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CSG Systems International 10-Q 2005
Form 10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2005

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission file number 0-27512

 

CSG SYSTEMS INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   47-0783182
(State or other jurisdiction
of incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

7887 East Belleview, Suite 1000

Englewood, Colorado 80111

(Address of principal executive offices, including zip code)

 

(303) 796-2850

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

YES  x   NO  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

YES  x   NO  ¨

 

Shares of common stock outstanding at August 3, 2005: 49,095,373

 



Table of Contents

 

CSG SYSTEMS INTERNATIONAL, INC.

 

FORM 10-Q For the Quarter Ended June 30, 2005

 

INDEX

 

          Page No.

Part I  -    FINANCIAL INFORMATION     
Item 1.    Condensed Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004 (Unaudited)    3
     Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2005 and 2004 (Unaudited)    4
     Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004 (Unaudited)    5
     Notes to Condensed Consolidated Financial Statements (Unaudited)    6
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    17
Item 3.    Quantitative and Qualitative Disclosures About Market Risk    38
Item 4.    Controls and Procedures    39
Part II -    OTHER INFORMATION     
Item 1.    Legal Proceedings    40
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    40
Item 4.    Submission of Matters to a Vote of Security Holders    40
Item 5.    Other Information    41
Item 6.    Exhibits    41
     Signatures    42
     Index to Exhibits    43

 

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Table of Contents

 

CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

 

     June 30,
2005


    December 31,
2004


 
     (unaudited)  
ASSETS                 

Current assets:

                

Cash and cash equivalents

   $ 130,787     $ 133,551  

Short-term investments

     34,090       23,927  
    


 


Total cash, cash equivalents and short-term investments

     164,877       157,478  

Trade accounts receivable-

                

Billed, net of allowance of $3,576 and $4,818

     133,950       142,056  

Unbilled and other

     14,195       14,030  

Deferred income taxes

     7,093       5,336  

Income taxes receivable

     28       4,064  

Other current assets

     14,190       11,723  
    


 


Total current assets

     334,333       334,687  

Property and equipment, net of depreciation of $93,851 and $87,068

     33,124       34,476  

Software, net of amortization of $84,105 and $77,086

     17,840       24,695  

Goodwill

     217,899       218,346  

Client contracts, net of amortization of $69,253 and $62,898

     47,878       50,427  

Deferred income taxes

     33,736       39,478  

Other assets

     7,891       8,298  
    


 


Total assets

   $ 692,701     $ 710,407  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY                 

Current liabilities:

                

Client deposits

   $ 19,378     $ 19,497  

Trade accounts payable

     18,870       22,412  

Accrued employee compensation

     39,725       31,859  

Deferred revenue

     50,177       53,250  

Income taxes payable

     10,174       15,085  

Other current liabilities

     20,831       19,909  
    


 


Total current liabilities

     159,155       162,012  
    


 


Non-current liabilities:

                

Long-term debt

     230,000       230,000  

Deferred revenue

     8,872       6,844  

Other non-current liabilities

     6,033       3,481  
    


 


Total non-current liabilities

     244,905       240,325  
    


 


Total liabilities

     404,060       402,337  
    


 


Stockholders’ equity:

                

Preferred stock, par value $.01 per share; 10,000,000 shares authorized; zero shares issued and outstanding

     —         —    

Common stock, par value $.01 per share; 100,000,000 shares authorized; 49,413,881 and 51,016,326 shares outstanding

     603       595  

Additional paid-in capital

     305,841       298,767  

Deferred employee compensation

     (65 )     (1,320 )

Treasury stock, at cost, 10,848,992 and 8,482,496 shares

     (266,978 )     (224,008 )

Accumulated other comprehensive income (loss):

                

Unrealized loss on short-term investments, net of tax

     (9 )     (5 )

Cumulative translation adjustments

     7,480       9,400  

Accumulated earnings

     241,769       224,641  
    


 


Total stockholders’ equity

     288,641       308,070  
    


 


Total liabilities and stockholders’ equity

   $ 692,701     $ 710,407  
    


 


 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

 

CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)

 

     Three Months Ended

    Six Months Ended

 
     June 30,
2005


    June 30,
2004


    June 30,
2005


    June 30,
2004


 
     (unaudited)     (unaudited)  

Revenues:

                                

Processing and related services

   $ 88,717     $ 80,895     $ 172,083     $ 162,027  

Software

     9,762       8,109       20,864       15,746  

Maintenance

     25,103       23,653       49,649       48,704  

Professional services

     18,137       17,006       36,029       33,550  
    


 


 


 


Total revenues

     141,719       129,663       278,625       260,027  
    


 


 


 


Cost of revenues:

                                

Cost of processing and related services

     41,975       34,619       84,433       68,425  

Cost of software and maintenance

     15,655       17,162       31,260       33,436  

Cost of professional services

     15,811       15,616       31,248       29,766  
    


 


 


 


Total cost of revenues

     73,441       67,397       146,941       131,627  
    


 


 


 


Gross margin (exclusive of depreciation)

     68,278       62,266       131,684       128,400  
    


 


 


 


Operating expenses:

                                

Research and development

     15,667       14,382       31,116       30,222  

Selling, general and administrative

     29,043       22,242       57,281       45,465  

Depreciation

     3,751       3,517       7,518       7,153  

Restructuring charges

     6,129       145       6,844       2,296  
    


 


 


 


Total operating expenses

     54,590       40,286       102,759       85,136  
    


 


 


 


Operating income

     13,688       21,980       28,925       43,264  
    


 


 


 


Other income (expense):

                                

Interest expense

     (1,850 )     (2,684 )     (3,765 )     (6,238 )

Write-off of deferred financing costs

     —         (6,569 )     —         (6,569 )

Interest and investment income, net

     1,306       273       2,275       556  

Other, net

     868       (537 )     644       (1,050 )
    


 


 


 


Total other

     324       (9,517 )     (846 )     (13,301 )
    


 


 


 


Income before income taxes

     14,012       12,463       28,079       29,963  

Income tax provision

     (5,465 )     (4,707 )     (10,951 )     (11,374 )
    


 


 


 


Net income

   $ 8,547     $ 7,756     $ 17,128     $ 18,589  
    


 


 


 


Basic net income per common share:

                                

Net income available to common stockholders

   $ 0.18     $ 0.15     $ 0.35     $ 0.36  
    


 


 


 


Weighted-average common shares

     48,151       51,285       48,598       51,483  
    


 


 


 


Diluted net income per common share:

                                

Net income available to common stockholders

   $ 0.17     $ 0.15     $ 0.35     $ 0.36  
    


 


 


 


Weighted-average common shares

     48,881       52,096       49,233       52,175  
    


 


 


 


 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

 

CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Six Months ended

 
     June 30,
2005


    June 30,
2004


 
     (unaudited)  

Cash flows from operating activities:

                

Net income

   $ 17,128     $ 18,589  

Adjustments to reconcile net income to net cash provided by operating activities-

                

Depreciation

     7,518       7,153  

Amortization

     14,372       13,572  

Restructuring charge for abandonment of facilities

     3,492       595  

(Gain) loss on short-term investments

     (170 )     3  

Write-off of deferred financing costs

     —         6,569  

Deferred income taxes

     3,788       7,046  

Tax benefit of stock-based compensation awards

     1,073       423  

Stock-based employee compensation

     8,650       7,945  

Changes in operating assets and liabilities:

                

Trade accounts and other receivables, net

     5,787       11,654  

Other current and non-current assets

     (2,692 )     (401 )

Arbitration charge payable

     —         (25,181 )

Income taxes payable/receivable

     (398 )     27,454  

Accounts payable and accrued liabilities

     2,916       (9,064 )

Deferred revenue

     684       5,794  
    


 


Net cash provided by operating activities

     62,148       72,151  
    


 


Cash flows from investing activities:

                

Purchases of property and equipment

     (6,458 )     (2,785 )

Purchases of short-term investments

     (31,535 )     (15,013 )

Proceeds from sale of short-term investments

     21,538       11,310  

Acquisition of and investments in assets

     (297 )     (852 )

Acquisition of and investments in client contracts

     (3,964 )     (1,185 )
    


 


Net cash used in investing activities

     (20,716 )     (8,525 )
    


 


Cash flows from financing activities:

                

Proceeds from issuance of common stock

     1,683       4,833  

Repurchase of common stock

     (43,816 )     (40,448 )

Proceeds from long-term debt

     —         230,000  

Payments on long-term debt

     —         (228,925 )

Payments of deferred financing costs

     (87 )     (7,158 )
    


 


Net cash used in financing activities

     (42,220 )     (41,698 )
    


 


Effect of exchange rate fluctuations on cash

     (1,976 )     179  
    


 


Net increase (decrease) in cash and cash equivalents

     (2,764 )     22,107  

Cash and cash equivalents, beginning of period

     133,551       100,397  
    


 


Cash and cash equivalents, end of period

   $ 130,787     $ 122,504  
    


 


Supplemental disclosures of cash flow information:

                

Cash paid (received) during the period for-

                

Interest

   $ 3,063     $ 5,009  

Income taxes

     9,405       (25,172 )

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

 

CSG SYSTEMS INTERNATIONAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. GENERAL

 

The accompanying unaudited condensed consolidated financial statements as of June 30, 2005 and December 31, 2004, and for the three and six months ended June 30, 2005 and 2004, have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, and pursuant to the instructions to Form 10-Q and the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the financial position and operating results have been included. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, filed with the SEC (the “Company’s 2004 10-K”). The results of operations for the three and six months ended June 30, 2005, are not necessarily indicative of the expected results for the entire year ending December 31, 2005.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Postage. The Company passes through to its clients the cost of postage that is incurred on behalf of those clients, and typically requires an advance payment on expected postage costs. These advance payments are included in “client deposits” in the accompanying unaudited Condensed Consolidated Balance Sheets and are classified as current liabilities regardless of the contract period. The Company nets the cost of postage against the postage reimbursements, and includes the net amount in processing and related services revenues. The total cost of postage incurred on behalf of clients that has been netted against processing and related services revenues for the three months ended June 30, 2005 and 2004 was $45.3 million and $44.8 million, respectively, and for the six months ended June 30, 2005 and 2004 was $90.5 million and $88.8 million, respectively.

 

Stock-Based Compensation Expense. At June 30, 2005, the Company had six stock-based compensation plans (see Note 3). The Company recorded stock-based compensation expense of $4.3 million and $3.8 million, respectively, for the three months ended June 30, 2005 and 2004 and $8.7 million and $7.9 million, respectively, for the six months ended June 30, 2005 and 2004.

 

The Company continues to follow Accounting Principles Board (“APB”) No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations (“APB 25”) for all stock-based awards granted prior to January 1, 2003, and follows Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), using the prospective method of transition as outlined in SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure — An Amendment of FASB Statement No. 123” (“SFAS 148”) for stock-based awards granted, modified, or settled on or after January 1, 2003. Thus, compensation expense recorded in the Company’s accompanying unaudited Condensed Consolidated Statements of Income is less than what would have been recognized if the fair value based method under SFAS 123 had been applied to all awards for all periods. Had compensation expense for the Company’s stock-based compensation plans been based on the fair value at the grant dates for awards under those plans for all periods, consistent with the methodology of SFAS 123, the Company’s net income and net income per share for the three and six months ended June 30, 2005 and 2004, would approximate the pro forma amounts as follows (in thousands, except per share amounts):

 

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Table of Contents
     Three Months Ended
June 30,


    Six Months Ended
June 30,


 
     2005

    2004

    2005

    2004

 

Net income, as reported

   $ 8,547     $ 7,756     $ 17,128     $ 18,589  

Add: Stock-based compensation expense included in reported net income, net of related tax effects

     2,679       2,362       5,381       4,938  

Deduct: Total stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects

     (3,424 )     (3,814 )     (6,908 )     (7,667 )
    


 


 


 


Net income, pro forma

   $ 7,802     $ 6,304     $ 15,601     $ 15,860  
    


 


 


 


Net income per share:

                                

Basic – as reported

   $ 0.18     $ 0.15     $ 0.35     $ 0.36  

Basic – pro forma

     0.16       0.12       0.32       0.31  

Diluted – as reported

     0.17       0.15       0.35       0.36  

Diluted – pro forma

     0.16       0.12       0.32       0.31  

 

Cash and Cash Equivalents. In the first quarter of 2005, the Company reclassified its holdings in auction rate securities from cash equivalents to short-term investments, based on further interpretative guidance on the underlying characteristics of such instruments. Prior period amounts for cash and cash equivalents and short-term investments have been reclassified to conform to the current year presentation. As a result, as of December 31, 2004, June 30, 2004 and December 31, 2003, cash and cash equivalents amounts were decreased and short-term investments amounts were increased by $7.2 million, $6.5 million and $5.0 million, respectively. The change in classification had no impact on the Company’s previously reported current assets, net income, cash flows from operating activities, or changes in stockholders’ equity for any period.

 

Short-term Investments and Other Financial Instruments. The Company’s balance sheet financial instruments as of June 30, 2005 and December 31, 2004 include cash and cash equivalents, short-term investments, accounts receivable, accounts payable, and long-term debt. Because of their short maturities, the carrying amounts of cash equivalents, accounts receivable, and accounts payable approximate their fair value. Short-term investments are considered “available-for-sale” in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, and thus are stated at fair value in the accompanying unaudited Condensed Consolidated Financial Statements. As of June 30, 2005 and December 31, 2004, the fair value of the Company’s long-term debt, based upon quoted market prices, was approximately $212 million and $232 million, respectively. As of June 30, 2005 and December 31, 2004, the fair value of the contingent interest feature of the Company’s long-term debt, considered an embedded derivative, was $0.2 million and $0.1 million, respectively. The Company does not utilize any derivative financial instruments for purposes of managing the market risks related to its financial instruments.

 

Accounting Pronouncements Issued But Not Yet Effective. In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). This statement is a revision of SFAS 123, and supersedes APB 25 and its related implementation guidance. SFAS 123R establishes standards for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments.

 

Under SFAS 123R, the Company was required to adopt SFAS 123R no later than July 1, 2005. However, on April 14, 2005, the SEC announced the adoption of a new rule that amended the compliance dates for SFAS 123R. As a result, the Company is required to implement SFAS 123R no later than January 1, 2006. However, the new rule also provides that the Company may adopt SFAS 123R earlier. The Company has not determined the date (the “Effective Date”) when it will adopt SFAS 123R. When the Company does adopt SFAS 123R, it expects to use the modified prospective method of transition. Under the modified prospective application, SFAS 123R will apply to new awards and to awards modified, repurchased, or cancelled after the Effective Date. Additionally, compensation cost for the portion of awards that the Company continues to account for in accordance with APB 25 for which the requisite service has not been rendered that are outstanding as of the Effective Date will be recognized as the requisite service is rendered on or after the Effective Date. The compensation cost for that

 

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Table of Contents

portion of awards shall be based on the grant-date fair value of those awards as calculated for either recognition or pro forma disclosures under SFAS 123. The Company does not expect the adoption of SFAS 123R to have a significant impact to its consolidated financial statements.

 

Reclassification. Certain prior period amounts have been reclassified to conform to the June 30, 2005 presentation.

 

3. STOCKHOLDERS’ EQUITY AND EQUITY COMPENSATION PLANS

 

Stock Repurchase Program. The Company has a stock repurchase program, approved by the Board of Directors, authorizing the Company to purchase up to 15 million shares of its common stock from time-to-time as market and business conditions warrant (the “Stock Repurchase Program”). In April 2005, the Company established a formal plan with a financial institution that complies with the provisions of Rule 10b5-1 under the Securities Exchange Act of 1934 (the “Rule 10b5-1 Plan”) to repurchase shares of the Company’s common stock on the open market. Any shares repurchased under the Rule 10b5-1 Plan are counted towards the 15 million share limit authorized under the Stock Repurchase Program. The Rule 10b5-1 Plan supplements any stock repurchases the Company may decide to purchase under the existing terms of its Stock Repurchase Program. In effect, the Rule 10b5-1 Plan facilitates achieving stock buyback objectives more readily by permitting the execution of trades during periods that would otherwise be prohibited by internal trading policies. The maximum quarterly repurchase limitation established by the Company under the Rule 10b5-1 Plan is $15 million.

 

During the first six months of 2005, the Company repurchased 2.4 million shares of its common stock under the Stock Repurchase Program for approximately $43 million (weighted-average price of $18.16 per share), of which $12 million was repurchased under the guidelines of the Rule 10b5-1 Plan. Including these shares, the total shares repurchased under the Stock Repurchase Program since its inception in August 1999 is 11.7 million shares, at a total repurchase price of $295.6 million (a weighted-average price of $25.29 per share). As of June 30, 2005, the remaining number of shares authorized for repurchase under the Stock Repurchase Program is 3.3 million shares. The Stock Repurchase Program does not have an expiration date. The shares repurchased under the Stock Repurchase Program are being held as treasury shares.

 

Subsequent to June 30, 2005 through August 3, 2005, the Company has repurchased approximately 405,000 shares under the Stock Repurchase Program at a total purchase price of $7.2 million (a weighted-average price of $17.89 per share).

 

Stock Repurchases for Minimum Tax Withholdings. In addition to the above mentioned stock repurchases and outside of the Stock Repurchase Program, during the first six months of 2005, the Company repurchased and cancelled approximately 163,000 shares of common stock for $3.1 million from certain employees in connection with minimum tax withholding requirements resulting from the vesting of restricted stock under the Company’s stock incentive plans.

 

2005 Stock Incentive Plan. In February 2005, the Company’s Board adopted, subject to the approval of the Company’s stockholders, the 2005 Stock Incentive Plan (the “2005 Plan”). In May 2005, the Company’s stockholders approved the 2005 Plan. The 2005 Plan replaces one of the existing stock incentive plans, the 1996 Stock Incentive Plan (the “1996 Plan”). No further grants may be made under the 1996 Plan, but any stock awards which are outstanding under the 1996 Plan will remain in effect in accordance with their respective terms. Under the 2005 Plan, shares may be granted to officers and other key employees of the Company and its subsidiaries and to non-employee directors of the Company in the form of stock options, stock appreciation rights, performance unit awards, restricted stock awards, or stock bonus awards. The aggregate number of shares of common stock available for issuance pursuant to the 2005 Plan is 12.4 million, which may be authorized and unissued shares or treasury shares. Shares granted under the 2005 Plan in the form of a performance unit award, restricted stock award or stock bonus award are counted toward the aggregate number of shares of common stock available for issuance under the 2005 Plan as two shares for every one share granted or issued in payment of such award. As of June 30, 2005, the Company had a total of 12.9 million shares available for issuance under its stock incentive plans, of which 12.3 million shares were available for issuance under the 2005 Plan.

 

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Table of Contents

Stock Based Award Grants. In January 2005, the Company granted 325,000 shares of restricted stock at no cost to key members of executive management at a market value on date of grant of $17.48 per share. The shares vest at various increments over two to four years. Certain shares of the restricted stock become fully vested upon a change in control of the Company and certain shares have acceleration of vesting provisions related to termination of employment. There are no restrictions on these shares other than the passage of time.

 

In February 2005, the Company granted approximately 288,000 shares of restricted stock and approximately 22,000 stock options to key members of management. The restricted stock was granted at no cost to the employees at a market value on date of grant of $17.23 per share. The stock options were granted with exercise prices ranging from $17.23 to $17.74 per share. The equity awards vest ratably over four years from the date of grant and have no restrictions placed upon them other than the passage of time.

 

In March 2005, the Company granted 70,000 shares of restricted stock at no cost to key members of executive management at a market value on date of grant of $16.04 per share. The restricted stock awards will vest ratably over three years from the date of grant and have no restrictions placed upon them other than the passage of time. The restricted stock awards have acceleration of vesting provisions upon an involuntary termination of employment without cause after a change of control.

 

In June 2005, the Company granted 75,000 shares of restricted stock at no cost to key members of executive management at a market value on the date of grant of $18.98 per share. The restricted stock awards will vest ratably over four years from the date of grant and have no restrictions placed upon them other than the passage of time. Certain shares of the restricted stock become fully vested upon a change in control of the Company and certain shares have acceleration of vesting provisions related to termination of employment.

 

Modifications to Stock Based Awards. During the first quarter of 2005, the Company modified the terms of approximately 70,000 shares of unvested restricted stock, and 75,000 unvested stock options held by key members of executive management. The terms of the restricted stock awards were modified to include a provision which allows for full vesting of any unvested restricted stock upon involuntary termination of employment without cause. Unless such an event occurs, the restricted stock will continue to vest as set forth in the original terms of the agreements. The terms of the stock option awards were modified to accelerate vesting of such awards to January 1, 2006 upon continuous employment with the Company to such date.

 

4. EARNINGS PER COMMON SHARE

 

Calculation of Earnings Per Common Share. Earnings per common share (“EPS”) has been computed in accordance with SFAS No. 128, “Earnings Per Share”. Basic EPS is computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding during the period (the denominator). Diluted EPS is consistent with the calculation of basic EPS while considering the effect of potentially dilutive common shares outstanding during the period. Unvested shares of restricted stock are not included in the basic EPS calculation. Basic and diluted EPS are presented on the face of the Company’s unaudited Condensed Consolidated Statements of Income.

 

No reconciliation of the basic and diluted EPS numerators is necessary for the three and six months ended June 30, 2005 and 2004, as net income is used as the numerator for each period. The reconciliation of the EPS denominators is included in the following table (in thousands).

 

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Table of Contents
    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

   2004

   2005

   2004

Basic common shares outstanding

   48,151    51,285    48,598    51,483

Dilutive effect of stock options

   285    403    278    341

Dilutive effect of unvested restricted stock

   445    408    357    351

Dilutive effect of Convertible Debt Securities

   —      —      —      —  
    
  
  
  

Diluted common shares outstanding

   48,881    52,096    49,233    52,175
    
  
  
  

 

The Company calculates the dilution related to the Convertible Debt Securities using the “treasury stock” method. Under the treasury stock method, the Company has experienced no dilution related to the Convertible Debt Securities since their issuance in June 2004, as the Company’s average stock price has not exceeded the current effective conversion price of $26.77 per share during any period. In future periods, the Convertible Debt Securities will impact the Company’s diluted earnings per share calculation only in those periods in which the Company’s average stock price exceeds the current effective conversion price of $26.77 per share.

 

The following table sets forth the potential common shares that were excluded from the EPS computation as their effect was anti-dilutive (in thousands):

 

    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

   2004

   2005

   2004

Common stock options

   747    799    768    993

Unvested restricted stock

   390    529    445    816
    
  
  
  

Total

   1,137    1,328    1,213    1,809
    
  
  
  

 

5. COMPREHENSIVE INCOME

 

The Company’s components of comprehensive income were as follows (in thousands):

 

    

Three Months Ended

June 30,


   

Six Months Ended

June 30,


 
     2005

    2004

    2005

    2004

 

Net income

   $ 8,547     $ 7,756     $ 17,128     $ 18,589  

Other comprehensive income (loss), net of tax, if any:

                                

Foreign currency translation adjustments

     (1,099 )     (764 )     (1,920 )     237  

Unrealized gain (loss) on short-term investments

     4       (3 )     (4 )     (3 )
    


 


 


 


Comprehensive income

   $ 7,452     $ 6,989     $ 15,204     $ 18,823  
    


 


 


 


 

6. SEGMENT INFORMATION

 

The Company serves its clients through its two operating segments: the Broadband Services Division (the “Broadband Division”) and the Global Software Services Division (the “GSS Division”). During the first quarter of 2005, the Company reorganized certain components of its operating segments as a result of changes in the Company’s management and internal reporting structure. The reorganization consisted primarily of moving the plaNet Consulting (“plaNet”) division, including the Integrated Customer Management System (“ICMS”) assets acquired by the Company in 2002 from IBM, from the GSS Division to the Broadband Division. PlaNet was acquired in 2001 and its current business model includes providing professional and consulting services to Broadband Division clients and managing the ICMS service bureau business. The reorganization was done after evaluating the business plans and relationship of plaNet with the Broadband Division, along with how the plaNet business has evolved and how it is expected to continue developing a business model based more on recurring revenues.

 

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Table of Contents

The Company’s operating segment information and corporate overhead costs, reflecting this reorganization, are presented below (in thousands, except percentages). Information for the three and six months ended June 30, 2004 has been restated to conform to the new reporting structure.

 

     Three Months Ended June 30, 2005

 
     Broadband
Division


   

GSS

Division


    Corporate

    Total

 

Processing revenues

   $ 88,717     $ —       $ —       $ 88,717  

Software revenues

     3,026       6,736       —         9,762  

Maintenance revenues

     6,539       18,564       —         25,103  

Professional services revenues

     3,554       14,583       —         18,137  
    


 


 


 


Total revenues

     101,836       39,883       —         141,719  

Segment operating expenses (1)

     64,669       36,597       20,636       121,902  
    


 


 


 


Contribution margin (loss) (1)

   $ 37,167     $ 3,286     $ (20,636 )   $ 19,817  
    


 


 


 


Contribution margin percentage

     36.5 %     8.2 %     N/A       14.0 %
    


 


 


 


Certain non-cash expenses:

                                

Amortization (2)

   $ 4,327     $ 2,599     $ —       $ 6,926  

Depreciation

     1,786       1,107       858       3,751  

Stock-based compensation

     1,452       487       2,374       4,313  
    


 


 


 


Total

   $ 7,565     $ 4,193     $ 3,232     $ 14,990  
    


 


 


 


 

     Three Months Ended June 30, 2004

 
     Broadband
Division


   

GSS

Division


    Corporate

    Total

 

Processing revenues

   $ 80,895     $ —       $ —       $ 80,895  

Software revenues

     1,202       6,907       —         8,109  

Maintenance revenues

     6,516       17,137       —         23,653  

Professional services revenues

     4,082       12,924       —         17,006  
    


 


 


 


Total revenues

     92,695       36,968       —         129,663  

Segment operating expenses (1)

     57,064       34,113       16,361       107,538  
    


 


 


 


Contribution margin (loss) (1)

   $ 35,631     $ 2,855     $ (16,361 )   $ 22,125  
    


 


 


 


Contribution margin percentage

     38.4 %     7.7 %     N/A       17.1 %
    


 


 


 


Certain non-cash expenses:

                                

Amortization (2)

   $ 4,184     $ 2,568     $ —       $ 6,752  

Depreciation

     1,772       858       887       3,517  

Stock-based compensation

     1,247       673       1,880       3,800  
    


 


 


 


Total

   $ 7,203     $ 4,099     $ 2,767     $ 14,069  
    


 


 


 


 

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Table of Contents
     Six Months Ended June 30, 2005

 
     Broadband
Division


   

GSS

Division


    Corporate

    Total

 

Processing revenues

   $ 172,083     $ —       $ —       $ 172,083  

Software revenues

     7,605       13,259       —         20,864  

Maintenance revenues

     12,950       36,699       —         49,649  

Professional services revenues

     7,817       28,212       —         36,029  
    


 


 


 


Total revenues

     200,455       78,170       —         278,625  

Segment operating expenses (1)

     129,697       72,548       40,611       242,856  
    


 


 


 


Contribution margin (loss) (1)

   $ 70,758     $ 5,622     $ (40,611 )   $ 35,769  
    


 


 


 


Contribution margin percentage

     35.3 %     7.2 %     N/A       12.8 %
    


 


 


 


Certain non-cash expenses:

                                

Amortization (2)

   $ 8,581     $ 5,193     $ —       $ 13,774  

Depreciation

     3,569       2,139       1,810       7,518  

Stock-based compensation

     2,767       1,094       4,789       8,650  
    


 


 


 


Total

   $ 14,917     $ 8,426     $ 6,599     $ 29,942  
    


 


 


 


 

     Six Months Ended June 30, 2004

 
     Broadband
Division


   

GSS

Division


    Corporate

    Total

 

Processing revenues

   $ 162,027     $ —       $ —       $ 162,027  

Software revenues

     2,152       13,594       —         15,746  

Maintenance revenues

     13,407       35,297       —         48,704  

Professional services revenues

     7,098       26,452       —         33,550  
    


 


 


 


Total revenues

     184,684       75,343       —         260,027  

Segment operating expenses (1)

     114,220       68,563       31,684       214,467  
    


 


 


 


Contribution margin (loss) (1)

   $ 70,464     $ 6,780     $ (31,684 )   $ 45,560  
    


 


 


 


Contribution margin percentage

     38.2 %     9.0 %     N/A       17.5 %
    


 


 


 


Certain non-cash expenses:

                                

Amortization (2)

   $ 7,255     $ 5,145     $ —       $ 12,400  

Depreciation

     3,641       1,748       1,764       7,153  

Stock-based compensation

     2,494       1,355       4,096       7,945  
    


 


 


 


Total

   $ 13,390     $ 8,248     $ 5,860     $ 27,498  
    


 


 


 


 

(1) Segment operating expenses and contribution margin (loss) exclude restructuring charges of $6.1 million and $0.1 million, respectively, for the three months ended June 30, 2005 and 2004, and $6.8 million and $2.3 million, respectively, for the six months ended June 30, 2005 and 2004.

 

(2) Amortization of investments in client contracts related to incentives provided to new or existing clients to convert and process their customers on the Broadband Division’s customer care and billing system of $3.2 million and $3.0 million, respectively, for the three months ended June 30, 2005 and 2004, and $6.3 million and $5.1 million, respectively, for the six months ended June 30, 2005 and 2004, has been reflected as a reduction in processing and related services revenues in the segment information presented above and in the accompanying unaudited Condensed Consolidated Statements of Income.

