FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 ------------------- [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: SEPTEMBER 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ Commission file number 0-21055 TELETECH HOLDINGS, INC. ------------------------ (Exact name of registrant as specified in its charter) DELAWARE 84-1291044 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1700 LINCOLN STREET, SUITE 1400 DENVER, COLORADO 80203 (Address of principal (Zip Code) executive office) (303) 894-4000 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at Class of Common Stock November 2, 1999 Common Stock, par value $.01 per share 61,380,428
TELETECH HOLDINGS, INC. FORM 10-Q TABLE OF CONTENTS <TABLE> <CAPTION> PAGE NUMBER <S> <C> PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed consolidated balance sheets--December 31, 1998 and September 30, 1999 3 Condensed consolidated statements of income--Three months ended September 30, 1999 and 1998 5 Condensed consolidated statements of income--Nine months ended September 30, 1999 and 1998 6 Condensed consolidated statements of cash flows--Nine months ended September 30, 1999 and 1998 7 Notes to condensed consolidated financial statements--September 30, 1999 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3. Quantitative and Qualitative Disclosures about Market Risk 18 PART II . OTHER INFORMATION Item 1. Legal Proceedings 19 Item 5. Recent Developments 19 Item 6. Exhibits and Reports on Form 8-K 19 SIGNATURES 21 </TABLE>
Item 1. TELETECH HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS) <TABLE> <CAPTION> DECEMBER 31, SEPTEMBER 30, ASSETS 1998 1999 ------------ ------------- (Unaudited) <S> <C> <C> CURRENT ASSETS: Cash and cash equivalents $ 8,796 $ 20,254 Short-term investments 37,082 37,273 Accounts receivable, net of allowance for doubtful accounts of $2,900 and $3,448, respectively 68,830 77,014 Prepaids and other assets 2,811 4,350 Deferred tax asset 3,855 4,201 -------- -------- Total current assets 121,374 143,092 -------- -------- PROPERTY AND EQUIPMENT, net of accumulated depreciation of $38,432 and $56,479, respectively 77,546 100,764 -------- -------- OTHER ASSETS: Long-term accounts receivable 4,274 4,232 Goodwill, net of accumulated amortization of $1,599 and $2,692, respectively 15,022 19,372 Contract acquisition cost, net of accumulated amortization of zero and $1,158, respectively 10,900 9,740 Other assets 1,794 2,786 -------- -------- Total assets $230,910 $279,986 ======== ======== </TABLE> The accompanying notes are an integral part of these condensed consolidated balance sheets. 3
TELETECH HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS) <TABLE> <CAPTION> DECEMBER 31, SEPTEMBER 30, LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1999 ------------ ------------- (Unaudited) <S> <C> <C> CURRENT LIABILITIES: Current portion of long-term debt $ 7,989 $ 6,634 Bank overdraft 778 1,085 Accounts payable 11,814 6,072 Accrued employee compensation 18,134 25,584 Accrued income taxes 4,191 2,855 Other accrued expenses 11,520 16,013 Customer advances, deposits and deferred income 3,803 4,309 -------- -------- Total current liabilities 58,229 62,552 -------- -------- DEFERRED TAX LIABILITIES 835 1,026 -------- -------- LONG-TERM DEBT, net of current portion: Capital lease obligations 4,208 1,961 Line of credit -- 22,000 Other debt 2,145 808 -------- -------- Total liabilities 65,417 88,347 -------- -------- STOCKHOLDERS' EQUITY: Common stock; $.01 par value; 150,000,000 shares authorized; 60,769,724 and 61,361,982 shares, respectively, issued and outstanding 606 612 Additional paid-in capital 111,080 115,140 Accumulated other comprehensive income (1,610) (627) Retained earnings 55,417 76,514 -------- -------- Total stockholders' equity 165,493 191,639 -------- -------- Total liabilities and stockholders' equity $230,910 $279,986 ======== ======== </TABLE> The accompanying notes are an integral part of these condensed consolidated balance sheets. 4
TELETECH HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) (UNAUDITED) <TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30, --------------------------- 1998 1999 ------------ ---------- <S> <C> <C> REVENUES $ 92,366 $126,131 -------- -------- OPERATING EXPENSES: Costs of services 59,143 83,869 Selling, general and administrative Expenses 25,085 31,274 -------- -------- Total operating expenses 84,228 115,143 -------- -------- INCOME FROM OPERATIONS 8,138 10,988 OTHER INCOME (EXPENSE): Interest expense (413) (567) Interest income 725 488 Equity in income of affiliate (16) -- Business combination expenses (440) -- Gain on settlement of long-term contract -- 6,726 Other (220) 334 -------- -------- (364) 6,981 -------- -------- INCOME BEFORE INCOME TAXES 7,774 17,969 Provision for income taxes 3,059 7,138 -------- -------- NET INCOME $ 4,715 $ 10,831 ======== ======== WEIGHTED AVERAGE SHARES OUTSTANDING Basic 60,234 61,247 ======== ======== Diluted 62,040 63,280 ======== ======== NET INCOME PER SHARE Basic $ .08 $ .18 ======== ======== Diluted $ .08 $ .17 ======== ======== </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements 5
TELETECH HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) (UNAUDITED) <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, --------------------------- 1998 1999 ------------ ---------- <S> <C> <C> REVENUES $ 260,709 $ 357,334 --------- --------- OPERATING EXPENSES: Costs of services 168,294 238,072 Selling, general and administrative Expenses 69,505 91,243 --------- --------- Total operating expenses 237,799 329,315 --------- --------- INCOME FROM OPERATIONS 22,910 28,019 OTHER INCOME (EXPENSE): Interest expense (946) (1,460) Interest income 2,444 1,690 Equity in income of affiliate 70 -- Business combination expenses (1,321) -- Gain on settlement of long-term contract -- 6,726 Other (371) 229 --------- --------- (124) 7,185 --------- --------- INCOME BEFORE INCOME TAXES 22,786 35,204 Provision for income taxes 9,055 14,108 --------- --------- NET INCOME $ 13,731 $ 21,096 ========= ========= WEIGHTED AVERAGE SHARES OUTSTANDING Basic 59,784 61,037 ========= ========= Diluted 62,026 62,607 ========= ========= NET INCOME PER SHARE Basic $ .23 $ .35 ========= ========= Diluted $ .22 $ .34 ========= ========= </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements 6
