10-K 1 csgs-10k_20171231.htm 10-K csgs-10k_20171231.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 0-27512

 

CSG SYSTEMS INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

47-0783182

(State or other jurisdiction
of incorporation or organization)

 

(I.R.S. Employer
Identification No.)

6175 S. Willow Drive, 10th Floor

Greenwood Village, Colorado

 

 

80111

(Address of principal executive offices)

 

(Zip Code)

Registrant’s telephone number, including area code: (303) 200-2000

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, Par Value $0.01 Per Share

 

NASDAQ Stock Market LLC

Securities Registered Pursuant to Section 12(g) of the Act: None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes      No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes      No  

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 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 a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  

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

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a small reporting company)

  

Small reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

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 Act).    Yes      No  

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the last sales price of such stock, as of the close of trading on June 30, 2017, was $1,008,021,565.

Shares of common stock outstanding at February 16, 2018: 33,439,441

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for its 2018 Annual Meeting of Stockholders to be filed on or prior to April 30, 2018, are incorporated by reference into Part III of the Form 10-K.

 

 

 

 


 

CSG SYSTEMS INTERNATIONAL, INC.

2017 FORM 10-K

TABLE OF CONTENTS

 

 

 

 

  

Page

PART I

  

 

 

 

 

 

Item 1.

 

Business

  

3

Item 1A.

 

Risk Factors

  

7

Item 1B.

 

Unresolved Staff Comments

  

14

Item 2.

 

Properties

  

14

Item 3.

 

Legal Proceedings

  

14

Item 4.

 

Mine Safety Disclosures

  

14

 

 

 

PART II

  

 

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

  

18

Item 6.

 

Selected Financial Data

  

21

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

22

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

  

38

Item 8.

 

Financial Statements and Supplementary Data

  

40

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

  

69

Item 9A.

 

Controls and Procedures

  

69

Item 9B.

 

Other Information

  

69

 

 

 

PART III

  

 

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

  

70

Item 11.

 

Executive Compensation

  

70

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  

70

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

  

70

Item 14.

 

Principal Accounting Fees and Services

  

70

 

 

 

PART IV

  

 

 

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

  

71

 

 

Signatures

  

88

 

 

 

2


 

PART I

 

Item  1.

Business

Overview

CSG Systems International, Inc. (the “Company”, “CSG”, or forms of the pronoun “we”) is one of the world’s largest and most established business support solutions (“BSS”) providers, primarily serving the global communications industry, and a trusted partner to some of the most well-known companies around the globe. We help our clients simplify the complexity of a rapidly changing business landscape, bringing more than 35 years of experience supporting the world’s most respected communications, media and entertainment 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 delivering 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.

 

Our principal executive offices are located at 6175 S. Willow Drive, 10th Floor, Greenwood Village, Colorado 80111, and the telephone number at that address is (303) 200-2000.

Our common stock is listed on the NASDAQ Stock Market LLC (“NASDAQ”) under the symbol “CSGS”. We are a S&P Small Cap 600 company.

Industry Overview

Background. We provide BSS to the world’s leading communications service providers (“CSPs”). With an unwavering commitment to their success, we help our clients thrive in the most dynamic, challenging, and complex market conditions imaginable, allowing them to:

 

Optimize their business, addressing the critical need to reduce operating costs to enable the redeployment of operating capital to support business growth and transformation.

 

Enable new revenue streams through the monetization of multiple services, across multiple locations and channels, and bringing new services to market quickly.

 

Protect and maintain existing revenue streams by improving service delivery that drives higher customer satisfaction and increases retention.

 

Leverage data and insights to better know and understand their customers and deliver exceptional experiences.

Market Trends of Communications Industry. The global communications industry is going through an unprecedented level of change.  This dramatic disruption is driving the emergence of heightened competition, innovative digital products, compelling customer engagements, real-time operational processes, and intense cost pressures. There are some key trends that are emerging as CSPs try to evolve and compete in this highly complex ecosystem.

 

Consumer choice:  Customers have more choices than ever for information, communications, and entertainment services.  While the shift in power to the consumer from the service provider has been occurring over the past several years, the adoption of new technologies and services which enable a more ubiquitous and personalized customer experience is becoming mainstream.  Service providers – whether traditional or new digital native – are developing offerings that result in a more recurring, loyal, and “branded” customer experience.  The “brand” and the “experience” become much more important to these providers as both play a larger role in purchasing decisions.  The customer experience, from acquisition to termination of service, will determine the winners and losers in this “always connected” consumer world.  

3


 

 

Competitive landscape: The proliferation of digital native service providers (e.g., Facebook, Apple, Netflix, Google, Amazon, etc.) has changed the competitive landscape forever.  This new breed of competitors is not burdened with the infrastructure or legacy operational expenses that traditional CSPs have and, as a result, are more nimble, agile, and competitively priced for consumers.  This has forced traditional providers to evaluate the viability of their existing business model in this consumer-driven economy, causing them to evolve their businesses to remain competitive.  Scale, breadth of offerings, speed to react, user experience has forced traditional CSPs to evaluate strategies to not only remain competitive, but to survive.  Consolidation continues between traditional wireline and wireless providers (e.g., AT&T and DirecTV), traditional CSPs and content providers (e.g., Comcast and NBC Universal) and traditional providers and digital natives (e.g., Verizon and Yahoo).  Direct-to-consumer offerings are becoming more prevalent:  DisneyLife, Xfinity Stream, Crave TV, and iFlix.  And, cooperation not only with new partners, but even competitors (e.g., Netflix and traditional cable operators) is accelerating.

 

Technology: Fueled by the collision of artificial intelligence, the Internet of Things (“IoT”), cloud technologies, and analytics, providers are fundamentally changing the way that they get their products to market and engage with their customers.  5G technologies will fuel the expansion of IoT and sensor enabled services.  IoT will underpin the “servicification” of offerings — the transition of routine activities and purchases (e.g., checking gas meters, driving a car, buying groceries, etc.) to on demand services and pervasive consumer relationships (e.g., only servicing meters that show faults, recommending best parking spots, recommending meals for dinner tonight, etc.).  In addition, providers are transitioning their legacy technology infrastructure to a combination of private and public cloud technologies to help enhance their speed-to-market, agility, scalability, and cost structure.  

 

New Revenue Sources:  Finally, the last trend relates to an increased pressure for CSPs to find new revenue sources, while also managing their cost structure and quality of service delivery during their business transformation. CSPs are seeing a decline in revenues and profits associated with their traditional services like wireline voice and video as a result of new or increased competition.  In order to offset these declining revenues and profits, CSPs are looking for ways to improve their cost structure, grow through acquisitions, and launch new, revenue generating services with minimal capital investment. The result is many CSPs are cutting costs associated with their traditional systems, integrating disparate acquired business operations, and launching new digital services with highly-flexible, lower cost solutions.

Overall, these market trends drive the demand for scalable, flexible, and cost-efficient BSS and revenue management, customer experience, and digital monetization solutions, which we believe will provide us with revenue opportunities. As a result, we have historically invested a meaningful amount of our revenues in research and development (“R&D”) and have acquired companies that enable us to expand our offerings in a timely and efficient manner. We believe that our scalable, modular, and flexible solutions combined with our rich 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.

Business Strategy

Our goal is to be the most trusted provider of world-class cloud and software-based solutions to service providers around the globe by helping make our clients’ hardest decisions simpler and smarter, no matter the challenge.  We believe that by successfully executing on this goal we can grow our revenues and earnings, and therefore, create long-term value for our clients, employees, and stockholders. Our strategic focus to accomplish this goal is as follows:

Create More Long-Term, Recurring Relationships Within the Communications Industry. Our relentless, relationship-driven, customer-focused business approach is built on a foundation of respect, integrity, and collaboration. As a result, we enjoy long-term relationships with many of the world’s leading CSPs based on a true partnership aimed at helping providers enable sustainable growth, create efficiencies, and deliver differentiated services to their customers. We have seen successful adoption of our managed services approach with global CSPs based upon our compelling value proposition and proven track record.

Expand Our Product and Services Portfolio Through Continuous Innovation. We believe that our product technology, cloud-based solutions, and pre-integrated suite of solutions give service providers a competitive advantage. Our solutions allow providers to effectively manage their traditional businesses while being able to also quickly deliver new digital services directly to consumers with a modern, personalized, branded experience driving customer satisfaction and loyalty. We continually add new, relevant capabilities to what we do as a company, both in terms of our people and our solutions. By doing this, we build very strong recurring relationships which are difficult for our competitors to displace.

4


 

Deliver On Our Commitments. Our products and services are business critical. We help our clients manage the entire customer lifecycle, from acquisition to servicing to billing for their end customers. As a result, it is imperative that we deliver on our commitments. For over 35 years, we have been helping blue-chip companies manage periods of explosive and sustained market growth and change – helping them drive revenues, improve their profitability, and deliver positive customer experiences. Our track record of doing what we say we are going to do has enabled us to be a trusted advisor and integral member of our clients’ operations.

Bring New Skills and Talents to Market. In order to maintain our competitiveness in the market, we invest in our people so that they are prepared to bring the highest quality technical skills, interpersonal skills, and managerial skills to our business and our clients.

In summary, we are focused on helping our clients compete more effectively and successfully in an ever-changing market.

Description of Business

Key Clients. We work with the leading communication providers located around the world. A partial list of those service providers as of December 31, 2017 is included below:

 

América Móvil

  

Hutchinson Whampoa 3G

AT&T

 

Liberty

Bharti Airtel

 

MTN

Charter Communications, Inc.  (“Charter”)

  

Telefônica

JPMorgan Chase

  

Telstra  

Comcast Corporation (“Comcast”)

 

Verizon

DISH Network Corporation (“DISH”)

  

Vodafone

Deutsche Telecom

 

 

Clients that represented 10% or more of our revenues for 2017 and 2016 were as follows (in millions, except percentages):

 

 

  

2017

 

 

2016

 

 

  

Amount

 

  

% of Revenues

 

 

Amount

 

  

% of Revenues

 

Comcast

  

$

219

 

 

 

28

 

$

195

 

 

 

26

Charter

  

 

171

 

 

 

22

 

 

160

 

 

 

21

DISH

  

 

89

 

 

 

11

 

 

102

 

 

 

13

See the Significant Client Relationships section of our Management’s Discussion and Analysis (“MD&A”) for additional information regarding our business relationships with these key clients.

Research and Development. Our clients around the world are facing competition from new entrants and at the same time, are deploying new services at a rapid pace and dramatically increasing the complexity of their business operations. Therefore, we continue to make meaningful investments in R&D to ensure that we stay ahead of our clients’ needs and advance our clients’ businesses as well as our own. We recognize these challenges and believe our value proposition is to provide solutions that help our clients ensure that each customer communication is an opportunity to create value and deepen the business relationship. As a result of our R&D efforts, we have broadened our footprint within our client base with many new innovative product offerings.

Our total R&D expenses for 2017 and 2016 were $113.2 million and $98.7 million, respectively, or approximately 14% and 13%, respectively, of our total revenues, with the increase reflective of our heightened level of investment in 2017.  In the near term, we anticipate the level of R&D investment activities will be relatively consistent with that of 2017.

There are certain inherent risks associated with significant technological innovations. Some of these risks are described in this report in our Risk Factors section below.

Products and Services. Our products and services help companies with complex transaction-centric business models manage the opportunities and challenges associated with accurately capturing, managing, generating, and optimizing the revenue associated with the immense volumes of customer communications and then manage the intricate nature of those customer relationships. Our primary product solutions include the following:

 

Revenue Management & Customer Experience Solutions:  Our revenue management solutions provide global service providers with a robust, integrated real-time revenue management framework in either a cloud-based or stand-alone environment to support a single view of the customer across all services and transactions.

5


 

 

o

Our Advanced Convergent Platform (“ACP”), is a private, cloud-based solution for cable and satellite providers in North America. ACP and our related business support solutions are relied upon every single day by approximately 62 million consumers of voice, video, and data services, and are used by more than 115,000 of our clients’ customer service agents, and 40,000 of our clients’ field force technicians, dispatchers, and routers.

 

o

Ascendon is deployed in some of the world’s leading media and entertainment companies and is a software-as-a-service (“SaaS”)-based, cloud platform that provides a trusted path to digital transformation. With Ascendon, organizations can offer new, digital services right now, while moving purposefully toward a business model that dramatically reduces operational expenses, fully digitizes front and back offices, and unites a portfolio of services into a single customer relationship that allows for a deep customer engagement across all communication channels.

 

o

And, leading wireline, wireless, IP carriers, Mobile Virtual Network Operators (“MVNOs”), and financial service providers rely on our Singleview solution to deliver real-time charging, pre-and post-paid billing for fully converged services from a single platform.  

 

Customer Communications Management: Our customer communications management solutions are a diverse and integrated suite of tools designed to manage and improve every aspect of the customer experience. We are an industry leader in supporting omni-channel communications between our clients and their customers, processing more than one billion interactive voice, SMS/text, print, e-mail, web, and fax messages each year.  

 

Managed Services: Our managed services offering leverages our 35+ year history in running highly scalable, complex business support solutions to improve operational efficiencies and effectiveness.  For our managed services clients, we assume long-term responsibility for delivering our software solutions and related operations under a defined scope and specified service levels.  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 (including public cloud providers) we contract with for such services.  

 

Mediation and Data Management: Our Total Service Mediation (“TSM”) solution provides a comprehensive framework enabling network operators to achieve maximum efficiency with the lowest cost for all interactions between the network and other business support solution applications and related processes. The TSM framework supports offline and real-time mediation requirements as well as service activation. Recognized for its high performance and exceptional throughput, TSM provides the event processing foundation to manage today’s exploding network traffic.

 

Wholesale Settlement and Routing: Our market-leading Wholesale Business Management Solution (“WBMS”) is a comprehensive and powerful settlements system delivered in either a cloud or stand-alone environment. It handles every kind of traffic – from simple voice to the most advanced data and content services – in a single, highly-integrated platform. It helps operators around the globe improve profits, meet strict regulatory and audit compliance requirements, and comply with the broadest range of global standards.

Historically, a substantial percentage of our total revenues have been generated from ACP and customer communications management solutions. These products and services are expected to provide a large percentage of our total revenues in the foreseeable future as well.

Business Acquisitions. Our strategy includes acquiring assets and businesses which provide the technology and personnel to expedite our product development efforts, provide complementary products and services, increase market share, and/or provide access to new markets and clients.

Professional Services. We employ professional services experts globally who bring a wide-ranging expertise – including solution architecture, project management, systems implementation, and business consultancy – to every project. We apply a proven methodology to each of our engagements, leveraging consistent world-class processes, best-practice programs, and systemized templates for all engagements.

Sales and Marketing. We organize our sales efforts to clients primarily within our geographically dispersed, dedicated account teams, with senior level account managers who are responsible for new revenues and renewal of existing contracts within a client account. The account teams are supported by sales support personnel who are experienced in the various products and services that we provide.

Competition. The market for BSS products and services in the communications industry, as well as in other industries we serve, is highly competitive. We compete with both independent providers and in-house developers of customer management systems. We believe that our most significant competitors in our primary markets are Amdocs Limited and NEC Corporation; network equipment providers such as Ericsson and Huawei; and internally-developed solutions. Some of our actual and potential competitors have substantially greater financial, marketing, and technological resources than us and in some instances, we may partner and collaborate with our competitors on large opportunities and projects.

6


 

We believe service providers in our industry use the following criteria when selecting a vendor for the mission critical management of their revenue, customer communications, and digital ecosystem: (i) functionality, scalability, flexibility, interoperability, and architecture of the software assets; (ii) the breadth and depth of pre-integrated product solutions; (iii) product quality, client service, and support; (iv) operational excellence and reliability; (v) quality of R&D efforts; and (vi) total cost of ownership. We believe that our products and services allow us to compete effectively in these areas.

Proprietary Rights and Licenses

We rely on a combination of trade secret, copyright, trademark, and patent laws in the United States (“U.S.”) and similar laws in other countries, and non-disclosure, confidentiality, and other types of contractual arrangements to establish, maintain, and enforce our intellectual property rights in our solutions. Despite these measures, any of our intellectual property rights could be challenged, invalidated, circumvented, or misappropriated. Although we hold a limited number of patents and patent applications on some of our newer solutions, we do not rely upon patents as a primary means of protecting our rights in our intellectual property. In any event, there can be no assurance that our patent applications will be approved, that any issued patents will adequately protect our intellectual property, or that such patents will not be challenged by third parties. Also, much of our business and many of our solutions rely on key technologies developed or licensed by third parties, and we may not be able to obtain or continue to obtain licenses and technologies from these third parties at all or on reasonable terms. Our failure to adequately establish, maintain, and protect our intellectual property rights could have a material adverse impact on our business, financial condition, and results of operations. For a description of the risks associated with our intellectual property rights, see “Item 1A - Risk Factors - Failure to Protect Our Intellectual Property Rights or Claims by Others That We Infringe Their Intellectual Property Rights Could Substantially Harm Our Business, Financial Condition and Results of Operations.”

Employees

As of December 31, 2017, we had a total of 3,373 employees, an increase of 61 employees when compared to the number of employees we had as of December 31, 2016. Our success is dependent upon our ability to attract and retain qualified employees. We are subject to various foreign employment laws and regulations based on the country in which our employees are located. We believe that our relations with our employees are good.

Available Information

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy materials, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act are available free of charge on our website at www.csgi.com. Additionally, these reports are available at the SEC’s Public Reference Room at 100 F Street, NE., Washington, D.C. 20549 or on the SEC’s website at www.sec.gov. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330.

Code of Conduct and Business Ethics

A copy of our Code of Conduct and Business Ethics (the “Code of Conduct”) is maintained on our website. Any future amendments to the Code of Conduct, or any future waiver of a provision of our Code of Conduct, will be timely posted to our website upon their occurrence. Historically, we have had minimal changes to our Code of Conduct, and have had no waivers of a provision of our Code of Conduct.

Item 1A.

Risk Factors

We or our representatives from time-to-time may make or may have made certain forward-looking statements, whether orally or in writing, including without limitation, any such statements made or to be made in MD&A contained in our various SEC filings or orally in conferences or teleconferences. We wish to ensure that such statements are accompanied by meaningful cautionary statements, so as to ensure, to the fullest extent possible, the protections of the safe harbor established in the Private Securities Litigation Reform Act of 1995.

7


 

Accordingly, the forward-looking statements are qualified in their entirety by reference to and are accompanied by the following meaningful cautionary statements identifying certain important risk factors that could cause actual results to differ materially from those in such forward-looking statements. This list of risk factors is likely not exhaustive. We operate in rapidly changing and evolving markets throughout the world addressing the complex needs of communication service providers, financial institutions, and many others, and new risk factors will likely emerge. Further, as we enter new market sectors such as financial services, as well as new geographic markets, we are subject to new regulatory requirements that increase the risk of non-compliance and the potential for economic harm to us and our clients. Management cannot predict all of the important risk factors, nor can it assess the impact, if any, of such risk factors on our business or the extent to which any risk factor, or combination of risk factors, may cause actual results to differ materially from those in any forward-looking statements. Accordingly, there can be no assurance that forward-looking statements will be accurate indicators of future actual results, and it is likely that actual results will differ from results projected in forward-looking statements and that such differences may be material.

We Derive a Significant Portion of Our Revenues From a Limited Number of Clients, and the Loss of the Business of a Significant Client Could Have a Material Adverse Effect on Our Financial Position and Results of Operations.

Over the past decade, the worldwide communications industry has experienced significant consolidation, resulting in a large percentage of the market being served by a limited number of service providers with greater size and scale, and there are possibilities of further consolidation. Consistent with this market concentration, we generate approximately 60% of our revenues from our three largest clients, which are (in order of size) Comcast, Charter, and DISH, which each individually accounted for 10% or more of our total revenues. See the Significant Client Relationships section of MD&A for key renewal dates and a brief summary of our business relationship with these clients.

There are inherent risks whenever a large percentage of total revenues are concentrated with a limited number of clients. Such risks are that a significant client could: (i) undergo a formalized process to evaluate alternative providers for services we provide; (ii) terminate or fail to renew their contracts with us, in whole or in part for any reason; (iii) 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 (iv) experience significant financial or operating difficulties. Any such development could have a material adverse effect on our financial position and results of operations and/or trading price of our common stock.

Our industry is highly competitive, and as a result, it is possible that a competitor could increase its footprint and share of customers serviced at our expense or a service provider could develop their own internal solutions. While our clients may incur some costs in switching to our competitors or their own internally-developed solutions, they may do so for a variety of reasons, including: (i) price; (ii) dissatisfaction with our solutions or service levels; or (iii) dissatisfaction with our relationships.

We May Not Be Able to Efficiently and Effectively Implement New Solutions or Convert Clients onto Our Solutions.

Our continued growth plans include the implementation of new solutions, as well as migrating both new and existing clients to our solutions. Such implementations or conversions (collectively referred to hereafter in this section as “implementations”), regardless of whether they involve new solutions or new customers, have become increasingly more difficult because of the sophistication, complexity, and interdependencies of the various software and network environments impacted, combined with the increasing complexity of the clients’ underlying business processes. In addition, the complexity of the implementations increases when the arrangement includes other vendors participating in the project, including but not limited to, prime and subcontractor relationships with our company. For these reasons, implementations subject our clients to potential business disruption, which could cause them to delay or even cancel future implementations.  

As a result, there is a risk that we may experience cancellations, delays, or unexpected costs associated with implementations. In addition, our inability to complete implementations in an efficient and effective manner could have a material adverse effect on our results of operations, and could damage our reputation in the market place, reducing our opportunity to grow our business with both new and existing clients.

The Delivery of Our Solutions is Dependent on a Variety of Computing Environments and Communications Networks Which May Not Be Available or May Be Subject to Security Attacks.

Our solutions are generally delivered through a variety of sources including public cloud, third-party data center providers, and internally-operated computing environments (collectively referred to hereafter in this section as “Systems”). The end users are connected to the Systems through a variety of public and private communications networks, which we will collectively refer to herein as “Networks.” Our solutions are generally considered to be mission critical customer management systems by our clients. As a result, our clients are highly dependent upon the high availability and uncompromised security of the Networks and Systems to conduct their business operations.

8


 

Networks and Systems are subject to the risk of an extended interruption, outage, or security breach due to many factors such as: (i) changes to the Systems and Networks for such things as scheduled maintenance and technology upgrades, or conversions to other technologies, service providers, or physical location of hardware; (ii) failures or lack of continuity of services from public could or third-party data center providers; (iii) defects in software program(s); (iv) human and machine error; (v) acts of nature; (vi) intentional, unauthorized attacks from computer “hackers”, or cyber-attacks; and (vii) using our systems to perpetrate identity theft through unauthorized authentication to our clients’ customers’ accounts. Most recently, the marketplace is experiencing an ever-increasing exposure to both the number and severity of cyber-attacks.  In addition, we continue to expand our use of the Internet with our product offerings thereby permitting, for example, our clients’ customers to use the Internet to review account balances, order services or execute similar account management functions. Access to Networks and Systems via the Internet has the potential to increase their vulnerability to unauthorized access and corruption, as well as increasing the dependency of the Systems’ reliability on the availability and performance of the Internet and end users’ infrastructure they obtain through other third-party providers.

The method, manner, cause and timing of an extended interruption, outage, or security breach in the Networks or Systems are impossible to predict. As a result, there can be no assurances that these Networks and Systems will not fail, not suffer a security breach or that our business continuity or remediation plans will adequately mitigate the negative effects of a disruption or security breach to the Networks or Systems. Further, our property, technology errors and omissions, and business interruption insurance may not adequately compensate us for losses that we incur as a result of such interruptions or security breaches. Should the Networks or Systems: (i) experience an extended interruption or outage; (ii) have their security breached; or (iii) have their data lost, corrupted or otherwise compromised, it would impede our ability to meet product and service delivery obligations, and likely have an immediate impact to the business operations of our clients. This would most likely result in an immediate loss to us of revenue or increase in expense, as well as damaging our reputation. The loss of confidential information could result in losing the customers’ confidence, as well as imposition of fines and damages. Any of these events could have an immediate, negative impact upon our financial position and our short-term revenue and profit expectations, as well as our long-term ability to attract and retain new clients.

The Occurrence or Perception of a Security Breach or Disclosure of Confidential Personally Identifiable Information Could Harm Our Business.

In providing solutions to our clients, we process, transmit, and store confidential and personally identifiable information (“PII”), including social security numbers and financial information. Our treatment of such information is subject to contractual restrictions and federal, state, and foreign data privacy laws and regulations, which continue to evolve resulting in greater scrutiny over the protection of PII. In response to these evolving restrictions and regulations, including the European Union’s adoption of the General Data Protection Regulation (“GDPR”), we leverage various data encryption strategies and have implemented measures to protect against unauthorized access to such information, and comply with these laws and regulations. These measures include standard industry practices (e.g. payment card industry (“PCI”) requirements), periodic security reviews of our systems by independent parties, secure development practices, network firewalls, policy directives, procedural controls, intrusion detection systems, and antivirus applications. Because of the inherent risks and complexities to defend against cybercrime, these measures may fail to adequately protect this information. Any failure on our part to protect the privacy of personally identifiable information or comply with data privacy laws and regulations may subject us to contractual liability and damages, loss of business, damages from individual claimants, substantial fines/penalties, criminal prosecution, and unfavorable publicity. Even the mere perception of a security breach or inadvertent disclosure of personally identifiable information could damage our reputation and inhibit market acceptance of our solutions. In addition, third party vendors that we engage to perform services for us may unintentionally release personally identifiable information or otherwise fail to comply with applicable laws and regulations. The occurrence of any of these events could have an adverse effect on our business, financial position, and results of operations.

Our Business is Highly Dependent on the Global Communications Industry.

Since a large percentage of our revenues are generated from clients that operate within the global communications industry sector, we are highly dependent on the health and the business trends occurring within this industry (in particular for our North American cable and satellite clients).  Key factors within this industry that could potentially impact our clients’ businesses, and thus, our business, are as follows:

 

Key Market Conditions:  The global communications industry has undergone significant fluctuations in growth rates and capital investment cycles in the past decade. Current economic indices suggest a slow stabilization of the industry, but it is impossible to predict whether this stabilization will persist or be subject to future instability.

In addition, changes in demand for traditional services for CSPs are causing them to seek new revenue sources, while also managing their cost structure and quality of service delivery during their business transformation. The result is that many CSPs are delaying investment decision on maintaining/advancing legacy systems, and/or making investments in new solutions to drive their business forward into new areas.

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Market Consolidation: The pace of consolidation within the industry continues to accelerate as service providers look to increase the scale of their operations and footprint within the entire communications ecosystem.  Potential byproducts of this consolidation that could impact us are as follows: (i) there could be fewer providers in the market, each with potentially greater bargaining power and economic leverage due to their larger size, which may result in our having to lower our prices to remain competitive, retain our market share, or comply with the surviving client’s current more favorable contract terms, and (ii) the controlling entity in a consolidation that is not our current client, may acquire one of our existing clients and choose to consolidate both entities onto the controlling entity’s software platform, thus reducing and possibly eliminating our business with our existing client.

Also, as consolidated entities execute upon their revenue and operational synergies, there is generally a slowdown in decision-making on large transformational projects, discretionary spending, and/or on new business initiatives.  While this could be a timing issue only, it could impact quarterly and annual results.  

 

Increased Competition: Our clients operate in a highly competitive environment. Competitors range from traditional wireline and wireless providers to new entrants like new digital lifestyle service providers such as Facebook, Apple, Netflix, Google, and Amazon. Should these competitors be successful in their strategies, it could threaten our clients’ market share, pricing power, and level of services delivered, all of which could negatively impact our clients’ revenues, putting pressure on our source of revenues, as generally speaking, these companies do not use our core solutions and there can be no assurance that new entrants will become our clients. In addition, demand for spectrum, network bandwidth and content continues to increase and any changes in the regulatory environment could have a significant impact to not only our clients’ businesses, but in our ability to help our clients be successful.

The above industry factors are impacting our clients’ businesses, and thus could cause delays, cancellations/loss of business, and/or downward pricing pressure on our sales and services. This could cause us to either fall short of revenue expectations or have a cost model that is misaligned with revenues, either or both of which could have a material adverse effect on our financial position and results of operations.  

We May Not Be Able to Respond to Rapid Technological Changes.

The market for business support solutions, such as customer care and billing solutions, is characterized by rapid changes in technology and is highly competitive with respect to the need for timely product innovations and new product introductions. As a result, we believe that our future success in sustaining and growing our revenues depends upon: (i) our ability to continuously expand, adapt, modify, maintain, and operate our solutions to address the increasingly complex and evolving needs of our clients without sacrificing the reliability or quality of the solutions; (ii) the integration of acquired technologies and their widely distributed, complex worldwide operations; and (iii) creating and maintaining an integrated suite of customer care and billing solutions, which are portable to new verticals such as utilities, financial services, and content distribution.  In addition, the market is demanding that our solutions have greater architectural flexibility and interoperability, and that we are able to meet the demands for technological advancements to our solutions at a greater pace. Our attempts to meet these demands subjects our R&D efforts to greater risks.

As a result, substantial and effective R&D and product investment will be required to maintain the competitiveness of our solutions in the market. Technical problems may arise in developing, maintaining, integrating, and operating our solutions as the complexities are increased. Development projects can be lengthy and costly, and may be subject to changing requirements, programming difficulties, a shortage of qualified personnel, and/or unforeseen factors which can result in delays. In addition, we may be responsible for the implementation of new solutions and/or the conversion of clients to new solutions, and depending upon the specific solution, we may also be responsible for operations of the solution.

There is an inherent risk in the successful development, implementation, conversion, integration, and operation of our solutions as the technological complexities, and the pace at which we must deliver these solutions to market, continue to increase. The risk of making an error that causes significant operational disruption to a client, or results in incorrect computer processing of customer or vendor data that we perform on behalf of our clients, increases proportionately with the frequency and complexity of changes to our solutions and new delivery models. There can be no assurance: (i) of continued market acceptance of our solutions; (ii) that we will be successful in the development of enhancements or new solutions that respond to technological advances or changing client needs at the pace the market demands; or (iii) that we will be successful in supporting the implementation, conversion, integration, and/or operations of enhancements or new solutions.

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A Reduction in Demand for Our Key Business Support Solutions Could Have a Material Adverse Effect on Our Financial Position and Results of Operations.

Historically, a substantial percentage of our total revenues have been generated from our core cloud-based product, ACP, and related solutions. These solutions are expected to continue to provide a large percentage of our total revenues in the foreseeable future. Any significant reduction in demand for ACP and related solutions could have a material adverse effect on our financial position and results of operations. Likewise, a large percentage of revenues derived from our software license and services business have been derived from wholesale billing, retail billing and mediation products which are typically associated with large implementation projects. A sudden downward shift in demand for these products or for our professional services associated with these products could have a material adverse effect on our financial position and results of operations.

Failure to Attract and Retain Our Key Management and Other Highly Skilled Personnel Could Have a Material Adverse Effect on Our Business.

Our future success depends in large part on the continued service of our key management, sales, product development, professional services, and operational personnel. We believe that our future success also depends on our ability to attract and retain highly skilled technical, managerial, operational, and sales and marketing personnel, including, in particular, personnel in the areas of R&D, professional services, and technical support. Competition for qualified personnel at times can be intense, particularly in the areas of R&D, conversions, software implementations, and technical support. This risk is heightened with a widely dispersed customer base and employee populations. For these reasons, we may not be successful in attracting and retaining the personnel we require, which could have a material adverse effect on our ability to meet our commitments and new product delivery objectives.

Variability of Our Quarterly Revenues and Our Failure to Meet Revenue and Earnings Expectations Would Negatively Affect the Market Price of Our Common Stock.

From time to time, we may experience variability in quarterly revenues and operating results. Common causes of failure to meet revenue and operating expectations include, among others:

 

Inability to close and/or recognize revenue on certain transactions in the period originally anticipated;

 

Delays in renewal of multiple or individually significant agreements;

 

Inability to renew existing arrangements at anticipated rates;

 

Delays in timing of initiation and/or implementation of significant projects or arrangements;

 

Inability to meet client expectations materially within our cost estimates;

 

Changes in spending and investment levels;

 

Foreign currency fluctuations; and

 

Economic and political conditions.

Should we fail to meet our revenue and earnings expectations of the investment community, by even a relatively small amount, it would most likely have a disproportionately negative impact upon the market price of our common stock.

Our International Operations Subject Us to Additional Risks.

We currently conduct a portion of our business outside the U.S. We are subject to certain risks associated with operating internationally including the following items:

 

Product development not meeting local requirements;

 

Fluctuations in foreign currency exchange rates for which a natural or purchased hedge does not exist or is ineffective;

 

Staffing and managing foreign operations;

 

Longer sales cycles for new contracts;

 

Longer collection cycles for client billings or accounts receivable, as well as heightened client collection risks, especially in countries with highly inflationary economies and/or restrictions on the movement of cash out of the country;

 

Trade barriers;

 

Governmental sanctions;

 

Complying with varied legal and regulatory requirements across jurisdictions;

 

Reduced protection for intellectual property rights in some countries;

 

Inability to recover value added taxes and/or goods and services taxes in foreign jurisdictions;

 

Political instability and threats of terrorism; and

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A potential adverse impact to our overall effective income tax rate resulting from, among other things:

 

Operations in foreign countries with higher tax rates than the U.S.;

 

The inability to utilize certain foreign tax credits; and

 

The inability to utilize some or all of losses generated in one or more foreign countries.

One or more of these factors could have a material adverse effect on our international operations, which could adversely impact our results of operations and financial position.

We May Not Be Successful in the Integration or Achievement of Financial Targets of Our Acquisitions.

As part of our growth strategy, we seek to acquire assets, technology, and businesses which will provide the technology and personnel to expedite our product development efforts, provide complementary solutions, or provide access to new markets and clients.

Acquisitions involve a number of risks and difficulties, including: (i) expansion into new markets and business ventures; (ii) the requirement to understand local business practices; (iii) the diversion of management’s attention to the assimilation of acquired operations and personnel; (iv) being bound by acquired client or vendor contracts with unfavorable terms; and (v) potential adverse effects on a company’s operating results for various reasons, including, but not limited to, the following items: (a) the inability to achieve financial targets; (b) the inability to achieve certain financial expectations, operating goals, and synergies; (c) costs incurred to exit current or acquired contracts or activities; (d) costs incurred to service any acquisition debt; and (e) the amortization or impairment of acquired intangible assets.

Due to the multiple risks and difficulties associated with any acquisition, there can be no assurance that we will be successful in achieving our expected strategic, operating, and financial goals for any such acquisition.

Our International Operations Require Us To Comply With Applicable U.S. and International Laws and Regulations.

Doing business on a worldwide basis requires our company and our subsidiaries to comply with the laws and the regulations of the U.S. government and various international jurisdictions.  In addition, the number of countries enacting anti-corruption laws and related enforcement activities is increasing. These regulations place restrictions on our operations, trade practices and trade partners. In particular, our international operations are subject to U.S. and foreign anti-corruption laws and regulations such as the Foreign Corrupt Practices Act (“FCPA”), the U.K. Anti-Bribery Act and economic sanction programs administered by the Office of Foreign Assets Control (“OFAC”).  

The FCPA prohibits us from providing anything of value to foreign officials for the purposes of influencing official decisions or obtaining or retaining business. In addition, the FCPA imposes accounting standards and requirements on publicly traded U.S. corporations and their foreign affiliates, which are intended to prevent the diversion of corporate funds to the payment of bribes and other improper payments, and to prevent the establishment of “off books” slush funds from which such improper payment can be made. As part of our business, we regularly deal with state-owned business enterprises, the employees of which are considered foreign officials for purposes of the FCPA. In addition, some of the international locations in which we operate lack a developed legal system and have higher than normal levels of corruption. We inform our personnel and third-party sales representatives of the requirements of the FCPA and other anti-corruption laws, including, but not limited to their reporting requirements. We have also developed and will continue to develop and implement systems for formalizing contracting processes, performing due diligence on agents and improving our recordkeeping and auditing practices regarding these regulations. However, there is no guarantee that our employees, third-party sales representatives or other agents have not or will not engage in conduct undetected by our processes and for which we might be held responsible under the FCPA or other anti-corruption laws.

Economic sanctions programs restrict our business dealings with certain countries and individuals. From time to time, certain of our foreign subsidiaries have had limited business dealings with entities in jurisdictions subject to OFAC-administered sanctions. As a result of our worldwide business, we are exposed to a heightened risk of violating anti-corruption laws and OFAC regulations. Violations of these laws and regulations are punishable by civil penalties, including fines, injunctions, asset seizures, debarment from government contracts and revocations or restrictions of licenses, as well as criminal fines and imprisonment.

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Our Use of Open Source Software May Subject Us to Certain Intellectual Property-Related Claims or Require Us to Re-Engineer Our Software, Which Could Harm Our Business.

We use open source software in connection with our solutions, processes, and technology. Companies that use or incorporate open source software into their products have, from time to time, faced claims challenging their use, ownership and/or licensing rights associated with that open source software. As a result, we could be subject to suits by parties claiming certain rights to what we believe to be open source software. Some open source software licenses require users who distribute open source software as part of their software to publicly disclose all or part of the source code in their software and make any derivative works of the open source code available on unfavorable terms or at no cost. In addition to risks related to license requirements, use of open source software can lead to greater risks than use of third party commercial software, as open source licensors generally do not provide warranties, support, or controls with respect to origin of the software. Use of open source software also complicates compliance with export-related laws. While we take measures to protect our use of open source software in our solutions, open source license terms may be ambiguous, and many of the risks associated with usage of open source software cannot be eliminated. If we were found to have inappropriately used open source software, we may be required to release our proprietary source code, re-engineer our software, discontinue the sale of certain solutions in the event re-engineering cannot be accomplished on a timely basis, or take other remedial action that may divert resources away from our development efforts, any of which could adversely affect our business, financial position, and results of operations.

We Face Significant Competition in Our Industry.

The market for our solutions is highly competitive. We directly compete with both independent providers and in-house solutions developed by existing and potential clients. In addition, some independent providers are entering into strategic alliances with other independent providers, resulting in either new competitors, or competitors with greater resources. Many of our current and potential competitors have significantly greater financial, marketing, technical, and other competitive resources than our company, many with significant and well-established domestic and international operations. There can be no assurance that we will be able to compete successfully with our existing competitors or with new competitors.

Failure to Protect Our Intellectual Property Rights or Claims by Others That We Infringe Their Intellectual Property Rights Could Substantially Harm Our Business, Financial Position and Results of Operations.

We rely on a combination of trade secret, copyright, trademark, and patent laws in the U.S. and similar laws in other countries, and non-disclosure, confidentiality, and other types of contractual arrangements to establish, maintain, and enforce our intellectual property rights in our solutions. Despite these measures, any of our intellectual property rights could be challenged, invalidated, circumvented, or misappropriated. Further, our contractual arrangements may not effectively prevent disclosure of our confidential information or provide an adequate remedy in the event of unauthorized disclosure of our confidential information. Others may independently discover trade secrets and proprietary information, which may complicate our assertion of trade secret rights against such parties. Costly and time consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position. In addition, the laws of certain countries do not protect proprietary rights to the same extent as the laws of the U.S. Therefore, in certain jurisdictions, we may be unable to protect our proprietary technology adequately against unauthorized third party copying or use, which could adversely affect our competitive position.

Although we hold a limited number of patents and patent applications on some of our solutions, we do not rely upon patents as a primary means of protecting our rights in our intellectual property. In any event, there can be no assurance that our patent applications will be approved, that any issued patents will adequately protect our intellectual property, or that such patents will not be challenged by third parties. Also, much of our business and many of our solutions rely on key technologies developed or licensed by third parties, and we may not be able to obtain or continue to obtain licenses and technologies from these third parties at all or on reasonable terms.

Finally, third parties may claim that we, our clients, licensees or other parties indemnified by us are infringing upon their intellectual property rights. Even if we believe that such claims are without merit, they can be time consuming and costly to defend and distract management’s and technical staff’s attention and resources. Claims of intellectual property infringement also might require us to redesign affected solutions, enter into costly settlement or license agreements or pay costly damage awards, or face a temporary or permanent injunction prohibiting us from marketing or selling certain of our solutions. Even if we have an agreement to indemnify us against such costs, the indemnifying party may be unable to uphold its contractual obligations. If we cannot or do not license the infringed technology on reasonable pricing terms or at all, or substitute similar technology from another source, our business, financial position, and results of operations could be adversely impacted. Our failure to adequately establish, maintain, and protect our intellectual property rights could have a material adverse impact on our business, financial position, and results of operations.

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We May Incur Material Restructuring Charges in the Future.

In the past, we have recorded restructuring charges related to involuntary employee terminations, various facility abandonments, and various other restructuring and reorganization activities. We continually evaluate ways to reduce our operating expenses through new restructuring opportunities, including more effective utilization of our assets, workforce, and operating facilities. As a result, there is a risk, which is increased during economic downturns and with expanded global operations, that we may incur material restructuring or reorganization charges in the future.

Substantial Impairment of Long-lived Assets in the Future May Be Possible.

As a result of various acquisitions and the growth of our company over the last several years, we have approximately $115 million of long-lived assets other than goodwill (principally, property and equipment, software, and client contracts) as of December 31, 2017. Long-lived assets are required to be evaluated for possible impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. We utilize our market capitalization and/or cash flow models as the primary basis to estimate the fair value amounts used in our long-lived asset impairment valuations. If an impairment was to be recorded in the future, it could materially impact our results of operations in the period such impairment is recognized, but such an impairment charge would be a non-cash expense, and therefore would have no impact on our cash flows.

 

Item  1B.

Unresolved Staff Comments

None.

 

Item 2.

Properties

As of December 31, 2017, we were operating in over 25 leased sites around the world, representing approximately 565,000 square feet.

Our corporate headquarters is located in Greenwood Village, Colorado. In addition, we lease office space in the U.S. in Atlanta, Georgia; Bloomfield, New Jersey; Chicago, Illinois; Omaha, Nebraska; and Philadelphia, Pennsylvania. The leases for these office facilities expire in the years 2019 through 2027. We also maintain leased facilities internationally in Australia, Brazil, Canada, Colombia, Denmark, France, India, Ireland, Malaysia, South Africa, Sweden, United Arab Emirates, and the U.K. The leases for these international office facilities expire in the years 2018 through 2025. We utilize these office facilities primarily for the following: (i) client services, training, and support; (ii) product and operations support; (iii) systems and programming activities; (iv) professional services staff; (v) R&D activities; (vi) sales and marketing activities; and (vii) general and administrative functions.

Additionally, we lease two statement production and mailing facilities totaling approximately 176,000 square feet. These facilities are located in: (i) Omaha, Nebraska; and (ii) Crawfordville, Florida. The leases for these facilities expire in the 2018 and 2019, respectively.

We believe that our facilities are adequate for our current needs and that additional suitable space will be available as required. We also believe that we will be able to either: (i) extend our current leases as they terminate; or (ii) find alternative space without experiencing a significant increase in cost. See Note 9 to our Financial Statements for information regarding our obligations under our facility leases.

 

Item  3.

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. In the opinion of our management, we are not presently a party to any material pending or threatened legal proceedings.

 

Item 4.

Mine Safety Disclosures

Not applicable.

************************************************************************************************

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Executive Officers of the Registrant

Our executive officers are Bret C. Griess (President and Chief Executive Officer), Randy R. Wiese (Executive Vice President and Chief Financial Officer), Brian A. Shepherd (Executive Vice President and Group President), and Kenneth M. Kennedy (Executive Vice President, President of Technology and Product).  We have employment agreements with each of the executive officers.

Bret C. Griess

President and Chief Executive Officer

Mr. Griess, 49, currently serves as our President and Chief Executive Officer. He joined CSG in 1996 and held a variety of positions in Operations and Information Technology, until being appointed Executive Vice President of Operations in February 2009, Chief Operations Officer in March 2011, and President in June 2015. In January 2016, Mr. Griess was appointed President and Chief Executive Officer and a member of our Board. Mr. Griess holds an M.A. degree in Management and a B.S. degree in Management from Bellevue University in Nebraska, and an A.A.S. degree from the Community College of the Air Force.

Randy R. Wiese

Executive Vice President and Chief Financial Officer

Mr. Wiese, 58, serves as Executive Vice President and Chief Financial Officer for CSG. Mr. Wiese joined CSG International in 1995 as Controller and later served as Chief Accounting Officer. He was named Executive Vice President and Chief Financial Officer in April 2006. Prior to joining CSG, he was manager of audit and business advisory services and held other accounting-related positions at Arthur Andersen & Co. Mr. Wiese is a member of the AICPA and the Nebraska Society of Certified Public Accountants. He holds a B.S. degree in Accounting from the University of Nebraska-Omaha.

Brian A. Shepherd

Executive Vice President and Group President

Mr. Shepherd, 50, was named Executive Vice President and Group President of CSG in October 2017. In this position, he leads the profit and loss organization for the entire global organization. Prior to this role, Mr. Shepherd served as Executive Vice President and President of Global Broadband, Cable and Satellite Business from 2016 to 2017, where he focused on accelerating the growth and strategic direction of CSG’s global broadband, cable and direct broadcast satellite business. Mr. Shepherd is an international business expert with strong management, customer relationship, global sales, strategy and corporate growth experience. In previous executive roles at companies such as TeleTech, Amdocs, DST Innovis, and McKinsey & Company, Mr. Shepherd built a successful history of helping companies drive and achieve their strategic growth initiatives. With more than 15 years in the cable and communications industries, he has built wide and deep relationships with C-Suite leaders, decision-makers and policy influencers who have shaped these industries globally. Mr. Shepherd graduated Magna cum laude in Economics from Wabash College and received a Master of Business Administration degree from Harvard Business School.

Kenneth M. Kennedy

Executive Vice President, President of Technology and Product

Mr. Kennedy, 48, was named President of Technology and Product in October 2017. In this position, he oversees all product development, product management, platform architecture and operations across CSG’s solutions portfolio. His expertise and vision contribute to new innovations that enable CSG’s clients to have more agile and dynamic operations. Prior to this role, Mr. Kennedy served as CSG’s Executive Vice President of Product Development from 2016 to 2017. Prior to this role, he served as CSG’s Chief Technology Officer and Senior Vice President of Product Management, Development and Operations from 2006 to 2016, managing CSG’s software development organization and implementing technology initiatives for CSG’s product offerings. Prior to CSG, Mr. Kennedy was one of the original founders of Telution where he served as Vice President of Software Development and Professional Services from 1998 to 2006. Prior to Telution, Mr. Kennedy worked at Andersen Consulting where he was responsible for developing highly-scalable distributed software solutions for the manufacturing, financial services, and communications industries. Mr. Kennedy received a Bachelor of Business Administration and Management Information Systems from the University of Notre Dame.

 

Board of Directors of the Registrant

Information related to our Board of Directors (the “Board”) is provided below.

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Donald B. Reed

Mr. Reed, 73, was elected to the Board in May 2005 and has served as CSG’s non-executive Chairman of the Board since January 2010. He is presently retired. Mr. Reed served as CEO of Cable & Wireless Global from 2000 to 2003. Cable & Wireless Global, a subsidiary of Cable & Wireless plc, is a provider of internet protocol (“IP”) and data services to business customers in the U.S., United Kingdom, Europe, and Japan. From June 1998 until May 2000, Mr. Reed served Cable & Wireless in various other executive positions. Mr. Reed’s career includes 30 years at NYNEX Corporation (now part of Verizon), a regional telephone operating company. From 1995 to 1997, Mr. Reed served NYNEX Corporation as President and Group Executive with responsibility for directing the company’s regional, national, and international government affairs, public policy initiatives, legislative and regulatory matters, and public relations. Mr. Reed holds a B.A. degree in History from Virginia Military Institute.

Bret C. Griess

Mr. Griess’ biographical information is included in the “Executive Officers of the Registrant” section shown directly above.

David G. Barnes

Mr. Barnes, 56, was appointed to the Board in February 2014. He currently serves as the Executive Vice President, Global Operations of Stantec Inc., a publicly traded global provider of engineering, consulting, and construction services. From 2009 through 2016, he served as Executive Vice President and CFO of MWH Global Inc., an employee-owned engineering and construction firm. MWH Global Inc. was acquired by Stantec Inc. in 2016. From 2006 to 2008, he was Executive Vice President of Western Union Financial Services. From 2004 to 2006, Mr. Barnes served as CFO of Radio Shack Corporation, and from 1999 to 2004, he was Vice President, Treasurer, and U.S. CFO for Coors Brewing Company. Mr. Barnes holds an M.B.A. degree from the University of Chicago and a B.A. degree from Yale University.

Ronald H. Cooper

Mr. Cooper, 61, was elected to the Board in November 2006. Mr. Cooper is retired. He most recently served as the President and Chief Executive Officer of Clear Channel Outdoor Americas, Inc. (an outdoor advertising company) from 2009 through 2012. Prior to this position, he was a Principal at Tufts Consulting LLC from 2006 through 2009. Previously, he spent nearly 25 years in the cable and telecommunications industry, most recently at Adelphia Communications where he served as President and Chief Operating Officer from 2003 to 2006. Prior to Adelphia, Mr. Cooper held a series of executive positions at AT&T Broadband, RELERA Data Centers & Solutions, MediaOne, and its predecessor Continental Cablevision, Inc. He has served on various boards of directors and committees with the National Cable Television Association, California Cable & Telecommunications Association, Cable Television Association for Marketing, New England Cable Television Association, and Outdoor Advertising Association of America. Mr. Cooper holds a B.A. degree from Wesleyan University.

Marwan H. Fawaz

Mr. Fawaz, 55, was appointed to the Board in March 2016. He is currently the CEO of Nest Labs, Inc., an Alphabet Inc. company. With more than 28 years of experience in the media, cable, telecommunications, and broadband industries, Mr. Fawaz offers a wealth of knowledge and expertise, developed from his time as Executive Vice President and CEO of Google/Motorola Mobility from 2012 to 2013, and Executive Vice President of Strategy and Operations and Chief Technology Officer of Charter Communications from 2006 to 2011. In addition, he served as Senior Vice President and Chief Technology Officer of Adelphia Communications from 2003 to 2006, and held leadership positions for other cable industry companies such as MediaOne, among others. Mr. Fawaz is currently a board member of Synacor Inc. In addition, he was the founder and principal of Sarepta Advisors, a strategic advisory and consulting group supporting the technology, media, and telecommunications industries. He holds an M.S. degree in Electrical and Communication Engineering and a B.S. degree in Electrical Engineering, both from California State University at Long Beach.

Janice I. Obuchowski

Ms. Obuchowski, 66, was elected to the Board in November 1997. She is the founder and President of Freedom Technologies, Inc. (a firm providing public policy, strategic, and engineering advice to companies in the communications sector, government agencies, and international clients), a position she has held since 1992. In 2003, Ms. Obuchowski was appointed by President George W. Bush to serve as Ambassador and Head of the U.S. Delegation to the World Radiocommunication Conference. She has served as Assistant Secretary for Communications and Information at the Department of Commerce and Administrator for the National Telecommunications and Information Administration (“NTIA”), and as the head of international government relations at NYNEX Corporation. Ms. Obuchowski currently serves as a Director on the boards for Orbital ATK and Inmarsat. She also has served on several non-profit and other publicly traded company boards. She holds a J.D. degree from Georgetown University and a B.A. degree from Wellesley College, and also attended the University of Paris.

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Frank V. Sica

Mr. Sica, 66, has served as a director of the Company since its formation in 1994. He is currently a Partner of Tailwind Capital (a private equity firm) since 2006. From 2004 to 2005, Mr. Sica was a Senior Advisor to Soros Private Funds Management. During that period, Mr. Sica was also President of Menemsha Capital Partners, Ltd., a private investment firm. From 2000 until 2003, he was President of Soros Private Funds Management, where he oversaw the direct real estate and private equity investment activities of Soros. In 1998, he joined Soros Fund Management where he was a Managing Director responsible for Soros’ private equity investments. Mr. Sica was also previously Managing Director for Morgan Stanley Merchant Banking Division. He currently serves as a director on the boards of JetBlue Airways, Kohl’s Corporation, and Safe Bulkers, Inc. Mr. Sica holds an M.B.A. degree from the Tuck School of Business at Dartmouth College and a B.A. degree from Wesleyan University.

Donald V. Smith

Mr. Smith, 75, was elected to the Board in January 2002. He is presently retired. Previously, Mr. Smith served as Senior Managing Director of Houlihan Lokey Howard & Zukin, Inc., an international investment banking firm with whom he had been associated from 1988 through 2009, and where he served on the board of directors. From 1978 to 1988, he served as a Principal with Morgan Stanley & Co. Inc., where he headed the company’s valuation and reorganization services. He also serves on the board of directors of several non-profit organizations. Mr. Smith holds an M.B.A. degree from the Wharton Graduate School of the University of Pennsylvania and a B.S. degree from the United States Naval Academy.

James A. Unruh

Mr. Unruh, 77, was elected to the Board in June 2005. He became a founding Principal of Alerion Capital Group, LLC (a private equity investment company) in 1998 and currently holds such position. Mr. Unruh was an executive with Unisys Corporation (a global information technology company) from 1987 to 1997, including serving as its Chairman and CEO from 1990 to 1997. From 1982 to 1986, Mr. Unruh held various executive positions, including Senior Vice President–Finance and CFO with Burroughs Corporation, a predecessor of Unisys Corporation. Prior to 1982, Mr. Unruh was CFO with Memorex Corporation and also held various executive positions with Fairchild Camera and Instrument Corporation, including CFO. Mr. Unruh currently serves as director on the board of Tenet Healthcare Corporation, and formerly served as director on the boards for Prudential Financial, Inc. and CenturyLink, Inc. during the past five years. He holds an M.B.A. degree from the University of Denver and a B.S. degree from the University of Jamestown.

 

17


 

PART II

 

Item  5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is listed on NASDAQ under the symbol ‘‘CSGS’’. The following table sets forth, for the fiscal quarters indicated, the high and low sale prices of our common stock as reported by NASDAQ.

 

2017:

  

High

 

  

Low

 

  

Dividends
Declared

 

 

First quarter

  

$

$51.34

  

  

$

36.58

  

  

$

0.1975

  

Second quarter

  

 

42.26

  

  

 

35.48

  

  

 

0.1975

  

Third quarter

  

 

42.87

  

  

 

37.21

  

  

 

0.1975

  

Fourth quarter

  

 

46.41

  

  

 

39.71

  

  

 

0.1975

  

 

2016:

  

High

 

  

Low

 

  

Dividends
Declared

 

 

First quarter

  

$

45.96

  

  

$

32.45

  

  

$

0.185

  

Second quarter

  

 

46.54

  

  

 

38.47

  

  

 

0.185

  

Third quarter

  

 

44.76

  

  

 

39.38

  

  

 

0.185

  

Fourth quarter

  

 

49.85

  

  

 

36.33

  

  

 

0.185

  

On February 20, 2018, the last sale price of our common stock as reported by NASDAQ was $47.71 per share. On January 31, 2018, the number of holders of record of common stock was 133.

Dividends

Quarterly cash dividends were paid to stockholders in March, June, September, and December of 2017 and 2016, as detailed in the table above.  Going forward, we expect to continue to pay dividends each year in March, June, September, and December, with the amount and timing subject to the Board’s approval. In February 2018, our Board declared a dividend of $0.21 per share of common stock to be paid on March 29, 2018 for shareholders of record as of the close of business on March 14, 2018.

The payment of dividends is subject to the covenants of our Credit Agreement, and has certain impacts to our convertible debt (the 2016 Convertible Notes). See Note 5 to our Financial Statements for additional discussion of our long-term debt.


18


 

Stock Price Performance

The following graph compares the cumulative total stockholder return on our common stock, the Russell 2000 Index, and our Standard Industrial Classification (“SIC”) Code Index: Data Preparation and Processing Services during the indicated five-year period. The graph assumes that $100 was invested on December 31, 2012, in our common stock and in each of the two indexes, and that all dividends, if any, were reinvested.

 

 

 

As of December 31,

 

 

 

2012

 

 

2013

 

 

2014

 

 

2015

 

 

2016

 

 

2017

 

CSG Systems International, Inc.

 

$

100.00

 

 

$

164.62

 

 

$

143.67

 

 

$

210.79

 

 

$

288.56

 

 

$

266.39

 

Russell 2000 Index

 

 

100.00

 

 

 

138.82

 

 

 

145.62

 

 

 

139.19

 

 

 

168.85

 

 

 

193.58

 

Data Preparation and Processing Services

 

 

100.00

 

 

 

147.30

 

 

 

160.25

 

 

 

176.89

 

 

 

203.78

 

 

 

244.88

 

Equity Compensation Plan Information

The following table summarizes certain information about our equity compensation plans as of December 31, 2017:

 

Plan Category

 

Number of securities to be issued upon exercise of outstanding options, warrants, and rights

 

Weighted-average exercise price of outstanding options, warrants, and rights

 

 

Number of securities remaining available for future issuance

 

Equity compensation plans approved by security holders

 

 

$

 

 

 

2,702,005

 

Of the total number of securities remaining available for future issuance, 2,355,712 shares can be used for various types of stock-based awards, as specified in the equity compensation plan, with the remaining 346,293 shares to be used for our employee stock purchase plan. See Note 11 to our Financial Statements for additional discussion of our equity compensation plans.

19


 

Issuer Repurchases of Equity Securities

The following table presents information with respect to purchases of our common stock made during the fourth quarter of 2017 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.

 

Period

 

Total

Number of Shares

Purchased (1) (2)

 

 

Average

Price Paid

Per Share

 

 

Total Number of

Shares Purchased as

Part of Publicly

Announced Plans or

Programs (2)

 

 

Maximum Number

(or Approximate

Dollar Value) of

Shares that May

Yet Be Purchased

Under the Plan or

Programs (2)

 

October 1 - October 31

 

 

51,334

 

 

$

41.09

 

 

 

50,600

 

 

 

6,307,767

 

November 1 - November 30

 

 

54,730

 

 

 

44.23

 

 

 

39,100

 

 

 

6,268,667

 

December 1 - December 31

 

 

26,400

 

 

 

44.50

 

 

 

26,400

 

 

 

6,242,267

 

Total

 

 

132,464

 

 

$

43.07

 

 

 

116,100

 

 

 

 

 

 

(1)

The total number of shares purchased that are not part of the Stock Repurchase Program represents shares purchased and cancelled in connection with stock incentive plans.

 

(2)

See Note 10 to our Financial Statements for additional information regarding our share repurchases.

 

 


20


 

Item 6. Selected Financial Data

The following selected financial data have been derived from our audited financial statements. The selected financial data presented below should be read in conjunction with, and is qualified by reference to, our MD&A and our Financial Statements. The information below is not necessarily indicative of the results of future operations.

 

 

 

Year Ended December 31,

 

 

 

2017

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

 

 

(in thousands, except per share amounts)

 

Statements of Income Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues (1)

 

$

789,582

 

 

$

760,958

 

 

$

752,520

 

 

$

751,286

 

 

$

747,468

 

Operating income (1)

 

 

105,685

 

 

 

132,629

 

 

 

113,140

 

 

 

75,690

 

 

 

76,704

 

Net income

 

 

61,364

 

 

 

62,882

 

 

 

62,567

 

 

 

35,711

 

 

 

45,268

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average diluted shares outstanding

 

 

32,865

 

 

 

33,014

 

 

 

33,438

 

 

 

33,736

 

 

 

32,873

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted net income per common share

 

$

1.87

 

 

$

1.90

 

 

$

1.87

 

 

$

1.06

 

 

$

1.38

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividend declared per share (3)

 

$

0.79

 

 

$

0.74

 

 

$

0.70

 

 

$

0.62

 

 

$

0.45

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Key Capital Activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares repurchased under Stock Repurchase Program (4)

 

 

500

 

 

 

318

 

 

 

1,838

 

 

 

733

 

 

 

500

 

Cost of shares repurchased under Stock Repurchase Program (4)

 

$

20,548

 

 

$

11,565

 

 

$

56,959

 

 

$

19,106

 

 

$

10,129

 

Dividends declared (3)

 

 

26,823

 

 

 

23,753

 

 

 

22,852

 

 

 

21,327

 

 

 

15,214

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Data (at Period End):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash, cash equivalents and short-term investments (2)

 

$

261,360

 

 

$

276,498

 

 

$

240,936

 

 

$

201,800

 

 

$

210,837

 

Total assets (6)

 

 

904,534

 

 

 

891,879

 

 

 

862,731

 

 

 

839,367

 

 

 

848,705

 

Total debt (2)(6)

 

 

331,736

 

 

 

416,260

 

 

 

279,130

 

 

 

250,376

 

 

 

257,269

 

Total treasury stock (2)(4)(5)

 

 

814,732

 

 

 

826,002

 

 

 

814,437

 

 

 

757,478

 

 

 

738,372

 

Total stockholders' equity (4)

 

 

342,746

 

 

 

251,360

 

 

 

345,845

 

 

 

358,633

 

 

 

358,262

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

In September 2015, we sold our cyber-security business, marketed under the Invotas brand, to certain former management personnel, resulting in a gain on the sale of $3.7 million.  In February 2016, this business was acquired by a third-party.  Based on the terms of the agreement, we received additional consideration upon a liquidation event, as defined in the agreement, which resulted in an additional gain on the sale of $6.6 million. The impact of Invotas to our business prior to the divestiture date was not material.

On July 1, 2013, we sold a small print operation, and on December 31, 2013, we sold our marketing analytics business marketed under the Quaero brand.  As a result of these divestitures, 2014 revenue levels were approximately $13 million lower when compared to our 2013 revenues generated from these businesses. We sold these businesses for a total of approximately $6 million, and recorded a total loss on the dispositions of approximately $3 million.

(2)

In March 2016, we completed an offering of $230 million of 4.25% senior convertible notes due March 15, 2036.  The net proceeds of approximately $223 million were used to settle the outstanding 2010 Convertible Notes, due March 1, 2017.  During 2016, we repurchased approximately $115 million of the 2010 Convertible Notes for approximately $216 million, and recognized a loss on the repurchases of $8.7 million.  In March 2017, we settled our conversion obligation by paying cash of $34.8 million for the remaining par value of the notes and delivered 694,240 shares of our common shares from treasury stock to settle the $28.8 million value of the conversion obligation in excess of par value.    

In February 2015, we refinanced our Credit Agreement.  As a result, under the refinanced Credit Agreement, we: (i) extended the term of the agreement to February 2020; (ii) increased the amount of the revolving credit facility from $100 million to $200 million; and (iii) borrowed $150 million, resulting in a net increase of available cash of $30 million, after paying off the outstanding $120 million balance from the term loan under the previous Credit Agreement.

See Note 5 to our Financial Statements for additional discussion of our debt.

(3)

In June 2013, our Board approved the initiation of a quarterly cash dividend to be paid to our stockholders for the first time in our history.  Quarterly dividends are typically paid each year in March, June, September, and December with the amount and timing subject to the Board’s approval.  Because of the timing of when we initiated our dividend, 2013 only includes three quarterly dividends.

(4)

In March 2015, we entered into an accelerated share repurchase (“ASR”) Agreement with a counterparty to repurchase $50 million of our common stock.  Final share settlement occurred in December 2015, with total shares purchased under the ASR Agreement of 1.6 million.

(5)

In January 2017, Comcast exercised approximately 1.4 million vested stock warrants, which we net share settled under the provisions of the warrant agreement by delivering 649,221 of our common shares from treasury stock, which had a fair value of $31.5 million.  The carrying value of the shares of treasury stock delivered was $15.4 million.  See Note 10 to our Financial Statements for additional discussion of the stock warrants.

(6)

In 2016, we adopted Accounting Standards Update (“ASU”) 2015-03, Interest-Imputation of Interest (Subtopic 835-30) and ASU 2015-17, Income Taxes (Topic 740).  ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a reduction from the carrying amount of that debt liability, consistent with debt discounts.  ASU 2015-17 requires that all deferred tax liabilities and assets be classified as noncurrent.  We adopted both ASU’s on January 1, 2016, which resulted in a reclassification of our Balance Sheets for the periods presented.


21


 

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 above within Item 1A., “Risk Factors”. Item 1A. constitutes an integral part of this report, and readers are strongly encouraged to review this section closely in conjunction with MD&A.

MD&A Basis of Discussion - Impact of Divestiture

In September 2015, we sold our cyber-security business, marketed under the Invotas brand, to certain former management personnel, resulting in a gain on the sale of $3.7 million, which is included in restructuring and reorganization charges in our 2015 Income Statement.  The impact of Invotas to our business prior to the divestiture date was not material.  We retained a minority interest in the business such that the results of operations from the business are not included in our financial statements subsequent to the divestiture date.  

In February 2016, this business was acquired by a third-party.  Based on the terms of our agreement with former management personnel, we received additional consideration contingent upon a liquidation event, as defined in the agreement, resulting in an additional gain on the sale of $6.6 million, which reduced our 2016 restructuring and reorganization charges in our Income Statement.

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 after December 31, 2017. We currently expect our effective income tax rates going forward to be in the range of 26% to 28% percent. This represents an estimated improvement of 10 to 11 percentage points for 2018 had the new legislation not been enacted, which represents an estimated net income benefit for us of approximately $10 to $11 million for 2018. We plan to invest about one-fourth of this benefit back into our business, with this investment directed almost entirely towards our employees in the form of higher wages, fringe benefits, and training and development programs. At this time, we expect the remaining three-quarters of this benefit to fall to the bottom line in 2018, thereby, resulting in higher net income for the year had the Tax Reform Act not been enacted.

 

See Note 7 to our Financial Statements 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 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

The FASB has issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606).  In August 2015, the FASB issued ASU 2015-14 Revenue from Contracts with Customers (Topic 606):  Deferral of the Effective Date which deferred the effective date of ASU 2014-09 for one year. In December 2016, the FASB issued ASU 2016-20 Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers (collectively referred to as ASU 606). Collectively, ASU 606 is a single comprehensive model which supersedes nearly all existing revenue recognition guidance under U.S. GAAP.  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.  ASU 606 also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. 

 

22


 

We adopted this ASU 606 in January of 2018, utilizing the cumulative effect approach. 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.

 

Beginning in 2018, certain deferred contract costs that are currently included in our client contracts and other current and non-current assets on our Consolidated Balance Sheet will be reclassified and presented separately as a non-current client contract asset, net of related amortization. The adoption of this ASU also results in a reclassification of investments in client contracts on our Consolidated Statement of Cash Flows to operating activities from investing activities, which if applicable to 2017 would have decreased operating cash flows and increased investing cash flows by approximately $12 million.

Management Overview

Results of Operations. A summary of our results of operations for 2017 and 2016, and other key performance metrics are as follows (in thousands, except percentages and per share amounts):

 

 

 

Year Ended December 31,

 

 

 

2017

 

 

2016

 

Revenues

 

$

789,582

 

 

$

760,958

 

Operating Results:

 

 

 

 

 

 

 

 

Operating income

 

 

105,685

 

 

 

132,629

 

Operating income margin

 

 

13.4

%

 

 

17.4

%

Diluted EPS

 

$

1.87

 

 

$

1.90

 

Supplemental Data:

 

 

 

 

 

 

 

 

Restructuring and reorganization charges

 

$

8,796

 

 

$

416

 

Stock-based compensation (1)

 

 

20,782

 

 

 

22,795

 

Amortization of acquired intangible assets

 

 

6,864

 

 

 

8,489

 

Amortization of OID

 

 

2,790

 

 

 

4,866

 

Loss on repurchase of convertible notes

 

 

-

 

 

 

(8,651

)

 

 

(1)

Stock-based compensation included in the table above excludes amounts that have been recorded in restructuring and reorganization charges.

Revenues. Our revenues for 2017 were $789.6 million, a 4% increase when compared to $761.0 million for 2016. The increase can be primarily attributed to a 7% increase in our cloud and related solutions revenues.  The increase in our cloud and related solutions revenues for 2017 was driven largely by the conversion of new customer accounts onto ACP during the year, and increases in revenues from recurring managed services arrangements.  These increases more than offset the decline in our software and services revenues.

Operating Results. Operating income for 2017 was $105.7 million, or a 13.4% operating income margin percentage, compared to $132.6 million, or a 17.4% operating income margin percentage for 2016, with the decreases in operating income and operating income margin percentage reflective of the increase in planned investments that began late in 2016 and continued through 2017, aimed at generating future long-term growth in our business.  These increased expenditures were primarily within the following areas of our business: (i) our R&D efforts; (ii) our go-to-market programs; and (iii) operating environment for our cloud solutions (e.g., resiliency, security, and capacity).  

Diluted EPS. Diluted EPS for 2017 was $1.87 compared to $1.90 for 2016 with the decrease mainly attributed to the lower operating results, discussed above.  Additionally, 2016 EPS was negatively impacted by the loss on the repurchase of the 2010 Convertible Notes related to the refinancing of this instrument in early 2016.

Balance Sheet and Cash Flows. As of December 31, 2017, we had cash, cash equivalents, and short-term investments of $261.4 million, as compared to $276.5 million as of December 31, 2016. Cash flows from operating activities for 2017 were $127.2 million, compared to $84.2 million for 2016.  Cash flows from operations for 2016 were negatively impacted by year-end working capital timing fluctuations and a payment made at year end as part of the closure of several years of outstanding tax audits with the IRS.  See the Liquidity section below for further discussion of our cash flows.

23


 

Significant Client Relationships

Comcast. Comcast continues to be our largest client. For 2017 and 2016, revenues from Comcast were $219 million and $196 million, respectively, representing approximately 28% and 26% of our total revenues. This increase is driven primarily by the conversion of an additional four million and three million, respectively, Comcast customer accounts onto our cloud solutions in 2017 and 2016, from one of our competitor’s platforms as part of Comcast’s standardization initiatives for their residential business. Since July 2014, when we entered into an expanded and extended contract with Comcast, we have converted approximately eleven million residential Comcast customer accounts onto our cloud solutions. Our agreement with Comcast runs through June 30, 2019, with an option for Comcast to extend the agreement for two consecutive one-year terms by exercising the renewal options no later than January 1, 2019 for the first extension option, and January 1, 2020 for the second extension option.

A copy of the Comcast agreement and related amendments, with confidential information redacted, is included in the exhibits to our periodic filings with the SEC.

Charter. Charter is our second largest client. In May 2016, Charter, our then fourth largest client, received final approval from regulators and closed on its acquisition of Time Warner Cable, Inc (“Time Warner”), which was previously our third largest client.  Our revenues from the combined Charter/Time Warner entity for 2017 and 2016 were $171 million and $160 million, respectively, representing approximately 22% and 21% of our total revenues for both periods.  

In connection with Charter’s acquisition of Time Warner, the Time Warner Master Subscriber Management Agreement (the “Time Warner Agreement”) was assigned to Charter.  Our existing agreement with Charter ran through December 31, 2019.  The Time Warner Agreement, which covered the Time Warner customer accounts serviced by CSG and now owned by Charter, was originally set to expire on March 31, 2017, but was extended for additional one-month periods through July 31, 2017, while the parties continued to finalize terms relating to a new long-term Charter Consolidated Master Subscriber Management System Agreement that would provide our products and services covering both Time Warner and Charter customer accounts under one master agreement.  

 

On July 17, 2017, we entered into a new Consolidated CSG Master Subscriber Management System Agreement with Charter (the “New Agreement”) which supersedes all previous agreements with Charter and Time Warner.

 

The key terms and conditions of the New Agreement are as follows:

 

 

The New Agreement, effective August 1, 2017, extends our contractual relationship with Charter (an additional two years) and covers the Time Warner customer accounts serviced by CSG and now owned by Charter (an additional four-and-a-half years) through December 31, 2021.  In addition, Charter has the option to extend the New Agreement for an additional one-year term.  

 

 

Consistent with the previous agreements, the fees generated under the New Agreement will be based primarily on monthly per unit charges for our cloud and related solutions, and other various ancillary services. Certain of the per-unit fees include volume-based pricing tiers, and are subject to annual inflationary price escalators.  

 

 

The New Agreement includes incentives for Charter to convert additional customer accounts onto our ACP customer care and billing solution.  

 

 

The New Agreement includes minimum commitments for the number of Charter customer accounts to be serviced on ACP.  

 

 

The New Agreement contains certain rights and obligations of both parties, including the following key items: (i) the termination of the Agreement under certain conditions; (ii) various service level commitments; and (iii) remedies and limitation on liabilities associated with specified breaches of contractual obligations.

                

Under the New Agreement, we provided Charter with a pricing discount in-line with the extended contract term through December 31, 2021, and the roll out of additional products and services by Charter.  As a result, we anticipate our annual revenues from Charter under the New Agreement to be relatively consistent on a go forward basis.  

 

The anticipated revenue impact of the New Agreement in both the near and long term is only an estimate and may vary depending on the actual level of products and services consumed by Charter and a variety of factors.  We undertake no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

A copy of the New Agreement along with the original Charter and Time Warner agreements and related amendments, with confidential information redacted, are included in the exhibits to our periodic filings with the SEC.

24


 

DISH. DISH is our third largest client. For 2017 and 2016, revenues from DISH were $89 million and $102 million, respectively, representing approximately 11% and 13% of our total revenues, with the decrease in revenues driven mainly by the net loss of DISH customers utilizing their satellite services.

On August 11, 2017, we entered into an amendment to our current agreement with DISH Network Corporation (“DISH”) (the “Amended Agreement”).

The key terms and conditions of the Amended Agreement are as follows:

 

 

The Amended Agreement extends our contractual relationship with DISH for an additional four years, through December 31, 2021.  

 

 

Consistent with the previous agreements, the fees generated under the Amended Agreement will be based primarily on monthly per unit charges for our cloud and related solutions, and other various ancillary services. Certain of the per-unit fees are subject to annual inflationary price escalators.  

 

 

The Amended Agreement includes minimum commitments for the number of DISH customer accounts to be serviced on ACP.  

 

 

The Amended Agreement contains certain rights and obligations of both parties, including the following key items: (i) the termination of the Agreement under certain conditions; (ii) various service level commitments; and (iii) remedies and limitation on liabilities associated with specified breaches of contractual obligations.

 

Under the Amended Agreement, we provided DISH a small per-unit pricing discount in-line with the extended contract term through December 31, 2021, and the roll out of additional products and services by DISH.  As a result, our revenues from DISH under the New Agreement going forward are highly dependent on the number of customer accounts DISH maintains on our platform, and the level of additional products and services DISH may choose to purchase from us.

 

The anticipated revenue impact of the Amended Agreement in both the near and long term is only an estimate and may vary depending on the actual level of products and services consumed by DISH and a variety of other factors.  We undertake no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The DISH agreement and related amendments, with confidential information redacted, is included in the exhibits to our periodic filings with the SEC.

Stock-Based Compensation Expense

Stock-based compensation expense is included in the following captions in our Income Statement (in thousands):

 

  

 

2017

 

 

2016

 

 

2015

 

Cost of cloud and related solutions

 

$

3,573

 

 

$

3,958

 

 

$

2,589

 

Cost of software and services

 

 

895

 

 

 

1,348

 

 

 

2,563

 

Cost of maintenance

 

 

357

 

 

 

371

 

 

 

204

 

Research and development

 

 

3,103

 

 

 

3,339

 

 

 

3,206

 

Selling, general and administrative

 

 

12,854

 

 

 

13,779

 

 

 

12,809

 

Restructuring

 

 

267

 

 

 

(80

)

 

 

(241

)

Total stock-based compensation expense

 

$

21,049

 

 

$

22,715

 

 

$

21,130

 

See Notes 2 and 11 to our Financial Statements for additional discussion of our stock-based compensation expense.

25


 

Amortization of Acquired Intangible Assets

Amortization of acquired intangible assets is included in the following captions in our Income Statement (in thousands):

 

 

 

2017

 

 

2016

 

 

2015

 

Cost of cloud and related solutions

 

$

1,065

 

 

$

1,092

 

 

$

1,347

 

Cost of maintenance

 

 

5,799

 

 

 

7,397

 

 

 

10,636

 

Total amortization expense

 

$

6,864

 

 

$

8,489

 

 

$

11,983

 

  

See Note 4 to our Financial Statements for additional discussion of our amortization of acquired intangible assets.

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. These critical accounting policies were determined by considering our accounting policies that involve the most complex or subjective decisions or assessments. The most critical accounting policies identified relate to: (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 disclosed in the notes to our Financial Statements.

Revenue Recognition. The revenue recognition policy that involves the most complex or subjective decisions or assessments that may have a material impact on our business’ operations relates to the accounting for certain software license and services arrangements. For the 2017, 2016, and 2015, software and services revenues was approximately 8%, 10%, and 12%, respectively, of our total revenues.

The accounting for software license arrangements, especially when software is sold in a multiple-element arrangement, can be complex and may require considerable judgment. Key factors considered in accounting for software license and related services include the following criteria: (i) the identification of the separate elements of the arrangement; (ii) the determination of whether any undelivered elements are essential to the functionality of the delivered elements; (iii) the assessment of whether the software, if hosted, should be accounted for as a services arrangement and thus outside the scope of the software revenue recognition literature; (iv) the determination of vendor specific objective evidence (“VSOE”) of fair value for the undelivered element(s) of the arrangement; (v) the assessment of whether the software license fees are fixed or determinable; (vi) the determination as to whether the fees are considered collectible; and (vii) the assessment of whether services included in the arrangement represent significant production, customization or modification of the software. The evaluation of these factors, and the ultimate revenue recognition decision, requires significant judgments to be made by us. The judgments made in this area could have a significant effect on revenues recognized in any period by changing the amount and/or the timing of the revenue recognized. In addition, because software licenses typically have little or no direct, incremental costs related to the recognition of the revenue, these judgments could also have a significant effect on our results of operations.

The initial sale of our software products generally requires significant production, modification or customization and thus falls under the guidelines of contract accounting. In these software license arrangements, the software license and professional services elements of the arrangement fee are typically combined and subject to contract accounting using the percentage-of-completion (“POC”) method of accounting. Under the POC method of accounting, software license and professional services revenues are typically recognized as the professional services related to the software implementation project are performed. We are using hours performed on the project as the measure to determine the percentage of the work completed.

A portion of our professional services revenues does not include an element of software delivery (e.g., business consulting services, etc.), and thus, do not fall within the scope of specific authoritative accounting literature for software arrangements. In these cases, revenues from fixed-price, professional service contracts are recognized using a method consistent with the proportional performance method, which is relatively consistent with our POC methodology. Under a proportional performance model, revenue is recognized by allocating revenue between reporting periods based on relative service provided in each reporting period, and costs are generally recognized as incurred. We utilize an input-based approach (i.e., hours worked) for purposes of measuring performance on these types of contracts. Our input measure is considered a reasonable surrogate for an output measure. In instances when the work performed on fixed price agreements is of relatively short duration, or if we are unable to make reasonably dependable estimates at the outset of the arrangement, we use the completed contract method of accounting whereby revenue is recognized when the work is completed.

26


 

Our use of the POC and proportional performance methods of accounting on professional services engagements requires estimates of the total project revenues, total project costs and 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 the POC and proportional performance methods of accounting as we are exposed to various business risks in completing these engagements. The estimation process to support these methods of accounting 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 the POC and proportional performance methods of accounting, we track our performance on projects and reevaluate the appropriateness of our estimates as part of our monthly accounting cycle.

Revenues are recognized only if we determine that the collection of the fees included in an arrangement is considered probable (i.e., we expect the client to pay all amounts in full when invoiced). In making our determination of collectability for revenue recognition purposes, we consider a number of factors depending upon the specific aspects of an arrangement, which may include, but is not limited to, the following items: (i) an assessment of the client’s specific credit worthiness, evidenced by its current financial position and/or recent operating results, credit ratings, and/or a bankruptcy filing status (as applicable); (ii) the client’s current accounts receivable status and/or its historical payment patterns with us (as applicable); (iii) the economic condition of the industry in which the client conducts the majority of its business; and/or (iv) the economic conditions and/or political stability of the country or region in which the client is domiciled and/or conducts the majority of its business. The evaluation of these factors, and the ultimate determination of collectability, requires significant judgments to be made by us. The judgments made in this area could have a significant effect on revenues recognized in any period by changing the amount and/or the timing of the revenue recognized.

Impairment Assessments of Long-Lived Assets. Long-lived assets, which for us relates primarily to property and equipment, software, and client contracts, are required to be evaluated for possible impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. A long-lived asset (or group of long-lived assets) is impaired if estimated future undiscounted cash flows associated with that asset, without consideration of interest, are insufficient to recover the carrying amount of the long-lived asset. Once deemed impaired, even if by $1, the long-lived asset is written down to its fair value which could be considerably less than the carrying amount or future undiscounted cash flows. The determination of estimated future cash flows and, if required, the determination of the fair value of a long-lived asset, are by their nature, highly subjective judgments. Changes to one or more of the assumptions utilized in such an analysis could materially affect our impairment conclusions for long-lived assets.

Income Taxes. We are required to estimate our income tax liability in each jurisdiction in which we operate, which includes the U.S. (including both Federal and state income taxes) and numerous foreign countries.

Various judgments are required in evaluating our income tax positions and determining our provisions for income taxes (including the estimations noted above in conjunction with the adoption of the Tax Reform Act for 2017). During the ordinary course of our business, there are certain transactions and calculations for which the ultimate income tax determination may be uncertain. In addition, we may be subject to examination of our income tax returns by various tax authorities which could result in adverse outcomes. For these reasons, we establish a liability associated with unrecognized tax benefits based on estimates of whether additional taxes and interest may be due. We adjust this liability based upon changing facts and circumstances, such as the closing of a tax audit, the closing of a tax year upon the expiration of a statute of limitations, or the refinement of an estimate. Should any of the factors considered in determining the adequacy of this liability change significantly, an adjustment to the liability may be necessary. Because of the potential significance of these issues, such an adjustment could be material.

One of the more complex items within our income tax expense is the determination of our annual research and experimentation income tax credit (“R&D credit”).  We have incurred approximately $100 - $110 million annually in R&D expense over the last three years.  The calculation of the R&D tax credit involves the identification of qualifying projects, and then an estimation of the qualifying costs for such projects.  Because of the size, nature, and the number of projects worked on in any given year, the calculation can become complex and certain judgments are necessary in determining the amount of the R&D credits claimed.

Loss Contingencies. In the ordinary course of business, we are subject to claims (and potential claims) related to various items including but not limited to the following: (i) legal and regulatory matters; (ii) client and vendor contracts; (iii) product and service delivery matters; and (iv) labor matters. Accounting and disclosure requirements for loss contingencies requires us to assess the likelihood of any adverse judgments in or outcomes to these matters, as well as the potential ranges of probable losses. A determination of the amount of reserves for such contingencies, if any, for these contingencies is based on an analysis of the issues, often with the assistance of legal counsel. The evaluation of such issues, and our ultimate accounting and disclosure decisions, are by their nature, subject to various estimates and highly subjective judgments. Should any of the factors considered in determining the adequacy of any required reserves change significantly, an adjustment to the reserves may be necessary. Because of the potential significance of these issues, such an adjustment could be material.

27


 

Detailed Discussion of Results of Operations

Total Revenues. Total revenues for: (i) 2017 were $789.6 million, a 4% increase from $761.0 million for 2016; and (ii) 2016 were $761.0 million, a 1% increase from $752.5 million for 2015.

 

The 4% year-over-year increase in total revenues between 2017 and 2016 can be mainly attributed to the 7% increase in our cloud and related solutions revenues, driven largely by the conversion of new customer accounts onto ACP during the year (primarily from Comcast), and increases in revenues from recurring managed services arrangements, with these increases reduced by lower software and services revenues.  We continue to work towards converting more of our software and services arrangements into more long-term recurring revenue managed services engagements.

 

The 1% year-over-year increase in total revenues between 2016 and 2015 can be attributed to the 5% growth of our cloud and related solutions revenues, driven primarily from continued conversions of customer accounts onto ACP, and increases in revenues from recurring managed services arrangements.  These increases more than offset the decline in our software and services and maintenance revenues, and negative foreign currency movements of approximately $5 million.

 

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

 

 

Year Ended December 31,

 

 

 

2017

 

 

2016

 

 

2015

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Cloud and related solutions

 

$

651,010

 

 

$

606,936

 

 

$

577,410

 

Software and services

 

 

62,892

 

 

 

79,400

 

 

 

93,678

 

Maintenance

 

 

75,680

 

 

 

74,622

 

 

 

81,432

 

Total revenues

 

$

789,582

 

 

$

760,958

 

 

$

752,520

 

Cloud and Related Solutions Revenues. Cloud and related solutions revenues for: (i) 2017 increased 7% to $651.0 million, from $606.9 million for 2016; and (ii) 2016 increased 5% to $606.9 million, from $577.4 million for 2015.  These year-over-year increases in cloud and related solutions revenues can be mainly attributed to the conversion of customer accounts onto ACP and increases in revenues from recurring managed services arrangements.  During 2017, 2016, and 2015, Comcast added four million customer accounts, three million customer accounts (of which half were converted during the fourth quarter of 2016), and approximately two million customer accounts (which were all converted in during the second half of 2015) onto ACP, respectively.  Additionally, our recurring managed services revenues nearly doubled between 2016 and 2017 and grew by over 60% between 2015 and 2016.

Amortization of the investments in client contracts intangible asset (reflected as a reduction of cloud and related solutions revenues) for 2017, 2016, and 2015 was $7.4 million, $6.6 million, and $5.2 million, respectively.

Software and Services Revenues. Software and services revenues for: (i) 2017 decreased 21% to $62.9 million, from $79.4 million for 2016; and (ii) 2016 decreased 15% to $79.4 million, from $93.7 million for 2015.  These year-over-year decreases in software and services revenues can be primarily attributed to the continued low market demand for large transformational software and service deals and the shift of our focus towards more predictable recurring managed services revenue arrangements, which are included in our cloud and related solutions revenues.  

Maintenance Revenues. Maintenance revenues for: (i) 2017 increased 1% to $75.7 million, from $74.6 million for 2016; and (ii) 2016 decreased 8% to $74.6 million, from $81.4 million for 2015.  These variances are mainly attributed to the timing of maintenance renewals and related revenue recognition, and reflective of the lower software and services revenues, discussed above.

Total Operating Expenses. Our operating expenses for: (i) 2017 increased 9% to $683.9 million, from $628.3 million for 2016; and (ii) 2016 decreased 2% to $628.3 million, from $639.4 million for 2015.

 

The $55.6 million increase in total operating expenses between 2017 and 2016 can be primarily attributed to the increased planned investments aimed at generating future long-term growth in our business, higher cost of sales, reflective of the increase in cloud revenues, and an additional $8.4 million of restructuring and reorganization charges.

 

The $11.1 million decrease in total operating expenses between 2016 and 2015 is primarily due to favorable foreign currency movements of approximately $8 million, operational cost improvements, to include the divestiture of Invotas in September 2015, and lower restructuring and reorganization costs, which offset the increased cost of sales, reflective of our increased revenues.  

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

28


 

Cost of Cloud and Related Solutions (Exclusive of Depreciation). The cost of cloud and related solutions revenues consists principally of the following: (i) computing capacity and network communications costs; (ii) statement production costs (e.g., labor, paper, envelopes, equipment, equipment maintenance, etc.); (iii) client support organizations (e.g., our client support call center, account management, etc.); (iv) various product delivery and support organizations (e.g., managed services delivery, product management, product maintenance, etc.); (v) facilities and infrastructure costs related to the statement production and support organizations; and (vi) amortization of acquired intangibles. The costs related to new product development (including significant enhancements to existing products and services) are included in R&D expenses.

The cost of cloud and related solutions for: (i) 2017 increased 11% to $315.0 million, from $283.0 million for 2016; and (ii) 2016 increased 5% to $283.0 million, from $270.7 million for 2015.  Total cloud and related solutions cost of revenues as a percentage of our cloud and related solutions revenues for 2017, 2016, and 2015, were 48.4%, 46.6%, and 46.9%, respectively.

 

The year-over-year increase in cost of cloud and related solutions between 2017 and 2016 relate primarily to higher variable costs associated with the increase in revenues related to use of our ACP and related solutions, and growth in our managed services arrangements since last year.  

 

The year-over-year increase in cost of cloud and related solutions between 2016 and 2015 is reflective of the increases we experienced in cloud and related solutions revenues and are primarily related to increased ACP cloud-based computing costs and the reassignment of personnel and the related costs from other areas of the business to client directed and funded work.

Cost of Software and Services (Exclusive of Depreciation). The cost of software and services revenues consists principally of the following: (i) professional services organization; (ii) various product support organizations (e.g., delivery, etc.); (iii) facilities and infrastructure costs related to these organizations; and (iv) third-party software costs and/or royalties related to certain software products. The costs related to new product development (including significant enhancements to existing products and services) are included in R&D expenses.

The cost of software and services for: (i) 2017 decreased 21% to $39.0 million, from $49.2 million for 2016; and (ii) 2016 decreased 28% to $49.2 million, from $68.6 million for 2015.  

 

The year-over-year decrease in cost of software and services between 2017 and 2016 is reflective of the decreases in revenues, which resulted in the reassignment of personnel and the related costs, previously allocated to professional services projects, to other areas of the business.  

 

The year-over-year decrease in cost of software and services between 2016 and 2015 is mainly due to targeted efficiencies and cost improvements within our professional services practice, estimated costs overruns recorded in the first quarter of 2015 related to a large software and services implementation project, discussed below, and foreign currency movements.  

Total cost of software and services as a percentage of our software and services revenues for 2017, 2016, and 2015, were 62.0%, 62.0%, and 73.2%, respectively, with the level and variability of these percentages reflective of the negative impact of a large implementation project.  In the first quarter of 2015, we incurred a loss of approximately $5 million on a large software and services implementation project (substantially completed in the third quarter of 2016) due to estimated cost overruns.

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 consists principally of the following: (i) client support organizations (e.g., our client support call center, account management, etc.); (ii) various product support organizations (e.g., product maintenance, product management, etc.); (iii) facilities and infrastructure costs related to these organizations; and (iv) amortization of acquired intangibles.

The cost of maintenance for: (i) 2017 decreased 5% to $40.8 million, from $43.0 million for 2016; and (ii) 2016 increased 6% to $43.0 million, from $40.4 million for 2015.  

 

The decrease in cost of maintenance between 2017 and 2016 can be mainly attributed to lower amortization expense for certain technology assets.

29


 

 

The increase in cost of maintenance between 2016 and 2015 can be primarily attributed to the reassignment of personnel and the related costs to maintenance projects from other projects, and an increase in third party maintenance costs.

Total cost of maintenance as a percentage of our maintenance revenues for 2017, 2016, and 2015 were 53.9%, 57.6%, and 49.6%, respectively.

R&D Expense (Exclusive of Depreciation). R&D expense for: (i) 2017 increased 15% to $113.2 million, from $98.7 million for 2016; and (ii) 2016 decreased 3% to $98.7 million, from $102.0 million for 2015.

 

The increase in R&D expense between 2017 and 2016 is reflective of our increased level of investment in 2017 aimed at generating long-term growth of our business (mainly around our Ascendon platform).

 

The decrease in R&D expense between 2016 and 2015 is primarily due to the reassignment of personnel and the related costs previously allocated to development projects to other area of the business.

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).

As a percentage of total revenues, R&D expense for 2017, 2016, and 2015 was 14.3%, 13.0%, and 13.5%, respectively. We anticipate the level of R&D investment in the near-term to be relatively consistent with that of the current year, reflective of our continued heightened level of planned investment.

Selling, General and Administrative Expense (Exclusive of Depreciation) (“SG&A”). SG&A expense for: (i) 2017 increased 9% to $153.7 million, from $140.5 million for 2016; and (ii) 2016 was $140.5 million, relatively consistent when compared to $139.8 million for 2015.

 

The increase in SG&A expense between 2017 and 2016 reflect an increased investment in our sales and marketing activities (principally, towards greater global sales coverage and Ascendon sales capabilities) and system security.

 

SG&A expense increased $0.7 million between 2016 and 2015, due primarily to higher incentive compensation for 2016, which was offset by favorable foreign currency movements.

As a percentage of total revenues, SG&A expense for 2017, 2016, and 2015 was 19.5%, 18.5%, and 18.6%, respectively.

Depreciation Expense. 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 expense for: (i) 2017 was $13.4 million, a 2% decrease from $13.6 million for 2016; and (ii) 2016 was $13.6 million, an 8% decrease from $14.8 million for  2015.  These decreases in depreciation expense are reflective of the reduced level of capital expenditures made over the past few years.  During 2017, our capital expenditures returned to a more normal investment level of approximately $29 million, and going forward, we expect our capital expenditures to be at or above this more normalized investment level.

Restructuring and Reorganization Charges. In 2017, 2016, and 2015, we implemented various cost reduction and efficiency initiatives that resulted in restructuring and reorganization charges of $8.8 million, $0.4 million, and $3.1 million, respectively. These initiatives included: (i) reducing and reorganizing our workforce to further align it around our long-term growth initiatives; (ii) the abandonment of space at some of our facility locations; (iii) the impairment of a long-term receivable related to the disposition of a business in 2013; and (iv) the divestiture of our Invotas cyber security business. We completed these initiatives in order to better align and allocate our resources around our long-term growth initiatives.

See Note 6  to our Financial Statements for additional information regarding these initiatives.

30


 

Operating Income. Operating income and operating income margin for: (i) 2017 was $105.7 million, or 13.4% of total revenues, compared to $132.6 million, or 17.4% of total revenues for 2016; and (ii) 2016 was $132.6 million, or 17.4% of total revenues, compared to $113.1 million, or 15.0% of total revenues for 2015.

 

The decreases in operating income and operating income margin percentage between 2017 and 2016 are reflective of the increase in planned investments aimed at generating future long-term growth in our business, and to a lesser degree, due to the increase in restructuring and reorganization charges.

 

The increases in operating income and operating income margin between 2016 and 2015 can be mainly attributed to the overall reduction in operating expenses, as discussed above, and to a lesser degree, the scale benefits from adding more customer accounts to our cloud solutions and higher revenues.

Going forward, we expect our operating income and operating margin percentage to trend slightly downward from our 2017 full year level, as a result of our decision to invest some of the benefits from the Tax Reform Act back into our operations for 2018, as noted above.

Interest Expense and Amortization of Original Issue Discount (“OID”). Our interest expense relates primarily to our 2010 and 2016 Convertible Notes and our Credit Agreement. See Note 5 to our Financial Statements for additional discussion of our long-term debt, to include the non-cash interest expense related to the amortization of the convertible debt OID.

Interest expense for: (i) 2017 increased 3% to $16.8 million, from $16.3 million for 2016; and (ii) 2016 increased 48% to $16.3 million, from $11.0 million for 2015.

 

The increase in interest expense between 2017 and 2016 is primarily due to an increase in interest rates between periods.

 

The increase in interest expense between 2016 and 2015 is mainly due to the interest on the 2016 Convertible Notes, which were issued in March 2016, offset by the decrease in interest on the 2010 Convertible Notes due to repurchases throughout 2016.

Loss on Repurchase of Convertible Notes.  During 2016, we repurchased $115.3 million aggregated principal amount of the 2010 Convertible Notes for an aggregated purchase price of $215.7 million, and recognized a loss on the repurchases of $8.7 million.  

Income Tax Provision. Our effective income tax rates for 2017, 2016, and 2015 were as follows:

 

2017 (1)

 

 

2016

 

 

2015 (2)

 

 

30

%

 

 

37

%

 

 

35

%

 

(1)

Our 2017 effective income tax rate reflects the following items:

 

As a result of Comcast’s exercise of 1.4 million vested stock warrants in January 2017 (see Note 10 to our Financial Statements), we received an additional $5 million income tax benefit when exercised due to the stock warrants appreciating in value since their vesting.  

 

As discussed in Note 2, we adopted ASU 2016-09, Compensation – Stock Compensation (Topic 718) in the first quarter of 2017.  This ASU required a change in the recognition of excess tax benefits and tax deficiencies, related to share-based payment transactions, which were recorded in equity, and now are recorded discrete to the quarter incurred as a component of income tax expense in the income statement.  Under guidance of this ASU, we recognized an income tax benefit of approximately $3 million for 2017.  

 

We recorded an income tax benefit of approximately $2 million from the remeasurement of U.S.-based net deferred tax liabilities as required under the Tax Reform Act, as noted above (see Note 7 to our Financial Statements).

 

(2)

Our 2015 effective tax rate was positively impacted by improved earnings in our non-U.S. operations.

 

Liquidity

Cash and Liquidity. As of December 31, 2017, our principal sources of liquidity included cash, cash equivalents, and short-term investments of $261.4 million, compared to $276.5 million as of December 31, 2016. We generally invest our excess cash balances in low-risk, short-term investments to limit our exposure to market and credit risks.

As part of our 2015 Agreement, we have a $200 million senior secured revolving loan facility (“Revolver”) with a syndicate of financial institutions that expires in February 2020.  As of December 31, 2017, there were no borrowings outstanding on the Revolver.

31


 

The Credit Agreement contains customary affirmative covenants and financial covenants. As of December 31, 2017, and the date of this filing, we believe that we are in compliance with the provisions of the 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):

 

 

 

December 31,

 

 

December 31,

 

 

 

2017

 

 

2016

 

Americas (principally the U.S.)

 

$

196,053

 

 

$

220,269

 

Europe, Middle East and Africa

 

 

48,030

 

 

 

46,941

 

Asia Pacific

 

 

17,277

 

 

 

9,288

 

Total cash, equivalents and short-term investments

 

$

261,360

 

 

$

276,498

 

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 and potential negative economic consequences. As of December 31, 2017, we had $4.2 million of cash restricted as to use to collateralize outstanding letters of credit.

Cash Flows From Operating Activities. We calculate our cash flows from operating activities beginning with net income, adding back the impact of non-cash items or non-operating activity (e.g., depreciation, amortization, amortization of OID, impairments, deferred income taxes, stock-based compensation, etc.), and then factoring in the impact of changes in operating assets and liabilities.

Our primary source of cash is from our operating activities. Our current business model consists of a significant amount of recurring revenue sources related to our long-term cloud-based and managed services arrangements (mostly billed monthly), and software maintenance agreements (billed monthly, quarterly, or annually). This recurring revenue base provides us with a reliable and predictable source of cash. In addition, software license fees and professional services revenues are sources of cash, but the payment streams for these items are less predictable.

The primary use of our cash is to fund our operating activities. Over half of our total operating costs relate to labor costs (both employees and contracted labor) for the following: (i) compensation; (ii) related fringe benefits; and (iii) reimbursements for travel and entertainment expenses. The other primary cash requirements for our operating expenses consist of: (i) computing capacity and related services and communication lines for our outsourced cloud-based business; (ii) paper, envelopes, and related supplies for our statement processing solutions; (iii) hardware and software; and (iv) rent and related facility costs. These items are purchased under a variety of both short-term and long-term contractual commitments. A summary of our material contractual obligations is provided below.

32


 

Our 2017 and 2016 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):

 

 

 

 

 

 

 

 

 

 

 

Net Cash

 

 

 

 

 

 

 

Changes in

 

 

Provided by

 

 

 

 

 

 

 

Operating

 

 

Operating

 

 

 

 

 

 

 

Assets and

 

 

Activities –

 

 

 

Operations

 

 

Liabilities

 

 

Totals

 

Cash Flows from Operating Activities:

 

 

 

 

 

 

 

 

 

 

 

 

2017:

 

 

 

 

 

 

 

 

 

 

 

 

March 31 (1)

 

$

43,495

 

 

$

(13,531

)

 

$

29,964

 

June 30

 

 

26,364

 

 

 

8,160

 

 

 

34,524

 

September 30

 

 

30,536

 

 

 

7,798

 

 

 

38,334

 

December 31 (3)

 

 

37,752

 

 

 

(13,379

)

 

 

24,373

 

Total

 

$

138,147

 

 

$

(10,952

)

 

$

127,195

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2016:

 

 

 

 

 

 

 

 

 

 

 

 

March 31 (1)(2)

 

$

36,755

 

 

$

(26,081

)

 

$

10,674

 

June 30

 

 

28,880

 

 

 

11,211

 

 

 

40,091

 

September 30 (3)

 

 

31,309

 

 

 

(22,568

)

 

 

8,741

 

December 31 (4)

 

 

29,178

 

 

 

(4,498

)

 

 

24,680

 

Total

 

$

126,122

 

 

$

(41,936

)

 

$

84,186

 

 

 

(1)

Cash flows from operating activities for the first quarter of 2017 and 2016 reflect the negative impacts of the payment of the 2016 and 2015 year-end accrued employee incentive compensation in the first quarter subsequent to the year-end accrual for those items.  

 

(2)

Cash flows from operating activities for the first quarter of 2016 were negatively impacted by a prospective change in the timing of payment terms for a key vendor related to postage.  

 

(3)

For the third quarter of 2016 and fourth quarter of 2017, cash flows from operating activities were negatively impacted by the increase in the accounts receivable balance primarily related to the timing around certain recurring client payments that were delayed at quarter-end.

 

(4)

Cash flows from operating activities for the fourth quarter of 2016 were negatively impacted by year-end working capital timing fluctuations, and a payment made at year-end as part of the closure of several years of outstanding tax audits with the IRS.

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.  The quarterly and annual variations in our net cash provided by operating activities are related mostly 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 2017 and 2016 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 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.

 

33


 

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):

 

Quarter Ended

 

Gross

 

 

Allowance

 

 

Net Billed

 

 

DBOs

 

2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31

 

$

198,135

 

 

$

(2,824

)

 

$

195,311

 

 

 

70

 

June 30

 

 

200,192

 

 

 

(2,706

)

 

 

197,486

 

 

 

65

 

September 30

 

 

204,293

 

 

 

(2,456

)

 

 

201,837

 

 

 

72

 

December 31

 

 

223,680

 

 

 

(4,149

)

 

 

219,531

 

 

 

70

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31

 

$

185,297

 

 

$

(3,647

)

 

$

181,650

 

 

 

61

 

June 30

 

 

182,640

 

 

 

(3,726

)

 

 

178,914

 

 

 

63

 

September 30

 

 

204,516