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Executives

James M. Culligan – Director – IR

James R. Boldt – Chairman, President, CEO & Head – IR

Brendan M. Harrington – Senior VP, Chief Financial & Risk Officer

Analysts

Bill Sutherland – Northland Securities

Matthew J. McCormack – BGB Securities

Frank Dilorenzo – Singular Research

Rick D’Auteuil – Columbia Management

Vincent A. Colicchio – Noble Financial

Computer Task Group, Inc. (CTGX) Q2 2012 Earnings Call July 24, 2012 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the CTG Second Quarter 2012 Earnings Call. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for your questions and instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I’ll now turn the conference over to Jim Culligan Director of Investor relations at CTG. Please go ahead sir.

James Culligan

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

On the call today, we have CTG’s Chief Executive Officer, Jim Boldt, and Brendan Harrington, Senior Vice President and Chief Financial Officer. Jim and Brendan are going to review the results for the second quarter of 2012 and then update you on the company’s strategy and outlook. We’ll follow with an opportunity for Q&A. If you don’t have the news release discussing our financial results, you can access it at the company’s website at ctg.com.

Before we begin, I want to mention that statements in the course of this conference call that state the company’s or management’s intentions, hopes, beliefs, expectations and predictions for the future are forward-looking statements.

It’s important to note that the company’s actual results could differ materially from those projected. Additional information concerning factors that could cause actual results to differ from those in the forward-looking statements is contained in our earnings release as well as in the company’s SEC filings. You can find these at our website or at 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 second quarter earnings conference call. As you saw in our news release, we had an excellent second quarter with revenue above our guidance and earnings per share excluding our insurance gain. At the high end of our guidance revenue in the second quarter 2012 increased over 2011 by 9%. The operating margin expanded by a 100 basis points and earnings per share excluding the onetime insurance gain increased 29%. As we expected, our higher margin solutions business continues to grow and increased 23% in the second quarter 2012, while revenue from our lower margin staffing business was approximately the same as it was in the second quarter of 2011.

I’m going to talk more about our results and what we see for the 2012 third 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 second quarter of 2012, CTG’s revenue was $106.7 million, an increase of $8.4 million or 9% compared with the second quarter of 2011. Second quarter 2012 had 64 billing days, the same as in the second quarter 2011.

Solutions revenue in the second quarter of 2012 was $44.3 million, an increase of $8.4 million or 23% compared with the second quarter of 2011. As a percentage of total revenue, Solutions revenue was 42% compared with 37% a year ago. The continued improvement in our business mix was mainly being driven by revenue growth from our more profitable healthcare projects. Staffing revenue in the quarter remained flat at $62.4 million.

Second quarter revenue from IBM, our largest customer, was $29 million compared with $29.6 million in the second quarter 2011. As a percent of total revenue, revenue from IBM decreased to 27.2% in the 2012 second quarter compared with 30.1% of total revenue in the 2011 second quarter.

Revenue from our European operations was $16.8 million, a 3% decrease from the $17.3 million recorded in last year’s second quarter. The effect of foreign currency fluctuations during the second quarter of 2012 decreased consolidated revenue by approximately $1.9 million or 1.8%. At a local currency basis, our European revenue increased by 7.8% compared with the 2011 second quarter.

Direct costs as a percentage of revenue were at 78.5% in the second quarter compared with 78.9% in the second quarter of 2011. SG&A expenses as a percent of revenue decreased to 15.7% from 16.3% in the second quarter of 2011.

The billable travel expenses included in the second quarter 2012 revenue and direct costs are $3,658,000. The billable travel expenses included in the second quarter 2011 revenue and direct costs were $3,079,000.

Second quarter operating income grew to $6.1 million, an increase of $1.5 million or 31% year-over-year reflecting the favorable effect of operating leverage and our higher margin solutions work. Compared with the trailing first quarter of 2011, the second quarter operating income increased $544,000 or 9.7%.

Operating margin in the second quarter increased to 5.8% of revenue, a 100 basis point improvement from last year’s 4.8% and 40 basis points higher than the 5.4% operating margin in first quarter 2012. The year-over-year increase was primarily due to the increase in the Solutions business and our sales mix and the additional operating leverage.

The company received $423,000 of non-taxable proceeds from life insurance policies in the second quarter, which resulted in a non-operational gain of approximately $0.025 per diluted share. Excluding this one-time gain, net income would have been $3.7 million in the quarter, an increase 31% from $2.8 million in the second quarter of 2011, and a 10% increase from the first quarter of 2012. On a per diluted share basis, excluding the one-time gain, net income would have been $0.22 for the second quarter 2012, a 29% increase from the $0.17 in the 2011 second quarter and $0.02 higher than the 2012 first quarter.

Net income, including the gain from the insurance proceeds was $4.1 million, an increase of $1.3 million or 46% compared to the second quarter 2011. On a per diluted share basis, net income, which includes a gain, was $0.25 for the quarter, an increase of 47% increase compared to the second quarter of 2011.

Both the 2012 and 2011 second quarter results include equity compensation expense of approximately $0.02 per diluted share, net of tax. The tax rate for 2012 second quarter was 36.8%. Excluding the non-taxable one-time insurance gain, the tax rate was 39.4% compared with 38.9% in the 2011 second quarter. Both including and excluding the insurance gain, we expect the tax rate for the full year 2012 to be between 38% and 40% compared with 37.6% in 2011. The increase in the rate in 2012 was primarily due to the expiration of certain federal tax credits that we realized in 2011.

