Sykes Enterprises, Incorporated
Q4 2017 Earnings Call Transcript

Published: 27 Feb 2018

[Operator:]

Good morning, and welcome to the Sykes Enterprises Inc's Fourth Quarter 2017 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions [Operator Instructions]. Management has asked me to relate to you that certain statements made during the course of this call as they relate to the company's future business and financial performance are forward-looking. Such statements contain information that are based on the beliefs of management as well as assumptions made by and information currently available to management. Phrases such as our goal, we anticipate, we expect and similar expressions as they relate to the company are intended to identify forward-looking statements. It is important to note that the company's actual results could differ materially from those projected in such forward-looking statements. Factors that could cause and actual results to differ materially from those in the forward-looking statements were identified in yesterday's press release and the company's Form 10-K and other filings with the SEC from time-to-time. Please note this event is being recorded. I'd now like to turn the conference over to Mr. Chuck Sykes, President and Chief Executive Officer. Mr. Sykes, please go ahead.

[Chuck Sykes:]

Thank you, Galley, and good morning, everyone and thank you for joining us today to discuss Sykes Enterprises Fourth Quarter 2017 financial results. Joining me on the call today are John Chapman, our Chief Financial Officer; and Subhaash Kumar, our Head of Investor Relations. Let me start with a quick recap of the year and then make some general comments. John will then take you through our financial results and then we will turn the call over for Q&A. Overall, I think, it’s fair to say that 2017 proved to be just as notable for its successes as it was for some of its challenges. Financially it was a year of record revenues, which came in at roughly $1.6 billion, up 8.6% on a nominal basis and 8.9% on a constant currency basis. This revenue performance came despite significant headwinds from our largest vertical, which is communications, which stood at 34% of revenues and was down 2%. Most of the decline within the communications vertical came from our key clients beginning in the middle part of the year somewhat accelerating through the remainder of the year. While overall revenues were strong, operating margins did get pinched. The main culprit in this, as we have stated before, was the US, which is contending with some cross currents. These include labor tightness, wage inflation and excess capacity. We have been phasing an action plan that should yield results in 2018. And finally, free cash flow from operations, which is cash flow from operating activities minus capital expenditures, was robust up 31% in 2017 versus 2016. We sustained our strong balance sheet, which with the new tax law we can deploy capital with more flexibility in order unlike value for our shareholders. And as much as 2017 was eventful financially, it was eventful strategically as well. We advanced our leadership in digital marketing and demand generation through our investment in XSELL technologies. And recall that the XSELL platform leverages machine learning and artificial intelligence algorithms to enhance the agent work experience thereby driving higher sales throughput from our agents and higher value per transaction for our clients. We can leverage this capability across our platform. We also strengthened our delivery footprint in Larnaca, Cyprus, to service our Northern European clients and we began rolling out the OneSYKES platform to optimize human capital processes and costs internally by leveraging artificial intelligence and rich data sets to enhance the agent experience, drive agent performance and generate greater end customer satisfaction. And finally, we leveraged our solid industry reputation and vertical strength to opportunistically capitalize on a client's decision to divest certain non-core customer engagement assets. As we enter 2018, our focus will be to capitalize on the growth opportunities while restoring the operating margin potential of our operations. The good news is that save for the U.S., and here I am commenting only on the customer engagement business, most of our other geographies are virtually performing on target. And although the U.S. remains challenged by the cross currents of labor tightness and wage inflation, they have swiftly broadened in span and scope, client satisfaction with our operational performance and quality remains high. Still addressing the U.S. is an imperative because as you have heard us referenced in the past, the drag from the U.S. in 2017 was over 200 basis points to our overall operating margin performance. We have several action plans we had been working, which are at various stages of implementation, with various degrees of impact that should start to deliver outcomes in the second half of 2018. These plans include increasing our utilization rate and operating margins by repositioning the mix of service delivery of certain programs to more international and at home agent assets as well as driving capacity rationalization. In addition, we’re also instituting price increases where feasible to offset some higher input costs while reducing soft and hard carrying costs of underutilized capacity. Demand wise, we expect a similar mix of vertical opportunities driving revenue growth in 2018 as it did in 2017. This includes financial services, technology, transportation and other verticals. Meanwhile, our continued strength in digital marketing, demand generation, artificial intelligence and machine learning through investments in Clearlink, XSELL Technologies and OneSYKES positions us uniquely in an evolving industry. In all, while we work through some of our near term margin challenges in the U.S., we should reach an inflection point toward the middle part of 2018. We believe our solid strategic positioning should translate into a long-time runway for growth and margin expansion. With that, I’d like to hand the call over to John Chapman. John?

[John Chapman:]

Thank you, Chuck, and good morning, everyone. On today's call, I'll focus my comments on the fourth quarter results, particularly key P&L cash flow and balance sheet highlights after which I will come to the business outlook for the first quarter and full year of 2018. From a revenue perspective, the quarter was strong despite the ongoing headwind from the communications vertical. We came in at $419.2 million for the fourth quarter of 2017 exceeding the midpoint of the revenue outlook range by almost $10 million or 200 basis points. Virtually all of the revenue outperformed in the quarter relative to the business outlook was demand driven which find the range of clients and verticals. On a year-over-year comparable basis, revenues were up 7.7% on a reported basis and up 6% on a constant currency basis. By vertical market on a constant currency basis, financial services was up around 38%, the other ventricle, which includes retail was up 29%, technology was up 5%, healthcare up 2%, more than offsetting the impact of the communications as well as transportation and leisure verticals which were down 17% and 1% respectively. Fourth quarter 2017 operating margin decreased to 5.6% from 7.4% in the comparable period last year while non-GAAP operating margin similarly declined to 7.2% from 9.1% in the year ago period. The quarterly comparable decline was largely due in part to sub-optimize revenues from the acquired customer engagement assets of a Global 2000 Telecommunications Services Provider in the second quarter of 2017 and the ongoing operational inefficiencies around U.S. recruitment and retention, which the company is addressing through various action plans. Fourth quarter 2017 diluted earnings per share were a loss of $0.41 versus a diluted per share gain of $0.43 in the comparable quarter last year, with the fourth quarter 2017 earnings per share loss related specifically to the passage in December 2017 of the Tax Cuts and Jobs Act and which the company recognized the tax expense of $0.78 per share, the majority of which relates to the tax due on undistributed form earnings. On a non-GAAP basis, fourth quarter 2017 diluted earnings per share were $0.48 versus $0.52 in the same period last year with a delta due to sub-optimized revenues and operational inefficiencies. Fourth quarter 2017 diluted earnings per share were $0.08 higher relative to the midpoint of the company's November 2017 business outlook range of $0.39 to $0.41. Of the $0.08 bit roughly $0.06 is operational in nature and the remainder was a lower than projected tax rate. Coming to our client mix for a moment, we continue to have only 1/10% plus clients, our largest client AT&T, which represents various contracts, including the demand generation business of Clearlink, represented roughly 11% of revenues in the fourth quarter of 2017 versus 16% in the year ago period, driven by lower demand and operational inefficiencies. Our second largest client, which is in the financial services vertical, represented almost 8% of revenues in the fourth quarter of 2017 versus 6% from the year ago period due to higher demand. On a consolidated basis, our top 10 clients represented approximately 45% of total revenues during the fourth quarter of 2017, down from 50% from the year ago period due solely to a decline in revenues from a largest client. Now let me turn to select cash flow and balance sheet items. During the quarter, capital expenditures were $14.9 million or 3.6% of revenues versus 4.9% of revenues in year ago period. Trade DSOs on a consolidated basis for the fourth quarter was 74 days, unchanged sequentially and unchanged comparatively. The DSO was split between 71 days for the Americas region and 86 days for EMEA. Our balance sheet at 31st December 2017 remains strong with cash and cash equivalents of $343.7 million of which approximately 97.5% or $335.1 million was held in international operations. The majority of which will not be subject to additional taxes if we repatriated to the United States. At 31st December 2017, we had $275 million in borrowings outstanding with $165 million available under our $440 million credit facility. In January 2018, however, we paid down $175 million of the $275 million of outstanding borrowings. We continued to hedge some of our foreign exchange exposure for the first quarter and full year 2018 we are hedged approximately 69% and 71% at a weighted average rate of 51.4 and 51.7 Philippine peso to the U.S. dollar. In addition, our Costa Rico Colon exposure for the first quarter and full year is hedged approximately 68% and 66% at weighted average rates of approximately 580 and 586 colon to the U.S. dollar respectively. Now, I'd