FORM 10-Q 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, 1997 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 8, 1997: 25,505,204
CSG SYSTEMS INTERNATIONAL, INC. FORM 10-Q For the Quarter Ended June 30, 1997 INDEX <TABLE> <CAPTION> Page No. -------- <S> <C> <C> Part I - FINANCIAL INFORMATION Item 1. Condensed Consolidated Balance Sheets as of June 30, 1997 and December 31, 1996............................................. 3 Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 1997 and 1996........................... 4 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1997 and 1996...................................... 5 Notes to Condensed Consolidated Financial Statements.............. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................. 8 Part II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders............... 14 Item 6. Exhibits and Reports on Form 8-K.................................. 16 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, 1997 1996 -------------- ------------- ASSETS (unaudited) ------ <S> <C> <C> Current Assets: Cash and cash equivalents.................................................................... $ 2,020 $ 6,134 Accounts receivable- Trade- Billed, net of allowance of $837 and $819............................................. 36,297 33,141 Unbilled.............................................................................. 2,906 5,220 Other..................................................................................... 1,810 1,342 Deferred income taxes........................................................................ 117 45 Other current assets......................................................................... 3,126 2,574 ------------ ----------- Total current assets...................................................................... 46,276 48,456 ------------ ----------- Property and equipment, net of depreciation of $15,717 and $10,664............................. 15,797 13,093 Investment in discontinued operations.......................................................... 732 732 Software, net of amortization of $28,941 and $22,924........................................... 14,487 13,629 Noncompete agreements and goodwill, net of amortization of $16,031 and $12,572................. 22,141 25,730 Client contracts and related intangibles, net of amortization of $10,574 and $8,528............ 7,706 9,752 Deferred income taxes.......................................................................... 3,657 1,356 Other assets................................................................................... 2,273 2,162 ------------ -------------- Total assets.............................................................................. $ 113,069 $ 114,910 ============ ============== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current Liabilities: Current maturities of long-term debt......................................................... $ 9,000 $ 10,000 Customer deposits............................................................................ 6,801 6,450 Trade accounts payable....................................................................... 10,331 12,620 Accrued liabilities.......................................................................... 7,096 8,177 Deferred revenue............................................................................. 6,100 5,384 Accrued income taxes......................................................................... 1,365 945 Other current liabilities.................................................................... 335 450 ------------ ------------- Total current liabilities................................................................. 41,028 44,026 ------------ ------------- Long-term debt, net of current maturities...................................................... 18,500 22,500 Deferred revenue............................................................................... 8,546 6,420 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; 25,501,348 shares and 25,488,876 shares issued and outstanding............................ 255 255 Additional paid-in capital................................................................... 111,696 111,367 Deferred employee compensation............................................................... (896) (1,207) Notes receivable from employee stockholders.................................................. (861) (861) Accumulated translation adjustments.......................................................... 69 573 Accumulated deficit.......................................................................... (65,268) (68,163) ------------ -------------- Total stockholders' equity................................................................ 44,995 41,964 ------------ -------------- Total liabilities and stockholders' equity................................................ $ 113,069 $ 114,910 ============= ============== The accompanying notes are an integral part of these condensed consolidated financial statements. </TABLE> 3
