Vincent Webb – VP, IR and Marketing
Roger Ballou – President and CEO
Ty Govatos – CL King & Associates
CDI Corp. (CDI) Q3 2010 Earnings Call Transcript October 28, 2010 10:30 AM ET
Welcome and thank you for standing by. We want to welcome you to the CDI Corporation third quarter investor conference call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session during the conference. (Operator Instructions) Today’s conference is being recorded. If you have any objections, you may disconnect at this time.
I will now turn today’s meeting over to your host, Vince Webb, Vice President of Investor Relations.
Thank you. Good morning and welcome to CDI’s third quarter 2010 conference call. 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 mail you a copy or you can find a copy on our website at cdicorp.com.
Please also refer to our website for information on a replay of today’s call, which will be available 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 will begin with some remarks by Roger, and then we will open up the line for questions.
This conference call includes forward-looking statements, which are subject to risks and uncertainties. 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, 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 Mr. Roger Ballou. Roger?
Thanks, Vince and thanks to all of you for joining us today to discuss CDI’s Third Quarter 2010 Results. Following my opening remarks, Mark and I will be happy to answer any questions.
We were pleased with our solid results for the quarter. Third quarter revenue increased by 11.5% versus the prior year quarter, where we include revenue from our new infrastructure vertical, L.R. Kimball, which as previously announced, was acquired on June 28, 2010. Excluding the Kimball revenue, organic year-over-year growth in the quarter was 4.8%.
We were able to leverage that revenue growth into strong earnings growth. Excluding certain one-time charges noted in our third quarter 2009 press release, adjusted 2009 third quarter earnings were approximately 0.6 million or $0.03 per diluted share. Third quarter 2010 earnings more than doubled to 1.7 million or $0.09 per diluted share versus the adjusted year-ago total.
Driving net earnings leverage was a strong revenue growth, with a mix shift to higher margin solutions, primarily due to CDI Infrastructure, increased permanent placement revenues in MRI and proven expense control discipline.
During the quarter, we saw indications of increasing momentum in three of our four businesses, signaling that we could anticipate higher revenue and continued profit growth in future quarters.
CDI IT Solutions revenue increased by 10.9% sequentially in the third quarter and our current sales pipeline trends indicate continuing solid momentum. MRI franchise owners continue to see solid demand for skilled executive, technical, professional and managerial personnel that we place in permanent positions.
Franchise billings replacements made, which generally translate into royalty revenue 8 to 12 weeks in the future continued to grow. Billings for the third quarter were up 36% on a same-office basis versus the prior year quarter.
In Engineering Solutions, driven primarily by increased spending in oil and gas clients, we saw a third quarter turn in our largest vertical, Process & Industrial vertical. P&I revenue increased 12.4% sequentially and is up 1.4% versus the year-ago third quarter.
Overall, Engineering Solutions revenue including – excluding infrastructure, increased sequentially by over 8%. As I noted previously, we saw revenue momentum in three of our four CDI businesses.
AndersElite revenue decreased by 47.6% versus the year-ago third quarter, due to continued weakness in the UK construction or build environment industry. I’ll provide more color on Anders and the other businesses later in my remarks.
In summary, we feel we had a very solid quarter in a gradually improving business environment. This environment is not improving across the board in all markets served by CDI, but conditions in strategic markets where we’re focusing our business development efforts are tending to recover more quickly than in other sectors of the economy.
For example, in IT Solutions, we saw growth in our technology and financial services customers and recovering global IT services marketplace. In MRI, over 55% of our franchise owners permanent placement activity is occurring in market segments with faster than average growth in white collar permanent placement. These markets include healthcare, financial services, information technology, export-oriented industrial clients and in professional services.
These are markets which was recommended to our MRI franchise owners as having greater-than-average potential for long-term growth and in which we’ve seen significant new desk migration by owners.
This focus on more quickly recovering industries is related to our long-term strategy to build CDI capabilities around five global megatrends, which we think will influence capital investment in engineering and IT solutions, as well as in demand for hiring skilled workers through the foreseeable future.
