CSG Systems International Inc (CSGS) 2003 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the CSG Systems third-quarter earnings release conference call.

At this time, all participants are in a listen-only mode.

Following today's presentation, instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today, Tuesday, October 28th of 2003.

I would now like to turn the conference over to Ms. Liz Bauer.

Please go ahead, ma'am.

Thank you.

Today's discussion will contain a number of forward-looking statements, particularly with respect to any financial projections that may arise, the company's ability to successfully deliver on complex implementation projects, manage its international operations, perform satisfactorily under the terms of its contract with Comcast, successfully manage its credit agreement with its lenders, and implement accounts reduction programs which inherently includes a risk of material restructuring charges.

All these statements reflect our best current judgment.

They are subject to risks and uncertainties that could cause actual results to vary.

In addition to the factors noted during the presentation, these risk factors are discussed in more detail in our most recently filed 10-Q, 10-K, and 8-K.

In addition, as many of you know, on October 7th we received the ruling on the arbitration between Comcast and CSG.

The ruling has significant impact on our third-quarter results as we recorded the entire $119.6 million in damages awarded to Comcast in the quarter.

As a result, in order to provide you with additional insight as to how the business performed pre-ruling, which is the basis that we used in providing our third-quarter guidance, today's call will include a discussion of our performance on an adjusted basis, which does not include the impact of the $119.6 million damages award.

Management does not believe that these results are more important than the GAAP performance.

We provide this analysis for additional insight into how the company performed.

If you did not receive a copy of our press release, you can obtain a copy from our website.

We have with us today Neal Hansen, Chairman and Chief Executive Officer;

Jack Pogge, President;

Peter Kalan, Chief Financial Officer;

William Fisher, President of Global Software Services;

Ed Nafus, President of Broadband Services; and Joe Ruble, General Counsel.

Mr. Hansen will begin.

Thank you, Liz, and thank you all for joining us today.

We've had a couple of very busy months, months that included receiving the ruling on the arbitration between CSG and Comcast.

And as Liz stated earlier, my comments today will be referring to our performance on an adjusted basis.

We believe that this allows you to see how we performed against the guidance that we provided you in July, and that guidance did not contemplate the arbitration ruling.

I believe that the third quarter is a great indicator of how the base business is performing, and I'm very pleased with what I'm seeing.

Today I would like to really go over three areas.

First, I would like to provide you with insight as to how the business is performing.

Second, I'd like to spend some time on the arbitration ruling.

And finally, I will share with you what we see going forward.

So let's begin with the business.

On an adjusted basis, CSG generated revenues of $145.1 million, and we achieved adjusted net income per share of 28 cents.

This is the second quarter in a row that we have seen our top and bottom lines increase.

These types of results lead us to be cautiously optimistic that the business environment out there has stabilized.

It is still an extremely challenging and difficult environment, but we do see signs that it is not continuing to deteriorate and, in fact, it may have found the bottom.

I am extremely pleased that our Global Services -- Software Services division continued to make progress towards becoming breakeven.

This quarter, the team had a contribution loss of approximately $900,000, and that was down from last quarter's $2 million contribution loss.

Bill and his team have done a tremendous job of continuing to align expense and revenue expectations.

In addition, we just received the results from our annual customer satisfaction survey, and that survey reflects the first full year that CSG has owned the Kenan and ICMS assets.

I am happy to report that we made gains in all areas measured, areas including product selection, account management, customizations, product support, training and documentation.

Importantly, 95 percent of our respondents say they definitely or probably will continue doing business with us.

This validates the decision we made to add a dedicated account management organization, and that organization is headed by Al Michaels , to service our clients, and the decision as well to continue to invest in our products.

Now this investment in our product set culminated with the introduction of Kenan FX in September.

And Kenan FX is the result of 18 months of very heavy R&D spend, a spend in which we married the best of Kenan's and CSG's products.

This framework consists of pre-integrated modules that are available through a common middle layer.

This simplifies the process and reduces the cost for operators to add new products and services to their infrastructure.

I am very happy that since the mid-September introduction, five customers have signed contracts to upgrade to the Kenan FX framework.

Upgrades of this type help drive professional services revenue in every case and software license revenues in many cases.

Well, in addition to our Kenan FX wins, I am very pleased with the level of activity and the contracts coming out of our sales organization.

A few of the customers that signed contracts with us this quarter include Sky Italia.

They are the DBS provider for Italy.

They are owned by News Corp and Telecom Italia.

This new entity will consolidate two building platforms onto the Kenan platform.

We now do business with three News Corp divisions, including Sky Italia, Sky Mexico and B Sky B. Telecom Italia selected Kenyan/BP as the billing platform of choice for their new international subsidiaries that they have acquired in France and Germany.

This and the Sky Italia win really increases our presence in Telecom Italia where we already do the billing for their residential and commercial wireline businesses.

British Telecom expanded our professional services relationship to include automating several other aspects of their business.

Vodafone Spain added our roaming module and the on-site support services for this quarter, and Vodafone Portugal increased its license for capacity.

Saudi Telecom expanded their use of ICMS for their 3.5 million sub wireline and 7 million GSM customers.

And earlier this quarter, we had announced our entree into China with our first customer care and billing customer, Beijing Telephone.

Again, I'm very pleased with the results that Bill and his team generated this quarter and with the progress that they've made in getting to breakeven in GSS.

Turning to the broadband services division, we are starting to see a slight increase in software and professional services, as our customers look to automate additional operations and to roll out some new services.

This was a good quarter for our Workforce Express solution.

Direct TV expanded the number of seats that they use.

Time Warner expanded the number of seats that they use in two existing sites.

And after the quarter ended, we signed a new contract with Time Warner Los Angeles for our Workforce Express solution.

In addition, we announced in the second quarter the establishment of our North American wireline and wireless service bureau and our first customer, FairPoint Communications.

In fact, the joint team from FairPoint and CSG were just in Denver for a multi-day meeting the last week, and they are very happy with the progress that has been made.

They are on track for their first site conversion onto the system, and that is scheduled for the first quarter of 2004.

In addition, we demonstrated this solution at the USTA trade show a couple of weeks ago, and we were able to generate some great leads from that show.

Finally, we signed our first processing contract with a Wi-Fi provider, Cometa.

Cometa is a venture backed by AT&T, Intel and IBM, and provides wireless broadband Internet access sites in partnership with nationally and regionally branded partners.

With this contract, service providers entering the Wi-Fi market that are using the Cometa network can utilize the CSG retailed billing and customer care solution, and that includes online service marketing, user enrollment, credit card authentication, and processing and online customer care.

As I stated earlier, I believe that our performance in the third quarter was really a true indicator of how our base business is performing.

We are beginning to see strong activity in both the Broadband Services and in the Global Software Services divisions.

We are continuing to align our costs to be more appropriate for the expected revenue levels, and we continue to improve the quality of the service that we provide, as is evidenced by our customer service satisfaction surveys.

Next, I would like to turn the discussion to the Comcast arbitration ruling.

As most of you know, after the quarter ended, we received the ruling from the judge on the Comcast arbitration.

We issued a press release, and we held a conference call on October 8.

And in that, we went through all the details of the announcement.

Today, I would like to provide you with an update as to where we are with the various open items.

First, and most important, we continue to have positive conversations with Comcast.

I am confident that we will be able to establish a working relationship that is beneficial to both companies.

I cannot provide you with a timeframe as to when we will come -- really come up with more definition around that relationship.

But for now, we continue to serve their AT&T Broadband customers, and we plan to do that for a long time.

Second, we asked the judge for clarification on the financial minimums and the calculation for the damages awarded.

The judge responded to us yesterday and has modified the financial minimums and has stood by his original damage award of $119.6 million.

This is consistent with what we booked for total award damages in the third quarter.

Finally, we paid Comcast the uncontested portion of the damages award that amounted to $65 million last week.

In doing so, we felt that it was important to demonstrate to Comcast that we want to get this situation behind us and that we want to work towards restructuring our relationship with a focus on how we can help one another be successful, not spend more money on attorneys.

And now that we have received a clarification from the judge regarding the damages award, we will be paying Comcast the additional $55 million.

Again, the arbitrator has ruled on this case.

We stated from the beginning that we would live with the arbitrator's decision and that we would be forthright and prompt in our disclosures with all of you.

I believe that we've done that.

I would really like to spend my remaining time reviewing with you what you should expect from CSG going forward.

Obviously, as a result in the decrease of revenue that is anticipated from this ruling, the management team has been and is working diligently at realigning expenses and identifying additional areas to gain revenues.

We will be implementing a cost reduction program, a program aimed at eliminating $30 million in costs over the next year.

These reductions will come across-the-board; they'll come from Broadband Services; they'll come from GSS; and they will come from Corporate.

And they will include, among some other things, moving some of our development and support activities to less expensive locales around the world.

We are confident in our ability to get these expense reductions and to get them over the next year, and our outlook that Peter will talk about later contains this guidance.

One thing that I am really heartened to say is that this management team is working extremely well together, working to make some very tough decisions together.

And by the way, our employee base has proactively come to us with ideas on how they can make sacrifices to help us through this challenging time.

I have always said that we have the most talented and the most focused employee base in the world, and their efforts and ideas after the ruling came out really demonstrate that over and over again.

So next, I would like to talk to you a little bit about what we see for the coming year.

In talking to our customers and talking to other leaders in the industry, I am feeling confident in our solution set, and I am feeling confident in the value proposition that we provide in our ability to continue to gain momentum.

In addition, I am pleased to see that the majority of the players in the communications industry are seeing signs of strength in their own business, which, by the way, increases their ability and their willingness to make investments in the customer care and billing systems that they need.

Service providers are seeing the financial benefits from cost reduction measures, and measures that they have been implementing, frankly, over the past couple of years, and that are enabling them to help reduce their debt loads.

Our customers are starting to upgrade for capacity or to upgrade to newer versions of the software that they run.

In addition, they are spending money on solving specific problems that they have, whether that be automating various activities within their IT infrastructure or turning to us to help them maximize the use of systems, they're beginning to spend some money.

In addition, we want to continue the momentum that we've gained over the past year.

We want to capitalize on the fact that we have continued to see improvements in our business quarter after quarter.

We've been planting a lot of seeds, and those seeds will bear fruit for us in the future.

Some of them include, signing our first client in China; introducing our North American Wireline and wireless service bureau; combining our Wi-Fi processing client, in addition to our existing Wi-Fi customers and using our products that are using our product software; expanding into the e-commerce industry and doing so with a marquee customer like eBay; and continuing to expand our product suite to provide pre-integrated modules.

Now, while some may view the arbitration ruling as a setback, frankly, we look at it as an opportunity to get this situation behind us and move forward, rather than focusing our attention on the past.

Your management team has been tremendous job in identifying our next steps, and it's acutely aware that we need to demonstrate to our shareholders, our customers and our employees that we have not and will not miss a beat.

Finally, let me just reiterate why I feel so really positive about our future.

CSG generates cash and makes money.

We are gaining momentum.

We launched several new products, like our North American service bureau and Kenan FX.

We continue to enter new markets and verticals.

We know how to manage the business.

We know how to create shareholder value.

And finally, and maybe most importantly, we do have one of the most talented and dedicated employee bases in the industry.

I am confident that our team will be able to make the necessary adjustments and be able to rise to the occasion and continue to demonstrate why CSG is the market leader.

With that, I would like to turn it over to Peter Kalan and ask him if he would review the financials for you.

Thank you, Neal, and welcome to all of you listening today.

As Neal discussed earlier, although we are not happy with the results of the arbitration ruling, we are glad to have it behind us so that we can focus on our business going forward.

However, the arbitration ruling did have a significant impact on our financial results for the third quarter of 2003.

During the quarter, we recorded the $119.6 million arbitration award as a charge to revenue.

As a result, our GAAP financial results were as follows.

Revenues were $25.5 million.

We had an operating loss of $93.8 million.

And our net loss per diluted share was $1.04.

Adjusting out the impact of the $119.6 million arbitration charge and using an estimated normalized overall income tax rate of 38 percent, CSG performed well in relation to our guidance.

On an adjusted basis, revenues were $145.1 million, in the mid-range of our guidance.

Operating income was $25.8 million, or 18 percent of revenue.

Earnings per diluted share was 28 cents, at the high end of our guidance.

And included in these adjusted results are restructuring charges associated with previously announced cost reduction efforts totaling $3.5 million, which had the effect of reducing earnings per diluted share by 4 cents.

The composition of third-quarter revenues before the impact of the arbitration charge were $92.8 million in processing and related revenues, $24.1 million in maintenance revenues, $17.6 million in professional services revenues and $10.6 million in software revenues.

Total operating expenses, excluding the restructuring charges of $3.5 million, were $115.9 million in the current quarter.

Total expenses excluding the restructuring charge decreased sequentially from the second quarter, in large part, due to legal expenses associated with the arbitration, coming in at $1.1 million for the quarter, which is significantly below our anticipated projection of 4 to $5 million.

For the third quarter, 24 percent of the Company's gross revenues were generated from international markets, consistent with prior quarters.

This consisted of 16 percent from EMEA, 5 percent from Asia-Pacific and 3 percent from Latin America.

Revenue from Comcast before the impact of the arbitration ruling totaled 25 percent of the Company's total revenues, a slight decline from the 26 percent attributed to Comcast in the second quarter of this year.

Based on the arbitrator's ruling and the impact on revenues on a prospective basis, we anticipate that revenues from Comcast will represent approximately 18 percent of total revenues.

We continue to produce very strong cash flows, with cash flow from operations for the third quarter totaling approximately $39.4 million.

This is higher than our traditional normalized cash flows due to our successes in collecting our accounts receivables during the third quarter.

Adjusted earnings before interest, taxes, depreciation and amortization, which excludes the effect of the arbitration ruling, equaled $36.8 million for the third quarter.

Our strong cash flows for the third quarter contributed to the strengthening of the balance sheet.

We finished the third quarter with $144.4 million in cash and short-term investments.

During the third quarter, we made a volunteer $20 million prepayment on our debt facilities, reducing our total debt outstanding to less than $230 million.

Subsequent to the end of the third quarter on October 21st, we paid approximately $65 million to Comcast, which was the undisputed amount of the arbitrator's award.

Based on the arbitrator's subsequent determination that we are liable for the full amount of the damages award, we owe an additional $55 million to Comcast that we intend to pay.

As of October 24th, CSG had cash and short-term investments of approximately $90 million.

We will be working with our banks and with Comcast on our plans for the payment for the remaining damage award.

We have evaluated the impact of the arbitration ruling on our credit agreement as of the end of the third quarter and believe that we are in compliance with the required financial ratios and covenants, and we do not believe that the ruling has resulted in a default to the credit agreement.

However, payments to Comcast for the arbitration award are expected to negatively impact CSG's calculation of EBITDA for the fourth quarter as defined in the credit agreement, which will cause CSG not to meet certain financial ratios and covenants as of December 31, 2003.

Therefore, we have begun discussions with our lenders and are asking for the necessary waiver and/or amendment to the credit agreement to avoid the situation as of year-end.

Since the inception of our current bank facility, we have voluntarily prepaid $70 million in debt and do not have any scheduled principal repayments due until the second quarter of 2004.

There are no scheduled principal repayments for the remainder of 2003, and for the full year 2004 scheduled principal payments total approximately $15 million.

We finished the third quarter with $149 million in net billed accounts receivables, down from $169 million as of the end of the second quarter of 2003.

Our primary measure of accounts receivable turnover, days billed outstanding or DBOs, was 78 days for the third quarter, in excess of our targeted range of 65 to 75 days.

I am very pleased with the progress that we have made in reducing our accounts receivables balance, and the team remains focused in making further improvements in the coming quarters.

As of September 30th, billed accounts receivables related to clients located in India totaled $8.8 million.

This is a decrease from the June 30th balance of $19.3 million.

We expect to collect a substantial portion of the remaining balances by the end of this year 2003.

During the third quarter, we didn't repurchase any shares of the company's stock, and to date since the inception of the company's stock repurchase program, CSG has repurchased 6.3 million shares with 3.7 million shares remaining authorized for repurchase.

I will now turn to a review of the company's business divisions.

Within the Global Software Services division, total revenues for the third quarter were $45.6 million, with a contribution loss of approximately $900,000.

The third-quarter results are an improvement when compared to the contribution loss of $7 million for the first quarter, and the contribution loss of $2 million in the second quarter of this year.

I am confident that Bill and his team have this division on track for being breakeven by the first quarter in 2004, as we communicated earlier in the year.

For the Broadband Services division, I will review the results before the effect of the arbitration ruling and provide you with a basis for looking at this business going forward.

Within the Broadband Services division, total gross revenues were $99.5 million for the third quarter with an adjusted contribution margin of approximately $45 million.

If you factor in the impact from the arbitration ruling, this division had a GAAP contribution loss of $74.6 million.

Incorporated in the reduction in Comcast revenues resulting from the arbitrator's ruling is a change in the way that we count Comcast subscribers for invoicing purposes.

Subscribers with multiple services will now be reflected as a single subscriber in the calculation of the number of subscribers for which we provide processing.

Additionally, we will no longer charge Comcast for certain inactive subscribers.

This will result in a reduction of subscribers and make the comparison of subscriber counts with prior periods meaningless.

As a result, we will also change the way we provide the financial measure of annualized revenue per subscriber.

Instead of separately providing the revenue per subscriber for video and for Internet, we will now provide an average annualized revenue per subscriber regardless of the types of services being delivered.

For the fourth quarter of this year, we would expect that this measure would be between $7.10 and $7.25.

At the end of the third quarter, the broadband division was servicing 47.4 million total subscribers.

When you factor in the impact of the arbitrator's ruling, we had 43.9 million subscribers on our system.

For a more detailed calculation of the number of our subscribers, we have provided analysis in our press release for your review.

We are providing financial guidance for the fourth quarter of 2003 and full-year 2004, taking into account the quarterly revenue reduction awarded to Comcast by the arbitrator.

Additionally, we will be initiating cost reduction initiatives to improve the financial performance of the company.

For the fourth quarter of this year, we expect that revenues will total between $125 million and $132 million.

Within our revenue categories, we expect that processing and related revenues will total between 79 and $80 million, and maintenance revenues will be between 23 million and $25 million.

We also expect that professional services revenues will be between 16 million and $18 million, and license fees will total between 7 million and $9 million for the fourth quarter.

We are slightly lowering our expectations for license fees in the fourth quarter, as the rollout of the Kenan FX product and its add-on modules may in certain circumstances impact our ability to recognize revenue in the near-term.

We finished the third quarter with a software and services backlog of approximately $110 million, in line with the software and services backlog as of the end of the second quarter of this year.

We anticipate that fourth-quarter pretax income will be between 13 million and $15 million.

And as I mentioned earlier, we anticipate that we will initiate cost reduction initiatives in the fourth quarter, but we have not included any restructuring expenses in the fourth quarter financial guidance, as we cannot estimate the restructuring cost at this time.

We are projecting that for the fourth quarter, earnings per diluted share will be between 14 cents and 16 cents.

This is calculated using an effective tax rate of 46 percent, which is higher than our traditional tax rate, primarily as a result of the arbitration ruling.

We are also assuming 51.7 million diluted shares for the fourth quarter.

On a normalized basis going into 2004, we expect that the effective tax rate of the company will be approximately 38 percent.

As we look into 2004, our initial target for full-year revenues is between $520 million and $535 million.

We are committed to improving the financial results of the company, and through our cost reduction efforts that Neal outlined, we anticipate that we will lower our operating expenses for 2004 by approximately $30 million.

We will start to initiate these expense reductions in the fourth quarter of this year, and would expect that we will be incurring restructuring charges as I stated previously.

Based on our initial 2004 revenue targets and our expected success of cost reduction initiatives, we expect that earnings per diluted share will be between 90 cents and $1 for the full-year 2004.

Again, these targeted earnings expectations for 2004 do not include any restructuring charges, as they currently cannot be estimated.

Based on these expectations of revenues and profits, projected cash flow from operations would range between 80 and $100 million, excluding any tax benefits that we may receive in 2004 as a result of the arbitration ruling and payment of the arbitration award.

In summary, excluding the financial impacts of the arbitrator's ruling, we were pleased with the results for the third quarter of this year as we continue to contain cost, improve the contribution margin of the GSS Division, and make significant improvements in the collection of our accounts receivable.

We are now focused on working with Comcast to cement the business relationship between our companies, while at the same time managing the cost of our business to strengthen our financial results in 2004.

We are very confident in the capabilities of the processing services and the strengths of our software assets, and are excited about the opportunities that are in front of us here in the United States and around the world.

I look forward to reporting on our successes next quarter.

With that, I will now turn it over to the moderator for questions.

(OPERATOR INSTRUCTIONS) Todd Rosenbluth with Standard & Poor's Equity Research.

I'm wondering if you can give a little more clarity of the $30 million in cost reductions that you are talking about without -- obviously without restructuring charges.

You're still going to have to bring a lot of costs out of the business to get to 90 cents to $1 dollar, and any more clarity you can provide us would be greatly appreciated.

Todd, this is Peter.

We are looking at several things, as Neal mentioned.

We are looking at finding less expensive locales to do certain pieces of our business from.

We are looking at certain programs within the company to see if we can deliver services within the company at lower cost.

And in some cases, we will be having to reduce the number of employees that we have within the company.

We do anticipate that we will incur a restructuring charge.

I just can't estimate it at this point and, therefore, have not factored that into the numbers at this point.

But we do expect that the initiatives of cost reductions will come across all divisions in the company, both the corporate functions as well as the Broadband and Global Software Services divisions.

Okay, is there a cut expectation in R&D?

We're not in a position to give you specifics of what line items within the income statement that will flow through.

We would expect that we would see cost benefits really across all parts of our business and all parts of the P&L.

And then one last one, I apologize.

Is there other income or investment income that is baked into these '04 numbers that that we should -- that are not normal?

No, it is normal from an interest expense or net interest expense position.

We would expect it to be normal and historical.

And William Fisher has a comment to add to this as well.

Todd, this is William Fisher.

The R&D that we were doing in the GSS group, you can look at it in this manner.

We are going to continue to do the same level of R&D, but we've already got our group working at ways to lower the overall cost of that R&D.

We've been proactive in the company doing work in other locales around the world.

We do a lot of our sustaining engineering and testing now in parts of the world where the resources are a lot cheaper.

So we may end up spending less money on R&D, but not less equivalent as to FTE employees.

Okay, thank you.

Adam Waldo with Lehman Brothers.

Good afternoon everyone.

Peter, I think my questions are mainly for you, since all kinds of things are going on with capital structure and cost base this quarter.

Can you comment on the tone of your discussions with the lenders on the potential 2003 year-end covenant breach, and specifically what areas you see to be at risk in terms of covenant breach and what kind of feedback you've received so far?

Well, Adam, from the impact of the financial covenants, the most significant item is that the payment of the damages awarded will have an impact to the EBITDA.

And hence, our EBITDA multiple that is set within our bank agreement, that is the significant item that first comes to visibility.

From our discussions, I don't want to talk on this form about where we are with the banks except they understand the work that we are undertaking to get a relationship with Comcast cemented.

We are providing them information so that they are comfortable as we continue to run the business during this time, and pursue the waiver and the amendment.

So I think that, in general, we are working together to try to achieve the needs of the business.

Okay, that's helpful.

Can you provide a little more specificity around your 2004 guidance, specifically with respect to what kind of GSS division level profitability you are contemplating for the year overall?

And then also what kind of Comcast revenue base you are contemplating?

Adam, I don't want to go into too much specifics between what we are expecting out of each division or where we expect the expenses to fall specifically.

We have some plans in place, but we are wanting to get those finalized.

We clearly are expecting that the GSS division will be an improved profitability year-over-year.

We have clearly set that as a plan of attack for the business since the first quarter of this year, and based on the progress we've been making this year, we would expect that we will see that come to fruition in 2004.

From the Comcast perspective, you are fully aware that we are looking to make sure that ourselves and Comcast are in sync with where each other want to take businesses.

And at this point, we are keeping a conservative estimate in our numbers for 2004, and that is generally business as usual for ourselves and Comcast, incorporating the new rates that were awarded by the arbitrator.

One final line of questioning.

With respect to the cash tax benefit on the 120 million of MFN damages, can you give us any guidance as to what we should think about in terms of the timing of those cash tax benefits in '04?

And is any of this 120 million likely to be covered by insurance?

On the second half of your question, Adam, based on our review and discussions with our insurance carriers, we do not believe that we have a claim that we can file for the coverage that we have.

And then from the tax benefit on the $120 million payment, we will see a slight benefit in 2003 in the fourth quarter.

But the bulk of it will be late in the first quarter, early in the second quarter, is when we would expect to see the tax benefits or tax refunds coming back.

Thank you all very much.

Tom Ernst with Thomas Weisel Partners.

Good afternoon, thank you.

We've been looking forward to the term-based kind of contracting for a while.

Can you outline with Kenan FX, is this going to be the only way to procure products now in the GSS division, or is it still going to be flexible with the customers?

This is William Fisher.

No, it's not the only way.

As I commented probably the first time I ever talked about it, Tom, this is something we will gradually get the customer base into doing.

We continue each quarter to assign new term contracts.

I don't know the exact count now, but every quarter we add additional customers on term basis.

We continue to also license customers on the old perpetual basis, and I expect that to continue for us actually the not too distant future.

The previous experience I have in another company in doing that, it took us 7 years to get half the customers converted.

So it's a slow process.

Okay.

You were talking about seeing the environment improve.

I think this is one obscuring factor.

Maybe you can help us understand with other metrics perhaps, because the guidance to me, if I'm doing the math right, looks like essentially a flattish kind of quarterly guidance Q4 versus Q3.

If we look at, say, some of your competitors that have announced already, they sound pretty bleak.

Specifically, Convergys' talk about the environment sounded like they thought it was getting much worse.

Maybe help us understand competitively what is happening and maybe if you've got any way to help us understand behind the moving pieces here why you are so encouraged in terms of things getting better?

I really can't speak for the competitors, Convergys or Amdocs or any of the other ones.

But I would tell you that part of it is my team is probably hitting the ground better now than they were.

They've got seasoning, and then we've changed a lot in that team.

I think we've gotten very close to our current customer base.

We derive a lot of revenue out of that customer base for upgrades, not only for capacity but also for functionality.

We've actually just continued to do very well in Europe.

The team over there may be the best team we have.

We are still competing hard with the competitors, and we are not winning all the deals.

They win some.

We just appear, I think, to be getting our fair share, maybe a little bit more than that.

The new functionality, the monies that we've spent in the last year and a half in R&D are paying off for us.

When we show our new products, our customers are excited.

Our prospects are excited because they see it saving them money.

And it is integrated front-end and back-end, and I think not integrated vaporware; it is integrated with real live code.

So I think they are seeing the value of how that can work in their environment.

So I don't think you would get any of us to say that we are overly optimistic.

I just think that we feel like the position we have in the marketplace is good.

We have good strength in international marketplaces, and the team just seems to be overall working a little better together.

If I could just interject, we told you when we bought Kenan that Lucent had broken that pretty badly, including the sales organization.

And we told you that what we were going to do was aggressively go back to the customer base, and that was one of the things that we'd found that Lucent hadn't done.

We told you we were going to build an organization, and I guess what I would say is what I am seeing is just the management things that Bill and his crew have done; they're paying dividends.

I go to EMEA, go to Europe, and it is just apparent that you're in an organization where the information flows.

And as deals are coming about, they are on the deals.

So I think we are just executing against a plan, and we are getting opportunities and good opportunities at the things that are out there.

Tom, this is Peter.

Just to add some more to this; from the broadband services side, we need to get our relationship with Comcast clearly cemented during this time.

But separate from that, we don't have significant renewals coming up in 2004 with the exception of Echostar, which is late in 2004.

So we don't really have what we would view as significant business risk within the broadband services division.

And we believe that we have some stability in there and look forward to proving that out in 2004.

So it sounds like more confidence on the organizational coherence, I guess, and what you're seeing with the products.

Are you also confident, though, in terms of the environment is offering perhaps more opportunities, and if so, is that both large and small?

I think if I were to say the environment was going down every quarter that we spoke to you, that certainly has decelerated in what we see, and maybe we are down towards the bottom where the environment is.

So that is encouraging.

And I think just the team is pulling together, and I think the dollars that we invested both in GSS and in broadband in new products are paying dividends, and I think particularly in broadband we'll pay some big dividends going forward.

Okay, thank you.

Marianne Wolk with Susquehanna.

I had a couple of quick questions.

First of all, can I assume that your guidance does not assume any subscriber losses with Comcast for 2004?

At this point, we are maintaining for purposes of this guidance that the Comcast subscriber stays the same.

That will be something that we look to get further clarity on as we work with the relationship with Comcast.

To that end, have they been willing to meet with you to sit down to try to come up with a longer-term solution?

I'm not sure it would be appropriate for us to discuss in this forum what we're doing with our client.

Just one other quick questions for Peter then.

Can you confirm that Echostar's ARPU right now is in line with the $7.10 and $7.25 average that you just talked out, or is there risk related to that renewal on the pricing side?

I don't want to get into the specifics of where each customer is in relation.

I think that our business team, as they work with our clients on the value proposition, has proven over time that we are able to prove our value for -- the service for the price point.

So I'm not going to go into the specifics of that, Marianne.

Thank you very much.

Matt Reinger with Yenco Partners.

I was wondering if you could give a little more color, help me get my arms around the contractual monthly minimums that remain in place as it relates to Comcast, and maybe help us quantify what that's going to look like going into 2004, 2005.

And secondly, at this point what type of legal expenses are you guys factoring into your guidance for Q4 and beyond?

Can I assume at this point that the majority of the legal costs related to Comcast are gone?

Matt, let me first start with the legal fees, and then we'll address your other question.

We've spent about $1.1 million in the third quarter, and we would anticipate that our legal cost would be insignificant as we move forward in the fourth quarter, as we are really focusing at this point on the business relationship and not on litigation.

This is Jack.

As far as the minimums are concerned, we really aren't focusing on those.

We're focusing on trying to restructure our relationship with Comcast.

We are currently processing approximately 13 million subscribers for Comcast, and we intend to do our best to keep that business going forward.

Under the existing contract that is in place, our exclusivity for the AT&T Broadband customer still remains in place.

So it is a simple mathematical equation of multiplying the new rates and fees that the judge imposed upon us against the number of subscribers that we process for Comcast.

Great, thanks.

Thomas P. Vincent with Smith Barney.

Just a quick follow-up on the previous question.

Peter, you said early in the call that you expect Comcast to go 18 percent of revenues.

Was that in the fourth quarter, or is that -- would you build in for the full year '04?

That was my focus for the fourth quarter.

Okay.

Could you, on the covenant issue and the discussions you had with your lenders, can you maybe just provide some color on when you would expect to be able to actually meet those covenants during the normal course of business?

So is this a one or two-quarter issue, or would this be an issue throughout the entire year?

Well, it depends on what type of waiver that -- or amendment that we get constructed, but if we were to be able to have an agreement where you would exclude the impact of the arbitration award, I think we would feel pretty comfortable that our performance relative to all of the covenants would be satisfactory.

The numbers I gave you that we think we can achieve for 2004 show very strong cash flow.

It shows that we have the ability to service the debt, and if you were to carry those numbers and do an EBITDA projection, you would see that we would have very strong EBITDA into 2004 as well.

Okay, what if you assume that you will not be able to get a waiver on the covenants?

How long would it take you to get to the covenants?

To get back to the covenants?

Yes.

Well, we would be out of compliance, we believe, as of 12-31-2003, and potentially could be for a couple of quarters, but that is not our focus.

We are very focused on working an amendment and covenant modification with the bank group, and we believe that is in the best interest of all parties.

Okay.

And on the maintenance contracts, can you just highlight how many of your contracts that were up for renewal this quarter that you actually were able to renew, and if you had any success in renewing some of the previous outstanding maintenance contracts that still haven't been renewed?

This is William Fisher.

Most of those maintenance contracts are in the GSS group.

I don't have a count for you.

I would say high 90 -- 95 percent of them.

No material issues with anybody that we thought would renew that didn't.

I just don't do the specific counts, don't have those.

Tom, this is Peter.

We did have some of the prior ones that previously had not renewed in either first or second quarter, did renew in the third quarter.

For note, we did pick up a little bit of revenue of catch-up for the year.

That was built into the results that we announced in the third quarter, and those renewals have been fully projected into our fourth-quarter guidance that I gave you as well.

We can try to get those numbers to you separately on a follow-up call.

Okay, that's great.

And my last question, you mentioned that five customers -- or five customers had signed up for the new Kenan FX.

Could you maybe provide some color on what type of customers that is and what they will be using the Kenan FX for?

They are primarily wireline or wireless billing customers.

They're located kind of around the world.

There were three of them that were existing and two were new that we won in a competition.

So not small customers with some volume.

Beyond that, I can't really give you much specific until we can get it released or be able to release the press release on it.

That's great.

Thank you very much.

Russ Dukruth with Sterling Capital.

This is a question for William Fisher.

Do you have an idea of how much revenue you're capable of doing in GSS with the current headcount in GSS?

I get asked this by my boss all the time.

This is a product software company, and the leverage is in license fees.

I think we've covered this in previous quarters.

My ability to get incremental license fees, you know, this is a business that ought to have license fees close to 50 percent of its revenue.

Given you do that, you're going to have to add some implementation staff, but we are basically running the business now because of the marketplace we've been in under tough results to get license fees in the business.

But if you were able to see that free up and thus generate a lot more license fees, we will get them from upgrades which require no people for capacity.

And, by the way, these networks -- that's why we got close to this current customer base -- these networks are growing and they need upgrade capacity.

And then we will get upgrades for functionality and new customers, and that will pick up in our license fee number and it will pick up in our services number.

That's really where the leverage is in the business, and what you've got, as everyone is telling you, is a huge downcycle in the customers being able to buy licenses.

So I don't know that Bill and I are going to quantify the number.

No, I'm not going to give you a number.

But there's substantial leverage available for us.

Yes, a lot of leverage room in license fees.

Okay, so do you think it is possible at some point that the 50 percent might be doable in more normal times?

Historically, I think you see application software companies that are running well do that.

Okay, thank you very much.

Sameer Bhasin with Okumus Capital.

This is Sameer Bhasin.

My first point is, first of all, I wanted to applaud you guys for the actions you took on October 8th.

I've never seen a management that within 12 hours it'll put a negative release out there and also quantify it with knowing that their stock would get hit.

So I truly applaud you guys for that action.

So having said that, just a few quick questions.

First is, what is your estimate for CAPEX next year?

We would expect that CAPEX based on normal business would be somewhere 10 to $15 million.

Okay, and D&A?

We would probably look at depreciation and amortization to be somewhere around $40 million, approximately.

Okay, and so on an after-tax basis, obviously the impact of the 120 million is about 75 million.

I know it's simple;

I just wanted to make sure that's --.

The effective tax rate that we will receive a refund on or get a tax benefit on is approximately 37 percent, is what our tax advisers are telling us.

Right, so the net-net payment if you back that out is 75 million?

Yes, that's approximate, yes.

And you said 80 to 100 million cash in operations in '04?

Yes.

Got it.

That's excluding any tax benefit that would be recognized next year.

Okay.

And when you're providing 2004 guidance, you are assuming or you have some estimate as to what ancillary services that Comcast may or may not be taking, and you have an idea as to how your relationship is going to progress going forward in terms of the service you're going to provide.

That is baked in your guidance?

We've made general estimates, but again, we will be looking to get further clarity as we work our relationship with Comcast in the coming weeks.

Got it.

And final question is, I know it might be too early, but at what point would you consider a stock buyback given the extreme undervaluation as where your stock is trading at right now?

You're aware that we do have a program that we still have 3.7 million shares authorized.

Our Security Council is advising us until we get public information with clarity around where we're going with Comcast in a relationship that we should refrain from being in the public markets.

So we will look to get that resolved before we become active again.

Okay.

Thanks, once again, and great job.

We have time for one more question.

Mr. Su (indiscernible) with Edison Capital Partners.

I have one question -- I have actually a couple of questions.

The first one relates to the R&D cycle.

If you just exclude the cost reduction efforts that you have, just related to the product cycle given that you have completed it in 18 months, a significant R&D project, would you anticipate your R&D to go down just because of that?

Yes, I want to be careful when I answer here, because R&D is a little about cycles but also about sustaining investment in the product.

We have had a timeframe here where we've spent quite a bit of money on our new product, the FX product, and primarily on integrating the front-end.

And we are coming to the end of that, so you would expect that you'd see spending decrease as it relates to that particular part of the product set.

However, we have an energized customer set now who wants to buy from us, and I would say that we have a list of items that we feel will bring us revenue in the future that we are going to look at spending that money on.

I am really focused on trying to get more bang for my buck and not reduce my FTEs.

I reduced my R&D expenditure by moving it into parts of the world where it will cost me less money.

Okay, thank you.

And my final question relates to your ARPU guidance.

Just for reference's sake, could you give us the ARPU for this quarter?

Composite would be good and if you could (indiscernible) the (indiscernible) for Q3 with year-end into that, that would be great.

I don't have those numbers where they would be reflective of the change coming about from the judge's award.

I can give you the composite of what they were before the award and what the numbers were individually before the award.

But I think it's probably best just to discuss that off-line, and if you could call into our offices, I can probably make sure I answer your question correctly.

Okay.

With that, maybe I could wrap it up and thank each of you for joining us.

Let me just reiterate, CSG is a great company.

We generate cash and we make money.

We have great and terrific products, and by the way, we have a wonderful employee base and management team that remains committed to drive it forward.

So looking forward to seeing you and talking to you next quarter.

Thank you.

Ladies and gentlemen, this concludes the CSG systems third-quarter earnings release conference call.

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