<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 SEPTEMBER 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 October 31, 1998, 152,502,500 Common Shares were outstanding.
<PAGE>
Form 10-Q Part I Convergys Corporation
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Millions of Dollars, Except Per Share Amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------- -----------------------
1998 1997 1998 1997
------ ------ -------- ------
<S> <C> <C> <C> <C>
Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . $370.3 $238.5 $1,042.5 $725.0
------ ------ -------- ------
Costs and Expenses
Cost of providing services and products sold. . . . . . . . . 210.8 127.4 597.5 392.9
Selling, general and administrative . . . . . . . . . . . . . 54.5 39.7 160.3 117.1
Research and development costs. . . . . . . . . . . . . . . . 24.2 17.7 105.4 55.5
Depreciation and amortization . . . . . . . . . . . . . . . . 27.8 15.9 72.5 44.3
Year 2000 programming costs . . . . . . . . . . . . . . . . . 7.2 3.3 20.7 5.4
------ ------ -------- ------
Total costs and expenses. . . . . . . . . . . . . . . . . . . 324.5 204.0 956.4 615.2
------ ------ -------- ------
Operating Income . . . . . . . . . . . . . . . . . . . . . . . . 45.8 34.5 86.1 109.8
Other Income (Expense), net. . . . . . . . . . . . . . . . . . . 4.4 6.9 15.9 16.6
Interest Expense . . . . . . . . . . . . . . . . . . . . . . . . 9.1 1.6 26.7 3.7
------ ------ -------- ------
Income Before Income Taxes . . . . . . . . . . . . . . . . . . . 41.1 39.8 75.3 122.7
Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 15.5 13.5 28.4 41.3
------ ------ -------- ------
Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25.6 $ 26.3 $ 46.9 $ 81.4
------ ------ -------- ------
------ ------ -------- ------
Other Comprehensive Income, Net of Tax:
Foreign currency translation adjustments . . . . . . . . . . . $ (1.0) $ (.1) $ (2.8) $ (1.5)
Unrealized loss on investments . . . . . . . . . . . . . . . . (2.1) - (2.1) -
------ ------ -------- ------
Total other comprehensive income . . . . . . . . . . . . . . (3.1) (.1) (4.9) (1.5)
------ ------ -------- ------
Comprehensive Income . . . . . . . . . . . . . . . . . . . . . . $ 22.5 $ 26.2 $ 42.0 $ 79.9
------ ------ -------- ------
------ ------ -------- ------
Earnings Per Common Share
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ .18 $ .19 $ .34 $ .59
------ ------ -------- ------
------ ------ -------- ------
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . $ .18 $ .19 $ .34 $ .59
------ ------ -------- ------
------ ------ -------- ------
Average Common Shares Outstanding Including Equivalents (000)
Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144.8 137.0 139.6 137.0
Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . 145.1 137.0 139.7 137.0
</TABLE>
See Notes to Financial Statements.
2
<PAGE>
CONDENSED CONSOLIDATED BALANCE SHEETS
(Millions of Dollars)
<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
1998 1997
-------- ------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents . . . . . . . . . . . . . . . . . . $ 1.4 $ 2.1
Receivables, less allowances of $9.3 and $6.4 . . . . . . . . 307.9 222.8
Deferred income taxes . . . . . . . . . . . . . . . . . . . . 7.0 13.7
Prepaid expenses and other current assets . . . . . . . . . . 29.3 27.2
-------- ------
Total current assets. . . . . . . . . . . . . . . . . . . 345.6 265.8
Property and equipment - net . . . . . . . . . . . . . . . . . . 229.4 130.0
Goodwill and other intangibles - net . . . . . . . . . . . . . . 681.1 177.6
Investments in unconsolidated entities . . . . . . . . . . . . . 85.3 72.7
Deferred charges and other assets. . . . . . . . . . . . . . . . 30.8 8.3
-------- ------
Total Assets. . . . . . . . . . . . . . . . . . . . . . . $1,372.2 $654.4
-------- ------
-------- ------
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities
Debt maturing in one year . . . . . . . . . . . . . . . . . . $ 0.9 $ 6.1
Intercompany debt payable to CBI. . . . . . . . . . . . . . . 477.6 53.0
Payables and other current liabilities. . . . . . . . . . . . 201.3 157.5
-------- ------
Total current liabilities . . . . . . . . . . . . . . . . 679.8 216.6
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . 0.3 1.2
Other long-term liabilities. . . . . . . . . . . . . . . . . . . 12.7 5.8
-------- ------
Total liabilities . . . . . . . . . . . . . . . . . . . . 692.8 223.6
-------- ------
Shareowners' Equity
Common shares - without par value, 500,000,000 authorized;
151,950,000 issued and outstanding. . . . . . . . . . . . 205.9 -
Additional paid-in capital. . . . . . . . . . . . . . . . . . 457.1 -
Retained earnings . . . . . . . . . . . . . . . . . . . . . . 18.9 -
Shareowner's net investment . . . . . . . . . . . . . . . . . - 428.4
Accumulated other comprehensive income. . . . . . . . . . . . ( 2.5) 2.4
-------- ------
Total shareowners' equity . . . . . . . . . . . . . . . . 679.4 430.8
-------- ------
Total Liabilities and Shareowners' Equity. . . . . . . . . . . . $1,372.2 $654.4
-------- ------
-------- ------
</TABLE>
See Notes to Financial Statements.
3
<PAGE>
<TABLE>
<CAPTION>
CONDENSED CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
(Millions of Dollars)
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------- -----------------------
1998 1997 1998 1997
------ ------ -------- ------
<S> <C> <C> <C> <C>
Common Shares
Balance, beginning of period. . . . . . . . . . . . . . . . . - $ - - $ -
Issuance of 100 shares. . . . . . . . . . . . . . . . . . . . - - - -
Share split . . . . . . . . . . . . . . . . . . . . . . . . . - - - -
Issuance of 14,950,000 shares . . . . . . . . . . . . . . . . $205.9 - $205.9 -
------ ------ ------ ------
Balance, end of period. . . . . . . . . . . . . . . . . . $205.9 $ - $205.9 $ -
------ ------ ------ ------
Additional Paid-In Capital
Balance, beginning of period. . . . . . . . . . . . . . . . . - $ - - $ -
Transfer from shareowner's net investment . . . . . . . . . . $457.1 - $457.1 -
------ ------ ------ ------
Balance, end of period. . . . . . . . . . . . . . . . . . $457.1 $ - $457.1 $ -
------ ------ ------ ------
Retained Earnings
Balance, beginning of period. . . . . . . . . . . . . . . . . - $ - - $ -
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . $ 18.9 - $ 18.9 -
------ ------ ------ ------
Balance, end of period. . . . . . . . . . . . . . . . . . $ 18.9 $ - $ 18.9 $ -
------ ------ ------ ------
Shareowner's Net Investment. . . . . . . . . . . . . . . . . . .
Balance, beginning of period. . . . . . . . . . . . . . . . . $450.4 $424.9 $428.4 $360.2
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . 6.7 26.2 28.0 81.4
Transfers from CBI, net . . . . . . . . . . . . . . . . . . . - (6.4) 0.7 3.1
Transfers to additional paid-in capital . . . . . . . . . . . (457.1) - (457.1) -
------ ------ ------ ------
Balance, end of period. . . . . . . . . . . . . . . . . . $ - $444.7 $ - $444.7
------ ------ ------ ------
Accumulated Other Comprehensive Income
Balance, beginning of period. . . . . . . . . . . . . . . . . $ 0.6 $ 2.6 $ 2.4 $ 4.0
Foreign currency translation adjustments. . . . . . . . . . . (1.0) (0.1) (2.8) (1.5)
Investment valuation allowance. . . . . . . . . . . . . . . . (2.1) - (2.1) -
------ ------ ------ ------
Total other comprehensive income, net of tax. . . . . . . $ (2.5) $ 2.5 $ (2.5) $ 2.5
------ ------ ------ ------
Total Shareowners' Equity. . . . . . . . . . . . . . . . . . . . $679.4 $447.2 $679.4 $447.2
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
<TABLE>
<CAPTION>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Millions of Dollars)
(Unaudited)
Nine Months
Ended September 30,
----------------------
1998 1997
------- ------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 46.9 $ 81.4
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72.5 44.3
Acquired research and development costs . . . . . . . . . . . . . . . . . . . . . . . . . 42.6 -
Provision for loss on receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 .4
Undistributed earnings of unconsolidated entities . . . . . . . . . . . . . . . . . . . . (15.4) (5.3)
Changes in assets and liabilities net of effects from acquisitions and disposals:
Increase in receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (36.4) (11.9)
Decrease (increase) in other current assets . . . . . . . . . . . . . . . . . . . . . . . 5.9 (3.0)
Decrease in accounts payable and accrued liabilities. . . . . . . . . . . . . . . . . . . (26.6) (37.3)
Increase (decrease) in other current liabilities. . . . . . . . . . . . . . . . . . . . . 18.9 7.4
Increase (decrease) in deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . 1.7 (1.0)
Increase in other assets and liabilities, net . . . . . . . . . . . . . . . . . . . . . . (14.7) (4.6)
------- ------
Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . . 97.8 70.4
------- ------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (65.0) (40.4)
Acquisitions, net of cash acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (658.3) -
------- ------
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . (723.3) (40.4)
------- ------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayment of long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6.1) (8.2)
Change in intercompany debt payable to CBI . . . . . . . . . . . . . . . . . . . . . . . . . 424.6 (25.0)
Issuance of common shares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206.3 -
Transfers from CBI, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 3.1
------- ------
Net cash provided (used) in financing activities. . . . . . . . . . . . . . . . . . . . . 624.8 (30.1)
------- ------
Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . (.7) .1
Cash and cash equivalents at beginning of period . . . . . . . . . . . . . . . . . . . . . . 2.1 2.3
------- ------
Cash and cash equivalents at end of period . . . . . . . . . . . . . . . . . . . . . . . . . $ 1.4 $ 2.2
------- ------
------- ------
Supplemental cash flow information:
Cash paid for interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 26.7 $ 3.7
------- ------
------- ------
Cash paid for income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 29.4 $ 43.6
------- ------
------- ------
</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. Upon transfer of the common
shares of CBIS and MATRIXX to the Company, the two subsidiaries became
divisions of the Company doing business as the Information Management Group
(IMG) and Customer Management Group (CMG), respectively. In August 1998,
the Company sold approximately 10% of its outstanding shares to the public
in an initial public offering (the "Offering"). CBI has announced its
intention to distribute to its shareowners by December 31, 1998, subject to
certain conditions, its remaining interest in the Company (the
"Distribution").
On August 12, 1998, the Company issued 14,950,000 common shares to the
public in the Offering at a price of $15 per share less underwriting
discounts and commissions of approximately $.98 per share. After deducting
other expenses of the Offering, the net proceeds from the Offering,
approximately $206 million, were used to repay a portion of the Company's
intercompany debt payable to CBI. The Company began accumulating retained
earnings on July 20, 1998, the date of the contribution of the outstanding
common shares of CBIS and MATRIXX to the Company by CBI. At that same
date, the amount of shareowner's net investment was transferred into
additional paid-in capital.
