CSG SYSTEMS INTERNATIONAL INC - Quarter Report: 2015 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2015

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 November 2, 2015: 32,695,388

CSG SYSTEMS INTERNATIONAL, INC.

FORM 10-Q for the Quarter Ended September 30, 2015

INDEX

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CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS - UNAUDITED

(in thousands, except per share amounts)  

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

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CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME - UNAUDITED

(in thousands, except per share amounts)

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

4

CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - UNAUDITED

(in thousands)

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

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CSG SYSTEMS INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

(in thousands)

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

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CSG SYSTEMS INTERNATIONAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. GENERAL

We have prepared the accompanying unaudited condensed consolidated financial statements as of September 30, 2015 and December 31, 2014, and for the quarters and nine months ended September 30, 2015 and 2014, 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, 2014 (our “2014 10-K”), filed with the SEC. The results of operations for the quarter and nine months ended September 30, 2015 are not necessarily indicative of the expected results for the entire year ending December 31, 2015.

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.

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 September 30, 2015 and December 31, 2014, our cash equivalents consist primarily of institutional money market funds, commercial paper, and time deposits held at major banks.

As of September 30, 2015 and December 31, 2014, we had $4.9 million and $4.7 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 September 30, 2015 and December 31, 2014 include cash and cash equivalents, short-term investments, accounts receivable, accounts payable, and debt. Because of their short maturities, the carrying amounts of cash equivalents, accounts receivable, and accounts payable approximate their fair value.

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

Primarily all short-term investments held by us as of September 30, 2015 and December 31, 2014 have contractual maturities of less than two years from the time of acquisition. Our short-term investments as of September 30, 2015 and December 31, 2014 consisted almost entirely of fixed income securities. Proceeds from the sale/maturity of short-term investments for the nine months ended September 30, 2015 and 2014 were $127.8 million and $146.4 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.  See Note 4 for discussion regarding the amendment to our credit agreement.

Accounting Pronouncement Issued But Not Yet Effective. The Financial Accounting Standards Board (“FASB”) has 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.

In August 2015, the FASB issued ASU 2015-14 Revenue from Contracts with Customers (Topic 606):  Deferral of the Effective Date which defers the effective date of ASU 2014-09 for one year.  The updated accounting guidance is now effective for annual and interim reporting periods in fiscal years beginning after December 15, 2017.  Early adoption is 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.

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3. LONG-LIVED ASSETS

Goodwill. The changes in the carrying amount of goodwill for the nine months ended September 30, 2015, were as follows (in thousands):

Other Intangible Assets. Our intangible assets subject to ongoing amortization consist primarily of client contracts and software. As of September 30, 2015 and December 31, 2014, the carrying values of these assets were as follows (in thousands):

The total amortization expense related to intangible assets for the third quarters of 2015 and 2014 were $6.8 million and $7.8 million, respectively, and for the nine months ended September 30, 2015 and 2014 were $20.1 million and $23.5 million, respectively. Based on the September 30, 2015 net carrying value of our intangible assets, the estimated total amortization expense for each of the five succeeding fiscal years ending December 31 are: 2015 – $26.4 million; 2016 – $21.3 million; 2017 – $16.1 million; 2018 – $12.7 million; and 2019 – $9.1 million.

4. DEBT

Our long-term debt, as of September 30, 2015 and December 31, 2014, was as follows (in thousands):

2015 Credit Agreement. In February 2015, we entered into an amended and restated $350 million credit agreement with several financial institutions (the “2015 Credit Agreement”) to replace the 2012 Credit Agreement.    

The 2015 Credit Agreement provides borrowings in the form of:  (i) a $150 million aggregate principal five-year term loan (the “2015 Term Loan”); and (ii) a $200 million aggregate principal five-year revolving loan facility (the “2015 Revolver”).  With the $150 million proceeds from the 2015 Term Loan, we repaid the outstanding $120 million balance from term loan under the 2012 Credit Agreement, resulting in a net increase of available cash by $30 million, a portion of which was used to pay certain fees and expenses in connection with the refinancing.

