Executives
Kathryn Herr – Vice President of Marketing & Communications
William M. Bambarger, Jr. – Chief Financial Officer & Treasurer
Paul G. Casner, Jr. – President, Chief Executive Officer & Director
Analysts
[Chip Richardson – Private Investor]
Steve McNeil – Jennison Associates
Edward Antoian – Chartwell Investment Partners
Integral Systems, Inc. (ISYS) F2Q10 Earnings Call May 3, 2009 11:00 AM ET
Operator
Welcome to the Integral Systems second quarter 2010 earnings conference call. This call is being recorded. At this time all participants are in a listen only mode. We will be facilitating a question and answer portion at the conclusion of the presentation. (Operator Instructions) I’d now like to turn the conference over to your host Ms. Kathryn Herr, Vice President of Marketing and Communications.
Kathryn Herr
I’d like to welcome you to Integral Systems second quarter 2010 earnings conference call. Before we start, please understand that this call contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Such statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
During today’s call we will discuss second quarter 2010 results and highlights for our operations. We may refer to non-GAAP measures which are defined and reconciled on our website at www.Integ.com under our investors tab. Joining me today on the call are Paul Casner, our President and Chief Executive Officer and Bill Bambarger, our Chief Financial Officer.
All participants are advised that the audio of this conference is being broadcast live over the Internet and is also being recorded for playback purposes. The audio of the call will be archived on Integral Systems’ investor relations website until later this year. We have quite a bit of news to discuss in our business operations and we encourage questions at the conclusions of our remarks.
With that said, I’d like to turn the call over to Bill to provide an overview of our second quarter results and full year financial outlook followed then by Paul with his perspective on the cooperation.
William M. Bambarger, Jr.
I hope that you had the opportunity to review today’s earnings release with our second quarter results and reaffirmed 2010 guidance. We’re pleased with our second quarter results and the progress we have made towards the goals established early this year. As previously announced, we are focused on effectively managing our indirect costs, increasing our bookings and backlog and investing in future growth. We have successfully executed on all three of these goals in the second quarter.
Revenue for the quarter was $40.3 million compared to $42.8 million in the second quarter of 2009. While this is a decrease year-over-year, the second quarter of 2009 was extraordinary due to the intensive work associated with the GPS OCX Phase A contract that resulted in a large increase in revenue for that quarter including a significant amount of high margin license revenue. Revenue in our military and intelligence group is also lower due to delays in the definitization of RAIDRS ECP 9 contract. We are actively working with our customer to mutually advance this contract and Paul will talk more about that in a moment.
Revenue grew year-over-year in both of our other two operating segments. Gross margin for the company was a healthy 40.5% for the second quarter and is 35.9% year-to-date. This is primarily due to two things, number one a more favorable mix in high margin product revenue and the recovery of the ProtoStar bad debt reserve that we recorded in the third quarter of 2009. We recently received a favorable ruling from the bankruptcy court and will be paid the full amount owed on the ProtoStar-II contract plus interest. The recovery recorded in this quarter amounted to approximately $2.2 million.
Operating expenses were $16 million in the second quarter of 2010, an increase of approximately $3 million over the second quarter of 2009. This increase is attributed to acquisition and interest related costs associated with our acquisition of CVG Avtec and an increase in our lease loss provision. We incurred approximately $1.5 million in third party and interest expenses associated with the acquisition of CVG Avtec. The majority of these costs were for legal and accounting services.
The new accounting rules relating to acquisitions acquire us to expense these costs as incurred. We also increased our reserved for unoccupied lease space in Lanham that we vacated last year by approximately $1.5 million. We have been working very closely with a third party to sublease a significant portion of this unoccupied space and initially expected to have the sublease finalized by now.
While we are continuing to actively work with this potential subtenant as we actively market the space to other potential occupants, we needed to adjust our assumptions as a result of our inability to finalize a sublease arrangement before the end of the quarter. This reserve provides us approximately two more years to sublease the unoccupied space and we are hopeful that we’ll be able to retain a subtenant prior to the end of this two year period.
Fully diluted earnings per share for the quarter were $0.01 including the onetime non-recurring charge associated with the CVG Avtec acquisition. Excluding this onetime charge, earnings per share would have been $0.06. EBITDA was $2.1 million for the quarter after taking in to consideration $1.2 million of depreciation and amortization expense and $600,000 of non-cash stock compensation.
