Computer Task Group, Incorporated
Q2 2015 Earnings Call Transcript

Published: 28 Jul 2015

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the CTG Second Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session instructions will be given at that time. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to our host Jim Culligan, Director of Investor Relations. Please go ahead.

[James M. Culligan:]

Thank you, Lisa, and good morning everyone. We certainly appreciate your timing, your interest in CTG. On the call today, we have CTG’s Chief Executive Officer, Cliff Bleustein, and Brendan Harrington, Senior Vice President and Chief Financial Officer. Cliff and Brendan are going to review our financial results for the second quarter of 2015 and then update you on the company's emerging strategies and outlook. We will 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 statement. 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 this date. 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 in the forward-looking statements is contained in our earnings release, as well as in the company’s SEC filings. You can find these in our website or the SEC’s website at sec.gov. Please review our forward-looking statements in conjunction with these precautionary factors. Also please note that a reconciliation to GAAP of the non-GAAP financial measures we are providing on this call is included in our earnings release. I will now turn the call over to Brendan to begin the discussion.

[Brendan M. Harrington:]

Thanks, Jim. Good morning, everyone. Thank you for joining for this second quarter earnings conference call. As we indicated in this morning's news release, revenue was $94.7 million, $5.6 million lower than the 2014 second quarter. Revenue was unfavorably impacted by $3.9 million due to the weakness in the value of the euro and we have one less billing day in the 2015 period than in the second quarter 2014. The 2015 second quarter at 63 billings days, as compared to 64 in the 2014 second quarter. Staffing revenue grew by $3 million or 5% and revenues from our solutions business declined by $8.6 million or 21%, primarily in our healthcare business. Compared with the first quarter 2015, revenue for billing days in the second quarter of 2015 increased by 1.8%. 2015, second quarter revenue from IBM were $25 million or 26.4% of revenue, as compared with $22.7 million or 22.6% of revenue in last year's second quarter. Our revenue from Lenovo in the 2015 second quarter generated through STI, a vendor manager for Lenovo was $11.4 million or 12.1% of revenue, as compared with $7.4 million or 7.4% of revenue in the 2014 second quarter. The increase in revenue from Lenovo in 2015 was due in part to the sale of IBM’s x86 server division to Lenovo, which was effective October 1, 2014. Direct costs, as a percentage of revenue were 83.5% in the 2015 second quarter, as compared with 82.2% of revenue in the 2015 first quarter. The increase in cost in Q2, 2015 is primarily due to the charges related to the European workforce realignment and the write-off of the capitalized cost for medical management software. Excluding these charges, direct cost as a percentage of revenue would have been $77.1 million or 81.3% of revenue. SG&A expenses were 15.3% of revenue in the 2015, second quarter, down from 15.7% of revenue in the 2014 second quarter, primarily due to disciplined cost control. The effective tax rate for the 2015 second quarter was 48.4%, as compared with 40.3% in last years second quarter. The higher rates was primarily due to the lower pretax income and the lack of a current tax deduction in UK related to certain cost in the second quarter. We anticipate our annual effective tax rate to be approximately 40% to 42%. Net income in the 2015 second quarter was 554,000, a decrease of $2.7 million as compared with the 2014 second quarter. Excluding the unusual charges, net income would have been $1.8 million or $1.4 million lower than last year second quarter. On a per diluted share basis, net income was $0.03 in the second quarter of 2015, as compared with $0.20 in the second quarter of 2014. Excluding the unusual charges, net income per diluted share would have been $0.11 in the 2015 second quarter. Compared to the first quarter of 2015, excluding this two unusual charges, net income increased 550,000 or approximately $0.035 per diluted share, as a result of increased direct profit margin and lower SG&A expense. The 2015 and 2014 second quarter results respectively includes equity based compensation expense of approximately $0.01 and $0.02 per diluted share net of tax. Our headcount at the end of the 2015 second quarter was 3800 people, 100 people less than at the end of the trailing first quarter 2015 and the same at the end of the second quarter 2014. The decrease in headcount from the end of March primarily relates to lower demand from our largest clients in our staffing business. Of the 3800 employees at the end of the second quarter, approximately 92% were billable resources. Our day’s sales outstanding were 61 days at the end of the 2015 second quarter compared with 67 days at the end of the second quarter 2014 and four [ph] fewer days at the end of the 2015 first quarter. The timing of cash collections at the end of the second quarter 2015 positively impacted the DSO balance. Our cash provided by operations in the 2015 second quarter was approximately $2.2 million, as compared with cash generated from operations of $2.7 million in the 2014 second quarter. The 2014 second quarter ended between payroll day, while the 2015 second quarter ended on a US payroll days. In the 2015 second quarter we incurred $518,000 in capital expenditures and recorded depreciation expense of $517,000. We repurchased 6,000 shares of CTG common stock during the 2015 second quarter and 50,000 shares in the third quarter through yesterday under our 10b5 Plan. As of today, our repurchased authorization totals totaled approximately 475,000 shares. I'd now like to discuss the recent changes and other upcoming changes to our balance sheet. Our cash balance at the end of the second quarter 2015 was $31.4 million compared with $31.7 million at the end of the second quarter of 2014. We've examined the cost of certain financing that we support to utilize and decided to utilize more cost effective bank financing for borrowing. As a result, during the second quarter 2015, we used approximately $2 million of cash to pay down loans outstanding against the cash surrender value of company owned life insurance policies on several former officers. This also resulted in a corresponding increase to the other asset balance with the loans that historically been net against the cash surrender value of the policy. We also intend to utilize another courses [ph] of our cash balance to pay down the remaining outstanding loans we have on the company owned life insurance policy of approximately $17.5 million. We are also renewing ourselves from an advance payment program with a significant customer during the third quarter. Under that program payment due in 65 days were paid in 15 days for which we paid a fee. As a result of this change the account receivable balance and DSO will increase and our cash balance will decrease by approximately $30 million. The net savings on an annualized basis of using the new financing method is approximately $0.04 per diluted share. We will use the savings generated in the second half of 2015 from the exchanges for additional business development and recruiting resources. I am now going to turn the call over to Cliff for his remarks. Cliff?

