Fitch Ratings has assigned a ''BB+'' rating to Convergys Corporation''s (Convergys) new 5.75% junior subordinated convertible debentures due 2029 issued in conjunction with the company''s debt exchange that concluded on Oct. 6, 2009.
Fitch has also affirmed the company''s existing ratings as follows:
--Long-term Issuer Default Rating (IDR) at ''BBB-'';
--Senior unsecured revolving credit facility at ''BBB-'';
--Senior unsecured notes at ''BBB-'';
--Short-term IDR at ''F3'';
--Commercial paper program at ''F3''.
Approximately $610 million of debt is affected by Fitch''s action. The Rating Outlook is Negative.
Fitch''s rating concerns and Negative Outlook center on Convergys'':
--Continued implementation challenges and free cash flow pressure relating to two significant Human Resources Management (HRM) contracts, as well as uncertainty regarding the timing and ultimate resolution of ongoing client negotiations to restructure these contracts;
--Continued revenue pressures expected in the second half of 2009 due primarily to lower than expected call volume under existing Customer Management (CM) contracts, partially offset by revenue from new contract signings;
--Continued decline in funds flow from operations (FFO), defined as cash flow from operations (CFO) minus the change in working capital, as the increase in CFO in the last 12 months (LTM) ended June 30, 2009 was driven entirely by significant working capital improvements, primarily accounts receivable. Since Fitch believes further improvement in the company''s cash conversion cycle is limited, CFO going forward will approximate FFO, resulting in lower free cash flow in the absence of increases in FFO. In the LTM ended June 30, 2009, FFO was approximately $165 million, representing declines of 14% and 54% compared with the corresponding periods in 2008 and 2007, respectively.
The ratings are supported by Convergys'':
--Strengthened liquidity position from the aforementioned debt exchange;
--Significant profitability improvement in CM (70% of total revenue) with gross margin increasing by 7.4 percentage points to nearly 38% in the quarter ended June 30, 2009, the highest in the last five years;
--Significant recurring revenue base primarily from long-term CM contracts partially offset by fluctuations in call volumes with existing clients;
--Long-term customer relationships.
Negative rating actions could occur if:
--Funds flow from operations continues to deteriorate, resulting in a material decline in liquidity;
--Convergys ceases to provide CM services to any of its largest customers, including AT&T Inc. (rated ''A'', Stable Outlook by Fitch), Comcast Corporation (rated ''BBB+'', Stable Outlook) or DirecTV, which Fitch views as unlikely in the absence of an acquisition given the significant switching costs of transitioning customer care either in-house or to an alternate third-party vendor, and considering the company''s established, long-term relationships with its largest customers.
Positive rating actions could occur if Convergys:
--Achieves a favorable resolution with respect to ongoing client negotiations to restructure two HRM outsourcing contracts, resulting in lower implementation costs and greater and more consistent FFO;
--The company continues to expand into new industries, enabling greater diversity of its revenue base by further reducing customer (AT&T/Sprint) and industry concentration (communications).
Under the terms of the debt exchange, Convergys offered up to $125 million of new 5.75% junior subordinated convertible debentures due Sept. 15, 2029 in exchange for up to $122.5 million of its 4.875% senior notes due Dec. 15, 2009 ($193 million outstanding at June 30). Approximately $171 million of existing senior notes were tendered (oversubscribed), thereby reducing remaining debt maturities in 2009 by nearly $123 million to approximately $70 million in exchange for $125 million of new 2029 debentures. Fitch assigns zero equity credit to the junior subordinate convertible debentures primarily due to a lack of coupon deferral or mandatory equity conversion, which limit the company''s financial flexibility in times of financial duress. The indenture governing the debentures has no financial covenants, but includes a change of control.
Fitch believes the debt exchange will not have a material effect on the company''s credit metrics. Excluding special charges, Fitch projects leverage (total debt/operating EBITDA) will decline to 1.8 times (x) from 2.1x as of June 30, 2009 and 2.2x at year-end 2008. Fitch believes interest coverage (EBITDA/gross interest expense) will decline to 10x in 2009 from approximately 13x in 2008. However, Fitch estimates the inclusion of $88 million of cash charges relating to excess HRM implementation costs incurred in second-quarter 2009 increases projected year-end 2009 leverage to 2.6x and reduces interest coverage to 7x.
Convergys'' liquidity position pro forma for the debt exchange has strengthened markedly to nearly $619 million as of June 30, 2009 after reaching a five-year low of $122 million as of year-end 2008. Fitch derives one-year liquidity based on the difference between liquidity sources (cash + revolver availability + securitization availability + trailing 12 months [TTM] CFO + any other sources) and required liquidity uses (TTM capital expenditures + current debt maturities + TTM dividends + any other uses). The improved liquidity position primarily reflects a significant improvement in free cash flow to nearly $236 million in the LTM ended June 30, 2009 compared with $91 million in 2008, albeit primarily reflecting a nearly nine-day reduction in days sales outstanding (DSO), a new undrawn $125 million A/R securitization facility and $180 million reduction in near-term debt maturities since year-end 2008, primarily reflecting prepayment of the 4.875% senior notes due in December 2010 through cash prepayments ($58 million) and the debt exchange ($122 million). Fitch anticipates free cash flow of approximately $200 million in 2009 compared with $92 million in 2008, excluding $42 million of dividends received from investments in cellular partners that are included in cash flow from investing.
Pro forma for the debt exchange, Convergys'' total debt is approximately $610 million, primarily consisting of:
--$70 million of 4.875% senior unsecured notes due on Dec. 15, 2009;
--$400 million revolving credit facility borrowings due on Oct. 20, 2011;
--$125 million of 5.75% junior subordinated convertible debentures due in October 2029.
Additional information is available at ''www.fitchratings.com''.
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Contacts:
Fitch Ratings, New York
John M. Witt, CFA, +1-212-908-0673
Nick
P. Nilarp, CFA, +1-212-908-0649
Cindy Stoller, +1-212-908-0526
(Media Relations)
cindy.stoller@fitchratings.com
