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Sykes Enterprises, Incorporated (NASDAQ:SYKE)

Q2 2008 Earnings Call Transcript

August 5, 2008 10:00 am ET

Executives

Chuck Sykes – President and CEO

Mike Kipphut – Group Executive, SVP and CFO

Analysts

Josh Vogel – Sidoti & Company

David Koning – Robert W. Baird

Sam Saunders – SIG

Matthew McCormack – Friedman, Billings, Ramsey & Co.

Robert Evans – Craig-Hallum Capital

Thomas Smith – First Analysis Corp.

Albert Lee – The Maxim Group

Operator

Good day, everyone and welcome to Sykes Enterprises Incorporated second quarter 2008 conference call. Management has asked me to relay to you that certain statements made during the course of this call as they relate to the company's future business and financial performance are forward-looking. Such statements contain information that is based on the beliefs of management as well as assumptions made by and information currently available to management. Phrases such as our goal, we anticipate, we expect, and similar expressions as they relate to the Company are intended to identify forward-looking statements.

It is important to note that the company's actual results could differ materially from those projected in such forward-looking statements. Factors that could cause actual results to differ materially from those in the forward-looking statements were identified in yesterday's press release and the company's Form 10-K and other filings with the SEC from time to time.

At this time, I would like to turn the call over to Mr. Chuck Sykes, President and Chief Executive Officer. Please go ahead sir.

Chuck Sykes

Thank you, Dana. Good morning, everyone, and thank you for joining us today to discuss Sykes Enterprises second quarter 2008 financial results. Joining me on the call today are Mike Kipphut, our Chief Financial Officer, and Subhaash Kumar, our Vice President of Investor Relations.

On today's call, I will touch on the highlights of the quarter and then comment on the demand environment. Mike Kipphut will then discuss the financials for the quarter, after which I will wrap up the call with my closing remarks and then open up the call to Q&A.

Let me begin by saying that we posted another quarter of solid results and our employees worldwide deserve praise for solid execution. This strong financial performance comes amid an increasingly uneasy macroeconomic backdrop and continued dislocation within our peer group. And while we have seen a handful of clients down a fraction in terms of demand, out of our 200 plus base clients, we have not seen any material drag on demand across our embedded client base thus far. This is reflected in our upwardly revised full-year 2008 business outlook.

From our perspective, our business strategy has enabled us to sustain our financial performance. The underpinning of this strategy is a focus on our core business with an eye toward achieving the right kind of business mix, while proactively managing our exposures.

Let me briefly expand on that. First on the business mix, we are globally diversified from a markets and verticals perspective. For instance, we serve 16 markets which translates into almost 50% of our revenues coming from outside the U.S. market. In addition, we have a compelling value proposition for about 80% of the addressable $37 billion global contact management market, and we are diversified across five verticals and various business lines within each of those verticals.

Second, on managing exposures, we do not have any outsized exposure to any one client. Our largest client represents around 6.4% of revenues. Moreover, we have shown discipline in how we manage our balance sheet, which is solid, and we believe will create opportunities for us in this environment.

With that, here are some of the highlights from the second quarter of 2008. First, we delivered another quarter of record consolidated revenues of $207.6 million, up 23.4% on a comparable basis. The growth was driven by the Americas and EMEA regions, both up 21.5% and 27.3%, respectively. Not only did 60% of our comparable revenue growth come from existing clients, but that growth also remained broad-based as our top 40 clients, which represent over three-quarters of total revenues, were up 32.4%. This broad-based growth highlights our strong operational performance and the overall quality of our revenue growth.

Second, our operating income grew more than fivefold in relation to our consolidated revenue growth, highlighting the strong operating leverage in our business model. Additionally, we sustained 8% operating margins. Third, we increased capacity utilization rates worldwide to 81% from 78% on a comparable basis. Similarly, utilization rates in the United States jumped to 75% from 57% on a comparable basis and continued their upward trend sequentially. Finally, we maintained our industry-leading low client concentration profile with top 10 clients at 39.8% of consolidated revenues, virtually unchanged on a comparable basis.

I would now like to comment on the demand environment. From our vantage point, the demand environment still remains encouraging. This view partly reflects our sales strategy. Our sweet spot for an average deal size is between $6 million and $12 million. This is in contrast to deals pursued by some of our competitors, which are four to five times our average deal size and can sometimes take longer to close.

As such, we continually see healthy conversion of opportunities in our sales pipeline both within the Americas and EMEA regions. Specifically speaking, we are seeing sales activity in both the business-to-consumer and business-to-business segments within the technology and communication verticals, while mostly business-to-consumer within the financial services vertical.

Here are some examples of that. For instance, we recently won a new business-to-business program with a current client, which is a telecom original equipment manufacturer. We also added a new program with our current financial services client in the business-to-consumer fraud area. Finally, we added a new business-to-business mobility program with a current communications client.

All-in-all, we remained encouraged by the demand environment and our ability to convert sales prospects. Equally important though, with our philosophy of controlled growth, we believe we can manage through the ramp-up of these new sales opportunities without the significant disruption caused by rapid growth, especially when labor markets are relatively tight and wage inflation still remains a challenge.

Now, I would like to hand the call over to Mike Kipphut. Mike?

Mike Kipphut

Thank you, Chuck. Good morning, everyone. On today's call, I will focus our remarks on key P&L, cash flow, and balance sheet highlights for the second quarter, after which I will turn to the business outlook for the third quarter and full year of 2008.

For the second quarter of 2008, consolidated revenues increased 23.4% to $207.6 million over the comparable quarter last year. That growth is spread across various verticals, most notably transportation, which was up 76%, financial services up 42%, and technology up 31%. Our second-quarter earnings per diluted share were $0.43 versus $0.16 on a comparable basis and versus $0.30, the midpoint of the diluted earnings per share range we provided in our second-quarter outlook.

The $0.13 earnings per diluted share performance versus the midpoint range breaks down as follows. Approximately $0.02 to $0.03 per diluted share is due to a combination of better leverage of G&A expenses as well as shifts and delays in certain expenses to the last half of the year. Approximately $0.07 to $0.08 of the $0.13 per diluted share is due to an increase in realized and unrealized foreign currency transaction gains, primarily from U.S. dollar denominated assets and liabilities held in international operations, and the balance $0.02 to $0.03 from a lower than anticipated effective tax rate.

During the quarter, the approximate net operating profit impact of all foreign currencies, including hedges, was an unfavorable $1.8 million to operating income.

Given the rapid and unexpected strength in U.S. dollar relative to the Philippines peso during the second quarter of 2008, the FX hedge gain was $400,000. By contrast, the hedge gains in the first quarter of 2008 were $2.6 million when the dollar was still weak relative to the Philippine peso.

However, the second quarter strength in the U.S. dollar relative to the Philippine peso in the first quarter did favorably impact our Philippine peso denominated expenses. We continue our cash flow hedging program with the Philippine peso and are approximately 83% hedged, based on our latest forecast through the remainder of 2008 at an average rate of approximately 43.23 Philippine pesos to the U.S. dollar.

Likewise for 2009, we are approximately 66% hedged at an average rate of 43.43 Philippine pesos to the U.S. dollar. Now, let me turn to select balance sheet and cash flow items. Our cash and cash equivalents at quarter end, June 30, totaled $208.4 million with $194.4 million or 93%, held in international operations and would be subject to additional taxes if repatriated back to the U.S.

Cash flow from operating activities totaled $29.9 million, up 69% from $17.7 million in the comparable period last year. The increase in cash flow from operating activities was due largely to increases in net income and non-cash reconciliation items such as depreciation. Similarly, free cash flow from operations more than doubled to $21.7 million from $9.9 million in the same period last year.

At quarter end, we had no outstanding debt. Receivables were at $165.6 million. Trade DSOs for the second quarter were at 69 days, up one day sequentially and up four days comparably. The DSO is split between 61 days for the Americas and 87 days for EMEA. We spent $8.2 million in capital expenditures. Depreciation and amortization totaled $7.2 million for the second quarter. Trailing 12 month return on invested capital was approximately 32%.

Now, let's review some seat count and capacity utilization metrics. We ended the quarter with approximately 27,400 seats split between 21,750 in the Americas region and 5,650 in the EMEA region. The total seat count was up almost 2,100 for the second quarter of 2007 and up approximately 100 seats sequentially.

The sequential increase in seats occurred principally in the U.S. and in Argentina. Offshore seat count at the end of the second quarter was approximately 17,700 or 65% of our total seats versus approximately 16,550 in the same period last year. Capacity utilization rates at the end of the second quarter 2008 were 82% for the Americas region and 79% for the EMEA region.

On a consolidated basis, the capacity utilization rate was 81%. Capacity utilization rates in the same period last year were 77% for the Americas region and 82% for the EMEA region. On a consolidated basis, the capacity utilization rate in the prior year period was 78%.

Now, let me turn to our business outlook. The company's third quarter and full year 2008 business outlook reflects a demand environment for its value proposition that thus far remains largely unchanged from the first half of the year. The company continues to experience a healthy conversion of its new sales pipeline with new clients. Similarly, the company continues to see expansion of existing and new programs with current clients.

A handful of such scale programs, notably within the retail, appliance, and handset lines of business in the company's embedded base of clients have been down a fraction due to either client-specific challenges or macroeconomic unease. That downtick, however, has been partially offset by demand from new and existing programs with current as well as new clients.

Client demand continues to be driven across various segments of our customer contact management industry. This includes clients within the business to consumer and the business-to-business segments of the customer contact management industry that span the Americas and EMEA regions, as well as various verticals within those segments and regions including technology, communications, and financial services.

Accordingly, the company plans to add approximately 1,300 seats in the third quarter of 2008, 400 of which are seat additions originally anticipated in the second quarter of 2008 that are now expected to be deployed in the third quarter. These seat additions are slated for the U.S. and countries in Latin America.

Therefore, the third quarter and to a lesser extent the fourth quarter are expected to be disproportionately impacted by advertising, recruiting, and training expenses associated with these ramps. Also in the third quarter, the company expects to implement planned wage increases in certain offshore geographies. Finally, the third quarter business outlook further reflects the impact of summer seasonality on demand related to European holidays in the EMEA region.

The company now expects a lower than projected tax rate for the third quarter and full year 2008, due to a combination of lower-than-expected taxable gains from hedging the Filipino peso, which has weakened significantly versus the U.S. dollar and the continued shift in geographic mix of earnings to lower tax rate jurisdictions.

Considering the above factors, the company anticipates the following financial results for the three months ended September 30, 2008. Revenues in the range of $205 million to $208 million, tax rate of approximately 17% to 18%, earnings per share in the range of $0.26 to $0.29 per diluted share, and capital expenditures in the range of $12 million to $16 million.

