Computer Task Group Inc (CTG) 2006 Q4 法說會逐字稿

Ladies and gentlemen, welcome to the CTG Q4 2006 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a Q&A 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 over to our host, Mr. James Boldt. Please go ahead, sir.

Good morning, everyone. This is Jim Boldt. I want to thank you for joining us this morning for our Q4 2006 earnings conference call. Joining me is our CFO, Brendan Harrington. As to the format of the call this morning, Brendan is going to begin with a review of our financial results and then I'll talk about the trends that we saw in the fourth quarter, as well as what we anticipate for 2007, and then we'll open the call for questions.

Brendan, would you start us off please?

Sure. Thanks, 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," 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 news releases and from time to time in the Company's SEC filings.

For the fourth quarter of 2006, CTG's revenues were $78 million; net income was $1.1 million; net income per diluted share was $0.06; and net income per diluted share, including equity compensation, was $0.08. Revenues in the fourth quarter of 2006 were approximately the same as in the fourth quarter of 2005, while net income increased by 57%.

Under the accounting rules that went into effect on January 1, 2006, fourth quarter net income includes a $195,000 after-tax, non-cash charge for equity compensation, or $0.01 per diluted share. Net income in the fourth quarter was favorably affected by an increase in the proportion of solutions revenue to approximately 31% of total revenue, compared to 28% in the fourth quarter of 2005. Additionally, (inaudible) for employee benefit expenses were lower than anticipated in the fourth quarter of 2006 and several solutions projects were completed in the fourth quarter with more favorable than anticipated results.

Revenues from IBM were $23.6 million in the fourth quarter of 2006, as compared to $29 million in the fourth quarter of 2005. Quarterly revenues from our European operations were $16.1 million in the 2006 fourth quarter, a 31% increase from the $12.3 million recorded at last year's fourth quarter. Foreign exchange fluctuations accounted for approximately 10% of the 31% increase in our European revenues in the quarter.

The Company had approximately 3,300 employees at the end of 2006, of which approximately 87% are billable resources.

On the balance sheet, our DSOs decreased to 63 days from 85 days at the end of 2005. This was largely a result of our change to a cash discount option for a significant customer in the first quarter of 2006.

Our cash provided by operations was approximately $262,000 in the quarter. We had $430,000 in CapEx, and we recorded depreciation expenses of $669,000.

During the fourth quarter of 2006, while adhering to SEC-imposed volume limitations, we repurchased 152,000 shares of CTG common stock. The repurchases in the fourth quarter were made at an average price of $4.40 per share. As indicated in our earnings release, our Board of Directors increased our authorization to repurchase CTG stock by an additional 1 million shares. We expect to continue our repurchase program in the first quarter of 2007.

Jim?

Thanks, Brendan.

First, I'd like to say that we're pretty pleased with our fourth quarter results, despite the fact that we had an over $5 million reduction in our revenues from IBM from last year's fourth quarter, resulting from the decline in their staffing needs in the 2006 third quarter. Our fourth quarter revenues were approximately the same as last year, as we replaced the IBM reduction with increased revenue from other clients. As the new revenue hit a higher concentration of solutions business, that helped to push our operating margins up. When you add that to lower employee benefit costs and a few large projects ending favorably, you get the highest quarterly earnings per share that the Company has recorded since 1999.

Obviously, with the $5 million reduction of the IBM business, our strategic staffing business declined overall when compared to the fourth quarter of last year. We are seeing more of our customers refine their IT staffing procurement processes by reducing their IT staffing providers from hundreds to 5 to 15 vendors. Given the delivery structure that we've developed, we're doing exceptionally well at making the new short list of IT services providers. The transition of this work from previous vendors takes time, as most customers want to retain existing resources from their displaced vendors until the projects end. Going forward, we do see this trend of fewer vendors accelerating, which bodes well for our long-term growth prospects for our strategic staffing group.

On the solutions side of the business, we continue to see an increase in demand for some of the high-growth solutions that we're focused on. There is of greatest demand continue to include testing and information security in our financial services and general industry markets.

In our healthcare vertical, which includes our hospital, health insurers, and life insurance, life trends of business, the means continues to be strong for consulting, clinical transformation projects, transitional outsourcing, and testing. We see a lot of opportunity for our healthcare vertical, both in Europe and the U.S., and in 2007, we're investing in additional offerings, more healthcare sales territories, an additional sales staff, in order to capitalize on our market position.

With respect to the National Healthcare System project in the U.K., the project is progressing at a slower-than-expected pace. We have, however, been placing additional staff on the project and expect to do so throughout 2007. As a result of our U.S. and U.K. healthcare practice, we've begun work in Europe to assist a European software company with the development of a hospital-related software package.

