SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
---
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
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 April 30, 2001, 170,875,320 Common Shares were outstanding.
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Amounts in Millions, Except Per Share Amounts)
Three Months
Ended March 31,
----------------------
2001 2000
-------- ---------
Revenues ................................................... $ 577.8 $ 513.6
--------- ---------
Costs and Expenses
Cost of providing services and products sold............ 319.4 292.1
Selling, general and administrative..................... 98.5 86.0
Research and development costs.......................... 23.2 23.0
Depreciation............................................ 31.4 25.0
Amortization............................................ 13.3 12.5
Year 2000 programming costs............................. - 0.3
-------- ---------
Total costs and expenses.......................... 485.8 438.9
-------- ---------
Operating Income............................................ 92.0 74.7
Equity in Earnings of Cellular Partnership.................. 1.8 5.8
Other Income/(Expense), net................................. 0.1 (0.1)
Interest Expense............................................ (6.9) (8.1)
-------- ---------
Income Before Income Taxes.................................. 87.0 72.3
Income Taxes................................................ 33.5 27.9
-------- ---------
Net Income ................................................. $ 53.5 $ 44.4
======== =========
Other Comprehensive Income, net of tax:
Foreign currency translation adjustments.................. $ (5.5) $ (4.7)
Unrealized loss on cash flow hedging...................... (0.8) -
Unrealized loss on investments............................ (3.2) (18.2)
-------- ---------
Total other comprehensive loss.......................... (9.5) (22.9)
-------- ---------
Comprehensive Income........................................ $ 44.0 $ 21.5
======== =========
Earnings Per Common Share...................................
Basic................................................... $ 0.35 $ 0.29
======== =========
Diluted................................................. $ 0.34 $ 0.28
======== =========
Average Common Shares Outstanding
Basic................................................... 154.4 151.9
Diluted................................................. 159.0 156.8
See Notes to Financial Statements.
2
Form 10-Q Part I Convergys Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Millions)
March 31, December 31,
2001 2000
------------ -------------
ASSETS
- ------
Current Assets
Cash and cash equivalents........................................... $ 43.5 $ 28.2
Receivables, less allowances of $16.1 and $11.9..................... 357.5 386.4
Deferred income taxes............................................... 30.1 27.1
Prepaid expenses and other current assets........................... 50.2 39.4
---------- ----------
Total current assets.............................................. 481.3 481.1
Property and equipment - net........................................... 371.7 392.6
Goodwill and other intangibles - net................................... 739.0 740.2
Investment in cellular partnership..................................... 63.3 66.0
Investments in marketable securities................................... 4.4 7.5
Deferred charges and other assets...................................... 99.9 92.1
---------- ----------
Total Assets...................................................... $ 1,759.6 $ 1,779.5
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Debt maturing in one year........................................... $ 1.2 $ -
Payables and other current liabilities.............................. 318.7 359.0
---------- ----------
Total current liabilities......................................... 319.9 359.0
Long-term debt......................................................... 244.2 290.7
Other long-term liabilities............................................ 18.1 17.3
---------- ----------
Total liabilities................................................. 582.2 667.0
---------- ----------
Shareholders' Equity
Preferred shares - without par value, 5.0 authorized................ - -
Common shares - without par value, 500.0 authorized;
156.0 and 154.8 issued and outstanding............................ 206.0 206.0
Additional paid-in capital.......................................... 551.8 531.8
Retained earnings................................................... 438.2 384.7
Accumulated other comprehensive income.............................. (17.7) (8.2)
Treasury shares - 0.2 and 0.4, at cost.............................. (0.9) (1.8)
---------- ----------
Total shareholders' equity..................................... 1,177.4 1,112.5
---------- ----------
Total Liabilities and Shareholders' Equity..................... $ 1,759.6 $ 1,779.5
========== ==========
See Notes to Financial Statements.
