Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013
OR
o
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 001-11919
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.)
9197 South Peoria Street
Englewood, Colorado 80112
(Address of principal executive offices)
Registrant’s telephone number, including area code: (303) 397-8100
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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
As of October 24, 2013, there were 50,424,066 shares of the registrant’s common stock outstanding.
TELETECH HOLDINGS, INC. AND SUBSIDIARIES
SEPTEMBER 30, 2013 FORM 10-Q
TABLE OF CONTENTS
Page No.
PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
Consolidated Balance Sheets as of September 30, 2013 (unaudited) and December 31, 2012
1
Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2013 and 2012 (unaudited)
2
Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2013 (unaudited)
3
Consolidated Statements of Cash Flows for the three and nine months ended September 30, 2013 and 2012 (unaudited)
4
Notes to the Unaudited Consolidated Financial Statements
5
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
31
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
44
Item 4.
Controls and Procedures
47
PART II. OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
48
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
49
SIGNATURES
50
EXHIBIT INDEX
51
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets
(Amounts in thousands, except share amounts)
September 30, 2013
December 31, 2012
(Unaudited)
ASSETS
Current assets
Cash and cash equivalents
$
144,903
164,485
Accounts receivable, net
245,080
251,206
Prepaids and other current assets
58,987
58,702
Deferred tax assets, net
8,672
14,169
Income tax receivable
9,367
14,982
Total current assets
467,009
503,544
Long-term assets
Property, plant and equipment, net
120,111
112,276
Goodwill
98,695
94,679
Contract acquisition costs, net
2,077
1,860
46,720
35,429
Other long-term assets
103,757
99,385
Total long-term assets
371,360
343,629
Total assets
838,369
847,173
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable
35,719
23,494
Accrued employee compensation and benefits
67,982
71,621
Other accrued expenses
26,365
29,056
Income taxes payable
4,504
12,650
Deferred tax liabilities, net
300
341
Deferred revenue
33,609
26,892
Other current liabilities
10,519
7,351
Total current liabilities
178,998
171,405
Long-term liabilities
Line of credit
118,000
108,000
2,277
3,029
Deferred rent
9,826
8,589
Other long-term liabilities
57,897
55,813
Total long-term liabilities
188,000
175,431
Total liabilities
366,998
346,836
Commitments and contingencies (Note 10)
Stockholders’ equity
Preferred stock - $0.01 par value: 10,000,000 shares authorized; zero shares outstanding as of September 30, 2013 and December 31, 2012
—
Common stock - $0.01 par value; 150,000,000 shares authorized; 50,496,816 and 52,288,567 shares outstanding as of September 30, 2013 and December 31, 2012, respectively
504
522
Additional paid-in capital
354,501
350,714
Treasury stock at cost: 31,555,437 and 29,763,686 shares as of September 30, 2013 and December 31, 2012, respectively
(473,318
)
(428,716
Accumulated other comprehensive income (loss)
(7,886
22,981
Retained earnings
588,710
540,791
Noncontrolling interest
8,860
14,045
Total stockholders’ equity
471,371
500,337
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Statements of Comprehensive Income
(Amounts in thousands, except per share amounts)
Three Months Ended September 30,
Nine Months Ended September 30,
2013
2012
Revenue
296,995
286,268
875,070
867,720
Operating expenses
Cost of services (exclusive of depreciation and amortization presented separately below)
208,648
201,766
625,689
622,782
Selling, general and administrative
50,165
43,845
142,080
137,689
Depreciation and amortization
11,463
10,695
33,281
31,040
Restructuring charges, net
758
2,440
4,181
20,694
Impairment losses
161
1,205
2,958
Total operating expenses
271,034
258,907
806,436
815,163
Income from operations
25,961
27,361
68,634
52,557
Other income (expense)
Interest income
938
780
2,182
2,235
Interest expense
(1,799
(2,129
(5,567
(4,810
Loss on deconsolidation of subsidiary
(3,655
Other income (expense), net
427
97
1,503
(227
Total other income (expense)
(434
(1,252
(5,537
(2,802
Income before income taxes
25,527
26,109
63,097
49,755
(Provision for) benefit from income taxes
(6,358
3,611
(12,603
3,030
Net income
19,169
29,720
50,494
52,785
Net income attributable to noncontrolling interest
(1,526
(1,291
(2,575
(3,152
Net income attributable to TeleTech stockholders
17,643
28,429
47,919
49,633
Other comprehensive income (loss)
Foreign currency translation adjustment
(1,708
7,358
(18,191
10,607
Derivative valuation, gross
(1,440
7,260
(21,851
21,650
Derivative valuation, tax effect
412
(2,906
8,620
(8,480
Other, net of tax
152
298
451
933
Total other comprehensive income (loss)
(2,584
12,010
(30,971
24,710
Total comprehensive income
16,585
41,730
19,523
77,495
Comprehensive income attributable to noncontrolling interest
(1,642
(1,357
(2,471
(3,265
Comprehensive income attributable to TeleTech stockholders
14,943
40,373
17,052
74,230
Weighted average shares outstanding
Basic
50,732
54,093
51,643
55,233
Diluted
51,678
54,905
52,499
55,991
Net income per share attributable to TeleTech stockholders
0.35
0.53
0.93
0.90
0.34
0.52
0.91
0.89
Consolidated Statement of Stockholders’ Equity
(Amounts in thousands)
Stockholders’ Equity of the Company
Accumulated
Additional
Other
Preferred Stock
Common Stock
Treasury
Paid-in
Comprehensive
Retained
Noncontrolling
Total
Shares
Amount
Stock
Capital
Income (Loss)
Earnings
interest
Equity
Balance as of December 31, 2012
52,288
2,575
Dividends distributed to noncontrolling interest
(3,420
Purchases of outstanding noncontrolling interest
3,715
(4,140
(425
Deconsolidation of a subsidiary
(121
Foreign currency translation adjustments
(18,087
(104
Derivatives valuation, net of tax
(13,231
Vesting of restricted stock units
400
5,717
(9,866
(4,145
Exercise of stock options
90
1,285
(430
856
Excess tax benefit from equity-based awards
644
Equity-based compensation expense
9,724
25
9,749
Purchases of common stock
(2,281
(23
(51,604
(51,627
Balance as of September 30, 2013
50,497
Consolidated Statements of Cash Flows
Cash flows from operating activities
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of contract acquisition costs
753
763
Amortization of debt issuance costs
488
531
Imputed interest expense
600
Provision for doubtful accounts
490
(Gain) loss on disposal of assets
(94
180
Deferred income taxes
5,467
2,134
(1,074
(1,005
9,842
10,310
Gain on foreign currency derivatives
(75
(574
Loss on deconsolidation of subsidiary, net of cash of $897 and zero, respectively
2,758
Changes in assets and liabilities, net of acquisitions:
Accounts receivable
709
1,091
Prepaids and other assets
(11,241
(30,893
Accounts payable and accrued expenses
(14,020
(15,696
Deferred revenue and other liabilities
(3,225
8,697
Net cash provided by operating activities
76,613
63,411
Cash flows from investing activities
Proceeds from grant for property, plant and equipment
110
Proceeds from sale of long-lived assets
450
Purchases of property, plant and equipment, net of acquisitions
(31,832
(33,259
Acquisitions, net of cash acquired of $6,423 and $1,373, respectively
(8,956
(4,809
Net cash used in investing activities
(40,788
(37,508
Cash flows from financing activities
Proceeds from line of credit
1,114,050
857,650
Payments on line of credit
(1,104,050
(833,650
Proceeds from other debt
3,709
8,014
Payments on other debt
(4,293
(2,783
Proceeds from exercise of stock options
1,135
1,074
1,005
Purchase of treasury stock
(55,211
Payments of debt issuance costs
(1,800
(432
Net cash used in financing activities
(45,501
(25,712
Effect of exchange rate changes on cash and cash equivalents
(9,906
13,815
(Decrease) increase in cash and cash equivalents
(19,582
14,006
Cash and cash equivalents, beginning of period
156,371
Cash and cash equivalents, end of period
170,377
Supplemental disclosures
Cash paid for interest
3,271
3,168
Cash paid for income taxes
12,329
13,213
Non-cash investing and financing activities
Purchases of equipment through financing agreements
6,100
Acquisition of equipment through increase in accounts payable
3,803
396
Landlord incentives credited to deferred rent
1,016
1,723
Contract acquisition costs credited to accounts receivable
1,000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) OVERVIEW AND BASIS OF PRESENTATION
Overview
TeleTech Holdings, Inc. and its subsidiaries (“TeleTech” or the “Company”) is a geographically diverse global provider of technology-enabled, fully-integrated customer experience management solutions for Global 1000 clients and their customers. A global provider of data-driven, technology-enabled business process outsourcing, technology integration, consulting and customer management, and hosted and managed technology services. TeleTech’s 39,000 employees serve clients in the automotive, communication, financial services, government, healthcare, logistics, media and entertainment, retail, technology, transportation and travel industries via operations in the U.S., Argentina, Australia, Belgium, Brazil, Canada, China, Costa Rica, France, Germany, Ghana, Italy, Lebanon, Mexico, New Zealand, the Philippines, Singapore, South Africa, Spain, Thailand, Turkey, the United Arab Emirates, and the United Kingdom.
Basis of Presentation
The Consolidated Financial Statements are comprised of the accounts of TeleTech, its wholly owned subsidiaries, its 55% interest in Percepta, LLC, and its 80% interest in iKnowtion, LLC. All intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited Consolidated Financial Statements do not include all of the disclosures required by accounting principles generally accepted in the U.S. (“GAAP”), pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The unaudited Consolidated Financial Statements reflect all adjustments which, in the opinion of management, are necessary to present fairly the consolidated financial position of the Company and the consolidated results of operations and comprehensive income (loss) and the consolidated cash flows of the Company. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.
These unaudited Consolidated Financial Statements should be read in conjunction with the Company’s audited Consolidated Financial Statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.
Use of Estimates
The preparation of the Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions in determining the reported amounts of assets and liabilities, disclosure of contingent liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenue and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates including those related to derivatives and hedging activities, income taxes including the valuation allowance for deferred tax assets, self-insurance reserves, litigation reserves, restructuring reserves, allowance for doubtful accounts and valuation of goodwill, long-lived and intangible assets. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ materially from these estimates under different assumptions or conditions. In the three months ended June 30, 2012, the Company recorded a change in estimate which resulted in a decrease of $4.6 million to employee related expenses in connection with an authoritative ruling in Spain related to the legally required cost of living adjustment for employees’ salaries for the years 2010, 2011 and 2012.
Recently Issued Accounting Pronouncements
In February 2013, the FASB issued new accounting guidance that improves the reporting of reclassifications out of accumulated other comprehensive income. This new guidance requires entities to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income when applicable or to cross-reference the reclassifications with other disclosures that provide additional detail about the reclassifications made when the reclassifications are not made to net income. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2012. The Company’s adoption of this guidance did not have a material impact on the Company’s financial position, results of operations, or cash flows since it was an enhancement to current required disclosures.
(2) ACQUISITONS
Peppers & Rogers Group
On September 18, 2013, the Company acquired the remaining 20% interest in Peppers & Rogers Group (“PRG”) for $425 thousand. The buy-out accelerated TeleTech’s rights pursuant to the sale and purchase agreement to acquire the remaining portion of the business in 2015. All future earn-out payment entitlements tied to the PRG’s performance as a part of TeleTech’s Customer Strategy Services segment have been extinguished with this transaction.
WebMetro
On August 9, 2013, the Company acquired 100% of the stock of WebMetro. WebMetro is a digital marketing agency that provides online direct marketing services. WebMetro has offices in San Dimas and Los Angeles, California and Modiin, Israel and has approximately 90 employees.
The expected total purchase price was $16.4 million, subject to an up and down dollar for dollar working capital adjustment equivalent to any acquired working capital from WebMetro against an agreed working capital level as defined in the stock purchase agreement. This adjustment will be determined during the fourth quarter of 2013.
The Company is also obligated to make earn-out payments over the next two years if WebMetro achieves specified earnings before interest, taxes, depreciation and amortization (“EBITDA”) targets, as defined by the stock purchase agreement. The fair value of the contingent payments was measured based on significant inputs not observable in the market (Level 3 inputs). Key assumptions include a discount rate of 5.3% and expected future value of payments of $1.4 million. The $1.4 million of expected future payments was calculated using a probability weighted EBITDA assessment with higher probability associated with WebMetro achieving the smaller EBITDA targets. As of the acquisition date, the fair value of the contingent payments was approximately $1.3 million. As of September 30, 2013, the fair value of the contingent consideration was $1.3 million, of which $0.2 million and $1.1 million were included in Other accrued expenses and Other long-term liabilities in the accompanying Consolidated Balance Sheets, respectively.
6
The following summarizes the preliminary estimated fair values of the identifiable assets acquired and liabilities assumed as of the acquisition date (in thousands). The estimates of fair value of identifiable assets acquired and liabilities assumed, are preliminary, pending completion of a valuation, thus are subject to revisions that may result in adjustments to the values presented below:
Preliminary Estimate of Acquisition Date Fair Value
Cash
6,423
3,692
Other assets
215
Property, plant and equipment
887
Customer relationships
6,120
Software
3,700
5,042
26,079
7,232
Accrued expenses
422
Customer deposits
1,316
Capital lease obligation
444
274
9,688
Total purchase price
16,391
The WebMetro customer relationships and software have an estimated useful life of six years and four years, respectively. The goodwill recognized from the WebMetro acquisition was attributable primarily to the acquired workforce of WebMetro, expected synergies, and other factors. The tax basis of the acquired intangibles and goodwill are deductible for income tax purposes. The acquired goodwill and the operating results of WebMetro are reported within the Customer Growth Services segment from the date of acquisition.
OnState
On January 1, 2012, the Company entered into an asset purchase agreement with OnState Communications Corporation (“OnState”) to acquire 100% of its assets and assume certain of its liabilities for total cash consideration of $3.3 million. OnState provides hosted business process outsourcing solutions to a variety of small businesses. OnState was headquartered in Boston, MA with a minimal employee base.
As of September 30, 2013, the Company paid $3.1 million towards the purchase price. The remaining purchase price of $0.2 million will be paid out once the potential for covered losses has expired per the purchase agreement, which is expected to be in early 2014. The remaining purchase price of $0.2 million was included within Other accrued expenses in the accompanying Consolidated Balance Sheets as of September 30, 2013. The Company paid $0.1 million of acquisition related expenses as part of the OnState purchase. These costs were recorded in Selling, general and administrative expenses in the accompanying Consolidated Statements of Comprehensive Income during the first quarter of 2012.
7
The following summarizes the fair values of the identifiable assets acquired and liabilities assumed as of the acquisition date (in thousands):
Acquisition Date Fair Value
36
Accounts Receivable
68
33
2,100
1,132
3,369
93
3,276
The software acquired will be amortized over four years once it is placed into service. The goodwill recognized from the OnState acquisition is primarily attributable to the synergies resulting from incorporating the acquired software into the Company’s current technology platforms in addition to the acquisition of the employees who developed the acquired software. Since this acquisition is an asset acquisition for tax purposes, the goodwill and software are deductible over their respective tax lives. The acquired goodwill of OnState is reported within the Customer Technology Services segment from the date of acquisition.
iKnowtion
On February 27, 2012, the Company acquired an 80% interest in iKnowtion, LLC (“iKnowtion”). iKnowtion integrates proven marketing analytics methodologies and business consulting capabilities to help clients improve their return on marketing expenditures in such areas as demand generation, share of wallet, and channel mix optimization. iKnowtion is located in Boston, MA and has approximately 40 employees.
The up-front cash consideration paid was $1.0 million. The Company was also obligated to pay a working capital adjustment equivalent to any acquired working capital from iKnowtion in excess of a working capital floor as defined in the purchase and sale agreement. The working capital adjustment was $0.2 million and was paid during the second quarter of 2012.
The Company is also obligated to make earn-out payments over the next four years if iKnowtion achieves specified earnings before interest, taxes, depreciation and amortization (“EBITDA”) targets, as defined by the purchase and sale agreement. The fair value of the contingent payments was measured based on significant inputs not observable in the market (Level 3 inputs). Key assumptions include a discount rate of 21% and expected future value of payments of $4.3 million. The $4.3 million of expected future payments was calculated using a probability weighted EBITDA assessment with higher probability associated with iKnowtion achieving the maximum EBITDA targets. As of the acquisition date, the fair value of the contingent payments was approximately $2.9 million. As of September 30, 2013, $1.1 million of contingent consideration has been paid and the fair value of the remaining contingent consideration was $3.0 million, of which $1.1 million and $1.9 million were included in Other accrued expenses and Other long-term liabilities in the accompanying Consolidated Balance Sheets, respectively.
The fair value of the 20% noncontrolling interest in iKnowtion at the date of acquisition was $0.9 million and was estimated based on a 20% interest of the fair value of a 100% interest in iKnowtion and was discounted for a lack of control at a rate of 23.1%.
8
In the event iKnowtion meets certain EBITDA targets for calendar year 2015, the purchase and sale agreement requires TeleTech to purchase the remaining 20% interest in iKnowtion in 2016 for an amount equal to a multiple of iKnowtions’s 2015 EBITDA as defined in the purchase and sale agreement. These terms represent a contingent redemption feature. The fair value of the redemption feature is based on a comparison of EBITDA multiples and the EBITDA multiple to purchase the remaining 20% of iKnowtion approximates EBITDA multiples in the market for similar acquisitions.
The Company paid $0.1 million of acquisition related expenses as part of the iKnowtion purchase. These costs were recorded in Selling, general and administrative expenses in the accompanying Consolidated Statements of Comprehensive Income during the months ended June 30, 2012.
The following summarizes the fair values of the identifiable assets acquired and liabilities and noncontrolling interest assumed as of the acquisition date (in thousands).
1,337
1,792
1,400
447
5,227
18
19
164
201
941
4,085
The iKnowtion customer relationships have an estimated useful life of five years. The goodwill recognized from the iKnowtion acquisition was attributable primarily to the acquired workforce of iKnowtion, expected synergies, and other factors. The tax basis of the acquired intangibles and goodwill are deductible for income tax purposes. The acquired goodwill and the operating results of iKnowtion are reported within the Customer Strategy Services segment from the date of acquisition.
Guidon
On October 4, 2012, the Company acquired 100% of the stock of Guidon Performance Solutions’ (“Guidon”) parent company. Guidon provides operational consulting services and designs solutions for operational and cultural transformation for global clients. Guidon is located in Mesa, AZ and has approximately 25 employees.
The up-front cash consideration paid was $5.6 million. The Company was also obligated to pay a working capital adjustment equivalent to any acquired working capital from Guidon in excess of a working capital floor defined in the stock purchase agreement. The working capital payment was less than $0.1 million and was paid during the fourth quarter of 2012.
9
The Company is also obligated to make earn-out payments over the next two years if Guidon achieves specified EBITDA targets as defined in the stock purchase agreement. The fair value of the contingent payments was measured based on significant inputs not observable in the market (Level 3 inputs). Key assumptions included in the fair value calculation include a discount rate of 21% and expected future value of payments of $2.8 million. The $2.8 million of expected future payments was calculated using a probability weighted EBITDA assessment with higher probability associated with Guidon achieving the maximum EBITDA targets. As of the acquisition date, the fair value of the contingent payments was approximately $2.1 million. As of September 30, 2013, the fair value of the contingent consideration was $2.5 million, of which $1.4 million and $1.1 million were included in Other accrued expenses and Other long-term liabilities in the accompanying Consolidated Balance Sheets, respectively.
The Company paid $0.1 million of acquisition related expenses as part of the Guidon purchase. These costs were recorded in Selling, general and administrative expenses in the accompanying Consolidated Statements of Comprehensive Income for the year ended December 31, 2012.
376
1,375
228
2,490
3,619
8,137
202
122
65
389
7,748
The Guidon customer relationships have an estimated useful life of five years. The goodwill recognized from the Guidon acquisition was attributable primarily to the acquired workforce of Guidon, expected synergies, and other factors. The tax basis of the acquired intangibles and goodwill are deductible for income tax purposes. The acquired goodwill and the operating results of Guidon are reported within the Customer Strategy Services segment from the date of acquisition.
TSG
On December 31, 2012, the Company acquired a 100% interest in Technology Solutions Group, Inc. (“TSG”). TSG designs and implements custom communications systems for a variety of business types and sizes. TSG is located in Aurora, IL and has approximately 90 employees.
The up-front cash consideration paid was $32.7 million. The Company was also obligated to pay a working capital adjustment equivalent to any acquired working capital from TSG in excess of a working capital floor as defined in the stock purchase agreement. The working capital adjustment was $0.6 million and was paid during the second quarter of 2013.
10
The Company is also obligated to make earn-out payments over three years if TSG achieves specified EBITDA targets, as defined by the stock purchase agreement. The fair value of the contingent payments was measured based on significant inputs not observable in the market (Level 3 inputs). Key assumptions included in the fair value calculation include a discount rate of 4.6% and expected future value of payments of $7.3 million. The $7.3 million of expected future payments was calculated using a probability weighted EBITDA assessment with higher probability associated with TSG achieving the maximum EBITDA targets. As of the acquisition date, the fair value of the contingent payments was approximately $6.7 million. As of September 30, 2013 the fair value of the contingent consideration was $6.9 million of which $2.4 million and $4.5 million were included in Other accrued expenses and Other long-term liabilities in the accompanying Consolidated Balance Sheets, respectively.
The Company paid $0.1 million of acquisition related expenses as part of the TSG purchase. These costs were recorded in Selling, general and administrative expenses in the accompanying Consolidated Statements of Comprehensive Income during the year ended December 31, 2012.
The following summarizes the preliminary estimated fair values of the identifiable assets acquired and liabilities and noncontrolling interest assumed as of the acquisition date (in thousands). The estimates of fair value of identifiable assets acquired and liabilities assumed, are preliminary, pending completion of a valuation, thus are subject to revisions that may result in adjustments to the values presented below:
1,995
4,871
Prepaid assets - cost deferrals
3,665
583
1,886
15,300
Noncompete agreements
2,300
Trade name
1,100
Consulting services backlog
800
19,421
51,921
3,091
1,539
7,295
11,925
39,996
11
The TSG customer relationships have an estimated useful life of 10 years. The goodwill recognized from the TSG acquisition was attributable primarily to the acquired workforce of TSG, expected synergies, and other factors. The tax basis of the acquired intangibles and goodwill are deductible for income tax purposes. The acquired goodwill and the operating results of TSG are reported within the Customer Technology Services segment from the date of acquisition.
The acquired businesses noted above contributed revenues of $19.4 million and $47.1 million and income from operations of $2.7 million and $4.9 million, inclusive of $1.2 million and $2.9 million of acquired intangible amortization, to the Company for the three and nine months ended September 30, 2013, respectively. The acquired businesses noted above contributed revenues of $2.2 million and $4.9 million and income from operations of $0.4 million and $0.8 million, inclusive of $0.1 million and $0.2 million of acquired intangible amortization, to the Company for the three and nine months ended September 30, 2012, respectively.
(3) SEGMENT INFORMATION
The Company reports the following four segments:
· the Customer Management Services segment includes the customer experience delivery solutions which integrate innovative technology with highly-trained customer experience professionals to optimize the customer experience across all channels and all stages of the customer lifecycle from an onshore, offshore or work-from-home environment;
· the Customer Growth Services segment includes the technology-enabled sales and marketing business, including certain acquired assets of the digital marketing business of WebMetro;
· the Customer Technology Services segment includes the system integration and hosted and managed technology offerings, including certain acquired assets of TSG; and
· the Customer Strategy Services segment includes the customer experience strategy and data analytics offerings.
The Company allocates to each segment its portion of corporate operating expenses. All intercompany transactions between the reported segments for the periods presented have been eliminated.
The following tables present certain financial data by segment (amounts in thousands):
Three Months Ended September 30, 2013
Gross Revenue
Intersegment Sales
Net Revenue
Depreciation & Amortization
Income (Loss) from Operations
Customer Management Services
217,347
(312
217,035
8,322
17,944
Customer Growth Services
25,893
1,148
588
Customer Technology Services
40,712
(63
40,649
1,538
5,165
Customer Strategy Services
13,418
455
2,264
297,370
(375
Three Months Ended September 30, 2012
224,041
8,349
21,001
28,200
1,201
2,487
25,219
(2,876
22,343
794
3,054
11,913
(229
11,684
351
819
289,373
(3,105
12
Nine Months Ended September 30, 2013
661,201
(943
660,258
24,716
55,140
71,148
2,622
1,244
111,075
(220
110,855
4,543
13,882
33,604
(795
32,809
(1,632
877,028
(1,958
Nine Months Ended September 30, 2012
688,318
24,811
38,438
75,373
2,899
1,409
76,570
(3,719
72,851
2,286
11,089
32,623
(1,445
31,178
1,044
1,621
872,884
(5,164
Capital Expenditures
15,108
11,752
25,504
27,171
1,274
2,385
2,025
3,428
1,642
1,346
3,930
2,216
148
373
18,172
15,781
31,832
33,259
Total Assets
547,320
588,627
85,924
54,164
155,466
148,043
49,659
56,339
19,981
20,288
29,481
24,439
39,146
38,591
10,087
11,361
13
The following table presents revenue based upon the geographic location where the services are provided (amounts in thousands):
United States
137,205
119,572
401,294
342,005
Philippines
89,206
83,299
263,365
245,301
Latin America
43,343
47,914
132,673
142,069
Europe / Middle East / Africa
18,929
22,164
52,551
93,614
Asia Pacific
4,955
13,087
13,126
Canada
3,808
8,364
12,100
31,605
(4) SIGNIFICANT CLIENTS AND OTHER CONCENTRATIONS
The Company had one client that contributed in excess of 10% of total revenue for the three and nine months ended September 30, 2013. This client contributed 11.5% and 9.8% of total revenue for the three months ended September 30, 2013 and 2012. This client contributed 11.7% and 9.7% for the nine months ended September 30, 2013 and 2012. This client had an outstanding receivable balance of $29.3 million and $25.8 million as of September 30, 2013 and 2012.