TELETECH HOLDINGS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS) (UNAUDITED) <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, --------------------------- 1998 1999 ------------ ---------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 13,731 $ 21,096 --------- --------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 13,935 21,012 Allowance for doubtful accounts 387 463 Deferred income taxes (176) (355) Equity in income of affiliate 981 -- Deferred compensation expense 95 -- Changes in assets and liabilities: Accounts receivable (8,458) (7,587) Prepaids and other assets (1,237) (618) Accounts payable and accrued expenses 6,662 3,998 Customer advances, deposits and deferred income (355) 120 --------- --------- Net cash provided by operating activities 25,565 38,129 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (23,939) (39,983) Purchase of Intellisystems (2,000) -- Purchase of Pamet River, net of $339 cash acquired -- (1,462) Purchase of Smart Call -- (2,590) Contract acquisition costs (10,900) -- Changes in accounts payable and accrued liabilities related to investing activities (781) (55) (Increase) decrease in short-term investments 13,790 (191) --------- --------- Net cash used in investing activities (23,830) (44,281) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in short-term borrowings 1,549 307 Net increase in line of credit -- 22,000 Cash received in acquisition 276 -- Payments on long-term debt and capital leases (1,908) (4,991) Proceeds from exercise of stock options 2,302 2,313 --------- --------- Net cash provided by financing activities 2,219 19,629 --------- --------- Effect of exchange rate changes on cash (1) (2,019) --------- --------- NET INCREASE IN CASH AND CASH EQUIVALENTS 3,953 11,458 CASH AND CASH EQUIVALENTS, beginning of period 7,338 8,796 --------- --------- CASH AND CASH EQUIVALENTS, end of period $ 11,291 $ 20,254 ========= ========= </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 7
TELETECH HOLDINGS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 NOTE (1)--BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission. The condensed consolidated financial statements reflect all adjustments (consisting of only normal recurring accruals) which, in the opinion of management, are necessary to present fairly the financial position, results of operations and cash flows of TeleTech Holdings, Inc. and subsidiaries (the "Company") as of September 30, 1999 and 1998 and for the periods then ended. Operating results for the three and nine months ended September 30, 1999 are not necessarily indicative of the results that may be expected for the year ended December 31, 1999. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated and combined financial statements and footnotes thereto included in the Company's Form 10-K for the year ended December 31, 1998. NOTE (2)-- SEGMENT INFORMATION AND CUSTOMER CONCENTRATIONS The Company classified its business activities into four fundamental areas: outsourced operations in the United States, facilities management operations, international outsourced operations, and technology services and consulting. These areas are separately managed and each has significant differences in capital requirements and cost structures. Outsourced, facilities management and international outsourced operations are reportable business segments with their respective financial performance detailed herein. Technology services and consulting is included in corporate activities as it is not a material business segment. Also included in corporate activities are general corporate expenses and overall operational management expenses. Assets of corporate activities include unallocated cash, short-term investments and deferred income taxes. There are no significant transactions between the reported segments for the periods presented. The Company's three largest clients accounted for 51% of consolidated revenue for the three months ended September 30, 1999 as compared to 49% for the three months ended September 30, 1998. Due to the declines in operating income caused largely by decreased capacity utilization in several of the Company's North American shared customer interaction centers, these large clients' contribution to the operating income of the Company has increased. <TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30, ---------------------- (in thousands) 1998 1999 --------- --------- <S> <C> <C> REVENUES: Outsourced $ 50,969 $ 74,369 Facilities Management 21,442 23,556 International Outsourced 17,775 23,434 Corporate Activities 2,180 4,772 --------- --------- Total $ 92,366 $ 126,131 ========= ========= INCOME (LOSS) FROM OPERATIONS: Outsourced $ 11,739 $ 17,451 Facilities Management 2,961 1,118 International Outsourced 399 2,011 Corporate Activities (6,961) (9,592) --------- --------- Total $ 8,138 $ 10,988 ========= ========= </TABLE> 8
TELETECH HOLDINGS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 - CONTINUED <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, ---------------------- (in thousands) 1998 1999 --------- --------- <S> <C> <C> REVENUES: Outsourced $ 140,382 $ 213,145 Facilities Management 61,032 64,289 International Outsourced 53,553 62,260 Corporate Activities 5,742 17,640 --------- --------- Total $ 260,709 $ 357,334 ========= ========= INCOME (LOSS) FROM OPERATIONS: Outsourced $ 28,493 $ 48,007 Facilities Management 8,376 4,172 International Outsourced 3,949 3,144 Corporate Activities (17,908) (27,304) --------- --------- Total $ 22,910 $ 28,019 ========= ========= </TABLE> <TABLE> <CAPTION> BALANCE AS OF ---------------------------- DECEMBER 31 SEPTEMBER 30, (in thousands) 1998 1999 ----------- ------------- <S> <C> <C> ASSETS: Outsourced Assets $101,105 $124,515 Facilities Management Assets 18,121 15,653 International Outsourced Assets 57,567 66,106 Corporate Activities Assets 54,117 73,712 -------- -------- Total $230,910 $279,986 ======== ======== GOODWILL (INCLUDED IN TOTAL ASSETS): International Outsourced Goodwill, Net $ 6,803 $ 8,965 Corporate Activities Goodwill, Net 8,219 10,407 -------- -------- Total $ 15,022 $ 19,372 ======== ======== </TABLE> 9
TELETECH HOLDINGS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 - CONTINUED The following geographic data include revenues based on the location the services are provided (in thousands). <TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30, ---------------------- 1998 1999 --------- --------- <S> <C> <C> REVENUES: United States $ 70,443 $ 97,594 Australia 8,946 12,983 Canada 9,409 8,218 Rest of world 3,568 7,336 -------- -------- Total $ 92,366 $126,131 ======== ======== </TABLE> <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, ---------------------- 1998 1999 --------- --------- <S> <C> <C> REVENUES: United States $197,221 $280,248 Australia 26,672 36,930 Canada 26,789 24,622 Rest of world 10,027 15,534 -------- -------- Total $260,709 $357,334 ======== ======== </TABLE> NOTE (3)--SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AND NONCASH INVESTING AND FINANCING ACTIVITIES (IN THOUSANDS): <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 1998 1999 ------------ ------------ <S> <C> <C> Cash paid for interest $ 946 $ 1,461 Cash paid for income taxes $ 5,641 $15,444 Noncash investing and financing activities: Stock issued in purchase of Intellisystems $ 3,389 $ -- Stock issued in purchase of Pamet River, Inc. $ -- $ 1,753 </TABLE> NOTE (4)--ACQUISITIONS On March 18, 1999, the Company acquired 100% of the common stock of Pamet River, Inc. ("Pamet") for approximately $1,821,000 in cash and 285,711 shares of common stock in the Company. Pamet is a global marketing company offering end-to-end marketing solutions by leveraging Internet and database technologies. The transaction has been accounted for as a purchase and goodwill will be amortized using the straight-line method over 20 years. The operations of Pamet for all periods prior to the acquisition are immaterial to the results of the Company and, accordingly, no pro forma financial information has been presented. On March 31, 1999, the Company acquired 100% of the common stock of Smart Call S.A. ("Smart Call") for approximately $2,350,000 in cash including costs related to the acquisition. Smart Call is based in Buenos Aires, Argentina and provides a wide range of customer management solutions to Latin American and 10
TELETECH HOLDINGS, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 - CONTINUED multinational companies. The transaction has been accounted for as a purchase and goodwill will be amortized using the straight-line method over 20 years. The operations of Smart Call for all periods prior to the acquisition are immaterial to the results of the Company and, accordingly, no pro forma financial information has been presented. As a part of the Smart Call acquisition, the Company paid $300,000, including costs associated with the transaction, for the option to acquire Connect S.A. ("Connect"), a sister company with additional customer service and systems integration capabilities. The option has been accounted for as an other asset. Refer to Note (6)--Subsequent Event for an update on this acquisition. NOTE (5)--COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). The purpose of SFAS 130 is to report a measure of all changes in equity that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. The only item of other comprehensive income reported by the Company is the cumulative translation adjustment. The Company's comprehensive income for the three and nine months ended September 30, 1998 and 1999 was as follows (in thousands): <TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30, 1998 1999 -------- -------- <S> <C> <C> Net income for the period $ 4,715 $10,831 Change in cumulative translation adjustment (191) 307 ------- ------- Comprehensive income $ 4,524 $11,138 ======= ======= </TABLE> <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, 1998 1999 -------- -------- <S> <C> <C> Net income for the period $ 13,731 $ 21,096 Change in cumulative translation adjustment (758) 983 -------- -------- Comprehensive income $ 12,973 $ 22,079 ======== ======== </TABLE> NOTE (6)--SUBSEQUENT EVENT On October 12, 1999, the Company acquired 100% of the common stock of Connect (See "Note (4)--Acquisitions" above) for approximately $2,300,000 in cash including costs related to the acquisition. The former owners of Connect will also be entitled to an earn-out premium based on the results of the Company's consolidated operations in Argentina in 2000. Connect is located in Buenos Aires, Argentina and provides customer relationship management solutions, as well as help desk, systems integration and information technology solutions to Latin American and multinational companies in a variety of industries. The transaction has been accounted for as a purchase and goodwill will be amortized using the straight-line method over 20 years. The operations of Connect for all periods prior to the acquisition are immaterial to the results of the Company and, accordingly, no pro forma financial information has been presented. 