 

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Reconciling information between reportable segment contribution margin and the Company’s consolidated totals is as follows (in thousands):

 

     Three Months Ended June 30,

    Six Months Ended June 30,

 
     2005

    2004

    2005

    2004

 

Segment contribution margin

   $ 19,817     $ 22,125     $ 35,769     $ 45,560  

Restructuring charges

     (6,129 )     (145 )     (6,844 )     (2,296 )
    


 


 


 


Operating income

     13,688       21,980       28,925       43,264  

Interest expense

     (1,850 )     (2,684 )     (3,765 )     (6,238 )

Write-off of deferred financing costs

     —         (6,569 )     —         (6,569 )

Other

     2,174       (264 )     2,919       (494 )
    


 


 


 


Income before income taxes

   $ 14,012     $ 12,463     $ 28,079     $ 29,963  
    


 


 


 


 

Substantially all of the $6.1 million and $6.8 million restructuring charges recorded in the three and six months ended June 30, 2005 related to the GSS Division. Of the $0.1 million and $2.3 million restructuring charges recorded in the three and six months ended June 30, 2004, zero and $0.2 million related to the Broadband Division, $0.1 million and $1.4 million related to the GSS Division, and zero and $0.7 million related to Corporate.

 

7. DEBT

 

The Company’s long-term debt as of June 30, 2005 and December 31, 2004 consists of the Convertible Debt Securities. As of June 30, 2005: (i) none of the contingent conversion features have been achieved, and thus, the Convertible Debt Securities are not convertible by the holders at this time; and (ii) the Company is in compliance with the provisions of the bond indenture and the registration rights agreement related to the Convertible Debt Securities.

 

As of June 30, 2005, the Company: (i) has made no borrowings under its $100 million 2004 Revolving Credit Facility; (ii) is in compliance with the financial ratio and other covenants of the 2004 Revolving Credit Facility; and (iii) has approximately $100 million of the Revolving Credit Facility available to be drawn upon.

 

8. LONG-LIVED ASSETS

 

Reorganization of Reporting Structure. In conjunction with the Company’s change in reporting structure for its operating segments as discussed in Note 6 above, the Company changed the components of its reporting units for purposes of its goodwill impairment assessments under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). Previously, the plaNet component was aggregated with the GSS Division and considered one reporting unit under the GSS Division. As a result of this reorganization, the plaNet component is now aggregated with the Broadband Division and considered one reporting unit under the Broadband Division as these components are considered to have similar economic characteristics. As a result, $19.3 million of goodwill was reallocated from the GSS Division reporting unit to the Broadband Division reporting unit during the first quarter of 2005. The $19.3 million represents the historical carrying value of goodwill related to the acquisitions of the plaNet and ICMS businesses.

 

The changes in the carrying amount of goodwill by reporting unit for the six months ended June 30, 2005 were as follows (in thousands):

 

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Table of Contents
     Broadband
Division


   

GSS

Division


    Consolidated

 

Balance as of December 31, 2004

   $ 623     $ 217,723     $ 218,346  

Restatement to reflect segment reorganization (see Note 6)

     19,288       (19,288 )     —    

Effects of changes in foreign currency exchange rates and other

     (81 )     (366 )     (447 )
    


 


 


Balance as of June 30, 2005

   $ 19,830     $ 198,069     $ 217,899  
    


 


 


 

Other Intangible Assets. The Company’s intangible assets subject to amortization consist of client contracts and software. As of June 30, 2005 and December 31, 2004, the carrying values of these assets were as follows (in thousands):

 

     June 30, 2005

   December 31, 2004

     Gross
Carrying
Amount


   Accumulated
Amortization


    Net
Amount


   Gross
Carrying
Amount


   Accumulated
Amortization


    Net
Amount


Client contracts

   $ 117,131    $ (69,253 )   $ 47,878    $ 113,325    $ (62,898 )   $ 50,427

Software

     101,945      (84,105 )     17,840      101,781      (77,086 )     24,695
    

  


 

  

  


 

Total

   $ 219,076    $ (153,358 )   $ 65,718    $ 215,106    $ (139,984 )   $ 75,122
    

  


 

  

  


 

 

The aggregate amortization related to intangible assets for the three months ended June 30, 2005 and 2004 was $6.9 million and $6.8 million, respectively, and for the six months ended June 30, 2005 and 2004 was $13.8 million and $12.4 million, respectively.

 

Carrying Value of the GSS Division’s Intangible Assets. As of June 30, 2005, there was approximately $16 million of net software intangible assets, and approximately $198 million of goodwill that was attributable to the Kenan Business and Davinci acquisitions. Key drivers of the value assigned to these acquisitions were the global telecommunications industry client base and the software assets acquired. To date, the GSS Division has not achieved the financial performance that the Company had originally anticipated due to many factors, including the economic downturn experienced within the global telecommunications industry since the Company acquired these assets. The Company’s current business plan anticipates substantial revenue and earnings growth for the GSS Division over the next several years. The Company will continue to monitor the carrying value of the GSS Division’s goodwill and other long-lived intangible assets as it executes on its business plan to achieve this revenue and earnings growth. The Company expects to perform the GSS Division goodwill impairment test (the Company’s annual required test) in the third quarter of 2005. If the Company fails to execute to its business plan (due to market conditions or other business reasons), and as a result, the Company materially revises its GSS Division financial projections, it is reasonably possible that a review for impairment of the GSS Division’s goodwill and/or related long-lived intangible assets in the future may indicate that these assets are impaired, and the amount of impairment could be substantial.

 

Carrying Value of Broadband Division’s Intangible Assets. As of June 30, 2005, the Broadband Division had approximately $50 million in net intangible assets (primarily client contracts). Of this net intangible asset amount, approximately $39 million relates to the Comcast Contract. In addition, at June 30, 2005, the Broadband Division had approximately $20 million of goodwill, which relates almost entirely to the ICMS and plaNet Consulting acquisitions.

 

9. RESTRUCTURING CHARGES

 

Cost Reduction Initiatives and Restructuring Charges. Since the third quarter of 2002, the Company has implemented several cost reduction initiatives, mainly due to the economic decline in the global telecommunications industry and the uncertainty in the timing and the extent of any economic turnaround within the industry, and due to the reduction in revenues resulting from the Comcast arbitration ruling received in October 2003. During the second quarter of 2005, the Company restructured its management and sales team in the

 

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Europe, Middle East, and Africa (“EMEA”) region and abandoned facility space in its London office. As a result of these cost reduction initiatives, the Company has recorded restructuring charges related to involuntary employee terminations and various facility abandonments. The accounting for facility abandonments requires significant judgments in determining the restructuring charges, primarily related to the assumptions regarding the timing and the amount of any potential sublease arrangements for the abandoned facilities. The Company continually evaluates its assumptions, and adjusts the related facility abandonment reserves based on the revised assumptions at that time. In addition, the Company continually evaluates ways to reduce its operating expenses through new restructuring opportunities, including utilization of its workforce and current operating facilities.

 

During the three months ended June 30, 2005 and 2004, the Company recorded restructuring charges of $6.1 million and $0.1 million, respectively, related to its cost reduction initiatives. During the six months ended June 30, 2005 and 2004, the Company recorded restructuring charges of $6.8 million and $2.3 million, respectively. The restructuring costs have been reflected as a separate line item on the accompanying unaudited Condensed Consolidated Statements of Income. The components of the restructuring charges are as follows (in thousands):

 

    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

   2004

   2005

   2004

Involuntary employee terminations

   $ 2,507    $ 145    $ 3,075    $ 1,699

Facility abandonments

     3,622      —        3,768      595

All other

     —        —        1      2
    

  

  

  

Total restructuring charges

   $ 6,129    $ 145    $ 6,844    $ 2,296
    

  

  

  

 

Restructuring Reserves. The activity in the business restructuring reserves during the six months ended June 30, 2005 is as follows (in thousands):

 

     Termination
Benefits


    Facilities
Abandonment


    Other

    Total

 

December 31, 2004, balance

   $ 57     $ 7,652     $ —       $ 7,709  

Charged to expense during the period

     3,075       3,768             1       6,844  

Cash payments

     (1,813 )     (3,311 )     (1 )     (5,125 )

Other

     (166 )     (460 )     —         (626 )
    


 


 


 


June 30, 2005, balance

   $ 1,153     $ 7,649     $ —       $ 8,802  
    


 


 


 


 

Of the $8.8 million business restructuring reserve balance as of June 30, 2005, $6.5 million was included in current liabilities and $2.3 million was included in non-current liabilities. As of June 30, 2005, the present value of the estimated proceeds from any sublease agreements used in the calculation of the business restructuring reserves was approximately $14 million, of which approximately $13 million is related to future sublease proceeds from signed noncancelable sublease agreements.

 

10. COMMITMENTS, GUARANTEES AND CONTINGENCIES

 

Service Agreements. The Company’s Broadband Division outsources to First Data Corporation (“FDC”) the data processing and related computer services required for the operation of its processing services and certain related products. In June 2005, the Company extended its contract with FDC for these services through June 2010. The contract was previously scheduled to expire in June 2008. Under the agreement, the Company is charged a fixed fee plus a variable fee based on usage and/or actual costs.

 

Executive Retirement Benefits. In December 2004, the Company announced its Chairman of the Board of Directors (the “Chairman”) and then Chief Executive Officer (“CEO”) would retire on June 30, 2005. In

 

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Table of Contents

consideration for certain changes to the Chairman and CEO’s employment agreement and for post-termination consulting services to be provided, the Company agreed to pay the Chairman and CEO a total of $9.6 million, $5.6 million which will be paid on January 2, 2006, $2.0 million which will be paid on July 1, 2006, and $2.0 million which will be paid on January 2, 2007. As of June 30, 2005, the Company has recorded expense of $9.0 million related to his retirement package. The remainder of the $0.6 million expense will be recorded over the period from his June 30, 2005 retirement date through the January 2, 2007 final payment date.

 

Product Warranties. The Company generally warrants that its products and services will conform to published specifications, or to specifications provided in an individual client arrangement, as applicable. The typical warranty period is 90 days from delivery of the product or service. In certain client arrangements, the warranty period may begin upon acceptance testing or installation. The typical remedy for breach of warranty is to correct or replace any defective deliverable, and if not possible or practical, the Company will accept the return of the defective deliverable and refund the amount paid to the Company under the client arrangement that is allocable to the defective deliverable. Historically, the Company has incurred minimal warranty costs, and as a result, does not maintain a warranty reserve.

 

Product Indemnifications. The Company’s software arrangements generally include a product indemnification provision that will indemnify and defend a client in actions brought against the client that claim the Company’s products infringe upon a copyright, trade secret, or valid patent. Historically, the Company has not incurred any significant costs related to product indemnification claims, and as a result, does not maintain a reserve for such exposure.

 

Contingent Consideration. Contingent consideration represents an arrangement to provide additional consideration in a business combination to the seller if contractually specified conditions related to the acquired entity are achieved. In the Davinci Business Acquisition, which closed in December 2002, the stock purchase agreement included contingent purchase provisions providing the sellers of Davinci the opportunity to receive additional purchase price amounts in 2003 through 2006. During 2005 and 2006, the sellers of Davinci are eligible to receive contingent purchase price amounts of up to $1.8 million. Any contingent purchase price amounts will be recorded as additional purchase price when the events associated with the contingencies occur. As of June 30, 2005 the Company had not accrued any amount for the 2005 portion of the contingent consideration as the outcome of the contingency is not determinable beyond a reasonable doubt.

 

Claims for Company Non-performance. The Company’s arrangements with its clients typically cap the Company’s liability for breach to a specified amount of the direct damages incurred by the client resulting from the breach. From time-to-time, the Company’s arrangements may also include provisions for possible liquidated damages or other financial remedies for non-performance by the Company, or in the case of certain of the Company’s out-sourced customer care and billing solutions, provisions for damages related to service level performance requirements. The service level performance requirements typically relate to system availability and timeliness of service delivery. As of June 30, 2005, the Company believes it had adequate reserves, based on its historical experience, to cover any reasonably anticipated exposure as a result of the Company’s nonperformance for any past or current arrangements with its clients.

 

Legal Proceedings. From time-to-time, the Company is involved in litigation relating to claims arising out of its operations in the normal course of business. In the opinion of the Company’s management, the Company is not presently a party to any material pending or threatened legal proceedings.

 

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Table of Contents

 

CSG SYSTEMS INTERNATIONAL, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

(in thousands, except per share amounts and percentages)

 

     Three months ended June 30,

    Six months ended June 30,

 
     2005

    2004

    2005

    2004

 
     Amount

    % of
Revenue


    Amount

    % of
Revenue


    Amount

    % of
Revenue


    Amount

    % of
Revenue


 

Revenues:

                                                        

Processing and related services

   $ 88,717     62.6 %   $ 80,895     62.4 %   $ 172,083     61.8 %   $ 162,027     62.3 %

Software

     9,762     6.9       8,109     6.3       20,864     7.5       15,746     6.1  

Maintenance

     25,103     17.7       23,653     18.2       49,649     17.8       48,704     18.7  

Professional services

     18,137     12.8       17,006     13.1       36,029     12.9       33,550     12.9  
    


 

 


 

 


 

 


 

Total revenues

     141,719     100.0       129,663     100.0       278,625     100.0       260,027     100.0  
    


 

 


 

 


 

 


 

Cost of revenues:

                                                        

Cost of processing and related services

     41,975     29.6       34,619     26.7       84,433     30.3       68,425     26.3  

Cost of software and maintenance

     15,655     11.0       17,162     13.2       31,260     11.2       33,436     12.9  

Cost of professional services

     15,811     11.2       15,616     12.1       31,248     11.2       29,766     11.4  
    


 

 


 

 


 

 


 

Total cost of revenues

     73,441     51.8       67,397     52.0       146,941     52.7       131,627     50.6  
    


 

 


 

 


 

 


 

Gross margin (exclusive of depreciation)

     68,278     48.2       62,266     48.0       131,684     47.3       128,400     49.4  
    


 

 


 

 


 

 


 

Operating expenses:

                                                        

Research and development

     15,667     11.1       14,382     11.1       31,116     11.2       30,222     11.6  

Selling, general and administrative

     29,043     20.5       22,242     17.2       57,281     20.6       45,465     17.5  

Depreciation

     3,751     2.6       3,517     2.7       7,518     2.7       7,153     2.8  

Restructuring charges

     6,129     4.3       145     0.1       6,844     2.5       2,296     0.9  
    


 

 


 

 


 

 


 

Total operating expenses

     54,590     38.5       40,286     31.1       102,759     37.0       85,136     32.8  
    


 

 


 

 


 

 


 

Operating income

     13,688     9.7       21,980     16.9       28,925     10.3       43,264     16.6  
    


 

 


 

 


 

 


 

Other income (expense):

                                                        

Interest expense

     (1,850 )   (1.3 )     (2,684 )   (2.1 )     (3,765 )   (1.3 )     (6,238 )   (2.4 )

Write-off of deferred financing costs

     —       —         (6,569 )   (5.0 )     —       —         (6,569 )   (2.5 )

Interest and investment income, net

     1,306     0.9       273     0.2       2,275     0.8       556     0.2  

Other, net

     868     0.6       (537 )   (0.4 )     644     0.2       (1,050 )   (0.4 )
    


 

 


 

 


 

 


 

Total other

     324     0.2       (9,517 )   (7.3 )     (846 )   (0.3 )     (13,301 )   (5.1 )
    


 

 


 

 


 

 


 

Income before income taxes

     14,012     9.9       12,463     9.6       28,079     10.0       29,963     11.5  

Income tax provision

     (5,465 )   (3.9 )     (4,707 )   (3.6 )     (10,951 )   (3.9 )     (11,374 )   (4.4 )
    


 

 


 

 


 

 


 

Net income

   $ 8,547     6.0 %   $ 7,756     6.0 %   $ 17,128     6.1 %   $ 18,589     7.1 %
    


 

 


 

 


 

 


 

Basic net income per common share:

                                                        

Net income available to common stockholders

   $ 0.18           $ 0.15           $ 0.35           $ 0.36        
    


       


       


       


     

Weighted-average common shares

     48,151             51,285             48,598             51,483        
    


       


       


       


     

Diluted net income per common share:

                                                        

Net income available to common stockholders

   $ 0.17           $ 0.15           $ 0.35           $ 0.36        
    


       


       


       


     

Weighted-average common shares

     48,881             52,096             49,233             52,175        
    


       


       


       


     

 

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The information contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and Notes thereto (the “Financial Statements”) included in this Form 10-Q and the audited consolidated financial statements and notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2004 (our “2004 10-K”).

 

Forward-Looking Statements

 

This report contains a number of forward-looking statements relative to our future plans and our expectations concerning the global customer care and billing industry, as well as the converging telecommunications industry it serves, and similar matters. These forward-looking statements are based on assumptions about a number of important factors, and involve risks and uncertainties that could cause actual results to differ materially from estimates contained in the forward-looking statements. Some of the risks that are foreseen by management are contained in Exhibit 99.01 “Safe Harbor for Forward-Looking Statements Under the Private Securities Litigation Reform Act of 1995—Certain Cautionary Statements and Risk Factors”. Exhibit 99.01 constitutes an integral part of this report, and readers are strongly encouraged to review this exhibit closely in conjunction with MD&A.

 

Market Conditions of the Global Telecommunications Industry

 

Over the last several years, the global telecommunications industry has experienced an economic downturn for various reasons. Since the vast majority of our clients operate within this industry, the economic state of this market sector directly impacts our business. During this time period, most telecommunications companies reduced their operating costs and capital expenditures to cope with the difficult market conditions. This resulted in a decrease in spending on business and operational support systems, including customer care and billing products and services. We believe the market has stabilized and is beginning to show positive signs of economic improvement. In addition, increased competition from non-traditional telecommunication providers has accelerated the rollout of new products and services and increased the focus on customer retention. Consolidation within the industry continues, driving providers to look for additional means for leveraging their existing networks and workforce and reducing their costs. We believe these events, combined with improving market conditions noted above, will increase the demand for scalable, flexible, and cost efficient solutions, resulting in an improved growth outlook for the customer care and billing industry.

 

Although we see improvements in the industry as noted above, we continue to be cautious in our outlook, as our ability to increase our revenues and improve our operating performance is highly dependent upon the pace at which the market recovers, the spending patterns of our client base, and ultimately, our success in developing and selling new products and services to new and existing clients.

 

Reorganization of Operating Segments

 

We serve our clients through our two operating segments: the Broadband Services Division (the “Broadband Division”) and the Global Software Services Division (the “GSS Division”). During the first quarter of 2005, we reorganized certain components of our operating segments as a result of changes in our management and internal reporting structure. The reorganization consisted primarily of moving the plaNet Consulting (“plaNet”) division, including the Integrated Customer Management System (“ICMS”) assets acquired by us in 2002 from IBM, from the GSS Division to the Broadband Division. The results of operations reflecting this reorganization for the two divisions are shown in Note 6 to the Financial Statements. Segment financial information for 2004 has been restated, as required by GAAP, in order to conform to the new reporting structure. The 2004 restated segment results reflecting this reorganization for each of the individual quarters and the full year were presented in our quarterly report on Form 10-Q for the three months ended March 31, 2005. Throughout the remainder of MD&A, all references to 2004 operating segment results and corporate overhead costs are made to the restated results.

 

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Management Overview of Quarterly Results

 

The Company. We are a global leader in next-generation billing and customer care solutions for the cable television, direct broadcast satellite, advanced IP services, next-generation mobile, and fixed wireline markets. Our combination of proven and future-ready solutions, delivered in both outsourced and licensed formats, enables our clients to deliver high quality customer service, improve operational efficiencies and rapidly bring new revenue-generating products to market. We are a S&P Midcap 400 company.

 

A summary of our consolidated results of operations for the second quarter of 2005 is as follows:

 

    Our consolidated revenues for the second quarter of 2005 were $141.7 million, compared to $129.7 million for the same period last year (a 9.3% increase), and first quarter of 2005 consolidated revenues of $136.9 million (a 3.5% increase). The increase in year-over-year and sequential quarter performance is attributable primarily to higher processing revenues within the Broadband Division.

 

    Our consolidated operating expenses for the second quarter of 2005 were $128.0 million, compared to $107.7 million for the same period last year (an 18.9% increase), and first quarter of 2005 consolidated operating expenses of $121.7 million (a 5.2% increase). The increase in consolidated operating expenses between the first and second quarters of 2005 relates primarily to a $5.4 million increase in restructuring charges, related primarily to the abandonment of a facility and the restructuring of our management and sales team in our Europe, Middle East, and Africa (“EMEA”) region during the second quarter of 2005.

 

The year-over-year increase in consolidated operating expenses relates primarily to: (i) an increase in data processing costs, primarily due to growth in the number of customers processed on our systems, and greater processing requirements for ACP functionality; (ii) an increase in labor-related costs, primarily as a result of merit wage increases and an increase in staff levels; (iii) the accrual of $4.3 million of retirement benefits for Neal Hansen in the second quarter of 2005 (as discussed below); and (iv) higher restructuring charges (as discussed above) between periods. The increase in staff between periods is to address the growth opportunities we see for our Voice over IP products and services and migration of clients to ACP, as well as staff added in our GSS Division’s foreign operations to address various revenue opportunities, primarily within the Asia Pacific (“APAC”) region.

 

    Our net income for the second quarter of 2005 was $8.5 million, or $0.17 per diluted share. Net income for the second quarter of 2005 was impacted by the following key items of significance:

 

    During the second quarter of 2005, we entered into a contract termination settlement agreement with a former client, and settled our outstanding bankruptcy claims with MCI, formerly WorldCom (collectively, the “Contract Settlements”). After taking into consideration the amounts of our allowance for doubtful accounts and deferred revenues related to these matters, the total benefit of the Contract Settlements included in the second quarter of 2005 results of operations was $3.7 million (pretax impact), or $0.05 per diluted share. Of the total amount of the earnings benefit, $2.3 million was recognized as processing revenues, with the remainder realized primarily as a reduction of bad debt expense and legal fees.

 

    Net income was reduced by expense of $4.3 million (pretax impact), or $0.05 per diluted share, for the accrual of benefits related to Mr. Hansen’s retirement, and expense of $6.1 million (pretax impact), or $0.08 per diluted share, for restructuring activities. The total impact to net income for these expense items was $10.4 million (pretax impact), or $0.13 per diluted share.

 

    The second quarter of 2005 also included a foreign currency transaction gain of $0.9 million (pretax impact), or $0.01 per diluted share.

 

Our net income for the second quarter of 2004 was $7.8 million, or $0.15 per diluted share. Net income for the second quarter of 2004 was impacted by the following key items of significance:

 

   

During the second quarter of 2004, we signed a new five-year customer care and billing services contract with Adelphia Communications (“Adelphia”). In conjunction with signing of this new contract, we sold, without recourse, $8.0 million of Adelphia pre-bankruptcy accounts receivable

 

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to an independent third party for $6.3 million. After taking into consideration the amounts of our allowance for doubtful accounts and deferred revenues related to this matter, the total benefit of this transaction included in the second quarter of 2004 results of operations was $3.5 million (pretax impact), or $0.04 per diluted share. Of the total amount of the earnings benefit, $1.3 million was recognized as processing revenues and $2.2 million as a reduction of bad debt expense.

 

    Net income was reduced by the write-off of deferred financing costs of $6.6 million and restructuring charges of $0.1 million. The total impact to net income for these expense items was $6.7 million (pretax impact), or $0.08 per diluted share.

 

    The second quarter of 2004 also included a foreign currency transaction loss of $(0.5) million (pretax impact), or $0.01 per diluted share.

 

    For the second quarter of 2005, stock-based compensation expense was $4.3 million, depreciation expense was $3.8 million, and amortization of intangible assets was $7.2 million. These non-cash charges totaled $15.3 million (pretax impact), or $0.19 per diluted share. For the second quarter of 2004, stock-based compensation expense was $3.8 million, depreciation expense was $3.5 million, and amortization of intangible assets was $7.3 million. These non-cash charges totaled $14.6 million (pretax impact), or $0.17 per diluted share.

 

    We continue to generate strong cash flows from our operations. We ended the second quarter of 2005 with $164.9 million of cash and cash equivalents and short-term investments, compared to $146.8 million as of March 31, 2005, and $157.5 million as of December 31, 2004. Cash flows from operations for the second quarter of 2005 were $43.3 million, compared to $40.2 million for the second quarter of 2004, and $18.9 million for the first quarter of 2005. The second quarter 2005 cash flows from operations of $43.3 million were higher than our expectations as a result of our strong operating performance for the quarter and favorable changes in working capital. This included the impact of a key domestic client making payment on certain invoices which had been delayed during the first quarter of 2005, which resulted in the payment of four monthly invoices by this client in the second quarter of 2005.

 

Other key events for the second quarter of 2005 are as follows:

 

    Neal Hansen retired as our Chief Executive Officer (“CEO”) at the end of the first quarter of 2005, and effective April 1, 2005, Edward C. Nafus, our then President of the Broadband Division, assumed the position of CEO and President of our company. In conjunction with his retirement, effective June 30, 2005, Mr. Hansen resigned as our Chairman of the Board of Directors (“Chairman”) and also resigned from our Board of Directors. Effective July 1, 2005, Bernard Reznicek, a current Board member, was named non-executive Chairman to replace Mr. Hansen.

 

Mr. Hansen will receive a total of $9.6 million of benefits related to his retirement from our company, which will be paid out beginning in January 2006. We recorded expense of $9.0 million related to his retirement package over his related service period for such benefits, which began in December 2004 and ended upon Mr. Hansen’s retirement on June 30, 2005. Of this expense, $0.5 million was recorded in the fourth quarter of 2004, $4.2 million was recorded in the first quarter of 2005, and $4.3 million was recorded in the second quarter of 2005. The remainder of $0.6 million will be recorded over the period from the retirement date through the final payment date of January 2007. See Note 10 to the Financial Statements for additional discussion of this matter.

 

    We also had several other changes to our Board of Directors during the most recent quarter. George Haddix resigned from our Board of Directors and Don Reed and James Unruh were added to our Board of Directors. After these changes, six of our seven Board members are non-employee directors. See our Form 8-Ks filed on June 1, 2005 and July 6, 2005 for additional details of these matters.

 

    During the second quarter of 2005, we repurchased 1.1 million shares of our common stock for approximately $20 million (weighted-average price of $18.49 per share).

 

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Broadband Division. The Broadband Division generates its revenues primarily by providing outsourced customer care and billing services with its core product CSG ACP (“ACP”, formerly CCS/BP) to North American, primarily the United States (“U.S.”), broadband service providers, primarily for cable television, Internet, and satellite television product offerings. The market for the Broadband Division’s products and services is highly competitive, resulting in significant pricing pressures for contract renewals.

 

The North American broadband industry has experienced significant consolidation over the last few years, resulting in a large percentage of the market being served by a limited number of service providers. Consistent with this market concentration, a large percentage of our Broadband Division’s revenues are generated from a limited number of clients. The Broadband Division’s and our company’s two largest clients (in order of size) are Comcast Corporation (“Comcast”) and Echostar Communications (“Echostar”).

 

A summary of the key business matters for the Broadband Division in the second quarter of 2005 is as follows:

 

    The Broadband Division’s second quarter of 2005 revenues totaled $101.8 million, compared to second quarter of 2004 revenues of $92.7 million (a 9.9% increase), and first quarter of 2005 revenues of $98.6 million (a 3.3% increase). The year-over-year and the sequential quarterly increases relate primarily to an increase in processing revenues in the second quarter of 2005 when compared to the other periods. As discussed above, the second quarter of 2005 includes $2.3 million of one-time, non-recurring revenues related to the Contract Settlements.

 

    The Broadband Division’s segment operating expenses for the second quarter of 2005 totaled $64.7 million, compared to second quarter of 2004 segment operating expenses of $57.1 million (a 13.3% increase), and were relatively flat when compared to the first quarter of 2005 segment operating expenses of $65.0 million. As discussed above, the increase in year-over-year expenses is primarily related to an increase in: (i) data processing costs, primarily due to growth in the number of customers processed on our systems and greater processing requirements for ACP functionality; and (ii) labor-related costs, primarily as a result of merit wage increases and the increase in staff added to support the growth opportunities of our Voice over IP products and services and migration of clients to ACP.

 

    The Broadband Division’s segment contribution margin for the second quarter of 2005 totaled $37.2 million, compared to second quarter of 2004 segment contribution margin of $35.6 million (a 4.3% increase), and first quarter of 2005 segment contribution margin of $33.6 million (a 10.6% increase). The increase in year-over-year and sequential quarter performance is attributable primarily to higher processing revenues. Non-cash charges for the second quarter of 2005 that are included in the determination of segment contribution margin are stock-based compensation expense of $1.5 million, depreciation expense of $1.8 million, and amortization of intangible assets of $4.3 million, for total non-cash charges of $7.6 million.

 

    Total domestic customer accounts processed on our systems as of June 30, 2005 were 44.4 million, compared to 43.9 million as of March 31, 2005. The annualized revenue per processing unit (“ARPU”) for the second quarter of 2005 was $8.02, compared to $7.42 for the second quarter of 2004, and $7.63 for the first quarter of 2005. The ARPU for the second quarter of 2005 includes $0.21 related to the one-time, non-recurring processing revenues of $2.3 million related to the Contract Settlements mentioned above.

 

    The Broadband Division continues to migrate customer accounts processed on our system to the ACP platform. As of June 30, 2005, we have successfully migrated approximately 16 million of the customer accounts processed on our system to this new platform, and we expect to migrate a substantial number of additional customer accounts to this platform during the remainder of 2005. See the “Business” section of our 2004 10-K for additional discussion of this effort.

 

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    The Broadband Division has successfully renewed all of its material client relationships scheduled for renewal in 2005.

 

GSS Division. The GSS Division is a global provider of convergent billing and customer care software and services that enable telecommunications service providers to bill their customers for existing and next-generation services, including mobile and wireline telephony, Internet, cable television, and satellite.

 

The GSS Division’s revenues consist of software license and maintenance fees, and various professional and consulting services related to its software products (principally, implementation services). The market for the GSS Division’s products and services is highly competitive, resulting in significant pricing pressures for both new and existing client purchases. Historically, approximately three-fourths of the GSS Division’s revenues have been generated outside the U.S. We expect that a similar portion of the GSS Division’s 2005 revenues will be generated outside the U.S.

 

A summary of the key business matters for the GSS Division in the second quarter of 2005 is as follows:

 

    The GSS Division’s second quarter of 2005 revenues totaled $39.9 million, compared to second quarter of 2004 revenues of $37.0 million (a 7.9% increase), and first quarter of 2005 revenues of $38.3 million (a 4.2% increase). The year-over-year and the sequential quarterly increases relate primarily to an increase in professional services revenues and maintenance revenues in the second quarter of 2005 when compared to the other periods.

