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Executives

Deborah Pawlowski

James R. Boldt – Chairman of the Board, President & Chief Financial Officer

Brendan M. Harrington – Chief Financial Officer & Senior Vice President

Analysts

Richard Doty – Columbia Management

William Sutherland – Boenning & Scattergood

Computer Task Group, Incorporated (CTGX) Q4 2007 Earnings Call February 21, 2008 10:00 AM ET

Operator

Ladies and gentlemen thank you for standing by. Welcome to the CTG Fourth quarter earnings conference call. At this time all participants are in listen only mode. Later we will conduct a question and answer session. (Operator Instructions) As a reminder today’s conference is being recorded. I would like to turn the conference over to Deborah Pawlowski.

Deborah Pawlowski

Good morning everyone. We certainly appreciate your time and your interest in CTG. On the call today we have President and Chief Executive officer Jim Boldt and Brendan Harrington, Senior Vice President and Chief Financial Officer. Jim and Brendan are going to review the results for the fourth quarter and full year 2007 and update you on the company’s strategy and outlook. We’ll follow with an opportunity for Q&A. If you don’t have the press release discussing our financial results you can access it at the company’s website at www.CTG.com.

Before we begin, I want to mention that statements in the course of this conference call that state the company’s or management’s intentions, hopes, beliefs or 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 them at our website or the SEC’s website at www.SEC.gov. So, 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 R. Boldt

Good morning everyone this is Jim Boldt. I want to thank you for joining us this morning for our fourth quarter conference call. As you saw in our earnings release our fourth quarter revenue and earnings were at the midpoint of our guidance. We’re certainly pleased with the fact that before merger evaluation costs net income in the fourth quarter increased by 34%. Our higher margin solutions business continues to grow causing us to be very optimistic about our outlook for 2008. I’m going to talk more about our business expectations in a minute but first I’m going to ask Brendan to start us off with a review of our financial results.

Brendan M. Harrington

Good morning. For the fourth quarter of 2007 CTG’s revenues were $84.5 million an increase of approximately $6.5 million or 8.3% compared with the fourth quarter of 2006. Net income of $1.2 million in the fourth quarter of 2007 grew at a faster rate than revenue and increased by 13% from $1.1 million in the fourth quarter of 2006. For the quarter net income per diluted share was $0.07 and net income per diluted share excluding equity compensation was $0.08. These results include approximately $200,000 or $0.01 per diluted share that CTG recorded in costs related to advisory fees incurred in connection with our consideration of two unsolicited merger proposals from RCM Technologies, Inc. As mentioned in the release our board unanimously rejected both proposals. We expect an additional $200,000 in advisory fees in the first quarter as we close out the activities associated with these proposals. When you exclude the merger evaluation fees from our fourth quarter results operating income was $2.2 million, 9.5% higher than the 2006 fourth quarter. Net income excluding these fees was $1.4 million or $0.09 per diluted share a 34% increase from 2006 fourth quarter net income. Our 2007 fourth quarter net income and net income per diluted share before both merger evaluation costs and equity based compensation expense was $1.6 million or $0.10 per diluted share a 26% increase from $1.3 million or $0.08 per diluted share in the fourth quarter 2006. The proportion of solutions revenue in 2007 was 32% of total revenue or $105.3 million compared with 30% or $98.2 million in 2006. This represents 7% growth in our solutions revenue.

Direct costs as a percentage of revenue were 77.8% in the fourth quarter compared with 75.5% in the fourth quarter of 2006 and 77.3% in the third quarter of 2007. Slightly higher direct costs were primarily due to lower utilization of available staff. Operating margin excluding merger evaluation costs was 2.6% of revenue in both the fourth quarter of 2007 and 2006. We had $27.9 million in revenue from IBN, our largest staffing customer in the fourth quarter of 2007 compared with $23.7 million in the fourth quarter of 2006. This represents 33% and 30% of total revenue in the 2007 and 2006 fourth quarters respectively. The majority of growth in staffing was from IBN although they made a major cut back in the fourth quarter 2006, we did see solid improvement in this last quarter.

