<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
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 1-4379
CONVERGYS CORPORATION
Incorporated under the laws of the State of Ohio
201 East Fourth Street, Cincinnati, Ohio 45202
I.R.S. Employer Identification Number 31-1598292
Telephone - Area Code (513) 397-5364
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 . No X .
--- ---
At August 31, 1998, 152,456,600 Common Shares were outstanding.
<PAGE>
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME,
COMPREHENSIVE INCOME AND RETAINED EARNINGS
(Millions of Dollars, Except Per Share Amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
--------------------- ----------------------
1998 1997 1998 1997
-------- -------- --------- ---------
<S> <C> <C> <C> <C>
Revenues................................................... $ 363.6 $ 243.1 $ 672.2 $ 486.5
-------- -------- --------- ---------
Costs and Expenses
Cost of providing services and products sold........... 213.6 131.1 386.8 265.5
Selling, general and administrative.................... 54.8 38.5 105.7 77.4
Research and development costs......................... 19.5 19.4 81.2 37.7
Depreciation and amortization.......................... 26.3 14.5 44.7 28.4
Year 2000 programming costs............................ 7.8 1.5 13.5 2.1
-------- -------- --------- ---------
Total costs and expenses.......................... 322.0 205.0 631.9 411.1
-------- -------- --------- ---------
Operating Income........................................... 41.6 38.1 40.3 75.4
Other Income (Expense), net................................ 7.5 5.4 11.5 9.6
Interest Expense........................................... 11.2 .8 17.6 2.1
-------- -------- --------- ---------
Income Before Income Taxes................................. 37.9 42.7 34.2 82.9
Income Taxes............................................... 14.3 14.5 12.9 27.9
-------- -------- --------- ---------
Net Income................................................. $ 23.6 $ 28.2 $ 21.3 $ 55.0
-------- -------- --------- ---------
-------- -------- --------- ---------
Other comprehensive income, net of tax:
Foreign currency translation adjustments................. $ (1.6) $ - $ (1.8) $ (1.4)
-------- -------- --------- ---------
Total other comprehensive income...................... (1.6) - (1.8) (1.4)
-------- -------- --------- ---------
Comprehensive Income....................................... $ 22.0 $ 28.2 $ 19.5 $ 53.6
-------- -------- --------- ---------
-------- -------- --------- ---------
Earnings Per Common Share..................................
Basic.................................................. $ .17 $ .21 $ .16 $ .40
-------- -------- --------- ---------
-------- -------- --------- ---------
Diluted................................................ $ .17 $ .21 $ .16 $ .40
-------- -------- --------- ---------
-------- -------- --------- ---------
Average Common Shares Outstanding Including Equivalents (000)
Basic.................................................. 137.0 137.0 137.0 137.0
Diluted................................................ 137.0 137.0 137.0 137.0
</TABLE>
See Notes to Financial Statements.
2
<PAGE>
CONDENSED CONSOLIDATED BALANCE SHEETS
(Millions of Dollars)
<TABLE>
<CAPTION>
(Unaudited)
June 30, December 31,
1998 1997
----------- ------------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents........................................ $ 1.5 $ 2.1
Receivables, less allowances of $8.2 and $6.4.................... 331.9 222.8
Deferred income taxes............................................ 6.3 13.7
Prepaid expenses and other current assets........................ 30.2 27.2
---------- ---------
Total current assets........................................... 369.9 265.8
Property and equipment - net........................................ 215.3 130.0
Goodwill and other intangibles - net................................ 708.8 177.6
Investments in unconsolidated entities.............................. 83.6 72.7
Deferred charges and other assets................................... 31.7 8.3
---------- ---------
Total Assets................................................... $ 1,409.3 $ 654.4
---------- ---------
---------- ---------
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities
Debt maturing in one year........................................ $ 3.4 $ 6.1
Intercompany debt payable to CBI................................. 751.4 53.0
Payables and other current liabilities........................... 194.5 157.5
---------- ---------
Total current liabilities...................................... 949.3 216.6
Long-term debt...................................................... .9 1.2
Other long-term liabilities......................................... 8.1 5.8
---------- ---------
Total liabilities.............................................. 958.3 223.6
---------- ---------
Shareowners' Equity
Shareowners' net investment...................................... 450.4 428.4
Accumulated other comprehensive income........................... .6 2.4
---------- ---------
Total shareowners' equity...................................... 451.0 430.8
---------- ---------
Total Liabilities and Shareowners' Equity........................... $ 1,409.3 $ 654.4
---------- ---------
---------- ---------
</TABLE>
See Notes to Financial Statements.
3
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF SHAREOWNER'S EQUITY
(Millions of Dollars)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------------
1998 1997
---------- ---------
<S> <C> <C>
Shareowners' Equity at January 1..................................... $ 430.8 $ 364.2
Net income........................................................ 21.3 55.0
Transfers from CBI, net........................................... .7 9.7
Other comprehensive income, net of tax............................ (1.8) (1.4)
---------- ---------
Shareowners' Equity at June 30....................................... $ 451.0 $ 427.5
---------- ---------
---------- ---------
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Millions of Dollars)
(Unaudited)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
--------------------
1998 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
- ------------------------------------
Net income.......................................................................... $ 21.3 $ 55.0
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization..................................................... 44.7 28.4
Acquired research and development costs........................................... 42.6 -
Provision for loss on receivables................................................. 4.1 .3
Undistributed earnings of unconsolidated entities................................. (11.0) (5.2)
Changes in assets and liabilities net of effects from acquisitions and disposals:
Increase in receivables........................................................... (62.1) (2.8)
Decrease (increase) in other current assets....................................... 5.7 (.3)
Decrease in accounts payable and accrued liabilities.............................. (14.1) (12.2)
Decrease in other current liabilities............................................. (.4) (9.3)
Increase (decrease) in deferred income taxes...................................... 1.7 (.9)
Increase in other assets and liabilities, net..................................... (29.6) (4.6)
------- -------
Net cash provided by operating activities......................................... 2.9 48.4
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
- ------------------------------------
Capital expenditures - other........................................................ (41.2) (26.8)
Acquisitions, net of cash acquired.................................................. (658.3) -
------- -------
Net cash used in investing activities............................................. (699.5) (26.8)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Repayment of long-term debt......................................................... (3.1) (2.9)
Change in intercompany debt payable to CBI.......................................... 698.4 (25.0)
Transfers from CBI, net............................................................. .7 9.7
------- -------
Net cash provided (used) in financing activities.................................. 696.0 (18.2)
------- -------
Net increase (decrease) in cash and cash equivalents................................ (.6) 3.4
Cash and cash equivalents at beginning of period.................................... 2.1 2.3
------- -------
Cash and cash equivalents at end of period.......................................... $ 1.5 $ 5.7
------- -------
------- -------
Supplemental cash flow information:
Cash paid for interest............................................................ $ 17.6 $ 2.1
------- -------
------- -------
Cash paid for income taxes........................................................ $ 11.1 $ 19.5
------- -------
------- -------
</TABLE>
See Notes to Financial Statements.
5
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(1) BACKGROUND AND BASIS OF PRESENTATION
The Company was organized on May 8, 1998, as a wholly owned
subsidiary of Cincinnati Bell Inc. ("CBI"). In the second quarter of
1998, CBI announced its intention to contribute to the Company the
outstanding common shares of Cincinnati Bell Information Systems Inc.
("CBIS") and MATRIXX Marketing Inc. ("MATRIXX"). During the second
quarter of 1998, CBI contributed to CBIS its interest in Cincinnati
Bell Cellular Systems Inc. ("CBCS") which owns a 45% limited
partnership interest in a cellular communications services provider in
southwestern and central Ohio and Northern Kentucky. In July 1998, CBI
contributed the outstanding common shares of CBIS and MATRIXX to the
Company. CBI also announced its intention to offer to the public up to
20% of the common shares of the Company and distribute to its
shareowners in late 1998 or early 1999, subject to certain conditions,
its remaining interest in the Company (the "Offering" and the
"Distribution", respectively).
The consolidated financial statements reflect the results of
operations, financial position, changes in shareowner's equity and cash
flows of the businesses that were contributed in July 1998 to the
Company by CBI as if the Company were a separate entity for all periods
presented. The consolidated financial statements have been prepared
using the historical basis in the assets and liabilities and historical
results of operations related to the Company businesses. Changes in
shareowner's equity represent the net income of the Company, currency
translation adjustments related to the Company's international
operations and net cash transfers to or from CBI. Additionally, the
financial statements include the allocation of certain expenses
relating to the Company from CBI. Management believes these allocations
are reasonable. All material intercompany transactions and balances
between the Company and its subsidiaries have been eliminated.
The liabilities of the Company include outstanding direct
third-party indebtedness and the amounts of debt and related interest
expense determined based upon the capital structure that is anticipated
at the date of the Distribution. Interest expense shown in the
consolidated financial statements reflects the interest expense
associated with the allocated borrowings for each period presented
using the average short-term interest rate of CBI, and the interest
rate associated with any direct outstanding indebtedness of the Company
and its subsidiaries.
General corporate overhead related to CBI's corporate headquarters
and common support divisions has been allocated to the Company based on
the ratio of the Company's revenues, assets and payroll to CBI's
revenues, assets and payroll. Management believes these allocations are
reasonable. However, the costs of these services charged to the Company
are not necessarily indicative of the costs that would have been
incurred if the Company had performed these functions as a stand-alone
entity. Subsequent to the Distribution, the Company will perform these
functions using its own resources or purchased services and will be
responsible for the costs and expenses associated with the management
of a public corporation. Additionally, income taxes are presented as if
calculated on a separate tax return basis.
The Company's financial statements include the costs incurred by the
CBI pension and postretirement benefit plans for employees and retirees
for whom the Company will assume responsibility.
The financial information included herein may not necessarily
reflect the consolidated results of operations, financial position,
changes in shareowner's equity and cash flows of the Company in the
future or what they would have been had it been a separate, stand-alone
entity during the periods presented.
The consolidated financial statements of the Company have been
prepared pursuant to the rules and regulations of the SEC and, in the
opinion of management, include all adjustments necessary for a fair
presentation of the results of operations, financial position and cash
flows for each period shown. All adjustments are of a normal and
recurring nature except for those outlined in Note 4. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to SEC rules and
regulations. The December 31, 1997 condensed balance sheet was derived
from audited financial statements, but does not include all disclosures
required by generally accepted accounting
6
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
principles. It is suggested that these financial statements be read in
conjunction with financial statements and notes thereto included in
the Company's Form S-1 dated August 12, 1998.
(2) EARNINGS PER SHARE
In connection with its organization on May 8, 1998, the Company
issued 100 common shares to CBI. Effective August 4, 1998, the Company
approved a share split which increased the number of outstanding common
shares to 137,000,000. Basic and diluted earnings per share have been
calculated using the 137,000,000 common shares that were outstanding
after the share split. The dilutive effect of Company stock options
that may be issued in the future to holders of CBI stock options has
not been considered in the calculation of earnings per share, as
Company options were not outstanding in the historical periods
presented.
(3) MATRIXX BUSINESS RESTRUCTURING
In the fourth quarter of 1997, the Company approved a restructuring
plan for MATRIXX. The restructuring plan will result in the
consolidation of certain operating divisions and facilities. A charge
of $35.0 million was recorded which reduced net income by $23.0
million. During the first six months of 1998, MATRIXX recorded cash
expenditures of $3.1 million primarily for severance pay and recorded
non-cash asset writedowns of $5.6 million. The restructuring reserve
had a balance of $17.3 million at June 30, 1998. At December 31, 1997,
the restructuring reserve balance was $24.9 million. Management expects
the restructuring plan activities to be completed by December 31, 1998
and that the remaining balance in the reserve is adequate to complete
the plan.
(4) ACQUISITIONS
Effective February 28, 1998, MATRIXX acquired American Transtech,
Inc. and the assets of AT&T's Canadian customer care business
("Transtech") from AT&T for approximately $625 million in cash. The
acquisition was accounted for under the purchase method of accounting
and was financed through short-term, variable rate debt issued by CBI,
which was allocated to the Company by CBI.
In the first quarter of 1998, the Company recorded a charge of $42.6
million to expense in-process research and development costs associated
with the acquisition. The amount expensed relates to two ongoing
development projects at Transtech that had not reached technological
feasibility at the time of the acquisition and had no alternative
future use.
