ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Executive Summary
TTEC Holdings, Inc. (“TTEC”, “the Company”, “we”, “our” or “us”) is a leading global customer experience technology and services company focused on the design, implementation and delivery of transformative solutions for many of the world’s most iconic and disruptive brands. We help large global companies increase revenue and reduce costs by delivering personalized customer experiences across every interactional channel and phase of the customer lifecycle as an end-to-end provider of customer engagement services, technologies, insights and innovations.
Through the first quarter of 2019, we were reporting on four segments known as Customer Strategy Services (CSS), Customer Technology Services (CTS), Customer Growth Services (CGS) and Customer Management Services (CMS).
Starting in the second quarter of 2019, we changed our strategy, how we go to market, how our clients and potential clients evaluate and consume our services and how we assess our performance. Based on these changes, we now report our financial information based on the following two segments: TTEC Digital and TTEC Engage.
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TTEC Digital designs, builds and delivers tech-enabled, insight-based and outcome-driven customer experience solutions through our professional services and suite of technology offerings. These solutions are critical to enabling and accelerating digital transformation for our clients. These services were previously included in the CSS and CTS segments.
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TTEC Engage provides the essential technologies, human resources, infrastructure and processes to operate customer care, acquisition, and fraud detection and prevention services. These services were previously included in the CGS and CMS segments.
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We do not believe that this segment change results in any material impact on our financial results of operations.
TTEC Digital and TTEC Engage come together under our unified offering, HumanifyTM Customer Experience as a Service, which drives measurable results for clients through delivery of personalized omnichannel interactions that are seamless and relevant. Our business is supported by 48,500 employees delivering services in 21 countries from 80 customer engagement centers on six continents. Our end-to-end approach differentiates the Company by combining service design, strategic consulting, data analytics, process optimization, system integration, operational excellence, and technology solutions and services. This unified offering is value-oriented, outcome-based, and delivered on a global scale across both our business segments.
Our revenue for the three months ended September 30, 2019 was $395.5 million. Approximately $317 million, or 80%, came from our TTEC Engage segment and $79 million, or 20%, came from our TTEC Digital segment.
Since our establishment in 1982, we have helped clients strengthen their customer relationships, brand recognition and loyalty by simplifying and personalizing interactions with their customers. We deliver thought leadership, through innovation in programs that differentiate our clients from their competition.
To improve our competitive position in a rapidly changing market and stay strategically relevant to our clients, we continue to invest in innovation and growth businesses, diversifying and strengthening our core customer care services with consulting, data analytics, and technology-enabled, outcome-focused services.
We also invest in businesses that enable us to expand our geographic footprint, broaden our product and service capabilities, increase our global client base and industry expertise, and further scale our end-to-end integrated solutions platform. In 2018, we acquired Strategic Communications Services, a system integrator for multichannel contact center platforms based in the United Kingdom.
We deliver industry specific solutions and have developed tailored expertise in the automotive, communications, financial services, government, healthcare, logistics, media and entertainment, retail, technology, travel and transportation industries. We target customer-focused industry leaders in the Global 1000 and serve approximately 275 clients globally.
Our Integrated Service Offerings and Business Segments
Our integrated service offering Humanify Customer Experience as a service (CXaas) is delivered through our two operating and reportable segments, TTEC Digital and TTEC Engage.
TTEC Digital designs, builds and delivers tech-enabled, insight-based and outcome-driven customer experience solutions through our professional services and suite of technology offerings. These solutions are critical to enabling and accelerating digital transformation for our clients.
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We help our clients design, build and execute their customer experience (CX) vision by leveraging expertise in CX technologies, strategy, operations, analytics, learning and performance. We design, implement and manage cloud, on-premise or hybrid CX environments to deliver a consistent and superior experience across all touch points on a global scale that results in higher quality, lower costs and reduced risk for our clients. Through our Humanify™ Technology platform, we provide omnichannel contact center software-as-a-service (“SaaS”) solutions that enable clients to integrate their existing CX tech stack, orchestrate data and interactions across disparate technologies and contextually link customers directly to appropriate resources, anywhere and using any channel. We leverage proprietary capabilities in AI, machine learning, and robotics to automate low-value tasks and continuously improve the customer journey. Our platform enables clients to interact with their customers across the growing array of channels including voice, chat, email, mobile, web, SMS text, social networks, and video. Our ability to architect, deploy and host or manage the client’s customer experience environments is a differentiator and becomes a key enabler to achieving and sustaining the client’s CX objectives.
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TTEC Engage provides the essential technologies, human resources, infrastructure and processes to operate customer care, acquisition, and fraud detection and prevention services.
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We design and manage clients’ front-to-back office processes to deliver personalized, protected, omnichannel interactions. Our front-office solutions seamlessly integrate voice, chat, email, mobile, web, SMS text, social networks, and video to optimize the customer experience for our clients. In addition, we manage client back-office processes to enhance their customer-centric view of relationships, maximize operating efficiencies and prevent fraud. Our delivery of integrated business processes via our highly trained professional onshore, offshore or work-from-home associates reduces operating costs and allows customer needs to be met more quickly and efficiently, resulting in higher satisfaction, brand loyalty and a stronger competitive position for our clients.
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Based on our clients’ requirements, we can provide our services on an integrated, cross-business segment basis or discretely, on an as needed basis.
Additional information with respect to our segments and geographic footprint is included in Part I. Item 1. Financial Statements, Note 3 to the Consolidated Financial Statements.
Financial Highlights
In the third quarter of 2019, our revenue increased $30.6, or 8.4%, to $395.5 million over the same period in 2018 including an increase of $2.2 million, or 0.6%, due to foreign currency fluctuations and a decrease of $1.0 million, or 0.3%, due to the initial adoption of ASC 606 for revenue in the first quarter of 2018. The increase in revenue was comprised of a $11.9 million increase for TTEC Digital and a $18.6 million increase for TTEC Engage.
Our third quarter 2019 income from operations increased $11.3 million, or 77.3%, to $26.0 million or 6.6% of revenue, compared to $14.7 million or 4.0% of revenue in the third quarter of 2018. The change in operating income is comprised of a number of factors across the segments. The TTEC Digital operating income expanded with a 38% improvement over the same period last year primarily on the growth of its higher margin cloud business and its system integration business which provides services pre and post the buildout of each client’s cloud platform. The TTEC Engage operating income increased 131% compared to the prior year quarter based on the increase in revenue and a $2.1 million benefit related to foreign currency fluctuations which was offset by a $0.6 million decrease related to the initial adoption of ASC 606 during the first quarter of 2018.
Income from operations in the third quarter of 2019 and 2018 included $0.2 million and $2.7 million of restructuring and integration charges and asset impairments, respectively.
Our offshore customer engagement centers serve clients based in the U.S. and in other countries and spans five countries with 24,400 workstations, representing 57% of our global delivery capability. Revenue for our TTEC Engage segment provided from these offshore locations was $107 million and represented 34% of our revenue for the third quarter of 2019, as compared to $106 million and 36% of our revenue for the corresponding period in 2018.
As of September 30, 2019, the total production workstations for our TTEC Engage segment was 42,881 and the overall capacity utilization in our centers was 70%. The utilization is lower than the previous year as we expand and shift capacity in certain countries to accommodate the volume and location related to client specific customer engagement volumes. The table below presents workstation data for all of our centers as of September 30, 2019 and 2018. Our utilization percentage is defined as the total number of utilized production workstations compared to the total number of available production workstations.
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September 30, 2019
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September 30, 2018
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Total
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Total
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Production
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% In
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Production
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% In
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Workstations
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In Use
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Use
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Workstations
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In Use
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Use
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Total centers
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Sites open >1 year
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40,388
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28,609
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71
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%
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42,560
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32,838
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77
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%
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Sites open <1 year
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2,493
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1,438
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58
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%
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51
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51
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100
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%
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Total workstations
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42,881
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30,047
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70
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%
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42,611
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32,889
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77
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%
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We continue to see demand from all geographic regions to utilize our offshore delivery capabilities and expect this trend to continue. On the other hand, some of our clients may be subject to regulatory pressures to bring more services onshore to the United States. In light of these trends we plan to continue to selectively retain and grow capacity in and expand into new offshore markets, while maintaining appropriate capacity in the United States. As we grow our offshore delivery capabilities and our exposure to foreign currency fluctuations increases, we will continue to actively manage this risk via a multi-currency hedging program designed to minimize operating margin volatility.
Recently Issued Accounting Pronouncements
Refer to Part I, Item I, Financial Statements, Note 1 to the Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, as well as the disclosure of contingent assets and liabilities. We regularly review our estimates and assumptions. These estimates and assumptions, which are based upon historical experience and on various other factors believed to be reasonable under the circumstances, form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Reported amounts and disclosures may have been different had management used different estimates and assumptions or if different conditions had occurred in the periods presented. For further information, please refer to the discussion of all critical accounting policies in Note 1 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2018.
Results of Operations
During the second quarter of 2019, we finalized changes to our operating strategy and the way in which we assess performance. In accordance with this change, we adjusted certain reporting relationships between our Chief Operating Decision Maker (“CODM”) and other members of management, updated the compensation metrics for senior management, and modified the internal financial reporting provided to the CODM and his direct reports to be consistent with this revised management and measurement structure. Accordingly, during the second quarter of 2019, we reevaluated the definition of the operating segments, reportable segments, and reporting units which resulted in a change to the reportable segments. Effective June 30, 2019, the segment information was reported consistent with these updated reportable segments comprised of TTEC Digital and TTEC Engage.
Three months ended September 30, 2019 compared to three months ended September 30, 2018
The tables included in the following sections are presented to facilitate an understanding of Management’s Discussion and Analysis of Financial Condition and Results of Operations and present certain information by segment for the three months ended September 30, 2019 and 2018 (amounts in thousands). All inter-company transactions between the reported segments for the periods presented have been eliminated.
TTEC Digital
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Three Months Ended September 30,
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2019
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2018
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$ Change
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% Change
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Revenue
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$
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78,620
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$
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66,679
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$
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11,941
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17.9
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%
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Operating Income
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11,704
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8,469
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3,235
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38.2
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%
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Operating Margin
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14.9
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%
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12.7
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%
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The increase in revenue for the TTEC Digital segment was related to significant increases in the cloud platform, the systems integration practice including a large multi-year governmental contract and increases in the digital learning and insights practices, offset by reductions in legacy facility based training and lower volumes primarily in the Middle East business which the Company is in the process of winding down.
The operating income expansion is primarily attributable to the increased revenue and improved utilization of technology and people assets as the business scales its cloud and system integration revenue. The operating income as a percentage of revenue increased to 14.9% in the third quarter of 2019 as compared to 12.7% in the prior period. Included in the operating income was amortization expense related to acquired intangibles of $0.6 million and $0.6 million for the quarters ended September 30, 2019 and 2018, respectively.
TTEC Engage
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Three Months Ended September 30,
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2019
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2018
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$ Change
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% Change
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Revenue
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$
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316,887
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$
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298,257
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$
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18,630
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6.2
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%
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Operating Income
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14,277
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6,188
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8,089
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130.7
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%
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Operating Margin
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4.5
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%
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2.1
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%
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The increase in revenue for the TTEC Engage segment was due to a net increase of $33.3 million in client programs offset by a decrease for program completions of $16.1 million, a decrease of $1.0 million due to the initial adoption of ASC 606 for revenue in 2018, and an $2.4 million increase due to foreign currency fluctuations.
The operating income increased in line with improved revenue, pricing increases related to rising wages, lower healthcare costs and improved profitability in our customer growth offering and healthcare and auto client portfolios. Additionally, the operating income was positively affected by $2.1 million of foreign currency fluctuation and negatively impacted by a $0.6 million decrease due to the initial adoption of ASC 606 in 2018. As a result, the operating income as a percentage of revenue increased to 4.5% in the third quarter of 2019 as compared to 2.1% in the prior period. Included in the operating income was amortization expense related to acquired intangibles of $2.0 million and $2.0 million for the quarters ended September 30, 2019 and 2018, respectively.
Interest Income (Expense)
For the three months ended September 30, 2019 interest income decreased to $0.5 million from $1.4 million in the same period in 2018. Interest expense decreased to $4.0 million during 2019 from $8.4 million during 2018 due to lower utilization of the line of credit, and a $2.2 million reduction in the charge related to the future purchase of the remaining 30% interest in Motif versus the prior year period.
Other Income (Expense)
For the three months ended September 30, 2019 Other income (expense), net increased to net income of $2.7 million from net income of $1.0 million during the prior year quarter.
Included in the three months ended September 30, 2019 was a $1.4 million gain on recovery of receivables in connection with the Consulting business that we are winding down, and a $0.7 million gain on the sale of trademarks.
Included in the three months ended September 30, 2018 was a $0.6 million gain related to the quarterly royalty payment for the June 30, 2017 divestiture of TSG.
Income Taxes
The effective tax rate for the three months ended September 30, 2019 was 20.6%. This compares to an effective tax rate of 21.9% for the comparable period of 2018. The effective tax rate for the three months ended September 30, 2019 was influenced by earnings in international jurisdictions currently under an income tax holiday, the distribution of income between the U.S. and international tax jurisdictions and the associated U.S. tax impacts of increased foreign earnings. Without $0.2 million of benefit related to return to provision adjustments, a $0.2 million expense related to tax contingencies, and $0.2 million other expense, the Company’s effective tax rate for the third quarter of 2019 would have been 21.1%.
Results of Operations
Nine months ended September 30, 2019 compared to nine months ended September 30, 2018
The tables included in the following sections are presented to facilitate an understanding of Management’s Discussion and Analysis of Financial Condition and Results of Operations and present certain information by segment for the nine months ended September 30, 2019 and 2018 (in thousands). All intercompany transactions between the reported segments for the periods presented have been eliminated.
TTEC Digital
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Nine Months Ended September 30,
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2019
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2018
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$ Change
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% Change
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Revenue
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$
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222,992
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$
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169,247
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$
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53,745
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31.8
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%
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Operating Income
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27,172
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20,579
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6,593
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32.0
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%
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Operating Margin
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12.2
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%
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12.2
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%
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The increase in revenue for the TTEC Digital segment was related to significant increases in the cloud platform and the systems integration practice including a large multi-year governmental contract and increases in the digital learning and insights practices, offset by reductions in legacy facility based training and lower volumes primarily in the Middle East business, which the Company is in the process of winding down.
The operating income expansion is primarily attributable to the revenue growth, improved utilization of technology and people assets as the business scales its cloud and system integration revenue. The operating income increase was offset by a $2.0 million impairment of intangible and other long-lived assets for one of the consulting components in this segment. The operating income as a percentage of revenue remained flat at 12.2% for the nine months ended September 30, 2019 as compared to 12.2% in the prior period. Included in the operating income was amortization expense related to acquired intangibles of $1.9 million and $1.9 million for the nine months ended September 30, 2019 and 2018, respectively.
TTEC Engage
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Nine Months Ended September 30,
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2019
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2018
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$ Change
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% Change
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Revenue
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$
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959,386
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$
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920,791
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$
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38,595
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4.2
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%
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Operating Income
|
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53,774
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32,522
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|
|
21,252
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65.3
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%
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Operating Margin
|
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5.6
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%
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3.5
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%
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The increase in revenue for the TTEC Engage segment was due to a net increase of $114.3 million in client programs offset by a decrease for program completions of $56.2 million, a $17.0 million reduction due to the initial adoption of ASC 606 related to revenue in 2018, and a $2.5 million decrease due to foreign currency fluctuations.
The operating income increased in line with the improved revenue, pricing increases related to rising wages, lower healthcare costs, improved profitability in our customer growth offering and healthcare and auto client portfolios, and a $6.4 million volume commitment payment. Additionally, the operating income was positively affected by $4.3 million of foreign currency fluctuations and negatively impacted by an $9.3 million decrease due to the initial adoption of ASC 606 in 2018. As a result, the operating income as a percentage of revenue increased to 5.6% for the nine months ended September 30, 2019 as compared to 3.5% in the prior period. Included in the operating income was amortization expense related to acquired intangibles of $6.0 million and $6.2 million for the nine months ended September 30, 2019 and 2018, respectively.
Interest Income (Expense)
For the nine months ended September 30, 2019 interest income decreased to $1.3 million from $3.9 million in the same period in 2018 due to lower average cash balances. Interest expense decreased to $13.5 million during 2019 from $22.6 million during 2018 due to lower utilization of the line of credit, and a $5.5 million reduction in the charge related to the future purchase of the remaining 30% interest in Motif versus the prior year period.
Other Income (Expense)
For the nine months ended September 30, 2019 Other income (expense), net increased to net income of $5.4 million from a net expense of $10.8 million during the prior year quarter.
Included in the nine months ended September 30, 2019 was a $2.4 million benefit related to the fair value adjustment of contingent consideration for an acquisition, a $1.4 million gain on recovery of receivables in connection with the Consulting business that we are winding down, and a $0.7 million gain on the sale of trademarks.
Included in the nine months ended September 30, 2018 was a $15.6 million impairment of the full value of an equity investment and the related bridge loan, a $2.0 million estimated loss on a business unit which was classified as assets held for sale then reclassified to held and used, offset by a $1.6 million gain related to the quarterly royalty payments for the June 30, 2017 divestiture of TSG, and a $0.7 million gain related to the bargain purchase for the Percepta acquisition that closed on March 31, 2018.
