CSG SYSTEMS INTERNATIONAL INC - Quarter Report: 2014 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2014

OR

For the transition period from                      to                      

Commission file number 0-27512

CSG SYSTEMS INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

9555 Maroon Circle

Englewood, Colorado 80112

(Address of principal executive offices, including zip code)

(303) 200-2000

(Registrant’s telephone number, including area code)

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

YES   x           NO   ¨

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

YES   x           NO   ¨

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.

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

YES  ¨            NO   x

Shares of common stock outstanding at August 1, 2014: 34,686,310

CSG SYSTEMS INTERNATIONAL, INC.

FORM 10-Q for the Quarter Ended June 30, 2014

INDEX

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CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS - UNAUDITED

(in thousands, except per share amounts)

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

4

CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED

(in thousands, except per share amounts)

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

5

CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - UNAUDITED

(in thousands)

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

6

CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

(in thousands)

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

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CSG SYSTEMS INTERNATIONAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. GENERAL

We have prepared the accompanying unaudited condensed consolidated financial statements as of June 30, 2014 and December 31, 2013, and for the second quarters and six months ended June 30, 2014 and 2013, in accordance with accounting principles generally accepted in the United States of America (“U.S.”) (“GAAP”) for interim financial information, and pursuant to the instructions to Form 10-Q and the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of our management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of our financial position and operating results have been included. The unaudited Condensed Consolidated Financial Statements (the “Financial Statements”) should be read in conjunction with the Consolidated Financial Statements and notes thereto, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), contained in our Annual Report on Form 10-K for the year ended December 31, 2013 (our “2013 10-K”), filed with the SEC. The results of operations for the quarter and six months ended June 30, 2014 are not necessarily indicative of the expected results for the entire year ending December 31, 2014.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates in Preparation of Financial Statements. The preparation of the accompanying Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our Financial Statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Reclassifications. Maintenance revenues, as well as the cost of maintenance revenues, previously included in software, maintenance and service revenues and software, maintenance and services costs of revenues, respectively, have been presented separately in our Condensed Consolidated Statements of Income (“Income Statements” or “Income Statement”) for the quarter and six months ended June 30, 2013. In addition, certain other 2013 amounts have been reclassified to conform to the 2014 presentation.

Cash and Cash Equivalents. We consider all highly liquid investments with original maturities of three months or less at the date of the purchase to be cash equivalents. As of June 30, 2014 and December 31, 2013, our cash equivalents consist primarily of institutional money market funds, commercial paper, and time deposits held at major banks.

As of June 30, 2014 and December 31, 2013, we had $4.9 million and $4.5 million, respectively, of restricted cash that serves to collateralize outstanding letters of credit. This restricted cash is included in cash and cash equivalents in our Condensed Consolidated Balance Sheets (“Balance Sheets” or “Balance Sheet”).

Short-term Investments and Other Financial Instruments. Our financial instruments as of June 30, 2014 and December 31, 2013 include cash and cash equivalents, short-term investments, accounts receivable, accounts payable, an interest rate swap contract, and debt. Because of their short maturities, the carrying amounts of cash equivalents, accounts receivable, and accounts payable approximate their fair value.

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

Primarily all short-term investments held by us as of June 30, 2014 and December 31, 2013 have contractual maturities of less than two years from the time of acquisition. Our short-term investments as of June 30, 2014 and December 31, 2013 consisted almost entirely of fixed income securities. Proceeds from the sale/maturity of short-term investments for the six months ended June 30, 2014 and 2013 were $109.1 million and $41.4 million, respectively.

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

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

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

The fair value for our Credit Agreement was estimated using a discounted cash flow methodology, while the fair value for our convertible debt was estimated based upon quoted market prices or recent sales activity, both of which are considered Level 2 inputs.

Accounting Pronouncement Issued But Not Yet Effective. In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606).  This ASU 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.  The ASU 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. The updated accounting guidance is effective for annual and interim reporting periods in fiscal years beginning after December 15, 2016.  Early adoption is not permitted.  An entity may choose to adopt this ASU either retrospectively or through a cumulative effect adjustment as of the start of the first period for which it applies the standard.  We are currently in the process of evaluating the impact that this new guidance will have on our consolidated financial statements and our method of adoption.