like to review some seat count and capacity utilization metrics. On a consolidated basis, we ended fourth quarter with approximately 52,600 seats, up 4,900 seats comparably and up 200 seats sequentially, included in the comparable fourth quarter increase in seat count, our 2,900 seats associated with the acquisition of the customer engagement assets of our Global 2000 telecommunications service provider. Even excluding the acquisition, the comparable seat count increased, reflecting net capacity additions outside the U.S., including APAC, Latin America and EMEA. Fourth quarter seat count can be further broken down to 45,400 in the Americas and 7,200 in EMEA. Capacity utilization rates at the end of the fourth quarter of 2017 were 71% for the Americas and 81% for EMEA versus 74% for Americas and 80% for EMEA in the year ago quarter. The decrease in the Americas utilization was driven by capacity additions owing to higher projected demand on previously stated operational inefficiencies. The capacity utilization rate on a combined basis is 72% versus 75% in the prior year ago period with the decline mainly due to previously stated factors. Now I'll turn to business outlook. Our business outlook reflects continuation of healthy demand trend. This demand trend spans various verticals including financial services, technology, retail and travel. Our implied operating margin however reflects the impact of labor tightness and wage inflation cost cuts, primarily in the U.S., that swiftly broadened in spun and scope on a sequential basis un-relative to the same period last year. This is in turn being driven by the changes in the economic backdrop in the U.S. served in part by the passage of the Tax Cuts and Jobs Act of 2017. We continue to address the challenges in the U.S. through various measures. These until shifting some existing and new client demand to either bare position facilities or to our home agent or to other international geographies coupled with rationalizing excess capacity and optimizing the cost base as well as negotiating price increases where feasible. Our first quarter 2018 outlook reflects a disproportionate impact of the previously mentioned actions. We, however, expect operational improvement from the already mentioned actions as the year progresses. Our revenues and earnings per share assumptions for the first quarter and full year are based on foreign exchange rate as of February 2018. Therefore, the continued volatility of exchange rates between the U.S. dollar and the functional currencies of the markets we serve should have further impact positive or negative on revenues in both GAAP and non-GAAP earnings-per-share relative to the business outlook for the first quarter and full year. We anticipate total other interest expense of approximately $700,000 million for the first quarter and $3.2 million for the full year of 2018. The reduction in interest expense in 2018 versus 2017 largely reflects the $175 million pay down of our credit facility, partially offset by expectations of fund, interest rate increases on the remaining borrowing and increase its fees related to the undrawn portion of the credit facility. We still have $100 million of borrowing expanding under our $440 million revolving credit facility. The amounts in other interest income expense excluding the potential impact of foreign exchange gains and losses. We expect a reduction in our full year 2018 effective tax rate compared to 2017 due largely to the passage of the Tax Cuts and Jobs Act in December 2017, which reduced U.S. corporate income tax to 21% from 35%. Considering the above factors, we anticipate the following financial results for the three months ending March 31, 2018. Revenues in the range of $407 million to $412 million, effective tax rate of approximately 28%, on a non-GAAP basis the effective tax rate of approximately 26%, fully diluted share count of approximately $42.2 million, diluted earnings per share of approximately $0.15 to $0.18, non-GAAP diluted earnings per share in the range of $0.26 to $0.29, capital expenditures in the range of $13 million to $16 million. For the 12 months ending 31st December, we anticipate the following financial results. Revenues in the range of $1.687 billion $1.707 billion, and effective tax rate of approximately 21% on a non-GAAP basis and effective tax rate of approximately 22%, fully diluted share count of approximately $42.2 million, diluted earnings per share of approximately $1.54 to $1.57, non-GAAP diluted earnings per share in the range of $1.94 to $2.07 and capital expenditures in the range of $50 million to $55 million. With that, I’d like to open the call up for questions. Operator?

