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StarTek (NYSE:SRT)
Q3 2019 Earnings Call
Nov 06, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good afternoon, everyone, and thank you for participating in today's conference call to discuss StarTek's financial results for the quarter ended September 30, 2019. Joining us today are StarTek's president and global CEO, Lance Rosenzweig; and the company's CFO, Ramesh Kamath. Following their remarks, we'll open the call for your questions. Before we continue, we would like to remind all participants that the discussion today may contain certain statements, which are forward-looking in nature, pursuant to the safe harbor provisions of the federal securities laws.

These statements are based on information currently available to us and are subject to various risks and uncertainties that could cause actual results to differ materially. StarTek advises all those listening to this call to review the latest 10-Q and 10-K posted on its website for a summary of these risks and uncertainties. StarTek does not undertake the responsibility to update any forward-looking statements. Further, the discussion today may include some non-GAAP measures.

In accordance with Regulation G, the company has reconciled these amounts back to the closest GAAP-based measurement. The reconciliations can be found in their earnings release on the Investor Relations section of their website. I would like to remind everyone that a webcast replay of today's call will be available via the Investors section of the company's website at www.startek.com. Now I'd like to turn the call over to StarTek's president and global CEO, Lance Rosenzweig.

Sir, please proceed.

Lance Rosenzweig -- President and Global Chief Executive Officer

Thank you, Daniel. Good afternoon, everyone, and thank you all for joining. Our third quarter was one of the strongest in the history of StarTek with record high revenue, gross margin and adjusted EBITDA since last year's business combination with Aegis. The work we have put in place over the last year to integrate with Aegis, drive synergies, create a powerful client-centric operating model and execute on our sales pipeline are all translating into material improvements in our business.

We are very pleased that our operating results are now proving out the thesis in combining StarTek and Aegis to create such a strong platform and global customer experience management. These solid results have been further supported by our client diversification strategy. In Q3, our non-telco verticals accounted for 63% of revenue, up from 59% last quarter and 51% in calendar 2018. As we have stated in the past, we are highly focused on targeting new clients that accelerate our growth, both by cross-selling services and geographies and also organically, driven by our clients' own growth.

Most of these new client wins have come from exciting high-growth verticals, like technology, next-gen retail, healthcare, financial services and even travel and education. However, that does not preclude us from winning new business in established verticals, like telco or media and cable as long as we find the right opportunities with strong growth prospects and attractive margins. And during the third quarter, we found just that in a growing U.K.-based wireless telco leader, where StarTek is now providing a broad suite of customer experience management solutions for this company's broadband and mobile businesses. We had a successful launch of this new client and expect subsequent launches into 2020, both in customer experience management and in accounts receivable management solutions.

StarTek has a long history with companies operating in the telco vertical, and recent years have seen more headwinds than tailwinds. However, today most of our U.S. telco vertical is stable and even growing, and our U.K. telco region is showing strong growth.

We do continue to see softness with our telco business in India. During the quarter, we decided not to bid on a renewal of one particular Indian telco client due to its low-margin characteristics and limited opportunity for growth. Although, this decision will offset some of our revenue growth in the near term, the result will be an improvement in our margins. We remain committed to positioning StarTek as a premium provider in the industry, which means partnering with the right companies, companies that are growing and seeking a truly differentiated experience for their customers.

This is where StarTek is at its best. As we have stated in the past, we want to serve as a strategic partner to our clients and help them achieve their customer goals, which is very different from merely serving as a vendor with traditional call center support services. This mindset across the StarTek organization is driving the improvements that we are seeing in pricing and expanded relationships with our clients and ultimately, our growth and profitability, which tells us that our strategy is working. Building on this momentum at the high end of the market, during the quarter, we signed an exciting new SaaS-driven engagement, where we are providing a pure technology solution for one of our client's captive customer care operations in addition to winning the outsourcing business for this client.

