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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 June 30, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________.
Commission File Number 1-14379
CONVERGYS CORPORATION
Incorporated under the laws of the State of Ohio
201 East Fourth Street, Cincinnati, Ohio 45202
I.R.S. Employer Identification Number 31-1598292
Telephone - Area Code (513) 723-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
At July 31, 2002, 173,194,420 Common Shares were outstanding.
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Amounts in Millions, Except Per Share Amounts)
Three Months Six Months
Ended June 30, Ended June 30,
-------------------- ------------------------
2002 2001 2002 2001
-------------------- ------------------------
Revenues ....................................... $ 572.7 $ 571.2 $ 1,160.2 $ 1,162.7
--------- --------- ----------- -----------
Costs and Expenses
Cost of providing services and products sold 315.0 311.5 641.0 633.6
Selling, general and administrative ........ 99.8 97.8 202.9 205.6
Research and development costs ............. 29.2 28.5 55.4 54.4
Depreciation ............................... 30.6 31.6 60.8 64.1
Amortization ............................... 3.6 12.6 7.1 25.3
Acquisition and integration costs .......... -- 31.8 -- 31.8
--------- --------- ----------- -----------
Total costs and expenses .............. 478.2 513.8 967.2 1,014.8
--------- --------- ----------- -----------
Operating Income ............................... 94.5 57.4 193.0 147.9
Equity in Earnings of Cellular Partnership ..... 3.0 2.8 3.9 4.6
Other Income (Expense), net .................... 0.2 0.6 (1.3) 0.7
Interest Expense ............................... (2.3) (5.3) (5.9) (12.5)
--------- --------- ----------- -----------
Income Before Income Taxes ..................... 95.4 55.5 189.7 140.7
Income Taxes ................................... 36.3 28.2 71.0 61.3
--------- --------- ----------- -----------
Net Income ..................................... $ 59.1 $ 27.3 $ 118.7 $ 79.4
========= ========= =========== ===========
Other Comprehensive Income, net of tax:
Foreign currency translation adjustments ..... $ 9.2 $ 2.2 $ 8.9 $ (3.1)
Unrealized gain on cash flow hedging ......... 4.2 2.3 6.7 1.5
Unrealized gain (loss) on investments ........ -- 0.1 -- (4.2)
--------- --------- ----------- -----------
Total other comprehensive income (loss) ... 13.4 4.6 15.6 (5.8)
--------- --------- ----------- -----------
Comprehensive Income ........................... $ 72.5 $ 31.9 $ 134.3 $ 73.6
========= ========= =========== ===========
Earnings Per Common Share
Basic ...................................... $ 0.35 $ 0.16 $ 0.71 $ 0.47
========= ========= =========== ===========
Diluted .................................... $ 0.35 $ 0.16 $ 0.69 $ 0.45
========= ========= =========== ===========
Average Common Shares Outstanding
Basic ...................................... 167.3 169.8 167.7 169.6
Diluted .................................... 170.9 175.5 171.7 175.5
See Notes to Financial Statements.
2
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Millions)
June 30, December 31,
2002 2001
---------- ------------
ASSETS
- ------
Current Assets
Cash and cash equivalents ..................................... $ 23.8 $ 41.1
Receivables, less allowances of $15.9 and $14.7 ............... 463.7 413.6
Deferred income taxes ......................................... 24.3 31.9
Prepaid expenses and other current assets ..................... 46.8 36.5
---------- ----------
Total current assets ........................................ 558.6 523.1
Property and equipment - net ..................................... 330.9 350.4
Goodwill - net ................................................... 668.8 665.2
Other intangibles - net .......................................... 35.6 39.7
Investment in Cellular Partnership ............................... 35.6 35.3
Deferred charges ................................................. 86.4 87.8
Other assets ..................................................... 36.8 41.4
---------- ----------
Total Assets ................................................ $ 1,752.7 $ 1,742.9
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Debt maturing in one year ..................................... $ 118.0 $ 129.9
Payables and other current liabilities ........................ 329.6 362.5
---------- ----------
Total current liabilities ................................... 447.6 492.4
Long-term debt ................................................... 4.1 3.6
Other long-term liabilities ...................................... 25.1 20.3
---------- ----------
Total liabilities ........................................... 476.8 516.3
---------- ----------
Shareholders' Equity
Preferred shares - without par value, 5.0 authorized .......... -- --
Common shares - without par value, 500.0 authorized;
173.1 and 172.2 issued and outstanding ...................... 206.0 206.0
Additional paid-in capital .................................... 606.8 590.4
Treasury shares - 6.7 shares at June 30, 2002 and 2.8 shares
at December 31, 2001 ........................................ (170.3) (68.9)
Retained earnings ............................................. 636.6 517.9
Accumulated other comprehensive income ........................ (3.2) (18.8)
---------- ----------
Total shareholders' equity .................................. 1,275.9 1,226.6
---------- ----------
Total Liabilities and Shareholders' Equity .................. $ 1,752.7 $ 1,742.9
========== ==========
See Notes to Financial Statements.
3
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Millions)
Six Months
Ended June 30,
-------------------
2002 2001
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
- ------------------------------------
Net income ...................................................................... $ 118.7 $ 79.4
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization ............................................... 67.9 89.4
Deferred income tax expense (benefit) ....................................... 12.9 (0.1)
Cellular partnership distributions in excess of (less than) earnings ........ (0.3) 3.3
Income tax benefit from stock option exercises .............................. 3.4 5.6
Repayments of receivables securitization, net ............................... (20.0) (30.0)
Changes in assets and liabilities, net of effects from acquisitions:
Decrease (increase) in receivables .......................................... (30.1) 93.1
Increase in other current assets ............................................ (10.3) (4.2)
Decrease (increase) in deferred charges ..................................... 1.4 (18.6)
Increase in other assets .................................................... -- (2.9)
Decrease in payables and other current liabilities .......................... (24.9) (52.8)
Other, net .................................................................. 0.2 12.4
-------- --------
Net cash provided by operating activities ................................... 118.9 174.6
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
- ------------------------------------
Capital expenditures ............................................................ (48.2) (60.2)
Acquisitions, net of cash acquired .............................................. -- (36.3)
-------- --------
Net cash used in investing activities ......................................... (48.2) (96.5)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
- ------------------------------------
Payments of debt, net ........................................................... (11.4) (121.0)
Purchase of treasury shares ..................................................... (89.6) --
Issuance of treasury shares, net ................................................ -- 1.2
Issuance of common shares ....................................................... 13.0 22.9
-------- --------
Net cash provided by financing activities ..................................... (88.0) (96.9)
-------- --------
Decrease in cash and cash equivalents ........................................... (17.3) (18.8)
Cash and cash equivalents at beginning of period ................................ 41.1 49.3
-------- --------
Cash and cash equivalents at end of period ...................................... $ 23.8 $ 30.5
======== ========
See Notes to Financial Statements.
4
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
1) BACKGROUND AND BASIS OF PRESENTATION
Convergys Corporation (the Company or Convergys) serves its clients
through its two operating segments: (i) the Information Management Group
(IMG), which provides outsourced billing and information services and
software; and (ii) the Customer Management Group (CMG), which provides
outsourced marketing, customer support and employee care services. The
Company also has a 45% limited partnership interest in a cellular
communications services provider in southwestern and central Ohio and
northern Kentucky (the Cellular Partnership).
These financial statements have been prepared pursuant to the rules
and regulations of the Securities and Exchange Commission (SEC) and, in the
opinion of Management, include all adjustments necessary for a fair
presentation of the results of operations, financial position and cash
flows for each period shown. All adjustments are of a normal and recurring
nature. The December 31, 2001 condensed balance sheet has been derived from
audited financial statements, but does not include all disclosures required
by accounting principles generally accepted in the United States of
America. It is suggested that these financial statements be read in
conjunction with the financial statements and the notes thereto included in
the Company's annual report on Form 10-K. Certain prior period amounts have
also been reclassified to conform to current period presentation.
(2) ACQUISITIONS
On April 6, 2001, the Company acquired 100% of the outstanding shares
of Geneva Technology Ltd. (Geneva), based in Cambridge, UK (the Geneva
Acquisition), for approximately 14.9 million Convergys common shares.
Approximately 2.7 million Convergys stock options were also issued to
replace outstanding Geneva stock options. Geneva was a provider of
convergent billing software for the communications, e-commerce, finance,
utilities and online services industries. The transaction qualified as a
tax-free reorganization and was accounted for as a pooling-of-interests.
Accordingly, all amounts presented were adjusted to reflect the combined
results of the companies as if the acquisition had occurred as of the
earliest period presented.
In connection with the acquisition of Geneva, the Company recorded
one-time costs of $31.8 in the second quarter of 2001 to expense
transaction costs and certain costs to integrate the combined businesses.
The one-time charge consisted of $20.6 of transaction costs and $11.2 of
integration costs. The integration costs included $1.0 for lease
terminations and other costs associated with the consolidation of
facilities, $6.2 for severance associated with the consolidation of
facilities and certain functions, $3.0 for the expensing of software that
will not be deployed by the combined businesses and $1.0 for other
integration costs. The integration activities were substantially completed
by the end of the second quarter of 2002.
On February 12, 2001, the Company paid approximately $16 to acquire
the customer support business of Keane, Inc.
5
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(3) BUSINESS RESTRUCTURING
As discussed more fully in the Company's Annual Report on Form 10-K
for the year ended December 31, 2001, the Company initiated a plan during
the third quarter of 2001 to rationalize CMG's contact center capacity. The
plan resulted in a pre-tax restructuring charge of $53.3. The charge
consisted of $29.0 in costs associated with the closing of contact centers,
$16.2 in asset impairment related to software that will not be deployed
into those contact center operations and $8.1 to write-down investments in
certain of CMG's European contact center operations. The contact center
closing costs included $11.8 for lease terminations, $6.4 in severance pay
under existing severance plans and $10.8 related to the impairment of
leasehold improvements. The $6.4 charge for severance under the plan
involves the elimination of approximately 550 employees in contact center
operations and administrative functions.
The Company completed the closure of the centers in 2001 and expects
to complete the employee reductions by the end of the third quarter of
2002. The total cash cost of the plan is expected to be approximately
$20.2. Through the first half of 2002, the Company paid $10.3 of this cost,
consisting primarily of severance payments for approximately 500 employees
and facility closing costs. Except for certain lease termination costs, the
Company expects to pay the remaining restructuring costs by the end of the
third quarter of 2002.
(4) GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002, the Company adopted, on a prospective basis,
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets," which eliminated the amortization of goodwill.
Upon adoption of SFAS No. 142, the Company performed an initial impairment
test of its goodwill and determined that no goodwill impairment existed.
Under SFAS No. 142, goodwill will be tested for impairment at least
annually or more frequently if an event occurs which indicates that
goodwill may be impaired.
The impact of discontinuing amortization of goodwill on net income,
basic and diluted earnings per share for the three and six-month periods
ended June 30, 2001 is as follows:
Three months ended June 30, 2001 Goodwill
Amortization,
As Reported Net of Tax Adjusted
----------- ---------- --------
Net income .......................... $27.3 $ 7.4 $34.7
Basic earnings per common share ..... $0.16 $0.04 $0.20
Diluted earnings per common share ... $0.16 $0.04 $0.20
Six months ended June 30, 2001 Goodwill
Amortization,
As Reported Net of Tax Adjusted
----------- ---------- --------
Net income .......................... $79.4 $15.0 $94.4
Basic earnings per common share ..... $0.47 $0.09 $0.56
Diluted earnings per common share ... $0.45 $0.08 $0.53
6
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
As required by SFAS No. 142, intangible assets that do not meet the
criteria for recognition apart from goodwill must be reclassified. As a
result of the Company's analysis, $19.2 of acquisition costs, net of
accumulated amortization, were transferred to goodwill.
As of June 30, 2002, the Company's other intangible assets consisted
of the following:
Gross Carrying Accumulated
Amount Amortization Net
------ ------------ ---
Software (classified with Property, Plant & Equipment) .... $ 28.9 $(14.6) $14.3
Contracts and other intangibles ........................... 72.7 (37.1) 35.6
------- ------ -----
Total .................................................. $ 101.6 $(51.7) $49.9
Intangible amortization expense for the three and six-month periods
ended June 30, 2002 was $3.6 and $7.1, respectively, and is estimated to be
approximately $14 for the year ending December 31, 2002. Estimated
intangible amortization expense for the four subsequent fiscal years is as
follows:
For the year ended 12/31/03 ............. $14
For the year ended 12/31/04 ............. $14
For the year ended 12/31/05 ............. $11
For the year ended 12/31/06 ............. $1
(5) SHAREHOLDERS' EQUITY
On January 18, 2002, the Company's Board of Directors authorized the
repurchase of up to 10 million of its common shares. During the first six
months of 2002, the Company repurchased 3.9 million common shares at prices
ranging between $18.79 to $31.95 per share for a total cost of $101.4,
$11.8 of which was settled in early July.
(6) SIGNIFICANT CUSTOMERS
Both of the Company's segments derive significant revenues from AT&T
Corporation (AT&T) and AT&T Wireless Services Inc. (AT&T Wireless), which
was spun off from AT&T in July 2001.
Revenues from AT&T Wireless were 18.4% and 17.9% of the Company's
consolidated revenues for the six-month periods ended June 30, 2002 and
June 30, 2001, respectively. Related accounts receivable from AT&T Wireless
totaled $64.1 and $58.1 at June 30, 2002 and December 31, 2001,
respectively.
Revenues from AT&T were 18.3% and 21.0% of the Company's consolidated
revenues for the six-month periods ended June 30, 2002 and June 30, 2001,
respectively. Related accounts receivable from AT&T totaled $47.2 and $49.4
at June 30, 2002 and December 31, 2001, respectively. The relationship with
AT&T includes the Company's use of AT&T communications services, which is
particularly significant to the CMG segment. Spending for these services
with AT&T was $39.8 and $48.6 for the six-month periods ended June 30, 2002
and June 30, 2001, respectively.
7
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
(7) CONTINGENCIES
The Company is from time to time subject to claims and administrative
proceedings that are filed in the ordinary course of business. The Company
believes that the results of any such claims or administrative proceedings,
either individually or in the aggregate, will not have a materially adverse
effect on the Company's financial condition.
(8) BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION
Industry Segment Information
----------------------------
The Company operates in two industry segments, which are identified by
service offerings. IMG provides outsourced billing and information services
and software primarily to the communications industry. CMG provides
outsourced marketing, customer support and employee care services to
clients in various industries including communications, technology and
financial services.
The Company does not allocate activities below the operating income
level to its reported segments. Certain corporate administrative expenses
have been allocated to segments based upon the nature of the expense. The
Company's business segment information is as follows:
Three Months Six Months
Ended June 30, Ended June 30,
---------------- -------------------
Millions of Dollars 2002 2001 2002 2001
------------------- ------ ------ -------- --------
Revenues
IMG ........................................ $231.8 $232.3 $ 468.0 $ 454.9
CMG ........................................ 343.5 341.8 697.7 714.0
Less: intersegment ......................... (2.6) (2.9) (5.5) (6.2)
------ ------ -------- --------
$572.7 $571.2 $1,160.2 $1,162.7
====== ====== ======== ========
Depreciation and Amortization
IMG ........................................ $ 12.4 $ 14.0 $ 23.8 $ 28.0
CMG ........................................ 20.1 28.6 40.3 58.1
Corporate .................................. 1.7 1.6 3.8 3.3
------ ------ -------- --------
$ 34.2 $ 44.2 $ 67.9 $ 89.4
====== ====== ======== ========
Operating Income (Loss) Excluding Special Items
IMG ........................................ $ 50.4 $ 46.6 $ 106.8 $ 91.3
CMG ........................................ 45.7 43.8 89.7 91.2
Corporate .................................. (1.6) (1.2) (3.5) (2.8)
------ ------ -------- --------
$ 94.5 $ 89.2 $ 193.0 $ 179.7
====== ====== ======== ========
Special Item - Acquisition and Integration Costs
IMG ........................................ $ -- $ -- $ -- $ --
CMG ........................................ -- -- -- --
Corporate .................................. -- 31.8 -- 31.8
------ ------ -------- --------
$ -- $ 31.8 $ -- $ 31.8
====== ====== ======== ========
Operating Income (Loss)
IMG ........................................ $ 50.4 $ 46.6 $ 106.8 $ 91.3
CMG ........................................ 45.7 43.8 89.7 91.2
Corporate .................................. (1.6) (33.0) (3.5) (34.6)
------ ------ -------- --------
$ 94.5 $ 57.4 $ 193.0 $ 147.9
====== ====== ======== ========
8
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
Three Months Six Months
Ended June 30, Ended June 30,
------------------- -------------------
Millions of Dollars 2002 2001 2002 2001
------------------- ------ ------ ------ ------
Capital Expenditures (excluding acquisitions)
IMG ............................................. $ 12.5 $ 6.8 $ 24.2 $ 19.3
CMG ............................................. 12.4 16.7 20.1 37.2
Corporate ....................................... 2.7 2.0 3.9 3.7
------ ------ ------ ------
$ 27.6 $ 25.5 $ 48.2 $ 60.2
====== ====== ====== ======
At June 30, 2002
----------------
Goodwill, Net
IMG ........................................... $135.7
CMG ........................................... 533.1
------
$668.8
======
(9) EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominator of
the basic and diluted earnings per share (EPS) computations:
Three Months Ended Net Per Share
June 30, Income Shares Amount
------------------ ------ ------ ------
2002
Basic EPS ............................. $ 59.1 167.3 $ 0.35
Effect of dilutive securities:
Stock-based compensation arrangements . -- 3.6 --
------ ----- ------
Diluted EPS ........................... $ 59.1 170.9 $ 0.35
====== ===== ======
2001
Basic EPS ............................. $ 27.3 169.8 $ 0.16
Effect of dilutive securities:
Stock-based compensation arrangements . -- 5.7 --
------ ----- ------
Diluted EPS ........................... $ 27.3 175.5 $ 0.16
====== ===== ======
9
NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)
Six Months Ended Net Per Share
June 30, Income Shares Amount
---------------- ------ ------ ------
2002
Basic EPS ............................. $118.7 167.7 $ 0.71
Effect of dilutive securities:
Stock-based compensation arrangements -- 4.0 (0.02)
------ ----- ------
Diluted EPS .......................... $118.7 171.7 $ 0.69
====== ===== ======
2001
Basic EPS ............................ $ 79.4 169.6 $ 0.47
Effect of dilutive securities:
Stock-based compensation arrangements -- 5.9 (0.02)
------ ----- ------
Diluted EPS .......................... $ 79.4 175.5 $ 0.45
====== ===== ======
(10) SUBSEQUENT EVENTS
On July 3, 2002, Convergys purchased substantially all of the assets
of TelesensKSCL Limited (in receivership) (Telesens) for approximately $10.
Telesens, of Edinburgh, Scotland and a former subsidiary of TelesensKSCL
AG, of Cologne, Germany, develops and licenses billing systems for voice
and data services for mobile networks in the global telecommunications
industry. The acquisition enables the Company to expand its position as one
of the top billing and customer care companies in the European, Middle
Eastern and Asian markets, opens opportunities to provide advanced billing
and customer care products to Telesens' existing client base and provides
the Company with a talented group of employees.
On July 15, 2002, the Company purchased the iBasis Speech Solutions
(Speech Solutions) line of business from iBasis Inc., a provider of
international Internet-based communication services. The Company paid $17
in cash with an additional $1.5 placed in escrow. Additionally, up to $16
in earn-out payments are possible if Speech Solutions achieves certain
milestones, representing $25 in additional revenues, for calendar years
2002 and 2003. The acquisition of Speech Solutions supplements the
Company's existing customer management and employee care capabilities with
state-of-the-art interactive voice response (IVR) and advanced speech
recognition (ASR) technology allowing for broader account penetration.
Additionally, Speech Solutions provides an advanced technical platform
compatible with existing software and fully scaleable to meet the needs of
the largest clients and, positions the Company in the speech-enabled IVR
market.
On July 23, 2002, Convergys' Board of Directors authorized an increase
in the number of common shares the Company may repurchase to 15 million
from 10 million. As of June 30, 2002, the Company had repurchased 3.9
million shares at a cost of $101.4.
During the month of July, the Company repurchased 2,002,000 additional
shares at a cost of $30.9.
10
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
BACKGROUND
Convergys Corporation (the Company) is a global leader in the provision of
outsourced, integrated billing software and customer and employee care services.
The Company serves its clients through its two operating segments: (i) the
Information Management Group (IMG), which provides outsourced billing and
information services and software; and (ii) the Customer Management Group (CMG),
which provides outsourced marketing, customer support and employee care
services.
FORWARD-LOOKING STATEMENTS
This report may contain "forward-looking" statements, as defined in the
Private Securities Litigation Reform Act of 1995, that are based on current
expectations, estimates and projections. Statements that are not historical
facts, including statements about the beliefs and expectations of the Company,
are forward-looking statements. Sometimes these statements will contain words
such as "believes," "expects," "intends," "should," "will," "plans" and other
similar words. These statements discuss potential risks and uncertainties and,
therefore, actual results may differ materially. You are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date on which they were made. The Company expressly states that it has no
current intention of updating any forward-looking statements, whether as a
result of new information, future events or otherwise.
Important factors that may affect these projections or expectations
include, but are not limited to: the loss of a significant client; difficulties
in completing or integrating acquisitions; terrorist acts or threats of
terrorist acts and the response thereto, and acts of war; changes in the overall
economy; changes in competition in markets in which the Company operates;
changes in the regulatory environment in which the Company's customers operate;
changes in the demand for the Company's services; changes in technology that
impact both the markets served and the types of services offered; and
consolidation within the industries in which the Company's customers operate.
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the condensed
consolidated financial statements and segment data. Detailed comparisons of
revenue and expenses are presented in the discussions of the operating segments,
which follow the consolidated overview discussion. Results for interim periods
may not be indicative of the results for the full years.
Consolidated Overview
- ---------------------
Three Months Ended June 30, 2002 versus Three Months Ended June 30, 2001
Revenues for the second quarter of 2002 totaled $572.7, compared with
$571.2 reported during the second quarter of 2001, reflecting slightly higher
revenues at CMG and essentially flat IMG revenues. Operating expenses for the
second quarter of 2002 totaled $478.2 compared with $472.7 in the same period
last year, excluding a special item and goodwill amortization recorded in the
prior year. The increase in operating expenses reflects higher compensation and
medical costs, partially offset by the savings realized through cost cutting
measures implemented during 2001, primarily related to the rationalization of
CMG's contact center capacity as described in Note 3 of Notes to the Financial
Statements. Operating income was $94.5 in the second quarter of 2002 compared
with $98.5 in the prior year, excluding the prior year special item and goodwill
amortization.
11
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
The Company's equity in earnings of the Cellular Partnership for the second
quarter was $3.0 compared with $2.8 in the prior year. Interest expense
decreased 57% in the second quarter of 2002 to $2.3 from the second quarter of
2001, as a result of significantly lower borrowings and reduced interest rates.
The Company's effective tax rate was 38.1% during the second quarter 2002, which
was an increase from 36.9% in the same period last year, excluding goodwill
amortization and the special item. The increase reflects operating losses being
incurred in certain international jurisdictions with no corresponding tax
benefit. Net income of $59.1 was slightly below the $61.0 in the prior year,
excluding goodwill amortization and the special item recorded in the prior year,
while earnings per diluted share remained flat at $0.35. Earnings per diluted
share reflects the lower average number of diluted shares outstanding, which
resulted from the Company's share repurchase activity including the second
quarter of 2002 repurchase of approximately 2.5 million shares for $55.6.
The Company incurred a special item during 2001 resulting from the Geneva
acquisition totaling $31.8 ($26.3 after tax or $0.15 per share). Additionally,
as disclosed in Note 4 of Notes to the Financial Statements, the Company adopted
SFAS No. 142 as of January 1, 2002, which eliminated $9.3 of goodwill
amortization ($7.4 after tax or $0.04 per diluted share) for the second quarter
of 2001. Including goodwill amortization and the special item recorded during
the second quarter of 2001, reported operating income, net income and diluted
earnings per share for the second quarter of 2001 were $57.4, $27.3 and $0.16,
respectively.
Six Months Ended June 30, 2002 versus Six Months Ended June 30, 2001
Revenues for the first six months of 2002 totaled $1,160.2, slightly lower
than the $1,162.7 reported during the first six months of 2001. The decrease in
revenues reflects lower revenues at CMG, partially offset by growth at IMG.
Operating expenses for the first half of 2002 totaled $967.2 compared with
$964.3 in the same period in 2001, excluding the special item and goodwill
amortization recorded in the prior year. The increase in operating expenses
reflects higher compensation and medical costs, partially offset by the savings
realized through cost cutting measures implemented during 2001. Operating income
was $193.0 in the first six months of 2002 compared with $198.4 in the prior
year, excluding the prior year special item and goodwill amortization,
reflecting higher operating costs on slightly lower revenues.
The Company's equity in earnings of the Cellular Partnership for the first
half of 2002 was $3.9 compared with $4.6 in the prior year. Interest expense
decreased to $5.9 in the first six months of 2002 from $12.5 in the same period
in 2001, as a result of significantly lower borrowings and reduced interest
rates. The fluctuation in other income (expense) primarily reflects foreign
currency losses incurred early in 2002. Excluding the prior year special item
and goodwill amortization, net income of $118.7 was slightly below the $120.7 in
the prior year, while earnings per diluted share of $0.69 was flat with the
prior year. Earnings per diluted share reflects the lower average number of
diluted shares outstanding, which resulted from the Company's repurchase of 3.9
million shares during the first six months of 2002 for $101.4 and 2.6 million
shares during the second half of 2001.
As noted above, the Company recorded a special item during the second
quarter of 2001 resulting from the Geneva acquisition totaling $31.8 ($26.3
after tax or $0.15 per share) and recorded $18.7 ($15.0 after tax or $0.08 per
diluted share) in goodwill amortization. Including goodwill amortization and the
special item, reported operating income, net income and diluted earnings per
share for the six months of 2001 was $147.9, $79.4 and $0.45, respectively.
12
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
INFORMATION MANAGEMENT
Three Months Six Months
($ Millions) Ended June 30, Ended June 30,
-------------------------------- ---------------------------------
2002 2001 Change % 2002 2001 Change %
------ ------ ------------ ------- ------ ------------
Revenues:
Data processing ...................... $139.1 $129.9 $ 9.2 7 $273.0 $256.3 $16.7 7
Professional and consulting .......... 50.5 51.1 (0.6) (1) 103.6 92.3 11.3 12
License and other .................... 12.5 16.4 (3.9) (24) 25.3 31.6 (6.3) (20)
International ........................ 27.1 32.0 (4.9) (15) 60.6 68.5 (7.9) (12)
------ ------ ------ ------- ------ -----
External revenues .................. 229.2 229.4 (0.2) -- 462.5 448.7 13.8 3
Intercompany services ................ 2.6 2.9 (0.3) (10) 5.5 6.2 (0.7) (11)
------ ------ ------ ------- ------ -----
Total revenues ..................... 231.8 232.3 (0.5) -- 468.0 454.9 13.1 3
Costs of products and services ............ 107.1 112.8 (5.7) (5) 217.3 216.2 1.1 1
Selling, general and administrative
expenses ................................ 35.7 33.9 1.8 5 70.6 71.6 (1.0) (1)
Research and development costs ............ 26.2 25.0 1.2 5 49.5 47.8 1.7 4
Depreciation .............................. 11.0 9.5 1.5 16 21.0 19.0 2.0 11
Amortization .............................. 1.4 4.5 (3.1) (69) 2.8 9.0 (6.2) (69)
------ ------ ----- ------- ------ -----
Total costs ........................ 181.4 185.7 (4.3) (2) 361.2 363.6 (2.4) (1)
------ ------ ----- ------- ------ -----
Operating income .......................... $ 50.4 $ 46.6 $ 3.8 8 $106.8 $ 91.3 $15.5 17
Three Months Ended June 30, 2002 versus Three Months Ended June 30, 2001
Excluding intercompany activity, IMG revenues for the second quarter of
2002 remained essentially flat at $229.2. Data processing revenues increased 7%
in the second quarter of 2002 over the second quarter of 2001, reflecting a
combination of factors including: an increase in cable data processing revenues;
modest growth in wireline processing; lower data processing revenues for IP
clients; wireless clients' contractual rate reductions; and 25% wireless
subscriber growth. Professional and consulting revenues decreased slightly to
$50.5 from $51.1 in the prior year reflecting ongoing implementations of Atlys,
IMG's global wireless billing system, for AT&T Wireless and Triton PCS. License
and other revenues decreased 24% to $12.5 in the second quarter of 2002 from
$16.4 in the prior year, reflecting the transition of IMG's license agreement
with AT&T Broadband to a data processing outsourcing agreement. International
revenues for the segment decreased 15% to $27.1, resulting from lower software
license revenues and the completion of the Atlys implementation for Telesp
Celular in first half of 2001.
Overall, IMG's business continues to be affected by the impact of the
global economic weakness in the communications sector. This had led to the
deferral of billing system buying decisions by many carriers as well as
increased pricing pressure.
IMG's operating costs and expenses of $181.4 during the second quarter of
2002 remained relatively flat compared to the prior year, after excluding
goodwill amortization recorded in the prior year. Despite the flat revenues, IMG
continued to invest in research and development and sales and marketing
activities, which resulted in a slight increase in these expenses compared to
the prior year. Additionally, IMG incurred a higher level of depreciation
primarily due to further upgrades of its two data centers. These increases were
offset by lower costs of products and services, which reflects the mix in
revenues. IMG's operating income of $50.4 and operating margin of 22.0% were
about the same as the $50.0 and 21.8% in the prior year, excluding second
quarter 2001 goodwill amortization.
Including goodwill amortization expense of $3.4, IMG's reported operating
income for the second quarter of 2001 was $46.6.
13
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
Six Months Ended June 30, 2002 versus Six Months Ended June 30, 2001
Excluding intercompany revenues, IMG revenues were $462.5 for the first six
months of 2002, a 3% increase from the first six months of 2001. Data processing
revenues increased 7% to $273.0 in the first six months of 2002 compared with
revenues in the same period reflecting a combination of factors including: an
increase in cable data processing revenues; modest growth in wireline
processing; lower data processing revenues for IP clients; wireless clients'
contractual rate reductions; and 26% wireless subscriber growth. Professional
and consulting revenues increased 12% to $103.6 in the first six months of 2002
over the first six months of 2001 reflecting ongoing implementations of Atlys
for AT&T Wireless and Triton and growth in cable broadband services. License and
other revenues decreased 20% to $25.3 in the first six months of 2002 as
compared to the first six months of 2001 resulting from the transition of IMG's
license agreement with AT&T Broadband to a data processing outsourcing
agreement. International revenues decreased 12% to $60.6 in the first six months
of 2002, primarily due to lower license revenues and the completion of the Atlys
implementation for Telesp Celular in the first half of 2001.
The Information Management segment's costs and expenses were $361.2 in the
first six months of 2002, a slight increase over the $357.1 in the first six
months of 2001, excluding goodwill amortization recorded in the prior year. The
increase in costs and expenses for the first six months of 2002 reflects IMG's
increased focus on sales and marketing efforts and increased research and
development efforts.
Including goodwill amortization expense of $6.5, IMG's reported operating
income for the first six months of 2001 was $91.3.
CUSTOMER MANAGEMENT
Three Months Six Months
($ Millions) Ended June 30, Ended June 30,
-------------------------------- ---------------------------------
2002 2001 Change % 2002 2001 Change %
------ ------ ------------ ------- ------ ------------
Revenues:
Communications ...................... $224.4 $215.2 $ 9.2 4 $455.9 $444.1 $ 11.8 3
Technology .......................... 50.0 57.1 (7.1) (12) 104.0 120.2 (16.2) (13)
Financial services .................. 22.7 18.7 4.0 21 42.6 40.5 2.1 5
Other ............................... 46.4 50.8 (4.4) (9) 95.2 109.2 (14.0) (13)
------ ------ ----- ------ ------ ------
Total revenues ................. 343.5 341.8 1.7 -- 697.7 714.0 (16.3) (2)
Costs of products and services ........... 210.5 201.6 8.9 4 429.2 423.6 5.6 1
Selling, general and administrative
expenses ............................... 64.2 64.2 -- -- 132.6 134.5 (1.9) (1)
Research and development costs ........... 3.0 3.6 (0.6) (17) 5.9 6.6 (0.7) (11)
Depreciation ............................. 17.9 20.5 (2.6) (13) 36.0 41.8 (5.8) (14)
Amortization ............................. 2.2 8.1 (5.9) (73) 4.3 16.3 (12.0) (74)
------ ------ ----- ------ ------ ------
Total costs .................... 297.8 298.0 (0.2) -- 608.0 622.8 (14.8) (2)
------ ------ ----- ------ ------ ------
Operating income ......................... $ 45.7 $ 43.8 $ 1.9 4 $ 89.7 $ 91.2 $ (1.5) (2)
14
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
Three Months Ended June 30, 2002 versus Three Months Ended June 30, 2001
CMG revenues were $343.5 in the second quarter of 2002, slightly higher
than the $341.8 in the second quarter of 2001. Revenues from communications
clients were $224.4, a 4% increase from the second quarter of 2001, resulting
from strong growth in services provided to DirecTV and Sprint offset by reduced
spending by AT&T. Revenues from the financial services sector increased 21% to
$22.7 reflecting an increase in volume from CMG's largest client in the
financial services sector. The decrease in revenues from technology clients
during the second quarter of 2002 compared to the prior year resulted primarily
from reduction in spending by certain PC manufacturing clients.
CMG's costs and expenses were $297.8 in the second quarter of 2002, a 2%
increase from the prior year, excluding prior year goodwill amortization. The
increase in operating costs and expenses reflects higher wage, salary and
medical benefits costs, partially offset by the savings realized through the
restructuring activities initiated during the third quarter of 2001. CMG's
operating income decreased 8% to $45.7 and operating margin decreased to 13.3%
from 14.5% in the second quarter of 2001, excluding prior year goodwill
amortization. The lower operating margin resulted from increases in compensation
and medical costs.
Including goodwill amortization of $5.9 recorded in the prior year, CMG's
reported operating income for the second quarter of 2001 was $43.8.
Six Months Ended June 30, 2002 versus Six Months Ended June 30, 2001
CMG revenues were $697.7 in the first six months of 2002, a 2% decrease
from the same period in 2001, reflecting reduced spending by AT&T, partially
offset by double-digit revenue increases with six of CMG's top ten clients.
Revenues from communications clients were $455.9, an increase of 3% compared
with the first six months of 2001, resulting from strong growth in services
provided to DirecTV and Sprint offset by reduced spending by AT&T. Revenues from
the financial services sector increased 5% to $42.6 reflecting an increase in
volume from CMG's largest client in the financial services sector. The decreases
in revenues from technology and other industries during the first half of 2002
compared to the prior year reflect the continued general economic weakness and
its impact on client spending for customer support services.
CMG's costs and expenses of $608.0 were essentially flat compared with the
first six months of 2001, excluding prior year goodwill amortization. The flat
operating expenses reflect the costs savings realized through the restructuring
activities initiated during the third quarter of 2001, offset by higher wage,
salary and medical benefits costs. CMG's operating income decreased 13% to $89.7
and operating margin decreased to 12.9% from 14.5% in the first half of 2001,
excluding prior year goodwill amortization. The lower operating margin reflects
the impact of lower revenues and higher wage, salary and medical costs,
partially offset by cost savings related to the third quarter 2001
rationalization of CMG's contact centers.
Including goodwill amortization of $12.2 recorded in the prior year, CMG's
reported operating income for the first half of 2001 was $91.2.
15
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
CLIENT CONCENTRATION
The Company's four largest clients accounted for 55.0% and 53.7% of its
revenues in the first six months of 2002 and 2001, respectively. The risk posed
by this revenue concentration is reduced by the long-term contracts the Company
has with its largest clients. The Company serves AT&T Wireless, its largest
client at 18.4% of revenues in the first half of 2002, under a customer
management contract that expires in 2006 and an information management contract
that expires in 2008. AT&T, the Company's second largest client at 18.3% of
revenues in the first half of 2002, is principally served under a long-term
information management contract that expires at the end of 2002 and customer
management contract that expires in 2009. Sprint, the Company's third largest
client, is served under a contract with CMG that expires during the second
quarter of 2003 and a contract with IMG that expires at the end of 2004.
DirecTV, the Company's fourth largest client in the first six months of 2002, is
served by CMG under a contract that expires at the end of 2003. Volumes under
certain of the Company's long-term contracts with its four largest clients are
subject to variation based, among other things, on the client's spending on
outsourced customer support and subscriber levels.
FINANCIAL CONDITION
Liquidity and Capital Resources
- -------------------------------
The Company generated $118.9 and $174.6 in cash flows from operating
activities during the first six months of 2002 and 2001, respectively. The
Company's cash flows from operating activities for the first six months of 2002
reflect a $20.0 repayment in borrowings under its accounts receivable
securitization program, compared to a $30.0 repayment during the first six
months of 2001.
Operating cash flows have historically been more than sufficient to fund
the Company's cash needs, other than for very large acquisitions. With the
exception of the Geneva transaction, acquisitions have historically been
financed with a combination of borrowings and operating cash flows. At June 30,
2002, the Company had $122.1 of borrowings outstanding. The Company's borrowing
facilities include a credit facility with $325 in borrowing capacity that
expires in July 2005 and $100 in notes which expire in September 2002. The
Company also has a $150 accounts receivable securitization agreement, under
which it had no outstanding borrowings at June 30, 2002. The accounts receivable
securitization agreement expires in September 2002 and it is anticipated that
the agreement will be renewed at that time. The expiration of the $100 notes
will be financed with a combination of borrowings from the Company's other
borrowing facilities and operating cash flow. The Company anticipates that
future operating cash flows, its available credit under existing facilities and
its access to capital markets will be sufficient to meet future capital needs.
Synthetic Lease
- ---------------
The Company is a party to a financing transaction related to its office
complex in Orlando, Florida, which was constructed for total costs of
approximately $65. Under the terms of the financing transaction, which was
structured as a synthetic lease, a special purpose trust owns the office complex
and leases it to the Company. No Company employee or director holds any
ownership interest in the trust. The lease has an initial term of three years,
with two one-year renewal options. As the initial term expired at the end of
2001, the Company exercised the first one-year renewal option and anticipates
that it will elect to exercise the second. The Company's lease payment includes
a variable interest component, but the Company has effectively converted it to a
fixed rate of 4.49% through an interest rate swap with a nominal value of $65.
As the lease qualifies as an operating lease and the bank, the owner of the
special purpose trust (the Trust), has made a substantive residual equity
investment, the transaction is accounted for off-balance sheet and the related
costs are reported as rent expense. Furthermore, the synthetic lease provides
that the Company's maximum obligation, including the guaranteed residual value,
will not be greater than 89.9% of the total construction costs. As of June 30,
2002, the assets and liabilities of the special purpose trust were comprised
primarily of the office complex and $65 bank debt used to fund the construction
of the office complex. In connection with these financing transactions, the
Company has made a residual value guarantee for the leased property equal to 85%
of the financing, or $55.
16
MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)
On June 28, 2002, the Financial Accounting Standards Board issued an
exposure draft, Consolidation of Certain Special-Purpose Entities, which if
adopted in its current form, could require the Company to consolidate the assets
and liabilities of the Trust. The consolidation requirement would be effective
April 1, 2003. In response to this pending pronouncement, the Company is
considering various refinancing and purchase options related to the office
complex.
Balance Sheet
- -------------
Adjusting for a $20.0 reduction in the balance of receivables sold under
the Company's accounts receivable securitization program, accounts receivable
increased $30.1 from December 31, 2001 to June 30, 2002. Excluding the effects
of the securitization, days sales outstanding increased by 6 days during the
first half of 2002 to 74 days. About one half of the increase is due to a timing
issue in which a payment from a large customer was received immediately after
June 30, 2002. Treasury stock increased from December 31, 2001 as the Company
repurchased 3.9 million shares during the first half of 2002 for a total cost of
$101.4, $11.8 of which was settled in early July.
Foreign Currency and Interest Rate Risk
- ---------------------------------------
The Company derived 7% of its first half 2002 consolidated revenues from
outside of North America. The Company's activities expose it to a variety of
market risks, including the effects of changes in foreign currency exchange
rates and interest rates. The Company's risk management strategy includes the
use of derivative instruments to reduce the effects on its operating results and
cash flows from fluctuations caused by volatility in currency exchange and
interest rates. In using derivative financial instruments to hedge exposures to
changes in exchange rates and interest rates, the Company exposes itself to some
counterparty credit risk. The Company manages exposure to counterparty credit
risk by entering into derivative financial instruments with highly rated
institutions that can be expected to fully perform under the terms of the
agreements and by diversifying the number of financial institutions with which
it enters into such agreements.
The Company currently uses cash flow hedges for foreign currency and
interest rate exposure. These instruments are hedges of forecasted transactions
or of the variability of cash flows to be received or paid related to a
recognized asset or liability. The Company generally enters into forward
exchange contracts expiring within one year as hedges of anticipated cash flows
denominated in foreign currencies. These contracts are entered into to protect
against the risk that the eventual cash flows resulting from such transactions
will be adversely affected by changes in exchange rates.
The Company is exposed to market risk from its variable rate borrowings. At
June 30, 2002, the Company had $118.0 in outstanding variable rate borrowings.
The Company entered into an interest rate swap agreement to effectively fix the
interest rate for $100 of variable rate borrowings. The swap agreement exposes
the Company to credit risk in the event the counterparty could not perform under
the agreement. The Company managed this risk by entering into the interest rate
swap agreement with a highly rated financial institution. Based upon the
Company's exposure to variable rate borrowings, a one percent point change in
the weighted average interest rate would change the Company's annual interest
expense by approximately $0.2.
Fluctuations in Quarterly Results
- ---------------------------------
The Company has experienced, and in the future could experience, quarterly
variations in revenues as a result of a variety of factors, many of which are
outside of the control of the Company. These factors include: economic cycles,
the timing of new contracts, the timing of increased expenses incurred in
support of new business, the timing and frequency of client spending for system
enhancement requests, the timing of contractual rate reductions triggered by
subscriber growth or the passage of time and the seasonal pattern of the CMG
business.
17
Item 4. Submission of Matters to a Vote of Security Holders
- -----------------------------------------------------------
There were no matters submitted to a vote of security holders during the
first quarter of 2002. The Company's annual meeting of shareholders was held on
April 23, 2002 in Cincinnati, Ohio, at which the following matters were
submitted to a vote of the shareowners:
(a) Votes regarding the election of three Directors for a term expiring in 2005
were as follows:
For Against
----------- ---------
David B. Dillon 141,253,358 1,733,263
Eric C. Fast 140,625,533 2,361,088
Sidney A. Ribeau 140,533,763 2,452,858
Additional Directors, whose terms of office as Directors continued after the
meeting, are as follows:
Term expiring in 2003: John F. Barrett
Joseph E. Gibbs
Steven C. Mason
James F. Orr
Term expiring in 2004: Gary C. Butler
Roger L. Howe
Philip A. Odeen
James M. Zimmerman
(b) Votes on a proposal to amend the 1998 Long Term Incentive Plan were as
follows:
For 92,550,062
Against 48,650,794
Abstentions 1,785,764
Broker non-votes None
(c) Votes on a proposal to approve the Annual Executive Incentive Plan were as
follows:
For 129,273,622
Against 11,906,232
Abstentions 1,806,766
Broker non-votes None
Item 6. Exhibits and Reports on Form 8-K
- ----------------------------------------
(a) Exhibits.
The following is filed as an Exhibit to Part I of this Form 10-Q:
Exhibit
Number
------
12 Computation of Ratio of Earnings to Fixed Charges
(b) Reports on Form 8-K.
None.
18
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Convergys Corporation
Date: August 13, 2002 /s/ Steven G. Rolls
----------------------------------
Steven G. Rolls
Chief Financial Officer
19