Startek Inc (SRT) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter 2007 StarTek Earnings Conference Call. My name is Karma; I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session before the end of this conference. (OPERATOR INSTRUCTIONS) I would now like to turn your presentation over to your host for today's call, Mr. David Durham, CFO. Please proceed.

Thanks, Karma. Good morning, everyone and thanks for calling in. I'm David Durham, the newly appointed CFO of StarTek and it's my pleasure to be here on my first StarTek earnings call. I'm joined on the call today by StarTek's President and CEO, Larry Jones and Pat Hayes, our Chief Operating Officer. Larry and I will be delivering our prepared remarks today, with some brief comments about our release this morning. At the conclusion of our prepared remarks, we will conduct a question-and-answer session.

For those of you who have not received a copy of today's press release, please go to www.startek.com or you can download a copy from the investor relations section of our Web site. And of course, please note that the discussion today may contain certain statements which are forward looking in nature pursuant to the safe harbor provisions of the federal securities laws. These statements are subject to various risks and uncertainties, and actual results may vary materially from these projections. StarTek advises all of those listening to this call to review our 2006 Form 10-K posted on our Web site for a summary of these risks and uncertainties. StarTek does not undertake the responsibility to update these projections.

Further, our discussion today includes some non-GAAP financial measures. In accordance with Regulation G, we have reconciled these amounts back to the closest GAAP basis measurement and have included those reconciliations in our press release and on our Web site. I will now turn the call over to Larry Jones, StarTek's President and CEO.

Thank you, Dave. Good morning, everyone and thanks for joining us. First, let me start with some general comments and then Dave will discuss with you the financial results for the third quarter. In closing, I will wrap up with a discussion of the operating highlights of the quarter and open up the call for questions.

This quarter, we continue to deliver on our strategy articulated in January -- focus on growth and restoring profitability in 2007, while preparing for growth and acquisition expansion in 2008. We made good progress on all fronts, by delivering both sequential and quarter-over-quarter revenue growth, increased sales momentum by securing new business, both from the base and from new clients, and delivered continued margin improvement despite continued Canadian FX headwinds. We posted positive net income of $0.03 per share on a fully diluted basis, while absorbing another $1 million of the Hawkesbury facility write-offs and receiving a beneficial tax adjustment.

In addition to the impressive financial performance during the quarter, we completed to build-out of our executive team with the hire of Dave Durham in September. Dave is a great addition to our team and brings twelve years of public company experience as CFO of CIBER, an IT services firm. Dave understands outsourcing and people intensive businesses and has experience building infrastructure to support a growing operation. While at CIBER, he also led over 20 acquisitions, a skill we will surely exploit. So, it is with great pleasure that I welcome Dave and turn the call over to him.

Thanks, Larry. As Larry mentioned, we reported strong financial results for the third quarter, making progress in several fundamental areas. Our top line growth was solid, both on a sequential and quarter-over-quarter basis. Gross margins expanded and we returned to profitability after reporting losses in each of the last two quarters.

Revenue for the third quarter totaled $63.2 million, our highest revenue quarter ever in the customer service business, an increase of 7.4% compared to the second quarter of 2007 and an increase of 2.1% compared to the third quarter of 2006. Most of this growth was attributable to the reopening of our Petersburg, Virginia location, increased business from current clients and the addition of new clients. Recognizing that many of you track our client concentration, revenue from our largest client, AT&T, was flat in the quarter in terms of revenue dollars, but as a percentage of revenue, declined to 49% from 53% in the prior year quarter. And revenue from T-Mobile increased to 23% of our current quarter total, up from 21% in the second quarter. It's worth noting that while these clients represent a significant percentage of our overall revenue, each of those accounts have numerous programs serving multiple lines of business with multiple service types.

For the nine months ended September 30, revenue totaled $179.6 million in 2007, an approximate 1% increase compared to $178.5 million for the same period in 2006. Perhaps more important than our strong top line performance was the progress made in the quarter to expand gross margins. Gross margin for the third quarter of 2007 was 16.3% of revenue, 180-basis point improvement compared to 14.5% in the second quarter of 2007. This improvement came in spite of continued weakening of the U.S. dollar against the Canadian dollar, which negatively affected gross profit by approximately $600,000 or approximately 100 basis points of gross margin. This margin improvement was primarily due to better capacity utilization associated with the re-opening of our Petersburg facility and expansion of higher margin business within other accounts. Gross margin also improved compared to the third quarter of 2006, increasing 50 basis points compared to the 15.8% reported in that period.