Quarterly revenue from our European operations was $19.8 million in the 2007 fourth quarter a 23% increase from the $16.1 million recorded in last year’s fourth quarter. Foreign exchange fluctuations accounted for 12% of the 23% increase in our European revenue in the quarter. The remainder reflects our efforts to expand into healthcare and financial services verticals. The tax rate for the 2007 fourth quarter was 36.5%. The tax rate for the full year 2007 was 37.6%. The rate decrease from approximately 43% in 2006 due to the utilization of net operating loss carry forward in 2007. The expected tax rate for 2008 is between 38 and 40%.

The company had 3,400 employees at the end of the fourth quarter 2007 of which approximately 88% are billable resources. On the balance sheet our days outstanding decreased to 58 days from 63 days at the end of 2006. Our days sales outstanding decreased from 60 days at the end of the third quarter 2007. Our cash provided by operations in the fourth quarter was approximately $600,000. We had $772,000 in capital expenditures and recorded depreciation expense of $567,000 in the quarter. For the full year capital expenditures were $2.1 million and depreciation expense was $2.4 million.

During the fourth quarter of 2007, while adhering to SEC imposed volume limitations we repurchased 499,000 shares of CTG common stock. The repurchases in the quarter were made at an average price of $4.98 per share. During most recent self imposed black out period prior to releasing earnings we repurchased shares under our 10B51 plan. As announced the board has authorized a new $1 million share repurchase program and we plan to continue to manage our purchases throughout the year.

James R. Boldt

Demand for staffing was somewhat inconsistent in 2007. Overall, client demand for staffing held up as the year ended and the staffing business had a good fourth quarter. As for our solutions business, overall growth was approximately 7% in 2007. We’re beginning to release the benefit from the investments we made in our solutions business last year. Most of those investments were in our healthcare business where we expanded offerings, added sales territories and hired more sales staff to capitalize on our leading market position and the many opportunities in the healthcare market.

Proposal activity in our healthcare vertical has been robust and we’re seeing a continuation of that activity into 2008. As for the first quarter of 2008 we’re forecasting revenues in the range of $83 to $85 million, 3.7 to 6.2% higher than last year’s first quarter. The first quarter of 2008 will have 63 billing days, one less than the first quarter of 2007. One billing day equates to approximately $1.3 million of revenue. If you adjusted for the lower number of billing days in this year’s first quarter, on a comparable basis revenue is forecast to be 5.4, 7.9% higher than the first quarter of 2007.

As most of you are aware we incur higher SG&A expense in the first quarter of the year than we do in other quarters. Most notably, our audit fees are generally $250 to $300,000 greater in the first quarter of the year than in the second quarter, lower $0.01 per diluted share. Despite that, given our revenue forecast and the increasing mix of the solutions business we expect that first quarter’s net income before merger evaluation costs will be in the $0.07 to $0.09 per diluted share range and also excluding equity compensation to be in the $0.08 to $0.10 per diluted share range. As Brendan mentioned, merger evaluation costs in the 2008 first quarter will be approximately $250,000 reducing net income per diluted share by $0.01. We do not expect any additional expenses related to the 2007 merger proposals beyond those incurred in the first quarter.

As you know, 2007 earnings benefitted from a $0.02 per share gain in the first quarter from the sale of marketable securities. If you exclude that and look at operations in the first quarter of 2008 excluding merger evaluation costs, we’re forecasting a 57 to 99% increase in income from operations. Lots has been written about the slowing US economy, from what we’ve read we’re expecting that economic growth will be slow or even perhaps negative in the first two quarters of 2008 and then pick up in the last half of the year. Historically, our staffing business has been moved in tandem with economic growth and as a consequence we have seen a slowdown in demand from many of our staffing customer so far in the first quarter. Fortunately, we’re in the process of bringing on some new additional staffing business that’s offsetting the weakness we’ve seen elsewhere and as a consequence we’re projecting that our staffing business in the first half of 2008 will remain at the fourth quarter 2007 run rate and will begin to grow in the later part of the year.

As to our solutions business, as I mentioned before, our proposal activity can best be described as robust particularly in our healthcare vertical. We have new solutions engagements starting up in the first quarter of 2008 and we believe that we’re well positioned for more business to begin in the second quarter of the year. As a result, we believe that CTG’s 2008 revenue will be in the range of $340 to $350 million, 4.5 to 7.6% above 2007. We expect that net income in 2008 will be in the $0.33 to $0.43 per diluted share range, 32 to 72% above 2007 and then excluding equity compensation expense diluted EPS will be in the range of $0.37 to $0.47 an increase of 28 to 62%.

