Chad Carlson - President, CEO Don Norsworthy - CFO

Dave Koning - Baird

Good afternoon, everyone, and thank you for participating in today's conference call to discuss STARTEK's financial results for the first quarter ended March 31, 2018. Joining us today is STARTEK's President and CEO, Chad Carlson; and the company's CFO, Don Norsworthy. Following their remarks, we'll open the lines for questions. Before we continue, we'd 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 security laws. These statements are subject to various risks and uncertainties, and actual results may vary materially from these projections. STARTEK advises all those listening to this call to review the latest 10-Q posted on their website for a summary of all these risks and uncertainties. STARTEK does not undertake the responsibility to update these projections. Further, the discussions today may include some non-GAAP measures. In accordance with Regulation G, the company has reconciled these amounts back to the closest GAAP-based measurements. The reconciliations can be found in the earnings release on the Investors 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 CEO, Chad Carlson. Sir, please begin.

Thank you, Towanda. Good afternoon, and thank you all for joining. As noted in our press release, the first quarter might very well have been the most strategically significant quarter in STARTEK's history. In January, we entered into a multi-year strategic alignment with Amazon. And in March, we announced a strategic transaction involving Aegis, one of the leading global service providers of customer experience management. Both developments provide us with the opportunity to significantly diversify our revenue base and expand into new growth markets, while enhancing margin and profitability. I'd first like to expand on the agreement with Aegis, as there will be a meaningful amount of new information provided in our proxy statement to be filed later today. If you have a chance to review it, I'd highly recommend doing so. Quickly reviewing the transaction itself, STARTEK will issue 20.6 million shares of its common stock to Capital Square Partners, who I will call CSP, primary shareholder of Aegis, to acquire all of the outstanding common stock of Aegis. Concurrently, CSP will purchase approximately 833,000 primary shares of STARTEK common stock at $12 per share, representing a $10 million investment in STARTEK. Post closing, this will result in STARTEK's shareholders owning about 45% of the combined equity value and CSP owning about 55%. Aegis operates out of eight countries with no geographical overlap to STARTEK and a very diverse revenue base. Last year, Aegis had approximately 400 million of revenue and just under 40 million of EBITDA. Together with Aegis, we will establish a global enterprise with over 50,000 employees and operations in 13 countries, serving clients from six continents. The combined revenue and EBITDA of the business in 2017 would have been $700 million and $50 million, respectively, which is before the benefit of any operational or revenue synergies. The combined company will also create a business with significant client revenue diversification as we have virtually zero client overlap. In fact, as a combined entity, our top 3 clients would only account for less than 30% of revenue compared to 51% for STARTEK last year on a stand-alone basis. Also included in the upcoming proxy are the details of our transaction with Amazon. As a reminder, in January, we granted Amazon warrants to acquire up to 4 million shares of STARTEK common stock at a price of $9.96 per share. Vesting of the warrants is tied to future STARTEK revenues generated from providing our services to this client with full vesting tied to future revenues of $600 million or more over an 8-year period. For context, in 2017, revenue from Amazon was a single digit as a percentage of our total revenue. With so much going on in our business, I would like to take a few minutes to give some perspectives on these transactions. For additional information, I will also note that the proxy will provide additional details on our projections and synergies among other important items, and I'd like to highlight a few key points. First, as proud as I am of the improvements in our business over the last couple of years, Aegis will be providing a greater contribution to the EBITDA of the combined entity, roughly 75% based on 2017 results. This compares to the 54% of equity value that their shareholders will receive. As such, we feel our shareholders are receiving an immediate premium for their stock