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As a result of the 2015 Credit Agreement, we have pledged assets under a security agreement in favor of a financial institution as collateral agent (the “Security Agreement”).  Under the Security Agreement, all of our domestic subsidiaries have pledged substantially all of their assets to secure the obligations under the 2015 Credit Agreement and related security agreement.

In conjunction with the closing of the 2015 Credit Agreement, we incurred financing costs of $2.7 million.  When combined with the remaining deferred financing costs for the 2012 Credit Agreement, financing costs of $5.9 million have been deferred and are being amortized to interest expense using the effective interest method over the related term of the 2015 Credit Agreement, and financing costs of $0.9 million were recorded in interest expense.

2010 Convertible Notes. Refer to Note 5 in our 2014 10-K for disclosure of the 2010 Convertible Notes’ three contingent conversion features.

As the result of our declaring a cash dividend in August 2015 (see Note 7), the previous conversion rate for the 2010 Convertible Notes of 43.1307 shares of our common stock for each $1,000 in principal amount of the 2010 Convertible Notes (equivalent to a conversion price of $23.19 per share of our common stock) has been adjusted to 43.3794 shares of our common stock for each $1,000 in principal amount of the 2010 Convertible Notes (equivalent to a conversion price of $23.05 per share of our common stock).

Prior to September 1, 2016, holders of the 2010 Convertible Notes can convert their securities at any time in the fiscal quarter following the period in which the price of our common stock trades over 130% of the conversion price for at least 20 consecutive trading days in the last 30 trading days of a fiscal quarter.  As of June 23, 2015, the closing price of our common stock exceeded 130% of the conversion price for the required period and the 2010 Convertible Notes were convertible at the holder’s option during the quarter beginning July 1, 2015 and ending September 30, 2015; however, none of the 2010 Convertible Notes were converted during this period.  As of September 30, 2015, none of the contingent conversion features were achieved, and thus, the 2010 Convertible Notes are not convertible by the holders.

Upon any conversion of the 2010 Convertible Notes, we will settle our conversion obligation as follows: (i) we are required to 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 can satisfy the remaining conversion obligation in our common stock, cash or any combination of our common stock and cash, at our discretion. Based on our September 30, 2015 closing stock price of $30.80 per share, the 2010 Convertible Notes would have had a total settlement value of approximately $200 million.

5. 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 September 30, 2015, 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 of Directors (the “Board”) and certain of our officers if they are named or threatened to be named as a party to any proceeding by reason of the fact that they acted in such capacity. We maintain directors’ and officers’ (D&O) insurance coverage to protect against such losses. We have not historically incurred any losses related to these types of indemnifications, and are not aware of any pending or threatened

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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 September 30, 2015. In addition, as a result of the insurance policy coverage, we believe these indemnification agreements are not significant to our results of operations.

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

6. 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):

In March 2015, we received an initial delivery of 1.3 million shares related our accelerated stock repurchase transaction agreement which reduced our weighted average shares outstanding for purposes of calculating basic and diluted EPS for the first quarter and nine months of 2015 (see Note 7).

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 4).

The Stock Warrants have a dilutive effect only in those quarterly periods in which our average stock price exceeds the exercise price of $26.68 per warrant (under the treasury stock method), and are not subject to performance vesting conditions (see Note 7).  

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

7. STOCKHOLDERS’ EQUITY AND EQUITY COMPENSATION PLANS

Stock Repurchase Program. We currently have a stock repurchase program, approved by our Board, authorizing us to repurchase our common stock from time-to-time as market and business conditions warrant (the “Stock Repurchase Program”). In February 2015, our Board approved a 7.5 million share increase in the number of shares authorized for repurchase under the Stock Repurchase Program, bringing the total number of shares authorized to 42.5 million.  During the nine months ended September 30, 2015 and 2014, we repurchased 0.3 million shares of our common stock for $7.0 million (weighted-average price of $27.06 per share) and 0.2 million shares of our common stock for $5.2 million (weighted-average price of $27.26 per share), respectively, under a Securities and Exchange Commission (“SEC”) Rule 10b5-1 Plan.  

