Computer Task Group Inc (CTG) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the CTG third-quarter 2013 conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, today's conference call is being recorded.

I'd now like to turn the conference over to our host, Director of Investor Relations, Jim Culligan. Please go ahead.

Thank you Paul, and good morning, everyone. We certainly appreciate your time and your interest in CTG. On the call today, we have CTG's CEO, Jim Boldt, and Brendan Harrington, Senior Vice President and CFO. Jim and Brendan are going to review the results for the third quarter of 2013, 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 website's 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. You saw in our news release our revenues decreased when compared to last year, as we continue to experience delays in healthcare project starts, as hospitals deal with lower reimbursements caused by sequester cuts, and as we experienced a reduction in spending from a significant staffing customer.

Our focus on expense control helped our earnings per share to come in at the midpoint of our guidance, and once again caused our operating margin to be 6%. 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 results. Brendan?

Thanks, Jim. Good morning, everyone. For the third quarter of 2013, CTG's revenue was $100.7 million, a decrease of $5.7 million compared to the third quarter of 2012. Third-quarter 2013 had 63 billing days, the same as in the third quarter of 2012. Solutions revenue in the third quarter of 2013 totaled $40 million, a decrease of $4.2 million or 9.5% compared to the third quarter 2012, primarily due to lower revenue from Electronic Medical Record projects. As a percentage of total revenues, solutions revenue was 40% compared to 42% a year ago. Staffing revenue in the quarter decreased $1.5 million or 2.5% to $60.7 million, reflecting reductions in staffing from a large client, offset by higher demand for technical resources from several other clients.

Third-quarter revenue from IBM, our largest customer, was $23 million, compared with $28.3 million in the third quarter 2012. As a percent of total revenue, revenue from IBM decreased to 22.9% in the 2013 third-quarter compared with 26.6% of total revenue in the 2012 third-quarter. The revenue from IBM in the quarter was negatively impacted by approximately $1.2 million when compared with the third quarter of 2012 as a result of IBM's spinoff of its retail business to another large company. Although this change lowered our revenue from IBM, the spinoff did not have a negative impact on CTG's overall revenue, since we retained the business with this new client.

Revenue from our European operations was $18.2 million, a 12% increase from the $16.3 million recorded in last year's third quarter. The effect of foreign currency fluctuations during the third quarter of 2013 increased consolidated revenue by approximately $1 million. On a local currency basis, our European revenue increased 5.6% compared with the 2012 third-quarter. Excluding the effect of the etrinity acquisition that we closed in February 2013, European revenue increased by 8% or 2.5% in constant currencies.

Direct costs as a percentage of revenue were 79% in the third quarter compared with 78.3% in the third quarter of 2012, reflecting the decrease in the higher margin EMR revenue. SG&A expenses as a percentage of revenue decreased to 15% from 15.8% in the third quarter of 2012 as a result of our disciplined cost management.

The billable travel expenses included in the third quarter 2013 revenue and direct costs were $2.8 million. The billable travel expenses for the third quarter 2012 totaled $3.3 million. Third-quarter operating income was $6.1 million, a decrease of approximately $300,000 or 4.3% year-over-year. Operating margin in the third quarter increased to 6% of revenue, a 10 basis point improvement from last year's 5.9%. The year-over-year decrease in operating income was due primarily to the decreases in our EMR revenue, offset by lower SG&A expenses.

Net income in the third quarter was $3.9 million, an increase of $50,000 or 1.3% compared to the third quarter 2012. On a per diluted share basis, net income was $0.23 for the quarter, the same as in the third quarter 2012.

The tax rate for the 2013 third quarter was 35.2% compared with 39% in the 2012 third quarter. The lower rate is primarily a result of the reversal of certain tax reserves and federal tax credits recorded in the third quarter 2013 that did not occur in the third quarter 2012. We expect the tax rate for the full year 2013 to be between 35% and 37% compared to 36.5% for 2012. Excluding the effect of approximately $1.3 million of nontaxable insurance proceeds we received in the second and fourth quarters of 2012, the tax rate for 2012 was 38.4%.

The 2013 third-quarter results included equity compensation expense of approximately $0.03 per diluted share net of tax, while the third quarter 2012 included equity compensation expense of $0.02 per diluted share net of tax. Our headcount at the end of the third quarter was 3800, a decrease of 100 people or 2.6% compared to the end of the second quarter 2013, and the same as compared to the end of the third quarter 2012. Of the 3800 employees at the end of the third quarter 2013, 91% were billable resources.

At the end of the third quarter 2013, we had no debt and $31.5 million of cash on the balance sheet compared to $29.4 million of cash at the end of the third quarter of 2012. Both the third quarter of 2013 and 2012 ended on a US biweekly payroll date. Our days sales outstanding was 68 days at the end of the third quarter 2013 compared with 64 days of the end of the second quarter 2013. The increase in DSO was due to the timing of cash proceeds received at the end of the comparative quarters, as a result of a general lengthening of clients' payment cycles.

Our cash provided by operations in the third quarter of 2013 was approximately $3 million as compared with approximately $6.2 million in the third quarter of 2012, primarily related to changes in working capital. In the quarter, we had $949,000 in capital expenditures, and recorded depreciation expense of $685,000. We repurchased 224,000 shares of CTG common stock during the third quarter of 2013. With the new 1 million share repurchase authorization, our current repurchase authorization is for approximately 1.2 million shares. As it remains accretive to our earnings, we intend to continue our repurchase program during the remainder of 2013.

