10-K 1 ctgx201210-k.htm 10-K CTGX 2012 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition period from                      to                    
Commission File No. 1-9410
COMPUTER TASK GROUP, INCORPORATED
(Exact name of registrant as specified in its charter)
New York
 
16-0912632
(State of incorporation)
 
(I.R.S. Employer Identification No.)
800 Delaware Avenue, Buffalo, New York
 
14209
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (716) 882-8000
 
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, $.01 par value
 
The NASDAQ Stock Market LLC
Rights to Purchase Series A
Participating Preferred Stock
 
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ¨    NO  x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
Accelerated filer
x
 
 
 
 
Non-accelerated filer
¨ (Do not  check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    YES  ¨    NO  x
The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates, computed by reference to the price at which the common equity was last sold on the last business day of the registrant’s most recently completed second quarter was $209.1 million. Solely for the purposes of this calculation, all persons who are or may be executive officers or directors of the registrant have been deemed to be affiliates.
The total number of shares of Common Stock of the Registrant outstanding at February 8, 2013 was 18,767,505.
DOCUMENTS INCORPORATED BY REFERENCE
Certain sections of the Company’s definitive proxy statement to be filed with the Securities and Exchange Commission (SEC) within 120 days of the end of the Company’s fiscal year ended December 31, 2012, are incorporated by reference into Part III hereof. Except for those portions specifically incorporated by reference herein, such document shall not be deemed to be filed with the SEC as part of this annual report on Form 10-K.




SEC Form 10-K Index
 
Section
 
Page
Part I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Part II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
Part III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Part IV
 
Item 15.



As used in this annual report on Form 10-K, references to “CTG,” “the Company” or “the Registrant” refer to Computer Task Group, Incorporated and its subsidiaries, unless the context suggests otherwise.
PART I
Forward-Looking Statements
This annual report on Form 10-K contains forward-looking statements made by the management of Computer Task Group, Incorporated (CTG, the Company or the Registrant) that are subject to a number of risks and uncertainties. These forward-looking statements are based on information as of the date of this report. The Company assumes no obligation to update these statements based on information from and after the date of this report. Generally, forward-looking statements include words or phrases such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “projects,” “could,” “may,” “might,” “should,” “will” and words and phrases of similar impact. The forward-looking statements include, but are not limited to, statements regarding future operations, industry trends or conditions and the business environment, and statements regarding future levels of, or trends in, revenue, operating expenses, capital expenditures, and financing. The forward-looking statements are made pursuant to safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Numerous factors could cause actual results to differ materially from those in the forward-looking statements, including the following: (i) the availability to CTG of qualified professional staff, (ii) domestic and foreign industry competition for customers and talent, (iii) the Company's ability to protect confidential client data (iv) the partial or complete loss of the revenue the Company generates from International Business Machines Corporation (IBM), (v) risks associated with operating in foreign jurisdictions, (vi) renegotiations, nullification, or breaches of contracts with customers, vendors, subcontractors or other parties, (vii) the change in valuation of recorded goodwill balances, (viii) the impact of current and future laws and government regulation, as well as repeal or modification of such, affecting the information technology (IT) solutions and staffing industry, taxes and the Company's operations in particular, (ix) industry and economic conditions, including fluctuations in demand for IT services, (x) consolidation among the Company's competitors or customers, (xi) the need to supplement or change our IT services in response to new offerings in the industry, and (xii) the risks described in Item 1A of this annual report on Form 10-K and from time to time in the Company's reports filed with the Securities and Exchange Commission (SEC).

Item 1.
Business

Overview
CTG was incorporated in Buffalo, New York on March 11, 1966, and its corporate headquarters are located at 800 Delaware Avenue, Buffalo, New York 14209 (716-882-8000). CTG is an IT solutions and staffing services company with operations in North America and Europe. CTG employs approximately 3,900 people worldwide. During 2012, the Company had six operating subsidiaries: Computer Task Group of Canada, Inc., providing services in Canada; and Computer Task Group Belgium N.V., CTG ITS S.A., Computer Task Group IT Solutions, S.A., Computer Task Group Luxembourg PSF, and Computer Task Group (U.K.) Ltd., each primarily providing services in Europe. Services provided in North America are primarily performed by CTG.
Services
The Company operates in one industry segment, providing IT services to its clients. These services include IT Solutions and IT Staffing. CTG provides these primary services to all of the markets that it serves. The services provided typically encompass the IT business solution life cycle, including phases for planning, developing, implementing, managing, and ultimately maintaining the IT solution. A typical customer is an organization with large, complex information and data processing requirements. The Company’s IT Solutions and IT Staffing services are further described as follows:

IT Solutions: CTG’s services in this area include helping clients assess their business needs and identifying the right IT solutions to meet these needs. The delivery of services includes the selection and implementation of packaged software and the design, development, testing, and integration of new systems, and the development and implementation of customized software and solutions designed to fit the needs of a specific client or vertical market.
Generally, IT Solutions services include taking responsibility for the service related deliverables on a project and may include high-end consulting services. CTG has significant experience in implementing electronic medical records (EMR) systems in integrated delivery networks and other provider organizations. CTG’s

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experience in supporting EMR systems and the formation of Health Information Exchanges (HIEs) favorably positions the Company as demand for these services is expected to remain strong in future years. Additionally, the Company continues to provide services to assist in the start-up and development of HIEs. HIEs are consortiums of providers, payers, and government agencies at the local level that are charged with implementing secure community-wide electronic medical records.
Also included within IT Solutions is Transitional Application Management (TAM). In 2012, the healthcare market accounted for most of CTG’s TAM business. In a TAM engagement, the client hires CTG to manage an existing application for an extended time period, typically ranging from one to three years, while its internal IT staff focuses on implementation of a new application replacing the application being phased out. Additionally, CTG’s services in this area could include outsourcing support of single or multiple applications and help desk functions. Depending on client needs, these engagements are performed at client or CTG sites.
In 2012, CTG continued to invest in new IT Solutions development, primarily targeted to the healthcare market, which supports cost reductions and productivity improvements. In 2011 and 2012, several healthcare solutions under development moved from the pilot stage of testing using live data into the sales process as completed tools. These solutions include medical fraud, waste, and abuse detection and reduction, medical care and disease management. The Company has developed proprietary software to support these offerings which expands the potential market for sale and support of these solutions. These solutions support both the healthcare provider and payer markets.

IT Staffing: CTG recruits, retains, and manages IT talent for its clients, which are primarily large technology service providers and companies with multiple locations and significant need for high-volume external IT resources. The Company also supports larger companies and organizations that need to augment their own IT staff on a flexible basis. Our clients may require the services of our IT talent on a temporary or long-term basis. Our IT professionals generally work with the client’s internal IT staff at client sites. Our recruiting organization works with customers to define their staffing requirements and develop competitive pricing to meet those requirements.
The primary focus of the Company’s staffing business is a managed services model that provides large clients with higher value support through cost-effective supply models customized to client needs, resource management support, vendor management programs, and a highly automated recruiting process and system with global reach.
Independent software testing is a common practice in Western Europe and represents a significant portion of the IT staffing business of CTG’s European operations. This comprehensive testing offering supports IT environments across multiple industries.
A trend affecting the staffing industry in recent years is that large users of external technology support are reducing their number of approved suppliers to fewer firms with a preference for those firms able to fulfill high volume requirements at competitive rates and to locate resources with specialized skills on a national level. CTG’s staffing business model fits this profile and it has consistently remained a preferred provider with large technology service providers and users that have reduced their lists of approved IT staffing suppliers.
IT solutions and staffing revenue as a percentage of total revenue for the years ended December 31, 2012, 2011 and 2010 is as follows:
 
 
2012
 
2011
 
2010
IT solutions
41
%
 
37
%
 
34
%
IT staffing
59
%
 
63
%
 
66
%
Total
100
%
 
100
%
 
100
%
In recent years, a major strategic focus of the Company has been to increase the amount of revenue from its IT solutions business, and the percentage of IT solutions revenue to total revenue, as operating margins generated by the IT solutions business are generally significantly higher than those of the IT staffing business. Overall, the Company’s revenue increased $28.1 million or 7.1% from 2011 to 2012 due to the continuing strong demand for the Company’s IT solutions services. The higher margin IT solutions business increased $26.4 million or 17.9% from 2011 to 2012, while IT staffing services increased $1.8 million or 0.7% in the same period. The Company’s

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operating margin in 2012 was 5.8%, which was the highest level for the Company since 1999. The Company’s operating margin was 4.9% in 2011, and was 4.2% in 2010.
Vertical Markets
The Company promotes a majority of its services through four vertical market focus areas: Healthcare (which includes services provided to healthcare providers, health insurers (payers), and life sciences companies), Technology Service Providers, Financial Services, and Energy. The remainder of CTG’s revenue is derived from general markets.
CTG’s revenue by vertical market for the years ended December 31, 2012, 2011 and 2010 is as follows:
 
 
2012
 
2011
 
2010
Healthcare
33
%
 
30
%
 
27
%
Technology service providers
31
%
 
34
%
 
36
%
Financial services
6
%
 
7
%
 
6
%
Energy
6
%
 
6
%
 
7
%
General markets
24
%
 
23
%
 
24
%
Total
100
%
 
100
%
 
100
%
The Company’s growth efforts are primarily focused in the healthcare market based on its leading position in serving the provider market, its expertise and experience serving all segments of this market (providers, payers and life sciences companies), higher demand for solutions offerings and support from healthcare companies, and the greater relative strength of this sector due to higher demand compared with other sectors of the U.S. economy. The Company’s healthcare revenue increased $21.6 million or 18.4% from 2011 to 2012 primarily due to a significant increase in demand for new healthcare related solutions projects, including those related to EMR projects. Revenue from the provider market was very strong in 2012 due to U.S. Federal government legislation which provides funding for EMRs, and the continued improvement in the U.S. credit markets. Revenue from the payer market was also very strong from 2011 to 2012, while revenue from the life sciences market decreased year-over-year as life sciences companies in the U.S. continue to limit spending on discretionary IT projects due to the challenging overall economic environment. Accordingly, as revenue from the Company’s targeted EMR market was strong in 2012, this caused the percentage of revenue for the healthcare vertical market as compared with consolidated revenue to increase from 27% in 2010, to 30% in 2011, and then to 33% in 2012.
Revenue for the Company's technology service providers vertical market decreased slightly in 2012 as compared with 2011 due to sluggish demand in this vertical market. The percentage of total revenue for this vertical market declined in 2012 as compared with 2011 due to the significant growth in the Company's healthcare vertical market. The Company’s technology service provider customers cut back significantly in 2009 due to the global economic recession, and CTG believes the growth the Company experienced in 2010 and 2011 in this vertical market was much higher than normal due to customers' efforts to backfill for those positions cut in 2009.
During 2012, the percentage of revenue attributable to the financial services market fell slightly from 2011 primarily due to the weakness of the Euro. In recent years, most of CTG’s revenue in the financial services market was generated from its European operations, totaling 96.6% of the Company’s 2012 revenue from the financial services vertical market. Revenue in this vertical market increased in 2011 from 2010 due to growth in IT staffing services in Europe. The 2011 growth was a reverse of a trend from 2010 as the financial services market to CTG’s total revenue declined in that year primarily as of result of greater use of offshore support and lower overall demand in this sector due to the global economic recession.
Revenue for the Company's energy vertical market remained consistent as a percentage of consolidated revenue in 2012 as compared with 2011 as modest demand fueled growth in this vertical market that kept pace with the overall revenue growth of the Company of approximately 7.1%.
At December 31, 2012, CTG provided IT services to approximately 400 clients in North America and Europe. In North America, the Company operates in the United States and Canada, with greater than 99% of 2012 North American revenue generated in the United States. In Europe, the Company operates in Belgium, Luxembourg, and the United Kingdom. Of total 2012 consolidated revenue of $424.4 million, approximately 84% was generated in

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North America and 16% in Europe, and only one client, International Business Machines Corporation (IBM), accounted for greater than 10% of CTG’s consolidated revenue in 2012, 2011, and 2010.
Pricing and Backlog
The Company recognizes revenue when persuasive evidence of an arrangement exists, when the services have been rendered, when the price is determinable, and when collectibility of the amounts due is reasonably assured. For time-and-material contracts, revenue is recognized as hours are incurred and costs are expended. For contracts with periodic billing schedules, primarily monthly, revenue is recognized as services are rendered to the customer. Revenue for fixed-price contracts is recognized as per the proportional method of accounting using an input-based approach whereby salary and indirect labor costs incurred are measured and compared with the total estimate of costs at completion for a project. Revenue is recognized based upon the percentage-of-completion calculation of total incurred costs to total estimated costs. The Company infrequently works on fixed-price projects that include significant amounts of material or other non-labor related costs which could distort the percent complete within a percentage-of-completion calculation. The Company’s estimate of the total labor costs it expects to incur over the term of the contract is based on the nature of the project and its past experience on similar projects, and includes management judgments and estimates which affect the amount of revenue recognized on fixed-price contracts in any accounting period.

The Company’s revenue from contracts accounted for under time-and-material, progress billing, and percentage-of-completion methods for the years ended December 31, 2012, 2011 and 2010 is as follows:
 
 
2012
 
2011
 
2010
Time-and-material
90
%
 
91
%
 
91
%
Progress billing
8
%
 
7
%
 
6
%
Percentage-of-completion
2
%
 
2
%
 
3
%
Total
100
%
 
100
%
 
100
%
As of December 31, 2012 and 2011, the backlog for fixed-price and all managed-support contracts was approximately $35.7 million and $34.4 million, respectively. Approximately 77.6% or $27.7 million of the December 31, 2012 backlog is expected to be earned in 2013. Of the $34.4 million of backlog at December 31, 2011, approximately 69.1%, or $23.8 million was earned in 2012. Revenue is subject to slight seasonal variations, with a minor slowdown in months of high vacation and legal holidays (July, August, and December). Backlog does not tend to be seasonal; however, it does fluctuate based upon the timing of entry into long-term contracts.
Competition
The IT services market, for both IT solutions and IT staffing services, is highly competitive. The market is also highly fragmented with many providers and no single competitor maintaining clear market leadership. Competition varies by location, the type of service provided, and the customer to whom services are provided. The Company’s competition comes from four major channels: large national or international vendors, including major accounting and consulting firms; hardware vendors and suppliers of packaged software systems; small local firms or individuals specializing in specific programming services or applications; and from a customer’s internal IT staff. CTG competes against all four of these channels for its share of the market. The Company believes that to compete successfully it is necessary to have a local geographic presence, offer appropriate IT solutions, provide skilled professional resources, and price its services competitively.
CTG has implemented a Global Management System, with the goal to achieve continuous, measured improvements in services and deliverables. As part of this program, CTG has developed specific methodologies for providing high value services that result in unique solutions and specified deliverables for its clients. The Company believes these methodologies will enhance its ability to compete. CTG initially achieved worldwide ISO 9001:1994 certification in June 2000. CTG received its worldwide ISO 9001:2000 certification in January 2003. The Company believes it is the only IT services company of its size to achieve worldwide certification.
Intellectual Property
The Company has registered its symbol and logo with the U.S. Patent and Trademark Office and has taken steps to preserve its rights in other countries where it operates. We regard patents, trademarks, copyrights and other intellectual property as important to our success, and we rely on them in the United States and foreign

4


countries to protect our investments in products and technology. Our patents expire at various times, but we believe that the loss or expiration of any individual patent would not materially affect our business. We, like any other company, may be subject to claims of alleged infringement of the patents, trademarks and other intellectual property rights of third parties from time to time in the ordinary course of business. CTG has entered into agreements with various software and hardware vendors from time to time in the normal course of business, and has capitalized certain costs under software development projects.
Employees
CTG’s business depends on the Company’s ability to attract and retain qualified professional staff to provide services to its customers. The Company has a structured recruiting organization that works with its clients to meet their requirements by recruiting and providing high quality, motivated staff. The Company employs approximately 3,900 employees worldwide, with approximately 3,300 in the United States and Canada and 600 in Europe. Of these employees, approximately 3,500 are IT professionals and 400 are individuals who work in sales, recruiting, delivery, administrative and support positions. The Company believes that its relationship with its employees is good. No employees are covered by a collective bargaining agreement or are represented by a labor union. CTG is an equal opportunity employer.
Financial Information Relating to Foreign and Domestic Operations
The following table sets forth certain financial information relating to the performance of the Company for the years ended December 31, 2012, 2011, and 2010. This information should be read in conjunction with the audited consolidated financial statements and notes thereto included in Item 8, “Financial Statements and Supplementary Data” included in this report.
 
 
2012
 
2011
 
2010
(amounts in thousands)
 
 
 
 
 
Revenue from External Customers:
 
 
 
 
 
United States
$
355,022

 
$
328,422

 
$
269,071

       Belgium (1)
41,957

 
43,011

 
41,317

Other European countries
26,653

 
23,969

 
19,396

Other country
783

 
873

 
1,623

Total revenue
$
424,415

 
$
396,275

 
$
331,407

Operating Income:
 
 
 
 
 
United States
$
21,203

 
$
16,508

 
$
12,401

Europe
3,209

 
2,729

 
1,465

Other country
50

 
73

 
64

Total operating income
$
24,462

 
$
19,310

 
$
13,930

Total Assets:
 
 
 
 
 
United States
$
132,795

 
$
119,912

 
$
104,914

       Belgium (1)
18,908

 
15,148

 
13,326

Other European countries
14,211

 
12,133

 
11,575

Other country
291

 
299

 
458

Total assets
$
166,205

 
$
147,492

 
$
130,273

 
(1)
Revenue and total assets for Belgium have been disclosed separately as they exceed 10% of the consolidated balances in certain of the years presented.


5


Executive Officers of the Company
As of December 31, 2012, the following individuals were executive officers of the Company:
 
Name
Age

Office
Period During
Which Served
as Executive Officer
Other Positions
and Offices
with Registrant
James R. Boldt
61

Chairman, President and Chief Executive Officer
June 21, 2001 for President, July 16, 2001 for Chief Executive Officer, May 2002 for Chairman, all to date
Director
 
 
Executive Vice President
February 2001 to June 2001
 
 
 
Vice President, Strategic Staffing
December 2000 to September 2001
 
 
 
Acting Chief Executive Officer
June 2000 to November 2000
 
 
 
Vice President and Chief Financial Officer
February 12, 1996 to October 1, 2001
 
Michael J. Colson
50

Senior Vice President
January 3, 2005 to date
None
Arthur W. Crumlish
58

Senior Vice President
September 24, 2001 to date
None
Filip J. L. Gydé
52

Senior Vice President
October 1, 2000 to date
None
Brendan M. Harrington
46

Senior Vice President, Chief Financial Officer
September 13, 2006 to date
None
 
 
Interim Chief Financial Officer
October 17, 2005 to September 12, 2006
None
Peter P. Radetich
58

Senior Vice President, General Counsel
April 28, 1999 to date
Secretary
Ted Reynolds
57

Vice President, Health Solutions
March 7, 2011 to date
None
Mr. Boldt was appointed President and joined CTG’s Board of Directors on June 21, 2001, and was appointed Chief Executive Officer on July 16, 2001. Mr. Boldt became the Company’s Chairman in May 2002. Mr. Boldt joined the Company as a Vice President and its Chief Financial Officer and Treasurer in February 1996.
Mr. Colson joined the Company as Senior Vice President of Solutions Development in January 2005. Prior to that, Mr. Colson was Chief Executive Officer of Manning and Napier Information Services, a software and venture capital firm, from September 1998 until the time he joined CTG.
Mr. Crumlish was promoted to Senior Vice President in September 2001, and is currently responsible for the Company’s Strategic Staffing Services organization. Prior to that, Mr. Crumlish was the Financial Controller of the Company’s Strategic Staffing Services organization. Mr. Crumlish joined the Company in 1990.
Mr. Gydé was promoted to Senior Vice President in October 2000, at which time he assumed responsibility for all of the Company’s European operations. Prior to that, Mr. Gydé was Managing Director of the Company’s Belgium operation. Mr. Gydé has been with the Company since May 1987.

Mr. Harrington was promoted to Senior Vice President and Chief Financial Officer on September 13, 2006.  Previously he was Interim Chief Financial Officer and Treasurer from October 17, 2005 to September 12, 2006.  Mr. Harrington joined the Company in February 1994 and served in a number of managerial financial positions in the Company’s corporate and European operations, including as the Director of Accounting since 2003, before being appointed Corporate Controller in May 2005.
Mr. Radetich joined the Company in June 1988 as Associate General Counsel, and was promoted to General Counsel and Secretary in April 1999.
Mr. Reynolds was promoted to Vice President for CTG Health Solutions in March 2011 and is currently responsible for CTG’s entire provider and payer related services.  Prior to that, Mr. Reynolds served as the

6


Company’s Client Services Executive for its Epic practice.  Mr. Reynolds joined CTG in 2006, and previously had approximately 30 years of experience in healthcare and IT.
Available Company Information
The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (Exchange Act), and reports pertaining to the Company filed under Section 16 of the Exchange Act are available without charge on the Company’s website at www.ctg.com as soon as reasonably practicable after the Company electronically files the information with, or furnishes it to, the SEC. The Company’s code of ethics, committee charters and governance policies are also available without charge on the Company’s website at http://investors.ctg.com/governance.cfm.


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Item 1A.
Risk Factors
The following risk factors should be read carefully in connection with evaluating our business and the forward-looking information contained in this Annual Report on Form 10-K. The risk factors below represent what we believe are the known material risk factors with respect to the Company and our business. Any of the following risks could materially adversely affect our business, our operations, the industry in which we operate, our financial position or our future financial results.
Our business depends on the availability of a large number of highly qualified IT professionals and our ability to recruit and retain these professionals.
We actively compete with many other IT service providers for qualified professional staff. The availability of qualified professional staff may affect our ability to provide services and meet the needs of our customers in the future. An inability to fulfill customer requirements at agreed upon rates due to a lack of available qualified staff may adversely impact our revenue and operating results in the future.
Increased competition and the bargaining power of our large customers may cause our billing rates to decline, which would have an adverse effect on our revenue and, if we are unable to control our personnel costs accordingly, on our margins and operating results.
We have experienced reductions in the rates at which we bill some of our larger customers for services during previous highly competitive market conditions. Additionally, we actively compete against many other companies for business with new and existing clients. Bill rate reductions or competitive pressures may lead to a decline in revenue or the rates we bill our customers for services. If we are unable to make commensurate reductions in our personnel costs, our margins and operating results in the future may be adversely affected.
Liability or damage to our reputation could arise if we fail to protect client and Company data or information systems as obligated by law or contract if our information systems are breached.
As a company operating in the IT and professional services industry, we are dependent on information technology networks and systems to process, transmit and store electronic information, and to communicate among our locations within the United States and around the world, as well as with our clients and vendors.  Although the Company has had no prior significant cyber incidents, and we believe the likelihood of the occurrence of such incidents is low, the breadth and complexity of our technological infrastructure increases the potential risk of security breaches.  Such breaches could lead to shutdowns or disruptions of our systems and potential unauthorized disclosure of confidential information such as protected health information (PHI) under the Health Insurance Portability and Accountability Act of 1996 (HIPAA).  The Company’s failure to protect PHI covered under HIPAA could result in fines and penalties which could have a material, adverse impact on us.
We derive a significant portion of our revenue from a single customer and a significant reduction in the amount of IT services requested by this customer would have an adverse effect on our revenue and operating results.
IBM is CTG’s largest customer. CTG provides services to various IBM divisions in many locations. During 2011, the National Technical Services Agreement (NTS Agreement) was renewed for three years until December 31, 2014. In 2012, 2011, and 2010, IBM accounted for $113.5 million or 26.7%, $116.5 million or 29.4%, and $102.3 million or 30.9% of the Company’s consolidated revenue, respectively. No other customer accounted for more than 10% of the Company’s revenue in 2012, 2011 or 2010. The Company’s accounts receivable from IBM at December 31, 2012 and 2011 amounted to $12.6 million and $12.8 million, respectively. If IBM were to significantly reduce the amount of IT services they purchase from the Company, our revenue and operating results would be adversely affected.

The currency exchange, legislative, tax, regulatory and economic risks associated with international operations could have an adverse effect on our operating results if we are unable to mitigate or hedge these risks.
We have operations in the United States and Canada in North America, and in Belgium, Luxembourg, and the United Kingdom in Europe. Although our foreign operations conduct their business in their local currencies, these operations are subject to their own currency fluctuations, legislation, employment and tax law changes, and economic climates. These factors as they relate to our foreign operations are different than those of the United States. Although we actively manage these foreign operations with local management teams, our overall operating

8


results may be negatively affected by local economic conditions, changes in foreign currency exchange rates, or tax, regulatory or other economic changes beyond our control.
Our customer contracts generally have a short term or are terminable on short notice and a significant number of failures to renew contracts, early terminations or renegotiations of our existing customer contracts could adversely affect our results of operations.
Our clients typically retain us on a non-exclusive, engagement-by-engagement basis, rather than under exclusive long-term contracts. We performed approximately 90% of our services on a time-and-materials basis during 2012. As such, our customers generally have the right to terminate a contract with us upon written notice without the payment of any financial penalty. Client projects may involve multiple engagements or stages, and there is a risk that a client may choose not to retain us for additional stages of a project, or that a client will cancel or delay additional planned engagements. These terminations, cancellations or delays could result from factors that are beyond our control and are unrelated to our work product or the progress of the project, but could be related to business or financial conditions of the client, changes in client strategies or the economy in general. When contracts are terminated, we lose the anticipated future revenue and we may not be able to eliminate the associated costs required to support those contracts in a timely manner. Consequently, our operating results in subsequent periods may be lower than expected. Our clients can cancel or reduce the scope of their engagements with us on short notice. If they do so, we may be unable to reassign our professionals to new engagements without delay. The cancellation or reduction in scope of an engagement could, therefore, reduce the utilization rate of our professionals, which would have a negative impact on our business, financial condition, and results of operations. As a result of these and other factors, our past financial performance should not be relied on as a guarantee of similar or better future performance. Due to these factors, we believe that our results from operations may fluctuate from period to period in the future.
A significant portion of our total assets consists of goodwill, which is subject to a periodic impairment analysis and a significant impairment determination in any future period could have an adverse effect on our results of operations even without a significant loss of revenue or increase in cash expenses attributable to such period.
We have goodwill recorded totaling approximately $35.7 million at December 31, 2012. At least annually, we evaluate this goodwill for impairment based on the fair value of the business operations to which this goodwill relates. This estimated fair value could change if there is a significant decrease in the enterprise value of CTG, if we are unable to achieve operating results at the levels that have been forecasted, the market valuation of transactions involving similar companies decreases which could occur given the economic downturn in recent years in the countries in which the Company operates, or there is a permanent, negative change in the market demand for the services offered by this business unit. These changes could result in an impairment of the existing goodwill balance that could require a material non-cash charge which would have an adverse impact on our results of operations.

Changes in government regulations and laws affecting the IT services industry, including accounting principles and interpretations, and the taxation of domestic and foreign operations could adversely affect our results of operations.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Patient Protection and Affordable Care Act (PPACA), and new SEC regulations, create uncertainty for companies such as ours. These new or updated laws, regulations and standards are subject to varying interpretations which, in many instances, is due to their lack of specificity. As a result, the application of these new standards and regulations in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, our efforts to comply with evolving laws, tax regulations and other standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. In particular, our continuing efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting and our independent auditors’ audit of internal control require the commitment of significant internal, financial and managerial resources.

9


The Financial Accounting Standards Board (FASB), the SEC, and the Public Company Accounting Oversight Board (PCAOB) or other accounting rule making authorities may issue new accounting rules or auditing standards that are different than those that we presently apply to our financial results. Such new accounting rules or auditing standards could require significant changes from the way we currently report our financial condition, results of operations or cash flows.
U.S. generally accepted accounting principles have been the subject of frequent changes in interpretations. As a result of the enactment of the Sarbanes-Oxley Act of 2002 and the review of accounting policies by the SEC as well as by national and international accounting standards bodies, the frequency of future accounting policy changes may accelerate. Such future changes in financial accounting standards may have a significant effect on our reported results of operations, including results of transactions entered into before the effective date of the changes.
The Company currently offers limited healthcare coverage to its hourly employees, which includes nearly half of its total employees. Under the PPACA, the Company will be required to offer healthcare coverage to those employees, or pay penalties currently totaling at least $2,000 per person. The Company intends to pass these additional costs on to its customers. However, in the event the Company is not able to pass some or all of these costs to its customers, the Company’s operating results could be significantly negatively impacted when the legislation goes into effect in 2014.
We are subject to income and other taxes in the United States (federal and state) and numerous foreign jurisdictions. Our provisions for income and other taxes and our tax liabilities in the future could be adversely affected by numerous factors. These factors include, but are not limited to, income before taxes being lower than anticipated in countries with lower statutory tax rates and higher than anticipated in countries with higher statutory tax rates, changes in the valuation of deferred tax assets and liabilities, and changes in various federal, state and international tax laws, regulations, accounting principles or interpretations thereof, which could adversely impact our financial condition, results of operations and cash flows in future periods.
During 2012 and 2011, the Company experienced higher unemployment tax rates in many of the states in which we do business, which increased our direct costs and negatively impacted our profitability. Considering current economic conditions in the U.S., the Company expects these rates will not significantly decrease in 2013 and future years.

Existing and potential customers may outsource or consider outsourcing their IT requirements to foreign countries in which we may not currently have operations, which could have an adverse effect on our ability to obtain new customers or retain existing customers.
In the past few years, more companies started using or are considering using low cost offshore outsourcing centers to perform technology-related work and complete projects. Currently, we have partnered with clients to perform services in Russia to mitigate and reduce this risk to our Company. However, the risk of additional increases in the future in the outsourcing of IT solutions overseas to countries where we do not have operations could have a material, negative impact on our future operations.
The introduction of new IT products or services may render our existing IT Solutions or IT Staffing offerings to be obsolete, which, if we are unable to keep pace with these corresponding changes, could have an adverse effect on our business.
Our success depends, in part, on our ability to implement and deliver IT Solutions or IT Staffing services that anticipate and keep pace with rapid and continuing changes in technology, industry standards and client preferences. We may not be successful in anticipating or responding to these developments on a timely basis, and our offerings may not be successful in the marketplace. Also, services, solutions and technologies developed by our competitors may make our solutions or staffing offerings uncompetitive or obsolete. Any one of these circumstances could have a material adverse effect on our ability to obtain and successfully complete client engagements.
Decreases in demand for IT solutions and staffing services in the future would cause an adverse effect on our revenue and operating results.
The Company’s revenue and operating results are significantly affected by changes in demand for its services. In recent years, the U.S. economy, where the Company performs greater than 80% of its total business based upon revenue, significantly deteriorated primarily due to subprime mortgage issues, financial market conditions, and other

10


economic concerns. In 2009, these economic pressures also extended to the European markets where the Company operates. These negative pressures on the economy led to a worldwide contraction of the credit markets, more severe recessionary conditions, and a decline in demand for the Company’s services which negatively affected the Company’s revenue and operating results in 2009 as compared with 2008. Economic pressures also led to customers’ reducing their spending on IT projects and external professional services. Economic conditions in 2010 through 2012 stabilized in the U.S., but continued to be challenging in Europe. Declines in spending for IT services in 2013 or future years may adversely affect our operating results in the future as they have in the past.
The IT services industry is highly competitive and fragmented, which means that our customers have a number of choices for providers of IT services and we may not be able to compete effectively.
The market for our services is highly competitive. The market is fragmented, and no company holds a dominant position. Consequently, our competition for client requirements and experienced personnel varies significantly by geographic area and by the type of service provided. Some of our competitors are larger and have greater technical, financial, and marketing resources and greater name recognition than we have in the markets we collectively serve. In addition, clients may elect to increase their internal IT systems resources to satisfy their custom software development and integration needs. Finally, our industry is being impacted by the growing use of lower-cost offshore delivery capabilities (primarily India and other parts of Asia). There can be no assurance that we will be able to continue to compete successfully with existing or future competitors or that future competition will not have a material adverse effect on our results of operations and financial condition.

Changing economic conditions and the effect of such changes on accounting estimates could have a material impact on our results of operations.
The Company has also made a number of estimates and assumptions relating to the reporting of its assets and liabilities and the disclosure of contingent assets and liabilities to prepare its consolidated financial statements pursuant to the rules and regulations of the SEC and other accounting rulemaking authorities. Such estimates primarily relate to the valuation of goodwill, the valuation of stock options for recording equity-based compensation expense, allowances for doubtful accounts receivable, investment valuation, valuation allowances for deferred tax assets, legal matters, other contingencies and estimates of progress toward completion and direct profit or loss on contracts, as applicable. As future events and their effects cannot be determined with precision, actual results could differ from these estimates. Changes in the economic climates in which the Company operates may affect these estimates and will be reflected in the Company’s financial statements in the event they occur. Such changes could result in a material impact on the Company’s results of operations.


11


Item 1B.
Unresolved Staff Comments
None.


Item 2.
Properties
The Company owns and occupies its headquarters building at 800 Delaware Avenue, and an office building at 700 Delaware Avenue, both located in Buffalo, New York. These buildings are operated by CTG of Buffalo, a subsidiary of the Company which is part of the Company’s North American operations. The corporate headquarters consists of approximately 48,000 square feet and is occupied by corporate administrative operations. The office building consists of approximately 42,000 square feet and is also occupied by corporate administrative operations. At December 31, 2012, these properties were not mortgaged as part of the Company’s existing revolving credit agreement.
All of the remaining Company locations, totaling approximately 20 sites, are leased facilities. Most of these facilities serve as sales and support offices and their size varies, generally in the range from 250 to 26,000 square feet, with the number of people employed at each office. The Company’s lease terms generally vary from periods of less than a year to five years and typically have flexible renewal options. The Company believes that its presently owned and leased facilities are adequate to support its current and anticipated future needs.


Item 3.
Legal Proceedings
The Company and its subsidiaries are involved from time to time in various legal proceedings arising in the ordinary course of business. Although the outcome of lawsuits or other proceedings involving the Company and its subsidiaries cannot be predicted with certainty and the amount of any liability that could arise with respect to such lawsuits or other proceedings cannot be predicted accurately, management does not expect these matters, if any, to have a material adverse effect on the financial position, results of operations, or cash flows of the Company.


Item 4.
Mine Safety Disclosures
Not applicable.


12


PART II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Stock Market Information
The Company’s common stock is traded on The NASDAQ Stock Market LLC under the symbol CTGX. The following table sets forth the high and low sales prices for the Company’s common stock for each quarter of the previous two years.
 
Stock Price
High
 
Low
Year ended December 31, 2012
 
 
 
Fourth Quarter
$
19.14

 
$
16.20

Third Quarter
$
16.66

 
$
13.71

Second Quarter
$
15.53

 
$
11.79

First Quarter
$
15.45

 
$
13.39

Year ended December 31, 2011
 
 
 
Fourth Quarter
$
14.50

 
$
9.68

Third Quarter
$
14.25

 
$
9.47

Second Quarter
$
15.00

 
$
11.19

First Quarter
$
13.58

 
$
10.65

On February 8, 2013, there were 2,210 holders of record of the Company’s common shares. Although the Company has not paid a dividend since 2000, it intends to initiate a quarterly dividend of $0.05 per common share in March 2013. The Company is required to meet certain financial covenants under its current revolving credit agreement in order to pay dividends. The Company was in compliance with these financial covenants at each of December 31, 2010, 2011 and 2012. The determination of the timing, amount and the continuation of the payment of dividends in the future on the Company’s common stock is at the discretion of the Board of Directors and will depend upon, among other things, the Company’s profitability, liquidity, financial condition, capital requirements and compliance with the aforementioned financial covenants.
For information concerning common stock issued in connection with the Company’s equity compensation plans, see Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
Issuer Purchases of Equity Securities
The Company’s share repurchase program (originally announced on May 12, 2005) does not have an expiration date, nor was it terminated during the 2012 fourth quarter. During February 2011, the Company’s Board of Directors authorized the addition of one million shares to the repurchase program. The information in the table below does not include shares tendered to the Company either to satisfy the exercise cost for the cashless exercise of employee stock options, or tax withholding obligations associated with employee equity awards.

Purchases by the Company of its common stock during the fourth quarter ended December 31, 2012 are as follows:
Period
Total
Number
of Shares
Purchased
 
Average
Price
Paid per
Share*
 
Total Number of
Shares
Purchased  as
Part of Publicly
Announced Plans
or Programs
 
Maximum
Number of
Shares that May
Yet be Purchased
Under the Plans
or Programs
September 29 – October 31

 
$

 

 
559,794

November 1 – November 30
24,762

 
$
17.55

 
24,762

 
535,032

December 1 – December 31

 
$

 

 
535,032

Total
24,762

 
$
17.55

 
24,762

 
 
*
 Excludes broker commissions

13


Company Performance Graph
The following graph displays a five-year comparison of cumulative total shareholder returns for the Company’s common stock, the S&P 500 Index, and the Dow Jones U.S. Computer Services Index, assuming a base index of $100 at the end of 2007. The cumulative total return for each annual period within the five years presented is measured by dividing (1) the sum of (A) the cumulative amount of dividends for the period, assuming dividend reinvestment, and (B) the difference between the Company’s share price at the end and the beginning of the period by (2) the share price at the beginning of the period. The calculations were made excluding trading commissions and taxes.
 
 


 
Base
Period
 
Indexed Returns
Years Ending
 
Dec. 07
 
Dec. 08
 
Dec. 09
 
Dec. 10
 
Dec. 11
 
Dec. 12
Computer Task Group, Inc.
$
100.00

 
$
58.23

 
$
144.85

 
$
196.75

 
$
254.61

 
$
329.66

S&P 500 Index
$
100.00

 
$
63.00

 
$
79.67

 
$
91.68

 
$
93.61

 
$
108.59

Dow Jones U.S. Computer Services Index
$
100.00

 
$
75.32

 
$
121.10

 
$
139.53

 
$
165.58

 
$
182.17

The information included under this section entitled “Company Performance Graph” is deemed not to be “soliciting material” or “filed” with the SEC, is not subject to the liabilities of Section 18 of the Exchange Act, and shall not be deemed incorporated by reference into any of the filings previously made or made in the future by the Company under the Exchange Act or the Securities Act of 1933, except to the extent the Company specifically incorporates any such information into a document that is filed.


14


Item 6.
Selected Financial Data
Consolidated Summary—Five-Year Selected Financial Information
The selected operating data and financial position information set forth below for each of the years in the five-year period ended December 31, 2012 has been derived from the Company’s audited consolidated financial statements. This information should be read in conjunction with the audited consolidated financial statements and notes thereto included in Item 8, “Financial Statements and Supplementary Data” included in this report.
 
 
2012
 
2011
 
2010
 
2009
 
2008
(amounts in millions, except per-share data)
(1)
 
 
 
 
 
 
 
 
Operating Data
 
 
 
 
 
 
 
 
 
Revenue
$
424.4

 
$
396.3

 
$
331.4

 
$
275.6

 
$
353.2

Operating Income
$
24.5

 
$
19.3

 
$
13.9

 
$
9.9

 
$
13.1

Net Income
$
16.2

 
$
11.9

 
$
8.4

 
$
5.9

 
$
7.8

Basic net income per share
$
1.07

 
$
0.80

 
$
0.57

 
$
0.40

 
$
0.51

Diluted net income per share
$
0.96

 
$
0.71

 
$
0.52

 
$
0.38

 
$
0.49

Cash dividend per share
$

 
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
 
 
Financial Position
 
 
 
 
 
 
 
 
 
Working capital
$
63.5

 
$
45.4

 
$
33.0

 
$
25.8

 
$
24.8

Total assets
$
166.2

 
$
147.5

 
$
130.3

 
$
114.7

 
$
115.8

Long-term debt
$

 
$

 
$

 
$

 
$

Shareholders’ equity
$
102.8

 
$
88.8

 
$
77.9

 
$
71.7

 
$
67.6

 
(1)
During 2012, the Company received life insurance proceeds upon the death of two of its former executives. In total, the Company received $1.3 million, which is included in net income, and equaled $0.08 basic and diluted net income per share.


15


Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This annual report on Form 10-K contains forward-looking statements made by the management of Computer Task Group, Incorporated (CTG, the Company or the Registrant) that are subject to a number of risks and uncertainties. These forward-looking statements are based on information as of the date of this report. The Company assumes no obligation to update these statements based on information from and after the date of this report. Generally, forward-looking statements include words or phrases such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “projects,” “could,” “may,” “might,” “should,” “will” and words and phrases of similar impact. The forward-looking statements include, but are not limited to, statements regarding future operations, industry trends or conditions and the business environment, and statements regarding future levels of, or trends in, revenue, operating expenses, capital expenditures, and financing. The forward-looking statements are made pursuant to safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Numerous factors could cause actual results to differ materially from those in the forward-looking statements, including the following: (i) the availability to CTG of qualified professional staff, (ii) domestic and foreign industry competition for customers and talent, (iii) the Company's ability to protect confidential client data (iv) the partial or complete loss of the revenue the Company generates from International Business Machines Corporation (IBM), (v) risks associated with operating in foreign jurisdictions, (vi) renegotiations, nullification, or breaches of contracts with customers, vendors, subcontractors or other parties, (vii) the change in valuation of recorded goodwill balances, (viii) the impact of current and future laws and government regulation, as well as repeal or modification of such, affecting the information technology (IT) solutions and staffing industry, taxes and the Company's operations in particular, (ix) industry and economic conditions, including fluctuations in demand for IT services, (x) consolidation among the Company's competitors or customers, (xi) the need to supplement or change our IT services in response to new offerings in the industry, and (xii) the risks described in Item 1A of this annual report on Form 10-K and from time to time in the Company's reports filed with the Securities and Exchange Commission (SEC).
Industry Trends
The market demand for the Company’s services is heavily dependent on IT spending by major corporations, organizations and government entities in the markets and regions that we serve. The pace of technology advances and changes in business requirements and practices of our clients all have a significant impact on the demand for the services that we provide. Competition for new engagements and pricing pressure has been strong. During 2009 through 2011, we experienced an increase in demand for our services, primarily in the healthcare provider solution and general IT staffing businesses. While demand in our healthcare vertical market remained strong in 2012, demand for our IT staffing services was modest which limited revenue growth for these services in 2012 as compared with 2011. We added new electronic medical records (EMR) projects throughout 2012 ranging from one to three years in duration, and have a total of 17 significant EMR engagements in process as of December 31, 2012. We anticipate a continuation of the strong demand for our EMR healthcare solutions services in 2013 due to the continuation of U.S. government funding for such projects, and the greater demand for healthcare services in the U.S. due to the aging population.

We provide two main services to our customers, which are providing IT solutions and IT staffing to our clients. With IT solutions services, we generally take responsibility for the deliverables on a project and the services may include high-end consulting services. When providing IT staffing services, we typically supply personnel to our customers who then, in turn, take their direction from the client’s managers. IT solutions and IT staffing revenue as a percentage of total revenue for the years ended December 31, 2012, 2011 and 2010 is as follows:
 
 
2012
 
2011
 
2010
IT solutions
41
%
 
37
%
 
34
%
IT staffing
59
%
 
63
%
 
66
%
Total
100
%
 
100
%
 
100
%
The Company promotes a majority of its services through four vertical market focus areas: Healthcare (which includes services provided to healthcare providers, health insurers, and life sciences companies), Technology Service Providers, Financial Services, and Energy. The remainder of CTG’s revenue is derived from general markets.


16


CTG’s revenue by vertical market for the years ended December 31, 2012, 2011 and 2010 is as follows:
 
 
2012
 
2011
 
2010
Healthcare
33
%
 
30
%
 
27
%
Technology service providers
31
%
 
34
%
 
36
%
Financial services
6
%
 
7
%
 
6
%
Energy
6
%
 
6
%
 
7
%
General markets
24
%
 
23
%
 
24
%
Total
100
%
 
100
%
 
100
%
The IT services industry is extremely competitive and characterized by continuous changes in customer requirements and improvements in technologies. Our competition varies significantly by geographic region, as well as by the type of service provided. Many of our competitors are larger than CTG, and have greater financial, technical, sales and marketing resources. In addition, the Company frequently competes with a client’s own internal IT staff. Our industry is being impacted by the growing use of lower-cost offshore delivery capabilities (primarily India and other parts of Asia). There can be no assurance that we will be able to continue to compete successfully with existing or future competitors or that future competition will not have a material adverse effect on our results of operations and financial condition.
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, when the services have been rendered, when the price is determinable, and when collectibility of the amounts due is reasonably assured. For time-and-material contracts, revenue is recognized as hours are incurred and costs are expended. For contracts with periodic billing schedules, primarily monthly, revenue is recognized as services are rendered to the customer. Revenue for fixed-price contracts is recognized as per the proportional method of accounting using an input-based approach whereby salary and indirect labor costs incurred are measured and compared with the total estimate of costs of such items at completion for a project. Revenue is recognized based upon the percentage-of-completion calculation of total incurred costs to total estimated costs. The Company infrequently works on fixed-price projects that include significant amounts of material or other non-labor related costs which could distort the percent completed within a percentage-of-completion calculation. The Company’s estimate of the total labor costs it expects to incur over the term of the contract is based on the nature of the project and our past experience on similar projects, and includes management judgments and estimates which affect the amount of revenue recognized on fixed-price contracts in any accounting period.
In 2010, the Company entered into a series of contracts with a customer that provided for application customization and integration services, as well as post contract support (PCS) services, specifically utilizing one of several of the software tools the Company has internally developed. These services were provided under a software-as-a-service model. As the contracts were closely interrelated and dependent on each other, for accounting purposes the contracts were considered to be one arrangement. Additionally, as the project included significant modification and customization services to transform the previously developed software tool into an expanded tool intended to meet the customer’s requirements, the percentage-of-completion method of contract accounting was being utilized for the project. Total revenue and costs were recognized equally until completion of the application customization and integration services portion of the project. The remaining unrecognized portion of the contract value was recognized on a straight-line basis over the term of the PCS period which ended on December 31, 2011.
The Company’s revenue from contracts accounted for under time-and-material, progress billing, and percentage-of-completion methods for the years ended December 31, 2012, 2011 and 2010 is as follows:
 
 
2012
 
2011
 
2010
Time-and-material
90
%
 
91
%
 
91
%
Progress billing
8
%
 
7
%
 
6
%
Percentage-of-completion
2
%
 
2
%
 
3
%
Total
100
%
 
100
%
 
100
%

17


Results of Operations
The table below sets forth percentage information calculated as a percentage of consolidated revenue as reported on the Company’s consolidated statements of income as included in Item 8, “Financial Statements and Supplementary Data” in this report.
 