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 INTRODUCTION Management's discussion and analysis of financial condition and results of operations in this Form 10-Q should be read in conjunction with the risk factors included in the Company's Form 10-K for the year ended December 31, 1998. Specifically, the Company has experienced, and in the future could experience, quarterly variations in revenues and earnings as a result of a variety of factors, many of which are outside the Company's control, including: the timing of new contracts; the timing of new product or service offerings or modifications in client strategies; the expiration or termination of existing contracts; the timing of increased expenses incurred to obtain and support new business; the timing of increased expenses resulting from addressing potential Year 2000 problems; and the seasonal pattern of certain of the businesses serviced by the Company. In addition, the Company has concentrated its marketing efforts towards obtaining larger, more complex, strategic customer care programs. As a result, the time required to negotiate and execute an agreement with the client has increased. This may lead to short-term delays in the anticipated start-up of new client programs and in the Company achieving full capacity utilization. FORWARD-LOOKING STATEMENTS All statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" or elsewhere in this quarterly report that are not statements of historical fact are forward-looking statements that involve substantial risks and uncertainties. Forward-looking statements include, without limitation (i) the expectation that selling, general, and administrative expenses will decline in periods of significant revenue increases; (ii) the anticipated level of capital expenditures for 1999; (iii) the Company's belief that existing cash, available borrowings and cash from operations will be sufficient to finance the Company's near term operations; (iv) the Company's estimate of the impact of the Year 2000 issues; (v) the Company's belief that near-term interest rate fluctuations will not result in a material effect on future earnings, fair values or cash flows of the Company; (vi) the Company's belief that foreign currency rate fluctuations may positively or negatively affect revenues and net income attributable to the Company's foreign subsidiaries; and (vii) statements relating to the Company or its operations that are preceded by terms such as "anticipates", "expects," "believes," "intends," "will," "plans" and similar expressions. The Company's actual results, performance or achievements may differ materially from expectations implied by such forward-looking statements as a result of various factors, including, without limitation, the following: - agreements with its clients do not ensure that the Company will generate a specific level of revenue and may be canceled by the clients on short notice; - amount of revenue the Company generates from a particular client is dependent upon customers' interest in and use of the client's products or services, some of which are recently introduced or untested; - loss of a significant client or the termination or completion of a significant client program may have a material adverse effect on the Company's capacity utilization and results of operations; - there can be no assurance that the Company will be successful in integrating acquired companies into the Company's existing businesses or that any completed acquisition will enhance the Company's business, results of operations or financial condition; - certain risks inherent in conducting international business, including without limitation exposure to currency fluctuations, longer payment cycles and greater difficulties in accounts receivable collection; and - management's view of the most reasonably likely worst case Year 2000 scenario may be too optimistic. 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 - CONTINUED These cautionary statements should not be construed as an exhaustive list. The Company cannot always predict what factors would cause actual results to differ materially from those indicated by its forward-looking statements. All cautionary statements should be read as being applicable to all forward-looking statements. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1998 Total consolidated revenues increased $33.8 million or 37% to $126.1 million for the three months ended September 30, 1999 from $92.4 million for the three months ended September 30, 1998. Revenues from the Company's Outsourced segment increased $23.4 million to $74.4 million for the three months ended September 30, 1999 from $51.0 million for the three months ended September 30, 1998. This revenue growth was derived as follows. This increase resulted from $5.7 million in revenues from new client programs and $18.5 million in increased revenue from existing client programs. Contract expirations and other client reductions offset a portion of these increases. Revenues for the three months ended September 30, 1999 include $23.6 million from the Facilities Management segment as compared with $21.4 million for the three months ended September 30, 1998 due to increased client volumes. Revenues from the Company's International Outsourced segment increased $5.7 million to $23.4 million for the three months ended September 30, 1999 from $17.8 million for the three months ended September 30, 1998. This increase is primarily due to increased revenue from existing clients in Australia and Latin America offset by declines in revenue in Canada. Revenues from the Corporate Activities segment (which includes technology-related revenues) increased $2.6 million to $4.8 million for the three months ended September 30, 1999 from $2.2 million for the three months ended September 30, 1998. This is primarily related to revenues from the Cygnus and Pamet River acquisitions completed in the fourth quarter of 1998 and the first quarter of 1999, respectively. Costs of services increased $24.7 million, or 42%, to $83.9 million for the three months ended September 30, 1999 from $59.1 million for the three months ended September 30, 1998. Costs of services as a percentage of revenues increased from 64.0% for the three months ended September 30, 1998 to 66.5% for the three months ended September 30, 1999. This is primarily due to gross margin declines resulting from the decreased revenue in the Facilities Management segment. Also, increased revenues in several large client programs as they matured through the start-up phase caused a change in the revenue and service mix and resulted in cost of services as a higher percentage of revenues. Selling, general and administrative expenses increased $6.2 million, or 25% to $31.3 million for the three months ended September 30, 1999 from $25.1 million for the three months ended September 30, 1998. Selling, general and administrative expenses as a percentage of revenues decreased from 27.2% for the three months ended September 30, 1998 to 24.8% for the three months ended September 30, 1999 due to significant cost containment measures. As a result of the foregoing factors, income from operations increased $2.9 million or 35%, to $11.0 million for the three months ended September 30, 1999 from $8.1 million for the three months ended September 30, 1998. Operating income as a percentage of revenues decreased slightly from 8.8% for the three months ended September 30, 1998 to 8.7% for the three months ended September 30, 1999. Income from operations from the Company's Outsourced segment increased $5.7 million to $17.5 million for the three months ended September 30, 1999 from $11.7 million for the three months ended September 30, 1998. Income from operations as a percentage of revenue for the outsourced segment increased from 23.0% for the three months ended September 30, 1998 to 23.5% for the three months ended September 30, 1999. This increase resulted from significant increases in revenues in several large client programs offset by excess capacity in several customer interaction centers. Income from operations for the three months ended September 30, 1999 includes approximately $1.1 million from the Facilities Management segment as compared with $3.0 million for the three 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 - CONTINUED months ended September 30, 1998. Income from operations as a percentage of revenue for the Facilities Management segment decreased from 13.8% for the three months ended September 30, 1998 to 4.7% for the three months ended September 30, 1999. This decrease resulted primarily from increased healthcare costs in one of the Company's Facilities Management contracts and decreased volumes in another Facilities Management contract. Income from operations in the Company's International Outsourced segment increased $1.6 million to $2.0 million for the three months ended September 30, 1999 from $399,000 for the three months ended September 30, 1998. Income from operations as a percentage of revenue for the International Outsourced segment increased from 2.2% for the three months ended September 30, 1998 to 8.6% for the three months ended September 30, 1999. This increase resulted primarily from increased revenues in Australia and Latin America offset by lower volumes in Canada. The operating loss from operations from the Corporate Activities segment (which includes technology-related operations) increased $2.6 million to $9.6 million for the three months ended September 30, 1999 from $7.0 million for the three months ended September 30, 1998. This increase is primarily related to the increased expenses resulting from the Company's significant growth over the period and the Company's increased investment in technology. The Company's three largest clients accounted for 51% of the Company's revenues for the three months ended September 30, 1999. Due to the declines in operating income caused largely by the capacity utilization in several of the Company's North American shared customer interaction centers, these large clients contribution to the operating income of the Company has increased from prior periods. Other income totaled $7.0 million for the three months ended September 30, 1999 compared with a $364,000 loss during the three months ended September 30, 1998. This is primarily related to a $6.7 million gain on the settlement of a long-term contract (See "Part II. Other Information, Item 1. Legal Proceedings.") and a decrease in business combination expenses. As a result of the foregoing factors, net income increased $6.1 million or 129.7%, to $10.8 million for the three months ended September 30, 1999 from $4.7 million for the three months ended September 30, 1998. Exclusive of the impact of the one time gain on settlement of the long term contract in 1999 and the business combination expenses in 1998, net income increased $1.8 million or 36.0% from $5.0 million for the three months ended September 30, 1998 to $6.8 million for the three months ended September 30, 1999. NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1998 Revenues increased $96.6 million or 37% to $357.3 million for the nine months ended September 30, 1999 from $260.7 million for the nine months ended September 30, 1998. This revenue growth was derived as follows. Revenues from the Company's Outsourced segment increased $72.8 million to $213.1 million for the nine months ended September 30, 1999 from $140.4 million for the nine months ended September 30, 1998. This increase resulted from $13.4 million in revenues from new client programs and $66.7 million in increased revenue from existing client programs. Contract expirations and other client reductions offset a portion of these increases. Revenues for the nine months ended September 30, 1999 include $64.3 million from the Facilities Management segment as compared with $61.0 million for the nine months ended September 30, 1998. This increase is due to increased volumes in one of the Company's facilities management contracts and lower volumes in another contract. Revenues from the Company's International Outsourced segment increased $8.7 million to $62.3 million for the nine months ended September 30, 1999 from $53.6 million for the nine months ended September 30, 1998. This increase is primarily due to increased revenue from existing clients in Australia and Latin America offset by declines in volumes in Canada. Revenues from the Corporate Activities segment (which includes technology-related revenues) increased $11.9 million to $17.6 million for the nine months ended September 30, 1999 from $5.7 million for the nine months ended September 30, 1998. This is primarily related to revenues from the Cygnus and Pamet River acquisitions completed in the fourth quarter of 1998 and the first quarter of 1999, respectively. 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 -- CONTINUED Costs of services increased $69.8 million, or 42%, to $238.1 million for the nine months ended September 30, 1999 from $168.3 million for the nine months ended September 30, 1998. Costs of services as a percentage of revenues increased from 64.6% for the nine months ended September 30, 1998 to 66.6% for the nine months ended September 30, 1999. This is primarily a result of increased revenues in several large client programs as they matured through the start-up phase caused a change in the revenue and service mix and resulted in cost of services as a higher percentage of revenues. Also decreased revenue in the Facilities Management segment contributed to gross margin declines. Selling, general and administrative expenses increased $21.7 million, or 31% to $91.2 million for the nine months ended September 30, 1999 from $69.5 million for the nine months ended September 30, 1998. Selling, general and administrative expenses as a percentage of revenues decreased from 26.7% for the nine months ended September 30, 1998 to 25.5% for the nine months ended September 30, 1999 due to significant cost containment measures. As a result of the foregoing factors, income from operations increased $5.1 million or 22%, to $28.0 million for the nine months ended September 30, 1999 from $22.9 million for the nine months ended September 30, 1998. Operating income as a percentage of revenues decreased from 8.8% for the nine months ended September 30, 1998 to 7.8% for the nine months ended September 30, 1999. Income from operations from the Company's outsourced segment increased $19.5 million to $48.0 million for the nine months ended September 30, 1999 from $28.5 million for the nine months ended September 30, 1998. Income from operations as a percentage of revenue for the Outsourced segment increased from 20.3% for the nine months ended September 30, 1998 to 22.5% for the nine months ended September 30, 1999. This increase resulted from significant increases in revenues in several large client programs offset by excess capacity in several customer interaction centers. Income from operations for the nine months ended September 30, 1999 includes approximately $4.2 million from the Facilities Management segment as compared with $8.4 million for the nine months ended September 30, 1998. Income from operations as a percentage of revenue for the Facilities Management segment decreased from 13.7% for the nine months ended September 30, 1999 to 6.5% for the nine months ended September 30, 1998. This decrease resulted primarily from decreased volumes and increased healthcare costs in one of the Company's Facilities Management contracts. Income from operations from the Company's International Outsourced segment decreased $805,000 to $3.1 million for the nine months ended September 30, 1999 from $3.9 million for the nine months ended September 30, 1998. Income from operations as a percentage of revenue for the International Outsourced segment decreased from 7.3% for the nine months ended September 30, 1999 to 5.0% for the nine months ended September 30, 1998. This decrease resulted primarily from lower volumes in Canada. The loss from operations from the Corporate Activities segment (which includes technology-related operations) increased $9.4 million to $27.3 million for the nine months ended September 30, 1999 from $17.9 million for the nine months ended September 30, 1998. This increase is primarily related to the increased expenses resulting from the Company's significant growth over the period and the Company's increased investment in technology. Other income totaled $7.2 million for the nine months ended September 30, 1999 compared with a $124,000 loss during the nine months ended September 30, 1998. This is primarily related to a $6.7 million gain on the settlement of a long-term contract (See "Part II. Other Information, Item 1. Legal Proceedings.") and a decrease in business combination expenses offset by an increase in interest expense. As a result of the foregoing factors, net income increased $7.4 million or 53.6%, to $21.1 million for the nine months ended September 30, 1999 from $13.7 million for the nine months ended September 30, 1998. Exclusive of the impact of the one time gain on settlement of the long term contract in 1999 and the business combination expenses in 1998, net income increased $2.5 million or 17.4% from $14.5 million for the nine months ended September 30, 1998 to $17.0 million for the nine months ended September 30, 1999. 15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 - CONTINUED LIQUIDITY AND CAPITAL RESOURCES As of September 30, 1999 the Company had cash and cash equivalents of $20.3 million and short-term investments of $37.3 million. Cash provided by operating activities was $38.1 million for the nine months ended September 30, 1999, which primarily resulted from income from operations and increased collections of accounts receivable during the period. Cash used in investing activities was $44.3 million for the nine months ended September 30, 1999 resulting primarily from $40.0 million in capital expenditures, $1.5 million toward the purchase of Pamet River and $2.6 million toward the purchase of Smart Call (see Note 4 accompanying the condensed financial statements). Cash provided by financing activities was $19.6 million resulting from the increase in borrowings of $22.0 million on the Company's line of credit offset in part by pay downs of capital leases and other debt. The Company has a $50.0 million unsecured revolving line of credit with a syndicate of five banks. The Company also has the option to secure at any time up to $25.0 million of the line with available cash investments. The Company has two interest rate options: an offshore rate option or a bank base rate option. The Company will pay interest at a spread of 50 to 150 basis points over the applicable offshore or bank base rate, depending upon the Company's leverage. Interest on the secured portion is based on the applicable rate plus 22.5 basis points. Borrowings under this agreement totaled $22.0 million at September 30, 1999 of which $15.0 million was secured at the Company's option with temporary short term investments disclosed on the balance sheet. Interest rates under these borrowings averaged 6.4% at September 30, 1999. Under this line of credit, the Company has agreed to maintain certain financial ratios and capital expenditure limits. The Company is in compliance with all covenants of this agreement as of September 30, 1999. The Company currently expects total capital expenditures in 1999 to be approximately $50 million of which $40.0 million was expended in the first nine months. The Company believes that existing cash on hand and available borrowings under the line of credit together with cash from operations should be sufficient to finance the Company's operations, planned capital expenditures and anticipated growth through 2000. YEAR 2000 The Year 2000 problem results from date-sensitive computer programs being written using two digits, rather than four digits, to define the applicable year. Computer programs that are not Year 2000 compliant will be unable, for example, to determine whether date references to "00" refers to the year 1900 or 2000. Determining whether the Company's and its clients' systems are Year 2000 compliant is critical because the Company utilizes a significant number of software programs and operating systems throughout its organization, and the Company's systems regularly interface with the various information systems of its clients. The Company's or its clients' failure to detect and remediate Year 2000 related problems in its or their computer and information systems could have a material adverse effect on the business, results of operations or financial condition of the Company. The Company, with the assistance of two outside consulting firms, has implemented a multiphased program to inventory, assess, remediate and test its information technology ("IT") and non-ITsystems for Year 2000 compliance (the "Program"). The Company has completed the enterprisewide inventory, assessment, analysis and most of the remediation activities associated with Year 2000 issues. The Company is currently conducting an intensive Year 2000 follow up audit of each of its sites which has resulted in minor additional remediation activities. 16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 - CONTINUED The Company's Year 2000 consulting firms work with full-time Company employees who are dedicated to the Program. The assessments completed to date have led to the need to migrate several human resource- and payroll-oriented applications to Year 2000 compliant software, upgrade several telephone switches and procure several hundred replacement workstations. Analysis and testing of Company-generated software applications has been completed and only minor remediation has been required. The Company does not anticipate a significant need for software conversion due to Year 2000 issues, given the Company's extensive use of off-the-shelf products. Although the Company has completed its assessment of its internal systems, many of the Company's client programs interact with and are at least partially dependent upon the clients' internal computer systems. The Company has sought representations from each of its clients as to the Year 2000-compliance status of their systems. The Company has only received positive responses from five of its clients, which represent approximately 10% of the Company's consolidated revenues, the remainder of the Company's clients have indicated that they are in process of reviewing these systems or have referred the Company to their website for Year 2000 updates. The Company will continue to monitor the progress of its clients Year 2000 readiness and is in the process of developing contingency plans for each client program in the event that clients' systems experience Year 2000 problems. While the estimated cost to address Year 2000 issues are subject to change as the project nears completion, the Company currently anticipates that the total cost of assessment and remediation will be between $4 million and $5 million. Of this total estimated costs approximately 70% is anticipated to be new capital expenditures to replace non-compliant computer hardware and software. For the nine months ended September 30, 1999, the Company has incurred approximately $3.5 million in inventory, assessment and remediation and equipment and software replacement work on Year 2000 issues. Of this amount, $1.4 million was expensed in the accompanying statement of operations ($300,000 related to the third quarter of 1999) and were funded through cash flow from operations. The remaining expenditures in 1999 will be funded primarily through cash flow from operations and available cash on hand. In management's view, the most reasonably likely worst case Year 2000 scenario is that one or more of the Company's client programs are unable to interact with the client's computer systems. In addition, a limited number of applications may unexpectedly fail. The Company's inability to interact with the client computer systems or the failure of certain applications could result in a disruption of the Company's ability to service customers of the Company's clients. In the event that the Company's most reasonably likely worst case scenario occurs, the Company will assist its clients customers with systems that are operational and return calls and e-mail at the earliest opportunity in the event that a particular system or application is temporarily unavailable. The Company also plans to have key managers and staff available to address any problems that may arise. 17