The loss of one or more of its significant clients could have a material adverse effect on the Company’s business, operating results, or financial condition. The Company does not require collateral from its clients. To limit the Company’s credit risk, management performs periodic credit evaluations of its clients and maintains allowances for uncollectible accounts and may require pre-payment for services. Although the Company is impacted by economic conditions in various industry segments, management does not believe significant credit risk existed as of September 30, 2013.
(5) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill consisted of the following (amounts in thousands):
Acquisitions
Impairments
Deconsolidation of Subsidiary
Effect of Foreign Currency
(307
478
77
(1,274
5,520
(230
The Company performs a goodwill impairment test on at least an annual basis. The Company conducts its annual goodwill impairment assessment during the fourth quarter, or more frequently, if indicators of impairment exist.
As of December 2012 and March 31, 2013, the Company had one reporting unit with goodwill of $7.3 million and a calculated fair value which exceeded its carrying value by 4%.
During the three months ended June 30, 2013, the Company reorganized the reporting structure of the Customer Strategy Services segment, which is included in the above reporting unit, which necessitated an interim impairment analysis. Therefore, the Company tested the following assets of this reporting unit for impairment: indefinite-lived intangible assets, definite-lived long-lived assets and goodwill. There were no other indicators of impairment in any of the remaining reporting units as of June 30, 2013.
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The indefinite-lived intangible asset evaluated for impairment consisted of the PRG trade name. The Company calculated the fair value of the trade name using a relief from royalty method based on forecasted revenues sold under the trade name using significant inputs not observable in the market (Level 3 inputs). The valuation assumptions included an estimated royalty rate of 6.0%, a discount rate specific to the trade name of 38.0% and a perpetuity growth rate of 7.0%. Based on the calculated fair value of $5.3 million, the Company recorded impairment expense of $1.1 million in the three months ended June 30, 2013. Changes in the outcome of some or all of these assumptions may impact the calculated fair value of the trade name resulting in a different amount of impairment.
Definite-lived long-lived assets consisted of fixed assets and an intangible asset related to the PRG customer relationships. The Company determined that the undiscounted future cash flows would be sufficient to cover the net book value all definite-lived long-lived assets.
For the goodwill impairment analysis, the Company calculated the fair value of the PRG reporting unit and compared that to the updated carrying value after the above impairments were recorded and determined that the fair value was not in excess of its carrying value. Key assumptions used in the fair value calculation for goodwill impairment testing include, but were not limited to, a perpetuity growth rate of 7.0% based on the then current inflation rate combined with the GDP growth rate for the reporting unit’s geographical region and a discount rate of 26.0%, which is equal to the reporting unit’s equity risk premium adjusted for its size and company specific risk factors. Estimated future cash flows under the income approach were based on the Company’s internal business plan excluding the results of the deconsolidated subsidiary and adjusted as appropriate for the Company’s view of market participant assumptions. The current business plan assumes the occurrence of certain events, such as continued realignment of operations and reduction of general and administrative costs. Significant differences in the outcome of some or all of these assumptions could impact the calculated fair value of this reporting until resulting in a different outcome to goodwill impairment in a future period.
Since the fair value of the reporting unit was not in excess of its carrying value, the Company calculated the implied fair value of goodwill and compared that value to the carrying value of goodwill. Implied fair value of goodwill is equal to the fair value of the reporting unit less the recorded value of any net assets and the fair value of intangible assets. Upon completing this assessment, the Company determined that the implied fair value of goodwill significantly exceeded the carrying value of goodwill by over 50%; therefore, there was no impairment of goodwill as of June 30, 2013.
During the quarter ended September 30, 2013, the Company assessed whether any indicators of impairment existed for any of the reporting units and concluded there were none.
15
(6) DERIVATIVES
Cash Flow Hedges
The Company enters into foreign exchange and interest rate related derivatives. Foreign exchange derivatives entered into consist of forward and option contracts to reduce the Company’s exposure to foreign currency exchange rate fluctuations that are associated with forecasted revenue earned in foreign locations. Interest rate derivatives consist of interest rate swaps to reduce the Company’s exposure to interest rate fluctuations associated with its variable rate debt. Upon proper qualification, these contracts are designated as cash flow hedges. It is the Company’s policy to only enter into derivative contracts with investment grade counterparty financial institutions, and correspondingly, the fair value of derivative assets consider, among other factors, the creditworthiness of these counterparties. Conversely, the fair value of derivative liabilities reflects the Company’s creditworthiness. As of September 30, 2013, the Company has not experienced, nor does it anticipate, any issues related to derivative counterparty defaults. The following table summarizes the aggregate unrealized net gain or loss in Accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2013 and 2012 (amounts in thousands and net of tax):
Aggregate unrealized net gain (loss) at beginning of period
(2,644
2,964
9,559
(5,852
Add: Net gain/(loss) from change in fair value of cash flow hedges
(630
4,945
(9,332
14,040
Less: Net (gain)/loss reclassified to earnings from effective hedges
(398
(591
(3,899
(870
Aggregate unrealized net gain (loss) at end of period
(3,672
7,318
The Company’s foreign exchange cash flow hedging instruments as of September 30, 2013 and December 31, 2012 are summarized as follows (amounts in thousands). All hedging instruments are forward contracts unless noted otherwise.
As of September 30, 2013
Local Currency Notional Amount
U.S. Dollar Notional Amount
% Maturing in the Next 12 Months
Contracts Maturing Through
Canadian Dollar
12,750
12,415
70.6
%
June 2015
Philippine Peso
15,835,000
372,909
(1)
37.8
December 2017
Mexican Peso
2,056,000
147,144
34.5
British Pound Sterling
2,508
4,217
(2)
100.0
June 2014
New Zealand Dollar
235
March 2014
536,920
16
As of December 31, 2012
7,750
7,407
11,710,000
271,970
1,320,500
94,530
3,518
5,575
398
379,782
(1) Includes contracts to purchase Philippine pesos in exchange for New Zealand dollars and Australian dollars, which are translated into equivalent U.S. dollars on September 30, 2013 and December 31, 2012.
(2) Includes contracts to purchase British pound sterling in exchange for Euros, which are translated into equivalent U.S. dollars on September 30, 2013 and December 31, 2012.
The Company’s interest rate swap arrangements as of September 30, 2013 and December 31, 2012 were as follows:
Notional Amount
Variable Rate Received
Fixed Rate Paid
Contract Commencement Date
Contract Maturity Date
25 million
1 - month LIBOR
2.55
April 2012
April 2016
15 million
3.14
May 2012
May 2017
40 million
Fair Value Hedges
The Company enters into foreign exchange forward contracts to economically hedge against foreign currency exchange gains and losses on certain receivables and payables of the Company’s foreign operations. Changes in the fair value of derivative instruments designated as fair value hedges are recognized in earnings in Other income (expense), net. As of September 30, 2013 and December 31, 2012 the total notional amount of the Company’s forward contracts used as fair value hedges were $247.2 million and $189.3 million, respectively.
Embedded Derivatives
In addition to hedging activities, the Company’s foreign subsidiary in Argentina was party to U.S. dollar denominated lease contracts which the Company determined contain embedded derivatives. As such, the Company bifurcated the embedded derivative features of the lease contracts and valued these features as foreign currency derivatives. As of September 30, 2013 and December 31, 2012, the fair value of the embedded derivative was $0.1 million and $0.3 million, respectively, and was included in Other current liabilities and Other long-term liabilities in the accompanying Consolidated Balance Sheets as shown in the table below.
17
Derivative Valuation and Settlements
The Company’s derivatives as of September 30, 2013 and December 31, 2012 were as follows (amounts in thousands):
Designated as Hedging Instruments
Not Designated as Hedging Instruments
Foreign Exchange
Interest Rate
Leases
Derivative contracts: Derivative classification:
Cash Flow
Fair Value
Embedded Derivative
Fair value and location of derivative in the Consolidated Balance Sheet:
4,607
20
2,971
(3,155
(1,029
(147
(8,159
(1,258
Total fair value of derivatives, net
(3,736
(2,287
(410
11,421
7,619
(157
(1,032
(476
(59
(65
(1,955
(219
18,818
(2,987
(465
(278
The effects of derivative instruments on the Consolidated Statements of Comprehensive Income for the three months ended September 30, 2013 and 2012 were as follows (amounts in thousands):
Derivative contracts:
Derivative classification:
Amount of gain or (loss) recognized in other comprehensive income (loss) - effective portion, net of tax
(154
5,331
(386
Amount and location of net gain or (loss) reclassified from accumulated OCI to income - effective portion:
917
1,367
Interest Expense
(264
(381
Amount and location of net gain or (loss) reclassified from accumulated OCI to income - ineffective portion and amount excluded from effectiveness testing:
Option and Forward Contracts
Amount and location of net gain or (loss) recognized in the Consolidated Statement of Comprehensive Income (Loss):
Costs of services
(2,373
544
The effects of derivative instruments on the Consolidated Statements of Comprehensive Income for the nine months ended September 30, 2013 and 2012 were as follows (amounts in thousands):
(9,254
(78
14,902
(862
7,227
2,016
(778
(564
131
259
(3,620
4,399
(7) FAIR VALUE
The authoritative guidance for fair value measurements establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires that the Company maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
Level 1 — Quoted prices in active markets for identical assets or liabilities.
Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, similar assets and liabilities in markets that are not active or can be corroborated by observable market data.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
The following presents information as of September 30, 2013 and December 31, 2012 for the Company’s assets and liabilities required to be measured at fair value on a recurring basis, as well as the fair value hierarchy used to determine their fair value.
Accounts Receivable and Payable - The amounts recorded in the accompanying balance sheets approximate fair value because of their short-term nature.
Debt - The Company’s debt consists primarily of the Company’s Credit Agreement, which permits floating-rate borrowings based upon the current Prime Rate or LIBOR plus a credit spread as determined by the Company’s leverage ratio calculation (as defined in the Credit Agreement). As of September 30, 2013 and December 31, 2012, the Company had $118.0 million and $108.0 million, respectively, of borrowings outstanding under the Credit Agreement. During the three and nine months ended September 30, 2013 outstanding borrowings accrued interest at an average rate of 1.4% and 1.5% per annum, respectively, excluding unused commitment fees. The amounts recorded in the accompanying balance sheets approximate fair value due to the variable nature of the debt.
Derivatives - Net derivative assets (liabilities) are measured at fair value on a recurring basis. The portfolio is valued using models based on market observable inputs, including both forward and spot foreign exchange rates, interest rates, implied volatility, and counterparty credit risk, including the ability of each party to execute its obligations under the contract. As of September 30, 2013, credit risk did not materially change the fair value of the Company’s derivative contracts.
The following is a summary of the Company’s fair value measurements for its net derivative assets (liabilities) as of September 30, 2013 and December 31, 2012 (amounts in thousands):
Fair Value Measurements Using
Quoted Prices in Active Markets for Identical Assets
Significant Other Observable Inputs
Significant Unobservable Inputs
(Level 1)
(Level 2)
(Level 3)
At Fair Value
Cash flow hedges
Interest rate swaps
Embedded derivatives
Fair value hedges
Total net derivative asset (liability)
(6,580
15,088
21
The following is a summary of the Company’s fair value measurements as of September 30, 2013 and December 31, 2012 (amounts in thousands):
Assets
Money market investments
240
Derivative instruments, net
Liabilities
Deferred compensation plan liability
(6,191
Purchase price payable
(13,779
(12,771
350
15,438
(5,305
(12,533
Money Market Investments — The Company invests in various well-diversified money market funds which are managed by financial institutions. These money market funds are not publicly traded, but have historically been highly liquid. The value of the money market funds are determined by the banks based upon the funds’ net asset values (“NAV”). All of the money market funds currently permit daily investments and redemptions at a $1.00 NAV.