The consolidated financial statements reflect the results of
operations, financial position, changes in shareowners' 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. 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 terms of the Plan of Reorganization and
Distribution Agreement between the Company and CBI (the "Agreement").
Interest expense shown in the consolidated financial statements reflects
the interest expense associated with the CBI borrowings allocated to the
Company under the Agreement 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, which are
likely to be somewhat higher than the costs included herein. 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. Immediately after the
Distribution, the Company will establish a defined benefit pension plan for
its eligible employees and actuarial calculations will be made to determine
the amount of assets to be transferred from the CBI Pension Trust to the
newly-formed Company plan. As the determination of the assets to be
transferred to and liabilities to be assumed by the Company plan will
6
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
be based on actuarial assumptions made as of the date of the Distribution,
no estimate of the assets to be transferred to or liabilities to be assumed
by the Company plan have been reflected in the accompanying financial
statements. The amounts of any such transfers of assets or liabilities
will be reflected on a net basis as an addition to or reduction of
additional paid in capital.
The financial information included herein may not necessarily reflect
the consolidated results of operations, financial position, changes in
shareowners' 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 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
Basic and diluted earnings per share have been calculated by dividing
net income by the weighted average common shares and, if applicable, common
share equivalents, that were outstanding in the respective periods.
Included in the weighted average is the retroactive recognition of a share
split, effective August 4, 1998, which increased the number of then
outstanding common shares to 137,000,000. 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.
(3) CMG BUSINESS RESTRUCTURING
In the fourth quarter of 1997, the Company approved a restructuring
plan for CMG. 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. At December 31, 1997,
the restructuring reserve balance was $24.9 million. During the first nine
months of 1998, CMG recorded cash expenditures of $4.1 million, primarily
for severance pay, and non-cash asset writedowns of $4.6 million. The
restructuring reserve had a balance of $16.2 million at September 30, 1998.
Management expects the restructuring plan activities to be substantially
complete by December 31, 1998 and that the remaining balance in the reserve
is adequate to complete the plan.
(4) ACQUISITIONS
Effective February 28, 1998, CMG 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 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 three-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 excess of the purchase price and acquisition
costs over the fair value of the assets
7
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
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 the recording of additional
goodwill. Through September 30, 1998, the Company has accrued and paid
nearly $6 million in severance, primarily for management employees, related
to the integration plan for Transtech. 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 and
acquired contingent liabilities will be reflected as adjustments to
goodwill.
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>
Nine Months
Ended September 30,
-------------------
Millions of Dollars 1998 1997
------------------- -------- --------
<S> <C> <C>
Revenues. . . . . . . . . . . . . . . . . . . . . $1,104.9 $1,025.0
Net income. . . . . . . . . . . . . . . . . . . . $ 41.5 $ 70.8
Earnings per share:
Basic. . . . . . . . . . . . . . . . . . . . . $ .30 $ .52
Diluted. . . . . . . . . . . . . . . . . . . . $ .30 $ .52
</TABLE>
The pro forma results for 1998 include the recording of $42.6 million
($26.4 million after tax) of acquired research and development costs
associated with Transtech.
On January 8, 1998, CMG 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 nine months of 1998.
(5) TRANSACTIONS WITH CBI
During the three and nine month periods ended September 30, 1998, the
Company recognized $12.0 million and $39.5 million, respectively, in
revenues resulting from billing and information systems services and
customer management solutions provided to CBI and its subsidiaries.
Revenues from CBI and its subsidiaries were $12.3 and $35.1 for the three
and nine month periods ended September 30, 1997. The related receivables
amounted to $5.5 million and $5.3 million at September 30, 1998 and
December 31, 1997, respectively.
CBI has allocated general corporate overhead expenses to the Company
totaling $2.7 million and $8.0 million for the three and nine month periods
ended September 30, 1998, respectively. These expenses totaled $1.9
million and $5.7 million, respectively, for the three and nine month
periods ended September 30, 1997, respectively. Additionally, the Company
incurred expenses for communications and other services provided by CBI and
its subsidiaries of $4.0 million and $11.9 million for the nine months
ended September 30, 1998 and 1997, respectively. Amounts payable to CBI
and its subsidiaries for these services were $1.9 million and $1.6 million
at September 30, 1998 and December 31, 1997, respectively.
8
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(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 40.6%
and 37.5% of the Company's consolidated revenues for the three and nine
month periods ended September 30, 1998, respectively. Revenues from AT&T
for the three and nine month periods ended September 30, 1997 were 29.9%
and 31.6%, respectively of the Company's consolidated revenues. Related
accounts receivable from AT&T totaled $90.3 million and $54.1 million at
September 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 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.
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. The Information
Management Group, is principally engaged in providing information systems and
billing services to the communications and broadband services industries. The
Customer Management Group, provides a full range of customer management
solutions to large companies. The Company's business segment information is as
follows:
9
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------- -----------------------
Millions of Dollars 1998 1997 1998 1997
- ------------------- ------ ------ -------- ------
<S> <C> <C> <C> <C>
Revenues
Information management. . . . . . . . . . . . . . . . . . . . $147.9 $137.2 $ 437.9 $401.7
Customer management . . . . . . . . . . . . . . . . . . . . . 231.4 103.0 620.4 329.4
Intersegment. . . . . . . . . . . . . . . . . . . . . . . . . (9.0) (1.7) (15.8) (6.1)
------ ------ -------- ------
$370.3 $238.5 $1,042.5 $725.0
------ ------ -------- ------
------ ------ -------- ------
Intersegment Revenues
Information management. . . . . . . . . . . . . . . . . . . . $ (8.9) $ (1.7) $ (15.6) $ (5.9)
Customer management . . . . . . . . . . . . . . . . . . . . . (0.1) - (0.2) (0.2)
------ ------ -------- ------
$ (9.0) $ (1.7) $ (15.8) $ (6.1)
------ ------ -------- ------
------ ------ -------- ------
Special Items (1)
Customer management . . . . . . . . . . . . . . . . . . . . . $ - $ - $ 42.6 $ -
------ ------ -------- ------
------ ------ -------- ------
Operating Income
Information management. . . . . . . . . . . . . . . . . . . . $ 28.9 $ 28.2 $ 83.5 $ 76.4
Customer management . . . . . . . . . . . . . . . . . . . . . 17.1 6.2 2.9 33.4
Corporate and other . . . . . . . . . . . . . . . . . . . . . (0.2) 0.1 (0.2) -
------ ------ -------- ------
$ 45.8 $ 34.5 $ 86.1 $109.8
------ ------ -------- ------
------ ------ -------- ------
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------- -----------------------
Millions of Dollars 1998 1997 1998 1997
- ------------------- ------ ------ -------- ------
<S> <C> <C> <C> <C>
Assets
Information management. . . . . . . . . . . . . . . . . . . . $ 280.5 $264.0
Customer management . . . . . . . . . . . . . . . . . . . . . 988.5 300.3
Corporate and other . . . . . . . . . . . . . . . . . . . . . 103.2 72.7
-------- ------
$1,372.2 $637.0
-------- ------
-------- ------
Capital Additions (including acquisitions)
Information management. . . . . . . . . . . . . . . . . . . . $ 9.5 $ 6.0 $ 31.1 $ 15.8
Customer management . . . . . . . . . . . . . . . . . . . . . 15.3 7.5 697.0 24.6
------ ------ -------- ------
$ 24.8 $ 13.5 $ 728.1 $ 40.4
------ ------ -------- ------
------ ------ -------- ------
Depreciation and Amortization
Information management. . . . . . . . . . . . . . . . . . . . $ 7.6 $ 9.2 $ 21.8 $ 24.8
Customer management . . . . . . . . . . . . . . . . . . . . . 20.2 6.7 50.7 19.5
------ ------ -------- ------
$ 27.8 $ 15.9 $ 72.5 $ 44.3
------ ------ -------- ------
------ ------ -------- ------
</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.
10
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
GEOGRAPHIC INFORMATION
The following table presents certain information regarding the
Company's domestic and international operations:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------- -----------------------
Millions of Dollars 1998 1997 1998 1997
- ------------------- ------ ------ -------- ------
<S> <C> <C> <C> <C>
Revenues
United States . . . . . . . . . . . . . . . . . . . . . . $337.8 $215.3 $ 953.3 $650.2
International . . . . . . . . . . . . . . . . . . . . . . 32.5 23.2 89.2 74.8
------ ------ -------- ------
$370.3 $238.5 $1,042.5 $725.0
------ ------ -------- ------
------ ------ -------- ------
Operating Income
United States . . . . . . . . . . . . . . . . . . . . . . $ 44.4 $ 33.7 $ 82.7 $106.1
International . . . . . . . . . . . . . . . . . . . . . . 1.4 0.8 3.4 3.7
------ ------ -------- ------
$ 45.8 $ 34.5 $ 86.1 $109.8
------ ------ -------- ------
------ ------ -------- ------
Assets
United States . . . . . . . . . . . . . . . . . . . . . . $1,271.2 $555.9
International . . . . . . . . . . . . . . . . . . . . . . 101.0 81.1
-------- ------
$1,372.2 $637.0
-------- ------
-------- ------
</TABLE>
11
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BACKGROUND
The consolidated financial statements of the Company 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 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 distribution. 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 IMG and
CMG 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.
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 IMG and CMG and could lead to a charge to earnings later in 1998 or in early
1999.
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 SEPTEMBER 30, 1998 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
1997
The Company's revenues for the third quarter of 1998 totaled $370.3
million, an increase of $131.8 million (55%) from $238.5 million in the third
quarter of 1997. The acquisitions of Transtech and Maritz contributed
approximately $111 million to the quarterly revenue increase, with the remaining
increase attributable to growth in existing operations.
The Company's operating expenses for the third quarter of 1998 totaled
$324.5 million, an increase of $120.5 million (59%) from $204.0 million in the
third quarter of 1997. The acquisitions of Transtech and Maritz contributed
approximately $104 million to this increase. Expenses associated with the
Company's Year 2000 programming efforts also contributed to the operating
expense increase, growing to $7.2 million in the third quarter of 1998 from $3.3
million in the third quarter of 1997. The remaining operating expense increases
were largely the result of increased business volume in the Company's operating
segments.
The Company's operating income for the third quarter of 1998 was $45.8, an
increase of $11.3 (33%) from $34.5 million in the third quarter of 1997.
Excluding the $3.9 million increase in Year 2000 programming costs, the
Company's operating income for the third quarter of 1998 increased $15.2 million
(44%).
