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Computer Task Group, Incorporated (NASDAQ:CTG)

Q3 2013 Earnings Call

October 22, 2013 10:00 AM ET

Executives

James Culligan – Director, IR

James Boldt – Chairman, President and CEO

Brendan Harrington – SVP and CFO

Analysts

Brian Kinstlinger – Sidoti & Company

Vincent Colicchio – Noble Financial

Kevin Liu – B. Riley & Company

Frank DiLorenzo – Singular Research

Rick D’Auteuil – Columbia Management

William Sutherland- Emerging Growth Equity

Operator

Ladies and gentlemen, thank you for standing by and welcome to the CTG Third Quarter 2013 Conference Call. At this point, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions). As a reminder today’s conference call is being recorded.

I’d now like to turn the conference over to our host, Director of Investor Relations, Jim Culligan. Please go ahead.

James Culligan

Thank you, Paul and good morning, everyone. We certainly appreciate your time and your interest in CTG.

On the call today we have CTG’s CEO, Jim Boldt; and Brendan Harrington, Senior Vice President and CFO. Jim and Brendan are going to review the results for the third 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 could 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 third quarter earnings conference call. As you saw in our news release our revenues decreased when compared to last year, as we continue to experience delays in healthcare project starts, as hospitals deal with lower reimbursements caused by sequester cuts and as we experienced a reduction in spending from a significant staffing customer.

Our focus on expense control helped our earnings per share to come in at the midpoint of our guidance and once again caused our operating margin to be 6%. I’m going to talk more about our results and what we see for the fourth quarter and the 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 third quarter of 2013 CTG’s revenue was $100.7 million, a decrease of $5.7 million compared to the third quarter of 2012. Third quarter 2013 had 63 billing days, the same as in the third quarter of 2012. Solutions revenue in the third quarter of 2013 totaled $40 million, a decrease of $4.2 million or 9.5% compared to the third quarter 2012, primarily due to lower revenue from electronic medical record projects. As a percentage of total revenue, Solutions revenue was 40% compared to 42% a year ago.

Staffing revenue in the quarter decreased $1.5 million or 2.5% to $60.7 million, reflecting reductions in staffing from a large client offset by higher demand for technical resources from several other clients.

Third quarter revenue from IBM, our largest customer, was $23 million compared with $28.3 million in the third quarter 2012. As a percent of total revenue, revenue from IBM decreased to 22.9% in the 2013 third quarter compared with 26.6% of total revenue in the 2012 third quarter. The revenue from IBM in the quarter was negatively impacted by approximately $1.2 million when compared with the third quarter of 2012, as a result of IBM’s spin-off of its retail business to another large company. Although this change lowered our revenue from IBM the spin-off did not have a negative impact on CTG’s overall revenue since we’ve retained the business with this new client.

Revenue from our European operations was $18.2 million, a 12% increase from the $16.3 million recorded in last year’s third quarter. The effect of foreign currency fluctuation during the third quarter of 2013 increased consolidated revenue by approximately $1 million. On a local currency basis our European revenue increased 5.6% compared with the 2012 third quarter. Excluding the impact of the etrinity acquisition that we closed in February 2013, European revenue increased by 8% or 2.5% in constant currency.

Direct costs as a percentage of revenue were 79% in the third quarter compared with 78.3% in the third quarter of 2012, reflecting the decrease in the higher margin EMR revenue. SG&A expenses as a percent of revenue decreased to 15% from 15.8% in the third quarter of 2012, as a result of our disciplined cost management. The billable travel expenses included in the third quarter 2013 revenue and direct costs were $2.8 million. The billable travel expenses for the third quarter of 2012 totaled $3.3 million.

Third quarter operating income was $6.1 million, a decrease of approximately $300,000 or 4.3% year-over-year. Operating margin in the third quarter increased to 6% of revenue, a 10 basis point improvement from last year’s 5.9%. The year-over-year decrease in operating income was due primarily to the decreases in our EMR revenue offset by lower SG&A expenses.

Net income in the third quarter was $3.9 million, an increase of $50,000 or 1.3% compared to the third quarter 2012. On a per-diluted share basis net income was $0.23 for the quarter, the same as in the third quarter of 2012.

The tax rate for the 2013 third quarter was 35.2% compared with 39% in the 2012 third quarter. The lower rate is primarily a result of the reversal of certain tax reserves and federal tax credits recorded in the third quarter of 2013 that did not occur in the third quarter 2012.

We expect the tax rate for the full year 2013 to be between 35% and 37% compared to 36.5% for 2012. Excluding the effect of approximately $1.3 million of non-taxable insurance proceeds we received in the second and fourth quarters of 2012, the tax rate for 2012 was 38.4%. The 2013 third quarter results include equity compensation expense of approximately $0.03 per diluted share net of tax, while the third quarter 2012 included equity compensation expense of $0.02 per diluted share net of tax.

Our headcount at the end of the third quarter was 3,800, a decrease of 100 people or 2.6% compared to the end of the second quarter 2013 and the same as compared to the end of the third quarter 2012. Of the 3,800 employees at the end of the third quarter 2013, 91% were billable resources.

At the end of the third quarter 2013 we had no debt and $31.5 million of cash on the balance sheet compared to $29.4 million of cash at the end of the third quarter 2012. Both the third quarter of 2013 and 2012 ended on a U.S. bi-weekly payroll date.

Our day sales outstanding was 68 days at the end of the third quarter 2013 compared with 64 days at the end of the second quarter 2013. The increase in DSO was due to the timing of cash proceeds received at the end of the comparative quarters as a result of the general lengthening of clients’ payment cycles.

Our cash provided by operations in the third quarter of 2013 was approximately $3 million as compared with approximately $6.2 million in the third quarter of 2012 primarily related to change in working capital.

