UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended March 31, 2018

OR

For the transition period from                      to                      

Commission file number 0-27512

 

CSG SYSTEMS INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

6175 S. Willow Drive, 10^th Floor

Greenwood Village, Colorado 80111

(Address of principal executive offices, including zip code)

(303) 200-2000

(Registrant’s telephone number, including area code)

 

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

YES   ☒           NO   ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES   ☒           NO   ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES  ☐            NO   ☒

Shares of common stock outstanding at April 30, 2018:  33,653,228

 

 

 

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CSG SYSTEMS INTERNATIONAL, INC.

FORM 10-Q for the Quarter Ended March 31, 2018

INDEX

 

 

 

 

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CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS - UNAUDITED

(in thousands, except per share amounts)  

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

 

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CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED

(in thousands, except per share amounts)

 

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

 

 

 

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CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - UNAUDITED

(in thousands)

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

(in thousands)

 

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

 

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CSG SYSTEMS INTERNATIONAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. GENERAL

We have prepared the accompanying unaudited condensed consolidated financial statements as of March 31, 2018 and December 31, 2017, and for the quarters ended March 31, 2018 and 2017, in accordance with accounting principles generally accepted in the United States of America (“U.S.”) (“GAAP”) for interim financial information, and pursuant to the instructions to Form 10-Q and the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of our management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of our financial position and operating results have been included. The unaudited Condensed Consolidated Financial Statements (the “Financial Statements”) should be read in conjunction with the Consolidated Financial Statements and notes thereto, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), contained in our Annual Report on Form 10-K for the year ended December 31, 2017 (our “2017 10-K”), filed with the SEC. The results of operations for the quarter ended March 31, 2018 are not necessarily indicative of the expected results for the entire year ending December 31, 2018.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates in Preparation of Financial Statements. The preparation of the accompanying Financial Statements in conformity with GAAP 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 our Financial Statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.  

Revenue.  We adopted Topic 606 Revenue from Contracts with Customers (“ASC 606”) as of January 1, 2018 using the cumulative effect method and have applied ASC 606 to all contracts with clients that had not been completed as of the date of initial application. In conjunction with the adoption of ASC 606, we recorded a cumulative adjustment increasing beginning retained earnings (net of tax) by approximately $7 million, primarily related to contracts that we were previously required to defer revenue as we did not have vendor specific objective evidence (“VSOE”) of fair value for certain undelivered elements. Since we adopted ASC 606 using the cumulative effect method, comparative information in our Financial Statements has not been adjusted and continues to be as previously reported.

 

The following tables summarize the impacts of adopting ASC 606 on our Financial Statements as of and for the quarter ended March 31, 2018 (in thousands, except per share amounts):

 

 

 

 

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As a result of adopting ASC 606, we have changed our accounting policies for revenue recognition as discussed in more detail below.

 

In summary, our revenue from client contracts is primarily related to our cloud and related solutions and, to a lesser degree, software and service and related maintenance arrangements, and is measured based on consideration specified within each of our contracts, excluding sales incentives and amounts collected on behalf of third parties, if any.  We account for various products and services separately if they are distinct. A product or service, or group of products or services, is distinct if it is separately identifiable from other items in the context of the contract and if our client can benefit from the product or service on their own or with other resources that are readily available to that client. We recognize revenue when we satisfy our performance obligations by transferring control

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over a particular product or service, or group of products or services, to our clients, as described in more detail below.  Taxes assessed on our products and services based on governmental authorities at the time of invoicing are excluded from our revenue.

Cloud and Related Solutions.

Our cloud and related solutions revenue relates to: (i) our software-as-a-service (“SaaS”), cloud-based, revenue management and content monetization solutions, and various related ancillary services; and (ii) our managed services offering in which we operate software solutions (primarily our software solutions) on behalf of our clients.  

We contract for our cloud-based solutions using long-term arrangements whose terms have typically ranged from three to ten years. The long-term cloud-based arrangements include a series of multiple services delivered daily or monthly, to include such things as: (i) revenue billing and customer care services; (ii) business support services (e.g., workforce management tools, consumer credit verifications, etc.); (iii) content monetization and delivery functions; and (iv) customer statement invoice printing and mailing services. The fees for these services typically are billed to our clients monthly based upon actual monthly volumes and/or usage of services (e.g., the number of client customers maintained on our systems, the number of transactions processed on our systems, and/or the quantity and content of the monthly statements and mailings processed through our systems).

For cloud-based solution contracts, the total contract consideration (including impacts of discounts or incentives) is primarily variable dependent upon actual monthly volumes and/or usage of services; however, these contracts can also include ancillary fixed consideration in the form of one-time, monthly or annual fees. Although there may be multiple performance obligations, there is generally no allocation of value between the individual performance obligations as all are considered cloud and related solutions revenues that are recognized based on activities performed in each daily or monthly period.

We contract for managed services solutions using long-term arrangements whose terms have typically ranged from three to five years.  Under managed services agreements, we may operate software products (primarily our software solutions) on behalf of our clients: (i) out of a client’s data center; (ii) out of a data center we own and operate; or (iii) out of a third-party data center we contract with for such services. Managed services can also include us providing other services, such as transitional services, fulfillment, remittance processing, operational consulting, back office, and end user billing services. The fees for these services typically are billed to our clients monthly on a fixed schedule.

For managed services contracts, the total contract consideration is typically a fixed fee but these contracts may also have variable fee components. Unless managed services are included with a software license contract (as discussed further below), there is generally only one performance obligation and revenue is recognized for these arrangements on a ratable basis as the services are performed.

Fees related to set-up or implementation activities for both cloud-based solution and managed services contracts are deferred and recognized ratably over the related service period to which the activities relate.

Due to the significance of variable consideration, number of products/services, complex pricing structures and long-term nature of these types of contracts, the judgments and estimates made in this area could have a significant effect on the amount and timing of revenues recognized in any period.

Prior to the adoption of ASC 606, we recognized revenue related to our cloud and related solutions contracts on a monthly basis as we provided the services.  The adoption of ASC 606 did not result in any significant changes to the timing of revenue recognition related to these contracts.

Software and Services.

Our software and services revenue relates primarily to: (i) software license sales on either a perpetual or term license basis; and (ii) professional services to implement the software. Our software and services contracts are often contracted in bundled arrangements that include not only the software license and related implementation services, but can also include maintenance, managed services and/or additional professional services.

 

For our software arrangements, the total contract consideration is allocated between the separate performance obligations based on stand-alone selling prices for software licenses, cost plus applicable margin for services and established pricing for maintenance.  The initial sale of software products generally requires significant production, modification or customization, such that the delivery of the software license and the related professional services required to implement the software represent one combined performance obligation that is satisfied over time based of hours worked (hours-based method). We are using hours worked on the project as the measure to determine progress toward completion as we believe it is the most appropriate metric to measure such progress. The software and services fees are generally billed to our clients on a milestone or date basis.

The determination of the performance obligations and allocation of value for software license arrangements require significant judgement.  We generally determine stand-alone selling prices using pricing calculations (which include regional market factors) for our software license fees and maintenance, and cost-plus margins for services. Additionally, our use of an hours-based method of

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accounting for software license and other professional services performance obligations that are satisfied over time requires estimates of total project revenues and costs, along with the expected hours necessary to complete a project. Changes in estimates as a result of additional information or experience on a project as work progresses are inherent characteristics of this method of revenue recognition as we are exposed to various business risks in completing these types of performance obligations. The estimation process to support our hours-based recognition method is more difficult for projects of greater length and/or complexity. The judgments and estimates made in this area could: (i) have a significant effect on revenues recognized in any period by changing the amount and/or the timing of the revenue recognized; and/or (ii) impact the expected profitability of a project, including whether an overall loss on an arrangement has occurred. To mitigate the inherent risks in using this hours-based method, we track our performance on projects and reevaluate the appropriateness of our estimates as part of our monthly accounting cycle.

