COMPUTER TASK GROUP INC - Annual Report: 2016 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2016

OR

For the Transition period from                      to                    

Commission File No. 1-9410

COMPUTER TASK GROUP, INCORPORATED

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (716) 882-8000 

Securities registered pursuant to Section 12(b) of the Act:

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 ☒

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 ☒

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 ☒    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 ☒    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:

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    YES ☐    NO ☒

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 $77.6 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 17, 2017 was 15,694,865.

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, 2016, 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

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 business strategy and expectations, new business opportunities, cost control initiatives, business wins, market demand, 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 clients and talent, including technical, sales and management personnel, (iii) increased bargaining power of large clients, (iv) the Company's ability to protect confidential client data, (v) the partial or complete loss of the revenue the Company generates from International Business Machines Corporation (IBM) and SDI International (SDI), (vi) the uncertainty of clients' implementations of cost reduction projects, (vii) the effect of healthcare reform and initiatives, (viii) the mix of work between staffing and solutions, (ix) currency exchange risks, (x) risks associated with operating in foreign jurisdictions, (xi) renegotiations, nullification, or breaches of contracts with clients, vendors, subcontractors or other parties, (xii) 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, (xiii) industry and economic conditions, including fluctuations in demand for IT services, (xiv) consolidation among the Company's competitors or clients, (xv) the need to supplement or change our IT services in response to new offerings in the industry or changes in client requirements for IT products and solutions, (xvi) the risks associated with acquisitions, and (xvii) 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).

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 3,400 people worldwide. During 2016, the Company had eight operating subsidiaries: Computer Task Group of Canada, Inc., providing services in Canada; Computer Task Group Belgium N.V., CTG ITS S.A., Computer Task Group IT Solutions, S.A., Computer Task Group Luxembourg PSF, Computer Task Group (U.K.) Ltd., and CTG Health Solutions N.V., each primarily providing services in Europe, and Computer Task Information Technology Private Services Limited, providing services in India. Services provided in North America are primarily performed by the parent corporation, CTG.

Services

The Company primarily operates in one industry segment, providing IT services to its clients. At the highest level, CTG delivers services that are considered either IT solutions, or IT and other staffing. CTG delivers 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 client is an organization with large, complex information and data processing requirements. The Company’s IT solutions and IT and other staffing services are further described as follows:

1

IT solutions and IT staffing and other revenue as a percentage of consolidated revenue for the years ended December 31, 2016, 2015 and 2014 is as follows:

Capabilities

CTG provides a full range of offerings spanning seven service areas that, collectively, address many of our clients’ most pressing technology and business challenges. CTG’s capabilities ensure that our clients are utilizing the right information technology to meet their business needs, maximizing the value from their IT systems, and operating in the most efficient and effective manner.

CTG’s flexible offerings are delivered as an IT solution or IT and other staffing service, or as a strategy or service offering, allowing CTG to meet the unique needs of each client. All offerings are supported with proven program and project management processes and tools that ensure the reliability, transparency, and accountability that CTG clients have come to expect.

CTG provides capabilities in the following service areas:

2

Vertical Markets

The Company promotes a majority of its services through five vertical market focus areas: Technology Service Providers, Manufacturing, Healthcare (which includes services provided to healthcare providers, health insurers (payers), and life sciences companies), Financial Services, and Energy. The remainder of CTG’s revenue is derived from general markets.

CTG’s revenue by vertical market as a percentage of consolidated revenue for the years ended December 31, 2016, 2015 and 2014 is as follows:

Revenue for the Company's technology service providers vertical market as a percentage of consolidated revenue increased in 2016 as compared with 2015 due to a change in business mix. Revenue from IBM, our largest client, which is included in this vertical market, remained consistent in 2016 as compared with 2015, which aided in minimizing the decrease in revenue in this vertical market. However, revenue from a number of our other vertical markets fell year-over-year. Demand from this vertical market did slow in the 2016 fourth quarter due to a reduction in requirements from IBM. The revenue increase for 2015 as compared with 2014 was due to strong demand for the first three quarters of 2015 from several of the Company's largest clients in its IT staffing services business unit, which are included in this vertical market. Demand from this vertical market did slow significantly in the 2015 fourth quarter, however, as several large clients cut back on their requirements for our services due to their own challenging financial results.

The revenue in our manufacturing vertical market is primarily generated from several large staffing clients, including Lenovo (through SDI as a vendor manager for Lenovo) which is our second largest client. Revenue from Lenovo and others in this vertical market fell throughout 2016 due to various reductions in requirements.  However, a reduction in revenue in other vertical markets reduced the impact of these losses as a percentage of total revenue. Revenue from Lenovo increased by approximately $7 million in 2015 as compared with 2014 primarily as a result of the acquisition from IBM of the x86 server business.

In 2014, 2015 and 2016, the demand from our healthcare clients decreased. This decrease was directly related to the U.S. federal government sequestration which cut Medicare reimbursements to hospitals and health systems by 2% starting in April 2013. As a result, the Company’s healthcare revenue, primarily from electronic health records (EHR) and related projects, declined in 2014, and continued to decrease in 2015 and 2016 as the Company continues to transform its business from selling primarily EHR projects to advisory and technical services, outsourcing, and staff augmentation.

Revenue for the Company’s financial services vertical market as a percentage of consolidated revenue increased in 2016 as compared with 2015 due to a change in business mix. Revenue in this vertical market decreased slightly in 2016, while revenue from a number of the other vertical markets had larger reductions during this time period. During 2015, the percentage of revenue attributable to the financial services market decreased from 2014, primarily due to the fact that most of the revenue generated in this vertical market is in Europe, and there was a significant decrease in the value of the Euro in 2015 as compared with 2014.

Revenue for the Company's energy vertical market decreased as a percentage of consolidated revenue in 2016 as compared with 2015, and in 2015 as compared with 2014, as demand in this vertical market declined. Generally, the decrease in the price of oil caused several of our clients to reduce their overall spending, including requirements for IT services, in each of 2016, 2015 and 2014.

For the year ended December 31, 2016, CTG provided its services to approximately 450 clients in North America and Europe. In North America, the Company operates in the United States and Canada, with greater than 99% of 2016 North American revenue generated in the United States. In Europe, the Company operates in Belgium, Luxembourg, and the United Kingdom. Of total 2016 consolidated revenue of $324.9 million, approximately 78% was generated in North America and 22% in Europe. Two clients, IBM and Lenovo (through SDI as a vendor manager), each accounted for greater than 10% of CTG’s consolidated revenue in 2016.

3

Revenue Recognition 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 client. Revenue for fixed-price contracts is recognized per the proportional method of accounting using an input-based approach. On a given project, actual salary and indirect labor costs incurred are measured and compared against the total estimated costs of such items at the completion of the 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.

The Company’s revenue from contracts accounted for under time-and-material, progress billing, and percentage-of-completion methods as a percentage of consolidated revenue for the years ended December 31, 2016, 2015 and 2014 is as follows:

As of December 31, 2016 and 2015, the backlog for fixed-price and all managed-support contracts was approximately $29.7 million and $30.2 million, respectively. Approximately 75% or $22.2 million of the December 31, 2016 backlog is expected to be earned in 2017. Approximately 68% of the $30.2 million of backlog at December 31, 2015, or $20.7 million, was earned in 2016. Revenue is subject to slight seasonal variations, with a minor slowdown and a decrease in billable resource utilization 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 client to whom services are provided. The Company’s competition comes from four major channels: large national or international companies, including major accounting and consulting firms and large companies headquartered in India; hardware vendors and suppliers of packaged software systems; small local firms or individuals specializing in specific programming services or applications; and from a client’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.