CSG SYSTEMS INTERNATIONAL, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED (in thousands, except share and per share amounts) <TABLE> <CAPTION> Quarter ended Six months ended ---------------------------- ----------------------------- June 30, June 30, June 30, June 30, 1997 1996 1997 1996 ------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> Total revenues................................................... $ 41,030 $ 30,431 $ 79,612 $ 57,188 Expenses: Cost of revenues: Direct costs................................................. 18,253 14,369 36,834 27,200 Amortization of acquired software............................ 2,892 2,751 5,776 5,501 Amortization of client contracts and related intangibles..... 1,023 1,023 2,046 2,046 ------------- ------------- ------------- ------------- Total cost of revenues................................. 22,168 18,143 44,656 34,747 ------------- ------------- ------------- ------------- Gross margin................................................... 18,862 12,288 34,956 22,441 ------------- ------------- ------------- ------------- Operating expenses: Research and development..................................... 5,799 4,792 10,654 9,348 Selling and marketing........................................ 2,760 1,570 5,101 2,990 General and administrative: General and administrative................................ 4,658 3,146 8,787 6,428 Amortization of noncompete agreements and goodwill........ 1,732 1,519 3,463 2,939 Stock-based employee compensation......................... 85 97 287 3,374 Depreciation................................................. 1,711 1,246 3,220 2,436 ------------- ------------- ------------- ------------- Total operating expenses................................ 16,745 12,370 31,512 27,515 ------------- ------------- ------------- ------------- Operating income (loss).......................................... 2,117 (82) 3,444 (5,074) ------------- ------------- ------------- ------------- Other income (expense): Interest expense............................................. (616) (870) (1,257) (2,610) Interest income.............................................. 166 256 377 485 Other........................................................ 64 - 331 - ------------- ------------- ------------- ------------- Total other............................................. (386) (614) (549) (2,125) ------------- ------------- ------------- ------------- Income (loss) before income taxes and extraordinary item......... 1,731 (696) 2,895 (7,199) Income tax (provision) benefit................................. - - - - ------------- ------------- ------------- ------------- Income (loss) before extraordinary item.......................... 1,731 (696) 2,895 (7,199) Extraordinary loss from early extinguishment of debt........... - - - (1,260) ------------- ------------- ------------- ------------- Net income (loss)................................................ $ 1,731 $ (696) $ 2,895 $ (8,459) ============= ============= ============= ============= Net income (loss) per common and equivalent share: Income (loss) before extraordinary item........................ $ 0.07 $ (0.03) $ 0.11 $ (0.30) Extraordinary loss from early extinguishment of debt........... - - - (0.05) ------------- ------------- ------------- ------------- Net income (loss).............................................. $ 0.07 $ (0.03) $ 0.11 $ (0.35) ============= ============= ============= ============= Weighted average common and equivalent shares.................... 25,492,658 25,532,945 25,490,958 24,490,889 ============= ============= ============= ============= The accompanying notes are an integral part of these condensed consolidated financial statements. </TABLE> 4
CSG SYSTEMS INTERNATIONAL, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED (in thousands, except share amounts) <TABLE> <CAPTION> Six months ended ---------------------- June 30, June 30, 1997 1996 -------- --------- <S> <C> <C> Cash flows from operating activities: Net income (loss)...................................................... $ 2,895 $ (8,459) Adjustments to reconcile net income (loss) to net cash provided by operating activities- Depreciation....................................................... 3,220 2,436 Amortization....................................................... 11,773 10,901 Stock-based employee compensation.................................. 287 3,374 Extraordinary loss from early extinguishment of debt............... - 1,260 Changes in operating assets and liabilities: Trade accounts receivable, net.................................... (924) (5,999) Other receivables................................................. (468) 835 Deferred income taxes............................................. (2,373) (1,446) Other current and noncurrent assets............................... (896) (1,374) Customer deposits................................................. 351 472 Trade accounts payable and accrued liabilities.................... (2,890) 3,315 Deferred revenue.................................................. 2,855 4,329 Other current liabilities......................................... (115) 71 -------- -------- Net cash provided by operating activities....................... 13,715 9,715 -------- -------- Cash flows from investing activities: Purchases of property and equipment, net............................... (5,964) (2,715) Acquisition of businesses, net of cash acquired........................ - (3,518) Additions to software.................................................. (6,875) - Net investment in discontinued operations.............................. - 2,000 -------- -------- Net cash used in investing activities........................... (12,839) (4,233) -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock................................. 377 44,794 Purchase and cancellation of common stock.............................. (24) (20) Payment of dividends for redeemable convertible preferred stock........ - (4,497) Payments on long-term debt............................................. (5,000) (45,068) -------- -------- Net cash used in financing activities........................... (4,647) (4,791) -------- -------- Effect of exchange rate fluctuations on cash............................. (343) - -------- -------- Net increase (decrease) in cash and cash equivalents..................... (4,114) 691 Cash and cash equivalents, beginning of period........................... 6,134 3,603 -------- -------- Cash and cash equivalents, end of period................................. $ 2,020 $ 4,294 ======== ======== Supplemental disclosures of cash flow information: Cash paid (received) during the period for- Interest............................................................. $ 1,049 $ 2,666 Income taxes......................................................... $ 1,958 $ (653) Supplemental disclosure of noncash financing activities: During March 1996, the Company converted 8,999,999 shares of redeemable convertible preferred stock into 17,999,998 shares of common stock. The accompanying notes are an integral part of these condensed consolidated financial statements. </TABLE> 5
CSG SYSTEMS INTERNATIONAL, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. GENERAL The condensed consolidated financial statements at June 30, 1997, 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 period. 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, 1996, filed with the Securities and Exchange Commission. The results of operations for the three and six months ended June 30, 1997, are not necessarily indicative of the results for the entire year ending December 31, 1997. 2. STOCKHOLDERS' EQUITY The Company completed an initial public offering (IPO) of its common stock in March 1996. The Company sold 3,335,000 shares of common stock at an initial public offering price of $15 per share, resulting in net proceeds to the Company, after deducting underwriting discounts and offering expenses, of approximately $44,794,000. As of the closing of the IPO, all of the 8,999,999 outstanding shares of redeemable convertible Series A Preferred Stock were automatically converted into 17,999,998 shares of common stock. 3. NET INCOME PER SHARE Net income per common and equivalent share is based on the weighted average number of shares of common stock and common equivalent shares outstanding, which includes redeemable convertible Series A Preferred Stock prior to the conversion into common stock in March 1996. Common equivalent shares related to stock options have been excluded from the weighted average number of shares as the dilutive effect is not significant. 4. EXTRAORDINARY LOSS The Company used $40.3 million of the IPO proceeds to repay a portion of outstanding bank indebtedness (the Indebtedness). Upon repayment of the Indebtedness, the Company recorded an extraordinary loss of $1.3 million for the write-off of deferred financing costs. 5. BYTEL ACQUISITION In June 1996, the Company acquired all of the outstanding capital stock of Bytel Limited (Bytel), a United Kingdom-based company which provides customer management software systems to the cable and telecommunications industries in the United Kingdom. The acquisition was accounted for using the purchase method of accounting. The Company's condensed consolidated financial statements include Bytel's results of operations since the acquisition date. 6
6. ACCOUNTING PRONOUNCEMENTS ISSUED BUT NOT YET EFFECTIVE In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128), which specifies the computation, presentation and disclosure requirements for earnings per share (EPS). SFAS No. 128 is effective for periods ending after December 15, 1997, and requires retroactive restatement of EPS for all prior periods presented. The statement replaces the current "primary earnings per share" computation with a "basic earnings per share" and redefines the "dilutive earnings per share" computation. Adoption of the statement is not expected to have a significant effect on the Company's reported EPS. 7
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). The Company acquired Bytel Limited (Bytel) on June 28, 1996. The results of Bytel's operations since the acquisition are included in the following table and considered in the discussion of the Company's operations that follow: <TABLE> <CAPTION> Quarter ended June 30, Six Months ended June 30, ---------------------------------------- ------------------------------------- 1997 1996 1997 1996 ------------------ ------------------ ----------------- ----------------- % of % of % of % of Amount Revenue Amount Revenue Amount Revenue Amount Revenue ------- -------- ------- -------- ------- -------- ------- -------- <S> <C> <C> <C> <C> <C> <C> <C> <C> Total revenues.................................. $41,030 100.0% $30,431 100.0% $79,612 100% $57,188 100% Expenses: Cost of revenues: Direct costs............................. 18,253 44.5% 14,369 47.2% 36,834 46.3% 27,200 47.6% Amortization of acquired software........ 2,892 7.0% 2,751 9.0% 5,776 7.3% 5,501 9.6% Amortization of client contracts and related intangibles................. 1,023 2.5% 1,023 3.4% 2,046 2.6% 2,046 3.6% ------- -------- ------- -------- ------- -------- ------- -------- Total cost of revenues.............. 22,168 54.0% 18,143 59.6% 44,656 56.2% 34,747 60.8% ------- -------- ------- -------- ------- -------- ------- -------- Gross margin.................................. 18,862 46.0% 12,288 40.4% 34,956 43.8% 22,441 39.2% ------- -------- ------- -------- ------- -------- ------- -------- Operating expenses: Research and development................... 5,799 14.1% 4,792 15.7% 10,654 13.4% 9,348 16.3% Selling and marketing...................... 2,760 6.7% 1,570 5.2% 5,101 6.4% 2,990 5.2% General and administrative: General and administrative .............. 4,658 11.4% 3,146 10.3% 8,787 11.0% 6,428 11.2% Amortization of noncompete agreements and goodwill....................... 1,732 4.2% 1,519 5.0% 3,463 4.3% 2,939 5.1% Stock-based employee compensation........ 85 0.2% 97 0.3% 287 0.4% 3,374 5.9% Depreciation............................... 1,711 4.2% 1,246 4.1% 3,220 4.0% 2,436 4.3% ------- -------- ------- -------- ------- -------- ------- -------- Total operating expenses................. 