Our headcount at the end of second quarter was 3800, 100 people or a 3% higher compared to the end of both the second quarter 2011 and the end of the first quarter 2012. Of those 3800 employees at the end of the second quarter 2012, 90% were billable resources.

At the end of the second quarter, we had no debt and $23.6 million of cash on the balance sheet. At the end of 2011 second quarter, we had no debt and $13 million of cash. Both the second quarter 2012 and 2011 ended between a US by-weekly payroll days.

Our day sales outstanding, was 61 days at the end of second quarter 2012, slightly lower than the 62 days at the end of the second quarter 2011. Our cash provided by operations in the second quarter of 2012 was approximately $6 million, as compared with cash provided operations of approximately $2.8 million in the second quarter of 2011.

In the quarter, we had $283,000 in capital expenditures and recorded depreciation expense of $656,000. We repurchased approximately 204,000 shares of CTG common stock during the second quarter of 2012. During the third quarter, prior to releasing earnings, we repurchased approximately 25,000 shares under our 10b5-1 plan. As of today, our repurchase authorization is for approximately 575,000 shares and as it remains accretive to our earnings, we intend to continue our repurchase program during 2012. Jim?

James Boldt

Thanks, Brendan. As mentioned, in aggregate our Solutions business which is significantly more profitable than our Staffing business increased by 23% in the second quarter of 2012. The Solutions business was 42% of our total revenue in the second quarter. The growth in Solutions work is primarily coming from healthcare projects and is continuing to drive margin expansion. Overall, our healthcare business was up 25% over the second quarter of last year.

On our conference call at the end of April, we mentioned we had received four RFPs for electronic medical record projects for which the hospitals had not decided what IT services firms would be awarded those projects. In addition, we received two RFPs for EMR projects in the second quarter 2012. Of those six projects, we won one project, one of the hospital systems decided to withdraw their RFP and will issue a new RFP shortly, one system decided not to engage on IT services firm and then try and implement the EMR themselves, and we lost the project for a state run hospital system that selected a Staffing company with lower hourly rate. That means we still have two bids outstanding for which an IT services firm has not been selected.

When we started the second quarter of 2012, we had 18 active EMR projects. During the second quarter we started two projects and two projects came to an end. Therefore at the end of the second quarter 2012, we had 18 active EMR projects. We also have one project that we won in the second quarter of 2012 that will not start up until the third quarter.

As we mentioned before, currently we have a significant amount of opportunity for EMR business. While we increase the EMR revenue by 30% in the second quarter and we expect further growth in EMR work, the limited number of resources with EMR experience challenges our ability to grow our EMR business to its full potential until the market begins to accept newly trained staff, the number of experienced resources we can hire is going to be the limiting factor to our growth in our EMR business.

Our other healthcare solutions offerings continue to grow at significant rate. On June 29th of this year, we announced that we had won four new contracts. Those contracts were for our outsourcing, IT medical management model, health information exchange, and health edge offerings. These four contracts alone should increase our total healthcare business by 9% over the next 12 months. It’s contracts like these and opportunities for similar projects, combined with our growth in EMR work that reaffirm our belief that our healthcare business in total will grow at a 25% rate in 2012.

Having covered healthcare, I would also like to talk about the other three vertical market on which we focus, our technology service provider market, which is an all Staffing business recorded a slight decline in the second quarter, as to our energy vertical, an increase during the second quarter 2012, while our Financial Services business declined. Most of the decline in the Financial Services business was a result of unfavorable foreign currency fluctuation.

Turning to our Staffing business, its revenue was flat when you compare the second 2012 to the second quarter 2011. While in US dollar, our Staffing business did not show an increase when compared with the second quarter of last, we depict our Staffing business that it is improving slightly in the second quarter of 2012. Most of our headcount increase in the second quarter came from our Staffing business, and if you look at our Staffing business in local currencies, revenue increased by 2% in the second quarter. The reason the Staffing business was flat to last year was the unfavorable foreign currency adjustments that occurred in the second quarter of the year.

Looking at the third quarter 2012, we’re forecasting total revenue to be in the range of $105 million to $107 million or a 5% increase at the midpoint of our guidance over the last year’s third quarter. The forecasting earnings per share in the third quarter 2012 is in the range of $0.21 to $0.23 per diluted share or a 22% increase at the midpoint of guidance relative to third quarter of last year.

For the 2012 full year, we expect the revenue range of $420 million to $430 million or a 7% increase at the midpoint of our guidance over 2011. Based upon our revenue forecast and the anticipated mix of business, we expect 2012 net income per diluted share, excluding the one-time insurance gain of $0.025, to be in the range of $0.83 to $0.91 or a 23% increase from 2011 at the midpoint of our guidance.

We thought it would be helpful to once again recap the assumptions we use to set our 2012 guidance. We continue to see significant growth opportunities in our Healthcare Solutions business. We think our healthcare business will grow by approximately 25% in 2012. For our non-healthcare solutions business, we’re projecting a revenue increase of approximately 8% in 2012. For the reasons I mentioned earlier today, we’re not forecasting a change in our staffing revenues for the year.

