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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 1, 2004
Commission file number 1-9410
COMPUTER TASK GROUP, INCORPORATED
- --------------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
New York 16-0912632
- ---------------------------------------- ------------------------------------
(State of incorporation) (IRS Employer Identification No.)
800 Delaware Avenue, Buffalo, New York 14209
- ---------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (716) 882-8000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
Number of shares of common stock outstanding:
Shares outstanding
Title of each class at November 1, 2004
------------------- ----------------------
Common stock, par value 20,868,834
$.01 per share
1
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
COMPUTER TASK GROUP, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
FOR THE THREE
FOR THE QUARTER ENDED QUARTERS ENDED
OCT. 1, SEPT. 26, OCT. 1, SEPT. 26,
2004 2003 2004 2003
------------ ------------ ------------ ------------
(amounts in thousands, except per share data)
Revenue $ 57,857 $ 59,577 $ 178,351 $ 184,043
Direct costs 42,581 43,132 130,630 134,075
Selling, general and administrative expenses 14,602 14,912 44,798 45,874
------------ ------------ ------------ ------------
Operating income 674 1,533 2,923 4,094
Interest and other income 36 11 93 45
Interest and other expense (183) (186) (552) (820)
------------ ------------ ------------ ------------
Income from continuing operations before
income taxes 527 1,358 2,464 3,319
Provision (benefit) for income taxes (91) 570 397 1,393
------------ ------------ ------------ ------------
Income from continuing operations 618 788 2,067 1,926
Loss from discontinued operations (including
loss on disposal of $3.7 million in the first
quarter of 2004) (14) (448) (4,392) (998)
------------ ------------ ------------ ------------
Net income (loss) $ 604 $ 340 $ (2,325) $ 928
============ ============ ============ ============
Basic net income (loss) per share:
Continuing operations $ 0.04 $ 0.05 $ 0.12 $ 0.12
Discontinued operations (0.00) (0.03) (0.26) (0.06)
------------ ------------ ------------ ------------
Total basic income (loss) per share $ 0.04 $ 0.02 $ (0.14) $ 0.06
============ ============ ============ ============
Diluted net income (loss) per share:
Continuing operations $ 0.04 $ 0.05 $ 0.12 $ 0.11
Discontinued operations (0.00) (0.03) (0.26) (0.05)
------------ ------------ ------------ ------------
Total diluted income (loss) per share $ 0.04 $ 0.02 $ (0.14) $ 0.06
============ ============ ============ ============
Weighted average shares outstanding:
Basic 16,781 16,677 16,748 16,649
Diluted 16,991 16,817 17,156 16,765
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
COMPUTER TASK GROUP, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
OCTOBER 1, DECEMBER 31,
2004 2003
---------- ------------
(amounts in thousands)
ASSETS
Current Assets:
Cash and temporary cash investments $ 2,907 $ 2,230
Accounts receivable, net 46,907 39,932
Prepaids and other 2,190 2,256
Income taxes receivable - 1,239
Deferred income taxes 528 502
Assets from discontinued operations - 2,549
-------- ---------
Total current assets 52,532 48,708
Property and equipment, net of accumulated depreciation 6,190 6,846
Goodwill 35,678 35,678
Deferred income taxes 4,426 4,511
Other assets 1,708 1,500
-------- ---------
Total assets $100,534 $ 97,243
======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 6,938 $ 7,315
Accrued compensation 19,546 19,066
Income taxes payable 525 -
Advance billings on contracts 1,007 1,140
Other current liabilities 5,054 4,255
Current portion of long-term debt 4,454 -
Liabilities from discontinued operations - 939
-------- ---------
Total current liabilities 37,524 32,715
Long-term debt - -
Deferred compensation benefits 8,424 8,337
Other long-term liabilities - 60
-------- ---------
Total liabilities 45,948 41,112
Shareholders' Equity:
Common stock, par value $.01 per share, 150,000,000
shares authorized; 27,017,824 shares issued 270 270
Capital in excess of par value 111,281 111,333
Retained earnings 38,116 40,441
Less: Treasury stock of 6,148,990 shares at cost (31,416) (31,416)
Stock Trusts of 4,069,015 and 4,152,119 shares at cost, respectively (58,093) (58,446)
Accumulated other comprehensive loss:
Foreign currency adjustment (4,361) (4,840)
Minimum pension liability adjustment (1,211) (1,211)
-------- --------
Accumulated other comprehensive loss (5,572) (6,051)
-------- --------
Total shareholders' equity 54,586 56,131
-------- --------
Total liabilities and shareholders' equity $100,534 $ 97,243
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
COMPUTER TASK GROUP, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE QUARTERS ENDED
OCT. 1, SEPT. 26,
2004 2003
------------ ------------
(amounts in thousands)
Cash flows from operating activities:
Net income from continuing operations $ 2,067 $ 1,926
Adjustments:
Depreciation expense 2,098 2,527
Deferred income taxes 73 307
Tax benefit on stock option exercises 18 -
Loss on sales of property and equipment 33 227
Deferred compensation 87 (179)
Changes in assets and liabilities:
Increase in accounts receivable (6,943) (162)
(Increase) decrease in prepaids and other 85 (53)
Decrease in income taxes 1,685 892
Increase in other assets (196) (113)
Increase (decrease) in accounts payable (324) 1,440
Increase (decrease) in accrued compensation 497 (2,972)
Decrease in advance billings on contracts (133) (486)
Increase (decrease) in other current liabilities 799 (74)
Decrease in other long-term liabilities (60) (290)
------------ ------------
Net cash provided by (used in) operating activities (214) 2,990
------------ ------------
Cash flows from investing activities:
Additions to property and equipment (1,494) (1,349)
Proceeds from sales of fixed assets 10 2,269
------------ ------------
Net cash provided by (used in) investing activities (1,484) 920
------------ ------------
Cash flows from financing activities:
Proceeds from (payments on) long-term revolving debt, net 4,454 (1,630)
Proceeds from Employee Stock Purchase Plan 123 170
Proceeds from other stock plans 160 29
------------ ------------
Net cash provided by (used in) financing activities 4,737 (1,431)
------------ ------------
Net cash from discontinued operations (2,290) (36)
Effect of exchange rate changes on cash and temporary cash investments (72) 304
------------ ------------
Net increase in cash and temporary cash investments 677 2,747
Cash and temporary cash investments at beginning of year 2,230 -
------------ ------------
Cash and temporary cash investments at end of quarter $ 2,907 $ 2,747
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
COMPUTER TASK GROUP, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. FINANCIAL STATEMENTS
The condensed consolidated financial statements included herein reflect,
in the opinion of the management of Computer Task Group, Incorporated ("CTG" or
"the Company"), all normal recurring adjustments necessary to present fairly the
condensed consolidated financial position, results of operations and cash flows
for the periods presented. Certain amounts in the prior period's condensed
consolidated financial statements have been reclassified to conform to the
current year presentation.
