<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
---
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 July 31, 1999, 152,597,721 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 Six Months
Ended June 30, Ended June 30,
---------------- ----------------
1999 1998 1999 1998
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues .................................................... $426.2 $363.6 $826.0 $672.2
------ ------ ------ ------
Costs and Expenses
Cost of providing services and products sold............. 243.3 213.6 470.8 386.8
Selling, general and administrative...................... 73.0 54.8 137.2 105.7
Research and development costs........................... 20.4 19.5 39.9 38.6
Depreciation............................................. 20.3 17.0 40.4 30.0
Amortization............................................. 10.3 9.3 19.8 14.7
Year 2000 programming costs.............................. 2.8 7.8 9.0 13.5
Purchased research and development costs................. 2.0 -- 2.0 42.6
------ ------ ------ ------
Total costs and expenses............................ 372.1 322.0 719.1 631.9
------ ------ ------ ------
Operating Income............................................. 54.1 41.6 106.9 40.3
Equity in Earnings of Cellular Partnership................... 9.1 6.8 16.7 10.8
Other Income (Expense), net.................................. (0.5) 0.7 (1.2) 0.7
Interest Expense............................................. 8.5 11.2 16.0 17.6
------ ------ ------ ------
Income Before Income Taxes................................... 54.2 37.9 106.4 34.2
Income Taxes................................................. 21.4 14.3 41.2 12.9
------ ------ ------ ------
Net Income .................................................. $ 32.8 $ 23.6 $ 65.2 $ 21.3
------ ------ ------ ------
------ ------ ------ ------
Other Comprehensive Income, net of tax:
Foreign currency translation adjustments................... $ 1.5 $ (1.6) $ 2.1 $ (1.8)
Unrealized gain on investments............................. 2.7 -- 2.7 --
------ ------ ------ ------
Total other comprehensive income........................ 4.2 (1.6) 4.8 (1.8)
------ ------ ------ ------
Comprehensive Income......................................... $ 37.0 $ 22.0 $ 70.0 $ 19.5
------ ------ ------ ------
------ ------ ------ ------
Earnings Per Common Share....................................
Basic.................................................... $ .22 $ .17 $ .43 $ .16
------ ------ ------ ------
------ ------ ------ ------
Diluted.................................................. $ .21 $ .17 $ .42 $ .16
------ ------ ------ ------
------ ------ ------ ------
Average Common Shares Outstanding Including Equivalents
Basic.................................................... 151.6 137.0 151.6 137.0
Diluted.................................................. 154.1 137.0 154.1 137.0
</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)
June 30, December 31,
1999 1998
---------- ------------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents....................................... $ 20.3 $ 3.8
Receivables, less allowances of $12.3 and $9.8.................. 339.6 314.3
Deferred income taxes........................................... 10.1 10.9
Prepaid expenses and other current assets....................... 37.9 31.5
-------- --------
Total current assets.......................................... 407.9 360.5
Property and equipment - net....................................... 290.5 249.8
Goodwill and other intangibles - net............................... 702.0 687.4
Investment in cellular partnership................................. 87.0 81.6
Deferred charges and other assets.................................. 60.2 71.6
-------- --------
Total Assets.................................................. $1,547.6 $1,450.9
-------- --------
-------- --------
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities
Debt maturing in one year....................................... $ 464.0 $ 466.8
Payables and other current liabilities.......................... 251.4 239.6
-------- --------
Total current liabilities..................................... 715.4 706.4
Long-term liabilities.............................................. 13.4 13.0
-------- --------
Total liabilities............................................. 728.8 719.4
-------- --------
Minority interest.................................................. 10.6 --
-------- --------
Shareowners' Equity
Common shares - without par value, 500,000,000 authorized;
152,504,423 issued and outstanding............................ 206.0 206.0
Additional paid-in capital...................................... 481.8 475.1
Retained earnings............................................... 118.2 53.0
Accumulated other comprehensive income.......................... 2.2 (2.6)
-------- --------
Total shareowners' equity..................................... 808.2 731.5
-------- --------
Total Liabilities and Shareowners' Equity..................... $1,547.6 $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>
Six Months
Ended June 30,
------------------
1999 1998
------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................................................. $ 65.2 $ 21.3
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization........................................................ 60.2 44.7
Deferred income tax provision........................................................ 2.5 1.7