In the quarter we had $941,000 in capital expenditures and recorded depreciation expense of $685,000. We repurchased 224,000 shares of CTG common stock during the third quarter of 2013. With the new 1 million share repurchase authorization our currently purchase authorization is for approximately 1.2 million shares. As it remains accretive to our earnings we intend to continue our repurchase program during the remainder of 2013.

Jim?

James Boldt

Thanks, Brendan. In aggregate revenue declined by 5% in 2013 third quarter with our Solutions business decreasing 9.5% to 40% of our total revenue. The decline in our Solutions business came from our healthcare vertical where our hospital clients faced with a reduction in income and cash flow due to the sequester cuts to Medicare have reduced spending.

In our conference call at the end of July we mentioned we had received one RFP for an electronic medical record project for which the hospital had not decided what IT services firms would be awarded that project. We received one new RFP for an EMR project in the last three months. We are still waiting on the decision on those two RFPs as to what IT services firm will be chosen for those projects.

When we started the third quarter 2013 we had 16 active EMR projects during the third quarter; one project started and two projects ended in the quarter. Therefore at the end of the third quarter 2013 we had 15 active EMR projects.

We also mentioned on our last several conference calls that one of the hospital systems that we had bid on, that had not yet picked an IT services company has approximately 5,000 beds, significantly more than our average client. While we still think we are in a good position to get some of their work the timing of the starting of their project has been delayed. Also the very significant implementation project we previously talked about that was originally expected to start in early 2013 continues to be delayed.

In the short-term we believe that our EMR business growth will be constrained due to hospitals having to deal with the reimbursement cuts that have occurred. We’ve seen hospitals go through cycles like this before where they had to delay capital spending. It occurred in 1998 when the U.S. government balanced the federal budget by reducing Medicare and Medicaid payments. After a period of time the government realized it was beginning to bankrupt smaller hospitals and increased reimbursement.

Again in the first half of 2009 hospitals stopped launching new projects as the tax-exempt bond markets where most hospitals finance their long-term capital needs virtually disappeared. When this credit crunch eased CTG’s EMR business recovered. While the market is again constrained in the short-term, in the long-term there is still a significant opportunity for the growth in our EMR business.

Only 40% of hospitals in the United States have reached the meaningful use stage one threshold. Not all of the software that hospitals use for EMR has been upgraded to meet the standards of meaningful use stage two and many are concerned that some of the existing software cannot be modified to meet the more rigid standards.

The same is true of physicians practices. A recent report on healthcare IT speculated that up to 50% of the practices that had installed an EMR system in the last two to seven years would have to convert to another software application in the next two years as their existing software applications will not meet the increasingly stringent standards that the government is imposing on them.

Further in order to achieve the kind of savings that the U.S. Federal government projected the healthcare system is going to have to exchange health record and that means the health information exchanges or HIEs will have to be built. So you can see why we are still optimistic in our long-term for our U.S. EMR business as most of the work for the healthcare system to convert to electronic medical record still appears to be ahead of us.

And finally we believe that European hospitals will ultimately install U.S. software and that will likely create EMR work for CTG for another decade given our recent acquisition in Europe of etrinity. Recently CTG won our first advisory consulting project for a European hospital. While the initial engagement is small it puts CTG in a position to provide consultants as the project ramps up in 2014 and to leverage our experience on this project for EMR work at other European providers.

Fortunately for CTG EMR is not our only healthcare offering and our acquisition of the etrinity, and our other healthcare offerings continue to have a position impact on our business. We started two new healthcare outsourcing engagements in the second quarter of 2013 and bid on four additional projects in the third quarter. In the current tight provider spending environment we see an excellent opportunity for us in application outsourcing as it supports significant immediate savings for hospitals without them making a large financial investment.

CTG has an outstanding reputation in this area and these engagements are typically for multiple years, providing annuity like revenue stream. In the third quarter 2013 our SaaS offering for the same incremental impact have aided approximately $1 million to revenue and $0.02 to earnings per share as the offerings we had in the third quarter of 2012.

We still anticipate closing at least one additional fraud, waste, and abuse engagement by year-end. Originally we would expect this additional customer would have signed an engagement contract early in the third quarter and therefore aided to income in the fourth quarter of the year. As we’ve not yet signed this new customer and as it would be impossible to process their claims and recover monies by year-end we now estimate that our SaaS offering will incrementally increase our EPS by $0.10 per share at the midpoint of our guidance in 2013 and that $0.03 to $0.05 per share of profit will come from our SaaS offering in the fourth quarter of the year.

Having covered healthcare I would also like to talk about the other three vertical markets in which we focus. Our technology service provider market, which is in all-staffing business declined by 17% in the third quarter 2013 when compared to the third quarter of last year. Our financial services vertical had another excellent quarter. Most of their revenue gains in financial services came from our European operations. Our energy business revenue was flat when compared to the third quarter 2012.

Turning to our staffing business its revenue declined by 2.5% when you compare to third quarter of 2013 to the third quarter 2012. The staffing business was negatively impacted by staffing reductions made by a significant customer in both the second and third quarter.

Looking at the fourth quarter 2013 we’re forecasting total revenue to be in the range of $104 million to $106 million. We are forecasting earnings per share in the fourth quarter of 2013 to be in the range of $0.22 to $0.24 per diluted share.

For the 2013 full year we now expect a revenue range of $420 million to $422 million, or a 1% decrease at the midpoint of our guidance when compared to 2012. Based upon our revenue forecast and the anticipated mix of business we now expect 2013 net income per diluted share to be in the range of $0.93 to $0.95 or a 7% 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 set our recent guidance for the year. First we think our healthcare business will decline by approximately 7% in 2013. For our non-healthcare solutions business we’re projecting a revenue increase of approximately 3%. We are forecasting a 1.5% increase in our staffing business in 2013.

We continue to remain optimistic about CTG’s long-term growth potential. While we are going through a transitional period at this time we expect our U.S. healthcare business to return to growth particularly when some of the larger hospital systems begin their EMR project. In the short-term we expect to see growth in our outsourcing business. With the recent acquisition of etrinity, a Benelux Health IT Consulting firm we have positioned CTG to participate in the adoption of U.S. packaged software by European hospitals.

