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CTGX > SEC Filings for CTGX > Form 10-Q on 26-Oct-2012All Recent SEC Filings

Show all filings for COMPUTER TASK GROUP INC

Form 10-Q for COMPUTER TASK GROUP INC


26-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations for the Quarter and Three Quarters Ended September 28, 2012

Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements made by the management of Computer Task Group, Incorporated ("CTG," "the Company" or "the Registrant") that are subject to a number of risks and uncertainties. These forward-looking statements are based on information as of the date of this report. The Company assumes no obligation to update these statements based on information from and after the date of this report. Generally, forward-looking statements include words or phrases such as "anticipates," "believes," "estimates," "expects," "intends," "plans," "projects," "could," "may," "might," "should," "will" and words and phrases of similar impact. The forward-looking statements include, but are not limited to, statements regarding future operations, industry trends or conditions and the business environment, and statements regarding future levels of, or trends in, revenue, operating expenses, capital expenditures, and financing. The forward-looking statements are made pursuant to safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Numerous factors could cause actual results to differ materially from those in the forward-looking statements, including the following: (i) the availability to CTG of qualified professional staff,
(ii) renegotiations, nullification, or breaches of contracts with customers, vendors, subcontractors or other parties, (iii) the partial or complete loss of the revenue the Company generates from International Business Machines Corporation (IBM), (iv) risks associated with operating in foreign jurisdictions, (v) the change in valuation of recorded goodwill balances,
(vi) the impact of current and future laws and government regulation, as well as repeal or modification of such, affecting the IT solutions and staffing industry, taxes and the Company's operations in particular, (vii) industry and economic conditions, including fluctuations in demand for information technology (IT) services, (viii) consolidation among the Company's competitors or customers, (ix) domestic and foreign industry competition for customers and talent, (x) the need to supplement or change our IT services in response to new offerings in the industry, and (xi) the risks described in Item 1A of the most recently filed Form 10-K and from time to time in the Company's reports filed with the Securities and Exchange Commission (SEC).

Industry Trends

The Company operates in one industry segment, providing IT services to its clients. These services include IT solutions and IT staffing. The market demand for the Company's services is heavily dependent on IT spending by major corporations, organizations and government entities in the markets and regions that it serves. The pace of technological change and changes in business requirements and practices of the Company's clients all have a significant impact on the demand for the services that we provide. Competition for new engagements and pricing pressure has been and, management believes, will continue to be strong.

IT solutions and IT staffing revenue as a percentage of total revenue for the quarter and three quarters ended September 28, 2012 and September 30, 2011 are as follows:

                                 For the                       For the Three
                              Quarter Ended                    Quarters Ended
                       Sept. 28,        Sept. 30,       Sept. 28,         Sept. 30,
                          2012            2011             2012             2011
        IT solutions           42 %             39 %            41 %              36 %
        IT staffing            58 %             61 %            59 %              64 %

        Total                 100 %            100 %           100 %             100 %


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The Company promotes a significant portion of its services through four vertical market focus areas: Technology Service Providers, Healthcare (which includes services provided to healthcare providers, health insurers, and life sciences companies), Financial Services, and Energy. The Company focuses on these four vertical areas as it believes that these areas are either higher growth markets than the general IT services market and the general economy, or are areas that provide greater potential for the Company's growth due to the size of the vertical market. The remainder of CTG's revenue is derived from general markets.

The Company's revenue by vertical market as a percentage of total revenue for the quarter and three quarters ended September 28, 2012 and September 30, 2011 are as follows:

                                          For the                     For the Three
                                       Quarter Ended                  Quarters Ended
                                 Sept. 28,       Sept. 30       Sept. 28,        Sept. 30
                                    2012           2011            2012            2011
  Healthcare                             33 %           30 %            32 %            29 %
  Technology service providers           31 %           35 %            32 %            35 %
  Financial services                      6 %            6 %             6 %             7 %
  Energy                                  6 %            6 %             6 %             6 %
  General markets                        24 %           23 %            24 %            23 %

  Total                                 100 %          100 %           100 %           100 %

The IT services industry is extremely competitive and characterized by continuous changes in customer requirements and improvements in technologies. The Company's competition varies significantly by geographic region, as well as by the type of service provided. Many of the Company's competitors are larger than CTG, and have greater financial, technical, sales and marketing resources. In addition, the Company frequently competes with a client's own internal IT staff. Our industry is being impacted by the growing use of lower-cost offshore delivery capabilities (primarily India and other parts of Asia). There can be no assurance that CTG will be able to continue to compete successfully with existing or future competitors or that future competition will not have a material adverse effect on our results of operations and financial condition.

Revenue and Cost Recognition

The Company recognizes revenue when persuasive evidence of an arrangement exists, when the services have been rendered, when the price is determinable, and when collectability of the amount due is reasonably assured. For time-and-material contracts, revenue is recognized as hours are incurred and costs are expended. For contracts with periodic billing schedules, primarily monthly, revenue is recognized as services are rendered to the customer. Revenue for fixed price contracts is recognized as per the proportional method of accounting using an input-based approach whereby salary and indirect labor costs incurred are measured and compared with the total estimate of costs at completion of a project. Revenue is recognized based upon the percent complete calculation of total incurred costs to total estimated costs. The Company's estimate of the total labor costs it expects to incur over the term of the contract is based on the nature of the project and our past experience on similar projects, and includes management judgments and estimates which affect the amount of revenue recognized on fixed-price contracts in any accounting period.

The Company entered into a series of contracts with a customer that provide for application customization and integration services, specifically utilizing one of the software tools the Company has internally developed. As the contracts are closely interrelated and dependent on each other, for accounting purposes the contracts are considered to be one arrangement. Additionally, as the project includes significant modification and customization services to transform the previously developed software tool into an expanded tool that meets the customer's requirements, the percentage-of-completion method of contract accounting is being utilized for the project.


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The Company's revenue from contracts accounted for under time-and-material, progress billing and percentage-of-completion methods for the quarter and three quarters ended September 28, 2012 and September 30, 2011 are as follows:

                                       For the                       For the Three
                                    Quarter Ended                    Quarters Ended
                             Sept. 28,        Sept. 30,       Sept. 28,         Sept. 30,
                                2012            2011             2012             2011
  Time-and-material                  90 %             90 %            90 %              91 %
  Progress billing                    8 %              8 %             8 %               7 %
  Percentage-of-completion            2 %              2 %             2 %               2 %

  Total                             100 %            100 %           100 %             100 %

Results of Operations

The table below sets forth data as contained in the condensed consolidated
statements of income with the percentage information calculated as a percentage
of consolidated revenue.



For the Quarter Ended:                              September 28, 2012             September 30, 2011
                                                                 (amounts in thousands)
Revenue                                             100.0 %     $ 106,418         100.0 %      $ 101,119
Direct costs                                         78.3 %        83,283          79.3 %         80,152
Selling, general, and administrative expenses        15.8 %        16,812          16.2 %         16,391

Operating income                                      5.9 %         6,323           4.5 %          4,576
Interest and other income (expense), net              0.0 %           (68 )         0.1 %             50

Income before income taxes                            5.9 %         6,255           4.6 %          4,626
Provision for income taxes                            2.3 %         2,442           1.6 %          1,635

Net income                                            3.6 %     $   3,813           3.0 %      $   2,991


For the Three Quarters Ended:                       September 28, 2012             September 30, 2011
                                                                 (amounts in thousands)
Revenue                                             100.0 %     $ 316,490         100.0 %      $ 295,355
Direct costs                                         78.6 %       248,608          79.2 %        233,858
Selling, general, and administrative expenses        15.7 %        49,817          16.1 %         47,645

Operating income                                      5.7 %        18,065           4.7 %         13,852
Interest and other income (expense), net              0.1 %           266          (0.0 )%           (35 )

Income before income taxes                            5.8 %        18,331           4.7 %         13,817
Provision for income taxes                            2.2 %         7,035           1.8 %          5,168

Net income                                            3.6 %     $  11,296           2.9 %      $   8,649


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The Company recorded revenue in the 2012 and 2011 periods as follows:

                                                                                    Year-over
                                                                                      -Year
  For the Quarter Ended:     September 28, 2012          September 30, 2011          Change
                                         (amounts in thousands)
  North America                84.6 %    $  90,079         84.1 %    $  85,081             5.9 %
  Europe                       15.4 %       16,339         15.9 %       16,038             1.9 %

  Total                       100.0 %    $ 106,418        100.0 %    $ 101,119             5.2 %

There were 63 billable days in both the 2012 and 2011 third quarters. Reimbursable expenses billed to customers and included in revenue totaled $3.3 million and $3.1 million in the 2012 and 2011 third quarters, respectively.

                                                                                                      Year-over
                                                                                                        -Year
For the Three Quarters Ended:                  September 28, 2012          September 30, 2011          Change
                                                           (amounts in thousands)
North America                                    84.1 %    $ 266,209         82.9 %    $ 244,901             8.7 %
Europe                                           15.9 %       50,281         17.1 %       50,454            (0.3 %)

Total                                           100.0 %    $ 316,490        100.0 %    $ 295,355             7.2 %

There were 191 billable days and 192 billable days in the 2012 and 2011 year-to-date periods, respectively. Reimbursable expenses billed to customers and included in revenue totaled $10.2 million and $9.4 million in the 2012 and 2011 year-to-date periods, respectively.

The revenue increase in North America in the 2012 third quarter and first three quarters as compared with the corresponding 2011 period was due to significant demand for the Company's IT solutions services. IT solutions revenue increased 13.1% and 20.6% in the 2012 third quarter and year-to-date period, respectively, as compared with the corresponding 2011 periods. The IT solutions revenue increase was primarily driven by an increase in electronic medical records work for providers in the Company's healthcare vertical market. IT staffing revenue in the 2012 third quarter and year-to-date period was consistent with the revenue recorded in the corresponding 2011 period. The Company's headcount was approximately 3,800 employees at September 28, 2012, which was a 3% increase from approximately 3,700 employees at both December 31, 2011 and September 30, 2011.

The slight increase in revenue in the Company's European operations in the 2012 third quarter, and decrease in the 2012 year-to-date period, as compared with the corresponding 2011 periods, was primarily due to strength in our European IT solutions business, offset by weakness relative to the U.S. dollar of the currencies of Belgium, Luxembourg, and the United Kingdom, the countries in which the Company's European subsidiaries operate. In Belgium and Luxembourg, the functional currency is the Euro, while in the United Kingdom the functional currency is the British Pound. In the 2012 third quarter as compared with the 2011 third quarter, the average value of the Euro decreased 11.6% while the average value of the British Pound decreased 2.0%. A significant portion of the Company's revenue from its European operations is generated in Belgium and Luxembourg. If there had been no change in these exchange rates from the 2011 third quarter to the 2012 third quarter, total European revenue would have been approximately $2.1 million higher, or $18.4 million as compared with the $16.3 million reported. In the first three quarters of 2012 as compared with the first three quarters of 2011, the average value of the Euro decreased 8.9% while the average value of the British Pound decreased 2.3%. If there had been no change in the exchange rates from the first three quarters of 2011 to the corresponding 2012 period, total European revenue would have been approximately $4.7 million higher, or $55.0 million as


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compared with the $50.3 million reported. Additionally, operating income in the 2012 third quarter and year-to-date period would have been higher by approximately $0.1 million and $0.2 million, respectively, if there had been no change in the exchange rates year-over-year.

In the 2012 third quarter, IBM was the Company's largest customer, accounting for $28.3 million or 26.6% of consolidated revenue as compared with $30.8 million or 30.4% of revenue in the comparable 2011 period. In the first three quarters of 2012, IBM accounted for $85.6 million or 27.1% of consolidated revenue, compared with $89.0 million or 30.2% in the comparable 2011 period. During the 2011 fourth quarter, the National Technical Services Agreement ("NTS Agreement") with IBM was renewed for three years to December 31, 2014. As part of the NTS Agreement, the Company provides its services as a predominant supplier to IBM's Integrated Technology Services unit and as sole provider to the Systems and Technology Group business unit. The Company's accounts receivable from IBM at September 28, 2012 and September 30, 2011 totaled $11.6 million and $15.4 million, respectively. No other customer accounted for more than 10% of the Company's revenue in the third quarter or first three quarters of 2012 or 2011.

Direct costs, defined as the costs for billable staff including billable out-of-pocket expenses, were 78.3% of revenue in the 2012 third quarter as compared with 79.3% of revenue in the 2011 third quarter, and 78.6% of revenue in the first three quarters of 2012 as compared with 79.2% in the corresponding 2011 period. The Company's direct costs as a percentage of revenue fell in the 2012 third quarter and year-to-date period as compared with the corresponding 2011 periods due to a shift in the Company's business mix to a higher level of solutions business, which incurs lower direct costs as a percentage of revenue than the Company's staffing business.

Selling, general and administrative ("SG&A") expenses were 15.8% of revenue in the 2012 third quarter and 16.2% in the corresponding 2011 period, and 15.7% in the first three quarters of 2012 as compared with 16.1% in the corresponding 2011 period. The decrease in SG&A expenses as a percentage of revenue in the 2012 third quarter and first three quarters as compared with the corresponding 2011 periods is primarily due to continued disciplined cost management and the effect of operating leverage resulting from revenue growth.

Operating income was 5.9% of revenue in the 2012 third quarter as compared with 4.5% in the 2011 third quarter, and 5.7% of revenue in the first three quarters of 2012 as compared with 4.7% in the corresponding 2011 period. The increase in operating income as a percentage of revenue in the 2012 third quarter and year-to-date period as compared with the corresponding 2011 periods is primarily due the favorable change in business mix from the prior periods. Operating income from North American operations was $16.1 million and $12.0 million in the first three quarters of 2012 and 2011, respectively. European operations recorded operating income of $2.0 million and $1.9 million, respectively, in the corresponding 2012 and 2011 periods.

Interest and other income (expense) was 0.1% of revenue in the first three quarters of 2012 as compared with (0.0)% in the corresponding 2011 period. The increase in net interest and other income in the 2012 year-to-date period resulted from receipt of life insurance proceeds of approximately $0.4 million for one of the Company's previous chief executive officers who passed away in the 2012 second quarter.

The Company's effective tax rate ("ETR") is calculated quarterly based upon current assumptions relating to the full year's estimated operating results and various tax-related items. The Company's normal annual ETR typically ranges from 38% to 42% of pre-tax income.

The 2012 third quarter ETR was 39.1% and the 2012 year-to-date ETR was 38.4%. The 2011 third quarter ETR was 35.3% and the 2011 year-to-date ETR was 37.4%. During the 2011 third quarter, the Company recorded certain favorable tax adjustments to tax expense totaling less than $0.1 million


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associated with the filing of its 2010 federal and state income tax returns. Also during the 2011 third quarter, the Company recorded additional tax credits totaling less than $0.1 million related to its research and development activities, and recognized federal tax credits totaling approximately $0.1 million related to the retention of certain individuals hired during 2010.

Net income for the 2012 third quarter was 3.6% of revenue or $0.23 per diluted share, compared with net income of 3.0% of revenue or $0.18 per diluted share in the 2011 third quarter. Net income for the first three quarters of 2012 was 3.6% of revenue or $0.67 per diluted share, compared with net income of 2.9% of revenue or $0.52 per diluted share in the corresponding 2011 period. Net income in the 2012 year-to-date period included approximately $0.025 per share from the life insurance proceeds mentioned above. Diluted earnings per share was calculated using 16.8 million and 16.7 million weighted-average equivalent shares outstanding for the quarters and year-to-date periods ended September 28, 2012 and September 30, 2011, respectively.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles requires the Company's management to make estimates, judgments and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. The Company's significant accounting policies, along with the underlying assumptions and judgments made by the Company's management in their application, have a significant impact on the Company's condensed consolidated financial statements. The Company identifies its most critical accounting policies as those that are the most pervasive and important to the portrayal of the Company's financial position and results of operations, and that require the most difficult, subjective and/or complex judgments by management regarding estimates about matters that are inherently uncertain. The Company's most critical accounting policies are those related to income taxes, specifically relating to deferred taxes and valuation allowances, and goodwill valuation.

Income Taxes - Deferred Taxes and Valuation Allowances - At September 28, 2012, the Company had a total of $7.1 million of current and non-current deferred tax assets, net of deferred tax liabilities, recorded on its consolidated balance sheet. The changes in deferred tax assets and liabilities from period to period are determined based upon the changes in differences between the basis of assets and liabilities for financial reporting purposes and the basis of assets and liabilities for tax purposes, as measured by the enacted tax rates when these differences are estimated to reverse. The Company has made certain assumptions regarding the timing of the reversal of these assets and liabilities, and whether taxable income in future periods will be sufficient to recognize all or a part of any gross deferred tax asset of the Company.

At September 28, 2012, the Company had deferred tax assets recorded resulting from net operating losses totaling approximately $1.1 million. Management of the Company has analyzed each jurisdiction's tax position, including forecasting potential taxable income in future periods, and the expiration of the net operating loss carryforwards as applicable, and determined that it is unclear whether some of these deferred tax assets will be realized at any point in the future. At September 28, 2012, the Company has offset substantially all of these deferred tax assets with a valuation allowance totaling $1.0 million, resulting in a net deferred tax asset from net operating loss carryforwards of approximately $0.1 million.

The Company's deferred tax assets and their potential realizability are evaluated each quarter to determine if any changes should be made to the valuation allowance. Any change in the valuation allowance in the future could result in a change in the Company's effective tax rate ("ETR"). A 1% change in the ETR in the 2012 third quarter would have increased or decreased net income in the quarter by approximately $63,000.


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Goodwill Valuation - The Company has a goodwill balance of $35.7 million related to its healthcare vertical market recorded as of September 28, 2012. As of the fiscal month-end October 2011, with the assistance of an independent appraisal company, the Company completed its annual valuation of the business to which the Company's goodwill relates. The valuation indicated that the estimated fair value of the business was substantially in excess of its carrying value by approximately 116%. Additionally, no facts or circumstances have arisen since October 2011 which have led management to believe the goodwill may be impaired.

Other Estimates - The Company has also made a number of estimates and assumptions relating to the reporting of other assets and liabilities and the disclosure of contingent assets and liabilities to prepare the consolidated financial statements pursuant to the rules and regulations of the SEC. Such estimates primarily relate to actuarial assumptions including discount rates and expected rates of return on assets, as applicable, for the Company's defined benefit and postretirement benefit plans, an allowance for doubtful accounts receivable, assumptions underlying stock option valuation, investment valuation, legal matters, other contingencies, and progress toward completion and direct profit or loss on contracts. As future events and their effects can not be determined with precision, actual results could differ from these estimates. Changes in the economic climates in which the Company operates may affect these estimates and will be reflected in the Company's financial statements in the event they occur.

Financial Condition and Liquidity

Operating activities provided cash of $9.8 million in the first three quarters of 2012 ("2012 period"), and used $1.5 million of cash in the first three quarters of 2011 ("2011 period"). In the 2012 period, net income totaled $11.3 million, while other non-cash adjustments, primarily consisting of depreciation and amortization expense, equity-based compensation expense, deferred income taxes, and deferred compensation totaled a net of $4.8 million. In the 2011 period, net income was $8.6 million, while the corresponding non-cash adjustments netted to $2.5 million. Accounts receivable balances increased $2.8 million in the 2012 period, and increased $10.3 million in the 2011 period. The increase in the accounts receivable balance in the 2012 period primarily resulted from a 7.2% increase in revenue year-over-year, offset by a two day decrease in days sales outstanding ("DSO"). DSO decreased two days to 60 days at September 28, 2012, from 62 days at December 31, 2011. The increase in accounts receivable in the 2011 period primarily resulted from a 21% increase in revenue year-over-year. DSO was 61 days at September 30, 2011 as compared with 60 days at December 31, 2010.

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