Convergys' (CVG) CEO Andrea Ayers on Q2 2014 Results - Earnings Call Transcript

Aug.12.14 | About: Convergys Corporation (CVG)

Convergys Corporation (NYSE:CVG)

Q2 2014 Results Earnings Conference Call

August 12, 2014, 09:00 AM ET

Executives

David Stein - IR

Andrea Ayers - President and CEO

Andre Valentine - CFO

Analysts

David Koning - Robert W. Baird

Bill Johnson - Wells Fargo

Joshua James - Stifel Nicolaus

Josh Vogel - Sidoti & Company

Operator

Welcome to the Convergys Second Quarter Earnings Teleconference. Your lines have been placed on a listen-only mode until the question-and-answer session. (Operator Instructions) Today's conference is being recorded.

I would now like to turn the call over to Mr. David Stein, Vice President of Investor Relations. You may begin, sir.

David Stein

Thank you, Shirley and good morning. Welcome to the Convergys second quarter 2014 earnings call and webcast presentation. This call is the property of Convergys. Please note that slides accompanying today's prepared remarks are available on the Convergys Investor Relations website under Events and Webcast.

Today's call contains forward-looking statements that address our expected future performance and that, by their nature, address matters that are uncertain. These uncertainties may cause our actual future results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements as a result of new information or future events or developments.

Please refer to yesterday's earnings release and our most recent filings with the SEC for additional information regarding uncertainties that could adversely or positively affect our future financial results. This includes the risk factors provided in our Form 10-K for the year ended December 31, 2013.

Also during the call, we'll discuss non-GAAP financial measures, including adjusted free cash flow, operating income, EBITDA and EPS. A reconciliation of these non-GAAP measures is available in the News Release and on the convergys.com website under Investor Relations.

With me on the call today are Andrea Ayers, our President and Chief Executive Officer; and Andre Valentine, our Chief Financial Officer. Andrea will provide a summary of our operating performance, and Andre will cover our financial results and business outlook. Then we'll open the call for your questions.

Now I'll turn the call over to Andrea.

Andrea Ayers

Good morning and thank you joining us today. We generated solid revenue, profit and free cash flow during the second quarter and continue to successfully integrate stream into the business. Year-over-year, revenue grew 46% to $736 million. This included $249 million from the acquisition.

On an adjusted basis, EBITDA increased to $87 million and earnings increased to $0.34 per share. Our integration efforts are on track and according to plan this scale acquisition is delivering the expected contributions to revenue and profitability.

So far the process of blending best practices into our global operating model is going smoothly. For example, we are on schedule configuring best of breed information technology and network infrastructure across our expanded footprint.

Also we have unified our global account management approach, integrating our sales team and healthy pipeline. We are gaining traction with opportunities to cross-sell our capabilities and we remain on plan to realize the expected cost synergies from the acquisition.

Given our current financial strength and confidence in the future, we continue to return cash to investors in the second quarter. We paid a $6 million dividend and repurchased $11 million of our stock in the quarter. As of today, $118 million is authorized for future share repurchase and we remain committed to modest purchases as market conditions warrant.

Now let's talk about our operating performance in more detail. In terms of revenue, call volumes remain strong across our service delivery regions during the second quarter. We grew with 14 of our top 20 clients. In terms of client diversification, as anticipated before the acquisition, our revenue from technology clients has more than doubled to 20% of revenue and revenues from Europe and Latin America has increased four-fold to 20% of revenues.

Once again we experienced broad-based growth across the vertical markets we serve. This included volume increases with several clients in the communications industry, growth with existing and new financial services clients, volume increases with technology clients, including both software and hardware manufacturers and growth with other clients in the healthcare and retail industries.

Offsetting these gains in the second quarter were the planned completion of the postal service program and some customer technology platform migrations. We also experienced lower than anticipated volumes with some of our largest communication clients during the quarter.

Recall that in this industry, client volume can fluctuate based on a range of factors. These include the impact of program changes, process improvements, marketing campaigns and other specific client initiatives. Consolidation and competition in the clients industry can also be a factor.

