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CTG > SEC Filings for CTG > Form 10-Q on 23-Apr-2014All Recent SEC Filings

Show all filings for COMPUTER TASK GROUP INC

Form 10-Q for COMPUTER TASK GROUP INC


23-Apr-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations for the Quarter Ended March 28, 2014 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 quarters ended March 28, 2014 and March 29, 2013 was as follows:

For the Quarter Ended

             March 28, 2014     March 29, 2013
IT solutions         39.4 %              39.3 %
IT staffing          60.6 %              60.7 %
Total               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 quarters ended March 28, 2014 and March 29, 2013 was as follows:

                                   For the Quarter Ended
                             March 28, 2014     March 29, 2013
Healthcare                           30.2 %              31.8 %
Technology service providers         24.9 %              30.1 %
Financial services                    8.1 %               6.6 %
Energy                                6.2 %               6.0 %
General markets                      30.6 %              25.5 %
Total                               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). 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 per the proportional method of accounting using an input-based approach. On a given project, actual salary and indirect labor costs incurred are measured and compared with the total estimate of costs of such items at the completion of the project. Revenue is recognized based upon the percentage-of-completion calculation of total incurred costs to total estimated costs. The Company infrequently works on fixed-price projects that 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 the 2013 first quarter, the Company performed services for a customer under a series of contracts that provided for application customization and integration services, specifically utilizing one of the software tools the Company has developed for internal use. These services were provided under a software-as-a-service model. As the contracts were closely interrelated and dependent on each other, for accounting purposes the contracts were considered to be one arrangement. As the project included significant modification and customization services to transform the previously developed software tool into an expanded tool intended to meet the customer's requirements, the percentage-of-completion method of contract accounting was 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 as a percentage of consolidated revenue for the quarters ended March 28, 2014 and March 29, 2013 was as follows:

                               For the Quarter Ended
                         March 28, 2014     March 29, 2013
Time-and-material                87.5 %              89.6 %
Progress billing                  9.9 %               8.0 %
Percentage-of-completion          2.6 %               2.4 %
Total                           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:                          March 28, 2014           March 29, 2013
                                                         (amounts in thousands)
Revenue                                      100.0  %   $ 97,911     100.0  %   $ 108,495
Direct costs                                  78.6  %     76,979      79.2  %      85,896
Selling, general and administrative expenses  15.8  %     15,457      15.1  %      16,417
Operating income                               5.6  %      5,475       5.7  %       6,182
Interest and other expense, net               (0.1 )%        (97 )    (0.1 )%        (109 )
Income before income taxes                     5.5  %      5,378       5.6  %       6,073
Provision for income taxes                     2.3  %      2,212       1.9  %       2,016
Net income                                     3.2  %   $  3,166       3.7  %   $   4,057

The Company recorded revenue in the 2014 and 2013 periods as follows:

                                                                     Year-over-
For the Quarter Ended:   March 28, 2014         March 29, 2013      Year Change
                                 (amounts in thousands)
North America           78.8 %   $ 77,148     82.1 %   $  89,091        (13.4 )%
Europe                  21.2 %     20,763     17.9 %      19,404          7.0  %
Total                  100.0 %   $ 97,911    100.0 %   $ 108,495         (9.8 )%

There were 62 billable days in the first quarter of 2014 and 63 billable days in the first quarter of 2013. Reimbursable expenses billed to customers and included in revenue totaled $2.5 million and $3.1 million in the 2014 and 2013 first quarters, respectively.

The revenue decrease in North America in the 2014 first quarter as compared with the corresponding 2013 period was due to a decrease in demand for both the Company's IT solutions and IT staffing services. On a consolidated basis, IT solutions revenue decreased 9.5% in the 2014 first quarter as compared with the corresponding 2013 period. The IT solutions revenue decrease was primarily driven by the sequestration the U.S. government imposed starting on April 1, 2013, and other reimbursement reductions to hospitals and health systems. These cuts reduced revenue for our healthcare customers, causing them to reduce their expenditures in the later half of 2013 and in the 2014 first quarter, including previously planned spending on IT projects. On a consolidated basis, IT staffing revenue decreased 9.9% in the 2014 first quarter as compared with the corresponding 2013 period. The IT staffing decrease was primarily due to a significant decrease in demand from our largest staffing customer which originally began in the 2013 second quarter. In the 2014 first quarter, this decrease in demand was partially offset by a modest increase in demand from our other large staffing customers. The Company's headcount was approximately 3,700 employees at March 28, 2014, which was a 7.5% decrease


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from approximately 4,000 employees at March 29, 2013, and no change from approximately 3,700 employees at December 31, 2013.

The increase in revenue in the Company's European operations in the 2014 first quarter as compared with the corresponding 2013 period was primarily due to strength in our European IT solutions business. The increase was supported by the strength 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 2014 first quarter as compared with the 2013 first quarter, the average value of the Euro increased 3.7% while the average value of the British Pound increased 6.5%. 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 2013 first quarter to the 2014 first quarter, total European revenue would have been approximately $0.8 million lower, or $20.0 million as compared with the $20.8 million reported. Operating income in the 2014 first quarter was not significantly impacted by the change in the exchange rates year-over-year.

In the 2014 first quarter, IBM was the Company's largest customer, accounting for $21.5 million or 22.0% of consolidated revenue as compared with $28.9 million or 26.7% of revenue in the comparable 2013 period. 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 March 28, 2014 and December 31, 2013 totaled $10.0 million and $11.0 million, respectively. No other customer accounted for more than 10% of the Company's revenue in the first quarter of 2014 or 2013.

In January 2014, IBM announced its intention to spin off its x86 server division to Lenovo. A portion of the Company's 2014 and 2013 first quarter revenue from IBM was related to the x86 server division. The Company expects to retain a significant share of the revenue derived from the x86 server division despite the transition of the division from IBM to Lenovo.

Direct costs, defined as the costs for billable staff including billable out-of-pocket expenses, were 78.6% of revenue in the 2014 first quarter as compared with 79.2% of revenue in the 2013 first quarter. The Company's direct costs as a percentage of revenue decreased in the 2014 first quarter as compared with the corresponding 2013 period due to a decrease in 2014 in employee benefit costs, primarily medical expenses.

Selling, general and administrative ("SG&A") expenses were 15.8% of revenue in the 2014 first quarter and 15.1% in the corresponding 2013 period. The increase in SG&A expenses as a percentage of revenue in the 2014 first quarter as compared with the corresponding 2013 period is primarily due to the effect of a loss of operating leverage resulting from the revenue decrease year-over-year.

Operating income was 5.6% of revenue in the 2014 first quarter as compared with 5.7% in the 2013 first quarter. Operating income from North American operations was $4.6 million and $5.4 million in the first quarters of 2014 and 2013, respectively. Operating income from our European operations was $0.9 million and $0.8 million, respectively, in the corresponding 2014 and 2013 periods.

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 2014 first quarter ETR was 41.1% and the 2013 first quarter ETR was 33.2%. The ETR was higher in the 2014 first quarter than the normal range primarily due to the expiration of certain federal income tax credits as of December 31, 2013. The Work Opportunity Tax Credit and the Research and Development tax credits have not been renewed by the U.S. federal government as of March 28, 2014.

The ETR was lower than the normal range in the 2013 first quarter primarily due to the Company recording a tax benefit for its 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.

Net income for the 2014 first quarter was 3.2% of revenue or $0.19 per diluted share, compared with net income of 3.7% of revenue or $0.24 per diluted share in the 2013 first quarter. Diluted earnings per share was


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calculated using 16.6 million and 17.1 million weighted-average equivalent shares outstanding for the quarters ended March 28, 2014 and March 29, 2013, respectively. The decrease in weighted-average outstanding shares year-over-year was in part due to purchases of shares for treasury of approximately 0.6 million shares in the twelve- month period ended March 28, 2014. Additionally, the dilutive effect of outstanding common stock equivalents decreased by approximately 0.2 million shares year-over-year.

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 goodwill valuation, and income taxes, specifically relating to the valuation allowance for deferred income taxes. Goodwill Valuation
The Company has a goodwill balance of $37.6 million related to its healthcare vertical market recorded as of March 28, 2014. This balance reflects an increase of approximately $2.0 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 2013 measurement date the Company completed its annual valuation of the business to which the Company's goodwill relates. During 2013, 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. From its internal qualitative assessment completed in 2013, the Company believes that although the fair value of the business decreased from 2012, it 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 2014 first quarter which led management to believe the goodwill balance was impaired.

