Convergys Management Discusses Q4 2012 Results - Earnings Call Transcript

| About: Convergys Corporation (CVG)
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Convergys (NYSE:CVG) Q4 2012 Earnings Call February 7, 2013 10:00 AM ET

Executives

David Stein - Head of Investor Relations

Andrea J. Ayers - Chief Executive Officer, President and Director

Andre S. Valentine - Chief Financial Officer

Analysts

Eric J. Boyer - Wells Fargo Securities, LLC, Research Division

Paul B. Thomas - Goldman Sachs Group Inc., Research Division

Howard Smith - First Analysis Securities Corporation, Research Division

Ashwin Shirvaikar - Citigroup Inc, Research Division

David J. Koning - Robert W. Baird & Co. Incorporated, Research Division

Kunal Doctor

Operator

Good morning, and welcome to Convergys Fourth Quarter 2012 Earnings Teleconference. [Operator Instructions] I would like to inform participants that today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to turn the call over to your conference host today to Mr. David Stein, Vice President of Investor Relations. Sir, you may begin.

David Stein

Thank you, Tray, and good morning. Welcome to the Convergys Fourth Quarter 2012 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 Webcasts.

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 today'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, 2011.

Also, during the call, we'll discuss non-GAAP financial measures, including free cash flow, adjusted operating income, adjusted net income from continuing operations, adjusted earnings from continuing operations per share and adjusted EBITDA. A reconciliation of these non-GAAP measures is available in the news release and on the Convergys 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 J. Ayers

Good morning, everyone. We delivered our seventh consecutive quarter of revenue growth and profit improvement in the fourth quarter. Our revenue of $509 million represents an increase of 2% compared to revenue of $501 million in the fourth quarter last year. And adjusted EPS from continuing operations increased 19% to $0.25 a share compared with $0.21 per share last year. Consistent with our disciplined capital deployment strategy, we repurchased $59 million of our stock at an average price of $16.05 per share during the quarter. We also paid a quarterly dividend of $0.05 per share in early January.

In 2012, our strategic and financial position continued to strengthen, as did our flexibility to invest in the business and reward our shareholders. Full year revenue was up 4% and earnings per share increased 21% on an adjusted basis. We repurchased $184 million of our stock and paid $15 million in dividends during 2012. As we enter 2013, we are, pleased to raise our quarterly dividend 20% and increase our share repurchase authorization to $250 million.

Now let's review our operating progress in more detail. Overall industry trends in the fourth quarter were consistent with our experience over the past several quarters, and these trends continue to play to our strengths. As I discussed at our Investor Day in November, we see 4 key industry trends relating to call complexity; full life cycle services; vendor consolidation; and offshoring.

Regarding call complexity. Demand for agent-assisted services remains strong, even as consumers adopt alternate interaction channels and new technologies to address their simpler transactions. This is because agent calls are getting more complex. When a customer needs to speak with an agent, typically this means something could not be handled in an alternate channel. More complex transactions tend to increase the time an agent spends to resolve the call. This trend plays to our ability to invest in a Global Operating Model to cost effectively handle this complexity with the right talent and quality at scale.

The second trend is client demand for service flexibility across the full life cycle of contact types. Our clients' needs change rapidly. As their customer strategies change, clients want to work with partners that offer a breadth and depth of capabilities and the flexibility to make rapid adjustments. This plays to our ability to invest in comprehensive solutions to rapidly address our clients' changing needs.

The third trend is vendor consolidation. Our clients tell us, it is difficult and expensive to drive a consistent customer experience when dealing with many vendors. For this reason, clients tend to consolidate with strategic partners. This plays to our ability to invest in account management to ensure close client engagement. Our approach allows us to understand their unique needs, consistently deliver the right mix of solutions and quickly ramp programs when consolidating volume from other vendors.

Finally, client demand for offshore services remains strong. Our investment in global capacity positions us to provide the right work types in the right geographies to drive the consistent quality and value our clients demand. We continue to invest in our winning business model, combining global, quality delivery, comprehensive solutions and close client engagement to address these industry trends.