Based on the volume fluctuations in the second quarter and the outlook for the remainder of the year, we are revising our revenue expectations for 2014. Importantly, the entire team is doing a great job managing profitability. We achieved our expected profitability in the second quarter and we are leaving our profit improvement guidance unchanged for the year.

As a leader in this industry, we have invested for years in tools that enable our team to quickly react to volume fluctuations and protect profitability. We continue to grow with some of the biggest and most recognized brands in the world.

Good visibility into these clients 90 and 120-days forecast support our updated guidance for the full year. Andrea will provide more details on our outlook in a moment.

In terms of new business, during the second quarter, we had several contract wins with existing and new clients. We signed new business worth more than $50 million in 2014 revenue and more than $100 million in 2015 revenue. This included new programs with multiple clients within each of the communication, technology, financial services and other market verticals.

Within other markets, we won new business with retail, consumer packaged goods, eCommerce and healthcare clients. Examples of recent cross-sell success include new programs to serve the multilingual requirements of a large U.S. communications client from new contact centers in Latin America and Europe and selection as a strategic partner by a larger software provider to support its vendor consolidation effort.

Also our analytics services and lead generation capabilities are gaining traction with existing and new clients. For example, our analytics team is helping clients to diagnose root causes and create training solutions to increase the customer's willingness to recommend our clients to other consumers.

For one large communications client, this increased overall satisfaction by more than 40% and nearly tripled first call resolution rates. Our investment in quality service delivery, global capacity and sales success continues to drive growth with our large and world client base, accelerate cross-selling of enhanced offerings and expand services to handle our client's customers located outside the U.S. particularly in Europe.

Our ability to deliver the right service at the required skill level in a more cost effective manner from the right geography is helping our clients to increased revenue, decrease their cost and improve their customer experience.

In terms of profitability, on an adjusted basis, operating income increased 32% and EBITDA increased 42%. Drivers of profit improvement in the second quarter included contributions from the acquisition and increased delivery from low cost geographies. Going forward, we remain focused on tight control of operational spans and expenses. We expect to penetrate further as more acquisition synergies are realized and we are pleased to confirm our EBITDA and our EPS expectations for the full year.

In summary, the business is generating solid results consistent with our strategic objectives. We are encouraged by the progress integrating our scale acquisition, which as expected, is strengthening our competitive position in the large and growing contact center services industry.

Our solid balance sheet allows us to return capital to shareholders and we expect performance improvement throughout the rest of 2014. I want to thank our I want to thank our fantastic team for delivering another quarter of solid results. I would also like to thank our clients for their trust in Convergys, as we partner to support their customers.

Now Andre will provide more detail on our financial results and guidance.

Andre Valentine

Thanks Andrea and good morning. In the next few minutes, I’ll review our results and provide our updated guidance for 2014.

Revenue in the second quarter was $736 million, up $232 million compared with last year. Volume increased with several existing, acquired and new clients across the verticals we serve. This was offset by the expected softening of volumes that we discussed on our call in May and lower-than-anticipated volumes and reduced call handle times on certain programs for some of our largest communications clients.

These volume fluctuations reflect program changes and efficiencies that reduced the need for agents across their business. As a result, we've reduced our full year revenue outlook. We now anticipate fairly modest sequential revenue improvements for the third and fourth quarter.

In terms of our regional mix of contact center employees, at the end of the second quarter, 45% of our employees were in the Philippines, 28% were in North America, 11% were in India, Southeast Asia and China, 10% in EMEA and 6% were in Latin America.

Turning to profitability, adjusted operating income was $53 million in the second quarter, up $13 million compared with last year. Adjusted operating income margin was 7.2%. Also on an adjusted basis, EBITDA was $87 million, up $26 million compared with last year.

EBITDA margin was 11.8%. We continue to take steps to further streamline our cost structure and we remain committed to achieving our goal of greater than 13% EBITDA margin in 2016.

GAAP results in the second quarter included $5 million of integration expenses, $7 million of amortization for acquired intangible assets, $6 million of depreciation from the fair value write-up of acquired property and equipment and a gain of $2 million related to a real estate sale last year.

Results from the second quarter of last year included an $8 million pension settlement charge and a $1 million asset impairment charge related to prior corporate simplification actions and $1 million of amortization expense from prior acquisitions.

