CTG Reports Strong Q2 '20 Results; Raising Price Target from $6.00 to $6.25

CTG, Inc. (CTG) reported Q2 ’20 results well above our estimates. Despite headwinds from the COVID-19 pandemic, the IT Solutions segment outperformed our expectations by a wide margin as CTG supported clients in their work-from-home initiatives, delivered positive growth in Europe and benefited from a surge in business from an oil and gas customer. The strength in solutions more than offset anticipated weakness in the IT Staffing segment, which has been more significantly impacted by the pandemic and by management’s decision to forego lower margin engagements in recent quarters. Of course, the higher mix of solutions proved favorable to gross margin, which was further boosted by increased utilization and efficiencies realized as consultants were not required to travel to client sites. As a result, both adjusted EBITDA and non-GAAP EPS were considerably better than we projected even as operating expenses came in higher than modeled. Of note, earnings on a GAAP basis were actually greater than the adjusted figures as CTG realized gains from the sale of its corporate headquarters and from life insurance proceeds.

Although CTG has executed well thus far during the COVID-19 crisis, management again refrained from providing guidance amid the ongoing uncertainty. On a positive note, the pipeline remains strong due to the launch of testing services in North America, opportunities to support service desks and patient access to online records in healthcare settings and demand for remote work solutions. Sales cycles remain elongated, however, and management anticipates more pronounced seasonality than usual in the coming quarters as employees deferred vacations earlier in the year and may look to take advantage of easing lockdown restrictions. Additionally, an ownership change affecting a large energy customer coupled with the expiration of government reimbursements in Europe later this quarter suggest both revenue and margins are likely to moderate from Q2 levels. We therefore reduce our estimates for 2H ’20 but note that our full year estimates still move up slightly on the upside in Q2. For FY ’21, our adjusted EBITDA estimate increases marginally despite a reduction in our growth expectations for the IT Staffing segment.

Reflecting a higher than anticipated influx in cash during Q2 from the aforementioned sale of CTG’s headquarters and life insurance proceeds, as well as the increase in our profitability expectations for this year and next, we raise our price target from $6.00 to $6.25. Our price target reflects an unchanged FY ’21 EV/EBITDA multiple of 5x. As evidenced by CTG’s performance in Q2, management’s emphasis on solutions growth provides ample opportunity for margin expansion. Thus, we continue to believe CTG’s investments in business development will translate into higher returns in FY ’21 and beyond.

Q2 revenue of $89.1 million (-11.2% Y/Y) exceeded our estimate of $85.3 million due to stronger than anticipated results from the solutions business. Specifically, IT Solutions revenue was $33.8 million (-5.0% Y/Y) versus our $29.3 million forecast, while IT Staffing revenue of $55.3 million (-14.6% Y/Y) was marginally below our $56.0 million estimate. Per management, the COVID-19 pandemic continues to have a more pronounced impact on the staffing segment, which tends to require on-site personnel, whereas the solutions business has been insulated to a degree due to the ability to deliver services remotely.

Gross margin of 21.0% was well ahead of our 18.2% assumption and reflected meaningful expansion on both a sequential and Y/Y basis. The strong performance was fueled by the higher mix of solutions revenue and was further bolstered by higher utilization and efficiencies realized as consultants were not required to commute to client sites. Selling, general and administrative expenses of $16.8 million were well above our $14.9 million estimate due to $0.6 million in non-recurring severance expenses not included in our forecast and CTG’s ongoing investments in business development. Regardless, the combination of higher revenue and better than anticipated gross margin resulted in adjusted EBITDA of $4.0 million (4.5% margin), which was basically double the amount we anticipated. Non-GAAP EPS of $0.10 beat our estimate by $0.06, and we note that GAAP EPS of $0.12 beat by even more due to gains from the sale of the company’s corporate headquarters and a payout on its life insurance policies.

Given the ongoing uncertainty related to the duration and magnitude of the COVID-19 crisis, management was again reticent to provide guidance for Q3 or FY ‘20. However, management’s commentary suggests seasonal softness is likely to be more pronounced than usual in 2H ‘20 as billable resources have largely deferred vacations to date. With many regions already easing stay-at-home restrictions, utilization is expected to fall in the coming quarters as employees take previously delayed vacations. Also affecting the near-term outlook is Hilcorp Energy’s acquisition of BP Alaska’s energy assets at the end of Q2. While BP Alaska has had a longstanding relationship with CTG, management has assumed a cautious view with respect to any potential changes under new ownership. Finally, government reimbursements implemented in Europe to defray the cost of retaining inactive employees amid the pandemic are slated to expire in August, which may create near-term margin pressure if not extended.

Considering management’s near-term outlook, we lowered our top line projections for 2H ’20 and FY ’21, primarily reflecting more conservative expectations for a rebound in the IT Staffing segment. However, we increased our gross margin assumptions to account for both a higher mix of IT Solutions revenue and the efficiencies realized within the solutions business, which combined with a slight reduction in our operating expense assumptions, resulted in a modest uptick to our FY ’20 and FY ’21 adjusted EBITDA estimates.

Our report with model and disclosures is available here.

Disclosure(s):

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

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