Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended March 31, 2007 |
or
¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to . |
Commission File Number:0-20807
ICT GROUP, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania | 23-2458937 | |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) |
100 Brandywine Boulevard, Newtown, PA | 18940 | |
(Address of principal executive offices) | (Zip code) |
267-685-5000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark whether the registrant is a large accelerated filer, and accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large Accelerated Filer ¨ Accelerated Filer x Non- accelerated Filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) YES x NO ¨
As of May 7, 2007, there were 15,767,429 outstanding shares of common stock, par value $0.01 per share, of the registrant.
Table of Contents
ICT GROUP, INC.
PART I | FINANCIAL INFORMATION | PAGE | ||
Item 1 | FINANCIAL STATEMENTS (unaudited) | |||
Consolidated Balance Sheets - March 31, 2007 and December 31, 2006 | 3 | |||
Consolidated Statements of Operations - Three months ended March 31, 2007 and 2006 | 4 | |||
Consolidated Statements of Cash Flows - Three months ended March 31, 2007 and 2006 | 5 | |||
Notes to Consolidated Financial Statements | 6 | |||
Item 2 | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 12 | ||
Item 3 | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 21 | ||
Item 4 | CONTROLS AND PROCEDURES | 22 | ||
PART II | OTHER INFORMATION | |||
Item 1 | LEGAL PROCEEDINGS | 22 | ||
Item 5 | OTHER INFORMATION | 22 | ||
Item 6 | EXHIBITS | 22 | ||
23 |
2
Table of Contents
PART I: FINANCIAL INFORMATION
ICT GROUP, INC. AND SUBSIDIARIES
(In thousands, except per share amounts)
(Unaudited)
March 31, | December 31, | |||||
2007 | 2006 | |||||
ASSETS | ||||||
CURRENT ASSETS: | ||||||
Cash and cash equivalents | $ | 30,494 | $ | 32,367 | ||
Accounts receivable, net of allowance for doubtful accounts of $442 and $489 | 86,907 | 83,673 | ||||
Prepaid expenses and other current assets | 10,420 | 10,898 | ||||
Income taxes receivable | 2,666 | 2,676 | ||||
Deferred income taxes | 246 | 250 | ||||
Total current assets | 130,733 | 129,864 | ||||
PROPERTY AND EQUIPMENT, NET | 60,923 | 61,667 | ||||
DEFERRED INCOME TAXES | 4,896 | 4,756 | ||||
GOODWILL | 12,786 | 12,862 | ||||
OTHER ASSETS | 6,326 | 6,517 | ||||
$ | 215,664 | $ | 215,666 | |||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||
CURRENT LIABILITIES: | ||||||
Accounts payable | $ | 22,019 | $ | 21,376 | ||
Accrued expenses and other current liabilities | 20,887 | 22,506 | ||||
Income taxes payable | 3,109 | 4,193 | ||||
Deferred income taxes | 2,266 | 2,266 | ||||
Total current liabilities | 48,281 | 50,341 | ||||
OTHER LIABILITIES | 4,727 | 3,443 | ||||
DEFERRED INCOME TAXES | 731 | 737 | ||||
SHAREHOLDERS’ EQUITY: | ||||||
Preferred stock, $0.01 par value 5,000 shares authorized, none issued | — | — | ||||
Common stock, $0.01 par value, 40,000 shares authorized, 15,765 and 15,734 shares issued and outstanding | 158 | 157 | ||||
Additional paid-in capital | 116,343 | 115,633 | ||||
Retained earnings | 44,193 | 44,377 | ||||
Accumulated other comprehensive income | 1,231 | 978 | ||||
Total shareholders’ equity | 161,925 | 161,145 | ||||
$ | 215,664 | $ | 215,666 | |||
The accompanying notes are an integral part of these consolidated financial statements.
3
Table of Contents
ICT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three Months Ended March 31, | ||||||||
2007 | 2006 | |||||||
REVENUE | $ | 115,177 | $ | 113,053 | ||||
OPERATING EXPENSES: | ||||||||
Cost of services | 73,624 | 69,927 | ||||||
Selling, general and administrative (including share-based compensation of $491 and $341) | 41,178 | 39,006 | ||||||
114,802 | 108,933 | |||||||
Operating income | 375 | 4,120 | ||||||
INTEREST EXPENSE | (65 | ) | (667 | ) | ||||
INTEREST INCOME | 184 | 43 | ||||||
Income before income taxes | 494 | 3,496 | ||||||
INCOME TAX PROVISION | 84 | 734 | ||||||
NET INCOME | $ | 410 | $ | 2,762 | ||||
EARNINGS PER SHARE: | ||||||||
Basic earnings per share | $ | 0.03 | $ | 0.22 | ||||
Diluted earnings per share | $ | 0.03 | $ | 0.21 | ||||
Shares used in computing basic earnings per share | 15,745 | 12,791 | ||||||
Shares used in computing diluted earnings per share | 16,060 | 13,265 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
Table of Contents
ICT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended March 31, | ||||||||
2007 | 2006 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
Net income | $ | 410 | $ | 2,762 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 6,274 | 5,766 | ||||||
Share-based compensation | 491 | 341 | ||||||
Deferred income tax benefit | (172 | ) | (119 | ) | ||||
Amortization of deferred financing costs | 45 | 45 | ||||||
(Increase) decrease in: | ||||||||
Accounts receivable | (3,088 | ) | 7,478 | |||||
Prepaid expenses and other current assets | 463 | 684 | ||||||
Other assets | (22 | ) | (79 | ) | ||||
Increase (decrease) in: | ||||||||
Accounts payable | 610 | (425 | ) | |||||
Accrued expenses and other liabilities | (2,705 | ) | (6,477 | ) | ||||
Income taxes payable, net | 292 | (349 | ) | |||||
Net cash provided by operating activities | 2,598 | 9,627 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
Purchases of property and equipment | (5,135 | ) | (5,886 | ) | ||||
Net cash used in investing activities | (5,135 | ) | (5,886 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
Borrowings under line of credit | — | 10,000 | ||||||
Payments on line of credit | — | (11,000 | ) | |||||
Proceeds from exercise of stock options | 257 | 7 | ||||||
Tax benefit from stock option exercises and stock awards | — | 1 | ||||||
Net cash provided by (used in) financing activities | 257 | (992 | ) | |||||
EFFECT OF FOREIGN EXCHANGE RATE CHANGE ON CASH AND CASH EQUIVALENTS | 407 | (1,331 | ) | |||||
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS | (1,873 | ) | 1,418 | |||||
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD | 32,367 | 10,428 | ||||||
CASH AND CASH EQUIVALENTS, END OF PERIOD | $ | 30,494 | $ | 11,846 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
5
Table of Contents
ICT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1: BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of our management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2007 are not necessarily indicative of the results that may be expected for the complete fiscal year. For additional information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006. Unless the context indicates otherwise, “ICT,” the “Company,” “we,” “our,” and “us” refer to ICT Group, Inc., and, where appropriate, one or more of its subsidiaries.