Our revenue forecast for the full year takes into account the effect of foreign currency exchange rates on our European business, given that the euro and British pound have dropped in relationship to the dollar, we’re no assuming a 10% negative impact on our European revenue in US Dollars when compared to 2011 due to foreign currency exchange fluctuations.

To sum it up, despite a slowing US economy and Europe’s financial problems CTG is performing very well based upon our strategic focus on higher growth industries particularly healthcare. CTG’s net income in the second quarter of the year increased by 29 % before the one-time gain, and we continue to expect another excellent year in 2012.

With that I I’d like 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

Certainly. [Operator Instructions] Our first question will come from Bill Sutherland with Northland Capital Markets. Go ahead please.

Bill Sutherland – Northland Securities

Thank you. Hey Jim.

James Boldt

Good morning Bill.

Bill Sutherland – Northland Securities

Brendan.

Brendan M. Harrington

Good morning Bill.

Bill Sutherland – Northland Securities

On the quarter – the third quarter guidance, not to focus too hard on just a single quarter but just to provide a little more backdrop on the growth rate not being at the same level that we saw in the first half.

James Boldt

Okay. All right, probably a couple of things are coming into play. One, we always have a seasonal drop in the third quarter. We lose about 3% of our revenue just because people take vacation. Now for the last, probably four to five years, we have been able to make that up by getting additional business. But there is always some drop off in the third quarter. We have said since the beginning of the year, if you go back even to our February conference call that we expect that the European financial crisis was going to backup and hurt the U.S economy and it has done that. I would think in the third quarter we’ll probably see our staffing business perhaps off slightly. Now the fourth quarter of the year has one additional billing day, so the one additional billing causes about a 2% increase just from having that additional day. So it will probably make it up in the fourth quarter of the year and will essentially we think will be flat for the entire year.

Part of our healthcare growth in the second quarter of the year was from overtime, and we just don’t get as many people to work overtime in the third quarter as we do in the second quarter because of vacation. So we will probably see a slight dip there as well.

Bill Sutherland – Northland Securities

Well, I was actually – I didn’t mean to confuse the question. I didn’t mean quarter over quarter, sequential, I was thinking year-over-year, it looks like the growth is just…

James Boldt

Going a little bit [inaudible].

Bill Sutherland – Northland Securities

Going a bit, yeah.

James Boldt

Yeah. It’s the foreign currency adjustments probably being even worse than they were in the second quarter of the year. As I said the staffing business may actually go negative slightly in the third quarter and then pick it back up again on the fourth quarter of the year. It’s pretty much though what we, you know, when we started the year this was pretty much what we expected. That the third quarter probably would show the least amount of increase. If you look at last year, the third quarter of last year actually was our highest revenue such that the…

Bill Sutherland – Northland Securities

Right. Yeah, I was thinking is that a tougher comp, but then I was just thinking particularly away from healthcare solutions, the other solutions business look like that had quite an unsustainable growth level through first half or extraordinarily high? Is that fair?

James Boldt

It’s much higher than the industry; it’s above what we would expect. We expect for the year an 8% increase in the other solutions business and in the second quarter of the year it was 7.2%.

Bill Sutherland – Northland Securities

Okay. Can you update us on the ICD-10 implementation, the developments there and how that’s developing for you?

James Boldt

Certainly, we do have one project that’ ongoing and then we have done some assessments. The government’s postponements of deadline, the proposed date now has been moved from October of 2013 to October of 2014 has definitely slowed the hospitals down. We’ve actually had some of the hospital that we thought would probably begin the projects by now said that they had reallocated the money to more urgent IT needs in the short term because of that longer term to do it. We think that at some point the government and I suspect it’s probably this October 1st of 2014 date is going to have the – put their foot down and say, we got to make the change for a couple of reasons. One, CMS’s one other numbers, we are not tracking all the decision the rest of the world has. It’s also causing structural problems in billing, probably the best example in this instance, when ICD-9 came out in 1977, they didn’t exist. So there is one code for stents and ICD-9 has 80 codes than ICD-10. So currently when hospitals are billing for putting a stent in, they kind of get any average reimbursement. They may be putting in a much harder one, much more complex operation, but they can only get the average reimbursement. So they got to make the change at some point. I think some of the hospitals we’ve talked to said that they are kind of going to take it seriously because they think that CMS is going to eventually say this is it. They know they have got a little bit more time. I think we’re probably not going to see a tremendous amount of ICD-10 work in 2012, but starting in 2013, I think we’ll start to see some of the larger hospital system start to do something.

Bill Sutherland – Northland Securities

Okay. Then last one from me is just an update on the fraud, waste and abuse product.

James Boldt

We're still working with one small payer that we have a contract with to look for fraud, waste and abuse. They are still analyzing what they are going to push back to their provider network. They happen to be the payer that we used to develop the application. And, well, I guess what we've learned from this is that smaller payers are much more hesitant to charge money back because they don't have the power in a particular market that one of the larger payers might. So we kind of refocused our efforts in the states and the larger payers. We have about six I think betas going on, while we have data from – for a shorter period of time from either the state of the payer and we are analyzing it and giving them back data as to how much money they could expect to save.

Bill Sutherland – Northland Securities

Great.

James Boldt

Thank you.

Operator

Next question comes from Matt McCormick with BGB. Go ahead please.

