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Executives

James Boldt – Chairman and CEO

Computer Task Group, Incorporated (CTGX) Wall Street Analyst Forum's 20th Annual Institutional Investor Conference Transcript March 26, 2009 9:10 AM ET

Unidentified Participant

Good morning ladies and gentlemen. In our ongoing attempt to adhere to the published schedule, I like to introduce the next company in this morning's program, we are pleased to have with us Computer Task Group. They have presented for the – a couple of times, and now we've been doing this for 20 years not all of a sudden. In some cases the company has presented with us 2 or 3 times in the past, and the management might not even be aware of it, because we did it maybe in ’87, in 2004 or in 2005 et cetera.

So in any case, Computer Task Group has presented maybe three times over the years with us. They provide IT solutions and services to Global 2000 clients. They focus on their core businesses, and use IT as a competitive advantage to excel in their markets. CTG combines in-depth understanding of their clients’ businesses with a full range of integrated services, and proprietary ISO 9001:2000 certified services methodologies.

There are 3500 IT professionals based on an international network of offices in North America and Europe, and have a proven track record of delivering high-value industry specific solutions.

Without any further introduction, I would like to introduce James Boldt, Chairman and Chief Executive Officer. He is accompanied by Brendan Harrington, Senior Vice President of Finance and Chief Financial Officer.

James Boldt

Good morning. Brendan and I are pleased to be here this morning to talk a little bit about our company. I think everybody has seen our forward-looking statement disclaimer. Little background on CTG, if you're not familiar with the firm, we're a $353 million international IT solutions and services firm. We have 30 offices spread across the US and Western Europe. Last year 22% of our total revenue came from Western Europe.

We have about 3100 employees and market cap is around $60 million. We have 18 million shares outstanding. While the serve a lot of constituents, most of our revenues actually come from the Fortune 1000. We have strong customer satisfaction and a number of years ago we decided to direct most of our investment dollars into our healthcare vertical. I'm going to talk quite a bit about this as I go through the presentation.

In 2001, we realized that the technology industry was a maturing industry. It is now mature. It is going to grow faster than the GDP, but it is not going to grow at a 20% or 30% rate that it did when it was a growth industry, and in a maturing industry, we believed we had to be more focused. We decided to focus on three industries or vertical markets. Those were the technology service providers. The three largest in the world are IBM, HP and Fujitsu. Healthcare, which by far is our fastest-growing vertical market, and the financial services? And then I will talk about some of our offerings in some of those verticals.

The pie chart on the right side shows our offerings at the very highest level. At the highest level, we have only to offerings. It is IT staffing and IT solutions. In an IT staffing engagement, we will provide a technical employee, usually a program [ph] at one of our clients. While they are employees, I will take their technical direction on a daily basis from one of our clients’ project managers.

In a solutions engagement, we take responsibility for something inside of our clients’ IT department. It could be the implementation and integration of a new software package. It could be high-end consulting. It could be lots of different things. But at the end of the day, we are responsible for something.

Historically, our company has been 50% staffing and 50% solutions. After the Y2K work ended in 2000, the industry went through a prolonged period, where it was relatively flat. In 2004, the staffing business started to come back. The solutions business didn’t start to come back until 2007. As a consequence of that, we went through a period where our staffing business was growing, and our solutions business wasn't.

Two years ago, our staffing business where they were 72% of our total mix and solutions 28%. Since then solutions have grown faster than staffing. In the fourth quarter of the year, our mix was 64% staffing and 36% solutions, and having the solutions business grow faster than the staffing business is very good for us, because the two sides of the business have very different operating margins. The aggregate operating margin on the staffing side of the business was 3%, on the solutions side of the business it is 10%.

I'm going to talk more about that as I go through the presentation. Taking a look first at our healthcare business. We segment our healthcare business into three component parts, providers, which for us are large hospitals and hospital chains; payers, those are the 240 health insurance companies in the United States; and life sciences, which for us is primarily large pharmaceutical companies.

In 2001 when we were deciding that we focus our whole company on three verticals, obviously, we wanted to pick verticals that are going to grow faster than the GDP. We looked at healthcare and it was a no-brainer. So as the world's population is aging at a rapid rate. As people get older, they spend more on healthcare. So the healthcare industry is going to have more to spend on IT services.

It is estimated in the United States in 2006, 2007 rather, the US spent $2.2 trillion on healthcare. It was 16% of the GDP. It is going to grow at at least twice the rate of inflation going forward. That means by 2015 the US will spend $4.3 trillion on healthcare, every 20% of the GDP.

And I've read articles that speculate as the baby boomers get older, as they get into their 70s and 80s, the US may have to spend between a third and 40% of the GDP just on healthcare. So there is no doubt about it. It is by far the world's fastest-growing major industry. The other reason that we picked it was due to regulatory compliance, offering we can meet the new regulation through the use of IT.

Taking a look first at the healthcare provider market or the hospitals, what are some of the growth drivers, well an adequate medical records system. US Federal Government estimates that 80% of all doctors do maintain their medical records in paper form. Cost control and efficiency initiatives, it is estimated that one-third of the cost of healthcare in the United States is spent on administration. It is much higher than any of the major industry. It is because the healthcare industry underspent on IT for literally decades.

In hospital mergers and consolidations, most hospitals operate between 30 and 50 different software packages in their IT environment. If you merge 10 of them together, you literally have hundreds of different software packages, far too many to operate on an ongoing basis.

What are some of CTG’s solutions? We have a group of people who are experts on all software that is used in hospitals today. We generally go in and help a hospital first to select a software package. We really don't care whether they pick Epic [ph], or Sonor [ph] or Siemens, MEDITECH, IDX. We have people that are experts in all of those software packages.

Generally, we will stay after that and we will help them do the package implementation. Whenever you put a new software package into a hospital or do a major version upgrade, you will have to reintegrate that package with all the other packages that operate in the hospital environment, and that is really where our people have their expertise.

A growing part of our businesses has been in electronic medical records. These are installing the modules of the software packages that I mentioned, Epic and Sonor for instance, in hospital environments. Our electronic medical record business was 1% of our total revenues in 2005. By 2007 it was 5% of our total revenues. Last year it grew by more than 50% to 7% of our total revenues. We believe that that business will grow even faster going forward because of the money in the stimulus package for electronic medical records, and I will talk about that in a little bit more detail in a minute.

One of the ways that we go to market in the hospital space is through our quality, and the hospitals have a rating system that is called class enterprises. If you went to the class enterprises ratings for last year, and wanted to pick up the IT services companies that had a full package of all services, and wanted to pick the one with the best quality, you will discover that CTG was tied with one of our competitors for the number one slot.

Taking a look at the payer market and some of the growth drivers, one is cost reduction initiatives for insurers. We have a medical plan in every year we go to our provider, and ask them to help us try and mitigate some of our ever rising healthcare costs. Also, the industry consolidation, the Blue Cross and Blue Shields are (inaudible) in buying each other up. Health insurance IT environments are very complex. Merging two of them together is a big deal. It takes a lot of time and a lot of money to do it.

What are some of CTG's solutions, for a number of years we have been working on RHIO development and integration projects, RHIO stands for Regional Health Information Organization. The payers and providers realized a number of years ago that neither one of them could effectively put up a communitywide application. And this really was needed to drive healthcare costs down. So they have formed the RHIOs. It has been funded by the states’ payers and providers.

For the last couple of years, we have been working on things for them like electronic prescription application. In an electronic prescription application, a physician will enter the prescription either using a PC or pamphlet [ph] device. The savings that as soon as these enter the prescription, it immediately goes to a server. If he enters a prescription for a brand-name, and there is a generic offset, the server will immediately ping him back, and ask him if the generic is acceptable.

If you talk to most physicians and ask them, why they write prescriptions for brand names, they will tell you it is not because they don’t think the generics work. It is because for almost 20 years there was only the brand-name on the market. When they think of a medical problem, they immediately think of a brand-name. If the physician hits yes, then obviously the generic is transmitted to the pharmacy. If he hits now, then the brand-name is transmitted to the pharmacy.

For a medium-size city, a city with 1 million population, for every 1% you can switch from a brand-name to a generic, it saves the community about $8 million a year in medical costs, and it is not unreasonable to think that you can switch 20% or 30% to generics. Starting last April, we began to work on communitywide electronic medical record applications, particularly in New York State. Last April, the New York State granted $100 million to the 12 RHIOs in New York to start their electronic medical record projects.