2. BASIS OF PRESENTATION
The condensed consolidated financial statements have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission (the SEC). Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to the SEC rules and regulations. Management
believes that the information and disclosures provided herein are adequate to
present fairly the condensed consolidated financial position, results of
operations and cash flows of the Company. It is suggested that these condensed
consolidated financial statements be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's latest Annual
Report on Form 10-K filed with the SEC.
3. DISPOSITION OF OPERATIONS
During the first quarter of 2004, the Company disposed of its Dutch
operating subsidiary, CTG Nederland B.V., in a transaction that sold the stock
and transferred the unit's business, staff, and lease and equipment obligations
to the unit's management team. The contractual effective date of the disposition
was January 1, 2004, and the transaction has been treated as discontinued
operations in these condensed consolidated financial statements. This unit had
previously been included in the financial results of the Company's European
operations.
The loss from discontinued operations resulting from this divestiture
totaled approximately $4.4 million in the first three quarters of 2004, with
approximately $4.3 million of that loss incurred in the first quarter of 2004.
The loss includes a cumulative loss on disposal of approximately $3.9 million,
and approximately $0.5 million from a foreign currency adjustment which has
previously been reported as a direct charge to shareholders' equity. Although
the divestiture was effective January 1, 2004, if the Company had included the
revenues and losses from this unit in its first quarter 2004 operating results
rather than in the first quarter loss on disposal, revenues would have been
approximately $1.8 million higher and the income before income taxes would have
been approximately $0.5 million lower. The assets divested in this transaction
totaled approximately $2.5 million, including $2.2 million of current assets
(primarily accounts receivable of $1.6 million), and non-current assets of $0.3
million consisting of the net value of property and equipment. The liabilities
divested in the transaction totaled approximately $0.9 million of current
liabilities.
5
4. NET INCOME (LOSS) PER SHARE
Basic and diluted earnings (loss) per share information is as follows:
FOR THE THREE
FOR THE QUARTER ENDED QUARTERS ENDED
OCT. 1, SEPT. 26, OCT. 1, SEPT. 26,
2004 2003 2004 2003
------------ ------------ ------------ ------------
(amounts in thousands, except per share data)
Weighted-average number of shares outstanding
during period 16,781 16,677 16,748 16,649
Common Stock equivalents -
Incremental shares under stock option plans 210 140 408 116
------------ ------------ ------------ ------------
Number of shares on which diluted earnings
per share is based 16,991 16,817 17,156 16,765
============ ============ ============ ============
Income from continuing operations $ 618 $ 788 $ 2,067 $ 1,926
Loss from discontinued operations (14) (448) (4,392) (998)
------------ ------------ ------------ ------------
Net income (loss) $ 604 $ 340 $ (2,325) $ 928
============ ============ ============ ============
Basic net income (loss) per share:
Continuing operations $ 0.04 $ 0.05 $ 0.12 $ 0.12
Discontinued operations (0.00) (0.03) (0.26) (0.06)
------------ ------------ ------------ ------------
Total basic income (loss) per share $ 0.04 $ 0.02 $ (0.14) $ 0.06
============ ============ ============ ============
Diluted net income (loss) per share:
Continuing operations $ 0.04 $ 0.05 $ 0.12 $ 0.11
Discontinued operations (0.00) (0.03) (0.26) (0.05)
------------ ------------ ------------ ------------
Total diluted income (loss) per share $ 0.04 $ 0.02 $ (0.14) $ 0.06
============ ============ ============ ============
Options to purchase 1.8 million and 2.5 million shares of common stock
were outstanding at October 1, 2004 and September 26, 2003, respectively, but
were not included in the computation of diluted earnings (loss) per share as the
options exercise price was greater than the average market price of the common
shares.
