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Executives

James M. Culligan – Director-Investor Relations

James R. Boldt – Chairman, President, CEO and Head-Investor Relations

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

Analysts

Matthew J. Mccormack – BGB Securities, Inc.

Brian Kinstlinger – Sidoti & Company, LLC

Frank DiLorenzo – Singular Research

Kevin Liu – B. Riley & Company, Inc.

Vincent A. Colicchio – Noble Financial Capital Markets

Bill Sutherland – Northland Capital Markets

Rick G. D'Auteuil – Columbia Management Investment Advisers LLC

Michael S. Needleman – Preservation Asset Management LLC

Computer Task Group, Inc. (CTGX) Q3 2012 Earnings Call October 23, 2012 10:00 AM ET

Operator

Ladies and gentlemen, good morning, thank you for standing by, and welcome to the CTG Third Quarter Earnings Conference Call. At this time, all lines are in a listen-only mode. And there will be an opportunity for your questions. [Operator Instructions]

At this time, I would like to turn the conference over to our host, Director of Investor Relations, Mr. Jim Culligan. Please go ahead.

James Culligan

Thank you, Tom, 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 third 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 those at our website or the SEC’s website at sec.gov. Please review our forward-looking statements in conjunction with these precautionary factors.

With that, I’d like to turn it over to Jim to begin the discussion.

James R. Boldt

Thanks, Jim. And good morning everyone, this is Jim Boldt. I want to thank you for joining us this morning for our third quarter earnings conference call. As you saw in our news release, we had an excellent third quarter with revenue at our guidance and earnings per share at the high end of our guidance. Revenue in the third quarter of 2012 increased over 2011 by 5%.

The operating margin expanded by 140 basis points and earnings per share increased 28%. As we expected, our higher margin solutions business continues to grow and increased 13% in the third quarter of 2012 while revenue from our lower margin staffing business was approximately the same as it was in the third quarter of 2011.

I’m going to talk more about our results and what we see for the 2012 fourth quarter and the full year. but first I’m going to ask Brendan to start this off with a review of our financial results, Brendan?

Brendan M. Harrington

Thanks, Jim. Good morning everyone. For the third quarter of 2012, CTG’s revenue was $106.4 million, an increase of $5.3 million or 5% compared with the third quarter of 2011. Third quarter of 2012 had 63 billing days, the same as in the third quarter 2011.

Solutions revenue in the third quarter of 2012 was $44.2 million, an increase of $5.1 million or 13% compared with the third quarter of 2011. As a percentage of total revenue, solutions revenue was 42% compared with 39% a year ago. The continued improvement in our business mix is mainly being driven by revenue growth from more profitable healthcare projects.

Staffing revenue in the quarter increased $200,000 or three tenth of 1% to $62.2 million. Third quarter revenue from IBM, our largest customer was $28.3 million compared with $30.8 million in the third quarter 2011. As a percent of total revenue, revenue from IBM decreased to 26.6% in the 2012 third quarter compared with 30.4% of total revenue in the 2011 third quarter.

Approximately $1.2 million or 46% of the decrease in revenue from IBM in the quarter was the result of IBM spinoff of its retail business to another large company. Although this change lowered our revenue from IBM, the spinoff had no impact on CTG’s overall revenue since we’ve retained the business with this new client.

Revenue from our European operations was $16.3 million, a 2% increase from the $16 million recorded in last year’s third quarter. The effect of foreign currency fluctuations during the third quarter of 2012 decreased consolidated revenue by approximately $2.1 million or 1.9%. On a local currency basis, our European revenue increased by 14.7% compared with the 2011 third quarter.

Direct costs as a percentage of revenue were at 78.3% in the third quarter compared with 79.3% in the third quarter compared with 79.3% in the third quarter of 2011. SG&A expenses as a percent of revenue decreased to 15.8% from 16.2% in the third quarter of 2011.

The billable travel expenses included in the third quarter of 2012 revenue and direct costs are $3,312,000. The billable travel expenses for the third quarter 2011 totaled $3,074,000. Third quarter operating income grew to $6.3 million, an increase of $1.7 million or 38% year-over-year.

Compared with the trailing second quarter of 2011, operating income increased $180,000 or 2.9%. Operating margin in the third quarter increased to 5.9% of revenue, a 140 basis point improvement from last year’s 4.5%. The year-over-year increases in operating income and margin were due primarily to the increase in the solutions business and our sales mix and the additional operating leverage.

Net income was $3.8 million, an increase of $822,000 or 27%, compared to the third quarter 2011. On a per diluted share basis, net income was $0.23 for the quarter, an increase of 28% compared to third quarter of last year. Both the 2011 and 2012 third quarter results include equity compensation expense of approximately $0.02 per diluted share, net of tax. The tax rate for the 2012 third quarter was 39%, compared with 35.3% in the 2011 third quarter.

We expect the tax rate for the full year 2012 to be between 38% and 40%, compared to the 37.6% in 2011.The increase in the tax rate in the quarter and in the full year 2012 is due to the expiration of certain federal tax credits that we realized in 2011.

Our headcount at the end of third quarter was 3,800, the same as at the end of the second quarter 2012, and 100 people or a 3% higher compared to the end of the third quarter 2011. Of the 3,800 employees at the end of the third quarter 2012, 90% were billable resources.

At the end of third quarter, we had no debt and $29.4 million of cash on the balance sheet compared with $12.6 million of cash at the end of third quarter last year, both the third quarter of 2012 and 2011 ended on a U.S. by-weekly payroll days.

Our day sales outstanding was 60 days at the end of third quarter, one day lower than at the end of the third quarter last year. Our cash provided by operations in the third quarter of 2012 was approximately $6.2 million as compared with approximately $2.8 million in the third quarter 2011.

