Computer Task Group Inc (CTG) 2017 Q4 法說會逐字稿

Ladies and gentlemen. Welcome, and thank you for joining today's CTG Fourth Quarter 2017 Earnings Conference Call. (Operator Instructions) With that, I'll turn the call over to Jim Culligan, Director of Investor Relations. Jim, please go ahead.

Thank you, Jordan, and good morning, everyone. With me on today's call are Bud Crumlish, CTG's President and Chief Executive Officer; and John Laubacker, Senior Vice President and Chief Financial Officer.

Before we begin, I want to mention that statements during 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. These forward-looking statements are based on information as of today, Tuesday, February 20, 2018. The company assumes no obligation to update these statements based on information from and after the date of this conference call.

Additional information concerning factors that could cause actual results to differ from those made in forward-looking statements is contained in earnings release as well as in the company's filings with the SEC.

Also, the company's press release and management's statements during this conference call will include discussions of certain adjusted non-GAAP measures and financial information. These financial measures and a reconciliation of GAAP to non-GAAP results, are provided in both today's press release and the related Form 8-K. It's now my pleasure to turn the call over to Bud for his opening remarks.

Thanks, Jim, and good morning to everyone on the call. There are a number of exciting developments to cover on today's call, but before addressing all of the significant news announced last week, I want to begin with a brief overview of our fourth quarter financial results. Revenue for the quarter was $74.6 million, which was above the midpoint of our guidance of $72 million to $75 million. Our operating results were strong in the quarter as well, with operating margin and earnings per share both at or above the midpoint of guidance.

(technical difficulty) European business performed exceptionally well on both a sequential and year-on-year basis, even after adjusting for favorable currency translation. Revenue excluding our 3 largest staffing clients increased more than 11% year-over-year, reflecting our continued success in securing and growing incremental new business. This helped to somewhat offset softer demand from these staffing clients.

Before I go into specifics for the quarter in greater detail, I'd like to take a step back and highlight several meaningful actions CTG has taken over the past 14 months towards the achievement of our strategic initiative shareholder value creation. While 2017 was challenging, the significant steps we undertook to realign our business and build the right foundation for successful achievement of our 3-year plan leave us confident in our ability to achieve the goals we set for year-end 2019. I'm going to talk about each of the areas in which we've made progress, then I'll discuss the acquisition we made last week and finally, the quarter specifically.

With an objective toward advancing operational excellence, we added several high-profile executives in newly created sales leadership roles. We are transforming our approach to marketing and development and are already seeing a pay off with new customer wins. The new hires included Jeff Gerkin as Executive Vice President of Sales for North America in December; Rob Barras as Vice President of Sales for CTG's North America Healthcare business in October; and Susan Tidswell as Vice President of Sales to lead the North America Strategic Staffing business this month. We're very pleased and excited to have them aboard.

We also expanded the selling and delivery of existing solutions across all lines of our business. The ONE CTG program, launched in January of 2017, establishes a company-wide framework that encourages pervasive collaboration across the organization, including the cross-selling of staffing and solution offerings to both new and existing clients. Last May, we introduced Application Advantage, which is a hybrid offering combining several existing services into a single comprehensive solution, designed to maximize the value, efficiency and cost-effectiveness of application services.

We have already secured more than 10 engagements for application management-related services across multiple end markets. We made efforts to strengthen our financial approach by maintaining disciplined cost management and limiting or reducing fixed costs. Some of our accomplishments have included: optimizing underutilized resources in selective areas, making our CFO and Treasurer into a single role, consolidating all Buffalo-based employees into 1 building. We will continue to make this a priority and are looking at ways to further streamline our costs, ultimately improving our profitability.

We've been very focused on diversifying and driving revenue growth, and improving our contract mix by pursuing higher margin opportunities and increasing our market share penetration in areas we already have a strong foothold.

Already seeing results in our newly strengthened sales team, we're excited about converting our robust pipeline of opportunities into engagements. These include: an electronic health record implementation with a major North America hospital system with multistate operations; a 2-year project optimizing a patient portal for a large university medical center; a multiyear engagement supporting documentation and regulatory compliance with a refinery for one of the world's largest energy companies; and a contract with a large public university system, which is a new end market for the company.

But revenue driven from new clients isn't the whole story. We also expanded relationships with current clients to maximize organic opportunities. Our largest client selected us as the preferred provider for a new division, which is incremental business. This is in addition to the 2-year contract extension with this client for technical services I discussed last quarter. We currently expect to begin servicing this new contract in the first half of 2018, followed by a more meaningful ramp during the balance of the year.

For another large client, we are now supporting them in a new country, again, incremental business. Our work over the last 14 months also included reviewing and improving our corporate governance. We refreshed 2/3 of our Board of Directors, adding 4 of the 6 current directors since November of 2015. Added 1 in 2017 with significant IT services experience and is a seasoned industry executive with over 30 years implementing staffing solutions. The insight and guidance provided by all of our directors of the board has been invaluable.

Additionally, we made 2 significant changes to further align the interest of both executive management and our board for CTG's shareholders. In May, we implemented an innovative equity-based compensation program for management with aggressive vesting hurdles. Then in August, the board adopted a new director compensation program consisting of payment exclusively in CTG shares.

Finally, we continued to take a diligent shareholder value enhancing approach to capital management execution. We maintained an active stock buyback program throughout 2017, with the board increasing its prior repurchase authorization by an additional $10 million in October. In total, we repurchased 1,169,000 shares for $6.1 million in 2017, including 252,000 shares for $1.3 million during the fourth quarter. We've returned $7.3 million or 9% of the outstanding shares since the start of this program in November of 2016.

Most recently, we announced a planned cash tender offer for up to 10% of CTG's common outstanding shares. Upon successful closing of the tender offer, we will have purchased approximately 19% of our total outstanding shares over a 17-month period. And as you saw last week, we announced our highly synergistic and immediately accretive acquisition that I'll speak to in a moment. Any number of the items that I just outlined represent meaningful actions in support of our strategic objectives. But collectively, I believe

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the dedication and the board's commitment to CTG's future growth and building tangible shareholder value.

Now turning to the big news, we announced late last week. The acquisition of SOFT COMPANY is a significant milestone in our growth strategy, that expands our portfolio of services and extends our reach in Europe. Importantly, the acquisition is immediately accretive to both CTG's operating margins and earnings per share, including customary acquisition-related expenses. At the highest level, the acquisition represents a transaction that brings together 2 exceptional companies with outstanding reputations and a shared culture of consistently addressing client's business and technology challenges.

As I said at the start of the call, we had solid results in Europe in 2017. It has been one of the best performing areas of CTG's business over the last year. Consistent with our growth strategy, this transaction provides an exceptional opportunity to further enhance growth by capturing meaningful share in a very attractive adjacent market. More specifically, the acquisition broadens CTG's strong existing market position in Belgium and Luxembourg with an established market presence in France, which has a growing and accelerating $40 billion IT servicing market. SOFT COMPANY has long-term clients, with a strong foothold in the financial sector and the services they provide are positioned high on the value chain, which drives solution engagements.

SOFT COMPANY has more than 200 [consultants] that CTG is focused on providing specialized business consulting services, [PM] offering, business intelligence and data analytic offerings as well as mobile application development. In addition of SOFT COMPANY's team and capability through CTG's established operating platform in Europe is also highly synergistic and provides CTG the ability to leverage increased scale and complementary offerings as part of cross selling and serving as a shared portfolio of prominent European clients. Today CTG and SOFT COMPANY serve a number of common clients within our respective geographies. However, each company is currently providing many of these clients with different services. This acquisition significantly increases the opportunity for CTG to deliver a larger number of solution and increase value to its clients.

The all-cash transaction is estimated to be [$16.5] million, for SOFT COMPANY's approximately $30 million in annualized revenue and approximately $3.5 million of cash equivalents as of December 31, 2017. This equates to a purchase multiple of approximately 0.6x trailing revenue, which we believe is strongly aligned with our commitment to prudent capital allocation and prioritizing shareholder value.

Now I'll go back to the fourth quarter and provide comments on the addition of Jeff Gerkin as our North American Executive Vice President of Sales, along with our 3 focus areas of healthcare, diversified industrials and Europe.

Prior to joining CTG, Jeff has held several executive levels positions at Manpower, serving as Senior Vice President North American Sales, Senior Vice President and General Manager for Right Management, Vice President of Metro Marketing and Director of Marketing. In addition, he served as Client Sales Director for Accenture Information Management Services. Adding a seasoned business development executive was an important part of CTG's plan to accelerate revenue growth to reach the goal of outlining our 3-year strategic plan.

Moving onto healthcare. As part of our ongoing commitment to renew growth in this area, we've taken a number of decisive actions over the last year to reposition our offerings and strategy, including the previously mentioned employment of Rob Barras. In addition to identifying and realigning new strategic offerings aligning with market trends, we are continuing to invest in our sales organization to leverage our strong delivery capability that we already have in place today. Although still in its early stages, we are increasingly seeing evidence of renewed traction in healthcare. During the quarter we expanded or extended contracts with several existing clients for our application management and service desk solutions, EMR optimization and implementation.

In our diversified industrials business. We provide strategic consulting solutions, delivered by a highly skilled group of solution architects and software engineers, primarily for the gas and oil industry. In addition, we have extensive expertise in warehouse logistics for the food and beverage and automobile industry. We are expanding our industry geographic, reach as evidenced by the recent win I previously mentioned, and I am confident that this organization will continue to grow by leveraging a combination of technology, in conjunction with deep industry expertise and supplemented by teaming agreements with partners for enterprise information management, 3D virtualization of facilities and business process management.

Europe has been a key highlight, both during the quarter and over the past year. After adjusting for the favorable impact from currency, Europe grew 12% sequentially and 19% year-over-year in the fourth quarter to over $23 million. For the full year, revenue from our business in Europe was approximately $81 million, representing 27% of total revenue, growing 13% over 2016. Billable headcount remained strong during the quarter in response to healthy demand from the financial services sector. We continue to build on our market-leading positions in both Belgium and Luxembourg as well as an emerging presence in the U.K.

During the quarter, we secured a series of new client wins and our pipeline of new business expanded in terms of both the number of new opportunities and aggregate dollar value. More specifically, in Belgium, we are seeing increased demand for our testing, validation and general data protection regulation offerings. In Luxembourg, we successfully contracted a multiyear agreement in Application Advantage solution with a prominent global insurance company.

Our team's ability to execute on the strategic objective of capping incremental market share in Europe has achieved impressive results as well as the growing momentum over the last year. The acquisition of SOFT COMPANY immediately positions CTG

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performance success in Europe by expanding entry into an attractive and growing adjacent market. I'll now turn the call over to John for more a detailed review of our financial results and guidance. John?

Thank you, Bud. Good morning, everyone. We appreciate you joining us today -- on today's conference call. As we indicated in this morning's news release, consolidated revenue in the fourth quarter was $74.6 million compared with $74 million in the third quarter of 2017 and $77.5 million in the fourth quarter of 2016. Fourth quarter 2017 revenue included a $1.9 million benefit from currency translation. Total days in the fourth quarter were 63, same number as in both the previous year and the year-ago quarters. Staffing revenue in the fourth quarter was $51.1 million, representing a decline of 2% sequentially and 6.9% year-over-year, primarily due to continued weak demand from a few of our larger staffing accounts.

Revenue from our solutions business in the fourth quarter [increased] 7.4% sequentially and 4.1% compared to the year-ago quarter. Excluding our 3 largest clients, total revenue in the fourth quarter increased 5.6% from the third quarter of 2017 and 11.3% from the fourth quarter of 2016. Revenue from IBM in the fourth quarter was $[18.5] million or 24.8% of total revenue compared with $18.6 million or 25.1% in the third quarter of 2017 and $23 million or 29.7% of total revenue in last year's fourth quarter.

Revenue from Lenovo in the fourth quarter was $[7] million or 9.4% of total revenue compared with $8.4 million or 11.3% in the third quarter of 2017 and $9.3 million or 12.1% of total revenue in the fourth quarter of 2016.

Direct cost as a percentage of revenue was [79.7%] in the fourth quarter compared with 82.4% in the third quarter of 2017 and 80.8% of revenue the year-ago quarter.

Direct costs in the third quarter were high due to significant unexpected increase in medical costs associated with the company's self-insured plan. As indicated on our last call, we believe these medical costs will remain closer to historical averages going forward.

GAAP net loss in the fourth quarter of 2017 was $419,000 or $0.03 per diluted share, which includes an $0.11 per share noncash charge related to the write-down of deferred tax assets to reflect the future federal tax rate under the recently enacted U.S. tax laws, and a $0.02 per share nontaxable gain from the proceeds from life insurance policy on a former CTG executive. Non-GAAP net income excluding these items was $0.06 per diluted share compared with non-GAAP net income in the third quarter of 2017 of $700,000 or $0.05 per diluted share. GAAP net income in the fourth quarter of 2016 was $1.1 million or $0.07 per diluted share.

CTG's headcount at the end of the fourth quarter was approximately 3,200 compared with 3,250 at the end of the third quarter of 2017 and 3,450 at the end of the fourth quarter of 2016. Approximately 90% of our fourth quarter 2017 employees were billable resources consistent with previous levels.

Turning to our balance sheet. Cash and short-term investments in the fourth quarter were $11.2 million and we had $4.4 million of outstanding long-term debt at quarter-end. In December 2017, we entered into a new 3-year revolving credit agreement totaling $45 million to replace our existing $40 million revolver and providing improved capital flexibility.

Late last year we consolidated our Buffalo-based employees into our headquarters building. And in February, we closed on $1.8 million sales of vacated buildings. We expect to record a gain of less than $100,000 from the sale in the first quarter of 2018. In addition, we estimate that our consolidation into a single building could reduce our annual operating expenses by approximately $0.02 per share.

CTG's tangible book value at the end of the fourth quarter was $5.15 per share. During the fourth quarter of 2017, the company repurchased 252,000 shares at an average price of $5.15 per share for a total cost of approximately $1.3 million. As of yesterday, we had approximately $12.5 million available under the expanded repurchase authorization. Subsequent to last week, we announced a planned cash tender offer to purchase up to 10% of CTG's outstanding shares. We expect to initiate the tender offer in the near future and will remain open for at least 20 business days. Additional details on the cash tender offer can be found in the press release issued last week. On the successful closing of the tender offer, the company will have purchased approximately 19% of total outstanding shares over the past 17 months.

Turning to our guidance, we anticipate total revenue in the first quarter of 2018, which will include approximately 0.5 of a quarter contribution from SOFT COMPANY, to be in the range of between $77 million and $82 million. In addition, we expect first quarter GAAP net income to be in the range of between $0.02 and -- sorry, $0.02 and $0.04 per diluted share and non-GAAP net income to be estimated between $0.05 and $0.07 per diluted share. There are 64 total days in the first quarter of 2018, the same as in the first quarter of 2017.

With respect to our tax rate, we expect in the first quarter and throughout 2018, an effective tax rate of approximately 28%. For the full year 2018, we anticipate revenue to be in the range between $340 million and $360 million, full year GAAP net income is expected to be between $0.25 and $0.37 per diluted share and non-GAAP net income to be in the range between $0.30 and $0.42 per diluted share. With that, we'll now open the call to questions. Jordan, can you please manage our question-and-answer session? Thank you.

(Operator Instructions) We'll go to our first caller.

It's Kevin Liu with B. Riley FBR. Congrats on a very strong quarter and outlook. First question I had here with just regarding the SOFT COMPANY acquisition. What have you assumed within your first quarter and full year revenue guidance? And then could you give us some context around what sort of gross and operating margins they've generated historically?

The growth has been varied, Kevin, this is John. We're not going to release operating margins for SOFT COMPANY, as we haven't for any of our significant locations or subsidiaries that we've done in the past. Part of what attracted us to the CO (inaudible) is the fact that they have a growing organization, with a $30 million run rate in U.S. revenue, which is growing, which is more focused on solutions than staffing, we think this is a great opportunity to add a quality business into the CTG group of companies and grow our solution business in Europe.

Got it. And with respect to the healthcare practice, you guys referenced that you felt like -- there's a little bit of traction seen in the fourth quarter. Can you talk about what the pipeline of opportunity there looks like? The scope of work that you anticipate going forward and what level of growth you might anticipate in '18?

Kevin, it's Bud. The growth in healthcare it's definitely -- we've got a real positive outlook for healthcare. And we're -- as we talked over the past, I don't know, year and a half or so, the implementations business has been declining. But we were successful in moving that forward as well as going back in and optimizing some things. So we have a significant pipeline in healthcare. We're adding more of our client partners, which are our business development executives. And I think that with the appointment of Jeff Gerkin, it's going to help support all that. We're really excited about it. And we're getting, as I mentioned also, 10 Application Advantage engagements that we've sold since May. And there's a lot more out there that we're looking at as well. So it's hard to say exactly in terms of a percentage of growth, but it's definitely picking...