Note 2: CREDIT FACILITY AND LONG-TERM DEBT
Our revolving credit facility (“Credit Facility”) is structured as a $125.0 million secured revolving facility with a $5.0 million sub-limit for swing line loans and a $30.0 million sub-limit for multicurrency borrowings. The Credit Facility includes a $50.0 million accordion feature, which allows us to increase our borrowing capacity to $175.0 million, subject to obtaining commitments for the incremental capacity from existing or new lenders. The Credit Facility matures on June 24, 2010.
Borrowings under the Credit Facility can bear interest at various rates, depending upon the type of loan. We have two borrowing options, either a “Base Rate” option, under which the interest rate is calculated using the higher of the federal funds rate plus 0.5% or the Bank of America prime rate, plus a spread ranging from 0% to 0.75%, or a “Eurocurrency Rate” option, under which the interest rate is calculated using LIBOR plus a spread ranging from 1% to 2.25%. The amount of the spread under each borrowing option depends on our ratio of funded debt to EBITDA (which, for purposes of the Credit Facility, is defined as income before interest expense, interest income, income taxes, and depreciation and amortization and certain other charges. At March 31, 2007, we had no outstanding borrowings.
For the three months ended March 31, 2007 and 2006, our interest expense related to our Credit Facility, exclusive of the amortization of debt issuance costs, was $0 and $621,000, respectively
The Credit Facility contains certain affirmative and negative covenants including limitations on specified levels of consolidated leverage, consolidated fixed charges and minimum net worth requirements, and includes limitations on, among other things, liens, mergers, consolidations, sales of assets, incurrence of debt and capital expenditures. We are also required to pay a quarterly commitment fee ranging from 0.2% to 0.5% of the unused amount. Upon the occurrence of an event of default under the Credit Facility, such as non-payment or failure to observe specific covenants, the lenders would be entitled to declare all amounts outstanding under the facility immediately due and payable. As of March 31, 2007, we were in compliance with all covenants contained in the Credit Facility.
At March 31, 2007, we had $583,000 of unamortized debt issuance costs associated with the Credit Facility that are being amortized over the remaining term of the Credit Facility.
At March 31, 2007, there were no outstanding foreign currency loans nor were there any outstanding letters of credit. The amount of the unused Credit Facility at March 31, 2007 was $125.0 million. The Credit Facility can be drawn upon through June 24, 2010, at which time all amounts outstanding must be repaid. Borrowings under the Credit Facility are collateralized with substantially all of our assets, as well as the capital stock of our subsidiaries.
6
Table of Contents
Note 3: EARNINGS PER SHARE
We follow Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share.” Basic earnings per share (“Basic EPS”) is computed by dividing net income by the weighted average number of shares of common stock outstanding. Diluted earnings per share (“Diluted EPS”) is computed by dividing net income by the weighted average number of shares of common stock outstanding, after giving effect to the potential dilution from the exercise of securities, such as stock options and restricted stock units (“RSUs”), into shares of common stock as if those securities were exercised. A reconciliation of shares used to compute EPS is shown below:
For the three months ended March 31, | ||||||
(in thousands, except per share amounts) | 2007 | 2006 | ||||
Net income | $ | 410 | $ | 2,762 | ||
Basic earnings per share: | ||||||
Weighted average shares outstanding | 15,745 | 12,791 | ||||
Basic earnings per share | $ | 0.03 | $ | 0.22 | ||
Diluted earnings per share: | ||||||
Weighted average shares outstanding | 15,745 | 12,791 | ||||
Dilutive shares resulting from common stock equivalents (1) | 315 | 474 | ||||
Shares used in computing diluted earnings per share | 16,060 | 13,265 | ||||
Diluted earnings per share | $ | 0.03 | $ | 0.21 | ||
(1) | Excluded from the calculation of diluted shares is the effect of options to purchase 10,000 and 8,000 shares for the three months ended March 31, 2007 and 2006, respectively, as giving effect to such options would be antidilutive. Also excluded from the calculation of diluted shares is the effect of 50,000 restricted stock unit awards for the three months ended March 31, 2006, as giving effect to such awards would also be antidilutive. There were no antidilutive restricted stock unit awards for the three months ended March 31, 2007. |
Note 4: SHARE-BASED COMPENSATION
We have share-based compensation plans covering a variety of employee groups, including executive management, the Board of Directors and other full-time employees. The consolidated statements of operations for the three months ended March 31, 2007 and 2006 reflects share-based compensation expense of $491,000 and $341,000, respectively. The related tax benefit recorded from share-based compensation expense for the three months ended March 31, 2007 and 2006 was $172,000 and $119,000, respectively. Our share-based compensation, by category, is shown below.
Three Months Ended March 31, | ||||||
(in thousands) | 2007 | 2006 | ||||
Share-based compensation: | ||||||
Stock options | $ | 81 | $ | 170 | ||
Restricted stock units (“RSUs”) | 410 | 96 | ||||
Long-term incentive plan | — | 75 | ||||
Total share-based compensation | $ | 491 | $ | 341 | ||
7
Table of Contents
Stock Option Awards:
Stock option awards are available under our current existing equity plans. We recognize compensation expense based on the grant date fair value of the award on a straight-line basis over the requisite service period, which for these awards is the vesting period. None of the stock options granted to date have performance-based or market-based vesting conditions.
Aggregated information regarding stock options outstanding is summarized below.
Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | ||||||||
Outstanding, January 1, 2007 | 593,745 | $ | 10.97 | ||||||||
Granted | — | — | |||||||||
Exercised | (26,995 | ) | 13.05 | ||||||||
Canceled/forfeited | (2,205 | ) | 12.11 | ||||||||
Outstanding, March 31, 2007 | 564,545 | $ | 10.96 | 5.0 years | $ | 3,693,874 | |||||
Vested and Exercisable at March 31, 2007 | 452,195 | $ | 10.57 | 4.2 years | $ | 3,135,791 | |||||
Expected to Vest as of March 31, 2007 | 558,928 | $ | 10.94 | 4.9 years | $ | 3,666,008 |
Restricted Stock Units:
In 2006, we began issuing RSUs for incentive compensation purposes. For RSU awards with a graded–vesting schedule and with only service conditions, we recognize compensation expense based on the grant-date fair value of the award on a straight-line basis over the vesting period. The fair value of an RSU is the fair value of the Company’s common stock (closing market price) on the date of grant.
To the extent an RSU award has performance conditions and graded-vesting, we treat each vesting tranche as an individual award and recognize compensation expense on a straight-line basis over the requisite service period for each tranche. The requisite service period over which we will record compensation expense is a combination of the performance period and subsequent vesting period based on continued service. The following table summarizes the changes in non-vested RSUs that have only service conditions for the three months ended March 31, 2007.
Shares | Weighted Average Grant Date Fair Value | Aggregate Intrinsic Value | |||||||
Non-vested RSUs at January 1, 2007 | 157,616 | $ | 24.75 | ||||||
Granted | 85,008 | 24.47 | |||||||
Vested | (17,922 | ) | 22.74 | ||||||
Canceled/Forfeited | (2,500 | ) | 33.14 | ||||||
Non-vested RSUs at March 31, 2007 | 222,202 | $ | 24.71 | $ | 3,888,535 | ||||
Included in the vested number of RSUs for the three months ended March 31, 2007, were 1,410 RSUs that employees surrendered to the Company in payment of minimum tax obligations upon the vesting. During the three months ended March 31, 2007, we valued the stock at the closing market price on the date of surrender for an aggregate value of approximately $42,000, or $29.73 per share. Also included in the vested number of RSUs for the three months ended March 31, 2007 were 12,500 RSUs that were cash-settled based on the closing market price on the vesting date of $27.53, per share.
8
Table of Contents
Long-Term Incentive Plan:
The ICT Group, Inc. Long-Term Incentive Plan (“LTIP”), provides for both a performance-based incentive and an executive retention incentive. The LTIP first establishes a performance-based incentive by requiring achievement of specific annual financial targets over a three-year period in order to determine the ultimate value of an award under the LTIP. The Compensation Committee determines what portion of an award is payable in cash and what portion is payable through an RSU award. Because the number of RSUs to be awarded depends on the price of the Company’s stock at the date the performance level is determined and the award, if any, is made by the Compensation Committee, we do not have a grant date for accounting purposes until the number of RSUs is known. Therefore, the LTIP will be liability-classified until the RSUs are awarded and a grant date is established. The Compensation Committee may impose a vesting schedule with respect to any award under the LTIP, which provides an additional executive retention incentive. For the three months ended March 31, 2007, we recognized no compensation expense pursuant to the LTIP since the minimum incentive targets, as defined by the LTIP, are not expected to be achieved for fiscal year 2007. All compensation expense relating to the LTIP is based on Management’s best estimate at that time as to what financial targets will be achieved. This estimate is re-evaluated quarterly and adjusted to reflect Management’s then best estimate.
Note 5: COMPREHENSIVE INCOME
We follow SFAS No. 130, “Reporting Comprehensive Income.” SFAS No. 130 requires companies to classify items of other comprehensive income by their nature in financial statements and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the consolidated balance sheet.
Three Months Ended March 31, | ||||||||
(in thousands) | 2007 | 2006 | ||||||
Net income | $ | 410 | $ | 2,762 | ||||
Derivative instruments, net of tax | 307 | 1 | ||||||
Foreign currency translation adjustments | (54 | ) | (920 | ) | ||||
Comprehensive income | $ | 663 | $ | 1,843 | ||||
Note 6: LEGAL PROCEEDINGS
From time to time, we are involved in litigation incidental to our business. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict.
On April 28, 2006, a broker with whom we executed an agreement in June 2001 filed a Demand for Arbitration and Statement of Claim against us with the American Arbitration Association. The Demand alleged various contract, quasi-contract and tort claims against us arising out of commissions we allegedly owe this broker pursuant to the June 2001 agreement for work we perform for one of our customers. We filed an Answer to the Demand on June 14, 2006 denying the allegations. Since that time, the parties have engaged in discovery. On January 16, 2007, the broker filed an Amended Demand and an expert report estimating damages. On April 6, 2007, the broker filed an addendum to the expert report that estimated a total of approximately $1.3 million of commissions allegedly owed for work we already performed and estimated a total of approximately $5.8 million of future commissions for work he projects we might perform over the next seven years. We believe that we have paid this broker all amounts due under the June 2001 agreement, have denied the allegations of the Amended Demand, and intend to vigorously defend ourselves against the claims. On March 2, 2007, we filed a Motion for Partial Summary Judgment with the three person arbitration panel seeking judgment in our favor on the broker’s tort, unjust enrichment, punitive damages, interest and attorney’s fees claims, as well as on several of the broker’s contract
9
Table of Contents
claims, including the claim for future commissions. On April 12, 2007, the arbitration panel granted our motion in part, dismissing the broker’s tort, unjust enrichment and punitive damages claims, but denied our motion with respect to the broker’s contract claims and claims for interest and attorney’s fees. The arbitration hearing is currently scheduled for the end of May 2007. The June 2001 agreement states that the decision of a majority of the arbitration panel shall be final and binding on the parties. We are unable at this time to determine the likelihood of an unfavorable outcome or to estimate the amount or range of possible loss.
Note 7: OPERATING AND GEOGRAPHIC INFORMATION
Based on guidance in SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” we believe that we have one reportable segment. Our services are provided through contact centers located throughout the world and include customer care management services as well as telesales, database marketing services, marketing research services, technology hosting services, and data management and collection services on behalf of customers operating in our target industries. Technological advancements have allowed us to better control production output at each contact center by routing customer call lists to different centers depending on capacity. A contact center and the technology assets utilized by the contact center may have different geographic locations. Accordingly, many of our contact centers are not limited to performing only one of the above-mentioned services; rather, they can perform a variety of different services for different customers in different geographic markets.
The following table shows information by geographic area. For the purposes of our disclosure, revenue is attributed to countries based on the location of the customer being served and property and equipment is attributed to countries based on physical location of the asset.
Three Months Ended March 31, | ||||||
(in thousands) | 2007 | 2006 | ||||
Revenue: | ||||||
United States | $ | 87,511 | $ | 90,941 | ||
Canada | 15,989 | 14,272 | ||||
Other foreign countries | 11,677 | 7,840 | ||||
$ | 115,177 | $ | 113,053 | |||
(in thousands) | March 31, 2007 | December 31, 2006 | ||||
Property and equipment, net: | ||||||
United States | $ | 30,787 | $ | 31,653 | ||
Canada | 7,351 | 7,651 | ||||
Philippines | 14,362 | 14,044 | ||||
Other foreign countries | 8,423 | 8,319 | ||||
$ | 60,923 | $ | 61,667 | |||
Note 8: DERIVATIVE INSTRUMENTS
We have operations in Canada, Ireland, the United Kingdom, Australia, Barbados, Mexico, Argentina, Costa Rica, India and the Philippines that are subject to foreign currency fluctuations. As currency rates change, translation of the statement of operations from local currencies to U.S. dollars affects period-to-period comparability of operating results.
Our most significant foreign currency exposures occur when revenue and associated accounts receivable are collected in one currency and expenses incurred to generate that revenue are paid in another currency. Our most significant area of exposure has been with the Canadian operations, where a portion of revenue is generated in U.S. dollars (USD) and the corresponding expenses are generated in Canadian dollars (CAD). We also experience foreign currency exposure in the Philippines, where the revenue is typically earned in USD, but operating costs are denominated in Philippine pesos (PHP). Recently, the PHP has experienced increased volatility with respect to the USD. As we continue to increase outsourcing to the Philippines, we will experience a greater degree of foreign currency exposure. We mitigate a portion of this exposure with foreign currency derivative contracts.
10
Table of Contents
The foreign currency forward contracts and currency options that are used to hedge these exposures are designated as cash flow hedges. The gain or loss from the effective portion of the hedge is reported as a component of accumulated other comprehensive income in shareholders’ equity until settlement of the contract occurs. Settlement occurs in the same period that the hedged item affects earnings. Any gain or loss from the ineffective portion of the hedge that exceeds the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized immediately in the consolidated statement of operations. For accounting purposes, effectiveness refers to the cumulative changes in the fair value of the derivative instrument being highly correlated to the inverse changes in the fair value of the hedged item.
For the three months ended March 31, 2007 and 2006, we realized gains (losses) of $(159,000) and $432,000 on these derivative instruments, respectively. The fair value of outstanding derivative instruments is recorded on our consolidated balance sheets. As of March 31, 2007, the fair value of outstanding derivative instruments was an asset of $220,000 ($143,000, net of tax). At December 31, 2006, our outstanding derivatives had a fair value of $252,000 of unrealized losses ($164,000, net of tax). The outstanding derivative instruments at March 31, 2007 hedge a portion of anticipated operating costs and payables associated with the CAD and the PHP from April 2007 through March 2008.
We have also entered into a foreign exchange forward contract to reduce the effects of foreign currency fluctuations related to an $11.0 million intercompany note payable from our Netherlands subsidiary to a U.S. subsidiary. These gains and losses are recognized in earnings as the Company elected not to designate the contract as an accounting hedge. The gains and losses on this foreign exchange forward contract are expected to offset the foreign currency remeasurement gains and losses recorded on the note payable. We realized $114,000 of losses on these contracts for the three months ended March 31, 2007, which were offset by the foreign currency gains and losses.
Note 9: INCOME TAXES
Effective January 1, 2007, we adopted the provisions of Financial Accounting Standards Board’s Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. FIN 48 states that a tax benefit from an uncertain tax position may be recognized only if it is “more likely than not” that the position is sustainable, based on its technical merits. Under FIN 48, the liability for unrecognized tax benefits is classified as noncurrent unless the liability is expected to be settled in cash within 12 months of the reporting date.
We operate internationally, within various tax jurisdictions, and face examinations from the various tax authorities regarding transfer pricing, the deductibility of certain expenses, intercompany transactions as well as other matters. Our Federal income tax returns are closed to examination by the Internal Revenue Service through the tax year 2002, with the exception of transfer pricing matters, which have a longer statute of limitations. State and other income tax returns are generally subject to examination for a period of three to four years after the filing of the respective returns. The state impact of any amended Federal returns remains subject to examination by various states for a period of up to one year after formal notification of such amendments to the states. We are not currently under any income tax related examinations by the Internal Revenue Service or any state tax authorities, except for the State of New York. At the adoption date, we applied FIN 48 to all tax positions for which the statute of limitations remained open. As a result, we recognized an increase in our liability for unrecognized income tax benefits of $594,000, which was accounted for as a decrease to our January 1, 2007 balance of retained earnings. With this adjustment, the total liability for unrecognized tax benefits related to Federal, state and foreign taxes at January 1, 2007 was approximately $1.9 million, including estimated interest and penalties of $191,000. Our policy is to classify interest and penalties related to unrecognized tax benefits as income tax expense. This liability is included in other liabilities on our consolidated balance sheet. For the three months ended March 31, 2007 there were no changes to our liability for uncertain tax positions, except for additional interest, which was not significant. We do not anticipate that this liability will significantly change due to the settlement of examinations and the expiration of the statutes of limitations prior to March 31, 2008.
11
Table of Contents
Note 10: CORPORATE RESTRUCTURING
The following is a rollforward of the accrual associated with our December 2002 corporate restructuring:
(in thousands) | Accrual at December 31, 2006 | Cash Payments | Accrual at March 31, 2007 | |||||||
Lease obligations and facility exit costs | $ | 913 | $ | (82 | ) | $ | 831 |
During the three months ended March 31, 2007, we did not enter into any sublease arrangements. All cash payments made were related to the ongoing lease obligations.
We continue to evaluate and update our estimate of the remaining liabilities. At March 31, 2007 and December 31, 2006, $517,000 and $594,000, respectively, of the restructuring accrual is recorded in other liabilities in the consolidated balance sheet, which represents lease obligation payments and estimated facility exit cost payments to be made beyond one year. As of March 31, 2007, the expiration date of the remaining facility lease is 2009. The balance of the restructuring accrual is included in accrued expenses and other current liabilities in our consolidated balance sheet at March 31, 2007 and December 31, 2006.
Note 11: RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently assessing the impact that SFAS No. 157 will have on our results of operations and financial position.
In February 2007, the FASB issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities,”which provides companies with an option to report selected financial assets and liabilities at fair value in an attempt to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. This Statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. We are currently assessing the impact that SFAS No. 159 will have on our results of operations and financial position.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a leading global provider of outsourced customer management support services. Our comprehensive, balanced mix of services includes:
• | Customer Care Services(including customer care, retention and technical support); |
• | Telesales; and |
• | Marketing, Technology and Business Process Outsourcing(BPO) Solutions(including market research, database marketing, interactive voice response (IVR), alert notification, e-mail management, data capture and collections and other back-office business processing services). |
We provide our services through contact centers located throughout the world, including the U.S., Ireland, the U.K., Canada, Australia, Mexico, Barbados, the Philippines, Costa Rica and Argentina. As of March 31, 2007, we had operations in 45 contact centers from which we support clients primarily in the financial services, insurance, healthcare, telecommunications, information technology, business and consumer services, government and energy services sectors. We also utilize a facility in India for our back office processing services.
12
Table of Contents
Our domestic sales force is organized by specific industry verticals, which enables our sales personnel to develop in-depth industry and product knowledge. We also have sales operations in the U.K., Canada, Mexico, Australia and Argentina.
We invest heavily in systems and software technologies designed to improve productivity, thereby lowering the effective cost per contact made or received. Our systems and software technologies are also designed to improve sales and customer service effectiveness by providing sales and service representatives with real-time access to customer and product information. We currently offer and/or utilize a comprehensive suite of CRM technologies, available on a hosted basis for use by clients at their own in-house facilities or on a co-sourced basis in conjunction with our fully integrated, Web-enabled contact centers. Our technologies include automatic call distribution (ACD) voice processing, IVR, advanced speech recognition (ASR), Voice over Internet Protocol (VoIP), contact management, automated e-mail management and processing, sales force and marketing automation, alert notification and Web self-help.
We believe that we were one of the first fully automated outsourced customer management services companies, and we were among the first such companies to implement predictive dialing technology for telemarketing and market research, provide collaborative Web browsing services and utilize VoIP capabilities. Through our global implementation of VoIP, we have established a redundant voice and data network infrastructure that can seamlessly route inbound and outbound voice traffic to our contact centers worldwide. We do not provide telecommunications or VoIP services to the general public.
Our customer care/retention clients typically enter into longer-term, contractual relationships that may contain provisions for early contract terminations. We generally operate under month-to-month contractual relationships with our telesales clients. The pricing component of a contract is often comprised of a base service charge and separate charges for ancillary services. Our services are generally priced based upon per-minute or hourly rates. On occasion, we perform services for which we are paid incentives based on completed sales. The nature of our business is such that we generally compete with other outsourced service providers as well as the retained in-house call center operations of our customers. This can create pricing pressures and impact the rates we can charge in our contracts.
Revenue is recognized as the services are performed, and is generally based on hours or minutes of work performed; however, certain types of revenue relating to upfront project setup costs must be deferred and recognized over a period of time, typically the length of the customer contract. The incremental direct cost associated with this revenue is also deferred over the same period of time. Some of our client contracts have performance standards, which can result in service penalties and other adjustments to monthly billings if the standards are not met. Any required adjustments to our monthly billings are reflected in our revenue on an as-incurred basis.
We refer to our revenue as either Sales revenue or Services revenue. Our Sales revenue includes outbound telesales for new customer acquisition and cross-selling products and services to existing customers. Services revenue encompasses all our other revenue, which is classified into the categories of customer service and ancillary services. Customer service includes inbound order handling, customer care, help desk support, technical support and patient assistance whereas ancillary services include market research, database marketing, lead qualification, technology hosting, data processing, data entry, receivables management and other BPO activities.
Results for the three months ended March 31, 2007 reflect the following:
• | Increased revenue, which grew 2% compared to the comparable prior year period. |
• | Growth in our Services and Sales revenue was 2% and 1%, respectively, compared to the comparable prior year period. |
• | The modest growth in revenue is reflective of the fact that many of our clients are migrating their service to offshore contact centers, which have lower revenue rates per production hour. |
13
Table of Contents
• | Our revenue reflects the impact of approximately $1.1 million of service penalties and credits given to two customers, which did not occur in the comparable prior year period. |
• | Net income decreased by 85% as compared to the comparable prior year period, driven largely by an increase in labor costs of 15%, primarily due to certain first quarter calling volumes being higher than anticipated. We incurred additional staffing and training costs in order to meet these demands. These increased costs were not fully offset with increased revenue. |
We continued increasing our near-shore and offshore operations during the three months ended March 31, 2007 by:
• | Opening our first contact center in Quebec, Canada. |
• | Increasing the capacity of our contact centers in Costa Rica and the Philippines. |
• | Our Philippines operations handled approximately 27% of total production for the first quarter of 2007 as compared to 19% of total production for the first quarter of 2006. |
Our future profitability will be impacted by, among other things, our ability to expand our service offerings to existing customers as well as our ability to obtain new customers and grow new vertical markets. Our profitability is also impacted by our ability to manage costs, perform in accordance with contract requirements to avoid service penalties and mitigate the effects of foreign currency exchange risk. Our business is very labor-intensive and consequently, in an effort to reduce costs and be as competitive as possible in the marketplace, we have been moving some of our services to near-shore and offshore contact centers, which typically have lower labor costs. Our success is dependent upon our ability to perform work in locations where we can find qualified labor at cost-effective rates.
Some of these benefits, however, may be offset by the expanded training and associated costs we may incur because of our service mix. Many of our customer care services require more complex and costly training processes and to the extent we cannot bill these amounts to our clients, our profitability will be impacted. In addition to the more complex training, the employees who work on our customer care programs are generally paid a higher hourly rate because of the more complex level of services they are providing.
We believe that our success in 2007 will be largely dependent on our ability to continue capturing new business and leveraging the investment we have made in our infrastructure by expanding our business service offerings. We believe that major corporations will continue to leverage the skills of companies like ours and that the services outsourced will continue to expand beyond the contact center services that currently comprise the large majority of our business. We plan to leverage our existing strength in the financial services and insurance and healthcare markets and provide additional business services to our customers in these industries. To capitalize on these opportunities, we will continue to enhance the technologies we use.
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. These generally accepted accounting principles require our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenue and expenses during the reporting period. Actual results could differ from those estimates. Our significant accounting policies are described in the footnotes to our audited consolidated financial statements, which are included in our Annual Report on Form 10-K for the year ended December 31, 2006.
Our critical accounting policies are those that are most important to the portrayal of our financial condition and results and require our management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. If actual results were to differ significantly from estimates made, the reported results could be materially affected. The accounting policies we consider critical include revenue recognition; allowance for doubtful accounts; impairment of long-lived assets, goodwill and other intangible assets; accounting for income taxes; restructuring; accounting for contingencies; and share-based compensation.
14
Table of Contents
During the three months ended March 31, 2007, we did not make any material changes to our critical accounting policies, except for the adoption of FASB Interpretation No. 48, as discussed below. For additional discussion of our critical accounting policies, please refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the year ended December 31, 2006.
Accounting for Income Taxes
As part of the process of preparing our consolidated financial statements, Management is required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items, such as depreciation of property and equipment, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be realized through future taxable income. At December 31, 2006, we had deferred tax assets relating to net operating loss (NOL) carryforwards for state tax purposes, foreign NOL carryforwards and Federal tax credit carryforwards. The results of our evaluation as to whether we will be able to realize these deferred tax assets remains unchanged since December 31, 2006. Based on our current estimates for 2007, we anticipate that we will also create a deferred tax asset with respect to Federal NOL carryforwards. Based on our current assessment, we believe it is more likely than not that these deferred tax assets will be realized. Should our position change, we would be required to place a valuation allowance on these deferred tax assets, which could have a material impact on our results of operations. Generally, our ability to realize any of the above NOLs in the future will depend upon the Company’s ability to generate profits in the various tax jurisdictions to which they apply. The amount of the deferred tax assets considered realizable, however, could be reduced in the near-term if estimates of future taxable income are reduced. We will continue to evaluate and assess the realizability of all deferred tax assets and adjust valuation allowances, if required in the future.
Effective January 1, 2007, we adopted the provisions of Financial Accounting Standards Board’s Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. FIN 48 states that a tax benefit from an uncertain tax position may be recognized only if it is “more likely than not” that the position is sustainable, based on its technical merits. Under FIN 48, the liability for unrecognized tax benefits is classified as noncurrent unless the liability is expected to be settled in cash within 12 months of the reporting date. Unrecognized tax benefits involve management judgment regarding the likelihood of the benefit being sustained. The final resolution of uncertain tax positions could result in adjustments to recorded amounts and may affect the company’s results of operations, financial position and cash flows. Any adjustments related to our uncertain tax positions will impact our effective income tax rate. Additional information related to accounting for uncertainty in income taxes is discussed in Note 9 of the Notes to the Consolidated Financial Statements herein.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2007 and 2006:
Three months ended March 31, | |||||||||
(dollars in thousands) | 2007 | 2006 | % change | ||||||
Revenue: | $ | 115,177 | $ | 113,053 | 1.9 | % | |||
Services | 87,481 | 85,688 | 2.1 | % | |||||
Sales | 27,696 | 27,365 | 1.2 | % | |||||
Average Number of Workstations | 12,822 | 10,795 |
15
Table of Contents
During the three months ended March 31, 2007, we experienced modest growth in both our Services revenue and Sales revenue. Our Services revenue, which is made up primarily of inbound customer service programs, represented 76% of total revenue for the both the three months ended March 31, 2007 and 2006. Our overall revenue growth is impacted by the migration of our services to lower-cost offshore contact centers, particularly in the Philippines, which have lower revenue rates per production hour. Our Philippines operations handled 27% of our total production during the first quarter of 2007 as compared to 19% during the prior year first quarter. This is indicative of the trend in our industry as our clients strive to reduce their costs. Included in our 2006 first quarter, was approximately $9.0 million of revenue related to the initial enrollment period for Medicare Part D and $5.5 million of revenue from two large, low margin technology clients from whose programs we exited in 2006. Our revenue during the first quarter of 2007 was reduced by $1.1 million of service penalties and credits given to two clients.