These are relatively large projects. Even for a medium-sized city, it is probably going to cost $50 million to $60 million to put up the application. But just in the elimination of duplicate testing, the applications will more than pay for themselves. So in regional electronic medical records there was one new offering that we had in 2008. The other was a facet [ph] offering, facets of an ERP system that is used by most health insurance companies, and they use it because it is particularly good at the automatic adjudication of claims.

Most health insurance companies need at least 80% of all claims to be paid automatically, without human intervention and facets are particularly good at that. We have a group of people, who go around and basically tweak the facet systems to get higher auto adjudication of claims, and also to help with version upgrades.

Taking a look at life sciences, we picked it for the same reason as it relates to healthcare, as the population gets older, they are going to take more medicine. Therefore, the large pharmaceutical companies are going to have a bigger percentage of the GDP going forward. One of the areas that they spend a lot of money on is new drug development, and they've got a lot of regulatory compliance issues.

One of our solutions is in the testing and validation area. There is an FDA requirement that every time a pharmaceutical company changes an IT application that has anything to do with new drug development, they had to go back, retest it and validate it to make sure it is working correctly, and we support them in those efforts. Almost all of our business in the payer and provider segments of our healthcare business are solutions we do deal with some staffing in the life sciences market.

We are really excited actually about our growth going forward. I will talk about why we grew in the past, but for a couple of reasons we are excited about the future. One is in 2008 we had two new offerings. In 2009, we have three new offerings. The first is in the area of fraud, waste, and abuse, and they will probably go commercial in the third quarter of this year.

It is estimated in the Medicaid area alone that between 4% and 7% of all claims or fraud, waste, or an abuse of the system. That means the US spends about $125 billion a year really on nothing.

For a couple of years, we have been working on an ontology. And ontology is an IT system that uses an expert language to pull data from the spread of databases to get better information. Most of the fraud, waste and abuse applications that are on the market today look at billing codes. They want to make sure that you if you have a particular medical problem, only certain billing codes are paid for. Our ontology will do that, but it goes far beyond that. It uses all the data in a payer or provider’s database in order to validate whether the claim is legitimate or not.

Just as an example, last year our guys were finishing a dermatology session, and when you finish a session, you want to test it to make sure it is working okay. We were working with the payer, they got 30 claims from the payers. They ran them through the ontology, not expecting – not looking for fraud, waste and abuse claims, just wanted to make sure that the application was picking up the information from the right databases. And they were shocked when a fraud, waste, and abuse claim actually was picked out. It was a dermatologist that was reimbursed for doing a chemical peel on a 4-year-old. It is illegal in your New York State to do a chemical peel on anyone under the age of 18.

And our guys shouldn't have done this, but they work with them all the time. They went and met the Chief of Medicine for the payer, who is a physician and asked him if they should call the police and have him arrested. And the Chief of Medicine laughed and said, he didn't do a chemical peel. There is no physician in the world that would do a chemical peel on a four-year old. He probably would have done a work that is $80. He put it through as a chemical peel, and he got paid $800 for that.

And he asked us to do something, and we have done it actually, that we weren’t thinking of. We were thinking of claims current and prospective. He asked that if we could build in in the application the ability, if we found a claim like this to go back and look at one physician and just on one task, if you did a chemical peel on a child. Because he said, he is absolutely convinced that if we look to the last three years, we would find 10 or 20 claims coming from that physician for chemical peels.

The reality is that if today a physician would write a prescription for a two-year old male for birth control pills, and the child was covered by a medical plan, and the prescription was filled. There is absolutely nothing in the payer system to stop that. They would have paid, and no one would ever have questioned it. Because it is an automated payment, the child is covered, he has got a legitimate prescription.

If our ontology is in place, it would actually get stopped for two reasons. Males shouldn't be getting birth control pills, and two-year-olds shouldn’t birth control pills. The good news for us is that the payers are now starting to get blood work electronically. And the blood is kind of like your report card for your body. If you have most medical problems, it will show up on your blood work.

If you take any kind of drugs, it shows up on your blood work. If you take a prescription, it shows up on your blood work. So we can use the electronic copy of the blood work really to go back and bring the search for fraud, waste and abuse to a level that it has never been brought to before. We have two other offerings that are going to become public this year. We are not going to talk much about them for competitive reasons or probably commercial in the fourth quarter.

One is a healthcare underwriting application. It better identifies risk when underwriting a group medical plan. We have been working with a different payer, who has actually run three years of a history through, and they are asking that we (inaudible) that if they had used our application, they would have made a lot more money in the last three years then just on using their own underwriting. And the last one is an IT medical model that improves patients’ outcomes by lowering costs, and it is designed really to monitor severe and very costly chronic diseases.

We are actually ecstatic that the US Federal government put $19 billion in the stimulus package for electronic medical records. It is estimated that to bring all people in the US up on electronic medical records, it will cost $100 billion, $10 a year for 10 years. President Obama originally asked Congress for $50 billion, $10 billion a year for five years. Congress cut him back and said it is not a stimulus package if it goes out five years. But they gave him the first two years. No doubt in our mind this is one of his focal points that he is going to go back eventually and ask for the rest of the money.

The good news is though this has been an investment that has a payback. If the US spends $100 billion to put up electronic medical records, primarily from the elimination of duplicate testing, it is estimated that it will reduce healthcare costs in the United States by between $200 billion and $300 billion a year. There aren’t many places where you can invest $100 billion and get a payback in less than six months.

The US Government agencies paid last year for 55% of all healthcare in the United States. So if the Federal Government is the one that upfront the money they will probably get a return within 12 months. It is a huge project. The US Federal Government estimate is that it will take 212,000 people 10 years to put up electronic medical records for the entire US. We think that the number is high, but certainly there are a lot of people. If you went back today and counted all of the consultants working in every hospital in the United States, there are about 10,000. So it is clearly a multiple for the number of people that are out there today.

CTG is one of the largest providers currently of IT services for electronic medical records in the United States, and we’re one of the seven companies in the world that are running projects to put up electronic medical records for an entire community. Absolutely no doubt this is going to have a significant impact on our business moving forward.

Unfortunately, we don't think that we are going to see very much of it in 2009. Under the legislation, the US Federal Government has to establish a new department. That department has to establish policies, procedures, and standards. Once that happens then hospitals and physician’s practices will have to do RFPs to select IT services companies to help them. Then you have to select the software packages you are going to use, then you have to develop a detailed project plan. Often it takes a couple of months where there is some revenue in that for us. There are not a lot of people that have to do that.

We think that we may get a little bit of revenue from it in the fourth quarter of the year, but there is no doubt in our mind that this is going to drive our business probably for the next 10 years. Switching gears a little bit, looking at technology service providers again, these are large aggregators, IBM, HP, and Fujitsu are the three largest in the world.

What are some of the growth drivers? Well Gartner estimates in 2009 that more than 50% of all IT staffing demand would be procured by the large aggregators. The reality is when IBM takes over the outsourcing of one of its clients’ IT departments, they stop using the 300 IT services companies their clients used to use. They only use 20 or 30 companies that are on IBM's preferred provider list. It is a large volume low-cost model. We think we have one of the lowest costs in the market today.

You need a geographic presence and that is shifting business from the small regional players to the national firms like CTG. We have a great relationship with IBM. There were 31% of our business last year. IBM has told us from time to time we have more people on IBM’s side than any other company in the world. We think that IBM may have been our largest customer for our entire 40 plus year history.

Obviously, the only thing that we deliver to this market is staffing. Taking a look at some of our financial results starting with the fourth quarter, clearly in the fourth quarter we began to see the impact of the global recession. We had one significant customer that came to us in mid-October, where they only told us that they no longer needed 250 of our people, the number later grew to 425 people. While our revenues in 2008 grew by 9% in total, they actually decreased by 1% in the fourth quarter.

You can see it didn't have an impact on our earnings per share. Earnings per share in the fourth quarter grew 114%. Two reasons for that, one, we had more solutions in our revenue mix. Again our solutions business operating margin was up 10%, the staffing business is 3%. The other reason is we had two new offerings in our mix in the fourth quarter of last year, while our average solutions business on operating income is about 10%, it is not unusual on a new solution to get 20% or 30% operating margins.

Taking a look at the first quarter, we are going to be further impacted by the global recession, mostly in the staffing business but we are starting to see some impact on the solutions business as well. Not-for-profit hospitals historically have financed their capital needs through the tax-exempt markets. Those markets are virtually dead at the moment. We see a lot of projects out there including electronic medical records that the not-for-profits would like to start up but they don't have the cash to do it.

