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, 2014
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 o
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). Yes x No o
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 30, 2014, there were 48,732,502 shares of the registrant’s common stock outstanding.
TELETECH HOLDINGS, INC. AND SUBSIDIARIES
SEPTEMBER 30, 2014 FORM 10-Q
TABLE OF CONTENTS
Page No.
PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013 (unaudited)
1
Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2014 and 2013 (unaudited)
2
Consolidated Statement of Equity as of and for the nine months ended September 30, 2014 (unaudited)
3
Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 (unaudited)
4
Notes to the Unaudited Consolidated Financial Statements
5
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
36
Item 4.
Controls and Procedures
39
PART II. OTHER INFORMATION
Legal Proceedings
40
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
41
SIGNATURES
42
EXHIBIT INDEX
43
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets
(Amounts in thousands, except share amounts)
(unaudited)
September 30, 2014
December 31, 2013
ASSETS
Current assets
Cash and cash equivalents
$
87,612
158,017
Accounts receivable, net
266,846
236,099
Prepaids and other current assets
67,803
52,332
Deferred tax assets, net
9,939
11,905
Income tax receivable
7,296
11,198
Total current assets
439,496
469,551
Long-term assets
Property, plant and equipment, net
147,905
126,719
Goodwill
128,830
102,743
Contract acquisition costs, net
1,381
1,642
42,868
42,791
Other intangible assets, net
61,831
54,812
Other long-term assets
38,998
44,084
Total long-term assets
421,813
372,791
Total assets
861,309
842,342
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable
34,154
32,031
Accrued employee compensation and benefits
68,421
80,130
Other accrued expenses
34,212
31,659
Income taxes payable
6,224
6,066
Deferred tax liabilities, net
34
590
Deferred revenue
30,187
28,799
Other current liabilities
15,666
11,512
Total current liabilities
188,898
190,787
Long-term liabilities
Line of credit
115,000
100,000
2,551
2,281
Deferred rent
9,080
9,635
Other long-term liabilities
75,297
63,648
Total long-term liabilities
201,928
175,564
Total liabilities
390,826
366,351
Commitments and contingencies (Note 10)
Mandatorily redeemable noncontrolling interest
2,790
2,509
Stockholders’ equity
Preferred stock - $0.01 par value: 10,000,000 shares authorized; zero shares outstanding as of September 30, 2014 and December 31, 2013
—
Common stock - $0.01 par value; 150,000,000 shares authorized; 48,805,900 and 50,352,881 shares outstanding as of September 30, 2014 and December 31, 2013, respectively
489
503
Additional paid-in capital
355,824
356,381
Treasury stock at cost: 33,246,353 and 31,699,372 shares as of September 30, 2014 and December 31, 2013, respectively
(518,745
)
(477,399
Accumulated other comprehensive income (loss)
(33,750
(20,586
Retained earnings
655,720
606,502
Noncontrolling interest
8,155
8,081
Total stockholders’ equity
467,693
473,482
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Statements of Comprehensive Income (Loss)
(Amounts in thousands, except per share amounts)
(Unaudited)
Three Months Ended September 30,
Nine Months Ended September 30,
2014
2013
Revenue
305,900
296,995
903,611
875,070
Operating expenses
Cost of services
220,244
208,648
646,346
625,689
Selling, general and administrative
49,847
50,165
148,016
142,080
Depreciation and amortization
13,893
11,463
41,152
33,281
Restructuring charges, net
593
758
1,750
4,181
Impairment losses
1,205
Total operating expenses
284,577
271,034
837,264
806,436
Income from operations
21,323
25,961
66,347
68,634
Other income (expense)
Interest income
542
938
1,545
2,182
Interest expense
(1,646
(1,799
(5,197
(5,567
Loss on deconsolidation of subsidiary
(3,655
Other income (expense), net
248
427
5,498
1,503
Total other income (expense)
(856
(434
1,846
(5,537
Income before income taxes
20,467
25,527
68,193
63,097
Provision for income taxes
(5,778
(6,358
(14,071
(12,603
Net income
14,689
19,169
54,122
50,494
Net income attributable to noncontrolling interest
(1,442
(1,526
(3,795
(2,575
Net income attributable to TeleTech stockholders
13,247
17,643
50,327
47,919
Other comprehensive income (loss)
Foreign currency translation adjustment
(16,660
(1,708
(11,373
(18,191
Derivative valuation, gross
(18,908
(1,440
(5,044
(21,851
Derivative valuation, tax effect
7,675
412
2,282
8,620
Other, net of tax
152
804
451
Total other comprehensive income (loss)
(27,645
(2,584
(13,331
(30,971
Total comprehensive income (loss)
(12,956
16,585
40,791
19,523
Less: Comprehensive income attributable to noncontrolling interest
(1,053
(1,642
(3,212
(2,471
Comprehensive income (loss) attributable to TeleTech stockholders
(14,009
14,943
37,579
17,052
Weighted average shares outstanding
Basic
49,093
50,732
49,493
51,643
Diluted
49,940
51,678
50,338
52,499
Net income per share attributable to TeleTech stockholders
0.27
0.35
1.02
0.93
0.34
1.00
0.91
Consolidated Statement of Stockholders’ Equity
(Amounts in thousands)
Stockholders’ Equity of the Company
Preferred Stock
Common Stock
Treasury
Additional Paid-in
Accumulated Other Comprehensive
Retained
Noncontrolling
Total
Shares
Amount
Stock
Capital
Income (Loss)
Earnings
interest
Equity
Balance as of December 31, 2013
50,353
3,379
53,706
Dividends distributed to noncontrolling interest
(3,150
Adjustments to redemption value of mandatorily redeemable noncontrolling interest
(1,109
Foreign currency translation adjustments
(11,206
(167
Derivatives valuation, net of tax
(2,762
Vesting of restricted stock units
346
5,203
(9,983
(4,776
Exercise of stock options
47
713
(400
314
Excess tax benefit from equity-based awards
885
Equity-based compensation expense
8,941
12
8,953
Purchases of common stock
(1,940
(19
(47,262
(47,281
Other
Balance as of September 30, 2014
48,806
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
740
753
Amortization of debt issuance costs
527
488
Imputed interest expense and fair value adjustments to contingent consideration
(3,675
933
Provision for doubtful accounts
471
Gain on disposal of assets
(94
Deferred income taxes
13,051
5,467
(1,086
(1,074
9,031
9,842
Gain on foreign currency derivatives
1,756
(75
Loss on deconsolidation of subsidiary, net of cash of zero and $897, respectively
2,758
Changes in assets and liabilities, net of acquisitions:
Accounts receivable
(24,179
709
Prepaids and other assets
(16,118
(11,241
Accounts payable and accrued expenses
(17,830
(14,020
Deferred revenue and other liabilities
3,945
(3,225
Net cash provided by operating activities
61,907
76,613
Cash flows from investing activities
Proceeds from sale of property, plant and equipment
135
Purchases of property, plant and equipment, net of acquisitions
(52,234
(31,832
Acquisitions, net of cash acquired of $3,525 and $6,423, respectively
(23,903
(8,956
Net cash used in investing activities
(76,002
(40,788
Cash flows from financing activities
Proceeds from line of credit
1,540,100
1,114,050
Payments on line of credit
(1,525,100
(1,104,050
Proceeds from other debt
3,709
Payments on other debt
(3,769
(4,293
Payments of contingent consideration related to acquisitions
(8,547
Dividends paid to noncontrolling interest
(4,838
(3,420
Proceeds from exercise of stock options
856
1,086
1,074
Purchase of treasury stock
(51,627
Payments of debt issuance costs
(1,800
Net cash used in financing activities
(48,035
(45,501
Effect of exchange rate changes on cash and cash equivalents
(8,275
(9,906
Decrease in cash and cash equivalents
(70,405
(19,582
Cash and cash equivalents, beginning of period
164,485
Cash and cash equivalents, end of period
144,903
Supplemental disclosures
Cash paid for interest
4,038
3,271
Cash paid for income taxes
10,540
12,329
Non-cash investing and financing activities
Acquisition of equipment through increase in accounts payable
2,944
3,803
Landlord incentive credited to deferred rent
1,016
Contract acquisition costs credited to accounts receivable
1,000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) OVERVIEW AND BASIS OF PRESENTATION
Summary of Business
TeleTech Holdings, Inc. (“TeleTech” or the “Company”) is a leading provider of customer strategy, analytics-driven and technology-enabled customer engagement management solutions with 41,700 employees delivering services across 25 countries from 59 delivery centers on six continents.
We have deep industry expertise and serve more than 250 customer-focused industry leaders in the Global 1000. Our business is structured and reported in four segments: Customer Management Services (“CMS”), Customer Growth Services (“CGS”), Customer Technology Services (“CTS”), and Customer Strategy Services (“CSS”).
Basis of Presentation
The Consolidated Financial Statements are comprised of the accounts of TeleTech, its wholly owned subsidiaries, its 55% equity owned subsidiary Percepta, LLC, its 80% interest in iKnowtion, LLC, and its 80% interest in Peppers & Rogers Group through the third quarter of 2013 when the final 20% interest was purchased (see Note 2). All intercompany balances and transactions have been eliminated in consolidation.
The 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, 2014.
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, 2013.
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 on-going basis, the Company evaluates its estimates including those related to derivatives and hedging activities, income taxes including valuation allowances for deferred tax assets, self-insurance reserves, litigation reserves, restructuring reserves, allowance for doubtful accounts, contingent consideration, 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.
Recently Issued Accounting Pronouncements
In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-08, “Presentation of Financial Statements and Property, Plant, and Equipment — Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” ASU 2014-08 provides new guidance related to the definition of a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. This new guidance is effective for annual periods beginning on or after December 15, 2014 and interim periods within those years. Beginning in 2015, the Company will apply the new guidance, as applicable, to future disposals of components or classifications as held for sale.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” ASU 2014-09 provides new guidance related to how an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, ASU 2014-09 specifies new accounting for costs associated with obtaining or fulfilling contracts with customers and expands the required disclosures related to revenue and cash flows from contracts with customers. This new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and can be adopted either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment as of the date of adoption, with early application not permitted. The Company is currently determining its implementation approach and assessing the impact on the consolidated financial statements.
In June 2014, the FASB issued ASU 2014-12, “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period”. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. This new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015, and early adoption is permitted. Beginning in 2016, the Company will apply the new guidance as applicable.
In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements - Going Concern”, as a new Sub-topic, Accounting Standards Codification Sub-topic 205.40. The new going concern standard codifies in GAAP management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. This ASU is effective for interim and annual periods beginning on or after December 15, 2016 and early adoption is permitted. The Company does not expect the adoption of this standard to have a material impact on its financial position, results of operation or related disclosures.
(2) ACQUISITIONS
rogenSi
In the third quarter of 2014, the Company acquired substantially all operating assets of rogenSi Worldwide PTY, Ltd., a global sales and leadership performance training and applied leadership consulting company.
The total purchase price was $33.8 million, subject to certain working capital adjustments, and consists of $17.5 million in cash at closing and $14.5 million in three earn-out payments, contingent on the acquired companies and TeleTech’s CSS business segment achieving certain agreed earnings before interest, taxes, depreciation and amortization (“EBITDA”) targets, as defined in the sale and purchase agreement. Additionally, the estimated purchase price included a $1.8 million hold-back payment for contingencies as defined in the sale and purchase agreement which will be paid in the first quarter of 2016, if required. The earn-out payments are payable in early 2015, 2016 and 2017, based on July 1, 2014 through December 31, 2014, and full year 2015 and 2016 performance, respectively.
The fair value of the contingent consideration was measured based on significant inputs not observable in the market (Level 3 inputs). Key assumptions include a discount rate of 4.6% and expected future value of payments of $15.3 million. The $15.3 million of expected future payments was calculated using probability weighted EBITDA assessment with the highest probability associated with rogenSi achieving the targeted EBITDA for each earn-out year. As of the acquisition date, the fair value of the contingent consideration was approximately $14.5 million. As of September 30, 2014, the fair value of the contingent consideration was $14.5 million, of which $5.8 million and $8.7 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):
Preliminary Estimate of Acquisition Date Fair Value
Cash
2,668
6,415
Other assets
3,342
Property, plant and equipment
578
Customer relationships
9,169
18,038
40,210
715
2,199
Accrued expenses
1,112
2,427
6,453
Total purchase price
33,757
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 above.
The rogenSi customer relationships have been estimated based on similar acquisitions and are amortized over an estimated useful life of five years. The goodwill recognized from the rogenSi acquisition is estimated to be attributable, but not limited to, the acquired workforce and expected synergies within CSS and the Company’s other segments. A portion of the tax basis of the acquired intangibles and goodwill, determined by jurisdiction, will be deductible for income tax purposes. The acquired goodwill and the operating results of rogenSi are reported within the CSS segment from the date of acquisition.
Sofica
In the first quarter of 2014, the Company acquired a 100% interest in Sofica Group, a Bulgarian joint stock company (“Sofica”). Sofica provides customer lifecycle management and other business process services across multiple channels in multiple sites in over 18 languages.
The estimated purchase price of $14.2 million included $9.4 million in cash consideration (including working capital adjustments) and $3.8 million in earn-out payments, payable in 2015 and 2016, contingent on Sofica achieving specified EBITDA targets, as defined by the stock purchase agreement. Additionally, the estimated purchase price includes a $1.0 million hold-back payment for contingencies as defined in the stock purchase agreement which will be paid in the second quarter of 2016, if required.
7
The fair value of the contingent consideration was measured based on significant inputs not observable in the market (Level 3 inputs). Key assumptions include a discount rate of 5.0% and expected future value of payments of $4.0 million. The $4.0 million of expected future payments was calculated using a probability weighted EBITDA assessment with the highest probability associated with Sofica achieving the targeted EBITDA for each earn-out year. As of the acquisition date, the fair value of the contingent consideration was approximately $3.8 million. During the third quarter of 2014, the Company recorded a fair value adjustment of the contingent consideration of $1.8 million based on revised estimates noting higher probability of exceeding the EBITDA targets (see Note 7). As of September 30, 2014, the fair value of the contingent consideration was $5.7 million, of which $2.8 million and $2.9 million were included in Other accrued expenses and Other long-term liabilities in the accompanying Consolidated Balance Sheets, respectively.
