CSG Systems International, Inc.
Q3 2014 Earnings Call Transcript

Published: 5 Nov 2014

[Operator:]

Good day, and welcome to the CSG Systems Third Quarter 2014 Earnings Announcement Conference Call. Today's conference is being recorded. [Operator Instructions] At this time, I would like to turn the conference over to Liz Bauer. Please go ahead.

[Liz Bauer:]

Thank you, Justin, and thanks, everyone, for joining us. Today's discussion will contain a number of forward-looking statements. These will include but are not limited to statements regarding our projected financial results, our ability to meet our clients needs through our products, services and performance; and our ability to successfully integrate and manage acquired businesses in order to achieve their expected strategic operating and financial goals. While these statements reflect our best current judgment, they are subject to risks and uncertainties that could cause our actual results to differ materially. Please note that these forward-looking statements reflect our opinion only as of the date of this call, and we undertake no obligation to revise or publicly release any revisions to these forward-looking statements in light of new or future events. In addition to the factors noted during this call, a more comprehensive discussion of our risk factors can be found in today's press release as well as our most recently filed 10-K and 10-Q, which are all available on the Investor Relations section of our website. Also we disclose certain financial information that is not prepared in accordance with GAAP. We believe that these non-financial measures -- non-GAAP financial measures when compared in conjunction or when reviewed in conjunction with our GAAP financial measures provide investors with greater transparency to the information used by our management team and our financial and operational decision-making. For more information regarding our use of non-GAAP financial measures, we refer you to today's earnings release and our non-GAAP reconciliation tables on our websites, which will also be furnished at the SEC and Form 8-K. With me today on the phone are Peter Kalan, our Chief Executive Officer; and Randy Wiese, our Chief Financial Officer. With that, I'd now like turn the call over to Peter.

[Peter E. Kalan:]

Thank you, Liz, and I apologize for getting choked up during your intro and risk factors. And I want to thank everyone for joining us today. For the third quarter, we reported revenues of $185 million and non-GAAP earnings per share of $0.49. And I'd like to share my perspective on these results. When we provided our annual guidance back in February, we expected our revenues to be more heavily weighted toward the second half of the year. With flat quarter-over-quarter revenues between Q2 and Q3, we obviously didn't achieve the pickup in revenues that we'd anticipated. In particular, we continue to see softness in our Americas region where we experienced a significant shortfall in anticipated spending by the U.S. government. While these results did not meet our internal expectations, we've started the fourth quarter off strong with several important contract signings and other parts of the world, and we do expect fourth quarter strength in software and services sales that we normally see at year-end. As we look to 2015 and beyond, we continue to adjust our approaches and investments to the evolving market conditions, which creates opportunities and challenges for both communication service providers and the companies that serve them. Our view of the new market reality looks like this

[Randy R. Wiese:]

