Computer Task Group Inc (CTG) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the CTG fourth quarter earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session giving instructions at that time. If you should require assistance during this call, please press star, then zero. As a reminder, today's conference is being recorded. I would now like to turn the conference 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 fourth quarter 2004 earnings conference call. Joining me is our CFO, Greg Dearlove. As to the format of the call this morning, Greg's going begin with a review of our financial results. After the review, I'll talk about the trends we saw in the fourth quarter as well as what we anticipate for the first quarter of 2005, and then we'll open the call 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 in the course of this conference call that state the Company's or Management's intentions, hopes, beliefs, expectations or 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 fourth quarter of 2004, CTG's revenues from continuing operations were $58.8 million. Net income from continuing operations were $900,000 and net income per diluted share was $0.05. Our fourth quarter revenues were in line with our expectations. Our net income from continuing operations slightly exceeded our expectations for reasons I will address.

Our direct profit percentage increased to 27.9 percent in the fourth quarter, up about 2 percentage points from the fourth quarter last year, and our operating income decreased from 2.3 percent last year to 3/10 of a percent in the fourth quarter this year. Excluding the impact of our accounting change in 2002, this is the 14th consecutive quarter that the Company has reported net income from continuing operations.

SG&A increased over $622,000 in the fourth quarter versus the same quarter last year, an approximated 27.6 percent of revenue; an increase of about 2.3 percentage points from last year. For both the quarter and the year in total, the Company had a net tax benefit. For the year the Company had a number of favorable tax adjustments, including being able to recognize approximately $500,000 in previously reserved foreign net (ph) income loss benefits. We were also able, due to changing tax legislation in Europe, to release approximately $600,000 in previously reserved tax liabilities.

At year end, the Company also adopted a tax strategy through the combination of subsidiaries, which allowed for the recognition of approximately $400,000 in state net operating loss benefits, which were previously fully reserved. And finally, we had approximately $200,000 in various net deferred tax liabilities, which were determined to be no longer required and were released. Approximately $800,000 of these matters were determined during the fourth quarter, which combined with operating income, resulted in a $900,000 tax benefit in the quarter.

The Company also has a number of formula-based incentive plans, which are driven off of EPS. The favorable tax benefits realized in the fourth quarter caused us to accrue for these incentives. If we had not had these favorable tax benefits, we would have not accrued for these incentives and SG&A would have approximated the fourth quarter of 2003. Operating income would have been approximately 1.3 percent and fully diluted earnings per share would have been about $0.02 from continuing operations.

Revenues from IBM were 20----or $12.8 million in the fourth quarter of 2004 as compared to $12.9 million in the fourth quarter of 2003. Quarterly revenues from our European operations were $12.1 million in 2004 as compared to $9.2 million in the last year's fourth quarter. On the balance sheet our day sales outstanding and receivables increased to 72 days from 63 days in the fourth quarter of 2003, but is down from 74 days in the third quarter of 2004. Long-term debt was just under $4.7 million at quarter end, which ended on a payroll date. This is up from having no debt at year end in 2003 and up slightly from the $4.5 million at the end of the third quarter of 2004, both of which fell on payroll periods-- between payroll periods. Excuse me.

Our cash flows will reflect an increase in cash during the quarter of approximately $745,000. We made $347,000 in capital acquisitions and recorded depreciation expense of $527,000. Also, total employment in the fourth quarter was 2500, of which approximately 85 percent are billable employees. Regarding our review of internal controls and procedures in connection with section 404 of the Sarbanes-Oxley act of 2002; the Company is in the process of completing our internal assessment of controls over financial accounting and reporting.

We do plan to report on one matter, which we identified during the fourth quarter, to be a material weakness in internal controls. Although properly designed, certain controls relating to income tax accounting, specifically related to deferred taxes, failed due to human error. The resulting errors, which were recorded and which were not material to the financial results, could have materially impacted our results. To address this weakness, the Company is increasing the role of an outside tax consultant engaged to enhance our review process, and we will strengthen our internal tax capabilities. Jim, that concludes my summary of the Company's financial results for the fourth quarter of 2004.

Thanks, Greg. As you know, our fourth quarter revenues were pretty much what we expected. As we mentioned on our third quarter conference call, we had 62 billing days in the fourth quarter of 2004 versus 66 billing days in the fourth quarter of 2003. If you look at our revenues on a daily basis, our revenues actually increased by 2 percent when compared to the fourth quarter of 2003 and 3 percent sequentially. While there are several areas that contributed to the increase, most of the gains came from our staffing business. The gains that were seen in the staffing business are expected to accelerate in the first quarter of 2005 and I'll talk a little bit more about that in a moment.

Our healthcare group had a good 2004 and particularly benefited from two new large multiyear implementation engagements. Our healthcare business continues to grow and we expect to see its revenues increase at a double-digit rate in 2005. Our life sciences vertical also had a good 2004. We continue to add new customers to that business and believe they, too, should have a good 2005. Revenues from our financial services vertical declined in 2004, due to the multiyear projects that ended last year. We've introduced new offerings into our financial services vertical and we expect that it will improve in 2005.

As you know, we sold our Netherlands operating company in early 2004 ; now that the Dutch operations have been divested, our European region is growing and profitable again. We see a lot of opportunity in Europe at the moment.

As to the first quarter of 2005, we're forecasting revenues in the range of 64 to 66 million. As you know, we'll have 65 billing days in the first quarter of this year, the same that we had in the first quarter of 2005. Our staffing demand has remained very strong overall. In addition, we have an opportunity to take on a significant amount of staffing work at an existing customer and primarily due to this business, we expect to add approximately 500, or 24 percent, more to our billable staff by the end of the first quarter.

Based upon the continued strength of the staffing business and having a full quarter of revenue from the additional billable staff added in the current quarter, we expect our revenues in the second quarter of 2005 to exceed $70 million on organic increase over the second quarter of 2004 of more than 18 percent.

While most of my comments have focused on the staffing side of the business, as it is the dominant factor and the increase in our revenue forecast, we have been seeing significantly more opportunities on the solution side of the business as well. In January, we brought Mike Colson back to CTG to be our Senior Vice President of solutions development; with our solutions market improving and with the right combination of new offerings, we think the solution side of the business will have a good year as well.

Even though revenue forecasts, we believe earnings to be in the $0.03 to $0.04 per share range in the first quarter of 2005. We have some startup costs associated with bringing on this new staffing business, which are limiting our profitability in the first quarter, in addition to the hiring costs and the reduction in profitability that you normally get as you put overhead in place in advance of the billable staff. We've hit off our retention bonuses to many of the new billable staff in order to ensure a smooth transition. As such, we expect our profitability in this business will increase as the year progresses. Overall, the strength of our staffing business and the improving solutions market have us feeling optimistic that we can achieve both top and bottom line growth in 2005. With that, I would like to open the call up for questions if there are any. Operator, would you please manage our question and answer period?

Thank you, ladies and gentlemen. [Operator Instructions.] And we do have a question from Bill Sutherland, Boenning & Scattergood. Please go ahead.

Good morning, guys.

Good morning.

Hey, Bill.

I notice that you ended the year with about the same head count, the billable head count as you'd had for most of '04, and I know you've been talking about, you know, the growth in the staffing head count pretty steadily. I'm not sure if it was 100 per month starting last year, but I know you've been adding a lot of people. Can you talk about kind of the rate of the growth and what happened with net growth. It kind of stayed flat until, you know, through the end of last year.

Sure. We still believe that, and I'll exclude the significant opportunity that we have, that we should be able to add about 100 people a quarter on the staffing side of the business based upon the demand that we currently have. Some quarters are going to end up being better than other quarters. The fourth quarter just inherently is not a good quarter to add billable staff. Starting in about the middle of November, just before Thanksgiving, most people don't like to take on new people, new billable staff, because they know they are going to be shut down for the holidays, et cetera, but at the same time you still have people rolling off of engagements that started six months before.

So the fourth quarter's never really been particularly good. Actually we thought we were close. We thought that we were going to be able to report that we were up 100 people, but it just didn't work out. But in terms of the future and the demand that we currently have, you know, adding 100 people a quarter certainly would be realistic. We've indicated in the first quarter we think we'll add 500. Second quarter of the year I suspect we'll add at least 100 people.

So, and as far as the other quarters in '04, Jim, it was just a matter of offsets occurring while the additions were occuring?

Exactly. In the -- in the third quarter of -- the staffing side of the business really started to come back in the second quarter of 2004. In the third quarter, we hit a large outsourcing agreement that ended as a customer went into liquidation and we lost 100 people on that engagement. We added 100 people on the staffing side of the business and it just offset.

Do you-- I guess you can't have too much more than 30 days visibility on that, but as far as you know, no major wind downs or engagements ending?

No. That one hit us by surprise. As I said, the customer essentially was in bankruptcy and liquidated and decided to begin shutting things down, and we weren't expecting that. But right now we don't really know of any large projects, outsourcings, for instance that, are scheduled to end.

Now with the big push in staffing, particularly under a large agreement, what do you think's the mix in margins as you look into '05 between gross and SG&A, or direct and SG&A?

That's a good question. In the fourth quarter, you probably noticed that our direct profit margin increased and that actually was a result of some of the new offerings, solutions offerings that we launched in, at the end of the second quarter of last year, beginning to kick in and the solutions part of the business taking a bigger share of our revenue. With this large staffing opportunity, our direct profit margin's going decline in the first quarter.

The direct profit margin will probably be someplace around 26 percent. The SG&A margin, someplace around 24 percent and the operating margins probably around 2 percent. And then as the year goes on and some of the startup cost starts to go away, we would expect to see the operating margin go up, primarily as a result of SG&A as a percentage of revenue starting to decline.

The GP is going to be closer to 26 for the time being?

Until we get more of the solutions in the mix, I think so. I think it will be around 26. The people being brought on in the first quarter, the 500 people, all weren't brought on January 1st. It's not evenly, but it's spread throughout the entire quarter, so you're going to get more of an impact off the staffing business in the second quarter obviously. As you know, we brought Mike Colson back.

He's already identified a couple of really good areas for us to roll out new offerings, and we're hoping that with those new offerings we'll get the solutions side of the business to grow and also some of the staffing business. I mean ultimately our goal is to get back to 50/50 mix on staffing and solutions because we think that's the right mix for us. They're not totally counter-cyclical but the're somewhat counter-cyclical, and there is opportunities on both sides. At the moment, because staffing's so strong, we're just taking as much of it as we can.

The-- you had talked recently, during the last year or two, about what you thought your model in this market can generate as far as a target for operating margin at a certain revenue scale. Is that still intact, you know, 6 to 8 percent I think was the goal?

Actually it was 7, 8 percent operating margin, and, yes, our goal is to get the business back to a 50/50 mix of solutions and staffing and if we do that back to a normal market, obviously the revenues are going to have to be higher, but we should get back to 7 to 8 percent operating margin.

Okay, and a little lower if you still have this higher ratio staffing?

Right. Our belief in a normal market is that the staffing side of the business is probably 5 percent operating margin and the solutions, 10 percent. So if we were 60/40, obviously we would be a little bit below the 7 percent.

Right. You mentioned that----the 3 verticals pretty quickly: healthcare, financial services, what was the third one that you discussed?

Life sciences.

Life sciences.

Which is primarily from a pharmaceutical company.

And what was your comment there? I just----

Same as healthcare, really. We've got a lot of opportunity there. We think they're going have a really good year in 2005.

How significant is that practice? You don't count that as part of healthcare?

No, we do not. If you add them together, they are 25 percent of our business.

Life science and health care?

Yes.

Okay.

