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Executives

James Boldt – Chief Executive Officer

Brendan Harrington – Chief Financial Officer

James Culligan – Director, Investor Relations

Analysts

Bill Sutherland – Northland Capital

Brian Kinstlinger – Sidoti & Co.

Vincent Colicchio – Noble Financial

Rick D’Auteuil – Columbia Management

Kevin Liu – B. Riley

Frank Sparacino – First Analysis

Computer Task Group Inc. (CTGX) Q1 2013 Earnings Call April 23, 2013 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the CTG 2013 First Quarter Earnings 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, and if you should require assistance during the call, please press star then zero. As a reminder, this morning’s conference call is being recorded.

I would like to turn the conference over to our first speaker, Director of Investor Relations for CTG, Mr. Jim Culligan. Please go ahead, sir.

James Culligan

Thank you, Coleman, 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 of the first quarter of 2013 and then 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 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 statements. It’s 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 website or the SEC’s website at SEC.gov. Please review our forward-looking statements in conjunction with these precautionary factors. With that, I’d like to turn it over to Jim to begin the discussion.

James Boldt

Thanks, Jim, and good morning everyone. This is Jim Boldt. I want to thank you for joining us this morning for our first quarter earnings conference call. As you saw in our news release, we had a good first quarter with revenues increasing 5% over 2012 and earnings per share increasing 20%. Both revenue and earnings per share were at the midpoint of our guidance for the quarter.

I’m going to talk more about our results and what we see for the 2013 second quarter and full year, 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 everyone. For the first quarter of 2013, CTG’s revenue was 108.5 million, an increase of 5.1 million or 5% compared with the first quarter of 2012. First quarter 2013 had 63 billing days, one less day than in the first quarter of 2012. Solutions revenue in the first quarter of 2013 increased 1.9 million or 4.7% compared to the first quarter of 2012 and totaled 42.7 million. As a percentage of total revenues, solutions revenue was 39%, approximately the same as a year ago. Staffing revenue in the quarter increased 3.2 million or 5.1% to 65.8 million.

First quarter revenue from IBM, our largest customer, was 28.9 million compared with 28.4 million in the first quarter 2012. As a percent of total revenue, revenue from IBM decreased to 26.7% in the 2013 first quarter compared with 27.4% of total revenue in the 2012 first quarter. Our revenue from IBM in the quarter was negatively impacted by approximately 1.1 million when compared with the first quarter 2012 as a result of IBM’s spinoff of its retail business to another large company. Although this change lowered our overall revenue from IBM, the spinoff did not have a negative impact on CTG’s revenue since we have retained the business with this new client.

Revenue from our European operations was 19.4 million, a 13% increase from the 17.2 million recorded in last year’s first quarter. The effect of foreign currency fluctuations during the first quarter of 2013 increased consolidated revenue by approximately 100,000. On a local currency basis, our European revenue increased by 12.2% compared with the first quarter of 2012. A portion of the increase was due to the acquisition in February of a Belgian-based IT services firm.

Direct costs as a percentage of revenue were 79.2% in the first quarter compared with 78.9% in the first quarter of 2012. SG&A expenses as a percent of revenue decreased to 15.1% from 15.7% in the first quarter of 2012. The billable travel expenses included in the first quarter of 2013 revenue and direct costs were 3.1 million. The billable travel expenses for the first quarter of 2012 totaled 3.2 million.

First quarter operating income grew to 6.2 million, an increase of approximately 600,000 or 10.4% year-over-year. Operating margin in the first quarter increased to 5.7% of revenue, a 30 basis point improvement from last year’s 5.4%. The year-over-year increases in operating margin and income were due primarily to the increase in the higher margin business in our sales mix and the additional operating leverage. Operating margin declined 20 basis points compared with the fourth quarter of 2012 due to the ending of two EMR projects, the delayed start of three new EMR projects, and due to increased revenue from our staffing business.

Net income in the first quarter was 4.1 million, an increase of 700,000 or 20.7% compared to the first quarter 2012. On a per-diluted share basis, net income was $0.24 for the quarter, an increase of 20% compared to the first quarter of 2012.

The tax rate for the 2013 first quarter was 33% compared with 39% in the 2012 first quarter. The low tax rate for the quarter is primarily the result of the 2012 research and development credit which was retroactively passed in January 2013. We expect the tax rate for the full year 2013 to be between 37 and 39% compared to 38.4% for 2012, which excludes the effect of approximately 1.3 million of non-taxable insurance proceeds that we received in the second and fourth quarters of 2012. Both the 2013 and 2012 first quarter results include equity compensation expense of approximately $0.02 per diluted share net of tax.

Our headcount at the end of the first quarter was 4,000, an increase of 100 people or 3% compared to the end of the fourth quarter of 2012. Of the 4,000 employees at the end of the first quarter 2013, 91% were billable resources.

At the end of the first quarter 2013, we had no debt and 30.7 million of cash on the balance sheet compared to 19.3 million of cash at the end of the first quarter 2012. Both the first quarter of 2013 and 2012 ended on a U.S. biweekly payroll date.

Our days sales outstanding was 61 days at the end of the first quarter 2013, the same as at the end of the first quarter 2012. Our cash used in operations in the first quarter of 2013 was approximately 7.1 million as compared with approximately 2.4 million in the first quarter of 2012. In the quarter, we had 675,000 in capital expenditures and recorded depreciation expense of 631,000.

