Convergys Corporation Q3 2009 Earnings Call Transcript

Convergys Corporation (CVG)

Q3 2009 Earnings Call Transcript

October 27, 2009 10:00 am ET

Executives

David Stein – VP, IR

Dave Dougherty – President and CEO

Earl Shanks – CFO

Analysts

Kevin McVeigh – Credit Suisse

Jason Kupferberg – UBS

Ashwin Shirvaikar – Citigroup

David Koning – Robert W. Baird

Eric Boyer – Wells Fargo

T.C. Robillard – Signal Hill Capital Group

Scott Sutherland – Wedbush Morgan Securities

Karl Keirstead – Kaufman Brothers

Matt McCormack – Brigantine Advisors

Howard Smith – First Analysis

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

Presentation

Operator

Welcome to the Convergys third quarter earnings teleconference. All lines will be on listen-only until the question and answer session of today's conference. This conference is being recorded, if you have any objections, please disconnect at this time. I would now like to turn the call over to Mr. David Stein, Vice President of Investor Relations. Sir, you may begin.

David Stein

Thank you, Tania, and good morning. Welcome to Convergys' third quarter 2009 earnings call and webcast presentation. This call is the property of Convergys. Please note that slides accompanying today's prepared remarks are available on the Convergys Investor Relations website under events and webcast.

Today's call contains forward-looking statements that address our expected future performance, and that by their nature address matters that are uncertain. Uncertainties that could adversely or positively affect our future results include the behavior of financial markets, the impact of regulation and regulatory investigative and legal actions, strategic actions, including acquisitions and dispositions, future integration of acquired businesses, future financial performance of major industries we serve, loss of a significant client or significant business from a client, difficulties in completing a contract or implementing its provisions and other matters of national, regional and global scale.

These uncertainties may cause our actual future results to be materially different than those expressed in our forward-looking statements. Please refer to Convergys' most recent news releases and filings with the SEC for additional information regarding risk factors.

We do not undertake to update our forward-looking statements as a result of new information or future events or developments. Also during the call, we'll discuss non-GAAP financial measures, including free cash flow and adjusted operating results after excluding for charges related to two HR management contracts and restructuring actions to each of our business segment.

Non-GAAP measures should not be construed as being more important than comparable GAAP measures. Convergys' management believes free cash flow and adjusted operating results after excluding charges related to two HR management contracts and restructuring actions in each of our business segments provides the users of the financial statements with a more comprehensive understanding of the company's underlying performance. A reconciliation of these non-GAAP measures is available on the Convergys website at www.convergys.com.

With me on the call today are Dave Dougherty, our President and Chief Executive Officer, and Earl Shanks, our Chief Financial Officer. Dave will provide a summary of our operational results. Earl will cover our financial performance and business outlook. Then, we'll open the call for your questions.

Now, I'll turn the call over to Dave.

Dave Dougherty

Thank you David and good morning. We made progress on multiple fronts to improve the position of the company in the third quarter. Our income from operations improved substantially from year ago. During the quarter, we successfully renegotiated a contract with one of our large HR management clients. While this is good news, it did result in a large charge. For the other client, we moved the ball forward, and we continue providing services for more than half the employees of both clients.

Customer management profitability improved significantly compared with the prior. The debt for debt exchange offer launched in the quarter improved our debt maturity and liquidity position. And we expect our non-GAAP earnings in the fourth quarter to be more than $0.30 per diluted share.

I will now discuss the performance of each of the business segments in more detail beginning with customer management. Customer management financial results in the third quarter continued to show substantial year-over-year improvement. Customer management revenue grew 2% year-over-year. More than all of this growth was due to the Intervoice acquisition. As we said a quarter ago, we have seen a continuation of the call volume softness for many of our existing clients.

During the quarter, we ramped several new live agent programs. We increased our presence in the Philippines where we now have more than 17,000 employees, and we continue to expand in Latin America. We also announced substantial contract renewals the quarter. Demand for offshore remains strong. During the quarter, we launched two new relationship management technology solutions, intelligent self-service, and intelligent notification. These provide our clients' customers a more personalized and proactive service experience.

By enabling intelligent interactions, these solutions help our clients to increase customer satisfaction and loyalty at a lower total cost of interaction. Our relationship management technologies are enabling us to deliver superior value at a competitive price. Increasingly, existing and new clients are choosing our comprehensive suite of agent assistance and automated solutions.

We signed substantial new business in the quarter. For example, live agent wins in the quarter represent $89 million in new 2010 revenue. Our pipeline for new business remains strong. Customer management operating performance improved in the quarter. Operating income increased 59% and operating margin expanded 270 basis points to 7.5% on a non-GAAP basis. Operating metrics remained strong during the quarter as well. For example, absenteeism and attrition improved sequentially and year-over-year. The customer management teams focus on effective workforce management and disciplined cost management continue to positively impact positive operating performance during the quarter.

The team is driving efficiency via our proprietary global operating model. This means that we deploy standardized program management and contact center operating processes across all geographies. Our global approach is often cited by clients as a key reason for choosing Convergys. In the quarter, we extended our home agent solution to the UK. We're committed to growing our home agent capability as it improves schedule flexibility and business continuity. Four of our five largest clients are now benefiting from our home agent solution.

I'll now discuss information management. The slowdown in telecom sector spending continued to pressure information management in the third quarter; this negatively impacted profitability. We had a delay in closing license revenue with a large client that we now expect to close in the fourth quarter. We are beginning to see some encouraging signs in terms of strengthening pipeline for this business primarily in North America.

I'm very pleased that we were able to announce our groundbreaking entry into the utilities market for smart grid customer information systems. Smart grid requires complex rating and billing technologies similar to what we have been providing to the communications industry for years, which is why we're well positioned. This new market extension shows the versatility of the core Infinys technology. We are configuring it to meet the specific needs of smart grid energy providers like Duke.

This is forecast to be a fast-growing market. The number of smart meters in North America is expected to more than triple to 65 million in the next three years. While still very early in the rollout, this represents an exciting future growth opportunity for information management. We stand ready to support this new technology for the utilities industry.