While the SaaS offering as a relatively small engagement, it comes with very strong margins and demonstrates the success of our digital initiatives and our growing position as a value-added partner to our clients. This is further reflected by the numerous awards StarTek has won over the last couple of months, including being named the BPO the year in Malaysia by Frost & Sullivan, receiving Aon's best employer award in India; and most recently, winning the IDG India's CIO 100 award, recognizing our IT team's great work in AI-powered digital solutions. I am incredibly proud of what our teams has accomplished in just over one year as we have transformed StarTek into a purpose-driven organization that leverages innovation and technology to deliver extraordinary customer experiences for our clients, while at the same time, being recognized as a great place to work. Finally, during the quarter, we completed our rebranding, and we now go to market globally as StarTek.

Our rebranding was very well received by our clients and employees around the world. StarTek is passionate about becoming the premier partner for the world's finest brands. We now have global consistency and uniformity in operations, sales and marketing under the StarTek brand. Before I wrap up with closing remarks, I would like to now turn the call over to CFO Ramesh Kamath to take you through StarTek's financial results for the quarter.

Ramesh?

Ramesh Kamath -- Chief Financial Officer

Thank you, Lance. The quarterly results we are reporting today is for the group and include StarTek and Aegis financials from July 1 to September 30, 2019. Due to certain limitations with regard to publicly available financial information, we are unable to provide the combined company financials from the year-ago period. As a result, we will not discuss year-over-year comparisons as we would be comparing the financials of two companies against one for a certain portion of the quarter.

Instead, we believe it would be more effective to highlight the quarter-over-quarter results with qualitative commentary about the general trends and the drivers for each major line item. This will be the final quarter that we will only highlight sequential results as we lap our reporting anniversary of the merger. Well, moving on. Total revenues for the quarter increased 3% sequentially to $164.6 million as compared to $160.6 million in the quarter ended June 30, 2019.

As Lance mentioned, we continue to increase the revenue mix in our high-growth verticals, with non-telcos accounting for 63% of revenue in Q3. Gross profit for the quarter increased 3% to $28.5 million as compared to $27.6 million in the second quarter, with the gross margin percentage increasing 10 basis points to 17.3% as compared to 17.2%. Margins have, once again, improved sequentially, keeping up with our track record of expanding margins every quarter since the business combination with Aegis last year. Our margins continue to benefit from our client-centric management model, which enables stronger employee utilization across our global footprint.

Margins also continue to improve as a result of positioning StarTek as a premium provider, which enables us to command stronger pricing. SG&A for the quarter was $22.9 million as compared to $24.9 million in the quarter ending June 30, 2019. As a percentage of revenue, SG&A was 13.9% as compared to 15.5%, with the improvement driver, driven by local spend on infrastructure repairs, communication, provision for doubtful debts, legal and other costs. Net loss for the quarter was $2.8 million or $0.07 per share as compared to a loss of $3.6 million or $0.10 per share in the quarter ending June 30.

Although, net loss improved this quarter, it would have been even better had it not been for the foreign exchange losses and deferred tax adjustments below the operating line. Adjusted EBITDA for the quarter increased strongly to $13.4 million as compared to $11 million in the quarter ending June 30, 2019. As a percentage of revenue, adjusted EBITDA was 8.1% as compared to 6.9%. As Lance mentioned earlier, our improvements here reflect the culmination of executing our various initiatives over the last one year, including group synergies, cost optimization and operational efficiency.

During the quarter, we reduced our net debt by over $10 million to $160.4 million at the end of September as compared to $170.9 million at June 30. We will remain focused on keeping a tight cash flow cycle but with adequate funds available to support our growth. This concludes my prepared remarks. I will now turn the call over to back to Lance.

Lance?

Lance Rosenzweig -- President and Global Chief Executive Officer

Thank you, Ramesh. Our team has worked very hard this past year to turn StarTek's merger with Aegis into a great success. We are pleased that our results this quarter demonstrate the powerful advantages we can now bring to our clients, our employees and our shareholders. With the anniversary of our Aegis business combination now behind us, I believe, we are in a strong, sustainable position to provide more color on the longer-term outlook for StarTek.

