ICT Group Inc. Q3 2009 Earnings Call Transcript

Oct.29.09 | About: Sykes Enterprises, (SYKE)

ICT Group Inc. (OTCPK:ICTG) Q3 2009 Earnings Call October 29, 2009 10:00 AM ET

Executives

Betsy Brod - MBS Value Partners

John Brennan - Chairman and CEO

Vincent Paccapaniccia - EVP and CFO

Analysts

David Koning - Robert W. Baird

Bob Evans - Craig-Hallum

Howard Smith - First Analysis

Operator

Greetings, and welcome to the ICT Group Inc. 2009 third quarter Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms. Betsy Brod of MBS Value Partners, Thank you Ms. Brod. You may begin.

Betsy Brod

Thank you operator, and good morning everyone. Thank you for joining us for today's third quarter conference call with the management of ICT Group.

Since we will be discussing certain forward-looking statements during today's conference call that are subject to risks and uncertainties, including those related to ICT Group's future revenues and earnings projections, the company claims protection of the Safe Harbor forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Now I would like to turn the call over to John Brennan, Chairman, Chief Executive Officer and President of ICT Group. John, you may begin.

John Brennan

Thank you very much Betsy, and with me this morning is Vince Paccapaniccia, our Executive Vice President and Chief Financial Officer of the company.

Welcome everyone, and thank you for participating in today’s call. I will review the highlights of ICT Group’s third quarter performance, including key operating and business development initiatives, and Vince will follow that with details of our third quarter financials, at which point we'll open the call for Q&A.

Before we begin, I want to remind everyone that the purpose of today's call is to review ICTs third quarter performance, and we'll not be able to answer any questions relating to the merger agreement with Sykes announced on Tuesday, October 6, and we will not be providing any forward-looking guidance.

Third quarter performance: I'm very pleased to report that we exceeded our operational and financial objectives for the third quarter of 2009. Total revenue increased 4% from 98.4 million in the second quarter of '09 to $102.6 million for the third quarter. That was a 4% sequential increase, but it was down 5% from $108.3 million achieved in the third quarter of 2008 as a result of our strategy, the focus on our core business services and markets, as well as the impact of a stronger US dollar on revenue recognized in the foreign markets we serve.

On a constant currency basis, total revenues decreased 3% year-over-year, or was up 2% sequentially from this year's second quarter. Our third quarter performance was impacted by the Typhoon Ondoy which hit Manila in the last week of September. We estimate that we lost approximately $600,000 of revenue, or about 48,000 hours of production during the last week of the month and of the quarter.

Consistent with our guidance at the end of quarter 2, core business revenue comprised of North American customer care, back office processing operations, technology, and international operations, increased 9% year-over-year on a constant currency basis driven by a 9% increase in core production volume. Core business revenue totaled $99.6 million in the third quarter of '09 and accounted for 97% of total revenue.

Our gross margin for the period was 41.1%, above our 40% target, and our SG&A as a percent of revenues declined to 38%, down from 38.9% in last year's third quarter, and 39.2% in this year's second quarter.

Net income for the third quarter was $2.1 million or $0.13 per diluted share versus a loss of $546,000 or $0.03 per diluted share a year ago. Adjusted net income for the period, which excludes $583,000 for asset impairments related to Typhoon Ondoy, and $554,000 of deal related cost related cost was $3.2 million or $0.20 per diluted share. This compares with adjusted net income of $1.2 million or $0.08 per diluted share in the third quarter of 2008, which excluded a $2.3 million restructuring charge related to facility closings in the year ago period, along with a $236,000 government grant adjustment.

So you can see that even with the loss revenue from the Typhoon, we posted an extremely strong quarter, largely as a result of solid program execution with effective cost management. Improved operational and financial performance within our international units, especially Australia, also contributed to the gains we achieved. The direct contribution of our international units is $1.7 million in this year's third quarter, compared to a $900,000 loss in third quarter of 2008.

Worldwide capacity utilization was up to 80% in the third quarter of '09, up slightly from the 79% reported for the previous quarter, and up 4 percentage points from 76% in the third quarter of 2008.

Our balance sheet remained strong, and net cash increased from 42.3 million at the end of the second quarter this year to $48.7 million at September 30, 2009. Free cash flow for the period was $8.9 million.

Finally, we closed approximately $30 million of new business from new and existing clients during the third quarter in line with what we achieved in the second quarter. Approximately 50% of the value of the wins came from the telco technology sector, 40% from the financial services sector, and 10% from healthcare and other sectors. In addition, we won a very competitive re-bid against eight other major competitors to manage the national contact center for the US General Services Administration. The value of the new award was $24 million over the five-year life of the contract.

Approximately 60% of the wins during the quarter with the clients in the US, the balance coming from clients in Canada, Australia, Mexico and Argentina, approximately 50% of the value of US wins will be implemented onshore with the balance being supported from our offshore operations in Asia and Latin America.

Our new business pipeline is strong in our targeted verticals in terms of markets with the exception of the UK, where the economic conditions are so very challenging. The pipeline for new business remained strong for our core service offerings, particularly in the financial services and telco technology sectors.

Overall as I said earlier, we are very pleased with our third quarter performance and the progress we made in new revenue and earnings growth, which benefitted from the actions we have taken to expand our core service offerings, reduce our exposure to discretionary non-core services, and to focus on supporting our higher cost international markets with an offshore delivery model, similar to that, which we have implemented for US clients.

Strength in our core business revenue was driven again this quarter by strength in the financial services and telco sector. In financial services, core financial services revenue totaled $42.9 million for the third quarter of 2009, up 7% year-over-year when measured on a constant currency basis, driven by 6% increase in core production volume over period.

Core business represented 94% of total financial services revenue this year, compared to 76% last year. Our core telco technology sector revenue was driven by 23% increase in production hours, and continues to grow rapidly reaching $38.1 million in the third quarter of 2009, up 19% on a constant currency basis from the third quarter of 2008.

Within this sector, we continue to expand programs, both onshore and offshore for several US, UK, Canadian and Australian clients. Core healthcare sector revenue amounted to $11 million in third quarter '09, essentially flat with both the third quarter of 2008 and the second quarter of 2009.

At this point, I'd now like to turn the call over to Vince Paccapaniccia, who will provide you with more financial details of our third quarter 2009 performance.

Vince Paccapaniccia

Thank you, John. For everyone's reference, reconciliation tables for non-GAAP financial measures and quarterly core volumes statistics may be found at the company's website. In addition, my discussion of gross margin, EBITDA, operating profit, net income and diluted earnings per share for the third quarter of 2009 are before the impact of certain charges, which I will address separately.

We continue to make significant progress on improving the company's profitability, strengthening our balance sheet and enhancing our liquidity during the third quarter of 2009. Total revenue for the third quarter of '09 was $102.6 million. Core revenue was up 6% year-over-year was offset by an $11 million decrease in our non-core revenue.

On a constant currency basis, core revenue grew by 9% year-over-year. Total revenue increased 4% sequentially versus $98,350,000 in the second quarter of 2009. Gross margin increased to 41.1% in the third quarter of '09, up approximately 140 basis points versus the third quarter of 2008, primarily due to improved margins in our international markets, they were largely driven by the success of Australia to offshore work to the Philippines. Our Australian market now produces almost 60% of its production in our Philippine centers.

SG&A expenses were reduced by $3.1 million, 7% to $39.1 million in the third quarter of '09 versus the prior year. The reduced SG&A levels are primarily the result of the company's cost reduction efforts. As discussed in last several conference calls, we have made significant progress in reducing our infrastructure costs, as of June 30, we announce cumulative annualized cost savings of $18.4 million. In the third quarter of '09, we realized approximately $4.3 million, or 94% of these savings.

During the third quarter of this year the Philippine peso weakened against the US dollar by 6%, versus the third quarter of last year. We had approximately 85% of our Philippine exposure hedge for the third quarter of 2009 at 45.80 Philippine pesos to the US dollar. In the third quarter of '09, the Philippine peso denominated costs comprised 21% of the company's consolidated cost structure.

Third quarter 2009 adjusted EBITDA increased 29% sequentially and 17% year-over-year to $8.7 million, or 8.5% of revenue. Adjusted operating profit for the third quarter of 2009 totaled $3.1 million, or 3% of revenue. During the last weekend in September, Manila suffered through a typhoon that caused major flooding and temporarily shutdown two of our centers.

Where possible, we reallocated the work to other centers during the storm and worked with our clients while we brought the effective centers back online. These two effective centers are back in production.

Included within our operating results discussed above, there's approximately $600,000 of lost revenue and $400,000 of lost operating profit related to the Manila flooding. This $400,000 of the lost operating profit is comprised of approximately 370,000 of lost gross profit and $30,000 of extra expenses incurred in September. Without the impact of these floods, we would have generated $9.1 million of EBITDA or 8.8% of revenue and $3.5 million of operating profit, representing 3.4% of revenue.

Net interest expense of $24,000 in the third quarter of 2009, increased versus the third quarter of ‘08 net interest income of $48,000, primarily due to higher amortization of the deferred financing charges for our credit facility, combined with lower interest rates on our cash balances.

Adjusted pre-tax income for the third quarter of 2009 was $3.1 million. For the third quarter of ’09, we’ve recognized an adjusted income tax benefit of $125,000, resulting in adjusted net income of $3.2 million or $0.20 per diluted share. At our projected 20% effective income tax rate, adjusted earnings per share would have been $0.15. It would have been $0.17 without the impact of the flood in Manila.

The third quarter 2009 financial results reflect the impact of share-based compensation of $1,050,000 compared to $551,000 in the third quarter of 2008. Now, our adjusted charges we recorded in the third quarter. During the third quarter of 2009, the company incurred $583,000 of asset impairments associated with the Manila flooding while we expect that our flood insurance will be responsive to these impairments and to the $400,000 of lost profits we discussed above, we will not recognized recoveries from the insurance proceeds , net of deductibles until we receive the fund.

During the third quarter of ’09, the company also incurred $554,000 of cost associated with the merger agreement that was announced on October 6.

At September 30, we had 12,341 workstations in operation, declining by 59 workstations during the third quarter of 2009. During the quarter, we [wrote] of 321 workstations, lost to the Manila flooding which were partially offset by workstation additions in Australia and United States.

We grew our cash and cash equivalents by $6.4 million during the third quarter of 2009 to a total of $48.7 million at September 30 and the company remains debt free. Approximately two thirds of our September 30 cash balances were maintained offshore and we would incur additional taxes if we repatriated those funds to the US.

At September 30, DSOs were 66 days. We received a payment from two customers on October 2nd that we had expected to receive in September. As a result we had an increase in DSO from 61 days at June 30th.

In the third quarter of 2009, property and equipment purchases totaled $3.6 million or 3.5% of revenue. Capacity utilization for the U.S. and Canada increased from 66% in the third quarter of ‘08 to 68% in the third quarter of ‘09. Capacity in the Philippines remains over 90% utilized, while total company third quarter 2009 capacity utilization was 80%. That was up four points versus the prior year quarter. We generated $12.5 million of cash flow from operations in the third quarter of 2009 and free cash flow totaled $8.9 million.

During the third quarter of 2009, we also made payments totaling $1.1 million for restructuring charges that were reported in prior periods.

As relates to guidance, due to the transaction announced on October 6, we will not provide any revenue or earnings guidance.

At this point, I’d like to open the call for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question is coming from David Koning with Robert W. Baird.

David Koning - Robert W. Baird

First of all, the last couple years you had Q4 revenues that were down sequentially and I know you don’t want to get into much guidance, but I’m just wondering if now that you’ve done a lot of restructuring work and done a great job getting revenues back on track. Are more normalized seasonal trends inq4, is that more the expectation now in the last couple years more of an anomaly?

Vince Paccapaniccia

I think at this point in time, we are going to [refrain] from adjusting Q4.

David Koning - Robert W. Baird

That’s fair enough. The second question is in Q3, were there any large client swings in revenue? Was it pretty normalized in terms of the contribution from all the top clients?

Vince Paccapaniccia

I would say it was pretty normalized. I think we have seen some cold volumes by some clients, they are down and others go up, but I don’t think there was any significant shift within the client base. We had a few of our large telco clients in Canada and for one of them, the volume of business went down and was more than offset by an increase to the volume of business than the others.

David Koning - Robert W. Baird

And then finally, on the peso hedges, what's left I guess into next year, and based on the hedges you have in place now into next year, I would imagine the rate would be favorable in 2010 relative to 2009?

Vince Paccapaniccia

That's correct. We are about two-thirds hedged for calendar 2010, and we're hedged just shy of $49.50.

David Koning - Robert W. Baird

The arbitrage you pay in 2009 based on hedges is probably closer to 45 throughout the year?

Vince Paccapaniccia

That's correct. Just a little north of 45, that's right.

Operator

Our next question is coming from Bob Evans with Craig-Hallum.

Bob Evans - Craig-Hallum

I realize you can't get into guidance, but I guess from what you've seen this quarter and next quarter, the margin improvement that you had been expecting previously, would you say you're still comfortable with or have confidence in as you are looking out through 2010?

Vince Paccapaniccia

I think what we can say is, we fairly exceeded our internal expectations for the third quarter of '09 and we've certainly made significant progress towards attaining our operating margin goals, and I think that's as far as we can say, in terms of giving guidance for next year.

Bob Evans - Craig-Hallum

You again say, if you are comfortable with previous statement?

Vince Paccapaniccia

I think we are going to leave it as we made a lot of progress towards achieving our goal.

Bob Evans - Craig-Hallum

Fair enough. New business, can you give us a little bit. It was what? Is it $30 million this quarter?

John Brennan

Correct, it's $30 million. It was pretty well distributed across both the worlds, and significant growth in new business coming in Australia, we have many years of, what we are no growth, that's a strategy of focusing on the Philippines as the deliver sight has created new businesses in Australia as well as to our offshore of the Philippine. I think it's been 60% of that is offshore.

Vince Paccapaniccia

I'm sorry what person was it? 50%

John Brennan

It's about 60% of the work we did in the third quarter for the Australian market moved out of the Philippines, which is quite beneficial since the time zones are quite comparable, so we're getting a lot of utilization out of the Philippine operations which combining Australian work and the US work. We made a significant progress among US clients. I think that accounted for about half of all the sales, we also had a significant new business wins in Canada, primarily with the existing for new programs.

Bob Evans - Craig-Hallum

Okay, so US clients accounted for roughly half of sales?

John Brennan

That's approximately was about half of sales was the US clients.

Bob Evans - Craig-Hallum

And what would be mix of new clients versus existing clients on the $30 million?

John Brennan

It was primarily with our existing clients. I'd say, 80 to 90% was with existing clients. We had some new logos.

Bob Evans - Craig Hallum

Fair enough. Overall, just your view of the demand side and pricing side of the market, can you just see this getting better or worse or just looking kind of for your overview.

John Brennan

I think the demand side remains strong. I think we are still seeing a lot of outsourcing opportunities. I think the flavor of it is across the industries we serve. I think there's certain areas where we are seeing somewhat less calls. I think the high volume and growth related to mortgage refinancing got more tempered, as the year progressed, and all the people had given up or whatever.

We have the other side of our business there with those same clients and some new clients in regards to first-party mortgage collection work has been continued to expand, so I’d say overall that's been pretty consistent.

That is varying from client-to-client in terms of overall call volumes, and some we are increasing where they were picking up market share, or they getting more call. It's hard to tell and other clients were seeing some softness in the call volume, but overall I think the demand is strong across the marketplaces. Companies are still seeking to reduce infrastructure cost.

Bob Evans - Craig Hallum

And which your verticals are you seeing the most demand in or interest in?

John Brennan

We've seen tremendous growth in the telco sector over the past couple years as focused on that. As the financial services sector, we’ve got [stopped for us] in '08, so we continue to make significant in-roads there, but at the same time, we're seeing a continued growth in both, the customer care and our back-office processing services for the financial services clients.

We are pretty much leveled off in the healthcare sector, and we are continuing to pursue opportunities in all three segments with pharmaceutical, with health insurance carriers, and with the hospital sector but there are lots of unknowns there right now and we are very pleased to win a five year renewal with General Services Administration to keep a good foothold in the government markets.

Operator

(Operator Instructions) Our next question is coming from Howard Smith with First Analysis.

Howard Smith - First Analysis

Two questions, both relating to the Philippines operation; is all of the effect of the typhoons captured in this quarter, between the charges and the lost revenue, or is there potential for a effect in Q4?

Vince Paccapaniccia

There will be some continuing effect into October. We do have some expenses we are continuing to incur. While our centers are operational, transportation industries are getting people to the centers. I think all of that is for a large part worked out now, the deliveries and expenses incurred in October.

Howard Smith - First Analysis

And then on the accounting for the insurance etcetera, it sounds like you're taking all your costs now you expect to recover from insurance. Would there be kind of a one-time gain at that point, or kind of reversal of a charger when that happens?

Vince Paccapaniccia

We will carve out or explain any recoveries we do get, but we do plan on recording those when we receive the funds from the carriers.

Howard Smith - First Analysis

I think I got it. That's all I had. Thank you.

Operator

That does brings us to our Q&A session. I will now turn the floor back over to Mr. John Brennan for any closing comments.

John Brennan

At this point, I'd just like to take this opportunity to thank our clients and our shareholders for the continued interest in ICT and I would especially like to thank the thousands of ICT employees worldwide for their many contributions to the renewed revenue and earnings growths of ICT Group, and just like to end by saying (inaudible). Thank you very much.

Operator

This does conclude today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.

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