During the quarter, we also announced a multiyear renewal of Fortune 50 BSS client. We invested in our differentiated solution capabilities as well as additional sales and marketing resources in the third quarter. We took further action to streamline our development costs, and we expect sequential revenue and margin improvement in information management in the fourth quarter.

Moving to HR management, we made progress reducing costs and further limiting risks in this business. With one client, the client that had not gone live, with a key implementation phase last quarter, we agreed to stop implementation work related to services not yet live. Our focus is on continuing to deliver the services already in operation that now support over half of their employees. The agreement eliminates future implementation obligations and liability for services not yet operational.

For the other large client, the implementation remains in pause mode. We continue to actively negotiate to change the scope and other terms of the contract. Our work over the last few months has substantially reduced the risk in the HR management business. Also in the quarter, we announced renewals with two other HR management clients. With these, we have now renewed four of our contracts in 2009. Across the HR management business, we remain focused on driving further efficiencies into all existing client operations.

In summary, we continue to make progress across the business. The substantial new business signings and continued solid margin performance in customer management are positive indicators that our strategy is working. We expect the sequential fourth-quarter improvement in information management and are pursuing substantial growth opportunities in the utility market. For HR management, we closed out one contract negotiation, we have one to go. We have strengthened our liquidity position and our cash balance remains solid. Finally, as Earl will discuss in more detail in a moment, we expect overall performance improvement in the fourth quarter.

Before handing the call off to Earl, I want to take a minute to acknowledge our people and the effort they put forth in a time of crisis during the quarter. As you all know, late in September, the Philippines suffered its worst tropical storm in over 40 years, leaving almost 80% of Metropolitan Manila underwater. We have a significant presence in Manila. Sadly, nearly 800 of our employees felt the wrath of the storm personally. Two of our customer service representatives lost their lives. Hundreds of our colleagues' homes were completely lost or damaged to varying degrees. Our thoughts remain with the Filipino people who are still recovering.

The response to this need from our Convergys family has been overwhelming. While there was a significant human toll, our people made sure that our clients had minimal operational impact. Despite the difficulty and challenges brought about by the storm, our facilities and network maintained normal operations throughout this event. We rerouted calls as necessary and our preparation and practice in disaster recovery scenarios really paid off.

Our colleagues demonstrated a strong desire to get back to work and to focus on the outstanding customer service they provide on a daily basis. The spirit and dedication of our Philippines team members and those employees supporting them throughout our global network has been an inspiration to all of us. I want to thank our clients and employees for the donations to our relief fund to help the Philippines employees and their families. At a time like this, you see the soul of a company. And I know for one I feel very privileged to be part of an organization that has the spirit, the grit and determination to succeed even in the most challenging of circumstances.

At this time, I will turn the call over to Earl.

Earl Shanks

Thank you Dave. I share your feelings about the character and the quality of our employees. Good morning to everyone on the call.

Let me begin with a review of third quarter financial results. Convergys revenue was $765 million. This includes $106 million of accelerated recognition of deferred implementation revenue related to one large HR management contract. In addition to this revenue recognition, the net charge of $131 million in the quarter mostly reflects impairment implementation and restructuring in HR management, although it also includes $9 million in restructuring charges in the quarter associated with the other two business segments. On a non-GAAP basis, operating income was $41 million. Net income was $34 million and earnings were $0.27 per diluted share.

Turning to the segments, broadly speaking, customer management results were similar to the second quarter with margins well above the prior year. Customer management revenue was $492 million in the third quarter. This was up 2% from the prior year period. The Intervoice acquisition represented $42 million in the third quarter, a net impact of $28 million over last year. Recall, we closed the acquisition of Intervoice last year in September 2008. So we only recognized one month of Intervoice revenue in the prior year quarter.

Customer management operating income increased 59% to $37 million, and operating margin improved 270 basis points to 7.5% on a non-GAAP basis. The $3 million restructuring charge was for severance expense. This severance related to an unexpected direction in the size of one international program. The improvement in operating performance reflects our continued focus on effective workforce management. During the quarter, we continued to invest in capabilities and sales resources in order to remain well positioned for an economic recovery. Foreign exchange impact helped margins by about $2 million in the quarter compared with the prior year. We now have 28% of our customer management employees working in the Philippines, 14% in India, and 11% in Canada.

I will now review results for the information management segment. Information management revenue was $99 million in the quarter. This reflects the impact of North American consolidation and their international project completion. Information management operating income was $9 million in the quarter on a non GAAP basis. The $6 million restructuring charge reflects additional lease rental growth for properties closed during the 2007, shifting the geographic mix of some development resources and further streamlining operations in the quarter. The revenue declines negatively impacted margins in the quarter.

As Dave mentioned, we were working to close a license deal with one international client during the quarter which did not close. We expected to close in the fourth quarter. With that expectation, we expect sequential improvement in information management revenue and margin in the fourth quarter.

Moving to HR management, third quarter revenue was $175 million. This includes accelerated recognition of the $106 million in deferred implementation revenue related to one large client contract. Apart from the accelerated revenue recognition, we have $9 million year-over-year increase in revenue of $68 million dollars. This was primarily from ongoing services supporting two large clients.

The sequential revenue decline was due to the impact of the acquisition of one of our clients. HR management operating loss declined by more than half, $3 million in the quarter on a non-GAAP basis. Implementation, impairment and restructuring cost reported in the quarter included $148 million of deferred cost for services not yet live reported on the cost of goods sold line, $76 million of asset impairment, primarily for deferred cost related to services and operations that are no longer projected to be profitable. This change in forecast is due to the negotiated reduction in the scope of the contract. And $4 million in severance costs to align staffing levels of expected revenue. We have now written off all the capitalized implementation cost and recognized a portion of the implementation revenue for one large contract.

I'll now turn to non operating items. Our Cellular partnership contributed $10 million of earnings in the third quarter. Other income was down $10 million. In the prior year quarter, we had a gain of the settlement of an interest rate hedge and more favorable foreign exchange impact. The low effective tax benefit rate in the third quarter resulted from the impact of the HR management related charges.

