Computer Task Group Inc (CTG) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome 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, Director of Investor Relations, Mr. Jim Culligan. Please go ahead.

Thank you, Greg, and good morning, everyone. We certainly appreciate your time and your interest in CTG.

On the call today, we have CTG's Chief Executive Officer, Jim Boldt, and Brendan Harrington, Senior Vice President and Chief Financial Officer. Jim and Brendan are going to review the results for the third quarter of 2011 and then update you on the Company's strategy and outlook. We'll follow 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 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 the SEC's website at sec.gov. 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.

Thanks, Jim, 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 read in our earnings release, in the third quarter of 2011 we were above our guidance for revenue and at the high end of our guidance for earnings per share. For the full year at the midpoint of our revised guidance we anticipate a revenue increase over 2010 of 19% and an increase in EPS of 37%. Our revenue and earnings continue to grow as demand for our services expands, both as a result of the continued need in the United States for staffing services and as the healthcare industry invests in electronic medical records and other initiatives requiring IT support.

I'm going to talk more about our results and what we see for the 2011 fourth quarter and the full year, but first I'm going to ask Brendan to start us off with a review of our financial results. Brendan?

Thanks, Jim. Good morning, everyone.

For the third quarter of 2011, CTG's revenue was $101.1 million, an increase of $16.7 million, or 20%, compared with the third quarter of 2010. On a sequential basis compared with the trailing second quarter of 2011, revenue increased 2.8% and was 4% higher per billing day.

Solutions revenue in the third quarter of 2011 was $38.8 million, an increase of $10.4 million, or 36%, compared with last year's third quarter. As a percentage of total revenue, solutions revenue was 38% compared with 34% a year ago. The improvement in our business mix was mainly driven by revenue growth from more profitable healthcare projects. Continued strong demand from our clients increased staffing revenue in the quarter by $6.3 million, or 11.2%, to $62.3 million.

Third-quarter revenue from IBM, our largest customer, was $30.8 million compared with $27.2 million in the same period last year. Although the total revenue from IBM increased, as a percent of total revenue IBM decreased to 30.4% in the 2011 third quarter compared with 32.2% of total revenue in the third quarter of last year.

Revenue from our European operations was $16 million, a 16.2% increase from the $13.8 million recorded in last year's third quarter. The effect of foreign currency fluctuations during the third quarter of 2011 increased consolidated revenue by approximately $1.3 million, or 1.3%. The recovery in Europe continues to lag that of the US, as indicated by the lower growth rate of our European business, which was 6.6% on a local currency basis as compared with the third quarter of 2010.

Direct costs as a percentage of revenue were 79.3% in the quarter compared with 79.5% in the third quarter of 2010 and 78.9% in the trailing second quarter of 2011. SG&A expenses as a percent of revenue decreased to 16.2% from 16.8% in the third quarter of 2010. This improvement reflects the operating leverage from higher revenue and continued discipline in controlling costs.

Third-quarter operating income expanded at a greater rate than revenue and was $4.6 million, up $1.5 million, or 47%, year over year, reflecting the favorable effect of operating leverage and our higher-margin solutions work. Compared with the trailing second quarter of 2011, third-quarter operating income decreased $101,000, or 2.2%.

Operating margin in the third quarter increased to 4.5% of revenue, an 80 basis point improvement from last year's 3.7%, due primarily to an increase in the profitability of solutions projects, cost controls, and the additional operating leverage. Operating margin declined 30 basis points compared to the second quarter 2011, reflecting one less billing day and the seasonal effect of increased vacation time used by billable employees in the summer months of the third quarter.

Net income was $3 million in the quarter, an increase of 48% from $2 million in the third quarter of 2010 and a 5.7% increase from the second quarter of 2011. On a per-diluted-share basis net income was $0.18 for the quarter, a 38% increase from the third quarter 2010 and $0.01 higher, or 5.9%, as compared with the 2011 second quarter. The 2011 third-quarter results include equity compensation expense of approximately $0.02 per diluted share, net of tax, while equity compensation expense in the third quarter 2010 was approximately $0.01 per diluted share.

The tax rate for the 2011 third quarter was 35.3% compared with 34.1% in the 2010 third quarter. We expect the tax rate for the full year 2011 to be between 36% and 38%.

We added approximately 50 employees in the third quarter, with total headcount rounding to 3,700, the same as at the end of the second quarter 2011. Of the 3,700 employees at the end of the third quarter 2011, 90% were billable resources.

CTG's financial position continues to be strong. At the end of the third quarter 2011 we had no long-term debt and $12.6 million of cash on the balance sheet. Both the third quarter 2011 and 2010 ended on a US payroll date.

Our days sales outstanding was 61 days at the end of the third quarter 2011, the same as at the end of the third quarter 2010, and down one day compared to the end of the second quarter 2011.

Cash provided from operations in the third quarter of 2011 was approximately $2.8 million as compared with cash provided from operations of approximately $928,000 in the third quarter of 2010. In the quarter we had $463,000 in capital expenditures and recorded depreciation expense of $649,000.

We repurchased approximately 187,000 shares of CTG common stock during the third quarter of 2011, bringing the total repurchases to approximately 281,000 shares for 2011 through September 30. During this most recent self-imposed blackout period prior to releasing earnings we repurchased approximately 19,000 shares under our 10b5-1 plan. As of today our repurchase authorization is for approximately 900,000 shares and, because it remains accretive to our earnings, we intend to continue our repurchase program during the fourth quarter of 2011.

Jim?

Thanks, Brendan.

In aggregate, our solutions business, which is more profitable than our staffing business, increased by 36% in the third quarter of 2011. The growth in solutions work is primarily coming from EMR projects and is continuing to drive margin expansion. Overall our healthcare business was up 32% over the third quarter of last year.

On our conference call at the end of July we mentioned that we'd bid on an RFP for an electronic medical record project, for which the hospital had not decided what IT services firm would be awarded the project. Since that call we were notified that we had won that project.

When we started the third quarter of 2011 we had 17 active EMR projects. During the third quarter we started the project I just mentioned and one project came to an end. That means that at the end of the third quarter 2011 we once again had 17 active EMR projects. As the size of the new projects we have been winning are significantly larger than the sizes of the engagements ending, we remain very optimistic about our EMR business. Add to that the two RFPs for EMR projects we received in the third quarter, for which the clients have not yet selected an IT services firm, and the engagements that our sales force are still pursuing, and you can see why we have every expectation our EMR business will continue to grow.

Currently we see our new offerings for ICD-10 in accountable care organizations, known in the industry as ACOs, as our next major revenue growth opportunity. Our ICD-10 offering supports conversions in the US from ICD-9, the current US standard for diagnostic codes, to ICD-10, the international standard which the federal government is requiring providers and payors to adopt by October 1, 2013. We currently have one ICD-10 remediation project for a payor underway and are working on an ICD-10 assessment for a hospital.

Our ACO offering supports the formation of accountable care organizations to improve the quality of care and reduce unnecessary costs, the concept conceived as part of healthcare reform. Going forward we believe the mix of our offerings we are selling will begin to change. Hospitals need to start their ICD-10 conversion projects or they will not be ready to go live with the new codes on the October 1, 2013 conversion date. While some hospitals will begin their ICD assessments in 2011, we believe that in 2012 and '13 a larger part of our revenue growth will be derived from ICD-10 projects as hospitals begin implementing the changes they need in their environments to accommodate the ICD-10 codes.

As we've talked about before, another trend we see emerging has to do with the smaller hospitals. As you know, we've been focused on the 500-bed to 2,000-bed hospital market and have not been marketing to the 100-bed-and-less hospitals, which constitute approximately half of the hospitals in the US. Unfortunately, most of those hospitals have been slow to implement their EMR projects due to their limited capital. In general, these smaller hospitals often lack the financial resources to implement EMRs or to fund the ICD-10 conversion and do not have adequate capital structures to form their own accountable care organization.