In the first quarter of 2007, we're forecasting revenues in the range of $79 to $81 million, slightly above the level of our fourth revenue. Given the revenue forecast, the investments we're making, and some additional expenses that occur in the first quarter of the year, we expect that our first quarter GAAP net income will be in the $0.05 to $0.07 per diluted share range. Our guidance includes a gain of approximately $0.02 per share from the sale of securities, as well as a $0.01 per share non-cash expense for equity compensation.

As for the full-year, we believe that CTG's 2007 revenues will be in the range of $336 to $346 million, 3 to 6% above 2006 revenues. It's noteworthy that we expect to see revenue growth in 2007, despite the $35 million annualized reduction that we had in our staffing business in the third quarter of 2006. We expect that GAAP net income in 2007 will be in the $0.23 to $0.30 per diluted share range. Our guidance includes $0.04 per diluted share non-cash expense for equity compensation.

To sum it up, we ended 2006 on a high note. Given some of the opportunities we were pursuing and our position in the market, our leadership team believes we are going to have an even better year in 2007.

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

Thank you. [Operator Instructions] Rick D'Auteuil, Columbia Management

Jim, in your guidance, obviously it implies that margins are going to be down. Is that more mix related with some of the end of life solutions business rolling off, or is it more related to the spending initiatives that you just spoke to?

Okay, I'm sure you're referring to the first quarter. It's a combination of the spending and the fact that in the first quarter of the year we have expenses that generally only occur in that quarter. Some examples would be a couple of years ago we went to -- implemented our Sarbanes-Oxley, or Sarbanes-Oxley, we had been expensing different types of expenses differently and we decided that we really should be expensing services when they occur. So a good part of our [audit fee], certainly more than any other quarter, we end up expensing in the first quarter of the year. It goes down to virtually nothing in the second quarter. We also have a quota club for people who went over their quota in the previous year. Sales people went over their quota in the previous year and we have things like the Annual Report. So we've got -- it comes to about -- nearly $0.02 actually per share. More expenses that just occur in the first quarter of the year. So that definitely is part of it.

In addition to that, I mentioned that we were adding sales people in the healthcare area, and we've already done that and started ramping up the sales people in the first quarter. They have a longer sales cycle, often 6 to 9 months, so we've got the expense and the benefit comes later in the year.

How about in your guidance for the year, what are you expecting out of the U.K. healthcare systems?

I wish we were expecting more. The 4 northern regions, there are 5 regions, the 4 northern regions don't have software and things are moving at a -- just an incredibly slow pace, if it all. The southern region has software, but the implementation keeps getting pushed back. Now, the NHS hasn't given any relief on the end date, so what's happening is every year they are going to have to do more and more hospitals. I think that we've probably ended last year with maybe a $6 million run rate. I think the run rate probably by the end of the year should at least double. And then I think that we'll get more business in 2008. We believe that the project is going to happen. I mean, people are spending incredible amounts of money towards it. It's just that it's a lot slower than anyone anticipated.

So those deadlines are -- I guess you can officially throw those deadlines away at this point?

Well, I think so, but the primes have some -- my understanding is that the prime have some very significant penalties that they have to pay if they don't make their deadline. So somehow they are going to have to address it.

I don't -- I'm sure you saw since your last conference, well, actually earlier this year, [Pre-Teen] was acquired.

Yes.

I do some quick math on the valuation of the acquisition, almost .9 times revenues and 25 times earnings and 9 times EBITDA. I mean, does it make sense to -- we're kind of plodding along now. As you said, your guidance is up 3% or something in revenues. At the bottom end of your guidance, you're only up $0.02 for the year on earnings. Granted, the top end of your guidance would be a nice percentage increase. Does it makes sense, I mean, shareholders have been sort of in a long suffering mode here, I applaud your buyback, I think you helped at least put a floor under it while we muddle through things, but does it make sense to look at some of these other options if those kinds of prices are being paid?

Well, as you know, that's the Board's charge constantly to evaluate the various options, and they take that seriously. Going back to the [Teen] transaction, I suspect that they were sold more based upon their EBITDA or earnings per share multiple. And if you multiply out our trailing times the EBITDA, or earnings per share, you'd probably get something in the 560 range or so, 565, something like that. We tend to focus in more on the midpoint of our guidance, which is about $0.26, $0.27, and that's about a 26% improvement over the previous year. And we've had two very good years. Our operating income in 2005 went up 58%. Last year, it's up 40%. This year, we're basically saying okay, we think our earnings will probably go up another 26%. If you look at those numbers versus using at least the income from the [Teen] transaction, you would imagine that the stock price would go up faster in a year than selling out for 9 times EBITDA. In the end, it's all in our price strength. I mean, it depends on what the price is.