We have met with many of our shareholders and prospective investors over the past year, and we are consistently asked about the potential for StarTek down the road. As a matter of company policy, we have not provided annual financial guidance and will continue to keep that policy in place. However, we do think it is important to share our vision and expectations with investors so that they can understand why we are so excited about the potential we are unlocking at StarTek. We expect StarTek to become a leader of innovative and tech-enabled customer experience management solutions, ultimately becoming $1 billion organization that is capable of consistently delivering double-digit EBITDA margins.

While we don't expect this to happen in 2020, I do believe we can get to low double-digit EBITDA margins in the next couple of years, well before achieving $1 billion in revenue. Although, we have some offsetting headwinds with telco in India, our growth elsewhere is ramping and taking over a stronger portion of our total revenue mix with strong margins and ample opportunity for growth. Our sales pipeline is robust around the world with numerous high-growth prospects seeking a premium provider. The best years for StarTek are right in front of us, and I look forward to the benefits this will bring to all our stakeholders.

Daniel, Ramesh and I will now like to open the call up for questions.

Questions & Answers:


Operator

[Operator instructions] Our first question comes from Mark Argento with Lake Street Capital. Please proceed.

Mark Argento -- Lake Street Capital -- Analyst

Just a quick -- I wanted to delve down a little bit into the some of the vertical strength you're seeing with the -- with telco -- non-telco being 63%. Obviously, you're getting some traction in some other areas. Could you highlighted a couple of the areas that you're seeing some good traction in? And where you see the activity going forward?

Lance Rosenzweig -- President and Global Chief Executive Officer

Yes. Thank you, Mark. It's actually quite a broad range of verticals. We're seeing some strong growth in our healthcare vertical, we're seeing particularly strong growth in next-gen retail in our education vertical, where we have a really wonderful niche in travel.

And kind of a broader spectrum of really diverse opportunities in pretty diverse geographies.

Mark Argento -- Lake Street Capital -- Analyst

Great. And then also in terms of the ability to cross sell, have you seen kind of same client revenue expand in certain areas more than others?

Lance Rosenzweig -- President and Global Chief Executive Officer

I think that client growth within a client is a function of a number of things, and part of it is performance. We deal with some of the finest, largest companies in the world, and they prioritize their partners that perform well. And we're thrilled with the operating performance that our teams are executing and the new business that we're winning with some really fine clients. A second part is also due to the growth that our clients have just themselves.

And we're increasingly aligning ourselves with very rapidly growing businesses, and so we grow as they grow. And third, some verticals that we focus on have disproportionately high levels of growth, and we're benefiting from some of that vertical diversification as well.

Mark Argento -- Lake Street Capital -- Analyst

Great. That's helpful. And then just turning to the balance sheet, I mean kind of trailing 12-month basis EBITDA, $46 million, $47 million. Like you said, this quarter, you put up a pretty good number.

In terms of opportunity around the balance sheet, we find that I think there's still a lot of legacy in debt facility, the legacy facility pre the merger. What are you guys thoughts in terms of the balance sheet going forward?

Lance Rosenzweig -- President and Global Chief Executive Officer

Yes. I think we've done really an excellent job in improving the income statement and revenues are growing, EBITDA grew tremendously this quarter, and we're just quite excited about our operating performance. In terms of the balance sheet, we do have a legacy debt, which was in place at the merger of our two companies, and we are continuing to work to make sure we've got the right capital structure in place to support our future growth. So maybe, Ramesh, you want to add a little color to that as well?

Ramesh Kamath -- Chief Financial Officer

No, Lance. I think, you've summed it up well. I'm quite comfortable that we were able to keep a tight lid on our cash flows and improve -- and try and convert a large part of our EBITDA into cash, and that is a focus that we are not going to change.

Lance Rosenzweig -- President and Global Chief Executive Officer

And I think you saw that in the numbers for the quarters where our net debt was $10 million lower than the prior quarter.