We continue to invest in our corporate infrastructure in support of future growth and as a result, selling, general and administrative expenses for the quarter increased to $9.7 million compared to $9 million in the second quarter of 2007. As a percentage of revenue, however, SG&A actually declined approximately 10 basis points to 15.3%. Corporate staffing and human resources programs made up the bulk of the current quarter increase. Going forward, we expect SG&A to kick up slightly in the fourth quarter, as we will incur the full expense of hires made throughout the current quarter and expect SG&A to level off in early 2008.

We are pleased that operating income before impairment and restructuring charges returned to profitability in the current quarter, after losses in both Q1 and Q2. Income totaled approximately $600,000 in the quarter, a $1.1 million improvement compared to losses of approximately $500,000 in both the first and second quarters of 2007. Taking into account foreign currency effects, the sequential improvement would have been $1.8 million. We incurred impairment and restructuring charges of $1 million this quarter in connection with the closure of our Hawkesbury, Ontario facility, resulting in an operating loss of $400,000. This compares to an operating loss of $3.5 million in the second quarter of 2007, which included impairment and restructuring charges of approximately $3 million.

Other income of approximately $200,000 combined with an adjustment to our income tax provision that resulted in a tax benefit of approximately $600,000 yielded net income for the third quarter of $400,000 or $0.03 per diluted share.

Moving on to the balance sheet, our balance sheet remains strong with cash and investments totaling $33.4 million as of September 30. This balance does, however, represent a decrease of approximately $10 million compared to the cash and investments balance at the end of June. This decrease is due almost entirely to an increase in accounts receivable, which resulted from billing delays earlier in the quarter. Since quarter-end, we collected the cash associated with those delayed billings. Another use of cash in the quarter was the reduction of long-term debt, which totaled $13 million at the end of September, down from approximately $14 million at the end of June.

And finally, CapEx for the quarter totaled $4.5 million, which included cost associated with the build-out of our new Victoria, Texas contact centre. And year-to-date, CapEx totaled $10.6 million.

With that, I will turn the call back over to Larry.

Thanks, Dave. Before I talk about some of the key operating highlights of the quarter, I would like to make some comments about the industry. The communication industry is enjoying good times. Subscriber growth in broadband, wireless and cable continues; the demand for data products is on the rise; and consumers and businesses are rapidly converting to more complex products like the iPhone and voice-over-IP. This growth coupled with increased competition, especially between the wireline, wireless and cable players, has created a significant shift whereby more and more companies are viewing customer service as a competitive advantage rather than just a cost of doing business. Likewise, they are viewing outsourcing as a way to better quality and increased capacity rather than just a cost reduction strategy. All this is driving a significant increase in demand for customer service agents. This increased demand in voice customer service and the lead time to bring new capacity online is forcing many BPO players to scramble for capacity. StarTek is seeing this first hand, as many of our clients are asking us for more seats as soon as we can provide them. Thus, our short-term revenue growth will be driven less by our ability to sell new clients and more by our ability to hire agents and our ability to bring on new centers like Victoria.

Let me talk about some of the key accomplishments in the quarter. David has already talked about our sequential revenue growth of 7.4%. This was driven by significant add-on business in two existing clients and by ramping of agents in our newly performing -- newly reopened Petersburg facility. In addition, we activated two smaller accounts during the quarter. We also reduced our client concentration in AT&T and we are awaiting corporate sign-off of the AT&T Mobility consumer contract that has been under an extension of the existing contract since January. Again, we have no reason to believe that this contract will not be signed soon, with terms that are relatively consistent with the prior contract.

Recently, we also announced a two-year extension of the T-Mobile contract. At this point, all contracts that we targeted earlier this year for re-negotiation have been completed. During the quarter, we also completed the build-out of the executive team. In addition to hiring Dave as our new CFO in September, we added two new executives in HR and expanded our launch team to support the opening of future sites. With these additions in place, StarTek now has an A Team in place to scale the business.

We also continued to make progress on agent recruiting and attrition. As we have previously reported, attrition issues in the second half of '06 and early 2007 had a negative impact on our revenues and margins. We continue to make progress on this issue by changes in people, processes and systems, and expect incremental progress quarter-to-quarter. We also are experiencing recruiting challenges in certain markets due to wage inflation, particularly in Canada. We are addressing these issues community-by-community with new recruiting techniques, wage adjustments were appropriate, and by adding new sites in fresh new markets.

Finally, we have already discussed our site optimization and expansion strategy, a key component of our growth. Improving our operating performance in every site is a major priority. During the quarter, we drove higher margins in most of our sites through higher utilization, higher performance metrics and higher revenue per FTE. In addition to maximizing performance in all of our existing sites, we need to bring new sites online to support new demand as well as to optimize existing capacity where appropriate. Petersburg, which began to ramp in this quarter, is the first of such sites and will continue to grown in Q4. We have secured commitments for our existing client -- from an existing client for the Greenfield site we announced last quarter in Victoria, Texas. We will start agent trading in December and go live in January. In addition, we are diligently screening communities to identify the location of our next site to support our growth objectives.

As per guidance, we continue to be reluctant to provide specific guidance on the coming quarter, but do expect revenue to continue to grow as we continue to staff our Petersburg facility. And while we expect pricing and utilization improvements to continue to help margins, we also acknowledge the continued weakening of the U.S. dollar, combined with the fourth quarter training costs of the new Victoria, Texas center, will put a near-term drag on margins.

In closing, we remain focused on growth and profitability. The business in trending in the right direction, as a result of the many programs we put in place in the first half of this year. We will continue to remain focused on agent recruiting, site optimization and expansion, new sale and margin improvement, which should result in continued quarter-over-quarter improvements.

With that, I would now like to open it up for questions.

(OPERATOR INSTRUCTIONS) And the first question comes for the line of Tobey Sommer from SunTrust Robinson Humphrey. Please proceed.

I had a question for you just regarding your longer-term strategy over the next 24 months, you started up by articulating that you wanted to correct some of your contracts, make sure they were firmed up and appropriate for you to generate a reasonable gross margin, help start some better human resource practices to lower attrition, prop up your EBITDA, and then maybe deploy some cash to either diversify or go offshore or something like that 18 months from now or something like -- to that respect. Any changes to that strategy over the next 24 months or do you still see it unfolding kind of more or less in that order, if I characterized it appropriately?

Yeah, I think you articulated it pretty well. The focus in 2007 has been on restoring margins through contract and site optimization, and on making sure that we start the growth curve. '08, we will be focused on organic growth and continuing to sustain and improve both gross and operating margins. As we already said before, we also '08 would look at acquisitions as a way of expanding both our capabilities and our services, in our potentially offshore and in opening up new verticals. So as I look at the window you talked about in 24 months, we are looking forward to get through 2007 and making sure that all those operating issues are behind us and focusing on growth and expansion in 2008.

Thanks. And then I was wondering if you could comment about your cash position, which went down primarily as a result of growth in receivables. Anything about the receivables which changed or would you expect that to --- prospectively, would you expect your cash balance to continue to ebb down a little bit as you get this forecasted revenue growth that you talked about?

Yeah, I'll take that. Tobey, this is Dave Durham. As I mentioned in my prepared remarks, we did have some billing delays associated with a couple of clients early in the quarter, which resulted in higher AR balances at the end of September for those clients. Then we had at the end of June, I would tell you that the quality of the receivables have never been better, our relationship with our clients has never been better. So, in terms of the integrity of the receivables, there is no issue. I think we do need to continue to work to get bills out the door as timely and as accurately as possible, and work with our clients to be paid as quickly as possible. So, while I can't guarantee that we won't have fluctuations like that, like we experienced in this quarter and future quarters, it's certainly an area that we are focusing on and intend to improve upon. In terms of -- the growth in AR is the result of organic growth of the business, I don't see there being a huge uptick as a result of that.

Thank you. And then I was just wondering if you could comment on the internal attrition or client retention, you can project from whichever angle you'd like, and the extent to which you have seen some of your early attempts to enhance your hiring and training practices actually materialize in the form of better metrics. Thanks.

Yeah, great question, and let me come at it in two different ways. First of all is, a lot of the programs we have put in place have reduced our attrition, but we see that as a multi-quarter event that will unfold well into 2008. Some of the newer programs we are putting in place are also focusing on recruiting, which is the front end, filling the front ends of the pipeline. So, the combinations of those two should allow us to continue to grow our FTE, which we did this quarter, and to be able to continue to grow and ramp FTE, both in our existing sites and our new sites. But, as the industry is aware, labor is tight, wage inflation is a reality and we continue to ask to be better than we were a year ago to keep raising the FTE and hiring faster than we attrition.

Thank you very much. I will get back in the queue.