Jim?

Thanks, Brendan. In aggregate, revenue declined by 5% in the 2013 third-quarter, and with our solutions business decreasing 9.5% to 40% of our total revenue. The decline in our solutions business came from our healthcare vertical, where our hospital clients, faced with a reduction in income and cash flow due to the sequester cuts to Medicare, have reduced spending.

On our conference call at the end of July, we mentioned we had received one RFP for an Electronic Medical Record project, for which the hospital had not decided what IT services firms would be awarded that project. We received one new RFP for an EMR project in the last three months. We're still waiting on a decision on those two RFPs as to what IT services firm will be chosen for those projects. When we started the third quarter 2013, we had 16 active EMR projects; during the third quarter, one project started, and two project ended in the quarter. Therefore, at the end of the third quarter 2013, we had 15 active EMR projects.

We also mentioned on our last several conference calls that one of the hospital systems that we bid on, that had not yet picked an IT services company, has approximately 5000 beds, significantly more than our average client. But we still think we're in a good position to get some of their work. The timing of the starting of their project has been delayed. Also, the very significant implementation project we've previously talked about, that was originally expected to start in early 2013, continues to be delayed.

In the short-term, we believe that our EMR business growth will be constrained, due to hospitals having to deal with the reimbursement costs that have occurred. We've seen hospitals go through cycles like this before, where they've had to delay capital spending. It occurred in 1998, when the US government balanced the federal budget by reducing Medicare and Medicaid payments. After a period of time, the government realized it was beginning to bankrupt smaller hospitals, and increased reimbursement.

Again, in the first half of 2009, hospitals stopped launching new projects, as the tax-exempt bond market, where most hospitals financed their long-term capital needs, virtually disappeared. When this credit crunch eased, CTG's EMR business recovered. While the market is again constrained in the short-term, and long-term there is still a significant opportunity for the growth in our EMR business, only 40% of hospitals in the United States have reached the meaningful use Stage I threshold. Not all of the software the hospitals use for EMR has been upgraded to meet the standards of meaningful use Stage II, and many are concerned that some of the existing software cannot be modified to meet the more rigid standards.

The same is true of physicians practices. A recent report on healthcare IT speculated that up to 50% of the practices that have installed an EMR systems in the last two to seven years would have to convert to another software application in the next two years, as their existing implications would not meet the increasingly stringent standards that the government is imposing on them. Further, in order to achieve the kind of savings that the US federal government has projected, the healthcare system is going to hit the exchange health records, and that means the Health Information Exchanges, or HIEs, will have to be built.

So you can see why we're still optimistic in our long-term for our US CMR business, as most of the work for the healthcare system in virtual Electronic Medical Records still appears to be ahead of us. And finally, we believe the European hospitals will ultimately install US software, and it will likely create EMR work for CTG for another decade, given our recent acquisition in Europe of etrinity.

Recently, CTG won our first advisory consulting project for a European hospital. While the initial engagement is small, it puts CTG in a position to provide consultants, as the project ramps up in 2014, and to leverage our experience on this project for EMR work and other European providers. Fortunately for CTG, EMR is not our only healthcare offering. And our acquisition of etrinity and our other healthcare offerings continue to have a positive impact on our business.

We started two new healthcare outsourcing engagements in the second quarter of 2013, and bid on four additional projects in the third quarter. In the current tight provider spending environment, we see an excellent opportunity for us in application outsourcing, as it supports significant and immediate savings for hospitals without them making a large financial investment. CTG has an outstanding reputation in this area, and these engagements are typically for multiple years, providing annuity-like revenue streams.

In the third-quarter 2013, our sales offerings had the same incremental impact of adding approximately $1 million to revenue and $0.02 to earnings per share, as the offerings had in the third quarter of 2012. We still anticipate closing at least one additional fraud waste and abuse engagement by year-end. Originally we'd expected this additional customer would have signed an engagement contract early in the third quarter, and therefore added to income in the fourth quarter of the year.

As we have not yet signed this new customer, and as it would be impossible to process the claims and recover monies by year-end, we now estimate that our sales offerings will incrementally increase our EPS by $0.10 per share at the midpoint of our guidance in 2013, and that $0.03 to $0.05 per share of profit will come from our sales offering in the fourth quarter of the year.

Having covered healthcare, I'd also like to talk about the other three vertical markets in which we focus. Our technology service provider market, which is an all staffing business, declined by 17% in the third quarter of 2013 when compared to the third quarter of last year. Our financial services vertical had another excellent quarter. Most of their revenue gain in financial services came from our European operations. Our energy business revenue was flat when compared to the third quarter of 2012.

Turning to our staffing business, its revenue declined by 2.5% when you compare the third quarter of 2013 to the third quarter of 2012. The staffing business was negatively impacted by staffing reductions made by a significant customer in both the second and third quarter. Looking at the fourth quarter of 2013, we are forecasting total revenue to be in the range of $104 million to $106 million. We are forecasting earnings per share in the fourth quarter of 2013 to be in the range of $0.22 to $0.24 per diluted share.

For the 2013 full-year, we now expect a revenue range of $420 million to $422 million or a 1% decrease from the midpoint of our guidance when compared to 2012. Based upon our revenue forecast and the anticipated mix of business, we now expect 2013 net income per diluted share to be in the range of $0.93 to $0.95 or a 7% increase from 2012 at the midpoint of our guidance, excluding the gains from life insurance proceeds in 2012.