To sum up, our fourth quarter performance was pretty much where we’d expect it. We expect our staffing business will remain constant for the first two quarters of the year and then grow in the second half of 2008. We also anticipate winning some additional solutions projects that will benefit earnings throughout the year. We therefore expect that our improving mix of more profitable solutions business will drive higher margins and operating profits throughout the year. With that, I’d like to open the call for questions if there are any. Operator will you please manage our question and answer period.

Question-and-Answer Session

Operator

(Operator Instructions) At this time I’d like to take the first question from Rick Doty. Please go ahead.

Richard Doty – Columbia Management

With the slowdown that you’re predicting or that people are saying in the economy, you’re actually seeing that with your customers pulling back on some of the staffing needs you’re saying?

Brendan M. Harrington

Yes. It’s very different depending on the customer and the industry. I described so far in our first quarter technology service providers, the staffing business there is a little soft, not dramatic but it’s definitely soft. We don’t do much staffing in healthcare outside of life sciences, life sciences is also a little soft. Then, you get to financial services and that’s weak, that’s really where we’re seeing most of the decline but fortunately as I said we’ve got some other new business coming on so we fully expect it to be flat for the first six months.

Richard Doty – Columbia Management

What’s the percent of the staffing business that is financial services?

James R. Boldt

Financial services is 11% of our total business and of that I believe between 6 and 7% is staffing.

Richard Doty – Columbia Management

Okay. And you’re seeing – is the weakness on the solution side too in financial services?

James R. Boldt

No. We haven’t really seen that. In the United States we did not focus on solutions for financial service companies because they were tending to take things offshore and we just didn’t think it was a place to invest our money in. Most of our investment in financial services in solutions is over in Europe and they seem to be holding up okay.

Richard Doty – Columbia Management

Okay. What are you seeing with pricing and gross margins on the staffing side with some of the slowdown?

James R. Boldt

No impact, we’re still in a situation where for some of the hotter skills like .net or IBN’s web spheres that there’s a shortage and we have some advantage in doing pricing where there’s a shortage obviously. On the older skills it’s flat but that’s the way it’s been for a while.

Richard Doty – Columbia Management

So flat to up slight?

James R. Boldt

Yes.

Richard Doty – Columbia Management

Then, one could probably back into this, I guess what you’re saying is solutions maybe grows a percentage or two from the 33%, what was that in Q4?

James R. Boldt

In Q4 was 33% so it’s quite possible that when we record the first quarter we’ll say 34 and if we don’t for sure by the second quarter we will.

Richard Doty – Columbia Management

Okay. But, maybe that growth as we exit the year, maybe something closer to what 35, 36?

James R. Boldt

I would think so. Just maybe to give you the numbers for last year and you can kind of see what happen. Last year our staffing business dropped 4% and the solutions grew 7%. The solutions as a percent of revenue for 2007 were 32 in total, 2006 was 30. So, even when you have one growing and the other one dropping it takes a while to get up a percent. I think what you’ve said is probably reasonable by the fourth quarter.

Richard Doty – Columbia Management

Okay. And that doesn’t presume anything going on in a material fashion in the UK, right?

James R. Boldt

No. Let me give you an update, I know I didn’t mention that in my comments but, the [inaudible] in the UK hasn’t really changed. The primes are many of them renegotiating the deal with the NHS, obviously they’re behind they’re not going to hit the original date, they have to deal with that. And, there’s also issues about what functionality will be rolled out and in what timeframe. We’re still being told that the software that we’re waiting for is going to be available in the second quarter of 2008 probably April is the time frame that they’ve set. But, we’ve been told that before. So, in terms of our forecast and the guidance we just gave out, we’ve assumed that we will continue with the $5 to $6 million run rate and revenues from the NHS project. Then, if the project starts up, if it’s all upside we’ll adjust our guidance as the year goes on.

Richard Doty – Columbia Management

Okay. The merger advisory fees going into Q1 was that something contractual with whoever you engaged there? It has nothing to do with anybody else showing up or ongoing discussions with RCM, right?

James R. Boldt

No. It’s a contractual agreement that we made with the investment bankers last summer. They’re advisory fees actually go through the end of March.

