Sykes Enterprises, Incorporated
Q2 2013 Earnings Call Transcript

Published: 6 Aug 2013

[Operator:]

Welcome to the Sykes Enterprises Second Quarter 2013 Earnings Call. Management has asked me to relay 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 is 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 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 call is being recorded. Now I'd now like to turn the call over to Chuck Sykes, President and Chief Executive Officer. Please go ahead, sir.

[Charles E. Sykes:]

Thank you, Emily. And good morning, everyone, and thank you for joining us today to discuss Sykes Enterprises Second Quarter 2013 Financial Results. Joining me on the call today are Mike Kipphut, our Chief Financial Officer; and Subhaash Kumar, our Vice President of Investor Relations. On today's call, I will kick off with some high-level remarks about our operating results and the overall state of our business, after which I will turn the call over to Mike who will walk you through our financials. And then we will open the call up to questions. Let me begin by saying that I am pleased with our financial results for the quarter. We reported another set of healthy financial metrics. And the numbers were once again either above or at the top end of the expectations range. Let's start with revenues, which were close to the top end of our range. During the second quarter, comparable organic and constant currency revenue growth was 5.6%. The last time we posted positive comparable revenue growth was in the second quarter of 2011. Operating margins came in above what was implied in our business outlook despite heavy investment in capacity additions and ongoing program ramps. Meanwhile, earnings per share were at the top end of the business outlook range despite a higher tax rate, and our balance sheet remained strong even as we invested for growth. I would now like to comment on the demand environment and operations. On our first quarter conference call, I mentioned that I was encouraged about the outlook for demand in the customer care marketplace, and I am pleased to say that the overall trends we saw in the first quarter from a demand perspective are holding as evidenced by our second quarter results. Although demand varied by client, it was healthy across the majority of our verticals, including communications, financial services, technology and transportation. These 4 verticals represent close to 90% of our revenues. Drilling down even further, programs in the wireless, broadband, retail banking, tech hardware and software, and airline sectors saw a nice pickup in volume. That, in turn, was a function of share gains from competition and shifts from our clients' in-house operations. The only exception to the favorable demand backdrop in the second quarter was the healthcare vertical. There, the underlying demand trend has been soft. Any growth comparisons have been skewed further by either temporary programs, pandemic events, the weather or promotional activity around the program. But given the breadth of our service offerings, we are taking steps to bolster our healthcare client portfolio. In all, the overall demand picture remains encouraging for the year. If current trends hold, the Americas region based on our current year and revenue outlook is on track to generate positive organic revenue growth for the full year, compared with revenue declines in 2 out of the last 3 years. The EMEA region, meanwhile, is expected to deliver revenue growth around the low double-digit range. The last time EMEA delivered this kind of growth was in the 2007-2008 time period. Turning to operations, I am encouraged by the progress we are making. As part of our effort to merge the Alpine and legacy SYKES at-home platforms, I'm excited to report that we have now completed the platform integration in the United States. Accordingly, I am happy to point out that we have successfully completed the transfer of certain legacy SYKES at-home clients over to the Alpine platform. Meanwhile, we are making headway in leveraging some of the processes and best practices from Alpine across our footprint in order to drive greater productivity over the coming quarters. Second, with respect to the facility consolidation and transfer efforts, we are hitting all the milestones. We have now formalized the closure of 2 sites in the U.S. I would also like to point out that several of the clients in the closed facilities have agreed to be transferred to our virtual at-home agent platform. The ratio of clients that have migrated to the Alpine platform versus migrating to another brick-and-mortar facility is running at a 5

[W. Michael Kipphut:]

Thank you, Chuck, and good morning, everyone. On today's call, I'll focus my remarks on key P&L, cash flow and balance sheet highlights for the second quarter of 2013, after which I'll turn to the business outlook for our third quarter and full year 2013. During the second quarter, revenues were $304.7 million. They were $1.7 million above the midpoint of the business outlook range, $301 million to $305 million. The revenue increase relative to the midpoint of our business outlook was driven by run rate demand and new client programs from several clients spanning the communications, financial services and technology verticals. On a comparable basis, second quarter 2013 revenues were up approximately by 5.6% excluding currency effects in Alpine. This increase was driven largely by the expansion of existing and some new client programs across the following verticals

[Operator:]

[Operator Instructions] Our first question comes from Josh Vogel of Sidoti & Company.

[Josh Vogel:]

Chuck and Mike, regarding EMEA, you're obviously seeing very nice growth there, and I was curious just of the growth you saw, was that driven by new logos or existing clients? And can you also talk about the nature of the business you're seeing in the pipeline, whether it's inbound, outbound or collections?