In terms of net income, adjusted EPS was $0.34, up from $0.26 last year. As expected, the effective tax rate in the second quarter was 23% on an adjusted basis.

Moving to cash flow. Adjusted free cash flow was $45 million in the second quarter. This reflects the strong cash flow generation characteristics of this business. Excluded from this metric, are cash payments of $7 million related to transaction and integration expenses.

Turning to the balance sheet, at the end of the quarter, we had cash and short-term investments of $197 million with about 75% of this held offshore. We repurchased 1.5 million shares of our stock during the quarter for $11 million.

Our buyback activity has continued into the third quarter and we repurchased another $4 million of stock. We also used $28 million of cash to pay down our debt. In addition to our strong balance sheet, at the end of second quarter we had availability on $430 million of revolving credit facilities.

Our strong cash flow and ample liquidity provide substantial financial flexibility. This allows us to continue investing in strategic growth while also allocating our capital toward paying dividends, repurchasing stock and retiring debt.

Now I’ll discuss our updated business outlook for 2014. For the full year, we now expect revenue to exceed $2.85 billion. This is a change from our prior guidance, which was to exceed $2.9 billion. Our profit expectations however remain unchanged.

On an adjusted basis, we continue to expect EBITDA of $350 million to $360 million for the full year and we expect EPS of $1.45 to $1.50. This yields in EPS growth rate of above 30% for the year. Our EPS outlook is based on a share count of approximately 107 million shares, reflecting the shares we have repurchased year-to-date.

Excluded from our guidance our acquisition related impact such as fair value write-up depreciation, intangible amortization, integration costs, transaction costs and the tax expense associated with the efficient repatriation of cash related to the transaction.

Also not included in the guidance are the impacts of previous real estate transactions, non-cash pension settlement charges or future share repurchase activities.

In conclusion, we are successfully executing our operating plan. We continue to make significant progress integrating the operations into our business and remain focused on achieving our long-term revenue growth and margin expansion targets.

At this time, Shirley please open the line for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session (Operator Instructions) And our first question comes from Dave Koning with Baird. You may ask your question.

David Koning - Robert W. Baird

Yes. Hey guys. Good job with Stream so far.

Andrea Ayers

Thanks.

David Koning - Robert W. Baird

I guess my question is on the core business. The organic growth was a 4% decline or so and I know that the slowest since Q4 of '10 and I am wondering is that less to do with the overall market and more just to do with higher number of one-off kind of events that you mentioned in this quarter.

And maybe you can just talk about how you think the overall market is going and if it's going as well as just those kind of handful of one-off event that caused the weakness?

Andrea Ayers

Yes, I really do think this for us is very one-off event program specific and we were actually pleased to see the market doing fairly well, Dave, as we look at it.

We grew as you heard me say in 14 of our top 20 accounts and then I was happy with the signings again we talked about this in previous calls. What I am loving about that is the variety and the mix of work, geographies, vertical markets that we were seeing that growth occur in.

In terms of the communication client’s reference that I made, really I've said in the script, those volumes can fluctuate for a number of different reasons that are very program-specific for example for us, we actually, I’ll give an example, I had a client situation where we were actually -- and they were concerned that they were understaffed as we were walking into the first quarter and we were actually ramping.

Of course some anticipated volume that we expected to materialize in Q2, Q3 and Q4, and so spent the first quarter ramping for that and then in the second quarter both they and we were surprised that, that volume wasn’t going to materialize. So we adjusted quickly on both of our parts and you see that kind of things reflected in the guidance.

So overall, I would say market we are seeing growth, we are seeing broad-based growth. We are still seeing growth with our existing clients. We just have a couple of unique situations going on in the portfolio that frankly surprised us a little bit and surprised the client a little bit; therefore the reason they surprised us.

Andre Valentine

And David, one thing it didn't surprise us, but certainly contributed to the year-over-year impact is the postal service and this is the first full quarter of that is kind of completely out of current year revenue where it was certainly in very much the comparison last year, that on the organic business so on the legacy Convergys business is almost a three point drag in this quarter year-over-year?

Andrea Ayers

And so this was the quarter we knew that was going to happen and so when we had a little bit of surprises in other places, you see that ramping through and hence the adjustment.

David Koning - Robert W. Baird

Okay. Great and just one follow-up on margins, you mentioned the 7.2% adjusted EBIT margin, how much synergies are now in this quarter and how much more to come and may be the best way just to ask that question is what can normalize EBIT margins be once all the synergies are looped in, how much better than that 7.2% should we expect.

Andre Valentine

So, David. I think the way to think about the synergy is that we are very much on track for the $25 million that we talked about. When we announced the deal we said that roughly half of those will be realized in the first year. That’s how they are coming through. So as I think, as we think about the future that there is call it half of that $25 million still to go in terms of margin left, if you just normalize for that.

And so certainly as we think about getting to 13% EBIDTA margin in 2016 the full achievement of those synergies and the lift -- natural lift that those should give us into next year and into '16 are all part and parcel of that guidance.

David Koning - Robert W. Baird

Got you. Great, thank you.

Andrea Ayers

Thank you.

Operator

Thank you. Our next question comes from Kevin McVeigh with Macquarie. You may ask your question. Kevin your line is open. Go ahead with your question and please check your mute feature.

He is not responding. We will go ahead with the next person (Operator instructions). Our next question comes from Bill Warmington with Wells Fargo Securities. You may ask your question.

Bill Johnson - Wells Fargo

Hi, it’s Bill Johnson on for Bill Warmington. Can everyone hear me?

Andrea Ayers

Yes, we can.

Bill Johnson - Wells Fargo

Great. Okay, I just have a couple of questions. I was hoping if you could shed more light on what’s driving growth in the 14 of the top 20 clients you were talking about? Is that from competitive wins, clients expanding or clients outsourcing more?

Andrea Ayers

Some of all of the above. So again with that growth being broad-based across all of our vertical markets, there are different things going on in each of those client portfolios in each of the vertical markets.

What I think is really helping us, we’ve been investing for the last five years or so on our platform and being able to offer them the ability to handle any type of transaction that they want to have handled at scale, where they want it with the language capabilities that they need is really helping us to drive good broad-based growth pattern with these existing clients.

We’re also still seeing many of these clients embraced under consolidation and so depending on the client and the industry, they’re either well on their way with that or just starting and that really plays to the scale players in our space, the ones who have the ability like we do to invest in the technology and the capabilities and the geographies that they want to do the work and if they are only going to choose six or seven, five, four, three players to do work with, you need to be one of the players that can invest that way and have scale and be able to handle their transaction types in a quality manner.

And so I think that’s the other thing you see, Bill playing out through the portfolio is kind of various degrees of vendor consolidation effort on part of our clients and as participating in those.

Bill Johnson - Wells Fargo

Speaking of vendor consolidation, can you talk a little bit about what you’re seeing in the EMEA region?

Andrea Ayers

Same trends that we’re seeing in the U.S. regarding vendor consolidation. Again we see that really broad-based across the industry and I think we will continue to see that play out and I think it has implications for some of the smaller providers in our space quite frankly because it really requires a fair amount of scale and investment to be able to make that cut with these large companies but we see the same exact trend in EMEA that we see in the U.S.

Bill Johnson - Wells Fargo

All right, probably that’s it.

Andrea Ayers

Thank you.

Operator

Thank you, at this time, I am showing no further questions. (Operator instructions) And we do have a question from Shlomo Rosenbaum with Stifel. You may ask your question.

Joshua James - Stifel Nicolaus

Hello. This is actually Joshua James filling in for Shlomo. I just have a quick modeling question. According to the 10-Q the effective tax rate after the first half was $18.6 million, but you kept guidance at 23% for the full year, so I just wanted to see if it's safe to assume an upper 20% tax rate for each of the next two quarters. Thank you.

Andre Valentine

Yeah Josh, this is Andre. So I think what you’ve just quoted correlated is kind of the GAAP tax rate. The adjusted tax rate for the quarter is in the 23.5% range and roughly as you’re doing your modeling for the remainder of the year, we would still think for the full year we will end up somewhere right around that range for the full year. So flat-lining at 23% or so would be a reasonable thing for you to do.