James Boldt

Good morning, Matt.

Matthew J. McCormack – BGB Securities

Hi, good morning. I guess just on the Staffing side, I guess could you just talk about your visibility there both with IBM and the other U.S. businesses, and also if you could provide some insight into the Staffing business in Europe, that would be great.

James Boldt

Okay. First, for Staffing in the United States, it definitely got slightly better in the second quarter than it had been. We saw a pick-up, we added more people certainly in the second quarter. The IBM business, we’re the sole provider to one of their division. So we’re not losing market share, it's just how many people they need and they go through periods of times when they start a lot of products and they go through periods of time when they just don't start as many, and that's when our people are needed, when they are starting up new projects. So, we think that going into the summer months, and the summer months are always tough because they are always – a lot of people are on vacation, a lot of project managers, so they don’t take on as many staff. But we think the slight increase that was on the second quarter, it appears to be ultimately in the third quarter of the year. So in the United States, we’re seeing more demand than we certainly had in almost a year. The Staffing business really fell off for us in August of 2011 and really didn't pick up in the United States until April of 2012.

Europe, the commercial business in Europe, Staffing is a little weak. You would probably expect that given the economy over there, fortunately because we are headquartered in the Flemish part of Belgium with the new European Union starting up we are seeing demand from the European Union, a lot of their work Solutions with some of the Staffing. So, I actually was pretty pleased. If you look at the European numbers on local currencies, it was up 7.8% in the second quarter. Given what’s happening in Europe, I was very pleased that they were up pretty much in Euros.

Matthew J. McCormack – BGB Securities

Okay. And then you mentioned the headcount as of the beginning of the year was up 3% and I know revenue – or you pushed revenue up 9% year-over-year. Is that – should we continue to expect to see revenue growth exceed headcount growth, and is that a function of greater leverage on the Solutions side or should we see that this growth rate has kind of equalized over time?

James Boldt

Well, certainly for this year it’s going to continue, and it is a function of a mix. One person on the Solutions side of the business billed two to three times what a person does on the Staffing side of the business. So as our Solutions business grows faster than Staffing, it doesn’t take as many people drive revenue growth.

Matthew J. McCormack – BGB Securities

Okay. And then you had mentioned in terms of the EMR wins and losses. I guess you mentioned as Staffing company that you lost to; I recall few quarters ago there was maybe two other deals that you lost through the Staffing agencies. Is there any – do you have any ideas or color or indication on how they had been in terms of their implementation for EMR, I know it’s difficult for a Staffing company to come in and do that type of work.

James Boldt

Right. We’ve heard that they have problems. Actually in the last five-and-a-half years, we have won 30 bids and RFPs out of 40, so we’ve lost 10, I think 9 out of the 10 were state run hospital system where at the end of the day the hospital has to follow the state rule, so picked a person with the lowest count. So virtually every time when we lose, like this one, it’s a state-run or municipality-run institution where picking them it says, you got to pick the person with the lowest rate. And from what we’ve heard later on from – and sometimes we even hear this when we are being told as DIO knows that it’s going to cost some more money to do this and it’s going to take longer et cetera, but they had to follow the state rules.

Matthew J. McCormack – BGB Securities

Okay. Then in terms of capital obviously you have been buying back shares, you’ve talked for a while about the supply constrain in terms of qualified healthcare IT professionals. I mean are there any acquisitions that you think you could make in that area? Are there any small $5 million to $10 million revenue consultancies that you could potentially purchase to continue to grow that practice?

James Boldt

Yeah. We have been looking. We have been actively looking for particularly healthcare solutions business, not so much to pick up additional EMR people but to actually expand our offering in some way geographically or the offerings themselves. The problem with buying a small company or a staffing company, all of the people that they have are generally on engagements. They don’t carry events. So you pick up their revenue but all their people are already booked. It’s not like you pick up a huge bunch of people that you can use on your project.

Matthew J. McCormack – BGB Securities

Right, okay. All right, thank you so much.

James Boldt

Thank you.

Operator

We will go next to Frank Dilorenzo with Singular Research. Go ahead please.

Frank Dilorenzo – Singular Research

Thanks, good morning. I had a couple of questions. One, about the potential – just looking out over the next 12 to 24 months, if you could provide us on with some color on the potential for health insurance exchanges and sort of your thoughts there. I was also wondering about the recent Supreme Court ruling and the possible implementation of the Healthcare Act. If that has changed or maybe your strategic thinking over the mid to long term in any way, thanks.

Brendan Harrington

Yeah, they’ll implement it separately. In terms of the health exchanges, these are exchanges that are going to be run essentially by the state to setup an ability for individuals to shop electronically to buy medical insurance and when we looked at healthcare reform we decided that we would not build an offering for this, and really a couple of reasons. We’d like to have offerings where we either have relationships that we can use or we have a differentiation that allows us to be better in the marketplace. The health exchanges were going to be purchased by states, there are a lot of large aggregators who have longer relationships with states. We didn’t have any particular differentiation so we decided that we would not pursue those and we haven't pursued that part of the market. The rest of healthcare reform that we have, the biggest benefit I think in healthcare reform are also going to be the products that we have launched in the last couple of years and also we have an ACO offering that would help an entity set up an accountable care organization with IT.

