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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
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
(State or other jurisdiction of incorporation or organization)
47-0783182
(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)
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.01 Per Share
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 a check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to the Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, computed by reference to the last sales price of such stock, as of
the close of trading on January 31, 1999 was $1,706,906,316.
Shares of common stock outstanding at March 15, 1999: 51,613,111.
DOCUMENTS INCORPORATED BY REFERENCE
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Portions of the Registrant's Proxy Statement for its Annual Meeting of
Stockholders to be filed on or prior to April 30, 1999, are incorporated by
reference into Part III of the Form 10-K.
1
CSG SYSTEMS INTERNATIONAL, INC.
1998 FORM 10-K
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business..................................................... 3
Item 2. Properties................................................... 9
Item 3. Legal Proceedings............................................ 9
Item 4. Submission of Matters to a Vote of Security Holders.......... 9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters...................................................... 10
Item 6. Selected Financial Data...................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 13
Item 8. Financial Statements and Supplementary Data.................. 27
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure..................................... 48
PART III
Item 10. Directors and Executive Officers of the Registrant........... 49
Item 11. Executive Compensation....................................... 49
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................... 49
Item 13. Certain Relationships and Related Transactions............... 49
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K.......................................................... 49
Signatures.............................................................. 50
2
ITEM 1. BUSINESS
GENERAL
CSG Systems International, Inc. (the "Company" or "CSG") was formed in
October 1994 and acquired all of the outstanding stock of CSG Systems, Inc.
(formerly Cable Services Group, Inc.) from First Data Corporation ("FDC") in
November 1994 (the "CSG Acquisition"). CSG Systems, Inc. had been a subsidiary
or division of FDC from 1982 until the acquisition.
The Company's principal executive offices are located at 7887 East
Belleview, Suite 1000, Englewood, Colorado 80111, and the telephone number at
that address is (303) 796-2850. The Company's common stock is listed on the
Nasdaq National Market under the symbol "CSGS".
COMPANY OVERVIEW
The Company provides customer care and billing solutions worldwide for the
converging communications markets, including cable television, direct
broadcast satellite ("DBS"), telephony, on-line services and others. The
Company's products and services enable its clients to focus on their core
businesses, improve customer service, and enter new markets and operate more
efficiently. The Company offers its clients a full suite of processing and
related services, and software and professional services which automate
customer care and billing functions. These functions include set-up and
activation of customer accounts, sales support, order processing, invoice
calculation, production and mailing, management reporting, and customer
analysis for target marketing. The Company's products and services combine the
reliability and high volume transaction processing capabilities of a mainframe
platform with the flexibility of client/server architecture. The Company
generated revenue of $236.6 million in 1998 compared to $171.8 million in
1997, an increase of 38%, and revenue grew at a compound annual growth rate of
35% over the three-year period ended December 31, 1998.
The Company has established a leading presence by developing strategic
relationships with major participants in the cable television and DBS
industries, and derived approximately 78% and 13% of its total revenues in
1998 from the U.S. cable television and DBS industries, respectively. The
Company provides customer care and billing to one-third of the households in
the U.S. During 1998, the Company derived approximately 81% of its total
revenues from processing and related services. At December 31, 1998, the
Company was servicing client sites having an aggregate of 29.5 million
customers in the U.S., compared to 21.1 million customers serviced as of
December 31, 1997, an increase of 39%. During 1998, the Company converted and
processed approximately 9.0 million new customers on its systems, with
approximately 7.7 million of these new customers coming from Tele-
Communications, Inc. ("TCI"). Total domestic revenue per customer account for
1998 was $8.71, compared to $7.73 for 1997, an increase of 13%, and revenue
per customer account grew at a compound annual growth rate of 16% over the
three-year period ended December 31, 1998.
The convergence of communications markets and growing competition are
increasing the complexity and cost of managing the interaction between
communications service providers and their customers. Customer care and
billing systems coordinate all aspects of the customer's interaction with a
service provider, from initial set-up and activation, to service activity
monitoring, through billing and accounts receivable management. The growing
complexity of communications services and the manner in which they are
packaged and priced, has created increased demand for customer care and
billing systems which deliver enhanced flexibility and functionality. Because
of the significant level of technological expertise and capital resources
required to develop and implement such systems successfully, the majority of
cable television, DBS, and wireless service providers have elected to
outsource customer care and billing.
In 1998, the Company acquired substantially all of the assets of US Telecom
Advanced Technology Systems, Inc. ("USTATS") for approximately $6.0 million in
cash and assumption of certain liabilities of approximately $1.3 million.
USTATS, a South Carolina-based company, specializes in open systems,
client/server customer care and billing systems serving the telecommunications
markets. This acquisition
3
strengthened CSG's core telephony system serving cable television providers
and provided technology for use in entering new markets, including the
competitive local exchange carrier ("CLEC") and incumbent local exchange
carriers ("ILEC").
In September 1997, the Company entered into a 15-year processing agreement
with TCI (the "TCI Contract") which expires in 2012. The TCI Contract has
minimum financial commitments over the 15-year life of the contract and
includes exclusive rights to provide customer care and billing products and
services for TCI's offerings of wireline video, all Internet/high-speed data
services, residential wireline telephony services, and print and mail
services. As of December 31, 1998, the Company had successfully converted
approximately 8 million of the over 9 million TCI customers originally
scheduled to be converted under the TCI Contract. The remaining customers are
scheduled to be converted to the Company's processing system by the second
quarter of 1999. AT&T completed a merger with TCI in March 1999. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for additional discussion of the TCI Contract and the TCI and AT&T
merger.
In addition, during 1997, the Company purchased certain SUMMITrak software
technology assets that were in development from TCI. The development efforts
are on schedule and the resource requirements for completion of the
development efforts are consistent with the original expectations. The related
products from these development efforts are expected to be available for
general release in 1999. See Note 4 to the Company's Consolidated Financial
Statements for additional discussion of the SUMMITrak asset acquisition.
The Company expanded its operations internationally through the acquisition
of Bytel Limited in June 1996. During 1998, Bytel Limited changed its name to
CSG International Limited ("CSGI"). CSGI, established in 1992, is a leading
provider of customer care and billing solutions in the United Kingdom to
providers of converged cable television and telephony services. During 1998,
1997, and 1996, the Company derived 6.3%, 9.6%, and 8.1%, respectively, of its
total revenues from international sources. See Note 3 to the Company's
Consolidated Financial Statements for additional discussion of the Company's
international operations.
Growth Strategy
The Company's growth strategy is designed to provide revenue and profit
growth. The key elements of the strategy include:
Expand Core Processing Business. The Company will continue to leverage its
investment and expertise in high-volume transaction processing to expand its
processing business. The processing business provides highly predictable
recurring revenues through multi-year contracts with a client base which
includes leading communications service providers in growing markets. The
Company increased the number of customers processed on its systems from 18.0
million as of December 31, 1995 to 29.5 million as of December 31, 1998. The
Company's approach to customer care and billing provides a full suite of
products and services which combines the reliability and high volume
transaction processing capabilities of a mainframe platform with the
flexibility of client/server architecture.
Introduce New Products and Services. The Company has a significant installed
client base to which it can sell additional value-added products and services.
The Company has increased its annual revenue per customer from $5.60 in 1995
to $8.71 in 1998, a compound annual growth rate of 16%, due primarily to the
introduction of new products and services. The Company will continue to
develop software applications, which will enhance and extend the functionality
of its customer care and billing solution and also provide additional revenue
opportunities.
4
Enter New Markets. As communications markets converge, the Company's
products and services can facilitate efficient entry into new markets by
existing or new clients. For example, as the cable television providers expand
into on-line services and telephony, the Company will continue to offer the
customer care and billing solutions necessary to meet their needs. The Company
also seeks to identify other industries, such as the CLEC and ILEC markets,
that with acquired technology or modifications to the Company's existing
technology, could be served by the Company's customer care and billing
solutions.
Enhance Growth Through Focused Acquisitions. The Company follows a
disciplined approach to acquire assets and businesses which provide the
technology and technical personnel to expedite the Company's product
development efforts, provide complementary products or services, or provide
access to new markets or clients.
Continue Technology Leadership. The Company believes that its technology in
customer care and billing solutions gives communications service providers a
competitive advantage. The Company's continuing investment in research and
development ("R&D") is designed to position the Company to meet the growing
and evolving needs of existing and potential clients.
Pursue International Opportunities. The Company believes that privatization
and deregulation in international markets presents new opportunities for
customer care and billing providers. In the United Kingdom, CSGI is one of the
leading providers of customer care and billing solutions to providers of
converged cable television and telephony services. The Company also intends to
market the telephony customer care and billing system acquired in the USTATS
transaction in European and other international markets.
CSG Products and Services
CSG's Multi-Tier Architecture. CSG's multi-tier approach maximizes the
strength of the technological components in each tier. CSG's clients benefit
from having a highly scaleable system that can grow with their businesses, as
well as access to next generation technologies that are flexible and adaptable
to their changing needs. In addition, these products are supported by CSG's
Professional Services Group, which provides project management, and technical,
business and marketing consulting services.
CSG's Base Tier. This layer in CSG's customer care and billing solution does
the "heavy lifting". The billing engine uses proven, world-class technology,
providing the highest throughput available. This allows CSG's clients to
easily and affordably handle high-volume transactions. As communications
providers begin to offer more than their traditional single service, such as
cable or telephony, their ability to increase the scope of their customer care
and billing solution is very important.
Communications Control System ("CCS") enables a client's customer service
representatives ("CSRs") to enroll new customers, modify services to
current customers, schedule installation and repairs, and process billing.
CCS can handle more than 100 million accounts without significant capital
investments. CCS also has a complete set of customer service functions,
from order processing to customer information that can be used for target
marketing.
Financial Services include an entire suite of financial products aimed at
increasing CSG's clients' cash flow, managing risk and improving operating
margins. Financial products include:
. Credit Verification Service lets clients verify applicants' identities,
assess risks and make service decisions while the applicant is on the
phone.
. Risk Management System helps CCS clients determine the credit-worthiness
of prospective customers, relative to their general as well as cable
credit histories.
. Auto-Check Refunds Service processes refunds, issues and tracks checks
and communicates directly with the customer.
. PayBill Advantage Service allows customers to have their bills debited
from their checking accounts or placed on their credit cards.
5
. Credit Card Processing Services uses a one-time credit card transaction
to automatically collect payments for monthly services and special
circumstances, such as a delinquent customer.
. Electronic Lockbox Service automates the process of posting electronic
payments, dramatically reducing the possibility for error in payment.
. Collections Service automates the accounts receivable system, increasing
recovery rates and reducing costs.
