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Computer Task Group, Incorporated (CTGX) Noble Financial Equity Conference January 17, 2012 12:00 PM ET

Unidentified Company Speaker

(Technical Difficulty)

77% of our revenue now comes from those four fast growing industries. Towards the end of 2004, we are looking at our strategy and we realized that we grow quicker and be much more profitable. We focused in primarily in IT solutions for healthcare. So since the beginning of 2005, almost all of our discretionary investment money has gone into our healthcare vertical. And as I go through the presentation, I’ll explain what we invest in.

The pie chart on the right side of this page shows the offerings at the highest level. The highest level will really only have two offerings, it’s IT staffing and IT solutions. In a staffing engagement, we’ll provide a technical employee usually a program or an analyst. In a solutions engagement, we will take on responsibility for something inside of our clients’ IT environment, almost all of our healthcare businesses, IT solutions, because we’ve been focused on it. The solutions side of our business is growing much faster than our staffing side.

In the third quarter of the year, for instance, our staffing business grew by 11%. The solutions side of the business grew by 36%. Obviously, that’s good for us, because the two sides of the business have very different operating margins. The aggregate operating margin in the staffing side of the business is usually about 3%. It’s 10% in the solutions side of the business. We’ll talk more about that as we go through the presentation as well.

In 2001, we picked healthcare for pretty simple reason, the world’s population was aging as people get older they spend more in healthcare. So, we reasoned that the healthcare industry would have more money to spend on us, IT services. Healthcare was 16% of the GDP in 2009, 17% in 2010, it’s projected to be 20% of the U.S. GDP by 2015. There are lot of forecasts out there that speculated as the Baby Boomers gets older that the U.S. may have to spend as much as 40% of the GDP just on healthcare. Now, we don’t know if the U.S. will ever hit the 40% mark or not. What we do know is healthcare was the fastest growing major industry in the world during the last five years and its projected to be the fastest growing major industry in the world for the next decade and that’s really why we are focused on it. We want to participate in that growth.

Taking a look at some growth drivers, one is certainly in inadequate medical record systems, President Obama went to Congress in the first quarter of 2009 and he asked for money for electronic medical records and he got a lot of it. There is $19 billion in the stimulus package, they are a legislation for electronic medical records, less than $1 billion of that’s been spent. So, there is $18 billion yet to come. In addition to the RL legislation on the same day, Congress passed the HITECH Act. Under the HITECH Act, every physician in the United States gets between $44,000 and $64,000 each. Every hospital gets between $2 million and $11 million each. They can prove a meaningful use of electronic medical records. Those payments are in the form of higher payments under the Medicare and Medicaid system between 2011 and 2014. In aggregate, it’s estimated those payments will amount to $40 billion to $45 billion. So in one day, President Obama got somewhere between $59 billion and $64 billion for electronic medical records. HITECH Act is an unusual piece of legislation and here is both a carrot and a stick.

Starting in 2015, the reimbursement goes away and it’s replaced with a penalty. We don’t have an EMR system in 2015. You begin by losing 1% of your Medicare and Medicaid. It goes up to 5% over a period of time. So, it is just one of the leading suppliers of IT services for electronic medical records, somewhere between the third largest and fifth largest in the United States and most likely in the world. We’ve been in this business since 2003. In 2003, we begin to install software packages made by companies like Epic, Cerner, Siemens, Meditech, and hospitals.

We go to market two ways. We first go based upon our quality. Hospitals have a radiant service, it’s called KLAS Enterprises. KLAS rates every IT services company on every project, every month, and publishes an aggregate rating. And if you got the KLAS ratings for the last three years and look to the clinical ratings, which is the area where EMRs fall almost every month for the last 36 months. CTG was rated number one in quality, couple of months we dipped to number two, only for a month, we usually pop right back to number one.

There is an article that appeared in InformationWeek. In the first line of the article, they asked a question. Who to call for help with health IT? They answered in the second line, Affiliated Computer Services, CTG, and Deloitte, top KLAS’ list of electronic medical record and clinical systems consultants. If you read the whole article what it says is that, well our quality is number one. They didn’t think the other two companies, where that far below us. So, they grouped the three of us together. The next highest rated company was Accenture and they were 10% below the lowest of the three of us. And the article actually says, you pick somebody whose quality is 10% below, you are going to notice that when you do your implementation.

So, first we go and point to the fact that our quality is number one. Second way, we go to market is based up on price. Starting about six years ago, the large aggregators bought everyone of our competitors. There is only seven IT services companies left in the United States that can go into a 1000-bed hospital and install an EMR system as a solution. There is an eighth competitor actually it’s a software vendor has the services arms.

The seven IT services companies though are IBM, CSC, Affiliated Computer Services, they were bought in 2010 by Xerox with their EMR work. Deloitte Consulting, Accenture, Perot, they were bought in 2010 by Dell for their EMR work in CTG, obviously by far were the smallest in the group. It’s common in our industry for one of the large aggregators’ corporate office to run 20% to 25% of their revenue.

CTG’s corporate office runs less than 5% of our revenue. So, when we bid on a project we’ll generally bid 15% to 20% less than they do, because we don’t need to pay for a large corporate office. And we’ll point to the fact that our quality is number one. That’s been a very successful strategy for us. In the last five years, we’ve won 83% of all the bids that we have made for electronic medical record work. No other vendor could be over 20%. Some other areas for future growth in healthcare for CTG and there quite frankly are a lot. One is the ICD-10 conversion. ICD stands for the International Classification of Diseases. It’s a coding system maintained by the WHO, the World Health Organization. The WHO came out with ICD version number 10 in 1993.

The U.S. is the only major industry in the world that has not adopted it. The U.S. is still on ICD number 9, which came out in 1977. The reason is we are the only country in the world that uses the coding system, not only for diagnostic purposes, but also for billing purposes. So, it’s much more complex for us to convert. There are about 14,000 codes under ICD-9. There are approximately 140,000 codes under the ICD-10 that the U.S. is going to implement.

CMS, which is the government agency that controls Medicare and Medicaid originally set the conversion date in 2010, postponed it to 2011, and then they postponed it to October 1 of 2013. Last time, they postponed it they pre-announced that they would not postpone it anymore. They have a real problem. They run on the codes. So, every time that the WHO, the World Health Organization identifies a new disease that they think should be followed, the U.S. first test to figure out whether we are going to follow or not. If we decide to follow it, then CMS has to stop following an older disease and assign the older diseases number to it. It’s estimated that it’s going to cost the U.S. between $4 billion and $30 billion to make the conversion and hospitals now are just starting to do their assessments as to how much it’s going to cost them.

Accountable care organizations or ACOs are an outcome of healthcare reform. Currently, as you know, Medicare and Medicaid pay hospitals for overnight stays and doctors for doctors’ visits. Under healthcare reform starting in January of 2014, Medicare and Medicaid are only going to make a capitated payment, so the total one payment to an accountable care organization has to be a provider when a patient is diagnosed with the disease. So, the disease could be end-stage rental disease where their kidneys are failing, cancer etcetera. Patient could have the diseases for 2 to 10 years. That accountable care organization is totally responsible for their care of the entire time that they have that particular disease. The ACOs don’t exist yet. Quite frankly, we don’t think all the IT systems that they need exist yet either. It’s estimated that it’s going to cost the U.S. over a $100 billion to establish the ACOs and really that’s got to be spend in the next couple of years.

Health Information Exchanges or HIEs, our another new emerging area for CTG. When a community goes to bring up its community-wide EMR, they have to establish a network. In a city with a population of about a million, there is usually about 15 hospitals, there is usually around 2,500 to 3,000 doctors. For them to transmit their records directly to each other would be a nightmare. So, in the communities, where we have begun to bring up community wide EMRs, the payers and providers have first established a health information exchange and not for profit.

Once it’s up and running, everybody in the community transmits their EMRs into the HIE’s network and HIE figures out how to get it to the physician that needs it. CTG has as much shift and more experience in the HIE space as any other company in the country today. We also have three new offerings. These are being delivered as software-as-a-service, which is in the area of fraud, waste and abuse that’s estimated between 3% and 10% of all healthcare claims in the United States are totally fraudulent waste for an abuse of the system. There are fraud, waste, and abuse applications on the market today, what they focus on that was the ICD code. They want to make sure if you have a particular disease, only certain ICD codes are paid for them. For the last four years, CTG has been developing an ontology for fraud, waste and abuse. An ontology is an IT system that uses an expert language to pull data from despaired databases and put it together and analyze it. So, you have better information and we have proven through the use of ontology is that our clients will be in a much better position to detect fraud, waste, and abuse.

The second is a healthcare underwriting implication that better assess its financial risk on underwriting group medical plant. And the third is an IT medical model that improves patients’ outcomes while lowering cost. It was designed for the 10 severe and chronic diseases that account for about 70% of all healthcare costs in the United States. The disease that we have done so far is end-stage renal disease. When you have end-stage renal disease, you have your blood work taken every month, you see a physician every month. He looks at one stated blood work and he will decide whether or not he is going to change your treatment or not.

Unfortunately, when kidneys are failing, they slowly fail for a period of time and then they rapidly fail. Most patients with end-stage renal disease end up in an emergency room. Their kidneys are failing. Toxins are building up in their blood system. The only thing the emergency room could do for them is give them a drug like Epogen. Epogen is very good at flushing our toxins in your bloodstream, has two limitations, takes 24 hours to work, and it’s very expensive. So, on the first day in the emergency room, they give you a massive dose of Epogen hoping to release you on day two. They send you to a specialist that you need to go over the dialysis that takes three months from that point, treat over the dialysis.

So, couple of times a week you’ll see a specialist and he will continue to treat you with a drug like Epogen chemically managing the toxins in your bloodstream. The application that we designed pulls the electronic copy of your blood work that payers and providers are beginning for years. And it does trend analysis on it and runs algorithms on it. And by doing that, we can calculate an intervention point before your kidneys start to fail. And at that point, we say that your physician should transfer the patient to a specialist and they should probably decide whether or not they should change the treatment. Obviously, it saves a lot of cost to the healthcare system and it’s a better care for the patient.

Taking a look at the technology service provider market, what are some of the growth drivers there? Gartner, who follows our industry estimates of more than 50% of all U.S. IT staffing demand will be procured by the large aggregators in 2012. The reality is when IBM outsources one of its clients’ IT departments, it immediately stops using the 200 IT services companies that it’s client used to use and IBM only use the 15 companies that are on IBM’s preferred provider list. Obviously, CTG is one of those companies. So, large volume, low cost model requires a geographic presence that’s shifting business from the small regional players to the larger national firms like CTG, got a great relationship with IBM. They were 30% of our total business in the third quarter of 2011. We think that IBM has probably been our largest customer for our entire 46-year history. They just renewed our contract for another three years. The only thing we deliver to this market obviously is staffing.

Taking a look at some financial results in the third quarter of the year, our revenues increased from $84.5 million last year to $101.1 million, that’s a 20% increase in revenues. Earnings per share increased from $0.13 last year to $0.18, that’s a 38% increase in EPS. If you look at our revenues and earnings over the last few years, our earnings have increased at a much more significant rate than our revenue. The reason is we are getting more solutions in our mix and they are more profitable than our staffing business.

The next couple of slides show numbers for the fourth quarter and the year. We actually haven’t announced our numbers yet. We are using the midpoint of the guidance that we gave out in October for comparative purposes. And revenues in the fourth quarter of the year we think will be about $101 million, it’s up from $87.3 million last year. It’s a 16% increase in earnings per share. Our EPS we think will increase from $0.16 to $0.19. It’s a 19% increase in EPS.

Taking a look at our revenue growth over a longer period of time, this is all organically. We haven’t done an acquisition since before 2004. For the four years ended December 31 of 2008, our compound annual growth rate in revenue was 10.5%. The IT services industry in the United States and the world grew a little bit less than 5% during that period of time. So, we were growing at about twice – the little over twice the rate of the industry. In 2009, we are impacted by the global recession. Our revenue has dropped 22%. Since then, our revenues have been increasing our compound annual growth rate of just less than 20%, 19.9%, that’s about four to five times the rate of the industry.

If you look at our operating margins, if we are getting more solutions in our mix, you’d expect to see our operating margins increase in 2011. We are expecting them to increase from 4.2% last year to 4.8% to about 0.6%. They also increased by about 0.6% in 2010 from 3.6% to 4.2%.

Taking a look at our earnings over a longer of period of time, for the four years ended December 31 of 2008, compound annual growth rate and our EPS was 30.3%. Obviously, that’s probably five or six times the rate of the industry. In 2009, we were impacted by the global recession. Our revenues dropped by 22%. Our EPS also dropped by 22%. Well, we are disappointed with that despite the global economy. It was the second best yield we had in a decade in terms of earnings. Since then for the last two years, our earnings have been growing at a rate just a little bit less than 37%.

Taking a look at our financial strength and stability, we have strong cash flows. Our EBITDA in the last 12 months was $20 million. We didn’t have any debt outstanding at the end of 2006, ‘07, ‘08, ‘09, ‘10 or any quarter in 2011. Actually at the end of the third quarter, we had $12.6 million of cash on hand. We have quality receivables. Most of them are from the Fortune 1000. We have 61 days sales outstanding, that’s actually a low metric for our industry.

Taking a look at our strategic goals, we are going to continue to target faster growing major markets. Quite frankly, we think healthcare is probably the place to be for the next decade. We want to grow more rapidly than the industry average as I mentioned we are growing about probably four to five times the rate of the industry now. We want to get our solutions business up to at least 50% of our revenue mix by the fourth quarter of 2013. If we do that, our operating margins should increase from the 4.8% we are expecting in 2011 to the 6% to 7% range. And we are going to continue to develop in-demand, niche, and repeatable solutions like the ones we have rolled out in the last couple of years.

Some investment merits for the reason as I mentioned, we have a strong financial position. We have one of the largest IT consulting practices for the U.S. healthcare industry. It’s not just us saying, there is lots of studies out there. If you look at any of them, we’ll appear towards the top of the list. KLAS ranks us as number one in clinical. They also selected us as one of the top three healthcare IT professional services firms in December of 2010 and they just selected us for (indiscernible) again in December of 2011. We are very focused on our EMR business, and in fact, the government is going to spend about $60 billion on EMRs in the next few years. We have strong cash flows. We’ve been using our free cash for a number of years to buyback our own stock. In 2007 and 2008 in both years, we repurchased 1 million shares; 2009 about 750,000 shares; 2010 400,000 shares. For the first nine months of 2011, we repurchased 300,000 shares.

We had double-digit EPS growth in 2005, ’06, ‘07, ‘08, ‘10 and ‘11. And I think it will be hard-pressed to find another IT services from that can say that. Actually, if you look at our compound annual growth rate and earnings per share for the last 10 years, the period that we have had this strategy in place, it’s 26% on a compound annual growth rate over 10 years. That means that – it’s pretty even too. It’s a little bit less than 26% for the first five years, a little bit more for the next five years. That means that we doubled our EPS every three years for the last decade and I don’t think you can find another IT services from that can say that.

That’s it for our presentation. I’d be glad to answer any questions anyone might have. Yes, please.

Question-and-Answer Session

Unidentified Analyst

(Question Inaudible)

Unidentified Company Speaker

Good question. The government put $19 billion in the stimulus package in 2009. The government spent less than $1 billion of that so far. It can be spent totally at the discretion of the Secretary of HHS. We suspect it will be spent over the next couple of years. The HITECH Act basically reimburses hospitals and doctors. What they missed and there wasn’t anybody, my understanding is on the panel that wrote the legislation that had a healthcare background. They knew they were something that we’re going to miss. It was the HIE market. Somebody has got to fund the HIEs to get them up and running. So far a little bit of the stimulus money about $600 million has been dispersed to the states and they gave it to their HIEs. They’ve got to give more money to the HIEs for them to get their networks up and running. Any other questions?

Unidentified Analyst

(Question Inaudible)

Unidentified Company Speaker

Yeah, question is how we are doing getting competent staff? There is becoming an acute shortage of staff in the healthcare area. So far, we have been able to find people who staffed up every project that we have won. I have been very proud actually of recruiting although they have been able to do that. There are couple of reasons why we pay as much as anyone else that’s kind of one of the keys. In addition that, IT people want to be known as working for the people that have the best quality, so we even advantage one of the recruiting. We can train people even for the healthcare area. We have a training facility. We train people for 46 years actually and we have did one project in the U.S., where half the people were experienced. They had an average of 15 years experience. The other half of the people were trained. The problem is the market isn’t willing to buy it at the moment.

CIOs looked at you and say, but my heads on the block, we probably should have started this project earlier. I got to get it done. I want experienced people. We have the same phenomenon in the Y2K, in 2000 or 1997 where the clients would not accept newly trained people. By 1998, they had no choice. I mean, if you train the person they definitely took him. We think probably some place in 2012 is the cutover point, where clients will start to take newly trained people, but we haven’t seen, they’re still asking for experienced people.

Unidentified Analyst

(Question Inaudible)

Unidentified Company Speaker

No. actually, well, there is an investment depending on what you are training, I mean, if we get a nurse we give them some training in the application that might be months worth of training. If we hire someone out of college, they pick up the application pretty quickly, but we actually have to put him in a hospital. Our physicians have this, because they need to learn workflows that hospitals have. There is an investment for a couple of months. Usually if it’s two months worth of training, they’ve usually paid for themselves within two months. Of the software industry, well, delivering solutions for in IT usually you’ve got probably 40% to 50% direct profit percentage, newly trained people often in the percentage of 60% or 70% for the first year, because we’re getting reimbursed. It’s a great opportunity for the person get out of college starts off and maybe 35,000 a year later is making 55,000, year after, there is making 75,000. We, of course, adjust the bill rates accordingly. Any other questions?

Unidentified Analyst

(Question Inaudible)

Unidentified Company Speaker

The question is which of the software-as-a-service that we feel best about? I feel good quite frankly about all of them, because we have sold all of them to at least one commercial customer. I think that the biggest opportunity in terms of earnings growth for CTG is probably fraud, waste, and abuse, because fraud, waste, and abuse is just so ramp it out there. And when we tell our customers, they are thinking, I think that there is a silver bullet, that’s going to catch off fraud, waste, and abuse. It doesn’t work that way. For a customer, we actually got their data after day one or two fraud, waste, and abuse applications and then gave them piles of additional ones that the two applications didn’t cap. So, really you’ve got to run it through a multitude of FWA applications if you’re really going to get your fraud, waste, and abuse down. Any other questions?

Unidentified Company Speaker

Alright, we are almost out of time anyway. We’ll be around if you want us any questions. Thank you very much for coming.

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