CSG Systems -- A Fundamental, In-Depth Review (CSGS)

| About: CSG Systems (CSGS)

Telecom billing service provider CSG Systems (NASDAQ:CSGS) posted $0.33 EPS in the first quarter, $0.02 ahead of the consensus estimates. A review of the 10Q indicates that the company, which has both bought and sold businesses in the last several months, remains a stable cash flow generator.

The absence of the lavish retirement payout to the former CEO last year made margin comparisons favorable. However, with one customer representing 24 per cent of sales and the top five accounting for 71 per cent, investors need to beware the potential loss of a top client. Further, looking at past trading patterns suggests investors may be wise to sell in May and wait awhile.

Income statement analysis

Sales growth - Processing and related services revenues for the three months ended March 31, 2006 increased $3.1 million or 3.8% to $86.4 million, from $83.3 million for the three months ended March 31, 2005. Software, maintenance and services revenues decreased $3.4 million, or 33.9% to $6.5 million, from $9.9 million. The decrease between periods is related primarily to several large software transactions in the first quarter of 2005 for workforce automation and call center products, with no comparable amounts in the first quarter of 2006.

Seasonality - the nature of the business does not result in seasonal fluctuation of revenues. However, like many tech stocks the company tends to do poorly in the summer months. This chart from Thomsonfn illustrates this all too clearly.

Earnings quality

· Capitalization of expenses – The company’s acquisition of Telution on March 1 resulted in capitalized software of $8.7 million, client contracts of $0.5 million, and goodwill of $9.8 million. Had the company developed these assets internally the associated expense recorded on the income statement would have been significantly higher in the current period.

· Operating margins - SG&A expense for the three months ended March 31, 2006 decreased 32.0% to $9.9 million, from $14.6 million for the three months ended March 31, 2005. As a percentage of total revenues, SG&A expense was 10.7% for the three months ended March 31, 2006 as compared to 15.7% for the three months ended March 31, 2005. The decrease in SG&A expense between periods is primarily due to: (i) the $4.2 million of retirement benefits for former CEO, Mr. Hansen, recorded in the first quarter of 2005, compared to $0.1 million in the first quarter of 2006; and to a much lesser degree, (ii) certain restructuring activities implemented in the fourth quarter of 2005.

· Stock options – the company has been expensing stock options since 2003. However, the shift to FAS 123R, which requires companies to estimate forfeitures in advance rather than recognizing them at the time of forfeiture as previously, makes for some invalid comparisons.

Balance sheet analysis

Debt load and maturity schedule - $230 million.

Value of unexercised options – unexercised options have an intrinsic (minimum) value of $8.2 million, which some consider to be an off-balance sheet liability.


· Doubtful accounts – the allowance for doubtful accounts decreased despite an increase in both sales and accounts receivable. However, adjusting the income statement to reflect the rate prevalent last quarter was immaterial to EPS.

Cash flow analysis

Operating cash flow and net income were both up on a year/year basis, although net income grew faster (from $8.6 million to $15.5 million, compared to growth from $18.9 million to $22.0 million for cash flow.)

Capital investment relative to depreciation – capex and depreciation were roughly equal, indicative of the company’s maturity.


Legal issues - none

Social concerns – none apparent

Growth indicators

Guidance – the company expects quarterly operating income to trend down slightly over the remainder of 2006 due primarily to the inclusion of Telution’s expected results of operations. From the Q1 earnings press release:

For the second quarter of 2006, we are expecting revenues of between $91 million and $93 million and GAAP earnings per diluted share of between 30 and 31 cents. In addition, there are approximately $9.8 million of non-cash items included in our second quarter earnings per share guidance. These non-cash items include intangible asset amortization of approximately $4.4 million, depreciation expense of approximately $2.6 million, and stock-based employee compensation expense of approximately $2.8 million.

For the full-year 2006, revenues are expected to be between $371 million and $381 million, and GAAP earnings per diluted share of between $1.28 and $1.35. The revised numbers take into account the Telution acquisition and the higher than expected interest and investment income than was originally expected in the company’s January guidance.

Backlogs – N/A

Deferred revenue and client deposits grew, in aggregate, from $29 million to $38 million in the first quarter of 2006.

CSGS 1-yr chart: