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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 APRIL 1, 2005
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 May 9, 2005
------------------- --------------
Common stock, par value 20,868,834
$.01 per share
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COMPUTER TASK GROUP, INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
QUARTER ENDED
APRIL 1, APRIL 2,
2005 2004
--------- ----------
(amounts in thousands,
except per share data)
Revenue $ 68,683 $ 61,447
Direct costs 52,170 44,853
Selling, general and administrative expenses 15,585 15,163
--------- ----------
Operating income 928 1,431
Interest and other income 21 43
Interest and other expense (243) (170)
--------- ----------
Income from continuing operations before income taxes 706 1,304
Provision for income taxes 222 522
--------- ----------
Income from continuing operations 484 782
Loss from discontinued operations (including loss on disposal
of $3.7 million in the first quarter of 2004) - (4,316)
--------- ----------
Net income (loss) $ 484 $ (3,534)
========= ==========
Basic net income (loss) per share:
Continuing operations $ 0.03 $ 0.05
Discontinued operations - (0.26)
--------- ----------
Basic net income (loss) per share $ 0.03 $ (0.21)
========= ==========
Diluted net income (loss) per share:
Continuing operations $ 0.03 $ 0.05
Discontinued operations - (0.25)
--------- ----------
Diluted net income (loss) per share $ 0.03 $ (0.20)
========= ==========
Weighted average shares outstanding:
Basic 16,813 16,718
Diluted 17,242 17,243
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
COMPUTER TASK GROUP, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
APRIL 1, DECEMBER 31,
2005 2004
----------- ------------
(amounts in thousands)
ASSETS
Current Assets:
Cash and temporary cash investments $ 3,685 $ 4,488
Accounts receivable, net of allowances of $1,348,000 and $1,327,000
in 2005 and 2004, respectively 66,707 46,771
Prepaids and other 2,173 2,103
Income taxes receivable 56 113
Deferred income taxes 1,985 2,020
----------- ------------
Total current assets 74,606 55,495
Property and equipment, net of accumulated depreciation of $28,843,000
and $24,618,000 in 2005 and 2004, respectively 7,101 6,075
Goodwill 35,678 35,678
Deferred income taxes 4,085 4,249
Other assets 1,834 1,846
----------- ------------
Total assets $ 123,304 $ 103,343
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 8,258 $ 9,263
Accrued compensation 28,405 16,831
Advance billings on contracts 1,962 1,922
Other current liabilities 6,529 5,287
Current portion of long-term debt - 4,650
----------- ------------
Total current liabilities 45,154 37,953
Long-term debt 12,271 -
Deferred compensation benefits 8,561 8,570
Other long-term liabilities 696 336
----------- ------------
Total liabilities 66,682 46,859
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 111,268 111,272
Retained earnings 39,481 38,997
Less: Treasury stock of 6,148,990 shares at cost (31,416) (31,416)
Stock Trusts of 4,047,640 and 4,057,857 shares at cost, respectively (58,002) (58,045)
Accumulated other comprehensive loss:
Foreign currency adjustment (3,567) (3,205)
Minimum pension liability adjustment (1,412) (1,389)
----------- ------------
Accumulated other comprehensive loss (4,979) (4,594)
----------- ------------
Total shareholders' equity 56,622 56,484
----------- ------------
Total liabilities and shareholders' equity $ 123,304 $ 103,343
=========== ============
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)
QUARTER ENDED
APRIL 1, APRIL 2,
2005 2004
---------- -----------
(amounts in thousands)
Cash flows from operating activities:
Net income (loss) $ 484 $ (3,534)
Loss from discontinued operations - (4,316)
---------- -----------
Income from continuing operations 484 782
Adjustments:
Depreciation expense 709 732
Deferred income taxes 171 (612)
Tax benefit on stock option exercises 1 -
Gain on sales of property and equipment (2) (2)
Deferred compensation (32) 35
Changes in assets and liabilities:
Increase in accounts receivable (20,396) (6,682)
(Increase) decrease in prepaids and other (97) 253
Decrease in income taxes 88 997
(Increase) decrease in other assets (23) 261
Decrease in accounts payable (609) (2,150)
Increase (decrease) in accrued compensation 11,793 (714)
Increase (decrease) in advance billings on contracts 41 (305)
Increase in other current liabilities 1,334 14
Increase in other long-term liabilities 360 -
---------- -----------
Net cash used in operating activities (6,178) (7,391)
---------- -----------
Cash flows from investing activities:
Additions to property and equipment (1,846) (556)
Proceeds from sales of property and equipment 76 4
---------- -----------
Net cash used in investing activities (1,770) (552)
---------- -----------
Cash flows from financing activities:
Proceeds from long-term revolving debt, net 7,621 8,961
Change in cash overdraft, net (263) (2,274)
Proceeds from Employee Stock Purchase Plan 33 48
Proceeds from other stock plans 5 10
---------- -----------
Net cash provided by financing activities 7,396 6,745
---------- -----------
Net cash from discontinued operations - (414)
Effect of exchange rate changes on cash and temporary cash investments (251) (28)
---------- -----------
Net decrease in cash and temporary cash investments (803) (1,640)
Cash and temporary cash investments at beginning of quarter 4,488 5,197
---------- -----------
Cash and temporary cash investments at end of quarter $ 3,685 $ 3,557
========== ===========
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 U.S. generally
accepted accounting principles 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 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 and Form 10-K/A
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 in which the Company
sold the subsidiary's stock and transferred the unit's business, staff, and
lease and equipment obligations to the unit's management team. The effective
date of the disposition was January 1, 2004, and the transaction has been
treated as discontinued operations in these condensed consolidated financial
statements. As part of the transaction, the Company retained the assets and
liabilities related to the defined-benefit plan for its previous employees in
The Netherlands. At the time of the disposition, the net assets of the plan
totaled approximately $0.5 million. 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 $4.3 in the first quarter of 2004. The loss in the first
quarter of 2004 included a loss on disposal of approximately $3.7 million, and
approximately $0.5 million from a foreign currency adjustment which had
previously been reported as a direct charge to shareholders' equity. 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 for the quarters ended April
1, 2005 and April 2, 2004 is as follows:
APRIL 1, APRIL 2,
2005 2004
--------- ----------
(amounts in thousands,
QUARTER ENDED except per share data)
Weighted-average number of shares outstanding during period 16,813 16,718
Common Stock equivalents -
Incremental shares under stock option plans 429 525
--------- ----------
Number of shares on which diluted earnings per share is based 17,242 17,243
========= ==========
Income from continuing operations $ 484 $ 782
Loss from discontinued operations - (4,316)
--------- ----------
Net income (loss) $ 484 $ (3,534)
========= ==========
Basic net income (loss) per share:
Continuing operations $ 0.03 $ 0.05
Discontinued operations - (0.26)
--------- ----------
Total basic income (loss) per share $ 0.03 $ (0.21)
========= ==========
Diluted net income (loss) per share:
Continuing operations $ 0.03 $ 0.05
Discontinued operations - (0.25)
--------- ----------
Total diluted income (loss) per share $ 0.03 $ (0.20)
========= ==========
Options to purchase 2.4 million and 1.8 million shares of common stock
were outstanding at April 1, 2005 and April 2, 2004, 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 $(4,979,000) and $(4,594,000)
at April 1, 2005 and December 31, 2004, respectively. Total comprehensive income
(loss) for the quarters ended April 1, 2005 and April 2, 2004 is as follows:
APRIL 1, APRIL 2,
2005 2004
--------- ---------
QUARTER ENDED (amounts in thousands)
Net income (loss) $ 484 $ (3,534)
Foreign currency (362) (38)
Foreign currency - disposition of Dutch operations - 531
Minimum pension liability (23) -
--------- ---------
Comprehensive income (loss) $ 99 $ (3,041)
========= =========
6
6. INCOME TAXES
The estimated effective tax rate (ETR) used to calculate the provision for
income taxes from continuing operations was 31.4% in the first quarter of 2005
compared to 40.0% in the first quarter of 2004. The ETR is calculated quarterly
based upon current assumptions relating to the full years estimated operating
results, and various tax related items. The decrease in the rate in 2005 as
compared to 2004 is primarily due to several items that created tax benefits in
2005 of approximately $67,000. One such item was related to a net increase of
approximately $108,000 in the cash surrender value for company owned life
insurance policies that had previously not been recorded which created a tax
benefit of approximately $44,000. Without these items, the Company's ETR in 2005
would have approximated 41%.