[Charles E. Sykes:]

Yes, we sure can, Josh. I think just to give a little context on the question, I'll remind everybody, in Europe, remember we had eliminated the countries that we felt were problematic for us. We didn't have a particular strong position and particularly given this macroeconomic environment. Second thing is that we needed to obviously get some costs under control once we did that. And the third thing -- and this is what, I think, becomes the most important relative to your question -- is that we structured Europe into 2 components

[Josh Vogel:]

Yes, definitely. And just looking at the capacity around the world, you spent the last few years consolidating centers and getting out of certain countries and lowering the seat count in EMEA. Now utilization has picked up pretty rapidly. How much excess capacity do you have in EMEA before we would see a pretty sizable build-out there? Just looking at your 3 sets of seat counts you give out, it was the only region that was up sequentially. So you know of the 3,000-or-so gross seats you have in a gross basis, how many of those are going to go towards EMEA in the back half of the year?

[Charles E. Sykes:]

On the gross addition, yes. On a...

[W. Michael Kipphut:]

Yes, there's probably going to be approximately 500 added at the back end of the year for EMEA.

[Josh Vogel:]

Okay. So you think you have enough -- I'm sorry?

[W. Michael Kipphut:]

On a gross basis.

[Josh Vogel:]

Right, on a gross basis. So you think you have enough capacity in place to handle low double-digit growth in EMEA for several quarters?

[Charles E. Sykes:]

Yes, given the nature of the program that's been awarded to us, it will work that way, yes.

[Josh Vogel:]

Okay. And if I could just sneak one more in, regarding Alpine, I know you saw low double-digit organic growth year-over-year, but it was down about $6 million sequentially. And I was just curious if that was just seasonality?

[W. Michael Kipphut:]

Yes, it's principally seasonality as we go from Q1 to Q2. It typically, in years past, has dropped anywhere from 15% to 20%.

[Operator:]

Our next question is from Mike Malouf of Craig-Hallum Capital Group.

[Michael Fawzy Malouf:]

Great. I'm just wondering if we could explore the organic growth a little bit. As you kind of look forward maybe into 2014, what do you think the organic growth is going to settle out at after the restructuring that you've had? And then in particular, maybe just some highlights on where it's going to come? I was a little surprised to see healthcare down so much, but I imagine it's probably Canadian-related or something? Maybe you could just talk a little bit about...

[Charles E. Sykes:]

Yes, yes. Mike, I know as we get into next year, you know we always get a little hesitant with how much stuff in the guidance, things we give, but I can tell you that in a normal -- what I would call a little more of a normal setting for us, we ought to be in the mid-single digit type of range of growth for us as a company. Certainly, that can ebb and flow from quarter-over-quarter. But that's really, I think for company of our size -- and candidly, it actually is a nice steady place to grow in this business. As we're already having to explain in Europe, when we explained in years past, when you get into double digits, it typically does coincide with margin pressure. But if you can get in that mid-single digit on a net new growth basis, that actually is a nice way to grow the company. So that would be our ideal type of goal and scenario on a steady state. Regarding to where the growth would come from, we still, for us -- communication, finance, technology and healthcare are still 4 places today that we still see. Certainly, the story for us has primarily been around communication and financial services over the last couple of years, and I think you're going to still hear a lot from us in those 2 areas. Regarding health care, you are correct that those are a little more acute, I would say, to SYKES and just the mix of our clients. We had some offshore. Yes, we do have a large program in Canada that the volumes going up and down for a number of reasons can affect the overall growth profile. But we are seeing opportunities in that space with the healthcare legislation, and what's driving that is if you read -- as you read the materials, there is significant anticipation that with the new health care legislation, you're going to see a big growth in the individual marketplace. And many of the carriers today, they just don't have the platforms in place to serve a large individual marketplace. Everything has mainly been geared for group insurance. So that is starting to create opportunities and then certainly, just with them trying to get their own cost in line because there are percents, as I think we all have become aware now, that they have to derive or give towards care and not towards administration. So that's also causing them now to start looking at that. And I think with the clarity that people are starting to see now with the law, starting to understand what the implications are going to be in the marketplace, I think we're starting to see more opportunities build up in our sales pipeline in healthcare insurance.

[Operator:]

Our next question is from Dave Koning of Baird.

[David J. Koning:]

Yes. Good job returning to organic growth again.

[Charles E. Sykes:]

Dave, thank you. Thanks.

