Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

David Stein – Vice President, Investor Relations

Jeff Fox – President and CEO

Earl Shanks – Chief Financial Officer

Analysts

Kevin Mcveigh – Macquarie

Scott Sutherland – Wedbush Securities

Jason Kupferberg – UBS

Matt McCormack – BGB Securities

Gary Bisbee – Credit Suisse

T.C. Robillard – Signal Hill Capital Group

Dave Koning – Baird

Ashwin Shirvaikar – Citi

Convergys Corporation (CVG) Q2 2010 Earnings Call August 10, 2010 8:30 AM ET

Operator

Welcome to the Convergys Second Quarter 2010 Earnings Teleconference. Today’s conference is being recorded. If anyone objects they may disconnect. All parties will be on listen-only for the presentation. (Operator Instructions)

I’d like to turn the conference over to Mr. David Stein, Vice President of Investor Relations. Sir, you may begin.

David Stein

Thank you, Catherine and good morning. Welcome to Convergys’ second quarter 2010 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 webcasts.

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 from those expressed in our forward-looking statements. Please refer to Convergys’ most recent filings with the SEC for additional information including risk factors. We do not undertake to update our forward-looking statements as a result of new information or future events or developments.

During the call, we’ll discuss non-GAAP financial measures including free cash flow and results from continuing operations, adjusted for impacts related to the sale of the HR Management business and charges related to restructuring the business. Non-GAAP measures should not be construed as being more important than comparable GAAP measures.

Convergys’ management believes free cash flow and results from continuing operations adjusted for HR Management-related impacts and charges related to restructuring the business, 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 in the news release and on the Convergys website at www.convergys.com.

With me on the call today are Jeff Fox, our President and Chief Executive Officer and Earl Shanks, our Chief Financial Officer. Jeff will provide a summary of our operating results, Earl will cover our financial performance and business then we’ll open the call for your questions.

Now, I’ll turn the call over to Jeff.

Jeff Fox

Good morning, everyone and thank you for joining us. On a consolidated basis, total earnings from the company in the second quarter were $0.22 per diluted share. EPS from continuing operations was $0.19 per share on a non-GAAP basis. These results exclude charges of approximately $18 million for actions we took in the quarter to reduce costs. In addition, some items related to the successful sale of our HR Management business are also excluded from these numbers. Earl will provide more detail on the specifics around EPS in a few minutes.

Now, I’d like to talk about the results from our continuing operations in the quarter. Revenue from continuing operations totaled $528 million. While consistent with the caution we expressed on our last call, this was a bit lower than we expected. Adjusting EBITDA came in at $67 million for the second quarter. This was $5 million less than last quarter.

We generated strong adjusted free cash flow of $79 million and strengthened the balance sheet during the quarter. This helped drive the $73 million improvement in net debt compared with the first quarter. We also took material steps during the quarter to simplify the business and improve our cost structure. As Earl will review later, we are tightening our 2010 business outlook to reflect the progress we’ve made and the opportunities we see near term in our client base.

To be frank, the $67 million of EBITDA generated this quarter is not enough, given the collective opportunities we have here at Convergys. As a team, we are focused on simplifying the business and executing a plan to get back to profit and revenue growth.

The first step we took to focus and simplify our business was to substantially complete the sale of the HR Management business in the second quarter. This allows us to simplify our business and focus on investment of capital in businesses where we are a market leader. We are simplifying the way we engage our clients. We are focusing on the metrics that matter most and I’m personally listening to our clients in order to understand how we can provide the most value to them in this challenging business environment.

Specifically, we are hearing that our clients need technology and processes for [right showing], call type handling and customer life cycle management. I believe we have made the investments to be positioned to help our clients with these complex issues. Our clients are eager to hear our ideas since we spend so much time interacting with our customers and I see evidence that our clients value us as a partner. Several clients have told me that they value our scale and skill and our overall client satisfaction level remains strong.

In the second quarter, we closed a number of pieces of business with clients that had previously been on a decline curve. This indicates to us that we are delivering good quality. We signed several new logos in the second quarter and I do continue to see new logos in both our Customer Management and Information Management pipelines.

In recent months, we’ve also taken steps to simplify the way we do business. We’ve made adjustments to the organization and cost structure, reducing the number of separate functional groups in the organization. This has shortened the distance between what the client needs and what we deliver. We’ve realigned the client engagement functions and service delivery functions of the company by vertical market and aggregate our internal/external technology units.

This will allow us to be more efficient and drive more value into client solutions across both of our businesses. We have also taken companywide cost actions to improve profitability and competitiveness. These actions should result in better flow-through as our revenue stabilizes in the back half of the year.

While still cautious near term, we are pushing hard to make sure that performance and Customer Management and Information Management improves in the third and fourth quarters. I’ll now discuss the second quarter results in Customer Management and Information Management.

I’d like to begin with Customer Management. As we said on our last call in April, one of our largest clients made a meaningful change in their business expectations for the year. This change began to negatively impact our results in the second quarter.

Like our competitors, we also experienced a broad reduction in volumes across the markets we serve. This was due to our client’s own volume declines, shifts offshore and some program completions. We did see increases with certain clients in the quarter, though overall volume declines were deeper than we expected at the beginning of the quarter.

In terms of profitability, Customer Management did not achieve the flow-through to operating income we anticipated in the second quarter. This was principally due to the revenue declines.