And then just lastly from me, can you talk a little bit about where you expect the debt balance and interest expense to be following the acquisition as well tender offer? And to what extent -- what sort of assumptions have you made around the tender offer within your fiscal '18 guidance?

We -- at this point in time, because we are unsure of how many shares will be tendered within the tender offer, we have not factored in a reduction in shares in the EPS calculation going forward. However, as part of that equation, we would expect an increase in interest expense as you just indicated, that would probably offset any real benefit that we would get from the reduction in shares. It's not a one for one, but you will definitely see an increase in interest, that will be offset somewhat by the reduction in the shares, or more so by the reduction in shares.

And with that we have one more question on the phone lines at this time and we'll go to that caller now.

It's Vince Colicchio of Barrington. Could you give us some help in terms of understanding the growth rate of the pipeline for staffing and solutions, respectively, including both North America and Europe?

Well, typically, if you take a look at the purely industry average, you're talking between [4 and 3]% and we're really about doing much better than that. We're about taking market share from our competitors. And that's why we're really investing in it, we're putting the caliber of the people in place. So we certainly expect to -- book for staffing business in Europe to grow better than that and they have, well. Certainly, we expect them to. But in Europe, it has -- we've gotten held back by our 3 largest clients, although the rest of our business in staffing has grown 11%. So that's what we're looking for in the future.

Vince, this is John. You may have heard from my script that we talked about solutions increase. We did see an increase in solutions over the third quarter and year-over-year as well. So we have seen a slight uptick in that business, primarily being driven by that increase in revenue on our European business, which has got a higher percentage of solutions versus staffing than the U.S. organization (inaudible) .

Okay. And then John, you responded to some questions on the SOFT acquisition. I had some background noise. Did you talk about the historical growth pattern of SOFT COMPANY?

We didn't specifically talk about it, Vince. From our perspective, this is a growing organization that we've looked at for some time. Feel very strongly about, they have a definitive plan for growing their revenue and we have seen that demonstrated over a number of years. So while we haven't given out a specific growth rate for that organization because we don't for any of our individual components. This is definitely a growing organization, with a higher solution -- like with the rest of our European business, a higher mix of solutions versus staffing, that we feel very excited about, that can grow and add market share at a very good level.

And two quick ones is all I have left. Tax rate for 2018, I didn't hear you say that for the year?

Yes. 28%.

Okay. And then what was capital spending in the quarter?

Capital spending in the quarter was, one moment, was about $1.1 million. A little bit higher than usual for us.

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Yes, we had some renovation that we did to our existing corporate headquarters to make sure we could appropriately accommodate moving everybody into the building. But I expect those to return to normal levels of maybe $500,000, $600,000 a quarter going forward.

And with that we have no further questions on the phones at this time.

Okay. Thank you operator. In closing, I'm pleased by the significant contributions from CTG's board, management and employees and by what we've accomplished together over the past 14 months since the beginning of our (inaudible) strategic 3-year

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significant actions taken to drive tangible improvement across the company, in both the staffing and solutions as well as in focus areas of healthcare, diversified industrial and Europe. During 2017, we significantly strengthened our sales organization, highlighted by the appointment of 3 seasoned sales leaders, that have generated solid top line growth outside of our 3 largest clients. In addition, we consistently maintain one of the largest pipelines for new business in recent history, while proving our ability to convert sizable opportunities into new contracted businesses.

Taken together, we believe our strategic initiatives for 2017 successfully established the foundation required for CTG to achieve our 3-year financial objectives by the end of 2019. Additionally, we actively demonstrated our commitment to driving increased shareholder value through a combination of actions. Specifically, we further aligned management and the board with shareholders by implementing an innovative equity-based compensation performance program for executive management, and by modifying the board's compensation program to eliminate cash and consist of equity only compensation for nonemployee directors.

During 2017, we also used over $6 million to repurchase nearly 1.2 million shares of stock. Then last week we announced a planned cash tender offer for up to 10% of CTG's current outstanding shares. Finally, we're very excited about the acquisition of SOFT COMPANY. In addition to broadening our existing presence in Europe into France and providing highly complementary IT services and consulting offerings, this immediately accretive transaction accelerates progress towards our strategic plan and the achievement of our financial objectives. I sincerely want to thank all of you today for joining us on this call. Jordan, you may now disconnect the call.

Thank you very much and thank you all for joining us on the call today. The conference has concluded, and you may now disconnect.