[Operator:]

We will now begin the question and answer session. [Operator Instructions] The first question comes from Dave Koning from Baird. Please go ahead.

[Dave Koning:]

And I guess my first question, Q1, your implied margin, it looks like around 4% is kind of what you're implying within the rest of the year, it actually looks a lot similar to Q2 through Q4 of '17. So I'm just wondering is it fair to say that once we get past kind of the Q1 headwinds we're back to kind of a more normalized margin profile from Q2 through the rest of the year?

[John Chapman:]

Yeah, David, that's the fair assessment. I mean if you think about business we normally have our Q1 to Q2 seasonal downturn. It could be as much as a 100-150 basis points. You won't really see that this year because the improvements will start to come in, in Q2, when we normally see a drop off between Q1 and Q2. So we do see Q1 being the low point and thereafter being relatively normalized.

[Dave Koning:]

And are we at a point now where if this -- so let's say 2018 is around 6.5% margin, but without Q1, it'll probably be 7.5%. Do you still feel pretty good about the 8% to 10% margin? And maybe from here what would have to happen if the labor market have to get a little better or you know what has to happen to bridge from this year, which might be 6.5% or so back to that 8% to 10%?

[John Chapman:]

Yeah, I mean, it really is all about the U.S. David. And if you look at the numbers and work through for Q3 and Q4 imply this, we're not given you by quarter or you can see where that's trending. Then you're absolutely right. And if that continues then assuming that we are there where we expect to be in the set latter half of 2018, we'll be trending towards that 8% for 2019, yes.

[Dave Koning:]

Okay. Great. And then one just quick one, is the tax rate that you're guiding Q4 '18 on an adjusted basis, is that pretty much what you expect around 21% or so going forward as well?

[John Chapman:]

Yeah, I mean, there's more in timer guidance includes everything we know in terms of the new tax law interpretation. And again, I'm sure everybody's saying that there's lots of regulations that's going to be issued. That could change things, I think, as there are number of items that are unknown, but as we look forward, we think that even with the U.S. improves and we get profitability in the U.S. coming increasing. We don't see that rate changing as significantly. So that's the good news.

[Dave Koning:]

Got you. Great. Well, thanks, and you have great quarter.

[Chuck Sykes:]

Thanks David.

[Operator:]

The next question comes from Mr. Bill Warmington from Wells Fargo. Please go ahead.

[Bill Warmington:]

Good morning, everyone.

[John Chapman:]

Hi, Bill. Good morning.

[Chuck Sykes:]

Good morning.

[Bill Warmington:]

So first question I wanted to ask is about the wage inflation in the U.S. So if you look at your agent population today, about what percentage would you say you've put through wage increases? And then about what percentage of the clients are actually paying those higher wages, just to get a sense for how it's flowing through wherever you’re in that?

[John Chapman:]

Yes, I mean, we've given wage increases, let’s call it’s a significant – we've given more wage increases than we've had price increases. Let me say that. Even as we speak today and some of the clients, I’d say we've had a significant minority of clients where we've seen they moved the billing rate that allowed us to move our labor rate. And the wage changes us although there are wide spread, they are not same in each vertical, they're not the same in each site. But what I’d say is we still got a long way to go in terms of the clients giving us what we think the new norms going to be in terms of required prices in the U.S. Included in our guidance, Bill, just to give you an – we've included in our guidance the line side that we can see in terms of what clients are going to do in plan. What I’d say is even in our guidance, there is still more room to go in terms of where we think we need to get clients' bill rates too so that we could pay a labor raise to get supply of labor that’s going to allow us to get attrition and retention to the point we have and the U.S. is at least getting closer to its normalized target that we've given for the U.S. market.

[Bill Warmington:]

Okay. And then toward the ’18 guidance looks like you implies about 60, 70 basis points lower margin. And this is going to ask for some detail in terms of the different buckets that where the drivers are sitting for that in terms of how much is coming from wage inflation, how much is coming from capacity under utilization et cetera?

[John Chapman:]

Yes, I mean, I don’t think we are going to split all of that dome in that detail Bill. What I’d say is if you look year-over-year and you look at Q1, I think, David pointed out there, most of the year-over-year degradation we see in Q1 and most of that is related to the U.S. challenges exactly the split between retention, attrition et cetera. I really wouldn’t want to say exactly where that is, but year-over-year and much of the degradation is actually happening in Q1.

[Chuck Sykes:]

Yes, Bill, one thing I’d just say as we are looking at that is really even the under utilization that we have in our facilities or the wage pressures, I mean, the single driving factor of higher margin obtained is all about labor. We can’t get the sites full enough because of the attrition and even absenteeism to get it through the point we can reach our target markets. And at the same time just because what’s happening now before labor, I mean, the recent announcements after the tax law came in, I mean, many of our clients as you guys fall are announcing increases of 20%, 22%. And that is just creating even more pressure on the situation in the U.S. And if we can’t move our wages up because our customers aren’t giving those price increases, we are just seeing a significant acceleration in the attrition and absenteeism level. And then where we have moved wages, John's key word that he used was where's the new normal in the U.S. labor supply for our demographic that we hire? That’s the part for us, that’s just big unknown right now.

[Bill Warmington:]

Well, you, Chuck you bring me to my next question, specifically to you is, you've managed the business through a number of different cycles, starting back with the late 90s, early 2000 tech bubble and then the 2011, 2010 demand compression there. You know 2018 to '19 looks like it’s a very different type of cycle. Looks like the demand side with corporate profits being strong, cyclically looks pretty good, and it really -- it looks like it’s a battle of the wage inflation. That said, I wanted to ask about what you're operating strategy is going to be for the next couple of years to manage through that?

[Chuck Sykes:]

Yeah, it is interesting, Bill. I would say to your point correctly, I mean each of the phases have been driven by their own unique aspect. But this definitely in the U.S., I at least in my time, there is no time in the company's history that I can recall that we're seeing this level of labor challenge. And it actually is something that you're going to see in a lot of developed countries around the world. I think the hopping around labor gross supply is going to be a big-big topic as far as our strategy to deal with it. But one thing that we are fortunate in, even though every time these points of inflection hit us, it creates some short-term pain, but fortunately being a global company with our platform for domestic based program, we are absolutely adamant about enforcing the home agent strategy in terms of meeting current client needs versus building new U.S. sites, and then we're emphasizing the international operations as well. And that's something that, I think, we are seeing more interest in all the way around. So that's going to be the way we're addressing it, just trying to get our timing straight. Until we can get better visibility in just understanding what the new normal is in the U.S. for the wages we have to pay and what the corresponding prices are that we need to access that labor market. That's the unknown right now.

[Bill Warmington:]

Well, thank you for the insight.

[Chuck Sykes:]

Yes, thank you, Bill.

[Operator:]

The next question comes from Mr. Vincent Colicchio from Barrington Research. Please go ahead.

[Vincent Colicchio:]

Yes, I'm looking for a little more help on sort of the sentiment in terms of how helpful clients are. So would you say there are more clients this quarter than there was last quarter that are willing to shift to work off shore? And also on the waging, the pricing increases, did the numbers go up this quarter versus last quarter?

