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CDI Corp. (NYSE:CDI)

Q4 2013 Results Earnings Conference Call

February 26, 2014 11:00 AM ET

Executives

Vince Webb - Vice President, Investor Relations

Paulett Eberhart - President and CEO

Bob Larney - Executive Vice President and CFO

Analysts

Jeff Silber - BMO Capital Markets

Ty Govatos - TG Research

Operator

Welcome and thank you for standing by. All participants will be in listen-only mode until we open for questions and answers. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

I’d now like to turn the meeting over to Vince Webb, Vice President of Investor Relations for CDI Corp. Sir you may begin.

Vince Webb

Thank you. Good morning and welcome to CDI’s fourth quarter 2013 conference call. At this point, you should have a copy of the earnings press release. If not, please call our office at 215-636-1240 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 to your questions.

Before handing the call over to Paulett, I’d 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 February 26, 2014 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 the 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 will provide an overview of 2013 including current trends and talk about our longer term outlook. I will then turn the call over to Bob to review our fourth quarter and full year results and discuss guidance for the next quarter.

In 2013, we continued to increase sales in our strategic verticals overall through strong year-over-year gains in OGC in both engineering and staffing. We also produced solid revenue increases in AIE on the engineering side. We benefited from good wins in both downstream and midstream OGC business and continue to strengthen our relationships with large aerospace clients. Our target verticals now represent 67% of total revenues compared to 64% in 2012.

We also grew our international revenue through gains in our Canadian pipeline and UK staffing businesses. While we did make gains in several of our businesses in 2013, we also faced challenges to our plan to accelerate profitable revenue growth. First, sales from our largest client representing close to 20% of total revenues were down significantly during 2013. This business is reported in our staffing operations and the decline reflects the client’s continued efforts to respond to market dynamics. We are holding a steady market share with this client and our relationship remains solid as we continue to focus on providing quality service and gaining additional responsibilities with multiple divisions. Excluding this client, CDI’s program business achieved mid single-digit revenue growth in 2013.

We also dealt with federal government spending reductions, primarily due to sequestration cuts initiated in the first quarter of 2013. We are pleased that Congress has reached an agreement to prevent additional reductions to federal defense budgets, providing a more stable base for this business in 2014. We also experienced continued revenue declines in our high margin state and local infrastructure business in 2013. At present, bid activity seems to be increasing as our state transportation and highway clients primarily in the Northeast U.S. are beginning to raise their budgets for infrastructure investment. We are optimistic that we will see revenue stabilize in this business in 2014.

Turning to MRI, we are making investments to improve revenues and profits. We are working to add productive franchises and we’re helping existing franchises grow contract staffing revenues. Our goal is to build both contract staffing revenue and royalty income during 2014 and what we anticipate will be a gradually improving permanent placement market.

Finally, revenues in our non-program staffing business declined during 2013. Frankly, we focused more on large programs when we launched our strategy at the end of 2011 but starting late last year we began to reinvest in the non-program area and we recently installed new leadership. Our goal is to return this business to revenue growth in 2014.

Our renewed focus on non-program staffing is based on the premise that building business with regional clients is not only profitable for CDI but also provides an opportunity for some of these local relationships to develop into larger national program staffing accounts.

In summary, while we faced a number of revenue and profit challenges in 2013, we have responded to key issues quickly and effectively and we are well-positioned now in 2014 to capitalize on our long-term strategy.

I’d like to take a few minutes to talk about trends we’re seeing in our business units. Beginning on the engineering side, we expect our OGC vertical to continue to capitalize on strong growth in shale gas. For CDI, this trend should lead the growth in two areas, our midstream business for processing and transportation and our chemicals business as we see new capacity additions driven by lower feedstock prices.

Business in our AIE engineering vertical has been driven by industry investments and new commercial airplanes. These investments ultimately result in new engine development which is an area of particular strength for CDI. We are experiencing backlog growth in both the OGC and AIE engineering verticals and we continue hiring to meet client needs.

Before I leave engineering, I’m very pleased with the successful leadership transition of this business unit to Bill Wasilewski. Bill joined CDI in August 2013 as Executive Vice President in charge of gas. Most of Bill’s career was spent at Fluor Corporation where he had broad responsibilities for business operations, sales, marketing, and strategic planning.

Turning to staffing: It is important to note that our largest client represents about 30% of PSS revenues and close to 75% of revenues within the PSS Hi-Tech vertical. At that scale, any significant change in staffing demand from this client clearly skews reported results. In fact, excluding that client, our overall staffing revenues increased 2.5% year-over-year and 7% in the fourth quarter. Overall, CDI staffing verticals are poised to benefit from increasing demand for contract IT, engineering and technical professionals as contract workers became a larger part of the U.S. labor market. We recognize this opportunity and we are taking steps to take advantage of this trend.

In order to extend our ability to quickly source qualified candidates, we are investing in new applicant tracking software that will be fully implemented by the end of this year. This system will improve our speed to hire and increase our recruiter productivity.

In addition, by the end of the first quarter, we will have completed structural changes to our recruitment organization, resulting in a hub and [support] model which will optimize our ability to support our program and non-program businesses. From an organizational standpoint, we announced the realignment plan in December to improve our operational effectiveness and increase accountability within our business units.

The realignment brings key resources including business development closer to our clients, as client delivery executives are now based within our engineering and staffing organizations. Additionally, we are moving support functions directly into the engineering and staffing business units. We believe the realignment will streamline decision making and better leverage resources to more effectively deliver CDI solutions to our clients.

Before I turn the call over to Bob, I would like to mention some of our fourth quarter business wins. In our engineering OGC downstream operations, we were awarded a significant design project in Texas for a European based refiner. In the GETS OGC chemical business, we won a design project for a chemical plant in (inaudible) region from another European client. And we added a new client to our roster with an engineering design project for a major chemical plant expansion in Louisiana.

These last two projects are examples of specialty chemical production investments that are being driven by the availability of low price natural gas feedstock. We also won a number of refinery upgrade projects in our gas OGC downstream business on the Gulf Coast.

On the staffing side, our EMEA business won a large manage program with a new client, capitalizing on improving conditions in the UK construction industry. We also secured a significant renewal with one of our major U.S. state staffing clients and one additional business in a separate division. These wins position us for growth, particularly when combined with the actions we are taking to invest in high growth markets, expand our program and non-program staffing businesses, turnaround MRI, and realign our organization.

CDI’s long term goals remain the same, accelerate growth in our target verticals; improve growth in our lower performing businesses; increase operating margin by capitalizing on our lower cost structure; and gradually improving gross margin as a percent of revenue; and grow earnings per share and cash flow. As always, all of our efforts are focused on increasing shareholder returns.

I’ll now turn the call over to Bob Larney. Bob?

Bob Larney

Thank you, Paulett and good morning everyone. CDI’s fourth quarter 2013 revenues were $277 million, up 2.4% over the year ago fourth quarter. Revenues rose in two of our three business units with GETS and PSS revenues both up 3%. MRI revenues declined 10%. Target vertical revenues rose 10% in GETS and increased 4% in PSS through significant gains in our OGC operations in both businesses.

The $277 million was also above the high-end of the projected fourth quarter revenue range of $263 million to $273 million that we gave to you at the end of the third quarter. This performance largely reflects greater than expected Canadian pipeline demand for site-based technicians in the OGC vertical within PSS.

CDI’s gross profits were down 2% to $52.2 million during the fourth quarter and our gross profit margin was 18.9% compared to 19.8% in the year ago quarter. The margin decline was primarily mix driven due to declines in higher margin GETS government revenues and significant increases in lower margin OGC pipeline revenue.

CDI reported operating and admin expenses of $42.7 million in the fourth quarter of 2013. This figure includes the previously disclosed $3.3 million legal settlement benefit related to a claim in our GETS business unit. Excluding the impact of the legal settlement, operating and admin expenses declined as a percentage of sales during the fourth quarter to 16.6% versus 16.8% in the year ago period.

As Paulett discussed, we announced a realignment plan in December of 2013 to improve our operational effectiveness and increase accountability within the businesses. The plan includes a reduction in headcount of 65 to 75 employees and the consolidation of several facilities. We anticipate pre-tax cost savings of $11 million to $13 million in 2014 due to these efforts.

Our 2013 fourth quarter results included a $5.7 million charge for this realignment plan related to employee severance and facility consolidation. $1 million of the charge was included in corporate expenses with remaining $4.7 million affecting business unit operating expenses as follows; $2.1 million in GETS, $2.4 million in PSS, $0.2 million in MRI. We anticipate additional charges of approximately $1 million to $3 million for further facility consolidation during 2014.

Let me now turn to results within our business units. GETS revenues rose 3% in the fourth quarter to $82 million. OGC grew 15% driven by gains with both ongoing and new projects in the midstream and downstream sectors. AIE revenues also rose double-digit up 10% as gains in commercial aviation more than offset postponed client spending in AIE’s government defense projects. Reduced federal government spending primarily driven by sequestration and lower infrastructure revenue from reduced state and local government spending caused revenues in the other category to decline 12%.

GETS gross profit rose just under 1% to $23 million with a gross profit margin of 27.9% compared to 28.7% in the fourth quarter of 2013. The lower margin primarily reflects the sales decline in the higher margin federal government and infrastructure businesses.

Turning to PSS, revenues rose 3% to $181 million. OGC revenues rose a very strong 36% driven by increased demand for site-based technicians for our Canadian pipeline clients. AIE revenues declined 16% as we exited a low margin account that was only partially replaced with new higher margin business. Hi-Tech revenues were down 5%. As anticipated, we experienced lower sales with our largest client which represents close to 75% of Hi-Tech revenue within PSS. Revenue rose 2% in the other category, representing double-digit gains in our rapidly growing UK business partially offset by declines in non-program staffing.

PSS gross profit declined 4% to $22 million during the quarter and the gross profit margin was 12.4% versus 13.3% in the year ago period. The margin decline reflects a revenue shift to lower margin business, primarily related to OGC pipeline clients and decreases in the higher margin non-program staffing business.

MRI revenues were down 10% in the fourth quarter. Contract staffing declined 11% and royalty and franchise fees combined were down 7%. As we have seen in recent quarters, franchisees are finding it challenging to replenish lost or completed contract staffing business as quickly as they have in the past. Royalty income is down, due to lower permanent placement activity. MRI's gross profit declined 6% during the fourth quarter to $7 million and the gross profit margin was 47.9% versus 45.6%.

CDI reported operating profit of $3.8 million during the fourth quarter of 2013, giving us an operating margin of 1.4%. This figure includes the two items I discussed earlier. One, a restructuring charge of $5.7 million related to our business realignment activities. And two, a benefit of $3.3 million related to the settlement of legal claims in GETS. These two items netted together lowered our reported operating profit by $2.4 million and reduced our operating profit margin by 90 basis points.

CDI’s effective tax rate for the fourth quarter of 2013 was 37.3% and we reported diluted earnings per share of $0.12. The net effect of the restructuring charge and the legal settlement benefit reduced our reported earnings per share by $0.08.

Turning to the full year, 2013 revenues fell 1.5% to just under $1.1 billion. Revenues for our target verticals grew 2% with double-digit gains in OGC partially offset by lower AIE and high-tech revenues. GETS revenues fell 1%, PSS revenues were essentially flat and MRI revenues were down 17%.

Gross profit declined 6% in 2013, operating profit adjusted for the realignment and the legal settlement fell 27% to 2.1% of revenue as the gross profit decline was only partially offset by improved operating expenses.

The effective tax rate was 37.3% for the full year compared to 39.3% in 2012. Diluted earnings per share were $0.65 in 2013 compared to $0.97 in 2012. The combined impact of the restructuring charge and the legal settlement lowered diluted earnings per share for 2013 by $0.08.

Turning to cash, we remained committed to generating strong cash flow. We generated $15 million of operating cash flow during the fourth quarter of 2013 and $16 million for the entire fiscal year.

Capital expenditures in 2013 were $7.5 million, up $1.3 million from last year. I expect capital spending for 2014 to increase again as we deployed funds for technology including a recruiting system upgrade and make investments to meet client requirements.

As we look to the first quarter of 2014, revenue momentum should continue in many of the areas that were strongest in the second half of 2013 including OGC and EMEA. We currently expect to report first quarter 2014 revenues in a range of $264 million to $274 million more or less in line with the $269.5 million we reported in the first quarter of 2013, as low revenues from our largest client will likely offset gains in other businesses.

In summary, I’m pleased with our growth in OGC, EMEA, our program business and the non-government portion of our AIE vertical. As Paulett discussed, we are focused on building profitable revenue growth in 2014 as we keep a keen eye on cost control, as well as business building efforts in order to create long-term shareholder value.

Vince, I’ll turn it over to you to start the Q&A.

Vince Webb

Okay. Thanks Bob and Malinda if you could please give the instructions for the question-and-answer?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jeff Silber, BMO Capital Markets. Your line is open.

Jeff Silber - BMO Capital Markets

Thanks so much. You mentioned a few times the impact this past quarter of the Canadian pipeline businesses in the OGC area in PSS, is that something that you expect to continue at least early on this year or was that just really a fourth quarter event?

Paulett Eberhart

Good morning, Jeff.

Jeff Silber - BMO Capital Markets

Good morning.

Paulett Eberhart

This is Paulett, Bob do you want to…?

Bob Larney

Yes, sure, hi Jeff, how are you?

Jeff Silber - BMO Capital Markets

Good. How are you doing?

Bob Larney

Yes, I think in the fourth quarter the revenue guidance that we offered was 263 to 273 we did come in to 277 which obviously was above the upper end of our guidance range. The primary reason was the higher than expected revenues in PSS, OGC related to the pipeline maintenance and inspection in Canada.

This business is good business but there is an unplanned factor associated with that business and because of that reason it is somewhat difficult for us to predict. So that unplanned issue is what we faced relative to our guidance. EMEA revenues were also above expectations in the fourth quarter due to new clients, the impact of additional recruiters and also strengthening in the UK construction industry.

Jeff Silber - BMO Capital Markets

Okay, right, I got that, thanks. I know you don’t give specific guidance for margins but assuming you come in at the midpoint of your range, should we see margins expand year-over-year versus first quarter 2013?

Bob Larney

Yes, let me address that. We’re currently expecting first quarter of 2014 to be in line with the fourth quarter of 2013 and rising above 19% beginning in Q2 of 2014. Now factors include the pipeline inspection and maintenance business, the improvement in infrastructure and government operations as well as our ability to raise margins within our strategic vertical business. Now as always Jeff our largest client is a factor. Now the range we’ve been giving is 19% to 20%. In 2014 I am going to continue with that range, but overall for the full year it’s going to be towards the lower part of that 19% to 20% range.

Jeff Silber - BMO Capital Markets

Okay, great. That’s extremely helpful. I appreciate that color. And then moving on to the operating margins side, you mentioned the realignment plan looking at about $11 million to $13 million in savings, is that savings you think you will get in 2014 or is that something we should see sort of on an annualized basis as we exit the year?

Bob Larney

No, Jeff, that’s going to be booked in 2014.

Jeff Silber - BMO Capital Markets

And any specific vertical will receive more than others?

Bob Larney

I think you’re going to see, about 75% of that is going to be associated with people. And then the balance pretty much in facilities with a bit of a larger portion in the GETS arena followed by PSS and to a lesser extent MRI.

Jeff Silber - BMO Capital Markets

Okay, great. And then a couple of more, and I will let somebody else jump in. Corporate expenses, what should be the run rate we should be using for the year?

Bob Larney

Corporate expenses, we were running about 2.1% in 2013's fourth quarter. Let me address operating and admin expenses for you, I think that would be more helpful.

Jeff Silber - BMO Capital Markets

Okay, that's fair.

Bob Larney

And my comments will discuss operating expenses Jeff excluding the impact of the legal settlement, the 3.3 legal settlement that I talked about earlier.

Jeff Silber - BMO Capital Markets

Yes.

Bob Larney

The adjusted operating expenses were 16.6% of revenues in the fourth quarter, 20 basis points below last year’s 16.8%. We do remain focused on keeping an eye on our operating expenses. Overall, the longer term we see 16% to 17% for 2014, but Q1 is going to be similar to Q4 of last year. And having said that, because of the restructuring benefits, we’re going to be toward -- for the full year, toward the lower end of that 16% to 17% range.

So, you have an idea what Q1 is, you have an idea what the year-end is.

Jeff Silber - BMO Capital Markets

All right, this is really helpful. One more quick one, what tax rate should we be using?

Bob Larney

Yes, that's a good question. On an annualized basis an annual rate, we're looking at 39% to 41%. However I do want to make a comment, if you look at this last year and even the year before our track record is that we have a higher tax rate in Q1. Last year’s Q1 was 47%, this year 2014 although we went up in 39% to 41%, the Q1 is going to be above last year’s 47%.

Jeff Silber - BMO Capital Markets

Okay, great. I will let somebody else jump in. Thanks so much.

Paulett Eberhart

Thanks Jeff.

Operator

The next question is from Ty Govatos, TG Research.

Ty Govatos - TG Research

Hi, some questions, I guess on the restructuring to take it a little further. Do you expect when will the $11 million to $13 million in savings to flow down to the bottom line, will a part of it be reinvested?

Bob Larney

There is a large portion of that that will drop to the bottom line Ty, but we do have some investments that we are putting in throughout the businesses. The $12 million that we were referring to is all for 2014 and the charge for the year will be $5.7 million and that’s broken down into the different businesses.

Ty Govatos - TG Research

Yes. If I look at the second restructuring $2 million to $3 million that you expect this year, will that add to the 11 to 13 or does the 11 to 13 assume that also?

Bob Larney

That’s included.

Ty Govatos - TG Research

Okay, thanks. You have answered most of my questions. I appreciate it.

Paulett Eberhart

Thanks, Ty, appreciate it.

Operator

Showing no question. (Operator Instructions). Thank you for standing by, we are showing no further questions on the phone lines.

Paulett Eberhart

Okay. Thank you operator. Let me just say that before end the call, I want to thank all of you for joining us today. And we look forward to updating you on our progress next quarter. With that we’ll end the call.

Operator

Thank you. This does conclude the presentation. You may now disconnect.

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