We think if the financial markets begin to become more stable, later in the year they will be able to start those. We think in the first quarter of this year, the mid-point of our guidance that our revenues will drop by about 15% earnings per share at the midpoint of our guidance will drop a penny or 11%.

Taking a look at our longer perspective, our revenue growth for the last four years, compounded annual growth rate has been 10.5%. Our industry in total grew at about 4.5% during that period of time. Almost all of the industry growth happened over offshore, mostly in India. All of our growth was either in the United States or Europe. On midpoint of our guidance, we think that in 2009 our revenues will drop about 16%. Then it will start to grow up again as the electronic medical records projects begin.

With having more solutions in our mix, you would expect to see our operating margins go up. Last year, our operating margins nearly doubled from 2% to 3.7%. In 2009, at the midpoint of our guidance we think that those up to 3.2%. About 75% of all of our costs are variable or mostly people. Since the beginning of the fourth quarter of last year, we've reduced our variable cost by $50 million approximately.

Unfortunately, we can't reduce the 25% in the short term and that is fixed cost and that is the reason the operating margins are dropping in 2009. We expect to see the operating margins increase again in 2010. Taking a look at our earnings growth over the last few years, in 2008 we had a subsidiary in the Netherlands that was losing money. We sold it for a loss. The loss on the sale cost [ph] the loss that year, otherwise we would have made positive income in 2004.

Our compound annual growth rate and earnings per share over the last three years has been 51.8%. We don't think there is another IT services company that income grew at that rate during that period of time, and in 2008 despite the fact that the fourth quarter was influenced by the global recession, our earnings per share were up 96%. The midpoint of our guidance, we think that our EPS will probably drop about 29% to $0.35 in 2009. After that we expect it will return to our growth mode in earnings per share, particularly because of the stimulus money in the electronic medical record work.

Electronic medical records, of all of our offerings, has one of the highest operating margins. Still in our financial side, our EBITDA last year was $15.6 million. We haven’t had any debt outstanding at the end of 2006, 2007, or 2008. We do occasionally at the end of one of our quarters have a little debt outstanding.

Our biweekly payables were about $8 million and at the end of quarter on a payable date, we have to borrow a couple of million dollars for a couple of days to finance that. We do that through the use of $35 million revolving credit facility that we have in place through 2011. We have quality receivables, most of them come from the Fortune 1000, and had 57 days outstanding on our receivables at the end of the year.

Some of our strategic goals are to continue to target faster growing major markets. We put all of our discretionary investment money in the healthcare in the last three years. We suspect we'll probably do that from the next decade. We want to grow more rapidly than the industry average as we saw from the chart before. We've been growing by more than twice the rate of the industry average for the last four years. We are animate that we're going to get our solutions business back to at least 50% of our mix.

We know if we do that our operating margins will double to the 6% to 7% range, and we are going to continue to develop in demand (inaudible) solutions. Some investment metrics, little over a year ago Business 2.0 wanted to identify the hundred fastest publicly traded technology companies. This is any kind of technology. So it includes video game manufacturers, iPods, hardware-software services. They looked at the three–year period of time. They looked at three elements of growth, revenue growth, operating income growth, and cash flow growth, and out of the over 2000 publicly traded technology companies that they looked at, CTG was the 69th fastest growing of the IT services companies, and we were the third fastest growing.

Modern Healthcare in the fourth quarter of last year recognized us as having the eight largest consulting practice for the healthcare provider IT market. We are absolutely focused on our solutions revenue. We are very early entrant in the electronic medical records. We've been doing electronic medical records work now for over five years, but that business as I mentioned before grew by over 50% last year to 7% of our total revenue. And we believe because of the $19 million in the stimulus package it will grow even further going forward.

We have a very active stock repurchase program. In both 2007 and 2008, we repurchased 1 million of our shares of about 5% of the outstanding in both years. We think the price is very attractive. Our Board gave us authorization in February to repurchase another million shares. We have hit double-digit EPS growth in 2005, 2006, 2007, and 2008, and I think if you look at it – you know, it is going to be hard for us to find another IT services firm that can say that.

That is it actually for my presentation. I will be glad to answer any questions that anybody might have.

No. No questions. You made it easy for me this morning. Brendan and I will be next door in the breakout room, if you have any further thoughts. Thank you for attending today.

Question-and-Answer Session

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