Last year the healthcare, which is predominantly to hospitals was about 14 percent, I believe, and actually I haven't seen the final numbers, but I expect it to run 14 percent and life sciences around 9 percent of our total business.

Okay. One last question. How is the IBM revenue? Is that growing now? Looked like it was kind of flat for the quarter.

Actually the IBM revenues will grow significantly in the first quarter. It's a big part of the 500 people that are being added in the first quarter.

Okay. And what's the pricing, I guess in general and I guess relative to the issue you had last year? What's the pricing outlook?

The pricing at the moment is stable to increasing slightly on some of the hotter skills. There are some skills in certain cities that are in short supply and we're actually starting to see some price increases; it'd be skills like, that you would expect like dot net and web logics, et cetera. In general on the rest of the basis, it's stable. I think the period that we went through for a year and then got caught again last year of customers reducing bill rates is probably behind us.

Great. And then on the balance sheet, you did have a little bit of free cash in the quarter, even with the DSO's expanding.

Yes I'll let Greg [inaudible].

Yes, we will---- as I said, we will improve our cash position about $740,000 for the quarter.

Oh, that was the free cash.

Yes.

That wasn't operating cash, okay.

Operating cash, I believe will show a decline because our receivable increased.

Okay. I'm missing something. Operating cash flow is--

Operating cash flows, I believe, for the quarter will show a decline of about 1.6 million and it's all related to our growth in receivables.

And obviously our debt's up, which is the other factor.

And how-- so your free-- so were you free cash flow positive? I'm not--

No, we were free cash flow negative for the quarter.

Okay, okay. What's your outlook on DSO's and cash flow?

The-- our outlook is that the DSO's are stabilizing. As Jim mentioned, the DSO's increased during the year primarily because of that large outsourcing engagement that ended that had been a prepaid engagement. We replaced those revenues with I'll call it more normal receivables. And we hope that we'll be able to work the DSO's down slightly as the year progresses.

Okay, but we won't be seeing this next----the low 60's?

I don't expect-- actually I don't expect in 2005 that we'll get in the low 60's, but we're going to continue to work that number down.

I don't know if you'll see them, but I talked to Greg about that all the time.

And it was the outsourcing deal you lost that had the prepay?

That's correct, Bill.

Okay. Thanks, guys.

Thank you.

And we have a question from Rick D'Auteuil, Columbia Management. Please go ahead.

Good morning.

Good morning, Rick. How are you?

All right. Just a couple followups. It sounds like you sort of just disclosed that the new business in the first quarter that you're hiring for is mostly IBM-related. Can you speak to whether that is dilutive to margins? I mean it's hard to be dilutive to the margins you have, but where does that come out?

First, let me say, and I know you know this, but so everyone knows, that we're limited on what we can say regarding IBM because we do have a non-disclosure agreement in our contract, but--

How about I rephrase it? "The large customers you're doing business with. " [laughter]

Okay. It's the large customer. But the reality is that in total for our aggregate margins, it's accretive because the margins, as you mentioned, were so low. Clearly, there is staffing business that has better than 5 percent and less than 5 percent margins.

The strategic staffing business that we're talking about is the, would be in the less than 5 percent, so obviously at the lower end of the scale because there is so much volume associated with it. We, we've run numbers, but we still believe in total, in aggregate on our staffing business, that we should be able to hit our 5 percent target for operating income.

Okay. There were-- I'm sure you're aware, as we went into late December there, were lots of rumors out there and the message boards were very active on your stock and the specifics, and I don't know where this business is, but the specifics were around a large incremental piece of business out of IBM and I think they even got so specific as to say maybe it was even geographically in the Texas area. It seemed to me that, you know, that might be something that deserves a press release and, you know, rather than let the rumor mills kind of decide things, and I'm just curious why there was no press release on this piece of business.

The-- well, let me address that. First place, as I mentioned, we cannot release anything unless IBM agrees to it and at the moment, IBM hasn't. And they won't. I have talked to them about it. The-- we have disclosed, we have a national technical services contract with IBM and it has been disclosed and is public. The fact that we have that agreement.

This business is under that contract and it's staffing business that isn't a solutions situation where you could actually say I have a contract, to you know, add 500 people. We have an opportunity to staff individuals and there is no commitment by IBM or any customers to say that they will absolutely hire 500 people. It's just a very large opportunity that we're pursuing. And that's the reason. There-- I've been through this with our attorneys as well. It's simply an opportunity under an existing staff agreement.

There's all kinds of-- we actually read some of the messages on the Yahoo! message board and quite frankly, we don't know where some of the people are coming from with some of that. I mean I even saw numbers that I looked at and said, whoa, I wonder where that number came from. Unfortunately, I think people have to realize, anybody can post one of those messages and anybody can make up any number that they want and stick it on there. Our policy is not to comment on those things and to disclose things that we legally are required to and obviously to disclose things that our customers are comfortable with.

Yeah, I mean I hear-- I agree, maybe there were some things that-- somebody had something, though, because, you know, we learn now that there was incremental IBM business and it wasn't all, you know, completely out in left field, what was out there. Maybe the quantification of some of the----the body count or whatever was a bit lofty , but---- Separate subject : you began spending a lot on recruiters in the second half of '04.

Yes.

You know, sort of I think that what we were hearing 60 days to become efficient. They should be efficient now and are you getting your money's worth from that effort?

I think that we are. Obviously in the first quarter, this 500-person increase, part of that is coming from our recruiting organization and a good part of it, and that's what allows us to add the 100 people a quarter, we believe, going forward on the staffing side of the business. But certainly the recruiters that we've hired up until, well, through December, by now are definitely efficient.

Quite frankly, given the demand, we're still hiring recruiters. We still don't have enough recruiters and I know we've released probably three or four times----we need 30 percent more recruiters on our strategic staffing business. We hired them and we still, with demand going up, need more recruiters.

Is there a higher turnover now or what--

For recruiters or--

No, when you hire them, I mean it's-- I guess you can hire them, but there's a two-way door. Are you losing--

No. We rarely lose a recruiter unless we decide that their performance isn't up to a standard. They are not leaving. They are here.

Okay, okay, and in the first quarter you're talking about a 30 percent increase there?

No. I'm sorry. We had announced that a couple times last for a [inaudible] 20, 30 percent.

Right, I know that.

But we still, you know, we're probably 10 to 15 percent at least short on recruiters at the moment and we're actively out hiring.

The-- I found your comments a little curious that the tax benefits that kicked in in the fourth quarter basically tripped your incentive levels. It seems to me like that kind of thing should be excluded from incentive as really very little, if not-- and you could justify nothing to do with business and operations and why should, you know, incentives kick in based on something that's not in the, you know, has nothing to do with the operations.

That's a very good point actually, and historically, at least as long as I've been with CTG it, goes back before me. I've been here about nine years. A lot of our incentives were paid on EPS and the logic was kind of that, you know, EPS was good for the shareholders. The-- some of the favorable benefit actually had been expensed in previous years. So in those years, it lowered the incentives from many of the people. But we've looked at that and I think going forward we're going to switch back to another metric, operating income or pretax income to avoid that happening in the future.

Was it that number over $500,000?

Yes, the number actually approximated the increase from 2003 to 2004, so it was slightly over $600,000.

And if the tax bene wasn't there, that would have been zero or something much less?

It doesn't-- the 600,000 is the increase. Greg actually figured out what the tax benefit was. So the incentives may or may not have gone to zero, but the 600,000 is just those that were related to EPS and the 600,000 is the increase that was caused by the tax benefits.

Let me get back in line. I'll come back in case somebody else wants to ask questions. Thanks.

Okay. Thanks, Rick.

Gentlemen there, are no further questions at this time. Please continue.

Okay. I'd like to thank you very much for joining us this morning and have a great day. Thanks. Bye.

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