For further information on the above items, see Part I. Item 1. Financial Statements, Note 2 and Note 7 to the Consolidated Financial Statements.
Income Taxes
The effective tax rate for the nine months ended September 30, 2019 was 27.0%. This compared to an effective tax rate of 19.7% for the comparable period of 2018. The effective tax rate for the nine months ended September 30, 2019 was influenced by earnings in international jurisdictions currently under an income tax holiday, the distribution of income between the U.S. and international tax jurisdictions and associated U.S. tax impacts of increased foreign earnings. Without $0.9 million of benefit from restructuring expenses, a $0.5 million expense related to tax contingencies, a $2.3 million expense related to changes in valuation allowances, and $0.1 million other expense, the Company’s effective tax rate for the nine months ended September 30, 2019 would have been 23.6%.
Liquidity and Capital Resources
Our principal sources of liquidity are our cash generated from operations, our cash and cash equivalents, and borrowings under our Credit Facility. During the nine months ended September 30, 2019, we generated positive operating cash flows of $184.4 million. We believe that our cash generated from operations, existing cash and cash equivalents, and available credit will be sufficient to meet expected operating and capital expenditure requirements for the next 12 months.
We manage a centralized global treasury function in the United States with a focus on concentrating and safeguarding our global cash and cash equivalents. While the majority of our cash is held outside the U.S., we prefer to hold U.S. Dollars in addition to the local currencies of our foreign subsidiaries. We expect to use our offshore cash to support working capital and growth of our foreign operations. While there are no assurances, we believe our global cash is protected given our cash management practices, banking partners and utilization of diversified, high quality investments.
We have global operations that expose us to foreign currency exchange rate fluctuations that may positively or negatively impact our liquidity. We are also exposed to higher interest rates associated with our variable rate debt. To mitigate these risks, we enter into foreign exchange forward and option contracts through our cash flow hedging program. Please refer to Item 3. Quantitative and Qualitative Disclosures About Market Risk, Foreign Currency Risk, for further discussion.
The following discussion highlights our cash flow activities during the nine months ended September 30, 2019 and 2018.
Cash and Cash Equivalents
We consider all liquid investments purchased within 90 days of their original maturity to be cash equivalents. Our cash and cash equivalents totaled $85.5 million and $78.2 million as of September 30, 2019 and December 31, 2018, respectively. We diversify the holdings of such cash and cash equivalents considering the financial condition and stability of the counterparty institutions.
We reinvest our cash flows to grow our client base, expand our infrastructure, for investment in research and development, for strategic acquisitions, for the purchase of our outstanding stock and to pay dividends.
Cash Flows from Operating Activities
For the nine months ended September 30, 2019 and 2018, net cash flows provided by operating activities was $184.4 million and $166.1 million, respectively. The increase is primarily due to a $13.4 million increase in net cash income from operations and a $4.9 million improvement in net working capital.
Cash Flows from Investing Activities
For the nine months ended September 30, 2019 and 2018, net cash flows used in investing activities was $44.1 million and $36.0 million, respectively. The increase was due to a $12.6 million increase in capital expenditures offset by a $4.1 million decrease related to acquisitions.
Cash Flows from Financing Activities
For the nine months ended September 30, 2019 and 2018, net cash flows used in financing activities was $119.6 million and $95.8 million, respectively. The change in net cash flows from 2018 to 2019 was primarily due to an $11.5 million paydown on the line of credit, a $5.1 million payment related to the hold-back for an acquisition, and a $4.8 million of increased payments on other debt.
Free Cash Flow
Free cash flow (see “Presentation of Non-GAAP Measurements” below for the definition of free cash flow) increased for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018 primarily due to an increase in net cash from operations offset by higher capital expenditures. Free cash flow was $140.0 million and $134.3 million for the nine months ended September 30, 2019 and 2018, respectively.
Presentation of Non-GAAP Measurements
Free Cash Flow
Free cash flow is a non-GAAP liquidity measurement. We believe that free cash flow is useful to our investors because it measures, during a given period, the amount of cash generated that is available for debt obligations and investments other than purchases of property, plant and equipment. Free cash flow is not a measure determined by GAAP and should not be considered a substitute for “income from operations,” “net income,” “net cash provided by operating activities,” or any other measure determined in accordance with GAAP. We believe this non-GAAP liquidity measure is useful, in addition to the most directly comparable GAAP measure of “net cash provided by operating activities,” because free cash flow includes investments in operational assets. Free cash flow does not represent residual cash available for discretionary expenditures, since it includes cash required for debt service. Free cash flow also includes cash that may be necessary for acquisitions, investments and other needs that may arise.
The following table reconciles net cash provided by operating activities to free cash flow for our consolidated results (in thousands):
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Three Months Ended
September 30,
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|
Nine Months Ended
September 30,
|
|
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2019
|
|
2018
|
|
2019
|
|
2018
|
|
Net cash provided by operating activities
|
|
$
|
63,131
|
|
$
|
61,403
|
|
$
|
184,397
|
|
$
|
166,109
|
|
Less: Purchases of property, plant and equipment
|
|
|
16,010
|
|
|
14,958
|
|
|
44,438
|
|
|
31,841
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|
Free cash flow
|
|
$
|
47,121
|
|
$
|
46,445
|
|
$
|
139,959
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|
$
|
134,268
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Obligations and Future Capital Requirements
Other than changes related to the adoption of lease accounting standard ASC 842 as described in Note 1 and Note 11 to the Consolidated Financial Statements, there were no material changes to the Company’s contractual obligations and future capital requirements outside the normal course of business from the date of our 2018 Form 10-K filing on March 6, 2019 through the filing of this report.
Future Capital Requirements
We currently expect total capital expenditures in 2019 to be between $60 million and $65 million. Approximately 65% of these expected capital expenditures are to support growth in our business and 35% relate to the maintenance for existing assets. The anticipated level of 2019 capital expenditures is primarily driven by new client contracts and the corresponding requirements for additional delivery center capacity as well as enhancements to our technological infrastructure.
The amount of capital required over the next 12 months will depend on our levels of investment in infrastructure necessary to maintain, upgrade or replace existing assets. Our working capital and capital expenditure requirements could also increase materially in the event of acquisitions or joint ventures, among other factors. These factors could require that we raise additional capital through future debt or equity financing. We can provide no assurance that we will be able to raise additional capital upon commercially reasonable terms acceptable to us.
Client Concentration
During the nine months ended September 30, 2019, none of our clients represented more than 10% of our total revenue. Our five largest clients, collectively, accounted for 37.1% and 32.5% of our consolidated revenue for the three months ended September 30, 2019 and 2018, respectively. Our five largest clients accounted for 36.9% and 34.5% of our consolidated revenue for the nine months ended September 30, 2019 and 2018, respectively. We have had long-term relationships with our top five clients, ranging from one to 23 years, with most of these clients having completed multiple contract renewals with us. The relative contribution of any single client to consolidated earnings is not always proportional to the relative revenue contribution on a consolidated basis and varies greatly based upon specific contract terms, our scope of service and where the services are delivered. In addition, clients may adjust business volumes served by us based on their business requirements. We believe the risk of this concentration is mitigated, in part, by the long-term contracts we have with our largest clients and the fact that most of these relationships are based on multiple smaller contracts with different termination dates. Although certain client contracts may be terminated for convenience by either party, we believe this risk is mitigated, in part, by the service level disruptions and transition/migration costs that would arise for our clients when they terminate relationships with limited notice.
The contracts with our five largest clients expire between 2020 and 2023. Additionally, a particular client may have multiple contracts with different expiration dates. We have historically renewed most of our contracts with our largest clients, but there can be no assurance that future contracts will be renewed or, if renewed, will be on terms as favorable as the existing contracts.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our consolidated financial position, consolidated results of operations, or consolidated cash flows due to adverse changes in financial and commodity market prices and rates. Market risk also includes credit and non-performance risk by counterparties to our various financial instruments. We are exposed to market risk due to changes in interest rates and foreign currency exchange rates (as measured against the U.S. dollar); as well as credit risk associated with potential non-performance of our counterparty banks. These exposures are directly related to our normal operating and funding activities. We enter into derivative instruments to manage and reduce the impact of currency exchange rate changes, primarily between the U.S. dollar/Philippine peso, the U.S. dollar/Mexican peso, and the Australian dollar/Philippine peso. To mitigate against credit and non-performance risk, it is our policy to only enter into derivative contracts and other financial instruments with investment grade counterparty financial institutions and, correspondingly, our derivative valuations reflect the creditworthiness of our counterparties. As of the date of this report, we have not experienced, nor do we anticipate, any issues related to derivative counterparty defaults.
