<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, 2000
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, 2000, 153,909,136 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,
--------------------- -----------------------
2000 1999 2000 1999
------- ------- --------- -------
<S> <C> <C> <C> <C>
Revenues ....................................... $ 521.9 $ 426.2 $ 1,035.5 $ 826.0
======= ======= ========= =======
Costs and Expenses
Cost of providing services and products sold 296.7 243.3 588.9 470.8
Selling, general and administrative ........ 85.5 73.0 171.5 137.2
Research and development costs ............. 22.7 20.4 45.6 39.9
Depreciation ............................... 26.8 20.3 51.8 40.4
Amortization ............................... 12.6 10.3 25.1 19.8
Year 2000 programming costs ................ -- 2.8 0.3 9.0
Purchased research and development costs ... -- 2.0 -- 2.0
------- ------- --------- -------
Total costs and expenses .............. 444.3 372.1 883.2 719.1
------- ------- --------- -------
Operating Income ............................... 77.6 54.1 152.3 106.9
Equity in Earnings of Cellular Partnership ..... 5.4 9.1 11.3 16.7
Other Expense, net ............................. -- (0.5) (0.1) (1.2)
Interest Expense ............................... (8.8) (8.5) (16.9) (16.0)
------- ------- --------- -------
Income Before Income Taxes ..................... 74.2 54.2 146.6 106.4
Income Taxes ................................... 28.7 21.4 56.6 41.2
------- ------- --------- -------
Net Income ..................................... $ 45.5 $ 32.8 $ 90.0 $ 65.2
======= ======= ========= =======
Other Comprehensive Income, net of tax:
Foreign currency translation adjustments ..... $ (2.1) $ 1.5 $ (7.0) $ 2.1
Unrealized gain (loss) on investments ........ (13.3) 2.7 (31.7) 2.7
------- ------- --------- -------
Total other comprehensive income .......... (15.4) 4.2 (38.7) 4.8
------- ------- --------- -------
Comprehensive Income ........................... $ 30.1 $ 37.0 $ 51.3 $ 70.0
======= ======= ========= =======
Earnings Per Common Share
Basic ...................................... $ 0.30 $ 0.22 $ 0.59 $ 0.43
======= ======= ========= =======
Diluted .................................... $ 0.29 $ 0.21 $ 0.57 $ 0.42
======= ======= ========= =======
Average Common Shares Outstanding
Basic ...................................... 152.4 151.6 152.2 151.6
Diluted .................................... 158.1 154.1 157.4 154.1
</TABLE>
See Notes to Financial Statements.
2
<PAGE>
Form 10-Q Part I Convergys Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Millions)
<TABLE>
<CAPTION> (Unaudited)
June 30, December 31,
2000 1999
----------- -----------
<S> <C> <C>
ASSETS
------
Current Assets
Cash and cash equivalents .......................... $ 31.8 $ 30.8
Receivables, less allowances of $14.2 and $12.4 .... 192.8 214.8
Deferred income taxes .............................. 26.5 16.5
Prepaid expenses and other current assets .......... 50.8 35.8
---------- ----------
Total current assets ............................. 301.9 297.9
Property and equipment - net .......................... 361.7 335.6
Goodwill and other intangibles - net .................. 746.5 754.3
Investment in cellular partnership .................... 77.1 79.4
Investments in marketable securities .................. 23.2 55.5
Deferred charges and other assets ..................... 55.5 56.8
---------- ----------
Total Assets ..................................... $ 1,565.9 $ 1,579.5
========== ==========
LIABILITIES AND SHAREOWNERS' EQUITY
-----------------------------------
Current Liabilities
Debt maturing in one year .......................... $ 8.7 $ 48.0
Payables and other current liabilities ............. 280.6 339.4
---------- ----------
Total current liabilities ........................ 289.3 387.4
Long-term debt ........................................ 252.2 250.3
Other long-term liabilities ........................... 15.2 14.6
---------- ----------
Total liabilities ................................ 556.7 652.3
---------- ----------
Shareowners' Equity
Preferred shares - without par value, 5.0 authorized -- --
Common shares - without par value, 500.0 authorized;
153.8 and 152.4 issued and outstanding ........... 206.0 206.0
Additional paid-in capital ......................... 518.5 491.5
Retained earnings .................................. 280.3 190.0
Accumulated other comprehensive income ............. 12.9 51.6
Treasury shares - 0.5 and 0.6, at cost ............. (8.5) (11.9)
---------- ----------
Total shareowners' equity ........................ 1,009.2 927.2
---------- ----------
Total Liabilities and Shareowners' Equity ........ $ 1,565.9 $ 1,579.5
========== ==========
</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,
---------------------
2000 1999
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ...................................................................... $ 90.0 $ 65.2
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization ................................................. 76.9 60.2
Deferred income tax provision ................................................. (8.3) 2.5
Purchased research and development costs ...................................... -- 2.0
Cellular partnership distributions in excess of earnings ...................... (2.3) (5.4)
Proceeds from receivables securitization, net ................................. 47.0 --
Changes in assets and liabilities, net of effects from acquisitions:
Increase in receivables ....................................................... (25.0) (17.3)
Increase in other current assets .............................................. (15.0) (6.4)
Increase (decrease) in payables and other current liabilities ................. (58.8) 8.2
Other, net .................................................................... 2.4 6.5
-------- --------
Net cash provided by operating activities ..................................... 106.9 115.5
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures ............................................................ (81.6) (52.2)
Acquisitions, net of cash acquired .............................................. (17.3) (50.7)
-------- --------
Net cash used in investing activities ......................................... (98.9) (102.9)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments under revolving credit facility, net ................................. (37.4) (2.8)
Issuance of treasury shares, net ................................................ 3.4 --
Issuance of common shares ....................................................... 27.0 6.7
-------- --------
Net cash provided (used) by financing activities .............................. (7.0) 3.9
-------- --------
Net increase in cash and cash equivalents ....................................... 1.0 16.5
Cash and cash equivalents at beginning of period ................................ 30.8 3.8
-------- --------
Cash and cash equivalents at end of period ...................................... $ 31.8 $ 20.3
======== ========
</TABLE>
See Notes to Financial Statements.
4
<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
The condensed consolidated financial statements of Convergys
Corporation include the results of the Company's wholly-owned subsidiaries,
the Information Management Group (IMG) and the Customer Management Group
(CMG), as well as its 45% limited partnership interest in a cellular
communications services provider in southwestern and central Ohio and
northern Kentucky (the Cellular Partnership). These financial statements
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. The December 31, 1999
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 period
amounts have been reclassified to conform to current period presentation.
(2) CMG RESTRUCTURING
In the fourth quarter of 1997, a restructuring plan for CMG was
approved that included the consolidation of certain CMG operating divisions
and facilities. At June 30, 2000, the balance of the restructuring
liability was $5.7 related to ongoing lease termination payments. The
Company made payments related to this plan of $0.9 and $3.1 in the first
half of 2000 and 1999, respectively.
(3) ACQUISITIONS
On June 5, 2000, the Company paid approximately $11 to acquire the
assets of MAXWorldwide LLC, a provider of loyalty programs for Fortune 500
corporations. The acquisition was accounted for under the purchase method
of accounting with the resulting goodwill being amortized over a 25-year
life.
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 increase its
ownership interest in Wiztec Solutions Ltd. (Wiztec) to 70% from nearly
20%. 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 and had no alternative future use. During the
remainder of 1999, the Company paid approximately $70 in a series of
transactions to increase its ownership interest in Wiztec to 100%. Wiztec,
based in Herzlia, Israel, is a provider of subscriber management systems
for multi-channel subscription television operators.
In January 1998, CMG acquired the customer management assets of
Maritz, Inc. for approximately $30 in cash. Under the terms of the
acquisition agreement, the Company made additional performance based
payments to the former owner of Maritz of approximately $4 in the first
quarter of 1999 and $3 in the first quarter of 2000. These payments were
recorded as additions to goodwill.
5
<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.