Thank you, Peter, and welcome to all of you on the call today to discuss our financial results for the third quarter and our outlook for the remainder of the year. Total revenues for the third quarter were $185 million, down 1% from the same quarter last year. Sequentially, revenues were consistent between quarters. Underlying these results are very strong processing revenues, which have more than offset the weakness we have experienced in our software and services revenues for the last 3 quarters. I would like to expand on these points as it provides additional insight of what we are seeing in our business right now. We have experienced a 5% year-over-year increase in our processing revenues for the first 9 months of this year. Additionally, if you consider the impact of our divestiture of $7 million of revenues during 2013, our year-over-year growth in processing revenues would be closer to 7%. The growth in our processing revenues reflect the strength of our North American cable business and some of the early successes we are experiencing around our international managed services offering. This strength has more than offset the weakness in our software and services revenues, resulting in top line revenue growth for the year. Getting back to the quarterly results, breaking down the components of revenues further. In the third quarter, we had 3 clients that each individually generated revenues of 10% or more of our revenues. Comcast, DISH and Time Warner, together they were 48% of our revenue for the quarter. Additionally, for the quarter, we've generated 85% of our revenues from the Americas region, 10% of our revenues from the Europe, Middle East and Africa region and 5% of our revenues from the Asia-Pacific region. Moving on. Our non-GAAP operating income for the third quarter was $30 million with a margin of 16%. GAAP operating income for the quarter was $14 million or a margin of 7%. Our GAAP results reflect a charge of $8 million, associated with the restructuring of our Content Direct organization and incentives to align with investments across all of our offerings, which we discussed in our last earnings call in August. For the third quarter, our non-GAAP adjusted EBITDA was $37 million or 20% of our total revenues. Non-GAAP EPS for the third quarter was $0.49, which compares to $0.52 for the same period last year. Our non-GAAP effective income tax rate for the quarter was 40%, which was higher than expected. The higher tax rate had a negative EPS impact of $0.03 for the quarter. We now anticipate our 2014 full year rate coming in at 38% compared to our previous expectation of 36% to 37%. This requires that we record a tax rate of 40% for both the third and fourth quarters in order for us to have an average rate of 38% for the full year. The increase in our tax rate for the year is largely due to our expected R&D tax credits now coming in lower than our original estimates and to a lesser degree, lower estimated profitability on our foreign operations. GAAP EPS for the third quarter was $0.15. Foreign currency movements did not have a material impact on our results. And now on to the cash flows and balance sheet. Overall, we ended the quarter with $183 million of cash and short-term investments, a decrease of $6 million from the ending balance last quarter. We reported cash flows from operations for the quarter of $20 million, which includes a negative impact of $8 million related to our Content Direct restructuring this quarter. We are disappointed with our cash flow performance for the quarter. We continue to experience some working capital challenges related mainly to the timeliness of payments by some of our larger clients at quarter end that we've seen several times this year. However, it's important to note, we have no concerns on the ultimate collection of the amounts due to us or in our ability to continue our historical strong cash flow performance in the future. During the quarter, we reduced our debt by $4 million to end the quarter with a total of $274 million in par value debt on our balance sheet. We also spend approximately $10 million on capital expenditures, resulting in non-GAAP free cash flow of $9 million. We also used our cash position to return capital to shareholders. First, we paid a cash dividend of $5 million during the quarter. Additionally, we resumed our share repurchase activity, following an extended blackout periods as we negotiated extended Comcast agreement that we announced in July. During the third quarter, we repurchased nearly 200,000 shares of common stock for total of $5 million at a weighted average share price of $27.26. We remain committed to our goal to return 25% to 50% of our annual free cash flow to our shareholders. Moving onto our full year guidance. Our 2014 revenue guidance is unchanged from our previous range of $745 million to $770 million. As a result of our lower-than-expected performance during the first 9 months of the year, we now expect to land more towards the midpoint of this range. We continue to expect non-GAAP operating margins for 2014 to be approximately 16.5% and our non-GAAP adjusted EBITDA to be within the range of $152 million to $158 million or 20% of expected total revenues. As I noted in my earlier comments, we are increasing our expected full year 2014 non-GAAP effective income tax rate to 38% from our previous expectation of 36% to 37%. Also unchanged is our 2014 non-GAAP EPS guidance range of $2.05 and $2.17. Consistent with our revenue outlook, we expect that we'll end the year more towards the midpoint of this range. Our guidance assumes a consistent level of outstanding shares for the remainder of the year. We are reducing our expected cash flows from operations to $75 million to $90 million from our previous level of $100 million to $110 million. Our ability to generate strong cash flows from our operations remained solid and was driven by our long-term recurring revenue contracts and profitable operations. We have no concerns regarding our future cash flow generating capabilities. However, we are reducing our cash flow guidance for the remainder of the year to reflect some of the near-term pressures we are experiencing around the working capital items that I mentioned earlier in my comments. We also continue to expect our capital expenditures to be around $30 million for the year. To summarize, while we are disappointed with our overall third quarter financial results, we're pleased with the continued strength of our processing business and the opportunities we see ahead to improve and grow our overall business. Before I turn the call back to the moderator, I want to leave you with a couple of thoughts of why I'm excited about our business. First, we are converting new customers like Cable One and a Tier 2 cable operator off of our competitor's systems and onto our solutions, thanks to our continued innovation in our solutions. Next, we are delivering on our commitments to our new international managed services clients and earning the trust, respect and business that comes from having a strong partner relationship. And finally, we are committed to using our solid balance sheet and cash generation capabilities to enhance our shareholder returns and invest in the future growth of our business. We look forward to sharing our continued successes with you after we wrap up the year. With that, I will turn the call over to the moderator for questions.