We also had less technology software sales than had been expected. Our relationship technology management sales had been weak for multiple quarters. This unit accounts for about 10% of the Customer Management business and we are continuing to focus on improving the cost structure and performance of our technology operations.

On a positive note, we are encouraged by the solid new business signings with existing and new clients in the quarter. We signed new live agent business worth $46 million in 2010 revenue and about $74 million in 2011 revenue. These signings are consistent with our guidance for the balance of the year.

During the quarter, we adjusted costs to improve the expense structure. We took restructuring charges for severance and facilities. We continue to drive toward double-digit margins for the CM business.

We expect future margin improvement in Customer Management to come from further cost cutting, more use of technology and increase in volumes. In a complex economy, we remain focused on driving sequential improvement in profitability in our CM business.

Achieving our plan requires a solid ramp and flow-through in the third and fourth quarters. We have to continue to make the sales in our accounts and targeted markets and improve our expense structure to make this happen and we are working hard to execute that plan.

Now, I’ll discuss second quarter results for our Information Management business. The revenue decline in the quarter resulted primarily from expected client migrations and program completions. The impact of cost reductions allowed us to achieve a double-digit operating margin in the quarter.

During the quarter, Information Management successfully went live at Duke Energy with our utilities building solution. The pipeline for smart grid applications is growing. As Earl has said previously, though, we do not expect to see any impacts this year. We do see opportunity for the near term, also our investment in technology and distribution capability is paying off.

Information Management had two key wins in the quarter, one with a wireless carrier and one with a large satellite company. Since the end of second quarter, we also renewed a long-standing contract with a large cable company. Based upon this progress, we expect to see sequential improvement in operating income for the rest of the year.

In summary, our plan is to focus, simplify and execute in a very volatile business environment. As a market leader in the markets we serve, we’re focused on making sure clients understand the investment we are making and that they are in a position to benefit from our expertise. Despite the current growth challenges, we are investing in capabilities that will support our clients’ multi-year business needs. This will help us to strengthen the strategic value of our businesses.

We also continue to focus on simplifying the organization to drive productivity and efficiency. Our cost structure is significantly improved since the beginning of 2010. We are generating strong cash flow and our balance sheet is in great shape. We are working hard to meet our commitments in the guidance we made for the year. We are optimistic that our actions will improve our performance in the third and fourth quarters and will make our market leading businesses more competitive over time.

Before I turn the call over to Earl, I want to make sure that our operating team is recognized for the progress they’ve made simplifying our business and executing our plan to get back to growth. Our clients consistently tell me that Convergys is a company that does what it says it will do. This is a reflection of the very strong work ethic of our dedicated people and I want to thank them all for their efforts.

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

Earl Shanks

Thank you, Jeff and good morning. Before I get into the numbers, I’ll discuss how some of what we’re doing to focus, simplify and execute is impacting our reporting in the quarter.

There are three items that are impacting our disclosure this quarter. One relates to a loan refinancing which is now on the balance sheet, the second is a new classification for the cash distributed from our sell partnerships and the third relates to the impacts of the sale of the HR Management business.

More specifically, regarding the refinancing, during the quarter we refinanced the Orlando facility lease at a favorable rate and extended its maturity by five years. Accounting for the loan on the balance sheet provides increased visibility to our shareholders and is consistent with how we think about this obligation.

Also in the quarter, we made a change in how we report the cash distributions from the Cellular Partnerships. We’re moving the cash received into the operating activity section of the cash flow statement. As a result of this change, cash from the Cellular Partnerships is now included in free cash flow. We believe this change also makes our financials easier to understand.

We discussed in the last call how the sale of HR Management is impacting reporting. This quarter, HR Management results including the gain on the sale are recorded in discontinued operations. The cost and offsetting revenues for transition services provided after the sale are recorded in corporate and other within continuing operations.

The transition cost incurred in the quarter prior to the sale of HR Management have been excluded from adjusted EBITDA. The recorded gain on the sale of the business was $8 million in the second quarter, for which we received $79 million in cash.

As part of the sale, we also eliminated a related multi-year contract liability at a discounted payment of $28 million. This negatively impacted operating cash flow. Reporting regarding discontinued operations should be considerably less complex next quarter.

Moving to the financial results for the quarter, from an earnings perspective there are three numbers that are relevant. Total net income, income from continuing operations, and non-GAAP income from continuing operations.

Total net income was $27 million or $0.22 per share in the second quarter. On a non-GAAP basis, income from continuing operations was $24 million or $0.19 per share. This excludes the $18 million restructuring costs to further streamline Customer Management and corporate functions.

Also excluded are $3 million of costs incurred prior to the HR Management sale that were not included in discontinued operations. We provided in a slide presentation GAAP and non-GAAP results. Tables in the news release reconcile GAAP to non-GAAP.

I’ll now review in more detail the results from continuing operations. Revenue from continuing operations for the second quarter was $528 million. This includes $4 million of revenue from the HR Management transition services.

Operating income from continuing operations was $28 million in the quarter. This excludes the restructuring and HR Management costs I mentioned a moment ago. Adjusted EBITDA was $67 million in the second quarter.

Now, I’ll move to the operating -- the Customer Management segment. During the quarter, Customer Management continued to be the provider of choice, delivering high quality on the metrics that matter most to our clients. Customer Management revenue was $446 million in the second quarter.

We were impacted by the expected significant drop in volume for the large client that we told you about last quarter. The weak economy also reduced volumes for several of our clients which in turn impacted our revenue.