Deferred Compensation Plan — The Company maintains a non-qualified deferred compensation plan structured as a Rabbi trust for certain eligible employees. Participants in the deferred compensation plan select from a menu of phantom investment options for their deferral dollars offered by the Company each year, which are based upon changes in value of complementary, defined market investments. The deferred compensation liability represents the combined values of market investments against which participant accounts are tracked.
22
Purchase Price Payable — The Company recorded purchase price payables related to the acquisitions of iKnowtion, Guidon, TSG and WebMetro. These purchase price payables were recognized at fair value using a discounted cash flow approach and a discount rate of 21.0%, 21.0%, 4.6%, or 5.3%, respectively. These measurements were based on significant inputs not observable in the market. The Company will record interest expense each period using the effective interest method until the future value of these purchase price payables reaches their expected future value of $14.8 million. Interest expense related to all recorded purchase price payables is included in Interest expense in the Consolidated Statements of Comprehensive Income.
(8) INCOME TAXES
The Company accounts for income taxes in accordance with the accounting literature for income taxes, which requires recognition of deferred tax assets and liabilities for the expected future income tax consequences of transactions that have been included in the Consolidated Financial Statements. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using tax rates in effect for the year in which the differences are expected to reverse. Quarterly, the Company assesses the likelihood that its net deferred tax assets will be recovered. Based on the weight of all available evidence, both positive and negative, the Company records a valuation allowance against deferred tax assets when it is more-likely-than-not that a future tax benefit will not be realized.
As of September 30, 2013, the Company had $55.3 million of gross deferred tax assets (after a $21.3 million valuation allowance) and net deferred tax assets (after deferred tax liabilities) of $52.8 million related to the U.S. and international tax jurisdictions whose recoverability is dependent upon future profitability which the Company believes is more-likely-than-not to occur.
The effective tax rate for the three and nine months ended September 30, 2013 was 24.9% and 20.0%, respectively. The effective tax rate during these periods in 2013 was influenced by the distribution of earnings in international jurisdictions currently under an income tax holiday and the $5.4 million and $1.8 million, respectively, in restructuring and impairment expenses and the income tax benefit related to these incremental expenses. The effective tax rate for the three and nine months ended September 30, 2012 was (13.8)% and (6.1)%, respectively. The effective tax rate during these periods in 2012 was influenced by the distribution of earnings in international jurisdictions currently under an income tax holiday, the $2.6 million and $23.7 million in restructuring and impairment expenses and their related income tax benefit, the benefit related to Australia transfer pricing and the release of an uncertain tax position.
The Company’s U.S. income tax returns filed for the tax years ending December 31, 2010 to present, remain open tax years subject to IRS audit. The Company is currently under audit of income taxes in Canada. Although the outcome of examinations by taxing authorities are always uncertain, it is the opinion of management that the resolution of these audits will not have a material effect on the Company’s Consolidated Financial Statements.
(9) RESTRUCTURING CHARGES AND IMPAIRMENT LOSSES
Restructuring Charges
During the three and nine months ended September 30, 2013 and 2012, the Company undertook a number of restructuring activities primarily associated with reductions in the Company’s capacity and workforce in its Customer Management Services, Customer Technology Services and Customer Strategy Services segments to better align the capacity and workforce with current business needs.
During the second quarter of 2012, the Company made the decision to cease operations in Spain and terminated the contracts with its clients. The Company notified the employees and commenced severance procedures as required under Spanish law. The Company recorded $14.7 million of severance and $0.4 million of center closure expenses for the year ended December 31, 2012. As of the third quarter of 2013, $14.9 million was paid and the remaining $0.2 million was included in Other accrued expenses in the Consolidated Balance Sheets as of September 30, 2013.
23
A summary of the expenses recorded in Restructuring, net in the accompanying Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2013 and 2012, respectively, is as follows (amounts in thousands):
Reduction in force
628
2,678
3,614
20,642
62
198
73
60
189
708
2,745
3,883
20,900
Facility exit charges
(305
(206
A rollforward of the activity in the Company’s restructuring accruals is as follows (amounts in thousands):
Closure of Delivery Centers
Reduction in Force
4,079
Expense
4,098
4,396
Payments
(298
(5,762
(6,060
Change in estimates
(215
2,200
The remaining restructuring accruals are expected to be paid during 2013 and are all classified as current liabilities within Other accrued expenses in the Consolidated Balance Sheets.
Impairment Losses
During each of the periods presented, the Company evaluated the recoverability of its leasehold improvement assets at certain delivery centers. An asset is considered to be impaired when the anticipated undiscounted future cash flows of an asset group are estimated to be less than the asset group’s carrying value. The amount of impairment recognized is the difference between the carrying value of the asset group and its fair value. To determine fair value, the Company used Level 3 inputs in its discounted cash flows analysis. Assumptions included the amount and timing of estimated future cash flows and assumed discount rates. During the three and nine months ended September 30, 2013, the Company recognized zero and $0.1 million, respectively, of losses related to leasehold improvement assets in the Customer Management Services segment. During the three and nine months ended September 30, 2012, the Company recognized $0.2 million and $1.2 million, respectively of losses related to leasehold improvement assets in the Customer Management Services segment.
24
During the second quarter of 2013, the Company recorded an impairment charge of $1.1 million related to the PRG trade name intangible asset within the Customer Strategy Services segment. See Note 5 for further information. This expense was included in the Impairment losses in the Consolidated Statements of Comprehensive Income.
During the first quarter of 2012, the Company rebranded its Direct Alliance Corporation (“DAC”) subsidiary to RevanaTM, thus the $1.8 million DAC trade name was impaired as of March 31, 2012. This expense was included in the Impairment losses in the Consolidated Statements of Comprehensive Income.
(10) COMMITMENTS AND CONTINGENCIES
Credit Facility
On June 3, 2013, the Company entered into a $700.0 million, five-year, multi-currency revolving credit facility (the “Credit Agreement”) with a syndicate of lenders which includes an accordion feature that permits the Company to request an increase in total commitments up to $1.0 billion, under certain conditions. Wells Fargo Securities, LLC, KeyBank National Association, Bank of America Merrill Lynch, BBVA Compass and HSBC Bank USA, National Association served as Joint Lead Arrangers. The Credit Agreement amends and restates in its entirety the Company’s prior credit facility entered into during 2010 and amended in 2012.
The Credit Agreement provides for a secured revolving credit facility that matures on June 3, 2018 with an initial maximum aggregate commitment of $700.0 million. At the Company’s discretion, direct borrowing options under the Credit Agreement include (i) Eurodollar loans with one, two, three, and six month terms, and/or (ii) overnight base rate loans. The Credit Agreement also provides for a sub-limit for loans or letters of credit in both U.S. dollars and certain foreign currencies, with direct foreign subsidiary borrowing capabilities up to 50% of the total commitment amount. The Company may increase the maximum aggregate commitment under the Credit Agreement to $1.0 billion if certain conditions are satisfied, including that the Company is not in default under the Credit Agreement at the time of the increase and that the Company obtains the commitment of the lenders participating in the increase.
Base rate loans bear interest at a rate equal to the greatest of (i) Wells Fargo’s prime rate, (ii) one half of 1% in excess of the federal funds effective rate, and (iii) 1.25% in excess of the one month London Interbank Offered Rate (“LIBOR”), in each case adding a margin based upon the Company’s leverage ratio. Eurodollar loans bear interest based upon LIBOR, plus a margin based upon the Company’s leverage ratio. Alternate loans bear interest at rates applicable to their respective currencies. Letter of credit fees are one eighth of 1% of the stated amount of the letter of credit on the date of issuance, renewal or amendment, plus an annual fee equal to the borrowing margin for Eurodollar loans. Commitment fees are payable to the Lenders in an amount equal to the unused portion of the credit facility and are based upon the Company’s leverage ratio.
Indebtedness under the Credit Agreement is guaranteed by certain of the Company’s present and future domestic subsidiaries. Indebtedness under the Credit Agreement and the related guarantees are secured by security interests (subject to permitted liens) in the U.S. accounts receivable and cash of the Company and certain of its domestic subsidiaries and may be secured by tangible assets of the Company and such domestic subsidiaries if borrowings by foreign subsidiaries exceed $100.0 million and the leverage ratio is greater than 3.00 to 1.00. The Company also pledged 65% of the voting stock and 100% of the non-voting stock of certain of the Company’s material foreign subsidiaries and may pledge 65% of the voting stock and 100% of the non-voting stock of the Company’s other foreign subsidiaries.
The Credit Agreement, which includes customary financial covenants, may be used for general corporate purposes, including working capital, purchases of treasury stock and acquisition financing. As of September 30, 2013, the Company was in compliance with all financial covenants.
The Company primarily utilizes its Credit Agreement to fund working capital, general operations, stock repurchases and other strategic activities, such as the acquisitions described in Note 2. As of September 30, 2013 and December 31, 2012, the Company had borrowings of $118.0 million and $108.0 million, respectively, under its credit facilities, and its average daily utilization was $240.9 million and $144.4 million for the nine months ended September 30, 2013 and 2012, respectively. After consideration for issued letters of credit under the Credit Agreement, totaling $3.5 million, the Company’s remaining borrowing capacity was $578.5 million as of September 30, 2013.
Letters of Credit
As of September 30, 2013, outstanding letters of credit under the Credit Agreement totaled $3.5 million and primarily guaranteed workers’ compensation and other insurance related obligations. As of September 30, 2013, letters of credit and contract performance guarantees issued outside of the Credit Agreement totaled $0.6 million.
Guarantees
Indebtedness under the Credit Agreement is guaranteed by certain of the Company’s present and future domestic subsidiaries.
From time to time, the Company has been involved in legal actions, both as plaintiff and defendant, which arise in the ordinary course of business. Accruals for legal actions have been provided for to the extent that losses are deemed both probable and estimable. Although the ultimate outcome of these claims or lawsuits cannot be ascertained, on the basis of currently available information and advice received from counsel, as appropriate, the Company believes that the disposition or ultimate resolution of such legal actions will not have a material adverse effect on its financial position, cash flows or results of operations. During the quarter ended September 30, 2013, there were no material changes to the legal proceedings described in our Annual Report on Form 10-K for the year ended December 31, 2012.
(11) NONCONTROLLING INTEREST
The following table reconciles equity attributable to noncontrolling interest (amounts in thousands):
Noncontrolling interest, January 1
11,260
Acquisition of noncontrolling interest
3,152
Purchase of remaining interest in subsidiary
113
Noncontrolling interest, September 30
14,026
On September 18, 2013, the Company acquired the remaining 20% interest in Peppers & Rogers Group for $425 thousand. In connection with this transaction the remaining Noncontrolling interest balance of $4.1 million was reclassified to Additional paid-in-capital in the Consolidated Balance Sheet as of September 30, 2013.
(12) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
In 2013, the Company adopted new accounting guidance that requires an entity to present significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. The following table presents changes in the accumulated balance for each component of other
26
comprehensive income (loss), including current period other comprehensive income (loss) and reclassifications out of accumulated other comprehensive income (loss) (amounts in thousands):
Foreign Currency Translation Adjustment
Derivative Valuation, Net of Tax
Other, Net of Tax
Totals
Accumulated other comprehensive income (loss) at December 31, 2012
15,673
(2,251
Other comprehensive income before reclassifications
(27,415
Amounts reclassified from accumulated other comprehensive income (loss)
(3,452
Net current period other comprehensive income (loss)
(30,867
Accumulated other comprehensive income (loss) at September 30, 2013
(2,414
Accumulated other comprehensive income (loss) at December 31, 2011
3,156
(2,778
(5,474
Other comprehensive income (loss) before reclassifications
10,494
277
656
(214
13,170
24,597
Accumulated other comprehensive income (loss) at September 30, 2012
13,650
(1,845
19,123
The following table presents the classification and amount of the reclassifications from accumulated other comprehensive income (loss) to the statement of comprehensive income (loss) (in thousands):
For the Three Months Ended September 30,
Statement of Comprehensive Income
(Loss) Classification
Derivative valuation
Gain on foreign currency forward exchange contracts
Loss on interest rate swaps
(380
Tax effect
(255
(396
Provision for income taxes
591
Net income (loss)
Actuarial loss on defined benefit plan
(156
(235
Cost of services
(222
27
For the Nine Months Ended September 30,
Gain (loss) on foreign currency forward exchange contracts
(2,550
(582
3,899
870
(473
(695
39
(447
(656
(13) NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted shares for the periods indicated (amounts in thousands):
Shares used in basic earnings per share calculation
Effect of dilutive securities:
Stock options
425
377
378
Restricted stock units
521
435
380
Performance-based restricted stock units
Total effects of dilutive securities
946
812
Shares used in dilutive earnings per share calculation
For the three months ended September 30, 2013 and 2012, options to purchase 0.1 million and 0.1 million shares of common stock, respectively, were outstanding, but not included in the computation of diluted net income per share because the exercise price exceeded the value of the shares and the effect would have been anti—dilutive. For the nine months ended September 30, 2013 and 2012, options to purchase 0.1 million and 0.1 million shares of common stock, respectively, were outstanding, but not included in the computation of diluted net income per share because the effect would have been anti-dilutive. For the three months ended September 30, 2013 and 2012, restricted stock units (“RSUs”) of 0.2 million and 0.7 million, respectively, were outstanding, but not included in the computation of diluted net income per share because the effect would have been anti-dilutive. For the nine months ended September 30, 2013 and 2012, RSUs of 0.2 million and 0.8 million, respectively, were outstanding, but not included in the computation of diluted net income per share because the effect would have been anti-dilutive.
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(14) EQUITY-BASED COMPENSATION PLANS
All equity—based awards to employees are recognized in the Consolidated Statements of Comprehensive Income at the fair value of the award on the grant date. During the three and nine months ended September 30, 2013 and 2012, the Company recognized total compensation expense of $3.3 million and $9.8 million and $3.4 million and $10.3 million, respectively. Of the total compensation expense, $0.6 million and $1.6 million was recognized in Cost of services and $2.7 million and $8.3 million was recognized in Selling, general and administrative during the three and nine months ended September 30, 2013. During the three and nine months ended September 30, 2012, the Company recognized total compensation expense of $0.5 million and $1.5 million in Cost of services and $2.9 million and $8.8 million was recognized in Selling, general and administrative.
Stock Options
As of September 30, 2013, there was approximately $0.4 million of total unrecognized compensation cost (including the impact of expected forfeitures) related to unvested option arrangements granted under the Company’s equity plans. The Company recognizes compensation expense straight—line over the vesting term of the option grant. The Company recognized compensation expense related to stock options of approximately $0.1 million and $0.1 million for the three months ended September 30, 2013 and 2012, respectively. The Company recognized compensation expense related to stock options of approximately $0.3 million and $0.4 million for the nine months ended September 30, 2013 and 2012, respectively.
Restricted Stock Unit Grants
During the nine months ended September 30, 2013 and 2012, the Company granted 755,835 and 637,042 RSUs, respectively, to new and existing employees, which vest in equal installments over four or five years. The Company recognized compensation expense related to RSUs of $3.1 million and $9.4 million for the three and nine months ended September 30, 2013, respectively. The Company recognized compensation expense related to RSUs of $3.3 million and $9.9 million for the three and nine months ended September 30, 2012, respectively. As of September 30, 2013, there was approximately $28.6 million of total unrecognized compensation cost (including the impact of expected forfeitures) related to RSUs granted under the Company’s equity plans.
As of September 30, 2013 and 2012, the Company had performance-based RSUs outstanding that vest based on the Company achieving specified revenue and operating income performance targets. The Company determined that it was not probable these performance targets would be met; therefore, no expense was recognized for the three and nine months ended September 30, 2013 or 2012.
(15) DECONSOLIDATION OF SUBSIDIARY
During the second quarter of 2013, the Company concluded that it no longer had controlling influence over Peppers & Rogers Gulf WLL (“PRG Kuwait”), a once consolidated subsidiary in the Customer Strategy Services segment, because the Company was no longer confident that it could exercise its beneficial ownership rights. Upon deconsolidation of PRG Kuwait, the Company wrote off all PRG Kuwait assets and liabilities resulting in a loss of $3.7 million which was recorded in Loss on deconsolidation of subsidiary in the Consolidated Statements of Comprehensive Income. The $3.7 million loss included $1.3 million of goodwill allocated to PRG Kuwait immediately prior to deconsolidation based on PRG Kuwait’s relative fair value of the Customer Strategy Services segment. The retained noncontrolling interest was recorded at fair value which was determined to be zero as the Company does not believe it will recognize any financial benefit from this interest.
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CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS
The following discussion and analysis should be read in conjunction with our Annual Report on Form 10—K for the year ended December 31, 2012. Except for historical information, the discussion below contains certain “forward—looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) or in releases made by the Securities and Exchange Commission (“SEC”), all as may be amended from time to time. All projections and statements regarding our expected financial position and operating results, our business strategy, our financing plans and the outcome of any contingencies are forward-looking statements. These statements can sometimes be identified by our use of forward-looking words such as “may,” “believe,” “plan,” “will,” “anticipate,” “estimate,” “expect,” “intend,” “project,” “would,” “could,” “should,” “seeks,” or “scheduled to” and other words and phrases of similar meaning. We intend the forward-looking statements throughout this Form 10-Q and the information incorporated by reference to be covered by the safe harbor provisions for forward-looking statements. Important risks, uncertainties and other factors that could cause the actual results to materially differ from those contemplated by the forward-looking statements include but are not limited to:
· U.S. and global economic conditions;
· our ability to develop new clients and retain existing clients;
· the impact of client consolidations;
· geographic concentration of our business activities;
· unauthorized disclosure of sensitive or confidential client and customer data;
· fluctuations in customer demand and our capacity utilization;
· service interruptions, security threats or other disruptions at our facilities relating to our computer and telecommunications equipment and software systems;
· negotiated provisions in our contracts, including fee structures, early termination provisions and increased costs;
· compliance with credit facility covenant restrictions, and our ability to obtain financing and manage counterparty credit risks from financial institutions;
· risks associated with conducting business operations in foreign countries;
· fluctuations in foreign currency exchange rates;
· compliance with laws and the impact of pending legislation and regulations or changes in existing federal, state, local or foreign laws and regulations;
· our ability to maintain and improve the cost efficiency of our operations, including labor costs;
· movement for delivery center workers to unionize, and possible related impacts on labor costs, especially outside of the United States;
· intense competition in the business process outsourcing industry;
· disruptions in the supply chain of the Customer Technology Services segment;
· our ability to develop and protect our intellectual property and contractual rights and avoid infringement;
· our ability to attract and retain personnel;
· our ability to grow our operations and the integration of businesses acquired through joint ventures or acquisitions;
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· the effects of a natural disaster, terrorist attack, health epidemic or other emergencies;
· ownership by our senior management of a majority of our common stock;
· failures of our controls and procedures and internal controls over financial reporting; and
· other risks and uncertainties affecting our business described in this Quarterly Report on Form 10-Q, under the captions Item 1A. Risk Factors and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2012, in our other SEC filings and in our press releases.
The forward-looking statements are based on information available as of the date of this Form 10-Q and on numerous assumptions and developments that are not within our control. Although we believe these forward-looking statements are reasonable, we cannot assure you they will turn out to be correct. We assume no obligation to update any forward-looking statements to reflect actual results, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Summary
TeleTech is a large and geographically diverse global provider of technology-enabled, fully-integrated customer experience management solutions. We have a 31-year history of helping our clients maximize the value of their brand through the design and delivery of exceptional customer experiences. Our end-to-end offering originates with the design of data-rich customer-centric strategies which are then enabled by a suite of technologies and operations that allow for effective management and growth of the economic value of our client’s customer relationships.
We have developed deep vertical industry expertise and serve more than 250 global clients in the automotive, communications, financial services, government, healthcare, logistics, media and entertainment, retail, technology, travel and transportation industries. We target customer-focused industry leaders in the Global 1000, which are the world’s largest companies based on market capitalization, due to their size, global reach and desire for a partner who can quickly and globally scale a suite of fully-integrated services. We typically enter into long-term relationships which provide us with a more predictable revenue stream. Although most of our contracts can be terminated for convenience with reasonable notices, our relationships with our top five clients have ranged from seven to 17 years with the majority of these clients having completed multiple contract renewals with us.
To further improve our competitive position and stay ahead of a rapidly changing market for our services, we continue to invest in new growth areas. We believe our commitment to innovation will enable us to remain strategically relevant to our clients and to grow and diversify our revenue into higher margin, more technology-enabled services. Of the $297.0 million in revenue we reported in the third quarter of 2013, approximately 27% or $80.0 million came from customer-centric consulting strategy, growth or technology-based services with the remainder coming from our traditional customer management services.
We believe our track record of innovation, operational excellence, financial strength and ability to deliver on the business goals of our clients represent our strongest competitive advantages and have been significant contributors to our client retention rate of 92% for the combination of our Customer Management Services and Customer Growth Services segments during the first nine months of 2013.
Our solid balance sheet, cash flows from operations and access to capital markets have provided us the financial flexibility to fund our organic growth, strategic acquisitions and our ongoing stock repurchase program.
Consistent with our growth and diversification strategy, we have in the past and may in the future acquire additional companies, products or technologies. In 2013, we completed the acquisition of WebMetro in August, completed the buy-out of a 20% interest in Peppers & Rogers Group in September, and potential additional acquisitions are planned for the remainder of 2013. During 2012, we completed four acquisitions including OnState Communications Corporation and iKnowtion LLC (“iKnowtion”) in the first quarter of 2012, and Guidon Performance Solutions (“Guidon”) and Technology Solutions Group, Inc. (“TSG”) in the fourth quarter of 2012. We have included the financial results of the business combinations in our consolidated results of operations beginning on the respective acquisition dates in their applicable segments.
Our Market Opportunity
We believe that our revenue will grow over the long-term as global demand for our services is fueled by the following trends:
· Increasing focus on the customer experience to sustain competitive advantage. The ability to sustain a competitive advantage based on price or product differentiation has significantly narrowed given the speed of technological innovation. As customers become more connected and widely broadcast their experiences across a variety of social networking channels, the quality of the experience is having a profound impact on brand loyalty and business performance. We believe customers are increasingly shaping their attitudes, behaviors and willingness to recommend or stay with a brand on the totality of their experience, including not only the superiority of the product or service but more importantly on the quality of their ongoing service interactions. Given the strong correlation between high customer satisfaction and improved profitability, we believe more companies are increasingly focused on selecting third-party partners, such as TeleTech, who can deliver a data-driven, fully-integrated solution that increases the lifetime value of each customer relationship versus merely reducing costs.
· Increasing percentage of companies consolidating their customer experience requirements with the most capable partners who can deliver measurable business outcomes by offering a fully-integrated, technology-rich solution. The proliferation of mobile communication technologies and devices along with customers’ increased access to information and heightened expectations are driving the need for companies to implement enabling technologies that ensure customers have the best experience regardless of the device, location or media they choose. These two-way interactions need to be received or delivered seamlessly via the customer channel of choice and include voice, email, chat, SMS text, intelligent self serve, virtual agents and the social web. We believe companies will continue to consolidate to third-party partners, such as TeleTech, who have demonstrated expertise in increasing brand value by delivering a holistic, fully-integrated customer-centric solution that spans strategy to execution versus the time, expense and often failed returns resulting from linking together a series of point solutions from different providers.
· Focus on speed-to-market by companies launching new products or entering new geographic locations. As companies broaden their product offerings and seek to enter new emerging markets, they are looking for partners that can provide speed-to-market while reducing their capital and operating risk. To achieve these benefits, companies select us because of our extensive operating history, established global footprint, financial strength to invest in ongoing technological innovation and the ability to quickly scale infrastructure and large, complex business processes around the globe in a short period of time while assuring a high-quality experience for their customers.
Our Future Growth Strategy
We aim to grow our revenue and profitability by focusing on higher margin, technology-enabled services that drive a superior customer experience. To that end we plan to:
· Accelerate investment in both vertical sales leadership and our technology-enabled services and platforms;
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· Build deeper, more strategic relationships with existing global clients to drive enduring, transformational change within their organizations;
· Pursue new clients who lead their respective industries and who are committed to the customer experience as a differentiator;
· Target additional, accretive acquisitions that further complement and expand our integrated solutions; and
· Build on our heritage of technology innovation through the creation of proprietary new intellectual property and bring new capabilities to the market that previously did not exist.
As we further develop and scale our strategic business segments, we are continually evaluating ways to maximize stockholder value, which could include, among other things, the sale, merger or spin-off of equity interests in our subsidiaries or the disposition of business units, in whole or in part.
Our Business Segments
Based on the requirements of our clients, we provide our services both on a fully-integrated and discrete basis.
