Computer Task Group Inc (CTG) 2007 Q3 法說會逐字稿

Ladies and gentleman, we thank you for standing by and welcome you to the CTG Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions.) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, James Boldt. Please go ahead.

Ladies and gentlemen, give us one more moment, please. Ladies and gentlemen, your host, Mr. James Boldt, has been added to the conference.

Good morning, everyone. This is Jim Boldt. I want to thank you for joining us this morning for our third quarter 2007 earnings conference call. Joining me is our CFO, Brendan Harrington. As you saw in our earnings release, our third quarter revenues were at the midpoint of our guidance. While before-merger evaluation costs made income increase by 34%, earnings per share were $.07, at the high end of our guidance. Our higher margin solutions business continues to grow, causing us to forecast an even greater increase in net income and EPS for the fourth quarter.

I'm going to talk more about our business and expectations in a minute, but first I'm going to ask Brendan to start us off with a review of our financial results. Brendan?

Thanks, Jim. Good morning. Before I begin, I want to mention that the 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 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 third quarter of 2007, CTG's revenues were $80.6 million, an increase of approximately $0.8 million compared to third quarter 2006. Net income of $0.9 million in the third quarter of 2007 increased by 10% from $0.8 million in the third quarter of 2006. For the quarter, net income per diluted share was $0.06, and net income per diluted share including equity compensation was $0.07.

These results include $0.3 million, or $0.01 per diluted share, that CTG reported in costs primarily related to advisory fees incurred in the connection with its consideration of two unsolicited merger proposals from RCM Technology. Excluding these fees, operating income was $2 million in the third quarter of 2007, 12.6% higher than $1.7 million in the 2006 third quarter, and CTG's net income was $1.1 million, or $0.07 per diluted share, a 34% increase from 2006 third quarter net income of $0.8 million, or $0.05 per diluted share. Net income and net income per diluted share for merger evaluation costs and equity-based compensation expense for this 2007 third quarter was $1.3 million, or $0.08 per diluted share, a 28% increase from $1 million, or $0.06 per diluted share in the 2006 third quarter. Third quarter net income for both quarters includes an after-tax non-cash charge for equity compensation of approximately $0.01 per diluted share, which is excluded from net income before equity compensation.

The proportion of solutions revenue was approximately 32% of total revenue in the quarter, compared to 31% in the third quarter of 2006 and 31% in the second quarter of 2007. Direct costs as a percentage of revenue were 77.3% in the quarter, compared to 77.2% in the third quarter of 2006 and 77.6% in the second quarter of 2007.

Operating margin, excluding merger evaluation costs, was 2.4% of revenue in the third quarter of 2007 compared to 2.2% in the third quarter of 2006. Revenue from IBM was $26.3 million in the third quarter of 2007 as compared to $26.9 million in the third quarter of 2006. This year's lower revenue from IBM primarily reflects a reduction in their external staffing requirements during the third quarter of 2006.

Quarterly revenue from our European operations was $17.5 million in the 2007 third quarter, a 23% increase from $14.3 million recorded in last year's third quarter. Foreign exchange fluctuations accounted for 9% of the 23% increase in our European revenue during the quarter.

The tax rate for 2007 third quarter was 38%. The expected tax rate for the 2007 full year is estimated to between 38% to 40%.

The Company has 3,400 employees at the end of third quarter 2007, of which approximately 88% are billable resources.

On the balance sheet, our days sales outstanding decreased to 60 days from 61 days at the end of third quarter of 2006, and our days sales outstanding decreased from 64 days at the end of the second quarter 2007. Our cash generated from operations was approximately $9.4 million in the quarter. We had $427,000 in capital expenditures, and we reported depreciation expenses of $604,000. During the third quarter of 2007, while adhering to SEC-imposed volume limitations, we repurchased 234,000 shares of CTG common stock. The repurchases in the third quarter were made at an average price of $4.46 per share. We repurchased shares during the most recent self-imposed blackout period under our 10b5-1 plan and will continue to manage our repurchase programs in the fourth quarter of 2007. Jim?

Thanks, Brendan. Demand for staff has been somewhat inconsistent this year and is very different from client to client. Overall, client demand for staffing gradually improved during the third quarter. For the rest of the year we expect that staffing demand will continue to increase. As to our solutions business, we continue to make additional investments in our healthcare business in the third quarter of the year. In 2007, we're investing in expanded offerings, more healthcare sales territories, and additional sales staff in order to capitalize on our leading market position and the many opportunities in the healthcare market. Our proposal activity in our healthcare vertical has been robust, and we're expecting to see a continuation of that trend in the fourth quarter of 2007 and throughout 2008.