The reason for – there is a big change that’s going to occur we think. If you think about it, right now there is not an incentive for a hospital to figure out ways to reduce the number of days that somebody stays in a hospital bed, I mean that’s how they get paid. The more nights the people stay, the better off the hospital system is. The medical management application that we built for end-stage renal disease calculates an intervention point where the kidneys are just about to fail, and by doing that the patient avoids going to an emergency room, he is going to avoid the overnight stay in a hospital. So a hospital today probably isn’t going to purchase that application because it’s not to their benefit. When the hospital is part of an ACO system, that’s their for profit. There is going to be an incentive to do that.

The application also calculates the cost versus the progression of the disease and by doing that we’ve realized that when patients are being sent from a primary physician to the specialist, it’s costing more money. The payers have taken the position that they want patients to stay with your primary physician because their hourly rate is less. When you actually look at the cost versus the progression of the disease you realize that if the patient was `shifted earlier that the total cost would be less even though the specialist was charging more. It used to be more effective. It also measures for all the doctors in a community their cost versus the progression of the disease.

By looking at all those elements and moving people to more efficient lower-cost solutions, we think that we may be able to save 10, maybe even 20 % of the cost of treating end-stage renal disease by using the application. At least that’s what our model has indicated.

So, today a hospital has no incentive to put that in because it would cost them revenue. As the ACOs are formed that’s going to be their profit. We think that that is the perfect market actually for that application.

Even the fraud, waste and abuse if you think about it, hospitals and physicians other than the states they’ve been on kind of other case to reduce fraud, waste and abuse. They haven't really had a big incentive to do it because it lowers their revenue, it lowers their profitability. When they become part of an ACO and you are sharing the profit amongst the players, everyone in the ACO wants to eliminate fraud, waste and abuse because why should a person who is – perpetrator of fraud, waste and abuse get paid more of the money for treating a patient than the people who are honest about it.

Then the ACO offering itself, to install IT systems, I think we have the methodology, we have people to do implementation, we are not doing much of it now and it’s going to be a while really before that kicks in. there is only about 60 I think, 57 maybe, ACOs that have been approved. And they are in a conceptual stage, they’re trying to figure how they get a relationship with the physicians and how they’re going to share revenues. And do they have enough dialysis centers inside their system or do they have to go out and buy them, or contractually somehow agree that the dialysis center that they are using is going to share some of their revenue. They are far away from IT system, so I think it’s going to be a while. I don’t see a lot of work from the AC offering in 2012, but ’13, ’14 I think they are going to kick in too. So, in terms of revenue growth, I think Healthcare Reform is going to be good for CTG.

Frank Dilorenzo – Singular Research

Okay. Thank you.

Brendan Harrington

Thank you.

Operator

Next we have Rick D’Auteuil with Columbia Management. Please go head.

Rick D’Auteuil – Columbia Management

Good morning. A couple. One of the EMR loss you attributed to of a hospital taking it in-house, and I know they generally have staff, but I wouldn’t think they’d have sufficient staff without supplementing with outside resources. How are they suited to deal in a tight market for resources with a painting that goes in incremental people.

James Boldt

Not well. Sometimes they’d go out and try and get additional people needed to do the project. Even some of the larger hospital systems in the country have started and said we can do this by ourselves and realized after working on it and really using a lot of money for six months to a year, we’ll go out and get somebody to come in and help them run the solution. So I expect it to be possible with CN RFP from their hospital system. Again, it’s something.

Rick D’Auteuil – Columbia Management

Is it financial decision that drove the decision to do in-house? I mean they did go outside with an RFP but ultimately, yeah.

James Boldt

I don’t specifically know about that hospital because they did not tell us exactly why. They just announced they weren’t going to engage with them. But generally it is. They kind of get thicker shock. That happen to be around a 1000-bed hospitals, so in total IT services was probably $10 million from most of the players at least and there was probably another $20 million for the software and hardware. And when they looked at the number, that’s a big number for a hospital system, so they kind of go through the rational that they can do this themselves a lot cheaper and they start the process and then realize they can’t. I mean if you think about it, most likely, no one in that hospital system has ever worked on an EMR project before, and they don’t have the methodology to install it.

Rick D’Auteuil – Columbia Management

You brought in an ICD-10 update to an earlier question, my understanding is, many of those projects are likely to be two years in duration, so even if you are talking October 2014 as the new deadline, don’t these hospitals need to start something relatively soon?

James Boldt

I think you’re right. Many of the hospitals, because they haven’t done their assessments, don’t realize how many version upgrades they have to do. I think, in general, the hospitals and maybe even the physicians believe that the EMA has been successful three times and pushing the date back and are hoping for another date pushback. We are not so sure that they’re going to be able to get it again. Another problem is that ICD-11, the WHO has come out – World Health Organization has come out and said that it’s going to announced on January 1st of 2015. So, not only with the USB one version behind but they’re going to be two.

Rick D’Auteuil – Columbia Management

Okay. And it doesn’t make sense just to wait till that’s out and just a leap –I mean ICD-10 and go right to ICD-11?

James Boldt

Well, it’s possible. I mean maybe that’s the conclusion at the end of the day. But they won’t issue what it is until January of 2015. That means that if you – if it does take two years to do an implementation, it wouldn’t be live until 2017, so it pushes it out more than a couple of months.

Rick D’Auteuil – Columbia Management

And then as it relate to that, at one point this year you thought ICD-10 was likely to be a more meaningful part of your growth this year in healthcare, that happens – that hasn’t transpired. So, if you have excess – do you have a bench time with people with those skill sets or you don’t have them on the payroll.

James Boldt

We do have people with those skill sets, but they have multi-skills, so most of them we put on other projects or the project that we have currently. The question is, are we carrying a large bench of ICD-10 people, the answer is no.

Rick D’Auteuil – Columbia Management

Okay. The EMR side of the business, the competitive universe, I know you are only looking at certain sized hospitals, but the other bigger competitors that provides the service is the feeling that they are all out with the project that they have won over the last several years?

James Boldt

Yeah. We don’t think anybody here has a bench.

Rick D’Auteuil – Columbia Management

Okay. Okay, good quarter, guys.

James Boldt

Thank you.

Operator

[Operator Instructions] Our next question will come from Vincent Colicchio with Noble Financial. Go ahead please.

James Boldt

Good morning, Vince.

Vincent A. Colicchio – Noble Financial

Yeah, good morning, nice quarter, Jim. Couple from me that weren’t asked. Of your EMR pipe – the two deals that you’re bidding on, are any of them state hospitals? And then also related to that of your – in the niche of the market where you focus, what percentage of the hospitals would you say are state hospitals?

James Boldt

Both are good questions. I’m trying to think of the names of the two hospitals that we’ve bid on in the quarter that we don’t have an answer to. One definitely is not, and I can’t remember the name of the other hospital. So I’m going to have to actually look through the sheet. No, neither one of them looks like it’s a state hospital. So that was your first question. So neither one of those are state hospitals, and what was your second?

Vincent A. Colicchio – Noble Financial

The overall universe that you target, in terms of the size of hospitals you go after, what does the landscape look like in terms of how many – what portions of those are state hospitals?

James Boldt

Well, based upon the bids that we did over the last five years, it was about 25%.

Vincent A. Colicchio – Noble Financial

Okay.

James Boldt

So I would suspect that’s probably the universe.

Vincent A. Colicchio – Noble Financial

Okay. And then how many EMR projects do you anticipate will be completed by you in the third quarter?

James Boldt

I don’t know, there will probably be a couple. The reason, we don’t know, there’s always a schedule targeted go live dates, but they often get pushed back. And then the other problem or it’s a good problem I have I guess is often when the hospital goes live, they have told us just focusing on meaningful use. So as an example, one of the meaningful useful requirements is to get 30% of the doctor’s PUs, CPOE, computerized physician order entry for prescription, and so we just train 30% of the doctors, get them up and using it. So, meaningful use, and then of course the hospitals says it’s going to believe they just give 30% of it go trying the rest of the hospital, go into areas that we didn’t have to do, because for one reason or another to meet meaningful use for most of the hospital system. So very often we can engage to continue on to do further work to get more value out of the EMR system. Just because we got to go live date doesn’t necessarily mean we’re going to have a project in a particular quarter.

We seem to be averaging about two a quarter, if you go back for two or three quarters in the past that seems to be the average. Kind of internally that’s what we are thinking. We have one project that is not counted in the 18 that we want. At the very end, I think we might find out that we want it at the last week in June, it will start up in the third quarter and then we’ve got the two RFPs and then probably other RFPs that could potentially start in the quarter as well.

Vincent A. Colicchio – Noble Financial

If you could remind me the margin on your EMR business and your non-EMR healthcare business, how they compare?

James Boldt

Well, we’ve never actually given them out. So that’s probably why you don’t remember them.

Vincent A. Colicchio – Noble Financial

Okay.

James Boldt

The EMR has one of our highest offerings – highest margins of all of our offerings. But all of our healthcare offerings are significantly higher than our average solution. We have some older solutions in other parts of business that just don’t have the operating margins that healthcare has.

Vincent A. Colicchio – Noble Financial

Okay. And then what portion of your revenue guidance for healthcare for this year comprises book business?

James Boldt

That’s an excellent question. It’s got to be at least 75% I guess. I’m looking at Brendan to see if he comes up with a different number.

Brendan Harrington

Probably in the 75% range.

James Boldt

Okay.

Vincent A. Colicchio – Noble Financial

Okay. So fairly hard obviously.

James Boldt

Yes.

Vincent A. Colicchio – Noble Financial

Then one last one from me, and I’ll go back in the queue. The outsourcing of the existing applications, is that a large business for you and is that a business that – you mentioned in your prepared remarks that that's starting to improve. So I’m wondering if it’s a new development and if you have a big pipeline for that kind of work?

James Boldt

Outsourcing is 6% of our total revenue and growing at a rapid rate. What’s happening is it’s – and it’s not just the EMR people, but in all of healthcare, hospitals are having a hard time retaining the people because there are so many new opportunity. As they’re experiencing more turnover they are looking to us. I mean if you are a hospital and you don’t have dedicated healthcare recruiters in the IT space, you don’t have a list of people who have those skills in a particular community. So you advertise it on papers and things like that but it’s often very difficult to get some of those skill sets. More and more of our current clients and particularly clients that are coming at the end of their EMR implementation are asking us about outsourcing. If you look most of the wins in the country are for EPIC, EPIC probably is the more severe shortage of qualified people out there that are trained in EMR. And when you take your own internal hospital and you put them on an EMR project, they work on the EMR project for two years, they probably can make 50% or 100% more if they go work for a consultant company at that point. So our clients are starting to lose people. We have databases for all of obviously EPIC people and all the skill sets required to run a hospital. So we are in a better position than they are to find people as turnover. I think that outsourcing in hospitals will probably accelerate over the next couple of years as they experience more problems, more turnover.