16,745 40.8% 12,370 40.6% 31,512 39.5% 27,515 48.0% ------- -------- ------- -------- ------- -------- ------- -------- Operating income (loss)......................... 2,117 5.2% (82) (0.2)% 3,444 4.3% (5,074) (8.8)% ------- -------- ------- -------- ------- -------- ------- -------- Other income (expense): Interest expense........................... (616) (1.5)% (870) (2.9)% (1,257) (1.6)% (2,610) (4.6)% Interest income............................ 166 0.4% 256 0.8% 377 0.5% 485 0.8% Other...................................... 64 0.2% - - 331 0.4% - - ------- -------- ------- -------- ------- -------- ------- -------- Total other.............................. (386) (0.9)% (614) (2.1)% (549) (0.7)% (2,125) (3.8)% ------- -------- ------- -------- ------- -------- ------- -------- Income (loss) before income taxes and extraordinary item......................... 1,731 4.3% (696) (2.3)% 2,895 3.6% (7,199) (12.6)% Income tax (provision) benefit................ - - - - - - - - ------- -------- ------- -------- ------- -------- ------- -------- Income (loss) before extraordinary item......... 1,731 4.3% (696) (2.3)% 2,895 3.6% (7,199) (12.6)% Extraordinary loss from early extinguishment of debt.................................. - - - - - - (1,260) (2.2)% ------- -------- ------- -------- ------- -------- ------- -------- Net income (loss)............................... $ 1,731 4.3% $ (696) (2.3)% $ 2,895 3.6% $(8,459) (14.8)% ======= ======== ======= ======== ======= ======== ======= ======== </TABLE> 8
Three Months Ended June 30, 1997 Compared to Three Months Ended June 30, 1996 Revenues. Total revenues for the three months ended June 30, 1997, increased 34.8% to $41.0 million, from $30.4 million for the three months ended June 30, 1996, due primarily to i) increased revenue from the Company's processing and related services, and ii) increased revenue from the Company's software and related product sales and professional consulting services. Revenues from processing and related services for the three months ended June 30, 1997, increased 16.8% to $32.2 million, from $27.6 million for the three months ended June 30, 1996. This increase is due primarily to an increase in the number of customers of the Company's clients which were serviced by the Company and increased revenue per customer. Customers serviced as of June 30, 1997, and 1996, respectively, were 20.0 million and 18.1 million, an increase of 10.8%. The increase in the number of customers was due to internal customer growth experienced by existing clients and the addition of new clients. Revenue per customer increased due primarily to price increases included in client contracts and increased usage of ancillary services by clients. Revenues from software and related product sales and professional consulting services for the three months ended June 30, 1997, were $8.8 million, compared to $2.8 million for the three months ended June 30, 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 the inclusion of revenues from Bytel's operations for the three months ended June 30, 1997, with no comparable amounts included for Bytel for the second quarter of 1996. Gross Margin. Gross margin for the three months ended June 30, 1997, increased 53.5% to $18.9 million, from $12.3 million for the three months ended June 30, 1996, due primarily to revenue growth. The gross margin percentage increased to 46.0% for the three months ended June 30, 1997, compared to 40.4% for the three months ended June 30, 1996. The overall increase in the gross margin percentage is due primarily to i) the increase in revenues while the amount of amortization of acquired software and amortization of client contracts and related intangibles remained approximately the same, and ii) the improvement in gross margin from 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 for the three months ended June 30, 1997, increased 21.0% to $5.8 million, from $4.8 million for the three months ended June 30, 1996. As a percentage of total revenues, R&D expense decreased to 14.1% for the three months ended June 30, 1997, from 15.7% for the three months ended June 30, 1996. The Company capitalized software development costs, related to CSG Phoenix(TM), of approximately $3.7 million during the three months ended June 30, 1997, which consisted of $2.8 million of internal development costs and $0.9 million of purchased software. No software development costs were capitalized during the three months ended June 30, 1996. As a result, total R&D expenditures (i.e., the total R&D costs expensed, plus the capitalized internal development costs) for the three months ended June 30, 1997, and 1996, were $8.6 million, or 21.0% of total revenues, and $4.8 million, or 15.7% of total revenues, respectively. The overall increase in the R&D expenditures is due primarily to continued efforts on several products which are in development, principally CSG Phoenix, and to enhancements of the Company's existing products. The increased R&D expenditures consist primarily of increases in salaries, benefits, and other programming-related expenses. Selling and Marketing Expense. Selling and marketing expense for the three months ended June 30, 1997, increased 75.8% to $2.8 million, from $1.6 million for the three months ended June 30, 1996. As a percentage of total revenues, selling and marketing expense increased to 6.7% for the three months ended June 30, 1997, from 5.2% for the three months ended June 30, 1996. The increase in expense is due primarily to continued growth of the Company's direct sales force. The Company began building a new direct sales force in mid-1995 and has continued to expand its sales force since that time. General and Administrative Expense. General and administrative (G&A) expense for the three months ended June 30, 1997, increased 48.1% to $4.7 million, from $3.1 million for the three months ended June 30, 1996. As a percentage of total revenues, G&A expense increased to 11.4% for the three months ended June 30, 1997, from 10.3% for the three months ended June 30, 1996. The increase in expense relates primarily to i) the continued development of the 9
