<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, 1999
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 1-14379
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) 723-7000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X. No .
- -
At October 31, 1999, 152,711,727 Common Shares were outstanding.
<PAGE>
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- ---------------------
1999 1998 1999 1998
--------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Revenues ....................................... $ 450.2 $ 370.3 $ 1,276.2 $ 1,042.5
--------- --------- ---------- ---------
Costs and Expenses
Cost of providing services and products sold 255.1 210.8 725.9 597.5
Selling, general and administrative ........ 74.5 54.5 211.7 160.3
Research and development costs ............. 22.1 24.2 62.0 62.8
Depreciation ............................... 21.8 18.6 62.2 48.6
Amortization ............................... 12.4 9.2 32.2 23.9
Year 2000 programming costs ................ 2.2 7.2 11.2 20.7
Purchased research and development costs ... -- -- 2.0 42.6
--------- --------- ---------- ---------
Total costs and expenses .............. 388.1 324.5 1,107.2 956.4
--------- --------- ---------- ---------
Operating Income ............................... 62.1 45.8 169.0 86.1
Equity in Earnings of Cellular Partnership ..... 10.2 4.6 26.9 15.4
Other Income (Expense), net .................... 0.3 (0.2) (0.9) 0.5
Interest Expense ............................... (8.4) (9.1) (24.4) (26.7)
--------- --------- ---------- ---------
Income Before Income Taxes ..................... 64.2 41.1 170.6 75.3
Income Taxes ................................... 24.5 15.5 65.7 28.4
--------- --------- ---------- ---------
Net Income ..................................... $ 39.7 $ 25.6 $ 104.9 $ 46.9
--------- --------- ---------- ---------
--------- --------- ---------- ---------
Other Comprehensive Income, net of tax:
Foreign currency translation adjustments ..... $ (0.7) $ (1.0) $ 1.3 $ (2.8)
Unrealized gain on investments ............... 8.3 (2.1) 11.0 (2.1)
--------- --------- ---------- ---------
Total other comprehensive income .......... 7.6 (3.1) 12.3 (4.9)
--------- --------- ---------- ---------
Comprehensive Income ........................... $ 47.3 $ 22.5 $ 117.2 42.0
--------- --------- ---------- ---------
--------- --------- ---------- ---------
Earnings Per Common Share
Basic ...................................... $ .26 $ .18 $ .69 $ .34
--------- --------- ---------- ---------
--------- --------- ---------- ---------
Diluted .................................... $ .26 $ .18 $ .68 $ .34
--------- --------- ---------- ---------
--------- --------- ---------- ---------
Average Common Shares
Basic ...................................... 151.7 144.8 151.7 139.6
Diluted .................................... 155.0 145.1 154.4 139.7
</TABLE>
See Notes to Financial Statements.
2
<PAGE>
Form 10-Q Part I Convergys Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Millions, Except Share Amounts)
<TABLE>
<CAPTION>
(Unaudited)
September 30, December 31,
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents..................................... $ 42.4 $ 3.8
Receivables, less allowances of $15.6 and $9.8................ 351.8 314.3
Deferred income taxes......................................... 17.6 10.9
Prepaid expenses and other current assets..................... 39.8 31.5
------------ ------------
Total current assets........................................ 451.6 360.5
Property and equipment - net..................................... 298.1 249.8
Goodwill and other intangibles - net............................. 744.0 687.4
Investment in cellular partnership............................... 97.2 81.6
Deferred charges and other assets................................ 72.1 71.6
------------ ------------
Total Assets................................................ $ 1,663.0 $ 1,450.9
------------ ------------
------------ ------------
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities
Debt maturing in one year..................................... $ 500.5 $ 466.8
Payables and other current liabilities........................ 289.2 239.6
------------ ------------
Total current liabilities................................... 789.7 706.4
Long-term liabilities............................................ 15.7 13.0
------------ ------------
Total liabilities........................................... 805.4 719.4
------------ ------------
Shareowners' Equity
Common shares - without par value, 500,000,000 authorized;
152,717,745 issued and outstanding.......................... 206.0 206.0
Additional paid-in capital.................................... 484.0 475.1
Retained earnings............................................. 157.9 53.0
Accumulated other comprehensive income........................ 9.7 (2.6)
Total shareowners' equity................................... 857.6 731.5
------------- ------------
Total Liabilities and Shareowners' Equity................... $ 1,663.0 $ 1,450.9
------------ ------------
------------ ------------
</TABLE>
See Notes to Financial Statements.