857
3,175
378
653
3,531
7,603
16,197
296
697
664
Deferred tax liability and other
368
2,025
14,172
The Sofica customer relationships have been estimated based on similar acquisitions and are amortized over an estimated useful life of five years. The goodwill recognized from the Sofica acquisition was attributable primarily to the acquired workforce of Sofica, expected synergies, and other factors. A portion of the tax basis of the acquired intangibles and goodwill, determined by jurisdiction, will be deductible for income tax purposes. The acquired goodwill and the operating results of Sofica are reported within the CMS segment from the date of acquisition.
WebMetro
In the third quarter of 2013, the Company acquired 100% of WebMetro, a California corporation (“WebMetro”), a digital marketing agency.
8
The total purchase price was $17.8 million, including $15.3 million in cash consideration (inclusive of working capital adjustments) and $2.5 million in earn-out payments, payable in 2014 and 2015, contingent on WebMetro achieving specified EBITDA targets, as defined by the stock purchase agreement. The first contingent payment of $1.0 million was made in the second quarter of 2014. During the third quarter of 2014, the Company recorded a fair value adjustment to reduce the contingent consideration by $1.7 million based on revised estimates noting the achievement of the EBITDA target is remote (see Note 7). The acquired goodwill and the operating results of WebMetro are reported within the CGS segment.
In the third quarter of 2014, the Company finalized its valuation of WebMetro for the acquisition date assets acquired and liabilities assumed. There were no material measurement period adjustments in 2014.
Financial Impact of Acquired Businesses
The acquired businesses purchased in 2014 and 2013 noted above contributed revenues of $11.1 million and $23.9 million and income from operations of $1.0 million and $1.9 million, inclusive of $0.8 million and $2.1 million of acquired intangible amortization, to the Company for the three and nine months ended September 30, 2014. The acquired businesses purchased in 2013 noted above contributed revenues of $2.5 million and $2.5 million and income from operations of $0.4 million and $0.4 million, inclusive of $0.3 million and $0.3 million of acquired intangibles amortization to the Company for the three and nine months ended September 30, 2013.
Peppers & Rogers Group
In the third quarter of 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.
(3) SEGMENT INFORMATION
The Company reports the following four segments:
· the CMS 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 CGS segment provides technology-enabled sales and marketing solutions that support revenue generation across the customer lifecycle, including sales advisory, search engine optimization, digital demand generation, lead qualification, and acquisition sales, growth and retention services;
· the CTS segment includes operational and design consulting, systems integration, and cloud and on-premise managed services, the requirements needed to design, deliver and maintain best-in-class multichannel customer engagement platforms; and
· the CSS segment provides professional services in customer experience strategy, customer intelligence analytics, system and operational process optimization, and culture development and knowledge management.
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.
9
The following tables present certain financial data by segment (in thousands):
Three Months Ended September 30, 2014
Gross Revenue
Intersegment Sales
Net Revenue
Depreciation & Amortization
Income (Loss) from Operations
Customer Management Services
226,814
9,973
18,625
Customer Growth Services
28,765
1,511
1,800
Customer Technology Services
35,203
(9
35,194
1,927
(286
Customer Strategy Services
15,127
482
1,184
305,909
Three Months Ended September 30, 2013
217,347
(312
217,035
8,322
17,944
25,893
1,148
588
40,712
(63
40,649
1,538
5,165
13,418
455
2,264
297,370
(375
Nine Months Ended September 30, 2014
673,421
29,607
55,941
86,545
4,535
5,401
103,735
(28
103,707
5,650
1,641
39,938
1,360
3,364
903,639
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
1,400
(1,632
877,028
(1,958
Capital Expenditures
13,891
15,108
38,390
25,504
1,270
1,274
2,939
2,371
10,409
3,930
219
148
496
373
17,751
18,172
52,234
31,832
10
Total Assets
540,868
554,015
85,202
86,416
168,026
157,040
67,213
44,871
27,274
19,819
30,395
30,128
42,709
28,452
10,087
The following table presents revenue based upon the geographic location where the services are provided (in thousands):
United States
143,854
137,205
427,919
401,294
Philippines
89,963
89,206
262,171
263,365
Latin America
42,725
43,343
128,029
132,673
Europe / Middle East / Africa
20,825
18,929
62,308
52,551
Asia Pacific
7,168
4,504
18,926
13,087
Canada
1,365
3,808
4,258
12,100
Total Revenue
(4) SIGNIFICANT CLIENTS AND OTHER CONCENTRATIONS
The Company had one client that contributed in excess of 10% of total revenue for the nine months ended September 30, 2014. This client contributed 11.9% and 11.5% of total revenue for the three months ended September 30, 2014 and 2013. This client contributed 11.9% and 11.7% for the nine months ended September 30, 2014 and 2013. This client had an outstanding receivable balance of $31.5 million and $29.3 million as of September 30, 2014 and 2013.
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, 2014.
11
(5) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill consisted of the following (in thousands):
Acquisitions/ Adjustments
Impairments
Effect of Foreign Currency
(148
267
18,388
(23
26,258
(171
The Company performs a goodwill impairment assessment 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.
The Company identified a triggering event based on the continued decline during the second quarter of 2014 in operating results of the TSG reporting unit within the CTS segment. At June 30, 2014, the Company completed an interim quantitative assessment of the TSG reporting unit’s fair value using an income based approach. Key assumptions used in the fair value calculation included, but were not limited to, a perpetuity growth rate of 3.0% based on the current inflation rate combined with the GDP growth rate for the reporting unit’s geographical region and a discount rate of 19.1%, 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 and adjusted as appropriate for the Company’s view of market participant assumptions. The business plan assumed the occurrence of certain events in the future, such as realignment of operations and reduction of general and administrative costs. Significant differences in some or all of these assumptions may impact the calculated fair value of this reporting unit resulting in impairment to goodwill in a future period. The goodwill attributable to the TSG reporting unit was $23.0 million. As of June 30, 2014, the fair value of the TSG reporting unit exceeded its carrying value by 8%. The TSG reporting unit is meeting expectation and there were no further triggering events. The Company will continue to review the calculated fair value of the TSG reporting unit until the fair value is substantially in excess of its carrying value.
During the quarter ended September 30, 2014, the Company assessed whether any indicators of impairment existed for any of the reporting units and concluded there were none.
(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, 2014, 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, 2014 and 2013 (in thousands and net of tax):
Aggregate unrealized net gain/(loss) at beginning of period
119
(2,644
(8,352
9,559
Add: Net gain/(loss) from change in fair value of cash flow hedges
(11,245
(630
(4,948
(9,332
Less: Net (gain)/loss reclassified to earnings from effective hedges
(398
2,186
(3,899
Aggregate unrealized net gain/(loss) at end of period
(11,114
(3,672
The Company’s foreign exchange cash flow hedging instruments as of September 30, 2014 and December 31, 2013 are summarized as follows (amounts in thousands). All hedging instruments are forward contracts.
As of September 30, 2014
Local Currency Notional Amount
U.S. Dollar Notional Amount
% Maturing in the Next 12 Months
Contracts Maturing Through
Canadian Dollar
3,000
2,909
100.0
%
June 2015
Philippine Peso
17,753,000
405,369
(1)
34.7
August 2019
Mexican Peso
2,411,000
171,234
28.9
July 2019
579,512
As of December 31, 2013
7,500
7,336
17,355,000
404,638
2,305,500
166,132
British Pound Sterling
1,200
1,853
New Zealand Dollar
150
117
580,076
(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, 2014 and December 31, 2013.
