SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 October 31, 2000, 154,235,637 Common Shares were outstanding.
<PAGE>
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Amounts in Millions, Except Per Share Amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues ........................................................ $ 544.5 $ 450.2 $ 1,580.0 $ 1,276.2
--------- --------- --------- ---------
Costs and Expenses
Cost of providing services and products sold ................ 306.6 255.1 895.5 725.9
Selling, general and administrative ......................... 90.5 74.5 262.0 211.7
Research and development costs .............................. 23.4 22.1 69.0 62.0
Depreciation ................................................ 28.3 21.8 80.1 62.2
Amortization ................................................ 12.5 12.4 37.6 32.2
Year 2000 programming costs ................................. - 2.2 0.3 11.2
Purchased research and development costs .................... - - - 2.0
--------- --------- --------- ---------
Total costs and expenses ............................... 461.3 388.1 1,344.5 1,107.2
--------- --------- --------- ---------
Operating Income ................................................ 83.2 62.1 235.5 169.0
Equity in Earnings of Cellular Partnership ...................... 6.0 10.2 17.3 26.9
Other Income/(Expense), net ..................................... 1.1 0.3 1.1 (0.9)
Interest Expense ................................................ (8.2) (8.4) (25.1) (24.4)
--------- --------- --------- ---------
Income Before Income Taxes ...................................... 82.1 64.2 228.8 170.6
Income Taxes .................................................... 31.7 24.5 88.3 65.7
--------- --------- --------- ---------
Net Income ...................................................... $ 50.4 $ 39.7 $ 140.5 $ 104.9
========= ========= ========= =========
Other Comprehensive Income, net of tax:
Foreign currency translation adjustments ...................... $ (0.9) $ (0.7) $ (7.9) $ 1.3
Unrealized loss on cash flow hedging .......................... (1.2) - (1.2) -
Unrealized gain (loss) on investments ......................... (12.9) 8.3 (44.5) 11.0
--------- --------- --------- ---------
Total other comprehensive income/(loss) .................... (15.0) 7.6 (53.6) 12.3
--------- --------- --------- ---------
Comprehensive Income ............................................ $ 35.4 $ 47.3 $ 86.9 $ 117.2
========= ========= ========= =========
Earnings Per Common Share
Basic....................................................... $ 0.33 $ 0.26 $ 0.92 $ 0.69
========= ========= ========= =========
Diluted ..................................................... $ 0.32 $ 0.26 $ 0.89 $ 0.68
========= ========= ========= =========
Average Common Shares Outstanding
Basic ....................................................... 153.1 151.7 152.5 151.7
Diluted ..................................................... 158.6 155.0 157.8 154.4
</TABLE>
See Notes to Financial Statements.
2
<PAGE>
Form 10-Q Part I Convergys Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Millions)
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
--------------- -------------
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents........................................................ $ 37.4 $ 30.8
Receivables, less allowances of $9.6 and $12.4................................... 320.2 214.8
Deferred income taxes............................................................ 31.4 16.5
Prepaid expenses and other current assets........................................ 56.1 35.8
------------ ------------
Total current assets........................................................... 445.1 297.9
Property and equipment - net........................................................ 367.6 335.6
Goodwill and other intangibles - net................................................ 748.7 754.3
Investment in cellular partnership.................................................. 71.8 79.4
Investments in marketable securities................................................ 10.4 55.5
Deferred charges and other assets................................................... 56.0 56.8
------------ ------------
Total Assets................................................................... $ 1,699.6 $ 1,579.5
============ ============
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities
Debt maturing in one year........................................................ $ 0.6 $ 48.0
Payables and other current liabilities........................................... 315.3 339.4
------------ ------------
Total current liabilities...................................................... 315.9 387.4
Long-term debt...................................................................... 312.2 250.3
Other long-term liabilities......................................................... 17.2 14.6
------------ ------------
Total liabilities.............................................................. 645.3 652.3
------------ ------------
Shareowners' Equity
Preferred shares - without par value, 5.0 authorized............................. - -
Common shares - without par value, 500.0 authorized;
154.2 and 152.4 issued and outstanding......................................... 206.0 206.0
Additional paid-in capital....................................................... 526.3 491.5