For the 12 months ended December 31, 2008, the company anticipates the following financial results. Revenues in the range of $825 million to $830 million, tax rate of approximately 17% to 18%, earnings per share in the range of $1.39 to $1.44 per diluted share, and capital expenditures in the range of $30 million to $35 million.

With that, I will hand the call back over to Chuck for a few closing remarks.

Chuck Sykes

Thanks Mike. In closing, I would just like to reiterate some of the comments that I made earlier in the call. We are really proud of the financial performance we delivered in the second quarter. We believe this performance has been a result of our focus on our core business.

As a pure play customer contact management outsourcer, it's our view that our value proposition translates into a comparative advantage for our clients versus their in-house solution. We also believe this view takes on a greater recognition among clients who are under financial pressure. Under such circumstances, we believe clients that are under pressure are likely to focus on stabilizing their business through aggressive cost-cutting, which means they are likely to outsource non-core activities in order to preserve scarce capital.

Given the twin challenges of slowing economic growth and rising inflation, we believe this scenario is even more likely. As such, we remain encouraged about the opportunities we see in the marketplace. At the same time though, we continue to monitor the inflections in our clients' business and strive to stay ahead of the curve as best as possible.

In light of the economic uncertainty coupled with the currency volatility and wage inflation headwinds, we believe the proactive steps we have taken to manage our risk profile positions us well to manage through the challenges posed by the current economic environment.

With that, I would like to open the call up for questions. Operator?

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) And we will go first today to Josh Vogel of Sidoti & Co.

Josh Vogel – Sidoti & Company

Good morning, thank you. First, with regard to the unprofitable programs within the Americas unit that you discussed in the press release, I was wondering if you can maybe quantify for us the size of this business in terms of revenue or maybe seat count, and of the business that you are targeting here, how much is being culled out versus re-priced?

Chuck Sykes

Josh, this is Chuck. From an unprofitable standpoint, looking at the number of clients or the size, really it's difficult for me probably to look at the overall revenue. But just given our client concentration with no one client really being more than 6.7%, usually those programs that we had I would probably say they were almost clients who were running around 1% of revenue, just to give you a ballpark figure. So they weren't significant in size, and we were able to do it. But at the same time, from a margin standpoint, it certainly helps just sustain in the maybe 1 to 2 basis points to our gross margins in that case.

Mike Kipphut

Let me just clarify something real quick. The programs you classify as unprofitable are not unprofitable. They are lower than our targeted operating margins. All our programs are very profitable; it's just that it's not at the targeted rates we wanted. So, I don't want you to get the wrong idea that we do have unprofitable programs because we do make a profit on all our contracts.

Josh Vogel – Sidoti & Company

Okay, I'm sorry about that misunderstanding.

Chuck Sykes

That is a good point there. Josh, the other thing, too, regarding the pricing though, most of the focus, I would say 80% to 90% of our effort has really been on re-pricing programs and that was particularly in light of the offshore locations where wage increases for the last four years have run in double digits. We expect they will continue to do that. Again, in the past, it really wasn't a problem because you had the local currencies that were devaluing against the dollar.

But certainly, when that turned, it heightened our focus on needing to go and address some of the pricing issues. I think again, we didn't really get into quantifying that there before. It was more just to outline to you guys that we believe that we can respond and address to the margins. I think when you look at our business and you look at what has happened, particularly to the Philippine peso, since that is such a big component of our business, I think it's evident that we have been able to certainly manage through those things without breaking out too much detail.

Josh Vogel – Sidoti & Company

Okay, great. That is helpful, thank you. Now, I know you don't typically disclose total client signings each quarter, but I was wondering if you could maybe give us a sense of new client signings last quarter maybe versus Q1 and the year-ago quarter. Were they up or down?

Chuck Sykes

Yes, for us, again, I just really do try to stay away from that and I really try to focus more on just the credibility I hope that we have built over the last four years that when we give you guys a number that you just can count on it and know that it's coming from both existing business and new business.

Because I can talk internally about pipelines and new sales and at the same time maybe not be telling you about difficulties in the base business, so to me it just doesn't feel right in the communication. I can – just want to clarify again that we do continue to see good opportunities across a multitude of verticals, particularly in technology, finance and communications.

Mike Kipphut

Let me just add to that too, that is – Josh, that is why we give a breakdown of our new revenues historically on what is being generated from new clients and what is being generated from existing clients. From existing clients during the second quarter, about 60% of our increase was associated with those existing clients, and then about 40% of new clients. And that is on a consolidated basis and that of course would be different from region to region.

But to go along with that too, what you really have to take into consideration, which we provide, is how our depth and breadth of the clients, our top 40 clients, representing 70% plus of our revenues is in the 30% plus range. We think it's pretty robust overall. We think that is more meaningful than giving you any type of sales funnel or any other type of metric right now.

Josh Vogel – Sidoti & Company

Okay, thank you. You mentioned that total seat count is up 2,100 year-over-year. That is a net number. What were the gross adds year-over-year?

Chuck Sykes

The gross adds.

Mike Kipphut

All we do is give the number of seats that we add or delete, and I guess I don't know exactly what you mean by –

Josh Vogel – Sidoti & Company

I guess I was a little surprised and encouraged by the capacity utilization increase in the U.S. from 57% to 75%. I was wondering if you rationalized any capacity here.

Chuck Sykes

Okay. No, we didn't rationalize any capacity. These are actually seats in our existing network that have been underutilized. I think – I don't know if you go back almost two or three quarters we thought that we would be putting most of the capacity to work, so the 75% is getting pretty full. In fact, we are at the point now that we are opening more centers in the United States.

Mike Kipphut

In fact, we added all of 50 seats sequentially in the quarter in the U.S. So, they are very comparable numbers. It's pretty flat year-to-date. It's about the same number.

Josh Vogel – Sidoti & Company

Okay, great. Just one last one, do you have an idea of how many seats you are looking to add in Q4?

Mike Kipphut

Well, let me just comment on that a little bit. We do plan on adding 1,300, as we mentioned, in the third quarter. We also indicated earlier this year that we would add between 3,000 to 4,000 seats for all of 2008 with some of those spilling over into 2009. I think at this point, we probably are going to be at that lower end at the 3,000 seats for 2008 with the remaining spilling over to 2009 into the first quarter sometime. So, the number of seats haven't changed, it's the timing more than anything else.

Josh Vogel – Sidoti & Company

Okay, thank you very much.

Operator

And we will take our next question from David Koning of Robert W. Baird.

David Koning – Robert W. Baird

Yes, hey guys, another great job. I guess, first of all, when we look at the guidance range, it basically implies for Q4 organic constant currency growth in the ballpark of, say, 6%, 7% or so. And over the last ten quarters, you have been 10% to 20% year-over-year, so it does imply, I guess, the slowest revenue growth in a few years. I'm just wondering is that just solely due to a tough comp or is there something that you are seeing now that does imply a little slower environment? I'm just trying to get my hands around that.

Chuck Sykes

No. I think, David, one of the challenges in our business, if you look back over, I mean it does kind of have the fits and starts. I think you guys have used the term it's somewhat lumpy. And that is that it doesn't always just have that nice consistent – every quarter things happen. Just like we really thought Q2 we would have – some of these seats hitting in Q2, but instead it got pushed to Q3.When we look at the overall domain environment that we are in and we look at the health of our client base right now, I have to say we feel just as confident right now going into '09 as we did sitting in '07 going into '08. I think again, it really is just a matter of the way that the timing is going to come in and hit on some of these ramp ups.

The other thing is that going back to a point that Mike made about the capacity utilization, one of the things right now that is going to make it a little more challenging in today's environment from a capacity standpoint is that today we are growing – which is a good issue, we are growing almost in every country location. In the past, it was always about offshoring, so everything that we did in growing we had to pretty much add new seats. But, for instance, you saw in Q2 where we suddenly started putting the U.S., it really was coming to work, we didn't have to add a lot of seats.

Now, we are at the point where we are starting to grow over in Europe as well. We are getting some capacity utilization there put to work and it just the matter of the timing with the revenue and where it hits. Now we are at a point to where we are going to have to start building capacity again. That will affect, to some extent, the timing and predictability of the revenue that we have got. So all of those things combined, I can just say that our business isn't of such that just every quarter it's always a predictable way in which it grows and it has somewhat of that lumpy characteristic. I think you are just seeing that perhaps in the numbers the way it's working out for December. Mike, do you want to add anything?

Mike Kipphut

David, just to add a little bit, you got to keep in mind that our seat additions aren't front-end loaded, so they are going to come in as we originally timed them to be. So that may be towards the latter part of a quarter. And again, that gives us the danger sometimes that it will spill over to the next quarter, especially when you are dealing with capacity additions in different parts of the world.

Sometimes those additions are just hard to control completely, although you can do it within a relatively short period of time. It's tough to time it exactly when you need it. Of course, you want to have some leeway in there as well. Then overall, just another point, I take what you say on the revenue growth on a sequential basis, but on a year-over-year basis for the full year, this still translates into 16.5% to 17% growth rate, which is a pretty nice growth rate from a revenue standpoint.

David Koning – Robert W. Baird

Yes, I definitely agree. So it sounds more like the timing of certain things rather than any real change at all in the environment.

Mike Kipphut

Yes, everything looks really good still and we are really pleased.

David Koning – Robert W. Baird

Yes, that's great. I guess the second question is a little bit along the same lines. We have had five years in a row where the second half of the year's margins, operating margins have been better than the first half, but this year you are guiding for worse margins in the second half than the first year. I know that largely reflects kind of the timing of some of these ramps. But, the only surprise I guess is that it seasonally has been better, plus this year you get a nice FX boost given the nice movement in the pace, so maybe just a couple of comments on that.

Mike Kipphut

Sure, again, we did have a very nice second quarter with 8% operating margins, which was higher than we anticipated. But we also mentioned some of those expenses are – some of the reasons why those margins are higher is because they have been delayed until the second half of the year, either dealing with ramps or professional fees or consulting fees. But it's primarily related – as you go from second quarter to third quarter, if you look at some of the guidance we have given, it really translates into 6%, 6.5% operating margins. That difference from the 8% operating margins really is broken down into several different buckets.

But one is you got to keep in mind that the EMEA holidays that we encounter in the third quarter, and that can represent anywhere 50 basis points to 75 basis points in that range from a sequential second quarter. The other 50 basis points to 150 basis points is a combination of ramps.

Salary increases, which we do anticipate and have planned accordingly to take place at various times throughout the year, it just so happens that we have some of those coming in the August and September timeframe and some in the October timeframe, so we got to take those into consideration, the professional fees and consulting fees.

And then one other thing outside of operating margins that I really would like to point out to everyone is that, yes, we have very good other income as it relates to foreign currency transaction gains. That is something that is really tough to predict, so all I am counting on at this point in time is $1 million to $1.3 million in interest income that will hit other income.

