Q4 Beat Caps Year of Stellar Execution
CTG, Inc. (CTG) reported Q4 ‘20 results above expectations. The beat relative to our model was attributable to robust IT Solutions growth as CTG completed a large go-live implementation and training project, captured year-end budget flushes in its infrastructure business and rode a favorable currency tailwind. In addition, the IT Staffing segment, which has been impacted more significantly by the COVID-19 pandemic and management’s disengagement from lower margin arrangements, exhibited strong sequential growth. With IT Solutions solidly over 40% of the revenue mix for the first time in nearly a decade and IT Staffing margins up materially on both a sequential and Y/Y basis, both adjusted EBITDA and non-GAAP EPS exceeded our estimates and consensus.
After successfully navigating through the depths of the pandemic, we assumed management would return to issuing guidance at least on a quarterly basis. Instead, management opted for more qualitative commentary, indicating that the company expects solid revenue growth in FY ‘21. Considering the upside in Q4 drove FY ’20 revenue to within striking distance of our current year projection, management’s outlook suggests our prior estimates and consensus may have been conservative. As for margins, CTG made significant strides over the past year but still sees room for expansion in FY ’21. Given that we assumed only a nominal uptick in margins this year, management’s comments again point to higher expectations.
Near-term, management appears undaunted by the completion of a large project and budget flush activity in Q4, noting that revenue per billable day is expected to hold. In addition to ongoing initiatives to support remote work, automated testing and help desk services that have fueled the solutions business in recent quarters, CTG has been awarded the first of a potential series of engagements to rapidly deploy and manage help desk solutions related to a healthcare provider’s COVID-19 vaccine efforts. We raise our revenue estimates accordingly for this year and next, reflecting higher expectations for the solutions business. As management teased the imminent launch of major new initiatives to capitalize on accelerating demand for digital transformation and has consistently emphasized the need to invest in sales and business development, we assume much of the incremental revenue is reinvested in sales and marketing. Thus, our adjusted EBITDA and non-GAAP EPS estimates increase more modestly for this year and next. Applying an unchanged FY ’21 EV/EBITDA multiple of 6x to our revised estimates yields an increase in our price target from $8.25 to $8.75. We believe CTG’s progress in re-orienting its business towards higher growth and higher margin opportunities associated with its digital transformation solutions remains underappreciated by the market, and we continue to see significant upside in shares as the strategic benefits become more apparent.
Exhibit I: Reported Results Versus Expectations
Revenues of $101.3 million (+2.0% Y/Y) exceeded our estimate of $93.9 million and consensus of $93.7 million. The upside relative to our model stemmed mostly from an acceleration in IT Solutions growth, although IT Staffing revenue also outpaced our projection. In this regard, IT Solutions revenue was $42.8 million (+12.7% Y/Y) versus our $37.3 million projection, while IT Staffing revenue was $58.6 million (-4.6% Y/Y) compared to our $56.6 million estimate. Management attributed the strong solutions performance to the completion of a go-live implementation and training project for a large healthcare system in the U.S., strong demand for infrastructure solutions as customers utilized their remaining budgets for the year and a favorable currency tailwind. While still down from the prior year, the staffing business grew sequentially on increased spending by CTG’s largest customer and the easing of some COVID-related restrictions between the summer and holiday seasons.
Gross margin expanded by 90 basis points from the year-ago period to 21.3% but was short of our 21.7% assumption due to the mix of services within the solutions segment. By segment, IT Solutions gross margin was 25.9% compared to 26.6% a year ago, and IT Staffing gross margin was 18.0% versus 16.5% in Q4 ‘19. Selling, general and administrative expenses of $18.3 million were a hair higher than our $18.1 million estimate. Reflecting the upside in revenue, both adjusted EBITDA of $4.7 million (4.7% margin) and non-GAAP EPS of $0.14 exceeded our estimates of $3.9 million and $0.12, respectively.
Exhibit II: Estimate Revisions
Management again refrained from providing any guidance due to the ongoing pandemic but indicated that CTG anticipates solid growth in FY ’21 along with continued margin expansion. We raised our revenue estimates across our forecast horizon, primarily reflecting higher expectations for the IT Solutions segment. We continue to anticipate gross margin expansion in this year and next as the revenue mix skews more towards the higher margin solutions business. Reflecting management’s plans to invest further in sales and business development and to incorporate expectations for a gradual return in travel and marketing spend during the latter part of FY ‘21, we raised our operating expense estimates. This in turn limited the flow through of higher revenues to our adjusted EBITDA and non-GAAP EPS estimates, although both moved higher for FY ’21 and FY ’22.
Our report with model and disclosures is available here.
Disclosure(s):
K. Liu & Company LLC has received compensation from CTG, Inc. (CTG) in the past 12 months for “Sponsored Research.”
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