Computer Task Group Inc (CTG) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the CTG conference call. At this time, all participants are in a listen-only mode. Later there will be an opportunity for questions. 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, Investor Relations CTG, Miss Deborah Pawlowski. Please go ahead.

Thank you, Rochelle, and good morning, everyone, and welcome to CTG's third quarter 2010 earnings conference call. We certainly appreciate your time and interest in CTG.

On the call today are CTG's Chief Executive Officer Jim Boldt and Senior Vice President and Chief Financial Officer Brendan Harrington. Jim and Brendan are going to review the results for the third quarter and update you on the Company's strategy and outlook. We will follow that with an opportunity for Q&A. If you don't have the news release discussing our financial results, you can access it at the Company's website at www.CTG.com.

Before we begin, I want to mention that statements in the course of this conference call that state the Company's or management's intentions, hopes, beliefs, expectations and predictions for 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 earnings release as well as in the Company's SEC filings. You can find these at our website or at the SEC's website, SEC.gov.

So please review our forward-looking statements in conjunction with these precautionary factors. With that, I'd like to turn it over to Jim to begin the discussion. Jim?

Thanks, Debbie, and good morning, everyone. This is Jim Boldt. I want to thank you for joining us this morning for our third-quarter earnings conference call.

As you saw in our earnings release in the third quarter of 2010, we surpassed the upper end of our revenue guidance and achieved the high end of our guidance for earnings per share. We continue to grow as demand for our services expands both as a result of the continued need in the United States for staffing and as the healthcare industry invests in electronic medical records systems.

As a result in the third quarter, we added 200 people, a 6% increase to our staff, bringing our total headcount to 3400. Year to date, we've added 500 staff to our headcount for an increase of 17%.

I'm going to talk more about our results and what we see for the fourth quarter and the full year, but first I'm going to ask Brendan to start us off with a review of our financial statements. Brendan?

Thanks, Jim, good morning. For the third quarter of 2010, CTG's revenue grew to $84.5 million, an increase of $17.7 million or 26% from the third quarter of 2009. On a sequential basis, revenue increased 4.1% compared with the second quarter 2010.

Solutions revenue in the third quarter of 2010 was $28.5 million, $5.5 million or 24% higher than last year's third quarter. As a percentage of total revenue, solutions revenue was 34%, the same as a year ago and up from 32% in the 2010 second quarter.

Driven by strong demand in the quarter, staffing revenue increased $12.2 million or 27.9% to $56 million. Third-quarter revenue from IBM, our largest customer, was $27.2 million, an increase of 58% or $10 million compared with last year's third quarter.

As a percent of total revenue, IBM increased to 32.2% in the quarter and has now returned to the level we experienced prior to the recent economic downturn. In the third quarter of 2009, revenue from IBM was 25.8% of total revenue.

Revenue from our European operations was $13.8 million, down 6.6% from the $14.8 million recorded in last year's third quarter. The recovery in the European economy continues to lag that of the US and that continues to be reflected in our European revenues.

Excluding foreign exchange fluctuations, European revenue in the quarter would've increased 3.2% from last year. The effect of the fluctuations in the US dollar during the third quarter of 2010 decreased our consolidated revenue by approximately $1.5 million or 1.7%.

Direct costs as a percentage of revenue were 79.5% in the third quarter compared with 77.2% in the third quarter of 2009 and 78.1% in the trailing second quarter of 2010. Our direct profit margin was negatively impacted in the third quarter by the significant increase in our staffing revenue especially from our lower direct margin staffing business.

However, this lower than average direct margin managed staffing business has a significantly lower SG&A cost than our solutions business. This is reflected in the favorable impact on our overall estimate costs as a percentage of revenue which decreased to 16.8% from 19% in the third quarter of 2009 and from 17.6% in the second quarter of 2010.

Also adversely affecting direct profit margin in the quarter was the revenue recognition method required for our software sales. On projects where we are engaged to deliver both software and services, the revenue recognized is limited to the extent of the costs incurred until the software has been modified as necessary and then accepted by the client.