5. COMPREHENSIVE INCOME (LOSS)
Accumulated other comprehensive loss totaled $(5,572,000) and $(6,051,000)
at October 1, 2004 and December 31, 2003, respectively. Total comprehensive
income (loss) for the quarter and three quarters ended October 1, 2004 and
September 26, 2003 is as follows:
FOR THE THREE
FOR THE QUARTER ENDED QUARTERS ENDED
OCT. 1, SEPT. 26, OCT. 1, SEPT. 26,
2004 2003 2004 2003
------------ ------------ ------------ ------------
(amounts in thousands)
Net income (loss) $ 604 $ 340 $ (2,325) $ 928
Foreign currency 34 - (53) 726
Foreign currency - disposition of Dutch operations - - 532 -
------------ ------------ ------------ ------------
Comprehensive income (loss) $ 638 $ 340 $ (1,846) $ 1,654
============ ============ ============ ============
6
6. INCOME TAXES
The estimated effective tax rate (ETR) used to calculate the provision for
income taxes from continuing operations was 16.1% in 2004 and 42.0% in 2003. The
ETR is recalculated quarterly based upon current assumptions relating to the
full years estimated operating results, and various tax related items. The
decrease in the rate in 2004 as compared to 2003 is primarily due to the Company
utilizing previously recorded net operating loss tax benefits of approximately
$0.3 million for its European operations that had been fully offset by a
valuation allowance. Additionally, the decrease in the ETR also reflects a
release of approximately $0.4 million of previously recorded tax liabilities
resulting from tax legislation recently enacted in the Netherlands. Without
these adjustments to the ETR, the rate would have been approximately 43% in
2004.
7. DEBT
The Company's current revolving credit agreement (Agreement) allows the
Company to borrow up to $45 million. The Agreement is due in May 2005. The
Agreement has interest rates ranging from 25 to 200 basis points over the prime
rate and 125 to 300 basis points over Libor, and provides certain of the
Company's assets as security for outstanding borrowings. The Company is required
to meet certain financial covenants in order to maintain borrowings under the
Agreement, pay dividends, and make acquisitions. At October 1, 2004, and during
2004, the Company was in compliance with these covenants.
At October 1, 2004, there was a total of $4.5 million outstanding under
this Agreement. As the Agreement is due in May 2005, the Company has recorded
this outstanding balance at October 1, 2004 as a current portion of long-term
debt, and included the balance in current liabilities. Prior to May 2004, the
outstanding balance had been recorded as long-term debt and recorded in
non-current liabilities. The Company is currently in the process of negotiating
with a number of financial institutions for a new, long-term agreement. Upon
signing a new agreement, the Company expects to again record the outstanding
amount under the new agreement as long-term debt.
8. DEFERRED COMPENSATION AND OTHER BENEFITS
DEFERRED COMPENSATION BENEFITS
The Company maintains a non-qualified defined-benefit Executive
Supplemental Benefit Plan (ESBP) that provides one current and certain former
key executives with deferred compensation benefits, based on years of service
and base compensation, payable during retirement. The plan was amended as of
November 30, 1994, to freeze benefits for participants at that time.
Net periodic pension cost for the ESBP is as follows:
FOR THE THREE
FOR THE QUARTER ENDED QUARTERS ENDED
OCT. 1, SEPT. 26, OCT. 1, SEPT. 26,
NET PERIODIC PENSION COST - ESBP 2004 2003 2004 2003
---------- ---------- ---------- ----------
(amounts in thousands)
Interest cost $ 129 $ 134 $ 402 $ 402
Amortization of unrecognized net loss 22 6 66 18
---------- ---------- ---------- ----------
Net periodic pension cost $ 151 $ 140 $ 468 $ 420
========== ========== ========== ==========
7
The Company also maintains a contributory defined-benefit plan for its
former employees located in the Netherlands (NDBP). Benefits paid are a function
of a percentage of career average pay. The Plan was curtailed for additional
contributions in January 2003, which resulted in the recording of a gain of $0.2
million in the first quarter of 2003.
Net periodic pension benefit for the NDBP is as follows:
FOR THE THREE
FOR THE QUARTER ENDED QUARTERS ENDED
OCT. 1, SEPT. 26, OCT. 1, SEPT. 26,
NET PERIODIC PENSION COST (BENEFIT) - NDBP 2004 2003 2004 2003
--------- --------- --------- ---------
(amounts in thousands)
Interest cost $ 55 $ 52 $ 164 $ 155
Expected return on plan assets (68) (64) (202) (190)
--------- --------- --------- ---------
Net periodic pension benefit $ (13) $ (12) $ (38) $ (35)
========= ========= ========= =========
401(k) PROFIT-SHARING RETIREMENT PLAN
The Company maintains a contributory 401(k) profit-sharing retirement plan
covering substantially all U.S. employees. Company contributions, which are
discretionary, consist of cash, and may include the Company's stock, were funded
and charged to operations in the amounts of $0.2 million and $0.5 million in the
quarters ended October 1, 2004 and September 26, 2003, respectively. The
Company's contributions for the three quarters ended October 1, 2004 and
September 26, 2003 were $1.1 million and $1.6 million, respectively.
OTHER RETIREMENT PLANS
The Company maintains various other retirement plans other than the NDBP
discussed above, covering a portion of the remaining European employees. Company
contributions charged to operations were $38,000 and $0.1 million in the
quarters ended October 1, 2004 and September 26, 2003, respectively, and $0.1
million and $0.3 million, respectively, for the three quarters ended October 1,
2004 and September 26, 2003.
OTHER POSTRETIREMENT BENEFITS
The Company provides limited healthcare and life insurance benefits to one
current and eight retired employees and their spouses, totaling 14 participants,
pursuant to contractual agreements.