3
<PAGE>
Form 10-Q Part I Convergys Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Millions)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
---------------------
1999 1998
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................................................................... $ 104.9 $ 46.9
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization............................................................... 94.4 72.5
Deferred income tax provision............................................................... 1.5 1.7
Purchased research and development costs.................................................... 2.0 42.6
Undistributed earnings of cellular partnership.............................................. (15.6) (15.4)
Changes in assets and liabilities, net of effects from acquisitions:
Increase in receivables..................................................................... (30.6) (34.0)
Decrease (increase) in other current assets................................................. (8.3) 5.9
Increase (decrease) in payables and other current liabilities............................... 52.5 (7.7)
Other, net.................................................................................. (6.5) (14.7)
--------- ---------
Net cash provided by operating activities................................................... 194.3 97.8
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures.......................................................................... (88.8) (65.0)
Acquisitions, net of cash acquired............................................................ (114.4) (658.3)
-------- --------
Net cash used in investing activities....................................................... (203.2) (723.3)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under revolving credit facility, net............................................... 33.7 -
Repayment of long-term debt................................................................... - (6.1)
Change in debt payable to CBI................................................................. - 424.6
Issuance of Wiztec common shares under Wiztec option plans.................................... 4.9 -
Issuance of common shares..................................................................... 8.9 206.3
-------- --------
Net cash provided by financing activities................................................... 47.5 624.8
-------- --------
Net increase (decrease) in cash and cash equivalents.......................................... 38.6 (0.7)
Cash and cash equivalents at beginning of period.............................................. 3.8 2.1
-------- --------
Cash and cash equivalents at end of period.................................................... $ 42.4 $ 1.4
-------- --------
-------- --------
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
(1) BACKGROUND AND BASIS OF PRESENTATION
BACKGROUND
Convergys Corporation (the Company) was organized on May 8, 1998, as a
wholly owned subsidiary of Cincinnati Bell Inc. (CBI) with 100 common
shares outstanding. 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), to sell up to 20% of the Company's outstanding shares
in an initial public offering and to distribute the remaining shares of
the Company to shareowners of CBI in late 1998. In July 1998, CBI
contributed to the Company the outstanding common shares of CBIS and
MATRIXX along with its 45% limited partnership interest in a cellular
communications services provider in southwestern and central Ohio and
northern Kentucky (the Cellular Partnership). Upon transfer of the
common shares of CBIS and MATRIXX, the two subsidiaries became
subsidiaries of the Company doing business as the Information
Management Group (IMG) and Customer Management Group (CMG),
respectively. 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.
Effective August 4, 1998, the Company approved a share split which
increased the number of outstanding common shares to 137.0. On August
13, 1998, the Company issued an additional 14.95 common shares,
approximately 10% of the then outstanding shares, to the public at a
price of $15 per share less underwriting discounts and commissions of
$.98 per share. On December 31, 1998, CBI distributed all of its
remaining interest in the Company to existing CBI shareholders.
BASIS OF PRESENTATION
The consolidated financial statements for 1998 have been prepared using
the historical results of operations and historical bases of the assets
and liabilities of the Company's businesses and have been presented as
if the Company was a separate entity during 1998. Additionally, the
consolidated financial statements for 1998 include the allocation of
certain CBI corporate headquarters' expenses. Management believes these
allocations are reasonable. All intercompany transactions and balances
between the Company's businesses have been eliminated.
The consolidated financial statements of the Company have been prepared
pursuant to the rules and regulations of the Securities and Exchange
Commission (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 3. The December 31, 1998 condensed balance sheet has
been 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 the financial statements and the notes thereto included in the
Company's annual report on Form 10-K. Certain prior year amounts have
been reclassified to conform to current year presentation.
(2) CMG BUSINESS RESTRUCTURING
In the fourth quarter of 1997, the Company approved a restructuring
plan for CMG. The restructuring plan included the consolidation of
certain CMG operating divisions and facilities. CMG recorded a special
charge of $35.0, which reduced net income by $23.0. At September 30,
1999, the balance of the restructuring liability was $9.0, primarily
for lease termination and other facility consolidation costs.
Management expects the restructuring plan activities to be
substantially completed by the end of 1999.
(3) ACQUISITIONS
On June 15, 1999, the Company paid approximately $20 to acquire the
assets of Technology Applications Inc. (TAI), a software development
and systems integration company that creates customer care and billing
software for Internet service providers. The acquisition was accounted
for under the purchase method of accounting with resulting goodwill
being amortized over a ten-year life.
5
<PAGE>
During the nine months ended September 30, 1999, the Company paid
approximately $115 in a series of transactions to acquire an additional
75% ownership interest in Wiztec Solutions Ltd. (Wiztec). These
transactions increased the Company's ownership of Wiztec to
approximately 95%. Wiztec, based in Herzlia, Israel, is a provider of
subscriber management systems for multi-channel subscription television
operators. The investment was accounted for under the purchase method
of accounting. The Company allocated $2.0 of the purchase price to one
in-process research and development project that had not reached
technological feasibility at the time of the acquisition and had no
alternative future use. The fair value of the assets acquired was
determined by an independent valuation performed at the time of the
acquisition. The excess of the purchase price over the fair value of
the tangible assets acquired was allocated principally to software
($29), trademarks ($13) and goodwill ($51). Goodwill will be amortized
over a 15-year life.
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 in cash. The acquisition was accounted for
under the purchase method of accounting. At the time of the
acquisition, the Company began a process of evaluating an integration
plan for the acquired operations. In 1998, the Company increased
goodwill by approximately $9 for employee severance and other
integration costs. At September 30, 1999, implementation of this plan
was substantially complete.
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 the nine-month period ended
September 30, 1998:
<TABLE>
<CAPTION>
1998
-------------
<S> <C>
Revenues......................................... $ 1,104.9
Net Income....................................... $ 41.5
Earnings per share:
Basic........................................ $ .30
Diluted...................................... $ .30
</TABLE>
On January 8, 1998, CMG acquired the customer management assets of
Maritz, Inc. for approximately $30 in cash. The acquisition agreement
contains provisions that could increase the purchase price by up to $20
based upon the operating results of the acquired business over the two-
year period after the acquisition. Based on the first year of results
following the acquisition, the Company has paid an additional $3.7 to
the former owners of Maritz, which has been included in goodwill. The
acquisition was accounted for under the purchase method of accounting
with goodwill amortized over a twenty-five year life.
(4) SIGNIFICANT CUSTOMER
Both of the Company's segments derive significant revenues from AT&T.
Revenues from AT&T were 39.6% and 37.5% of the Company's consolidated
revenues for the nine-month periods ended September 30, 1999 and 1998,
respectively. Related accounts receivable from AT&T totaled $102.4 and
$99.6 at September 30, 1999 and December 31, 1998, respectively. The
Company's relationship with AT&T includes its use of AT&T communication
services, which is particularly significant to the CMG segment. The
Company's spending for these services with AT&T was $78.5 and $69.8 for
the nine-month periods ended September 30, 1999 and September 30, 1998,
respectively.
(5) 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 or results of operations.
6
<PAGE>
(6) BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION
INDUSTRY SEGMENT INFORMATION
The Company operates in two industry segments which are identified by
service offerings. IMG is principally engaged in providing information
systems and billing services to the communications, cable and broadband
services industries. CMG provides a full range of outsourced marketing
and customer management services to large companies.
The Company does not allocate activities below the operating income
level to its reported segments. Certain corporate administrative
expenses have been allocated to segments based upon the nature of the
expense. The Company's business segment information is as follows:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------- -------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues
Information management....................... $ 179.1 $ 147.9 $ 507.3 $ 437.9
Customer management.......................... 279.9 231.4 795.4 620.4
Less: intersegment........................... (8.8) (9.0) (26.5) (15.8)
--------- --------- --------- ---------
$ 450.2 $ 370.3 $ 1,276.2 $ 1,042.5
--------- --------- --------- ---------
--------- --------- --------- ---------
Depreciation
Information management....................... $ 7.7 $ 6.2 $ 21.7 $ 17.3
Customer management.......................... 13.6 12.4 39.5 31.3
Corporate.................................... 0.5 -- 1.0 --
--------- --------- --------- ---------
$ 21.8 $ 18.6 $ 62.2 $ 48.6
--------- --------- --------- ---------
--------- --------- --------- ---------
Amortization
Information management....................... $ 4.5 $ 1.5 $ 8.6 $ 4.5
Customer management.......................... 7.9 7.7 23.6 19.4
Corporate.................................... -- -- -- --
--------- --------- --------- ---------
$ 12.4 $ 9.2 $ 32.2 $ 23.9
--------- --------- --------- ---------
--------- --------- --------- ---------
Special Items - Acquired Research and Development
Information management....................... $ -- $ -- $ 2.0 $ --
Customer management.......................... -- -- -- 42.6
--------- --------- --------- ---------
$ -- $ -- $ 2.0 $ 42.6
--------- --------- --------- ---------
--------- --------- --------- ---------
Operating Income
Information management....................... $ 34.3 $ 28.9 $ 95.3 $ 83.5
Customer management.......................... 29.6 17.1 78.4 2.9
Corporate.................................... (1.8) (0.2) (4.7) (0.3)
--------- --------- --------- ---------
$ 62.1 $ 45.8 $ 169.0 $ 86.1
--------- --------- --------- ---------
--------- --------- --------- ---------
Capital Expenditures
Information management....................... $ 9.7 $ 9.5 $ 24.8 $ 31.1
Customer management.......................... 26.1 15.3 55.3 33.9
Corporate.................................... 0.5 -- 8.7 --
--------- --------- --------- ---------
$ 36.3 $ 24.8 $ 88.8 $ 65.0
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
7
<PAGE>
(7) SUBSEQUENT EVENTS
On October 1, 1999, the Company entered into transactions in which it
simultaneously purchased and sold call options on the S&P 500 index of
equity securities (the Index Options) expiring in January 2000. The
Index Options were purchased for approximately $3.9 for investment
purposes. The investments in the purchased and sold call option
contracts were recorded by the Company at their fair market value of
$3.9 on a net basis because the terms of the Index Option contracts
provide for the right of offset. On October 6, 1999, the Company closed
its position in the purchased call options and replaced them with
similar options at the current market price resulting in a realized
gain which is offset by unrealized losses. These subsequent
transactions resulted in an investment in the Index Options totaling
$7.8. The realized gain will be offset by net unrealized losses
recognized in the fourth quarter of 1999.
Also on October 1, 1999, the Company entered into an agreement under
which it received $193 for the sale of accounts receivable without
recourse. The sale did not result in any gain or loss to the Company.