Once the software has been modified and accepted, we will then recognize profit ratably over the remaining term of these engagements. Under the current accounting guidelines, this revenue recognition policy is required until we are able to establish an objective price in the marketplace for the particular software being delivered.

Third-quarter operating income was $3.1 million, up $629,000 or 25% year over year. Compared with the trailing second quarter, our third-quarter operating income decreased by $372,000 or 10.6%.

The contraction in the margin from 4.3% in the 2010 second quarter reflects higher than expected growth in the lower margin managed staffing business and the decline in utilization rates normally seen in the third quarter due to vacation time taken by the billable staff. Operating margin in the third quarter of 2010 was 3.7% which was equal to last year's third-quarter margin of 3.7%.

Net income increased $421,000 to $2 million in the quarter, an increase of 26.2%. On a per diluted share basis, net income was $0.13 for the quarter, a 30% increase from third-quarter 2009 and an 8.3% increase from the 2010 second quarter.

The 2010 third-quarter results included equity compensation expense of approximately $0.01 per diluted share net of tax while the third-quarter 2009 results included approximately $0.02 per share net of tax. The tax rate for the 2010 third quarter was 34.1% compared with 34.7% in the third quarter of 2009.

During the third quarter of 2010, the Company realized two tax benefits. The first related to the completion of a 2008 IRS examination and the second benefit was associated with the filing of our 2009 state income tax returns. We expect the tax rate for the full year 2010 to be between 38 and 40%.

As Jim noted, our headcount has been increasing. We had approximately 3400 employees at the end of the third quarter 2010 of which 90% were billable resources. On the balance sheet, our day sales outstanding was 61 days at the end of the third-quarter 2010 compared with 60 days at the end of third-quarter 2009.

Our cash generated from operations in the third quarter of 2010 was $928,000 as compared with cash used in operations of approximately $2.9 million in the third quarter of 2009. Both the third quarters of 2010 and 2009 ended on a payroll date for our US operations.

In the quarter, capital expenditures were $494,000 and depreciation expense was $453,000. At the end of 2010 third quarter we had no debt outstanding on the balance sheet and $9.8 million of cash. We've continued to use our free cash flow to repurchase shares of CTG stock.

During the third quarter of 2010 we repurchased approximately 89,000 shares of CTG common stock. As of October 26, 2010 our remaining repurchase authorization is for approximately 228,000 shares. Because it remains accretive to our earnings and since we believe it's a good investment of our cash, we intend to continue our repurchase program during the balance of 2010. Jim?

Thanks, Brendan. In aggregate our solutions business increased by 24% in the third quarter of 2010. As we reported on previous calls, the tight credit markets that moderated demand for our solutions business throughout 2009 and at the beginning of this year particularly in the healthcare provider market no longer seems to be an issue for starting projects.

On our last conference call, we mentioned that we had received four RFPs for electronic medical record projects during the second quarter and had won three of the four. We are still waiting to hear the outcome of the fourth RFP that we bid on in the second quarter.

During the third quarter of 2010, we received RFPs for six additional electronic medical record projects. None of those projects have been awarded as of yet, but we expect to hear the outcome of those projects during the fourth quarter of the year.

For the third quarter of 2010, electronic medical record projects accounted for 14% of our total revenue. Our pipeline for EMR projects has never been stronger.

We believe that data analytics will be another major opportunity for growth in serving the healthcare industry. We have developed and are marketing three new solutions for the healthcare market that employ data analytics to identify the ways to improve the quality and efficiency of healthcare delivery.

The first offering is a medical care management model that improves patients' outcomes while lowering cost. We had our first sale of this offering in the first quarter of 2010.

In the third quarter of 2010 it was announced that the University of Buffalo's medical practice had won a HEAL grant from the State of New York which will be used in part to install our application in two hospitals in the Western New York area. We expect to begin to record revenue from this new project starting in the first quarter of 2011.

Our second offering is for an actuarial tool for the more accurate underwriting of group medical plans, helping insurers more equitably price premiums by taking into account the financial condition of employer groups. We made the first sale of this offering in June of 2010 and the pipeline for additional clients for this offering is building nicely.