[David J. Koning:]

Yes. And so I guess, first of all, just when we look at the rest of the year, we can kind of back into implied Q4 guidance, and it seems to imply that the margins will probably be somewhere near a targeted 8% to 10% range by Q4. And I'm wondering, is there anything in Q4 that's one-off? Or is -- basically kind of the way that you're guiding to Q3 and then implied to Q4, is that kind of the normalized run rate as we look into the future?

[Charles E. Sykes:]

I don't -- Dave, I don't believe there's anything that I would say is one-off. I think that the nature of what you're seeing that is a little different is just the significance of some of the growth that we're experiencing. And the thing that -- for those of you guys, when you look at that and you think, "Well, you did 5.6% growth. That doesn't seem too crazy." Well, as you think about it, it's how that growth occurs. And we're experiencing a really big ramp-up with a couple of programs in Europe, very good. We're excited about that, but it's causing a disproportionate impact to us right now in the margins. And even in the U.S. right now, a lot of the ramp that we're adding, particularly for all new growth, is all U.S.-based. And those programs, as I've had to explain in the past -- and I know it does sound counterintuitive, when our facility utilization was so low, why in the world are you building centers? And so much of that had to do that where we're growing, we're growing with companies that are giving us big programs. So when they grow, they say, "No, we want a center." They don't give you 100 seats. They don't give you 50 seats. And in order for us to meet their demands and to put them in the right location in communities that we think have long-term viability from a human capital standpoint, labor standpoint, we've had to build new sites. So that's kind of the part to us that we just have a lot of big moving pieces, and that's what's kind of baked into our guidance. But there isn't anything from the standpoint of one-off that's an event-driven type of thing that's going to come and go and that type of thing. I don't know, Mike, if there's more color you can add to that.

[W. Michael Kipphut:]

No, I think that, that answered the question.

[David J. Koning:]

Okay, good. And I guess my follow-up question just on CapEx being a little higher. I think that's related to Alpine, and I'm just wondering if we should expect CapEx to stay high?

[Charles E. Sykes:]

But anyway you're asking about CapEx?

[David J. Koning:]

Yes.

[W. Michael Kipphut:]

CapEx side, this year, we did see quite a bit more than usual, and really, as you recall, there's a couple of things going on. First of all, we do have some net seat additions, but we're also -- have some facility transfers that we spoke about previously as it relates to, in particular, the Asia Pacific region. And that, in turn, is part of the reason why our CapEx was a little bit lower than we anticipated in the second quarter. It was primarily a timing situation, but they're all in place now and it's really just a matter of a few weeks. And then if you also recall, we had mentioned that some of these ramps and timing of CapEx with build-out facilities are dependent upon construction and weather and things as related as such. But we're pretty much in line where we thought we would be. It's just that we had a couple of weeks' difference here before some of those seats were -- facilities were placed in service, and that's what's reflected in the results of the second and third quarter.

[Operator:]

Our next question is from Steven Shui with Stifel.

[Steven Shui:]

Chuck and Mike, so I wanted to dig a little bit more into the free cash flow. I know you guys mentioned that you had some receivable collections at the end of the quarter after the quarter. Should we expect a very strong free cash flow quarter next quarter? Are we going to see a pretty much complete reversal of all the working capital that took away from this quarter next quarter?

[W. Michael Kipphut:]

Yes, you should definitely see that improved. As we've mentioned, we've pretty much collected about 11 days of receivables in just a few days after quarter end. There's always window addressing to a certain extent on every quarter, but this quarter, we seemed to -- we happen to see a little bit more than we normally do. But we don't anticipate that to continue in future quarters, although it may happen from time to time. So no, we do see a significant turnaround, and it -- as it relates to cash flow in the third quarter.

[Steven Shui:]

Okay. And a follow-up question. You guys had -- your EPS guidance for the year implies a pretty steep ramp in the fourth quarter. Can you just talk about what gives you comfort in hitting that target and whether you're tracking towards the middle of the range or the upper end of the range?

[W. Michael Kipphut:]

Yes, we're tracking. Therein lies the reason we give ranges. Sometimes we're at the mercy of some of the weather and build-out as what happened in the second and third quarter. And sometimes we're at the mercy of some of the client ramps and timing. They may be a week or 2 difference, and -- but for most part, we're really targeted towards the midrange of the guidance that we do give, and we feel reasonably comfortable. I mean, with the -- with predicting the future, as most companies do have issues and -- with crystal balls as we do, we do -- we approach it primarily from a confidence level of about 90%, 92%. And this is pretty consistent with what we've done in the past, and feel reasonably comfortable with what we've provided the Street at this point.