The Company allocated $68.2 million of the purchase price to an
eight-year contract under which the Company will provide customer
management solutions services to AT&T, $11.4 million to the assembled
workforce which will be amortized over a fifteen-year useful life, $4.4
million to capitalized software to be amortized over a four-year useful
life and $91.0 million to the fair value of the acquired tangible net
assets. The fair values of the acquired assets were determined by an
independent valuation. The assembled workforce asset will be amortized
on a straight-line basis and the capitalized software will be amortized
in accordance with the Company's methodology for internally-developed
software. The excess of the purchase price and acquisition costs over
the fair value of the assets acquired, approximately $415 million, was
recorded as goodwill, which will be amortized on a straight-line basis
over a thirty-year life.
The Company is currently evaluating certain acquired contingent
liabilities and its integration plan for Transtech and will incur
integration liabilities, including severance pay and lease
termination costs. Such liabilities will result in additional
goodwill which will be amortized over a thirty-year life. In the
second quarter of 1998, the Company recorded approximately $8
million in severance costs related to the integration plan for
Transtech, primarily for management employees. Of this amount,
approximately $3 million has been paid in the second quarter of
1998, with the remainder expected to be paid in the third quarter of
1998. The integration plan has not been finalized, but is awaiting
determination of the facilities portion of the plan which could
result in additional severance and lease termination costs. Any
subsequent adjustments of estimated integration costs will be
reflected as adjustments to goodwill.
7
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
The following unaudited pro forma data summarizes the combined
results of operations of the Company and Transtech as though the
acquisition had occurred as of the beginning of each period:
<TABLE>
<CAPTION>
Six Months
Ended June 30,
-----------------------
Millions of Dollars 1998 1997
------------------- --------- ---------
<S> <C> <C>
Revenues................................. $ 734.6 $ 687.4
Net income............................... $ 15.9 $ 50.1
Earnings per share:
Basic................................. $ .12 $ .37
Diluted............................... $ .12 $ .37
</TABLE>
The pro forma results for 1998 include the expensing of $42.6
million ($26.4 million after tax) of acquired research and development
costs associated with Transtech.
On January 8, 1998, MATRIXX acquired the teleservices assets of
Maritz, Inc. for approximately $30 million in cash. The acquisition
agreement contains provisions that could increase the purchase price by
up to $20 million. The acquisition was accounted for under the purchase
method of accounting with resulting goodwill to be amortized over a
twenty-five year life. The acquisition of Maritz did not have a
material effect on the Company's results of operations during the first
six months of 1998.
(5) TRANSACTIONS WITH CBI
During the six months ended June 30, 1998 and 1997, the Company
recognized $27.5 million, and $22.9 million, respectively, in revenues
resulting from billing and information systems services and customer
management solutions provided to CBI and its subsidiaries. The related
receivables amounted to $5.3 million at both June 30, 1998 and December
31, 1997.
CBI has allocated general corporate overhead expenses to the Company
totaling $5.3 million and $3.8 million for the six months ended June
30, 1998 and 1997, respectively. Additionally, the Company incurred
expenses for communications and other services provided by CBI and its
subsidiaries of $5.4 million and $6.2 million for the six months ended
June 30, 1998 and 1997, respectively. Amounts payable to CBI and its
subsidiaries for these services were $1.6 million both at June 30, 1998
and December 31, 1997.
(6) SIGNIFICANT CUSTOMER
Both of the Company's subsidiaries derive significant revenues from
AT&T and its affiliates (AT&T) by providing billing and information
systems services and customer management solutions. Revenues from AT&T
were 27.9% and 32.5% of the Company's consolidated revenues for the six
month periods ended June 30, 1998 and 1997, respectively. Related
accounts receivable from AT&T totaled $87.4 million and $54.1 million
at June 30, 1998 and December 31, 1997, respectively.
(7) CONTINGENCIES
The Company is from time to time subject to routine complaints
incidental to the business. The Company believes that the results of
any complaints and proceedings will not have a material adverse effect
on the Company's financial condition.
(8) NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the AICPA issued Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use." SOP 98-1 requires the capitalization of
8
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
certain expenditures for software that is purchased or internally
developed for use in the business. Company management believes that
the prospective implementation of SOP 98-1 in 1999 is likely to
result in some capitalization of software expenditures in the future.
However, the amount of such capitalized software expenditures cannot be
determined at this time.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-up Activities." The SOP provides guidance on financial reporting
of costs of start-up activities. SOP 98-5 requires such costs to be
expensed instead of being capitalized and amortized. SOP 98-5 is
effective for fiscal years beginning after December 15, 1998. The
Company believes the implementation of SOP 98-5 will not have a
material impact on its financial reporting.
In June 1998, Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivative Instruments and Hedging Activities,"
was issued. SFAS No. 133 establishes accounting and reporting standards
for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. It requires
that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. The Company may employ a small number of
financial instruments to manage its exposure to fluctuations in
interest rates and foreign currency exchange rates. The Company does
not hold or issue such financial instruments for trading purposes. The
Company will adopt SFAS No. 133, as required in the year 2000, and does
not expect the impact of adoption to be material.
Effective January 1, 1998, the Company implemented SOP 97-2,
"Software Revenue Recognition." SOP 97-2 revises standards for the
recognition of software revenue in connection with certain software
development and licensing arrangements. SOP 97-2 did not have a
material effect on the Company's results of operations for the six
months ended June 30, 1998; however, its effect on future operating
results will be dependent on the nature and terms of the Company's
individual software agreements.
