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, 2002
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, 2002, 172,903,454 Common Shares were outstanding.
Form 10-Q Part I Convergys Corporation
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Amounts in Millions, Except Per Share Amounts)
Three Months
Ended March 31,
------------------------
2002 2001
---------- -----------
Revenues ............................................. $ 587.5 $ 591.5
---------- ----------
Costs and Expenses
Cost of providing services and products sold ..... 326.0 322.1
Selling, general and administrative .............. 103.1 107.8
Research and development costs ................... 26.2 25.9
Depreciation ..................................... 30.2 32.5
Amortization ..................................... 3.5 12.7
---------- ----------
Total costs and expenses .................... 489.0 501.0
---------- ----------
Operating Income ..................................... 98.5 90.5
Equity in Earnings of Cellular Partnership ........... 0.9 1.8
Other Income (Expense), net .......................... (1.5) 0.1
Interest Expense ..................................... (3.6) (7.2)
---------- ----------
Income Before Income Taxes ........................... 94.3 85.2
Income Taxes ......................................... 34.7 33.1
---------- ----------
Net Income ........................................... $ 59.6 $ 52.1
========== ==========
Other Comprehensive Income (Loss), net of tax:
Foreign currency translation adjustments ........... $ (0.4) $ (6.1)
Unrealized gain (loss) on cash flow hedging ........ 2.6 (0.8)
Change in unrealized loss on investments ........... -- (3.2)
---------- ----------
Total other comprehensive income (loss) .......... 2.2 (10.1)
---------- ----------
Comprehensive Income ................................. $ 61.8 $ 42.0
========== ==========
Earnings Per Common Share
Basic ............................................ $ 0.35 $ 0.31
========== ==========
Diluted .......................................... $ 0.35 $ 0.30
========== ==========
Average Common Shares Outstanding
Basic ............................................ 168.1 169.3
Diluted .......................................... 172.5 175.5
See Notes to Financial Statements.
2
Form 10-Q Part I Convergys Corporation
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Millions)
March 31, December 31,
2002 2001
---------- ------------
ASSETS
- ------
Current Assets
Cash and cash equivalents ................................................................... $ 74.9 $ 41.1
Receivables, net of allowances of $16.9 and $14.7 ........................................... 450.0 413.6
Deferred income tax benefits ................................................................ 23.6 31.9
Prepaid expenses and other current assets ................................................... 42.8 36.5
---------- ----------
Total current assets ...................................................................... 591.3 523.1
Property and equipment - net ................................................................... 335.0 350.4
Goodwill - net ................................................................................. 666.9 665.2
Other intangibles - net ........................................................................ 37.2 39.7
Investment in Cellular Partnership ............................................................. 32.8 35.3
Deferred charges ............................................................................... 82.9 87.8
Other assets ................................................................................... 48.8 41.4
---------- ----------
Total Assets .............................................................................. $ 1,794.9 $ 1,742.9
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Debt maturing in one year ................................................................... $ 141.2 $ 129.9
Payables and other current liabilities ...................................................... 373.0 362.5
---------- ----------
Total current liabilities ................................................................. 514.2 492.4
Long-term debt ................................................................................. 4.1 3.6
Other long-term liabilities .................................................................... 23.6 20.3
---------- ----------
Total liabilities ......................................................................... 541.9 516.3
---------- ----------
Shareholders' Equity
Preferred shares - without par value, 5.0 authorized ........................................ - -
Common shares - without par value, 500.0 authorized;
172.8 and 172.2 issued and outstanding .................................................... 206.0 206.0
Additional paid-in capital .................................................................. 600.8 590.4
Treasury shares - 4.3 shares in 2002 and 2.8 shares in 2001 ................................. (114.7) (68.9)
Retained earnings ........................................................................... 577.5 517.9
Accumulated other comprehensive loss ........................................................ (16.6) (18.8)
---------- ----------
Total shareholders' equity ................................................................ 1,253.0 1,226.6
---------- ----------
Total Liabilities and Shareholders' Equity ................................................ $ 1,794.9 $ 1,742.9
========== ==========
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,
---------------
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
- ------------------------------------
Net income ................................................................................... $ 59.6 $ 52.1
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization ............................................................ 33.7 45.2
Deferred income tax expense (benefit) .................................................... 2.3 (0.2)
Cellular Partnership distributions in excess of earnings ................................. 2.5 2.7
Income tax benefit from stock option exercises ........................................... 2.5 4.3
Repayments of receivables securitization, net ............................................ (20.0) (40.0)
Changes in assets and liabilities, net of effects from acquisitions:
Decrease (increase) in receivables ....................................................... (16.4) 66.3
Increase in other current assets ......................................................... (6.2) (7.0)
Decrease (increase) in deferred charges .................................................. 4.9 (4.6)
Decrease (increase) in other assets ...................................................... (0.4) 11.1
Increase (decrease) in payables and other current liabilities ............................ 14.3 (39.4)
Other, net ............................................................................... 3.7 (0.1)
------- -------
Net cash provided by operating activities ................................................ 80.5 90.4
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
- ------------------------------------
Capital expenditures ......................................................................... (20.6) (34.7)
Acquisitions, net of cash acquired ........................................................... -- (15.7)
------- -------
Net cash used in investing activities ...................................................... (20.6) (50.4)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Borrowings (payments) of debt, net ........................................................... 11.8 (46.6)
Purchase of treasury shares .................................................................. (45.8) --
Issuance of treasury shares, net ............................................................. -- 4.6
Issuance of common shares .................................................................... 7.9 12.7
------- -------
Net cash used in financing activities ...................................................... (26.1) (29.3)
------- -------
Net increase in cash and cash equivalents .................................................... 33.8 10.7
Cash and cash equivalents at beginning of period ............................................. 41.1 49.3
------- -------
Cash and cash equivalents at end of period ................................................... $ 74.9 $ 60.0
======= =======
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
Convergys Corporation (the Company or Convergys) 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. 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).
On April 6, 2001, Convergys acquired 100% of the outstanding shares
of Geneva Technology Ltd. (Geneva), based in Cambridge, UK (the Geneva
Acquisition). Geneva was a provider of convergent rating and billing
software for the communications, e-commerce, utilities and online
services industries. The transaction was accounted for under the
pooling-of-interests method of accounting. Accordingly, the
consolidated financial statements have been restated for all periods
prior to the acquisition to reflect the combined results of both
companies as if the acquisitions had occurred as of the earliest period
presented.
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, 2001 condensed balance sheet has
been derived from audited financial statements, but does not include
all disclosures required by accounting principles generally accepted in
the United States of America. 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 2. Certain prior
period amounts have also been reclassified to conform to current period
presentation.
(2) 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 the first quarter of 2001 are as follows:
Quarter Ended March 31, 2001 Convergys Geneva Combined
---------------------------- --------- ------- --------
Revenues $577.8 $13.7 $591.5
Net income (loss) 53.5 (1.4) 52.1
Basic earnings per share $ 0.35 $ 0.31
Diluted earnings per share $ 0.34 $ 0.30
5
Form 10-Q Part I Convergys Corporation
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 $2.0 had
been paid as of March 31, 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, $5.5 had been incurred at March 31, 2002. The remaining amounts
are expected to be paid as plan activities are carried out through the
second quarter of 2002.
On February 12, 2001, the Company paid approximately $16 to acquire
the customer support business of Keane, Inc.
(3) BUSINESS RESTRUCTURING
As discussed more fully in the Company's Annual Report on Form 10-K
for the year ended December 31, 2001, the Company initiated a plan
during the third quarter of 2001 to rationalize CMG's contact center
capacity. The plan resulted in a pre-tax restructuring charge of $53.3.
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 Company completed the closure of the centers in 2001 and
expects to complete the employee reductions by the third quarter of
2002. The total cash cost of the plan is expected to be approximately
$20.2. Through the first quarter of 2002, the Company paid $8.6 of this
cost, consisting primarily of severance payments for approximately 440
employees and facility closing costs. Except for certain lease
termination costs, the Company expects to substantially pay the
remaining restructuring costs by the end of the third quarter of 2002.
(4) GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002, the Company adopted, on a prospective basis,
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill
and Other Intangible Assets," which eliminated the amortization of
goodwill. Upon adoption of SFAS No. 142, the Company performed an
initial impairment test of its goodwill and determined that no goodwill
impairment existed. Under SFAS No. 142, goodwill will be tested for
impairment at least annually or more frequently if an event occurs
which indicates that goodwill may be impaired.
The impact of discontinuing amortization of goodwill on net income,
basic and diluted earnings per share for the three-month period ended
March 31, 2001 is as follows:
Goodwill
Amortization,
As Reported Net of Tax Adjusted
----------- ---------- --------
Net income $ 52.1 $ 7.6 $59.7
Basic earnings per common share $ 0.31 $0.04 $0.35
Diluted earnings per common share $ 0.30 $0.04 $0.34
6
Form 10-Q Part I Convergys Corporaton
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
As required by SFAS No. 142, intangible assets that do not meet the
criteria for recognition apart from goodwill must be reclassified. As a
result of the Company's analysis, $19.2 of acquisition costs, net of
accumulated amortization, were transferred to goodwill.
As of March 31, 2002, the Company's other intangible assets consisted
of the following:
Gross Carrying Accumulated
Amount Amortization Net
-------------- ------------ ---
Software (classified with Property, Plant & Equipment) $ 28.9 $(13.4) $15.5
Contracts and other 72.2 (35.0) 37.2
-------- -------- ------
Total $101.1 $(48.4) $52.7
Intangible amortization expense for the three-month period ended
March 31, 2002 was $3.5 and is estimated to be $14.0 for the year
ending December 31, 2002. Estimated intangible amortization expense for
the four subsequent fiscal years is as follows:
For the year ended 12/31/03 $14.0
For the year ended 12/31/04 $14.0
For the year ended 12/31/05 $11.1
For the year ended 12/31/06 $1.2
(5) SHAREHOLDERS' EQUITY
On January 18, 2002, the Company's Board of Directors authorized
the repurchase of up to 10 million of its common shares. During the
first quarter of 2002, the Company repurchased 1.5 million shares of
its common stock at prices ranging between $30 to $33 per share for a
total cost of $45.8. From April 1, 2002 through the date of this
report, the Company had repurchased 170,000 additional shares at a cost
of $4.7.
(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 Wireless were 18.1% and 16.7% of the Company's
consolidated revenues for the three-month periods ended March 31, 2002
and March 31, 2001, respectively. Related accounts receivable from AT&T
Wireless totaled $71.3 and $58.1 at March 31, 2002 and December 31,
2001, respectively.
Revenues from AT&T were 17.8% and 21.9% of the Company's
consolidated revenues for the three-month periods ended March 31, 2002
and March 31, 2001, respectively. Related accounts receivable from AT&T
totaled $49.9 and $49.4 at March 31, 2002 and December 31, 2001,
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 $20.2 and $25.0
for the three-month periods ended March 31, 2002 and March 31, 2001,
respectively.
7
Form 10-Q Part I Convergys Corporaton
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(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) BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION
Industry Segment Information
----------------------------
The Company operates in two industry segments, which are identified
by service offerings. IMG provides outsourced billing and information
services and software primarily to the communications industry. CMG
provides outsourced marketing, customer support and employee care
services to clients in various industries including communications,
technology and financial 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 2002 2001
------------------- --------- ---------
Revenues
IMG ........................................... $ 236.2 $ 222.6
CMG ........................................... 354.2 372.2
Less: intersegment ........................... (2.9) (3.3)
--------- ---------
$ 587.5 $ 591.5
========= =========
Depreciation and Amortization
IMG ........................................... $ 11.4 $ 14.0
CMG ........................................... 20.2 29.5
Corporate ..................................... 2.1 1.7
--------- ---------
$ 33.7 $ 45.2
========= =========
Operating Income (Loss)
IMG ........................................... $ 56.4 $ 44.7
CMG ........................................... 44.0 47.4
Corporate ..................................... (1.9) (1.6)
--------- ---------
$ 98.5 $ 90.5
========= =========
Capital Expenditures (excluding acquisitions)
IMG ........................................... $ 11.7 $ 12.5
CMG ........................................... 7.7 20.5
Corporate ..................................... 1.2 1.7
--------- ---------
$ 20.6 $ 34.7
========= =========
At March 31, 2002
-----------------
Goodwill, Net
IMG ........................................... $ 136.1
CMG ........................................... 530.8
---------
$ 666.9
=========
8
Form 10-Q Part I Convergys Corporaton
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(9) 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 Net Per Share
March 31, Income Shares Amount
------------------------ ------ ------ ---------
2002
Basic EPS $ 59.6 168.1 $ 0.35
Effect of dilutive securities:
Stock-based compensation arrangements -- 4.4 --
------- ------ --------
Diluted EPS $ 59.6 172.5 $ 0.35
======= ====== ========
2001
Basic EPS $ 52.1 169.3 $ 0.31
Effect of dilutive securities:
Stock-based compensation arrangements -- 6.2 (0.01)
------- ------ --------
Diluted EPS $ 52.1 175.5 $ 0.30
======= ====== ========
The diluted EPS calculation for the three months ended March 31, 2002
excludes the effect of 8.0 million outstanding stock options because they
were anti-dilutive.
9
Form 10-Q Part I 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 global leader in the provision of
outsourced, integrated billing software and customer and employee care 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.
FORWARD-LOOKING STATEMENTS
This report may contain "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. Sometimes these statements will contain words
such as "believes," "expects," "intends," "should," "will," "plans" and other
similar words. 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 loss of a significant client; difficulties
in completing or integrating acquisitions; terrorist acts or threats of
terrorist acts and the response thereto, and acts of war; 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 overview 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 March 31, 2002 versus Three Months Ended March 31, 2001
Revenues for the first quarter of 2002 totaled $587.5, slightly lower than
the $591.5 reported during the first quarter of 2001. The decrease reflects
lower CMG revenues partially offset by revenue growth at IMG. Operating expenses
for the first quarter of 2002 totaled $489.0 compared with $491.6 from the first
quarter of 2001, excluding goodwill amortization of $9.4 ($7.6 after tax or
$0.04 per diluted share) recorded in the prior year. The slight decrease in
operating expenses reflects lower general and administrative and depreciation
expenses offset by the higher costs of providing services. General and
administrative expenses decreased as a result of cost cutting measures
implemented during 2001 including the integration of the Geneva business and the
rationalization of CMG's contact center capacity as described in Notes 2 and 3
of Notes to the Financial Statements. The contact center rationalization also
caused the decrease in depreciation expense. The increase in costs of providing
services reflects the higher business volume at IMG. Operating income was $98.5
in the first quarter of 2002 compared with $99.9 in the prior year, excluding
prior year goodwill amortization, reflecting the slight decline in revenues
partially offset by lower operating expenses.
10
Form 10-Q Part I Convergys Corporation
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 first
quarter was $0.9 compared with $1.8 million in the prior year. Interest expense
decreased 50% in the first quarter of 2002 to $3.6 from the first quarter of
2001, as a result of significantly lower borrowings and reduced interest rates.
The fluctuation in other income (expense) primarily reflects foreign currency
losses incurred during the first quarter of 2002. Excluding prior year goodwill
amortization, net income of $59.6 was essentially flat compared to the $59.7 in
the prior year, while earnings per diluted share increased 3% to $0.35 compared
with $0.34 in the first quarter of 2001. The increase in earnings per diluted
share reflects the lower average number of diluted shares outstanding, which
resulted from the Company's repurchase of 1.5 million shares during the first
quarter of 2002 for $45.8 and 2.6 million shares during the second half of 2001.
As disclosed in Note 4 of Notes to the Financial Statements, the Company
adopted SFAS No. 142 as of January 1, 2002, which eliminated the amortization of
goodwill. Including goodwill amortization recorded during the first quarter of
2001, reported operating income, net income and diluted earnings per share for
the first quarter of 2001 was $90.5, $52.1 and $0.30, respectively.
INFORMATION MANAGEMENT GROUP
Three Months
($ Millions) Ended March 31,
------------------------------------
2002 2001 Change %
--------- -------- --------------
Revenues:
Data processing ................... $ 133.9 $ 126.4 $ 7.5 6
Professional and consulting ....... 53.1 41.2 11.9 29
License and other ................. 12.8 15.2 (2.4) (16)
International ..................... 33.5 36.5 (3.0) (8)
-------- -------- -------
External revenues ............... 233.3 219.3 14.0 6
Intercompany services ............. 2.9 3.3 (0.4) (12)
-------- -------- -------
Total revenues .................. 236.2 222.6 13.6 6
Costs of products and services ......... 110.2 103.4 6.8 7
Selling, general and administrative
expenses ............................. 34.9 37.7 (2.8) (7)
Research and development costs ......... 23.3 22.8 0.5 2
Depreciation ........................... 10.0 9.5 0.5 5
Amortization ........................... 1.4 4.5 (3.1) (69)
-------- -------- -------
Total costs ..................... 179.8 177.9 1.9 1
-------- -------- -------
Operating income ....................... $ 56.4 $ 44.7 $ 11.7 26
Three Months Ended March 31, 2002 versus Three Months Ended March 31, 2001
Excluding intercompany activity, IMG revenues were $233.3 in the first
quarter of 2002, a 6% increase from the first quarter of 2001. Data processing
revenues increased 6% in the first quarter of 2002 over the first quarter of
2001, primarily as a result of 23% wireless clients' subscriber growth. The data
processing revenue growth rate was partially offset by wireless clients'
contractual rate reductions and by slower growth in wireline data processing
revenues. Professional and consulting revenues increased 29% from the first
quarter of 2001 due to continued enhancement requests from wireless carriers,
ongoing implementations of Atlys, IMG's global wireless billing system, for AT&T
Wireless (AWS) and Triton PCS and growth in cable broadband services. License
and other revenues decreased to $12.8 in the first quarter of 2002 from $15.2 in
the prior year, reflecting the transition of IMG's license agreement with AT&T
Broadband for residential and commercial telephony billing services to a data
processing outsourcing agreement. International revenues for the segment
decreased 8% to $33.5, resulting from lower license revenues and the 2001
completion of the Atlys implementation for Telesp Celular in Brazil.
11
Form 10-Q Part I Convergys Corporation
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
Overall, IMG's business continues to be affected by the impact of the
global economic weakness in the communications sector. This had led to the
deferral of billing system buying decisions by many carriers as well as
increased pricing pressure.
IMG's costs and expenses increased 3% to $179.8 in the first quarter of
2002 compared to the first quarter of 2001, excluding the prior year goodwill
amortization of $3.1. The increase reflects higher direct costs of providing
products and services, partially offset by lower general and administrative
expenses. Direct costs of providing products and services increased as a result
of increased business volume. The decrease in general and administrative
expenses reflects the savings realized through IMG's cost cutting measures
including the integration of the Geneva business. Research and development
expense increased only slightly compared to the prior year as IMG continued to
spend more productivity on Atlys, Geneva, ICOMS and Catalys enhancements. IMG's
operating income increased 18% to $56.4 and operating margin increased to 24.2%
from 21.8% in the prior year, excluding first quarter 2001 goodwill
amortization. The increase in the margin is the result of lower general and
administrative expenses and relatively flat research and development expenses.
Including goodwill amortization expense, IMG's reported operating income
for the first quarter of 2001 was $44.7.
CUSTOMER MANAGEMENT GROUP
Three Months
Ended March 31,
-----------------------------
($ Millions) 2002 2001 Change %
------- ------- ------------
Revenues:
Communications ....................... $ 231.5 $ 228.9 $ 2.6 1
Technology ........................... 54.0 63.1 (9.1) (14)
Financial services ................... 19.9 21.8 (1.9) (9)
Other ................................ 48.8 58.4 (9.6) (16)
-------- ------- ------
Total revenues .................. 354.2 372.2 (18.0) (5)
Costs of products and services ............ 218.7 222.0 (3.3) (1)
Selling, general and administrative
expenses ................................ 68.4 70.3 (1.9) (3)
Research and development costs ............ 2.9 3.0 (0.1) (3)
Depreciation .............................. 18.1 21.3 (3.2) (15)
Amortization .............................. 2.1 8.2 (6.1) (74)
-------- ------- ------
Total costs ..................... 310.2 324.8 (14.6) (4)
-------- ------- ------
Operating income .......................... $ 44.0 $ 47.4 $ (3.4) (7)
Three Months Ended March 31, 2002 versus Three Months Ended March 31, 2001
CMG revenues were $354.2 in the first quarter of 2002, a 5% decrease from
the first quarter of 2001, reflecting continued general weakness in the economy
and reduced spending by AT&T. It is important to note that at CMG, revenues were
not impacted by weakening in the economy or a significant decline in AT&T
revenues until the second quarter of 2001. The overall decrease in revenues was
partially offset by double-digit revenue increases with six of CMG's top ten
clients. Revenues from communications clients were $231.5, a slight increase
from the first quarter of 2001, resulting from strong growth in services
provided to DirecTV and Sprint offset by reduced spending by AT&T. The decreases
in revenues from technology, financial services and other industries during the
first quarter of 2002 compared to the prior year reflect the continued general
economic weakness and its impact on client spending for customer support
services.
12
Form 10-Q Part I Convergys Corporation
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
CMG's costs and expenses were $310.2 in the first quarter of 2002, a 3%
decrease from the first quarter of 2001, excluding prior year goodwill
amortization of $6.3. The decrease in operating expenses reflects the lower
level of volume, which resulted in a decrease in direct costs of providing
services, and costs savings realized through the restructuring activities
initiated during the third quarter of 2001. Partially offsetting these
reductions was higher wage, salary and medical benefits costs. CMG's operating
income decreased 18% to $44.0 and operating margin decreased to 12.4% from 14.4%
in the first quarter of 2001, excluding prior year goodwill amortization. The
lower operating margin reflects the impact of lower revenues, excess contact
center capacity and higher wage, salary and medical costs, partially offset by
costs savings related to the third quarter 2001 rationalization of CMG's contact
centers.
Including goodwill amortization, CMG's reported operating income for the
first quarter of 2001 was $47.4.
CLIENT CONCENTRATION
The Company's four largest clients accounted for 54.1% and 52.3% of its
revenues in the first quarter of 2002 and 2001, respectively. The risk posed by
this revenue concentration is reduced by the long-term contracts the Company has
with its largest clients. The Company serves AT&T Wireless, its largest client
at 18.1% of revenues in the first three months of 2002, under contracts that
expire in 2006 and 2008. AT&T, the Company's second largest client at 17.8% of
revenues in the first three months of 2002, is principally served under
long-term information and customer management contracts that expire in 2006.
Sprint, the Company's third largest client, is served under a contract with IMG
that expires at the end of 2004. DirecTV, the Company's fourth largest client in
the first three months of 2002, is served by CMG under a contract that expires
at the end of 2003. Volumes under certain of the Company's long-term contracts
with its four largest clients are subject to variation based, among other
things, on the client's spending on outsourced customer support and subscriber
levels.
FINANCIAL CONDITION
Liquidity and Capital Resources
- -------------------------------
The Company generated $80.5 and $90.4 in cash flows from operating
activities during the first three months of 2002 and 2001, respectively. The
Company's cash flows from operating activities for the first three months of
2002 reflect a $20.0 repayment of borrowings under its accounts receivable
securitization program, compared to a $40.0 repayment during the first three
months of 2001. Capital expenditures were $20.6 and $34.7 for the first three
months of 2002 and 2001, respectively. The decrease in capital expenditures
resulted from reduced spending on the expansion of CMG's contact center
facilities in reaction to the flattening of its sales volumes.
Operating cash flows have historically been more than sufficient to fund
the Company's cash needs, other than for very large acquisitions. Historically,
acquisitions have generally been financed with a combination of borrowings and
operating cash flows. At March 31, 2002, the Company had $145.3 of borrowings
outstanding. The Company's borrowing facilities include two revolving credit
facilities that expire in November 2002, one with $100 in borrowing capacity and
the other with a $250 in borrowing capacity, and $100 in notes which expire in
September 2002. The Company also has a $150 accounts receivable securitization
agreement, under which it had no outstanding borrowings at March 31, 2002. The
accounts receivable securitization agreement expires in September 2002 and it is
anticipated that the agreement will be renewed at that time. 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.
13
Form 10-Q Part I Convergys Corporation
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
Balance Sheet
- -------------
Adjusting for a $20.0 reduction in the balance of receivables sold under
the Company's accounts receivable securitization program, accounts receivable
increased $16.4 from December 31, 2001 to March 31, 2002. Excluding the effects
of the securitization, days sales outstanding increased by 1 day during the
first three months of 2002 to 69 days. Treasury stock increased from December
31, 2001 as the Company repurchased 1.5 million shares for a total cost of
approximately $45.8.
Foreign Currency and Interest Rate Risk
- ---------------------------------------
The Company derived 7% of its first three months of 2002 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.
The Company currently uses cash flow hedges for foreign currency and
interest rate exposure. 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, 2002, the Company had $141.2 in outstanding variable rate borrowings.
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 $0.4.
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: economic cycles,
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.
14
Form 10-Q Part I Convergys Corporation
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
There were no matters submitted to a vote of security holders in the first
quarter of 2002.
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:
(12) Computation of Ratio of Earnings to Fixed Charges
(b) Reports on Form 8-K
On January 18, 2002, the Company filed a Form 8-K announcing that its
Board of Directors authorized the repurchase of up to 10 million of
its common shares as market and business conditions warrant.
15
Form 10-Q Part I Convergys Corporation
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Convergys Corporation
Date: May 10, 2002 /s/ Steven G. Rolls
---------------------------------
Steven G. Rolls
Chief Financial Officer
16