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CTG > SEC Filings for CTG > Form 10-Q on 23-Oct-2013All Recent SEC Filings

Show all filings for COMPUTER TASK GROUP INC

Form 10-Q for COMPUTER TASK GROUP INC


23-Oct-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations for the Quarter and Three Quarters Ended September 27, 2013 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) domestic and foreign industry competition for customers and talent, (iii) the Company's ability to protect confidential client data (iv) the partial or complete loss of the revenue the Company generates from International Business Machines Corporation (IBM), (v) risks associated with operating in foreign jurisdictions, (vi) renegotiations, nullification, or breaches of contracts with customers, vendors, subcontractors or other parties, (vii) the change in valuation of recorded goodwill balances, (viii) the impact of current and future laws and government regulation, as well as repeal or modification of such, affecting the information technology (IT) solutions and staffing industry, taxes and the Company's operations in particular, (ix) industry and economic conditions, including fluctuations in demand for IT services, (x) consolidation among the Company's competitors or customers, (xi) the need to supplement or change our IT services in response to new offerings in the industry, and
(xii) 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 27, 2013 and September 28, 2012 was as follows:

                           For the                           For the Three
                        Quarter Ended                        Quarters Ended
              Sept. 27, 2013     Sept. 28, 2012    Sept. 27, 2013     Sept. 28, 2012
IT solutions         39.7 %             41.5 %             39.3 %            40.8 %
IT staffing          60.3 %             58.5 %             60.7 %            59.2 %
Total               100.0 %            100.0 %            100.0 %           100.0 %

The Company promotes a significant portion of its services through four vertical market focus areas: Healthcare (which includes services provided to healthcare providers, health insurers, and life sciences companies), Technology Service Providers, 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.


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The Company's revenue by vertical market as a percentage of total revenue for the quarter and three quarters ended September 27, 2013 and September 28, 2012 was as follows:

                                                       For the                           For the Three
                                                    Quarter Ended                        Quarters Ended
                                          Sept. 27, 2013     Sept. 28, 2012    Sept. 27, 2013     Sept. 28, 2012
Healthcare                                       31.4 %             33.5 %             31.9 %            32.8 %
Technology service providers                     26.6 %             30.3 %             28.5 %            31.0 %
Financial services                                6.7 %              5.9 %              6.5 %             6.0 %
Energy                                            6.1 %              5.8 %              6.0 %             5.9 %
General markets                                  29.2 %             24.5 %             27.1 %            24.3 %
Total                                           100.0 %            100.0 %            100.0 %           100.0 %

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). Additionally, our healthcare clients have been effected by the U.S. government sequestration cuts which have lowered their reimbursements. 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 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 infrequently works on fixed-price projects which include significant amounts of material or other non-labor related costs which could distort the percent complete within a percentage-of-completion calculation. 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.

During both the 2013 and 2012 third quarters, the Company performed under 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 27, 2013 and September 28, 2012 was as follows:

                                                       For the                           For the Three
                                                    Quarter Ended                        Quarters Ended
                                          Sept. 27, 2013     Sept. 28, 2012    Sept. 27, 2013     Sept. 28, 2012
Time-and-material                                88.0 %             90.4 %             89.1 %            90.5 %
Progress billing                                  9.5 %              7.7 %              8.6 %             7.8 %
Percentage-of-completion                          2.5 %              1.9 %              2.3 %             1.7 %
Total                                           100.0 %            100.0 %            100.0 %           100.0 %

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 27, 2013          September 28, 2012
                                                            (amounts in thousands)
Revenue                                        100.0  %   $  100,689       100.0 %    $  106,418
Direct costs                                    79.0  %       79,506        78.3 %        83,283
Selling, general and administrative expenses    15.0  %       15,129        15.8 %        16,812
Operating income                                 6.0  %        6,054         5.9 %         6,323
Interest and other expense, net                 (0.1 )%          (91 )         - %           (68 )
Income before income taxes                       5.9  %        5,963         5.9 %         6,255
Provision for income taxes                       2.1  %        2,100         2.3 %         2,442
Net income                                       3.8  %   $    3,863         3.6 %    $    3,813


For the Three Quarters Ended:                   September 27, 2013         September 28, 2012
                                                           (amounts in thousands)
Revenue                                       100.0  %   $  316,301      100.0 %    $  316,490
Direct costs                                   79.0  %      249,872       78.6 %       248,608
Selling, general and administrative expenses   15.1  %       47,794       15.7 %        49,817
Operating income                                5.9  %       18,635        5.7 %        18,065
Non-taxable life insurance proceeds               -  %            -        0.1 %           423
Interest and other expense, net                (0.1 )%         (306 )        - %          (157 )
Income before income taxes                      5.8  %       18,329        5.8 %        18,331
Provision for income taxes                      2.0  %        6,354        2.2 %         7,035
Net income                                      3.8  %   $   11,975        3.6 %    $   11,296


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The Company recorded revenue in the 2013 and 2012 periods as follows:

                                                                            Year-over-
For the Quarter Ended:   September 27, 2013        September 28, 2012      Year Change
                                    (amounts in thousands)
North America            81.9 %     $  82,464      84.6 %     $  90,079       (8.5 )%
Europe                   18.1 %        18,225      15.4 %        16,339       11.5  %
Total                   100.0 %     $ 100,689     100.0 %     $ 106,418       (5.4 )%

There were 63 billable days in both the 2013 and 2012 third quarters. Reimbursable expenses billed to customers and included in revenue totaled $2.8 million and $3.3 million in the 2013 and 2012 third quarters, respectively.

