Convergys Q3 2007 Earnings Call Transcript

| About: Convergys Corporation (CVG)
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Convergys Corporation (NYSE:CVG) Q3 2007 Earnings Call October 26, 2007 10:00 AM ET

Executives

David Stein - VP of IR

Dave Dougherty - President and CEO

Earl Shanks - CFO

Analysts

Jason Kupferberg – UBS

Ashwin Shirvaikar - Citigroup

James Kissane - Bear Stearns

T.C. Robillard - Banc of America Securities

David Koning - Robert W. Baird

Julie Santoriello - Morgan Stanley

Schlomo Rosenbaum - Stifel Nicolaus

Kim - Goldman Sachs

Eric Boyer - Wachovia

Larry Berlin - First Analysis

Shaul Eyal - CIBC World Markets

Robert Kirkpatrick - Cardinal Capital

Operator

Good day, ladies and gentlemen, and welcome to the ThirdQuarter 2007 Convergys Corporation's Earnings Conference Call. My name isKatrina and I will be your coordinator for today. At this time, allparticipants are in a listen-only mode. We will conduct a question-and-answersession towards the end of this conference. (Operator Instructions). As areminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your hostfor today's call, Mr. David Stein, Vice President of Investor Relations. Pleaseproceed, sir.

David Stein

Thank you, Katrina, and good morning. I am David Stein, VicePresident of Investor Relations, and I want to welcome you all to theConvergys' third quarter 2007 earnings call. This call is the property ofConvergys.

Today's discussion contains a number of forward-lookingstatements, including future financial results, operating projections, and costestimates, that involve potential risk and uncertainty for Convergys. Futureresults could differ materially from those discussed. Please refer toConvergys' most recent news release and filings with the SEC for additionalinformation, including risk factors.

Currently, we do not intent to revise or update anyforward-looking statements made during the call. During the call, we willdiscuss non-GAAP financial measures, including free cash flow and revenue,excluding AT&T. These non-GAAP financial measures should not be construed asbeing more important than comparable GAAP measures.

Convergys' management believes these non-GAAP measuresprovide the users of the financial statements with a more comprehensiveunderstanding of the company's underlying performance and provide an additionaland useful comparison of Convergys' current results with past and futureperiods. A reconciliation of these non-GAAP measures to the comparable GAAPmeasures is available on the Convergys website at www.convergys.com.

With me on the call today are Dave Dougherty, our Presidentand Chief Executive Officer and Earl Shanks, our Chief Financial Officer. Davewill provide a summary of the financial and operational results for the thirdquarter. Earl will follow up with segment results and forward guidance. Thenwe'll open the call for your questions.

I'll now turn the call over to Dave.

Dave Dougherty

Thanks, David. Good morning to all of you who have joined ustoday. We are three quarters into this year and still plan on delivering recordrevenue and EPS in 2007. In our last earnings call, we discussed challengeswith the large HRO contracts. Recall, we took a $6 million charge in thequarter, and said we could incur up to $35 million in additional charges thatwould hit the P&L in the second half of 2007, and the potential forcontinuing P&L impact in 2008.

I am pleased to report we've successfully resolved thecontract issues related to the implementation. We expect no additionalexpensing of implementation costs, as we complete this phase of the project.

Let me repeat, we will not incur the potential additionalcharges we spoke about on our second quarter call and discussed in the 10-Q.

In our Information Management business, we maintained strongprofitability and international growth during the quarter. We also madeprogress building the Customer Care pipeline. As these client opportunitiesfully ramp, we anticipate significant improvement in revenue growth.

In terms of quarterly financial performance, revenue was$704 million in the quarter. Growth in Employee Care and Customer Care offsetthe expected decline in Information Management.

Third quarter EPS of $0.30 includes a restructuring expenseof $3 million. Year-to-date EPS of $0.89 puts us on track to achieveapproximately $1.20 for the year, which again will represent record high EPSfor the company in 2007.

In August, the Board of Directors approved an additional 20million shares to repurchase, roughly 15% of shares outstanding. We bought over5 million shares in the quarter, reflecting our confidence in the long-termstrategic outlook for Convergys.

I will now discuss some of the operating highlights in eachof our business segments. I will begin with Customer Care. During the quarter,we continued to face currency headwinds and had excess contact center capacitycreated by client program changes and delayed ramps. While the Customer Careoperating results were below our expectations, we look steps during the quarterto drive Customer Care revenue growth and operating efficiencies. I am confidentthese actions will have a long-term positive effect on our business.

Given the broad-based demand forour multishore contact center services, we expanded our sales in consultingheadcount to build and accelerate pipeline convergence.

As we've said before, it takesthree to six months to ramp clients like these, and we are making importantprogress. We are in the mid to late stages, converting the sizable new clientopportunities, and I am confident we'll accelerate our growth in the quartersahead.

As this is the case for otherfirms in the industry, we continue to face currency headwinds in the thirdquarter. To address the continuing foreign exchange challenge, we're, first,pursuing selective price increases with contracts on which we have been hardesthit by foreign exchange movements. Second, evaluating additional operationsfacilities and infrastructure changes to address this continuing risk. Andfinally, targeting more business within country clients from which we willreceive local currency revenue.

The currency impact in the thirdquarter was $3 million, net of hedges. During the quarter, we continue tocapture new clients. For example, we announced a three-year contract with thelarge U.S.industrial manufacturer to support its contact center transformationinitiative. We were also recognized by InformationWeek for our innovative useof technology to encourage customer care, employee engagement, productivity andretention.