CSG's Middle-Tier. CSG's middle tier uses next generation technology to
route, rate and deliver messages and transactions. Next generation
technologies were chosen for these applications because of their openness,
flexibility and adaptability. All of these products were introduced in the
last three years.
Usage Handling System allows clients to rate different transactions based
on the amount they are used, rather than using flat fee pricing. Rated
transactions may include everything from telephone calls to downloading
files on the worldwide web.
CSG Workforce Express helps make dispatchers and technicians more
productive. It automatically routes the nearest technician to the next job.
Technicians have a hand-held device, called CSG TechNet, with many
functions, such as providing customer background, allowing them to up-sell
new services and receive payments from customers, and providing a map to
the next site.
Service Delivery System takes manual and automated tasks and configures
them into a logical work flow system, to perform certain functions such as
notifying external providers and activating service.
CSG Vantage is a sophisticated reporting package that allows clients to
conduct market analyses and use that data to monitor customer behavior.
CSG Call Center Express is a suite of products that allow customers to
complete a number of common service functions over the phone, increasing
CSRs' productivity. The four products include:
. CSG Info Express allows customers to perform tasks such as checking
account balances without having to speak to a CSR.
. CSG Ticket Express allows customers to order a pay-per-view event
without speaking to a CSR.
. CSG Screen Express allows CSRs to get general customer background on
their computer screens as each call comes in.
. CSG Statement Express allows CSRs to view a customer's statement as it
was printed and sent to the customer.
CSG Enhanced Statement Presentation allows clients to tailor their logos,
graphics and messages on customer invoices, including printing coupons.
This helps them turn monthly bills into an easy-to-read communications and
marketing tool.
Client Tier. These applications were designed with a variety of
"touchpoints", or opportunities where CSG's clients' employees work directly
with customers. Touchpoints include everything from a customer paying a bill
over the Internet, to a technician completing a service call, to a CSR adding
a new service for a customer. All of these applications have been introduced
in the past three years, a visible sign of CSG's R&D efforts.
CSG Advanced Customer Service Representative (ACSR) is a "graphical user
interface" to CCS. This allows CSRs to use "point and click" technology
when performing customer care and billing functions. ACSR gives CSRs an
integrated view of multiple services, such as cable TV, telephony, high-
speed data, from one workstation. ACSR has two add-on modules:
. Customer Information Tracking tracks interactions with customers by type
and subject and allows CSRs to add notes to them.
6
. Application Object Interface allows clients to create customized
applications that access customer information and get updates from ACSR.
CSG TechNet is a handheld device that facilitates communication between
technicians and dispatchers, and helps technicians to close their work
orders in real time.
CSG.web is a self-directed customer service tool that allows customers to
perform most service-related tasks over the Internet.
YEAR 2000
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" for discussion of the Company's efforts to address the year
2000 risks related to the Company's business.
CLIENTS
The majority of the Company's largest clients are cable television and DBS
providers and based on 1998 revenues are listed below in alphabetical order.
All of such clients are located in the U.S. except Telewest, which is located
in the United Kingdom.
CableVision Systems Corporation Media One Group, Inc.
Century Communications Corporation Primestar, Inc.
Comcast Corporation TCI
Echostar Communications Corporation Telewest
Falcon Cable TV Time Warner
During the years ended December 31, 1998, 1997, and 1996, revenues from TCI
represented approximately 37.4%, 32.9%, and 25.9% of total revenues, and
revenues from Time Warner Cable and its affiliated companies ("Time Warner")
represented approximately 14.1%, 20.1%, and 22.9% of total revenues,
respectively. The increase in the TCI percentage between 1998 and 1997 relates
primarily to the additional TCI customers converted to the Company's systems
as a result of the 15-year TCI Contract executed in September 1997. The
Company has separate processing agreements with multiple affiliates of Time
Warner and provides products and services to them under separately negotiated
and executed contracts.
CLIENT AND PRODUCT SUPPORT
The Company's clients typically rely on CSG for ongoing support and training
needs relating to the Company's products. The Company has a multi-level
support environment for its clients. The Company's Product Support Center
operates 24 hours a day, seven days a week. Clients call an 800 number and
through an automated voice response unit, direct their calls to the specific
product support areas where the questions are answered . In addition, each
client has a dedicated account manager. This professional helps clients
resolve strategic and business issues. The Company has a full-time training
staff and conducts ongoing training sessions both in the field and at its
training facilities located in Denver, Colorado and Omaha, Nebraska.
SALES AND MARKETING
The Company has assembled a direct sales and sales support organization. The
market for the Company's products and services is concentrated, with each
existing and potential client representing multiple revenue opportunities. The
Company has organized its sales efforts around senior level account managers
who are responsible for new revenues and renewal of existing contracts within
an account. Account managers are supported by direct sales and sales support
personnel who are experienced in the various products and services that the
Company provides.
7
FDC Data Processing Facility
The Company outsources to FDC data processing and related services required
for operation of the CCS system. The Company's proprietary software is run in
FDC's facility to obtain the necessary mainframe computer capacity and support
without making the substantial capital investment that would be necessary for
the Company to provide this service internally. The Company's clients are
connected to the FDC facility through a combination of private and
commercially provided networks. FDC provides the services to the Company
pursuant to a five-year agreement which is scheduled to expire December 31,
2001. The Company believes it could obtain data processing services from
alternative sources, if necessary.
Research and Development
The Company's product development efforts are focused on developing new
products and improving existing products. The Company believes that the timely
development of new applications and enhancements is essential to maintaining
its competitive position in the marketplace.
The Company's total R&D expense, excluding purchased R&D, was $27.5 million,
$22.6 million, and $20.2 million for the years ended December 31, 1998, 1997,
and 1996, or 11.6%, 13.2%, and 15.3% of total revenues, respectively. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Competition
The market for customer care and billing systems in the converging
communications industries is highly competitive. The Company competes with
both independent providers and in-house developers of customer management
systems. The Company believes its most significant competitors are DST
Systems, Inc., Convergys Corporation, and in-house systems. As the Company
enters additional market segments, it expects to encounter additional
competitors. Some of the Company's actual and potential competitors have
substantially greater financial, marketing and technological resources than
the Company.
The Company believes that the principal competitive factors in its markets
include time to market, flexibility and architecture of the system, breadth of
product features, product quality, customer service and support, quality of
R&D effort, and price.
Proprietary Rights and Licenses
The Company relies on a combination of trade secrets and copyright laws,
patents, license agreements, non-disclosure and other contractual provisions,
and technical measures to protect its proprietary rights. The Company
distributes its products under service and software license agreements which
typically grant clients non-exclusive licenses to use the products. Use of the
software products is restricted and subject to terms and conditions
prohibiting unauthorized reproduction or transfer of the software products.
The Company also seeks to protect the source code of its software as a trade
secret and as a copyrighted work. Despite these precautions, there can be no
assurance that misappropriation of the Company's software products and
technology will not occur. The Company also incorporates via licenses or
reselling arrangements a variety of third party technology and software
products that provide specialized functionality within its own products and
services. Although the Company believes that its product and service offerings
conform with such arrangements and do not infringe upon the intellectual
property rights of the other parties to such arrangements or of other third
parties, there can be no assurance that any third parties will not assert
contractual or infringement claims against the Company.
Employees
As of December 31, 1998, the Company had a total of 1,328 employees, an
increase of 187 from December 31, 1997. The Company's success is dependent
upon its ability to attract and retain qualified employees. None
8
of the Company's employees are subject to a collective bargaining agreement.
The Company believes that its relations with its employees are good.
Item 2. Properties
The Company leases four facilities, totaling approximately 118,000 square
feet in Denver, Colorado and surrounding communities. The Company utilizes
these facilities primarily for (i) corporate headquarters, (ii) sales and
marketing activities, (iii) business offices for its professional consultants,
and (iv) certain R&D activities. The leases for these facilities expire in the
years 1999 through 2004.
The Company leases four facilities, totaling approximately 187,000 square
feet in Omaha, Nebraska. The Company utilizes these facilities primarily for
(i) client services and product support, (ii) systems and programming
activities, (iii) R&D activities, (iv) statement production and mailing, and
(v) general and administrative functions. The leases for these facilities
expire in the years 2000 through 2007.
The Company leases one facility, totaling 17,000 square feet in Jasper
County, South Carolina. This facility is used for product support functions
and R&D activities, and the lease expires in 2009.
The Company leases one facility, totaling 63,000 square feet in Wakulla
County, Florida. This facility is used for statement production and mailing
and the lease expires in 2008.
The Company leases office space totaling 13,000 square feet in Slough,
Berkshire, in the United Kingdom for its U. K. operations. The lease for this
facility expires in 2002.
The Company believes that its facilities are adequate for its current needs
and that additional suitable space will be available as required. The Company
also believes that it will be able to extend leases as they terminate. See
Note 9 to the Company's Consolidated Financial Statements for information
regarding the Company's obligations under its facilities leases.
Item 3. 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, after consultation with legal counsel, the
Company is not presently a party to any material pending or threatened legal
proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
None.
***
Executive Officers of the Registrant
The present executive officers of the Company are Neal C. Hansen (Chairman
of the Board and Chief Executive Officer), John P. Pogge (President and Chief
Operating Officer), Greg A. Parker (Vice President and Chief Financial
Officer) and Edward C. Nafus (Executive Vice President). During 1998, the
Company executed employment agreements with each of the executive officers.
Information concerning such executive officers appears in the following
paragraphs:
Mr. Hansen, 58, is a co-founder of the Company and has been the Chairman of
the Board and Chief Executive Officer and a director of the Company since its
inception in 1994. From 1991 until founding the Company, Mr. Hansen served as
a consultant to several software companies, including FDC. From 1989 to 1991,
Mr. Hansen was a General Partner of Hansen, Haddix and Associates, a
partnership which provided advisory management services to suppliers of
software products and services. From 1983 to 1989, Mr. Hansen was Chairman and
Chief Executive Officer of US WEST Applied Communications, Inc., and President
of US WEST Data Systems Group.
9
Mr. Pogge, 45, joined the Company in 1995 and has served as President, Chief
Operating Officer and a director of the Company since September 1997. Prior to
that time, Mr. Pogge was an Executive Vice President of the Company and
General Manager, Business Units. From 1992 to 1995, Mr. Pogge was Vice
President, Corporate Development for US WEST, Inc. From 1987 to 1991, Mr.
Pogge served as Vice President and General Counsel of Applied Communications,
Inc. Mr. Pogge holds a J.D. degree from Creighton University School of Law and
a BBA in Finance from the University of Houston. Mr. Pogge and Mr. Parker are
brothers-in-law.