3
Form 10-Q Part I Convergys Corporation
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Millions)
Three Months
Ended March 31,
----------------------
2001 2000
----------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
- ------------------------------------
Net income............................................................... $ 53.5 $ 44.4
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization.......................................... 44.7 37.5
Deferred income tax benefit............................................ (5.2) (9.2)
Cellular partnership distributions in excess of (less than) earnings... 2.7 (5.8)
Income tax benefit from stock option exercises ........................ 4.3 5.1
Proceeds from (repayments of) receivables securitization, net.......... (40.0) 40.0
Changes in assets and liabilities, net of effects from acquisitions:
Decrease (increase) in receivables..................................... 68.9 (21.0)
Increase in other current assets....................................... (10.8) (6.5)
Decrease in payables and other current liabilities..................... (46.6) (50.7)
Other, net............................................................. (1.5) 1.5
--------- --------
Net cash provided by operating activities.............................. 70.0 35.3
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
- ------------------------------------
Capital expenditures..................................................... (10.3) (41.3)
Acquisitions, net of cash acquired....................................... (15.7) (7.1)
-------- --------
Net cash used in investing activities................................ (26.0) (48.4)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Payments of debt, net.................................................... (45.3) (2.3)
Purchase of treasury shares.............................................. - (2.5)
Issuance of treasury shares, net......................................... 4.6 3.8
Issuance of common shares................................................ 12.0 10.4
-------- ---------
Net cash provided by (used in) financing activities.................. (28.7) 9.4
-------- ---------
Net increase (decrease) in cash and cash equivalents..................... 15.3 (3.7)
Cash and cash equivalents at beginning of period......................... 28.2 30.8
-------- ---------
Cash and cash equivalents at end of period............................... $ 43.5 $ 27.1
======== =========
See Notes to Financial Statements.
4
Form 10-Q Part I Convergys Corporation
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(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 unaudited 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, 2000
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) MERGER WITH GENEVA TECHNOLOGY, LTD.
On April 6, 2001, the Company acquired 100% of the outstanding
shares of Geneva Technology, Ltd. (Geneva), based in Cambridge, UK, for
approximately 14.9 million shares of Convergys common stock and
approximately 2.7 million Convergys stock options. Geneva is a provider of
convergent billing software for the communications, e-commerce, utilities
and online services industries. The transaction will be accounted for under
the pooling of interests method. Since the merger closed in April 2001, the
consolidated results for the three months ended March 31, 2001 and 2000 do
not include Geneva's operations. The following table presents the pro forma
results of the combined companies as if the merger had occurred at the
beginning of both periods:
Three Months
Ended March 31,
----------------------------
Millions of Dollars 2001 2000
------------------- ----------------------------
Revenues......................................... $ 591.5 $ 518.2
Operating income................................. 90.5 73.4
Net income....................................... 52.1 43.5
Basic earnings per share......................... $ 0.31 $ 0.26
Diluted earnings per share....................... $ 0.30 $ 0.25
(3) ACQUISTION
On February 12, 2001, the Company paid approximately $16 to acquire
the customer support business of Keane, Inc. The acquisition was accounted
for under the purchase method of accounting with the resulting goodwill
being amortized over a twenty-five-year life.
5
Form 10-Q Part I Convergys Corporation
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(4) SIGNIFICANT CUSTOMER
Both of the Company's segments derive significant revenues from
AT&T. Revenues from AT&T were 38.3% and 41.2% of the Company's consolidated
revenues for the three-month periods ended March 31, 2001 and March 31,
2000, respectively. Related accounts receivable from AT&T totaled $102.0
and $148.8 at March 31, 2001 and December 31, 2000, respectively. The
relationship with AT&T includes the Company's use of AT&T communications
services, which is particularly significant to the CMG segment. Spending
for these services with AT&T was $21.0 and $30.2 for the three-month
periods ended March 31, 2001 and March 31, 2000, respectively.
(5) CONTINGENCIES
The Company is from time to time subject to routine complaints
incidental to the business. The Company believes that the results of any
complaints and proceedings will not have a material adverse effect on the
Company's financial condition.
(6) BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION
Industry Segment Information
----------------------------
The Company operates in two industry segments which are identified
by service offerings. IMG is principally engaged in providing information
systems and billing services to 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:
Three Months
Ended March 31,
-----------------------
Millions of Dollars 2001 2000
------------------- --------- ---------
Revenues
Information management....................... $ 208.9 $ 179.8
Customer management.......................... 372.2 340.0
Less: intersegment.......................... (3.3) (6.2)
---------- ----------
$ 577.8 $ 513.6
========== ==========
Depreciation and Amortization
Information management....................... $ 13.5 $ 13.7
Customer management.......................... 29.5 23.5
Corporate.................................... 1.7 0.3
---------- ----------
$ 44.7 $ 37.5
========== ==========
Operating Income
Information management....................... $ 46.2 $ 35.9
Customer management.......................... 47.4 40.7
Corporate.................................... (1.6) (1.9)
---------- ----------
$ 92.0 $ 74.7
========== ==========
Capital Expenditures (excluding acquisitions)
Information management....................... $ 6.2 $ 12.1
Customer management.......................... 2.4 26.6
Corporate.................................... 1.7 2.6
---------- ----------
$ 10.3 $ 41.3
========== ==========
6
Form 10-Q Part 1 Convergys Corporation
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(Unaudited)
(7) EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator of
the basic and diluted earnings per share (EPS) computations:
Three Months Ended Per Share
March 31, Income Shares Amount
--------- ------ ------
2001
Basic EPS $ 53.5 154.4 $ 0.35
Effect of dilutive securities:
Stock-based compensation arrangements - 4.6 (0.01)
-------- --------- -------
Diluted EPS $ 53.5 159.0 $ 0.34
======== ========= =======
2000
Basic EPS $ 44.4 151.9 $ 0.29
Effect of dilutive securities:
Stock-based compensation arrangements - 4.9 (0.01)
-------- --------- -------
Diluted EPS $ 44.4 156.8 $ 0.28
======== ========= =======
The diluted EPS calculation for the three months ended March 31, 2001 excludes
the potential dilutive effect of 4,097,750 outstanding stock options because
they are currently anti-dilutive.
7
Form 10-Q Part 1 Convergys Corporation
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
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 internet and call
center based 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 March 31, 2001 versus Three Months Ended March 31, 2000
The Company's revenues for the first quarter of 2001 totaled $577.8, a 13%
increase from the first quarter of 2000. This higher revenue reflects increases
experienced by both of the Company's operating groups primarily due to strong
wireless subscriber growth, solid demand for billing systems enhancements and
expanding relationships with technology companies. The Company's operating
expenses for the first quarter of 2001 totaled $485.8, an 11% increase from the
first quarter of 2000, reflecting greater business volume, increased spending on
sales and marketing activities and higher depreciation. The increase in sales
and marketing expenses reflects the Company's strategy to increase its
investment in these areas to accelerate growth. The increase in depreciation
results from data center upgrades and new customer contact facilities. The
Company's operating income was $92.0 in the first quarter of 2001, a 23%
increase from the first quarter of 2000.
The Company's equity in earnings of its Cellular Partnership decreased 69%
for the first quarter of 2001 as compared to the same period in 2000, reflecting
lower subscriber revenues and higher marketing and other operating costs
experienced by the partnership. Interest expense decreased 15% in the first
quarter of 2001 from the first quarter of 2000, as a result of lower borrowings
and lower interest rates. Net income was $53.5, or $0.34 per diluted share, a
20% increase from $44.4, or $0.28 per diluted share, in the first quarter of
2000.