The Company’s interest rate swap arrangements as of September 30, 2014 and December 31, 2013 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
and December 31, 2013
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, 2014 and December 31, 2013 the total notional amounts of the Company’s forward contracts used as fair value hedges were $226.8 million and $204.5 million, respectively.
13
Derivative Valuation and Settlements
The Company’s derivatives and related fair value as of September 30, 2014 and December 31, 2013 were as follows (in thousands):
Designation:
Designated as Hedging Instruments
Not Designated as Hedging Instruments
Derivative contract type:
Foreign Exchange
Interest Rate
Leases
Derivative classification:
Cash Flow
Fair Value
Embedded Derivative
Fair value and location of derivative in the Consolidated Balance Sheet:
1,998
77
(8,671
(1,019
(2,585
(11,609
(562
Total fair value of derivatives, net
(17,098
(1,581
(2,508
97
1,439
(4,595
(1,028
(815
(116
(11,708
(1,124
(11,485
(2,152
(718
The effects of derivative instruments on the Consolidated Statements of Comprehensive Income (Loss) for the three months ended September 30, 2014 and 2013 were as follows (in thousands):
Designation :
Amount of gain or (loss) recognized in other comprehensive income (loss) - effective portion, net of tax
(11,271
(476
(154
Amount and location of net gain or (loss) reclassified from accumulated OCI to income - effective portion:
917
Interest Expense
(267
(264
14
Option and Forward Contracts
Amount and location of net gain or (loss) recognized in the Consolidated Statement of Comprehensive Income:
Costs of services
18
3,708
(2,373
The effects of derivative instruments on the Consolidated Statements of Comprehensive Income (Loss) for the nine months ended September 30, 2014 and 2013 were as follows (in thousands):
Derivative contracts:
(4,814
(134
(9,254
(78
(2,795
7,227
(790
(778
116
131
1,502
(3,620
(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.
15
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, 2014 and December 31, 2013 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, 2014 and December 31, 2013, the Company had $115.0 million and $100.0 million, respectively, of borrowings outstanding under the Credit Agreement. During the three and nine months ended September 30, 2014 outstanding borrowings accrued interest at an average rate of 1.2% and 1.2% 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, 2014, 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, 2014 and December 31, 2013 (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)
(21,187
(14,471
16
The following is a summary of all the Company’s fair value measurements as of September 30, 2014 and December 31, 2013 (in thousands):
Assets
Money market investments
Derivative instruments, net
Liabilities
Deferred compensation plan liability
(8,237
Contingent consideration
(27,302
(29,424
240
(6,829
(21,748
(21,300
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”). As of December 31, 2013, the money market funds 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.
17
Contingent Consideration — The Company recorded contingent consideration related to the acquisitions of iKnowtion, Guidon, TSG, WebMetro, Sofica and rogenSi. These contingent payables were recognized at fair value using a discounted cash flow approach and a discount rate of 21.0%, 21.0%, 4.6%, 5.3%, 5.0% or 4.6%, respectively. The discount rates vary dependant on the specific risks of each acquisition including the country of operation, the nature of services and complexity of the acquired business, and other factors. These measurements were based on significant inputs not observable in the market. The Company will accrete interest expense each period using the effective interest method until the future value of these contingent payables reaches their expected future value of $28.5 million. Interest expense related to all recorded contingent payables is included in Interest expense in the Consolidated Statements of Comprehensive Income (Loss).
During the second quarter of 2014, the Company recorded a fair value adjustment of the contingent consideration associated with the TSG reporting unit within the CTS segment based on revised estimates noting achievement of the targeted 2014 EBITDA is remote. Accordingly, a $4.0 million reduction in the payable was recorded as of June 30, 2014 and was included in Other income (expense) in the Consolidated Statements of Comprehensive Income (Loss).
During the third quarter of 2014, the Company recorded a fair value adjustment of the contingent consideration associated with the Sofica reporting unit within the CMS segment of $1.8 million as revised estimates reflect Sofica exceeding its EBITDA targets under stock purchase agreement for both 2014 and 2015. Accordingly, the $1.8 million increase in the payable was recorded as of September 30, 2014 and is included in Other income (expense) in the Consolidated Statements of Comprehensive Income (Loss).
Additionally, during the third quarter of 2014, the Company recorded a fair value adjustment of the contingent consideration associated with the WebMetro reporting unit within the CGS segment based on revised estimates noting achievement of the targeted 2014 EBITDA is remote. Accordingly, a $1.7 million reduction in the payable was recorded as of September 30, 2014 and was included in Other income (expense) in the Consolidated Statements of Comprehensive Income (Loss).
A rollforward of the activity in the Company’s fair value of the contingent consideration is as follows (in thousands):
Acquisitions
Payments
Imputed Interest / Adjustments
iKnowtion
3,470
(1,400
165
2,235
Guidon
2,637
(1,426
(211
TSG
12,933
(5,292
(3,799
3,842
2,708
(1,026
(1,682
3,830
1,822
5,652
14,543
30
14,573
21,748
18,373
(9,144
27,302
(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.
During the first quarter of 2014, a benefit of $1.2 million was recorded due to the closing of statutes of limitations in Canada.
During the third quarter of 2014, the Company settled an audit with the taxing authorities in the Netherlands for tax years 2010 and 2011. An expense of $1.3 million was recorded in the quarter as a result of that settlement and the related impact through 2014.
As of September 30, 2014, the Company had $52.8 million of gross deferred tax assets (after an $10.2 million valuation allowance) and net deferred tax assets (after deferred tax liabilities) of $50.2 million related to the U.S. and international tax jurisdictions whose recoverability is dependent upon future profitability.
The effective tax rate for the three and nine months ended September 30, 2014 was 28.2% and 20.6%, respectively. The effective tax rate for the three and nine months ended September 30, 2013 was 24.9% and 20.0%, respectively.
The Company’s U.S. income tax returns filed for the tax years ending December 31, 2011 to present remain open tax years. The IRS has concluded its audit in the United Sates for tax years 2009, 2011 and 2012 resulting in no changes to the Company’s financial statements or tax liabilities as previously reported.
The Company is currently under audit of income taxes in Canada for tax years 2009 and 2010. Although the outcome of examination by taxing authorities is always uncertain, it is the opinion of management that the resolution of this audit 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, 2014 and 2013, the Company undertook restructuring activities primarily associated with reductions in the Company’s capacity and workforce in several of its segments to better align the capacity and workforce with current business needs.
A summary of the expenses recorded in Restructuring, net in the accompanying Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2014 and 2013, respectively, is as follows (in thousands):
Reduction in force
358
628
1,404
3,614
37
235
73
309
189
708
3,883
19
Facility exit charges
50
298
A rollforward of the activity in the Company’s restructuring accruals is as follows (in thousands):
Closure of Delivery Centers
Reduction in Force
1,353
Expense
1,790
(1,935
Change in estimates
(40
1,168
The remaining restructuring accruals are expected to be paid or extinguished during the next 12 months 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 its 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, 2014, the Company recognized no losses related to leasehold improvement assets. 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 CMS segment.
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 CSS segment. This expense was included in the Impairment losses in the Consolidated Statements of Comprehensive Income (Loss).
(10) COMMITMENTS AND CONTINGENCIES
Credit Facility
In the second quarter of 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.
20
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.
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, 2014 and December 31, 2013, the Company had borrowings of $115.0 million and $100.0 million, respectively, under its Credit Agreement, and its average daily utilization was $291.0 million and $240.9 million for the nine months ended September 30, 2014 and 2013, respectively. After consideration for issued letters of credit under the Credit Agreement, totaling $3.5 million, the Company’s remaining borrowing capacity was $581.5 million as of September 30, 2014. As of September 30, 2014, the Company was in compliance with all covenants and conditions under its Credit Agreement.
From time-to-time, the Company has unsecured, uncommitted lines of credit to support working capital for a few foreign subsidiaries. As of September 30, 2014 and 2013, no foreign loans were outstanding.
Letters of Credit
As of September 30, 2014, 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, 2014, letters of credit and contract performance guarantees issued outside of the Credit Agreement totaled $1.4 million.
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. The Company accrues for exposures associated with such legal actions to the extent that losses are deemed both probable and estimable. To the extent specific reserves have not been made for certain legal proceedings, their ultimate outcome, and consequently, an estimate of possible loss, if any, cannot reasonably be determined at this time.
Based on currently available information and advice received from counsel, the Company believes that the disposition or ultimate resolution of its legal proceedings, except as otherwise specifically reserved for in its financial statements, will not have a material adverse effect on the Company’s financial position, cash flows or results of operations.
In the fourth quarter of 2012, a class action complaint was filed in the State of California against a TeleTech subsidiary and Google Inc. (“Google”), as co-defendants. Pursuant to its contractual commitments, the Company has agreed to indemnify Google for costs and expenses related to the complaint. The Company settled the matter for an immaterial amount during the first quarter of 2014.
21
(11) NONCONTROLLING INTEREST
The following table reconciles equity attributable to noncontrolling interest (in thousands):
Noncontrolling interest, January 1
12,978
2,290
(3,148
Deconsolidation of a subsidiary
(121
Purchase of remaining interest in subsidiary
(4,140
(104
25
Noncontrolling interest, September 30
7,780
(12) MANDATORILY REDEEMABLE NONCONTROLLING INTEREST
The Company holds an 80% interest in iKnowtion. 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 iKnowtion’s 2015 EBITDA as defined in the purchase and sale agreement. These terms represent a contingent redemption feature which the Company determined is probable of being achieved.
The Company has recorded the mandatorily redeemable noncontrolling interest at the redemption value based on the corresponding EBITDA multiples as prescribed in the purchase and sale agreement at the end of each reporting period. At the end of each reporting period the changes in the redemption value are recorded in retained earnings. Since the EBITDA multiples as defined in the purchase and sale agreement are below the current market multiple, the Company has determined that there is no preferential treatment to the noncontrolling interest shareholders resulting in no impact to earnings per share.
A rollforward of the mandatorily redeemable noncontrolling interest is included in the table below (in thousands).
Mandatorily redeemable noncontrolling interest, January 1
1,067
Net income attributable to mandatorily redeemable noncontrolling interest
416
284
Working capital distributed to mandatorily redeemable noncontrolling interest
(1,244
(272
Change in redemption value
1,109
1,178
Mandatorily redeemable noncontrolling interest, September 30
2,257
22
(13) ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table presents changes in the accumulated balance for each component of other comprehensive income (loss), including current period other comprehensive income (loss) and reclassifications out of accumulated other comprehensive income (loss) (in thousands):
Foreign Currency Translation Adjustment
Derivative Valuation, Net of Tax
Other, Net of Tax
Totals
Accumulated other comprehensive income (loss) at December 31, 2013
(10,581
(1,653
Other comprehensive (loss) income before reclassifications
(16,113
Amounts reclassified from accumulated other comprehensive income (loss)
763
2,949
Net current period other comprehensive income (loss)
(13,164
Accumulated other comprehensive income (loss) at September 30, 2014
(21,787
(849
Accumulated other comprehensive income (loss) at December 31, 2012
15,673
(2,251
22,981
Other comprehensive income (loss) before reclassifications
(18,087
(27,415
447
(3,452
(13,231
(30,867
Accumulated other comprehensive income (loss) at September 30, 2013
(2,414
(7,886
The following table presents the classification and amount of the reclassifications from accumulated other comprehensive income to the statement of comprehensive income (in thousands):
For the Three Months Ended
Statement of Comprehensive Income
September 30, 2013
(Loss) Classification
Derivative valuation
Gain (loss) on foreign currency forward exchange contracts
Loss on interest rate swaps
Tax effect
(255
(12
398
Net income (loss)
Actuarial loss on defined benefit plan
(270
(156
(254
(147
Net (loss)
23
For the Nine Months Ended
1,399
(2,550
(2,186
3,899
(811
(473
48
(763
(447
(14) NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted shares for the periods indicated (in thousands):
Shares used in basic earnings per share calculation
Effect of dilutive securities:
Stock options
420
425
Restricted stock units
521
444
Performance-based restricted stock units
Total effects of dilutive securities
847
946
845
Shares used in dilutive earnings per share calculation
For the three months ended September 30, 2014 and 2013, 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, 2014 and 2013, 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, 2014 and 2013, restricted stock units (“RSUs”) of 0.4 million and 0.2 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, 2014 and 2013, RSUs of 0.2 million and 0.2 million, respectively, were outstanding, but not included in the computation of diluted net income per share because the effect would have been anti-dilutive.
24
(15) EQUITY-BASED COMPENSATION PLANS
All equity—based awards to employees are recognized in the Consolidated Statements of Comprehensive Income (Loss) at the fair value of the award on the grant date. During the three and nine months ended September 30, 2014 and 2013, the Company recognized total compensation expense of $3.2 million and $9.0 million and $3.3 million and $9.8 million, respectively. Of the total compensation expense, $0.5 million and $1.7 million was recognized in Cost of services and $2.2 million and $7.3 million was recognized in Selling, general and administrative during the three and nine months ended September 30, 2014. During the three and nine months ended September 30, 2013, the Company recognized compensation expense of $0.6 million and $1.6 million in Cost of Services and $2.7 million and $8.3 million, in Selling, general and administrative, respectively.
Restricted Stock Unit Grants
During the nine months ended September 30, 2014 and 2013, the Company granted 583,333 and 755,835 RSUs, respectively, to new and existing employees, which vest in equal installments over four or five years. During the nine months ended September 30, 2014 and 2013, the grants weighted average stock price was $27.00 and $21.56, respectively. The Company recognized compensation expense related to RSUs of $3.0 million and $8.6 million for the three and nine months ended September 30, 2014, respectively. 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. As of September 30, 2014, there was approximately $29.5 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, 2014 and 2013, the Company had performance-based RSUs outstanding that vest based on the Company achieving specified revenue and operating income performance targets. The Company determined it was not probable that some grants’ performance targets would be met; therefore no expense was recognized related to these grants for the three and nine months ended September 30, 2014 or 2013. For another issued grant, the Company has estimated that the performance condition will be partially met, and therefore, an appropriate amount was expensed in the third quarter of 2014.
(16) 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 CSS 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 during the second quarter of 2013. Effective April 2014, the Company entered into a stock and membership interest purchase agreement with PRG Kuwait’s other shareholders to sell its 48% interest in the company for $175 thousand.
CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995, relating to our operations, expected financial position, results of operation, and other business matters that are based on our current expectations, assumptions, and projections with respect to the future, and are not a guarantee of performance. In this report, when we use words such as “may,” “believe,” “plan,” “will,” “anticipate,” “estimate,” “expect,” “intend,” “project,” “would,” “could,” “target,” or similar expressions, or when we discuss our strategy, plans, goals, initiatives, or objectives, we are making forward-looking statements.
We caution you not to rely unduly on any forward-looking statements. Actual results may differ materially from what is expressed in the forward-looking statements, and you should review and consider carefully the risks, uncertainties and other factors that affect our business and may cause such differences, as outlined but are not limited to factors discussed in the “Risk Factors” section of our Annual Report on Form 10-K as amended in this Report.
The forward-looking statements are based on information available as of the date that this Form 10-Q is filed with the United States Securities and Exchange Commission (“SEC”) and we undertake no obligation to update them, except as may be required by applicable laws. They are based 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.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Summary
TeleTech Holdings, Inc. is a leading provider of customer strategy, analytics-driven and technology-enabled customer engagement management solutions with 41,700 employees delivering services across 25 countries from 59 delivery centers on six continents. Our revenue for the quarter ended September 30, 2014 was $306 million.
For over thirty years we have helped clients strengthen their customer relationships through strategy, innovation, technology, and process that provide exceptional customer engagement. The results are customer interactions that are more personalized, seamless, and relevant, and in turn improve our clients’ brand recognition and loyalty. 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 clients’ customer relationships.
We continue to transform the Company by providing a distinct value proposition through our integrated customer engagement offerings. Our services are value-oriented, outcome-based, and delivered on a global scale across all of our business segments, including Customer Management Services (“CMS”), Customer Growth Services (“CGS”), Customer Technology Services (“CTS”), and Customer Strategy Services (“CSS”). Our integrated platform is an industry differentiator, one that unites strategic consulting, data analytics, process optimization, system design and integration, technology solutions and services, and operational excellence. This holistic approach increases customer outcomes, satisfaction and loyalty, improves operating effectiveness and efficiencies, and drives long-term growth and profitability for our clients.
We have developed industry expertise and serve more than 250 customer-focused industry leaders in the Global 1000. Our business is structured and reported in the following four segments, each serving multiple industry segments:
Operating Segments and Industry Verticals
Automotive
√
Communication
Financial Services
Government
Healthcare
Media and Entertainment
Retail
Travel and Transportation
Technology
To improve our competitive position in a rapidly changing market and stay strategically relevant to our clients, we continue to invest in innovation and growth businesses, diversifying our traditional business process outsourcing into high-margined analytics and technology-enabled services. Of the $306 million in revenue we reported in the current period, approximately 26% or $79 million came from our emerging CGS, CTS, and CSS segments.
Consistent with our growth and diversification strategy, we continue to invest in technology differentiation, analytics, cloud computing, digital marketing, and geographic footprint. In the third quarter 2014, we acquired substantially all operating assets of rogenSi Worldwide PTY, Ltd., a global sales and leadership performance training and applied leadership consulting company. In first quarter 2014, we acquired Sofica, a customer lifecycle management and business process company based in Central Europe. In 2013, we acquired WebMetro, a digital marketing agency, and completed the buy-out of a 20% interest in Peppers & Rogers Group, our global strategic consulting business.
Our strong balance sheet, cash flows from operations and access to capital markets have provided us the financial flexibility to effectively fund our organic growth, strategic acquisitions, incremental investments and stock repurchase program.
Business Overview
In the third quarter of 2014, our revenue increased 3.0% to $305.9 million over the same period in 2013. The increase in revenue is comprised of growth in the Customer Management Services, Customer Growth Services and Customer Strategy Services segments which collectively grew 5.6%, offset by a decline in the Customer Technology Services segment. The decline in the Customer Technology Services segment is primarily related to a decline in revenue from our Avaya based offerings.
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Our third quarter 2014 income from operations decreased $4.6 million to $21.3 million or 7.0% of revenue, from $26.0 million or 8.7% of revenue in the third quarter of 2013. The decrease is primarily due to a $5.5 million reduction in Customer Technology Services with $1.0 million related to the decrease in revenue from Avaya based offerings, $1.4 million of one-time technology and managed service expenses, $1.2 million in additional selling, general and administrative expenses related to investments in sales, marketing and research and development associated with the build out of the CISCO cloud solution, and $0.5 million associated with severance and other costs related to the integration of TSG into the Customer Technology Services segment. Income from operations in the third quarter of 2014 and 2013 included $0.6 million and $0.8 million of restructuring charges and asset impairments, respectively.
Our offshore delivery centers serve clients based in North America and in other countries, and spans four countries with 18,900 workstations and representing 63% of our global delivery capability. Revenue from services provided in these offshore locations was $115 million and represented 45% of our revenue for the third quarter of 2014, as compared to $123 million and 50% of our revenue for third quarter of 2013, with both years excluding revenue from the acquisitions completed outside the CMS and CGS segments.
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. At September 30, 2014, we had $87.6 million of cash and cash equivalents, total debt of $121.1 million, and a total debt to total capitalization ratio of 20.6%.
We internally target capacity utilization in our delivery centers at 80% to 90% of our available workstations. As of September 30, 2014, the overall capacity utilization in our multi-client centers was 82%. The table below presents workstation data for our multi-client centers as of September 30, 2014 and 2013. Dedicated and Managed Centers (5,401 and 4,145 workstations, at September 30, 2014 and 2013, 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 multi-client production workstations compared to the total number of available multi-client production workstations. We may change the designation of shared or dedicated centers based on the normal changes in our business environment and client needs.
Total Production Workstations
In Use
% In Use
Multi-client centers
Sites open <1 year
441
394
89
1,317
449
Sites open >1 year
24,099
19,622
81
22,368
18,258
82
Total multi-client centers
24,540
20,016
23,685
18,707
79
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.
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Refer to Part I, Item 1. Financial Statements, Note 1 to the Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of the Company’s 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.
Management believes there have been no significant policy changes during the nine months ended September 30, 2014, to the items we disclosed as our critical accounting policies in “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, 2013.
Results of Operations
Three months ended September 30, 2014 compared to three months ended September 30, 2013
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, 2014 and 2013 (in thousands). All inter—company transactions between the reported segments for the periods presented have been eliminated.
$ Change
% Change
9,779
4.5
Operating Income
681
3.8
Operating Margin
8.2
8.3
The change in revenue for the Customer Management Services segment was attributable to a $13.4 million net increase in client programs and acquisitions offset by program completions of $3.6 million. Revenue was relatively unaffected due to foreign currency fluctuations.
The operating income as a percentage of revenue decreased slightly to 8.2% in the third quarter of 2014 as compared to 8.3% in the prior period. Adjusted for the positive $0.4 million of foreign currency impact, the operating income margin decreased due to increased investment in sales, marketing and research and development offset by operational efficiencies and lower restructuring charges of $0.4 million in the third quarter of 2014 as compared to $0.7 million in the third quarter of 2013. Included in the operating income was amortization related to acquired intangibles of $0.2 million and zero for the quarters ended September 30, 2014 and 2013, respectively.
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2,872
11.1
1,212
206.1
6.3
2.3
The change in revenue for the Customer Growth Services segment was due to the combination of a net increase in client programs and the acquisition of WebMetro in August 2013 of $5.1 million in an aggregate amount, offset by program completions of $2.2 million.
The operating income as a percentage of revenue increased to 6.3% in the third quarter of 2014 as compared to 2.3% in the prior period. This increase was primarily driven by program operational improvements and a shift in program mix to additional outcome-based higher margin programs. Included in the operating income was amortization related to acquired intangibles of $0.7 million and $0.5 million for the quarters ended September 30, 2014 and 2013, respectively.
(5,455
(13.4
)%
Operating Income (Loss)
(5,451
(105.5
(0.8
12.7
Revenue for the Customer Technology Services segment decreased by $5.5 million compared to the prior year quarter. The decrease in revenue was primarily attributable to a reduction in the Avaya based offerings.
The segment had an operating loss of (0.8)% as a percentage of revenue in the third quarter of 2014 as compared to income of 12.7% in the prior period. The decrease in operating income was primarily the result of a $1.0 million decline tied to the lower Avaya platform revenue, $1.4 million related to one-time technology and managed service expenses, $1.2 million in additional selling, general and administrative expenses related to investments in sales, marketing and research and development associated with the build out of the CISCO cloud solution, and $0.5 million associated with severance and other costs related to the integration of TSG into the Customer Technology Services segment. Included in the operating income was amortization related to acquired intangibles of $1.1 million and $1.0 million for the quarters ended September 30, 2014 and 2013, respectively.
1,709
(1,080
(47.7
7.8
16.9
The increase in revenue for the Customer Strategy Services segment was related to organic growth across our geographies and our consulting practices including our strategy, operations and technology, analytics and learning innovations practices and the acquisition of rogenSi in August 2014.
The operating income as a percentage of revenue decreased to 7.8% in the third quarter of 2014 as compared to 16.9% in the prior period. The reduction in operating income was related to the third quarter billable utilization which was adversely impacted by geographic and practice area supply versus demand which is not anticipated to continue. Included in the operating income was amortization expense of $0.5 million and $0.4 million for the quarters ended September 30, 2014 and 2013, respectively.
Interest Income (Expense)
For the three months ended September 30, 2014 interest income decreased to $0.5 million from $0.9 million in the same period in 2013. Interest expense decreased to $1.6 million during 2014 from $1.8 million during 2013 which primarily resulted from lower accretion of deferred acquisition costs.
Other Income (Expense), Net
Included in the three months ended September 30, 2014 was a $1.8 million expense and a $1.7 million benefit related to fair value adjustments of the contingent consideration for two of our acquisitions (see Part I, Item 1. Financial Statements, Note 7 to the Consolidated Financial Statements for further details).
Income Taxes
The effective tax rate for the three months ended September 30, 2014 was 28.2%. This compares to an effective tax rate of 24.9% for the same period of 2013. The effective tax rate for the three months ended September 30, 2014 was influenced by earnings in international jurisdictions currently under an income tax holiday and the relative distribution of income between the U.S. and international tax jurisdictions. Without a $0.2 million benefit related to restructuring charges, and $1.3 million of expense related to the Netherlands audit, our effective tax rate for the third quarter would have been 22.0%.
Nine months ended September 30, 2014 compared to nine months ended September 30, 2013
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, 2014 and 2013 (in thousands). All inter—company transactions between the reported segments for the periods presented have been eliminated.
13,163
2.0
801
1.5
8.4
The change in revenue for the Customer Management Services segment was attributable to a $52.2 million net increase in client programs and acquisitions offset by program completions of $18.7 million. Revenue was further impacted by a $20.3 million reduction due to foreign currency fluctuations, primarily associated with the Australian dollar and the Brazilian Real.
The operating income as a percentage of revenue decreased slightly to 8.3% in the nine months ended September 30, 2014 as compared to 8.4% in the prior period. Adjusted for the negative $5.2 million of foreign currency impact, the operating income margin increased on operational efficiencies, increased revenue and lower restructuring charges of $1.4 million in the nine months of 2014 as compared to $3.9 million in the nine months of 2013. Included in the operating income was amortization related to acquired intangibles of $0.2 million and zero for the nine months ended September 30, 2014 and 2013, respectively.
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15,397
21.6
4,157
334.2
6.2
1.7
The change in revenue for the Customer Growth Services segment was due to the combination of a net increase in client programs and the acquisition of WebMetro in August 2013 of $22.5 million in an aggregate amount, offset by program completions of $6.4 million, and a $0.7 million reduction due to foreign currency fluctuations.
The operating income as a percentage of revenue increased to 6.2% in the nine months ended September 30, 2014 as compared to 1.7% in the prior period. This increase was primarily driven by program operational improvements and a shift in program mix to additional outcome-based higher margin programs. Included in the operating income was amortization related to acquired intangibles of $2.0 million and $0.9 million for the nine months ended September 30, 2014 and 2013, respectively.
(7,148
(6.4
(12,241
(88.2
1.6
12.5
Revenue for the Customer Technology Services segment decreased by $7.1 million between the two periods. The decrease in revenue was primarily attributable to a $10.2 million decrease in revenue from the Avaya based offerings offset, in part, by approximately $1.9 million of additional CISCO cloud revenue.
The operating income as a percentage of revenue decreased to 1.6% in the nine months ended September 30, 2014 as the compared to 12.5% in the prior period. The decrease in operating income was primarily the result of a $4.4 million decline tied to lower Avaya platform revenue, $4.0 million of additional selling, general and administrative expenses related to investments in sales, marketing and research and development expenses related to the build out of the CISCO cloud solution, $1.4 million related to one-time charges for technology and managed service expenses, a $1.1 million increase in depreciation expense tied to the increased number of cloud solutions in service, and $0.5 million in severance and other cost associated with the integration of TSG into the Customer Technology Services segment. Included in the operating income was amortization related to acquired intangibles of $3.4 million and $3.0 million for the nine months ended September 30, 2014 and 2013, respectively.
7,129
21.7
4,996
306.1
(5.0
The increase in revenue for the Customer Strategy Services segment was related to organic growth across our geographies and our consulting practices including our strategy, operations and technology, analytics and learning innovation practices and the acquisition of rogenSi in August 2014.
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The operating income as a percentage of revenue increased to 8.4% in the nine months ended September 30, 2014 as compared to a loss of (5.0)% in the prior period. The improvement in the CSS operating income was primarily the result of the 21.7% increase in revenue in combination with the restructure and full integration of this segment’s multiple acquisitions initiated in the third quarter of 2013. Additionally the increase in operating income was partially related to the impairment charges of $1.1 million recorded as a result of the deconsolidation of a subsidiary in the prior period (see Part I, Item 1. Financial Statements, Note 16 to the Consolidated Financial Statements for further details). Included in the operating income was amortization expense of $1.3 million and $1.2 million for the nine months ended September 30, 2014 and 2013, respectively.
For the nine months ended September 30, 2014 interest income decreased to $1.5 million from $2.2 million in the same period in 2013. Interest expense decreased to $5.2 million during 2014 from $5.6 million in 2013 which primarily resulted from lower accretion of deferred acquisition costs.
Included in the nine months ended September 30, 2014 was a $4.0 million benefit, a $1.7 million benefit and a $1.8 million expense related to fair value adjustments of the contingent consideration for three of our acquisitions (see Part I, Item 1. Financial Statements, Note 7 to the Consolidated Financial Statements for further details).
