Computer Task Group, Incorporated
Q2 2017 Earnings Call Transcript

Published: 25 Jul 2017

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the CTG Second Quarter 2017 Financial Results Call. At this time, all lines 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 like to now turn the conference over to the Director of Investor Relations, Jim Culligan. Please go ahead.

[Jim Culligan:]

Thank you, Ryan, and good morning, everyone. With me today 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 states 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, July 25, 2017. 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 our earnings release, as well as in the Company’s SEC filings. It’s now my pleasure to turn the call over to Bud for his opening remarks.

[Bud Crumlish:]

Thanks, Jim and good morning, to all of you. I’ll start with a brief overview of our financial results for the quarter as announced in today’s press release. Second quarter revenue was $75.5 million which is lower than the midpoint of our guidance due to softer demand and a few of our larger staffing clients. This softness was further magnified by the delayed issuance of purchase orders that one client in particular, a portion of these purchase orders have ultimately been released others remain on hold, but we expected to be issued in the next coming months. In regards to the new business offers that continues to emphasis on expansion and diversification of CTG’s client base resulted in a number of new client wins for the quarter as well as a sequential increase in new revenue. The majority of these accounts are still nearly stage of ramping and a do business offsets some of the quarterly weakness we saw at our larger accounts. Despite lower revenue our diligent cost management and further improvement and efficiencies throughout the organization enabled us to deliver earnings of $0.06 excluding severance charges which was at the high end of our guidance. This achievement demonstrates our continued commitment to preserve earnings while simultaneously remaining focused on driving new business and client expansion. The actions we’ve taken this year laid a foundation to accelerate growth in the future and we see that our strategy is working. Our sales pipeline is significantly stronger, we’ve been increasing the size in caliber by sales organization, we’re building an accountable sales culture and we continue to make judicious investments in our leadership team. As part of these investments, we made significant progress in our search for a newly created senior executive sales leadership position. The decision to create this new role better aligned with our ongoing emphasis on driving new business across the enterprise and replace as a search for [SL] position that we mentioned last quarter. We expect to fill this sales leadership position and formally announce an appointment by the end of August. In terms of our stock repurchase we repurchased an additional 257,000 shares under our authorized share buyback program during the quarter amounted to $1.45 million and a total of $4.8 million since the announcement of our share buyback program last year November. Now giving update on our staffing solution business in conjunction with our focus areas of Europe, healthcare and diversified industrials. Our staffing business which represents of 70% of total revenue as I previously mentioned stays weaker than anticipated demand at several large clients. These isolated areas of weakness are related to client specific challenges in the respective businesses, but we continue to observe positive indicators elsewhere in the market and across our broader client base importantly, our relationships with all of our large staffing clients remains strong and we continue to provide them with a reliable high value services and support they come to expect from CTG. In fact, during the quarter we continued to advance multiple new and potentially sizeable business opportunities at our largest staffing clients. We believe that at least one of these new opportunities could lead to an engagement that could be a relevant contributor in the second half of 2017. We’ve also continued to make meaningful progress on increasing our share business at other existing clients most notable we recently secured incremental work at an existing global IT management and services clients that represents an opportunity to significantly expand our North America footprint. We’ve been allocated an initial small group of individuals and we’re in the process of transitioning from another provider. And we expect to onboard our larger number of additional individuals in the coming months and quarters. This is a significant win for CTG and we believe the incremental business has the potential to grow the account to a top 5 staffing client overtime. In addition, we’re increasing our business at existing clients we successfully grown the pipeline of targeting business opportunities over the first half of 2017, consistent with our strategic objectives, our primary focus continues to be on expanding CTG’s client base in key geographies where we already have a strong market presence. And since our earnings call in April we’ve made significant progress towards finalizing engagements with a number of these perspective accounts. We believe some of these accounts have the potential to contribute to our second half results as well. Shifting to an update on CTG’s offshore delivery center in India where last quarter I talked about having implemented a number of operational improvements both sourcing activity and bill rates of increase and response times have improved. More recently we began positioning resources in Hyderabad to deliver technical work as part of our planned proof of concept with an existing U.S. based client. Once proven successful, we believe there will be a significant opportunity to scale the amount of India based technical work we can provide to both current and perspective clients. Turning to our solutions business, which is 30% of our revenue most areas performed in-line with our expectations although we were down fractionally on sequential basis. Our primary solutions offerings, our application development and management, IT service desks, business process management, implementation and optimization as well as execution. As I’ve highlighted on previous calls, the expansion of these solutions across all other lines of business is a key strategic objective. In May, we achieved a significant milestone and supported this objective with our formal launch of application advantage. This new offering combines several CTG’s existing services into a single comprehensive solution that is designed to maximize the value efficiency and cost effectiveness of application services. In less than three months we’ve secured multiple client engagements and our global sales team is now working to further expand as new portfolio of services. In addition, the one CTG program we launched at the beginning of the year encouraging enterprise wide collaboration and established our frame work across selling is also demonstrating early signs of success. During the second quarter proactive collaboration between separate business units within CTG resulted in implementing higher margin solution engagements beyond what would have typically been standard staffing agreements. Now I’d like to provide a few highlights on the additional progress we made throughout the quarter within our three key focus areas which include Europe, healthcare and diversified industrials. Beginning with Europe, our business was effectively flat on a sequential basis with revenue of $18.9 remaining near the two year high and record percentage of total CTG revenue achieved in the first quarter. Our stable client base in Belgium, Luxemburg and the UK continues to be a solid foundation to further grow market share in their respective geographies. During the quarter the team added a double digit number of new accounts for the sixth consecutive quarter including our first [EMR] implementation for a French speaking hospital in the Walloon region of Belgium. Although, implementations in Europe were smaller engagements than those we’ve historically seen in U.S. we’ve now signed a total of eight contracts some of which also include application advantage support services as a follow on offering. Additionally, we’re experiencing strong demand for our software testing capabilities in Belgium and the team is now actively working to build out and grow CTG’s cloud service and data protection offering. Overall, our pipeline of new business in Europe continues to expand in terms of both the number of opportunities and aggregate dollar value. As we look to the second half of the year, we’ve currently submitted proposals on a number of meaningful opportunities within European ministry and minor implementations as well as other potential work in the financial and government sectors. Moving to healthcare, we’ve neared the geographic focus of each sales person and are concentrating these focus areas in regions where CTG has strong existing support resources. Combined with a newly implemented strategy for lead generation is more focused centralized sales approach enables us to better leverage relationships we have developed over the years with our healthcare clients. Although revenue from this business has been stabilizing over the past four quarters we took decisive actions during this quarter in order to drive a more meaningful turnaround in the performance of the business. In addition to consolidating certain resources and continuing to strengthen leadership across the organization we have recently expanded our sales team and made a number of enhancements to our sales approach. Each of these actions were motivated by our objective to consistently improve effectiveness throughout the organization. Our improved pipeline is an early indicator of success. Collectively these actions establish a fresh combination of strategy for renewed growth in healthcare and continues to represent an attractive and strategic market opportunity for CTG. Finally, in our diversified industrial business, which spans multiple different sectors we are consistently uncovering and pursuing new opportunities to further leverage this proven platform which consists of a unique team of highly skilled solution architects and software engineers. Year-to-date we have secured and extended several meaningful engagements with both corporate and government clients as well as advanced multiple strategic partnerships to either co-sell or re-sell complementary services and solutions. On our last call I highlighted the new staffing agreement with a global engineering and construction firm. We are currently working to build out a custom solution for this new client that has the potential to contribute meaningful growth once fully ramped. We also recently completed an agreement with a software banner that complements our significant depth in business process management a number of our employees are now becoming certified in this software to provide a high level consulting service and bring this solution to a growing list of prospects. Collectively, we continue to be optimistic about our ability to grow the diversified industrial organization in the coming quarters. In conclusion, in 2017, we have achieved some significant accomplishments including formalized in a definitive three years strategic plan for growth, upgrading and expanding our sales organization, flatten the organization to drive efficiencies and improve performance adding new board member with extensive IT service experience and directly aligning the executive leadership team with shareholders with performance based equity grasp. These are just a few of the ideas we accomplished this year along with the others previously mentioned on this call. We have been building the foundation for growth and our strategy is working. We believe that the overall market environment remains favorable and we are better positioned in the company to capture incremental market share. In fact, today we have the largest pipeline of proposals that the company has had in recent history and I am very optimistic about the progress we are making to advance our growing number of opportunities with both new and existing clients. As we look to the second half of 2017, execution remains paramount and is a companywide focus. Our priorities continue to be on re-establishing top line growth and diversifying CTG's client based while also carefully managing expenses to preserve near term earnings. Longer term, we remain committed to our strategic plan and drive incremental improvement towards achieving or to exceeding our three year financial objectives. With that I will turn the call over to John for discussion of our financial results and guidance.