Capital expenditures for the quarter were $1.2 million. Our cash balances grew by $14.5 million to a total of $16.7 million in the second quarter mostly due to collection of tax credits that we were expecting and a reduction in our accounts receivable balances. Bookings for the quarter were $31.6 million, mostly attributed to several large contracts in Singapore and strong performance in our products group. Year-to-date bookings totaled $95.7 million. We have achieved our goal of booking more business than we burned so far this year and expect to continue this trend throughout the remainder of the year. Backlog at the end of the second quarter is $181.8 million.
I’ll now move on to our updated guidance for the second half of 2010. As we mentioned in our earnings release this morning, we’re holding to our previously issued guidance of $0.35 to $0.40 per share of earnings for 2010. While we anticipate the CVG Avtec acquisition to be accretive in year one, we only have half of the year left in our current fiscal year. Due to the significant acquisition and integration costs that we have incurred up front and will continue to incur, we expect the overall impact of the CVG acquisition to be breakeven for the last two quarters of fiscal 2010.
We expect revenue to increase to $180 to $185 million in 2010 due to an increase of approximately $19 million for CVG now called SAT Com Solutions and a decrease of approximately $15 million for our military intelligence group as a result of losing the GPS Phase B contract and delays in definitizing the RADIRS ECP 9 contract.
Gross margin is expected to remain solid at approximately 40% and we expect to finish the year with approximately $60 million of operating expenses. Interest expense is expected to be higher due to our financing of the CPG acquisition and EBITDA for 2010 is expected to stay near the $20 million that we initially estimated.
Finally, I’d like to address the notice late last week announcing my intent to resign as CFO of Integral. I have been with the company for almost three years and there have been many high points as well as challenges and difficulty but I am truly thankful for the opportunity that the board and management team has given me. I am confident that the company and its financial infrastructure has significantly improved over my tenure and that is due to the support, cooperation and hard work of my leaders as well as the folks on my team.
I am taking some time off to spend with my family and address some health returns. I do plan to return to industry and leverage the many lessons learned here and throughout my career. My transition will occur over the next 90 days and I am committed to helping Paul, the board and the rest of the management team to ensure a smooth transition and will assist them in any way I can.
Now, I’d like to turn the call over to Paul Casner for his comments.
Paul G. Casner, Jr.
Before I begin my discussion I’d like to say a few words about Bill’s announcement. Over the past three years Bill has led the transformation of Integral Systems’ financial infrastructure and governance. Bill’s expertise and leadership has contributed to a stronger more mature and more integrated company. We sincerely appreciate Bill’s ongoing support over the next 90 days.
We have initiated a search for a new CFO and are confident in the current finance team and in the company’s ability to execute a smooth transition. I know you all join me in wishing Bill all the best in his future endeavors.
Now, as you heard from Bill, our earnings for this quarter excluding acquisition related expense are on track with our projections for the year. I’m pleased with these results. We see excellent customer interest in our new product launches from our RT Logic, SAT Corporation and new core technology divisions and we continue to hit the mark in our commercial sales. However, as Bill mentioned, our military intelligent group is behind plan as a result of the delayed definitization of ECP-9 for the RAIDRS Block 10 contract.
The RAIDRS team, Integral Systems and our government customer continues to discuss the scope, schedule and budget with the shared goal of providing this critical capability to the war fighter as soon as possible. In addition, the Military Intelligence Group is aggressively pursuing opportunities to support our customers’ space situation awareness requirements. I firmly believe that we have solid long range opportunities ahead for our Military Intelligence Group and space situation awareness which I will discuss in more detail later in my remarks.
I would like to note that we have made great progress in our discuss with the DCAA and we now have approved provisional 2010 rates. In addition, we’re addressing the remaining issues with the DCAA audit conducted at the beginning of the year and feel that these issues will be resolved successfully in the next few months.
We continue to see solid bookings growth in the organization. Midway through our fiscal year we have booked $96 million, more than we realized during all of FY 2009. We added $30 million to bookings in the second quarter led by our products group, in particular our RT Logic, SAT Corporation and new core technologies divisions. I’m also encouraged by the increased bookings in our European subsidiaries. Backlog continues to move in a positive direction. Excluding the CVG Avtec organization, our backlog grew $7 million in the second quarter.