Specifically, we’ll look for growth opportunities in engineering and IT outsourcing and professional staffing businesses that are influenced by continued growth in the emerging BRIC economies, responsive to the long-term drive to create more energy efficient plants, equipment and aircraft in order to mitigate high carbon-based energy usage; focused on delivering services to firms who are modernizing outdated infrastructure to meet demand for clean, efficient power and improved road, rail, air, seaport, schools and other civic projects; providing exposure to long-term investment in defense and homeland security spending, and finally that are influenced by changing demographics and an aging population, as we help clients to develop next-generation managerial, executive, technical and professional leadership.
While positioning our company for growth in industries and companies influenced by these megatrends, we remain committed to proven balance sheet management and expense controls. We are managing the company what we believe is a recovering economy, but not a broad-based recovering economy.
Our management team anticipates a two-phased recovery, with industry sectors like automotive and homebuilding in a delayed recovery cycle, and industries like information technology, life sciences, infrastructure, finance and clean energy in an early recovery cycle.
We’ll pick our business development investment targets and we’ll make our investment decisions within this framework while remaining focused on creating shareholder value.
Now, let’s look at third quarter performance in each of our business segments. Engineering Solutions revenue increased 10.2% versus the prior year third quarter, including results from our infrastructure acquisition, L.R. Kimball.
On an organic basis, year-over-year ES revenue for the third quarter declined 2%, driven by declines in government services and aerospace revenue on a year-over-year basis, somewhat offset by an increase in P&I revenue.
In the Process & Industrial vertical, we saw a 1.4% increase in revenue versus the previous year third quarter, a sequential growth of 12.4%, driven primarily by a solid recovery in the oil and gas area. We’ve seen increases in project bid activity with predominant increases in smaller projects.
CDI Government Services revenue decreased 11.7% versus the year-ago third quarter, driven primarily by continuing funding delays in large contract. However, revenue was slightly up sequentially.
In the CDI Aerospace vertical, revenue decreased by 7.7% on a year-over-year basis, driven by continued weakness in the commercial aviation sector. But the good news however was that revenue was flat sequentially and we’re seeing an increase in bid activity, particularly in commercial aviation projects, which may augur well for future revenue growth.
Our new infrastructure vertical, L.R. Kimball, reported revenue of 14.9 million, which was in line with our expectations. We are pleased with the ongoing execution of our integration plan, and we are achieving milestones that we established prior to the acquisition.
Engineering Solutions operating profit increased by over 33% to $4 million versus the prior-year third quarter, driven by the increase in revenue and increases in higher margin project outsourcing services in infrastructure and by decreases in operating and administration expenses.
MRI’s revenue showed solid increases in the third quarter versus the year-ago quarter, as revenue grew 28.8%. We saw strong increases in franchise royalties, which grew over 40% year-over-year and 17% sequentially.
Additionally, as I noted previously, franchise quarter three billings for recently completed searches increased 36% on a year-over-year basis. These billings generally result in royalty payments in 8 to 12 weeks, and are a good indicator of current demand for permanent placement services.
Operating profit more than doubled to 1.9 million, driven primarily by the increase in higher margin royalties.
During the third quarter, we initiated a management succession plan for the position of President of the MRI business unit. Tony McKinnon, our current President, had announced his plan to retire in early 2011. Tony’s successor, Rob Romaine, our Senior Vice President of Recruiting and our IT Solutions division was introduced to the MRI network early in this third quarter. We have initiated a transition schedule that will allow Rob to assume leadership duties following a five to six month orientation period. We thank Tony for his leadership for the MRI network and for the excellent team that he leaves in place for Rob.
In what we believe to be a robust recovery cycle in the permanent placement recruitment marketplace for skilled white collar professionals, Rob and his team’s goal will be to continue to guide network officers into faster-growing industry segments, to increase training to help franchise owners to efficiently add recruiting desks to grow their businesses and to increase the rate of new franchise sales.
AndersElite revenue declined by 47.6%, 44.6 in constant currency during the third quarter when compared to the year-ago quarter, driven by continued weakness in the UK construction industry. Operating losses were driven by revenue declines, somewhat offset by cost control steps.