3. STOCKHOLDERS’ EQUITY AND EQUITY COMPENSATION PLANS

Stock Repurchase Program. We currently have a stock repurchase program, approved by our Board of Directors (the “Board”), authorizing us to repurchase our common stock from time-to-time as market and business conditions warrant (the “Stock Repurchase Program”). We did not repurchase any shares under our Stock Repurchase Program during the six months ended June 30, 2014. During the six months ended June 30, 2013, we repurchased 0.5 million shares of our common stock for $10.0 million (weighted-average price of $20.21 per share). As of June 30, 2014, the total remaining number of shares available for repurchase under the Stock Repurchase Program totaled 2.1 million shares.

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Stock Repurchases for Tax Withholdings. In addition to the above mentioned stock repurchases, during the six months ended June 30, 2014 and 2013, we repurchased and then cancelled 0.2 million shares of common stock for $6.6 million and 0.2 million shares of common stock for $4.9 million, respectively, in connection with minimum tax withholding requirements resulting from the vesting of restricted common stock under our stock incentive plans.

Dividends.  In June 2013, the Board approved the initiation of a quarterly cash dividend to be paid to our stockholders.  During the second quarter of 2014, the Board approved a quarterly cash dividend of $0.1575 per share of common stock, totaling $5.4 million. During the second quarter of 2013, the Board approved a quarterly cash dividend of $0.15 per share of common stock, totaling $5.1 million. Dividends for the six months ended June 30, 2014 and 2013, totaled $10.5 million and $5.1 million, respectively.         

Stock Incentive Plan.  In May 2014, our stockholders approved an increase of 2.9 million shares authorized for issuance under the 2005 Stock Incentive Plan, from 15.8 million shares to 18.7 million shares.  

Stock-Based Awards. A summary of our unvested restricted common stock activity during the second quarter and six months ended June 30, 2014 is as follows (shares in thousands):

Included in the awards granted during the six months ended June 30, 2014, are performance-based awards for 0.1 million restricted common stock shares issued to members of executive management, which vest in equal installments over three years upon meeting either pre-established financial performance objectives or pre-established stock price objectives. The performance-based awards become fully vested upon a change in control, as defined, and the subsequent involuntary termination of employment.

All other restricted common stock shares granted during the quarter and six months ended June 30, 2014 are time-based awards, which vest annually over four years with no restrictions other than the passage of time. Certain shares of the restricted common stock become fully vested upon a change in control, as defined, and the subsequent involuntary termination of employment.

We recorded stock-based compensation expense for the second quarters of 2014 and 2013 of $3.9 million and $3.9 million, respectively, and for the six months ended June 30, 2014 and 2013 of $7.7 million $7.5 million, respectively.

4. EARNINGS PER COMMON SHARE

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

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

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There were no potentially dilutive common shares related to stock options and unvested shares of restricted common stock for the second quarters of 2014 and 2013 and six months ended June 30, 2014 and 2013 excluded from the computation of diluted EPS related to common shares.

The 2010 Convertible Notes have a dilutive effect only in those quarterly periods in which our average stock price exceeds the current effective conversion price (see Note 5).

5. DEBT

Our long-term debt, as of June 30, 2014 and December 31, 2013, was as follows (in thousands):

2012 Credit Agreement. During the six months ended June 30, 2014, we made $7.5 million of principal repayments.

As of June 30, 2014, we were in compliance with the financial ratios and other covenants related to the 2012 Credit Agreement and had no borrowings outstanding on our revolving loan facility and had the entire $100 million available to us.

2010 Convertible Notes.  Upon conversion of the 2010 Convertible Notes, we will settle our conversion obligation as follows: (i) we will pay cash for 100% of the par value of the 2010 Convertible Notes that are converted; and (ii) to the extent the value of our conversion obligation exceeds the par value, we will satisfy the remaining conversion obligation in our common stock, cash or any combination of our common stock and cash.

As the result of us declaring a cash dividend in June 2014 (see Note 3), the previous conversion rate for the 2010 Convertible Notes of 41.8811 shares of our common stock for each $1,000 in principal amount of the 2010 Convertible Notes (equivalent to a conversion price of $23.88 per share of our common stock) has been adjusted to 42.1363 shares of our common stock for each $1,000 in principal amount of the 2010 Convertible Notes (equivalent to a conversion price of $23.73 per share of our common stock).

