APAC Customer Services, Inc. F4Q09 (Qtr End 1/3/10) Earnings Call Transcript

Executives

Harriet Freid – Investor Relations

Michael P. Marrow – President and Chief Executive Officer

Andrew B. Szafron – Senior Vice President and Chief Financial Officer

Analysts

David Koning - Robert W. Baird & Co.

Howard Smith - First Analysis Corp.

Matthew McCormack - BGB Securities

Robert Riggs - William Blair

Michael Kim - Imperial Capital, LLC

APAC Customer Services, Inc. (APAC) F4Q09 Earnings Call February 19, 2010 10:00 AM ET

Operator

Good morning and welcome to APAC's fourth quarter and full year 2009 financial results conference call and webcast. This call is being recorded. At this time, I would like to turn the call over to Ms. Harriet Freid of LHA.

Harriet Freid

Good morning and thanks for joining us for the fourth quarter and full year 2009 conference call for APAC Customer Services. The company issued a press release yesterday afternoon, containing financial results for the fourth quarter and full year 2009. This release is available on the company's website, as well as on various financial websites.

The company representatives on today's call are Mike Marrow, President and Chief Executive Officer and Andrew B. Szafron, Senior Vice President and Chief Financial Officer.

Before opening the call, I would like to remind you that statements about future operating and financial results are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to various risks, uncertainties, and other factors that could cause the company's actual results to differ materially.

Yesterday's earnings release and the company's Annual Report on Form 10-K for the fiscal year ended December 28, 2008 and its quarterly reports on Form 10-Q for the fiscal quarters ended March 29, 2009, June 28, 2009, and September 27, 2009 discuss some of these factors. The company's forward-looking statements speak only as of today's date.

To supplement the company's consolidated financial statements, APAC uses certain non-GAAP financial information when describing financial performance. The company presents EBITDA and adjusted EBITDA, which are defined as non-GAAP financial measures and also presents the fiscal year 2009 financial results excluding the financial impact of the reversal of the valuation allowance recorded against the deferred tax assets and the financial impact of the 53rd week of operations.

The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. The items excluded from this non-GAAP financial information are significant components of the financial statements and must be considered in performing a comprehensive analysis of overall financial results.

A reconciliation of these results to GAAP is attached to yesterday's earnings release. The company has posted a downloadable presentation to accompany the webcast in the Investor Relations section of its website, at www.apaccustomerservices.com. The presentation can be viewed in the webcast section of APAC's IR website by clicking on the link shown under the title of today's event. It will also be posted under Investor Presentations after this call.

I would now like to turn the call over to Mike Marrow.

Michael P. Marrow

Thank you Harriet and thanks everyone for joining us on our fourth quarter conference call. As we noted in our press release, we had a very solid quarter and a very solid year. A lot of hard work by a bunch of dedicated people has produced revenue and pre-tax margin increases for the full year, for the quarter, and sequentially.

Andrew B. Szafron, our Chief Financial Officer, is going to provide considerable detail on our results during the course of today’s call. The valuation allowance reversal and the 53rd week, both of which are positive issues, add a level of complexity to our results that we would not normally see.

We produced an unusually long press release that walked through these complexities. Andrew will do that again on today’s call. When you sort through the noise, the bottom line is that 2009 was a great year. We surpassed consensus on both revenue and EPS and we are prepared for an equally successful 2010.

Before Andrew gets started, I would like to briefly comment on our guidance for 2010 as well as the 10b5 plan announced by our Chairman of the Board, Ted Schwartz. In our press release we stated that we expect 2010 revenue to be in the range of $320 million to $330 million and our full year EPS to be in the range of $0.44 to $0.46. This represents strong revenue growth of 11% to 15% and equally strong 12% to 17% growth in earnings when normalized for taxes.

As part of this discussion, Andrew will describe how this guidance compares to 2009, taking into account the impact of the 53rd week in 2009 as well as our anticipated tax rates for 2010.

So switching over for a moment to the 10b5 plan for Ted Schwartz that was announced yesterday, this is a new plan. When Ted initiated his earlier plan at the beginning of 2009, it was a two year plan. As it turns out, there was a high level of interest and the quantity of shares he planned to sell over a two year period were absorbed by the market quicker than anticipated.

As stated in yesterday’s press release, Mr. Schwartz is putting in place a new 10b5 plan. He believes, and the company agrees, that this will be positive for existing shareholders as well as others who would like to participate in the success of APAC.

So I am now going to turn the call over to Andrew to discuss our results for the fourth quarter. Following Andrew’s discussion, I would like to review some of the successes we have had in 2009 and the momentum those bring into 2010. After that, we will open up the call to questions and with that, Andrew please take it away.

Andrew B. Szafron

Thank you Mike. Our results for the quarter and full year are quite strong. As you mentioned, there is some complexity to the numbers. I’m going to walk everyone through that today.

For those of you following along via the webcast, my commentary begins on Page 5 of the presentation. Fourth quarter 2009 revenue of $85.5 million was up 31% from $65.3 million in the fourth quarter of 2008. Our growth came both organically from existing clients as well as from new clients signed up this year.

APAC’s fiscal year ends on the Sunday closest to December 31. So 2009 was a leap year in our fiscal calendar which means that we had one additional week in our results. I will go through a reconciliation of the impact of the extra week a little later on but as far as revenue is concerned, the 53rd week was worth $6 million.

So on an equivalent basis, our quarterly revenue was up 22% year-over-year. Gross profit in Q4 was strong at $17.2 million with a gross margin of 20.1% compared to a gross profit of $12.3 million or an 18.8% margin in the prior year’s quarter.

Our margins continue to reflect some start up expenses associated with the strong growth that we are experiencing from the ramping up of new business. Our operating expenses increased this quarter by a little more than $1 million over the prior year. However, you can see how we leveraged our expense base as we brought operating expenses as a percentage of revenues down from 10.4% last year to 9.2% this past quarter.

Our IBT was $9.4 million for Q4 of ’09 compared to $5.1 million a year ago which is an increase of 83%. As a percentage of sales, our IBT or pre-tax profit was 10.9% and right in the middle of our expected operating range of 9% to 13%.

We also recorded a substantial one-time tax benefit of $23.8 million in the fourth quarter. A few years ago, it was determine to be unlikely that the company would ever be able to utilize its sizable NOL carry forward. At that time, we recorded a valuation allowance which fully reserved our deferred tax asset. Now that APAC has demonstrated sustained profitability, GAAP requires that we unwind the valuation allowance and restore our remaining deferred tax asset on the balance sheet.

Our results from operations, combined with the one-time tax benefit, yielded net income for the fourth quarter of $33.1 million or $0.61 per fully diluted share compared to net income of $5.1 million or $0.10 per fully diluted share in the fourth quarter of 2008. Excluding the impact of the tax benefit, APAC would have earned $9.3 million or $0.17 per fully diluted share for the quarter.

Moving on to adjusted EBITDA, we improved the quarter year-over-year by $3.9 million, increasing from $8.6 million to $12.5 million. On a percentage of sales basis, adjusted EBITDA increased from 13.1% to 14.6% which keeps APAC in good standing with the top performers in the industry.

Once again, it is noteworthy that the company continued to invest in the business and generate positive cash flow during the quarter. We spent $4.1 million in net capital expenditures related to new business and on our IT infrastructure versus $2.7 million in the fourth quarter of 2008. We also had $20.6 million of cash on hand versus $16.2 million at the end of the third quarter.

So let’s take a look at our full year results on Page 6 of the presentation. For 2009 top line revenues were $293.2 million compare to $248.8 million last year, which represents growth of 17.8%. Adjusting that for the 53rd week, revenues would be $287.2 million at an annual growth rate of 15.4%.

Full year gross profit was $65.3 million or a 22.3% gross margin versus $40.9 million or a gross margin of 16.4% in 2008. Our IBT or pre-tax profit was $37.4 million at an 11.8% return on sales compared to $3.1 million in the prior year. Net income for fiscal 2009 was $58.1 million against $3.0 million in 2008. Excluding the impact of the tax benefits I described earlier, net income would have been $34.2 million.

So let’s move to Page 7 of the presentation. Here we’ve laid out how the tax benefit and 53rd week impacted various lines on our P&L for the fourth quarter. The income tax benefit of $23.8 million is a simple add back to the tax line and a deduction from net income. On an EPS basis, this translates into a $0.44 reduction.

The 53rd week contributed $6 million to our revenues and calculating our revenue and costs for the week, we’ve looked at actual hours worked for each program. This extra week was relatively less profitable for us because it included a holiday as well as higher payroll related taxes which commenced with the start of calendar 2010.

So the gross profit contribution for the additional week was $0.9 million and the associated earnings contribution was $0.4 million. Excluding the combined impact of both of these items, net income for the quarter would be reduced from $33.1 million to $8.9 million. On a diluted EPS basis, from $0.61 to $0.16.

So let’s move ahead to Page 8 of the presentation. Here we have a similar schedule showing the same impacts for the full year. Revenue is adjusted to $287.2 million. IBT or pre-tax profit would be $34.4 million. Net income is adjusted to $33.8 million or $0.64 per diluted share. EBITDA is $46.1 million for the year.

So Page 9 is our last financial slide. This schedules shows you APAC’s progress over the last two years and our view on 2010. As you can see, we’ve had substantial improvement in the company’s revenues and profitability. The middle column shows our adjusted 2009 results.

Realize that our adjusted net income of $33.8 million is essentially an income tax free number. For 2010 we are estimating a book effective tax rate of 38%. We are expecting revenues in the range of $320 million to $330 million which represents growth from our base line of 11% to 15%. We expect to increase our IBT from $34.4 million to a range of $38.7 million to $40.3 million which is an improvement of 12% to 17%.

When our estimated book tax rate for 2010 of 38%, back to 2009, our net income pro-forma for tax would be $21.3 million. We expect to increase on this amount to a range of $24 million to $25 million which is an improvement of 12% to 17%.

To better compare to our 2010 guidance, 2009’s tax free diluted EPS of $0.64 needs to be viewed as $0.40 when adjusted for our go-forward 38% book tax rate. We anticipate increasing our pro-forma diluted EPS from $0.40 to a range of $0.44 to $0.46 in 2010.

We also expect EBITDA to increase from $46.1 million to a range of $51.8 million to $53.5 million. One final thing to keep in mind is that while our book effective tax rate is estimated at 38%, we expect to pay cash taxes at a rate of about 10%. This is due to our NOL carry forward which is now back on the balance sheet.

So with my review completed I will turn the call back over to Mike.

Michael P. Marrow

Thank you Andrew. At this point I would like to spend a few minutes and talk about some of the successes we have had at APAC in the past year. So first and foremost, we got our magic back. You will recall that in 2008 we began the effort to turn around the company. We made tremendous strides and began to generate real excitement amongst the APAC team.

In 2009 our efforts came to fruition and the level of excitement and the winning spirit have fully returned to APAC. People are genuinely having a great time taking care of our clients, winning new business, and contributing to the success of APAC. Not surprisingly, this excitement and our continued success has generated a buzz in the industry.

Star players that may not have considered being part of APAC a few years ago are now asking how can they get on the team. We are delighted to be experiencing this level of interest. As you will recall, one of our key business philosophies is to continue to add top talent to the organization in order to serve current and future client needs.

Speaking of clients, we have had a great year in adding business. We have seen steady growth with our existing clients, and we have added 8 new ones in 2009. These new clients include a leader in the social networking space, one of the largest healthcare service providers in the country, a cable television provider, one of the leading companies in credit card and travel industry, the most innovative technology and digital media company in the world, a leading media and entertainment provider and a major utility.

As is typical in our industry and for competitive reasons, we generally cannot identify specific clients. Our sales team has really come together and today we are in the middle of a number of meaningful discussions for additional new business.

In our last earnings call, we talked about our new Tucson site as well as the Dominican Republic. In addition to our logistics client in Tucson, we now have two additional clients in this site. There is a very good chance that combined, business from these three clients will fill the entire site over the course of the year. We now have two clients operating in the Dominican site and are in discussions with several others. We expect to see this site grow substantially during 2010.

Great news, you may remember that we opened our Leyte site in the Philippines early in 2009. We had a 24 month plan to fill it up and I’m happy to report that this site has essentially been full and operating profitably since midway through the fourth quarter , well ahead of our plans.

In addition to these sites, we expanded our seating in our Davenport, Iowa, Green Bay, Wisconsin, Tucson, Arizona, and Cedar Rapids, Iowa sites. We continue to explore additional domestic near shore and offshore sites as we prepare for future growth.

Next, as we return to profitability, we were again in the position to invest in the company and prepare ourselves for the future. During 2009 we invested considerable funds in our technology and infrastructure in order to strengthen our overall business continuity. Today we can safely say with agreement from our clients that we have one of the most solid technology infrastructures and operating environments in the outsourcing industry.

During the year we migrated portions of our internal business functions over to the Philippines. This includes some of our finance and accounting work, some of our information and technology work, and some of the administrative work supporting our day to day operations.

This has had a positive financial benefit and it begins to diversify our company and allows us to capture talent around the globe. It was a relatively small number of people but a very big step in APAC’s evolution into a leading global competitor.

So there’s lots more going on at APAC but I know we want to get to questions. Before we go there, I want to thank our clients for the trust they’ve put in us and all the people dedicated to the APAC team. I would also like to remind everyone of our four core priorities.

Our first priority is to continually enhance the quality and dependability and overall value of the services we provide for our clients. Our second priority is to maintain a constant focus on eliminating waste and reducing overhead so we can operate as efficiently as possible. Our third priority is to continue to win business with both new logo companies and existing clients. Our fourth priority is to ensure we continue to develop and recruit talented people to operate the business and to service the needs of our clients both today and into the future.

So again, there’s lots happening at APAC and I could go on for some time; however, at this point we will open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Koning - Robert W. Baird & Co.