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 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.

4

Employees

CTG’s business depends on the Company’s ability to attract and retain qualified professional staff to provide services to its clients. 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 3,400 employees worldwide, with approximately 2,700 in the United States and Canada and 700 in Europe. Of these employees, approximately 3,100 are IT professionals and 300 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 About Geographic Areas

The following table sets forth certain financial information relating to the performance of the Company for the years ended December 31, 2016, 2015, and 2014. 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.

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 (Code of Conduct), committee charters and governance policies are also available without charge on the Company’s website at http://investors.ctg.com/governance.cfm. If applicable, the Company intends to disclose future amendments to, or waivers from, certain provisions of the Code of Conduct on the Company's website or in a current report on Form 8-K.

5

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, sales and management personnel, and our ability to recruit and retain these individuals.

We actively compete with many other IT service providers for qualified personnel, including professional IT staff, recruiters, sales people, and management. The availability of qualified personnel may affect our future ability to provide services and meet the requirements of our clients. An inability to fulfill client requirements at agreed upon rates due to a lack of available qualified personnel may adversely impact our revenue and operating results in the future.

Increased competition and the bargaining power of our large clients 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 we bill some of our larger clients for services due to highly competitive market conditions. Additionally, we actively compete against many other companies for business at both new and existing clients. Billing rate reductions or competitive pressures may lead to a further decline in revenue. When faced with such pressures, if we are unable to make commensurate reductions in our personnel costs, our margins and operating results would be adversely affected.

We derive a significant portion of our revenue from two clients, and a significant reduction in the amount of requirements requested by these clients would have an adverse effect on our revenue and operating results.

IBM and SDI are CTG’s two largest clients. CTG provides services to various IBM divisions in a number of locations. SDI acts as a vendor manager for Lenovo, and all of the Company's revenue generated through SDI relates to CTG employees working at various divisions of Lenovo. During 2014, the National Technical Services Agreement (NTS Agreement) with IBM was renewed for three years until December 31, 2017. In 2016, 2015, and 2014, IBM accounted for $98.4 million or 30.3%, $99.2 million or 26.9%, and $90.5 million or 23.0% of the Company’s consolidated revenue, respectively. SDI accounted for $34.5 million or 10.6%, $44.0 million or 11.9%, and $36.6 million or 9.3% of the Company's consolidated revenue, respectively, during these periods. The Company’s accounts receivable from IBM at December 31, 2016 and 2015 amounted to $28.0 million and $26.4 million, respectively, and accounts receivable from SDI amounted to $5.6 million and $5.5 million, respectively.

During the 2016 third quarter, the Company was informed by IBM that there would be significant reductions in both requirements and billable rates for certain of the employees provided to this client beginning in the 2016 fourth quarter. Originally, these employee reductions could have totaled as much as 40% of the revenue earned from IBM.  However, CTG was able to negotiate to retain a number of these requirements, although many of the retained employees were subject to reductions in billable rates. If IBM or Lenovo were to significantly reduce their requirements for the Company's services in future periods, our revenue and operating results would be adversely affected.

Our client contracts generally have a short term or are terminable on short notice, and a significant number of failures to renew contracts in place, or early terminations or renegotiations of our existing client 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 86.5% of our services on a time-and-materials basis during 2016. As such, our clients 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

6

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 improved future performance. Due to these factors, we believe that our results from operations in the future may fluctuate from period to period.

The introduction of new IT services or changes in client requirements for IT services may render our existing IT Solutions or IT Staffing offerings obsolete or unnecessary, 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 and other staffing services that anticipate and keep pace with rapid and continuing changes in technology, industry standards and client preferences and requirements. 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.

We could be subject to liability and damage to our reputation resulting from cyber attacks or data breaches.

Cyber risks for companies providing information technology (IT) and professional services, especially in healthcare-related and financial services industries, continue to increase. This increase in risk may be attributed to the value of intellectual property, the value of personal information or data used for identity theft and fraud, the increasing sophistication of attacks, the variety of threat actors and their motives such as organized crime, hackers, terrorists, activists, insider threats, foreign governments, and third parties, and the reliance on electronic communications, mobile technologies, cloud-based resources, smart devices, and emerging technologies. The Company’s operations, business, and its customers rely on the secure processing, transmission, storage and availability of information, services, and resources provided by its IT environments. The Company’s complex IT environments support a variety of technologies, industries, services, delivery teams, and clients globally.

Although the Company has not experienced any prior material data breaches or cyber security incidents, its environments may be impacted by cyber attacks or cyber security incidents caused via the aforementioned threat actors or the Company's personnel. These cyber security incidents could result in information loss, result in the disruption of the Company's internal and client-facing operations and services, adversely affect its adherence with regulatory requirements, or result in a data breach. Information losses and data breaches could include the unauthorized disclosure, misuse, loss, and destruction of both the Company’s and its clients’ intellectual property, financial information, or other regulated or privacy-related information, including but not limited to United States-designated personally identifiable information (PII), personal data under the European General Data Protection Directive (GDPR), and protected health information (PHI) under the United States Health Insurance Portability and Accountability Act of 1996 (HIPAA).

The Company’s failure to protect sensitive data and reasonably address the requirements of regulated data under its control could result in reputational damage, fines and penalties, litigation costs, external investigations, compensation costs including reimbursement and monetary awards, and/or additional compliance costs which could have a material, adverse impact on the Company's operations. It could also have an adverse impact on the Company’s ability to maintain and execute new contracts with clients that produce or work with similar data, and make it more difficult to retain and recruit qualified personnel to perform its services in the future. As the cyber threat landscape continues to evolve or the Company’s cyber risk profile changes, it may be required to expend additional resources to implement new or enhance existing risk mitigation strategies.

The foreign 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, in Belgium, Luxembourg, and the United Kingdom in Europe, and in India. 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 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.

7

Government cuts in healthcare programs, such as Medicare, and delays in legislative or regulatory healthcare mandates could cause a reduction in IT spending by our healthcare clients, which could materially and adversely affect our revenue and results of operations.

The Company’s growth efforts have previously been primarily focused in the healthcare market. Growth in this market depends on continued spending by our healthcare clients on IT projects. Cuts in government healthcare programs, such as sequestration, which cut Medicare reimbursements to hospitals and health systems in April 2013, may result in reduced expenditures by our healthcare clients on IT projects. If further government cuts in healthcare programs were to occur, whether due to the failure of Congress to adopt a budget, pass appropriations bills or raise the U.S. debt ceiling or for other reasons, there may be delays, reductions or cessation of funding to our clients, which could cause our clients to purchase less IT services from us, which could materially and adversely affect our revenue and results of operations.

In addition, delays in implementation of legislative or regulatory healthcare mandates could adversely affect the IT spending by our healthcare clients to implement such mandates. If the implementation of existing or contemplated legislative or regulatory healthcare mandates are deferred, the resulting reduction in IT spending by our healthcare clients could materially and adversely affect our revenue and results of operations.