Right. Well, I understand that, but to the extent there are consolidators out there, there are probably some benefits to be derived from consolidating this industry. And the numbers I quoted on the earnings were off '07 numbers, not the trailing numbers, but the --

You and I have talked a lot about the margins part of the equation, with staffing being sort of capped out at 5% kind of level, and I guess with IBM as part of the mix, it's probably capped out at a lower level than that. But the solutions were what we were -- kind of had in our back pocket is coming back and improving the overall profitability picture. Has the gun gone off yet and can we now say solutions is now marching forward? I mean, at least in this quarter, I guess there are -- it grew faster than your staffing, probably mostly because of the IBM loss, but --

Although our -- the non-IBM in business in this quarter grew by 11%, and for the year, 12%. I don't think the solutions business in the United States grew anywhere close to that. Also, look at some of the large solutions companies. I think [Teen] is a great example. They are most solutions and their revenues are flat at best. I think they are getting hit by a decline each quarter on revenues.

I'm not sure the gun has gone off. What is becoming very attractive to us is the healthcare industry. And it's because of these new RHIO, Regional Health Information Organization. It's a brand new market and in order to participate you use their expertise in both the hospital area and the payer area, the health insurer area, and most companies don't have it. There are only probably 5 companies that, 5 IT service providers in the U.S., that actually can say we have a lot of experience on both sides, and we're one of the 5. The others are larger companies, like IBM and CSC. And that's really the area in terms of healthcare, either hospitals or the RHIO market or the [care] market where we're making our investments, because I think that we can grow that business a lot quicker than the solutions business in the United States.

Christopher [Mint], Boenning & Scattergood

Most of my questions have been answered. I just had a quick question on the anticipated tax rate throughout 2007. Do you have any numbers to give?

Yes. I'll let Brendan answer that one.

We think our tax rate going forward should be in the 40 to 42% range.

Carter Newbold, Rutabaga Capital

I wondered if you could -- I can't recall if you disclosed this or just talked more generally about it in the past, but your win rate on the solutions side of the business, was there any material change between '06 and '05?

No, I don't think so. I think our win rate is probably about the same. We are doing better in the healthcare area than our overall rate. So the more we go into healthcare, I suspect that our total rate will go up.

Okay. And then, specifically on the IBM piece of the business, I think I'm -- I'm hearing you say that your expectation is sort of for a stable outlook. I guess given the last few years the stability has not been the characteristic that has defined that business. Are you getting some communications from them that an event like the one that came along in '06 is unlikely for '07, or is stable just the best outlook in a period of uncertainty?

I think it's the latter. It's stable is the best outlook when you don't know. We've had both from IBM. I mean, we've had significant demand --

Right.

-- in terms of 2005, and then last year, a reduction. It has to do, quite frankly, with their projects. How many new projects are they going to launch? They tend to use our people for specific projects because we're very good at hiring people and sometimes letting them go at the end of the project or redeploy them to something else. So it really depends internally on how many projects they have. And we serve such a large customer base, so there is not one point that I could go to and say -- within IBM, and say what do you think it's going to look like for 2007, because there are so many people making decisions about what projects that are going to be launched in terms of IBM. So at the moment, we're more like assuming that it's going to be stable and be growing slightly. But just stable is probably a good assumption.

Okay. Last for me, and I think we've had either a portion of this discussion, or perhaps all of it previously, and I may have forgotten, but could you just talk about how you think about cost of capital and what capital base you think you have to earn or turn on? I'll just leave it there.

Yes. Well, actually, that came from the chemical industry. For 20 years, my incentive was based upon the weighted cost of capital. So that's the way that I think of it. Which for us, because we have a large data, is a relatively large number. I mean, it's about 10% -- well, actually, last time I did it, I think it was like 14%?

And you are doing this on all end capital, not excluding the intangibles?

Correct.

Okay. So, I guess, kind of circling slowly back to the initial question about running the Company versus auctioning the Company. It takes a lot of years of incremental improvements of even mid-teens or low-20s earnings per share or net income growth, I think, to get to earning your cost of capital on an after-tax basis. Is the -- and I think this is sort of similar to a previous question. I have always believed that growing the solutions mix was going to be the mechanism through which you might take sort of a quantum leap over an 18-month period to get there. Is that still the case?

It absolutely is the case. Over 18 months to 3 years, if the solutions business came back, I think we could get above our cost of capital. Unfortunately, the industry hasn't come back and what we've really done is focused in on just certain solutions that we think are going to have to be done, whether the solutions business (inaudible) comes back or not.

Great. Thank you.

Bill Sutherland, Boenning & Scattergood

Take you back on Carter's question, what is the mix that you would need for solutions? Is it that 60/40 to get to where you're at a positive return on capital?

I think even if we got 50/50, I think it would have.

And where are you today and where do you think you'll be based on your outlook for '07, by year-end '07?

Outlook in terms of?

I'm sorry. Solutions strategic staffing, right?

Well, in the fourth quarter of the year, the solutions actually improved. Our staffing business dropped to 68%. In the fourth quarter of '05, it was 72%. So solutions went up to 32 versus 28, and that's where we're putting our investment money is into that area. The other thing to bear in mind, our average debt last year was about $6 million. And we add that to our shareholders equity, you're probably talking about a return of around $9 million, in order to hit the 14% range. And if you look at our operating margins last year, they were 6.8. So we actually -- our operating income has more than doubled in the last 2 years, but we need one more I guess, a $2, $3 million push to get over the cost of capital.

The healthcare business, do you see any opportunities to expand more rapidly than just through organic growth?

Well, it's possible through an acquisition, but some of the areas that we're going after, like the RHIO market, they're -- it's kind of a jump ball, they are just starting up, there are no players that have a significant amount of market share. So one opportunity might be to buy a healthcare company that has the potential to go into the RHIOs. It's possible, but it would be -- you would have to find something that is a pure vertical in healthcare in order to do that. Not unlike the aluminum business that we bought in 1999.

But they are just -- they are just not very -- keep it in mind?

No, there is not many, unfortunately, good plays on verticals right now. There are probably some small ones. But the problem with a small one is what are you really getting? I mean, if the guy is wanting to leave, will the business continue? And if you get 10 or 20 guys, would you accomplish anything?

Where -- do you think the European business, based on what you just said about the U.K. and where you'll be on an annualized basis potentially, do you think that will be a factor for your business, growth business?

Yes. It's one of the reasons that our European business grew so much last year. And it's not that the project is going to stop. We can't imagine that the U.K. government will say okay, we're not going to do this. It's going to go through. It's just that it's the world's largest project kind of [thinning] away.

And last, you mentioned the hit, not the hit, but the impact of the reduced requirements from IBM at about $5 million in Q4?

Yes.

And you said the whole annualized impact of that would be $35 million?

Yes.

So is there -- is that a particularly small quarter, as far as that impact?

Well, it was about -- it was probably $5 million in the third quarter too. There wasn't a full quarter's impact. The IBM business increased up through the second quarter of --

'05?

Well, I'll say '06. It was just over $33 million in the second quarter of '06. It was $31.6 million in the first quarter of '06. So, if you look at our first quarter of '07, and let's just assume that IBM stays at the same level as in the fourth quarter, so it's $23.6, last year, it was $31.6, that's an $8 million decline in the quarter.

Helpful. And Q2 similar?

Well, Q2, it goes up -- in 2006, it was $33.2 million. So it would actually go up $2 more million. It would be about $10 million in Q2.

Okay.

Rick D'Auteuil, Columbia Management

A couple of quick follow-ups. Bill asked the question, I'm not sure I heard the answer, what is the implied solutions mix in -- of the, call it midpoint $340 million in revenue this year? 31% was the fourth quarter. What's the -- assume you make some progress on that, or --?

I think that we will make progress on it. I think that it will probably be -- well, certainly someplace between 32 and 35%. One of the reasons we're not getting the full benefit from it this year is that we're investing in more sales people and building offering, particularly in the first half of the year, so the benefits from those investments come in the second half of the year.

The guidance of 23 to 30, last year you provided guidance with and without the stock option expenses. I assume this is including the stock option expense?

It is. And the stock option expense would be $0.04. So, if we were to give out cash, as we did last year, it would be 27 to 34.

Thanks. And, lastly, it seems like every quarter you guys, I know, are trying to more actively buy your stock back and you go into this blackout period after the quarter ends until after you report earnings. It seems like a lot of the volume in the quarter gets traded in and around the blackout period. Have you guys considered doing one of these 10b5-1 kind of plans, where you sort of -- you can buy -- there are no blackout periods and you buy right along, it's out of your hands, to give some, I guess, guidance to whatever broker is handling the buyback? And that way you can be buying 12 months a year, rather than 8 or 8.5 months a year.

Actually, we haven't given any thought to that, but that's an excellent thought. I really hadn't thought about that. That would be an excellent way around a blackout. So, particularly, this first quarter blackout drives us nuts. We can't [buy some] the first week in January until tomorrow. So I will definitely take a look at that. It's something that we should evaluate.

Okay, appreciate it. Thank you.

[Operator Instructions]

Mr. Boldt, there are no questions. Please continue.

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

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