Computer Task Group, Incorporated (NASDAQ:CTG) Q1 2023 Earnings Call Transcript May 14, 2023

Operator: Good morning, and welcome to the CTG First Quarter Fiscal Year 2023 Financial Results Conference Call. All participants will be listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask question. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Craig Mychajluk, Investor Relations. Please go ahead.

Craig Mychajluk: Yeah. Thank you, and good morning, everyone. We certainly appreciate your time today and your interest in CTG. Joining me are Filip Gyde, our President and CEO; and John Laubacker, our Chief Financial Officer. We released our first quarter 2023 financial results this morning before the markets open. You can access the release at our website at ctg.com. After Filip and John’s formal discussion this morning, we will open the line for Q&A. Just let me remind you that we may make some forward-looking statements during the formal discussions as well as during the Q&A session. 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. You should not consider this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliation of non-GAAP measures with comparable GAAP measures in the tables in today’s release and SEC filings. I’ll now turn the call over to Filip to begin. Filip?

Filip Gyde: Thank you, Craig, and good morning, everyone. We appreciate you joining us today. During the first quarter, we continued to drive our transformation strategy as we work to make CTG a pure-play IT solutions business. Our digital solutions and services business now accounts for more than 80% of the total revenue mix despite the difficult macroeconomic environment. Our pipeline continues to be strong, and we achieved IT solutions and services bookings near $100 million in the quarter, including one project totaling $20 million in revenue expected to be earned over two years. I thank our employees for their hard work in the quarter. We are pleased with our progress, and we remain focused on accelerating our efforts and delivering for our clients and shareholders.

We saw some additional encouraging signs in the quarter. For example, one area of focus is our software engineering services, which includes designing, testing, operating and enhancing digital products and platforms. We generated more than $100 million in revenue from these services last year and are off to a strong start in 2023, with more than $30 million in revenue in the first quarter. Importantly, our change in business mix has led to a step change in our gross margin growth, which increased 430 basis points over the past two years on a consolidated basis. Further highlighting the potential of our business model was the performance in our North America IT Solutions and Services segment, which achieved gross margins of 38.7% in the quarter, up 510 basis points from a year ago and 610 basis points over a two-year period.

We attribute this performance to our focus on driving digital solutions, including software engineering services, which yielded a gross margin of nearly 32% in the quarter as well as contributions from our recent acquisition, Eleviant. Overall, the Eleviant integration has gone exceptionally well. And this past quarter highlighted an excellent example of the sales synergy potential of the acquisition. We won a sophisticated digital IT solutions engagement for a North American client where the services will be primarily provided by the Eleviant team using our offshore model. While we have been doing some work for this client previously, under what we categorized as non-strategic staffing business, the new capabilities and talent of the Eleviant team helped us secure this new business.

Overtime, we look forward to further driving sales synergies and delivering even greater value for our clients while leveraging lower delivery costs to improve profitability. We are approaching this year with conviction in our strategy. We made investments during the quarter to further expand our North America sales, solutions and marketing teams. While these investments reduced our operating margin in the quarter, we continue to take a long-term approach to ensure we are positioned for accelerated growth and profitability in the future. Looking ahead, we remain focused on what we can control around solution innovation, being a top-tier place to work and cultivating relationships to improve our mix in an effort to drive our earnings power. Given the significant new projects, and overall strong bookings level during the recent quarter, we now anticipate delivering more than 10% growth in the IT Solutions and Services segments during the upcoming second quarter when compared to the last year’s period.

This performance is also driving the improved mix for the full year as John will discuss in more detail. Before I turn the call over to John. I would like to reiterate that the board and management are always focused on enhancing shareholder value and regularly review our strategic plan, priorities and capital allocation. To highlight our transformation strategy, we continue to deliver a higher mix of digital IT solutions and services focused on software engineering, while thoughtfully disengaging from non-strategic staffing services to improve our financial profile. As you know, by the end of 2023, we expect to deliver 7% adjusted EBITDA margins, completing what we consider the first phase of our transformation. Importantly, this is just a milestone and not the end destination.

For the second phase, we expect to achieve 10% adjusted EBITDA margins by the end of 2025. With the support of the board, our management team embarked on this mission in 2018 because through this transformation, we expect to drive a re-rating in our multiple and create significant shareholder value. With that, let me turn it over to John to review our results in more detail. John?

John Laubacker : Thank you, Filip. And again, good morning, everyone. We thank you for joining us on today’s call. Consolidated revenue in the first quarter was $78.2 million. The change in revenue year-over-year reflects our continued shift to a mix of more solutions and services-based business and the intentional disengagement of $11.6 million from our lower-margin Non-Strategic Technology Services business during the quarter. Of note, the Non-Strategic Technology Services segment now represents less than 20% of our total revenue mix. Looking specifically at our IT Solutions and Services segments. North America revenue was up 13.5%, as we are closing new customer engagements and benefiting from the contribution from the Eleviant acquisition.

In Europe, revenue declined 5.6%. However, this was largely due to a change in foreign currency exchange rates. As Filip noted, we achieved IT Solutions and Services bookings of nearly $100 million in the second quarter, our second highest quarterly total in the last five years. The consolidated gross margin was 25.7%, up 270 basis points over last year’s first quarter and 430 basis points over two years ago, highlighting the success of our continued transformation to a digital IT solutions company. The combined North America and Europe IT Solutions and Services segments delivered a first quarter gross margin of 28.9%, up 130 basis points year-over-year and 220 basis points over two years. Filip highlighted the strong margin performance with our North America IT Solutions & Services segment, we saw a substantial expansion given the focus on digital solutions and contribution from Eleviant.

Europe, which has faced greater macroeconomic headwinds, including labor constraints, saw some contraction in gross margin due to the timing associated with significant mandated salary adjustments in the European countries in which we operate. Within the European segment, we expect to see a gradual increase in margins as costs are passed along to our clients throughout the year, and we benefit from improved utilization and a greater mix of digital solutions. For the first quarter, GAAP operating income was $0.7 million with a margin of 0.9% when excluding $600,000 of acquisition-related expenses, $500,000 of ERP system implementation costs, and $300,000 of severance. Non-GAAP operating income was $2.1 million or 2.7% of revenue. The change from last year largely reflects the increases in acquisition-related expenses, offset by additional investments made in support of the North America IT Solutions & Services segment business development efforts.

We recorded net income of $300,000 or $0.02 per diluted share. Non-GAAP diluted EPS, excluding the previously noted cost was $0.08. The effective tax rate was 34% compared with 23.9% in last year’s first quarter, which benefited from windfalls and equity-based compensation transactions. We expect in the long term, our tax rate to be approximately 35%. We continue to maintain a strong and flexible balance sheet that can be leveraged to accelerate the pace of our growth in the future. Cash and cash equivalents were $23.3 million at the end of the quarter, and we had just $1.4 million outstanding on our revolving line of credit facility with no other long-term debt. Our revenue outlook range for 2023 was adjusted to an overall range of $310 million to $340 million.

We continue to maintain a midpoint of $325 million for the year. However, we did adjust the anticipated revenue mix by increasing our IT Solutions & Services revenue to a range of $265 million to $285 million. The outlook also now includes a reduction of $40 million to $45 million in revenue from the disengagement of our non-strategic technology services business given the acceleration we saw during the recent quarter. Of note, the midpoint of our IT Solutions & Services revenue expectation is an 18% growth rate year-over-year, which includes a whole year of revenue from Eleviant and well over 10% organic growth for the rest of the business. We expect 2023 GAAP diluted earnings per share to range from $0.34 to $0.42 and non-GAAP diluted earnings per share to range from $0.56 to $0.64, a reduction of $0.02 at the midpoint of our range from last quarter.

The GAAP EPS estimates reflect the previously announced ERP system implementation project. However, these costs are being backed out as part of the non-GAAP EPS disclosures. As a reminder, the total ERP project cost is estimated at $8 million to $10 million and will be largely spread over a two-year period with a completion date around the end of 2024. As we indicated last quarter, we had expected a slower start to the year with the results significantly improving in the second half of the year. We are committed to our plan, including reducing our overall cost structure and the continued disciplined execution of our digital IT Solutions and Services strategy to drive long-term shareholder value. This completes our prepared remarks. Kate, could you please open the call for questions?

Q&A Session

Operator: [Operator Instructions] The first question is from Kevin Liu of K. Liu & Company. Please go ahead.

Operator: [Operator Instructions] The next question is from Marc Riddick of Sidoti. Please go ahead.

Operator: This concludes our question-and-answer session. I would like to turn the conference back over to management for closing remarks.

Filip Gyde: Thank you for participating in our teleconference today. And as always, please feel free to reach out to us at any time. We look forward to talking with all of you again after our second quarter 2023 results. We hope you have a great day. Kate, you may now disconnect the call.