Other income (expense), net decreased to $4.4 million in the third quarter
of 1998 from $6.9 million in the third quarter of 1997, reflecting $2.0 million
in interest income recognized in the third quarter of 1997 resulting
12
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
from the settlement of federal tax audits of CBI's consolidated tax returns for
1989 through 1994. Cellular partnership earnings, which are included in other
income (expense), net, were $4.6 million in the third quarter of 1998 as
compared to $4.5 million in the third quarter of 1997. Interest expense
increased to $9.1 million in the third quarter of 1998 from $1.6 million in the
third quarter of 1997, as a result of incremental borrowings to finance the
acquisitions of Transtech and Maritz. The effective income tax rate for the
third quarter of 1998 increased to 37.8% from 33.9% in the third quarter of 1997
reflecting the 1997 settlement of federal tax audits of CBI's consolidated
returns for 1989 through 1994 which resulted in the recognition of $2.4 million
in tax benefit in the third quarter of 1997. Net income for the third quarter
of 1998 was $25.6 million or $.18 per share as compared to $26.3 million or $.19
per share. The $3.9 million increase in Year 2000 programming costs decreased
net income by $2.4 million or $.02 per share.
NINE MONTHS ENDED SEPTEMBER 30, 1998 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1997
The Company's revenues for the first nine months of 1998 were $1,042.5
million, an increase of $317.5 (44%) from $725.0 million in the first nine
months of 1997. The acquisitions of Transtech and Maritz contributed
approximately $261 million to the revenue increase in the first nine months of
1998.
The Company's operating expenses for the first nine months of 1998,
excluding a first quarter 1998 special item, totaled $913.8 million, an increase
of $298.6 million (49%) from $615.2 million for the first nine months of 1997.
The acquisitions of Transtech and Maritz contributed approximately $250 million
to this increase. Year 2000 programming costs increased to $20.7 million in the
first nine months of 1998 from $5.4 million in the first nine months of 1997.
Operating income, excluding a first quarter 1998 special item, was $128.7
million in the first nine months of 1998, an increase of $18.9 million (17%)
from $109.8 million in the first nine months 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 $18.9 million increase in operating income,
excluding the special item, was achieved despite the $15.3 million increase in
Year 2000 costs. Including the special item, the Company's operating income for
the first nine months of 1998 was $86.1 million.
Other income (expense), net for the first nine months of 1998 was $15.9
million which compares to $16.6 million in the first nine months of 1997 as
increased cellular partnership earnings were offset by the effect of the
recognition of interest income associated with federal tax audit settlements in
1997. Interest expense increased to $26.7 million for the first nine months of
1998 from $3.7 million for the first nine months of 1997, reflecting interest
associated with acquisitions. The Company's effective tax rate was 37.7% for
the first nine months of 1998 as compared to 33.7% in the first nine months of
1997, reflecting the federal tax audit settlements which occurred in 1997.
Excluding the first quarter 1998 special item, net income for the first nine
months of 1998 was $73.3 million or $.52 per share as compared to $81.4 million
or $.59 per share for the first nine months of 1997. Including the special
item, net income for the first nine months of 1998 was $46.9 million or $.34 per
share. The $15.3 million increase in Year 2000 costs decreased net income by
$9.5 million or $.07 per share.
The Company's results for both the third quarter and first nine months 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 CMG 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 $65 million for the third quarter of 1998. AT&T has provided
assurances that it plans to meet its requirements under the contract and Company
management is actively monitoring and evaluating progress towards the
requirement.
13
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INFORMATION MANAGEMENT
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------------ ------------------------------------
($ Millions) 1998 1997 Change % 1998 1997 Change %
------ ------ ----- ---- ------ ------ ----- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Information processing . . . . . . . . . $ 88.9 $ 85.8 $ 3.1 4 $266.9 $238.8 $28.1 12
Professional and consulting. . . . . . . 33.0 30.6 2.4 8 103.8 96.8 7.0 7
License and other. . . . . . . . . . . . 6.7 6.2 0.5 8 19.8 19.6 0.2 1
International. . . . . . . . . . . . . . 10.4 13.0 (2.6) (20) 31.8 40.6 (8.8) (22)
Intercompany services for CMG. . . . . . 8.9 1.6 7.3 - 15.6 5.9 9.7 -
------ ------ ----- ------ ------ -----
Total revenues. . . . . . . . . . . . 147.9 137.2 10.7 8 437.9 401.7 36.2 9
Costs of products and services . . . . . . . 75.5 64.1 11.4 18 221.4 194.9 26.5 14
Selling, general and administrative
expenses . . . . . . . . . . . . . . . . 15.5 16.1 (0.6) (4) 49.7 48.6 1.1 2
Research and development costs . . . . . . . 15.3 16.6 (1.3) (8) 46.8 51.8 (5.0) (10)
Depreciation and amortization. . . . . . . . 7.7 9.2 (1.6) (17) 21.8 24.9 (3.1) (12)
Year 2000 programming costs. . . . . . . . . 5.0 3.0 2.0 67 14.7 5.1 9.6 -
------ ------ ----- ------ ------ -----
Total costs . . . . . . . . . . . . . 119.0 109.0 10.0 9 354.4 325.3 29.1 9
------ ------ ----- ------ ------ -----
Operating income . . . . . . . . . . . . . . $ 28.9 $ 28.2 $ 0.7 3 $ 83.5 $ 76.4 $ 7.1 9
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
1997
Revenues for the Company's information management segment were $147.9
million for the third quarter of 1998, an increase of $10.7 million (8%) from
$137.2 million in the third quarter of 1997. Billing and related information
processing revenues increased to $88.9 million in the third quarter of 1998 from
$85.8 million in the third quarter of 1997, primarily as a result of growth in
wireless billing services. IMG's wireless billing clients' subscriber levels
increased 26% in the quarter from levels in the third quarter of 1997. The
increase in billing and related information processing revenues was partially
offset by a decline in the number of subscribers for whom IMG bills the long
distance portion of wireless calls. This decline has resulted from a client's
loss of wireless long distance market share to competitors. Additionally, the
increase in IMG's information processing revenues was partially offset by
contractual rate reductions triggered by certain clients' higher subscriber
levels. IMG's professional and consulting service revenues increased to $33.0
million in the third quarter of 1998 from $30.6 million in the third quarter of
1997. This increase was primarily attributable to growth in such services for
cellular and personal communication services (PCS) clients, which was partially
offset by reduced enhancement requests from certain other wireless clients.
IMG's license and other revenues were $6.7 million in the third quarter of 1998
as compared to $6.2 million in the third quarter of 1997. IMG's international
revenues decreased $2.5 million in the third quarter of 1998 from the third
quarter of 1997, reflecting the winding down of two long-term international
contracts. IMG's intercompany revenues for services provided to CMG increased
by $7.3 million over the third quarter of 1997, principally as a result of IMG
providing the processing services supporting CMG's Transtech operations
beginning in June 1998.
IMG's costs and expenses were $119.0 million in the third quarter of 1998,
an increase of $10.0 million (9%) over $109.0 million in the third quarter of
1997. The increase was principally the result of increased direct costs
associated with higher revenues, the direct costs of performing processing for
CMG's Transtech operations, 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
IMG's cost increases were attributable to the increase in Year 2000 programming
costs to $5.0 million in the third quarter of 1998 from $3.0 million in the
third quarter of 1997.
NINE MONTHS ENDED SEPTEMBER 30, 1998 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1997
IMG's revenues for the first nine months of 1998 were $437.9 million, an
increase of $36.2 million (9%) from $401.7 million in the first nine months of
1998. Billing and related information services revenues increased to $266.9
million in the first nine months of 1998 from $238.8 million in the first nine
months of 1997.
14
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This increase was driven by clients' wireless subscriber growth of 26%,
partially offset by a reduction in the number of clients' subscribers for whom
IMG bills the long distance portion of cellular calls. The increase in IMG's
information processing revenues was also partially offset by contractual rate
reductions triggered by certain clients' higher subscriber levels. Professional
and consulting revenues for the first nine months of 1998 increased to $103.8
million from $96.8 million in the first nine months of 1997, reflecting an
increase in services for PCS clients which was partially offset by reduced
enhancement requests from certain other wireless clients. IMG's license and
other revenues were $19.8 million in the first nine months of 1998 and $19.6
million in the first nine months of 1997. International revenues decreased $8.8
million in the first nine months of 1998 from the first nine months of 1997,
reflecting the winding down of two international contracts. IMG's intercompany
revenues for the first nine months of 1998 increased primarily because of IMG's
processing for CMG's Transtech operations, which began in June 1998.
IMG's costs and expenses for the first nine months of 1998 were $354.4
million, an increase of $29.1 million (9%) from $325.3 million in the first nine
months of 1997. Excluding the increase of Year 2000 programming costs to $14.7
million in the first nine months of 1998 from $5.1 million in the first nine
months of 1997, costs and expenses grew at a rate of 6% over the first nine
months of 1997. Higher direct costs of providing services, including increases
related to the information processing for CMG's Transtech operations, additional
headcount, data center upgrades, client-specified development efforts, increased
bill finishing costs and higher wage rates, particularly for software
professionals, led to the increase.
CUSTOMER MANAGEMENT
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------------ ------------------------------------
($ Millions) 1998 1997 Change % 1998 1997 Change %
------ ------ ----- ---- ------ ------ ----- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Dedicated services. . . . . . . . . . . . $177.2 $ 62.2 $115.0 185 $460.4 $181.8 $278.6 153
Traditional services. . . . . . . . . . . 46.2 34.7 11.5 33 135.8 126.5 9.3 7
International . . . . . . . . . . . . . . 8.0 6.1 1.9 31 24.2 21.1 3.1 15
------ ------ ------ ---- ------ ------ ------ ----
Total revenues. . . . . . . . . . . . $231.4 $103.0 $128.4 125 $620.4 $329.4 $291.0 88
Costs of products and services . . . . . . . 143.1 64.8 78.3 121 387.8 203.9 183.9 90
Selling, general and administrative. . . . .
expenses . . . . . . . . . . . . . . . . . 40.0 23.8 16.2 68 114.4 68.7 45.7 67
Research and development costs . . . . . . . 8.9 1.1 7.8 - 16.0 3.6 12.4 -
Depreciation and amortization. . . . . . . . 20.1 6.8 13.3 196 50.7 19.5 31.2 160
Year 2000 programming costs. . . . . . . . . 2.2 .3 1.9 - 6.0 .3 5.7 -
Special items:
Acquired research and
development costs. . . . . . . . . . . . - - - - 42.6 - 42.6 -
------ ------ ------ ---- ------ ------ ------ ----
Total costs . . . . . . . . . . . . . 214.3 96.8 117.5 121 617.5 296.0 321.5 109
------ ------ ------ ---- ------ ------ ------ ----
Operating income (loss). . . . . . . . . . . $ 17.1 $ 6.2 $ 10.9 176 $ 2.9 $ 33.4 $(30.5) (91)
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
1997
Revenues for the Company's customer management segment, CMG, were $231.4
million in the third quarter of 1998, an increase of $128.4 million (125%) from
$103.0 million in the third quarter of 1997. The acquisitions of Transtech and
Maritz, which occurred in the first quarter of 1998, contributed approximately
$111 million to this increase. Excluding acquisitions, CMG's revenues grew by
approximately 17% over the third quarter of 1997. Dedicated services revenues
(typically longer-term relationships where CMG provides value-added customer
service, technical support and sales account management primarily through
personnel dedicated to a specific client) increased by approximately $115
million, including most of the revenues contributed by the two first quarter
1998 acquisitions. Traditional campaign-based teleservices revenues reflected a
strong recovery for this portion of the business as these revenues grew by
approximately 33% over the third quarter of 1997. Excluding acquisitions,
CMG's international revenues increased $1.9 million in the third quarter of 1998
over levels in the third quarter of 1997.