Refer to Note 6 in our 2013 10-K for disclosure of the 2010 Convertible Notes’ three contingent conversion features. As a result of the cash dividend declaration in June 2014, prior to September 1, 2016, holders of the 2010 Convertible Notes can convert their securities at any time the price of our common stock trades over $30.85 per share, or 130% of the $23.73 conversion price (previously $31.04 per share, or 130% of the $23.88 conversion price) for a specified period of time.

As of June 30, 2014, none of the contingent conversion features have been achieved, and thus, the 2010 Convertible Notes are not convertible by the holders.

6. LONG-LIVED ASSETS

Goodwill. The changes in the carrying amount of goodwill for the six months ended June 30, 2014, were as follows (in thousands):

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Other Intangible Assets. Our intangible assets subject to ongoing amortization consist primarily of client contracts and software. As of June 30, 2014 and December 31, 2013, the carrying values of these assets were as follows (in thousands):

The total amortization expense related to intangible assets for the second quarters of 2014 and 2013 were $7.7 million and $8.4 million, respectively, and for the six months ended June 30, 2014 and 2013 were $15.7 million and $17.5 million, respectively. Based on the June 30, 2014 net carrying value of our intangible assets, the estimated total amortization expense for each of the five succeeding fiscal years ending December 31 are: 2014 – $30.4 million; 2015 – $22.3 million; 2016 – $16.1 million; 2017 – $12.5 million; and 2018 – $9.3 million.

7. COMMITMENTS, GUARANTEES AND CONTINGENCIES

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

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

Claims for Company Non-performance. Our arrangements with our clients typically cap our liability for breach to a specified amount of the direct damages incurred by the client resulting from the breach. From time-to-time, these arrangements may also include provisions for possible liquidated damages or other financial remedies for our non-performance, or in the case of certain of our outsourced customer care and billing solutions, provisions for damages related to service level performance requirements. The service level performance requirements typically relate to system availability and timeliness of service delivery. As of June 30, 2014, we believe we have adequate reserves, based on our historical experience, to cover any reasonably anticipated exposure as a result of our nonperformance for any past or current arrangements with our clients.

Indemnifications Related to Officers and the Board of Directors. We have agreed to indemnify members of our Board and certain of our officers if they are named or threatened to be named as a party to any proceeding by reason of the fact that they acted in such capacity. We maintain directors’ and officers’ (D&O) insurance coverage to protect against such losses. We have not historically incurred any losses related to these types of indemnifications, and are not aware of any pending or threatened actions or claims against any officer or member of our Board. As a result, we have not recorded any liabilities related to such indemnifications as of June 30, 2014. In addition, as a result of the insurance policy coverage, we believe these indemnification agreements are not significant to our results of operations.

Favorable Settlement of Claims.  In March 2014, we executed a settlement agreement ending litigation we asserted against a third party for patent infringement and misappropriation of trade secrets.  In exchange for the release from the lawsuit initiated, we will receive a total of $6 million, with a portion paid in 2014 and the remainder over the next three years.  We have recorded a total $3.9 million (net of a time value discount and legal costs incurred) as a reduction of selling, general and administrative (“SG&A”) expenses during the six months ended June 30, 2014.

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

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8. SUBSEQUENT EVENTS

Employee Compensation Arrangement.  In 2009, we entered into an incentive arrangement with certain employees to develop and then grow our Content Direct solution (the “Arrangement”).  The Arrangement included certain liquidation options for the employees in the event of a change of control of the Content Direct solution.  Because of the contingent nature of the Arrangement (i.e., payable only upon the occurrence of a change of control related to the Content Direct solution), we have not recognized any amounts in our financial statements related to this matter to date.   In July 2014, in conjunction with an organizational restructuring of our Content Direct solution to facilitate its integration with our other offerings, we terminated the Arrangement in exchange for a one-time cash payment of $8 million, which will be reflected as a restructuring charge in the third quarter of 2014.

Comcast Agreement.  On July 25, 2014, we entered into an amendment to our current agreement with Comcast Corporation (“Comcast”) (the “Amended Agreement”).  The Amended Agreement provides the framework for Comcast to consolidate its residential customer accounts onto our Advanced Convergent Platform (“ACP”) customer care and billing solution.  Key changes from the current agreement included in the Amended Agreement, and possible impacts to our business, are as follows:

Term Extension

Migration of Comcast Residential Customer Accounts

Issuance of Warrants

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

The information contained in this MD&A should be read in conjunction with the Financial Statements and Notes thereto included in this Form 10-Q and the audited consolidated financial statements and notes thereto in our 2013 10-K.

