Computer Task Group Inc (CTG) 2005 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the CTG Fourth Quarter Earnings Conference Call. [OPERATOR INSTRUCTIONS] As a reminder, today's conference will be recorded. At this time I'd like to turn the conference over to your host, Mr. 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 2005 earnings conference call. Joining me in our Interim CFO Brendan Harrington. As to the form of the call this morning I'm going to begin with a review of our financial results and talk about the trends we saw in the fourth quarter as well as what we anticipate in the first quarter and remainder of 2006. Then we'll open the call for questions.

Before I begin, I want to mention that statements made in the course of this conference call that state Company's or Managements intentions, hopes, beliefs, expectations and prediction in the future are forward-looking statements. It is important to note that the Company's actual results could differ material 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 from time-to-time in the Company's Securities and Exchange Commission filings.

For the fourth quarter of 2005 CTG's revenues from continues operations were 78.1 million. Net income was 676,000. And net income per diluted share was $0.04. Revenues increased 33% in the quarter while net income was below last year due to the favorable tax benefits recorded in the fourth quarter of 2004. Operating income as a percentage of revenue was 1.7% in the fourth quarter of 2005 versus .03 of 1% in the fourth quarter of last year. Our direct profit percentage was 23.1% in the fourth quarter of 2005 compared to 27.9% last year. Other SG&A increased by 392,000 in the fourth quarter versus the same quarter of last year.

SG&A as a percentage of revenue was 21.3% in the 2005 period versus the 27.6% recorded in the fourth quarter of last year. The single largest reason for the changes in the direct profit in SG&A percentages was the shift in our sales mix to a higher concentration of staffing. Revenues from IBM were 29 million in the fourth quarter of 2005 as compared to 12.8 million in the fourth quarter of 2004. Quarterly revenues from our European operations were 12.3 million in the 2005 quarter, an increase of 2% from the 12.1 million recorded in last year's fourth quarter. On the balance sheet our day sales outstanding increased to 85 days from 72 days in the forth quarter of 2004 but are down from the 88 days reported in the fourth quarter of 2005. Our cash used by operations was approximately 6.4 million in the quarter.

In the quarter we had 720,000 in capital expenditures and recorded depreciation expense of 637,000. Total employment at the end of the fourth quarter was 3600 of which approximately 87% were billable employees. As previously announced on May 12, 2005, the board of directors authorized the repurchase of 1 million shares of stock. During the quarter while adhearing to the SEC imposed volume limitations we repurchased 194,800 of CTG common stock. We expect to continue our repurchase program if the thirst quarter of 2006.

Were pleased with our fourth quarter performance as we achieved 33% in our revenues when compared to the fourth quarter of 2004, all in all the quarter came in pretty much as we expected. It caused our revenues and earnings per share to be at the mid-point of our guidance. One favorable unexpected event that happened in the quarter was the addition of 100 people to our head count, we normally don't see any head count growth in a fourth quarter of a year. As additional placements on the staffing side of the business are typically limited due to the holidays. This brings our year-to-date head count increase to 1100 employees, 44% higher than a year ago.

As to the individual business units, our strategic staffing business clearly had a good fourth quarter. The transition cost associated with the significant new staffing business we had in the first quarter of 2005 ended in the fourth quarter of the year. Overall demand for staffing continues to increase and one of the process of adding additional recruiters do deal with the increasing number of requirements. As to our solutions business, while it is not back to what we would consider a normal market, we continue to see an increase in demand, particularly in some of the higher gross solutions that were focused on.

In the health care area, for example in the fourth quarter of 2005, we saw greater demand for assistance with software implementation projects as well as transitional outsourcing from clients installing new software. Our testing offering has been very well received in our life sciences, financial services and general industry markets. We're working with several very large clients to establish centralized testing centers which we expect will ramp up as 2006 progresses.

In the fourth quarter of 2005, as well as the first quarter of 2006, we've seen a nice increase in demand for our Information Security Services, particularly in our IT Audit and Visa Customer Identification Security Program offerings. Our European revenues increased by 2% in the fourth quarter of 2005 versus the first quarter of last year. If there have been no change in exchange rates the revenue increase would have been 11%. Once again our testing offering did very well in European in the fourth quarter.

As mentioned on previous calls, the delay in the National Health Care System Project in the U.K. limited Europe's revenue growth in 2005, while our staffing on the project did begin in the first quarter of 2006, the ramp-up is a little slower than we originally expected. We do expect by the end of the first quarter of 2006 that the NHS business will reach an annual run rate of $ 5 million and anticipate that the business will continue to grow as the year progresses. Whether this business will add to our revenues in the first half of 2006, due to the recruiting and training expenses associated with ramping up the business, we're not expecting to see much profitability from the project until the second half of the year.

As for the first quarter of 2006, we are forecasting revenues in the range of 81to 83 million, an increase of 18 to 21% over the first quarter 2005. We believe that earnings will be in the $0.03 to $0.05 per share range in the first quarter of 2006. As we disclosed in our earnings release we're going to avail ourselves of a cash discount payment option with a with a significant customer on the first quarter of 2006, while the ongoing cost of the program will not be significantly different from our bank financing, due to the accounting rules, there's a doubling up of cost on the first quarter, as we make the transition. The cost of the transition has been included in our first quarter guidance.

As I mentioned in our earnings release, this alternative method of financing will enhance our ability to repurchase additional shares of our stock and finance our growth going forward. We've not provided any annual guidance in several years with the strength of our staffing business and a glimmer of our recovery in the solution side of the business we feel a little bit more comfortable in providing guidance for the upcoming year. We expect revenues in 2006 to be in the range of 333 to 343 million, 13 to 16% above 2005.

Before an anticipated $0.03 non cash charge for equity compensation, we expect 2006 cash earnings per share to be in the range of $0.18 to $0.24 after the non cash charge we expect 2006 diluted net income per share to be in the range of $0.15 to $0.21. As we mentioned in the past, one of CTG's long-term goals is to grow faster than the IT services industry with another double-digit revenue growth in 2005 and another double-digit revenue growth herein anticipated in 2006, we're well on our way to achieving that goal.

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.

[OPERATOR INSTRUCTIONS] Our first question today is from Rick [Totah] from Columbia Management

I have a number of questions. You didn't reference the New York stock exchange. What's the status of that?

We filed a plan with the New York stock exchange in September or October of last year and how we're going to get back in compliance with their continuing listing requirements. We've been tracking actually slightly above the plan. So we expect that within the next year we'll be back in compliance.

You talk about the new terms of the cash discount terms on the significant customer?

Sure. We have this option actually for a number of years. We can be paid early by a customer and take a cash discount, so it would reduce our revenues, actually. We, in the past, elected not to do it. We had a lot of flexibility in our bank financing. As our business grows and the debt amount grows, it will begin to potentially trigger some of our debt governance. The higher amount of our debt or instance. The less capability we would have to repurchase our own shares. We decided that rather than face that we would elect a cash discount from the customer. The ongoing cost of that isn't any difference. It may in the long-term be a little less than our bank financing. It does do a couple things. The very first quarter that you switch over to it you double up in cost. If you think about it, if we decided to do this on March 31, the last day of the quarter, you'd have all of your bank interest expense during the quarter because you're being -- receiving revenues for the quarter that would be discounted, you would also have the discount. So in effectively in addition to our bank interest this quarter were going to have about a $ 400,000 reduction in receivables. So basically doubles the cost over just in the very first quarter that you do it. If we didn't have this change that we're making, we actually would have higher earnings per share, 400,000 is about $0.01 per share so we would have given out guidance between $0.04 and $0.06. After the first quarter is over it really doesn't effect our earnings though it does effectively move interest expense up as a reduction of revenue.

Just so I understand, you had -- I don't know, can you disclose what your receivables were to this significant customer at year-end?

I believe that the cash flow -- let's say it was all effective in the first quarter, it won't quite be most of it will be, it's about $20 million that will reduce our debt. I'm expecting at the end of the first quarter that our debt will probably be $5 million maybe or a little less.

Just doctors the debt issue. Were you on a payroll week or off payroll week at year-end? It was on a payroll, the payroll was on the last day of the year. Remind me how much that swing factor is?

It's gone up actually. It used to be -- we used to tell people it was like $5 million. It's more 7 to $8 million per pay period right now.

So as you look at this cash discount option, you're not just -- let's say you do 29 million in business with this customer in Q1, you're not just talking about those receivables going forward, you're also talking about what the outstanding balance of receivables were to this customer?

Yes.

Is that why we have a double hit of?

We have a double hit just because of the accounting. The receivables that will be effected will relate to revenues in the first quarter so you have to accrue for it, at the same time you potentially couldn't have any reduction in your interest expense because the payment might not be made until the beginning of April. So, again, using the example that we decided to do it on the last day of March, we'd have the full bank interest for the quarter. We'd also have the full discount that we'd have to record for the quarter but we wouldn't get that cash in until the first part of April.

This cash discount, you're not getting paid on a services performed basis, zero day basis, you're still getting a lag?

A slight lag, yes. A couple weeks.

It's only a couple weeks? Okay. But you're paying your people as you go, right?

Yes.

Okay. All right. Just what is the operating margin implied in your guidance for 2006?

Okay. Unfortunately I'm probably going to give you a couple numbers. But -- and if we could just use the mid point of the guidance and make it a little easier. The -- when we make this change to this cash discount, which actually there will be four quarters that effects it, we're effectively moving the interest expense up as a reduction of the operating profit so it's not comparable to what we had in the past.

To be fair, it's probably more fair to look at what your post interest income is on an apples-to-apples basis, because the reality is if you have a customer that's beating you up on terms, on DSOs, then that's a real expense to doing business with that customer.

Okay. Let me give it to you both ways.

Okay.

The mid point of the guidance, which would include the stock option expense and moving up the interest effectively to as a reduction in revenues would be 1.8%. My point really is that it's just not comparable with the way that it's been looked at before. If you take out the non cash equity, which obviously wasn't in the previous year's, that would be 2% at the mid point. And if you move the interest expense back down below operating income, it would be 2.4%. So it's pretty much what a year ago we anticipated it would be. It's very similar in the first quarter. If you look at your operating income on a comparable basis over the 2004, it was 1.3%. 2005 it was 1.7%. We are projected about 2.4% in 2006. If you were to do net income --

More on the pretax.

Pretax?

Pretax because that incorporates the -- the customer's forcing you into debt, which has got an interest expense attached to it that really is a cost of doing business with that customer. Granted you're reversing that this year, but there's the cost of taking a discount, giving them a discount to do business with them. So then it gets reincorporate back into the operating line, but anyway, I'm not sure we're getting that -- I think last year there was a comment made that early in the year related to this customer that retention bonuses and transition costs were somewhere in the 90 to 110 basis point range. And that should have taken us up to at least into the mid twos. It doesn't feel like it. The one thing I'd take out is the stock option to make it apples-to-apples. We're not getting there. It's back to 2%.

On a comparable basis, it's the numbers I gave you. If you -- if we didn't use this cash discount option, we'd have gone from 1.3 to 1-7 to 2-4. All customers we carry some receivables for. And I apologize, I didn't actually have those numbers computed. So if you go back and do, say, pretax income, which I think is what you asked.

Yes.

In 2004 it would have been 1%. In 2005 it's 1.2. In 2006 it is 1.8 without the equity compensation. At the mid point. Obviously it would be around 2 or so if you went to the high end of the range.

Where did DSOs, with this new deal, where did DSOs come to?

Around 70 day's.

But that customer is only 14 days?

Right. Brendan is sitting next to me, actually it works out to be about 30, actually it's 45. If you think about the month of March, you'd have 30 days for the month of March and then it would get paid 15 days later, so it's 45 days.