Included in the nine months ended September 30, 2013, was a $3.7 million charge related to the deconsolidation of a subsidiary (see Part I, Item 1. Financial Statements, Note 16 to the Consolidated Financial Statements for further details).
The effective tax rate for the nine months ended September 30, 2014 was 20.6%. This compares to an effective tax rate of 20.0% for the same period of 2013. The effective tax rate for the nine months ended September 30, 2014 was influenced by earnings in international jurisdictions currently under an income tax holiday and the relative distribution of income between the U.S. and international tax jurisdictions. Without a $0.4 million benefit related to changes in the valuation allowance, a $0.6 million benefit related to restructuring charges, a $1.2 million benefit related to the lapse of statute of limitations in Canada, $1.3 million of expense related to the Netherlands audit, and a $0.1 million benefit related to other discrete items recognized during the period, the Company’s effective tax rate for the nine months would have been 21.6%.
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 quarter ended September 30, 2014, we generated positive operating cash flows of $61.9 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. See Part I, Item 1. Financial Statements, Note 10 to the Consolidated Financial Statements for further details.
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 outside the U.S, we prefer to hold U.S. dollars in addition to the local currencies of our foreign subsidiaries. We expect to use our cash outside the U.S. 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.
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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. See Item 3. Quantitative and Qualitative Disclosures About Market Risk, Foreign Currency Risk, for further details.
The following discussion highlights our cash flow activities during the nine months ended September 30, 2014 and 2013.
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 $87.6 million and $158.0 million as of September 30, 2014 and December 31, 2013, 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, expand our infrastructure, 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, 2014 and 2013, we reported net cash provided by operating activities was $61.9 million and $76.6 million, respectively. Despite increases in net income and depreciation and amortization of $11.5 million, the decrease was primarily due to a $24.9 million decrease in cash collected from accounts receivable and an increase of $3.8 million in payments made for operating expenses.
Cash Flows from Investing Activities
For the nine months ended September 30, 2014 and 2013, we reported net cash used in investing activities of $76.0 million and $40.8 million, respectively. The increase was due to increased spending on acquisitions of $14.9 million along with a $20.4 million increase in capital expenditures.
Cash Flows from Financing Activities
For the nine months ended September 30, 2014 and 2013, we reported net cash used in financing activities of $48.0 million and $45.5 million, respectively. The change in net cash flows from 2013 to 2014 was primarily due to $8.5 million of payments for contingent consideration related to acquisitions, a decrease of $4.3 million in purchases of our outstanding common stock and a $5.0 million increase in net borrowings from our line of credit.
Free Cash Flow
Free cash flow (see “Presentation of Non—GAAP Measurements” below for the definition of free cash flow) decreased for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 due to the decrease in cash flows provided by operating activities as well as an increase in capital expenditures and an increase in cash paid for acquisitions. Free cash flow was $9.7 million and $44.8 million for the nine months ended September 30, 2014 and 2013, respectively.
Presentation of Non—GAAP Measurements
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 (in thousands):
30,276
36,402
Less: Purchases of property, plant and equipment
Free cash flow
12,525
18,230
9,673
44,781
Obligations and Future Capital Requirements
Future maturities of our outstanding debt and contractual obligations as of September 30, 2014 are summarized as follows (in thousands):
Less than 1 Year
1 to 3 Years
3 to 5 Years
Over 5 Years
Credit Facility(1)
2,752
4,854
116,402
124,008
Equipment financing arrangements
11,408
12,032
23,440
Purchase obligations
31,625
28,399
60,024
Operating lease commitments
7,081
65,774
34,256
5,488
112,599
Other debt
3,126
2,310
390
5,826
55,992
113,369
151,048
325,897
(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, 2014.
· 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 $1.0 million related to uncertain tax positions because we cannot reliably estimate the timing of cash payments.
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.
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Future Capital Requirements
We expect total capital expenditures in 2014 to be within the range of $55 to $65 million. Approximately 70% of these expected capital expenditures are to support growth in our business and 30% relates to the maintenance for existing assets. The anticipated level of 2014 capital expenditures is primarily dependent upon 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.
Client Concentration
During the nine months ended September 30, 2014, one of our clients represented 11.9% of our total revenue. Our five largest clients accounted for 39.3% and 40.9% of our consolidated revenue for the three months ended September 30, 2014 and 2013, respectively. Our five largest clients accounted for 38.3% and 40.9% of our consolidated revenue for the nine months ended September 30, 2014 and 2013, respectively. We have experienced long-term relationships with our top five clients, ranging from one to 18 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.
The contracts with our five largest clients expire between 2015 and 2017. 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, 2014, we had $115.0 million of outstanding borrowings under the Credit Agreement. Based upon average outstanding borrowings during the three and nine months ended September 30, 2014, interest accrued at a rate of approximately 1.2% and 1.2% 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 Bulgaria, 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, 2014 and 2013, revenue associated with this foreign exchange risk was 32% and 32% 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, 2014 and December 31, 2013 are summarized as follows (amounts in thousands). All hedging instruments are forward contracts.
The fair value of our cash flow hedges at September 30, 2014 was (in thousands):
Assets / (Liabilities)
Maturing in the Next 12 Months
(238
(16,251
(6,488
(609
53
(6,673
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, 2014 largely reflects a broad strengthening in the U.S. dollar.
We recorded net (losses)/gains of approximately $(2.8) million and $7.2 million for settled cash flow hedge contracts and the related premiums for the nine months ended September 30, 2014 and 2013, respectively. These (losses)/gains were reflected in Revenue in the accompanying Consolidated Statements of Comprehensive Income (Loss). 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.
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Other than the transactions hedged as discussed above and in Part I. Item 1. Financial Statements, Note 6 to the Consolidated Financial Statements in the accompanying 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, 2014 and 2013, approximately 24% and 22%, 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, 2014 or December 31, 2013.
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, 2014. 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, 2014 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, 2014 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 1. LEGAL PROCEEDINGS
Part I, Item 1. Financial Statements, Note 10 to the Consolidated Financial Statements of this Form 10-Q is hereby incorporated by reference.
ITEM 1A. RISK FACTORS
There were no material changes to the risk factors described in Item 1A. Risk Factors described in our Annual Report on Form 10-K for the year ended December 31, 2013.
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, 2014:
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, 2014
31,862
July 1, 2014 - July 30, 2014
August 1, 2014 - August 31, 2014
90,831
26.48
29,457
September 1, 2014 - September 30, 2014
296,620
26.44
21,614
387,451
(1) In November 2001, our Board of Directors (“the 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 May 2014, whereby the Board increased the program allowance by $25.0 million. Since inception of the program through September 30, 2014, the Board has authorized the repurchase of shares up to a total value of $637.3 million, of which we have purchased 41.7 million shares on the open market for $615.7 million. As of September 30, 2014 the remaining amount authorized for repurchases under the program was approximately $21.6 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, 2014 and December 31, 2013 (unaudited), (iii) Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2014 and 2013 (unaudited), (iv) Consolidated Statements of Stockholders’ Equity as of and for the nine months ended September 30, 2014 (unaudited), and (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 (unaudited).
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
TELETECH HOLDINGS, INC.
(Registrant)
Date: November 5, 2014
By:
/s/ Kenneth D. Tuchman
Kenneth D. Tuchman
Chairman and Chief Executive Officer
/s/ Regina M. Paolillo
Regina M. Paolillo
Chief Financial Officer