Interest Rate Risk
We have previously entered into interest rate derivative instruments to reduce our exposure to interest rate fluctuations associated with our variable rate debt. The interest rate on our Credit Agreement is variable based upon the Prime Rate and LIBOR and, therefore, is affected by changes in market interest rates. As of September 30, 2019, we had $199.0 million of outstanding borrowings under the Credit Agreement. Based upon average outstanding borrowings during the three months ended September 30, 2019, interest accrued at a rate of approximately 3.4% per annum, respectively. If the Prime Rate or LIBOR increased by 100 basis points, there would be an annualized $1.0 million of additional interest expense per $100.0 million of outstanding borrowing under the Credit Agreement.
Foreign Currency Risk
Our subsidiaries in the Philippines, Mexico, India, Bulgaria and Poland use the local currency as their functional currency for paying labor and other operating costs. Conversely, revenue for these foreign subsidiaries is derived principally from client contracts that are invoiced and collected in U.S. dollars or other foreign currencies. As a result, we may experience foreign currency gains or losses, which may positively or negatively affect our results of operations attributed to these subsidiaries. For the nine months ended September 30, 2019 and 2018, revenue associated with this foreign exchange risk was 22% and 24% of our consolidated revenue, respectively.
In order to mitigate the risk of these non-functional foreign currencies weakening against the functional currencies of the servicing subsidiaries, which thereby decreases the economic benefit of performing work in these countries, we may hedge a portion, though not 100%, of the projected foreign currency exposure related to client programs served from these foreign countries through our cash flow hedging program. While our hedging strategy can protect us from adverse changes in foreign currency rates in the short term, an overall weakening of the non-functional foreign currencies would adversely impact margins in the segments of the servicing subsidiary over the long term.
Cash Flow Hedging Program
To reduce our exposure to foreign currency exchange rate fluctuations associated with forecasted revenue in non-functional currencies, we purchase forward and/or option contracts to acquire the functional currency of the foreign subsidiary at a fixed exchange rate at specific dates in the future. We have designated and account for these derivative instruments as cash flow hedges for forecasted revenue in non-functional currencies.
While we have implemented certain strategies to mitigate risks related to the impact of fluctuations in currency exchange rates, we cannot ensure that we will not recognize gains or losses from international transactions, as this is part of transacting business in an international environment. Not every exposure is or can be hedged and, where hedges are put in place based on expected foreign exchange exposure, they are based on forecasts for which actual results may differ from the original estimate. Failure to successfully hedge or anticipate currency risks properly could adversely affect our consolidated operating results.
Our cash flow hedging instruments as of September 30, 2019 and December 31, 2018 are summarized as follows (in thousands). All hedging instruments are forward contracts, except as noted.
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Local
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Currency
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U.S. Dollar
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% Maturing
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Contracts
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Notional
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Notional
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in the next
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Maturing
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As of September 30, 2019
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Amount
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Amount
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12 months
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Through
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Philippine Peso
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6,311,000
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119,751
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(1)
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57.6
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%
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April 2022
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Mexican Peso
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1,162,500
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55,672
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|
|
50.9
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%
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December 2021
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$
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175,423
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Local
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Currency
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U.S. Dollar
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Notional
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Notional
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As of December 31, 2018
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Amount
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Amount
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Philippine Peso
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6,710,000
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|
|
130,957
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(1)
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|
|
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Mexican Peso
|
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1,091,500
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|
|
57,708
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|
|
|
|
|
|
|
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$
|
188,665
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|
|
|
|
|
|
|
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(1)
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|
Includes contracts to purchase Philippine pesos in exchange for New Zealand dollars and Australian dollars, which are translated into equivalent U.S. dollars on September 30, 2019 and December 31, 2018.
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The fair value of our cash flow hedges at September 30, 2019 was assets/(liabilities) (in thousands):
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Maturing in the
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|
|
|
September 30, 2019
|
|
Next 12 Months
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Philippine Peso
|
|
$
|
209
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|
$
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(154)
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|
Mexican Peso
|
|
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(8)
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|
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(754)
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|
|
|
$
|
201
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|
$
|
(908)
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|
Our cash flow hedges are valued using models based on market observable inputs, including both forward and spot foreign exchange rates, implied volatility, and counterparty credit risk. The increase in fair value from
December 31, 2018 reflects fewer outstanding cash flow hedges, partially offset by a strong U.S. dollar against the Mexican Peso and Philippine Peso.
We recorded net losses of approximately $4.6 million and $14.3 million for settled cash flow hedge contracts and the related premiums for the nine months ended September 30, 2019 and 2018, respectively. These losses were reflected in Revenue in the accompanying Consolidated Statements of Comprehensive Income (Loss). If the exchange rates between our various currency pairs were to increase or decrease by 10% from current period-end levels, we would incur a material gain or loss on the contracts. However, any gain or loss would be mitigated by corresponding increases or decreases in our underlying exposures.
Other than the transactions hedged as discussed above and in Part I, Item 1. Financial Statements, Note 6 to the Consolidated Financial Statements, the majority of the transactions of our U.S. and foreign operations are denominated in their respective local currency. However, transactions are denominated in other currencies from time-to-time. We do not currently engage in hedging activities related to these types of foreign currency risks because we believe them to be insignificant as we endeavor to settle these accounts on a timely basis. For the nine months ended September 30, 2019 and 2018, approximately 22% and 25%, respectively, of revenue was derived from contracts denominated in currencies other than the U.S. Dollar. Our results from operations and revenue could be adversely affected if the U.S. Dollar strengthens significantly against foreign currencies.
Fair Value of Debt and Equity Securities
We did not have any investments in marketable debt or equity securities as of September 30, 2019 or December 31, 2018.
ITEM 4. CONTROLS AND PROCEDURES
This report includes the certifications of our Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”) required by Rule 13a-14 of the Securities Exchange Act of 1934 (the “Exchange Act”). See Exhibits 31.1 and 31.2. This Item 4 includes information concerning the controls and control evaluations referred to in those certifications.
Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to provide reasonable assurance that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.
We carried out an evaluation under the supervision and with the participation of management, including the CEO and CFO, of the effectiveness of our disclosure controls and procedures, as of September 30, 2019, the end of the period covered by this Form 10-Q. Based on this evaluation, our CEO and CFO have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were effective at the reasonable assurance level.
Inherent Limitations of Internal Controls
Our management, including the CEO and CFO, believes that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of internal control are met. Further, the design of internal controls must consider the benefits of controls relative to their costs. Inherent limitations within internal controls include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by unauthorized override of controls. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with associated policies or procedures. While the objective of the design of any system of controls is to provide reasonable assurance of the effectiveness of controls, such design is also based in part upon certain assumptions about the likelihood of future events, and such assumptions, while reasonable, may not take into account all potential future conditions. Thus, even effective internal control over financial reporting can only provide reasonable assurance of achieving their objectives. Therefore, because of the inherent limitations in cost effective internal controls, misstatements due to error or fraud may occur and may not be prevented or detected.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Part I, Item 1. Financial Statements, Note 10 to the Consolidated Financial Statements of this Form 10-Q is hereby incorporated by reference.
ITEM 1A. RISK FACTORS
In addition to the other information presented in this Quarterly Report on Form 10-Q, you should carefully consider the risks and uncertainties discussed in this section when evaluating our business. If any of these risks or uncertainties actually occur, our business, financial condition, and results of operations (including revenue, profitability and cash flows) could be materially and adversely affected and the market price of our stock could decline.
Our markets are highly competitive, and we might not be able to compete effectively
The markets where we offer our services are highly competitive. Our future performance is largely dependent on our ability to compete successfully in markets we currently serve, while expanding into new, profitable markets. We compete with large multinational service providers; offshore service providers from lower-cost jurisdictions that offer similar services, often at highly competitive prices and more aggressive contract terms; niche solution providers that compete with us in specific geographic markets, industry segments or service areas; companies that utilize new, potentially disruptive technologies or delivery models, including artificial intelligence powered solutions; and in-house functions of large companies that use their own resources, rather than outsourcing customer care and customer experience services we provide. Some of our competitors have greater financial or marketing resources than we do and, therefore, may be better able to compete.
Further, the continuing trend of consolidation in the technology sector and among business process outsourcing competitors in various geographies where we have operations may result in new competitors with greater scale, a broader footprint, better technologies, or price efficiencies that may be attractive to our clients. If we are unable to compete successfully and provide our clients with superior service and solutions at competitive prices, we could lose market share and clients to competitors, which would materially adversely affect our business, financial condition, and results of operations.