We’ve been working on a number of betas with states and payers over the last year or so for our fraud, waste and abuse applications. We expect another one of those betas will close before year-end and others in 2014.

We are stepping up the marketing of our IT medical management model following a very successful implementation of large university affiliated medical practice. This offering is a clinical decision support application and alerts doctors when the kidneys of patients with chronic kidney disease are about to fail thus allowing the doctor to intercede avoiding a costly visit to an emergency room.

We are also working with the client to combine genomic sequencing with electronic clinical records. This will only be the third time that we know of this combinations being done. This work will position CTG with one of the first of its kind cutting edge offering in the genomic science field. We think that if you look at how CTG is positioned in healthcare the world’s fastest growing industry you can see why we continue to be optimistic about our future growth opportunities.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And our first question will come from Brian Kinstlinger of Sidoti & Company. Please go ahead.

Brian Kinstlinger – Sidoti & Company

Good morning, thanks, hi, good morning. How are you?

James Boldt

Good.

Brian Kinstlinger – Sidoti & Company

So the first question, I want to – couple of questions I want to talk about SaaS little bit. You gave some clear statistics and guidance numbers. You are looking for an additional $0.01 to $0.03 in SaaS related earnings in the fourth quarter from each of the last three quarters. Can you tell us what that suggest about this second customer, has it already begun to generate revenue or is that $0.01 to $0.03 suggests that it hasn’t generated revenue and it will contribute based on when it starts $0.01 to $0.03?

James Boldt

Yeah, it is the additional customer, we did not get any revenue from them in the second or third quarter the year. It took – and it was just some issues on their end at getting the data et cetera. So we expect in the fourth quarter we will now have the data actually and we are processing it. So we believe that they will be able to recover monies in the fourth quarter then.

Brian Kinstlinger – Sidoti & Company

Has that started to generate revenue or not yet, in October?

James Boldt

Not yet. Actually though we are expecting within a week or so to begin to give them the runs on the fraud, waste, and abuse client.

Brian Kinstlinger – Sidoti & Company

Thanks. Now you’ve talked about and you gave some details on you are still expecting a third by the end of the year. Can you talk about what happened there? It seemed like you thought it would happening about two to three months ago. And maybe comment at the bigger picture of the pipeline, you’ve had five customers in the pipeline for quite a long time, a little bit longer than eighteen months that you expected. Have any pulled out, are they communicating, they are less enticed by the product, may be just take us through how that’s all playing out.

James Boldt

Yeah, I think a lot of the reason for the delay has to be with the current environment. I mean and it doesn’t matter whether they are payers you have to deal with the expenses that just came up, you have to deal with changes that have been made in Medicare and Medicaid and there are lot of our payer customers even, both and the states obviously have to process Medicare and Medicaid claims for the government.

So normally in the fourth quarter of the year if you are payer or even a state you won’t make any changes to your systems or lock down their systems. Most of our payer customers even refuse to let any of their employees take any vacation in the fourth quarter of the year because things are so hectic really doing enrollment for the next year.

And then you add on to that what they’ve got to deal with the ObamaCare changes and I think that it’s just overwhelming. They don’t have more people do deal with it, with all these changes that they are having to deal with, the customer that we think will sign has told us that they want to go forward with it but I think that they are just constrained by the number of people and number of hours they have to deal with and obviously they’ve got to deal with any of the regulatory changes first before they can do something which is good for their business but is somewhat discretionary on their part.

Actually the five original customers we have more than in the pipeline but the five original customers they are all still talking to us. They are also saying they want to do something. None of them have come to us and said we are not interested in it. It’s just taking longer and probably for some of the same reasons I just mentioned.

Brian Kinstlinger – Sidoti & Company

I guess a follow-up to that is well, I lost my train of thought, so I’ll come back to that. The other, the last question and I’ll get back in the queue is on healthcare, it might have dropped 10% sequentially. But the sequester wasn’t new. It was fully impacted in second quarter. So I am curious what you think has happened here. Did you have to lay off EMR staff, is that part of the cuts you’ve had? And do you think we’ll see another drop off for the next six months or so before it re-bounces?

James Boldt

Well what’s happening is we consequently have projects ending so we have more projects ending then starting. And the size of the hospital systems that we are starting are the same that we’ve been starting over the last few years. But they are putting more of their own staff on these projects because if they do that they don’t have to lay their own staff off. So it’s still the sequester’s the problem and the hospital financial conditions really what I think is delaying them from starting these projects.

In order to start a project every one of our clients has to go to the bond market and finance the project and at the moment I don’t think they want to show the bond agencies their financials because they don’t look too well. And there is a lot of public releases, I don’t know of one of our customers that hasn’t laid off people. If you look at some of the public ones, Vanderbilt, that’s in Nashville laid off a thousand people, Indiana University Health laid off 900, of their own employees and Cleveland Clinic is offering buy outs to 3,000 of their employees in order to reduce their cost and they are going to get the cost down about $330 million.

So I – they are dealing with these reductions. And at some point like any other company we expect they are going to get back to a point that they feel comfortable to start going forward but they are just not there yet.

In terms of the fourth quarter I think the revenue rates for our EMR business will stay the same or maybe go up just slightly. The reason it would go up just slightly is that we get better utilization of our employees in the fourth quarter. More people take off vacation in the third quarter of the year and when they are on vacation obviously they are not billing in the fourth quarter.

So we are kind of anticipating that the revenue from EMR will be about the same roughly the same in the third quarter of the year. And we have clients and potential clients that are telling us they are going to come out with RFPs in the fourth quarter, same clients told us they are putting out RFPs in the third quarter. Until we actually know if they issue those RFP it’s kind of hard to predict what’s going to happen in the first couple of quarters the next year.

Brian Kinstlinger – Sidoti & Company

And just about, did you lay off EMR staff or did you keep that level?

James Boldt

Our EMR staff is probably down slightly from where it was. We didn’t so much lay them off. If the project came to an end and most people’s contracts are sometimes tied to those projects and it’s just kind of an natural ending point. But we would have less, I am not going to say it’s materially but we have less EMR consultants now than we had a couple of quarters ago. Some of the people though we’ve actually moved in another, one of the outsourcing offerings that we’ve come up with is in the EMR area.

When we finish a client and you got to remember this is a thousand bed multiple hospital situation. So we’ll finish their EMR project. They then have to support it and that means that you have to have call centers where people will call in and because hospitals operate 24 hours a day you got to have call centers up 24 hours a day and you have to have experts, kind of three levels of experts.

The first level somebody that would help if you couldn’t remember your password, get re-logged on. Second level they might actually walk you through a more technical situation and get to look at some data. The third level up they can actually go in and change the system if they have to in order to meet your needs.

If you think about it from a hospital standpoint you are going to have a lot of calls during the day, fair amount actually at night because emergency rooms then take a lot of people in the night hours. When you get to the 11 o’clock to 7 AM shift you are going to get a few calls but you are going to have a couple of people at least sitting taking those calls, right probably two or three, somebody is on vacation, you got to have multiple levels that you can support.

So we’ve gone and we’ve been successful now a couple of times for our clients and we said look we can actually deliver this much cheaper than you can because well we will have people in the middle of the night that are only taking a few calls and we can have those peoples take calls for multiple customers. I know this is a long intro but we’ve been successful already in a couple of those proposals and we are working on more.

We actually took some of the people who used to do implementations and they are now actually working more in the outsourcing part of the business. So it’s kind of a transfer for some of them.

Brian Kinstlinger – Sidoti & Company

Thanks so much I’ll get back in the queue.

James Boldt

Okay.

Operator

Thank you. The next from Noble Financial we’ll go to the line of Vincent Colicchio. Please go ahead.

James Boldt

Good morning, Vince.

Vincent Colicchio – Noble Financial

Good morning, Jim. Let’s assume the deadline for EMR gets extended beyond next year. Should we still remain optimistic about a rebound in such a case? And if so articulate your reasons?

James Boldt

Well, I think firstly I don’t think – I think if they extend it they are not going to extended until sometime during the summer months and they’ve done that in other areas where they’ve waited until kind of the 11th hour to kind of force people to go forward. And it’s not just the EMR penalty, the incentive goes away and the penalty kicks in October 1st. They have to reach meaningful use 2 October 1st or they have to pay the penalty and they have to be compliant with ICD-10 October 1st or they’re going to lose a lot in terms of revenue.

I saw a report from an investment banking firm not too long ago that indicated that 40% of large hospitals in the United States still haven’t reached meaningful use one. So they don’t have an EMR system. 55% of the medium hospitals and 64% of the small hospitals and there was also data that I think that CMS provided.

To put an EMR system into a large hospital, a 1,000 bed hospital takes two years. There is no way to shorten it. We used to do it in three years, we actually shortened it to two years, that’s about as good as it gets. So if the government decides to delay the penalty by six months or a year, if you are a large system and according to that 40% of the large hospitals in the U.S., still haven’t put EMRs in. You got to start soon because no matter what, if they delay it a year, you’re still going to end up with paying some of the penalty.

I think the bigger problem at the moment is just them dealing with getting their cost back in line. If they don’t have their cost back in line, they can’t go to the bond market and finance the project. So I think they’ve got to work through that cycle first. I don’t think that there will be a bell that goes off and they’ve all done that. I suspect it’s going to be a different time hospital by hospital when they get comfortable and beginning and spending money again. And it depends on what the government does going forward obviously with reimbursements and also how quickly they can cut their cost and get their margins back in line.

Vincent Colicchio – Noble Financial

And did I hear you say that some clients may start issuing RFPs next quarter, fourth quarter?

James Boldt

Yeah, actually we hit several hospitals systems vis-à-vis 1,000 bed type and up hospital systems that originally told us they have got to get their RFPs down in Q3. They’re now telling us they will put their RFPs out in Q4.

Vincent Colicchio – Noble Financial

Okay. And do you have an EMR pipeline in Europe for some of these consulting – for consulting or is this still on...

James Boldt

Well, we started the one project up, it’s a consulting project, but sometime next year we should be able to place consultants on it as they get into their implementation. And there are now hospitals in Europe that are either a couple that have started to sign for their software or at least have narrowed it down to one software package. And that’s – they’ve got to narrow it down to one software package before we really can engage and start to provide consultants.

We can provide a little bit before that, maybe one or so to help them pick the package but after that they need them to get the funding forward and select the software they are going to use to go forward. So yeah, there are hospitals in Europe, that we are calling on, on a regular basis that are trying to figure out what system they’re going to put in and then how much funding they’re going to need and how they’re going to get that funding.

Vincent Colicchio – Noble Financial

And on the ICD-10 side are we missing opportunities there or do you feel like – do you ever expect this to sort of become a big business?

James Boldt

Well, I’d like to get, I’ve mixed emotions on this one, as you know because it’s a Y2K problem, and like Y2K it’s going to end in a particular day. We have one payer that we’ve been working on their ICD-10 solution for a couple of years now. We started up hospitals, ICD-10 project, it was in the first quarter of the year as I recall. And we currently just won another project and we’ll start the implementation of that in the fourth quarter of the year.

In addition to that we started to get requirements, not so much for running the entire project but for additional resources. A lot of clients think that they can do this themselves. We’re not quite sure that they can do it totally themselves. So we’ve started to begin to place people at customers, just individuals doing ICD work with the hopes that eventually they will realize they need a lot more help to bring a lot more of our people.

Vincent Colicchio – Noble Financial

So you’re working on two projects right now, is that right?

James Boldt

We’re working on two, currently, one hospital and one payer. And by the end of this quarter we’ll staff up the third hospital project.