Joshua James - Stifel Nicolaus

Okay. Thank you very much.

Andrea Ayers

Thank you.

Andre Valentine

My pleasure.

Operator

Thanks. Our next question comes from Josh Vogel with Sidoti & Company, LLC. You may ask your question.

Josh Vogel - Sidoti & Company

Thank you, good morning.

Andre Valentine

Good morning, Josh.

Josh Vogel - Sidoti & Company

I hopped on the call late, I apologize, but I had a question about and I know it's still early here, but with Teleperformance buying Aegis USA, can you talk about the competitive landscape domestically and if you’ve seen any pressures in pricing as a result of this deal?

Andrea Ayers

Yeah, let me take the landscape in general and I’ll slip the pricing question to Andre. The Teleperformance Aegis deal not really is a surprise given the fact that I think Teleperformance have been pretty public about wanting to focus on increasing their U.S. presence.

Frankly it’s consistent with the acquisition we did to increase our European presence and I think it speaks to the scale players making certain that we can all provide any geography that our clients want at scale and so nothing really changes from my perspective about that particular acquisition.

The thing I think we see changing is again really getting tougher for some of the smaller players to compete in some of these very large client vendor consolidation plays.

You really need scale and the ability to invest in the tools and the capabilities in the Geos that they need in order to make the cut in some of those transactions. So I think you see that playing out as some of the -- you see some movement now with some consolidation in the space.

Andre Valentine

Yeah, Josh, I'll just chime in. The strategic rationale that Teleperformance gave for that deal was almost like the mirror image of the rationale we had for the Stream deal. It was all about Geo diversification, market diversification, client diversification and so it's good to see another scale player thinking about things roughly the same way.

On the margin, we like our deal a little bit better than theirs, but we wish them luck with their deal. As for the pricing alignment generally, it certainly is competitive as it's ever been, still generally rationale. What we are seeing is a continued shift towards more of the risk in the contracts being shifted to the vendors through pricing methodologies that have moved from payroll hour to per minute or per call.

And as that risk shift happens, that plays to the strengths of the larger scale providers who’ve been able to invest in the tools and technology to be able to manage in that riskier environment and still generate profit for their shareholders.

I do think over time, this will cause us to be more choiceful about the work that we choose to pursue and the work that we choose to retain, but certainly that would be my thoughts generally on the pricing environment.

Andrea Ayers

Yeah and just to add to that in terms of the profit point that Andre made in the tool, we’ve been investing for at least five years now in an operating model we talked to you about Global Operating Model and we talked about the technology.

That becomes really important in those higher risk pricing scenarios like what we saw in Q2 to be able to real-time manage through your variable cost and hold your profitability in the face of that flexing revenue and so again, very proud of the work that our teams did in the quarter and think those investments are important.

Josh Vogel - Sidoti & Company

Okay. Great. Just a quick one on Stream. Now I think the deal closed about five months ago now, so do you have a sense of the seasonality in the business? Is anything different than what you though it would be five months ago? I am just looking at a quarterly like revenue forecast over the next six quarters or so. I was just wondering if we should aware of any seasonality.

Andre Valentine

Yeah I think -- obviously they were a public reporter Josh for a number of years and there is a seasonal pattern to their business. It’s not too dissimilar from the seasonal pattern in our Legacy business where the second quarter is typically their softest quarter and then they have a nice seasonal ramp with many of their technology and communications clients over the back half of the year, much like we do.

So I would look to their past public disclosure to see that that pattern and I think it will end up looking pretty much like ours or maybe for different reasons and different concentrations and different verticals, but the net-net it ends up looking pretty similar.

Josh Vogel - Sidoti & Company

Okay. Great. Thank you very much.

Andre Valentine

All right. Thanks Josh.

Andrea Ayers

Thank you.

Operator

(Operator instructions) And at this time, I'm showing no further questions.

David Stein

Okay. Shirley, thank you very much. So with that, just a reminder that Andrea and I will be available the rest of the day if you have additional questions. Happy to address those for you at that time and we'll just thank you all for participating on the call this morning, and have a great day.

Operator

Thank you. And this does conclude today's conference. We thank you for your participation. At this time, you may disconnect your lines.

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