FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _________________ Commission file number 0-27512 CSG SYSTEMS INTERNATIONAL, INC. (Exact name of registrant as specified in its charter) DELAWARE 47-0783182 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 7887 EAST BELLEVIEW, SUITE 1000 ENGLEWOOD, COLORADO 80111 (Address of principal executive offices, including zip code) (303) 796-2850 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES [X] No [ ] Shares of common stock outstanding at August 9, 2001: 53,216,397 ----------
CSG SYSTEMS INTERNATIONAL, INC. FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2001 INDEX <TABLE> <CAPTION> PAGE NO. -------- <S> <C> Part I - FINANCIAL INFORMATION Item 1. Condensed Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000.................................................................. 3 Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2001 and 2000 ............................................... 4 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2001 and 2000................................................ 5 Notes to Condensed Consolidated Financial Statements............................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................................. 9 Item 3. Quantitative and Qualitative Disclosures About Market Risk......................... 16 Part II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders................................ 17 Item 6. Exhibits and Reports on Form 8-K................................................... 17 Signatures......................................................................... 18 Index to Exhibits.................................................................. 19 </TABLE> 2
CSG SYSTEMS INTERNATIONAL, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 2001 2000 ------------ ----------- (UNAUDITED) ASSETS ------ <S> <C> <C> Current assets: Cash and cash equivalents $ 31,436 $ 32,751 Short-term investments.................................................................. 24,096 10,982 --------- -------- Total cash, cash equivalents and short-term investments.............................. 55,532 43,733 Accounts receivable- Trade- Billed, net of allowance of $5,217 and $5,001...................................... 101,181 128,902 Unbilled........................................................................... 20,597 4,306 Other................................................................................ 2,994 1,259 Deferred income taxes................................................................... 4,078 3,247 Other current assets.................................................................... 7,802 7,507 --------- -------- Total current assets................................................................. 192,184 188,954 Property and equipment, net of depreciation of $49,032 and $42,457......................... 39,145 36,630 Software, net of amortization of $36,627 and $39,112....................................... 3,354 4,284 Goodwill, net of amortization of $3,637 and $4,883......................................... 1,532 1,894 Client contracts and related intangibles, net of amortization of $28,718 and $28,855....... 66,190 52,368 Deferred income taxes...................................................................... 43,368 47,331 Other assets............................................................................... 521 628 --------- -------- Total assets......................................................................... $ 346,294 $332,089 ========= ======== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Current maturities of long-term debt.................................................... $ 32,500 $ 25,436 Client deposits......................................................................... 13,095 12,391 Trade accounts payable.................................................................. 12,264 14,850 Accrued employee compensation........................................................... 19,210 19,147 Deferred revenue....................................................................... 28,568 8,172 Accrued income taxes.................................................................... 1,772 15,633 Other current liabilities............................................................... 14,930 12,008 --------- -------- Total current liabilities............................................................ 122,339 107,637 --------- -------- Non-current liabilities: Long-term debt, net of current maturities............................................... 13,000 32,820 Deferred revenue........................................................................ 307 463 --------- -------- Total non-current liabilities........................................................ 13,307 33,283 --------- -------- Stockholders' equity: Preferred stock, par value $.01 per share; 10,000,000 shares authorized; zero shares issued and outstanding.................................................... - - Common stock, par value $.01 per share; 100,000,000 shares authorized; 53,172,490 shares and 52,530,203 shares outstanding................................... 573 543 Common stock warrants; zero and 2,000,000 warrants outstanding.......................... - 17,430 Additional paid-in capital.............................................................. 247,019 180,750 Accumulated other comprehensive income (loss): Unrealized gain (loss) on short-term investments, net of tax.......................... 7 (350) Cumulative translation adjustments.................................................... (799) (654) Treasury stock, at cost, 4,110,986 shares and 1,830,986 shares.......................... (156,692) (71,497) Accumulated earnings.................................................................... 120,540 64,947 --------- -------- Total stockholders' equity........................................................... 210,648 191,169 --------- -------- Total liabilities and stockholders' equity........................................... $ 346,294 $332,089 ========= ======== </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 3
<TABLE> <CAPTION> CSG SYSTEMS INTERNATIONAL, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) THREE MONTHS ENDED SIX MONTHS ENDED ------------------------------ ---------------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 2001 2000 2001 2000 ------------ ----------- ----------- ----------- <S> <C> <C> <C> <C> Revenues: Processing and related services.......................... $ 83,469 $ 72,921 $ 162,567 $ 143,548 Software and professional services....................... 36,617 23,141 71,618 44,577 ------------ ----------- ----------- ----------- Total revenues........................................ 120,086 96,062 234,185 188,125 ------------ ----------- ----------- ----------- Cost of Revenues: Cost of processing and related services.................. 29,862 26,315 58,377 52,085 Cost of software and professional services............... 14,093 9,903 27,372 20,419 ------------ ----------- ----------- ----------- Total cost of revenues................................ 43,955 36,218 85,749 72,504 ------------ ----------- ----------- ----------- Gross margin (exclusive of depreciation)..................... 76,131 59,844 148,436 115,621 ------------ ----------- ----------- ----------- Operating expenses: Research and development................................. 13,566 10,366 25,177 20,254 Selling, general and administrative...................... 13,111 11,084 26,651 21,172 Depreciation............................................. 3,518 2,962 6,868 5,774 ------------ ----------- ----------- ----------- Total operating expenses.............................. 30,195 24,412 58,696 47,200 ------------ ----------- ----------- ----------- Operating income............................................. 45,936 35,432 89,740 68,421 ------------ ----------- ----------- ----------- Other income (expense): Interest expense........................................ (813) (1,482) (1,895) (3,023) Interest and investment income, net..................... 887 1,355 1,834 2,618 Other................................................... (4) (24) (23) (17) ------------ ----------- ----------- ----------- Total other........................................... 70 (151) (84) (422) ------------ ----------- ----------- ----------- Income before income taxes................................... 46,006 35,281 89,656 67,999 Income tax provision..................................... (17,479) (13,295) (34,063) (25,704) ------------ ----------- ----------- ----------- Net income................................................... $ 28,527 $ 21,986 $ 55,593 $ 42,295 ============ ========== ========== =========== Basic net income per common share: Net income available to common stockholders.............. $ 0.54 $ 0.42 $ 1.06 $ 0.81 ============ ========== ========== =========== Weighted average common shares........................... 52,867 52,158 52,668 52,007 ============ ========== ========== =========== Diluted net income per common share: Net income available to common stockholders.............. $ 0.52 $ 0.39 $ 1.01 $ 0.74 ============ ========== ========== =========== Weighted average common shares........................... 54,915 56,910 55,025 56,870 ============ ========== ========== =========== </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 4
<TABLE> <CAPTION> CSG SYSTEMS INTERNATIONAL, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED (in thousands) SIX MONTHS ENDED ---------------------------- JUNE 30, JUNE 30, 2001 2000 ------------ ----------- <S> <C> <C> Cash flows from operating activities: Net income................................................................................... $ 55,593 $ 42,295 Adjustments to reconcile net income to net cash provided by operating activities- Depreciation............................................................................... 6,868 5,774 Amortization............................................................................... 3,931 3,663 Loss on short-term investment.............................................................. 655 - Deferred income taxes...................................................................... 2,916 2,671 Stock-based employee compensation.......................................................... - 45 Changes in operating assets and liabilities: Trade accounts and other receivables, net................................................ 9,695 (13,432) Other current and noncurrent assets...................................................... (470) (1,643) Accounts payable and accrued liabilities................................................. 4,313 (1,477) ------------ ----------- Net cash provided by operating activities............................................. 83,501 37,896 ------------ ----------- Cash flows from investing activities: Purchases of property and equipment.......................................................... (9,370) (11,513) Purchases of short-term investments.......................................................... (33,690) - Proceeds from sale of short-term investments................................................. 20,494 - Acquisitions of and investments in client contracts.......................................... (1,274) - ------------ ----------- Net cash used in investing activities................................................. (23,840) (11,513) ------------ ----------- Cash flows from financing activities: Proceeds from issuance of common stock....................................................... 13,039 9,100 Proceeds from exercise of stock warrants..................................................... 24,000 - Repurchase of common stock................................................................... (85,195) (2,987) Payments on notes receivable from employee stockholders...................................... - 44 Payments on long-term debt................................................................... (12,756) (11,000) ------------ ----------- Net cash used in financing activities................................................. (60,912) (4,843) ------------ ----------- Effect of exchange rate fluctuations on cash................................................... (64) (462) ------------ ----------- Net increase (decrease) in cash and cash equivalents........................................... (1,315) 21,078 Cash and cash equivalents, beginning of period................................................. 32,751 48,676 ------------ ----------- Cash and cash equivalents, end of period....................................................... $ 31,436 $ 69,754 ============ =========== Supplemental disclosures of cash flow information: Cash paid during the period for- Interest.................................................................................. $ 1,305 $ 3,140 Income taxes.............................................................................. $ 33,125 $ 14,865 Noncash operating and investing activities: During the six months ended June 30, 2001, the Company acquired certain client contract rights valued at approximately $15.0 million in exchange for the performance of certain future services. </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 5
