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CDI Corporation (NYSE:CDI)

Q2 2013 Earnings Call

August 1, 2013 11:00 AM ET

Executives

Vince Webb – VP, Investor Relations

Paulett Eberhart – President & CEO

Bob Larney – EVP & CFO

Stuart Batchelor – EVP and President of Global Staffing Services

Analysts

Andrew Steinerman – JP Morgan

Jeff Silber – BMO Capital Markets

Operator

Welcome to CDI’s Second Quarter Earnings Conference Call. At this time all lines are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator Instructions) Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the meeting over to your host Vince Webb, Vice President, Investor Relations.

Vince Webb

Good morning and welcome to CDI’s second quarter 2013 conference call. At this point, you should have a copy of the earnings press release. If not, please call our office at 215-636-1162 and we will be happy to email you a copy or you can find a copy on our website at, cdicorp.com. Please also refer to our website for information concerning a replay of today’s call.

On the line with us today is CDI’s President and Chief Executive Officer, Paulett Eberhart, our Executive Vice President and Chief Financial Officer, Bob Larney and other members of our executive leadership team. We will begin with some prepared remarks from Paulett and Bob and then we will open up the line for your questions.

Before handing the call over to Paulett, I would like to remind you that today's conference call is being recorded and includes forward-looking statements that are subject to risks and uncertainties. The information being shared in this call is effective as of today’s date August 1, 2013 and will not be updated. Actual results might 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 same language applies to any comments made during this morning’s conference call.

At this time, I would like to turn the call over to CDI’s President and CEO, Paulett Eberhart.

Paulett Eberhart

Thank you, Vince and we thank all of you for participating on our call today. This morning I would like to provide a major assessment of CDI’s performance, including an update on our strategy. I will then turn the call over to Bob to review our second quarter results and discuss guidance for the third quarter.

Starting with our recent performance, I am disappointed that 2013 revenues and gross margins continued to be below last year’s levels. From a big picture standpoint, we are benefitting from our focused sales and business development efforts with larger clients in our strategic verticals, in particular our oil, gas and chemical vertical is experiencing solid growth in both engineering and staffing. However the conversion of wins into revenues is taking longer than we would like in the other strategic verticals. In addition, we have seen unanticipated declines in spending by our largest client, reduced spending by both federal and state and local government accounts and significantly lower revenues in the non-program staffing business and MRI.

Looking forward, we expect revenues in the third quarter to be below year ago levels. We expect continued pressure from some of our largest clients to cut costs and reduce spending. We also see continued declines in MRI, non-program staffing revenues and government engineering services although at a lesser rate than experienced during the first half of 2013.

On a positive note, capital spending by clients in the midstream and downstream energy sectors as well as in commercial aviation continues to provide solid revenue growth for CDI. Additionally, our business mix is improving as reflected in sequential gains in our gross profit margins. Bob will provide a detailed discussion of these results in his remarks.

As you recall, our strategy is to grow business in our selected verticals in both the US and internationally, cross-sell between engineering and staffing, strengthen and expand our relationship with existing clients, develop strategic relationships with new clients and continue to review and strengthen our portfolio businesses. We are gaining momentum with this strategy but the growth we achieved in our strategic verticals during the first half of 2013 was not enough to offset the areas of decline I mentioned a few minutes ago. The continued slow growth of the economy is part of the reason but it has also taken some time for the changes to our organization has held for us to gain traction, I believe we are making good progress.

[We got to take] considerable effort to change the culture throughout our entire company during the past two years. As a result, we are working more effectively as a unified team today than we were even six months ago and we are on the right path to achieve profitable growth. In addition, from a portfolio standpoint, we are exploring opportunities to improve CDI’s mix of businesses and growth prospects. During the next couple of years, the majority of CDI’s revenue gains will come from existing clients. Over the longer term new clients should provide a more significant share of our growth.

