Computer Task Group, Incorporated
Q3 2015 Earnings Call Transcript

Published: 27 Oct 2015

[Operator:]

Ladies and gentlemen, thank you standing by. Welcome to the CTG Third Quarter 2015 Earnings Call. During today's conference all participants will be in a listen-only mode. Later, we will conduct a question-and-answer session instructions will be given at that time. [Operator Instructions] I would now like to turn the conference over to our host Director of Investor Relations, Jim Culligan. Please go ahead.

[James M. Culligan:]

Thank you, Shannon, and good morning everyone. We have CTG’s Chief Executive Officer, Cliff Bleustein, and Brendan Harrington, Senior Vice President and Chief Financial Officer on the call today. Cliff will open the call with an overview of our business during the quarter and Brendan will follow with a detail review of our financial results for the third quarter of 2015. We will then open the call for questions. If you don’t have a copy of the earnings results press release distributed early this morning, you can access it in the Investor section of the company’s website at www.ctg.com. 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 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 the 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 cautionary factors. I will now turn the call over to Cliff to begin the discussion.

[Clifford Bleustein:]

Thank you, Jim. And good morning, everyone. Today I will provide a brief overview of our financial results in the quarter, followed by a discussion of our business initiatives and updates on both our staffing and solutions businesses. Quarterly revenue was $93.1 million, slightly below our original guidance range of $94 million to $96 million, driven by an unexpected reduction in headcount at a large staffing customer. Despite the lower revenue, we were able to generate earnings per share of $0.13 per share exceeding the high end of our earnings guidance of $0.10 to $0.12 per share. Perhaps most importantly, the improvements in profitability reflects the meaningful progress we made on a number of our business initiatives during the quarter, including efforts to drive cost efficiencies and capital improvements, that are funding our investments in future growth. Although further improvement in profitability will not be linear due to fluctuations in revenue and the initial costs associated with these investments over the next several quarters, I believe we have identified a realistic path towards repositioning CTG for success in the future. Now let me address each of our business lines in more detail, beginning with our staffing business. Staffing revenue was essentially flat sequentially. We anticipate the revenue would increase during third quarter, but a weaker economic environment impacted our clients more than expected, which resulted in the headcount reductions that I mentioned previously. We were largely able to mitigate this pressure by closely aligning services with our direct customers and their customers, combined with multiple smaller wins at other accounts. More specifically, we were able to increase staffing revenue at a number of large technology manufacturing clients during the quarter and we also won a number of new customer accounts as we seek to diversify our staffing business. This is consistent with our objective to not only expand our staffing business across industry verticals, but also within additional division at existing customers. We are pleased to see these positive developments. But it’s important to note, that new accounts typically start as smaller engagements and they grow over time. We also continued to strengthen the depth and breadth of our sales organization by hiring a new managing director and transitioning three account directors to account executive roles. We have continued a diligent search for a vice president position to lead and drive the business. Year to date, we now have increased recruiter headcount by 33% which is inline with our previously stated goals of 35% for the year. Specific to Europe, the headcount adjustments we made earlier this year to become cost efficient and growth focused have already generated an increase in our European sales pipeline. Further supporting this initial progress, we hired more recruiters in Europe and are adding a technical writer to increase our RFP capabilities. And finally, we are also interviewing for five additional sales positions to further expand our growth capabilities in Europe. Last quarter I also referenced several initiatives aimed at making our internal themes more effective and originating sales within our existing customer base, such as cross selling our platforms to maximize client and geographic coverage. These efforts primarily consist of increasing the knowledge that each of the team members had about CTG's other business units, so that they can identify and source new opportunities within the current client base. One great example of this, we recently secured contract with the top national hospital site where our staffing and our solutions team worked jointly to close the opportunity. This is a highly effective strategy and I ultimately want this packet to become intuitive throughout our organization. Let me now transition to our solutions business, starting with healthcare. We continue to experience the anticipated trail-off of EMR business, and expect this strength to continue as the industry shifts its focus from new EMR implementations to conversion and optimization solutions. Despite these evolving trends, earlier this year we begin realigning our healthcare solutions and resources by investing in technology services, application support, delivery, population health initiatives, off shore provider partnerships and advisory capabilities. As part of this initiative, we brought Al Hamilton on board in July to conduct a full review of the business and manage the transition process. Al has completed the review and begun to leverage his network of context to open doors for CTG, simultaneously realigning our solutions unit to focus on new and emerging opportunities. We are also in a process of interviewing and hiring additional healthcare sales professionals to increase our market reach and assist in selling more diversified solution set as part of these efforts. Similarly, I should mention that we are seeing good initial progress from the renewed focus on sales within our energy vertical which is almost [ph] exclusively solutions business. We recently hired a new sales professional for this market and the activity and pipeline development over the first six weeks has been encouraging. Even as lower oil prices have reduced spending we believe a dedicated focus on delivering differentiated best practice solutions will enable CTG to be successful in this market, as well as in our other market verticals. In addition to the significant increase in our focus on sales process staffing teams and realigning our healthcare solutions business, we've also completed extensive changes in our capital structure. These improvements include paying down loans against cash value of life insurance policies on former CTG officers, using a combination of cash on hand and lower cost bank debt, as well as ending an early customer payment program for which we are paying a fee. Never the changes, we improved our cost of capital by approximately $0.04 annually. More importantly the cost savings from these more efficient capital strategies enable further investment in growth initiatives, including the staffing and solution efforts outline on this call. Also noteworthy, we continue to evaluate our capital allocation priorities, which could include opportunistic strategic investments in organic growth, as well as potentially considering smaller tuck-in acquisitions that could accelerate the achievement of our longer term growth aspiration. In summary, we expect to face continued headwinds [ph] for the next few quarters, including a challenging macro environment for customers and the transition of healthcare - of our healthcare business in response to the trail-off of legacy EMR implementation. The investments we are making in leadership, sales and technology services will take time to implement and yield material results, but I strongly believe that successful execution on our initiatives will create a business with a more diverse revenue, improved profitability and broader growth opportunities in the future. With that, I will turn the call over to Brendan to discuss our financial results in more detail. Brendan?

[Brendan M. Harrington:]

Thanks, Cliff. Good morning, everyone. As we indicated in this mornings news release, revenue was $93.1 million compared with $94.7 million in the second quarter and $96.8 million in the third quarter last year. The year-over-year revenue decline reflects lower revenue from EMR solution and $3.1 million in negative currency fluctuations due to the weaker euro. We had 64 billing days in the 2015 third quarter versus 63 days in the year ago quarter. Staffing revenue grew by $1.5 million or 2.4% year-over-year and revenues from our solutions business declined by $5.2 million or 14.7%, primarily in our healthcare business. Revenue from IBM was $26.3 million or 28.3% of revenue, compared with $25.1 million or 26% of revenue in last year's third quarter. Revenue from Lenovo was $10.5 million or 11.3% of revenue, compared with $8.2 million or 8.5% of revenue in last years third quarter. The increase in revenue from both IBM and Lenovo was primarily due to higher demand in the technology services and manufacturing verticals. Direct costs, as a percentage of revenue were 81.2% in the third quarter, compared with 83.5% in the 2015 second quarter, and 80.3% of revenue in the 2014 third quarter. The sequential decrease in Q3, 2015 is primarily due to the charges related to the European workforce realignment and the write-off of capitalized cost for medical management software incurred earlier this year. SG&A expenses were 15% of revenue in the third quarter, compared with 15.3% of revenue in the second quarter, and 15% of revenue in the year ago quarter. The effective tax rate for third quarter was 41.5%, compared with 48.4% in the second quarter and 39.9% in last years third quarter. The abnormally high tax rate in the trailing quarter was due to lower pretax income and the lack of a tax deduction in UK related to certain cost in the second quarter. We anticipate our annual effective tax rate to be approximately 41% to 43%. Net income in the 2015 third quarter was $2.1 million, or $0.13 per diluted share, compared with 554,000 or $0.03 per dilutes share last quarter and compared with $2.7 million or $0.17 per diluted share in a year ago quarter. 2015 second quarter net income reflects $0.08 per share in charges related to our European workforce realignment and write-off the medical management software. The 2015 third quarter results include equity compensation expense of approximately $0.01 per diluted share net of tax. Our headcount at the end of the 2015 third quarter was 2700 [ph] compared with 3800 at the end of the prior quarter and 3900 at the end of the third quarter 2014. The decrease in headcount from the prior quarter primarily relates to macro economic pressures affecting a large customer which we were partially able to mitigate, approximately 92% of our third quarter employees were billable resources. Our cash used in operations in the 2015 third quarter was $1.7 million, compared with second quarter of cash generated of approximately $2.2 million and cash used in operations of $2.4 million in the 2014 third quarter. We repurchased 78,000 shares of CTG common stock at an average price of $7.24 per share in the third quarter, compared with 6000 shares of common stock during the 2015 third quarter – sorry, second quarter. Our repurchased authorization totaled approximately 455,000 shares. I'd like now highlight the recent changes in our balance sheet. Our cash balance at the end of the third quarter was $20.9 million compared with of second quarter 2015 balance of $31.4 million. The decline in cash reflects a number of changes in our asset structure, including paying down $17.5 million in outstanding loans against company owned life insurance policy, in part with cash and in part with $10 million of more favorably priced bank debt. We also terminated an early paid program with a large customer, resulting in an associated increase in accounts receivables to $75 million at the end of the third quarter from $63.5 million at the end of the second quarter. Day’s sales outstanding also increased as a result of this change to 73 days as of the third quarter from 61 days at the end of the second quarter. After these changes, the cash surrender value on the balance sheet for these life insurance policies is approximately $29 million. The debt benefit on these policies is approximately $40 million as of October 2, 2015. The net savings on an annualized basis from our balance sheet restructuring is approximately $0.04 per diluted share. As Cliff, previously mentioned, we are using the savings generated from these changes to fund additional business development and recruiting investment to drive growth in both our staffing and solutions businesses. Turning to our guidance, we anticipate fourth quarter 2015 revenue to be between $87 million and $89million, with 62 billing days in the quarter. Full year 2015 revenue is expected to be between $373 million and $375 million or approximately 4.9% below full year 2014 revenue at the mid point of the range, with staffing up 3% and solutions down 24%. Full year revenue expectations include approximately $12 million of negative currency adjustment. Fourth quarter diluted earnings per share is expected to be between $0.11 and $0.13 per share. Full year net income is expected to be between $0.35 and $0.37 per diluted share and includes $0.08 in charges associated with our European workforce reduction and the write-down of medical management tools undertaken earlier in 2015. With that, we'd like to open the call for questions. Operator, can you please manage our question-and-answer session.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Bill Sutherland with Emerging Growth Equity. Please proceed with your question.

[William Sutherland:]

Thanks very much. Good morning. Cliff, I was curious if you could give us a little color on your – you were going to let some lower margin contracts run off in the prior quarter. Just kind of - if you could discuss maybe the net impact that you saw in your overall growth as a function of that?

[Brendan M. Harrington:]

Yes. Bill, this Brendan. I'll just say the tail-off in any lower margin contract had a minimal impact in Q3. We'll continue to review the low – any lower margin contract that we have. But the expected impact on these – from these contracts, we don’t expect will be significant.

[William Sutherland:]

Okay. The – which vertical market the large customer that you referenced that had a reduced requirement in the quarter, what vertical is that?

[Clifford Bleustein:]

In the technology.

[William Sutherland:]

Okay. I was just confused, because both of the two biggest customers were up?

[Brendan M. Harrington:]

Yes, actually that was in the manufacturing vertical, Bill.

[William Sutherland:]

The decline?

[Brendan M. Harrington:]

Correct, yes. The softness from that one particular…

[William Sutherland:]

So its not – this is not of your two biggest?

[Brendan M. Harrington:]

Yes, actually it is. Its - yes, the second customer and I'll just give you the revenue numbers for Lenovo, we had - it was $10.5 million in the third quarter of revenue, that was up from $8.2 million last year, but it was down sequentially from a $11.4 million in that…

[William Sutherland:]

Okay. That makes sense. The – I was curious that – if we could get a little more color Cliff on some of the realignment that you are making in healthcare, as far as where you're kind of placing your bats with new sales and business development?

[Clifford Bleustein:]

So we are already - have solutions that we've been bringing to market across applications or across partial IT outsourcing, technology support, advisory capabilities and many of those - as well as delivering, many of the advisory capabilities that we continue to grow and enhance are those that are going to be catering towards population health and population management and security services, as we are seeing an increase in demand for these types of services. These are also being funded on a state level through grants, designs to try and improve the overall cost structures by managing populations of the individuals more tightly.

[William Sutherland:]

Okay. And in Europe, if you could – you've done quite a bit there, maybe just little more color on the vertical focus or anything else that perhaps we don’t know about that effort over there?

[Clifford Bleustein:]

In Europe, the capabilities within IT solutions and services is a much broader capability that goes across industries. So when you look at Europe as a whole, their is skill sets expand multiple industries and the services that are provided are very similar, whether there are call centers or testing capabilities or other aspects of solution development. So they play within not only the European Union, and contracts related to that, but also finance, government, life sciences, healthcare and other industries. So that the support of those is a broader basement, you typically see in the United States. And as such the sales capabilities that we're building and growing there in the RFP capabilities that we continue to enhance, our design across industries to support the solution focuses that we have.

[William Sutherland:]

Okay. Thanks for that. And then Brendan I just didn’t – I couldn’t quite catch the expected growth by staffing and solutions in quarter four?

[Brendan M. Harrington:]

Well, full year is 3% growth we're anticipating for staffing and 24% decline in solutions.

[William Sutherland:]

Okay.

[Brendan M. Harrington:]

For the fourth quarter, we're expecting staffing to be down about 4% and total - sorry, total solution is down about 20%.

[William Sutherland:]

Okay. Okay. Thanks very much.

[Operator:]

The next question is coming from the line of Sarkis Sherbetchyan with B. Riley & Company. Please proceed with your question.

[Sarkis Sherbetchyan:]

Yes, thank you. So first on the healthcare side of the business. Can you talk about the business opportunities you are seeing around ICD-10?

[Clifford Bleustein:]

ICD-10 is we implemented relatively slowly on that organizations that haven’t already done it already with the passing of October of maintaining ICD-10. We're just seeing really a maintenance in terms of the amount of ICD-10 work that we're seeing. It doesn’t seem to be growing, it doesn’t really seem to be declining yet. I think most organizations really have until October of next year to be fully implemented into ICD-10. So I think they are going to continue to see maintenance work in that area. But I don’t think that, that would be growth area by any stretch of the imagination.

[Sarkis Sherbetchyan:]

Okay. That’s helpful. And then with respect to the sales capacity additions, where are you with sales reps sitting on the healthcare side of business and where do you get to in the next few quarters?

[Clifford Bleustein:]

So as I said for dedicated healthcare solution sales people, we are currently looking for a total 4 before the end of the year. We already have one accepted offer of a sales person who is going to be starting in November and we have several individuals in the pipeline right now and we're optimistic that we'll be able to bring them on before the end of the year.

[Sarkis Sherbetchyan:]

Thanks for that. And then with respect to the increase in recruiters on the staffing side, what kind of growth do you expect to generate on that side of the business next year?

[Clifford Bleustein:]

We're not giving guidance yet at this time for next year.

[Sarkis Sherbetchyan:]

Yes, that’s all the questions I have today. Thank you.

[Operator:]

[Operator Instructions] Our next question comes from the line of Gregory Macosko with Montrose Advisors. Please proceed with your question.

[Gregory Macosko:]

Yes. Thank you. Just to - a question regarding the cut backs in the like, with regard to those reductions, have you lost any specific customer as a result or is it cut backs just across the board and the customers will remain in place?

[Clifford Bleustein:]

The customers have remained in place and we continue to grow our business in other areas at that client. So we haven’t lost the client. It’s a solid client that has year-over-year growth. But quarter-over-quarter there was a decrease in one of the business units that isn’t performing as well, as that client as expected.

[Gregory Macosko:]

I see. Okay. And then with regard to the 73 days of accounts receivable, is that a normal level, what is the normal level kind of that you expect on an ongoing basis with the adjustments that you've made regarding the balance sheet and restructuring?

[Brendan M. Harrington:]

Yes. The increase in the third quarter related to us going away from the payment discount with those are large clients, was about 12 days. And so 73 days roughly the low to mid 70s will be about what I would expect for DSO on a go forward basis. That’s in a range of what would be normalized for us.

[Gregory Macosko:]

I see. And then on the last quarter call you mentioned selling the building or putting it up for sale, how is that gone and could you give us some color on that?

[Brendan M. Harrington:]

Sure. We've had interest in the building, as well as several offers. At the present time we don’t have an accepted offer. I think that there maybe challenges, you know, it’s a unique historic building that’s going to require very specific buyer. And there is an additional challenge that there is school next door and a temple across the street. So - and may make it challenge for potential buyer in terms of changes deserving [ph] requirements. So we're going to continue to pursue that and see what happens. But there continues to be interest and we'll see what happens in the coming months.

[Gregory Macosko:]

Okay. And then my last question if you will. You mentioned that you did well with cross selling and could you - is there anything driving that, is there a particular incentive that you put in place and can we expect to see that kind of cross selling increase as we look forward?

[Brendan M. Harrington:]

Yes. The goal certainly is to do additional cross selling. In the past each of the business units had operated really in their own little silos to some extent, without as much cross pollination as we had hoped. On a go forward basis, we are encouraging greater collaboration across the different industries and across the different types of businesses of staffing and solutions to improve peoples understanding of what one CTG can offer to our clients and improve the penetration into clients, as staffing typically operates at different levels than our solutions businesses. So that it allow us to enter into clients at multiple different touch points.

[Gregory Macosko:]

Was Al Hamilton behind that?

[Brendan M. Harrington:]

We had started that prior to Al's coming on board. But Al certainly is a large supporter of continuing to drive a one CTG [ph] of solution to all of our customers.

[Gregory Macosko:]

Thank you.

[Operator:]

[Operator Instructions] I am sorry there are no further questions in queue. Please continue.

[Clifford Bleustein:]

Okay. Thank you. This is Cliff Bleustein. Thank you everyone for joining us today. We remain focused on our efforts to improve the fundamentals of our business, both in terms of cost efficiencies and market position. We do not expect progress to be linear, as we are navigating both external pressures on our customers, while simultaneously making investments in sales, marketing and technology services to drive future revenue growth. However, ultimately we believe these efforts will create a more diverse, sustainable and profitable business for both shareholders and employees. We look forward to updating you on our continued progress on our next quarterly conference call.

[James M. Culligan:]

Shannon?

[Operator:]

Yes. Sir, I am here.

[James M. Culligan:]

There is somebody in the queue. Could you take this one?

[Operator:]

Yes, one moment please.

[James M. Culligan:]

Thank you.

[Operator:]

You're welcome. And the next question – we have a question from the line of Juan Bejarano [ph] from Noble Financial. Please proceed with your question.

[Unidentified Analyst:]

Hi, good morning. And thank you for taking my questions. Just wanted to kind of follow up on the hiring of new sales guys. Can you maybe just talk a little bit about, like once you hire someone how long do you expect that sales person to ramp up, maybe the average time it takes them to build a pipeline and then are there revenue targets that you have each sales person?

[Clifford Bleustein:]

We do have revenue targets. We don’t publish what those are. At the current time it you look at the industry for a services sales person within healthcare, depending upon their non-compete and depending upon the geographic market that they are in, ramp up time can take anywhere between 3 to 6 months for them to start developing a type line, with an expectation that they start closing smaller deals within the nine month period and than larger deals by the end of the year, which is the normal ramp up of a sales person.

[Unidentified Analyst:]

Got it. Okay. That’s helpful. And Brendan, can you just repeat the IBM revenue, I missed that, year-over-year and sequentially?

[Brendan M. Harrington:]

Yes, IBM, we're $26.3 million of revenue, in Q3 it was $25.1 million in last years third quarter and it was $25 million flat in Q2.

[Unidentified Analyst:]

Okay. All right. Perfect. Thank you. That’s it from me.

[Brendan M. Harrington:]

Thanks.

[Operator:]

There are no further questions, please continue.

[Clifford Bleustein:]

All right, thank you everyone for joining us today.

[Operator:]

Ladies and gentlemen, this conference will be available for playback beginning today at 10