CDI Corp. Q3 2008 Earnings Call Transcript

CDI Corp. (CDI)

Q3 2008 Earnings Call Transcript

October 30, 2008, 11:00 am ET

Executives

Vince Webb – VP, Corporate Communications and Marketing

Roger Ballou – President and CEO

Mark Kerschner – EVP and CFO

Analysts

Jeff Silber – BMO Capital Markets

Presentation

Operator

Good morning ladies and gentlemen, my name is Kathleen and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter CDI investors’ conference call. (Operator instructions) It is now my pleasure to turn the floor over to your host Vince Webb. Sir, you may begin your conference.

Vince Webb

Okay, thank you, Kathleen. Good morning and welcome to the third quarter conference call for 2008. At this point, you should have a copy of the third quarter press release. If not, please call our office at 215-636-1162 and we'll be happy to send one to you immediately after the call. A replay of today's call will begin one hour after we've finished and will run for one week. It can be accessed by dialing 706-645-9291 and entering the pass code 67253495. In addition, a replay will be made available on the Internet at cdicorp.com for the next 14 days.

On the line with us today are CDI President and Chief Executive Officer, Roger Ballou and our Executive Vice President and Chief Financial Officer, Mark Kerschner. We'll begin with some remarks by Roger and then the line will be opened up for questions.

As a reminder, this conference call includes forward-looking statements which are subject to risks and uncertainties. Actual results may differ materially from those projected in these forward-looking statements. We would therefore like to point out the cautionary language regarding forward-looking statements contained in the news release and remind everyone that the same language applies to any comments made during this conference call.

Now, at this time, I'd like to turn the call over to Mr. Roger Ballou. Roger, please go ahead.

Roger Ballou

Thank you Vince and thanks to all of you for joining us this morning. How about those fillings by the way as a starter?

Following my opening remarks, Mark and I will be happy to answer your questions.

The third quarter was a challenging period for CDI. Overall, I was very satisfied with our ability to react to quickly changing economic and for a short period meteorological events. Our entire management team recognized the need to be proactive in the face of a shifting global business environment and I feel we kept our focus on monitoring and reacting effectively to the marketplace.

Top line revenue declined by 5.6% versus the year ago quarter to $281.9 million. More than half of the revenue decline was driven by the weakening in North American and the UK employment markets that began earlier in the year and continued throughout the third quarter. Permanent hiring in the UK property development and residential housing construction sectors remained weak and MRI continued to see softness in the consumer product and services industry as well as in the industrial and financial service segments of our franchise offices’ customer base. A significant foreign currency impact and the previously announced impact of the Gulf Coast hurricane accounted to the balance of the revenue decline versus the prior year quarter. Our entire Gulf Coast engineering operation has recovered from the shutdown and we anticipate a catch-up in delayed projects. However in the third quarter there was a reduction that we announced of $2.2 million in operating profits due to these delays.

As reported, the company generated earnings of $0.41 per diluted share during the quarter but there are moving parts that I want to point out to you to get a better look at year-over-year comparisons. As reported earlier in the October 8 press release, we recognized $2.2 million in foreign research and development tax credits for the years 2005 and 2006. In today’s press release we noted that we have also recognized an additional $1.1 million in research and development tax credits for 2007 and year-to-date 2008. In prior years we recorded those R&D tax credits on a cash basis, however based on the past successful applications and after consultations with our outside auditors, we believe it is appropriate to record these credits on an accrual basis going forward.

During the third quarter we also incurred pretax costs of $0.5 million associated with these tax credits. These costs are reflected in corporate expense for the quarter. Additionally the company incurred $0.5 million in costs during the quarter related to a previously announced major account expansion in our IT solutions segment which should produce profitable revenue growth in later quarters. As disclosed on October 21, the United Kingdom’s office of fair trading issued a draft Statement of Objections in which the OFT proposes to make a finding that the company’s AndersElite subsidiary violated the UK Competition Act of 1998. The OFT has been investigating a less handy competitive behavior by Anders and a number of its competitors in the UK construction recruitment industry. We are in the process of reviewing the OFTs document while we have until January 9, 2009 to respond to the OFT regarding its content, the document does not propose a specific find nor does it provide a enough new information for the company to determine with any reliability the amount of the fine or an estimated range of the fine, nor does the document make it clear when we might be able to reach a reliable estimate of the fine or the range of the fine. We have therefore not made any provisions for the matter in our consolidated financial statements.

As we stated previously we anticipate that a fine will be imposed and we continue to believe it could be an immaterial amount. We continue to fully cooperate with the OFT investigation under the corporate leniency program. As soon as we have sufficient information to estimate the potential amount of any fine or any estimated range of the fine, we will record a charge to earnings. We remain firmly committed for our long-term business strategy however built on three factors. First, our business development efforts will continue to focus on providing customers with services at the upper end of the value continuum, services like engineering, IT outsourcing, project management, permanent placement and franchise services. Secondly, we believe that there is long-term secular drivers who will require massive capital investment in the markets including the development of clean and sustainable energy resources, specialty chemical production, infrastructure build out, upstream refining expansion, commercial and military aircraft development, and sustained homeland security investments. Third, we believe that CDI needs to focus on increasing our service delivery capability in a global marketplace to meet the needs of our current customers as well as to create new customer relationships as we grow. Despite the current economic volatility, we are convinced that these are the three critical drivers of our future growth. We will make short-term tactical decisions to adjust for short-term economic conditions. We will remain focused on these three long-term realities.

Now let us look at our third quarter performance in each of our business units. Overall, we are pleased with performance in Engineering Solutions during the quarter. Year-over-year revenue growth would have been positive when adjusted to the effects of the Gulf Coast hurricane which primarily impacted the process in industrial vertical causing project delays. As we noted previously, we expect to recapture most of this lost revenue in future quarters. Government services revenue increased by 18.2% over the prior year quarter reflecting ramp up of previously announced projects and growth in existing accounts. Aerospace revenue increased by 7.7% reflecting the impact of our acquisition of TK Engineering for a partial period somewhat offset by the loss of three days due to the storm impact in the Cincinnati area. We are pleased with the integration of TK into our overall aerospace business and that is meeting our forecasted expectations. As we have noted previously, we remain interested in additional acquisitions that could add skills or scale for engineering services portfolio. Engineering Solutions operating profit declined by 19% versus the prior year due primarily to the Gulf Coast hurricanes’ impact on higher margin alternative energy projects in the P&I vertical. Continued permanent placement weakness in sectors of the US economy primarily in consumer products and the industrial and financial services sectors contributed to the 12.7% decline in year-over-year third quarter revenue at our MRI segment.

Additionally contract staffing revenue declined by about 10% versus a year ago due to softness in domestic employment markets. Operating profit declined by 27.8% due to the slowdown in high margin royalties. The weakness in permanent placement is not evenly distributed throughout the MRI franchise office system. Those with services in healthcare, business services and technology are performing better than average and generally having some growth. We expect to accelerate our focus on training and back to basics operational metrics in the fourth quarter. We also appointed a new president at the MRI business unit Tony McKinnon. Mr. McKinnon is a veteran executive with extensive experience in providing effective services to multi-office networks of entrepreneurially driven owners and managers.

AndersElite revenue was down 16.3% during the quarter on a year-over-year basis or down 11.3% on a constant currency basis driven by continued weakness in the property development and residential housing construction sector of the UK economy. We anticipate continued weakness here and have devised strategies to redeploy recruiters into healthier parts of the UK construction market to build national account relationships to capture a larger share of perm placement assignments from new and existing customers and to focus on growth in Australia and the Middle East. Anders has of course continued to align cost with marketplace changes and has consolidated some offices as well as reduced headcount where necessary.

IT solutions revenue declined 2.2% versus the prior year quarter reflecting declines in retail staffing in the automotive sectors somewhat offset by the ramp up of a previously announced account expansion of a major IT client. Operating profits declined by 32% on a year-over-year basis due primarily to the aforementioned factors as well as the account expansion costs of $0.5 million. We anticipate a continued ramp up of this large IT account to contribute to improved profits in future quarters. We also expect this to be offset somewhat by softness in retail accounts and continued decline in the automotive sector.

Now let’s look at some of the financial details for the quarter. We continue to monitor cash and days sales outstanding very closely. We finished the quarter with $77.5 million in cash and cash equivalents in a quarter that included the purchase of TK Engineering, our stock repurchases, an increase in capital spending due primarily to software acquisitions in our aerospace vertical, and the continued payment of our dividend. We anticipate a return to more normal ranges of capital spending in the fourth quarter. With our cash on hand and untapped borrowing capacity, we should have sufficient resources to support organic growth, capital spending, our stock repurchase programs, shareholders’ dividends and strategic acquisitions. As noted in the release, we purchased 880,672 shares of common stock during the third quarter. We also purchased approximately 536,000 additional shares in the first weeks of the fourth quarter under the stock repurchase program which authorizes us to purchase up to $50 million in CDI stock.

Corporate overhead decreased by 11.2% on a year-over-year basis primarily reflecting lower variable compensation cost and cost containment efforts somewhat offset by the cost associated with the previously mentioned research and development tax credits in the quarter. CDI will also pay a quarterly dividend of $0.13 per share to all shareholders of record as of November 12, 2008 to be paid on November 26, 2008. Looking ahead, we anticipate continued weakness in hiring demand over the short-to-medium term particularly in the UK sectors mentioned previously as well as in US consumer products and industrial and finance sectors. In spite of anticipated growth in aerospace, government services and in life sciences the global market environment could cause total fourth quarter revenues to decline 9% to 12% or 4% to 6% in constant currency terms based on the exchange rates as of 10-28. We also anticipate a pretax operating profit decline of 30% to 40% versus the prior year quarter.

As noted in our release, the current economic environment makes it difficult to provide reliable guidance for 2009. Internally, we built three different financial models reflecting different macroeconomic scenarios for 2009. We looked at every CDI business unit’s results during past economic recessions and factored those past trends into an analysis of our current business models. For example, at MRI, we looked at white collar unemployment rates during the 1990 to 1992 and the 2001 to 2002 periods where we experienced downturns as well as the changes in GDP during those periods. These two variables proved to be highly predictive of future royalty trends. We modeled various GDP and white collar unemployment scenarios for 2009 and factored in our current 100% franchise-owned business model to arrive at potential revenue outcomes for 2009.

We have done similar modeling for Engineering Solutions using the 2000 to 2002 downturn and 1980 to 1982 downturn. To that model, we factored in variables not present in the prior periods, elements like a strong Canadian energy market and aerospace R&D spending environments offset somewhat by potential project cancellations due to the credit crunch and falling oil prices that could impact our process in industry vertical. We continue to monitor market and economic trends to evaluate our modeling assumptions however it is clear to us that we are facing negative conditions in most sectors. In light of these adverse macroeconomic factors we have been and we will continue to be aggressive in executing cost-reduction initiatives to better align our cost structure with overall revenue trends. We will however maintain prudent investments in business development and improvements to our service infrastructure.

Overall, we feel we have a good strategic mix of businesses that rotate in different cycles compared to the past recession period. We have a more globally balanced portfolio with a strong base of blue chip clients. We also have a robust management business review process to quickly identify and react to changing market conditions.

With that, Mark and I would be happy to take your questions. Operator, can we go ahead and get the Q&A.

Question-and-Answer Session

Operator

(Operator instructions) Your first question is coming from Jeff Silber of BMO Capital Markets.

Jeff Silber – BMO Capital Markets

That is close enough, how are you doing this morning?

Roger Ballou

Good Jeff, how are you?

Jeff Silber – BMO Capital Markets

All right. I would like to start just in terms of the fourth quarter guidance. When you are looking at a decline in constant currency about 4% to 6%, I know you are not going to give guidance by specific segments but if you can just rank the segments along that spectrum I think it would help us.

Roger Ballou

Yes, I would expect to see significant continuing slowdowns in Anders and MRI. We would expect to see the other two businesses flat to slightly up. So the shrinkage in general will be in those two segments.

Jeff Silber – BMO Capital Markets

Okay, great, that’s helpful. Again focusing on guidance, this 30% to 40% decline in operating income, it looks like it is a little what I would call less worse than what you saw in the third quarter, I know in the third quarter you had the Gulf Coast impact, you also had the costs and the tax credit, any other reason why things would “improve” third quarter to fourth quarter?

Roger Ballou

Let me tell you that a piece of it is the continuing rollout of the significant IT account that we referred to. So in the third quarter we have $0.5 million of costs related to that new account win and we are really just beginning to see revenue from the account. In the fourth quarter we will see substantially more revenue so there should be an uptick there. That is one element of it. The other is that we are expecting the claw back in the fourth quarter of the significant slowdown from the hurricane. So if you look at those two things alone as well as the absence of the $0.5 million in costs related to the R&D credits, you have got a little over $3 million that should not recur in the fourth quarter in a direct fashion. So that is the predominant factors in there Jeff.

Jeff Silber – BMO Capital Markets

Okay. Just a few numbers and then I will let somebody else jump on, other income went up to actually roughly to double to year over year, is that kind of rate we should expect to continue at?

Roger Ballou

No. Under accounting rules Jeff, what we do is we indicated we occasionally engage in transactions in foreign currency to protect our income coming into the country. We did cashless collars [ph] around currency for the UK, Canada, etc and you have to mark those to market currently in the quarters, so with the significant rise of the dollar against currencies in the third quarter, we had mark ups on some of those open contracts that gets reflected to other income and at the unit level, we reflect the actual currency exchange rate in reflecting their income up there. So you see a drop in income at the unit when the dollar rises but it is offset by a rise down in the other income because we have got a mark to market.