15
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CMG's costs and expenses were $214.3 million in the third quarter of 1998,
an increase of $117.5 million (121%) from $96.7 million in the third quarter of
1997. The acquisitions of Transtech and Maritz contributed approximately $104
million to this increase. Included in the increase resulting from the two
acquisitions was approximately $6 million in goodwill and other intangible
amortization relating to the two acquired businesses and the majority of CMG's
increased research and development costs. The remaining increase of
approximately $14 million included higher direct cost levels associated with
higher revenue and higher research and development costs associated with system
development projects in the traditional teleservices business and a $1.9 million
increase in Year 2000 programming costs.
NINE MONTHS ENDED SEPTEMBER 30, 1998 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1997
CMG's revenues for the first nine months of 1998 were $620.4 million, an
increase of $291.0 million (88%) from $329.4 million in the first nine months of
1997. The acquisitions of Transtech and Maritz contributed approximately $261
million to the increase. The remaining increase of approximately $30 million
was principally attributable to increased dedicated services revenues which grew
by approximately $18 million, in comparison to the same period in 1997,
excluding acquisitions. Traditional teleservices revenues increased
approximately $9 million in the first nine months of 1998 from the first nine
months of 1997, reflecting the strong recovery in these revenues in the third
quarter of 1998. Excluding acquisitions, CMG's international revenues increased
$3.1 million in the first nine months of 1998 over levels in the first nine
months of 1997.
CMG's costs and expenses for the first nine months of 1998, excluding a
first quarter special item, were $574.9 million, an increase of $278.9 million
(94%) from $296.0 million in the first nine months of 1997. The acquisitions of
Transtech and Maritz contributed approximately $250 million to this increase,
including approximately $14 million in additional goodwill and other intangible
amortization. The remaining increase of approximately $28 million reflects
additional direct costs associated with higher revenues, 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 $6.0 million during the first nine months of 1998
compared to $.3 million during the first nine months of 1997.
In connection with the Transtech acquisition, CMG expensed $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. 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.
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 $55 million in working capital, which has been
financed through short-term debt issued by CBI and allocated to the Company.
The $206 million in net proceeds from the Offering and cash flows from
operations were used to repay a portion of this intercompany indebtedness during
the third quarter of 1998.
Until the earlier of the date that the Company arranges its own external
financing or the date of the Distribution, the Company's principal source of
external funds will be its intercompany financing arrangement with CBI, which is
expected to continue to be funded by CBI through commercial paper borrowings.
The
16
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Company pays 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. 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 $97.8 million for the first nine
months of 1998 compared to $70.4 million for the same nine 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 nine months of 1998 would have been
approximately $153 million. Capital expenditures were the other principle use
of cash during the first nine months of 1998. Excluding acquisitions, capital
expenditures for the first nine months of 1998 were $65 million, up $25 million
from the first nine months of last year. The Transtech and Maritz acquisitions
involved approximately $660 million in capital spending.
BALANCE SHEET
The $85.1 million increase in accounts receivable from December 31, 1997 to
September 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, intercompany debt payable to 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
principally 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
As a part of CBI's Year 2000 compliance efforts, the Company initiated a
program in 1996 to identify and address issues associated with the ability of
its date-sensitive information and business systems and equipment to recognize
the Year 2000 properly. 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
$20.7 million in expenses during the first nine months 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.
A steering committee chaired by the Company's Chief Executive Officer and
composed of upper-level management personnel, has set the direction for, and
monitored the activity of, Cincinnati Bell's and Convergys' Year 2000 Program
Management Office. The Program Management Office's responsibility is to make
CBI and Convergys Year 2000 compliant. In addition to the internal Year 2000
activities, the Program Management Office is communicating with vendors and
clients with which the Company's systems interface or upon which the Company's
systems rely to determine their progress toward Year 2000 compliance.
IMG's goal is to have its data centers, software and other information
technology systems Year 2000 compliant and tested by June 30, 1999. IMG's
efforts are proceeding in accordance with its plans and are on track to achieve
this goal. Additionally, the Year 2000 efforts for several IMG systems have
moved into the testing phase to verify that the modifications made to the
systems had been effective in making the systems Year 2000 compliant. While
work continues with system modifications and testing, IMG has also begun its
efforts to plan its procedures for the date of the millennium change.
CMG's goal is to have its call centers, software, telecom equipment and
other information technology systems Year 2000 compliant by June 30, 1999. The
majority of CMG's individual Year 2000 projects are on schedule. Additionally,
the Year 2000 efforts for several CMG projects have also moved into the testing
phase.
17
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company maintains business continuity plans to limit the disruptions
to its operations that may result from a variety of occurrences. As part of
its Year 2000 efforts, the Company is updating its business continuity plans
to assure that they adequately address Year 2000 issues that might arise.
Although the Company anticipates minimal business disruption as a result of
the century change, if the Company were to be unsuccessful in readying its
software and systems for the Year 2000 or preparing adequate plans to avoid
business interruption that could result from the century change, this would
have a material adverse impact on the Company and its client relationships.
This material adverse impact could include the inability of IMG to process
bills and other transactions for its clients' customers in a timely manner,
which could lead to the incurrence of contractual penalties which could be
material. Similarly, this adverse effect could include disruptions to CMG's
ability to appropriately handle client call volumes, which could also lead to
contractual penalties which could be material. 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 business continuity planning
also could have an adverse impact on the Company as the Company is, to a
certain extent, dependent on the success of its clients in their markets.
Additionally, the failure of one of the Company's significant suppliers to
modify its systems for the Year 2000 could also lead to client service
disruptions that would have a material adverse effect 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 September 30, 1998.
The Company's exposure to interest rate risk results from its variable rate
short-term intercompany debt payable to CBI. At September 30, 1998, the Company
had approximately $478 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 September 30, 1998, a one percentage point
increase in the weighted average interest rate would increase the Company's
annual interest expense by approximately $4.8 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.
BUSINESS OUTLOOK
INFORMATION MANAGEMENT IMG continues to rely on a few large clients for
most of its revenue. IMG's top three clients accounted for 60% of its
revenues for the first nine months of 1998. IMG maintains multi-year
contracts with its clients, but some contracts have early termination
clauses. IMG 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 IMG client representing approximately 11% of
IMG's year-to-date 1998 revenues was recently acquired by one of IMG's
competitors. The related contract extends through 2006 and does not provide
for early termination without an IMG incurred breach. It was also announced
in the second quarter of 1998 that another IMG client representing
approximately 9% of IMG's year-to-date 1998 revenues intends to be acquired
by another company. IMG and the client have signed a binding letter of
intent which is intended to expand into a contract that is expected to run
through 2004.
A significant amount of IMG's growth is directly related to increased
wireless subscribers in the domestic marketplace. While that trend has
continued in the first nine months of 1998, if the domestic wireless industry
growth rate declines in the future, IMG's 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.
18
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CUSTOMER MANAGEMENT
CMG's top three clients accounted for 50% of its revenues for the first
nine months of 1998 up from 34% for the same period in 1997. Loss of any
significant contracts would have an adverse effect on its revenues and profits.
CMG 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 CMG's
revenues from its top three clients, but the related eight-year customer
management agreement with AT&T helps reduce the risk of loss for that portion of
the business. However, significant quarterly fluctuations may still occur.
In the fourth quarter of 1997, CMG initiated a restructuring plan to
respond to increased competition and the softness in the market for traditional
teleservices that began to impact the business in the second half of 1997. CMG
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.
BUSINESS DEVELOPMENT
The Company continues to review opportunities for acquisitions and
divestitures for its businesses to enhance shareowner value.
19
<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
99 Employee Benefits Agreement between Cincinnati Bell Inc. and
Convergys Corporation
</TABLE>
(b) Reports on Form 8-K
Form 8-K, date of report September 2, 1998, reported the new
management teams of Convergys Corporation and Cincinnati Bell Inc.
This announcement was made in anticipation of the planned separation
of the two companies by December 31, 1998.
20
<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: November 16, 1998 /s/ Steven G. Rolls
------------------------------
Steven G. Rolls
Chief Financial Officer
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 1,400
<SECURITIES> 0
<RECEIVABLES> 307,900
<ALLOWANCES> 9,300
<INVENTORY> 0
<CURRENT-ASSETS> 345,600
<PP&E> 476,400
<DEPRECIATION> 247,000
<TOTAL-ASSETS> 1,372,200
<CURRENT-LIABILITIES> 679,800
<BONDS> 300,000
0
0
<COMMON> 151,900
<OTHER-SE> 527,500
<TOTAL-LIABILITY-AND-EQUITY> 1,372,200
<SALES> 0
<TOTAL-REVENUES> 1,042,500
<CGS> 0
<TOTAL-COSTS> 956,400
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 2,400
<INTEREST-EXPENSE> 26,700
<INCOME-PRETAX> 75,300
<INCOME-TAX> 28,400
<INCOME-CONTINUING> 46,900
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 46,900
<EPS-PRIMARY> .34
<EPS-DILUTED> .34
</TABLE>
<PAGE>
EMPLOYEE BENEFITS AGREEMENT
BETWEEN
CINCINNATI BELL INC.
AND
CONVERGYS CORPORATION
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
ARTICLE I DEFINITIONS . . . . . . . . . . . . . . . . . . . . . . . . . . 1
ARTICLE II GENERAL PRINCIPLES. . . . . . . . . . . . . . . . . . . . . . . 2
ARTICLE III DEFINED BENEFIT PLANS . . . . . . . . . . . . . . . . . . . . . 4
ARTICLE IV DEFINED CONTRIBUTION PLANS. . . . . . . . . . . . . . . . . . . 6
ARTICLE V HEALTH AND WELFARE PLANS. . . . . . . . . . . . . . . . . . . . 7
ARTICLE VI EXECUTIVE BENEFITS AND NON-EMPLOYEE
DIRECTOR BENEFITS . . . . . . . . . . . . . . . . . . . . . .11
ARTICLE VII GENERAL AND ADMINISTRATIVE. . . . . . . . . . . . . . . . . . .14
ARTICLE VIII MISCELLANEOUS . . . . . . . . . . . . . . . . . . . . . . . . .16
</TABLE>
i
<PAGE>
EMPLOYEE BENEFITS AGREEMENT
This EMPLOYEE BENEFITS AGREEMENT, dated as of October 14, 1998, is by and
between Cincinnati Bell Inc. ("CBI") and Convergys Corporation ("Convergys").