With respect to the National Healthcare System Project in the U.K., the project continues to progress at a slower-than-expected pace due to limitations of the existing version of the software. We do, however, anticipate that we'll be able to place additional staff on the project when a new version of the software being utilized in the region we're supporting is available for implementation next year.

After the fourth quarter of 2007, we're forecasting revenues in the range of $83 million to $85 million, 6.4% to 9% higher than last year's fourth quarter. Given the revenue forecast, we expect that our fourth quarter net income before merger evaluation costs will be in the $0.08 to $0.10 per diluted share range, and that EPS, also excluding equity compensation, to be in the $0.09 to $0.11 per diluted share range. After the full year, we believe that CTG's 2007 revenues will be in the range of $324 million to $326 million. We expect that before merger evaluation costs, net income in 2007 will be in the $0.27 to $0.29 per diluted share range, 29% to 38% above 2006, and that also excluding equity compensation, diluted EPS will be in the range of $0.31 to $0.33, also an increase of 29% to 38% above 2006.

To sum it up, from a profitability perspective, our third quarter operating performance was a little bit better than we expected. Going forward, we anticipate that there are additional solutions projects, particularly in our healthcare vertical, that will benefit earnings in the fourth quarter of 2007 and into 2008. With respect to where we are an ongoing transition and higher margin solutions business, we're on target with our goals for 2007.

On our first quarter conference call this year, in response to a question about our fourth quarter operating margins, we said that by the fourth quarter of 2007, we expected that our increasing mix with solutions business would bring operating margins to around 3% and EPS of $0.09 per share. We're at the midpoint of our current guidance. We're right where we expected to be at this point in time.

Looking forward into 2008, we expect that our improving mix of more profitable solutions business is going to continue to drive higher margins and operating profits throughout next year.

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 is from Rick D'Autevil of Columbia Management. Please go ahead.

Good morning. Just, actually it's a little bit into the detail of your guidance for the fourth quarter. You referenced ongoing M&A potential charges. Is there anything ongoing with respect to the RCM proposal?

We haven't heard anything from them since they publicly announced their proposal over nine weeks ago. We did, however, engage people to advise us who are on retainer, so there will be some costs in the fourth quarter, but it's difficult to estimate what that's going to be.

Okay. What, so it's--anything that you've set out here relates to RCM. It's not related to any other activity, right?

That is correct.

Okay. That's all I have right now.

Okay.

Thank you. Our next question is from Bill Sutherland of Scatterberg--Boenning & Scattergood. Please go ahead.

Interesting. I haven't heard Scatterberg before. Gentlemen, a couple of housekeeping. I'm sorry. Brennan, I didn't hear the solutions percent of revenue.

It was 32% in the quarter.

And that was comparing to what?

Thirty-one percent from last year and 31% from second quarter last year.

Okay. And what was the percentage growth for solutions and for staff?

For the first nine months of the year, solutions was up 6%. Staffing is actually down 3%, but it's primarily because of the IBM cutback last year.

And in your forecast for Q4, roughly, kind of what proportions do you look for as far as growth in those two sectors?

I think in the fourth quarter, we could reach a double-digit growth in the solutions business in the fourth quarter. And staffing, I think, is probably going to be more flat, up just a little bit. It's pretty much what we're projecting actually, going forward, that what we've done really is we are definitely supporting all the customers that we have in staffing and we want to do that going forward, but we've stopped trying to go out and get brand-new staffing customers, and we've taken that money instead and devoted it into the solutions business.

I want to get back to healthcare, but I want to get one little housekeeping thing. Brendan, did you give headcount?

Yes. That was 3,400 at the end of the quarter, Bill.

That's total?

Right.

So it's 85%?

It's about 88% are billable.

Oh, sorry. Okay. If, Jim, I'd love to get more color on the initiatives in healthcare, both the sales force expansion and the service offering, where that's focused, and maybe the split between outsourcing and consulting and et cetera.

Okay. The, in terms of the sales force, we're expanding geographically. Actually, the--remember, our healthcare is divided into three parts. It's the provider, the payer, and life sciences. The investment dollars that we're talking to are going in primarily to the provider and payer sectors, and so the hospitals and the health insurance companies. In the provider area, for instance, we will double our sales force, actually, so we're expanding geographically in that area to sell some of the solutions that would go out over the years.

