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, 1998
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 1-8519
CINCINNATI BELL INC.
Incorporated under the laws of the State of Ohio
201 East Fourth Street, Cincinnati, Ohio 45202
I.R.S. Employer Identification Number 31-1056105
Telephone - Area Code 513 397-9900
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, 1998, 136,638,243 Common Shares were outstanding.
Form 10-Q Part I Cincinnati Bell Inc.
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
(Millions of Dollars, Except Per Share Amounts)
(Unaudited)
Three Months
Ended March 31,
-----------------------
1998 1997
------- -------
Revenues .................................................... $ 508.1 $ 429.5
------- -------
Costs and Expenses
Cost of providing services and products sold .............. 281.1 231.1
Selling, general and administrative ....................... 83.7 74.0
Depreciation and amortization ............................. 45.2 44.2
Acquired research and development cost .................... 42.6 -
Year 2000 programming costs ............................... 8.6 .6
Mandated telecommunications costs ......................... 4.4 1.1
Special charges (credits) ................................. - (15.0)
------- -------
Total Costs and Expenses ................................ 465.6 336.0
------- -------
Operating Income ............................................ 42.5 93.5
Other Income (Expense), Net ................................. 1.6 3.4
Interest Expense ............................................ 10.8 8.6
------- -------
Income Before Income Taxes .................................. 33.3 88.3
Income Taxes ................................................ 10.5 31.1
------- -------
Net Income .................................................. $ 22.8 $ 57.2
------- -------
------- -------
Other comprehensive income, net of tax:
Foreign currency translation adjustments .................... (.1) (1.4)
Pension liability adjustment ................................ - .8
------- -------
Total other comprehensive income ......................... (.1) (.6)
------- -------
Comprehensive income ........................................ $ 22.7 $ 56.6
------- -------
------- -------
Earnings Per Common Share
Basic ..................................................... $ .17 $ .42
Diluted ................................................... $ .16 $ .42
Dividends Declared Per Common Share ......................... $ .10 $ .10
Average Common Shares Outstanding Including Equivalents (000)
Basic ..................................................... 135.8 134.9
Diluted ................................................... 138.4 137.6
Retained Earnings
Beginning of Period ....................................... $ 217.7 $ 288.5
Net Income ................................................ 22.8 57.2
Common Share Dividends Declared ........................... (13.7) (13.6)
Other ..................................................... (1.1) .6
------- -------
End of Period ............................................. $ 225.7 $ 332.7
------- -------
------- -------
Accumulated other comprehensive income:
Beginning of Period ....................................... $ (8.1) $ (7.3)
Foreign currency translation adjustments .................. (.1) (1.4)
Pension liability adjustment .............................. - .8
------- -------
End of period ............................................. $ (8.2) $ (7.9)
------- -------
------- -------
See Notes to Financial Statements.
2
Form 10-Q Part I Cincinnati Bell Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Millions of Dollars)
(Unaudited)
March 31, December 31,
1998 1997
------------- ------------
ASSETS
Current Assets
Cash and cash equivalents ................................. $ 12.7 $ 9.9
Receivables, less allowances of $19.0 and $14.0 ........... 424.9 350.8
Material and supplies ..................................... 15.5 16.3
Deferred income taxes ..................................... 16.1 24.6
Prepaid expenses and other current assets ................. 50.0 48.4
-------- --------
Total current assets .............................. 519.2 450.0
Property, plant and equipment - net ......................... 796.5 703.2
Goodwill and other intangibles .............................. 726.9 195.0
Investments in unconsolidated entities ...................... 79.4 77.6
Deferred charges and other assets ........................... 81.1 72.9
-------- --------
Total Assets ................................................ $2,203.1 $1,498.7
-------- --------
-------- --------
LIABILITIES AND SHAREOWNERS' EQUITY
Current Liabilities
Debt maturing in one year ................................. $ 848.6 $ 190.6
Accounts payable and accrued liabilities .................. 238.4 197.6
Accrued taxes ............................................. 64.3 51.5
Advance billing and customers' deposits ................... 34.0 35.0
Other current liabilities ................................. 48.2 60.2
-------- --------
Total current liabilities ......................... 1,233.5 534.9
Long-term debt .............................................. 268.4 269.2
Deferred income taxes ....................................... - 12.7
Other long-term liabilities ................................. 105.7 102.2
-------- --------
Total liabilities ................................. 1,607.6 919.0
-------- --------
Shareowners' Equity
Common shares-$1 par value; 480,000,000 shares authorized . 136.5 136.1
Additional paid-in capital ................................ 237.3 229.8
Retained earnings ......................................... 225.7 217.7
Currency translation adjustments .......................... (4.0) (3.9)
-------- --------
Total shareowners' equity ......................... 595.5 579.7
-------- --------
Total Liabilities and Shareowners' Equity ................... $2,203.1 $1,498.7
-------- --------
-------- --------
See Notes to Financial Statements.
