CTG’s Q1 ’23 results were mixed relative to our estimates and below consensus, which we previously noted in our “Q1 ’23 Earnings Preview” was comprised of just one other set of estimates that skewed too high for the quarter. Relative to our model, revenue outperformed as a stronger than expected performance in Europe more than offset slightly lower revenues elsewhere. As we had anticipated a slower start to the year in Europe due to wage inflation and the potential impact on new project starts, we were pleasantly surprised to see solid sequential growth. While revenue in the North America IT Solutions and Services segment was a tad shy of our forecast, the segment still exhibited strong double-digit growth Y/Y and contributed meaningfully to what management characterized as the second strongest bookings quarter in the past five years. Among other deals, CTG signed a two-year project expected to generate revenue of $20 million and booked nearly $100 million in total IT Solutions and Services engagements in Q1. Moving down the P&L, gross margin fell short of our assumption due to the higher mix of revenue from Europe, while operating expenses ran higher as CTG hired opportunistically across its sales, solutions delivery and marketing teams. As a result, adjusted EBITDA missed our estimate while non-GAAP EPS were in line due to favorable comparisons below the operating income line.

Given the strong bookings performance to start the year, management raised its FY ’23 expectations for revenue from the core IT Solutions and Services segments. However, the company has also dis-engaged from additional non-strategic staffing assignments. All told, management narrowed its prior FY ’23 revenue guidance but left the midpoint unchanged. Despite the more favorable revenue mix, management reduced the high-end of its FY ’23 non-GAAP EPS guidance to reflect the outsized hiring in Q1, resulting in a $0.02 decline at the midpoint. More importantly, management reaffirmed its prior expectations for a 7% adjusted EBITDA margin exiting the year and introduced a 10% adjusted EBITDA margin target exiting 2025.

We trimmed our FY ’23 estimates slightly to reflect lower revenues from the Non-Strategic Technology Services segment, a more conservative assumption for gross margin expansion and higher operating expenses. While we made a similar top line adjustment in our FY ’24 projections, we note that our adjusted EBITDA and non-GAAP EPS estimates move up slightly to reflect a more favorable mix of revenues and better leverage of operating expenses. Reflecting the decline in our near-term expectations, our price target falls from $9.50 to $8.25 based on an unchanged FY ’23 EV/EBITDA multiple of approximately 6x. Regardless, we are encouraged by the budding momentum in the core IT Solutions and Services segments and are increasingly confident in CTG’s ability to reaccelerate growth while expanding margins materially in the years to come.

Exhibit I: Reported Results and Guidance Versus Expectations

*Sources: CTG; K. Liu & Company LLC; FactSet Estimates*

Q1 revenue of $78.2 million (-12.5% Y/Y) was above our estimate of $75.5 million. The revenue decline reflected management’s ongoing dis-engagement from Non-Strategic Technology Services, slightly offset by a modest uptick in IT Solutions and Services revenue. Relative to our model, higher than expected revenue from the Europe IT Solutions and Services segment more than offset slightly lower revenue from the rest of the business. By segment, North America IT Solutions and Services revenue was $23.2 million (+13.5% Y/Y) versus our estimate of $25.0 million; Europe IT Solutions and Services revenue was $40.1 million (-5.6% Y/Y) versus our estimate of $35.2 million; and Non-Strategic Technology Services revenue was $14.9 million (-43.7% Y/Y) versus our estimate of $15.4 million. More importantly, CTG closed nearly $100 million in global IT bookings during Q1, including a two-year engagement with a North American healthcare client expected to generate $20 million in revenue. Headcount at quarter-end was approximately 3,050, of which 85% represented billable resources.

Gross margin of 25.7% was below our 26.8% assumption, primarily due to a higher mix of revenue from the Europe IT Solutions and Services segment than we assumed. By segment, gross margin was 38.7% in the North America IT Solutions and Services segment versus our 39.0% assumption; 23.3% in the Europe IT Solutions and Services segment compared to our 24.0% assumption; and 12.3% in the Non-Strategic Technology Services segment versus our 13.6% assumption. Operating expenses of $19.4 million were slightly above our $19.2 million forecast due to opportunistic hires to support long-term growth. Adjusted EBITDA of $2.8 million fell short of our $3.3 million projection, but non-GAAP EPS of $0.08 were still in line with our estimate due to lower interest and other expenses as well as a modestly lower tax rate than we modeled.

In Q1, CTG used $2.6 million in operating cash flow and had $0.7 million in capital expenditures. The company exited Q1 with $23.1 million in cash and $1.4 million in debt.

As for the outlook, management narrowed its prior FY ’23 revenue guidance from $300.0-$350.0 million to $310.0-$340.0 million, leaving the midpoint unchanged and slightly above our prior estimate and consensus. The revised revenue guidance now assumes a higher level of IT Solutions and Services revenue offset by an uptick in dis-engagement from lower margin non-strategic services. Due to the opportunistic hiring to start the year, management lowered the high-end of its prior non-GAAP EPS guidance, which now calls for $0.56-$0.64 and reflects a decline of $0.02 at the midpoint. Management also reaffirmed its prior expectations to achieve a 7% adjusted EBITDA margin exiting the year and guided for a 10% margin by the end of 2025.

Exhibit II: Estimate Revisions

We reduced our FY ’23 estimates to reflect lower revenues from non-strategic staffing customers, a more gradual improvement in gross margin for the Europe IT Solutions and Services segment and higher operating expenses. For FY ’24, our revenue estimate also declined as we assumed a faster fall-off in non-core revenues but our adjusted EBITDA and non-GAAP EPS estimates move higher due to a more favorable revenue mix and better leverage of operating expenses.

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.”

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.

Mixed Q1 Results Belie Strength in Bookings

Company

Support