<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 MARCH 31, 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 1-4379
CONVERGYS CORPORATION
Incorporated under the laws of the State of Ohio
201 East Fourth Street, Cincinnati, Ohio 45202
I.R.S. Employer Identification Number 31-1598292
Telephone - Area Code (513) 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 April 30, 1999, 152,222,623 Common Shares were outstanding.
<PAGE>
Form 10-Q Part I Convergys Corporation
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
----------------------
1999 1998
------- -------
<S> <C> <C>
Revenues . . . . . . . . . . . . . . . . . . . . . . . . . $ 399.8 $ 308.6
------- -------
Costs and Expenses
Cost of providing services and products sold . . . . . 227.5 173.1
Selling, general and administrative. . . . . . . . . . 64.2 51.0
Research and development costs . . . . . . . . . . . . 19.5 19.1
Depreciation and amortization. . . . . . . . . . . . . 29.6 18.4
Year 2000 programming costs. . . . . . . . . . . . . . 6.2 5.7
Purchased research and development costs . . . . . . . - 42.6
------- -------
Total costs and expenses. . . . . . . . . . . . . 347.0 309.9
------- -------
Operating Income. . . . . . . . . . . . . . . . . . . . . . 52.8 (1.3)
Equity in Earnings of Cellular Partnership. . . . . . . . . 7.6 4.0
Other Expense, net. . . . . . . . . . . . . . . . . . . . . 0.7 -
Interest Expense. . . . . . . . . . . . . . . . . . . . . . 7.5 6.4
------- -------
Income (Loss) Before Income Taxes . . . . . . . . . . . . . 52.2 (3.7)
Income Taxes. . . . . . . . . . . . . . . . . . . . . . . . 19.8 (1.4)
------- -------
Net Income (Loss) . . . . . . . . . . . . . . . . . . . . . $ 32.4 $ (2.3)
------- -------
------- -------
Other Comprehensive Income, net of tax:
Foreign currency translation adjustments. . . . . . . . . $ 0.6 $ (0.2)
------- -------
Comprehensive Income. . . . . . . . . . . . . . . . . . . . $ 33.0 $ (2.5)
------- -------
------- -------
Earnings Per Common Share . . . . . . . . . . . . . . . . .
Basic. . . . . . . . . . . . . . . . . . . . . . . . . $ .21 $ (.02)
------- -------
------- -------
Diluted. . . . . . . . . . . . . . . . . . . . . . . . $ .21 $ (.02)
------- -------
------- -------
Average Common Shares Outstanding
Basic. . . . . . . . . . . . . . . . . . . . . . . . . 151.7 137.0
Diluted. . . . . . . . . . . . . . . . . . . . . . . . 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 Per Share Amounts)
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
1999 1998
---------- ------------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . $ 20.2 $ 3.8
Receivables, less allowances of $9.5 and $9.8. . . . . . . . . . 355.3 314.3
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . 9.3 10.9
Prepaid expenses and other current assets. . . . . . . . . . . . 35.8 31.5
---------- --------
Total current assets. . . . . . . . . . . . . . . . . . . . 420.6 360.5
Property and equipment - net. . . . . . . . . . . . . . . . . . . . . 250.7 249.8
Goodwill and other intangibles - net. . . . . . . . . . . . . . . . . 726.8 687.4
Investment in cellular partnership. . . . . . . . . . . . . . . . . . 89.2 81.6
Deferred charges and other assets . . . . . . . . . . . . . . . . . . 58.4 71.6
---------- --------
Total Assets. . . . . . . . . . . . . . . . . . . . . . . . $ 1,545.7 $1,450.9
---------- --------
---------- --------
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities
Debt maturing in one year. . . . . . . . . . . . . . . . . . . . $ 510.6 $ 466.8
Payables and other current liabilities . . . . . . . . . . . . . 227.6 231.1
---------- --------
Total current liabilities . . . . . . . . . . . . . . . . . 738.2 697.9
Long-term liabilities . . . . . . . . . . . . . . . . . . . . . . . . 31.4 21.5
---------- --------
Total liabilities . . . . . . . . . . . . . . . . . . . . . 769.6 719.4
---------- --------
Minority interest . . . . . . . . . . . . . . . . . . . . . . . . . . 8.5 --
---------- --------
Shareowners' Equity
Common shares - without par value, 500,000,000 authorized;
152,187,997 issued and outstanding. . . . . . . . . . . . . 206.0 206.0
Additional paid-in capital . . . . . . . . . . . . . . . . . . . 478.2 475.1
Retained earnings. . . . . . . . . . . . . . . . . . . . . . . . 85.4 53.0
Accumulated other comprehensive income . . . . . . . . . . . . . (2.0) (2.6)
---------- --------
Total shareowners' equity . . . . . . . . . . . . . . . . . 767.6 731.5
---------- --------
Total Liabilities and Shareowners' Equity . . . . . . . . . . . . . . $ 1,545.7 $1,450.9
---------- --------
---------- --------
</TABLE>
See Notes to Financial Statements.
3
<PAGE>
Form 10-Q Part I Convergys Corporation
CONDENSED CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
(Amounts in Millions)
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
-----------------------
1999 1998
-------- --------
<S> <C> <C>
Common Shares
Balance, beginning of period . . . . . . . . $ 206.0 $ -
-------- --------
Balance, end of period. . . . . . . . . $ 206.0 $ -
-------- --------
Additional Paid-In Capital
Balance, beginning of period . . . . . . . . $ 475.1 $ -
Issuance of common shares. . . . . . . . . . 3.1 -
-------- --------
Balance, end of period. . . . . . . . . $ 478.2 $ -
-------- --------
Retained Earnings
Balance, beginning of period . . . . . . . . $ 53.0 $ -
Net income . . . . . . . . . . . . . . . . . 32.4 -
-------- --------
Balance, end of period. . . . . . . . . $ 85.4 $ -
-------- --------
Shareowner's Net Investment . . . . . . . . . . .
Balance, beginning of period . . . . . . . . $ - $ 428.4
Net loss . . . . . . . . . . . . . . . . . . - (2.3)
Transfers from CBI, net. . . . . . . . . . . - 1.4
-------- --------
Balance, end of period. . . . . . . . . $ - $ 427.5
-------- --------
Accumulated Other Comprehensive Income
Balance, beginning of period . . . . . . . . $ (2.6) $ 2.4
Foreign currency translation adjustments . . 0.6 (0.2)
-------- --------
Balance, end of period. . . . . . . . . $ (2.0) $ 2.2
-------- --------
Total Shareowners' Equity . . . . . . . . . . . . $ 767.6 $ 429.7
-------- --------
-------- --------
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
Form 10-Q Part I Convergys Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Millions)
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
----------------------
1999 1998
------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 32.4 $ (2.3)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29.6 18.4
Deferred income tax provision . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.7 0.9
Purchased research and development costs. . . . . . . . . . . . . . . . . . . . . . . - 42.6
Undistributed earnings of cellular partnership. . . . . . . . . . . . . . . . . . . . (7.6) (4.0)
Changes in assets and liabilities, net of effects from acquisitions:
Increase in receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (33.7) (23.8)
Decrease (increase) in other current assets . . . . . . . . . . . . . . . . . . . . . (4.3) 5.5
Decrease in payables and other current liabilities. . . . . . . . . . . . . . . . . . (5.7) (16.8)
Other, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.7 (24.1)
------- -------
Net cash provided (used) by operating activities. . . . . . . . . . . . . . . . . . . 24.1 (3.6)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (23.4) (10.4)
Acquisitions, net of cash acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . (31.2) (658.3)
------- -------
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . (54.6) (668.7)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under revolving credit facility, net. . . . . . . . . . . . . . . . . . . . . . 43.8
Repayment of long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (2.0)
Change in intercompany debt payable to CBI . . . . . . . . . . . . . . . . . . . . . . . . - 671.7
Issuance of common shares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 -
Transfers from CBI, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 1.4
------- -------
Net cash provided by financing activities . . . . . . . . . . . . . . . . . . . . . . 46.9 671.1
------- -------
Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . . . . . . . . . 16.4 (1.2)
Cash and cash equivalents at beginning of period . . . . . . . . . . . . . . . . . . . . . 3.8 2.1
------- -------
Cash and cash equivalents at end of period . . . . . . . . . . . . . . . . . . . . . . . . $ 20.2 $ 0.9
------- -------
------- -------
</TABLE>
See Notes to Financial Statements.