Changes in government regulations and laws affecting the IT services industry, and the industries in which our clients operate, including accounting principles and interpretations, and the taxation of domestic 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.

The Financial Accounting Standards Board (FASB), the SEC, and the Public Company Accounting Oversight Board (PCAOB) or other accounting rule making authorities have issued and may continue to 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.

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.

8

Existing and potential clients 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 clients or retain existing clients.

In recent years, more companies have 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 outside of North America to mitigate and reduce this risk to our Company. However, the risk of additional outsourcing of IT solutions overseas to countries where we do not have operations could have a material, negative impact on our future operations.

Decreases in demand for IT Solutions and IT and Other 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 the past, when the world economy deteriorated, such as in 2008, there was a significant decline in demand for the Company’s services which negatively affected the Company’s revenue and operating results as compared with prior years. Declines in demand for the requirement for our IT services in 2017 or future years would adversely affect our operating results as it has in the past.

The IT services industry is highly competitive and fragmented, which means that our clients 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.

If we are unable to collect our receivables or unbilled services, our results of operations, financial condition and cash flows could be adversely affected.

Our business depends on our ability to successfully obtain payment from our clients of the amounts they owe us for work performed. We evaluate the financial condition of our clients and typically bill and collect on reasonable cycles. We might, however, not accurately assess the creditworthiness of our clients, or macroeconomic conditions could also result in financial difficulties for our clients, including bankruptcy and insolvency. In certain industries, some clients have requested longer payment terms, which has adversely affected, and may continue to adversely affect, our cash flows. The timely collection of client balances also depends on our ability to complete our contractual commitments as required. If we are unable to meet our commitments, or bill our clients on a timely basis, our results of operations and cash flows could be adversely affected. We have established allowances for losses of receivables and unbilled services where we deem the amounts to be uncollectible. The uncollectible amounts due to the Company from clients could differ from those that we currently anticipate.

Our share price could fluctuate and be difficult to predict.

Our share price has fluctuated in the past and could continue to fluctuate in the future in response to various factors, both external and internal. These factors include:

9

If we repatriate our cash balances from our foreign operations, we may be subject to additional tax liabilities.

We earn a portion of our operating income outside of the United States, and any repatriation of funds currently held in foreign jurisdictions to the United States may result in higher effective tax rates and additional tax liabilities for the Company. In addition, there have been proposals to change the tax laws in the United States that would significantly impact how United States-based multinational corporations are taxed on foreign earnings. Although we cannot predict whether or in what form, or in what time frame, any proposed legislation may be passed, if enacted, these tax laws could have a material adverse impact on our tax expense and cash flows.

Ineffective internal controls could impact the Company's business and operating results. 

The Company's internal control over financial reporting may not prevent or detect misstatements because of the inherent limitations of internal controls, including the possibility of human error, the circumvention or overriding of controls, poorly designed or ineffective controls, or fraud. Internal controls that are deemed to be effective can provide only reasonable assurance with respect to the preparation and fair presentation of the Company's financial statements. If the Company fails to maintain the adequacy of its internal controls, including the failure to implement new or improve existing controls, or fails to properly execute or properly test these controls, the Company's business and operating results could be negatively impacted and the Company could fail to meet its financial reporting obligations.

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 stock options for recording equity-based compensation expense, allowances for doubtful accounts receivable, investment valuation, discount rates associated with pension plans, incurred but not recorded claims related to the Company's self-insured medical plan, 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.

Risks to the Company from acquisitions include integration challenges, disruptions of the Company's core business, a failure to achieve objectives, and the assumption of liabilities.  

The Company regularly evaluates acquisitions to aid the Company's growth in revenue and profits by expanding the services the Company offers, and its client base. Acquisitions often present significant challenges and risks relating to the integration of the business into the Company, and there can be no assurances that the Company will manage future acquisitions successfully, that the Company's core business will not be significantly disrupted after an acquisition is finalized, or that strategic acquisition opportunities will be available to the Company on acceptable terms. The risks from an acquisition include the Company failing to achieve strategic objectives and anticipated revenue and profit improvements, borrowing a significant amount of money to fund the acquisitions which creates financial stress for the Company's operations, as well as failing to retain the key personnel of the acquired business. Finally, the assumption of liabilities related to litigation or other legal proceedings involving the acquired business may present a significant risk.

We may require additional capital to support our business, and this capital may not be available to us on acceptable terms, if at all.

We have a revolving line of credit of up to $40 million available to us. At December 31, 2016, we had $4.7 million of borrowings outstanding under our revolving credit line. We may be dependent on our revolving credit facility to meet working capital and operational requirements, and access to our facility is dependent on, among other things, compliance with applicable covenants, including a leverage ratio (total outstanding debt divided by earnings before interest taxes, depreciation and amortization), a calculation of minimum tangible net worth, and a limit on annual expenditures for

10

property, equipment, and capitalized software. The amount available for borrowing under the credit facility could be significantly reduced due to poor operational performance, or other factors. Any loss or material reduction of our ability to access funds under the credit facility could materially and negatively impact our liquidity.

None.

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, 2016, these properties were not used as collateral as part of the Company’s existing revolving credit agreement.

During 2016, the Company listed both its corporate headquarters and corporate administrative office building as management is exploring a potential sale, for an amount in excess of $3.0 million each. As the carrying value of these buildings is approximately $1.2 million and $1.8 million at December 31, 2016, respectively, the Company does not expect to record a loss on the sale of either of these buildings if they are sold.

All of the remaining Company locations, totaling approximately 20 sites, are leased facilities. Most of these facilities are located in the United States, with approximately four of these locations in Europe in the countries of Belgium, Luxembourg and the United Kingdom, where our European operations are located, and one in Hyderabad, India. These facilities generally serve as sales and support offices and their size varies with the number of people employed at each office, ranging from 300 to 26,000 square feet. 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.

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.

Not applicable.

11

PART II

Stock Market Information

The Company’s common stock is traded on The NASDAQ Stock Market LLC under the symbol CTG. 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.

On February 17, 2017, there were 2,096 holders of record of the Company’s common shares. The Company paid a quarterly dividend of $0.06 per common share during 2015, and for the first three quarters of 2016.  The dividend was suspended in the 2016 fourth quarter. At December 31, 2016, as per the Company's revolving line of credit, the Company is required to meet certain financial covenants in order to pay dividends. The Company was in compliance with these financial covenants at both December 31, 2016 and 2015. For additional information regarding these financial covenants, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition and Liquidity." The determination of the timing, amount and the payment of dividends, if any, on the Company’s common stock in the future 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 covenants under the Company's revolving credit agreement.

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

During the 2016 fourth quarter, the Company’s Board of Directors authorized the repurchase of up to $10.0 million of its stock over the next two years. This share repurchase authorization replaces the Company’s previous share repurchase program. The information below does not include shares withheld by or surrendered to the Company either to satisfy the exercise cost for the cashless exercise of employee stock options, or to satisfy tax withholding obligations associated with employee equity awards as the number of shares is minor.

12

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 2011. 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.

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.

13

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, 2016 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.

Included in net income is $0.2 million from a non-taxable life insurance gain for a former executive that passed away in 2015.

14

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 business strategy and expectations, new business opportunities, cost control initiatives, business wins, market demand, 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 clients and talent, including technical, sales and management personnel, (iii) increased bargaining power of large clients, (iv) the Company's ability to protect confidential client data, (v) the partial or complete loss of the revenue the Company generates from International Business Machines Corporation (IBM) and SDI International (SDI), (vi) the uncertainty of clients' implementations of cost reduction projects, (vii) the effect of healthcare reform and initiatives, (viii) the mix of work between staffing and solutions, (ix) currency exchange risks, (x) risks associated with operating in foreign jurisdictions, (xi) renegotiations, nullification, or breaches of contracts with clients, vendors, subcontractors or other parties, (xii) 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, (xiii) industry and economic conditions, including fluctuations in demand for IT services, (xiv) consolidation among the Company's competitors or clients, (xv) the need to supplement or change our IT services in response to new offerings in the industry or changes in client requirements for IT products and solutions, (xvi) the risks associated with acquisitions, and (xvii) 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. In 2016 there was a further overall decline in demand for our services as compared with 2015 and 2014 as many of our healthcare clients did not begin new projects when existing projects ended due to their capital constraints. Additionally, the demand for our IT staffing and other services from certain of our large staffing clients diminished throughout 2016.

The Company primarily operates in one industry segment, providing IT services to its clients. These services include IT solutions and IT and other staffing. With IT solutions services, we generally take responsibility for the deliverables on a project and the services may include high-end consulting. When providing IT and other staffing services, we typically supply personnel to our clients who then, in turn, take their direction from the client’s managers. The Company at times provides administrative or warehouse employees to clients to supplement the IT staffing resources we place at those clients.

IT solutions and IT and other staffing revenue as a percentage of consolidated revenue for the years ended December 31, 2016, 2015 and 2014 is as follows:

The Company promotes a majority of its services through five vertical market focus areas: Technology Service Providers, Manufacturing, Healthcare (which includes services provided to healthcare providers, health insurers (payers), and life sciences companies), Financial Services, and Energy. The remainder of CTG’s revenue is derived from general markets.

15

CTG’s revenue by vertical market as a percentage of consolidated revenue for the years ended December 31, 2016, 2015 and 2014 is as follows:

The IT services industry is extremely competitive and characterized by continuous changes in client 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 progress billing schedules, primarily monthly, revenue is recognized as services are rendered to the client. Revenue for fixed-price contracts is recognized per the proportional method of accounting using an input-based approach. On a given project, actual salary and indirect labor costs incurred are measured and compared against the total estimated costs of such items at the completion of the 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.

The Company’s revenue from contracts accounted for under time-and-material, progress billing, and percentage-of-completion methods as a percentage of consolidated revenue for the years ended December 31, 2016, 2015 and 2014 is as follows:

16

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 operations as included in Item 8, “Financial Statements and Supplementary Data” in this report.

2016 as compared with 2015

The Company recorded revenue in 2016 and 2015 as follows:

Reimbursable expenses billed to clients and included in revenue totaled $4.0 million and $6.5 million in 2016 and 2015, respectively.  The decrease in reimbursable expenses year-over-year is primarily due to a reduction in the number of consultants in our healthcare vertical market, as many of those employees travel to client locations to perform services.

The revenue decrease in North America in 2016 as compared with 2015 was primarily due to a significant decrease in demand for the Company's IT solutions business, primarily in our healthcare vertical market, and a decrease in demand for our IT and other staffing services business from several large clients. The revenue increase in Europe is primarily due to strong demand for the Company’s services in the European markets we serve.

On a consolidated basis, IT solutions revenue decreased $27.3 million or 22.4% in 2016 as compared with 2015. The Company’s healthcare vertical market grew from 2008-2012 primarily from installing electronic health records (EHR) systems in hospitals and health systems. As of today, EHR installations are largely complete within the U.S. healthcare market. Beginning in late 2014, the Company began to see significant reductions in billable resources at a number of its larger healthcare clients which further decreased IT solutions revenue in the Company's healthcare vertical market as existing projects came to an end. This decrease in spending on healthcare IT projects continued throughout 2016 for the clients that we serve. As part of our strategy to shift to non-EHR services, the Company expanded its healthcare IT business development team in 2016 with individuals who have experience selling healthcare IT services such as advisory and technical services, outsourcing, and staff augmentation.  However, in 2016 this team as a whole was not successful in reducing our revenue losses in this vertical market, and expanding the non-EHR healthcare related services we provide.

Also on a consolidated basis, IT and other staffing revenue decreased $17.3 million or 7.0% during 2016 as compared with 2015. The IT staffing decrease was primarily due to a decrease in demand from a number of the Company's largest staffing clients. Additionally, during the 2016 third quarter, the Company was informed by its largest client that there would be significant reductions in both requirements and billable rates for certain of the employees provided to this client beginning in the 2016 fourth quarter. Originally, these employee reductions could have totaled as much as 40% of the total revenue earned from this client.  However, CTG was able to negotiate the retention of a number of these requirements, although many of the retained employees were subject to reductions in billable rates. The Company reduced its cost structure supporting its staffing clients in the 2016 fourth quarter to partially offset this loss in revenue and reductions in billable rates.

17

The Company’s headcount was approximately 3,400 employees at December 31, 2016, which was a 6% decrease from approximately 3,600 employees at December 31, 2015.  Approximately 90% of this headcount is for technical resources, and 10% for support positions.

The increase in revenue in the Company’s European operations in 2016 as compared with the corresponding 2015 period was due to an increase in demand for the Company’s IT solutions services across a number of the vertical markets we serve, partially offset by weakness relative to the U.S. dollar of the currencies of Belgium, Luxembourg, and the United Kingdom, 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. In 2016 as compared with 2015, the average value of the Euro decreased 0.3%, and the average value of the British Pound decreased 11.3%. 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 2015 to 2016, total European revenue would have been approximately $0.6 million higher, or $71.2 million as compared with the $70.6 million reported. When considering the year-over-year change in revenue in constant currencies, revenue from our European operations increased 5.9%. Operating income was essentially unchanged in 2016 as compared with 2015 given the change in the exchange rates year-over-year.

The Company is currently assessing the potential impact, if any, that the United Kingdom’s pending exit from the European Union will have on the Company’s operations. As the total revenue generated by our British subsidiary is immaterial when compared with the Company’s total consolidated revenue, we do not expect the impact of the pending exit to have a material impact on the Company’s operations.

International Business Machines Corporation (IBM) was CTG’s largest client and accounted for $98.4 million or 30.3% and $99.2 million or 26.9% of the Company’s consolidated revenue in 2016 and 2015, respectively. During the 2014 fourth quarter, the NTS Agreement with IBM was renewed for three years until December 31, 2017. As part of the NTS Agreement, the Company also provides its services as a predominant supplier to IBM’s Integrated Technology Services and the Systems and Technology Group business units. This agreement accounted for approximately 89% of all of the services provided to IBM by the Company in 2016. As previously mentioned, although there could have been a significant reduction in the number of requirements from this client beginning in the 2016 fourth quarter, the headcount losses were partially mitigated as of the 2016 year-end, and the expected annual loss in revenue is approximately $15-20 million in 2017. The Company’s accounts receivable from IBM at December 31, 2016 and 2015 totaled $28.0 million and $26.4 million, respectively.

SDI was the Company's second largest client and accounted for $34.5 million or 10.6% and $44.0 million or 11.9% of the Company’s consolidated revenue in 2016 and 2015, respectively. SDI acts as a vendor manager for Lenovo, and all of the Company's revenue generated through SDI relates to CTG employees working at Lenovo. The Company's accounts receivable from SDI at December 31, 2016 and December 31, 2015 totaled $5.6 million and $5.5 million, respectively.

We expect to continue to derive a significant portion of our revenue from IBM and SDI in future years; however a significant decline or the loss of the revenue from these clients would have a significant negative effect on our operating results. No other client accounted for more than 10% of the Company’s revenue in 2016 or 2015.

Direct costs, defined as costs for billable staff including billable out-of-pocket expenses, were 81.8% of consolidated revenue in both 2016 and 2015. In the 2016 second quarter, the Company’s European operations recorded a payroll tax credit totaling approximately $0.7 million which reduced direct costs in 2016. The credited amounts returned certain costs incurred from 2011-2014, and the Company does not anticipate a significant credit in the future. In the 2015 second quarter, the Company recorded several charges totaling $2.1 million which increased direct costs. When considering these items, direct costs as a percentage of revenue in 2016 increased as compared with 2015. This increase was due to the significant shift in the mix of the Company's business to a much higher level of IT staffing revenue. These services are provided to the Company's largest IT staffing clients, which have much higher direct costs as a percentage of revenue as compared with the Company's IT solutions clients.

Selling, general and administrative (SG&A) expenses were 17.0% of revenue in 2016 as compared with 15.3% of revenue in 2015. The increase in SG&A expenses as a percentage of revenue in 2016 as compared with 2015 is primarily due to costs incurred by our operating units as the Company continues to make investments in sales, recruiting and delivery resources in order to focus on the Company’s long-term growth, and the loss of operating leverage from a decrease in revenue. Additionally, severance incurred for the resignation of two former executives totaled $1.5 million and was included in the 2016 results.

18

During the 2016 first quarter, the Company determined that a goodwill impairment indicator existed which required an interim impairment analysis. As a result of the analysis, the Company determined the implied fair value of its goodwill balance was below the carrying value. Accordingly, the Company recorded a non-tax deductible goodwill impairment charge of $21.5 million to reduce the value of its goodwill balance to the implied fair value. Additionally, during the 2016 third quarter, the Company determined that another goodwill impairment indicator existed which required a second interim impairment analysis. As a result of the analysis, the Company determined the implied fair value of its goodwill balance was again below the carrying value. Accordingly, the Company recorded a non-tax deductible goodwill impairment charge of $15.8 million to reduce the value of its goodwill balance to the implied fair value, which reduced the Company’s goodwill balance to $0.0.

The significant decrease in operating income in 2016 was due to the goodwill impairment charges taken in the 2016 first and third quarters totaling $37.3 million. Operating income (loss) was (10.3)% of revenue in 2016 as compared with 2.9% of revenue in 2015. Operating income (loss) from North American operations was reduced by goodwill impairment charges of $35.6 million, and totaled $(35.7) million in 2016 compared with $9.0 million in 2015. Operating income from our European operations was $2.4 million in 2016 compared with $1.7 million in 2015. The 2016 results in Europe were reduced by a goodwill impairment charge of approximately $1.7 million, offset by a payroll tax credit of $0.7 million recorded in the 2016 second quarter.

Other income (expense) was (0.1)% of revenue in 2016 and 0.0% of revenue in 2015. In 2015, the Company recorded a non-taxable life insurance gain of approximately $0.2 million as one of its former executives passed away in the 2015 fourth quarter. The Company received proceeds from the policy totaling approximately $0.4 million in the 2016 first quarter.

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 40%. The ETR in 2016 was (3.3)%, while the 2015 ETR was 39.3%.

The ETR was lower than the normal range in 2016 primarily due to the non-deductible goodwill impairment charges totaling $37.3 million in the 2016 first and third quarters, and also due to the extension of the Work Opportunity Tax Credit (WOTC) and the Research and Development tax credit (R&D) which were renewed by the U.S. federal government in the 2015 fourth quarter and were effective for all of 2016.  These credits totaled approximately $0.6 million.

Net loss for 2016 was (10.7)% of revenue or $(2.22) per diluted share, compared with net income of 1.8% of revenue or $0.41 per diluted share in 2015. Diluted earnings per share were calculated using 15.6 million weighted-average equivalent shares outstanding in 2016 and 15.9 million in 2015. The decrease in shares year-over-year is due to there being no dilutive effect of outstanding equity-based compensation grants in 2016 due to the net loss.

2015 as compared with 2014

The Company recorded revenue in 2015 and 2014 as follows:

Reimbursable expenses billed to clients and included in revenue totaled $6.5 million and $8.6 million in 2015 and 2014, respectively.  The decrease in reimbursable expenses year-over-year is primarily due to a reduction in the number of consultants in our healthcare vertical market, as many of those employees travel to client locations to perform services.

The revenue decrease in North America in 2015 as compared with 2014 was primarily due to a significant decrease in demand for the Company's IT solutions business, primarily in our healthcare vertical market, offset by a modest increase in demand for our IT and other staffing services business. The revenue decrease in Europe is primarily due to a significant decrease in the value of the Euro and the British pound as compared with the U.S. dollar.

19

On a consolidated basis, IT solutions revenue decreased $27.7 million or 18.5% in 2015 as compared with 2014. The Company's IT solutions healthcare vertical market revenue began to decrease with the sequestration imposed by the U.S. government starting on April 1, 2013, which reduced Medicare reimbursements to hospitals and health systems by 2%. This reduction in revenue for our healthcare clients caused them to significantly reduce planned expenditures for IT services, primarily for electronic health records (EHR) and related projects, beginning in the latter half of 2013. By late 2014 and continuing through all of 2015, the Company experienced significant reductions in billable resources at several of its larger healthcare clients which further decreased IT solutions revenue in the Company's healthcare vertical market as EHR projects come to an end. At the end of 2015, a majority of the EHR implementation projects at our clients were substantially complete.

Also on a consolidated basis, IT and other staffing revenue increased $3.9 million or 1.6% during 2015 as compared with 2014. The year-to-date IT staffing increase was primarily due to an increase in demand from the Company's largest staffing clients. However, demand for our IT staffing services began to slow in the 2015 third quarter, and further slowed in the 2015 fourth quarter (and remained soft in 2016), as our largest IT staffing clients experienced declines in their business and cut back on their IT spending for the Company's services. The Company’s headcount was approximately 3,600 employees at December 31, 2015, which was a 5% decrease from approximately 3,800 employees at December 31, 2014.

The decrease in revenue in the Company’s European operations in 2015 as compared with the corresponding 2014 was due to weakness relative to the U.S. dollar of the currencies of Belgium, Luxembourg, and the United Kingdom, 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. In 2015 as compared with 2014, the average value of the Euro decreased 16.5%, while the average value of the British Pound decreased 7.2%. 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 2014 to 2015, total European revenue would have been approximately $13.0 million higher, or $80.3 million as compared with the $67.3 million reported. When considering the year-over-year change in revenue in constant currencies, the revenue from our European operations increased 2.5%. Operating income would have been approximately $0.4 million higher in 2015 as compared with 2014 if there had been no change in the exchange rates year-over-year.

International Business Machines Corporation (IBM) was CTG’s largest client and accounted for $99.2 million or 26.9% and $90.5 million or 23.0% of the Company’s consolidated revenue in 2015 and 2014, respectively. During the 2014 fourth quarter, the NTS Agreement with IBM was renewed for three years until December 31, 2017. As part of the NTS Agreement, the Company also provides its services as a predominant supplier to IBM’s Integrated Technology Services and the Systems and Technology Group business units. This agreement accounted for approximately 90.0% of all of the services provided to IBM by the Company in 2015.

In January 2014, IBM announced its intention to sell its x86 server division to Lenovo, and the initial closing of that sale occurred on September 29, 2014. A portion of the Company's 2014 revenue from IBM was related to the x86 server division. The Company retained a significant share of the revenue derived from the x86 server division subsequent to the transition of the division from IBM to Lenovo.

The Company’s accounts receivable from IBM at December 31, 2015 and 2014 totaled $26.4 million and $7.8 million, respectively. The increase in accounts receivable is due to the Company removing itself in the 2015 third quarter from an advance pay program with IBM. Under the program, payments due from IBM in 65 days were paid in 15 days for a fee.

SDI was the Company's second largest client and accounted for $44.0 million or 11.9% and $36.6 million or 9.3% of the Company’s consolidated revenue in 2015 and 2014, respectively. SDI acts as a vendor manager for Lenovo, and all of the Company's revenue generated through SDI relates to CTG employees working at Lenovo. The Company's accounts receivable from SDI at December 31, 2015 and December 31, 2014 totaled $5.5 million and $9.2 million, respectively.

We continued to derive a significant portion of our revenue from IBM and SDI in 2016. No other client accounted for more than 10% of the Company’s revenue in 2015 or 2014.

20

Direct costs, defined as costs for billable staff including billable out-of-pocket expenses, were 81.8% of consolidated revenue in 2015 and 79.8% of consolidated revenue in 2014. The increase in direct costs as a percentage of revenue in 2015 compared with 2014 was due to the significant shift in the mix of the Company's business to a much higher level of IT staffing revenue. These services are provided to the Company's largest IT staffing clients, which have much higher direct costs as a percentage of revenue as compared with the Company's IT solutions clients. Additionally, the Company recorded charges totaling $2.3 million in the 2015 second quarter for the impairment of capitalized software ($1.1 million) related to an IT medical model for chronic kidney disease, and for severance charges ($1.2 million) in the Company's European operations. The impairment of the capitalized software occurred after the Company performed a review and determined that it had no net realizable value. Although the Company had previously experienced some sales success with research institutions, the Company has been unable to sell the product to payers, its intended market, and discontinued the effort to sell the technology. Of the total charges of $2.3 million, approximately $2.1 million was recorded in direct costs. Finally, these increases in direct costs in 2015 were partially offset by a reduction of the Company's accrual for fringe benefit costs primarily related to medical expenses of $1.4 million as actual costs incurred in the 2015 fourth quarter were $1.2 million less than those incurred in 2014 fourth quarter, and significantly less than planned.

Selling, general and administrative (SG&A) expenses were 15.3% of revenue in 2015 as compared with 15.8% of revenue in 2014. The SG&A decrease as a percentage of revenue in 2015 as compared with 2014 was primarily due to disciplined cost control, primarily related to the SG&A expenses associated with our operating units, and $2.0 million included in the 2014 balance associated with the death in the 2014 fourth quarter of the Company's Chairman and CEO.

Operating income was 2.9% of revenue in 2015 as compared with 4.4% of revenue in 2014. The decrease in operating income year-over-year was due to the significant decrease in IT solutions in the Company's business mix which has higher margins than the Company's IT and other staffing services, and the charges taken in the 2015 second quarter totaling $2.3 million. In 2014, operating income included costs of $2.0 million associated with the death of the Company's Chairman and CEO, and the software impairment charge of $1.5 million. Operating income from North American operations was $9.0 million and $14.2 million in 2015 and 2014, respectively, while European operations generated operating income of $1.7 million and $2.9 million in the corresponding periods. Operating income in 2015 in the Company’s European operations was reduced by the second quarter severance charge totaling $1.2 million, and would have been approximately $0.4 million higher if there had been no change in foreign currency exchange rates year-over-year.

Other income (expense) was 0.0% of revenue in 2015, and (0.1)% of revenue in 2014. In 2015, the Company recorded a non-taxable life insurance gain of approximately $0.2 million as one of its former executives passed away in the 2015 fourth quarter. The Company received proceeds from the policy totaling about $0.4 million in the 2016 first quarter.

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 40%. The ETR in 2015 was 39.3%, while the 2014 ETR was 38.9%.

Net income for 2015 was 1.8% of revenue or $0.41 per diluted share, compared with net income of 2.6% of revenue or $0.64 per diluted share in 2014. Diluted earnings per share were calculated using 15.9 million weighted-average equivalent shares outstanding in 2015 and 16.3 million in 2014. The decrease in shares year-over-year is due to a lesser dilutive effect of outstanding equity-based compensation grants in 2015.

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.

21

Goodwill Valuation

The goodwill recorded on the Company's condensed consolidated balance sheet at December 31, 2015 related to CTG’s Healthcare Solutions (CTGHS) reporting unit. In accordance with current accounting guidance for “Intangibles - Goodwill and Other,” the Company performs goodwill impairment testing at least annually (in the Company’s fourth quarter), unless indicators of impairment exist in interim periods. The Company uses the two-step approach to test goodwill for potential impairment. Step One compares the estimated fair value of a reporting unit with goodwill to its carrying value. If the carrying value exceeds the estimated fair value, Step Two must be performed. Step Two compares the carrying value of the reporting unit to the fair value of all of the assets and liabilities of the reporting unit (including any unrecognized intangibles) as if the reporting unit was acquired in a business combination. If the carrying amount of a reporting unit’s goodwill exceeds the implied fair value of its goodwill, an impairment loss is recognized in an amount equal to the excess.

During the 2016 first quarter, the Company determined that a goodwill impairment indicator existed which required an interim impairment analysis. This impairment indicator was a significant and sustained decrease in the Company’s overall market capitalization, as the Company’s stock price in the 2016 first quarter fell by as much as 29% from its value at December 31, 2015. As a result of this indicator, the Company conducted an interim analysis of CTGHS to determine if an impairment existed. In performing the assessment, the Company estimated the fair value of CTGHS based on a combination of the income and market approaches. The income approach uses a discounted cash flow (DCF) method which utilizes the present value of expected future cash flows to estimate fair value of the reporting unit. The future cash flows for CTGHS was projected based on estimates of future revenue, operating income and other factors such as working capital and capital expenditures and a discount rate used in the present value calculation. As part of the projections, the Company took into account expected industry and market conditions for the healthcare industry, as well as trends currently affecting CTGHS. The market approach utilizes multiples of revenue and earnings before interest expense, taxes, depreciation and amortization (EBITDA) to estimate the fair value of the reporting unit. The market multiples used for CTGHS were based on competitor industry data, along with the market multiples for the Company and other factors. The Company also completed a comparison of its overall market capitalization to the market value of CTGHS and the Company’s other non-reporting business units. Based upon the analysis performed, the Company determined that the fair value of CTGHS was less than its carrying value, which required the Company to perform a Step Two goodwill impairment test.