Moving to Information Management.We continue to win business with a number of new and existing clients duringthe quarter, especially in the Middle East and Asia.In the quarter, we announced the expansion of our relationship with Telecom Egypt. Convergyswill provide professional consulting services to help reengineer all billingprocesses to align with the new billing platform. Recall, Telecom Egypt's newplatform is based on our Infinys billing and rating solution.

Recent client interest is particularly focused on thesuperior convergent charging capabilities of our Infinys platform.

Convergent charging helps clients streamlining the order andoffer process, consolidate product lines and decrease revenue leakage. This candramatically improve the end customers' experience as well as serviceproviders' bottom line. We're also seeing traction for our dynamic decisioningsolution.

In the quarter, we announced a new contract with the U.S.Cable Provider and are in discussions with several other clients. This solutionis already helping a leading USwireless carrier [improvisation-efficiency], provide proactive customer care,improve automation and maximize customer lifetime value.

Billing services revenue from Sprint Nextel in the thirdquarter declined 16% compared to the same period last year. We're committed toexecuting Sprint's current plan to complete the migration of subscribers during2008. The underlying information business is growing, excluding the AT&Tand Sprint convergence.

We grew at a double-digit rate outside North America in the third quarter. Another good quarter in terms ofprofitability was driven by strong licensed software sales and ongoing actionsto take out cost, nice job by our information management team.

I'll now move to Employee Care. Employee Care had solidrevenue growth in the third quarter. Importantly, working closely with a largeHR BPO client, we successfully addressed contract challenges we spoke about onour second quarter call. Recall, in July, we told you about the potential forexpensing significant additional implementation cost. However, we have nowsuccessfully amended the terms of the contracts. This represents a win forConvergys and a win for the client, and sets the stage for a mutuallyprofitable long-term relationship.

Therefore, we expect no additional expensing of implementationcost, as we move to the next stage of implementation. This remains a veryimportant contract. We continue to expect it to be profitable over the term ofthe agreement, again nice job by our folks who worked on this.

Progress in the last six months on this implementationdemonstrates that when difficulties arise on a large and complex HRO project,we are able to negotiate a win-win agreement with our client. This is one ofthe many reasons I am confident about our ability to make this a large andprofitable business for Convergys.

We are also progressing on schedule with our implementationsfor J&J and Starbucks. The HR services we will be providing to J&Jinclude HR administration, payroll, workforce intelligence, compensation,performance management and succession planning, benefits learning, recruitingand resourcing.

For Starbucks, we'll provide HR administration, payroll andbenefit services beginning in North America,with the opportunity to expand in support of Starbucks' global expansion.

The Employee Care business model provides a compellingopportunity to create significant shareholder value. Our uniquetransform-then-transfer delivery model is working. We are selectively signingand renewing business with marquee clients, and we are well positioned in anumber of new opportunities. We are keeping fixed cost under control, we aredriving operational and technological efficiencies with clients over time andwe are successfully advancing our implementations.

In summary, we are well positioned to grow and createsignificant shareholder value across the business. We made progress overcomingour short-term challenge in Employee Care. We've taken action to acceleraterevenue growth and margin expansion in Customer Care, and we are successfullymanaging the Information Management business through a top transitionpreserving strong profitability and international growth, and we remaincommitted to talent management and the development of our people. And all thisprogress puts on track to deliver full year earnings of approximately $1.20 ashare.

As a team we remain committed to preserving our leadershipposition in the markets we serve, while gaining further operationalefficiencies across the business and creating sustainable shareholder value. Andthis team has demonstrated the ability to execute and get the critical thingsdone that need to get done.

At this time, I will turn over the call to Earl. He willprovide greater detail on our third quarter financial results and forwardguidance.

Earl Shanks

Thank you, Dave, and good morning. Let's begin by reviewingCustomer Care performance. Customer Care revenue was up 2% to $463 million inthe third quarter. Increases with several communications clients contributed tothe growth. As Dave mentioned, we've taken action to accelerate Customer Carepipeline conversions. We expect to begin seeing the impact of these actionslater this year.

At the end of the third quarter, Customer Care hadapproximately 23,000 employees in Asia. Thiswas an increase from 19,500 employees in the third quarter of 2006,approximately one-third of Customer Care employees work in Asia.While it is good to build capacity and capability in a low cost geography, theweakening dollar does pressure the profitability of business that wascontracted at more favorable exchange rates.

Customer Care operating income was $40 million. Thisincludes higher labor costs, several million dollars of capacity expansioncosts and an approximately $3 million negative impact from the weakened U.S.dollar. Lower volume driven by client budgetary constraints and the negativeimpact of slower client ramps also contributed to the decline in operatingincome.

Moving now to Information Management. Revenue was $178million in the third quarter, down 10%. Excluding AT&T and Sprint,Information Management grew in the third quarter. Strong growth ininternational operations partially offset North American client migrations.

The Information Management operating income increased 9% to$34 million, and operating margin jumped 330 basis points to 19.2%. Costactions to right size the business drove strong profitability.

I will now review Employee Care performance. Revenue was up24% to $63 million compared to the prior year. This reflects successful implementationsand the early stage of live operations with several clients. The Employee Careoperating loss improved 3% to $8 million in the third quarter. Importantly, theoperating loss improved 51% sequentially from the second quarter, reflectingthe large HRO Contract Resolution.

As Dave mentioned earlier, we've reached an acceptableoutcome for both parties, which will help us to be successful in the future.Terms of the contract have been adjusted to ensure a quality implementationwhile containing costs and scope.

In this situation, both Convergys and the clientunderestimated the complexity, timing and cost of gathering requirements,standardizing policies and completing the implementation on schedule. Thisresulted in implementation costs higher than originally planned. Recall, whenimplementation costs exceed the term for convenience fees in the contract, evenfor a profitable contract, we expense incremental costs instead of capitalizingthem on the balance sheet.

At the end of the second quarter, we said we could have seenadditional charges of as much as $35 million in the second half of 2007, andindicated the impact could continue into next year. This created a high degreeof uncertainty after our second quarter call.

I am pleased to say, as a result of this agreement that,that uncertainty related to these potential charges is eliminated.

Overall, there is significant opportunity for Employee Careto create shareholder value. We believe there are four drivers we should factorin this business, winning the right type of business, managing fixed costs,achieving operating efficiencies after goal line, and executing implementationson time and on budget.

I'll spend a moment discussing our status on each of thesein more detail. First, we've shown we can capture revenue, evidenced by ourrecent wins with J&J and Starbucks and renewals with other clients,including Fifth Third Bank. Demand for HRO services is strong. We continue toselectively pursue new business opportunities to augment our backlog of morethan $3 billion in contracted revenue.

Second, we've managed to control our fixed costs. Forexample, the Employee Care SG&A in the quarter was down 17% year-over-year,due to better employee productivity. Also, we've been much more effective in leveragingour earlier investments in standards and talents, as we pursue new deal. Thisleverage comes from our investment in process globalization andstandardization, integrated technology solutions and centralized centers ofexcellence.

Third, we have been able to drive further operationalefficiency and improved contribution margins after the client is fullyoperational. We were able to increase employee and management self-help,increase staff utilization and workflow automation, and increase global servicecenter and IT efficiency.

For an example, with the application of technology, we haveseen self-help adoption rates increased over time, and in some cases exceed70%. This has resulted in labor cost reductions of more than a third in severalcases, while at the same time improving our service delivery to the client.

Fourth, we are making progress with our HR BPOimplementations. I feel good about what we've accomplished in terms of profitsand execution improvements that have helped us effectively deliver againstschedule and cost targets established early this year.

Having said that, these are still large and complexprojects. Scope, schedule and cost changes are expected. Even in thatcircumstance, we've demonstrated an ability to implement win-win solutions withour several clients, including the recent challenge with a large HRO contract.

Levers that we can pull when faced with these issues includeimproving contract terms, such as the termination for convenience clause,adding or accelerating cash payments from the clients while improving termshelpful to the clients. Enhancing scope definitions and tightening changecontrol methods and adding senior dedicated leaders and other resources to theproject to ensure quality implementation on schedule and budget. The EmployeeCare business is intently focused on these derivers of success. The opportunityfor value creation more than offsets the implementation mix.

Turning to other items outside our reporting segments.During the quarter, we incurred $3 million in long-term incentive plan expensesversus the $8 million in the prior year. We had lower cost in this line,because compensation is pay-for-performance and based upon total shareholderreturn.

Net non-operating expenses were flat at $1 million comparedto the prior year. The effective tax rate for the third quarter was 32.8%. Thisreflects our ongoing efforts to minimize tax expense. Cash flow from operationswas $6 million in the third quarter. Free cash flow was negative $25 million inthe quarter. There were three factors that negatively impacted free cash flowin the third quarter, an increased days sales outstanding, our pensioncontribution and deferred charges.

DSO was 77 days in the quarter, up 6 days compared to thesecond quarter. Strong collections reversed half of this delay in the first fewweeks of October, and I expect to see further improvements as we progressthrough the fourth quarter.

In the third quarter, we made a pension plan contribution of$19 million. This is a once-a-year incurrence, so we won't see a fourth quarterimpact. Net deferred charges increased $23 million in the third quarter, abouttwice the amount we saw in the second quarter. Recall that net deferred chargesis cash that we spent on implementation less amortization and cash we'vereceived from customers for the implementation. We expect more cash fromcustomers for implementations during the fourth quarter than we saw in thethird quarter.

As a result of relative improvements in net deferredcharges, DSO, and pension we will see much stronger cash flow in the fourthquarter. While full year free cash flow may not match net income, we do expectto get much closer to that objective.

Capital expenditures for the quarter were $31 million. Netdebt increased $68 million in the third quarter to $158 million. During thethird quarter, we exhausted the previous share repurchase authorization, andthe Board approved an additional 20 million shares for purchase. Thisrepresents about 15% of our outstanding stock. We purchased 5.1 million sharesfor approximately $88.7 million in the third quarter. Approximately 17.9million shares remain authorized for future purchases. Our strong balance sheetprovides significant financial capacity for further stock purchases as well asM&A activity. I will now move to discussion of our forward financialguidance.

We continue to expect record revenue and EPS in 2007.Year-to-date earnings of $0.89 per share keeps us on track to achieve full yearEPS of approximately $1.20. While we've left the EPS guidance essentiallyunchanged since July of 2006, we've observed $6 million of charges related toone HR client in the second quarter, $3 million of restructuring expense in thethird quarter and approximately $4 million of additional currency impact forthe second half of the year due to the recent drop in the U.S. dollar. Notincluded in this guidance is the potential for additional cost actions tofurther streamline the business.

Looking forward, we are focused on overcoming challenges andrealizing significant opportunities, including driving more Customer Carerevenue growth to extend our leadership position, improving operatingefficiencies to expand margins while overcoming increases in labor costs,continuing to manage significant foreign currency risks through forwardcontract hedging and growth of in-country clients revenue, continuing costalignment of the Information Management business as the Sprint conversion movesahead, growing share in the BSS market around the globe, maintaining tightcontrols on Employee Care implementation, achieving go-live targets torecognize 2009 contracted revenue surpassing $300 million in Employee Care, andimproving margin from further productivity and cost actions across thebusiness.

We will provide more detailed guidance in January, but we doexpect to see another year of record revenue and EPS in 2008.

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

Question-and-AnswerSession

Operator

Thank you. (Operator Instructions) Your first question comesfrom the line of Jason Kupferberg, representing UBS. Please proceed.

Jason Kupferberg –UBS

Thanks and good morning, guys. Kudos on the contractresolution, I think that's a big upside surprise for everybody. I wanted to aska follow-up question on that specifically, now that this contract is resolvedfrom a renegotiating standpoint.

Does that pave the way for some more revenue recognition onthat contract to materialize over the next few quarters here and to the extentthat might be the case? Does that enable the overall quarterly revenue run rateof Employee Care to start increasing from current levels?

Earl Shanks

Jason, when we talked at last quarter about the revenuegrowth rate in the Employee Care business, we were optimistic that we would beable to get this resolved. So, we have taken that into account as we thoughtabout what we will see in 2008 and 2009 in that business.

As I indicated in my comments, we certainly are targetinggetting more than $300 million of revenue in that business in 2009, and we willsee growth during 2008, but I don't expect to be above the $300 million level.

Dave Dougherty

And just add to that, just to remind you, we don't startrecognizing the revenue until Feb we go live with the implementation.

Jason Kupferberg –UBS

Right, okay. And on the Customer Care side, I think, in thelast quarter, you talked about targeting 5% growth in that business for thisyear. Fair to say that needs to be softened a little bit further here, given thatsome of the pipeline conversions are going to be pushed to the right?

Earl Shanks

Well, we are certainly a little short of where we would havelike to be this quarter in that regard, Jason. We are still driving for betterrevenue growth in the fourth quarter and certainly that's what we expect tosee, whether or not we fully get to 5% for the full year. We will just have towait and see how it plays out.

Dave Dougherty

And Jason, hopefully again, we're signaling, we were seeinga very robust pipeline and making very encouraging progress in converting thatpipeline, and as we speak in process of ramping up a number of important clientprograms. So, I feel very good about the prospects of this business on a go-forwardbasis.

Jason Kupferberg -UBS

Okay. And just a final question to cover all the segments onbilling, operating margins clearly held up really strong here for a second straightquarter, despite the Sprint migration. Are you more optimistic about where theoperating margins in that business might end up dropping as the migrationcontinues into next year?

I think what you said in the past was you will keep double-digitmargins, which was somewhat of an open-ended statement, can you bound that anybetter now?

Earl Shanks

Jason, I think when you think about that business, theslower the migration is, the easier it is to take cost out on a timely basisand match all of that. And certainly, we are finding that with what's happeningin that, that's helped us continue to be a bit of uncertainty in terms ofexactly what the migration is going to be.

So, we certainly expect double-digit margins in thisbusiness, and at this point I am not going to go in more detail in terms ofguidance around it.

Dave Dougherty

So, we continue to be optimistic about what we are seeing interms of growth prospects outside of North Americaand particularly that business.

Earl Shanks

And it certainly is a whole lot easier, as we worked throughit, the more time we have to match the clock phase out will be the revenue rampchanges in that business easier to get.

Jason Kupferberg -UBS

Thanks for the comments guys.

Dave Dougherty

Thank you, Jason.

Earl Shanks

Thank you, Jason.

Operator

Your next question comes from the line of Ashwin Shirvaikar,representing Citigroup. Please proceed.

Ashwin Shirvaikar -Citigroup

Hi, and my congratulations on the HR outsourcing resolution.

Dave Dougherty

Thanks, Ashwin.

Ashwin Shirvaikar -Citigroup

My question is first on the Customer Care business. As you triedto accelerate the push to fill capacity, what kind of pricing and terms andconditions are you seeing on those contracts?

Dave Dougherty

Well, as I mentioned in my opening remarks, we continue topush pricing and particularly, better pricing where we have currencychallenges. Our position in the marketplace has always been and continues tobe, we are going to be the highest quality provider in this space, and myexpectation is, we deliver superior quality, we will get premium pricing.

So, we continue to head in that direction, and again I'mvery optimistic that we can grow our way through this with what we're in theprocess of ramping, plus what we're seeing in terms of robust demand in thepipeline.

Ashwin Shirvaikar -Citigroup

Okay, but you are seeing reasonable success as you try toget the better pricing and the terms and conditions that take into accountcurrency fluctuations?

Dave Dougherty

No, question here, we talked about that over the last year,and we continue to position ourselves that way in the marketplace and continueto expect. The good news is, I think, largely our client base, if we candeliver superior quality experience, they're willing to pay a premium price.

Ashwin Shirvaikar -Citigroup

Thanks. Now a question on deferred charge impact on cashflow, it was not clear to me, was that related to the resolution?

Earl Shanks

No, Ashwin, we were continuing to work on all of ourimplementations as you would expect us to. Certainly as you recognize, we havea couple of new ones that we started in the second quarter, and didn't havemuch impact in the second quarter but certainly had some impact in the thirdquarter.

And just when we put the cost we were incurring and thetiming of payments from clients together in the third quarter, we had moremoney out than in. I expect that we are going to be better positioned in thefourth quarter just because the timing of the contractual payments that we willreceive across the portfolio.

Ashwin Shirvaikar -Citigroup

Okay, and last question is on tax rate, is that the one-timeevent, the lower tax rate?

Earl Shanks

Well, I think this is in the neighborhood, Ashwin, of whatwe have delivered all year. So, it really not one-time headed by any charge. Imean, I think, we are able to continue to generate a tax rate within thatrange, and we are obviously looking for ways to reduce it pretty constantly,but this is kind of our average rate for the year at this point.

Ashwin Shirvaikar -Citigroup

Okay, great. Thanks.

Dave Dougherty

Thanks Ashwin.

Operator

Your next question comes from the line of James Kissane, representingBear Stearns. Please proceed.

James Kissane - BearStearns

Thanks. And good job guys.

Dave Dougherty

Hey, Jim.

James Kissane - BearStearns

Is the $300 million still the break-even level for EmployeeCare?

Dave Dougherty

Yes.

James Kissane - BearStearns

And that should be achieved in the first half of '09, that'sa reasonable assumption?

Earl Shanks

Jim, we haven't, other than saying we are going to have morethan $300 million of revenue in '09, we haven't got more details on theforecast at this point.

James Kissane - BearStearns

Okay. And just on the big contracts, do you sense that theperformance progress has improved?

Dave Dougherty

I think, no question, are you trying to speak in about interms of implementations?

James Kissane - BearStearns

That's right, particularly on the big one.

Dave Dougherty

Yeah, I think we have evidenced by been able to completenegotiations with the large client that we talked about last quarter I think.There is no question, we couldn't have gotten that over the finish line withoutmaking significant progress on the implementation, and then the otherimplementations, we've talked about the large ones, J&J and Starbucks,although it's still early, I am very encouraged by the progress that we aremaking.

James Kissane - BearStearns

So, it's definitely more than terms and accounting on thecontract?

Dave Dougherty

Yeah, no question. The client had to see that they had highconfidence in our ability to execute this contract to completion, and theycertainly see that, and that has to be part of or was part of certainlysuccessfully renegotiating the contract, which again I think is somethingthat's very different than what our competitors have been able to do in thisspace.

Jim Kissane - BearStearns

Yeah. And Dave or Earl, is it possible to put a range aroundthe cost actions required to right size IMG, and when do you think?

Earl Shanks

At this point, Jim, we're still working through that. It's farfrom certain that we will have separate cost actions, but it's something thatwe continue to look at and have, and therefore that's why I excluded it fromthe guidance.

Jim Kissane - BearStearns

Okay, thank you.

Dave Dougherty

But, I mean, obviously we demonstrated over the last coupleof years, the ability to take out the cost, so we need to take out of thatbusiness.

Jim Kissane - BearStearns

Okay. But these are step function here, just given the dataprocessing revenue and the whole lot?

Earl Shanks

I think, Jim, as I said earlier, it depends to some extenton exactly what the timing is of the migration and as we have a longer periodof the migration, it makes it easier for us to make those costs variable,frankly, and to avoid the step function charge that you could have, if you hadto do it very suddenly.

Jim Kissane - BearStearns

Okay, great. Thank you very much.

Dave Dougherty

Thanks, Jim.

Operator

Your next question comes from the line of T.C. Robillard,representing Banc of America Securities. Please proceed.

T.C. Robillard - Bancof AmericaSecurities

Great, thank you. Just a couple of questions, Earl, I wantedto dig down a little bit more in the cash from operation because something isjust not adding up from my standpoint. And did you have a positive pensioncontribution last year or did you also have a net cost, because if you look atthe depreciation and the net income levels are essentially in the same ballparkyear-on-year. Even if I just back out the $23 million, in terms of the increasein differed charges, there is a still a big gap. I understand that the DSOshad. So maybe if you can give us a sense as to what working capital changesactually were in the quarter and then if I am missing something else in there?

Earl Shanks

T.C., for a year-over-year basis, certainly there were somedifferent movements in terms of what happened to taxes and accounts payablethis year versus last year. The comparison I did in my comments was really thisquarter, third quarter versus second quarter, because I think that's the moreimmediate change that was out there and for that, that was really the threedrivers that I talked about.

When you look at year-over-year, certainly there isreceivables impact year-over-year. As I said, there is taxes and accountspayable impact year-over-year, and then there is certainly some differences indeferred charges and what happened year-over-year there. This was a prettyheavy quarter in terms of deferred charges for us because of the size of a coupleother ramps and as I said, the timing of the collections from the customers.

T.C. Robillard - Bancof AmericaSecurities

And so, can you give us what the working capital change wasfor the quarter or for nine months, whatever stat that you have?

Earl Shanks

T.C., I don't have that directly in front of me at themoment. David, will give you a call back and follow up with that number.

T.C. Robillard - Bancof AmericaSecurities

Okay. That's fair enough. And then, just in terms of lookingat the CMG business with respect to your margin. The growth rates slowed butnot dramatically. So, we are expecting an uptick in revenue, what else ispushing down the margins here and where should we drop out, because it doesn'tappear to be all revenue driven or maybe it is. I am just missing something?

Dave Dougherty

Earl, do you want to…?

Earl Shanks

No, go ahead.

Dave Dougherty

I'll talk about the margin and then you can add to it. Thebig drivers we are seeing in the higher agent wages than we would normally see,in part, because we are doing a significant amount of training and we get alower rate typically when we are training them than we are in full production.So that's a piece of it. We are also seeing a significant still excess capacitycharges and we talked about those in the second quarter.

I am very encouraged that we are filling up that capacity.One example for one of our major North American wireless carriers, we went livewith the new center for them on September 26, and we are going to be going livewith another center, November 19. So, we are filling that capacity up, but inthe quarter we are still incurring excess capacity charges, then of course thethird one we've talked about is currency.

T.C. Robillard - Bancof AmericaSecurities

But, I guess, I have got disconnected. If you are filling upsome of those excess capacity charges, I am just surprised to see margins downsequentially a 100 basis points, and Dave I understand the other moving partsthere, and maybe that's just a function of the training cost being a little bithigher relative to rev. I am just trying to get a sense, I guess maybe to moredirectly ask you, have we bottomed out in the CMG margins or do you expect tosee it as you are trying to convert this pipeline, do we expect to see somemore degradation in margins?

Earl Shanks

No, certainly we expect to see improvement in margins, Q3 toQ4 pretty clearly, and I think that capacity description alone would describemore than a 100 basis point change in margins. So, I mean, I think, it'sexactly what Dave described a minute ago in terms of how these are set to go.

Dave Dougherty

And again, I don't see that. I mean, again, I think, we arevery well positioned to grow our way through that capacity. So, I mean, interms of things, keep you up at night, that's not one of them remains.

T.C. Robillard - Bancof AmericaSecurities

Okay, great. I appreciate the insights. Thank you.

Operator

Your next question comes from the line of David Koning,representing Baird. Please proceed.

David Koning - RobertW. Baird

Yeah. Hi, guys.

Dave Dougherty

Hi, David.

David Koning - RobertW. Baird

You mentioned how Employee Care contracts require theimmediate expensing, if you do go over the contractual implementation costs.And I am just wondering on this contract that you renegotiated, did theybasically allow for more implementation costs, meaning you are still going todo the same work and have those same costs, they just don't have to beimmediately expensed?

Earl Shanks

David, we've tried not to discuss specific terms in specificcontracts. In my comments, I tried to pick through for you, generally the kindsof terms we address, and I think it's reasonable to presume that we looked forvariety of terms as we redid this contract, and I tried to give you the kindsof ones that we would have considered in that process. So, I'll have to leaveit there in terms of talking about the specifics.

David Koning - RobertW. Baird

Okay, great. And I guess secondly, did you expect corporateexpense to be around $3 million this quarter, and maybe how should we thinkabout that in future quarters?

Earl Shanks

As I said, David, that expense is very dependent on ourpaper performance plans, and in particular, the measurement there, theprinciple measurement there is total shareholder return. Certainly, we didn'thave a very good quarter in terms of total shareholder return, and that drovethat down pretty significantly. It will move around directly with our overalltotal shareholder return performance.

Dave Dougherty

Grow our plans to get back.

David Koning - RobertW. Baird

Okay. So as long as the shareholder return gets back to amaybe more normalized level, that expense line should get back to a normalizelevel?

Dave Dougherty

Yeah, right.

David Koning - RobertW. Baird

Okay, great. Thank you.

Dave Dougherty

Thanks David.

Operator

Your next question comes from the line of Julie Santoriello,representing Morgan Stanley. Please proceed.

Julie Santoriello -Morgan Stanley

Thank you, good morning.

Dave Dougherty

Hi, Julie.

Julie Santoriello - Morgan Stanley

Hello. Just a general question. I want to understand alittle bit more about what you are seeing in the Customer Care area. Some ofthe delayed ramps you are talking about, are these mainly just due to longersales cycles, maybe perhaps with customers making decisions about offshore, ordo you think some of these clients or potential clients are just going throughconcerns about the economy and uncertainty there or perhaps slowdowns in theirown businesses? Thanks.

Dave Dougherty

Well, a lot of the work, a fairly significant amount of thework that were in the process are ramping up for our very strategic newinitiatives for a number of these customers and so they are quite frankly maybegoing a bit slower than what the original plan was intended there. But from myview, I think it's still all systems go, I mean those things are so importantto those customers that my expectation is that we'll see significant growthhere as we go forward.

Beyond that, as we look to the marketplace, we've addedsignificant new sales headcount, it's particularly focused in a number of thenew vertical markets. So outside of our traditional communication space, andagain, I'm very encouraged by the demand we're seeing, as well as theopportunities that we're getting over the finish line that obviously will befeathered in here in the next couple of quarters.

Julie Santoriello -Morgan Stanley

Okay, thanks. And just generally, since the FinancialServices sector is a piece of that business and it's getting a lot of attentionthese days, a lot of preference. Have you seen any specific points of slowdownor transaction slowdown?

Dave Dougherty

Well, the good news for us is, we don't have any exposure tothe subprime situation. So, make that clear, and most of the work we are doingin the Financial Services area is in and around credit cards. And, I know somespeculate that in fact people can't use their home equity, they are going tostart using more credit card debt, so that may bode well for us in the longrun. But, we are not seeing really any softness in the work that we are doingin Financial Services at this point.

Julie Santoriello -Morgan Stanley

Okay, great. Thank you.

Operator

Your next question comes from the line of Schlomo Rosenbaum,representing Stifel Nicolaus. Please proceed.

Schlomo Rosenbaum -Stifel Nicolaus

Hi, guys, good job on that HR contract. Let's fill in mykudos there.

Dave Dougherty

Thanks a lot.

Schlomo Rosenbaum -Stifel Nicolaus

I just want to dig in a little bit more on the CustomerCare. I thought that there was a comment about some client budgetaryconstraints, it was one of the issues on the top line growth. Just wondering,if you could quantify that in terms of verticals or give us just a little bitmore detail, because one hand we were seem to have not really a lot of changein the demand environment, but we are still seeing a little bit of that?

Dave Dougherty

Schlomo, as much as not, that's the reflection of the clientwe talked about during the second quarter that constrained their spending oncustomer service and impacted the revenue for the year in total, and you recallthat we quantify that on an annual basis, it is about $40 million impact andobviously we didn't take all that impact in Q2. We saw some of it in Q3 and wewill see some of it in Q4. So, that's the easy example in that space thatrelates to that.

Schlomo Rosenbaum -Stifel Nicolaus

So really it is particular to this one client, it's not somethingthat that you are seeing a little bit of something coming out of the grassroots, if there is any changes in terms of budget?

Dave Dougherty

It's not something that's across the Board, Schlomo. No.

Schlomo Rosenbaum -Stifel Nicolaus

Okay. And just, in the credit card side, we are hearing alittle bit more about some credit card companies that are curtailing some oftheir acquisition programs. And I am wondering if you have any way to segmentsome of your credit card work, about how much of it is Customer Care and aredoing any at the lower end of the credit quality, because that's where I amhearing they are curtailing the work?

Dave Dougherty

Well, again, keep in mind, most of the work we do is inboundcustomer service related and what I think you are talking about is outboundacquisition work, which really is not anything that we do any significantamount of. The outbound work we do tends to be business-to-business relatedwork for companies. So, I don't see that as a big issue for us.

Schlomo Rosenbaum -Stifel Nicolaus

Okay. Fair enough. Thank you.

Operator

Your next question comes from the line Liz Grausam, representingGoldman Sachs. Please proceed.

Kim - Goldman Sachs

Hi, this is Kim for Liz.

Dave Dougherty

Hi, Kim.

Kim - Goldman Sachs

Hi, how are you, guys?

Dave Dougherty

Good.

Kim - Goldman Sachs

I was just wondering, you talked a little bit about theSprint migration in terms of the timing of the role off of that, it looks likeit's been pushed out to 2008 a bit. And, if you guys could give any color as towhat you are expecting in terms of when that revenue will roll off?

Dave Dougherty

Well, I hesitate to really comment much on that. I thinkthose questions ought to be addressed to the Sprint probes. We didn't provide anyreal new news here. I mean we said in the last call that the migration wasgoing to roll off in 2008. So, this really isn't any significant change fromwhat we said in the quarter.

Kim - Goldman Sachs

Okay. And to ask a little bit about the international that'sdriving IM key growth, if you guys could give any color as to what you areseeing there and what's really driving that?

Dave Dougherty

Well, as we've said and seen in our last several quarters,we are very encouraged by the growth of our international business inInformation Management. The pockets of the areas where we're seeing the mostactivity, I would say, Middle East and I talked about Egypt Telecom here on thecall, but we've got several announced wins in major projects going on in the Middle East. And in the Asia-Pacific region, I would sayis another area of strong demand. And actually I have recently been kind ofquite pleasantly surprised with some of the things that we are starting to workon in Latin America as well. So, I feel very goodabout the long-term prospects for our growth in the international.

Kim - Goldman Sachs

Okay. Thanks.

Operator

Your next question will come from the line of Eric Boyer,representing Wachovia. Please proceed.

Earl Shanks

Hi, Eric.

Eric Boyer - Wachovia

Hi, how are you doing?

Earl Shanks

Good.

Eric Boyer - Wachovia

Just on the point of addressing FX on combating some of theissues around that. You talked about adding new locations. I was wondering ifthose are new geographic locations or just new locations in the currentcountries that you have call centers in?

Earl Shanks

Eric, I think we talked about anumber of things, and I am not sure exactly which parts you are looking forresponses to. So, let me try to summarize where I think we are. We areparticularly for the Canadian market, but also for the Asian markets, doingmore to built in-country revenue which will help us long-term to bettermitigate some of the risks we faced around the currency, some of the challengeswe faced on the currency. So, that's one of the things that we invested insales resources and otherwise to make sure that that happens.

We are also pretty clearly assessingthe profitability of the centers that are, particularly at Canada at themoment, it's a longer-term challenge. And thinking about how those fit togetherwith the portfolio, in total, and to the extent that it makes sense to migratesome of that work to other geographies, we will likely do that as well. So that'sone of the income measure of the relative costs and the margins that we canachieve out of that business.

So those are at a macro level,two of the big things that we are doing in that process. As I think youunderstand, we also continue to price contracts as spot, and to the extent thatwe've had started into the future, that certainly helps us with the existingcontracts we've got in place. And we just have to re-price those contracts asthey come due to improved margins as well. So we can pick that up as well.

There are number of levers that Ithink we are pulling in and can pull to offset some of the currency risk. And thatwe have the advantage given the portfolio that we have, both the U.S. centers, centersin Canada and centers in Asia of moving the mix business around in a way that itsvolume impacts us and obviously has impacted this quarter, doesn't impact thisso much, as much as some of the competition that's more concentrated in onlyone or two geographies.

Eric Boyer - Wachovia

And just finally, on the CustomerCare front again. You are talking about throwing out the extra capacity. Lastquarter, you talked about being may be a three or six months' timeframe. Youpromised it will take longer than three months. Say, are we talking more Q1, Q2of '08 type timeframe that kind of get that behind us?

Earl Shanks

Yeah. I'd say, no question, it's nearer in than further out.As I referenced here a couple of minutes ago, I feel very good about what we'redoing in terms of ramping up in this new capacity. And I used a couple ofexamples of centers that literally we are opening here and had it opened just afew weeks ago and will be opening here in the next few weeks to support one ofthe major North American wireless carriers. So, I would say it's more nearer inthan far away.

Eric Boyer - Wachovia

All right. Thanks a lot

Operator

Your next question comes from the line of Larry Berlin,representing First Analysis. Please proceed.

Larry Berlin - FirstAnalysis

Good afternoon, or good morning, guys. How are you doingtoday?

Dave Dougherty

Hey, Larry. Good, how are you?

Larry Berlin - FirstAnalysis

Good. All is well here. Just a couple of quick questionsfirst. First, how much stock-based compensation in the quarter?

Earl Shanks

About $3 million

Larry Berlin - FirstAnalysis

Okay. So you are equating that when you are saying thevariable corporate costs is basically your stock-based comp?

Earl Shanks

The corporate expense is almost entirely stock-basedcompensation.

Larry Berlin - FirstAnalysis

Okay. Just wanted to be sure. Second of all, the declines[to get] sequential in SG&A and R&D, are those going back mostly fromthe Employee Care or is there a split between Employee Care and the other twodivisions?

Earl Shanks

Well, certainly, we have some declines as we said in EmployeeCare. We also saw declines in both of those lines, in the InformationManagement business, as you would expect us to, as we were balancing [cost ofrevenue].

Larry Berlin - FirstAnalysis

Okay. And lastly, you just gave us these wonderful numberson the growth rates in CMG for the different sectors, are those available byany chance?

Earl Shanks

I think that'll be in a queue.

Larry Berlin - FirstAnalysis

That'll be in a queue. Okay, great. Thanks guys

Dave Dougherty

Hey, Larry. I'm still working on my reading lessons.

Larry Berlin - FirstAnalysis

Oh, super, Dave, I am working on mine also. I will call youwhen I am done.

Operator

Your next question comes from the line of Shaul Eyal,representing CIBC World Markets. Please proceed.

Shaul Eyal - CIBCWorld Markets

Thank you. Hi, good morning, and also congratulations frommy end for the contract resolution.

Dave Dougherty

Thanks, Shaul.

Shaul Eyal - CIBCWorld Markets

Couple of quick questions, starting on the IMG front. Howare you guys doing with the implementation on the Century 21st Project with theBritish Telecom?

Dave Dougherty

Well, that project and our part of that implementationremains on schedule to the best of my knowledge. And that we are still a criticalcomponent of what is obviously a much bigger plan, but I don't have anythingmore than that.

Shaul Eyal - CIBCWorld Markets

Okay. Fair enough. As you look into 2008, are you seeing thenumber of kind of big RSPs on the rise, or is it basically flat, at least fromyour end the number of contract that you are bidding for right now?

Earl Shanks

Are you talking in our Customer Care business?

Shaul Eyal - CIBCWorld Markets

No, I am talking on the IMG?

Earl Shanks

On the IMG side?

Shaul Eyal - CIBCWorld Markets

Yeah.

Earl Shanks

Again, like as I said few minutes ago, I am very encouragedby the demand we are seeing in Latin America, opportunities we are working inAsia-Pac, and then also the wins we have already in the Middle East and otheropportunities that we see. So I characterize this as, probably it is in myperspective very encouraging and wins that can have a significant impact on theIM business long-term.

Shaul Eyal - CIBCWorld Markets

Thanks. Fair enough. One quick final question, on comingmore from the close center of the CMG front, I know you guys talked about itduring your analyst day in the past couple of years. But the importance ofsoftware analytics as it relates to the agent sitting in the call center, canyou just kind of provide us with more color, have you seen its importance onthe rise, if it's growing, what are you guys seeing coming from that angle?

Dave Dougherty

Great question. We see huge demand from our customer set,one in more analytics and we believe the scenario that we can provide terrificsolutions, and then be a key differentiator for us as a company on a go-forwardbasis. And in remarks I referenced, one of those technologies that we havetoday installed in one of the major North American wireless carriers, thatliterary in real-time is determining the value of the customer and then decisioningfor the call center agent, what's the right offer, and what's the rightproposal to be talked to that customer about.

So, for example, if they've had three dropped calls in thelast five minutes, you actually have that information as an agent to know that,you probably got somebody calling in who is pretty upset, and don't be tryingto upset them on something else until you resolve those particular issues. So,the whole area of relationship management which for us is a critical componentof that is analytics. We see that as a huge differentiator for us on ago-forward basis.

Shaul Eyal - CIBCWorld Markets

Got it. Thank you very much and good luck.

Earl Shanks

Thanks.

Operator

Your final question will come from the line of Robert Kirkpatrick,representing Cardinal Capital. Please proceed.

Robert Kirkpatrick -Cardinal Capital

Good morning and congratulations as well from us.

Dave Dougherty

Hi, Rob, thank you.

Robert Kirkpatrick -Cardinal Capital

You mentioned in your release, your cash provided byoperations is $5 million, but your cash provided by investment activities is$10 million, but that includes $31 million of CapEx. So, what generated the $40million else that's in there?

Earl Shanks

Rob, I don't have that sitting here.

Robert Kirkpatrick -Cardinal Capital

You sold something, I would assume.

Earl Shanks

That would have been just changes. I think we had some auctionrate securities that we sold during the quarter.

Robert Kirkpatrick -Cardinal Capital

Okay, great. That would explain it.

Earl Shanks

It was cash equivalent as far I am concerned, but theaccounts I don't think so.

Robert Kirkpatrick -Cardinal Capital

Okay, great. That's all, I couldn't figure out. Thank you somuch.

Dave Dougherty

Thanks, Rob.

Robert Kirkpatrick -Cardinal Capital

Bye.

Dave Dougherty

Okay. I would like to add that Earl and I will be availablethe rest of the day to answer any questions about the third quarter results orthe forward guidance that we've discussed. And thank you all for yourparticipation today.

Operator

Ladies and gentlemen, this concludes your presentation.Thank you for your participation. You may now disconnect and have a good day.

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