Mr. Parker, 40, joined the Company in July 1995 and has served as Vice
President and Chief Financial Officer since April 1997. Prior to that time,
Mr. Parker was Vice President, Finance. Previously, Mr. Parker was with Banc
One for thirteen years and was Chief Financial Officer for Banc One in Houston
and San Antonio. Mr. Parker received a BBA in Accounting and Economics from
the University of Iowa in 1980. Mr. Pogge and Mr. Parker are brothers-in-law.
Mr. Nafus, 58, joined the Company in August 1998 as Executive Vice
President. From 1992 to 1998, Mr. Nafus served as Executive Vice President of
First Data Corporation and President of First Data International. Mr. Nafus
was President of First Data Resources from 1989 to 1992, Executive Vice
President of First Data Resources from 1984 to 1989 and held various other
management positions with that company since 1984. Mr. Nafus holds a B.S.
degree in Mathematics from Jamestown College.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock is listed on the Nasdaq National Market
("NASDAQ/NMS") under the symbol "CSGS". The following table sets forth, for
the fiscal quarters indicated, the high and low sale prices of the Company's
Common Stock as reported by NASDAQ/NMS since the Company's Initial Public
Offering on February 28, 1996. The per share amounts disclosed herein have
been adjusted to reflect the Company's two-for-one stock split which was
effective on March 5, 1999.
High Low
------ ------
1998
First quarter.................................................. $22.63 $18.44
Second quarter................................................. 24.50 18.91
Third quarter.................................................. 24.63 18.38
Fourth quarter................................................. 39.50 19.13
High Low
------ ------
1997
First quarter.................................................. $10.13 $ 7.50
Second quarter................................................. 15.50 7.38
Third quarter.................................................. 20.13 11.00
Fourth quarter................................................. 24.88 15.31
On March 15, 1999, the last sale price of the Company's Common Stock as
reported by NASDAQ/NMS was $35.31 per share. On January 31, 1999, the number
of holders of record of Common Stock was 220.
Dividends
The Company has not declared or paid cash dividends on its Common Stock
since its incorporation. The Company's debt agreement contains restrictions on
the payment of dividends. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and Note 6 to the Company's
Consolidated Financial Statements.
10
Item 6. Selected Financial Data
The following selected financial data have been derived from the audited
financial statements of the Company and CSG Systems, Inc., formerly Cable
Services Group, Inc. (the "Predecessor"). The selected financial data
presented below should be read in conjunction with, and is qualified by
reference to "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the Company's and the Predecessor's Consolidated
Financial Statements. The information below is not necessarily indicative of
the results of future operations.
Company(1)(2) Predecessor(1)
--------------------------------------------------------- --------------
One month 11 Months
Year ended December 31, ended ended
------------------------------------------- December 31, November 30,
1998 1997 1996 1995 1994 1994
--------- ---------- --------- --------- ------------ --------------
(in thousands, except per share amount)
Statements of Operations
Data:
Revenues:
Processing and related
services.............. $ 191,802 $ 131,399 $ 113,422 $ 96,343 $ 7,757 $76,081
Software license and
maintenance fees...... 31,021 26,880 14,736 57 -- --
Professional services.. 13,817 13,525 4,139 4 -- --
--------- ---------- --------- --------- -------- -------
Total revenues........ 236,640 171,804 132,297 96,404 7,757 76,081
--------- ---------- --------- --------- -------- -------
Expenses:
Cost of processing and
related services:
Direct costs........... 77,155 58,259 52,027 46,670 3,647 34,977
Amortization of
acquired software(1).. -- 10,596 11,003 11,000 917 --
Amortization of client
contracts and related
intangibles(1)........ 5,043 4,293 4,092 4,092 341 1,594
--------- ---------- --------- --------- -------- -------
Total cost of
processing and
related services..... 82,198 73,148 67,122 61,762 4,905 36,571
Cost of software
license and
maintenance fees...... 17,907 9,787 5,040 -- -- --
Cost of professional
services.............. 7,141 7,047 2,083 -- -- --
--------- ---------- --------- --------- -------- -------
Total cost of
revenues............. 107,246 89,982 74,245 61,762 4,905 36,571
--------- ---------- --------- --------- -------- -------
Gross margin (exclusive
of depreciation)....... 129,394 81,822 58,052 34,642 2,852 39,510
--------- ---------- --------- --------- -------- -------
Operating expenses:
Research and
development:
Research and
development........... 27,485 22,586 20,206 14,278 1,044 7,680
Charge for purchased
research and
development(1)(5)..... -- 105,484 -- -- 40,953 --
Impairment of
capitalized software
development costs(6).. -- 11,737 -- -- -- --
Selling and marketing.. 11,810 10,198 8,213 3,770 293 3,054
General and
administrative:
General and
administrative........ 22,959 19,385 13,702 11,406 3,073 9,461
Amortization of
goodwill and other
intangibles(1)........ 5,381 6,927 6,392 5,680 547 826
Impairment of
intangible assets(7).. -- 4,707 -- -- -- --
Stock-based employee
compensation(1)....... 297 449 3,570 841 -- --
Depreciation........... 8,159 6,884 5,121 5,687 433 3,520
--------- ---------- --------- --------- -------- -------
Total operating
expenses............. 76,091 188,357 57,204 41,662 46,343 24,541
--------- ---------- --------- --------- -------- -------
Operating income (loss). 53,303 (106,535) 848 (7,020) (43,491) 14,969
--------- ---------- --------- --------- -------- -------
Other income (expense):
Interest expense....... (9,771) (5,324) (4,168) (9,070) (769) (1,067)
Interest income........ 2,484 1,294 844 663 39 227
Other.................. (21) 349 -- -- -- --
--------- ---------- --------- --------- -------- -------
Total other........... (7,308) (3,681) (3,324) (8,407) (730) (840)
--------- ---------- --------- --------- -------- -------
Income (loss) before
income taxes,
extraordinary item and
discontinued
operations............. 45,995 (110,216) (2,476) (15,427) (44,221) 14,129
Income tax (provision)
benefit(8)............. 39,643 -- -- -- 3,757 (5,519)
--------- ---------- --------- --------- -------- -------
Income (loss) before
extraordinary item and
discontinued
operations............. 85,638 (110,216) (2,476) (15,427) (40,464) 8,610
Extraordinary loss from
early extinguishment
of debt(3)(5)......... -- (577) (1,260) -- -- --
--------- ---------- --------- --------- -------- -------
Income (loss) from
continuing operations.. 85,638 (110,793) (3,736) (15,427) (40,464) 8,610
Discontinued
operations(4):
Loss from operations... -- -- -- (3,093) (239) --
Gain (loss) from
disposition........... -- 7,922 -- (660) -- --
--------- ---------- --------- --------- -------- -------
Total gain (loss) from
discontinued
operations........... -- 7,922 -- (3,753) (239) --
--------- ---------- --------- --------- -------- -------
Net income (loss)....... $ 85,638 $ (102,871) $ (3,736) $ (19,180) $(40,703) $ 8,610
========= ========== ========= ========= ======== =======
Diluted net income
(loss) per common
share(9):
Income (loss)
attributable to common
stockholders.......... $ 1.62 $ (2.16) $ (.07) $ (2.76) $ (7.88)
Extraordinary loss from
early extinguishment
of debt............... -- (.01) (.03) -- --
Gain (loss) from
discontinued
operations............ -- 15 -- (.54) (.04)
--------- ---------- --------- --------- --------
Net income (loss)
attributable to common
stockholders.......... $ 1.62 $ (2.02) $ (.10) $ (3.30) $ (7.92)
========= ========== ========= ========= ========
Weighted average
diluted common shares. 52,991 50,994 43,746 6,901 5,175
========= ========== ========= ========= ========
11
Company(1)(2) Predecessor(1)
-------------------------------------------------- --------------
One month 11 Months
Year ended December 31, ended ended
------------------------------------ December 31, November 30,
1998 1997 1996 1995 1994 1994
-------- -------- -------- -------- ------------ --------------
(in thousands)
Other Data (at Period
End):
Number of clients'
customers processed.... 29,461 21,146 19,212 17,975 16,435 16,347
Balance Sheet Data (at
Period End):
Cash and cash
equivalents............ $ 39,593 $ 20,417 $ 6,134 $ 3,603 $ 6,650 $ 22
Working capital......... 7,050 3,518 4,430 2,359 4,681 8,356
Total assets(5)......... 271,496 179,793 114,910 105,553 130,160 65,695
Total debt(3)(5)........ 128,250 135,000 32,500 85,068 95,000 10,438
Redeemable convertible
preferred stock(3)..... -- -- -- 62,985 59,363 --
Stockholders' equity
(deficit)(1)(3)(5)(6).. 60,998 (33,086) 41,964 (61,988) (40,429) 43,031
- --------
(1) The Company was formed in October 1994 and acquired all of the outstanding
shares of CSG Systems, Inc., formerly Cable Services Group, Inc., from
First Data Corporation ("FDC") on November 30, 1994 (the "CSG
Acquisition"). The Company did not have any substantive operations prior
to the CSG Acquisition. The CSG Acquisition was accounted for as a
purchase and the Company's Consolidated Financial Statements (the
"Consolidated Financial Statements") since the date of the acquisition are
presented on the new basis of accounting established for the purchased
assets and liabilities. The Company incurred certain acquisition-related
charges as a result of the CSG Acquisition. These acquisition-related
charges included an immediate charge of $40.9 million as of the
acquisition date for purchased research and development and recurring,
periodic amortization of acquired software, client contracts and related
intangibles, noncompete agreement and goodwill, and stock-based employee
compensation.
(2) On June 28, 1996, the Company acquired all of the outstanding shares of
Bytel Limited. Bytel Limited changed its name to CSG International Limited
("CSGI") in 1998. The acquisition was accounted for using the purchase
method of accounting.
(3) The Company completed an initial public offering ("IPO") of its Common
Stock in March 1996. The Company sold 6,670,000 shares of Common Stock
resulting in net proceeds to the Company of $44.8 million. Such proceeds
were used to repay long-term debt of $40.3 million and to pay accrued
dividends of $4.5 million on Redeemable Convertible Preferred Stock
("Preferred Stock"). As of the closing of the IPO, all of the Preferred
Stock was automatically converted into 35,999,996 shares of Common Stock.
The Company incurred an extraordinary loss of $1.3 million for the write-
off of deferred financing costs attributable to the portion of the long-
term debt repaid.
(4) Contemporaneously with the Acquisition, the Company purchased from FDC all
of the outstanding capital stock of Anasazi Inc. ("Anasazi"). On August
31, 1995, the Company completed a substantial divestiture of Anasazi,
resulting in the Company owning less than 20% of Anasazi. In September
1997, the Company sold its remaining ownership interest in Anasazi for
$8.6 million in cash and recognized a gain of $7.9 million. The Company
accounted for its ownership in Anasazi as discontinued operations after
its acquisition in 1994.