Vincent Colicchio – Noble Financial

Okay. I’ll go back in the queue. Thanks.

James Boldt

Okay, thanks.

Operator

Thank you. The next from B. Riley, Kevin Liu, your line is open.

Kevin Liu – B. Riley & Company

Good morning, guys. Jim, you mentioned you’re seeing some of your hospital customers lay out lot of staff. You touched on projects that you guys have some natural attrition that happens is small. Given what you saw the last time the cycle was pretty strong, does it make sense to be adding more heads on the healthcare side now in anticipation of kind of the next upturn?

James Boldt

Well, that’s always a tough decision that we have to make because there are resources available in the market, we could hire them for the bench that will cause obviously our expense to go up. And at the moment we think that if we need to start a project we can find the resources we need. So at the moment that doesn’t seem to be a compelling reason to add to the bench and expense. When we start to see projects start up, when we start to see RFPs come out, we probably will begin to do it.

Kevin Liu – B. Riley & Company

And I guess maybe this is similar type question, so given the environment that you’re in now, are there more opportunities on the acquisition front for firms that are focused on healthcare IT services?

James Boldt

I would have to say, yes. We are seeing more opportunities for us to acquire companies. We are though very focused. I think as you know on what we are looking for, we only want IT solutions companies with a focus on healthcare. One of our focuses is in data analytics. We have couple of data analytics offerings already out there, the SaaS offerings for instance.

The other area that we think will be strong for a couple of years is in ICD-10. So those companies tend to be more in revenue cycle management.

Kevin Liu – B. Riley & Company

Got it. And then just with respect to the large EMR implementations that have been delayed so far, what’s – what are you hearing from your customers around when they actually intend to start these back up and is there any risk here that they fall off and you either have to go out to rebid again or perhaps they decide to look for other ways to get these implemented more cost effectively?

James Boldt

Yeah. Actually we’ve only bid on one of them. And you are right, the bid’s getting a little stale because they received all their bids, I think in late March. I think they were ready to go. And remember it was kind of the middle of the March before the government decided or Obama announced that the sequester was going to happen. And I think they just got caught and they too I don’t think have done their financing and are trying to figure out what to do.

Kevin Liu – B. Riley & Company

Got it. And maybe just going back to the European win you announced, could you talk a little bit about how that opportunity kind of unfolds in terms of how much staff you allocate initially, what you’re getting paid for. And then, you kind of can ensure that you’re working on the actual implementation?

James Boldt

Okay. It was very – it’s kind of funny because the initial engagement itself was a clearly a consulting one that helped them get going in terms of the project and make sure that it was working correctly. You think that it would have been the biggest project in the world because everybody sent their head of healthcare from United States over to bid on it. And we bid against the usual people we bid in the United States. And we were the only consultants firm that they picked.

So we’re helping them get started and doing what I would consider very high level consulting on that. And at some point next year we believe that they are going to need outside resources. I think they believe that too. And they’ll begin to ramp up. But quite frankly right now, they’re still trying to figure out how to get the project done and how many consultants and what the mix is going to be going in next year. So it’s going to be a couple of quarters.

Because we’re the only consulting firm in kind of inside the tent, we have the best shot at placing consultants once the project ramps up.

Kevin Liu – B. Riley & Company

And then switching gears to the staffing side of the business, with IBM’s hardware business kind of still struggling here do you feel you’re seeing all of the cuts you would expect and that’s fully embedded within kind of the expectations for Q4 or are there any potential cuts that could still be coming here ?

James Boldt

We don’t know of any more cuts that are coming. And I can only – I can’t talk about anything that isn’t public. So I’m limited to the public disclosure. I’m sure you looked at the IBM’s release et cetera. If you look at the transcript of IBM’s conference call, their CFO indicated that the reason that STG, which is the hardware division, revenues were down, they were down 17% last quarter.

It was that their revenue in China dropped by 40% in hardware sales. And apparently the Chinese government does a relook at the economy every five years or something like that and comes out with a new plan and that plan is scheduled to be out in November. So he tended to indicate that the revenue had dropped to 40% and that they were expecting probably, well, he put it a day after the first quarter of next year that the business would come back as the government accepted their plan and then they went back to that kind of business as normal.

So if you read the transcript, your impression is that they had this problem; they’ve gone through it; and addressed it. He talked about STG’s numbers and that they expect demand is going to be start to back up after the first quarter of next year and that’s really about the best insight we have.

Kevin Liu – B. Riley & Company

Thanks for taking the questions.

James Boldt

Okay. Thank you.

Operator

Thank you. Next we’ll move to line of Frank DiLorenzo of Singular. Please go ahead.

Frank DiLorenzo – Singular Research

Hi, how are you. I’d appreciate if you could give us an update on how you are thinking along the lines of acquisitions we’ve in force strategic acquisitions and also if you are starting to think internally about may be some other growth areas to kind of get the growth engine going and not just in healthcare but with regards to IT and some other spaces, whether it’s technology, energy, financials et cetera? Thanks.

James Boldt

Okay. As I mentioned I think in answer to a previous question we are looking for acquisitions in healthcare, healthcare IT. Our main focus there is in data analytics. We also think when the ICD-10 conversion happens that it’s not going to be a one day event. The new codes are so complicated that’s probably going to take a couple of years of working with the doctors and coders to get the hospitals revenues back up to where they were before.

So we also have an interest in finding an ICD-10 or most likely would be a revenue cycle type company because there would be an offering that would augment our existing ones. And in the near-term we are very focused on our SaaS offerings. We talked earlier about fraud, waste, and abuse. The IT medical management model, we did have a very successful implementation.

Starting in September we really have the total package that we could go to a payer and present to him because now we have not just a physician’s practice but also a hospital who has used medical management model and we have a whole department full of nephrologists that will go with us and say this absolutely works. This does provide the doctor with enough information so that they can avoid emergency room visit by patients with end stage renal disease and those visits usually on average run $30,000 to $40,000 a year.

So we have already approached payers and we’ve either done proposals or are in the process of doing proposals for that application as well. So we are expecting that application to roll out next year. We have thought and are somewhat tempted about other IT services but if you look at the IT services market in general it’s off. I mean if you look at IBM is the largest provider of IT services in the world and for the last three quarters their revenue has dropped 3%.

If you look at HP they are probably number two, I think their revenue last quarter was up 8% or 9% in their services area. So it’s not like you can look to another industry and say hey that industry is much more robust than healthcare. If you step back and look at kind of the global picture, the baby boomers are still getting old at a rapid rate while the government is really so much penalizing hospitals at the moment and physicians by reimbursing them less than it costs them to treat a patient and while that works – while that helps the Federal government it doesn’t help the healthcare system.

No matter what people do there is going to be more people that are older, over the age of 65 for each one or probably the next 20 year. When we looked at healthcare and decided that we would focus in at it mainly because of the changing demographics it was 2000 and healthcare was 8.1% of the U.S. economy. It’s 18% of the U.S. economy and still most of the projections that are out there, unless something dramatically changes if the U.S. decides they are not going to take care of their older population. Healthcare may become 40% of the U.S. economy at some point. And as it grows it’s kind of squeezing out other growth and other industries.

So we are still of the opinion that healthcare is the right place to be long-term. And I don’t want to lose focus and take our resources and look to somewhere else. And then in a year from now or next quarter have the healthcare market come back.

Frank DiLorenzo – Singular Research

Sure. Okay, thanks.

Operator

Thank you. And next from Columbia Management, Rick D’Auteuil. Your line is open.

Rick D’Auteuil – Columbia Management

Good morning. Just did you guys say what your DSO number was in the quarter usually you do I think?

Brendan Harrington

Yeah it was 68 days at the end of Q3. Mainly it’s the hospital, hospitals have slowed down on payment to us. And it really is annoying to me because like I can look at the hospital’s balance sheet and realize they still have $500 million or $1 billion of cash. And one of, as you know when you do a bond raising your operating margins and cash on the balance sheet are two critical factors and basically they are slowing down their payments to make their cash liquid.

Rick D’Auteuil – Columbia Management

Okay. So if I look at the last stage you release on the year-to-date other, on the cash flow statement, other operating items, is that just DSO creep primarily for what you just said, the 15 million outflow?

Brendan Harrington

Right. Yeah that’s correct, that’s the majority of it.

Rick D’Auteuil – Columbia Management

Okay. So it’s flat revenues so it’s got to be the explanation. I mean is there is any way to do – you have any influence on the timing of that or have not...?

Brendan Harrington

We have our people calling them up on a regular basis. The one comment that I get back, I often see the comments the hospital say somebody went on vacation and they can’t approve it for three weeks so we are going to be three weeks late which you think about it as borders on the absurd. They are just slowing down on their payments because they’ve got a problem. Fortunately for us I mean the smallest hospital we are dealing with is probably a thousand bed, they probably have $400 million of cash on their balance sheet. We are ultimately going to get paid, it’s just that it’s delayed for days.

Rick D’Auteuil – Columbia Management

Okay. What were DSO last year?

Brendan Harrington

They were 61 days last year at the end of Q3.

Rick D’Auteuil – Columbia Management

Okay. And the IBM influence is probably it helps you a little bit for that business to be down some?

James Boldt

Not and actually it’s hurting us at the moment because the IBM contract’s structured for a certain number of days and they abide by it.

Rick D’Auteuil – Columbia Management

Okay. And then I know when you said both this quarter and last year Q3 ended on a payroll date, did Q2 end on a payroll date?

James Boldt

No, that was, I think between a payroll date.

Rick D’Auteuil – Columbia Management

So incrementally just a quarter-over-quarter there was a little working capital as far as the math, right?

James Boldt

Correct. We also repurchased shares, that’s the other thing that happened in cash, we purchased a couple hundred thousand shares in the quarter.

Rick D’Auteuil – Columbia Management

But that wouldn’t end up flowing cash flow from operations though, right Jim?

James Boldt

No, it would not but it does influence the cash balance of it.

Rick D’Auteuil – Columbia Management

What the swing factor on payroll versus off payroll in dollars?

Brendan Harrington

My payroll is about $9 million every two weeks so it’s probably 4.5.

Rick D’Auteuil – Columbia Management

Okay, all right. That’s all I have, I appreciate it, thanks.

James Boldt

Okay, thanks.

Operator

Thank you. Then we are back to Brian Kinstlinger of Sidoti & Company. Please go ahead.

Brian Kinstlinger – Sidoti & Company

Right, thanks. Couple of follow ups. First of all as you mentioned in January you guys started showing fraud, waste, and abuse into other targets other than your initial view, can you talk about how many you have may be in total and also how that procurement process and selling process is progressing compared to how it was progressing six to nine months in on your initial bunch?

James Boldt

I don’t actually have in front of me the number of customers that we have called on but it is progressing and they are following the normal pattern but again we think this is a relatively long sales cycle it’s not a quick as our EMR for instance from proposal to selection. But we definitely are out selling more than the initial five or at least attempting to sell more than the initial five, fraud, waste, and abuse.

Brian Kinstlinger – Sidoti & Company

Well with the – you have two referenceable small clients and with the adjustments you’ve made to the software to improve the positioning to collect monies for small hospitals, help the smaller hospitals, do you still expect the sale cycle will improve for the smaller hospitals, I mean the smaller payers or are you not as sure now?

James Boldt

It’s just shortened because getting – we had the original customer that we worked with getting the next one signed with only having one reference is much tougher than if we have a bunch. Having two is easier. And if we expect we will land one by the end of the year and having three references is even better. So as we go on the sales cycle should shorten.

Brian Kinstlinger – Sidoti & Company

Okay. Moving to the European consulting contract that you got, can you talk about how many beds their hospital has, can you mention what country, I know you are pushing in a couple of countries stronger than others, that would be helpful.

James Boldt

Well actually the country was England and I am not sure of the number of beds but I suspect that’s got to be 500 or 1,000 beds at least. And it’s – I can’t, I don’t have the permission from the customer to give out their name but it is one of the premier hospitals in England. So in the United States it would be like saying that we had just one, the Mayo or Cleveland Clinic.

Brian Kinstlinger – Sidoti & Company

Got it, okay. And Germany I think is the place if I recall where you are positioning yourself as well, is that right and is that market starting to heat up at all?

James Boldt

No, it’s actually, it’s the Netherland, Belgium and Luxembourg. It’s – the market is progressing. I mean they have started to kick the tires, they are starting to narrow down their selections. When we bought etrinity we bought it – if they followed the decisions cycle in the United States we figure there are at a least a year off from making a decision. So we didn’t really expect decision until next year.

Actually if we go back and look at the original forecast we are actually ahead because this hospital made the selection, has picked the software package and actually has us in doing some consulting as they start off.

Brian Kinstlinger – Sidoti & Company

Okay. And then the last set of questions is I am interested in the medical IT management model. You mentioned you are rolling it out next year. And I am not sure when you say you rolling out does that means it’s available for sale? Or do you think you’ll actually have some clients and generate revenue? And I guess then in addition to that the way you went to market with fraud, waste, and abuse where you selected a handful of customers and that could be sizable and worth, that would provide returns, how are you going to market with this software?

James Boldt

We are doing it a little bit differently. We’ve actually the first place there we’ve proven the application in [inaudible]. What we did was we narrowed the application so that we are only focused in on avoiding these – are primarily focused in on avoiding these emergency room visits. We actually decided that we would go to customers we already do business with because we could get in quicker with that and shorten the sales cycle somewhat and we do absolutely expect to have revenue from this next year.

Brian Kinstlinger – Sidoti & Company

And then given these are customers you already worked with the last question I have got is can you take a stab at what the sales cycle might be for this?

James Boldt

I think for customers we’re already doing business if we are successful we probably could do that within a six month period of time. I would think six to nine months period they are going to do it in that?

Brian Kinstlinger – Sidoti & Company

Great, thanks so much.

James Boldt

Thank you.

Operator

Thank you. The next from Emerging Growth Equity, Bill Sutherland. Please go ahead.

William Sutherland- Emerging Growth Equity

Hi, Jim.

James Boldt

Hi Bill.

William Sutherland- Emerging Growth Equity

Hi, I just have a couple at this point. I am curious on the outsourcing deals you’ve had to, I guess start-up here, what was it, Q3?

James Boldt

Q2.

William Sutherland- Emerging Growth Equity

Q2.

James Boldt

And we bid on four in Q3.

William Sutherland- Emerging Growth Equity

So now additional. Kind of curious about the size of these and you mentioned that they have quite a long runway to them so are these not those transitional outsourcing deals that you have been getting in the midst of these, all these projects going on?

James Boldt

Well it’s a mix actually. It’s a mix of transitional and we are actually supporting the new application. It’s going up. On average the four we are about $3 million a year in revenue. One of the things about the transitional one and I often think this is funny and this is not in healthcare was actually in a manufacturing environment. But we’ve bid on doing an outsourcing in 1992 to maintain some legacy applications that the customer was working on and that customers was actually putting in SAP.

And in two years they were going to be finished with SAP and we’d shutdown the application. We still have people working on those old application because often when customers put up the new one that discover there is some functionality they need from the old one and we continue. It’s not unusual for us to get a temporary outsourcing that is expected to last a year or two and it’s five years. So it’s hard to tell really, till they actually put the new application.

William Sutherland- Emerging Growth Equity

So you say these are a mix of that and putting in new apps.

James Boldt

Yes.

William Sutherland- Emerging Growth Equity

And I just had a – of the four you are bidding on, they are 3 million each or in aggregate?

James Boldt

Each, no, no, each. So they will be 12 million roughly in aggregate.

William Sutherland- Emerging Growth Equity

Per year?

James Boldt

Yeah.

William Sutherland- Emerging Growth Equity

And so you cover the DSO issue what was healthcare revenue in the quarter?

Brendan Harrington

Healthcare revenue in the quarter was 31% it was 31.7 million.

William Sutherland- Emerging Growth Equity

Okay and that includes a little bit of staffing, doesn’t it?

Brendan Harrington

Yes.

William Sutherland- Emerging Growth Equity

Okay. All right that’s all I had, gentlemen, thanks.

James Boldt

Thanks.

Operator

Thank you. The next from [Loffman Financial Group, Bill Loffman]. Please go ahead.

Unidentified Analyst

Jim, Good morning.

James Boldt

Morning, Bill.

Unidentified Analyst

Could you talk about your other potential successful offerings as you’ve done with renal, kidney failure with the group of nephrologists, what about the chemical dependency, mental health, coronary heart diseases and several others that you hope to have offerings in markets those, any progress in those areas?

James Boldt

It’s a good question. We actually do have opportunities in those other areas. So for congestive heart failure for instance we found a way to – often patients with congestive heart failure are misdiagnosed, they are diagnosed as having asthma or something else. And we have an application that can identify the patients that have been misdiagnosed and it’s more than 75% accurate. And all that happens is those patients identified have to have a $15 blood test and you can tell whether they’ve been misdiagnosed or not.

The cost actually, the treatment for asthma ironically is about a $1,000 a month and it’s probably a $50 a month if they’re being treated for congestive heart failure and the biggest problem is with the patients being mistreated have the potentiality of a heart attack before the physician realizes that the diagnosis isn’t correct.

What we’ve decided to is and there are – and I don’t want to go into them on a call like this but there are other areas that under those grants we discovered that we can launch applications but we need to be more focused. I guess if I let the guys work on it we will have a lifetime of doing research and coming up with more new things.

So what we decided to do is launch one where the payer in this case has a significant opportunity to reduce cost by about $35,000 a patient, get that up in running for multiple payers and then at some point when we are getting enough of a revenue strength from that go back and launch another one. We believe and Brian talked a little bit about this, about the sale cycles but if we’ve already sold the end state renal disease model to a payer and they’ve reduced their cost significantly selling them the next module will be a much shorter sales cycle.

Unidentified Analyst

Good point. One more comment. Given the multiple millions of shares of CTG stock that traded over the last two to three months, I lost track when it went over 6 million and given your purchase of 225,000 shares at a price of $18 and change in the last quarter, I would have thought you would have purchased more shares and possibly even more in the $15, $16, $17 area any comments there?

James Boldt

Well unfortunately companies have different rules that they have to play by. So we are not allowed to be the first purchase of the day and I don’t think we can be the last purchase of the day. We are limited as to how many shares we can buy a day, it’s called the retail non-block shares basically. So and if we buy one share in the morning and a block becomes available retail we can’t flip and buy the block. So when stock price drops we start to buy shares but we get limited in how many shares we can buy in a day.

And with the limitations, I don’t know what it is currently but it’s usually like 15,000 shares to 25,000 shares. As the price begins to recover and we see that there are buyers in the market we generally stop. If we are buying and there is a buyer in the market no one’s helped, the company is buying at a higher price and whoever is trying to accumulate shares are buying at a higher price.

So we try to buy when the markets – when they aren’t significant buyers in the markets. 200,000 shares I think this year so far it’s been a little over $5 million in buying back stock it’s not an insignificant amount of shares or dollars.

Unidentified Analyst

I’ve been with you for years you’ve done a great job and all we have to do is keep you healthy, the energy you are having keep it going you are going to have a great future and I appreciate your time.

James Boldt

Okay, thank you.

Unidentified Analyst

Thank you.

Operator

Thank you. And next from Columbia Management, Rick D’Auteuil, your line is open.

Rick D’Auteuil – Columbia Management

Just a couple of follow-ups please. On the hospital outsourcing deals that you have or are looking at how does that sort of fit into your margin mix, is that better than company average but not at the EMR level or just for a general – give me a general guideline for that.

James Boldt

Okay. It’s kind of funny because the direct profit on outsourcing is lower than in EMR. The SG&A is also lower. So when you get to the operating income line outsourcing operating margins are virtually the same as EMR margins.

Rick D’Auteuil – Columbia Management

Okay. That’s helpful. And the expectation is that these are not – these could go a couple of years or what’s the duration on average?

James Boldt

Yeah, even a temporary outsourcing usually goes 18 months to two years, at least that’s what we were told initially. But as I mentioned before, it’s very common for one of those to go four or five years until they actually sunset those old applications.

Rick D’Auteuil – Columbia Management

Okay. And then, unrelated but the fraud, waste and abuse assignment that you’re hoping to win this quarter, if in fact you do win that, is that likely to be – are you going to be able to put a press release out on that?

James Boldt

I don’t know. We’ll have to decide that. We, in the past typically haven’t done press releases when we won a particular piece of business. So we’re going to have to – I know that there is a sensitivity at the moment and the other problem we have is there is a biggest gap between this call and the next call, so we’re going to have to decide whether it warrants a separate press release or not. And we really haven’t decided that.

Rick D’Auteuil – Columbia Management

I mean actually if in fact it’s something that will be precise that seems like that would make sense.

James Boldt

That’s right.

Rick D’Auteuil – Columbia Management

Okay, all right. Thank you.

Operator

Thank you. The next from Sidoti & Company, Brian Kinstlinger. Please go ahead.

Brian Kinstlinger – Sidoti & Company

Sorry, just one last question, maybe a follow up. But the five that are still on your pipeline from fraud, waste and abuse, you seem to now have targeted one you expect to be signed by the end of the year. I think previously you said you have a couple towards the end of the stages and so you expected at least one would hit. I think it’s a little bit of a change that you see that one now.

I’m curious when you expect decisions from maybe the other four, is that a first quarter event, first half event, maybe just give us some timing assumptions that you guys sort of think you’ll hear decisions?

James Boldt

Well, I guess we said that one that we’re going to land it’s possible it’s out of the original five. The – and that is based upon discussions we’ve had with the client obviously. It – I don’t know how we can project when the other ones would. I actually would have thought by now the other ones would have closed. But it goes back to the issues they’re dealing with and the priorities. So I don’t want to kind of handicap when we expect another one to close because quite frankly I just don’t know when that is.

Brian Kinstlinger – Sidoti & Company

I guess that – I think it’s new information I think that, I know you said you might land one out of the original five but I guess I assume that your promise today was that one of those five you are going to land by the end of the year. And now that is not the case – those five are all large payers or states. Are you expecting the one that you’re going to land will be larger than the two very small insurers you have and maybe be give us some magnitude?

James Boldt

Yeah, the – I guess what we’ve said in the past is that we expect one to close by the end of the year and that it’s the – that ended the year significantly larger than the first two that we already have engagement.

Brian Kinstlinger – Sidoti & Company

Great. Okay, thank you.

Operator

Thank you. Then with that, there is no further questions in the queue at this time.

James Boldt

Thank you. CTG is firmly established in healthcare, one of the fastest growing major U.S. industries. While on the short-term our hospital clients have to deal with the reimbursement reductions imposed by them by the U.S. federal government they still have significant long-term information technology needs.

We have offerings to meet the IT needs of providers and payers, including 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 long-term future growth prospects.

I would like to thank you for your continued support and for joining us this morning. Have a great day.

Operator

Thank you. Ladies and gentlemen, this conference will be available for replay after 12 noon Eastern Time through October 25th at midnight. You may access the AT&T Executive replay system by dialing 1800-475-6701 or international 6 – excuse me, 1320-365-3844, and entering the access code 269075. Those numbers again, 1800-475-6701 or 1320-365-3844, with access code 269075. That does conclude our conference for today. Thank you for your participation and for using AT&T. You may now disconnect.

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