CTG Delivers Solid Q1 ’20 Results Amid Global Pandemic

CTG, Inc. (CTG) reported Q1 ’20 results in line with management’s guidance and considerably better than our estimates. Recall that we reduced our Q1 and Q2 projections on March 31, 2020 to reflect the potential impact of COVID-19. In hindsight, our assumptions at the time were overly conservative although we continue to expect a more significant impact on the current quarter’s performance. As for Q1, a slight headwind from measures to restrict the spread of coronavirus was mostly offset by expansion of help desk solutions and opportunities to assist clients with work-from-home initiatives. Gross margin in the IT solutions segment expanded 250 basis points from the year-ago period, which combined with lower levels of operating expenses, enabled CTG to deliver non-GAAP EPS growth of nearly 50%, consistent with management’s guidance.

Although disruption from COVID-19 was nominal in Q1, management anticipates a more pronounced impact in Q2 as shelter-in-place orders remain in effect and start dates for new projects have been delayed. Due to the lack of clarity regarding the duration and magnitude of COVID-19, however, no specific targets were provided for Q2, and management withdrew its prior guidance for the year. Operationally, CTG has taken a number of precautions in response to the uncertainty, including the drawdown of $12 million against an existing revolver; a full furlough of a limited number of non-billable employees as well as a 20% furlough of nearly all other non-billable employees, including the senior management team; and the accelerated collection of receivables from its largest client. In addition, CTG is participating in government-backed programs in Belgium, Luxembourg and France that offer assistance to offset a majority of the bench costs arising from inactive personnel. On a positive note, the company added multiple experienced sales professionals in Q1 and has seen sales cycles remain relatively unaffected thus far. In fact, CTG secured a multi-year contract valued in excess of $5 million earlier this month to provide application support to a health solutions client, and additional opportunities with that same client have since emerged. CTG has also received unsolicited offers to acquire its corporate headquarters, which we expect to result in added liquidity and a net benefit to operating expenses if and when a deal is done.

As our initial revisions associated with COVID-19 proved too dire, we increased our estimates for Q2. However, our estimates for 2H ’20 and beyond had been left intact pending further insight into any potential recovery post-pandemic. We admittedly have no greater clarity today, but we believe the V-shaped recovery implicit in our prior model was overly optimistic and have therefore reduced our projections for the latter half of this year and for FY ‘21 to reflect a more gradual return to growth. Although our price target declines slightly from $6.25 to $6.00 based on an unchanged FY ’21 EV/EBITDA multiple of 5x, we continue to see significant upside in shares.

Q1 revenue of $86.9 million (-10.6% Y/Y) was consistent with guidance for approximately $87.0 million and well above our $81.0 million estimate. We had lowered our estimates at quarter-end on the assumption that CTG’s IT staffing revenue would be negatively affected by restrictions related to COVID-19. As it turns out, the pandemic had just a modest impact on Q1. By segment, IT solutions revenue was $29.1 million (-13.0% Y/Y) and IT staffing revenue was $57.9 million (-10.6% Y/Y). The decline in the solutions business was attributed to one less billable day in the quarter than the year-ago period and the completion of several projects. While services associated with CTG’s IT solutions segment may generally be performed remotely, management indicated that COVID-19 has caused delays in new project starts, thereby weighing on growth in the near-term. That said, sales activity appears unaffected thus far with management highlighting a multi-year win in excess of $5 million and pointing to a healthy flow of RFPs. With respect to IT staffing, the Y/Y decline was far less than we anticipated and primarily reflected the company’s transition away from lower margin engagements at the end of the prior year and early in FY ‘20.

Gross margin of 19.6% represented an improvement of 140 basis points from the prior year period driven by an increase in IT solutions gross margin from 25.0% to 27.5%. Selling, general and administrative expenses of $15.0 million were well below our $17.5 million estimate as management reined in costs amid the global pandemic. Reflecting the combined impact of higher revenues and lower expenses, adjusted EBITDA of $3.4 million easily exceeded our estimate of $(0.2) million and non-GAAP EPS of $0.10 met management’s guidance for growth of approximately 50% while surpassing our $(0.05) forecast.

Due to the lack of clarity around the duration and magnitude of the COVID-19 crisis, management refrained from providing guidance for Q2 and withdrew its prior outlook for FY ‘20. As mentioned earlier, the coronavirus outbreak is expected to have a more pronounced impact on Q2, and the company has taken a number of steps to reduce costs and enhance liquidity in the interim.

We had previously reduced our Q2 estimates to account for the lingering effects of COVID-19. However, with Q1 not nearly affected to the degree we anticipated and additional measures taken earlier this month to lower costs, we raised our Q2 estimates. Conversely, our estimates for 2H ’20 and FY ’21 were originally left intact as we hoped for a rapid rebound once the world returned to normalcy. At this juncture, we believe a V-shaped recovery is unlikely to materialize. As such, we now model a more gradual return to growth in FY ’21, resulting in a cut to our out-year forecasts. Of note, we expect CTG to sustain modest levels of profitability throughout the next couple of quarters despite the reduction in our growth assumptions.

Our report with model and disclosures is available here.

Disclosure(s):

K. Liu & Company LLC (“the firm”) receives or intends to seek compensation from the companies covered in its research reports. The firm has received compensation from CTG, Inc. (CTG) in the past 12 months for “Sponsored Research.”

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