Retained earnings................................................................ 330.5 190.0
Accumulated other comprehensive income........................................... (2.1) 51.6
Treasury shares - 0.4 and 0.6, at cost........................................... (6.4) (11.9)
------------- -------------
Total shareowners' equity...................................................... 1,054.3 927.2
------------ ------------
Total Liabilities and Shareowners' Equity...................................... $ 1,699.6 $ 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>
Nine Months
Ended September 30,
-------------------
2000 1999
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................................................................... $ 140.5 $ 104.9
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization............................................................... 117.7 94.4
Deferred income tax provision............................................................... (3.7) 1.5
Purchased research and development costs.................................................... - 2.0
Cellular partnership distributions in excess of (less than) earnings........................ 7.6 (15.6)
Reduced borrowings under receivables securitization program, net............................ (41.0) -
Changes in assets and liabilities, net of effects from acquisitions:
Increase in receivables..................................................................... (64.4) (30.6)
Increase in other current assets............................................................ (20.3) (8.3)
Increase (decrease) in payables and other current liabilities............................... (11.8) 56.2
Other, net.................................................................................. (13.2) (6.5)
--------- ---------
Net cash provided by operating activities................................................... 111.4 198.0
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures.......................................................................... (110.4) (88.8)
Acquisitions, net of cash acquired............................................................ (36.9) (114.4)
--------- ---------
Net cash used in investing activities....................................................... (147.3) (203.2)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under revolving credit facility, net............................................... 14.5 33.7
Issuance of Wiztec common shares under Wiztec option plans.................................... - 4.9
Issuance of treasury shares, net.............................................................. 5.5 -
Issuance of common shares..................................................................... 22.5 5.2
-------- --------
Net cash provided by financing activities................................................... 42.5 43.8
-------- --------
Net increase in cash and cash equivalents..................................................... 6.6 38.6
Cash and cash equivalents at beginning of period.............................................. 30.8 3.8
-------- --------
Cash and cash equivalents at end of period.................................................... $ 37.4 $ 42.4
======== ========
</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 September 30, 2000, the balance of the restructuring liability
was $5.0 related to ongoing lease termination payments. The Company made
payments related to this plan of $1.6 and $4.1 in the first nine months of 2000
and 1999, respectively.
(3) ACQUISITIONS
On September 1, 2000, the Company paid approximately $17 to acquire the
assets of Taima Corporation, a provider of integrated, technical help desk
support services for Internet Service Providers (ISPs) and other Internet-based
clients. The acquisition was accounted for under the purchase method of
accounting with the resulting goodwill being amortized over a twenty-five-year
life.
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 twenty-five-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 the 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 with the
resulting goodwill being amortized over a fifteen-year life. 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 and
are being amortized over a twenty-five-year life.
5
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
(4) DEBT AND RECEIVABLES SECURITIZATION
On September 7, 2000, the Company issued $100 in notes, which will mature
on September 9, 2002. Proceeds from the notes were used to repay a portion of
the Company's outstanding short-term borrowings. The notes bear interest at a
variable rate, which is based on LIBOR. Additionally, on September 7, 2000, the
Company entered into an interest rate swap agreement with a notional value of
$100, which has the effect of converting the variable rate notes into 7.82%
fixed rate debt. The interest rate swap agreement terminates on the day the
notes mature.
Separately, on September 26, 2000, the Company extended its agreement to
sell a portion of its domestic trade accounts receivable through September 2001.
The maximum amount of outstanding receivables that can be sold under the
agreement was reduced from $200 to $150.
(5) SIGNIFICANT CUSTOMER
Both of the Company's segments derive significant revenues from AT&T.
Revenues from AT&T were 42.0% and 39.6% of the Company's consolidated revenues
for the nine-month periods ended September 30, 2000 and September 30, 1999,
respectively. Related accounts receivable from AT&T totaled $108.9 and $83.9 at
September 30, 2000 and December 31, 1999, respectively.
(6) 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.
(7) IMPLEMENTATION OF SFAS 133
Effective July 1, 2000, the Company adopted SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 requires that all
derivative instruments be recognized on the balance sheet at fair value. Fair
values are determined based on quoted market prices of comparable instruments,
if available, or on pricing models using current assumptions. On the date the
derivative contract is entered into, the Company designates it as either a fair
value or cash flow hedge. At September 30, 2000, the Company's derivative
contracts are all designated as cash flow hedges and have all been determined by
the Company to be highly effective. Unrealized gains and losses of highly
effective cash flow hedges are recorded in other comprehensive income, until the
underlying transaction occurs. At September 30, 2000, the Company's balance
sheet reflects derivative liabilities of $1.2. Additionally, the interest rate
swap was a liability with a fair value of $0.5 at September 30, 2000. As of
September 30, 2000, accumulated other comprehensive income included deferred net
losses of $1.2. The Company formally documents all relationships between hedging
instruments and hedged items, as well as its related risk management objective.
The Company also formally assesses whether the derivatives that are used in
hedging transactions are highly effective in offsetting changes in the hedged
cash flows.
(8) RECENTLY ISSUED ACCOUNTING STANDARD
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 Company does not expect SAB 101 to have a material impact on revenue
recognition for current contracts. 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.
6
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
(9) 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.
The Company does not allocate activities below the operating income level
to its reported segments. Certain corporate administrative expenses have been
allocated to segments based upon the nature of the expense. The Company's
business segment information is as follows:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------- ----------------------
MILLIONS OF DOLLARS 2000 1999 2000 1999
------------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues
Information management....................... $ 205.4 $ 179.1 $ 573.6 $ 507.3
Customer management.......................... 342.7 279.9 1,020.4 795.4
Less: intersegment.......................... (3.6) (8.8) (14.0) (26.5)
---------- --------- ---------- ---------
$ 544.5 $ 450.2 $ 1,580.0 $ 1,276.2
========= ========= ========== =========
Depreciation and Amortization
Information management....................... $ 14.8 $ 12.2 $ 42.6 $ 30.3
Customer management.......................... 24.9 21.5 72.7 63.1
Corporate.................................... 1.1 0.5 2.4 1.0
--------- --------- ---------- ---------
$ 40.8 $ 34.2 $ 117.7 $ 94.4
========= ========= ========== =========
Special Item - Acquired Research and Development
Information management....................... $ -- $ -- $ -- $ 2.0
Customer management.......................... -- -- -- --
--------- --------- --------- ---------
$ -- $ -- $ -- $ 2.0
========= ========= ========= =========
Operating Income (Loss)
Information management....................... $ 43.0 $ 34.3 $ 117.1 $ 95.3
Customer management.......................... 42.1 29.6 124.1 78.4
Corporate.................................... (1.9) (1.8) (5.7) (4.7)
--------- --------- ---------- ---------
$ 83.2 $ 62.1 $ 235.5 $ 169.0
========= ========= ========= =========
Capital Expenditures (excluding acquisitions)
Information management $ 17.3 $ 9.7 $ 33.3 $ 24.8
Customer management.......................... 27.0 26.4 71.9 55.3
Corporate.................................... 0.8 0.5 5.2 8.7
--------- --------- --------- --------
$ 45.1 $ 36.6 $ 110.4 $ 88.8
========= ========= ========= =========
</TABLE>
7
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
(10) EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator of the basic
and diluted earnings per share (EPS) computations:
<TABLE>
<CAPTION>
Nine Months Ended PER SHARE
September 30, INCOME SHARES AMOUNT
------ ------ ------
<S> <C> <C> <C>
2000
Basic EPS $ 140.5 152.5 $ 0.92
Effect of dilutive securities:
Stock-based compensation arrangements -- 5.3 (0.03)
-------- -------- --------
Diluted EPS $ 140.5 157.8 $ 0.89
======== ======== ========
1999
Basic EPS $ 104.9 151.7 $ 0.69
Effect of dilutive securities:
Stock-based compensation arrangements -- 2.7 (0.01)
-------- -------- --------
Diluted EPS $ 104.9 154.4 $ 0.68
======== ======== ========
Three Months Ended
September 30,
2000
Basic EPS $ 50.4 153.1 $ 0.33
Effect of dilutive securities:
Stock-based compensation arrangements -- 5.5 (0.01)
-------- -------- --------
Diluted EPS $ 50.4 158.6 $ 0.32
======== ======== ========
1999
Basic EPS $ 39.7 151.7 $ 0.26
Effect of dilutive securities:
Stock-based compensation arrangements -- 3.3 --
-------- -------- --------
Diluted EPS $ 39.7 155.0 $ 0.26
======== ======== ========
</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, technology and financial services. 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 SEPTEMBER 30, 2000 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
1999
The Company's revenues for the third quarter of 2000 totaled $544.5, a 21%
increase from the third quarter of 1999. This higher revenue reflects increases
experienced by both of the Company's operating groups. The Company's operating
expenses for the third quarter of 2000 totaled $461.3, a 19% increase from the
third quarter of 1999, reflecting greater business volume, increased spending on
sales and marketing and research and development activities and higher
depreciation. The increases in sales and marketing expenses and research and
development spending reflect the Company's strategy to accelerate growth. The
increase in depreciation results from data center upgrades and new customer
contact facilities. The Company's operating income was $83.2 in the third
quarter of 2000, a 34% increase from the third quarter of 1999.
The Company's equity in earnings of its Cellular Partnership decreased 41%
for the third 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 decreased 2% in the third quarter of 2000 from the
third quarter of 1999, as a result of slightly lower borrowings, partially
offset by increased interest rates. Net income was $50.4, or $0.32 per diluted
share, a 27% increase from $39.7 or $0.26 per diluted share in the third quarter
of 1999.
9
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 2000 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1999
The Company's revenues for the first nine months of 2000 totaled $1,580.0,
a 24% increase from the first nine months of 1999. The Company's operating
expenses for the first nine months of 2000 totaled $1,344.5, a 21% increase over
the first nine months of 1999, excluding a special item in 1999 to expense
purchased in-process research and development costs. The Company's operating
income was $235.5 in the first nine months of 2000, a 38% increase from the
first nine months of 1999, excluding the special item. Including the 1999
special item, operating income in the first nine months of 1999 was $169.0.
The Company's equity in earnings of its Cellular Partnership in the first
nine months of 2000 was $17.3, a 36% decrease from the first nine months of
1999. Interest expense increased 3% in the first nine months of 2000 from the
first nine months of 1999 as a result of higher interest rates. Net income for
the first nine months of 2000 was $140.5, or $0.89 per diluted share, a 31%
increase compared to $106.9, or $0.69 per diluted share, for the first nine
months of 1999, excluding the special item in 1999. Including the 1999 special
item, the Company's net income was $104.9 or $0.68 per diluted share in the
first nine months of 1999.
INFORMATION MANAGEMENT
<TABLE>
<CAPTION>
Three Months Nine Months
($ Millions) Ended September 30, Ended September 30,
------------------------------------- -----------------------------------
2000 1999 CHANGE % 2000 1999 CHANGE %
--------- -------- ------------ --------- --------- --------------
Revenues:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Information processing.............. $ 125.3 $ 110.3 $ 15.0 14 $ 354.5 $ 305.4 $ 49.1 16
Professional and consulting......... 44.4 34.9 9.5 27 112.4 109.9 2.5 2
License and other................... 12.8 10.4 2.4 23 39.0 27.8 11.2 40
International....................... 19.3 14.7 4.6 31 53.7 37.7 16.0 42
--------- -------- ------- ------- -------- -------
External revenues................. 201.8 170.3 31.5 18 559.6 480.8 78.8 16
Intercompany services............... 3.6 8.8 (5.2) (59) 14.0 26.5 (12.5) (47)
--------- -------- ------- ------- -------- --------
Total Revenues.................... 205.4 179.1 26.3 15 573.6 507.3 66.3 13
Costs of products and services........... 102.9 92.2 10.7 12 290.2 266.9 23.3 9
Selling, general and administrative
expenses............................... 25.0 20.6 4.4 21 66.1 57.1 9.0 16
Research and development costs........... 19.7 18.0 1.7 9 57.3 48.3 9.0 19
Depreciation............................. 10.1 7.7 2.4 31 28.6 21.7 6.9 32
Amortization............................. 4.7 4.5 0.2 4 14.0 8.6 5.4 63
Year 2000 programming costs.............. - 1.8 (1.8) - 0.3 7.4 (7.1) (96)
Special item............................. - - - - - 2.0 (2.0) -
--------- -------- -------- --------- --------- --------
Total costs ................. 162.4 144.8 17.6 12 456.5 412.0 44.5 11
-------- --------- -------- --------- --------- -------
Operating income......................... $ 43.0 $ 34.3 $ 8.7 25 $ 117.1 $ 95.3 $ 21.8 23
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 2000 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
1999
Excluding intercompany activity, revenues for the Company's information
management segment were $201.8 for the third quarter of 2000, an 18% increase
from the third quarter of 1999. Information processing revenues increased 14% in
the third quarter of 2000 over the third quarter of 1999, primarily as a result
of a 31% increase in subscribers in IMG's wireless client base and a decline in
revenues from wireline clients. The increase in information processing revenues
was partially offset by contractual rate reductions. Professional and consulting
revenues increased 27% from the third quarter of 1999 due to increased
enhancement requests from wireless clients, particularly Sprint and Verizon.
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 23% to $12.8 in the third
quarter of 2000, reflecting general growth in the Company's cable operations.
IMG's international revenues increased 31% to $19.3, 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 $162.4 in the third quarter of 2000, a 12%
increase over the third quarter of 1999. 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 $2.4 million primarily from data center upgrades, while amortization
expense increased slightly from the completion of the acquisition of Wiztec
Solutions Ltd. (Wiztec) in the fourth quarter of 1999. These increases were
partially offset by a reduction of $1.8 in Year 2000 programming costs.
NINE MONTHS ENDED SEPTEMBER 30, 2000 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1999
Excluding intercompany revenues, IMG's revenues were $559.6 for the first
nine months of 2000, a 16% increase from the first nine months of 1999.
Information processing revenues increased 16% to $354.5 in the first nine months
of 2000 from the first nine months 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 and a
decline in revenues from wireline clients. IMG's professional and consulting
service revenues increased 2% to $112.4 in the first nine months of 2000 over
the first nine months of 1999. This increase was primarily attributable to
increased enhancement requests from wireless clients in the third quarter 2000,
partially offset by the expiration of a small Canadian wireless billing
relationship. IMG's license and other revenues increased $11.2 in the first nine
months of 2000 as compared to the first nine months of 1999, reflecting growth
in the Company's cable operations. IMG's international revenues increased $16.0
in the first nine months of 2000, primarily reflecting the Telesp Celular
implementation revenues and the Wiztec acquisition in March 1999.
IMG's costs and expenses were $456.5 in the first nine months of 2000, an
11% increase over the first nine months of 1999, excluding a special item. The
increase in IMG's costs and expenses for the first nine months 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 increased 63%
from the first nine months of 1999 as a result of the Wiztec acquisition in
1999. These increased costs and expenses were partially offset by a $7.1
reduction in Year 2000 programming costs.
In connection with the purchase of a controlling interest in Wiztec, IMG
expensed $2.0 of in-process research and development costs as a special item in
the second quarter of 1999. The amount expensed related to an ongoing
development project that had not reached technological feasibility at the time
of the transaction and has no alternative future use.
11
<PAGE>
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
CUSTOMER MANAGEMENT
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------------------- -----------------------------------
($ Millions) 2000 1999 CHANGE % 2000 1999 CHANGE %
-------- -------- ------------- -------- ------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Dedicated services.................. $ 301.6 $ 224.0 $ 77.6 35 $ 879.6 $ 615.9 $ 263.7 43
Traditional services................ 29.7 42.6 (12.9) (30) 103.2 136.6 (33.4) (24)
International....................... 11.4 13.3 (1.9) (14) 37.6 42.9 (5.3) (12)
-------- -------- ------- -------- ------ ------
Total revenues................. $ 342.7 $ 279.9 $ 62.8 22 $ 1,020.4 $ 795.4 $ 225.0 28
Costs of products and services........... 207.5 171.7 35.8 21 619.3 485.4 133.9 28
Selling, general and administrative
expenses............................... 64.7 52.6 12.1 23 192.8 151.0 41.8 28
Research and development costs........... 3.5 4.1 (0.6) (15) 11.5 13.7 (2.2) (16)
Depreciation............................. 17.0 13.6 3.4 25 49.0 39.5 9.5 24
Amortization............................. 7.9 7.9 - - 23.7 23.6 0.1 -
Year 2000 programming costs.............. - 0.4 (0.4) - - 3.8 (3.8) -
------- ------- -------- ---------- ------- -------
Total costs.................... 300.6 250.3 50.3 20 896.3 717.0 179.3 25
------- ------- ------- ---------- ------- -------
Operating income......................... $ 42.1 $ 29.6 $ 12.5 42 $ 124.1 $ 78.4 $ 45.7 58
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 2000 VERSUS THREE MONTHS ENDED SEPTEMBER 30,
1999
Revenues for the Company's customer management segment, CMG, were $342.7 in
the third quarter of 2000, a 22% increase from the third 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 $77.6. 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 technical support revenues from technology clients. The strong
increase in dedicated services was partially offset by a 30% 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 $1.9 in the third quarter of 2000 over
the third quarter of 1999 mostly due to lower revenues in CMG's French
operations and unfavorable shifts in foreign currencies.
CMG's costs and expenses were $300.6 in the third quarter of 2000, a 20%
increase from the third 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 $3.4 as a result of
new contact centers opened to support the increased business volume. CMG's
operating margin increased to 12.3%, up from 10.6% in the third quarter of 1999,
reflecting the positive impact of higher revenues and continuous improvement
initiatives on operating margin.
NINE MONTHS ENDED SEPTEMBER 30, 2000 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 1999
CMG's revenues were $1,020.4 in the first nine months of 2000, a 28%
increase from the first nine months of 1999. Dedicated services revenues rose
$263.7, reflecting strong customer support revenues from AT&T, DirecTV and
technology clients. Traditional, campaign-based, teleservices revenues decreased
by 24% from the first nine months of 1999. CMG's international revenues
decreased $5.3 in the first nine months of 2000 over levels in the first nine
months of 1999, primarily reflecting lower revenues in CMG's French operations
and unfavorable shifts in foreign currencies.
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 $896.3 in the first nine months of 2000, a
25% increase from the first nine months 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 52% of its
revenues in the first nine months 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 first nine months of 2000, is principally served under long-term
information and customer management contracts that expire in 2006. DirecTV, the
Company's second largest client in the first nine months of 2000, 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 September
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, AT&T acquired Media One, an IMG client
representing less than 1% of the Company's third quarter 2000 revenues. AT&T had
a cable billing contract with an IMG competitor through an earlier acquisition.
In October 2000, AT&T announced its intention to move the majority of the Media
One cable subscribers to the competitor's system by late 2001 and all of the
subscribers by June 2002. Over 70% of IMG's revenues under the Media One
contract are guaranteed. Under its license contract with Media One, which was
signed in the fourth quarter of 1998, IMG had converted approximately 800,000 of
Media One's approximately 5 million subscribers onto IMG software as of
September 30, 2000. It is expected that these subscribers will be removed from
IMG's systems by late 2001 or in the first half of 2002. As the majority of the
revenues under the Media One license contract are guaranteed, the movement of
the subscribers to the competitor's system is not expected to have a material
impact on IMG's operating results.
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 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. 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.
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 $111.4 and $198.0 in cash
during the first nine months of 2000 and 1999, respectively. The Company's cash
flows from operating activities for the first nine months of 2000 reflect a
$41.0 reduction in borrowings under its accounts receivable securitization
program. Capital expenditures were $110.4 and $88.8 for the first nine months 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 September 30, 2000, the Company had $312.8 of debt outstanding.
The Company's borrowing facilities include revolving credit facilities with a
$250 borrowing capacity expiring in November 2000, an additional $250 borrowing
capacity expiring in November 2002 and $100 in notes which expire in September
2002. The Company is in discussions to renew the facility expiring in November
2000, but may reduce the size of the facility. During the fourth quarter of
1999, the Company entered into an accounts receivable securitization agreement.
The Company decreased its balance of outstanding sold receivables by $41 during
the first nine months of 2000, bringing the total outstanding balance of sold
receivables to $110 at September 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 $105.4 increase in accounts receivable from December 31, 1999 to
September 30, 2000 reflects increases related to higher revenue in addition to a
$41 reduction in the sale of receivables sold under the Company's securitization
agreement. Excluding the effects of the securitization, days sales outstanding
increased by 5 days, compared with December 31, 1999, to 73 days. Accounts
receivable allowances at September 30, 2000 decreased by $2.8 from December 31,
1999, reflecting the resolution of certain client accounts receivable that had
been specifically reserved. Marketable securities decreased $45.1 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 $24.1 from December 31, 1999, largely as the result of the timing
of payments for certain accrued expenses, particularly accrued taxes and accrued
payroll and related employee benefits, and an $11 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 $11.2
in expenses during the first nine months 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)
FOREIGN CURRENCY AND INTEREST RATE RISK
The Company derived approximately 6% of its revenues for the first nine
months of 2000 outside of North America. The Company maintains a foreign
currency risk management strategy that uses derivative instruments to manage its
foreign currency exposures. The Company uses cash flow hedging strategies to
reduce the potentially adverse effects that market volatility can have on its
operating results. The use of these instruments exposes the Company to credit
risk and market risk. The Company manages these credit and market risks by
entering into derivative agreements only with highly rated institutions and by
establishing parameters that limit the type and degree of market risk that can
be assumed.
The Company is exposed to market risk from its variable rate borrowings. At
September 30, 2000, the Company had $312.8 in outstanding variable rate
borrowings and had sold $110 in accounts receivable on a variable rate basis.
The Company entered into an interest rate swap agreement to effectively fix the
interest rate for $100 of variable rate borrowings. The swap agreement exposes
the Company to credit risk in the event the counterparty could not perform under
the agreement. The Company managed this risk by entering into the interest rate
swap agreement with a highly rated financial institution. Based upon the
Company's exposure to variable rate borrowings, a one percentage point change in
the weighted average interest rate would change the Company's annual interest
expense by approximately $3.
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>
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>
12 Computation of Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
The Company filed a Form 8-K, dated September 26, 2000, reporting that the
Company responded to an inquiry from CBS MarketWatch regarding Convergys'
recent share price decline.
16
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Convergys Corporation
Date: November 13, 2000 /s/ Steven G. Rolls
---------------------------------------
Steven G. Rolls
Chief Financial Officer
17