Mark Argento -- Lake Street Capital -- Analyst

It's nice to see the deleveraging happen, so that's great. Just one last one, in terms of the long-term double-digit EBITDA margin target, what do you need -- obviously, you got to get the revenues, keep the revenues growing. You need a bunch of capex investment into the business to be able to achieve the -- that level of EBITDA margins. What do you need to see happen -- what do you need to have happen to see that double-digit EBITDA margin?

Lance Rosenzweig -- President and Global Chief Executive Officer

It's a great question. Part of it has to do with revenue, but there are a lot of other factors that, I think, will contribute to improved EBITDA margins. One is capacity utilization, and if we're able to grow our clients in existing capacity, then that has the benefit of generating much higher returns on that incremental capacity, while at the same time, minimizing the capex that will be required for new capacity. So we're very tightly managing our capacity utilization to try to do it without requiring huge increases in capex.

In some areas, though, where we are working with very sophisticated clients, we do have capex requirements to support their growth, and we'll be funding that from our operating sources as well as our balance sheet going forward.

Mark Argento -- Lake Street Capital -- Analyst

Congrats on the one-year anniversary, nice work. You guys have come a long way.

Lance Rosenzweig -- President and Global Chief Executive Officer

Thank you, Mark, really appreciate it.

Operator

Our next question comes from Omar Samla. Please proceed.

Unknown speaker

Hey, guys. How are you?

Lance Rosenzweig -- President and Global Chief Executive Officer

Excellent, Omar. Good.

Unknown speaker

A lot to like here, guys, revenue growth, lower SG&A, higher operating income and EBITDA, free cash flow positive and debt repayment, I mean that's -- what a job well done, and I really -- sincere congratulations to you guys.

Lance Rosenzweig -- President and Global Chief Executive Officer

We appreciate it. Thank you.

Unknown speaker

OK. So could you guys explain that higher than usual tax expense for the quarter that essentially took you from breakeven before taxes to the net loss?

Ramesh Kamath -- Chief Financial Officer

Lance, shall I take this?

Lance Rosenzweig -- President and Global Chief Executive Officer

Yes, please, Ramesh.

Ramesh Kamath -- Chief Financial Officer

Omar, during the quarter, we started upstreaming the cash to help us pay for our debt. In a couple of geographies we started for the first time. And once we do that under an accounting standard, the presumption is that the company will move all its retained earnings upstream again in future, and therefore, the appropriate taxes on dividend, whether it's withholding or dividend tax, needs to be provided on the entire retained earnings of that particular country/company. Because of that, in two of our geographies where we started dividending the first time, only on the opening results, we had to make a deferred tax provision of $1.35 million.

So that was a significant impact. The second impact is typical investment companies, when they receive dividend, if they don't have too much further income taxes to pay as is the want in investment companies, any withholding tax on the dividends they receive, which is foreign tax credit they're unable to offset, so we have to expense it off. That was another $400,000, approximately. So if you take those two out, you are left with between $1.6 million to $1.7 million, which is higher over the last quarter.

That's because all my geographies have started making taxable profits largely. Does that explain, Omar?

Unknown speaker

Absolutely. You were ready for that question, for sure.

Ramesh Kamath -- Chief Financial Officer

Yes. The board had also asked me and I knew somebody would.

Unknown speaker

OK. So although the gross margin was marginally higher sequentially, it seems that it could have been even higher given the revenue growth. So could you explain if that is due to costs that're -- you're incurring associated with new programs that are ramping up as we speak?

Ramesh Kamath -- Chief Financial Officer

Yes. As Lance explained in even earlier calls that every time we start ramping, there is a cost associated which starts earlier than the growth in margins and revenue, and therefore, it tends to, at times, hold the margins down there. So in a sense, it's not a bad sign.

Unknown speaker

OK. I got it. And -- so doing a quick rough calculation, it looks like you guys were free cash flow positive for the quarter after interest expense by about $10 million, and then with that cash, you guys repaid about $4.7 million in short-term debt and in addition to the long-term debt amortization payment that you have to make. Correct?

Ramesh Kamath -- Chief Financial Officer

That's right. And we have one payment coming up, so we'll use that to clear that.