Larry Jones. Okay, thanks.

And the next question comes from the line of Arnold Ursaner from CJS Securities. Please proceed.

Hi, Good Morning. Going to Victoria, Texas, you indicated you are ramping that up already. Do you actually have clients signed up for the facility?

We do and as it was kind of buried in the comments. But, this quarter, we secured one of our existing clients for capacity in that center. We have been hiring both management and supervisory level. We will bring agents on in December and continue to ramp that and go live in the first quarter.

Okay. And the additional facilities you're thinking about in the U.S., would these be in direct response to the client demand or again, more build them and then figure out where you are going to fill these seats with?

We will continue to build sites ahead of demand, but the good news is demand is very strong. And therefore, like the Victoria center, every time we get another one planed and identified, the demand is right there to fill it up. So, at least for the short term, we view a continued expansion of sites in an orderly fashion that we think we can do on a quarter-by-quarter basis.

Okay. You mentioned that you built-out your team and I know there were expenses incurred during the course of the quarter. Can you give us a feel for sort of a run rate SG&A level as either dollars or percent of sales?

Sure, and this is Dave Durham. As I mentioned in my comments, we do anticipate SG&A to tick up a little bit in the fourth quarter from levels that we reported in Q3. I think it's premature and then probably inappropriate to try to be too precise in terms of what that number will be, but we don't foresee that number on a run rate basis ticking up in any material way from here and expect it to level off early in 2008.

Okay, final question. You mentioned it various times along the way that your goal of returning to historic margins by next year and I am wondering if, now that you have signed the major contracts that perhaps had held that back with a better feel for new facilities expansion, can you freshen up whether you in fact continue to view that as a reasonable goal and if so, the steps you need to continue to take to get there?

I think as we said in the past, we want to make sure people understand historic margins isn't in the realm of when we are in a supply chain business. We continue to believe that we can take the margins up sequentially over the next several quarters. We are in the budget planning process now for 2008. I would say we would be much better positioned to talk about the 2008 numbers, which will have all the benefit of the contract, all the benefit of the production, all the benefit from the utilization, all the benefit from the incremental revenue, but it also has the drag of the Canadian dollar and other factors that we are trying to balance out. So, that's the best I can give you right now. And hopefully, next quarter, we will be able to give a better guidance on '08.

Thank you very much.

(OPERATOR INSTRUCTIONS) The next question comes from the line of Josh Vogel from Sidoti & Company. Please proceed.

Larry, I just want to first touch on your prepared comments. At the end, you said that the training costs and currency exposure are going to be a near-term drag on margins, did you mean just in general or relative to the third quarter?

I think, yeah, related to the same comments I just made is that we have got a lot of things pushing the margins uphill and those are the two things that are pulling it down. And again, not to give guidance as to where it's going to be absolutely, but we got a lot more good things happening than we do drags.

Okay. And with the SOW signed with T-Mobile, was it similar pricing terms that you had in place?

This is Pat. I will let Pat talk about that.

Hi, Josh. Yeah, the -- we just recently signed a two-year deal with T-Mobile. The pricing terms are similar; I would say they more reflect some of the increases in cost that we are seeing associated with our exposure in Canada and some of the increases in FX that we've seen. So, they're probably better than past, but our cost too have risen.

Okay and you said that you do anticipate a long-term deal signed with Cingular soon. I know we've been waiting several months for this.

Yeah, we are on our third extension I believe and it takes us through November 29. I am told that's still a low number of extensions relative to some of our competitors. But, yes, it's a long process. I would say the relationship there is as strong as it's ever been.

Okay and shifting over, do you have six centers in Canada now, with the closure in Ontario?

Yes, we do.

Okay. And can you quantify how much of your revenue comes from these centers and more importantly, what percentage of your expenses are denominated in Canadian dollars?

Yeah, without getting too specific on the revenue split, roughly two-thirds of our Canadian expense is related to U.S. revenue. And clearly, one of the strategies in the face of the FX headwinds is to try to move more of our Canadian operations to Canada-based clients, so that the revenue and expense are both fluctuate with FX. But, at this point, it's about a two-thirds/one-third split.

Okay. And just lastly, I know that you don't really discuss capacity utilization in detail, but can you maybe give us a sense of how much existing excess capacity remains today and at what point would a meaningful build-out -- is that a possibility that if we look at into '08 or you'd have start building out many new facilities?