Clients also continue to shift programs offshore and we had some program completions in the second quarter. Revenue increased in the other segment during the quarter. The majority of this increase was due to one short-term program that we’ll complete in the third quarter.

As Jeff said, we continue to sign new business for live agent service at a healthy pace in the second quarter. Live agent accounts for about 90% of Customer Management revenue. In terms of the deployment of our Customer Management workforce outside the United States, about 34% of our Customer Management employees are now working in the Philippines, 16% in India, 5% in Canada and 2% in Latin America.

Second quarter Customer Management operating income was $23 million. This excludes a $15 million restructuring charge. Customer Management operating income was negatively impacted by the continuing volume softness in the quarter. We continued to invest in technology facilities, sales and marketing. Another item impacting the quarter was the revenue weakness in our software sales that Jeff mentioned a moment ago.

On a sequential basis, in the face of the deeper than expected volume declines, we have some challenges for labor. Some new programs with existing clients signed later than we expected in the quarter. As a result, we’ve a gap between our labor profile and the timing of revenue ramps.

Turning to the Information Management segment, Information Management revenue was $78 million in the second quarter. This reflects the expected completion of North America client migrations and other client projects.

As Jeff mentioned, we’re seeing good progress in growth opportunities for Information Management. Our pipeline for smart grid applications in the utilities market is growing. We also had a couple of key wins in North America in the quarter.

For both clients, we were selected after an extensive review period of our capabilities versus the competition. We’ve begun to help plan the migration to our platform, both clients are expected to be fully implemented over the next 24 months.

In the second quarter, Information Management maintained gross margin. We took further steps to align the cost structure to a lower revenue base and improve overall efficiencies. Operating income was $9 million and operating margin was 12.1% in the quarter. We appreciate the energy and commitment to the business model, the Information Management operating team has exhibited to position this business for growth.

Moving to Corporate and Other, results reported in Corporate and Other for the second quarter include the HR Management related revenue and transition costs I mentioned earlier, corporate function restructuring and related charges and lower than normal executive compensation recorded in Other costs.

Moving now to non-operating items. Other income improved year-over-year. This was due to the impact of a strengthening U.S. dollar. The sequential decline in Other income was due to the release of a litigation reserve discussed last quarter.

Interest expense declined in the quarter, due to the reduction in average outstanding debt. In the second quarter, we had an effective tax rate of 9.7%. This reflects the geographic mix of the restructuring charges, the worldwide income and the associated deferred tax benefits.

Moving to cash, adjusted free cash flow in the quarter was $79 million. This includes a large tax refund we received in April. Adjusted free cash flow excludes the HR Management payments that I mentioned earlier.

Turning to the balance sheet. As Jeff already pointed out, net debt decreased significantly to $36 million in the second quarter, that is a $236 million reduction since the second quarter of last year. This greatly reduced net debt includes a previously off-balance sheet liability of $55 million related to the Orlando lease. Note that we now have no borrowings on our $400 million revolver. We expect to continue to generate additional free cash flow each quarter consistent with our guidance and historical performance.

I’ll now discuss our outlook for the business in 2010. Six months into the year, we have tightened our guidance and expect performance to improve in the third and fourth quarters. Based on our expectation of stabilizing volumes, solid new business signings and the impact of cost actions, our target for Customer Management revenue for the full year is $1.8 billion to $1.85 billion.

We continue to execute on a plan for sequential margin improvement in Customer Management. For Information Management, we continue to expect revenue of about $350 million for the full year.

Operating margin is expected to improve sequentially and to be double-digit for the full year. Our adjusted EBITDA target is approximately $310 million. This means we expect to generate about 55% of the full year EBITDA target in the second half of the year.

This reflects our expectation for improving revenue and margin trends in the second half. We expect non-GAAP earnings from continuing operations to range from $0.95 to $1.05 per diluted share. The target for adjusted free cash flow remains exceeding $190 million. Recall, this includes the approximately $40 million in cash from the Cellular Partnerships.

We are already about 60% of the way to achieving the full year free cash flow target. This full year guidance excludes the HR Management related impacts, the CEO transition costs and litigation reserve reduction we discussed on the last call, the second quarter restructuring charges and any future restructuring actions.

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

Questions-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Kevin Mcveigh from Macquarie. Your line is open.

Kevin Mcveigh – Macquarie

Great. Thanks. Jeff, I want -- can you help us just understand, if you look at the adjustment to the Customer Management revenue, how much of that was related to existing clients versus new clients versus shifts offshore as you think about kind of those trends in the second half of the year?

Jeff Fox

Kevin, as we think about the second half of the year and the guidance we provided for the second half of the year, the low end of our guidance obviously is a continuation of where we are in the second quarter and the higher end of the guidance expect some revenue growth. You know, the revenue growth as it comes from the clients is very much related to the continuing new business signings that we see and what we’re getting in that regard. One of the things that does continue to impact is we do expect that there will be a continued migration over the longer term with clients buying a larger and larger share of what they’re buying on an offshore basis and so that’s continuing one of the pieces in the puzzle, so-to-speak.

But the new business signings are obviously hugely important and new business signings from existing clients in the year are probably the most important signings we’re doing in that regard. As we look out into next year, certainly the new logos we signed in the second quarter are one of the things that provides us lots of encouragement about how we think about ways to generate growth into next year but new clients tend not to have a huge impact in the first year, just because of how the clients ramp up.

Kevin Mcveigh – Macquarie

Great. And then Earl, obviously real nice job on the free cash flow. You were able to maintain that guidance in the face of little bit lower EBITDA. What drove that kind of being able to really maintain that free cash flow?

Earl Shanks

Well, you know, it’s obviously a mix of lots of things that play out in total. Most importantly, as we lowered EBITDA, we’ve also lowered our expectations of what we’re going to do on CapEx. So we’ve tightened our spending quite a lot from where we started expectations at the beginning of the year.

Kevin Mcveigh – Macquarie

Great. Okay. Thanks. And then just one more, if I could. As you think about the 95 to 105, in the second quarter, does that -- is that $0.19 versus $0.22 or I just want to make sure, I’m kind of apples-to-apples as I think about the non-GAAP EPS.

Earl Shanks

The relative number would be the $0.19.

Kevin Mcveigh – Macquarie

Great. Thank you.

Operator

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

Scott Sutherland – Wedbush Securities

Good morning. When you guys look at the growth in the second half of the year, especially in the Customer Management space, how much is this just seasonal uptick in volumes that you typically see annually and how much of this can you attribute to kind of share gains and winning new customers, kind of can follow through into 2011?

Jeff Fox

Well, certainly, there is always some seasonal impact, Scott, as you know. We also highlighted, though, if I think about the second half of the year, the short-term program we’ve been running in the second quarter and has some impact in the third quarter will be gone. So I’d maybe call that a wash from a seasonal perspective between the short term and the seasonal aspects and then we’re obviously continuing to sign new clients, continuing to win new clients and we would expect that that would be pretty helpful.

We’re really pretty encouraged about our client relationships and the feedback we’re getting from clients about the quality of work we’re doing and, therefore, their propensity to buy from us for the services we’re providing. And so we’re -- that’s why we laid out guidance that basically says that one end of the range that we’ll be flat for the balance of the year with the second quarter and at the higher end of the range obviously we’d see some growth in the second half.

Scott Sutherland – Wedbush Securities

Information Management group, you talked about two wins. I think you might have mentioned in North America. Can you talk about maybe the process and what allowed you to win those deals?

Jeff Fox

Yeah. So this -- I think that both wins were very competitive processes where our product was evaluated, in addition to our total cost of ownership value proposition and our cost to delivery and history of executing on delivery and so when you take all of those things in one place.

I think that both wins had a very similar result for a similar set of characteristics, in that we invest heavily in our product and continue to believe that, that gives us total cost of ownership value as well as functionality, which is competitive and continues to be evaluated as competitive and then we have a really good history of delivering large, complex integration projects with multiple customers worldwide. So we are a good overall choice when you’re going through a very major set of process and system changes.

Earl Shanks

And it’s clear in both cases that the clients went through some very significant referencing process of us, along with our competitors, to get some real feedback about what it took to get these things installed on both sides, what we proposed and what the competitors proposed. I think the reference has helped us a lot.

Scott Sutherland – Wedbush Securities

Okay. Great. Thank you.

Operator

Our next question comes from Jason Kupferberg from UBS. Your line is open.

Jason Kupferberg – UBS

Thanks. Good morning, guys. Just wanted to start with a question on Information Management and the visibility on the second half ramp that seems to be implied in the revenue guidance there. I think you’re still talking about getting to about 350 for the year and I think you’re about 160 through the first half. Sounds like some of these new wins are kind of post 2010 contributors to the top line. So can you just talk about some of the moving parts that give you the confidence to get that second half ramp there?

Earl Shanks

The quarterly spread that we’re seeing, Jason, is pretty consistent with what we expected at the beginning of the year. That’s why we talked about at the beginning of the year the second half being better than the first half. That really relates to some pretty specific client relationships and the timing that we expect the revenue from those relationships, that will drive most of the year-over-year change. There is -- in particular, there’s a few big deals that are out there that we know -- we’ve known since the beginning of the year were going to be in the second half. So that’s why we have the guidance has been the same for the whole year around the Information Management business.

Jason Kupferberg – UBS

Are those deals that you still need to push over the finish line or you’ve been down selected for them already?

Jeff Fox

I think that there are -- this is Jeff. There are a few deals where we believe we are in the process of getting them done, which is why we haven’t changed our numbers. And they do have a fourth quarter impact which is consistent with our history. This is still a business where fourth quarter licenses do make an incremental contribution.

Jason Kupferberg – UBS

Right. Okay. And then just shifting to Customer Management, I know you guys had been looking for double-digit margins, exiting the year in Q4. Obviously, you’ve done some cost take-out here in Q2. Is that enough to still get you there or is that really kind of the delta in EBITDA as far as your guidance change there and it will be tough to get to the double digits by year end?

Jeff Fox

Well, the way we’re looking at it is -- I want to reiterate. We are seeing some evidence of stabilization in our revenue. Obviously, it was down in Q2 versus Q1 and so to get to the double-digit EBITDA number, we need to find stability in our revenue and that has to come from a combination of current clients which we’ve seen some good fact patterns there and bringing on and successfully ramping some new business.

We’ve also taken out and expect some better flow-through, as I said and Earl said as well. We have worked hard on our SG&A. There’s certainly more we can do there and on or cost of operations in terms of some facility closures. So all of that coming together with closing business in the right geo’s give us some confidence that we will be able to produce upward momentum in our EBITDA margins in the back half of the year. Getting all the way to the double-digit number is something that is -- we’re not giving specifics on that.

Jason Kupferberg – UBS

Okay. Understood. Last one from me. Just from a big picture perspective, Earl, I think you mentioned that you’re still seeing kind of this ongoing longer term shift toward demand for offshore based volume. I mean, what kind of inning of that game are we in? I guess, it feels like the industry there was a big wave and then it felt like at one point it kind of stabilized and some clients stopped moving offshore because there was some consumer back lash and even some regulatory noise but it sounds like now maybe the offshore piece is regaining some momentum. Do you still see a lot of head room there in terms of thinking about longer term impacts on your mix and your business?

Jeff Fox

I mean, I would tell you that, again, it’s client by client, program by program, segment by segment that these decisions are being made. But net-net, we do see demand in our pipeline and are increasing our capacity for offshore capabilities because we think that for clients, the value proposition is very strong to get better cost. And I don’t see that ever ending. I think that, that is -- you know, we are a participant in an economy that is not experiencing revenue growth at the consumer level and so folks driving through, getting the right calls in the right place at the right price with the right underlying technology and processes, we see that -- we do not see that changing.

We still are selling U.S. capacity to some folks. And in fact, in the last quarter had a couple of decent-sized transactions that frankly won’t hit until next year from a ramp perspective that have a U.S. component. So I don’t think that’s -- I think the specific answer is as long as our customers are feeling pressure to drive their value proposition and their cost and their price, they’re going to look to scale curve and experienced folks like us to deliver an underlying support structure which is why we continue to invest in new capacity offshore.

Jason Kupferberg – UBS

Okay. Thanks for the comments.

Operator

Our next question comes from Matt McCormack, BGB Securities. Your line is open.

Matt McCormack – BGB Securities

Yeah, good morning. In terms of the software sales within the CMG business, could you give us a little bit more detail on why exactly those are weak and just remind us about the strategic rationale of having that business along with your live agent business.

Jeff Fox

Let me start with why they’re weak. They’re weak because we have work to do in terms of channel partnerships and specifically -- it’s not been a great new software sales economy the last 18 months to two years. And so I would say that we’re underperforming our expectations a bit there and are working hard on it but I would not say that we’re an anomaly in terms of software companies in this global economy, particularly in a couple of the spaces we serve.

From a strategic rationale perspective, again, I try to spend a lot of time with clients because clients will tell you whether or not you’re investing in the right things. And if you look at our overall technology and business capabilities, I think our clients very much -- at least some of our clients very much value our knowledge and ownership of some proprietary software.

We’re seeing uptake in the relationships. We’re seeing engagement in terms of thought processes around how they manage their customer relationships to the right location with the right processes.

And so, we view the software business, the software and technology business because it’s broader than just software as it relates to CM as integrated, important and complementary to the live agent capabilities that we deliver. They’re not separated once you get inside the operation of these customers. They need us to understand all of that and they all buy at slightly different at different points in their own lifecycle, but it’s clearly important at a number of our customers.

Matt McCormack – BGB Securities

Okay. And then Jeff, you’re about six months into your one-year contract. Could you provide us an update on your possible commitment past one year?

Jeff Fox

Well, without being specific, I hope you’re hearing commitment in my voice. I really think that these customers, we’re working hard on, what we call focus, simplify and execute, because we are making investments in both CM and IM, that we feel like customers are asking for and in a position to use. And so my -- I hope that mindset indicates a level of commitment for the long-term of this business.

Matt McCormack – BGB Securities

Okay. And then in terms of the cash flow, obviously, strong, it’s projected to be strong. So the use of cash, should we continue to see paying down debt and then, could we see a buyback or do you really have to get through the restructuring part?

Jeff Fox

Well, I want Earl to tag in here because he’s got more history with you guys on this. I feel really, again, I was very -- I hope you all know, I was pretty blunt, $67million of EBITDA we produced in the quarter was not the right number for this set of assets.

That said, we generated a lot of cash. We are a profitable business and we will continue to generate cash, so it is important to us to focus on the operations and get them right and we do have 7 million shares authorized under our share buyback, so that’s, we feel like that is a good use of cash at the appropriate time and but net-net I would say we’re very operationally focused right now. We have clients. I have a statistic I’ll give you guys which is over half of our top 20 clients made a proactive purchase decision with us in the last 90 days.

So that feels to me like we are getting some acknowledgement for the investment of capital we’re making and the capabilities, and our mindset to deal with these customers. So as we generate cash, I’m going to kick it over to Earl to see if he would like to elaborate any more, but net-net, our balance sheet is in very good order, there’s always improvement to make. And again, I’d remind you, we do have share, 7 million -- 7.1 million shares authorized under our current repurchase program.

Earl Shanks

I’ve said before to all of the investors as we think about the business, there’s really three things we focus on which is liquidity and investing in the business and returning cash to shareholders. Obviously, we’ve done enormous work in the last year and a year and-a-half to improve liquidity and so we’re in pretty good shape there. It provides us the flexibility to think about what the best use for cash is and we’ll be pretty deliberate as we think about that.

Matt McCormack – BGB Securities

Okay. Thank you so much.

Operator

Our next question comes from [Gary Bisbee] from Credit Suisse. Your line is open.

Gary Bisbee – Credit Suisse

Hi. Good morning. Had a couple of questions. As we look at your outlook for the second half, what are your thoughts around pace of new business signings and do you expect them to maybe improve sequentially in the next couple of quarters or if so, what verticals do you see strengthening and maybe give us a little more color on that?

Earl Shanks

Let me start this and Jeff may pick up on the back end. I think as we think about our new business signings, I think we had a solid quarter in the second quarter, not a great quarter, but a solid quarter and so we were pleased with that. It was consistent with the guidance that we provided to the investment community, so we were pleased with that as well.

Obviously, we’re pushing hard to capitalize on the high quality of services that we’re providing to the clients and to our existing client set and expecting the result of that, we should be able to capture market share with those clients and broadly capture market share.

But that’s in progress work and not a forecast of where we’re at but just in progress work and those are certainly opportunities for us and we feel like we’re pretty well positioned with our delivery capabilities and what we’ve done for the clients, as well as the mix of technology services we’re adding into the mix. So we feel pretty good about where we’re positioned, not huge celebration with last quarter but a decent quarter in terms of what we did.

Jeff Fox

Yeah. And I would just -- you’re going to hear the focus and investment theme from me over and over again, so just expect it. We are focused on making sure we’re delivering great service at a competitive price to our customers both in IM and CM, okay. And we are investing in capacity, capability, expertise and technology, that help those folks drive their business to better places.

And the efforts we’re making to sell to new and current customers, I think our team would agree with Earl and I that we think we can get more for the dollars we’re spending and so, I think, there’s room for our business to become more effective in those areas.

I would reiterate what I said. When over half of your largest customers have a choice and make a proactive purchase decision with you that means, that we’re doing some things well and right. Now, should it be all of them, don’t think there’s a decision from every customer, every quarter, but I feel like our teams are doing the job right.

Gary Bisbee – Credit Suisse

Okay. And how would you categorize the pricing environment relative to last quarter? Would you say it’s about the same or is it, do you see signs that it’s improving?

Jeff Fox

I think it’s competitive. We don’t see the number of competitors for any opportunity going down at all and so, I wouldn’t say improving is the right number, we’re not seeing a decline either.

Gary Bisbee – Credit Suisse

Okay. And then, just one last question on the restructuring. Is that focused more on the customer management segment and how far would you say you’ve gotten into, are we in -- what inning are we in to use the analogy?

Earl Shanks

Well, so, I think, obviously, the restructuring we did in the fourth quarter of last year is all pretty much implemented at this point in time. The restructuring we did in the second quarter is mostly yet to be implemented. It is primarily focused in the Customer Management segment and that’s where the results will show up.

We expect to see pretty significant improvement over the balance of the year in our SG&A spending as a result of what we’ve done in the second quarter. Obviously, all of that’s baked into the guidance numbers that we provided to you. So, and there’s, so I feel like we’re pretty well positioned in terms of the things we’ve done.

In terms of what inning we’re in, it probably has to do more with the revenue trend than it does to do with where we are from a cost standpoint. If we get stabilizing to growing revenue then I think we’ve got most of it behind us. Not all of it, perhaps, but certainly most of it behind us and if revenue trends don’t show up the way we see them today for the balance of the year, then we’ll be back and balance the cost with the revenue.

Gary Bisbee – Credit Suisse

Okay. Thank you.

Operator

Our next question comes from T.C. Robillard from Signal Hill Capital Group. Your line is open.

T.C. Robillard – Signal Hill Capital Group

Thank you. Good morning. Just a couple of questions. Earl or Jeff, can you give us a sense on volume trend, existing client volume trends in the CMG segment as the second quarter progressed and maybe any commentary as what you saw through July?

Jeff Fox

I’m not going to, keep that real simple, we did watched the beginning of the quarter was a little off and we saw some stabilization, and a little bit of improvement later in the quarter. I mean, obviously by holding to our overall revenue number for the CM business, we expect stabilization to continue.

I think Earl’s been pretty clear about to make the numbers that we’ve continued to leave out there on the low end. We can’t have material new declines in the back half of the year. Again, we feel like customers making some proactive decisions to do more business with us and some of the new wins in the aggregate adding to a little bit of seasonal business gives us a reasonable view that we’re in a stabilization mode near-term in CM.

T.C. Robillard – Signal Hill Capital Group

Okay. And do you feel in terms of the stabilization, is this something that was just over kind of call it the past 30 or 60 days, or is this something that you saw for almost the past 90 days, assuming kind of to date?

Jeff Fox

I think that’s maybe too specific.

T.C. Robillard – Signal Hill Capital Group

Okay. I guess, what I’m trying to figure out is, understanding that you guys have to make some expectations when you give guidance, I’m just trying to figure we -- you saw the problem where there was the expectation for the seasonal uptick in the fourth quarter that that ended up becoming much more muted because of the macro environment.

Given what you’re seeing in financial services, what you’re seeing in the telecom space and what you’re seeing just in a broad variety of consumer metrics, it doesn’t look like there’s going to be a really great second half this year, just on an overall economic basis.

So what I’m just trying to get a sense for is how much of this is what you’re seeing in hard commitments versus typical expectations or typical trends that you’ve seen just historically?

Jeff Fox

Yeah. Let me start this and then Earl has a lot more history with you guys, so I’ll let him -- I’d like him to throw in. The most important thing we can do right now to stabilize and ultimately position this business for growth is continue to improve our operating delivery to our customers, okay. Our forecast doesn’t have a material seasonal uptick, it has some seasonal business in it but it’s not the most important piece of the puzzle and it incrementally adds some revenue.

Again, what I would tell you we’re focused on and I want Earl to specifically answer the question, is we are focused on being in the game with our customers delivering the right service level metrics at the right price, in the right location, with the right underlying technology support and that is what it’s going to take to stabilize this business and position it for growth. The seasonal question I’d like to kick to Earl and see if you want to put some color on that.

Earl Shanks

Yeah. So on a pretty continuous basis, we look at a number of statistics around where the business is going in terms of what the call volume is and what the billable hours are, what the occupancy is and et cetera, what the level of agents we have employed based on the demand from the customers and forward forecasts we get from the customers to fit all of that together.

I think what the conclusion we’ve come to and the reason we laid the guidance out the way we had is when you look at all of those pieces together. I think there was a range of outcomes that are likely for the balance of the year and I think what we’ve tried to do is to narrow down that range for you, that there’s about a $50 million spread here between the top and the bottom of the range for the balance of the year in CM and that -- and what we’re seeing is consistent with that range and our ability to fit inside that range by the time we get to the year.

So that’s really how we think about and what we tried to do in this case, and that’s taking into account the data we have through yesterday to look at where we are, so we thought about where we are in the quarter so far and we’ve certainly thought about what the pattern we saw in the second quarter.

T.C. Robillard – Signal Hill Capital Group

Okay. That’s great extra color. I appreciate it. And then, just on the restructuring charge for the second quarter, is that reflective of the level of business that you’ve seen over the last couple quarters or Jeff, was that something more when you came in as the CEO really rolled up your sleeves, were able to dig in further to the business, realized that there was just some lingering inefficiencies. I’m trying to get a sense of how much of this is more of this business wasn’t as lean as it should be versus a reactive situation to what trends have been over the last quarters.

Jeff Fox

I would -- I wanted to make sure, I complimented the operating team and the business early. The operating team knows that we have to get better what we’re doing and I use the term focus, simplify. We brought some functions together. We’ve done some things as a team. This is not a Jeff did it. That’s not the way a business like this at this scale works.

I think the operating team here knows what it looks like to be getting all we can out of these businesses and I feel like as we’ve been chasing the volume declines the last couple of years, I think this team has sharpened their focus on what does good look like, function-by-function, process-by-process and is going to continue to make improvement.

So that’s a soft answer to a specific question. I believe that the engagement with the customers is where we will grow this business. We will not cut our way because this business, we deliver good quality, we had to improve our cost structure some. I think we still have some things we have to work on, but net-net, we have to make sure that these customers are deeply engaged with us and valuing what we’re investing in, in terms of capacity and capabilities to grow the business.

So focus and simplify, we have clearly simplified our organization in the last really 120 days. Clearly simplified it and we’re getting I think some near-term feedback from some of our customers that they understand how we want to engage. Does that make sense to you?

T.C. Robillard – Signal Hill Capital Group

It does. Thank you.

Operator

Our next question is from Dave Koning, Baird. Your line is open.

Dave Koning – Baird

Yeah. Hey, guys. One thing I noticed in the 10-Q was it looked like the AT&T revenue was down $30 million or so sequentially but you also give good data on the top three clients and it looked like you exclude AT&T, other top three clients, meaning number two and number three, I think Direct Tv and one other was also down about $20 million sequentially.

And I guess, I’m just wondering, I don’t know if you can give us any more color on which one of those was the one that you talked about some deconversions or and I guess also just a little color, it seems like more than one of your top three clients are declining pretty significantly. On the positive side, it seems like some of your smaller clients are growing nicely and I would imagine that to be a better margin opportunity. So, maybe you can just talk through some of those topics.

Earl Shanks

Sure, David. We certainly -- we’ve got some important clients that made some changes. I, yeah, some of it we had had known going into the year we were going to see. Some of it we didn’t know going into the year. Some of what you’re seeing as you look quarter-to-quarter is certainly the impact of seasonality. I’m not going to on this call talk about a specific client and which one did what when but there is a mix of different things going on with our clients.

As Jeff said, probably the most important thing recently that’s going on with the clients is the new business that they’re signing with us and the new decisions they’re making around that. But and so that is the thing that I would focus on.

Jeff also alluded to in his comments earlier that we had some clients in particular that were on a downward trend with us for a while that have gone and made some fairly recent positive decisions to expand business with us again.

So we’re encouraged about that as well, but, given the comments we made a quarter ago with the changes with a particular client, just reflect that that’s what happened with one client but certainly we expected some changes with the other clients just as we move through the year.

Jeff Fox

And I’ll reiterate, our operations team has to continue to make progress and deliver the goods to these customers, so that there’s validation for them, giving us some business and so that’s the phase we’re in. We have gotten some near-term wins within our client base that show engagement. We have to deliver the goods and I feel good about our operating teams’ focus on those issues, as well as the cost structure and so that’s the business we’re in.

The underlying economy is driving complexity and call patterns and volumes that is also embedded in what’s going on in our business. I think clearly the telecom sector has worldwide call volumes are down in the telecom sector. That’s what we’re hearing from our competitors. That’s what we’re seeing from some of our clients.

Dave Koning – Baird

Yeah. That makes a lot of sense. That’s helpful. And then, I guess secondly, the other line of the CM business was up a lot. You mentioned that it was mostly due to the non-recurring government program. Is Q2 the main quarter where that revenue falls or was there some in Q1 or Q3? And I guess, the reason I’m asking, just to understand, you said a 1% headwind to next year’s growth, I just want to kind of know about how big it’s going to be this year.

Earl Shanks

We saw a little bit of impact in Q1. We’ll see some impact in Q3 as well. Q3 will be, expect less than Q2, but still important.

Dave Koning – Baird

Okay.

Jeff Fox

We’re also, again, this is Jeff. We’ve also picked up a couple of small, I say small, I mean, we picked up a couple of accounts and our pipeline says that there are accounts that I guess we classify into other, right, where we can make a difference for them and so our expertise and our investment and our ability to make a difference on accounts that fall into that category, I still feel good about. It’s certainly not as easy, it’s not as big a sector individually. There’s no one specific sector like telecom. But we have a good pipeline and we add value to a number of these type of customers, so long-term we need to grow the category.

Earl Shanks

Yeah. Just to point out the specific words we said around what happened with the other segment, the largest impact was this one client that wasn’t the only impact.

Jeff Fox

Right.

Dave Koning – Baird

Okay. Good. And then finally, just to understand free cash flow, you’re doing a very good job there. Is there anything really non-recurring in 2010 that we shouldn’t expect to recur in 2011, and obviously without giving guidance. I’m just wondering if there’s anything to call out in the 2010 number, I know you wiped out HR impacts from the free cash flow, but anything else more non-recurring in nature in this year’s cash flow?

Earl Shanks

I think when you look at it, certainly the tax refund we got in the first half of the year is sort of non-recurring. I mean, we obviously do what we can around taxes in any given year in terms of reducing the tax cost we’re incurring. But some of that’s probably driven by what’s happened in the HR business last year in terms of the timing of how that flows through.

I think in reality when you look at even our free cash flow guidance for the year, I wouldn’t tell you that we pulled out all the cash impacts of HRM this year. We pulled out some pretty discrete items that are easy to capture but there’s undoubtedly some impacts there as well.

So in general, I always -- when I think about cash flow, I always come back to the starting point to what my forecast is for net income and then think about how we -- how much better than net income we can do. I’m not in a position today to give you a forecast for next year, but that would be the benchmark I’d start with, which is where’s net income going to be and then what are the key adjustments and on balance they’ll be upward adjustments from net income.

Dave Koning – Baird

Yeah. That’s great. Well, thank you.

Jeff Fox

David Stein

Operator, there’s time for just one more question.

Operator

Thank you. Our last question is from Ashwin Shirvaikar with Citi. Your line is open.

Ashwin Shirvaikar – Citi

Hi, Jeff. Hi, Earl. Most of my questions have been answered. Let me just end with sort of a clarification type question and a couple of clean-ups. So the lower end of the range that the new range does not anticipate a material improvement in existing client volumes and also, if you kind of stay at that level, then the cost cutting should give you a modest second half lift in margins. Is that accurate to start with?

Earl Shanks

Yeah. I think that’s generally true, Ashwin. What I think we said is that the lower end of our CM guidance range is basically a continuation of our Q2 revenue level. There’s some pluses and minuses in that, the program we just talked about as an example of it will be a minus in the second half, some seasonal impacts being a positive impact and some of the new signings being a positive impact.

So it’s never quite so simple as no changes to get there but in general that’s right. And from a margin perspective, you’re right, we would expect to see improvement in margin in the second half, based on the cost actions we’re taking against the same revenue base.

Ashwin Shirvaikar – Citi

Okay. So two quick sort of clean-up questions. One is on if you can help me with the forward tax rate, both accrual and cash and then the second quick question is why is it taking 24 months to implement the two IM contracts, if I understood your comment right?

Jeff Fox

I’ll let Earl do taxes and then I’ll talk about IM.

Earl Shanks

So we’ve done a pretty decent job overtime of driving our tax rate below 30% on a reported basis. I think, we will likely be able to continue to drive it below 30% on a reported basis and we’ve also done a pretty decent job over many years of having the cash tax rate actually be less than that reported basis. I think that continues to be my expectation and the goals for the team and as I said, they’ve done a pretty good job of executing against that.

Jeff Fox

On the IM, I think, that we’ve given you some rough justice guidance there and that one of the contracts is will likely be implemented by mid-next year is and then one of the contracts mid the following year.

And again, those type of major conversions to a new platform are all very much guided by the customer’s environment and the overall degree and scale and complexity of the change you’re implementing, and so the one that’s a longer situation is longer for all the right reasons. I’m pretty familiar with it and I think that it’s the right approach.

In fact, the customer’s taken a very thoughtful approach there and it’s not ours to determine timing. We’re supposed to -- we’re a service supplier and we think that they’re being very thoughtful about the risk of that scale transformation.

Earl Shanks

Just as a reminder, some of the comparable ones we’ve seen in the past have taken closer to three years or perhaps more than three years to do the same kind of a transformation. And so our view is quite frankly that because of the quality of the software and the product, we’re able to get it done on a relatively faster timeframe than what some of our competitors can do similar transformations.

Ashwin Shirvaikar – Citi

And these would be data processing?

Jeff Fox

Yeah. They’re both major software implementations that have processing deals attached, yeah.

Ashwin Shirvaikar – Citi

Okay.

Jeff Fox

Transparent.

Ashwin Shirvaikar – Citi

Okay. Thank you guys.

Jeff Fox

Thank you.

David Stein

Okay. I’d like to add that Earl and I will be available the rest of the day to answer any questions about the quarter results or the business outlook that we’ve discussed on the call and I want to thank you all for participating today. That concludes the call.

Operator

Today’s call is concluded. All parties may disconnect. Thank you for participating in today’s conference.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Convergys Corporation Q2 2010 Earnings Call Transcript
This Transcript
All Transcripts