CSG Systems International Inc (CSGS) 2004 Q2 法說會逐字稿

Good afternoon ladies and gentlemen and welcome to the second quarter earnings release conference call.. [OPERATOR INSTRUCTIONS].

I would like to now turn the conference over to Miss Liz Bauer, Senior Vice President of Investor Relations, 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 perform satisfactorily and maintain good customer relations with its customers, provide products and services that meet the needs of the marketplace, manage our international operations, which by nature is much more complex and carries a higher collection risk, and our ability to successfully deliver on lengthy and/or complex implementation projects.

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

In addition, if you did not receive a copy of our press release, you can obtain a copy from our Web site.

We have with us today Neal Hansen, Chairman and Chief Executive Officer, Peter Kalan, Chief Financial Officer, Ed Nafus, President of our Broadband Services Division, Alan Michels, Senior Vice President of our Global Software Services Division and Sally Else, Senior Vice President of our Strategic Initiatives Group.

Mr. Hansen will begin.

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

This quarter, we achieved revenues of $129.7 million and GAAP earnings per diluted share of $0.15.

Those earnings were reduced by a one-time charge of $0.08 per diluted share as a result of our early debt retirement.

Today, I'd like to discuss three areas.

First, I will review the changes that we have made regarding our capital structure and the organization this quarter.

Second, I will provide an overview of how our two divisions performed and finally, I'd like to provide some insight as to what we are seeing in the marketplace and why we are optimistic about the future.

Let me begin with the changes that we've made to the business.

In June, we completed a very successful $230 million contingent convertible debt offering.

As many of you may recall, we ended the first quarter with approximately $199 million in bank debt.

This bank debt was extremely restrictive.

In general, the old bank debt required us to take the strong cash flow that we generate from the business and to use it only for paying down the debt.

We could not make acquisitions.

We could not buy back stock, and we could not invest in the business.

With the new debt, these restrictions are gone and now we can invest in growing the company.

Part of our investment includes investing in our people.

Last October after the arbitration ruling, we made a very difficult decision and among other things, froze our employees' salaries.

I'm pleased to announce that we are lifting this freeze and we're implementing salary increases for our employees in the third quarter.

This is two quarters earlier than we had planned.

Next, we have flattened our organization so that we do not have as many layers between the various organizations within the company and myself.

I've added each of the regional general managers, our Chief Technology Officer, and our worldwide delivery organizations as my direct reports.

This allows me to be more involved in large sales transactions and in prospecting.

I recently completed a tour of a significant number of our offices in Asia, Europe and North America, and I had the opportunity to meet with our employees, our customers, prospects and partners.

Several messages resonated with the various offices -- audiences.

In Asia Pacific there is money to be spent because there are markets like China and India that are expanding.

However, the approaches must be different because even though there is phenomenal growth, there are dramatically different price points that have to be met.

In Europe, our products are an integral part of our customers' operations.

Our customers are looking to streamline their operations so that they are much more effective and efficient.

Many of them are asking us to get more involved in those operations.

Whether that be working more closely with their systems integrators or working more closely with their own employees.

Finally, customers and prospects were not talking to me about adding more features and functionality to our products.

They asked me to help institutionalize and share with them our expertise in running large-scale operations, in consolidating numerous billing systems onto one platform and in leveraging both the technology and the people assets to help run their businesses more profitably.

In addition to these meetings, I have been attending the operating sessions of our delivery, our CPO and our sales organizations.

These sessions have reaffirmed what we have known, and that is that over the past few years, there have not been that many deals out there for anyone, but of the deals that have occurred, CSG has won its fair share.

Our customers are a very strong asset for us to sell additional products and services into and our sales organization is becoming much more effective and our account management organization is improving our customers' satisfaction with CSG.

Next, our products are being well received in the marketplace validating the investment that we have continued to make for over 10 years.

And finally, the deals that are out there are much bigger than what we have seen over the past several years.

As a result, partners become more and more important to us.

Based on input from our customers, our prospects, our partners, and our employees, I believe that we are pursuing the right opportunities to set this company up for future growth.

Well, next, I'd like to share with you how our broadband services division and our global software services division performed this quarter.

Let's start with broadband services.

This quarter, we continue to strengthen our relationship with Time Warner.

Not only have we helped several Time Warner locations roll out voiceover IP services, we have also sold a financial product into 21 Time Warner sites that are not using CSG as their billing platform.

Next, we signed a new 5-year agreement with Adelphia Communications.

That agreement includes the delivery of voiceover IP services.

The bankruptcy court approved this agreement during the quarter, and in addition, Adelphia expanded its use of all of our call center applications.

Finally, we continued the migration of several of our customers to our re-architected processing platform.

We expect that the majority of our customers will be fully migrated by the end of 2005.

Let me turn now to our global software services division.

During the second quarter, we sold six additional licenses for Kenan FX.

Of those six, three were with brand new customers to CSG.

Two of those new customers are located in China, Sichuan Telecom and Shanghai Telecom.

To date since the introduction of Kenan FX last fall, we have 16 customers signed up for the product.

This quarter, US LEC, an existing customer who provides integrated voice, data and Internet services to businesses and enterprises in the Eastern United States deployed FX.

This deployment is important as US LEC is using a majority of the products in the Kenan FX business framework.

In addition, we've continued to expand our relationship with customers in every geographic region.

For example, some of our wins this quarter included upgrades for GCI in North America, BellSouth Ecuador in South America, Casema in Europe and BSNL in India.

Customers like 02 in Germany, British Telecom and Easy Link, formerly AT&T Worldnet, continue to turn our professional services organization for expertise.

Finally, let me summarize my comments today with why I am optimistic about our future.

First, we are seeing very large opportunities as a result of the market expansion of billing consolidations.

These opportunities require investments and creative thinking and these certainly are two of CSG's strengths.

Second, providers are looking for ways to increase their revenues and decrease their cost.

As a result there's growing interest in outsourced solutions, and we believe that we are well positioned to help operators.

Third, our customers are being successful in rolling out new services like voiceover IP, MMF services, push-to-talk and others.

As our customers grow, we grow.

Finally, we have much more freedom to invest in our business and in our customers as a result of our new capital structure.

This will allow us to be much more competitive and strengthen our business.

Next, I'd like to hand it over to Peter Kalan, our Chief Financial Officer and ask Peter to review the financials in more detail with you.

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

I am pleased to report the financial results for our most recently completed quarter in which, overall, we achieved our targeted expectations positioning us for continued strong financial performance.

For the second quarter ended June 30, 2004, total revenue was $129.7 million and net income under generally accepted accounting principles was $7.8 million, or $0.15 per diluted share.

Net income was reduced by $0.08 per diluted share as a result of the write-off of deferred financing costs related to our previous bank debt, which was repaid during the quarter.

Processing revenues totaled $80.9 million for the second quarter.

The second quarter processing fees include the full quarter impact of the change in amortization related to the Comcast client contract intangible.

The amortization of the client contract intangible is reflected as an offset to processing revenues.

During the second quarter, we signed a new processing agreement with Adelphia and also sold approximately $8 million in pre-bankruptcy Adelphia accounts receivable to a third party.

This sales transaction resulted in approximately $1.2 million of pre-bankruptcy processing revenues being recognized in the second quarter, which had previously been deferred.

Software maintenance revenues totaled $23.7 million for the second quarter, which was slightly lower than our previously communicated expectations.

Our second quarter expectations had anticipated some one-time fees primarily from smaller clients whose maintenance contracts had lapsed in prior quarters.

We continue to work to renew these maintenance contracts.

Overall, our maintenance services and revenues continue to be very steady and consistent and are indicative of the strength of our client relationships.

Professional services revenues totaled $17 million for the second quarter driven by installation of Kenan FX upgrades and new product module installations.

Software license revenues for the second quarter were $8.1 million.

For the second quarter, 26% of CSG's total revenues were derived from international markets, which was consistent with the first quarter of this year.

Within the world regions, AMEA contributed 16% total revenues, Asia Pacific generated 7% and Latin America delivered 3%.

Revenue from our largest client, Comcast was approximately 15% of the company's total revenues for the second quarter.

We continue to expect that revenues from Comcast will be in line with their contractual minimums.

Total expenses for the second quarter were approximately $108 million, in line with the first quarter total expenses.

During the second quarter, we had two events of significance that effectively offset each other within our reported expenses.

Primarily as a result of the previously mentioned sale of the Adelphia receivables, the allowance for bad debts was reduced, which resulted in a expense benefit of approximately $3 million.

Also in the second quarter, we incurred approximately $2.5 million of expense associated with the changes in certain executive management.

These expenses are reflected within the corporate segment and are classified within the SG&A category.

The second quarter gross margin was 48%, which is a sequential decline from the first quarter as expenses associated with revenues increased to approximately $3 million.

We continue to see opportunities both in the broadband division and GSS and we are starting to spend an increased amount on delivery and operations as our products and services are brought to market.

The operating margin for the second quarter was approximately 17% and restructuring expenses for the quarter were negligible, as we have completed our expense reduction initiatives.

For the second quarter, non-cash stock base compensation charges were $3.8 million and depreciation expense was $3.5 million.

Amortization of intangibles totaled $7.3 million for the second quarter of 2004, which compares to $6.3 million of expense in the first quarter of this year.

These non-cash charges totaled $14.6 million for the second quarter.

Turning to the company's divisional results, the broadband services division generated $86 million in revenues for the second quarter and produced a contribution margin of $37.3 million, or 43% of revenues.

Total non-cash charges within the broadband services division totaled $5.8 million for the second quarter.

We finished the second quarter with $43.7 million subscriber accounts on our processing system.

The average annualized revenue per subscriber for the second quarter was $7.42.

One-time revenues associated with the sale of Adelphia pre-bankruptcy receivables contributed $0.12 to the annualized second quarter revenue per subscriber.

We anticipate that, for the third quarter, the annualized revenue per subscriber will range $7.10 and $7.25.

CSG's global software division produced $7.3 million in revenues for the second quarter with a contribution margin of approximately $1 million.

The second quarter results for the global software services division included non-cash charges of $5.5 million associated with amortization of intangibles, stock-based compensation and depreciation.

As of June 30, our billed trade accounts receivable totaled approximately $124 million, net of the allowance for bad debts of approximately $7 million.

This compares to the March 31 net billed trade receivables balance of approximately $138 million.

This sequential improvement is primarily the result of successful cash collections and also reflects the sale of the Adelphia receivables.

The billed trade accounts receivables reflected days billed outstanding, or DBOs, of 66 days for the second quarter, consistent with the first quarter level.

This is within our communicated target range of 65 to 75 days.

Cash flows from operations for the second quarter were approximately $40 million with the sale of the Adelphia receivables and the higher than normal collection receivables contributing approximately $14 million.

In June, we completed an offering of $230 million of 2.5% senior subordinated convertible contingent debt securities in a private placement.

We used the proceeds from the debt securities along the available cash to repay the $199 million of bank debt and terminate the bank facility and also repurchased 2.1 million shares of our common stock for $40 million.

The convertible securities have a maturity of June 15, 2024.

As previously communicated in June, these transactions will result in lower interest expense going forward and also a reduced number of shares outstanding, which is expected to be accretive by approximately $0.03 per quarter.

For the second quarter, due to the timing of the convertible offering, earnings per diluted share were positively impacted by $0.01.

Under current accounting rules, the convertible contingent debt will not impact the computation of diluted earnings per share until the holders have the right to convert the debt securities into CSG's common stock.

However, the accounting standards organizations are reviewing the accounting treatment for contingent convertible debt instruments and may change the current accounting treatment, which could cause CSG to report dilution in its diluted shares, diluted earnings per share.

As of June 30, 2004, cash and short-term investments totaled approximately $131 million.

We have a business that generates strong cash flows and we are focused on reinvesting our cash back into the business.

We will look for opportunities to increase our market share through putting our money to work in processing opportunities, and we are also focused on acquiring fill-in technologies and also are looking at additional markets to attack with our software and operating skills.

Finally, we will look for opportunities to repurchase our stock.

In the second quarter, the board of directors authorized an additional 5 million shares for repurchase, increasing the total authorized shares for repurchase to 15 million.

With the 2.1 million shares repurchased concurrent with the issuance of the convertible debt, CSG has repurchased a total of 8.5 million shares since the authorization of the stock repurchase program.

And as of June 30th, there are 6.5 million shares remaining authorized for repurchase under the program.

For the third quarter of 2004, we are expecting that revenues will range between $126 million and $133 million.

We anticipate that processing revenues will be between $79 and $80 million and that maintenance revenues will range between $23 and $24 million consistent with the second quarter.

Even though the third quarter is a period with significant seasonality within our European business, we are projecting that services revenues and license revenues will be consistent with our second quarter guidance.

We expect that services revenues will total between $16 and $18 million and software license fees will range between $8 and $11 million.

As of June 30, our software and services backlog totaled approximately $112 million.

We expect to recognize this software and services backlog over the next 12 months.

The software and services backlog, along with the visibility that we have in processing revenues, provide a 12-month backlog of total revenues of approximately $425 million.

As a result of the activities of our broadband clients and our support of the rollout of voiceover IP along with the success that we are experiencing overseas in Asia Pacific, we are increasing our staff and expenses within our delivery and support functions.

We're excited about the opportunities that we're seeing and will invest to ensure that we are successful in supporting our clients' offerings and business needs.