Yeah, Josh, this is Pat. I would say that we have some capacity. It's limited; there are pockets of capacity. But, Larry mentioned the demand we have and our strategy around staying ahead of that demand relative to new site expansion.

And this is Larry. Given the comments I made about the industry, we are having clients come to us and asking for larger pockets of agents, and there's just no capacity to put those into existing centers. And therefore, we see, and the same reason we made the decision for Victoria, we would make this decisions for others, is to even on a Greenfield basis, we believe there's plenty of demand to be able to go fill those sites. As far as overall utilization, again, we don't give those figures out, but I do believe that given the demand, we will build new centers.

Okay. Thank you, guys.

Thanks.

And the next question comes from the line of Melissa Moran from Thomas Weisel Partners. Please proceed.

Oh, hello, good morning.

Good morning.

Hi, Melissa.

Hi, I was wondering if you could just talk a bit about any new trends in competition in your space that you've been seeing and also if you could provide some commentary on any changes in pricing or how you've been seeing that move in the quarter.

Let me start with competition. We continued to run in to the same suspects that we have over the last couple of years. I would say that the industry in general has got more demand than supply and therefore, all of us are trying to meet the demands of our existing clients. And therefore, it is not as hyper competitive as it was say two or three years ago. Mind it, it was a reverse situation, under utilization and very competitive on contracts. So, as far as pricing, I would say, because of that lack of hyper competition, there is no huge pricing pressure but, at the same time, this is an outsourcing business where there's always pricing pressure. But clients are also realizing, because of their internal sites, that the cost of labor is going up and the Canadian dollar is different than it was a while ago. So, I would say that in general, we're seeing rational negotiations when we come to the contracts on the pricing side.

Okay. And then I know you've talked about this in the past but, in terms of new verticals, are there any in particular that you would find interesting to get into, either organically or through acquisitions?

I think we've -- at this point, clearly in '07 and even in the early part of '08, would not Greenfield a new vertical. It takes significant amount of expertise and resources to go open up a new vertical and without reference accounts and other things, it's a huge effort. So, a lot of our acquisition focus will be on looking at new vertical to able to enter. Relative to which one's are attractive and not attractive, our business is focused heavily on technology, our business is heavily focused on subscriber-based business model where customer service is king and quality is important as opposed to some more of the commodity-based verticals. Short of that, I would say we are going to kind of follow our nose on acquisitions and see where it goes.

Okay. And then just finally, one last question, how much, if it all, has iPhone had an impact on your business? What type of work do you do for them and is that something that's really material to that segment?

Yeah, Melissa, this is Pat -- Pat Hayes. The --- it's not any in particular. The iPhone generated more overall customer care volume if you will, so it drove volume on the AT&T side, which trickles its way down. But, there wasn't specific customer care outsourcing that was set up directly for the iPhone, so it was more of an indirect, but we did see increases in the volume and again, it turns into increased demand as we talked about.

Okay, great. Thank you very much.

And the next question comes from the line of Tobey Sommer from SunTrust Robinson Humphrey. Please proceed.

Thank you. I was wondering if you could talk to us about what sales lead times are like and maybe break it down into two buckets. First, I guess I would like to know whether you are seeing these sales cycles contract or lengthen currently and maybe get your answer on that for two buckets, whether it's the new customers and potential customers you're talking to on that side, and how quickly are existing customers initiating conversations with you and then implementing those new projects. Thanks.

Let me start by talking about the existing accounts. Typically, in the accounts we are in and it's true across the industry, the shortest lead time and the quickest time to new ramping is by incremental lines of business or by taking volume away from a competitor in an existing line of business. So in that case, we can respond as quickly as 30 days to 90 days, but I would say that's the window to be able to capture new business in that front. And year-to-date, that's been the majority of our efforts. On new accounts, we are actually seeing smaller RFPs, smaller come-join-our-portfolio vendors, and here's a small project and grow it. And therefore, smaller RFPs have smaller lead times. So in that case, you are talking 90 -- three months to six months kind of sales lead time to be able to bring those accounts on. It doesn't say there aren't a couple of bigger RFPs floating around out there, which tend to be six to nine months of selling coupled with a year to sometimes even a year-and-a-half to implementation. But, I would skew everything towards the short end, at least from what we are seeing versus the other.

Thank you very much.

(OPERATOR INSTRUCTIONS)

Well, great. If there is no further question, I would like to thank everybody for participating and we'll talk to you next quarter.

This concludes the presentation for today, ladies and gentlemen. You may now disconnect. Have a wonderful week.