[Charles E. Sykes:]

And, Steven, I think just to add a little color to that, from my standpoint, the confidence comes from the known things, the known steps that we've taken around our G&A. I mean, that's one thing about when you make cost reductions, it's pretty predictable in that case. But the other thing is the ramps and things that we're talking about, I mean, their done deals. I mean, they're in process and they're happening. That doesn't mean that we can have delays or hiccups or things such as that. But it's a little different than when you're at the beginning of the year and a lot of your guidance is based off of your sales funnel and the confidence that you have in that. So as time goes on, it's -- certainly, we're closer and closer to having more of a run rate and win perspective versus new sales at risk.

[Operator:]

Our next question is from Al Tobia of Sidus.

[Alfred Victor Tobia:]

Yes. I was just going to continue on that line of questioning. On 2014 guidance, not to get too into that, but just in terms of looking at where your operating margin should begin to sort of normalize with the mix of work at home now and elimination of the excess capacity in the U.S., do you think that you will return to sort of high historical operating margins?

[Charles E. Sykes:]

Well, the thing that we've always stated and the 8% to 10% that everyone is quoting and referencing and accurately doing so is, again, for us, the expectations that we have to be a $1.2 billion, $1.3 billion company. That's what we believe we should be running at if we're doing a good job. And so any time any company in this space, for that matter, is running at those levels, our expectation is that should be the range, and it is a range because there is seasonality. The business, as some of you guys have described it, is lumpy, so you could see a plus or minus 1 percentage point quarter-over-quarter for getting yearly average. So it's 7% per year, that could be 6% to 8% on any given quarter type of thing. So anyway, I mean, I -- we see the path and the trajectory that we're on to get into that range. And in fact, we're still looking out for Q4 to be entering into that range. So that should position us much, much better going into 2014 to run more consistently around that point. But we'll have to wait as we're getting into our budgeting time, and we starting to looking at all the puts and takes and everything that's coming in and get to that visibility.

[W. Michael Kipphut:]

Typically, we won't provide guidance for 2014 until fourth quarter earnings release. And then what Chuck was speaking to is just generally the trends that we've passed along.

[Alfred Victor Tobia:]

I -- no, I guess, my question, just to drill in a little bit, is that if a larger portion of your revenue comes from work at home versus having to -- having a more of a fixed cost, able to then move up the bottom of that range or tighten that range where maybe you would not dip down in the 6% level? Or how does it affect the business going forward? Forget taking the top -- assume the top line range is out to what you think, you get some modest level of organic growth and you're at that 1.2% to 1.3% level. Having a clean year of work-at-home mix in there, does that let you be more -- raise the bottom of your operating margin range?

[Charles E. Sykes:]

Yes, I appreciate your question. I -- the thing that we've -- at least I hope we've done an adequate job in educating everyone about our views on the virtual model is that, granted, it is unmatched compared to brick-and-mortar and flexibility and speed, but it is not immune to some of the challenges of margin pressures when you're ramping up and down. It does perform better from a G&A standpoint, okay, because to your point, you don't have the facilities and everything, but you do have still the ramp expense when you're training people on your hourly basis. And the challenge in it, again, is just -- and giving more clarity with it, most of the virtual at-home people are working fewer than 40 hours. And so in that training ramp time, it can actually be a little bit exacerbated on the labor standpoint. But you don't have the facility expense standpoint. But let me just go to the point, then, you may be saying, "Well, why end up going into virtual?" The thing about virtual is that for us as a company, we have to continue to make investments to say relevant to what we see are the trends of today. Certainly, we did a big job with that when offshoring was relevant. Today, we see virtual being relevant. And the other thing is when we couple all of these collective capabilities together, not that we run them separate and distinct but when we couple them together, it really begins a really nice differentiated business model. And to give you an example of this, here we are doing all of these centers, trying to meet the needs of several clients that are wanting thousands of people, and it's taken us almost a year to build centers and get those things provisioned. For the same number of times, the same number of people, I should say, we just did an agreement where we're ramping in 7 weeks, in 7 weeks, hiring the number of people ready for training that it would take to do a year in brick-and-mortar. So to clients that have needs, that have a fast response time, it's a great unmatched differentiation. But again to us financially, yes, you would still hear us talking about some margin pressures and things and ramping because it still is present. But it's a great delivery model for unmatched speed and flexibility in the eyes of the client, I should say. I hope that helps.

[Operator:]

I'm showing no further questions. I'd like to turn the call back over to Mr. Sykes for any closing remarks.

[Charles E. Sykes:]

Great. Well as always, I really appreciate everyone's interest in SYKES and following the company. And we look forward to updating you guys on our next quarter call. Everybody, have a good day. Thanks.

[Operator:]

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