CSG SYSTEMS INTERNATIONAL, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED 1. GENERAL The accompanying condensed consolidated financial statements at June 30, 2001, and for the three and six months then ended, are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the interim periods. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with management's discussion and analysis of financial condition and results of operations, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2000, filed with the Securities and Exchange Commission (the Company's 2000 10-K). The results of operations for the three and six months ended June 30, 2001, are not necessarily indicative of the results to be expected for the entire year ending December 31, 2001. 2. STOCKHOLDERS' EQUITY Common Stock Warrants. On February 28, 2001, AT&T exercised its rights under the Warrants to purchase 2.0 million shares of the Company's Common Stock at an exercise price of $12 per share, for a total exercise price of $24.0 million. Immediately following the exercise of the Warrants, the Company repurchased the 2.0 million shares for $37.00 per share (approximately the closing price on February 28, 2001) for a total repurchase price of $74.0 million, pursuant to the Company's stock repurchase program. As a result, the net cash outlay paid to AT&T for this transaction was $50.0 million, which was paid by the Company with available corporate funds. After this transaction, AT&T no longer has any warrants or other rights to purchase the Company's Common Stock. Stock Repurchase Program. In August 1999, the Company's Board of Directors approved a stock repurchase program which authorized the Company at its discretion to purchase up to a total of 5.0 million shares of its Common Stock from time-to-time as market and business conditions warrant. This program represents approximately 10% of the Company's outstanding shares. During the three months ended June 30, 2001, the Company did not repurchase any shares under the program. During the three months ended March 31, 2001, the Company repurchased 2.28 million shares under the program for approximately $85.2 million (a weighted-average price of $37.37 per share), including the 2.0 million shares repurchased as part of the AT&T warrant exercise discussed above. As of June 30, 2001, the Company has purchased a total of 4.03 million shares for approximately $156.5 million (a weighted-average price of $38.88 per share) since the program was announced in 1999. The repurchased shares are held as treasury shares. Income Tax Benefit from Exercise of Stock Options. Income tax benefits associated with nonqualified stock options and disqualifying dispositions of incentive stock options reduced accrued income taxes by $10.9 million and $1.2 million for the three months ended June 30, 2001 and 2000, and $11.8 million and $6.2 million for the six months ended June 30, 2001 and 2000, respectively. Such benefits were recorded as an increase to additional paid-in capital and are included in net cash provided by operating activities in the Company's Condensed Consolidated Statements of Cash Flows. 3. NET INCOME PER COMMON SHARE Basic net income per common share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income per common share is consistent with the calculation of basic net income per common share while giving effect to dilutive potential common shares outstanding during the period. Basic and diluted earnings per share (EPS) are presented on the face of the Company's Condensed Consolidated Statements of Income. No 6
reconciliation of the EPS numerators is necessary as net income is used as the numerator for each period presented. The reconciliation of the EPS denominators is as follows (in thousands): <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ------------------------------------------------------- 2001 2000 2001 2000 ------------------------------------------------------- <S> <C> <C> <C> <C> Basic common shares outstanding................... 52,867 52,158 52,668 52,007 Dilutive effect of common stock options........... 2,048 2,471 1,886 2,582 Dilutive effect of common stock warrants.......... - 2,281 471 2,281 ------ ------ ------ ------ Diluted common shares outstanding................. 54,915 56,910 55,025 56,870 ====== ====== ====== ====== </TABLE> Common Stock options of 123,400 shares and 92,000 shares for the three months ended June 30, 2001 and 2000, and 407,400 and 92,000 shares for the six months ended June 30, 2001 and 2000, respectively, have been excluded from the computation of diluted EPS because the exercise prices of these options were greater than the average market price of the common shares for the respective periods. 4. COMPREHENSIVE INCOME The Company's components of comprehensive income were as follows (in thousands): <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ---------------------------------------- 2001 2000 2001 2000 ---------------------------------------- <S> <C> <C> <C> <C> Net income............................................... $28,527 $21,986 $55,593 $42,295 Other comprehensive income (loss), net of tax, if any: Foreign currency translation adjustments................. 14 (300) (145) (403) Reclassification adjustment for loss included in net income................................................... --- --- 335 --- Unrealized gain (loss) on short-term investments......... (5) --- 22 --- ------- ------- ------- ------- Comprehensive income..................................... $28,536 $21,686 $55,805 $41,892 ======= ======= ======= ======= </TABLE> 5. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 141, "Business Combinations" (SFAS 141). SFAS 141 addresses financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, "Business Combinations". SFAS 141 introduces a single-method approach to accounting for business combinations, requiring the use of the purchase method and eliminating the use of the pooling-of-interests approach. In addition, SFAS 141 changes the criteria for the separate recognition of intangible assets in a business combination. SFAS 141 is effective for all business combinations initiated after June 30, 2001, and for all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001 or later. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). SFAS 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supercedes APB Opinion No. 17, "Intangible Assets". SFAS 142 addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in the financial statements upon their acquisition. SFAS 142 also addresses how goodwill and other intangibles should be accounted for after 7
they have been initially recognized in the financial statements. SFAS 142 is required to be applied by the Company beginning January 1, 2002 to all goodwill and other intangible assets recognized in the financial statements at that date. Goodwill and intangible assets acquired after June 30, 2001, are subject immediately to the nonamortization and amortization provisions of SFAS 142. The Company expects to adopt SFAS 141 and 142 on January 1, 2002. The adoption of SFAS 141 and 142 is not expected to have a significant effect on the Company's consolidated financial statements. 8
CSG SYSTEMS INTERNATIONAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations The following table sets forth certain financial data and the percentage of total revenues of the Company for the periods indicated (in thousands): <TABLE> <CAPTION> THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------------------------------- --------------------------------------- 2001 2000 2001 2000 ----------------- ----------------- ----------------- ------------------ % OF % OF % OF % OF AMOUNT REVENUE AMOUNT REVENUE AMOUNT REVENUE AMOUNT REVENUE ------ ------- ------ ------- ------ ------- ------ ------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Revenues: Processing and related services $ 83,469 69.5% $ 72,921 75.9% $162,567 69.4% $143,548 76.3% Software and professional services 36,617 30.5 23,141 24.1 71,618 30.6 44,577 23.7 -------- ----- -------- ----- -------- ----- -------- ----- Total revenues 120,086 100.0 96,062 100.0 234,185 100.0 188,125 100.0 -------- ----- -------- ----- -------- ----- -------- ----- Cost of Revenues: Cost of processing and related services 29,862 24.9 26,315 27.4 58,377 24.9 52,085 27.7 Cost of software and professional services 14,093 11.7 9,903 10.3 27,372 11.7 20,419 10.8 -------- ----- -------- ----- -------- ----- -------- ----- Total cost of revenues 43,955 36.6 36,218 37.7 85,749 36.6 72,504 38.5 -------- ----- -------- ----- -------- ----- -------- ----- Gross margin (exclusive of depreciation 76,131 63.4 59,844 62.3 148,436 63.4 115,621 61.5 -------- ----- -------- ----- -------- ----- -------- ----- Operating expenses: Research and development 13,566 11.3 10,366 10.8 25,177 10.8 20,254 10.8 Selling, general and administrative 13,111 10.9 11,084 11.5 26,651 11.4 21,172 11.2 Depreciation 3,518 2.9 2,962 3.1 6,868 2.9 5,774 3.1 -------- ----- -------- ----- -------- ----- -------- ----- Total operating expenses 30,195 25.1 24,412 25.4 58,696 25.1 47,200 25.1 -------- ----- -------- ----- -------- ----- -------- ----- Operating income 45,936 38.3 35,432 36.9 89,740 38.3 68,421 36.4 -------- ----- -------- ----- -------- ----- -------- ----- Other income (expense): Interest expense (813) (0.7) (1,482) (1.6) (1,895) (0.8) (3,023) (1.6) Interest and investment income, net 887 0.7 1,355 1.4 1,834 0.8 2,618 1.4 Other (4) - (24) - (23) - (17) - -------- ----- -------- ----- -------- ----- -------- ----- Total other 70 - (151) (0.2) (84) - (422) (0.2) -------- ----- -------- ----- -------- ----- -------- ----- Income before income taxes 46,006 38.3 35,281 36.7 89,656 38.3 67,999 36.2 Income tax provision (17,479) (14.5) (13,295) (13.8) (34,063) (14.6) (25,704) (13.7) -------- ----- -------- ----- -------- ----- -------- ----- Net income $ 28,527 23.8% $ 21,986 22.9% $ 55,593 23.7% $ 42,295 22.5% ======== ===== ======== ===== ======== ===== ======== ===== </TABLE> 9
THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000 Revenues. Total revenues for the three months ended June 30, 2001, increased 25.0% to $120.1 million, from $96.1 million for the three months ended June 30, 2000. Revenues from processing and related services for the three months ended June 30, 2001, increased 14.5% to $83.5 million, from $72.9 million for the three months ended June 30, 2000. Of the total increase in these revenues, approximately 83% resulted from an increase in the number of customers of the Company's clients which were serviced by the Company and approximately 17% was due to increased revenue per customer. Customers served were as follows (in thousands): As of June 30, ------------------------------------------- 2001 2000 Increase ------------------------------------------- Video................... 35,830 32,864 2,966 Internet................ 2,640 1,453 1,187 Telephony............... 738 217 521 ------ ------ ----- Total................... 39,208 34,534 4,674 ====== ====== ===== 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. From July 1, 2000 through June 30, 2001, the Company converted and processed approximately 3.0 million new customers on its systems, including approximately 1.6 million for the second quarter of 2001. As of June 30, 2001, the Company had a total conversion backlog of approximately 3.2 million customers, which are expected to be converted to the Company's processing system during the remainder of 2001. Total annualized processing revenue per video and Internet account was as follows: For the three months ended June 30, -------------------------------------- Increase 2001 2000 (Decrease) -------------------------------------- Video account................ $8.70 $8.44 3.1% Internet account............. $4.96 $5.31 (6.6%) The change in processing revenues per account relates primarily to (i) changes in the usage of ancillary services by clients, (ii) the introduction of new products and services and the clients use of these products and services, and (iii) price changes included in client contracts (e.g., price escalators for inflationary factors, tiered pricing, etc.). Revenues from software and professional services for the three months ended June 30, 2001, increased 58.2% to $36.6 million, from $23.2 million for the three months ended June 30, 2000. The Company sells its software products and professional services principally to its existing client base to (i) enhance the core functionality of its service bureau processing application, (ii) increase the efficiency and productivity of its clients' operations, and (iii) allow clients to effectively rollout new products and services to new and existing markets. The increase in revenue between periods relates to the continued demand for the Company's existing software products and services to meet the changing needs of the Company's client base. Cost of Processing and Related Services. Processing costs as a percentage of related processing revenues were 35.8% for the three months ended June 30, 2001, compared to 36.1% for the three months ended June 30, 2000. The costs as a percentage of related revenues remained relatively unchanged between periods as the Company continues to (i) focus on cost controls and cost reductions within its core processing business, and (ii) experience better overall leveraging of its processing costs as a result of the continued growth of the customer base processed on the Company's systems. 10
Cost of Software and Professional Services. The cost of software and professional services as a percentage of related revenues was 38.5% for the three months ended June 30, 2001, compared to 42.8% for the three months ended June 30, 2000. The improvement between periods relates primarily to better overall leveraging of costs as a result of higher software and professional services revenues for the quarter. Gross Margin. Overall gross margin for the three months ended June 30, 2001, increased 27.2% to $76.1 million, from $59.8 million for the three months ended June 30, 2000, due primarily to revenue growth. The overall gross margin percentage increased to 63.4% for the three months ended June 30, 2001, compared to 62.3% for the three months ended June 30, 2000. The overall increase in the gross margin percentage is due primarily to the increase in gross margin for software and professional services due to the factors discussed above. Research and Development Expense. Research and development (R&D) expense for the three months ended June 30, 2001, increased 30.9% to $13.6 million, from $10.4 million for the three months ended June 30, 2000. As a percentage of total revenues, R&D expense increased to 11.3% for the three months ended June 30, 2001, from 10.8% for the three months ended June 30, 2000. The Company did not capitalize any software development costs during the three months ended June 30, 2001 and 2000. The overall increase in the R&D expenditures between periods is due primarily to increased efforts on several products which are in development and enhancements of the Company's existing products. The Company's development efforts for the second quarter of 2001 were focused primarily on the development of products to: . address the international customer care and billing system market, . increase the efficiencies and productivity of its clients' operations, . address the systems needed to support the convergence of the communications markets, . support a web-enabled, customer self-care and electronic bill presentment/payment application, and . allow clients to effectively rollout new products and services to new and existing markets, such as residential telephony, High-Speed Data/ISP and IP markets. The Company expects its development efforts to focus on similar tasks through the remainder of 2001. Selling, General and Administrative Expense. Selling, general and administrative (SG&A) expense for the three months ended June 30, 2001, increased 18.3% to $13.1 million, from $11.1 million for the three months ended June 30, 2000. The increase in SG&A expense relates primarily to sales and administrative costs to support the Company's overall growth and its international business expansion. As a percentage of total revenues, SG&A expense decreased to 10.9% for the three months ended June 30, 2001, from 11.5% for the three months ended June 30, 2000. The decrease in SG&A expenses as a percentage of total revenues is due primarily to revenues increasing at a faster pace than the SG&A expenses. Depreciation Expense. Depreciation expense for the three months ended June 30, 2001, increased 18.8% to $3.5 million, from $3.0 million for the three months ended June 30, 2000. The increase in expense relates to capital expenditures made during the last six months of 2000 and the first six months of 2001 in support of the overall growth of the Company, consisting principally of (i) computer hardware and related equipment, (ii) statement processing equipment, and (iii) facilities and internal infrastructure expansion. 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. Operating income for the three months ended June 30, 2001, was $45.9 million or 38.3% of total revenues, compared to $35.4 million or 36.9% of total revenues for the three months ended June 30, 2000. The increase between periods relates to the factors discussed above. Interest Expense. Interest expense for the three months ended June 30, 2001, decreased 45.1% to $0.8 million, 11
from $1.5 million for the three months ended June 30, 2000, with the decrease due primarily to scheduled principal payments on the Company's long-term debt and a decrease in interest rates. The balance of the Company's long-term debt as of June 30, 2001, was $45.5 million, compared to $70.0 million as of June 30, 2000, a decrease of $24.5 million. Income Tax Provision. For the three months ended June 30, 2001, the Company recorded an income tax provision of $17.5 million, or an effective income tax rate of approximately 38%, which represents the Company's estimate of the effective book income tax rate for 2001. The Company's effective income tax rate for 2000 was also approximately 38%. As of June 30, 2001, management continues to believe that sufficient taxable income will be generated to realize the entire benefit of the Company's deferred tax assets. The Company's assumptions of future profitable operations are supported by its strong operating performances over the last several years. SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000 Revenues. Total revenues for the six months ended June 30, 2001, increased 24.5% to $234.2 million, from $188.1 million for the six months ended June 30, 2000. Revenues from processing and related services for the six months ended June 30, 2001, increased 13.2% to $162.6 million, from $143.5 million for the six months ended June 30, 2000. Of the total increase in these revenues, approximately 85% resulted from an increase in the number of customers of the Company's clients which were serviced by the Company and approximately 15% was due to increased revenue per customer. From July 1, 2000 through June 30, 2001, the Company converted and processed approximately 3.0 million new customers on its systems, including approximately 2.0 million for the six months ended June 30, 2001. Total annualized processing revenue per video and Internet account was as follows: For the six months ended June 30, ------------------------------------ Increase 2001 2000 (Decrease) ------------------------------------ Video account...................... $8.57 $8.38 2.3% Internet account................... $4.95 $5.38 (8.0%) The change in processing revenues per account relates primarily to (i) changes in the usage of ancillary services by clients, (ii) the introduction of new products and services and the clients use of these products and services, and (iii) price changes included in client contracts (e.g., price