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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 March 31, 2003

OR

o

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 o.

At April 30, 2003, 174,021,636 Common Shares were outstanding, of which 26,065,457 were held in Treasury.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Act of 1934). Yes x No o

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PART I - FINANCIAL INFORMATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Amounts in Millions, Except Per Share Amounts)

See Notes to Financial Statements.

2

CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Millions)

See Notes to Financial Statements.

3

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Millions)

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 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 services 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, 2002 condensed balance sheet has been derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles in the United States of America. It is suggested that these financial statements are 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 been reclassified to conform to current period presentation.

The Company files annual, quarterly, special reports and proxy statements with the SEC. These filings are available to the public over the Internet on the SEC’s Web site at http://www.sec.gov and on the Company’s Web site at http://www.convergys.com. You may also read and copy any document the Company files with the SEC at its public reference facilities in Washington, D.C. You can also obtain copies of the documents at prescribed rates by writing to the Public Reference Section of the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference facilities. You can also inspect reports, proxy statements and other information about Convergys at the offices of the New York Stock Exchange, 20 Broad Street, New York, New York 10005.

(2)

RECENT ACCOUNTING PRONOUNCEMENTS

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” an interpretation of ARB No. 51, “Consolidated Financial Statements.” Interpretation No. 46 changes the criteria currently used by companies in deciding whether it is required to consolidate another entity. As discussed further in Item II under the heading “Financial Condition,” the Company leases an office complex from a special purpose entity (Trust), which under existing rules, the Company does not consolidate. The Company has concluded that the Trust qualifies as a variable interest entity, as defined by Interpretation No. 46, and that the Company is the primary beneficiary of the Trust. Accordingly, if the Company elects to keep the existing lease structure in place, it will be required to consolidate the assets and liabilities of the Trust beginning July 1, 2003. This would result in an after-tax charge, which the Company has not yet quantified, reflecting a cumulative effect of change in method of accounting.

In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123.” This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The additional disclosures have been included in Note 7. Since the Company has not elected to change from the intrinsic value method to the fair value method, the provisions related to the transition methods had no impact on the Company’s financial statements.

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NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)

In November 2002, the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables,” providing further guidance on how to account for multiple element contracts. Issue No. 00-21 is effective for all arrangements entered into after the second quarter of 2003. Although the Company currently is evaluating the impact of this new guidance, it is not expected to have a material impact on the Company’s accounting treatment of multiple element contracts.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit and Disposal Activities.” This pronouncement is effective for exit or disposal activities that are initiated after December 31, 2002, and requires these costs to be recognized when the liability is incurred and not at the project initiation. The adoption of this statement will impact the timing of exit costs, primarily related to lease terminations, associated with future restructuring charges. Under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),” these costs were accrued when the Company committed to an exit plan. Under SFAS No. 146, exit costs related to future restructuring plans will be expensed as the costs are incurred.

(3)

ACQUISITIONS

In February 2003, the Company acquired Cygent, Inc. (Cygent), a software provider of a Web-based customer, order and service management platform for the communications industry. The purchase price was less than $5. The acquisition of Cygent is expected to expand the Company’s offering to the global communications market place, especially in the wireline market.

In July 2002, the Company purchased substantially all the assets of iBasis Speech Solutions, Inc. (Speech Solutions), a wholly owned subsidiary of iBasis, Inc., a provider of international Internet-based communication services. The Company paid approximately $19, subject to final purchase price adjustments. Additionally, up to $8 in earn-out payments are possible if Speech Solutions achieves certain revenue milestones during 2003. No earn-out payments were made related to 2002 milestones. 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.

Also in July 2002, the Company purchased substantially all of the assets of TelesensKSCL Limited (in receivership) (Telesens) for approximately $10. Telesens, of Edinburgh, Scotland, and a 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, and opens opportunities to provide advanced billing and customer care products to Telesens’ existing client base. As discussed further in Note 9, the Company is a defendant in a lawsuit filed by former employees of Telesens.

