TTEC Holdings, Inc. - Annual Report: 2006 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

Form 10-K

 

 

 

 

 

Commission File Number: 0-21055

 

 

 

 

TeleTech Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

 

9197 South Peoria Street

Englewood, Colorado 80112

(Address of principal executive offices)

 

Registrant’s telephone number, including area code:

(303) 397-8100

 

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

None

 

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value per share
(Title of Class)

 

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes þ      No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer þ          Accelerated filer o           Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of June 30, 2006, the last business day of the registrant’s most recently completed second fiscal quarter, there were 68,824,244 shares of the registrant’s common stock outstanding. The aggregate market value of the registrant’s voting and non-voting common stock that was held by non-affiliates on such date was $381,931,678 based on the closing sale price of the registrant’s common stock on such date as reported on the NASDAQ National Market.

 

As of February 1, 2007, there were 70,137,732 shares of the registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of TeleTech Holdings, Inc.’s definitive proxy statement for its annual meeting of stockholders to be held on May 24, 2007, are incorporated by reference into Part III of this Form 10-K, as indicated.

 

 

PART I

 

This Form 10-K and the documents incorporated by reference herein contain “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on current expectations and projections. Statements that are not historical facts, including those about the beliefs and expectations of TeleTech Holdings, Inc., are forward-looking statements. These statements discuss potential risks and uncertainties and, therefore, actual results may differ materially. We have set forth, in Item 1A which covers Risk Factors and Item 7 which covers Management’s Discussion and Analysis of Financial Condition and Results of Operations, a detailed discussion of risks and uncertainties relating to our business. We caution investors not to place undue reliance on these forward-looking statements, as they are current as of the date they are made. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events, or otherwise, except as required by law.

 

In various places throughout this Form 10-K we use certain non-GAAP (accounting principles generally accepted in the United States (“U.S.”) (“GAAP”)) financial measures when describing our performance. We believe such non-GAAP financial measures are informative to the users of our financial information. We discuss non-GAAP financial measures in Item 7 of this Form 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Presentation of Non-GAAP Measurements.”

 

ITEM 1.  BUSINESS

 

Our Business

 

Our 25-year history has enabled us to become one of the largest global providers of onshore, offshore and work-from-home business process outsourcing (BPO) services with a customer management focus. We help Global 1000 companies enhance their strategic capabilities, improve quality and lower costs by designing, implementing and managing their critical front and back office processes. We provide a 24 x 7, 365 day fully integrated global solution that spans people, process, proprietary technology and infrastructure for clients and governments in the automotive, broadband, cable, financial services, healthcare, logistics, media and entertainment, retail, satellite, technology, travel, wireline and wireless industries. Our 47,000 employees provide services from 33,600 workstations across 88 Delivery Centers in 17 countries. We have approximately 135 global clients, many of who are in the Global 1000. The Global 1000 is a ranking of the world’s largest companies based on market capitalization. We perform services for many of our clients’ subsidiaries and support approximately 300 unique BPO programs.

 

We believe BPO is a key enabler of improved business performance as measured by a company’s ability to consistently outperform peers through business and economic cycles. We believe the benefits of BPO include renewed focus on core capabilities, faster time-to-market, streamlined processes, moving from a fixed to variable cost structure, access to global sourcing capabilities, and proprietary best operating practices and technology, all of which contribute to increased customer satisfaction and shareholder returns.

 

Industry studies indicate that companies with high customer satisfaction levels enjoy premium pricing in their industry, which we believe results in increased profitability and greater shareholder returns. Given the strong correlation between customer satisfaction and improved profitability, more and more companies are increasingly focused on selecting outsourcing partners, such as TeleTech, that can deliver strategic front and back office capabilities that improve the customer experience versus simply reducing costs.

 

Our Business History

 

We (“TeleTech,” “Management,” or “the Company”) were founded in 1982 and organized as a Delaware corporation on December 22, 1994 to continue the operations of our predecessor company. We

completed an initial public offering in 1996 and since that time our revenue has grown from $183 million to $1.2 billion in 2006, which is a compounded annual growth rate (“CAGR”) of 21%.

 

The majority of our revenue, or 97%, comes from BPO services and is reported in our North American and International BPO segments. These services involve the transfer of our clients’ front and back office business processes to our 88 Delivery Centers or our work-from-home associates. We also manage the operations of Delivery Centers for our clients. Front office services include helping clients acquire, grow, serve and retain their customers. Back office services include: managing clients critical processes such as products or service provisioning; lead generation, fulfillment and sales support; expense, loyalty, reward and supply chain management; claims, collections, loans, payment and warranty processing; Tier 1 through 3 technical support; retirement plan administration; data analysis, intelligence and market research; network management; and workforce recruiting, training and scheduling.

 

Our strategy is to sell our services to clients in G-20 countries while performing an increasing amount of the work in emerging markets where there is a growing pool of high quality, lower cost labor with strong multilingual skills. The G-20 represents 19 of the world’s largest economies, together with the European Union.

 

Of the 17 countries we operate in, seven provide services, partially or entirely, for offshore clients including Argentina, Brazil, Canada, India, Malaysia, Mexico and the Philippines. The total workstations in these countries are 18,700, or 56% of our total delivery capacity. Many of our clients choose a blended strategy whereby they offshore work with us in four to five locations as well as utilize our work-from-home offering. We believe our ability to offer one of the most geographically diverse offshore footprints reduces clients’ operational and delivery risk in the event of a service interruption due to environmental or political risks, in any of these locations.

 

Our offshore revenue is the fastest growing part of our business. In 2006, our offshore revenue grew 39% to $400 million and represented 33% of our total revenue. We believe this makes us one of the largest and most geographically diverse providers of BPO services. We are currently expanding into two new emerging markets and plan to selectively increase the number of offshore markets we operate in over time.

 

The other 10 countries in which we operate provide services for onshore clients including the U.S., Australia, China, England, Germany, New Zealand, Northern Ireland, Scotland, Singapore and Spain. A key part of our future strategy is to perform more services for these clients in offshore locations.

 

Historical Performance

 

As summarized below, following our initial public offering in 1996 we experienced double-digit revenue growth through 2000, undertook a business transformation strategy in late 2001 and began realizing the benefits of this transformation in 2004 and going forward.

 

From 1996 to 2000, our revenue grew at a CAGR of 48% from $183 million to $885 million, while diluted earnings per share grew at a CAGR of 54% from $0.15 to $0.85. Our growth during this period was primarily organic and attributable to strong demand for our services from both new and existing clients across an expanding array of industry verticals. Beginning in 1997, we were one of the first companies to provide BPO services to U.S. clients from Delivery Centers in Argentina, Canada and Mexico.

 

While revenue growth continued at a CAGR of 7% from $885 million in 2000 to $1.0 billion in 2002, we experienced net losses in 2001 which continued through 2003. This was due primarily to the global economic downturn, the dot-com bubble, the September 11, 2001 attacks and the business transformation we undertook to further strengthen TeleTech’s industry position and future competitiveness. The business transformation redefined our delivery model, reduced our cost structure and improved our competitive and financial position by:

 

 

 

As a result of the above business transformation, we returned to profitability in 2004. From 2005 to 2006, our year-over-year revenue grew 11.5% from $1.1 billion to $1.2 billion and diluted earnings per share grew 92% from $0.38 to $0.73. Our 2006 operating margin more than doubled from 2.9% in 2005 to 6.0% in 2006 and we ended the fourth quarter of 2006 with an operating margin of 8.6% and a return on invested capital (“ROIC”) of 21%. ROIC is defined as earnings before interest and taxes (“EBIT”) divided by average shareholders’ equity.

 

As of December 31, 2006, we had $60.5 million in cash and cash equivalents and a debt to equity ratio of 20%. We generated $29.2 million in free cash flow during 2006 and our cash flows from operations and borrowings under our revolving credit facility have enabled us to fund $66 million in capital expenditures. Approximately 70% of our capital expenditures were related to growth primarily in offshore markets with the remaining 30% used for the maintenance of our embedded infrastructure.

 

Our improved financial performance resulted from strong growth both with new and existing clients across an expanding array of industry verticals, a 39% growth rate in offshore revenue and our achievement of $90 million in cost improvements from mid-2003 through 2006.

 

On June 30, 2006, we acquired Direct Alliance Corporation (“DAC”), a provider of e-commerce, professional sales and account management solutions to Fortune 500 companies that sell into and maintains long-standing relationships with small and medium businesses. We acquired DAC for $46.4 million in cash and used borrowings under our revolving credit facility to finance the acquisition. DAC’s annual revenues are approximately $68 million and they contributed $34.1 million in revenue to our consolidated results during the last six months of 2006. The acquisition was slightly accretive to our earnings during that period.

 

Since announcing our stock repurchase program in late 2001, the Board of Directors approved $165 million of share repurchases. Since inception of the plan through December 31, 2006, we repurchased 13.2 million shares of common stock, or approximately 18% of our shares outstanding during that period, for $115.7 million, leaving a remaining balance of $49.3 million for future share repurchases.