escalators for inflationary factors, tiered pricing, etc.). Revenues from software and professional services for the six months ended June 30, 2001, increased 60.7% to $71.6 million, from $44.6 million for the six months ended June 30, 2000. The Company sells its software products and professional services principally to its existing client base to (i) enhance the core functionality of its service bureau processing application, (ii) increase the efficiency and productivity of its clients' operations, and (iii) allow clients to effectively rollout new products and services to new and existing markets. The increase in revenue between periods relates to the continued demand for the Company's existing software products and services to meet the changing needs of the Company's client base. Cost of Processing and Related Services. Processing costs as a percentage of related processing revenues were 35.9% for the six months ended June 30, 2001, compared to 36.3% for the six months ended June 30, 2000. The costs as a percentage of related revenues remained relatively unchanged between periods as the Company continues to (i) focus on cost controls and cost reductions within its core processing business, and (ii) experience better overall leveraging of its processing costs as a result of the continued growth of the customer base processed on the Company's systems. 12
Cost of Software and Professional Services. The cost of software and professional services as a percentage of related revenues was 38.2% for the six months ended June 30, 2001, compared to 45.8% for the six months ended June 30, 2000. The improvement between periods relates primarily to better overall leveraging of costs as a result of higher software and professional services revenues for the period. Gross Margin. Overall gross margin for the six months ended June 30, 2001, increased 28.4% to $148.4 million, from $115.6 million for the six months ended June 30, 2000, due primarily to revenue growth. The overall gross margin percentage increased to 63.4% for the six months ended June 30, 2001, compared to 61.5% for the six months ended June 30, 2000. The overall increase in the gross margin percentage is due primarily to the increase in gross margin for software and professional services due to the factors discussed above. Research and Development Expense. R&D expense for the six months ended June 30, 2001, increased 24.3% to $25.2 million, from $20.3 million for the six months ended June 30, 2000. As a percentage of total revenues, R&D expense remained unchanged at 10.8% for the six months ended June 30, 2001 and 2000. The Company did not capitalize any software development costs during the six months ended June 30, 2001 and 2000. The overall increase in the R&D expenditures between periods is due primarily to increased efforts on several products which are in development and enhancements of the Company's existing products. The Company's development efforts for the six months ended June 30, 2001 were focused primarily on the development of products to: . address the international customer care and billing system market, . increase the efficiencies and productivity of its clients' operations, . address the systems needed to support the convergence of the communications markets, . support a web-enabled, customer self-care and electronic bill presentment/payment application, and . allow clients to effectively rollout new products and services to new and existing markets, such as residential telephony, High-Speed Data/ISP and IP markets. Selling, General and Administrative Expense. SG&A expense for the six months ended June 30, 2001, increased 25.9% to $26.7 million, from $21.2 million for the six months ended June 30, 2000. The increase in SG&A expense relates primarily to sales and administrative costs to support the Company's overall growth and its international business expansion. As a percentage of total revenues, SG&A expense increased to 11.4% for the six months ended June 30, 2001, from 11.2% for the six months ended June 30, 2000. Depreciation Expense. Depreciation expense for the six months ended June 30, 2001, increased 18.9% to $6.9 million, from $5.8 million for the six months ended June 30, 2000. The increase in expense relates to capital expenditures made during 2000 and the first six months of 2001 in support of the overall growth of the Company, consisting principally of (i) computer hardware and related equipment, (ii) statement processing equipment, and (iii) facilities and internal infrastructure expansion. 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. Operating income for the six months ended June 30, 2001, was $89.7 million or 38.3% of total revenues, compared to $68.4 million or 36.4% of total revenues for the six months ended June 30, 2000. The increase between periods relates to the factors discussed above. Interest Expense. Interest expense for the six months ended June 30, 2001, decreased 37.3% to $1.9 million, from $3.0 million for the six months ended June 30, 2000, with the decrease due primarily to scheduled principal payments on the Company's long-term debt and a decrease in interest rates. Interest and Investment Income, Net. Interest and investment income, net for the six months ended June 30, 13
2001, decreased 29.9% to $1.8 million, from $2.6 million for the six months ended June 30, 2000, with the decrease due primarily to the Company recording a charge of $0.6 million for an "other-than-temporary" decline in market value for a short-term investment. Income Tax Provision. For the six months ended June 30, 2001, the Company recorded an income tax provision of $34.1 million, or an effective income tax rate of approximately 38%, which represents the Company's estimate of the effective book income tax rate for 2001. The Company's effective income tax rate for 2000 was also approximately 38%. Financial Condition, Liquidity and Capital Resources As of June 30, 2001, the Company's principal sources of liquidity included cash, cash equivalents and short-term investments of $55.5 million. The Company also has a revolving credit facility in the amount of $40.0 million, of which there were no borrowings outstanding as of June 30, 2001. The Company's ability to borrow under the revolving credit facility is subject to maintenance of certain levels of eligible receivables. At June 30, 2001, all of the $40.0 million revolving credit facility was available to the Company. The revolving credit facility expires in September 2002. As of June 30, 2001 and December 31, 2000, respectively, the Company had $101.2 million and $128.9 million in net billed trade accounts receivable. The decrease between periods relates primarily to the collection (in January 2001) of a large receivable from a software transaction that was outstanding at yearend. The payment terms on this transaction were scheduled three weeks across yearend to assist a client in its capital planning. The Company's billed 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 billings for the period (including non-revenue items) divided by the average net billed trade accounts receivable balance for the period. The Company's DBO calculations for the quarters ended June 30, 2001 and 2000 were 52 days and 53 days, respectively. The Company's target range for DBOs is 55 to 60 days. As of June 30, 2001 and December 31, 2000, respectively, the Company had $20.6 million and $4.3 million of unbilled trade receivables. The increase in the unbilled trade receivables between periods relate primarily to the timing of billings on items for which revenue was recognized in the three months ended June 30, 2001. Approximately 80 percent of the June 30, 2001 unbilled trade receivables balance is due to be billed and paid by mid-October 2001. The Company's net cash flows from operating activities for the six months ended June 30, 2001 and 2000 were $83.5 million and $37.9 million, respectively. The increase of $45.6 million between periods relates to (i) an increase in net cash flows from operations of $15.5 million and (ii) an increase in the net changes in operating assets and liabilities of $30.1 million. The increase in the net changes in operating assets and liabilities relates primarily to the large decrease in December 31, 2000 billed accounts receivable, for the reasons stated above. The Company's cash flows from operating activities would have been approximately $46.6 million for the six months ended June 30, 2001 if the receivable for the large software transaction mentioned above would have been collected in the fourth quarter of 2000 rather than in the first quarter of 2001. The Company's net cash flows used in investing activities totaled $23.8 million for the six months ended June 30, 2001, compared to $11.5 million for the six months ended June 30, 2000, an increase of $12.3 million. The increase between periods relates primarily to net purchases of short-term investments of $13.2 million during the six months ended June 30, 2001, with no comparable activity during the six months ended June 30, 2000. During the third quarter of 2000, the Company began investing its excess cash balances in various low-risk, short- term investments. 14
The Company's net cash flows used in financing activities was $60.9 million for the six months ended June 30, 2001, compared to $4.8 million for the six months ended June 30, 2000, an increase of $56.1 million. The increase between periods relates to (i) an increase in stock repurchases of $82.2 million, as discussed below, and (ii) an increase in debt payments of $1.8 million. This increase is offset by an increase in proceeds between periods of $27.9 million from the exercise of stock options and warrants. Earnings before interest, taxes, depreciation and amortization (EBITDA) for the six months ended June 30, 2001 was $99.6 million, or 42.5% of total revenues, compared to $77.5 million, or 41.2% of total revenues for the six months ended June 30, 2000. 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 in accordance with generally accepted accounting principles. Interest rates for the Company's long-term debt 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 spread, with the spread dependent upon the Company's leverage ratio. As of June 30, 2001, the spread on the LIBOR rate and the prime rate was 0.50% and 0%, respectively. As of June 30, 2001, the entire amount of the debt was under either three-month or six-month LIBOR contracts with an overall weighted average interest rate of 4.77% (i.e., LIBOR at 4.27% plus spread of 0.50%). This compares to an overall weighted average interest rate of 7.14% at December 31, 2000. On February 28, 2001, AT&T exercised its rights under the Warrants to purchase 2.0 million shares of the Company's Common Stock at an exercise price of $12 per share, for a total exercise price of $24.0 million. Immediately following the exercise of the Warrants, the Company repurchased the 2.0 million shares for $37.00 per share (approximately the closing price on February 28, 2001) for a total repurchase price of $74.0 million, pursuant to the Company's stock repurchase program. As a result, the net cash outlay paid to AT&T for this transaction was $50.0 million, which was paid by the Company with available corporate funds. After this transaction AT&T no longer has any warrants or other rights to purchase the Company's Common Stock. In August 1999, the Company's Board of Directors approved a stock repurchase program which authorized the Company at its discretion to purchase up to a total of 5.0 million shares of its Common Stock from time-to-time as market and business conditions warrant. During the three months ended June 30, 2001, the Company did not repurchase any shares under the program. During the three months ended March 31, 2001, the Company repurchased 2.28 million shares of Common Stock for approximately $85.2 million (a weighted-average price of $37.37 per share), including the 2.0 million shares repurchased as part of the AT&T warrant exercise discussed above. As of June 30, 2001, the Company had purchased a total of 4.03 million shares for approximately $156.5 million (a weighted-average price of $38.88 per share) since the program was announced. The repurchased shares are held as treasury shares. The Company continues to make significant investments in client contracts, capital equipment, facilities, research and development, and at its discretion, may continue to make stock repurchases under its stock repurchase program. In addition, as part of its growth strategy, the Company is continually evaluating potential business and asset acquisitions and plans to expand its international business. The Company had no significant capital commitments as of June 30, 2001. The Company believes that cash generated from operations, together with its current cash, cash equivalents, and short-term investments, and the amount available under its current revolving credit facility, will be sufficient to meet its anticipated cash requirements for operations, income taxes, debt service, capital expenditures, investments in client contracts, and stock repurchases for both its short and long-term purposes. The Company also believes it has significant additional borrowing capacity and could obtain additional cash resources by amending its current credit facility and/or establishing a new credit facility. Forward-Looking Statements This report contains a number of forward-looking statements relative to future plans of the Company and its 15
expectations concerning the customer care and billing industry, as well as the converging telecommunications industry it serves, and similar matters. Such forward-looking statements are based on assumptions about a number of important factors, and involve risks and uncertainties that could cause actual results to differ materially from estimates contained in the forward-looking statements. Some of the risks that are foreseen by management are contained in Exhibit 99.01 of this report. Exhibit 99.01 constitutes an integral part of this report, and readers are strongly encouraged to read that section closely in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations. Dependence on AT&T AT&T completed its merger with Tele-Communications, Inc. (TCI) in 1999 and completed its merger with MediaOne Group, Inc. (MediaOne) in 2000. During the six months ended June 30, 2001 and 2000, revenues from AT&T Broadband and affiliated companies (AT&T) represented approximately 59.6% and 45.3% of total revenues, respectively. The increase in the percentage between periods relates primarily to the timing and the amount of software and services purchased by AT&T. There are inherent risks whenever this large of a percentage of total revenues is concentrated with one client. One such risk is that, should AT&T's business generally decline, it would have a material impact on the Company's results of operations. Contract Rights and Obligations (as amended) The AT&T Contract expires in 2012. The AT&T Contract has minimum financial commitments (based upon processing 13 million wireline video customers) over the term of the contract and includes exclusive rights to provide customer care and billing products and services for AT&T's offerings of wireline video, all Internet/high-speed data services, and print and mail services. During the fourth quarter of 2000, the Company relinquished its exclusive rights to process AT&T's wireline telephony customers, and expects these AT&T customers to be fully converted to another service provider by the end of 2001. The Company does not expect the loss of these customers to have a material impact on the Company's result of operations. Effective April 2001, the Company amended its agreement with AT&T giving the Company certain contractual rights to continue to process certain AT&T customers for a minimum of one year in the event that AT&T divests a portion of its customers to another company. These new rights are co-terminus and are in addition to the existing minimum processing commitments the Company has with AT&T through September 2012. Any such divestitures to a third party would not relieve AT&T of its minimum financial commitments over the term of the contract. It has been recently reported in the public press that AT&T Broadband may be acquired or merged with one or more third parties in a single transaction or a series of transactions. It is impossible and premature at this time to speculate what impact any particular transaction(s) would have on the Company's operations, if any. The Company believes the AT&T Contract would remain in effect in the event there is a change in control of AT&T Broadband. The AT&T Contract contains 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. The Company expects to perform successfully under the AT&T Contract, and is hopeful that it can continue to sell products and services to AT&T that are in excess of the minimum financial commitments and exclusive rights included in the contract. Should the Company fail to meet its obligations under the AT&T Contract, and should AT&T be successful in any action to either terminate the AT&T Contract in whole or in part, or collect damages caused by an alleged breach, it would have a material adverse impact on the Company's results of operations. A copy of the AT&T Contract and all subsequent amendments are included in the Company's exhibits to its periodic public filings with the Securities and Exchange Commission. These documents are available on the Internet and the Company encourages readers to review those documents for further details. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes to the Company's market risks during the six months ended June 30, 2001. See the Company's 2000 10-K for additional discussion regarding the Company's market risks. 16
CSG SYSTEMS INTERNATIONAL, INC. PART II. OTHER INFORMATION Item 1-3. None. Item 4. Submission of Matters to a Vote of Security Holders. (a) The 2001 annual meeting (the "Annual Meeting") of stockholders of CSG Systems International, Inc. was held on June 1, 2001. (b) The following persons were elected as directors at the Annual Meeting: Class I (term expiring in 2004) Janice I. Obuchowski John P. Pogge Rockwell A. Schnabel The following directors' term of office continued after the Annual Meeting: Royce J. Holland Bernard W. Reznicek George F. Haddix Neal C. Hansen Frank V. Sica (c) Votes were cast or withheld at the Annual Meeting as follows: (i) Election of directors: Director For Withheld --------- ---------- -------- Janice I. Obuchowski 44,143,373 377,544 John P. Pogge 44,141,725 379,192 Rockwell A. Schnabel 44,139,470 381,447 (ii) Increase the 1996 Stock Incentive Plan by 3,000,000 shares: For Against Abstain --- ------- ------- 16,698,155 22,994,186 166,087 Item 5. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 10.44 CSG Systems International, Inc. Stock Option Plan for Non-Employee Directors 99.01 Safe Harbor for Forward-Looking Statements Under the Private Securities Litigation Reform Act of 1995-Certain Cautionary Statements and Risk Factors (b) Reports on Form 8-K None 17
SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: August 14, 2001 CSG SYSTEMS INTERNATIONAL, INC. /s/ Neal C. Hansen ----------------------------------- Neal C. Hansen Chairman and Chief Executive Officer (Principal Executive Officer) /s/ Peter E. Kalan ----------------------------------- Peter E. Kalan Vice President and Chief Financial Officer (Principal Financial Officer) /s/ Randy R. Wiese ----------------------------------- Randy R. Wiese Vice President and Controller (Principal Accounting Officer) 18
CSG SYSTEMS INTERNATIONAL, INC. INDEX TO EXHIBITS Exhibit Number Description - ------ ----------- 10.44 CSG Systems International, Inc. Stock Option Plan for Non-Employee Directors 99.01 Safe Harbor for Forward-Looking Statements Under the Private Securities Litigation Reform Act of 1995-Certain Cautionary Statements and Risk Factors 19