Anders’ primary focus has been in the UK construction industry, including transportation and rail, a sector that’s been facing a slowdown in both public and private spending, and we do not anticipate any near-term recovery. We’ve identified two-core strategies that we’ll execute in the fourth quarter and in 2011 to improve performance.
First, we will invest in business development positions in targeted UK construction sectors. Second, we’ll provide innovative hiring process outsourcing services to national accounts in the UK. In order to accelerate this transition, I have asked Ed Zetusky, formerly Senior Vice President of CDI’s US-based talent management division and a leading recruitment process outsourcing innovator to lead Anders in these efforts. Ed has already relocated to the UK and he is moving forward to implement these changes.
CDI IT Solutions revenue continue to increase at a rate significantly higher than the industry growth rate. For the third quarter, IT Solutions revenue increased 35.6% versus the year-ago third quarter. These results were driven by solid growth in virtually every industry segment and most geographies in IT Solutions. Our IT Solutions management team has done a terrific job in efficiently ramping up production to meet this increased demand from our existing customers and in adding capacity for new account wins.
As I noted earlier, a sequential revenue growth of 10.9% and a solid sales pipeline augur well for continuing revenue momentum in IT Solutions. We anticipate this growth rate will moderate in 2011 as we higher [ph] year-over-year comparable sales. We have however strengthened our business development organization to dampen this effect.
Operating profit more than doubled to 3.9 million versus the prior year third quarter, reflecting operating leverage and ongoing cost control efforts.
Now, let’s look at some other elements of our financial performance during the third quarter. Overall, revenue came in a bit above our guidance, up year-over-year 11.5% including the L.R. Kimball acquisition and 4.8% on an organic basis. We continue to carefully manage cost as we reduced corporate expenses by 11% versus the prior year quarter. We finished the quarter with net cash of 21.1 million, 29.1 million in cash and cash equivalents and short-term borrowing of 8 million.
Cash used during the quarter included an extra pay period due to timing of our payroll cycle. With our cash and cash equivalents and our borrowing capacity, we should have sufficient resources to support revenue growth and ongoing capital needs.
Our income tax rate for the third quarter was 59.1%. That rate is higher primarily because it’s discrete tax items associated with stock-based compensation. We expect our full year rate to be in the range of 47 to 49%.
CDI will pay a dividend of $0.13 per share on November 24, 2010 to all shareholders of record as of November 11, 2010.
Looking forward, with anticipated strong fourth quarter performance in both our IT Solutions and MRI segments, with improving project and staffing demand in our P&I vertical, as well as revenues from our new infrastructure vertical, we could see fourth quarter revenue growth of 13 to 17% versus the year-ago quarter.
Variable contribution margin during the quarter on this year-over-year incremental revenue could be in the mid-to-high teen range.
For the full year 2011, we could achieve year-over-year revenue growth in the range of 8 to 12% while delivering a variable contribution margin for the year in the mid-teen range in that incremental revenue.
With that, Mark and I will be happy to take questions. Shelly [ph], can you – okay, go ahead.
Thank you. We will now take the questions. (Operator instructions) And our first question comes from Ty Govatos of CL King. Your line is now open.
Ty Govatos – CL King & Associates
Hey, how are you guys doing?
Thanks, Ty. How are you?
Ty Govatos – CL King & Associates
I think you have already answered this, but I wanted to double check. Were there any kind of restructuring charges or anything in the quarter especially at Anders?
No, nothing in the quarter that we called out at all.
Ty Govatos – CL King & Associates
Okay. Two broad questions. Can you talk about Kimball and what you see for them next year, maybe revenue wise or EBITDA wise, once you get finished with all the restructuring? And the IT thing keeps – astounding on the growth rate. Can you talk about what that might look like next year on a year-to-year basis?
Well, I can give you – I’ll give you directional guidance as opposed to specific in those areas Ty. I mean, we don’t really go to the vertical level in giving guidance and we don’t – but I can give you some directional…
Ty Govatos – CL King & Associates
Anything, Roger, down to single digits is fine.
Okay. But I’d say with Kimball, couple of comments. First, it is a business that has some degree of seasonality where its fourth quarter and first quarter are affected by weather. The outdoor construction diminishes in those periods of times, so there are portions of their work that fall off in the winter and come back in the second and third quarter.
So, I’d say, this third quarter number is probably a pretty representative run rate for the second and third quarter, and you should see somewhat less than that in the fourth and first in terms of revenue that’s in the current trends. If we generate growth over there, that would be great, but that’s kind of what’s in the current trends.
From a margin perspective, this is a very high margin business, significantly above the margins we generate in our engineering businesses. So, if I rank ordered our engineering businesses, the highest would be this infrastructure business. Next highest would be life sciences and aerospace, and some of our alternative energy work would be up in those ranges. More traditional power and government be – processes and industrial and government being at the lower end, but at the lower end you still low up into the 20s. So, you are looking at margins here that are 20s and above with infrastructure being way above.
So, it’s a business with great margins that should generate very good EBITDA margins. Again, it should be probably among our highest in terms of EBITDA margins. And again, those would rank aerospace, government and infrastructure would be our highest EBITDA margins. So, this is a very high-end business for us. It’s consistent with our strategy to move up the value continuum.
From an IT – and the other point is that I’ll give – yeah, I made the comment earlier, but the integration area is going very, very well. We are slightly ahead of our plan in terms of timing, we are ahead of our plan in terms of effect, so we should see a pretty clean full year next year, with limited negative effects from integration costs or anything like that. So, we are quite optimistic it’ll be a good run rate for next year.
When I look at IT, obviously when you come off the back of a – close to 30% growth rate for the year, there is going to be a much higher hurdle in terms of the comparables next year that we’re running off of. But our expectations is that we should still be able to maintain good solid growth in our IT business next year, and as based on the business development investment we’ve made and the clients that we have won and then the account management we’ve done within those accounts. So, I think those are the – the real key is that we’ve done – we’ve got three components in IT that are working for us.
One is, we more than doubled our business development resources during the downturn when other people were pulling back, and as a result, we won significant amounts of new client relationships. Two, we’ve put good people on those accounts working and providing good service and good account management so that they were satisfied and then as they started to open up their coffers and start spending again, we got the benefit of in not only the new wins, but the new spending. So it’s a compounding effect that’s working for us.
We are certainly going to maintain that business development and account management investment as we roll into 2011. And I’d be surprised if we didn’t see double-digit growth in that business as we look into next year.
Ty Govatos – CL King & Associates
Terrific. Thanks an awful lot.
(Operator instructions) At this time, we show no further questions in queue, I’ll now turn the call back to Roger Ballou.
Thank you, operator. We are pleased with the momentum that continued into the third quarter 2010 in IT Solutions, MRI, and within the Process & Industrial vertical and Engineering Solutions. Our acquisition of L.R. Kimball has provided us with access to the civil infrastructure market, with a trusted brand, a very capable management team and the opportunity to cross-sell higher margin solutions throughout our entire business platform. We anticipate an uptick in demand in the commercial aerospace market and in defense spending and some key areas of our government services vertical.
And we have a path forward to over time return to profitability in our AndersElite business. However, we are tempering this optimism with a very pragmatic approach to profitably building revenue in what could be a very choppy recovery. I have tasked the management team to move forward on all strategic fronts, with similar advice as that provided by Winston Churchill soon after the Allies’ first victories in North Africa.
Churchill famously said this is not the end, it’s not even the beginning of the end, but it is perhaps the end of the beginning. My paraphrase to the CDI troops is to treat this apparent positive turn in the marketplace not as an end, but a beginning as an opportunity to press vigorously forward into those business sectors which typically rebound early in a recovery.
Additionally, our personnel will prudently mange expenses in what we assume will be a gradually improving business environment and we’ll remain focused on our long-term strategy to shift our services mix up to value continuum to provide more outsourcing solutions, to expand our global services and talent delivery capabilities and to remain financially disciplined as we consistently implement our business model.
Thank you for joining our call today and thank you for your interest in CDI.
Thank you for participating in today’s conference. You may disconnect at this time.