If we are unsuccessful in implementing our business strategy, our long-term financial prospects could be adversely affected
Our growth strategy is based on continuous diversification of our business beyond contact center customer care outsourcing to an integrated customer experience platform that unites innovative and disruptive technologies, strategic consulting, data analytics, client growth solutions, and customer experience focused system design and integration. These investments in technologies and integrated solution development, however, may not lead to increased revenue and profitability. If we are not successful in creating value from these investments, there could be a negative impact on our operating results and financial condition.
Our results of operations and ability to grow could be materially affected if we cannot adapt our service offerings to changes in technology and customer expectations
Our growth and profitability will depend on our ability to develop and adopt new technologies that expand our existing offerings by leveraging new technological trends and cost efficiencies in our operations, while meeting rapidly evolving client expectations. As technology evolves, more tasks currently performed by our agents may be replaced by automation, robotics, artificial intelligence, chatbots and other technological advances, which puts our lower-skill, tier one, customer care offerings at risk. These technology innovations could potentially reduce our business volumes and related revenues, unless we are successful in adapting and deploying them profitably.
We may not be successful in anticipating or responding to our client expectations and interests in adopting evolving technology solutions, and their integration in our offerings may not achieve the intended enhancements or cost reductions. Services and technologies offered by our competitors may make our service offerings not competitive or even obsolete and may negatively impact our clients’ interest in our offerings. Our failure to innovate, maintain technological advantage, or respond effectively and timely to transformational changes in technology could have a material adverse effect on our business, financial condition, and results of operations.
Cyber-attacks, cyber-fraud, and unauthorized information disclosure could harm our reputation, cause liability, result in service outages and losses, any of which could adversely affect our business and results of operations
Our business involves the use, storage, and transmission of information about our clients, customers of our clients, and our employees. While we take reasonable measures to protect the security of and unauthorized access to our systems and the privacy of personal and proprietary information that we access and store, our security controls over our systems may not prevent the improper access to or disclosure of this information. Such unauthorized access or disclosure could subject us to liability under relevant law or our contracts and could harm our reputation resulting in loss of revenue and loss of business opportunities.
In recent years, there have been an increasing number of high-profile security breaches at companies and government agencies, and security experts have warned about the growing risks of hackers and cyber criminals launching a broad range of attacks targeting information technology systems. Our business is dependent on information technology systems. Information security breaches, computer viruses, interruption or loss of business data, DDoS (distributed denial of service) attacks, and other cyber-attacks on any of these systems could disrupt the normal operations of our contact centers, our cloud platform offerings, and our enterprise services, impeding our ability to provide critical services to our clients.
We are experiencing an increase in frequency of cyber-fraud attempts, such as so-called “social engineering” attacks and phishing scams, which typically seek unauthorized money transfers or information disclosure. We actively train our employees to recognize these attacks and have implemented proactive risk mitigation measures to curb them. There are no assurances, however, that these attacks, which are also growing in sophistication, may not deceive our employees, resulting in a material loss.
While we have taken reasonable measures to protect our systems and processes from intrusion and cyber-fraud, we cannot be certain that advances in cyber-criminal capabilities, discovery of new system vulnerabilities, and attempts to exploit such vulnerabilities will not compromise or breach the technology protecting our systems and the information that we manage and control, which could result in damage to our systems, our reputation and our profitability.
Our need for consistent improvements in cybersecurity may force us to expend significant additional resources to respond to system disruptions and security breaches, including additional investments in repairing systems damaged by such attacks, reconfiguring and rerouting systems to reduce vulnerabilities, and resolving of legal claims that may arise from data breaches. A significant cyber security breach could materially harm our business, financial condition, and operating results.
A large portion of our revenue is generated from a limited number of clients and the loss of one or more of our clients could adversely affect our business
We rely on strategic, long-term relationships with large, global companies in targeted industries and certain agencies of the United States government. As a result, we derive a substantial portion of our revenue from relatively few clients. Our five and ten largest clients collectively represented 37% and 50% of our revenue for the first nine months of 2019 with no one client over 10%.
Although we have multiple engagements with all of our largest clients and all contracts are unlikely to terminate at the same time, the contracts with our five largest clients expire between 2020 and 2023 and there can be no assurance that these contracts will continue to be renewed at all or be renewed on favorable terms. While our on-going sales and marketing activities aim to add new opportunities with existing and new commercial and government clients, there can be no assurances that such additional work can be secured nor that it would yield financial benefits comparable to expiring contracts. The loss of all or part of a major client’s business could have a material adverse effect on our business, financial condition, and results of operations, if the loss of revenue was not replaced with profitable business from other clients.
We serve clients in industries that have historically experienced a significant level of consolidation. If one of our clients is acquired (including by another of our clients) our business volume and revenue may materially decrease due to the termination or phase out of an existing client contract, volume discounts or other contract concessions which could have an adverse effect on our business, financial condition, and results of operations.
If we cannot recruit, hire, train, and retain qualified employees to respond to client demands, our business will be adversely affected
Our business is labor intensive and our ability to recruit and train employees with the right skills, at the right price point, and in the timeframe required by our client commitments is critical to achieving our growth objective. Demand for qualified personnel with multiple language capabilities and fluency in English may exceed supply. Employees with specific backgrounds and skills may also be required to keep pace with evolving technologies and client demands. While we invest in employee retention, we continue to experience high employee turnover and are continuously recruiting and training replacement staff. Some of our facilities are located in geographies with low unemployment, which makes it costly to hire personnel, and in several jurisdictions, jurisdiction-specific wage regulations are changing rapidly making it difficult to recruit new employees at price points acceptable for our business model. Our inability to attract and retain qualified personnel at costs acceptable under our contracts, our costs associated with attracting, training, and retaining employees, and the challenge of managing the continuously changing and seasonal client demands could have a material adverse effect on our business, financial condition, and results of operations.
Uncertainty related to cost of labor across various jurisdictions in the United States could adversely affect our results of operating
As a labor intensive business, we sign multi-year client contracts that are priced based on prevailing labor costs in jurisdictions where we deliver services. Yet, in the United States, our business is confronted with a patchwork of ever changing minimum wage, mandatory time off, and rest and meal break laws at the state and local levels. As these jurisdiction-specific laws change with little notice or grace period for transition, we often have no opportunity to adjust and change how we do business and pass cost increases to our clients. The frequent changes in the law and inconsistencies in laws across different jurisdictions in the United States, may result in higher costs, lower contract profitability, higher turnover, and reduced operational efficiencies, which could in the aggregate have material adverse impact on our results of operations.
Our delivery model involves geographic concentration exposing us to significant operational risks
Our business model is dependent on our customer engagement centers and enterprise support functions being located in low cost jurisdictions around the globe. We have on the ground presence in 21 countries, but our customer care and experience management delivery capacity and our back-office functions are concentrated in the United States, the Philippines, Mexico, India, and Bulgaria and our technology solutions centers are concentrated in a few locations in the United States. Natural disasters (floods, winds, and earthquakes), terrorist attacks, pandemics, large-scale utilities outages, telecommunication and transportation disruptions, labor or political unrest, and restriction on repatriation of funds at some of these locations may interrupt or limit our ability to operate or may increase our costs. Our business continuity and disaster recovery plans, while extensive, may not be effective, particularly if catastrophic events occur.
Our dependence on our customer engagement centers and enterprise services support functions in the Philippines, which is subject to frequent severe weather, natural disasters, and occasional security threats, represents a particular risk. For these and other reasons, our geographic concentration could result in a material adverse effect on our business, financial condition and results of operations. Although we procure business interruption insurance to cover some of these exposures, adequate insurance may not be available on an ongoing basis for a reasonable price.
Compliance with laws, including unexpected changes to such laws, could adversely affect our results of operations
Our business is subject to extensive regulation by the United States and foreign national, state and provincial authorities relating to confidential client and customer data, customer communications, telemarketing practices, and licensed healthcare and financial services activities, among other areas. Costs and complexity of compliance with existing and future regulations could adversely affect our profitability. If we fail to comply with regulations relevant to our business, we could be subject to civil or criminal liability, monetary damages and fines. Private lawsuits and enforcement actions by regulatory agencies could also materially increase our costs of operations and impact our ability to serve our clients.
As we provide services to clients’ customers residing in countries across the world, we are subject to numerous, and sometimes conflicting, legal regimes on matters as diverse as data privacy, import/export controls, communication content requirements, trade restrictions and sanctions, tariffs, taxation, labor regulations, wages and severance, health care requirements, internal and disclosure control obligations, and immigration. Violations of these laws and related regulations could impact our reputation and result in financial liability, criminal prosecution, unfavorable publicity, restrictions on our ability to process information, financial penalties, and breach of our contractual commitments.
Adverse changes in laws or regulations that impact our business may negatively affect the sale of our services, slow the growth of our operations, or mandate changes to how we deliver our services, including our ability to use offshore resources. These changes could threaten our ability to continue to serve certain markets.
Uncertainty and inconsistency in privacy and data protection laws that impact our business and high cost of compliance with such laws may impact our ability to deliver services and our results of operations
Recently, there has been a significant increase in data protection and privacy laws and enforcement in many jurisdictions where we and our clients do business. Some of these laws are complex and at times they impose conflicting regulatory requirements. For example, the recently enacted General Data Protection Regulation (GDPR) expands the European Union’s authority to oversee data protection for controllers and processers of personally identifiable information collected in Europe; while the State of California in the United States imposed similar regulations with a different reach. Failure to comply with all relevant privacy and data protection laws may result in legal claims, significant fines, sanctions, or penalties, or may make it difficult for us to secure business. Compliance with these evolving regulations may require significant investment which would impact our results of operations.
Our growth of operations could strain our resources and cause our business to suffer
We plan to continue growing our business through expansion, sales efforts, and strategic acquisitions, while maintaining tight controls on our expenses and overhead. Lean overhead functions combined with focused growth may place a strain on our management systems, infrastructure and resources, resulting in internal control failures, missed opportunities, and staff attrition which could impact our business and results of operations.
Our profitability could suffer if our cost-management strategies are unsuccessful
Our ability to improve or maintain our profitability is dependent on our ability to engage in continuous management of our costs. Our cost management strategies include optimizing the alignment between the demand for our services and our resource capacity, including our contact center utilization; the costs of service delivery; the cost of sales and general and administrative costs as a percentage of revenues; and the use of process automation for standard operating tasks. If we are not effective in managing our operating and administrative costs in response to changes in demand and pricing for our services, or if we are unable to absorb or pass on to our clients the increases in our costs of operations, our results of operations could be materially adversely affected.
Our financial results depend on our capacity utilization and our ability to forecast demand and make timely decisions about staffing levels, investments, and operating expenses
Our ability to meet our strategic growth and profitability objectives depends on how effectively we manage our customer engagement center capacity against the fluctuating and seasonal client demands. Predicting customer demand and making timely staffing level decisions, investments, and other operating expenditure commitments in each of our delivery center locations is key to our successful execution and profitability maximization. We can provide no assurance that we will continue to be able to achieve or maintain desired delivery center capacity utilization, because quarterly variations in client volumes, many of which are outside our control, can have a material adverse effect on our utilization rates. If our utilization rates are below expectations, because of our high fixed costs of operation, our financial conditions and results of operations could be adversely affected.
Our sales cycles for new client relationships and new lines of business with existing clients can be long, which results in a long lead time before we receive revenues
We often face a long selling cycle to secure contracts with new clients or contracts for new lines of business with existing clients. When we are successful in securing a new engagement, it is generally followed by a long implementation period when clients must give notice to incumbent service providers or transfer in-house operations to us. There may also be a long ramp up period before we commence our services, and for certain contracts we receive no revenue until we start performing the work. If we are not successful in obtaining contractual commitments after the initial prolonged sales cycle or in maintaining the contractual relationship for a period of time necessary to offset new project investment costs and appropriate return on that investment, the investments may have a material adverse effect on our results of operations.
Contract terms typical in our industry can lead to volatility in our revenue and our margins
Our contracts do not have guaranteed revenue levels. Most of our contracts require clients to provide monthly forecasts of volumes, but no guaranteed or minimum volume levels. Such forecasts vary from month to month, which can impact our staff utilizations, our cost structure, and our profitability.
Many of our contracts have termination for convenience clauses with short notice periods, which could have a material adverse effect on our results of operation. Although many of our contracts can be terminated for convenience, our relationships with our top five clients have ranged from one to 23 years with the majority of these clients having completed multiple contract renewals with us. Yet, our contracts do not guarantee a minimum revenue level or profitability, and clients may terminate them or materially reduce customer interaction volumes, which would reduce our earning potential. This could have a material adverse effect on our results of operations and makes it harder to make projections.
Many of our contracts utilize performance pricing that link some of our fees to the attainment of performance criteria, which could increase the variability of our revenue and operating margin. These performance criteria can be complex, and at times they are not entirely within our control. If we fail to satisfy our contract performance metrics, our revenue under the contracts and our operating margin are reduced.
We may not always offset increased costs with increased fees under long-term contracts. The pricing and other terms of our client contracts, particularly on our long-term contact center agreements, are based on estimates and assumptions we make at the time we enter into these contracts. These estimates reflect our best judgments regarding the nature of the engagement and our expected costs to provide the contracted services but these judgments could differ from actual results. Not all our larger long-term contracts allow for escalation of fees as our cost of operations increase. Moreover, those that do allow for such escalations, do not always allow increases at rates comparable to increases that we experience due to rising minimum wage costs and related payroll cost increases. If and to the extent we do not negotiate long-term contract terms that provide for fee adjustments to reflect increases in our cost of service delivery, our business, financial conditions, and results of operation could be materially impacted.
Our pricing depends on effectiveness of our level of effort forecasts. Pricing of our services in our technology and strategic consulting businesses is contingent on our ability to accurately forecast the level of effort and cost necessary to deliver our services, which is data dependent and can be inaccurate. The errors in level of effort estimations could yield lower profit margins or cause projects to become unprofitable, resulting in adverse impacts on our results of operations.
Our contracts seldom address the impacts of currency fluctuation on our costs of delivery. As we continue to leverage our global delivery model, more of our expenses may be incurred in currencies other than those in which we bill for services. An increase in the value of certain currencies, such as the United States or Australian dollar against the Philippine peso and India rupee, could increase costs for our delivery at offshore sites by increasing our labor and other costs that are denominated in local currencies. Our contractual provisions, cost management efforts, and currency hedging activities may not be sufficient to offset the currency fluctuation impact, resulting in the decrease of the profitability of our contracts.
Increases in income tax rates, changes in income tax laws or disagreements with tax authorities could adversely affect our business, financial condition or results of operations
We are subject to income taxes in the United States and in certain foreign jurisdictions in which we operate. Increases in income tax rates or other changes in income tax laws in any particular jurisdiction could reduce our after-tax income from such jurisdictions and could adversely affect our business, financial condition or results of operations. Our operations outside the United States generate a significant portion of our income and many of the other countries in which we have significant operations, have recently made or are actively considering changes to existing tax laws. For example, in December 2017, the Tax Cuts and Jobs Act (“2017 Tax Act”) was signed into law in the United States. While our accounting for the recorded impact of the 2017 Tax Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the Internal Revenue Service (“IRS”) could impact our recorded amounts in future periods.
Additional changes in the U.S. tax regime or in how U.S. multinational corporations are taxed on foreign earnings, including changes in how existing tax laws are interpreted or enforced, could adversely affect our business, financial condition or results of operations.
There are no assurances that we will be able to implement effective contracting structures that are necessary to optimize our tax position under the 2017 Tax Act. If we are unable to implement cost effective contracting structure, our effective tax rate and our results of operations would be impacted.
We face special risks associated with our business outside of the United States
An important component of our business strategy is service delivery outside of the United States and our continuing international expansion. For the first nine months of 2019, we derived approximately 40% of our revenue from operations outside of the United States. Conducting business abroad is subject to a variety of risks, including:
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inconsistent regulations, licensing and legal requirements may increase our cost of operations as we endeavor to comply with multiple, complex laws that differ from one country to another;
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·
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uncertainty of tax regulations in countries where we do business may affect our costs of operation;
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·
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special challenges in managing risks inherent in international operations, such as unique and prescriptive labor rules, corrupt business environments, restrictive immigration and export control laws may cause an inadvertent violation of laws that we may not be able to immediately detect or correct;
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longer payment cycles and/or difficulties in accounts receivable collections particular to operations outside of the United States could impact our cash flows and results of operations;
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political and economic instability and unexpected changes in regulatory regimes could adversely affect our ability to deliver services overseas and our ability to repatriate cash;
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the withdrawal of the UK from the European Union (known as “Brexit”) created substantial uncertainty about the political and economic relationship between the UK and the EU, and the UK’s other trading partners which could, depending on future trade term negotiations, impact our European operations;
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currency exchange rate fluctuations, restrictions on currency movement, and impact of international tax laws could adversely affect our results of operations, if we are forced to maintain assets in currencies other than U.S. dollars, while our financial results are reported in U.S. dollars; and
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terrorist attacks or civil unrests in some of the regions where we do business (e.g. the Middle East, Latin America, the Philippines, and in Europe), and the resulting need for enhanced security measures may impact our ability to deliver services, threaten the safety of our employees, and increase our costs of operations.
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While we monitor and endeavor to mitigate timely the relevant regulatory, geopolitical, and other risks related to our operations outside of the United States, we cannot assess with certainty what impact such risks are likely to have over time on our business, and we can provide no assurance that we will always be able to mitigate these risks successfully and avoid adverse impact on our business and results of operations.