We did not repurchase any shares of CTG common stock during the first quarter of 2013. During this most recent self-imposed blackout period, we repurchased 48,000 shares of CTG stock. As of today, our repurchase authorization is for approximately 490,000 shares. As it remains accretive to our earnings, we intend to continue our repurchase program during 2013.

Jim?

James Boldt

Thanks Brendan. In aggregate, our solutions business, which is significantly more profitable than our staffing business, increased by 5% in the first quarter of 2013. The solutions business was 39% of our total revenue in the first quarter. On our conference call at the end of February, we mentioned that we’d received two RFPs for electronic medical record projects which the hospitals had not decided what IT services firms would be awarded those projects. We received one new RFP for an EMR project in the last two months. We’re still waiting on a decision in all three RFPs as to what IT services firm will be chosen for these projects.

When we started the first quarter of 2013, we had 17 active EMR projects. During the first quarter, two projects came to an end in the early part of the quarter; therefore at the end of the first quarter of 2013, we had 15 active EMR projects.

While we reported on our last conference call that we had been notified that we had won three new EMR projects, the starts on these projects were delayed. These three projects will become active and ramp up staffing during the second quarter of 2013. This delay caused our EMR revenue to be flat when compared to the first quarter of last year. While having people on the bench between engagements is a normal part of the solutions business, it’s not happened in our EMR business in several years and limited our EMR growth in the first quarter. While we still have more reqs than we can find staff for, the skill sets and geography for a particular opportunity do not always match and that, combined with a very competitive market for health IT consultants, continues to constrain our growth opportunities.

As we look to the second quarter of the year, we know that we have three new EMR projects ramping up. We also know that we will have projects come to an end. In our recent conference calls, we began to tell you that the EMR business would start to change in 2013. We expect that there will be more starts of EMR implementations at the largest hospital systems in the country this year. We also mentioned on our last call that one of the two systems that we’d bid on that had not picked an IT services firm has approximately 5,000 beds, significantly more than our average client. While we still think we’re in a good position to get some of their work, the timing of the start of their project has been delayed and we currently don’t think that project will ramp up until the third quarter of the year. Also, the very significant system we’d previously talked about that was originally expected to start up in the first quarter 2013 has also been delayed. We now think it will not begin to ramp up until the third quarter of the year.

Long-term, we still see a tremendous opportunity for growth in our EMR business. There is still 1,000 to 2,000-bed hospital EMR projects that we’re pursuing. In addition, the very large systems’ EMR projects have to start up eventually. Further, there has been very little work done on the small hospitals in the U.S. In order to achieve the kind of savings that the U.S. federal government has projected, the healthcare system is going to have to exchange records, and that means that the health information exchanges, or HIEs, will have to be built. Finally, we believe that the European hospitals will ultimately install software and that will likely create EMR work for CTG for another decade, given our recent acquisition in Europe of etrinity. Given the work that still needs to be done, I think you can see why we remain very optimistic for the long-term growth potential of our EMR business.

Fortunately for CTG, EMRs are not our only healthcare offering and our acquisition of etrinity and our other healthcare offerings caused our healthcare business to grow in the first quarter of 2013. You saw in our press release we began our first ICD-10 remediation project for a hospital system in the first quarter. That project will continue to ramp up and should be fully staffed by the end of the second quarter.

We’re starting two new healthcare outsourcing engagements beginning in the second quarter 2013. In the first quarter 2013, our SAS offerings increased our revenue by approximately $1 million and our EPS by $0.02 per share over the first quarter of last year. Most notably, we recently signed an agreement with another payor for our fraud, waste and abuse offering. In addition to this engagement, we anticipate closing at least one additional fraud, waste and abuse engagement in 2013.

Based upon the new business, we now anticipate that our SAS offerings will increase our earnings per share at the midpoint of our guidance by approximately $0.15 per share in 2013 versus the $0.08 per share increase we discussed on our last call. As we sign this new engagement in April, we expect that the vast majority of the incremental $0.07 will accrue to the latter part of the year and should offset the impact of the delay in EMR project starts.

Having covered healthcare, I’d also like to talk about the other three vertical markets on which we focus. Our technology service provider market, which is an all-staffing business, was flat in the first quarter when compared to the first quarter of last year. Our financial services vertical had an excellent first quarter. Most of the revenue gain in financial services came from our European operations. Our energy business revenue was flat when compared to the first quarter 2012.

Turning to our staffing business, its revenue was up 5% when you compare the first quarter of 2013 to the first quarter 2012. That’s more of an increase than we were expecting and reflects higher client demand attributable to the improving economy.

If I had to sum up the recent changes in our business in one paragraph, I’d say that the EMR project delays are limiting the growth of our healthcare business. That impact is being offset by stronger demand for our staffing business and the increased profitability from our SAS offerings. Looking to the second quarter 2013, we’re forecasting total revenue to be in the range of 111 to $113 million, or a 5% increase to the midpoint of our guidance over last year’s second quarter. We’re forecasting earnings per share in the second quarter of 2013 to be in the range of $0.23 to $0.25 per diluted share or a 9% increase over 2012 at the midpoint of our guidance when you exclude the insurance theme from the second quarter of 2012’s earnings.

For the 2013 full year, we continue to expect a revenue range of 450 to $460 million or a 7% increase to the midpoint of our guidance over 2012. Based upon our revenue forecast and the anticipated mix of business, we continue to expect 2013 net income per diluted share to be in the range of $1.02 to $1.12 or 22% increase from 2012 at the midpoint of our guidance, excluding the gains from life insurance proceeds in 2012.

We thought it would be helpful to briefly share our thinking on how we’ve set our recent guidance for the year. First, we think that our healthcare business will grow by approximately 12% in 2013 with more of the growth coming in the second half of the year. For our non-healthcare solutions business, we’re projecting a revenue increase of approximately 11% in 2013. We’re forecasting a 3% increase in our staffing business in 2013.

We’re very optimistic about CTG’s growth going forward. Our staffing business is improving and will continue to do so as the global economy improves. While we’re going through a transition period, we expect our U.S. healthcare business to continue to grow, particularly once some of the larger hospital systems begin their EMR projects. With the recent acquisition of etrinity, a Benelux health IT consulting firm, we’ve positioned CTG to participate in the adoption of U.S. software by European hospitals.

We’ve been working on approximately half a dozen betas with states and payors over the last 12 months for our fraud, waste and abuse application. While these opportunities have a very long sales cycle, we’re beginning to close some of those opportunities.

We are currently building out our IT medical management model for four more severe and chronic diseases. That means by the end of 2013, the IT medical model will be capable of handling five of the 10 chronic diseases that account for approximately 70% of all healthcare costs in the U.S. We’re also working with a client to combine genomic sequencing with electronic medical records. This will only be the third time that we know of that this combination has been done. This work will position CTG with one of the first of its kind, cutting-edge offerings in the genomics science field.

We think that if you look at how well CTG is positioned in healthcare, the world’s fastest growing industry, you can see why we continue to be confident in our future growth opportunities.

With that, I’d like to open the call for questions if there are any. Operator, would you please manage our question and answer period? Coleman?

Question and Answer Session

Operator

Yes, sir. [Operator instructions]

Our first question is from the line of Bill Sutherland from Northland Capital. Please go ahead.

James Boldt

Morning Bill.

Bill Sutherland – Northland Capital

Hey Jim. I’m glad I guessed it was star, one. So I wanted to ask you one specific thing to start and that’s in EMR. Did you say you expected another end or two, project end this quarter?

James Boldt

Yeah, we normally get two to three projects that end every quarter. It’s just the normal cycle, and if we started up two or three two years ago, then two or three have come to an end this quarter. It’s kind of hard to predict because often, and it’s happened to us a few times, we think that we’re going to end a project and the client will come to us and say that they’re acquiring some small hospitals and that will continue the project for another year or so. But most quarters, we would anticipate that we’d be ending two or three projects.

Now, the new projects we’re starting up are probably larger than the projects that we started a couple years ago, so we’d expect some increase in revenue from that.

Bill Sutherland – Northland Capital

When you do conclude with a client, where are they in that process in terms of meaningful use and so forth?

James Boldt

They are clearly in a position to certify that they’ve met meaningful use phase one, and they’ll begin to get the reimbursement.

Bill Sutherland – Northland Capital

So you don’t really get involved in the last two stages of that to any great degree – is that pretty typical?

James Boldt

Yeah, we may. I don’t think that there’s many systems out there that are actually ready for meaningful use 2, so that’s still yet to be seen.

Bill Sutherland – Northland Capital

Okay. ICD-10, your deal there – there was a new readiness report as far as ICD-10, people making the deadline, about the new deadline in ’14. Did that—is it your sense that there’s going to be some catch-up here, or any change in the environment from your view?

James Boldt

There’s been a little change. You know, we started a project up, so some of the larger systems are starting to get serious about it. As I recall, the report that you’re talking about basically said that the payors have done a pretty good job but the hospitals are definitely behind. We still talk to a lot of the hospitals that think the the AMA is going to be successful in pushing the date out. The AMA’s position on it is that the U.S. should stay on ICD-9 forever, which isn’t practical, so you’ve really got a mixed bag out there.

I think I may have mentioned this before – what we’re telling hospitals is, look, the biggest part of this project is actually in doing version upgrades to get to the most current version, which would be the ICD-10 compliant version. You’re going to end up, unless you’re planning in the next couple years on sun-setting those systems, doing those version upgrades at some point. If you want to hedge your bets, start doing the version upgrades and then if the date sticks, start to train the doctors on the new codes.

Bill Sutherland – Northland Capital

But the deal you got is not just a version upgrade?

James Boldt

No. Well, most of our work will be version upgrades, but this particular system, which is one of the larger systems in the U.S., is convinced that they are going to hold at the date. CMS has been pretty forthright in saying that they’re not going to postpone it again, so they’ve decided actually to do the upgrades and they are anticipating that by October of 2014, they’re going to have to use the ICD-10 codes.

Bill Sutherland – Northland Capital

This is a larger system that you guys have to deal with?

James Boldt

It is a larger system, but because they’re a larger system they have a relatively large IT department, so they can do a lot of the work themselves but they need us for some of the work.

Bill Sutherland – Northland Capital

Perhaps you can give us a little more color on the win you had in the fraud, waste and abuse application in the quarter.