70 is really 45?

No, no, no, I'm sorry, you said the one customer, if you use a cash discount program. It's payable 15 days after the end of the month, it effectively works out to 45 days..

We can take this offline too but I guess I challenge you to go back and look at whether this is a good customer or not a good customer. There's a lot of people out there that have determined that they are not a good customer. And you guys, I think, came out and said we have a different operating model. We can make it work. What I hear in your guidance, we're going from $0.04 quarters to $0.05 quarters with this phenomenal top line growth. It's just not too impressive. It sort of gets me back to I'm not sure that the Kings in the World did not make the right move in firing their customer.

Let me address that. The reason we're only going from a 4 to 5, a lot of it has to do -- at least in 2005, with the fact that we had negative income taxes in 2004, that that really is the distortion. There was a nickel or $0.06 of tax benefit year-to-year.

I'm talking '05 to '06, Jim.

It's $0.03 to $0.05 then the first quarter of last year when had $0.03 earnings per share. That would be the comparison.

I sort of took your whole year. And it looks like on balance. If you take out the stock options to make it comparable, it may be a penny of maybe a little more than a penny a quarter better than what you reported last year.

Well, if you look at the mid point, though, it would be $0.21 versus 14, so it's a 50% improvement on EPS.

Is that the game? We're kind of -- we're looking off pennies going to next year if we're looking at '07, maybe if we add another penny on, that's another 20-something percent, so that's a victory?

A lot depends on what happens with the solutions side of the business. We're seeing a recovery in the hotter solutions now. If you look at most economists' forecasts for 2006, they're forecasting an increase in capital spending primarily due to spending on technology. We really are forecasting the market as it stands now. If that happens, then obviously it would be a significant upside.

Is there money to be made? Or is it just -- you have now transitioned your model to be good at growing the top line but not the bottom line.

You don't consider a 50% improvement in the bottom line good, I guess?

Well, let's go back to when you last reported 300 million in revenue, Jim, and see what kind of money you made.

It was significantly more.

That's what I'm talking about. My guess is you have a whole lot of business that is not very profitable or not profitable.

I obviously differ. And one of the advantages is that I get to actually see all of the numbers. And we do segregate certainly the larger customers so we can see what they're doing. If you look at your aggregate numbers, though and this includes the interest expense et cetera, we did go from a 1% margin pretax to 1.2 to 1.8 in the middle of our guidance. So it's obvious if there was a significant part of the business, we must be making more not less money in it. The last time that we made $300 million in revenue was 1994, I believe. And we made $0.27 per share then. I believe in the 2000s we also hit 300 million. And we were pretty much break even or maybe even a loss at that point.

Down after the bubble?

Pardon? This is down after the bubble.

Just to give me a sense, if you're doing anything that's profitable, the health care business, the U.K. health care, what kind of margins does that have? Is the opportunity -- you mentioned this $500 million run rate number, I thought the opportunity, I thought the number was bigger than that.

The $500 million run rate is at the end of the first quarter. We think the opportunity is a multiple event number. The project started really to ramp up in the current quarter. So in the fourth quarter of the year, the annual run rate would have been about 2 million. The actual revenue in the first quarter would probably be about 3.5 million. But by the end of the quarter we'll be at about a $5 million run rate. Then we expect it could be a multiple of that. In our health care business overall, we should be able to achieve what we think is the long-term goal of a solutions business, which will be an operating income of 10%. And I would expect that we could achieve that in 2006, not sometime out in the future.

So I understand that, the solutions part of the business in 2006, you expect to have a 10% operating margin?

For health care

For health care?

Only our health care business.

Why are the other solutions components are they materially less than that?

Yes, at the moment they are. Because the demand in health care, it picked up really about two years ago and it's been really strong in the last couple of years. The trend in health care, particularly the hospital side of it, have not mirror the the economy as a whole.

Back to this U.K. business are you saying you have some staff-up expenses. Are you having to offer the same deal with that customer in the United States incentive?

No, on the staffing side of the business everything is volume-based, so we're not going to have $100 million business in the U.K. so you would not get the same -- the pricing would be different obviously. There are not any technical people in the U.K. who are trained up on U.S. technical packages. We have sent some people and will continue to send some people over that have expertise in Sonar IDX, ecetera, to do project management. We have to not only hire people in the U.K. in order to work on the project, we also have to train them in the package so there's a training cost associated with everybody person that we hire for this project in the U.K. The ramp-up of the project will probably be fairly quickly. We have determined the long term we're better off to use partial external recruiting, which is much more expensive for us. Between the external recruiting and the fact the individuals have to be trained on the packages in the first half of the year, it offsets the direct profit that we're getting.

Believe that after that it's nicely profitable?

Yes.

So you actually get a return on it?

Second half of the year will look very different than the first half of the year, because at that point in time you'll have enough people that will offset the people you're bringing on and the people you're training.

Let me let others ask questions and I'll get back in the queue. Thanks.

Okay.

Thank you for your question. And we have a question from Boenning and Scattergood from the line of Bill Sutherland. Please go ahead.

Thanks good morning, Jim. Just maybe to shed a little light on the discussion you and Rick were having about the model back in the last time your were if it was '95 when you guys were going revenue about like what you are walking about ' 06.

Right.

The operating margin was 3.8%?

Right.

The following year -- I guess this should give us hope -- revenue went to 365 and you did a 5.1% operating margin?

That's correct.

What -- and actually that kind of leads into a question I had on one aspect on margin of course is recruiter turnover and productivity. How is that looking? Where is that headed?

Our productivity actually is increasing. It increased in 2005 per recruiter. The reason is that we're installing and were still doing some tweaking on it, a new recruiting system that is far more automated in terms of looking at resumes and being able to sort them into a priority queue. A lot of the work that the recruiter used to have to do is being done by the system. The productivity went up last year. I suspect it will continue to go up this year. We're continuing to do some reengineering to make sure everyone properly trained.

It's fully installed but not completely utilized?

Yes. People are using it but not to the full extent. We put people in training and people tend to go back to their old habits. We have to go back and retrain them in the new way to do things.

What kind of gain did you get in percentage terms?

I average higher per recruiter. It had to go up by 30% last year. It was pretty significant.

There must have been an offset to that given the -- I mean, we would have seen a margin improvement, right?

We've got a shift in our business overall. We were about 55% staffing and 45% solutions going into the year. At the end of the year we were more 72/28. That's offsetting -- if you looked at the reports I look at, which is by business unit, you'd see it. But then when you put the business together, the product mix shift, if you will, offset it.

So in other words it was exiting '04 you were 55/45?

Yes. And the fourth quarter was 72/28. Actually the year was 71/29.

And remind us again the inherent, so of profitability metrics of staffing versus solutions, I mean, broadly speaking.

If the market -- when the market fully recovers, we think that staffing will continue to be an aggregate around 5% and solutions should be at least 10. With certain of our businesses now, even in solutions we can prove or we know that the operating margin can run 10%. The one factor that is going a little bit against us is the fact that when you look at staffing overall, it has some large volume staffing and some flex staffing, one or two people, who is a much higher profitability level. Obviously the volume staffing has a lower profitability level. Our mix of large volume to small volume has changed from what it was a couple of years ago. So long-term, I'm thinking that we'll probably be more 3.5 to 4% on the staffing side of the business than 5%. We still see our long-term. Once the solution side of the business comes back which is a key and we are starting to see that in certain niches now that we should be able to get up to 6.5 to 7% operating margins.

That will require you to be at least 50/50?

That's right. That's our long-term goal, to get back to 50/50.

Of course, the other thing that was notable by '05 was that your head count growth outstripped the revenue and that's the mix?

That's the mix. On the solution side of the business, technical staff person, an average, may bill $200,000 a year. It's less than $100,000 a year on the staffing side. So the average comes out to about 100, actually. But it's really the mix. We took on more staffing, which is a much lower bill rate per person.

Okay. I think you've covered everything. I'll hop back on if I -- oh, I know what it was. Did you get a constant currency -- the growth in revenue adjusted for currency?

For the European operations -- actually for the year, it's about the same. But if it's -- the report is about 11.2 or 11.3. Constant currency would have been about 11.5%. For the fourth quarter it's very different. It's 2% as reported and it would have been 11% if the currencies have been constant.

Okay. Thanks, Jim.

Okay, thanks.

Okay, thank you for your question. At this time we don't have any other questions in queue. [OPERATOR INSTRUCTIONS] And we have a question again from Columbia Management, from Rick. Please go ahead.

Just on a follow-up, if you look at '05, was there any growth ex IBM?

Yes, that's actually an excellent point. For the year, if you took IBM out and said we didn't have it at all, the revenues would have gone about 2.4%. But it's very different and the beginning and the end of the year. If you look at the fourth quarter, the non-IBM business would have grown 7%. And that's really being constrained by the currency fluctuations. If you took the currency fluctuations out the non-IBM would have grown 9% in the fourth quarter versus the previous year. That's one of the reasons that we feel comfortable in giving out our revenue increase in the 13 to 16 % range, because were now starting to see the rest of the business, including some of the solutions start to grow again.

Talk about general trends bill rates and pay rates ex IBM?

Ex IBM on the staffing side of the business, in general, bill rates are flat, not increasing or decreasing. However, in certain cities we're starting to see storages, particularly some of the hotter skills, in a larger city if you're looking for dot net people or IBM web strip people you are going to pay them whatever they want, because you just can't get enough qualified candidates. On the solution side of the business, there's actually a slight amount of -- there are increases in certain of the areas. Information security, for instance, there is a relative shortage of information security people. On the health -- even in the health care area, some of the packages, there are shortages occurring. And there has been some movement in pricing. So if the first time really since probably 1998, we're actually starting to see some movement in the hotter skills of bill price.

The pay, I mean, I assume to the extent on the hotter services, you're seeing some movement on bill rates, you're giving it away on pay rates?

We're increasing it. But if you do the math, for us having -- as long as you're increase in the bill rate and the pay rate are the same, we're actually better off.

Do you have anything like that in your guidance for this year? What are you looking for on bill rate increases on your solutions side and then -- what have you modeled in there?

Actually when we built the plan, it was pretty much flat on both.

Okay, so maybe -- and you think you'll probably get just flat on the staffing overall?

I think -- it's kind of surprising. The supply and demand in many cities is starting to come back in to sync on all skills. So I think that it would be -- I think that flat would probably be the most probable, on the solutions side, I think in the hotter skills, if the solutions business was coming back and as I said, I think that it is, I think that you're going to see some bill rate increases again. It's been five, six years. It's certainly overdue.

In your guidance, what have you modeled for IBM? Is it the same percentage as Q4 or is it a declining percentage?

No. Actually for the guidance, we pretty much assume that IBM would stay as a same percentage of revenue for the entire year. We actually believe -- a lot of this has to do with the NHS, the solutions business will actually grow faster than the IBM business in the second half of the year.

What did you -- separate subject, the buyback price in Q4 , do you have that handy?

Sure. The average buyback price in the fourth quarter was 376. For the year it was 370. The highest that we paid was in the fourth quarter was four weeks.

And when your blackout period ends Monday?

Actually tomorrow. We have not been able to buy any stock back this year so far. We really stopped buying stock back at the end of last year.

All right that's all I have for now. Thanks.

Okay.

Next question is from the line of David Lane from Bear Stearns. Go ahead.

Just had a quick question. U.S. IT staffing, do you think it's going to be flat in '06?

No, the bill rates.

The bill rates will be flat. What do you think your growth in U.S. IT staffing will be in '06?

It's probably going to be around the mid point of our guidance, so probably 14, 15%.

All right, thank you. That's my only question.

Okay.

And there are no further questions in queue at this time.

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

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