Again, we are very fortunate to have gotten a nice gain, $0.07 to $0.08 in the second quarter. I think realistically, you can expect to give some of that back. It can also go the other direction too. So the only thing I want to point out to the Street and everyone else in our forward-looking statement is that we really only count on the interest income associated with investing our cash and that has typically ranged about $1 million to $1.3 million per quarter.

Chuck Sykes

David, one thing, just to give you a real long answer to this question, but you have been with us here for awhile quite awhile and everyone – a lot of the folks on the phone, if you recall over the past three years when everyone was asking where can your margins get to, and particularly when our margins were below 6%, this is like in the '05 timeframe. Keep in mind at that time that I was trying to set expectations for everyone but the way we model the business at that size of our company, when we were around $500 million, we felt that if we had 85% capacity utilization that we as a team would be disappointed if we couldn't generate any operating margins every quarter in a range of 6% to 8%.

We have put the Company in that range. As you look at – that is still 2 percentage points, which is a pretty big swing, but that is just indicative of the way we know our business can come in and with these ramp ups and things like that can affect you. So what I would focus on is look at the business model that as we now are approaching and getting over this $800 million mark, you go back and look at our quarters, we are now stepping into a new band to where instead of 6% to 8%, removing more towards 7% to 9%. You will see it gradually continuing to move.

If we can keep the gross margins and nothing comes out here and surprises us in this economy and get our economy of scale in our corporate overhead costs, as we approach that $1 billion mark in the years ahead, you will continue to see those operating margins. Yes, they will swing probably 2 percentage points possibly.

Now this time on the second half, one of the things, too, I want to highlight about the capacity is in the past we have been growing an awful lot in offshoring. These centers in the offshore area are very large centers. When we are expanding seats in the offshore, we already have a lot of embedded overhead expense that has already been done. Today we are adding more sites in the U.S. These are separate, stand-alone facilities that unfortunately require us to hire a site director and put our HR in and put IT in.

So what happens is what you are seeing in the second half of this year is capacity that is being added that is a little different than the kind of capacity we used to add. And I think that is hitting the operating expense a little more than typically what you have seen when we were acting like 1,000 seats in the Philippines in a high-rise that only required us to execute nine more floors in a lease.

So that is part of the difference that you are seeing right now. But the good news is it's still growth, it's still capacity, and we are still very confident that moving in the overall trend is an improvement in growth in our overall margins.

David Koning – Robert W. Baird

That is great color. I really appreciate it and it seems like the momentum here is very strong. If I can just add one quick final one, we model next year a tax rate of 28%. It seems like, given the hedging gains probably aren't going to be nearly as big as once potentially forecasted, our tax rate might be way too high. I know you haven't done your '09 forecast yet, but isolating just the FX benefits, is it fair to say that our assumption is probably high?

Mike Kipphut

That is a good observation. You are right we typically don't give guidance for 2009, but your assumption is right on. With the tax rate, we are very fortunate to have tax holidays in certain countries. As I look out into 2009, I don't see any material different effective tax rate than what we are experiencing right now, as we see things right now.

So you are looking at the midteens on up to 20%. You are right, if currency gains expand more than we have had in the past, it will have an impact on our effective tax rate. It will increase it.

David Koning – Robert W. Baird & Co., Inc.

Great, thanks for all the color.

Chuck Sykes

Absolutely. Thank you.

Operator

And will take our next question from Sam Saunders of SIG.

Sam Saunders – SIG

Good morning. I wanted to drill down into the communications vertical, which has had lumpy growth for the last few quarters coincident with a customer lost last year. As that loss sunsets, should we expect momentum to increase in the back half of the year?

Chuck Sykes

Yes, communications – as in the past we have communicated – no play on words – that we have discussed with you, you guys. We still see most of our growth for in the next two years coming from the financial and communications vertical. Some of the year-over-year comparison that you are seeing represented in our numbers, I know it doesn't really support that thesis. But the reason for that is because, without getting into specifics, one or two of the programs that we had to address with our margins did fall into the communication sides.

The other thing is that we did have a communications client that we needed to take a few of the seats from the U.S. to the Filipino operation. So what happened was that that took a hit in the year-over-year comparison basis. But we are still – as we look at the growth going forward, it's still communication, finance, and the technology, which has been our base foundation. We still see it creating opportunities. But really communication and finance, they will still be there.

Sam Saunders – SIG

Great, thank you for that color. Then my second question is on the cost side. We have seen an increase in global inflation expectations of late and I wanted to get an understanding of how this might affect the business in general. In specific, could you remind us which geographies are subject to collective bargaining agreements and when those might be up for renewal?

Chuck Sykes

The economy, despite how good we feel right now with the work that our teams are doing out there and things, it's a crazy time out there right now. Sometimes as good as we feel about our company, I just want to feel that we are not being too overly optimistic on it. So, to answer your question, the inflation that we are seeing and particularly for the offshore locations – and when I say offshore for us that is Philippines, Costa Rica, El Salvador, and even down into Argentina, particularly in this region of the world, we continue to see the double-digit inflation.

That doesn't concern us with inflation alone, because we have been experiencing that ever since we have been in these locations. What did concern us is when the currency started moving in the opposite direction. That really started giving us a double whammy there. Now, that again only became a concern to us when we had to go to our clients and ask for price increases, which of course clients are never happy about price increases.

But they understand when they looked at the value proposition what options do they have, and they know what it takes to be successful in this business, and we have been successful in getting price increases. That is in comparison to the U.S. The only time I would be concerned about it is when – if the pricing because of inflation in these offshore areas ever gets so close to the U.S. pricing to where the value proposition just doesn't make sense, that is when it would become a problem.

