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TELETECH HOLDINGS INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND(Edgar Glimpses Via Acquire Media NewsEdge) RESULTS OF OPERATIONS Executive Summary TeleTech Holdings, Inc. ("TeleTech", "the Company", "we", "our" or "us") is a leading provider of customer strategy, analytics-driven and technology-enabled customer engagement management solutions with 41,000 employees delivering services across 24 countries from 54 delivery centers on five continents. Our revenue for fiscal 2013 was $1,193 million. Founded in 1982, 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. 21 -------------------------------------------------------------------------------- Table of Contents 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 global clients in the automotive, communications, financial services, government, healthcare, logistics, media and entertainment, retail, technology, travel and transportation industries. We target customer-focused industry leaders in the Global 1000, companies that desire a partner that can quickly and globally scale a suite of integrated services. 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 $1,193 million in revenue we reported in 2013, approximately 25% or $302.3 million came from customer-centric strategy, growth or technology-based services with the remainder coming from our traditional customer management services. Our business is structured around four operating segments structured to execute on our strategy of expanding integrated customer engagement solutions. Design - Customer Strategy Services We typically begin by engaging our clients at a strategic level. Through our analytics-driven management consulting expertise we help our clients design and build their customer engagement strategies. We improve our clients' ability to better understand and predict their customers' behaviors and preferences along with their current and future economic value so that they can deploy resources to achieve the greatest return. Using proprietary analytic models, we provide the insight clients need to build the business case for customer centricity, to better optimize their marketing spend and then work alongside them to help implement our recommendations. A key component of this practice involves instilling a high performance culture through a lean management framework. This process optimization capability enables the client to align and cascade the recommended initiatives to ensure accountability and transparency for the ultimate achievement and sustainability of future results. Enable - Customer Technology Services Once the design of the customer engagement is completed, our ability to architect, deploy and host or manage the client's customer management environments becomes a key enabler to achieving and sustaining the client's customer engagement vision. Given the proliferation of mobile communication technologies and devices, we enable our clients' operations to interact with their customers across the growing array of channels including email, social networks, mobile, web, SMS text, voice and chat. We design, implement and manage cloud, on-premise or hybrid customer management environments to deliver a consistent and superior experience across all touch points on a global scale that we believe result in higher quality, lower costs and reduced risk for our clients. 22 -------------------------------------------------------------------------------- Table of Contents Manage - Customer Management Services We redesign and manage clients' front-to-back office processes to deliver just-in-time, personalized, multi-channel interactions. Our front-office solutions seamlessly integrate voice, chat, e-mail, ecommerce and social media to optimize the customer engagement for our clients. In addition, we manage certain back-office processes for our clients to enhance their ability to obtain a customer-centric view of their relationships and maximize operating efficiencies. Our delivery of integrated business processes via our onshore, offshore or work-from-home associates reduces operating costs and allows customer needs to be met more quickly and efficiently, resulting in higher satisfaction, brand loyalty and a stronger competitive position for our clients. Grow - Customer Growth Services We offer integrated sales and marketing solutions to help our clients boost revenue in new, fragmented or underpenetrated business-to-consumer or business-to-business markets. We deliver approximately $1 billion in client revenue annually via the acquisition, growth and retention of customers through a combination of our highly trained, client-dedicated sales professionals and our proprietary Revana Analytic Multichannel PlatformTM. This platform continuously aggregates individual customer information across all channels into one holistic view so as to ensure more relevant and personalized communications. These communications are dynamically triggered to send the right message to the right customer at the right time via their preferred communication channel. The ability of our sales associates to be backed by a highly scalable, technology-enabled platform that delivers smarter, more targeted digital marketing messages over email, social networks, mobile, web, SMS text, voice and chat results in higher conversion rates at a lower overall cost for our clients. Based on the requirements of our clients, we provide our services both on an integrated cross-business and discrete basis. See Note 3 to the Notes to the Consolidated Financial Statements for additional discussion regarding our segment information. Our 2013 Financial Results In 2013, our revenue increased 2.6% to $1,193 million over the 2012 year, despite a decrease of 1.0% or $12.1 million due to foreign currency fluctuations, primarily the Australian dollar. Revenue, adjusted for the $12.1 million decrease related to foreign exchange, $1.2 million of lost revenue due to a typhoon in the Philippines during the third quarter, and a $37.6 million decrease related to the exit of our business in Spain, increased by $81.1 million over the prior year. This increase was due to organic growth and revenue from recent acquisitions. Our 2013 income from operations increased 29.1% to $101.4 million or 8.5% of revenue, from $78.5 million or 6.8% of revenue in 2012. This increase is due to the benefits of increased capacity utilization, income from the recent acquisitions, organic revenue growth and the exit of our business in Spain which caused large restructuring expenses in the prior year. These were partially offset by $5.1 million negative impact from foreign currency fluctuations, $3.5 million additional amortization of intangibles related to the acquisitions, $0.8 million negative impact from the lost revenue from the typhoon, and investments in sales and research and development. Income from operations in 2013 included $4.4 million and $1.2 million of restructuring charges and asset impairments, respectively. Income from operations in 2012 included $22.9 million and $3.0 million of restructuring charges and impairments, respectively. Our offshore delivery centers serve clients based in North America and in other countries. Our offshore delivery capacity spans five countries with 18,250 workstations and currently represents 63% of our global delivery capabilities. Revenue from services provided in these offshore locations was $490 million and represented 49% of our revenue for 2013, as compared to $506 million and 49% of our revenue for 2012, with both years excluding revenue from the five acquisitions. Our cash flow from operations and available credit allowed us to finance a significant portion of our capital needs and stock repurchases through internally generated cash flows. At December 31, 2013, we had $158.0 million of cash and cash equivalents, total debt of $109.8 million, and a total debt to total capitalization ratio of 18.8%. 