The agreement specifies that the Company will continue to service these
accounts and provides for the sale of additional receivables as
collections reduce the outstanding balance of the accounts that were
sold. Proceeds from the sale were used to repay a portion of the
Company's outstanding short-term borrowings.
8
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
BACKGROUND
Convergys Corporation (the Company) is a leading provider of outsourced
information and customer management services. The Company focuses on developing
long-term strategic relationships with clients in customer-intensive industries
including telecommunications, cable, broadband, satellite broadcasting, Internet
services, utilities, technology, banking and financial services, consumer
products, healthcare and pharmaceuticals. The Company serves its client base
through its two operating subsidiaries: (i) Information Management Group (IMG),
which provides outsourced billing and information services; and (ii) Customer
Management Group (CMG), which provides outsourced marketing and customer support
services. For certain clients, IMG and CMG jointly provide a full range of
billing and customer management services.
The amounts presented for the three and nine months ended September 30, 1998
have been carved out from the financial statements of Cincinnati Bell Inc. (CBI)
using the historical results of operations and the historical bases of the
assets and liabilities of the contributed businesses. The 1998 financial
statements include the allocation of certain corporate expenses from CBI to the
Company. Additionally, through December 23, 1998, the Company's debt financing
was provided by CBI at rates based on CBI's external borrowing rates. On
December 23, 1998, the Company repaid the debt payable to CBI with financing
obtained through a revolving credit facility. Management believes that the
assumptions made in preparing the 1998 consolidated financial statements of the
Company on a carve-out basis are reasonable. The 1998 financial information
presented, however, may not necessarily reflect the results of operations,
financial position and cash flows of the Company in the future or what they
would have been had the Company been a separate, stand-alone entity during 1998.
As disclosed at the time of the Company's initial public offering, the
Company will continually evaluate opportunities to change the operations of
its businesses, as warranted, to improve efficiency and client focus.
Management is currently evaluating plans to merge its data center activities
and other support functions. These plans could lead to certain facility
consolidations, which could result in a charge to earnings in the fourth
quarter of 1999. Any such charge would primarily be for leased facility exit
costs. The amount of any such charge can not be determined at this time.
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. Detailed comparisons of
revenue and expenses are presented in the discussions of IMG and CMG, which
follow the consolidated results discussion. Results for interim periods may not
be indicative of the results for the full years.
CONSOLIDATED OVERVIEW
THREE MONTHS ENDED SEPTEMBER 30, 1999 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
1998
The Company's revenues for the third quarter of 1999 totaled $450.2, a 22%
increase from the third quarter of 1998. Revenue increases were experienced by
both of the Company's subsidiaries. The Company's operating expenses for the
third quarter of 1999 totaled $388.1, a 20% increase from the third quarter of
1998, reflecting greater business volume. The Company's operating income was
$62.1 in the third quarter of 1999, a 36% increase from the third quarter of
1998.
The Company's equity in the earnings of its Cellular Partnership was $10.2 for
the third quarter of 1999, a $5.6 increase compared to the same period in 1998.
Interest expense decreased 8% in the third quarter of 1999 from the third
quarter of 1998, as a result of strong operating cash flows and application of
the August 1998 initial public offering proceeds to repay borrowings. Net income
was $39.7, or $.26 per share, a 55% increase from $25.6 or $.18 per share in the
third quarter of 1998.
One factor impacting results for the third quarter of 1999 was the Company's
investment in the development of platforms to provide complex billing
capabilities for Internet Protocol (IP) services. IP services initiatives
reduced earnings per share for the quarter by approximately one-and-one half
cents. It is expected that this investment will continue in future quarters
through 2000 at similar or somewhat higher levels as IMG develops solutions for
Internet service providers, digital subscriber line carriers and backbone
transport carriers.
9
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1999 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1998
The Company's revenues for the first nine months of 1999 totaled $1,276.2, a 22%
increase from the first nine months of 1998. Effective February 28, 1998, the
Company acquired American Transtech, Inc. and the Canadian assets of AT&T's
Canadian customer care business (Transtech) from AT&T. The Company's revenues
for the nine-month period increased approximately 16% adjusted to include
Transtech as if it had been acquired at the beginning of 1998. The Company's
operating expenses for the first nine months of 1999 totaled $1105.2, a 21%
increase over the first nine months of 1998, excluding special items. The
Company's operating expenses, excluding special items in both periods, increased
approximately 13% adjusted to include Transtech as if it had been acquired at
the beginning of both periods. Results for the nine months ended September 30,
1999 and 1998 reflect the expensing of $2.0 (pre-tax and after tax) and $42.6
($26.4 after tax) in acquisition-related research and development costs,
respectively.
The Company's operating income was $171.0 in the first nine months of 1999, a
33% increase from the first nine months of 1998, excluding special items.
Including the special items, operating income was $169.0 in the first nine
months of 1999 and $86.1 in the first nine months of 1998.
The Company's equity in the earnings of its Cellular Partnership in the first
nine months of 1999 was $26.9, an increase of $11.5 compared to the first nine
months of 1998. Interest expense decreased 9% in the first nine months of 1999
from the first nine months of 1998 as a result of strong operating cash flow and
application of the August 1998 initial public offering proceeds to repay
borrowings. Net income for the first nine months of 1999 was $106.9, or $.69 per
share, a 46% increase compared to $73.3, or $.52 per share, for the first nine
months of 1998, excluding special items in both periods. Including the special
items, the Company's net income was $104.9 or $.68 per share in the first nine
months of 1999 and $46.9 or $.34 per share in the first nine months of 1998.
INFORMATION MANAGEMENT
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------------------- --------------------------------
1999 1998 Change % 1999 1998 Change %
------- ------- ------------- ------ ------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Information processing............... $ 110.3 $ 88.9 $ 21.4 24 $305.4 $266.9 $ 38.5 14
Professional and consulting.......... 34.9 33.0 1.9 6 109.9 103.8 6.1 6
License and other.................... 10.4 6.7 3.7 55 27.8 19.8 8.0 40
International........................ 14.7 10.4 4.3 41 37.7 31.8 5.9 19
------- ------- ------- ------ ------ -------
External revenues ............... 170.3 139.0 31.3 23 480.8 422.3 58.5 14
Intercompany services for CMG........ 8.8 8.9 (0.1) (1) 26.5 15.6 10.9 70
------- ------- ------- ------ ------ -------
Total revenues...................... 179.1 147.9 31.2 21 507.3 437.9 69.4 16
Costs of products and services 92.2 75.5 16.7 22 266.9 221.4 45.5 21
Selling, general and administrative
expenses............................... 20.6 15.5 5.1 33 57.1 49.7 7.4 15
Research and development costs........... 18.0 15.3 2.7 18 48.3 46.8 1.5 3
Depreciation............................. 7.7 6.2 1.5 24 21.7 17.3 4.4 25
Amortization............................. 4.5 1.5 3.0 - 8.6 4.5 4.1 91
Year 2000 programming costs.............. 1.8 5.0 (3.2) (64) 7.4 14.7 (7.3) (50)
Special item............................. - - - - 2.0 - 2.0 -
------- ------- ------- ------ ------ -------
Total costs......................... 144.8 119.0 25.8 22 412.0 354.4 57.6 16
------- ------- ------- ------ ------ -------
Operating income......................... $ 34.3 $ 28.9 $ 5.4 19 $ 95.3 $ 83.5 $ 11.8 14
</TABLE>
10
<PAGE>
THREE MONTHS ENDED SEPTEMBER 30, 1999 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
1998
Excluding intercompany activity, revenues for the Company's information
management segment increased 23% from the third quarter of 1998. Information
processing revenues increased 24% in the third quarter of 1999 over the third
quarter of 1998, primarily as a result of subscriber growth in IMG's wireless
client base. IMG's wireless billing clients' subscriber levels increased 33% in
the quarter from levels in the third quarter of 1998. Professional and
consulting revenues rose 6% from the third quarter of 1998 reflecting increased
system enhancement services for personal communication services (PCS) clients.
IMG's license and other revenues increased 55% to $10.4 in the third quarter of
1999 reflecting general growth in the Company's cable operations and license and
support fees associated with the Company's contract with Media One which was
signed in the fourth quarter of 1998. IMG's international revenues increased 41%
to $14.7 in the third quarter of 1999 from the third quarter of 1998, primarily
reflecting the Company's acquisition of a controlling interest in Wiztec
Solutions, Ltd. (Wiztec). Wiztec's revenues more than offset the termination of
one international wireless contract in the first quarter of 1999 and the winding
down of two long-term international contracts at the end of 1998.
IMG's costs and expenses in the third quarter of 1999 increased 22% over the
third quarter of 1998. The increase was the result of increased direct costs
associated with higher business volume and incremental costs associated with the
acquisitions of controlling interests in Wiztec and Technology Applications Inc
(TAI). Included in the cost increases is a $3.0 increase in amortization of
intangible assets related to these acquisitions. Cost increases also included
the effect of higher wage rates, particularly for software professionals. An
additional factor leading to the cost increase was IMG's spending to develop its
billing platforms to provide billing services for IP services. These increases
were partially offset by a $3.2 decrease in Year 2000 programming costs in the
third quarter of 1999 from the third quarter of 1998. The decrease in Year 2000
programming costs reflects IMG's progress in substantially completing its
systems and software modifications to prepare for the Year 2000 date change.
NINE MONTHS ENDED SEPTEMBER 30, 1999 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1998
Excluding intercompany revenues, revenues for the Company's information
management segment for the first nine months of 1999 increased 14% from the
first nine months of 1998. Information processing revenues increased 14% in the
first nine months of 1999 from the first nine months of 1998, primarily as a
result of subscriber growth in IMG's wireless client base. IMG's wireless
billing clients' subscriber levels increased 30% in the first nine months from
levels in the first nine months of 1998. The increase resulting from the
subscriber base was partially offset by contractual rate reductions which went
into effect in the first quarter of 1999, some of which were triggered by
certain clients' higher subscriber levels. IMG's professional and consulting
service revenues increased 6% in the first nine months of 1999 over the first
nine months of 1998. This increase was primarily attributable to growth in such
services for cellular and personal communication services (PCS) clients and new
opportunities in the cable broadband market. These increases were partially
offset by reduced services to a client that was acquired by an IMG competitor.
IMG's license and other revenues increased 40% in the first nine months of 1999
as compared to the first nine months of 1998 reflecting general growth in the
Company's cable operations and license and support fees associated with the
Company's contract with Media One. IMG's international revenues increased 19% in
the first nine months of 1999 from the first nine months of 1998, primarily
reflecting the Wiztec acquisition in March 1999, which was offset by termination
of one wireless contract and the winding down of two long-term international
contracts.
IMG's costs and expenses, excluding a $2.0 special item for purchased in-process
research and development associated with Wiztec, in the first nine months of
1999 increased 16% over the first nine months of 1998. This increase was
principally the result of higher direct costs associated with greater business
volume and incremental costs from the Wiztec and TAI acquisitions. Labor costs
increased due to higher wage rates, particularly for software professionals.
These increased costs and expenses were partially offset by a $7.3 decrease in
Year 2000 programming costs in the first nine months of 1999 from the first nine
months of 1998.
IMG's top three clients accounted for 56% and 60% of its revenues for the first
nine months of 1999 and 1998, respectively. IMG maintains multi-year contracts
with its clients. On August 2, 1999, IMG announced an extension of its contract
with AT&T Wireless Services, an affiliate of AT&T Corporation which is IMG's
largest customer. The billing and customer service contract, which was to expire
in 2001, will now run into 2004.
11
<PAGE>
The wireless industry, which IMG serves, is currently experiencing
consolidation. 360(degree) Communications, representing approximately 3% of the
Company's revenues in the first nine months of 1999, was acquired during 1998 by
ALLTEL, one of IMG's competitors. On September 14, 1999, the companies reached
an agreement on a contract amendment, under which ALLTEL will migrate its
subscribers from IMG's billing software beginning in the second quarter of 2000.
ALLTEL has indicated that it expects to complete the migration of its
subscribers by the end of 2001. The contract will terminate when this migration
of subscribers is complete. Under the terms of the amended contract, Convergys
will receive payments totaling $55 in installments made primarily in 1999 and
2000 as well as amounts for data processing and professional and consulting
services through the contract termination date. The amended contract provides a
floor for annual processing revenues to be billed to ALLTEL in both 2000 and
2001 as well as a monthly minimum for any period after 2001 during which IMG
provides any information processing services under the contract. The amended
contract is not expected to impact IMG's revenues or operating income
significantly in 1999 and 2000, but IMG will have to replace lost revenues
beginning in 2001 to offset the negative impact on operating results.
On October 8, 1999, SBC Communications completed its acquisition of Ameritech, a
client representing approximately 4% of the Company's revenues for the first
nine months of 1999. On August 5, 1999, IMG announced that it had agreed to an
extension of the Ameritech contract through September 30, 2004. The extended
contract replaced an existing arrangement under a binding letter of intent.
Under the agreement, IMG will remain the exclusive wireless billing service
provider for Ameritech. Additionally, the Ameritech contract extension provides
terms under which IMG would continue to serve the approximately 50% of
Ameritech's wireless subscribers that Ameritech has agreed to transfer to GTE
into 2001 under provisions that the Company believes are as favorable as those
currently in place.
On October 22, 1999, Media One, an IMG client representing less than 1% of the
Company's revenues, announced that its shareholders had approved its merger with
AT&T. AT&T's acquisition of Media One is currently awaiting regulatory approval.
Under its contract with Media One, IMG has converted over 500,000 Media One
subscribers onto its systems. In October 1999, Media One notified IMG that,
following a conversion scheduled for the fourth quarter of 1999, they would not
move forward with additional subscriber conversions to IMG's systems until after
the merger with AT&T is completed. IMG provides services to Media One under a
license agreement with over 70% of the contract revenues guaranteed.
Accordingly, the delay in Media One conversions will not materially impact the
Company's operating results for 1999 or 2000.
A significant amount of IMG's growth is the result of continued increases in the
number of wireless subscribers in the domestic marketplace. If the domestic
wireless industry growth rate were to decline in the future, IMG's ability to
grow revenues and earnings could be affected.
CUSTOMER MANAGEMENT
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------------------- --------------------------------
1999 1998 Change % 1999 1998 Change %
------- ------- ------------- ------ ------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Dedicated services.................. $ 224.0 $ 177.2 $ 46.8 26 $615.9 $460.4 $ 155.5 34
Traditional services................ 42.6 46.2 (3.6) (8) 136.6 135.8 0.8 1
International....................... 13.3 8.0 5.3 66 42.9 24.2 18.7 77
------- ------- ------- ------ ------ -------
Total revenues................. $ 279.9 $ 231.4 $ 48.5 21 $795.4 $620.4 $ 175.0 28
Costs of products and services........... 171.7 143.1 28.6 20 485.4 387.8 97.6 25
Selling, general and administrative
expenses............................... 52.6 40.0 12.6 32 151.0 114.4 36.6 32
Research and development costs........... 4.1 8.9 (4.8) (54) 13.7 16.0 (2.3) (14)
Depreciation............................. 13.6 12.4 1.2 10 39.5 31.3 8.2 26
Amortization............................. 7.9 7.7 0.2 3 23.6 19.4 4.2 22
Year 2000 programming costs.............. 0.4 2.2 (1.8) (82) 3.8 6.0 (2.2) (37)
Special item............................. -- -- -- -- -- 42.6 (42.6) --
------- ------- ------- ------ ------ -------
Total costs.................... 250.3 214.3 36.0 17 717.0 617.5 99.5 16
------- ------- ------- ------ ------ -------
Operating income ........................ $ 29.6 $ 17.1 $ 12.5 73 $ 78.4 $ 2.9 $ 75.5 -
</TABLE>
12
<PAGE>
THREE MONTHS ENDED SEPTEMBER 30, 1999 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
1998
Revenues for the Company's customer management segment increased 21% in the
third quarter of 1999 from the third quarter of 1998. 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 26% which is
primarily the result of growth in services provided to communications and direct
broadcast clients. Traditional, campaign-based, teleservices revenues decreased
by 8% as AT&T shifted its emphasis towards dedicated programs. CMG's
international revenues increased 66% in the third quarter of 1999 over levels in
the third quarter of 1998, reflecting the growth of the Company's dedicated
customer service business in Europe and the acquisition of Exit Marketing AB in
Sweden late in 1998.
CMG's costs and expenses in the third quarter of 1999 increased 17% from the
third quarter of 1998. This increase was primarily due to higher labor and
facility costs needed to support the increased business volume. These increases
were partially offset by lower research and development spending resulting from
the completion of a project to implement a new platform for CMG's employee care
business and lower Year 2000 programming costs.
NINE MONTHS ENDED SEPTEMBER 30, 1999 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1998
Revenues for the Company's customer management segment increased 28% in the
first nine months of 1999 from the first nine months of 1998. The revenue
increase was approximately 16%, adjusted for the acquisition of Transtech.
Dedicated services revenues rose 34%, including most of the revenue increase
contributed by Transtech. Traditional, campaign-based, teleservices revenues
increased by approximately 1% over the first nine months of 1998. CMG's
international revenues increased $18.7 in the first nine months of 1999 over
levels in the first nine months of 1998, reflecting the growth of the Company's
dedicated customer service business in Europe and the acquisition of Exit
Marketing AB in Sweden late in 1998.
CMG's costs and expenses increased 16% in the first nine months of 1999 from the
first nine months of 1998. Costs and expenses excluding special items in 1998
increased by approximately 13% adjusted for the acquisition of Transtech. This
increase was primarily due to higher labor and facility costs needed to support
higher revenues and was partially offset by lower Year 2000 programming costs.
Included in the increase resulting from the Transtech acquisition was an
increase of approximately $4 in amortization of goodwill and other intangible
assets.
CMG's top three clients accounted for 55% of its revenues for the first nine
months of 1999 and 50% for the same period in 1998. The acquisition of Transtech
and growth in existing business with AT&T 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. Additionally, during the first quarter of 1999, CMG agreed to an
extension of its contract through 2002 to provide customer management services
to DirecTV, its second largest client. However, despite long-term contracts with
CMG's two largest clients, significant quarterly fluctuations may still occur.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
Operating cash flows have historically been more than sufficient to fund the
Company's cash needs, other than for acquisitions. The Company's acquisitions
have historically been financed with a combination of borrowings and operating
cash flows. At September 30, 1999, the Company had $500.5 of short-term variable
rate debt outstanding. The Company's short-term borrowing facilities have a $600
borrowing capacity and expire in December 1999. The Company has begun
discussions to extend the facility with some of the extension likely to be on a
longer-term basis. Additionally, on October 1, 1999, the Company entered into a
receivables securitization agreement which generated $193 which was used to
repay a portion of outstanding short-term borrowings under its short-term
borrowing facilities.
13
<PAGE>
CASH FLOW STATEMENT
The Company's operating activities generated $194.3 in cash during the first
nine months of 1999 compared to $97.8 during the first nine months of 1998. The
$97.8 in cash flows from operating activities for the first nine months of 1998
were negatively impacted by $50 in post-acquisition working capital needs at
Transtech and Maritz. The remaining increase in cash from operating activities
is the result of increased earnings, the receipt of an $11.3 distribution from
the Cellular Partnership in the second quarter of 1999 and net favorable
fluctuations in working capital accounts.
The additional investments in Wiztec and the acquisition of TAI during the first
nine months of 1999 required approximately $110 in cash, net of cash acquired.
Excluding acquisitions, capital expenditures in the first nine months of 1999
were $88.8, up from $65.0 from 1998 and were principally related to opening of
additional call centers. During the first nine months of 1999, the Company
incurred $3.0 in cash payments related to the 1997 CMG restructuring plan.
Future cash outflows under the plan are expected to be approximately $7,
primarily for ongoing facility lease obligations.
BALANCE SHEET
The $37.5 increase in accounts receivable from December 31, 1998 to September
30, 1999 was largely attributable to revenue increases and the inclusion of
Wiztec's accounts receivable in the September 30, 1999 balance sheet. The nearly
60% increase in receivables allowances reflects additional allowances for a CMG
client that has subsequently filed for bankruptcy protection and for CMG client
disputes. Increases in property and equipment and goodwill and other intangibles
were also caused by the Wiztec and TAI transactions. The increase in other
comprehensive income is primarily the result of unrealized investment gains on
investments in publicly-traded companies, most notably Kana Communications, Inc.
YEAR 2000 PROGRAMMING
The Company initiated a program in 1995 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. Given its reliance on
its information and business systems, the Company's Year 2000 efforts have
primarily focused on information technology systems. The Company incurred $2.2
and $11.2 in expenses during the three and nine month periods ended September
30, 1999, respectively, in order to prepare for the Year 2000 and $7.2 and $20.7
in the same periods of 1998. The Company estimates its Year 2000 expenses in
1999 will be approximately $13.
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, Convergys' Year 2000 Program Management Office. The
Program Management Office's responsibility is to make Convergys Year 2000
compliant. The Program Management Office is also communicating with vendors and
clients with which the Company's systems interface, or upon whom the Company's
systems rely, to determine their progress toward Year 2000 compliance.
Additionally, senior management provides a report on the Company's progress
toward Year 2000 compliance at each meeting of the Company's Board of Directors.
IMG has adopted a repair strategy to modify its existing systems for the Year
2000. IMG's assessment, remediation, implementation and testing phases of the
project are substantially complete. IMG has met its goal for its data centers,
software and other information technology systems to be Year 2000 compliant and
tested by June 30, 1999. Continual testing will occur through the remainder of
1999 and into 2000 to ensure continued compliance.
CMG has adopted a strategy that includes both repair and replacement of current
systems. CMG has completed the assessment, implementation and remediation phases
of its plan and is substantially complete regarding systems testing. CMG has met
its goal for its critical systems to be Year 2000 compliant by the end of the
third quarter. Testing activities will continue throughout the remainder of 1999
and into 2000 to ensure continued compliance.
14
<PAGE>
For the remainder of 1999, the majority of the Company's Year 2000 efforts will
be focused on rollover and contingency planning to address issues that may arise
despite the Company's remediation and testing efforts. These plans include post
rollover readiness confirmation activities, key subject matter expert
availability, and alternative business processes. The Company maintains business
continuity and disaster recovery plans to limit disruptions to its operations.
As part of its Year 2000 efforts, the Company has updated these plans to address
Year 2000 issues. The Company has obtained Year 2000 compliance statements from
all significant vendors. Although the Company anticipates minimal business
disruption as a result of the century change, if the Company were to be
unsuccessful in preparing for the Year 2000, this could have a material adverse
impact on the Company. Such an impact could include the inability of IMG to
process bills and other transactions for its clients in a timely manner, which
could lead to contractual penalties. Similarly, this could include disruptions
to CMG's ability to handle client call volumes appropriately, which could also
lead to contractual penalties. The failure of one of the Company's significant
clients or vendors (in particular, utilities or telecommunication services
providers) to prepare for the Year 2000 successfully could have a material
adverse impact on the Company.
MARKET RISK
The Company is exposed to the impact of interest rate changes and, to a lesser
extent, foreign currency fluctuations. It is the Company's policy to enter into
interest rate and foreign currency transactions only to the extent considered
necessary to meet its objectives. The Company has not entered into interest rate
or foreign currency transactions for speculative purposes.
At September 30, 1999, the Company had approximately $500 in variable rate,
short-term debt. The Company's exposure to interest rate risk results from it's
variable rate, short-term debt outstanding under its credit facility. Based upon
the Company's level of indebtedness at September 30, 1999, a one-percentage
point increase in the weighted-average interest rate would increase the
Company's annual interest expense by $5.0.
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,
the timing and frequency of client spending for system enhancement requests, the
timing of contractual rate reductions triggered by subscriber growth or the
passage of time and the seasonal pattern of the customer management segment of
the Company.
15
<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:
Exhibit
Number
------
27 Financial Data Schedule
(b) Reports on Form 8-K
None.
16
<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 15, 1999 /s/ Steven G. Rolls
----------------------------------------
Steven G. Rolls
Chief Financial Officer
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 42,400
<SECURITIES> 0
<RECEIVABLES> 351,800
<ALLOWANCES> 15,600
<INVENTORY> 0
<CURRENT-ASSETS> 451,600
<PP&E> 600,400
<DEPRECIATION> 302,300
<TOTAL-ASSETS> 1,663,000
<CURRENT-LIABILITIES> 789,700
<BONDS> 0
0
0
<COMMON> 152,700
<OTHER-SE> 704,900
<TOTAL-LIABILITY-AND-EQUITY> 1,663,000
<SALES> 0
<TOTAL-REVENUES> 1,276,200
<CGS> 0
<TOTAL-COSTS> 1,107,200
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 6,500
<INTEREST-EXPENSE> 24,400
<INCOME-PRETAX> 170,600
<INCOME-TAX> 65,700
<INCOME-CONTINUING> 104,900
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 104,900
<EPS-BASIC> .69
<EPS-DILUTED> .68
</TABLE>