WHEREAS, CBI has determined to distribute to its shareholders all of the
Convergys common shares owned by CBI (the "Distribution"); and
WHEREAS, in conjunction with the Distribution, the parties have agreed to
enter into an agreement allocating assets, liabilities and responsibilities with
respect to certain employee compensation and benefit programs;
NOW, THEREFORE, the parties agree as follows:
ARTICLE I
DEFINITIONS
For purposes of this Agreement the following terms shall have the following
meanings:
1.1 AGREEMENT means this Employee Benefits Agreement.
1.2 CBI ENTITY means CBI and any corporation that is, at the relevant
time, a direct or indirect subsidiary of CBI, except that, for periods beginning
on and after the Distribution Date, the term "CBI Entity" shall not include a
Convergys Entity.
1.3 CODE means the Internal Revenue Code of 1986, as amended, or any
successor federal income tax law. Reference to a specific Code provision also
includes any proposed, temporary, or final regulation in force under that
provision.
1.4 CONVERGYS ENTITY means Convergys and any corporation that is, at the
relevant time, a direct or indirect subsidiary of Convergys, Cincinnati Bell
Information Systems Inc. and its direct and indirect subsidiaries and MATRIXX
Marketing Inc. and its direct and indirect subsidiaries.
1.5 CONVERGYS INDIVIDUAL means any individual (a) who is either actively
employed by or on leave of absence from a Convergys Entity on the Distribution
Date; (b) who is transferred from a CBI Entity to a Convergys Entity on the
Distribution Date or (c) who retired or separated from a Convergys Entity prior
to the Distribution Date and has not been reemployed by a CBI Entity or
Convergys Entity since retiring or separating. In addition, CBI and Convergys
may designate, by mutual agreement, any other individual or group of individuals
as Convergys Individuals.
1.6 DISTRIBUTION DATE means the date on which the Distribution occurs.
<PAGE>
1.7 ERISA means the Employee Retirement Income Security Act of 1974, as
amended. Reference to a specific provision of ERISA also includes any proposed,
temporary, or final regulation in force under that provision.
1.8 IPO DATE means the date on which the initial public offering of
Convergy's common shares is closed.
1.9 NON-EMPLOYEE DIRECTOR, when immediately preceded by "CBI," means a
member of CBI's Board of Directors who is not an employee of a CBI Entity or a
Convergys Entity. When immediately preceded by "Convergys," Non-Employee
Director means a member of Convergys's Board of Directors who is not an employee
of a CBI Entity or a Convergys Entity.
1.10 PLAN, when immediately preceded by "CBI" or "Convergys," means any
plan, policy, program, payroll practice, on-going arrangement, contract, trust,
insurance policy or other agreement or funding vehicle providing benefits to
employees, former employees or Non-Employee Directors of a CBI Entity or a
Convergys Entity, as applicable.
ARTICLE II
GENERAL PRINCIPLES
2.1 ASSUMPTION OF LIABILITIES. Convergys hereby assumes and agrees to
pay, perform, fulfill and discharge, in accordance with their respective terms,
all of the following (regardless of when or where such liabilities arose or
arise or were or are incurred): (i) all liabilities, other than those arising
out of or relating to workers' compensation claims, arising out of or relating
to Convergys Individuals and their respective dependents and beneficiaries, in
each case relating to, arising out of or resulting from employment by a CBI
Entity before becoming Convergys Individuals (including liabilities under CBI
Plans and Convergys Plans); (ii) all other liabilities to or relating to
Convergys Individuals and other employees or former employees of Convergys
Entities, and their dependents and beneficiaries, to the extent relating to,
arising out of or resulting from future, present or former employment with a
Convergys Entity (including liabilities under CBI Plans and Convergys Plans) and
(iii) all other liabilities relating to, arising out of or resulting from
obligations, liabilities and responsibilities expressly assumed or retained by a
Convergys Entity or a Convergys Plan pursuant to this Agreement.
2.2 CONVERGYS PARTICIPATION IN CBI PLANS.
(a) CBI'S GENERAL OBLIGATIONS AS PLAN SPONSOR. CBI shall continue
through the Distribution Date to administer, or cause to be administered, in
accordance with their terms and applicable law, the CBI Plans, and shall have
the sole discretion and authority to interpret the CBI Plans as set forth
therein. Before the Distribution Date, CBI shall not, without the prior consent
of Convergys, amend any material feature of any CBI Plan in which a Convergys
Entity is a participating company, except to the extent such amendment
2
<PAGE>
would not affect any benefits of Convergys Individuals under such Plan or as may
be necessary or appropriate to comply with any collective bargaining agreement
or applicable law.
(b) CONVERGYS' GENERAL OBLIGATIONS AS PARTICIPATING COMPANY.
Convergys shall perform with respect to its participation in the CBI Plans, and
shall cause each other Convergys Entity that is a participating company in any
CBI Plan to perform, the duties of a participating company as set forth in such
Plans or any procedures adopted pursuant thereto, including: (i) assisting in
the administration of claims, to the extent requested by the claims
administrator of the applicable CBI Plan; (ii) cooperating fully with CBI Plan
auditors, benefit personnel and benefit vendors; (iii) preserving the
confidentiality of all financial arrangements CBI has or may have with any
vendors, claims administrators, trustees or any other entity or individual with
whom CBI has entered into an agreement relating to the CBI Plans; and (iv)
preserving the confidentiality of participant health information (including
health information in relation to FMLA leaves).
(c) TERMINATION OF PARTICIPATING COMPANY STATUS. Effective as of the
Distribution Date, each Convergys Entity shall cease to be a participating
company in the CBI Plans.
2.4 CONVERGYS PLANS. The Convergys Plans shall be, with respect to
Convergys Individuals who are participating in CBI Plans, in all respects the
successors in interest to, and shall not provide benefits that duplicate
benefits provided by, the corresponding CBI Plans. CBI and Convergys shall
agree on methods and procedures, including amending the respective plan
documents, to prevent Convergys Individuals from receiving duplicative benefits
from the CBI Plans and the Convergys Plans. With respect to Convergys
Individuals, each Convergys Plan shall provide that all service, all
compensation and all other benefit-affecting determinations that, as of the
Distribution Date, were recognized under the corresponding CBI Plan shall, as of
immediately after the Distribution Date, receive full recognition, credit, and
validity and be taken into account under such Convergys Plan to the same extent
as if such items occurred under such Convergys Plan, except to the extent that
duplication of benefits would result. The provisions of this Agreement for the
transfer of assets from certain trusts relating to CBI Plans to the
corresponding trusts relating to Convergys Plans are based upon the
understanding of the parties that each such Convergys Plan will assume all
liabilities of the corresponding CBI Plan to or relating to Convergys
Individuals, as provided for herein. If any such liabilities are not
effectively assumed by the appropriate Convergys Plan, then the amount of assets
transferred to the trust relating to such Convergys Plan from the trust relating
to the corresponding CBI Plan shall be recomputed, ab initio, as set forth below
but taking into account the retention of such liabilities by such CBI Plan, and
assets shall be transferred by the trust relating to such Convergys Plan to the
trust relating to such CBI Plan so as to place each such trust in the position
it would have been in, had the initial asset transfer been made in accordance
with such recomputed amount of assets.
3
<PAGE>
2.5 PORTABILITY OF BENEFITS. On or before the Distribution Date, CBI and
Convergys may enter into an Interchange Agreement providing for (among other
things) the portability of benefits and mutual recognition of service with
respect to individuals who terminate employment with a CBI Entity and who become
employees of a Convergys Entity during the six month period commencing on the
Distribution Date or who terminate employment with a Convergys Entity and who
become employees of a CBI Entity during such six month period.
ARTICLE III
DEFINED BENEFIT PLANS
3.1 ESTABLISHMENT OF MIRROR PENSION PLAN. Effective immediately after the
Distribution Date, Convergys shall establish a qualified defined benefit pension
plan (the "Convergys Pension Plan") for its eligible employees the provisions of
which shall mirror the provisions of CBPP and CBMPP.
3.2 ASSUMPTION OF LIABILITIES BY CONVERGYS PENSION PLAN. Immediately
after the Distribution Date, all liabilities to or relating to Convergys
Individuals under CBPP and CBMPP (collectively, the "CBI Pension Plans"), shall
cease to be liabilities of the CBI Pension Plans and shall be assumed by the
Convergys Pension Plan.
3.3 CALCULATION OF CBMPP ASSET ALLOCATION.
(a) As soon as practicable after the Distribution Date, CBI shall
cause to be calculated, for CBMPP and the Convergys Pension Plan, as of the
Distribution Date:
(i) An "Initial Allocation Amount," which shall reflect a 75%
probability that CBMPP and the Convergys Pension Plan assets at the end of ten
years will each exceed the present value of all projected future benefit
payments for each plan, with any difference (positive or negative) between these
assets and the present value of projected future benefit payments at the end of
ten years for the combined plans allocated between the plans on a proportional
basis reflecting the present value of all projected future benefit payments at
the end of ten years for each plan.
(ii) The Initial Allocation Amount for CBMPP and the Convergys
Pension Plan shall be determined in a manner consistent with CBI's pension
funding policy in effect on January 1, 1998, a summary of which is attached
hereto.
(b) A "414(1)(1) Amount" for each of CBMPP and the Convergys Pension
Plan shall be determined, which shall equal the minimum amount necessary to
fully fund benefits under CBMPP and the Convergys Pension Plan on a "termination
basis" (as that term is defined in Treas. Reg. Section 1.414(1)-1(b)(5)). The
assumptions used in determining the 414(1)(1) Amounts shall be those used in the
determination of the minimum required contribution under ERISA for the Plan Year
beginning January 1, 1998, except that the discount rate and mortality
assumption shall be determined in accordance with Internal Revenue Code Section
414(1).
4
<PAGE>
(c) If the aggregate amount of the assets of CBMPP as of the
Distribution Date is not less than the sum of the 414(1)(1) Amounts for CBMPP
and the Convergys Pension Plan, then such assets shall be allocated between
CBMPP and the Convergys Pension Plan in accordance with the following:
(i) If the Initial Allocation Amount is greater than or equal to
the 414(1)(1) Amount for CBMPP, and the Initial Allocation Amount is greater
than or equal to the 414(1)(1) Amount for the Convergys Pension Plan, then the
amounts of assets allocated to CBMPP and the Convergys Pension Plan shall equal
their respective Initial Allocation Amounts.
(ii) If the Initial Allocation Amount is greater than or equal to
the 414(1)(1) Amount for CBMPP, but the Initial Allocation Amount is less than
the 414(1)(1) Amount for the Convergys Pension Plan, then the amount of assets
allocated to the Convergys Pension Plan shall equal the 414(1)(1) Amount for the
Convergys Pension Plan, and the amount of assets allocated to CBMPP shall equal
the excess of (x) the total amount of assets, as of the Distribution Date, of
CBMPP over (y) the 414(1)(1) Amount for the Convergys Pension Plan.
(iii) If the Initial Allocation Amount is less than the 414(1)(1)
Amount for the CBMPP, but the Initial Allocation Amount is greater than or equal
to the 414(1)(1) Amount for the Convergys Pension Plan, then the amount of
assets allocated to CBMPP shall equal the 414(1)(1) Amount for CBMPP, and the
amount of assets allocated to the Convergys Pension Plan shall equal the excess
of (x) the total amount of assets, as of the Distribution Date, of CBMPP over
(y) the 414(1)(1) Amount for CBMPP.
(d) If the aggregate amount of the assets of CBMPP as of the
Distribution Date is less than the sum of the 414(1)(1) Amounts for CBMPP and
the Convergys Pension Plan, then such assets shall be allocated between CBMPP
and the Convergys Pension Plan as follows:
(i) CBI and Convergys shall obtain a quote from a mutually
agreeable insurance company for the provision of immediate and deferred
annuities payable under CBMPP and the Convergys Pension Plan for all accrued
benefits under CBMPP as of the Distribution Date.
(ii) If the aggregate amount of assets of the Distribution Date
is not less than the amount of such quote, the amount of assets allocated to
CBMPP and the Convergys Pension Plan shall be determined in accordance with
Subsection (c) above, except that, in making that determination, the amount of
such quote for CBMPP and the Convergys Pension Plan shall be substituted for the
414(1)(1) Amount for each plan.
(iii) If the aggregate amount of assets as of the Distribution
Date is less than the amount of such quote, the amount of assets allocated to
CBMPP and the Convergys Pension Plan shall be determined on a plan termination
basis in accordance with ERISA Section 4044 using the same assumptions as those
used in computing the 414(1)(1) Amounts.
5
<PAGE>
(e) For purposes of this Section 3.3, references to the "Convergys
Pension Plan" shall mean that portion of the Convergys Pension Plan
corresponding to CBMPP.
3.4 CALCULATION OF CBPP ASSET ALLOCATION. The asset allocation of the
CBPP and the Convergys Pension Plan shall be determined by applying Section 3.3
but substituting "CBPP" for "CBMPP" wherever it appears in that Section.
3.5 TRANSFER OF CONVERGYS PENSION PLAN'S INTERESTS FROM THE CBI PENSION
TRUST TO THE CONVERGYS PENSION TRUST. The actual segregation of the interests
of the Convergys Pension Plan in Cincinnati Bell Pension Plans Trust (the "CBI
Pension Trust") into separate trust accounts, and the transfer of the Convergys
Pension Plan's allocable share of the assets from the CBI Pension Trust to the
trust established in conjunction with the Convergys Pension Plan (the "Convergys
Pension Trust"), shall occur as soon as practicable after the calculation of
such interests pursuant to Sections 3.3 and 3.4. The assets to be transferred
from the CBI Pension Trust to the Convergys Pension Trust share shall consist of
a pro rata share of each class of assets in the CBI Pension Trust, unless CBI
and Convergys agree otherwise.
ARTICLE IV
DEFINED CONTRIBUTION PLANS
4.1 RETIREMENT SAVINGS PLANS. Effective as of the Distribution Date, (a)
a Convergys Savings Plan designated by Convergys shall assume and be solely
responsible for all liabilities relating to each Convergys Individual under any
CBI Savings Plan and (b) CBI shall cause the accounts of such Convergys
Individual under each CBI Savings Plan to be transferred to the Convergys
Savings Plan designated by Convergys and Convergys shall cause such transferred
accounts to be accepted by the Convergys Savings Plan. CBI and Convergys shall
take such action as may be needed to cause the assets associated with each
transferred account to be transferred from the trust established in conjunction
with the CBI Savings Plan to the trust established in conjunction with the
Convergys Savings Plan. For purposes of this Section 4.1, "CBI Savings Plan"
means Cincinnati Bell Inc. Savings and Security Plan and "Convergys Plan" means
CBIS Retirement and Savings Plan and MATRIXX Marketing Inc. Profit
Sharing/401(k) Plan.
4.2 CBI ESOP. The Cincinnati Bell Inc. Employee Stock Ownership Plan (the
"CBI ESOP") shall be solely responsible for all liabilities relating to
Convergys Individuals under the CBI ESOP. The parties acknowledge that, as a
result of the Distribution, the CBI ESOP will, after the Distribution Date, hold
both CBI common shares and Convergys common shares and that, in order to
continue to qualify as an employee stock ownership plan, the CBI ESOP will be
required to dispose of the Convergys common shares and reinvest in CBI common
shares. The parties further acknowledge that applicable law generally prohibits
such plans from holding securities that are not "qualifying employer securities"
within the meaning of Code Section 409 for more than a reasonable time after the
Distribution Date unless the Internal Revenue Service ("IRS") grants an
extension of time. Accordingly, CBI shall request the IRS to grant an
6
<PAGE>
extension of such holding period as its financial advisors shall deem prudent to
allow the CBI ESOP to dispose of the Convergys common shares received by it as a
result of the Distribution and, to reinvest in CBI common shares, in a manner
consistent with the best interests of the ESOP participants. It also is
understood that, for purposes of the CBI ESOP, each Convergys Individual will be
deemed to have terminated employment on the Distribution Date.
ARTICLE V
HEALTH AND WELFARE PLANS
5.1 TRANSFER OF RETIREMENT FUNDING ACCOUNT ASSETS. This Section 5.1 shall
apply to the CBI group life insurance contract that has a retirement funding
account (the "CBI RFA") maintained for the purpose of accumulating, through
employer contributions in advance of employee retirements, a fund to be used to
pay all or a portion of the costs for continuing life insurance protection for
employees after their retirement. As soon as practicable after the Distribution
Date, there shall be transferred to the retirement funding account of a
Convergys Entity group life insurance contract an amount of assets having a
fair market value as of the Distribution Date equal to the product obtained by
multiplying (a) the present value, as of the Distribution Date, of the future
benefit obligation with respect to Convergys Individuals to be discharged from
the CBI RFA, divided by the present value of the future benefit obligations with
respect to all individuals whose benefits are to be discharged from the CBI RFA
assets as of the Distribution Date times (b) the fair market value of all CBI
RFA assets as of the Distribution Date. CBI and Convergys shall adopt, and
shall use their reasonable best efforts to cause their insurers to adopt,
procedures to implement such asset transfers in a reasonable and expeditious
manner that is consistent with the underlying group life insurance contracts and
applicable legal requirements. Nothing in this Agreement shall be interpreted
to provide that any assets so transferred have reverted to CBI or Convergys.
5.2 VENDOR CONTRACTS.
(a) GROUP INSURANCE POLICIES.
(i) This Section 5.2(a) applies to group insurance policies
other than the group life insurance contract referred to in Section 5.1 ("Group
Insurance Policies").
(ii) To the extent that Convergys Individuals are covered under a
CBI Group Insurance Policy in existence as of the date of this Agreement, at the
request of Convergys, CBI shall use its reasonable best efforts to amend such
Group Insurance Policy to permit Convergys to participate in the terms and
conditions of such policy from immediately after the Distribution Date until the
expiration of the financial fee and rate guarantees in effect under such Group
Insurance Policy as of the Distribution Date.
(iii) Convergys' participation in the terms and conditions of
each such Group Insurance Policy shall be effectuated by obligating the
insurance company that issued such insurance policy to CBI to issue one or more
separate policies to Convergys. Such terms
7
<PAGE>
and conditions shall include the financial and termination provisions,
performance standards and target claims.
(iv) If CBI is not successful in negotiating policy provisions
that will permit compliance with Sections 5.2(a)(ii) and (iii) prior to the
Distribution Date, at the request of Convergys, CBI shall use its reasonable
best efforts to either continue to cover Convergys under its Group Insurance
Policies or procure a separate policy for Convergys until Convergys has procured
such separate insurance policy or made other arrangements for replacement
coverage, and Convergys shall bear all costs incurred by CBI to continue such
coverage.
(b) EFFECT OF CHANGE IN RATES. CBI and Convergys shall use their
reasonable best efforts to cause each of the insurance companies, HMOs,
point-of-service vendors and third-party administrators providing services and
benefits under the CBI Health and Welfare Plans and the Convergys Health and
Welfare Plans to maintain the premium and/or administrative rates based on the
aggregate number of participants in both the CBI Health and Welfare Plans and
the Convergys Health and Welfare Plans through the expiration of the financial
fee or rate guarantees in effect as of the Distribution Date under the
respective ASO Contracts, Group Insurance Policies, and HMO Agreements. To the
extent they are not successful in such efforts, CBI and Convergys shall each
bear the revised premium or administrative rates attributable to the individuals
covered by their respective Health and Welfare Plans.
5.3 CBI WORKERS' COMPENSATION PROGRAM.
(a) ADMINISTRATION.
(i) Through the Distribution Date or such earlier date as may be
agreed by CBI and Convergys, CBI shall continue to be responsible for the
administration of all claims and associated premiums, fees and other costs that
(1) are, or have been, incurred under the various arrangements established by
any CBI Entity to comply with the workers' compensation regulations of the
states where CBI and its affiliates conduct business (the "CBI WCP") before the
Distribution Date by Convergys Individuals and other employees and former
employees of the Convergys Entities through the Distribution Date ("Convergys
WCP Claims") and (2) have been historically administered by CBI or its insurance
company.
(ii) Effective immediately after the Distribution Date or such
earlier date as may be agreed by CBI and Convergys, (A) Convergys shall, to the
extent Legally Permissible (as defined below), be responsible for the
administration of all Convergys WCP Claims and associated premiums, fees and
other costs, whether those claims were previously administered by CBI or
Convergys, and (B) CBI shall be responsible for the administration of all
Convergys WCP Claims not administered by Convergys pursuant to clause (A),
whether previously administered by CBI or Convergys and whether under the
self-insured or insured portion of the CBI WCP. Any determination made, or
settlement entered into, by either party or its insurance company with respect
to Convergys WCP Claims for which it is administratively responsible shall be
final and binding upon the other party.
8
<PAGE>
(iii) Each party shall fully cooperate with the other with respect
to the administration and reporting of Convergys WCP Claims, the payment of
Convergys WCP Claims determined to be payable, and the transfer of the
administration of any Convergys WCP Claims to the other party as determined
under Section 5.3(a)(ii).
(iv) For purposes of this Section 5.3(a), "Legally Permissible"
shall be determined on a state-by-state basis, and shall mean that
administration of Convergys WCP Claims by Convergys both (A) is permissible
under the applicable state's workers' compensation laws (taking into account all
relevant facts, including that Convergys may have a self-insurance certificate
in that state) and (B) would not have a material adverse effect on CBI's
self-insurance certificate within that state. If it is determined that, in a
particular state, it is Legally Permissible for Convergys to administer
Convergys WCP Claims, then Convergys shall be responsible for the administration
of all Convergys WCP Claims incurred in that state, whether previously
administered by CBI, Convergys, or an insurance company. If it is determined
that, in a particular state, it is not Legally Permissible for Convergys to
administer Convergys WCP Claims, then CBI shall be responsible for the
administration of all Convergys WCP Claims incurred in that state, whether
previously administered by CBI, Convergys, or an insurance company.
(b) SELF-INSURANCE STATUS.
(i) CBI shall amend its certificates of self-insurance with
respect to workers' compensation and any applicable group insurance policies to
include Convergys until the Distribution Date, and Convergys shall fully
cooperate with CBI in obtaining such amendments. All costs incurred by CBI in
amending such certificates or group insurance policies, including filing fees,
adjustments of security and excess loss policies and amendment of safety
programs, shall be shared equally by CBI and Convergys. CBI shall use its
reasonable best efforts to obtain self-insurance status for workers'
compensation for Convergys effective immediately after the Distribution Date in
each jurisdiction in which Convergys conducts business and in which CBI is
self-insured, if CBI determines that such status is beneficial to Convergys.
Convergys hereby authorizes CBI to take all actions necessary and appropriate on
its behalf in order to obtain such self-insurance status.
(ii) CBI shall also arrange a contingent insured or other
arrangement for payment of workers' compensation claims, into which Convergys
shall enter if and to the extent that CBI fails to obtain self-insured status
for Convergys as provided in Section 5.3(b)(i), unless Convergys obtains another
such arrangement that is effective immediately after the Distribution Date, in
which event Convergys shall reimburse CBI for any expenses incurred by CBI in
procuring such contingent arrangement.
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<PAGE>
(c) INSURANCE POLICY.
(i) In the event the workers' compensation insurance policy that
CBI maintains under the CBI WCP expires before the Distribution Date, CBI shall
use its reasonable best efforts to renew such policy and to cause the issuing
insurance company to issue a separate policy to Convergys. If CBI is not able
to cause such insurance company to issue such separate insurance policy,
Convergys shall use its reasonable best efforts to procure a separate policy
from another insurance company or to obtain self-insurance status, and CBI shall
use its reasonable best efforts to continue to cover Convergys under its renewed
policy until the earlier of (A) the date on which Convergys' application for
such self-insurance status is approved or (B) the date on which a separate
insurance policy is procured. Convergys shall compensate CBI for all costs
incurred by CBI to continue such coverage. Any claims incurred by Convergys
Individuals after the Distribution Date that will be covered under and during
any such continuation of coverage shall be treated as being incurred before the
Distribution Date for purposes of determining the party responsible for the
administration of benefits.
(ii) CBI shall use its reasonable best efforts to maintain the
premium rates for all workers' compensation insurance policies for both CBI and
Convergys in effect for periods through the Distribution Date to be based on the
aggregate number of employees covered under the workers' compensation insurance
policies of both CBI and Convergys. Any premiums due under the separate
workers' compensation insurance issued to Convergys shall be payable by
Convergys.
5.4 CONTINUANCE OF ELECTIONS, CO-PAYMENTS AND MAXIMUM BENEFITS.
(a) The transfer or other movement of employment from CBI to
Convergys at any time before the Distribution Date shall constitute a "status
change" under the CBI Health and Welfare Plans or the Convergys Health and
Welfare Plans.
(b) Convergys shall cause the Convergys Health and Welfare Plans to
recognize and give credit for (i) all amounts applied to deductibles,
out-of-pocket maximums, and other applicable benefit coverage limits with
respect to which such expenses have been incurred by Convergys Individuals under
the CBI Health and Welfare Plans for the remainder of the year in which the
Distribution occurs, and (ii) all benefits paid to Convergys Individuals under
the CBI Health and Welfare Plans for purposes of determining when such persons
have reached their lifetime maximum benefits under the Convergys Health and
Welfare Plans.
(c) Convergys shall provide coverage to Convergys Individuals under
the Convergys Group Life Program without the need to undergo a physical
examination or otherwise provide evidence of insurability.
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<PAGE>
ARTICLE VI
EXECUTIVE BENEFITS AND NON-EMPLOYEE DIRECTOR BENEFITS
6.1 LONG TERM INCENTIVE PLANS. For purposes of this Agreement, "CBI LTIP"
means any of the CBI 1988 Long Term Incentive Plan, the CBI 1989 Stock Option
Plan, the CBI 1997 Long Term Incentive Plan, the CBI 1988 Stock Option Plan for
Non-Employee Directors and the CBI 1997 Stock Option Plan for Non-Employee
Directors and "Convergys LTIP" means the Convergys Corporation 1998 Long Term
Incentive Plan.
(a) STOCK OPTIONS. For purposes of this Agreement, "CBI Option"
means an option to purchase CBI common shares pursuant to a CBI LTIP and
"Convergys Option" means an option to purchase Convergys common shares pursuant
to the Convergys LTIP. At the time of the Distribution, each holder of a CBI
Option shall receive a Convergys Option to purchase a number of Convergys common
shares equal to the number of CBI common shares subject to the CBI Option. Each
Convergys Option shall have the same terms and conditions (including vesting) as
the CBI Option with respect to which it is granted, except that termination of
employment shall mean (i) in the case of a CBI employee or director, termination
of employment with CBI and (ii) in the case of a Convergys employee or director,
termination of employment with Convergys. Each CBI Option shall be amended to
provide that, in the case of a Convergys employee or director, termination of
employment shall mean termination of employment with Convergys. The exercise
price per share of each CBI Option (the "CBI Exercise Price") shall be reduced,
and the exercise price per share of the associated Convergys Option (the
"Convergys Exercise Price") shall be set so that (i) the sum of the CBI Exercise
Price (after the reduction provided herein) and the Convergys Exercise Price is
equal to the CBI Exercise Price (before the reduction provided herein) and (ii)
the ratio of the CBI Exercise Price (after the reduction provided herein) to the
Convergys Exercise Price is equal to the ratio of the average of the daily high
and low per-share prices of CBI common shares on the New York Stock Exchange
("NYSE") during each of the five trading days starting on the ex-dividend date
for the Distribution to the average of the daily high and low per-share prices
of Convergys common shares on the NYSE during each of the five trading days
starting on the ex-dividend date for the Distribution. Notwithstanding the
foregoing, in the event that the number of Convergys common shares to be
distributed to each CBI shareholder at the time of the Distribution with respect
to each CBI common share owned by the shareholder on the record date for the
Distribution is greater or less than one, the number of Convergys common shares
represented by each Convergys Option and the Convergys Exercise Price shall be
adjusted to reflect such difference.
(b) RESTRICTED STOCK. For purposes of this Agreement, "CBI
Restricted Stock" means CBI common shares issued subject to restrictions
pursuant to a CBI LTIP and "Convergys Restricted Stock" means Convergys common
shares issued subject to restrictions pursuant to the Convergys LTIP. At the
time of the Distribution, the Convergys common shares distributable to each
holder of CBI Restricted Stock shall be issued pursuant to the Convergys LTIP
and shall be subject to the same restrictions, terms and conditions (including
vesting) as the CBI Restricted Stock with respect to which they are distributed,
except that termination of employment shall mean (i) in the case of a CBI
employee, termination of employment with CBI
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<PAGE>
and (ii) in the case of a Convergys employee, termination of employment with
Convergys. Each CBI Restricted Stock grant shall be amended to provide that, in
the case of a Convergys employee or director, termination of employment shall
mean termination of employment with Convergys.
6.5 CBI EXECUTIVE DEFERRED COMPENSATION PLAN. Immediately after the
Distribution Date, the accrued benefit of any Convergys Individual in the CBI
Executive Deferred Compensation Plan shall be transferred to and assumed by the
Convergys Executive Deferred Compensation Plan.
6.6 DEFERRED COMPENSATION PLAN FOR OUTSIDE DIRECTORS. Immediately after
the Distribution Date, the accrued benefit of any Convergys Non-Employee
Director in the CBI Deferred Compensation Plan for Outside Directors (the "CBI
Directors Plan") shall be transferred to and assumed by the Convergys Deferred
Compensation Plan for Non-Employee Directors (the "Convergys Directors Plan").
The Convergys Directors Plan shall be, with respect to the Convergys
Non-Employee Directors who participated in the CBI Director Plan, in all
respects the successor in interest to, and shall not provide benefits that
duplicate benefits provided by, the CBI Directors Plan.
6.7 CONSENTS AND NOTIFICATIONS. CBI and Convergys shall use their
reasonable best efforts to obtain, or cause to be obtained, to the extent
necessary, the written consent of each Convergys Individual and Convergys
Director who is a party to an individual agreement and/or a participant in the
CBI Executive Deferred Compensation Plan, the CBI Long Term Plan, or the CBI
Deferred Compensation Plan for Outside Directors, to the treatment of such
individual agreement or plan, as applicable, in accordance with this Article VI,
including the assumption by Convergys and the Convergys Entities, of sole
responsibility for, and the release of the CBI Entities from, all liabilities
thereunder; provided, that no failure to seek or to obtain any such consent
shall have any effect upon the obligations of the Convergys Entities with
respect to such liabilities.
6.8 NON-COMPETITION AND CONFIDENTIALITY.
(a) NON-COMPETITION AGREEMENTS AND POLICIES. Prior to the
Distribution Date, CBI and Convergys shall take such action as may be necessary
to ensure that, during the 18-month period commencing on the Distribution Date,
(i) employment with a Convergys Entity shall not be deemed to be in violation of
any CBI Entity non-competition policy or agreement and (ii) employment with any
CBI Entity shall not be deemed to be in violation of any Convergys Entity
non-competition policy or agreement.
(b) CONFIDENTIALITY AND PROPRIETARY INFORMATION. No provision of
this Agreement shall be deemed to release any individual for any violation of
any agreement or policy of a CBI Entity or Convergys Entity pertaining to
confidential or proprietary
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<PAGE>
information of a CBI Entity or Convergys, or otherwise relieve any individual of
his or her obligations under such agreement or policy.
6.9 CORPORATE-OWNED LIFE INSURANCE. CBI shall retain all corporate-owned
life insurance policies that were purchased by CBI in 1986, including those
policies insuring Convergys Individuals. CBI shall continue, liquidate and/or
administer such corporate-owned life insurance policies on terms and conditions
agreed to by CBI and Convergys. Convergys and CBI shall share all information
that may be necessary to identify the individuals insured by the corporate-owned
life insurance policies owned by CBI and to determine when and whether such
individuals are deceased.
6.10 MANAGEMENT INCENTIVE COMPENSATION PAYMENTS. Effective as of the
Distribution Date, Convergys shall assume all liabilities to Convergys
Individuals for bonuses under CBI's 1998 bonus program and all liabilities to
Convergys Individuals for performance awards under CBI's Senior Management Long
Term Incentive Plan for the three-year performance periods commencing in 1996,
1997 and 1998. CBI and Convergys shall determine (a) the extent to which
established performance criteria (after taking into account the effects of the
initial public offering of Convergys common shares and the Distribution) have
been met and (b) the payment level for each Convergys Individual.
ARTICLE VII
GENERAL AND ADMINISTRATIVE
7.1 PAYMENT OF LIABILITIES, PLAN EXPENSES AND RELATED MATTERS.
(a) ACTUARIAL AND ACCOUNTING METHODOLOGIES AND ASSUMPTIONS. For
purposes of this Agreement, unless specifically indicated otherwise: (i) all
actuarial methodologies and assumptions used for a particular Plan shall (except
to the extent otherwise determined by CBI and Convergys to be reasonable or
necessary) be substantially the same as those used in the actuarial valuation of
that Plan used to determine minimum funding requirements under ERISA Section 302
and Code Section 412 for 1998, or, if such Plan is not subject to such minimum
funding requirements, used to determine CBI's deductible contributions under
Code Section 419A or, if such Plan is not subject to Code Section 419A, the
assumptions used to prepare CBI's audited financial statements for 1997, as the
case may be; and (ii) the value of plan assets shall be the value established
for purposes of audited financial statements of the relevant plan or trust for
the period ending on the date as of which the valuation is to be made.
Convergys liabilities relating to, arising out of or resulting from the status
of the Convergys Entities as participating companies in CBI and all accruals
relating thereto shall be determined using actuarial assumptions and
methodologies (including with respect to demographics, medical trends and other
relevant factors) in a manner consistent with CBI's practice as in effect on the
effective date of this Agreement and in conformance with the generally accepted
actuarial principles promulgated by the American Academy of Actuaries, the Code,
ERISA, and/or generally accepted accounting principles, as applicable, in each
case consistent with past CBI
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<PAGE>
practice. Except as otherwise contemplated by this Agreement or as required by
law, all determinations as to the amount or valuation of any assets of or
relating to any CBI Plan (whether or not such assets are being transferred to a
Convergys Plan) shall be made pursuant to procedures to be established by the
parties before the Distribution Date.
(b) PAYMENT OF LIABILITIES; DETERMINATION OF EMPLOYEE STATUS.
Convergys shall pay directly, or reimburse CBI promptly for, all liabilities
assumed by it pursuant to this Agreement, including all compensation payable to
Convergys Individuals for services rendered to a Convergys Entity (i) after the
date of this Agreement, (ii) while in the employ of a CBI Entity and (iii)
before becoming a Convergys Individual. Determinations of what entity employs or
employed a particular individual shall be made by reference to the applicable
legal entity and/or other appropriate accounting code, to the extent possible.
7.2 NON-TERMINATION OF EMPLOYMENT; NO THIRD-PARTY BENEFICIARIES. No
provision of this Agreement shall be construed to create any right, or
accelerate entitlement, to any compensation or benefit whatsoever on the part of
any Convergys Individual or other future, present or former employee of any CBI
Entity or Convergys Entity under any CBI Plan or Convergys Plan or otherwise.
Without limiting the generality of the foregoing: (i) neither the Distribution
nor the termination of the participating company status of a Convergys Entity
shall cause any employee to be deemed to have incurred a termination of
employment which entitles such individual to the commencement of benefits under
any of the CBI Plans (other than the CBI ESOP), any of the Convergys Plans, or
any of the Individual Agreements; and (ii) except as expressly provided in this
Agreement, nothing in this Agreement shall preclude Convergys, at any time after
the Distribution Date, from amending, merging, modifying, terminating,
eliminating, reducing, or otherwise altering in any respect any Convergys Plan,
any benefit under any Convergys Plan or any trust, insurance policy or funding
vehicle related to any Convergys Plan.
7.3 BENEFICIARY DESIGNATIONS. All beneficiary designations made by
Convergys Individuals for CBI Plans shall be transferred to and be in full force
and effect under the corresponding Convergys Plans until such beneficiary
designations are replaced or revoked by the Convergys Individual who made the
beneficiary designation.
7.4 REQUESTS FOR IRS RULINGS AND DOL OPINIONS. The parties shall
cooperate fully with each other on any issue relating to the transactions
contemplated by this Agreement for which either party elects to seek a
determination letter or private letter ruling from the IRS or an advisory
opinion from the Department of Labor.
7.5 FIDUCIARY STATUS. CBI and Convergys each acknowledges that actions
required to be taken pursuant to this Agreement may be subject to fiduciary
duties or standards of conduct under ERISA or other applicable law, and no party
shall be deemed to be in violation of this Agreement if it fails to comply with
any provisions hereof based upon its good faith determination that to do so
would violate such a fiduciary duty or standard.
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7.6 CONSENT OF THIRD PARTIES. If any provision of this Agreement is
dependent on the consent of any third party and such consent is withheld, CBI
and Convergys shall use their reasonable best efforts to implement the
applicable provisions of this Agreement to the full extent practicable. If any
provision of this Agreement cannot be implemented due to the failure of such
third party to consent, CBI and Convergys shall negotiate in good faith to
implement the provision in a mutually satisfactory manner. The phrase
"reasonable best efforts" as used herein shall not be construed to require the
incurrence of any non-routine or unreasonable expense or liability or the waiver
of any right.
ARTICLE VIII
MISCELLANEOUS
8.1 EFFECT IF DISTRIBUTION DOES NOT OCCUR. If the Distribution does not
occur, then all actions and events that are, under this Agreement, to be taken
or occur effective as of the Distribution Date, immediately after the
Distribution Date, or otherwise in connection with the Distribution, shall not
be taken or occur except to the extent specifically agreed by Convergys and CBI.
8.2 RELATIONSHIP OF PARTIES. Nothing in this Agreement shall be deemed or
construed by the parties or any third party as creating the relationship of
principal and agent, partnership or joint venture between the parties, it being
understood and agreed that no provision contained herein, and no act of the
parties, shall be deemed to create any relationship between the parties other
than the relationship set forth herein.
8.3 AFFILIATES. Each of CBI and Convergys shall cause to be performed,
and hereby guarantees the performance of, all actions, agreements and
obligations set forth in this Agreement to be performed by a CBI Entity or a
Convergys Entity, respectively.
8.4 GOVERNING LAW. To the extent not preempted by applicable federal law,
this Agreement shall be governed by, construed and interpreted in accordance
with the laws of the State of Ohio, irrespective of the choice of law
principles of the State of Ohio, as to all matters, including matters of
validity, construction, effect, performance and remedies.
8.5 ARBITRATION. Any dispute, controversy or claim arising out of or in
connection with this Agreement (including any questions of fraud or questions
concerning the validity and enforceability of this Agreement or any of the
rights herein) shall be determined and settled in accordance with Article 11 of
the Plan of Reorganization.
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IN WITNESS WHEREOF, the parties have caused this Employee Benefits
Agreement to be duly executed as of the day and year first above written.
CINCINNATI BELL INC.
By: /s/ John T. LaMacchia
------------------------------------------
John T. LaMacchia, President
and Chief Executive Officer
CONVERGYS CORPORATION
By: /s/ James F. Orr
------------------------------------------
James F. Orr, President
and Chief Executive Officer
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<PAGE>
SUMMARY OF CBI FUNDING POLICY
METHODOLOGY FOR PENSION BENEFITS
Establishment and periodical evaluation of the CBI funding policy require
the determination of current asset and liability values, as well as simulating
the financial operation of the pension plans in future years. A financial
modeling system described below is used to develop a distribution of outcomes
for the financial status of the pension plans in future periods.
Accrued benefit and total projected benefit payment liabilities are
actuarially calculated on the basis of existing plan obligations, and future
liabilities are calculated by projecting future plan operation and experience,
in accordance with reasonable actuarial methods and assumptions, over specified
time periods. The determination of the current market value of plan assets is
based upon market quotations of such values and upon professionally determined
appraisal values. The determination of the distribution of potential future
asset values for the plans is based upon assumed rates of return for each such
asset class, as well as the variability of those returns (standard deviation)
and the relative relationships across each asset class (correlation
coefficient). Once a distribution of possible future asset values has been
determined, the funding policy can be evaluated by determining the probability
of there being adequate assets to meet pension liabilities in the future periods
(e.g., 75% of the possible asset return scenarios in ten years will provide
adequate assets to meet the actuarially determined pension liabilities). The
expected rate of return for each principal asset class, as well as the
mathematical factors used in adjusting each rate of return, are specified below.
The computations based on this Schedule are made using the following
assumptions:
- All actuarial assumptions, including assumptions related to accrued
liability, are identical to the assumptions to be used in the
determination of required minimum contributions under ERISA for the
plan year beginning on January 1, 1998.
- Level future eligible employee populations are assumed.
- No future employer contributions are assumed.
- No transfers in or out of the Plan of liabilities or assets are
assumed.
- Only employees of companies participating in the plan before
January 1, 1998 are taken into account.
- All demographic experience is assumed to occur in accordance with the
actuarial assumptions used to determine the minimum required
contributions under ERISA for the plan year beginning January 1, 1998.
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<PAGE>
- The Wilshire PENSIM model, incorporating ASA system enhancements, with
benefits and present values determined by ASA in accordance with the
assumptions and methods specified in this Schedule are used in the
application of the CBI funding policy requirements.
<TABLE>
<CAPTION>
ASSET CLASS EXPECTED RETURN STAND. DEVIATION
<S> <C> <C>
Large Cap Equities 9.50% 14.86%
Small Cap Equities 11.50% 23.01%
CBI Shares 10.50% 26.81%
International Equities 11.00% 18.87%
Renaissance 8.00% 12.00%
Domestic Bonds 6.00% 8.23%
Convertible Bonds 7.50% 12.82%
High-Yield Bonds 7.00% 8.39%
International Bonds 6.00% 12.42%
Real Estate 6.00% 6.93%
Venture Capital 12.00% 24.54%
Cash 5.00% 2.55%
</TABLE>
18
<PAGE>
CORRELATION COEFFICIENTS
<TABLE>
<CAPTION>
LRG SML HIGH
ASSET CLASS CAP CAP CBI INTL DMST CONV YIELD INTL REAL VENT
EQUITY EQUITY SHRS EQUIT REN BOND BOND BOND BOND ESTAT CAP CASH
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Large Cap
Equities 1.00
Small Cap
Equities 0.82 1.00
CBI Shares 0.40 0.34 1.00
International
Equities 0.46 0.40 0.20 1.00
Renaissance 0.66 0.56 0.35 0.35 1.00
Domestic
Bonds 0.37 0.24 0.30 0.25 0.59 1.00
Convertible
Bonds 0.88 0.79 0.39 0.44 0.64 0.37 1.00
High-Yield
Bonds 0.50 0.42 0.25 0.28 0.45 0.42 0.48 1.00
International
Bonds -0.04 -0.08 0.04 0.01 0.11 0.31 -0.04 0.07 1.00
Real Estate -0.06 -0.03 0.01 -0.12 -0.09 -0.21 -0.05 -0.14 -0.09 1.00
Venture
Capital 0.75 0.68 0.31 0.37 0.51 0.24 0.72 0.39 -0.06 -0.04 1.00
Cash -0.04 -0.03 0.07 -0.11 0.02 -0.03 -0.02 -0.09 -0.02 0.68 -0.04 1.00
</TABLE>
