TTEC Holdings, Inc. (TTEC) Q3 2017 Earnings Report, Transcript and Summary

Welcome to TeleTech's Third Quarter 2017 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 Paul Miller, TeleTech's Senior Vice President, Treasurer and Head of Investor Relations. Thank you, and you may begin.

Good morning, and thank you for joining us today. TeleTech is hosting this call to discuss the third quarter financial results for the period ended September 30, 2017. Participating on today's call are, Ken Tuchman, our Chairman and Chief Executive Officer; and Regina Paolillo, our Chief Financial and Administrative Officer. Yesterday, TeleTech issued a press release announcing its financial results. While this call will reflect items discussed within those documents, we encourage all listeners 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 related 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 as of the date of this call, and we undertake no obligation to revise this information as a result of new developments that may occur. Forward-looking statements are subject to various risks, uncertainties and other factors that could cause our actual results to differ materially from those expected and described today. Such factors include, but are not limited to, reliance on several large clients, the risks associated with lower profitability from or the loss of one or more significant clients, execution risks associated with ramping new business or integrating acquired businesses, the possibility of asset impairments and/or restructuring charges as well as fluctuations to our financial results due to foreign exchange or other legislative developments in the United States or other countries where we do business. For a more detailed description of our risk factors, please review our Annual Report on Form 10-K. A replay of this conference call will be available on our website under the Investor Relations section. I now turn the call over to Ken Tuchman, TeleTech's Chairman and Chief Executive Officer.