[Operator:]

[Operator Instructions] Our first question will come from Howard Smith with First Analysis.

[Howard Smith:]

Yes, I wanted to follow-up on the shortfall you mentioned with the U.S. government, is that in the software and services line?

[Peter E. Kalan:]

Yes, Howard, it is. And it's around our Mediation and our [indiscernible] products.

[Howard Smith:]

Okay. And you've got a few things going on. As you try to do more managed services, sometimes that takes stuff out of software and puts it up in processing as more recurring. But how should we be thinking about on a medium-term basis, the growth and the outlook for that software and services line item?

[Peter E. Kalan:]

Well, one of the things, Howard, that as we go to existing traditional clients and we look to expand our relationship, we're really not displacing the software license revenues because those have already been -- the software has already been deployed and we're really expanding the services scope. And those services works will be shown in processing and managed services. And from a growth perspective, we think there is solid growth that we can achieve long term in our international markets. It's everything from driving our international managed services, as well as really taking and exploiting the position that we've developed around the video and content side in the U.S. and exploiting that, whether that's being with some of our traditional cable management type services, or whether it's Content Direct services over-the-top for the content owners as well as communication providers that want to add adjunct services. We had spoken, I think, in one of our previous conference calls of sizing the international managed services of -- expecting that over a 5-year period, we could generate $50 million to $100 million worth of revenues on an annual recurring basis. And we still believe that we're trending and tracking towards that as we continue to sign contracts and build the backlog, we think we're well on that way. So between those different record characteristics, we have good confidence that we're going to see success internationally. That being said, in areas where we aren't performing as well, we'll be looking to thin some of our spending so that we can drive improved margins along the way.

[Howard Smith:]

Okay. Great. I was just going to take advantage and ask one more, this time on the processing and services line. I know you've got Cable One coming over, you got some growth there. But you've talked in the past about ebbs and flows and kind of the discretionary marketing and sort of other things in that line. I'm just curious if some of the strength this quarter was due to some of that discretionary items coming back, or if it was really just the strength of the underlying subscriber count.

[Randy R. Wiese:]

I think it's a combination of many different things Howard, this quarter. We've got the benefit of some successes around, some of the managed services offering coming through that. We've got some ancillary business coming through you referenced there and the subscriber count remains strong. So it's just an overall good performance on the processing side.

[Operator:]

[Operator Instructions] The next question comes from Tom Roderick with Stifel.

[Tom M. Roderick:]

Peter, let me throw the first question, you mentioned -- you talked a little bit about the migration at Comcast being on track, you've already started the migration process. Can you just go into a little bit deeper detail with respect to -- I know it's not a simple process. And I guess the question is, what sort of challenges are you running up against as you try to migrate those subs? What are you finding out as you go through that? Are there ways to make that process more efficient? Just would love any more detail you can add as far as what you've learned from the migration process already.