In the quarter, we had $471,000 in capital expenditures and recorded depreciation expense of $672,000. We repurchased approximately 38,000 shares of CTG common stock during the third quarter of 2012. As of today, our repurchase authorization is for approximately 550,000 shares, as it remains accretive to our earnings, we intend to continue our repurchase program during the fourth quarter of 2012. Jim?

James R. Boldt

Thanks, Brendan. As I mentioned, in aggregate our solutions business, which is significantly more profitable than our staffing business increased by 13% in the third quarter of 2012. The solutions business was 42% of our total revenue in the third 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 17% over the third quarter of last year.

On our conference call at the end of July, we mentioned that we had received two 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 third quarter 2012. Of those projects, we won one project, and we still have three bids outstanding for which an IT services firm has not been selected.

When we started the third quarter of 2012, we had 18 active EMR projects. During the quarter, we started two projects, one of which, we had won in our second quarter of 2012, and two projects came to an end. therefore, at the end of the third quarter 2012, we had 18 active EMR projects. Our EMR work continues to grow with the size and scope of the engagements continues to increase.

As we mentioned before, we currently have a significant amount of opportunity for EMR business while we increased our EMR revenue by 25% in the third quarter and we expect continued growth in EMR work. competitions with a 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 that we can hire is going to be the limiting factor to growth in our EMR business.

Our software-as-a-service or SaaS offerings are beginning to contribute to our improved profitability for still only approximately 1% of our total revenue. two of our SaaS offerings are IT medical management; fraud, waste, and abuse offerings added approximately $0.02 to earnings per share in the third quarter 2012 when compared to the third quarter of last year.

Having covered healthcare, I’d also like to talk about the other three vertical markets that we focus on. Our technology service provider market, which is an all staffing business, declined by 8% in the third quarter, as to our energy vertical, an increase during the third quarter of 2012, while our financial services business was approximately same as it was last year. The lack of growth in the financial services business in U.S. dollars was the result of unfavorable foreign currency fluctuations.

Turning to our staffing business, its revenue was flat when you compare to the third quarter 2012 to the third 2011. while on U.S. dollars, our staffing business did not show an increase when compared to the third quarter of last year. We depict our staffing business is improving slightly in the third quarter 2012.

If you look at our staffing business in local currencies, revenue increased by 3% in the quarter. the reason that staffing business was flat in the last year in U.S. dollars was the unfavorable foreign currency adjustments that occurred in the third quarter 2012.

Looking at the fourth quarter 2012, we’re forecasting total revenue to be in a range of $108 million to $110 million or an 8% increase in the midpoint of our guidance over the last year’s fourth quarter. We’re forecasting earnings per share in the fourth quarter of 2012, excluding the gain from life insurance proceeds to be in the range of $0.22 to $0.24 per diluted share or 15% increase in the midpoint of our guidance over the fourth quarter of last year.

For the 2012 full year, we expect the revenue range of $424 million to $426 million or 7% increase in 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 gains from life insurance proceeds to be in the range of $0.87 to $0.89 or 24% increase from 2011 at the midpoint of our guidance.

To sum it up despite a slowing U.S. economy and Europe’s financial problem, CTG is performing very well based upon our strategic focus on higher growth industries, particularly healthcare, CTG’s earnings per share in the third quarter increased by 28% and we are in paced for another excellent year in 2012.

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

Question-and-Answer Session

Operator

(Operator Instructions) our first question comes from the line of Matt Mccormack with BGB Securities. Please go ahead.

James R. Boldt

Good morning, Matt.

Matthew J. Mccormack – BGB Securities, Inc.

Good morning. I guess first question, in terms of the SaaS offering, I don’t believe you’ve really discussed this much in the past, if there’s any detail that you can provide, it looks like, referred to be $0.02 accretive, you are looking at 1% of revenue, you are looking at about 32% net margin, so obviously very profitable. Is that just one client? Is that in a full production or are you just testing it with one client, I guess, what is the possibility? How much can this grow to? I guess this is the question.

James R. Boldt

Okay, that’s a very difficult question. But in terms of what it is currently, we have one client for both offerings. So two different clients, one of the clients is the IT medical management model, it’s the original client that we were working with to develop it, and under a grant from New York State, we are in the process of installing it in a couple of hospitals in Western New York. We are also building the model out for other diseases. So we have then stage real disease developed, and that’s actually being used, and by the same clients. And then the other diseases that we’re building out for are congestive heart failure, diabetes, chemical dependency and that will help.

The fraud, waste, and abuse also with one client, I think we announced probably at the end of the first quarter that we had one small payer, who had signed up to use the application. It is commercial. And so we have given the client our fine dealings and the client is now working through pursuing, getting the money back from the providers, for some of the claims that we’ve indicated. And we have received our first payment it’s based on what they say is the way that we’re marketing so we get a percent of what they say. So we received our first payment in the third quarter of the year. That’s the first time commercially, that we have ever received a payment for it.

With these two applications are totally new to us, for our existing offerings, we think we have a pretty good method of estimating our future revenue and profitability. If you look for instance at the midpoint of our guidance for this year, while many companies have changed the midpoint of their guidance, that's been the same midpoint that we have really sensed at the end of the first quarter.

So for our existing offerings, we have a pretty good method of we know how many clients are interested, how many bids we are going to get, how many times we are going to win, et cetera, these are totally new to us. And we are also marketing clients that we’ve never really done business with before or so, and in the fraud, waste, and abuse side for instance we’re marketing that product to payers, which we have our experience with overall some marketing United States and we’re really never done now, any business with the four states.

So, in a year or two, we’ll probably be able to come up with a pretty good model to estimate what the future is going to look at, but until we’ve got more history that's just impossible to do.

Matthew J. Mccormack – BGB Securities, Inc.

Okay. And turning to this healthcare vertical, it’s like get the math right, it looks like into the quarter it was down slightly $1 million or $1.5 million sequentially. First of all, is that accurate, and if it is, what’s going on there, is that mainly seasonality, or something else?

James R. Boldt

It sounds like you did the math correctly, and it is seasonality. We’d mentioned when we had the second quarter conference call, that we had worked a lot of overtime in the second quarter of the year. And our people work a lot of overtime when hospitals go live because if anything needs to be adjusted, or if anyone has any questions, our people have to be there on the spot to be able to deal with that.

In the third quarter of the year business for the whole company we generally lose about 3% of our revenue, just because more people take vacations. We also don't work much overtime, including in healthcare in the third quarter of the year. I don't ever remember a hospital scheduling a significant go live of hospital in the third quarter of the year, because people just, because it is summer time they want to be with their families. The weather is nice; they don't want to work a lot of overtime. So we expect and in our guidance, we have the fourth quarter, the less vacation time, we always experience less in the fourth quarter than the third quarter. And we have more overtime, booked for the fourth quarter of the year.

Matthew J. Mccormack – BGB Securities, Inc.

Okay, okay. And then the contraction in the technology vertical, I guess, could you talk about what the drivers are there? I think the demand for IT professional has been pretty strong, so it’s to be down 8%. I guess was just curious, is there any color that you can provide there?

James R. Boldt

Right. This is our public information, so almost all of our technology, service provider businesses is really with IBM. The vast majority of it is with IBM. Our IBM business, if you do the comparison, Brendan gave out the numbers, is down 8% when compared to last year, it is actually 8.2%. Part of it is because our business with them is down. Most of our businesses about 75% of our business is with their Systems and Technology Group, STG, that’s their server group, worldwide. And their business is half FDA adjusted for divestiture that they did and exclude currency exchange fluctuation. If you look at IBM's release from last week, STG was down about 9%. And that’s not just IBM’s server business, if you look at any other server manufacturers, their businesses down particularly in the European market. Because their businesses down, they are launching less projects, and that’s really when they need our people, but the STG division they have component of it, which was called the RSS, the Retail Store Systems. Our business unit of IBM and at the end of July of this year, they were sold from IBM to Toshiba. And we still retain that business, we have the business with Toshiba, didn't go away actually it’s fine and growing a little bit.

However it comes out of the IBM’s numbers, so if you adjusted for that, and said okay take the RSS business unit out of the 2011 quarter, IBM's business with us is down 4.4% so part of it just a switch and classification in my mind, it’s going from technology service providers and the other category and part of it 4.4% is a decline from IBM and it just based upon the fact that the business unit that we're serving their revenues off.

Matthew J. Mccormack – BGB Securities, Inc.

Okay, great. And then the last question very strong cash flow quarter, now $30 million in cash and so on the balance sheet. I know you haven’t particularly been acquisitive, so I just your thoughts on returning cash, I know there is, I think 500,000 shares authorized. But that would only account for that $8.5 million worth of stock. Given the current share price and you’re going to continue to be cash flow positive, so what are your thoughts on returning that cash to shareholders.

James R. Boldt

Well, our first preference would really be to buy something to buy a small very small IT services company that has solutions for the healthcare market. Something that perhaps would expand us geographically or something that would be an offering that we currently don't have or that would enhance one of our current offering. Unfortunately because a lot of aggregators bought up most of them over the last three years, brought many of them for sales so, we're still looking, we’re still hopeful to buy something, which has doesn't happen yet, and if we do buy something our preference would be to use cash to pay for that.

In terms of the stock buyback, it is true there is about 550,000 shares left. Our Board has tended to give us authorizations and on million share increments, I haven’t really talked to them about what happens when this authorization runs up, but I suspect that they would be favorable totally, is considering increasing the authorization going forward. This is about third or fourth authorization that we’ve actually had from them, so if we go back probably to 2007, we probably repurchased between 3 million and 4 million shares.

The other thing that, I know the Board has been looking and I think they are continued to look at is the possibility of a cash dividend. Before 2008, very few actually less than 10% of the technology companies with market capital of our size, actually paid a cash dividend, but more and more as we go out and talk to shareholders, more and more of them are asking if we consider dividend, so I'm sure that our Board will take that under consideration

Matthew J. Mccormack – BGB Securities, Inc.

Okay, great thank you so much.

Operator

Question today comes from the line of Brian Kinstlinger with Sidoti & Company. Please go ahead.

Brian Kinstlinger – Sidoti & Company, LLC

Hi good morning guys.

James R. Boldt

Good morning Brian.

Brian Kinstlinger – Sidoti & Company, LLC

Especially I wanted to talk about first couple of questions on EMR. I'm wondering with the discussions you're having in the hospitals are not yet going to an implementation. What are they saying? What are the plans? What are the timelines? When do you expect to see a surge from some of those hospitals out there?

James R. Boldt

That’s a difficult question to answer because, each one of the hospitals actually is looking at different way, a lot of the hospitals decided that they were not going to avail themselves the ARRA funding, funding actually came out of the HITECH bill. So, those hospitals that wanted to get the reimbursement from the government kind of jumped on the process early.

The hospitals now they were facing potential penalty, if they don't have electronic medical records by the beginning of 2015, and I suspect most of the larger hospitals that can afford to put an EMR system would probably do so and trying to avoid the penalty, because it starts-off with 1% year Medicare, Medicaid, it can run up to 5% over a period time as government thinks but, so I think that you’re going to see this second batch of systems that in this time they want to avoid the penalty instead of getting payments, are going to start their projects up. And if you really want to be up and running on January 1 2015, you really start up probably January or first quarter of next year.

The other thing that we do know is that some of the larger hospital systems, who didn't start up our planning on starting up there is one hospital system, that's quite large for instance that we know is targeting January 1, the next year, and the larger the hospital systems obviously the more people that they need. So, we think that the resources are probably going to be certainly tied for the next year, it can maybe through 2014.

Brian Kinstlinger – Sidoti & Company, LLC

Do you think that the date that compliance starts will hold, and you think there will be announcement that a) will hold or b) were moving it. Is it some hospitals, don’t necessarily believe that date will hold?

James R. Boldt

Some hospitals are very hopeful that they won’t hold. The government in the past when hospitals as a group said that they couldn’t do something, the government has been pretty accommodative in moving the date for instance the ICD-10 conversion date while it’s needed for the system has been postponed three times. So it’s a lot of the hospitals think that the government is going to back off and perhaps not impose the penalty. As to whether they move the date or not, first tell me who is going to win the Presidential Election, because he probably got a different answer depending on we just assume who wins the election, that’s largely a political decision and really that can go just anywhere from here.

I intend to think that the government is serious about and I mean the federal government believes and there’s a report out from them that it will cost the United States about $100 billion to provide everyone with an electronic medical records and the report estimates that everybody in the United States had an electronic medical record, it would reduce healthcare cost by $200 billion to $300 billion a year. Government agencies pay for 55% of all healthcare in the United States, because of Medicare and Medicaid, veterans et cetera. so most of that, majority of that savings would accrue back to the government, and as we all know the government is looking for ways to reduce the deficit, getting healthcare costs to drop, because if you’re eliminating duplicate payments, would be one that would definitely be politically acceptable.

So, I suspect that eventually they will use it, but the whole HITECH Bill is kind of cared and stick to it early, get paid, wait we’re going to penalize here. That’s pretty unusual for Congress; it’s hard to tell whether they’ll actually enforce it in ‘15.

Brian Kinstlinger – Sidoti & Company, LLC

So Jim you brought the Presidential race, so is it fair to say that you think that if Romney wins that there will be extensions more so or maybe take it through, if one candidate is better for your business or another. So we could figure out what we think about November?

James R. Boldt

Well, I am not a political analyst. But certainly, Romney has indicated that if he were to become President and he would try and have Obamacare, that legislation overturned and certainly, President Obama isn’t favor of it. And if you take a step back and say okay, that that makes sense, I suspect that Romney would be a little bit more accommodative to the hospitals, particularly if they said we’re not ready for this. Now even Romney faces the rise in healthcare cost and the budget deficit. So again, he is a business person, if you can reduce government cost by a significant amount, by having hospitals use electronic medical records and you’ve got the tools to be able to do that. You probably would do it, but I think he’d be a little bit more accommodative than perhaps, President Obama would be.

Brian Kinstlinger – Sidoti & Company, LLC

I guess the one, sorry.

James R. Boldt

Yeah. In terms of our business, healthcare costs are going up and all of our major offerings, the SaaS offerings and the electronic medical records are really designed to help reduce healthcare costs. so, whichever Presidential candidate gets in, I suspect our healthcare business is going to be good going forward.

Brian Kinstlinger – Sidoti & Company, LLC

Okay. Now, two other questions and I’ll get in the queue and ask some more. But the first one is, can you talk about pricing in EMR especially once that large customer, potential customer, [is it G&A base] of the entire industry, get that will be even less supply, is everyone raising prices at that point? And then second, in the EMR side, you only have three projects that you bid on right now, that’s small compared to, I think sometimes in the past, so I’m wondering either a number that you expect to got an RFP in the next six months. Can you quantify that number?

James R. Boldt

Okay. In terms of the number in the next six months that’s hard to say, we still have pipeline of hospitals, let’s say that they are going to put out RFPs. it’s really the size of other systems like the one that I mentioned, which is one of the top 10 systems in the country that particular hospital system going live with an EMR project is equivalent to 43 1,000 bed hospitals, starting up the project at the same point of time.

So when you look at the size of the systems that are talking about doing RFPs, that’s kind of the worse maybe the backlog that we’ve had in the past. the healthcare costs, wages and bill rates have been increasing probably this year; it’s in the 5% to 10% kind of range I would think. I think that it’s the large system goes live that resources are going to even be more constrained and I would expect to see more wage inflation. Now everyone in our industry, we have to give out an increase to one of our employees, because we have to keep them when market goes to the customer, and says basically, you look you’re going to lose this person unless we give them this increase. So having wage inflation at the moment is probably more of a good thing for us than a bad thing.

Brian Kinstlinger – Sidoti & Company, LLC

Okay, thanks.

Operator

Our next question comes from the line of Frank DiLorenzo with Singular Research. Please go ahead.

James R. Boldt

Good morning, Frank.

Operator

Mr. DiLorenzo, your line is open. Mr. DiLorenzo?

Frank DiLorenzo – Singular Research

Hi, can you hear me?

James R. Boldt

Yes.

Frank Dilorenzo – Singular Research

Hi, thanks. Got a question on SG&A, it looks like this year, you’ve done a nice job of throwing your SG&A costs, and going back to last year, there was a little bit of spike in your fourth quarter, my question was with regards to the SG&A situation, if you think there will be well-controlled, relatively flat going into this fourth quarter here and also into fiscal 2013? That was my first question. Thanks.

