Item 1. Business
General
CSG Systems International, Inc. (the "Company" or "CSG") was formed in October 1994 and acquired all of the outstanding stock of CSG Systems, Inc. (formerly Cable Services Group, Inc.) from First Data Corporation ("FDC") in November 1994 (the "CSG Acquisition"). CSG Systems, Inc. had been a subsidiary or division of FDC from 1982 until the acquisition.
The Company's principal executive offices are located at 7887 East Belleview, Suite 1000, Englewood, Colorado 80111, and the telephone number at that address is (303) 796-2850. The Company's common stock is listed on the Nasdaq National Market under the symbol "CSGS".
Company Overview
The Company provides customer care and billing solutions worldwide for the converging communications markets, including cable television, direct broadcast satellite ("DBS"), telephony, on-line services and others. The Company's products and services enable its clients to focus on their core businesses, improve customer service, and enter new markets and operate more efficiently. The Company offers its clients a full suite of processing and related services, and software and professional services which automate customer care and billing functions. These functions include set-up and activation of customer accounts, sales support, order processing, invoice calculation, production and mailing, management reporting, and customer analysis for target marketing. The Company's products and services combine the reliability and high volume transaction processing capabilities of a mainframe platform with the flexibility of client/server architecture. The Company generated revenue of $322.2 million in 1999 compared to $236.6 million in 1998, an increase of 36%, and revenue grew at a compound annual growth rate of 35% over the five-year period ended December 31, 1999.
The Company has established a leading presence by developing strategic relationships with major participants in the cable television and DBS industries, and derived approximately 76% and 16% of its total revenues in 1999 from the U.S. cable television and U.S. and Canadian DBS industries, respectively. The Company provides customer care and billing to one-third of the households in the U.S. During 1999, the Company derived approximately 79% of its total revenues from processing and related services. At December 31, 1999, the Company was servicing client sites having an aggregate of 33.8 million customers in the U.S., compared to 29.5 million customers serviced as of December 31, 1998, an increase of 15%. During 1999, the Company converted and processed approximately 4.5 million new customers on its systems. Total domestic revenue per customer account for 1999 was $9.88, compared to $8.71 for 1998, an increase of 13%, and revenue per customer account grew at a compound annual growth rate of 15% over the five-year period ended December 31, 1999.
The convergence of communications markets and growing competition are increasing the complexity and cost of managing the interaction between communications service providers and their customers. Customer care and billing systems coordinate all aspects of the customer's interaction with a service provider, from initial set-up and activation, to service activity monitoring, through billing and accounts receivable management. The growing complexity of communications services and the manner in which they are packaged and priced has created increased demand for customer care and billing systems which deliver enhanced flexibility and functionality. Because of the significant level of technological expertise and capital resources required to develop and implement such systems successfully, the majority of cable television, DBS, and wireless service providers have elected to outsource customer care and billing.
In 1998, the Company acquired substantially all of the assets of US Telecom Advanced Technology Systems, Inc. ("USTATS") for approximately $6.0 million in cash and assumption of certain liabilities of approximately $1.3 million. USTATS, a South Carolina-based company, specializes in open systems,
client/server customer care and billing systems serving the telecommunications markets. The Company used the acquired technology and software primarily to enhance its current service-bureau telephony customer care and billing system.
In September 1997, the Company entered into a 15-year processing agreement with Tele-Communications, Inc. ("TCI") which expires in 2012. In March 1999, AT&T completed its merger with TCI and consolidated the TCI operations into AT&T Broadband ("AT&T"). The Company continues to service AT&T under the terms of the 15-year processing contract (the "AT&T Contract"). The AT&T Contract has minimum financial commitments over the 15-year life of the contract and includes exclusive rights to provide customer care and billing products and services for AT&T's offerings of wireline video, all Internet/high-speed data services, residential wireline telephony services, and print and mail services. As of December 31, 1999, the Company had successfully converted approximately 11 million AT&T cable television customers onto its system, bringing the total of AT&T customers on the Company's system to approximately 14 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional discussion of the AT&T Contract and the TCI and AT&T merger.
In addition, during 1997, the Company purchased certain SUMMITrak software technology assets that were in development from TCI. The Company continued the research and development ("R&D") of certain software technologies acquired from TCI. Such efforts included the completion of the R&D projects and the integration of the completed software technologies into certain of the Company's current products. The related products from these development efforts were available for general release in 1999. See Note 4 to the Company's Consolidated Financial Statements for additional discussion of the SUMMITrak asset acquisition.
Growth Strategy
The Company's growth strategy is designed to provide revenue and profit growth. The key elements of the strategy include:
Expand Core Processing Business. The Company will continue to leverage its investment and expertise in high-volume transaction processing to expand its processing business. The processing business provides highly predictable recurring revenues through multi-year contracts with a client base which includes leading communications service providers in growing markets. The Company increased the number of customers processed on its systems from 18.0 million as of December 31, 1995 to 33.8 million as of December 31, 1999. The Company provides a full suite of customer care and billing products and services which combine the reliability and high volume transaction processing capabilities of a mainframe platform with the flexibility of client/server architecture.
Introduce New Products and Services. The Company has a significant installed client base to which it can sell additional value-added products and services. The Company has increased its annual revenue per U.S. domestic customer from $5.60 in 1995 to $9.88 in 1999, a compound annual growth rate of 15%, due primarily to the introduction of new products and services. The Company will continue to develop software applications, which will enhance and extend the functionality of its customer care and billing solution and also provide additional revenue opportunities.
Enter New Markets. As communications markets converge, the Company's products and services can facilitate efficient entry into new markets by existing or new clients. For example, as the cable television providers expand into on-line services and telephony, the Company will continue to offer the customer care and billing solutions necessary to meet their needs. The Company plans to enter new markets, such as the HSD/ISP and IP markets, that with new and/or acquired technology, or modifications to the Company's existing technology, could be served by the Company's customer care and billing solutions.
Enhance Growth Through Focused Acquisitions. The Company follows a disciplined approach to acquire assets and businesses which provide the technology and technical personnel to expedite the Company's product development efforts, provide complementary products or services, or provide access to new markets or clients.
Continue Technology Leadership. The Company believes that its technology in customer care and billing solutions gives communications service providers a competitive advantage. The Company's continuing investment in R&D is designed to position the Company to meet the growing and evolving needs of existing and potential clients.
CSG Products and Services
CSG offers the most complete suite of flexible, scaleable products and services in the communications market, serving voice, video and data providers--handling all aspects of the customer lifecycle. CSG has invested an average of 12% of revenues in R&D in the last five years. This has allowed the Company to increase its offering from two products to more than 25. Listed below are several of the products that make up the Company's Broadband Express(TM) solution.
Customer Acquisition
Advanced Customer Service Representative(R) (ACSR(R)) is a Windows-based software program that provides CSRs (customer service representatives) with a complete view of a customer's account, easily showing all the customer's services. Add-on modules include Customer Interaction Tracking(R)--which tracks customers by type and subject, and features a planner for scheduling follow-ups and reminders; Customer Based Training--a tutorial system; and Application Object Interface--which develops customized applications and requests special status updates from the ACSR system.
Credit Verification Service allows clients to determine whether an individual qualifies for service based on their credit history and risk.
Risk Management System helps clients determine the credit-worthiness of applicants and assists in collection efforts through online access to credit histories and previous unpaid accounts.
Provisioning and Usage
Real-Time Usage Handling System provides real-time rating and aggregation of convergence usage-based services such as Internet and telephony. The robust and easy-to-use graphical user interface (GUI) enables clients to set up and modify complex service plans in real-time.
Service Delivery System takes manual and automated tasks and configures them into a logical workflow system, to perform certain functions such as notifying external providers and activating telephony and high-speed Internet services.
Product Pricing and Discounting
CSG Vantage(R) allows clients to collect and leverage marketing and consumer behavior information to offer specific package pricing and discounts to their customers.
CSG Convergent Express allows clients to seamlessly offer multiple lines of business and cross product discount for these services. Using this product, clients can create special package and pricing models based on types of services to which their customers subscribe.
CCS Discount Module automates the process of establishing package pricing and special discount programs within the customer care and billing system. This module allows CSG clients to monitor their customer's buying patterns as well as competitive trends, and to build and automatically apply frequent buyer programs, loyalty discounts and other enhanced discounting packages.
Customer Maintenance
Communications Control System (CCS(R)) lets CSRs enroll new customers, modify services for current customers, schedule installation and repairs, and process billing.
Call Center ExpressSM is a suite of products that promotes customer self- care and improves CSR efficiency. Over the phone, without the assistance of a CSR, customers can check account balances and order a pay-per-view event. In addition, when a call comes into the call center, a customer's account information automatically appears on the CSR's computer screen.
CSG WorkForce ExpressSM is a suite of products that efficiently dispatches field technicians, provides automatic and manual routing of work orders, and workforce management functions. It connects each technician with the customer care and billing system through a hand-held device (CSG TechNet(R)), which presents information including the route to the next job and background on the customer.
CSG Care Express(TM) is a web-based application providing end-user customers with the ability to sign up for new services, add or modify existing services, and manage their convergent account.
Billing and Invoicing
CSG Enhanced Statement Presentation(R) lets clients tailor logos, graphics, and messages on customer invoices--turning a monthly bill into an easy-to-read communications and marketing tool.
Internet Bill Presentment and Payment (IBPP) allows end-user customers to view and pay bills via the Internet. This product maintains the previous month's statements online and notifies customers of new statements via e- mail. In addition, IBPP allows customers to view unbilled usage in real- time.
CSG Statement Express(R) allows CSRs to use their computers to call up the actual invoice a customer receives, so that it can be discussed with the customer.
Collection and Delinquency
Paybill Advantage(R) lets customers have their bills automatically debited from their checking accounts or placed on their credit cards.
Credit Card Processing Services uses a one-time credit card transaction to automatically collect payments for monthly services and special circumstances, such as a delinquent customer.
Electronic Lockbox Service(R) (ELS(R)) automates the process of posting electronic payments, dramatically reducing the possibility of an error in payment.
Collections Service automates the accounts receivable and collections systems for clients, increasing recovery rates and reducing costs.
Year 2000
See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for discussion of the Company's efforts to address the year 2000 risks related to the Company's business.
Clients
The majority of the Company's largest clients (listed in alphabetic order) are cable television and DBS providers located in the United States and Canada, and are as follows:
AT&T Broadband (formerly TCI) Echostar Communications Corporation Adelphia Communications Corp Media One Group, Inc. Ameritech New Media Primestar by DIRECTV Bell ExpressVu Prodigy Communications Corp Charter Communications Time Warner
During the years ended December 31, 1999, 1998, and 1997, revenues from AT&T represented approximately 50.5%, 37.4%, and 32.9% of total revenues, and revenues from Time Warner Cable and its affiliated companies ("Time Warner") represented approximately 10.2%, 14.1%, and 20.1% of total revenues, respectively. The increase in the AT&T percentage between 1999 and 1998 relates primarily to the additional AT&T customers converted to the Company's systems as a result of the 15-year AT&T Contract executed in September 1997. The Company has separate processing agreements with multiple affiliates of Time Warner and provides products and services to them under separately negotiated and executed contracts.
Client and Product Support
The Company's clients typically rely on CSG for ongoing support and training needs relating to the Company's products. The Company has a multi-level support environment for its clients. The Company's Product Support Center operates 24 hours a day, seven days a week. Clients call an 800 number and through an automated voice response unit, direct their calls to the specific product support areas where the questions are answered. In addition, each client has a dedicated account manager. This professional helps clients resolve strategic and business issues. The Company has a full-time training staff and conducts ongoing training sessions both in the field and at its training facilities located in Denver, Colorado and Omaha, Nebraska.
