Reports Mixed Q2 '21 Results; Raising Price Target from $11.00 to $13.00
CTG, Inc. (CTG) reported mixed Q2 ’21 results with both adjusted EBITDA and non-GAAP EPS surpassing Street expectations despite a modest revenue shortfall. Importantly, the slight miss on the top line was mostly due to management’s ongoing efforts to disengage from lower margin staffing business, and growth in the higher margin solutions business remained in the double-digits. Furthermore, we were encouraged to hear that conversion of the solutions pipeline into contracted business improved markedly in Q2. Among the deals closed was a significant go-live implementation project with a healthcare provider that is expected to contribute meaningfully to revenue by year-end, which increases our confidence in CTG’s ability to sustain growth even as comparisons become more challenging in the latter half of the year. From a profitability standpoint, the higher mix of solutions revenue in the quarter boosted gross margin ahead of our assumption, while operating expenses came in lower than we modeled. As a result, adjusted EBITDA was slightly above our projection and non-GAAP EPS beat our estimate by a penny.
Although pipeline conversion rates improved in Q2, management noted that sales cycles have yet to return to pre-pandemic norms. As such, CTG continues to offer more qualitative commentary on the outlook as opposed to specific financial guidance. Near-term, management sees potential for more pronounced seasonality in Q3 given the recovery and interest in leisure travel, suggesting revenue could be down slightly on a sequential basis albeit still up from last year. Prior to revisions, both our estimates and consensus reflected expectations for a modest sequential increase in revenue. For the full year, management reaffirmed its prior expectations for solid revenue growth and operating profit improvement.
Reflecting reduced contribution from the IT Staffing segment, we lower our revenue estimates for this year and next. We note that our forecast for IT Solutions revenue increases slightly, resulting in an uptick in our margin expectations and no material changes to our adjusted EBITDA estimates. Considering the improvement in conversion rates and our expectations for sustained double-digit growth in solutions beyond FY ’21, we are raising our price target from $11.00 to $13.00. We continue to derive our price target based on the same EV/EBITDA multiple of 8x we used previously but now applied to our FY ’22 projections.
Exhibit I: Reported Results Versus Expectations
Q2 revenue of $92.2 million (+3.4% Y/Y) was short of our $93.7 million estimate and the $94.1 million consensus forecast. The miss relative to our model was solely attributable to the IT Staffing segment, which contributed revenue of $50.8 million (-1.6% Y/Y) versus our estimate of $52.3 million. Per management, CTG continues to disengage from lower margin staffing opportunities. The IT Solutions segment generated revenue of $41.4 million (+10.3% Y/Y), which was in line with our projection. More importantly, management indicated that the conversion of pipeline into contracted solutions business improved from prior quarters, setting the stage for sustained growth in the latter half of FY ‘21. Headcount at quarter-end was approximately 3,650, of which 90% are billable, and was down from 3,700 in both the prior and year-ago quarters.
Reflecting a higher mix of solutions revenue, gross margin expanded by over 100 basis points from the year-ago period to 22.1% and was ahead of our 21.7% assumption. By segment, IT Solutions gross margin was 32.3% compared to 31.4% a year ago, and IT Staffing gross margin was 13.8% versus 13.4% in Q2 ‘20. Selling, general and administrative expenses of $17.6 million were lower than our $18.1 million estimate. As a result, both adjusted EBITDA of $4.1 million and non-GAAP EPS of $0.13 were slightly ahead of our $3.8 million and $0.12 estimates, respectively. Cash at quarter-end totaled $29.2 million, and the company had no outstanding debt.
Exhibit II: Estimate Revisions
Although no formal guidance was issued for Q3, management noted that seasonality could be more pronounced amid a rise in planned vacations this quarter. When pressed, management acknowledged that the time-off could mean revenue is down to up slightly on a sequential basis while emphasizing that a move in either direction is likely to be nominal. Ultimately, growth is expected to be positive on a Y/Y basis. We were previously forecasting a sequential increase in revenue and have now opted to pare our top line estimates for Q3 and beyond to account for CTG’s disengagement from additional staffing business. We note that our assumptions for IT Solutions growth increase slightly over our forecast horizon, thereby negating the impact of lower revenue on our margin and adjusted EBITDA forecasts. The decline in our non-GAAP EPS estimates reflects higher estimates for depreciation and amortization expenses.
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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