James R. Boldt

Okay, we did get a spike in the fourth quarter of last year. There are more days, so you would expect the absolute amount of it to go up. we actually timed some of our SG&A expenditures, particularly on marketing and development based upon what we think our profit levels are going to be. So when we got to the fourth quarter of last year as we started, we’ve realized that our profit levels were going to increase, as you know, last year in 2011, it went from $0.18 to $0.20 in the fourth quarter, and we elected to put more into marketing and more into solutions work automatically because our profitabilities were going up, our incentives also in total were higher in that quarter.

Longer-term in terms of a target if you will, and this goes back probably 11 years ago, we had targeted around 16% for our SG&A expense, and then we’re shooting for 22% to 23% in terms of our direct profit and what we achieved there obviously, we’re going to hit an operating margin of 6% to 7%, which has been our long-term objective.

Frank Dilorenzo – Singular Research

Okay, that’s helpful, thanks. Also another question regarding your 18 EMR projects, you had an announcement earlier in the months of that in expansion of one deal. I was wondering if you can give us a little more color on your ongoing agreements, what the potential might be for expanded deals regarding your current agreements going forward. Thanks.

James R. Boldt

Right, I think you’re going to see, we have seen in the past, we often have been seeing an increase in the amount of work once we’ve won one of these deals. What happens is just you can tend to understand it’s, use of 1,000 bed hospital system, because it’s just easy math, you actually need about 75 people to do an EMR for our 1,000 bed hospital system. 25 of those people are generally IT consultants from the outside, our people and imagine that you’re staffing a pyramid; all of our people have at least one that three EMRs as they’ve done before and build staffing entire on top of the pyramid.

The client usually will estimate that they can provide the other 50 people generally 25 of those, they’re trying to get out of their IT department, their people need to learn those applications, if they don’t, when we leave who is going to maintain them. 25 of those people, they try and take out of their clinical area, often what happens to a hospital while they think they can do it, when they actually go and take people out of clinicals and take people out of IT, they discover that they’re, that it’s very difficult to do. They can’t totally staff their 50.

We’ve agreed to provide them with the 25 people when we do. they then come back to us with additional requirements and say, look, can you fill these positions that we originally were trying to fill. I would love it if we could fill all those positions, the problem we’re having at the moment is that because resources are scarce for filling some of those additional requirements, but not all of them. So to the extent that the labor market is constrained and remains constrained for people with EMR skills, we’ll probably get some of that additional revenue, but not all.

Frank Dilorenzo – Singular Research

Thanks.

James R. Boldt

Okay.

Operator

And we have a question from the line of Kevin Liu, representing B. Riley & Company. Please go ahead.

James R. Boldt

Good morning, Kevin.

Kevin Liu – B. Riley & Company, Inc.

The healthcare business outside of EMR, just wanted to talk a little bit about what you’re seeing in terms of upgrades, the clinical systems ahead of potential ICD-10 adoption and then also just anything with respect to growth and your application outsourcing fees.

James R. Boldt

Yeah. That’s a good question. We are not seeing anything in terms of ICD-10. That was kind of funny, we actually had a lot of clients that had budgeted money to do remediation this year, and we are expecting to get it as soon as the government belated a year. They took their money and they used it for another one of their projects. most of our clients think that they can get their ICD-10 remediation done in about 12 months.

So when we talk to our clients, most of them are talking about starting projects up in the second or third quarter of 2013 in order to get their ICD-10 compliance. And we still have a lot of clients out there that are open that the EMA successful and gets the government to postpone the date again. I think that’s possible, but I suspect this time that the date is probably going to stick for a while.

In terms of our outsourcing, we had two relatively large, we call them transitional outsourcings were, client was going to a new application and our people came in and maintained the old application till the new one was up and running that actually ended in the second quarter of the year. We had expected and larger, permanent outsourcing startup in August. unfortunately, it was delayed, so it’s actually starting up now in the month of October. So our outsourcing business was actually negative, revenues were negative in the third quarter, but we’re expecting once this other outsourcing is fully staffed, that that will pick back up again, and we’ll see a lot of opportunity in outsourcing going forward. Our clients historically have not had much turnover in their IT departments and particularly, because wages are rising for people with IT experience. They’re seeing much more turnovers than they had in the past. And we think that they are going to look to us to do outsourcing in order to address that.

Kevin Liu – B. Riley & Company, Inc.

And then shifting gears a bit, we had talked a little bit about the fraud, waste and abuse earlier, but just wanted to get as much color as possible around who within your execution has been put in charge of the initiative? Are you guys looking to hire aggressively on the business side? Just to bring on board more folks with relationships with the payers and kind of what does the pipeline look like in terms of how many payers you are funding and going after seeing the next year or so?

James R. Boldt

We have our national sales force that calls unfair. so on a fair side; we have certain geographies that I know they’re looking to perhaps fill with the person that has stronger payer relationships perhaps, but we already have people calling and many of the payers, so we’re pretty well set on that side, but the market that we’re not as really well-structured as actually the states. Historically, we have not sold directly to state governments; we did not have as many people there with relationships. We do have relationships in a few other states that we’re marketing to. But there is an area over the next 12 months that will probably increase our capability too.

We currently have six leaders for either states or payers underway. I apologize, I have downloading problems. So we have six leaders for either states or payers that are underway. And obviously, the guys and girls are trying to close those. One of the things that we’ve found now, it’s a much longer sales cycle than we’re accustomed to. An EMR might be and let us paid work to get in position to get in RFP, and then probably 60 days later, you come to the end of it. When dealing with the states, I think they tend more to think in terms of year cycles versus two-month cycles. So we’ve got a good pipeline, everyone we’ve showed the application to has basically told us, yeah, you’re right, it works. Now it’s just a matter of just closing more.

Kevin Liu – B. Riley & Company, Inc.

Okay, thank you.

Operator

Next question comes from the line of Vincent Colicchio with Noble Financial. Please go ahead.

Vincent A. Colicchio – Noble Financial Capital Markets

Good morning, Jim.

James R. Boldt

Hi, Vince.

Vincent A. Colicchio – Noble Financial Capital Markets

Just a couple, most of mine were answered. On the European business, if you could talk about that a little bit, how visible is that, is that a short-term agreement? And is it just a matter of the EU staying intact, and you’ll see a nice flow of business there from the government. Does the economy impact that? what are the factors that we need to think about?

James R. Boldt

Let me just give some background of Vince’s question, the increase in our business over in Europe is primarily related to a business with the European Union. The headquarters for the European Union is in the Flemish portion of Belgium. That’s where our European operations are headquartered, and most of our European revenue actually comes from the Flemish part of Belgium. We are one of the largest IT services companies in that part of Belgium. And basically, the EU government is rebuilding Washington DC, 200 years later, every month; they announced they opened a new government ministry or agency. And that agency needs IT support.

So we’ve been selling more and more to the EU. The contracts tend to be longer in term, not shorter actually. Their contracts can go one as far as four or five years in terms of supporting some of the names that they have. It’s definitely a good market for us. we’re a player in their market, obviously a recognized player. And I think that we have opportunities, going forward as the European Union government has established to sell more and more IT services. so it definitely is a bright spot.

Our commercial business over in Europe has been somewhat weak, because of the European economy, and obviously were being hurt by the foreign currency exchange. But this quarter, I am pleased to [function] this quarter that our European revenues and U.S. dollars were up a couple of percent, I don’t think that we have another IT services company we can stay there.

Vincent A. Colicchio – Noble Financial Capital Markets

And on the Toshiba business, I know it’s early Jim, but any sense for how secure that is?

James R. Boldt

We are one of their primary providers that business has been going very well. actually, its revenue was up. We’re taking on more people. And we believe we’ve maintained or perhaps even improved our position, going forward. So we’re pretty optimistic about it continuing into the future and growing.

Vincent A. Colicchio – Noble Financial Capital Markets

Last question healthcare solutions revenue as a portion of total revenue, does anyone have that number handy.

James R. Boldt

Healthcare I have to look.

Vincent A. Colicchio – Noble Financial Capital Markets

33%, but just the healthcare solutions piece.

James R. Boldt

It's about 30%.

Vincent A. Colicchio – Noble Financial Capital Markets

Okay. Thanks nice quarter guys.

James R. Boldt

Thank you.

Operator

Next we go to the line of Bill Sutherland representing Northland Capital. Please go ahead.

James R. Boldt

Good morning, Bill.

Bill Sutherland – Northland Capital Markets

Thanks Jim. I’m a bit late, but I caught some of your commentary about the software sales. So is this, should we think about kinds of same kind of impact for Q4, the two initiatives that the group enable in Q3.

James R. Boldt

Yes, actually in our guidance for the fourth quarter, we assume that the profitability would be the same in Q4 as it was in Q3.

Bill Sutherland – Northland Capital Markets

Okay. And were up, how they are contributing some what equally or just proportionally.

James R. Boldt

It is a little disproportionate, I really don't want to disclose the actual numbers for two reasons, actually one is we don't disclose profitability numbers for any of our offerings. But in this particular case if I disclose the numbers that there is only one client, so I am actually disclosing profitability for a client so I’d rather not do that.

Bill Sutherland – Northland Capital Markets

Okay. On the vertical management solution, the grant funding I think is the primary source of funding there, does that as far as you can say (inaudible)?

James R. Boldt

No this project, there will be some revenue through the end of ‘13 but the development of the application, have to be finished by June 30 of 2013. And then in the last six months of 2013, the hospitals and the medical group are actually using the application on patients, it kind of creating beta groups, patients try to using the application without the application and then they are supposed to write white papers in the first quarter 2014 and how well the application worked.

Bill Sutherland – Northland Capital Markets

So, I'm just trying to understand it, will if they, how are you thinking about this sequencing out as far as revenue, if you once finish development mid year, next year will there be a drop off, while the commercial real commercial revenue bills

James R. Boldt

It’s possible, but the end stage renal disease application the beta groups that there was completed in the past, actually it’s completed in 2011 and the beta groups are cramped between July 1 of 2012, and December 31 during the first quarter of next year, that actually in the first quarter of 2013, will actually write the White Papers and how well the application did in terms of in the renal disease. So our hope would be by the third quarter of next year, that we gain a position that we certainly are now in a position to commercially sell the application, but there would be able to actually make sales and implement the application because the White Papers would already be out and the applications done.

Bill Sutherland – Northland Capital Markets

Right, okay. I think that's all I had, thanks so much

James R. Boldt

Okay thanks Bill.

Operator

Rick D’Auteuil, please go ahead sir

Rick G. D'Auteuil – Columbia Management Investment Advisers LLC

Hi Jim.

James R. Boldt

Good morning Rick.

Rick G. D'Auteuil – Columbia Management Investment Advisers LLC

Good morning, I actually getting in the back of the queue almost all my questions have been answered, I just I go back, well this probably three or four years ago there was a big opportunity in front of you and European Healthcare the hospital updating, what is the status of that I know it never really happened, but is that still out there, or what's that you bring out the turn on that.

James R. Boldt

Sure that Rick referring to was the National Health System project in the UK, a centralized national health system organization was putting U.S. software in all the hospitals or trust record over there in Europe. And we were supporting a vendor that was in the southern region and doing install, then actually we put the application, and it was [Cerner] was being installed in the southern region and we put it in two or three hospitals and as far as I know it’s up and running. And that is more a political problem, it wasn’t a technology problem, but political problems reasoned their projects ended that there was a central part of the national health system have taken all the capital spending away from the hospitals and one controlling their project estimated would cost more than $10 billion.

They never run a project like that before and it was divided into five regions, where you had different IT services companies and even different software being installed. So, it is in the way, if I was in charge of running the project. I wouldn't have done it that way, it would've been one IT services company, and it would've been one software. At any rate there was a change in the UK government, the NHS has released the money to the local hospitals now. so that the hospitals or trust are now in charge of spending their own money, and we actually are talking to some of them about putting in U.S. software packages. The same is true in the continent of Europe. The U.S. software is so much rather ahead than the software that they’re using. They should be able to implement it in and reduce costs. EPIC, which is one of the software vendors of private company, but certainly a big winner in the EMR space, opened an office in Amsterdam in the Netherlands last November, and they actually installed their software in the two hospitals, the very first hospital that came live, so it’s fully functional with that is reporting significant savings as a result of putting the software.

So Europe has the same particularly worse the population is aging quicker than ours is, they have the same healthcare problems that we do in terms of cost rising, and we think that the European market starting probably now over the next couple of years are going to start to install U.S. software, and we would like to be a larger player in doing this.

Rick G. D'Auteuil – Columbia Management Investment Advisers LLC

All right. So you have done, have you worked with that EPIC over there on these few opportunities that has gone forward?

James R. Boldt

No. The first two hospitals, they actually did the install themselves. We do work with EPIC; we worked very well with them. We know the person that runs their European operations actually he was one of the guys that used to be in United States. EPIC like all the software manufacturers would love to do all the services themselves. it doesn’t work out and why, because we do something a little bit different than they do. When they go into a hospital, and install it, the doctors (inaudible) change their workflows in order to match up with the workflows that are already setup in the version of the software that they are putting in. where we go in and changed the software? So that it matches their workflow. So, we expect the European market will probably go to the way of the U.S. market that people will want the software adjusted to their works best in their environment.

Rick G. D'Auteuil – Columbia Management Investment Advisers LLC

How about available talent there that would help you attack the end market?

James R. Boldt

Well, Europe does have some EMR packages. They’re not, perhaps as robust, there’s the EPIC package of what we use in the United States, but there are some people with those skills, there are people with PACS skills, and radiology has stored images for a long period of time, it’s called PACS. Those skills are very close to what we need. When we did the installs in the UK, 50% of the people need projects, where from the United States, there are concerns that for two or three year period moved over the UK and 50% were people that we trained in the local areas. So we suspect that in Europe, we’re going to have to do the same thing, it’s going to be a combination of experts from the United States plus locally trained people.

Rick G. D'Auteuil – Columbia Management Investment Advisers LLC

Okay. So maybe that starts to pick up late ‘13 you think or?

James R. Boldt

It’s quite possible. there are a lot of hospitals looking at that software today.

Rick G. D'Auteuil – Columbia Management Investment Advisers LLC

All right, thank you.

Operator

And next we’ll go to line of Michael Needleman, please go ahead with Preservation Asset.

Michael S. Needleman – Preservation Asset Management LLC

Gentlemen, a lot of my question has been answered, but just a couple, on the fraud aspect, as far as revenue guidance for the fourth quarter, I know you’re not breaking it down on those two SaaS products, but it’s my understanding that you collect the revenue after the process for billing issues have been kind of found. How do you guide on revenues on that type of market is in fact you’re receiving the revenues after the process and how do you have visibility in that process?

James R. Boldt

Yeah. I mentioned that before, unfortunately, we don’t have a good model currently in order to be able to do that rather than just talking to the customer and asking them hey, what do you think that we found that you’re going to push through, that’s kind of the way that we’re doing it currently. Eventually, we know exactly how much money we found in various categories, and what we’re starting to do is, keep track of how much the pair is willing to go back to the provider and ask for their money back again. So eventually, I think we have a model like we do for all the rest of our offerings.

Michael S. Needleman – Preservation Asset Management LLC

So in other words, if I can interrupt and pardon me that the process that you’re guiding towards about the same amount of money for those two SaaS opportunities. Some of that is not on a true SaaS basis, but there is some type of revenue that you think that you will achieve on that fraud business. is that correct?

James R. Boldt

Yes.

Michael S. Needleman – Preservation Asset Management LLC

Okay.

James R. Boldt

Based upon talking to their customer and asking them what they’re going to do in the fourth quarter.

Michael S. Needleman – Preservation Asset Management LLC

You’ve mentioned a number of times in the whole process here about being, I guess the detour, but hard to find people in the areas of the EMR as far as people that are capable. What exactly on the technology standpoint is required or needed that you’re finding, it’s so difficult to find people that are able to put these in?

James R. Boldt

Okay. Well, we can train people to do this. we have done it, just mentioned in Europe 50% of the people were normally trained. The problem at the moment is that the CIOs are saying, look, I have to get this in or late to begin. I don’t want to be late and I want to see the resume of every person that’s going to be on my project and all of the people that I will accept have to have at least worked on one EMR project before from start to finish, and it’s generally a two-year process. So what they’re looking for people that understand hospital workflows and that have actually worked on one EMR project in the past.

Michael S. Needleman – Preservation Asset Management LLC

Okay. And then just a follow up, if I heard you correctly, you just mentioned that to install one of these is about a two-year process. is that correct?

James R. Boldt

Yeah. 1,000 or 2,000 bed hospital system. that’s correct.

Michael S. Needleman – Preservation Asset Management LLC

So with the 18 that you currently have, would you kind of say that I’m not asking for a percentage or a more than half well into that process as far as this implementation of this program?

James R. Boldt

Yeah. I don’t have the project sheets in front of me, but my guess is it’s half.

Michael S. Needleman – Preservation Asset Management LLC

Okay.

James R. Boldt

We usually figure it’s about half. For the last couple of years, we have been ending two projects in a quarter roughly and starting to…

Michael S. Needleman – Preservation Asset Management LLC

Two as well, okay. and two last quick questions if I might. the process of how you are able to – your utilization in the EMR, is it basically you’re running, what kind of utilization you guys are running in that area?

James R. Boldt

If a person gets a couple of weeks vacation, his normal sick time et cetera and takes the normal holidays, you’d get 88% utilization and that’s roughly what we’re running.

Michael S. Needleman – Preservation Asset Management LLC

Okay. And then just to come back on the price and this is my last question, if it is so tight right now with people from the standpoint that are qualified in terms of the customer. why are prices actually accelerating up more?

James R. Boldt

One more I don’t know, but prices in both 2011 and 2012 have been increasing about 5% to 10%. and we’re not the only person out in the market. so the market kind of determined so much of an increase.

Michael S. Needleman – Preservation Asset Management LLC

But they’re all in the same boat. are they not?

James R. Boldt

Yep, absolutely.

Michael S. Needleman – Preservation Asset Management LLC

All right. thank you so much, gentlemen.

James R. Boldt

Thank you.

Operator

We’ll next go to the line of Brian Kinstlinger with Sidoti & Company. Please go ahead.

Brian Kinstlinger – Sidoti & Company, LLC

Thanks. A couple of quick follow-ups, first of all, we’ve talked about 5% to 10% price increases and 5% to 10% wage inflation. so you’re not able to capture anymore margin, it still holds it about 10% for healthcare solutions in this part of your business as well?

James R. Boldt

No. That’s not actually true. Usually, what happens with, probably while a project is live, we don’t capture anymore. so if we start a project with a customer, we’ll keep the margins the same, as those people moved to a new project, their bill rates generally tend to go up. and often, we will increase our margins at that point.

Brian Kinstlinger – Sidoti & Company, LLC

Okay. And then you’ve talked about that large hospital is 43 1,000 bed hospitals. if I calculate that right, 25 people per 1,000 bed, it’s 1,075 people too busy industry, not just you have enough people giving your fully utilized basically outside of vacation, and have enough people to meet that, and what happens at that point when they want those people?

James R. Boldt

Well, your calculation is correct. we think it will probably take about 3,000 people in total, probably about a 1,000 from the outside with experience. This has never happened before. the industry doesn’t, I mean, no one, I don’t believe that any of our competitors has any one sitting on the bench right now. everybody with the EMR experience has already an existing project and the industry in total could supply 1,000 people if we shut down all the rest of the projects or half at least of the other projects probably. so it’s, I think that it may be the point that people start to accept newly trained people, but we have to wait and see how they comes.

Brian Kinstlinger – Sidoti & Company, LLC

Has that been discussed with this customer?

James R. Boldt

No, because the RFP isn’t even out with that customer.

Brian Kinstlinger – Sidoti & Company, LLC

Okay. And then just the last question, it’s minor. but mine is something other income line, and why you have cash and no debt and you have a net expect?

Brendan M. Harrington

We do have some bank fees that just we’re having the lines available to us, Brian that we get a three-year commitment and that’s just the amortization of the fees.

James R. Boldt

But there’s also smaller items that hit that item, that line item that caused it to be expensed too. but the biggest item in that line item is the cost that we paid to keep a revolver.

Brian Kinstlinger – Sidoti & Company, LLC

Okay. Thank you.

James R. Boldt

Thank you.

Operator

Our final question today comes from the line of Bill Sutherland with Northland Capital. Please go ahead.

Bill Sutherland – Northland Capital Markets

Thanks. Quick one, any completion slightly in EMR fourth quarter, Jim?

James R. Boldt

Yeah. they probably are quite frankly; I usually figure that it’s going to be two completions a quarter.

Bill Sutherland – Northland Capital Markets

Okay.

James R. Boldt

Yeah, problem is that although their customers have a date, often the date slides some and even when we hit the date, often the customer will ask us to stand, do optimization, so…

Bill Sutherland – Northland Capital Markets

Right.

James R. Boldt

But it’s quite possible; we have a couple just like the other quarters.

Bill Sutherland – Northland Capital Markets

and it’s correct, probably has been discussed, I know you don’t have much visibility outside of this quarter. but is it your sense that will continue to try to bring in the clients next year as well for, as they’re finding through their patch?

James R. Boldt

No. that the data that we processed for them actually was old, I believe it was 2011.

Bill Sutherland – Northland Capital Markets

Correct.

James R. Boldt

And they’re very happy with the results. So they’ve given us every indication that they’re going to continue with it.

Bill Sutherland – Northland Capital Markets

Okay. thanks, Jim.

James R. Boldt

Thank you.

Operator

Do you have any closing remarks?

James R. Boldt

Yes. CTG is firmly on track for another year of double-digit earnings growth, our six in the last seven years. CTG has firmly established in healthcare, one of the fastest growing major U.S. industries. We have offerings for electronic medical records, ICD-10 conversions, accountable care and medical informatics, all of which are expected to be in strong demand for several years. As such, we remain very excited about CTG’s future growth prospects.

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

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using the AT&T Executive TeleConference Service. You may now disconnect.

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