[Clifford Bleustein:]

Thanks, Brendan. During the last four months I have been meeting with our clients in the US, UK, Belgium and Luxembourg to learn about their industry challenges and the role that we play in our organization. I've also hosted internal CTG town hall meetings, met with delivery teams and worked with senior management to learn more about our operation, strategy, capabilities and areas for improvement. As a result of this feedback and an initial review of businesses, we've already undertaken several strategic initiatives to address opportunities for growth or improvements in financial and operational efficiency. I will continue to make adjustments as our strategy evolves in the coming months. Our staffing business performed well during the second quarter, as we accelerated growth with the addition of US recruiters. We have already increased our recruiting force by over 20% in 2014 and we anticipate adding additional recruiters to grow our recruiting capacity 35% in 2015. We also plan to strengthen our management team through the addition of our Vice President, who will assist in our business development efforts into new accounts. We are also in the process of identifying underperforming contracts from a margin perspective and plan to allow them to expire over the normal course of business. CTGs executive management team has also been strengthened with the addition of Al Hamilton, who joined CTG last week. He will be responsible for guiding our Health Solutions and Life Sciences factor. Al's, breadth of experience in health IT and track record of successfully improving the performance of various healthcare businesses makes him a valuable addition to our management team. I am confident that under Al's leadership this business will return to growth in 2016. We are already seeing that parts of CTGs healthcare business is stabilizing as to two years of declining revenue and we are investing and rebuilding sales capacity with the addition of four client partners. On our last investor call, I mentioned that CTGs success in Europe was one of things that impressed me about the company. I spent some time in Europe getting familiar with our operations and continued to impress with our operations over there. However, during my review it was apparent that despite the significant cost of severance in Europe it made business sense to absorb the cost of eliminating 30 positions and redirect the funds for these resources to areas where we are likely to grow. Similarly, I conducted a review of CTGs medical management software, which although conceptually promising had not gained traction with our payers. I concluded that we would be better absorbing the cost associated with discontinuing this tool, so we could redirect those resources to our technology consulting practice which is been expanding quickly. The charges recorded in the second quarter to the European workforce realignment and the medical tool write-off totaled $0.08 per diluted share, but I consider them to be an investment in growth. We've added a new client partner in our energy business as well, who will focus on expanding our sales to that market, as well identifying alternative markets that may require the capabilities as CTGs energy grew. For nearly 40 years CTG has utilized the former Knox Mansion mentioned as its corporate headquarter. It is historic in nature and is a magnificent building in the area of Buffalo that is seen significant appreciation in real estate values. We currently have fewer than 35 employees working in the building and they can easily be relocated to our other Buffalo office building, resulting in a reduction in operating costs and improved staff performance efficiency. We have put it on the market with a well known national real estate brokerage for a $3.95 million. Although sales can not be guaranteed, should the building sell we don’t expect any disruption in our operations resulting from the move to our other facility. Another quality that attracted me to CTG was its strong balance sheet. We determined them prevalence [ph] can be made here as well and as Brendan mentioned we are in the process of making changes that we expect would equate to annual savings of approximately $0.04 per diluted share to a more economical way of financing our business. However, the savings for 2015 and the first half of 2016 will be reinvested in business development activity. I am going to turn the call over to Brendan for his discussion of our verticals and guidance. Brendan?

[Brendan M. Harrington:]

Thanks, Cliff. Turning to our vertical market, classified [ph] healthcare business appeared to be stabilizing with our advisory and technical consulting practices contributing in a higher levels than they have in the past, although revenue from our EMR practice continues to show a decline as we move through 2015. Our energy business continues to be adversely affected by the decline in the price of oil which is caused an industry-wide pull back on spending. We plan to explore complementary opportunities for this group and have added a client partner to grow in two additional account. Likewise our financial services business which is mostly in Europe has been challenged due to weakness of the euro relative to the US dollar. In local currencies this business was growing at 1.9%. Our manufacturing vertical is benefiting from the transfer of the x86 server business to Lenovo and was up significantly over last years second quarter. Looking at our guidance, we anticipate third quarter 2015 revenue to be between $94 million and $96 million, about 2% below last year with one additional billing day in the current quarter. Full year 2015 revenue is expected to be between $378 million and $386 million or 3% lower than 2014 at the mid point of the range, with staffing up 5% and solutions down 16%. Third quarter diluted earnings per share is expected to be between $0.10 and $0.12 per share, 35% below last year and full year earnings per diluted share are expected to be between $0.30 and $0.38 or 47% below 2014 earnings at the mid point of the range. With that, I would like to open the call for questions, if there are any. Operator, can you please manage our question and answer period.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of analyst, Ivan Baranov [ph] with Noble Financial. Please go ahead.

[Unidentified Analyst:]

Hi, good morning. And thank you for taking my questions. Regarding your staffing service initiatives, I know you are evaluating all of your projects there and that will allow some of those to run off or not renew? But should we expect things, some revenue declines coming from that in 2016 or do you expect to replace some of those revenues any thoughts around this would be welcome? Just want to get your sense on how you're looking at that?

[Brendan M. Harrington:]

Yes. We've seen very pretty significant growth at some of our larger customers and as we said, we're taking a look at some of the other pieces of the business that maybe not as profitable. But we would not expect to see a significant impact to our revenue with regard to the evaluation of those account.

[Unidentified Analyst:]

Okay. Fair enough. And then I know you just – Al Hamilton recently joined the company. Can you maybe expand on what he will be looking at? I know you stated that he commenced an in-depth review of the healthcare business. And I know it’s really early since he basically just joined. But are there any timelines on when he should start implementing changes?

[Clifford Bleustein:]

So Al, started last week and Al came with tremendous set of relationships that he has already started to make introductions to our sales team and started to arrange and set out meetings for him to go seek [ph] now only with his relationships, but our clients. At the same time, he is working with the team on evaluating each of their business plans for the coming years and helping them to set milestones for progress. I expect that he will be able to come up with his review or his plan, along with me in the coming months. We have four different major lines of business within our healthcare provider group, including technology, application support, delivery and advisory services. We also have a life sciences practice and a payer who have been - he is going to be evaluating each of those individual aspects for their current situation and how they are going to continue to grow with our investments that we're making in the sale support in the coming months.

[Unidentified Analyst:]

Great. Thank you. And as far as your director search, what sort of expertise are you looking for, anything in particular?

[Brendan M. Harrington:]

We're each tapping into our network to look at the current board and see what gaps we have along different lines. We have evaluated people from different backgrounds, including experiences with international growth strategies, evaluated individuals with significant IT backgrounds, as well as financial backgrounds to start.

[Unidentified Analyst:]

Okay. Great. That’s it from me. Thank you.

[Operator:]

Thank you. [Operator Instructions] We will go to the line of Bill Sutherland [Emerging Growth Equity]. Please state your company.

[William Sutherland:]

Emerging Growth Equity's. Good morning, everybody.

[Brendan M. Harrington:]

Good morning, Bill.

[William Sutherland:]

Hey, Brendan, would you – I know that in terms of your segments the growth mix you - I think staffing growth for the year is now looking more like 5% at the mid-point of your guidance?

[Brendan M. Harrington:]

Correct.

[William Sutherland:]

What are the other – what's healthcare solutions and other solutions, if you are still looking at the – at particularly that way?

[Brendan M. Harrington:]

Yes. For the other solutions as projected they would be down about 5% and healthcare is projected to – so healthcare solutions is projected to be down about 21%.

[William Sutherland:]

Okay. And then I noticed in the release the commentary on the healthcare IT consulting group growing very nicely in the first half. So was – maybe you could just provide a little color on that, I am not sure how big that group is now?

[Clifford Bleustein:]

So we're not giving the breakdown and the size of the individual business units. But what I will say is that as the EMR implementations throughout the United States had tailored off in terms of greater than 97% of the hospitals having an EMR, our group has continued to focus on diversifying their portfolio or services that they are having across the different areas. One of those that we're seeing a significant amount of business up take is technology consulting, which goes anywhere from business intelligence, to data warehousing, to the interoperability of the information security and so forth. These are all areas that continue to drive significant needs in the marketplace and are continuing to expand really on a macro level as well.

[William Sutherland:]

So Cliff this is a – this would be a different professional than the folks you had actually providing an EMR solution. I mean, this sounds more like a deltoid [ph] or here on kind of person am I right, right on that?

[Clifford Bleustein:]

So the skill set of an individual who is implementing an electronic health record is often quite different from an individual who is doing a technology consulting engagement. We had a significant number of individuals who are in the medical products group that had very technical background, but within healthcare as well as under other industries that dealt with data management, warehousing, business intelligence and analytics, integration and normalization of data set. So we already had significant capabilities housed [ph] in our medical products division. We have merged those individuals with our group of technical consultants that has complementary skill sets to those that I just stated, to create a relatively large group of individuals that have deep technical expertise. So I think that it is a higher value skill set in the market place and we're seeing both engagements where individuals are being asked for in more of a staff augmentation capability, as well as in a solution capability. So we're seeing that growth in both areas of the business.

[William Sutherland:]

Okay. Thanks for that. One last one from me. So I look at the verticals, I noticed that healthcare is now at least for the quarter, the third largest vertical for you guys and after tacking [ph] manufacturing. So just wonder if you could comment a little strategically Cliff about what you think about as your vertical focus going forward, I know you are focused on growth, that’s for sure across the board?

[Clifford Bleustein:]

Yes. I mean, I think our business has both services and solution and one of the services that we had is staffing and we're seeing significant growth in that across all of our industries. At the same time, we still believe that energy and healthcare are exciting solutions that have significant opportunity ahead of them. Over the last couple of years within both of those industries the sales force had been cut. And we're in the process of rebuilding those sales individuals to help us continue to push through the solutions that we have that we know are going to do well in the market place. We continue to do well in ratings via external agencies and customers value many of those external agencies as well. So we believe that not only do we have the capabilities internally, but our clients see the value that we provide as well. I think both healthcare, energy are exciting areas that we're going to be able to grow hopefully in both the mid term, as well as into 2016.

[William Sutherland:]

Okay. Thanks, Cliff. Thanks, Brendan.

[Brendan M. Harrington:]

Thanks, Bill.

[Operator:]

Thank you. We have a question from Brian Kinstlinger with Maxim Group. Please go ahead.

[Brian Kinstlinger:]

Great. Thanks for taking my question. Cliff, you mentioned – you had some comments on the medical IT management business. I am wondering if you can outline your evaluation of fraud, waste and abuse application I might have missed it, is there value in the asset, is the sales force actively working on pipeline or should we no longer expect there to be a focus to sell that asset?

[Brendan M. Harrington:]

Yes. Brian, this Brendan. And as you know we wrote that off at the end of 2014 and really the evaluation at that point in time was that it was a fairly crowded space. We were having a lot of difficulty in being able to differentiate our space and to basically try to push out the vendors that a lot of the payers already had in place. They already had a lot of the applications that were - even though we thought ours was more capable in certain areas, it was still situation where it was very difficult to convince the payers that they would benefit from implementing this solution into their system. So it was decided that – we decided at that point in time to really no longer focus on the fraud, waste and abuse application and really are not pursuing opportunity in that space at this point.

[Brian Kinstlinger:]

Okay. And then if I look at that application, medical IT management, is there an opportunity to sell those or did it not seem there was value to sell to any competitors those businesses?

[Clifford Bleustein:]

Yes, I don’t think that there is an opportunity to sell those products to other vendors. I think that the competition has created tools on and we see a challenge in integrating our tool on to theirs. So I think that that would be a very difficult sale cycle or sale overall.

