Earnings Transcript for CTG - Q2 Fiscal Year 2021

Operator: Ladies and gentlemen, thank you for standing by, and welcome to CTG's Second Quarter 2021 Financial Results Conference Call. As a reminder, today's conference call is being recorded for replay purposes. I would like to now turn the conference call over to CTG's Executive Vice President and Chief Financial Officer, John Laubacker. John, please go ahead.

John Laubacker: Thank you, Selina, and good morning to everyone on the call. Joining me on today's call is Filip Gyde, CTG's President and Chief Executive Officer. Before we begin, I want to remind listeners that statements made during the course of this conference call that state the company's or management's intentions, hopes, beliefs, expectations, and predictions for the future are forward-looking statements. It is important to note that the company's actual results could differ materially from those projected. These forward-looking statements are based upon information as of today, Thursday, July 29, 2021.

Filip Gyde: Thank you, John. Good morning to everyone on the phone and webcast, and thank you for joining us on today's conference call. I'm pleased to report we had another solid quarter as we continue to execute our digital solutions strategy. Revenue from solutions business grew 10% year-over-year, reached 45% of total revenue in the second quarter, and also increased 18% over the first half of 2020. Coupled with our ongoing actions to disengage from lower-margin staffing engagements. We continue to drive an increased mix of higher-value solutions business and significant improvement in our consolidated operating performance. Our gross profit margin and operating income for the second quarter increased sequentially and year-over-year, contributing to non-GAAP earnings increasing 30% in the first half of 2021 over the prior year period. To continue year-over-year improvement in our operating results further demonstrates that our strategy is very effective. As part of our broader solution strategy, we've increasingly narrowed our focus and continue to make ongoing investments around the core group of scalable digital transformation solutions. These include Agile and DevSecOps, Internet of Things, Intelligent Automation, Data and Analytics, Cloud and Automated Testing. Collectively, these core digital accelerators meaningfully expand our addressable market as a series of disruptive trends drive the need for new business models across a growing number of companies and industries. CTG is increasingly well-positioned to benefit from this accelerating demand for digital transformation. And we continue to expand our portfolio of digital solutions in order to further capitalize on this rapidly growing market opportunity.

John Laubacker: Thank you, Filip. And again, good morning, everyone, and thank you for joining us on today's call. As reported in our press release earlier this morning, consolidated revenue in the second quarter was $92.2 million prior was $97.1 million in the first quarter and $89.1 million in the second quarter of 2020. The sequential decrease in second quarter revenue primarily reflects two few bill over days in the quarter as well as our continued disengagement from lower-margin IT staffing business. The increase in revenue year-over-year was driven by the continued expansion of our solutions business as well as year-over-year growth in Europe. Currency translation had a positive impact of $3.9 million on revenue in the second quarter of 2021 compared with a positive impact of $4 million in the first quarter and a negative impact of $800,000 in the second quarter of 2020. Total billable days in the second quarter were 63 compared with 65 days in the first quarter and 64 days in the year-ago second quarter. Solutions revenue in the second quarter was $41.4 million or 44.9% of total revenue. This compared with $43.4 million or 44.7% of total revenue in the previous quarter. Year-over-year, solutions revenue increased $3.9 million or approximately 10% from $37.5 million or 42.1% of total revenue in the second quarter of 2020. Revenue from IBM in the second quarter was $19.6 million or 21.2% total revenue compared with $19.6 million or 20.2% of total revenue in the first quarter and $18.9 million or 21.2% of total revenue in the year-ago quarter. No other client represented more than 10% of our revenue during the second quarter of 2021 or in recent comparable periods. Gross profit in the second quarter was $20.4 million or 22.1% of revenue compared with $20.8 million or 21.4% of revenue in the first quarter of 2021 and $18.7 million or 21% of revenue in the year-ago second quarter. Second quarter SG&A expense of $17.6 million reflects our continued investment in IT digital transformation offerings and business development resources consistent with our solutions strategy. This compared with $18.7 million in the first quarter and $16.8 million in the second quarter of 2020. GAAP operating margin in the second quarter improved to 3% compared with 2.2% in the first quarter and 2.1% in the second quarter of 2020. Non-GAAP operating margin in the second quarter, which excludes approximately $165,000 of acquisition-related expenses, was 3.2% compared with 2.8% in the first quarter and 3.2% in the year-ago second quarter.

Operator: And our first question comes from the line of Josh Vogel with Sidoti.

Josh Vogel: First question, I have can you quantify the pipeline conversion rate in the quarter and how it measured up to historical rates? I just -- with the heightened focus and need for digital transformation services and capabilities, especially those brought to light by the pandemic. I was just kind of curious seeing a level of pent-up demand that's coming through the channel that's meaningfully -- compressing the sales cycle but also improving the conversion rates.

Filip Gyde: No, we've seen that the new delta variant still creates or sustained a challenging environment. However, we also saw a higher closure rate than we have seen in the last quarter. I think our teams worldwide have done an outstanding job of closing new deals and at the same time, building the pipeline. I wouldn't say the conversion rate is already at pre-cohort levels, but we're seeing a noticeable improvement.

Josh Vogel: And maybe just a little tangent. I'm seeing vailing theme there around pent-up demand even as the pandemic lingers. I'm curious, once a contract is signed, are clients looking to start engagements as soon as possible? Are you seeing any sort of compression there between when it's signed versus when you start ramping?

Filip Gyde: That's a very good question, Josh, because it also shows that there's a positive change in the market. And it is, in fact, as soon as the clients have signed, they want to get started. And that is very much how it was pre-pandemic too. What still isn't pre-pandemic is the clients are still cautious about making decisions. And the base of the decision is slower. But once the decision is made, then we almost start immediately. So, we really have to be ready with our approaches, with our people, with our teams to start as soon as that signature has been put.

Josh Vogel: And shifting gears a little bit, maybe for John. Thinking about the strategic initiatives and what it takes to expand your addressable market, we've highlighted or you've highlighted is like sales and business development, new offerings, depending on the global delivery. However, can you just give some directional commentary around the level of spend we should expect outside or above normal business operations as well as other targeted areas that you plan to focus on the back half of this year?

John Laubacker: What we have -- the approach that we've taken overall from a spend standpoint is to position the company for what comes next. And so as we pretty consistently talked about, we continue to make investments to the solutions leadership and solutions to talent to -- as Filip was indicating on signed contract, be very responsible when those contracts come in and are signed and have people in a position to drive those solutions. Some of it is thought leadership around building out and developing those solutions to expand them, to expand the market. Some of those investments are in traditional sales roles and business development roles as well. And so the investments themselves are across the gamut from solutions to business development to thought leadership. From that perspective, we made significant investments at the beginning of the year to bring people on board and drive, again, drive those perspectives that will drive revenue in the second half of the year and years beyond. I would anticipate that we will continue to be aggressive in building that knowledge base and that talent base and that business development base in the second half of the year, but not as aggressive on a spend perspective as we did in the first and second quarter, at least not in the first quarter.

Josh Vogel: Filip mentioned the new multimillion-dollar contract with the go-live limitation in Q3 ramps in Q4 ends at the end of the year. Can you just give us a sense of what type of revenue contribution that could and should add in the quarters?

Filip Gyde: Well, it's significant. We're talking multimillion. We were thinking that most of the work is going to happen in Q4 as Q3 is already ongoing, of course, and it needs to start. Prep work is never the big mass of people or work. So it's going to be Q4 mostly. Yes. And that's how it's going to be distributed.

Josh Vogel: John, could you add some color?

John Laubacker: Josh, we haven't -- and as you know, we didn't put out guidance or didn't extend guidance for the second half of the year. This is a significant project that, again, to Filip's point, will mostly be completed in the fourth quarter -- our fiscal fourth quarter. So we do expect a significant increase in revenue in that quarter.

Josh Vogel: Last one for me. The adjusted EBITDA generated by the business, your press release mentioned 70% coming from solutions. I'm curious when you hit your targets, what 50-50 revenue split, what do you think the contribution will be from solutions? And then also, I calculate about a 7% margin there for solutions. And if I recall, you recently talked about solutions being a 10%. I know that you're in the midst of investing. But is that still the goal or target when we think about long-term EBITDA among the solutions business?

Filip Gyde: Maybe I'll start with the high-level answer, and then I'll pass on to John. Our longer-term target for EBITDA, Josh, is obviously higher than the 7%. Knowing that we're still investing in getting the solutions, the business development, the marketing already. When the, let's say, the machine is starting to run at the right speed cruising altitudes, so to speak. I think those investments will obviously weigh less and less on the total. Also looking at our margins, moving to digital solutions, our global delivery network, helping us to lower delivery costs but also moving work offshore to India and South America. All those elements should help us increase that EBITDA level above that 7%. And yes, 10% does seem for the long-term percentage where we need to go to. John, you want to add some more detail?

John Laubacker: I think that the points you made are great and sort of round out the continued thought process around investments that we're going to make going forward. But I would agree, Josh, in the release itself and some of the financial information in the back, we had gross profit went up to 22.1%. So overall, you see that, that increased in gross profit and solutions was 32.3%, up 2% from last quarter. So, as we continue to sell the right business. And as Filip said, deliver it as effective as we can, utilizing offshore and whatnot. Those margins will continue to go up. We're going to continue to invest, as we've talked a couple of times already on this call. But at the end of the day, a long-term target of 10% is certainly out there. It's certainly something that we think we can achieve. And Filip and I talk about this a lot, not to get ahead of ourselves because, again, we've got a lot of work to do to get to 10%. But we talk about destinations. I don't think that's a milepost on the destination. I don't think that, that's the ultimate destination.

Operator: And our next question comes from the line of Kevin Liu with K. Liu & Company.

Kevin Liu: First question here. Just wanted to dive into some of the seasonality dynamics a little bit more. Certainly, if we go back past years, Q3 tends to be down, as you guys mentioned, because of vacation, particularly in Europe. At the same time, this quarter, you're talking about a lot more pipeline conversion into new business. So when we flush that all out, are you guys -- can you just give us some help on whether you expect revenues to actually be down seasonally here in Q3? Or do you have enough new business to perhaps help offset that and see things relatively stable, if not growing?

Filip Gyde: John, I think this is a question right up your alley.

John Laubacker: Kevin, there's really, I think, a number of moving dynamics. One is the seasonality that we talked about and mentioned specifically around Q3 and not just in Europe, but certainly in Europe and throughout the North America people's interest in taking some time off, taking a holiday after a very long COVID period. Now obviously, the rise of the increase of the delta variant of COVID might impact that. And I think we've got transforming or changing perspectives, quite frankly, over the last few weeks. And so if that delta variant continues to rise, we may see less vacations taken and holiday time taken than we originally anticipated. At the same time, we do have, as you mentioned, and as we've said, pipeline conversion and nice opportunities, and we do have a large project that will start, although most of it's in Q4, some of it will start in Q3. And then you've got our continued strategic part of our plan to disengage from the lowest margin staffing business. So, I don't anticipate a sequential -- a significant sequential change in revenue, either up or down, might be up at it might be down. But I do anticipate revenue overall being higher than last year's number, which was almost $89 million. So, year-over-year, I do expect an increase sequentially. I don't expect a lot of change, again, maybe up, maybe down, but it's -- there's three or four factors that are driving that underneath the surface.

Kevin Liu: Certainly, some of the new wins you guys talked about tended to stem more from the health care side. I was curious if that's indeed the case where it's mostly coming in health care? Or are you seeing other industries where conversion rates are picking up as well?

Filip Gyde: We're actually seeing the same trend in more industries. We're seeing in Europe, though, usually, Europe is a little more cautious in picking up the positive trends than happens in normally in the States, but also in Europe in the finance sector, even in the government, we see more and more movement indications. Health care, of course, you heard the examples. We see that conversion rates picking up, but also energy. So, I think we're pleased that it's kind of almost all over the board.

Kevin Liu: And just looking at your headcount numbers and kind of what you ended up reporting to the staffing segment, it did look like you guys perhaps disengaged with some business intra-quarter. The questions I had around that was just, is your headcount at the appropriate level to support some of the pipeline conversion you've had or would you expect to add talent over the next quarter or two? And then more specific to the staffing side of the business. Have we seen that full impact of any business you've disengaged from in the quarter, or would there be another kind of fall off as we move forward in the back half of the year?

Filip Gyde: I think we will add talent going forward. With the higher conversion rates, we see new projects starting. There are no projects that are only focused on -- or mostly focused on one quarter. A lot of the wins we have are multi yields and are ramping up over time. So, I see us growing in the solutions area. And I think we picked it up very well. We are continuing to disengage from lower-margin staffing. We have done that already this year, and we plan to continue that. Whenever it makes sense, like we said, we have a very solid and strict way of looking at that business and seeing if it makes sense to continue or to walk away at renewal time. So, we anticipate that our staffing resources will go down, not only in the next couple of quarters that will probably see that continuing, knowing that we're also focusing on staffing that is more and more aligned with the skill sets that we need for our digital solutions. So, our staffing and solution is coming together in digital solutions and the staffing that's outside of that and low-margin is going to slowly disappear.

Kevin Liu: And then just one last question from me. Perhaps using kind of the renewal of the managed services contract. As an example, or if you guys want to generalize a little bit more outside of this customer. But for an engagement where you are getting that renewal and you're able to move more of the delivery offshore to your Columbia center. Can you just talk a little bit about what sort of impact that has, both in terms of the amount of revenue you can generate from the program as well as what impact you see on the margin side?

Filip Gyde: We see that trend for CTG is only just starting. So, we will see that we have a proven global delivery network that our clients are seeing that we're delivering results and that each time there's a renewal or each time there's a new managed services contract. We can present them with different options, an option that's fully onshore, an option that's fully offshore and options that are mixed, that are hybrid. When you look at the costs difference between delivering something fully from India, for instance, and fully from the United States. It easily is a third or a fourth of the cost. Obviously, if you work with a client that -- where we have worked with always on an onshore basis, and we're moving the work offshore. That client is naturally expecting some of the benefit and some of the price cuts from that and also wants to pay a lower price. So, it's not that cost savings we're doing on the delivery side is immediately an increased margin. So it's -- like I said in my prepared remarks, it always is a win-win for clients and CTG.

Operator: I would like to now turn the call back over to management for closing remarks.

Filip Gyde: Thank you, Selina. In closing, we have a comprehensive strategy in place centered around digital solutions that is producing tangible results as evidenced by the continued year-over-year growth of our solutions business as well as improved operating performance in both the second quarter and for the first half of 2021. I am very proud of the CTG teams throughout our global organization. And the consistent progression we've demonstrated toward achieving CTG's longer-term vision and positioning the company as a leading enabler and accelerator of digital transformation services. As we continue to execute our strategy and build off of our solid pipeline in the second half of the year, I'm confident we will continue to succeed in driving higher revenue and operating profits and, in turn, create higher value for our shareholders. Thank you for participating on today's conference call and your continued support of CTG. Selina, you may now disconnect the call.

Operator: Ladies and gentlemen, your conference has now terminated. You may now disconnect. Thank you for using AT&T teleconference and services.