SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 October 31, 1998, 136,417,592 Common Shares were outstanding.
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME,
COMPREHENSIVE INCOME AND RETAINED EARNINGS
(In Millions, Except Per Share Amounts)
(Unaudited)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- ----------------------
1998 1997 1998 1997
------- ------- -------- --------
Revenues............................................................... $ 578.4 $ 433.2 $1,653.7 $1,295.8
------- ------- -------- --------
Costs and Expenses
Cost of providing services and products sold........................ 324.1 228.3 926.0 692.2
Selling, general and administrative................................. 92.0 68.1 269.3 212.6
Depreciation and amortization....................................... 56.2 47.4 154.9 137.2
Year 2000 programming costs......................................... 9.7 4.8 28.4 6.9
Mandated telecommunications costs................................... .9 2.8 10.7 5.0
Purchased research and development costs............................ -- -- 42.6 --
Special credits........................................................ -- -- -- (21.0)
------- ------- -------- --------
Total Costs and Expenses.......................................... 482.9 351.4 1,431.9 1,032.9
------- ------- -------- --------
Operating Income....................................................... 95.5 81.8 221.8 262.9
Other Income (Expense), Net............................................ (2.7) 6.0 (1.9) 14.3
Interest Expense....................................................... 16.1 9.1 44.5 26.8
Minority Interest...................................................... 1.5 -- 1.5 --
------- ------- -------- --------
Income Before Income Taxes............................................. 75.2 78.7 173.9 250.4
Income Taxes........................................................... 26.8 26.9 60.2 87.2
------- ------- -------- --------
Net Income............................................................. $ 48.4 $ 51.8 $113.7 $ 163.2
------- ------- -------- --------
------- ------- -------- --------
Other Comprehensive Income, Net of Tax:
Foreign currency translation adjustments............................ $ (1.0) $ (.1) $ (2.7) $ (1.5)
Pension liability adjustment........................................ -- -- -- .8
Unrealized loss on investments...................................... (2.1) -- (2.1) --
------- ------- -------- --------
Total Other Comprehensive Income....................................... (3.1) (.1) (4.8) (.7)
------- ------- -------- --------
Comprehensive Income................................................... $ 45.3 $ 51.7 $ 108.9 $ 162.5
------- ------- -------- --------
------- ------- -------- --------
Earnings Per Common Share..............................................
Basic............................................................... $ .36 $ .38 $ .84 $ .21
------- ------- -------- --------
------- ------- -------- --------
Diluted............................................................. $ .35 $ .38 $ .82 $ 1.19
------- ------- -------- --------
------- ------- -------- --------
Dividends Declared Per Common Share.................................... $ .10 $ .10 $ .30 $ .30
------- ------- -------- --------
------- ------- -------- --------
Average Common Shares Outstanding Including Equivalents................
Basic............................................................... 136.0 135.3 135.9 135.2
Diluted............................................................. 138.1 137.7 138.3 137.7
Retained Earnings
Beginning of period................................................. $ 261.0 $ 373.5 $ 221.9 $ 288.5
Net income.......................................................... 48.4 51.8 113.7 163.2
Common dividends declared........................................... (13.6) (13.5) (41.0) (40.7)
Other............................................................... .6 (.4) 1.8 .4
------- ------- -------- --------
End of period....................................................... $ 296.4 $ 411.4 $ 296.4 $ 411.4
------- ------- -------- --------
------- ------- -------- --------
Accumulated Other Comprehensive Income:
Beginning of period................................................. $ (9.8) $ (7.9) $ (8.1) $ (7.3)
Foreign currency translation adjustments............................ (1.0) (.1) (2.7) (1.5)
Pension liability adjustment........................................ -- -- -- .8
Unrealized loss on investments...................................... (2.1) -- (2.1) --
------- ------- -------- --------
End of period.......................................................... $ (12.9) $ (8.0) $ (12.9) $ (8.0)
------- ------- -------- --------
------- ------- -------- --------
See Notes to Financial Statements.
2
CONDENSED CONSOLIDATED BALANCE SHEETS
(Millions of Dollars)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- --------
ASSETS
Current assets
Cash and cash equivalents........................................... $ 1.5 $ 9.9
Receivables, less allowances of $20.7 and $14.0..................... 461.3 350.8
Material and supplies............................................... 14.7 16.3
Deferred income taxes............................................... 25.2 24.6
Prepaid expenses and other current assets........................... 52.3 48.4
---------- ----------
Total current assets.............................................. 555.0 450.0
Property, plant and equipment - net.................................... 838.9 703.2
Goodwill and other intangibles - net................................... 698.2 195.0
Investments in unconsolidated entities................................. 90.1 77.6
Deferred charges and other assets...................................... 110.2 72.9
---------- ----------
Total Assets...................................................... $ 2,292.4 $ 1,498.7
---------- ----------
---------- ----------
LIABILITIES AND SHAREOWNERS' EQUITY
Current liabilities
Debt maturing in one year........................................... $ 619.3 $ 190.6
Accounts payable and accrued liabilities............................ 275.8 208.4
Accrued taxes....................................................... 55.3 51.5
Advance billing and customers' deposits............................. 36.1 35.0
Other current liabilities........................................... 45.2 49.4
---------- ----------
Total current liabilities......................................... 1,031.7 534.9
Long-term debt......................................................... 267.8 269.2
Deferred income taxes.................................................. 26.8 12.7
Other long-term liabilities............................................ 111.1 102.2
---------- ----------
Total liabilities................................................. 1,437.4 919.0
---------- ----------
Minority interest...................................................... 207.8 --
Shareowners' equity
Common shares-$1 par value; 480,000,000 shares authorized;
136,401,037 and 136,066,965 issued and outstanding.............. 136.4 136.1
Additional paid-in capital.......................................... 227.3 229.8
Retained earnings................................................... 296.4 221.9
Accumulated other comprehensive income.............................. (12.9) (8.1)
---------- ----------
Total shareowners' equity......................................... 647.2 579.7
---------- ----------
Total Liabilities and Shareowners' Equity.............................. $ 2,292.4 $ 1,498.7
---------- ----------
---------- ----------
See Notes to Financial Statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Millions of Dollars)
(Unaudited)
NINE MONTHS
ENDED SEPTEMBER 30,
-------------------
1998 1997
------- ------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................................................................... $113.7 $163.2
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization............................................................. 154.9 137.2
Special credits........................................................................... -- (21.0)
Acquired research and development costs................................................... 42.6 --
Provision for loss on receivables......................................................... 11.8 9.7
Other, net................................................................................ (15.3) (11.6)
Changes in assets and liabilities, net of effects from acquisitions and
disposals:
Increase in receivables................................................................... (65.3) (34.8)
Increase in other current assets......................................................... (1.1) (5.0)
Increase in accounts payable and accrued liabilities...................................... 40.9 6.6
Increase (decrease) in other current liabilities.......................................... (23.7) .7
Increase (decrease) in deferred income taxes and unamortized
investment tax credits ................................................................. 14.1 (3.6)
Increase in other assets and liabilities - net............................................ (38.0) (31.7)
------- -------
Net cash provided by operating activities................................................. 234.6 209.7
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures - telephone plant........................................................ (105.4) (114.1)
Capital expenditures - other.................................................................. (78.1) (62.6)
Acquisitions, net of cash acquired............................................................ (658.3) --
Other, net.................................................................................... .5 5.9
------- ------
Net cash used in investing activities....................................................... (841.3) (170.8)
------- ------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in short-term debt............................................................... 434.1 5.4
Repayment of long-term debt................................................................... (6.0) (8.9)
Issuance of common shares..................................................................... 4.9 9.0
Issuance of Convergys common shares .......................................................... 206.3 --
Dividends paid................................................................................ (41.0) (40.7)
------- ------
Net cash provided by (used in) financing activities......................................... 598.3 (35.2)
------ -------
Net increase (decrease) in cash and cash equivalents............................................. (8.4) 3.7
Cash and cash equivalents at beginning of period................................................. 9.9 2.0
------ ------
Cash and cash equivalents at end of period....................................................... $ 1.5 $ 5.7
------ ------
------ ------
Cash paid for:
Interest (net of amount capitalized).......................................................... $ 43.6 $ 22.9
Income taxes.................................................................................. $ 71.3 $ 70.6
See Notes to Financial Statements.
4
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
Communications Services segment, consisting of Cincinnati Bell
Telephone Company (CBT), Cincinnati Bell Directory Inc. (CBD),
Cincinnati Bell Long Distance Inc. (CBLD), Cincinnati Bell Supply
Company (CBS) and Cincinnati Bell Wireless Company (CBW), provides
local telephone exchange services and products in Greater Cincinnati,
and long distance services, yellow pages and directory services,
telecommunications equipment and advanced digital personal
communications services (PCS) and products. The Information Management
segment, which consists of the Convergys Information Management Group
Inc., formerly known as Cincinnati Bell Information Systems Inc.
(CBIS), provides and manages customer care and billing solutions for
the communications and cable TV industries. The Customer Management
segment, which consists of the Convergys Customer Management Group
Inc., formerly known as MATRIXX Marketing Inc. (MATRIXX), provides a
full range of customer management solutions to large corporations.
Certain prior year amounts have been reclassified to conform to the
current classifications with no effect on financial results.
The consolidated financial statements of the Company 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 and the
current year's previously issued Quarterly Reports on Form 10-Q.
(2) FORMATION OF CONVERGYS CORPORATION - On April 27, 1998, the Company
announced the formation of a new subsidiary, Convergys Corporation
(Convergys), which holds the Company's billing and customer management
businesses, and which the Company intends, subject to certain
conditions, to spin-off by December 31, 1998 (the Convergys
Distribution).
In July 1998, the Company contributed the common shares of CBIS and
MATRIXX, as well as its 45% interest in a cellular partnership with
Ameritech to Convergys. Additionally, in July 1998 the Company received
a tax ruling from the Internal Revenue Service (IRS) indicating that
the planned distribution of Convergys shares will qualify as a tax-free
distribution for federal income tax purposes under Section 355 of the
Internal Revenue Code. Company shares owned as of the record date of
the distribution will entitle holders to receive Convergys common
shares on a one-to-one basis.
On August 12, 1998, Convergys issued 14,950,000 common shares or
approximately 10% of its outstanding shares to the public. The offering
price was $15 less underwriting discounts and commissions of $.98 per
share. The net proceeds from the offering, approximately $206 million,
were used by the Company to repay a portion of its short-term variable
rate debt. The sale of the Convergys common shares to the public
resulted in the Company recording a minority interest equal to the sum
of the net proceeds and a proportionate amount of Convergys' net income
for the period subsequent to the offering.
(3) ACQUISITIONS - During the first quarter of 1998, MATRIXX acquired
American Transtech, Inc. and the assets of AT&T's Canadian customer
care business (the Transtech Acquisition) from AT&T for approximately
$625 million in cash. The acquisition was accounted for under the
purchase method of accounting. It was financed through short-term
commercial paper borrowings.
5
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
In the first quarter of 1998, the Company recorded a charge of $42.6
million to expense purchased research and development costs associated
with the acquisition. The amount expensed relates 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.
Approximately $68 million of the purchase price was allocated to an
eight-year contract under which MATRIXX provides customer management
solutions services to AT&T, approximately $11 million to the assembled
workforce which is being amortized over a fifteen-year useful life,
approximately $4 million to capitalized software that is being
amortized over a three-year useful life and approximately $91 million
to the acquired tangible net assets. The fair values of the acquired
assets were based on an independent valuation. The excess of the
purchase price over the fair value of the net assets acquired,
approximately $415 million, was recorded as goodwill, which is being
amortized on a straight-line basis over a thirty-year life.
MATRIXX is currently evaluating certain acquired contingent liabilities
and its integration plan for Transtech and will incur integration
liabilities, including severance pay and lease termination costs. Such
liabilities will result in the recording of additional goodwill.
Through September 30, 1998, MATRIXX has accrued and paid nearly $6
million in severance, primarily for management employees, related to
the integration plan for Transtech. The integration plan has not been
finalized, but is awaiting determination of the facilities portion of
the plan, which could result in additional severance and lease
termination costs. Any subsequent adjustments of estimated integration
costs and acquired contingent liabilities will be reflected as
adjustments to goodwill.
The following unaudited pro forma data summarizes the combined results
of the operations of the Company and Transtech as though the
acquisition had occurred as of the beginning of each period:
NINE MONTHS
ENDED SEPTEMBER 30,
MILLIONS OF DOLLARS 1998 1997
------------------- ---------- ------
Revenues......................................... $1,716.1 $1,595.8
Net income....................................... $ 108.3 $ 152.6
Earnings per share:
Basic........................................ $ .80 $ 1.13
Diluted...................................... $ .78 $ 1.11
On January 8, 1998, MATRIXX acquired the teleservices assets of Maritz,
Inc. for approximately $30 million in cash. 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 and the resulting goodwill is being amortized over a
twenty-five year life. The acquisition of Maritz did not have a
material effect on the Company's results of operations during the first
nine months 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 restructuring reserve balance was
$24.9 million. During the first nine months of 1998, MATRIXX recorded
cash expenditures of $4.1 million primarily for severance pay and
recorded non-cash asset writedowns of $4.6 million. The restructuring
reserve has a balance of $16.2 million at September 30, 1998.
Management expects the restructuring plan activities to be
substantially complete by December 31, 1998 and that the remaining
balance in the reserve will be adequate to complete the plan.
6
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
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 nine months ended September 30, 1997, the Company
recorded non-cash settlement gains of $21.0 million resulting from
lump-sum pension distributions to employees retiring under the offer.
For the first nine months of 1998, there were cash expenditures of $.5
million for severance pay. Management believes that the remaining
reserve balance of $3.9 million at September 30, 1998 (primarily for
obligations under terminated leases) is adequate to complete the
restructuring plan.
(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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- ---------------------
MILLIONS OF DOLLARS 1998 1997 1998 1997
------------------- -------- ------- -------- ------
Revenues........................................... $179.5 $168.3 $532.9 $495.0
Costs and expenses................................. 142.4 135.8 430.4 382.7
------ ------ ------ ------
Operating income................................... $ 37.1 $ 32.5 $102.5 $112.3
Net income......................................... $ 20.8 $ 17.9 $ 57.7 $ 64.9
------ ------ ------ ------
------ ------ ------ ------
CBT incurred mandated telecommunications and Year 2000 programming
costs of $3.5 million for the third quarter in 1998 compared with $4.3
million for the third quarter in 1997, and $18.5 million for the nine
months ended September 30, 1998 compared with $6.5 million for the nine
months ended September 30, 1997. These costs reduced CBT's net income
by $2.3 million for the third quarter in 1998 compared to $2.8 million
in 1997 and $12.0 million for the nine months ended September 30, 1998
compared to $4.2 million for the nine months ended September 30, 1997.
Results for the nine months ended September 30, 1997 include $21.0
million of pension settlement gains that increased net income by $13.4
million.
SEPTEMBER 30, DECEMBER 31,
MILLIONS OF DOLLARS 1998 1997
------------------- ---------- ----------
Current assets.................................. $ 147.4 $ 142.5
Telephone plant - net........................... 578.0 550.6
Other noncurrent assets......................... 13.8 13.3
-------- --------
Total assets.................................... $ 739.2 $ 706.4
-------- --------
-------- --------
Current liabilities............................. $ 239.3 $ 214.0
Noncurrent liabilities.......................... 34.8 33.8
Long-term debt.................................. 217.8 218.4
Shareowner's equity............................. 247.3 240.2
-------- --------
Total liabilities and shareowner's equity....... $ 739.2 $ 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, information systems and billing services and customer
management solutions. Revenues from AT&T were 27% and 23% of the
Company's consolidated revenues for the nine months ended September 30,
1998 and 1997, respectively.
7
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(7) CONTINGENCIES - The Company is from time to time subject to routine
complaints incidental to the business. The Company believes that the
results of any complaints and proceedings will not have a materially
adverse effect on the Company's financial condition.
(8) EARNINGS PER SHARE - In 1997, the Company adopted Statement of
Financial Standards (SFAS) 128, "Earnings Per Share." SFAS 128 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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- ---------------------
IN MILLIONS, EXCEPT PER SHARE AMOUNTS 1998 1997 1998 1997
------------------------------------- -------- ------- -------- ------
Basic EPS
Net Income......................................... $ 48.4 $ 51.8 $ 113.7 $ 163.2
Average common shares outstanding ................. 136.0 135.3 135.9 135.2
Basic earnings per share........................... $ .36 $ .38 $ .84 $ 1.21
-------- -------- -------- -------
-------- -------- -------- -------
Diluted EPS
Net Income......................................... $ 48.4 $ 51.8 $113.7 $ 163.2
Effect of dilutive securities:
Average common shares outstanding............. 136.0 135.3 135.9 135.2
Stock options................................. 1.5 1.8 1.8 1.9
Stock-based compensation arrangements........ .6 .6 .6 .6
-------- -------- -------- -------
Total.............................................. 138.1 137.7 138.3 137.7
Diluted earnings per share......................... $ .35 $ .38 $ .82 $ 1.19
-------- -------- -------- -------
-------- -------- -------- -------
8
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(9) BUSINESS SEGMENT INFORMATION - The Company operates primarily in three
industry segments, Communications Services, Information Management, and
Customer Management. 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 NINE MONTHS
MILLIONS OF DOLLARS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- ------------------------ -----------------------
1998 1997 1998 1997
--------- -------- -------- --------
REVENUES
Communications services..................... $ 222.6 $ 211.0 $ 658.6 $ 618.0
Information management...................... 147.9 137.2 437.9 401.7
Customer management......................... 231.4 103.0 620.4 329.4
Intersegment................................ (23.5) (18.0) (63.2) (53.3)
-------- -------- -------- --------
$ 578.4 $ 433.2 $1,653.7 $1,295.8
-------- -------- -------- --------
-------- -------- -------- --------
INTERSEGMENT REVENUES
Communications services..................... $ 2.5 $ 4.0 $ 7.9 $ 12.1
Information management...................... 18.0 11.6 46.9 35.6
Customer management......................... 3.0 2.4 8.4 5.6
-------- -------- -------- --------
$ 23.5 $ 18.0 $ 63.2 $ 53.3
-------- -------- -------- --------
-------- -------- -------- --------
SPECIAL ITEMS (see MD&A)
Communications services..................... $ -- $ -- $ -- $ (21.0)
Information management...................... -- -- -- --
Customer management......................... -- -- 42.6 --
-------- -------- -------- --------
$ -- $ -- $ 42.6 $ (21.0)
-------- -------- -------- --------
-------- -------- -------- --------
OPERATING INCOME
Communications services..................... $ 50.5 $ 45.8 $ 141.0 $ 152.5
Information management...................... 28.9 28.2 83.5 76.4
Customer management......................... 17.1 6.2 2.9 33.4
Corporate and eliminations.................. (1.0) 1.6 (5.6) .6
-------- -------- -------- --------
$ 95.5 $ 81.8 $ 221.8 $ 262.9
-------- -------- -------- --------
-------- -------- -------- --------
ASSETS
Communications services..................... $ 844.2 $1,105.4
Information management...................... 280.5 264.0
Customer management......................... 988.5 300.3
Corporate and eliminations.................. 179.2 82.4
-------- --------
$2,292.4 $1,752.1
CAPITAL ADDITIONS (including acquisitions)
Communications services..................... $ 30.8 $ 37.6 $ 115.7 $ 126.8
Information management...................... 9.5 5.9 31.1 15.8
Customer management......................... 15.3 7.5 697.0 24.5
Corporate................................... 2.0 .3 2.5 5.4
-------- -------- -------- --------
$ 57.6 $ 51.3 $ 846.3 $ 172.5
-------- -------- -------- --------
-------- -------- -------- --------
DEPRECIATION AND AMORTIZATION
Communications services..................... $ 28.1 $ 31.4 $ 81.6 $ 92.6
Information management...................... 7.7 9.1 21.8 24.8
Customer management......................... 20.1 6.8 50.7 19.5
Corporate................................... .3 .1 .8 .3
-------- -------- -------- --------
$ 56.2 $ 47.4 $ 154.9 $ 137.2
-------- -------- -------- --------
-------- -------- -------- --------
9
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 Company's
Registration Statement on Form S-3 filed October 13, 1998, the Company's 1997
Annual Report on Form 10-K, the current year's previously issued Quarterly
Reports on Form 10-Q and the Convergys Corporation's Registration Statement on
Form S-1, as amended, filed initially on May 26, 1998. Readers are cautioned not
to place undue reliance on those 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 $578.4 million and $1,653.7 million for the third quarter and nine
months of 1998, up 34% and 28%, respectively, from $433.2 million and $1,295.8
million for the same periods of 1997. The acquisitions of the teleservices
operations of Maritz, Inc. (Maritz) and of AT&T Solutions Customer Care
(Transtech) by MATRIXX in the first quarter of 1998 produced approximately $111
million and $261 million of the revenue increase for the third quarter and nine
months, respectively.
Costs and expenses excluding special items were $482.9 million and $1,431.9
million for the third quarter and nine months of 1998, up 37% and 39% from
$351.4 million and $1,032.9 million for the same periods in 1997. MATRIXX's
first quarter 1998 acquisitions contributed $104 million and $250 million of the
increase during the third quarter and nine months, respectively. Special items
affected costs and expenses for both years. For 1998, $42.6 million of purchased
research and development costs were recorded during the first quarter by MATRIXX
as a result of its acquisition of Transtech. Pension settlement gains from a
1995 restructuring at CBT and CBI were $21.0 million for the nine months ended
September 30, 1997.
Operating income was $95.5 million, and $221.8 million for the third quarter and
nine months of 1998, up 17% from $81.8 million and down 16% from $262.9 million,
respectively for the same periods in 1997. Excluding special items, the
increases were 17% and 9% for the three and nine month periods, respectively.
MATRIXX's acquisitions contributed $7 million and $11 million of the increases
in operating income.
The Company's commitment to fund start-up operating losses associated with its
pending 80% investment in a venture with AT&T Wireless PCS, Inc. (AT&T PCS) to
provide personal communications services (PCS) in the Greater Cincinnati and
Dayton markets, resulted in the equity method recording of losses totaling $7.5
million and $16.3 million for the third quarter and nine month periods in 1998.
The Company believes that the transaction will close sometime in the fourth
quarter or early 1999. Subsequent to the closing of this transaction, the
venture's operating results will be reflected in the Company's reporting on a
consolidated basis, with AT&T PCS's 20% ownership interest reflected as a
minority interest. Income from the Company's cellular partnership investment did
not increase for the third quarter of 1998 compared to the third quarter 1997
but was higher by $4.3 million for the nine months of 1998 compared to nine
months of 1997. Borrowings to finance the Company's two 1998 acquisitions
increased interest expense by $8 million and $21 million for the three and nine
month periods, respectively.
Reported net income for the third quarter of 1998 was $48.4 million or $.35 per
common share and for the first nine months of 1998 was $113.7 million or $.82
per common share. In 1997, net income was $51.8 million or $.38 per common share
for the third quarter and $163.2 million or $1.19 per common share for the first
nine months. Excluding special items, net income for the third quarter of 1998
was $48.4 million or $.35 per common share and for the first nine months of 1998
was $140.1 million or $1.01 per common share. Excluding special items, net
income for the third quarter of 1997 was $51.8 million or $.38 per common share
and for the first nine months of 1997 was $149.8 million or $1.09 per common
share.
10
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In 1998, the Company incurred significant Year 2000 programming costs and
regulator mandated telecommunications costs. Each of the Company's segments
incurred costs to ready its systems and software for the Year 2000. These costs
totaled $9.7 million and $28.4 million for the three and nine months ended
September 30, 1998, compared with $4.8 million and $6.9 million for the three
and nine months ended September 30, 1997, CBT also incurred 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 $.9 million and $10.7 million
for the three and nine months ended September 30, 1998, compared with $2.8
million and $5.0 million for the same two periods in 1997.
COMMUNICATIONS SERVICES
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------- -------------------------------------
($ MILLIONS) 1998 1997 CHANGE % 1998 1997 CHANGE %
-------- -------- ----------- -------- -------- -----------
Revenues
Local service............. $ 102.3 $ 96.6 $ 5.7 6 $303.8 $287.3 $ 16.5 6
Network access............ 44.5 42.7 1.8 4 134.8 126.4 8.4 7
Other services............ 75.8 71.7 4.1 6 220.0 204.3 15.7 8
------- ------- ------ ------ ------ ------
Total 222.6 211.0 11.6 5 658.6 618.0 40.6 7
Operating expenses........... 168.6 160.9 7.7 5 499.1 480.0 19.1 4
Year 2000 programming
costs..................... 2.6 1.5 1.1 73 7.8 1.5 6.3 --
Mandated telecommunications
costs..................... .9 2.8 (1.9) (68) 10.7 5.0 5.7 --
Special items:
Pension settlement
gains................... -- -- -- -- -- (21.0) 21.0 --
------- ------- ------ ------ ------ ------
Total 172.1 165.2 6.9 4 517.6 465.5 52.1 11
Operating income............. $ 50.5 $ 45.8 $ 4.7 10 $141.0 $152.5 $(11.5) (8)
Access lines (In thousands) 1,032 994 38 4
Minutes of use (In millions) 1,078 1,013 65 6 3,177 2,998 179 6
The Company's communications services businesses continued to perform strongly
in the third quarter of 1998. Increased marketing activities fueled revenue
growth of 5% and 7% for the third quarter and nine months, respectively. Costs
for Year 2000 programming were $1.1 million and $6.3 million higher for the
third quarter and nine months of 1998 compared with the same periods last year.
Mandated telecommunications costs were $1.9 million lower in the third quarter
of 1998 compared to the third quarter of 1997 as a result of completing the
implementation of local number portability earlier this year. These costs were
$5.7 million higher for the first nine months of 1998 compared to 1997.
Local service revenues increased $5.7 million and $16.5 million for the third
quarter and nine months, respectively. Access lines grew approximately 4% during
the past twelve months as a result of a strong economy. The introduction of pay
per usage programs for custom calling features also contributed to the revenue
growth. Somewhat offsetting the revenue increases was a rate reduction for
business services resulting from the agreement reached with the Public Utilities
Commission of Ohio (PUCO) on CBT's alternative regulation plan, which became
effective in April 1998.
Network access revenues increased $1.8 million for the three months and $8.4
million for the nine months principally in end user and special access services.
The increase resulted from growth in access lines, customer demand for special
access services and growth in access minutes of use. Access revenues were
11
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
also affected by FCC changes in access charges which include the
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 as a result
of FCC changes partially offset the growth in access minutes of use and
caused a decrease in switched access revenues. The increase in access
revenues for the nine months also reflects the effect of potential
overearnings liabilities that were recorded in the first quarter of 1997.
Other communications services revenues increased $4.1 million and $15.7 million
for the third quarter and nine months, respectively, primarily as a result of
higher revenues at CBT from the deregulation of public telephone services, new
data services business, wire maintenance services, internet access, and higher
billable minutes at CBLD. The increases were partially offset by reduced
intrastate message revenue at CBT from customers transitioning to extended-area
local service and softness in equipment sales at CBS.
Operating expenses increased $7.7 million for the third quarter and $19.1
million for the nine months. The increases were principally at CBT and CBLD. The
factors that caused the increases at CBT were expenses for personnel costs,
contract labor and consulting fees, materials and costs for wiring and data
services, and charges for universal service funding as mandated by regulatory
requirements. Partially offsetting the CBT increases was a decrease in
depreciation expense 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. At CBLD, the increases were caused by higher selling, general
and administrative expenses.
CBT recorded $21.0 million in pension settlement gains during the nine months
ended September 30, 1997 as special items. There were no special items through
the first nine months of 1998.
INFORMATION MANAGEMENT (CBIS)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------- -------------------------------------
($ Millions) 1998 1997 Change % 1998 1997 CHANGE %
------- ------- ------- -- ------- ------ ------ --
Revenues ..................... $ 147.9 $ 137.2 $ 10.7 8 $ 437.9 $401.7 $ 36.2 9
Operating expenses............ 114.0 106.0 8.0 8 339.7 320.2 19.5 6
Year 2000 programming
costs ..................... 5.0 3.0 2.0 67 14.7 5.1 9.6 --
------- ------- ------- ------- ------ ------
Total 119.0 109.0 10.0 9 354.4 325.3 29.1 9
Operating income.............. $ 28.9 $ 28.2 $ .7 3 $ 83.5 $ 76.4 $ 7.1 9
Revenues increased $10.7 million for the three months and $36.2 million for the
nine months. Billing and related information processing revenues increased $10.4
million for the three months and $37.8 million for the nine months primarily as
a result of growth in wireless billing services and because of increased
intercompany revenues from MATRIXX resulting from CBIS providing processing
services supporting MATRIXX's Transtech operations beginning in June 1998.
Wireless billing clients' subscriber levels increased 26% for both the three and
nine month periods. The increase in billing and related information processing
revenues was partially offset by a decline in the number of subscribers for whom
CBIS bills the long distance portion of wireless calls. This decline has
resulted from a client's loss of wireless long distance market share to
competitors. Additionally, the increase in information processing revenues was
partially offset by rate reductions triggered by certain clients' higher
subscriber levels. Professional and consulting service revenues increased $2.4
million and $7.0 million for the three and nine month periods. This increase was
primarily attributable to growth in such services for cellular and personal
communication services (PCS) clients, which was partially offset by reduced
enhancement requests from certain other wireless clients. License and other
revenues were comparable for both periods. International revenues decreased $2.6
million and $8.8 million for the three and nine month periods reflecting the
winding down of two long-term international contracts.
12
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Operating expenses increased $8.0 million and $19.5 million for the third
quarter and nine months of 1998, respectively. The increase was principally the
result of increased direct costs associated with higher revenues, the direct
costs of performing processing for MATRIXX's Transtech operations, additional
labor costs, data center upgrade costs and higher bill finishing costs. Labor
cost increases included the effect of higher wage rates, particularly for
software professionals.
Costs to reprogram systems and software for the Year 2000 increased
significantly in 1998. The increases were $2.0 million and $9.6 million for the
three and nine months of 1998 compared to the same periods of last year.
CUSTOMER MANAGEMENT (MATRIXX)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------- -----------------------------------------
($ Millions) 1998 1997 CHANGE % 1998 1997 CHANGE %
-------- ------- --------- --- ------- -------- --------- ---
Revenues ..................... $ 231.4 $ 103.0 $128.4 125 $ 620.4 $ 329.4 $ 291.0 88
Operating expenses............ 212.1 96.5 115.6 120 568.9 295.7 273.2 92
Year 2000 programming
costs...................... 2.2 .3 1.9 -- 6.0 .3 5.7 --
Special items:
Purchased research
and development costs.... -- -- -- -- 42.6 -- 42.6 --
-------- ------- ------ --- ------- --------
Total 214.3 96.8 117.5 121 617.5 296.0 321.5 109
Operating income.............. $ 17.1 $ 6.2 $ 10.9 176 $ 2.9 $ 33.4 $ (30.5) (91)
Revenues and costs and expenses increased significantly during the third quarter
and nine months of 1998, principally as a result of the Maritz and Transtech
acquisitions made in the first quarter 1998. Excluding the impact of these
acquisitions and a special item from the first quarter, operating income
increased approximately $4 million for the three-month period and approximately
$1 million for the nine-month period.
Revenues increased $128.4 million for the third quarter of 1998 and $291.0
million for the first nine months of 1998. The acquisitions accounted for
approximately $111 million and $261 million of the increases, respectively.
Without the acquisitions, revenues increased 17% in the third quarter of 1998
and 9% in the first nine months of 1998.
Dedicated services revenues (which are typically longer-term relationships where
MATRIXX provides value-added customer service, technical support and sales
account management by a dedicated service team) increased by approximately $115
million and $279 million including the acquisitions. Excluding acquisitions,
dedicated services revenues increased approximately $4 million for the third
quarter and approximately $18 million for the nine months. Traditional
campaign-based teleservices revenues reflected a strong recovery in the third
quarter of 1998 for this portion of the business as these revenues grew by 33%
in the third quarter and 7% for the nine-month period. Excluding acquisitions,
international revenues increased $1.9 million and $3.1 million for the three and
nine months of 1998 compared to the same periods last year.
Operating expenses increased $117.5 million for the third quarter of 1998 and
$321.5 million for the nine months ended September 30, 1998, of which
approximately $104 million and $250 million, respectively, was related to the
acquisitions. The majority of the remaining increases included higher direct
costs associated with higher revenue, personnel costs and research and
development costs for system development projects in the traditional
teleservices business. Costs to modify systems for Year 2000 compliance
increased $1.9 million and $5.7 million for the third quarter and nine months of
1998 compared to the third quarter and nine months of 1997.
13
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MATRIXX's results for both the third quarter and first nine months of 1998 were
adversely impacted by lower than anticipated revenues from AT&T under the
contract associated with the Transtech. Revenues from AT&T under that contract
totaled approximately $65 million in the third quarter of 1998, which is below
the level necessary to achieve the $300 million annual amount required in each
of the first three years of the contract.
In connection with the Transtech acquisition, MATRIXX expensed $42.6 million of
purchased research and development costs in the first quarter of 1998. The
amount expensed was determined through an independent valuation that MATRIXX
used to allocate the Transtech purchase price to the acquired assets. The $42.6
million relates to two development projects at Transtech that had not reached
technological feasibility at the time of the acquisition and had no alternative
future use. MATRIXX intends to continue both of these development projects. One
of these projects was the development of proprietary technology for Transtech's
employee-care business offering. The other project involved the development of
technology to provide billing detail to clients' customers that would allow
those customers to manipulate and analyze the billing information. MATRIXX
expects the employee-care proprietary technology project to be completed later
in 1998. Management believes this project will be successfully completed. The
billing technology project has been delayed based upon management's view of
recent changes in the demand for the technology in MATRIXX's market.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------- ----------------------------------------
($ MILLIONS) 1998 1997 CHANGE % 1998 1997 CHANGE %
------- ------- ------- --- ------- ------- ------ ---
Other income/
(expense), net............. $ (2.7) $ 6.0 $ (8.7) -- $ (1.9) $ 14.3 $(16.2) --
Interest expense.............. $ 16.1 $ 9.1 $ 7.0 77 $ 44.5 $ 26.8 $ 17.7 66
Minority interest............. $ 1.5 $ -- $ 1.5 -- $ 1.5 $ -- $ 1.5 --
Income taxes.................. $ 26.8 $ 26.9 $ (.1) -- $ 60.2 $ 87.2 $(27.0) (31)
Start-up operating costs of $7.5 million and $16.3 million for the wireless
venture in the three month and nine month periods, respectively, caused
decreases in other income (expense), net. For the nine month period, income from
the Company's cellular partnership investment increased but was partially offset
by a decrease in interest income associated with 1997 federal income tax refunds
from the settlement of IRS audits for tax years 1989-94.
Interest expense increased principally as a result of acquisitions made in the
first quarter 1998 that have been financed with short-term debt. The weighted
average interest rate for debt was 6.1% for the nine months ended September 30,
1998 compared to 7.2% for the same period last year. For the nine months ended
September 30, 1998 and 1997, average debt outstanding was $973 million and $500
million, respectively.
The sale of approximately 10% of Convergys' common shares to the public in
August 1998 resulted in the recording of a minority interest, net of tax, equal
to approximately 10% of Convergys' net income for the period subsequent to the
offering.
Excluding special items, the effective tax rate was 35.3% for nine months ending
September 30, 1998 and 34.7% for nine months ended September 30, 1997. The nine
months 1997 effective tax rate included the benefit of a research and
experimentation tax credit from a federal tax law passed in the third quarter of
1997.
14
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
CAPITAL INVESTMENT, RESOURCES AND LIQUIDITY
The acquisitions of Transtech and Maritz for MATRIXX by the Company during the
first quarter of 1998 were financed by the issuance of short-term debt, largely
commercial paper. During the third quarter Convergys sold approximately 10% of
its outstanding stock in an initial public offering. The proceeds from the
Convergys offering of approximately $206 million were used to repay a portion of
the Company's outstanding short-term debt. The Company's pending investment in a
venture with AT&T PCS to provide PCS services in Cincinnati and Dayton, expected
to close later in 1998 or early 1999, will likely require financing up to $170
million. On October 30, 1998, the Company called for redemption $50 million of
its 7 3/8% Debentures due August 1, 2011, which will be redeemed on November 30,
1998. The Company and CBT filed a shelf registration statement with the
Securities and Exchange Commission (SEC) on October 13, 1998, covering the
issuance of up to $350 million in debt. The Company and CBT intend to use the
net proceeds from the offerings pursuant to this shelf registration statement to
repay existing debt and for general corporate purposes.
Cash provided by operating activities was $234.6 million for the first nine
months of 1998 compared to $209.7 million for the first nine months of 1997. The
Company's most significant investing activity was cash paid for the MATRIXX
acquisitions. Maritz was acquired in January for $30 million in cash and
Transtech in March for $625 million in cash. Excluding acquisitions, capital
expenditures were comparable for the nine months of 1998 compared to the nine
months of 1997.
BALANCE SHEET
The increases to receivables, property, plant and equipment, goodwill and other
intangibles, debt maturing in one year, accounts payable and accrued liabilities
and deferred income taxes were principally caused by the MATRIXX acquisitions
during the first quarter of 1998.
CAPITALIZATION
On November 10, 1998, Moody's Investors Service (Moody's) raised the long-term
senior unsecured debt ratings of the Company to "A3" from "Baa1" and confirmed
its "Prime-2" rating for short-term borrowings. Moody's also confirmed the
senior unsecured long-term debt ratings of CBT at "A2".
In October 1998, both Duff & Phelps Credit Rating Company (DCR) and Standard and
Poor's (S&P) raised or reaffirmed its long-term and short-term ratings on the
Company and CBT. DCR has upgraded the Company's notes to "A" and its commercial
paper to "D-1" from "A-" and "D-1-", respectively. In addition, DCR reaffirmed
the rating of CBT's debentures at "AA-". S&P has upgraded the Company's
senior unsecured debt and corporate credit rating to "A" and its commercial
paper rating to "A-1" from "A-" and "A-2", respectively. CBT's senior
unsecured debt has been upgraded to "AA-" from "A+".
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 local exchange carriers (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 . Oral arguments before the U.S. Supreme Court
took place on October 13, 1998. CBT cannot determine the impact or timing of a
decision by the U.S. Supreme Court regarding this matter.
In May 1997, the FCC adopted an order in the access charge reform proceeding.
The 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
15
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
for these services to more cost-based levels. CBT and numerous other LECs
filed appeals in the U.S. Court of Appeals for the Eighth District
challenging various aspects of the FCC's May 1997 order. On August 19, 1998,
the Court issued a decision upholding the FCC's order. Since CBT is complying
with the FCC's order, the Court's decision is not expected to have a material
impact on CBT's operations.
Also in May 1997, the FCC adopted an order on the new universal service program.
Several parties, including CBT, filed petitions for review of the order in
various circuits of the U.S. Court of Appeals. Through a lottery process, the
Fifth Circuit in New Orleans was selected to hear these appeals. CBT was granted
permission to file a separate brief concentrating on the issue of whether
intrastate revenues can be assessed by the FCC for a federal universal service
program. All briefs and reply briefs have been filed and the Court has scheduled
the case for oral argument on December 1, 1998. Given the ongoing judicial
developments in this case, the Company cannot determine the full impact that its
ultimate resolution may have on CBT's 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% productivity offset. In addition, several appeals have
been filed with the U.S. Court of Appeals regarding the order establishing the
6.5% productivity offset. At this time, the outcome of the petition for
reconsideration and the appeals cannot be determined.
A separate pending FCC proceeding that could impact CBT is the FCC's
consideration of whether Internet communications should be classified as local
or interstate traffic for reciprocal compensation purposes. Reciprocal
compensation is billed to CBT by Competitive Local Exchange Carriers (CLECs) for
the termination of certain local exchange traffic. Much of this traffic involves
calls to Internet service providers which obtain their local service from a
CLEC. Incumbent LECs, like CBT, believe these calls are interstate traffic,
which is regulated by the FCC and are not subject to reciprocal compensation. At
this time, the Company cannot determine the full impact that the ultimate
outcome of the proceeding will have on CBT's operations.
On May 5, 1998, the FCC entered an order to allow telecommunications carriers to
recover over a five-year period their carrier-specific costs of implementing
long-term number portability. Long-term number portability allows customers to
retain their local telephone numbers in the event they change local exchange
carriers. CBT implemented long-term number portability in May 1998. The FCC
Order permits such cost recovery through query charges to carriers who access
our local number portability database and through an end-user surcharge.
Application of the surcharges can begin no earlier than February 1, 1999.
OHIO - On March 19, 1998, CBT, the PUCO, the Office of Consumers Counsel and
other intervenors reached a settlement for CBT's "Commitment 2000" alternative
regulation plan application. The settlement was approved by the PUCO on April 9,
1998.
Terms of the settlement include: (i) greater pricing flexibility for most
services and elimination of rate-of-return regulation; (ii) no increase in basic
residential access line rates for the term of the plan; (iii) business rates set
based on CBT's discretion and market conditions; and (iv) 30% reduction in basic
rates for qualified, low income residential customers. The term of the plan is
three years but can be extended up to an additional two years at CBT's
discretion as long as a service quality benchmark is maintained.
KENTUCKY - On June 29, 1998, CBT filed an application with the Public Service
Commission of Kentucky (PSCK), requesting pricing flexibility similar to the
plan approved by the PUCO, a continuation of uniform rates throughout CBT's
three-state service area, a rate reduction of $250,000 and new rates that were
to become effective August 1, 1998. Pursuant to an Order dated August 24, 1998,
the PSCK suspended the proposed rates until January 23, 1999. It is anticipated
that the PSCK will render a decision early in the first quarter of next year.
16
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS OUTLOOK
COMMUNICATIONS SERVICES - The telecommunications industry in the United States
is in a period of dynamic change in response to regulatory and technological
developments. Consolidation of companies is occurring both within the
marketplace for local telephone service and across other telecommunications
services, such as long distance, cellular, cable television and Internet and
other data transmission services. Companies operating in some of these markets
are also expanding into others, such as the provision of local service by
long-distance companies. CBT can expect increased pressure in 1998 and beyond
from various competitors including CLECs, interexchange carriers and resellers.
With the passage of the Telecommunications Act and other regulatory initiatives,
CBT's local service markets have been more extensively opened to new
competitors, many of which will initially target high-volume business customers.
Interconnection agreements with competitive service providers require CBT to
provide interconnection or access to unbundled network elements at cost-based
rates and telecommunications services at discounted, wholesale rates. CBT
continues to develop new service offerings, including the ability to provide
delivery of complete solutions to customer communications need and a growing
presence in the data transmission and network integration market, to offset
anticipated future competitive losses. CBT continues to work to assure
implementation of rules that result in fair competition. The Ohio "Commitment
2000" plan approved by the PUCO in April 1998 will provide a more flexible form
of price regulation and opportunities to grow value-added service revenue in an
environment of stable basic service prices. Nevertheless, the dynamic changes in
the industry could still make it more difficult for CBT to maintain current
revenue and profit levels.
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 MANAGEMENT - CBIS continues to rely on a few large clients for
most of its revenues. CBIS's top three clients accounted for 60% of its
revenues for the first nine months 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, which
could involve exchanging lower prices for longer contract terms and broader
relationships. Any reduction in prices would negatively impact future
results. Additionally, one CBIS client representing approximately 11% of
CBIS's year-to-date 1998 revenues was acquired in June 1998 by one of CBIS's
competitors. The related contract extends through 2006 and does not provide
for early termination without a CBIS breach. It was also announced in the
second quarter of 1998 that another CBIS client representing approximately 9%
of CBIS's year-to-date 1998 revenues intends to be acquired by another
company. CBIS and the client have signed a binding letter of intent with this
client which is intended to expand into a contract that is expected to run
through 2004.
A significant amount of CBIS's growth is directly related to increased wireless
subscribers in the domestic marketplace. While that trend has continued in the
first nine months of 1998, if the domestic wireless industry growth rate
declines in the future, CBIS's ability to grow revenues and earnings could be
adversely affected. Additionally, certain international network-management
systems development efforts have been reduced as long-term contracts have
reached completion.
CUSTOMER MANAGEMENT - MATRIXX's top three clients accounted for 50% of its
revenues for the first nine months of 1998 up from 34% 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 excess
capacity in its call centers. The acquisition of Transtech has increased 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. MATRIXX's revenues from the agreement with AT&T continue to run
below expectations. Those revenues are subject to guaranteed minimums under the
first three years of the eight-year contract. Subject to certain exceptions, if
there is a shortfall to the $300 million revenue commitment, AT&T must pay 40%
of the shortfall to MATRIXX. AT&T has provided assurances that it plans to meet
its requirements under the contract.
17
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In the fourth quarter of 1997, MATRIXX initiated a restructuring plan to respond
to increased competition and the softness in the market for traditional
teleservices that began to impact the business in the second half of 1997.
MATRIXX continues to move aggressively to complete its restructuring program,
including reducing its workforce and closing certain facilities. Implementation
of the restructuring plan is expected to be substantially complete 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 also is moving forward with the
integration of Transtech, which has resulted in workforce reductions, and is
currently evaluating its facilities integration plan for Transtech.
YEAR 2000 PROGRAMMING - Since 1996, the Company has devoted significant time and
resources to achieve Year 2000 compliance. Accordingly, the Company will incur a
substantial amount of Year 2000 remediation costs to repair or replace
non-compliant network elements, operations support systems and application
software prior to the new millennium.
A Steering Committee, chaired by the Company's Chief Operating Officer and
composed of upper-level management personnel, sets the direction and monitors
the activity of the Company's Year 2000 Program Management Office. In addition
to internal Year 2000 activities, the Program Management Office is communicating
with suppliers and clients with which the Company's systems interface with or
which the Company's systems rely upon to determine their progress toward Year
2000 compliance. The Program Management Office's responsibility is to make the
Company and its subsidiaries Year 2000 compliant.
The Company incurred Year 2000 costs of approximately $14 million prior to 1998
with approximately $4 million occurring at Communications Services segment and
the remainder at CBIS and MATRIXX. The Company expects Year 2000 costs in 1998
to be in the range of $35 million to $40 million, with approximately $10 to $15
million in the Communications Services segment and the remainder at CBIS and
MATRIXX. Year 2000 costs in 1999 are estimated to be in the range of $5 million
to $8 million for the Communications Services segment and in the range of $10
million to $15 million at CBIS and MATRIXX.
CBT's goal is to have its network, information technology ("IT") and facilities
systems equipped with any required fixes or upgrades and tested by March 31,
1999. Certain other systems and equipment will be replaced rather than fixed,
and CBT's goal is to have these replacements installed and tested within the
first six months of 1999.
CBLD hopes to have its network, IT and facilities systems, other than its
billing system, equipped with any required fixes or upgrades and tested by March
31, 1999. CBLD's goal is to have its billing system equipped with any required
fixes or upgrades and tested by June 30, 1999.
CBD hopes to have its network, IT and facilities systems equipped with any
required fixes or upgrades and tested by March 31, 1999. Certain other systems
and equipment will be replaced rather than fixed, and CBD's goal is to have
these replacements installed and tested within the first six months of 1999.
CBS hopes to have its systems equipped with any required fixes or upgrades and
tested by December 31, 1998.
CBIS' goal is to have its data centers, software and other information
technology systems Year 2000 compliant and tested by June 30, 1999. CBIS'
efforts are proceeding in accordance with its plans and are on track to achieve
this goal. Additionally, the Year 2000 efforts for several CBIS systems have
moved into the testing phase to verify that the modifications made to the
systems had been effective in making the systems Year 2000 compliant. While work
continues with system modifications and testing, CBIS has also begun its efforts
to plan its procedures for the events which will occur on the date of the
millennium change.
18
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MATRIXX's goal is to have its call centers, software, telecom equipment and
other information technology systems Year 2000 compliant by June 30, 1999. The
majority of MATRIXX's individual Year 2000 projects are on schedule.
Additionally, the Year 2000 efforts for several MATRIXX projects have also moved
into the testing phase.
Although the Company has currently targeted June 30, 1999 for achieving full
Year 2000 compliance, its original goal was December 31, 1998. The Company
currently believes that the June 30, 1999 target date can be achieved but,
because of the complexity of the Year 2000 problem, there can be no assurance
that the Company will achieve complete Year 2000 compliance by this date or
before the year 2000.
The Company maintains business continuity plans to limit the disruption to its
operations that may result from a variety of occurrences. While the Company has
no explicit contingency plan, the Company is updating its business continuity
plans to assure that they adequately address Year 2000 issues that might arise.
Although the Company anticipates minimal business disruption as a result of the
century change, if the Company were to be unsuccessful in readying its software
and systems for the Year 2000 or preparing adequate plans to avoid business
interruption that could result from the century change, this would have a
material adverse impact on the Company. This material adverse effect could
include a disruption to the provision of services to its clients which could
result in lost revenues, the incurrence of material contractual penalties and
damaged client relationships. The failure of one of the Company's significant
clients to modify its systems for the Year 2000 successfully or to provide the
appropriate business continuity planning also could have an adverse impact on
the Company as the Company is, to a certain extent dependent on the success of
its clients. The Company's success in becoming Year 2000 compliant on or before
June 30, 1999 largely depends on the Company's vendors and business partners
being Year 2000 compliant on or before June 30, 1999. The Program Management
Office is working diligently with the Company's vendors and business partners to
assure itself, to the extent possible, that the vendors and business partners
are taking the necessary steps to become Year 2000 compliant. To the extent that
any of the Company's vendors or business partners experience Year 2000
technology difficulties which materially affect their businesses, such
difficulties could have a material adverse effect on the Company's business,
results of operations and financial condition.
MARKET RISK - The Company is exposed to the impact of interest rate changes and,
to a lesser extent, foreign currency fluctuations. It has been the Company's
policy to enter into interest rate and foreign currency transactions only to the
extent considered necessary to meet its objectives. The Company has not entered
into interest rate or foreign currency transactions for speculative purposes.
The acquisition of Transtech in the first quarter of 1998 has significantly
increased the Company's exposure to interest rate risk. The Company's foreign
currency exposures were immaterial at September 30, 1998.
The Company's exposure to interest rate risk results from its variable rate
short-term debt which totaled approximately $618 million at September 30, 1998.
Based upon the Company's level of indebtedness at September 30, 1998, a
one-percentage point increase in the weighted average interest rate would
increase the Company's annual interest expense by approximately $6.2 million.
In March 1998, the AICPA issued Statement of Position (SOP) 98-1, "Accounting
for the Costs of 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 capitalization of software expenditures in the future.
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. SOP 98-5 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.
In June 1998, Statement of Financial Accounting Standards (SFAS) No. 133,
"Accounting for Derivative instruments and Hedging Activities", was issued. SFAS
No. 133 establishes accounting and reporting
19
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. The Company may employ a small number of financial
instruments to manage its exposure to fluctuations in interest rates and
foreign currency exchange rates. The Company does not hold or issue such
financial instruments for trading purposes. The Company will adopt SFAS No.
133, as required in the year 2000, and does not expect the impact of adoption
to be material.
Effective January 1, 1998, the Company implemented SOP 97-2, "Software Revenue
Recognition." SOP 97-2 revises 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 Company's results of operations for
the six months ended June 30, 1998; however, its effect on future operating
results will be dependent on the nature and terms of the Company's individual
software agreements
BUSINESS DEVELOPMENT - The Company continues to review opportunities for
acquisitions and divestitures for all its businesses to enhance shareowner
value.
20
PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION
The following historical and pro forma financial data is presented herein in
conjunction with a Registration Statement on Form S-3 filed by the Company on
October 13, 1998. The Registration Statement registered for sale to the public
up to $350 million in debt securities and guaranteed debt securities to be
issued by the Company and CBT.
CINCINNATI BELL CONSOLIDATED HISTORICAL FINANCIAL DATA
The following table presents consolidated historical financial data of
Cincinnati Bell. The statement of operations data for each of the three years
ended December 31, 1995, 1996 and 1997 and the balance sheet data at December
31, 1996 and 1997 are taken from and should be read along with the audited
consolidated historical financial statements and the notes thereto of Cincinnati
Bell included in its most recent Annual Report on Form 10-K . The statement of
operations data for the nine months ended September 30, 1997 and 1998 and the
balance sheet data at September 30, 1997 and 1998 are taken from and should be
read along with the unaudited consolidated financial statements and the notes
thereto of Cincinnati Bell included elsewhere in this Quarterly Report on Form
10-Q. The interim financial statements are unaudited, but management of
Cincinnati Bell believes they fairly present its financial position and results
of operations for those periods.
Information for the nine months ended September 30, 1998 reflects, beginning
February 28, 1998, the Transtech Acquisition.
21
CINCINNATI BELL CONSOLIDATED HISTORICAL
FINANCIAL DATA (IN MILLIONS EXCEPT FOR PER SHARE
INFORMATION, OPERATING DATA AND RATIOS)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
-------------------------------------------- ---------------------------
1995 1996 1997 1997 1998
--------------- -------------- ----------- ------------- ------------
STATEMENT OF OPERATIONS DATA:
Revenues...................................... $ 1,336.1 $ 1,573.7 $ 1,756.8 $ 1,295.8 $ 1,653.7
Costs and expenses:
Costs of providing services and products sold 695.1 839.8 937.9 692.2 926.0
Selling, general and administrative......... 253.3 279.3 286.0 212.6 269.3
Depreciation and amortization............... 162.3 172.8 185.4 137.2 154.9
Year 2000 Programming costs................. -- -- 14.1 6.9 28.4
Mandated telecommunications costs........... -- -- 6.3 5.0 10.7
Special items (credits) (1)................. 178.7 (24.7) 14.0 (21.0) 42.6
--------- --------- --------- --------- ---------
Total costs and expenses............... 1,289.4 1,267.2 1,443.7 1,032.9 1,431.9
Operating income (2).......................... 46.7 306.5 313.1 262.9 221.8
Other income (expense), net (3)............... (13.5) 12.1 19.3 14.3 (3.4)
Interest expense (4).......................... 52.8 33.9 35.5 26.8 44.5
--------- --------- --------- --------- ---------
Income (loss) before income taxes ............ (19.6) 284.7 296.9 250.4 173.9
Income taxes.................................. 5.7 99.7 103.3 87.2 60.2
--------- --------- --------- --------- ---------
Income (loss) from continuing operations.... (25.3) 185.0 193.6 163.2 113.7
--------- --------- --------- --------- ---------
Extraordinary items (5)....................... (7.0) (210.0) -- --
--------- --------- --------- --------- ---------
--
--
Net income (loss) ............................ $ (32.3) $ 185.0 $ (16.4) $ 163.2 $ 113.7
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Earnings (loss) per common share
From continuing operations
Basic.................................... $ (.19) $ 1.38 $ 1.43 $ 1.21 $ .84
Diluted.................................. $ (.19) $ 1.35 $ 1.41 $ 1.19 $ .82
Net income (loss)
Basic.................................... $ (.24) $ 1.38 $ (.12) $ 1.21 $ .84
Diluted.................................. $ (.24) $ 1.35 $ (.12) $ 1.19 $ .82
Weighted average common shares outstanding
including equivalents
Basic..................................... 132.0 133.9 135.2 135.2 135.9
Diluted................................... 132.0 137.2 137.7 137.7 138.3
OTHER FINANCIAL DATA:
Capital additions (including acquisitions).... $ 166.8 $ 220.8 $ 236.1 $ 172.5 $ 846.3
Ratio of earnings to fixed charges (6)........ -- 5.57 5.22 5.71 3.08
OPERATING DATA:
Network access lines (in thousands)........... 906 958 1,005 994 1,032
Employees..................................... 15,086 19,741 20,790 19,428 30,840
22
(IN MILLIONS)
AS OF DECEMBER 31, AS OF SEPTEMBER 30,
----------------------------- -----------------------------
1996 1997 1997 1998
--------------- ------------ ------------ ---------------
BALANCE SHEET DATA:
$ 2.0 $ 9.9 $ 5.7 $ 1.5
Cash and cash equivalents.....................
Net property, plant and equipment (7)......... 985.8 703.2 1,020.7 838.9
Total assets.................................. 1,670.9 1,498.7 1,752.1 2,292.4
Debt:
Maturing within one year................... 224.2 190.6 219.3 619.3
Long-term.................................. 279.5 269.2 269.9 267.8
--------- --------- --------- ---------
Total debt............................. 503.7 459.8 489.2 887.1
634.4 579.7 770.7 647.2
Shareowners' equity (7).......................
NOTES TO CINCINNATI BELL CONSOLIDATED HISTORICAL FINANCIAL DATA
(1) The special items in 1995 were a $131.6 million charge associated with
a restructuring of Cincinnati Bell and Cincinnati Bell Telephone
operations, a $39.6 million goodwill impairment charge at MATRIXX and
$7.5 million of in-process research and development costs, which were
expensed in connection with an acquisition at CBIS. Special items in
1996 were $29.7 million in pension settlement gains related to the 1995
Cincinnati Bell and Cincinnati Bell Telephone restructuring plan, net
of $5.0 million of in-process research and development costs, which
were expensed in connection with acquisitions at CBIS and MATRIXX. The
special items recorded in 1997 were a charge of $35.0 million
associated with a restructuring of MATRIXX operations, net of the $21.0
million in pension settlement gains related to the 1995 Cincinnati Bell
Telephone and Cincinnati Bell restructuring plan. The special credit
recorded in the first nine months of 1997 was $21.0 million in non-cash
settlement gains resulting from lump-sum pension distributions pursuant
to the 1995 Cincinnati Bell and Cincinnati Bell Telephone restructuring
plan. The special item recorded in the first nine months of 1998 was
$42.6 million of in-process research and development costs, which were
expensed in connection with the Transtech Acquisition.
(2) Operating income includes special items as discussed in Note 1 above.
Excluding special items, operating income would have been $225.4
million in 1995, $281.8 million in 1996, $327.1 million in 1997 and
$241.9 million and $264.4 million for the nine months ended September
30, 1997 and 1998, respectively.
(3) Other income (expense), net for 1995 includes a charge of $5.0 million
to reduce real estate held for sale to its fair market value and a
charge of $13.3 million resulting from the termination of a currency
and interest rate swap agreement intended to hedge MATRIXX's investment
in its operations in France. Other income (expense), net for the nine
months ended September 30, 1998 includes $16.3 million in equity losses
from the Cincinnati Bell Wireless venture with AT&T PCS.
(4) Interest expense for 1996 includes a $2.5 million reversal of accrued
interest related to liabilities to interexchange carriers.
(5) Extraordinary items include a $7.0 million charge, net of tax benefit,
recorded in 1995 for debt extinguishment and a $210.0 million charge,
net of tax benefit, recorded in 1997 resulting from Cincinnati Bell
Telephone's discontinuance of Statement of Financial Accounting
Standards ("SFAS") No. 71, "Accounting for the Effects of Certain Types
of Regulation."
23
(6) For these ratios, "earnings" is determined by adding "total fixed
charges" (excluding capitalized interest), income taxes, minority
interest and amortization of capitalized interest to income from
continuing operations after eliminating equity in undistributed
earnings. For this purpose, "total fixed charges" consists of (i)
interest on all indebtedness and amortization of debt discount and
expense, (ii) capitalized interest and (iii) the interest component of
rental expense. Cincinnati Bell's earnings in 1995 were insufficient to
cover fixed charges by $24.1 million. Cincinnati Bell's ratio of
earnings to fixed charges reflects special items (credits) of $178.7
million in 1995, $(24.7) million in 1996, $14.0 million in 1997,
$(21.0) million for the first nine months of 1997 and $42.6 million for
the first nine months of 1998. Excluding these special items,
Cincinnati Bell's ratio of earnings to fixed charges would have been
3.04 in 1995, 5.17 in 1996, 5.42 in 1997, 5.30 for the nine months
ended September 30, 1997 and 3.63 for the nine months ended September
30, 1998.
(7) The extraordinary item in 1997 resulting from Cincinnati Bell
Telephone's discontinuance of SFAS No. 71 resulted in a $327.7 million
reduction in property, plant and equipment and a $210.0 million
reduction in shareowners' equity.
24
CINCINNATI BELL CONSOLIDATED PRO FORMA FINANCIAL DATA
The following table presents consolidated pro forma financial data for
Cincinnati Bell, giving effect to the Transtech Acquisition and the Convergys
Distribution. The pro forma statement of operations data for each of the three
years ended December 31, 1995, 1996 and 1997 and the nine months ended September
30, 1997 and 1998 are taken from, or prepared on a basis consistent with, and
should be read along with, the Cincinnati Bell consolidated pro forma financial
statements and the notes thereto included elsewhere in this Quarterly Report on
Form 10-Q and the Company's current Report on Form 8-K filed October 13, 1998.
The consolidated pro forma balance sheet data have been presented as if the
Convergys Distribution had occurred on September 30, 1998. The consolidated pro
forma statement of operations data for the year ended December 31, 1997 and the
nine months ended September 30, 1997 and 1998 have been presented as if the
Transtech Acquisition had occurred on January 1, 1997. The consolidated pro
forma statement of operations data for the years ended December 31, 1995, 1996
and 1997 and the nine months ended September 30, 1997 and 1998 have been
presented as if the Convergys Distribution had occurred on January 1, 1995.
The consolidated pro forma financial data provided below are unaudited, are
presented for informational purposes only and do not necessarily indicate what
the actual results of operations would have been had the Transtech Acquisition
and the Convergys Distribution occurred on the dates assumed, or what the future
operating results or financial position of Cincinnati Bell may be. The data
provided below should be read along with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the consolidated
historical and pro forma financial statements and notes thereto of Cincinnati
Bell incorporated by reference in Cincinnati Bell's most recent Annual Report on
Form 10-K and set forth in its most recent filing on Form 8-K.
25
CINCINNATI BELL CONSOLIDATED PRO FORMA FINANCIAL DATA
(IN MILLIONS EXCEPT FOR PER SHARE INFORMATION, OPERATING DATA AND RATIOS)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------- ---------------------------------
1995 1996 1997 1997 1998
------------- -------------- ------------ ------------------ -------------
STATEMENT OF OPERATIONS DATA:
Revenues............................. $ 736.0 $ 779.8 $ 834.5 $ 618.0 $ 658.6
Costs and expenses:..................
Costs of providing services and
products sold................... 301.9 321.3 344.6 255.7 279.1
Selling, general and
administrative................... 176.7 186.6 184.7 136.5 150.9
Depreciation and amortization...... 116.4 121.0 124.3 92.8 82.4
Year 2000 programming costs........ -- -- 4.2 1.5 7.7
Mandated telecommunications
costs............................ -- -- 6.3 5.0 10.7
Special items (credits) (1)........ 131.6 (29.7) (21.0) (21.0) --
------------ ------------- ----------- ------------ ------------
Total costs and expenses...... 726.6 599.2 643.1 470.5 530.8
Operating income (2)................. 9.4 180.6 191.4 147.5 127.8
Other income (expense), net (3)...... (9.1) 0.5 (2.7) (2.3) (17.8)
Interest expense (4)................. 45.4 27.9 30.1 23.1 17.8
------------ ------------- ----------- ------------ ------------
Income (loss) before income
taxes.............................. (45.1) 153.2 158.6 122.1 92.2
------------ ------------- ----------- ------------ ------------
Income taxes......................... (16.0) 53.7 56.3 42.3 32.6
------------ ------------- ----------- ------------ ------------
$ (29.1) $ 99.5 $ 102.3 $ 79.8 $ 59.6
------------ ------------- ----------- ------------ ------------
------------ ------------- ----------- ------------ ------------
Income (loss) from continuing
operations (5).....................
Earnings (loss) per common
share
Basic............................ $ (.22) $ .74 $ .76 $ .59 $ .44
Diluted.......................... $ (.22) $ .73 $ .74 $ .58 $ .43
Weighted average common
shares outstanding including
equivalents
Basic............................ 132.0 133.9 135.2 135.2 135.9
Diluted.......................... 132.0 137.2 137.7 137.7 138.3
OTHER FINANCIAL DATA:
Capital additions (including
acquisitions)...................... $ 92.8 $ 106.4 $ 159.6 $ 127.3 $ 116.2
Ratio of earnings to fixed charges
(6)............................... -- 5.96 5.66 5.75 5.41
OPERATING DATA:
Network access lines
(in thousands)..................... 906 958 1,005 994 1,032
Employees............................ 3,088 3,109 3,318 3,223 3,516
26
(IN MILLIONS)
AS OF
SEPTEMBER 30, 1998
------------------
BALANCE SHEET DATA:
Cash and cash equivalents.................................. $ 0.1
Net property, plant and equipment.......................... 609.5
Total assets............................................... 870.2
Debt:
Maturing within one year................................. 140.8
Long-term................................................ 267.5
-----
Total debt.......................................... 408.3
Shareowners' equity (7).................................... 133.1
NOTES TO CINCINNATI BELL CONSOLIDATED PRO FORMA FINANCIAL DATA
(1) The special item in 1995 was a $131.6 million charge, net of settlement
gains, associated with a restructuring of Cincinnati Bell and
Cincinnati Bell Telephone operations. The special credits recorded in
1996 and in 1997 were non-cash settlement gains resulting from lump-sum
pension distributions pursuant to the 1995 Cincinnati Bell and
Cincinnati Bell Telephone restructuring plan.
(2) Operating income includes special items as discussed in Note 1 above.
Excluding special items, pro forma operating income would have been
$141.0 million in 1995, $150.9 million in 1996, $170.4 million in 1997
and $126.5 million for the nine months ended September 30, 1997. Pro
forma operating income for the nine months ended September 30, 1998 was
not affected by special items.
(3) Other income (expense), net for 1995 includes a charge of $5.0 million
to reduce real estate held for sale months ended September 30, 1998
includes $16.3 million in equity losses from the Cincinnati Bell
Wireless venture with AT&T to its fair market value. Other income
(expense), net for the nine PCS.
(4) Interest expense in 1996 includes a $2.5 million reversal of accrued
interest related to liabilities to interexchange carriers.
(5) Income from continuing operations excludes a $7.0 million extraordinary
charge, net of tax benefit, recorded in 1995 for debt extinguishment
and a non-cash $210.0 million extraordinary charge, net of tax benefit,
recorded in 1997 resulting from Cincinnati Bell Telephone's
discontinuance of SFAS No. 71, "Accounting for the Effects of Certain
Types of Regulation."
(6) For these ratios, "earnings" is determined by adding "total fixed
charges" (excluding capitalized interest), income taxes, minority
interest and amortization of capitalized interest to income from
continuing operations after eliminating equity in undistributed
earnings. For this purpose, "total fixed charges" consists of (i)
interest on all indebtedness and amortization of debt discount and
expense, (ii) capitalized interest and (iii) the interest component of
rental expense. Cincinnati Bell's earnings in 1995, pro forma for the
Convergys Distribution, were insufficient to cover fixed charges by
$45.1 million. Cincinnati Bell's ratio of earnings to fixed charges,
pro forma for the Convergys Distribution, reflects special items
(credits) of $131.6 million in 1995, $(29.7) million in 1996, and
$(21.0) million in 1997 and $(21.0) million for the first nine months
of 1997. Excluding these special items, Cincinnati Bell's ratio of
earnings to fixed charges, pro forma for the Convergys Distribution,
would have been 2.75 in 1995, 5.00 in 1996, 5.05 in 1997 and 4.94 for
the nine months ended September 30, 1997. Cincinnati Bell's ratio of
earnings to fixed charges, pro forma for the Convergys Distribution,
for the nine months ended September 30, 1998 was not affected by
special items.
27
(7) Pro forma shareowners' equity reflects the elimination of Convergys'
shareowners' equity from Cincinnati Bell's historical amounts and the
incurrence of approximately $10 million in nonrecurring costs, net of
tax benefit, related to the Convergys Distribution. Included in the
elimination of Convergys' shareowners' equity is an estimated amount of
approximately $33 million, net of deferred tax benefit, resulting from
the allocation of Cincinnati Bell pension trust assets and obligations
to Convergys. The actual amount of shareowners' equity transferred to
Convergys as a result of the allocation of the Cincinnati Bell pension
trust assets will be determined by calculations agreed to by the
management of Cincinnati Bell and Convergys, and may differ from the
amount reflected. The final allocation may differ due to the discount
rates and other assumptions used in the final calculation at the time
of the Convergys Distribution. In addition, the final pension asset
allocation will be subject to regulatory approval.
28
Cincinnati Bell Telephone Historical Financial Data
The following table presents summary historical financial data of Cincinnati
Bell Telephone. The statement of operations data for each of the three years
ended December 31, 1995, 1996 and 1997 and the balance sheet data at December
31, 1996 and 1997 are taken from and should be read along with the audited
consolidated financial statements and the notes thereto of Cincinnati Bell
included or incorporated by reference in its most recent Annual Report on Form
10-K. The statement of operations data for the nine months ended September 30,
1997 and 1998 and the balance sheet data at September 30, 1997 and 1998 are
taken from and should be read along with the unaudited financial statements and
the notes thereto of Cincinnati Bell included in this Quarterly Report on Form
10-Q. The interim financial statements have not been audited, but management of
Cincinnati Bell believes they fairly present Cincinnati Bell Telephone's
financial position and results of operations for those periods.
Cincinnati Bell Telephone is a wholly owned subsidiary of Cincinnati Bell, and
it receives general and administrative services from Cincinnati Bell. Cincinnati
Bell Telephone's cash is managed by Cincinnati Bell and its operations are
partially financed through borrowings of Cincinnati Bell. The financial data
provided below are presented for informational purposes only and does not
necessarily indicate what the results of operations and financial position of
Cincinnati Bell Telephone would have been if Cincinnati Bell Telephone was not a
wholly owned subsidiary of Cincinnati Bell, or what Cincinnati Bell Telephone's
future performance may be.
29
CINCINNATI BELL TELEPHONE HISTORICAL FINANCIAL DATA
(IN MILLIONS EXCEPT FOR OPERATING DATA AND RATIOS)
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------------- --------------------
1995 1996 1997 1997 1998
--------- --------- --------- -------- --------
STATEMENT OF OPERATIONS DATA:
Revenues ................................. $ 624.4 $ 650.8 $ 670.1 $ 495.0 $ 532.9
Costs and expenses:
Costs of providing services and products
sold ................................ 253.6 257.7 267.6 197.4 217.8
Selling, general and administrative .... 142.1 149.3 145.6 109.5 115.3
Depreciation and amortization .......... 113.0 116.6 120.6 90.3 78.8
Year 2000 programming costs ............ -- -- 4.2 1.5 7.8
Mandated telecommunications cost ....... -- -- 6.3 5.0 10.7
Special items (credits) (1) ............ 121.7 (28.5) (21.0) (21.0) --
--------- --------- --------- -------- --------
Total costs and expenses .......... 630.4 495.1 523.3 382.7 430.4
Operating income (loss) (2) .............. (6.0) 155.7 146.8 112.3 102.5
Other income, net ........................ 11.4 3.9 5.7 4.3 --
Interest expense (3) ..................... 26.9 17.4 20.4 16.0 14.5
--------- --------- --------- -------- --------
Income (loss) before income taxes ........ (21.5) 142.2 132.1 100.6 88.0
Income taxes ............................. (10.2) 49.6 46.9 35.7 30.3
--------- --------- --------- -------- --------
Income (loss) from continuing
operations ............................. (11.3) 92.6 85.2 64.9 57.7
--------- --------- --------- -------- --------
Extraordinary item (4) ................... -- -- (210.0) -- --
--------- --------- --------- -------- --------
Net income (loss) ........................ $ (11.3) $ 92.6 $ (124.8) $ 64.9 $ 57.7
--------- --------- --------- -------- --------
--------- --------- --------- -------- --------
OTHER FINANCIAL DATA:
Capital additions ........................ $ 90.3 $ 101.4 $ 141.1 $ 112.2 $ 105.4
Ratio of earnings to fixed charges (5) ... -- 8.15 6.60 6.53 6.21
OPERATING DATA:
Network access lines (in thousands) ...... 906 958 1,005 994 1,032
Employees ................................ 2,732 2,710 2,863 2,810 2,934
30
AS OF DECEMBER 31, AS OF SEPTEMBER 30,
------------------------- --------------------------
1996 1997 1997 1998
------------------------- --------------------------
BALANCE SHEET DATA:
Cash and cash equivalents (6)........................ $ (2.3) $ (3.6) $ (3.7) $ (3.1)
Net property, plant and equipment (4)................ 855.2 550.6 879.1 578.0
Total assets......................................... 1,005.5 706.4 1,037.3 739.2
Notes payable to Cincinnati Bell..................... 56.6 63.4 66.7 86.2
Debt maturing within one year........................ 0.8 3.4 3.4 3.2
Long-term debt....................................... 221.5 218.4 218.7 217.9
Shareowner's equity (4).............................. 450.6 240.2 443.2 247.3
NOTES TO CINCINNATI BELL TELEPHONE HISTORICAL FINANCIAL DATA
(1) The special item in 1995 was a $121.7 million charge, net of settlement
gains, associated with a restructuring of Cincinnati Bell Telephone
operations. The special credits recorded in 1996 and 1997 were non-cash
settlement gains resulting from lump-sum pension distributions pursuant
to the 1995 Cincinnati Bell Telephone restructuring.
(2) Operating income (loss) includes special items as discussed in Note 1
above. Excluding special items, operating income would have been $115.7
million in 1995, $127.2 million in 1996, $125.8 million in 1997 and
$91.3 million for the nine months ended September 30, 1997. Operating
income for the nine months ended September 30, 1998 was not affected by
special items.
(3) Interest expense in 1996 includes a $2.5 million reversal of
accrued interest related to liabilities to interexchange carriers.
(4) The extraordinary item recorded in 1997 was a non-cash charge of $210.0
million, net of tax benefit, resulting from Cincinnati Bell Telephone's
discontinuance of SFAS No. 71, "Accounting for the Effects of Certain
Types of Regulation." The charge resulted in a $327.7 million reduction
in Cincinnati Bell Telephone's property, plant and equipment and a
$210.0 million reduction in shareowner's equity.
(5) For these ratios, "earnings" is determined by adding "total fixed
charges" (excluding capitalized interest), income taxes, minority
interest and amortization of capitalized interest to income from
continuing operations after eliminating equity in undistributed
earnings. For this purpose, "total fixed charges" consists of (i)
interest on all indebtedness and amortization of debt discount and
expense, (ii) capitalized interest and (iii) the interest component of
rental expense. In 1995 Cincinnati Bell Telephone's earnings were
insufficient to cover fixed charges by $21.4 million. Cincinnati Bell
Telephone's ratio of earnings to fixed charges reflects special items
(credits) of $121.7 million in 1995, $(28.6) million in 1996, $(21.0)
million in 1997 and $(21.0) million for the first nine months of 1997.
Excluding these special items, Cincinnati Bell Telephone's ratio of
earnings to fixed charges would have been 4.28 in 1995, 6.71 in 1996,
5.71 in 1997 and 5.37 for the nine months ended September 30, 1997.
Cincinnati Bell Telephone's ratio of earnings to fixed charges for the
nine months ended September 30, 1998 was not affected by special items.
(6) Cincinnati Bell has historically managed cash on a centralized basis,
which resulted in negative cash balances for Cincinnati Bell Telephone
for financial reporting purposes at the dates presented above.
31
CINCINNATI BELL CONSOLIDATED PRO FORMA FINANCIAL STATEMENTS
The following consolidated pro forma financial statements present pro forma
information for Cincinnati Bell, giving effect to the Transtech Acquisition and
the Convergys Distribution. These consolidated pro forma financial statements
are based upon the historical consolidated financial statements of Cincinnati
Bell for the periods presented and on the historical financial statements of
Transtech for the two months ended February 28, 1998. The historical
consolidated financial statements of Cincinnati Bell as of and for the nine
months ended September 30, 1998 and the historical financial statements of
Transtech for the two months ended February 28, 1998 are unaudited.
The consolidated pro forma statement of operations for the nine months ended
September 30, 1998 has been presented as if the Transtech Acquisition and the
Convergys Distribution had occurred on January 1, 1997. The consolidated pro
forma statement of operations indicated above reflects the Transtech Acquisition
using the purchase method of accounting and the resulting amortization of
goodwill and other intangibles as well as the financing of, and interest expense
related to the acquisition.
The consolidated pro forma balance sheet as of September 30, 1998 has been
presented as if the Convergys Distribution had occurred on September 30, 1998.
(The Transtech Acquisition was completed on February 28, 1998 and is reflected
in the historical consolidated balance sheet of Cincinnati Bell as of September
30, 1998.)
The consolidated pro forma financial statements are unaudited, are presented for
informational purposes only and do not necessarily indicate what the actual
results of operations would have been had the Transtech Acquisition and the
Convergys Distribution occurred on the dates assumed, or what the future
operating results or financial position of Cincinnati Bell may be. The
consolidated pro forma financial statements should be read along with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated historical financial statements and the notes
thereto of Cincinnati Bell included or incorporated by reference in Cincinnati
Bell's most recent Annual Report on Form 10-K. and set forth in its most recent
filing on Form 8-K.
32
CINCINNATI BELL CONSOLIDATED PRO FORMA STATEMENT OF OPERATIONS
(IN MILLIONS, EXCEPT PER SHARE INFORMATION)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
------------------------------------------------------------------------------------------
PRO FORMA
HISTORICAL BEFORE
HISTORICAL TRANSTECH CONVERGYS CONVERGYS
CINCINNATI (1/1/98 - ACQUISITION DISTRIBUTION DISTRIBUTION
BELL 2/28/98) ADJUSTMENTS ADJUSTMENTS ADJUSTMENTS PRO FORMA
---------- ---------- ----------- ------------ ------------ ---------
Revenues.................... $ 1,653.7 $ 62.4 -- $ 1,716.1 $(1,057.5) (4) $ 658.6
Costs and expenses.......... 1,431.9 61.1 $ 3.9 (1) 1,496.9 (966.1) (5) 530.8
--------- --------- ------- --------- --------- ---------
Operating income............ 221.8 1.3 (3.9) 219.2 (91.4) 127.8
Other income
(expense)................. (3.4) -- -- (3.4) (14.4) (6) (17.8)
Interest expense............ 44.5 -- 6.1 (2) 50.6 (32.8) (7) 17.8
--------- --------- ------- --------- --------- ---------
Income before taxes......... 173.9 1.3 (10.0) 165.2 (73.0) 92.2
Income taxes................ 60.2 0.5 (3.8) (3) 56.9 (24.3) (8) 32.6
--------- --------- ------- --------- --------- ---------
Income from
continuing operations..... $ 113.7 $ 0.8 $ (6.2) $ 108.3 $ (48.7) $ 59.6
--------- --------- ------- --------- --------- ---------
--------- --------- ------- --------- --------- ---------
Earnings per share
Basic.................... $ .84 $ .80 $ .44
Diluted.................. $ .82 $ .78 $ .43
Weighted average
common shares
outstanding
including equivalents
Basic........................ 135.9 135.9 135.9
Diluted...................... 138.3 138.3 138.3
NOTES TO CINCINNATI BELL CONSOLIDATED PRO FORMA STATEMENT OF OPERATIONS
(1) Adjustment gives effect to the amortization of intangible assets
acquired and depreciation of property and equipment acquired.
Cincinnati Bell's allocation of the Transtech purchase price is as
follows: acquired contracts - $68.2 million; in-process research and
development - $42.6 million; assembled workforce - $11.4 million;
internally-developed software - $4.4 million; fair value of other
tangible assets acquired - $91.0 million; and goodwill - $414.4
million. Assigned lives for the acquired intangible assets are as
follows: acquired contracts - 8 years; assembled workforce - 15 years;
and goodwill - 30 years. Assigned lives for property and equipment are
as follows: software and personal computers - 3 years; equipment - 5
years; and buildings - 30 years.
(2) The Transtech Acquisition and associated costs were financed entirely
through short-term variable rate commercial paper issued by Cincinnati
Bell. Interest expense has been recorded at the rate (5.75%) for the
commercial paper that was issued to finance the acquisition.
(3) Adjustment reflects the income tax effect of the acquisition
adjustments at Convergys' statutory tax rate for the respective period.
33
(4) Adjustment eliminates Convergys' pro forma revenues after giving
effect to the Transtech Acquisition.
(5) Adjustment eliminates Convergys' pro forma expenses after giving effect
to the Transtech Acquisition. For purposes of this adjustment, general
overhead expenses incurred by Cincinnati Bell, which had been charged
to Convergys as a management fee, remain a part of the expenses of
Cincinnati Bell and have not been eliminated by the Convergys
Distribution adjustments.
(6) Adjustment eliminates other income (expense), net related to Convergys.
Adjustment includes the elimination of equity earnings from Cincinnati
SMSA Limited Partnership which operates a cellular telecommunications
business in southwestern Ohio and northern Kentucky.
(7) Adjustment eliminates Convergys' pro forma interest expense after
giving effect to the Transtech Acquisition. Interest expense for
Convergys is determined based upon the weighted average interest rate
for Cincinnati Bell's short-term and long-term interest rates for the
respective period for Cincinnati Bell debt allocated to Convergys and
the interest rate associated with any direct indebtedness of Convergys.
(8) Adjustment reflects the provision for income taxes for the pre-tax
adjustments at Convergys' statutory tax rate for the respective period.
34
CINCINNATI BELL CONSOLIDATED PRO FORMA BALANCE SHEET
(IN MILLIONS)
AS OF SEPTEMBER 30, 1998
----------------------------------------------
CONVERGYS
HISTORICAL DISTRIBUTION
CINCINNATI BELL ADJUSTMENTS (1) PRO FORMA
--------------- --------------- ---------
Cash and cash equivalents ......................................... $ 1.5 $ (1.4) $ 0.1
Receivables ....................................................... 461.3 (307.9) 153.4
Materials and supplies ............................................ 14.7 -- 14.7
Deferred income taxes ............................................. 25.2 (7.0) 18.2
Prepaid expenses and other current assets ......................... 52.3 (29.3) 23.0
---------- ---------- ----------
Total current assets ......................................... 555.0 (345.6) 209.4
---------- ---------- ----------
Property, plant and equipment ..................................... 838.9 (229.4) 609.5
Goodwill and other intangibles, net ............................... 698.2 (681.1) 17.1
Investments in unconsolidated entities ............................ 90.1 (85.3) 4.8
Deferred charges and other current assets ......................... 110.2 (80.8) 29.4
---------- ---------- ----------
Total assets ................................................. $ 2,292.4 $ (1,422.2) $ 870.2
---------- ---------- ----------
---------- ---------- ----------
Debt maturing within one year ..................................... 619.3 (478.5)(2) 140.8
Accounts payable and other current liabilities .................... 412.4 (191.3) 221.1
---------- ---------- ----------
Total current liabilities .................................... 1,031.7 (669.8) 361.9
Long-term debt .................................................... 267.8 (0.3) 267.5
Other long-term liabilities ....................................... 345.7 (238.0) 107.7
---------- ---------- ----------
Total liabilities ............................................ 1,645.2 (908.1) 737.1
---------- ---------- ----------
Shareowners' equity ............................................... 647.2 (514.1)(3) 133.1
---------- ---------- ----------
Total Liabilities and Shareowners' Equity .................... $ 2,292.4 $ (1,422.2) $ 870.2
---------- ---------- ----------
---------- ---------- ----------
NOTES TO CINCINNATI BELL CONSOLIDATED PRO FORMA BALANCE SHEET
(1) Adjustments in this column reflect the elimination of assets and
liabilities that will be transferred from Cincinnati Bell to Convergys
based on the September 30, 1998 consolidated balance sheet of
Cincinnati Bell.
(2) Adjustments to debt maturing within one year and long-term debt
represent the amount of direct outstanding indebtedness of Convergys
and its subsidiaries and approximately $478 million in intercompany
debt that Convergys owes to Cincinnati Bell at September 30, 1998.
Pursuant to the terms of the Distribution Agreement, Convergys will
repay this intercompany indebtedness at or before the date of the
Convergys Distribution date. The actual amount of the intercompany
indebtedness repayment will be determined based on Convergys' cash flow
activity from October 1, 1998 to the date of the repayment and the
resultant intercompany balances. The proceeds from the intercompany
indebtedness repayment from Convergys will be used by Cincinnati Bell
to repay outstanding short-term variable rate debt.
(3) Pro forma shareowners' equity reflects the elimination of Convergys'
shareowners' equity from Cincinnati Bell's historical amounts and the
incurrence of approximately $10 million in nonrecurring costs, net of
tax benefit related to the Convergys Distribution. Included in the
elimination of Convergys' shareowners' equity is an estimated amount of
approximately $33 million, net of deferred tax benefit resulting from
the allocation of Cincinnati Bell pension trust assets and obligations
to Convergys. The
35
actual amount of shareowners' equity transferred to Convergys as a
result of the allocation of the Cincinnati Bell pension trust assets
will be determined by calculations performed as of the date of the
Convergys Distribution, using a methodology that has been agreed to
by the management of Cincinnati Bell and Convergys, and may differ
from the amount reflected. The final allocation may differ due to
the discount rates and other assumptions used in the final
calculation at the time of the Convergys Distribution. In addition,
the final pension asset allocation will be subject to regulatory
approval.
36
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
The following are filed as Exhibits to Part I of this Form 10-Q:
EXHIBIT
NUMBER
-------
27 Financial Data Schedule
99 Employee Benefits Agreement between Cincinnati
Bell Inc. and Convergys Corporation
(b) Reports on Form 8-K.
Form 8-K, date of report September 2, 1998, reported the management
teams of the Company and Convergys. This announcement was made in
anticipation of the planned separation of the two companies by
December 31, 1998.
Form 8-K, date of report October 13, 1998, (i) explained the
Company's relationship with its subsidiary, Convergys; (ii) updated
information regarding the Year 2000 preparedness of the Company
(excluding Convergys); and (iii) updated information regarding the
(a) regulatory affairs, (b) historical financial data and (c) pro
forma financial data of both the Company and CBT.
37
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: November 16, 1998 /s/ Kevin W. Mooney
--------------------- -------------------------
Kevin W. Mooney
Chief Financial Officer
38