8
Form 10-Q Part 1 Convergys Corporation
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
INFORMATION MANAGEMENT
Three Months
(Dollars in Millions) Ended March 31,
-----------------------------------
2001 2000 Change %
-------- -------- ------- ---
Revenues:
Information processing.............. $ 126.3 $ 112.9 $ 13.4 12
Professional and consulting......... 41.2 33.9 7.3 22
License and other................... 15.3 13.9 1.4 10
International....................... 22.8 12.9 9.9 77
------- ------- ------ ---
External revenues................. 205.6 173.6 32.0 18
Intercompany services............... 3.3 6.2 (2.9) (47)
------- ------- ------ ---
Total Revenues.................... 208.9 179.8 29.1 16
Costs of products and services........... 103.4 91.7 11.7 13
Selling, general and administrative
expenses............................... 25.6 19.5 6.1 31
Research and development costs........... 20.2 18.7 1.5 8
Depreciation............................. 9.0 9.1 (0.1) (1)
Amortization............................. 4.5 4.6 (0.1) (2)
Year 2000 programming costs.............. - 0.3 (0.3) -
------- ------- ------ ---
Total costs....................... 162.7 143.9 18.8 13
------- ------- ------ ---
Operating income......................... $ 46.2 $ 35.9 $ 10.3 29
======= ======= ====== ===
Three Months Ended March 31, 2001 versus Three Months Ended March 31, 2000
Excluding intercompany activity, revenues for the Company's information
management segment were $205.6 for the first quarter of 2001, an 18% increase
from the first quarter of 2000. Information processing revenues increased 12% in
the first quarter of 2001 over the first quarter of 2000, primarily as a result
of a 33% increase in subscribers in IMG's wireless client base. This increase
was partially offset by contractual price reductions for certain wireless
clients and a decline in revenues from wireline clients. Professional and
consulting revenues increased 22% from the first quarter of 2000 due to
increased enhancement requests from wireless clients, particularly Sprint PCS
and AT&T Wireless. IMG's license and other revenues increased 10% to $15.3 in
the first quarter of 2001, primarily reflecting general growth in the Company's
cable operations. IMG's international revenues increased 77% to $22.8,
reflecting implementation and license revenues from Telesp Celular and higher
license and support fees from international cable clients.
IMG's costs and expenses were $162.7 in the first quarter of 2001, a 13%
increase over the first quarter of 2000. 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 and Catalys, IMG's international wireless
billing system and Internet billing and customer care platform, respectively.
9
Form 10-Q Part 1 Convergys Corporation
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
CUSTOMER MANAGEMENT
Three Months
Ended March 31,
----------------------------------------
(Dollars in Millions) 2001 2000 Change %
---------- -------- -------- ----
Revenues:
Communications ..................... $ 226.7 $ 223.1 $ 3.6 2
Technology.......................... 65.5 42.3 23.2 55
Financial services ................. 21.4 25.3 (3.9) (15)
Other............................... 58.6 49.3 9.3 19
-------- ------- ------- ----
Total revenues...................... 372.2 340.0 32.2 9
Costs of products and services........... 219.3 206.6 12.9 6
Selling, general and administrative
expenses............................... 73.0 64.9 8.1 12
Research and development costs........... 3.0 4.3 (1.3) (30)
Depreciation............................. 20.7 15.6 5.1 33
Amortization............................. 8.8 7.9 0.9 11
-------- ------ ------- ----
Total costs.................... 324.8 299.3 25.5 9
-------- ------ ------- ----
Operating income......................... $ 47.4 $ 40.7 $ 6.7 16
Three Months Ended March 31, 2001 versus Three Months Ended March 31, 2000
Revenues for the Company's customer management segment, CMG, were $372.2 in
the first quarter of 2001, a 9% increase from the first quarter of 2000.
Revenues from communications clients increased 2% in the first quarter of 2001
over the first quarter of 2000. This reflects slower growth than had been
achieved in recent quarters from this sector, largely as a result of AT&T
slowing its spending on outsourced customer support. Technology service revenues
increased 55% primarily due to increased services provided to Microsoft and
Hewlett Packard and small contributions from acquisitions. Revenues from
financial services clients decreased 15% as a result of reduced marketing
activity in this sector caused by the general slowdown in the U.S. economy.