Total annualized revenue per average workstation for the three months ended March 31, 2007 decreased by 14% to $35,931 from $41,890 for the three months ended March 31, 2006, reflecting the increased volume of work performed at lower cost facilities in Asia and Latin America. Additionally, while our total production hours increased 23% during the three months ended March 31, 2007 as compared to the prior year quarter, our revenue per production hour declined 17% over the same periods.
As we continue to perform work for our customers in near-shore and offshore locations, our revenue will be impacted by fluctuations in foreign currency exchange rates. For the three months ended March 31, 2007, changes in foreign exchange rates had a positive impact of $250,000 on total revenue as compared to the same period in the prior year. The impact was primarily due to changes in the Canadian dollar, the Euro, and the British pound sterling.
For the three months ended March 31, 2007 one customer accounted for 12% of our revenue. No other customers accounted for 10% or more of our revenue in the first quarter of 2007, nor did any customers account for 10% or more of our revenue for the three months ended March 31, 2006.
Three months ended March 31, | |||||||||||
(dollars in thousands) | 2007 | 2006 | % change | ||||||||
Cost of Services: | $ | 73,624 | $ | 69,927 | 5.3 | % | |||||
Labor costs | 55,597 | 48,170 | 15.4 | % | |||||||
Telecom costs | 5,724 | 5,486 | 4.3 | % | |||||||
Other direct costs | 12,303 | 16,271 | -24.4 | % | |||||||
Total Cost of Services as a Percentage of Revenue | 63.9 | % | 61.9 | % | |||||||
Production Hours (in thousands) | 5,295 | 4,312 |
Our cost of services consists primarily of direct labor costs associated with our customer service representatives (CSRs) and telecommunications costs. Other direct costs we incur for our client programs include information technology support, quality assurance costs, other billable labor costs and support services costs.
For the three months ended March 31, 2007, the increase in our cost of services over the first quarter of 2006 was driven primarily by direct labor cost increases. Our labor costs are impacted by production hour volume, foreign exchange rates and changes in hourly payroll rates. Our direct labor cost per production hour for the three months ended March 31, 2007 was $10.50, compared to $11.17 for the three months ended March 31, 2006. This decrease reflects an overall decrease in wage rates of approximately 7% due to the volume of services performed in lower wage contact centers in Asia and Latin America, partially offset by the impact of foreign currency exchange rates. The primary reason for the increase in direct labor cost was the increased volume of production hours. A portion of this client demand
16
Table of Contents
was not anticipated which required us to hire additional staff at high labor rates which contributed to the overall increase in direct labor costs. The increase in telecom costs for the three months ended March 31, 2007 was volume driven as our telephony cost per production hour actually decreased by 15% from the prior year period.
Other costs of services for the three months ended March 31, 2007 decreased primarily due to significantly lower amounts of subcontracting costs and other labor costs, which decreased by $4.0 million as compared to the prior year. During the prior year, much of our subcontracting costs and other labor costs were derived from the various Medicare Part D programs we were supporting. Also impacting these costs in the prior year was an estimate of the expected loss recorded on a client program that was exited in 2006.
For the three months ended March 31, 2007, changes in foreign exchange rates had the effect of increasing our cost of services by $577,000 as compared to the same period in the prior year. Foreign exchange rate fluctuations will continue to have an impact on our results.
Three months ended March 31, | |||||||||||
(dollars in thousands) | 2007 | 2006 | % change | ||||||||
Selling, General and Administrative Expenses: | $ | 41,178 | $ | 39,006 | 5.6 | % | |||||
Salaries, benefits and other personnel-related costs | 17,056 | 16,063 | 6.2 | % | |||||||
Facilities and equipment costs | 14,028 | 13,191 | 6.3 | % | |||||||
Depreciation and amortization | 6,274 | 5,766 | 8.8 | % | |||||||
Other SG&A costs | 3,820 | 3,986 | -4.2 | % | |||||||
Total SG&A as a Percentage of Revenue | 35.8 | % | 34.5 | % |
Selling, general and administrative (“SG&A”) expenses primarily are comprised of salaries and benefits, rental expenses relating to our facilities and some of our equipment, equipment maintenance and depreciation and amortization costs.
SG&A expenses for the three months ended March 31, 2007 increased as compared to the same period in the prior year primarily because of increased salaries and benefits along with facilities costs. Our salaries and benefits costs reflect $491,000 and $341,000 of share-based compensation costs for the three month periods ended March 31, 2007 and 2006, respectively. Salaries and benefits costs also increased due to headcount increases. Our facilities costs consist primarily of rental fees, which increased in both periods because of our expansion over the past year. Since March 31, 2006, we have opened four new contact centers and expanded other offshore centers. In addition, our operations in Argentina, which began in December 2006, incurred $600,000 of SG&A expenses during the three months ended March 31, 2007. Approximately 39% and 33% of our SG&A expenses for the three months ended March 31, 2007 and 2006, respectively, were incurred in foreign locations, which are subject to changes in foreign exchange rates. Foreign exchange rates had the effect of increasing SG&A expenses by $647,000 for the three months ended March 31, 2007, as compared to the same period in the prior year.
As a percentage of revenue, our SG&A expenses increased for three months ended March 31, 2007 as compared to the same period in the prior year, primarily as a result of our incurring costs associated with expanding our infrastructure in an effort to manage the future increases of offshore demand for our services.
17
Table of Contents
Three months ended March 31, | |||||||||||
(dollars in thousands) | 2007 | 2006 | % change | ||||||||
Interest Expense: | $ | (65 | ) | $ | (667 | ) | -90.3 | % | |||
Interest Income: | $ | 184 | $ | 43 | 327.9 | % |
The interest expense for the three months ended March 31, 2007 represents the period amortization of the deferred financing costs that we have recorded. In the prior year, interest expense also included interest on outstanding borrowings under the Credit Facility. The increase in interest income for the three months ended March 31, 2007 as compared to the prior year period is reflective of higher average cash investment balances.
