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, 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 October 31, 2001, 172,072,704 Common Shares were outstanding.
Form 10-Q Part 1 Convergys Corporation
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Amounts in Millions, Except Per Share Amounts)
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- --------------------
2001 2000 2001 2000
-------------------- --------------------
Revenues ............................................ $ 567.2 $ 553.5 $ 1,729.9 $ 1,602.6
--------- --------- --------- ---------
Costs and Expenses
Cost of providing services and products sold..... 309.2 313.3 940.1 909.1
Selling, general and administrative ............. 91.7 94.1 300.0 270.1
Research and development costs .................. 32.4 25.3 86.8 73.7
Depreciation .................................... 30.5 28.5 94.5 81.0
Amortization .................................... 12.8 12.6 38.2 37.7
Restructuring and impairment charges ............ 58.0 - 58.0 -
Acquisition and integration costs ............... - - 31.8 -
--------- --------- --------- ---------
Total costs and expenses ................... 534.6 473.8 1,549.4 1,371.6
--------- --------- --------- ---------
Operating Income .................................... 32.6 79.7 180.5 231.0
Equity in Earnings of Cellular Partnership .......... 1.3 6.0 5.9 17.3
Other Income (Expense), net ......................... (7.6) 1.2 (6.9) 1.4
Interest Expense .................................... (4.0) (8.2) (16.5) (25.1)
--------- --------- --------- ---------
Income Before Income Taxes .......................... 22.3 78.7 163.0 224.6
Income Taxes ........................................ 19.3 31.1 80.6 87.6
--------- --------- --------- ---------
Net Income .......................................... $ 3.0 $ 47.6 $ 82.4 $ 137.0
========= ========= ========= =========
Other Comprehensive Income, net of tax:
Foreign currency translation adjustments .......... $ (0.3) $ (0.9) $ (4.5) $ (7.9)
Unrealized loss on cash flow hedging .............. (2.5) (1.2) (1.0) (1.2)
Change in unrealized gain (loss) on investments.... 1.4 (12.9) (1.7) (44.5)
--------- --------- --------- ---------
Total other comprehensive loss ................. (1.4) (15.0) (7.2) (53.6)
--------- --------- --------- ---------
Comprehensive Income ................................ $ 1.6 $ 32.6 $ 75.2 $ 83.4
========= ========= ========= =========
Earnings Per Common Share
Basic ........................................... $ 0.02 $ 0.28 $ 0.49 $ 0.82
========= ========= ========= =========
Diluted ......................................... $ 0.02 $ 0.27 $ 0.47 $ 0.79
========= ========= ========= =========
Average Common Shares Outstanding
Basic ........................................... 169.9 167.9 169.7 167.4
Diluted ......................................... 174.2 174.8 175.1 173.9
See Notes to Financial Statements.
2
Form 10-Q Part 1 Convergys Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Millions)
September 30, December 31,
2001 2000
--------------- -------------
ASSETS
- ------
Current Assets
Cash and cash equivalents.......................................... $ 36.9 $ 49.3
Receivables, less allowances of $14.3 and $11.9.................... 391.3 395.7
Deferred income taxes.............................................. 30.9 28.1
Prepaid expenses and other current assets.......................... 53.1 43.1
------------ ------------
Total current assets............................................. 512.2 516.2
Property and equipment - net.......................................... 338.1 397.6
Goodwill and other intangibles - net.................................. 715.5 740.2
Investment in Cellular Partnership.................................... 41.8 66.0
Deferred charges and other assets..................................... 115.9 84.1
------------ ------------
Total Assets..................................................... $ 1,723.5 $ 1,804.1
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Debt maturing in one year.......................................... $ 1.8 $ 0.6
Payables and other current liabilities............................. 351.2 370.8
------------ ------------
Total current liabilities........................................ 353.0 371.4
Long-term debt........................................................ 184.5 291.4
Other long-term liabilities........................................... 19.0 17.3
------------ ------------
Total liabilities................................................ 556.5 680.1
------------ ------------
Shareholders' Equity
Preferred shares - without par value, 5.0 authorized............... - -
Common shares - without par value, 500.0 authorized;
171.7 and 169.7 issued and outstanding........................... 206.0 206.0
Additional paid-in capital......................................... 582.2 549.5
Retained earnings.................................................. 461.5 379.1
Accumulated other comprehensive loss............................... (16.2) (8.8)
Treasury shares - 2.7 and 0.4 shares............................... (66.5) (1.8)
------------- -------------
Total shareholders' equity....................................... 1,167.0 1,124.0
-------------- -------------
Total Liabilities and Shareholders' Equity....................... $ 1,723.5 $ 1,804.1
============ =============
See Notes to Financial Statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Millions)
Nine Months
Ended September 30,
-------------------
2001 2000
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
- ------------------------------------
Net income.................................................................................... $ 82.4 $ 137.0
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization............................................................. 132.7 118.7
Restructuring, impairment and integration costs........................................... 45.2 -
Deferred income tax expense (benefit)..................................................... 2.9 (3.7)
Cellular Partnership distributions in excess of earnings.................................. 24.2 7.6
Income tax benefit from stock option exercises............................................ 6.0 12.3
Repayments of receivables securitization, net............................................. (55.0) (41.0)
Changes in assets and liabilities, net of effects from acquisitions:
Decrease (increase) in receivables........................................................ 59.4 (63.6)
Increase in other current assets.......................................................... (10.0) (20.9)
Increase in deferred charges and other assets............................................. (40.6) (8.7)
Decrease in payables and other current liabilities........................................ (34.9) (32.8)
Other, net................................................................................ 15.8 16.6
-------- --------
Net cash provided by operating activities................................................. 237.1 121.5
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
- ------------------------------------
Capital expenditures.......................................................................... (79.2) (114.1)
Acquisitions, net of cash acquired............................................................ (36.3) (36.9)
-------- --------
Net cash used in investing activities....................................................... (115.5) (151.0)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Borrowings (payments) of debt, net............................................................ (105.7) 14.0
Purchase of treasury shares................................................................... (56.2) (5.8)
Issuance of treasury shares, net.............................................................. 1.2 0.3
Issuance of common shares..................................................................... 26.7 22.9
-------- --------
Net cash provided by (used in) financing activities......................................... (134.0) 30.8
-------- --------
Net increase (decrease) in cash and cash equivalents.......................................... (12.4) 1.3
Cash and cash equivalents at beginning of period.............................................. 49.3 45.4
-------- --------
Cash and cash equivalents at end of period.................................................... $ 36.9 $ 46.7
======== ========
See Notes to Financial Statements.
4
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
1) BACKGROUND AND BASIS OF PRESENTATION
Convergys Corporation (the Company) serves its clients through its
two operating segments: (i) the Information Management Group (IMG),
which provides outsourced billing and information services and
software; and (ii) the Customer Management Group (CMG), which provides
outsourced marketing, customer support and employee care services. IMG
includes the operations of the Information Management Group and the
acquired operations of Geneva Technology Limited (Geneva). The Company
also has a 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 except for items described in Notes 2 and
3. 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. Prior periods have been restated as a
result of the pooling-of-interests transaction described in Note 3.
Certain prior period amounts have also been reclassified to conform to
current period presentation.
(2) RESTRUCTURING AND IMPAIRMENT CHARGES
In the third quarter of 2001, the Company approved a plan to
rationalize CMG's contact center capacity. The plan resulted in a pre-
tax restructuring charge of $53.3 ($41.0 after tax). The charge
consists of $29.0 in costs associated with the closing of contact
centers, $16.2 in asset impairment related to software that will not be
deployed into those contact center operations and $8.1 to write-down
investments in certain of CMG's European contact center operations. The
contact center closing costs include $11.8 for lease terminations, $6.4
in severance pay under existing severance plans and $10.8 related to
the impairment of leasehold improvements. The $6.4 charge for severance
under the plan involves the elimination of approximately 550 employees
in contact center operations and administrative functions. The total
cash cost of the plan is expected to be approximately $20.2.
The execution of the plan began during the third quarter of 2001
with the closure of a majority of the affected centers. The Company
expects to complete the closure of the remaining centers by the end of
2001 and the employee reductions by the third quarter of 2002. During
the third quarter, $3.6, consisting primarily of severance payments for
approximately 460 employees, was paid by the Company. The Company
expects to pay substantially all of the remaining $16.6 in
restructuring costs by the third quarter of 2002.
Unrelated to the CMG restructuring activities, IMG recorded an
impairment charge of $4.7 ($2.9 after tax) in the third quarter of 2001
related to purchased software that will not be deployed as determined
by Management in the third quarter of 2001.
5
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
As presented in the Condensed Consolidated Statements of Income and
Comprehensive Income, Restructuring and Impairment Charges includes the
following components:
CMG IMG Total
--- --- -----
Facility Closing Costs:
Severance costs $ 6.4 - $ 6.4
Lease terminations 11.8 - 11.8
------ ------
Total 18.2 - 18.2
Impairment Costs and Other Special Items:
Leasehold improvements 10.8 - 10.8
Software 16.2 $ 4.7 20.9
Investments in European contact centers 8.1 - 8.1
------ ----- ------
Total 35.1 4.7 39.8
------ ----- ------
Total $ 53.3 $ 4.7 $ 58.0
====== ===== ======
Also during the third quarter of 2001, the Company recorded a non-
operating expense of $6.5 to reflect the permanent impairment of
certain equity investments whose valuations have been adversely
affected by recent economic conditions. This has been presented in the
Condensed Consolidated Statements of Income and Comprehensive Income in
Other Income (Expense), net.
(3) ACQUISITIONS
On April 6, 2001, the Company acquired 100% of the outstanding
shares of Geneva Technology Limited (Geneva), based in Cambridge, UK,
for approximately 14.9 million shares of Convergys common stock.
Approximately 2.7 million Convergys stock options were also issued to
replace outstanding Geneva stock options. Geneva was a provider of
convergent billing software for the communications, e-commerce,
finance, utilities and online services industries. The transaction
qualified as a tax-free reorganization and has been accounted for as a
pooling-of-interests. Accordingly, all amounts presented have been
adjusted to reflect the combined results of the companies as if the
acquisition had occurred as of the earliest period presented. Separate
and combined results for certain interim periods are as follows:
Three Months Nine Months
Ended March 31, Ended September 30,
--------------- -------------------
2001 2000
---- ----
Revenues:
Convergys $ 577.8 $1,580.0
Geneva 13.7 22.6
------- --------
Combined $ 591.5 $1,602.6
======= ========
Net Income:
Convergys $ 53.5 $ 140.5
Geneva (1.4) (3.5)
------- --------
Combined $ 52.1 $ 137.0
======= ========
Combined Earnings Per Share:
Basic $ 0.31 $ 0.82
Diluted $ 0.30 $ 0.79
6
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
In connection with the acquisition of Geneva, the Company recorded
one-time costs of $31.8 in the second quarter of 2001 to expense
transaction costs and certain costs to integrate the combined
businesses. Transaction costs totaled $20.6, of which all but $2.1 had
been paid at September 30, 2001. The remaining costs principally relate
to the registration of approximately 49% of the shares issued in the
transaction, which will occur on or before April 6, 2002. The
integration costs totaled $11.2, which includes $1.0 for lease
terminations and other costs associated with the consolidation of
facilities, $6.2 for severance associated with the consolidation of
facilities and certain functions, $3.0 for the expensing of software
that will not be deployed by the combined businesses and $1.0 for other
integration costs. Of the integration costs, $5.6 had been paid at
September 30, 2001. The remaining amounts are expected to be paid as
plan activities are carried out through the second quarter of 2002. The
after-tax impact of the charge was $26.3.
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 to be amortized over a twenty-five year life.
(4) INCOME TAXES
The Company's effective tax rate for the third quarter and first
nine months of 2001 was 86.5% and 49.4%, respectively, compared to
39.5% and 39.0%, respectively, in the same periods of 2000. The higher
effective tax rates in 2001 resulted from the charges recorded in the
second and third quarters, which included a significant level of non-
deductible items. Excluding the impact of these special items, the
effective income tax rate for the third quarter and first nine months
of 2001 was 38.5% and 38.6%, respectively, which was slightly lower
than the rates in both periods of 2000.
(5) SHAREHOLDERS' EQUITY
During the third quarter of 2001, the Company repurchased 2.5
million shares of its common stock at prices ranging between $25 to $28
per share for a total cost of approximately $66, $10 of which was
settled in early October 2001. The Company acquired an additional .1
million shares for a total cost of approximately $2.4 in October 2001.
(6) SIGNIFICANT CUSTOMERS
Both of the Company's segments derive significant revenues from AT&T
Corporation (AT&T) and AT&T Wireless Services Inc. (AT&T Wireless),
which was spun off from AT&T in July 2001.
Revenues from AT&T were 20.8% and 21.9% of the Company's
consolidated revenues for the nine-month periods ended September 30,
2001 and September 30, 2000, respectively. Related accounts receivable
from AT&T totaled $73.4 and $101.4 at September 30, 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 $66.6 and $76.4 for the nine-month periods ended September 30, 2001
and September 30, 2000, respectively.
7
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
Revenues from AT&T Wireless were 16.5% and 18.9% of the Company's
consolidated revenues for the nine-month periods ended September 30,
2001 and September 30, 2000, respectively. Related accounts receivable
from AT&T Wireless totaled $54.9 and $60.5 at September 30, 2001 and
December 31, 2000, respectively.
Additionally, revenues from Sprint Corporation were 10.1% and 7.0%
of the Company's consolidated revenues for the nine-month periods ended
September 31, 2001 and September 30, 2000, respectively.
(7) CONTINGENCIES
The Company is from time to time subject to claims and
administrative proceedings that are filed in the ordinary course of
business. The Company believes that the results of any such claims or
administrative proceedings, either individually or in the aggregate,
will not have a materially adverse effect on the financial condition of
the Company.
(8) RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, Statement of Financial Accounting Standard (SFAS) 141,
"Business Combinations," was issued. Under SFAS 141, the purchase
method of accounting will be used for all mergers and acquisitions
initiated after June 30, 2001.
Also in June 2001, SFAS 142, "Goodwill and Other Intangible Assets,"
was issued. SFAS 142 will require that goodwill no longer be amortized
to earnings, but instead be reviewed at least annually for impairment.
The Company will adopt SFAS 142, as required, in January 2002 for
acquisitions made prior to June 30, 2001. Goodwill from any
acquisitions made after June 30, 2001 will not be amortized. Based on
the amount of goodwill outstanding at September 30, 2001, the adoption
of SFAS 142 would result in an approximately $36 reduction in annual
operating expenses and an increase in annual net income of
approximately $29.
8
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(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
sophisticated software systems and outsourced customer billing services
to all segments of the communications industry, including wireless,
wireline, cable, broadband and Internet services. CMG provides a full
range of outsourced marketing, customer management and human resource
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 Nine Months
Ended September 30, Ended September 30,
-------------------- -------------------
Millions of Dollars 2001 2000 2001 2000
------------------- -------- -------- -------- --------
Revenues
Information Management....................... $ 238.5 $ 214.4 $ 693.4 $ 596.2
Customer Management.......................... 331.6 342.7 1,045.6 1,020.4
Less: intersegment.......................... (2.9) (3.6) (9.1) (14.0)
-------- -------- -------- --------
$ 567.2 $ 553.5 $1,729.9 $1,602.6
======== ======== ======== ========
Depreciation and Amortization
Information Management....................... $ 14.2 $ 15.1 $ 42.2 $ 43.6
Customer Management.......................... 27.2 24.9 85.3 72.7
Corporate.................................... 1.9 1.1 5.2 2.4
-------- -------- -------- --------
$ 43.3 $ 41.1 $ 132.7 $ 118.7
======== ======== ======== ========
Operating Income (Loss) Excluding Special Items
Information Management....................... $ 50.7 $ 39.5 $ 142.0 $ 112.6
Customer Management.......................... 40.0 42.1 131.2 124.1
Corporate.................................... (0.1) (1.9) (2.9) (5.7)
-------- -------- -------- --------
$ 90.6 $ 79.7 $ 270.3 $ 231.0
======== ======== ======== ========
Operating Income (Loss)
Information Management....................... $ 46.0 $ 39.5 $ 137.3 $ 112.6
Customer Management.......................... (13.3) 42.1 77.9 124.1
Corporate.................................... (0.1) (1.9) (34.7) (5.7)
-------- -------- -------- --------
$ 32.6 $ 79.7 $ 180.5 $ 231.0
======== ======== ======== ========
Special Items
Information Management....................... $ 4.7 $ -- $ 4.7 $ --
Customer Management.......................... 53.3 -- 53.3 --
Corporate.................................... - -- 31.8 --
-------- -------- -------- --------
$ 58.0 $ -- $ 89.8 $ --
======== ======== ======== ========
Capital Expenditures (excluding acquisitions)
Information Management $ 7.3 $ 19.7 $ 26.7 $ 37.0
Customer Management.......................... 9.2 27.0 46.4 71.9
Corporate.................................... 2.5 0.8 6.1 5.2
-------- -------- -------- --------
$ 19.0 $ 47.5 $ 79.2 $ 114.1
======== ======== ======== ========
9
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Amounts)
(10) 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
September 30, Income Shares Amount
------------------------------ ------- ------ ------
2001
Basic EPS $ 3.0 169.9 $ 0.02
Effect of dilutive securities:
Stock-based compensation arrangements -- 4.3 --
------- ----- ------
Diluted EPS $ 3.0 174.2 $ 0.02
======= ===== ======
2000
Basic EPS $ 47.6 167.9 $ 0.28
Effect of dilutive securities:
Stock-based compensation arrangements -- 6.9 (0.01)
------- ----- ------
Diluted EPS $ 47.6 174.8 $ 0.27
======= ===== ======
Nine Months Ended
September 30,
------------------------------
2001
Basic EPS $ 82.4 169.7 $ 0.49
Effect of dilutive securities:
Stock-based compensation arrangements -- 5.4 (0.02)
------- ----- ------
Diluted EPS $ 82.4 175.1 $ 0.47
======= ===== ======
2000
Basic EPS $ 137.0 167.4 $ 0.82
Effect of dilutive securities:
Stock-based compensation arrangements -- 6.5 (0.03)
------- ----- ------
Diluted EPS $ 137.0 173.9 $ 0.79
======= ====== ======
The diluted EPS calculation for the three and nine months ended
September 30, 2001 excludes the potentially dilutive effect of
approximately 7.1 million and 4.2 million outstanding stock options,
respectively, because they were anti-dilutive.
10
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, customer management and employee care 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 segments: (i) the
Information Management Group (IMG), which provides outsourced billing and
information services and software; and (ii) the Customer Management Group (CMG),
which provides outsourced marketing, customer support and employee care
services. For certain clients, the Company's two operating segments 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 expressly states
that it has no current intention of updating 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: the consequences of the September 11, 2001
attacks on the United States and the United States' response to the attacks;
other terrorist attacks; the loss of a significant client; difficulties in
completing or integrating acquisitions; 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 the operating segments,
which follow the consolidated results discussion. Results for interim periods
may not be indicative of the results for the full years. All prior year period
amounts have been restated to reflect the Geneva pooling-of-interests
transaction.
Consolidated Overview
- ---------------------
Three Months Ended September 30, 2001 versus Three Months Ended September 30,
2000
Revenues for the third quarter of 2001 totaled $567.2, a 2% increase from
the third quarter of 2000. This higher revenue reflects increases experienced by
IMG partially offset by declines in CMG revenues. Operating expenses for the
third quarter of 2001 totaled $476.6 excluding special items, a 1% increase from
the third quarter of 2000, reflecting greater business volume, increased
spending on research and development activities and higher depreciation expense
offset by slightly lower cost of providing services and selling, general and
administrative expenses. The increase in research and development spending
reflects the Company's commitment to remaining the technology leader in
communications billing. The increase in depreciation results from new contact
center facilities opened in 2000. Operating income excluding special items was
$90.6 in the third quarter of 2001, a 14% increase from the third quarter of
2000.
11
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
The Company's equity in earnings of the Cellular Partnership for the third
quarter was $1.3, a 78% decrease as compared to the same period in 2000,
reflecting lower subscriber revenues and higher operating costs experienced by
the partnership. Interest expense decreased 51% in the third quarter of 2001
from the third quarter of 2000, as a result of significantly lower borrowings
and decreased interest rates. Net income excluding special items was $53.4, or
$0.31 per diluted share, a 12% increase from $47.6, or $0.27 per diluted share,
in the third quarter of 2000.
As discussed more fully in the notes to the Consolidated Condensed Financial
Statements, the Company approved a plan to rationalize CMG's contact center
capacity resulting in a pre-tax restructuring charge of $53.3 ($41.0 after tax).
Unrelated to the CMG restructuring activities, IMG recorded an impairment charge
of $4.7 ($2.9 after tax) related to purchased software it does not intend to
use. Also, included in non-operating expense was a $6.5 charge to reflect the
permanent impairment of certain equity investments. Including these items, the
Company reported third quarter 2001 operating income of $32.6, net income of
$3.0 and diluted earnings per share of $0.02.
Nine Months Ended September 30, 2001 versus Nine Months Ended September 30, 2000
Revenues for the first nine months of 2001 totaled $1,729.9, an 8% increase
from the first nine months of 2000. Operating expenses for the first nine months
of 2001 totaled $1,459.6, a 6% increase over the first nine months of 2000,
excluding special items in 2001. Operating income excluding special items was
$270.3 in the first nine months of 2001, a 17% increase from the first nine
months of 2000.
The Company's equity in earnings from the Cellular Partnership in the first
nine months of 2001 was $5.9, a 66% decrease from the first nine months of 2000.
Interest expense decreased 34% in the first nine months of 2001 from the first
nine months of 2000 as a result of lower borrowings and lower interest rates.
Excluding special items, net income for the first nine months of 2001 was
$159.1, or $0.94 per diluted share, a 15% increase compared to $137.0, or $0.79
per diluted share, for the first nine months of 2000.
In addition to the special items recorded in the third quarter of 2001 as
described above, the Company recorded $31.8 in non-recurring transaction and
integration costs related to the Geneva acquisition in the second quarter of
2001. Including the special items, the Company reported operating income of
$180.5, net income of $82.4 and diluted earnings per share of $0.47 for the
first nine months of 2001.
INFORMATION MANAGEMENT
Three Months Nine Months
($ Millions) Ended September 30, Ended September 30,
------------------------------------- -----------------------------------
2001 2000 Change % 2001 2000 Change %
--------- -------- ----------- ------- -------- ------------
Revenues:
Data processing..................... $ 139.8 $ 125.3 $ 14.5 12 $ 396.1 $ 354.5 $ 41.6 12
Professional and consulting......... 49.5 44.4 5.1 11 141.8 112.4 29.4 26
License and other................... 13.9 12.8 1.1 9 45.5 39.0 6.5 17
International....................... 32.4 28.3 4.1 14 100.9 76.3 24.6 32
--------- ------- ------ ------- -------- -------
External revenues................. 235.6 210.8 24.8 12 684.3 582.2 102.1 18
Intercompany services............... 2.9 3.6 (0.7) (19) 9.1 14.0 (4.9) (35)
--------- ------- ------ ------- -------- -------
Total revenues.................... 238.5 214.4 24.1 11 693.4 596.2 97.2 16
12
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
Costs of products and services........... 112.7 109.4 3.3 3 328.9 303.8 25.1 8
Selling, general and administrative
expenses............................... 31.3 28.6 2.7 9 102.9 74.0 28.9 39
Research and development costs........... 29.6 21.8 7.8 36 77.4 62.2 15.2 24
Depreciation............................. 9.6 10.4 (0.8) (8) 28.6 29.6 (1.0) (3)
Amortization............................. 4.6 4.7 (0.1) (2) 13.6 14.0 (0.4) (3)
Impairment charge........................ 4.7 - 4.7 - 4.7 - 4.7 -
------- ------- ------ -------- -------- -------
Total costs......................... 192.5 174.9 17.6 10 556.1 483.6 72.5 15
------- ------- ------ -------- -------- -------
Operating income......................... $ 46.0 $ 39.5 $ 6.5 16 $ 137.3 $ 112.6 $ 24.7 22
Three Months Ended September 30, 2001 versus Three Months Ended September 30,
2000
Excluding intercompany activity, IMG revenues were $235.6 for the third
quarter of 2001, a 12% increase from the third quarter of 2000. Data processing
revenues increased 12% in the third quarter of 2001 over the third quarter of
2000, primarily as a result of 34% wireless clients' subscriber growth. The data
processing revenue growth rate was partially offset by slower growth in wireline
data processing revenues and by wireless clients' contractual rate reductions.
Professional and consulting revenues increased 11% from the third quarter of
2000 due to increased enhancement projects from two large wireless clients.
License and other revenues increased 9% to $13.9 in the third quarter of 2001,
reflecting growth in revenues from cable and broadband clients. International
revenues for the segment increased 14% to $32.4, reflecting greater penetration
in Europe.
IMG's costs and expenses, excluding special items, were $187.8 in the third
quarter of 2001, a 7% increase over the third 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 as a result of increased spending on Atlys, IMG's Internet Protocol
capabilities and Geneva.
During the third quarter of 2001, IMG recorded an impairment charge of $4.7
related to purchased software it does not intend to use. Including the special
item, IMG's operating income was $46.0.
Nine Months Ended September 30, 2001 versus Nine Months Ended September 30, 2000
Excluding intercompany revenues, IMG revenues were $684.3 for the first
nine months of 2001, an 18% increase from the first nine months of 2000. Data
processing revenues increased 12% to $396.1 in the first nine months of 2001
from the first nine months of 2000, primarily as a result of 33% wireless
clients' subscriber growth. The data processing revenue growth rate was
partially offset by slower growth in wireline data processing revenues and by
wireless clients' contractual rate reductions. Professional and consulting
revenues increased 26% to $141.8 in the first nine months of 2001 over the first
nine months of 2000. This increase was primarily attributable to increased
enhancement requests from wireless clients. License and other revenues increased
$6.5 in the first nine months of 2001 as compared to the first nine months of
2000, reflecting growth from cable and broadband clients. The segment's
international revenues increased $24.6 in the first nine months of 2001,
primarily the result of increased sales of Geneva, revenues from the completion
of the Telesp Celular implementation in the second quarter of 2001, growth from
cable clients and revenue generated from the Orange France contract.
Excluding the special item, IMG's costs and expenses were $551.4 in the
first nine months of 2001, a 14% increase over the first nine months of 2000.
The increase was the result of higher direct costs associated with the revenue
increase, increased focus on sales and marketing efforts and increased research
and development efforts. Including the special item, operating income was
$137.3.
13
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
CUSTOMER MANAGEMENT
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------------------- ------------------------------------
($ Millions) 2001 2000 Change % 2001 2000 Change %
------- ----- ------------- -------- -------- --------------
Revenues:
Communications...................... $ 216.6 $ 232.4 $(15.8) (7) $ 658.6 $ 686.7 $ (28.1) (4)
Technology.......................... 53.4 43.0 10.4 24 175.9 126.0 49.9 40
Financial services.................. 16.1 19.5 (3.4) (17) 56.2 66.8 (10.6) (16)
Other............................... 45.5 47.8 (2.3) (5) 154.9 140.9 14.0 10
------- ------- ------ -------- -------- --------
Total revenues................. 331.6 342.7 (11.1) (3) 1,045.6 1,020.4 25.2 2
Costs of products and services........... 199.4 207.5 (8.1) (4) 620.3 619.3 1.0 -
Selling, general and administrative
expenses............................... 62.2 64.7 (2.5) (4) 199.4 192.8 6.6 3
Research and development costs........... 2.8 3.5 (0.7) (20) 9.4 11.5 (2.1) (18)
Depreciation............................. 19.0 17.0 2.0 12 60.8 49.0 11.8 24
Amortization............................. 8.2 7.9 0.3 4 24.5 23.7 0.8 3
Restructuring and impairment charge...... 53.3 - 53.3 - 53.3 - 53.3 -
------- ------- ------ -------- -------- --------
Total costs.................... 344.9 300.6 44.3 15 967.7 896.3 71.4 8
------- ------- ------ -------- -------- --------
Operating income (loss).................. $ (13.3) $ 42.1 $(55.4) (132) $ 77.9 $ 124.1 $ (46.2) (37)
Three Months Ended September 30, 2001 versus Three Months Ended September 30,
2000
CMG revenues were $331.6 in the third quarter of 2001, a 3% decrease from
the third quarter of 2000, reflecting general weakness in the economy and
service level reductions and volume cutbacks by several clients. Revenues from
communications clients were $216.6, a 7% decrease from the third quarter of
2000, resulting from reduced spending by AT&T and other communications clients
on outsourced customer support. Revenues from technology clients increased 24%,
primarily due to increased services provided to Microsoft and Hewlett Packard
and contributions from acquisitions made in the second half of 2000 and in the
first quarter of 2001. Revenues from financial services clients decreased 17% as
a result of reduced marketing activity in this sector caused by adverse
conditions in the U.S. economy. Other revenues decreased 5% from the third
quarter of 2000 to $45.5 primarily as a result of general economic weakness.
Excluding special items, CMG's costs and expenses were $291.6 in the third
quarter of 2001, a 3% decrease from the third quarter of 2000. Depreciation
expense increased by $11.8 as a result of new contact centers opened in 2000 to
support the anticipated increase in business volume. CMG's operating margin,
excluding special items, decreased slightly to 12.1% from 12.3% in the third
quarter of 2000 reflecting the impact of lower revenues and excess capacity.
During the third quarter of 2001, the Company approved a plan to
rationalize CMG's contact center capacity resulting in a pre-tax restructuring
charge of $53.3 ($41.0 after tax). Including the special item, CMG had an
operating loss of $13.3.
14
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
Nine Months Ended September 30, 2001 versus Nine Months Ended September 30, 2000
CMG's revenues were $1,045.6 in the first nine months of 2001, a 2%
increase from the first nine months of 2000. Revenues from communications
clients were $658.6, a 4% decrease from the first nine months of 2000. This
decrease is the result of slowing spending by AT&T and other communications
clients on outsourced customer support as a result of the slowdown in the U.S.
economy. Technology service revenues increased 40%, primarily due to increased
services provided to Microsoft and Hewlett Packard and contributions from
acquisitions. Revenues from financial services clients decreased 16% as a result
of reduced marketing activity in this sector caused by the general slowdown in
the U.S. economy. Other revenues increased 10% from the first nine months of
2000 primarily due to increased services provided to Federal Express and
Wal-Mart and increased demand for outsourced employee benefit services from
CMG's Employee Care division offset by the impact of the general slowdown in the
third quarter.
Excluding special items, CMG's costs and expenses were $914.4 in the first
nine months of 2001, a 2% increase from the first nine months of 2000. Increases
in direct costs of products and services and selling, general and administrative
expenses were the result of increased business volume experienced in the first
half of 2001. Depreciation expense increased by $11.8 as a result of new contact
centers opened in 2000 to support the increased business volume. Amortization
expense increased 3%, primarily due the acquisitions of MaxWorldwide LLC and
Taima in 2000 and the acquisition of the contact center business of Keane, Inc.
in the first quarter of 2001. These increases were partially offset by an 18%
decrease in research and development spending as certain projects were
completed. Including the special item, CMG's operating income was $77.9 for the
first nine months of 2001.
CLIENT CONCENTRATION
The Company's four largest clients accounted for 53.4% and 55.5% of its
revenues in the first nine months 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 20.8% of
revenues in the first nine months of 2001, is principally served under long-term
information and customer management contracts that expire in 2006. The Company
serves AT&T Wireless, its second largest customer, under contracts that expire
in 2008. 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
third 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 data processing revenue growth beginning in the first quarter of 2002.
DirecTV, the Company's fourth largest client in the first nine months of 2001,
is served by CMG under a contract that expires at the end of 2003.
15
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 $237.1 and $121.5 in cash flows from operating
activities during the first nine months of 2001 and 2000, respectively. The
Company's cash flows from operating activities for the first nine months of 2001
reflect a $55.0 reduction in borrowings under its accounts receivable
securitization program, compared to a $41.0 decrease in these borrowings during
the first nine months of 2000. Capital expenditures were $79.2 and $114.1 for
the first nine months of 2001 and 2000, respectively. The decrease in capital
expenditures resulted from CMG's curtailment of the expansion of its contact
facilities during the first nine months of 2001 in reaction to the flattening of
its volumes.
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, 2001, the Company had $186.3 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 revolving credit facilities which expire in November 2001
will be renewed upon expiration. The Company also has a $150 accounts receivable
securitization agreement, under which it had sold $60.0 in accounts receivable
at September 30, 2001. 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 $4.4 decrease in accounts receivable from December 31, 2000 to
September 30, 2001 reflects significantly improved collections in the first nine
months of 2001, the impact of which was offset by a $55.0 reduction in the
balance of receivables sold under the Company's accounts receivable
securitization program. Excluding the effects of the securitization, days sales
outstanding decreased by 6 days during the first nine months of 2001 to 73 days.
The Company's investment in the Cellular Partnership decreased by $24.2 as a
result of the Company's receipt of approximately $30.1 in distributions from the
partnership to date in 2001, which exceeded equity earnings of $5.9. Payables
and other current liabilities decreased by $21.5 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 nine months of 2001, and a decrease in
advanced billings and customer deposits. Treasury stock increased $64.7 from
December 31, 2000 as the Company repurchased 2.5 million shares for a total cost
of approximately $66.
Foreign Currency and Interest Rate Risk
- ---------------------------------------
The Company derived approximately 8% of its first nine months of 2001
consolidated revenues from 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 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
perform fully under the terms of the agreements and by diversifying the number
of financial institutions with which it enters into such agreements.
16
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
September 30, 2001, the Company had $182.8 in outstanding variable rate
borrowings and had sold $60.0 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 agreements expose
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 agreements 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 $1.
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 CMG business.
17
Item 4. Submission of Matters to a Vote of Security Holders
- -----------------------------------------------------------
There were no matters submitted to a vote of security holders in the third
quarter of 2001.
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:
(3-1) Amended Articles of Incorporation (Incorporated by reference
to Exhibit 5.1 to Form S-3 Registration Statement filed on
August 10, 2000, File Number 333-43404.)
(3-2) Code of Regulations (Incorporated by reference to Exhibit
3.2 to Form S-3 Registration Statement filed on August 10,
2000, File Number 333-43404.)
(12) Computation of Ratio of Earnings to Fixed Charges
(b) Reports on Form 8-K
On July 25, 2001, the Company filed a Form 8-K announcing its
financial results for the second quarter ended June 30, 2001.
On September 7, 2001, the Company filed a Form 8-K approving
amendments to the Company's Insider Trading Policy to permit its
officers, directors and other insiders to enter into trading plans or
arrangements for the trading of the Company's shares complying with
SEC Rule 10b5-1.
On September 17, 2001, the Company filed a Form 8-K to announce that
the Company's Board of Directors authorized the repurchase of up to 5
million common shares in accordance with the Securities and Exchange
Commission's September 14, 2001 Emergency Order Pursuant to Section
12(k)(2) of the Securities and Exchange Act of 1934 Taking Temporary
Action to Respond to Market Developments.
18
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, 2001 /s/ Steven G. Rolls
------------------------------
Steven G. Rolls
Chief Financial Officer
19
EXHIBIT INDEX
Exhibit No. Page No.
(3-1) Amended Articles of Incorporation (Incorporated by reference to Exhibit
5.1 to Form S-3 Registration Statement filed on August 10, 2000, File
Number 333-43404.)
(3-2) Code of Regulations (Incorporated by reference to Exhibit 3.2 to Form
S-3 Registration Statement filed on August 10, 2000, File Number
333-43404.)
(12) Computation of Ratio of Earnings to Fixed Charges 21
20