As a result of the first quarter Step Two analysis, the Company determined the implied fair value of its goodwill balance was below the carrying value. Accordingly, the Company recorded a non-tax deductible goodwill impairment charge of $21.5 million to reduce the value of its goodwill balance to the implied fair value.

During the 2016 third quarter, the Company again determined that goodwill impairment indicators existed which required an interim impairment analysis. These impairment indicators were the unexpected decline in the revenue and profits of the CTGHS business unit, the resignation of both the sales leader (who was the Company’s former CEO) and delivery leader of CTGHS in the 2016 third quarter, effectively leaving the business unit without executive leadership, and a continued decrease in the Company’s overall market capitalization. As a result of these indicators, the Company conducted an interim analysis of CTGHS to determine if an impairment existed. In performing the assessment, the Company again performed the procedures it had previously performed in the 2016 first quarter, as detailed above. The most significant changes in our Step One analysis from the first quarter to the third quarter were reductions in the Company’s estimates of future revenue and operating income based upon the unexpected negative trends experienced in the third quarter, as well as the resulting reductions in the revenue and EBITDA market multiples that correlate to the decline in the Company’s overall market capitalization. Based upon the analysis performed, the Company determined that the fair value of CTGHS was less than its carrying value, which required the Company to perform a Step Two goodwill impairment test.

As a result of the third quarter Step Two analysis, the Company determined the implied fair value of its goodwill balance was below the carrying value. Accordingly, the Company recorded a non-tax deductible goodwill impairment charge in the 2016 third quarter of $15.8 million which reduced the value of its goodwill balance to the implied fair value, or $0.0 as of September 30, 2016.

22

Income Taxes—Valuation Allowances on Deferred Tax Assets

At December 31, 2016, the Company had a total of approximately $6.9 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, 2016, the Company had deferred tax assets recorded resulting from net operating losses in previous years totaling approximately $1.0 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, 2016, the Company had offset a portion of these assets with a valuation allowance totaling approximately $0.9 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 2016 would have increased or decreased net loss by approximately $335,000, 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, discount rates associated with pension plans, incurred but not reported healthcare claims, 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 (used in) operating activities was $2.1 million, $(4.0) million and $7.4 million in 2016, 2015 and 2014, respectively. In 2016,the net loss was $(34.6) million, while other non-cash adjustments, primarily consisting of depreciation expense, equity-based compensation, deferred income taxes, deferred compensation, and goodwill impairment charges totaled $40.0 million. In 2015 and 2014, net income was $6.5 million and $10.4 million, respectively, while the corresponding non-cash adjustments netted to $4.9 million and $7.7 million, respectively.

Accounts receivable balances increased $0.7 million in 2016 as compared with 2015, increased $6.0 million in 2015 as compared with 2014, and increased $2.6 million in 2014 as compared with 2013. The increase in the accounts receivable balance in 2016 resulted from an increase in days sales outstanding (DSO). DSO is calculated by dividing accounts receivable obtained from the consolidated balance sheet by average daily revenue for the fourth quarter of the respective year. DSO was 85 days at December 31, 2016 as compared with DSO at December 31, 2015 of 76 days. The increase was due to the timing of payments received from our largest client in relation to quarter-end, and a general lengthening of payment terms from the largest clients in our IT staffing and other business. The increase in DSO was offset by a reduction in year-over-year revenue in the 2016 fourth quarter of 8.0%. The increase in the accounts receivable balance in 2015 as compared with 2014 resulted from an increase in DSO to 76 days at December 31, 2015 from 66 days at December 31, 2014 as the Company removed itself from an advance pay program with its largest client in 2015 where invoices that had previously been paid in 15 days for a fee were now paid in 70 days. The increase in DSO was partially offset by a decrease in revenue in the 2015 fourth quarter of approximately 14.3% when compared with the 2014 fourth quarter. The increase in the accounts receivable balance in 2014 as compared with 2013 resulted from an increase in DSO of four days from 62 days at December 31, 2013.

23

The cash surrender value of life insurance policies increased $0.8 million in 2016, increased $0.2 million in 2015, and increased $0.8 million in 2014. The increase in each of the years were due to normal appreciation of the existing cash surrender value that the Company has recorded which totaled approximately $31.0 million. Accounts payable decreased $1.1 million in 2016, decreased $1.2 million in 2015, and decreased $2.4 million in 2014. The decrease year-over-year in all years presented was primarily due to lower payables as the Company's business contracted, and the timing of certain payments near year-end. Accrued compensation was essentially unchanged in 2016 as compared with 2015 as the U.S. bi-weekly payroll was paid on the last business day of the year consistent with 2015, decreased $9.1 million in 2015 primarily due to the timing of the U.S. bi-weekly payroll which was paid on the last business day of the year in 2015 and lower headcount, and decreased $3.2 million in 2014 primarily due to lower incentive compensation. Income taxes receivable were essentially unchanged in 2016 due to the timing and amount of payments made in 2016, decreased $1.9 million in 2015 due to the timing of payments made in 2015, and increased $2.3 million in 2014 due to the timing of estimated payments made and lower taxable income.

Investing activities used $2.6 million, $2.0 million, and $3.7 million of cash in 2016, 2015 and 2014, respectively, primarily due to additions to property, equipment and capitalized software of $2.2 million in 2016, $1.9 million in 2015, and $3.1 million in 2014. The Company has no significant commitments for the purchase of property or equipment at December 31, 2016, and does not expect the amount to be spent in 2017 on additions to property, equipment and capitalized software to significantly vary from the amount spent in 2016.

As of December 31, 2016, the Company has both its corporate headquarters and corporate administrative office building listed as management is exploring a potential sale, each for an amount in excess of $3.0 million. As the carrying value of these buildings is approximately $1.2 million and $1.8 million at December 31, 2016, respectively, the Company does not expect to record a loss on the sale of either of these buildings if they are sold.

Financing activities used $0.5 million, used $23.0 million, and used $7.8 million of cash in 2016, 2015 and 2014, respectively. The Company recorded $0.3 million, $3.0 million, and $3.2 million during 2016, 2015, and 2014, respectively, from the proceeds from stock option exercises and excess tax benefits from equity-based compensation transactions. These amounts decreased in 2016 as compared with 2015 and 2014 primarily due to a lower average stock price in 2016 which led to fewer stock option exercises, and lower tax benefits from equity-based compensation activity.

The Company paid dividends totaling $2.9 million in 2016, $3.6 million in 2015 and $3.4 million in 2014.  Dividends paid in 2016 were lower than previous years as the Company suspended the payment of its dividend in the 2016 fourth quarter.

During the 2016 fourth quarter, the Company’s Board of Directors authorized the repurchase of up to $10 million of its stock over the next two years. This share repurchase authorization replaced the Company’s previous buyback program. During 2016, 2015 and 2014, the Company used $1.2 million, $1.4 million, and $7.4 million, respectively, to purchase approximately 0.3 million, 0.2 million, and 0.5 million shares of its stock for treasury. Approximately $8.8 million, and 0.5 million and 0.6 million shares, respectively, remained authorized for future purchases under the Company’s share repurchase plans at December 31, 2016, 2015 and 2014, respectively. At December 31, 2016, 2015 and 2014, the Company also experienced changes in its cash account overdrafts, which are primarily due to the timing of payments near year-end, of $(0.4) million, $0.4 million, and $(0.4) million, respectively.