In March 2015, we entered into an accelerated share repurchase transaction agreement (the “ASR Agreement”) with a counterparty to repurchase $50 million of our common stock.  We paid $50 million to the counterparty and received an initial delivery of 1.3 million shares of our outstanding common stock for an aggregate value of approximately $40 million.  The initial shares were reflected as treasury stock in the period the shares were delivered.  The remaining amount was recorded as a forward contract indexed to our common stock in additional paid in capital.  The final delivery of shares under the ASR Agreement will be based generally upon the daily volume weighted average price of our common stock during the repurchase period.  At settlement, under certain circumstances, the counterparty may be required to deliver additional shares of common stock to us, or under certain circumstances, we may be required to deliver shares of common stock or cash, at our option, to the counterparty.  Final settlement of the transactions under the ASR Agreement is expected to occur no later than December 2015.  The ASR Agreement meets all the applicable criteria for equity classification, and, therefore, is not accounted for as a derivative instrument.  

As of September 30, 2015, the total remaining number of shares available for repurchase under the Stock Repurchase Program totaled 7.3 million shares.

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Stock Repurchases for Tax Withholdings. In addition to the above mentioned stock repurchases, during the nine months ended September 30, 2015 and 2014, we repurchased and then cancelled 0.3 million shares of common stock for $8.0 million and 0.2 million shares of common stock for $6.7 million, respectively, in connection with minimum tax withholding requirements resulting from the vesting of restricted common stock under our stock incentive plans.

Cash Dividends.  During the third quarter of 2015, the Board approved a quarterly cash dividend of $0.1750 per share of common stock, totaling $5.7 million. During the third quarter of 2014, the Board approved a quarterly cash dividend of $0.1575 per share of common stock, totaling $5.5 million.  Dividends declared for the nine months ended September 30, 2015 and 2014, totaled $17.2 million and $16.0 million, respectively      

Warrants.  In 2014, in conjunction with the execution of an amendment to our current agreement with Comcast Corporation (“Comcast”), we issued stock warrants (the “Warrant Agreement”) for the right to purchase up to approximately 2.9 million shares of our common stock (the “Stock Warrants”) as an additional incentive for Comcast to migrate new customer accounts to ACP. The Stock Warrants have a 10-year term and an exercise price of $26.68 per warrant. As of September 30, 2015, approximately 1.0 million Stock Warrants have vested.         

Upon vesting, the Stock Warrants are recorded as a client incentive asset with the corresponding offset to stockholders’ equity.  The client incentive asset related to the Stock Warrants is amortized as a reduction in processing and related services revenues over the remaining term of the Comcast amended agreement.  As of September 30, 2015, we recorded a client incentive asset related to these Stock Warrants of $7.3 million and have amortized $1.6 million as a reduction in processing and related services revenues.  

The remaining unvested Stock Warrants will be accounted for as client incentive assets in the period the performance conditions necessary for vesting have been met.  As of September 30, 2015, none of the Stock Warrants had been exercised.

Stock-Based Awards. A summary of our unvested restricted common stock activity during the third quarter and nine months ended September 30, 2015 is as follows (shares in thousands):

Included in the awards granted during the nine months ended September 30, 2015, 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 third quarter and nine months ended September 30, 2015 are time-based awards, which vest primarily 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 third quarters of 2015 and 2014 of $5.3 million and $4.5 million, respectively, and for the nine months ended September 30, 2015 and 2014 of $15.8 million and $12.3 million, respectively.

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

The information contained in this MD&A should be read in conjunction with the Financial Statements and Notes thereto included in this Form 10-Q and the audited consolidated financial statements and notes thereto in our 2014 10-K.