5
<PAGE>
Form 10-Q Part I Convergys Corporation
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.
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 these 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 assets, liabilities and expenses relating to the
Company's businesses that were transferred to the Company from CBI.
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 months ended March 31, 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.
(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 March 31, 1999, the balance
of the restructuring liability was $10.8, primarily for lease termination
and other facility consolidation costs. Remaining cash outflows under the
plan are expected to be approximately $9 million. Management expects the
restructuring plan activities to be substantially completed by the end of
1999.
6
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Amounts in Millions Except Per Share Amounts
(Unaudited)
(3) ACQUISITIONS
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 additional investment was financed using the Company's revolving credit
facility. The investment will be accounted for under the purchase method
of accounting. The Company is evaluating, through an independent valuation
which is not yet complete, the final allocation of purchase price which
could include an amount to be allocated to a research and development
project that was in process at the time of the acquisition and has no
alternative future use. The excess of purchase price and acquisitions
costs over the fair value of assets acquired will be recorded as goodwill,
which will be amortized on a straight-line basis over an anticipated
fifteen-year life. The transaction has resulted in the Company's recording
of a minority interest of $8.5 at March 31, 1999 related to the
approximately 30% of Wiztec that is not owned by the Company.
On March 26, 1999, the Company announced that its Board of Directors
had authorized its wholly-owned subsidiary, Convergys Israel Investments,
Ltd., to acquire through a tender offer all of the outstanding shares of
Wiztec at a price of $18.30 per share. On April 29, 1999, the Company
announced that approximately 80,000 shares were tendered pursuant to the
offer by shareholders that were not affiliated with Convergys.
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. The Company allocated $42.6 of the purchase price to
two in-process research and development projects that had not reached
technological feasibility at the time of the acquisition and had no
alternative future use. The fair values of the acquired assets were
determined by an independent valuation performed at the time of the
acquisition. The excess of the purchase price and acquisition costs over
the fair value of the assets acquired was recorded as goodwill, which is
being amortized on a straight-line basis over a thirty-year life.
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 $9.0 for severance
of approximately 375 employees and other integration costs under this plan.
Payments through March 31, 1999 under the plan were approximately $6. At
March 31, 1999, the remaining balance of the integration liability is
approximately $2, primarily for facility consolidation costs.
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 three month period ended March 31,
1998:
<TABLE>
<S> <C>
Revenues . . . . . . . . . . . . . . . . . . $ 371.0
Net loss . . . . . . . . . . . . . . . . . . $ (7.7)
Loss per share:
Basic . . . . . . . . . . . . . . . . . $ (.06)
Diluted . . . . . . . . . . . . . . . . $ (.06)
</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 March 31,
1999. The acquisition was accounted for under the purchase method of
accounting with resulting goodwill amortized over a twenty-five year life.
7
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Amounts in Millions Except Per Share Amounts
(Unaudited)
(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 37.7% and 31.4% of the
Company's consolidated revenues for the three-month period ended March 31,
1999 and March 31, 1998, respectively. Related accounts receivable from
AT&T totaled $100.6 and $99.6 at March 31, 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 $19.0 and
$7.5 for the three-month period ended March 31, 1999 and March 31, 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) RECENTLY ISSUED ACCOUNTING STANDARDS
In March 1998, the AICPA issued Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." SOP 98-1 is effective for fiscal years beginning after
December 15, 1998 and requires the capitalization of certain expenditures
for software that is purchased or internally developed for use in the
business. The prospective implementation of SOP 98-1 in the first quarter
of 1999 did not have a material impact on the Company's results of
operations for the three months ended March 31, 1999.
In June 1998, SFAS 133, "Accounting for Derivative Instruments and
Hedging Activities," was issued. SFAS 133 establishes accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure
those instruments at fair value. The Company occasionally employs a small
number of financial instruments to manage its exposure to fluctuations in
interest rates and foreign currency exchange rates. The Company does not
hold or issue such financial instruments for trading purposes. The Company
does not expect the impact of adoption of SFAS 133 to be material.
8
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Amounts in Millions Except Per Share Amounts
(Unaudited)
(7) 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.
Assets are those assets used in the operations of the segment. The
Company's business segment information is as follows:
<TABLE>
<CAPTION>
Three Months
Ended March 31,
-----------------------
MILLIONS OF DOLLARS 1999 1998
------------------- -------- --------
<S> <C> <C>
Revenues
Information management. . . . . . . . . $ 157.1 $ 143.9
Less: intersegment . . . . . . . . . . (9.0) (2.1)
Customer management . . . . . . . . . . 251.7 166.9
Less: intersegment . . . . . . . . . . -- (0.1)
-------- --------
$ 399.8 $ 308.6
-------- --------
-------- --------
Depreciation and Amortization
Information management. . . . . . . . . $ 8.6 $ 6.7
Customer management . . . . . . . . . . 20.7 11.7
Corporate and other . . . . . . . . . . .3 --
-------- --------
$ 29.6 $ 18.4
-------- --------
-------- --------
Special Item - Acquired Research and Development
Customer management . . . . . . . . . . $ -- $ 42.6
-------- --------
-------- --------
Operating Income (Loss)
Information management. . . . . . . . . $ 30.3 $ 27.0
Customer management . . . . . . . . . . 23.7 (28.3)
Corporate and other . . . . . . . . . . (1.2) --
-------- --------
$ 52.8 $ (1.3)
-------- --------
-------- --------
Capital Expenditures (including acquisitions)
Information management. . . . . . . . . $ 63.5 $ 5.6
Customer management . . . . . . . . . . 12.3 663.1
Corporate and other . . . . . . . . . . .7 --
-------- --------
$ 76.5 $ 668.7
-------- --------
-------- --------
Total Assets
Information management. . . . . . . . . $ 474.5 $ 280.5
Customer management . . . . . . . . . . 1,010.2 981.4
Corporate and other . . . . . . . . . . 61.0 96.9
-------- --------
$1,545.7 $1,358.8
-------- --------
-------- --------
</TABLE>
9
<PAGE>
Form 10-Q Part I Convergys Corporation
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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, cable
telephony, satellite broadcasting, Internet services, utilities, technology,
financial services, consumer products, healthcare and direct marketing. 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 to large
companies. 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 months ended March 31, 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 financial statements include the allocation of certain
corporate overhead 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. The Company's borrowing costs are expected to be somewhat
higher under its external financing arrangements. 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 MARCH 31, 1999 VERSUS THREE MONTHS ENDED MARCH 31, 1998
The Company's revenues for the first quarter of 1999 totaled $399.8, an
increase of $91.2 (30%) from $308.6 in the first quarter 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 increased approximately 8% adjusted to include
Transtech as if it had been acquired at the beginning of both periods. This
revenue increase reflects increases experienced by both of the Company's
subsidiaries.
The Company's operating expenses for the first quarter of 1999 totaled
$347.0, an increase of $79.7 (30%) from $267.3 in the first quarter of 1998.
The Company's operating expenses, excluding the 1998 special item, increased
approximately 4% adjusted to include Transtech as if it had been acquired at
the beginning of both periods. This increase was largely the result of
increased business volume in the Company's operating segments.
The Company recorded a $42.6 special item in the first quarter of 1998
related to the expensing of in-process research and development costs for the
Transtech acquisition. This special item decreased net income by $26.4.
10
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's operating income was $52.8 in the first quarter of 1999,
an increase of $11.5 (28%) from $41.3 in the first quarter of 1998, excluding
the 1998 special item.
The Company's equity in earnings of its Cellular Partnership increased
to $7.6 for the first quarter 1999 as compared to $4.0 for the same period in
1998. Interest expense increased to $7.5 in the first quarter of 1999 from
$6.4 in the first quarter of 1998, as a result of a full quarter's interest
on borrowings to finance the acquisition of Transtech and borrowings to
finance the increased ownership interest in Wiztec in 1999. Net income for
the first quarter of 1999 was $32.4 or $.21 per share as compared to net
income of $.17 per share in the first quarter of 1998, excluding the 1998
special item. Including the 1998 special item, the Company reported a net
loss of $2.3 or $.02 per share in the first quarter of 1998.
INFORMATION MANAGEMENT
<TABLE>
<CAPTION>
Three Months
Ended March 31,
---------------------------------
($ Millions) 1999 1998 CHANGE %
------ ------ -------------
<S> <C> <C> <C> <C>
Revenues:
Information processing. . . . . . . $ 94.3 $ 88.7 $ 5.6 6
Professional and consulting . . . . 37.5 34.3 3.2 9
License and other . . . . . . . . . 6.3 6.8 (0.5) (7)
International . . . . . . . . . . . 10.0 11.9 (1.9) (16)
Intercompany services for CMG . . . 9.0 2.2 6.8 -
------ ------ ------
Total revenues. . . . . . . . . . 157.1 143.9 13.2 9
Costs of products and services . . . . . 84.9 71.4 13.5 19
Selling, general and administrative
expenses . . . . . . . . . . . . . . . 16.9 17.6 (0.7) (4)
Research and development costs . . . . . 13.5 16.5 (3.0) (18)
Depreciation and amortization. . . . . . 8.5 6.7 1.8 27
Year 2000 programming costs. . . . . . . 3.0 4.7 (1.7) (36)
------ ------ ------
Total costs . . . . . . . . . . . . 126.8 116.9 9.9 8
------ ------ ------
Operating income . . . . . . . . . . . . $ 30.3 $ 27.0 $ 3.3 12
</TABLE>
THREE MONTHS ENDED MARCH 31, 1999 VERSUS THREE MONTHS ENDED MARCH 31, 1998
Revenues for the Company's information management segment were $157.1
for the first quarter of 1999, an increase of $13.2 (9%) from $143.9 in the
first quarter of 1998. Information processing revenue increased to $94.3 in
the first quarter of 1999 from $88.7 in the first quarter of 1998, primarily
as a result of subscriber growth in IMG's wireless client base. IMG's
wireless billing clients' subscriber levels increased 22% in the quarter from
levels in the first quarter of 1998. The increase in information processing
revenues was partially offset by contractual rate reductions, some of which
were triggered by certain clients' higher subscriber levels. IMG's
professional and consulting service revenues increased to $37.5 in the first
quarter of 1999 from $34.3 in the first quarter 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 were $6.3 in the first quarter of 1999 as compared to $6.8 in the
first quarter of 1998. IMG's international revenues decreased $1.9 in the
first quarter of 1999 from the first quarter of 1998, primarily reflecting
the termination of one wireless contract and the winding down of two
long-term international contracts. IMG's intercompany revenues for services
provided to CMG increased by $6.8 over the first quarter of 1998, principally
as a result of IMG providing the processing services supporting CMG's
Transtech operations beginning in June 1999.
11
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
IMG's costs and expenses were $126.8 in the first quarter of 1999, an
increase of $9.9 (8%) over $116.9 in the first quarter of 1998. The increase
was principally the result of increased direct costs associated with a higher
level of 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 decreased research and development investment of $3.0 mainly as projects
moved toward increased focus on support and enhancement opportunities. The
increase was also offset by a decrease in Year 2000 programming costs to $3.0
in the first quarter of 1999 from $4.7 in the first quarter of 1998.
IMG relies on a few large clients for a majority of its revenue. IMG's
top three clients accounted for 46% of its revenues for the first three
months of 1999, down from 53% in the first quarter of 1998. IMG maintains
multi-year contracts with its clients. IMG may renegotiate one or more major
contracts in 1999, which could involve exchanging lower prices for longer
contract terms and broader relationships.
The wireless industry, which IMG serves, is currently experiencing a
trend toward consolidation. 360 Degree Communications, representing
approximately 3% of the Company's first quarter 1999 revenues, 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 quarter 1999 revenues. IMG and Ameritech have signed a binding letter
of intent, which extends the current contract through 2004. Additionally,
Ameritech has agreed to sell certain of its wireless communications
properties, representing approximately 50% of its wireless subscribers, to
GTE. The sale of these properties 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
Ended March 31,
--------------------------------
($ Millions) 1999 1998 Change %
------ ------ -------------
<S> <C> <C> <C> <C>
Revenues:
Dedicated services. . . . . . . . . $186.8 $113.3 $73.5 65
Traditional services. . . . . . . . 49.7 45.7 4.0 9
International . . . . . . . . . . . 15.2 7.9 7.3 92
------ ------ ------
Total revenues. . . . . . . . . . $251.7 $166.9 $84.8 51
Costs of products and services . . . . . 151.7 103.9 47.8 46
Selling, general and administrative. . .
expenses . . . . . . . . . . . . . . . 46.5 33.5 13.0 39
Research and development costs . . . . . 6.0 2.6 3.4 131
Depreciation and amortization. . . . . . 20.7 11.6 9.1 78
Year 2000 programming costs. . . . . . . 3.1 1.0 2.1 --
Special items:
Acquired research and . . . . . . .
development costs . . . . . . . . . -- 42.6 (42.6) --
------ ------ ------
Total costs. . . . . . . . . . 228.0 195.2 32.8 --
------ ------ ------
Operating income (loss). . . . . . . . . $23.7 $(28.3) $ 52.0 --
</TABLE>
12
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 VERSUS THREE MONTHS ENDED MARCH 31, 1998
Revenue for the Company's customer management segment, CMG, were $251.7
in the first quarter of 1999, an increase of $84.8 (51%) from $166.9 in the
first quarter of 1998. The revenue increase was approximately 10%, adjusted
for the acquisition of Transtech. Dedicated services revenues (typically
longer-term relationships where CMG provides value-added customer service,
technical support and sales account management primarily through personnel
dedicated to a specific client) increased by $73.5, including most of the
revenue increase contributed by Transtech. Traditional campaign-based
teleservices revenues increased by approximately 9% over the first quarter of
1998, reflecting a strong recovery for this portion of the business. CMG's
international revenues increased $7.3 in the first quarter of 1999 over
levels in the first 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 $228.0 in the first quarter of 1999, an
increase of $75.4 (49%) from $152.6 in the first quarter of 1998, excluding
special items. Costs and expenses increased by approximately 5% adjusted for
the acquisition of Transtech. This increase was primarily due to higher
wage costs and a $2.1 increase in 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 44% of its revenues for the first
three months of 1999, up from 35% for the same period in 1998. The loss of
any significant clients 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 a four-year extension of its contract to provide customer management
services to DirecTV, its second largest client. However, significant
quarterly fluctuations may still occur. CMG must continue to win new
contracts and expand its business with existing clients in a competitive
industry that has current excess capacity in its call centers.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
Operating cash flows have generally been sufficient to fund the Company's
cash needs, other than for acquisitions. The Company's acquisitions have
historically been financed by borrowings. At March 31, 1999, the Company had
$511 of short-term variable rate debt outstanding. The Company's short-term
borrowing facilities have a $600 maximum 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 $24.1 in cash during the first
quarter of 1999 while the Company used $3.6 in cash during 1998. The Transtech
and Maritz acquisitions in the first quarter of 1998 required cash to finance
post-acquisition working capital needs, as accounts receivable for both acquired
entities increased, as expected, from the levels at the acquisition date.
Excluding approximately $50 in cash used to finance these working capital needs,
cash provided by operating activities in the first quarter of 1998 was
approximately $46.4. The decline in cash from operating activities, after
adjusting for the 1998 post-acquisition working capital needs, is the result of
increased accounts receivable levels, principally at CMG. The increase in CMG's
receivables is primarily attributable to the timing of the receipt of payments
from one large customer.
The additional investment in Wiztec was the most significant use of cash
during the first quarter of 1999. Excluding Wiztec, capital expenditures in
the first quarter of 1999 were $23.4, up $13.0 from 1998. During the first
quarter of 1999, the Company incurred $1.2 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
BALANCE SHEET
The $41.0 increase in accounts receivable from December 31, 1998 to March
31, 1999 was largely attributable to the increase in CMG's accounts receivable
discussed above and the inclusion of Wiztec's accounts receivable in the March
31, 1999 balance sheet. Increases in goodwill and other intangibles and
outstanding debt, were also caused by the Wiztec transaction.
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 $6.2 in expenses during the first three months of 1999 in
order to prepare for the Year 2000 and $5.7 in the first three months of
1998. The Company estimates its Year 2000 expenses in 1999 will be in a
range of $10 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 reports 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 and testing phases of the project
are substantially complete and IMG is in the process of completing
implementation procedures. IMG's goal is for data centers, software and
other information technology systems to be Year 2000 compliant and tested by
June 30, 1999.
CMG has also adopted a strategy that includes both repair and
replacement of current systems. CMG has completed the assessment and
remediation phases of its plan and is substantially complete with regard to
systems testing. Implementation efforts are currently underway. CMG's goal
is for software, telecom equipment and other information technology systems
to be Year 2000 compliant and tested by June 30, 1999.
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 the incurrence of 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. The
Company's foreign currency exposures were immaterial at March 31, 1999.
At March 31, 1999, the Company had approximately $511 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 March 31, 1999, a one
percentage point increase in the weighted average interest rate would
increase the Company's annual interest expense by $5.1.
14
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 and the
seasonal pattern of the customer management segment of the Company.
BUSINESS DEVELOPMENT ACTIVITIES
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%.
On March 26, 1999, the Company announced that its Board of Directors has
authorized its wholly-owned subsidiary, Convergys Israel Investments, Ltd.,
to acquire through a tender offer all of the outstanding shares of Wiztec.
On April 29, 1999, the Company announced that an approximately 80,000
additional shares had been tendered by shareholders not affiliated with the
Company pursuant to the offer.
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:
<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: May 10, 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> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 20,200
<SECURITIES> 0
<RECEIVABLES> 355,300
<ALLOWANCES> 9,500
<INVENTORY> 0
<CURRENT-ASSETS> 420,600
<PP&E> 515,300
<DEPRECIATION> 264,600
<TOTAL-ASSETS> 1,545,700
<CURRENT-LIABILITIES> 738,200
<BONDS> 0
0
0
<COMMON> 152,200
<OTHER-SE> 615,400
<TOTAL-LIABILITY-AND-EQUITY> 1,545,700
<SALES> 0
<TOTAL-REVENUES> 399,800
<CGS> 0
<TOTAL-COSTS> 347,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,200
<INTEREST-EXPENSE> 7,500
<INCOME-PRETAX> 52,200
<INCOME-TAX> 19,800
<INCOME-CONTINUING> 32,400
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 32,400
<EPS-PRIMARY> .21
<EPS-DILUTED> .21
</TABLE>