Purchased research and development costs............................................. 2.0 42.6
Undistributed earnings of cellular partnership....................................... (5.4) (11.0)
Changes in assets and liabilities, net of effects from acquisitions:
Increase in receivables.............................................................. (17.3) (58.0)
Decrease (increase) in other current assets.......................................... (6.4) 5.7
Increase (decrease) in payables and other current liabilities........................ 8.2 (14.5)
Other, net........................................................................... 6.5 (29.6)
------- -------
Net cash provided by operating activities............................................ 115.5 2.9
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures................................................................... (52.2) (41.2)
Acquisitions, net of cash acquired..................................................... (50.7) (658.3)
------- -------
Net cash used in investing activities................................................ (102.9) (699.5)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments under revolving credit facility, net........................................ (2.8) --
Repayment of long-term debt............................................................ -- (3.1)
Change in debt payable to CBI.......................................................... -- 698.4
Issuance of common shares.............................................................. 6.7 --
Transfers from CBI, net................................................................ -- 0.7
------- -------
Net cash provided by financing activities............................................ 3.9 696.0
------- -------
Net increase (decrease) in cash and cash equivalents................................... 16.5 (0.6)
Cash and cash equivalents at beginning of period....................................... 3.8 2.1
------- -------
Cash and cash equivalents at end of period............................................. $ 20.3 $ 1.5
------- -------
------- -------
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(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 (the Offering). On December 31, 1998, CBI distributed
all of its remaining interest in the Company to existing CBI
shareholders (the Distribution).
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 were a separate entity. 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. Earnings per
share for the three and six months ended June 30, 1998 has been
calculated using the 137.0 common shares outstanding prior to the
Offering.
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.
5
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
(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 June 30, 1999,
the balance of the restructuring liability was $10.0, primarily for
lease termination and other facility consolidation costs. Remaining
cash outflows under the plan are expected to be approximately $8
million. 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.
On March 1, 1999, the Company paid approximately $53 to acquire an
additional 50% ownership interest in Wiztec Solutions Ltd. (Wiztec).
This investment increased the Company's ownership of Wiztec to
approximately 70%. 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 excess of the purchase price over the fair
value of the tangible assets acquired was allocated principally to
Wiztec's software ($30) and trademarks ($13). The fair value of the
assets acquired was determined by an independent valuation performed at
the time of the acquisition. The transaction resulted in the Company
recording a minority interest of $10.6 at June 30, 1999 related to the
approximately 30% of Wiztec owned by minority shareowners.
On August 5, 1999, the Company paid approximately $57 in cash to
increase its ownership interest in Wiztec to 95%. The additional shares
were acquired pursuant to a $25.00 per share tender offer which expired
on July 30, 1999. This transaction will result in the Company recording
goodwill which will be amortized over a useful life of 15 years.
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 and was financed through
short-term, variable rate debt.
At the time of the acquisition, the Company began a process of
evaluating an integration plan for the acquired operations. In 1998,
the Company accrued as an addition to goodwill approximately $9 for
severance of approximately 375 employees and other integration costs
under this plan. Payments through June 30, 1999 under the plan were
approximately $7. At June 30, 1999, the remaining balance of the
integration liability is approximately $2, primarily for facility
consolidation costs.
6
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
The following unaudited pro forma data summarizes the combined
results of operations of the Company and Transtech as though the
acquisition had occurred as of the beginning of the six-month period
ended June 30, 1998:
<TABLE>
<CAPTION>
1998
------
<S> <C>
Revenues........................................... $734.6
Net Income......................................... $ 15.9
Income per share:
Basic.......................................... $ .12
Diluted........................................ $ .12
</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 at
June 30, 1999. The acquisition was accounted for under the purchase
method of accounting with resulting goodwill amortized over a
twenty-five year life.