Unknown speaker

OK. OK. I have noticed increased activity in your hiring efforts for most of your offshore markets, such as India, Malaysia, Saudi Arabia, the Philippines. I was wondering if you could add some color to that activity in those markets.

And if the hiring increase has stemmed from programs that you're switching? Or is it from actual new business growth?

Lance Rosenzweig -- President and Global Chief Executive Officer

Yes. It's varied by region. And in some areas, it's strong kind of same-store sales, per se, growth within our installed base, and in other regions, it involves launches of new clients as well. And I would say that there is a little bit of a -- and you'll see more of that in this current quarter, seasonal hiring for some of our strong retail-oriented clients.

Unknown speaker

OK. Got you. OK. And on the Philippines specifically, prior to the merger, StarTek's sales pipeline for that market was entirely for U.S.

business. I was wondering maybe you could talk about what is your focus now for that market given the U.K. business that you explained during your -- during the call, I saw some things that it had something to do with the Philippine market, so maybe there's something that you can add some color.

Lance Rosenzweig -- President and Global Chief Executive Officer

Yes. We're just absolutely thrilled with our performance in the Philippines. We have several sites there. We're in both metro Manila as well as in the more provincial areas, and the teams are just killing it.

And we're seeing more international business flowing into the Philippines as well. So in addition to the U.S., which, as you correctly mentioned, has -- had been pretty much the exclusive location for services in the past. We are now seeing growth from the U.K., and we've recently done a restructuring and a focus on our Australian operations, where we think that there were also great opportunities for some of the leading Australian brands to outsource to the Philippines as well. So we are seeing more international diversification to those campuses.

Unknown speaker

Beautiful. OK. Could you talk about, to the extent that you can, how you see the picture of profitable revenue growth forming for you going forward? And maybe also, what steps have you taken internally within the sales team to incentivize that?

Lance Rosenzweig -- President and Global Chief Executive Officer

Yes. It's a multifaceted approach. So what I'll caveat the whole answer is that we are not taking our eye off running very efficient operations in a lean and well-managed business. So that sort of underlies everything we do.

But as we do that, we're seeing strong opportunities for growth, and growth is coming from new clients. It's coming from existing clients. In some cases, it's improving capacity utilization, which is driving higher margins. We're seeing some arbitrage opportunities from higher-cost locations to lower-cost locations.

And all of that is driving improvements in both top and bottom-line performance.

Unknown speaker

OK. Good. And then finally, and I really appreciate your comments at the end with your long-term goals, you've mentioned the desire to be more transparent in terms of information, such as utilization rates and business wins and margin goals and all that. Can you tell us where are you in that process? And when do you foresee releasing maybe a little bit more information to shareholders?

Lance Rosenzweig -- President and Global Chief Executive Officer

Yes. We are super excited about the progress that we're making and the opportunity ahead for us. The Q will be out tomorrow, and that's got some good information both on individual geographies as well as individual verticals. Capacity utilization is a little trickier for us to make sure that we're consistently talking about.

So some of the other metrics, we are looking internally about releasing publicly. We do want to be very transparent in everything we do, but we don't want to put too much subjectivity in it where sort of non-GAAP measures are difficult to compare and contrast. And so we're looking at it, we are on it. We want to make sure that we are providing really excellent quality information for all our investors.

Unknown speaker

Great, guys. Well, thank you very much for taking my questions, and good luck going forward. You've been great.

Lance Rosenzweig -- President and Global Chief Executive Officer

Thank you, Omar.

Operator

Thank you. At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Mr. Rosenzweig.

Mr. Rosenzweig, please proceed.

Lance Rosenzweig -- President and Global Chief Executive Officer

Thank you, Daniel, and thank you all for joining us this afternoon and for your continued support of StarTek. We look forward to speaking with you next when we report on our quarterly and annual results. Thank you.

Operator

[Operator signoff]

Duration: 30 minutes

Call participants:

Lance Rosenzweig -- President and Global Chief Executive Officer

Ramesh Kamath -- Chief Financial Officer

Mark Argento -- Lake Street Capital -- Analyst

Unknown speaker

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