 

Our Future Growth Goals and Strategy

 

Our financial goals for 2007 are to reach a revenue run-rate of $1.5 billion, an operating margin of 10% and an earnings before interest, taxes, depreciation and amortization (“EBITDA”) margin of 15% by the fourth quarter of 2007. We plan to achieve this by:

 

 

 

 

Our Market Opportunity

 

The global BPO industry is large and growing. Based on industry reports, we estimate the total market opportunity for BPO services is more than $5 trillion.

 

The global BPO industry is large and growing. According to the International Data Corporation, the global BPO market was $385 billion in 2005 and is projected to grow to $618 billion in 2010, representing a 10% CAGR.

 

Our Business Description

 

We help Global 1000 clients improve front and back office business processes while increasing customer satisfaction. We manage our clients’ outsourcing needs with the primary goal of delivering a high-quality customer experience while also reducing their total delivery costs.

 

Our solutions provide access to skilled people in 17 countries using standardized operating processes and a centralized delivery platform to:

 

 

 

Our Competitive Strengths

 

Entering a business services outsourcing relationship is typically a long-term strategic commitment for companies. The outsourced processes are usually complex and require a high degree of customization and integration with a client’s core operations. Accordingly, our clients tend to enter long-term contracts which provide us with a more predictable revenue stream. In addition, given the significant transition costs to exit the relationship, we have very high levels of client retention given our operational excellence and ability to meet our clients’ outsourcing objectives. As a result, our client retention in both 2005 and 2006 was 93%.

 

Clients select us because of our:

 

 

We believe that technological excellence, best operating practices and innovative human capital strategies that can scale globally are key elements to our continued industry leadership as described more fully below.

 

Technological Excellence

 

Over the past five years, we have measurably transformed our technology platform by moving to a secure, private 100% internet protocol (“IP”) based infrastructure. This transformation has enabled us to centralize and standardize our worldwide delivery capabilities resulting in improved quality of delivery for our clients along with lower capital and information technology (“IT”) operating costs.

 

The foundation of this platform is our six IP hosting centers known as TeleTech GigaPOPs^®, which are located on four continents. These centers provide a fully integrated suite of voice and data routing, work force management, quality monitoring, storage and business analytic capabilities. This enables ‘anywhere to anywhere,’ real-time processing of our clients’ business needs from any location around the globe and is the foundation for new, innovative offerings including OnDemand, TeleTech@Home and our suite of human capital solutions. This hub and spoke model enables us to provide our services at the lowest cost while increasing scalability, reliability, redundancy, asset utilization and the diversity of our service offerings.

 

Prior to this technology transformation, each of our Delivery Centers had a significant investment in disparate hardware and software maintained by on-site IT staff, which was costly to operate and maintain and did not provide the level of reliability or failover we now provide.

 

To ensure high end-to-end security and reliability of this critical infrastructure, we monitor and manage the TeleTech GigaPOPs 24 x 7, 365 days per year from several strategically located state-of-the-art Global Command Centers.

 

Our technology innovations have resulted in the filing of more than a dozen intellectual property patents.

 

Globally Deployed Best Operating Practices

 

Globally deployed best operating practices assure that we can deliver a consistent, scalable, high-quality experience to our clients’ customers from any of our 88 Delivery Centers or work-from-home associates around the world. Standardized processes include our approach to attracting, screening, hiring, training, scheduling, evaluating, coaching and maximizing associate performance to meet our clients’ needs. We provide real-time reporting on performance across the globe to ensure consistency of delivery. In addition, this information provides valuable insight into what is driving customer inquiries enabling us to proactively recommend process changes to our clients to optimize their customer’s experience.

 

Innovative Human Capital Strategies

 

To effectively manage and leverage our human capital requirements we have developed a proprietary suite of business processes, software tools and client engagement guidelines that work together to improve performance for our clients while enabling us to reduce time to hire, decrease attrition and improve time-to-service and quality of performance.

 

The three primary components of our human capital platform — Talent Acquisition, Learning Services and Performance Optimization — combine to form a powerful and flexible management system to streamline and standardize operations across our global Delivery Centers. These three components work to allow us to make better hires, improve training quality and provide real-time feedback and incentives for performance.

 

Several of our clients have expressed interest in licensing all or parts of the above components and over time this will be an additional opportunity for us to diversify our revenue into higher margin offerings.

 

Innovative New Revenue Opportunities

 

We continue to develop other new innovative services that leverage our investment in a centralized and standardized delivery platform to meet our clients’ needs and we believe that these solutions will represent a growing percentage of our future revenue.

 

OnDemand

 

OnDemand delivers a fully-integrated suite of best-in-class customer management applications on a hosted (software as a service) basis, providing streamlined delivery center technology, knowledge and services. This allows our clients to empower their associates with the same technology and best practices we use internally, on a monthly subscription license model. With OnDemand, there is no need for our clients to license software, purchase on-premise hardware, or staff up to provide ongoing technology support.

 

Our OnDemand solutions are easy to implement and scale seamlessly to support business growth, encompassing the full breadth of customer management and BPO operations including: Interaction Routing, Self-Service, Employee Desktop Management, Business Intelligence and Performance Management. Because they are based on our rigorous first-hand use, our hosted services are proven, reliable, scalable and continually refined and expanded.

 

TeleTech@Home

 

Our dispersed workforce solution enables employees to work out of their home while accessing the same proprietary training, workflow, reporting and quality tools as our Delivery Center associates. TeleTech@Home associates are TeleTech employees — not independent contractors — providing a strong cultural fit, seamless workforce control and high levels of job satisfaction. Our TeleTech@Home solution utilizes our highly scalable and centralized technical architecture and enables secure access, monitoring and reporting for our Global 1000 clients.

 

Features of the new TeleTech@Home offering include:

 

 

 

Clients

 

Our client concentration has decreased as we continue to grow, and in 2006 we had one client that represented more than 10% of total revenue. Sprint Nextel (we contract with IBM, who contracts with Sprint Nextel) represented 16% of total revenue in 2006. Our top five and 10 clients represented 42% and 61% of total revenue, respectively.

 

Certain of our communications clients, which represent approximately 30% of our total annual revenue, also provide us with telecommunication services. We believe each of these supplier contracts is negotiated on an arms-length basis and may be negotiated at different times and with different legal entities. Expenditures under these supplier contracts represent less than one percent of total costs.

 

Competition

 

We compete primarily with the in-house business processing operations of our current and potential clients. We also compete with certain companies that provide BPO services including: Accenture; Convergys Corporation; Computer Sciences Corporation; EDS; ExlService Holdings; IBM; People Support; SR.Teleperformance; Sykes Enterprises Incorporated and WNS Limited among others. We work with Accenture; Computer Sciences Corporation and IBM on a sub-contract basis and approximately 20% of our total revenue is generated from these system integrator relationships.

 

We compete primarily on the basis of our 25 years of experience, our global locations, our quality and scope of services, our speed and flexibility of implementation, our technological expertise, and our price and contractual terms. A number of competitors may have different capabilities and resources than ours. Additionally, niche providers or new entrants could capture a segment of the market by developing new systems or services that could impact our market potential.

 

Seasonality

 

Historically, we experience a seasonal revenue lift in the fourth quarter related to higher volumes from clients primarily in the healthcare, package delivery and retail industry as they have seasonality in their business. Also, our operating margins in the first quarter are typically lower due to higher payroll-related taxes with our global workforce.

 

As discussed below, we earned a significant amount of revenue during the third and fourth quarters of 2005 from a short-term U.S. Government program to provide disaster relief services related to hurricanes in the U.S.

 

Database Marketing and Consulting Segment

 

This segment represents 3% of total revenue and provides outsourced database and marketing services for automotive dealerships and manufacturers to generate and qualify leads, schedule, remind and follow up on customer service appointments. Other services include email campaign management, event marketing, Internet-based appointment setting, lead qualification and related customer acquisition and retention services utilizing email, direct mail and phone based services.

 

Markets and Clients

 

This segment provides services to automotive dealers and manufacturers in the U.S. and Canada and has contracts with approximately 2,400 automobile dealers representing 27 different automotive brand

names. Additionally, they provide services directly to automobile manufacturers primarily related to national sales and service promotions.

 

Competition

 

This segment competes with a variety of companies, including large national or multi-national companies and smaller regional or local companies. In addition, this segment competes with the in-house database marketing and consulting services of our automotive dealership clients.

 

Employees

 

As of December 31, 2006, TeleTech had approximately 47,000 employees in 17 countries. Approximately 83% of these employees held full-time positions and 76% were located outside of the U.S. Our employees in Spain are subject to a collective bargaining agreement mandated under national labor laws, which expired on December 31, 2006. A new collective bargaining agreement is currently being negotiated. The collective bargaining agreement in Spain covers approximately 3,300 employees. We have not experienced any significant work stoppages with our ongoing business. We believe that our relations with our employees and unions are satisfactory.

 

Patents and Trademarks

 

Our trademarks include, among others, TELETECH^®, the TELETECH GLOBE Design, TELETECH GIGAPOP^®, HIREPOINT^®, EXPERT IN-SITE^®, TELETECH GLOBAL VENTURES^®, TOTAL DELIVERED VALUE^® and YOUR CUSTOMER MANAGEMENT PARTNER^®. We believe that several of our trademarks are of material importance. None of the material trademarks are of limited duration and we believe our intellectual property is adequately protected in customary fashion under applicable law. We have applied for, and will continue to apply for, in the U.S. and foreign countries, patents to protect the inventions and technologies developed by or for us. Fourteen provisional and utility patent applications for Company inventions (processes and technologies) are currently pending before the U.S. Patent and Trademark Office, with several more in progress and international filing rights reserved. While we currently utilize these processes and technologies in the conduct of our business, we do not believe our competitiveness and market share are dependent on the ultimate disposition of our patent applications.

 

Our Corporate Information

 

Our principal executive offices are located at 9197 South Peoria Street, Englewood, Colorado 80112 and the telephone number at that address is (303) 397-8100. Electronic copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and current Reports on Form 8-K are available free of charge by visiting the “Investors” section of our website at http://www.teletech.com. These reports are posted as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). In addition, we will provide electronic or paper copies of our SEC filings, free of charge, upon request.

 

ITEM 1A.  RISK FACTORS

 

You should not construe the following cautionary statements as an exhaustive list. We cannot always predict what factors would cause actual results to differ materially from those indicated in our forward-looking statements. All cautionary statements should be read as being applicable to all forward-looking statements wherever they appear. We do not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed herein might not occur.

 

Forward-looking information may prove to be inaccurate. Some of the information presented in this Annual Report on Form 10-K constitutes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements that include terms such as “may,” “will,” “intend,” “anticipate,” “estimate,” “expect,” “continue,” “believe,” “plan,” or the like, as well as all statements that are not historical facts. Forward-looking statements are inherently subject to risks and uncertainties that could cause actual results to differ

materially from current expectations. Although we believe our expectations are based on reasonable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that actual results will not differ materially from expectations. Factors that could cause actual results to differ from expectations or have a material adverse effect upon our business are as follows.

 

Our Revenues are Generated from a Limited Number of Clients

 

We rely on strategic, long-term relationships with large, global companies in targeted industries. As a result, we derive a substantial portion of our revenue from relatively few clients. Additionally, client consolidations could result in a loss of clients. There can be no assurance that we will not become more dependent on a few significant clients, that we will be able to retain any of our largest clients, that the volumes or profit margins of our most significant programs will not be reduced, or that we would be able to replace such clients or programs with clients or programs that generate comparable revenue and profits.

 

Our Business May be Affected by the Success of Our Clients

 

In substantially all of our client programs, we generate revenue based, in large part, on the amount of time our associates devote to our clients’ customers. Consequently, the amount of revenue generated from any particular client program is dependent upon consumers’ interest in and use of our client’s products and/or services. There can be no assurance that our clients will continue to market products and services or develop new products and services that require them to use our services.

 

Our Financial Results May be Adversely Impacted by the Global Economy

 

Our ability to enter into new multi-year contracts with large clients may be impacted by the general macroeconomic environment in which our clients and their customers operate. Weakening economic conditions, both global and local in nature, could result in increased sales cycles, delays in finalizing new business opportunities and slower growth and reduced revenue from existing contracts. An economic downturn could negatively impact the financial condition of our clients, thereby increasing our risk of not receiving payment for services. There can be no assurance that weakening economic conditions or acts of terrorism throughout the world will not adversely impact our results of operations and/or financial position.

 

Our Business is Subject to Federal, State and International Regulations

 

Changes in U.S. federal, state and international outsourcing requirements, restrictions and disclosures may affect the sale of our services, including expansion of overseas operations. In the U.S., some of our services must comply with various federal and state requirements and regulations regarding the method and practices of placing outbound telephone calls. There can be no assurance that changes in these regulations and requirements, or new restrictive regulations and requirements, will not slow growth of these services or require us to incur substantial costs.

 

Our Success is Subject to the Terms of Our Contracts

 

Most of our contracts do not ensure that we will generate a minimum level of revenue and the profitability of each client program may fluctuate, sometimes significantly, throughout the various stages of a program. Our objective is to sign multi-year contracts with our clients. However, our contracts generally enable the clients to terminate the contract or reduce customer interaction volumes. Our larger contracts generally require the client to pay a contractually agreed amount in the event of early termination. Additionally, certain contracts have performance-related bonus and/or penalty provisions, whereby the client may pay us a bonus or we may have to issue a credit based upon our ability to meet agreed upon performance metrics. There can be no assurance that we will be able to collect early termination fees, avoid performance penalties, or earn performance bonuses.

 

Our Business May be Affected by Our Ability to Obtain Financing

 

From time to time, we may need to obtain debt or equity financing for capital expenditures, for payment of existing obligations, or to replenish cash reserves. Additionally, our existing debt agreements require us to comply with certain financial covenants. There can be no assurance that we will be able to obtain debt

or equity financing, or that any such financing would be on terms acceptable to us. There can be no assurance that we will be able to meet the financial covenants under our debt agreements or, in the event of noncompliance, will be able to obtain waivers or amendments from the lenders.

 

Our Business May be Affected by Risks Associated with International Operations and Expansion

 

An important component of our growth strategy is continued international expansion. There are certain risks inherent with conducting international business including, but not limited to, management of personnel overseas, longer payment cycles, difficulties in accounts receivable collections, difficulties in complying with foreign laws, unexpected changes in regulatory requirements, political and social instability and potentially adverse tax consequences. Any one or more of these or other factors could have a material adverse effect on our international operations and, consequently, on our business, results of operations, or financial condition. There can be no assurance that we will be able to manage our international operations successfully.

 

Our Financial Results May be Impacted by Our Ability to Find New Locations

 

Our future success will be dependent upon being able to find cost effective locations in which to operate, both domestically and internationally. There is no assurance that we will be able to find cost effective locations, obtain favorable lease terms and build or retrofit facilities in a timely or economic manner.

 

Our Financial Results May be Adversely Affected by Increases in Business Costs

 

Some of our larger contracts allow us to increase our service fees if and to the extent certain cost or price indices increase. The majority of our expenses are payroll and payroll-related, which includes healthcare costs. Over the past several years, healthcare costs have increased at a rate much greater than that of general cost or price indices. Increases in our service fees that are based upon increases in cost or price indices may not fully compensate us for increases in labor and other costs incurred in providing services. There can be no assurance that we will be able to recover increases in our costs through increased service fees.

 

Our Financial Results Depend on Our Ability to Manage Capacity Utilization

 

Our profitability is influenced significantly by our Delivery Center capacity utilization. We attempt to maximize utilization. However, because the majority of our business is inbound from customer initiated encounters, we have significantly higher utilization during peak (weekday) periods than during off-peak (night and weekend) periods. We have experienced periods of idle capacity, particularly in our Multi-Client Delivery Centers. Historically, we experience idle peak period capacity upon opening a new Delivery Center or termination or completion of a large client program. On a quarterly basis, we assess the expected long-term capacity utilization of our Delivery Centers. We may consolidate or close under-performing Delivery Centers in order to maintain or improve targeted utilization and margins. In the event we close Delivery Centers in the future, we may be required to record restructuring or impairment charges, which could adversely impact our results of operations. There can be no assurance that we will be able to achieve or maintain optimal Delivery Center capacity utilization.

 

Our Business Operates in a Highly Competitive Market

 

The market in which we operate is fragmented and highly competitive and competition may intensify in the future. We compete with small firms offering specific applications, divisions of large entities, large independent firms and, most significantly, the in-house operations of clients or potential clients. A number of competitors may develop greater capabilities and resources than ours. Because our primary competitors are the in-house operations of existing or potential clients, our performance and growth could be adversely affected if our existing or potential clients decide to provide in-house business processing services for customer care they currently outsource, or retain or increase their in-house business processing services and product support capabilities. In addition, competitive pressures from current or future competitors also could cause our services to lose market acceptance or result in significant price erosion, which could have a material adverse effect upon our business, results of

operations and financial condition. There can be no assurance that additional competitors, some with greater resources than ours, will not enter our market.

 

Our Future Success Requires Continued Growth

 

Continued future growth will depend on a number of factors, including our ability to: (i) initiate, develop and maintain new client relationships; (ii) expand existing client programs; (iii) staff and equip suitable Delivery Center facilities in a timely manner; and (iv) develop new solutions and enhance existing solutions we provide to our clients. There can be no assurance that we will be able to effectively manage expanded operations or maintain our profitability.

 

Our Financial Results May be Affected by Rapidly Changing Technology

 

Our business is highly dependent on our computer and telecommunications equipment and software capabilities. Our failure to maintain our technological capabilities or to respond effectively to technological changes could have a material adverse effect on our business, results of operations, or financial condition. Our continued growth and future profitability will be highly dependent on a number of factors, including our ability to: (i) expand our existing solutions offerings; (ii) achieve cost efficiencies in our existing Delivery Center operations; and (iii) introduce new solutions that leverage and respond to changing technological developments. Our ability to effectively market and implement software solutions developed by our Database Marketing and Consulting segment, including recoverability of capitalized costs based on estimated future cash flows, is a factor in our future success. There can be no assurance that technologies or services developed by our competitors will not render our products or services non-competitive or obsolete, that we can successfully develop and market any new services or products, that any such new services or products will be commercially successful, or that the integration of new technological capabilities will achieve their intended cost reductions.

 

Our Success Depends on Key Personnel

 

Our success will depend upon our ability to recruit, hire and retain experienced executive personnel who can successfully execute our business plans. There can be no assurance that we will be able to hire, motivate and retain highly effective executive employees on economically feasible terms who can successfully execute our business plans.

 

Our Business is Dependent on Our Ability to Maintain Our Workforce

 

Our success is largely dependent on our ability to recruit, hire, train and retain qualified employees. Our industry is labor-intensive and experiences high employee turnover. A significant increase in the employee turnover rate could increase recruiting and training costs, thereby decreasing operating effectiveness and productivity. Also, if we obtain several significant new clients or implement several new, large-scale programs, we may need to recruit, hire and train qualified personnel at an accelerated rate. We may not be able to continue to hire, train and retain sufficient qualified personnel to adequately staff new BPO service programs. In addition, certain Delivery Centers are located in geographic areas with relatively low unemployment rates, which could make it more difficult and costly to hire qualified personnel. There can be no assurance that we will be able maintain our workforce at necessary levels.

 

Our Success May be Affected by Our Ability to Complete and Integrate Acquisitions and Joint Ventures

 

We may pursue strategic acquisitions of companies with services, technologies, industry specializations, or geographic coverage that extend or complement our existing business. We may face increased competition for acquisition opportunities, which may inhibit our ability to complete suitable acquisitions on favorable terms. We may pursue strategic alliances in the form of joint ventures and partnerships, which involve many of the same risks as acquisitions as well as additional risks associated with possible lack of control if we do not have a majority ownership position. There can be no assurance that we will be successful in integrating acquisitions or joint ventures into our existing businesses, or that any acquisition or joint venture will enhance our business, results of operations, or financial condition.

 

Our Business Depends on Uninterrupted Service to Clients

 

Our operations are dependent upon our ability to protect our computer and telecommunications equipment and software systems against damage or interruption from fire, power loss, cyber attacks, telecommunications interruption or failure, natural disaster and other similar events. Our operations may also be adversely affected by damage to our facilities resulting from fire, natural disaster, or other events. Additionally, severe weather can cause interruption in our ability to deliver our services, such as when our employees cannot attend work, resulting in a loss of revenue. In the event we experience a temporary or permanent interruption at one or more of our locations (including our corporate headquarters building), through the reasons noted above or otherwise, our business could be materially adversely affected and we may be required to pay contractual damages or face the loss of certain clients altogether. We maintain property and business interruption insurance. However, there can be no assurance that such insurance will adequately compensate us for any losses we may incur.

 

Our Financial Results May Experience Variability

 

We experience quarterly variations in operating results because of a variety of factors, many of which are outside our control. In addition, we make decisions regarding staffing levels, investments and other operating expenditures based on our revenue forecasts. If our revenue is below expectations in any given quarter, our operating results for that quarter could be materially adversely affected. There can be no assurance that future quarterly or annual operating results will reflect past operating results.

 

Our Financial Results May be Impacted by Foreign Currency Exchange Risk

 

We serve an increasing number of our clients from Delivery Centers in other countries including Argentina, Brazil, Canada, India, Malaysia, Mexico and the Philippines. Contracts with these clients are typically priced in the currency of the contracting subsidiary while the costs incurred to operate these Delivery Centers are denominated in the foreign currency of the operating subsidiary, thereby representing a foreign currency exchange risk to us.

 

Although we enter into financial hedge instruments for certain foreign currencies, we do not hedge 100% of these risks. If the functional currency of the contracting subsidiary weakens, the operating income of the operating subsidiary Delivery Centers, once translated into the functional currency of the operating subsidiary, decreases in comparison to prior years to the extent we have not hedged 100%.

 

In addition, if the U.S. dollar was to materially weaken against any of the functional currencies of our subsidiaries, our financial results may be adversely impacted. While our hedging strategy effectively offsets a portion of these foreign currency changes during 2006, there can be no assurance that we will continue to successfully hedge this foreign currency exchange risk or that the U.S. dollar will not materially weaken.

 

Our Financial Results May be Adversely Impacted by Our Database Marketing and Consulting Segment

 

Prior to 2005, our Database Marketing and Consulting segment had historically experienced high levels of profitability. During 2005 and 2006, the segment reported an operating loss. We have plans to return this segment to profitability. There can be no assurance that we will be successful in executing our plans to return this segment to prior levels of profitability. We have approximately $13.4 million of goodwill recorded for this segment whose ultimate recoverability is dependent upon the profitability of this segment. Our results of operations or financial condition may be adversely impacted if we are unable to return that segment to profitability.

 

ITEM 1B.  UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2.  PROPERTIES

 

Our corporate headquarters are located in Englewood, Colorado. In February 2003, we purchased our corporate headquarters building, including furniture and fixtures, for $38.3 million, which consists of approximately 264,000 square feet of office space.

 

As of December 31, 2006, excluding Delivery Centers we have exited, we operated 88 Delivery Centers that are classified as follows:

 

 

As of December 31, 2006, our Delivery Centers were located in the following countries:

 

 

Our Database Marketing and Consulting segment leases space for its corporate headquarters in San Diego, California.

 

The leases for our Delivery Centers have remaining terms ranging from approximately one to 14 years and generally contain renewal options. We believe that our existing Delivery Centers are suitable and adequate for our current operations and we have plans to build additional centers to accommodate future business.

 

ITEM 3.  LEGAL PROCEEDINGS

 

From time to time we may be involved in claims or lawsuits that arise in the ordinary course of business. Accruals for claims or lawsuits have been provided for to the extent that losses are deemed both probable and estimable. Although the ultimate outcome of these claims or lawsuits cannot be ascertained, it is our opinion, based on present information and advice received from counsel, that the disposition or ultimate determination of such claims or lawsuits will not have a material adverse effect on our Company.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matters were submitted to a vote of our stockholders during the fourth quarter of our fiscal year ended December 31, 2006.

 

ITEM 4A.  EXECUTIVE OFFICERS OF TELETECH HOLDINGS, INC.

 

Set forth below are the names, position and ages, as of December 31, 2006, of our executive officers:

 

 

There are no arrangements or understandings between any executive officer and another person pursuant to which such executive officer was selected as an officer.

 

 

 

 

PART II

 

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Our common stock is traded on the NASDAQ National Market under the symbol “TTEC.” The following table sets fourth the range of the high and low sales prices per share of the common stock for the quarters indicated as reported on the NASDAQ National Market:

 

 

As of February 1, 2007, there were 70,137,732 shares of common stock outstanding, held by stockholders of record.

 

We have never declared or paid any dividends on our common stock and we do not expect to do so in the foreseeable future.

 

Securities Authorized for Issuance Under Equity Plans

 

This item is discussed in Note 17 to the Consolidated Financial Statements.

 

Stock Repurchase Program

 

In November 2001, the Board of Directors (“Board”) authorized a stock repurchase program to repurchase up to $5 million of our common stock. That plan was subsequently amended by the Board resulting in the authorized repurchase amount increasing to $165 million. During the three months ended December 31, 2006, we purchased 126,900 shares for $1.9 million. During the year ended December 31, 2006, we purchased 1.3 million shares for $16.6 million. From inception of the program through December 31, 2006, we have purchased 13.2 million shares for $115.7 million, leaving $49.3 million remaining under the repurchase program as of December 31, 2006. The program does not have an expiration date.

 

Following is a summary of issuer purchases of equity securities for the fourth quarter of 2006:

 

 

ITEM 6.  SELECTED FINANCIAL DATA

 

The following selected financial data should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and the related notes appearing elsewhere in this report.

 

 

 

 

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Introduction

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains certain forward-looking statements that involve risks and uncertainties. The projections and statements contained in these forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements.

 

All statements not based on historical fact are forward-looking statements that involve substantial risks and uncertainties. In accordance with the Private Securities Litigation Reform Act of 1995, following are important factors that could cause our actual results to differ materially from those expressed or implied by such forward-looking statements, including but not limited to the following: our belief that we are continuing to see strong demand for our services and that sales cycles are shortening; risks associated with successfully integrating DAC which we acquired on June 30, 2006 and achieving anticipated future revenue growth, profitability and synergies; estimated revenue from new, renewed and expanded client business as volumes may not materialize as forecasted or be sufficient to achieve our Business Outlook; achieving continued profit improvement in our International BPO operations; the ability to close and ramp new business opportunities that are currently being pursued or that are in the final stages with existing and/or potential clients in order to achieve our Business Outlook; our ability to execute our growth plans, including sales of new products (such as OnDemand); our ability to achieve our year-end 2007 financial

goals, including those set forth in our Business Outlook; the possibility of our Database Marketing and Consulting segment not increasing revenue, lowering costs, or returning to profitability resulting in an impairment of its $13.4 million of goodwill; the possibility of lower revenue or price pressure from our clients experiencing a business downturn or merger in their business; greater than anticipated competition in the BPO services market, causing adverse pricing and more stringent contractual terms; risks associated with losing or not renewing client relationships, particularly large client agreements, or early termination of a client agreement; the risk of losing clients due to consolidation in the industries we serve; consumers’ concerns or adverse publicity regarding our clients’ products; our ability to find cost effective locations, obtain favorable lease terms and build or retrofit facilities in a timely and economic manner; risks associated with business interruption due to weather, pandemic, or terrorist-related events; risks associated with attracting and retaining cost-effective labor at our Delivery Centers; the possibility of additional asset impairments and restructuring charges; risks associated with changes in foreign currency exchange rates; economic or political changes affecting the countries in which we operate; changes in accounting policies and practices promulgated by standard setting bodies; and new legislation or government regulation that impacts the BPO and customer management industry.

 

Executive Overview

 

We serve our clients through two primary businesses, BPO and Database Marketing and Consulting. Our BPO business provides outsourced business process, customer management and marketing services for a variety of industries through Delivery Centers throughout the world and represents approximately 97% of total revenue. When we begin operations in a new country, we determine whether the country is intended to primarily serve U.S. based clients, in which case we include the country in our North American BPO segment, or if the country is intended to serve both domestic clients from that country and U.S. based clients, in which case we include the country in our International BPO segment. This is consistent with our management of the business, internal financial reporting structure and operating focus. Operations for each segment of our BPO business are conducted in the following countries:

 

 

On June 30, 2006, we acquired 100 percent of the outstanding common shares of DAC. DAC is a provider of outsourced direct marketing services to third parties in the U.S. and its acquisition is consistent with our strategy to grow and focus on providing outsourced marketing, sales and BPO solutions to large multinational clients. DAC is included in our North American BPO segment. The acquisition of DAC contributed approximately $34.1 million of revenue and was slightly accretive to earnings during the last six months of 2006, which were the first six months of combined operations.

 

Database Marketing and Consulting provides outsourced database management, direct marketing and related customer acquisition and retention services for automobile dealerships and manufacturers.

 

See Note 3 to the Consolidated Financial Statements for additional discussion regarding our preparation of segment information.

 

BPO Services

 

The BPO business generates revenue based primarily on the amount of time our associates devote to a client’s program. We primarily focus on large global corporations in the following industries; automotive, communications and media, financial services, healthcare, government, logistics, retail, technology and travel. Revenue is recognized as services are provided. The majority of our revenue is from multi-year contracts and we expect it will continue to be. However, we do provide certain client programs on a short-term basis.

 

We have historically experienced annual attrition of existing client programs of approximately 7% to 15% of our revenue. Attrition of existing client programs during 2006 was 7%, excluding the short-term contract with the U.S. Government during the third and fourth quarters of 2005. However, during 2005, we experienced net attrition of existing client programs of 3% (attrition of existing client programs was greater than the expansion of existing client programs) whereas during 2006, excluding the short-term contract with the U.S. Government, we experienced net growth of existing client programs of 11% as expansion of existing client programs exceeded attrition of existing client programs. We believe this trend is attributable to our investment in an account management and operations team focused on client service.

 

Our invoice terms with clients typically range from 30 to 60 days, with longer terms in Europe.

 

The BPO industry is highly competitive. We compete primarily with the in-house business processing operations of our current and potential clients. We also compete with certain companies that provide BPO on an outsourced basis. Our ability to sell our existing services or gain acceptance for new products or services is challenged by the competitive nature of the industry. There can be no assurance that we will be able to sell services to new clients, renew relationships with existing clients, or gain client acceptance of our new products.

 

We have improved our revenue and profitability in both the North American and the International BPO segments by:

 

 

Our ability to enter into new or renew multi-year contracts, particularly large complex opportunities, is dependent upon the macroeconomic environment in general and the specific industry environments in which our clients operate. A weakening of the U.S. or the global economy could lengthen sales cycles or cause delays in closing new business opportunities.

 

Our potential clients typically obtain bids from multiple vendors and evaluate many factors in selecting a service provider including, among other factors, the scope of services offered, the service record of the vendor and price. We generally price our bids with a long-term view of profitability and, accordingly, we consider all of our fixed and variable costs in developing our bids. We believe that our competitors, at times, may bid business based upon a short-term view, as opposed to our longer-term view, resulting in a lower price bid. While we believe our clients’ perceptions of the value we provide results in our being

successful in certain competitive bid situations, there are often situations where a potential client may prefer a lower cost.

 

Our industry is labor-intensive and the majority of our operating costs relate to wages, employee benefits and employment taxes. An improvement in the local or global economies where our Delivery Centers are located could lead to increased labor-related costs. In addition, our industry experiences high personnel turnover and the length of training time required to implement new programs continues to increase due to increased complexities of our clients’ businesses. This may create challenges if we obtain several significant new clients or implement several new, large-scale programs and need to recruit, hire and train qualified personnel at an accelerated rate.

 

As discussed above, our profitability is influenced, in part, by the number of new or expanded client programs. We defer revenue for the initial training that occurs upon commencement of a new client contract (“Start-Up Training”) if that training is billed separately to the client. Accordingly, the corresponding training costs, consisting primarily of labor and related expenses, are also deferred. In these circumstances, both the training revenue and costs are amortized straight-line over the life of the contract. In situations where Start-Up Training is not billed separately, but rather included in the production rates paid by the client over the life of the contract, no deferral is necessary as the revenue is recognized over the life of the contract and the associated training expenses are expensed as incurred. For the year ended December 31, 2006, we incurred $0.4 million of training expenses for client programs for which we did not separately bill Start-Up Training.

 

The following summarizes the impact of the deferred Start-Up Training for the years ended December 31, 2006, 2005 and 2004 (amounts in thousands):

 

 

As of December 31, 2006, we had $7.3 million of net deferred Start-Up Training that will be amortized straight-line over the remaining life of the corresponding client contracts (approximately 24 months).

 

We may have difficulties managing the timeliness of launching new or expanded client programs and the associated internal allocation of personnel and resources. This could cause a decline or delay in recognition of revenues and an increase in costs, either of which could adversely affect our operating results. In the event we do not successfully expand our capacity or launch new or expanded client programs, we may be unable to achieve the revenue and profitability targets set forth in the Business Outlook section below.

 

Quarterly, we review our capacity utilization and projected demand for future capacity. In conjunction with these reviews, we may decide to consolidate or close under-performing Delivery Centers, including those impacted by the loss of a major client program, in order to maintain or improve targeted utilization and margins. In addition, because clients may request that we serve their customers from International Delivery Centers with lower prevailing labor rates, in the future we may decide to close one or more of our Delivery Centers, even though it is generating positive cash flow, because we believe the future profits from conducting such work outside the current Delivery Center may more than compensate for the one-time charges related to closing the facility.

 

Our profitability is significantly influenced by our ability to increase capacity utilization in our Delivery Centers. We attempt to minimize the financial impact resulting from idle capacity when planning the development and opening of new Delivery Centers or the expansion of existing Delivery Centers. As such, management considers numerous factors that affect capacity utilization, including anticipated

expirations, reductions, terminations, or expansions of existing programs and the potential size and timing of new client contracts that we expect to obtain. We continue to win new business with both new and existing clients. As a result, we expanded our capacity in 2006 by approximately 7,000 workstations in Argentina, Canada and the Philippines.

 

To respond more rapidly to changing market demands, to implement new programs and to expand existing programs, we may be required to commit to additional capacity prior to the contracting of additional business, which may result in idle capacity. This is largely due to the significant time required to negotiate and execute a client contract as we concentrate our marketing efforts toward obtaining large, complex BPO programs.

 

We internally target capacity utilization in our Delivery Centers at 85% to 90% of our available workstations. As of December 31, 2006, the overall capacity utilization in our Multi-Client Centers was 80%. The table below presents workstation data for our multi-client centers as of December 31, 2006 and 2005. Dedicated and Managed Centers (10,355 workstations) 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.

 

 

As shown above, there was a significant increase in the total production workstations resulting from our growth plans (see discussion under BPO above), a corresponding increase in the number of production workstations in use and an increase in the utilization percentage.

 

Database Marketing and Consulting

 

The revenue from this segment is generated utilizing a database and contact system to promote the sales and service business of automobile dealership customers using targeted marketing solutions through the phone, mail, e-mail and the Web. As of December 31, 2006, our Database Marketing and Consulting segment had relationships with more than 2,400 automobile dealers representing 27 different automotive brand names. These contracts generally have terms ranging from month-to-month to 24 months. For a few major automotive manufacturers, the automotive manufacturer collects from the individual automobile dealers on our behalf. Our average collection period is 30 to 60 days. A combination of factors contributed to this segment generating a loss from operations of approximately $15.4 million after corporate allocations for the year ended December 31, 2006.

 

For 2006, we modified our agreement with Ford (whose dealers represented approximately 47% of the revenue of our Database Marketing and Consulting segment for the year ended December 31, 2006), to provide services to Ford’s automotive dealerships on a preferred basis, rather than on an exclusive basis. The new agreement gives us flexibility to customize service offerings and the ability to contract directly with Ford’s dealerships under our defined terms and conditions. Primarily due to Ford offering a competing product, our dealer attrition rate has exceeded our new account growth in 2006, resulting in a significant decrease in revenue from the prior year.

 

The clients of our Database Marketing and Consulting segment, as well as our joint venture with Ford, come from the automotive industry. The U.S. automotive industry is currently reporting declining earnings, which may result in client losses, lower volumes, or additional pricing pressures on our operations.

 

As we work to implement the plans outlined above to return this segment to profitability, we anticipate this segment will incur a loss from operations in the first quarter of 2007 in the range of $3.5 million to $4.5 million.

 

In 2007, we plan to continue our focus on the following to return this segment to profitability:

 

 

Overall

 

As shown in the “Results of Operations” we have improved income from operations for our North American and International BPO segments. The increases are attributable to a variety of factors such as expansion of work on certain client programs, our multi-phased cost reduction plan, transitioning work on certain client programs to lower cost operating centers, increased capacity utilization and improving individual client program profit margins and/or eliminating such programs.

 

As we pursue merger and acquisition opportunities, it is possible that the contemplated benefits of any future acquisitions may not materialize within the expected time periods or to the extent anticipated. Critical to the success of our acquisition strategy in the future is the orderly, effective integration of acquired businesses into our organization. If this integration is unsuccessful, our business may be adversely impacted. There is also the risk that our valuation assumptions and models for an acquisition may be overly optimistic or incorrect.

 

Critical Accounting Policies and Estimates

 

Management’s discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales 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

 

For each client arrangement, we determine whether evidence of an arrangement exists, delivery of our service has occurred, the fee is fixed or determinable and collection is probable. If all criteria are met, we recognize revenue at the time services are performed. If any of these criteria are not met, revenue recognition is deferred until such time as all of the criteria are met.

 

Our BPO segments recognize revenue under three models:

 

Production Rate — Revenue is recognized based on the billable time or transactions of each associate, as defined in the client contract. The rate per billable time or transaction is based on a predetermined contractual rate. This contractual rate can fluctuate based on our performance against certain pre-determined criteria related to quality and performance.

 

Performance-based — Under performance-based arrangements, we are paid by our clients based on achievement of certain levels of sales or other client-determined criteria specified in the client contract. We recognize performance-based revenue by measuring our actual results against the

performance criteria specified in the contracts. Amounts collected from clients prior to the performance of services are recorded as customer advances.

 

Hybrid — Under hybrid models we are paid a fixed fee or production element as well as a performance-based element.

 

Certain client programs provide for increases or decreases to monthly billings based upon whether we meet or exceed certain performance criteria as set forth in the contract. Increases or decreases to monthly billings arising from such contract terms are reflected in revenue as earned or incurred.

 

Our Database Marketing and Consulting segment recognizes revenue when services are rendered. Most agreements require the billing of predetermined monthly rates. Where the contractual billing periods do not coincide with the periods over which services are provided, we recognize revenue straight-line over the life of the contract (typically six to 24 months).

 

From time-to-time, we make certain expenditures related to acquiring contracts (recorded as contract acquisition costs in the accompanying Consolidated Balance Sheets). Those expenditures are capitalized and amortized in proportion to the initial 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 of revenue.

 

Income Taxes

 

We account for income taxes in accordance with SFAS No. 109 “Accounting for Income Taxes” (“SFAS 109”), which requires recognition of deferred tax assets and liabilities for the expected future income tax consequences of transactions that have been included in the Consolidated Financial Statements. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted 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.

 

As required by SFAS 109, 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 SFAS 109 requires that all available evidence, both positive and negative, should be considered to determine whether, based on the weight of that evidence, a valuation allowance is required. As of December 31, 2006, we had $56.8 million of deferred tax assets (after an $19.0 million valuation allowance) and net deferred tax assets (after deferred tax liabilities) of $49.7 million related to the U.S. and international tax jurisdictions whose recoverability is dependent upon future profitability.

 

In the future, our effective tax rate could be adversely affected by several factors, many of which are outside of our control. Our effective tax rate is affected by the proportion of revenues 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.

 

The Financial Accounting Standards Board (“FASB”) recently issued Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of SFAS 109. FIN 48 will be effective for our 2007 fiscal year. See Note 1 and Note 10 to the Consolidated Financial Statements for a more complete description of the impact FIN 48 will have on our consolidated financial statements.

 

Allowance for Doubtful Accounts

 

We have established an allowance for doubtful accounts to reserve for uncollectible accounts receivable. Each quarter, management reviews the receivables on an account-by-account basis and assigns a

probability of collection. Management’s judgment is used in assessing the probability of collection. Factors considered in making this judgment include, among other things, the age of the identified receivable, client financial condition, previous client payment history and any recent communications with the client.

 

Impairment of Long-Lived Assets

 

We evaluate the carrying value of our individual Delivery Centers in accordance with SFAS 144. SFAS 144 requires that a long-lived asset group be reviewed for impairment only when events or changes in circumstances indicate that the carrying amount of the long-lived asset group may not be recoverable. When the operating results of a Delivery Center have deteriorated to the point it is likely that losses will continue for the foreseeable future, or we expect that a Delivery Center will be closed or otherwise disposed of before the end of its estimated useful life, we select the Delivery Center for further review.

 

For Delivery Centers selected for further review, we estimate the probability-weighted future cash flows, using EBITDA (see “Presentation of Non-GAAP Measurements”) as a surrogate for cash flows, resulting from operating the Delivery Center over its useful life. Significant judgment is involved in projecting future capacity utilization, pricing, labor costs and the estimated useful life of the Delivery Center. We do not subject to the same test Delivery Centers that have been operated for less than two years or those Delivery Centers that have been impaired within the past two years (the “Two Year Rule”) because we believe sufficient time is necessary to establish a market presence and build a client base for such new or modified Delivery Centers in order to adequately assess recoverability. However, such Delivery Centers are nonetheless evaluated in case other factors would indicate an impairment had occurred. For impaired Delivery Centers, we write the assets down to their estimated fair market value. If the assumptions used in performing the impairment test prove insufficient, the fair market value estimate of the Delivery Centers may be significantly lower, thereby causing the carrying value to exceed fair market value and indicating an impairment had occurred.

 

The following table presents a sensitivity analysis of the impairment evaluation assuming that the future results were 10% less than the two-year forecasted EBITDA for all physical Delivery Centers containing Company assets (excluding India, which was impaired during 2006). As shown in the table below, the analysis indicates that an impairment of approximately $3.4 million (an increase of $0.4 million from the third quarter of 2006) would arise. However, for the Delivery Centers tested, the current probability-weighted projection scenarios indicated that impairment had not occurred as of December 31, 2006 (amounts in thousands, except number of Delivery Centers):

 

We also assess the realizable value of capitalized software development costs on a quarterly basis based upon current estimates of future cash flows from services utilizing the underlying software (principally utilized by our Database Marketing and Consulting segment). No impairment had occurred as of December 31, 2006.

 

Goodwill

 

Goodwill is tested for impairment at least annually at the segment level for the Database Marketing and Consulting segment (which consists of one subsidiary company) and for reporting units one level below the segment level for the other two segments in accordance with SFAS 142. Impairment occurs when the carrying amount of goodwill exceeds its estimated fair value. The impairment, if any, is measured based on the estimated fair value of the reporting unit. Fair value can be determined based on discounted cash flows, comparable sales, or valuations of other similar businesses. Our policy is to test goodwill for impairment in the fourth quarter of each year unless an indicator of impairment arises during a prior period.

 

The most significant assumptions used in these analyses are those made in estimating future cash flows. In estimating future cash flows, we generally use the financial assumptions in our internal forecasting model such as projected capacity utilization, projected changes in the prices we charge for our services and projected labor costs. We then use a discount rate we consider appropriate for the country where the business unit is providing services. If actual results are less than the assumptions used in performing the impairment test, the fair value of the reporting units may be significantly lower, causing the carrying value to exceed the fair value and indicating an impairment had occurred. Based on the analyses performed in the fourth quarter of 2006, there was no impairment to the December 31, 2006 goodwill balance of our North American and International BPO segments of $36.3 million and $8.6 million, respectively. If projected revenue used in the analysis of goodwill was 10% less than forecast (the projections assumed revenue growth rates ranging from 0% to 25% per annum over a three-year period), there would still be no impairment to goodwill.

 

Our Database Marketing and Consulting segment has experienced operating losses. We have plans to improve the future profitability of this segment. The goodwill for our Database Marketing and Consulting segment is $13.4 million as of December 31, 2006. As a result of this segment’s financial performance in the year ended December 31, 2006, we updated our cash flow analyses (which assume annual revenue increases approximately 10 percent per annum, calculated on a smaller revenue base than our historical revenue base and following our planned efforts to sell business to non-Ford dealers). Our analyses indicated that an impairment in goodwill had not occurred as of December 1, 2006. In addition, we engaged an independent appraisal firm to assess the fair value of this segment. The independent firm also indicated that no impairment of goodwill had occurred as of December 1, 2006. However, a sensitivity analysis of the forecast indicated that, without considering corresponding reductions in future operating expenses that we would implement in the event of a further revenue decline, it would not take a material change in the revenue forecast for an impairment to arise.

 

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. We follow SFAS 146, which specifies that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, rather than upon commitment to a plan.

 

A significant assumption used in determining the amount of the estimated liability for closing Delivery Centers is the estimated liability for future lease payments on vacant centers, which we determine based on a third-party broker’s assessment of our ability to successfully negotiate early termination agreements with landlords and/or our ability to sublease the facility. If our assumptions regarding early termination and the timing and amounts of sublease payments prove to be inaccurate, we may be required to record additional losses, or conversely, a future gain.

 

Adoption of SFAS No. 123(R) and Equity-Based Compensation Expense

 

During the first quarter of 2006, we adopted SFAS No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123(R)”) applying the modified prospective method. SFAS 123(R) requires all equity-based payments to employees, including grants of employee stock options, to be recognized in the Consolidated Statement of Operations and Comprehensive Income based on the grant date fair value of the award. Prior to the adoption of SFAS 123(R), we accounted for equity-based awards under the intrinsic value method, which followed recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations and equity-based compensation was included as pro-forma disclosure within the notes to the financial statements.

 

We did not modify the terms of any previously granted options in anticipation of the adoption of SFAS 123(R).

 

Income from Operations for the year ended December 31, 2006 was adversely affected by the impact of equity-based compensation due to the implementation of SFAS 123(R). For the year ended December 31, 2006, we recorded expense of $6.9 million for equity-based compensation. We expect that equity-based compensation expense for fiscal 2007 and 2008 from existing awards will be approximately $6.6 million and $5.8 million, respectively. However, any future significant awards granted or required changes in the estimated forfeiture rates may impact this estimate. See Note 17 to the Consolidated Financial Statements for additional information.

 

Contingencies

 

We record a liability in accordance with SFAS No. 5 “Accounting for Contingencies” for pending litigation and claims where losses are both probable and reasonably estimable. Each quarter, management, with the advice of legal counsel, reviews all litigation and claims on a case-by-case basis and assigns probability of loss and range of loss based upon the assessments of in-house counsel and outside counsel, as appropriate.

 

Explanation of Key Metrics and Other Items

 

Cost of Services

 

Cost of services principally include costs incurred in connection with our BPO operations and database marketing services, including direct labor, telecommunications, printing, postage, sales and use tax and certain fixed costs associated with Delivery Centers. In addition, cost of services includes income related to grants we may receive from time-to-time 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 equity-based compensation expense, outside professional fees (i.e. legal and accounting services), building maintenance 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 and amortization of debt issuance costs associated with our grants, debt and capitalized lease obligations.

 

Other Income

 

The main components of other income are miscellaneous receipts not directly related to our operating activities, such as foreign exchange transaction gains and corporate legal settlements.

 

Other Expenses

 

The main components of other expenses are expenditures not directly related to our operating activities, such as corporate legal settlements and foreign exchange transaction losses.

 

Presentation of Non-GAAP Measurements

 

Free Cash Flow

 

Free cash flow is a non-GAAP liquidity measurement. We believe that free cash flow is useful to our investors because it measures, during a given period, the amount of cash generated that is available for debt obligations and investments other than purchases of property, plant and equipment. Free cash flow is not a measure determined by GAAP and should not be considered a substitute for “income from operations,” “net income,” “net cash provided by operating activities,” or any other measure determined in accordance with GAAP. We believe this non-GAAP liquidity measure is useful, in addition to the most directly comparable GAAP measure of “net cash provided by operating activities,” because free cash flow includes investments in operational assets. Free cash flow does not represent residual cash available for discretionary expenditures, since it includes cash required for debt service. Free cash flow also excludes cash that may be necessary for acquisitions, investments and other needs that may arise.

 

The following table reconciles free cash flow to net cash provided by operating activities for our consolidated results (amounts in thousands):

 

 

We discuss factors affecting free cash flow between periods in the “Liquidity and Capital Resources” section below.

 

EBIT and EBITDA

 

EBIT is defined as net income before interest and taxes. EBITDA is calculated by adding depreciation and amortization for the period to EBIT. EBIT and EBITDA are not defined GAAP measures and should not be considered alternatives to net income determined in accordance with GAAP as an indicator of operating performance, nor an alternative to cash flows from operating activities determined in accordance with GAAP as a measure of liquidity. Because others may not calculate EBIT and EBITDA in the same manner as TeleTech, the EBIT and EBITDA information presented below may not be comparable to similar presentations by others.

 

However, we believe that EBIT and EBITDA provide investors and Management with a valuable and alternative method for assessing our operating results. Management evaluates the performance of our subsidiaries and operating segments based on EBIT and believes that EBIT is useful to investors to demonstrate the operational profitability of our business segments by excluding interest and taxes, which are generally accounted for across the entire Company on a consolidated basis. EBIT is also one of the measures Management uses to determine resource allocations and incentive compensation. Further, we use EBITDA to evaluate the profitability and cash flow of our Delivery Centers when testing the impairment of long-lived assets.

The following table reconciles net income to EBIT and EBITDA for our consolidated results (amounts in thousands):

 

RESULTS OF OPERATIONS

 

Year Ended December 31, 2006 Compared to December 31, 2005

 

The following tables are presented to facilitate Management’s Discussion and Analysis. The following table presents results of operations by segment for the years ended December 31, 2006 and 2005 (amounts in thousands):

 

Revenue

 

Revenues for the North American BPO for 2006 compared to 2005 were $815.0 million and $678.8 million, respectively. The increase in revenue for the North American BPO between periods was due to new client programs, expansion of existing client programs and $34.1 million resulting from the acquisition of DAC. Further, the prior year included approximately $45.4 million of revenue related to a short-term government program that did not have 2006 revenues as previously disclosed.

 

Revenues for the International BPO for 2006 compared to 2005 were $356.1 million and $325.0 million, respectively. The increase in revenue for the International BPO between periods was due to new client programs and the expansion of existing client programs in Latin America and Europe.

 

Revenues for Database Marketing and Consulting for 2006 compared to 2005 were $40.2 million and $82.8 million, respectively. The decrease is due primarily to a net decrease in the customer base as previously discussed.

 

Cost of Services

 

Cost of services for the North American BPO for 2006 compared to 2005 were $589.8 million and $505.3 million, respectively. Cost of services as a percentage of revenue in the North American BPO decreased compared to the prior year due to the expansion of off-shore opportunities with a lower cost structure. In absolute dollars, the increase in cost of services corresponds to revenue growth from the implementation of new and expanded client programs and $19.5 million resulting from the acquisition of DAC.

 

Cost of services for the International BPO for 2006 compared to 2005 were $272.6 million and $262.3 million, respectively. Cost of services as a percentage of revenue in the International BPO decreased due to increased capacity utilization that resulted from the expansion of off-shore opportunities with a lower cost structure. In absolute dollars, the increase in cost of services corresponds to revenue growth from the implementation of new or expanded client programs.

 

Cost of services for Database Marketing and Consulting for 2006 compared to 2005 were $23.1 million and $44.6 million, respectively. The decrease from the prior year was primarily due to the decrease in revenue and cost reductions.

 

Selling, General and Administrative

 

Selling, general and administrative expenses for the North American BPO for 2006 compared to 2005 were $111.6 million and $82.8 million, respectively. The expenses increased in both absolute dollars and as a percentage of revenue primarily due to the stock option expense required by the adoption of SFAS 123(R) (see Note 17 to the Consolidated Financial Statements), the acquisition of DAC and increased allocation of corporate-level operating expenses.

 

Selling, general and administrative expenses for the International BPO for 2006 compared to 2005 were $62.8 million and $61.7 million, respectively. These expenses for the International BPO remained relatively constant in absolute dollars and as a percentage of revenue. The slight decrease as a percentage of revenue reflects reduced salaries and benefits expense resulting from headcount reductions in our operations in Europe and Asia Pacific.

 

Selling, general and administrative expenses for Database Marketing and Consulting for 2006 compared to 2005 were $24.9 million and $37.8 million, respectively. The decrease was primarily due to cost reductions and the lower allocation of corporate-level operating expenses.

 

Depreciation and Amortization

 

Depreciation and amortization expense on a consolidated basis for 2006 compared to 2005 were $51.4 million and $53.3 million, respectively. Depreciation and amortization expense in both the North American BPO and the International BPO remained relatively consistent with the prior year.

 

Depreciation and amortization expense in Database Marketing and Consulting decreased compared to the prior year due to assets, primarily software development costs, reaching the end of their depreciable lives.

 

Restructuring Charges, Net

 

During 2006, we recognized restructuring charges in the amount of $1.1 million related to reductions in force across all three segments and facility exit charges in the amount of $0.8 million related to the International BPO. This was offset by the reversal of $0.2 million in excess accruals across both the North American BPO and the International BPO as the actual costs incurred were less than the estimated accrual.

 

Impairment Losses

 

During 2006, we recognized impairment losses of $0.6 million related to the following items: (i) $0.4 million related to the reduction of the net book value of long-lived assets in New Zealand, Malaysia and India to their then estimated fair values; and (ii) $0.2 million for the difference between the estimated and the actual value received for assets in the closed South Korea Delivery Center.

 

Other Income (Expense)

 

For 2006, interest income decreased by $0.5 million due to less average daily cash and cash equivalent balances during the year. Interest expense increased by $2.4 million due to increased borrowings compared to the prior year due primarily to the acquisition of DAC. The remaining change is primarily the result of foreign currency transaction losses and unfavorable settlements of non-operating items.

 

Income Taxes

 

The effective tax rate (after minority interest) for 2006 was 22%. This compares to an effective tax rate (after minority interest) of 8% in 2005. As discussed in Note 10 to the Consolidated Financial Statements, in 2006 we reversed $5.6 million of the deferred tax valuation allowance during the year. In addition, we recorded new deferred tax assets of $3.3 million associated with loss carry forwards that due to a corporate restructuring, which are now available for use against future taxable income. Without these items, our effective tax rate (after minority interest) in 2006 would have been 36%. The effective tax rate (after minority interest) in 2005 included the reversal of $12.7 million of deferred tax valuation allowances and additional tax expenses (after minority interest) of $3.7 million related to our Domestic Reinvestment Plan. Without these items, our effective tax rate (after minority interest) in 2005 would have also been 38%.

 

We expect that our effective tax rate (after minority interest) in future periods will be approximately 35%.

Year Ended December 31, 2005 Compared to December 31, 2004

 

The following table presents results of operations by segment for the years ended December 31, 2005 and 2004 (amounts in thousands):

 

Revenue

 

Revenues for the North American BPO for 2005 compared to 2004 were $678.8 million and
$638.4 million, respectively. The increase in the North American BPO revenue between periods was driven primarily by the ramp up, during the third quarter that ended in the fourth quarter, of a short-term U.S. Government program to aid in hurricane relief efforts that generated $45 million in revenue during 2005. Revenue also increased as a result of net expansion of existing client programs, that was offset by declining Minimum Commitments.

 

Revenues for the International BPO for 2005 compared to 2004 were $325.0 million and $315.9 million, respectively. The increase was primarily due to growth in our operations in Latin America and favorable changes in foreign currency exchange rates. These were offset by the loss of certain client programs, primarily in Scotland.

 

Revenues for Database Marketing and Consulting for 2005 compared to 2004 were $82.8 million and $98.4 million, respectively. The decrease was primarily due to the decrease in their customer base.

 

Cost of Services

 

Cost of services for the North American BPO for 2005 compared 2004 were $505.3 million and $476.2 million, respectively. Cost of services as a percentage of revenue in the North American BPO was essentially flat compared to the prior year. In absolute dollars, cost of services increased as a result of the implementation of new programs, which was partially offset by the implementation of our plans to reduce costs and increase client profitability.

 

Cost of services for the International BPO for 2005 compared to 2004 were $262.3 million and $255.7 million, respectively. Cost of services as a percentage of revenue in the International BPO decreased slightly compared to the prior year due to our efforts to terminate and/or renegotiate unfavorable client contracts, which was offset by increased costs from new client programs in Latin America.

 

Cost of services for Database Marketing and Consulting for 2005 compared to 2004 were $44.6 million and $42.7 million, respectively. Cost of services as a percentage of revenue for Database Marketing and Consulting increased primarily due to lower revenue without a corresponding decrease in costs. In addition, costs increased when we transitioned certain back-office functions to lower cost locations.

 

Selling, General and Administrative

 

Selling, general and administrative expenses for the North American BPO for 2005 compared to 2004 were $82.8 million and $70.9 million, respectively. The increase as a percentage of revenue and in absolute dollars in the North American BPO was related to increased sales and marketing expenses, new product development and software maintenance.

 

Selling, general and administrative expenses for the International BPO for 2005 compared to 2004 were $61.7 million and $57.9 million, respectively. These expenses in the International BPO increased both as a percentage of revenue and in absolute dollars, as a result of changes in foreign currency exchange rates, a regional litigation settlement and increased salaries and benefits expense resulting from headcount additions. These were offset by our efforts to reduce costs.

 

Selling, general and administrative expenses for Database Marketing and Consulting for 2005 compared to 2004 were $37.8 million and $36.9 million, respectively. The increase as a percentage of Revenue and in absolute dollars in Database Marketing and Consulting was caused primarily by the decrease in revenue as costs for selling, general and administrative expenses are primarily fixed in nature.

 

Depreciation and Amortization

 

Depreciation and amortization expense for 2005 compared to 2004 on a consolidated basis were $53.3 million and $59.4 million, respectively.

Depreciation and amortization expense in the North American BPO decreased in absolute dollars between periods due to the closure of certain facilities. Depreciation and amortization expenses in the International BPO remained relatively unchanged. Depreciation and amortization expense in Database Marketing and Consulting also remained relatively unchanged, but increased as a percentage of revenue due to the decrease in revenue discussed above.

 

Restructuring Charges, Net

 

During 2005, we recognized restructuring charges in the amount of $2.1 million related to reductions in force across both BPO segments and facility exit charges in the amount of $0.7 million related to both BPO segments. This was offset by the reversal of $0.1 million in excess accruals in the North American BPO as the actual costs incurred were less than the estimated accrual.

 

Impairment Losses

 

During 2005, we recognized impairment losses in the amount of $4.7 million related to the following items: (i) $2.1 million change in the International BPO related to its decision to close the Glasgow, Scotland Delivery Center; (ii) $2.0 million charge in the International BPO related to the impairment of long-lived assets in its South Korea Delivery Center when we determined that we would no longer serve clients from, or market, that Delivery Center; and (iii) a $0.6 million impairment charge in the North American BPO related to its decision to exit a lease early and to discontinue use of certain software.

 

Other Income (Expense)

 

Other income (expense) for 2005 compared to 2004 increased from an expense of $14.3 million to income of $0.7 million, respectively. Interest income decreased $1.3 million due to less average daily cash and cash equivalents during the year. Interest expense decreased $5.0 million due to decreased borrowings resulting from the restructuring of our long-term debt. We also incurred debt restructuring charges of $10.4 million related to this restructuring. Included in the debt restructuring charge for 2004 is $7.6 million of one-time charges of which $6.4 million was a cash charge and the remaining $1.2 million was a non-cash charge to write-off previously capitalized debt issuance costs. Additionally, we recorded a one-time charge of $2.8 million related to the termination of an interest rate swap.

 

Income Taxes

 

The effective tax rate (after minority interest) for 2005 was 8%. This included the reversal of $12.7 million of deferred tax valuation allowances and additional tax expenses of $3.7 million related to our Domestic Reinvestment Plan. Without these items, our effective tax rate (after minority interest) in 2005 would have been 38%.

 

Liquidity and Capital Resources

 

Our primary sources of liquidity during 2006 were existing cash balances, cash generated from operations and borrowings under the Company’s revolving line of credit. We expect that our future working capital, capital expenditures and debt service requirements will be satisfied primarily from existing cash balances and cash generated from operations. Our ability to generate positive future operating and net cash flows is dependent upon, among other things, our ability to sell new business, expand existing client relationships and efficiently manage our operating costs.

 

The amount of capital required in 2007 will also depend on our levels of investment in infrastructure necessary to maintain, upgrade, or replace existing assets. Our working capital and capital expenditure requirements could increase materially in the event of acquisitions or joint ventures, among other factors. These factors could require that we raise additional capital in the future.

 

The following discussion highlights our cash flow activities during the years ended December 31, 2006, 2005 and 2004.

Cash and Cash Equivalents

 

We consider all liquid investments purchased within 90 days of their maturity to be cash equivalents. Our cash and cash equivalents totaled $60.5 million and $32.5 million as of December 31, 2006 and 2005, respectively.

 

Cash Flows from Operating Activities

 

We reinvest our cash flows from operating activities in our business or in the purchases of treasury stock. For the years 2006, 2005 and 2004, we reported net cash flows provided by operating activities of $94.7 million, $41.5 million and $112.7 million, respectively. The increase from 2005 to 2006 resulted from increased net income as well as changes in working capital accounts. The decrease from 2004 to 2005 resulted from changes in working capital accounts, primarily due to increased accounts receivable. The increase in accounts receivable primarily resulted from the ramp-up of the short-term U.S. Government program discussed previously and other new or expanded clients that ramped in the fourth quarter of 2005.

 

Cash Flows from Investing Activities

 

We reinvest cash in our business primarily to grow our client base and to expand our infrastructure. For the years 2006, 2005 and 2004, we reported net cash flows used in investing activities of $113.0 million, $41.4 million and $42.1 million, respectively. The increase from 2005 to 2006 resulted from the acquisition of DAC and expanded capital expenditures for our embedded client base as well as new client contracts. The amount from 2004 to 2005 remained relatively consistent.

 

Cash Flows from Financing Activities

 

For the years 2006, 2005 and 2004, we reported net cash flows provided by (used in) financing activities of $43.7 million, ($36.1) million and ($123.0) million, respectively. The change from 2005 to 2006 resulted from a decrease in the purchase of treasury stock and increased exercises of stock options. The change from 2004 to 2005 relates primarily to the fact that in 2004 we restructured our debt and there was no such transaction in 2005.

 

Free Cash Flow

 

Free cash flow (see “Presentation of Non-GAAP Measurements” for definition of free cash flow) was $29.2 million, $3.9 million and $71.0 million for the years 2006, 2005 and 2004, respectively. The increase from 2005 to 2006 primarily resulted from higher cash flows from operations, which outpaced the increase in capital expenditures. The decrease from 2004 to 2005 resulted from lower cash flows from operations due to increased accounts receivable balances from the ramp up of the short-term government program discussed above.

 

Obligations and Future Capital Requirements

 

Future maturities of our outstanding debt and contractual obligations are summarized as follows: