

Going back to last year's second quarter, if you take out the net can you do a continuing ops sort of pro forma?

I will ask Greg that.

I would guess that the quarter is going to be up slightly from last quarter. I don't have that number right in front of me though.

In other words, the continuing op will be a little bit higher than --

It should be an improvement over the second quarter last year, yes.

Let me just explain that. We are in the process of working through that pro forma and we have to file it as an addendum to the K that we filed. Our Dutch Holding Company is also in the Netherlands, that's a holding company for the European operations and we had an operating company there and they filed a combined return and we have to go back and separate out those results and that's what's taking the time.

Thank you.

Michael Keller with Banc Capital Markets.

I think we lost the key in the KeyBanc Capital Markets. So proud of our new name here and we can't even get it right, oh well. First of all the cash flow from operations, you have that number handy, Greg, I guess.

No, I don't have that handy, Mike. Sorry.

Was it possible that it was a cash use this quarter just based on the receivables?

Yes. We have an overall cash use from operations of a little over $7 million.

That includes obviously the debt drawdown.

What about, what were the actual cash flows related to divestiture, if any? I know the income statement effects but --

Very little of cash has been used through the first quarter on that divestiture. I would think that at the end of the day we will spend about 1 million to $1.5 million in outflow of cash.

Just looking at the improvements in the gross and operating margins, I wonder if you could talk at all about what portion of the Delta there is explained by the divestiture of the unprofitable Dutch operations versus other improvements. Obviously the SG&A being lower as a percentage of revenue is a big help there but is there, is it a heavy weight of the Dutch divestiture or is that fairly minor?

The direct profit margin benefit is primarily because of the Dutch situation. As you know the problem in the Netherlands was we couldn't lay people off fast enough so there were a lot sitting on the bench so we picked up versus the fourth quarter, for instance about a little over half a percent, I think. That largely was the result of the Dutch. (multiple speakers) The SG&A is more of us continuing to drive out SG&A expense.

Right, but going forward then with an increasing or with the continued goal of adding recruiters, does that -- is that likely to keep SG&A fairly steady as a percentage of revenue here looking forward? Or do you think you can continue to -- I think you said you would probably grow expenses faster than revenue, at least next quarter. But beyond that, where does the SG&A go beyond that, I guess is what I'm asking.

That's an excellent question. In the next quarter we are going to probably going 300 to 600,000 more in SG&A expense in the three areas that I mentioned. Part of that because we are short on recruiters now and it takes a while to get them productive but we definitely want to capture some of these jobs in the healthcare group, we've had to go to outside recruiting which is very expensive to do. It's kind of a onetime shot to get the people. By the end of this second quarter I think most of that will have abated and we will be back to doing most of our own recruiting in-house again.

It will probably push SG&A expense in the second quarter up to around 25 percent. And part of the reason we do not know how much is we actually re-gauge our SG&A expense on almost a weekly basis as we see what revenues are coming in we release some of them, thus spending (inaudible) thinking about doing. Longer term I'm still convinced that SG&A expense as a percentage of revenue for CTG should drop down to the 21 to 22 percent range. It was there historically; it's unusually high now. We know that we have salespeople -- if you went back into the even early '90s you'd say that they weren't selling enough versus their cost. It's just a function of the current market particularly the solution side of the market there isn't that much business out there. So that SG&A I would think long-term, we should be able to do 21 to 22 percent. The last year or two, really, the staffing business has been better than the solutions business. We now think that the solutions business is starting to come back; it has a higher direct profit margin. We think that our normal, kind of direct profit margin should go back to the 28 to 29 percent range and that we should be able to get operating margins back up to 70 percent.

Thanks for that. As you look at the year going forward, I guess obviously you don't have a full year guidance target, but on the solution side in particular, are you looking more at I guess the two levers if you will being rates and hours, and headcount of course is the third lever. Which levers, where are you going to get the revenue growth basically is what I'm asking. Presuming that the hourly rates not a huge opportunity to grow there -- headcount obviously can grow ideally as well as and headcount and the hours is the same question. Where do you see or is it utilization driven, I guess more broadly as you look at 2004 there the balance of the year, where do see the topline growth or what are the buttons you have to push?

Clearly staffing demand is very good and that's going to be driven by headcount increases. The staffing market is more stable than it was but I don't think we are yet to the point that a general kind of staffing that we have the ability to raise prices so that will be driven by headcount growth. The other variable kind of is in your sales mix. We see tremendous demand for instance for healthcare. And our healthcare rates, bill rates run about 2.5 to 3 times what our average rate is. So as we add more healthcare people to the mix that will drive revenues because the bill rates are higher, same with life sciences the bill rates there are significantly more and in the projects business in general the bill rates are more. It's actually going to be a combination, I don't think that there will be a tremendous amount because of bill rate increases; its going to be a combination of headcount increases plus a shift in the sales mix back heavier to the solutions business, particularly the healthcare and life sciences businesses.

Okay, great, thank you.

Rick (indiscernible) with Columbia Management.

A couple of follow-ups to some of the prior questions. One, the negative cash flow, just to get a clear understanding, the negative cash flow you referred to in the first quarter, how much of that is a swing of the day that which week the payroll was paid? I mean that payroll being an off-week versus an on-week, what is that swing factor?

Most of the swing factor is being driven from our DS0 movement up. Our payroll date was actually a week before quarter end.

Okay, so it was not on a payroll week?

It was not.

If you think about it, our day sales are just under one million a day, so if the DSO goes up by seven days, that is about $7 million (multiple speakers).

The operating margin level that you referred to I think you even referenced before on prior conference calls, that one of the loose kind of time frames back six months ago when that 7 to 8 percent was mentioned, you are talking maybe two to three years out. If you kind of look in an operating model what kind of revenues, hypothetically do you need to be at to get to that 7 to 8 percent?

I think it's a number over 300 million. It's probably somewhere between 325 and 350 million.

Which implies pretty good growth from your current run rate then.

Yes.

Do you think that can be achieved internally with the kind of investments you are making? Even though you have seen some growth on the staffing side it's been sort of slow, steady, to me to get to the 325 in a reasonable period of time, 325 million in revenue on an annual basis. It's got to be more than just a half million here and a half million there. It's got to truly ramp and you think that's something that your crystal ball might include in the realm of possibilities?

If I had given out forecasts for multiple years three years ago I guarantee you I would have been dead wrong. I am no better than anybody else in forecasting the future. It equates to a revenue growth of probably between 10 and 12 percent maybe over a three-year period of time. There is no doubt that the staffing business continues to ramp up, and I think that's going to just continue going forward. What we really need is more CAPEX, more of the solutions business to kick in. What we've had in the last three years really is, and I think this is was probably true, or four years, for almost all of our competitors the staffing business began to come back. We saw nice increases in revenue growth there, and then as longer-term solutions project end as they do, you hit a negative on the solutions side. What we need is for the solution side of the business to go positive again.

More of a short term obviously that hurts your mix too with the solution side being, what's been going on is staffing is becoming a bigger piece of the equation through that runoff of solutions.

That is right, and the staffing business has a lower operating margin as you know.

The operating margin in this quarter was 2.3 percent, that's benefited from the Netherlands not being part of the equation this quarter. It sounds like with some of the spending initiatives in the second quarter, do you think that that is the short term, given your guidance it looks like you do compress margins a little bit in the second quarter. You have already said that the SG&A will be slighter higher, 30 or 40 basis points, right?

Right. You'll probably end up with an operating margin of closer to 2 percent in the second quarter but I think that's a short term one quarter event. By the third quarter I would expect the margins would go back up again.

Okay. I was going to say if these are investments for the second half of the year you start to get some benefit out from that especially as the mix starts to flip to the outsourcing side of the business.

As I mentioned to Mike, a lot of it is having to go outside and get outside recruiting, that is very expensive. I mean that is a multiple of what we pay if we use internal recruiting, but we have to do it. I mean we want to get these jobs, it is the right long-term decision for the company and the clients aren’t going to sit and wait another quarter while we ramp up our recruiting.

What was the third spending initiative? I missed that.

Information security. We have a small information security group that was originally formed to address the needs of HIPPA. It is a real solid group, it has a lot of talent in it. We brought in a new director recently. We've had more and more customers and we are talking to them and they ask us if we can do work on their Sarbanes-Oxley work. From an information and securities standpoint in order to be Sarbanes-Oxley compliant, and you have to do this really before your auditors come in, you have got to make sure that your networks are secure, your firewalls, you probably really need to do penetration testing, you have to have a disaster recovery plan that is current, it is all that kind of stuff. What we are finding is that the larger companies appear to have started their Sarbanes-Oxley work probably last year, most of the larger companies have their own internal information security people. They can do a good portion of it internally but the mid tier companies, the 250 million in revenue to 2 billion, don't have internal people to do information security. And most of them seem to have waited until now to begin to do some of that testing. We just seem to be getting more and more inquiries, can you come in and help us in that area? And long-term, if you think about it, I think that's a very good market because keeping information secure with everyone using the Internet these days, it's going to become a bigger and bigger price that companies are going to have to pay.

Is that again recruiting related for that sector? What is the actual expenditure that you are putting on?

Part of it is recruiting but actually the larger part is bringing in information security people to sell. We often call this kind of -- we have several different names for them, but they are more business consultants. They are technical people who have gained a tremendous amount of experience and they are the resource that the salesperson brings in that a customer says, gee, I am having a problem with his firewall. The actual technical work is usually done by a technical person who is charged the direct cost but the person that has just the domain expertise really helps close the sale. They are charged to SG&A.

Thank you.

(OPERATOR INSTRUCTIONS) There are no further questions, Mr. Boldt, please continue.

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

Ladies and gentlemen, this conference will be available for replay after 12:45 PM today through midnight April 23, 2004. You may access the replay service by dialing 1-800-475-6701 and entering access code 725745. International participants dial 320-365-3844. (OPERATOR INSTRUCTIONS) This concludes our conference for today and thank you for using AT&T executive teleconference. You may now disconnect.