Net periodic postretirement benefit cost is as follows:
FOR THE THREE
FOR THE QUARTER ENDED QUARTERS ENDED
OCT. 1, SEPT. 26, OCT. 1, SEPT. 26,
NET PERIODIC POSTRETIREMENT BENEFIT COST 2004 2003 2004 2003
--------- --------- --------- ---------
(amounts in thousands)
Interest cost $ 9 $ 9 $ 27 $ 27
Amortization of transition amount 7 7 21 21
--------- --------- --------- ---------
Net periodic postretirement benefit cost $ 16 $ 16 $ 48 $ 48
========= ========= ========= =========
8
9. STOCK-BASED EMPLOYEE COMPENSATION
The Company accounts for its stock-based employee compensation plans in
accordance with the provisions of FAS No. 123, "Accounting for Stock-Based
Compensation," and FAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," which allows entities to continue to apply the
recognition and measurement provisions of Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. As such, no stock-based employee compensation cost is reflected
in the net income or loss of the Company for the periods presented in these
condensed consolidated financial statements as all options granted by the
Company had an exercise price that was equal to or greater than the underlying
common stock at the date of grant.
The following table details the effect on net income (loss) and basic and
diluted net income (loss) per share as if the Company had adopted the fair value
recognition provisions of FAS No. 123 as they apply to stock-based employee
compensation:
FOR THE THREE
FOR THE QUARTER ENDED QUARTERS ENDED
OCT. 1, SEPT. 26, OCT. 1, SEPT. 26,
2004 2003 2004 2003
--------- -------- -------- ---------
(amounts in thousands, except per share data)
Net income (loss), as reported $ 604 $ 340 $ (2,325) $ 928
Stock-based employee compensation
expense as calculated under the fair
value method for all awards, net of tax 278 285 788 873
--------- -------- -------- --------
Pro forma net income (loss) $ 326 $ 55 $ (3,113) 55
========= ======== ======== ========
Basic net income (loss) per share:
As reported $ 0.04 $ 0.02 $ (0.14) $ 0.06
========= ======== ======== ========
Pro forma $ 0.02 $ 0.00 $ (0.19) $ 0.00
========= ======== ======== ========
Diluted net income (loss) per share:
As reported $ 0.04 $ 0.02 $ (0.14) $ 0.06
========= ======== ======== ========
Pro forma $ 0.02 $ 0.00 $ (0.18) $ 0.00
========= ======== ======== ========
Pro forma amounts for compensation cost may not be indicative of the
effects on earnings for future quarters.
10. ACCOUNTING STANDARDS PRONOUNCEMENTS
During January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities," and a revision of this Interpretation in
December 2003. These Interpretations of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," address the consolidation by business
enterprises of certain variable interest entities. If applicable, the provisions
of these Interpretations were effective for interim periods beginning after June
15, 2003. The Company has reviewed the provisions of these Interpretations and
determined that they did not have any effect on its financial position or
results of operations for the period ended October 1, 2004.
In December 2003, the FASB issued FAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other Post Retirement Benefits." This revision of
FAS No. 132 requires additional quarterly disclosures about the net periodic
benefit costs of defined benefit plans and other defined benefit postretirement
plans, and other general disclosures. The provisions of the statement related to
interim period disclosures are effective for interim periods beginning after
December 15, 2003. The Company has included these additional required
disclosures, as applicable, in the notes to its condensed consolidated financial
statements under note 8, "Deferred Compensation and Other Benefits."
During December 2003, the SEC published Staff Accounting Bulletin No. 104
(SAB 104). This staff accounting bulletin revises or rescinds portions of the
interpretive guidance previously published relating to revenue recognition. The
Company has reviewed the interpretations as documented in SAB 104 and determined
that its current accounting for revenue recognition activities is consistent
with these interpretations.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE QUARTER AND THREE QUARTERS ENDED OCTOBER 1, 2004
FORWARD-LOOKING STATEMENTS
Statements included in this Management's Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in this document
that do not relate to present or historical conditions are "forward-looking
statements" within the meaning of that term in Section 27A of the Securities Act
of 1933, as amended, and Section 21F of the Securities Exchange Act of 1934, as
amended. Additional oral or written forward-looking statements may be made by
the Company from time to time, and such statements may be included in documents
that are filed with the Securities and Exchange Commission. Such forward-looking
statements involve risks and uncertainties that could cause results or outcomes
to differ materially from those expressed in such forward-looking statements.
Forward-looking statements may include, without limitation, statements relating
to the Company's plans, strategies, objectives, expectations, and intentions and
are intended to be made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Words such as "believes," "forecasts,"
"intends," "possible," "expects," "estimates," "anticipates," or "plans" and
similar expressions are intended to identify forward-looking statements.
Several important factors should be taken into consideration when
reviewing the operational results of the Company either on a quarterly or annual
basis. These include:
THE ANTICIPATED DEMAND FOR INFORMATION TECHNOLOGY (IT) SERVICES
There was a steady decline in demand in the technology services sector
from 2000-2003 as a recession in the technology industry has negatively affected
spending for information technology services. While the Company believes that
demand has begun to increase in 2004, additional declines in spending for IT
services later in 2004 and in future years may continue to adversely affect the
Company's operating results in the future.
THE AVAILABILITY OF QUALIFIED PROFESSIONAL STAFF
The Company currently actively competes with other IT services providers
for qualified professional staff. The availability, or lack thereof, of
qualified professional staff may affect the Company's ability to provide
services and meet the needs of its customers in the future. An inability to
fulfill customer requirements due to a lack of available qualified staff may
adversely impact the operations of the Company in the future.
RATE AND WAGE INFLATION OR DEFLATION
While the rates at which the Company billed its customers for its services
stabilized in the later part of 2003, there had been a general decline in these
rates over recent years as a result of the technology recession mentioned above.
The Company did experience a reduction in the rates at which it bills its
customers for its services for one significant customer during the first half of
2004. Additionally, the Company actively competes against many other companies
for business with new and existing clients. A continuation of the recession or
competitive pressures may lead to a further decline in the rates that the
Company bills its customers for its services, which may adversely effect the
Company's operating results in the future.
OPERATIONS
The Company operates in one industry segment, providing IT services to its
clients. The services provided typically encompass the IT business solution life
cycle, including phases for planning, developing, implementing, managing, and
ultimately maintaining the IT solution. A typical customer is an organization
with large, complex information and data processing requirements. The Company
promotes a portion of its services through four vertical market focus areas:
Technology Service Providers, Financial Services, HealthCare, and Life Sciences.
CTG provides three primary services to all of the markets that it serves. These
services include IT Staffing, Application Management Outsourcing, and IT
Solutions.
10
DISPOSITION OF OPERATIONS
During the first quarter of 2004, the Company disposed of its Dutch
operating subsidiary, CTG Nederland B.V., in a transaction that sold the stock
and transferred the unit's business, staff, and lease and equipment obligations
to the unit's management team. The contractual effective date of the disposition
was January 1, 2004, and the transaction has been treated as discontinued
operations in these condensed consolidated financial statements. This unit had
previously been included in the financial results of the Company's European
operations.
The loss from discontinued operations resulting from this divestiture
totaled approximately $4.4 million in the first three quarters of 2004, with
approximately $4.3 million of that loss incurred in the first quarter of 2004.
The loss includes a cumulative loss on disposal of approximately $3.9 million,
and approximately $0.5 million from a foreign currency adjustment which has
previously been reported as a direct charge to shareholders' equity. Although
the divestiture was effective January 1, 2004, if the Company had included the
revenues and losses from this unit in its first quarter 2004 operating results
rather than in the first quarter loss on disposal, revenues would have been
approximately $1.8 million higher and the income before income taxes would have
been approximately $0.5 million lower. The assets divested in this transaction
totaled approximately $2.5 million, including $2.2 million of current assets
(primarily accounts receivable of $1.6 million), and non-current assets of $0.3
million consisting of the net value of property and equipment. The liabilities
divested in the transaction totaled approximately $0.9 million of current
liabilities.
RESULTS OF OPERATIONS
The table below sets forth data as contained on the condensed consolidated
statements of operations, with the percentage information calculated as a
percentage of consolidated revenues. All activities related to the Company's
Dutch subsidiary, CTG Nederland B.V., which was sold during the first quarter of
2004, have been removed from the Company's individual accounts and subsequently
combined and included on the line entitled "Loss from discontinued operations."
FOR THE QUARTER ENDED
OCT. 1, SEPT. 26,
2004 2003
--------------------- --------------------
Revenue 100.0% $ 57,857 100.0% $ 59,577
Direct costs 73.6% 42,581 72.4% 43,132
Selling, general, and administrative expenses 25.2% 14,602 25.0% 14,912
----- --------- ----- ---------
Operating income 1.2% 674 2.6% 1,533
Interest and other expense, net (0.3)% (147) (0.3)% (175)
----- --------- ----- ---------
Income from continuing operations before income taxes 0.9% 527 2.3% 1,358
Provision (benefit) for income taxes (0.2)% (91) 1.0% 570
----- --------- ----- ---------
Income from continuing operations 1.1% 618 1.3% 788
Loss from discontinued operations (0.1)% (14) (0.7)% (448)
----- --------- ----- ---------
Net income 1.0% $ 604 0.6% $ 340
===== ========= ===== =========
11
FOR THE QUARTER ENDED
OCT. 1, SEPT. 26,
2004 2003
--------------------- --------------------
Revenue 100.0% $ 178,351 100.0% $ 184,043
Direct costs 73.2% 130,630 72.9% 134,075
Selling, general, and administrative expenses 25.2% 44,798 24.9% 45,874
----- --------- ----- ---------
Operating income 1.6% 2,923 2.2% 4,094
Interest and other expense, net (0.2)% (459) (0.4)% (775)
----- --------- ----- ---------
Income from continuing operations before income taxes 1.4% 2,464 1.8% 3,319
Provision for income taxes 0.2% 397 0.7% 1,393
----- --------- ----- ---------
Income from continuing operations 1.2% 2,067 1.1% 1,926
Loss from discontinued operations (2.5)% (4,392) (0.6)% (998)
----- --------- ----- ---------
Net income (loss) (1.3)% $ (2,325) 0.5% $ 928
===== ========= ===== =========
In the third quarter of 2004, the Company recorded revenue of $57.9
million, a decrease of 2.9% compared to revenue of $59.6 million recorded in the
third quarter of 2003. Revenue from the Company's North American operations
totaled $47.1 million in the third quarter of 2004, a decrease of 8.5% when
compared to 2003 third quarter revenue of $51.5 million. Revenue from the
Company's European operations in the third quarter of 2004 totaled $10.8
million, an increase of 33.3% when compared to the third quarter 2003 revenue of
$8.1 million. The European revenue represented 18.7% and 13.6% of third quarter
2004 and 2003 consolidated revenue, respectively. The company's revenue includes
reimbursable expenses billed to customers. These expenses totaled $2.3 million
and $1.8 million in the third quarter of 2004 and 2003, respectively.
Revenue for the 2004 year-to-date period were $178.4 million, a decrease
of 3.0% from 2003 year-to-date revenues of $184.0 million. Revenue from the
Company's North American operations totaled $147.1 million in the 2004
year-to-date period, as compared to $159.7 million in the comparable 2003
period. The Company's European operations accounted for $31.3 million or 17.5%
of year-to-date 2004 consolidated revenue, as compared to $24.3 million or 13.2%
in the comparable 2003 period. Reimbursable expenses billed to customers totaled
$5.9 million and $5.1 million in the year-to-date periods in 2004 and 2003,
respectively.
In North America, the revenue decrease is primarily a result of the
ongoing recession in technology related investments which has had an overall
negative effect on customer spending for information technology services for a
number of years. Additionally, during the third quarter of 2004, a large
outsourcing engagement of approximately 100 billable staff ended at the end of
July 2004 as the customer, which is in liquidation, decided to in-source its IT
department. Offsetting this engagement that ended was stronger demand for the
staffing services the Company provides to its clients. Although demand for
staffing services increased, the addition of billable staff was throughout the
quarter as compared to the large engagement ending near the beginning of the
quarter, and therefore only partially offset the decline in revenue.
The significant increase in revenue in the Company's European operations
in 2004 as compared to 2003 was primarily due to the addition of a large
healthcare project in the United Kingdom. This project accounted for
approximately two-thirds of the year-over-year revenue increase. Additionally,
the increase in year-over-year revenue was partially due to the strength of the
currencies of Belgium, the United Kingdom, and Luxembourg, the countries in
which the Company's European subsidiaries operate. In Belgium and Luxembourg,
the functional currency is the Euro, while in the United Kingdom, the functional
currency is the British pound. If there had been no change in these foreign
currency exchange rates from the third quarter 2003 to 2004, European and total
consolidated revenues in the third quarter of 2004 would have been $1.0 million
lower. Without any foreign exchange rate change in all of 2004 in Europe, total
European revenue would have $3.7 million lower, or $27.6 million in total as
compared to the $31.3 million reported in the 2004 year-to-date period.
12
In November 2003, the Company signed a contract with International
Business Machines (IBM) for one year as one of IBM's national technical service
providers for the United States. IBM has the right to extend the contract for
three additional one-year periods. The Company and IBM are currently in the
process of completing the extension of the contract for one additional year. In
the third quarter of 2004, IBM was the Company's largest customer, accounting
for $12.6 million or 21.8% of total revenue as compared to $12.7 million or
21.3% of third quarter 2003 revenue. For the 2004 year-to-date period, revenues
from IBM were $39.8 million or 22.3% of consolidated revenue as compared to
$38.5 million or 20.9% of consolidated 2003 revenues. The Company expects to
continue to derive a significant portion of its revenue from IBM in the
remainder of 2004 and in future years. While a decline in revenue from IBM would
have a negative effect on the Company's revenues and profits, the Company
believes a simultaneous loss of all IBM business is unlikely to occur due to the
diversity of the projects performed for IBM and the number of locations and
divisions involved.
Direct costs, defined as costs for billable staff including billable
out-of-pocket expenses, were 73.6% of revenue in the third quarter of 2004 as
compared to 72.4% of third quarter 2003 revenue, and 73.2% of revenue in the
2004 year-to-date period as compared to 72.9% of revenue in the 2003
year-to-date period. The increase in direct costs as a percentage of revenue in
the third quarter of 2004 as compared to third quarter of 2003 is primarily due
to higher medical costs (0.7%), the cost of shutting down the previously
mentioned outsourcing engagement (0.3%), and a change in the mix of services
provided to clients.
Selling, general and administrative (SG&A) expenses were 25.2% of revenue
in the third quarter of 2004 as compared to 25.0% of revenue in the third
quarter of 2003, and 25.2% in the 2004 year-to-date period as compared to 24.9%
in the 2003 year-to-date period. Although the percentages have increased in
2004, total SG&A expenses have decreased from 2003 as the Company continues to
actively manage its cost structure in response to the ongoing recession in
technology related investments mentioned above, which has caused overall Company
revenue to decrease.
Operating income was 1.2% of revenue in the third quarter of 2004 as
compared to 2.6% of revenue in the third quarter of 2003, and 1.6% in the 2004
year-to-date period as compared to 2.2% in the 2003 year-to-date period.
Operating income from North American operations was $0.6 million and $2.4
million in the third quarter of 2004 and 2004 year-to-date period, respectively,
while European operations recorded operating income of $0.1 million and $0.5
million, respectively, in such periods.
Interest and other expense, net was 0.2% of revenue in the 2004
year-to-date period and 0.4% in the corresponding 2003 period. The decrease as a
percentage of revenue from 2003 to 2004 is primarily due to lower average
outstanding indebtedness balances in 2004. The estimated effective tax rate
(ETR) used to calculate the provision for income taxes from continuing
operations was 16.1% in 2004 and 42.0% in 2003. The ETR is recalculated
quarterly based upon current assumptions relating to the full year's estimated
operating results, and various tax related items. The decrease in the rate in
2004 as compared to 2003 is due to the Company utilizing previously recorded net
operating loss tax benefits of approximately $0.3 million for its European
operations that had been fully offset by a valuation allowance. Additionally,
the decrease in the ETR also reflects a release of approximately $0.4 million of
previously recorded tax liabilities resulting from tax legislation recently
enacted in the Netherlands. Without these adjustments to the ETR, the rate would
have been approximately 43% in 2004.
Net income from continuing operations for the third quarter of 2004 was
1.1% of revenue or $0.04 per diluted share, compared to net income from
continuing operations of 1.3% of revenue or $0.05 per diluted share in the third
quarter of 2003, and 1.2% of revenue or $0.12 per diluted share in all of 2004
as compared to 1.1% of revenue or $0.11 per diluted share in the comparable 2003
period. Diluted earnings per share were calculated using 17.2 million and 16.8
million equivalent shares outstanding in all 2004 and 2003 periods,
respectively. The increase in equivalent shares outstanding in 2004 is due to an
increase in the Company's stock price which resulted in a greater dilutive
effect of outstanding stock options.
13
CRITICAL ACCOUNTING POLICIES
Goodwill Valuation - With the required adoption of FAS No. 142 in 2002,
CTG recorded a charge of $37.0 million, representing the cumulative effect of
the change in accounting principle. The remaining goodwill balance of $35.7
million, relating to the company's North American operations, is evaluated
annually or more frequently if facts and circumstances indicate impairment may
exist. These evaluations are based on estimates and assumptions that may analyze
the appraised value of similar transactions from which the goodwill arose, the
appraised value of similar companies, or estimates of future discounted cash
flows. The estimates and assumptions on which the Company's evaluations are
based necessarily involve judgments and are based on currently available
information, any of which could prove wrong or inaccurate when made, or become
wrong or inaccurate as a result of subsequent events.
As of both January 1, 2003 and 2004, the Company completed its annual
valuation of the business unit to which the Company's goodwill relates. This
valuation indicated that the estimated fair value of the business unit exceeded
the carrying value of this unit at both January 1, 2003 and 2004. Additionally,
there are no facts or circumstances that arose during 2004 that led management
to believe the goodwill may be impaired. Accordingly, the Company believes no
additional impairment was required to be recorded in its condensed consolidated
financial results. Changes in future valuations, however, could lead to
additional impairment charges.
Income Taxes - At October 1, 2004, the Company had a total of
approximately $5.0 million of current and non-current net deferred tax assets
recorded on its balance sheet. The changes in deferred tax assets and
liabilities from year to year, and quarter to quarter, are determined based upon
the changes in differences between the basis of assets and liabilities for
financial reporting purposes and the basis of assets and liabilities for tax
purposes, as measured by the enacted tax rates when these differences are
estimated to reverse. The Company has made certain assumptions regarding the
timing of the reversal of these assets and liabilities, and whether taxable
operating income in future periods will be sufficient to recognize all or a part
of any gross deferred tax asset of the Company.
At October 1, 2004, the Company has a deferred tax asset resulting from
the net operating loss in The Netherlands of approximately $3.7 million. The
Company also has net operating loss benefits of approximately $0.9 million in
various other countries where it does business. Management of the Company has
analyzed each country's tax position and determined that it is unclear whether
approximately $3.7 million of these assets totaling $4.6 million will be
realized at any point in the future. Accordingly, at October 1, 2004, the
Company has offset a portion of the asset with a valuation allowance totaling
$3.7 million. The valuation allowance was reduced by approximately $0.3 million
during 2004 due to the Company utilizing recorded net operating loss benefits of
approximately $0.3 million for its European operations. In the future, the
asset, and its potential realizability, will be evaluated each quarter to
determine if any additional portion of the valuation allowance should be
reversed. Any additional reversal of this valuation allowance in the future will
result in a reduction of the Company's effective tax rate. The $0.3 million
reduction in the valuation allowance resulted in a reduction in the ETR for 2004
of approximately 11%. Any additional 1% decrease in the ETR would have equaled
approximately $25,000 of additional net income for the first three quarters of
2004.
The Company has also made a number of estimates and assumptions relating
to the reporting of assets and liabilities and the disclosure of contingent
assets and liabilities to prepare these condensed consolidated financial
statements pursuant to the rules and regulations of the Securities and Exchange
Commission (the SEC). Such estimates primarily relate to allowances for doubtful
accounts receivable, investment valuation, legal matters, and estimates of
progress toward completion and direct profit or loss on fixed-price contracts.
Actual results could differ from these estimates.
14
FINANCIAL CONDITION AND LIQUIDITY
Cash used by operating activities was $0.2 million through the first three
quarters of 2004. Net income from continuing operations totaled $2.1 million,
while other non-cash adjustments, primarily consisting of depreciation expense
totaled $2.3 million. Accounts receivable increased by $6.9 million as compared
to December 31, 2003 primarily due to the timing of certain billings and the
collection of outstanding balances in the third quarter of 2004, which resulted
in an increase in days sales outstanding to 74 days from 62 days at December 31,
2003. The ending of the large outsourcing engagement previously mentioned also
negatively affected the Company's days sales outstanding calculation as the
customer had prepaid its balances due to the Company. Income taxes decreased
$1.7 million primarily due to the receipt of approximately $1.4 million of tax
refunds net of tax payments, and reduced taxes payable due on current year
income as compared to 2003. Accounts payable decreased $0.3 million, accrued
compensation increased $0.5 million, and other current liabilities increased
$0.8 million primarily due to the timing of certain payments near quarter-end.
