Q3 2022 Computer Task Group Inc Earnings Call
Greetings and welcome to the CTG, Inc, third quarter fiscal year 2022 financial adult.
At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad.
A reminder, this conference is being recorded it is now.
Now my pleasure to introduce your host Craig Mahalik Investor Relations. Thank you Craig you may begin.
Yes, Thank you and good morning, everyone. We certainly appreciate your time today and your interest in CTG joining me our fleet today are president and CEO and John <unk>, Our Chief Financial Officer.
We released our third quarter 2022 financial results. This morning before the market open you can access the release at our website at CTG Dot com after.
After fleet and John's formal discussion. This morning, we will open the line for Q&A let.
Let me first I'll just remind you that you are likely aware that we may make some forward looking statements during the formal discussion as well as during the Q&A session. These.
These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what is stated on today's call.
These risks and uncertainties and other factors are provided in the earnings release as well as with other documents filed with the Securities and Exchange Commission.
These documents can be found on our website or at SEC Gov.
During today's call. We'll also discuss non-GAAP financial measures, which we believe are useful in evaluating our performance.
Not consider this additional information in isolation.
Or anything else.
Two for results prepared in accordance with GAAP.
We have provided a reconciliation of non-GAAP measures with comparable GAAP measures in the tables in today's release and our SEC filings.
I'll now turn the call over to Felipe to begin please.
Yes.
Thank you, Greg and good morning, everyone.
Reshaped you joining us today.
I would like to spend a few minutes on the progress against our strategy and then highlight the acquisition we completed at the end of the quarter.
Our third quarter results continue to validate the effectiveness of our strategy.
Evolve into the digital solutions and services business with.
With solid margin expansion.
Even against revenue headwinds.
Our gross margin expanded 190 basis points.
94, 3% year over year and was up 40 basis points sequentially.
This improvement demonstrates the advancement of our strategy to drive a higher level mix of digital solutions, while reducing our exposure to lower margin noncore businesses.
Our non-GAAP operating margin also expanded 70 basis points, despite ongoing investments in inflationary pressures.
We recorded net income of $1 1 million.
Adjusted EBITDA increased 2.0% to $3 8 million.
100 <unk>.
With a 100 basis points improvement in margin to five 1%.
From a segment perspective.
The gross margin for our North America, and Europe , It solutions and services segments was a combined 29, 1%.
Further highlighting our continued transformation to a digital solutions company.
We have also seen a strengthening of our nonstrategic technology services segment margins as we have consistently been disengaging from the lowest margin business for us.
During the quarter, we disengage from an over $8 8 million of revenue within that segment.
The labor environment remains competitive.
And our overall growth has been impeded by labor constraints, particularly in Europe .
We expect to combat this challenge by expanding our offshore delivery center capacity.
While we have had some success increasing our delivery head counts in both our Colombia and India centres, we look forward to leveraging our recent acquisition Alleviant, which we announced on September 29.
<unk> was privately owned digital transformation company headquartered in Dallas, Texas.
During a 17 year history, they have built a reputation of exceeding expectations.
As a result have enjoys high client retention rates.
This acquisition was driven in part by the strong alignment of our respective visions for accelerating our clients digital transformation by leveraging emerging technologies and the commitment to deliver meaningful business results.
The rationale behind the transaction was quite competitive.
Our base strengthen our digital offerings in AI machine learning and intelligent automation.
Expand our capabilities in cloud migration mobile application development and notebook technologies such as blockchain.
Our best in class.
Forbes complement many of our existing solutions and services.
And increase our global delivery center capacity and flexibility.
Addition of established teams in Chennai in Coimbatore, India.
The purchase price was $18 6 million and was largely funded with cash and the small acreage and simple.
Our sites.
Sure.
Is it accelerating.
Accelerating integration and our combined ability to drive sales synergies and deliver even greater value for our clients.
<unk> is expected to add incremental annual revenue of approximately $10 million and given its strong margin profile is immediately accretive to our EBITDA margin.
We look forward to a bright future together.
And welcome the entire <unk> team to the CTG.
Sean will speak to our specific guidance.
But generally speaking we recognize that the global outlook has continued to soften.
There are underlying pressures and uncertainties.
We remain confident in our ability to navigate these challenges by continuing to focus our efforts on developing stronger earnings profile to meet our long term objectives.
With that.
Let me turn it over to John to review our results in more detail.
John .
Thank you Felipe and again good morning, everyone. Thank you for joining us on today's call.
Consolidated revenue in the third quarter was $75 million.
Which reflected an $8 8 million decrease related to the disengagement from lower margin non strategic business and a $5 7 million unfavorable impact to revenue due to changes in foreign currency exchange rates.
Excluding these two items revenue was down approximately 1%.
From a segment perspective, North America, IP solutions and services revenue was down about 4% largely the result of the macroeconomic climate, which has slowed clients' decision, making process for IP solutions and services.
Also contributing to the change was the ramp up in last year's third quarter of a significant project that was completed in the 2021 fourth quarter overall, our core business in North America has been solid and there is a steady pipeline of opportunities.
In our Europe segment on a constant currency basis revenue was relatively flat compared with the prior year period.
Strong execution helped to offset some of the challenges that are present in that part of the world, particularly around labor constraints as Felipe discussed.
We are currently looking to leverage our global resource pool with improved capacity that alleviant brings to our offshore delivery centers.
As we highlighted today our margin profile improved during the quarter as we continue to optimize our revenue mix.
Consolidated gross margin was 24, 3% up 190 basis points over last year's third quarter, and 220 basis points higher over two year period.
<unk> solutions and services the North America gross margin expanded 370 basis points, despite lower revenue given the improved mix of digital solutions.
<unk> gross margin was down about 60 basis points are solid results, given the labor and inflationary pressures.
While we continue to disengage from the lowest margin projects in the non strategic technology services that segment has seen a steady improvement in margins.
SG&A expense declined 9% to $16 million, though as a percentage of revenue increased 190 basis points largely due to the loss of operating leverage.
GAAP operating income was $2 3 million for an operating margin of 3%, which was flat with last year.
non-GAAP operating margin, which excludes 744000 of acquisition related expenses.
It was $3 million or 4% of revenue up 70 basis points.
We recorded net income of $1 1 million or <unk> <unk> per diluted share in the quarter.
non-GAAP EPS again, excluding the acquisition related cost was <unk> 11, compared with 13 and the year ago quarter of note. The effective tax rate was elevated in the quarter at 48% due to a reversal of deductions previously taken in a foreign jurisdiction.
Lastly, our adjusted EBITDA margin also improved to five 1% in the quarter, which was up 100 basis points.
Ctg's total headcount at the end of the quarter was 3250 of which approximately 88% was billable.
This compares with 90% bill during the prior year period.
Turning to our balance sheet and cash flow.
Cash and cash equivalents were $26 8 million.
Down from $35 6 million at the end.
At year end 2021, reflecting the cash used to acquire Alleviant.
We generated strong cash from operations during the quarter of $9 7 million for year to date total of $12 5 million.
There was no debt outstanding at quarter end, we still maintain a strong and flexible balance sheet that can continue to be leveraged to accelerate our pace of growth in the future.
For our outlook, we are adjusting our revenue for 2022.
To range from $320 million to $330 million.
Which reflects a reduction of approximately $30 million as a result of the intentional disengagement from the lowest margin business in our non strategic technology services segment.
$20 million from foreign currency exchange impacts.
And a significant expected reduction in the fourth quarter compared with the prior year due to the completion of a large project last year in our North America segment.
<unk> is expected to add approximately $2 $5 million in revenue in the fourth quarter.
Despite the top line decrease in challenging macroeconomic headwinds, we expect our operating margin for the year to improve over the prior year given the positive ongoing changes to our business mix.
We now expect 2022 GAAP diluted earnings per share to range from 42.
To <unk> 48.
And non-GAAP diluted earnings per share to range from 52 to.
58.
As we continue to execute our plan. We believe we have further earnings power to unleash and our long range goal remains unchanged as we drive our adjusted EBITDA margins to approximately 7% by the end of 2023.
That completes our prepared remarks, operator could you. Please open the call for questions.
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Please while we poll for questions.
Thank you. Our first question is from Kevin Liu with K Liu <unk> Company. Please proceed with your question.
Hi, Good morning, guys, maybe just starting with some questions on the acquisition of obedient, how much head count did that add and in terms of the quarter end number and then how should we think about kind of the gross margin and incremental Opex you would expect on an annualized basis.
Well, Kevin the head count is around 300 employees.
And most of them obviously are software engineers.
And the vast majority are in the two delivery centers in India.
As to the gross margin.
That's significantly higher than that.
<unk>.
It solutions and services margin even than the one in the states. So we're talking about is above 50%.
And we see a very strong <unk>.
Financial profile John .
Tom anything you would like to add to that.
Yes.
Not really flip that was that was <unk>.
The operating expense you asked about Kevin our operating margins also will be well above where we have been in the past even with our solutions business earlier really nicely profitable business.
That's great to hear and then just focusing on the North American <unk>.
Leasing segment for a bit obviously, the gross margin expansion there was impressive to see.
The flattish revenues quarter to quarter, just wondering if you could talk a little bit about kind of the mix of work Youre getting there.
In this current environment and whether the type a license we saw in Q3 are sustainable moving forward.
I didn't sense that very long sentence, you said could you repeat that.
Just wondering if the 38% gross margin we solve for the North America segment in Q3 is that going to be sustainable going forward.
Okay. Thanks.
No.
Our mix of business, we see in North America.
Really strong.
It's been certified by origin.
We see a good pipeline.
Good level of digital opportunities in the pipeline.
And of course, you know about the significant projects we have.
We had last year in the second half primarily in the fourth quarter, that's going to make comparisons.
Between years difficult.
But on your question about the 38% margin.
Most of that business at this moment.
It delivers onshore.
We have already offered.
Sure capabilities, we had them before elysium.
In Colombia and in the hydro about India.
But still most of the business in North America was delivered offshore onshore sorry, so that means suites.
Leverage of lesions.
Yeah.
Cost difference between India, and North America, and the margins that.
<unk> is able to create in their delivery system.
We believe that 38%.
It is not yet.
We're aiming higher.
Great and then maybe if I could just wrap up with some questions on the <unk> It solutions.
Solutions segment can you talk about quarter over quarter have you seen any.
Improvement at all in kind of the labor constraints you've talked about.
And then as we move forward from here.
Do you feel about your ability to.
The increased margins there either through pricing actions are continuing to win.
New business that could potentially push that margin up.
Sure.
Quarter over quarter.
Labor constraints.
<unk> remained.
Same level.
It's still very hard to.
To fill client demands.
In the areas steps, we want to focus on solving the digital skill set space.
In other areas, we see it.
Becoming less stringent.
It's in.
In the areas, we want to grow.
It's a difficult situations.
About how we battle that and how we.
Are combating that.
And two way, Kevin mostly two ways first.
Again, the offshore components.
We're looking forward to.
<unk> deliver at lower costs and a higher margin.
Our mix is moving in that direction.
So definitely impacts our profitability.
Seconds.
If you go back to the <unk> acquisition.
We also acquired some best in class SaaS platforms with that acquisition.
A number of those are very well positioned to automate.
Parts of our existing solutions and services and by the way that's not only in Europe Thats in Europe , and North America. So we can look at the existing assignments existing projects and automating part of that work with the bulk of RV chats two of their.
Platforms in their G suite.
And increasing margins. So those are the two areas, obviously moving the legacy solutions business, we still have in Europe .
Towards digital model.
Is the main driver of profit improvement.
Okay, great. Thank you for taking the questions and good luck, finishing out the year.
Thanks, Kevin Thanks, Kevin.
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Our next question is from Marc Riddick with Sidoti. Please proceed with your question.
Hey, good morning.
Hi, Mark wondering mark.
So a couple of things I wanted to start on maybe you could touch a little bit on the.
The tax rate that.
You mentioned it was in the press release as far as the elevated tax rate I was wondering if you touch a little bit on that and whether we should expect that to.
Is that also.
Expected to be elevated in the fourth quarter and that being part of your guidance there as well.
John would you like to comment on that.
Sure. Thanks Felipe Hi.
Mark relative to the tax rate in the corner.
40%.
The.
It really was due to.
Some revisions on.
<unk>.
Deductions that we had previously taken so we've got a very conservative approach.
Round tax across the company worldwide.
But youre always going to face.
Situations, where folks thought where you take a look and do some audits of prior years. There was a multi year audit that was done and there were some things that were disallowed debt raise the the rate in the quarter. So I don't expect that to continue in the quarter it might be a little bit higher in Q4.
But I don't think it pervasive Lee goes from where it was hanging out around 20% to 30% to 40, 41% unless unless statutory rates change of course.
Got you Okay I just wanted to get that company and then moving on to one of the things I thought was kind of interesting I mean, certainly you've been working on winding down the non strategic but the wind on that you've done. So far has actually led to an increase in the margins.
I was I guess, maybe better margins than we thought we would see but also year over year, an increase in non strategic so maybe talk a little bit about that.
<unk>.
Is there maybe some business in there that you might revisit or how should we think about that sort of overall picture and then how that.
The reduction rolls off next year.
Sure Mark.
Yes.
It's very obvious that we are.
Moving away from the lowest margin business.
Having the <unk>.
I'll list of contracts.
We're looking at where the margins are lowest and obviously thats our first.
The area of focus to go and talk with the client.
See if there is another way we can provide the same services. If we can get out of the nonstrategic parts and move it to solutions and if not then we're not going to renew or only want to renew.
And a significantly higher margin.
Which so far has resulted in.
The average margin of the remaining.
Of the remaining non strategic business increasing.
So is there parts of this business that we might revisit it.
It's our policy to always go in talk with declines and find ways to increase our added value to look at the profitability, we have and make it more acceptable to us.
Our clients.
Sees the value for them in thinking in the same direction with us.
Yes.
As we look at the business how is this being positioned right now.
Then I think that this all business, we want to move away from.
Except that we're able to change the.
The parameters that we're working on.
And for next year Mark.
Our plan is to continue.
Continue at the same rates.
This engaging the business.
This year is as little more than last year I think for next year, we're looking at somewhere in between the two numbers, maybe John you could.
Spend on that.
Sure we were at about 20.
$20 million last year in 2021 of which we disengage from in this year, it's a little bit over $30 million. So we've averaged $25 million over the last couple of years and think that that's.
Sort of a run rate going forward, so a little bit higher in 'twenty, two but gravitate back down into the mid twenty's as far as what we think will disengage from.
Okay, great and that kind of leads me into the next part as far as there seems to be continued comfort as far as the goal of reaching your adjusted EBITDA margin level.
A level of 7% by 2000 by the end of 'twenty. Three I was wondering can you talk a little bit about that because it seems as though between the disengagement from non strategic <unk> acquisition as well as just overall progress that you're making and maybe you can touch on the pricing dynamic that youre seeing as well, but it seems as though it would be reasonable from the Asa.
Looking into the view that goal as more attainable today or maybe more confidence in attaining that goal today than maybe six to nine months ago does that makes sense and maybe you can share some thoughts on that.
Sure well there.
Moving in the right direction.
All of the elements that.
Trying to influence.
First of all.
We're focusing on investing in sales solutions partnerships marketing to drive the organic growth that we're getting the right balance in the company to grow that digital business.
Because the digital business higher value higher margin is going to outputs increase that margin.
Second.
We're reducing our exposure to lower margin non strategic technology.
Third we're focusing on lowering our our delivery costs through the offshore delivery centers and with the leveraging of <unk> that we started.
We're going to make significant progress on that.
And.
Then lastly, our focus on acquisitions.
That grow and expand our digital solutions business.
Well again elysium.
A significant step forward.
So we're looking for additional prudent investments.
Still using our disciplined capital allocation approach.
But to continue so all of the four levers that help us increase that margin. We have made significant progress. So that's labor confidence to maintain that.
Our goal for end of 2020.
Okay, and then last last one for me and I appreciate all the feedback and color I was wanted to talk a little bit about maybe some of the demand dynamics that youre seeing some you certainly your customer base is fairly broad and certainly touch on all of the bold is certainly key.
Industry.
<unk>.
Areas and so maybe you could touch a little bit on maybe what youre seeing some from your customers.
Given the recessionary concerns in global pressures and alike.
If there are any sort of call outs that.
That might be helpful. Thanks.
Thanks.
Okay.
Sure.
The simple answer Mark is that we are.
The same kind of.
Effects.
Sure.
In almost all industry sectors.
It's a difficult economic environment in Europe , as we said.
Theyre, the only industry that isn't affected that much.
And that's still going strong.
The government's national.
National governments.
European governments, all the others.
Are the same as the discussions we have been in the states.
Not that our pipeline is shrinking it's very healthy.
The discussions are more details.
Slower definitely.
That global inflation causes everybody to falls and rethink the priorities and only focus on the absolute top priorities.
So.
Yes, looking at Europe , we have.
More of a labor constrained problem in Europe than in the states.
And the states that's not the case at this moment.
Globalization is.
Its slowing down.
Thanks, everyone.
Thank you much appreciate it.
Thanks Mark.
Thanks Mark.
Thank you there are no further questions at this time I would like to turn the floor back over to management for any closing comments.
Thanks, Paul.
In closing the third quarter marks another quarter of continued progress and execution on Ctg's digital solution strategy.
We are revising sustained improvements in the company's operating margins and with the acquisition of Elysium. We expect this to continue as we work towards our long term goals and the ongoing commitment to building value for all Ctg's shareholders.
Thank you for participating in our teleconference today.
As always.
Feel free to reach out to us at anytime.
And we look forward to talking with all of you again after our fourth quarter 2022 results.
We hope you have a great day.
Paul you may now disconnect the call.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
Okay.
Yeah.
Okay.