CONVERGYS CORP - 10-Q Quarterly Report

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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 September 30, 2002

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 October 31, 2002, 173,335,140 Common Shares were outstanding.

PART I

ITEM 1. FINANCIAL STATEMENTS

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

	Three Months						Nine Months
	Ended September 30,						Ended September 30,

	2002			2001			2002			2001


Revenues	$	561.2		$	567.2		$	1,721.4		$	1,729.9


Costs and Expenses
Cost of providing services and products sold		308.1			309.2			949.1			942.8
Selling, general and administrative		97.7			91.7			300.6			297.3
Research and development costs		29.8			32.4			85.2			86.8
Depreciation		32.1			30.5			92.9			94.5
Amortization		3.7			12.8			10.8			38.2
Restructuring and impairment charges		–			58.0			–			58.0
Acquisition and integration costs		–			–			–			31.8

Total costs and expenses		471.4			534.6			1,438.6			1,549.4

Operating Income		89.8			32.6			282.8			180.5
Equity in Earnings of Cellular Partnership		1.0			1.3			4.9			5.9
Other Income (Expense), net		(0.8	)		(7.6	)		(2.1	)		(6.9	)
Interest Expense		(3.1	)		(4.0	)		(9.0	)		(16.5	)

Income Before Income Taxes		86.9			22.3			276.6			163.0
Income Taxes		31.3			19.3			102.3			80.6

Net Income	$	55.6		$	3.0		$	174.3		$	82.4

Other Comprehensive Income, net of tax:
Foreign currency translation adjustments	$	(3.9	)	$	(0.3	)	$	5.0		$	(4.5	)
Unrealized gain (loss) on cash flow hedging		(3.3	)		(2.5	)		3.4			(1.0	)
Unrealized gain (loss) on investments		–			1.4			–			(1.7	)

Total other comprehensive income (loss)		(7.2	)		(1.4	)		8.4			(7.2	)

Comprehensive Income	$	48.5		$	1.6		$	182.8		$	75.2

Earnings Per Common Share
Basic	$	0.34		$	0.02		$	1.05		$	0.49

Diluted	$	0.34		$	0.02		$	1.03		$	0.47

Average Common Shares Outstanding
Basic		161.3			169.9			165.6			169.7
Diluted		163.7			174.2			169.0			175.1

See Notes to Financial Statements.

CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Millions)

	September 30,			December 31,
	2002			2001

ASSETS
Current Assets
Cash and cash equivalents	$	41.7		$	41.1
Receivables, less allowances of $16.7 and $14.7		332.0			413.6
Deferred income taxes		18.2			31.9
Prepaid expenses and other current assets		47.2			36.5

Total current assets		439.1			523.1

Property and equipment - net		334.1			350.4
Goodwill - net		693.1			665.2
Other intangibles - net		34.7			39.7
Investment in Cellular Partnership		36.6			35.3
Deferred charges		88.1			87.8
Other assets		36.8			41.4

Total Assets	$	1,662.5		$	1,742.9

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Debt maturing in one year	$	125.9		$	129.9
Payables and other current liabilities		343.5			362.5

Total current liabilities		469.4			492.4

Long-term debt		4.8			3.6
Other long-term liabilities		23.4			20.3

Total liabilities		497.6			516.3

Shareholders’ Equity
Preferred shares – without par value, 5.0 authorized		–			–
Common shares – without par value, 500.0 authorized; 173.2 and 172.2 issued and outstanding		206.0			206.0
Additional paid-in capital		609.9			590.4
Treasury shares – 16.5 shares at September 30, 2002 and 2.8 shares at December 31, 2001		(332.8	)		(68.9	)
Retained earnings		692.2			517.9
Accumulated other comprehensive loss		(10.4	)		(18.8	)

Total shareholders’ equity		1,164.9			1,226.6

Total Liabilities and Shareholders’ Equity	$	1,662.5		$	1,742.9

See Notes to Financial Statements.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Millions)

	Nine Months
	Ended September 30,

	2002			2001

CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	174.3		$	82.4
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		103.7			132.7
Restructuring, impairment and integration costs		–			45.2
Deferred income tax expense		18.6			2.9
Cellular partnership distributions in excess of (less than) earnings		(1.3	)		24.2
Income tax benefit from stock option exercises		3.4			6.0
Borrowings (repayments) of receivables securitization, net		80.0			(55.0	)
Changes in assets and liabilities, net of effects from acquisitions:
Decrease in receivables		5.8			59.4
Increase in other current assets		(10.4	)		(10.0	)
Increase in deferred charges		(0.3	)		(38.7	)
Decrease (increase) in other assets		4.2			(6.3	)
Decrease in payables and other current liabilities		(20.8	)		(21.5	)
Other, net		(0.1	)		15.8

Net cash provided by operating activities		357.1			237.1

CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures		(80.1	)		(79.2	)
Acquisitions, net of cash acquired		(28.4	)		(36.3	)

Net cash used in investing activities		(108.5	)		(115.5	)

CASH FLOWS FROM FINANCING ACTIVITIES
Payments of debt, net		(3.3	)		(105.7	)
Purchase of treasury shares		(260.8	)		(56.2	)
Issuance of treasury shares, net		–			1.2
Issuance of common shares		16.1			26.7

Net cash used in financing activities		(248.0	)		(134.0	)

Increase (decrease) in cash and cash equivalents		0.6			(12.4	)
Cash and cash equivalents at beginning of period		41.1			49.3

Cash and cash equivalents at end of period	$	41.7		$	36.9

See Notes to Financial Statements.

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 customer care 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 July 12, 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 $16 in earn-out payments are possible if Speech Solutions achieves certain revenue milestones 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.

		On July 3, 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 7, the Company is a party to a lawsuit filed by former employees of Telesens.

		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.

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

		In connection with the acquisition of Geneva, the Company recorded one-time costs of $31.8 in the second quarter of 2001 to expense transaction costs and certain costs to integrate the combined businesses. 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.

(3)		BUSINESS RESTRUCTURING AND IMPAIRMENT

		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 ($41.0 after tax). The charge consisted of $29.0 in costs associated with the closing of contact centers, $16.2 in asset impairment 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 p