Forward-Looking Statements

This report contains a number of forward-looking statements relative to our future plans and our expectations concerning our business and the industries we serve.  These forward-looking statements are based on assumptions about a number of important factors, and involve risks and uncertainties that could cause actual results to differ materially from estimates contained in the forward-looking statements.  Some of the risks that are foreseen by management are outlined within Part II Item IA. Risk Factors of this report and in Part I Item 1A. Risk Factors of our 2014 10-K.  Readers are strongly encouraged to review those sections closely in conjunction with MD&A.

Company Overview

We are one of the world’s largest and most established business support solutions 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 changing consumer demands, and address the challenges and opportunities of a dynamically evolving global business environment.  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, and customer interaction management platforms.  

We generate nearly 70% 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 nine months ended September 30, 2015, we generated approximately 85% of our revenues from the Americas region, approximately 10% of our revenues from the Europe, Middle East and Africa region, and approximately 5% of our revenues from the Asia Pacific region.

We are a S&P Small Cap 600 company.

Management Overview of Quarterly Results

Third Quarter Highlights.  A summary of our results of operations for the third quarter of 2015, when compared to the third quarter of 2014, is as follows (in thousands, except per share amounts and percentages):  

Revenues.  Our revenues for the third quarter of 2015 were $187.0 million, an increase of 1% when compared to $185.0 million for the same period in 2014. The year-over-year increase in revenues can be primarily attributed to continued strength in our processing

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revenues and increased professional services revenues during the third quarter of 2015, which more than offset $4.1 million of unfavorable foreign currency movements.

Operating Results.  Operating income for the third quarter of 2015 was $31.0 million, or a 16.6% operating income margin percentage, compared to $13.8 million, or a 7.5% operating income margin percentage for the third quarter of 2014, with the increases due primarily to lower operating expenses (driven primarily by a reduction in restructuring and reorganization costs, foreign currency movements, and our focus on cost management).    

Diluted EPS.  Diluted EPS for the third quarter of 2015 was $0.50 compared to $0.15 for the third quarter of 2014, with the increase due mainly to the higher operating income margin, discussed above.  

Cash and Cash Flows.  As of September 30, 2015, we had cash, cash equivalents and short-term investments of $199.8 million, as compared to $194.0 million as of June 30, 2015 and $201.8 million as of December 31, 2014.  Our cash flows from operating activities for the nine months ended September 30, 2015 were $25.8 million.  See the Liquidity section below for further discussion of our cash flows.

Divestiture.  In early September 2015, we sold our cyber-security business, marketed under the Invotas brand, to certain former management personnel.  We retained a minority interest in the business such that we will not include the results of operations from the business in our financial statements subsequent to the divestiture date.  The impact of Invotas to our business prior to the divestiture was not material.  

Significant Client Relationships

Client Concentration.  A large percentage of our historical revenues have been generated from our three largest clients, which are 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 2014 10-K for additional discussion of our business relationships and contractual terms with the above mentioned significant clients.

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

Critical Accounting Policies

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

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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 2014 10-K.

Results of Operations

Total Revenues.  Total revenues for the:  (i) third quarter of 2015 were $187.0 million, a 1% increase when compared to $185.0 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 were $555.2 million, a slight decrease when compared to $557.6 million for the nine months ended September 30, 2014.  Both periods were negatively impacted foreign currency movements which had a negative impact of $4.1 million and $10.7 million, respectively, on our revenues for the third quarter and nine months ended September 30, 2015.  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 third quarters and nine months ended September 30, 2015 and 2014 were as follows (in thousands):

Processing and related services revenues.  Processing and related services revenues for the:  (i) third quarter of 2015 increased 2% to $143.9 million, from $141.0 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 increased 2% to $429.0 million, from $419.7 million for the nine months ended September 30, 2014.  The increases in processing and related services revenues are due mainly to the following key items: (i) growth in our various processing solutions, driven mainly by the increase in customer accounts converted onto our systems, and our content monetization platform; and (ii) growth in our international managed services offering.  These revenue increases more than offset the year-over-year negative currency impact included in processing revenues.    

Additionally, amortization of our client contracts intangible assets related to investments in client contracts (reflected as a reduction of processing and related services revenues) for the: (i) third quarters of 2015 and 2014 were $1.3 million and $1.6 million, respectively; and (ii) nine months ended September 30, 2015 and 2014 were $3.9 million and $4.7 million, respectively.

Software and Services Revenues.  Software and services revenues for the:  (i) third quarter of 2015 increased 5% to $23.2 million, from $22.1 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 decreased 6% to $68.3 million, from $72.6 million for the nine months ended September 30, 2014. For the third quarter, we experienced an increase in our professional services revenue as a result of the normal fluctuations in project level work completed between quarters, which allowed us to more than offset the unfavorable foreign currency movements.  The year-to-date decrease in revenues is almost entirely related to foreign currency movements.  

Maintenance Revenues.  Maintenance revenues for the: (i) third quarter of 2015 decreased 10% to $19.8 million, from $21.9 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 decreased 11% to $57.9 million, from $65.3 million for the nine months ended September 30, 2014. These decreases are due mainly to foreign currency movements, the timing of maintenance renewals and related revenue recognition, and pricing reductions experienced on maintenance renewals.

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Total Expenses.  Our operating expenses for the: (i) third quarter of 2015 were $155.9 million, a 9% decrease when compared to $171.2 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 were $476.2 million, a 5% decrease when compared to $501.0 million for the nine months ended September 30, 2014.  These year-over-year decreases are due mainly to foreign currency movements, a reduction in restructuring and reorganization costs, and our focus on cost management.

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

Cost of Revenues.  See our 2014 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) third quarter of 2015 decreased 3% to $67.4 million, from $69.2 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 decreased 2% to $201.5 million, from $205.0 million for the nine months ended September 30, 2014.  These decreases are mainly due to cost savings initiatives and other decreases in variable costs, and to a lesser degree, favorable foreign currency movements, in the quarter and nine months ended September 30, 2015. Total processing and related services cost as a percentage of our processing and related services revenues for the: (i) third quarters of 2015 and 2014 were 46.9% and 49.1%, respectively; and (ii) nine months ended September 30, 2015 and 2014 were 47.0% and 48.8%, respectively.  

Cost of Software and Services (Exclusive of Depreciation).  The cost of software and services for the: (i) third quarter of 2015 decreased 13% to $15.2 million, from $17.5 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 decreased 13% to $52.9 million, from $60.7 million for the nine months ended September 30, 2014. These decreases in cost of software and services are primarily due to favorable foreign currency movements, and to a lesser degree, targeted efficiencies and cost improvements within our professional services practice. Total software and services cost as a percentage of our software and services revenues for the: (i) third quarters of 2015 and 2014 were 65.6% and 79.3%, respectively; and (ii) nine months ended September 30, 2015 and 2014 were 77.5% and 83.7%, 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) third quarter of 2015 increased 23% to $9.5 million, from $7.7 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 increased 22% to $29.9 million, from $24.5 million for the nine months ended September 30, 2014, with these increases mainly attributed to the reassignment of personnel and the related costs to maintenance projects from other projects, which more than offset the favorable movements in foreign currency between years.  Total cost of maintenance as a percentage of our maintenance revenues for the:  (i) third quarters of 2015 and 2014 were 47.9% and 35.3%, respectively; and (ii) nine months ended September 30, 2015 and 2014 were 51.6% and 37.6%, respectively.    

R&D Expense (Exclusive of Depreciation).  R&D expense for the: (i) third quarter of 2015 decreased 5% to $24.9 million, from $26.3 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 decreased 2% to $76.6 million, from $77.8 million for the nine months ended September 30, 2014, with the decreases attributed to favorable foreign currency movements. As a percentage of total revenues, R&D expense was 13.3% for the third quarter of 2015 compared to 14.2% for the third quarter of 2014.  