Three months ended March 31, | |||||||||
(dollars in thousands) | 2007 | 2006 | % change | ||||||
Income Tax Provision: | $ | 84 | $ | 734 | -88.6 | % |
For the first quarter of 2007, our effective income tax rate was approximately 17% compared to approximately 21% in the first quarter of 2006. Our effective income tax rate represents our current estimate of income taxes for the fiscal year, as limited by our ability to recognize income tax benefits during quarterly periods in the tax jurisdictions for which we are expecting operating losses. Based on quarterly changes in our estimated income or loss in each tax jurisdiction, particularly in jurisdictions where we have tax holidays, our effective tax rate can fluctuate from period to period and experience more volatility than in recent years. Our effective income tax rate can also be impacted by our ability to realize the tax benefit of any deferred tax assets recorded.
Quarterly Results and Seasonality
We have experienced, and expect to continue to experience, quarterly variations in operating results, principally as a result of the timing of programs conducted by new and existing clients (particularly programs with substantial amounts of upfront project set-up costs), the timing of the migration of client programs to offshore locations, and SG&A expenses to support the growth and development of existing and new business units.
Our business tends to be strongest in the fourth quarter due to the high level of client sales and service activity for the holiday season, while the first quarter often reflects a slowdown relating to the cessation of that activity. Currently, 76% of our revenue is being generated from service programs, which generally have less seasonality than sales programs. Typically, we experience higher call volumes and improved financial results during the second half of our fiscal year as compared to the first half.
Liquidity and Capital Resources
At March 31, 2007, we had $30.5 million of cash and cash equivalents compared to $32.4 million at December 31, 2006. We generate cash through various means, primarily through cash from operations and, when required, through borrowings under our Credit Facility. The primary areas of our business in which we spend cash include capital expenditures, payments of principal and interest on amounts owed under our Credit Facility to the extent we have outstanding borrowings, costs of operations and business combinations.
Cash From Operations
Cash provided by operations for the three months ended March 31, 2007 was $2.6 million, compared to cash provided by operations of $9.6 million for the three months ended March 31, 2006.
18
Table of Contents
Cash provided by operations for the three months ended March 31, 2007 was generated by net income of $410,000 and non-cash adjustments of $6.6 million, primarily depreciation and amortization. Net working capital changes and changes in non-current assets and liabilities decreased cash flow from operations by $4.4 million, largely driven by the increase in our accounts receivable balance of $3.1 million. The increase in accounts receivable was largely due to a delay in payments from two customers. These payments were subsequently received in early April 2007.
Cash provided by operations for the three months ended March 31, 2006 was generated by net income of $2.8 million and non-cash adjustments of $6.0 million, primarily depreciation and amortization. Net working capital changes and changes in non-current assets and liabilities increased cash flow from operations by $832,000. This change was primarily due to significant collections of accounts receivable which had the effect of reducing our accounts receivable balance by $7.5 million. This was largely offset by a decrease in accrued expenses and other liabilities. Included in accrued expenses at December 31, 2005 was an amount of $6.6 million due to a customer, which is an association, comprised of many member companies. The $6.6 million represented amounts previously collected from the association that were re-billed to the member companies at the request of the association in order to reflect a revised billing arrangement. These amounts were collected by us prior to December 31, 2005 and were repaid to the customer in the first half of 2006.
Credit Facility
For the three months ended March 31, 2007, we had no net borrowings under the Credit Facility as compared to $1.0 million of net repayments for the three months ended March 31, 2006. Our net repayments during the first quarter of 2006 were funded with cash generated from operations.
Our Credit Facility is a $125.0 million secured revolving facility with a $5.0 million sub-limit for swing line loans and a $30.0 million sub-limit for multicurrency borrowings. The Credit Facility includes a $50.0 million accordion feature, which will allow us to increase our borrowing capacity to $175.0 million, subject to obtaining commitments for the incremental capacity from existing or new lenders. As of March 31, 2007, we were in compliance with all of the covenants contained in the Credit Facility.
Capital Expenditures
For the three months ended March 31, 2007, we spent $5.1 million on capital expenditures as compared to $5.9 million for the three months ended March 31, 2006. A portion of our capital expenditures is reflected in our workstation growth. There were 12,925 workstations in operation at March 31, 2007, compared to 12,719 workstations in operation at December 31, 2006 and 10,928 at March 31, 2006.
During the three months ended March 31, 2007, we added a net total of 206 workstations. This included 406 workstations added to various contact centers both domestically and abroad. These additions were partially offset by the elimination of 200 seats that were located in one of our domestic facilities. We spent approximately $4.0 million on workstation expansion during the first quarter of 2007. The remainder of our capital expenditures related primarily to upgrades of information technology and software purchases.
During the three months ended March 31, 2006, we added a net total of 266 workstations. This included 300 workstations added to our third contact center in the Philippines, which was opened in February 2006. These additions were partially offset by the elimination of 54 seats that were located in one of our domestic facilities whose lease expired in January. We did not renew the lease for this facility. We spent approximately $3.9 million on workstation expansion during the first quarter of 2006. The remainder of our capital expenditures related primarily to information technology.
Our operations will continue to require significant capital expenditures to support the growth of our business. Historically, equipment purchases have been financed through cash generated from operations, the Credit Facility, our ability to acquire equipment through operating leases, and through capital lease obligations with various equipment vendors and lending institutions. We believe that cash-on-hand, the cash flow generated from operations, the ability to acquire equipment through operating leases, and funds available under our Credit Facility will be sufficient to finance our current operations and planned capital expenditures for at least the next twelve months.
19
Table of Contents
Commitments and Obligations
As of March 31, 2007, we are also parties to various agreements that create contractual obligations and commercial commitments. These obligations and commitments will have an impact on future liquidity and the availability of capital resources. We expect to satisfy our contractual obligations through cash flows generated from operations. We would also consider accessing capital markets to meet our needs. In April 2006, we completed an equity offering of our common stock, however, we can give no assurances that this type of financing would be available in the future. There has not been any material change to our outstanding contractual obligations from our disclosure in our Annual Report on Form 10-K.
FORWARD-LOOKING STATEMENTS
This document contains certain forward-looking statements that are subject to risks and uncertainties. Forward-looking statements include statements relating to our belief that the allegations against us in the litigation involving the company and one of our brokers are without merit and our intention to vigorously defend ourselves against them, our expectations regarding recent accounting pronouncements, the appropriateness of our reserves for contingencies, the realizability of our deferred tax assets, our ability to finance our operations and capital requirements for the next twelve months, our ability to finance our long-term commitments, certain information relating to outsourcing trends as well as other trends in the outsourced business services industry and the overall domestic economy, our business strategy including the markets in which we operate, the services we provide, our ability to attract new clients and the customers we target, our ability to comply with the terms of our customer agreements without being impacted by penalty provisions set forth therein, the benefits of certain technologies we have acquired or plan to acquire and the investment we plan to make in technology, our plans regarding international expansion, the implementation of quality standards, the seasonality of our business, variations in operating results and liquidity, as well as information contained elsewhere in this document where statements are preceded by, followed by or include the words “will,” “should,” “believes,” “plans,” “intends,” “expects,” “anticipates” or similar expressions. For such statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. The forward-looking statements in this document are subject to risks and uncertainties that could cause the assumptions underlying such forward-looking statements and the actual results to differ materially from those expressed in or implied by the statements.
Some factors that could prevent us from achieving our goals—and cause the assumptions underlying the forward-looking statements and our actual results to differ materially from those expressed in or implied by those forward-looking statements—include, but are not limited to, the following: (i) the competitive nature of the outsourced business services industry and our ability to distinguish our services from other outsourced business services companies and other marketing activities on the basis of quality, effectiveness, reliability and value; (ii) economic, political or other conditions which could alter the desire of businesses to outsource certain sales and service functions and our ability to obtain additional contracts to manage outsourced sales and service functions; (iii) the cost to defend or settle litigation against us or judgments, orders, rulings and other developments in litigation against us; (iv) government regulation of the telemarketing industry, such as the Do-Not-Call legislation; (v) our ability to offer value-added services to businesses in our targeted industries and our ability to benefit from our industry specialization strategy; (vi) risks associated with investments and operations in foreign countries including, but not limited to, those related to relevant local economic conditions, exchange rate fluctuations, relevant local regulatory requirements, political factors, generally higher telecommunications costs, barriers to the repatriation of earnings and potentially adverse tax consequences; (vii) equity market conditions; (viii) technology risks, including our ability to select or develop new and enhanced technology on a timely basis, anticipate and respond to technological shifts and implement new technology to remain competitive, as well as costs to implement these new technologies; (ix) the results of our operations, which depend on numerous factors including, but not limited to, the timing of clients’ teleservices campaigns, the commencement and expiration of contracts, the ability to perform in accordance with the terms of the contracts, the timing and amount of new business generated by us, our revenue
20
Table of Contents
mix, the timing of additional selling, general and administrative expenses and the general competitive conditions in the outsourced business services industry and the overall economy; (x) terrorist attacks and their aftermath; (xi) the outbreak of war, and (xii) our capital and financing needs.
All forward-looking statements included in this report are based on information available to us as of the date of this report, and we assume no obligation to update these cautionary statements or any forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our operations are exposed to market risks primarily as a result of changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments for speculative or trading purposes. To meet disclosure requirements, we perform a sensitivity analysis to determine the effects that market risk exposures may have on our debt and other financial instruments. Information provided by the sensitivity analysis does not necessarily represent the actual changes in fair value that would be incurred under normal market conditions because, due to practical limitations, all variables other than the specific market risk factor are held constant.
Interest Rate Risk
Our exposure to market risk for changes in interest rates has historically related to our Credit Facility as well as investments in short-term, interest-bearing securities such as money market accounts. A change in market interest rates exposes us to the risk of earnings or cash flow loss but would not impact the fair value of the related underlying instrument. Borrowings under our Credit Facility are subject to variable LIBOR or prime base rate pricing. Interest earned on our cash balances is based on current market rates. Accordingly, a 1.0% change (100 basis points) in these rates would have resulted in net interest income and expense changing by approximately $64,000 and $103,000 for the three months ended March 31, 2007 and 2006, respectively. Interest expense for the three months ended March 31, 2007, consists primarily of amortization of debt issuance costs associated with our Credit Facility. We have not incurred any interest expense on actual borrowings since May 2006. Correspondingly, our interest income earned has increased significantly as we have higher levels of invested cash due to the equity offering. The interest rates in effect for the Credit Facility at any point in time approximate market rates; thus, the fair value of any outstanding borrowings approximates its reported value. In the past, Management has not entered into financial instruments such as interest rate swaps or interest rate lock agreements. However, we may consider using these instruments to manage the impact of changes in interest rates based on Management’s assessment of future interest rates, volatility of the yield curve and our ability to access the capital markets in a timely manner.
Foreign Currency Risk
We have operations in Canada, Ireland, the United Kingdom, Australia, Barbados, Mexico, the Philippines, India, Argentina and Costa Rica that are subject to foreign currency fluctuations. Our most significant foreign currency exposures occur when revenue is generated in one currency and corresponding expenses are generated in another currency. Currently, our most significant exposure has been with our Canadian and Philippine operations, where revenue is generated in U.S. dollars (USD) and the corresponding expenses are generated in either Canadian dollars (CAD) or Philippine pesos (PHP). We mitigate a portion of these exposures through foreign currency derivative contracts.
The impact of foreign currencies will continue to present economic challenges for us and could negatively impact overall earnings. A 5% change in the value of the USD relative to foreign currencies would have had an impact of approximately $1.0 million and $650,000 on our earnings for the three months ended March 31, 2007 and 2006, respectively.
21
Table of Contents
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure.
(b) Change in Internal Control over Financial Reporting
No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
From time to time, we are involved in litigation incidental to our business. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. For more information on the legal proceedings we are involved in, please refer to Note 6 in the footnotes to the consolidated financial statements contained in this Quarterly Report on Form 10-Q. The disclosure in Note 6 is incorporated by reference into this Item 1.
On January 4, 2007, we issued a press release announcing that management had revised our fourth quarter 2006 earnings guidance to reflect the impact of a confluence of one-time events that occurred late in the fourth quarter. These revisions were caused by call center productivity reductions resulting from the Colorado blizzards that occurred in December 2006, the December 2006 earthquake in Taiwan, which damaged telecommunications lines to the Philippines, along with costs associated with the Company’s November 2006 acquisition of Argentina-based Proyectar Connect S.A. The revised guidance disclosed fourth quarter revenue would approximate $116 million, inclusive of the effects of the acquisition, and that diluted earnings per share would be in the range of $0.30 to $0.34. Revised earnings guidance for the period was based on approximately 16 million shares outstanding and took into account the full year benefit of the late December signing of the Work Opportunity Tax Credit (“WOTC”), which was retroactive to January 1, 2006 and was expected to reduce the company’s income taxes by $600,000 to $700,000.
31.1 | Chief Executive Officer’s Rule 13a-14(a)/15d-14(a) Certification * | |
31.2 | Chief Financial Officer’s Rule 13a-14(a)/15d-14(a) Certification * | |
32.1 | Chief Executive Officer’s Section 1350 Certification * | |
32.2 | Chief Financial Officer’s Section 1350 Certification * |
+ | Compensation plans and arrangements for executives and others. |
* | Filed herewith |
22
Table of Contents
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.
ICT GROUP, INC. | ||||||
Date: May 9, 2007 | By: | /S/ JOHN J. BRENNAN | ||||
John J. Brennan Chairman, President and Chief Executive Officer | ||||||
Date: May 9, 2007 | By: | /S/ VINCENT A. PACCAPANICCIA | ||||
Vincent A. Paccapaniccia Executive Vice President, Corporate Finance, Chief Financial Officer and Assistant Secretary |
23