while also retaining a meaningful opportunity to realize future value creation as part of a larger, more diversified public company with presence in exciting growth markets capable of producing stronger gross margins. In addition to our premium relative valuation, CSP is investing additional capital into the company at a price of $12 per share, so it certainly can be inferred that they feel very optimistic about the combined company's future prospects. Second, the management teams from STARTEK and Aegis along with our advisers in this transaction, believe that we can realize significant revenue and cost synergies in the near term. From a revenue perspective, given our complementary geographical presence, we see plenty of opportunity to cross-sell within our client basis, while providing an even greater value proposition and diverse offering for new clients. Further, our recent agreement with Amazon allows us the opportunity to expand upon our existing relationship to provide world-class support across what will be a truly global footprint. We're very excited to have the opportunity to support the global growth of such a well-regarded client. From a cost perspective, given the purchasing power of the combined company, we believe we can generate significant savings in the areas of technology and systems that both companies currently utilize. We also believe that we can eliminate redundancies at the operating level and SG&A, helping to bolster our confidence and achieving a target of $30 million of annualized EBITDA and synergies within 3 years. One of the final announcements I would like to make is in regards to the new leadership structure. Assuming the transaction closes this summer, as expected, Lance Rosenzweig will be taking over as Chief Executive Officer. Lance brings more than 25 years of executive experience across a range of service industries, including having served as CEO of Aegis USA until its previous sale in 2014. I have the utmost confidence in Lance and look forward to working with him to drive value as part of the senior team in the role of Chief Innovation Officer, building upon the differentiation which Aegis and STARTEK have developed to create unique value for clients and their customers. The timing of this Aegis transaction has been critical given the current dynamic state of our revenues. During the first quarter, and as highlighted on the last conference call, we continue to face challenges with lower volumes from our wireless customers. However, in the face of these soft wireless volumes, we still managed to win some vendor consolidation moves and thus expansions with other existing clients, as well as adding two new clients in the quarter. And the second quarter is shaping up to perhaps be the strongest quarter in new client wins that we have ever experienced. The pipeline is very robust, and we are seeing increased momentum in health care, financial services, education and retail sectors. We are working through somewhat of a rebalance of revenue diversification as we reposition some of our erosion in wireless with gains in other key verticals. As a reminder, these efforts tend to weigh on results while we ramp new business and transition personnel from existing to new programs due to training costs and lower revenues. Through this transition, we have taken steps to manage costs tightly. During the quarter, we removed over $1.5 million of SG&A and targeted over $5 million of total annual cost savings to better align to the revenue softness. We also started to realize some of the benefits of the high-grading effort in the first quarter especially in the domestic segment, a key geographic focus of this effort. where year-over-year results showed revenue for the quarter down $2.8 million while gross profit was up over $1 million. And we are not fully complete with the ramps associated with repletion of lower margin revenues since some of those efforts experienced delays. Despite some of the headwinds for STARTEK stand-alone, we remain focused on soon becoming a global player with differentiation, scale and almost unparalleled diversification in the BPO industry. I believe, we have substantially de-risked the business while simultaneously creating a platform for long-term shareholder value creation. We will work diligently to ramp our new business wins as we integrate with the Aegis platform, especially given the opportunity in retail. And I believe the execution of these initiatives puts us in the strongest position to deliver sustainable, predictable, profitable growth. Towanda, Don and I will now open the call for questions.

[Operator Instructions] Our first question comes from Dave Koning with Baird. Your line is now open.

So I've got a couple of questions. The first one is, on the surface, the EPS looks like a big loss, but if we adjust out the impairment costs in the warrant, it actually looks like close to breakeven on EPS. Is that at least in the ballpark?

Yes. If you look at the earnings release, we actually provided an adjusted net income schedule. If you -- I would put in that category also transaction-related fees. So if you add back the warrant contra revenue, the impairment losses in restructuring the transaction-related fees, the loss is $1.2 million for the quarter.

Yes. Okay. Okay, good. And then, secondly, is there any way to think about, I don't know if Aegis -- if you can kind of give comments. I think, you on a core basis, declined year-over-year around 10%, but if you add Aegis in, what sort of the combined revenue growth or decline on a combined basis right now?

I don't have that in front of me, Dave. It will be disclosed in the proxy.

Okay. That's good. And then, maybe, what about -- given kind of the new win pipeline, and I know we've had a few quarter of decline, so we're hitting easier comps plus the new wins are coming on, kind of -- in the second half, should you return -- just STARTEK-only, should you return to growth on a year-over-year basis?

So I think second half definitely will strengthen. Dave, we'll have to see the timing of some of those ramps with new wins and how some of the new wins that will work in the close here in the second quarter, what the start times on those look. But, yes, I mean, things are definitely looking stronger second half.

And then finally, the warrants, the $2.5 million warrant, the contra revenue, is that something that we should expect going forward? Or was that like a onetime no matter what else happens in the future, it's a one timer?

No. That is -- as each tranche of warrants vest will continue to have entries like that.

Okay. But it is a noncash cost?

It is a noncash cost. That is correct.

[Operator Instructions] Our next question comes from the line of [Omer Samalat].

So based on your previous comments, there seems to be obviously a disruption with the -- in the wireless market that is currently impacting the business, but it seems like the cable mobility area is gaining some traction. Is that an area of opportunity for you guys?

Yes, it is.

Okay. In terms of the SG&A...

And that's some of the cable expansion we mentioned in some of our content.

Okay. But obviously the market is seeing a shift from the traditional wireless to the cable mobility that they're offering.

Yes. Certainly, seeing some growth there.

Omar, you'll see in our Q, in our principal climates comment -- clients, Comcast has been added to that schedule.

In terms of the SG&A, well, we see more of an alignment from the right sizing measures you mentioned last quarter during maybe Q2?

Yes.

Yes.

All right. In terms of the Amazon relationship, I don't know if you're able to say, but have lines of business been already been identified with them? And are they in a ramping mode?

I'll just say we're having a lot of productive conversations, and we'll see how things play out.

Omar, just one point of clarification on the SG&A. We're looking at that on a holistic basis for the year and managing the expectations for the year.

Okay, got it. I get it. Okay. In terms of the merger with Aegis. I'm not sure, if you've addressed this, but what kind of gross margins would be attainable in those new markets for STARTEK, for example, India, Saudi Arabia, Malaysia? Are those type of margins that we see, for example, in off-shore segment today?

It's a mix, but they definitely have access to more 20%-plus gross margin markets than what we're currently in right now.

Okay. All right. That's good. All right. In terms of the transaction-related fees that you referenced on, are those in addition to the transaction fees disclosed as part of the deal? Or are these in addition too?

No. Those are included in.

Okay. So this is part of that, that amount that was just closed in that deal presentation?

But it's just where it had to be accounted for in the first quarter.

Right.

Got it. Okay. And so are these cash fees right now, or they're just being amortized?

No. They're cash fees.

Okay. Got it. But as part of that big amount. Okay, got it. All right. And could you walk us through that, that impairment and restructuring charges? Was that all due to the closure of the Colorado Springs site?

It was part of Colorado Springs site closure and it was partially due to some of the SG&A cost reductions we made.

And there was an element on -- impairment on writing off the Springs relationship.

Yes.

Okay. All right. And then, okay, excuse my ignorance, but can you walk us through that warrant contra win revenue adjustment? Or in simple terms?

There is no simple way to walk you through that. I can tell you that you use the Monte Carlo method to determine the value. And I can send it over to you, Omar, and your eyes will roll back in your head. It's a very, very complicated calculation.

Okay. But I guess the point is, I mean, it seems like it's completely independent from any actual income that is occurring right now or revenue, excuse me, in regards to the Amazon relationship?

That is correct.

That's all, okay. That's all about the warrant itself. Okay.

It's quite [indiscernible]

So obviously, it...

And it's cashless so...

Right. Okay. No, and I do appreciate that your more explanation in terms of the adjusted net income. I mean, it looks ugly, but it's really a $0.07 loss when we look at a non-GAAP basis. So I think it's within the expectation.

At this time, I'm showing no further questions. I would now like to turn the call back over to Mr. Carlson.

Well, thank you, everyone. Appreciate your interest. We'll get back to work. We'll talk to you next time.

Ladies and gentlemen, that concludes today's call. Thank you for your participation. You may now disconnect. Everyone, have a great day.