Jeff Silber – BMO Capital Markets

Got it, okay that is helpful. What was stock-based compensation in the quarter?

Roger Ballou

$980,000, I think it was.

Mark Kerschner

$950,000.

Roger Ballou

$950,000.

Jeff Silber – BMO Capital Markets

$950,000, great, and then in terms of the impact of the share repurchase and the share count for the fourth quarter, roughly what should we be modeling for diluted shares?

Roger Ballou

What I can tell you is that we are a little under 19 million shares. If you look at the end of the third quarter in the release itself, we give you what we averaged for the quarter which is 20 million and 23 million. We started the prior quarter, was it 20.4, so obviously during the quarter we came down 8.80, so you can look at having an end point in the third quarter around 19.55 and then we bought back roughly 530,000 shares incrementally.

Jeff Silber – BMO Capital Markets

Okay, great, that’s helpful and what should we be using for tax rate in the quarter, fourth quarter?

Roger Ballou

36% to 38%.

Jeff Silber – BMO Capital Markets

Alright, good, I will turn back into the queue, thanks.

Roger Ballou

Okay. Kathleen, any others?

Operator

(Operator instructions) There appears to be no further questions. We have a follow-up question from Jeff.

Jeff Silber – BMO Capital Markets

Okay I should have just continued, some of the other companies we have been talking to in this sector had talked about some of the banks that they are dealing with coming back and maybe trying to renegotiate some of the terms of credit lines, etc, have your banks done that, can you give us a little bit more color on that relationship?

Roger Ballou

I don’t want to comment specific on it. We do have a credit line in place that is good until the end of February next year.

Mark Kerschner

Committed.

Roger Ballou

It is a committed line. We have not had any dialogue with anyone about renegotiating the terms of that existing line specifically. So the bank has not come back to us to try to renegotiate or anything like that. We intend to probably maintain a line into the future and we will post you as that evolves, but we have not had any approach by the banks to renegotiate.

Jeff Silber – BMO Capital Markets

Okay, thanks. What’s left in terms of the balance for the share repurchase, was it (inaudible)?

Roger Ballou

We have an authorized amount of about 50 million and in round numbers we got about 20 million remaining within the authorization.

Jeff Silber – BMO Capital Markets

Then also can you give us for the total company the year-over-year decline in revenue in constant currency. I know you did it for AndersElite but just what is the impact for the total company?

Roger Ballou

You mean for the quarter?

Jeff Silber – BMO Capital Markets

For the quarter, yes.

Roger Ballou

For the quarter that is actually the number we are giving you in there, I think, maybe we didn’t I don’t know. Did we do it for Q3? I gave it to you for Q4, I know that.

Jeff Silber – BMO Capital Markets

You gave for Q4 but not for Q3. In my math it looks like it is about a 6.6% decline in constant currency.

Roger Ballou

Let me come back to you on that Jeff only because I don’t have it at hand.

Jeff Silber – BMO Capital Markets

No problem, we will talk about that.

Roger Ballou

We will come back to you on that though.

Jeff Silber – BMO Capital Markets

Alright, thank you.

Roger Ballou

Any other questions operator?

Operator

There appears to be no further questions at this time.

Roger Ballou

Okay, great. With that let me tell you that I would like to reiterate our confidence in the CDI business model and in the long-term key business drivers that we have talked about. However we do recognize that these long-term realities will not prevent short-term negative effects during short-term economic disruptions. We have a management team and tend to do our best to manage through those and expect to be able to do so. Thank you so much for joining us today on this call.

Operator

Thank you. This concludes today’s third quarter CDI investors’ conference call. You may now disconnect and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!

Comments

[BobStewart:]

CDI Corporation appear to have under performed other NYSE stock consistently for months and years. You can check this out on their own web site by bench-marking against NYSE. They also have a track record of questionable business and franchise ethics in their MRI Network arm. This includes misrepresentation for years regarding their franchisees. Plus some outstanding questions on Sarbanes-Oxley issues of large write-off’s of debt that Roger Ballou will not clarify. I also believe that Roger Ballou also made some misleading statements to shareholders at one of his quarterly reviews. Similarly, Joseph Seiders made some sworn affidavit statements that I believe cannot be true. Check these things out for yourself at www.cdicorp.info and decide for yourself about their ethics and business practices.

2008 Nov 17 04:48 AM