[Chuck Sykes:]

Yes, Vince, I would say that one thing -- that the one thing at least now, I mean, it was what I don’t know a year, year and a half ago when we are adding capacity that I remember saying we were starting to just kind of watch what was happening in the U.S. around labor supply and everything. But it wasn't really quite universally felt, but I would say today, absolutely, every client that we address is acknowledging it’s a challenge, which is a start. I mean at least we're not on opposite sides of the table. Now the question is so how we are going to work together to deal with it? I would say at this point time that we've had a much more favorable consideration for people to consider looking at all options, and that includes, if we can ship work out of a site to go home to the home agent platform, even though we're still in the U.S. we just have much more addressable markets to go to. And if it turns out that we have downturns, we're not stuck with the capacity to certainly a bigger willingness for people to go international. We've had a couple of clients that have granted us price increases. And we have several more right now that are considering request that we have before them to take a look at, but I can’t sit here and tell you right now that universally it’s easy for them to just keep status quo and increase pricing. If I were betting man right now looking out I’d say more than we are probably going to consider, looking at options of international and probably a home agent versus price increases. I think that’s probably -- in ranking order, that’s probably the third desirable option. And I -- again, for us, we just need a decision. The only thing that’s bad for us is the status quo. We just can’t sit here in the status quo thing. That will suffer us.

[Vincent Colicchio:]

It seems like the usefulness of at home is coming into play here.

[Chuck Sykes:]

Well, you know the one thing about it there is really interesting, and again, we – some of us read a lot and see the papers and things with it, but we've deployed home agent in our German market place. Germany's labor supply, which I know we've all read over the years, is super, super tight. And we now have a few hundred people on the home agent platform in Germany, which is great. We are deploying it in the UK as well and we even have some of our operational leaders in parts within Eastern Europe that are looking at it, but for the most part, we are rolling that now into UK. So -- and now to this point in the U.S., I mean, unless we have absolutely ironclad terms, I hate to use the word never, but it’s going to be a while before we build a brand new brick and mortar site in the United States. That would be my feeling right now.

[John Chapman:]

And it’s interesting – I mean, it’s kind of intuitive of our quality, actually in the U.S. is actually holding up. We are actually doing quite well for clients. And that goes back to then the urgency for change. We are the one today that’s feeling all of the financial pressure; lots of clients understand the market. But in terms of the pinpoint of the urgency, because we are delivering quality, it’s not there. And so some clients get, they understand it, but getting them on our cadence to change is sometimes wait until contract renewals or natural times and that’s what’s really impacting us in terms of our guidance that we would love to be quicker and sooner. But we are just working through the clients' demands. And the good thing is that despite these challenges, actually our quality, it's holding up remarkably well.

[Vincent Colicchio:]

And question on Clearlink, the things grew rapidly. One of the strategic benefits of Clearlink was the idea of cross selling. So I’m curious is that improving? Are there any metrics that you contract to provide us that is basic thoughts of those?

[John Chapman:]

Yes, in terms of metrics side, at least at this stage right now we are hesitant to want to get into breaking out too much it, but it's certainly the way that you would begin seen is that our margins overall should be able to start reaching to threshold levels once we work through our current U.S. challenges here where we are. I’ll tell you, I mean, the one thing for me just as I’m looking at it, we did just one -- a nice contract with the large insurance company that we were able to really create a nice sense of differentiation because of the whole digital marketing, the inbound sales company coupled with our service. So things like that for me Vince, when you are into it and starting to do the work, those are little points that really give you some belief that there is an attractiveness in the marketplace, which you never know till you get out there and start talking to clients. And so we're feeling -- we're feeling very good about the investment within Clearlink. And the opportunities candidly the ones that we're probably not even aware of today that we think it’s going to open for us, so we do continue to feel very positive about that.

[Vincent Colicchio:]

Thank you guys.

[John Chapman:]

Yes, thank you.

[Operator:]

[Operator Instructions] Yes, this concludes our question and answer session. I would like to turn the conference back over to Mr. Chuck Sykes for any closing remarks. Thank you.

[Chuck Sykes:]

Yes, thank you, Galley. And thank you every one for your questions. We look forward to updating you next quarter. Everybody have a good day.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.