[Brian Kinstlinger:]

Okay. And then can you quantify the amount of underperforming revenue in the staffing side and maybe what the impact of those contracts have to been to the bottom line, so we can kind of mile, if those go away, how that can improve that margin profile?

[Clifford Bleustein:]

Yes. We're not currently reporting what the margins are of any of our contracts. But as contracts continue to come in and as we continue to add new logos and new accounts, we believe that over the long-term margins are going to solely creep up Remember, it doesn’t take much improvement in margins, in the staffing business to have an impact on the bottom line. So we're looking to improve efficiency in small little pieces wherever we can.

[Brian Kinstlinger:]

Okay. And then on the EMR side, did you mention how many projects with revenue is from that and maybe how much of that will come to its natural conclusion by year end?

[Brendan M. Harrington:]

We had eight projects ongoing Brian. That’s unchanged from the previous quarter. And in the second quarter the EMR revenue was $7 million. Overall for the year we're expecting about $26 million of EMR revenue. So it’s down about 38% or so from 2014.

[Brian Kinstlinger:]

And is that suggested at the end of the year, are some of those projects are - of those eight are coming to a natural conclusion or are they going to continue into 2016?

[Brendan M. Harrington:]

There is somewhat, but we would expect that - I mean, there is a bit of a fall off in the second half of the year. So we would expect some of those projects to come to a natural end.

[Brian Kinstlinger:]

Great. Thanks so much.

[Operator:]

Thank you. We have a question from Sirca Sebastian [ph] with B. Riley & Company. Please go ahead.

[Unidentified Analyst:]

Yes. Thanks for taking my question. Will the strategic initiatives that you guys have outlined, do you realize it’s pretty much organically or are there plans to execute some bolt-on acquisition?

[Clifford Bleustein:]

So I think the answer is initially we are looking at organic growth and the initiatives that we are doing to supplement our sales force and our business development activities, as well as adding new individuals to the senior management team, such as Al, obviously those are all organic growth. We always look at acquisitions in terms of opportunities that are out there for growth that way as well. However, we are cautious in terms of those evaluations and those require significant amount off due diligence before we pull the trigger on any form of acquisition.

[Unidentified Analyst:]

That’s certainly helpful. And then as far as the corporate headquarter sale that you guys have mentioned, that put on for the market. I guess from a timetable perspective obviously we won't know how long it takes that, but assuming that you get the $3.95 million with that. What were the plans for the capital, if you can maybe give us some color on that?

[Brendan M. Harrington:]

Well, as I - we outlined, we've basically been taking a look at our use of capital and we're going to make some changes to our financing that we've had through life insurance policies and also with regard to the – a discount that we have with a significant – a payment discount with a significant customer. And you know the other…

[Clifford Bleustein:]

So I think when we look at our capital allocation, we have historically used it for acquisitions, stock buy backs and dividend payment and I think we are going to continue to evaluate all of those options as we move forward. And this is just another piece of the capital that we are trying to free out that we would be able to use more effectively as a company. We're already starting to invest some of the things, some of the capital that we're freeing up from interest payments to fund the investments that we're making in sales and business development.

[Unidentified Analyst:]

That’s certainly helpful. And then I guess just my last one here. Can you help to clarify the technology consulting factors has, recognized [ph] that your current proprietary software product offering?

[Clifford Bleustein:]

I am sorry, could you clarify your question again, I am not sure what you are asking.

[Unidentified Analyst:]

Yes. So if your technology consulting factors that is embedded in the business, if its I guess uses or is currently tied with software offerings that you have today?

[Clifford Bleustein:]

So some of the knowledge that has been gained over the life of the development of the medical products application are clearly applicable on a go forward basis. We still do have some engagement that utilize component pieces of that medical application software. However, those engagements are typically sold as services, as opposed to a licensing fee for an application itself. So the knowledge gained from that is baked into the engagements as part of the services that are being offered.

[Unidentified Analyst:]

All right. That’s certainly helpful. Thank you so much.

[Operator:]

Thank you. We have no further questions. Speakers, please continue.

[Clifford Bleustein:]

So it’s been an interesting and challenging four months from perspective. I firmly believe we've taken steps that will pay off in immediate efficiency and ultimately in growth. However, there is much work to be done to make CTG a stronger and more valuable organization. I look forward to sharing our progress with you when we report third quarter results in October. Thank you for your support and for joining us this morning.

[Operator:]

Thank you. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.