23 -------------------------------------------------------------------------------- Table of Contents We internally target capacity utilization in our delivery centers at 80% to 90% of our available workstations. As of December 31, 2013, the overall capacity utilization in our multi-client centers was 83%. The table below presents workstation data for our multi-client centers as of December 31, 2013 and 2012. Dedicated and Managed Centers (4,550 and 2,545 workstations, at December 31, 2013 and 2012, respectively) are excluded from the workstation data as unused workstations in these facilities are not available for sale. Our utilization percentage is defined as the total number of utilized production workstations compared to the total number of available production workstations. We may change the designation of shared or dedicated centers based on the normal changes in our business environment and client needs. December 31, 2013 December 31, 2012 Total Total Production % In Production % In Workstations In Use Use Workstations In Use Use Multi-client centers Sites open >1 year 22,358 18,731 84% 23,403 18,602 79% Sites open <1 year 2,028 1,417 70% 1,334 964 72% Total multi-client centers 24,386 20,148 83% 24,737 19,566 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 increase, we continue to actively manage this risk via a multi-currency hedging program designed to minimize operating margin volatility. Critical Accounting Policies and Estimates Management's Discussion and Analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. ("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. Below is a discussion of the policies that we believe may involve a high degree of judgment and complexity. Revenue Recognition We recognize revenue when evidence of an arrangement exists, the delivery of service has occurred, the fee is fixed or determinable and collection is reasonably assured. The BPO inbound and outbound service fees are based on either a per minute, per hour, per transaction or per call basis. Certain client programs provide for adjustments to monthly billings based upon whether we achieve, exceed or fail certain performance criteria. Adjustments to monthly billings consist of contractual bonuses/penalties, holdbacks and other performance based contingencies. Revenue recognition is limited to the amount that is not contingent upon delivery of future services or meeting other specified performance conditions. 24 -------------------------------------------------------------------------------- Table of Contents Revenue also consists of services for agent training, program launch, professional consulting, fully-hosted or managed technology and learning innovation. These service offerings may contain multiple element arrangements whereby we determine if those service offerings represent separate units of accounting. A deliverable constitutes a separate unit of accounting when it has standalone value and delivery or performance of the undelivered items is considered probable and substantially within our control. If those deliverables are determined to be separate units of accounting, revenue is recognized as services are provided. If those deliverables are not determined to be separate units of accounting, revenue for the delivered services are bundled into one unit of accounting and recognized over the life of the arrangement or at the time all services and deliverables have been delivered and satisfied. We allocate revenue to each of the deliverables based on a selling price hierarchy of vendor specific objective evidence ("VSOE"), third-party evidence, and then estimated selling price. VSOE is based on the price charged when the deliverable is sold separately. Third-party evidence is based on largely interchangeable competitor services in standalone sales to similarly situated customers. Estimated selling price is based on our best estimate of what the selling prices of deliverables would be if they were sold regularly on a standalone basis. Estimated selling price is established considering multiple factors including, but not limited to, pricing practices in different geographies, service offerings, and customer classifications. Once we allocate revenue to each deliverable, we recognize revenue when all revenue recognition criteria are met. Periodically, we will make certain expenditures related to acquiring contracts or provide up-front discounts for future services. These expenditures are capitalized as contract acquisition costs and amortized in proportion to the expected future revenue from the contract, which in most cases results in straight-line amortization over the life of the contract. Amortization of these costs is recorded as a reduction to revenue. Income Taxes Accounting for income taxes 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 or tax returns. 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. When circumstances warrant, we assess the likelihood that our net deferred tax assets will more likely than not be recovered from future projected taxable income. We continually review the likelihood that deferred tax assets will be realized in future tax periods under the "more-likely-than-not" criteria. In making this judgment, we consider all available evidence, both positive and negative, in determining whether, based on the weight of that evidence, a valuation allowance is required. We follow a two-step approach to recognizing and measuring uncertain tax positions. The first step is to determine if the weight of available evidence indicates that it is more likely than not that the tax position will be sustained on audit. The second step is to estimate and measure the tax benefit as the amount that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority. We evaluate these uncertain tax positions on a quarterly basis. This evaluation is based on the consideration of several factors including changes in facts or circumstances, changes in applicable tax law, and settlement of issues under audit. Interest and penalties relating to income taxes and uncertain tax positions are accrued net of tax in Provision for income taxes in the accompanying Consolidated Statements of Comprehensive Income. 25 -------------------------------------------------------------------------------- Table of Contents In the future, our effective tax rate could be adversely affected by several factors, many of which are outside our control. Our effective tax rate is affected by the proportion of revenue and income before taxes in the various domestic and international jurisdictions in which we operate. Further, we are subject to changing tax laws, regulations and interpretations in multiple jurisdictions in which we operate, as well as the requirements, pronouncements and rulings of certain tax, regulatory and accounting organizations. We estimate our annual effective tax rate each quarter based on a combination of actual and forecasted results of subsequent quarters. Consequently, significant changes in our actual quarterly or forecasted results may impact the effective tax rate for the current or future periods. Impairment of Long-Lived Assets We evaluate the carrying value of property, plant and equipment and definite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An asset is considered to be impaired when the forecasted undiscounted cash flows of an asset group are estimated to be less than its carrying value. The amount of impairment recognized is the difference between the carrying value of the asset group and its fair value. Fair value estimates are based on assumptions concerning the amount and timing of estimated future cash flows and assumed discount rates. Goodwill and Indefinite-Lived Intangible Assets We evaluate goodwill and indefinite-lived intangible assets for possible impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. We use a three step process to assess the realizability of goodwill. The first step, Step 0, is a qualitative assessment that analyzes current economic indicators associated with a particular reporting unit. For example, we analyze changes in economic, market and industry conditions, business strategy, cost factors, and financial performance, among others, to determine if there would be a significant decline to the fair value of a particular reporting unit. A qualitative assessment also includes analyzing the excess fair value of a reporting unit over its carrying value from impairment assessments performed in previous years. If the qualitative assessment indicates a stable or improved fair value, no further testing is required. If a qualitative assessment indicates that a significant decline to fair value of a reporting unit is more likely than not, or if a reporting unit's fair value has historically been closer to its carrying value, we will proceed to Step 1 testing where we calculate the fair value of a reporting unit based on discounted future probability-weighted cash flows. If Step 1 indicates that the carrying value of a reporting unit is in excess of its fair value, we will proceed to Step 2 where the fair value of the reporting unit will be allocated to assets and liabilities as it would in a business combination. Impairment occurs when the carrying amount of goodwill exceeds its estimated fair value calculated in Step 2. We estimate fair value using discounted cash flows of the reporting units. The most significant assumptions used in these analyses are those made in estimating future cash flows. In estimating future cash flows, we use financial assumptions in our internal forecasting model such as projected capacity utilization, projected changes in the prices we charge for our services, projected labor costs, as well as contract negotiation status. The financial and credit market volatility directly impacts our fair value measurement through our weighted average cost of capital that we use to determine our discount rate. We use a discount rate we consider appropriate for the country where the business unit is providing services. As of December 1, 2013, the Company's assessment of goodwill impairment indicated that for all reporting units, the fair values of the Company's reporting units were substantially in excess of their estimated carrying values, and therefore goodwill in these reporting units was not impaired. 26 -------------------------------------------------------------------------------- Table of Contents Similar to goodwill, the Company may first use a qualitative analysis to assess the realizability of its indefinite-lived intangible assets. The qualitative analysis will include a review of changes in economic, market and industry conditions, business strategy, cost factors, and financial performance, among others, to determine if there would be a significant decline to the fair value of an indefinite-lived intangible asset. If a quantitative analysis is completed, an indefinite-lived intangible asset (a trade name) is evaluated for possible impairment by comparing the fair value of the asset with its carrying value. Fair value was estimated as the discounted value of future revenues arising from a trade name using a royalty rate that a market participant would pay for use of that trade name. An impairment charge is recorded if the trade name's carrying value exceeds its estimated fair value. Restructuring Liability We routinely assess the profitability and utilization of our delivery centers and existing markets. In some cases, we have chosen to close under-performing delivery centers and complete reductions in workforce to enhance future profitability. Severance payments that occur from reductions in workforce are in accordance with postemployment plans and/or statutory requirements that are communicated to all employees upon hire date; therefore, we recognize severance liabilities when they are determined to be probable and reasonably estimable. Other liabilities for costs associated with an exit or disposal activity are recognized when the liability is incurred, rather than upon commitment to a plan. Derivatives We enter into foreign exchange forward and option contracts to reduce our exposure to foreign currency exchange rate fluctuations that are associated with forecasted revenue earned in foreign locations. We enter into interest rate swaps to reduce our exposure to interest rate fluctuations associated with our variable rate debt. Upon proper qualification, these contracts are accounted for as cash flow hedges under current accounting standards. From time-to-time, we also enter into foreign exchange forward contracts to hedge our net investment in a foreign operation. All derivative financial instruments are reported in the accompanying Consolidated Balance Sheets at fair value. Changes in fair value of derivative instruments designated as cash flow hedges are recorded in Accumulated other comprehensive income (loss), a component of Stockholders' Equity, to the extent they are deemed effective. Based on the criteria established by current accounting standards, all of our cash flow hedge contracts are deemed to be highly effective. Changes in fair value of any net investment hedge are recorded in cumulative translation adjustment in Accumulated other comprehensive income (loss) in the accompanying Consolidated Balance Sheets offsetting the change in cumulative translation adjustment attributable to the hedged portion of our net investment in the foreign operation. Any realized gains or losses resulting from the foreign currency cash flow hedges are recognized together with the hedged transactions within Revenue. Any realized gains or losses resulting from the interest rate swaps are recognized in interest income (expense). Gains and losses from the settlements of our net investment hedges remain in Accumulated other comprehensive income (loss) until partial or complete liquidation of the applicable net investment. We also enter into fair value derivative contracts to reduce our exposure to foreign currency exchange rate fluctuations associated with changes in asset and liability balances. Changes in the fair value of derivative instruments designated as fair value hedges affect the carrying value of the asset or liability hedged, with changes in both the derivative instrument and the hedged asset or liability being recognized in Other income (expense), net in the accompanying Consolidated Statements of Comprehensive Income. While we expect that our derivative instruments will continue to be highly effective and in compliance with applicable accounting standards, if our hedges did not qualify as highly effective or if we determine that forecasted transactions will not occur, the changes in the fair value of the derivatives used as hedges would be reflected currently in earnings. 27 -------------------------------------------------------------------------------- Table of Contents Contingencies We record a liability for pending litigation and claims where losses are both probable and reasonably estimable. Each quarter, management reviews all litigation and claims on a case-by-case basis and assigns probability of loss and range of loss. Explanation of Key Metrics and Other Items Cost of Services Cost of services principally include costs incurred in connection with our customer management services, including direct labor, telecommunications, technology costs, printing, sales and use tax and certain fixed costs associated with the delivery centers. In addition, cost of services includes income related to grants we may receive from local or state governments as an incentive to locate delivery centers in their jurisdictions which reduce the cost of services for those facilities. Selling, General and Administrative Selling, general and administrative expenses primarily include costs associated with administrative services such as sales, marketing, product development, legal settlements, legal, information systems (including core technology and telephony infrastructure) and accounting and finance. It also includes outside professional fees (i.e., legal and accounting services), building expense for non-delivery center facilities and other items associated with general business administration. Restructuring Charges, Net Restructuring charges, net primarily include costs incurred in conjunction with reductions in force or decisions to exit facilities, including termination benefits and lease liabilities, net of expected sublease rentals. Interest Expense Interest expense includes interest expense, amortization of debt issuance costs associated with our Credit Facility, and the accretion of deferred payments associated with our acquisitions. Other Income The main components of other income are miscellaneous income not directly related to our operating activities, such as foreign exchange gains. Other Expenses The main components of other expenses are expenditures not directly related to our operating activities, such as foreign exchange losses. Presentation of Non-GAAP Measurements Free Cash Flow Free cash flow is a non-GAAP liquidity measurement. We believe that free cash flow is useful to our investors because it measures, during a given period, the amount of cash generated that is available for debt obligations and investments other than purchases of property, plant and equipment. Free cash flow is not a measure determined by GAAP and should not be considered a substitute for "income from operations," "net income," "net cash provided by operating activities," or any other measure determined in accordance with GAAP. We believe this non-GAAP liquidity measure is useful, in addition to the most directly comparable GAAP measure of "net cash provided by operating activities," because free cash flow includes investments in operational assets. Free cash flow does not represent residual cash available for discretionary expenditures, since it includes cash required for debt service. Free cash flow also includes cash that may be necessary for acquisitions, investments and other needs that may arise. 28 -------------------------------------------------------------------------------- Table of Contents The following table reconciles net cash provided by operating activities to free cash flow for our consolidated results (amounts in thousands): Year Ended December 31, 2013 2012 2011Net cash provided by operating activities $ 137,979 $ 106,920 $ 113,799 Less: Purchases of property, plant and equipment 50,364 (1) 40,543 (1) 38,310 (1) Free cash flow $ 87,615 $ 66,377 $ 75,489 (1) Purchases of property, plant and equipment for the years ended December 31, 2013, 2012, and 2011 are net of proceeds from a government grant of zero, $0.1 million, and $0.4 million, respectively. We discuss factors affecting free cash flow between periods in the "Liquidity and Capital Resources" section below. RESULTS OF OPERATIONS Year Ended December 31, 2013 Compared to December 31, 2012 The tables included in the following sections are presented to facilitate an understanding of Management's Discussion and Analysis of Financial Condition and Results of Operations and present certain information by segment for the years ended December 31, 2013 and 2012 (amounts in thousands). All inter-company transactions between the reported segments for the periods presented have been eliminated. Customer Management Services Year Ended December 31, 2013 2012 $ Change % Change Revenue $ 890,883 $ 923,774 $ (32,891 ) -3.6% Operating Income 75,689 60,271 15,418 25.6% Operating Margin 8.5% 6.5% The change in revenue for the Customer Management Services segment was attributable to a $68.5 million net increase in client programs offset by program completions of $52.2 million. Revenue was further impacted by a $10.4 million reduction due to foreign currency fluctuations, primarily the Australian dollar, a $37.6 million reduction related to the exit of our business in Spain, and $1.2 million in lost revenue due to a typhoon in the third quarter of 2013. The operating income as a percentage of revenue increased to 8.5% in 2013 as compared to 6.5% in 2012. This increase in margin was primarily due to the improvement in utilization of our capacity, exit of our business in Spain as described above and the reduction of restructuring expenses noted below. These increases were offset by a $6.6 million adverse impact from foreign currency fluctuations and a $0.8 million negative impact due to lost revenue from a typhoon. During 2013 and 2012, we recorded $4.2 million and $8.2 million, respectively, in restructuring and impairment charges in various locations to better align our capacity and workforce with current business needs. In addition, during 2012, we recorded $15.1 million in restructuring charges and $0.4 million in impairment charges as a result of our decision to exit Spain. These items were offset during 2012 in part by a $4.6 million accrual release for salaries expense due to an authoritative ruling in Spain related to the legally required cost of living adjustments for our employees' salaries. 29 -------------------------------------------------------------------------------- Table of Contents Customer Growth Services Year Ended December 31, 2013 2012 $ Change % Change Revenue $ 100,996 $ 100,772 $ 224 0.2% Operating Income 3,024 2,258 766 33.9% Operating Margin 3.0% 2.2% The change in revenue for the Customer Growth Services segment was due to the combination of net increase in client programs and the acquisition of WebMetro in August 2013 of $20.0 million in an aggregate amount, offset by program completions of $19.8 million. The operating income as a percentage of revenue increased to 3.0% in 2013 as compared to 2.2% in 2012. Increases in income were primarily driven by a $1.8 million charge related to the impairment of the trade-name intangible asset due to the rebranding of our Direct Alliance subsidiary to Revana during the first quarter of 2012. There were also operational improvements and a shift in program mix to additional outcome-based higher margin programs. These increases were offset by net declines in client volumes, changes in pricing, the cost of ramping multiple clients and increases in amortization expense related to WebMetro. Included in the operating income was amortization related to acquired intangibles of $1.5 million and $0.7 million for the year ended December 31, 2013 and 2012, respectively. Customer Technology Services Year Ended December 31, 2013 2012 $ Change % Change Revenue $ 152,485 $ 96,848 $ 55,637 57.4% Operating Income 19,965 15,714 4,251 27.1% Operating Margin 13.1% 16.2% The increase in revenue for the Customer Technology Services segment was related to organic growth for eLoyalty in consulting and managed services and the acquisition of TSG on December 31, 2012. The operating income as a percentage of revenue decreased to 13.1% in 2013 as compared to 16.2% in 2012. This decrease was related to investments to integrate TSG, increases in sales and marketing expenses, and a $2.6 million increase in amortization expense related to TSG. Included in the operating income was amortization related to acquired intangibles of $4.1 million and $1.8 million for the year ended December 31, 2013 and 2012, respectively. Customer Strategy Services Year Ended December 31, 2013 2012 $ Change % Change Revenue $ 48,793 $ 41,587 $ 7,206 17.3% Operating Income 2,721 302 2,419 801.0% Operating Margin 5.6% 0.7% The increase in revenue for the Customer Strategy Services segment was related to a combination of growth in operational consulting, analytics and learning innovations revenue, and the acquisitions of iKnowtion, LLC ("iKnowtion") and Guidon Performance Solutions ("Guidon") during 2012. 30 -------------------------------------------------------------------------------- Table of Contents The operating income as a percentage of revenue increased to 5.6% in the 2013 as compared to 0.7% in 2012. This increase was related to the full integration of the businesses comprising the Customer Strategy Services segment, including their leadership, consultants, the services portfolio and infrastructure, and a consolidation of their geographies and personnel realignment. This integration allowed for additional revenue to be generated as well as cost savings based on the realignment. The increase also included the impairment charges of $1.1 million recorded as a result of decreased revenues resulting from the deconsolidation of a subsidiary in the second quarter of 2013 (see Notes 24 and 6 of the Notes to the Consolidated Financial Statements for further details). Included in the operating income was amortization expense related to acquired intangibles of $1.6 million and $1.2 million for the year ended December 31, 2013 and 2012, respectively. Interest Income (Expense) For 2013 and 2012, interest income decreased to $2.6 million in 2013 from $3.0 million in 2012. Interest expense increased to $7.5 million during 2013 from $6.7 million for the comparable period in 2012, due to higher average borrowings on our credit facility and additional accretion of deferred acquisition costs. Other Income (Expense), Net Included in the year ended December 31, 2013, was a $3.7 million charge related to the deconsolidation of a subsidiary (see Note 24 of the Notes to the Consolidated Financial Statements for further details). Also included was a $1.9 million charge related to a fair value adjustment of the contingent consideration for three of our acquisitions (see Note 6 of the Notes to the Consolidated Financial Statements for further details). Income Taxes The reported effective tax rate for 2013 was 22.4% as compared to (0.1)% for 2012. The effective tax rate for 2013 was impacted by earnings in international jurisdictions currently under an income tax holiday, a $1.8 million benefit related to restructuring charges, a $1.5 million benefit related to return to provision adjustments, and $1.8 million of expenses related to changes in valuation allowance. Without these items our effective tax rate for the year ended December 31, 2013 would have been 21.5%. In the year ended December 31, 2012, our effective tax rate would have been 19.9% without a $7.6 million tax benefit related to Australia and New Zealand transfer pricing, a $1.4 million benefit from the release of uncertain tax positions, a $9.2 million benefit related to restructuring charges, a $1.9 million benefit related to return to provision adjustments and $0.1 million of expense related to other discrete items. Year Ended December 31, 2012 Compared to 2011 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 years ended December 31, 2012 and 2011 (amounts in thousands). All inter-company transactions between the reported segments for the periods presented have been eliminated. Customer Management Services Year Ended December 31, 2012 2011 $ Change % Change Revenue $ 923,774 $ 983,627 $ (59,853) -6.1% Operating Income 60,271 71,945 (11,674) -16.2% Operating Margin 6.5% 7.3% The change in revenue for the Customer Management Services segment was attributable to a $50.9 million net increase in client programs offset by program completions of $33.5 million. Revenue was further impacted by a $13.1 million reduction due to foreign currency fluctuations and a $64.2 million reduction related to the exit of our business in Spain. 31 -------------------------------------------------------------------------------- Table of Contents The operating income as a percentage of revenue decreased to 6.5% in 2012 as compared to 7.3% in 2011. During 2012, we recorded $15.5 million in restructuring and impairment charges as a result of our decision to exit Spain and an incremental $8.2 million in restructuring charges and impairment in other locations to better align our capacity and workforce with the current business needs. These charges were offset in part by increases in margins based on the rationalization of unprofitable programs as described above and the related reduction in capacity. The margin also benefited from a $4.6 million accrual release for salaries expense due to an authoritative ruling in Spain related to the legally required cost of living adjustments for our employees' salaries, a $4.8 million decrease in depreciation expense related to assets which are now fully depreciated, and $3.7 million related to the finalization of certain real estate and employee related expenses. Customer Growth Services Year Ended December 31, 2012 2011 $ Change % Change Revenue $ 100,772 $ 95,629 $ 5,143 5.4% Operating Income 2,258 6,387 (4,129) -64.6% Operating Margin 2.2% 6.7% The increase in revenue for the Customer Growth Services segment was due to a net increase in client programs of $18.2 million offset by program completions of $13.1 million. The operating income as a percentage of revenue decreased to 2.2% in 2012 as compared to 6.7% in 2011. This decline was primarily due to a $1.8 million charge related to the impairment of the trade-name intangible asset due to the rebranding of our Direct Alliance subsidiary to Revana™ during the first quarter of 2012, other expenses incurred in connection with this rebranding, and increases in employee related expenses including salaries and benefits. Customer Technology Services Year Ended December 31, 2012 2011 $ Change % Change Revenue $ 96,848 $ 66,978 $ 29,870 44.6% Operating Income 15,714 13,652 2,062 15.1% Operating Margin 16.2% 20.4% The increase in revenue for the Customer Technology Services segment was primarily related to a full year of operations for our 2011 acquisition of eLoyalty Corporation ("eLoyalty") which occurred on May 28, 2011. The operating income as a percentage of revenue decreased to 16.2% in 2012 as compared to 20.4% in 2011. This decrease was related to the acquisition of eLoyalty as discussed above which results in a change in the mix of revenue from purely hosted solutions to both hosted and managed solutions. There were also investments in sales and marketing and additional amortization expense for the customer relationship asset related to the acquisition of eLoyalty. Customer Strategy Services Year Ended December 31, 2012 2011 $ Change % Change Revenue $ 41,587 $ 33,154 $ 8,433 25.4% Operating Income 302 1,470 (1,168) -79.5% Operating Margin 0.7% 4.4% The increase in revenue for the Customer Strategy Services segment was due to an $8.9 million increase due to the acquisition of iKnowtion and Guidon and a $0.5 million net increase in consulting revenue partially offset by a $1.0 million adverse impact from foreign currency fluctuations. 32 -------------------------------------------------------------------------------- Table of Contents The operating income as a percentage of revenue decreased to 0.7% in 2012 as compared to 4.4% in 2011. This decrease was related to an increased investment in geographic expansion, additional amortization expense for the customer relationship assets of iKnowtion and Guidon and negative changes in foreign currency translation, offset partially by the acquisitions of iKnowtion and Guidon. Other Income (Expense) For 2012, interest income decreased slightly to $3.0 million from $3.1 million in 2011. Interest expense increased to $6.7 million during 2012 from $5.1 million during 2011. This increase was due to a higher outstanding balance on our credit facility and additional expense related to the interest rate swap arrangements. Income Taxes The reported effective tax rate for 2012 was (0.1)% as compared to 14.5% for 2011. The effective tax rate for 2012 was impacted by earnings in international jurisdictions currently under an income tax holiday, a $7.6 million tax benefit related to Australia and New Zealand transfer pricing, a $1.4 million benefit from the release of uncertain tax positions, a $9.2 million benefit related to restructuring charges, a $1.9 million benefit related to return to provision adjustments and $0.1 million of expense related to other discrete items. Without these items our effective tax rate for the year ended December 31, 2012 would have been 19.9%. In the year ended December 31, 2011, our effective tax rate would have been 19.7% without a $8.7 million expense related to the adverse decision by the Canada Revenue Agency regarding our request for relief from double taxation, a $11.7 million benefit related to our mediated settlement with the IRS related to U.S. tax refund claims, a $1.4 million benefit related to the foreign earnings repatriation and a $0.3 million benefit related to other discrete items. 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 year ended December 31, 2013, we generated positive operating cash flows of $138.0 million. We believe that our cash generated from operations, existing cash and cash equivalents, and available credit will be sufficient to meet expected operating and capital expenditure requirements for the next 12 months. We manage a centralized global treasury function in the United States with a focus on concentrating and safeguarding our global cash and cash equivalents. While the majority of our cash is held offshore, we prefer to hold U.S. Dollars in addition to the local currencies of our foreign subsidiaries. We expect to use our offshore cash to support working capital and growth of our foreign operations. While there are no assurances, we believe our global cash is protected given our cash management practices, banking partners and utilization of diversified, high quality investments. We have global operations that expose us to foreign currency exchange rate fluctuations that may positively or negatively impact our liquidity. We are also exposed to higher interest rates associated with our variable rate debt. To mitigate these risks, we enter into foreign exchange forward and option contracts and interest rate swaps through our cash flow hedging program. Please refer to Item 7A. Quantitative and Qualitative Disclosures About Market Risk, Foreign Currency Risk, for further discussion. We primarily utilize our Credit Agreement to fund working capital, general operations, stock repurchases and other strategic activities, such as the acquisitions described in Note 2 of the Notes to Consolidated Financial Statements. As of December 31, 2013 and 2012, we had borrowings of $100.0 million and $108.0 million, respectively, under our Credit Agreement, and our average daily utilization was $238.1 million and $154.5 million for the years ended December 31, 2013 and 2012, respectively. After consideration for issued letters of credit under the Credit Agreement, totaling $3.5 million, our remaining borrowing capacity was $596.5 million as of December 31, 2013. As of December 31, 2013, we were in compliance with all covenants and conditions under our Credit Agreement. 33 -------------------------------------------------------------------------------- Table of Contents 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. The following discussion highlights our cash flow activities during the years ended December 31, 2013, 2012, and 2011. 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 $158.0 million and $164.5 million as of December 31, 2013 and 2012, respectively. We diversify the holdings of such cash and cash equivalents considering the financial condition and stability of the counterparty institutions. We reinvest our cash flows to grow our client base, and expand our infrastructure, and for investment in research and development, strategic acquisitions and the purchase of our outstanding stock. Cash Flows from Operating Activities For the years 2013, 2012 and 2011 we reported net cash flows provided by operating activities of $138.0 million, $106.9 million and $113.8 million, respectively. The increase of $31.1 million from 2012 to 2013 was primarily due to a $20.3 million decrease in cash spent on prepaid and other assets, a $13.8 million decrease in payments made for operating expenses, a $9.2 million increase in cash from net income and a $6.9 million increase in cash collected from accounts receivable. This increase was offset against a $19.1 million decrease in cash prepayments from customers. The net decrease of $6.9 million from 2011 to 2012 was primarily due to incremental cash paid of $29.3 million for prepaid and other assets and a decrease in cash from net income of $1.1 million offset by increases in prepayments from customers of $18.7 million, increases in cash collected from accounts receivable of $6.2 million, and an increase of $1.4 million in payments made for operating expenses. Cash Flows from Investing Activities For the years 2013, 2012 and 2011, we reported net cash flows used in investing activities of $59.5 million, $80.9 million and $86.9 million, respectively. The net decrease in cash used from investing activities from 2012 to 2013 was primarily due to the $31.7 million decrease in acquisition related spending offset by a $10.3 million increase in net spend on capital expenditures. The net decrease in cash used from investing activities from 2011 to 2012 was primarily due to the $8.0 million decrease in acquisition related spending offset by a $2.0 million increase in capital expenditures. Cash Flows from Financing Activities For the years 2013, 2012 and 2011, we reported net cash flows (used in) provided by financing activities of $(70.7) million, $(35.0) million and $15.9 million, respectively. The change from 2012 to 2013 was due to a decrease in net borrowings on our line of credit of $52.0 million, a decrease in proceeds received from other debt of $4.3 million and an increase in dividends paid to noncontrolling interests of $2.3 million. This increase in cash used in financing activities was offset against a decrease in cash used to repurchase common stock of $24.7 million. The change from 2011 to 2012 was due to a decrease in net borrowings on our line of credit of $20.0 million, an increase in cash used to repurchase common stock of $17.6 million and a decrease in cash received from the exercise of stock options of $13.4 million. 34 -------------------------------------------------------------------------------- Table of Contents Free Cash Flow Free cash flow (see "Presentation of Non-GAAP Measurements" above for the definition of free cash flow) was $87.6 million, $66.4 million and $75.5 million for the years 2013, 2012 and 2011, respectively. The increase from 2012 to 2013 resulted primarily from the $31.1 million increase in cash flow from operating activities offset by a $9.8 million increase in capital expenditures, net of grant monies received. The decrease from 2011 to 2012 resulted primarily from the $6.9 million decrease in cash flow from operating activities and a $2.2 million increase in capital expenditures, net of grant monies received Obligations and Future Capital Requirements Future maturities of our outstanding debt and contractual obligations as of December 31, 2013 are summarized as follows (amounts in thousands): Less than 1 to 3 3 to 5 Over 5 1 Year Years Years Years Total Credit Facility(1) $ 3,244 $ 6,042 $ 103,271 $ - $ 112,557 Equipment financing arrangements 31 - - - 31 Contingent consideration 9,217 13,619 - - 22,836 Purchase obligations 16,902 21,241 - - 38,143 Operating lease commitments 31,218 43,497 22,307 4,647 101,669 Other debt 4,698 4,037 976 - 9,711 Total $ 65,310 $ 88,436 $ 126,554 $ 4,647 $ 284,947 (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 December 31, 2013. † Contractual obligations to be paid in a foreign currency are translated at the period end exchange rate. † Purchase obligations primarily consist of outstanding purchase orders for goods or services not yet received, which are not recognized as liabilities in our Consolidated Balance Sheets until such goods and/or services are received. † The contractual obligation table excludes our liabilities of $0.5 million related to uncertain tax positions because we cannot reliably estimate the timing of future cash payments. See Note 11 to the Notes to the Consolidated Financial Statements for further discussion. The increase in our outstanding debt is primarily associated with the use of funds under our Credit Agreement to fund working capital, repurchase our common stock, and other cash flow needs across our global operations. Purchase Obligations Occasionally we contract with certain of our communications clients to provide us with telecommunication services. These clients currently represent approximately 17% of our total annual revenue. We believe these contracts are negotiated on an arm's-length basis and may be negotiated at different times and with different legal entities. 35 -------------------------------------------------------------------------------- Table of Contents 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% relate to the maintenance of existing assets. The anticipated level of 2014 capital expenditures is primarily driven by new client contracts and the corresponding requirements for additional delivery center capacity as well as enhancements to our technological infrastructure. We may consider restructurings, dispositions, mergers, acquisitions and other similar transactions. Such transactions could include the transfer, sale or acquisition of significant assets, businesses or interests, including joint ventures or the incurrence, assumption, or refinancing of indebtedness and could be material to the consolidated financial condition and consolidated results of our operations. Our capital expenditures requirements could also increase materially in the event of acquisition or joint ventures. In addition, as of December 31, 2013, we were authorized to purchase an additional $18.9 million of common stock under our stock repurchase program (see Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities in this Form 10-K). The stock repurchase program does not have an expiration date. The launch of large client contracts may result in short-term negative working capital because of the time period between incurring the costs for training and launching the program and the beginning of the accounts receivable collection process. As a result, periodically we may generate negative cash flows from operating activities. Debt Instruments and Related Covenants On June 3, 2013, we entered into a $700.0 million, five-year, multi-currency revolving credit facility (the "Credit Agreement") with a syndicate of lenders which includes an accordion feature that permits us to request an increase in total commitments up to $1.0 billion, under certain conditions. Wells Fargo Securities, LLC, KeyBank National Association, Bank of America Merrill Lynch, BBVA Compass and HSBC Bank USA, National Association served as Joint Lead Arrangers. The Credit Agreement amends and restates in its entirety our prior credit facility entered into during 2010 and amended in 2012. The Credit Agreement provides for a secured revolving credit facility that matures on June 3, 2018 with an initial maximum aggregate commitment of $700.0 million. At our discretion, direct borrowing options under the Credit Agreement include (i) Eurodollar loans with one, two, three, and six month terms, and/or (ii) overnight base rate loans. The Credit Agreement also provides for a sub-limit for loans or letters of credit in both U.S. dollars and certain foreign currencies, with direct foreign subsidiary borrowing capabilities up to 50% of the total commitment amount. We may increase the maximum aggregate commitment under the Credit Agreement to $1.0 billion if certain conditions are satisfied, including that we are not in default under the Credit Agreement at the time of the increase and that we obtain the commitment of the lenders participating in the increase. Base rate loans bear interest at a rate equal to the greatest of (i) Wells Fargo's prime rate, (ii) one half of 1% in excess of the federal funds effective rate, and (iii) 1.25% in excess of the one month London Interbank Offered Rate ("LIBOR"), in each case adding a margin based upon our leverage ratio. Eurodollar loans bear interest based upon LIBOR, plus a margin based upon our leverage ratio. Alternate loans bear interest at rates applicable to their respective currencies. Letter of credit fees are one eighth of 1% of the stated amount of the letter of credit on the date of issuance, renewal or amendment, plus an annual fee equal to the borrowing margin for Eurodollar loans. Commitment fees are payable to the Lenders in an amount equal to the unused portion of the credit facility and are based upon our leverage ratio. 36 -------------------------------------------------------------------------------- Table of Contents Indebtedness under the Credit Agreement is guaranteed by certain of our present and future domestic subsidiaries. Indebtedness under the Credit Agreement and the related guarantees are secured by security interests (subject to permitted liens) in the U.S. accounts receivable and cash of our Company and certain of its domestic subsidiaries and may be secured by tangible assets of our Company and such domestic subsidiaries if borrowings by foreign subsidiaries exceed $100.0 million and the leverage ratio is greater than 3.00 to 1.00. We also pledged 65% of the voting stock and 100% of the non-voting stock of certain of our Company's material foreign subsidiaries and may pledge 65% of the voting stock and 100% of the non-voting stock of our Company's other foreign subsidiaries. We primarily utilize our credit facilities to fund working capital, general operations, stock repurchases, acquisitions, and other strategic activities. As of December 31, 2013 and 2012, we had borrowings of $100.0 million and $108.0 million, respectively, under the Credit Agreement. During 2013, 2012 and 2011, borrowings accrued interest at an average rate of approximately 1.4%, 1.6%, and 1.6% per annum, respectively, excluding unused commitment fees. Our daily average borrowings during 2013, 2012 and 2011 were $238.1 million, $154.5 million and $112.4 million, respectively. Availability was $596.5 million as of December 31, 2013, reduced from $700.0 million by the outstanding borrowing and by $3.5 million in issued letters of credit; and $388.2 million as of December 31, 2012, reduced from $500.0 million by the outstanding borrowing and by $3.8 million in issued letters of credit. From time-to-time, we may have unsecured, uncommitted bank lines of credit to support working capital for a few foreign subsidiaries. As of December 31, 2013 and 2012, we had no foreign loans outstanding. Client Concentration During 2013, one of our clients represented 12% of our total annual revenue. Our five largest clients accounted for 40%, 39% and 37% of our annual revenue for the years ended December 31, 2013, 2012 and 2011, respectively. We have long-term relationships with our top five clients, ranging from seven to 18 years, with the majority of these clients having completed multiple contract renewals with TeleTech. 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 2014 and 2016. Additionally, a particular client may have multiple contracts with different expiration dates. We have historically renewed most of our contracts with our largest clients, but there can be no assurance that future contracts will be renewed or, if renewed, will be on terms as favorable as the existing contracts. Recently Issued Accounting Pronouncements We discuss the potential impact of recent accounting pronouncements in Note 1 to the Notes to the Consolidated Financial Statements. 37 -------------------------------------------------------------------------------- Table of Contents |