Year Ended December 31,
2012
 
2011
 
2010
(percentage of revenue)
 
 
 
 
 
Revenue
100.0
%
 
100.0
 %
 
100.0
 %
Direct costs
78.4
%
 
78.7
 %
 
78.5
 %
Selling, general and administrative expenses
15.8
%
 
16.4
 %
 
17.3
 %
Operating income
5.8
%
 
4.9
 %
 
4.2
 %
Interest and other income (expense), net
0.2
%
 
(0.1
)%
 
(0.1
)%
Income before income taxes
6.0
%
 
4.8
 %
 
4.1
 %
Provision for income taxes
2.2
%
 
1.8
 %
 
1.6
 %
Net income
3.8
%
 
3.0
 %
 
2.5
 %
2012 as compared with 2011
The Company recorded revenue in 2012 and 2011 as follows:
 
 
 
 
 
 
 
 
 
Year-over-
Year Ended December 31,
% of total
 
2012
 
% of total
 
2011
 
Year Change
(dollars in thousands)
 
 
 
 
 
 
 
 
 
North America
83.8
%
 
$
355,805

 
83.1
%
 
$
329,295

 
8.1
%
Europe
16.2
%
 
68,610

 
16.9
%
 
66,980

 
2.4
%
Total
100.0
%
 
$
424,415

 
100.0
%
 
$
396,275

 
7.1
%
Reimbursable expenses billed to customers and included in revenue totaled $13.4 million and $12.7 million in 2012 and 2011, respectively.

In North America, the significant revenue increase in 2012 as compared with 2011 was due to strong demand for the Company’s IT solutions services. On a consolidated basis, IT solutions revenue increased $26.4 million or 17.9%, and was primarily driven by an increase in the Company’s EMR work for providers in the healthcare vertical market in North America. The Company expects demand for its EMR solutions and other healthcare related services to remain strong in 2013. IT staffing revenue increased $1.8 million or 0.7% as demand for these services significantly slowed due to the continuing challenging economic conditions in the United States. During 2010 and 2011, the Company had strong demand for its IT staffing services as customers backfilled for positions that they had eliminated in 2009 due to the onset of the recession in North America in late 2008.
The Company’s European operations include Belgium, Luxembourg and the United Kingdom. The increase in year-over-year revenue in the Company’s European operations was primarily due to strength in the Company’s European IT solutions business. When considering the year-over-year change in revenue in constant currencies, the revenue from our European operations increased 10.9%. This revenue increase was offset by the weakness relative to the U.S. dollar of the currencies of Belgium, Luxembourg, and the United Kingdom. In Belgium and Luxembourg, the functional currency is the Euro, while in the United Kingdom the functional currency is the British Pound. In 2012 as compared with 2011, the average value of the Euro decreased 7.7%, while the average value of the British Pound decreased 1.2%. A significant portion of the Company's revenue from its European operations is generated in Belgium and Luxembourg. Had there been no change in these exchange rates from 2011 to 2012, total European revenue would have been approximately $5.4 million higher, or $74.0 million as compared with the $68.6 million reported.
IBM is CTG’s largest customer. CTG provides services to various IBM divisions in many locations. During 2011, the NTS Agreement was renewed for three years until December 31, 2014. As part of the NTS Agreement, the Company also provides its services as a predominant supplier to IBM’s Integrated Technology Services unit and as the sole provider to the Systems and Technology Group business unit. These agreements accounted for

18


approximately 91.9% of all of the services provided to IBM by the Company in 2012. In 2012, 2011, and 2010, IBM accounted for $113.5 million or 26.7%, $116.5 million or 29.4%, and $102.3 million or 30.9% of the Company’s consolidated revenue, respectively. In 2012, IBM spun its retail business off to another large company. While CTG retained the work, this reduced our revenue from IBM in 2012 by $3.2 million. We expect to continue to derive a significant portion of our revenue from IBM in future years. However, a significant decline or the loss of the revenue from IBM would have a significant negative effect on our operating results. The Company’s accounts receivable from IBM at December 31, 2012 and 2011 amounted to $12.6 million and $12.8 million, respectively. No other customer accounted for more than 10% of the Company’s revenue in 2012, 2011 or 2010.
Direct costs, defined as costs for billable staff including billable out-of-pocket expenses, were 78.4% of consolidated revenue in 2012 and 78.7% of consolidated revenue in 2011. The decrease in direct costs as a percentage of revenue in 2012 compared with 2011 was due to a continued shift in the Company's business mix to a higher percentage of solutions business, which incurs lower direct costs as a percentage of revenue than the Company's staffing business.
Selling, general and administrative (SG&A) expenses were 15.8% of revenue in 2012 as compared with 16.4% of revenue in 2011. The SG&A decrease as a percentage of revenue in 2012 as compared with 2011 is primarily due to disciplined cost management and the effect of operating leverage resulting from revenue growth.
Operating income was 5.8% of revenue in 2012 as compared with 4.9% of revenue in 2011. The increase in operating income year-over-year was primarily due to the favorable change in business mix to more solutions services in 2012, and lower SG&A costs as a percentage of revenue. Operating income from North American operations was $21.3 million and $16.6 million in 2012 and 2011, respectively, while European operations generated operating income of $3.2 million and $2.7 million in 2012 and 2011, respectively. Operating income in 2012 in the Company’s European operations would have been approximately $0.2 million higher if there had been no change in foreign currency exchange rates year-over-year.

Interest and other income (expense), net was 0.2% of revenue in 2012 and (0.1)% of revenue in 2011. Net other income in 2012 primarily resulted from the receipt of life insurance proceeds totaling approximately $1.3 million for two former executives that passed away during 2012. This income in 2012 was partially offset by bank fees. In 2011, partially offsetting net interest and other expenses that resulted from bank fees and a loss on intercompany balances settled or intended to be settled at year-end, was approximately $0.1 million resulting from a gain on a sale of property.
The Company’s effective tax rate (ETR) is calculated based upon the full year's operating results, and various tax related items. The Company’s normal ETR ranges from 38% to 42%. The ETR in 2012 was 36.5%, while the 2011 ETR was 37.6%. The ETR in 2012 was lower due to approximately $0.5 million in tax expense related to non-taxable life insurance proceeds received during the year. In addition, the Company recorded an additional $0.2 million reduction of state tax expense as a result of the recording of certain favorable provision-to-return adjustments associated with the Company's 2011 income tax returns. The ETR during 2011 was reduced as the Company recorded $0.3 million of tax credits related to research and development activities, and $0.3 million of federal tax credits related to the retention of certain individuals hired during 2010. The impact of these credits was partially offset by an increase in the valuation allowance of $0.2 million associated with net operating losses incurred by certain foreign subsidiaries.
The Company did not record a tax benefit for its research and development activities during 2012 as the legislation extending the tax credit related to these expenses, the American Taxpayer Relief Act of 2012, was not passed by the U.S. federal government until January 2013. As required under current accounting guidelines, the Company expects to recognize a tax benefit of approximately $0.3 million for these 2012 credits in the 2013 first quarter.
Net income for 2012 was 3.8% of revenue or $0.96 per diluted share, compared with net income of 3.0% of revenue or $0.71 per diluted share in 2011. Diluted earnings per share were calculated using 16.8 million weighted-average equivalent shares outstanding in 2012 and 16.7 million in 2011. The increase in shares year-over-year is due to the dilutive effect of incremental shares outstanding under the Company’s equity-based compensation plans. This increase was partially offset by purchases of approximately 0.3 million shares for treasury by the Company during 2012.


19


2011 as compared with 2010
The Company recorded revenue in 2011 and 2010 as follows:
 
 
 
 
 
 
 
 
 
Year-over-
Year Ended December 31,
% of total
 
2011
 
% of total
 
2010
 
Year Change
(dollars in thousands)
 
 
 
 
 
 
 
 
 
North America
83.1
%
 
$
329,295

 
81.7
%
 
$
270,694

 
21.6
%
Europe
16.9
%
 
66,980

 
18.3
%
 
60,713

 
10.3
%
Total
100.0
%
 
$
396,275

 
100.0
%
 
$
331,407

 
19.6
%
Reimbursable expenses billed to customers and included in revenue totaled $12.7 million and $9.1 million in 2011 and 2010, respectively.

In North America, the significant revenue increase in 2011 as compared with 2010 was due to strong demand for both the Company’s IT solutions and IT staffing services as general economic conditions continued to improve from those that existed during the recession in 2008/2009. IT solutions revenue increased 33.1% and IT staffing revenue increased 12.7% in 2011 as compared with 2010. The IT solutions revenue increase totaled $36.9 million and was primarily driven by an increase in the Company’s EMR work. The IT staffing revenue increase totaled $28.0 million as the Company’s customers filled staffing requirements that had remained open from 2009 due to the economic recession in the United States.
The Company’s European operations include Belgium, Luxembourg and the United Kingdom. The increase in year-over-year revenue in the Company’s European operations was primarily due to modest strength in the Company’s European IT staffing business, much of which is due to work with government ministries associated with the European Union. This revenue increase was supported by the strength relative to the U.S. dollar of the currencies of Belgium, Luxembourg, and the United Kingdom. In Belgium and Luxembourg, the functional currency is the Euro, while in the United Kingdom the functional currency is the British Pound. In 2011 as compared with 2010, the average value of the Euro increased 4.9%, while the average value of the British Pound increased 3.8%. Had there been no change in these exchange rates from 2010 to 2011, total European revenue would have been approximately $3.0 million lower, or $64.0 million as compared with the $67.0 million reported.
IBM is CTG’s largest customer. CTG provides services to various IBM divisions in many locations. During the 2011 fourth quarter, the NTS Agreement was renewed for three years until December 31, 2014. As part of the NTS Agreement, the Company also provides its services as a predominant supplier to IBM’s Integrated Technology Services unit and as the sole provider to the Systems and Technology Group business unit. These agreements accounted for approximately 94% of all of the services provided to IBM by the Company in 2011. In 2011, 2010, and 2009, IBM accounted for $116.5 million or 29.4%, $102.3 million or 30.9%, and $71.2 million or 25.8% of the Company’s consolidated revenue, respectively. The Company continued to derive a significant portion of its revenue from IBM in 2012. However, a significant decline or the loss of the revenue from IBM in 2013 or future years would have a significant negative effect on our operating results. The Company’s accounts receivable from IBM at December 31, 2011 and 2010 amounted to $12.8 million and $13.1 million, respectively. No other customer accounted for more than 10% of the Company’s revenue in 2011, 2010 or 2009.
Direct costs, defined as costs for billable staff including billable out-of-pocket expenses, were 78.7% of consolidated revenue in 2011 and 78.5% of consolidated revenue in 2010. The increase in direct costs as a percentage of revenue in 2011 compared with 2010 was due to an increase in employee benefit costs, primarily unemployment insurance, in 2011.
Selling, general and administrative (SG&A) expenses were 16.4% of revenue in 2011 as compared with 17.3% of revenue in 2010. The SG&A decrease as a percentage of revenue in 2011 as compared with 2010 is primarily due to disciplined cost management and the economies of scale, especially pertaining to fixed costs, associated with the revenue growth experienced in 2011 as compared with 2010.
Operating income was 4.9% of revenue in 2011 as compared with 4.2% of revenue in 2010. Operating income from North American operations was $16.6 million and $12.4 million in 2011 and 2010, respectively, while European operations generated operating income of $2.7 million and $1.5 million in 2011 and 2010, respectively. Operating income in the Company’s European operations increased by approximately $0.2 million due to the change in foreign currency exchange rates year-over-year.

20



Interest and other expense, net was 0.1% of revenue in both 2011 and 2010. This balance primarily consisted of interest expense on borrowings under the Company’s revolving line of credit, bank fees, and foreign exchange losses. The Company recorded a net exchange loss on intercompany balances totaling less than $0.1 million in both 2011 and 2010, resulting from balances settled during the year or those intended to be settled as of December 31, 2011. In 2011, partially offsetting the net interest and other expense balance was approximately $0.1 million resulting from a gain on a sale of property.
The Company’s ETR is calculated based upon the full year's operating results, and various tax related items. The Company’s normal ETR ranges from 38% to 42%. The 2011 ETR was 37.6%, and the 2010 ETR was 39.2%. The ETR during 2011 was reduced as the Company recorded $0.3 million of tax credits related to research and development activities, and $0.3 million of federal tax credits related to the retention of certain individuals hired during 2010. The impact of these credits was partially offset by an increase in the valuation allowance of $0.2 million associated with net operating losses incurred by certain foreign subsidiaries.
Net income for 2011 was 3.0% of revenue or $0.71 per diluted share, compared with net income of 2.5% of revenue or $0.52 per diluted share in 2010. Diluted earnings per share were calculated using 16.7 million weighted-average equivalent shares outstanding in 2011 and 16.1 million in 2010. The increase in shares year-over-year was due to the dilutive effect of incremental shares outstanding under the Company’s equity-based compensation plans. This increase was partially offset by purchases of approximately 0.3 million shares for treasury by the Company during 2011.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles requires the Company’s management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The Company’s significant accounting policies are included in note 1 to the consolidated financial statements contained in this annual report on Form 10-K under Item 8, “Financial Statements and Supplementary Data.” These policies, along with the underlying assumptions and judgments made by the Company’s management in their application, have a significant impact on the Company’s consolidated financial statements. The Company identifies its most critical accounting policies as those that are the most pervasive and important to the portrayal of the Company’s financial position and results of operations, and that require the most difficult, subjective and/or complex judgments by management regarding estimates about matters that are inherently uncertain. The Company’s critical accounting policies are those related to goodwill valuation, and the valuation allowance for deferred income taxes.
Goodwill Valuation
The Company has a goodwill balance of $35.7 million. The balance is evaluated annually as of the Company’s October fiscal month-end (the measurement date), or more frequently if facts and circumstances indicate impairment may exist. This evaluation, as applicable, is based on estimates and assumptions that may be used to analyze the appraised value of similar transactions from which the goodwill arose, the appraised value of similar companies, or estimates of future discounted cash flows. The estimates and assumptions on which the Company’s evaluations are based involve judgments and are based on currently available information, any of which could prove wrong or inaccurate when made, or become wrong or inaccurate as a result of subsequent events.
At the respective measurement dates for 2012, 2011, and 2010, the Company completed its annual valuation of the business to which the Company’s goodwill relates. During 2012, the Company utilized the provisions under Accounting Standards Update No. 2011-08, “Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment,” which allow public entities to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under this new process, an entity is no longer required to calculate the fair value of a reporting unit unless the qualitative assessment shows that it is more likely than not that its fair value is less than its carrying amount. During 2011 and 2010, the company utilized the assistance of an independent third party appraiser to complete its review.
The 2010 and 2011 measurement date valuations indicated that the estimated fair value of the business was substantially in excess of its carrying value, with the estimated fair value of the unit exceeding the carrying value by 116% in 2011, and 31% in 2010. From its internal qualitative assessment completed in 2012, the Company believes the fair value of the business has increased from 2011, and continues to be substantially in excess of the carrying value of the business. Additionally, there are no other facts or

21


circumstances that arose during 2012, 2011 or 2010 which led management to believe the goodwill balance was impaired.
Income Taxes—Valuation Allowances on Deferred Tax Assets
At December 31, 2012, the Company had a total of approximately $7.6 million of current and non-current deferred tax assets, net of deferred tax liabilities, recorded on its consolidated balance sheet. The deferred tax assets, net, primarily consist of deferred compensation, loss carryforwards and state taxes. The changes in deferred tax assets and liabilities from period to period are determined based upon the changes in differences between the basis of assets and liabilities for financial reporting purposes and the basis of assets and liabilities for tax purposes, as measured by the enacted tax rates when these differences are estimated to reverse. The Company has made certain assumptions regarding the timing of the reversal of these assets and liabilities, and whether taxable income in future periods will be sufficient to recognize all or a part of any gross deferred tax asset of the Company.
At December 31, 2012, the Company had deferred tax assets recorded resulting from net operating losses in previous years totaling approximately $1.1 million. The Company has analyzed each jurisdiction’s tax position, including forecasting potential taxable income in future periods and the expiration of the net operating loss carryforwards as applicable, and determined that it is unclear whether all of these deferred tax assets will be realized at any point in the future. Accordingly, at December 31, 2012, the Company had offset a portion of these assets with a valuation allowance totaling $1.0 million, resulting in a net deferred tax asset from net operating loss carryforwards of approximately $0.1 million.
The Company’s deferred tax assets and their potential realizability are evaluated each quarter to determine if any changes should be made to the valuation allowance. Any change in the valuation allowance in the future could result in a change in the Company’s ETR. A 1% change in the ETR in 2012 would have increased or decreased net income by approximately $255,000, or approximately $0.02 per diluted share.
Other Estimates
The Company has also made a number of estimates and assumptions relating to the reporting of its assets and liabilities and the disclosure of contingent assets and liabilities to prepare the consolidated financial statements pursuant to the rules and regulations of the SEC, the FASB, and other regulatory authorities. Such estimates primarily relate to the valuation of stock options for recording equity-based compensation expense, allowances for doubtful accounts receivable, investment valuation, legal matters, and estimates of progress toward completion and direct profit or loss on contracts, as applicable. As future events and their effect on the Company's operating results cannot be determined with precision, actual results could differ from these estimates. Changes in the economic climates in which the Company operates may affect these estimates and will be reflected in the Company’s financial statements in the event they occur.
Financial Condition and Liquidity
Cash provided by operating activities was $21.2 million, $8.6 million and $9.2 million in 2012, 2011 and 2010, respectively. In 2012, net income was $16.2 million, while other non-cash adjustments, primarily consisting of depreciation expense, equity-based compensation, deferred income taxes, and deferred compensation totaled $5.9 million. In 2011 and 2010, net income was $11.9 million and $8.4 million, respectively, while the corresponding non-cash adjustments netted to $1.9 million and $2.6 million, respectively. The increase in non-cash adjustments in 2012 as compared with 2011 was primarily due to an increase in depreciation and amortization expense of $0.6 million, equity-based compensation of $0.6 million, deferred taxes of $1.0 million, and deferred compensation of $1.6 million. The decrease in non-cash adjustments in 2011 as compared with 2010 was primarily due to an increase in depreciation and amortization expense of $0.6 million and equity-based compensation expense of $0.3 million, offset by a decrease in deferred taxes of $0.7 million and deferred compensation of $0.7 million. The increases in 2012 and 2011 for depreciation and amortization expense was due to the completion of all existing capitalized software projects and the corresponding initiation of depreciation expense on those projects. The change in 2012 from 2011 for deferred compensation primarily relates to a change in the discount rate for the Netherlands defined-benefit plan.
Accounts receivable balances increased $2.2 million in 2012 as compared with 2011, $10.6 million in 2011 as compared with 2010, and $13.2 million in 2010 as compared with 2009. The increase in the accounts receivable balance in 2012 resulted from an increase in revenue in the 2012 fourth quarter of approximately 6.9% when compared with the 2011 fourth quarter. The increase in revenue was offset by a decrease in days sales outstanding (DSO). DSO is calculated by dividing accounts receivable obtained from the consolidated balance sheet by

22


average daily revenue for the fourth quarter of the respective year. DSO was 61 days at December 31, 2012 , whereas the DSO at December 31, 2011 was 62 days. The increase in the accounts receivable balance in 2011 as compared with 2010 resulted from an increase in revenue in the 2011 fourth quarter of approximately 16% when compared with the 2010 fourth quarter. DSO also increased to 62 days at December 31, 2011 from 60 days at December 31, 2010. The increase in the accounts receivable balance in 2010 resulted from an increase in revenue in the 2010 fourth quarter of approximately 29% when compared with the 2009 fourth quarter.
Other assets decreased less than $0.1 million in 2012, approximately $1.1 million in 2011, and approximately $1.3 million in 2010. The decrease in 2011 from 2010 was primarily due to a decrease in the actuarially determined asset recorded for the Netherlands defined benefit plan, while the decrease in 2010 from 2009 was due to the timing of the Company’s borrowings against the cash surrender value of insurance policies it owns. Accounts payable decreased $0.3 million in 2012, increased $1.3 million in 2011, and decreased $0.6 million in 2010. The increase in accounts payable in 2011 is primarily due to a general increase in the size of the Company and the timing of payments near year-end. The decrease in accounts payable in 2010 is primarily due to the timing of certain payments near year-end. Accrued compensation increased $1.0 million in 2012 primarily due to an increase in employee headcount of about 200 from 2011, $1.5 million in 2011 primarily due to an increase in employee headcount of about 300 from 2010, and increased $10.0 million in 2010 primarily due to a significant increase in headcount of greater than 500 employees year-over-year and the accrual of year-end incentives due to higher profitability in 2010 as compared with 2009. Income taxes payable decreased $1.0 million in 2012 due to the timing of payments made in 2012 and certain provision-to-return adjustments made when filing the Company's 2011 tax returns. Income taxes payable increased $1.2 million in 2011 and $0.5 million in 2010 due to higher taxable income in 2011 and 2010, and the timing and amount of estimated tax payments near year-end.
Investing activities used $2.0 million, $1.7 million, and $2.0 million of cash in 2012, 2011 and 2010, respectively, primarily due to additions to property, equipment and capitalized software of $1.9 million in 2012, $1.9 million in 2011, and $2.0 million in 2010. The Company has no significant commitments for the purchase of property or equipment at December 31, 2012, and does not expect the amount to be spent in 2013 on additions to property, equipment and capitalized software to significantly vary from the amount spent in 2012.
Financing activities used $1.3 million of cash in 2012, provided $1.0 million of cash in 2011, and used $2.1 million of cash in 2010. The Company received $3.8 million, $3.8 million, and $1.0 million during 2012, 2011, and 2010, respectively, from the proceeds from stock option exercises and excess tax benefits from equity-based compensation transactions. These increases in 2012 and 2011 were larger as compared with 2010 due to a significant increase in the Company’s stock price during 2011 and 2012 which led to a higher level of stock option exercises.
During 2012, 2011 and 2010, the Company used $4.6 million, $3.6 million, and $3.0 million, respectively, to purchase approximately 0.3 million, 0.3 million, 0.4 million shares of its stock for treasury. During February 2011, the Company’s Board of Director’s authorized 1.0 million additional shares for future stock repurchases under this program. Approximately 0.5 million, 0.9 million, and 0.2 million shares remain authorized for future purchases under the Company’s share repurchase plan at December 31, 2012, 2011 and 2010, respectively. At December 31, 2012, 2011, and 2010, the Company also experienced changes in its cash account overdrafts, which are primarily due to timing of cash payments at year-end, of $(0.8) million, $0.5 million, and $(0.3) million, respectively.
The Company did not have any borrowings outstanding under its revolving line of credit (LOC) at December 31, 2012, 2011 or 2010. The term of the LOC was renewed during 2010 and now extends to April 2014. The LOC totals $35.0 million and can be used for borrowings or letter of credit commitments. Letters of credit at December 31, 2012, 2011, and 2010 totaled $0.5 million, $0.4 million, and $0.4 million, respectively. The Company borrows or repays the LOC as needed based upon its working capital obligations, including the timing of the U.S. bi-weekly payroll. The Company did not borrow any amounts under the line of credit during 2012. The average outstanding balances under the Company’s LOC for 2011 and 2010 were approximately $0.4 million and $1.3 million, respectively.
The Company is required to meet certain financial covenants in order to maintain borrowings under its revolving credit line, pay dividends, and make acquisitions. The covenants are measured quarterly, and at December 31, 2012 include a leverage ratio which must be no more than 2.75 to 1, a calculation of minimum tangible net worth which must be no less than $51.2 million, and total expenditures for property, equipment and capitalized software cannot exceed $5.0 million annually. The Company was in compliance with these covenants at December 31, 2012 as its leverage ratio was 0.0, its minimum tangible net worth was $66.7 million, and 2012 expenditures for property, equipment and capitalized software were $1.9 million. The Company was also in

23


compliance with its required covenants at December 31, 2011 and December 31, 2010. When considering current market conditions and the Company’s current operating results, the Company believes it will be able to meet its covenants, as applicable, in 2013 and future years.
Of the total cash and cash equivalents reported on the consolidated balance sheet at December 31, 2012 of $40.6 million, approximately $14.7 million is held by the Company’s foreign operations and is considered to be indefinitely reinvested in those operations. During January 2013, the Company used a portion of its cash held by its foreign operations to purchase etrinity, a company with operations in Belgium and the Netherlands. The Company has not repatriated any of its cash and cash equivalents from its foreign operations in the past five years, and has no intention of doing so in the foreseeable future as the funds are required to meet the working capital needs of its foreign operations.
The Company believes existing internally available funds, cash potentially generated from operations, and borrowings available under the Company’s LOC totaling approximately $34.5 million at December 31, 2012, will be sufficient to meet foreseeable working capital and capital expenditure needs, fund stock repurchases, and to allow for future internal growth and expansion.
Off-Balance Sheet Arrangements
The Company did not have off-balance sheet arrangements or transactions in 2012, 2011 or 2010 other than guarantees in our European operations that support office leases and the performance under government contracts. These guarantees totaled approximately $2.5 million at December 31, 2012.
Quantitative and Qualitative Disclosures about Market Risk
The Company’s primary market risk exposures consist of interest rate risk associated with variable rate borrowings and foreign currency exchange risk associated with the Company’s European operations. See Item 7A, “Quantitative and Qualitative Disclosure about Market Risk” in this report.

Contractual Obligations
The Company intends to satisfy its contractual obligations from operating cash flows, and, if necessary, from draws on its revolving credit line. A summary of the Company’s contractual obligations at December 31, 2012 is as follows:
 
(in millions)
 
 
 
Total
 
Less
than
1 year
 
Years
2-3
 
Years
4-5
 
More
than
5 years
Long-term debt
 
A
 
$

 
$

 
$

 
$

 
$

Capital lease obligations
 
B
 

 

 

 

 

Operating lease obligations
 
C
 
13.9

 
4.7

 
6.2

 
2.2

 
0.8

Purchase obligations
 
D
 
2.0

 
1.6

 
0.4

 

 

Deferred compensation benefits (U.S.)
 
E
 
8.4

 
1.0

 
1.5

 
1.3

 
4.6

Deferred compensation benefits Europe
 
F
 
3.8

 
0.1

 
0.3

 
0.4

 
3.0

Other long-term liabilities
 
G
 
0.4

 

 
0.1

 
0.1

 
0.2

Total
 
 
 
$
28.5

 
$
7.4

 
$
8.5

 
$
4.0

 
$
8.6

 
A
A $35.0 million revolving credit agreement (Agreement) that expires in April 2014. The Company uses this Agreement to fund its working capital obligations as needed, primarily funding the U.S. bi-weekly payroll. There were no borrowings outstanding under the Agreement at December 31, 2012. The Company does currently have one outstanding letter of credit under the Agreement totaling approximately $0.5 million that collateralizes an employee benefit program.
B
The Company does not have any capital lease obligations outstanding at December 31, 2012.
C
Operating lease obligations relate to the rental of office space, office equipment, and automobiles leased in the Company’s European operations. Total rental expense under operating leases in 2012, 2011, and 2010 was approximately $6.3 million, $6.8 million, and $6.4 million, respectively.

24


D
The Company’s purchase obligations in 2013, 2014 and 2015 total approximately $2.0 million, including $0.8 million for software maintenance, support and related fees, $0.3 million for telecommunications, $0.3 million for computer-based training courses, $0.2 million for professional organization memberships, $0.2 million for facilities, and $0.2 million for recruiting services.
E
The Company is committed for deferred compensation benefits in the U.S. under two plans. The Executive Supplemental Benefit Plan (ESBP) provides certain former key executives with deferred compensation benefits. The ESBP was amended as of November 30, 1994 to freeze benefits for participants at that time. Currently, 15 individuals are receiving benefits under this plan. The ESBP is deemed to be unfunded as the Company has not specifically identified Company assets to be used to discharge the deferred compensation benefit liabilities.
The Company also has a non-qualified defined-contribution deferred compensation plan for certain key executives. Contributions to this plan in 2012 were $0.4 million. The Company anticipates making contributions totaling approximately $0.3 million in 2013 to this plan for amounts earned in 2012.
F
The Company retained a contributory defined-benefit plan for its previous employees located in the Netherlands when the Company disposed of its subsidiary, CTG Nederland B.V. This plan was curtailed on January 1, 2003 for additional contributions. The Company does not anticipate making additional contributions to fund the plan in future years.
G
The Company has other long-term liabilities including payments for a postretirement benefit plan for six retired employees and their spouses, totaling nine participants.


25


Item 7A.
Quantitative and Qualitative Disclosure About Market Risk
The Company’s primary market risk exposures consist of interest rate risk associated with variable rate borrowings and foreign currency exchange risk associated with the Company’s European operations.
In December 2010, the Company entered into an amendment of its credit agreement which extended the expiration date of the agreement to April 2014. This credit agreement allows the Company to borrow up to $35.0 million. At both December 31, 2012 and 2011, there were no amounts outstanding under the credit agreement. However, at December 31, 2012 and 2011, there was $0.5 million and $0.4 million, respectively, outstanding under letters of credit under the credit agreement.
The Company did not borrow any amounts under the line of credit during 2012. The maximum amounts outstanding under the Company’s credit agreements during 2011 and 2010 were $5.8 million, and $7.8 million, respectively. Average bank borrowings outstanding for the years 2011 and 2010 were $0.4 million and $1.3 million, respectively, and carried weighted-average interest rates of 2.3% and 2.1%, respectively. A one percent change in the weighted-average interest rate during 2011 would have increased or decreased interest expense by $4,000. The Company incurred commitment fees totaling approximately $0.1 million in each of 2012, 2011 and 2010 relative to the agreement.
During 2012, revenue was affected by the year-over-year foreign currency exchange rate changes of Belgium, Luxembourg, and the United Kingdom, which are the countries in which the Company’s European subsidiaries operate. In Belgium and Luxembourg, the functional currency is the Euro, while in the United Kingdom the functional currency is the British Pound. Had there been no change in these exchange rates from 2011 to 2012, total European revenue would have been approximately $5.4 million higher in 2012, or $74.0 million as compared with the $68.6 million reported. Operating income in the Company’s European operations would have been approximately $0.2 million higher if there had been no change in foreign currency exchange rates year-over-year.
The Company recorded a net exchange loss on intercompany balances totaling approximately $0.1 million in 2011, resulting from balances settled during the year, or those intended to be settled as of December 31, 2011. No such amounts were recorded during 2012. The Company has historically not used any market risk sensitive instruments to hedge its foreign currency exchange risk. The Company believes the market risk related to intercompany balances in future periods will not have a material effect on its results of operations.


26


Item 8.
Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Computer Task Group, Incorporated:
We have audited the accompanying consolidated balance sheets of Computer Task Group, Incorporated and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Computer Task Group, Incorporated and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Computer Task Group, Incorporated’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 22, 2013 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Buffalo, New York
February 22, 2013

27


Consolidated Statements of Income
 
Year Ended December 31,
2012
 
2011
 
2010
(amounts in thousands, except per-share data)
 
 
 
 
 
Revenue
$
424,415

 
$
396,275

 
$
331,407

Direct costs
333,086

 
311,984

 
260,172

Selling, general and administrative expenses
66,867

 
64,981

 
57,305

Operating income
24,462

 
19,310

 
13,930

Interest and other income
1,424

 
231

 
102

Interest and other expense
441

 
418

 
263

Income before income taxes
25,445

 
19,123

 
13,769

Provision for income taxes
9,280

 
7,185

 
5,397

Net income
$
16,165

 
$
11,938

 
$
8,372

Net income per share:
 
 
 
 
 
Basic
$
1.07

 
$
0.80

 
$
0.57

Diluted
$
0.96

 
$
0.71

 
$
0.52

Weighted average shares outstanding:
 
 
 
 
 
Basic
15,172

 
14,968

 
14,697

Diluted
16,841

 
16,731

 
16,073

 


The accompanying notes are an integral part of these consolidated financial statements.

28


Consolidated Statements of Comprehensive Income


Year Ended December 31,
2012
 
2011
 
2010
(amounts in thousands)
 
 
 
 
 
Net Income
$
16,165

 
$
11,938

 
$
8,372

Foreign currency adjustment
370

 
(326
)
 
(1,093
)
Pension loss adjustment, net of taxes of $(396), $295, and $247 in 2012, 2011, and 2010, respectively
(2,820
)
 
(1,743
)
 
(542
)
Comprehensive income
$
13,715

 
$
9,869

 
$
6,737







































The accompanying notes are an integral part of these consolidated financial statements.

29





Consolidated Balance Sheets
 
December 31,
2012
 
2011
(amounts in thousands, except share balances)
 
 
 
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
40,614

 
$
22,414

Accounts receivable, net of allowances of $862 and $965 in 2012 and 2011, respectively
70,459

 
67,801

Prepaid and other current assets
1,450

 
1,876

Deferred income taxes
1,145

 
1,221

Total current assets
113,668

 
93,312

Property, equipment and capitalized software, net
6,916

 
7,969

Goodwill
35,678

 
35,678

Deferred income taxes
6,435

 
7,062

Other assets
2,871

 
2,921

Investments
637

 
550

Total assets
$
166,205

 
$
147,492

Liabilities and Shareholders’ Equity
 
 
 
Current Liabilities:
 
 
 
Accounts payable
$
10,170

 
$
9,532

Accrued compensation
32,162

 
30,971

Advance billings on contracts
2,481

 
1,756

Other current liabilities
4,747

 
3,972

Income taxes payable
641

 
1,695

Total current liabilities
50,201

 
47,926

Deferred compensation benefits
12,847

 
10,231

Other long-term liabilities
376

 
530

Total liabilities
63,424

 
58,687

Shareholders’ Equity:
 
 
 
Common stock, par value $0.01 per share, 150,000,000 shares authorized; 27,017,824 shares issued
270

 
270

Capital in excess of par value
119,183

 
115,895

Retained earnings
99,644

 
83,479

Less: Treasury stock of 8,276,014 and 8,540,864 shares at cost, in 2012 and 2011, respectively
(50,302
)
 
(47,320
)
Stock Trusts of 3,363,351 shares at cost in both periods
(55,083
)
 
(55,083
)
Other
(251
)
 
(206
)
Accumulated other comprehensive loss
(10,680
)
 
(8,230
)
Total shareholders’ equity
102,781

 
88,805

Total liabilities and shareholders’ equity
$
166,205

 
$
147,492





The accompanying notes are an integral part of these consolidated financial statements.

30


Consolidated Statements of Cash Flows
 
Year Ended December 31,
2012
 
2011
 
2010
(amounts in thousands)
 
 
 
 
 
Cash flow from operating activities:
 
 
 
 
 
Net income
$
16,165

 
$
11,938

 
$
8,372

Adjustments:
 
 
 
 
 
Depreciation and amortization expense
2,919

 
2,271

 
1,711

Equity-based compensation expense
2,236

 
1,654

 
1,349

Deferred income taxes
116

 
(883
)
 
(154
)
Deferred compensation
600

 
(1,036
)
 
(343
)
(Gain) loss on sales of property and equipment
20

 
(136
)
 
(9
)
Changes in assets and liabilities:
 
 
 
 
 
Increase in accounts receivable
(2,239
)
 
(10,561
)
 
(13,210
)
(Increase) decrease in prepaid and other current assets
403

 
93

 
(51
)
Decrease in other assets
50

 
1,091

 
1,318

Increase (decrease) in accounts payable
(293
)
 
1,250

 
(581
)
Increase in accrued compensation
1,002

 
1,530

 
9,962

Increase (decrease) in income taxes payable
(1,067
)
 
1,176

 
526

Increase (decrease) in advance billings on contracts
707

 
(568
)
 
850

Increase (decrease) in other current liabilities
732

 
733

 
(493
)
Increase (decrease) in other long-term liabilities
(195
)
 
53

 
(82
)
Net cash provided by operating activities
21,156

 
8,605

 
9,165

Cash flow from investing activities:
 
 
 
 
 
Additions to property and equipment
(1,872
)
 
(1,584
)
 
(1,000
)
Additions to capitalized software

 
(364
)
 
(1,016
)
Deferred compensation plan investments, net
(113
)
 
97

 
24

Proceeds from sales of property and equipment
5

 
176

 
41

Net cash used in investing activities
(1,980
)
 
(1,675
)
 
(1,951
)
Cash flow from financing activities:
 
 
 
 
 
Proceeds from stock option plan exercises
1,144

 
2,007

 
781

Excess tax benefits from equity-based compensation
2,615

 
1,801

 
242

Proceeds from Employee Stock Purchase Plan
294

 
274

 
178

Change in cash overdraft, net
(777
)
 
539

 
(321
)
Purchase of stock for treasury
(4,591
)
 
(3,601
)
 
(2,993
)
Net cash provided by (used in) financing activities
(1,315
)
 
1,020

 
(2,113
)
Effect of exchange rates on cash and cash equivalents
339

 
(373
)
 
(687
)
Net increase in cash and cash equivalents
18,200

 
7,577

 
4,414

Cash and cash equivalents at beginning of year
22,414

 
14,837

 
10,423

Cash and cash equivalents at end of year
$
40,614

 
$
22,414

 
$
14,837

The accompanying notes are an integral part of these consolidated financial statements.

31


Consolidated Statements of Changes in Shareholders’ Equity
 

 
Common Stock
 
Capital in
Excess of Par
Value
 
Retained
Earnings
 
Treasury Stock
 
Stock Trusts
 
Accumulated
Other
Comprehensive
Income (loss)
 
 
 
Total
Shareholders’
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Other
 
(amounts in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances as of December 31, 2009
27,018

 
$
270

 
$
112,473

 
$
63,169

 
8,877

 
$
(44,585
)
 
3,363

 
$
(55,083
)
 
$
(4,526
)
 
$

 
$
71,718

Employee Stock Purchase Plan share issuance

 

 
64

 

 
(22
)
 
114

 

 

 

 

 
178

Stock Option Plan share issuance, net

 

 
(155
)
 

 
(181
)
 
891

 

 

 

 

 
736

Excess tax benefits from equity-based compensation

 

 
242

 

 

 

 

 

 

 

 
242

Restricted stock plan share issuance/forfeiture

 

 
(389
)
 

 
(58
)
 
224

 

 

 

 

 
(165
)
Deferred compensation plan share issuance

 

 
94

 

 
(34
)
 
171

 

 

 

 
(147
)
 
118

Purchase of stock

 

 

 

 
381

 
(2,993
)
 

 

 

 

 
(2,993
)
Equity-based compensation

 

 
1,349

 

 

 

 

 

 

 

 
1,349

Net income

 

 

 
8,372

 

 

 

 

 

 

 
8,372

Foreign currency adjustment

 

 

 

 

 

 

 

 
(1,093
)
 

 
(1,093
)
Pension loss adjustment, net of tax

 

 

 

 

 

 

 

 
(542
)
 

 
(542
)
Balances as of December 31, 2010
27,018

 
270

 
113,678

 
71,541

 
8,963

 
(46,178
)
 
3,363

 
(55,083
)
 
(6,161
)
 
(147
)
 
77,920

Employee Stock Purchase Plan share issuance

 

 
155

 

 
(22
)
 
119

 

 

 

 

 
274

Stock Option Plan share issuance, net

 

 
(879
)
 

 
(637
)
 
2,806

 

 

 

 

 
1,927

Excess tax benefits from equity-based compensation

 

 
1,801

 

 

 

 

 

 

 

 
1,801

Restricted stock plan share issuance/forfeiture

 

 
(666
)
 

 
(50
)
 
(581
)
 

 

 

 

 
(1,247
)
Deferred compensation plan share issuance

 

 
152

 

 
(21
)
 
115

 

 

 

 
(59
)
 
208

Purchase of stock

 

 

 

 
308

 
(3,601
)
 

 

 

 

 
(3,601
)
Equity-based compensation

 

 
1,654

 

 

 

 

 

 

 

 
1,654

Net income

 

 

 
11,938

 

 

 

 

 

 

 
11,938

Foreign currency adjustment

 

 

 

 

 

 

 

 
(326
)
 

 
(326
)
Pension loss adjustment, net of tax

 

 

 

 

 

 

 

 
(1,743
)
 

 
(1,743
)
Balances as of December 31, 2011
27,018

 
270

 
115,895

 
83,479

 
8,541

 
(47,320
)
 
3,363

 
(55,083
)
 
(8,230
)
 
(206
)
 
88,805

 
 
(continued on next page)


32


 
Common Stock
 
Capital in
Excess of Par
Value
 
Retained
Earnings
 
Treasury Stock
 
Stock Trusts
 
Accumulated
Other
Comprehensive
Income (loss)
 
 
 
Total
Shareholders’
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Other
 
(amounts in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances as of December 31, 2011
27,018

 
270

 
115,895

 
83,479

 
8,541

 
(47,320
)
 
3,363

 
(55,083
)
 
(8,230
)
 
(206
)
 
88,805

Employee Stock Purchase Plan share issuance

 

 
181

 

 
(19
)
 
113

 

 

 

 

 
294

Stock Option Plan share issuance, net

 

 
(1,310
)
 

 
(476
)
 
1,533

 

 

 

 

 
223

Excess tax benefits from equity-based compensation

 

 
2,615

 

 

 

 

 

 

 

 
2,615

Restricted stock plan share issuance/forfeiture

 

 
(660
)
 

 
(70
)
 
(164
)
 

 

 

 

 
(824
)
Deferred compensation plan share issuance

 

 
226

 

 
(26
)
 
127

 

 

 

 
(45
)
 
308

Purchase of stock

 

 

 

 
326

 
(4,591
)
 

 

 

 

 
(4,591
)
Equity-based compensation

 

 
2,236

 

 

 

 

 

 

 

 
2,236

Net income

 

 

 
16,165

 

 

 

 

 

 

 
16,165

Foreign currency adjustment

 

 

 

 

 

 

 

 
370

 

 
370

Pension loss adjustment, net of tax

 

 

 

 

 

 

 

 
(2,820
)
 

 
(2,820
)
Balances as of December 31, 2012
27,018

 
$
270

 
$
119,183

 
$
99,644

 
8,276

 
$
(50,302
)
 
3,363

 
$
(55,083
)
 
$
(10,680
)
 
$
(251
)
 
$
102,781

 
The accompanying notes are an integral part of these consolidated financial statements.

33


Notes to Consolidated Financial Statements

1.
Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
The consolidated financial statements include the accounts of Computer Task Group, Incorporated, and its subsidiaries (the Company or CTG), located primarily in North America and Europe. There are no unconsolidated entities, or off-balance sheet arrangements other than certain guarantees supporting office leases or the performance under government contracts in the Company's European operations. All inter-company accounts and transactions have been eliminated. Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with U.S. generally accepted accounting principles. Such estimates primarily relate to the valuation of goodwill, valuation allowances for deferred tax assets, actuarial assumptions including discount rates and expected rates of return, as applicable, for the Company’s defined benefit and postretirement benefit plans, the allowance for doubtful accounts receivable, assumptions underlying stock option valuation, investment valuation, legal matters, other contingencies and estimates of progress toward completion and direct profit or loss on contracts. The current economic environment has increased the degree of uncertainty inherent in these estimates and assumptions. Actual results could differ from those estimates.
The Company operates in one industry segment, providing IT services to its clients. These services include IT Solutions and IT Staffing. CTG provides these primary services to all of the markets that it serves. The services provided typically encompass the IT business solution life cycle, including phases for planning, developing, implementing, managing, and ultimately maintaining the IT solution. A typical customer is an organization with large, complex information and data processing requirements. The Company promotes a significant portion of its services through four vertical market focus areas: Healthcare (which includes services provided to healthcare providers, health insurers, and life sciences companies), Technology Service Providers, Financial Services, and Energy. The Company focuses on these four vertical areas as it believes that these areas are either higher growth markets than the general IT services market and the general economy, or are areas that provide greater potential for the Company’s growth due to the size of the vertical market. The remainder of CTG’s revenue is derived from general markets.
CTG’s revenue by vertical market for the years ended December 31, 2012, 2011 and 2010 is as follows:
 
 
2012
 
2011
 
2010
Healthcare
33
%
 
30
%
 
27
%
Technology service providers
31
%
 
34
%
 
36
%
Financial services
6
%
 
7
%
 
6
%
Energy
6
%
 
6
%
 
7
%
General markets
24
%
 
23
%
 
24
%
Total
100
%
 
100
%
 
100
%
Revenue and Cost Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, when the services have been rendered, when the price is determinable, and when collectibility of the amounts due is reasonably assured. For time-and-material contracts, revenue is recognized as hours are incurred and costs are expended. For contracts with periodic billing schedules, primarily monthly, revenue is recognized as services are rendered to the customer. Revenue for fixed-price contracts is recognized as per the proportional method of accounting using an input-based approach whereby salary and indirect labor costs incurred are measured and compared with the total estimate of costs of such items at completion for a project. Revenue is recognized based upon the percentage-of-completion calculation of total incurred costs to total estimated costs. The Company infrequently works on fixed-price projects that include significant amounts of material or other non-labor related costs which could distort the percent complete within a percentage-of-completion calculation. The Company’s estimate of the total labor costs it expects to incur over the term of the contract is based on the nature of the project and our past experience on similar projects, and includes management judgments and estimates which affect the amount of revenue recognized on fixed-price contracts in any accounting period.

34


The Company’s revenue from contracts accounted for under time-and-material, progress billing, and percentage-of-completion methods for the years ended December 31, 2012, 2011 and 2010 is as follows:
 
 
2012
 
2011
 
2010
Time-and-material
90
%
 
91
%
 
91
%