7. DEBT
On April 20, 2005, the Company entered into a new revolving credit
agreement (Agreement) which allows the Company to borrow up to $35 million. This
new Agreement has a term of three years and expires in April 2008. Accordingly,
the Company has recorded its outstanding indebtedness at April 1, 2005 of $12.3
million as long-term debt. The Agreement has interest rates ranging from 0 to 75
basis points over the prime rate and 150 to 225 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.
8. DEFERRED COMPENSATION AND OTHER BENEFITS
DEFERRED COMPENSATION BENEFITS
The Company maintains a non-qualified defined-benefit Executive
Supplemental Benefit Plan (ESBP) that provides a 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 quarters ended April 1, 2005 and April
2, 2004 for the ESBP is as follows:
APRIL 1, APRIL 2,
NET PERIODIC PENSION COST - ESBP 2005 2004
---------- ---------
(amounts in thousands)
Interest cost $ 128 $ 144
Amortization of unrecognized net loss 27 22
---------- ---------
Net periodic pension cost $ 155 $ 166
========== =========
The ESBP is deemed to be unfunded as the Company has not specifically
identified Company assets to be used to discharge the deferred compensation
benefit liabilities. The Company has purchased insurance on the lives of certain
plan participants in amounts considered sufficient to reimburse the Company for
the costs associated with the plan for those participants. The Company does not
anticipate making contributions to the plan in 2005 and future years to fund the
ESBP.
The Company also retained a contributory defined-benefit plan for its
previous employees located in The Netherlands (NDBP) when the Company disposed
of its subsidiary, CTG Nederland B.V., in the first quarter of 2004. Benefits
paid are a function of a percentage of career average pay. The Plan was
curtailed for additional contributions in January 2003.
7
Net periodic pension benefit for the quarters ended April 1, 2005 and
April 2, 2004 for the NDBP is as follows:
APRIL 1, APRIL 2,
NET PERIODIC PENSION BENEFIT - NDBP 2005 2004
---------- ---------
(amounts in thousands)
Interest cost $ 64 $ 54
Expected return on plan assets (79) (66)
---------- ---------
Net periodic pension benefit $ (15) $ (12)
========== =========
The Company does not anticipate making contributions to the NDBP in 2005
or future years as the NDBP is currently over-funded.
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 amount of $0.5 million for both of the quarters
ended April 1, 2005 and April 2, 2004.
OTHER RETIREMENT PLANS
The Company maintains various other defined contribution retirement plans
other than the NDBP discussed above, covering substantially all of the remaining
European employees. Company contributions charged to operations were less than
$0.1 million in each of the quarters ended April 1, 2005 and April 2, 2004.
OTHER POSTRETIREMENT BENEFITS
The Company provides limited healthcare and life insurance benefits to one
current and nine retired employees and their spouses, totaling 16 participants,
pursuant to contractual agreements.