Turning to new wins, I am especially pleased that recent efforts to strengthen our business development organization have led to larger potential contract values, particularly in engineering services. Let me give you a few examples of our new business activity. In GETS OGC, we are providing front-end engineering design services for two ammonia fertilizer plants for a new client. These projects could lead to significant detailed design assignments in the second half of 2013 and also in 2014.

In the same vertical, we are providing detailed engineering and procurement services for another client for a new chemical plant and CDI is providing the third new client with engineering services for the expansion of a specialty chemical facility. These projects are driven by a favorable energy environment, including the availability of low-cost natural gas feedstock. We expect continued growth in this vertical as clients invest in leveraging new site of natural gas.

In the GETS AIE vertical, we are providing an existing client with engineering design, analysis and drafting services for an aircraft engine test set under one contract and verification and validation software testing for rail projects in its transportation division under a separate contract. These wins illustrate the success of our strategy to expand our relationships with clients that serve multiple industries.

On the federal defense side of AIE, we are providing an aerospace client with test solutions for a missile system as well as data acquisition solutions for NASA. And in government services we are providing ship design and engineering services for new clients within the US Navy. In global staffing, we are expanding program business with large clients. We are strategically focused on program staffing accounts due to their potential for global client relationships, opportunities to cross-sell CDI engineering services in a more efficient operating model.

Year-to-date program staffing revenues were up modestly. Excluding the revenue impact of spending cuts by our largest client, however this business has grown more than 10% during 2013. Putting our largest client back in the mix, program staffing represents more than three quarters of our total staffing business.

Our non-program staffing business has produced disappointing results in recent quarters. This is typically a more local business characterized by the need to quickly deliver candidates to multiple clients in a competitive environment. Non-program staffing reported a double-digit decline during the first half of the year. Frankly, we did not focus enough recruiting resources and effort to maintain existing levels of non-program staffing as we focused some program accounts. In response, we have added additional recruiters to stabilize the non-program business.

Our smallest reporting segment is MRI. As you know, MRI is a network of recruiting franchises. This business success depends heavily on the state of the economy. As a result of the slow growth recovery following the recession, the executive recruiting marketplace has not recovered sufficiently to improve performance in MRI and attract new franchises. MRI does continue to contribute high-gross profit margins and strong cash flow to CDI.

We are taking actions to improve trends at MRI. First, we are putting more focus on attracting new franchises. Second, we are working with franchises to increase contract staffing sales, and third, our global staffing services organization is working to leverage MRI’s global network of offices to provide in-country fulfillment to better serve CDI’s clients.

Turning to GETS, we feel very good about growth prospects in our OGC and AIE verticals. OGC is growing the fastest with revenue up 8% in the current quarter. The pipeline for this vertical is robust and we are growing at market rates. AIE revenues grew 6% in the second quarter and enjoyed even stronger gains when excluding government revenues. Backlog is up for both of these verticals as reflected in our higher book-to-bill ratio. Quite frankly, the biggest concern for the GET OGC and AIE businesses is the availability of talent. But we have been able to hire qualified people to meet demand and pass any higher costs of large clients as necessary.

What turned out in GETS so far this year is lower government spending on the federal state and local levels. Most of the impact is reflected in our other category within GETS but there are also federal government clients in the AIE vertical. In addition, sequestration cuts have negatively impacted overall spending levels by several of our commercial AIE clients.

On the federal government side, we anticipate continued pressure from sequestration at least through the end of the federal fiscal year, and we have limited visibility into 2014. I want to emphasize that we continue to win government contract renewals. Projects are not being canceled, the funding has been cut and start dates are being pushed back. On the state and local front, we do see signs of stabilized infrastructure spending in the transportation sector of that business. Within GETS, the infrastructure business has also helped us win several midstream OGC projects in the first half of 2013 and we are working to involve our infrastructure team in other new business opportunities.

In summary, we feel confident in our strategy to grow revenues in our chosen markets both in the US and internationally. As I said earlier, we're enjoying good gains in several of our businesses within key verticals. However our progress has been somewhat masked by slow economic growth and government spending declines. While current economic conditions are outside of our control, we expect improved results in our underperforming businesses by implementing appropriate action plans to more quickly return CDI to consistent profitable growth.

We are working to improve our gross profit margins by increasing the mix of engineering to staffing revenues, and we will continue to prudently manage operating expenses to maintain a competitive cost structure and improved operating profit margin. Our financial position is solid, our strategy is sound, and we are seeking to refine our business portfolio to enhance shareholder value.

I will now turn the call over to Bob Larney. Bob?

Bob Larney

Thank you, Paulett and good morning everyone. CDI’s second quarter 2013 revenues were $263 million representing a 4% decline compared to the second-quarter 2012. OGC revenues were up 12%, AIE revenues were down 3% and high-tech revenues declined 7%.

Revenue performance in the second quarter continued to reflect the trends that we saw in the first quarter, including weakness at MRI and lower spending by a number of major clients due to economic uncertainty. Also these completion of several projects within non-program staffing should have not yet been offset by new business and finally, lower revenues in our government services and infrastructure businesses.

Gross profits were down 7% to $51.5 million in the second quarter. Our gross profit margin of 19.6% was down from the 20.2% we achieved in the second quarter of 2012. The 19.6% level does however represent a solid increase from the 18.6% gross profit margin we reported in the first quarter this year and moves us back into the 19% to 20% range and we expect to be in this range for the balance of the year.

Operating and administrative expenses as a percentage of revenues were 17.6%, up versus the same period last year. We still expect that for the full year we will be within our targeted level of approximately 17% and we believe this level maintains our competitive cost structure.

Starting with our first business segment, GETS revenues declined slightly down 1% in the second quarter as solid gains in OGC and AIE were offset by lower revenues in hi-tech and other. The 8% gain in OGC revenues was driven by good growth with both ongoing and new projects. AIE revenues rose 6% led by strength in our commercial aviation business that was somewhat offset by reduced client spending in the defense sector.

The GETS hi-tech vertical is relatively small accounting for only 10% of the company’s overall hi-tech business and the revenue shortfall for this vertical was $600,000 in the second quarter. Reduced government spending and lower infrastructure sales drove revenues in other, down 13%. Excluding other, GETS revenues rose more than 5%.

PSS revenues were down 4%. OGC revenues rose a very strong 17% driven primarily by increased demand for pipeline maintenance and training activities. AIE revenues declined 10% as we exited a low-return account that was only partially replaced with new higher margin business. Hi-tech revenues were down 7%. We experienced low sales with our largest client which represents more than 70% of hi-tech revenues within PSS.

Revenues fell 6% in other, mainly due to project completions. On a positive note, we enjoyed good growth in AIE and hi-tech revenues and our small but growing EMEA business in the second quarter as we leveraged US client relationships to generate additional business.

MRI revenues declined 20% in the second quarter. Contract staffing was down 21% and royalty and franchise fees combined were down 19%. As we saw in the first quarter franchises are finding it challenging to replenish lost or completed contract staffing business. Royalty income is down as slow economic activity resulted in a lower number of permanent placements and franchise fees declined as fewer franchises were sold.

As I mentioned earlier, second-quarter gross profit for the Corporation declined 7% due to lower revenues in the segment and client mix in the quarter. GETS gross profit was down 3% to $22.8 million with a gross profit margin of 28.5% compared to 29% last year. The lower profits and margin reflect the sales decline in the higher-margin federal government and infrastructure businesses.

PSS gross profit declined 8% to $21.9 million during the quarter and the gross profit margin was 13% versus 13.6% in the year ago period. The lower margins reflect the business mix favoring program staffing over non-program business as well as the full year effect of new contract pricing with our largest client.

MRI’s gross profit was down from $8.3 million in the second quarter of 2012 to $6.9 million in the current quarter. MRI’s gross profit margin rose to 47.2% compared to 45.3% in the year ago period. We expanded gross margins in MRI through a mix shift to higher-margin permanent placement royalty income and higher-margin contract staffing business.

On a consolidated basis the company reported an operating profit of $5.2 million during the second quarter of 2013 compared to $7.9 million in the second quarter of 2012. Despite the continued disciplined management of our operating and administrative expenses that I have discussed earlier, our revenue and gross profit declines led to lower operating profit during the quarter.

CDI’s effective tax rate for the second quarter of 2013 was 32.5% and diluted earnings per share were $0.17 compared to 34.9% and $0.25 respectively in the year ago period. While the effective tax rate may vary from quarter to quarter there is no significant change to the company's tax position. We continue to expect the full year tax rate for 2013 of 40% to 42%.

Turning to cash, we remain committed to generating increased cash flow by improving profitability and managing receivables and payables. We expect the majority of these funds to be generated in the fourth quarter, following the usual pattern for our company. As we look forward to the third quarter of 2013 we currently expect revenues to be in a range of $263 million to $273 million compared to $279 million last year and we expect gross profit margins to be in the 19% to 20% range that we saw in the second quarter.

While the economic slowdown that negatively affected trends over the last three quarters continues to impact our near-term performance we are cautiously optimistic that we may have seen the low point with some of the operations that have produced the most challenging comparisons for us. As Paulett discussed, we have significantly strengthened our sales force and our technical expertise in key areas and our backlog and pipeline of new business looks promising.

Vince, I will turn it over to you to start the Q&A session.

Vince Webb

All right. Sherry if you could make the announcement please.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Andrew Steinerman from JP Morgan.

Andrew Steinerman – JP Morgan

Bob, I am going to queue into – you’ve sort of betted us by saying we may have past the low point, which segment do you feel like you’ve already passed the low point of cyclically and in particular if you could – you’re talking about kind of staffing oriented businesses first?

Bob Larney

I think, Andrew, overall I don't know that we can actually determine what the government services will be in the fourth quarter and beyond. But I think we have now gotten our arms around that relative to how we view the business. I think looking at MRI, I think we still have some issues there that we need to deal with. Our nonprogram business I think we now have our arms around that as well. And I think -- and of course one of our largest clients is always something that in the future there can be a bit of a wildcard for us. But having said that I think that Stuart who is here with us that handles MRI as well as the staffing business can maybe add some color to what I am saying as well.

Stuart Batchelor

Andrew, just a couple things. Paulett mentioned about adding recruiters, what we've done is evaluate the recruiting capacity across all three of facets of our business. So we put recruiting capacity to support the program business which you heard is it’s growing at a tick at the moment. We stabilized recruiting within the non-program business, try to get that back on to track and we’ve also ensure we’ve got some functional capability to support the ongoing requirements in the GETS business as that continues to grow too.

Andrew Steinerman – JP Morgan

And Bob, I would like to ask you about gross margin. I mean you noted quantitatively we picked up a point sequentially on gross margin. Is that all coming from MRI? What drove the lift of gross margins for the overall company from first to second quarter and what gives you the confidence that gross margin will kind of move into this near 19 to 20% range?

Bob Larney

Yeah, I think that’s a good question Andrew. I think sequentially the hundred basis point increase from the 18.6 to the 19.6 was driven primarily by an improved business mix within each of the businesses, and more specifically if you look at the 100 basis point GETS was 60 basis points of the 100 and that was due to the revenue growth with the higher-margin AIE client and improved gross profit margin within our government related businesses, we had an uptick there.

MRI was 30% -- I am sorry well, 30 basis points of the 100, that was due to a mix shift to higher margin permanent placement royalty and higher-margin contract staffing business mix. Then in PSS was the balance of the 10 bps and that was really due to improved client mix. Now going forward relative to the second half, which I think was your second piece, although we don’t provide formal guidance I can give you some idea of I think what the trend we currently expect. And quite frankly, we exceeded our expectations in Q2. But at this juncture, we expect the second half gross margins to really remain in that 19% to 20% range and it's because of continuing what we saw in Q2.

Andrew Steinerman – JP Morgan

And if I could get – just one more question, I will be done. On MRI the decline you mentioned one of the issues being selling fewer franchises and so my question is, if you took a look at the underlying businesses besides we’re just looking at what happens when we sell new franchises, how would you describe that remaining business?

Bob Larney

So Andrew, I think as you heard, all the revenue streams into MRI, driving the three streams, so if I break them out separately is probably the right way to address this. We are spending a lot more time trying to help the franchise offices both identify and close contract staffing opportunities. That’s a great way to the pull revenue streams back. On the new franchise sales we have seen a slight decline in franchises year we year-over-year which in itself impacts revenue streams. But we have got a pipeline of new franchises particularly North America and we do expect to see those sales to close in Q3. On the royalty front, we do expect that to be challenged for the rest of this year until we see some more widespread employee confidence in hiring.

Operator

Our next question comes from Jeff Silber from BMO Capital Markets.

Jeff Silber – BMO Capital Markets

Just wanted to get a little bit more color on your top line guidance, the range of revenues – if we take a look at the year over year declines that we saw in the second quarter, how will that compare to what you are guiding to in the third quarter?

Bob Larney

I think – Jeff, this is Bob. I think we are seeing good gains in several businesses within our key verticals. But these revenue increases are still not enough to offset the negative trends that we saw in the first half of 2013, particularly we talked about the weakness at MRI, the lower spending by a major client, the completion of several projects, lower revenues with the government. However I think to address growth in the future quarters we’ve taken a number of actions to improve performance. You’ve heard Stuart talk about adding recruiters for the non-program staffing and working with MRI and doing those sort things. I think when we look at the Q3 and Q4 although we have many signs of revenue improvement in our Q4, for example, the progressive improvement in new wins, I think we may have even mentioned that in our press release.

I think on an annualized basis, this growth in Q3 and Q4 is still not going to be sufficient enough to give us a year-over-year favorability. In other words, we will have an uptick in Q3, we will have an uptick in Q4 as well on top of Q3, but it’s still not going to get us to last year's level in revenues.

Jeff Silber – BMO Capital Markets

Let me drill down though by segments, so you’re guiding for the current quarter between 2.63 and 2.73, you generated a little over 2.63 in the second quarter. The sequential growth if we see it, will we see it in all three segments or will it be skewed to one or two of them?

Bob Larney

Yeah, I think you are going to see continued OGC, AIE and then you are going to see these new wins materialized into revenues and you will see a fair amount of that in GETS and then to a lesser extent in the PSS segment.

Jeff Silber – BMO Capital Markets

MRI, no, how about sequentially, what should we expect?

Bob Larney

I think sequentially we are going to be just slightly up.

Jeff Silber – BMO Capital Markets

And then on the corporate expense side, again just to help us from a modeling perspective, what should we be modeling in for the rest of the year?

Bob Larney

I think corporate expenses were running at the level that we had been. I think we had a little bit of an uptick in the Q2, we were at 6.4 million but overall I think on the operating expense perspective which obviously includes the corporate piece, we are still looking at a 17% -- approximate 17%, might be a couple of bps lower, maybe a couple of bps higher for the full year.

Paulett Eberhart

Jeff, this is Paulett, if I could add just a little bit of color to your comments. Overall as I said in my comments, I am pleased with our business development team and improving our sales processes and we have added additional resources as I indicated. We are seeing that pay off with a solid backlog in GETS and solid growth in our program staffing accounts, particularly as I mentioned, when you exclude our largest client. So we are seeing traction, we are pleased with the progress and we’re actually continuing to make progress growing outside the US by leveraging US client relationships through our program staffing contracts in EMEA. So we are certainly beginning to see the fruits of our labor around our business development team and their efforts. So thank you for your questions this morning. I appreciate it.

Operator

I have no further questions in queue.

Paulett Eberhart

Okay. So before we end the call, I just want to thank you for joining us today and we look forward to updating you on our progress next quarter. Thank you.

Operator

This concludes today’s conference. Thank you for participating. You may disconnect at this time.

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