We thought it'd be helpful to briefly share our thinking on how set our recent guidance for the year. First, we think our healthcare business will decline by approximately 7% in 2013. Our non-healthcare solutions business, we're projecting a revenue increase of approximately 3%. We're forecasting a 1.5% increase in our staffing business in 2013.

We continue to remain optimistic about CTG's long-term growth potential. While we're going through a transitional period at this time, we expect our US healthcare business to return to growth, particularly when some of the larger hospital systems begin their EMR projects. In the short-term, we expect to see growth in our outsourcing business. With the recent acquisition of etrinity, a Benelux health IT consulting firm, we've positioned CTG to participate in the adoption of US package software by European hospitals.

We've been working on a number of betas with states and payers over the last year or so for our fraud, waste and abuse applications. We expect another one of these betas will close before year-end and others in 2014.

We're stepping up the marketing of our IT and medical management model following a very successful implementation of a large university-affiliated medical practice. This offering is a clinical decision support application that alerts doctors when the kidneys of patients with chronic kidney disease are about to fail, thus allowing the doctor to intercede, avoiding a costly visit to an emergency room.

We're also working with a client to combine genomic sequencing with electronic clinical records. This will only be the third time that we know of this combination's been done. This work will position CTG with one of the first-of-its-kind cutting-edge offerings in the genomic science field. We think that if you look at how CTG is positioned in healthcare, the world's fastest-growing industry, you can see why we continue to be optimistic about our future growth opportunities.

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). Brian Kinstlinger, Sidoti & Company.

So the first question I wanted to -- a couple of questions I wanted to talk about SaaS a little bit. You gave some clear statistics and guidance numbers. You are looking for an additional $0.01 to $0.03 in SaaS related to earnings in the fourth quarter from each of the last three quarters. Can you tell us what that suggests about this second customer? Has it already begun to generate revenue? Or is that $0.01 to $0.03 suggest that it hasn't generated revenue and it will contribute based on when it starts $0.01 to $0.03?

Yes, it is the additional customer. We did not get any revenue from them in the second or third quarter of the year. It took -- and it was just some issues on their end at getting the data in, et cetera. So we expect in the fourth quarter we would now have the data actually in, we're processing it. So we believe that they'll be able to recover monies in the fourth quarter of the year.

Has that started to generate revenue or not yet? In October?

Not yet. Actually, we're expecting within a week or so to begin giving them runs on the fraud, waste and abuse claims.

Okay. Now you've talked about and you gave some details on still expecting a third by the end of the year. Can you talk about what happened there? It seemed like you thought it would be happening about two to three months ago. I know you commented at the bigger picture of the pipeline, you've had five customers in the pipeline for quite a long time, a little bit longer than the 18 months that you expected. Have any pulled out? Are they communicating they're less enticed by the product? Maybe just take us through how that's all playing out.

Yes. I think a lot of the reasons for the delay has to be -- has to do with the current environment. I mean -- and it doesn't matter whether you're a payer or a state, you have to deal with the exchanges that just came up. You have to deal with changes that are being made in Medicare and Medicaid, and there are a lot in -- a lot of our payer customers even, will in Asia and the states, obviously, have to process Medicare and Medicaid claims for the government.

So, in a -- normally in the fourth quarter of a year, if you're a payer or even a state, you won't make any changes to your systems. They'll lock down their systems. Most of our payer customers even refused to let any of their employees take any vacation in the fourth quarter of the year because things are so hectic, really doing enrollment for the next year. And then you add on to it what they've got to deal with the Obamacare changes, and I think that it's just overwhelming.

They don't have more people to deal with it. There's all these changes that they're having to deal with. The customers that we think will sign has told us that they want to go forward with it, but I think that they're just constrained by the number of people and the number of hours they have to deal with. And obviously, they've got to deal with any of the regulatory changes first before they can do something, which is good for their business, but is somewhat discretionary on their part.

Actually, the five original customers -- we'll get more than in the pipeline now -- but the five original customers are all still talking to us. They're all still saying they want to do something. None of them has come to us and said, gee, we're not interested in it; it's just taking longer probably for some of the same reasons I just mentioned.

Now I guess a follow-up to that is, well, I lost my train of thought so I'll come back to that. The other -- the last question and I'll get back in the queue, is on healthcare demand. It dropped 10% sequentially, but the sequester wasn't new. It was fully impacted in the second quarter. So I'm curious what you think has happened here? Did you have to lay off EMR staff? Is that part of the cuts you've had? And do you think we'll see another drop-off in the next six months or so before rebounds?

Well, what's happening is we constantly have projects ending, so we have more projects ending than starting. And the size of the hospital systems that we're starting are the same that we've been starting over the last few years, but they're putting more of their own staff on these projects. Because if they do that, they don't have to lay their own staff off.

So it's still -- the sequester's the problem. And the hospital financial condition is really what I think is delaying them from starting these projects. In order to start a project, every one of our clients has to go to the bond market and finance the project. And, at the moment, I don't think they want to show the bond agencies their financials because they don't look too well.

And there's a lot of public releases -- I don't know of one of our customers that hasn't laid off people. If you look at some of the public ones -- Vanderbilt, that's in Nashville, laid off 1000 people; Indiana University Health laid off 900 of their own employees; and Cleveland Clinic is offering buyouts to 3000 of their employees in order to reduce their costs. And they've got to get their costs down about $330 million. So, they're dealing with these reductions. At some point, like any other company, we expect that they're going to get back to a point that they feel comfortable to start going forward, but they're just not there yet.