(9) BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION
SEGMENT INFORMATION
The Company operates in two industry segments. CBIS, the Information
Management segment, is principally engaged in providing information
systems and billing services to the communications and broadband
services industries. MATRIXX, the Customer Management segment, provides
a full range of customer management solutions to large companies. The
Company's business segment information is as follows:
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
----------------------- -----------------------
Millions of Dollars 1998 1997 1998 1997
------------------- -------- -------- --------- --------
<S> <C> <C> <C> <C>
Revenues
Information management.......... $ 146.1 $ 134.0 $ 290.0 $ 264.5
Customer management............. 222.1 111.2 389.0 226.4
Intersegment.................... (4.6) (2.1) (6.8) (4.4)
-------- -------- --------- --------
$ 363.6 $ 243.1 $ 672.2 $ 486.5
-------- -------- --------- --------
-------- -------- --------- --------
Intersegment Revenues
Information management.......... $ 4.6 $ 2.1 $ 6.7 $ 4.2
Customer management............. - - .1 .2
-------- -------- --------- --------
$ 4.6 $ 2.1 $ 6.8 $ 4.4
-------- -------- --------- --------
-------- -------- --------- --------
Special Items (1)
Customer management............. $ - $ - $ 42.6 $ -
-------- -------- --------- --------
-------- -------- --------- --------
Operating Income
Information management.......... $ 27.6 $ 25.5 $ 54.6 $ 48.2
Customer management............. 14.0 12.6 (14.3) 27.2
-------- -------- --------- --------
$ 41.6 $ 38.1 $ 40.3 $ 75.4
-------- -------- --------- --------
-------- -------- --------- --------
</TABLE>
9
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
---------------------- -----------------------
Millions of Dollars 1998 1997 1998 1997
------------------- -------- -------- --------- --------
<S> <C> <C> <C> <C>
Assets
Information management.................... $ 295.1 $ 267.8
Customer management....................... 1,009.1 295.1
Other..................................... 105.1 68.2
--------- --------
$ 1,409.3 $ 631.1
--------- --------
--------- --------
Capital Additions (including acquisitions)
Information management.................... $ 16.0 $ 6.8 $ 21.6 $ 9.9
Customer management....................... 17.8 11.6 681.7 17.0
-------- -------- --------- --------
$ 33.8 $ 18.4 $ 703.3 $ 26.9
-------- -------- --------- --------
-------- -------- --------- --------
Depreciation and Amortization
Information management.................... $ 7.4 $ 7.9 $ 14.1 $ 15.7
Customer management....................... 18.9 6.6 30.6 12.7
-------- -------- --------- --------
$ 26.3 $ 14.5 $ 44.7 $ 28.4
-------- -------- --------- --------
-------- -------- --------- --------
</TABLE>
(1) The special item for acquired research and development costs is
included in research and development costs in the Condensed
Consolidated Statements of Income.
Certain corporate administrative expenses have been allocated to
segments based upon the nature of the expense. Assets are those
assets used in the operations of the segment.
GEOGRAPHIC INFORMATION
The following table presents certain information regarding the
Company's domestic and international operations:
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
----------------------- -----------------------
Millions of Dollars 1998 1997 1998 1997
------------------- -------- -------- --------- --------
<S> <C> <C> <C> <C>
Revenues
United States............................. $ 329.7 $ 216.7 $ 615.5 $ 434.9
International............................. 33.9 26.4 56.7 51.6
-------- -------- --------- --------
$ 363.6 $ 243.1 $ 672.2 $ 486.5
-------- -------- --------- --------
-------- -------- --------- --------
Operating Income
United States............................. $ 39.9 $ 36.4 $ 38.3 $ 72.5
International............................. 1.7 1.8 2.0 2.9
-------- -------- --------- --------
$ 41.6 $ 38.2 $ 40.3 $ 75.4
-------- -------- --------- --------
-------- -------- --------- --------
Assets
United States............................. $ 1,298.1 $ 547.1
International............................. 111.2 84.0
--------- --------
$ 1,409.3 $ 631.1
--------- --------
--------- --------
</TABLE>
10
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(10) SUBSEQUENT EVENTS
In August 1998, the Company issued 14,950,000 common shares in an
initial public offering (the Offering) for $15 less underwriting
discounts and commission of approximately $.98 per common share. After
completion of the Offering, CBI owned approximately 90.2% of the
Company's outstanding common shares. The net proceeds of the Offering,
totaling over $209 million, were used to repay a portion of the
Company's intercompany debt payable to CBI.
11
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BACKGROUND
At June 30, 1998, the Company was a wholly owned subsidiary of Cincinnati
Bell Inc. (CBI). Prior to April 27, 1998, CBI conducted the Company's businesses
through its two subsidiaries, CBIS and MATRIXX. In the second quarter of 1998,
CBI announced the creation of the Company to serve as a holding company for CBIS
and MATRIXX and its intention to contribute to the Company the outstanding
shares of CBIS and MATRIXX.
The consolidated financial statements of the Company, which are discussed
below, reflect the results of operations, financial position and cash flows of
the businesses contributed to the Company by CBI and have been carved-out from
the financial statements of CBI using the historical results of operations and
the historical basis of the assets and liabilities of the businesses. Management
believes that the assumptions made in preparing the consolidated financial
statements of the Company on a carve-out basis are reasonable. The contribution
of the outstanding common shares of CBIS, MATRIXX and CBCS to the Company
occurred in July 1998.
The financial information included herein, however, may not necessarily
reflect the results of operations, financial position and cash flows of the
Company in the future or what the result of operations, financial position or
cash flows would have been had the Company been a separate stand-alone entity
during the periods presented. The financial information included herein does not
reflect the changes that will occur in the funding of the Company as a result of
the initial public offering of the Company's common shares and the distribution
of the common shares held by CBI to the CBI shareholders. In this regard, the
Company is likely to incur somewhat higher interest expense once it obtains
external financing. In addition, certain employees of the Company have
participated in CBI's defined benefit pension plans and its medical benefit
plans, including plans that provide medical benefits for retirees. When the
Distribution occurs, the Company will establish its own employee and retiree
benefit plans, will assume responsibility for certain benefits for employees
that have retired from CBIS and MATRIXX and will receive assets from CBI's
plans. However, the Company and CBI have not finalized the calculation of the
allocation of the assets of the CBI benefit plans between CBI and the Company.
In addition, when the Company establishes its benefit plans, it may provide
different benefits and may have different administrative expenses than those of
the CBI plans. Accordingly, the labor costs included herein should not be viewed
as necessarily indicative of the labor costs to be incurred by the Company
subsequent to the Distribution. With the exception of those items discussed
above, management does not expect any significant changes in the daily
operations of the Company's businesses in the near term. Management will
evaluate opportunities to change the operations of the businesses as warranted
to improve efficiency and client focus. These changes could include the
combination of certain business activities currently performed by CBIS and
MATRIXX and could lead to a charge to earnings later in 1998.
The following discussion and the related consolidated financial statements
and accompanying notes contain certain forward-looking statements that involve
potential risks and uncertainties. The Company's future results could differ
materially from results discussed in such forward-looking statements.
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the condensed
consolidated financial statements and segment data. Results for interim periods
may not be indicative of the results for the full years.
CONSOLIDATED OVERVIEW
THREE MONTHS ENDED JUNE 30, 1998 VERSUS THREE MONTHS ENDED JUNE 30, 1997
The Company's revenues for the second quarter of 1998 totaled $363.6
million, an increase of $120.5 million (50%) from $243.1 million in the second
quarter of 1997. The acquisitions of Transtech and Maritz contributed
approximately $106 million to the quarterly revenue increase, with the remaining
increase attributable to growth in existing operations.
The Company's operating expenses for the second quarter of 1998 totaled
$322.0 million, an increase of $117.1 million (57%) from $204.9 million in the
second quarter of 1997. The acquisitions of Transtech and Maritz contributed
approximately $102 million to this increase. Expenses associated with the
Company's Year 2000 programming efforts also contributed to the operating
expense increase, growing to $7.8 million in the second quarter of 1998 from
$1.5 million in the second quarter of 1997. The remaining operating expense
12
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
increases were largely the result of increased business volume in the Company's
operating segments.
The Company's operating income for the second quarter of 1998 was $41.6, an
increase of $3.4 (9%) from $38.2 million in the second quarter of 1997.
Excluding the $6.3 million increase in Year 2000 programming costs, the
Company's operating income for the second quarter of 1998 increased $9.7 million
(25%).
Other income (expense), net increased to $7.5 million in the second quarter
of 1998 from $5.3 million in the second quarter of 1997, reflecting an increase
in earnings from the cellular partnership to $6.8 million from $3.6 million in
the second quarter of 1997. The increase in other income (expense) net resulting
from the cellular partnership earnings was partially offset by interest income
recognized in the second quarter of 1997 resulting from the settlement of
federal tax audits of CBI's consolidated tax returns for 1989 through 1994.
Interest expense increased to $11.2 million in the second quarter of 1998 from
$.8 million in the second quarter of 1997, largely as a result of incremental
borrowings to finance the acquisitions of Transtech and Maritz in the first
quarter of 1998. The effective income tax rate for the second quarter of 1998
increased to 37.7% from 34.0% in the second quarter of 1997 as a result of the
1997 settlement of federal tax audits of CBI's consolidated returns for 1989
through 1994. Net income for the second quarter of 1998 was $23.6 million or
$.17 per share as compared to $28.2 million or $.21 per share. The $6.3 million
increase in Year 2000 programming costs decreased net income by $3.9 million or
$.03 per share.
SIX MONTHS ENDED JUNE 30, 1998 VERSUS SIX MONTHS ENDED JUNE 30, 1997
The Company's revenues for the first six months of 1998 were $672.2 million,
an increase of $185.7 (38%) from $486.5 million in the first six months of 1997.
The acquisitions of Transtech and Maritz contributed approximately $150 million
to the revenue increase in the first half of 1998.
The Company's operating expenses for the first six months of 1998 excluding
a first quarter 1998 special item totaled $589.3 million, an increase of $178.2
million (43%) from $411.1 million for the first six months of 1997. The
acquisitions of Transtech and Maritz contributed approximately $146 million to
this increase. Year 2000 programming costs increased to $13.5 million in the
first six months of 1998 from $2.1 million in the first six months of 1997.
Operating income excluding a first quarter 1998 special item was $82.9
million in the first half of 1998, an increase of $7.5 million (10%) from $75.4
million in the first half of 1997. The Company recorded a special item of $42.6
million ($26.4 million after tax) in the first quarter of 1998 to expense
in-process research and development costs associated with the acquisition of
Transtech. The $7.5 million increase in operating income excluding the special
item was achieved despite the $11.4 million increase in Year 2000 costs.
Including the special item, the Company's operating income for the first half of
1998 was $40.3 million.
Other income (expense), net for the first half of 1998 increased to $11.5
million from $9.6 million in the first half of 1997 as increased cellular
partnership earnings more than offset the recognition of interest income
associated with federal tax audit settlements. Interest expense increased to
$17.6 million for the first half of 1998 from $2.1 million for the first half of
1997, reflecting interest associated with debt incurred for first quarter 1998
acquisitions. The Company's effective tax rate was 37.7% for the first half of
1998 as compared to 33.7% in the first half of 1997, reflecting the federal tax
audit settlements which occurred in 1997. Excluding the first quarter 1998
special items, net income for the first half of 1998 was $47.7 million or $.35
per share as compared to $55.0 million or $.40 per share for the first half of
1997. Including the special item, net income for the first half of 1998 was
$21.3 million or $.16 per share. The $11.4 million increase in Year 2000 costs
decreased net income by $7.1 million or $.5 per share.
The Company's results for both the second quarter and first half of 1998
were adversely impacted by lower than anticipated revenues from AT&T under the
contract associated with the acquisition of Transtech. In connection with the
acquisition of Transtech, the Company entered into an eight-year contract to
provide customer management services to AT&T. During the first three years of
the contract, AT&T has committed to outsource $300 million in customer
management services to MATRIXX in each year. Subject to certain exceptions, if
there is a shortfall to the revenue commitment, AT&T must pay 40% of the
shortfall to the Company. Revenues from AT&T under that contract totaled
approximately $57 million for the second quarter of 1998, which is below the
level necessary to achieve the $300 million annual amount required by the
contract. AT&T has provided assurances that it plans to meet its requirements
under the contract and
13
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Company management is actively monitoring and evaluating progress towards the
requirement. The Company's results for the second quarter and first half of
1998 do not reflect a material accrual of revenue for the current shortfall
to the revenue commitment.
INFORMATION MANAGEMENT
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------------- --------------------------------
($ Millions) 1998 1997 Change % 1998 1997 Change %
------- ------- -------------- ------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Data processing................... $ 93.8 $ 82.1 $ 11.7 14 $ 184.7 $ 157.3 $ 27.4 17
Professional and consulting....... 36.6 31.5 5.1 16 70.8 66.2 4.6 7
License and other................. 6.2 6.5 (.3) (5) 13.1 13.4 (.3) (2)
International..................... 9.5 13.9 (4.4) (32) 21.4 27.6 (6.2) (22)
------- ------- ------- ------- ------- -------
146.1 134.0 12.1 9 290.0 264.5 25.5 10
Costs of products and services 74.6 64.9 9.7 15 145.9 130.8 15.2 12
Selling, general and administrative
expenses............................ 16.6 16.1 .5 3 34.2 32.5 1.7 6
Research and development costs........ 15.0 18.1 (3.1) (17) 31.5 35.2 (3.7) (11)
Depreciation and amortization......... 7.4 7.9 (.5) (6) 14.1 15.7 (1.6) (10)
Year 2000 programming costs........... 5.0 1.5 3.5 - 9.7 2.1 7.6 -
------- ------- ------- ------- ------- -------
Operating income...................... $ 27.5 $ 25.5 $ 2.0 8 $ 54.6 $ 48.2 $ 6.4 13
</TABLE>
THREE MONTHS ENDED JUNE 30, 1998 VERSUS THREE MONTHS ENDED JUNE 30, 1997
Revenues for the Company's information management segment, CBIS, were
$146.1 million for the second quarter of 1998, an increase of $12.1 million (9%)
from $134.0 million in the second quarter of 1997. Billing and related
information processing revenues increased to $93.8 million in the second quarter
of 1998 from $82.1 million in the second quarter of 1997, primarily as a result
of growth in wireless billing services. CBIS wireless billing clients'
subscriber levels increased 26% in the quarter from levels in the second quarter
of 1997. The increase in CBIS billing and related information processing
revenues was partially offset by a decline in the number of subscribers for whom
CBIS bills the long distance portion of wireless calls. This decline has
resulted from a CBIS clients' loss of wireless long distance market share to
competitors. CBIS' professional and consulting service revenues increased to
$36.6 million in the second quarter of 1998 from $31.5 million in the second
quarter of 1997. This increase was primarily attributable to growth in such
services for cellular and personal communication services (PCS) clients. CBIS'
license and other revenues were $6.2 million in the second quarter of 1998 as
compared to $6.5 million in the second quarter of 1997. CBIS' international
revenues decreased $2.5 million in the second quarter of 1998 from the second
quarter of 1997, reflecting the winding down of a network provisioning system
development contract for an international client.
CBIS' costs and expenses were $118.6 million in the second quarter of 1998,
an increase of $10.1 million (9%) over $108.5 million in the second quarter of
1997. The increase was principally the result of increased direct costs
associated with higher revenues, including additional labor costs, data center
upgrade costs and higher bill finishing costs. Labor cost increases included the
effect of higher wage rates, particularly for software professionals. The
remainder of CBIS' cost increases were attributable to the increase in Year 2000
programming costs to $5.0 million in the second quarter of 1998 from $1.5
million in the second quarter of 1997.
SIX MONTHS ENDED JUNE 30, 1998 VERSUS SIX MONTHS ENDED JUNE 30, 1997
CBIS' revenues for the first half of 1998 were $290.0 million, an increase
of $25.5 million (10%) from $264.5 million in the first half of 1998. Billing
and related information services revenues increased to $184.7 million in the
first half of 1998 from $157.3 million in the first half of 1997. This increase
was driven by clients' wireless subscriber growth of 26%, partially offset by a
reduction in the number of clients' subscribers for whom CBIS bills the long
distance portion of cellular calls. Professional and consulting revenues for the
first half of 1998 increased to $70.8 million from $66.2 million in the first
half of 1997, reflecting an increase in
14
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
services for wireless clients. CBIS' license and other revenues were $13.1
million in the first half of 1998 and $13.4 million in the first half of
1997. International revenues decreased $5.5 million in the first six months
of 1998 from the first six months of 1997, reflecting the winding down of one
international contract.
CBIS' costs and expenses for the first half of 1998 were $235.4 million, an
increase of $19.1 million (9%) from $216.3 million in the first half of 1997.
Excluding the increase of Year 2000 programming costs to $9.7 million in the
first half of 1998 from $2.1 million in the first half of 1997, costs and
expenses grew at a rate of 5% over the first six months of 1997, approximately
half the rate of growth for revenues. Higher direct costs of providing services
including additional headcount, data center upgrades, client-specified
development efforts, increased bill finishing costs and higher wage rates,
particularly for software professionals, accounted for the majority of the
increase.
CUSTOMER MANAGEMENT
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------------- ---------------------------------
($ Millions) 1998 1997 Change % 1998 1997 Change %
------- ------- -------------- ------- ------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues.............................. $ 222.1 $ 111.2 $ 110.9 100 $ 389.0 $ 226.4 $ 162.6 72
Costs of products and services........ 143.7 68.4 75.3 110 247.7 139.1 108.6 78
Selling, general and administrative
expenses............................ 38.2 22.3 15.9 71 71.5 44.9 26.6 59
Research and development costs........ 4.5 1.3 3.2 - 7.1 2.5 4.6 -
Depreciation and amortization......... 18.9 6.6 12.3 186 30.6 12.7 17.9 141
Year 2000 programming costs........... 2.8 - 2.8 - 3.8 - 3.8 -
Special items:
Acquired research and
development costs............... - - - - 42.6 - 42.6 -
------- ------- ------- ------- ------- -------
Operating income (loss)............... $ 14.0 $ 12.6 $ 1.4 11 $ (14.3) $ 27.2 $ (41.5) -
</TABLE>
THREE MONTHS ENDED JUNE 30, 1998 VERSUS THREE MONTHS ENDED JUNE 30, 1997
Revenues for the Company's customer management segment, MATRIXX, were
$222.1 million in the second quarter of 1998, an increase of $110.9 million
(100%) from $111.2 million in the second quarter of 1997. The acquisitions of
Transtech and Maritz, which occurred in the first quarter of 1998, contributed
$106.2 million to this increase. Excluding acquisitions, MATRIXX's revenues grew
by $4.7 million over the second quarter of 1997. The revenue increase was
principally in dedicated services revenues which grew by $4.4 million reflecting
continued strong sales to clients in the technology and communications
industries. Almost all of the revenues contributed by Transtech and Maritz are
from dedicated services, bringing the total increase in dedicated services to
over $110 million. Traditional teleservices revenues continued to recover in the
second quarter of 1998 from the significant decline experienced in the third
quarter of 1997. Despite the recovery, traditional teleservices revenues
declined by approximately 1% in the second quarter of 1998 when compared to the
second quarter of 1997. Excluding acquisitions, MATRIXX's international revenues
increased $.5 million in the second quarter of 1998 over levels in the second
quarter of 1997.
MATRIXX's costs and expenses were $208.1 million in the second quarter of
1998, an increase of $109.5 million (110%) from $98.6 million in the second
quarter of 1997. The acquisitions of Transtech and Maritz contributed
approximately $102.2 million to this increase. Included in the increase
resulting from the two acquisitions was nearly $6 million in goodwill
amortization relating to the two acquired businesses. The remaining increase of
$7.3 million included $2.8 million in higher Year 2000 programming costs and
other cost increases primarily resulting from the increased dedicated services
business volume.
SIX MONTHS ENDED JUNE 30, 1998 VERSUS SIX MONTHS ENDED JUNE 30, 1997
MATRIXX's revenues for the first half of 1998 were $389.0 million, an
increase of $162.6 million (72%) from $226.4 million in the first half of 1997.
The acquisitions of Transtech and Maritz contributed $150.0
15
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
million to the increase. The remaining increase of $12.6 million was
attributable to increased dedicated services revenues. Traditional
teleservices revenues declined 2% in the first half of 1998 from the first
half of 1997, reflecting the third quarter 1997 downturn that continues to
affect the traditional teleservices volumes. Excluding acquisitions,
MATRIXX's international revenues increased $1.2 million in the first half of
1998 over levels in the first half of 1997.
MATRIXX's costs and expenses for the first six months of 1998, excluding a
first quarter special item, were $360.7 million, an increase of $161.5 million
(81%) from $199.2 million in the first six months of 1997. The acquisitions of
Transtech and Maritz contributed $146.1 million to this increase, including
approximately $8 million in additional goodwill amortization. The remaining
increase of $15.4 million reflects additional direct costs of providing
dedicated services, including higher personnel costs, equipment depreciation
expenses and facility lease expenses. Higher wage rates also contributed to the
expense increase. Year 2000 programming costs totaled $3.8 million during the
first half of 1998.
In connection with the Transtech acquisition, MATRIXX expensed a special
item of $42.6 million of acquired in-process research and development costs in
the first quarter of 1998. The amount expensed was determined through an
independent valuation that the Company used to allocate the Transtech purchase
price to the acquired assets. The $42.6 million relates to two ongoing
development projects at Transtech that had not reached technological feasibility
at the time of the acquisition and had no alternative future use. The Company
intends to continue both of these development projects. One of these projects
was the development of proprietary technology for Transtech's employee care
business offering. The other project involved the development of technology to
provide billing detail to clients' customers that would allow those customers to
manipulate and analyze the billing information. The Company expects the employee
care proprietary technology project to be completed later in 1998 and that the
cost to complete the project will be less than $2 million. Management believes
this project will be successfully completed. The billing technology project has
been delayed based upon management's view of very recent changes in the demand
for the technology in the Company's market. Management's estimate of the cost to
complete this project is approximately $5 million.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
The Company's businesses have historically required cash for expansion,
business development, acquisitions and working capital. These cash requirements
have been funded from the Company's operating cash flows as well as funds
provided by CBI. Operating cash flows have generally been sufficient to fund the
Company's cash needs, other than for acquisitions. The acquisitions of Transtech
and Maritz in the first quarter of 1998 required approximately $660 million in
cash and approximately $50 million in working capital, which has been financed
through short-term debt issued by CBI and allocated to the Company. The proceeds
from the Offering were used to repay a portion of this CBI-allocated
indebtedness in August 1998.
Until the Distribution is completed, the Company's principal source of
external funds will be its intercompany financing arrangement with CBI, which is
expected to be funded by CBI through commercial paper borrowings. The Company
will pay interest on its intercompany borrowings at an interest rate equal to
CBI's average short-term borrowing cost. Prior to the Distribution, the Company
intends to obtain its own external financing. Currently, the Company has not
explored external financing options with potential lenders. Although the Company
believes it will have little difficulty in obtaining external financing on
acceptable terms, no assurance can be given in this regard. The weighted average
interest rate at which the Company borrows may be higher when it obtains
financing independently.
Cash provided by operating activities was $2.9 million for the first six
months of 1998 compared to $48.4 million for the same six months of 1997. The
Transtech and Maritz acquisitions in the first quarter of 1998 required a
significant use of cash to finance post-acquisition working capital needs, as
accounts receivable for both acquired entities increased, as expected, from the
levels at the acquisition date. Excluding the approximately $55 million in cash
used to finance post acquisition working capital needs, cash provided by
operating activities for the first six months of 1998 would have been
approximately $58 million. Capital expenditures were the other major use of cash
during the first half of 1998. Capital expenditures for the first six months of
1998 were $41 million, up $14 million from the first six months of last year.
The Company's capital expenditures are estimated to be approximately $100
million in 1998. Capital spending in 1998 for the
16
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Transtech and Maritz acquisitions involved approximately $660 million in
capital spending, bringing the estimated total capital expenditures for the
Company to over $750 million in 1998. This estimated amount does not include
any additional acquisitions that may occur in 1998, although none have been
identified to date.
BALANCE SHEET
The $109.1 million increase in accounts receivable from December 31, 1997
to June 30, 1998 was largely attributable to receivables associated with the
acquired operations of Transtech and Maritz. The decrease in deferred income
taxes was principally the result of the payment of 1997 bonuses during the first
quarter of 1998. Increases in property, plant and equipment, goodwill and other
intangibles, debt allocated by CBI and payables and other current liabilities,
were primarily caused by the acquisitions of Transtech and Maritz. The increase
in deferred charges (benefits) and other current assets was the result of the
$16.2 million deferred tax benefit associated with the expensing of $42.6
million in research and development costs associated with Transtech.
YEAR 2000 PROGRAMMING
The Company has initiated a Company-wide program to identify and address
issues associated with the ability of its date-sensitive information and
business system and equipment to properly recognize the Year 2000. The purpose
of this effort is to avoid interruption of the operation of these systems as a
result of the century change on January 1, 2000. Given the reliance of the
Company on its information and business systems, this is a significant effort
for the Company. The Company incurred $13.5 million in expenses during the first
half of 1998 in order to prepare its software and systems for the Year 2000. The
estimate for total Year 2000 programming costs in 1998 is in a range of $25
million to $30 million, with costs thereafter, principally during 1999,
estimated in the range of $10 million to $15 million. These expenses will
materially reduce earnings and cash flows from operations accordingly.