 

    The GSS Division’s segment operating expenses for the second quarter of 2005 totaled $36.6 million, compared to second quarter of 2004 segment operating expenses of $34.1 million (a 7.3% increase) and first quarter of 2005 segment operating expenses of $36.0 million (a 1.8% increase). As discussed above, the increase in year-over-year expenses is primarily related to an increase in labor-related costs, primarily as a result of merit wage increases and an increase in staff added in our GSS Division’s foreign operations to address various revenue opportunities, primarily within the APAC region.

 

    The GSS Division’s segment contribution margin in the second quarter of 2005 totaled $3.3 million, compared to second quarter of 2004 segment contribution margin of $2.9 million (a 15.1% increase), and a first quarter of 2005 segment contribution margin of $2.3 million (a 40.7% increase). The year-over-year and the sequential quarterly increase relates primarily to an increase in revenues between periods, discussed in greater detail below. Non-cash charges for the second quarter of 2005 that are included in the determination of segment contribution margin are stock-based compensation expense of $0.5 million, depreciation expense of $1.1 million, and amortization of intangible assets of $2.6 million, for total non-cash charges of $4.2 million.

 

    During the second quarter of 2005, four providers, including three new clients, signed up for the GSS Division’s next generation solution, CSG Kenan FX, bringing the total number of CSG Kenan FX clients to 37. CSG Kenan FX is now live with nine providers, representing every telecommunications vertical and geographic region.

 

    The GSS Division signed several new clients this quarter, including Autotrader, an online automotive classified advertising company; Hawaiian Telcom, the leading provider of telecommunications services in Hawaii; and Instituto Costarriecense de Electricidad, Costa Rica’s largest telecommunications provider.

 

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Significant Client Relationships

 

Comcast. Comcast continues to be our largest client. For each of the quarters ended June 30, 2005 and 2004, revenues from Comcast represented approximately 15% of our consolidated revenues. We expect that the percentage of our consolidated revenues in 2005 related to Comcast will represent a percentage comparable to that of the second quarter of 2005, and continue to expect that revenues from Comcast will be in-line with or exceed its contractual minimums. The Comcast Contract has minimum annual financial commitments for 2005 and 2006, and runs through the end of 2008. The Comcast Contract and related amendments are included in the exhibits to our periodic filings with the SEC. The documents are available on the Internet and we encourage readers to review these documents for further details.

 

Echostar. Echostar continues to be our second largest client. For each of the quarters ended June 30, 2005 and 2004, revenues from Echostar represented approximately 14% of our consolidated revenues. We expect that the percentage of our consolidated revenues in 2005 related to Echostar will represent a percentage comparable to that of the second quarter of 2005. In February 2004, we extended our contract with Echostar through March 1, 2006. Although we are currently working with Echostar for a further renewal of the contract, there can be no assurance that such contract will be renewed on terms satisfactory to us, or at all. The Echostar Master Subscriber Agreement and related amendments are included in the exhibits to our periodic filings with the SEC. The documents are available on the Internet and we encourage readers to review these documents for further details.

 

Adelphia. During the second quarter of 2004, we signed a new five-year customer care and billing services contract with Adelphia. We currently process on our system approximately 50% of Adelphia’s domestic broadband customers. Adelphia has been operating under bankruptcy protection since June 2002. Recently it was publicly announced that Adelphia would sell out of bankruptcy its broadband business jointly to Time Warner Inc. and Comcast. The sale of the assets is subject to various Bankruptcy Court and regulatory approvals. If the sale of the assets was to occur, it is unknown at this time as to what, if any, financial impact the sale would have to our business.

 

Stock Repurchase Program

 

We have a stock repurchase program, approved by the Board of Directors, authorizing us to purchase up to 15 million shares of our common stock from time-to-time as market and business conditions warrant (the “Stock Repurchase Program”). In April 2005, we established a formal plan with a financial institution that complies with the provisions of Rule 10b5-1 under the Securities Exchange Act of 1934 (the “Rule 10b5-1 Plan”) to repurchase shares of our common stock on the open market. Any shares repurchased under the Rule 10b5-1 Plan are counted towards the 15 million share limit authorized under the Stock Repurchase Program. The Rule 10b5-1 Plan supplements any stock repurchases we may decide to purchase under the existing terms of our Stock Repurchase Program. In effect, the Rule 10b5-1 Plan facilitates achieving stock buyback objectives more readily by permitting the execution of trades during periods that would otherwise be prohibited by internal trading policies. The maximum quarterly repurchase limitation established by us under the Rule 10b5-1 Plan is $15 million.

 

During the second quarter of 2005, we repurchased 1.1 million shares of our common stock under the Stock Repurchase Program for $20.0 million (weighted-average price of $18.49 per share), of which $12 million was repurchased under the guidelines of the Rule 10b5-1 Plan. Including these shares, the total shares repurchased under the Stock Repurchase Program since its inception in August 1999 is 11.7 million shares, at a total repurchase price of $295.6 million (a weighted-average price of $25.29 per share). As of June 30, 2005, the remaining number of shares authorized for repurchase under the Stock Repurchase Program is 3.3 million shares. The Stock Repurchase Program does not have an expiration date. The shares repurchased under Stock Repurchase Program are being held as treasury shares.

 

Subsequent to June 30, 2005 through August 3, 2005, we have repurchased approximately 405,000 shares under the Stock Repurchase Program at a total purchase price of $7.2 million (a weighted-average price of $17.89 per share).

 

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Stock-Based Compensation Expense

 

Stock-based compensation expense is included in the following income statement captions and operating segment results in the accompanying Financial Statements (in thousands):

 

    

Three Months Ended

June 30,


   Six Months Ended
June 30,


     2005

   2004

   2005

   2004

Unaudited Condensed Consolidated Statements of Income:

                           

Cost of processing and related services

   $ 854    $ 643    $ 1,700    $ 1,264

Cost of software and maintenance

     207      251      382      469

Cost of professional services

     151      299      312      574

Research and development

     536      459      1,055      930

Selling, general and administrative

     2,565      2,148      5,201      4,708
    

  

  

  

Total stock-based compensation expense

   $ 4,313    $ 3,800    $ 8,650    $ 7,945
    

  

  

  

Segment Results:

                           

Broadband Division

   $ 1,452    $ 1,247    $ 2,767    $ 2,494

GSS Division

     487      673      1,094      1,355

Corporate

     2,374      1,880      4,789      4,096
    

  

  

  

Total stock-based compensation expense

   $ 4,313    $ 3,800    $ 8,650    $ 7,945
    

  

  

  

 

GSS Division Goodwill and Other Long-Lived Assets

 

As of June 30, 2005, there was approximately $16 million of net software intangible assets, and approximately $198 million of goodwill that was attributable to the Kenan Business and Davinci acquisitions. Key drivers of the value assigned to these acquisitions were the global telecommunications industry client base and the software assets acquired. To date, the GSS Division has not achieved the financial performance that we had originally anticipated due to many factors, including the economic downturn experienced within the global telecommunications industry since we acquired these assets. Our current business plan anticipates substantial revenue and earnings growth for the GSS Division over the next several years. We will continue to monitor the carrying value of the GSS Division’s goodwill and other long-lived intangible assets as we execute on our business plan to achieve this revenue and earnings growth. We expect to perform the next GSS Division goodwill impairment test (our annual required test) in the third quarter of 2005. If we fail to execute to our business plan (due to market conditions or other business reasons), and as a result, we materially revise our GSS Division financial projections, it is reasonably possible that a review for impairment of the GSS Division’s goodwill and/or related long-lived intangible assets in the future may indicate that these assets are impaired, and the amount of impairment could be substantial.

 

Critical Accounting Policies

 

The preparation of our Financial Statements in conformity with accounting principles generally accepted in the U.S. requires us to select appropriate accounting policies, and to make judgments and estimates affecting the application of those accounting policies. In applying our accounting policies, different business conditions or the use of different assumptions may result in materially different amounts reported in our Financial Statements.

 

We have identified the most critical accounting policies that affect our financial condition and results of operations. The critical accounting policies were determined by considering accounting policies that involve the most complex or subjective decisions or assessments. The most critical accounting policies identified relate to: (i) revenue recognition; (ii) allowance for doubtful accounts receivable; (iii) impairment assessments of long-lived

 

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assets; (iv) business restructurings; (v) loss contingencies; (vi) income taxes; (vii) business combinations and asset purchases; and (viii) capitalization of internal software development costs. These critical accounting policies and our other significant accounting policies are discussed in greater detail in our 2004 10-K.

 

Results of Operations – Consolidated Basis

 

Total Revenues. Total revenues for the: (i) three months ended June 30, 2005 increased to $141.7 million, from $129.7 million for the three months ended June 30, 2004, with the increase primarily due to an increase in processing revenues; and (ii) six months ended June 30, 2005 increased to $278.6 million, from $260.0 million for the six months ended June 30, 2004, with the increase primarily due to an increase in processing and software revenues.

 

We use the location of the client as the basis of attributing revenues to individual countries. Revenues by geographic region for the three and six months ended June 30, 2005 and 2004 were as follows (in thousands):

 

     Three Months Ended
June 30,


   Six Months Ended
June 30,


     2005

   2004

   2005

   2004

North America (principally the U.S.)

   $ 111,001    $ 96,304    $ 214,672    $ 193,218

Europe, Middle East and Africa (principally Europe)

     18,887      20,174      39,760      38,615

Asia Pacific

     6,054      9,000      12,704      17,988

Central and South America

     5,777      4,185      11,489      10,206
    

  

  

  

Total revenues

   $ 141,719    $ 129,663    $ 278,625    $ 260,027
    

  

  

  

 

For revenues generated outside North America, no single country accounts for more than 5% of our total revenues. The decrease in revenues in the Asia Pacific region between periods is due primarily to the completion of several large projects within India during 2004, with no comparable amounts in 2005.

 

See the “Results of Operations – Operating Segments” section below for a detailed discussion of revenues and related changes between periods on a segment basis.

 

Cost of Revenues. See our 2004 10-K for a description of the types of costs that are included in the individual line items for cost of revenues.

 

Cost of Processing and Related Services. The cost of processing and related services for the: (i) three months ended June 30, 2005 increased 21.2% to $42.0 million, from $34.6 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 increased 23.4% to $84.4 million, from $68.4 million for the six months ended June 30, 2004. The increases between periods are primarily due to: (i) an increase in labor-related costs, primarily as a result of merit wage increases and the increase in staff levels to support the growth opportunities of our Voice over IP products and services and migration of clients to ACP; and (ii) an increase in data processing costs, primarily due to growth in the number of customers processed on our systems, and greater processing requirements for ACP functionality.

 

Processing costs as a percentage of related processing revenues were: (i) 47.3% (gross margin of 52.7%) for the three months ended June 30, 2005 compared to 42.8% (gross margin of 57.2%) for the three months ended June 30, 2004; and (ii) 49.1% (gross margin of 50.9%) for the six months ended June 30, 2005 compared to 42.2% (gross margin of 57.8%) for the six months ended June 30, 2004. The decreases in the gross margin percentage between periods relate primarily to the increase in costs, as mentioned above, without a commensurate increase in revenues related to such costs. This is the result of the investment we are making in our Voice over IP products and services, as well as our efforts to migrate our clients to the ACP platform. That is, we do not initially receive any additional revenue from our clients as we migrate them to the ACP platform. In addition, at this time, the incremental revenues from Voice over IP products and services are not significant.

 

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Cost of Software and Maintenance. The combined cost of software and maintenance for the: (i) three months ended June 30, 2005 decreased 8.7% to $15.7 million, from $17.2 million for the three months ended June 30, 2004; and (ii) for the six months ended June 30, 2005 decreased 6.5% to $31.3 million, from $33.4 million for the six months ended June 30, 2004. The decreases between periods are primarily due to a reduction in personnel assigned internally to software maintenance projects.

 

The cost of software and maintenance as a percentage of related revenues was: (i) 44.9% (gross margin of 55.1%) for the three months ended June 30, 2005 as compared to 54.0% (gross margin of 46.0%) for the three months ended June 30, 2004, with the increase in the gross margin percentage between periods attributed primarily to higher software revenues within the Broadband Division and higher maintenance revenues within the GSS Division for the second quarter of 2005, combined with the impact of lower costs between periods, as noted above; and (ii) 44.3% (gross margin of 55.7%) for the six months ended June 30, 2005 as compared to 51.9% (gross margin of 48.1%) for the six months ended June 30, 2004, with the increase in the gross margin percentage between periods primarily related to higher software revenues within the Broadband Division for the first six months of 2005, combined with the impact of lower costs between periods, as noted above. As discussed below, fluctuations in the quarterly gross margin for software and maintenance revenues are an inherent characteristic of software companies, which can be impacted by, among others things, the timing of executed contracts in any one quarter.

 

Cost of Professional Services. The cost of professional services for the: (i) three months ended June 30, 2005 increased slightly to $15.8 million, from $15.6 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 increased 5.0% to $31.2 million, from $29.8 million for the six months ended June 30, 2004. The increase in cost of professional services between periods is generally consistent with the increase in professional services revenues for the corresponding periods.

 

The cost of professional services as a percentage of related revenues was: (i) 87.2% (gross margin of 12.8%) for the three months ended June 30, 2005, as compared to 91.8% (gross margin of 8.2%) for the three months ended June 30, 2004; and (ii) 86.7% (gross margin of 13.3%) for the six months ended June 30, 2005, as compared to 88.7% (gross margin of 11.3%) for the six months ended June 30, 2004. The improvement in the gross margin percentages for the respective periods is due primarily to increased professional services revenues within the GSS Division. As discussed below, fluctuations in the quarterly gross margin for professional services revenues are an inherent characteristic of professional services companies.

 

Gross Margin (Exclusive of Depreciation). Revenues from software licenses, maintenance services and professional services make up approximately 40% of our total revenues. Variability in quarterly revenues and operating results are inherent characteristics of companies that sell software licenses, maintenance services, and perform professional services. Our quarterly revenues for software licenses, maintenance services and professional services revenues may fluctuate, depending on various factors, including the timing of executed contracts and revenue recognition, and the delivery of contracted services or products. See Exhibit 99.01 for additional discussion of factors that may cause fluctuations in quarterly revenues and operating results. However, the costs associated with software and maintenance revenues, and professional services revenues are not subject to the same degree of variability (i.e., these costs are generally fixed in nature within a relatively short period of time), and thus, fluctuations in our software and maintenance, professional services, and overall gross margins, will likely occur between periods.

 

The overall gross margin (exclusive of depreciation) for the: (i) three months ended June 30, 2005 was $68.3 million (48.2% gross margin), compared to $62.3 million (48.0% gross margin) for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 was $131.7 million (47.3% gross margin), compared to $128.4 million (49.4% gross margin) for the six months ended June 30, 2004. The changes in the overall gross margin and overall gross margin percentages are due to the factors discussed above.

 

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Research and Development Expense. We continue to invest in the development of new products and services at a relatively consistent pace when compared to our total revenues. R&D expense: (i) increased 8.9% to $15.7 million for the three months ended June 30, 2005, from $14.4 million for the three months ended June 30, 2004; and (ii) increased 3.0% to $31.1 million for the six months ended June 30, 2005, from $30.2 million for the six months ended June 30, 2004. As a percentage of total revenues, R&D expense was: (i) 11.1% for both the three months ended June 30, 2005 and 2004; and (ii) 11.2% for the six months ended June 30, 2005, compared to 11.6% for the six months ended June 30, 2004. We did not capitalize any internal software development costs during 2005 and 2004.

 

During the first six months of 2005, we focused our development and enhancement efforts on:

 

    various R&D projects for the GSS Division, consisting principally of enhancements to the existing Kenan FX product suite, as well as new software modules; and

 

    various R&D projects for the Broadband Division, consisting principally of enhancements to ACP and related Broadband Division software products, targeted to increase the functionalities and features of the products, including those necessary to service Voice over IP product offerings.

 

At this time, we expect our investment in R&D over time will approximate our historical investment rate of 10-12% of total revenues. We expect this investment will be focused on the ACP and the Kenan FX product suites, as well as additional stand-alone products as they are identified.

 

Selling, General and Administrative (“SG&A”) Expense. SG&A expense for the: (i) three months ended June 30, 2005, increased 30.6% to $29.0 million, from $22.2 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005, increased 26.0% to $57.3 million, from $45.5 million for the six months ended June 30, 2004. As a percentage of total revenues, SG&A expense was: (i) 20.5% for the three months ended June 30, 2005 as compared to 17.2% for the three months ended June 30, 2004; and (ii) 20.6% for the six months ended June 30, 2005 as compared to 17.5% for the six months ended June 30, 2004. The increase in SG&A expense between periods relates primarily to: (i) the accrual of retirement benefits of $4.3 million and $8.5 million for the three and six months ended June 30, 2005, respectively, for our former CEO, Mr. Hansen, who retired on June 30, 2005; and to a much lesser degree (ii) the increase in bad debt expense between periods due to the $2.2 million reduction of bad debt expense recorded in the second quarter of 2004 related to the sale of the Adelphia pre-bankruptcy accounts receivable, as discussed above. See Note 10 to the Financial Statements for additional discussion of Mr. Hansen’s retirement benefits.

 

Depreciation Expense. Depreciation expense between 2005 and 2004 is relatively flat. Depreciation expense for the: (i) three months ended June 30, 2005 was $3.8 million, compared to $3.5 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 was $7.5 million, compared to $7.2 million for the six months ended June 30, 2004. The capital expenditures during the three and six months ended June 30, 2005 consisted principally of computer hardware and related equipment, and leasehold improvements. Depreciation expense for all property and equipment is reflected separately in the aggregate and is not included in the cost of revenues or the other components of operating expenses.

 

Restructuring Charges. Since the third quarter of 2002, we have implemented several cost reduction initiatives, mainly due to the economic decline in the global telecommunications industry and the uncertainty in the timing and the extent of any economic turnaround within the industry, and due to the reduction in revenues resulting from the Comcast arbitration ruling received in October 2003. Our most recent restructuring charges in the second quarter of 2005 relate primarily to the abandonment of a facility and restructuring of our management and sales team in the GSS Division’s EMEA region during the second quarter of 2005. This most recent restructuring activity is targeted to reduce total operating expenses by approximately $5 million on an annual basis, and will also better align our sales and delivery teams to more accurately reflect our customer base. We now have dedicated sales executives for our large Tier 1 customers and prospects and geographic sales executives covering our Tier 2 and Tier 3 customers and opportunities.

 

As of result of the various cost reduction initiatives mentioned above, we have recorded restructuring charges related to involuntary employee terminations and various facility abandonments. The accounting for facility abandonments requires significant judgments in determining the restructuring charges, primarily related to the

 

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assumptions regarding the timing and the amount of any potential sublease arrangements for the abandoned facilities. We continually evaluate our assumptions, and adjust the related facility abandonment reserves based on the revised assumptions at that time. In addition, we continually evaluate ways to reduce our operating expenses through new restructuring opportunities, including utilization of our workforce and current operating facilities.

 

The components of the restructuring charges included in total operating expenses, and the impact (net of related estimated income tax expense) these restructuring charges had on net income and diluted earnings per share, for the three and six months ended June 30, 2005 and 2004 are as follows (in thousands, except diluted earnings per share):

 

    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

   2004

   2005

   2004

Involuntary employee terminations

   $ 2,507    $ 145    $ 3,075    $ 1,699

Facility abandonments

     3,622      —        3,768      595

All other

     —        —        1      2
    

  

  

  

Total restructuring charges

   $ 6,129    $ 145    $ 6,844    $ 2,296
    

  

  

  

Impact of restructuring charges on results of operations (i.e., have reduced operating results):

                           

Net income

   $ 3,739    $ 90    $ 4,175    $ 1,424
    

  

  

  

Diluted earnings per share

   $ 0.08    $ 0.00    $ 0.08    $ 0.02
    

  

  

  

 

Operating Income. Operating income for the: (i) three months ended June 30, 2005, was $13.7 million, or 9.7% of total revenues, compared to $22.0 million or 16.9% of total revenues for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005, was $28.9 million, or 10.3% of total revenues, compared to $43.3 million or 16.6% of total revenues for the six months ended June 30, 2004. The decreases in operating income and operating income percentages between periods are due primarily to the increase in the cost of processing and relates services, SG&A expense, and restructuring charges, as discussed above, offset to a certain degree by an increase in revenues. The $4.3 million and $8.5 million of retirement benefits for Mr. Hansen, and the $6.1 million and $6.8 million of restructuring charges mentioned above for the three and six months ended June 30, 2005, lowered the operating margin percentage by 7.3 and 5.5 percentage points, respectively.

 

Our total operating expenses for the first and second quarters of 2005 were $121.7 million and $128.0 million, respectively. We expect our third quarter of 2005 total operating expenses to trend downward and range between $117 million to $120 million, as we do not anticipate any significant restructuring charges in the third quarter of 2005, and the significant expenses associated with Mr. Hansen’s retirement benefits have been accrued as of June 30, 2005.

 

Interest Expense. The following are the key changes related to our interest expense between periods:

 

    Interest expense for the: (i) three months ended June 30, 2005, decreased 31.1% to $1.9 million, from $2.7 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005, decreased 39.6% to $3.8 million, from $6.2 million for the six months ended June 30, 2004.

 

    The weighted-average balance of our long-term debt for the: (i) three months ended June 30, 2005 was $230 million, compared to approximately $209 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 was $230 million, compared to approximately $218 million for the six months ended June 30, 2004.

 

   

The weighted-average interest rate on our debt borrowings for the: (i) three months ended June 30, 2005, including the amortization of deferred financing costs and commitment fees on our revolving credit facility, was 3.2%, compared to 4.9% for the three months ended June 30, 2004; and (ii) six months ended

 

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June 30, 2005, including the amortization of deferred financing costs and commitment fees on our revolving credit facility, was 3.2%, compared to 5.4% for the six months ended June 30, 2004. The decrease in the weighted-average interest rate between periods relates to the issuance of our Convertible Debt Securities in June 2004 and the retirement of our then existing bank debt with the proceeds from such issuance. The Convertible Debt Securities have a stated coupon rate of 2.5%, which is substantially less than the interest rates paid on our previous bank debt.

 

Write-off of Deferred Financing Costs. As a result of the repayment and termination of the 2002 Credit Facility, we wrote-off unamortized deferred financing costs attributable to the 2002 Credit Facility of $6.6 million (pretax impact) during the second quarter of 2004, which had the effect of reducing our diluted earnings per share by $0.08 for both the three and six months ended June 30, 2004.

 

Other, net. Other income and expense, net for the: (i) three months ended June 30, 2005 was $0.9 million of income as compared to expense of $(0.5) million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 was $0.6 million of income as compared to expense of $(1.1) million for the six months ended June 30, 2004. These amounts consist primarily of foreign currency transaction gains and losses. The change between periods relates primarily to the change in the foreign currency exchange rates of the U.S. dollar against the Euro and the British pound.

 

Income Tax Provision. Our estimated annual income tax rate was relatively consistent between periods. For the three and six months ended June 30, 2005, our estimated annual effective income tax rate was 39%, compared to 38% for the three and six months ended June 30, 2004.

 

Our 39% effective income tax rate for 2005 represents our estimated annual effective income tax rate for 2005, which is based upon various assumptions, with the two primary assumptions related to our estimate of total pretax income, and the amounts and sources of foreign pretax income. The actual effective income tax rate for 2005 could deviate from this estimate based on our actual experiences with these items, as well as others.

 

As of June 30, 2005, our net deferred income tax assets of $40.8 million were related primarily to our domestic operations, and represented approximately 6% of total assets. We continue to believe that sufficient taxable income will be generated to realize the benefit of these net deferred income tax assets. Our assumptions of future profitable domestic operations are supported by the historically strong operating performance of the Broadband Division and our expectations of future profitability.

 

Results of Operations - Operating Segments

 

We serve our clients through our two operating segments: the Broadband Division and the GSS Division. We exclude restructuring charges in the determination of our GAAP segment results. As discussed above, during the first quarter of 2005, we reorganized certain components of our operating segments. Operating segment information reflecting the reorganization and corporate overhead costs for the three and six months ended June 30, 2005 and 2004, are presented in Note 6 to the Financial Statements.

 

Broadband Division

 

Total Revenues. Total Broadband Division revenues for the: (i) three months ended June 30, 2005 increased 9.9% to $101.8 million, from $92.7 million for the three months ended June 30, 2004, with the increase primarily due to an increase in processing revenues as discussed in more detail below; and (ii) six months ended June 30, 2005 increased 8.5% to $200.5 million, from $184.7 million for the six months ended June 30, 2004, with the increase primarily due to an increase in processing and software revenues as discussed in more detail below.

 

Processing revenues. Processing revenues for the: (i) three months ended June 30, 2005 increased 9.7% to $88.7 million, from $80.9 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 increased 6.2% to $172.1 million, from $162.0 million for the six months ended June 30, 2004. The increases in

 

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processing revenues are due primarily to: (i) an increase in the number of customer accounts processed on our systems; (ii) increased usage of ancillary product services; and as discussed above (iii) one-time, non-recurring revenues of $2.3 million related to the Contract Settlements included in the second quarter of 2005 processing revenues. Additional information related to processing revenues is as follows:

 

    Amortization of the client contracts intangible asset (reflected as a reduction of processing revenues) for the: (i) three months ended June 30, 2005 and 2004 was $3.2 million and $3.0 million, respectively; and (ii) six months ended June 30, 2005 and 2004 was $6.3 million and $5.1 million, respectively, with this increase due primarily to the acceleration of amortization related to the new Comcast Contract effective in March 2004. The Comcast Contract amortization will continue to be approximately $3 million per quarter through the end of the Comcast Contract term of December 31, 2008.

 

    Total domestic customer accounts processed on our system as of June 30, 2005 were 44.4 million compared to 43.7 million as of June 30, 2004, a 1.7% increase. Total domestic customer accounts processed on our system as of March 31, 2005 were 43.9 million, a 1.1% increase.

 

    The ARPU for the second quarter of 2005 was $8.02, compared to $7.42 for the second quarter of 2004, and $7.63 for the first quarter of 2005, with the second quarter of 2005 increases over both periods attributed primarily to: (i) the $2.3 million one-time, non-recurring processing revenues related to the Contract Settlements, which contributed $0.21 to the second quarter of 2005 ARPU; and (ii) higher revenues related to our clients’ discretionary and variable use of ancillary services. We expect our ARPU to range from $7.70 to $7.85 for the third quarter of 2005, and our total processing revenues to range between $86 million and $87 million in the third quarter of 2005.

 

Software Revenues. Software revenues for the: (i) three months ended June 30, 2005 increased to $3.0 million, compared to $1.2 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 increased to $7.6 million, compared to $2.2 million for the six months ended June 30, 2004. The increases in software revenues between periods are due primarily to licenses of our workforce automation and call center solutions. For the remainder of 2005, we expect a decrease in the Broadband Division’s software revenues when compared to the amounts recognized in the first half of the 2005.

 

Segment Operating Expenses and Contribution Margin. The Broadband Division operating expenses for the: (i) three months ended June 30, 2005 increased 13.3% to $64.7 million, from $57.1 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 increased 13.6% to $129.7 million, from $114.2 million for the six months ended June 30, 2004. The increases in the Broadband Division operating expenses between periods are due primarily to an increase in: (i) labor-related costs, primarily as a result of merit wage increases and the increase in staff levels to support the growth opportunities of our Voice over IP products and services and migration of clients to ACP; (ii) data processing costs, primarily due to growth in the number of customers processed on our system and greater processing requirements for ACP functionality; and (iii) an increase in bad debt expense due to the $2.2 million reduction of bad debt expense recorded in the second quarter of 2004 related to the sale of the Adelphia pre-bankruptcy accounts receivable, as discussed above.

 

The Broadband Division contribution margin for the: (i) three months ended June 30, 2005 was $37.2 million (contribution margin percentage of 36.5%), compared to $35.6 million (contribution margin percentage of 38.4%) for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 was $70.8 million (contribution margin percentage of 35.3%), compared to $70.5 million (contribution margin percentage of 38.2%) for the six months ended June 30, 2004. The decreases in the contribution margin percentages between periods relate primarily to the increase in segment operating expenses, as mentioned above, without a commensurate increase in revenues related to such expenses. This is the result of the investment we are making in our Voice over IP products and services, as well as our efforts to migrate our clients to the ACP platform. That is, we do not initially receive any additional revenue from our clients as we migrate them to the ACP platform. In addition, at this time, the incremental revenues from Voice over IP products and services are not significant.

 

Total non-cash charges related to depreciation, amortization, and stock-based compensation expense included in the determination of the Broadband Division’s contribution margin for the: (i) three months ended June 30, 2005

 

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and 2004 were $7.6 million and $7.2 million, respectively; and (ii) six months ended June 30, 2005 and 2004 were $14.9 million and $13.4 million, respectively, with this increase due primarily to the acceleration of amortization related to the Comcast Contract intangible asset, as discussed above.

 

GSS Division

 

Total Revenues. Total GSS Division revenues for the: (i) three months ended June 30, 2005 increased 7.9% to $39.9 million, from $37.0 million for the three month ended June 30, 2004; and (ii) six months ended June 30, 2005 increased 3.8% to $78.2 million, from $75.3 million for the six months ended June 30, 2004. The increases in revenues between periods are due primarily to an increase in maintenance and professional services revenues.

 

Software Revenues. Software revenues for the: (i) three months ended June 30, 2005 decreased 2.5% to $6.7 million, from $6.9 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 decreased 2.5% to $13.3 million, from $13.6 million for the six months ended June 30, 2004. The decreases in software revenues between periods were due primarily to the timing of executed software contracts and related revenue recognition between periods, and general market conditions. As discussed above, fluctuations in software revenues between periods is an inherent characteristic of software companies and is expected to continue in future periods.

 

Maintenance Revenues. Maintenance revenues for the: (i) three months ended June 30, 2005 increased 8.3% to $18.6 million, from $17.1 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 increased 4.0% to $36.7 million, from $35.3 million for the six months ended June 30, 2004. The increases in maintenance revenues were due primarily to an increase in the installed software license base between periods as a result of new sales.

 

Professional Services Revenues. Professional services revenues for the: (i) three months ended June 30, 2005 increased 12.8% to $14.6 million, from $12.9 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 increased 6.7% to $28.2 million, from $26.5 million for the six months ended June 30, 2004. The increases in professional services revenues between periods were due primarily to the timing of work performed and the number of professional services projects in progress during the respective periods.

 

Segment Operating Expenses and Contribution Margin. The GSS Division operating expenses for the: (i) three months ended June 30, 2005 increased 7.3% to $36.6 million, from $34.1 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 increased 5.8% to $72.5 million, from $68.6 million for the six months ended June 30, 2004. The increases in the GSS Division’s operating expenses between periods are due primarily to an increase in labor-related costs, primarily as a result of merit wage increases and an increase in staff levels added in the GSS Division’s foreign operations to address various revenue opportunities, primarily within the APAC region.

 

The GSS Division’s contribution margin for the: (i) three months ended June 30, 2005 was $3.3 million (contribution margin percentage of 8.2%) as compared to a contribution margin for the three months ended June 30, 2004 of $2.9 million (contribution margin percentage of 7.7%), with the increase due primarily to an increase in revenues between periods; and (ii) six months ended June 30, 2005 was $5.6 million (contribution margin percentage of 7.2%) as compared to a contribution margin for the six months ended June 30, 2004 of $6.8 million (contribution margin percentage of 9.0%), with the decrease due primarily to an increase in operating expenses between periods.

 

Total non-cash charges related to depreciation, amortization, and stock-based compensation expense included in the determination of the GSS Division’s contribution margin for the: (i) three months ended June 30, 2005 and 2004 were $4.2 million and $4.1 million, respectively; and (ii) six months ended June 30, 2005 and 2004 were $8.4 million and $8.2 million, respectively.

 

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Corporate

 

Corporate Operating Expenses. Corporate overhead expenses for the: (i) three months ended June 30, 2005 increased 26.1% to $20.6 million, from $16.4 million for the three months ended June 30, 2004; and (ii) six months ended June 30, 2005 increased 28.2% to $40.6 million, from $31.7 million for the six months ended June 30, 2004. The increases in Corporate operating expenses between periods relate primarily to the accrual of retirement benefits of $4.3 million and $8.5 million for the three and six months ended June 30, 2005, respectively, for our former CEO, Mr. Hansen, who retired on June 30, 2005, as discussed above.

 

Total non-cash charges related to depreciation, amortization, and stock-based compensation expense included in Corporate operating expenses for the: (i) three months ended June 30, 2005 and 2004 were $3.2 million and $2.8 million, respectively; and (ii) six months ended June 30, 2005 and 2004 were $6.6 million and $5.9 million, respectively.

 

Liquidity

 

Cash and Liquidity

 

As of June 30, 2005, our principal sources of liquidity included cash, cash equivalents, and short-term investments of $164.9 million, compared to $157.5 million as of December 31, 2004. We generally invest our excess cash balances in low-risk, short-term investments to limit our exposure to market risks.

 

In addition to the above sources of liquidity, we also have a five-year, $100 million senior secured revolving credit facility (the “2004 Revolving Credit Facility”) with a syndicate of U.S. financial institutions that expires in September 2009. The 2004 Revolving Credit Facility has a $40 million sub-facility for standby and commercial letters of credit and a $10 million sub-facility for same day advances. As of the date of this filing, there were no borrowings outstanding under the 2004 Revolving Credit Facility. Our ability to borrow under the 2004 Revolving Credit Facility is subject to a limitation of total indebtedness based upon the results of consolidated leverage and interest coverage ratio calculations, and a minimum liquidity requirement. As of June 30, 2005, we were in compliance with the financial ratios and other covenants of the 2004 Revolving Credit Facility, and had approximately $100 million of the 2004 Revolving Credit Facility available to us.

 

Our cash, cash equivalents, and short-term investment balances as of the end of the indicated periods were located in the following geographical regions (in thousands):

 

    

June 30,

2005


   March 31,
2005


   December 31,
2004


North America (principally the U.S.)

   $ 111,884    $ 93,613    $ 95,390

Europe, Middle East and Africa (principally Europe)

     43,802      42,892      51,977

Asia Pacific

     2,360      4,525      3,444

Central and South America

     6,831      5,781      6,667
    

  

  

Total cash, equivalents and short-term investments

   $ 164,877    $ 146,811    $ 157,478
    

  

  

 

We generally have ready access to substantially all of our cash and short-term investment balances, but do face limitations on moving cash out of certain foreign jurisdictions. As of June 30, 2005, the cash and short-term investments subject to such limitations were not significant.

 

Cash Flows From Operating Activities

 

We calculate our cash flows from operating activities in accordance with accounting principles generally accepted in the U.S., beginning with net income, adding back the impact of non-cash items (e.g., depreciation, amortization, stock-based compensation, etc.), and then factoring in the impact of changes in working capital items. See our 2004 10-K for a description of the primary uses and sources of our cash flows from operating activities.

 

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Our net cash flows from operating activities for the quarters ended for the indicated periods are as follows (in thousands):

 

     Quarter
Totals


   Year-to-
Date Totals


2004:

             

March 31 (1)

   $ 31,965    $ 31,965

June 30 (2)

     40,186      72,151

September 30

     24,805      96,956

December 31

     22,312      119,268

2005:

             

March 31 (3)

     18,865      18,865

June 30 (3)

     43,283      62,148

 

(1) Cash flows from operating activities for the first quarter of 2004 reflect approximately $10 million of favorable changes in working capital related to the Comcast arbitration.

 

(2) Approximately $14 million of the cash flows from operating activities for the second quarter of 2004 can be attributed to the sale of certain Adelphia pre-bankruptcy accounts receivable to a third party and to higher than normal cash collections of accounts receivable within the GSS Division.

 

(3) Cash flows from operating activities for the first quarter of 2005 were negatively impacted by approximately $9 million due to a domestic client delaying payment of an invoice until after quarter-end. This amount was subsequently paid in April 2005, which resulted in the payment of four monthly invoices by this client in the second quarter of 2005. The payment of the delayed invoice, along with payments related to the Contract Settlements mentioned above, contributed approximately $12 million to our cash flows from operating activities for the second quarter of 2005.

 

We believe this table illustrates our ability to consistently generate strong quarterly and annual cash flows, and the importance of managing our working capital items, in particular, timely collections of our accounts receivable. Absent any unusual fluctuations in working capital items, we expect our third quarter of 2005 cash flows from operating activities to range from $27 million to $31 million.

 

The key balance sheet items impacting our cash flows from operating activities are as follows.

 

Billed Accounts Receivable. Our billed accounts receivable balance by geographic region (based on the location of the client) as of the end of the indicated periods are as follows (in thousands):

 

    

June 30,

2005


    March 31,
2005


    December 31,
2004


 

North America (principally the U.S.)

   $ 100,129     $ 102,641     $ 103,884  

Europe, Middle East and Africa (principally Europe)

     20,217       26,460       21,540  

Asia Pacific

     11,598       11,578       13,540  

Central and South America

     5,582       7,348       7,910  
    


 


 


Total billed accounts receivable

     137,526       148,027       146,874  

Less allowance for doubtful accounts

     (3,576 )     (4,690 )     (4,818 )
    


 


 


Total billed accounts receivable, net of allowance

   $ 133,950     $ 143,337     $ 142,056  
    


 


 


 

Management of our billed accounts receivable is one of the primary factors in maintaining strong quarterly cash flows from operating activities. Our billed trade accounts receivable balance includes billings for several non-revenue items (primarily postage, sales tax, and deferred revenue items). As a result, we evaluate our performance in collecting our accounts receivable through our calculation of days billings outstanding

 

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(“DBO”) rather than a typical days sales outstanding (“DSO”) calculation. DBO is calculated based on the billings for the period (including non-revenue items) divided by the average monthly net trade accounts receivable balance for the period. Our target range for our DBO is 65-75 days.

 

Our gross and net billed trade accounts receivable and related allowance for doubtful accounts receivable (“Allowance”), as of the end of the indicated periods, and our DBOs for the quarters then ended, are as follows (in thousands, except DBOs):

 

Quarter Ended


   Gross

   Allowance

    Net
Billed


   DBO

2004:

                          

March 31

   $ 149,028    $ (11,397 )   $ 137,631    66

June 30 (1) (2)

     130,662      (6,942 )     123,720    66

September 30

     128,782      (5,438 )     123,344    65

December 31 (3)

     146,874      (4,818 )     142,056    61

2005:

                          

March 31

     148,027      (4,690 )     143,337    68

June 30 (4)(5)

     137,526      (3,576 )     133,950    69

 

  (1) The decrease in both the gross and net billed accounts receivable between March 31, 2004 and June 30, 2004 relates primarily to the sale of the Adelphia pre-bankruptcy accounts receivable to a third party, and the success we experienced collecting accounts receivable within the GSS Division during the second quarter of 2004.

 

  (2) The $4.5 million decrease in the Allowance between March 31, 2004 and June 30, 2004 relates primarily to the sale of the aforementioned Adelphia pre-bankruptcy accounts receivable.

 

  (3) The increase in both the gross and net billed accounts receivable between September 30, 2004 and December 31, 2004 was primarily the result of the timing of new invoices and cash collections.

 

  (4) Approximately $9 million of the decrease in the gross and net billed accounts receivable between March 31, 2005 and June 30, 2005 relates to the impact of a domestic client making payment on an invoice during the second quarter of 2005 which had been delayed in the first quarter of 2005, as discussed above.

 

  (5) The $1.1 million decrease in the Allowance between March 31, 2005 and June 30, 2005 relates primarily to the settlement of our outstanding bankruptcy claims with MCI during the second quarter of 2005, as discussed above.

 

Unbilled Accounts Receivable and Other Receivables. Revenue earned and recognized prior to the scheduled billing date of an item is reflected as unbilled accounts receivable. Unbilled accounts receivable are an inherent characteristic of certain software and professional services transactions and may fluctuate between quarters, as these types of transactions typically have scheduled invoicing terms over several quarters, as well as certain milestone billing events, which may differ from the timing of revenue recognition. Our unbilled accounts receivable and other receivables as of the end of the indicated periods are as follows (in thousands):

 

2004:

      

March 31

   $ 14,409

June 30

     13,756

September 30

     15,051

December 31

     14,030

2005:

      

March 31

     13,847

June 30

     14,195

 

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The June 30, 2005 unbilled accounts receivable balance consists primarily of several projects with various milestone and contractual billing dates which have not yet been reached. A substantial percentage of the June 30, 2005 unbilled accounts receivable is scheduled to be billed and collected by the end of the fourth quarter of 2005. However, there can be no assurances that the fees will be billed and collected within the expected time frames.

 

Income Taxes Receivable. We were in a domestic net operating loss (“NOL”) position for 2003 as a result of the $119.6 million Comcast arbitration charge recorded in the third quarter of 2003. Our income tax receivable as of December 31, 2003 was $35.1 million, which resulted from our ability to claim a refund for 2003 income taxes already paid, and from our ability to carry back our NOL to prior years. During the first quarter of 2004, we received approximately $34 million of this income tax receivable, and identified additional income tax receivable amounts during our final preparation of our 2003 U.S. Federal income tax return, which was filed in March 2004. As of December 31, 2004, our income tax receivable was $4.1 million, which was substantially collected as of June 30, 2005.

 

Deferred Revenue. Client payments and billed amounts due from clients in excess of revenue recognized are recorded as deferred revenue. Deferred revenue balances broken out by source of revenue as of the end of the indicated periods are as follows (in thousands):

 

     June 30,
2005


   March 31,
2005


   December 31,
2004


   September 30,
2004


  

June 30,

2004


   March 31,
2004


Processing

   $ 12,610    $ 9,477    $ 8,331    $ 7,384    $ 7,274    $ 7,010

Software

     3,877      3,521      5,215      4,435      6,784      8,518

Maintenance

     35,948      38,334      37,419      31,749      38,336      36,093

Professional services

     6,614      6,832      9,129      7,899      9,857      9,645
    

  

  

  

  

  

Total

   $ 59,049    $ 58,164    $ 60,094    $ 51,467    $ 62,251    $ 61,266
    

  

  

  

  

  

 

The changes in deferred revenues between periods generally relates to the timing of invoices for such products and services, and the related revenue recognition for such items. The increase in deferred processing revenues since December 31, 2004 relates primarily to the receipt of upfront fees for certain conversion/set-up services which are required to be recognized as revenue over the life of the related long-term processing arrangement. The majority of our maintenance agreements provide for invoicing of annual maintenance fees in the first and fourth quarters of the year.

 

Arbitration Charge Payable. The decrease in the arbitration charge payable reflected in the unaudited Condensed Consolidated Statements of Cash Flows relates to the $119.6 million Comcast arbitration award. We paid approximately $95 million of this amount in the fourth quarter of 2003. During the first quarter of 2004, we paid the remaining approximately $25 million.

 

Accounts Payable and Accrued Liabilities. The cash flow impact from changes in accounts payable and accrued liabilities changed from a cash use of $9.1 million for the six months ended June 30, 2004 to a cash source of $2.9 million for the six months ended June 30, 2005, primarily as a result of the $8.5 million of accrued retirement benefits related to Mr. Hansen’s retirement benefits that were recorded during the first six months of 2005. Of the $9.6 million total retirement benefits to be paid to Mr. Hansen, $5.6 million will be paid on January 2, 2006, $2.0 million will be paid on July 1, 2006, and $2.0 million will be paid on January 2, 2007.

 

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Cash Flows From Investing Activities

 

Our investing activities typically consist of purchases/sales of short-term investments, purchases of property and equipment, investments in client contracts intangible assets and business acquisitions.

 

Purchases/Sales of Short-term Investments. We generally invest our excess cash balances in low-risk, short-term investments to limit our exposure to market risks. These short-term investments are readily convertible back into cash. During the six months ended June 30, 2005, we purchased $31.5 million and sold $21.5 million of short-term investments. We continually evaluate the possible uses of our excess cash balances and will likely purchase additional short-term investments in the future.

 

Property and Equipment/Client Contracts. Our capital expenditures for the six months ended June 30, 2005 and 2004 for property and equipment, and investments in client contracts were as follows (in thousands):

 

     Six Months Ended June 30,

     2005

   2004

Property and equipment

   $ 6,458    $ 2,785

Client contracts

     3,964      1,185

 

The property and equipment expenditures during the first six months of 2005 consisted principally of computer hardware and related equipment, and leasehold improvements. The investments in client contracts for the six months ended June 30, 2005 relates primarily to costs incurred for conversion/set-up services related to long-term processing arrangements. As of June 30, 2005, we did not have any material commitments for capital expenditures or for investments in client contracts intangible assets.

 

Cash Flows From Financing Activities

 

Our financing activities typically consist of various debt-related transactions, and activities with our common stock.

 

Long-Term Debt. During the first quarter of 2004, we made a mandatory $30 million prepayment on our 2002 Credit Facility which was due no later than July 2004. This payment was made with the proceeds from our $34 million of income tax refunds received in March 2004.

 

In June 2004, we completed our offering of the Convertible Debt Securities. We used a portion of the $230 million of proceeds from the Convertible Debt Securities to repay the outstanding balance of $198.9 million and terminate our 2002 Credit Facility. In connection with the issuance of the Convertible Debt Securities, we incurred debt issuance costs of approximately $7 million.

 

Repurchase of Common Stock. As of June 30, 2005, a summary of the shares repurchased under our Stock Repurchase Program is as follows (in thousands, except per share amounts):

 

     2005

   2004

   2003

   2002

   1999-2001

   Total

Shares repurchased

     2,366      2,983    —        1,573      4,766      11,688

Total amount paid

   $ 42,970    $ 52,897    —      $ 18,920    $ 180,790    $ 295,577

Weighted-average price per share

   $ 18.16    $ 17.73    —      $ 12.02    $ 37.94    $ 25.29

 

At June 30, 2005, the total remaining number of shares available for repurchase under the Stock Repurchase Program totaled 3.3 million shares.

 

As mentioned above, subsequent to June 30, 2005 through August 3, 2005, we have repurchased approximately 405,000 shares under our Stock Repurchase Program at a total purchase price of $7.2 million (a weighted-average price of $17.89 per share).

 

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In addition to the above mentioned stock repurchases and outside of our Stock Repurchase Program, during the six months ended June 30, 2005 and 2004, we repurchased from certain of our employees and then cancelled approximately 163,000 shares and 28,000 shares of our common stock for $3.1 million and $0.4 million, respectively, in connection with minimum tax withholding requirements resulting from the vesting of restricted stock under our stock incentive plans.

 

Capital Resources

 

As discussed in greater detail above, we continue to make investments in client contracts, capital equipment, facilities, and research and development, and within certain parameters, will continue to make stock repurchases under our Stock Repurchase Program. In addition, as part of our growth strategy, we are continually evaluating potential business and asset acquisitions. As of June 30, 2005, we had no significant capital commitments. See Note 3 to our Financial Statements for additional discussion of our Stock Repurchase Program and the Rule 10b5-1 Plan we established in April 2005 and the financial commitments we have made under the Rule 10b5-1 Plan going forward.

 

We are required to pay our former CEO, Mr. Hansen, $9.6 million of retirement benefits, of which $5.6 million is scheduled to be paid on January 2, 2006, $2.0 million on July 1, 2006, and $2.0 million on January 2, 2007.

 

Our Convertible Debt Securities currently bear interest at a rate of 2.5% per annum, payable semiannually in arrears, on June 15 and December 15 of each year. Refer to MD&A and Note 7 to our audited consolidated financial statements in our 2004 10-K for more information regarding the call, put and conversion features of the Convertible Debt Securities. We do not expect the Convertible Debt Securities to be settled or converted during the next 12 months. As a result, in the near-term, we expect our annual debt service costs related to the Convertible Debt Securities to be limited to the annual interest payments totaling $5.8 million.

 

As of June 30, 2005, we had made no borrowings under our $100 million 2004 Revolving Credit Facility. Refer to Note 7 to our audited consolidated financial statements in our 2004 10-K for more information regarding the interest rates for borrowings under the 2004 Revolving Credit Facility. We pay a quarterly commitment fee on the unused portion of the 2004 Revolving Credit Facility. This rate is dependent on our leverage ratio and ranges from 25 to 50 basis points per annum. As of June 30, 2005, the commitment fee rate was 37.5 basis points per annum. As of June 30, 2005, approximately $100 million of the 2004 Revolving Credit Facility was available to us.

 

As of June 30, 2005, we had approximately $165 million of cash and short-term investments available to fund our operations. We believe that our current cash and short-term investments balance, together with cash expected to be generated from future operating activities and the amount available under the 2004 Revolving Credit Facility, will be sufficient to meet our anticipated cash requirements for at least the next 12 months.

 

Ratio of Earnings to Fixed Charges

 

The ratio of earnings to fixed charges is computed by dividing fixed charges into earnings. “Earnings” is defined as income from continuing operations before income taxes, plus fixed charges. “Fixed charges” consist of interest expense (including the amortization of deferred financing costs) and the estimated interest component of rental expense. Our consolidated ratio of earnings to fixed charges for the six months ended June 30, 2005, was 4.79:1.00. See Exhibit 12.10 to this document for information regarding the calculation of our ratio of earnings to fixed charges.

 

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Table of Contents
Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

As discussed in our 2004 10-K, we have historically been exposed to various market risks, including changes in interest rates and foreign currency exchange rates. Market risk is the potential loss arising from adverse changes in market rates and prices. We do not enter into derivatives or other financial instruments for trading or speculative purposes.

 

Interest Rate Risk

 

Market Risk Related to Long-term Debt. The interest rate on the Convertible Debt Securities is fixed, and thus, as it relates to our borrowings under the Convertible Debt Securities, we are not exposed to changes in interest rates. Commencing with the six-month period beginning June 15, 2011, we will pay contingent interest equal to 0.25% of the average trading price of the Convertible Debt Securities if the average trading price equals 120% or more of the principal amount of the Convertible Debt Securities.

 

We have a five-year, $100 million senior secured revolving credit facility (the “2004 Revolving Credit Facility”) with a syndicate of U.S. financial institutions that expires in September 2009. The interest rate for borrowings under the 2004 Revolving Credit Facility, except for same day advances, is chosen at our option, and is based upon a base rate or adjusted LIBOR rate, plus an applicable margin. The base rate represents the higher of a floating prime rate and a floating rate equal to 50 basis points in excess of the Federal Funds Effective Rate. The interest rate for same day advances is based upon base rate, plus an applicable margin. The applicable margins are dependent on our leverage ratio, as defined, and range from zero to 100 basis points for base rate loans and 125 to 225 basis points for LIBOR loans. As of June 30, 2005, we had made no borrowings under the 2004 Revolving Credit Facility.

 

Market Risk Related to Cash Equivalents and Short-term Investments. Our cash and cash equivalents as of June 30, 2005 were $130.8 million. Our cash balances are typically “swept” into overnight money market accounts on a daily basis, and at times, any excess funds are invested in low-risk, somewhat longer term, cash equivalent instruments and short-term investments. We have minimal market risk for our cash and cash equivalents due to the relatively short maturities of the instruments.

 

Our short-term investments as of June 30, 2005 were $34.1 million. Currently, we utilize short-term investments as a means to invest our excess cash only in the U.S. The day-to-day management of our cash equivalents and short-term investments in the U.S. is done by the money management branch of one of the largest financial institutions in the U.S. This financial institution manages our cash equivalents and short-term investments based upon strict and formal investment guidelines established by us. Under these guidelines, short-term investments are limited to highly liquid, short-term government and corporate securities that have a credit rating of A-1 / P-1 or better.

 

We do not utilize any derivative financial instruments for purposes of managing our market risks related to interest rate risk.

 

Foreign Exchange Rate Risk.

 

Our approximate percentage of total revenues generated outside the U.S. for the years ended December 31, 2004 and 2003 was 26% and 32%, respectively. Our approximate percentage of total revenues generated outside the U.S. for the six months ended June 30, 2005 and 2004 were 23% and 26%, respectively.

 

Because of the global markets we service, we are exposed to the impact of the changes in foreign currency exchange rates. For the year ended December 31, 2004, approximately 61% and 23%, respectively, of our GSS Division revenues were denominated in U.S. dollars and Euros. For the six months ended June 30, 2005, approximately 60% and 22%, respectively, of our GSS Division revenues were denominated in U.S. dollars and Euros. Since a significant amount of our revenues are contracted for in U.S. dollars, a decline in the value of local foreign currencies against the U.S. dollar will result in our products and services being more expensive to a potential foreign buyer, and in those instances where our goods and services have already been sold, could result in

 

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the accounts receivable being more difficult to collect. We do at times enter into revenue contracts that are denominated in the currency of the individual country (e.g., United Kingdom, Brazil, and Japan) or the European Union (“EU”) where we have substantive operations. This practice serves as a natural hedge to finance the expenses incurred in those locations.

 

We continue to evaluate whether we should enter into derivative financial instruments for the purposes of managing our foreign currency exchange rate risk, but as of the date of this filing, we have not entered into such instruments. A hypothetical adverse change of 10% in the June 30, 2005 exchange rates would not have a material impact upon our results of operations.

 

Item 4. Controls and Procedures

 

(a) Disclosure Controls and Procedures

 

As required by Rule 13a-15(b), our management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), conducted an evaluation as of the end of the period covered by this report of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e). Based on that evaluation, the CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

 

(b) Internal Control Over Financial Reporting

 

As required by Rule 13a-15(d), our management, including the CEO and CFO, also conducted an evaluation of our internal control over financial reporting, as defined by Rule 13a-15(f), to determine whether any changes occurred during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, the CEO and CFO concluded that there has been no such change during the quarter covered by this report.

 

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Table of Contents

 

CSG SYSTEMS INTERNATIONAL, INC.

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

From time-to-time, we are involved in litigation relating to claims arising out of our operations in the normal course of business. In the opinion of our management, we are not presently a party to any material pending or threatened legal proceedings.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

The following table presents information with respect to purchases of company common stock we made during the three months ended June 30, 2005 by CSG Systems International, Inc. or any “affiliated purchaser” of CSG Systems International, Inc., as defined in Rule 10b-18(a)(3) under the Exchange Act.

 

Period


   Total
Number of
Shares
Purchased2


   Average
Price Paid
Per Share


   Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs


   Maximum
Number (or
Approximate
Dollar Value) of
Shares that May
Yet Be Purchased
Under the Plan
or Programs1


April 1 – April 30

   751    $ 16.05    —      4,393,408

May 1 – May 31

   767,415      18.24    767,415    3,625,993

June 1 – June 30

   431,218      19.07    314,081    3,311,912
    
  

  
    

Total

   1,199,384    $ 18.54    1,081,496     
    
  

  
    

 

1 In August 1999, our Board of Directors approved a stock repurchase program which authorized us to purchase up to a total of five million shares of our common stock from time-to-time as business conditions warrant. In September 2001, our Board of Directors amended the program to authorize us to purchase an additional five million shares, for a total of ten million shares. Effective June 2, 2004, our Board of Directors amended the program to authorize us to purchase an additional five million shares, for a total of 15 million shares. The stock repurchase program does not have an expiration date.

 

2 The total number of shares purchased that are not part of the stock repurchase program represents shares purchased and cancelled in connection with minimum tax withholdings for employees as the result of the vesting of restricted stock under our stock-based compensation plans.

 

Item 3. None

 

Item 4. Submission of Matters to Vote of Security Holders

 

  (a) The 2005 annual meeting of stockholders of CSG Systems International, Inc. (the “Annual Meeting”) was held on May 27, 2005.

 

  (b) The following persons were elected as directors at the Annual Meeting:

 

Class II (expiring in 2008)

Bernard W. Reznicek

Donald V. Smith

 

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The following directors’ term of office continued after the Annual Meeting:

 

George F. Haddix (1)

Neal C. Hansen (1)

Edward C. Nafus

Janice I. Obuchowski

Frank V. Sica

 

  (c) Votes were cast or withheld at the Annual Meeting as follows:

 

  (i) Election of directors:

 

Director


   For

   Withheld

Bernard W. Reznicek

   41,535,358    5,583,980

Donald V. Smith

   43,068,442    4,050896

 

  (ii) Approval of the Company’s 2005 Stock Incentive Plan:

 

For


  

Against


  

Abstain


  

No Vote


29,745,816

   9,303,709    47,963    8,021,850

(1) Subsequent to the Annual Stockholders Meeting, George F. Haddix and Neal C. Hansen resigned from the Company’s Board of Directors and Don Reed and James A. Unruh were added to the Board.

 

Item 5. Other Information

 

Entry into a Material Definitive Agreement (as required by Section 1.01 of Form 8-K). CSG Systems International, Inc. (the “Company”) outsources to First Data Corporation (“FDC”) the data processing and related computer services required for the operation of its Broadband Services Division’s processing services and certain related products. On June 28, 2005, the Company amended its contract with FDC to: (i) extend the term of the contract through June 2010 (the contract was previously scheduled to expire in June 2008); and (ii) modify certain pricing terms of the contract. A copy of the amended contract is included as Exhibit 10.40A of this Form 10-Q.

 

Item 6. Exhibits

 

The Exhibits filed or incorporated by reference herewith are as specified in the Exhibit Index.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated: August 5, 2005

 

CSG SYSTEMS INTERNATIONAL, INC.

/s/ Edward C. Nafus

Edward C. Nafus

Chief Executive Officer and President

(Principal Executive Officer)

/s/ Peter E. Kalan

Peter E. Kalan

Executive Vice President and Chief Financial Officer

(Principal Financial Officer)

/s/ Randy R. Wiese

Randy R. Wiese

Senior Vice President and Chief Accounting Officer

(Principal Accounting Officer)

 

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CSG SYSTEMS INTERNATIONAL, INC.

 

INDEX TO EXHIBITS

 

Exhibit
Number


 

Description


  3.02(1)   Revised By-Laws of CSG Systems International, Inc.
10.04(2)   CSG Systems International, Inc. 2005 Stock Incentive Plan
10.14G(3)   Seventh Amendment to Employment Agreement with Neal C. Hansen, dated June 7, 2005
10.20D*   Fifth Amendment to the CSG Master Subscriber Management System Agreement between CSG Systems, Inc. and Comcast Cable Communications Management, LLC
10.40A*   First Amendment to Third Amended and Restated Services Agreement between First Data Technologies, Inc. and CSG Systems, Inc. dated June 28, 2005
10.70(4)   Employment Agreement with Robert M. Scott, dated June 6, 2005
10.71(5)   Employment Agreement with Alan Michels, dated June 1, 2005
10.72   Restricted Stock Award Agreement with Edward C. Nafus, dated June 30, 2005
10.73   Restricted Stock Award Agreement with John Bonde, dated June 30, 2005
10.80A   Forms of Agreement for Equity Compensation
12.10   Statement regarding computation of Ratio of Earnings to Fixed Charges
31.01   Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.02   Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.01   Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.01   Safe Harbor for Forward-Looking Statements Under the Private Securities Litigation Reform Act of 1995 – Certain Cautionary Statements and Risk Factors

(1) Incorporated by reference to the exhibit of the same number to the Registrant’s Current Report on Form 8-K for the event dated May 26, 2005.

 

(2) Incorporated by reference to the exhibit of the same number to the Registrant’s Current Report on Form 8-K for the event dated May 27, 2005.

 

(3) Incorporated by reference to the exhibit of the same number to the Registrant’s Current Report on Form 8-K for the event dated June 7, 2005.

 

(4) Incorporated by reference to the exhibit of the same number to the Registrant’s Current Report on Form 8-K/A (Amendment No. 2) for the event dated March 6, 2005.

 

(5) Incorporated by reference to the exhibit of the same number to the Registrant’s Current Report on Form 8-K/A (Amendment No. 1) for the event dated December 9, 2004.

 

* Portions of the exhibit have been omitted pursuant to an application for confidential treatment, and the omitted portions have been filed separately with the commission.

 

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