In addition to that, though, we are concentrating on newer solutions that we've developed or are still developing actually right now. One of the areas that I think is of great potential to us is electronic medical records. Our electronic medical record revenues have probably--has almost doubled in 2007 from 2006. They'll be just about 5% of our total revenues this year. They were about half of that the year before, and they were only a third in 2005, (inaudible) in 2000. And so far those are primarily systems that either hospitals use or practice would use, so it's not the community-wide ones that are about to come. So electronic medical records systems, whether they're for a hospital or a community, now and going forward, I think, is going to be a growing part of our business.

We're also doing for some of the wheels some of the first kind of community-wide projects. For instance, we're doing an e-prescribing application that will allow a physician to prescribe electronically, and when he does that, the system will actually give him alternatives. If he puts in a brand name, for instance, there will be other alternatives that pop up--generic drugs, et cetera--that might have the same effect but are obviously cheaper in cost. So that would be another area, starting with the wheels, and of course they're starting to look at electronic medical records (inaudible). Although we've done strategic planning, et cetera, I think the larger revenue numbers from that are probably at least a year off before we actually see communities start to put those systems in.

And these are, these are traditional implementations with a little bit of maintenance ongoing?

I expect that they would, but there's few, there are no communities that I'm aware of that have them, so that the electronic medical records, just work that we're doing now, is really some of the hospital packages, for instance, that we have a history of installing. So like Epic or Cerner, for instance. Going forward, it's yet to be determined what communities have any use for their systems, whether it's one of those systems, and even the veterans system, which has been up and running for a number of years, is under consideration at some places.

Another area for the health insurers that is increasing is FACETS. FACETS is an ERP system for health insurance companies. It's designed specifically for them. If you will, it's the SAP, what SAP is to manufacturing, FACETS is to health insurance.

Is that an acronym, FACETS?

Yes. F-A-C-E-T-S. I'm not sure it's an ac--I'm sure it is, but it's been around for a while. I don't remember what the acronym's for. It's, TriZetto is the software company that makes it. And more and more of the payers are going with FACET and increasing their use of FACET. It's excellent in terms of auto-adjudication. And it's tied in. It has automatic interfaces into really strong databases. It will work with Sybase, et cetera. So they're either redoing their systems, expanding their systems, or implementing FACET. That will be another area that I think is going to be very attractive for us going forward.

Do you have a nationwide footprint now as a provider for outsource?

Absolutely. We always have had one. I think what's really happening is we're having more salespeople that are just specializing in healthcare. So more and more, we added another one yesterday. We're adding salespeople that are strictly healthcare salespeople to health insurance. On the provider side, we've always given national presence. What we're doing now is the certain cities where, you've probably, if they had one salesperson, large metropolitan areas, we probably could use three salespersons. People do so much different things.

They're traditional quota-bearing types of salespeople?

Yes.

Your, you were at 25% of revenue in healthcare in Q2. Is that up a bit?

I think that's about the same, perhaps, until in the last couple of quarters.

Okay. And is that all solutions?

No, but healthcare, as I said, has three components. In total, 75% of healthcare is solutions, 25% is staffing. The provider and payer markets are almost 100% solutions. Most of the staffing is in the life sciences.

Oh, okay. I remember you had an offering for life sciences. It was a, it was the--.

21 CFR 11?

Yes, exactly.

Yes, we still do. It's testing and validation.

Right. Testing and validation, right. But that's mostly--do you have the staffings?

Well, we do it both. We will take down a project, but many of the large pharmaceutical companies want to control the deliverables because of the sensitivity.

Okay. Okay. And your, as far as where, where are the margins running right now for staffing and solutions? And that will be my last question for the moment.

Okay. In total, the staffing margins are running around 3%. A couple of years ago, we hit kind of a change where we thought that those margins would come out long term. Originally around 2001, we said we thought 5%. When we got a larger mix of strategic staffing, which obviously has a lower margin, we changed our guidance going forward of around 3% for staffing. The, so the staffing margins are running where they should be--about 3%.

The solutions margins should run over 10%. At the moment they're running in the 6% to 7% range. They're a little bit lower because of the investments we're making. When you add new salespeople, it takes a while before they can sell a solution. For many of the offerings we have, it's a six- to 12-month, actually sales cycles, Bill. You have to make an investment before you get a return. And even creating the new offerings, we have a lot of billable people who eventually will be billable but currently are working on just developing solutions, so they're more of an overhead expense.

The other factor, I guess, in going forward that is somewhat of a drag currently on our margins, we had said that we expect to get about, to about a 6.5% margin once we get back to a 50/50 mix in our business. Fifty percent at 3% staffing, 50% at 10% for the solutions. In addition to the mix shift on the Company we were forecasting would be larger, probably about $100 million larger than we are today. So our overhead, which has a considerable amount of what we think of as fixed cost--maybe not the economic term for fixed cost, though--but will lower itself by about 1% going forward. So if you took--I didn't want to do the calculation. If you take 30% of--I'm sorry--70% of 3% and around 30% at 6% to 7%, and then subtract the 1% that is going to come in the future as we grow, you should come up to around a 3%.

Uh-huh. But that's your seasonally strong quarter. I mean, you'll drop below 3% the first part of next year, won't you?

The fourth quarter of the year is our second best quarter, actually. The second quarter is the best. The fourth quarter is the second best, then the third quarter, then the first. The first is going to have less data next year, plus we have some expenses that only happen in the first quarter of the year. Our audit fees, for instance.

You know, looking forward into next year, we're right about where we thought we were going to be this year. If you exclude the merger evaluation costs, this year's operating income will come out to be about 2.4%. I think that next year we'll probably increase that by about 1%, so it will probably go up to about 3.4% next year.

The last question is, what, describe your outsourcing practice right now. What's, what do you, kind of how much are you doing there and what's the focus?

We still have kind of a reasonable amount of outsourcing. It's changed very much over the year. For instance, outsourcing year to date was about 7.5% of our total revenue. The changes, then, that, as more and more companies have taken the traditional outsourcing offshore and we do have some of that, we focus more on transitional outsourcing. When a customer decides that they're going to go to a new package within healthcare, they have to train their IT people up on the new package, and the best way to do that is have them involved in the implementation. So we will go in behind them and do it, a transitional outsourcing to outsource the legacy systems for a couple of years, two or three years, while they move over to move their people over to the development of their new application. So we tend to focus more on transitional outsourcing. Because of the fact that it's a shorter period of time and it just isn't economical, really, often, to take it offshore. I mean, when you do the transition to get it offshore, it's somewhat costly. You'll save money in the long run, but the first run, first year often costs you a fair amount of money. So most transitional outsourcing, particularly if it's only for a two- or three-year period, is done in the United States.

Okay. Thanks, Jim.

Okay. Thank you.

You do have a follow-up question from the line of Rick D'Autevil. Your line is open.

Yes. Just a, we talked a lot about the healthcare vertical. I think some of the other areas of focus, one of which was security, maybe you can address the growth prospects in some of the other verticals that you had been investing in.

Okay. Security, we think, is still a very attractive offering for us. We, in our pipeline currently, we actually have a lot. I don't think we've ever had more in terms of security opportunities going forward. The other area that we had mentioned is testing. We'd invested in testing for the healthcare but also the general practice, and it, too, is--health testing has been growing at a rapid rate, early a double-digit rate. And we see that probably accelerating going forward, particularly as we get more involved in FACETS, installing version upgrades for FACETS which bear a lot of testing, and we have an expertise in that particular niche.

Okay. Are you, as you've mentioned in healthcare, you said you were investing in people. Are you doing that in these areas still, or--?

We are, but they're somewhat combined, to be honest with you. For instance, the FACETS testing is in the healthcare vertical. So that's an area we're definitely investing in, but it's also focused on healthcare.

Okay. And maybe, there must be something that's contracting at the same time. You still have a, I don't know how big manufacturing is at this point, but is that declining?

I don't think it's declining so much as it's just that it's the kind of the all-over category. It's still around 25% of our total business, and it's been, it's not dropping, it's not going up as much as the rest of the business. It's just kind of stable.

Okay. If you were to complete the buyback, with the balance sheet where it is today, can we be comfortable that you're still committed to buying the stock worth at levels like we've seen recently?

If we complete the buyback, would we continue to buy back stock?

Right.

Absolutely. In our given, what we think our earnings growth is going to be going forward, the stock is at a very attractive level. We've been doing this for a couple of years now, and we still haven't increased our debt, really. Actually, our debt, our average daily debt has been dropping over the last couple of years, so we think we can effectively buy back stock. Not, you know, have more than enough cash flow coming in from operations to finance it, and it's cheap. It's the best investment we can make at the moment.

Were there any blocks in the 234,000 you repurchased, or was it pretty much just retail flow?

I think it was mostly retail flow, but I think I'll ask Brendan to answer that particular question. I think there was one small block, maybe 30,000 shares.

Yes, one block of 30,000. It would be 31,000 at the beginning of the quarter.

Okay.

You know, the problem, as you know we have with that, is every day if we buy one share of retail, we're precluded from buying a block. If a block becomes available, it trades during the day before we have a chance to bid on it. It's just the SEC rules.

Right.

Okay.

Thank you.

Thanks, Rick.

There are no further questions from the phone lines at this time. Please continue.

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

(Operator Instructions.) That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconferencing. You may now disconnect.