                                                                                   Year-over-
For the Three Quarters Ended:   September 27, 2013        September 28, 2012      Year Change
                                           (amounts in thousands)
North America                   82.2 %     $ 260,057      84.1 %     $ 266,209       (2.3 )%
Europe                          17.8 %        56,244      15.9 %        50,281       11.9  %
Total                          100.0 %     $ 316,301     100.0 %     $ 316,490       (0.1 )%

There were 190 billable days and 191 billable days in the 2013 and 2012 year-to-date periods, respectively. Reimbursable expenses billed to customers and included in revenue totaled $9.0 million and $10.2 million in the 2013 and 2012 year-to-date periods, respectively.

In North America, the revenue decrease in the 2013 third quarter as compared with the 2012 third quarter, and the slight decrease in revenue in the 2013 year-to-date period as compared with the corresponding 2012 period was primarily due to a reduction in technical resource requirements from a large client in CTG's IT staffing business in the 2013 second and third quarters. Additionally, there was a general reduction in IT project spending throughout 2013 in the North American markets that we serve primarily driven by the U.S. federal government sequestration which has lowered reimbursements to a number of our healthcare clients. Finally, the Company's revenue in the third quarter was negatively affected by the timing of the completion of certain projects when compared to the timing of the start of new projects which have been delayed.

On a consolidated basis, IT solutions revenue decreased 9.5% and 3.7% in the 2013 third quarter and year-to-date period, respectively, as compared with the corresponding 2012 periods. The decrease in IT solutions revenue was primarily driven by the delay in the start of IT projects as previously mentioned. Also on a consolidated basis, IT staffing revenue decreased 2.5% in the 2013 third quarter, and increased 2.4% in the 2013 year-to-date period as compared with the corresponding 2012 periods. The decrease in IT staffing revenue in the 2013 third quarter was due to the reduction in requirements from the large IT staffing customer noted above. The Company's headcount was approximately 3,800 employees at September 27, 2013, which was no change from approximately 3,800 employees at September 28, 2012, and a 3% decrease from approximately 3,900 employees at December 31, 2012.

In Europe, the strong increase in revenue in the Company's European operations in the 2013 third quarter and first three quarters as compared with the corresponding 2012 periods was primarily due to strength in our European IT solutions business and the acquisition of etrinity, which recorded approximately $0.5 million and $2.2 million of revenue in the 2013 third quarter and 2013 year-to-date period, respectively. The increase was supported by the strength relative to the U.S. dollar of the currencies of Belgium and Luxembourg, and offset by the weakness in the currency in 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 2013 third quarter as compared with the corresponding 2012 period, the average value of the Euro increased 5.8% 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 2012 third quarter to the 2013 third quarter, total European revenue would have been approximately $0.9 million lower, or $17.3 million as compared with the $18.2 million reported. In the first three quarters of 2013 as compared with the corresponding 2012 period, the average value of the Euro increased 2.7% while the average value of the British Pound decreased 2.0%. If there had been no change in the


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exchange rates from the first three quarters of 2012 to the corresponding 2013 period, total European revenue would have been approximately $1.3 million lower, or $54.9 million compared with the $56.2 million reported. Additionally, operating income in the third quarter and year-to-date period would have been approximately $26,000 and $54,000 lower, respectively, if there had been no change in the exchange rates year-over-year.

In the 2013 third quarter, International Business Machines Corporation (IBM) was the Company's largest customer and accounted for $23.0 million or 22.9% of consolidated revenue as compared with $28.3 million or 26.6% of revenue in the comparable 2012 period. In the first three quarters of 2013, IBM accounted for $78.6 million or 24.9% of consolidated revenue, compared with $85.6 million or 27.1% of consolidated revenue in the comparable 2012 period. In the 2012 third quarter, IBM spun its retail business off to another large company. Included in the 2012 year-to-date period was $1.2 million of revenue related to this business which was sold. The National Technical Services Agreement ("NTS Agreement") with IBM extends 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 27, 2013 and September 28, 2012 totaled $9.8 million and $11.6 million, respectively. No other customer accounted for more than 10% of the Company's revenue in the third quarter or first three quarters of 2013 or 2012.

Direct costs, defined as the costs for billable staff including billable out-of-pocket expenses, were 79.0% of revenue in the 2013 third quarter as compared with 78.3% of revenue in the 2012 third quarter, and 79.0% of revenue in the first three quarters of 2013 as compared with 78.6% in the corresponding 2012 period. The Company's direct costs as a percentage of revenue increased in the 2013 third quarter and year-to-date period as compared with the corresponding 2012 periods due to the percentage increase in staffing business in the Company's revenue mix, which has a higher direct cost.

Selling, general and administrative ("SG&A") expenses were 15.0% of revenue in the 2013 third quarter as compared with 15.8% in the corresponding 2012 period, and 15.1% of revenue in the first three quarters of 2013 as compared with 15.7% in the corresponding 2012 period. The decrease in SG&A expenses as a percentage of revenue in the 2013 third quarter and year-to-date period as compared with the corresponding 2012 periods is primarily due to lower levels of incentives earned in 2013, and continued disciplined cost management.

Operating income was 6.0% of revenue in the 2013 third quarter as compared with 5.9% in the 2012 third quarter, and 5.9% of revenue in the first three quarters of 2013 as compared with 5.7% in the corresponding 2012 period. The increase in operating income as a percentage of revenue in the 2013 third quarter and year-to-date period as compared with the corresponding 2012 periods is primarily due to lower levels of incentives earned in 2013, and disciplined cost management. Operating income from North American operations was $16.8 million and $16.0 million in the first three quarters of 2013 and 2012, respectively. European operations recorded operating income of $1.8 million and $2.0 million in the 2013 and 2012 periods, respectively.

During the 2012 second quarter, one of the Company's previous chief executive officers passed away. The Company received non-taxable net proceeds and recorded a gain from life insurance in the 2012 second quarter totaling approximately $0.4 million.

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 40% of pre-tax income. The 2013 third quarter ETR was 35.2% and the 2013 year-to-date ETR was 34.7%. The ETR was below the normal range in the 2013 third quarter primarily due to the Company recording a tax benefit related to the reversal of certain tax reserves. The 2013 year-to-date ETR was below the normal range due to the Company recording a tax benefit for its 2012 research and development activities for all of 2012 in the 2013 first quarter, as required under current accounting guidelines, as the legislation extending the tax credit related to these expenses, the American Taxpayer Relief Act of 2012, was not passed by the U.S. federal government until January 2013. Additionally, the 2013 year-to-date ETR was below the normal range due to the tax benefit of the Company's 2013 research and development activities, the reversal of the reserves as noted above, and the tax benefit of the Company's participation in the Work Opportunity Tax Credit (WOTC) program offered by the federal government to companies who have hired individuals who have traditionally faced barriers to employment. The 2012 third quarter ETR was 39.0% and the 2012 year-to-date ETR was 38.4%.


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Net income for the 2013 third quarter was 3.8% of revenue or $0.23 per diluted share, compared with net income of 3.6% of revenue or $0.23 per diluted share in the 2012 third quarter. Net income for the first three quarters of 2013 was 3.8% of revenue or $0.70 per diluted share, compared with net income of 3.6% of revenue or $0.67 per diluted share in the first three quarters of 2012. Net income in the 2012 year-to-date period included approximately $0.03 per share from the non-taxable life insurance proceeds mentioned above. Diluted earnings per share was calculated using 16.9 million and 16.8 million weighted-average equivalent shares outstanding for the quarters ended September 27, 2013 and September 28, 2012, respectively, and 17.0 million and 16.8 million weighted-average equivalent shares outstanding for the year-to-date periods ended September 27, 2013 and September 28, 2012, 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 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 critical accounting policies are those related to income taxes, specifically relating to the valuation allowance for deferred income taxes, and goodwill valuation. Goodwill Valuation
The Company has a goodwill balance of $38.0 million related to its healthcare vertical market recorded as of September 27, 2013. This balance reflects an increase of approximately $2.2 million in the 2013 first quarter due to the acquisition of etrinity, a provider of IT services to the healthcare market in Belgium and the Netherlands.
The balance is evaluated annually as of the Company's October fiscal month-end (the measurement date), or more frequently if facts and circumstances indicate impairment may exist. This evaluation, as applicable, is based on estimates and assumptions that may be used to analyze the appraised value of similar transactions from which the goodwill arose, the appraised value of similar companies, or estimates of future discounted cash flows. The estimates and assumptions on which the Company's evaluations are based involve judgments and are based on currently available information, any of which could prove wrong or inaccurate when made, or become wrong or inaccurate as a result of subsequent events.
At the October 2012 measurement date the Company completed its annual valuation of the business to which the Company's goodwill relates. During 2012, the Company utilized the provisions under Accounting Standards Update No. 2011-08, "Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment," which allow public entities to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under this new process, an entity is no longer required to calculate the fair value of a reporting unit unless the qualitative assessment shows that it is more likely than not that its fair value is less than its carrying amount. During 2011 and 2010, the company utilized the assistance of an independent third party appraiser to complete its review.
From its internal qualitative assessment completed in 2012, the Company believes the fair value of the business increased from 2011, and continues to be substantially in excess of the carrying value of the business. Additionally, there are no other facts or circumstances that arose during the year which led management to believe the goodwill balance was impaired. Income Taxes-Valuation Allowances on Deferred Tax Assets At September 27, 2013, the Company had a total of approximately $7.8 million of current and non-current deferred tax assets, net of deferred tax liabilities, recorded on its consolidated balance sheet. The deferred tax assets, net, primarily consist of deferred compensation and state taxes, offset by depreciation. 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


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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 27, 2013, the Company had deferred tax assets recorded resulting . . .

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