Moving to free cash flow, the negative $4 million free cash flow in the quarter reflects cost related to winding down HR management implementation work. In addition, the Cellular partnership provided an incremental $9 million cash dividend which is not included in the free cash flow metrics.

Moving down the balance sheet, we ended the third quarter with $336 million in cash. Last quarter, I told you that depending on market conditions, we may take actions to build liquidity and extend our debt maturity profile as opportunities arise. In the third quarter, we did take such an opportunity. We launched the debt for debt exchange which we closed successfully earlier this month. $123 million in senior notes were retired. The remaining balance of $70 million is to be paid with cash at maturity. We now have significantly more financial flexibility to address our $400 million revolver which comes due late in 2011.

As part of the exchange offer, we issued $125 million of 5.75% convertible bonds. The tax benefit of the convert outweighs the potential dilution impact under most stock price scenarios. From an accounting standpoint, we will be splitting the $125 million issue into three parts on the balance sheet as follows. $54 million is debt, $46 million is equity, and $25 million in deferred tax. Over time, we will amortize the difference between the book value and the face value into interest expense. The total amortization over 20 years would be $71 million. As the stock price moves above $12.07 per share, the shares outstanding will be adjusted accordingly.

I will now cover our current business outlook. For the fourth quarter, we expect revenue of $650 million to $670 million. We expect non-GAAP earnings of more than $0.30 per diluted share. This excludes any restructuring expense to streamline the business and HRM charges if any. There is likely to be a favorable tax impact in the fourth quarter. For the full year, we're tightening our free cash flow expectation to a range of $165 million to $185 million, and we still expect the cash dividend from the Cellular partnership to total about $40 million.

At this time Tanya, please open the line for questions.

Question-and-Answer Session

Operator

Thank you. And this time, we're ready for the question-and-answer session. (Operator instructions). Our first question, Kevin McVeigh with Credit Suisse. Your line is open.

Kevin McVeigh – Credit Suisse

Great, thank you. Hi, nice job in the quarter, and obviously a pretty tough environment. I wanted to if possible just try to understand the great job containing one of the HR contracts, I just wanted to understand number one, the cash flow impact in the quarter, I know we're talking about somewhere around $40 million in 2009 what the actual cash flow impact was and then just the revenue associated with that? And I have got a couple of different questions here but I just want to understand, I know we talked on the potentially $250 million charge, how those will kind of a, how actual results came payment relative to expectations?

Earl Shanks

Okay, so a few different questions, Kevin, if I don't get all of them (inaudible). Let me start with the cash flow piece of it. There is really two pieces that were discrete relative to HR management in the quarter. We had about $12 million of net deferred charges i.e. things we spent during the quarter, think of that as clean up of continued implementation just based on the timing of the shift we made in that. That was about $12 million there.

We also saw a reasonably meaningful reduction in our payables related to that, so those two factors together probably maybe about the same size of each, but it had a meaningful impact on the cash flow in the quarter. So I feel pretty good about where we are going for the year and obviously have a lot of confidence in our forecast for the cash flow for the year of 165 to 185 plus the 40. But in the third quarter we did have a couple of moving pieces to deal with.

As to what happened with the charge, as you said, there were a lot of moving pieces around this one. Because we reached a resolution with the client, besides the charge part of it, besides writing off the deferred charges that were on the balance sheet, we also recognized the deferred revenue. We only could recognize that deferred revenue because of the fact that we had reached the agreement with the client. So that was kind of a hand in glove thing. We knew revenue was out there, and we expect that we recognized it some point, but the timing of that revenue recognition was just a function of the agreement we reach with the client and the charges were obviously for what I've described earlier.

Dave Dougherty

But the go forward contract for the work that we are still providing today, certainly it will less than what we originally expected from this client, but is a contract that we feel good about and believe that will create long term value for us and for the client.

Kevin McVeigh – Credit Suisse

That's helpful Dave. And (inaudible) I know it is difficult to do with the last remaining contract, any sense on kind of when will the final resolution on that, are there any other deferred charges on the balance sheet right now, pretty much everything has been written off has been written off?

Earl Shanks

For the two big clients, everything has been pretty much written off at this point, other than pretty minor dollars. There are some deferred charges which relate to some of the other contracts, but not anywhere near the kind of scope that we have seen on these two big contracts.

Dave Dougherty

And Kevin, just to your point about timing, certainly I can't predict the timing. We're actively negotiating with the client and continue to work that one and I think we have demonstrated a pretty good track record of getting these things resolved.

Kevin McVeigh – Credit Suisse

Great job, appreciate it. Thank you.

Operator

Our next question, Jason Kupferberg with UBS. Your line is open.

Jason Kupferberg – UBS

Okay, thanks a lot. I had a question on the Q4 revenue guidance, maybe if you can give us a little bit of color by segment on how you think that will lay out?

Earl Shanks

You know Jason I think there are some moving pieces in there. I think when you look at it, we will see, as we indicated better from IM in the quarter than we saw in the third quarter. The CM operating performance and our operating performance broadly I think for the business would be pretty consistent on an overall basis for the company, and the revenue numbers will be pretty similar in that regard.

Jason Kupferberg – UBS

Okay, that is helpful. And then I know you made reference to a potential tax benefit in the fourth quarter, can you give us a rough estimate on size there?

Earl Shanks

Well let me go back to what I just said Jason, I think if you think about operating income in Q3 and Q4, I think on an overall basis, those numbers will be pretty similar. It'll be in the same range and obviously the balance of the impact is essentially the tax impact.

Jason Kupferberg – UBS

Okay. And then finally, on the IM side of things, obviously the licenses can be pretty lumpy quarter to quarter and you guys called that out, but can you talk about how you guys are kind of viewing the overall BSS (inaudible) market conditions right now, how much of the softness out there is simply weak expanding across the industry that you think all competitors are feeling versus how much of it you think would be Convergys specific? Kind of putting the effect impact of the conversion aside, by just trying to get a read on how you see your competitive footprint and contrast that with what kind of a broader market is seeing from a spending and demand perspective?

Dave Dougherty

Sure. Jason, let me start and then Earl can add any additional commentary. I mean we still see the environment as very challenging. You know unfortunately we can't put aside the legacies roll outs, that still is an issue very much. That is impacting their business but you know we see a very difficult environment. We are still seeing delays in some major decisions on what we see at some major potential opportunities, one in particular, where we've thought the decision was going to happen in March of this year, and likely it is not going to happen until the end of the year, even at that time. So there's just been a real slowdown on pulling the trigger on the big BSS kind of deals.

Having said that, what the leadership team is working hard on is, historically we have been too dependent as a business on the big deals, and we have done a good a lot of good work about getting our software modular so that clients can buy now a component at a time, and the idea there is to try to get ourselves into more deals where we can not have to be so dependent on the big ones. But likely, we won't see the impact of that approach, and our investment in sales organizations, which I think, our sales was kind of going to be double this year at the end of this year from what it was last year. So we're making huge investments in sales. Having said all that, I don't think we will see the impact of that probably until the second half of 2010.

Jason Kupferberg – UBS

So is the IM business so strategic to you guys or are you keeping your options open there?

Dave Dougherty

Right now our focus is on – I think everybody wants our focus ahead is making sure that that business gets growing again, that is really where we are putting our attention and we are putting our money where mouth is too. There is so much that word does and we believe in the long-term growth prospects of this business, that is why we are investing in the sales resources like we are, why we continue to invest aggressively in the product, so we believe there is a good market opportunity for us to capitalize on.

Jason Kupferberg – UBS

Okay, thank you guys.

Operator

Our next question, Ashwin Shirvaikar with Citigroup. Your line is open.

Ashwin Shirvaikar – Citigroup

Hi, thanks. Hi, how are you guys?

Dave Dougherty

Good. How are you?

Ashwin Shirvaikar – Citigroup

I am good, thanks. Would you think on the customer management business, would you say you are close to an infection point you know between the positive impact of ramping new work and the negative impact of year-over-year down volumes for existing clients?

Dave Dougherty

I hope so. The big down tick for us was between the first quarter and the second quarter. So revenues in the customer management segment is like 517 down to 495 and then we have been kind of holding here for the last couple of quarters. And as Earl just said, we expect roughly that same kind of results in the fourth quarter. And having said that, at the same time, we see tremendous demand in the marketplace and we posted $89 million of new revenues for 2010. So we are winning business in an unprecedented way and we are hopeful here to see some recovery pretty quickly in the underlying volumes of the business. But and my own belief is before that happens, the consumers got to come back and start spending again. I mean this is a consumer driven business and we need the consumer to start spending to get some get the volumes back I believe.

Ashwin Shirvaikar – Citigroup

Okay, so you're not necessarily as you look forward and you guys have a pretty good 90 day forward look, you're not really looking for a stronger holiday season?

Dave Dougherty

No, we are going to be – as we said, we're going to be roughly in line with what we think what the revenues were here in the third quarter. We would normally see you know a seasonal up tick in the fourth quarter, and we are not seeing them.

Earl Shanks

And Ashwin if you go back to the beginning of the third quarter, we were hearing from our clients and seeing some of the forward data that the client expected to be seeing a seasonal up tick at this point in time. And so one of the things that shifted over the last 90 days is the clients have become more cautious than they were 90 days ago in terms of what the forecasts were. So while, as Dave said, we are very pleased with the amount of new business we captured, we are seeing the underlying base of business where the clients continue to be quite cautious.

Dave Dougherty

That's right.

Ashwin Shirvaikar – Citigroup

Okay. And one question on the HR management, post resolution of the problem contract, you still have one remaining, but does the HR management business sort of reach 300 million run rate and roughly breakeven on a non GAAP basis next year?

Earl Shanks

I think Ashwin we're still in the midst especially with the one client negotiation still in process of adjusting our revenue expectations for next year. So I'm not going to be in a position that I'm going to describe my revenue expectations yet on this call in that regard. But as I look at where the business is and what we can do overall with the cost structure, we feel pretty good about our ability to get to modest profitability overall for the business and modest cash flow positive on an ongoing basis. So I feel pretty good about that. I understand what the bottom line is. I've got a little movement on the top line actually at the moment.

Dave Dougherty

Yes, we can adjust the cost structure. We are adjusting the cost structure.

Ashwin Shirvaikar – Citigroup

Okay. And last question if I can sneak that in, the tax impact that you mentioned from the fourth quarter, the positive, the beneficial tax impact, is it possible to quantify that and without that would you still be above $0.30?

Earl Shanks

Well I think Ashwin what I said was that I get operating performance I think similar to what I have in the third quarter is my expectation. So the difference when I think about the third quarter and the fourth quarter is largely going to be the tax impact. So that is the right way to think about it I think where it is coming from. As it relates to among other things the charges we have taken in HR and how you end up accounting for that over time, that's one of the thing that flowing into the fourth quarter and having an impact.

Ashwin Shirvaikar – Citigroup

Okay, thanks.

Earl Shanks

Thanks Ashwin.

Operator

Our next question, David Koning with Robert W. Baird. Your line is open.

David Koning – Robert W. Baird

Hi guys.

Dave Dougherty

Hi David.

David Koning – Robert W. Baird

I wanted to pursue the margins in customer management a little bit because this year certainly things have gotten quite a bit better there and I'm wondering as we look forward, I would imagine that the FX that there is probably a little headwind over the next several quarters in Canada because the rates strengthened there, but probably a little tailwind from India and the Philippines, so maybe that is a neutral. And then maybe quarter some of the other margin drivers, revenue doesn't seem to be in much growth mode, at least near-term. I don't get a lot of leverage, but maybe you get some cost actions and benefits, there is a lot of moving parts I know, but maybe how do you get margins to grow over the next year and is that even the expectation?

Earl Shanks

Well, certainly, we are going to continue to squeeze on the cost line across the organization. I think the team has done a wonderful job of managing the direct cause of revenue in this business in the last year and that's really what's driven the margins in this business principally in the last year. But we are looking, as you would expect us to at every line to say how do we reduce cost to maintain competitive position, to continue to help us win. I would expect that with the rate that we are winning at in the marketplace, that that should begin to generate top line revenue growth. You know as we look out over into next year and exactly how that plays out I think we are in the middle of working through, but top line revenue growth in this business will certainly provider us leverage based on the general leverage of the leverage of the business model but then also just because of where we are with capacity in several of the geographies and as we continue to soak up some of the capacity, that will help as well. And as I started, we will go back and squeeze on cost.

Dave Dougherty

No – I agree with that. I think we remain focused on building the margins in this business and want to get this business as quickly as possible back to double-digit margins and better over time. And I do think there are some significant upside for us in our margin with the demand we are continuing to seen offshore and near shore. So growth for us in Philippines remains strong. Our expectation is we will grow in Latin America and that should improve the growth margin profile. And I also referenced in the script the leadership team there has done a very good job of developing the standardized global operating model, which is helping us drive costs out of the business as it gets further implemented across the business over time. So we're pretty optimistic that we can continue to drive the margins and improve those.

David Koning – Robert W. Baird

Okay, great. Thanks. I guess secondly in information segment, there would still be some AT&T revenue in there, is that fair to say? You might not want to give the number exactly but there is probably still some and that goes away by the end of this year?

Earl Shanks

There is AT&T revenue there and there is a part of that revenue that will go away when you look at this year versus next year. But that is AT&T, I would expect will continue to be a client in that business, but just will not be supporting one of the systems that we had been supporting in the past with them.

David Koning – Robert W. Baird

Okay great. And then finally, the tax rate this year given a little bit of a benefit both in Q3 and then probably a bigger benefit in Q4, when we look into next year, is it best – and I know you don't want to give guidance yet on this but just because we ought to set expectations already, is it best to look back to 06 and 07 when you're about 30%, I mean is high 20s, low 30s, at least kind of the ballpark of where we should start with our model?

Earl Shanks

Obviously as an organization, it is one of the lines that we pay attention to in terms of what the cost is, and we bring it down as we are able to, but the history is the range you talked about.

David Koning – Robert W. Baird

Okay. Great, thank you.

Dave Dougherty

Thanks David.

Operator

Our next question, Eric Boyer with Wells Fargo. Your line is open.

Eric Boyer – Wells Fargo

Hi, thanks. I just wanted to talk about the revenue expectation for customer management, I was just wondering, heading into Q3 results, were they in line with your expectations heading into the quarter? Because if you look at the prior guidance, it was for customer management be flat year-over-year for 2009, which would assume a pretty steep decline in Q4, just trying to see if I'm thinking of that the right way?

Earl Shanks

I'm not sure exactly what data points you are following. I think we were pleased with the performance of customer management in the quarter both on a revenue line and on the operating income line as the team continue to do a lot of good things in the process and delivered pretty solid performance. As I said a few minutes ago, my expectations had been for the fourth quarter that we would see more of a seasonal ramp, that is what we were hearing quarter ago from our clients, and seen some of the data that they give us in advance, And obviously given our commentary today, we are a little more cautious on that seasonal ramp than we were three months ago.

Eric Boyer – Wells Fargo

Okay. And then just on – if you look at what you have done year to date and last quarter you said 2009 expectations was for customer management to be flat year-over-year, so if you look at what Q4 would have to be, I mean it would be down actually sequentially instead of seeing a ramp.

Earl Shanks

Sure, you're right. We are probably a little more optimistic than we are overall based on the third-quarter performance.

Eric Boyer – Wells Fargo

Okay. All right, thanks a lot. And just finally, can I get your thoughts on the M&A environment within customer management and possibly is 2010 a year where you could be back in the market as an acquirer?

Dave Dougherty

Well, as you know, we certainly did a big move last year within Intervoice with was a critical strategic move for us but you know we clearly want to continue to build the customer management business over time and you know believe there are opportunities in the marketplace to consolidate in addition to technology acquisitions. So we are obviously looking at those kinds of things and those moves all the time.

Earl Shanks

And our view of the couple of ones that have happened is we think some of the weaker competitors have been taken out and the capacity will come out of the marketplace and that should be a good thing (inaudible).

Eric Boyer – Wells Fargo

And then just on the home agent business, can you just give us a sense for the number of agents you have today?

Earl Shanks

About 1500.

Eric Boyer – Wells Fargo

All right, thanks a lot.

Operator

Our next question, T.C. Robillard with Signal Hill Capital Group. Your line is open.

T.C. Robillard – Signal Hill Capital Group

Great, thanks. Good morning guys.

Dave Dougherty

Hi, TC.

T.C. Robillard – Signal Hill Capital Group

Just a couple of real quick questions, first on CMG business, Earl or Dave, can you give us a sense on if you look at the call volumes with your existing customer base, are those declines on a year-over-year basis, are they accelerating, staying the same, are they kind of starting to show some improvement, can you just give us a sense just how that is working?

Dave Dougherty

You know it is still early here in the quarter but relative to where we finished out last quarter, they are about the same in terms of the rate of decline relative to the year ago. So but to me it is probably a bit early to call complete stabilization. But the early signs are you know somewhat encouraging.

T.C. Robillard – Signal Hill Capital Group

And what about in third quarter, did third-quarter shown kind of an accelerating decline?

Earl Shanks

No, I would describe it as that. I mean I think it would be, I would describe it, if I had to pick a choice between accelerating or decelerating decline, I would say it is probably more of a decelerating decline is the way to think about it. And there is enough that we're concerned about which is why we continue to call it out when we look at it and we recognize that the balance on the other side is the new business we can go (inaudible) driving that so hard.

Dave Dougherty

And the demand is there.

T.C. Robillard – Signal Hill Capital Group

No – understood. The color is helpful. IMG, would you be able to quantify that license opportunities as we are looking kind of sequentially?

Earl Shanks

Well obviously it was big enough for us to call out. And beyond that, no, I won't quantify it till we get it closed.

T.C. Robillard – Signal Hill Capital Group

Fair enough, I had to try though. On HR management, just curious, now that you've with the contract that you just came to resolution with your customer, I understand that you're providing service a little bit more than half of their existing customer base, is there risk that this customer looks to move those clients to another vendor. I mean they obviously got to do something with the other half of their employees, is this a situation where you can continue with this contract over the long term, or do you think that is some risk that maybe this client transfers those out at some point?

Earl Shanks

I think we have shown over time that once you get the solution implemented, it is very hard to move, and there is a lot of stickiness in this business. They may or may not go live in the balance of the geographies and quite frankly I some of the geographies and some of the countries it just doesn't make financial sense you know to implement a solution like this. So this is in some cases a lot of employees to be had. So that is something they can decide, this client can decide on their own. Once it is implemented, we have the service centers in place to catch the business so to speak, but we are not going to be doing any of the implementation, that is something we said we are not going to do.

Dave Dougherty

But I think it is pretty clear when you look at the client is that there is not near term risk around the clients. I mean if you think about multi year implementation to do these, this would be a multiyear time period to try to swap out as well.

T.C. Robillard – Signal Hill Capital Group

Okay. And then just off of that, how was this fitting, now that you had to – one of the earlier questions about the breakeven point which historically you guys always called out as the 300 million mark, I know you can adjust your cost structure, that revenue target has to get adjusted. But earlier it was kind of interesting with your comment about kind of modest breakeven, modest cash flow positive, I mean that obviously sounds to be below where your original expectations were for this business when you guys got into it years ago. I mean how does it – can you give us a sense if there is an update on your long-term strategy with this business? I know you laid out a few potential scenarios over the last couple of calls, I'm just thinking about this now that this business has shifted a little bit for you, how it fits into kind of the big picture for Convergys?

Earl Shanks

I think from the – the most strategic thing I think we can do from a long-term perspective is to get the business to a stabilized point and so we are…

Dave Dougherty

… drive profitability by continuing to drive up adoption of self care which is kind of how these contracts work.

Earl Shanks

And we're pretty focused on that as the priority. Looking beyond that, there are some theories on how you grow the business over time but our focus and our strategic focus is to bring the business to a point of stability, is to bring the business to cash flow positive and earnings positive. And if that means, in the near-term the business is smaller, that is okay, and we will come back and address it as we get it to a point of stability and think about what we do long-term.

T.C. Robillard – Signal Hill Capital Group

Okay, understood. Just one last one, not to harp on the tax benefits stuff (inaudible) but in the third quarter, was there anything unique or was that just traditional kind of revenue mix with your real keen focus on optimizing taxes?

Earl Shanks

Nothing particularly unique there.

T.C. Robillard – Signal Hill Capital Group

Okay, great. Thanks guys.

Earl Shanks

Thank you.

Operator

Our next question, Scott Sutherland with Wedbush Securities. Your line is open.

Scott Sutherland – Wedbush Morgan Securities

Hi, great. That you good morning.

Dave Dougherty

Hi, Scott.

Scott Sutherland – Wedbush Morgan Securities

Wanted to build on that last question on the HR side, with the contract that you have resolved, is there any sort of long-term contract that is now in place for the remaining – or the – the 50% employees that you are currently supporting, is there a long-term contract in place there now?

Earl Shanks

There is just a contract in place for the employees we're serving today which is a little over half of their employee base. And so that is a long-term contract and we see benefit to our shareholders and the client sees value in that and so that is what we are working under right now. And as we said eliminated any sort of contractual liability or responsibility of doing any sort of implementation outside of the geographies that we are live in today.

Scott Sutherland – Wedbush Morgan Securities

Okay, is it fair to say that the other contract that you are currently trying to fix, that you're trying to figure out what to do with the employees and try to get a long-term contract for e-support there as well?

Earl Shanks

Yes. We currently have a long-term contract in place with that client. The implementation, further implementation is paused and we are negotiating to change the scope and size and potentially the term of that contract.

Scott Sutherland – Wedbush Morgan Securities

Okay, great. So both are supported by contracts beyond the stickiness?

Earl Shanks

Yes.

Scott Sutherland – Wedbush Morgan Securities

Okay. When you look at the cash flow for Q4, it looks like you're going to have a good bounce back in cash flow in Q4, is there anything in particular moving there in the cash flow?

Earl Shanks

We will see the overall receivables balance come down a bit in the fourth quarter based on some pretty specific where we were with collections in the third quarter and where we expect to be in the fourth quarter. And I also don't expect to see a duplication of the negative impact that I described earlier on the call around HR management in terms of the wind down cost. We won't be incurring the same kind of wind down costs in the quarter.

Scott Sutherland – Wedbush Morgan Securities

Okay. The last question I had, and I did have a couple of financial questions, last major question, when you look at the customer management group and moving with Intervoice and you are seeing automation of IVR and speech systems, do think that cannibalizes revenue but helps margins over long-term or should we revenue growth and margin growth because you are automating a lot more calls?

Earl Shanks

Well, Scott, actually I think – yes, I do. I think it is both. The care market is a $300 billion market so there is a still huge opportunity to continue to grow the live agent business but we see moving with Intervoice into the automation both an offensive and a defensive play and there is no question more interactions are moving that direction leaving live agents to handle the more complex ones. But as we see technology become more and more revenue mix over time, my expectation is that it'll be accretive to margins.

Scott Sutherland – Wedbush Morgan Securities

Okay. And quickly over for financials, the Cellular partnership, is that still going to be about 10 million in your assumptions for Q4?

Earl Shanks

Yes. I mean yes.

Scott Sutherland – Wedbush Morgan Securities

In the last few quarters, great. Thank you.

Earl Shanks

Thanks Scott.

Operator

Our next question Karl Keirstead with Kaufman Brothers, your line is open.

Karl Keirstead – Kaufman Brothers

Hi, thanks for taking my question. Two quick ones on your fourth quarter non GAAP earnings guidance, just to be perfectly clear, Earl, is the guidance for more than $0.30, this is including the impact of a tax benefit and you're saying that excluding that tax benefit, the non- GAAP earnings will be roughly comparable to the $0.27 number that you just posted, do I understand you correctly?

Earl Shanks

Essentially Karl I think what I said is our operating performance will be pretty similar. So absolutely, if you look Q3 Q4, we are gong to have roughly same operating performance is what I think and then we will pick up a tax benefit.

Karl Keirstead – Kaufman Brothers

Okay, great. And then if excluding the tax benefit, the operating performance will be roughly comparable to 3Q, how does that square with the guidance you offered in late August where you indicated that fourth quarter would be substantially higher than third quarter, maybe you could just draw the link between those two statements? Thanks.

Earl Shanks

Sure. I think a couple of things happened. As you're recognized, we did a little better in Q3 than we were indicating at the time. And then at the time, as I said earlier in the call, we were hearing from clients that they expected to see a seasonal ramp, and there – and so that's I was kind of hearing that in the kind of early mid-August timeframe and they adjusted their expectations. The seasonal ramp was pretty normal, and now we are a little more cautious on the top line and therefore a little more cautious on the overall results.

Karl Keirstead – Kaufman Brothers

Okay, thanks. And then if I might, a question on foreign currency, Earl, you mentioned, that the call center business had about a $2 million year-over-year operating margin benefit, but what was it for the overall business? I think you said in Q1 it was 100 basis point headwind, 80 basis points tailwind in 2Q, where was it for the overall business in 3Q?

Earl Shanks

Karl, I think the numbers that I quote every quarter are actually just the CM business and the numbers we are reporting are all CM numbers.

Karl Keirstead – Kaufman Brothers

Okay great. And any notion for what you're thinking about in terms of the currency tailwind that gets you to your fourth quarter guidance, is it comparable to 3Q?

Earl Shanks

Yes. At this point, the currency movement, I am frankly breaking it out for you every quarter now just to be consistent but in our view it is one of many factors that are out there and certainly not the most important one and that would be true in the fourth quarter as well.

Karl Keirstead – Kaufman Brothers

Okay, thanks so much.

Earl Shanks

Thanks Karl.

Operator

Our next question, Matt McCormack with Brigantine Advisors. Your line is open.

Matt McCormack – Brigantine Advisors

Yes, hi. Good morning.

Earl Shanks

Hi, Matt.

Matt McCormack – Brigantine Advisors

In terms of your guidance for the fourth quarter, you mentioned it is pre-charged are you currently expecting any charges in any of your three divisions?

Earl Shanks

Good question Matt. We are looking very carefully at our 2010 plan and looking at our overall cost structure in the business. And as part of that, we may do things to significantly reduce the cost structure, and if we do those, those may come with cost of one kind or another. For example, if we did something on the real estate side, we might save, we've got to close this facility and there is cost of closing the facility. I don't have a specific plan around that yet but that is what we're in the process of working and it is why I called it out.

Matt McCormack – Brigantine Advisors

Okay. And then in terms of the IMG business, if you had signed that license deal, could we assume that revenues would have been flat 2Q to 3Q?

Dave Dougherty

Nice way to try to size the license deal, Matt. I think I'll pass on answering the question. It would have been higher.

Matt McCormack – Brigantine Advisors

Okay. That helps. So now, Dave, you had mentioned that you are saying very strong demand offshore. Could you I guess, could you just talk about that, is it materially different in terms of the percentage of work on new deals that source offshore and is that a trend that you continue to expect?

Dave Dougherty

We are seeing it. We continue to expect that. What we see is that our clients are willing to pay a premium for the quality of service delivery and we do that wherever we do the work and whether it be in the Philippines or in Latin America. And so we think we have got a very strong value proposition for our clients. And there is strong demand for that and so my expectation is that that will continue to grow in the Philippines, but importantly I think we have got a lot of upside potential to grow in Latin America as we offer that solution to our clients as well. Probably, the third dimension is that as we talked about is, home agent, which we took internationally for the first time here in the quarter to the UK. And that certainly has the potential to over time deploy that solution anywhere in the world. And clearly the benefit to that is that you don't have to be building facilities all over the world to get the folks that you need to support the business.

Dave Dougherty

Matt, just to be clear on the timing of that, I think we saw the beginning of that shift really starting a year ago when you know the financial markets we melting down and there was more of a change in sentiment there to – you know I mean we have always seen a trend towards offshore, so that is not new . But I think we saw some clients, some prospective clients come back and talk about moving things offshore, beginning a year ago that they wouldn't have discussed before that. So that is probably the timing of the shift in sentiment.

Matt McCormack – Brigantine Advisors

Okay. You talked about the typhoon in the Philippines and how you weren't – you were able to reroute the calls and such, but has that caused you to rethink your global delivery network whether it be increasing your total capacity in the Philippines or even diversifying even more within the Philippines and out of Metro Manila?

Dave Dougherty

No. We continue to grow our footprint in the Philippines. We are in many places in the Philippines beyond Metro Manila and we spend a lot of time, money and energy preparing for these kind of things, and we just don't face them in the Philippines. We faced Hurricane Katrina here in the US and we have had situation after situation like this that we how to manage this business through those kinds of traumatic events.

Matt McCormack – Brigantine Advisors

Okay, great. Thank you so much.

David Stein

Tanya, that is time for just two more questions.

Operator

Our next question, Howard Smith with First Analysis. Your line is open.

Howard Smith – First Analysis

Yes, thank you. Good morning.

Earl Shanks

Hi Howard.

Howard Smith – First Analysis

Hi, how are you. Good. On the customer management business, you seem to be picking up your wins there and I assume at decent pricing you are satisfied with, I was hoping you could update your comments of a quarter ago regarding some very aggressive competitors out there. We know it is a competitive industry but you comment some unusual things and also how you see capacity near-term, I guess long-term you expect the consolidation but kind of macro capacity trends affecting the business?

Earl Shanks

Referring to the first question, it kinds of sounds very enterprising right, kind of some sense of pricing. I continue to see, in fact with a couple of CEOs of clients last Friday, continuation of our clients are willing to pay a premium for quality of service delivery and better performance. And so in these times, they don't want to be cutting short the investment they need to make in customer service. And some of our comments at the last call you know to give you an extreme example that we were in the middle of at that point a number of situations where clients were doing an online auction and in fact we finished dead last in those only to find out our turnaround that in a number of those cases we ended up winning the business.

So it says to me at the end of the day I think you know more and more of the customers that we are trying to serve you know if we can deliver better performance, better quality, they are willing to pay a premium for that. How people are lowering costs, or how clients are lowering their costs, we are working with them in that regard by moving more of the work offshore, by moving more the interactions to technology using our IVR and speech technology, so we can work with the client to lower their cost, that doesn't necessarily mean that we do that at lower pricing.

Earl Shanks

And on the capacity side, certainly a couple of deals that have happened, the M&A deals that have happened this quarter as we said. We think we will have an impact on capacity and an impact on how the competitors approach the marketplace which we think will be positive in the long-term certainly but I think even in the short to medium term it'll be positive pretty quickly.

Howard Smith – First Analysis

Great, thank you.

Earl Shanks

Thanks Howard.

Operator

Our last question, Shlomo Rosenbaum with Stifel, Nicolaus. Your line is open.

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

Hi, thank you for squeezing me in under the wire over here, guys. And I also want to congratulate you on the significant improvement quarter over quarter here. I want to just dig into a couple of things, most of my questions have been answered but a couple of things. There was definitely a pickup in the strength in the customer management decision and just wanted to narrow down on the question that was asked beforehand, was this new business ramping faster than you had expected some of the declines to come within existing business, is that what has happened?

Earl Shanks

No, it's probably slower, less – more from the existing customer base than it was new business ramping faster. In most of the new businesses (inaudible) actually we won't really see a material effect of until 2010.

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

So it is slower declines in volumes than you guys had been forecasting?

Earl Shanks

Correct, yes, better volumes from the existing client base .

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

And then in Intervoice and as I step up quarter over quarter, was there particular deal, or are you noting that this business is just picking up?

Earl Shanks

The trends there are encouraging. And one of the things we look at as bookings in a given quarter and our bookings in the third quarter which our bookings is an indication of future revenue and so our bookings in the quarter, third quarter, were better than they were in either the first or second quarter. And we are anticipating that they will be better again in the fourth quarter. So we are starting to see some life back in that business but it is somewhat encouraging.

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

Okay. And then just switching gears a little to the HR contract, the implications of settling this contract, is there a financial implication in terms of the profitability and cash flow getting better from that contract you know going forward or this is pretty much limiting your liability going forward? I'm trying to assess how we should think of the HR business now that you guys have settled the contract.

Earl Shanks

Well certainly, Shlomo, we were very focused on limiting our liability. So we – there were a variety of changes made to that contract in the process as a result of this, it also kind of by definition, as Dave said, we are on the geographies that we're currently providing and so by not having the additional geographies, that does limit the upside a bit it in terms of what we actually have contracted as compared to what we had contracted before. So there are puts and takes I think on both sides of your question in terms of what the impact was I think from…

Dave Dougherty

… financially it an acceptable contract for us.

Earl Shanks

And I think from a shareholders standpoint, I think the shareholders generally I'm expecting them to be pleased that we limited the liability on this one given the challenges we've had in that business.

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

Right, and I agree with you. I'm just trying to figure out is there going to be a step up in operating income because of that? In other words, have you – other losses going to improve, or are you going to be sort of breakeven because of that that you will change the contract in that way?

Dave Dougherty

Well I mean there is a number of things we're in the process of doing with that business. The changes we made in the contracts basically helped the current run rate on the business but reduced some of the upside we have seen on the business in the past because of the nature of limiting the other countries that were actually going to bring live the other geographies that we were actually going to bring live. So there are puts and takes around that. I think where that gets us to for next year is as I said we are expecting that we're going to end up at positive income and positive cash flow of the business in total is where we're going to try to get to.

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

And as for next year?

Dave Dougherty

That is the objective and it looks reasonably doable at this point as we look at it.

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

Okay. And then on the CapEx is really low, is the lowest it has been since 2002 in this quarter, are you expecting that to pickup, or is there basically the new business is going to be soaking up existing capacity?

Dave Dougherty

We were trying to constrain our growth on capacity for a while, we were finishing earlier this year some expansions in the Philippines. There are – and that was driving it. We didn't have much of that in the third quarter. we may do some additional expansions in the Philippines as demand calls for but we're trying to be very cautious about how we spend money. My continued guidance is we are trying to keep it 4% or 5% of revenue and obviously we are going to be well below that this year.

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

Is this level of CapEx though excluding what you have done in the Philippines sustainable for the type of growth that you're looking at for next year or do you have to investment more? I'm just trying to figure out, can you soak up the capacity or you need to invest in…

Dave Dougherty

We may need to add some Philippines capacity in the process.

Earl Shanks

As well as Latin America.

Dave Dougherty

Right, and Latin America.

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

Okay. And then besides the 25, roughly 25 million you talked about on the HR BPO contract in terms of it seems like a drain on cash in the quarter, were there any other payments that went into it on was that pretty much it?

Earl Shanks

For the quarter, that was the major impact.

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

And how should we think of the 40 million that you guys were expecting over you know as a result of renegotiations in the contract, is the rest going to come in 4Q, or is that going to bleed into 2010?

Earl Shanks

I think just to refresh where we were, our guidance for the year was 160 to 180 –$160 million to $200 million of free cash flow. We thought there was risk in the year by about $40 million embedded in that 160 to 200, slightly narrowed the guidance this time to 165 to 185. So for the year, we have kind of come in not quite in the middle of where we thought was possible but certainly inside the range of where we thought was possible. So no big changes in our view on the year, just it is just timing quarter to quarter.

Shlomo Rosenbaum – Stifel, Nicolaus & Co.

All right, thanks a lot guys.

Earl Shanks

Thank you.

David Stein

Okay. I would like to add, this is David Stein that Earl and I will be available the rest of the day to answer any questions about the third quarter results or the business outlook that we have been discussing, and we also look forward to seeing you all at our November financial analyst meeting. Thank you all for participating today.

Operator

Thank you. That concludes today's conference call. All lines may disconnect. Once again that concludes today's conference call. All lines may disconnect.

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