Design — Customer Strategy Services
We typically begin by engaging our clients at a strategic level. Through our data-driven management consulting expertise we help our clients design and build their customer experience strategies. We improve our clients’ ability to better understand and predict their customers’ behaviors and preferences along with their current and future economic value so that they can deploy resources to achieve the greatest return. Using proprietary analytic models, we provide the insight clients need to build the business case for customer centricity, to better optimize their marketing spend and then work alongside them to help implement our recommendations. A key component of this practice involves instilling a high performance culture through a lean management framework. This process optimization capability enables the client to align and cascade the recommended initiatives to ensure accountability and transparency for the ultimate achievement and sustainability of future results.
Enable — Customer Technology Services
Once the design of the customer experience is completed, our ability to architect, deploy and host or manage the client’s customer management environments becomes a key enabler to achieving and sustaining the client’s customer experience vision. Given the proliferation of mobile communication technologies and devices, we enable our clients’ operations to interact with their customers across the growing array of channels including email, social networks, mobile, web, SMS text, voice and chat. We design, implement and manage cloud, on-premise or hybrid customer management environments to deliver a consistent and superior experience across all touch points on a global scale that we believe result in higher quality, lower costs and reduced risk for our clients.
Manage — Customer Management Services
We redesign and manage clients’ front-to-back office processes to deliver just-in-time, personalized, multi-channel interactions. Our front-office solutions seamlessly integrate voice, chat, e-mail, ecommerce and social media to optimize the customer experience for our clients. In addition, we manage certain back-office processes for our clients to enhance their ability to obtain a customer-centric view of their relationships and maximize operating efficiencies. Our delivery of integrated business processes via our onshore, offshore or work-from-home associates reduces operating costs and allows customer needs to be met more quickly and efficiently, resulting in higher satisfaction, brand loyalty and a stronger competitive position for our clients.
Grow — Customer Growth Services
We offer fully integrated sales and marketing solutions to help our clients boost revenue in new, fragmented or underpenetrated business-to-consumer or business-to-business markets. We deliver approximately $1 billion in client revenue annually via the acquisition, growth and retention of customers through a combination of our highly trained, client-dedicated sales professionals and our proprietary Revana Analytic Multichannel PlatformTM. This platform continuously aggregates individual customer information across all channels into one holistic view to ensure more relevant and personalized communications. These communications are dynamically triggered to send the right message to the right customer at the right time via their preferred communication channel. The ability of our sales associates to be backed by a highly scalable, technology-enabled platform that delivers smarter, more targeted digital marketing messages over email, social networks, mobile, web, SMS text, voice and chat results in higher conversion rates at a lower overall cost for our clients.
See Note 3 to the Notes to the Consolidated Financial Statements for additional discussion regarding our segment information.
Business Overview
In the third quarter of 2013, our revenue increased 3.7% to $297.0 million over the same period in 2012, despite a decrease of 2.4% or $6.9 million due to foreign currency fluctuations. Revenue adjusted for the $6.9 million decrease related to foreign exchange, $1.2 million of lost revenue due to a typhoon in the Philippines and a $5.2 million decrease related to the exit of our business in Spain increased by $24.0 million over the prior year quarter. This increase was due to organic growth and revenue from recent acquisitions. Our third quarter 2013 income from operations decreased (5.1)% to $26.0 million, or 8.7% of revenue, from $27.4 million, or 9.6% of revenue, in the third quarter of 2012. This decrease was primarily due to a $2.3 million negative impact from foreign currency fluctuations, $1.1 million additional amortization of intangibles related to the acquisitions, $0.8 million negative impact from the lost revenue due to a typhoon, and investments in sales and research and development. These decreases were offset by increases in our capacity utilization and income related to our acquisitions. Income from operations for the third quarter 2013 and 2012 included an aggregate $0.8 million and $2.6 million of expenses related to restructuring charges and asset impairments, respectively.
Our offshore delivery centers serve clients based in North America and in other countries. Our offshore delivery capacity spans five countries with 17,900 workstations and currently represents 64% of our global delivery capabilities. Revenue from services provided in these offshore locations was $123 million and represented 50% of our revenue for the third quarter of 2013, as compared to $122 million and 48% of total revenue for the third quarter of 2012, with both years excluding revenue from the five acquisitions.
Our cash flow from operations and available credit allowed us to finance a significant portion of our capital needs and stock repurchases through internally generated cash flows and borrowings. At September 30, 2013, we had $144.9 million of cash and cash equivalents and a total debt to total capitalization ratio of 22.0%.
We internally target capacity utilization in our delivery centers at 80% to 90% of our available workstations. As of September 30, 2013, the overall capacity utilization in our multi—client centers was 79%. The table below presents workstation data for our multi—client centers as of September 30, 2013 and 2012. Dedicated and managed centers (4,145 and 2,611 workstations as of September 30, 2013 and 2012, respectively) are excluded from the workstation data as unused workstations in these facilities are not available for sale. Our utilization percentage is defined as the total number of utilized production workstations compared to the total number of available production workstations. We may change the designation of shared or dedicated centers based on the normal changes in our business environment and client needs.
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September 30, 2012
Total Production Workstations
In Use
% In Use
Multi-client centers
Sites open <1 year
1,317
449
1,048
810
Sites open >1 year
22,368
18,258
82
24,311
18,646
Total multi-client centers
23,685
18,707
79
25,359
19,456
We continue to see demand from all geographic regions to utilize our offshore delivery capabilities and expect this trend to continue with our clients. In light of this trend, we plan to continue to selectively retain capacity and expand into new offshore markets. As we grow our offshore delivery capabilities and our exposure to foreign currency fluctuations increases, we continue to actively manage this risk via a multi-currency hedging program designed to minimize operating margin volatility.
Refer to Note 1 to the Notes to Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of its financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities. We regularly review our estimates and assumptions. These estimates and assumptions, which are based upon historical experience and on various other factors believed to be reasonable under the circumstances, form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Reported amounts and disclosures may have been different had management used different estimates and assumptions or if different conditions had occurred in the periods presented. For further information, please refer to the discussion of all critical accounting policies in Note 1 of the Notes to the Consolidated Financial Statement in our Annual Report on Form 10-K for the year ended December 31, 2012.
Explanation of Key Metrics and Other Items
Cost of Services
Cost of services principally include costs incurred in connection with our customer management services, including direct labor, telecommunications, technology costs, printing, sales and use tax and certain fixed costs associated with the delivery centers. In addition, cost of services includes income related to grants we may receive from local or state governments as an incentive to locate delivery centers in their jurisdictions which reduce the cost of services for those facilities.
Selling, General and Administrative
Selling, general and administrative expenses primarily include costs associated with administrative services such as sales, marketing, product development, legal settlements, legal, information systems (including core technology and telephony infrastructure) and accounting and finance. It also includes outside professional fees (i.e. legal and accounting services), building expense for non—delivery center facilities and other items associated with general business administration.
Restructuring Charges, Net
Restructuring charges, net primarily include costs incurred in conjunction with reductions in force or decisions to exit facilities, including termination benefits and lease liabilities, net of expected sublease rentals.
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Interest expense includes interest expense, accretion of deferred acquisition costs and amortization of debt issuance costs associated with our debts and capitalized lease obligations.
Other Income
The main components of other income are miscellaneous income not directly related to our operating activities, such as foreign exchange transaction gains.
Other Expense
The main components of other expense are expenditures not directly related to our operating activities, such as foreign exchange transaction losses.
Presentation of Non—GAAP Measurements
Free Cash Flow
Free cash flow is a non—GAAP liquidity measurement. We believe that free cash flow is useful to our investors because it measures, during a given period, the amount of cash generated that is available for debt obligations and investments other than purchases of property, plant and equipment. Free cash flow is not a measure determined by GAAP and should not be considered a substitute for “income from operations,” “net income,” “net cash provided by operating activities,” or any other measure determined in accordance with GAAP. We believe this non—GAAP liquidity measure is useful, in addition to the most directly comparable GAAP measure of “net cash provided by operating activities,” because free cash flow includes investments in operational assets. Free cash flow does not represent residual cash available for discretionary expenditures, since it includes cash required for debt service. Free cash flow also includes cash that may be necessary for acquisitions, investments and other needs that may arise.
The following table reconciles net cash provided by operating activities to free cash flow for our consolidated results (amounts in thousands):
36,402
14,754
Less: Purchases of property, plant and equipment
33,149
Free cash flow
18,230
(1,027
44,781
30,262
We discuss factors affecting free cash flow between periods in the “Liquidity and Capital Resources” section below.
Results of Operations
Three months ended September 30, 2013 compared to three months ended September 30, 2012
The tables included in the following sections are presented to facilitate an understanding of Management’s Discussion and Analysis of Financial Condition and Results of Operations and present certain information by segment for the three months ended September 30, 2013 and 2012 (amounts in thousands). All inter—company transactions between the reported segments for the periods presented have been eliminated.
$ Change
% Change
(7,006
-3.1
Operating Income
(3,057
-14.6
The change in revenue for the Customer Management Services segment was attributable to a $14.9 million net increase in client programs offset by program completions of $9.1 million. Revenue was further impacted by a $6.4 million reduction due to foreign currency fluctuations, a $5.2 million reduction related to the exit of our business in Spain, and $1.2 million in lost revenue due to a typhoon.
The operating income as a percentage of revenue decreased to 8.3% in the third quarter of 2013 as compared to 9.4% in the third quarter of 2012. The decrease in margin was primarily due to a $2.9 million adverse impact from foreign currency fluctuations, a $0.8 million negative impact due to lost revenue from a typhoon, and investments in sales and research and development. During the third quarters of 2013 and 2012, we recorded $0.6 million and $2.7 million, respectively, in restructuring charges in various locations to better align our capacity and workforce with current business needs.
(2,307
-8.2
(1,899
-76.4
The change in revenue for the Customer Growth Services segment was due to the acquisition of WebMetro in August 2013 offset by program completions of $4.3 million and net decreases in client programs.
The operating income as a percentage of revenue decreased to 2.3% in the third quarter of 2013 as compared to 8.8% in the third quarter of 2012. This decrease was due to net declines in client volumes, changes in pricing, and the cost of ramping multiple clients. Included in the operating income was amortization related to acquired intangibles of $0.5 million and $0.2 million for the quarters ended September 30, 2013 and 2012, respectively.
18,306
81.9
2,111
69.1
The increase in revenue for the Customer Technology Services segment was related to organic growth for eLoyalty and Technology Solutions Group, Inc. (“TSG”) in consulting and managed services and the acquisition of TSG on December 31, 2012.
The operating income as a percentage of revenue decreased to 12.7% in the third quarter of 2013 as compared to 13.7% in the third quarter of 2012. This decrease was related to an increase of $0.7 million, or 1.7%, in amortization expense related to the acquisition of TSG, offset by income from the increased organic revenue and the acquisition of TSG. Included in the operating income was amortization related to acquired intangibles of $1.0 million and $0.4 million for the quarters ended September 30, 2013 and 2012, respectively.
1,734
14.8
1,445
176.4
The increase in revenue for the Customer Strategy Services segment was related to a combination of growth in operational consulting, analytics and learning innovations revenue, and the acquisition of Guidon Performance Solutions in October 2012.
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The operating income as a percentage of revenue increased to 16.9% in the third quarter of 2013 as compared to 7.0% in the third quarter of 2012. The increase was related to the increases in revenue discussed above. Included in the operating income was amortization expense of $0.4 million and $0.3 million for the quarters ended September 30, 2013 and 2012, respectively.
Interest Income (Expense)
For the three months ended September 30, 2013 interest income increased slightly to $0.9 million from $0.8 million in the comparable period in 2012. Interest expense decreased to $1.8 million during 2013 from $2.1 million during 2012.
Income Taxes
The effective tax rate for the three months ended September 30, 2013 was 24.9%. This compares to an effective tax rate of (13.8)% for the comparable period in 2012. The effective tax rate for the three months ended September 30, 2013 was influenced by a reduction in earnings in international jurisdictions currently under an income tax holiday compared to other jurisdictions and the distribution of income between the U.S. and international tax jurisdictions to more earnings in the U.S. jurisdiction. Without a $0.3 million benefit related to restructuring charges, $0.3 million of additional expense related to changes in the valuation allowance, $0.3 million of expenses related to return to provision adjustments and $0.4 million of expense related to other discrete items recognized during the quarter, our effective tax rate for the third quarter would have been 21.3%. The effective tax rate for the three months ended September 30, 2012 was influenced by earnings in international jurisdictions currently under an income tax holiday, a $7.6 million benefit related to Australia transfer pricing, and a $1.4 million benefit for the release of uncertain tax positions.
Nine months ended September 30, 2013 compared to nine months ended September 30, 2012
The tables included in the following sections are presented to facilitate an understanding of Management’s Discussion and Analysis of Financial Condition and Results of Operations and present certain information by segment for the nine months ended September 30, 2013 and 2012 (amounts in thousands). All inter—company transactions between the reported segments for the periods presented have been eliminated.
