Reports Solid Q3 '21 Results and Provides Strong Q4 Outlook

CTG’s Q3 ’21 performance unfolded largely as we anticipated. Similar to last quarter, earnings beat despite a modest revenue shortfall, which was driven by management’s ongoing efforts to dis-engage from lower margin staffing business. As in the prior quarter, the impact of reduced staffing revenue was mitigated by slightly higher IT solutions revenue accompanied by higher gross margin. Additionally, operating expenses were also lower than we projected, contributing to the upside in both adjusted EBITDA and non-GAAP EPS. As for other puts-and-takes in the quarter, revenue in Europe was flattish Y/Y after robust growth in 1H, primarily reflecting a return to more normal seasonality as pandemic-related restrictions continue to ease and significantly reduced levels of government assistance relative to the year ago period. That said, utilization is expected to rebound in Q4 and support continued business momentum in the region. Per management, the pipeline of opportunities also remains solid and continues to grow, reflecting an increase in business transformation projects with existing clients. Although the conversion of pipeline into new contracted business remains below pre-pandemic rates, the pace of new wins has continued to improve relative to recent quarters.

For Q4, management provided formal guidance for the first time since the onset of the COVID-19 pandemic, calling for revenue of $110.0-$115.0 million and non-GAAP EPS of $0.16-$0.18. Guidance on both the top and bottom lines reflects markedly higher growth on both a sequential and Y/Y basis and compares favorably with our estimates and consensus heading into the print. The upside is primarily attributable to a previously announced large, multi-million dollar Epic implementation project, which is slated to go-live in the current quarter. In our view, management’s guidance leaves ample room for incremental investments to support growth in FY ’22 and beyond as well as another potential beat on the bottom line.

We raised our estimates for Q4 and FY ‘21. Beyond Q4, we lowered our FY ’22 revenue projections to reflect more conservative assumptions for the staffing segment, partially offset by a modest uptick in our forecast for solutions growth. Importantly, our FY ’22 margin and profitability expectations increased slightly due to the higher mix of solutions revenue. We also introduced our FY ’23 projections, which assume an IT Solutions mix above 50% throughout the year but leave both solutions revenue and adjusted EBITDA below management’s 2023 aspirations for $250 million and $35 million, respectively, as we suspect an acquisition will be necessary to achieve those targets. Our price target increases from $13.00 to $13.50 based on an unchanged FY ’22 EV/EBITDA multiple of 8x. We continue to see significant upside in shares as CTG makes further progress in its transformation.

Exhibit I: Reported Results Versus Expectations

Q3 revenue of $90.6 million (+2.2% Y/Y) was just shy of our $90.9 million estimate and consensus of $91.2 million. The slight shortfall relative to our model was solely attributable to the IT and Other Staffing segment, which generated revenue of $49.3 million (-4.6% Y/Y) versus our estimate of $49.8 million. Much like last quarter, CTG disengaged from additional lower margin staffing opportunities as management continues to focus on growth in higher margin digital solutions services. In this regard, the IT Solutions segment produced revenue of $41.3 million (+11.7% Y/Y), which was a touch higher than our $41.1 million projection. Although still below pre-pandemic levels, management again indicated that pipeline conversion rates improved as existing customers move forward with business transformation initiatives. Headcount at quarter-end was approximately 3,600, of which 90% are billable, and was down from 3,750 last year and 3,650 in Q2.

Reflecting a higher mix of solutions revenue, gross margin was 22.4% versus our 22.0% assumption. By segment, IT Solutions gross margin was 31.8% compared to 33.3% a year ago, and IT and Other Staffing gross margin was 14.5% versus 14.0% in Q3 ‘20. The decline in IT Solutions gross margin reflects a return to more typical seasonality in Europe as well as the lapse of government assistance programs present in the year ago period, while the expansion in staffing gross margin coincides with management’s willingness to walk away from lower margin engagements. Operating expenses of $17.6 million were lower than our $18.1 million estimate. As a result, both adjusted EBITDA of $3.7 million and non-GAAP EPS of $0.13 were ahead of our $3.5 million and $0.09 estimates, respectively, and the Street’s $3.6 million and $0.11. Cash at quarter-end totaled $31.1 million, and CTG had no debt outstanding.

For Q4, management’s guidance calls for revenue of $110.0-$115.0 million and non-GAAP EPS of $0.16-$0.18. Prior to revisions, we were projecting revenue and non-GAAP EPS of $100.2 million and $0.17, respectively, and consensus stood at $101.3 million and $0.17. The upside on the top line primarily reflects the anticipated go-live of a significant, multi-million dollar Electronic Health Record implementation currently underway at a sizeable healthcare client. Although management’s guidance on the bottom line suggests limited flow-through from the revenue upside, we surmise the outlook incorporates a degree of conservatism to allow for incremental investments in growth and another potential beat when all is said and done.

Exhibit II: Estimate Revisions

Our Q4 revenue estimate moves higher to reflect the anticipated contribution from the Epic go-live, while our adjusted EBITDA and non-GAAP EPS estimates remain relatively unchanged due to a lower gross margin assumption and higher investments to support future growth. As for next year, we lower our revenue projection slightly on more conservative assumptions for the staffing business but increase our margin and profitability expectations to reflect a higher mix of digital solutions revenue. We also introduce our FY ’23 estimates, which include revenue of $417.0 million (+6.4% Y/Y) and adjusted EBITDA of $29.6 million (7.1% margin).

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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