(4) SIGNIFICANT CUSTOMER
Both of the Company's segments derive significant revenues from
AT&T by providing information system and billing services and customer
management services. Revenues from AT&T were 39.0% and 35.6% of the
Company's consolidated revenues for the six-month periods ended June
30, 1999 and June 30, 1998, respectively. Related accounts receivable
from AT&T totaled $62.8 and $99.6 at June 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 $57.2 and $35.9 for the six-month periods ended June 30, 1999 and
June 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.
(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.
7
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
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 Six Months
Ended June 30, Ended June 30,
----------------- -----------------
Millions of Dollars 1999 1998 1999 1998
------------------- ------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues
Information management................ $171.1 $146.1 $328.2 $290.0
Customer management................... 263.8 222.1 515.5 389.0
Less: intersegment.................... (8.7) (4.6) (17.7) (6.8)
------ ------ ------ ------
$426.2 $363.6 $826.0 $672.2
------ ------ ------ ------
------ ------ ------ ------
Depreciation and Amortization
Information management................ $ 9.5 $ 7.4 $ 18.0 $ 14.1
Customer management................... 20.7 18.9 41.5 30.6
Corporate............................. 0.4 -- 0.7 --
------ ------ ------ ------
$ 30.6 $ 26.3 $ 60.2 $ 44.7
------ ------ ------ ------
------ ------ ------ ------
Special Item - Acquired Research
and Development
Information management................ $ 2.0 $ -- $ 2.0 $ --
Customer management................... -- -- -- 42.6
------ ------ ------ ------
$ 2.0 $ -- $ 2.0 $ 42.6
------ ------ ------ ------
------ ------ ------ ------
Operating Income (Loss)
Information management................ $ 30.7 $ 27.6 $ 61.0 $ 54.6
Customer management................... 25.2 14.0 48.9 (14.3)
Corporate............................. (1.8) -- (3.0) --
------ ------ ------ ------
$ 54.1 $ 41.6 $106.9 $ 40.3
------ ------ ------ ------
------ ------ ------ ------
Capital Expenditures (including
acquisitions)
Information management................ $ 25.6 $ 16.0 $ 89.1 $ 21.6
Customer management................... 16.6 17.8 28.9 681.7
Corporate............................. 7.5 -- 8.2 --
------ ------ ------ ------
$ 49.7 $ 33.8 $126.2 $703.3
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
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 consolidated financial statements of the Company reflect the results
of operations, financial position and cash flows of the businesses
contributed to the Company by Cincinnati Bell Inc. (CBI). The amounts
presented for the three and six months ended June 30, 1998 have been carved
out from the financial statements of 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.
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 JUNE 30, 1999 VERSUS THREE MONTHS ENDED JUNE 30, 1998
The Company's revenues for the second quarter of 1999 totaled $426.2, a
17% increase from the second quarter of 1998. This higher revenue reflects
increases experienced by both of the Company's subsidiaries. The Company's
operating expenses for the second quarter of 1999 totaled $372.1, a 16%
increase from the second quarter of 1998, reflecting greater business volume.
The Company's operating income, excluding a $2.0 million special item
recorded by IMG to expense purchased in-process research and development
costs, was $56.1 in the second quarter of 1999, a 35% increase from the
second quarter of 1998. Including the special item, operating income was
$54.1 in the second quarter of 1999.
The Company's equity in earnings of its Cellular Partnership increased
34% for the second quarter of 1999 as compared to the same period in 1998.
Interest expense decreased 24% in the second quarter of 1999 from the second
quarter 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, excluding the special item for the second quarter of 1999, was $34.8,
or $.23 per share, a 47% increase from $23.6 or $.17 per share in the second
quarter of 1998. Including the special item, net income for the second
quarter of 1999 was $32.8 or $.21 per share.
