The Company has two reporting segments, which are identified by service offerings. The Customer Management Group (CMG) provides outsourced customer care and human resource services. The Information Management Group (IMG) provides outsourced billing and information services and software.
CMG, which contributed approximately 71% of total nine-month revenue of $1.9 billion for the period ended September 30, 2005, continues to face a variety of challenges, including pricing pressure, the impact of the weakened U.S. dollar versus the Canadian dollar, the Indian rupee and the Philippine peso, and realizing the returns it expects from ongoing restructuring of its employee cost operations. Despite these challenges, the Company believes that it can continue to capitalize on the trend of large companies and governmental agencies using outsourcing providers to provide cost-effective, high-quality customer support and employee care solutions.
The Convergys strategy is to capture the growing demand for outsourced customer care and employee care support service dollars by expanding the scale and scope of its service offerings. CMG has served its top 10 clients, in terms of revenue, for an average of 10 years. The Company is also growing its backlog through acquisitions and new customer wins.
In August 2005, the Company acquired the finance and accounting business process outsourcing business of Deloitte Consulting Outsourcing LLC, a subsidiary of Deloitte Consulting LLP. This business provides finance and accounting outsourcing services to clients in multiple industries ranging from communications to retail to professional services. This acquisition expands the Company’s outsourcing capabilities and is expected to help enable it to address the full service outsourcing needs of its clients.
In May 2004, the Company acquired Encore Receivable Management, Inc. a Kansas-based provider of accounts receivable management and collection services. This transaction provides CMG entry into the accounts receivable management market and the ability to expand its business process outsourcing capabilities.
Also in May 2004, the Company acquired DigitalThink, Inc., a custom e-learning company. Convergys can now provide its clients customized, on-demand courses; expand its capabilities in the human resource business process outsourcing market to meet the needs of large global organizations for full service learning solutions; and, support its human resource and customer care clients more efficiently by accelerating the effectiveness of customer support teams through on-the-job training for client programs.
Approximately 70% of new growth in 2005 was driven by these and other firms purchased by CMG during 2004 and 2005.
Convergys has also won a contract worth an estimated $1.1 billion (over thirteen years) to provide human resources services to DuPont Co. Specifically, Convergys will develop an online information system that will allow employees and managers to sign up for transactions such as enrolling in benefits and changing payroll information and to provide workforce data management.
The IMG segment serves clients principally in the telecommunications industry by providing and managing complex billing and information software that addresses all segments of the communications industry. IMG provides its software products in one of three delivery modes: outsourced, licensed or build-operate-transfer (BOT). In the outsourced delivery mode, IMG provides the billing services by running its software in one of its data centers. In the licensed delivery mode, the software is licensed to clients who perform billing internally. Under the BOT delivery mode, IMG implements and initially runs its software in the client’s data center while the client has the option to transfer the operation of the center to itself at a future date.
For the nine months ended September 30, 2005, 43.8% of IMG’s revenues were from data processing services that generated monthly payments from its clients based upon the number of client subscribers or bills processed by IMG in its data centers. Professional and consulting services accounted for 34.8% of IMG’s revenues for the same period.
In 2005, Convergys' IMG generated approximately $100 million in revenue, or roughly 4 percent of its expected total 2005 revenue, from Sprint Nextel.
IMG continues to face intense competition as well as consolidation within the communications industry. Despite these challenges, the Company believes that strong growth opportunities within its billing market remain. In order to survive in an increasingly competitive and consolidated industry, communications companies are continuously looking to expand their service offerings, which has resulted in increasingly complex and ever changing billing system requirements. Communication providers are not replacing their entire legacy billing systems with next-generation end-to-end billing systems, but instead have have shifted to augmentation and upgrading. In order to meet this demand, Convergys continues to invest in research and development of INFINYS, its proprietary billing platform.
Red Flag #1. The Company’s three largest clients accounted for 33.5% and 36.3% of its revenues in the first nine months of 2005 and 2004, respectively. Of note, the risk posed by this revenue concentration is reduced somewhat by the long-term contracts the Company has with some of its largest clients. The Company serves Cingular, its largest client with 17.3% of revenues in the first nine months of 2005. The Company’s relationship with Cingular is represented by separate contracts/work orders with various IMG and CMG operating units. On December 14, 2005, Convergys did announce a contract win-extension. The Company serves DirecTV, its second largest client in the first nine months of 2005, under a customer management contract. Sprint Nextel is/was the third largest customer.
The 10Q Detective has an 'intuitive' tug that Convergys represents an attractive BUY at current levels. These separate contracts/work orders with the above clients have varying expiration dates, payment provisions, termination provisions and other conditions. As a result, the Company does not believe that it is likely that its entire relationship with Cingular, DirecTV or Sprint Nextel would terminate at one time. We agree with corporate, therefore, that Convergys is not substantially dependent on any particular contract/work order with these clients.
Red Flag #2. Receivables represent 79.3% of current assets. Nontheless, Days sales outstanding (DSO), which is an accurate picture of how long it takes a company to collect on monies it is owed, remains stable. In fact, it decreased to 74 days at September 30, 2005 versus 75 days at December 31, 2004.
Red Flag #3. Goodwill, , currently accounts for 38.3% of the $2.27 billion in total assets--attributable to the Company's recent buying spree. [Assuming this does not blow up in our faces], we will believe corporate, which recently performed its annual impairment tests during the fourth quarter of 2004 and concluded that no goodwill impairment existed.
Convergys, which we previously mentioned has been building up other business interests outside of billing, said that Sprint's plan to move off its billing system in 2006 and 2007 would not hurt its earnings outlook for this year, and remains comfortable with share-net guidance of at least $1.07 for 2006.
Catalysts for share-price gains include sequential improvements in operating margins and sustainable top-line growth. To position itself for profitable growth, Corporate has taken the following steps:
- Streamlining its Customer Management and corporate operations. The Company initiated a restructuring plan during the second quarter of 2005 that resulted in a charge of $8.9 million. The actions, which affected approximately 300 professional and administrative employees, were substantially completed during the third quarter of 2005. Convergys is expecting incremental savings of approximately $34.0 million in FY 2006.
- The Canadian dollar continues to pressure operating margins. By hedging the U.S. dollar, the Company estimates that the realized impact improved margins by 200 basis points.
- New IMG Revenue Drivers. For comparative purposes, new license and service revenues for the 12-months ended September 30, 2005, jumped 24% to $427 million.
- New CMG Revenue Drivers. Ongoing growth with existing, long-term clients plus new wins with Boston Scientific, Texas Instruments, and DuPont should, according to corporate, double employee-care sales in two years.
Shakespeare wrote in Macbeth: "Or have we eaten on the insane root. That takes the reason prisoner." Yes, there are "soft spots" in Convergys' financial statements...That said--Management seems committed to enhancing shareholder value. IF Convergys can demonstrate sustainable quarterly-Earnings-Growth (year-over-year) of at least 5%, industry comparables show that investors would be willing to expand the Company's forward earnings multiple to at least 25, from the current 14.8 times. Target sell price for Convergys Corp. is $26.75 per share.