In certain instances, we sell software license volume upgrades, which provide our clients the right to use our software to process higher transaction volume levels. In these instances, we analyze the contract to determine if the volume upgrade is a separate performance obligation and if so, we recognize the value associated with the software license as revenue on the effective date of the volume upgrade.

A portion of our professional services revenues are contracted separately (e.g., business consulting services, etc.). Such contracts can either be on a fixed-price or time-and-materials basis.  Revenues from fixed-price, professional service contracts are recognized using an hours-based method, as these professional services represent a performance obligation that is satisfied over time.  Revenues from professional services contracts billed on a time-and-materials basis are recognized as the services are performed.

 

Prior to the adoption of ASC 606, we recognized revenue for our software arrangements under the guidelines of contract accounting as our software products required significant production, modification or customization and if we had VSOE of fair value for undelivered elements (e.g., maintenance), which we generally had, we would allocate a portion of the total arrangement fee to the undelivered element based on its VSOE of fair value, and the balance of the arrangement fee was recognized using the percentage-of-completion (“POC”) method of accounting.

Maintenance.

Our maintenance revenue relates primarily to support of our software once it has been implemented.  Maintenance revenues are recognized ratably over the software maintenance period as services are provided. Our maintenance consists primarily of client and product support, technical updates (e.g., bug fixes, etc.), and unspecified upgrades or enhancements to our software products. If specified upgrades or enhancements are offered in a contract, which is rare, they are accounted for as a separate performance obligation. Maintenance can be invoiced to our clients on a monthly, quarterly or annual basis.

 

Transaction Price Allocated to the Remaining Performance Obligations

As of March 31, 2018, our aggregate amount of the transaction price allocated to the remaining performance obligations is approximately $517 million, which is made up of fixed fee consideration and guaranteed minimums expected to be recognized in the future related to performance obligations that are unsatisfied (or partially unsatisfied). We expect to recognize approximately 80% of this amount over the next three years, with the remaining amount recognized by the end of 2023. We have excluded from this amount variable consideration expected to be recognized in the future related to performance obligations that are unsatisfied (a practical expedient allowed under ASC 606). The majority of our future revenue is related to our cloud and related solution client contracts that include variable consideration dependent upon a series of monthly volumes and/or daily usage of services and have contractual terms ending from 2019 through 2023.

 

We have not disclosed transaction price allocation to remaining performance obligations or an explanation thereof of comparable amounts as of December 31, 2017 (a transitional practical expedient allowed under ASC 606).  

 

Disaggregation of Revenue

In the following table, revenue is disaggregated by geographic region (using the location of the client as the basis of attributing revenues to the individual regions):

 

 

Billed and Unbilled Accounts Receivable. Billed accounts receivable represents our unconditional rights to consideration. Once invoiced, our payment terms are generally between 30-60 days, and rarely do we have contracts with financing arrangements.

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Unbilled accounts receivable represents our rights to consideration for work completed but not billed.  Unbilled accounts receivable is transferred to billed accounts receivable when the rights become unconditional which is generally at the time of invoicing.

 

The following table rolls forward our unbilled accounts receivable from December 31, 2017 to March 31, 2018 (in thousands):

 

 

Deferred Revenue. Deferred revenue represents consideration received from clients in advance of services being performed.

 

The following table rolls forward our deferred revenue from December 31, 2017 to March 31, 2018 (in thousands):

 

 

Cash and Cash Equivalents. We consider all highly liquid investments with original maturities of three months or less at the date of the purchase to be cash equivalents. As of March 31, 2018 and December 31, 2017, our cash equivalents consist primarily of institutional money market funds, commercial paper, and time deposits held at major banks.

As of March 31, 2018 and December 31, 2017, we had $2.7 million and $4.2 million, respectively, of restricted cash that serves to collateralize outstanding letters of credit. This restricted cash is included in cash and cash equivalents in our Condensed Consolidated Balance Sheets (“Balance Sheets” or “Balance Sheet”).

Short-term Investments and Other Financial Instruments. Our financial instruments as of March 31, 2018 and December 31, 2017 include cash and cash equivalents, short-term investments, accounts receivable, accounts payable, and debt. Because of their short maturities, the carrying amounts of cash equivalents, accounts receivable, and accounts payable approximate their fair value.

Our short-term investments and certain of our cash equivalents are considered “available-for-sale” and are reported at fair value in our Balance Sheets, with unrealized gains and losses, net of the related income tax effect, excluded from earnings and reported in a separate component of stockholders’ equity. Realized and unrealized gains and losses were not material in any period presented.

Primarily all short-term investments held by us as of March 31, 2018 and December 31, 2017 have contractual maturities of less than two years from the time of acquisition. Our short-term investments as of March 31, 2018 and December 31, 2017 consisted almost entirely of fixed income securities. Proceeds from the sale/maturity of short-term investments for the three months ended March 31, 2018 and 2017 were $79.5 million and $37.8 million, respectively.

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The following table represents the fair value hierarchy based upon three levels of inputs, of which Levels 1 and 2 are considered observable and Level 3 is unobservable, for our financial assets and liabilities measured at fair value (in thousands):

 

 

Valuation inputs used to measure the fair values of our money market funds and corporate equity securities were derived from quoted market prices. The fair values of all other financial instruments are based upon pricing provided by third-party pricing services. These prices were derived from observable market inputs.

We have chosen not to measure our debt at fair value, with changes recognized in earnings each reporting period.  The following table indicates the carrying value (par value for convertible debt) and estimated fair value of our debt as of the indicated periods (in thousands):

 

 

The fair value for our credit agreement was estimated using a discounted cash flow methodology, while the fair value for our convertible debt was estimated based upon quoted market prices or recent sales activity, both of which are considered Level 2 inputs.  See Note  4 for additional discussion regarding an amendment to our Credit Agreement.

 

Other Accounting Pronouncements Adopted. In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740) Intra-Entity Transfers of Assets Other Than Inventory. This ASU requires entities to recognize at the transaction date the income tax consequences of intercompany asset transfers. This ASU is effective in annual and interim periods in fiscal years beginning after December 15, 2017, with early adoption permitted, and requires a modified retrospective transition method. We adopted this ASU in January 2018 and the adoption of this standard did not have a material impact on our Financial Statements.

 

Accounting Pronouncement Issued But Not Yet Effective. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842).  This ASU requires lessees to recognize a lease liability and a right-to-use asset for all leases, including operating leases, with a term greater than twelve months on its balance sheet.  This ASU is effective in annual and interim periods in fiscal years beginning after December 15, 2018, with early adoption permitted, and requires a modified retrospective transition method.  We are currently in the process of evaluating the impact this ASU will have on our Financial Statements.  Based on our initial evaluations, we believe the adoption of this standard will have a material impact on our consolidated balance sheet.

    

3. LONG-LIVED ASSETS

Goodwill. The changes in the carrying amount of goodwill for the first quarter of 2018, were as follows (in thousands):

 

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See Note 5 for discussion regarding the Business Ink acquisition.

 

Other Intangible Assets. As part of the adoption of ASC 606, at January 1, 2018, we reclassified our investment in client contracts and capitalized costs related to conversion/set-up activities from “client contracts” to “client contract costs” on our Balance Sheet.  As of March 31, 2018, our intangible assets subject to ongoing amortization consist of acquired client contracts and software. As of March 31, 2018 and December 31, 2017, the carrying values of our other intangible assets were as follows (in thousands):

 

 

Other intangible assets as of March 31, 2018 include assets acquired in the Business Ink business acquisition (see Note 5).

 

The total amortization expense related to other intangible assets for the first quarters of 2018 and 2017 were $4.0 million and $6.9 million, respectively.  Based on the March 31, 2018 net carrying value of our other intangible assets, the estimated total amortization expense for each of the five succeeding fiscal years ending December 31 are: 2018 – $14.2 million;  2019 – $14.8 million; 2020 – $12.1 million; 2021– $8.1 million; and 2022 – $6.4 million.

 

Client Contract Costs.  As of March 31, 2018, the carrying values of our contract cost assets, related to those contracts with a contractual term greater than one year, were as follows (in thousands):

 

 

The aggregate amortization related to our client contract costs include in our operations for the first quarter of 2018 was as follows (in thousands):

 

 

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4. DEBT

Our long-term debt, as of March 31, 2018 and December 31, 2017, was as follows (in thousands):

 

 

Credit Agreement

2018 Credit Agreement.  On March 5, 2018, we entered into a new $350 million credit agreement (the “2018 Credit Agreement”) with a consortium of banks to replace the 2015 Credit Agreement.  

The 2018 Credit Agreement provides borrowings in the form of:  (i) a $150 million aggregate principal five-year term loan (the “2018 Term Loan”); and (ii) a $200 million aggregate principal five-year revolving loan facility (the “2018 Revolver”).  With the $150 million proceeds from the 2018 Term Loan, CSG repaid the outstanding $120 million balance of the term loan under the 2015 Credit Agreement, resulting in a net increase of available cash by $30 million, a portion of which was used to pay certain fees and expenses in connection with the refinancing, and the remainder of which will be used for general corporate purposes.  

The interest rates under the 2018 Credit Agreement are based upon our choice of an adjusted LIBOR rate plus an applicable margin of 1.50% - 2.50%, or an alternate base rate plus an applicable margin of 0.50% -1.50%, with the applicable margin, depending on our then-net secured total leverage ratio.  We will pay a commitment fee of 0.200% - 0.375% of the average daily unused amount of the 2018 Revolver, with the commitment fee rate also dependent upon our then-net secured total leverage ratio.  The 2018 Credit Agreement includes mandatory repayments of the aggregate principal amount of the 2018 Term Loan (payable quarterly) for the first, second, third, fourth, and fifth years, with the remaining principal balance due at maturity.  The 2018 Credit Agreement has no prepayment penalties and requires mandatory repayments under certain circumstances, including:  (i) asset sales or casualty proceeds; and (ii) proceeds of debt or preferred stock issuances.    

The 2018 Credit Agreement contains customary affirmative covenants.  In addition, the 2018 Credit Agreement has customary negative covenants that places limits on our ability to:  (i) incur additional indebtedness; (ii) create liens on its property; (iii) make investments; (iv) enter into mergers and consolidations; (v) sell assets; (vi) declare dividends or repurchase shares; (vii) engage in certain transactions with affiliates; and (viii) prepay certain indebtedness; and (ix) issue capital stock of subsidiaries.  We must also meet certain financial covenants to include:  (i) a maximum total leverage ratio; (ii) a maximum first-lien leverage ratio; and (iii) a minimum interest coverage ratio.   In conjunction with the 2018 Credit Agreement, we entered into a security agreement in favor of

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Bank of America N.A, as collateral agent (the “Security Agreement”).  Under the Security Agreement and 2018 Credit Agreement, certain of our domestic subsidiaries have guaranteed our obligations, and have pledged substantially all of our assets to secure the obligations under the 2018 Credit Agreement and such guarantees.  

During the first quarter of 2017, we made  $3.8 million of principal repayments on our 2015 Credit Agreement. As of March 31, 2018, our interest rate on the 2018 Term Loan is 3.21% (adjusted LIBOR plus 1.50% per annum), effective through April 8, 2018, and our commitment fee on the 2018 Revolver is 0.20%.  As of March 31, 2018, we had no borrowing outstanding on our 2018 Revolver and had the entire $200.0 million available to us.  

 

In conjunction with the closing of the 2018 Credit Agreement, we incurred financing costs of $1.4 million.  When combined with the remaining deferred financing costs of the 2015 Credit Agreement, financing costs of $2.7 million have been deferred and are being amortized to interest expense using the effective interest method over the related term of the 2018 Credit Agreement. Additionally, as certain lenders from the 2015 Credit Agreement chose not to participate in the 2018 Credit Agreement syndication group, we wrote-off $0.8 million of unamortized debt issuance costs and recognized a loss on extinguishment of that debt.

Convertible Notes

2016 Convertible Notes.  Upon conversion of the 2016 Convertible Notes, we will settle our conversion obligation by paying or delivering, as the case may be, cash, shares of our common stock, or a combination thereof, at our election. It is our current intent and policy to settle our conversion obligations as follows: (i) pay cash for 100% of the par value of the 2016 Convertible Notes that are converted; and (ii) to the extent the value of our conversion obligation exceeds the par value, we can satisfy the remaining conversion obligation in our common stock, cash or a combination thereof.

The 2016 Convertible Notes will be convertible at the option of the note holders upon the satisfaction of specified conditions and during certain periods. During the period from, and including, December 15, 2021 to the close of business on the business day immediately preceding March 15, 2022 and on or after December 15, 2035, holders may convert all or any portion of their 2016 Convertible Notes at the conversion rate then in effect at any time regardless of these conditions.

As a result of us increasing our quarterly dividend in March 2018 (see Note 9), the previous conversion rate for the 2016 Convertible Notes of 17.4858 shares of our common stock per $1,000 principal amount of the 2016 Convertible Notes, which is equivalent to an initial conversion price of approximately $57.19 per share of our common stock, has been adjusted to 17.4951 shares of our common stock per $1,000 principal amount of the 2016 Convertible Notes, which is equivalent to an initial conversion price of approximately $57.16 per share of our common stock.

Holders may require CSG to repurchase the 2016 Convertible Notes for cash on each of March 15, 2022, March 15, 2026, and March 15, 2031, or upon the occurrence of a fundamental change (as defined in the 2016 Convertible Notes Indenture) in each case at a purchase price equal to the principal amount thereof plus accrued and unpaid interest.

We may not redeem the 2016 Convertible Notes prior to March 20, 2020. On or after March 20, 2020, we may redeem for cash all or part of the 2016 Convertible Notes if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which CSG provides notice of redemption. On or after March 15, 2022, we may redeem for cash all or part of the 2016 Convertible Notes regardless of the sales price condition described in the preceding sentence. In each case, the redemption price will equal the principal amount of the 2016 Convertible Notes to be redeemed, plus accrued and unpaid interest.

As of March 31, 2018, none of the conversion features have been achieved, and thus, the 2016 Convertible Notes are not convertible by the holders.

    

 

5.   BUSINESS INK ACQUISITION

On February 28, 2018, we acquired Business Ink for approximately $70 million in cash.  Business Ink is a company based in Austin, Texas, with facilities in multiple locations.  Business Ink provides outsourced, customized business communications services to the telecommunications, healthcare, financial services, utilities and government sectors across statements, email, mobile messaging and more. The acquisition extends the scale of our operations and platform capabilities, expands our customer base into new verticals, and further solidifies our customer communications footprint.

 

The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (in thousands):

 

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The above estimated fair values of assets acquired and liabilities assumed are considered provisional and are based on the information that was available as of the date of the Business Ink acquisition to estimate the fair value of assets acquired and liabilities assumed.  We believe that information provides a reasonable basis for estimating the fair values of assets acquired and liabilities assumed, but we are waiting for additional information necessary to finalize those fair values.  Thus, the provisional measurements of fair value set forth above are subject to change.  Such changes are not expected to be significant.  We expect to finalize the valuation and complete the purchase price allocation as soon as practicable, but not later than one year from the acquisition date.

 

The Business Ink goodwill has been assigned to our one reportable segment.  The estimated lives assigned to the acquired client contracts and the acquired software assets range from approximately four months to ten years (weighted-average life of nine years), and four years, respectively.  Amortization expense related to these acquired intangible assets is recognized based upon the pattern in which the economic benefits of the acquired intangible assets are expected to be received.  The Business Ink goodwill and acquired intangible assets are deductible for income tax purposes.

 

The results of operations of Business Ink are included in the accompanying Condensed Consolidated Statements of Income for the period subsequent to the acquisition date.  Pro forma information on our historical results of operations to reflect the acquisition of Business Ink is not presented as Business Ink’s results of operations during prior periods are not significant to our results of operations.

      

6.  INCOME TAXES

The effective income tax rates for the first quarters of 2018 and 2017 were as follows:

 

The effective income tax rate for the first quarter of 2018 reflects the impact of the U.S. Tax Cut and Jobs Act (the “Tax Reform Act”) that was passed into legislation in December 2017.  The Tax Reform Act reduces the U.S. maximum rate of income taxation from 35% to 21% applicable to taxable years beginning after December 31, 2017.  As a result, for the full-year 2018 we are currently estimating an effective income tax rate of approximately 30%.

 

The lower first quarter 2017 effective income tax rate reflects and approximately $5 million net benefit resulting from Comcast Corporation’s (“Comcast”) exercise of 1.4 million vested stock warrants in January 2017, as the stock warrants appreciated in value since their vesting, resulting in an income tax benefit to us when exercised.  

 

 

7.  COMMITMENTS, GUARANTEES AND CONTINGENCIES

Warranties. We generally warrant that our solutions and related offerings will conform to published specifications, or to specifications provided in an individual client arrangement, as applicable. The typical warranty period is 90 days from the date of acceptance of the solution or offering. For certain service offerings we provide a limited warranty for the duration of the services provided. We generally warrant that services will be performed in a professional and workmanlike manner. The typical remedy for breach of warranty is to correct or replace any defective deliverable, and if not possible or practical, we will accept the return of the defective deliverable and refund the amount paid under the client arrangement that is allocable to the defective deliverable. Our contracts also generally contain limitation of damages provisions in an effort to reduce our exposure to monetary damages arising from breach of warranty claims. Historically, we have incurred minimal warranty costs, and as a result, do not maintain a warranty reserve.

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Product and Services Indemnifications. Our arrangements with our clients generally include an indemnification provision that will indemnify and defend a client in actions brought against the client that claim our products and/or services infringe upon a copyright, trade secret, or valid patent. Historically, we have not incurred any significant costs related to such indemnification claims, and as a result, do not maintain a reserve for such exposure.

Claims for Company Non-performance. Our arrangements with our clients typically cap our liability for breach to a specified amount of the direct damages incurred by the client resulting from the breach. From time-to-time, these arrangements may also include provisions for possible liquidated damages or other financial remedies for our non-performance, or in the case of certain of our outsourced customer care and billing solutions, provisions for damages related to service level performance requirements. The service level performance requirements typically relate to system availability and timeliness of service delivery. Historically, we have not incurred significant costs associated with service level performance within our client contracts, and as a result, do not include estimates for potential credits or refunds related to service level performance in our contract consideration at the onset of the contract, but instead, account for credits or refunds as an adjustment to the transaction price of the contract as those events occur.

Indemnifications Related to Officers and the Board of Directors. We have agreed to indemnify members of our Board of Directors (the “Board”) and certain of our officers if they are named or threatened to be named as a party to any proceeding by reason of the fact that they acted in such capacity. We maintain directors’ and officers’ (D&O) insurance coverage to protect against such losses. We have not historically incurred any losses related to these types of indemnifications, and are not aware of any pending or threatened actions or claims against any officer or member of our Board. As a result, we have not recorded any liabilities related to such indemnifications as of March 31, 2018. In addition, as a result of the insurance policy coverage, we believe these indemnification agreements are not significant to our results of operations.

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

 

8. EARNINGS PER COMMON SHARE

Basic and diluted earnings per common share (“EPS”) amounts are presented on the face of the accompanying Income Statements.

No reconciliation of the basic and diluted EPS numerators is necessary as net income is used as the numerators for all periods presented.  The reconciliation of the basic and diluted EPS denominators related to the common shares is included in the following table (in thousands):

 

 

The Convertible Notes have a dilutive effect only in those quarterly periods in which our average stock price exceeds the current effective conversion price (see Note 4).  

The Stock Warrants have a dilutive effect only in those quarterly periods in which our average stock price exceeds the exercise price of $26.68 per warrant (under the treasury stock method), and are not subject to performance vesting conditions (see Note 9).  

Potentially dilutive common shares related to non-participating unvested restricted stock excluded from the computation of diluted EPS, as the effect was antidilutive, were not material in any period presented.    

 

 

9. STOCKHOLDERS’ EQUITY AND EQUITY COMPENSATION PLANS

Stock Repurchase Program. We currently have a stock repurchase program, approved by our Board, authorizing us to repurchase our common stock from time-to-time as market and business conditions warrant (the “Stock Repurchase Program”). During the first quarters of 2018 and 2017 we repurchased 0.1  million shares of our common stock for $5.7  million (weighted-average price of $45.78   per share) and 0.1  million shares of our common stock for $5.4  million (weighted-average price of $42.85  per share), respectively, under a SEC Rule 10b5-1 Plan.  

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As of March 31, 2018, the total remaining number of shares available for repurchase under the Stock Repurchase Program totaled 6.1 million shares.

Stock Repurchases for Tax Withholdings. In addition to the above mentioned stock repurchases, during the first quarters of 2018 and 2017 , we repurchased and then cancelled 0.1 million shares of common stock for $6.2  million and 0.2 million shares of common stock for $6.1 million, respectively, in connection with minimum tax withholding requirements resulting from the vesting of restricted common stock under our stock incentive plans.

Cash Dividends.  During the first quarter of 2018, the Board approved a quarterly cash dividend of  $0.21 per share of common stock, totaling $7.1 million. During the first quarter of 2017, the Board approved a quarterly cash dividend of $0.1975 per share of common stock, totaling $6.7 million.   

Warrants.  In 2014, in conjunction with the execution of an amendment to our current agreement with Comcast, we issued stock warrants (the “Warrant Agreement”) for the right to purchase up to approximately 2.9 million shares of our common stock (the “Stock Warrants”) as an additional incentive for Comcast to convert customer accounts onto our Advanced Convergent Platform based on various milestones. The Stock Warrants have a 10-year term and an exercise price of $26.68 per warrant.        

Upon vesting, the Stock Warrants are recorded as a client contract incentive asset with the corresponding offset to stockholders’ equity.  The client contract incentive asset related to the Stock Warrants is amortized as a reduction in cloud and related solutions revenues over the remaining term of the Comcast amended agreement.  As of March 31, 2018 and December 31, 2017, we recorded a client contract incentive asset related to these Stock Warrants of $25.1 million as of both periods and have recorded accumulated amortization related to these Stock Warrants of $11.8 million and $9.2 million, respectively.  The remaining unvested Stock Warrants will be accounted for as client contract incentive assets in the period the performance conditions necessary for vesting have been met.  

As of March 31, 2018, approximately 1.4 million Stock Warrants remain issued, of which 0.4 million were vested.          

Stock-Based Awards. A summary of our unvested restricted common stock activity during the quarter ended March 31, 2018  is as follows (shares in thousands):

 

Included in the awards granted during the first quarter of 2018 are performance-based awards for 0.1 million restricted common stock shares issued to members of executive management and certain key employees, which vest in the first quarter of 2020 upon meeting certain pre-established financial performance objectives related to 2019 performance. The performance-based awards become fully vested upon a change in control, as defined, and the subsequent involuntary termination of employment.

All other restricted common stock shares granted during the first quarter of 2018 are time-based awards, which vest annually over four years with no restrictions other than the passage of time. Certain shares of the restricted common stock become fully vested upon a change in control, as defined, and the subsequent involuntary termination of employment.

We recorded stock-based compensation expense for the first quarters of 2018 and 2017 of $4.6 million and $5.7 million, respectively.   

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The information contained in this MD&A should be read in conjunction with the Financial Statements and Notes thereto included in this Form 10-Q and the audited consolidated financial statements and notes thereto in our 2017 10-K.

Forward-Looking Statements

This report contains a number of forward-looking statements relative to our future plans and our expectations concerning our business and the industries we serve.  These forward-looking statements are based on assumptions about a number of important factors, and involve risks and uncertainties that could cause actual results to differ materially from estimates contained in the forward-looking statements.  Some of the risks that are foreseen by management are outlined within Part II Item 1A. Risk Factors of this report and in Part I Item 1A. Risk Factors of our 2017 10-K.  Readers are strongly encouraged to review those sections closely in conjunction with MD&A.

Company Overview

We are one of the world’s largest and most established business support solutions (“BSS”) providers, primarily serving some of the most well-known communications, information, and content companies around the globe. We help our clients simplify the complexity of a rapidly changing business landscape, bringing more than thirty-five years of experience supporting the world’s most respected service providers.  We make their hardest decisions simpler and smarter as they work to evolve their businesses from a single-product offering to highly complex and competitive multi-product offerings, while also requiring increasingly differentiated, real-time, and personalized experiences for their customers.

We offer BSS and revenue management, customer experience and digital monetization solutions for every stage of the customer lifecycle so service providers can deliver an outstanding customer experience that adapts to their customers’ rapidly changing demands.  Our solutions are built on proven public and private cloud platforms, with out-of-the-box and managed service models that adapt to fit their unique business needs and enable the transformative change required to create personalized experiences that drive loyalty and retention.

Over the years, we have focused our research and development (“R&D”) and acquisition investments on expanding our offerings in a timely and efficient manner to address the complex, transformative needs of service providers.  Our scalable, modular, and flexible solutions combined with our domain expertise and our ability to effectively migrate clients to our solutions, provide the industry with proven solutions to improve their profitability and consumers’ experiences.  We have specifically architected our solutions to offer service providers a phased, incremental approach to transforming their businesses, thereby reducing the business interruption risk associated with this evolution.  

We generate approximately 70% of our revenues from the North American cable and satellite markets, approximately 20% of our revenues from wireline and wireless communication providers, and the remainder from a variety of other verticals, such as financial services, logistics, and transportation. Additionally, during the first quarter of 2018,  we generated approximately 84% of our revenues from the Americas region, approximately 10% of our revenues from the Europe, Middle East and Africa region, and approximately 6% of our revenues from the Asia Pacific region.

We are a S&P Small Cap 600 company.

Key Impact of U.S. Tax Cuts and Jobs Act

On December 22, 2017, the U.S. Tax Cuts and Jobs Act (the “Tax Reform Act”) was passed into legislation. The Tax Reform Act amends the Internal Revenue Code, reducing the corporate income tax rate, changing or eliminating certain income tax deductions and credits and provides sweeping change to how U.S. companies are taxed on their international operations. The Tax Reform Act is generally effective for tax years beginning after December 31, 2017; however, certain provisions of the Tax Reform Act have effective dates beginning in 2017.

 

The Tax Reform Act reduces the U.S. maximum rate of income taxation from 35% to 21% applicable to taxable years beginning January 1, 2018.  We currently expect our GAAP effective income tax rates for the full year 2018 to be approximately 30%.

 

See Note 7 to our 2017 10-K for additional impacts of the Tax Reform Act.

 

The overall anticipated impacts of the Tax Reform Act (including our effective income tax rate going forward) are based on our current assessments and underlying estimates.  We may encounter changes in these assessments and estimates or come across unforeseen additional items in the future not currently contemplated by us that may result in changes to our current anticipated impacts

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of the Tax Reform Act (including our effective income rate going forward).  We undertake no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Impact of New Revenue Accounting Pronouncement

As discussed in Note 2 to our Financial Statements, in January 2018 we adopted ASU 606, a single comprehensive model which supersedes nearly all existing revenue recognition guidance under U.S. GAAP, utilizing the cumulative effect approach.  Under the new guidance, revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services.  

 

In conjunction with the adoption of this ASU, we recorded a cumulative adjustment increasing beginning retained earnings (net of tax) by approximately $7 million, primarily related to contracts that we were required to defer revenue as we did not have VSOE for certain undelivered elements.  We do not anticipate ASU 606 will have a material impact on our revenues in 2018 and beyond, as the new revenue accounting rules under ASU 606 are fairly consistent with our current policies and guidelines based on the nature of our client contracts.

 

Since we adopted ASC 606 using the cumulative effect method, prior period comparative information in our Financial Statements have not been adjusted and continue to be as previously reported. As a result, beginning in 2018, the following key reclassifications have occurred:

 

 

Refer to Note 2 for further detail and discussion regarding the adoption of ASU 606.  

Acquisition of Business Ink

As discussed in Note 5 to the Financial Statements, on February 28, 2017 we acquired Business Ink, a multi-channel communications company based in Austin, Texas, for approximately $70 million, excluding acquisition-related expenses.  This represents a purchase price of slightly over one times historical revenues.  For the first quarter of 2018, Business Ink contributed $5.2 million of cloud and related solutions revenues and was neutral to our results of operations for the quarter when factoring in acquired amortization expense.  At this time, for the full year 2018 we expect that Business Ink will contribute approximately $50 million of revenue for the ten months of 2018 and decrease our results of operations by approximately 5%.  After we complete our integration plan for Business Ink over the next year or so, we believe it will then be accretive to our earnings on a go forward basis.  

 

The expected impact of the Business Ink acquisition includes estimates for certain integration-related expenses and estimates for the amortization of acquired intangible assets.  Because of the inherent uncertainties in making such estimates, the actual impact of Business Ink on our financial performance for 2018 and beyond may vary from our current expectations as we work through our integration efforts and complete the Business Ink purchase accounting.  We undertake no duty to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

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Management Overview of Quarterly Results

First Quarter Highlights.  A summary of our results of operations for the first quarter of 2018, when compared to the first quarter of 2017, is as follows (in thousands, except per share amounts and percentages):

 

 

Revenues.  Our revenues for the first quarter of 2018 were $201.7 million, a 5% increase when compared to revenues of $192.5 million for the first quarter of 2017. The year-over-year increase in revenues can be mainly attributed to the following: (i) approximately $5 million of revenues generated from Business Ink, discussed above; and (ii) continued growth in our cloud solutions and managed services arrangements.  

Operating Results.  Operating income for the first quarter of 2018 was $25.8 million, or a 12.8% operating income margin percentage, compared to $27.0 million, or a 14.0% operating income margin percentage for the first quarter of 2017, with the decreases in operating income and operating income margin percentage mainly attributed to the $2.4 million of Business Ink acquisition-related costs.

Diluted EPS.  Diluted EPS for the first quarter of 2018 was $0.42 compared to $0.62 for the first quarter of 2017, with the decrease mainly attributed to a lower effective income tax rate of 9% for the first quarter of 2017, compared to an effective income tax rate of 31% for the current quarter.  The lower first quarter 2017 income tax rate of 9% was primarily the result of an approximately $5 million net income tax benefit resulting from Comcast’s exercise of 1.4 million vested stock warrants in January 2017.

Cash and Cash Flows.  As of March 31, 2018, we had cash, cash equivalents and short-term investments of $222.1 million, as compared $261.4 million as of as of December 31, 2017.  The quarterly decrease can be mainly attributed to the purchase of Business Ink for approximately $70 million.  Our cash flows from operating activities for the quarter ended March 31, 2018 were $29.9 million. See the Liquidity section below for further discussion of our cash flows.

Significant Client Relationships

Client Concentration.  A large percentage of our historical revenues have been generated from our largest clients, which are Comcast, Charter Corporation Inc. (“Charter”), and DISH Network Corporation (“DISH”).  

Revenues from these clients represented the following percentages of our total revenues for the indicated periods:

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The percentages of net billed accounts receivable balances attributable to our largest clients as of the indicated dates were as follows:

See our 2017 10-K for additional discussion of our business relationships and contractual terms with Comcast, Charter, and DISH.

Risk of Client Concentration.  We expect to continue to generate a significant percentage of our future revenues from our largest clients mentioned above. There are inherent risks whenever a large percentage of total revenues are concentrated with a limited number of clients.  Should a significant client: (i) terminate or fail to renew their contracts with us, in whole or in part, for any reason; (ii) significantly reduce the number of customer accounts processed on our solutions, the price paid for our services, or the scope of services that we provide; or (iii) experience significant financial or operating difficulties, it could have a material adverse effect on our financial condition and results of operations.  

Critical Accounting Policies

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

We have identified the most critical accounting policies that affect our financial position and the results of our operations.  Those critical accounting policies were determined by considering the accounting policies that involve the most complex or subjective decisions or assessments.  The most critical accounting policies identified relate to the following items: (i) revenue recognition; (ii) impairment assessments of long-lived assets; (iii) income taxes; and (iv) loss contingencies.  These critical accounting policies, as well as our other significant accounting policies, are discussed in our 2017 10-K.

Results of Operations

Total Revenues.  Total revenues for the first quarter of 2018 were $201.7 million, a 5% increase when compared to $192.5 million for the first quarter of 2017.  The year-over-year increase in revenues can be mainly attributed to the following:  (i) approximately $5 million of revenues generated from Business Ink, discussed above;  and (ii) continued growth in our cloud solutions and managed services arrangements.  

The components of total revenues, discussed in more detail below, are as follows (in thousands):

 

We use the location of the client as the basis of attributing revenues to individual countries.  Revenues by geographic regions for the first quarters of 2018 and 2017 were as follows (in thousands):

 

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Cloud and Related Solutions Revenues.  Cloud and related solutions revenues for the first quarter of 2018 were $177.5 million, a 12% increase when compared to $158.8 million for the first quarter of 2017.  The increase in cloud and related solutions revenues is primarily due to the adoption of ASC 606 which resulted in $7.0 million of revenue previously classified as software and services and maintenance revenue now being classified as cloud and related solutions revenues, and the $5.2 million of revenues generated by the acquired Business Ink business.  The remaining increase is mainly attributed to the execution of additional managed services arrangements, an increase in ancillary services revenues, and the conversion of approximately four million customer accounts onto ACP over the past twelve months.  

Software and Services Revenues.  Software and services revenues for the first quarter of 2018 were $12.0 million, a 21% decrease when compared to $15.1 million for the first quarter of 2017.  The decrease in software and services revenues can be attributed mainly to the shift in our focus towards more recurring revenue arrangements, which are included in our cloud and related solutions revenues, and the adoption of ASC 606, which resulted in $1.6 million of revenue previously classified as software and services now being classified as cloud and related solutions.  

Maintenance Revenues.  Maintenance revenues for the first quarter of 2018 were $12.2 million, a 34% decrease when compared to $18.6 million for the first quarter of 2017, with the decrease mainly due to the adoption of ASC 606, which resulted in $5.1 million of revenue previously classified as maintenance now being classified as cloud and related solutions.  

Total Expenses.  Our operating expenses for the first quarter of 2018 were $175.9 million, a 6% increase when compared to $165.5 million for the first quarter of 2017.  The year-over-year increase in total expenses can be mainly attributed to the following: (i) one month of operating expenses of Business Ink of $4.7 million included in our first quarter 2018 results; (ii) $2.4 million of acquisition-related costs from Business Ink; and (iii) the increase in our planned investment that began early in 2017.  

The components of total expenses are discussed in more detail below.

Cost of Revenues.  See our 2017 10-K for a description of the types of costs that are included in the individual line items for cost of revenues.

Cost of Cloud and Related Solutions (Exclusive of Depreciation).  The cost of cloud and related solutions for the first quarter of 2018 increased 14% to $86.9 million, from $76.1 million for the first quarter of 2017.  This increase relates almost entirely to the adoption of ASC 606, which resulted in $6.3 million of costs, previously classified as cost of software and services and maintenance, now being classified as cost of cloud and related solutions, and one month of cloud and related solutions expense from the acquired Business Ink business.  Total cloud and related solutions cost as a percentage of cloud and related solutions revenues for the first quarters of 2018 and 2017 were 49.0% and 47.9%, respectively, with the increase attributed to the reclassifications resulting from the adoption of ASC 606.

Cost of Software and Services (Exclusive of Depreciation).  The cost of software and services for the first quarter of 2018 decreased 24% to $8.5 million, from $11.3 million for the first quarter of 2017. This decrease is reflective of the decrease in revenues as personnel and the related costs previously allocated to professional services projects have been reassigned to other areas of the business. Total software and services cost as a percentage of our software and services revenues for the first quarters of 2018 and 2017 were 71.4% and 74.9%, respectively.

Variability in quarterly revenues and operating results are inherent characteristics of companies that sell software licenses and perform professional services.  Our quarterly revenues for software licenses and professional services may fluctuate, depending on various factors, including the timing of executed contracts and revenue recognition, and the delivery of contracted solutions.  However, the costs associated with software and professional services revenues are not subject to the same degree of variability (e.g., these costs are generally fixed in nature within a relatively short period of time), and thus, fluctuations in our cost of software and services as a percentage of our software and services revenues will likely occur between periods.  

Cost of Maintenance (Exclusive of Depreciation).  The cost of maintenance for the first quarter of 2018 decreased 46% to $5.7 million, from $10.4 million for the first quarter of 2017.  Total cost of maintenance as a percentage of our maintenance revenues for the first quarters of 2018 and 2017 were 46.2% and 55.7%, respectively.  These decreases can be attributed to the adoption of ASC 606, which resulted in $5.1 million of costs, previously classified as maintenance, now being classified as cost of cloud and related solutions.      

R&D Expense.  R&D expense for the first quarter of 2018 increased 9% to $29.4 million, from $26.8 million for the first quarter of 2017.  As a percentage of total revenues, R&D expense for the first quarters of 2018 and 2017 were 14.6% and 13.9%, respectively.  These increases are reflective of our heightened level of investment that began in early 2017.  

Our R&D efforts are focused on the continued evolution of our solutions that enable service providers worldwide to provide a more personalized customer experience while introducing new digital products and services. This includes the continued investment in our cloud-based solutions (principally, around our Ascendon platform). 

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Selling, General and Administrative (“SG&A”) Expense.  SG&A expense for the first quarter of 2018 increased 9% to $40.6 million, from $37.3 million for the first quarter of 2017.  The increase can be primarily attributed to the $2.4 million of Business Ink acquisition-related costs, and to a lesser degree, Business Ink’s SG&A costs.  Our SG&A costs as a percentage of total revenues for the first quarters of 2018 and 2017 were 20.2% and 19.4%, respectively.

 Operating Income. Operating income for the first quarter of 2018 was $25.8 million, or 12.8% of total revenues, compared to $27.0 million, or 14.0% of total revenues for the first quarter of 2017.  The decrease in operating income and operating income margin percentage can be mainly attributed to the $2.4 million of acquisition-related costs.

Loss on Extinguishment of Debt.  In March 2018, we refinanced our 2015 Credit Agreement (see Note 4 to our Financial Statements).  As a result, we incurred a loss of $0.8 million related to the write-off of unamortized debt issuance costs.

Income Tax Provision. The effective income tax rates for the first quarters of 2018 and 2017 were as follows:

 

 
The effective income tax rate for the first quarter of 2018 reflects the impact of the U.S. Tax Cut and Jobs Act (the “Tax Reform Act”) that was passed into legislation in December 2017.  The Tax Reform Act reduces the U.S. maximum rate of income taxation from 35% to 21% applicable to taxable years beginning January 1, 2018.  As a result, for the full-year 2018 we are currently estimating an effective income tax rate of approximately 30%.

 

The lower first quarter 2017 effective income tax rate reflects an approximately $5 million net benefit resulting from Comcast’s exercise of 1.4 million vested stock warrants in January 2017, as the stock warrants appreciated in value since their vesting, resulting in an income tax benefit to us when exercised.  

Liquidity

Cash and Liquidity

As of March 31, 2018, our principal sources of liquidity included cash, cash equivalents, and short-term investments of $222.1 million, as compared to $261.4 million as of as of December 31, 2017.  We generally invest our excess cash balances in low-risk, short-term investments to limit our exposure to market and credit risks.  

During the first quarter of 2018, we refinanced our 2015 Credit Agreement primarily to extend the term of the loan from February 2020 to March 2023 and obtain a reduction in the interest rate and other fees.  The 2018 Credit Agreement increased our liquidity and capital resources position by approximately $30 million.  

As part of our 2018 Credit Agreement, we have a $200 million senior secured revolving loan facility with a syndicate of financial institutions that expires in March 2023.  As of March 31, 2018, there were no borrowings outstanding on the 2018 Revolver.  The 2018 Credit Agreement contains customary affirmative covenants and financial covenants.  As of March 31, 2018, and the date of this filing, we believe that we are in compliance with the provisions of the 2018 Credit Agreement.  

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

We generally have ready access to substantially all of our cash, cash equivalents, and short-term investment balances, but may face limitations on moving cash out of certain foreign jurisdictions due to currency controls.  As of March 31, 2018, we had $2.7 million of cash restricted as to use primarily to collateralize outstanding letters of credit.

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Cash Flows from Operating Activities  

We calculate our cash flows from operating activities in accordance with GAAP, beginning with net income, adding back the impact of non-cash items or non-operating activity (e.g., depreciation, amortization, amortization of OID, impairments, gain/loss from debt extinguishments, deferred income taxes, stock-based compensation, etc.), and then factoring in the impact of changes in operating assets and liabilities.  See our 2017 10-K for a description of the primary uses and sources of our cash flows from operating activities.  

Our 2018 and 2017 net cash flows from operating activities, broken out between operations and changes in operating assets and liabilities, for the indicated quarterly periods are as follows (in thousands):

 

 

Cash flows from operating activities for the first quarters of 2018 and 2017 reflect the negative impacts of the payment of the 2017 and 2016 year-end accrued employee incentive compensation in the first quarter subsequent to the year-end accrual for these items.

We believe the above table illustrates our ability to generate recurring quarterly cash flows from our operations, and the importance of managing our working capital items.  Variations in our net cash provided by operating activities are generally related to the changes in our operating assets and liabilities (related mostly to fluctuations in timing at quarter-end of client payments and changes in accrued expenses), and generally over longer periods of time, do not significantly impact our cash flows from operations.

Significant fluctuations in key operating assets and liabilities between 2018 and 2017 that impacted our cash flows from operating activities are as follows:

Billed Trade Accounts Receivable

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

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

 

As a global provider of software and professional services, a portion of our accounts receivable balance relates to clients outside the U.S.  As a result, this diversity in the geographic composition of our client base may adversely impact our DBOs as longer billing cycles (i.e., billing terms and cash collection cycles) are an inherent characteristic of international software and professional services transactions.  For example, our ability to bill (i.e., send an invoice) and collect arrangement fees may be dependent upon, among other things: (i) the completion of various client administrative matters, local country billing protocols and processes (including local cultural differences), and/or non-client administrative matters; (ii) us meeting certain contractual invoicing milestones; or (iii) the overall project status in certain situations in which we act as a subcontractor to another vendor on a project.

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Unbilled Trade Accounts Receivable

Revenue earned and recognized prior to the scheduled billing date of an item is reflected as unbilled accounts receivable.  Our unbilled accounts receivable as of the end of the indicated periods are as follows (in thousands):

 

The unbilled accounts receivable balances above are primarily the result of several transactions with various milestone and contractual billing dates which have not yet been reached.  Unbilled accounts receivable are an inherent characteristic of certain software and professional services transactions and may fluctuate between quarters, as these types of transactions typically have scheduled invoicing terms over several quarters, as well as certain milestone billing events.  

Accrued Employee Compensation

Accrued employee compensation decreased $17.0 million to $46.0 million as of March 31, 2018, from $63.0 million as of December 31, 2017, due primarily to the payment of the 2017 employee incentive compensation that was fully accrued at December 31, 2016, offset to a certain degree by the accrual for the 2018 employee incentive compensation.

 Cash Flows from Investing Activities

Our typical investing activities consist of purchases/sales of short-term investments and purchases of property and equipment, which are discussed below.  Additionally, as discussed earlier, during the first quarter of 2018 we acquired Business Ink for $68.6 million, net of cash acquired, which is included in our cash flows from investing activities.

Purchases/Sales of Short-term Investments.  For the first quarters of 2018 and 2017, we purchased $15.1 million and $18.0 million, respectively, and sold (or had mature) $79.5 million and $37.8 million, respectively, of short-term investments. We continually evaluate the appropriate mix of our investment of excess cash balances between cash equivalents and short-term investments in order to maximize our investment returns and will likely purchase and sell additional short-term investments in the future.

Property and Equipment/Client Contracts.  Our capital expenditures for the first quarters of 2018 and 2017, for property and equipment, and investments in client contracts were as follows (in thousands):

 

Our property and equipment expenditures for these periods consisted principally of investments in: (i) computer hardware, software, and related equipment; and (ii) statement production equipment.

As a result of the adoption of ASC 606, $1.5 million of investments in client contracts have been reclassified to operating activities from investing activities for the first quarter ended March 31, 2018.

 Cash Flows from Financing Activities

Our financing activities typically consist of activities associated with our common stock and our long-term debt.  

Cash Dividends Paid on Common Stock.  During the first quarters of 2018 and 2017, the Board approved dividend payments totaling $7.1 million and $6.7 million, respectively.  During the first quarters of 2018 and 2017, we paid dividends of $7.4 million and $7.0 million, respectively (with the additional amounts attributed to dividends for incentive shares paid upon vesting).

Repurchase of Common Stock.  During the first quarters of 2018 and 2017, we repurchased 0.1 million shares of our common stock under the guidelines of our Stock Repurchase Program for $5.7 million and $5.4 million, respectively.

Outside of our Stock Repurchase Program, during the first quarters of 2018 and 2017, we repurchased from our employees and then cancelled 0.1 million and 0.2 million shares, respectively, of our common stock in each period for $6.2 million and $6.1 million, respectively, in connection with minimum tax withholding requirements resulting from the vesting of restricted common stock under our stock incentive plans.

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Long-term Debt.    

During the first quarter of 2018, we refinanced our 2015 Credit Agreement and as a result, we repaid the outstanding principal balance of $120.0 million and borrowed $150.0 million under the 2018 Credit Agreement, resulting in a net increase of available cash of $30.0 million.  As part of the refinancing, we paid $1.4 million of deferred financing costs.  

Additionally, during the first quarter of 2017, we made principal repayments of $3.8 million.

See Note 4 to our Financial Statements for additional discussion of our long-term debt.

Capital Resources

The following are the key items to consider in assessing our sources and uses of capital resources:

Current Sources of Capital Resources.

Uses/Potential Uses of Capital Resources. Below are the key items to consider in assessing our uses/potential uses of capital resources:

During the first quarter of 2018, we repurchased 0.1 million shares of our common stock for $5.7 million (weighted-average price of $45.78 per share).  

Under our Stock Repurchase Program, we may repurchase shares in the open market or a privately negotiated transaction, including through an ASR plan or under a SEC Rule 10b5-1 plan.  The actual timing and amount of the share repurchases will be dependent on the then current market conditions and other business-related factors.  

Outside of our Stock Repurchase Program, during the first quarter of 2018, we repurchased from our employees and then cancelled 0.1 million shares of our common stock for $6.2 million in connection with minimum tax withholding requirements resulting from the vesting of restricted common stock under our stock incentive plans.

Our common stock repurchases are discussed in more detail in Note 9 to our Financial Statements.

As part of our growth strategy, we are continually evaluating potential business and/or asset acquisitions and investments in market share expansion with our existing and potential new clients.

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The Stock Warrants are discussed in more detail in Note 9 to our Financial Statements.  

2016 Convertible Notes

During the next twelve months, there are no scheduled conversion triggers on our 2016 Convertible Notes.  As a result, we expect our required debt service cash outlay during the next twelve months for the 2016 Convertible Notes to be limited to interest payments of $9.8 million.

2018 Credit Agreement

Our 2018 Credit Agreement mandatory repayments and the cash interest expense (based upon current interest rates) for the next twelve months is $7.5 million, and $6.4 million, respectively. We have the ability to make prepayments on our 2018 Credit Agreement without penalty.  

Our long-term debt obligations are discussed in more detail in Note 4 to our Financial Statements.  

In summary, we expect to continue to have material needs for capital resources going forward, as noted above. We believe that our current cash, cash equivalents and short-term investments balances and our 2018 Revolver, together with cash expected to be generated in the future from our current operating activities, will be sufficient to meet our anticipated capital resource requirements for at least the next twelve months. We also believe we could obtain additional capital through other debt sources which may be available to us if deemed appropriate.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the potential loss arising from adverse changes in market rates and prices. As of March 31, 2018, we are exposed to various market risks, including changes in interest rates, fluctuations and changes in the market value of our cash equivalents and short-term investments, and changes in foreign currency exchange rates. We have not historically entered into derivatives or other financial instruments for trading or speculative purposes.

Interest Rate Risk

Long-Term Debt. The interest rate on our 2016 Convertible Notes is fixed, and thus, as it relates to our convertible debt borrowings, we are not exposed to changes in interest rates.

The interest rates under our 2018 Credit Agreement are based upon an adjusted LIBOR rate plus an applicable margin, or an alternate base rate plus an applicable margin. Refer to Note 4 to our Financial Statements for further details of our long-term debt.

A hypothetical adverse change of 10% in the March 31, 2018 adjusted LIBOR rate would not have had a material impact upon our results of operations.

Market Risk

Cash Equivalents and Short-term Investments. Our cash and cash equivalents as of March 31, 2018 and December 31, 2017 were $147.5 million and $122.3 million, respectively. Certain of our cash balances are “swept” into overnight money market accounts on a daily basis, and at times, any excess funds are invested in low-risk, somewhat longer term, cash equivalent instruments and short-term investments. Our cash equivalents are invested primarily in institutional money market funds, commercial paper, and time deposits held at major banks. We have minimal market risk for our cash and cash equivalents due to the relatively short maturities of the instruments.

Our short-term investments as of March 31, 2018 and December 31, 2017 were $74.6 million and $139.1 million, respectively. Currently, we utilize short-term investments as a means to invest our excess cash only in the U.S. The day-to-day management of our

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short-term investments is performed by a large financial institution in the U.S., using strict and formal investment guidelines approved by our Board. Under these guidelines, short-term investments are limited to certain acceptable investments with: (i) a maximum maturity; (ii) a maximum concentration and diversification; and (iii) a minimum acceptable credit quality. At this time, we believe we have minimal liquidity risk associated with the short-term investments included in our portfolio.

Long-Term Debt.  The fair value of our convertible debt is exposed to market risk.  We do not carry our convertible debt at fair value but present the fair value for disclosure purposes (see Note 2 to our Financial Statements).  Generally, the fair value of our convertible debt is impacted by changes in interest rates and changes in the price and volatility of our common stock.  As of March 31, 2018, the fair value of the 2016 Convertible Notes was estimated at $251.6 million, using quoted market prices.  

Foreign Currency Exchange Rate Risk

Due to foreign operations around the world, our balance sheet and income statement are exposed to foreign currency exchange risk due to the fluctuations in the value of currencies in which we conduct business. While we attempt to maximize natural hedges by incurring expenses in the same currency in which we contract revenue, the related expenses for that revenue could be in one or more differing currencies than the revenue stream.

During the first quarter of 2018, we generated approximately 87% of our revenues in U.S. dollars. We expect that, in the foreseeable future, we will continue to generate a very large percentage of our revenues in U.S. dollars.

As of March 31, 2018 and December 31, 2017, the carrying amounts of our monetary assets and monetary liabilities on the books of our non-U.S. subsidiaries in currencies denominated in a currency other than the functional currency of those non-U.S. subsidiaries are as follows (in thousands, in U.S. dollar equivalents):

 

A hypothetical adverse change of 10% in the March 31, 2018 exchange rates would not have had a material impact upon our results of operations based on the monetary assets and liabilities as of March 31, 2018.

 

 

Item 4. Controls and Procedures

(a) Disclosure Controls and Procedures

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

(b) Internal Control Over Financial Reporting

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

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CSG SYSTEMS INTERNATIONAL, INC.

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

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

 

Item 1A. Risk Factors

A discussion of our risk factors can be found in Item 1A.  Risk Factors in our 2017 Form 10-K.  There were no material changes to the risk factors disclosed in our 2017 Form 10-K during the first quarter of 2018.

 

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

The following table presents information with respect to purchases of company common stock made during the first quarter of 2018 by CSG Systems International, Inc. or any “affiliated purchaser” of CSG Systems International, Inc., as defined in Rule 10b-18(a)(3) under the Exchange Act.

 

 

 

Item 3. Defaults Upon Senior Securities

None

 

Item 4. Mine Safety Disclosures

None

 

Item 5. Other Information

None

 

Item 6. Exhibits

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

 

 

 

 

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CSG SYSTEMS INTERNATIONAL, INC.

INDEX TO EXHIBITS

 

 

 

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SIGNATURES

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

Dated: May 4, 2018

 

 

 

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