Revenues from AT&T were 41.7% and 39.0% of the Company's consolidated
revenues for the six-month periods ended June 30, 2000 and June 30, 1999,
respectively. Related accounts receivable from AT&T totaled $96.5 and $83.9
at June 30, 2000 and December 31, 1999, 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 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 nor issue such financial instruments for trading purposes. The Company
will adopt SFAS 133, as required, in the year 2001, and does not expect the
impact of adoption to be material.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements". SAB 101 interprets and expands upon existing guidance
regarding revenue recognition. SAB 101 will be effective in the fourth
quarter of 2000. The impact of SAB 101 on the Company's future revenue
recognition will be dependent on the nature and terms of services offered
by the Company in the future.
(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 all segments of the communications
industry, including wireless, wireline, cable, broadband services and
Internet services. CMG provides a full range of outsourced marketing and
customer management services.
6
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(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 2000 1999 2000 1999
------------------- -------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Revenues
Information management ..................... $ 188.4 $ 171.1 $ 368.2 $ 328.2
Customer management ........................ 337.7 263.8 677.7 515.5
Less: intersegment ........................ (4.2) (8.7) (10.4) (17.7)
-------- ---------- ---------- --------
$ 521.9 $ 426.2 $ 1,035.5 $ 826.0
======== ========== ========== ========
Depreciation and Amortization
Information management ..................... $ 14.1 $ 9.5 $ 27.8 $ 18.0
Customer management ........................ 24.3 20.7 47.8 41.5
Corporate .................................. 1.0 0.4 1.3 0.7
-------- ---------- ---------- --------
$ 39.4 $ 30.6 $ 76.9 $ 60.2
======== ========== ========== ========
Special Item - Acquired Research and Development
Information management ..................... $ -- $ 2.0 $ -- $ 2.0
Customer management ........................ -- -- -- --
-------- ---------- ---------- --------
$ -- $ 2.0 $ -- $ 2.0
======== ========== ========== ========
Operating Income (Loss)
Information management ..................... $ 38.2 $ 30.7 $ 74.1 $ 61.0
Customer management ........................ 41.3 25.2 82.0 48.9
Corporate .................................. (1.9) (1.8) (3.8) (3.0)
-------- ---------- ---------- --------
$ 77.6 $ 54.1 $ 152.3 $ 106.9
======== ========== ========== ========
Capital Expenditures (excluding acquisitions)
Information management ..................... $ 6.3 $ 4.7 $ 18.4 $ 15.1
Customer management ........................ 31.9 16.6 58.5 28.9
Corporate .................................. 2.1 7.5 4.7 8.2
-------- ---------- ---------- --------
$ 40.3 $ 28.8 $ 81.6 $ 52.2
======== ========== ========== ========
</TABLE>
(8) EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator of the basic
and diluted earnings per share (EPS) computations:
SIX MONTHS ENDED PER SHARE
JUNE 30, INCOME SHARES AMOUNT
------ ------ ---------
2000
Basic EPS $ 90.0 152.2 $ 0.59
Effect of dilutive securities:
Stock-based compensation arrangements -- 5.2 (0.02)
-------- ------- -------
Diluted EPS $ 90.0 157.4 $ 0.57
======== ======= =======
7
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
SIX MONTHS ENDED PER SHARE
JUNE 30, INCOME SHARES AMOUNT
------ ------ ------
1999
Basic EPS $ 65.2 151.6 $ 0.43
Effect of dilutive securities:
Stock-based compensation arrangements -- 2.5 (0.01)
-------- ------- -------
Diluted EPS $ 65.2 154.1 $ 0.42
======== ====== =======
THREE MONTHS ENDED
JUNE 30,
2000
Basic EPS $ 45.5 152.4 $ 0.30
Effect of dilutive securities:
Stock-based compensation arrangements -- 5.7 (0.01)
-------- ------- -------
Diluted EPS $ 45.5 158.1 $ 0.29
======== ====== =======
1999
Basic EPS $ 32.8 151.6 $ 0.22
Effect of dilutive securities:
Stock-based compensation arrangements -- 2.5 (0.01)
-------- ------- -------
Diluted EPS $ 32.8 154.1 $ 0.21
======== ====== =======
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, financial services, consumer products,
healthcare and pharmaceuticals. The company serves its clients through its two
operating subsidiaries: (i) the Information Management Group (IMG), which
provides outsourced billing and information services; and (ii) the 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.