Thank you, Paul, and good morning, everyone. I'm delighted to be here. It's been quite a productive quarter. Over the past few months, we have delivered strong bookings, including record Customer Technology Service bookings with strong growth in our cloud-based services. We reported a solid revenue performance; closed on the strategic acquisition of Motif; advanced our innovation in our omni-channel analytics and AI practices; completed the majority of the integration of our health care services acquisition, Connextions, and made the necessary preparations for a substantial seasonal ramp in the fourth quarter. While the seasonal ramp temporarily weighed on our third quarter operating income results as anticipated, it helps set the stage for an improved outlook and confidence to increase our full year guidance. Today, I will focus my comments on three topics, the strategic rationale behind our Motif acquisition; the growing market momentum for our Humanify Customer Engagement as a Service offering; and our focus on continuing to deliver increased shareholder value. I will then turn the call over to Regina for a more detailed review of our third quarter results and full year guidance. Yesterday, we announced the acquisition of Motif. This strategic acquisition expands our customer experience solution portfolio with essential digital trust and safety services along with community moderation capabilities. Digital safety is a lightning rod issue impacting every brand that does business online. Companies everywhere are making investments to build safe environments to protect their customers and their brands from digital fraud. Today, billions are being spent in trust and safety, and the market is expected to grow significantly within the next 5 years. As more and more time and money is being spent online, trust is emerging as an essential component to building and maintaining relationships with customers. Our acquisition of Motif provides us with a unique set of proving capabilities to help our clients build engagement with their customers by ensuring online interactions are safe, trustworthy and protected from fraud. Motif has earned the reputation as the leader in the growing field working with global innovative brands that understand that digital safety is essential to their business. Motif's proprietary approach combines technology and complex algorithms with specially trained knowledge workers to identify and stop fraudulent online activity 24/7, 365 days a year. Operating out of India and the Philippines, this acquisition also adds several of the world's largest iconic digital brands to our client portfolio in e-commerce, financial services, travel, and these customer-focused brands have the ability to take advantage of our full set of Humanify offerings. It also augments our omni-channel delivery services with extensive chat and e-mail capabilities. It provides us with a seasoned, strong management team and dedicated employee base, expands our presence into India and will be immediately accretive to earnings. In the near future, we believe that a brand's value will have as much to do with its ability to protect the digital safety of its customers as the quality of the products and services it provides. This acquisition adds key trust-building capabilities to our customer experience platform and we look forward to bringing them to our clients immediately. Now let me update you on our progress with Humanify Customer Engagement as a Service platform. Across the globe, we're leading the strategic discussions with clients about digital enablement and transformation. More and more, we are working with CEOs, CMOs, CIOs and business owners who are keenly focused on delivering long-term sustainable value through deeper customer engagement. Let me share a few examples. For a leading automotive manufacturer, we're designing a complex enterprise-wide AI bot implementation. For a financial services company, we're re-architecting the entire service experience to automate simple transactions and free up talent to advise on more complex financial topics. And for an online direct-to-consumer retailer, we're designing an omni-channel platform to enable customers and associates to interact in the customer's channel of choice. In each of these examples, we're bringing our full set of capabilities to bear. Our customer experience consultants are designing insight-based strategies for omni-channel journey orchestration. Our technology teams are installing cloud-based platforms to enable AI. Knowledge management, automation and knowledge workers are delivering empathetic experiences that are personalized, relevant and valued. While it is still early days, we are confident that this integrated approach will have a meaningful impact on our clients' businesses as well as their customer experiences. We're living in a time when brands are battling for mind share and wallet share through a differentiated service experience. Automobile manufacturers are becoming mobility companies, health insurers are becoming wellness providers. And new subscription services are emerging from everything from high-end fashion to men's grooming products, to grocery delivery. Dynamic new brands are cropping up overnight by successfully cutting out the middleman and building direct, one-to-one relationships with customers. Omni-channel technologies and analytics are enabling these new services, and artificial intelligence and machine learning is beginning to raise the bar. With every new personalized immersive interaction, customer expectations are rising and companies in every industry are rushing to figure out what to do and how to compete. From our early days, we have provided our clients with a way-to-use technology to meet the current needs of their customers while also providing them with a bridge to the future. We've continually invested in innovation with R&D, acquisitions and partnerships to keep ahead of the technology curve. This quarter, we brought new talent to our team with the addition of Tony Tsai as our Chief Information and Innovation Officer. With previous experience leading customer experience innovation at UST Global and Procter & Gamble, Tony understands that customers mindset and role technology plays in building engaging interactions and lasting relationships. With just a short time under his belt, he is already making an impact by adding advanced innovation to our client programs as well as internal IT infrastructure backbone and services. The customer experience market has reached an inflection point. Brands are working behind the scenes to make experiences appear simple to their customers. However, orchestrating dozens of insight-driven micro-interactions that crisscross multiple channels is a lot harder than it looks. The work is complex, the stakes are high and the pace is unrelenting. Companies are being forced to reinvent themselves in broad daylight in front of their customers. And in many cases, the results are not ready for prime time. We have built our business by helping our clients evolve quickly to meet the rapidly changing needs of their customers. Today, our Humanify Customer Engagement as a Service platform offers clients a combination of strategy, technology and operational excellence to move fast with limited risk. Companies choosing to compete on a differentiated service experience are embracing our end-to-end approach and together, we're designing and delivering experiences that increase revenue, reduce cost and build lasting customer engagement. Before I close, I'd like to share how we're using every lever available to continue to increase shareholder value. Through technology innovation, IT creation, thought leadership and a series of strategic acquisitions, we've expanded our customer experience platform across an array of value-oriented, outcome-based capabilities in our consulting, technology, growth and operations businesses. We have consistently delivered above average Net Promoter Score levels for our clients. We have profitably grown our business with foresight, discipline and conviction in our long-term strategy. We have reduced our outstanding shares by approximately half over the years through our share repurchase program. We have provided value to our semiannual dividend with a track record of frequent dividend increases. And through all of this, we continue to deliver strong return on invested capital. Most importantly, we have future-proofed our business for the decades to come. We have made the investments and done the work to stay ahead of where customers are going. Today, we have a unique platform and approach to innovation that will enable us to remain strategically relevant into the future. As we near the end of the year, we're well positioned. We have a proven set of customer experience solution, deep trusted relationships with premier brands in high-growth industries and an expanding global footprint, a strong revenue backlog, and a growing pipeline. In addition, we've made the required investments needed to deliver consistently with operational excellence. While we continue to have more work to do, we're encouraged by our progress and the opportunity before us. We look forward to updating you in the months ahead. On behalf of our approximately 49,000 employees across the globe, I thank you for your continued interest and support. And I now will turn the call over to Regina.

Thanks, Ken. Good morning, everyone. I'll start with the highlights of our third quarter 2017 financial guidance -- I'm sorry, excuse me. I'll start with the highlights of our third quarter 2017 financial results and then provide some commentary on our updated full year guidance. In the third quarter, we continued to execute in line with our 2017 financial guidance, which is on a non-GAAP basis, excluding restructure, integration, and impairment charges and the assets that we are exiting. During our last earnings call, we provided additional detail related to our 2017 guidance. Specifically, we estimated 27% of our full year revenue and 37% of our full year operating income was to be recognized in the fourth quarter. Using the midpoint of our full year guidance, $1.405 billion in revenue and 8.4% operating margin, our third quarter revenue, operating income and operating margin results exceeded guidance as follows. Revenue guidance was $348 million, we delivered $356 million. Operating income guidance was $22 million, we delivered $22.8 million. And operating margin guidance was 6.3%, we delivered 6.4%. The third quarter's 6.4% operating margin is lower than the first half, 7.7%, due to the planned increased spend associated with 2017's unprecedented seasonal ramp in Q4. In line with the midpoint of our updated guidance, which I will cover shortly, we anticipate fourth quarter revenue at $396 million, a sequential increase of 12% and a record-high quarter. To support this $44 million of sequential revenue growth, which is related to our CMS business, we incurred a planned step up in our recruiting, training, licensing, facilities management and support expenses in the third quarter. We are confident that the investment in these ramp expenses will be sufficiently covered within the fourth quarter where we estimate a standalone fourth quarter operating margin of approximately 11.4%. I'll now cover the details of our third quarter 2017 results. On a non-GAAP basis, revenue increased 14.8% to $359 million over the same period last year, of which 13.9% was acquired revenue growth. Foreign exchange had a positive impact on revenue of $1.7 million. Our GAAP operating income increased 26.1% to $15.8 million over the prior year, or 4.4% of revenue versus 4% last year. As previously indicated, the operating income in the third quarter was impacted by the ramp investments necessary to support increased CMS volume and acquisition-related charges and transition cost, partially offset by $3.8 million in positive foreign exchange impact. Our GAAP EPS grew 33% to $0.32 in the third quarter 2017 versus $0.24 in the prior-year period. Consistent with last quarter, the remainder of my financial comments on a non-GAAP basis, which excludes restructure integration and impairment charges in the assets that we are exiting. A reconciliation of our GAAP to non-GAAP numbers is included in the tables attached to the press release. Third quarter 2017 non-GAAP revenue increased 16.9% to $356 million over the same period last year. Of which, 14.3% is acquired revenue growth and 2.6% is organic. Operating income increased 0.6% to $22.8 million over the prior year period or 6.4% of revenue versus 7.5% last year. Regarding the assets held for sale and wind down, which are excluded from our non-GAAP results, they collectively comprised $3.1 million in revenue and a loss of $1 million in our third quarter. This compares to $8.4 million of revenue and $867,000 of operating loss in the prior year period. In the second quarter, we sold CTS' Avaya business. We continue to evaluate alternatives to -- for divesting our Middle East consulting business within the CSS segment and our digital marketing platform within our CGS segment. Additional information is available on the Acquisitions and Divestitures section of our Form 10-Q. New business signings in the third quarter of 2017 increased 31% to $114 million compared to $87 million in the prior year quarter. On a year-to-date basis, bookings increased 7% to $322 million. We're pleased with the increase in the annualized contract value and quality of our bookings, which continue to include strategic, multimillion-dollar transactions and integrated offerings across our solutions portfolio. Our reported tax rate in the third quarter 2017 was 11.7%, which reflects restructuring charges along with the distribution of income between the U.S. and international tax jurisdiction. This compares to a negative 6.9% rate in the prior year, which was impacted by restructure, intangible