Recently some of our clients have begun acquiring smaller hospitals. And while we had finished the EMR work for the larger hospital system, we'll be engaged by these clients to implement EMRs at their newly acquired hospitals. As such, we're beginning to access the smaller hospital market without having to go through the normal sales cycle. As the dates approach for the EMR penalties and the ICD-10 conversion, we expect to see more of the smaller hospitals be acquired by the larger hospital systems and, as a consequence, see the potential for more EMR work at multi-hospital organizations where we've already completed their initial implementation.

Longer term, we believe medical informatics will be a major opportunity for growth in serving the healthcare industry. We have a solid head start on this opportunity, having already developed three solutions for the healthcare market that employ medical informatics to identify ways to improve the quality and efficiency of healthcare delivery. These offerings are now commercial and we're actively marketing them.

Having covered healthcare, I'd also like to talk about the other three vertical markets on which we focus. Demand from the technology service provider market was good, although moderating, during the third quarter 2011. As to our financial services and energy verticals, we depict those businesses as stable and improving, and we're optimistic that they will continue to do so in the future.

Turning to our staffing business, which generates most of its revenue from the technology service provider market, it increased by 11% in the third quarter of 2011 when compared to the third quarter of 2010. As you know, since the beginning of 2011, we've been expecting our staffing revenue growth to slow. Although still at a double-digit growth rate of 11% in the third quarter, staffing revenue growth began slowing in the quarter. Longer term we expect our staffing business to grow at an 8% to 10% annual pace.

As was mentioned in our news release, IBM has informed CTG that it has been selected to continue as a supplier under the NTS agreement for the next three years. CTG expects the NTS agreement to be executed during the fourth quarter of 2011. While there are changes under the new agreement, in aggregate we expect that the new agreement will put us in about the same position in terms of the IBM business as we were under the old agreement.

Looking to the fourth quarter, we're forecasting total revenue to be in the range of $100 million to $102 million, or a 16% increase from the midpoint of our guidance over last year's fourth quarter. We're forecasting earnings per share in the fourth quarter of 2011 to be in the range of $0.18 to $0.20 per diluted share, or a 19% increase from the midpoint of our guidance over the fourth quarter of last year.

For the 2011 full year we expect a revenue range of $395 million to $397 million, or a 19% increase at the midpoint of our guidance over 2010. Based upon our revenue forecast and the anticipated mix of business we expect net income per diluted share in 2011 will be in the range of $0.70 to $0.72, or a 37% increase from 2010 at the midpoint of our guidance.

When you compare CTG to companies both in and outside of our industries, we had a strong third quarter in 2011. We're expecting 2011 to be another excellent year for CTG, with strong double-digit revenue and earnings growth.

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?

Thank you. (Operator instructions.) Matt McCormack.

I guess just a point of clarification on the segments. The solutions growing 36%, obviously very strong, but then your healthcare segment only grew 32%. So is there some staffing in there or where else did you see very strong solutions growth in the business?

Well, we have solutions in -- there is no staffing in there, to begin with. We have solutions in a lot of the other verticals. Energy, for instance, is made up of a great deal of solutions. And even Other, which is all other industries but the four we break out separately. There is solutions in that business as well. So the other parts of the solutions businesses just had a very good quarter.

Was there anything specific that you can point to in the other verticals?

No. You know, energy definitely improved. Energy had been lagging and it definitely picked up in the quarter. But there's nothing specific.

Okay. And would it be possible just to get the breakout of the other verticals?

Certainly. (Multiple speakers) do you want to do that?

Sure, yes. The financial services was up 21%. Technology services providers was up 14%. Other was up 19% and energy was up 4%.

Okay. And so obviously you've had a pretty good year. When you look out into '012, I guess could you kind of talk about the visibility that you have, both on the solutions and the staffing side? I think you said you're expecting staffing to trend to the 8% to 10% long-term revenue growth rate. So how should we look at that into next year, given the economy and given where you sit with your visibility right now?

Right. Well, if someone would definitively tell us what the economy was going to do, that would be very helpful.

