Reports Strong Finish to FY '21 and Issues Guidance for FY '22

CTG reported strong Q4 ’21 results, delivering adjusted EBITDA and non-GAAP EPS well above expectations on an in-line revenue performance. Relative to our model, the outperformance was attributable to higher contribution margin from a large Epic implementation go-live engagement than we had assumed. Although a change in CTG’s reporting segments makes for less relevant comparisons to our estimates, we believe strength in the North America IT Solutions and Services segment more than offset omicron and FX-related headwinds in the Europe IT Solutions and Services segment as well as ongoing declines in the Non-Strategic Technology Services segment. As a result, gross margin was comfortably ahead of our assumption and more than offset higher operating expenses than we modeled. Worth noting, the improved profitability of the North American business also prompted the reversal of a deferred tax asset valuation allowance, which boosted EPS on a GAAP basis. Even absent the tax benefit, however, CTG easily beat expectations on the bottom line.

Looking to the new year, management acknowledged that the Epic engagement in Q4 presents a difficult comparison as no projects of that scale are anticipated in FY ’22. Additionally, revenue from the Non-Strategic Technology Services segment will decline further, consistent with CTG’s strategic approach to disengage from lower margin staffing services. All told, these factors represent a $25-$30 million headwind to revenue, which management guided to $375-$395 million for FY ’22. While the midpoint of management’s revenue guidance implies a slight Y/Y decline, guidance for non-GAAP EPS of $0.64-$0.72 still reflects growth in FY ’22. Prior to revisions, both our estimates and consensus were near the high-end of the guided ranges. Beyond the current year, management anticipates achieving an adjusted EBITDA margin of 7%-8% by the end of FY ’23 driven in part by mid- to high-single digit organic growth in the IT Solutions and Services segments. Between the new segment disclosures and longer-term outlook, we believe there is now greater clarity into how management intends to deliver on its 2023 Vision target of $35 million in adjusted EBITDA.

Reflecting slightly lower organic growth assumptions for the two IT Solutions and Services segments, we reduced our revenue estimates for FY ’22 and FY ‘23. Although an uptick in our gross margin assumptions mitigated some of the impact, our adjusted EBITDA estimates also decline in concert. Applying an unchanged FY ’22 EV/EBITDA multiple of 8x to our revised estimates, our price target falls slightly from $13.50 to $13.00. Although our forecasts move down some, our confidence in CTG’s ability to execute against these targets is far greater, and we still anticipate significant upside in the stock as the market comes to appreciate CTG’s strategic transformation.

Exhibit I: Reported Results Versus Expectations

Sources: CTG; K. Liu & Company LLC; IBES Estimates

Q4 revenue of $112.4 million (+10.9% Y/Y) was in line with our estimate of $112.3 million and consensus of $112.7 million. As for the details, we note that CTG introduced three new reporting segments this quarter: North America IT Solutions and Services, Europe IT Solutions and Services and Non-Strategic Technology Services. Although the new structure makes any comparisons to our prior estimates a bit moot, we note that the new disclosures provide more transparency into the potential revenue headwind from CTG’s shift away from lower margin staffing engagements as well as greater insight into the margin benefits to be realized as the North American business gains scale. By segment, revenue from the North America IT Solutions and Services segment was $45.1 million, more than doubling from last year due to the large Epic implementation project, which generated in excess of $20 million in revenue in Q4. Revenue from the Europe IT Solutions and Services segment was $40.1 million (-8.6% Y/Y) and was negatively impacted by both FX and lower utilization rates arising from omicron-related illness. Non-Strategic Technology Services revenue was $27.2 million (-22.3% Y/Y), reflecting management’s ongoing efforts to disengage from lower margin arrangements. Headcount at quarter-end was approximately 3,450, of which 90% represented billable resources, and was down from 3,900 last year and 3,600 in Q3.

Gross margin was 22.3%, comfortably ahead of our 19.8% assumption as the large Epic project generated higher contribution margin than we had anticipated. By segment, gross margin from the North American and European IT Solutions segments were 29.4% and 22.0%, respectively, compared to 35.9% and 22.1% in the year-ago period. Gross margin in the Non-Strategic Technology Services segment was 10.8% versus 11.0% last year. Operating expenses of $19.9 million exceeded our $18.7 million forecast but both adjusted EBITDA of $6.5 million and non-GAAP EPS of $0.25 easily topped our estimates and consensus due to the strong gross margin performance. In Q4, CTG generated $5.7 million in free cash flow and ended the year with $35.6 million in cash and no debt.

For FY ‘22, management’s guidance calls for revenue of $375.0-$395.0 million and non-GAAP EPS of $0.64-$0.72. Prior to revisions, we were projecting revenue and non-GAAP EPS of $392.1 million and $0.73, respectively, while consensus stood at $397.0 million and $0.71. Per management, the completion of the Epic go-live implementation engagement in Q4 and ongoing declines in the Non-Strategic Technology Services segment represent a $25.0-$30.0 million headwind for the year. Near-term, revenue in Q1 is expected to be down slightly Y/Y and represent the lowest level for the year. Both our revenue estimate and the Street’s for Q1 reflected flat to modest growth. Finally, management also cited expectations for CTG’s adjusted EBITDA margin to expand from 4.6% in FY 21 to 7.0%-8.0% over the next two years. Our prior FY ’23 estimates reflected the low-end of that range but assumed organic growth in the low double-digits versus management’s target of mid- to high-single digit growth in its core IT Solutions and Services segments.

Exhibit II: Estimate Revisions

Source: K. Liu & Company LLC

We lower our revenue estimates for FY ’22 and FY ’23 to reflect slightly lower organic growth expectations. Although our gross margin assumptions move higher to reflect strong contribution from the North America IT Solutions and Services segment and a rebound in Europe, the reduction in our top line estimates also prompted a cut to our adjusted EBITDA and non-GAAP EPS projections. We note that our FY ’23 adjusted EBITDA margin sits just below 7.0%, leaving room for potential upside should CTG achieve its stated targets.

Our report with model and disclosure 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.”

Sponsored Research produced by the firm is paid for by the subject company in the form of an initial retainer and a recurring monthly fee. The analysis and recommendations in our Sponsored Research reports are derived from the same process and methodologies utilized in all of our research reports whether sponsored or not. The subject company does not review any aspect of our Sponsored Research reports prior to publication.