3
Form 10-Q Part I Cincinnati Bell Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Millions of Dollars)
(Unaudited)
Three Months
Ended March 31,
-----------------------
1998 1997
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ........................................................................... $ 22.8 $ 57.2
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization ..................................................... 45.2 44.2
Special charges (credits) ......................................................... - (15.0)
Acquired research and development costs ........................................... 42.6 -
Provision for loss on receivables ................................................. 4.6 2.5
Other, net ........................................................................ (4.0) (3.7)
Changes in assets and liabilities net of effects from acquisitions and
disposals:
Decrease (increase) in receivables ................................................ (27.6) 9.1
Decrease in other current assets ................................................. 9.4 2.1
Decrease in accounts payable and accrued liabilities .............................. (19.9) (24.7)
Increase in other current liabilities ............................................. 4.9 5.4
(Decrease) Increase in deferred income taxes and unamortized
investment tax credits ........................................................... 3.4 (4.7)
Decrease in other assets and liabilities-net ...................................... (14.4) 6.3
------- -------
Net cash provided by operating activities ....................................... 67.0 78.7
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures-telephone plant .............................................. (39.1) (33.3)
Capital expenditures-other ........................................................ (12.1) (13.3)
Acquisitions, net of cash acquired ................................................ (658.3) -
Disposition of assets ............................................................. - -
Other, net ........................................................................ .5 .3
------- -------
Net cash used in investing activities ........................................... (709.0) (46.3)
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CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in short-term debt ........................................ 659.4 (2.9)
Repayment of long-term debt ....................................................... (1.8) (5.0)
Issuance of common shares ......................................................... .8 5.2
Dividends paid .................................................................... (13.6) (13.5)
------- -------
Net cash provided by (used in) financing activities ............................. 644.8 (16.2)
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Net increase in cash and cash equivalents ............................................ 2.8 16.2
Cash and cash equivalents at beginning of period ..................................... 9.9 2.0
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Cash and cash equivalents at end of period ........................................... $ 12.7 $ 18.2
------- -------
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Cash paid for:
Interest (net of amount capitalized) ............................................... $ 7.2 $ 5.1
Income taxes ....................................................................... $ 3.2 $ 4.2
See Notes to Financial Statements.
4
Form 10-Q Part I Cincinnati Bell Inc.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(1) BASIS OF PRESENTATION - The consolidated financial statements include
the accounts of Cincinnati Bell Inc. and its wholly owned subsidiaries
(the Company). The Company is a diversified communications company
with principal businesses in three industry segments. The Information
Systems segment, Cincinnati Bell Information Systems Inc. (CBIS),
provides and manages customer care and billing solutions for the
communications and cable TV industries. The Teleservices segment,
MATRIXX Marketing Inc. (MATRIXX), provides a full range of customer
management solutions to large corporations. The Communications
Services segment, consisting of Cincinnati Bell Telephone Company
(CBT), Cincinnati Bell Long Distance Inc. (CBLD), Cincinnati Bell
Directory Inc. (CBD), Cincinnati Bell Supply Company (CBS) and
Cincinnati Bell Wireless Company (CBW) provides local telephone
exchange services and products in Greater Cincinnati, long distance
services, yellow pages and directory services, telecommunications
equipment and advanced digital personal communications services (PCS)
and products. Certain prior year amounts have been reclassified to
conform with the current classifications with no effect on financial
results.
The consolidated financial statements of Cincinnati Bell Inc. 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 those
outlined in Note (3). Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted
pursuant to SEC rules and regulations. The December 31, 1997 condensed
balance sheet was 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 financial statements and notes thereto included in the
Company's 1997 Annual Report on Form 10-K.
(2) FORMATION OF CONVERGYS CORPORATION - On April 27, 1998, the Company
announced that it intends to form a new subsidiary, Convergys
Corporation (Convergys), to hold its billing and customer management
businesses, CBIS and MATRIXX. The Company also announced its plan to
offer less than 20% of the common shares of Convergys to the public.
The Company intends to file and register the shares for public offering
in May 1998. The offering is expected to be completed in the third
quarter of 1998, with proceeds generally to be used to repay a portion
of the Company's short-term debt. Subject to certain conditions,
including a successful public offering and the receipt of a favorable
tax ruling, the Company's Board of Directors has approved the
distribution later in 1998 of the remaining shares of Convergys stock
to the Company's shareowners. Company shares owned as of the record
date of this distribution will entitle holders to receive a
proportionate number of Convergys common shares. Convergys may hold the
Company's minority interest in a cellular partnership with Ameritech.
The Company will determine the status of the partnership interest by
the date that the registration statement is filed.
5
Form 10-Q Part I Cincinnati Bell Inc.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(3) ACQUISITIONS - On March 3, 1998, MATRIXX acquired AT&T Solutions
Customer Care (Transtech) from AT&T for $625 million in cash. The
acquisition was accounted for under the purchase method of accounting.
It was financed through short-term commercial paper borrowings. In the
first quarter of 1998, the Company recorded a charge of $42.6 million
to expense acquired in-process research and development costs
associated with the acquisition. The acquired in-process research and
development costs relate to two projects at Transtech that had not
reached technological feasibility at the time of the acquisition and
for which there is no alternative future use. The Company intends to
continue both projects. Approximately $68.2 million of the purchase
price was allocated to an eight-year contract under which MATRIXX will
provide teleservices to AT&T, approximately $11.4 million to the
Transtech assembled workforce, approximately $4.4 million to
capitalized software and approximately $91.0 million to the other
acquired identifiable net assets of Transtech. The fair values of the
acquired assets were determined by an independent valuation. The excess
of the purchase price over the fair value of the net assets acquired
(approximately $414.4 million) is goodwill, which will be amortized on
a straight-line basis over a thirty-year life. The following unaudited
pro forma data summarizes the combined results of the operations of
Company and Transtech as though the acquisition had occurred on January
1, 1997:
Three Months
Ended March 31,
--------------------
1998 1997
------ ------
Revenues......................................... $570.5 $527.0
Net income....................................... $ 15.5 $ 55.8
Earnings per share:
Basic..................................... $ .11 $ .41
Diluted................................... $ .11 $ .41
On January 8, 1998, MATRIXX acquired the teleservices assets of Maritz,
Inc. for approximately $30 million. The acquisition agreement contains
provisions that could increase the purchase price by up to $20 million.
The acquisition was accounted for under the purchase method of
accounting. The acquisition of Maritz did not have a material effect on
the Company's results of operations in the first quarter of 1998.
(4) STATUS OF BUSINESS RESTRUCTURINGS - The following is an update of the
Company's business restructurings:
MATRIXX
In the fourth quarter of 1997, the Company approved a restructuring
plan for MATRIXX. The restructuring plan will result in the
consolidation of certain operating divisions and facilities. A charge
of $35.0 million was recorded which reduced net income by $23.0
million. At December 31, 1997, the balance of the restructuring reserve
was $26.0 million. During the first quarter of 1998, MATRIXX recorded
cash expenditures of $1.5 million primarily for severance pay and
recorded non-cash asset writedowns of $3.7 million. The restructuring
reserve has a balance of $20.8 million at March 31, 1998. Management
expects the restructuring plan activities to be completed by December
31, 1998 and that the remaining balance in the reserve is adequate to
complete the plan.
CBT and CBI
In 1995, the Company initiated a restructuring plan resulting in the
need for fewer people to operate the businesses of CBT and CBI. For the
three months ended March 31, 1997, the Company recorded non-cash
settlement gains resulting from lump-sum pension distributions to
employees retiring under the offer of $15.0 million. In the first
quarter of 1998 there were cash expenditures of $.4 million for
severance pay. Management believes that the remaining reserve balance
of $4.7 million at March 31, 1998, primarily for obligations under
terminated leases, is adequate to complete the restructuring plan.
6
Form 10-Q Part I Cincinnati Bell Inc.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(5) CINCINNATI BELL TELEPHONE COMPANY - The following summarized financial
information is for the Company's consolidated wholly owned subsidiary,
Cincinnati Bell Telephone Company:
Three Months
Ended March 31,
--------------------
Millions of Dollars 1998 1997
------------------- ------ ------
Revenues................................. $175.3 $160.8
Costs and Expenses....................... 141.4 117.3
------ ------
Operating Income......................... $ 33.9 $ 43.5
Net Income............................... $ 19.0 $ 25.2
Results for the three months of 1997 include $15.0 million of pension
settlement gains that increased net income by $9.6 million. Results for
the three months ended March 31, 1998 and 1997, include $4.4 million
and $1.1 million, respectively, of mandated telecommunications costs
necessary to modify CBT's network to accommodate connections with
competing networks and to allow customers to maintain their telephone
numbers when they switch local service providers. Additionally, results
for the first quarter 1998 include $2.9 million of Year 2000
programming costs. These mandated telecommunications and Year 2000
programming costs decreased net income by $4.7 million and $.7 million
for the three months ended March 31, 1998 and 1997, respectively.
March 31, December 31,
Millions of Dollars 1998 1997
------------------- --------- ------------
Current Assets................................... $ 137.0 $ 142.5
Telephone Plant-Net.............................. 564.0 550.6
Other Noncurrent Assets.......................... 14.3 13.3
--------- ----------
Total Assets..................................... $ 715.3 $ 706.4
--------- ----------
--------- ----------
Current Liabilities.............................. $ 216.1 $ 214.0
Noncurrent Liabilities........................... 34.4 33.8
Long-Term Debt................................... 218.2 218.4
Shareowner's Equity.............................. 246.6 240.2
--------- ----------
Total Liabilities and Shareowner's Equity........ $ 715.3 $ 706.4
--------- ----------
--------- ----------
(6) AT&T RELATIONSHIP - Each of the Company's major subsidiaries derives
significant revenues from AT&T and its affiliates (AT&T) by providing
network services, customer care and billing systems and teleservices.
Revenues from AT&T, including network access revenues, were 23% of the
Company's consolidated revenues for both periods ended March 31, 1998
and 1997, respectively.
(7) CONTINGENCIES - Ameritech, as general partner of a limited partnership
offering cellular service in much of central and southeastern Ohio,
including Greater Cincinnati, in which the Company is a 45% limited
partner, filed suit in a Delaware Chancery Court seeking a declaratory
judgment that the Company had withdrawn from the partnership. The
Delaware Chancery Court dismissed the suit and the Supreme Court of
Delaware affirmed.
The Company is from time to time subject to routine complaints
incidental to the business. The Company believes that the results of
any complaints and proceedings will not have a materially adverse
effect on the Company's financial condition.
7
Form 10-Q Part I Cincinnati Bell Inc.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(8) EARNINGS PER SHARE - In 1997, the Company adopted Statement of
Financial Standards (SFAS) 128, "Earnings Per Share." SFAS requires the
dual presentation of basic and diluted earnings per share (EPS). Basic
EPS is based on the weighted average common shares outstanding during
the period. Diluted EPS reflects the potential dilution that would
occur if common stock equivalents were exercised. Prior year EPS have
been restated to reflect the adoption of SFAS 128. The following table
is a reconciliation of the numerators and denominators of the basic and
diluted EPS computations:
Three Months Ended March 31,
--------------------------------------------------------------
1998 1997
--------------------------------------------------------------
Per Share Per Share
Millions of Dollars Income Shares Amount Income Shares Amount
----------------------------------------------------------------------------------------------
Net income $22.8 $57.2
Basic EPS $22.8 135.8 $ .17 $57.2 134.9 $ .42
----- -----
----- -----
Effect of dilutive securities:
Stock options 2.0 2.1
Stock based compensation
arrangements .6 .6
----- -----
Diluted EPS $22.8 138.4 $ .16 $57.2 137.6 $ .42
----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- -----
(9) RECENTLY ISSUED ACCOUNTING STANDARDS - In March 1998, the American
Institute of Certified Public Accountants (AICPA) issued Statement of
Position (SOP) 98-1, "Accounting for the Costs Computer Software
Developed or Obtained for Internal Use." SOP 98-1 requires the
capitalization of certain expenditures for software that is purchased
or internally developed for use in the business. Company management
believes that the prospective implementation of SOP 98-1 in 1999 is
likely to result in some additional capitalization of software
expenditures in the future. However, the amount of such additional
capitalization of software expenditures can not be determined at this
time.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-up Activities." The SOP provides guidance on financial reporting
of costs of start-up activities. It requires such costs to be expensed
instead of being capitalized and amortized. SOP 98-5 is effective for
fiscal years beginning after December 15, 1998. The Company believes
the implementation of SOP 98-5 will not have a material impact on its
financial reporting.
Effective January 1, 1998, the Company implemented SOP 97-2, "Software
Revenue Recognition." SOP 97-2 revises certain standards for the
recognition of software revenue in connection with certain software
development and licensing arrangements. SOP 97-2 did not have a
material effect on the results of operations for the three months ended
March 31, 1998, however, its effect on future operating results will be
dependent on the nature and terms of the Company's individual software
agreements.
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income"
in the first quarter of 1998. SFAS 130 establishes standards for
reporting and display of comprehensive income and its components in a
full set of financial statements. The objective of SFAS 130 is to
report a measure of all changes in the equity of an enterprise that
result from transactions and other economic events of the period other
than transactions with shareowners.
8
Form 10-Q Part I Cincinnati Bell Inc.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(10) BUSINESS SEGMENT INFORMATION - The Company operates primarily in three
industry segments, Communications Services, Information Systems, and
Teleservices. Certain corporate administrative expenses have been
allocated to segments based upon the nature of the expense. Assets are
those assets used in the operations of the segment. The Company's
business segment information is as follows:
Three Months
Millions of Dollars Ended March 31,
------------------- -------------------------
1998 1997
-------- --------
REVENUES
Communications Services $ 216.5 $ 199.9
Information Systems 143.9 130.5
Teleservices 166.9 115.2
Intersegment (19.2) (16.1)
-------- --------
$ 508.1 $ 429.5
-------- --------
-------- --------
INTERSEGMENT REVENUES
Communications Services $ 3.1 $ 2.5
Information Systems 13.5 12.2
Teleservices 2.6 1.4
-------- --------
$ 19.2 $ 16.1
-------- --------
-------- --------
SPECIAL ITEMS (see MD&A)
Communications Services $ - $ (15.0)
Information Systems - -
Teleservices 42.6 -
-------- --------
$ 42.6 $ (15.0)
-------- --------
-------- --------
OPERATING INCOME
Communications Services $ 46.7 $ 57.1
Information Systems 27.0 22.7
Teleservices (28.3) 14.6
Corporate and Eliminations (2.9) (.9)
-------- --------
$ 42.5 $ 93.5
-------- --------
-------- --------
ASSETS
Communications Services $ 773.6 $1,053.4
Information Systems 280.5 259.0
Teleservices 981.4 270.7
Corporate and Eliminations 167.6 88.3
-------- --------
$2,203.1 $1,671.4
-------- --------
-------- --------
CAPITAL ADDITIONS (including acquisitions)
Communications Services $ 40.4 $ 35.6
Information Systems 5.6 3.1
Teleservices 663.9 5.4
Corporate .4 -
-------- --------
$ 710.3 $ 44.1
-------- --------
-------- --------
DEPRECIATION AND AMORTIZATION
Communications Services $ 26.6 $ 30.3
Information Systems 6.7 7.7
Teleservices 11.7 6.1
Corporate .2 .1
-------- --------
$ 45.2 $ 44.2
-------- --------
-------- --------
9
Form 10-Q Part I Cincinnati Bell Inc.
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Information included in this quarterly report on Form 10-Q contains certain
forward-looking statements that involve potential risks and uncertainties.
The Company's future results could differ materially from those discussed
herein. Factors that could cause or contribute to such differences, include
but are not limited to, those discussed herein, and those discussed in the
Form 10-K for the year ended December 31, 1997. Readers are cautioned not to
place undue reliance on these forward-looking statements that speak only as
of the date thereof.
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated
financial statements and segment data. Results for interim periods may not be
indicative of the results for the full years.
CONSOLIDATED OVERVIEW
Revenues were $508.1 million for the first quarter of 1998, up 18% from
$429.5 million from the first quarter of 1997. The customer-care businesses
CBIS and MATRIXX produced 80% of the revenue increase.
Costs and expenses excluding special items were $422.9 million for the first
quarter, up 20% from $351.0 million from the first quarter last year. Special
items affected results for the quarter of both years. Included in the costs
and expenses for the first quarter of 1998 was the expensing of $42.6 million
for acquired research and development costs at MATRIXX for the acquisition of
AT&T Solutions Customer Care (Transtech). For the first quarter of 1997,
there were credits of $15.0 million for pension settlement gains from a 1995
restructuring.
Operating income excluding special items was $85.2 million, up 8% from $78.5
million in the first quarter 1997.
Net income excluding special items was $49.2 million or $.36 per common share
for the first quarter of 1998 compared to $47.7 million or $.35 per common
share for the first quarter of 1997. Reported net income for the first
quarter of 1998 and 1997 was $22.8 million or $.17 per common share and $57.2
million or $.42 per common share, respectively.
The Company continued to incur significant costs for two initiatives during
the first quarter of 1998. Each of the Company's segments incurred costs to
ready its systems and software for the Year 2000. These costs totaled $8.6
million for the three months ended March 31, 1998, compared to only $.6
million for the same period in 1997. CBT also incurred regulator-mandated
costs to modify its network to accommodate connections with competing
networks and to allow customers to maintain their telephone numbers when they
switch local service providers. These regulator-mandated costs totaled $4.4
million for the three months ended March 31, 1998, compared to only $1.1
million for the same period in 1997.
During the first quarter of 1998, the Company acquired two teleservices
businesses and announced a significant investment in a provider of personal
communications services (PCS). Maritz was acquired in January for $30 million
in cash and Transtech in March for $625 million in cash. These acquisitions
contributed revenues of $43.8 million for the quarter but had little impact
on operating income. Additionally, the debt financing of these acquisitions
increased the Company's interest expense by over $3 million. The Company
announced an 80% ownership investment in a venture with AT&T to provide PCS
in the Greater Cincinnati and Dayton markets. The Company believes that this
transaction will close sometime in 1998, although closure is dependent on,
among other things, FCC approval of a PCS license transfer from AT&T to the
venture. The Company is committed to fund certain start-up operating losses
of the venture beginning in February 1998, and accordingly, reflected $1.7
million of such losses in other income (expense), net in the first quarter of
1998. The Company's 1998 teleservices acquisitions and PCS venture reduced
net income by over $3 million and over $.02 per common share for the quarter.
10
Form 10-Q Part I Cincinnati Bell Inc.
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
COMMUNICATIONS SERVICES
Three Months Ended March 31,
-------------------------------------
($ Millions) 1998 1997 Change %
------- ------- ---------------
Revenues
Local service $ 100.6 $ 94.9 $ 5.7 6
Network access 44.6 40.5 4.1 10
Other services 71.3 64.5 6.8 11
------- ------- -------
Total 216.5 199.9 16.6 8
Operating expenses 162.5 156.7 5.8 4
Year 2000 programming costs 2.9 - 2.9
Mandated telecommunications costs 4.4 1.1 3.3
Special items:
Pension settlement gains - (15.0) 15.0
------- ------- -------
Total 169.8 142.8 27.0 19
Operating income $ 46.7 $ 57.1 $ (10.4) (18)
Excluding special items:
Operating income $ 46.7 $ 42.1 $ 4.6 11
Operating margin 21.6% 21.1%
Access lines (In thousands) 1,017 971 46 5
Minutes of Use (In millions) 1,053 996 57 6
The Company's communications services businesses had a very successful
quarter as increased marketing activities fueled revenue growth of 8%. Costs
and expenses excluding special items increased at the same rate as revenues
compared to the first quarter 1997. Costs for Year 2000 programming and
mandated telecommunications costs were higher by $6.2 million. Without the
increased costs related to these initiatives, the rate of expense increase
would have been 4%, reflecting successful efforts at controlling costs.
Local service revenues increased $5.7 million compared to the same period in
1997. Access lines grew 5% from a strong business economy. Increased
marketing fueled growth in call management, custom calling and central office
features. Also contributing to the increase were higher installations of
second lines and demand for access to on-line computer services.
Network access revenues increased $4.1 from a higher volume of end user and
special access services. The increase was principally from growth in access
lines and growth of 6% in access minutes of use and includes Federal
Communications Commission (FCC) changes in access charge methodologies. This
change in methodology includes implementation of an end user charge to long
distance carriers for pre-subscribed customers, offset by reductions in
certain switched access categories. Decreases in carrier common line and
transport rates partially offset the growth in access minutes of use and
caused a decrease in switched access revenues. Also contributing to the
increase was a first quarter 1997 reduction in access revenues of $1.1
million for potential overearnings liabilities.
Other services increased $6.8 million primarily as a result of higher
revenues at CBLD and CBD and the deregulation of public telephone services at
CBT partially offset by softness in telecommunications and information
systems equipment sales at CBS.
Operating expenses, excluding special items, increased $5.8 million. Over
half of the increases were at CBT. The factors that caused the increases at
CBT were expenses for contract labor, consulting fees, personnel costs and
charges for universal service as mandated by regulatory requirements.
Partially offsetting the increases was a
11
Form 10-Q Part I Cincinnati Bell Inc.
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
decrease in depreciation expenses principally as a result of the
discontinuance of SFAS No. 71, "Accounting for the Effects of Certain Types
of Regulation," in the fourth quarter of 1997. For external reporting
purposes, CBT is now using shorter economic lives of assets for depreciation.
Previously, CBT had used depreciation rates established by regulators that
were based on longer asset lives. The reduction of CBT's depreciable asset
base as a result of the discontinuance of SFAS No. 71 more than offset the
impact of the use of shorter economic lives for the determination of
depreciation. The remaining increases were at CBLD, CBD, CBW and CBS. Higher
selling, general and administrative expenses caused the increases.
Efforts at CBT to ready its systems for Year 2000 and to make mandated
modifications to its network caused notable increases in these costs as
compared to the first quarter of 1997.
CBT recorded $15.0 million in pension settlement gains during the first
quarter of 1997 as special items.
INFORMATION SYSTEMS
Three Months Ended March 31,
-------------------------------------
($ Millions) 1998 1997 Change %
------- ------- ---------------
Revenues $ 143.9 $ 130.5 $ 13.4 10
Operating expenses 112.2 107.2 5.0 5
Year 2000 programming costs 4.7 .6 4.1
------- ------- -------
Total 116.9 107.8 9.1 8
Operating income $ 27.0 $ 22.7 $ 4.3 19
Operating margin 18.8% 17.4%
The information systems segment provided more than half of the Company's
operating income growth for the first quarter. The operating income was
achieved despite increased spending for Year 2000 programming costs.
Revenues increased $13.4 million. Data processing revenues increased $15.7
million from growth in cellular subscriber services. CBIS's wireless clients'
subscriber levels increased nearly 30%. The increase in data processing
revenues attributable to the growth in wireless subscribers was partially
offset by a decline in the number of subscribers for whom CBIS performs
wireless long distance billing. The decline resulted from the
Telecommunications Act of 1996 (the Act) causing a loss in wireless long
distance market share for one of CBIS's clients to another long distance
carrier. Professional and consulting revenues were largely unchanged between
the periods. International revenues decreased $1.8 million primarily from a
reduction of efforts on one international contract that is winding down in
1998, partially offset by increased revenue from new clients. As the one
international contract has neared completion and risks regarding contract
performance have been alleviated, revenues have been recognized at higher
margins.
Operating expenses increased $5.0 million. Direct costs of providing services
increased somewhat more than $5 million to support business volume through
additional headcount, data center upgrades, client specific development, bill
finishing costs and increased wage rates, particularly for computer
programmers. Other costs increased from sales and marketing trade shows,
management fees and higher facility lease expenses. Depreciation and
amortization expense decreased primarily from the completion of the
amortization of capitalized software in 1997.
Costs to reprogram systems and software for the Year 2000 increased
$4.1 million as these efforts have increased significantly.
12
Form 10-Q Part I Cincinnati Bell Inc.
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TELESERVICES
Three Months Ended March 31,
-------------------------------------
($ Millions) 1998 1997 Change %
------- ------- ---------------
Revenues $ 166.9 $ 115.2 $ 51.7 45
Operating expenses 151.6 100.6 51.0 51
Year 2000 programming costs 1.0 - 1.0
Special items:
Acquired research and development
costs 42.6 - 42.6
------- ------- -------
Total 195.2 100.6 94.6 94
Operating income $ (28.3) $ 14.6 $ (42.9)
Excluding special items:
Operating income $ 14.3 $ 14.6 $ (.3) (2)
Operating margin 8.6% 12.7%
Revenues and operating income excluding special items increased by $51.7
million and decreased by $.3 million, respectively. Excluding the impact of
the Transtech and Maritz acquisitions, revenues increased by $7.9 million and
operating income decreased by $.2 million.
Dedicated services revenues, where clients are served by a dedicated MATRIXX
service team handling more complex customer service and sales account
management needs, increased by $9.2 million or 15% (excluding the
acquisitions). This was caused by continued strong sales to clients in the
technology and communications industries. Almost all of the revenues
contributed by Transtech and Maritz are dedicated services revenues, bringing
the total increase in dedicated services revenues to approximately $53
million. Traditional inbound/outbound revenues, where clients' significant
sales campaigns and direct response programs are served by clients-shared
facilities, continued to recover from the significant decline experienced in
the third quarter of 1997 when a shift in marketing efforts by certain major
clients occurred. Despite this recovery, traditional revenues were $2.0
million or 4% below the level experienced in the first quarter of 1997.
Operating expenses increased by $51.0 million of which $43.9 million was
related to the acquisitions and $7.1 million to the core MATRIXX businesses.
Operating expenses increases in the core business were the result of
additional headcount, depreciation expense, wage rate increases and facility
lease expense. Costs to modify systems for Year 2000 compliance were $1.0
million.
During the first quarter 1998, a special item was recorded expensing $42.6
million of certain costs of acquired research and development related to the
Transtech acquisition. The $42.6 million in expensed costs (approximately 7%
of the Transtech purchase price) relates to two ongoing development projects
at Transtech that had not reached technological feasibility at the time of
the acquisition. The Company has determined that no alternative future use
exists for the development projects and intends to continue both projects.
Operating margin, excluding the special item, decreased 4.1 points primarily
from the acquisitions made in the first quarter of 1998. Excluding the
special item and the acquisitions, the operating margin of MATRIXX's core
business declined by a point from 12.7% in 1997 to 11.7% in 1998. The 11.7%
core margin reflects a significant improvement over the 9.3% margin in the
fourth quarter of 1997.
13
Form 10-Q Part I Cincinnati Bell Inc.
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Three Months Ended March 31,
----------------------------------------
($ Millions) 1998 1997 Change %
-------- -------- ------------
OTHER INCOME (EXPENSE), NET $ 1.6 $ 3.4 $ (1.8) (53)
INTEREST EXPENSE $ 10.8 $ 8.6 $ 2.2 26
INCOME TAXES $ 10.5 $ 31.1 $(20.6) (66)
The decrease in other income (expense), net for the three months 1998
compared to 1997 was primarily the result of $1.7 million start-up operating
costs for the wireless venture.
Interest expense increased on short term borrowings principally as a result
of acquisitions made in the first quarter 1998. The weighted average interest
rate for debt was 6.5% at March 31, 1998 compared to 6.9% at March 31, 1997.
For the three months ended March 31, 1998 and 1997, average debt outstanding
was $691 million and $501 million, respectively.
Lower income before taxes was the principal reason for the decrease in income
taxes. Excluding special items, the effective tax rate was 35.1% for the
first quarter of 1998 compared to 35.0% for the first quarter of 1997.
FINANCIAL CONDITION
CAPITAL INVESTMENT, RESOURCES AND LIQUIDITY
Management believes that the Company has adequate internal and external
resources available to finance its on-going operating requirements, including
network expansion and modernization, business development and dividend
programs. The acquisitions of Transtech and Maritz for MATRIXX by the Company
during the first quarter of 1998 were financed primarily by the issuance of
short-term debt. The balance in short-term debt increased to $849 million at
March 31, 1998 from $191 million at December 31, 1997. On April 27, 1998, the
Company announced its intention to raise equity through the sale of less than
20% of Convergys' common shares. The Company has announced that the proceeds
from the planned offering of Convergys' common shares to the public will be
used to repay short-term debt. The Company may seek additional permanent
financing to maintain its financial flexibility.
Cash provided by operating activities was $67.0 million for the first quarter
of 1998 compared to $78.7 million for the first quarter of 1997. The decrease
in cash flows from operating activities was caused primarily from an increase
in accounts receivable related to increases in receivables at the two
acquired teleservices businesses and the timing of cash receipts from certain
significant clients.
The Company's most significant investing activity was cash paid principally
for the MATRIXX acquisitions. Maritz was acquired in January for $30 million
in cash and Transtech in March for $625 million in cash. Capital expenditures
were comparable for the first quarter of 1998 to the first quarter of 1997.
BALANCE SHEET
The increases to receivables, property, plant and equipment, goodwill and
other intangibles, debt maturing in one year, and accounts payable and
accrued liabilities were caused by the MATRIXX acquisitions during the first
quarter of 1998.
CAPITALIZATION
On April 27, 1998, Standard and Poor's (S&P) affirmed its senior unsecured
debt rating (A-) and corporate credit rating (A-) for the Company and at CBT
(A+). The Company's commercial paper rating (A-2) was also affirmed by S&P.
The affirmation followed the Company's announcement to spin off Convergys
later in the year. On April 28, 1998, Duff and Phelps Credit Rating Co. (DCR)
reported it was downgrading the Company's senior unsecured debt to A- from A
and its commercial paper to D-2 from D-1 in reaction to the Company's
Convergys announcement.
14
Form 10-Q Part I Cincinnati Bell Inc.
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
REGULATORY MATTERS AND COMPETITIVE TRENDS
FEDERAL - In August 1996, the FCC issued its order on interconnection, the
first of three significant rulings that will determine the ground rules for
local exchange competition. In July 1997, the Court of Appeals issued a
decision stating that the FCC rules exceeded their authority under the Act in
several areas. Among other things, the Court rejected the FCC pricing
guidelines and the "pick and choose" rule that would have allowed new
entrants to select the most favorable provisions of interconnection
arrangements. In October 1997, the Court issued an order that vacated the
portion of the FCC's interconnection rules that required incumbent LECs to
combine unbundled network elements for interconnectors. The Court of Appeals
decision has been appealed by the FCC to the U.S. Supreme Court. CBT cannot
determine the impact or timing of a decision by the U.S. Supreme Court.
In May 1997, the FCC adopted orders on access charge reform and a new
universal service program. The access charge reform order generally removed
from minute-of-use access rates, costs that are not incurred on a per
minute-of-use basis. The order also adopted changes to the interstate rate
structure for transport services which are designed to move the charges for
these services to more cost-based levels. Several parties have appealed with
the Court various issues regarding the FCC orders. Given the ongoing
regulatory and judicial developments in these areas, it is not yet possible
to determine the full impact of the Act and related FCC regulations on CBT
operations.
In July 1997, CBT's price cap tariff filing was approved by the FCC without
suspension. The election of price caps will better enable CBT to meet the
challenges faced in the new competitive environment. CBT and another company
have filed petitions for reconsideration with the FCC to revisit the
establishment of the 6.5 percent productivity offset. In addition, several
appeals have been filed with the U.S. Court of Appeals regarding the order
establishing the 6.5 percent productivity offset. At this time, the outcome
of the petition for reconsideration and the appeals cannot be determined.
OHIO - In February 1997, CBT filed an application with the Public Utilities
Commission of Ohio (PUCO) seeking approval of a new alternative regulation
plan called "Commitment 2000" to supersede an existing plan which expired in
May 1997. On March 19, 1998, CBT reached a settlement of this application
with the PUCO staff, the Office of Consumers Council and other intervenors in
CBT's Commitment 2000 application. The settlement was approved by the PUCO on
April 9, 1998.
Under terms of the settlement, CBT will: (i) not increase residential service
rates for local access services; (ii) set business rates based on market
conditions; (iii) reduce residential rates for qualified, low income
customers by approximately 30 percent; and (iv) include Touch-Tone as part of
all customers' basic telephone service.
Rates that business customers pay will decline by approximately $4 million
per year. The exact amount of the decrease will depend on the number of
additional features each business has activated, with rates decreasing an
average of 3.5 percent. Access charges, the amount paid by long distance
companies to use CBT's network, will also decrease by approximately $8
million per year. Approximately $4 million of the access charge annual
decrease was put in place in rates effective as of April 14, 1998 and the
remainder in rates that will become effective on January 1, 1999.
The settlement allows CBT to operate under an alternative form of regulation.
In particular, CBT is provided additional pricing flexibility and will no
longer be constrained by rate-of-return regulation. It includes service
quality requirements that will allow CBT to continue the plan up to an
additional two years.
KENTUCKY - It is expected that CBT will file a request with the Public
Service Commission of Kentucky (PSCK), similar to the Ohio settlement during
the second quarter of 1998.
The PSCK is currently conducting a management audit of CBT. This is a
requirement by the PSCK to periodically audit its largest regulated entities
under its jurisdiction.
15
Form 10-Q Part I Cincinnati Bell Inc.
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS OUTLOOK
COMMUNICATIONS SERVICES - Competition in the local exchange business is
increasing, due to legislative and regulatory initiatives, as well as new
technologies. CBT continues to develop new service offerings to offset
anticipated future competitive losses and is working to assure implementation
of rules that result in fair competition. Nevertheless, these initiatives and
developments could make it more difficult for CBT to maintain current revenue
and profit levels.
On February 2, 1998, the Company announced an agreement between CBT and AT&T
Corp. under which the companies provide service to each other. The revenues
from the new agreements will continue to represent less than 5% of the total
annual revenues of the Communications Services segment.
During the first quarter, CBT reached a settlement with the PUCO regarding
its Commitment 2000 plan. The settlement was approved by the PUCO in April
1998. The plan provides a flexible form of price regulation and opportunities
to grow value-added service revenue in an environment of stable basic service
prices and focus on its markets.
CBT is incurring significant expenses for regulator mandated interconnection
and local number portability, and Year 2000 programming. In 1998, total
mandated costs could be in a range of $15 to $20 million and Year 2000
programming costs are expected to be in the range of $10 to $15 million.
CBT will continue to develop new products and services in an effort to
broaden the services it can offer to its customers. CBT is focusing on its
ability to expedite complete delivery of solutions and offers to customers.
The threat of competitive losses in addition to high-cost regulator mandated
expenses will continue throughout the year.
CBLD, CBD, CBS and CBW face stiff competition in their markets especially
from larger companies. In order to assure success, they will continue to
offer and develop superior products, services and value. CBD now competes
with its former sales representative for Yellow Page Services. This new
competition may affect CBD's ability to grow revenues and profits.
INFORMATION SYSTEMS - CBIS provides quality service to its clients because of
its knowledge of the market, technology, resources and client needs. CBIS
continues to rely on significant clients for most of its revenue. CBIS's top
three clients, excluding CBT, accounted for 61% of its revenues in the first
quarter of 1998. CBIS maintains multi-year contracts with its clients, but
some contracts have early termination clauses. CBIS may renegotiate one or
more major contracts in 1998. This could involve exchanging lower prices for
longer contract terms and a broader relationship. Any reduction in prices
would negatively impact future results. Additionally, one CBIS client,
representing 11% of CBIS's 1997 revenues announced its intention to be
acquired by one of CBIS's competitors during the first quarter of 1998. The
contract, however, extends through 2006 and does not provide for an obvious
out without a CBIS breach.
A significant amount of CBIS's growth is directly related to increased
wireless subscribers in the domestic marketplace. That trend continued during
the first quarter of 1998. Certain international network management system
development efforts have been reduced as long-term contracts near competition.
CBIS's effort to program its systems and software for the Year 2000 continues
as the Company is reliant on information systems software and equipment. These
costs are expected to be in the range of $15 to $20 million in 1998 and
somewhat lower in 1999.
CBIS believes that its ability to maintain a leadership position in the
technological development of billing systems will be critical to its future.
16
Form 10-Q Part I Cincinnati Bell Inc.
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TELESERVICES - MATRIXX's strong market opportunity, service quality,
marketing skills and product offerings should continue to provide for future
growth. With the acquisitions of Maritz and Transtech during the first
quarter and combined with forecasted market growth in the teleservices
industry, this growth should continue. The teleservices business is very
competitive and MATRIXX experienced some softness in the market during the
second half of 1997. The softness affected the traditional teleservices
business, which through the acquisitions of Transtech and Maritz and internal
growth of MATRIXX's outsourced dedicated business, is becoming a smaller
portion of MATRIXX's business. While the traditional business recovery
continued in the first quarter of 1998, it remains below levels experienced
prior to the third quarter of 1997. In response to this softness, MATRIXX
initiated a restructuring plan and recorded a charge of $35 million in the
fourth quarter of 1997. Implementation of the plans is expected to be
completed by the end of 1998. When fully implemented, the plan is expected to
reduce costs by over $10 million from the levels that would have been
experienced had the planned restructuring activities not occurred.
MATRIXX's top three clients accounted for 43% of its 1998 revenues (including
acquisitions) up from 41% for the same period in 1997. Loss of any
significant contracts would have an adverse effect on its revenues and
profits. MATRIXX must continue to win new contracts and grow its business
with existing clients in a competitive market that has current capacity in
its call centers. The acquisition of Transtech will increase the portion of
MATRIXX's revenues from its top three clients, but the related eight-year
teleservices agreement with AT&T helps reduce the risk of loss for that
portion of the business, however, significant quarterly fluctuations may
still occur. The level of intensity and success of MATRIXX's clients in the
marketplace are also important drivers of MATRIXX's growth. MATRIXX's Year
2000 spending is expected to be $10 to $12 million in 1998 and somewhat lower
in 1999.
YEAR 2000 PROGRAMMING - The Company will incur a range of $35 to $50 million
in expenses in 1998 in order to ready its software and systems for the Year
2000. Year 2000 programming costs are expected to be lower in 1999. Some
major CBIS applications are expected to be Year 2000 compliant in 1998. If
the Company were to be unsuccessful in readying its software and systems for
the Year 2000, the effect that this would have on client relationships,
particularly in the Information Systems segment, would be a material adverse
impact on the Company. The failure of one of the Company's clients or
suppliers to successfully modify its systems for the Year 2000 could also
have an adverse impact on the Company.
BUSINESS DEVELOPMENT - The Company continues to review opportunities for
acquisitions and divestitures for all its businesses to enhance shareowner
value.
17
Form 10-Q Part II Cincinnati Bell Inc.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
The following is filed as an Exhibit to Part I of this Form 10-Q:
Exhibit
Number
-------
27 Financial Data Schedule
(b) Reports on Form 8-K.
(i) Form 8-K, date of report February 20, 1998, reporting that the
Company announced an agreement on February 2, 1998 on a multi-year
renewal of agreements between CBT and AT&T Corp. under which the
companies provide service to each other. The companies had earlier
agreed to continue operating under prior agreements during
negotiations. In addition, on February 3, 1998, the Company announced
that it and AT&T had agreed to form a joint venture to provide PCS in
the Cincinnati and Dayton, Ohio markets. The agreement provides that
CBW, a subsidiary of the Company, will acquire an 80% interest in a
new regional communications network from AT&T Wireless Services.
(ii) Form 8-K, date of report March 17, 1998, reporting that the
Company and AT&T Corp., on March 3, 1998, consummated their agreement
for MATRIXX, the teleservices subsidiary of the Company, to acquire
substantially all the assets of AT&T Solutions Customer Care,
formerly AT&T American Transtech for $625 million in cash.
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.
Cincinnati Bell Inc.
Date: May 14, 1998 /s/ Brian C. Henry
---------------- ------------------
Brian C. Henry
Executive Vice President and
Chief Financial Officer
19