In the past, the Company has developed various contingency plans for
conducting its business in the event of such occurrences as system outages or
natural disasters. As part of its Year 2000 efforts, the Company is reviewing
its contingency plans to assure that they adequately address Year 2000 issues
that might arise. If the Company were to be unsuccessful in readying its
software and systems for the Year 2000 or preparing adequate contingency plans
to avoid business interruption that could result from the century change, this
would have a material adverse impact on the Company. The failure of one of the
Company's significant clients or suppliers to modify its systems for the Year
2000 successfully or to provide the appropriate contingency planning also could
have an adverse impact on the Company.
MARKET RISK
The Company is exposed to the impact of interest rate changes and, to a
lesser extent, foreign currency fluctuations. Interest rate and foreign currency
risks have historically been managed on a centralized basis by CBI. It has been
CBI's policy to enter into interest rate and foreign currency transactions only
to the extent considered necessary to meet its objectives. CBI has not entered
into interest rate or foreign currency transactions for speculative purposes.
The acquisition of Transtech in the first quarter of 1998 has significantly
increased the Company's exposure to interest rate risk. The Company's foreign
currency exposures were immaterial at June 30, 1998.
The Company's exposure to interest rate risk results from its variable rate
short-term intercompany debt payable to CBI. At June 30, 1998, the Company had
$751.4 million in intercompany debt payable to CBI bearing interest at a
variable rate, which is equal to CBI's average short-term borrowing rate. Prior
to the Distribution, the Company intends to obtain its own external financing.
The weighted average interest rate at which the Company borrows may be higher
when it obtains financing independently. Based upon the Company's level of
indebtedness at June 30, 1998, a one percentage point increase in the weighted
average interest rate would increase the Company's annual interest expense by
approximately $7.5 million.
FLUCTUATIONS IN QUARTERLY RESULTS
The Company has experienced and in the future could experience quarterly
variations in revenues as a result of a variety of factors, many of which are
outside of the control of the Company. These factors include: the timing of new
contracts, the timing of increased expenses incurred in support of new business
and the somewhat seasonal pattern of the businesses served by the Company.
17
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS OUTLOOK
INFORMATION MANAGEMENT
CBIS continues to rely on a few large clients for most of its revenue.
CBIS' top three clients accounted for 60% of its revenues for the first six
months of 1998. CBIS maintains multi-year contracts with its clients, but some
contracts have early termination clauses. CBIS may renegotiate one or more major
contracts in 1998 which could involve exchanging lower prices for longer
contract terms and broader relationships. Any reduction in prices would
negatively impact future results. Additionally, one CBIS client representing
approximately 11% of CBIS' 1997 revenues announced its intention to be acquired
by one of CBIS' competitors during the first quarter of 1998. The related
contract extends through 2006 and does not provide for early termination without
a CBIS breach. It was announced in the second quarter of 1998 that another CBIS
client representing approximately 7% of CBIS' 1997 revenues intends to be
acquired by another company. CBIS and the client have signed a binding letter of
intent with this client which is intended to expand into a contract that is
expected to run through 2004.
A significant amount of CBIS' growth is directly related to increased
wireless subscribers in the domestic marketplace. While that trend has continued
in the first six months of 1998, if the domestic wireless industry growth rate
declines in the future, CBIS' ability to grow revenues and earnings could be
adversely affected. Additionally, certain international network-management
systems development efforts have been reduced as long-term contracts have
reached completion.
CUSTOMER MANAGEMENT
The teleservices business is very competitive and MATRIXX has experienced
some softness in the market beginning during the second half of 1997 and
continuing to a lesser extent through the first half of 1998. The softness has
affected the traditional teleservices business, which as a result of the
acquisitions of Maritz and Transtech and internal growth of MATRIXX's outsourced
dedicated business, is becoming a smaller portion of MATRIXX's business. While
the traditional business recovery that began in the fourth quarter of 1997 has
continued through the first half of 1998, revenues remain below levels
experienced prior to the aforementioned market softness. In response to this
softness, MATRIXX initiated a restructuring plan and recorded a charge of $35
million in the fourth quarter of 1997. MATRIXX continues to move aggressively to
complete its restructuring program, including reducing its workforce and closing
certain facilities. Implementation of the restructuring plan is expected to be
substantially complete by the end of 1998. When fully implemented, the plan is
expected to reduce costs by over $10 million from the levels that would have
been experienced had the planned restructuring activities not occurred. The
Company also is moving forward with the integration of Transtech which has
resulted in workforce reductions, and is currently evaluating its facilities
integration plan for Transtech.
MATRIXX's top three clients accounted for 47% of its revenues for the first
half of 1998 up from 39% for the same period in 1997. Loss of any significant
contracts would have an adverse effect on its revenues and profits. MATRIXX must
continue to win new contracts and grow its business with existing clients in a
competitive market that has current excess capacity in its call centers. The
acquisition of Transtech has increased the portion of MATRIXX's revenues from
its top three clients, but the related eight-year teleservices agreement with
AT&T helps reduce the risk of loss for that portion of the business. However,
significant quarterly fluctuations may still occur.
BUSINESS DEVELOPMENT
The Company continues to review opportunities for acquisitions and
divestitures for its businesses to enhance shareowner value.
18
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
The following is filed as an Exhibit to Part I of this Form 10-Q:
<TABLE>
<CAPTION>
Exhibit
Number
-------
<S> <C>
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the quarter for which
this report is filed.
19
<PAGE>
SIGNATURE
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.
Convergys Corporation
Date: September 25, 1998 /s/ Steven G. Rolls
------------------------------- ----------------------------------
Steven G. Rolls
Chief Financial Officer
20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 1,500
<SECURITIES> 0
<RECEIVABLES> 340,100
<ALLOWANCES> 8,200
<INVENTORY> 0
<CURRENT-ASSETS> 369,900
<PP&E> 524,700
<DEPRECIATION> 309,400
<TOTAL-ASSETS> 1,409,300
<CURRENT-LIABILITIES> 949,300
<BONDS> 900
0
0
<COMMON> 137,000
<OTHER-SE> 314,000
<TOTAL-LIABILITY-AND-EQUITY> 1,409,300
<SALES> 0
<TOTAL-REVENUES> 672,200
<CGS> 0
<TOTAL-COSTS> 631,900
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4,100
<INTEREST-EXPENSE> 17,600
<INCOME-PRETAX> 34,200
<INCOME-TAX> 12,900
<INCOME-CONTINUING> 21,300
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 21,300
<EPS-PRIMARY> .16
<EPS-DILUTED> .16
</TABLE>