(28,060
-4.1
16,702
43.5
The change in revenue for the Customer Management Services segment was attributable to a $55.3 million net increase in client programs offset by program completions of $43.3 million. Revenue was further impacted by a $2.9 million reduction due to foreign currency fluctuations, a $35.9 million reduction related to the exit of our business in Spain, and $1.2 million in lost revenue due to a typhoon.
The operating income as a percentage of revenue increased to 8.4% for the nine months ended September 30, 2013 as compared to 5.6% for the comparable period in 2012. This increase in margin was primarily due to the exit of our business in Spain as described above, the reduction of restructuring expenses noted below and the improvement in utilization of our capacity. These increases were offset by a $3.7 million adverse impact from foreign currency fluctuations and a $0.8 million negative impact due to lost revenue from a typhoon. During the nine months ended September 30, 2013 and 2012, we recorded $3.9 million and $6.4 million, respectively, in restructuring charges in various locations to better align our capacity and workforce with current business needs. In addition, during 2012, we recorded $14.0 million in restructuring charges and $0.4 million in impairment charges as a result of our decision to exit Spain. These items were offset during 2012 in part by a $4.6 million accrual release for salaries expense due to an authoritative ruling in Spain related to the legally required cost of living adjustments for our employees’ salaries.
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(4,225
-5.6
(165
-11.7
The change in revenue for the Customer Growth Services segment was due to the combination of net increases in client programs and the acquisition of WebMetro in August 2013 of $13.2 million, offset by program completions of $17.5 million.
The operating income as a percentage of revenue remained relatively flat at 1.7% for the nine months ended September 30, 2013 as compared to 1.9% for the comparable period in 2012. Increases in income were primarily driven by a $1.8 million charge related to the impairment of trade-name intangible asset due to the rebranding of our Direct Alliance subsidiary to Revana during the first quarter of 2012. There were also operational improvements and a shift in program mix to additional outcome-based higher margin programs. These increases were offset by net declines in client volumes, changes in pricing, the cost of ramping multiple clients and increases in amortization expense related to WebMetro. Included in the operating income was amortization related to acquired intangibles of $0.9 million and $0.5 million for the nine months ended September 30, 2013 and 2012, respectively.
38,004
52.2
2,793
25.2
The increase in revenue for the Customer Technology Services segment was related to organic growth for eLoyalty and TSG in consulting and managed services and the acquisition of TSG on December 31, 2012.
The operating income as a percentage of revenue decreased to 12.5% for the nine months ended September 30, 2013 as compared to 15.2% for the comparable period in 2012. This decrease was related to investments to integrate TSG, increases in sales and marketing expenses, and a $2.0 million increase in amortization expense related to TSG. Included in the operating income was amortization related to acquired intangibles of $3.0 million and $1.4 million for the nine months ended September 30, 2013 and 2012, respectively.
1,631
5.2
(3,253
-200.7
The increase in revenue for the Customer Strategy Services segment was related to a combination of growth in operational consulting, analytics and learning innovations revenue, and the acquisitions of iKnowtion, LLC and Guidon Performance Solutions.
The segment incurred an operating loss as a percentage of revenue of (5.0)% in the first nine months of 2013 as compared to income of 5.2% in the prior period. This decrease was primarily related to the impairment charges of $1.1 million recorded as a result of the deconsolidation of a subsidiary in the second quarter of 2013 (see Notes 15 and 5 of the Notes to the Consolidated Financial Statements for further details). The decrease was also related to the full integration of the businesses comprising the Customer Strategy Services segment, including their leadership, consultants, the services portfolio and infrastructure, and a consolidation of their geographies personnel realignment. Included in the operating income was amortization expense related to acquired intangibles of $1.2 million and $0.8 million for the nine months ended September 30, 2013 and 2012, respectively.
For the nine months ended September 30, 2013 and 2012, interest income was flat at $2.2 million. Interest expense increased to $5.6 million during the nine months ended September 30, 2013 from $4.8 million for the comparable period in 2012, due to higher average borrowings on our credit facility and additional accretion of deferred acquisition costs.
Other Income (Expense), Net
Included in the nine months ended September 30, 2013, was a $3.7 million charge related to the deconsolidation of a subsidiary (see Note 15 of the Notes to the Consolidated Financial Statements for further details).
The effective tax rate for the nine months ended September 30, 2013 was 20.0%. This compares to an effective tax rate of (6.1)% for the comparable period in 2012. The effective tax rate for the nine months ended September 30, 2013 was influenced by earnings in international jurisdictions currently under an income tax holiday and the distribution of income between the U.S. and international tax jurisdictions. Without a $0.2 million benefit related to changes in the valuation allowance, a $1.8 million benefit related to restructuring charges, a $0.8 million benefit related to return to provision adjustments, and $0.3 million in expenses related to other discrete items recognized during the period, the Company’s effective tax rate for the nine months ended September 30, 2013 would have been 20.9%. The effective tax rate for the nine months ended September 30, 2012 was influenced by earnings in international jurisdictions currently under an income tax holiday and a $8.6 million tax benefit associated with the $23.7 million in restructuring and impairment charges which influenced the distribution of pre-tax income between the U.S. and international tax jurisdictions, a $7.6 million benefit related to Australia transfer pricing, and a $1.4 million benefit for the release of uncertain tax positions.
Liquidity and Capital Resources
Our principal sources of liquidity are our cash generated from operations, our cash and cash equivalents, and borrowings under our Credit Agreement, dated June 3, 2013 (the “Credit Agreement”). During the nine months ended September 30, 2013, we generated positive operating cash flows of $76.6 million. We believe that our cash generated from operations, existing cash and cash equivalents, and available credit will be sufficient to meet expected operating and capital expenditure requirements for the next 12 months.
We manage a centralized global treasury function in the United States with a focus on concentrating and safeguarding our global cash and cash equivalents. While the majority of our cash is held offshore, we prefer to hold U.S. Dollars in addition to the local currencies of our foreign subsidiaries. We expect to use our offshore cash to support working capital and growth of our foreign operations. While there are no assurances, we believe our global cash is protected given our cash management practices, banking partners and utilization of diversified, high quality investments.
We have global operations that expose us to foreign currency exchange rate fluctuations that may positively or negatively impact our liquidity. We are also exposed to higher interest rates associated with our variable-rate debt. To mitigate these risks, we enter into foreign exchange forward and option contracts and interest rate swaps through our cash flow hedging program. Please refer to Item 3. Quantitative and Qualitative Disclosures About Market Risk-Foreign Currency Risk, for further discussion.
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We primarily utilize our Credit Agreement to fund working capital, general operations, stock repurchases and other strategic activities, such as the acquisitions described in Note 2 of the Notes to Consolidated Financial Statements. As of September 30, 2013 and December 31, 2012, we had borrowings of $118.0 million and $108.0 million, respectively, under our Credit Agreement, and our average daily utilization was $240.9 million and $144.4 million for the nine months ended September 30, 2013 and 2012, respectively. After consideration for issued letters of credit under the Credit Agreement, totaling $3.5 million, our remaining borrowing capacity was $578.5 million as of September 30, 2013. As of September 30, 2013, we were in compliance with all covenants and conditions under our Credit Agreement.
The following discussion highlights our cash flow activities during the nine months ended September 30, 2013 and 2012.
Cash and Cash Equivalents
We consider all liquid investments purchased within 90 days of their original maturity to be cash equivalents. Our cash and cash equivalents totaled $144.9 million and $164.5 million as of September 30, 2013 and December 31, 2012, respectively. We diversify the holdings of such cash and cash equivalents considering the financial condition and stability of the counterparty institutions.
We reinvest our cash flows to grow our client base, and expand our infrastructure, and for investment in research and development, strategic acquisitions and the purchase of our outstanding stock.
Cash Flows from Operating Activities
For the nine months ended September 30, 2013 and 2012, net cash flows provided by operating activities were $76.6 million and $63.4 million, respectively. The $13.2 million increase is attributable to a $19.7 million decrease in spend on prepaid and other assets, a $4.2 million increase in cash related net income and a $1.7 million decrease in cash spent on operating activities offset by a $11.9 million decrease in cash received from prepayments from customers and a $0.4 million decrease in collections of accounts receivable.
Cash Flows from Investing Activities
For the nine months ended September 30, 2013 and 2012, we reported net cash flows used in investing activities of $40.8 million and $37.5 million, respectively. The increase of $3.3 million was due to a $4.1 million increase in spending on acquisitions offset by a $1.4 million decrease in spend on capital expenditures.
Cash Flows from Financing Activities
For the nine months ended September 30, 2013 and 2012, we reported net cash flows used in financing activities of $45.5 million and $25.7 million, respectively. The $19.8 million increase in net cash flows used from 2012 to 2013 was primarily due to a $14.0 million decrease in net borrowings from our line of credit, and a reduction of $3.6 million in purchases of our outstanding common stock offset by a $5.8 million increase in net payments on other debt, a $1.4 million increase in payments for debt issuance costs and a $2.0 million increase in distributions made to noncontrolling interest.
Free cash flow, a non-GAAP measurement (see “Presentation of Non—GAAP Measurements” for definition of free cash flow) decreased for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012 due to the increase in cash flows provided by operating activities and the decrease in cash spent on capital expenditures between periods. Free cash flow was $44.8 million and $30.3 million for the nine months ended September 30, 2013 and 2012, respectively.
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Obligations and Future Capital Requirements
Future maturities of our outstanding debt and contractual obligations as of September 30, 2013 are summarized as follows (amounts in thousands):
Less than 1 Year
1 to 3 Years
3 to 5 Years
Over 5 Years
Credit Facility(1)
3,416
6,684
122,225
132,325
Equipment financing arrangements
72
Contingent consideration
5,164
9,071
14,235
Purchase obligations
16,851
11,109
27,961
Operating lease commitments
22,442
42,402
27,004
97,179
Other debt
5,494
4,628
1,171
11,293
53,439
73,894
150,401
283,065
(1) Includes estimated interest payments based on the weighted-average interest rate, unused commitment fees, current interest rate swap arrangements, and outstanding debt as of September 30, 2013.
· Contractual obligations to be paid in a foreign currency are translated at the period end exchange rate.
· Purchase obligations primarily consist of outstanding purchase orders for goods or services not yet received, which are not recognized as liabilities in our Consolidated Balance Sheets until such goods and/or services are received.
· The contractual obligation table excludes our liabilities of $0.5 million related to uncertain tax positions because we cannot reliably estimate the timing of cash payments.
The increase in our outstanding debt is primarily associated with the use of funds under our Credit Agreement to fund working capital, repurchase our common stock, and other cash flow needs across our global operations.
Future Capital Requirements
We expect total capital expenditures in 2013 to be within the range of $50 to $60 million. Approximately 70% of these expected capital expenditures are to support growth in our business and 30% relate to the maintenance of existing assets. The anticipated level of 2013 capital expenditures is primarily driven by new client contracts and the corresponding requirements for additional delivery center capacity as well as enhancements to our technological infrastructure.
The amount of capital required over the next 12 months will depend on our levels of investment in infrastructure necessary to maintain, upgrade or replace existing assets. Our working capital and capital expenditure requirements could also increase materially in the event of acquisitions or joint ventures, among other factors. These factors could require that we raise additional capital through future debt or equity financing. We can provide no assurance that we will be able to raise additional capital upon commercially reasonable terms acceptable to us.
Debt Instruments and Related Covenants
On June 3, 2013, we entered into a $700.0 million, five-year, multi-currency revolving credit facility (the “Credit Agreement”) with a syndicate of lenders which includes an accordion feature that permits us to request an increase in total commitments up to $1.0 billion, under certain conditions. Wells Fargo Securities, LLC, KeyBank National Association, Bank of America Merrill Lynch, BBVA Compass and HSBC Bank USA, National Association served as Joint Lead Arrangers. The Credit Agreement amends and restates in its entirety our prior credit facility entered into during 2010 and amended in 2012.
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The Credit Agreement provides for a secured revolving credit facility that matures on June 3, 2018 with an initial maximum aggregate commitment of $700.0 million. At our discretion, direct borrowing options under the Credit Agreement include (i) Eurodollar loans with one, two, three, and six month terms, and/or (ii) overnight base rate loans. The Credit Agreement also provides for a sub-limit for loans or letters of credit in both U.S. dollars and certain foreign currencies, with direct foreign subsidiary borrowing capabilities up to 50% of the total commitment amount. We may increase the maximum aggregate commitment under the Credit Agreement to $1.0 billion if certain conditions are satisfied, including that we are not in default under the Credit Agreement at the time of the increase and that we obtain the commitment of the lenders participating in the increase.
Base rate loans bear interest at a rate equal to the greatest of (i) Wells Fargo’s prime rate, (ii) one half of 1% in excess of the federal funds effective rate, and (iii) 1.25% in excess of the one month London Interbank Offered Rate (“LIBOR”), in each case adding a margin based upon our leverage ratio. Eurodollar loans bear interest based upon LIBOR, plus a margin based upon our leverage ratio. Alternate loans bear interest at rates applicable to their respective currencies. Letter of credit fees are one eighth of 1% of the stated amount of the letter of credit on the date of issuance, renewal or amendment, plus an annual fee equal to the borrowing margin for Eurodollar loans. Commitment fees are payable to the Lenders in an amount equal to the unused portion of the credit facility and are based upon our leverage ratio.
Indebtedness under the Credit Agreement is guaranteed by certain of our present and future domestic subsidiaries. Indebtedness under the Credit Agreement and the related guarantees are secured by security interests (subject to permitted liens) in the U.S. accounts receivable and cash of our Company and certain of its domestic subsidiaries and may be secured by tangible assets of our Company and such domestic subsidiaries if borrowings by foreign subsidiaries exceed $100.0 million and the leverage ratio is greater than 3.00 to 1.00. We also pledged 65% of the voting stock and 100% of the non-voting stock of certain of our Company’s material foreign subsidiaries and may pledge 65% of the voting stock and 100% of the non-voting stock of our Company’s other foreign subsidiaries.
The Credit Agreement includes customary financial covenants, and as of September 30, 2013 we were in compliance with all financial covenants.
We primarily utilize our credit facilities to fund working capital, general operations, stock repurchases and other strategic activities, such as the acquisitions described in Note 2 of the accompanying financial statements. As of September 30, 2013 and December 31, 2012, we had borrowings of $118.0 million and $108.0 million, respectively, under our credit facilities, and our average daily utilization was $240.9 million and $144.4 million for the nine months ended September 30, 2013 and 2012, respectively. After consideration for issued letters of credit under the Credit Agreement, totaling $3.5 million, our remaining borrowing capacity was $578.5 million as of September 30, 2013.
Client Concentration
During the nine months ended September 30, 2013, one of our clients represented 11.7% of our total revenue. Our five largest clients accounted for 40.9% and 39.7% of our consolidated revenue for the three months ended September 30, 2013 and 2012, respectively. Our five largest clients accounted for 40.8% and 38.0% of our consolidated revenue for the nine months ended September 30, 2013 and 2012, respectively. We have experienced long-term relationships with our top five clients, ranging from seven to 17 years, with the majority of these clients having completed multiple contract renewals with us. The relative contribution of any single client to consolidated earnings is not always proportional to the relative revenue contribution on a consolidated basis and varies greatly based upon specific contract terms. In addition, clients may adjust business volumes served by us based on their business requirements. We believe the risk of this concentration is mitigated, in part, by the long—term contracts we have with our largest clients. Although certain client contracts may be terminated for convenience by either party, we believe this risk is mitigated, in part, by the service level disruptions and transition/migration costs that would arise for our clients.
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The contracts with our five largest clients expire between 2014 and 2016. Additionally, a particular client may have multiple contracts with different expiration dates. We have historically renewed most of our contracts with our largest clients. However, there is no assurance that future contracts will be renewed, or if renewed, will be on terms as favorable as the existing contracts.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our consolidated financial position, consolidated results of operations, or consolidated cash flows due to adverse changes in financial and commodity market prices and rates. Market risk also includes credit and non-performance risk by counterparties to our various financial instruments. We are exposed to market risk due to changes in interest rates and foreign currency exchange rates (as measured against the U.S. dollar); as well as credit risk associated with potential non-performance of our counterparty banks. These exposures are directly related to our normal operating and funding activities. We enter into derivative instruments to manage and reduce the impact of currency exchange rate changes, primarily between the U.S. dollar/Canadian dollar, the U.S. dollar/Philippine peso, the U.S. dollar/Mexican peso, and the Australian dollar/Philippine peso. We enter into interest rate derivative instruments to reduce our exposure to interest rate fluctuations associated with our variable-rate debt. To mitigate against credit and non-performance risk, it is our policy to only enter into derivative contracts and other financial instruments with investment grade counterparty financial institutions and, correspondingly, our derivative valuations reflect the creditworthiness of our counterparties. As of the date of this report, we have not experienced, nor do we anticipate, any issues related to derivative counterparty defaults.
Interest Rate Risk
We entered into interest rate derivative instruments to reduce our exposure to interest rate fluctuations associated with our variable rate debt. The interest rate on our Credit Agreement is variable based upon the Prime Rate and LIBOR and, therefore, is affected by changes in market interest rates. As of September 30, 2013, we had $118.0 million of outstanding borrowings under the Credit Agreement. Based upon average outstanding borrowings during the three and nine months ended September 30, 2013, interest accrued at a rate of approximately 1.4% and 1.5% per annum, respectively. If the Prime Rate or LIBOR increased by 100 basis points during the quarter, there would not have been a material impact to our consolidated financial position or results of operations.
Foreign Currency Risk
Our subsidiaries in Argentina, Canada, Costa Rica, Mexico, and the Philippines use the local currency as their functional currency for paying labor and other operating costs. Conversely, revenue for these foreign subsidiaries is derived principally from client contracts that are invoiced and collected in U.S. dollars or other foreign currencies. As a result, we may experience foreign currency gains or losses, which may positively or negatively affect our results of operations attributed to these subsidiaries. For the nine months ended September 30, 2013 and 2012, revenue associated with this foreign exchange risk was 32% and 37% of our consolidated revenue, respectively.
In order to mitigate the risk of these non-functional foreign currencies weakening against the functional currencies of the servicing subsidiaries, which thereby decreases the economic benefit of performing work in these countries, we may hedge a portion, though not 100%, of the projected foreign currency exposure related to client programs served from these foreign countries through our cash flow hedging program. While our hedging strategy can protect us from adverse changes in foreign currency rates in the short term, an overall weakening of the non-functional foreign currencies would adversely impact margins in the segments of the servicing subsidiary over the long term.
Cash Flow Hedging Program
To reduce our exposure to foreign currency exchange rate fluctuations associated with forecasted revenue in non-functional currencies, we purchase forward and/or option contracts to acquire the functional currency of the foreign subsidiary at a fixed exchange rate at specific dates in the future. We have designated and account for these derivative instruments as cash flow hedges for forecasted revenue in non-functional currencies.
While we have implemented certain strategies to mitigate risks related to the impact of fluctuations in currency exchange rates, we cannot ensure that we will not recognize gains or losses from international transactions, as this is part of transacting business in an international environment. Not every exposure is or can be hedged and, where hedges are put in place based on expected foreign exchange exposure, they are based on forecasts for which actual results may differ from the original estimate. Failure to successfully hedge or anticipate currency risks properly could adversely affect our consolidated operating results.
Our cash flow hedging instruments as of September 30, 2013 and December 31, 2012 are summarized as follows (amounts in thousands). All hedging instruments are forward contracts, except as noted.
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The fair value of our cash flow hedges at September 30, 2013 was (assets/(liabilities)) (amounts in thousands):
Maturing in the Next 12 Months
(128
(93
(5,688
(696
2,074
2,234
142
(135
(3,735
1,452
Our cash flow hedges are valued using models based on market observable inputs, including both forward and spot foreign exchange rates, implied volatility, and counterparty credit risk. The decrease in fair value from September 30, 2013 largely reflects a broad strengthening in the U.S. dollar.
We recorded a net gain of approximately $7.2 million and $2.0 million for settled cash flow hedge contracts and the related premiums for the nine months ended September 30, 2013 and 2012, respectively. These gains were reflected in Revenue in the accompanying Consolidated Statements of Comprehensive Income. If the exchange rates between our various currency pairs were to increase or decrease by 10% from current period-end levels, we would incur a material gain or loss on the contracts. However, any gain or loss would be mitigated by corresponding increases or decreases in our underlying exposures.
Other than the transactions hedged as discussed above and in Note 6 of the Notes to Consolidated Financial Statements, the majority of the transactions of our U.S. and foreign operations are denominated in their respective local currency. However, transactions are denominated in other currencies from time-to-time. We do not currently engage in hedging activities related to these types of foreign currency risks because we believe them to be insignificant as we endeavor to settle these accounts on a timely basis. For the nine months ended September 30, 2013 and 2012, approximately 22% and 26%, respectively, of revenue was derived from contracts denominated in currencies other than the U.S. dollar. Our results from operations and revenue could be adversely affected if the U.S. dollar strengthens significantly against foreign currencies.
Fair Value of Debt and Equity Securities
We did not have any investments in debt or equity securities as of September 30, 2013 or December 31, 2012.
46
ITEM 4. CONTROLS AND PROCEDURES
This Report includes the certifications of our Chief Executive Officer and Chief Financial Officer required by Rule 13a-14 of the Securities Exchange Act of 1934 (the “Exchange Act”). See Exhibits 31.1 and 31.2. This Item 4 includes information concerning the controls and control evaluations referred to in those certifications.
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to reasonably assure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.
In connection with the preparation of this Quarterly Report on Form 10-Q, our management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2013. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of September 30, 2013 to provide such reasonable assurance.
Our management, including our Chief Executive Officer and Chief Financial Officer, believes that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must consider the benefits of controls relative to their costs. Inherent limitations within a control system include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by unauthorized override of the control. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with associated policies or procedures. While the design of any system of controls is to provide reasonable assurance of the effectiveness of disclosure controls, such design is also based in part upon certain assumptions about the likelihood of future events, and such assumptions, while reasonable, may not take into account all potential future conditions. Accordingly, because of the inherent limitations in a cost effective control system, misstatements due to error or fraud may occur and may not be prevented or detected.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting during the quarter ended September 30, 2013 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 1. LEGAL PROCEEDINGS
From time to time, we have been involved in legal actions, both as plaintiff and defendant, which arise in the ordinary course of business. Accruals for legal actions have been provided for to the extent that losses are deemed both probable and estimable. Although the ultimate outcome of these claims or lawsuits cannot be ascertained, on the basis of currently available information and advice received from counsel, as appropriate, we believe that the disposition or ultimate resolution of such legal actions will not have a material adverse effect on our financial position, cash flows or results of operations. During the quarter ended September 30, 2013, there were no material changes to the legal proceedings described in our Annual Report on Form 10-K for the year ended December 31, 2012.
ITEM 1A. RISK FACTORS
There were no material changes to the risk factors as previously reported in our Annual Report on Form 10-K for the year ended December 31, 2012.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
Following is the detail of the issuer purchases made during the quarter ended September 30, 2013:
Period
Total Number of Shares Purchased
Average Price Paid per Share (or Unit)
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in thousands)(1)
June 30, 2013
19,434
July 1, 2013 - July 31, 2013
541,432
23.73
6,586
August 1, 2013 - August 31, 2013
180,550
24.92
27,087
September 1, 2013 - September 30, 2013
135,364
24.29
23,800
857,346
(1) In November 2001, our Board of Directors (“Board”) authorized a stock repurchase program with the objective of increasing stockholder returns. The Board periodically authorizes additional increases to the program. The most recent Board authorization to purchase additional common stock occurred in August 2013, whereby the Board increased the program allowance by $25.0 million. Since inception of the program through September 30, 2013, the Board has authorized the repurchase of shares up to a total value of $587.3 million, of which we have purchased 39.5 million shares on the open market for $563.5 million. As of September 30, 2013 the remaining amount authorized for repurchases under the program is approximately $23.8 million. The stock repurchase program does not have an expiration date.
ITEM 6. EXHIBITS
Exhibit No.
Exhibit Description
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)
32.1
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)
32.2
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)
101.INS*
XBRL Instance Document
101.SCH*
XBRL Taxonomy Extension Schema Document
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*
XBRL Taxonomy Extension Label Linkbase Document
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF*
XBRL Taxonomy Extension Definition Linkbase Document
*
Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) Notes to the Consolidated Financial Statements, (ii) Consolidated Balance Sheets as of September 30, 2013 (unaudited) and December 31, 2012, (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2013 and 2012 (unaudited), (iv) Consolidated Statements of Stockholders’ Equity as of and for the nine months ended September 30, 2013 (unaudited), and (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012 (unaudited). Users of this data are advised pursuant to Rule 406T of Regulation S-T that this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.
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: October 30, 2013
By:
/s/ Kenneth D. Tuchman
Kenneth D. Tuchman
Chairman and Chief Executive Officer
/s/ Regina M. Paolillo
Regina M. Paolillo
Chief Financial Officer