We don't actually have a forecast yet for next year. We definitely assume that, long term, staffing is going to go back to about an 8% to 10% growth rate, which is the growth rate that we grew at for the four years ended 2008. We also believe that our solutions business, particularly the healthcare solutions, are going to grow at a much faster rate than our staffing business. So when we get to the February call, we'll probably be a little bit more definitive on our guidance. But certainly right now that's where we're thinking.

Okay. And then, what about the pricing environment, both in light of the IBM agreement that was just extended, and then also on the solutions side?

Well, I'm going to break our business down, because it's very different depending on which business you're looking at. There definitely has been wage inflation in the healthcare business, and that was true in 2010 and it continues in 2011. And that's picking up to a great extent because of the shortage of people who have skills in healthcare. There is a shortage in the market. Wages are going up and bill rates are going up as well.

In Europe, because of some statutory regulations in some of the countries that we're in, by statute we have to raise wages once a year. We also raise our prices at the same time. So Europe is seeing about a 3% or so increase in their bill rates versus a year ago.

We have just started to see some inflation in the general staffing business. While I know unemployment is high overall in the United States, I think it's very different for people who have IT backgrounds. A lot of the unemployment in the United States, as you know, is tied to the construction industry. And we, in the last couple of years, have seen a big change really in the availability of IT professionals. Before 2008 when we called a candidate we'd usually find that they had a couple job offers they were considering. During the Great Recession in 2009 and 2010 by and large we were the only person talking to the candidate.

We're back now, we think, to what the market was like in 2007, probably only a couple percent unemployment in the programmers and analysts in the United States. So we are starting to see some -- I wouldn't call it significant -- we're starting to see some mild bill rate inflation in the staffing business in the United States as well.

Vincent Colicchio; Noble Financial.

Nice quarter, guys. Jim, you mentioned in your prepared comments about ICD-10 becoming more important. Could you give us a sense of how your pipeline of opportunities has changed, say, last quarter to now? Have you seen a marked change there?

Absolutely. A quarter ago or so, we were talking to only a couple of hospitals about doing assessments. Now we're talking to between one and two handfuls of larger systems about doing assessments.

Basically what's happening, a lot of the hospitals where we've finished the EMR implementation, they kind of needed a breather. So if they finished it, let's say, in the first or second quarter of this year, they needed to do some work that they'd just been postponing. And now they're to the point that they are talking to us about doing assessments. Some hospitals, because depending on how they're staffed actually have started their own assessments and are going to select an IT service provider to help them with the remediation part because they don't have enough people to do the remediation. So we're definitely seeing the ICD-10 work pick up.

And on the EMR side you had mentioned that the project you added was bigger than the one that was -- where the delivery was completed. Can you talk to, in order of magnitude, how much bigger the new project was and also the two RFPs you have, order of magnitude how much bigger they are than your typical project you're working on today?

Yes. Just in general, probably the hospitals that we've either won or are looking at in the, let's say, last two quarters have tended to be 50% larger to 100% larger than the hospitals that we're ending. So the hospitals that we're ending tended to be 800 to 1,000 beds. And these hospitals tend to be around 1,400 to 1,800 beds. And it is virtually linear. I mean, it does cost about twice as much, almost twice as much, to do an 1,800-bed hospital than it does a 900-bed hospital.

On the European business, what are your expectations for growth there in the fourth quarter? And does the nature of the type of business you do there, does that somewhat insulate you from European economic issues?

Well, it somewhat does, yes. It absolutely does. We think that Europe will probably continue to grow at the same rate that it grew in the current quarter. So even if you look at it in real terms, it is growing, when you eliminate the currency fluctuations.

Most of our business in Europe is in Belgium. And the EU, as you know, is headquartered in Belgium. Literally they're building Washington, DC 200 years later. So every quarter new ministries will open up and they need IT support and we're doing some of that IT support. So while if we were in some of the countries in Europe I wouldn't be as optimistic, being where we are in Belgium, I think that we can continue to grow, though their growth rate is going to be low-single digits. I think it's going to be a while before the European economy improves enough to have our general business grow.