Vincent A. Colicchio – Noble Financial

Okay. I will go back in the queue. Thanks Jim.

James Boldt

Okay, thanks Vince.

Operator

[inaudible] with B. Riley and Company. Go ahead please.

Unidentified Analyst

Hi good morning. Just on the healthcare side, specifically EMR, the number of RFPs who currently have outstanding visits typically drop off from the first half as we go to the back half of the year and what are you expecting in terms of new RFPs coming through for the remainder of the year?

James Boldt

We have tried to come up with patterns for that before and there is no rhyme or reason. What’s happening is large hospital systems have many different projects and when they get done – for instance some of the larger ones were doing revenue cycle when incentive money came out from the federal government, and they are finishing their existing projects and then starting up the RFPs. So, we don’t have much visibility into how many RFPs we will get. Obviously our sales are out calling end-customers who have got a list of people who haven't done their EMR projects yet and were expecting them do an RFP, what quarter it’s going to come out and just don’t have much visibility to it.

Unidentified Analyst

Got it. And healthcare, I think you said the non-EMR related stuff was – were those skills you announced were going to contribute nine percentage points of growth? Just curious, do you continue to see growth on some of those newer offerings that you have that EMR continues to grow for you. Do you expect EMR to still be north of 50% of the healthcare revenues or do you think that starts to tail off over time?

James Boldt

I'm sorry. I missed the end of the question. Do we expect…

Unidentified Analyst

The EMR revenues to be over half of your healthcare business or do you expect that some of these newer categories can start to pick up in terms of the percentage of healthcare revenues?

James Boldt

In the next year I think that EMR will still stay close to 50% of our healthcare. But over time obviously they are going to pick up. Particularly one of the offerings we mentioned, and that is IT medical management model has [inaudible] offering are becoming more commercial. I would expect them to kick in a lot more in terms of revenue. Same of ICD-10, by next year I would hope that the hospitals will realize they are going to have to do this at some point and start their ICD-10 project. For this year EMR probably will stay 50% of the total healthcare practice. The demand that we see, at some point EMR has to peak, and we’d love to tell people when that is we have no idea. I mean, it’s probably the stuff where vendors picked either 13 or 14, they get their revenue at the beginning of a project, we get our revenue over the project. So if they are right and it’s 14, for us there might be 15 or 16. In terms of the peak of the EMR, it’s going to have a long tail. Even the federal government thinks that 30% of hospitals in the United States will not have EMR systems by 2019. So there is going to be a lot of additional work over a period of time.

The demand that we are currently seeing for outsourcing in the next couple of years I think we will be able to offset, more than offset any decline that comes after the peak in the EMR. Business because more and more when I go out and talk to the CIOs of hospitals, they say, look I, hospitals aren’t used to tremendous turnover. I mean they tend to have people sometimes for their entire careers. But because the market has become so hard and because they can make so much more money by leaving and going someplace else, they are experiencing turnover that they had never seen in the past. Then when they go out in the market they can’t find a replacement. So I think the – I'm expecting the outsourcing part of our business to grow substantially over the next couple of years and then also the sales offerings.

Unidentified Analyst

I see. I think this was the first quarter where you guys reported an increase in headcount in a few quarters, and I'm sure that’s probably mostly due to rounding. But how many of the conditions are more from the solutions side as opposed to staffing and as we look forward to the back half and into ’13, at what pace do you expect to continue hiring?

James Boldt

Actually we did add about 100 people during this quarter. So it wasn’t rounding. I mean, we really did add around 100 people. I didn’t look at the exact numbers but I would guess probably 70% to 75% of them are in the staffing side of the business. As I said before the revenue per person in the healthcare business is several times over the staffing business. So we don’t need as many people to increase the revenue from the healthcare area.

Unrecognized Analyst

Okay, thanks a lot.

James Boldt

Thank you.

Operator

We have a follow-up from Rick D’Auteuil. Go ahead please.

Rick G. D’Auteuil – Columbia Management

Yeah just on that topic first. So what has been the trend in the recruiter headcount on the staffing side?

James Boldt

You mean the average hire per recruiter?

Rick G. D’Auteuil – Columbia Management

No, the number of recruiters that you’re using.

James Boldt

On the non-healthcare?

Rick G. D’Auteuil – Columbia Management

On the Staffing side.

James Boldt

It’s about the same number of recruiters that we had last year. We haven’t changed substantially the number of recruiters.

Unidentified Analyst

You guys tend to flex with where trends in the market. With the market leveling off here, do you feel like you’re over-staffed or how do you feel about your current position?

James Boldt

We – a year ago, we probably would have continued to add recruiters but elected not to. So a year ago, we actually looked at the average number of regs per recruiter, and we have a target. So last year, the recruiters hit more regs than they should have which means they should add to the number of recruiters. From the beginning of 2011, if you go back and look at our first conference call, we said the Staffing business had to flow. So rather than bringing on new recruiters and then lay them off, we elected just incur more over time the recruiters that we’ve, and now we’re back in balance. The number of regs the recruiters have is just about our target. So I don’t see us flexing the Staffing recruiters. But as I mentioned before actually the volume seems to have picked up the last couple of months on the state of this.

Rick G. D’Auteuil – Columbia Management

Is the bill rate, pay rate spread steady too or are you seeing contraction?

James Boldt

No, actually I would say the reverse. For the first time in almost 11 years we’ve seen a slight amount of inflation. Now the margin is the same. But the bill rates are going up, the wages are also going up. But we think that less than 2% of programmers and analyst in the United States are unemployed at the moment. The market – when you go and talk to a person about non-healthcare Staffing engagement, they’ll usually tell you they are looking at three or four offers now.

Rick G. D’Auteuil – Columbia Management

Okay. One of the other themes that we talked about on our prior call I believe is the thought that some of the smaller hospitals are not going to be able to deal with their obligations to meet the deadlines on EMR and I guess ultimately some other things that might come up. That was generating some consolidation. In some of your customers that you’ve already done work with in healthcare have – could be on the consolidator side. Have you seen any of this so that you’re getting maybe some assignments you’ve finished up, you’re getting round two with an acquisition just to bring them up to the current requirements.

James Boldt

Absolutely. That’s one of the reasons the projects haven’t ended when they were supposed to. When they acquire one of these smaller hospitals they want us to put in the same EMR system that the larger system has. So we are seeing that, and when we talk to our clients they’re pretty open about telling us that they’re talking to other hospitals in their geography about the margin.

Rick G. D’Auteuil – Columbia Management

Okay. So that trend is likely to continue then.

James Boldt

Yes.

Rick G. D’Auteuil – Columbia Management

And the good thing there is once they’ve done the first project [inaudible] do an RFP for the second phase, right?

James Boldt

No, absolutely not, because you want to exactly the same methodology and EMR putt into that new hospital.

Rick G. D’Auteuil – Columbia Management

Okay. Has there been any lightning up on the customers’ side or the prospect side on requiring trained people as opposed to some folks that are newly hired to do EMR work, is that?

James Boldt

No. We haven’t seen any hospitals that will take newly trained or recently trained people. And we’re still sitting with a tremendous amount of requirement so we can’t bill because of that.

Rick G. D’Auteuil – Columbia Management

It’s interesting because a couple of points; they are hiring – you’ve lost in a several assignments over time to staffing people, some of the – you mentioned some of the state hospitals are doing it in-house. You would think that some money saving kind of decision and you can almost present two responses to their RFPs, one with up to end of newly trained or newly hired that might save them some money, and yet they’re not even considering that. I would think when they’re doing their own projects they’re getting that anyway, right?

James Boldt

The RFPs are specific that they want nice experienced people. So the CIOs, they know what the state rule is. All right, they don’t want people submitting newly trained people. The staffing companies are supplying them with trained people. They can do that at a lower cost than we can because they don’t have to maintain methodology and some of the other, the delivery people, the delivery management structure that we do because they’re just providing the person in the hospitals both to supply the methodology and the delivery oversight et cetera.

Rick G. D’Auteuil – Columbia Management

But ultimately, if the hours get run up even at a lower bill rate, they don’t end up saving money in that area.

James Boldt

That’s right.

Rick G. D’Auteuil – Columbia Management

Okay.

James Boldt

And it’s really ironic to actually talk to a CIO and have them acknowledge he knows that, but he can’t anything about it.

Rick G. D’Auteuil – Columbia Management

Your class ratings have been maintained?

James Boldt

They change every month. We spend a lot of time trying to make sure that we have very class renter.

Rick G. D’Auteuil – Columbia Management

Okay. Thank you.

Operator

Follow up from Frank Dilorenzo. Go ahead please.

Frank Dilorenzo – Singular Research

Thank you. There was a previous question about potential acquisitions on the staffing side. But can you talk about – if you are looking at anywhere on the acquisition front aside from staffing, any other areas, analytics, software solutions, things of that nature? Thanks.

James Boldt

Yeah. The actual question I think was that we thought about buying a staffing company to get more people for a solutions business, and the answer is no, because their people are already on engagement. So it doesn’t help you. The acquisitions that we would be looking at are all in the solutions areas. They are all healthcare IT services companies that focus in on solutions for their customers. We really don’t have any interest at all in buying a staffing company. We don’t think it would help the company long-term. Really what we are trying to do is either buy something that expands their offerings or perhaps their geography and some that makes more strategic sense for the company. We have talked and we have seen some companies we haven't really seen anything yet that’s good for us.

Frank Dilorenzo – Singular Research

Okay thanks.

Operator

Thank you and gentlemen we have no one else in queue. Please go ahead with any closing remarks.

James Boldt

Thank you. At mid-year CTG is firmly on track for another year of double-digit earnings growth. For six of the last seven years CTG has firmly established in healthcare, one of the fastest growing U.S industries. We have offerings for electronic medical records, ICD-10 conversions in clinical care and medical informatics, all of which are expected to be in strong demand for several years. [Inaudible] remain very excited about CTG’s future growth prospects. I would like to thank you for your continued support and for joining us this morning. Have a great day.

Operator

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