Operator

Our next question comes from the line of Bill Sutherland with Boenning & Scattergood. Please go ahead.

William Sutherland – Boenning & Scattergood

A quick question, you said you haven’t seen much change in the pricing what about in the bill rates, have you seen any changes in that?

James R. Boldt

On the hotter skills .net, IBN web sphere or even some of the Java skills, we actually bill rate increases so the cycle has started to change it just hasn’t yet changed for the masses.

William Sutherland – Boenning & Scattergood

Okay. With regards to your acquisition pipeline, has it been active this year? Do you expect it to be active?

James R. Boldt

In terms of looking for acquisitions?

William Sutherland – Boenning & Scattergood

Yes.

James R. Boldt

We have been looking for acquisitions. Quite frankly, at the moment we’re very picky we’re definitely not looking to expand our staffing business at all. The area that we would like to expand is in healthcare and it isn’t totally in healthcare, there are some areas in healthcare where we are stronger and some areas where we are weaker and we’d like to do an acquisition if possible to fill in some of the weaker areas to get us going a little quicker. In terms of size they would be smaller transactions, these aren’t [inaudible] deals they’re probably revenue of maybe $5 million to $20 million would be the kind of maximum and because the criterion is so specific we really just haven’t come across anything yet that looks attractive. But, if we do we definitely would do an acquisition at this point.

William Sutherland – Boenning & Scattergood

Okay. Great. What percentage of revenue now is healthcare?

James R. Boldt

It’s 25%.

Operator

We have a follow up question from the line of Rick Doty with Columbia Management.

Richard Doty – Columbia Management

On the sales recruiter sort of headcount what are your plans on the hiring side as we enter the year?

James R. Boldt

Well, we have more than enough people on the staffing side of the business at the moment. The equilibrium is pretty good there. On recruiters at the moment we are out actively trying to get more recruiters for the solutions side of the business. I hate to admit this but right now what we’ve got is more requirements offerings the sales force [inaudible] than we can handle in recruiting at the moment. We were hiring recruiters, we thought we had it under control but we had some of the offerings hit a little bit quicker and people want projects started a little bit sooner than we thought so we do have to hire additional recruiters in order to serve that market. It’s actually good news at the moment. I don’t think for the year though I mean last year for 2007 our SG&A expense was 20% of revenues. I don’t think you’re going to see it move much above that. It may go up a little bit as you know the solutions side the SG&A as a percentage of revenue is greater than the staffing side so you may see it inch up a little bit but I don’t expect any significant investments.

But we’ve pretty much have done the investments last year that we wanted in healthcare. We’ve now got the sales territories pretty much maybe there are one or two that we have to fill in but pretty much the investments were made. The other factor is that when we have business consultants and we’re developing a new offering we have to have them work on things like methodology and it has to be expensed just like a research cost when we actually do that and last year we were heavily working on a new methodologies for new offerings. Pretty much we had a few that we’ve got to finish up but pretty much we have most of those offerings in healthcare developed. So those billable people that were working on methodology etcetera that were SG&A expensed last year will go on the projects and be part of billable in 2008.

Richard Doty – Columbia Management

Okay. IBN grew in the quarter. I can’t recall when did we lap what was it the Texas area the runoff we had was some of the personnel there?

James R. Boldt

It was the third quarter.

Richard Doty – Columbia Management

It was third quarter?

James R. Boldt

It was the third quarter of 2006 that they cut back.

Richard Doty – Columbia Management

Okay so this was an apples-to-apples kind of comparison then?

James R. Boldt

Yes it is.

Richard Doty – Columbia Management

And so it grew you said did I get the number rights 27.9 versus 23 in change?

James R. Boldt

Yes.

Richard Doty – Columbia Management

Okay. That’s pretty good growth. Do you get any visibility on what you’re expectations are there for the year?

James R. Boldt

No we don’t. It’s a complicated situation obviously they have literally thousands upon thousands of contractors and each manager when he gets an approval for a new position he either picks a hire internally and make it a permanent IBN position or go outside. So it’s even difficult I believe for IBN to predict things they know in what they’ve approved in new seats for next year but how the individual managers will staff them the variables that’s very difficult to figure out for a company that size. We don’t usually get any forward-looking view. Occasionally we will in a particular department. Is with most company is their budgets were just set and our people are talking to the individual managers to try and figure out how many additional seats that they’ll have or if they’ll go outside for this year. But we really don’t have much visibility quite frankly.