Company's management team and related administrative staff, added throughout 1996 and during the first six months of 1997, to support the Company's revenue growth, ii) an increase in facility costs to support employee growth, including the cost of relocating the Company's corporate headquarters from Englewood to Denver, Colorado, iii) an increase in costs associated with the Company's annual report and other public reporting requirements, and iv) the inclusion of G&A expenses from Bytel's operations for the three months ended June 30, 1997, with no comparable amounts included for Bytel for the second quarter of 1996. Amortization of Noncompete Agreements and Goodwill. Amortization of noncompete agreements and goodwill for the three months ended June 30, 1997, increased 14.0% to $1.7 million, from $1.5 million for the three months ended June 30, 1996. The increase in expense relates to amortization of goodwill from the Bytel acquisition and amortization of an additional noncompete agreement acquired in April 1996. Depreciation Expense. Depreciation expense for the three months ended June 30, 1997, increased 37.3% to $1.7 million, from $1.2 million for the three months ended June 30, 1996. The increase in expense relates to capital expenditures made throughout 1996 and the first six months of 1997 in support of the overall growth of the Company. Operating Income. Operating income for the three months ended June 30, 1997, was $2.1 million, compared to an operating loss of $0.1 million for the three months ended June 30, 1996. The increase between years relates to the factors discussed above. The Company incurred certain one-time or acquisition-related charges (Acquisition Charges) in connection with its leveraged buy-out of CSG Systems, Inc. in November 1994. The Acquisition Charges include amortization of acquired software, client contracts and related intangibles, noncompete agreement, goodwill, and stock-based compensation. Operating income for the three months ended June 30, 1997, and 1996, excluding Acquisition Charges of $5.4 million and $5.3 million, was $7.6 million or 18.4% of total revenues, and $5.2 million or 17.1% of total revenues, respectively. See the Company's "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, 1996, for additional discussion regarding the Acquisition Charges and the impact of such charges on operations. Interest Expense. Interest expense for the three months ended June 30, 1997, decreased 29.2% to $0.6 million, from $0.9 million for the three months ended June 30, 1996, with the decrease attributable primarily to scheduled principal payments on the Company's long-term debt. Six Months Ended June 30, 1997 Compared to Six Months Ended June 30, 1996 Revenues. Total revenues for the six months ended June 30, 1997, increased 39.2% to $79.6 million, from $57.2 million for the six months ended June 30, 1996, due primarily to i) increased revenue from the Company's processing and related services, and ii) increased revenue from the Company's software and related product sales and professional consulting services. Revenues from processing and related services for the six months ended June 30, 1997, increased 16.0% to $63.0 million, from $54.3 million for the six months ended June 30, 1996. This increase is due primarily to an increase in the number of customers of the Company's clients which were serviced by the Company and increased revenue per customer. The increase in the number of customers was due to internal customer growth experienced by existing clients and the addition of new clients. Revenue per customer increased due primarily to price increases included in client contracts and increased usage of ancillary services by clients. Revenues from software and related product sales and professional consulting services for the six months ended June 30, 1997, were $16.6 million, compared to $2.9 million for the six months ended June 30, 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 the inclusion of revenues from Bytel's operations for the six months ended June 30, 1997, with no comparable amounts included for Bytel for the first six months of 1996. 10
Gross Margin. Gross margin for the six months ended June 30, 1997, increased 55.8% to $35.0 million, from $22.4 million for the six months ended June 30, 1996, due primarily to revenue growth. The gross margin percentage increased to 43.8% for the six months ended June 30, 1997, compared to 39.2% for the six months ended June 30, 1996. The overall increase in the gross margin percentage is due primarily to i) the increase in revenues while the amount of amortization of acquired software and amortization of client contracts and related intangibles remained approximately the same, and ii) the improvement in gross margin from 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 for the six months ended June 30, 1997, increased 14.0% to $10.7 million, from $9.3 million for the six months ended June 30, 1996. As a percentage of total revenues, R&D expense decreased to 13.4% for the six months ended June 30, 1997, from 16.3% for the six months ended June 30, 1996. The Company capitalized software development costs, related to CSG Phoenix, of approximately $6.8 million during the six months ended June 30, 1997, which consisted of $5.6 million of internal development costs and $1.2 million of purchased software. No software development costs were