Other revenue increased 19% primarily due to increased service provided to
Federal Express and Walmart. CMG's revenue growth in the first quarter was
negatively impacted by the U.S. economic slowdown, in general, and its impact on
communications services providers in particular. These negative factors are
expected to continue to slow CMG's growth at least through the second quarter of
2001.
CMG's costs and expenses were $324.8 in the first quarter of 2001, a 9%
increase from the first quarter of 2000. Increases in direct costs of products
and services and selling, general and administrative expenses were the result of
increased business volume, higher wage rates and increased personnel from
acquisitions. Depreciation expense increased by $5.1 as a result of new contact
centers opened to support the increased business volume. Amortization expense
increased 11% due to the acquisitions made in 2000 and to date in 2001. CMG's
operating margin increased to 12.7%, up from 12.0% in the first quarter of 2000,
reflecting the positive impact of higher revenues and continuous improvement
initiatives on operating margin.
10
Form 10-Q Part 1 Convergys Corporation
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
CLIENT CONCENTRATION
The Company's three largest clients accounted for 52% and 56% of its
revenues in the first quarter of 2001 and 2000, 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 38% of revenues
in the first quarter of 2001, is principally served under long-term information
and customer management contracts that expire in 2006. Volumes under some
contracts are subject to variation based, among other things, on AT&T's spending
on outsourced customer support. In January 2001, the Company announced that
IMG's contract with Sprint PCS, the Company's second largest client, was
extended through December 31, 2004. IMG's extended contract with Sprint PCS
provides for rate reductions which will impact the Company's information
processing revenue growth beginning in the first quarter of 2002. DIRECTV, the
Company's third largest client in the first quarter of 2001, is served by CMG
under a contract that expires at the end of 2002.
In September 1999, the Company amended its wireless billing contract with
ALLTEL. Under the September 1999 amendment, ALLTEL could begin migrating its
wireless subscribers from IMG's systems beginning in 2000. The companies had
announced that the subscriber migration would be completed by the end of 2001.
In December 2000, the Company signed an agreement under which IMG will continue
to provide wireless billing services to ALLTEL through at least 2003. The
September 1999 amended agreement called for ALLTEL to make payments totaling $55
to the Company, of which $50 had been received as of December 31, 2000, with the
remaining $5 to be received by the first half of 2002. The Company recorded the
payments upon receipt as deferred revenue to be recognized as the related
services are provided to ALLTEL.
In July 2000, the Company announced that it had reached an agreement to
extend 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 under separate
billing contracts. Under the five-year agreement, IMG will continue to serve the
Verizon markets it previously served under the former contracts.
In the second quarter of 2000, AT&T Broadband acquired Media One, an IMG
client representing less than 1% of the Company's 2001 revenues. AT&T Broadband
had a cable billing contract with an IMG competitor through an earlier
acquisition. In October 2000, AT&T Broadband 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. 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. It is expected that these subscribers will be removed from IMG's
systems by late 2001 or in the first half of 2002. However, in January 2001, the
Company amended its previous contract with Media One to provide billing services
to AT&T Broadband's residential telephony subscribers in IMG's service bureaus.
The term of the residential telephony contract amendment expires in December
2007. Company management does not expect the amendment to the previous Media One
contract to have a material impact on the Company's operating results in 2001.
Also in January 2001, IMG signed a contract to provide service bureau billing
services to AT&T Broadband's commercial telephony subscribers through October
2005.
11
Form 10-Q Part 1 Convergys Corporation
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
FINANCIAL CONDITION
Liquidity and Capital Resources
- -------------------------------
The Company generated $70.0 and $35.3 in cash flows from operating
activities during the first quarter of 2001 and 2000, respectively. The
Company's cash flows from operating activities for the first quarter of 2001
reflect a $40.0 reduction in receivables sold under its accounts receivable
securitization program, while the first quarter of 2000 reflected a $40.0
increase in these borrowings. Capital expenditures were $10.3 and $41.3 for the
first quarter of 2001 and 2000, respectively. This decrease primarily relates to
CMG's expansion of existing contact facilities and the opening of additional
facilities during the first quarter of 2000.