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 support solutions aimed at improving a providers’ time-to-market for new offerings, 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.

Selling, General and Administrative Expense (“SG&A”)(Exclusive of Depreciation).  SG&A expense for the:  (i) third quarter of 2015 decreased 12% to $34.2 million, from $39.0 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 decreased 10% to $102.3 million, from $113.5 million for the nine months ended September 30, 2014.  The lower sales and marketing costs in the quarter and nine months ended September 30, 2015 reflects:  (i) the financial benefits of the restructuring activities undertaken in 2014 to reduce our sales and marketing costs; (ii) focus on cost management, to include the divestiture of Invotas; and (iii) the impact of foreign currency movements.  Our SG&A costs as a percentage of total revenues for the third quarters of 2015 and 2014 were 18.3% and 21.1%, respectively.

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Restructuring and Reorganization Charges. Restructuring and reorganization charges for the:  (i) third quarter of 2015 were $0.8 million, compared to $7.8 million for the third quarter of 2014; and (ii) nine months ended September 30, 2015 were $1.8 million, compared to $9.0 million for the nine months ended September 30, 2014.  During the third quarter of 2014, we recorded restructuring and reorganization charges of $7.8 million primarily associated with the reorganization of our Content Direct solution to facilitate its alignment across our offerings, including management programs and incentives.

Operating Income. Operating income and operating income margin percentages for the:  (i) third quarter of 2015 was $31.0 million, or 16.6% of total revenues, compared to $13.8 million, or 7.5% of total revenues for the third quarter of 2014; and (ii) nine months ended September 30, 2015 was $79.1 million, or 14.2% of total revenues, compared to $56.6 million, or 10.1% of total revenues for the nine months ended September 30, 2014. The increases in operating income and operating income margin percentage between periods are due primarily to lower operating expenses (driven primarily by foreign currency movements, a reduction in restructuring and reorganization costs, and our focus on cost management), and the scale benefits we are achieving from increasing the number of customer accounts and clients on our solutions.

Income Tax Provision.  The effective income tax rates for the third quarters and nine months ended September 30, 2015 and 2014 were as follows:

For the full-year 2015, we are currently estimating an effective income tax rate of 42%, 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 2015 effective income tax rate.

Liquidity

Cash and Liquidity

As of September 30, 2015, our principal sources of liquidity included cash, cash equivalents, and short-term investments of $199.8 million, compared to $194.0 million as of June 30, 2015 and $201.8 million as of December 31, 2014.  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 Credit Agreement, we have a $200 million senior secured revolving loan facility with a syndicate of financial institutions that expires in February 2020.  As of September 30, 2015, there were no borrowings outstanding on the 2015 Revolver.  The 2015 Credit Agreement contains customary affirmative covenants and financial covenants.  As of September 30, 2015, and the date of this filing, we believe that we are in compliance with the provisions of the 2015 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 September 30, 2015, 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 2014 10-K for a description of the primary uses and sources of our cash flows from operating activities.  

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Our 2015 and 2014 net cash flows from operating activities, broken out between operations and changes in operating assets and liabilities, for each of the three quarters ended are as follows (in thousands):

Cash flows from operating activities for the quarters ended March 31, 2015 and 2014 reflect the negative impacts of the payment of year-end accrued employee incentive compensation related to 2014 and 2013, respectively. In addition, cash flows from operations for the quarter ended March 31, 2014 was negatively impacted by the increase in the accounts receivable balance primarily related to the timing around certain monthly client payments that were received after the quarter ended.

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 variations in our net cash provided by (used in) 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 2015 and 2014 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 by taking the average monthly net trade accounts receivable balance for the period divided by the billings for the period (including non-revenue items).

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 at March 31, 2014 and June 30, 2014 are primarily related to the timing around certain recurring customer payments that were delayed at each quarter end, thus negatively impacting our DBO for the second quarter of 2014.  

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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.