FORWARD-LOOKING STATEMENTS
This report contains "forward-looking" statements, as defined in the Private
Securities Litigation Reform Act of 1995, that are based on current
expectations, estimates and projections. Statements that are not historical
facts, including statements about the beliefs and expectations of the Company,
are forward-looking statements. These statements discuss potential risks and
uncertainties and, therefore, actual results may differ materially. You are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date on which they were made. The Company undertakes no
obligation to update any forward-looking statements, whether as a result of new
information, future events or otherwise.
Important factors that may affect these projections or expectations
include, but are not limited to: changes in the overall economy; changes in
competition in markets in which the Company operates; changes in the regulatory
environment in which the Company's customers operate; changes in the demand for
the Company's services; changes in technology that impact both the markets
served and the types of services offered; and consolidation within the
industries in which the Company's customers operate.
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, 2000 VERSUS THREE MONTHS ENDED JUNE 30, 1999
The Company's revenues for the second quarter of 2000 totaled $521.9, a 22%
increase from the second quarter of 1999. This higher revenue reflects increases
experienced by both of the Company's operating groups. The Company's operating
expenses for the second quarter of 2000 totaled $444.3, a 19% increase from the
second quarter of 1999, reflecting greater business volume, increased spending
on sales and marketing and research and development activities and higher
depreciation and amortization. The Company's operating income was $77.6 in the
second quarter of 2000, a 38% increase from the second quarter of 1999,
excluding a $2.0 million special item recorded by IMG in 1999 to expense
purchased in-process research and development costs. 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 decreased 41%
for the second quarter of 2000 as compared to the same period in 1999,
reflecting lower subscriber revenues and higher operating costs experienced by
the partnership. Interest expense increased 4% in the second quarter of 2000
from the second quarter of 1999, as a result of higher interest rates on the
Company's variable rate borrowings. Net income was $45.5, or $0.29 per share, a
31% increase from $34.8 or $.23 per share in the second quarter of 1999,
excluding the special item. 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, 2000 VERSUS SIX MONTHS ENDED JUNE 30, 1999
The Company's revenues for the first half of 2000 totaled $1,035.5, a 25%
increase from the first half of 1999. The Company's operating expenses for the
first half of 2000 totaled $883.2, a 23% increase over the first half of 1999,
excluding a special item in 1999. The Company's operating income was $152.3 in
the first half of 2000, a 40% increase from the first half of 1999, excluding
the special item. Including the 1999 special item, operating income in the first
half of 1999 was $106.9.
The Company's equity in earnings of its Cellular Partnership in the first
half of 2000 was $11.3, a 32% decrease from the first half of 1999. Interest
expense increased 6% in the first half of 2000 from the first half of 1999 as a
result of higher interest rates. Net income for the first half of 2000 was
$90.0, or $0.57 per share, a 34% increase compared to $67.2, or $0.44 per share,
for the first half of 1999, excluding the special item in 1999. Including the
1999 special item, the Company's net income was $65.2 or $0.42 per share in the
first half of 1999.
INFORMATION MANAGEMENT
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
($ Millions) ENDED JUNE 30, ENDED JUNE 30,
-------------------------------- ---------------------------------
2000 1999 CHANGE % 2000 1999 CHANGE %
-------- -------- --------- -------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Information processing.............. $ 116.3 $ 100.8 $ 15.5 15 $ 229.2 $ 195.1 $ 34.1 17
Professional and consulting......... 34.1 37.5 (3.4) (9) 68.0 75.0 (7.0) (9)
License and other................... 12.3 11.1 1.2 11 26.2 17.4 8.8 51
International....................... 21.5 13.0 8.5 65 34.4 23.0 11.4 50
------- ------- ------ ------ ------- ------
External revenues................. 184.2 162.4 21.8 13 357.8 310.5 47.3 15
Intercompany services............... 4.2 8.7 4.5 (52) 10.4 17.7 (7.3) (41)
------- ------- ------ ------ ------- ------
Total Revenues.................... 188.4 171.1 17.3 10 368.2 328.2 40.0 12
Costs of products and services........... 95.6 89.9 5.7 6 187.3 174.8 12.5 7
Selling, general and administrative
expenses............................... 21.6 19.6 2.0 10 41.1 36.5 4.6 13
Research and development costs........... 18.9 16.8 2.1 13 37.6 30.3 7.3 24
Depreciation............................. 9.4 7.1 2.3 32 18.5 13.9 4.6 33
Amortization............................. 4.7 2.4 2.3 96 9.3 4.1 5.2 127
Year 2000 programming costs.............. - 2.6 (2.6) - 0.3 5.6 (5.3) (95)
Special item............................. - 2.0 (2.0) - - 2.0 (2.0) -
------- ------- ------ ------ ------- ------
Total costs............................ 150.2 140.4 9.8 7 294.1 267.2 26.9 10
------- ------- ------ ------ ------- ------
Operating income......................... $ 38.2 $ 30.7 $ 7.5 24 $ 74.1 $ 61.0 $ 13.1 21
</TABLE>
THREE MONTHS ENDED JUNE 30, 2000 VERSUS THREE MONTHS ENDED JUNE 30, 1999
Excluding intercompany activity, revenues for the Company's information
management segment were $184.2 for the second quarter of 2000, a 13% increase
from the second quarter of 1999. Information processing revenues increased 15%
in the second quarter of 2000 over the second quarter of 1999, primarily as a
result of a nearly 32% increase in subscribers in IMG's wireless client base.
The increase in information processing revenues was partially offset by
contractual rate reductions. Professional and consulting revenues decreased 9%
from the second quarter of 1999 as a result of the expiration of a small
Canadian wireless billing relationship.
10
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
IMG's license and other revenues increased to $12.3 in the second quarter
of 2000, an 11% increase from the second quarter of 1999, reflecting general
growth in the Company's cable operations. IMG's international revenues increased
65% to $21.5 in the second quarter of 2000 from the second quarter of 1999,
primarily reflecting implementation revenues from the Company's contract with
Telesp Celular, which was signed in the first quarter of 2000.
IMG's costs and expenses were $150.2 in the second quarter of 2000, a 9%
increase over the second quarter of 1999, excluding a 1999 special item. Direct
costs of products and services increased as a result of increased business
volume. Selling, general and administrative expenses increased reflecting the
Company's intensified focus on sales and marketing efforts. Research and
development costs increased from continued development work on ATLYS, IMG's
international wireless billing system, and on Internet Protocol billing
capabilities. Depreciation expense increased $2.3 million primarily from data
center upgrades, while amortization expense increased $2.3 million from the
completion of the acquisition of Wiztec Solutions Ltd (Wiztec) in the fourth
quarter of 1999 and the acquisition of Technology Applications Inc. (TAI) in
June 1999. These increases were partially offset by a reduction of $2.6 in Year
2000 programming costs.
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 related to an ongoing
development project that had not reached technological feasibility at the time
of the transaction and has no alternative future use.
SIX MONTHS ENDED JUNE 30, 2000 VERSUS SIX MONTHS ENDED JUNE 30, 1999
Excluding intercompany revenues, revenues for the Company's information
management segment were $357.8 for the first half of 2000, a 15% increase from
the first half of 1999. Information processing revenues increased 17% to $229.2
in the first half of 2000 from the first half of 1999, primarily as a result of
31% subscriber growth in IMG's wireless client base. The increase in information
processing revenues was partially offset by contractual rate reductions. IMG's
professional and consulting service revenues decreased 9% to $68.0 in the first
half of 2000 over the first half of 1999. This decrease was primarily
attributable to the expiration of the above-mentioned wireless billing
relationship. IMG's license and other revenues increased $8.8 in the first half
of 2000 as compared to the first half of 1999. IMG's international revenues
increased $11.4 in the first half of 2000 from the first half of 1999, primarily
reflecting the Wiztec acquisition in March 1999 and the Telesp Celular
implementation revenues.
IMG's costs and expenses were $294.1 in the first half of 2000, an 11%
increase over the first half of 1999, excluding a special item. The increase in
IMG's costs and expenses for the first half of 2000 can be attributed to higher
direct costs associated with the revenue increase, increased focus on sales and
marketing efforts, increased research and development efforts and data center
upgrades. Amortization expense more than doubled from the first half of 1999 as
a result of the Wiztec and TAI acquisitions in 1999. These increased costs and
expenses were partially offset by a $5.6 reduction in Year 2000 programming
costs.
11
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
CUSTOMER MANAGEMENT
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
($ Millions) ENDED JUNE 30, ENDED JUNE 30,
--------------------------------- ---------------------------------
2000 1999 CHANGE % 2000 1999 CHANGE %
-------- -------- ------ --- -------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Dedicated services.................. $ 292.0 $ 205.1 $ 86.9 42 $ 578.0 $ 391.9 $186.1 47
Traditional services................ 32.8 44.3 (11.5) (26) 73.5 94.0 (20.5) (22)
International....................... 12.9 14.4 (1.5) (10) 26.2 29.6 (3.4) (11)
------- ------- ------ ------- ------- ------
Total revenues................. $ 337.7 $ 263.8 $ 73.9 28 $ 677.7 $ 515.5 $162.2 31
Costs of products and services........... 205.4 161.9 43.5 27 411.8 313.6 98.2 31
Selling, general and administrative
expenses............................... 63.0 52.0 11.0 21 128.1 98.4 29.7 30
Research and development costs........... 3.7 3.7 - - 8.0 9.7 (1.7) (18)
Depreciation............................. 16.4 12.9 3.5 27 32.0 25.8 6.2 24
Amortization............................. 7.9 7.8 0.1 1 15.8 15.7 0.1 1
Year 2000 programming costs.............. - 0.3 (0.3) - - 3.4 (3.4) -
Special item............................. - - - - - -- - -
------- ------- ------- ------- ------- ------
Total costs.................... 296.4 238.6 57.8 24 595.7 466.6 129.1 28
------- ------- ------- ------- ------- ------
Operating income......................... $ 41.3 $ 25.2 $ 16.1 64 $ 82.0 $ 48.9 $ 33.1 68
</TABLE>
THREE MONTHS ENDED JUNE 30, 2000 VERSUS THREE MONTHS ENDED JUNE 30, 1999
Revenues for the Company's customer management segment, CMG, were $337.7
in the second quarter of 2000, a 28% increase from the second quarter of
1999. 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 $86.9. The increase in dedicated services revenues
resulted from strong growth in customer support services for AT&T and DirecTV
and a more than doubling of CMG's revenues from technology clients, for which
CMG provides support services. The strong increase in dedicated services was
partially offset by a 26% decrease in traditional, campaign-based,
teleservices. This decrease reflects the continued migration of the CMG's
business towards dedicated, higher value-added services. CMG's international
revenues decreased $1.5 in the second quarter of 2000 over the second quarter
of 1999 mostly due to unfavorable foreign currency translation adjustments.
CMG's costs and expenses were $296.4 in the second quarter of 2000, a
24% increase from the second quarter of 1999. Increases in direct costs of
products and services and selling, general and administrative expenses were
the result of increased business volume. Depreciation expense increased by
$3.5 as a result of new contact centers opened to support the increased
business volume. CMG's operating margin increased to 12.2%, up from 9.6% in
the second quarter of 1999, reflecting profits from higher revenues and the
impact of continuous improvement initiatives. This increase was primarily due
to higher labor and facility costs needed to support the higher revenues.
SIX MONTHS ENDED JUNE 30, 2000 VERSUS SIX MONTHS ENDED JUNE 30, 1999
Revenues for the Company's customer management segment, CMG, were $677.7
in the first half of 2000, a 31% increase from the first half of 1999.
Dedicated services revenues rose $186.1, reflecting strong customer support
revenues from AT&T, DirecTV and technology clients. Traditional,
campaign-based, teleservices revenues decreased by 22% from the first half of
1999. CMG's international revenues decreased $3.4 in the first half of 2000
over levels in the first half of 1999, primarily reflecting unfavorable
foreign currency translation adjustments.
12
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
CMG's costs and expenses were $595.7 in the first half of 2000, a 28%
increase from the first half of 1999. 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.
CLIENT CONCENTRATION
The Company's three largest clients accounted for 56% and 51% of its
revenues in the first half of 2000 and 1999, respectively. The risk posed by
this revenue concentration is reduced by the long-term contracts the Company
has with its largest clients. AT&T, the Company's largest client at 42% of
revenues in the second quarter of 2000, is principally served under long-term
information and customer management contracts that expire in 2006. DirecTV,
the Company's second largest client, is served by CMG under a contract that
expires at the end of 2002. IMG's contract with Sprint PCS, the Company's
third largest client, expires at the end of 2001.
The communications and cable industries served by the Company have
experienced a consolidation trend. ALLTEL, an IMG competitor, became a client
of IMG in 1998 through its acquisition of 360 Degree Communications. In
September 1999, the Company reached an agreement with ALLTEL under which
ALLTEL will begin to migrate its subscribers off of IMG's billing software
beginning later this year. ALLTEL has indicated that it expects to complete
the migration of its subscribers by the end of 2001. The contract will
terminate when the migration of subscribers is complete. Under terms of the
amended contract, IMG will receive payments totaling $55 (of which $30 has
been received as of June 30, 2000), as well as amounts for continued data
processing and professional and consulting services through the date that the
contract is terminated. The payments will be recognized as revenue as the
related services are performed based on the value of the services provided,
with the remainder to be recognized as a termination penalty once the
contract is terminated. The amended contract provides annual data processing
revenue minimums for 2000 and 2001, as well as a monthly minimum for any
period after 2001 during which IMG provides data processing services to
ALLTEL. The amended contract is not expected to impact IMG's revenues or
operating income significantly in 2000, but will begin to in 2001. In the
first quarter of 2000, ALLTEL announced that it would be transferring its
interest in certain markets with approximately 1 million subscribers in the
aggregate to Verizon in return for Verizon markets with approximately 1.5
million subscribers. None of the Verizon markets that will be transferred to
ALLTEL is served by IMG.
In the second quarter of 2000, the merger of AT&T and Media One, an IMG
client representing less than 1% of the Company's second quarter 2000
revenues, received regulatory approval. Under its license contract with Media
One, IMG has converted approximately 800,000 Media One subscribers onto IMG
software. In October 1999, Media One notified IMG that it would not move
forward with additional subscriber conversions to IMG's systems in 2000 until
after the merger with AT&T is completed. In the second quarter of 2000, Media
One asked IMG to re-start the effort to convert markets aggregating to
approximately 80% of its subscribers to IMG's system. Over 70% of IMG's
revenues under the Media One contract are guaranteed. The delay in the Media
One conversions did not materially impact the Company's operating results for
the first half of 2000.
On July 27, 2000, the Company announced that it had reached an agreement to
expand its billing relationship with Verizon Wireless, the U.S. wireless
alliance formed by Bell Atlantic, PrimeCo Personal Communications (PrimeCo)
and AirTouch Cellular (AirTouch). Previously, IMG had served GTE which has
recently merged with Bell Atlantic, as well as PrimeCo and AirTouch Cellular
under separate billing contracts. Under the five-year agreement, IMG will
continue to serve the Verizon markets it previously served under the former
contracts. Additionally, Verizon will migrate additional markets to IMG's
ATLYS billing and customer care system beginning in late 2001 and continuing
into 2002. At the end of the migration period, IMG expects to serve markets
that should approximately double the number of Verizon subscribers currently
on its systems. The contract provides for reduced pricing effective January
1, 2001, which will initially have a dampening effect on IMG's information
processing revenue growth in 2001, until the additional Verizon markets are
migrated to IMG's systems.
13
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
The Company's operating activities generated $106.9 and $115.5 in cash
during the first half of 2000 and 1999, respectively. Capital expenditures
were $81.6 and $52.2 for the first half of 2000 and 1999, respectively. This
increase primarily relates to CMG's expansion of existing contact facilities
and the opening of additional facilities.
Operating cash flows have historically been more than sufficient to fund
the Company's cash needs, other than for very large acquisitions.
Acquisitions have historically been financed with a combination of borrowings
and operating cash flows. At June 30, 2000, the Company had $260.9 of debt
outstanding. The Company's borrowing facilities include a $250 borrowing
capacity expiring in November 2000 and an additional $250 borrowing capacity
expiring in November 2002. During the fourth quarter of 1999, the Company
entered into an accounts receivable securitization agreement. The Company
increased its balance of outstanding sold receivables by $47 during the first
half of 2000, bringing the total outstanding balance of sold receivables to
$198 at June 30, 2000. The Company anticipates that future operating cash
flows, its available credit under existing facilities and its access to
capital markets will be sufficient to meet future capital needs.
BALANCE SHEET
The $22.0 decrease in accounts receivable from December 31, 1999 to June
30, 2000 reflects the sale of an additional $47 in receivables under the
Company's securitization agreement. Absent the effects of the securitization,
days sales outstanding remained consistent with December 31, 1999 at 68 days.
Marketable securities decreased $32.3 from December 31, 1999, primarily due
to the decline in market value of the Company's equity investment in Kana
Communications, Inc. This decline in market value did not affect net income
as it was recorded directly to shareowners' equity as a component of other
comprehensive income. Payables and other current liabilities decreased by
$58.8 from December 31, 1999, largely as the result of the timing of payment
of certain accrued expenses, particularly accrued taxes and accrued payroll
and related employee benefits, and a $10 million reduction in advance
billings and customer deposits.
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
primarily focused on information technology systems. The Company incurred
$0.3 and $9.0 in expenses during the first half of 2000 and 1999,
respectively. The Company has not experienced any significant problems
associated with the date change and does not expect to incur any additional
Year 2000 costs other than for routine monitoring and testing of continued
compliance. While the Company does not anticipate any significant problems
regarding the Year 2000, there can be no assurance that problems will not
arise in the future.
14
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
MARKET RISK
The Company derived approximately 6% of its first half 2000 consolidated
revenues outside of North America and is, accordingly, exposed to the impact
of foreign currency fluctuations. The Company is also exposed to the impact
of interest rate changes based on its use of variable rate financing. It is
the Company's policy to enter into interest rate and foreign currency
transactions only to the extent considered necessary to manage the related
risks. The Company has not entered into interest rate or foreign currency
transactions for speculative purposes. The Company's foreign currency
exposures were immaterial at June 30, 2000. In January 2000, the Company
announced an agreement to provide outsourced billing services to a client in
Brazil that will modestly increase the Company's overall exposure to foreign
currency fluctuations.
The Company's exposure to interest rate risk results from its variable
rate debt outstanding under its credit facility and from its receivables
securitization program that involves fees based on market rates of interest.
At June 30, 2000, the Company had $260.9 in debt outstanding, almost all of
which bears interest at a variable rate, which is equal to LIBOR plus an
index based on the Company's credit ratings. Additionally, the Company has
sold $198 of accounts receivable that were still outstanding at June 30,
2000. Based upon the Company's level of variable rate debt and receivables
sold under the securitization agreement at June 30, 2000, a one percentage
point increase in the weighted average interest rate would increase the
Company's annual interest expense by approximately $5.
FLUCTUATIONS IN QUARTERLY RESULTS
The Company has experienced, and in the future could experience,
quarterly variations in revenues as a result of a variety of factors, many of
which are outside of the control of the Company. These factors include: the
timing of new contracts, the timing of increased expenses incurred in support
of new business, the timing and frequency of client spending for system
enhancement requests, the timing of contractual rate reductions triggered by
subscriber growth or the passage of time and the seasonal pattern of the
customer management segment of the Company.
15
<PAGE>
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:
Exhibit
NUMBER
3 Amended Articles of Incorporation (Incorporated by
reference to Exhibit 3.1 to Form S-3 filed on August 10,
2000, File Number 333-43404)
12 Computation of Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
(b) Reports on Form 8-K
None.
16
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Convergys Corporation
Date: August 14, 2000 /S/ STEVEN G. ROLLS
---------------------------
Steven G. Rolls
Chief Financial Officer
17
