Computer Task Group Inc (CTG) 2005 Q2 法說會逐字稿

Ladies and gentlemen than you for standing by and welcome to the CTG Second Quarter Earnings Conference Call.

At this time all participants’ lines are in a listen-only mode. Later there will be an opportunity for questions, and instructions will be given at that time. [OPERATOR INSTRUCTIONS]. As a reminder today’s conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Jim Boldt. Please go ahead.

Good morning everyone, this is Jim Boldt. I want to thank you for joining us this morning for our Second Quarter 2005 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 a review of our financial results. After his review, I will talk about the trends that we saw in the second quarter as well as what we anticipate in the third quarter of 2005, then we’ll open the call for question.

Greg, if you would start us off please.

Thank you Jim, good morning. Before I 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, 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 an actual result 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 second quarter of 2005 CTG’s revenues from continuing operations were $72.9 million. Net income from continuing operations and net income was $600,000, and net income from diluted share was $0.04. Our second quarter revenues from continuing operations and diluted earnings per share were all in line with our expectations for the quarter.

Our direct profit percentage decreased to 22.5% in the second quarter, down about 4 percentage points from the second quarter last year, but our operating profits improved from 1.4% last year to 1.6% in the second quarter this year. Excluding the impact of our accounting change in 2002, this is the 16th consecutive quarter that the Company has reported profitability from continuing operations.

Although SG&A increased by approximately $214,000 in the second quarter versus the same quarter last year, and approximately to 20.9% of revenue, this was an improvement of 5 percentage points from last year when SG&A expenses were 25.5% of revenue, an improvement of nearly 2 percentage points from the first quarter of this year when SG&A expenses were 22.7% of revenue.

Revenues from IBM were $26.9 million in the second quarter of 2005 as compared to the $13 million in the second quarter of 2004. Quarterly revenues from our European operations were $11.8 million in 2005 as compared to $10.3 million last year’s second quarter.

On the balance sheet, our days’ sales outstanding and receivables increased to 81 days from the 72 days in the fourth quarter of 2004, but are down from the 88 days reported in the second quarter of 2005. ON April 20, the Company closed on a new $35 million 3-year revolving loan agreement with a new bank group; therefore, bank debt is now reflected as long-term debt. Our debt was $18.8 million at quarter end, up from $4.7 million outstanding at year end, and up from $12.3 million as of the end of the first quarter of 2005.

Our cash flows reflect the use of cash from operations of approximately $6 million in the quarter. We made $360,000 of capital acquisitions and recorded depreciation expense of $668,000. Also total employment in the second quarter was 3,300 employees of which 87% were billable.

Lastly, as previous announced on May 12, 2005 the Board of Directors authorized the repurchase of an additional one million share of Company stock. During the quarter, while the SEC imposed volume limitations we repurchased 84,400 shares of Company stocks.

Jim that concludes my summary of the Company’s financial results for the second quarter of 2005.

Thanks Greg. We are pleased with our second quarter performance as it’s been a long time since we posted organic growth of 23%. With a few exceptions, which I’ll review, the quarter came in pretty much as we expected and caused our revenues and earnings per share to be at the mid-point of our guidance. Also as expected, we added 100 employees to our headcount during the quarter, bringing our year-to-date headcount increase to 800.

In terms of our profitability, our operating income increase by 42% when compared to the second quarter of 2004. All in all, we are pleased with our progress this quarter. As to the individual business units, our Strategic Staffing Business clearly had a good second quarter. While some of the transitions costs associated with the Staffing Business that we recorded in the first quarter of the year ended in the second quarter, a portion of the transition cost, such as retention bonuses, will continue for several quarters. Overall the need for staffing remains strong and we should see the staffing group continue to grow.