In the fourth quarter, call volume remained strong across our service delivery regions and the vertical markets we serve. Revenue was up in the Philippines, India and Latin America. This was driven by increases with several existing and new clients across the verticals we serve.

Revenue grew year-over-year in our technology, financial services and other verticals. Strong growth with a number of clients in the communications vertical, offset a decline with one large client during the quarter. During the fourth quarter, revenue increased with over a dozen of our top 20 clients. The anticipated seasonal pattern was a bit muted with a few of our clients in the quarter. It is typical in this industry for volumes to fluctuate with clients based on a range of factors. These include the impact of program changes, seasonality, process improvements, marketing campaigns and other client-specific initiatives. Going forward, we see opportunity for overall growth in all verticals, both with existing and new clients.

In the fourth quarter, we signed new live agent business worth $60 million of 2013 revenue. These wins were broad-based, across the vertical markets and clients we serve. In addition to revenue growth, we delivered solid profit improvement in the fourth quarter. On an adjusted basis, earnings before interest, taxes, depreciation and amortization increased 5% and EBITDA margin increased 40 basis points compared with last year. Drivers of this improvement included agent revenue growth, the continuing shift offshore and our focus on cost management.

These positive impacts more than offset continuing pressure from some interaction technology programs that completed in the quarter. We are successfully executing our profitable growth strategy and expect another year of revenue and profit improvement in 2013.

In summary, we are a well-capitalized market leader in customer management; we delivered consistent performance improvement in the fourth quarter and for the full year; our unique position allows us to invest in what matters most to our clients to drive organic growth. We also continue to consider opportunities for strategic growth through acquisition. Our focus is on adding new clients, expanding our geographic footprint and adding capabilities, such as new languages.

We remain disciplined in our pursuit to ensure any inorganic growth is linked to value creation for our clients and shareholders. Our strategic and financial strength also provides flexibility for us to return cash to investors, and we expect another year of revenue and profit improvement in 2013.

I want to thank our team for delivering solid results. I would also like to thank our clients for their trust in Convergys as we partner to support their customers and to strengthen and grow their businesses.

Now I'll turn the call over to Andre to provide more detail on our financial results.

Andre S. Valentine

Thank you, Andrea, and good morning. In the next few minutes, I'll review our results from continuing operations and provide our guidance for 2013. Having completed our corporate simplification, we are now reporting results as a single segment. The small amounts of corporate revenue and expense have been combined with Customer Management results. Total revenue in the fourth quarter was $509 million, which was up $8 million compared with last year. This growth was driven by increases with existing and new programs, which more than offset volume reductions and program completions.

During the quarter, we continue to see the negative impact of completing some interaction technology programs. Call volumes in the fourth quarter followed the seasonal pattern. As is typical, we expect volumes to soften a bit sequentially in the first quarter. We see stability in overall client demand, though at a time of lingering economic uncertainty, we remain cautious. Transition services revenue related to the sale of the Information Management business were $5 million in the fourth quarter.

At the end of the quarter, 43% of our contact center employees were in the Philippines. 36% were in the United States. This includes approximately 3,500 full-time agent equivalents in our work-at-home business. 14% were in India, 4% in Latin America, 2% in Canada and 1% in the United Kingdom.

Total adjusted operating income was $38 million in the fourth quarter, up $1 million from the prior year. This includes the impact of $3 million in severance charges in the fourth quarter. These charges relate to continuing actions to increase live agent efficiencies and align costs with expected revenue declines from our technology offerings. Adjusted operating income margin improved to 7.4%. Adjusted EBITDA increased $3 million to $62 million, and EBITDA margin improved 40 basis points to 12.2%. These results include $5 million of long-term stock compensation expense in the fourth quarter. Long-term compensation expense was $19 million for all of 2012, and we expect this noncash expense to run at a similar level in 2013.

Drivers of the profit improvement in the quarter included profit flow-through on revenue growth, delivering a higher proportion of services from lower cost geographies and continued focus on cost control, particularly in our G&A areas. We expect some sequential margin pressure in the first quarter as we maintain some agent headcount to support expected client volumes from new program ramps.

Foreign exchange impacts were not material in the fourth quarter. However, the strengthening of the Philippine's peso against the U.S. dollar will pressure margins somewhat in 2013.

Turning to net income, adjusted EPS from continuing operations was $0.25 per share compared with $0.21 last year. For comparison purposes, we have used a normalized tax rate of 24%. Our GAAP results include a tax benefit from a more favorable allocation of income across jurisdictions. Free cash flow for the quarter was a net use of $26 million. This included the expected $15 million tax payment in the quarter related to the Information Management sale. Also during the quarter, we reduced the long-term liability for a $20 million pension contribution. In addition, we increased our investment to expand our global delivery capacity and technology infrastructure to meet demand.

Turning to the balance sheet. At the end of the fourth quarter, we had cash and short-term investments of $639 million. This was consistent with our earlier guidance, setting aside the impact of $59 million in share repurchases in the quarter. About 70% of the cash and short-term investment balance is in the United States. In addition to our strong balance sheet, we have full availability on $450 million of revolving credit facilities.

As we have said previously, the strong cash generating characteristics of our business and our significant cash position allow us to invest in strategic growth and return cash to investors. Our dividend increase reflects our confidence in the future and our disciplined approach to capital deployment. We are also pleased to have raised our share repurchase authorization to $250 million.

Now I'll discuss our business outlook for 2013. We expect to deliver continuing revenue growth and earnings improvement in 2013. Specifically, we expect revenue to exceed $2.045 billion for the full year, up more than 2% from $2.00 billion last year. Included in this expectation is a 1% headwind from the completion of some interaction technology programs.

In terms of earnings, we expect adjusted EBITDA to exceed $245 million for the full year, up from $240 million last year. Our effective tax rate should be about 22% for the year. We expect adjusted EPS to exceed $1 for the full year, up more than 10% from $0.91 last year, which is consistent with our 3-year goal. Our free cash flow should approximate net income for the year. We also expect results in the second half of 2013 to exceed results in the first half of the year.

Our earnings guidance excludes an expected noncash pension settlement charge of $20 million to $30 million during 2013, primarily related to our sale of the Information Management business. Our guidance also excludes any acquisitions or additional stock repurchase activity.

Overall, we are pleased with the results in the fourth quarter, and we look forward to another year of improving performance in 2013. At this time, Trey, please open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question does come from Eric Boyer of Wells Fargo.

Eric J. Boyer - Wells Fargo Securities, LLC, Research Division

Andre, can you just go over your macro assumptions baked into your 2013 guidance?

Andre S. Valentine

So from a macro assumption basis, Eric, we expect relatively modest GDP growth, which is kind of where we think about where client demand and call volume starts. Also in that -- so relatively modest, call that, very, very low-single digits. On top of that, we do think we will add revenues from continuing trend of vendor consolidation at a rate kind of similar to what we've done in the past. And then we have 2 headwinds, obviously, more of the work moving -- being done offshore, higher proportion, that impacts revenue growth as does the 1% headwind that I talked about from the interaction technology programs.

Eric J. Boyer - Wells Fargo Securities, LLC, Research Division

Okay. Could you also just, I know you gave the EBITDA guidance, but could you talk about '13 in terms of your operating margin expectation? And then the drivers of expansion going forward?

Andre S. Valentine

Yes. So I'll start with the drivers of expansion in our margin. It's very clear to us Eric, that for us to expand margins most of that is going to have to come from revenue growth. I always talk about how we believe that, while there's not a tremendous amount of leverage in this business, that the incremental revenue dollar should drive roughly $0.20 to the margin line. And so that's going to drive margin expansion. We think we can continue to tweak our G&A a bit, although some of that will be lost in the currency headwinds we talked about as well. From an operating income margin perspective, I would see that moving, frankly, in joint step with EBITDA. There's nothing going on from a D&A percentage -- as a percent of revenue basis in 2013, that isn't similar to what you would have seen in 2012.

Eric J. Boyer - Wells Fargo Securities, LLC, Research Division

Okay. Then finally, did you guys talk about new signings at all?

Andrea J. Ayers

We did. We signed $60 million in the quarter of 2013 revenue across a broad base of our verticals, Eric.

Operator

Our next question does come from Julio Quinteros of Goldman Sachs.

Paul B. Thomas - Goldman Sachs Group Inc., Research Division

This is Paul Thomas for Julio. Just on the new signings. So any particular areas of strength there in the quarter for the new business?

Andrea J. Ayers

We really were pleased that we saw signings across a variety of our verticals and we saw growth across a number of our top accounts as well. So nothing. We just saw a pretty wide range, which we felt pretty good about.

Paul B. Thomas - Goldman Sachs Group Inc., Research Division

And then can you comment a little bit on financial services vertical. It sounds like you saw some improvement in the quarter. And what you're thinking about that segment in FY '13?

Andrea J. Ayers

I can. That's been a vertical that we have been very focused on. I think we've been very clear about that on another call. The team did a nice job in the quarter and it continues to be a strategic vertical for us. And one that we will stay focused on.

Andre S. Valentine

Yes, certainly contributed somewhat to the $60 million in signings numbers as well, Paul.

Operator

Our next question is from Howard Smith of First Analysis.

Howard Smith - First Analysis Securities Corporation, Research Division

Some questions regarding kind of the outlook for 2013 on the top line, at least indirectly. The attrition this year had been running pretty low, maybe below long-term sustainable trends. I was wondering if you could talk about what you saw in Q4, it sounds like it may have picked up, and what kind of you have assumed for 2013?

Andrea J. Ayers

Sure. So I'll start and then ask Andre to chime in. And thank you, Howard, appreciate it. So there is always, in this business as you well know, a base level of churn that exist based on program completions and volume fluctuations and changes just a fact of our business. You're right. In 2012, we saw lower than normal kind of runoff of revenue and churn. This year, we're projecting we will be more normal as we look at that. And so that's what you see in the assumptions.

Howard Smith - First Analysis Securities Corporation, Research Division

Okay. And then in terms of the Philippine peso and its appreciation here, trend, you said that'll hurt your cost a little bit, expenses, particularly cost next year. Where do you stand as far as passing some of that along to your customers as you look out to 2013?

Andre S. Valentine

Howard, this is Andre. Good to hear from you. So I've always said and it continues to be true, that pricing in the Philippines and in India is elastic with what happens over time with currency shifts. As you can imagine, though, what you get into is you can't reopen pricing with clients during a term of a contract and most of our contracts as we've talked tend to be 2- to 3-year deals. So as we price new business in the Philippines, we will be reflecting this economic reality. As we renegotiate contracts, as they come to term in the Philippines, we'll be reflecting this reality as well. We continue, even as we price today, with this currency impact, to see very, very strong demand for the Philippines. The value proposition is still very strong and we continue to invest very heavily in capacity in the Philippines because even at these levels, we can price and earn an acceptable return on our investment.

Operator

Our next question does come from Ashwin Shirvaikar of Citi.

Ashwin Shirvaikar - Citigroup Inc, Research Division

Guys, a good performance year. I guess my first question is with regards to your guidance and bringing it down to EPS. What level of a buyback are you assuming in there? Because it kind of seems like you're assuming maybe, back of the envelope, maybe a buyback of 5 million or 6 million shares, maybe. It doesn't really add up.

Andre S. Valentine

Yes, let me clarify that for you. So if you go back to what I said in our guidance, our guidance in excess of $1 in EPS for 2013, Ashwin, does not assume any additional buyback past what we've just disclosed that we did in Q4 2012. So hard to predict the amount or timing of buyback activity in 2013. And so rather than bake that into the guidance, we're just letting you know that it's not in there. So it's literally based on what is outstanding as of the end of 2012.

Ashwin Shirvaikar - Citigroup Inc, Research Division

But short of being involved in doing a large transaction, can you envision a scenario where you would not be deploying cash in this way?

Andre S. Valentine

Well, Ashwin, I will follow in my predecessors' footsteps by saying we'll never really indicate just how active we're going to be in share buyback. But certainly, trading at 5.5x EBITDA and with our confidence in our outlook for the future, that is something we will look at. But I don't want to dictate how aggressive we will be and what timing.

Ashwin Shirvaikar - Citigroup Inc, Research Division

Absolutely, understood. With regard to seasonality and you had commented about that, should we assume sort of a regular 40-60, first half, second half split roughly speaking, is that a good ballpark?

Andre S. Valentine

Yes, I think that's right in line. Yes.

Ashwin Shirvaikar - Citigroup Inc, Research Division

Okay. And question about the pipeline and about decision-making with regards to contract ramps. If you could provide more color on how clients are engaging with you guys nowadays and how that's different from maybe 3 to 6 months ago?

Andrea J. Ayers

Ashwin, I can do that. It's really not different from 3 to 6 months ago. It is relatively consistent. Timing varies by client and deal and opportunity and where it's going to be sourced as it always has. We really haven't seen much change in terms of the buying pattern or behavior of our client base.

Operator

Our next question does come from Dave Koning of Baird.

David J. Koning - Robert W. Baird & Co. Incorporated, Research Division

Ashwin just asked about it. I know he asked about the revenue kind of patterns through the year with the first and second half, but I guess from just a year-over-year growth perspective, Q1 is a pretty tough comp and then the rest of the year is easier. So does that mean Q1 this year will probably be the slowest? I know you said sequentially, there's just typical seasonal negative patterns, but will the year-over-year growth in Q1 probably be the slowest of the year?

Andre S. Valentine

Yes, David you've got that analyzed exactly correctly. With the sequential pattern that we're going to see from Q4 to Q1 and the Q1 revenues from last year, that will be -- should be our lowest growth quarter. And then we should accelerate from there.

Andrea J. Ayers

And that muted seasonal volume we saw in a few clients takes us into the first part of the quarter as well. So that follows us over because the normal season straddles the Q4 and Q1 results.

David J. Koning - Robert W. Baird & Co. Incorporated, Research Division

Okay, that makes sense. And then do you still expect some growth in Q1? Or could you actually decline year-over-year?

Andre S. Valentine

Too early to call that. It will be very, very tight with Q1 of 2012.

David J. Koning - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then I guess finally, communications, it's been up year-over-year for 7 quarters in a row. I think this is the first quarter of a decline in a while and you mentioned one large client that's going to decline mode. I guess is that something -- is there some kind of ongoing pattern, are you thinking communications will be a little weaker? Or was it just some kind of short-term shock to this?

Andrea J. Ayers

No. I feel very good about our communications vertical and we saw growth across a number of programs in that vertical. It's one of our strongest as you know, continues to be a big area of focus for us. I would take this as a volume fluctuation opportunity and nothing more.

Operator

Our next question does come from Manish Hemrajani of Oppenheimer.

Kunal Doctor

This is Kunal Doctor on for Manish Hemrajani. Good year, 2012. Okay, just a question on segments, how should we think going forward, as in what should be the trend for technology or technology financial services and others, as in for communication, I think, earlier discussed. Can you give us a brief idea about that?

Andrea J. Ayers

Right. So the key verticals for us continue to be the ones that you named off. We feel very strong about our communications vertical experience and then good also about financial services and the technology vertical. We really see opportunity across all of the verticals that we serve for growth with both new logos and our existing client base.

Kunal Doctor

Okay. And I think, I guess, I might have missed it, but can you give us the break up of the agent mix -- the number of live agents? Sorry.

Andre S. Valentine

Yes. So what we said there was that I will put it up for you. 43% of our contact center employees were in the Philippines; 36% were in the U.S. and that includes 3,500 full-time agent equivalents in our work-at-home business; 14% were in India, 4% in LATAM, 2% in Canada and 1% in the U.K.

Ashwin Shirvaikar - Citigroup Inc, Research Division

Okay. And how do you see the top 20 clients performing going forward?

Andrea J. Ayers

We grew with over a dozen of our top 20 in the quarter, so we feel very good about our investments in account management and our global quality delivery and comprehensive solution set to allow us to continue to grow organically with our existing clients.

David Stein

All right, Operator. That's all the time we have for today. I'd like to add that Andre and I will be available the rest of the day to answer any additional questions about our results or the outlook that we've discussed on this call, and I just want to thank you all for joining us today. And with that, have a good day.

Operator

Thank you. Today's conference has ended. All participants may disconnect at this time.

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