capitalized during the six months ended June 30, 1996. As a result, total R&D expenditures (i.e., the total R&D costs expensed, plus the capitalized internal development costs) for the six months ended June 30, 1997, and 1996, were $16.3 million, or 20.4% of total revenues, and $9.3 million, or 16.3% of total revenues, respectively. The overall increase in the R&D expenditures is due primarily to continued efforts on several products which are in development, principally CSG Phoenix, and to enhancements of the Company's existing products. The increased R&D expenditures consist primarily of increases in salaries, benefits, and other programming- related expenses. Selling and Marketing Expense. Selling and marketing expense for the six months ended June 30, 1997, increased 70.6% to $5.1 million, from $3.0 million for the six months ended June 30, 1996. As a percentage of total revenues, selling and marketing expense increased to 6.4% for the six months ended June 30, 1997, from 5.2% for the six months ended June 30, 1996. The increase in expense is due primarily to continued growth of the Company's direct sales force. The Company began building a new direct sales force in mid-1995 and has continued to expand its sales force since that time. General and Administrative Expense. General and administrative (G&A) expense for the six months ended June 30, 1997, increased 36.7% to $8.8 million, from $6.4 million for the six months ended June 30, 1996. As a percentage of total revenues, G&A expense decreased to 11.0% for the six months ended June 30, 1997, from 11.2% for the six months ended June 30, 1996. The increase in expense relates primarily to i) the continued development of the Company's management team and related administrative staff, added throughout 1996 and during the first six months of 1997, to support the Company's revenue growth, ii) an increase in facility costs to support employee growth, including the cost of relocating the Company's corporate headquarters from Englewood to Denver, Colorado, iii) an increase in costs associated with the Company's annual report and other public reporting requirements, and iv) the inclusion of G&A expenses from Bytel's operations for the six months ended June 30, 1997, with no comparable amounts included for Bytel for the first six months of 1996. Amortization of Noncompete Agreements and Goodwill. Amortization of noncompete agreements and goodwill for the six months ended June 30, 1997, increased 17.8% to $3.5 million, from $2.9 million for the six months ended June 30, 1996. The increase in expense relates to amortization of goodwill from the Bytel acquisition and amortization of an additional noncompete agreement acquired in April 1996. Stock-Based Employee Compensation. Stock-based employee compensation of $3.4 million in the six months ended June 30, 1996, relates to purchases of the Company's common stock through performance stock purchase agreements with executive officers and key employees. During 1995 and 1994, the Company sold common stock to executive officers and key employees pursuant to performance stock agreements. The structure of the performance stock agreements required "variable" accounting for the related shares until the performance conditions were removed on October 19, 1995, thereby establishing a measurement date. The fair value of the stock was estimated by the Company to be $2.75 per share at that date. Prior to the completion of the Company's initial public offering (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. Upon the completion of the IPO, shares owned by certain 11
executive officers of the Company were no longer subject to the repurchase option. In addition, the repurchase option for the remaining performance stock shares decreased to 20% annually over a five-year period, commencing on the later of an employee's hire date or November 30, 1994. As a result, approximately $3.2 million of stock-based employee compensation expense was recorded when the IPO was completed in March 1996. The scheduled amortization of the stock-based deferred compensation subsequent to June 30, 1997, is approximately $0.1 million per quarter. Depreciation Expense. Depreciation expense for the six months ended June 30, 1997, increased 32.2% to $3.2 million, from $2.4 million for the six months ended June 30, 1996. The increase in expense relates to capital expenditures made throughout 1996 and the first six months of 1997 in support of the overall growth of the Company. Operating Income. Operating income for the six months ended June 30, 1997, was $3.4 million, compared to an operating loss of $5.1 million for the six months ended June 30, 1996. The increase between years relates to the factors discussed above. Operating income for the six months ended June 30, 1997, and 1996, excluding Acquisition Charges of $11.0 million and $13.8 million, was $14.4 million or 18.1% of total revenues, and $8.7 million or 15.2% of total revenues, respectively. See the Company's "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, 1996, for additional discussion regarding the Acquisition Charges and the impact of such charges on operations. Interest Expense. Interest expense for the six months ended June 30, 1997, decreased 51.8% to $1.3 million, from $2.6 million for the six months ended June 30, 1996, with the decrease attributable to i) scheduled principal payments on the Company's long-term debt, ii) the retirement of $40.3 million of long-term debt with proceeds from the IPO in March 1996, and iii) a decrease in interest rates as a result of the Company favorably amending its long-term credit facility with its bank in April 1996. Extraordinary Loss From Early Extinguishment Of Debt. Upon the repayment of the $40.3 million of long-term debt with IPO proceeds, the Company recorded an extraordinary charge of $1.3 million in March 1996, for the write-off of deferred financing costs attributable to the portion of the long-term debt repaid. General - ------- The Company generates a significant amount of its revenues from Tele- Communications, Inc.'s (TCI) cable television operations. In July 1997, the Company signed a multi-year renewal contract to continue to provide customer care and billing systems to support TCI's cable television subscribers. The renewal contract replaced the Company's previous contract with TCI which was scheduled to expire December 31, 1997. On August 10, 1997, the Company signed a 15-year exclusive contract with a TCI affiliate to consolidate 13 million TCI subscribers onto the Company's customer care and billing systems (the 15-Year Contract). On August 10, 1997, the Company also entered into an agreement with TCI affiliates to acquire certain SUMMITrak assets, an in-house customer care and billing system developed by TCI, for $106 million in cash, up to $26 million in various contingent payments, and warrants to purchase up to 1.5 million shares of the Company's common stock, with the contingent payments and warrants based upon the achievement of certain milestones by TCI specified in the 15-Year Contract. Both the closing of the SUMMITrak asset purchase and the effectiveness of the 15-Year Contract are subject to certain conditions, including governmental filings and approvals. If the 15-Year Contract closes and becomes effective, it would replace the renewal contract signed in July 1997. Currently, the Company has approximately 4 million of TCI's subscribers on its systems. Under the 15-Year Contract, the Company and TCI plan to consolidate the 13 million subscribers under an agreed upon conversion schedule. Converting multiple sites under an aggressive time schedule poses certain risks. Factors affecting the conversion schedule include the frequency and severity of database discrepancies, installation of compatible hardware, network and software products, as well as the availability and cooperation of qualified personnel from all the parties involved in the conversion. TCI's minimum financial commitments under the 15-Year Contract are subject to certain performance criteria by the Company. As previously reported, the Company delivered Version 1.1 of CSG Phoenix, its next generation customer management system for the converging communications industries, on March 31, 1997. The primary purpose for the release of this code was for basic testing and integration at customer sites. This testing resulted in the discovery of a number of incident reports and configuration issues. The Company is currently examining the size and magnitude of these issues, and will have an estimated date for when CSG Phoenix will go into production when that analysis is completed. The Company is in the process of working with its Phoenix partners to coordinate the next steps for both the testing of the product, as well as rescheduling the new, estimated production date. Any statements regarding development and timing of the dates on which CSG Phoenix will go into production at any particular client site are forward-looking statements. The actual timing is subject to delay due to the variety of factors inherent in the development and initial implementation of a new, complex software system. Installation is also subject to factors relating to the integration of the new system with the client's existing systems. 12
Income Taxes - ------------ At June 30, 1997, management of the Company evaluated its previous operating results, as well as projections for 1997 and 1998, and concluded that it was more likely than not that certain of the Company's deferred tax assets would be realized. Accordingly, the Company has recognized a net deferred tax asset of $3.8 million. The Company has recorded a valuation allowance of approximately $22.9 million against the remaining net deferred tax assets since realization of these future benefits is not sufficiently assured as of June 30, 1997. The Company intends to analyze the realizability of the net deferred tax assets at each future quarterly reporting period. The current quarterly results of operations, as well as the Company's projected results of operations, will determine the required valuation allowance at the end of each quarter. Based on its current projections of operating results for 1997 and 1998, the Company expects to realize additional deferred tax assets in 1997. As a result, the Company does not expect income tax expense for 1997 to be significant. Due primarily to differences in the timing of recognition of the amortization of intangible assets for financial reporting and tax purposes, the Company expects to pay income taxes in 1997. Liquidity and Capital Resources - ------------------------------- As of June 30, 1997, the Company's principal sources of liquidity included cash and cash equivalents of $2.0 million. The Company also has a revolving bank line of credit in the amount of $5.0 million of which there were no borrowings outstanding. The line of credit expires November 30, 2001. During the six months ended June 30, 1997, the Company generated $13.7 million in net cash flow from operating activities. Cash generated from these sources was primarily used to fund capital expenditures of $6.0 million, additions to software of $6.9 million, and to repay long-term debt of $5.0 million. The Company believes that cash generated from operations and the amount available under the revolving bank line of credit will be sufficient to meet its anticipated cash requirements for operations (including research and development expenditures), income taxes, debt service, and capital expenditures through the next twelve months. 13
CSG SYSTEMS INTERNATIONAL, INC. PART II. OTHER INFORMATION Items 1 - 3. None. Item 4. Submission of Matters to a Vote of Security Holders. (a) The 1997 annual meeting (the "Annual Meeting") of stockholders of CSG Systems International, Inc. was held on May 29, 1997. (b) The following persons were elected as directors at the Annual Meeting: Class I (term expiring in 1998) ------------------------------- James D. Norrod Rockwell A. Schnabel Class II (term expiring in 1999) -------------------------------- Royce J. Holland Bernard W. Reznicek Class III (term expiring in 2000) --------------------------------- George F. Haddix Neal C. Hansen Frank V. Sica No other director's term of office continued after the Annual Meeting. (c) (i) Votes were cast or withheld in the election of directors at the Annual Meeting as follows: <TABLE> <CAPTION> Director For Against -------- --- ------- <S> <C> <C> James D. Norrod 21,263,062 13,043 Rockwell A. Schnabel 21,263,112 12,993 Royce J. Holland 21,263,112 12,993 Bernard W. Reznicek 21,262,787 13,318 George F. Haddix 21,263,006 13,099 Neal C. Hansen 21,263,162 12,943 Frank V. Sica 21,263,112 12,993 </TABLE> (ii) Votes were cast at the Annual Meeting with respect to approval of amendments to the corporation's Restated Certificate of Incorporation and Revised By-Laws to divide the Board of Directors into three classes and to provide for the composition of such classes as follows: For: 18,195,261 Against: 2,268,955 14
Abstain: 7,071 There were broker nonvotes as to 804,817 shares on this matter. This matter received sufficient votes to pass. (iii) Votes were cast at the Annual Meeting with respect to approval of amendments to the corporation's Restated Certificate of Incorporation and Revised By-Laws to provide that directors may be removed only for cause and only by a 75% vote of stockholders as follows: For: 18,236,990 Against: 2,239,111 Abstain: 5,869 There were broker nonvotes as to 794,135 shares on this matter. This matter received sufficient votes to pass. (iv) Votes were cast at the Annual Meeting with respect to approval of amendments to the corporation's Restated Certificate of Incorporation and Revised By-Laws to provide that any vacancy on the Board of Directors may be filled only by a vote of the remaining directors then in office as follows: For: 20,397,327 Against: 77,162 Abstain: 7,481 There were broker nonvotes as to 794,135 shares on this matter. This matter received sufficient votes to pass. (v) Votes were cast at the Annual Meeting with respect to approval of amendments to the corporation's Restated Certificate of Incorporation and Revised By-Laws to provide that the Board of Directors shall consist of not fewer than five members and not more than thirteen members and that the exact number of authorized directors shall be determined by a majority vote of the total number of authorized directors most recently fixed by the Board of Directors as follows: For: 20,392,618 Against: 84,832 Abstain: 4,519 There were broker nonvotes as to 794,135 shares on this matter. This matter received sufficient votes to pass. (vi) Votes were cast at the Annual Meeting with respect to approval of amendments to the corporation's Restated Certificate of Incorporation to provide that advance notice of 15
stockholder nominations of persons for election to the Board of Directors must be given to the corporation, together with certain required information, as follows: For: 19,444,746 Against: 1,032,782 Abstain: 4,442 There were broker nonvotes as to 794,135 shares on this matter. This matter received sufficient votes to pass. (vii) Votes were cast at the Annual Meeting with respect to approval of amendments to the corporation's Restated Certificate of Incorporation to require a 75% vote of stockholders to alter, amend, or repeal any of the provisions referred to in subparagraphs (ii) through (vi) above as follows: For: 18,216,365 Against: 2,260,137 Abstain: 5,467 There were broker nonvotes as to 794,135 shares on this matter. This matter received sufficient votes to pass. (viii) Votes were cast at the Annual Meeting with respect to approval of the corporation's Stock Option Plan for Non-Employee Directors as follows: For: 20,227,302 Against: 1,032,224 Abstain: 5,924 There were broker nonvotes as to 10,655 shares on this matter. This matter received sufficient votes to pass. Item 5. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits 3.02 Revised By-Laws of CSG Systems International, Inc. 3.03 Certificate of Amendment of Restated Certificate of Incorporation of CSG Systems International, Inc. 10.44 CSG Systems International, Inc. Stock Option Plan for Non-Employee Directors 16
27.01 Financial Data Schedule (EDGAR Version Only) 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, 1997 CSG SYSTEMS INTERNATIONAL, INC. /s/ Neal C. Hansen --------------------------------------- Neal C. Hansen Chairman and Chief Executive Officer (Principal Executive Officer) /s/ Greg A. Parker --------------------------------------- Greg A. Parker Vice President and Chief Financial Officer (Principal Financial Officer) /s/ Randy R. Wiese --------------------------------------- Randy R. Wiese Controller and Principal Accounting Officer (Principal Accounting Officer) 18
CSG SYSTEMS INTERNATIONAL, INC. INDEX TO EXHIBITS Exhibit Number Description - ------- ----------- 3.02 Revised By-Laws of CSG Systems International, Inc. 3.03 Certificate of Amendment of Restated Certificate of Incorporation of CSG Systems International, Inc. 10.44 CSG Systems International, Inc. Stock Option Plan for Non-Employee Directors 27.01 Financial Data Schedule (EDGAR Version Only) 99.01 Safe Harbor for Forward-Looking Statements Under the Private Securities Litigation Reform Act of 1995-Certain Cautionary Statements and Risk Factors 19