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Executives

Deborah Pawlowski – IR

Jim Boldt - CEO

Brendan Harrington - SVP & CFO

Analysts

William DiTullio – Boenning & Scattergood Inc.

Computer Task Group, Incorporated (CTGX) Q3 2008 Earnings Call Transcript October 22, 2008 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, welcome to the CTG conference call. (Operator instructions) As a reminder, today’s call is being recorded. Starting off, we have Deborah Pawlowski, please go ahead.

Deborah Pawlowski

Thank you Kevin and good morning everyone. We certainly appreciate your time and your interest in CTG. On the call today, we have CTG’s Chief Executive officer, Jim Boldt; and Brendan Harrington, Senior Vice President and Chief Financial Officer. Jim and Brendan are going to review the results for the third quarter of 2008 and update you on the company’s strategy and outlook. We’ll follow with an opportunity for Q&A. If you don’t have the news release discussing our financial results, you can access it at the company’s Web site at www.ctg.com.

Before we begin, I want to mention that statements in the course of this conference call that state the company's or management's intentions, hopes, beliefs, expectations and predictions for the future are forward-looking statements. It is important to note that the company's actual results could differ materially from those projected. Additional information concerning factors that could cause actual results to differ from those in the forward-looking statements is contained in our earnings release, as well as in the company's SEC filings. You can find these at our Web site or at the SEC's Web site www.sec.gov. So please review our forward-looking statements in conjunction with these precautionary factors.

With that, I would like to turn it over to Jim to begin the discussion. Jim?

Jim Boldt

Thanks Debbie and good morning everyone. This is Jim Boldt. I want to thank you for joining us this morning for our third quarter earnings conference call.

As you saw in our earnings release, our revenue in the third quarter of 2008 was at the lower end of guidance while our earnings once again exceeded our guidance. As Brendan will explain further in a minute, revenue was affected by the fluctuations in foreign exchange rates that occurred during the quarter. We are very excited about the fact that increased income primarily from our healthcare solutions business caused our earnings per share to once again more than double when compared to last year.

I’m going to talk more about our business and expectations in a minute but first I’m going to ask Brendan to start us off with a review of our financial results. Brendan?

Brendan Harrington

Thanks Jim. Good morning. For the third quarter of 2008, CTG's revenue was $89.1 million, an increase of $8.5 million or 10.6% compared with the third quarter of 2007. Operating income increased 113% in the third quarter to $3.5 million, largely as a result of the growth in our more profitable solutions offerings and favorable operating leverage. These factors also drove the year-over-year 190-basis point increase in our operating margin to 3.9% of revenue.

Net income in the third quarter increased 128% to $2.1 million from $0.9 million in the third quarter of 2007. Net income per diluted share was $0.13 for the quarter, a 117% increase from last year’s $0.06. Both the 2008 and 2007 third quarter results included equity compensation expense of approximately $0.01 per diluted share net of tax. The third quarter of 2007 results included a $0.01 net of tax charge related to merger evaluation cost incurred in 2007.

Solutions revenue in the third quarter of 2008 was 32% of total revenue or $28.9 million. This represents 4.5% growth in our solutions revenue compared to the third quarter of 2007. We had $28.7 million in revenue from IBM, our largest staffing customer in the quarter compared with $24.2 million in the third quarter of 2007. This represents 32.2% and 30% of total revenue in the 2008 and 2007 third quarters respectively. Total staffing revenue was $60.2 million in the quarter.

Revenue from our European operations was $18.7 million in the third quarter, a 6.5% increase from the $17.5 million recorded in last year's third quarter. Excluding the foreign exchange fluctuations, European revenue in the quarter would have decreased by 1.8% over last year. The strengthening of the US dollar during the 2008 third quarter negatively affected our third quarter revenue by approximately $0.7 million as compared to the revenue guidance we provided for the quarter. The impact of the strengthening dollar in our 2008 revenue guidance is an additional reduction of approximately $2.4 million for the full-year guidance that we provided in our second quarter earnings release. This change is reflected in our updated 2008 revenue guidance of $356 million to $358 million, a 9.4% to 10% increase over 2007 revenue.

Direct costs as a percentage of revenue were 78% in the third quarter compared with 77.3% in the third quarter of 2007 and 77% in the second quarter of 2008. The tax rate for the 2008 third quarter was approximately 39% compared with 38% last year. The expected tax rate for the full year 2008 is between 42% and 44% compared with 38% in 2007.

The company had 3,500 employees at the end of the third quarter of 2008 of which approximately 89% are billable resources. On the balance sheet, our days sales outstanding was 56 days compared with 60 days at the end of the third quarter 2007 and was 59 days at the end of the second quarter 2008.

Our cash flow from operations in the third quarter was approximately $12 million as compared to $9.4 million in the third quarter of 2007. We had $762,000 in capital expenditures and recorded depreciation expense of $508,000 in the quarter. At the end of the quarter, we had no debt outstanding on our $35 million revolving credit agreement that is in place through April 2011.

During the third quarter of 2008, while adhering to SEC-imposed volume limitations, we repurchased 176,000 shares of CTG common stock. The repurchases in the quarter were made at an average price of $5.92 per share. During this most recent self-imposed blackout period prior to releasing earnings, we repurchased shares under our 10b5-1 plan. We intend to continue our repurchase program through the remainder of 2008. Jim?

Jim Boldt

Thanks Brendan. The primary driver of the significant increase in our profitability in the third quarter was our solutions business. There is no doubt that we are realizing the benefits from the investments that we made in our solutions business over the last few years, particularly in the healthcare market. Our healthcare revenue increased by 9% during the third quarter. Our new healthcare offerings are yielding a much higher operating profit than our average solutions business. This higher operating margin on the new healthcare offerings is one of the main drivers in the 190-basis point improvement in our aggregate operating margin during the third quarter. As you know, for the last two years, we have been working on new healthcare offerings such as our offering for fraud, waste, and abuse and expect several new offerings go commercial in the next three to nine months.

Our staffing business increased 13.7% in the third quarter of 2008 well in excess of the IT staffing industry. As we indicated in our third quarter release, we were informed just last week by a significant customer of an immediate reduction in their need of approximately 250 CTG billable staff. In the staffing side our business, the reality is the customers often choose us for our ability to quickly increase and decrease technical staff. While this reduction equates to approximately $21 million of revenue on an annualized basis, going forward we expect to offset its impact on earnings through an increased level of higher margin solutions business.

As for our fourth quarter of 2008, we are forecasting revenue in the range of $86 million to $88 million, 2% to 4% higher than last year’s fourth quarter. Given the revenue forecast, we are forecasting earnings per share in the fourth quarter of 2008 to be in the range of $0.10 to $0.12 per diluted share, 43% to 71% above the fourth quarter of 2007. For the year, we currently believe that CTG’s 2008 revenue will be in the range of $356 million to $358 million, 9% to 10% above 2007. We expect the net income per diluted share in 2008 will be in the range of $0.45 to $0.47, 80% to 88% above last year.

To sum it up, our third quarter earnings performance was significantly better than we had forecasted while being realistic about current conditions in the financial markets in the economy, we believe that our solutions business will continue to advance as additional projects already in our pipeline ramp up and as we continue to introduce new and more profitable solutions offering. These offerings are primarily in our healthcare vertical where we are developing innovative solutions to improve patient care in a lower cost with technology. The bottom line is that despite a weaker economy and the recent adjustment in a significant customer staffing needs, we believe that CTG remains on track to have a very good year in 2008. Even more importantly, as we look beyond 2008, we see further opportunities to enhance our business mix as CTG capitalizes on its strong position and excellent traction in the growing healthcare industry.

With that, I lift open the call for questions if there are any. Operator, would you please manage our question-and-answer period.

Question-and-Answer Session

Operator

Absolutely. (Operator instructions) our first question is the line of William DiTullio. Please state your company name sir.

William DiTullio – Boenning & Scattergood Inc

Yes, good morning. Bill DiTullio from Boenning & Scattergood. Thank you for taking my call guys. First question I have is can you give us just an idea what the size of the IBM contract will be in Q4 as a percentage of revenues?

Brendan Harrington

As a percent of revenue, probably in the fourth quarter will be about 28%.

William DiTullio – Boenning & Scattergood Inc

28%, okay. What do you expect operating margins to be in Q4?

Brendan Harrington

At the midpoint of our guidance, we would expect about a 3.8% operating margin in the fourth quarter.

William DiTullio – Boenning & Scattergood Inc

Could you give us a little more color on the new initiatives that you are working on within occlusions vertical that will help improve the margins.

Brendan Harrington

Certainly. At the beginning of 2008, we really had six new offerings that were in process, five of those were in the healthcare area, and the one that wasn’t was a voice recognition system that is used in warehouses. It is an excellent system we believe based upon the installs that we have done and we have installed it now in over 100 warehouses, it has a payback of less than one year. It is not only very efficient but it also works in areas where the ambient noise is very high which is important in a warehouse environment. The second offering was for Facets, Facets is a software product made by a company called TriZetto. Many health insurance companies in the United States use it. It is particularly good at the automatic adjudication of claims. We have a group of people who go in and tweak the system to get a higher auto adjudication of claims. We also do testing around version upgrades when you are doing upgrade for Facets it is a lengthy process and very expensive and you need to do a lot of testing. The third was electronic medical records for RHIOs, the Regional Health Information Organization. We are working with one of the RHIOs in New York State in installing community-wide electronic medical record system. We actually believe that working with this RHIO that they are further ahead than any of the RHIOs really on getting medical record system up and running. The fourth that we’ve talked about that is in commercial yet is for fraud, waste, and abuse, it is an ontology which is an IT system that uses an expert language to pull data from various data bases to get much better information. We are working with the payer, we are actually expecting to get their claims data this week and we expect that we will do a (inaudible) in the fourth quarter to verify how much additional frauds, waste, and abuse claims that it identifies above what they have already identified themselves and then we think that we will go commercial with it probably in the first quarter of 2009. Then we have two other offerings we haven’t disclosed them yet that’s really for competitive reasons. They are both in the healthcare area and we expect them to go commercial in the first six months of next year and one of them truly is by one of the medics that it is the best and no one has ever done even one of them. One of them particularly will affect the way patients are cared for.

William DiTullio – Boenning & Scattergood Inc

Great. On the topic of tax rate, do you foresee the 2009 tax rate being in kind of where you are saying it is going to be for the rest of this year, for the full year between the 42% and 44% range, Brendan?

Brendan Harrington

It will probably be closer to 40%, probably in the 40% to 42% range for 2009.

William DiTullio – Boenning & Scattergood Inc

The last question here, assuming that currency rates stay about the same what they are right now, what do you see the impact in Q4 as far as FX impact, currency exchange impact?

Brendan Harrington

In the top line, I think we disclosed in the release that it was about $2.4 million in revenue. The rate that we used when we did the guidance in July was 1.56% [ph] I believe and we are currently using 1.39, so it costs $1.39 incurred by euro. So, it dropped right at 11%. In the fourth quarter of the year, it is actually the European group’s best quarter and as the consequence to that we lost $0.01 per share actually because of the exchange rate change from our guidance that we issued in July.

William DiTullio – Boenning & Scattergood Inc

Great got you. Those are all of my questions. Thank you very much.

Operator

(Operator instructions) Okay, at this time, we have no further questions in queue.

Jim Boldt

Okay, in closing then I would like to repeat that our strategy is to continue to increase CTG’s solutions business particularly in our healthcare vertical while being opportunistic in growing our staffing business. As the solutions part of our business grows, we look forward to further earnings growth and margin expansion. I would like to thank you for your continued support and for joining us this morning. Have a great day.

Operator

Ladies and gentlemen, that does conclude your conference with you. Thank you for joining us. You may now disconnect.

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