9
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
SIX MONTHS ENDED JUNE 30, 1999 VERSUS SIX MONTHS ENDED JUNE 30, 1998
The Company's revenues for the first half of 1999 totaled $826.0, a 23%
increase from the first half 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 six-month period increased approximately 12% adjusted to include
Transtech as if it had been acquired at the beginning of both periods. The
Company's operating expenses for the first half of 1999 totaled $717.1, a 22%
increase over the first half of 1998, excluding special items. The Company's
operating expenses increased approximately 4% adjusted to include Transtech
as if it had been acquired at the beginning of both periods.
The Company's results for the six months ended June 30, 1999 and 1998,
reflect special items recorded by the Company to expense in-process research
and development costs associated with acquisitions. Results for the six
months ended June 30, 1999 reflect the expensing of $2.0 (pre-tax and after
tax) in acquisition related research and development costs. Results for the
six months ended June 30, 1998 reflect the expensing of $42.6 (26.4 after
tax) in acquisition-related research and development costs.
The Company's operating income was $108.9 in the first half of 1999, a
31% increase from the first half of 1998, excluding special items. Including
the special items, operating income was $106.9 in the first half of 1999 and
$40.3 in the first half of 1998.
The Company's equity in earnings of its Cellular Partnership in the first
half of 1999 was $16.7, a 55% increase from the first half of 1998. Interest
expense decreased 9% in the first half of 1999 from the first half 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 half of 1999 was $67.2, or $.44 per share, a 41% increase compared to
$47.7, or $.35 per share, for the first half of 1998, excluding special items
in both periods. Including the special items, the Company's net income was
$65.2 or $.42 per share in the first half of 1999 and $21.3 or $.16 per share
in the first half of 1998.
INFORMATION MANAGEMENT
<TABLE>
<CAPTION>
Three Months Six Months
($ Millions) Ended June 30, Ended June 30,
------------------------------ ------------------------------
1999 1998 CHANGE % 1999 1998 CHANGE %
------ ------ ------ --- ------ ------ ------ ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Information processing........... $100.8 $ 89.3 $11.5 13 $195.1 $178.0 $17.1 10
Professional and consulting...... 37.5 36.5 1.0 3 75.0 70.8 4.2 6
License and other................ 11.1 6.2 4.9 79 17.4 13.1 4.3 33
International.................... 13.0 9.5 3.5 37 23.0 21.4 1.6 7
------ ------ ----- ------ ------ -----
External revenues.............. 162.4 141.5 20.9 15 310.5 283.3 27.2 10
Intercompany services for CMG.... 8.7 4.6 4.1 -- 17.7 6.7 11.0 --
------ ------ ----- ------ ------ -----
Total revenues................. 171.1 146.1 25.0 17 328.2 290.0 38.2 13
Costs of products and services 89.9 74.6 15.3 21 174.8 145.9 28.9 20
Selling, general and
administrative expenses.......... 19.6 16.6 3.0 18 36.5 34.2 2.3 7
Research and development costs..... 16.8 15.0 1.8 12 30.3 31.5 (1.2) (4)
Depreciation....................... 7.1 5.9 1.2 20 13.9 11.1 2.8 25
Amortization....................... 2.4 1.5 0.9 60 4.1 3.0 1.1 37
Year 2000 programming costs........ 2.6 5.0 (2.4) (48) 5.6 9.7 (4.1) (42)
Special item....................... 2.0 -- 2.0 -- 2.0 -- 2.0 --
------ ------ ----- ------ ------ -----
Total costs................... 140.4 118.6 21.8 18 267.2 235.4 31.8 14
------ ------ ----- ------ ------ -----
Operating income................... $ 30.7 $ 27.5 $ 3.2 12 $ 61.0 $ 54.6 $ 6.4 12
</TABLE>
10
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
THREE MONTHS ENDED JUNE 30, 1999 VERSUS THREE MONTHS ENDED JUNE 30, 1998
Excluding intercompany activity, revenues for the Company's information
management segment were $162.4 for the second quarter of 1999, a 15% increase
from the second quarter of 1998. Information processing revenues increased
13% in the second quarter of 1999 over the second quarter of 1998, primarily
as a result of subscriber growth in IMG's wireless client base. IMG's
wireless billing clients' subscriber levels increased 24% in the quarter from
levels in the second quarter of 1998. Professional and consulting revenues
rose 3% from the second quarter of 1998 as increased system enhancement
services for personal communication services (PCS) clients were offset by
reduced services to a client which was acquired by an IMG competitor. IMG's
license and other revenues increased to $11.1 in the second 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
37% to $13.0 in the second quarter of 1999 from the second quarter of 1998,
primarily reflecting the Company's acquisition of a controlling interest in
Wiztec Solutions, Ltd. (Wiztec) which more than offset the termination of one
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 excluding a special item were $138.4 in the
second quarter of 1999, a 17% increase over the second quarter of 1998. The
increase was principally the result of increased direct costs associated with
higher business volume and incremental costs from an acquired data center
facility. Labor cost increases included the effect of higher wage rates,
particularly for software professionals. This increase was partially offset
by a $2.4 decrease in Year 2000 programming costs in the second quarter of
1999 from the second quarter of 1998. The decrease in Year 2000 programming
costs reflects IMG's progress in modifying its systems and software to
prepare for the Year 2000 date change.
