TTEC Holdings, Inc. (TTEC) Q3 2012 Earnings Report, Transcript and Summary

Welcome to the third quarter 2012 Earnings Conference Call. [Operator Instructions] This call is being recorded at the request of TeleTech. I would now like to turn the call over to Karen Breen, TeleTech's Vice President of Investor Relations. Thank you, ma'am, you may begin.

Good morning, and thank you for joining us today. TeleTech is hosting this call to discuss the third quarter 2012 results ended September 30. Participating on today's call will be Ken Tuchman, our Chairman and CEO; and Regina Paolillo, our Chief Financial Officer. Yesterday, we issued a press release announcing our financial results for the third quarter and also filed our quarterly report on Form 10-Q with the SEC. This call will reflect items discussed within those documents, and we will make reference to them on the call today. We encourage all of you to read our quarterly report on Form 10-Q. Before we begin, I want to remind you that matters discussed on today's call may include forward-looking statements relating to our operating performance, financial goals and business outlook, which are based on management's current beliefs and assumptions. Please note that these forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise this information as a result of new information that may become available. Forward-looking statements are subject to various risks, uncertainties and other factors that could cause our actual results to differ materially from those described. They include, but are not limited to, reliance on several major clients, the risks associated with lower profitability from or the loss of one or more significant client relationship, execution risks associated with ramping new business or integrating acquired companies and the possibility of additional asset impairments and/or restructuring charges. For a more detailed description of our risk factors, please review our most recent SEC filings, including our 2011 annual report on Form 10-K. A replay of this call will be available on our website through November 22. I will now turn the call over to Ken Tuchman, our Chairman and CEO.

Thank you, Karen, and good morning to everyone. It's a pleasure to be with you today to review our financial performance along with the progress we've made on key imperatives. Before we discuss our third quarter results, I wanted to share an important milestone that we celebrated last month. October 22 marked the 30th year anniversary of our founding. As I look back over the last 3 decades, I'm both proud and humbled by what we've accomplished. We've started TeleTech with a simple idea. We wanted to provide an exceptional customer experience so that our clients could benefit from a more loyal customer base. Our passion to deliver and engage in consumer experience has never wavered. And today, our mission is more relevant than ever before. The customer experience is squarely at the forefront of every CEO's agenda, and that is what gives me great optimism about our next 30 years. Our focus on becoming the preeminent global provider of fully integrated customer experience solutions from strategy to execution remain steadfast. And to that end, we continue to concentrate on the following 3 priorities: first, position the company for top line growth; second, invest in innovation and technology-rich solutions that ensure we remain a vital partner to our clients, while also driving higher margin; and third, pursue strategic and accretive acquisitions. We believe that successful achievement of these objectives will lead to superior shareholder returns over the coming years. These initiatives are beginning to pay off, as demonstrated by our third quarter results. Now let me highlight several of our accomplishments this quarter. As we set our sights on 2013, we are keenly focused on profitable top line growth. As discussed before, revenue diversification is central to that strategy. Our diversified revenue business segment, which encompass analytics, strategy and technology enabled services grew 12% year-over-year -- excuse me, 12% over the year ago quarter, reaching $62 million. This is approximately $250 million of revenue on an annualized basis. These businesses represented just $35 million in the first quarter of 2011 and have grown nicely since our diversification efforts have been underway. Furthermore, these business segments reached 22% of revenue, up from 18% in the year ago quarter. Our goal is first outlined in our 2011 Investor Day, which is for these businesses to reach 25% of revenue by 2014. As you can see, we're well on our way to achieving that objective. As it relates to new business wins, we signed an incremental $90 million of annualized business during the third quarter of which 75% was reoccurring. This represents the expansion of 49 existing client programs along with the signing of 15 new clients. Importantly, nearly 30% of these wins came from our enhanced service offerings. Our pipeline remains strong with a number of potential opportunities across all segments. Our sales proceeds continue to be solely targeted towards clients that are focused on total value delivered versus tactical labor augmentation engagements. Clients are selecting TeleTech because of our demonstrated value proposition and our ability to analyze, design, deploy and deliver turnkey solutions that drive measurable outcomes that improve customer acquisition, retention and Net Promoter Scores. We're gaining particularly strong traction in our financial services, retail and transportation verticals, each of which grew more than 20% over the year ago quarter. In addition, we're pleased with the continued uptick rate by both new and existing clients for our integrated offerings. We now have more than 25 clients that have purchased multiple services from our solution set. We believe this is solid progress, and our goal is to double the number of clients buying these integrated services by this time next year. Our second priority is continued innovation. Over the last 30 years, our ability to stay strategically relevant to our clients and their customers' needs have continued to differentiate TeleTech. Innovation is in the DNA and it will continue to fuel our prosperity over the next decade. In 2012, we plan to invest approximately $20 million towards new innovative offerings. While this level of investment is just the beginning, our innovation pipeline is robust and we will continue to prudently pace this investment relative to near and long-term financial objectives. Let me provide a few examples of where we focus these investments during the quarter. In our CGS segment, we continue to strengthen our analytics and technology platform to enable it to scale more profitably. In our CTS segment, we further expanded our cloud-based market opportunity by being the first to receive a highly coveted contact center as a service designation from Cisco. As Cisco first authorized contact center as a service provider, we've deployed 2 distinct data centers to provide private and multi-tenant cloud services. This will further our leadership in this space as we continue to migrate to the cloud so they can deliver a higher quality multichannel experience at a lower overall cost. Turning to our third priority, the pursuit of complementary strategic acquisitions. In early October, we completed the acquisition of the Guidon Performance Management Solutions. Guidon is a global management consulting firm focused on helping some of the world's largest service companies realize the benefits of operational and cultural transformation. While we have a small internal team doing this work today, we're seeing increased client demand. Guidon not only expands our expertise and process optimization and organizational change, but allows us to quickly scale to capture the growing market opportunity. Unlike many strategic consulting firms, Guidon's partners and consultants bring deep operational experience in the same industries as our clients, and the work alongside them to help execute the recommendation, ensuring the achievement and sustainability of future results. Having now summarized progress against our 3 key priorities, let me also review certain accomplishments against our ongoing profit improvement initiatives. First, our actions to exit certain underperforming businesses will be substantially complete by year end, as originally outlined. We also remain on track to stay within the $15 million to $18 million of the originally estimated restructuring charges. Most importantly, we began to see the operating margin lift that we expected from these actions in our third quarter results. With this distraction behind us, we can now direct our full attention towards growth and innovation. Our capacity utilization reached nearly a 5-year high of 77% and also contributed to our operating margin lift this quarter. We will continue our efforts to align capacity with future needs. Lastly, SG&A has decreased nearly 9% at the start of the year. As we execute against our 3 imperatives, we continue to build our leadership team. During the quarter, we welcomed Susan Piotroski on board to lead our North American Consulting business. Most recently, Susan led the marketing and customer strategy practice at Accenture. She has a doctorate in analytics and has more than 20 years designing and implementing high-impact customer experience strategies for leading multinational companies. Also during the third quarter, we appointed Bob Frerichs to our board. Bob was one of the founding partners of Accenture, where he spent 35 years in executive leadership roles including the center's International Chairman and Group Chief Executive of North America. During his tenure at Accenture, Bob was instrumental in scaling the business to become a global leader in the business services space. His wealth of experience in management consulting and technology will be invaluable as we continue to leverage our higher value offerings, invest in innovation and advance our industry leading position in the field of customer experience management. Finally, our strong balance sheet provides us with tremendous optionality to invest in the business as well as pursue accretive acquisitions that further complement and enrich our existing suite of capabilities. In addition, we continue to drive enhanced return to shareholders via our long-term buyback program, which we first started 11 years ago. During the third quarter, we spent nearly $15 million on share repurchase and $60 million over the last 12 months. As we began the fourth quarter, we had $26.5 million available for future repurchases. In closing, as we embark on our fourth decade in business, our path forward is deliberate and focused entirely on profitable top line growth. We remain on track to deliver to the 2012 guidance that we first outlined at the beginning of the year, and we believe we're better positioned than ever before to capture this significant market opportunity ahead of us. Today, we serve nearly 200 of the world's leading brands, more than double the 85 clients we supported just 2 years ago. Given the majority of our historic growth has come from our embedded base, we see great future opportunity with these and other prospective clients. We have a strong management team, a solid balance sheet and proof points that our integrated value proposition is resonating with the market. I'm confident that our strategy will continue to create value for our clients, our employees and our shareholders. And with that, I'll turn the call over to Regina.

Thank you, Ken, and good morning, everyone. Let me start with the detailed review of our third quarter results, along with some notable highlights on our 9-month year-to-date number. Revenue for the quarter was $286.3 million compared to $304.2 million in the year ago quarter. The $17.9 million decline was related to the loss of $27.7 million in revenue from exiting certain unprofitable markets and a $4.5 million negative currency impact. Excluding these items, revenue grew 14.3%, or 4.7% over the year ago quarter. Our diversified businesses comprise $62.2 million or 22% of third quarter revenue, up from 18% in the year ago quarter. Revenue for the 9 months was $867.7 million compared to $878.9 million. The $11.1 million decline was attributable to $55.4 million in lost revenue due to the exit of certain unprofitable markets and a $17.7 million negative currency impact. Excluding these items, revenue grew $61.9 million or 7.1% over the same period a year ago. Our third quarter GAAP operating income was $27.4 million or 9.6% of revenue compared to 8.7% in the year ago quarter. Adding back the $2.6 million of restructuring and impairment charges, our non-GAAP operating income was $30 million or 10.5%. Our non-GAAP operating margin of 10.5% included nearly $3 million or a 100 basis point lift from the finalization of certain real estate and employee related expenses that will not reoccur in the fourth quarter. SG&A expenses in the quarter were 15.3% of revenue, up from 14.3% in the year ago quarter, due to higher variable compensation expense. Importantly, the third quarter SG&A of 15.3% is down from 16.1% in the first half of 2012. This is the result of ongoing efficiencies we are realizing as we leverage our general and administrative expenses across an expanding suite of services. As discussed on previous calls, we intend to drive further efficiencies in general and administrative costs to enable increased investment in R&D, along with sales and marketing. Our goal remains to bring our annualized SG&A spend over the longer term within the range of 15% to 16%. Our effective tax rate this quarter benefited from several items, the largest of which was a 5-year transfer pricing agreement with Australia. Excluding these benefits, our normalized effective tax rate for the quarter was 21.1% and 28.4% year-to-date. We continue to believe our full year 2012 effective normalized tax rate will approximate 20%. Our third quarter GAAP fully diluted earnings per share was $0.52 versus $0.44 in the year ago quarter. On a non-GAAP year-over-year basis, EPS was $0.39 versus $0.35 a year ago. During the quarter, the company repurchased 900,000 shares for a total of $14.5 million. As of quarter end, we had $26.5 million authorized for future share repurchases. Cash flow from operations increased by more than $23 million to $14.8 million from a negative $8.5 million in the year ago quarter, primarily due to the improved working capital items and higher net income. Free cash flow was a negative $1 million and was impacted by $14 million in restructuring payments made in the quarter related to exiting certain markets, as well as $7 million in higher CapEx. Capital expenditures were $15.8 million compared to $8.8 million in the third quarter of 2011. The higher expenditures were the consequence of timing, unplanned investments in our infrastructure and technology based offerings. We will continue to pace our capital investment in R&D and global infrastructure to maintain both CapEx and depreciation at a rate of approximately 3.75% of revenue and expect our full year 2012 CapEx to be within the range of $40 million to $45 million. We ended the quarter with $170.4 million in cash, $88 million of borrowings on our credit facility and total other debt of $12.8 million. This resulted in a net asset positive cash position of $69.6 million. Our total debt to capital ratio was 16.8%. Our current ratio was 3.2x and our adjusted return on capital, 24%. As of September 30, we had approximately $408 million of additional borrowing capacity available under our revolving credit facility. This continues to provide us the capacity to fund a combination of organic growth, share repurchases and accretive acquisitions. We'll continue to opportunistically execute tuck-in acquisitions consistent with the last 2 years adding additional competency, scales and geographies. Our DSOs were 78 days, down from 80 days in the year ago quarter. Turning now to our segments. I'll reiterate that we are managing the enhanced services segment to generate growth rates at a premium to our traditional BPO segment. As such, in the short run, our enhanced services will require further investment. We characterize 2012 as the launch year for these segments, including executive leadership, sales and marketing, product management and technology. These investments are fully included in our 2012 operating margin guidance of 8.5% to 9% and are pivotal to achieving our top line goals. Let me now review our segment results. Customer Management Services revenue was $224 million compared to $248.7 million a year ago. Revenue was reduced by $31.8 million in the third quarter, due to the combination of exiting certain unprofitable markets and a negative foreign currency impact. Excluding these items, revenue grew 2.9%. Operating income was $47.2 million, or 21.1% of revenue, compared to 17.4% in the year ago quarter. At the end of the third quarter, the cumulative quarterly impact of the $115 million restructured revenue with $28 million or nearly 100% of the $115 million estimated quarterly impact. The Operating margin lift in this segment was attributable to both our improved capacity utilization and the benefit we expect to begin seeing in the exit of these underperforming markets in the last half of this year. Customer Growth Services third quarter revenue grew more than 15% sequentially to $28.2 million as a result of new programs. Operating income improved 38% sequentially to $5.8 million or 20.6% of revenue on increased revenue. We continue to transition this segment to a high-performing digitized outcome-based SMB sales and marketing channels for our clients. Customer Technology Services third quarter revenue was $22.3 million compared to $22.9 million in the year ago quarter. Operating income decreased to $3.3 million from $4.3 million. The operating income declined as a result of the change in business mix, along with an increased investment in service offerings to support this segment's continued growth initiative. This segment, which has grown significantly year-over-year, was flat in the quarter, primarily on the timing of product sales and the conclusion of a large transformation project. The segment has a growing pipeline and significant opportunity in the expanding cloud market. As Ken mentioned earlier, we've recently achieved a very important cloud provider certification from Cisco, which diversified our cloud-based offerings across platforms. Customer Strategy Services third quarter revenue grew 70% to $11.7 million compared to $6.9 million in the year ago quarter. Operating margin improved to 7.1% from an operating loss of $322,000 in the year ago quarter. The operating margin lift was due to the acquisition of iKnowtion and the higher margin this business enjoys in its data analytics solution. In 2012, we will have invested $7 million in the segment to build a stronger footprint on both the U.S. and Asian markets. In the third quarter, corporate expenses were $29.7 million, down 3.3% sequentially. We are committed and on track to achieve further reductions in general and administrative expenses. We intend to redirect those savings, in part, into greater sales and product development initiatives. We are reiterating our initial 2012 guidance. We expect our revenue to be in the range of $1.15 billion to $1.2 billion and our non-GAAP operating margin to be in the range of 8.5% to 9%. The reiteration of our guidance confirms our belief that we will be in the range we communicated at the beginning of the year. While there is economic uncertainty that move and FX is likely to continue to affect the translation of our non-USD revenue, we believe we can sustain our recent progress in driving market share and profit improvement. In closing, our top priority remains driving increased shareholder value, we're committed to delivering on the priorities we outlined and look forward to providing updates on our progress in the coming quarters. Thank you and with that, I'll turn the call back to Karen.

Thank you, Regina. We'd now like to open the call for everyone's questions. [Operator Instructions] Carolyn, you can open the call.

[Operator Instructions] Our first question comes from Mike Malouf from Craig-Hallum.

I'm wondering, as you look out into over the next year or so with regards to the traditional business and I know that you're at 77% utilization right now. Are there any large changes or upgrades with facilities that you need to go through? And can you give us a sense of how your existing facilities are currently relative to where they need to be as far as technology upgrades and maybe even physical upgrades?

This is Ken. The answer is no. If you noticed in our CapEx line, we always report maintenance CapEx capital and we've always been very diligent in modernizing our facilities and making sure that they're state-of-the-art at all times. I just came back last week from the Philippines and I'm very comfortable that all of our sites are in perfect condition and have the latest technology, the latest desktops. And so, no, there is no unique onetime investments to upgrade any of our facilities anywhere in the world.

Okay, great. And if I can just squeeze in just a little bit of a follow-on question. You mentioned that your guidance remains in that 8.5% to 9%, that implies basically that the fourth quarter is anywhere from 7.7% to 9.5% and I'm just wondering if you can give us a little bit of clarity on what would swing that especially given that we're already 1 month into the quarter that dramatically? I mean, what kind of things would you expect that could hit it down to that 7.7% level because that would obviously be a lot different than how the third quarter came in?

First thing I would say is that our approach in articulating our guidance was to continue to indicate that we are in the range, it's not a statement of a lack of confidence of continuation of our profit improvement and our top line growth exiting Spain and other unprofitable markets. The one thing that I would point out very specifically is you'll see in, as I said in the script then you'll see in the queue, that we did have about $2.9 million of onetime items related to the finalization of some real estate and employee liabilities, and that will not be recurring. And so you can see that, that's about almost a point, a little bit more of our normalized operating income. And that will not repeat itself in Q4.

[Operator Instructions] Our next question comes from Tobey Sommer from SunTrust.

This is Frank in for Tobey. I had a question about that Customer Strategy Services, that performed well and iKnowtion and the strategy group has done well in terms of profitability and ramping up. Can you talk a little bit about your long-term margin goals there? And what you see as kind of the profitability level going forward for that group?

Right now, we're in a growth phase. So we think that our margins will be more likely than not a bit depressed as we're ramping the business and growing the business on a global basis. But I think that it's safe to say that the margins are going to be in the 15% to 20% range. And with focus on getting into a sustainable 20%, which is in line with other well-run strategic consulting organizations.

Okay, great. And in terms of new business, how are you seeing things looking in the first part of the fourth quarter? You've had nice wins there, can you talk a little bit about your pipeline, maybe in any impacts of retail or seasonal effects?

Yes, coming off of early in the quarter, I think you can expect that we'll be consistent with our average between $75 million and $100 million that we've had over the last year or so. I think good progress to the $90 million, up from Q2. Pipeline continues to grow and we're starting to make some headway on transformation of the front end into the vertical organization that we're building and expect that to pay off as well. So I think pretty consistent with the historical outside of the dip in Q2, and up from there as we start to monetize some of the investments we're making in the front end.

I think overall, we're very encouraged.

[Operator Instructions] Our next question comes from Shlomo Rosenbaum from Stifel.

Just after you guys exited Spain and with the work that you guys have done there, if we kind of take out that $3 million nonrecurring expense reversal, is this a level of operating margin that you guys feel comfortable with if the business should operate on, give or take with some seasonality?

Yes, I mean I would say that this is very consistent with the direction that was set last year relative to our long-term goal of 11% to 12% OI. And that we're seeing good progress in the utilization in our CMS business. We're making investments to drive the growth in our emerging businesses, but are starting to see some of those margins and that we believe that you'll continue to see progress towards that 11% to 12% over '13 and '14.

Especially as more and more people take advantage of our higher-margin capabilities, which was again, always part of our strategy and that is something that we're definitely seeing starting to take foothold.

Okay. I just want to get a little bit more color on what's been going on in the Customer Technology Services, you guys talked a little bit about a large project, can you just give us a little bit of color just of what's been going on over the last year, because we're seeing like a sequential downtrend in the revenue and I'm not sure if there's -- can you talk about how much of that business is recurring and maybe just go through what's happened over the last few quarters in terms of how much of that was project-related and how much of that is kind of the ongoing work that you guys do?

Yes. So somewhere in the range of 55% to 60% of the business is reoccurring and then the rest is a project based business. The good news is that this business I believe is going on its 21st year of operation. So these guys are pretty used to this type of business. We recently finished a very successful and very significant Salesforce.com implementation on behalf of a large automotive company. And so that has had an impact. That said, we feel very comfortable based on the pipeline that we'll be well on track to seeing nice growth in the 2013 timeframe. And we have very high confidence in this business. Its customer base is extremely loyal, continues to keep coming back for more and issuing us more and more projects. And more importantly, we're expanding CTS's product offering pretty aggressively right now so that they cover all aspects of the customer experience continuum. And we'll have a good chunk of that out built out towards the first quarter of 2013, which just simply means that we will generate, going forward, more revenue on a per client basis because we'll have more offerings that they need for each implementation that we're doing. As well as it will mean that there'll be more overall long-term reoccurring revenue, which is our stated goal.

This concludes the third quarter 2012 earnings conference call. You may disconnect at this time.