There is one opportunity that we believe is coming, but we can't figure out exactly when it's going to be, and that has to do with electronic medical records. There are actually some hospitals in Europe now that are starting to look at US software, not just for the electronic medical records, but software in general, because some of the software in the United States -- most of it, actually -- the EPIC, Siemens, Cerner software is more robust than the software that the individual hospitals built themselves. So we're hopeful that once the United States proves that the EMR model works, that all of Europe actually will begin to implement it, because they're experiencing the same cost pressures that the US is with rising healthcare costs.

You did mention that your medical informatics is an attractive growth opportunity. Could you give us more color there? Have you shown your product into most of your EMR clients? What type of feedback have you have and sort of when do you expect to see some significant traction there, if you --

Well, we -- no, we haven't shown it to most of our clients. Many of those products -- our current healthcare business is more concentrated in hospitals than it is in payors or life sciences. About 70%, actually, of our healthcare revenue comes from the hospital or provider market.

And a lot of the products that we're talking about, while they have -- they definitely can be used in hospitals, but they also have payoffs for payors. We are very encouraged with the products that we have out there.

We have very little revenue or any -- very little profitability in the third quarter in terms of our products. But we're getting to the point that we actually put some profitability in them in for the fourth quarter for the products, that we're starting to see them gain traction. So we're optimistic about it in the fourth quarter. And if that happens, we'll probably talk more about it on the call in February.

Thanks, Jim. Good quarter. I'll go back into the queue.

James Friedman; Susquehanna.

I wanted to ask -- and if this is too specific I'll move on. But do you have any view about the risks or opportunities in sequestration? So if I don't have to explain that I won't, but what I'm referring to is the Capitol Hill process now where there's budget cuts that are going to be enforced relative to especially healthcare and defense.

We don't have any specific information. As you know, in the budget ceiling legislation they put in there if this committee can't cut the deficit significantly there's automatically a 2% cut in CMS. We're obviously concerned about that.

I've talked to the president of at least one of the state hospital associations about it. They think that it's probably going to be at least 2% of a cut. The way that the budgeting system works for the federal government, they wouldn't be expected until the fiscal year that starts October of 2012. So when the hospitals look at next year they're looking at probably a cut in the fourth quarter.

It's a concern. However, you have to bear in mind that most of the hospitals that we deal with are 500-bed -- just about all of them -- 500-bed to 2,000-bed hospitals. So their revenues are between $500 million and $2 billion. Most 1,000-bed hospitals usually have $300 million to $400 million of cash on their balance sheets. So the clients that we're dealing with have a much better capability of dealing with a government cutback than the smaller hospitals might. Also, the hospitals that we deal with tend to have 2%, 3%, 4% operating margins.

Hospitals are obviously concerned about it. This is a cycle. The government's done this to them before. If you go back to the Balanced Budget Act of 1998 for instance, that largely came out of hospital reimbursements. And eventually the government had to fix that because we need hospitals in the United States. They can't continue to underfund them.

I think the -- where we're focused on, where we see the opportunity really is, is that the hospitals, the ACO, the payors, everybody needs ways to reduce their costs. And if you look at healthcare just in general, for 30 years they underspent on information technology. Some of the offerings that we've come out with, the fraud, waste, and abuse, lets them cut their costs without actually cutting any service to their clients. Also the medical management tool we have, that allows them to treat a patient better and at the same time it lowers their cost. So the products that we came out with we think will be very attractive, particularly to the ACO market, where they're going to be responsible, basically, for absorbing any cost overruns that they might have.

And at this time there are no further questions.

Thank you.

CTG is firmly established in healthcare, one of the fastest growing major US industries. We have offerings for electronic medical records, ICD-10 conversions, accountable care organizations and medical informatics, all of which are expected to be in strong demand for the next several years. We're therefore very excited about CTG's future growth. We believe the strength of our business, the growth opportunities in the healthcare market, and our strategy and ability to execute well, provide CTG 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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