In connection with the purchase of a controlling interest in Wiztec, IMG
expensed $2.0 of in-process research and development costs as a special item
in the second quarter of 1999. The amount expensed relates to an ongoing
development project that had not reached technological feasibility at the
time of transaction and has no alternative future use. The amount of the
charge was based on an independent valuation using the exclusion method with
a risk-adjusted discount rate of 30%. This project was estimated to be
approximately 16% complete at the time of the transaction, with anticipated
future costs of $14.8. The Company would not be materially affected if this
project were not to be completed successfully.
SIX MONTHS ENDED JUNE 30, 1999 VERSUS SIX MONTHS ENDED JUNE 30, 1998
Excluding intercompany revenues, revenues for the Company's information
management segment were $310.5 for the first half of 1999, a 10% increase
from the first half of 1998. Information processing revenues increased 10% to
$195.1 in the first half of 1999 from the first half of 1998, primarily as a
result of subscriber growth in IMG's wireless client base. IMG's wireless
billing clients' subscriber levels increased 23% in the first six months from
levels in the first six months of 1998. The increase in information
processing revenues 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% to $75.0 in the first half of 1999
over the first half 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, which was
acquired by an IMG competitor. IMG's license and other revenues increased
$4.3 in the first half of 1999 as compared to the first half of 1998. IMG's
international revenues increased $1.6 in the first half of 1999 from the
first half 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 special item, were $265.2 in the
first half of 1999, a 13% increase over the first half of 1998. This increase
was principally the result of higher direct costs associated with greater
business volume and incremental costs from an acquired data center facility.
Labor costs increased due to higher wage rates, particularly for software
professionals. These increased costs and expenses were partially offset by a
$4.1 decrease in Year 2000 programming costs in the first half of 1999 from
the first half of 1998.
11
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
IMG relies on a few large clients for a majority of its revenues. IMG's
top three clients accounted for 46% of its revenues for the first six months
of 1999, down from 52% in the first six months of 1998. IMG maintains
multi-year contracts with its clients. On August 2, 1999, IMG announced an
extension of its contract with AT&T Wireless Services (AWS), an affiliate of
AT&T Corporation which is IMG's largest customer. The billing and customer
service contract with AWS, which was to expire in 2001, will now run into
2004.
The wireless industry, which IMG serves, is currently experiencing a
trend toward consolidation. 360 Degree Communications, representing
approximately 3% of the Company's revenues in the first half of 1999 was
acquired during 1998 by Alltel, one of IMG's competitors. The related
contract extends through 2006 and does not provide for early termination
without a material uncured IMG breach. However, in December 1998, Alltel
purported to exercise a right to license the related software from IMG and
terminate the contract. The Company has filed a request for declaratory
judgment in the U.S. District Court affirming the Company's position that the
contract has no provision requiring that the software be licensed nor for its
early termination. In February 1999, Alltel filed a counterclaim against the
Company, asking the U.S. District Court to declare that Alltel has the right
to license the software and that the Company's failure to license constituted
a breach of the contract. In May 1998, SBC Communications reached an
agreement to acquire Ameritech, a client representing approximately 3% of the
Company's first half of 1999 revenues. On August 5, 1999, IMG announced that
it had agreed to an extension of the Ameritech contract through September 30,
2004. Under the agreement, IMG will remain the exclusive billing service
provider for Ameritech Mobile Communications, Inc. Additionally, the
Ameritech contract extension provides terms under which IMG would continue to
serve the approximately 50% of Ameritech's subscribers that Ameritech has
agreed to transfer to GTE under provisions that the Company believes are as
favorable as those currently in place. The transfer of these subscribers to
GTE is dependent on regulatory approval of SBC Communications' acquisition of
Ameritech, which is currently pending.
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 Six Months
($ Millions) Ended June 30, Ended June 30,
------------------------------ ------------------------------
1999 1998 CHANGE % 1999 1998 CHANGE %
------ ------ ------ --- ------ ------ ------ ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Dedicated services............... $205.1 $169.9 $ 35.2 21 $391.9 $283.3 $108.6 38
Traditional services............. 44.3 43.9 0.4 1 94.0 89.6 4.4 5
International.................... 14.4 8.3 6.1 73 29.6 16.1 13.5 83
------ ------ ------ ------ ------ ------
Total revenues............... $263.8 $222.1 $ 41.7 19 $515.5 $389.0 $126.5 33
Costs of products and services..... 161.9 143.7 18.2 13 313.6 247.7 65.9 27
Selling, general and
administrative expenses.......... 52.0 38.2 13.8 36 98.4 71.5 26.9 27
Research and development costs..... 3.7 4.5 (0.8) (18) 9.7 7.1 2.6 27
Depreciation....................... 12.9 11.0 1.9 17 25.8 18.9 6.9 37
Amortization....................... 7.8 7.9 (0.1) (1) 15.7 11.7 4.0 34
Year 2000 programming costs........ 0.3 2.8 (2.5) (89) 3.4 3.8 (0.4) (11)
Special item....................... -- -- -- -- -- 42.6 (42.6) --
------ ------ ------ ------ ------ ------
Total costs.................. 238.6 208.1 30.5 15 466.6 403.3 63.3 16
------ ------ ------ ------ ------ ------
Operating income (loss)............ $ 25.2 $ 14.0 $ 11.2 80 $ 48.9 $(14.3) $ 63.2 --
</TABLE>
THREE MONTHS ENDED JUNE 30, 1999 VERSUS THREE MONTHS ENDED JUNE 30, 1998
Revenues for the Company's customer management segment, CMG, was $263.8
in the second quarter of 1999, a 19% increase from the second quarter of
1998. Dedicated services revenues (typically longer-term relationships where
CMG provides value-added customer service, technical support and sales
account
12
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
management primarily through personnel dedicated to a specific client)
increased by $35.2 which is primarily the result of growth in services
provided to communications and direct broadcast clients. Traditional,
campaign-based, teleservices revenues were essentially unchanged. CMG's
international revenues increased $6.1 in the second quarter of 1999 over
levels in the second 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 were $238.6 in the second quarter of 1999, a 15%
increase from the second quarter of 1998. 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.
SIX MONTHS ENDED JUNE 30, 1999 VERSUS SIX MONTHS ENDED JUNE 30, 1998
Revenue for the Company's customer management segment, CMG, was $515.5 in
the first half of 1999, a 33% increase from the first half of 1998. The
revenue increase was approximately 14%, adjusted for the acquisition of
Transtech. Dedicated services revenues rose $108.6, including most of the
revenue increase contributed by Transtech. Traditional, campaign-based,
teleservices revenues increased by approximately 5% over the first half of
1998. CMG's international revenues increased $13.4 in the first half of 1999
over levels in the first half 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 were $466.6 in the first half of 1999, a 16%
increase from the first half of 1998. Costs and expenses increased by
approximately 1% 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 $3.3 in goodwill and other intangible amortization and the
majority of CMG's increased research and development costs.
CMG's top two clients accounted for 45% of its revenues for the first six
months of 1999, up from 41% for the same period in 1998. The loss of any
significant client would have an adverse effect on its revenues and profits.
The acquisition of Transtech has increased the portion of CMG's revenues from
its top two 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, 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 June 30, 1999, the Company had $464 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 will enter into discussions late in 1999 to extend the facility and
may seek to refinance some of the outstanding borrowings on a longer-term
fixed rate basis.
CASH PROVIDED BY OPERATING ACTIVITIES
The Company's operating activities generated $115.5 in cash during the
first half of 1999 compared to $2.9 during the first half of 1998. The
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 acquisition-related working capital needs
that decreased cash flows from operations in the first half of 1998.
The additional investment in Wiztec and the acquisition of TAI during the
first half of 1999 required approximately $51 in cash. Excluding
acquisitions, capital expenditures in the first half of 1999 were $52.2, up
from $41.2 from 1998 and were principally related to opening of additional
call centers. During the first half of 1999, the Company incurred $1.9 in
cash payments related to the 1997 CMG restructuring plan. Future cash
outflows under the plan are expected to be approximately $9, primarily for
ongoing facility lease obligations.
13
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
BALANCE SHEET
The $25.3 increase in accounts receivable from December 31, 1998 to June
30, 1999 was largely attributable to revenue increases and the inclusion of
Wiztec's accounts receivable in the June 30, 1999 balance sheet. Increases in
property and equipment and goodwill and other intangibles, were also caused
by the Wiztec and TAI transactions.
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
$2.8 and $9.0 in expenses during the three and six month periods ended June
30, 1999, respectively, in order to prepare for the Year 2000 and $7.8 and
$13.5 in the same periods of 1998. The Company estimates its Year 2000
expenses in 1999 will be in a range from $12 to $15.
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 second half 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's has extended its goal for completing compliance
testing for a limited number of projects beyond the original June 30, 1999
target date. All of CMG's software, telecom equipment and other information
technology systems are expected to be Year 2000 compliant and tested by the
end of the third quarter.
For the second half 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. The Company
maintains business continuity 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.
14
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
At June 30, 1999, the Company had approximately $464 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 June 30, 1999, a
one-percentage point increase in the weighted average interest rate would
increase the Company's annual interest expense by $4.6.
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.
BUSINESS DEVELOPMENT ACTIVITIES
On August 5, 1999, the Company paid approximately $57 in cash to increase
its ownership interest in Wiztec from approximately 70% to 95%. The
additional shares were acquired pursuant to a $25.00 per share tender offer
which expired on July 30, 1999. It is the Company's intention to acquire the
remaining 5% of Wiztec later in 1999 for approximately $10, based upon the
tender offer price of $25.00 per share.
15
<PAGE>
Form 10-Q Part II Convergys Corporation
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
The following is filed as an Exhibit to Part I of this Form 10-Q:
<TABLE>
<CAPTION>
Exhibit
Number
-------
<S> <C>
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
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: August 13, 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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 20,300
<SECURITIES> 0
<RECEIVABLES> 339,600
<ALLOWANCES> 12,300
<INVENTORY> 0
<CURRENT-ASSETS> 407,900
<PP&E> 574,300
<DEPRECIATION> 283,800
<TOTAL-ASSETS> 1,547,600
<CURRENT-LIABILITIES> 715,400
<BONDS> 0
0
0
<COMMON> 152,600
<OTHER-SE> 655,600
<TOTAL-LIABILITY-AND-EQUITY> 1,547,600
<SALES> 0
<TOTAL-REVENUES> 826,000
<CGS> 0
<TOTAL-COSTS> 719,100
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4,600
<INTEREST-EXPENSE> 16,000
<INCOME-PRETAX> 106,400
<INCOME-TAX> 41,200
<INCOME-CONTINUING> 65,200
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 65,200
<EPS-BASIC> .43
<EPS-DILUTED> .42
</TABLE>