But we do not see that happening for quite some time, if ever, because even in the U.S. if you are running with 3% inflation, that is still a pretty significant cost when you look at the wage rates you pay in the U.S. compared to offshore. So I tell you that and give you that explanation with it because, again, inflation is not something that is new in dealing with this.

We focus more on the impact it has on the value proposition. But as long as the value proposition is there, our clients know what it takes to be successful in this business. They just don't put unnatural force of pressure on you in pricing, unless they are in dire straits. There goes to the point with our company to where we are very, very fortunate that we have a strong quality base of clients.

That is the guys that we are doing business with today are some of the strongest in their respective sectors. And that makes us in a better spot, because they don't put unnatural pressure on us for price concessions. But if you do get a client that is in distress, they will do difficult things to you, but we are very fortunate in that regard. Of course, it's very diversified. Collective bargaining, Mike, how would you address it? I mean, it's a little different because in Europe you have the workers councils and –

Mike Kipphut

Yes, workers councils in Europe, however, that is not a major concern. In relation to the question, I think it really goes more towards Argentina than anything else. Most of the country is governed by unions and that is where we have had pretty significant increases overall, which have been even beyond what we originally anticipated. So we are looking at wage increases in Argentina from – I would say that collectively bargained wages in the country as a whole at the 25% to 26% range.

But one thing to note based on that is about 60% of our business in Argentina is with Argentine clients. They certainly understand the pressures that we face and they face as well in the country. So they are very used to the fact that we have to pass these wage increases on to the client in Argentina. So there is a little lag effect.

It usually takes a little bit of time, I would say anywhere from 30 to as much as 90 days before that price increase really goes into effect for the new wages for our clients. But we are able to pass that along. As far as any other country, Philippines and Costa Rica are not collectively bargained units per se, and so I think, principally, it is in Argentina.

Sam Saunders – SIG

Great. Thank you and congratulations.

Operator

And we will take our next question from Matt McCormick, FBR.

Matthew McCormack – Friedman, Billings, Ramsey & Co.

Good morning. In terms of the revenue guidance, you obviously tightened the low end of the range. I was wondering if you could talk about the visibility that you have now hitting into the end of the year. I am assuming that is built on volume forecasts from your clients. If you could just talk about that and when you last received an update, and if you have got an update volume estimates from all your clients recently.

Chuck Sykes

Matt, I would just – the revenue guidance at this point in time is high. I would just – I mean, our confidence level is good into that. You do always – we always want to have these caveats in here because things in this business can change pretty quickly. That is one of the negatives about it. But right now, just based on looking at our base business and what we have got. At this point in time of the year, there is a high confidence level. But, Mike, do you want to add some color to that?

Mike Kipphut

Yes, Matt, I would just say we are at 90%-plus confidence level. We do get volume updates from our clients on a 30-, 60-, 90-day basis. Obviously, we will bake in those volume increases or decreases, whatever the case may be, as we receive those. But based on our latest forecast, we are still pretty comfortable with where we are at and the guidance that we provided in our earnings release yesterday.

Matthew McCormack – Friedman, Billings, Ramsey & Co.

Okay, then in terms of those three, I guess sub-verticals, that you mentioned in terms of pockets of weakness, are those actually three customers, first of all? Then, secondly, what percentage of your overall revenues do they represent?

Mike Kipphut

Yes, it's basically less than 5% of our total revenues. These are clients that are very intuitive, that you would think would have a decline in volume based on an economic downturn. They are people like appliance manufacturers. Obviously, there is not as many washer and dryers being sold in this type of environment. I think we talked about others, such as handsets.

So it's not anything that is not apparent, but overall, based on our diversified client base that we have and based on the volumes that we now experience, I would say overall it's less than 5% of our revenues are being affected by an economic downturn in volumes.

Matthew McCormack – Friedman, Billings, Ramsey & Co.

Okay. Then in terms of margins, you obviously went through great detail what can – what is affecting margins in the back half of the year. But if I look at your guidance and normalize it for FX and the tax change, it does appear as though the EBIT margin is coming down possibly 40 basis points. So I just wanted to verify that. Then if that is true, what is the change in terms of the cost side from your prior expectations?

Mike Kipphut

Yes, Matt, you are right. For the full year, our expectations are coming down 30 to 50 basis points in that range. So you are right in the center of it. Again, as you get closer to year-end, you have a little bit clarity, more clarity and certainty based on some of the numbers. Again, as we going to the third quarter we will give you even more clarity. The only thing I can guarantee is it's going to change from what we provided at this quarter.

But other than what we have already discussed on the wages and salaries and some of the ramps and the timing of that, those are the major items overall that are impacting the margins. It's only, in my opinion, a slight tweak, a slight downward trend. I don't take it as negative because what we are doing is adding seat and adding the ability to get higher margins later on.

Matthew McCormack – Friedman, Billings, Ramsey & Co.

Okay, then my last question, which I think you get every quarter, is in terms of the cash besides an unsolicited counter for people support, what are your plans for that?

Mike Kipphut

Yes, the plans for the cash still remain the same. Our top priority is to look at acquisitions. We do have interest in acquisitions, whether it be domestically or internationally. We have seen activity in both areas. Other than that, we also think it makes a lot of sense to look at other parts of the world, whether it's an acquisition or if you build out a new facility just as we did in El Salvador in 2003.So we think both of those avenues are good, top priority cases for our cash. We will also look at doing repurchases of our stock, however that is really at a third tier as far as I'm concerned at this point in time.