In terms of our healthcare business, we previously disclosed the terms in 2004 we have been working on the national healthcare service project, and I think everyone knows that the NHS project is the largest healthcare project in the world today. The ultimate goal of the project is the installation of state-of-the-art software packages in the English Hospital System. We finished the first phase of our work early in the second quarter of 2005, at which time we had hope that we’d be able to redeploy our staff to begin to assist in hospital implementations. Unfortunately, the hospital implementation phase of the project has been delayed in the region for delivery our services. Those delays had an impact on our profitability as it is taking us some time to re-deploy those resources to other projects. Actually, had the project gone as we had originally expected, we would have exceeded our earnings guidance for the quarter.

The delay is unfortunate but as you know, they do occur in projects, particularly ones of this magnitude. While we still expect to place staff on the implementation portion of the NHS project, the implementation may not start until early next year.

Revenues from our financial services vertical declined in the second quarter of 2005 due to the termination of a large AMO engagement in mid-2004 with a customer that was in liquidation. Over the last 3 quarters, we have introduced new offerings in both our financial services and Life Sciences practices. Testing is an important new offering that we have introduced into both of those vertical markets; it’s currently in demand. We expect the new offerings will help us rejuvenate our solutions business even in the current market.

Our European revenues increased by 15% in the second quarter of 2005 versus the second quarter of last year. Of the 15% increase, approximately 4% was related to [inaudible]. While our testing offering did very well in Europe in the second quarter, as previously mentioned, the delay in the NHS project limited Europe’s growth. As to the third quarter of 2005, we’re forecasting revenues in the range of $73 million to $75 million. As you know, we had 64 billable days in the second quarter. One billable day equates to about $1.1 million of revenue, and we’ll have 63 billable days in the third quarter of 2005.

In addition to the effects of fewer billing days, due to vacations we have historically seen a decline in our revenues in the third quarter of the year when compared to the second quarter. However, because of our headcount growth, particularly on the staffing side of the business, revenues in the second and third quarters should be approximately the same this year. When compared to last year’s third quarter, the third quarter of 2005 should give us revenue growth in the range of 26% to 30%. Give our revenue forecast, we believe earnings to be in the $0.03 to $0.05 per share range in the third quarter of 2005.

As Greg mentioned, we announced a one million share addition to our repurchase authorization in May and have begun to actively repurchase shares. This action reflects the Board’s confidence in our business and our belief that CTG shares are attractively valued. We’re one of the very few IT service firms to achieve significant organic growth this year and to also report consistent quarterly operating profitability over the last 4 years. Our focus on staffing, higher demand verticals, and solutions that address cost savings of government mandates continues to favorably position CTG for the future.

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

Absolutely. [OPERATOR INSTRUCTIONS]. Rick D'Auteuil, Columbia Management.

Hi guys. A couple of things; in the first quarter I think operating margins were 1.4%; you were maybe 20 basis points better t his quarter on a reported basis. But you went through an analysis in the first quarter without the transition costs of I think my recollection was somewhere around 2.5% on the operating margin. Have you done the same for this quarter for that IBM transition?

I don’t think we did it to as fine as an analysis but we still think that by the time we hit the first quarter of next year and all of the transition costs are behind us and the NHS projects starts up again that we’ll be around 2.5% or right around there someplace.

The NHS project stopping, while we though we might initially took it out of our guidance for the second quarter, it had a fairly big impact on us this quarter. If the NHS project had just continued at the rate that it did in the first quarter our margins would have been 2.2% this quarter, so that delay unfortunately hurt us. But we are well positioned and we think we’ll get good business pickup when they actually start to do the implementations.

Okay, what happens to those people in the 9-month lag, or interim I should say?

Well, a lot of those people unfortunately sat on the bench during the second quarter because we had [inaudible] of the UK project. Most of them we believe will be able to get repositioned at other hospital implementations in the United States, not in the UK, and the ones that we can’t unfortunately we have to lay a few people off, but all of those people would have been told by now.

Okay, how is the U.S. healthcare business?

The U.S. healthcare business is actually good. We’ve got a lot of opportunities in the pipeline, a lot of software installations, so it seems to me to be good. Really the soft spot for our healthcare business was the UK project this quarter.

And as it relates to the retention bonuses, the sense I got from the first quarter conference call was that they would wind down through this year, you’re essentially amortizing them over the year, but I thought it was front-end loaded to some extent. Is that still true?

Yes, it is; they actually go for 9 months so it depends on when the person was hired. All these people were hired in the first quarter, so they end at some point during the fourth quarter.

The DSOs, it looks to me it was disappointing. I look back at my notes from the first quarter at 88 days that was up I think from 74 days before that, and I think that the comments then were timing of payments from IBM. Are they stringing you out?

I think I’d like Greg to answer that.

We had dropped 88 to 81; some of that is driven from the subcontracting types of billing that flows, receivables that don’t drive through our revenue cycle. Our new business has slightly terms than our old business, and that’s pretty much driving the DSOs up. If I backed out some of that new business with different terms, it actually, our DSOs are about 71 to 72 days, so it’s really in line with where we were a year ago.

Okay, and I’ll ask the question; I’ve asked it before. Is this good business or isn’t it good business? If you don’t get paid fast, you make very, very, very slender margins and hopefully somebody internally is measuring whether you’re making any money on that.

We absolute measure this contract apart from all the rest of our business, and we include any cost of carrying receivables. Quite frankly versus a year ago, if you look at a year ago our margins were 1.4; we’re 1.4 in the first quarter of the year. They’ve now moved up to 1.6. That’s actually a reflection of a good part of the transition cost driving that. And they moved up despite the fact that we lost some of our very profitable business healthcare business over in the UK.

And then do you have the average price you paid for the shares you bought in the quarter?

The average price was I think $3.49, it was just under $3.50.

Okay, so it’s continue forward with that.

Unfortunately, as you know unless we’re buying blocks as defined by the SEC, we have some restrictions. But we tried to buy as aggressively as we could, given the restrictions.

And on the revolver do you expect to I guess given your short-term views is that likely to come, the balance outstanding likely to come down some? Or are we expecting free cash flow, or are we expecting to continue to tap into the revolver?

The revolver will come down as the business continues to generate cash flow, free cash flow. It’s grown because receivables have grown. That’s steady actually since the first quarter and the second quarter. We believe it will continue go fairly consistently through the rest of this year, and cash flow will drive the debt down. But we will continue to have debt for the remainder of this year.

Thank you.

[OPERATOR INSTRUCTIONS]. Bill Sutherland, Boenning & Scattergood.

Thank you, good morning guys. Following up on Rick’s question there on the IBM contract, so if, what is the offset to longer cash cycle for you all? Is it just simply the volume or are there any other terms that are better than the prior contracts?

It’s the volume, I mean it’s a volume-driven contract. We haven’t picked up a significant amount of volume from it.

Okay, the tax rate -- I got on late, so Greg may have given it already.

Yes actually he did; go ahead Greg.

The tax rate in the quarter was about 21%. We would expect the effective rate going forward to be probably in the neighborhood of 41% to 42% depending on earnings. The quarterly rates under current accounting interpretations fluctuate as you continually true up your reserves, and we were impacted in the second quarter with some NOL benefits that had been previously reserved for, which have now been released primarily rolling into some foreign NOLs. So it was 21% in this quarter.

So for the year it comes in on my model at around 36%.

That should be about right.

And that would be what you would justify as a starting point for the subsequent year?

I would think for the subsequent year I would probably be looking at more 40% to 41%.

Okay.

Yes historically actually they’re around 41%.

The gross margin was lower than I had in the model. Is this about what we should expect given the blend -- and also I don’t have the IBM percentage with me.

The IMB percentage I think was around 37%.

Just under 37%.

Yes, 36.8%; certainly for the next quarter it’ll be around 22.5% or so. We are trying to build more solutions business. We’ve brought Mike Olson [ph] back to develop new solutions. We actually have some of those that have been rolled out. And I think that if those solutions start to kick in, we start to see our gross margins start to increase again.

It’ll pick up with first quarter if NIH is back.

That’s right.

Well I know that your goal is to get back to 50/50. The solution gross margin is still about where?

The solution gross margin really varies a lot depending on the offering. We have some solutions that are as high as 50%. I think on average though 35% to 40% is a really winnable gross profit for us in the current market.

Staffing is 20, is that right?

Yes, that’s right.

Can you talk Jim just a little bit about the more important, 1, 2, or 3 solution offerings? I mean, I know testing is --

Sure, I’ll be glad to. Testing is an offering we’ve had in our European operations for years. In Belgium for instance, we’ve probably had more of a testing market than any other company. We’ve had some strong relationships with some of the tool manufacturers like Mercury and [inaudible]. And we’ve brought essentially the testing methodology over to the United States. Many companies, the large companies more and more are realizing that by separating testing from implementation development it significantly reduces your costs because you get a lot fewer errors when your applications are rolled out. So testing is definitely one of our offerings at the moment that we’re concentrating on.

Many of the other offerings are in the information security area. Sarbanes-Oxley has been a really good offering for us. As you know, the larger companies who adopted last year are going to have to go to quarterly testing. Technically in the first couple of quarters it was required, but so much work was done in testing applications earlier in the year, I think it’s going to ramp up as the year goes on. And they would be I think a very good -- that is going to be a good offering for us because it’s more of an annuity type business, and we’re expecting clients to sign up for multiple years on giving us tests for internal controls for their quarterly Sarbanes-Oxley testing. And again, that’s a government-mandated regulation, so it’s not something that companies are going to avoid.

I think in the second quarter we started up 2 new Sarbanes-Oxley compliance, or initial compliance engagements. The smaller companies and also foreign entities have to be compliant by the end of 2006. But those companies have looked at the pain that the larger companies went through and realized that trying to do it in 6 months or a year probably won’t be enough time. So some forward-looking companies have actually started those up, and that too is an excellent offering for us. We did very well with it last year, and we’re hoping to build on it.

We have some other offerings in the information security area, and we’re a certified vendor for Visa’s Health CISP Program, which I think is Cargo-holder Identification Security Program, where there’s more and more identify theft happening. You read about it in The Wall Street Journal. Visa has come up with a kind of an audit plan to look at your IT controls as they relate to your customers, the ultimate Visa-holder’s identification, etc. And we’re one of the companies that are certified to go in and do those audits, and we started those audits I think in the first quarter, and we did more in the second quarter and I’m optimistic we’re going to do more as time goes on.

So those 2 areas, information security and testing at the moment at 2 of our hotter areas that we’ve started to work on.

And just lastly the AMO area and the near-shore/off-shore component, where are you with all of that?

As you know we started a partnership with Polaris who is probably one of the top 10 largest Indian firms in the IT services arena. [Inaudible] the top tiers, and Polaris has about 5,000 people and they’ve been around since 1985. They, formerly half of their company was old Citigroup India IT Services Company if you’re familiar with that. The other part was a software firm, and they specialized primarily in financial services. And we started to market together a year ago and actually I was happy; I figured it would take between 12 and 18 months before we got our first engagement. As you know, AMOs take longer; they’re a longer sales cycle than the rest of our business, and in the second quarter we actually started to do work for our bank under our relationship with Polaris. So it’s moving along; I really think that it will probably be a bigger event next year than this year, but it’s definitely progressing.

Okay, Greg 2 other little questions on a couple of numbers. Interest expense, were there some other when it went to 372?

Yes, in the quarter that’s an accumulation of a number of things but we had about $90,000 of foreign currency exchange loss in the quarter that’s unusual actually. We picked up about $30,000 in the first quarter, so there was a swing of about $120,000 quarter-to-quarter.

So the number is more like 250?

Yes, 250 to 280.

I’ll step out, thanks.

Thank you for your questions, and with that gentlemen there are no further questions in queue. Please continue.

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

And ladies and gentlemen that does conclude our conference call for today. We thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.