Income Taxes-Valuation Allowances on Deferred Tax Assets At March 28, 2014, the Company had a total of approximately $7.7 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 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 March 28, 2014, the Company had deferred tax assets recorded resulting from net operating losses in previous years totaling approximately $1.2 million. The Company has analyzed each jurisdiction's tax


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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 all of these deferred tax assets will be realized at any point in the future. Accordingly, at March 28, 2014, the Company had offset a portion of these assets with a valuation allowance totaling $1.1 million, resulting in a net deferred tax asset from net operating loss carryforwards of less than $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 ETR. A 1% change in the ETR in the first quarter of 2014 would have increased or decreased net income by approximately $55,000.
Other Estimates
The Company has also made a number of estimates and assumptions relating to the reporting of its 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, the FASB, and other regulatory authorities. Such estimates primarily relate to the valuation of stock options for recording equity-based compensation expense, allowances for doubtful accounts receivable, investment valuation, legal matters, and estimates of progress toward completion and direct profit or loss on contracts, as applicable. As future events and their effect on the Company's operating results cannot 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
Cash used by operating activities was $9.3 million and $7.1 million in the 2014 and 2013 first quarters, respectively. In the 2014 first quarter, net income was $3.2 million, while other non-cash adjustments, primarily consisting of depreciation expense, equity-based compensation, deferred income taxes, and deferred compensation totaled $1.2 million. In the 2013 first quarter, net income was $4.1 million while the corresponding non-cash adjustments netted to $0.8 million.
The accounts receivable balance increased $5.5 million in the 2014 first quarter and increased $3.6 million in the 2013 first quarter. The increase in the accounts receivable balance in the 2014 first quarter primarily resulted in days sales outstanding (DSO) increasing 3 days to 65 days at March 28, 2014 as compared with 62 days at December 31, 2013 due to the timing of receipts near quarter-end. The increase in the accounts receivable balance in the 2013 period resulted from an increase in revenue year-over-year of 5%. There was no change in DSO from period to period, as DSO was 61 days at both March 29, 2013 and December 31, 2012.
The accounts payable balance decreased $2.1 million and $2.2 million in the 2014 and 2013 first quarters, respectively, primarily due to the timing of certain payments near year-end as compared with the end of the first fiscal quarter of each year. Accrued compensation decreased $6.6 million and $5.9 million in the 2014 and 2013 first quarters, respectively, primarily due to one less week of accrued wages at March 28, 2014 and March 29, 2013 as compared with the prior year-end as both quarters ended on a pay date, and lower headcount in 2014 as compared with 2013. Income taxes payable increased $1.8 million and $1.7 million in the 2014 and 2013 first quarters, respectively, primarily due the timing of estimated tax payments in the respective periods.
Investing activities used $0.7 million and $3.5 million of cash in the 2014 and 2013 first quarters, respectively. The Company used cash for additions to property and equipment and capitalized software of $0.8 million in 2014 and $0.7 million in 2013, and net contributions to the Company's deferred compensation plans of $(0.1) million and $0.3 million in 2014 and 2013, respectively. The Company has no significant commitments for the purchase of property or equipment at March 28, 2014, and does not expect the amount to be spent in the remaining quarters of 2014 on additions to property, equipment and capitalized software to significantly vary from the amount spent in the first quarter. In the 2013 first quarter, the Company used $2.5 million, net of cash received, to complete the acquisition of etrinity.
Financing activities used $3.9 million of cash in the 2014 first quarter and provided $1.1 million of cash in the corresponding 2013 period. The Company recorded $0.5 million and $0.7 million in the 2014 and 2013 first quarters, respectively, from the proceeds from stock option exercises and excess tax benefits from equity-based compensation transactions. Cash overdrafts were $(0.2) million and $0.4 million in the first quarters of 2014 and 2013, respectively. The Company initiated a quarterly dividend in 2013, initially payable in the 2013 second quarter, and paid $0.7 million in the first quarter of 2014. The Company also used $3.6 million to purchase approximately


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211,000 shares for treasury in the 2014 first quarter, but did not purchase any shares for treasury in the 2013 first quarter. A total of 0.9 million shares are available under the Company's authorization to purchase shares in future periods.
The Company's revolving credit agreement expired in April 2014, and previously allowed the Company to borrow up to $35.0 million. At both March 28, 2014 or March 29, 2013, there were no amounts outstanding under the credit agreement. Although there were no borrowings outstanding, at March 28, 2014 and March 29, . . .

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