Chuck Sykes

Matt, this is Chuck again. I would just like want to re-emphasize the long explanation that we gave to David's question on this thing going back. But keep in mind in the first half of the year we were very fortunate to be able to put to work available capacity, and that gave us a real quick jump in the margins.

In the second half of the year, again, we are having to build new centers. You are just seeing a little more of an operating expense investment that we are having to make in those centers and of course, the subsequent inherent ramp up costs with them. I really think that is the main color of what is happening in the back half.

Matthew McCormack – Friedman, Billings, Ramsey & Co.

Right. There is no reason not to be conservative, especially in this tape. Thank you very much.

Chuck Sykes

Thank you.

Operator

And we will take our next question from Bob Evans, Craig-Hallum Capital.

Robert Evans – Craig-Hallum Capital

Good morning, everyone. Congratulations on another great quarter. First can you – I want to clarify that the 1,300 seats that you are adding this quarter, can you let me know what is the mix between new and existing?

Chuck Sykes

The 1,300 seats will all be new (inaudible).

Robert Evans – Craig-Hallum Capital

Is an expansion of existing –? I know they are new seats, but is it expansion from existing customers versus new customers.

Mike Kipphut

That is basically still the 60/40 mix that I spoke about previously.

Robert Evans – Craig-Hallum Capital

Okay, so it is consistent with what you did for revenue?

Chuck Sykes

Yes, 60% existing clients.

Robert Evans – Craig-Hallum Capital

Can you also comment the cash that you have internationally, is it in any one particular market or where would be – the bulk of that cash be? Would you face a tax consequence trying to use it for an acquisition in another area? I am just trying to get an understanding of how flexible that cash is.

Chuck Sykes

The cash is generally spread between Canada, Europe, and the Philippines. If we did an acquisition internationally, I don't think – well, it depends on where that acquisition is and where we need the cash. There could be some tax costs, but it would be somewhat minimal.

Minimal in the respect maybe it could cost 10% to 20% withholding taxes, maybe dividend some cash out from one entity to another. But that would be at one extreme. If it was domestically, and we were to bring back some of that cash into the U.S., the tax costs would be significantly higher.

Robert Evans – Craig-Hallum Capital

Okay. Is there any thought at all in terms of bringing some of that cash into the U.S., paying the taxes, and using it more from a buyback standpoint? I'm just wondering if these really acquisition opportunities as good as what your current valuation is.

Mike Kipphut

We think more the opportunity is in the acquisition market and we have been active in that. We are just very careful and very disciplined on some of the approaches we take in the acquisitions. I assure you, once you find something that makes sense, that is accretive from a cash flow standpoint, and more than anything else fits from a cultural and operations standpoint. We will certainly move to make that acquisition. We have looked at several opportunities. They just haven't measured up to those expectations at this point.

Robert Evans – Craig-Hallum Capital

Is the function there more price or is it more fit?

Mike Kipphut

It's a bit of both. I can't say it's all price or it's all operations or functionality. It has been both at different times.

Robert Evans – Craig-Hallum Capital

Okay. Can you update us in terms of – I think, Chuck, you talked about the wage rate differentials U.S. versus offshore, or perhaps Mike. What is the ballpark average wage rate offshore versus the U.S. right now? What is that differential?

Chuck Sykes

Right now, let me just say that I would say companies today, if they are looking at a domestic solution versus offshore, they are still saving in the range of 40%. Maybe it is more like 35%/40% range. Keep in mind it used to be almost 50%/55%.We believe that if the wages ever got to the point, particularly for the offshore locations, if the value proposition ever got to where it was around 20%, you may start to see really a change in behavior with the interest to go offshore, because it's not a very easy thing to do. That is really what we keep modeling and watching.

So right now with wage increases, and again it depends what happens to the currency. If the currency, Philippine peso continues to devalue, it just continues to push out that value proposition. But that is the thing about it, Bob, we just have to see. But right now I would say 35%/40% is the overall savings that people are still experiencing a year two of domestic solution.

Robert Evans – Craig-Hallum Capital

Would you be willing to give us the absolute dollar amounts? In terms of –?

Chuck Sykes

No, I don't want to – I don't really want to get into that much detail. That is a little too granular at this point.

Robert Evans – Craig-Hallum Capital

Okay, figured I would try. Okay, thank you very much.

Chuck Sykes

I appreciate it.

Operator

And now will take our next question from Tom Smith, First Analysis.

Thomas Smith – First Analysis

Thanks for taking my question. I know you have given some detail on this already, but just a quick one back on the seat count. Can you talk about what is the split between numbers of seats expected to add in the U.S. versus Latin America? And maybe what those seat counts were for the end of the second quarter?

Mike Kipphut

Let me see the best way to answer that. Overall, of the 1,300 seats that we plan to add, I was just say that most of them, 90%, are going to be in the Americas. Of that background, about – I guess maybe 400 would be in the U.S. as a general rule, and the rest in Latin or South America.

Thomas Smith – First Analysis

Okay. In the U.S. are you still around 3,300 to 3,400 seats?

Mike Kipphut

Yes, in the U.S. we are about 3,400 seats at the end of June.

Thomas Smith – First Analysis

Okay. Then I guess on a long-term margins outlook, you had said in the past you have been in a 6% to 8% range. I just want to make sure I heard correctly. I thought on the last call that you talked about you had to get to $1 billion being in the 8% to 10% range. I thought I heard on this call 7% to 9%?