The third offering is for the detection of fraud, waste and abuse which is estimated to account for 3 to 10% of all healthcare expenditures annually. As the time required to verify the results of this offering is significant, we had anticipated this offering would be the last of the three offerings to be sold.

We're working with several potential customers on this offering and still expect to make the first sale of this offering before the end of the year. The three offerings are being sold as software as a service. As a result, we will recognize revenue as we deliver those services to customers over the terms of the contracts.

I would also like to talk about the three other vertical markets that we are focused on. Demand from the technology service for market has been very strong during the first nine months of 2010 and right now we expect demand will remain strong through the rest of the year. As to the financial services vertical, we depict that business as being stable and we're not expecting it to change for the rest of the year.

As to our energy business, we reported on the last conference call that we've seen a reduction in revenue from a large energy customer due to factors that were unrelated to CTG's performance. That situation has not changed and we believe the energy client will continue to purchase at the same level we saw in the third quarter for the foreseeable future.

Turning to our staffing business which generates the majority of its revenue from the technology service provider market, it increased by 28% in the third quarter of 2010 when compared with the third quarter of 2009. We expect we will continue to see strong demand for staffing in the fourth quarter of 2010.

We're forecasting revenue in the fourth quarter of 2010 to be in the range of $85 million to $87 million or an increase at the midpoint of our guidance over last year's fourth quarter of 27%. We're forecasting earnings per share in the fourth quarter 2010 to be in the range of $0.13 to $0.15 per diluted share or an increase of the midpoint of our guidance of 40% over the fourth quarter of last year.

With our solid nine-month performance and our strong fourth quarter expectations, for the full year we have increased our expected 2010 revenue range to $329 million to $331 million or an increase of the midpoint of our guidance of 20% over 2009. Based upon our revenue forecast and the expected mix of business, we now expect that income per diluted share in 2010 will be in the range of $0.49 to $0.51 or a 32% increase from 2009 at the midpoint of our guidance.

When you compare CTG to companies both in and outside of our industry, we've had a stellar year thus far and as you can see from our guidance, we expect to close the year with a strong fourth quarter. Importantly, well beyond this year, we've established ourselves as IT solutions experts for the healthcare industry and we believe the solutions we have introduced will have a lasting effect on our future growth.

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

(Operator Instructions) Bill Sutherland, Boenning Scattergood.

I got on -- I apologize -- in the middle of Brendan's commentary. So I missed the IBM percent -- I'm sorry, the largest client percent.

Yes, it was 32.2%, Bill.

Okay, thank you.

$27.2 million.

Healthcare revenue -- and I missed that percentage increase, number two.

Healthcare was up 32% in the quarter.

Okay, did you give an EMR growth rate?

EMR was 14% in the quarter.

14% of total, but you don't have to give the gross?

Actually, I think it's over 100% -- it's in the (multiple speakers)

Yes, it was 105%.

It's in the written, okay. Great. Jim, it looks like the EBIT margins in Q4 based on the guidance range bounced back from the depressed level in Q3. Can you give us some color on kind of the shifts there?

Yes, if you look at the midpoint of our guidance, we usually talk about the operating margin. The operating margins in the third quarter were 3.7%. Fourth quarter it goes up to 4.3%.

It's a continuation of the mix shift. We had a lot of staffing business in the third quarter. There was the lower-margin, high-volume staffing business that somewhat depressed our operating margins.

In the fourth quarter we're getting a better mix of business. Also this accounting that Brendan referred to related to the services around the new solution products that we are putting in.

That had the greatest impact in the third quarter and essentially for those services that we rendered to that customer, we got zero direct profit margin. It isn't as large in the fourth quarter, so that's helping us as well. We really think in the fourth quarter that we will probably hit around 4.3% and that will bring us to about 4.1% for the year.

So, as you get your two other solutions into their first real commercial applications, I guess you will have a quarter or two with similar impact on those?

Yes, theoretically we could, but the medical management application has a great opportunity for services around it (inaudible) installed etc. The two others really don't. They are more sold. The customer has to do all the work on their end.

There wouldn't necessarily be any modifications that we would have to do. So we're not anticipating that we will get kind of the same effect when those launch.

And then after -- as Brendan mentioned, after we've sold the medical management tool a few times and have been able to establish its own profit margin separately, we can change from the accounting that we currently have to use to one that recognizes the services profit as we generate the revenues.

Okay, thanks for that clarification. The headcount additions that you think you'll be making in Q4, do you have a rough number?

We still think that we will increase our headcount by about 100 in the fourth quarter. Fourth quarter is a little bit softer for us than the other quarters generally because the month of December, people don't like to take on new contractors, particularly because of the vacations a lot of people take the week between Christmas and New Year's. So if we bring out 100 in the fourth quarter, that's still indicative of a very strong market.

Last one in EMR just for a second, how would you characterize the -- I guess the selling cycle at this point given that the hospitals seem to know where they stand in terms of credit and meaningful use? Do you see the cycle shortening?

Yes we do. On many projects, we see the cycle which is normally 90 days shortening down to about 60 days.

We have actually told some of the hospitals that we are dealing with every month they delay -- remember, these are generally hospitals with 500 to 2000 beds. So they're usually around a 1000-bed hospital chain. It costs them about $1 million a month for every month that the delay. So they really need to speed their processes up to get the project started as quick as possible.

How do you -- so I'm sorry, I missed that, how you calculate that million dollar --

It's the Arrow. They have to have the applications up and running. The Arrow refunding is actually a little bit heavier in the beginning than it is in 2014, for instance.

So a typical project for a 1000-bed hospital is about $25 million to $30 million. And literally when you work the math out for every month they delay particularly at the beginning, it's costing them $1 million per month in reimbursement under the Arrow program.

Gotcha.Okay, thanks, Jim.

Steve Shaw, Sidoti.

Can you explain the delay in the Q2 EMR project that you bid on?

Yes, that's a good question actually. Normally in a normal cycle, we would expect most hospitals to decide the service provider probably within 90 days of getting the RFP. In that particular case, we bid that late in the second quarter.

So we would have expected in a normal case that we would have heard sometime certainly during the third quarter of the year. This particular hospital is part of a university, a state university system.

So in addition to the procurement of people from the university being involved because of the size of the project, the procurement people from the state also are involved and have to go through a process and that is just causing the decision to be delayed. It's just normal for their cycle that it takes longer. But we hope it will be resolved certainly within the next 30 days.

James Friedman, Susquehanna.

So I wanted to ask Jim about the fraud detection product. I'm less familiar with that. I was wondering, I have seen other companies apply fraud detection to other adjacent industries and obviously fraud is a chronic issue in the economy. I was wondering about if there may be any other applicability of that solution to other industries outside of healthcare per se.

There certainly could be. The application that we're building is in ontology and ontologies are IT applications that use an expert language and they tend to pull data from disparate databases and analyze it so they get better information.

Ontologies are rule based, so you establish a bunch of rules. Is this person an adult or a child? You look up their age and then you determine whether the treatment is correct from them. That would be one of the tests out of hundreds of tests that the ontology might be running.

Because it's rule based, if you change the rules, you can make it applicable really to almost any situation. The ontology itself, the core of the implication has been built so you simply change the rules in other industries.

We think though at the moment, our concentration is clearly in healthcare. The estimate is that between 3 and 10% of all healthcare clients are totally fraudulent, wasteful or in abuse of that system. So the amount of money that's out there in abuse is just an astounding amount of money.

Most of the applications, all the applications that we've seen really in the market focus in on codes. They focus in on the billing and of the ICD codes and they look at if a person has a particular illness, is this code that is being billed appropriate for that illness.

Our ontology actually uses all the rest of the information that the payer or provider has to establish whether the claim is legitimate or not. So we think it has great applicability in the healthcare industry and we plan on marketing in there first. Eventually though we could bring it to other industries.

And then you had mentioned this HEAL grant. I apologize, I'm not familiar with that.

The State of New York has various grants for various industries. In the healthcare industry, they're referred to as HEAL grants and they will grant money.

Often it's money that the state's received from the federal government. This particular grant -- and they're numbered. This particular grant was HEAL 17 and it was grant of money, a little over $100 million actually, that the state government had received from the federal government.

They granted the University of Buffalo's medical practice, it's called UBMD or UB Associates, a $20 million grant and the core of the grant really is to put our application into hospitals in Western New York and then monitor how well the physicians do using an IT application to treat people with chronic kidney disease.

Okay, so maybe one more thing. With the new product introductions on the SaaS structure, I guess they're not that new, but now that they're more meaningful in terms of the revenue composition, how should we think about the margins of those products relative to the more traditional business?

Well, they're going to be very different margins. Really you need to think of them more like a software package. Our direct margin usually runs around 22%. These applications will probably have direct margins in the 70 to 80% range.

That's gross obviously. So the -- but I guess the issue is that rev rec is more ratable because they're SaaS based?

That's correct. The revenue is actually recognized as we deliver the services. So unlike a software company who would get kind of a hit when they license the particular application, we will sign contracts that will allow our customers to use our applications for a year or two year or three year period of time and will recognize the revenue over that period of the contract.

(Operator Instructions) Rick D'Auteuil, Columbia Management.

So, let me focus to start on the EMR business. As you have now had a year plus with a number of projects ramping, are the metrics for the timeframe tracking to your expectation and duration tracking to your expectation?

The metrics are changing slightly. Hospitals now want it done sooner. They are willing actually to pay a premium to get it done in two years instead of three years.

And the average contract value has been increasing. So where a year ago we'd say it's 2 million, $3 million for two to three ears, today we would probably say it's probably going to be in the $3 million to $5 million range probably for two years.

So $2 million a year for two years or $3 million to $5 million per year?

It would be $3 million to $5 million per year. So let's say $4 million a year on average maybe for two years will be more the norm now.

Okay, because you made a reference in your release to the size getting larger.

That's correct.

Is that because the scope of the work is more or is it because you're targeting larger hospitals than you originally talked about?

Actually, our target for hospitals is still probably about the same. It went up. Hospitals -- the normal process that we would use if the hospital said you can pick the timeframe, a 1000-bed hospital, we would probably say three years.

One of the reasons for that is that because hospital departments often don't make decisions right away, it gives us the ability to move our consultants around to someplace else and work and come back when they have made a decision. Because the hospitals have realized that the premium they have to pay to get it done quicker is a lot less than the Arrow funding they are losing, they're basically paying 25% let's say more to get the project done at two years and often have our consultants sitting and waiting for a department to make a decision rather than trying to do it in three years and lose a year's worth of Arrow funding.

So it's definitely -- that's the primary reason I think that the average is going up. The other thing that we're finding in more and more hospitals is because these are relatively large projects and because they want them done quickly, the hospitals themselves are having a harder time freeing up some of their people to go on the projects and if they can't free up one of their people to do part of a project, then we obviously supply that person. And to some extent, we're probably moving up the food chain a little bit quite frankly. We are probably on average dealing now with slightly higher -- more bed hospitals than we may have two years ago.

So you have a pipeline of I think you said six RFPs from Q3 that you expect responses for in Q4 and that doesn't include -- does that include the carryover from Q2?

No, right now, we are working on seven RFPs that carry over from Q2 plus the six new ones that we got in the third quarter and then in addition to that quite frankly our pipeline has never been stronger than it is now. We define our pipeline as customers who we have talked to who say that they're going to come out with an RFP for an EMR project in the next six months.

There are no further questions in queue. Please continue.

Looking forward, the solution side of our business clearly offers us the largest opportunity over the next several years specifically in electronic medical records work. With the US federal government beginning to spend some of the $19 billion in the stimulus package for EMRs and with the improvement in the credit markets, we expect her EMR business will build as time goes on.

Given the magnitude of creating electronic medical records for everyone in the US, we believe the electronic medical record work will most likely drive our solutions business for the next several years. Couple the EMR work with the additional profitability from our new offerings and you can see why we're very excited about the future of CTG.

We believe our strategy and our ability to execute it well provides us with strong growth prospects for the foreseeable future. I would like to thank you for your continued support and for joining us this morning. Have a great day.

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