James Boldt

Okay. This is one of the six betas that we’ve talked about previously. If you would classify it in terms of payor size, you’d probably still classify it as one of the smaller payors; but it’s twice the size of the first payor that we did. The reason that we wanted to sell this particular payor is that in going through the process with the first payor, we realized that one of the reasons that the payors, smaller payors particularly, are hesitant in using us for fraud, waste and abuse is they are going back to a client and perhaps telling them that they paid them for something they shouldn’t have last March, and the client has already closed their year, et cetera. Clearly we get the message that if they could be more current, they would be much more willing to push back on some of the payments. It’s very different if you got a payment yesterday and it’s clearly erroneous to tell the client, hey, that payment is incorrect.

So one of the things we’re doing with this client is we are modifying, and it doesn’t take very much, actually, but we’re modifying our application so that—well at the moment, the first thing we’re going to do is look at their history. The next thing that we’ll do is we’ll modify the application. They will actually transmit to us their claims that they’re paying the next day, and we’ll then transmit to them the ones that they shouldn’t pay and why they should take issue with those payments. The client believes that if they do that, that they can take a position that if the payment is wrong, the payment is wrong. It’s not like they’re going back a year and correcting something that the client has already recorded.

So this particular payor had a lot of attraction to us because we think that by modifying the application so we can basically overnight do the check, that we’ll have a much greater opportunity of going out to the small payors and saying, look, we’ll check this overnight.

The other thing is that while the large payors all use at least one to three, probably, fraud, waste and abuse applications, the small ones don’t. It’s very common with the smaller ones for them not to be using a fraud, waste and abuse application, just using their own internal compliance people to check whether or not the payment should be made. So we have a greater opportunity, we think, to find things in a client that isn’t using a fraud, waste and abuse application versus one that is using two or three.

Bill Sutherland – Northland Capital

Of your other four betas, how would you characterize them sort of size-wise, just ballparking?

James Boldt

Well actually it’s five. There was six; this was one, so there are still five left.

Bill Sutherland – Northland Capital

Oh, okay.

James Boldt

Some of them are states, which are significantly larger, you know, a multiple of what the payors that we’ve currently sold are. Originally we decided that we’d go after states because we know that they have agreements with the federal government – if they find fraud, waste and abuse, they basically have to pursue it. And then one of them is more the size of a small to medium-type payor.

Bill Sutherland – Northland Capital

Okay. One question, just operating cash flow – the DSO’s even, but I’m curious why it was more negative. Was it about the timing of payroll?

James Boldt

Yeah, it’s two things, really. The timing of payroll – our biweekly payroll, just in the United States, is $10 million or so. So when we close a quarter as we did at the end of the year between the payrolls, we haven’t paid those. When we close a payroll on the payroll date, which is what we did at the end of the first quarter, the cash gets impacted by $10 million, so that’s clearly the biggest impact.

The second impact would be the acquisition of etrinity. We don’t do that many acquisitions. That was around $2.5 million of cash that also came out in the first quarter.

Bill Sutherland – Northland Capital

But that’s below the operating cash flow line.

James Boldt

I’m sorry – that’s below--? Yes, it is, yeah; but it did impact the cash balance.

Bill Sutherland – Northland Capital

Yeah, okay. Thanks, Jim.

Operator

And our next question is from the line of Brian Kinstlinger with Sidoti & Company.

Brian Kinstlinger – Sidoti & Co.

Hi, good morning guys. I just wanted to check one thing that you said. I didn’t catch it quite. Was this customer you thought going to add $0.07 to earnings, that fraud, waste and abuse customer in the second half of the year for the most part? Is that what you mentioned?

James Boldt

Yeah, actually we’re anticipating that there will be two customers. It’s the one that we just sold, and then we’ll have one more; and most of the $0.07 would come from the first customer but we’d actually need to close the second one to get the full $0.07.

Brian Kinstlinger – Sidoti & Co.

But that’s more of a six-month number than a full—like, it’s a second half of the year number?

James Boldt

We expect that there will be some small amount of revenue and profit from the customer that we just signed in the second quarter. Almost all of the rest of it will come in the second half of the year.

Brian Kinstlinger – Sidoti & Co.

Can you remind us the margin profile and a rough revenue of what $0.07 suggests? Is that $10 million, a little bit less, a little bit more?

James Boldt

It’s more like $3 million in terms of revenue.

Brian Kinstlinger – Sidoti & Co.

Oh right, in the second half of the year. Right.

James Boldt

Yeah, in the second half of the year. It’s $3 million in revenue. It’s about a 70% operating margin and then of course normal taxes probably close to 40%, and that would be about $0.07 per share. We already in our original forecast had baked in that we would have $4 million roughly of revenue, which is our current run rate, and about $0.02 a quarter of earnings per share from the SAS offering.

Brian Kinstlinger – Sidoti & Co.

And given you’re doing this in a more real-time fashion for this customer as opposed to looking after the fact, is the same model if you catch something that’s erroneous, then you’ll still take a percentage of that? And is it going to be recurring, these numbers, for next year and does revenue change much per customer per year?

James Boldt

We haven’t actually worked out the deal yet on the real-time process claims, so we haven’t started to do that. We anticipate we’ll probably start to do that around July, so at the moment we’re actually still working on history and that definitely is a percent recovery. Our position would be it would continue to be a percent recovery, but I think the percent will drop. You know, if they are constantly telling a customer we’re not going to pay for this, the customer will at some point adjust their billing so that they’re not billing them for it. I mean, why get their payment delayed on a regular basis if they know they’re going to catch them for that one anyway?

Brian Kinstlinger – Sidoti & Co.

Right. And just a reminder – your first customer in FWA is about half the size in terms of revenue too?

James Boldt

Yes, that’s correct.

Brian Kinstlinger – Sidoti & Co.

Okay. And then moving to EMR just a little bit, do you think the EMR delays are specific to your customers, or is it industry-wide? And what affords them that luxury, given the deadline is not that far away?

James Boldt

Clearly I don’t think it’s unique to our customers. I think that there’s been delays in projects in general. I can’t prove this because no customer has come to us and said we’re delaying it because of this, but all of our customers, we know and because they’re pretty open about talking to us about it, have projects to try to see what they can do with their cost. Under the sequester, the U.S. federal government reduced their Medicare, not Medicaid but Medicare payments by 2% starting April 1, and most of our hospital systems have a 2 to 4% operating margin. Most of them, about half of the revenue comes from Medicare and Medicaid, so let’s say maybe a quarter comes from Medicare, so they just lost about half a percent of their revenue in operating profit and also cash flows, and there’s no reduction in costs. Basically, the government just cut back on the amount that they’re getting paid.

It affects their cash flow. Most of our clients are financing these in bond financing. You’ve got to make the bondholders a little careful, probably take a longer time, maybe get a better rate in interest when they are financing someone whose cash flow has just been cut. I think probably of equal concern is that while the Republicans for quite some time have been saying that there has to be a change in Medicare and Medicaid, you now have the President of the United States, who is a Democrat, saying he would agree with a change in the Medicare and Medicaid beyond the 2% sequester cut.

So I think that the delays—we know that all of our clients have been focusing in on how are they going to deal with the reduction in their revenue, and I think that the delays are just a function of that, that they are absolutely making sure they’ve got all their financing in place before they start projects, where before it was unusual for a client to start perhaps before. You can start the project up by only putting a couple people on it and the cash flow isn’t significant, but I think they’re just being more cautious as to what they do.

Brian Kinstlinger – Sidoti & Co.

Have all three of the wins you had that were delayed, have they started? Have any of them started?

James Boldt

One has started and—well, one has clearly started. One is in the process of getting the consulting people you need and the project managers you need to do the plan, and the third one, as I recall, hasn’t started up. But we’re convinced. They’re telling us exactly when the start date will be.

Brian Kinstlinger – Sidoti & Co.

Okay. Two more quick ones. The first one, EMR – maybe I missed it. What was first quarter revenue from EMR, and what was it in the fourth quarter?

James Boldt

It was down from the fourth quarter, and I’m going to have to look that one up – I don’t remember off the top of my head.

Brendan Harrington

Q1 was 16.3 million; Q4 was 18 million.

Brian Kinstlinger – Sidoti & Co.

Great. And the last question that I have is your IBM relationship, clearly your results were lackluster. And so just looking forward, is there any concern about the IBM relationship and staffing? Not the relationship, but more so demand with where IBM staffing is.

James Boldt

That’s an excellent question and so I’m going to give you kind of a long answer on it. Actually if you adjust for the store sales business that Brendan mentioned, our IBM business was up almost 6% in the first quarter, so the demand from IBM was pretty good.

About 25% of our demand from IBM is ITS, which is a subset of global services so our people are actually delivering services and obviously IBM is billing for those services. So we’d expect that—I mean, they are aggressively trying to sell global services, so we’d expect that demand is going to stay constant or even maybe go up in the future. IBM has not talked to us about this, so all I’m doing is repeating what we read in the paper, quite frankly; but there has been a lot of press in the last week about the fact that IBM is considering selling their X86 servers to Lenovo. The X-series is one of IBM’s server series – there’s an X, a Z, an I, et cetera – and the X is really kind of the bread-and-butter one, so those would be the—it’s lower end servers, and I say that with some hesitation because I think you can get 64 processors now in an X series. But it would be the kind of server that CTG might buy for its processing needs. I don’t think that IBM has come out specifically and said that they are actually doing this, but there has just been a tremendous amount of press about it.

Now ironically, Lenovo is our second biggest staffing company customer. We provide Lenovo with the vast majority of their temporary technical needs. We got that business when IBM sold Lenovo the PC business, the IBM Thinkpad back a number of years ago, and we didn’t have all the people – we had a few people really – in the PC division for IBM. They actually continued on with Lenovo and over a period of time we became their prominent supplier of technical resources.

So we think that if IBM does sell it to Lenovo, that it will just be a transfer from one customer to another. The people at Lenovo are good people; we have a great relationship with them. What will probably happen because this is Lenovo’s primary focus over a period of time, our business will probably go up. The store sales, for instance, business that we have is increasing nicely because Toshiba is absolutely focused on that particular business.

In addition to that, we’ve read that on IBM’s call they mentioned that they probably will do reductions in their hardware division, and SDG is their primary hardware division. So we actually looked at the run rate for the first quarter of our staffing revenue – it was up about 5% - and we factored in that there may be a reduction in the SDG people going forward. That’s why we came up with the 3% instead of a 5% increase for the year in staffing. So IBM has not talked to us about it, but based upon their comments we thought that it was probably prudent to factor in some reduction.

Brian Kinstlinger – Sidoti & Co.

That’s great detail. I actually have one last question and then I’ll get back in the queue. The fraud, waste and abuse customer, you expect hopefully to add one more, and you talked a little about a couple of states that are in the pipeline. Is it your sense the next customer will likely be a state?

James Boldt

It is quite possible. It could be a state.

Brian Kinstlinger – Sidoti & Co.

Okay. Thank you.

Operator

Our next question is from the line of Vincent Colicchio with Noble Financial. Please go ahead.

James Boldt

Hey, good morning Vincent.

Vincent Colicchio – Noble Financial

Yeah, Jim. I may have missed it – SDG, how large is that of a portion of the IBM revenue?

James Boldt

It’s about 75% of our IBM revenue. We’re the only customer that supplies that particular division.

Vincent Colicchio – Noble Financial

Okay. In Europe if we exclude the acquisition, what was the growth there? And then also in Europe for the rest of the year, do you expect growth and what will the key driver be? Will it continue to be EU spending?

James Boldt

Well, while I’m talking maybe Brendan can figure out the first question. But clearly in the first quarter it was financial services. We have a testing offering in Europe that’s been widely accepted, particularly in the Benelux countries, and that had a nice increase. Actually our financial services overall business increased by about 11.5% in the first quarter of the year, and almost all of that was in Europe and it was primarily in their testing.

The other thing that’s driving the European business is the European Union business. The European Union is located in the Flemish portion of Belgium. That’s where our European headquarters are. We’re one of the largest IT services companies in that area, and because of that we’re getting more and more business from the newer European Union. I mean, basically they’re rebuilding Washington DC 200 years later.

Brendan?

Brendan Harrington

Yeah. If you exclude the acquisition, Vince, the growth was about 7.5%.

Vincent Colicchio – Noble Financial

Thanks for that, Brendan. Back to healthcare, if we look at the ICD-10 and the application outsourcing opportunities, is the pipeline there growing? What does that look like?

James Boldt

Definitely the outsourcing is growing. The ICD-10 is growing as well but it’s more clients talking about maybe they should hedge their bets and do something about it than actually having RFPs and hospitals responding to them. I think, as I mentioned in my introductory remarks, we actually are starting up two nice-sized outsourcing engagements in the beginning of the first quarter. They’re almost fully staffed now, so we’ll have that revenue this quarter too.

Vincent Colicchio – Noble Financial

And can you give some more color on how—let’s say you have more delays on the EMR side. How easily can you redeploy those skill sets? I know geography is one issue, but in terms of technically, can you redeploy those people, say, into application outsourcing for example?

James Boldt

Some of them you could, because some of the application outsourcing requires you to have EMR skills. Actually more likely, we’d reposition them to other customers, quite frankly. Because some of the large systems have been burnt – we had a large competitor who was signed up for an engagement, and on the day the engagement started they only had three people. They sent them a bunch of resumes of other people that they had, but they were all working on other engagements – that was about a year and a half, two years ago. Since that time, hospitals are actually making you send the resume of the person who is going to be on their engagement. They want to actually look at it. You don’t have to have the name of the person but definitely their background. So most of the people that were on the three engagements that ended in the first quarter are actually going on the projects. We had already committed them to the projects that are starting up in the second quarter. If we didn’t do that, we probably would have staffed them on another client, but they were already kind of committed.

I think most of the EMR people will probably end up on EMR engagements going forward because there’s still a tremendous amount of demand out there.

Vincent Colicchio – Noble Financial

Well that’s it for me. Thanks for answering my questions.

Operator

Our next question is from line the line of Rick D’Auteuil with Columbia Management. Please go ahead.

James Boldt

Good morning, Rick.

Rick D’Auteuil – Columbia Management

Good morning. A lot of my questions have been answered, but I have a few. The bill rate trends and spreads in the various, if you can kind of break that down in your segments.

James Boldt

Okay. I’ll do Europe first because they actually have—in some of the countries, Belgium for instance, the countries that were the strongest, and they actually have statutory wage increases that go in every year and they are about 3%. So generally, we’re able to get a bill rate for those employees, so the European bill rates tend to go up 2.5, 3% a year as a consequence of that. The U.S. staffing business is going up very slightly, but it’s still somewhat muted. It’s probably going up at half a percent to a percent a year at the moment, and then for a number of years the healthcare bill rates have been going up about 5 to 10% because of the shortage, and that’s probably going to continue.

Rick D’Auteuil – Columbia Management

That would encompass anything that you had in the ICD-10 arena?

James Boldt

Yes.

Rick D’Auteuil – Columbia Management

Okay. Just back to the fraud, waste and abuse opportunities, I know you’ve talked about it in detail. If you were to win whatever state that you have in mind, my understanding is that’s multiple times the opportunity of your most recent win in there. Is it that the contribution isn’t that much because your expected timing is late in the year and it really would be a 2014 contribution, or is it not that big?

James Boldt

Well, states tend to be a multiple of payors, obviously, particularly larger states. It’s two things really. One is that we are saying that it’s later in the year, and that obviously reduces the amount of income. It’s going to take us a while to process those claims, get them back to the state. The state, they’re obviously going to want to go through them, make sure that they are legitimate adjustments, et cetera, going forward.

The other thing is that, and we have a system and have had one for a long period of time and we think it’s pretty good, about factoring all of our opportunities. We factor the revenue down and also the profitability down, given the probability that we’re going to close one. So there is also some factoring down of the estimate of what we’re going to earn, given the fact it’s not 100% probability that we’re going to earn one.

Rick D’Auteuil – Columbia Management

And what’s the status of, I think—if you only do win the one more this year, the other four, are they likely to go forward at some point or are some of them likely to just fold it up and not proceed with the opportunity?

James Boldt

There was actually six and we sold one, so there’s five opportunities left. It’s possible that they could fold it up. I mean, none of these states were planning on doing anything. We basically went in and sold them on the fact that they should do something, and until we actually get them to sign a contract they can always back out of it. So it is possible, but we are talking at relatively high levels in state organizations, generally to either the secretary of health or the attorney general; in some states it’s split as to who is responsible for fraud. We think that we have put enough before them to entice them to go ahead and do something.

Rick D’Auteuil – Columbia Management

And why is—do you expect that pipeline to grow from the original six to—is there anyone else that’s contemplating doing a beta, I guess?

James Boldt

We actually just started to open that up. One of the concerns I always have is we’ve got a great new offering and everybody runs to the great new offering. Nobody is selling the bread-and-butter stuff, and this tends to be the same sales force. So when we kind of started, we said okay, we’ll do six because we think that if we did six, we have a reasonable probability of closing on some of them. Once we began to close on the six, then we would start to deliberately go out and solicit more, so actually in the last month we’ve actually engaged additional people to start the sales cycle.

There’s no reason to limit it to six long-term, but it was just the right thing to do with the new offering initially.

Rick D’Auteuil – Columbia Management

And to the extent that some of these go forward, do you think it’s going to be required that new potential prospects go through a beta also, or might they just accept what your betas in the existing opportunities have—the results from those betas?

James Boldt

Actually we think that once we’re able to get a payor to tell a payor, or a state to tell a state, yeah, we saved this much and these are the areas we saved it in, that we probably can bypass the beta at that point. Without having that, we’ve been doing a beta to say this is how much we’re going to save in your environment.

Rick D’Auteuil – Columbia Management

Okay. And then I asked this question, I think, on the last call, but the European healthcare opportunity, is there any momentum building there?

James Boldt

Yeah, definitely there is. HIMSS is the big U.S. show, obviously in the United States. Belgium sent—well, 16 of their hospitals sent 35 people. There were over 50 people at HIMSS this year looking at the U.S. software. I talked to a good number of those CIOs from those hospitals and they definitely are seriously looking at it, but they are in the initial phases. I mean, if it was a U.S. hospital, I’d say it was going to be a year before this would sell. Right now, they are trying to understand what is the difference between Cerner and Epic, so they haven’t gotten it down to we think that we need Epic or Cerner. They are still trying to figure out what would be best in their environment and what really are the differences, but they are serious.

They have the same problems. Actually, it’s more acute in Europe because Europe’s population is aging and declining at a more rapid rate than the United States, so their healthcare costs are escalating probably quicker than they are in the U.S. The hospital—there’s actually two now, but the first hospital that Epic installed their software in in the Netherlands is reporting fairly significant savings, cost savings, because they have a system that’s now automated where the previous process was to do almost everything manually.

So I think that it’s real. I don’t—you know, we may get a sale this year but I think that more of the hospitals will begin to put out RFPs starting in the early part of 2014.

Rick D’Auteuil – Columbia Management

Is your competition there the same as the competition here, or what’s your position there competitively for healthcare assignments?

James Boldt

Actually it’s virtually the same as it is in the United States. There are some small firms that undoubtedly are going to want to come to the table. None of them have experience with the U.S. software and they’re not in a position where they can get their people trained on the U.S. software, so most likely it will be the same seven, eight players that we compete with in the United States.

Rick D’Auteuil – Columbia Management

And how are you positioned for talent there versus here?

James Boldt

I actually think we’re in a better position there than we are here. In the United States, we can’t get people to take a newly trained staff. They just won’t, even though the person may have healthcare background, they don’t have any EMR background. We subbed to Fujitsu on the NHS project and actually put Cerner software up in two hospitals in the southern region of England, and when we did that, half of the people were local employees that we had recently trained and half of the people were experienced people. It worked just fine. In Europe, because there aren’t people that have experience with the U.S. software packages, they’re just going to have to accept some of the people are newly trained, so I think it’s going to be a little bit easier for us over there to sell clients on newly trained people.

When we had the opportunity in England, we had an abundance of people who wanted to go over. Usually they were people who were either very young, didn’t have families, or kind of empty nesters who wanted to go to England for a couple years kind of on us and work on some projects. So I think the staffing will be a little bit easier over there.

Rick D’Auteuil – Columbia Management

Okay, thank you.

Operator

Our next question is from the line of Kevin Liu with B. Riley. Please go ahead.

Kevin Liu – B. Riley

Just clarifying some of the EMR RFPs that are out there. The large deals that you talked about, the 5,000 beds or $5 million worth, it sounded like those hadn’t been awarded yet. I just wanted to see if that was the case and whether you actually did anticipate receiving some of that work in the latter half of the year.

James Boldt

On the 5,000 bed one we talked about, we’re still waiting for a decision on that one and we think they’ll make a decision sometime in probably the middle to end of the second quarter, so the project dates will then ramp up in the third quarter. The very large project that we’ve talked about in the past, they haven’t even started their—sent out any RFPs, so we don’t think that they’re going to send out any RFPs until the third quarter of the year, and we think it will start up probably in the latter part of the third quarter.

I don’t want to leave you with the impression that we don’t have other RFPs that we’re expecting. Based upon the current sales cycle, I would guess that we’re probably going to get somewhere between two and five RFPs for kind of 1,000 to 2,000-bed hospital systems in the second quarter.

Kevin Liu – B. Riley

Got it. And then on the 100-person headcount increase, how much of that came from the acquisition of etrinity, and then how is the rest divided up between healthcare and non-healthcare?

James Boldt

About 20% was etrinity; very little from healthcare. It was almost all the staffing side of the business actually.

Kevin Liu – B. Riley

Great. And then just lastly, the SG&A line, you guys have been able to actually keep that going down despite the acquisition in the quarter. So just curious what you’ve been able to do in order to control costs there, and where you expect it to go as a percentage of revenues over the remainder of the year.

James Boldt

Well, most of our fixed cost in our overhead costs, our SG&A are in the corporate office. We’ve been this size before. It’s kind of funny – it’s very predictable. For every $100 million, the corporate office generally drops 1% of revenue. So as we get larger, even if it’s on the staffing side of the business, because our operations’ almost totally automated, we don’t have to add that many people in order to support it. In the case of etrinity, it was the same thing – we were able to take them on with really—I don’t think we added anyone in the corporate office in order to be able to process their revenue, again because we’re primarily automated.

I think the for the year, it will probably stay about where it was in the first quarter. I don’t really see it changing much. I don’t actually see it dropping much more from where it is. Fifteen percent for us is a really good level to shoot for going forward. The solutions side of the business actually has more SG&A as a percentage of revenue than the staffing side of the business does, and particularly if they go after more SAS offerings we’re probably going to have to add more sales force, particularly in terms of the state sales. Our existing sales force is accustomed to calling on payors and providers, not so much the states though.

Kevin Liu – B. Riley

Thank you.

Operator

Our next question is from the line of Frank Sparacino with First Analysis. Please go ahead.

Frank Sparacino – First Analysis

Hi Jim. Just had one question. Wanted to follow up on the earlier question regarding the EMR delays. Just curious – are the projects all related to stage one meaningful use, and if so, any feedback in terms of some of the pending deadlines in terms of when the penalties kick as maybe a motivator? And then maybe related to that, do you get the sense hospitals are retrenching in a lot of areas in terms of spending as it relates to overall IT?

James Boldt

In terms of the current projects, they are all meaningful use 1. They are not meaningful use 2 at all.

Frank Sparacino – First Analysis

Okay.

James Boldt

I think that some of the hospitals we see coming out of the woodwork now actually are afraid of the penalties. If they start now, they may get hit with some of the penalties but they pretty much should be done by the time the penalties kick in. Most of the hospitals are working on kind of longer term plans of how they’re going to deal with it, so we haven’t actually seen the cuts—well, I can’t say we haven’t seen them anywhere, but most of the hospitals haven’t actually enacted what they are going to do long-term. Definitely, though, they are reacting to the fact they just lost 2% of their revenue, and I think one of the reasons maybe that they haven’t enacted their total plan is they are still trying to figure out what the government and Obama is going to do in terms of this long-term deal with the Republicans in cutting back on Medicare and Medicaid.

Frank Sparacino – First Analysis

Thank you, Jim.

James Boldt

No problem.

Operator

And once again if you have a question, please press star then one on your phone at this time. Star then one on your phone at this time.

We do have a follow-up from the line of Bill Sutherland with Northland Capital. Please go ahead.

Bill Sutherland – Northland Capital

Thanks. Jim, just wanted to—the portion—the relative growth rates that you’re expecting for ’13 in the revenue guidance, could you run through those again? I have healthcare up 12, non-healthcare solutions up 11, and staffing up 3.

James Boldt

Actually it was 10 for the non-healthcare, so healthcare solutions up 12, non-healthcare solutions up 10, and staffing up 3. So if you look at the first quarter, actually our total healthcare business grew by about 6%. All of our businesses were impacted by the lack of one day of billing, so it’s really more like an 8% if you adjust for that. You know, we think if you kind of step back and look at it that etrinity probably will add about 3% to our healthcare business revenue this year, the SAS offerings probably 4%, so that’s 7% of the healthcare and then 5% from all the rest of our offerings, including EMR, ICD-10, et cetera.

Bill Sutherland – Northland Capital

Okay. And then of course healthcare solutions a little higher than total healthcare because it’s a life science. I assume that’s kind of still flattish?

James Boldt

Yes.

Bill Sutherland – Northland Capital

Okay, thanks guys.

Operator

And sir, we have no further lines in queue at this time. Please continue.

James Boldt

Thank you. We expect another year of double-digit earnings growth for CTG, our seventh out of the last eight years. CTG is firmly established in healthcare, one of the fastest growing major U.S. industries. We have offerings for electronic medical records, fraud, waste and abuse, ICD-10 conversions, accountable care organizations, genomic sequencing, and IT-driven medical management models for chronic diseases, all of which are expected to be in strong demand for several years. As such, we remain very excited about CTG’s future growth prospects.

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 our teleconference call for today. Thank you very much for your participation and for using the AT&T Executive Teleconference service. You may now disconnect.

James Culligan

Okay, thank you, Coleman.

Operator

Thank you, sir. You have a great day.

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