Our profitability may be adversely affected if we are unable to expand and maintain our delivery centers in countries with stable wage rates and find new locations required by our clients.
Our business is labor-intensive and therefore cost of wages, benefits and related taxes constitute a large component of our operating expenses. As a result, expansion of our business is dependent upon our ability to maintain and expand our operations in cost-effective locations, in and outside of the United States. Most of our customer engagement centers are located in jurisdictions subject to minimum wage regulations, which may result in increased wages in the future, thus impacting our profitability.
Our clients often dictate where they wish for us to locate the delivery centers that serve their customers, such as “near shore” jurisdictions located in close proximity to the United States or specific locations in Europe or Northern Africa. There is no assurance that we will be able to find and secure locations suitable for delivery center operations in jurisdictions which meet our cost-effectiveness and security standards. Our inability to expand our operations to such locations, however, may impact our ability to secure new and additional business from clients, and could adversely affect our growth and results of operations.
Increases in the cost of communication and data services or significant interruptions in such services could adversely affect our business
Our business is significantly dependent on telephone, internet and data service provided by various domestic and foreign communication companies. Any disruption of these services could adversely affect our business. We have taken steps to mitigate our exposure to service disruptions by investing in complex and multi-layered redundancies, and we can transition services among our different customer engagement centers around the world. Despite these efforts, there can be no assurance, that the redundancies we have in place would be sufficient to maintain operations without disruption.
Our inability to obtain communication and data services at favorable rates could negatively affect our results of operations. Where possible, we have entered into long-term contracts with various providers to mitigate short term rate increases and fluctuations. There is no obligation, however, for the vendors to renew their contracts with us, or to offer the same or lower rates in the future, and such contracts may be subject to termination or modification for various reasons outside of our control. A significant increase in the cost of communication services that is not recoverable through an increase in the price of our services could adversely affect our business.
Defects or errors in software utilized in our service offerings could adversely affect our business.
The third-party software and systems that we use to conduct our business and serve our clients are highly complex and may, from time to time, contain design defects, coding errors or other software errors that may be difficult to detect or correct, and which are outside of our control. Although our commercial agreements contain provisions designed to limit our exposure to potential claims and liabilities, these provisions may not always effectively protect us against claims in all jurisdictions. As a result, problems with software and systems that we use may result in damages to our clients for which we are held responsible, causing damage to our reputation, adversely affecting our business, our results of operations, and financial condition.
Restrictions on mobility of people across borders may affect our ability to compete for and provide services to clients
Our business depends on the ability of some of our employees to obtain the necessary visas and entry permits to do business in the countries where our clients and contact centers are located. In recent years, in response to terrorist attacks and global unrest, immigration authorities generally, and those in the United States in particular, have increased the level of scrutiny in granting such visas, and even imposed bans on immigration and commercial travel for citizens of certain countries. If further terrorist attacks occur or global unrest intensifies, these restrictions are likely to further increase. Furthermore, immigration laws in most countries where we do business are subject to legislative change and varying standards of application and enforcement due to political forces, economic conditions or other events unrelated to our operations. If we are unable to obtain the necessary visas for our personnel with need to travel to or from the United States in a timely manner, we may not be able to continue to provide services on a timely and cost-effective basis, receive revenues as early as expected or manage our customer engagement centers efficiently. Any of these developments could have a material adverse effect on our business, results of operations and financial condition.
If the transfer pricing arrangements we have among our subsidiaries are determined to be inappropriate, our tax liability may increase
We have transfer pricing arrangements among our subsidiaries in relation to various aspects of our business, including operations, marketing, sales, and delivery functions. The United States, Australia, Mexico, Philippines and other transfer pricing regulations in other countries where we operate, require that cross-border transactions between affiliates be on arm’s-length terms. We carefully consider the pricing among our subsidiaries to assure that they are at arm’s-length. If tax authorities were to determine that the transfer prices and terms we have applied are not appropriate, we may incur increased tax liability, including accrued interest and penalties, which would cause material increase in our tax liability, thereby impacting our profitability and cash flows, and potentially resulting in a material adverse effect on our operations, effective tax rate and financial condition.
We routinely consider acquisitions, divestitures or other strategic transactions and may enter into such transactions at any time
We are engaged in a regular review of our strategic opportunities, including acquisitions, divestitures or other strategic transactions that we believe would provide value for our stockholders. We routinely have merger, acquisition, and divestiture opportunities in various stages of active review, and we also routinely engage consultants and advisors to assist us in analyzing opportunities. While at this time we are not actively engaged in negotiations regarding a material merger, acquisition or divestiture transaction, we could do so at any time. If such transaction involves a sale of a part of the business, such a transaction would likely reduce the revenue and income of the remaining business and may impact the Company’s stock price. While we consider these transactions to improve our business and financial results over time, there can be no assurance that our goals will be realized.
Our strategy of growing through acquisitions may impact our business in unexpected ways
Our growth strategy involves acquisitions that help us expand our service offerings and diversify our geographic footprint. We continuously evaluate acquisition opportunities, but there are no assurances that we will be able to identify acquisition targets that complement our strategy and are available at valuation levels accretive to our business.
Even if we are successful in making acquisitions, the acquired businesses may subject our business to risks that may impact our results of operation; including:
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inability to integrate acquired companies effectively and realize anticipated synergies and benefits from the acquisitions;
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diversion of management’s attention to the integration of the acquired businesses at the expense of delivering results for the legacy business;
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inability to appropriately scale critical resources to support the business of the expanded enterprise and other unforeseen challenges of operating the acquired business as part of TTEC’s operations;
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inability to retain key employees of the acquired businesses and/or inability of such key employees to be effective as part of TTEC operations;
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impact of liabilities or ethical issues of the acquired businesses undiscovered or underestimated as part of the acquisition due diligence;
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failure to realize anticipated growth opportunities from a combined business, because existing and potential clients may be unwilling to consolidate business with a single supplier or to stay with the acquirer post acquisition;
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impacts of cash on hand and debt incurred to finance acquisitions, thus reducing liquidity for other significant strategic objectives; and
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internal controls, disclosure controls, corruption prevention policies, human resources and other key policies and practices of the acquired companies may be inadequate or ineffective.
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We have incurred and may in the future incur impairments to goodwill, long-lived assets or strategic investments
As a result of past acquisitions, as of September 30, 2019, we have approximately $203.8 million of goodwill and $72.1 million of intangible assets included on our Consolidated Balance Sheet. We review our goodwill and intangible assets for impairment at least once annually, and more often when events or changes in circumstances indicate the carrying value may not be recoverable. We perform an assessment of qualitative and quantitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of the goodwill or intangible asset is less than its carrying amount. In the event that the book value of goodwill or intangible asset is impaired, such impairment would be charged to earnings in the period when such impairment is determined. We have recorded goodwill and intangible impairments in the past, and there can be no assurance that we will not incur impairment charges in the future that could have material adverse effects on our financial condition or results of operations.
If we are unable to attract and retain talented and experienced executives for key positions in our business, our business and our strategy execution could be adversely impacted
Our business success depends on contributions of senior management and key personnel. Our ability to attract, motivate and retain key senior management staff is conditioned on our ability to pay adequate compensation and incentives. We compete for top senior management candidates with other, often larger, companies that at times have access to greater resources. Our ability to attract qualified individuals for our senior management team is also impacted by our requirement that members of senior management sign non-compete agreements as a condition to joining TTEC. If we are not able to attract and retain talented and experienced executives, we would be unable to compete effectively, and our growth may be limited, which could have a material adverse effect on our business, results of operations, and prospects.
Intellectual property infringement by us and by others may adversely impact our ability to innovate and compete
Our solutions could infringe intellectual property of others impacting our ability to deploy them with clients. From time to time, we and members of our supply chain receive assertions that our service offerings or technologies infringe on the patents or other intellectual property rights of third parties. While to date we have been successful in defending such claims and many of these claims are without basis, the claims could require us to cease activities, incur expensive licensing costs, or engage in costly litigation, which could adversely affect our business and results of operation.
Our intellectual property may not always receive favorable treatment from the United States Patent and Trademark Office, the European Patent Office or similar foreign intellectual property adjudication and registration agencies; and our “patent pending” intellectual property may not receive a patent or may be subject to prior art limitations.
The lack of an effective legal system in certain countries where we do business or lack of commitment to protection of intellectual property rights, may prevent us from being able to defend our intellectual property and related technology against infringement by others, leading to a material adverse effect on our business, results of operations and financial condition.