Forward-Looking Statements

This report contains a number of forward-looking statements relative to our future plans and our expectations concerning our business and the industries we serve.  These forward-looking statements are based on assumptions about a number of important factors, and involve risks and uncertainties that could cause actual results to differ materially from estimates contained in the forward-looking statements.  Some of the risks that are foreseen by management are outlined within Part I Item 1A. Risk Factors (“Risk Factors”) of our 2013 10-K.  Readers are strongly encouraged to review that section closely in conjunction with MD&A.

Company Overview

We are one of the world’s largest and most established business support solutions providers primarily serving the communications industry.  Our proven approach and solutions are based on our broad and deep experience in serving clients in the communications industry as their businesses have evolved from a single product offering to a highly complex, highly competitive, multi-product service offering.  Our approach has centered on using the best technology for the various functions required to provide world-class solutions.

Our solutions help service providers streamline and scale operations, introduce and adapt products and services to meet customer demands, and address the challenges and opportunities brought about by change.  Our broad suite of solutions helps our clients improve their business operations by creating more compelling product offerings and an enhanced customer experience through more relevant and targeted interactions, while at the same time, more efficiently managing the service provider’s cost structure.  Over the years, we have focused our research and development (“R&D”) and acquisition investments on expanding our solution set to address the ever expanding needs of communications service providers to provide a differentiated, real-time, and personal experience for their consumers.  This extensive suite of solutions includes revenue management, content management and monetization, customer interaction management, and business intelligence.  

We generate approximately 65% of our revenues from the North American cable and satellite markets, approximately 25% of our revenues from wireline and wireless communication providers, and the remainder from a variety of other verticals, such as financial services, logistics, and transportation.  Additionally, during the first half of 2014, we generated approximately 86% of our revenues from the Americas region, approximately 10% of our revenues from the Europe, Middle East and Africa region, and approximately 4% of our revenues from the Asia Pacific region.

We are a S&P Small Cap 600 company.

Management Overview of Quarterly Results

Second Quarter Highlights.  A summary of our results of operations for the second quarter of 2014, when compared to the second quarter of 2013, is as follows (in thousands, except per share amounts and percentages):  

Revenues.  Our revenues for the second quarter of 2014 were $184.6 million, a decrease of 1% when compared to $186.1 million for the same period in 2013.  The decrease in revenues can be attributed to the two business divestitures completed in the second half of

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2013 (discussed in our 2013 Form 10-K) which resulted in approximately $5 million of divested revenues for the second quarter, offset by a strong quarter of processing revenues in 2014, driven in large part by continued growth in several of our ancillary products and services.

Operating Results.  Operating income for the second quarter of 2014 was $21.8 million, or an 11.8% operating income margin percentage, relatively consistent when compared to $21.7 million, or an 11.6% operating income margin percentage, for the second quarter of 2013.  

Diluted EPS.  Diluted EPS for the second quarter of 2014 was $0.28 compared to $0.37 for the second quarter of 2013.  The second quarter of 2014 diluted EPS was negatively impacted by a higher effective income tax rate (see more detailed discussions in the Results of Operations section below) which negatively impacted diluted EPS by $0.06 per share.  

Cash and Cash Flows.  As of June 30, 2014, we had cash, cash equivalents and short-term investments of $189.6 million, as compared to $183.0 million as of March 31, 2014, and $210.8 million as of December 31, 2013.  Our cash flows from operating activities for the second quarter of 2014 were $24.8 million.  See the Liquidity section below for further discussion of our cash flows.

Significant Client Relationships

Client Concentration.  A large percentage of our historical revenues have been generated from our three largest clients, which are Comcast Corporation (“Comcast”), DISH Network Corporation (“DISH”), and Time Warner Cable, Inc. (“Time Warner”).  Revenues from these clients represented the following percentages of our total revenues for the indicated periods:

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

See our 2013 10-K for additional discussion of our business relationships and contractual terms with the above mentioned significant clients.

Comcast.  On July 25, 2014, we entered into an amendment to our Master Subscriber Management System Agreement with Comcast (the “Amended Agreement”).  The Amended Agreement provides the framework for Comcast to consolidate its residential customer accounts onto our Advanced Convergent Platform (“ACP”) customer care and billing solution.  Key changes included in the Amended Agreement, and possible impacts to our business, are as follows:

Term Extension

Migration of Comcast Residential Customer Accounts

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Issuance of Warrants

A copy of the Amended Agreement, along with the Warrant Agreement, with confidential information redacted, will be filed as an exhibit to our Form 10-Q for the quarter ended September 30, 2014.

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

Critical Accounting Policies

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

We have identified the most critical accounting policies that affect our financial position and the results of our operations.  Those critical accounting policies were determined by considering the accounting policies that involve the most complex or subjective decisions or assessments.  The most critical accounting policies identified relate to: (i) revenue recognition; (ii) allowance for doubtful accounts receivable; (iii) impairment assessments of goodwill and other long-lived assets; (iv) income taxes; (v) business combinations and asset purchases; and (vi) loss contingencies.  These critical accounting policies, as well as our other significant accounting policies, are discussed in our 2013 10-K.

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Results of Operations

Total Revenues.  Total revenues for the:  (i) second quarter of 2014 were $184.6 million, a 1% decrease when compared to $186.1 million for the second quarter of 2013; and (ii) six months ended June 30, 2014 were $372.6 million, a 2% increase when compared to $366.7 million for the six months ended June 30, 2013.  The components of total revenues, discussed in more detail below, are as follows (in thousands):

We use the location of the client as the basis of attributing revenues to individual countries.  Revenues by geographic regions for the quarters and six months ended June 30, 2014 and 2013 were as follows (in thousands):

Processing and related services revenues.  Processing and related services revenues for:  (i) the second quarter of 2014 increased 4% to $136.4 million, from $131.2 million for the second quarter of 2013; and (ii) six months ended June 30, 2014 increased 5% to $278.7 million, from $265.8 million for the six months ended June 30, 2013.  The increases in processing and related services revenues are due to continued growth in several of our ancillary products and services and special project work in the first quarter of 2014.  These increases were offset to a certain degree by divested revenues resulting from the sale of a small print operation and our marketing analytics business during the second half of 2013, which combined, totaled approximately $4 million and $7 million of processing revenues, respectively, for the second quarter and six months ended June 30, 2013.

Additional information related to processing and related services revenues is as follows:

Software and Services Revenues.  Software and services revenues for the:  (i) second quarter of 2014 decreased 18% to $25.6 million, from $31.4 million for the second quarter of 2013; and (ii) six months ended June 30, 2014 decreased 11% to $50.5 million, from $56.8 million for the six months ended June 30, 2013.  These decreases in software and services revenues can be mainly attributed to the normal fluctuations between periods in our software and professional services business, and to a much lesser degree, the divested services revenues related to our marketing analytics business which totaled approximately $1 million and $2 million, respectively, for the quarter and six months ended June 30, 2013.  

Maintenance Revenues.  Maintenance revenues for the:  (i) second quarter of 2014 were $22.6 million, relatively consistent when compared to $23.5 million generated in the second quarter of 2013; and (ii) six months ended June 30, 2014 were $43.4 compared to $44.2 million for the six months ended June 30 2013.

Total Expenses.  Our operating expenses for the:  (i) second quarter of 2014 were $162.7 million, a 1% decrease when compared to $164.4 million for the second quarter of 2013; and (ii) six months ended June 30, 2014 were $329.9 million, a 1% increase when compared to $327.0 million for the six months ended June 30, 2013, with the year-over-year changes reflective of the changes in revenues between periods.

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Additionally, during the first quarter of 2014, we incurred expenses related to the following unique items.  These items essentially offset each other within our total expenses, but are classified in different line items within our Income Statement for the six months ended June 30, 2014:

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

Cost of Revenues.  See our 2013 10-K for a description of the types of costs that are included in the individual line items for cost of revenues.

Cost of Processing and Related Services (Exclusive of Depreciation).  The cost of processing and related services for the:  (i) second quarter of 2014 increased 7%, to $67.4 million, from $63.0 million for the second quarter of 2013; and (ii) six months ended June 30, 2014 increased 9% to $135.8 million, from $124.5 million for the six months ended June 30, 2013.  These increases are primarily due to the following key items: (i) an increase in our ACP data processing costs resulting from our clients’ continued growth and increasing complexities of their businesses, thus requiring more computing resources; (ii) increased employee-related costs; and (iii) an increase in certain variable costs related to corresponding increases in related revenues.  Total processing and related services cost as a percentage of our processing and related services revenues for the:  (i) second quarters of 2014 and 2013 were 49.4% and 48.0%, respectively; and (ii) six months ended June 30, 2014 and 2013 were 48.7% and 46.9%, respectively.  

Cost of Software and Services (Exclusive of Depreciation).  The cost of software and services for the:  (i) second quarter of 2014 decreased 21%, to $17.9 million, from $22.5 million for the second quarter of 2013; and (ii) six months ended June 30, 2014 decreased 2% to $43.2 million, from $43.9 million for the six months ended June 30, 2013.  These decreases in cost of software and services is a result of a reassignment of personnel and the related costs previously assigned internally to software and consulting projects to other projects, with the year-to-date amount offset to certain degree by the estimated cost overruns related to the large software and services implementation project, discussed above.  Total software and services cost as a percentage of our software and services revenues for the:  (i) second quarters of 2014 and 2013 were 69.8% and 71.7%, respectively; and (ii) six months ended June 30, 2014 and 2013 were 85.6% and 77.4%, respectively.

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

Cost of Maintenance (Exclusive of Depreciation).  The cost of maintenance for the: (i) second quarter of 2014 decreased 9%, to $8.4 million, from $9.3 million for the second quarter of 2013; and (ii) six months ended June 30, 2014 decreased 14% to $16.8 million, from $19.6 million for the six months ended June 30, 2013, with the decreases mainly due to a decrease in amortization expense for certain technology assets that became fully amortized in previous periods.  Total cost of maintenance as a percentage of our maintenance revenues for the: (i) second quarters of 2014 and 2013 were 37.4% and 39.5%, respectively; and (ii) six months ended June 30, 2014 and 2013 were 38.7% and 44.4%, respectively.  

R&D Expense.  R&D expense for the: (i) second quarter of 2014 decreased 4%, to $26.4 million, from $27.5 million for the second quarter of 2013; and (ii) six months ended June 30, 2014 decreased 8% to $51.4 million, from $56.1 million for the six months ended June 30, 2013.  These decreases in R&D expense between years are primarily a result of the reassignment of resources previously assigned to development projects to other areas of the business, primarily client directed and funded work on our ACP platform.  As a percentage of total revenues, R&D expense was 14.3% for the second quarter of 2014 compared to 14.8% for the second quarter of 2013.  

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 turning transactions into revenues.  This includes the continued investment in our business

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support solutions aimed at improving a providers’ time-to-market, flexibility, scalability, and total cost of ownership.  We expect that our R&D investment activities in the near-term will be relatively consistent with previous quarters, with the level of R&D spend highly dependent upon the opportunities that we see in our markets.  

SG&A Expense.  SG&A expense for the: (i) second quarter of 2014 increased 5%, to $39.1 million, from $37.4 million for the second quarter of 2013; and (ii) six months ended June 30, 2014 increased 3% to $74.4 million, from $72.2 million for the six months ended June 30, 2013.  These increases are mainly due to the investments we are making in the business towards new initiatives, to include our enterprise security offerings.  Additionally, included in the first quarter 2014 SG&A expense is the $3.9 million reduction of expense related to the settlement agreement discussed above.  

Our SG&A costs as a percentage of total revenues for the second quarters of 2014 and 2013 were 21.2% and 20.1%, respectively.

Depreciation Expense.  Depreciation expense for the: (i) second quarter of 2014 decreased 28%, to $3.4 million, from $4.8 million for the second quarter of 2013; and (ii) six months ended June 30, 2014 decreased 29% to $6.9 million, from $9.8 million for the six months ended June 30, 2013, with the decreases a result of certain assets that became fully depreciated over the past year and assets sold as part of our 2013 divestures.

Operating Income. Operating income and operating income margin percentage for the:  (i) second quarter of 2014 was $21.8 million, or 11.8% of total revenues, relatively consistent when compared to $21.7 million, or 11.6% of total revenues for the second quarter of 2013; and (ii) six months ended June 30, 2014 was $42.7 million, or 11.5% of total revenues, compared to $39.7 million, or 10.8% of total revenues for the six months ended June 30, 2013, with the margin improvement a result of the higher year-to-date revenue performance, discussed above.

In July 2014, in conjunction with the organizational restructuring of our Content Direct solution to facilitate its alignment across our offerings, including management programs and incentives, (see Note 8 to our Financial Statements) we terminated an employee incentive arrangement in exchange for a one-time cash payment of $8 million, which will be reflected as a restructuring charge in the third quarter of 2014.

Income Tax Provision.  The effective income tax rates for the second quarters of 2014 and 2013 and six months ended June 30, 2014 and 2013 were as follows:

For the full-year 2014 we are currently estimating an effective income tax rate of 45%, which does not include any benefit from R&D tax credits generated during the year, as they have not yet received Congressional approval.  If enacted prior to the end of the year, we would include those income tax benefits in our 2014 effective income tax rate.

The low effective income tax rate for the six months ended June 30, 2013 reflects the benefit of approximately $6 million of R&D tax credits that we generated in 2012 but were recorded in the first quarter of 2013.  As a result of the American Taxpayer Relief Act of 2012 being signed into law on January 2, 2013, we were unable to include these credits in the determination of our 2012 effective income tax rate, as a change in tax law is accounted for in the period of enactment.  Thus, the benefit of these credits is reflected in our first quarter 2013 effective income tax rate.

Liquidity

Cash and Liquidity

As of June 30, 2014, our principal sources of liquidity included cash, cash equivalents, and short-term investments of $189.6 million, compared to $183.0 million as of March 31, 2014 and $210.8 million as of December 31, 2013.  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 Credit Agreement, we have a $100 million senior secured revolving loan facility (“Revolver”) with a syndicate of financial institutions that expires in November 2017 (or December 31, 2016 if certain conditions exist).  As of June 30, 2014, there were no borrowings outstanding on the Revolver.  The Credit Agreement contains customary affirmative covenants and financial

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covenants.  As of June 30, 2014, 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):

We generally have ready access to substantially all of our cash, cash equivalents, and short-term investment balances, but may face limitations on moving cash out of certain foreign jurisdictions due to currency controls.  As of June 30, 2014, we had $4.9 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 in accordance with GAAP, beginning with net income, adding back the impact of non-cash items or non-operating activity (e.g., depreciation, amortization, amortization of OID, impairments, deferred income taxes, stock-based compensation, etc.), and then factoring in the impact of changes in operating assets and liabilities.  See our 2013 10-K for a description of the primary uses and sources of our cash flows from operating activities.  

Our 2013 and 2014 net cash flows from operating activities, broken out between operations and changes in operating assets and liabilities, for the quarters ended are as follows (in thousands):

We believe the above table illustrates our ability to generate strong quarterly cash flows, and the importance of managing our working capital items. As the table above illustrates, the operations portion of our cash flows from operating activities remains a strong measure for us. The variations in our net cash provided by operating activities are related mostly to the changes in our operating assets and liabilities (related mostly to normal fluctuations in timing at quarter-end for such things as 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 2014 and 2013 that impacted our cash flows from operating activities are as follows:

Billed Trade Accounts Receivable

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

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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):

The increases in gross and net billed accounts receivable in the first and second quarters of 2014 are primarily related to the timing around certain recurring customer payments that were delayed at each quarter end, negatively impacting our DBO for the second quarter of 2014.  All other changes in our gross and net billed trade accounts receivable shown in the table above reflect the normal fluctuations in the timing of client payments made at quarter end, evidenced by the consistency of our DBO metric over the quarters presented.

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

Other Current and Non-Current Assets

Other current and non-current assets increased $7.2 million, from $45.6 million as of December 31, 2013 to $52.8 million as of June 30, 2014.  This increase is primarily due to an increase in various prepaid items, mainly prepaid internal use software and hardware maintenance fees.

Accrued Employee Compensation

Accrued employee compensation decreased $15.4 million, from $58.4 million as of December 31, 2013 to $43.0 million as of June 30, 2014.  This decrease is primarily due to the payment of 2013 employee incentive compensation that were fully accrued for at December 31, 2013, offset to a certain degree by the accrual for the 2014 employee incentive compensation.     

Cash Flows From Investing Activities

Our typical investing activities consist of purchases/sales of short-term investments, purchases of property and equipment, and investments in client contracts, which are discussed below.  

Purchases/Sales of Short-term Investments.  During the six months ended June 30, 2014 and 2013, we purchased $85.0 million and $98.9 million, respectively, and sold (or had mature) $109.1 million and $41.4 million, respectively, of short-term investments.  We continually evaluate the appropriate mix of our investment of excess cash balances between cash equivalents and short-term investments in order to maximize our investment returns and will likely purchase and sell additional short-term investments in the future.

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Property and Equipment/Client Contracts.  Our capital expenditures for the six months ended June 30, 2014 and 2013, for property and equipment, and investments in client contracts were as follows (in thousands):