Net periodic postretirement benefit cost for the quarters ended April 1,
2005 and April 2, 2004 is as follows:
APRIL 1, APRIL 2,
NET PERIODIC POSTRETIREMENT BENEFIT COST 2005 2004
---------- ---------
(amounts in thousands)
Interest cost $ 9 $ 9
Amortization of transition amount 7 7
---------- ---------
Net periodic postretirement benefit cost $ 16 $ 16
========== =========
No adjustments were made to the net periodic postretirement benefit cost
indicated above due to Medicare reform as the amounts were deemed to be
insignificant. The Company does not anticipate making contributions to fund the
plan in 2005 or future years.
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. No stock-based employee compensation cost is reflected in the
net income (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 QUARTER ENDED
APRIL 1, APRIL 2,
2005 2004
----------- -----------
(amounts in thousands, except per share data)
Net income (loss), as reported $ 484 $ (3,534)
Stock-based employee compensation
expense as calculated under the fair
value method for all awards, net of tax (299) (281)
----------- -----------
Pro forma net income (loss) $ 185 $ (3,815)
=========== ===========
Basic net income (loss) per share:
As reported $ 0.03 $ (0.21)
=========== ===========
Pro forma $ 0.01 $ (0.23)
=========== ===========
Diluted net income (loss) per share:
As reported $ 0.03 $ (0.20)
=========== ===========
Pro forma $ 0.01 $ (0.22)
=========== ===========
Pro forma amounts for compensation cost may not be indicative of the
effects on earnings for future quarters. The Company's pro forma amounts of
compensation expense, net of tax, are calculated using the straight-line method
of calculating expense for the pro rata vesting that occurs for the Company's
outstanding stock options.
10. ACCOUNTING STANDARDS PRONOUNCEMENTS
In December 2004, the FASB issued FAS No. 123 (revised 2004), "Share-Based
Payment." This FAS establishes standards for the accounting for transactions in
which the Company exchanges its equity instruments for goods or services. The
standard requires the Company to measure the cost of employee services received
in exchange for awards of equity instruments based upon the grant date fair
value of the award. Currently, the Company only issues stock options in exchange
for employee and director services. Under the new standard, the calculated cost
of the equity awards will be recognized in the Company's results of operations
over the period in which an employee or director is required to provide the
services for the award. Compensation cost will not be recognized for employees
or directors that do not render the requisite services.
Currently, the Company accounts for its stock-based employee compensation
plans as allowed under current guidance and does not record compensation cost in
its statements of operations for stock-based compensation. This new standard is
effective for the Company as of the beginning of its next fiscal year beginning
after June 15, 2005 (January 1, 2006). The Company is currently in the process
of evaluating the effect on its financial condition and results of operations of
the adoption of this new standard.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE QUARTER ENDED APRIL 1, 2005
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements by management and the
Company that are subject to a number of risks and uncertainties. The
forward-looking statements contained in the report are based on information as
of the date of this report. The Company assumes no obligation to update these
statements based on information from and after the date of this report.
Generally, forward-looking statements include words or phrases such as
"anticipates," "believes," "estimates," "expects," "intends," "plans,"
"projects," "could," "may," "might," "should," "will" and words and phrases of
similar impact. The forward-looking statements include, but are not limited to,
statements regarding future operations, industry trends or conditions and the
business environment, and statements regarding future levels of, or trends in,
revenue, operating expenses, capital expenditures, and financing. The
forward-looking statements are made pursuant to safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. Numerous factors could cause
actual results to differ materially from those in the forward-looking
statements, including the following: (i) industry conditions, including
fluctuations in demand for IT services, (ii) the availability to the Company of
qualified professional staff, (iii) industry competition, (iv) rate and wage
inflation or deflation, (v) risks associated with operating in foreign
jurisdictions, (vi) the impact of current and future laws and government
regulation, as well as repeal or modification of same, affecting the IT
solutions and staffing industry, taxes and the Company's operations in
particular, (vii) renegotiations, nullification, or breaches of contracts with
customers, vendors, subcontractors or other parties, (viii) consolidation among
the Company's competitors or customers, and (ix) the risks described elsewhere
herein and from time to time in the Company's reports to the Securities and
Exchange Commission.
Several important factors should be taken into consideration when
reviewing the operational results. These include:
THE ANTICIPATED DEMAND FOR INFORMATION TECHNOLOGY (IT) SERVICES
There was a steady decline in demand in the technology services sector
from the second half of 1999 through 2003 as a recession in the technology
industry negatively affected spending for information technology services. The
Company believes that demand began to increase in 2004, and staffing demand
returned to more normalized levels for the first time in five years. However,
declines in spending for IT services in 2005 and in future years may again
adversely affect the Company's operating results in the future as it has in the
past.
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
somewhat 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. 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.
10
INTERNATIONAL OPERATIONS
The Company has operations in the United States and Canada in North
America, and in Belgium, the United Kingdom and Luxembourg in Europe. The
Company's foreign operations are subject to currency fluctuations, legislation
and tax law changes, and economic climates that are different than that of the
United States. Although the Company actively manages these foreign operations,
economic conditions or other changes beyond the Company's control may negatively
effect the Company's overall operating results.
OPERATIONS
The Company operates in one industry segment, providing IT staffing
solutions services to its clients. These services include IT Staffing,
Application Management Outsourcing, and IT Solutions. CTG provides these three
primary services to all of the markets that it serves. 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.
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."
APRIL 1, APRIL 2,
Quarter ended: 2005 2004
--------------------- --------------------
Revenue 100.0% $ 68,683 100.0% $ 61,447
Direct costs 76.0% 52,170 73.0% 44,853
Selling, general, and administrative expenses 22.7% 15,585 24.7% 15,163
----- --------- ----- ---------
Operating income 1.3% 928 2.3% 1,431
Interest and other expense, net (0.3)% (222) (0.2)% (127)
----- --------- ----- ---------
Income from continuing operations before income taxes 1.0% 706 2.1% 1,304
Provision for income taxes 0.3% 222 0.8% 522
----- --------- ----- ---------
Income from continuing operations 0.7% 484 1.3% 782
Loss from discontinued operations - - (7.1)% (4,316)
----- --------- ----- ---------
Net income (loss) 0.7% $ 484 (5.8)% $ (3,534)
===== ========= ===== =========
In the first quarter of 2005, the Company recorded revenue of $68.7
million, an increase of 11.8% compared to revenue of $61.4 million recorded in
the first quarter of 2004. Revenue from the Company's North American operations
totaled $55.9 million in the first quarter of 2005, an increase of 9.2% when
compared to 2004 first quarter revenue of $51.2 million. Revenue from the
Company's European operations in the first quarter of 2005 totaled $12.8
million, an increase of 25.5% when compared to 2004 revenue of $10.2 million.
The European revenue represented 18.6% and 16.6% of 2005 and 2004 consolidated
revenue, respectively. The Company's revenue includes reimbursable expenses
billed to customers. These expenses totaled $2.5 million and $1.6 million in the
first quarter of 2005 and 2004, respectively.
In North America, the revenue increase in 2005 over 2004 is primarily the
result of adding approximately 700 billable staff in total during the first
quarter of 2005, which included significantly expanding a staffing client
relationship. This increase in staff represented a 34% increase in headcount in
North America when compared to the first quarter of 2004. The Company
anticipates that revenue in North America will continue to increase in the
second quarter of 2005 as the staff added during the first quarter of 2005 were
added gradually throughout the period and did not have a full quarter's impact
on revenue.
11
The significant increase in revenue in the Company's European operations
was primarily due to the addition of a large health care project in the United
Kingdom that did not exist in the first quarter of 2004. Additionally, the
increase in year-over-year revenue was in part 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 function
currency is the British pound. Had there been no change in these exchange rates
from 2004 to 2005, total European revenue would have been approximately $0.5
million lower, or $12.3 million as compared to the $12.8 million reported.
In December 2004, 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. In the first quarter of 2005, IBM was the
Company's largest customer, accounting for $21.8 million or 31.7% of total
revenue as compared to $14.2 million or 23.1% of first quarter 2004 revenue. A
significant portion of the additional staff added in the first quarter in North
America was with IBM. The Company expects to continue to derive a significant
portion of its revenue from IBM in the remainder of 2005 and in future years.
While a decline in revenue from IBM would have a negative effect on the
Company's revenue 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. No other customer
accounted for more than 10% of the Company's revenue in the first quarter of
2005 or 2004.
Direct costs, defined as costs for billable staff including billable
out-of-pocket expenses, were 76.0% of revenue in the first quarter of 2005 as
compared to 73.0% of 2004 revenue. The increase in direct costs as a percentage
of revenue in 2005 as compared to 2004 is primarily due to a significant
increase in the Company's staffing business, which generally yields lower direct
profit margins.
Selling, general and administrative (SG&A) expenses were 22.7% of revenue
in the first quarter of 2005 as compared to 24.7% of revenue in the first
quarter of 2004 revenue. The decrease in SG&A expense as a percentage of revenue
is due to the significant increase in headcount during the quarter which
increased revenue nearly 12% year-over-year, offset by a modest increase in SG&A
expense from 2004 to 2005. The increase in SG&A in 2005 as compared to 2004 was
primarily due to additional recruiting costs incurred of approximately $0.7
million to respond to an increase in demand for the Company's services and
additional audit fees of approximately $0.3 million related to the Company's
compliance with section 404 of the Sarbanes Oxley Act of 2002. These increases
in expenses were partially offset by an increase in cash surrender value of
approximately $0.1 million for company owned life insurance policies that had
previously not been recorded as well as the Company's continued efforts to
control and reduce its SG&A costs.
Operating income was 1.3% of revenue in the first quarter of 2005 as
compared to 2.3% of revenue in the first quarter of 2004. Operating income from
North American operations was $0.1 million and $1.3 million in the first quarter
of 2005 and 2004, respectively, while European operations recorded operating
income of $0.8 million and $0.1 million in the first quarter of 2005 and 2004,
respectively.
Interest and other expense, net was (0.3) % of revenue in the first
quarter of 2005 and (0.2) % in the first quarter of 2004. The increase as a
percentage of revenue from 2004 to 2005 is primarily due to an increase in the
average outstanding debt during 2005 as the Company utilized its revolving line
of credit to fund higher accounts receivable during the quarter, as well as
higher interest rates in 2005.
The estimated effective tax rate (ETR) used to calculate the provision for
income taxes from continuing operations was 31.4% in the first quarter of 2005
compared to 40.0% in the first quarter of 2004. The ETR is calculated quarterly
based upon current assumptions relating to the full years estimated operating
results, and various tax related items. The decrease in the rate in 2005 as
compared to 2004 is primarily due to several items that created tax benefits in
2005 of approximately $67,000. One such item was related to a net increase of
approximately $108,000 in the cash surrender value for company owned life
insurance policies that had previously not been recorded which created a tax
benefit of approximately $44,000. Without these items, the Company's ETR in 2005
would have approximated 41%.
Net income from continuing operations for the first quarter of 2005 was
0.7% of revenue or $0.03 per diluted share, compared to net income from
continuing operations of 1.3% of revenue or $0.05 per diluted share in 2004.
Diluted earnings per share were calculated using 17.2 million equivalent shares
outstanding in both 2005 and 2004, respectively.
12
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in
conformity with generally accepted accounting principles in the United States
requires the Company's management to make estimates, judgments and assumptions
that affect the amounts reported in the condensed consolidated financial
statements and accompanying notes. The Company identifies its most critical
accounting policies as those that are the most pervasive and important to the
portrayal of the Company's financial position and results of operations, and
that require the most difficult, subjective and/or complex judgments by
management regarding estimates about matters that are inherently uncertain. The
Company's most critical accounting policies are those related to goodwill
valuation and income taxes.
Goodwill Valuation - The goodwill balance of $35.7 million relates to the
Company's North American operations and is evaluated annually or more frequently
if facts and circumstances indicate impairment may exist. This evaluation, as
applicable, is 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 January 1, 2005 with the assistance of an outside third party
valuation expert, and as of January 1, 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 in each period. Additionally, there are no facts
or circumstances that arose during 2005 or 2004 that led management to believe
the goodwill was impaired. Accordingly, the Company believes no additional
impairment was required to be recorded in its consolidated financial results.
Changes in business conditions which could impact future valuations however,
could lead to additional impairment charges.
Income Taxes - Deferred Tax Assets and Valuation Allowances - At April 1,
2005, the Company had a total of approximately $6.1 million of current and
non-current net deferred tax assets recorded on its balance sheet. The changes
in deferred tax assets and liabilities from period to period 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 April 1, 2005, the Company has a deferred tax asset before the
valuation allowance resulting from net operating losses. This includes net
operating losses in various states totaling approximately $0.4 million, in The
Netherlands of approximately $3.6 million, and approximately $0.8 million in
various other countries where it does business. Management of the Company has
analyzed each jurisdiction's tax position, including forecasting potential
operating profits in future periods, and the expiration of the net operating
loss carryforwards as applicable, and determined that it is unclear whether all
of the deferred tax asset totaling $4.8 million will be realized at any point in
the future. Accordingly, at April 1, 2005, the Company has offset a portion of
the asset with a valuation allowance totaling $3.9 million, resulting in a net
deferred tax asset from net operating loss carryforwards of approximately $0.9
million.
There was no change in the valuation allowance during the first quarter of
2005. The deferred assets and their potential realizability are evaluated each
quarter to determine if any additional portion of the valuation allowance should
be reversed. Any additional change of this valuation allowance in the future
will result in a change of the Company's effective tax rate. An additional 1%
decrease in the ETR would have equaled approximately $7,000 of additional net
income during the first quarter of 2005.
FINANCIAL CONDITION AND LIQUIDITY
Cash provided by operating activities was $(6.2) million in the first
quarter of 2005. Net income from continuing operations totaled $0.5 million,
while other non-cash adjustments, primarily consisting of depreciation expense
and deferred taxes totaled $0.9 million. Accounts receivable increased by $20.4
million as compared to December 31, 2004 primarily due to the timing of billings
for the additional staff added during the quarter and the collection of the
outstanding balances for those billings which was primarily after the end of the
first quarter of 2005. The timing of the collection of these new billings
resulted in an increase in days sales outstanding to 88 days from 72 days at
December 31, 2004. Accounts payable decreased $0.6 million, and other current
liabilities increased $1.3
13
million primarily due to the timing of certain payments near quarter-end.
Accrued compensation increased $11.8 million due to the timing of the U.S.
bi-weekly payroll, the addition of 700 new employees in North America during the
first quarter of 2005, and additional amounts due to sub-tier firms.
Investing activities used $(1.8) million in the first quarter of 2005,
which primarily represented the additions to property and equipment. The Company
has no significant commitments for capital expenditures at April 1, 2005.
Financing activities provided $7.4 million of cash in the first quarter of
2005. On April 20, 2005, the Company entered into a new revolving credit
agreement (Agreement) which allows the Company to borrow up to $35 million. This
new Agreement has a term of three years and expires in April 2008. Accordingly,
the Company has recorded its outstanding indebtedness at April 1, 2005 of $12.3
million as long-term debt. The Agreement has interest rates ranging from 0 to 75
basis points over the prime rate and 150 to 225 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 April 1, 2005, the Company had a total of $12.3 million outstanding
under its previous revolving credit agreement. The Company borrows or repays its
revolving debt as needed based upon its working capital obligations, including
the timing of the U.S. bi-weekly payroll. Daily average borrowings under the
Company's previous agreement for the first quarter of 2005 were $11.1 million.