Investing activities used $1.5 million through the first three quarters of
2004, which represented the additions to property and equipment. The Company has
no significant commitments for capital expenditures at October 1, 2004.
Financing activities provided $4.7 million of cash through the first three
quarters of 2004. The Company's current revolving credit agreement (Agreement)
allows the Company to borrow up to $45 million. The Agreement is due in May
2005. The Agreement has interest rates ranging from 25 to 200 basis points over
the prime rate and 125 to 300 basis points over Libor, and provides certain of
the Company's assets as security for outstanding borrowings. The Company is
required to meet certain financial covenants in order to maintain borrowings
under the Agreement, pay dividends, and make acquisitions. At October 1, 2004,
and during 2004, the Company was in compliance with these covenants.
At October 1, 2004, there was a total of $4.5 million outstanding under
this Agreement, up from $0 at December 31, 2003. The Company borrows or repays
this revolving debt as needed based upon its working capital obligations,
including the timing of the U.S. bi-weekly payroll. Daily average borrowings
under this agreement for the first three quarters of 2004 were $8.8 million. As
the Agreement is due in May 2005, the Company has recorded this outstanding
balance at October 1, 2004 as a current portion of long-term debt, and included
the balance in current liabilities. Prior to May 2004, the outstanding balance
had been recorded as long-term debt and recorded in non-current liabilities. The
Company is currently in the process of negotiating with a number of financial
institutions for a new, long-term agreement. Upon signing a new agreement, the
Company expects to again record the outstanding amount under the new agreement
as long-term debt.
The Company also received approximately $0.3 million from employees for
stock purchased under the Employee Stock Purchase Plan and other stock plans.
The Company is authorized to repurchase a total of 3.4 million shares of
its common stock for treasury and the Company's stock trusts. At October 1,
2004, approximately 3.2 million shares have been repurchased under the
authorizations, leaving 0.2 million shares authorized for future purchases. No
share purchases were made in 2004.
At October 1, 2004, consolidated shareholders' equity totaled $54.6
million, which is a decrease of $1.5 million from December 31, 2003. The
decrease is primarily due to a net loss of $2.3 million, offset by the foreign
currency adjustment of approximately $0.5 million primarily resulting from the
sale of the Company's Dutch operations which had previously been reported as a
direct charge to shareholders' equity.
The Company believes existing internally available funds, cash potentially
generated by operations, and available borrowings under the Company's revolving
line of credit totaling approximately $40.3 million at October 1, 2004 will be
sufficient to meet foreseeable working capital, capital expenditure, and
possible stock repurchases, and to allow for future internal growth and
expansion.
The Company did not have any related party or off-balance sheet
arrangements or transactions in either the first three quarters of 2004 or 2003.
15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have any off balance sheet market risk sensitive
instruments for which disclosure is required. Total long-term revolving debt
outstanding at the end of the quarter totaled approximately $4.5 million. The
Company borrows or repays this revolving debt as needed based upon its working
capital obligations, including the timing of the U.S. bi-weekly payroll. Daily
average borrowings under this agreement for the first three quarters of 2004
were $8.8 million. Accordingly, a 1% increase or decrease in interest rates
would increase or decrease quarterly interest expense by approximately $22,000.
For the most part, prior to 2003, the Company had not been subject to
material effects from foreign currency exchange rate fluctuations. However,
throughout 2003, there was a significant strengthening of the currencies of
Belgium, the United Kingdom, and Luxembourg, the countries in which the
Company's European subsidiaries operate. In Belgium and Luxembourg, the
functional currency is the Euro, while in the United Kingdom, the functional
currency is the British pound. If there had been no change in these foreign
currency exchange rates from the third quarter 2003 to 2004, European and total
consolidated revenues in the third quarter of 2004 would have been $1.0 million
lower. Without any foreign exchange rate change in all of 2004 in Europe, total
European revenue would have $3.7 million lower, or $27.6 million in total as
compared to the $31.3 million reported in the 2004 year-to-date period. The
Company has historically not used any market risk sensitive instruments to hedge
its foreign currency exchange risk.
ITEM 4. CONTROLS AND PROCEDURES
Based upon an evaluation completed as of the end of the period covered by
this quarterly report with the SEC, the Company's Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures are effective for gathering and disclosing information as required
for reports filed under the Securities and Exchange Act of 1934. The Company is
in the process of documenting and testing its internal controls and procedures
in compliance with Section 404 of the Sarbanes - Oxley Act and continues to make
enhancements to its existing internal control environment. Such changes, in
management's, opinion have strengthened already existing internal controls or
have corrected potential process deficiencies. We will continue to evaluate the
effectiveness of our internal controls and procedures and take further action as
appropriate.
The Company's disclosure controls and procedures and internal controls
provide reasonable, but not absolute, assurance that all deficiencies in design
or operation of these control systems, or all instances of errors or fraud, will
be prevented or detected. These control systems are designed to provide
reasonable assurance of achieving the goals of these systems in light of our
resources and nature of our business operations. These control systems remain
subject to risks of human error and the risk that controls can be circumvented
for wrongful purposes by one or more individuals in management or non-management
positions.
16
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
Exhibit Description Page
- ------- ----------------------------------------------------------- -----
31.(a) Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 18
31.(b) Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 19
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 20
* * * * * * *
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COMPUTER TASK GROUP, INCORPORATED
By: /s/ Gregory M. Dearlove
----------------------------------
Gregory M. Dearlove
Principal Accounting and
Financial Officer
Title: Senior Vice President and
Chief Financial Officer
Date: November 10, 2004
17