Unbilled Trade Accounts Receivable

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

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

Deferred Revenue

Total deferred revenue (current and non-current) increased $4.5 million to $54.1 million as of September 30, 2015, from $49.7 million as of December 31, 2014, mainly as the result of annual recurring services that are typically billed in the first half of each year.

Other Assets

Total other assets (current and non-current) increased $7.2 million to $51.8 million as of September 30, 2015, from $44.6 million as of December 31, 2014, mainly as the result of annual prepaid hardware and software maintenance fees.

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 nine months ended September 30, 2015 and 2014, we purchased $107.5 million and $127.0 million, respectively, and sold (or had mature) $127.8 million and $146.4 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.

Property and Equipment/Client Contracts.  Our capital expenditures for the nine months ended September 30, 2015 and 2014, for property and equipment, and investments in client contracts were as follows (in thousands):

The property and equipment expenditures during the nine months ended September 30, 2015 consisted principally of investments in: (i) computer hardware, software, and related equipment; (ii) facilities and internal infrastructure items; and (iii) statement production equipment.

The investments in client contracts for the nine months ended September 30, 2015 and 2014 relate to client incentive payments ($1.5 million and $3.0 million, respectively), and the deferral of costs related to conversion/set-up services provided under long-term processing contracts ($4.9 million and $1.2 million, respectively).

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Cash Flows From Financing Activities

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

Cash Dividends Paid on Common Stock.  During the nine months ended September 30, 2015 and 2014, we made dividend payments totaling $16.8 million and $15.5 million, respectively.

Repurchase of Common Stock.  During the nine months ended September 30, 2015 and 2014, we repurchased approximately 0.3 million and 0.2 million shares of our common stock under the guidelines of our Stock Repurchase Program for approximately $7 million and $5 million, respectively. Additionally, we entered into an ASR Agreement to repurchase $50 million of our common stock, which was paid to a counterparty in March 2015.  

Outside of our Stock Repurchase Program, during the nine months ended September 30, 2015 and 2014, we repurchased from our employees and then cancelled approximately 0.3 million and 0.2 million shares of our common stock during each period for $8.0 million and $6.7 million, respectively, in connection with minimum tax withholding requirements resulting from the vesting of restricted common stock under our stock incentive plans.

Long-term Debt.  During the nine months ended September 30, 2015, we amended our 2012 Credit Agreement and as a result, we repaid the outstanding principal balance of $120.0 million and borrowed $150.0 million under the 2015 Credit Agreement, resulting in a net increase of available cash of $30 million.  As part of the refinancing, we paid $2.7 million of deferred financing costs.  Additionally, during the nine months ended September 30, 2015 and 2014, we made principal repayments of $5.6 million and $11.3 million, respectively.

Capital Resources

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

Current Sources of Capital Resources.

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

In February 2015, we announced an increase in our planned share repurchases of up to $150 million under our Stock Repurchase Program over the next three years.  Under our Stock Repurchase Program, we may repurchase shares in the open market or in privately negotiated transaction, including through an accelerated stock repurchase plan or under a SEC Rule 10b5-1 plan.  The actual timing and amount of the share repurchases will be dependent on then current market conditions and other business-related factors over the next three years.

In March 2015, we entered into an ASR Agreement with a counterparty to repurchase $50 million of our common stock. The final delivery of shares under the ASR Agreement will be based generally upon the daily volume weighted average price of our common stock during the repurchase period.  At settlement, under certain circumstances, the counterparty may be required to deliver additional shares of common stock to us, or under certain circumstances, we may be required to deliver shares of common stock or cash, at our option, to the counterparty.  Final settlement of the transactions under the ASR Agreement is expected to occur no later than December 2015.

As of September 30, 2015, we had 7.3 million shares authorized for repurchase remaining under our Stock Repurchase

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Program. Our 2015 Credit Agreement places certain limitations on our ability to repurchase our common stock. Our common stock repurchases are discussed in more detail in Note 7 to our Financial Statements.