[John Laubacker:]

Thank you, Bud. Good morning everyone, we appreciate you joining today’s call. As we indicated in this morning's news release revenue in the second quarter was $75.5 million compared with $77 million in the first quarter of 2017 and $83.5 million in the second quarter of 2016. Negative currency translation reduced second quarter 2017 revenue by approximately $600,000. We had 64 billing days in the second quarter of 2017 the same number of days as in the year ago quarter. Staffing revenue in the second quarter declined by approximately $1.1 million or 2% from the first quarter of 2017 and declined by $5.9 million or 10% year-over-year. Lower revenue in the second quarter of 2017 primarily reflected a combination of weaker demand in the quarter of severance accounts and delayed purchased orders at a large staffing client. Revenue from our solutions business in the second quarter declined sequentially from the first quarter by approximately $400,000 or 1.8% and declined by $2.1 million or 8.5% compared with the year ago quarter. Revenue from IBM in the second quarter was $19 million or 25.1% of total revenue compared with $20.3 million or 26.4% in the first quarter of 2017 and $25.1 million or 30.1% of total revenue in last year's second quarter. Revenue from Lenovo in the second quarter was $9.4 million or 12.5% of total revenue compared with $9.4 million or 12.2% in the first quarter of 2017 and $8.3 million or 10% of total revenue in the second quarter of 2016. Direct cost which included severance related cost of $400,000 were 81.9% as a percentage of revenue in the second quarter of 2017 compared with 81.5% in the previous quarter and 80.9% of revenue in the second quarter of 2016. Direct cost in the year ago quarter benefited from approximately $700,000 in foreign payroll tax credits. On a non-GAAP basis excluding the severance costs from the 2017 second quarter results in a direct cost percentage of 81.4% while excluding the foreign payroll tax credits from the 2016 second quarter result in a direct cost percentage of 81.8%. GAAP and SG&A expenses were 17.1% of revenue in second quarter includes approximately $400,000 in severance related charges. On a non-GAAP basis SG&A expense were 16.6% compared with 16.8% of revenue in the first quarter of 2017 and 16.8% of revenue in the year ago quarter. On a non-GAAP basis second quarter 2017 SG&A expenses were $1.5 million lower than the year ago second quarter. Second quarter GAAP operating income was $700,000 or 0.9% of revenue which included $800,000 in severance related charges. Non-GAAP operating income in the second quarter was $1.5 million or 2% of revenue compared with operating income of $1.3 million or 1.7% of revenue in the first quarter of 2017. Operating income in the second quarter of 2016 was $1.9 million or 2.3% of revenue but benefited from the foreign payroll tax credits previously mentioned. The effective tax rate for the second quarter of 2017 was 33.2% compared with 41.2% in the first quarter of 2017 and an effective tax rate of 29.6% in the second quarter of 2016. GAAP net income in the second quarter of 2017 was $434,000 or $0.03 per diluted share which included $600,000 in severance related charges. Non-GAAP net income in the second quarter of 2017 was $1 million or $0.06 per diluted share compared with net income of $751,000 or $0.05 per diluted share in the first quarter of 2017. Net income was $1.3 million or $0.08 per diluted share in the second quarter of 2016 included $0.03 per diluted share benefit related to the foreign payroll tax credits. Second quarter 2017 results included equity based compensation expense of approximately $0.01 per diluted share net of tax. CTG’s headcount at the end of the second quarter was approximately 3400 compared with 3300 at the end of the first quarter 2017 and 3500 at the end of the second quarter of 2016. Approximately 90% of our second quarter 2017 employees were billable resources consistent with the percentage at the end of 2016. Turning to our balance sheet, cash and short term investments at the end of the second quarter were $11.5 million and outstanding long term debt was $3 million. Day sales outstanding were 82 days in the second quarter of 2017 compared with 81 days in the year ago second quarter. The cash surrender value of life insurance was $31.8 million at the end of the quarter. We continue to list our three storey office buildings for sale, the office building has a net book value of $1.7 million that remains on the marketed at an asking price of $3.2 million. The company's other property is no longer on the market and our ultimate goal continues to be combining our Buffalo based employees into a single building here in Buffalo. We estimate the consolidation to a single building could reduce our annual operating cost expenses by approximately $500,000. CTG’s tangible book value at the end of the second quarter was $5.01 per share during the second quarter of 2017 the company repurchased 257,000 shares at an average price of $5.63 per share for total cost of approximately $1.45 million. We repurchased approximately 53000 additional shares subsequent to quarter end and as of today have approximately $5.2 million remaining under the existing repurchase authorization. Turing to your guidance, we anticipate total revenue in the third of 2017 to be in the range between $75 million and $77 million. Third quarter operating margin is expected to be between 1.6% and 1.8%. In addition we expect third quarter net income to be in the range between $0.04 and $0.06 per diluted share. There are 63 billing days in the third quarter of 2017 the same number of days as in the year ago third quarter. The effective tax rate for the third quarter is expected to be approximately 36%. Please note our reported net loss of $1.03 per diluted share in the third quarter of 2016 included goodwill impairment charges of $1.01 per share as well as severance related charges of $0.06 per diluted share. For the full year 2017 we anticipate revenue to be in the range between $305 million and $315 million. Non-GAAP operating margins for the year is expected to be approximately 2%. Full year non-GAAP net income is expected to be between $0.22 and $0.26 per diluted share. Finally, we expect the effective tax rate for the full year 2017 to be approximately 36%. Our revised full year revenue guidance reflects the weaker demand we experienced in the second quarter as several of our largest staffing clients combined with the unexpected delay in issue of purchase orders from one of our largest client. Importantly, we are maintaining the midpoint of our full year earnings guidance. Our expectations include ongoing diligent cost management as well as continued investments in business development and recruiting resources. We remain absolutely committed to driving growth and profitability and continue to be encouraged by the number of quality of opportunities in our pipeline. The progress we are making to secure new clients and projects together with the strength of our customer expansion opportunities makes us optimistic that we will return to revenue growth by the end of the year. With that we will now open the call for questions. Ryan, can you please manage our question-and-answer session?

[Operator:]

[Operator Instruction] Our first question comes from the line of Vincent Colicchio with Barrington Research. Please go ahead.

[Vincent Colicchio:]

Good morning guys. So Bud, I am curious the additional work that you won at an existing IT services client versus another provider, what do the margins look like in that work and I mean it was price meaningful factor and are there other opportunities like that?

[Bud Crumlish:]

Well, on that particular one it's always not transitioning to current employees from another provider that’s always at a lower price but we got the combination of both. We did a special arrangement to do that as well as support them for their new requirements which would be at higher margin. Really not to say what that particular margins are on this but that’s typically how it works standard in the industry.

[Vincent Colicchio:]

And you said that your pipeline is the highest in its industry. I am curious is it a meaningful increase versus the year ago period for example?

[Bud Crumlish:]

I would say absolutely it’s a meaningful increase in our pipeline. We are seeing a lot of activity. We are getting our people call those in and some of these are really, they are significant and I am very optimistic about them. I mean obviously we have to close them. We have to execute on them and sometimes it takes time to ramp up but now I am very optimistic about them. We haven't had something like this and I can't say how many years but a number of years.

[Vincent Colicchio:]

It sounds like somewhat related, it sounds like you have got a good amount of potential for upside of the second half versus your expectation. Do you think that would you say that you are being conservative with your expectations for the second half?

[Bud Crumlish:]

It's hard to, until we have things whacked down it's hard to actually put that in our guidance number that's the thing. It's we need like I said we need to close a lot of these. We need to execute on them and then that's going to make a difference but the - to put it in our guidance now we don't feel it’s prudent at this point.

[Vincent Colicchio:]

And I am curious on the regulatory front are you seeing any negative impact from uncertainty in the financial services and healthcare sides of things?

[Bud Crumlish:]

I would say, no. we don't really see anything negative. Like I said I am pretty optimistic we are getting - I would look at proposal levels and requirements and things like that to drive business and with all that we are going strong and like I said we never had a higher pipeline and we have made some changes operationally effectively with our recruiting organization to respond faster with high quality candidates. So we really haven't seen anything.

[Vincent Colicchio:]

Okay. Thanks. I will go back in the queue.

[Bud Crumlish:]

Thanks Vincent.

[Operator:]

[Operator Instruction] Our next question comes from the line of Kevin Liu with B. Riley and Company. Please go ahead.

[Kevin Liu:]

Hi, good morning.

[Bud Crumlish:]

Good morning, Kevin.

[Kevin Liu:]

First question I had was just on the delayed purchase order from the large customer any sense you can give us in terms of kind of the value of those purchase orders or perhaps just kind of what percentage you since have been able to close, I mean to what extent is the assumption made that you are going to close the remaining value of that and have that be able to help make your guidance for the full year?

[John Laubacker:]

Kevin it had a very significant impact on the quarter. We tend to be pretty realistic and conservative as we put our guidance forth. So that we are below our mid-point of our guidance for the second quarter and the impact at least delayed purchase orders have very significant direct impact on us not being in the range in the quarter. From where we have been to-date since this initially happened number of those POs have been released, so a number of that are still on hold at this point in time and we have been told that the expectations is that they will be released at some point in the future this year but haven't been given the clarity as to when that will be.

[Kevin Liu:]

Got it. And so have you guys assumed any sort of contribution from the delayed POs in terms of either your Q3 or Q4 guidance and then beyond that you talked about other large opportunities that could start to contribute in the second half from your earlier comments I would assume you haven't picked those in your guidance but just wanted to clarify?

[John Laubacker:]

We have been pretty conservative with the release of the remaining POs that are in hold so we have baked them in but again we haven't - we didn't do as that for instance July 1 to start the third quarter. So we have been pretty conservative. I can let Bud speak a little bit more on large opportunities but as he just indicated we were very conservative with that. We have a number of great opportunities in front of us which we feel very positive about. But until we convert proposals and opportunities and our fees into wins we tend to be pretty conservative about baking them into the forecast budget.

[Bud Crumlish:]

Yes, we like to see progress along the line of escalating through the state of sales funnel and we are in that process and as we get closer and feel more confident and comfortable then that makes a difference in our guidance and what we will come out with. But right now I guess we have got a really strong pipeline that I haven't seen in years but we are as John mentioned we are being conservative about our guidance with that. So we are holding back until we get further information, make further steps inroads and understand exactly when things could start and when we can close it.

[Kevin Liu:]

Understood and just with respect to the large pipeline could you just speak to whether that's concentrated with the handful of larger opportunities or whether you feel it's pretty well diversified amongst end customers?

[Bud Crumlish:]

I would say it's - there is a lot diversification with it but there definitely are some large opportunities in there with some large clients, absolutely. That's really a combination of both.

[Kevin Liu:]

And then, just lastly from me, on the application event side you talked about some solid initial traction maybe if you could talk about kind of the average field sizes that you have been able to secure to-date I mean how whether those start to contribute this year or do they have some sort of wrap up here before you get more meaningful contribution?

[Bud Crumlish:]

Those would be definitely included in this year. Deal size it's kind of hard to say but pretty wide range. I mean you can go from $1 million to $10 million. So it's a pretty broad range and multiple years as well. The one thing I just mentioned that when we have done our TMR implementations in the U.S. over the last number of years when we are done with the implementation we’re done with the implementation. One of the things that we have with application advantage is that in Europe they are going to need follow-on application support so although there is a initial surge in revenue to get the implementation done over a year or 18 months we have continuous follow on work for a long period of time typically three to five years. So that's another benefit to us I mean we are just starting these implementations in Belgium but that's a real plus in mind and we can use this same resource to implement to actually support and entail, and continue with revenue stream for a longer period of time.

[Kevin Liu:]

Got it, thanks for taking the questions.

[Bud Crumlish:]

Thank you.

[Operator:]

[Operator Instruction] Currently I have no further questions in queue.

[Jim Culligan:]

Okay. Thank you Ryan. To close up the call I want to state that we have laid the foundation for growth and profitability to drive shareholder value and we see significant progress across all the lines of business. We continue to take the decisive action and remain intently focused on execution in line with our strategic plans. We will make the required investment to re-establish top-line growth and diversify our client base while continuing to diligently manage cost preserved near term earnings. We appreciate you joining today's call and I also want to thank all of our shareholders for your continued support. We look forward to reporting additional progress next quarter. Ryan you may now disconnect the call. Thank you.

[Operator:]

Okay. Ladies and gentlemen that does conclude today's conference. Thank you for your participation. You may now disconnect.