Sales and Marketing
The Company has assembled a direct sales and sales support organization. The Company has organized its sales efforts around senior level account managers who are responsible for new revenues and renewal of existing contracts within an account. Account managers are supported by direct sales and sales support personnel who are experienced in the various products and services that the Company provides.
FDC Data Processing Facility
The Company outsources to FDC data processing and related services required for operation of the CCS system. The Company's proprietary software is run in FDC's facility to obtain the necessary mainframe computer capacity and support without making the substantial capital investment that would be necessary for the Company to provide this service internally. The Company's clients are connected to the FDC facility through a combination of private and commercially provided networks. FDC provides the services to the Company pursuant to a five-year agreement which is scheduled to expire December 31, 2001. The Company believes it could obtain data processing services from alternative sources, if necessary.
Research and Development
The Company's product development efforts are focused on developing new products and improving existing products. The Company believes that the timely development of new applications and enhancements is essential to maintaining its competitive position in the marketplace. The Company's development efforts for 1999 were focused primarily on the development of products to (i) increase the efficiencies and productivity of its clients' operations, (ii) address the systems needed to support the convergence of the communications markets, (iii) support a web-enabled, customer self-care and electronic bill presentment/payment application, and (iv) 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 in 2000 and expects to spend a similar percentage of its total revenues on R&D in the future.
The Company's total R&D expense, excluding purchased R&D, was $34.4 million, $27.5 million, and $22.6 million for the years ended December 31, 1999, 1998, and 1997, or 10.7%, 11.6%, and 13.2% of total revenues, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Competition
The market for customer care and billing systems in the converging communications industries is highly competitive. The Company competes with both independent providers and in-house developers of customer
management systems. The Company believes its most significant competitors are DST Systems, Inc., Convergys Corporation, Portal Software, Inc., Kenan Systems (a division of Lucent Technologies, Inc.), and in-house systems. As the Company enters additional market segments, it expects to encounter additional competitors. Some of the Company's actual and potential competitors have substantially greater financial, marketing and technological resources than the Company.
The Company believes that the principal competitive factors in its markets include time to market, flexibility and architecture of the system, breadth of product features, product quality, customer service and support, quality of R&D effort, and price.
Proprietary Rights and Licenses
The Company relies on a combination of trade secrets and copyright laws, patents, license agreements, non-disclosure and other contractual provisions, and technical measures to protect its proprietary rights. The Company distributes its products under service and software license agreements which typically grant clients non-exclusive licenses to use the products. Use of the software products is restricted and subject to terms and conditions prohibiting unauthorized reproduction or transfer of the software products. The Company also seeks to protect the source code of its software as a trade secret and as a copyrighted work. Despite these precautions, there can be no assurance that misappropriation of the Company's software products and technology will not occur. The Company also incorporates via licenses or reselling arrangements a variety of third party technology and software products that provide specialized functionality within its own products and services. Although the Company believes that its product and service offerings conform with such arrangements and do not infringe upon the intellectual property rights of the other parties to such arrangements or of other third parties, there can be no assurance that any third parties will not assert contractual or infringement claims against the Company.
Employees
As of December 31, 1999, the Company had a total of 1,522 employees, an increase of 194 from December 31, 1998. The Company's success is dependent upon its ability to attract and retain qualified employees. None of the Company's employees are subject to a collective bargaining agreement. The Company believes that its relations with its employees are good.
Item 2.
Item 2. Properties
The Company leases five facilities, totaling approximately 159,000 square feet in Denver, Colorado and surrounding communities. The Company utilizes these facilities primarily for (i) corporate headquarters, (ii) sales and marketing activities, (iii) product and operations support, and (iv) certain R&D activities. The leases for these facilities expire in the years 2000 through 2010.
The Company leases six facilities, totaling approximately 280,000 square feet in Omaha, Nebraska. The Company utilizes these facilities primarily for (i) client services, training and product support, (ii) systems and programming activities, (iii) R&D activities, (iv) statement production and mailing, and (v) general and administrative functions. The leases for these facilities expire in the years 2000 through 2007.
The Company leases one facility, totaling 63,000 square feet in Wakulla County, Florida. This facility is used for statement production and mailing and the lease expires in 2008.
The Company leases office space totaling 13,000 square feet in Slough, Berkshire, in the United Kingdom for its U. K. operations. The lease for this facility expires in 2002.
The Company believes that its facilities are adequate for its current needs and that additional suitable space will be available as required. The Company also believes that it will be able to extend leases as they terminate. See Note 9 to the Company's Consolidated Financial Statements for information regarding the Company's obligations under its facilities leases.
Item 3.
Item 3. Legal Proceedings
From time to time, the Company is involved in litigation relating to claims arising out of its operations in the normal course of business. In the opinion of the Company's management, after consultation with legal counsel, the Company is not presently a party to any material pending or threatened legal proceedings.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None
***
Executive Officers of the Registrant
The present executive officers of the Company are Neal C. Hansen (Chairman of the Board and Chief Executive Officer), John P. Pogge (President and Chief Operating Officer), Greg A. Parker (Vice President and Chief Financial Officer) and Edward C. Nafus (Executive Vice President). During 1998, the Company executed employment agreements with each of the executive officers. Information concerning such executive officers appears in the following paragraphs:
Mr. Hansen, 59, is a co-founder of the Company and has been the Chairman of the Board and Chief Executive Officer and a director of the Company since its inception in 1994. From 1991 until founding the Company, Mr. Hansen served as a consultant to several software companies, including FDC. From 1989 to 1991, Mr. Hansen was a General Partner of Hansen, Haddix and Associates, a partnership which provided advisory management services to suppliers of software products and services. From 1983 to 1989, Mr. Hansen was Chairman and Chief Executive Officer of US WEST Applied Communications, Inc., and President of US WEST Data Systems Group.
Mr. Pogge, 46, joined the Company in 1995 and has served as President, Chief Operating Officer and a director of the Company since September 1997. Prior to that time, Mr. Pogge was an Executive Vice President of the Company and General Manager, Business Units. From 1992 to 1995, Mr. Pogge was Vice President, Corporate Development for US WEST, Inc. From 1987 to 1991, Mr. Pogge served as Vice President and General Counsel of Applied Communications, Inc. Mr. Pogge holds a J.D. degree from Creighton University School of Law and a BBA in Finance from the University of Houston. Mr. Pogge and Mr. Parker are brothers-in-law.
Mr. Parker, 41, joined the Company in July 1995 and has served as Vice President and Chief Financial Officer since April 1997. Prior to that time, Mr. Parker was Vice President, Finance. Previously, Mr. Parker was with Banc One for thirteen years and was Chief Financial Officer for Banc One in Houston and San Antonio. Mr. Parker received a BBA in Accounting and Economics from the University of Iowa in 1980. Mr. Pogge and Mr. Parker are brothers-in-law.
Mr. Nafus, 59, joined the Company in August 1998 as Executive Vice President. From 1992 to 1998, Mr. Nafus served as Executive Vice President of First Data Corporation and President of First Data International. Mr. Nafus was President of First Data Resources from 1989 to 1992, Executive Vice President of First Data Resources from 1984 to 1989 and held various other management positions with that company since 1984. Mr. Nafus holds a B.S. degree in Mathematics from Jamestown College.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock is listed on the Nasdaq National Market ("NASDAQ/NMS") under the symbol "CSGS". The following table sets forth, for the fiscal quarters indicated, the high and low sale prices of the Company's Common Stock as reported by NASDAQ/NMS since the Company's Initial Public Offering on February 28, 1996. The per share amounts disclosed herein have been adjusted to reflect the Company's two-for-one stock split which was effective on March 5, 1999.
On March 20, 2000, the last sale price of the Company's Common Stock as reported by NASDAQ/NMS was $65.88 per share. On January 31, 2000, the number of holders of record of Common Stock was 273.
Dividends
The Company has not declared or paid cash dividends on its Common Stock since its incorporation. The Company's debt agreement contains certain restrictions on the payment of dividends. See Note 6 to the Company's Consolidated Financial Statements.
Item 6.
Item 6. Selected Financial Data
The following selected financial data have been derived from the audited financial statements of the Company. The selected financial data presented below should be read in conjunction with, and is qualified by reference to "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements. The information below is not necessarily indicative of the results of future operations.
- -------- (1) The Company was formed in October 1994 and acquired all of the outstanding shares of CSG Systems, Inc., formerly Cable Services Group, Inc., from First Data Corporation ("FDC") on November 30, 1994 (the "CSG Acquisition"). The Company did not have any substantive operations prior to the CSG Acquisition. The CSG Acquisition was accounted for as a purchase and the Company's Consolidated Financial Statements (the "Consolidated Financial Statements") since the date of the acquisition are presented on the new basis of accounting established for the purchased assets and liabilities. The Company incurred certain acquisition-related charges as a result of the CSG Acquisition. These acquisition-related charges include periodic amortization of acquired software, client contracts and related intangibles, noncompete agreement and goodwill, and stock-based employee compensation. (2) On June 28, 1996, the Company acquired all of the outstanding shares of Bytel Limited. Bytel Limited changed its name to CSG International Limited ("CSGI") in 1998. The acquisition was accounted for using the purchase method of accounting. (3) The Company completed an initial public offering ("IPO") of its Common Stock in March 1996. The Company sold 6,670,000 shares of Common Stock resulting in net proceeds to the Company of $44.8 million. Such proceeds were used to repay long-term debt of $40.3 million and to pay accrued dividends of $4.5 million on Redeemable Convertible Preferred Stock ("Preferred Stock"). As of the closing of the IPO, all of the Preferred Stock was automatically converted into 35,999,996 shares of Common Stock. The Company incurred an extraordinary loss of $1.3 million for the write- off of deferred financing costs attributable to the portion of the long- term debt repaid. (4) Contemporaneously with the CSG Acquisition, the Company purchased from FDC all of the outstanding capital stock of Anasazi Inc. ("Anasazi"). On August 31, 1995, the Company completed a substantial divestiture of Anasazi, resulting in the Company owning less than 20% of Anasazi. In September 1997, the Company sold its remaining ownership interest in Anasazi for $8.6 million in cash and recognized a gain of $7.9 million. The Company accounted for its ownership in Anasazi as discontinued operations after its acquisition in 1994. (5) During 1997, the Company purchased certain SUMMITrak technology assets from Tele-Communications, Inc. ("TCI") and entered into a 15-year processing contract with TCI. In March 1999, AT&T completed its merger with TCI and has consolidated the TCI operations into AT&T Broadband ("AT&T"). The Company continues to service AT&T under the terms of the 15-year processing contract (the "AT&T Contract"). The total purchase price was approximately $159 million, with approximately $105 million charged to purchased research and development and the remaining amount allocated primarily to the AT&T Contract. The Company financed the asset acquisition with a $150.0 million term credit facility (the "Term Credit Facility"), of which $27.5 million was used to retire the Company's previously outstanding debt, resulting in an extraordinary loss of $0.6 million for the write-off of deferred financing costs attributable to such debt. See Note 4 to the Consolidated Financial Statements for additional discussion. (6) During 1997, the Company recorded a non-recurring charge of $11.7 million to reduce certain CSG Phoenix assets to their net realizable value as of December 31, 1997. (7) During 1997, the Company recorded a non-recurring charge of $4.7 million for the impairment of certain intangible assets related to software systems which the Company decided to no longer market and support. (8) During 1998, the Company recorded an income tax benefit of $39.6 million related primarily to the elimination of its valuation allowance against its deferred tax assets. See Note 7 to the Consolidated Financial Statements for further discussion. (9) On March 5, 1999, the Company completed a two-for-one stock split for shareholders of record on February 8, 1999. In January 1996, the Company also completed a two-for-one stock split. Both splits were effected as a stock dividend. Share and per share data for all periods presented herein have been adjusted to give effect to both splits. Diluted net income (loss) per common share and the shares used in the per share computation have been computed on the basis described in Note 2 to the Consolidated Financial Statements.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
General
The Company. The Company was formed in October 1994 and acquired all of the outstanding stock of CSG Systems, Inc. from First Data Corporation ("FDC") in November 1994 (the "CSG Acquisition"). CSG Systems, Inc. had been a subsidiary or division of FDC from 1982 until the acquisition.
The Company provides customer care and billing solutions worldwide for the converging communications markets, including cable television, direct broadcast satellite, telephony, on-line services and others. The Company offers its clients a full range of processing services, software and support services that automate customer management functions, including billing, sales support and order processing, invoice calculation and production, management reporting and customer analysis for target marketing. The Company's products and services combine the reliability and high volume transaction processing capabilities of a mainframe platform with the flexibility of client/server architecture. The Company provides its services to more than one-third of the households in the United States.
Forward-Looking Statements. This report contains a number of forward-looking statements relative to future plans of the Company and its 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.
AT&T Contract and Merger. In September 1997, the Company entered into a 15- year processing contract with Tele-Communications, Inc. ("TCI"). In March 1999, AT&T completed its merger with TCI and has consolidated the TCI operations into AT&T Broadband ("AT&T"). The Company continues to service AT&T under the terms of the 15-year processing contract (the "AT&T Contract").
Stock Split. On March 5, 1999, the Company completed a two-for-one stock split, effected as a stock dividend, for shareholders of record on February 8, 1999. Share and per share data for all periods presented herein have been adjusted to give effect to the split.
Stock Offering. In April 1998, the Company completed a secondary public stock offering of approximately 7.0 million shares of Common Stock. The primary shareholders in the offering included Morgan Stanley affiliated entities and General Motors employee benefit plan trusts. The Company received none of the proceeds from the offering, nor incurred any expense.
Acquisitions
USTATS Asset Acquisition. On July 30, 1998, the Company acquired substantially all of the assets of US Telecom Advanced Technology Systems, Inc. ("USTATS") for approximately $6.0 million in cash and assumption of certain liabilities of approximately $1.3 million. USTATS, a South Carolina- based company, specializes in open systems, client/server customer care and billing systems serving the telecommunications markets. The Company used the acquired technology and software primarily to enhance its current service- bureau telephony customer care and billing system. The total purchase price of $7.3 million has been allocated to the technology and software acquired and is being amortized over its expected useful life of five years.
Acquisition of SUMMITrak Assets. In September 1997, the Company purchased certain SUMMITrak software technology assets that were in development from TCI. The Company continued the research and development ("R&D") of certain software technologies that were acquired from TCI. Such efforts included the completion of the R&D projects and the integration of the completed software technologies into certain of its
current products. The related products from these development efforts were available for general release in 1999. See Note 4 to the Company's Consolidated Financial Statements for additional discussion of the SUMMITrak asset acquisition.
Acquisition-Related Charges
Acquisition Charges. The CSG Acquisition was accounted for using the purchase method. As a result, the Company has recorded recurring, periodic amortization of acquired software, client contracts and related intangibles, noncompete agreement, goodwill and stock-based employee compensation (collectively, the "Acquisition Charges"). The Acquisition Charges totaled $7.5 million, $8.2 million, and $20.7 million for the years ended December 31, 1999, 1998 and 1997, respectively. Going forward, the Acquisition Charges will be approximately $0.2 million per year until fully amortized in 2004.
Discontinued Operations. Contemporaneously with the CSG Acquisition, the Company purchased from FDC all of the outstanding shares of Anasazi Inc. ("Anasazi") for $6.0 million cash. The Company accounted for its ownership in Anasazi as discontinued operations after its acquisition in 1994. On August 31, 1995, the Company completed a substantial divestiture of Anasazi, resulting in the Company owning less than 20% of Anasazi. As a result, Anasazi's results of operations subsequent to August 31, 1995 are not included in the Company's results of operations as the Company accounted for its investment in Anasazi under the cost method subsequent to August 31, 1995. In September 1997, the Company sold its remaining interest in Anasazi for $8.6 million in cash and recognized a gain of $7.9 million.
Non-Recurring Items
Charge for Purchased Research and Development. During 1997, the Company recorded a charge of $105.5 million related primarily to the portion of the SUMMITrak asset acquisition purchase price allocated to purchased research and development related to software technologies which had not reached technological feasibility and had no other alternative future use as of the acquisition.
Impairment of Capitalized Software Development Costs. During 1997, the Company recorded a charge of $11.7 million related to certain CSG Phoenix assets. After the consideration of multiple factors and events, consisting primarily of an increase in demand for the Company's outsourced processing services and previously announced delays in the delivery of CSG Phoenix, such assets were reduced to their estimated net realizable value as of December 31, 1997. The charge primarily included previously capitalized internal development costs and purchased software incorporated into the product.
Impairment of Intangible Assets. During 1997, the Company recorded a charge of $4.7 million for the impairment of certain intangible assets related to software systems which the Company decided to no longer market and support. This impairment charge related principally to the Company's CableMAX product. CableMAX was a personal computer-based customer management system targeted at smaller cable systems of 2,500 customers or less. During 1997, the Company decided not to invest the resources necessary to make the software year 2000 compliant, resulting in the impairment of the CableMAX intangible assets.
Extraordinary Loss From Early Extinguishment Of Debt. In September 1997, the Company retired its outstanding bank indebtedness of $27.5 million in conjunction with obtaining financing for the SUMMITrak asset acquisition. Upon repayment of the outstanding debt, the Company recorded an extraordinary loss of $0.6 million for the write-off of deferred financing costs.
Income Tax Benefit. As of September 30, 1998, the Company had a valuation allowance of $48.5 million against certain of its deferred tax assets due to the uncertainty that it would realize the income tax benefit from these assets. During the fourth quarter of 1998, the Company concluded that it was more likely than not that it would realize the entire tax benefit from its deferred tax assets. As a result, the Company eliminated the entire valuation allowance of $48.5 million as of December 31, 1998, which resulted in the Company recording a net
income tax benefit of $39.6 million during the fourth quarter. This conclusion was based primarily upon the Company's expected profitable operations in future periods. See below for additional discussion.
Adjusted Results of Operations
Impact of Acquisition Charges and Non-recurring Charges on Earnings. As discussed above, the Company has incurred Acquisition Charges and non- recurring charges in each of the last three years. The total of these charges was $7.5 million, $8.2 million, and $135.3 million for the years ended December 31, 1999, 1998 and 1997, respectively. The Company's adjusted results of operations excluding these items are shown in the following table. In addition to the exclusion of these expenses from the calculation, the adjusted results of operations were computed using an effective income tax rate of 38.0%, and outstanding shares on a diluted basis.
Results of Operations
The following table sets forth certain financial data and the percentage of total revenues of the Company for the periods indicated.
Twelve Months Ended December 31, 1999 Compared to Twelve Months Ended December 31, 1998
Revenues. Total revenues increased $85.5 million, or 36.1%, to $322.2 million in 1999, from $236.6 million in 1998.
Revenues from processing and related services increased $63.4 million, or 33.0%, to $255.2 million in 1999, from $191.8 million in 1998. Of the total increase in revenue, approximately 68% resulted from the Company serving a higher number of customers for its clients and approximately 32% was due to increased revenue per customer. Customers serviced as of December 31, 1999 and 1998 were 33.8 million and 29.5 million, respectively, an increase of 14.6%. The increase in the number of customers serviced was due to the conversion of additional customers by new and existing clients to the Company's systems, and internal customer growth experienced by existing clients. During 1999, the Company converted and processed approximately 4.5 million new customers on its systems, with approximately 3.4 million of these new customers coming from AT&T.
Revenues from software and professional services increased $22.1 million, or 49.4%, to $67.0 million in 1999, from $44.8 million in 1998. The Company sells its software products 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 years relates to the continued strong demand for the Company's existing software products, principally ACSR, and the rollout of additional new products to meet the changing needs of the Company's client base.
Total domestic revenue per customer account for 1999 was $9.88, compared to $8.71 for 1998, an increase of 13.4%. Revenue per customer increased due primarily to (i) a greater percentage of processing revenues in 1999 being generated under the AT&T Contract, (ii) price increases included in client contracts, and (iii) increased software sales to new and existing clients.
Cost of Processing and Related Services. Direct processing costs as a percentage of related revenues were 34.7% for 1999, compared to 40.2% for 1998. The improvement between years relates primarily to better overall leveraging of the direct processing costs as a result of the continued growth of the customer base processed on the Company's system. Amortization of client contracts and related intangibles increased $2.2 million, or 43.4%, to $7.2 million in 1999, from $5.0 million in 1998. The increase in expense is due primarily to the amortization of the value assigned to the AT&T Contract. The value assigned to the AT&T Contract is being amortized over the life of the contract in proportion to the financial minimums included in the contract. Amortization related to the AT&T Contract was $3.3 million in 1999, compared to $1.9 million in 1998. For 2000, the scheduled amortization for the AT&T Contract is $3.4 million.
Cost of Software and Professional Services. The cost of software and professional services as a percentage of related revenues was 54.4% in 1999, compared to 55.9% in 1998. The slight decrease in this percentage is due primarily to the timing of the sales cycle for new products introduced both in 1999 and 1998.
Gross Margin. Gross margin increased $60.6 million, or 46.9%, to $190.0 million in 1999, from $129.4 million in 1998, due primarily to revenue growth. The gross margin as a percentage of total revenues increased to 59.0% in 1999, compared to 54.7% in 1998. The overall increase in the gross margin percentage is due primarily to the improvement in the gross margin percentage for processing and related services, due primarily to the increase in revenue per customer while controlling the cost of delivering such services.
Research and Development Expense. R&D expense increased $6.9 million, or 25.1%, to $34.4 million in 1999, from $27.5 million in 1998. As a percentage of total revenues, R&D expense decreased to 10.7% in 1999, from 11.6% in 1998. The Company did not capitalize any software development costs during 1999. The Company capitalized third party, contracted programming costs of approximately $1.4 million during 1998, related primarily to enhancements to existing products. As a result, total R&D development expenditures (i.e., the total R&D costs expensed, plus the capitalized development costs) for 1999 and 1998, were $34.4 million, or 10.7% of total revenues, and $28.9 million, or 12.2% of total revenues, respectively.
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 1999 were focused primarily on the development of products to (i) increase the efficiencies and productivity of its clients' operations, (ii) address the systems needed to support the convergence of the communications markets, (iii) support a web-enabled, customer self-care and electronic bill presentment/payment application, and (iv) 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 in 2000 and expects to spend a similar percentage of its total revenues on R&D in the future.
Selling and Marketing Expense. Selling and marketing ("S&M") expense increased $2.6 million, or 21.6%, to $14.4 million in 1999, from $11.8 million in 1998. As a percentage of total revenues, S&M expense decreased to 4.4% in 1999, from 5.0% in 1998. The decrease in S&M expenses as a percentage of total revenues is due primarily to increased revenues, while controlling S&M costs.
General and Administrative Expense. General and administrative ("G&A") expense increased $2.8 million, or 12.3%, to $25.8 million in 1999, from $23.0 million in 1998. As a percentage of total revenues, G&A expense decreased to 8.0% in 1999, from 9.7% in 1998. The increase in G&A expenses relates primarily to the continued expansion of the Company's management and administrative staff and other administrative costs to support the Company's overall growth. The decrease in G&A expenses as a percentage of total revenues is due primarily to increased revenue, while controlling G&A costs.
Amortization of Noncompete Agreements and Goodwill. Amortization of noncompete agreements and goodwill decreased $0.5 million, or 9.1%, to $4.9 million in 1999, from $5.4 million in 1998. The decrease in amortization expense is due primarily to the noncompete agreement from the CSG Acquisition becoming fully amortized as of November 30, 1999.
Depreciation Expense. Depreciation expense increased $2.0 million, or 24.9%, to $10.2 million in 1999, from $8.2 million in 1998. The increase in expense relates to capital expenditures made throughout 1999 and 1998 in support of the overall growth of the Company, consisting principally of computer hardware and related equipment and statement processing equipment and related facilities. Depreciation expense for all property and equipment is reflected separately in the aggregate and is not included in the cost of revenues or the other components of operating expenses.
Operating Income. Operating income was $100.2 million for 1999, compared to $53.3 million in 1998, with the increase attributable to the factors discussed above. The Company's operating income margin, excluding the Acquisition Charges discussed above, was 33.4% for 1999, compared to 26.0% for 1998.
Interest Expense. Interest expense decreased $2.6 million, or 26.2%, to $7.2 million in 1999, from $9.8 million in 1998, with the decrease attributable primarily to (i) scheduled principal payments on the Company's long-term debt, (ii) optional prepayments on long-term debt made during 1999, and (iii) a decrease in interest rates between periods. The balance of the Company's long- term debt as of December 31, 1999, was $81.0 million, compared to $128.3 million as of December 31, 1998, a decrease of $47.3 million.
Interest Income. Interest income increased $0.5 million, or 20.0%, to $3.0 million in 1999, from $2.5 million in 1998, with the increase attributable primarily to an increase in operating funds available for investment.
Income Tax (Provision) Benefit. As of September 30, 1998, the Company had recorded a valuation allowance of $48.5 million against certain of its deferred tax assets due to the uncertainty that it would realize the income tax benefit from those assets. During the fourth quarter of 1998, the Company concluded that it was more likely than not that it would realize the entire tax benefit from its deferred tax assets. As a result, the Company eliminated the entire valuation allowance of $48.5 million as of December 31, 1998, which resulted in the Company reflecting a net income tax benefit of $39.6 million for 1998.
For the year ended December 31, 1999, the Company recorded an income tax provision of $36.1 million, or an effective income tax rate of approximately 38%. As of December 31, 1999, management continues to believe that sufficient taxable income will be generated to realize the entire benefit of its deferred tax assets. The Company's assumptions of future profitable operations are supported by its strong operating performances in 1999 and 1998, and the conversion of a significant number of new customers onto its processing system during these periods.
Twelve Months Ended December 31, 1998 Compared to Twelve Months Ended December 31, 1997
Revenues. Total revenues increased $64.8 million, or 37.7%, to $236.6 million in 1998, from $171.8 million in 1997.
Revenues from processing and related services increased $60.4 million, or 46.0%, to $191.8 million in 1998, from $131.4 million in 1997. Of the total increase in revenue, approximately 61% resulted from the Company serving a higher number of customers for its clients and approximately 39% was due to increased revenue per customer. Customers serviced as of December 31, 1998 and 1997 were 29.5 million and 21.1 million, respectively, an increase of 39.3%. The increase in the number of customers serviced was due to the conversion of additional customers by new and existing clients to the Company's systems, and internal customer growth experienced by existing clients. During 1998, the Company converted and processed approximately 9.0 million new customers on its systems, with approximately 7.7 million of these new customers coming from AT&T.
Revenues from software and professional services increased $4.4 million, or 11.0%, to $44.8 million in 1998, from $40.4 million in 1997. This increase relates to the continued strong demand of the Company's software products and related professional services.
Total domestic revenue per customer account for 1998 was $8.71, compared to $7.73 for 1997, an increase of 12.7%. Revenue per customer increased due primarily to (i) the AT&T Contract, which was executed in September 1997, (ii) increased usage of ancillary services by clients, and (iii) price increases included in client contracts.
Cost of Processing and Related Services. Direct processing costs as a percentage of related revenues were 40.2% for 1998, compared to 44.3% for 1997. The improvement between years relates primarily to better overall leveraging of the direct processing costs as a result of the continued growth of the customer base processed on the Company's system. Amortization of acquired software decreased to zero in 1998, from $10.6 million in 1997, due to acquired software from the CSG Acquisition becoming fully amortized as of November 30, 1997. Amortization of client contracts and related intangibles increased $0.7 million, or 17.5%, to $5.0 million in 1998, from $4.3 million in 1997. The increase in expense is due to amortization of the value assigned to the AT&T Contract, offset by a decrease in the amortization of certain intangible assets from the CSG Acquisition becoming fully amortized as of November 30, 1997. Amortization related to the AT&T Contract was $1.9 million in 1998, compared to $0.3 million in 1997.
Cost of Software and Professional Services. The cost of software and professional services as a percentage of related revenues was 55.9% in 1998, compared to 41.7% in 1997. The increase in this percentage between years relates primarily to the timing of the sales cycle for new products introduced in 1998.
Gross Margin. Gross margin increased $47.6 million, or 58.1%, to $129.4 million in 1998, from $81.8 million in 1997, due primarily to revenue growth. The gross margin as a percentage of total revenues increased to 54.7% in 1998, compared to 47.6% in 1997. The overall increase in the gross margin percentage is due primarily to the increase in revenues while the amount of amortization of acquired software decreased, and to a lesser degree, the improvement in the gross margin percentage for processing and related services, due primarily to the increase in revenue per customer while controlling the cost of delivering such services.
Research and Development Expense. R&D expense increased $4.9 million, or 21.7%, to $27.5 million in 1998, from $22.6 million in 1997. As a percentage of total revenues, R&D expense decreased to 11.6% in 1998, from 13.2% in 1997.
During 1997, the Company capitalized software development costs of approximately $9.7 million, which consisted of $8.4 million of internal development costs and $1.3 million of purchased software. The Company capitalized third party, contracted programming costs of approximately $1.4 million during 1998, related primarily to enhancements to existing products. As a result, total R&D development expenditures (i.e., the total R&D costs expensed, plus the capitalized development costs) for 1998 and 1997, were $28.9 million, or 12.2% of total revenues, and $31.0 million, or 18.0% of total revenues, respectively. The overall decrease in the R&D expenditures between periods is due primarily to effective control of development costs, primarily the reduction of third party, contracted programming services.
Selling and Marketing Expense. S&M expense increased $1.6 million, or 15.8%, to $11.8 million in 1998, from $10.2 million in 1997. As a percentage of total revenues, S&M expense decreased to 5.0% in 1998, from 5.9% in 1997. The overall decrease in S&M expenses as a percentage of total revenues is due primarily to increased revenues, while controlling S&M costs.
General and Administrative Expense. G&A expense increased $3.6 million, or 18.4%, to $23.0 million in 1998, from $19.4 million in 1997. As a percentage of total revenues, G&A expense decreased to 9.7% in 1998, from 11.3% in 1997. The increase in G&A expenses relates primarily to the continued expansion of the Company's administrative staff and other administrative costs to support the Company's overall growth. The decrease in G&A expenses as a percentage of total revenues is due primarily to increased revenue, while controlling G&A costs.
Amortization of Noncompete Agreements and Goodwill. Amortization of noncompete agreements and goodwill decreased $1.5 million, or 22.3%, to $5.4 million in 1998, from $6.9 million in 1997. The decrease in amortization expense is due primarily to a write-down of certain intangible assets in 1997. See Note 2 to the Consolidated Financial Statements for additional discussion.
Depreciation Expense. Depreciation expense increased $1.3 million, or 18.5%, to $8.2 million in 1998, from $6.9 million in 1997. The increase in expense relates to capital expenditures made throughout 1998 and 1997 in support of the overall growth of the Company, consisting principally of computer hardware and related equipment and statement processing equipment and related facilities. Depreciation expense for all property and equipment is reflected separately in the aggregate and is not included in the cost of revenues or the other components of operating expenses.
Operating Income (Loss). Operating income was $53.3 million for 1998, compared to an operating loss of $106.5 million in 1997. The change between years relates primarily to the non-recurring charges recorded in 1997, as discussed above. The Company's operating income margin, excluding the Acquisition Charges and non-recurring charges discussed above, was 26.0% for 1998, compared to 21.0% for 1997.
Interest Expense. Interest expense increased $4.5 million, or 83.5%, to $9.8 million in 1998, from $5.3 million in 1997, with the increase attributable primarily to the financing of the Company's acquisition of the SUMMITrak assets in September 1997. The balance of the Company's long-term debt as of December 31, 1998 was $128.3 million, compared to $135.0 million as of December 31, 1997, a decrease of $6.7 million.
Interest Income. Interest income increased $1.2 million, or 92.0%, to $2.5 million in 1998, from $1.3 million in 1997, with the increase attributable primarily to an increase in operating funds available for investment and an increase in interest charges on aged client accounts.
Income Tax Benefit. As of September 30, 1998, the Company had a valuation allowance of $48.5 million against certain of its deferred tax assets due to the uncertainty that it would realize the income tax benefit from these assets. During the fourth quarter of 1998, the Company concluded that it was more likely than not that it would realize the entire tax benefit from its deferred tax assets. As a result, the Company eliminated the entire valuation allowance of $48.5 million as of December 31, 1998, which resulted in the Company reflecting a net income tax benefit of $39.6 million for 1998.
Financial Condition, Liquidity and Capital Resources
As of December 31, 1999, the Company's principal sources of liquidity included cash and cash equivalents of $48.7 million and a revolving credit facility with a bank in the amount of $40 million, of which there were no borrowings outstanding as of December 31, 1999. The Company's ability to borrow under the revolving credit facility is subject to maintenance of certain levels of eligible receivables. At December 31, 1999, all of the $40.0 million revolving credit facility was available to the Company. The revolving credit facility expires in September 2002. The Company's working capital as of December 31, 1999 and 1998 was $32.1 million and $7.1 million, respectively.
As of December 31, 1999 and 1998, the Company had $67.5 million and $60.5 million, respectively, in net billed trade accounts receivable, an increase of $7.0 million, with the increase primarily a result of the Company's revenue growth. The Company's trade accounts receivable balance includes billings for several non-revenue items, such as postage, communication lines, travel and entertainment reimbursements, sales tax, and deferred items. As a result, the Company evaluates its performance in collecting its accounts receivable through its calculation of days billings outstanding (DBO) rather than a typical days sales outstanding (DSO) calculation. DBO is calculated based on the billing for the period (including non-revenue items) divided by the average net trade accounts receivable balance for the period. The Company's DBO calculations for the years ended December 31, 1999 and 1998 were 55 and 56 days, respectively.
The Company's net cash flows from operating activities for the years ended December 31, 1999, 1998 and 1997 were $102.1 million, $47.3 million and $31.4 million, respectively. The increase of $54.7 million, or 115.7% in 1999 over 1998 relates to a $37.8 million increase in net cash flows from operations, in addition to an increase in the net change in operating assets and liabilities of $16.9 million. The increase of $15.9 million, or 50.6%, in 1998 over 1997 relates to an $18.0 million increase in net cash flows from operations, offset by a decrease in the net change in operating assets and liabilities of $2.1 million.
The Company's net cash flows used in investing activities totaled $36.7 million in 1999, compared to $27.1 million in 1998, an increase of $9.6 million. The increase between years relates primarily to conversion incentive payments of $24.7 million (principally to AT&T) in 1999, compared to $4.0 million in 1998. This increase is offset by (i) a cash payment of $6.0 million for the acquisition of assets of USTATS in 1998, (ii) software additions of $1.4 million in 1998, and (iii) a decrease in property and equipment purchases of $3.7 million. The Company's net cash flows used in investing activities totaled $117.4 million in 1997. The decrease of $90.3 million between 1998 and 1997 relates primarily to the cash payments of $106.5 million for the SUMMITrak assets acquired in September 1997 and a decrease of $8.7 million in capitalized software development costs between years, with these decreases offset by (i) proceeds of $8.6 million from the final disposition of Anasazi in 1997, (ii) a cash payment of $6.0 million for the acquisition of assets of USTATS in 1998, (iii) conversion incentive payments of $4.0 million made in 1998, and (iv) an increase in purchases of net property and equipment of $6.3 million.
The Company's net cash flows used in financing activities was $56.1 million in 1999, compared to $1.1 million in 1998, an increase of $55.0 million. The significant increase between years relates to (i) an increase in scheduled principal payments on long-term debt of $8.9 million, (ii) optional long-term debt prepayments of $31.6 million made in 1999, and (iii) repurchase of 655,500 shares of common stock for $20.2 million in 1999, as discussed below. This increase is offset by an increase in proceeds received from the issuance of common stock of $5.4 million, related primarily to the exercise of stock options by employees. The Company's net cash flows used in financing activities was $100.7 million in 1997. The decrease of $101.8 million from 1997 to 1998 relates primarily to the net change in the Company's long-term debt between years. In 1997, the Company generated $150.0 million from a new debt agreement entered into primarily to fund the SUMMITrak asset acquisition, and repaid long-term debt of $47.5 million, which included (i) $5.0 million of scheduled payments on the previous debt agreement, (ii) $27.5 million of existing debt which was refinanced as part of the new debt agreement, and (iii) an optional prepayment of $15.0 million on the new debt. The scheduled principal payments made in 1998 were $6.8 million.
Earnings before interest, taxes, depreciation and amortization ("EBITDA") for 1999 was $124.6 million or 38.7% of total revenues, compared to $73.5 million or 31.0% of total revenues for 1998. EBITDA is presented here as a measure of the Company's debt service ability and is not intended to represent cash flows for the periods.
Interest rates for the Term Credit Facility and revolving credit facility are chosen at the option of the Company and are based on the LIBOR rate or the prime rate, plus an additional percentage spread, with the spread dependent upon the Company's leverage ratio. As of December 31, 1999, the spread on the LIBOR rate and prime rate was 0.50% and 0%, respectively. See Note 6 to the Consolidated Financial Statements for additional discussion of the Term Credit Facility.
The Company was required to make certain monetary conversion payments under the AT&T Contract. AT&T surpassed the milestone of 13 million customers processed on the Company's systems during the third quarter of 1999. Upon reaching this significant milestone, AT&T was paid its final monetary conversion incentive by the Company. The total monetary conversion incentives paid during 1999 to AT&T were $22.0 million.
Effective August 4, 1999, the Company's Board of Directors approved a stock repurchase plan 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. As of December 31, 1999, the Company had repurchased 655,500 shares of Common Stock for $20.2 million (a weighted average price of $30.88 per share). The repurchased shares are held as treasury shares.
For income tax purposes, the amortization of the intangible assets from acquisitions (including the intangible assets related to the CSG Acquisition and the charge for purchased R&D related to the SUMMITrak asset acquisition) are principally deductible over 15 years on a straight-line basis. The Company has paid U.S. income taxes since its inception in 1994. Based on its current projections, the Company expects to pay U.S. income taxes for 2000, and its effective book income tax rate for 2000 is expected to be approximately 38%.
The Company continues to make significant investments in capital equipment, facilities, research and development, and at its discretion, may continue to make stock repurchases. The Company had no significant capital commitments as of December 31, 1999. The Company believes that cash generated from operations, together with the current cash and cash equivalents and the amount available under the revolving credit facility, will be sufficient to meet its anticipated cash requirements for operations, income taxes, debt service, capital expenditures, and stock repurchases for both its short- and long-term purposes. The Company also believes it has significant unused borrowing capacity and could obtain additional cash resources by amending its current credit facility and/or establishing a new credit facility.
Market Risk
The Company is exposed to various market risks, including changes in interest rates and foreign currency exchange rates. Market risk is the potential loss arising from adverse changes in market rates and prices. The Company has entered into an interest rate collar agreement to manage its interest rate risk from the variable rate features of its long-term debt. The Company does not utilize any derivative financial instruments for purposes of managing its foreign currency exchange rate risk. The Company does not enter into derivatives or other financial instruments for trading or speculative purposes.
Interest Rate Risk. The Company had long-term debt (including current maturities) of $81.0 million as of December 31, 1999. Interest rates for the debt are chosen at the option of the Company and are based on the LIBOR rate or the prime rate, plus an additional percentage spread, with the spread dependent upon the Company's leverage ratio. As of December 31, 1999, the spread on the LIBOR rate and prime rate was 0.50% and 0%, respectively. As of December 31, 1999, the entire amount of the debt was under either a three- or six-month LIBOR contract, with an overall weighted average interest rate of 6.55% (i.e., LIBOR at 6.05% plus spread of 0.50%). The carrying amount of the Company's long-term debt approximates fair value due to its
variable interest rate features. See Note 6 to the Consolidated Financial Statements for additional description of the long-term debt and scheduled principal payments.
As required by the debt agreement with its bank, the Company entered into a three-year interest rate collar in December 1997 with a major bank to manage its risk from its variable rate long-term debt. The underlying notional amount covered by the collar agreement is $60.6 million as of December 31, 1999, and decreases over the three-year term in relation to the scheduled principal payments on the long-term debt. Any payment on the 4.9% (LIBOR) interest rate floor, or receipt on the 7.5% (LIBOR) interest rate cap component of the collar, would be recognized as an adjustment to interest expense in the period incurred. There are no amounts due or receivable under this agreement as of December 31, 1999, and the agreement had no effect on the Company's interest expense for 1999, 1998 or 1997. The fair value of the collar agreement is not recognized in the Company's financial statements. The fair value of the collar agreement at December 31, 1999, based on a quoted market price, was not significant.
Foreign Exchange Rate Risk. The Company's foreign currency transactions relate almost entirely to the operations conducted through its United Kingdom ("UK") subsidiary, CSGI. CSGI's transactions are executed primarily within the UK and generally are denominated in British pounds. The Company does not utilize any derivative financial instruments for purposes of managing its foreign currency exchange rate risk. Exposure to variability in currency exchange rates is mitigated by the fact that purchases and sales are typically in the same currency with similar maturity dates and amounts. A hypothetical adverse change of 10% in year-end exchange rates would not have a material effect upon the Company's financial condition or results of operations.
AT&T Contract and Merger
AT&T completed its merger with TCI in March 1999 and has consolidated the TCI operations into AT&T Broadband. During the years ended December 31, 1999, 1998 and 1997, revenues from AT&T and affiliated companies generated under the AT&T Contract represented approximately 50.5%, 37.4%, and 32.9% of total revenues, respectively. The AT&T Contract has a 15-year term and expires in 2012. The AT&T Contract has minimum financial commitments 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, residential wireline telephony services, and print and mail services. The AT&T Contract provides certain performance criteria and other obligations to be met by the Company. The Company is required to perform certain remedial efforts and is subject to certain penalties if it fails to meet the performance criteria or other obligations. The Company is also subject to an annual technical audit to determine whether the Company's products and services include innovations in features and functions that have become standard in the wireline video industry. To date, the Company believes it has complied with the terms of the contract. Since execution of the AT&T Contract in September 1997 through December 31, 1999, the Company has successfully converted approximately 11 million AT&T cable television customers onto its system.
AT&T began its efforts to provide convergent communications services in several United States cities during 1999 and expects to continue these efforts in 2000. The Company is working closely with AT&T to provide customer care and billing services to customers in those cities.
The Company expects to continue performing successfully under the AT&T Contract, and is hopeful that it can continue to sell products and services to the combined entity that are in excess of the minimum financial commitments and exclusive rights included in the contract.
See Note 4 to the Consolidated Financial Statements for discussion regarding the Company's Common Stock Warrants held by AT&T.
Year 2000
Results of Computer Systems Rollover Into Year 2000. The Company's year 2000 ("Y2K") program was described in the Company's most recent Form 10-Q dated November 15, 1999. This program was substantially
completed prior to January 1, 2000, and included rigorous compliance criteria and testing of the Company's various computer systems that could be affected by Y2K. As of the date of this filing, the Company has not experienced any significant disruptions in its operations as a result of its computer systems rollover to, and processing of dates within, the year 2000. This included the Company's information technology ("IT") systems (including products and services), non-IT systems with embedded technology, and software and hardware from significant vendors. Any Y2K-related disruptions within the Company's systems occurred primarily during the first week of January 2000, and consisted of minor items only (e.g., screen and/or report displays), all of which were timely resolved without significant cost to or effort by the Company, and had minimal impact to the Company's or its clients' operations. Although the Company has not experienced any significant disruptions to date, there is no assurance that the Company will not experience any future Y2K- related disruptions.
Costs to Address the Company's Year 2000 Issues. Since inception of its program in 1995 through December 31, 1999, the Company has incurred and expensed costs of approximately $4.2 million related to its Y2K compliance efforts, with approximately $1.4 million of this amount incurred in 1999. The total estimated costs to be incurred in the future related to this matter are not expected to be significant. However, there can be no assurance that these estimates will be achieved and actual results could differ materially from those anticipated.
Continuing Y2K Compliance Efforts and Remaining Risks. The Company believes that the year 2000 dates with the most significant risk of disruptions (January 1, 2000 and February 29, 2000) have passed without significant disruptions to the Company and/or its clients. The Company believes if any Y2k disruptions are experienced in the future, such disruptions would be of a similar nature as those items already reported to the Company's Product Support Center ("PSC"), and therefore, could be timely and adequately identified and resolved using existing problem reporting, remediation and recovery procedures. The Company continues to maintain its Y2K corporate program as a means to monitor continued Y2K compliance and whether any reported events to the PSC resulted from Y2K-related issues.
Although the Company believes the risk of any significant Y2K-related disruptions in the future is low, there can be no assurances that (i) the Company's systems and products (including software and hardware from significant vendors) contain all the necessary date code changes to avoid any significant disruptions related to processing of dates into and beyond the Year 2000, or (ii) if such disruptions are experienced, that the Company can timely identify and resolve any disruptions without significant impact to the Company's and/or its clients' operations. Furthermore, it has been widely reported that a significant amount of litigation surrounding business interruptions may arise out of Y2K issues. Although the Company is currently not aware of any such litigation that might affect the Company, the unprecedented nature of potential litigation regarding Y2K compliance issues makes it uncertain whether, or to what extent, the Company may be affected by such litigation in the future.
Certain Factors That May Affect Future Results of Operations. Except for statements of existing or historical facts, the foregoing discussion of Y2K consists of forward-looking statements and assumptions relating to forward- looking statements, including without limitation the statements relating to future costs, the timetable for completion of Y2K compliance efforts, potential problems relating to Y2K, the Company's state of readiness, third party representations, and the Company's plans and objectives for addressing Y2K problems. Certain factors could cause actual results to differ materially from the Company's expectations, including without limitation (i) the failure of vendors and service providers to timely achieve Y2K compliance, (ii) system incompatibilities with third parties resulting from software conversions, (iii) the Company's systems and products not containing all necessary date code changes, (iv) the failure of existing or future clients to achieve Y2K compliance, (v) potential litigation arising out of Y2K issues, the risk of which may be greater for information technology based service providers such as the Company, (vi) the failure of the Company's validation and testing phase to detect operational problems internal to the Company, in the Company's products or services or in the Company's interface with service providers, vendors or clients, whether such failure results from the technical inadequacy of the Company's validation and testing efforts, the technological infeasibility of testing certain non-IT systems, the perceived cost-benefit constraints against conducting all available testing, or the unavailability of third parties to participate in testing, or (vii) the failure to timely implement a contingency plan to the extent Y2K compliance is not achieved.
Item 8.
Item 8. Financial Statements and Supplementary Data
CSG SYSTEMS INTERNATIONAL, INC.
CONSOLIDATED FINANCIAL STATEMENTS
INDEX
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of CSG Systems International, Inc.:
We have audited the accompanying consolidated balance sheets of CSG Systems International, Inc. (a Delaware corporation) and Subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CSG Systems International, Inc. and Subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States.
Arthur Andersen llp
Omaha, Nebraska January 17, 2000
CSG SYSTEMS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
CSG SYSTEMS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
CSG SYSTEMS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (IN THOUSANDS)
The accompanying notes are an integral part of these consolidated financial statements.
CSG SYSTEMS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Supplemental disclosure of non-cash investing and financing activities:
During 1998, the Company assumed liabilities of $1.3 million as part of the purchase price for the USTATS asset acquisition.
During 1997, the Company granted 3.0 million common stock warrants, valued at $26.1 million, and recorded a liability for $26.0 million for conversion incentive payments as part of the purchase price for the SUMMITrak asset acquisition.
The accompanying notes are an integral part of these consolidated financial statements.
CSG SYSTEMS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
CSG Systems International, Inc. (the "Company" or "CSG"), a Delaware corporation, was formed in October 1994 and acquired all of the outstanding shares of CSG Systems, Inc. ("CSG Systems") from First Data Corporation ("FDC") in November 1994 (the "CSG Acquisition"). CSG Systems had been a subsidiary or division of FDC from 1982 until the acquisition. The Company did not have any substantive operations prior to the acquisition of CSG Systems.
Based in Denver, Colorado, the Company provides customer care and billing solutions worldwide for the converging communications markets, including cable television, direct broadcast satellite, telephony, on-line services and others. The Company offers its clients a full range of processing services, software and support services that automate customer management functions, including billing, sales support and order processing, invoice calculation and production, management reporting and customer analysis for target marketing.
On March 5, 1999, the Company completed a two-for-one stock split, effected as a stock dividend, for shareholders of record on February 8, 1999. Share and per share data for all periods presented herein have been adjusted to give effect to the split.
In April 1998, the Company completed a secondary public stock offering of approximately 7.0 million shares of Common Stock. The primary shareholders in the offering included Morgan Stanley affiliated entities and General Motors employee benefit plan trusts. The Company received none of the proceeds from the offering, nor incurred any expense.
2. Summary of Significant Accounting Policies
Principles of Consolidation. The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated.
Use of Estimates in Preparation of Consolidated Financial Statements. The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue Recognition. The Company classifies its revenues into two main categories: processing and related services, and software and professional services. Processing and related services revenues consist primarily of monthly processing fees generated from the Company's core service bureau customer care and billing application called Communication Control System ("CCS"), and services ancillary to CCS. Software and professional services revenues consist primarily of software license and maintenance fees, and professional services related to the delivery of such products, such as installation and training services.
Processing and related services are recognized as the services are performed. Processing fees are typically billed monthly based on the number of client's customers serviced, ancillary services are typically billed on a per transaction basis, and certain customized print and mail services are billed on a usage basis.
The Company follows the guidelines of Statement of Position ("SOP") 97-2, "Software Revenue Recognition", as amended, in accounting for its software transactions. For sales transactions which have multiple elements, such as software and services, the Company allocates the contract value to the respective elements based on their relative fair values. Arrangements for software license fees consist of both one-time perpetual licenses and term licenses. Perpetual license fees are typically recognized upon delivery, depending upon the
nature and extent of the installation and/or customization services, if any, to be provided by the Company. Term license fees and maintenance fees are recognized ratably over the contract term. Professional services are recognized as the related services are performed.
Payments received for revenues not yet recognized are reflected as deferred revenue in the accompanying consolidated balance sheets. Revenue recognized prior to the scheduled billing date of an item is reflected as unbilled accounts receivable.
Postage and Communications Lines. The Company passes through to its clients the cost of postage and the cost of communication lines between client sites and the mainframe data processing facility. Such reimbursements of costs are netted against the expense and are not included in total revenues. The Company requires postage and communications lines deposits from its clients based on contractual arrangements. These amounts are reflected as current liabilities regardless of the contract period.
Realizability of Long-Lived and Intangible Assets. The Company continually evaluates whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived and intangible assets may warrant revision or that the remaining balance of these assets may not be recoverable. The Company evaluates the recoverability of its long-lived and intangible assets by measuring the carrying amount of the assets against the estimated undiscounted future cash flows associated with them. At the time such evaluations indicate that the future undiscounted cash flows of certain long-lived and intangibles assets are not sufficient to recover the carrying value of such assets, the assets are adjusted to their estimated fair values.
Cash and Cash Equivalents. The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
Property and Equipment. Property and equipment are recorded at cost and are depreciated over their estimated useful lives ranging from two to ten years. Depreciation is computed using the straight-line method for financial reporting purposes. Depreciation expense for all property and equipment is reflected separately in the aggregate and is not included in the cost of revenues or the other components of operating expenses. Depreciation for income tax purposes is computed using accelerated methods.
Property and equipment at December 31 consists of the following (in thousands):
Software. Software at December 31 consists of the following (in thousands):
Acquired software resulted from acquisitions and is stated at cost. Amortization expense related to acquired software for the years ended December 31, 1999, 1998, and 1997 was $1.5 million, $0.6 million, and $10.6 million, respectively.
The Company's research and development ("R&D") efforts consist of development of new products and services as well as enhancements to existing products and services. The Company capitalizes certain software development costs when the resulting products reach technological feasibility and begins amortization of such costs upon the general availability of the products for licensing. The Company did not capitalize any costs in 1999, and capitalized costs of $1.4 million and $9.7 million for the years ended December 31, 1998, and 1997, respectively.
Amortization of internally developed software and acquired software costs begins when the products are available for general release to clients and is computed separately for each product as the greater of (i) the ratio of current gross revenue for a product to the total of current and anticipated gross revenue for the product, or (ii) the straight-line method over the remaining estimated economic life of the product. Estimated lives of two to five years are used in the calculation of amortization. Amortization expense related to capitalized software development costs for the years ended December 31, 1999, 1998, and 1997 was $0.4 million, $0.7 million, and $0.6 million, respectively.
The Company continually evaluates the carrying value of its unamortized capitalized software development costs. The amount by which the unamortized capitalized costs exceed the net realizable value of the asset is expensed. During 1997, the Company recorded a charge of $11.7 million related to certain CSG Phoenix capitalized costs. After the consideration of multiple factors and events, consisting primarily of an increase in demand for the Company's outsourced processing services and previously announced delays on the delivery of CSG Phoenix, such assets were reduced to their estimated net realizable value as of December 31, 1997. The charge primarily included previously capitalized internal development costs and purchased software incorporated into the product.
Noncompete Agreements and Goodwill. Noncompete agreements and goodwill as of December 31 are as follows (in thousands):
The noncompete agreements resulted from acquisitions and are being amortized on a straight-line basis over the terms of the agreements, ranging from three to five years. Goodwill resulted from acquisitions and is being amortized over seven to ten years on a straight-line basis.
During 1997, the Company recorded a charge of $4.7 million for the impairment of certain intangible assets related to software systems which the Company decided to no longer market and support. This impairment charge related principally to the Company's CableMAX product. CableMAX was a personal computer based customer management system that was targeted at smaller cable systems of 2,500 customers or less. During 1997, the Company decided not to invest the resources necessary to make the software year 2000 compliant, resulting in the impairment to the CableMAX intangible assets. The estimated fair value of the CableMAX intangible assets was based upon an analysis of expected future cash flows and a quoted purchase price from an independent buyer.
Client Contracts and Related Intangibles. Client contracts and related intangibles which resulted from the CSG Acquisition were amortized over their estimated lives of five and three years, respectively. The value
assigned to all other client contracts is being amortized over the lives of the respective contracts. As of December 31, 1999 and 1998, accumulated amortization for client contracts and related intangibles was $24.8 million and $17.7 million, respectively.
Financial Instruments with Market Risk and Concentrations of Credit Risk. In the normal course of business, the Company is exposed to credit risk resulting from the possibility that a loss may occur from the failure of another party to perform according to the terms of a contract. The Company regularly monitors credit risk exposures and takes steps to mitigate the likelihood of these exposures resulting in a loss. The primary counterparties to the Company's accounts receivable and sources of the Company's revenues consist of cable television providers throughout the United States. The Company generally does not require collateral or other security to support accounts receivable. The activity in the Company's allowance for uncollectible accounts receivable for the years ended December 31 is as follows (in thousands);
Financial Instruments. The Company's balance sheet financial instruments as of December 31, 1999 and 1998 include cash and cash equivalents, accounts receivable, accounts payable, conversion incentive payments, and long-term debt. Because of their short maturities, the carrying amounts of cash equivalents, accounts receivable, accounts payable, and conversion incentive payments approximate their fair value. The carrying amount of the Company's long-term debt (including current maturities) approximates fair value due to its variable interest rates.
In December 1997, the Company entered into a three-year interest rate collar with a major bank to manage its risk from its variable rate long-term debt. The underlying notional amount covered by the collar agreement was $60.6 million as of December 31, 1999, and decreases over the three-year term in relation to the scheduled principal payments on the long-term debt. Any payment on the 4.9% (LIBOR) interest rate floor, or receipt on the 7.5% (LIBOR) interest rate cap component of the collar, would be recognized as an adjustment to interest expense in the period incurred. There are no amounts due or receivable under this agreement as of December 31, 1999, and the agreement had no effect on the Company's interest expense for 1999, 1998, or 1997. The fair value of the collar agreement is not recognized in the Company's financial statements. The fair value of the collar agreement at December 31, 1999, based on a quoted market price, was not significant.
Translation of Foreign Currency. The Company's foreign subsidiaries use as their functional currency the local currency of the countries in which they operate. Their assets and liabilities are translated into U.S. dollars at the exchange rates in effect at the balance sheet date. Revenues and expenses are translated at the average rates of exchange prevailing during the period. Translation gains and losses are included in total comprehensive income in the Company's Consolidated Statements of Stockholders' Equity. Transaction gains and losses related to intercompany accounts are not material and are included in the determination of net income or loss.
Earnings Per Common Share. The Company follows Statement of Financial Accounting Standards ("SFAS") No. 128 in calculating earnings per share ("EPS"). Basic EPS is computed by dividing income attributable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS is consistent with the calculation of basic EPS while giving effect to any dilutive potential common shares outstanding during the period. Basic and diluted EPS are presented on the face of the Company's Consolidated Statements of Operations. No reconciliation of the EPS numerator is necessary as the basic and diluted net income available to common stockholders is the same for all periods presented. The reconciliation of the EPS denominator is as follows (in thousands):
Common Stock options of 4.2 million shares were excluded from the computation of diluted EPS for 1997 because their inclusion would have had an antidilutive effect on EPS as a result of the Company's loss from continuing operations for the year. Common Stock options of 0.6 million shares and 1.7 million shares for 1999 and 1998, respectively, were 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.
The diluted potential common shares related to the warrants were excluded from the computation of diluted EPS for all quarters the warrants were not considered exercisable. As of December 31, 1999, all of the 3.0 million warrants were considered exercisable (Note 4).
Stock-Based Compensation. The Company accounts for its stock-based compensation plans under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations, and follows the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). See Note 12 for the required disclosures under SFAS 123.
Comprehensive Income. During 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which establishes standards for reporting and display of comprehensive income and its components in a financial statement for the period in which they are recognized. The components of comprehensive income are reflected in the Company's Consolidated Statements of Stockholders' Equity.
Reclassification. Certain December 31, 1998 and 1997 amounts have been reclassified to conform to the December 31, 1999 presentation.
3. Segment Reporting
During 1998, the Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 requires disclosures of selected information about operating segments and related disclosures about products and services, geographic areas, and major customers. SFAS 131 requires operating segments to be determined based on the way management organizes a company for purposes of making operating decisions and assessing performance. Based on the guidelines of SFAS 131, the Company has determined it has only one reportable segment: customer care and billing solutions for the worldwide converging communications markets.
Products and Services. The Company provides customer care and billing solutions worldwide for the converging communications markets, including cable television, direct broadcast satellite, telephony, on-line services and others. The Company generates a significant portion of its revenues from its core service bureau processing product, CCS. The Company sells its software products and professional services principally to its existing client base of processing customers to (i) enhance the core functionality of its service bureau processing application, (ii) increase the efficiency and productivity of the clients' operations, and (iii) 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 derived approximately 78.3%, 78.0%, and 76.7% of its total revenues in the years ended December 31, 1999, 1998 and 1997, respectively, from CCS and related products and ancillary services. The Company generated 75.8%, 77.7%, and 73.1% of its total revenues from the U.S. cable television industry, and
15.5%, 13.0%, and 10.5% of its total revenues from the U.S. and Canadian direct broadcast satellite ("DBS") industry during the years ended December 31, 1999, 1998 and 1997, respectively.
Geographic Regions. Revenues are generated from external customers only. The Company uses the location of the customer as the basis of attributing revenues to individual countries. Financial information relating to the Company's operations by geographic areas is as follows (in thousands):
Significant Clients. During the years ended December 31, 1999, 1998, and 1997, revenues from AT&T represented approximately 50.5%, 37.4%, and 32.9% of total revenues, and revenues from Time Warner Cable and its affiliated companies ("Time Warner") represented approximately 10.2%, 14.1%, and 20.1% of total revenues, respectively. See Note 4 for discussion of the Company's contract with AT&T. The Company has separate processing agreements with multiple affiliates of Time Warner and provides products and services to them under separately negotiated and executed contracts.
4. Acquisitions
USTATS Asset Acquisition. On July 30, 1998, the Company acquired substantially all of the assets of US Telecom Advanced Technology Systems, Inc. ("USTATS") for approximately $6.0 million in cash and assumption of certain liabilities of approximately $1.3 million. USTATS, a South Carolina- based company, specializes in open systems, client/server customer care and billing systems serving the telecommunications markets. The Company used the acquired technology and software primarily to enhance its current service- bureau telephony customer care and billing system. The cash portion of the purchase price was paid out of corporate funds. The total purchase price of $7.3 million has been allocated to the technology and software acquired and is being amortized over its expected useful life of five years.
SUMMITrak Asset Acquisition. In September 1997, the Company purchased certain SUMMITrak software technology assets (the "SUMMITrak Acquisition") that were in development from Tele-Communications, Inc. ("TCI") and entered into a 15-year exclusive contract with a TCI affiliate to consolidate 13.0 million TCI customers onto the Company's customer care and billing system. In March 1999, AT&T completed its merger with TCI and has consolidated the TCI operations into AT&T Broadband ("AT&T"). The Company continues to service AT&T under the terms of the 15-year processing contract (the "AT&T Contract").
The purchase price for the SUMMITrak Acquisition was determined as follows (in thousands):
The purchase price included certain conversion incentive payments, with the amounts and the timing of the payments based principally upon the number of AT&T customers converted to and processed on the Company's customer care and billing system. AT&T surpassed the final milestone of 13 million customers processed on the Company's systems during the third quarter of 1999. Upon reaching this significant milestone, AT&T was paid its final monetary conversion incentive by the Company. The total monetary conversion incentives paid during 1999 and 1998 to AT&T were $22.0 million and $4.0 million, respectively. The amounts paid were reflected in the Company's Consolidated Balance Sheets as "conversion incentive payments".
The Company also granted 3.0 million Common Stock warrants to AT&T as part of the overall purchase price. The warrants have a five-year life with a $12 per share exercise price. The fair value of the warrants included in the purchase price was estimated as of the date of the grant using the Black- Scholes pricing model.
The Company engaged an independent party to assist in the allocation of the purchase price to the assets acquired. The Company allocated the purchase price as follows (in thousands):
Purchased research and development represents R&D of software technologies which had not reached technological feasibility as of the acquisition date, and had no other alternative future use. Purchased research and development was charged to operations in 1997. The Company continued the R&D of certain software technologies acquired from AT&T. Such efforts included the completion of the R&D projects and the integration of the completed software technologies into certain of its current products. The related products from these development efforts were available for general release in 1999.
The value assigned to the AT&T Contract is being amortized over the life of the contract in proportion to the financial minimums included in the contract. The amortization expense for the AT&T Contract was $3.3 million, $1.9 million, and $0.3 million for the years ended December 31, 1999, 1998 and 1997, respectively. The other assets are being depreciated over their estimated useful lives of three years.
5. Stock Repurchase Program
On August 4, 1999, the Company's Board of Directors approved a stock repurchase plan which authorized the Company 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 1999, the Company repurchased a total of 655,500 shares for approximately $20.2 million (a weighted average price of $30.88 per share). The repurchased shares are held as treasury shares.
6. Debt
In conjunction with the SUMMITrak Acquisition, the Company entered into a $190.0 million debt agreement with a bank in September 1997 (the "1997 Debt"), which consists of a $150.0 million term facility
(the "Term Credit Facility") and a $40.0 million revolving credit facility. The proceeds from the Term Credit Facility were used to pay the $106.0 million cash purchase price for the SUMMITrak assets, retire the Company's previous bank debt of $27.5 million, and pay transaction costs of $3.4 million. The remaining proceeds were used for general corporate purposes. In conjunction with this refinancing, the Company recorded an extraordinary loss of $0.6 million for the write-off of deferred financing costs. The Company did not recognize any income tax benefit related to the extraordinary loss. In addition to the scheduled quarterly principal payments, the Company also made optional principal payments on the Term Credit Facility of $31.6 million and $15.0 million in 1999 and 1997, respectively.
Interest rates for the 1997 Debt, including the term and revolving credit facilities, are chosen at the option of the Company and are based on the LIBOR rate or the prime rate, plus an additional percentage spread, with the spread dependent upon the Company's leverage ratio. As of December 31, 1999, the spread on the LIBOR rate and prime rate was 0.50% and 0%, respectively. The Company entered into an interest rate collar agreement in December 1997 to manage its risk from the variable rate features of the 1997 Debt agreement (Note 2). The 1997 Debt agreement is collateralized by all of the Company's assets and the stock of its subsidiaries.
The 1997 Debt agreement requires maintenance of certain financial ratios and contains other restrictive covenants, including restrictions on payment of dividends, a fixed charge coverage ratio, a leverage ratio, and restrictions on capital expenditures. As of December 31, 1999, the Company was in compliance with all covenants. The payment of cash dividends or other types of distributions on any class of the Company's stock is restricted unless the Company's leverage ratio, as defined in the 1997 Debt agreement, is under 1.50. As of December 31, 1999, the leverage ratio was 0.62.
Long-term debt as of December 31 consists of the following (in thousands):
There were no borrowings made on the revolving credit facilities during the years ended December 31, 1999, 1998, and 1997. Under the 1997 Debt agreement, the Company pays an annual commitment fee on the unused portion of the revolving credit facility, based upon the Company's leverage ratio. As of December 31, 1999, the fee was 0.25%. The Company's ability to borrow under the current revolving credit facility is subject to maintenance of certain levels of eligible receivables. At December 31, 1999, all of the $40.0 million revolving credit facility was available to the Company.
As of December 31, 1999 and 1998, unamortized deferred financing costs were $1.1 million and $2.0 million, respectively. Deferred financing costs are amortized to interest expense over the related term of the debt agreement using a method which approximates the effective interest rate method. Interest expense for the years ended December 31, 1999, 1998 and 1997 includes amortization of deferred financing costs of approximately $0.9 million, $0.9 million, and $0.5 million, respectively.
As of December 31, 1999, scheduled maturities of the Company's long-term debt for each of the years ending December 31 are: 2000--$21.7 million, 2001-- $25.9 million, and 2002--$33.4 million.
7. Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 is an asset and liability approach which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events which have been recognized in the Company's Consolidated Financial Statements or tax returns. In estimating future tax consequences, SFAS 109 generally considers all expected future events other than enactment of or changes in the tax law or rates.
Income tax provision (benefit) consists of the following (in thousands):
The difference between the income tax provision (benefit) computed at the statutory federal income tax rate and the financial statement provision (benefit) for income taxes is summarized as follows (in thousands):
The deferred tax assets and liabilities result from differences in the timing of the recognition of certain income and expense items for tax and financial reporting purposes. The sources of these differences at December 31 are as follows (in thousands):
As part of an acquisition accounted for as a purchase in 1996, the Company acquired certain net deferred tax assets (principally related to net operating loss carryforwards) and established a valuation allowance of approximately $1.0 million against those net deferred tax assets as of the acquisition date. Upon the realization of these deferred tax assets, the Company eliminated the valuation allowance and reduced goodwill by a corresponding amount of $0.9 million in 1998.
As of December 31, 1997, the Company had a valuation allowance of $61.3 million against certain of its deferred tax assets due to the uncertainty that it would realize the income tax benefit from these assets. During 1998, the Company concluded that it was more likely than not that it would realize the entire tax benefit from its deferred tax assets based on its evaluation of the Company's anticipated profitability over the period of years that the temporary differences were expected to become deductions. As a result, the Company eliminated the entire valuation allowance as of December 31, 1998, which resulted in the Company reflecting a net income tax benefit of $39.6 million for 1998. As of December 31, 1999, management continues to believe that sufficient taxable income will be generated to realize the entire benefit of these deferred tax assets. The Company's assumptions of future profitable operations are supported by its strong operating performances in 1999 and 1998, and the conversion of a significant number of new customers onto its processing system during these periods.
8. Employee Retirement Benefit Plans
Incentive Savings Plan. The Company sponsors a defined contribution plan covering substantially all employees of the Company. Participants may contribute up to 15% of their annual wages, subject to certain limitations, as pretax, salary deferral contributions. The Company makes certain matching and service-related contributions to the plan. The Company's matching and service- related contributions for the years ended December 31, 1999, 1998 and 1997, were approximately $3.4 million, $2.9 million, and $2.0 million, respectively.
Deferred Compensation Plan. The Company maintains a non-qualified deferred compensation plan for certain Company executives which allows the participants to defer a portion of their annual compensation. The Company provides a 25% matching contribution of the participant's deferral, up to a maximum of $6,250 per year. The Company also credits the participant's deferred account with a specified rate of return on an annual basis. The Company records the actuarially determined present value of the obligations expected to be paid under the plan. As of December 31, 1999 and 1998, the Company has recorded a liability for this obligation of $1.1
million and $1.0 million, respectively. The Company's expense for this plan for the years ended December 31, 1999, 1998 and 1997, which includes Company contributions and interest expense, was $0.4 million, $0.4 million, and $0.5 million, respectively. The plan is unfunded.
9. Commitments and Contingencies
Operating Leases. The Company leases certain office and production facilities under operating leases which run through 2010. Future aggregate minimum lease payments under these agreements for the years ending December 31 are as follows: 2000--$6.1 million, 2001--$6.8 million, 2002--$6.3 million, 2003--$5.8 million, 2004--$4.5 million, thereafter--$16.9 million.
Total rent expense for the years ended December 31, 1999, 1998, and 1997, was approximately $5.2 million, $3.9 million, and $3.4 million, respectively.
Service Agreements. The Company has service agreements with FDC and its subsidiaries for data processing services, communication charges and other related services. FDC provides data processing and related services required for the operation of the Company's CCS system.
Effective January 1, 1997, the Company renegotiated its services agreement with FDC and its subsidiaries. The new agreement expires December 31, 2001, and is cancelable at the Company's option with (i) notice of six months any time after January 1, 2000, and (ii) payment of a termination fee equal to 20% of the fees paid in the twelve months preceding the notification of termination. Under the agreement, the Company is charged based on usage and/or actual costs, and is subject to certain limitations as to the amount of increases or decreases in usage between years. The total amount paid under the service agreements for the years ended December 31, 1999, 1998 and 1997, was approximately $27.1 million, $22.1 million, and $19.2 million, respectively. The Company believes it could obtain data processing services from alternative sources, if necessary.
Legal Proceedings. From time to time, the Company is involved in litigation relating to claims arising out of its operations in the normal course of business. In the opinion of the Company's management, after consultation with outside legal counsel, the ultimate dispositions of such matters will not have a materially adverse effect on the Company's consolidated financial position or results of operations.
10. Discontinued Operations
Contemporaneously with the CSG Acquisition, the Company purchased from FDC all of the outstanding shares of Anasazi Inc. ("Anasazi") for $6.0 million cash. The Company accounted for its ownership in Anasazi as discontinued operations after its acquisition in 1994. On August 31, 1995, the Company completed a substantial divestiture of Anasazi as part of a tax-free reorganization, resulting in the Company owning less than 20% of Anasazi. As a result, Anasazi's results of operations subsequent to August 31, 1995 are not included in the Company's results of operations as the Company accounted for its investment in Anasazi under the cost method subsequent to this date. In September 1997, the Company sold its remaining interest in Anasazi for $8.6 million in cash and recognized a gain of $7.9 million.
11. Restricted Common Stock
During 1995 and 1994, the Company sold Common Stock to executive officers and key employees pursuant to restricted stock agreements. Certain of these shares vest over the individual's service period with the Company. The Company has the option upon termination of employment to repurchase unvested shares of restricted stock at either the original purchase price (ranging from $0.11 to $2.13 per share) or the net book value per share, depending upon the specific terms of the agreements. During the years ended December 31, 1998, and 1997, the Company repurchased unvested shares of 66,000, and 209,100, respectively, from terminated employees. The 66,000 shares repurchased in 1998 are held as treasury shares. The shares repurchased in 1997 were cancelled. There were no shares repurchased during 1999. As of December 31, 1999, 171,400 shares were still subject to the repurchase option. In January 2000, the Company repurchased 18,500 shares from a terminated
employee. The remainder of the 152,900 shares are scheduled to vest in 2000. Deferred compensation of $0.05 million and $0.3 million as of December 31, 1999 and 1998, respectively, relates to the unvested shares and is reflected as a component of stockholders' equity. Stock-based compensation expense related to these shares for 1999, 1998 and 1997 was $0.3 million, $0.3 million, and $0.4 million, respectively.
Certain employees financed a portion of their stock purchases with full recourse promissory notes. The notes accrue interest at 7% annually and have terms of approximately five years. As of December 31, 1999 and 1998, the outstanding balance of the promissory notes was approximately $0.1 million and $0.5 million, respectively, and is reflected as a component of stockholders' equity.
12. Stock-Based Compensation Plans
Stock Incentive Plans. During 1995, the Company adopted the Incentive Stock Plan (the "1995 Plan") whereby 514,000 shares of the Company's Common Stock have been reserved for issuance to eligible employees of the Company in the form of stock options. The 190,100 options outstanding under the 1995 Plan at December 31, 1999, vest annually over five years.
During 1996, the Company adopted the 1996 Stock Incentive Plan (the "1996 Plan") whereby 4,800,000 shares of the Company's Common Stock have been reserved for issuance to eligible employees of the Company in the form of stock options, stock appreciation rights, performance unit awards, restricted stock awards, or stock bonus awards. In December 1997, upon shareholder approval, the number of shares authorized for issuance under the 1996 Plan was increased to 8,000,000. In May 1999, upon shareholder approval, the number of shares authorized for issuance under the 1996 Plan was increased to 11,000,000. The 5,278,722 options outstanding under the 1996 Plan as of December 31, 1999, vest over four to five years. Certain options become fully vested upon a change in control of the Company.
During 1997, the Company adopted the Stock Option Plan for Non-Employee Directors (the "Director Plan") whereby 200,000 shares of the Company's Common Stock have been reserved for issuance to non-employee Directors of the Company in the form of stock options. The 136,000 options outstanding under the Director Plan at December 31, 1999, vest annually over three years.
Stock options are granted with an exercise price equal to the fair market value of the Company's Common Stock as of the date of the grant. All outstanding options have a 10-year term. A summary of the stock options issued under the 1996 Plan, the Director Plan, and 1995 Plan and changes during the years ending December 31 are as follows:
The following table summarizes information about the Company's stock options as of December 31, 1999:
In January 2000, the Company granted 919,800 options at prices that range from $38.44 per share to $47.63 per share under the 1996 Plan, with such options vesting over four years. These options are not reflected in the above tables as they were granted subsequent to December 31, 1999.
1996 Employee Stock Purchase Plan. During 1996, the Company adopted the 1996 Employee Stock Purchase Plan whereby 500,000 shares of the Company's Common Stock have been reserved for sale to employees of the Company and its subsidiaries through payroll deductions. The price for shares purchased under the plan is 85% of market value on the last day of the purchase period. Purchases are made at the end of each month. During 1999, 1998, and 1997, respectively, 34,352 shares, 31,374 shares, and 39,318 shares have been purchased under the plan for $0.9 million ($18.91 to $37.08 per share) $0.6 million ($15.62 to $33.58 per share), and $0.4 million ($7.17 to $17.00 per share).
Stock-Based Compensation Plans. At December 31, 1999, the Company had four stock-based compensation plans, as described above. The Company accounts for these plans under APB Opinion No. 25, under which no compensation expense has been recognized in 1999, 1998 or 1997.
Had compensation expense for the Company's four stock-based compensation plans been based on the fair value at the grant dates for awards under those plans consistent with the methodology of SFAS 123, the Company's net income (loss) and net income (loss) per share attributable to common stockholders for 1999, 1998 and 1997 would approximate the pro forma amounts as follows (in thousands, except per share amounts):
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for options granted in 1999, 1998 and 1997, respectively: risk- free interest rates of 5.0%, 4.9%, and 6.3%; dividend yield of zero percent for all years; expected lives of 4.1 years, 4.4 years, and 3.9 years; and volatility of 40.0% for all years. Consistent with SFAS 123, the Company assumed zero volatility for all options granted prior to the date the Company qualified as a public entity.
The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. SFAS 123 applies only to 1999, 1998 and 1997, and additional awards in future years are anticipated.
13. Unaudited Quarterly Financial Data
- -------- (1) The fourth quarter of 1998 included an income tax benefit of $39.6 million, or $0.74 per diluted share, related primarily to the elimination of the Company's valuation allowance against its deferred tax assets (Note 7).
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 10.
Item 10. Directors and Executive Officers of the Registrant
See the Proxy Statement for the Company's Annual Meeting of Stockholders, which information regarding directors is incorporated herein by reference. Information regarding the Company's executive officers will be omitted from such proxy statement and is furnished in a separate item captioned "Executive Officers of the Registrant" included in Part I of this Form 10-K.
Item 11.
Item 11. Executive Compensation
See the Proxy Statement for the Company's Annual Meeting of Stockholders, which information is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
See the Proxy Statement for the Company's Annual Meeting of Stockholders, which information is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
See the Proxy Statement for the Company's Annual Meeting of Stockholders, which information is incorporated herein by reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Financial Statements, Financial Statement Schedules, and Exhibits:
(1) Financial Statements
The financial statements filed as part of this report are listed on the Index to Consolidated Financial Statements on page 25.
(2) Financial Statement Schedules:
None. Any information required in the financial statement schedules is provided in sufficient detail in the Consolidated Financial Statements and notes thereto.
(3) Exhibits
Exhibits are listed in the Exhibit Index on page 47.
The Exhibits include management contracts, compensatory plans and arrangements required to be filed as exhibits to the Form 10-K by Item 601(10)(iii) of Regulation S-K.
(b) Reports on Form 8-K
None
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CSG Systems International, Inc.
/s/ Neal C. Hansen By: _________________________________ Neal C. Hansen Chief Executive Officer (Principal Executive Officer)
Date: March 24, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in capacities and on the dates indicated.
EXHIBIT INDEX
- -------- (1) Incorporated by reference to the exhibit of the same number to the Registration Statement No. 333-244 on Form S-1. (2) Incorporated by reference to the exhibit of the same number to the Registrant's Annual Report on Form 10-K, as amended, for the year ended December 31, 1996. (3) Incorporated by reference to the exhibit of the same number to the Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1997. (4) Incorporated by reference to the exhibit of the same number to the Registrant's Current Report on Form 8-K dated October 6, 1997.
(5) Incorporated by reference to the exhibit of the same number to the Registrant's Annual Report on Form 10-K, as amended for the year ended December 31, 1997. (6) Incorporated by reference to the exhibit of the same number to the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 1998. (7) Incorporated by reference to the exhibit of the same number to the Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1998. (8) Incorporated by reference to the exhibit of the same number to the Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 1998. (9) Incorporated by reference to the exhibit of the same number to the Registrant's Annual Report on Form 10-K, as amended for the year ended December 31, 1998. (10) Incorporated by reference to the exhibit of the same number to the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 1999. (11) Incorporated by reference to the exhibit of the same number to the Registrant's Quarterly Report on Form 10-Q for the period ended June 30, 1999. (12) Incorporated by reference to the exhibit of the same number to the Registrant's Quarterly Report on Form 10-Q for the period ended September 30, 1999. * Portions of the exhibit have been omitted pursuant to an application for confidential treatment, and the omitted portions have been filed separately with the Commission.