impairments and a loss on the assets held for sale. The normalized tax rate was 22.1% in the third quarter 2017. Capacity utilization was 78% in the third quarter of 2017, representing a 700 basis point improvement year-over-year. Capital expenditures were $14.3 million in the third quarter, up from $11.1 million in the prior year. The increase is primarily due to the Connextions acquisition. Regarding capital distributions. Our board declared a $0.25 dividend per share or $11.5 million in the third quarter, which was paid in October. The dividend represented a 25% increase over the distribution paid in October of last year. We ended the third quarter with $79 million in cash and $271 million in total debt, equating to a net debt position of $192 million. This represents a $17.5 million increase in net debt since the end of 2016, yet we have invested approximately $150 million over the past 9 months, including acquisitions, CapEx, stock repurchases and dividends. Our cash flow from operations was $24.2 million in the third quarter 2017 compared to $55.8 million in the prior year. The decline is primarily related to the timing of certain larger collections and payments, including the Connextions-related restructure and integration cost. Our DSO was 81 days in the third quarter of 2017 compared to 77 in the prior year period. Year-to-date, our cash flow from operations increased significantly to $149.6 million from $110.8 million, a 35% increase over the same 9-month period last year. Given the increase in our M&A activity over the last 12 months as well as our current pipeline, we did not execute any share buyback in the third quarter. We will continue to utilize our capital balancing, organic investment in the business, acquisition, dividends and share repurchases to maximize shareholder value. The remaining board-approved allowance available for share repurchases is $26.6 million. In the third quarter, we finalized the dissolution of our Spanish entity resulting in a onetime gain of $3.2 million. Turning to our segment results, which are presented on a non-GAAP basis. CMS' revenue grew 24% to $277.4 million over the prior year quarter, which included 19.5% growth related to our Connextions and Atelka acquisitions. Our 4.5% organic growth rate was well diversified across geographies' verticals in existing and new clients. Foreign exchange had a modest positive impact on revenue of $1.4 million. CMS' operating income was $15.1 million or 5.4% versus $15.8 million or 17 -- 7.1% in the prior year period. CMS' operating income is comprised of 40.6% organic growth, including 23 percentage points of positive foreign exchange impact, offset by planned investments to ramping increases in our recurring health care and retail seasonal volumes, which are driving the increase in our 2017 revenue guidance. With regard to the Connextions acquisition. We anticipate the acquisition to slightly exceed the prior 2017 revenue estimate of $85 million. In 2018, we expect revenue in excess of $130 million and operating margins at a premium to our CMS operating margin. With regard to the Connextions restructure and integration cost previously estimated between $15 million and $16 million, we now expect it to restructure at the low end of this range. To date, we have incurred $9 million. And we expect the remaining $6 million to be expensed in the fourth quarter. As Ken mentioned yesterday, we acquired Motif, which will be integrated into our CMS segment. Motif is estimated to add between $30 million and $35 million of revenue annually and to be accretive to the CMS operating income. We paid approximately $47 million for 70% of the company. The sales purchase agreement provides for TeleTech to purchase the remaining 30% in 2020. CGS' revenue declined 12.4% to $29.6 million, while operating income more than doubled to $1.7 million over the prior year. As previously shared, our commitment for CGS in 2017 was to focus on streamlining our solution portfolio, rationalizing nonstrategic low profit client relationships, improving the cost of our delivery platform and enhancing our go-to-market platform. Despite the fact that our performance is a bit behind plan, we are making good progress. As we focus on those markets and solutions with the greatest opportunity for growth and profitability, we are experiencing acceleration in client interest, particularly for our marketing and sales optimization solutions. The pipeline, size and diversity is advancing. We expect to have a handful of meaningful new business wins in the fourth quarter, which along with the third quarter year-to-date bookings of approximately $30 million, should enable improved revenue and operating income performance in 2018. CGS' revenue increased 10.7% to $34.6 million, while operating income of $4.2 million decreased 4.8% over the prior year. As Ken mentioned, we are experiencing favorable trends in our CTS segment. The business reported 3 consecutive quarters of revenue growth and record third quarter bookings. This includes record demand for our cloud-based platform and related services. We are also seeing more traction from our channel partners, an increase in the average deal size and industry diversity among our enterprise clientele. The CTS segment also reported 3 consecutive quarters of operating income improvement. This improvement is attributable to higher revenue, revenue mix and realized efficiencies as we prioritize our focus on delivering Cisco-based technology, architecture and services. CSS' revenue decreased 8.1% to $14.4 million, while operating income increased 7.6% to $1.8 million over the prior year. We've been focused in 2017 on streamlining the solution portfolio to better align the CSS strategy and talent with those practices that create synergies with our CMS, CGS and CTS capability. Additionally, within our product management, product marketing and demand management functions, we are focused on integrated solutions that place CSS at the front end of our client initiatives. As we make this transition, including deemphasizing certain practice areas and accelerating our capability in more modern customer engagement technologies and processes, we are seeing an uptick in the number of opportunities in which CSS can be integrated with CTS, CMS and CGS. We continue to see CSS as a critical asset in our Humanify Customer Engagement as a Service platform, especially in light of the amount of customer experience strategy and technology refresh required for our clients and prospects to remain relevant. We expect to see CSS return to positive revenue growth in 2018, and with increased volume, improve its utilization and expense to revenue ratios, which are critical in returning to a double-digit operating margin. In the third quarter, we cleared our revenue process material weakness. We exited 2015 with 5 material weaknesses, including reconciliations, journal entries, revenue processes, impairments and sufficiency and competency of staff. To date, we have cleared the first 3 and expect to clear impairments in conjunction with our 2017 year-end testing. Once we clear the impairments, the sufficiency and competency of staff should be cleared as well. As I comment on guidance, it's important to remember that our outlook excludes impairment restructuring and integration and assets that we are exiting. It is also important to note that Motif is not included in our guidance. We expect Motif to contribute $4 million to $5 million in revenue in 2017. We estimated full year revenue guidance as follows, revenue between $1.425 billion and $1.435 billion, up from $1.4 billion to $1.410 billion; operating income margin in the range of 8.3% to 8.5%, unchanged from prior guidance; capital expenditures of 4.4% of revenue, down from 4.6%. Our estimated full year effective tax rate is unchanged between 22% and 25%. On a full year basis and using the midpoint of our updated guidance, we expect 2017 segment performance on a full year basis as follows, CMS to comprise 78% of total revenue and 75% of OI; CGS, 9% of total revenue and 7% of total OI; CTS, 9% of total revenue and 13% of total OI; and CSS 4% of total revenue and 5% of total OI. In the third quarter, we continued an intense focus on our strategy to differentiate our solution portfolio, expand our go-to-market platforms and meaningfully improve our financial performance. Our bookings and revenue volumes increased as did our operating margin when you exclude the ramp costs associated with the client-committed increase in seasonal revenue in the fourth quarter. Based on the midpoint of our guidance, we estimate our full year 2017 revenue to grow 15.1%, and our operating income to grow 26.5% versus the prior year. Additionally, we expect the acquisitions we have completed and the organic investments we have made in our product management, marketing and channels to provide us the client-based solution portfolio, talent and geographic footprint to continue this revenue growth and profitability trend into 2018. I'll now turn the call back over to Paul

Thanks, Regina. As we open the call, we ask that you limit your questions to 1 or 2 at a time. Operator, you may now open the line.

[Operator Instructions]. Our first question comes from Frank Atkins from SunTrust.

First, congratulations on the Motif acquisition. Can you talk a little bit about the capabilities this team brings, the management and how they fit with the current culture at TeleTech?

Sure, hi. First of all, why don't we just start with the culture? Culture is something that we spend a great deal of time looking at before we do any acquisition. And as it happens, this is a management team that we've been chasing for almost 2 years. So this was not something that we just -- that just popped into our lap. It was something that we've had on our radar for quite some time, and we've been courting the management team. Frankly, we love the culture so much that the leadership of the company has sold no equity whatsoever and is staying on long term with the company. And we see them as a tremendous asset to our growth in India, to us growing trust and safety and our content moderation services across the globe, and we're giving them full access to our footprint and to our client base. So as far as a cultural fit, we think it's one of the best cultural fits of any of the acquisitions we've done. As it relates to what they actually do, as I mentioned in our script, it's no surprise that trust and safety, fraud protection and content moderation are all extremely important issues that every company is grappling with. So if we start out with something as basic as credit card fraud, which continues to increase year-over-year, one of the services that they offer is working with very, very large online companies across spaces like travel, et cetera, where they are taking -- where they are looking at unusual transactions and figuring out who the bad guys are and getting those transactions to become deleted before the expense is incurred. Additionally, if you move on to community moderation, that expands across multiple areas. Fake reviews, when you take companies like Amazon and TripAdvisor and so on and so forth, those reviews are absolutely critical to their brand. And if the reviews are not perceived as real, customers lose trust in the brand. And therefore, moderating the reviews and making sure that reviews are in fact from people that have either purchased products or that have taken trips, et cetera. To the more top of mind topic, which lets -- without me mentioning names, let's just say some of the largest social media companies in the world, that are dealing with very important issues as it relates to moderation and content moderation of everything from, let's say, child pornography, acts of hate, videos of hate, I could go on and on and on. And so this pans across many different areas but all of which fall under what we call trust and safety and community moderation as well as fraud prevention. So I hope that -- because I don't want to take up too much time on this. I hope that, that helps you have a better understanding. What I will tell you is that when you look at who our client base is and how focused they are on their brand and maintaining a brand that has not only the highest Net Promoter Score but the highest level of trust amongst their customers, this is something that is important to them. And it is very additive to our end-to-end set of Humanify capabilities.

Okay, great. That's very helpful. And my follow up, I wanted to ask a little bit about the margin ramp that's anticipated in 4Q as you've put a lot of work into preparing for that ramp. Just want to understand, is that primarily driven by CMS? Or should we expect some margin increases in the other segments as well?

Yes, it's predominately CMS.

Next question comes from Bill Warmington from Wells Fargo Securities.

It's Bill DiJohnson on for Bill Warmington. I was looking at -- the CMS segment had another solid quarter growing 4% year-over-year on a constant currency organic basis. Did you see any benefit from Hurricanes Irma and Harvey in the quarter?

Yes, we do. With a small amount in Q3 and we have included in our guidance in Q4 of FEMA as a client.

And then for capacity utilization, improved to 78% this quarter. Very strong and positive commentary around volume. Could we see you hit your target of 80% to 90% utilization in Q4 possibly next year?

You will see that in Q4.

Now mind you, just so that from a modeling standpoint that our fourth quarter is always our seasonal peak. So please understand that yes, you'll see very high utilization in Q4. But obviously, it then tapers off as you get past the health care enrollment season and obviously, the Christmas ramp up season and then the return season thereafter.

What about reaching a sustainable level in the 80% to 90% range?

Well, it's certainly our goal and it's something that we're working very hard at to make sure that we're optimized across the board in all aspects whether it be our infrastructure, our real estate, et cetera. It's something that's very important to us and obviously leads to better performance overall. So that is certainly the goal and that's what we're focused on. But one thing that -- as I'm sure you can imagine, at the end of the day, as we keep winning new logos and new clients, in many cases, where they need to be is not necessarily where we always have capacity at the time. So sometimes, that requires us to build out additional capacity over and above the capacity that we have, which is something that we probably don't talk about very often. But it's just the reality of our business.

And we are showing no questions at this at this time. [Operator Instructions]. And we're showing no questions at this time, and that's all the time we have today. Thank you for joining. And this concludes TeleTech's Third Quarter 2017 Earnings Conference Call. You may now disconnect at this time.