[Peter E. Kalan:]

Well, I'm a little dangerous on this because I'll tell you that as we've progressed on this, we believe we're doing exceedingly well. But I'm sure our convergence team in Gregory's would say, you don't know how hard this really is. But we are very good at it. What we do is we work with our domain expertise. And we work in concert with our clients to make sure that their business needs and how they think about standardizing their operations is done in sync with making sure that the migration of existing rate plans and product offerings go from the old system into the new systems such that it's really pretty seamless to the eyes of the consumer on the time that the conversion is complete. While at the same time, helping our clients drive the efficiencies of how they deliver their end operations in their processes within their business. So that means that we really have to work in concert and closely with Comcast to make sure how their business operations are going to be converted and migrated to a standardized world doesn't setback the consumer experience. And the work to date so far in the first -- we've been now at this for 3 months and we're working very much in sync. The scheduling is going, I'd say, in line with our expectations. And what we'd expect is for each subsequent market that we've moved to that, the teams would become even more refined and better kind of being able to work in sync better. The overall is, we're tracking, we expected that 2.3 million subscribers, the first 2.3 million of the 10 million subscribers of Comcast converted by the early part of 2015, and we're tracking well on that. And I can tell you, I don't think we've found anything that's a surprise because we've probably done this better than anybody else. But again the teams had have to do the detail work would probably say, we're very good at it, and we are very good at this, Tom. But don't minimize just because we're good at it, that it's not an easy thing to do because not many other people have been able to do this in the marketplace.

[Tom M. Roderick:]

That's helpful, that's good detail. The second question, I know you guys have been getting this question a lot. And I'd be curious just for your current thinking on the matter. With respect to the impact to margins and you talked a little bit about being able to mitigate that impact as Time Warner, if and when they become folded under the umbrella of the Comcast contract. So I'd love to hear a little bit more detail about what you can do to mitigate that impact. But also maybe the bigger question is at what point do you think you can get back to neutral from an operating margin perspective? Is that kind of a full year affair? Or can you do enough in advance of that maybe midway through next year, you're back at this sort of 16% operating margin level that you're at right now?

[Peter E. Kalan:]

Well, let me give a little more color on pieces, then I'll turn it over to Randy to talk about timing, and what we can expect near term versus longer term on margins because there's multiple things that we're focused on. But first of all, as we've talked in the past, when the Time Warner acquisition by Comcast, if and when it closes, there is an immediate benefit that Comcast will get from repricing the subscribers that Time Warner has on us onto the Comcast pricing. And there's a near-term benefit that Comcast gets that we'll be able to offset that as they bring the roughly 5 million Time Warner subscribers that aren't on us onto our platform, and that's going to drive incremental revenues, along with the 10 million subscribers that we're getting from Comcast. So we see driving of revenue and growing our processing revenues through all those pieces which will bring the opportunity to offset what we do, the impacts from repricing. That, coupled with efficiencies that we think we can drive into the business by combining teams that today may have to support 2 clients into 1, as well as our continual efficiency and the strength that we have in managing our operational structure and the cost that go with that and the way our systems operate, all contribute to how we improve and continue to improve our margin on the ACP processing in the cable business. That, coupled with what we're doing on the international side, is going to help us improve margins. The speed at which that happens, I'll let Randy talk about that and where he kind of sees things near term and long term.

[Randy R. Wiese:]

Yes, I think, Peter, you've touched on a lot of good points. I think the biggest opportunity for us to offset that impact is to bring the 15 million new accounts over to our platform at a very profitable level. That obviously take some time, so this is dependent upon the conversion timeframe and that. But the way I look at it right now, I think within -- probably within the first year, we're going to probably see a little bit of pressure on the margin from this. But I think outside of the, the next 12 to 24 months, we should be able to -- to be able to recoup the revenue, the top line revenue for sure and start to really make some good progress on the bottom line as well.

[Operator:]

[Operator Instructions] And we'll go back to Tom Roderick with Stifel.

[Tom M. Roderick:]

So the other question I was going to ask you was with respect to Europe. There's a lot of questions out there around the health of the economy in general. And I'd be curious particularly as you go after some of these managed services contracts. What are you seeing in the EMEA region? Any concerns of a broader slow down there? Any sort of changes that you've made to the sales force or the structure of that sales force as you've observed the goings on in EMEA?

[Peter E. Kalan:]

From an EMEA perspective, and especially on the western part of Europe, I think we all see that there's the continuing pressure of the Eurozone and what the credit pressures are doing as well as how the economies are responding. But at the same time, we're seeing the pressures that some of our clients are facing, where they want us to take over their operations and help them manage the systems that we've deployed with them. And we've seen that both with MTN South Africa, and the benefits that we're doing there. And we have several other opportunities that we're in discussions with, with clients because they have to find ways to rationalize their own expenses as they face challenges. So that's creating opportunities. All that being said, we're actually seeing, I think, overall, our EMEA market is growing year-over-year. And as we look into 2015, we continue to believe that we'll have growth out of that market. Is it being dampened by some of the economic factors in Western Europe? Most likely. But we still think that with our offerings and our clients that we have, and the things that we're doing, we think we'll continue to see strengthening in that marketplace from what we've seen probably 2 years ago. Randy, I don't know if you have any other options.

[Randy R. Wiese:]

No, I think your summary is good.

[Tom M. Roderick:]

Great. The Content Direct business, so it's pretty apparent you're landing some nice pieces of real estate with that product line. And then it becomes a matter of, I guess, when the volume starts to ramp on it. So the question I'd be curious to learn more about is, at what point should we expect to start seeing some more material impact on the revenue line? How do we think about what that's contributing today? And what we need to see from industry adoption and may be more readily, end consumer adoption to drive the volumes that create the revenues for it?

[Peter E. Kalan:]

Well, it's -- you're asking some very specific items of what are the trigger points and what volumes drive that. I think, I'm going to give you a broader answer to that. We've really been focused on investing for what's an evolution of the content consumption and that consumption is everything from personalization to new ways of delivering, to new ways to pay and also really new entrants. So that's -- whether it's cable operator like Comcast or Time Warner, whether it's a studio or whether it's somebody that's a new aggregator coming to the market, we believe there are going to have needs for a different way of engaging with the end consumer. And because we have such great domain expertise in customer and commerce management around video and entertainment, we think we're in the best position. Now, we're signing studios, we're signing electronic retailers, we're signing the cable and the cable operators. But as we look at this, it's -- you're going to see the benefit of Content Direct coming through in distinct revenues from that product, but it's also helping establish ourselves such that we're winning other market share for our billing platforms. So we're getting a dual benefit of that. Because that -- when we talk about the 250,000 subscribers that we'll be bringing on that we signed, they're recognizing us as the leader in the industry. So how much content, direct as a stand-alone single platform is going to drive is going to be somewhat driven to the economic models that content owners and studios and cable operators drive the balance, and how that ecosystem works and how much goes direct-to-consumer and how much is really done as an extension of the cable offerings or video offerings? And so it's very difficult for me to say, if we can get this adoption rate by the customers, it's going to trigger it. But we know one thing, we have strong confidence that as the leading provider to support studios and cable companies and new entrants, that all our solutions are going to benefit by being viewed as the leader in all types of video monetization and Customer Care around it. And we think that's what's going to be the overall exploitation that we have, whether it's in the U.S. or in markets around the world. So a more general perspective on it that I gave you versus hard numbers, but I think it's almost impossible to estimate hard numbers these days.

[Operator:]

At this time, there are no further questions. I'll now turn the conference back over to you for any additional or closing remarks.

[Peter E. Kalan:]

All right. Thank you, Justin. I'll just close with saying how extremely proud I am of the position that we've established in the markets we serve and the future opportunities that we have in front of us, whether it's Comcast/Time Warner, international managed services or supporting video providers who need to engage with their customers in new ways. And this is only due to the strength of our employees who live our values and deliver on the promises we make, and I thank them. And I look forward on sharing and telling you about our successes in future quarters. With that, we'll close.

[Operator:]

Thank you. That does conclude today's conference call. We do thank you for your participation today.