Chuck Sykes

No, what I was just wanting to illustrate is that as we continue to move towards the $1 billion mark, you will continue to see that band of the operating margin expand. If you look at the companies today in our peer group that are knocking on the door running around 10%.

Typically, they are around $1.4 billion and that to us has a lot to do with just our size and the economy of scale. If you were to take us and back out and equate it down, our performance I think is very, very strong relative to our size for us. So my whole point is just to illustrate is we continue to grow revenue.

You will continue to see quarter-over-quarter you could see almost a 2 percentage point swing, which I granted is pretty big in that case with it, but you will continue to see the band move towards the higher end.

Thomas Smith – First Analysis

Okay, great.

Chuck Sykes

But I haven't given anything to say at $1 billion 10% or those things. People have just asked in the past, Chuck, can your margins get better than where you have been running? I have only given from an illustrative standpoint to say that when we cross the $1 billion mark, we believe we will be able to start heading towards the 10% level.

Thomas Smith – First Analysis

Okay, great. I appreciate it.

Operator

And we will take our next question from Albert Lee, The Maxim Group.

Albert Lee – The Maxim Group

I think most of this issue was nicely addressed, but with the operating margin having been aided by the repricing and the replacing of some of these underperforming programs, and it looks like you are anticipating some of this subpar performance to stretch into the back half of this year. So I guess the question I have is, number one, has it primarily been a characteristic thus far of trends within the Americas segment relative to EMEA? Number two, have you seen thus far or foresee any of these sub-performance issues carrying over into other verticals in the back half of the year? Finally, I guess you mentioned the success in your ability to replace some of these contracts, but do you foresee – is it becoming more or less difficult to do should these wage increases continue at the double-digit rate?

Chuck Sykes

Albert, this is Chuck. If I understand your question correctly on the subpar performance programs, one of the things in this business that is really inherent, and it's something that – this isn't unique to SYKES. I think every company in this space is challenged with this.

We have over 200 clients and at any point in time we have a number of those clients that just are not meeting our internal profitability goals. To put that in perspective, if we had everything hitting on all cylinders, meaning all the clients everywhere running at the right place on all the capacity of 85%, today at the size that we are we would be a 10% operating margin company.

So what we do is in our business though, it's too idealistic to think that you are always going to have those things set. So that is why when we are always modeling, we are always tried to bake into that just what are the normal surprises that happen in this business. They can be frequent. I could get off this phone call today and I could get a call with a client that is having a change in their outsourcing strategy, positive or negatively. It's just a natural inherence.

The other thing is that with it not being a business that has a huge amount of economy of scale, those things can impact your margins rather quickly. Which, again, is why we always emphasize the highlight that we have no one client more than 6.7% of our business. That is a huge, huge differentiator compared to many of our peers in this space.

So we are always going to have a number of those programs going on. Today we are able to address those that are in the markets that are growing. So while we have clients that are in the offshore areas that are not meeting our performance criteria, we are in a pretty good position of strength to have good conversations with them about getting it resolved. But some of them are over in markets that we don't have a really huge, strong pipeline unfortunately and we are not doing dealing with a position of strength.

So it's difficult for us to always give you guys a quantitative answer in that. It's always going to be somewhat anecdotal, but we just try to give you the color in the business. At the same time, though, there is great opportunity there. We are able to get those things resolved. You can see how we could turn the margins very quickly.

So I think to answer your question, we are always to some extent going to have those issues going on. That became very relevant, because in the context of when the currency was moving, everybody was suddenly getting very concerned, oh my gosh, what is going to happen to the offshore locations, and that is why we started talking about it.

But if that wouldn't have happened, we really wouldn't be talking about it because, in all candor, it's always going on in our business. It's just a normal course of just running this type of industry. I hope that gives you a little color with it. I know I am not answering your question probably as specific as you like.

Albert Lee – The Maxim Group

How about on the repricing of the contracts? Is it becoming more or less difficult? I know that the – should these wage (inaudible) with a double-digit rate that they have been tracking.

Chuck Sykes

Yes, right now I would say that when – I am not noticing a difference as long as our clients business is healthy. And that is the one caveat that I would just throw out there. If any of our clients get in trouble and we are having a pricing issue with them, that is not a good match.

They are going to be inclined to probably make a difficult decision and say we are not going to accept it and maybe try to go bid. If someone that is a competitor wants to take it at that pricing, which fortunately in today's industry, we really haven't seen our competitors doing things that I would consider to be unnatural acts with pricing, which helps everybody.

I think that is indicative that we are still seeing the opportunities that are out there. So today I still feel that we can have good conversations. Now that is mainly for the Americas. Europe is different.

In some parts in Europe we can and I will tell you, as positive as we are with our business, if you want to watch anything, the things I want to watch is what is going to happen as we read about the economy challenges that could be heading Europe's way, and that is something we want to watch. With the workers councils and things like that, that could be a more difficult environment to have to respond to. But today, we are doing okay with it. But I just – to give you an answer to your question, that could be a little bit more challenging if we ever get to that point in Europe.

Albert Lee – The Maxim Group

Great, thank you.

Operator

With no further questions in the queue, I will turn the call back over to Mr. Sykes for any additional or closing remarks.

Chuck Sykes

Great. Well, as always everyone, thank you very much for your interest in Sykes, and a lot of good questions today. We really appreciate that and we look forward to seeing you next quarter. Take care.

Operator

And that does conclude today's conference call. Thank you for your participation. You may disconnect at this time.

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Source: Sykes Enterprises, Incorporated Q2 2008 Earnings Call Transcript

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