Our financial results may be adversely impacted by foreign currency exchange rate risk
Many contracts that we service from customer engagement centers based outside of the United States are typically priced, invoiced, and paid in U.S. and Australian dollars or Euros, while the costs incurred to deliver the services and operate are incurred in the functional currencies of the applicable operating subsidiary. The fluctuations between the currencies of the contract and operating currencies present foreign currency exchange risks. Furthermore, because our financial statements are denominated in U.S. dollars, but approximately 22% of our revenue is derived from contracts denominated in other currencies, our results of operations could be adversely affected if the U.S. dollar strengthens significantly against foreign currencies.
While we hedge at various levels against the effect of exchange rate fluctuations, we can provide no assurance that we will be able to continue to successfully manage this foreign currency exchange risk and avoid adverse impacts on our business, financial condition, and results of operations.
The current trend to outsource customer care may not continue and the prices that clients are willing to pay for the services may diminish, adversely affecting our business
Our growth depends, in large part, on the willingness of our clients and potential clients to outsource customer care and management services to companies like TTEC. There can be no assurance that the customer care outsourcing trend will continue; and our clients and potential clients may elect to perform in-house customer care and management services that they currently outsource. Reduction in demand for our services and increased competition from other providers and in-house service alternatives would create pricing pressures and excess capacity that could have an adverse effect on our business, financial condition, and results of operations.
Legislation discouraging offshoring of service by United States companies or making such offshoring difficult could significantly affect our business
A perceived association between offshore service providers and the loss of jobs in the United States has been a focus of political debate in recent years. As a result, current and prospective clients may be reluctant to hire offshore service providers like TTEC to avoid negative perceptions and regulatory scrutiny. If they seek customer care and management capacity onshore that was previously available to them through outsourcers outside of the United States, they may elect to perform these services in-house instead of outsourcing the services onshore. Possible tax incentives for United States businesses to return offshored, including outsourced and offshored, services to the United States could also impact our clients’ continuing interest in using our services.
Legislation aimed to expand protections for United States based customers from having their personal data accessible outside of the United States could also impact offshore outsourcing opportunities by requiring notice and consent as a condition for sharing personal identifiable information with service providers based outside of the United States. Any material changes in current trends among United States based clients to use services outsourced and delivered offshore would materially impact our business and results of operations.
Health epidemics could disrupt our business and adversely affect our financial results
Our customer engagement centers typically seat hundreds of employees in one location. Accordingly, an outbreak of a contagious infection in one or more of the locations in which we do business may result in significant worker absenteeism, lower capacity utilization rates, voluntary or mandatory closure of our customer engagement centers, travel restrictions on our employees, and other disruptions to our business. Any prolonged or widespread health epidemic could severely disrupt our business operations and have a material adverse effect on our business, its financial condition and results of operations.
Our bylaws designate Delaware courts as the exclusive forum for most disputes with our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for their disputes.
Our bylaws designate Delaware’s state courts as the exclusive forum for most disputes between us and our stockholders, including federal claims and derivative actions. We believe that this provision may benefit us by providing increased consistency in the application of Delaware law and federal securities laws by chancellors and judges, who are particularly experienced in resolving corporate disputes, efficient administration of cases relative to other forums, and protection against the burdens of multi-forum litigation. This choice of forum provision does not have the effect of causing our stockholders to waive our obligation to comply with the federal securities laws. This bylaw forum selection provision is not uncommon for companies incorporated in the State of Delaware, but it could limit our stockholders’ ability to select a more favorable judicial forum for disputes with us, our directors, officers or other employees; and thus, may discourage litigation. It is important to note, however, that our choice of forum provision would (i) not be enforceable with respect to any suits brought to enforce any liability or duty created by the Securities Exchange Act of 1934, as amended, and (ii) have uncertain enforceability with respect to claims under the Securities Act of 1933, as amended.
The volatility of our stock price may result in loss of investment
Our share price has been and may continue to be subject to substantial fluctuation. We believe that market prices for securities of companies that provide outsourced customer care management services have experienced volatility in recent years and such volatility may affect our stock price as well. As we continue to diversify our service offerings to include growth, technology and strategic consulting, our stock price volatility may stabilize, or it may be further impacted by stock price fluctuations in these new industries. In addition to fluctuations specific to our industry and service offerings, we believe that various other factors such as general economic conditions, changes or volatility in the financial markets, changing market condition for our clients, and the relatively small size of our public float could impact the valuation of our stock. The quarterly variations in our financial results, acquisition and divestiture announcements by us or our competitors, strategic partnerships and new service offering, our failure to meet our growth objectives or exceed our targets, and securities analysts’ perception about our performance could cause the market price of our shares to fluctuate substantially in the future.
Our Chairman and Chief Executive Officer controls a majority of our stock and has control over all matters requiring action by our stockholders; and his interest may conflict with the interests of our other stockholders
Kenneth D. Tuchman, our Chairman and Chief Executive Officer, directly and beneficially owns approximately 68% of TTEC’s common stock. As a result, Mr. Tuchman could and does exercise significant influence and control over our business practices and strategy. As long as Mr. Tuchman continues to beneficially own more than 50% of our common stock he will be able to elect all of the members of our Board of Directors, effect stockholder actions by written consent in lieu of stockholder meetings, and determine the outcome of all matters submitted to a vote of our stockholders, including matters involving mergers or other business combinations, the acquisition or disposition of assets, the incurrence of indebtedness, the issuance of any additional shares of common stock or other equity securities and the payment of dividends on our common stock.
The interest of Mr. Tuchman may not always coincide with the interest of our other stockholders, and Mr. Tuchman may seek to cause the Company to take actions that might involve risks to our business or adversely affect us or our other stockholders. For example, Mr. Tuchman’s control of TTEC could delay or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely, Mr. Tuchman’s control could result in the consummation of a transaction that our other stockholders do not support. As a controlling stockholder, Mr. Tuchman is entitled to vote his shares as he see fit, which may not always be in the interest of our other stockholders. This concentrated control could also discourage parties from acquiring our common stock or initiating potential mergers, takeovers or other change of control transactions, which could depress the trading price of our common stock.
Our status as a “controlled company” could make our common stock less attractive to some investors or otherwise harm our stock price.
Because we qualify as a “controlled company” under the listing rules of the NASDAQ Stock Market, we are not required to have a majority of our Board of Directors be independent, nor are we required to have an independent compensation committee or an independent nominating committee of the Board. While the Company has elected not to avail itself of these governance exceptions available to “controlled companies,” in the future the Company may elect to do otherwise. Accordingly, because of our “controlled company” status, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for NASDAQ-listed companies. Our status as a controlled company could make our common stock less attractive to some investors or otherwise harm our stock price.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
Following is the detail of the issuer purchases made during the quarter ended September 30, 2019:
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Total Number of
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Approximate Dollar
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Shares
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Value of Shares that
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Purchased as
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May Yet Be
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Part of Publicly
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Purchased Under
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Total Number
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Announced
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the Plans or
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of Shares
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Average Price
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Plans or
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Programs (In
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Period
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Purchased
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Paid per Share
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Programs
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thousands)(1)
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June 30, 2019
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$
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26,580
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July 1, 2019 - July 31, 2019
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—
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$
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—
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—
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$
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26,580
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August 1, 2019 - August 31, 2019
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—
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$
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—
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—
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$
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26,580
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September 1, 2019 - September 30, 2019
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—
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$
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—
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—
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$
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26,580
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Total
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—
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—
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(1)
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In November 2001, our Board of Directors (“Board”) authorized a stock repurchase program with the objective of increasing stockholder returns. The Board periodically authorizes additional increases to the program. The most recent Board authorization to purchase additional common stock occurred in February 2017, whereby the Board increased the program allowance by $25.0 million. Since inception of the program through September 30, 2019, the Board has authorized the repurchase of shares up to a total value of $762.3 million, of which we have purchased 46.1 million shares on the open market for $735.8 million. As of September 30, 2019 the remaining amount authorized for repurchases under the program was approximately $26.6 million. The stock repurchase program does not have an expiration date.
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ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
101.DEF**
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XBRL Taxonomy Extension Definition Linkbase Document
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*
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Filed or furnished herewith.
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**
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Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) Notes to the Consolidated Financial Statements, (ii) Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018 (unaudited), (iii) Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2019 and 2018 (unaudited), (iv) Consolidated Statements of Stockholders’ Equity as of and for the three and nine months ended September 30, 2019 and 2018 (unaudited), and (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018 (unaudited).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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TTEC HOLDINGS, INC.
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(Registrant)
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Date: November 5, 2019
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By:
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/s/ Kenneth D. Tuchman
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Kenneth D. Tuchman
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Chairman and Chief Executive Officer
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Date: November 5, 2019
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By:
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/s/ Regina M. Paolillo
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Regina M. Paolillo
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Chief Financial Officer
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TTEC (NASDAQ:TTEC)
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