During 2015, the Company paid off loans it had previously taken against its owned life insurance policies totaling $22.8 million. The Company chose to pay off these loans as it could obtain bank financing at a lower rate of interest. No such payments were made in 2016 or 2014.

In April 2014, the Company's unsecured revolving credit agreement, which allowed the Company to borrow up to $35.0 million, expired. During April 2014, the Company entered into a new, demand line of credit with its banks totaling $40.0 million, which was extended for three years until April 2017. In October 2015, the Company entered into a new unsecured revolving credit agreement which replaced the demand line of credit and allows the Company to borrow up to $40.0 million. The agreement also allows under its provisions for the Company to borrow up to $17.5 million against the cash surrender value of the Company's life insurance policies. The new agreement expires in October 2018, and has interest rates ranging from 0 to 50 basis points over the prime rate, and 150 to 200 basis points over LIBOR. The Company can borrow under the agreement with either a prime rate or LIBOR rate borrowing at its discretion. There was $4.7 million, $1.2 million, and $0.0 outstanding under the Company’s lines of credit at December 31, 2016, 2015, and 2014, respectively. The Company borrows or repays its debt as needed based upon its working capital obligations, including the timing of the U.S. bi-weekly payroll.

24

The maximum amount outstanding under its credit agreements in 2016 and 2015 was $4.7 million and $10.0 million, respectively. The Company did not borrow any funds under its various credit agreements at any time during 2014. The average amounts outstanding during 2016 and 2015 were $1.9 million and $5.0 million, respectively, and carried weighted-average interest rates of 2.9% and 1.8%, respectively. Total commitment fees incurred in 2016, 2015 and 2014 totaled less than $0.1 million in each year, while interest paid in 2016 and 2015 also totaled less than $0.1 million in each year.

Under the new agreement, 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, 2016, included a leverage ratio (total outstanding debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA) which must be no greater than 2.75 to 1, a calculation of minimum tangible net worth (total shareholders' equity less goodwill and intangible assets) which must be no less than $49.5 million, and total annual expenditures for property, equipment and capitalized software must be no more than $5.0 million. The Company was in compliance with these covenants at December 31, 2016 as the leverage ratio was 0.66, the minimum tangible net worth was $80.9 million, and capital expenditures for property, equipment and capitalized software were $2.2 million in 2016. The Company was also in compliance with its covenants at December 31, 2015.

Of the total cash and cash equivalents reported on the consolidated balance sheet at December 31, 2016 of $9.4 million, approximately $8.6 million is held by the Company’s foreign operations and is considered to be indefinitely reinvested in those operations. 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 generally required to meet the working capital needs of its foreign operations.

At December 31, 2016, the Company believes existing internally available funds, cash potentially generated from future operations, funds available under the Company's revolving line of credit totaling $35.3 million, and funds available to be borrowed against the cash surrender value of our life insurance policies of $17.5 million, will be sufficient to meet foreseeable working capital and capital expenditure needs, fund stock repurchases, pay a dividend (if any), fund acquisitions, and allow for future internal growth and expansion.

Off-Balance Sheet Arrangements

The Company did not have off-balance sheet arrangements or transactions in 2016, 2015 or 2014 other than guarantees in our European operations which support office leases and performance under government contracts. These guarantees totaled approximately $1.1 million at December 31, 2016.

Quantitative and Qualitative Disclosures about Market Risk

The Company’s primary market risk exposure consists of foreign currency exchange risk associated with the Company’s European operations. See Item 7A, “Quantitative and Qualitative Disclosure about Market Risk” in this report.

Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, "Revenue from Contracts with Customers (Topic 606)," ("ASU 2014-09"). ASU 2014-09 outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This new revenue recognition model provides a five-step analysis in determining when and how revenue is recognized. The new model will require revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration a company expects to receive in exchange for those goods or services. The pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is only permitted in years beginning after December 31, 2016.

The Company currently records approximately 98% of its annual revenue on a time-and-materials and progress billing basis, with the remaining 2% recorded under a proportional method of accounting using an inputs based methodology for fixed price projects.  For the 98% of the Company’s revenue recorded under the time-and-material method of accounting, the Company does not expect this new standard to change the timing or the amount of revenue that is recorded. The Company is currently evaluating the revenue recorded under its fixed price projects to determine if the manner or timing of revenue recognition would change for existing projects. However, the Company does not expect the impact of adopting this new accounting guidance will have a material impact on its consolidated operating results, and the related footnote disclosures.

25

In November 2015, the FASB issued ASU 2015-17, “Balance Sheet Classifications of Deferred Taxes,” which amended accounting guidance related to the presentation of deferred tax liabilities and assets. The amended guidance requires that all deferred tax liabilities and assets be classified as noncurrent on the balance sheet. This guidance is effective for reporting periods beginning after December 15, 2016. This guidance can also be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. Upon adoption of this guidance in 2017, the Company, given current financial results, would reclassify approximately $0.9 million from current to non-current assets.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. Topic 842 supersedes the previous leases standard, ASC 840, Leases. This guidance is effective for reporting periods beginning after December 15, 2018; however, early adoption is permitted. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. The Company is currently evaluating the impact that ASU 2016-02 will have on its condensed consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which amended accounting guidance related to seven aspects of the accounting for share-based payments award transactions. This guidance is effective for reporting periods beginning after December 15, 2016. Although the Company does not believe the impact of adopting ASU 2016-09 will have a material impact on its consolidated financial statements in 2017, the Company does anticipate recording approximately $0.1 million of additional tax expense for tax shortfalls in the 2017 first quarter that would previously have been recorded to capital in excess of par value.

Contractual Obligations

The Company intends to satisfy its contractual obligations from operating cash flows, and, if necessary, from draws on its demand credit line. A summary of the Company’s contractual obligations at December 31, 2016 is as follows:

26

The Company also has a non-qualified defined-contribution deferred compensation plan for certain key executives. Contributions to this plan in 2016 were $0.2 million. The Company anticipates making contributions totaling approximately $0.1 million in 2017 to this plan for amounts earned in 2016.

The Company’s primary market risk exposure consists of foreign currency exchange risk associated with the Company’s European operations.

During 2016, revenue was affected by the year-over-year foreign currency exchange rate changes of Belgium, Luxembourg, and the United Kingdom, 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 2015 to 2016, total European revenue would have been approximately $0.6 million higher in 2016, or $71.2 million as compared with the $70.6 million reported. Operating income in the Company’s European operations would not have been significantly impacted by the change in foreign currency exchange rates year-over-year.

The Company has historically not used any market rate sensitive instruments to hedge its foreign currency exchange risk as it conducts its foreign operations in local currencies, which generally limits 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.

27

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, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), cash flows, and changes in shareholders’ equity for each of the years in the three‑year period ended December 31, 2016. 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, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three‑year period ended December 31, 2016, 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, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 24, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

Buffalo, New York

February 24, 2017

28

Consolidated Statements of Operations

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

29

Consolidated Statements of Comprehensive Income (Loss)

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

30

Consolidated Balance Sheets

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

31

Consolidated Statements of Cash Flows