In terms of the fourth quarter, I think the revenue rate for our EMR business will stay the same or maybe go up just slightly. The reason it would go up just slightly is that we have better utilization of our employees in the fourth quarter. More people take off vacation in the third quarter of the year. And when they're on vacation, obviously, they're not billing in the fourth quarter. So we're kind of anticipating that the revenue from EMR will be about the same -- roughly the same -- in the third quarter of the year.

And we have clients and potential clients that are telling us they're going to come out with RFPs in the fourth quarter. Same clients told us they were putting out RFPs in the third quarter. Until we actually know if they issue those RFPs, it's kind of hard to predict what's going to happen in the first couple of quarters of next year.

And just a thought, did you lay off EMR staff? Or did you keep that level?

The -- our EMR staff is probably down slightly from where it was. We didn't so much lay them off; it's the project came to an end. And most people's contracts are sometimes tied to those projects and it's just kind of a natural ending point. But we would have less -- I'm not going to say it's materially, but we have less EMR consultants now than we had a couple of quarters ago.

Some of the people, though, we've actually moved into other roles. One of the outsourcing offerings that we've come up with is in the EMR area. When we finish a client -- and you've got to remember, this is a 1000-bed multiple hospital situation. So we'll finish their EMR project. They then have to support it. And that means that you have to have call centers for people to call in, because hospitals operate 24 hours a day. You've got to have call centers up 24 hours a day.

And you have to have experts -- kind of three levels of experts. The first level, somebody that would help you if you couldn't remember your password, get re-logged on. Second level, they might actually walk you through a more technical situation and get to look at some data. The third level up, they can actually go in and change the system of they have to, in order to meet your needs.

If you think about it from a hospital standpoint, you're going to have a lot of calls during the day, a fair amount actually at night, because emergency rooms then take a lot of people in the night hours. When you get to the 11 o'clock to 7 A.M. shift, you're going to get a few calls, but you've got to have a couple of people, at least, sitting, taking those calls. Right? Probably two or three -- somebody's on vacation; you've got to have multiple levels that you can support.

So, we've gone -- and we've been successful now a couple of times -- to our clients, and said, look, we can actually deliver this much cheaper than you can. Because while we will have people in the middle of the night that are only taking a few calls, and we can have those people take calls for multiple customers. And I know there's a long intro but we -- and we've been successful already in a couple of those proposals. And we're working on more. We actually took some of the people who used to do implementations and they're now actually working more in the outsourcing part of the business. So it's kind of a transfer for some of them.

Thanks so much. I'll get back in the queue.

Okay.

Vincent Colicchio, Noble Financial.

Let's assume the deadline for your markets extended beyond the next year. Should we still remain optimistic about a rebound in such a case? And if so, articulate your reasons.

Well, you know, first place, I don't think -- I think if they extend it, they're not going to extend it until sometime during the summer months. And they've done it in other areas, where they waited until kind of the 11th hour to kind of force people to go forward. And it's not just the EMR penalty, that the incentive goes away and the penalty kicks in October 1. They have to reach meaningful use to October 1 or they have to pay the penalty. And they have to be compliant with ICD10 October 1 or they're going to lose a lot in terms of revenue.

I saw a report from an investment banking firm not too long ago that indicated that 40% of large hospitals in the United States still haven't reached meaningful use one, so they don't have an EMR system -- 55% of the medium hospitals and 64% of the small hospitals, and that was off of data I think that CMS provided.

To put an EMR system into a large hospital, 1000-bed hospital, takes two years. There's no way to shorten it. We used to do it in three years, we actually shortened it to two years. That's about as good as it gets. So if the government decides to delay the penalty by six months or a year, if you're a large system, and according to that 40% of the large hospitals in the US still haven't put EMRs in, you've got to start soon. Because no matter what, if they delay it a year, you're still going to end up with paying some of the penalty.

I think the bigger problem at the moment is just them dealing with getting their costs back in line. If they don't have their costs back in line, they can't go to the bond market and finance the project. So I think they've got to work through that cycle first. I don't think that there will be a bell that goes off when they've all done that. I suspect it's going to be a different time, hospital by hospital, when they get comfortable, and beginning spending money again. And it depends on what the government does going forward, obviously, with reimbursements, and also how quickly they can cut their costs and get their margins back in line.

And did I hear you say that some clients may start issuing RFPs next quarter? In the fourth quarter?

Yes, actually we hit several hospital systems. These would be 1000-bed type and up hospital systems that originally told us they thought they'd get their RFPs out in Q3. They're now telling us they'll get their RFPs out in Q4.

Okay. And do you have a EMR pipeline in Europe for some of these consulting -- for consulting? Or is it just the one?

Well, we started the One project up. It's a consulting project, but sometime next year, we should be able to place consultants on that, as they get into their implementation. And we -- there are now hospitals in Europe that are either -- couples that have started to sign for their software or at least have narrowed it down to one software package. And they've got to narrow it down to one software package before we really can engage and start to provide consultants.

We can provide a little bit before that, maybe one or so, to help them pick the package, but after they need them to get the funding for it, and select the software they are going to use to go forward. But yes, there are hospitals in Europe that we are calling on, on a regular basis, that are trying to figure out what system they're going to put in, and then how much funding they're going to need, and how they're going to get that funding.

And on the ICD10 side, are we missing opportunities there? Or do you feel like -- do you ever expect this to become a big business?

Well, I'd like to get -- I have mixed emotions on this one, as you know, because it's a Y2K problem. And like Y2K, it's going to end on a particular day. We have one payer that we've been working on their ICD10 solution for a couple of years now. We started up a hospital's ICD10 project. I think it was in the first quarter of the year, as I recall. And we currently just won another project and we'll start the implementation of that in the fourth quarter of the year.

In addition to that, we've started to get requirements -- not so much for running the entire project but for additional resources. A lot of clients think that they can do this themselves. We're not quite sure that they can do it totally themselves. So, we've started to begin to place people at customers just individually doing ICD work, with the hopes that eventually they'll realize they need a lot more help and bring in a lot more of our people.

So you're on -- you're working on two projects right now, is that right?

We're working on two currently -- one hospital and one payer. And by the end of this quarter, we'll have staffed up for a third hospital project.

Okay. I'll go back in the queue, thanks.

Okay. Thanks.

Kevin Liu, B. Riley.

Jim, you mentioned you're seeing some of your hospital customers lay off a lot of staff. As projects have ended, you guys had some natural attrition that happens as well. But given what you saw the last time the cycle was pretty strong, does it make sense to be adding more heads on the healthcare side now in anticipation of kind of the next upturn?

Well, that's always a tough decision that we have to make, because there are resources available in the market. We could hire them to the bench. That will cause obviously our expense to go up. And at the moment, we think that if we need to start a project, we can find the resources we need. So, at the moment, there doesn't seem to be a compelling reason to add to the bench and expense. When we start to see projects start up and we start to see RFPs come out, we probably will begin to do that.

And I guess maybe a similar type question, given the environment that you're in now, are there more opportunities on the acquisition front for firms that are focused on healthcare IT services?

I would have to say yes. There are -- we are seeing more opportunities for us to acquire companies. We are, though, very focused, I think as you know, on what we're looking for. We only want IT solutions companies with a focus on healthcare. One of our focuses is in data analytics. We have a couple of data analytics offerings already out there, the SaaS offerings, for instance. The other area that we think will be strong for a couple of years is in ICD10. So, those companies tend to be more in revenue cycle management.

Got it. And then just with respect to the large EMR implementations that have been delayed so far, what are you hearing from your customers around when they actually intend to start these back up? And is there any risk here that they'd fall off and you'd have to go out to rebid again? Or perhaps they decide to look for other ways to get these implemented more cost-effectively?

Yes. Actually, we've only bid on one of them. And you're right, the bid is getting a little stale because they received all the bids I think in late March. I think they were ready to go. And remember, it was kind of the middle of March before the government decided or Obama announced that the sequester was going to happen. And I think they just got caught and they too -- I don't think they've done their financing and they're trying to figure out what to do.

Got it. And maybe just going back to the European win you announced, can you talk a little bit about how that opportunity kind of unfolds, in terms of how much staff you allocate initially, what you're getting paid for? And then how you've kind of yet ensured that you're working on the actual implementation?

Okay. It was very -- it's kind of funny because it -- the initial engagement itself was clearly a consulting one that helped them get going in terms of the project, and make sure that it was working correctly. You'd think that it would have been the biggest project in the world because everybody sends their head of healthcare from the United States over to bid on them it. And we bid against the usual people we bid in the United States. And we were the only consulting firm that they picked.

So, we are helping them get started and doing what I would consider very high-level consulting on that. And at some point next year, we believe that they all are going to need outside resources. I think they believe that too. And they'll begin to ramp up. But quite frankly right now, they haven't -- they're still trying to figure out how to get the project done and how many consultants and what the mix is going to be going into next year. So it's going to be a couple of quarters. Because we're the only consulting firm in kind of inside the tent, we have the best shot at placing consultants once the project ramps up.

And just switching gears to the staffing side of the business, with IBM's hardware business kind of still struggling here, do you feel like you've seen all of the cuts you would expect? And that's fully embedded kind of within the expectations for Q4? Or are there any potential cuts that could still be able to come here?

We don't know of any more cuts that are coming. And I can only -- I can't talk about anything that isn't public so, I'm limited to the public disclosure. I'm sure you looked at IBM's release, et cetera. If you look at the transcript of IBM's conference call, their CFO indicated that the reason that STG, which is the hardware division, the revenues were down -- they were down 17% last quarter -- was that their revenue in China dropped by 40% in hardware sales.

And apparently, the Chinese government does a relook at the economy every five years or something like that and comes out with a new plan. And that plan is scheduled to be out in November. So, he tended to indicate that the revenue had dropped the 40% and that they were expecting probably -- well, he put it after the first quarter of next year -- that the business would come back as the government accepted their plan, and then they went back to kind of business as normal.

So if you read the transcript, your impression is that they had this problem, they've gone through it and addressed it. He talked about STGs numbers and they expect -- the demand is going to start back up after the first quarter of next year. And that's really about the best insight we have into it.

Thanks for taking the questions.

Okay. Thank you.

Frank DiLorenzo, Singular.

I'd appreciate if you could give us an update on how you're thinking along the lines of acquisitions moving forward, strategic acquisitions? And also, if you're starting to think internally about maybe some other growth areas to kind of get the growth engine going again, not just in healthcare but with regards to IT and some other spaces, whether it's technology, energy, financials, et cetera. Thanks.

Okay. As I mentioned I think in answer to a previous question, we are looking for acquisitions in healthcare -- Healthcare IT. Our main focus there is in data analytics. We also think when the ICD10 conversion happens that it's not going to be a one-day event. The new codes are so complicated that it's probably going to take a couple of years of working with the doctors and coders to get the hospitals' revenues back up to where they were before.

So we also have an interest in finding an ICD10 or most likely it would be a revenue cycle type company. Because there would be an offering that would augment our existing one. And in the near term, we are very focused on our SaaS offerings. We talked earlier about fraud waste and abuse. The IT medical management model, we did have a very successful implementation. Starting in September, we really hit the total package that we could go to a payer and present to them. Because now we have not just a physician's practice but also a hospital who's used the medical management model.

And we have a whole department full of nephrologists that will go with us and say this absolutely works. This does provide the doctor with enough information so that they can avoid the emergency room visit by patients with end-stage renal disease. And those visits usually on average run $30,000 to $40,000 a year. So, we've already approached payers and we've either done proposals or are in the process of doing proposals for the application as well. So we're expecting that application to roll out next year.

You know we have thought and are somewhat tempted about other IT services, but if you look at the IT services market in general, it's off. I mean, if you looked at IBM as the largest provider of IT services in the world, and for the last three quarters, their revenues dropped 3%. If you look at HP, they are probably number two -- I think their revenue last quarter was off 8% or 9% in their services area.

So, it's not like you can look to another industry and say, hey, that industry is much more robust than healthcare. If you step back and look at kind of the global picture, the baby boom is still getting older in a rapid rate, while the government is somewhat penalizing hospitals at the moment and physicians by reimbursing them less than it costs them to treat a patient. And while that helps the federal government, it doesn't help the healthcare system. No matter what people do, there is going to be more people that are older, over the age of 65, for each one of probably the next 20 years.

When we looked at healthcare and decided that we'd focus in on it, mainly because of the change in demographics -- it was 2000 -- and healthcare was 8.1% of the US economy. It's 18% of the US economy and still most of the projections that are out there, unless something dramatically changes, the US decides they are not going to take care of their older population, healthcare may become 40% of the US economy at some point. And as it grows, it's kind of squeezing out other growth in other industries.

So, we're still of the opinion that healthcare is the right place to be long-term, and I don't want to lose focus and take our resources and look to somewhere else, and then in a year from now or next quarter, have the healthcare market come back.

Sure. Okay, thanks.

Rick D'Auteuil, Columbia Management.

Just to -- did you guys say what your DSO number was in the quarter? Usually you do, I think.

Yes, it was 68 days at the end of Q3.

Mainly -- yes, it's the hospitals. Hospitals have slowed down in payments to us. And it really is annoying to me because I can look at the hospitals balance sheet and realize they still have $500 million or $1 billion of cash. And one of the -- as you know, when you do a bond rating, your operating margins and cash on the balance sheet are two critical factors. And but basically, they're slowing down their payments to make their cash look good.

Okay. So with that, if I look at the last stage of release on the year-to-date, other -- on the cash flow statement, other operating items, is that just DSO creep primarily for what you just said, the $15 million outflow?

Right, that's correct. It's the majority of it.

Yes, that's correct. That's the majority of it.

Okay. So it's flat revenue so it's -- that's got to be the explanation. I mean is there any way to --? Do you have any influence on the timing of that or --?

We have our people calling them up on a regular basis. The one comment that I get back, I often see the comments the hospital say, is somebody went on vacation and they can't approve it for three weeks so we're going to be three weeks late. Which, if you think about it, it borders on the absurd. They're just slowing down on their payments because they've got a problem. Fortunately for us, I mean the smallest hospital we're dealing with is probably 1000 beds. They probably have $400 million of cash on their balance sheet. We're ultimately going to get paid. It's just that they're going to string us out for days.

Okay. What were DSOs last year?

They were 61 days last year at the end of Q3.

Okay. And the IBM influence is probably -- it helps you a little bit for that business to be down some?

No. It actually is hurting us at the moment, because the IBM contract is structured for us for a number of days and they abide by it.

Okay. And then I know you said both this quarter and last year's Q3 ended on a payroll date. Did Q2 end on a payroll date?

No. That was in between a payroll date.

So incrementally, just quarter-over-quarter, there was a little working capital hurt from that, right?

Correct. Yes.

But we also repurchase shares. That's the other thing that happened to cash. We purchased a couple hundred thousand shares in the quarter.

But that wouldn't have influence cash flow from operations though, right, Jim?

No. No, it would not. But it does influence the cash balance of it.

What's the swing factor on payroll versus off payroll in dollars?

Payroll is about $9 million every two weeks, so it's probably $4.5 million.

All right. That's all I have. I appreciate it, thanks.

Okay. Thanks.

Brian Kinstlinger, Sidoti & Company.

A couple of follow-ups. First of all, as you mentioned in January, you guys started selling fraud, waste, and abuse into other targets that had been your initial view. Can you talk about how many you have maybe in total? And also how that procurement process and selling process is progressing compared to how it's progressing six to nine months in on your initial bunch?

I don't actually have in front of me the number of customers that we've called on, but it is progressing and they're following the normal pattern. But it -- again, we think this is a relatively long sales cycle. It's not as quick as our EMR, for instance, from proposals to selection. But we definitely are out selling more than the initial five or at least attempting to sell more than the initial five for fraud, waste and abuse.

Well, with the adjustable -- you have two referenceable small clients, and with the adjustments you've made to the software to improve the positioning to collect money for small hospitals at the smaller hospitals, do you still expect the sales cycle will improve for the smaller hospitals -- or I mean, the smaller payers? Or are you not as sure now?

It should shorten, because getting -- we had the original customer that we worked with getting the next one signed with only having one reference, is much tougher than if you have a bunch. Having two is easier. And if we expect we'll land one by the end of the year, and having three references is even better. So, as we go on, the sales cycle should shorten.

Okay, and moving on to the European consulting contract that you've got, can you talk about how many beds that hospital has? Can you mention what country? Because I know you're positioned in a couple of countries stronger than others. That would be helpful.

Well, actually the country was England, and I'm not sure of the number of beds, but I suspect it's got to be 500 or 1000 beds at least. And it's -- I can't -- I don't have the permission from the customer to give out their name, but it is one of the premier hospitals in England. So, in the United States, it would be like saying that we have just won the Mayo or Cleveland Clinic.

Got it. Okay. And in Germany, I think, is a place, if I recall, where you're positioning yourself as well? Is that right? And is that market starting to heat up at all?

No. Actually it's the Netherlands, Belgium, and the Luxembourg. It's -- the market's progressing. I mean, they've started to kick the tires. They're starting to narrow down the selections. When we bought etrinity, we had thought that by -- if they follow the decision cycle in the United States, we figured they were at least a year off from making decisions. So we didn't really expect decisions until next year. Actually, if we go back and look at the original forecast, we're actually ahead, because this hospital made the selection, has picked the software package and actually has us in doing some consulting as they start off.

Okay. And then the last set of questions. I'm interested in the medical IT management model. You mentioned you're rolling it out next year. I'm not sure when you say rolling out, does that mean it's available for sale? Do you think you'll actually have some clients and generate revenue?

And I guess in addition to that, the way you went to market with fraud, waste and abuse, was you selected a handful of customers and that could be sizable, and were worth -- that would provide returns. How are you going to go to market with this software?

We're doing it a little bit differently. We've actually -- in the first place, we've proven the application works. And what we did was we narrowed the application, so that we're only focused in on avoiding these -- we're primarily focused in on avoiding these emergency room visits. We actually decided that we would go to customers that we already do business with, because we could get in quicker, we thought, and shorten the sales cycle somewhat. And we do absolutely expect to have revenue from this next thing.

And then given these are customers you already work with, the last question I've got is, can you take a stab at what the sales cycle might be for this?

I think for customers we're already doing business with, if we're successful, we probably could do that within a six-month period of time. You know, I would think six to nine months, we're either going to do it or not.

Great. Thanks so much.

Thank you.

Bill Sutherland, Emerging Growth Equity.

I just have a couple at this point. I'm curious on the outsourcing deals. You have two, I guess, start up your -- what was it, Q3?

Q2.

Q2.

And we did on [four] in Q3.

So, no additional. I'm kind of curious about the size of these? And you mentioned that they had quite a long runway to them. So are these not those transitional outsourcing deals that you had in getting in the midst of all these projects going on?

Well, it's a mix, actually. It's a mix of transitional and we're actually supporting a new application that's going up. On average, the four -- we're about $3 million a year in revenue.

One of the things about the transitional one, and I often think this is funny -- and this is not in healthcare; it was actually in a manufacturing environment -- but we bid on doing an outsourcing in 1992 to maintain some legacy applications that the customer was working on. And that customer was actually putting it on SAP. And in two years, they were going to be finished with SAP and then we'd shut down the application.

We still have people working on those old applications. Because often when customers put up the new one, they discover there's some functionality they need from the old one, and we continue. It's not unusual for us to get a temporary outsourcing that's expected to last a year or two, and it's five years. So, it's hard to tell, really, Bill, so they actually put the new applications.

So you said these are a mix of that and putting in new apps?

Yes.

Did you say of the four you're bidding on, they're $3 million each or in aggregate?

Each -- no, no, each. So there'd be $12 million roughly in aggregate.

Per year?

Yes.

And let's see, you covered the DSO issue. What was healthcare revenue in the quarter?

Healthcare revenue in the quarter was 31%, it was $31.7 million.

Okay, and that includes a little bit of staffing, doesn't it?

Yes.

Okay. All right, that's all I had, gentlemen. Thanks.

Thanks.

Bill O'Loughlin, O'Loughlin Financial Group.

Could you talk about your other potential successful offerings as you have done with renal kidney failure with a group of nephrologists? What about the chemical dependency, mental health, coronary heart disease and several others that you hope to have offerings and market those? Any progress in those areas?

That's a good question. We actually do have opportunities in those other areas. For congestive heart failure, for instance, we found a way to -- often patients with congestive heart failure are misdiagnosed. They're diagnosed with having asthma or something else. And we have an application that can identify the patients that have been misdiagnosed. And it's more than 75% accurate. And all that happens is those patients identified have to have a $15 blood test, and you can tell whether they've been misdiagnosed or not.

But the cost actually to treat them for asthma, ironically, is about $1000 a month, and it's probably $50 a month if they're being treated for congestive heart failure. And the biggest problem is that the patients being mistreated have a potential to have a heart attack before the physician realizes that the diagnosis is incorrect.

What we've decided to do is -- and there are -- and I don't want to go into them on a call like this -- but there are other areas that, under those grants, we discovered that we can launch applications for. But we need to be more focused. I guess if I let the guys work on it, we'd fill my life time of doing research and coming up with more new things.

So what we decided to do is launch one where the payer in this case has a significant opportunity to reduce costs by about $35,000 a patient, get that up and running for multiple payers. And then at some point, when we're getting enough of a revenue stream from that, go back and launch another one. We believe -- and Brian talked a little bit about this, about the sale cycles -- but if we've already sold the end stage renal disease model to a payer, and they've reduce their costs significantly, selling them the next module will be a much shorter sales cycle.

Good point. One more comment. Given the multiple millions of shares of CTG stock that traded over the last two or three months -- I lost track of it when it went over 6 million -- and given your purchase of 225,000 shares at a price of $18 and change in the last quarter, I would have thought you would have purchased more shares, and possibly even more in the $15, $16, $17 area. Any comments there?

Well, unfortunately, companies have different rules that they have to play by, so we're not allowed to be the first purchase of the day; I don't think we can be the last purchase of the day. We are limited as to how many shares we can buy a day -- it's called the retail non-block shares, basically.

So -- and if we buy one share in the morning and a block becomes available retail, we can't flip and buy the block. So, when the stock price drops, we start to buy shares, but we get limited in how many shares we can buy in a day. And the limitation -- I don't know what it is currently, but it's usually like 15,000 to 25,000 shares. As the price begins to recover, and we see that there are buyers in the market, we generally stop.

If we are buying and there's a buyer in the market, no one is helped. The company is buying at a higher price, and whoever is trying to accumulate shares is buying at a higher price. So we try to buy when the market -- when there aren't significant buyers in the market. You know, 200,000 shares I think this year so far, we've spent a little over $5 million in buying back stock; it's not an insignificant amount of shares or dollars.

I've been with you for years. You've done a great job. And all you have to do is keep you healthy. So with the energy you have and keep it going, you're going to have a great future. And I appreciate your time.

Okay, thank you.

Thank you.

Rick D'Auteuil, Columbia Management.

Just a couple of follow-ups. On the hospital outsourcing deal that you have or were looking at, how does that sort of fit into your margin mix? Is that better than company average but not at the EMR level? Or just put a general -- give me a general guideline for that.

Okay. It's kind of funny because the direct profit on an outsourcing is lower than an EMR. And the SG&A is also lower. So when you get to the operating income line, outsourcing operating margins are virtually the same as EMR margins.

Okay, that's helpful. And the expectation is, these are not -- these could go a couple of years? Or what's the duration on average?

Even a temporary outsourcing usually goes 18 months to two years -- at least that's what we're told initially. But as I mentioned before, it's very common for one of those to go four or five years until they actually sunset those old applications.

Okay. And then unrelated, but the fraud, waste and abuse assignment that you're hoping to land this quarter, if, in fact, you do land that, is that likely to be -- are you going to be able to put a press release out on that?

I don't know. We'll have to decide that. We, in the past, typically haven't done press releases when we won a particular piece of business. So we're going to have to -- I know that there's a sensitivity at the moment. And the other problem we have is there's the biggest gap between this call and the next call, so we're going to have to decide whether it warrants a separate press release or not. And we really haven't decided that.

I mean, especially if, in fact, it's something of decent size, that seems like that would make sense.

Right. Yes.

All right, thank you.

Brian Kinstlinger, Sidoti & Company.

Sorry, just one last question, maybe a follow-up. But the five that are still in your pipeline for fraud, waste and abuse, you seem to now have targeted one you expect to be signed by the end of the year. I think, previously, you said you have a couple towards the end of the stages and so you expect that at least one would hit. And it's a little bit of change that you see that one now. I'm curious when you expect decisions from maybe the other four? Is that a first-quarter event? Is it a first-half event? Maybe just give us some timing assumptions that you guys sort of think you'll hear decisions?

Well, I guess we've said that the one that we're going to land, it's possible it's out of the original five. The -- and that is based upon discussions we've had with the client, obviously. It -- I don't know how we can project when the other ones would. I actually would have thought by now the other ones would have closed, but it goes back to the issues they're dealing with and the priorities. So I don't want to kind of handicap when we expect another one to close, because quite frankly, I just don't know when that is.

Well, I guess that's -- I think that's new information. I think that I know you said you might land one out of the original five, but I guess I assumed that your comments today were that one of those five were going to land by the end of the year. And now that it's not the case, you -- those five are all large payers or states. Are you expecting the one that you're going to land will be larger than the two very small insurers you have? And maybe give us some magnitude?

Yes, the -- I guess what we've said in the past is that we expect one to close by the end of the year, and that it's -- the -- that entity is significantly larger than the first two that we already have engagements with.

Great. Okay, thank you.

Thank you. Then with that, there's no further questions in the queue at this time.

Thank you. CPG is firmly established in healthcare, one of the fastest-growing major US industries. While in the short-term, our hospital clients have to deal with the reimbursement reductions imposed on them by the US federal government, they still have significant long-term information technology needs.

We have offerings to meet the IT needs of providers and payers, including Electronic Medical Records; fraud, waste and abuse; ICD10 conversions; accountable care organizations; genomic sequencing; and IT-driven medical management models for chronic diseases, all of which are expected to be in strong demand for several years. As such, we remain very excited about CTG's long-term future growth prospects.

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

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