Richard Doty – Columbia Management

Okay. The operating margin adjusted in the fourth quarter was 2.6. I haven’t calculated it but what is the mid-point of your guidance for 08? I could run through that but.

James R. Boldt

It’s 3.2%, the range actually goes from 2.8 to 3.5 but the merger evaluation costs cost’s about a tenth of a percent. So if you took at the merger evaluation cost which isn’t ongoing it would be about 3.3.

Richard Doty – Columbia Management

Okay and if we look at sort of the run rate in Q4 is that 3.6, 3.7 or?

James R. Boldt

It’s got to be yes. It’s got to be higher than 3.2 to get there.

Richard Doty – Columbia Management

Okay so we’re slowly making progress toward you know a more traditional kind of operating number. I know the mix isn’t 50/50 either but probably isn’t going to be any time soon. Maybe if the UK were to kick in a more meaningful way you could get there in a year or two but.

James R. Boldt

We originally thought it would take us three years and you’re right unless we have a big project that kicks in and starts up quickly it’s probably going to take a couple of years to do.

Richard Doty – Columbia Management

Okay if the UK were to kick in a meaningful way are there, do you have the resources to staff up for that?

James R. Boldt

That’s going to be the biggest problem. You know it’s the world’s largest healthcare project, they’re going to scoop resources out of the Unites States. We have recruiting ready in England to hire people who work in hospitals before on hospital systems and then train them in some of the systems like Serner that’s being installed. So we definitely would have to train up people. If it kicks in in a meaningful way and you know it starts up just one region has a 1,000 hospitals that they’ve got to do installs in, it’s going to suck up all the resources in the world that know Serner pretty quick.

Richard Doty – Columbia Management

Just give me a sense and I think we’ve talked about this before what is the reputation of your healthcare solutions business you know I guess in the industry in general? You’re not a huge company but you know where do you guys rank I think by some of the outside services?

James R. Boldt

Well if you look at class the rates all IT service providers that provide services in the hospital as providers and you look for the last probably two or three years and added up all the rankings they rank you in individual areas like strategy implementation etcetera we would come up first. We have the best reputation, we can [inaudible] and entire market. There’s no one actually that ranks you in terms of health insurance markets so I don’t have an outside source per say but we think we have a very good reputation here as well as least as good as we do in the provider market.

Richard Doty – Columbia Management

In the provider market do the customers or prospects look at those rankings in evaluating who to use?

James R. Boldt

Yes actually occasionally we’ll get an RFP from a hospital that we’ve never even called on because they looked up a class rating and picked the top companies.

Richard Doty – Columbia Management

Okay. And how is your ability to find you know I guess without the UK having kicked in how’s your ability today here to find talent in that space?

James R. Boldt

At the moment it’s pretty good. There were some large projects it depends on the length [inaudible], Kaiser Permanente for instance had a very large aspect installation that won multiple years. It started off as a $1.8 billion project and I think in the end they’ve spent about $4.5 billion doing it and it ended about a year ago. So that led to a lot of Epic resources for instance on the market. So at the moment finding people for Epic and even Serner is defiantly doable. It is in a primal.

Operator

(Operator Instructions) Mr. Boldt please continue there are no more questions.

James R. Boldt

In closing I’ll repeat that our strategy is to increase CTG solutions business. We’re focused on specific verticals such as healthcare that we believe have a strong fundamental growth prospect especially if they increase their use of technology to improve efficiencies and service. As that part of our business grows we expect margins to expand yet we will continue to be opportunistic in our staffing business. Once again I would like to thank you for your continued support and for joining us this morning. Have a great day.

Operator

Ladies and gentleman this does conclude our conference for today. It will be available for replay beginning today at 11:30 am ending on Sunday February 24th at midnight. To access the AT&T playback please people in the US 800-475-6701 with the access code 899687. For people outside of the US the number is 320-365-3844 with the access code of 899687. Once again those numbers are 800-475-6701 and 320-365-3844 with the access code of 899687. Thank you for your participation and you can now disconnect.

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Source: Computer Task Group Q4 2007 Earnings Call Transcript
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