We realized solid strategic growth during the second quarter. Most significantly, we closed our acquisition of CVG, inc. and their wholly owned subsidiary Avtec Systems. That organization is now operating as Integral Systems SAT Com Solutions, a division of our products group. We are focused on successfully integrating them in to the company and I can report that we already see product and customer synergies as a result of the acquisition. Last week we announced the acquisition of the business assets of Sophia Wireless, Inc. which will be integrated in to SAT Com Solutions and brings differentiating amplifier technologies to Integral Systems.
The acquisition of CVG, Avtec and Sophia Wireless’ assets are indicative of our strategic growth initiatives, that is to make acquisitions that broaden the product and customer base, bring good management and be accretive. In addition, we continue to maintain our focus on organic growth and controlling our in direct costs. In Marc, we launched our new services organization Integral System Service Solutions during the Satellite 2010 Show in Washington DC. We see significant interest in our service capabilities and we are pursuing several exciting opportunities with commercial and government customers.
During our previous call I mentioned that we had developed an enterprise architecture to provide satellite and space operators with a platform for comprehensive space situational awareness capability. I am pleased to say that we debuted this capability as part of a demonstration called sat op enterprise a few weeks ago during the 26th National Space Symposium in Colorado Springs Colorado. By integrating mission relevant multisource data from Integral Systems products as well as third party products and data sources we are able to provide satellite operators with dynamic real time situational awareness.
Our flexible data source agnostic architecture gives our customers the ability to more easily integrate our powerful best in class products while minimizing changes to existing applications. I’m very excited about this new capability and based upon my conversations with our customers during the Symposium, our customers are intrigued by our new offering. The benefit of our enterprise architecture are clear and underscore the advantage we have achieved in integrating our products and technologies. This result is a truly flexible innovative customer centric demonstration of our ability to provide space situational awareness for our customers. This is the Integral difference.
Now, I generally have low expectations for meaningful customer interaction at trade shows but the 26th National Space Symposium is the best show I have ever been to in 40 years. Integral Systems was firing on all cylinders. The quality of the customer interaction during this event both in the Integral Systems’ exhibition booth and in smaller group meetings was outstanding. Customers were absolutely engaged and excited about the capabilities we have to offer.
From the integrated enterprise architecture demonstration to the demonstrations of our latest software and hardware from across the company, customers could see that the Integral difference is much more than an operating slogan, it is our operating principle and it is the differentiator we bring to meeting our customers’ needs.
Before I open the line for questions I want to take a moment to express our enthusiasm for our newest board member General Thomas S. Moorman, Jr. General Moorman brings an exceedingly distinguished list of qualifications to the Integral Systems board of directors. He served as a Vice Chief of Staff of the United States Air Force from 1994 to 1997. General Moorman’s vision and guidance have made an enduring contribution to the United States National Security space leadership and the integration of space and the United States Military war fighting doctrine.
He was involved in the fielding of virtually all of the space systems currently in the military inventory. Upon retiring from the Air Force, General Moorman served as a partner and vice president of Booz Allen where he led the Air Force and NASA practices. In 2004 Space News named him one of the top 10 most noteworthy contributors to the US space program. We are proud to welcome General Moorman to the board.
With that, I’d like to open the discussion for questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from [Chip Richardson – Private Investor].
[Chip Richardson – Private Investor]
I was unavoidably late to the conference call and I didn’t hear it all but what I did hear you say you spoke about your customer and spoke about the General that has joined the board and how excited you are about everything but I didn’t hear anything about delivering value to shareholders. Did miss that?
Paul G. Casner, Jr.
No. I think what we did say was that we confirmed our guidance. I think we’re moving forward pretty aggressively. We have a very active pipeline and my expectation is that we will do just that.
[Chip Richardson – Private Investor]
Well, you say that every time but it never seems to happen. Why do you think that is?
Paul G. Casner, Jr.
I think that we’re focused on reducing our cost. It takes a little bit of effort and a little bit of time. I think we’re achieving those objectives, I think we’re moving forward exactly as we told people we would. We have reduced our costs, we do believe that we’re going to make a reasonable amount of money this year. We also believe that we’re increasing our backlog and we have done exactly what we have stated about acquisitions. I think we’re growing the company in a strategic way and I think the outlook is very positive so my belief is that we’re focused on a path that would certainly increase shareholders’ value.
[Chip Richardson – Private Investor]
Let’s assume you’re right about all that. I’ll take you at your word that all those things are like that. Why do you think that message doesn’t get out? Why do you think the stock price hasn’t changed in a decade?
Paul G. Casner, Jr.
Well, I think the message doesn’t get out because we’ve come off a pretty bad year. I think people are waiting to see how we do. I think if we keep focused on the fundamentals and I think if we keep doing what we tell people we’re going to do that is, strategic acquisitions and reducing indirect costs and performing according to our guidance, I believe that the stock will change.
[Chip Richardson – Private Investor]
But that’s been the message every time and it hasn’t worked. How long are you going to keep doing that without delivering shareholder value?
Paul G. Casner, Jr.
Well this is my second quarter. I think we’ve made great strides and great progress. I can understand why you might be a little impatient but I think we’re doing exactly what we said. I think the fundamentals are there, I think they’ll continue to be there and I think the stock will respond accordingly.
Operator
Your next question comes from Steve McNeil – Jennison Associates.
Steve McNeil – Jennison Associates
Just a point of clarification on the guidance, so you guys earned $0.07 in Q1, is that right?
William M. Bambarger, Jr.
Correct.
Steve McNeil – Jennison Associates
Then what is the right Q2 number to use? Are you taking our CVG?
William M. Bambarger, Jr.
On a GAAP basis Steve, it was $0.01 per share. If we had not done the CVG acquisition it would have been $0.06 per share.
Steve McNeil – Jennison Associates
But does the guidance assume $0.06 a share for Q2?
William M. Bambarger, Jr.
No, it assumes the $0.01 per share. The guidance we gave is on a GAAP basis.
Steve McNeil – Jennison Associates
Can you just kind of walk us through what – I guess it’s implied that you’re going to have a pretty robust second half relative to the first half considering. So you basically earned $0.08 in the first half right? The guidance is $0.08 in the first half and $0.30 in the back half?
William M. Bambarger, Jr.
That’s correct.
Steve McNeil – Jennison Associates
So what are you expecting to happen in the back half such that you earn dramatically more relative to the first half?
William M. Bambarger, Jr.
Well, we have the results of the CVG acquisition in the second half and I think as we’ve been talking about before, our operating expenses are not going to increase substantially as a result of that so we get a great deal of benefit associated with that. Also, our products operations are going very, very well. Our backlog has grown considerably there and we expect going forward our military and intelligence group to improve considerably in the second half of the year over where we were in the first half of the year. So all of those combined again, with a steady cost base, all of those combine to higher earnings per share.
Steve McNeil – Jennison Associates
So you said CVG you have that in the back half but you said you don’t expect any benefit from that at all?
William M. Bambarger, Jr.
Well, after you take in to consideration $1.7 million that we spent already integrating them plus additional integration costs going forward. We have non-cash amortization of intangible assets, we have interest expense associated with financing the transaction, so it clearly adds benefit to us just over the immediate next six months it’s not going to show a great deal of accretion at the bottom line.
Steve McNeil – Jennison Associates
Can you just drill in a little more on the military and intelligence segment what you expect to happen there especially considering your earlier comments Paul about how the business is lagging?
Paul G. Casner, Jr.
Yes, the business is lagging for two reasons. One, we lost GPS, we had about $6 million in the forecast for this year for GPS. Secondly, we have not yet definitized ECP 9 for RAIDRS. The initial delay in that definitization was because we didn’t have our DCAA approved for pricing rates for 2010. That’s behind us now and has been for about a month and we’re working diligently with the customer to define the scope and the breadth of that contract and get it definitized.
So at this stage of the game it still is not definitized but our expectations are that sometime near the end of the fiscal year we’ll get that thing definitized and be able to earn the kind of revenue we expected from those guys. Having said that, we think they’re going to be about $15 million short this year.
Steve McNeil – Jennison Associates
M&I?
Paul G. Casner, Jr.
Right, M&I.
Steve McNeil – Jennison Associates
But it sounds like you’re expecting that back half of the year to be better than the first half of the year?
Paul G. Casner, Jr.
Yes, we are. We’re expecting it to be better and in addition to that, both of the other segments are going to be performing much better, the products organization and the civil and commercial organization. So we expect to have a very good second half.
Steve McNeil – Jennison Associates
Lastly, I was wondering if you could comment on just the kind of out year outlook beyond this year? I know in your slides before you had laid out some trajectory on EBITDA. I mean do you still feel like – I mean there are some things that have happened obviously in terms of the acquisitions and then losing GPS, do you feel like that trajectory has changed in anyway meaningfully one way or the other?
Paul G. Casner, Jr.
I think the projections still make sense. We have a very active pipeline right now for opportunities that we have identified. We’re talking about a pipeline that has at least $530 million in it. The civil and commercial guys are focused on $165 million either in proposal or awaiting award. The [inaudible] got identified $66 million in the space situational awareness arena and the products organization has $300 million in proposals outstanding, $274 of which are SAT Com Solutions. So, we think the future looks pretty bright. I think that the boost that we’re going to get in the second half is going to continue in to 2011.
Steve McNeil – Jennison Associates
So you still see a forward trajectory to $30 million plus of EBTIDA by ’12?
Paul G. Casner, Jr.
Yes, we do, we do.
Operator
Your next question comes from Edward Antoian – Chartwell Investment Partners.
Edward Antoian – Chartwell Investment Partners
I want to follow up on the first question that was asked, kind of the crap hit the fan at the company and management changes and the like and we brought in a new management team. There’s been a lot of frankly disappointment in awards not being won at the company and admittedly you’ve only been there two quarters, I apologize for throwing this on you. But, nevertheless, there’s a lot of other people at the company that have been there for a long time. There have been awards that just haven’t come to fruition and then when the stock was at a low price it seemed like at least I would have heard from management that the sum of the parts was worth a lot more than where the company was trading at.
I think the first person’s question was fair that why don’t we then take a different tact and frankly, put the company up for sale and seemingly even at a board level there were I don’t want to say people paid to be quite but there was a board announcement made where basically someone was paid to keep quite. Is there a fair timeline to say, “Hey if we’re not successful within X period of time then we won’t just keep bringing in another group of people to try to run this thing and maybe we’ll sell it to a different organization that might be more competent in running it?”
Paul G. Casner, Jr.
You made a whole bunch of statements.
Edward Antoian – Chartwell Investment Partners
All of which are pretty accurate.
Paul G. Casner, Jr.
Well, first of all when it comes to disappointments with respect to awards I think the only one that really applies to is GPS. We happen to be a sub and the prime that was bidding it lost that contract. The only other major glitch that I can remember as a disappointment is Gozar which was a situation where the company basically was prepared to prime that until the contract got too large and by that time we were excluded from joining anybody else’s team. Those are the only two disappointments I can think about right now. We certainly have had our share of issues. I don’t think the management team is unstable. My intention is not to go anywhere.
Edward Antoian – Chartwell Investment Partners
I didn’t say the management team was unstable, I said we’ve had a lot of different management teams the last five years.
Paul G. Casner, Jr.
We have.
Edward Antoian – Chartwell Investment Partners
And none of them have been successful.
Paul G. Casner, Jr.
Well, I think the have been successful. I think we have been very successful. I think we’ve cleaned up a lot of the issues, I think we reduced indirect costs, I think we’re focused on the marketing. We’ve got an incredibly positive pipeline. I think for the first time in several quarters we have reversed the trend of eating our backlog, the backlog is growing. I believe that we’ve done a decent job of forecasting what we were able to do under difficult circumstances. I think for the first time in a long time we’ve made some very nice strategic acquisitions and as I mentioned to the first caller I believe if we stick to the fundamentals, do what we say we’re going to do the stock will respond.
I don’t think there is any appetite right now from anybody to sell the company. I think the fact of the matter is that I believe we’re focused on a very successful path and I think we’re going to get there.
Edward Antoian – Chartwell Investment Partners
So no timeline for success?
Paul G. Casner, Jr.
Well, I think the time line is clear. We’re going to perform the way we said we are going to perform. We’ve made some strategic acquisitions. I think we’re poised for significant growth. I think the trajectory we talked about for 2011 and 2012 clearly is positive performance and I think if we’re able to achieve that which I believe we can, the results will be pretty positive. I believe that we’re absolutely focused on the right trajectory and as I said we’ve been at it a couple of quarters now.
I think we’re performing the way we said we would and cleaning up a lot of things, reducing in direct expenses, making the right acquisitions, filling up the pipeline. I believe that’s success and I believe that we’re pretty aggressively moving down the path.
Operator
I am showing no further questions at this time.
Kathryn Herr
Thank you all for your time this morning. Please keep in mind that you can access this call on Integral Systems investor relations website at investor.Integ.com. We look forward to talking to you soon and updating you during our next call together. Have a nice day.
Operator
Ladies and gentlemen that does conclude today’s conference. You may all disconnect and have a wonderful day.
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