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 April 1, 2005,
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 2005.
At April 1, 2005, consolidated shareholders' equity totaled $56.6 million,
which is an increase of $0.1 million from December 31, 2004. The increase is
primarily due net income in the quarter of $0.5 million, offset by a foreign
currency adjustment of $0.4 million.
The Company believes existing internally available funds, cash potentially
generated from operations, and available borrowings under the Company's previous
revolving line of credit totaling approximately $32.5 million at April 1, 2005,
will be sufficient to meet foreseeable working capital, capital expenditure, and
possible stock repurchases, and to allow for future internal growth and
expansion.
OFF-BALANCE SHEET ARRANGEMENTS
The Company did not have off-balance sheet arrangements or transactions in
either 2005 or 2004.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At April 1, 2005, there was a total of $12.3 million outstanding under the
Company's previous revolving credit agreement. On April 20, 2005, the Company
entered into a new revolving credit agreement (Agreement) which allows the
Company to borrow up to $35 million. This new Agreement has a term of three
years and expires in April 2008. The Agreement has interest rates ranging from 0
to 75 basis points over the prime rate and 150 to 225 basis points over Libor,
and provides certain of the Company's assets as security for outstanding
borrowings. Daily average borrowings for the first quarter of 2005 were $11.1
million. Accordingly, a 1% increase or decrease in interest rates would increase
or decrease annual interest expense by approximately $111,000.
For the first quarter of 2005 as compared to the first quarter of 2004,
there was a 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 first quarter of
2004 to 2005, European revenues for the first quarter of 2005 would have been
$0.5 million lower than the $12.8 million reported. The Company has historically
not used any market risk sensitive instruments to hedge its foreign currency
exchange risk.
14
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company's management has evaluated, under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, the effectiveness of the design and operations of the Company's
disclosure controls and procedures (as defined in Securities Exchange Act Rule
13a-15(e)), as of the end of the period covered by this periodic report. Based
on that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer have concluded that the Company's disclosure controls and procedures
were effective as of the end of the period covered by this periodic report.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
As of December 31, 2004, management identified a material weakness in
internal control over financial reporting associated with the Company's
calculation of its incurred but not reported claims related to its self-insured
medical insurance programs. Specifically, the Company's policies and procedures
associated with the calculation of these incurred but not reported claims did
not include an evaluation of the underlying assumptions used to estimate future
claims liabilities to reflect recent claims development experience. This
deficiency resulted in a material understatement of the Company's recorded
medical self-insurance reserves. This error in accounting was corrected prior to
issuance of the Company's 2004 financial statements.
Also as of December 31, 2004, management identified a material weakness in
internal control over financial reporting associated with the Company's
accounting for income taxes. Specifically, the Company did not have effective
management oversight and review controls to ensure that the Company's income tax
accounting was consistent with generally accepted accounting principles. This
control deficiency resulted in errors in the Company's accounting for both
current and deferred income tax amounts and related disclosures, which were
corrected prior to issuance of the Company's 2004 financial statements.
We continue to review, revise and improve the effectiveness of the
Company's internal controls including the additional controls implemented
relating to the Company's medical costs including the estimation of medical
self-insurance reserves, and strengthening the Company's income tax review
control procedures. We have made no other significant changes in the Company's
internal controls over financial reporting in connection with the Company's
first quarter 2005 evaluation that would materially affect, or are reasonably
likely to materially affect the Company's internal controls over financial
reporting. 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.
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of this evaluation.
15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
Exhibit Description Page
- ------- ----------- ----
31.(a) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 17
31.(b) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 18
32. Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 19
* * * * * * *
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: May 11, 2005
16