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 Market risk represents the risk of loss that may impact the financial position, results of operations or cash flows of the Company due to adverse changes in financial and commodity market prices and rates. The Company is exposed to market risk in the areas of changes in U.S. interest rates and changes in foreign currency exchange rates as measured against the U.S. dollar. These exposures are directly related to its normal operating and funding activities. Historically, and as of September 30, 1999, the Company has not used derivative instruments or engaged in hedging activities. INTEREST RATE RISK The interest on the Company's line of credit and its Canadian subsidiary's operating loan is variable based on the bank's base rate or offshore rate, and therefore, affected by changes in market interest rates. At September 30, 1999, there was approximately $25 million in borrowings subject to interest rate risk. The Company monitors interest rates frequently and has sufficient cash balances to pay off the line of credit and any early termination penalties, should interest rates increase significantly. The Company's investments are typically short-term in nature and as a result do not expose the Company to significant risk from interest rate fluctuations. Therefore, the Company does not believe that reasonably possible near-term changes in interest rates will result in a material effect on future earnings, fair values or cash flows of the Company. FOREIGN CURRENCY RISK The Company has wholly owned subsidiaries in Argentina, Australia, Brazil, Canada, Mexico, New Zealand, Singapore and the United Kingdom. The substantial majority of revenues and expenses from these operations are typically denominated in local currency, thereby creating financial statement translation exposures to changes in exchange rates. The changes in the exchange rates may positively or negatively affect the Company's revenues and net income attributed to these subsidiaries. 18
PART II. OTHER INFORMATION Item 1. Legal Proceedings As disclosed in the Company's 1998 Annual Report on Form 10-K, in December 1996, TeleTech filed suit against CompuServe in the Federal District Court for the Southern District of Ohio to enforce termination provisions and collect the termination fee. CompuServe filed a counterclaim in December 1996 alleging that the Company breached other provisions of this agreement and seeking unspecified monetary damages. In March 1997, CompuServe asserted a right to offset certain accounts receivable it owes to the Company for services rendered against the amount that may be awarded to CompuServe on its counterclaim, if any. These accounts receivable total $4.3 million. In July 1999, the Company reached a settlement with CompuServe and other parties whereby the Company would receive $12.0 million in final settlement, of which $5.5 million was received on August 10, 1999 and the remainder is required to be paid in the fourth quarter of 1999. From time to time, the Company is involved in litigation, most of which is incidental to its business. In the Company's opinion, no litigation to which the Company currently is a party is likely to have a material adverse effect on the Company's results of operations or financial condition. Item 5. Recent Developments On October 18, 1999, TeleTech named systems integration, solutions, and services industry expert, Scott D. Thompson ("Mr. Thompson") as president and chief executive officer. Mr. Thompson also joined the TeleTech board of directors. Mr. Thompson, 43, was formerly president of Lucent Technologies' Netcare Professional Services Division. Netcare designs, installs, maintains, manages and operates broadband networks that deliver converged voice, data and video. Prior to Lucent, Mr. Thompson was executive vice president of Global Integration Services for Ascend Communications, which was acquired by Lucent. His background also includes executive management internationally and domestically at Compaq Computer Corporation and Tandem Computers Incorporated. Kenneth D. Tuchman, (" Mr. Tuchman") 40, will continue as TeleTech chairman of the board. Mr. Tuchman has served as TeleTech chairman and CEO since he founded the company in 1982. As chairman, he will share in providing strategic direction and developing alliances and customer relationships. Mr. Thompson will lead development and execution of the company's strategic direction, provide day-to-day management of the company's operations and contribute to corporate relations activities. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits The following documents are filed as an exhibit to this report: <TABLE> <S> <C> 3.1 Restated Certificate of Incorporation of TeleTech[1] {Exhibit 3.1} 3.2 Amended and Restated Bylaws of TeleTech [1] {Exhibit 3.2} 10.19* Employment Agreement dated October 2, 1999 between Scott D. Thompson and TeleTech 10.20* Stock Option Agreement dated October 18, 1999 between Scott D. Thompson and TeleTech 10.21* Stock Option Agreement dated October 18, 1999 between Scott D. Thompson and TeleTech 27.1* Financial Data Schedule </TABLE> 19
PART II. OTHER INFORMATION (CONTINUED) Item 6. Exhibits and Reports on Form 8-K (continued) * Filed herewith [ ]Such exhibit previously filed with the Securities and Exchange Commission as exhibits to the filing indicated below, under the exhibit number indicated in brackets {}, and is incorporated by reference. [1] TeleTech's Registration Statement on Form S-1, as amended (Registration Statement No. 333-04097) 20
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TELETECH HOLDINGS, INC. ----------------------- (Registrant) Date: November 11, 1999 By: /s/ SCOTT D. THOMPSON ----------------- -------------------------- Scott D. Thompson President and Chief Executive Officer Date: November 11, 1999 By: /s/ NORMAN A. BLOME ----------------- -------------------------- Norman A. Blome, Acting Chief Financial Officer 21