We expect that the revenue associated with these investments will become visible in coming quarters.

Coupled with the implementation of the wage increase that Neal mentioned in his comments, we expect with this investment in voiceover IP in our Asia market that expenses will increase for the second half of the year.

We are projecting that total expenses in the third quarter will be between $109 million and $112 million.

Included in these projected expenses are amortization charges of approximately $7 million, depreciation expenses of approximately $4 million, and stock-based compensation charges of approximately $4 million.

Based on these targeted revenues and expenses, we anticipate that earnings per diluted share for the third quarter will be between $0.19 and $0.24.

For the full year, we continue to expect that revenues will total between $515 million and $530 million and that the composition of the revenues will be generally consistent with the third quarter projections.

With the additional expenses projected in the second half of the year, we project that our operating margins for the full year will range between 16% and 17%.

Included in these projections are non-cash amortization charges of $27 million, depreciation of $14 million and stock-based compensation of -- expense of approximately $15 million.

We expect that GAAP earnings per share will be between $0.77 and $0.87, which includes the reduction of $0.08 per diluted share associated with the write-off of deferred financing costs resulting from the repayment of the bank debt in the second quarter and also includes a reduction of $0.02 per diluted share associated with the restructuring expenses incurred in the first quarter.

These earnings per diluted share estimates are calculated based upon projected average shares of approximately 51.5 million for the full year 2004, which includes the benefit of the share repurchases completed in the second quarter.

We expect that cash flow from operations will range between $115 and $130 million for the full year, which is an increase from our prior guidance.

In closing, we are pleased with the financial results for the second quarter, and we are excited about the voice activities that we are seeing within our broadband business and the expansion activities occurring in Asia.

We intend to aggressively compete for business, but we are also focused on continuing to generate profits and strong cash flows.

We are well positioned with the flexibility of our capital structure to invest in our business and also optimize returns to our shareholders.

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

Thank you, sir. [OPERATOR INSTRUCTIONS].

Our first question comes from Marianne Wolk from Susquehanna.

Please go ahead with your question.

A couple of questions.

Peter, can you give us a better feeling for where those incremental expenses will occur in the second half?

Are we talking about broadband and voiceover IP for broadband?

Are these expenses that are likely to be focused on the Telecom division?

Secondly, you gave us a 16 to 17% operating margin target for the second half.

Can you give us a sense of where you think you might go once you've made these investments and we start to get some leverage?

Thanks.

OK, Marianne, on the first question of where the expense increases will be, I guess the first point to look at is the wage increases will be across the board in all the segments that we report.

But specifically when we look at investments in incremental staff and resources, it's going to be both within the broadband side around the voiceover IP initiatives and the other types of new offerings that they're having, but specifically, we see voiceover IP in the near term and it will be delivery and support organizations and operational support for that business.

But we also see it in our GSS division within Asia Pacific, support organizations, delivery organizations in those markets, as, well as we work with our partners to rollout these new systems that we've signed up and we have expectations that we'll continue to be successful in that market.

Is it 60/40, 70/30?

Can you give us some sense of the split between the two divisions?

I think you would expect it to be fairly comparable between the two at this point.

So 50/50.

What kind of margin targets would you expect going out a little bit?

I'd like to give you really hard and fast numbers on that, Marianne, but some of this is going to be dependent upon how fast and how successful our clients are in the rollout of their services.

Voiceover IP, we believe strongly that our clients have a very strong plant to offer services, but dependent upon how successful they are in rolling out and getting volumes on where we then get to see the revenues, will affect what those margins would be.

So I'm hesitant to try to model that out at this point because there's too many things outside of our control.

Moderator.

Our next question comes from Adam Waldo from Lehman Brothers.

Good afternoon, everyone.

You all have been busy this last quarter.

Starting with some of the recent management changes, I wonder, Neal, if you can give us a bit of a sense for the rationale for the changes involving Mr. Pogge and Mr. Fisher, and then going forward, is it your feeling that the organization structure is in a way you want to see it structured going forward?

I think we talked about it.

It's just an evolution.

I talked about it before.

Fisher planned on retiring quite a while.

That was well planned and Jack had finished what he committed to finish.

I think we're well lined up.

The whole team is pulling hard.

We're pulling very well as a team, I think, as the results of the quarter show.

You will see going forward, you will see as in any strong company, you're beginning to see more and more of our people rise to take on bigger responsibilities and they're just striving to get the chance to do it and where it's appropriate, you will probably see us if we need to, we'll bring in some talent in specific areas or specific geographies as it's required.

OK.

Thanks for that.

Peter, you made excellent sequential progress in taking down the ADA reserve in the second quarter relative to both the 2003 year-end and first quarter of '04 by our calculation about 4.8% of gross AR at the end of the latest quarter versus 7% of the prior two quarters' ending balances.

Can you give us some color around what drove that sequential decline within your client base or within your aging pattern within your receivables?

Adam, there were several things.

One is the Adelphia sale, was a significant reduction in the accounts receivable.

As a starting point, we collected approximately about somewhere in the range of $10 million from clients beyond what would be normal collections.

Those would be from clients around the world, nothing specifically that would be out of the norm.

Some of our clients that had become a little delinquent, more delinquent than others in their payment, we were able to collect successfully some of their older receivables and therefore, reduce what could be viewed as risk in the portfolio, so overall, I think we have seen a diversity.

It's not one or two accounts that really drove it with the exception of the sell of the Adelphia bankruptcy receivables.

Are those levels of reserving comfortable for you on a going forward versus percentage growth there are Peter in light of what you see on your book?

I'm comfortable with where we are today.

We still deal with a complex international environment, and so we're going to be cautious as we look at our reserves, but I will tell you that if we continue to have strong improvement with our collections and our balances, then we'll look over time and determine whether or not we have more opportunity.

This is a business we've owned now for about two years for our international side, and we've been very cautious about not being too aggressive about what we hold in reserves and will continue to be cautious but at the right appropriate time if there's more reserve than we think we need, we'll address it at that point.

OK.

And then finally, obviously in the last couple of years, you all have been busy, both in terms of restructuring the business, if you will, integrating Kenan, restructuring the capital structure and doing a number of other things with respect to product development.

Are you now at a point where you're comfortable starting to offer some longer-term top and bottom line growth targets for the enterprise?

And, secondly, given your longer-term growth trajectory that you foresee or may be willing to comment on at this point, what are your thoughts on dividend policy?

Well, first of all, on the first question, Adam, we are not going to give longer-term growth because the telecommunications market, the broader communications market is still going through its own challenges, and I'm not going to go out without more stability in the broader markets we serve.

That being said, we are very pleased in the position that we are in our markets.

We think we have great real estate, as I like to think, with our assets and our clients and with that, I think we're very focused that we believe that we can exploit that over time and we'll look first to go through and invest back into the business and are not focusing in the near term on a cash dividend policy.

Thanks very much.

Sure.

Our next question comes from Tom Roderick from Thomas Weisel Partners.

Please go ahead with your question.

Hi, thank you.

Good afternoon.

Hi, Tom.

Hi, Tom.

So, it's looks like even once you back out the impact of Adelphia this quarter, the pricing per sub on the broadband side came in even a little bit higher than you might have expected.

What were the drivers there?

And I know you guided down just slightly for pricing next quarter, but you know, how sustainable is this pricing and should we look forward to move up after next quarter?

You know, Tom, I thought you were going to say that we're just too conservative on our guidance.

You're right when you adjust out Adelphia from the 740, we get to about 728, slightly above what our range is and our range at 710 to 725 would suggest that there's some caution in our expectations.

The reason we give a range like this is there are certain aspects of the business that in our products and offerings that our clients can control how much they use within a quarter and so we try to give you a range of what we think could be the behavioral impact from our clients, but I tell you, we have been consistently seeing that on a normalized basis, we're tracking around the 720, 725 range, and if you will look at this as a business, you would probably guess that we may come out that way in the third quarter, as well, but I like to give that range for some variability based on our clients.

And I know it's early on the issue of voiceover IP, but are you seeing any impact to pricing on a per sub basis for voiceover IP today from Adelphia and Time Warner?

This is Ed Nafus.

We're really in the early stages of each of the client's rolling out their plans, so at this stage, we're not seeing any impact other than possibly some consulting work that we would be doing on the front end.

OK, great.

If we look over to the GSS division, it looks like we did six FX deals this quarter.

How about for total number of deals for GSS?

Can you talk about the level of deals that you did there and if you could talk about the pipeline, in general, how you feel about it in light of the fact that backlog is down a little bit this quarter?

Tom, on the, issue of the number of deals, we've never disclosed the number of deals we do on the GSS side.

So, I am not going to start that practice this quarter.

Your second question has to do with pipeline, is that correct?

That's correct.

Yes, the deals will come on yes I guess I shared that, it's been a couple of weeks, I went around the world to visit most of our offices and so, in addition to just looking at the pipeline reports, we had an opportunity to really look a lot of the prospects and customers in the eye and what I would say about the pipeline is I touched on it in my comments.

There's some big deals out there.

Those things take a while to materialize, but there are some pretty good size deals out there and just significantly we need to respond to those deals maybe in a little different fashion than we have before, and we're working hard on doing that.

You know, one of the other things, you know, geographically, I think we made some good decisions in APAC.

That business looks strong for us.

Witness our successes in China, and once again, the business is out there, but you can't think about doing business the way did you it a year ago or two years ago.

It's an entirely different kind of market out there, and so maybe that's the color you're looking for on the pipeline.

That's helpful, Neal.

Thank you for the commentary.

Thank you.

Our next question comes from Peter Jacobson from Kaufman Brothers.

Please go ahead with your question.

Thanks.

With respect to the guidance, the two elements to higher costs that you cited, costs to support clients' rollout of new services and continued expansion into new geographies, can you expand on that a little bit in terms of how much of that is proactive selling, positioning to achieve new business versus perhaps higher than anticipated costs of delivering on existing contracts and is it perhaps associated with more labor to accomplish milestones than you anticipated or maybe the same amount of labor but you needed to hire higher skills in order to perform on those contracts?

And do you view these as being expansion and higher support costs for this year that would perhaps be less so next year or are these -- just the cost of doing business that you think will continue into next year?

All right, Peter.

I'll take this one.

It sounded like a multiple choice question you were giving me there, but I won't answer it that way back.

It is none of the latter issues that you said where we're either not performing and we need more resources or any of those type aspects.

This is clearly, as we look at the business, we have clients that are starting to roll out new services on the broadband side, and they are looking to us, in several of our clients to support them, and we are putting the resources in place as they roll out their resources for the coming revenues that will follow.

On the GSS side, it is the same type of business issue.

We're sitting with the opportunities coming up that we have sold and that we are seeing as opportunity or things that we'll be delivering that have been contracted for, but additionally, we're also seeing strong pipeline in the Asia market and those are going to be things that we make sure that we have the resources for when they are sold.

And then Neal, you wanted to comment.

Yes.

And I think the comment I'd make is also you can sit back and just play a defensive game and I don't think that's what you pay us to do.

You know, what our interest is, is in building a business and in building a business, you make some investments and you intend to harvest the fruit of those investments into future quarters.

And that's exactly what we're doing and are investing in other regions, are investing in the strategic initiatives group and investing in working with our customers as they roll out new services here.

So I would say as much as anything, a healthy company invests for their future and I guess companies that are feeling weak take totally defensive postures and we're feeling healthy.

OK, thanks.

And with respect to these larger deals, presumably with larger deals, they become more complex, and my sense is over the last year or so, you've gained some experience with these larger contracts.

And is it a part of your strategy, at this point, to -- is that, in fact, true from your perspective, and are you proactively targeting some of these larger contracts that may have been traditionally handled by other vendors that involve a great deal of customization and development as opposed to being more of a package software provider?

And then along with that, are you taking a good portion of that systems integration work for yourself to add to your revenues, or are you pretty much conceding that to your systems integration partners?

I guess, once again, that's several questions.

What I would say is over the past couple of years, absolutely, we've -- Al and his people have done a great job of understanding more complex environments and controlling them and so that's a good observation that you made, and we're doing a great job of that.

The nature of the deal and the other observation that you make, one of the things I said in my comments, we have outstanding products.

If you look at the broadband division, we should not and will not and do not back away from anyone with what Ed has to deliver out there, and by the way, if you look at the software division, we should not, do not and will not back away from anyone on what we've got in a core product to deliver out there, in terms of volume, functionality, whether we're addressing wire line, wireless, we've got a terrific array of products.

So we're not backing away as maybe some might have before from any of the opportunities out there because we've got the products to meet the requirements.

Now, what we are doing, is and I guess the other thing is through our safe group we're just finding different kinds of opportunities that we can go after as well.

And what we are doing is not changing the basic thing that made us successful so far in that our partners are very important to us.

I don't -- I know you will not see me announce that we're going in general competition with the systems integration companies out there.

I think that would not make a lot of sense for our company.

What does make an awful lot of sense for our company is, as I say to have these products that are the key to opening the door to the big deals and to work closely with our integration partners to get our fair share of the revenues certainly, but to understand what's in it for the deal for everybody and to get the right solution out there for the customers.

You know, the customers aren't going to pay outlandish dollars anymore in, you know, three-year timeframes and then have it not work.

OK, thank you.

A final question.

Over the next year or so, where do you think the growth will mostly come from, the software division or the broadband division, or equally so?

I think we have a very, very solid broadband division, and we'll get some growth out of the broadband division.

I think we have a solid software business, and we'll get some growth out of the software business.

The reason we form strategic initiatives and I told you this a year ago was to find those new areas where we could combine the assets that we have in the software division with the expertise that we have in our processing, in operations, and to find those new revenue streams, and so that's where the real growth will come from in the company.

Thank you very much.

That's all I have.

Thank you.

Our next question comes from Scott Sutherland from Wedbush Morgan Securities.

Please go ahead with your question.

Thank you.

Good afternoon.

Just a few questions.

First, in the Kenan FX upgrades that you are having here, it seems like you're now gaining some larger customers with the two China wins.

Can you talk about how we could expect that to roll out as far as the software revenue.

It looks like these may be after the quarter.

Alan, do you want to address that?

Yes.

Specifically, Scott, what are you looking for?

I'm looking for the rollout.

I think last quarter you mentioned some of your biggest FX upgrades had been maybe about the 1, 1.5 million range of subscriber bases and these two deals in China are in the tens of millions, and I'm wondering when you will start seeing the impact in the GSS division from these deals?

I mean, I think we're already seeing an impact.

Where you see the impact is the add-on revenue on the services business that are required for the implementations and the additional revenue that we get from the additional modules that go with the FX product.

Certainly, the few Chinese deals are of subscriber counts which are in excess of what we have seen, and I think we will get the benefit of that over time as those subscribers grow.

Maybe I can just jump in, as well.

I think the important thing is that just like we have done in other geographies, the important thing is for us to get that critical mass of systems in that marketplace and to be well regarded by the partners that we are working with, in this case, specifically in China, and then to be opportunistic, with the opportunities that present themselves for us to make our partners more successful and our customers more successful.

So I think as Alan said, there's more revenue there.

The single big, most important thing that we've got is we're building a very significant foothold.

As we said earlier, we're investing.

We've got not only APAC and we have the safe group looking at what opportunities are and once again, it's what can you turn that investment and that footprint in, so I'd stay tuned on that one.

I'm optimistic.

Couple more questions.

You know, you're talking a little bit earlier about the environment out there in the GSS market.

Maybe you can talk more specifically in the price environment for the DSD and GSS divisions and one last question, you did a salary raise two quarters early.

You can quantify what kind of EPS impact that was?

It looks like you might have been able to deliver some more EPS for the back half of the year if not for that raise.

I will take that second one first.

If I don't take care of my people, you won't get any EPS, so I think it's a great balance.

I will let Pete talk about that, and that's probably one of the best investments I've made this quarter is taking care of the people.

So I think you'll get a bigger return on EPS by the fact that we took care of them.

Pete, do you want to?

In general, you know, we don't want to go into the specific dollar amount.

It's built into the guidance I gave you on expenses, so you can see that we're making an investment in our business in multiple ways, some in new hiring and their business as well, some investing in existing business.

From where we are on a sequential business, we're looking at $2 to $3 million of incremental expense between the third and the fourth quarter and investment in our exiting people is a critical part of that.

That's great.

You know, I talk about pricing.

Through the tough times in the telecommunications market, everyone has trained the buyer well, so they negotiate hard and they negotiate well, but you don't have any major contracts up through '05 in DSD.

Ed and his people have done a great job.

They have no contracts due for another 18 months and you know, I think we're competing effectively.

I think, you know, price competition impacts everyone.

I am very, very proud of this management team and the way they've responded in the way all of our people have put creativity toward meeting customers' objectives, toward working with partners and meeting price points out there.

Great, thank you.

Thanks, Scott.

Thank you.

Our next question comes from Peter Wright from PAW Partners.

Please go ahead with your question.

Hi, Neal.

How are you?

How are the Yanks treating you now?

The Yanks are doing OK.

They did lose two out of three to Boston.

A little bit of a fight there.

Boston needs a thrill.

It's still July.

You'd knew I would bring that up.

Go ahead, Peter.

I'm a little confused.

How much more are you spending in the second half of the year?

Our reported expenses, Peter, in the second quarter were about $108 million, and I'm giving you guidance of $109 to $112 per quarter at least for the third quarter, which the fourth quarter is going to be fairly comparable to that, so you can see on a sequential basis, expenses will go up between $2 to $3 million per quarter.

So 4 to 6 million, and the earnings change from the previous guidance to this guidance was from what to what?

There's a little bit of a sequential process in here we have to go through, Peter.

At the end the first quarter we gave guidance of approximately $0.88 to $0.96 EPS, and we then subsequently did the convert that generated a certain amount of accretion, that would be the, we were expecting $0.07 for the full year, and so that would take our guidance at that point up to $0.95 to about $1.03, so then you would have this additional expenses coming through, and then also subsequent to the guidance we gave on the convert, we now, based on the higher stock price, have more shares outstanding or at least dilution from the use of the treasury method for calculating dilutive shares, and with so we're seeing some loss back by having greater number of shares outstanding and then the write-off of the deferred financing fees.

If I were to take the write-off the deferred financing fees on your new GAAP number -- the new GAAP number is how much?

77 to 87.

So if I just added back the financing fees and the deferred issue, what would that become?

So the --.

Sorry.

That's OK. 77 to 87 becomes --.

85 to 95?

85 to 95.

Additionally, these are all GAAP numbers that I gave you.

There are restructuring charges that we took in the first quarter, which were $0.02, just so you want to make sure you have that as a measure, and so the 87 -- I'm sorry, 77 to 87 on the GAAP basis plus the add back is going to give you --.

87 to 97 and that's down from $0.95 to $1.03, is that how I should look at it?

I'm trying to do this in my head.

That's fine.

So basically what you are saying is there's $0.08 felt in the second half of the year.

Which is pretty much all from the expenses.

From 4 to 6 million.

Here's my couple questions.

Number one, is this likely to be recurring going into calendar, and I assume it's recurring going into calendar '05 and not one-time things.

OK, and number two is this to because you feel you need to better service your clients in your existing revenues, or is this because you think you have a better chance of getting more business development and therefore, have a higher growth rate in a future period of time?

Well, I'll take the first point on that, Peter.

We clearly expect that it will generate incremental revenues the out quarters.

That's why we're doing this.

We believe there's opportunities for us in voiceover IP in the new market.

As Neal said in his prior comments, we're invested because we see opportunities.

This isn't because, quote, you're over-earning.

It's more that you think there will be return on that invested $0.10 to $0.20 a year in future periods, hopefully, capturing some of that next year?

Absolutely, Peter.

I think your question is two-fold, and it was asked in a different fashion maybe earlier.

We're not spending money because we find ourselves in anything that we have to do, that we have to pour money into make up or, that's not why we're making the investment.

We're making the investment, as I said earlier, because we see opportunities out there.

We can't just sit in a defensive position and hope the opportunities fall off the end of the truck for us.

We've got to make some tangible and significant investments to be able to take advantage of them, and that's frankly what we're doing.

So basically, you expect a return on this investment?

I not only expect it, I got folks' feet to the fire and people being held accountable, Peter, including myself.

We're all accountable, and then I guess the other question is, so second half, you have a 16, 17% operating margin?

Do you have a long-term operating margin model of the business that is something that you think, not necessarily telling me when you get there, but is there now that Kenan is a little more stable and you have an understanding of what Kenan is and what Kenan isn't, where do you think the operating margin of the business can go over time?

I would like to answer that this way, Peter.

Without giving you overall, long-term kind of operating margin goals, when we look at the broadband, we think that we have contribution margins in that business that are -- we believe sustainable and as new offerings come up and new services and new revenues, we'll look to maintain those same margins, though we know will be in a competitive market and we will be looking to maintain those.

When you look at the GSS contribution margin, that's where we clearly need to get expansion on the products and services we deliver and our long-term goal on that -- not long term, intermediate goal on that is to get the 20% contribution margins for the overall business.

Where are they currently?

They're generally low single digit margins.

That's where we're expecting to get lift.

That's going to be through the strategic initiatives where we try to deliver the assets in different business models as well as getting more of the product sold in some of the opportunities that Neal also talked about.

OK.

So the -- what's the timeframe to go from low single digits to 20%?

Is that 12 months, 3 years, any concept on that?

We're going to be somewhat dependent upon the return of the telecommunication spending because we can't force the CapEx spending back into our coffers without some shift worldwide, so I'm going to be hesitant to give you anything on that, but we clearly believe as that turns around, we'll win our fair share and hopefully in excess our fair share of the deals that come about.

Thank you.

We have time for one more question.

Our next question comes from David Snyder from Hoover Investment Management.

It's already been answered.

Thanks.

Thank you, David.

If that's all the questions, let me just wrap up.

I know you all are busy.

You want to get going, but thanks, again, for your support during this quarter and your support going forward.

I hope you understand, you know, what you're investing in here is not only great products, but some great people, and your investment has performed well and I believe it will continue to do so.

I look forward to talking to you in 90 days and maybe taking in a Yankee game this fall.