(5) During 1997, the Company purchased certain SUMMITrak technology assets
from Tele-Communications, Inc. ("TCI") and entered into a 15-year
processing contract (the "TCI Contract"). The total purchase price was
approximately $159 million, with approximately $105 million charged to
purchased research and development and the remaining amount allocated
primarily to the TCI Contract. The Company financed the asset acquisition
with a $150.0 million term credit facility (the "Term Credit Facility"),
of which $27.5 million was used to retire the Company's previously
outstanding debt, resulting in an extraordinary loss of $0.6 million for
the write-off of deferred financing costs attributable to such debt. See
Note 4 to the Consolidated Financial Statements for additional discussion.
(6) During 1997, the Company recorded a non-recurring charge of $11.7 million
to reduce certain CSG Phoenix assets to their net realizable value as of
December 31, 1997.
(7) During 1997, the Company recorded a non-recurring charge of $4.7 million
for the impairment of certain intangible assets related to software
systems which the Company decided to no longer market and support.
(8) During 1998, the Company recorded an income tax benefit of $39.6 million
related primarily to the elimination of its valuation allowance against
its deferred tax assets. See Note 7 to the Consolidated Financial
Statements for further discussion.
(9) On March 5, 1999, the Company completed a two-for-one stock split for
shareholders of record on February 8, 1999. In January 1996, the Company
also completed a two-for-one stock split. Both splits were effected as a
stock dividend. Share and per share data for all periods presented herein
have been adjusted to give effect to both splits. Diluted net income
(loss) per common share and the shares used in the per share computation
have been computed on the basis described in Note 2 to the Consolidated
Financial Statements.
12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
The Company. The Company was formed in October 1994 and acquired all of the
outstanding stock of CSG Systems, Inc. from First Data Corporation ("FDC") in
November 1994 (the "CSG Acquisition"). CSG Systems, Inc. had been a subsidiary
or division of FDC from 1982 until the acquisition.
The Company is a leading provider of customer care and billing solutions for
cable television and direct broadcast satellite providers, and also serves on-
line services and telecommunications providers. The Company's products and
services enable its clients to focus on their core businesses, improve
customer service, and enter new markets and operate more efficiently. The
Company offers its clients a full suite of processing and related services,
and software and professional services which automate customer care and
billing functions. These functions include set-up and activation of customer
accounts, sales support, order processing, invoice calculation, production and
mailing, management reporting, and customer analysis for target marketing. The
Company's products and services combine the reliability and high volume
transaction processing capabilities of a mainframe platform with the
flexibility of client/server architecture.
Stock Splits. On March 5, 1999, the Company completed a two-for-one stock
split for shareholders of record on February 8, 1999. In January 1996, the
Company also completed a two-for-one stock split. Both splits were effected as
a stock dividend. Share and per share data for all periods presented herein
have been adjusted to give effect to both splits.
Stock Offerings. The Company completed the initial public offering ("IPO")
of its common stock in March 1996. The Company sold 6,670,000 shares of Common
Stock, resulting in net proceeds to the Company, after deducting the
underwriting discount and offering expenses, of approximately $44.8 million.
The net proceeds from the IPO were used to repay long-term debt of $40.3
million and to pay accrued dividends of $4.5 million on Preferred Stock. As of
the closing of the IPO, all of the 8,999,999 outstanding shares of Preferred
Stock were automatically converted into 35,999,996 shares of Common Stock and
all accrued dividends were paid. See Notes 5 and 6 to the Consolidated
Financial Statements for additional information regarding the Company's
Preferred Stock and long-term debt.
In April 1998, the Company completed a secondary public stock offering of
approximately 7.0 million shares of Common Stock. The primary shareholders in
the offering included Morgan Stanley affiliated entities and General Motors
employee benefit plan trusts. The Company received none of the proceeds from
the offering, nor incurred any expense.
Acquisitions
USTATS Asset Acquisition. On July 30, 1998, the Company acquired
substantially all of the assets of US Telecom Advanced Technology Systems,
Inc. ("USTATS") for approximately $6.0 million in cash and assumption of
certain liabilities of approximately $1.3 million. USTATS, a South Carolina-
based company, specializes in open systems, client/server customer care and
billing systems serving the telecommunications markets. The Company intends to
use the acquired technology and software to (i) enhance its current service-
bureau telephony customer care and billing system, and (ii) provide a customer
care and billing system for the domestic and international competitive local
exchange carrier ("CLEC") and incumbent local exchange carrier ("ILEC")
markets. The cash portion of the purchase price was paid out of corporate
funds. The total purchase price of $7.3 million has been allocated to the
technology and software acquired and is being amortized over its expected
useful life of five years.
Acquisition of SUMMITrak Assets. In September 1997, the Company purchased
certain SUMMITrak software technology assets that were in development from
Tele-Communications, Inc. ("TCI"). The development efforts are on schedule and
the resource requirements for completion of the development efforts are
consistent with the original expectations. The related products from these
development efforts are expected to be available for general release in 1999.
See Note 4 to the Company's Consolidated Financial Statements for additional
discussion of the SUMMITrak asset acquisition.
13
Acquisition of CSG International Limited. On June 28, 1996, the Company
acquired all of the outstanding shares of Bytel Limited for $3.1 million in
cash and assumption of certain liabilities of $1.6 million. During 1998, Bytel
Limited changed its name to CSG International Limited ("CSGI"). The
acquisition was accounted for using the purchase method. The cost in excess of
the fair value of the net tangible assets acquired of $4.2 million was
allocated to goodwill and is being amortized over seven years on a straight-
line basis. The Consolidated Financial Statements include CSGI's results of
operations since the acquisition date. CSGI, established in 1992, is one of
the leading providers of customer care and billing solutions in the United
Kingdom to providers of converged cable television and telephony services.
Acquisition-Related Charges
Acquisition Charges. The CSG Acquisition was accounted for using the
purchase method. As a result, the Company has recorded recurring, periodic
amortization of acquired software, client contracts and related intangibles,
noncompete agreement, goodwill and stock-based employee compensation
(collectively, the "Acquisition Charges"). The Acquisition Charges totaled
$8.2 million, $20.7 million, and $24.4 million for the years ended December
31, 1998, 1997 and 1996, respectively. The Acquisition Charges will be
approximately $7.5 million for 1999, and thereafter, the amounts will be
approximately $0.2 million per year until fully amortized in 2004.
Discontinued Operations. Contemporaneously with the CSG Acquisition, the
Company purchased from FDC all of the outstanding shares of Anasazi Inc.
("Anasazi") for $6.0 million cash. Anasazi provides central reservation
systems and services for the hospitality and travel industries. The Company
accounted for its ownership in Anasazi as discontinued operations after its
acquisition in 1994. On August 31, 1995, the Company completed a substantial
divestiture of Anasazi, resulting in the Company owning less than 20% of
Anasazi. As a result, Anasazi's results of operations subsequent to August 31,
1995 are not included in the Company's results of operations as the Company
accounted for its investment in Anasazi under the cost method subsequent to
August 31, 1995. In September 1997, the Company sold its remaining interest in
Anasazi for $8.6 million in cash and recognized a gain of $7.9 million.
Non-Recurring Items
Charge for Purchased Research and Development. During 1997, the Company
recorded a charge of $105.5 million related primarily to the portion of the
SUMMITrak asset acquisition purchase price allocated to purchased research and
development related to software technologies which had not reached
technological feasibility and had no other alternative future use as of the
acquisition.
Impairment of Capitalized Software Development Costs. During 1997, the
Company recorded a charge of $11.7 million related to certain CSG Phoenix
assets. After the consideration of multiple factors and events, consisting
primarily of an increase in demand for the Company's outsourced processing
services and previously announced delays in the delivery of CSG Phoenix, such
assets were reduced to their estimated net realizable value as of December 31,
1997. The charge primarily included previously capitalized internal
development costs and purchased software incorporated into the product.
Impairment of Intangible Assets. During 1997, the Company recorded a charge
of $4.7 million for the impairment of certain intangible assets related to
software systems which the Company decided to no longer market and support.
This impairment charge related principally to the Company's CableMAX product.
CableMAX was a personal computer-based customer management system targeted at
smaller cable systems of 2,500 customers or less. During 1997, the Company
decided not to invest the resources necessary to make the software year 2000
compliant, resulting in the impairment of the CableMAX intangible assets.
Extraordinary Loss From Early Extinguishment Of Debt. In September 1997, the
Company retired its outstanding bank indebtedness of $27.5 million in
conjunction with obtaining financing for the SUMMITrak asset acquisition. Upon
repayment of the outstanding debt, the Company recorded an extraordinary loss
of $0.6
14
million for the write-off of deferred financing costs. In March 1996, the
Company recorded an extraordinary charge of $1.3 million for the write-off of
deferred financing costs related to repayment of $40.3 million of long-term
debt with proceeds from the IPO.
Income Tax Benefit. As of September 30, 1998, the Company had a valuation
allowance of $48.5 million against certain of its deferred tax assets due to
the uncertainty that it would realize the income tax benefit from these
assets. During the fourth quarter of 1998, the Company concluded that it was
more likely than not that it would realize the entire tax benefit from its
deferred tax assets. As a result, the Company eliminated the entire valuation
allowance of $48.5 million as of December 31, 1998, which resulted in the
Company recording a net income tax benefit of $39.6 million during the fourth
quarter. This conclusion was based primarily upon the Company's expected
profitable operations in future periods. See below for additional discussion.
Adjusted Results of Operations
Impact of Acquisition Charges and Non-recurring Charges on Earnings. As
discussed above, the Company has incurred Acquisition Charges and non-
recurring charges in each of the last three years. The total of these charges
was $8.2 million, $135.3 million, and $25.6 million for the years ended
December 31, 1998, 1997 and 1996, respectively. The Company's adjusted results
of operations excluding these items are shown in the following table. In
addition to the exclusion of these expenses from the calculation, the adjusted
results of operations were computed using an effective income tax rate of
38.0%, and outstanding shares on a diluted basis.
For the year ended December 31,
-------------------------------------------
1998 1997 1996
------------- ------------- -------------
(in thousands, except per share amounts)
Adjusted Results of
Operations:
Operating income........... $ 61,512 $ 36,131 $ 25,194
Operating income margin.... 26.0% 21.0% 19.0%
Income before income taxes. 54,204 32,450 21,870
Net income................. 33,606 20,119 13,559
Earnings per diluted common
share..................... .63 .39 .27
Weighted average diluted
common shares............. 52,991 52,138 50,588
15
Results of Operations
The following table sets forth certain financial data and the percentage of
total revenues of the Company for the periods indicated. The results of CSGI's
operations since its acquisition on June 28, 1996 are included in the following
table and considered in the discussion of the Company's operations that
follows.
Year Ended December 31,
-------------------------------------------------------
1998 1997 1996
----------------- ------------------ -----------------
% of % of % of
Amount Revenue Amount Revenue Amount Revenue
-------- ------- --------- ------- -------- -------
(in thousands)
Revenues:
Processing and related
services.............. $191,802 81.1% $ 131,399 76.5% $113,422 85.8%
Software license and
maintenance fees...... 31,021 13.1 26,880 15.6 14,736 11.1
Professional services.. 13,817 5.8 13,525 7.9 4,139 3.1
-------- ----- --------- ------ -------- -----
Total revenues........ 236,640 100.0 171,804 100.0 132,297 100.0
-------- ----- --------- ------ -------- -----
Expenses:
Cost of processing and
related services:
Direct costs........... 77,155 32.6 58,259 33.9 52,027 39.3
Amortization of
acquired software..... -- -- 10,596 6.2 11,003 8.3
Amortization of client
contracts and related
intangibles........... 5,043 2.1 4,293 2.5 4,092 3.1
-------- ----- --------- ------ -------- -----
Total cost of
processing and
related services..... 82,198 34.7 73,148 42.6 67,122 50.7
Cost of software
license and
maintenance fees...... 17,907 7.6 9,787 5.7 5,040 3.8
Cost of professional
services.............. 7,141 3.0 7,047 4.1 2,083 1.6
-------- ----- --------- ------ -------- -----
Total cost of
revenues............. 107,246 45.3 89,982 52.4 74,245 56.1
-------- ----- --------- ------ -------- -----
Gross margin (exclusive
of depreciation)....... 129,394 54.7 81,822 47.6 58,052 43.9
-------- ----- --------- ------ -------- -----
Operating expenses:
Research and
development:
Research and
development........... 27,485 11.6 22,586 13.2 20,206 15.3
Charge for purchased
research and
development........... -- -- 105,484 61.4 -- --
Impairment of
capitalized software
development costs..... -- -- 11,737 6.8 -- --
Selling and marketing.. 11,810 5.0 10,198 5.9 8,213 6.2
General and
administrative:
General and
administrative........ 22,959 9.7 19,385 11.3 13,702 10.4
Amortization of
noncompete agreements
and goodwill.......... 5,381 2.3 6,927 4.0 6,392 4.8
Impairment of
intangible assets..... -- -- 4,707 2.7 -- --
Stock-based employee
compensation.......... 297 0.1 449 3 3,570 2.7
Depreciation........... 8,159 3.4 6,884 4.0 5,121 3.9
-------- ----- --------- ------ -------- -----
Total operating
expenses............. 76,091 32.1 188,357 109.6 57,204 43.3
-------- ----- --------- ------ -------- -----
Operating income (loss). 53,303 22.6 (106,535) (62.0) 848 .6
Other income (expense):
Interest expense....... (9,771) (4.1) (5,324) (3.1) (4,168) (3.1)
Interest income........ 2,484 1.0 1,294 .7 844 .6
Other.................. (21) -- 349 .2 -- --
-------- ----- --------- ------ -------- -----
Total other........... (7,308) (3.1) (3,681) (2.2) (3,324) (2.5)
-------- ----- --------- ------ -------- -----
Income (loss) before
income taxes,
extraordinary item and
discontinued
operations............. 45,995 19.5 (110,216) (64.2) (2,476) (1.9)
Income tax benefit..... 39,643 16.7 -- -- -- --
-------- ----- --------- ------ -------- -----
Income (loss) before
extraordinary item and
discontinued
operations............. 85,638 36.2 (110,216) (64.2) (2,476) (1.9)
Extraordinary loss from
early extinguishment
of debt............... -- -- (577) (.3) (1,260) (.9)
-------- ----- --------- ------ -------- -----
Income (loss) from
continuing operations.. 85,638 36.2 (110,793) (64.5) (3,736) (2.8)
Gain from disposition
of discontinued
operations............ -- -- 7,922 4.6 -- --
-------- ----- --------- ------ -------- -----
Net income (loss)....... $ 85,638 36.2% $(102,871) (59.9)% $ (3,736) (2.8)%
======== ===== ========= ====== ======== =====
16
Twelve Months Ended December 31, 1998 Compared to Twelve Months Ended December
31, 1997
Revenues. Total revenues increased $64.8 million, or 37.7%, to $236.6
million in 1998, from $171.8 million in 1997.
Revenues from processing and related services increased $60.4 million, or
46.0%, to $191.8 million in 1998, from $131.4 million in 1997. Of the total
increase in revenue, approximately 61% resulted from the Company serving a
higher number of customers for its clients and approximately 39% was due to
increased revenue per customer. Customers serviced as of December 31, 1998 and
1997 were 29.5 million and 21.1 million, respectively, an increase of 39.3%.
The increase in the number of customers serviced was due to the conversion of
additional customers by new and existing clients to the Company's systems, and
internal customer growth experienced by existing clients. During 1998, the
Company converted and processed approximately 9.0 million new customers on its
systems, with approximately 7.7 million of these new customers coming from
TCI. Total domestic revenue per customer account for 1998 was $8.71, compared
to $7.73 for 1997, an increase of 12.7%. Revenue per customer increased due
primarily to (i) the 15-year processing contract with TCI (the "TCI
Contract"), which was executed in September 1997, (ii) increased usage of
ancillary services by clients, and (iii) price increases included in client
contracts.
Revenues from software and related product sales and professional consulting
services increased $4.4 million, or 11.0%, to $44.8 million in 1998, from
$40.4 million in 1997. This increase relates to the continued growth of the
Company's software products and related product sales and professional
consulting services.
Cost of Processing and Related Services. Direct processing costs as a
percentage of related revenues were 40.2% for 1998, compared to 44.3% for
1997. The improvement between years relates primarily to better overall
leveraging of the direct processing costs as a result of the continued growth
of the customer base processed on the Company's system. Amortization of
acquired software decreased to zero in 1998, from $10.6 million in 1997, due
to acquired software from the CSG Acquisition becoming fully amortized as of
November 30, 1997. Amortization of client contracts and related intangibles
increased $0.7 million, or 17.5%, to $5.0 million in 1998, from $4.3 million
in 1997. The increase in expense is due to amortization of the value assigned
to the TCI Contract, offset by a decrease in the amortization of certain
intangible assets from the CSG Acquisition becoming fully amortized as of
November 30, 1997. The value assigned to the TCI Contract is being amortized
over the life of the contract in proportion to the financial minimums included
in the contract. Amortization related to the TCI Contract was $1.9 million in
1998, compared to $0.3 million in 1997. For 1999, the scheduled amortization
for the TCI Contract is $3.3 million.
Cost of Software License and Maintenance Fees. The cost of software license
and maintenance fees as a percentage of related revenues was 57.7% in 1998,
compared to 36.4% in 1997. The increase in this percentage between years
relates primarily to the timing of the sales cycle for new products introduced
in 1998. For 1999, the cost of software license and maintenance fees as a
percentage of related revenues is expected to be comparable to the 1997
percentage.
Gross Margin. Gross margin increased $47.6 million, or 58.1%, to $129.4
million in 1998, from $81.8 million in 1997, due primarily to revenue growth.
The gross margin as a percentage of total revenues increased to 54.7% in 1998,
compared to 47.6% in 1997. The overall increase in the gross margin percentage
is due primarily to the increase in revenues while the amount of amortization
of acquired software decreased, and to a lesser degree, the improvement in the
gross margin percentage for processing and related services, due primarily to
the increase in revenue per customer while controlling the cost of delivering
such services.
Research and Development Expense. Research and development ("R&D") expense
increased $4.9 million, or 21.7%, to $27.5 million in 1998, from $22.6 million
in 1997. As a percentage of total revenues, R&D expense decreased to 11.6% in
1998, from 13.2% in 1997.
During 1997, the Company capitalized software development costs of
approximately $9.7 million, which consisted of $8.4 million of internal
development costs and $1.3 million of purchased software. The Company
17
capitalized third party, contracted programming costs of approximately $1.4
million during 1998, related primarily to enhancements to existing products.
As a result, total R&D development expenditures (i.e., the total R&D costs
expensed, plus the capitalized development costs) for 1998 and 1997, were
$28.9 million, or 12.2% of total revenues, and $31.0 million, or 18.0% of
total revenues, respectively. The overall decrease in the R&D expenditures
between periods is due primarily to effective control of development costs,
primarily the reduction of third party, contracted programming services.
Selling and Marketing Expense. Selling and marketing ("S&M") expense
increased $1.6 million, or 15.8%, to $11.8 million in 1998, from $10.2 million
in 1997. As a percentage of total revenues, S&M expense decreased to 5.0% in
1998, from 5.9% in 1997. The overall decrease in S&M expenses as a percentage
of total revenues is due primarily to increased revenues, while controlling
S&M costs.
General and Administrative Expense. General and administrative ("G&A")
expense increased $3.6 million, or 18.4%, to $23.0 million in 1998, from $19.4
million in 1997. As a percentage of total revenues, G&A expense decreased to
9.7% in 1998, from 11.3% in 1997. The increase in G&A expenses relates
primarily to the continued expansion of the Company's administrative staff and
other administrative costs to support the Company's overall growth. The
decrease in G&A expenses as a percentage of total revenues is due primarily to
increased revenue, while controlling G&A costs.
Amortization of Noncompete Agreements and Goodwill. Amortization of
noncompete agreements and goodwill decreased $1.5 million, or 22.3%, to $5.4
million in 1998, from $6.9 million in 1997. The decrease in amortization
expense is due primarily to a write-down of certain intangible assets in 1997.
See Note 2 to the Consolidated Financial Statements for additional discussion.
Depreciation Expense. Depreciation expense increased $1.3 million, or 18.5%,
to $8.2 million in 1998, from $6.9 million in 1997. The increase in expense
relates to capital expenditures made throughout 1998 and 1997 in support of
the overall growth of the Company, consisting principally of computer hardware
and related equipment and statement processing equipment and related
facilities. Depreciation expense for all property and equipment is reflected
separately in the aggregate and is not included in the other components of
operating expenses.
Operating Income (Loss). Operating income was $53.3 million for 1998,
compared to an operating loss of $106.5 million in 1997. The change between
years relates primarily to the non-recurring charges recorded in 1997, as
discussed above. The Company's operating income margin, excluding the
Acquisition Charges and non-recurring charges discussed above, was 26.0% for
1998, compared to 21.0% for 1997.
Interest Expense. Interest expense increased $4.5 million, or 83.5%, to $9.8
million in 1998, from $5.3 million in 1997, with the increase attributable
primarily to the financing of the Company's acquisition of the SUMMITrak
assets in September 1997.
Interest Income. Interest income increased $1.2 million, or 92.0%, to $2.5
million in 1998, from $1.3 million in 1997, with the increase attributable
primarily to an increase in operating funds available for investment and an
increase in interest charges on aged client accounts.
Income Tax Benefit. As of September 30, 1998, the Company had a valuation
allowance of $48.5 million against certain of its deferred tax assets due to
the uncertainty that it would realize the income tax benefit from these
assets. During the fourth quarter of 1998, the Company concluded that it was
more likely than not that it would realize the entire tax benefit from its
deferred tax assets. As a result, the Company eliminated the entire valuation
allowance of $48.5 million as of December 31, 1998, which resulted in the
Company reflecting a net income tax benefit of $39.6 million for 1998.
Management believes the Company will obtain the full benefit of the deferred
tax assets on the basis of its evaluation of the Company's anticipated
profitability over the period of years that the temporary differences are
18
expected to become deductions. The Company believes that sufficient book and
taxable income will be generated to realize the entire benefit of these
deferred tax assets. The Company's assumptions of future profitable operations
are supported by (i) the Company's strong financial performance in 1998, (ii)
the successful conversion of approximately 9.0 million new customers onto the
Company's processing system in 1998, with approximately 7.7 million of these
customers coming from TCI, and (iii) continued strong demand from the
converging communications markets for the Company's service bureau customer
care and billing solutions and related software and services products,
evidenced by the signing of several significant clients (both renewal and new
contracts) to long-term processing contracts during 1998.
Twelve Months Ended December 31, 1997 Compared to the Twelve Months Ended
December 31, 1996
Revenues. Total revenues increased $39.5 million, or 29.9%, to $171.8
million in 1997, from $132.3 million in 1996.
Revenues from processing and related services increased $18.0 million, or
15.8%, to $131.4 million in 1997, from $113.4 million in 1996. Of the total
increase in revenue, approximately 59% resulted from the Company serving a
higher number of customers for its clients and approximately 41% was due to
increased revenue per customer. Customers serviced as of December 31, 1997 and
1996 were 21.1 million and 19.2 million, respectively, an increase of 10.1%.
The increase in the number of customers serviced was due primarily to internal
customer growth experienced by existing clients and the addition of new
clients. Total domestic revenue per customer account for 1997 was $7.73,
compared to $6.67 for 1996, an increase of 15.9%. Revenue per customer
increased due to price increases included in client contracts and increased
usage of ancillary services by existing clients.
Revenues from software and related product sales and professional consulting
services increased $21.5 million, or 114.1%, to $40.4 million in 1997, from
$18.9 million in 1996. This increase relates to the introduction of the
Company's new software products and professional consulting services in early
1996 with continued expansion throughout 1996 and 1997, and the inclusion of
revenues from CSGI's operations for all of 1997, whereas six months of
revenues for CSGI were included for 1996.
Cost of Processing and Related Services. Direct processing costs as a
percentage of related revenues were 44.3% for 1997, compared to 45.8% for
1996. The improvement between years relates primarily to better overall
leveraging of the direct processing costs as a result of the continued growth
of the customer base processed on the Company's system, and a reduction in
data processing costs resulting from the Company's renegotiated contract with
FDC effective January 1, 1997. Amortization of acquired software decreased
$0.4 million, or 3.7%, to $10.6 million in 1997, from $11.0 million in 1996,
due primarily to acquired software from the CSG Acquisition becoming fully
amortized as of November 30, 1997. Amortization of client contracts and
related intangibles increased $0.2 million, or 4.9%, to $4.3 million in 1997,
from $4.1 million in 1996 due primarily to amortization from the TCI Contract
executed in September 1997.
Gross Margin. Gross margin increased $23.7 million, or 40.9%, to $81.8
million in 1997, from $58.1 million in 1996, due primarily to revenue growth.
The gross margin as a percentage of total revenues increased to 47.6% in 1997,
compared to 43.9% in 1996. The increase in the gross margin as a percentage of
total revenues is due primarily to (i) a favorable change in revenue mix which
included more higher-margined software products, (ii) the increase in revenues
while the overall amount of amortization of acquired software and the
amortization of client contracts and related intangibles remained relatively
constant, and (iii) the improvement in the gross margin percentage for
processing and related services, due primarily to the increase in revenue per
customer while controlling the cost of delivering such services.
Research and Development Expense. R&D expense increased $2.4 million, or
11.8%, to $22.6 million in 1997, from $20.2 million in 1996. As a percentage
of total revenues, R&D expense decreased to 13.2% in 1997 from 15.3% in 1996.
The Company capitalized software development costs, related primarily to CSG
Phoenix, of approximately $9.7 million during 1997, which consisted of $8.4
million of internal development costs and
19
$1.3 million of purchased software. The Company capitalized software
development costs, related primarily to CSG Phoenix, ACSR Telephony and CSG
VantagePoint, of approximately $3.1 million in 1996, which consisted of $2.5
million of internal development costs and $0.6 million of purchased software.
As a result, total R&D expenditures (i.e., the total R&D costs expensed, plus
the capitalized internal development costs) for 1997 and 1996 were $31.0
million, or 18.0% of total revenues, and $22.7 million, or 17.2% of total
revenues, respectively. The overall increase in R&D expenditures is due
primarily to continued efforts on several products which are in development
and enhancements of the Company's existing products. The increased R&D
expenditures consist primarily of increases in salaries, benefits, contracted
programming services, and other programming-related expenses.
Selling and Marketing Expense. S&M expense increased $2.0 million, or 24.2%,
to $10.2 million in 1997, from $8.2 million in 1996. As a percentage of total
revenues, S&M expense decreased to 5.9% in 1997, compared to 6.2% in 1996. The
increase in expense is due primarily to continued growth of the Company's
direct sales force throughout 1996 and most of 1997. The Company began
building a new direct sales force in mid-1995 and continued to expand its
sales force through the end of 1997.
General and Administrative Expense. G&A expense increased $5.7 million, or
41.5%, to $19.4 million in 1997, from $13.7 million in 1996. As a percentage
of total revenues, G&A expense increased to 11.3% in 1997, from 10.4% in 1996.
The increase in expense relates primarily to (i) the continued expansion of
the Company's management team and related administrative staff, added
throughout 1996 and 1997, to support the Company's overall growth, (ii) an
increase in facility costs to support employee growth, including the cost of
relocating the Company's corporate headquarters, (iii) expenses of $0.7
million related to the closing of the TCI Contract and the SUMMITrak asset
purchase agreement, and (iv) the inclusion of G&A expenses from CSGI's
operations for all of 1997, whereas six months of G&A expenses for CSGI were
included for 1996.
Amortization of Noncompete Agreements and Goodwill. Amortization of
noncompete agreements and goodwill increased $0.5 million, or 8.4%, to $6.9
million in 1997, from $6.4 million in 1996. The increase in expense relates to
amortization of goodwill from the CSGI acquisition and amortization of an
additional noncompete agreement executed in April 1996.
Stock-Based Employee Compensation. During 1995 and 1994, the Company sold
Common Stock to executive officers and key employees pursuant to performance
stock agreements and recorded deferred compensation of $5.8 million related to
these purchases. Prior to the completion of the IPO, the deferred compensation
was being recognized as stock-based employee compensation expense on a
straight-line basis from the time the shares were purchased through November
30, 2001, as the shares became vested as of this date. Upon completion of the
IPO, shares owned by certain executive officers of the Company became fully
vested. In addition, the vesting for the remaining performance stock shares
decreased to 20.0% annually over a five-year period. As a result,
approximately $3.2 million of stock-based employee compensation expense was
recorded when the IPO was completed in March 1996. See Note 11 to the
Consolidated Financial Statements for additional discussion.
Depreciation Expense. Depreciation expense increased $1.8 million, or 34.4%,
to $6.9 million in 1997, from $5.1 million in 1996, with the increase
attributed to capital expenditures throughout 1996 and 1997 in support of the
overall growth of the Company. Depreciation expense for all property and
equipment is reflected separately in the aggregate and is not included in the
other components of operating expenses.
Operating Income (Loss). Operating loss was $106.5 million for 1997,
compared to operating income of $0.8 million for 1996. The change between
years relates primarily to the non-recurring charges recorded in the fourth
quarter of 1997, as discussed above. The Company's operating income margin,
excluding the Acquisition Charges and non-recurring charges discussed above,
was 21.0% for 1997, compared to 19.0% for 1996.
Interest Expense. Interest expense increased $1.1 million, or 27.7%, to $5.3
million in 1997, from $4.2 million in 1996, with the increase attributable
primarily to new debt incurred under the Term Credit Facility.
20
This increase was partially offset by the effects of (i) scheduled principal
payments on the Company's long-term debt, (ii) the retirement of $40.3 million
of long-term debt with the proceeds from the IPO in March 1996, and (iii) a
decrease in the Company's interest rate spread on LIBOR, as a result of the
Company favorably amending its long-term credit facility in April 1996.
Liquidity and Capital Resources
As of December 31, 1998, the Company's principal sources of liquidity
included cash and cash equivalents of $39.6 million and a revolving credit
facility with a bank in the amount of $40.0 million, of which there were no
borrowings outstanding as of December 31, 1998. The Company's ability to
borrow under the revolving credit facility is subject to maintenance of
certain levels of eligible receivables. At December 31, 1998, all of the $40.0
million revolving credit facility was available to the Company. The revolving
credit facility expires in September 2002. The Company's working capital as of
December 31, 1998 and 1997 was $7.1 million and $3.5 million, respectively.
As of December 31, 1998 and 1997, respectively, the Company had $60.5
million and $44.7 million in net billed trade accounts receivable, an increase
of $15.8 million, with the increase primarily a result of the Company's
revenue growth. The Company's trade accounts receivable balance includes
billings for several non-revenue items, such as postage, communication lines,
travel and entertainment reimbursements, sales tax, and deferred items. As a
result, the Company evaluates its performance in collecting its accounts
receivable through its calculation of days billings outstanding ("DBO") rather
than a typical days sales outstanding ("DSO") calculation. DBO is calculated
based on the billing for the period (including non-revenue items) divided by
the average net trade accounts receivable balance for the period. The
Company's DBO calculations for the years ended December 31, 1998 and 1997 were
56 days and 54 days, respectively.
The Company's net cash flows from operating activities for the years ended
December 31, 1998, 1997 and 1996 were $47.3 million, $31.4 million and $29.1
million, respectively. The increase of $15.9 million, or 50.6%, in 1998 over
1997 relates to a $20.1 million increase in net cash flows from operations,
offset by a decrease in the net change in operating assets and liabilities of
$4.2 million. The increase of $2.3 million, or 7.8%, in 1997 over 1996 relates
to a $9.2 million increase in net cash flows from operations, offset by a
decrease in the net change in operating assets and liabilities of $6.9
million.
The Company's net cash flows used in investing activities totaled $27.1
million in 1998, compared to $117.4 million in 1997, a decrease of $90.3
million. The decrease between years relates primarily to the cash payments of
$106.5 million for the SUMMITrak assets acquired in September 1997 and a
decrease of $8.7 million in capitalized software development costs between
years, with these decreases offset by (i) proceeds of $8.6 million from the
final disposition of Anasazi in 1997, (ii) cash payment of $6.0 million for
the acquisition of assets of USTATS, (iii) conversion incentive payments of
$4.0 million made in 1998, and (iv) an increase in purchases of net property
and equipment of $6.3 million (with the increase related to computer hardware
and related equipment and statement processing equipment and related
facilities). The Company's net cash flow used in investing activities totaled
$14.7 million in 1996. The increase of $102.7 million between 1996 and 1997
relates primarily to the cash payments of $106.5 million for the SUMMITrak
assets acquired in September 1997 and a increase of $6.6 million in
capitalized software development costs between years, with these increases
offset by proceeds of $8.6 million from the final disposition of Anasazi in
1997.
The Company's net cash flows used in financing activities was $1.1 million
in 1998, compared to net cash flows provided by financing activities of $100.7
million in 1997, a decrease of $101.8 million. The significant decrease
between years relates primarily to the net change in the Company's long-term
debt between years. In 1997, the Company generated $150.0 million from a new
debt agreement entered into primarily to fund the SUMMITrak asset acquisition,
and repaid long-term debt of $47.5 million, which included (i) $5.0 million of
scheduled payments on the previous debt agreement, (ii) $27.5 million of
existing debt which was refinanced as part of the new debt agreement, and
(iii) an optional prepayment of $15.0 million on the new debt. The scheduled
21
principal payments made in 1998 were $6.8 million. The net cash flows used in
financing activities totaled $12.1 million for 1996. The increase of $112.8
million between 1996 and 1997 relates primarily to the net change in the
Company's long-term debt between years. In addition, during 1996, the Company
sold 6,670,000 shares of Common Stock in its IPO, resulting in net proceeds to
the Company of approximately $44.8 million. The net proceeds from the IPO were
used to repay long-term debt of $40.3 million and to pay accrued dividends of
$4.5 million on Preferred Stock. As of the closing of the IPO in March 1996,
all of the 8,999,999 outstanding shares of the Preferred Stock were
automatically converted into 35,999,996 shares of Common Stock, at which time
the accrued dividends became payable.
Earnings from continuing operations (before extraordinary item and non-
recurring charges) before interest, taxes, depreciation and amortization
("EBITDA") for 1998 was $73.5 million or 31.0% of total revenues, compared to
$45.5 million or 26.5% of total revenues for 1997. EBITDA is presented here as
a measure of the Company's debt service ability and is not intended to
represent cash flows for the periods.
Interest rates for the Term Credit Facility and revolving credit facility
are chosen at the option of the Company and are based on the LIBOR rate or the
prime rate, plus an additional percentage spread, with the spread dependent
upon the Company's leverage ratio. As of December 31, 1998, the spread on the
LIBOR rate and prime rate was 0.75% and 0%, respectively. The Term Credit
Facility restricts, among other things, the payment of cash dividends or other
types of distributions on any class of the Company's stock unless the
Company's leverage ratio, as defined in the loan agreement, is under 1.50. As
of December 31, 1998, the leverage ratio was 1.63. See Note 6 to the
Consolidated Financial Statements for additional discussion of the Term Credit
Facility.
The purchase price for the SUMMITrak assets acquired in September 1997
included up to $26.0 million in conversion incentive payments. The timing of
the conversion incentive payments is based upon the achievement of certain
milestones by TCI and the Company, as specified in the SUMMITrak asset
acquisition agreement. The milestones are based principally upon the number of
TCI customers converted to, and the total number of TCI customers processed
on, the Company's customer care and billing system. Total payments as of
December 31, 1998 have been approximately $4.0 million. Based on the
conversions performed to date and the additional conversions scheduled as of
December 31, 1998, the Company expects to pay the remaining $22.0 million to
TCI in 1999. See Note 4 to the Consolidated Financial Statements for
additional discussion.
For income tax purposes, the amortization of the intangible assets from
acquisitions (including the intangible assets related to the CSG Acquisition
and the charge for purchased R&D related to the SUMMITrak asset acquisition)
are principally deductible over 15 years on a straight-line basis. The Company
has paid U.S. income taxes since its inception in 1994. Based on its current
projections, the Company expects to pay U.S. income taxes for 1999, and its
effective book income tax rate for 1999 is expected to be approximately 38%.
The Company continues to make significant investments in capital equipment,
facilities, and research and development. The Company had no significant
capital commitments as of December 31, 1998. The Company believes that cash
generated from operations, together with the current cash and cash equivalents
and the amount available under the revolving credit facility, will be
sufficient to meet its anticipated cash requirements for operations, income
taxes, debt service, conversion incentive payments and capital expenditures
for both its short and long-term purposes.
Market Risk
The Company is 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. The
Company has entered into an interest rate collar agreement to manage its
interest rate risk from the variable rate features of its long-term debt. The
Company does not utilize any derivative financial instruments for purposes of
managing its foreign currency exchange rate risk. The Company does not enter
into derivatives or other financial instruments for trading or speculative
purposes.
22
Interest Rate Risk. The Company had long-term debt (including current
maturities) of $128.3 million as of December 31, 1998. Interest rates for the
debt are chosen at the option of the Company and are based on the LIBOR rate
or the prime rate, plus an additional percentage spread, with the spread
dependent upon the Company's leverage ratio. As of December 31, 1998, the
spread on the LIBOR rate and prime rate was 0.75% and 0%, respectively. As of
December 31, 1998, the entire amount of the debt was under either one or six-
month LIBOR contracts with an overall weighted average interest rate of 5.89%
(i.e., LIBOR at 5.14% plus spread of 0.75%). The carrying amount of the
Company's long-term debt approximates fair value due to its variable interest
rate features. See Note 6 to the Consolidated Financial Statements for
additional description of the long-term debt and scheduled principal payments.
As required by the debt agreement with its bank, the Company entered into a
three-year interest rate collar in December 1997 with a major bank to manage
its risk from its variable rate long-term debt. The underlying notional amount
covered by the collar agreement is $71.3 million as of December 31, 1998, and
decreases over the three-year term in relation to the scheduled principal
payments on the long-term debt. Any payment on the 4.9% (LIBOR) interest rate
floor, or receipt on the 7.5% (LIBOR) interest rate cap component of the
collar, would be recognized as an adjustment to interest expense in the period
incurred. There are no amounts due or receivable under this agreement as of
December 31, 1998, and the agreement had no effect on the Company's interest
expense for 1998 or 1997. The fair value of the collar agreement is not
recognized in the Company's financial statements. The fair value of the collar
agreement at December 31, 1998, based on a quoted market price, was not
significant.
Foreign Exchange Rate Risk. The Company's foreign currency transactions
relate almost entirely to the operations conducted through its United Kingdom
("UK") subsidiary, CSGI. CSGI's transactions are executed primarily within the
UK and generally are denominated in British pounds. The Company does not
utilize any derivative financial instruments for purposes of managing its
foreign currency exchange rate risk. Exposure to variability in currency
exchange rates is mitigated by the fact that purchases and sales are typically
in the same currency with similar maturity dates and amounts. A hypothetical
adverse change of 10% in year-end exchange rates would not have a material
effect upon the Company's financial condition or results of operations.
TCI Contract and AT&T Merger
During the years ended December 31, 1998, 1997, and 1996, revenues from TCI
and affiliated companies represented approximately 37.4%, 32.9%, and 25.9% of
the Company's total revenues. The TCI Contract has a 15-year term and expires
in 2012. The TCI Contract has minimum financial commitments over the 15-year
life of the contract and includes exclusive rights to provide customer care
and billing products and services for TCI's offerings of wireline video, all
Internet/high-speed data services, residential wireline telephony services,
and print and mail services. The TCI Contract provides certain performance
criteria and other obligations to be met by the Company. The Company is
required to perform certain remedial efforts and is subject to certain
penalties if it fails to meet the performance criteria or other obligations.
The Company is also subject to an annual technical audit to determine whether
the Company's products and services include innovations in features and
functions that have become standard in the wireline video industry. To date,
the Company believes it has complied with the terms of the contract, and has
converted onto its processing system approximately 8 million of the over 9
million TCI customers originally scheduled to be converted under the TCI
Contract. The remaining customers are scheduled to be converted to the
Company's processing system by the second quarter of 1999.
AT&T completed its merger with TCI in March 1999. At this time, it is too
early to determine the near- and long-term impact, if any, the merger will
have on the Company's relationship with the combined entity. However, the
Company expects to continue performing successfully under the TCI Contract,
and is hopeful that it can continue to sell products and services to the
combined entity that are in excess of the minimum financial commitments
included in the contract.
23
Year 2000
The Company's business is dependent upon various computer software programs
and operating systems that utilize dates and process data beyond the year
2000. The Company's actions to address the risks associated with the year 2000
are as follows:
The Company's State of Readiness. The Company has established a corporate
program to coordinate its year 2000 ("Y2K") compliance efforts across all
business functions and geographic areas. The scope of the program includes
addressing the risks associated with the Company's (i) information technology
("IT") systems (including the Company's products and services), (ii) non-IT
systems that include embedded technology, and (iii) significant vendors and
their Y2K readiness. The Company is utilizing the following steps in executing
its Y2K compliance program: (1) awareness, (2) assessment, (3) renovation
(including upgrades and enhancements to the Company's products), (4)
validation and testing, and (5) implementation. The Company has completed the
awareness and assessment steps for all areas.
Products and Services. The renovation step has been substantially completed
for all significant products and services, and the Company now is focusing
its efforts on validation and testing. The Company's most significant
renovation effort involved its core product, Communications Control System
("CCS"). CCS utilizes one subroutine for calculating dates, with the
various computer programs within CCS with date dependent calculations
accessing this subroutine. As a result, all date calculations are performed
in one location. The renovation of this subroutine and the related
interfaces to the various date dependent programs has been completed. The
Company is now testing CCS using its standard testing methodologies, while
adding date simulation to specifically address the Y2K risk. Such date
simulation considers pre-2000, cross over, and post-2000 time frames,
including year 2000 leap year considerations. As of February 28, 1999,
approximately 90-95% of the testing for CCS was completed, with the
remaining testing consisting primarily of third party interfaces to CCS.
The Company is dependent upon the third parties for such testing, which is
expected to be completed in its entirety by the end of the second quarter
of 1999. The interfaces are not complex and are considered low risk by the
Company. Implementation into the production environment is expected to
occur shortly after testing is completed.
For the Company's software products, no significant renovation is believed
necessary as the products are relatively new and were designed to be Y2K
compliant. The Company plans to test these products with similar date
simulation techniques discussed above to ensure they are Y2K compliant.
Such testing is expected to be substantially completed by the end of the
first quarter of 1999, with the remaining testing expected to be done by
the end of the second quarter of 1999.
The Company is currently developing a process to manage further updates or
enhancements to any product related software code which has been tested and
internally certified as Y2K compliant, and is considering a plan to
"freeze" all changes to mission critical product related software after
November 1999. The Company also plans to retest CCS (through an initial
program load of the CCS system) in the fourth quarter of 1999 to ensure
continued Y2K compliance. Several CSG clients are conducting tests of the
Company's products in conjunction with their own operating environments.
Several test phases have been completed (beginning in December 1998), with
additional phases continuing into the second quarter of 1999, including
participation by TCI in such testing.
Internal Systems. Renovation and/or testing of the Company's significant
internal use IT Systems (e.g., payroll systems, accounting systems, etc.)
is underway and is expected to be substantially completed by the end of the
first quarter of 1999, with all systems expected to be tested and
implemented by the end of the second quarter of 1999. The Company has a
substantial number of non-IT systems that include embedded technology
(e.g., buildings, plant, equipment and other infrastructure) that are owned
and managed by the lessors of the buildings in which the Company is
located. The Company has sent letters to its lessors requesting
certifications of the Y2K compliance of the embedded systems. The Company
has received some of the certifications from lessors and expects to receive
the remaining certifications by the end of the second quarter of 1999.
Letters have also been sent to third parties providing other internal non-
IT systems with embedded technology (e.g., statement insertion machines,
copy machines, etc.). Y2K certifications and/or upgrades are expected be
substantially complete by the end of the first quarter of 1999, with all
systems
24
completed by the end of the second quarter of 1999. The Company is
currently assessing whether any testing of significant non-IT systems will
be required.
Significant Vendors. As part of the Company's Y2K compliance program, the
Company has contacted its significant vendors to assess their Y2K
readiness. For substantially all mission critical third party software
embedded in or specified for use in conjunction with the Company's IT
systems and products, the Company's communications with the vendors
indicates that the vendors believe they are fully Y2K compliant as of
December 31, 1998. The remaining vendors indicate that they are
substantially Y2K compliant as of December 31, 1998. The Company expects to
receive further enhancements from these vendors as they become available
throughout 1999 to bring the products into full Y2K compliance. Such third
party software has been or is being tested in conjunction with the testing
of the IT systems and products discussed above. All other significant
vendors (including the Company's vendor who provides data processing
services for CCS) have indicated they are substantially Y2K compliant as of
December 31, 1998, except for one of the Company's vendors which provides
data lines access for CCS. This vendor indicates that it expects to be Y2K
compliant by the end of the first quarter of 1999. There can be no
assurance that (i) the Company's significant vendors will succeed in their
Y2K compliance efforts, or (ii) the failure of vendors to address Y2K
compliance will not have a material adverse effect on the Company's
business or results of operations.
The Costs to Address the Company's Year 2000 Issues. Since inception of its
program in 1995 through December 31, 1998, the Company has incurred and
expensed costs of approximately $2.8 million related to Y2K compliance
efforts. The total estimated costs to complete the Company's Y2K compliance
effort are approximately $1.5 million. The estimated costs to complete, which
does not include any costs which may be incurred by the Company if its
significant vendors fail to timely address Y2K compliance, is based on
currently known circumstances and various assumptions regarding future events.
However, there can be no assurance that these estimates will be achieved and
actual results could differ materially from those anticipated.
The Risks of the Company's Year 2000 Issues. The Company's failure to timely
resolve the Y2K risks could result in system failures, the generation of
erroneous information, and other significant disruptions of business
activities, including among others, access to CCS and the use of related
software products, and timely printing and delivery of clients' customers'
statements. Although the Company believes it will be successful in its Y2K
compliance efforts, there can be no assurance that the Company's systems and
products contain all necessary date code changes. In addition, the Company's
operations may be at risk if its vendors and other third parties (including
public and private infrastructure services, such as electricity, water, gas,
transportation, and communications) fail to adequately address the Y2K issue
or if software conversions result in system incompatibilities with these third
parties. To the extent that either the Company or a third party vendor or
service provider on which the Company relies does not achieve Y2K compliance,
the Company's results of operations could be materially adversely affected.
Furthermore, it has been widely reported that a significant amount of
litigation surrounding business interruption will arise out of Y2K issues. It
is uncertain whether, or to what extent, the Company may be affected by such
litigation.
As is the case with many software companies and service providers, if the
Company's current or future clients experience significant business
interruptions due to their failure to achieve Y2K compliance, the Company's
results of operations could be materially adversely affected. There can be no
assurance that the Company's current or future clients will adequately and
successfully address their Y2K risk and not experience any business
interruptions.
The Company's Contingency Plan. The Company intends to address the need for
any Y2K specific contingency plan as part of its overall business continuity
planning, with modifications to the plan where Y2K specific exposures are
identified as the Company continues to execute its Y2K compliance project
during 1999. The Company is establishing a Y2K task force for all mission
critical operations of the Company which will provide dedicated personnel to
escalate the resolution of any Y2K specific matters that may occur. The
Company is also implementing a restricted vacation policy for December 1999
and January 2000 to ensure all mission critical personnel are available if any
Y2K specific matters occur.
25
The (i) inability to timely implement a contingency plan, if deemed
necessary, and (ii) the cost to develop and implement such a plan, may have a
material adverse effect on the Company's results of operations.
Certain Factors That May Affect Future Results of Operations. Except for
statements of existing or historical facts, the foregoing discussion of Y2K
consists of forward-looking statements and assumptions relating to forward-
looking statements, including without limitation the statements relating to
future costs, the timetable for completion of Y2K compliance efforts,
potential problems relating to Y2K, the Company's state of readiness, third
party representations, and the Company's plans and objectives for addressing
Y2K problems. Certain factors could cause actual results to differ materially
from the Company's expectations, including without limitation (i) the failure
of vendors and service providers (such as the vendors of data processing
services and data lines access for CCS and providers of third party software)
to timely achieve Y2K compliance, (ii) system incompatibilities with third
parties resulting from software conversions, (iii) the Company's systems and
products not containing all necessary date code changes, (iv) the failure of
existing or future clients to achieve Y2K compliance, (v) potential litigation
arising out of Y2K issues, the risk of which may be greater for information
technology based service providers such as the Company, (vi) the failure of
the Company's validation and testing phase to detect operational problems
internal to the Company, in the Company's products or services or in the
Company's interface with service providers, vendors or clients, whether such
failure results from the technical inadequacy of the Company's validation and
testing efforts, the technological infeasibility of testing certain non-IT
systems, the perceived cost-benefit constraints against conducting all
available testing, or the unavailability of third parties to participate in
testing, or (vii) the failure to timely implement a contingency plan to the
extent Y2K compliance is not achieved.
26
Item 8. Financial Statements and Supplementary Data
CSG SYSTEMS INTERNATIONAL, INC.
CONSOLIDATED FINANCIAL STATEMENTS
INDEX
Report of Independent Public Accountants................................... 28
Consolidated Balance Sheets as of December 31, 1998 and 1997............... 29
Consolidated Statements of Operations for the Years Ended December 31,
1998, 1997 and 1996....................................................... 30
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996.......................................... 31
Consolidated Statements of Cash Flows for the Years Ended December 31,
1998, 1997 and 1996....................................................... 32
Notes to Consolidated Financial Statements................................. 33
27
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
CSG Systems International, Inc.:
We have audited the accompanying consolidated balance sheets of CSG Systems
International, Inc. (a Delaware corporation) and Subsidiaries as of December
31, 1998 and 1997, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of CSG Systems International,
Inc. and Subsidiaries as of December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Omaha, Nebraska
January 20, 1999
28
CSG SYSTEMS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
December 31,
------------------
1998 1997
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................ $ 39,593 $ 20,417
Accounts receivable--
Trade--
Billed, net of allowance of $2,051 and $1,394........ 60,529 44,678
Unbilled............................................. 2,828 2,080
Other.................................................. 1,179 1,400
Deferred income taxes.................................... 1,803 443
Other current assets..................................... 2,275 2,664
-------- --------
Total current assets............................... 108,207 71,682
-------- --------
Property and equipment, net................................ 24,711 17,157
Software, net.............................................. 9,422 1,959
Noncompete agreements and goodwill, net.................... 7,596 13,938
Client contracts and related intangibles, net.............. 59,791 64,640
Deferred income taxes...................................... 59,389 6,909
Other assets............................................... 2,380 3,064
-------- --------
Total assets....................................... $271,496 $179,349
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt..................... $ 19,125 $ 6,750
Customer deposits........................................ 10,018 7,002
Trade accounts payable................................... 10,471 11,795
Accrued employee compensation............................ 12,276 5,719
Deferred revenue......................................... 13,470 10,619
Conversion incentive payments............................ 22,032 17,768
Accrued income taxes..................................... 6,756 3,207
Other current liabilities................................ 7,009 5,304
-------- --------
Total current liabilities.......................... 101,157 68,164
-------- --------
Non-current liabilities:
Long-term debt, net of current maturities................ 109,125 128,250
Deferred revenue......................................... 216 7,789
Conversion incentive payments............................ -- 8,232
-------- --------
Total non-current liabilities...................... 109,341 144,271
-------- --------
Commitments and contingencies (Note 9)
Stockholders' equity (deficit):
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; 11,421,416 and 11,993,126 shares
reserved for common stock warrants, employee stock
purchase plan and stock incentive plans; 51,465,646 and
50,959,936 shares outstanding (Note 2).................. 515 510
Common stock warrants; 3,000,000 warrants issued and
outstanding............................................. 26,145 26,145
Additional paid-in capital............................... 120,599 112,615
Deferred employee compensation........................... (328) (636)
Notes receivable from employee stockholders.............. (478) (685)
Cumulative translation