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 March 31, 2001, the Company had $245.4 of borrowings outstanding.
The Company's borrowing facilities include two revolving credit facilities with
$100 in borrowing capacity expiring in November 2001 and an additional $250 in
borrowing capacity expiring in November 2002, and $100 in notes which expire in
September 2002. The Company also has a $150 accounts receivable securitization
agreement, under which it had sold $75.0 in accounts receivable at March 31,
2001. The Company anticipates 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 $28.9 decrease in accounts receivable from December 31, 2000 to March
31, 2001 reflects significantly improved collections in the first quarter of
2001 particularly from one large client and a $40.0 reduction in the amount of
receivables sold under the Company securitization agreement. Excluding the
effects of the securitization, days sales outstanding decreased by 12 days
during the first quarter of 2001 to 67 days. The Company's investment in the
Cellular Partnership decreased by $2.7 as a result of the Company's receipt of
$4.5 in distributions from the partnership which exceeded equity earnings of
$1.8. The Company's investment in marketable securities decreased $3.1 from
December 31, 2000, 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 shareholders' equity as a
component of other comprehensive income. Payables and other current liabilities
decreased by $40.3 from December 31, 2000, largely as the result of the timing
of payments including the payment of employee bonuses earned in 2000 in the
first quarter of 2001, and a $5.7 decrease in advanced billings and customer
deposits.
Foreign Currency and Interest Rate Risk
- ---------------------------------------
The Company derived approximately 6% of its first quarter 2001 consolidated
revenues outside of North America. The Company's activities expose it to a
variety of market risks, including the effects of changes in foreign currency
exchange rates and interest rates. The Company's risk management program seeks
to reduce the potentially adverse effects that the volatility of the markets may
have on its operating results. The Company's risk management strategy includes
the use of derivative instruments to reduce the effects on its operating
results. The Company's risk management strategy includes the use of derivative
instruments to reduce the effects on its operating results and cash flows from
fluctuations caused by volatility in currency exchange and interest rates. In
using derivative financial instruments to hedge exposures to changes in exchange
rates and interest rates, the Company exposes itself to some counterparty credit
risk. The Company manages exposure to counterparty credit risk by entering into
derivative financial instruments with highly rated institutions that can be
expected to fully perform under the terms of the agreements and by diversifying
the number of financial institutions with which it enters into such agreements.
12
Form 10-Q Part 1 Convergys Corporation
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
The Company currently uses cash flow hedges. These instruments are hedges
of forecasted transactions or of the variability of cash flows to be received or
paid related to a recognized asset or liability. The Company generally enters
into forward exchange contracts expiring within one year as hedges of
anticipated cash flows denominated in foreign currencies. These contracts are
entered into to protect against the risk that the eventual cash flows resulting
from such transactions will be adversely affected by changes in exchange rates.
The Company is exposed to market risk from its variable rate borrowings. At
March 31, 2001, the Company had $242.2 in outstanding variable rate borrowings
and had sold $75.0 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 percent point change in the weighted
average interest rate would change the Company's annual interest expense by
approximately $2.
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.
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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
------
12 Computation of Ratio of Earnings to Fixed Charges
(b) Reports on Form 8-K
The Company filed a Form 8-K, dated March 5, 2001, reporting that the
Company entered into an agreement to issue approximately 17.6 million
Convergys common shares and stock options to acquire all of the issued
and outstanding capital stock and stock options of Geneva Technology
Limited, of Cambridge, U.K.
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SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Convergys Corporation
Date: May 14, 2001 /s/ Steven G. Rolls
--------------------------
Steven G. Rolls
Chief Financial Officer
15