6

NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)

(4)

BUSINESS RESTRUCTURING AND ASSET IMPAIRMENT

As discussed more fully in the “Business Restructuring and Asset Impairment” note to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, the Company announced a restructuring plan during the fourth quarter of 2002 in response to continued economic weakness. The restructuring plan includes a reduction in headcount affecting approximately 1,050 professional and administrative employees worldwide and the consolidation or closure of certain CMG and IMG facilities. The Company began the facility closures during the fourth quarter of 2002 and expects to complete them by the end of the third quarter of 2003. The Company began to make the headcount reductions during the fourth quarter of 2002 and expects to complete them by the end of 2003. The restructuring plan resulted in $26.0 of severance costs, $49.5 of facility abandonment costs associated with ongoing lease obligations and $6.7 of asset impairment for the disposal of leasehold improvements and equipment for the facilities that the Company had abandoned by the end of 2002. Additionally, the Company recorded $12.7 in asset impairments, consisting principally of purchase software that the Company will not deploy or further market.

In addition, as more fully discussed in Note 5 of the Company’s 10-K for the year ended December 31, 2002, the Company had an accrued liability pertaining to its 2001 restructuring initiatives. As of March 31, 2003, there was a remaining restructuring accrual of $3.7 related to ongoing facility and abandonment costs which the Company will pay over the remaining lease terms.

The facility abandonment component of the charge is equal to the future costs associated with those abandoned facilities, net of the proceeds from any probable future sublease agreements. The Company has used estimates, based on consultation with real estate advisors, to arrive at the proceeds from any future sublease agreements. The Company will continue to evaluate its estimates in recording the facilities abandonment charge. Consequently, there may be additional charges or reversals in the future.

During the fourth quarter of 2002, CMG also recorded $12.8 of additional facility abandonment costs associated with the contact centers that were closed in connection with the restructuring plan initiated by CMG during the third quarter of 2001.

These actions are expected to result in cash costs of $86.8, of which the Company had spent $11.9 through the first quarter of 2003 related principally to facility abandonment costs and severance payments for approximately 700 employees. Except for ongoing facility abandonment, which will be paid over several years as the leases expire, the cash payments will be made throughout 2003.

Restructuring liability activity for the 2002 and 2001 plans consisted of the following:

(5)

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 Company performed its annual impairment tests during the fourth quarter of 2002 and concluded that no goodwill impairment existed.

7

NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)

As of March 31, 2003, the Company’s other intangible assets acquired through business combinations consisted of the following:

Intangible amortization expense for the three-month periods ended March 31, 2003 and March 31, 2002 was $3.7 and $3.5, and is estimated to be approximately $15 for the year ending December 31, 2003. Estimated intangible amortization expense for the four subsequent fiscal years is as follows:

The intangible assets are being amortized using the following amortizable lives: six years for software; and two to ten years for contracts and other. The weighted average amortization period for intangible assets is seven years (six years for software, eight years for contracts and other).

(6)

SHAREHOLDERS’ EQUITY

On February 25, 2003, the Company’s Board of Directors authorized the repurchase of an additional 10 million of its common shares. During the first three months of 2003, the Company repurchased 4.9 million common shares pursuant to this authorization at prices ranging between $11.43 and $13.14 per share for a total cost of $60.6. Due to timing, $7.9 was settled in early April and, therefore, reflected as an other current liability as of March 31, 2003.

On January 18, 2002, the Company’s Board of Directors authorized the repurchase of up to 10 million of its common shares. The number of shares authorized for repurchase was increased to 15 million on July 23, 2002. During the first three months of 2002, the Company repurchased 1.5 million common shares pursuant to this authorization for a total cost of $45.8.

(7)

STOCK-BASED COMPENSATION PLANS

At March 31, 2003, the Company had authorized 38 million common shares for issuance under the Convergys Corporation 1998 Long-Term Incentive Plan (Convergys LTIP), as amended on February 26, 2002. The Convergys LTIP provides for the issuance of stock options and other stock-based awards to certain employees. In general, stock options are granted with exercise prices that are no less than market value of the stock at the grant date, have a ten-year term and have vesting terms of three to four years. Convergys accounts for its stock-based compensation plan under the intrinsic value method of accounting as defined by APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations.

The Convergys LTIP also permits the granting of other restricted stock awards, which generally have vesting terms of three to five years. During the restriction period, restricted stock awards entitle the holder to all the rights of a holder of common shares, including dividend and voting rights. Unvested shares are restricted as to disposition and subject to forfeiture under certain circumstances.

The Company’s operating results for the three-month periods ending March 31, 2003 and March 31, 2002 reflect the recognition of $2.3 and $2.7, respectively, in compensation expense related to restricted stock. Additionally, the Company’s operating results for the three-month periods ending March 31, 2003 and March 31, 2002 reflect the recognition of $0.6 and $0.5, respectively, in compensation expense related to the options outstanding in connection with the Geneva Acquisition in April 2001.

8

NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)

The effect on net income and earnings per share if the Company had accounted for stock options under the fair value method of accounting under SFAS No. 123, as amended by SFAS No. 148, is as follows:

The weighted average fair value on the date of grant for the Convergys options granted during the three months ended March 31, 2003 and March 31, 2002 was $4.97 and $14.27, respectively. Such amounts were estimated using the Black-Scholes option pricing model with the following weighted average assumptions:

(8)

SIGNIFICANT CUSTOMERS

Both of the Company’s segments derive significant revenues from AT&T Wireless Services, Inc. (AT&T Wireless) and AT&T Corporation (AT&T).

Revenues from AT&T Wireless were 20.4% and 18.1% of the Company’s consolidated revenues for the three-month periods ended March 31, 2003 and March 31, 2002, respectively. Related accounts receivable from AT&T Wireless totaled $72.0 and $75.2 at March 31, 2003 and December 31, 2002, respectively.

Revenues from AT&T were less than 10% of the Company’s consolidated revenues for the three-month period ended March 31, 2003. Revenues from AT&T were 11.0% of the Company’s consolidated revenues for the three-month period ended March 31, 2002. Related accounts receivable from AT&T totaled $30.5 and $29.3 at March 31, 2003 and December 31, 2002, respectively.

(9)

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.

9

NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)

The Company has been named as an additional defendant in a class action lawsuit filed by former employees of Telesens against Telesens (in receivership) and the three individual receivers (Receivers). The former employees were made redundant by the Receivers prior to the acquisition of Telesens’ assets by the Company. The action seeks damages of approximately $14. If upon completion of discovery, the Company concludes that it is probable that a liability has been incurred and the amount can be reasonably estimated, the Company’s estimate of probable exposure would be treated as additional purchase price consideration. If the Company concludes that no estimate can be made pending further negotiations with the claimant, then the allocation period would end and any subsequent settlement would be charged to earnings. In the event of an adverse judgment, the Company believes that the results of the claim would not have a materially adverse effect on the Company’s financial condition.

(10)

BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION

Industry Segment Information

The Company has two segments, which are identified by service offerings. IMG provides outsourced billing and information services and software. CMG provides outsourced customer care and employee care services.

The Company does not allocate activities below the operating income level to its reported segments. The Company’s business segment information is as follows:

10

NOTES TO FINANCIAL STATEMENTS
(Amounts in Millions Except Per Share Amounts)

(11)

EARNINGS PER SHARE

The following is a reconciliation of the numerator and denominator of the basic and diluted earnings per share (EPS) computations:

The diluted EPS calculation for the three months ended March 31, 2003 excludes the effect of 16.8 million outstanding stock options because they are anti-dilutive.

(12)

SUBSEQUENT EVENTS

On April 22, 2003, the Company’s Board of Directors authorized the repurchase of up to 10 million of its common shares. This is in addition to the 10 million share repurchase authorization the Board approved on February 25, 2003.

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ITEM 2.

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 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 contains “forward-looking” statements, as defined in the Private Securities Litigation Reform Act of 1995, that are based on current expectations, estimates and projections. Statements that are not historical facts, including statements about the beliefs and expectations of the Company, are forward-looking statements. 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 to update 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 consequence of terrorist attacks and the responses of the United States and other nations to such attacks; the loss of a significant client; difficulties in completing or integrating acquisitions; changes in the overall economy; changes in competition in markets in which the Company operates; changes in the regulatory environment in which the Company’s clients operate; changes in the demand for the Company’s services; changes in technology that impact both the markets served and the types of services offered; and, consolidation within the industries in which the Company’s customers operate.

RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the condensed consolidated financial statements and segment data. Detailed comparisons of revenue and expenses are presented in the discussions of the operating segments, which follow the consolidated results discussion. Results for interim periods may not be indicative of the results for the full years.

Consolidated Overview

Three Months Ended March 31, 2003 versus Three Months Ended March 31, 2002

The Company’s revenues for the first quarter of 2003 totaled $560.4, a 5% decrease from the first quarter of 2002. The revenue decrease is attributable to a 16% decrease in IMG revenues, offset by a 3% increase at CMG. The Company’s operating income was $68.5 in the first quarter of 2003 versus $98.5 in the prior year. This 30% decrease reflects the revenue decrease, the change in revenue mix and a $10.3 increase in selling, general and administrative expenses. Partially offsetting these items were $3.0 in lower research and development costs and $2.4 in lower costs of providing services. The increase in selling, general and administrative expenses reflects further expansion in IMG’s international operations and of CMG’s employee care operations. Research and development expenses decreased as a result of lower spending at both IMG and CMG. The decrease in costs of providing services was principally due to the decline in IMG revenues and savings that resulted from the restructuring actions that the Company initiated during the fourth quarter of 2002, partially offset by higher direct labor costs at CMG.

12

MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)

During the first quarter of 2003, the general partner of the Cellular Partnership settled a complaint against the Cellular Partnership for $22.0. The Company’s share of this loss was $9.9, which it recorded as a loss from its equity investment in the partnership. Including this settlement, the Cellular Partnership generated an equity loss of $9.9 in the first quarter of 2003 versus earnings of $0.9 in the first quarter of 2002.

Interest expense decreased 58% in the first quarter of 2003 from the first quarter of 2002, resulting from lower interest rates. The Company’s effective tax rate was 37.0% for the three months ended March 31, 2003, versus 36.75% during the three months ended March 31, 2002.

Net income in the first quarter of 2003 was $34.9, a 41% decrease from $59.6 in the first quarter of 2002. As a result of the Company’s 2002 and first quarter 2003 share repurchases, earnings per diluted share decreased by only 37% to $0.22 from $0.35 in the first quarter of 2002. This includes the $9.9 ($6.4 after tax or $0.04 per diluted share) equity loss resulting from the Cellular Partnership settlement.

INFORMATION MANAGEMENT

Three Months Ended March 31, 2003 versus Three Months Ended March 31, 2002

Revenues

13

MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)

Professional and consulting revenues for the first quarter of 2003 decreased 50% from the first quarter of 2002 as a result of decreased enhancement requests from its wireless and cable clients. IMG’s license and other revenues increased 6% to $13.6 in the first quarter of 2003, reflecting the expansion of IMG’s relationship with one of its largest cable clients. IMG’s international revenues increased 12% to $37.4, reflecting combined revenue growth of approximately $11 resulting from the July 2002 acquisition of Telesens and IMG’s expansion in the Asian Pacific and Latin American regions, partially offset by lower software sales from existing European and Middle Eastern markets.

Costs and Expenses

IMG’s costs of products and services decreased 10% to $99.0 in the first quarter of 2003 from the first quarter of 2002 reflecting lower revenues and approximately $6 in savings resulting from the fourth quarter restructuring actions. Selling, general and administrative expenses increased 13%, reflecting IMG’s further expansion in its international operations, particularly in the Asian Pacific market. Research and development expenses decreased 6% reflecting savings resulting from the restructuring initiatives. Depreciation expense decreased 22% reflecting a recent slowdown in capital expenditures, $0.6 in lower depreciation resulting from assets that were disposed during the fourth quarter of 2002 and $0.5 of depreciation related to assets that were transferred from IMG to Corporate at the beginning of the 2003.

Operating Margin

As a result of the foregoing, operating income and operating margin decreased to $28.2 and 14.3% from $56.4 and 24.2% in the prior year.

CUSTOMER MANAGEMENT

14

MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)

Three Months Ended March 31, 2003 versus Three Months Ended March 31, 2002

Revenues

CMG’s revenues were $363.7 in the first quarter of 2003, a 3% increase from the first quarter of 2002, reflecting increased levels of business with several of CMG’s top twenty clients including several clients in the financial services sector. Also contributing to the increase was the July 2002 acquisition of Speech Solutions, a division of iBasis, Inc., which generated revenues of approximately $5.0 in the first quarter of 2003. This was offset by $7.0 in lower revenues associated with the divestiture of two international contact centers. Revenues from communications clients were $229.9, a 1% decrease in the first quarter of 2003 over the first quarter of 2002. This reflects 38% growth in services provided to CMG’s largest wireless client, offset by a 29% reduction in spending by CMG’s largest long distance client. Technology service revenues remained flat compared to the first quarter of 2002, reflecting a 100% increase in spending by CMG’s largest PC client, offset by lower revenues from CMG’s largest software client. Revenues from financial services clients increased 56% to $31.0 as a result of an increase in volume from CMG’s three largest clients in the financials services sector. Other revenues remained flat compared to the first quarter of 2002.

Costs and Expenses

CMG’s costs and expenses increased 3% from the first quarter of 2002 to $320.7 reflecting the higher volume of revenues and a 2% increase in direct labor costs as a percentage of revenue. The increase in direct labor costs as a percentage of revenues resulted from higher wage, medical and benefit costs, partially offset by lower labor costs incurred as a result of increased utilization of CMG’s Indian operations. Selling, general and administrative expenses were $73.1 in the first quarter of 2003, a 7% increase compared to the prior year, reflecting higher medical and pension benefit costs and approximately $2 in increased costs incurred in connection with further investment in CMG’s employee care business. This was partially offset by $0.5 in cost savings realized through restructuring activities initiated during the fourth quarter of 2002. Depreciation expense increased 2% or $0.3 during the first quarter of 2003, reflecting CMG’s further investment in its contact centers in India. Although CMG did record less depreciation as a result of assets that were disposed of during the fourth quarter of 2002, this was offset by the acceleration of depreciation related to leasehold improvements and equipment that will be disposed of during 2003 as CMG completes its facility closures. CMG’s research and development expenses decreased $1.6 from the first quarter of 2002 as CMG concentrated more of its technical resources on client service and administration rather than on research and development initiatives.

Operating Income

As a result of the foregoing, CMG’s operating income and margin decreased to $43.0 and 11.8%, down from $44.0 and 12.4% in the first quarter of 2002, respectively.

Business Restructuring and Asset Impairment

As discussed more fully in the “Business Restructuring and Asset Impairment” note to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, the Company announced a restructuring plan during the fourth quarter of 2002 in response to continued economic weakness. The restructuring plan includes a reduction in headcount affecting approximately 1,050 professional and administrative employees worldwide and the consolidation or closure of certain CMG and IMG facilities. The Company began the facility closures during the fourth quarter of 2002 and expects to complete them by the end of the third quarter of 2003. The Company began to make the headcount reductions during the fourth quarter of 2002 and expects to complete them by the end of 2003. The restructuring plan resulted in $26.0 of severance costs, $49.5 of facility abandonment costs associated with ongoing lease obligations and $6.7 of asset impairment for the disposal of leasehold improvements and equipment for the facilities that the Company had abandoned by the end of 2002. Additionally, the Company recorded $12.7 in asset impairments, consisting principally of software that the Company will not deploy or further market.

15

MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)

The facility abandonment component of the charge is equal to the future costs associated with those abandoned facilities, net of the proceeds from any probable future sublease agreements. The Company has used estimates, based on consultation with real estate advisors, to arrive at the proceeds from any future sublease agreements. The Company will continue to evaluate its estimates in recording the facilities abandonment charge. Consequently, there may be additional charges or reversals in the future.

During the fourth quarter of 2002, CMG also recorded $12.8 of additional facility abandonment costs associated with the contact centers that were closed in connection with a restructuring plan initiated by CMG during the third quarter of 2001.

These actions are expected to result in cash costs of $86.8, of which the Company had spent $11.9 through the first quarter of 2003 related principally to facility abandonment costs and severance payments for approximately 700 employees. Except for ongoing facility abandonment, which will be paid over several years as the leases expire, the cash payments will be made throughout 2003. Completion of these actions is expected to result in annual operating expense savings of approximately $80, which should be fully realized during 2004. During the first quarter of 2003, the Company realized approximately $9 in savings as a result of these initiatives.

The reduction in the number of employees was based on the Company’s estimate of the future size and scope of its operations. To the extent that the Company has misjudged its future employee and facility capacity requirements, it may need to hire additional employees or obtain additional facilities if its business expands faster than anticipated. This would cause its expenses to increase and, if the Company was unable to service such expanded business, could cause it to forego opportunities to increase its revenues. Conversely, the Company may need to institute further cost-cutting measures if its business decreases unexpectedly.

BUSINESS OUTLOOK

Current economic factors and other events may have a significant impact on the Company’s future period results; for example: the continuing slowness of the global economy; lower spending by telecom carriers; slowing subscriber growth by leading wireless carriers; loss of clients; and limited new marketing spending by carriers. Additionally, because of the recent slowdown in the wireless communications business and increasing competition within our industry, the trend of granting subscriber rate reductions and cash signing bonuses in exchange for extensions of existing contractual relationships may continue, resulting in a negative near-term impact on the Company’s revenues, operating income and cash flows. The Company, as most other companies, has experienced during the quarter and will continue to see increased costs for wages and benefits, including pension and health care.

For the full year of 2003, CMG revenue could increase 6% to 11% from the 2002 level, and operating margin could be from 11% to 13%. CMG second quarter revenue could be up slightly from the first quarter level as revenue from a customer care contract with the U.S. Postal Service increases and CMG begins to provide its first phase of employee care services to the State of Florida employees under a seven-year employee care outsourcing arrangement. Operating margin could experience slight pressure from the first quarter level as a result of continued investment in our Employee Care business.

For the full year of 2003, IMG revenues could decline 7% to 15% from 2002 levels and operating margin could be from 15% to 19%. In the second quarter of 2003, IMG’s revenues could be flat or slightly higher than the first quarter of 2003 as international revenues may increase further, partially offsetting continued declines in professional and consulting revenues. As the benefits related to the fourth quarter restructuring initiatives continue to have a greater impact, IMG’s operating margin for the second quarter of 2003 should improve from the first quarter.

16

MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)

Despite IMG’s recent negative revenue trend, the Company believes that the long-term outlook for billing information systems and services is positive. Based on data from Gartner Dataquest, a leading industry analysis company, the Company estimates that the market for billing information systems and services is estimated to grow 4% annually over the next three years. IMG would benefit from this growth from existing wireless clients. In addition, to offset subscriber rate reductions, IMG must increase its volume with existing clients through delivery of new services and products. Also, IMG must capture new wireless clients, both domestically and internationally, representing service providers that will outgrow their current billing systems and be in the market for more advanced billing systems, which will enable them to bill for the broad range of wireless and other services that will be necessary for these service providers to compete.

CLIENT CONCENTRATION

The Company’s five largest clients accounted for 53.3% and 54.5% of its revenues in the first quarter of 2003 and 2002, respectively. The risk posed by this revenue concentration is reduced somewhat by the long-term contracts the Company has with its largest clients. The Company serves AT&T Wireless, its largest client with 20.4% of revenues in the first quarter of 2003 and Sprint PCS, the Company’s second largest client, under an information management contract and two customer management contracts. DIRECTV, the Company’s third largest client in the first quarter of 2003, is served by the Company under a customer management contract. AT&T, the Company’s fourth largest client, and Comcast, the Company’s fifth largest client in the first quarter of 2003, are served by the Company under both an information management contract and a customer management contract. Volumes under certain of the Company’s long-term contracts are subject to variation based, among other things, on the clients’ spending on outsourced customer support and subscriber levels.

The Company’s Information Management Group contract with Sprint PCS runs through 2004. In 2002, IMG generated approximately $150 in revenue from Sprint PCS, and IMG continues to operate its systems to process billing and usage for Sprint subscribers. The Company’s 2003 guidance assumes lower revenue from Sprint PCS, which is attributable to a lack of subscriber growth, lower professional and consulting revenues, and Sprint’s plan to begin converting certain subscribers to an internal billing system sometime during 2003. Under the terms of the contract, Sprint has until March 31, 2004 to notify Convergys if they intend to extend the existing contract, and the Company has provided Sprint with several proposals to extend this agreement. However, the Company has no assurance that the current Information Management Group contract will be extended, and while the final outcome is uncertain, the Company cannot be optimistic at this time.

FINANCIAL CONDITION

Capital Resources

At March 31, 2003, the Company had $46.8 of borrowings outstanding. The Company’s borrowing facilities include a credit facility with $325 in borrowing capacity that expires in July 2005 and a commercial paper program backed by this $325 credit facility. The participating agents in the credit facility include JPMorgan Chase, Citicorp USA, PNC Bank, Bank One, US Bank and The Royal Bank of Scotland. The credit facility includes certain restrictive covenants including maintenance of interest coverage and debt to capitalization ratios. The Company’s interest coverage ratio, defined as the ratio of consolidated earnings before interest, tax, depreciation and amortization (EBITDA) to consolidated interest expense, cannot be less than 4.00 to 1.00 for four consecutive quarters. The Company’s debt to capitalization ratio cannot be greater than 0.6 to 1.0 at any time. The Company was in compliance with all material covenants as of March 31, 2003.

The Company also has a $150 accounts receivable securitization agreement, under which it had sold $150.0 in accounts receivable at March 31, 2003.

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MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)

The Company is a party to a financing transaction related to its office complex in Orlando, Florida. Under the terms of the financing transaction, which was structured as a synthetic lease, a special purpose trust (Trust) owns the office complex and leases it to the Company. The Trust serves as a conduit between an unrelated commercial lender and the Company and the only substantive purpose is to lease the office complex to the Company. The Company has not made any equity investments in the Trust; nor has it provided any financing to the Trust; and it does not control the operations of the Trust. Furthermore, no Company employee or director holds any ownership interest in the Trust. The owner of record of the Trust has made an initial substantive residual equity capital investment that has been at risk during the entire term of the lease.

The lease had 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 in December 2002, the Company elected to exercise the second one-year renewal option. As of March 31, 2003, the assets and liabilities of the Trust were comprised primarily of the office complex and $65 bank debt used to fund the construction of the office complex. The Company’s lease payment includes a variable interest component, but the Company effectively has converted the variable interest rate to a fixed interest rate of 4.36% through an interest rate swap with a nominal value of $65.

In connection with this transaction, the Company has made a residual value guarantee for the leased property equal to 85% of the financing, or $55. The Company believes the fair market value of the leased property is greater than the Company’s guaranteed residual value.

At the end of the lease term, the Company has the option to purchase the property from the lessor for $65 or the lessor will sell the property. The Company believes it has sufficient sources of capital to purchase the property if that is the Company’s decision. The Company currently is evaluating whether to purchase the property or to enter into a new lease agreement. The Company expects to make its decision during the second quarter of 2003.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” an interpretation of ARB No. 51, “Consolidated Financial Statements,” which changes the criteria currently used by companies in deciding whether it is required to consolidate another entity. The Company has concluded that the Trust qualifies as a variable interest entity, as defined by Interpretation No. 46, and that the Company is the primary beneficiary of the Trust. Accordingly, if the Company elects to keep the existing lease structure in place, it will be required to consolidate the assets and liabilities of the Trust beginning July 1, 2003. This would result in an after-tax charge, which the Company has not yet quantified, reflecting a cumulative effect of a change in accounting method.

On February 25, 2003, the Company’s Board of Directors authorized the repurchase of an additional 10 million of its common shares. During the first quarter of 2003, the Company repurchased 4.9 million of its common shares for total costs of $60.6, of which due to timing $7.9 was settled in early April and classified in other current liabilities. During April 2003, the Company repurchased an additional 3.4 million shares for total costs of $47.9. Additionally, on April 22, 2003, the Company’s Board of Directors authorized the repurchase of an additional 10 million of its common shares. As of April 30, 2003, the Company is authorized to purchase an additional 11.7 million, which it intends to complete as it deems appropriate.

Operating cash flows historically have been more than sufficient to fund the Company’s cash needs, other than for large acquisitions. With the exception of the 2001 Geneva acquisition, which was a stock-for-stock transaction accounted for as a pooling-of-interests, acquisitions have been financed with a combination of borrowings and operating cash flows. 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.

Cash Flows

The Company generated $108.7 and $80.5 in cash flows from operating activities during the first quarter of 2003 and 2002, respectively. The Company’s cash flows from operating activities for the first quarter of 2003 reflect no change in borrowings under its accounts receivable securitization program, compared to a $20.0 repayment during the first quarter of 2002.

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MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Amounts in Millions Except Per Share Amounts)

During the first quarter of 2003, the Company used $34.9 for investing activities compared to $20.6 in the prior year. The investing activities during the first quarter of 2003, reflect the Company’s $11.3 further investment in the Cellular Partnership resulting from a capital call, $3.5 used for the acquisition of Cygent Inc. and $20.1 in capital expenditures. The $20.6 used during the first quarter of 2002 was for capital expenditures.

Cash used for financing activities totaled $57.7 during the first quarter of 2003 resulting mainly from the $52.7 in cash paid in the first quarter for shares repurchased pursuant to authorization by the Company’s Board of Directors.

Balance Sheet

Accounts receivable decreased $12.3 from December 31, 2002 to March 31, 2003. This reflects improved collections in the first quarter of 2003. Excluding the effects of the securitization, days sales outstanding decreased by 3 days during the first quarter of 2003 to 73 days, reflecting faster payment at the end of the quarter by some of the Company’s larger clients. Days sales outstanding is computed as follows: receivables, net of allowances, plus outstanding receivables sold under securitization divided by average days sales. Average days sales is defined as consolidated revenues for the quarter just ended divided by the number of calendar days in the quarter just ended.

Prepaid expenses and other current assets increased $12.2 largely as a result of an increase in the fair value of an outstanding forward exchange contract, which the Company has designated as a cash flow hedge. Deferred charges increased $12.8 from yearend 2002 due to the capitalization of customer acquisition costs and system implementation costs incurred in connection with the acquisition and extension of outsourcing arrangements, partially offset by amortization.

Payables and other current liabilities increased by $47.3 from December 31, 2002, reflecting the timing of payment of the Company’s taxes and payroll-related costs. Treasury stock increased from December 31, 2002 as the Company repurchased 4.9 million shares during the first three months of 2003 for a total cost of $60.6, $7.9 of which was settled in early April.

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 the Company’s control. 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. The Company expects reductions to its existing contractual wireless rates that are triggered by the passage of time to be less than 3% of the Company’s ongoing data processing revenues during 2003.

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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. Market risk is the potential loss arising from adverse changes in market rates and prices. The Company’s risk management strategy includes the use of derivative instruments to reduce the effects on its operating results and cash flows from fluctuations caused by volatility in currency exchange and interest rates. In using derivative financial instruments to hedge exposures to changes in exchange rates and interest rates, the Company exposes itself to some counterparty credit risk. The Company manages exposure to counterparty credit risk by entering into derivative financial instruments with highly rated institutions that can be expected to perform fully under the terms of the agreements and by diversifying the number of financial institutions with which it enters into such agreements.

Interest Rate Risk

At March 31, 2003, the Company had $46.8 in outstanding variable rate borrowings and had sold $150.0 in accounts receivable on a variable rate basis. The carrying amount of the Company’s borrowings reflects fair value due to its short-term and variable interest rate features. Additionally, as more fully disclosed under the heading “Financial Condition, Liquidity and Capital Resources,” the Company leases its office complex in Orlando, Florida under a synthetic lease arrangement accounted for as an operating lease. Under the terms of the arrangement, the Company pays a variable lease rate, but has converted the variable interest rate to a fixed interest rate of 4.36% through an interest rate swap with a nominal value of $65.0.

The Company uses cash flow hedges for 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. 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 interest rates. Other than the $65.0 interest rate swap associated with the synthetic lease arrangement, there were no outstanding cash flow hedges covering interest rate exposure at March 31, 2003.

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 $2.0.

Foreign Currency Exchange Rate Risk

Foreign currency exposures arise from transactions denominated in a currency other than the functional currency and from foreign denominated revenue and profit translated into U.S. dollars. The primary currencies to which the Company is exposed include the British Pound, the Indian Rupee, the Euro and the Canadian Dollar. The Company currently uses forward exchange contracts to limit potential losses in earnings or cash flows from adverse foreign currency exchange rate movements. 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 potential loss in fair value at March 31, 2003 for such contracts resulting from a hypothetical 10% adverse change in all foreign currency exchange rates is approximately $26. This loss would be mitigated by corresponding gains on the underlying exposures.

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ITEM 4.

CONTROL AND PROCEDURES

The Company’s management, under the supervision and with the participation of the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO), performed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures within 90 days before the filing date of this quarterly report. Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures were effective.

There have been no significant changes in the Company’s internal controls or in other factors that could affect these controls subsequent to the date of their evaluation.

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From 10-Q Part II

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 2003.

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: