TeleCommunication Systems' (TSYS) CEO Maurice Tose on Q2 2014 Results - Earnings Call Transcript

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 |  About: TeleCommunication Systems, Inc. (TSYS)
by: SA Transcripts

Start Time: 17:07

End Time: 17:37

TeleCommunication Systems, Inc. (NASDAQ:TSYS)

Q2 2014 Earnings Conference Call

July 31, 2014 05:00 PM ET

Executives

Maurice Tose - Chairman and CEO

Tom Brandt - SVP and CFO

Bruce White - SVP, General Counsel and Corporate Secretary

Analysts

Michael Latimore - Northland Capital Markets

Operator

Good day everyone. Welcome to the TeleCommunication Systems Inc. Second Quarter 2014 Earnings Conference. Today’s call is being recorded. At this time, I’d like to turn the conference over to Mr. Maurice Tose, Chairman and Chief Executive Officer. Please go ahead sir.

Maurice Tose

Good evening, and thank you for joining us to discuss TeleCommunication Systems second quarter 2014 report. Tom Brandt, our CFO; and Bruce White, our General Counsel are with me.

Before proceeding, Bruce will advise listeners as to cautions with regard to the content of this call. And following our presentation, we’ll open the lines for Q&A. Bruce?

Bruce White

Thank you, Maurice. Some of the statements you will hear during this call are forward-looking within the meaning of Federal Securities Laws. Some, but not all of the statements include language such as believes, expects or anticipates and you should listen to these statements with the knowledge that actual results may differ materially from the forward-looking statements.

For example, but without limitation, our statements about the 2014 outlook, guidance and backlog, expected improved visibility and 2014 prospects and longer term market size and demand, our strategies for growth and acceleration of order pays on large IDIQ contract awards, expected acceleration of VoLTE and next generation 9-1-1 deployments, and expectations regarding IP monetization are all forward-looking.

Risk factors that could cause the results to differ also may be found in our SEC filings, including Forms 10-K and 10-Q. We encourage all investors to read these documents. Also, during the call we may refer to measures of income that are not computed in accordance with Generally Accepted Accounting Principles. To the extent that we refer to non-GAAP data, we have provided reconciliations in our press release and on our Web site. Maurice?

Maurice Tose

Thank you, Bruce. Our second quarter 2014 earnings release was issued at about 4:15 today, and a full text copy has been distributed via e-mail and is also available on our Web site.

The second quarter’s results were again better than we budgeted. As we continue to execute our plan, our Company’s commercial and international business is growing by funding for our next wave of government business makes its way through processes.

We’ve begun another statewide next generation 9-1-1 deployment following a long period of delays. Additional statewide contracts are moving through the pipeline and other NextGen work involving state, local and federal agencies is underway.

Turning to some more detailed comments on second quarter operating results. Second quarter Commercial segment revenue was $47 million, up 12% from last year second quarter, while gross profit was $29 million, up 25% as both volume and margins were better in both our public safety and platforms in applications business.

Growth continued in our 9-1-1 related business during the quarter. This business includes network monitoring for wireless and Voice Over IP enhanced 9-1-1 call routing, SMS to 9-1-1 and next-generation emergency services, internet protocol, 9-1-1 networks or ESI nets and related NextGen call taker stations. Wireless 9-1-1 service requires upgrades to accommodate the new carrier LTE or long-term evolution network architectures.

In the second quarter, we continued wireless Voice Over LTE or VoLTE 9-1-1 testing and deployments at activities for two Tier-1 wireless carriers, one of which is publicly announced commercial VoLTE 9-1-1 deployments in Chicago.

We are also working with Tier-1 wireless carriers to deploy SMS 9-1-1 technology for compliance with FCC rules and voluntary commitments. In Tier-2 and Tier-3 wireless carriers are now also beginning deployment. TCS leads the industry with more than 70% of all local jurisdiction SMS deployments to date according to the latest FCC tracking report.

Residential and business wireline phone users are increasingly transitioning to Voice-over-Internet Protocol or VoIP services. TCS revenue from enabling 9-1-1 for U.S residential VoIP subscribers is expected to grow as more network operators add VoIP over their fiber or cable networks. Opportunities are emerging for enabling 9-1-1 services for Voice over Wi-Fi, another variation of telephone technology which major carriers are beginning to offer.

We are seeing substantially more bid and proposal activity for next-generation 9-1-1 call handling and ESInet Solutions for this year, as federal funds are flowing to state and local coffers following the end of sequestration.

Federal money comprises on average about 30% of state budgets, making it critical for new investments like the upfront part of NextGen 9-1-1 after virtually no statewide RFP last year, TCS proposals for multiple statewide ESInets in call handling systems are pending and in process.

During the quarter, we signed a new statewide Public Safety Answering Point call handling deal, in addition to our ESInet business with the state and make smaller new sales into the states of Washington, Idaho, Illinois, California, and Michigan. The FCC’s 2011 projections for the timing of state and local investment in NextGen 9-1-1 have proven to be more aggressive than actual 2012 and 2013 deployments. It’s only about 15% of the expected rollout of ESInet systems has occurred so far.

Frost & Sullivan now expect the ESInet software market to grow from approximately $40 million in 2013 to over $250 million by 2020. Based on our current ESInet request for proposal load, we expect contracts from additional 7.5% to 15% of the U.S population to be awarded or contracted by the end of 2015, representing a potential doubling of the ESInet next generation 9-1-1 business over the next 18 months.

TCS also sell software for PSAP customer premise equipment for call takers handling IP communications. We continue to make progress positioning TCS solutions for FirstNet. The commerce departments $7 billion federally funded initiative to build a nationwide LTE network to support first responders. This is a major procurement for the federal government that is subject to a multiyear procurement planning process. We now expect the initial solicitation documents for FirstNet will hit the street towards the end of the calendar year with awards in late 2015.

In our commercial mobile platforms and applications business, revenue from platforms for wireless network operator, location based services or LBS reflects a flow of new deals both domestically and abroad. New contracts were secured in Mexico and the Dominican Republic, while multiple customers in the U.S and Canada contracted for upgrades to enable LBS for LTE.

Software capacity increases continue be a profitable portion of our LBS platform revenue, driven primarily by operators Big Data initiatives in the transition of local transaction traffic away from other vendors to TCS. In the second quarter, a large U.S operator made a multi million dollar purchase of additional license software capacity for deployed LBS platforms to cover growth and usage.

Revenue from enterprise messaging platform licenses remains a growth opportunity. It’s noteworthy that for the 2014 FIFA World Cup, our Company together with HipLink, another messaging company provided a messaging platform for the city of Rio de Janeiro to handle messages on traffic conditions, critical information related to venues and events and issues a public safety.

We successfully deployed TCS’s next generation navigation application for a Tier-1 U.S operator and provided a portion 100 OEM with access to our geo location agent. TCS’s second generation search and navigation application uses the same location tool kit now used by several major device manufacturers and OEMS.

Finally, to leveraging our existing technologies and expertise, we’re proceeding with our launch on VirtuMedix, a telemedicine platform that connects patients directly with healthcare providers via smartphone or the Web. It was developed in conjunction with a highly respected and credentialed healthcare provider organization. We plan to launch to the public in the third quarter.

We include IP monetization proceeds in our commercial segments revenue. We now have four patent groups under enforcement action entailing about 20 infringement cases. We also have a growing number of patent groups under review by interested companies for sale and/or licensing and several more groups in varying stages of study.

During the quarter, we also closed a patent transaction with a confidential buyer for some messaging portfolio in wireless data assets. Partnering with third-party patent enforcement entities, generally involves two major components, the upfront consideration to TCS and the future royalties or payments resulting from enforcement. We expect to see income in future quarters from the second component of our IP monetization projects as the enforcement campaigns mature.

Activities to date still entail less than half of the portfolio. Government segment revenue for second quarter was $39 million and gross profit was $9 million, down from Q1 ’14 and Q2 ’13 results as growth in cyber security business was more than offset by the effects of lower war-related communications technology spending.

Government services revenue was $29 million, up $1.5 million from the first quarter of 2014, although down from last year with gross profit of $7 million. TCS to Cyber Intelligence Service revenue in the quarter was up 12% year-over-year from international training and more timely funding of Department of Defense contracts.

In the quarter, our contract ceiling doubled to $6.6 million for DoDs art of exploitation cyber training and support services. And we were engaged by Evolve Technology Systems to enable delivery of TCS professional services to the U.S Air force cyber operations training program, with a total TCS contract value of $3.3 million.

In C4ISR, we were awarded a $30 million contract during the quarter through the Defense Information Systems Agency or DISA, Future COMSATCOM Services Acquisition or FCSA contract vehicle, to supply machine critical satellite bandwidth services supporting operations in North Africa. This is TCS’s second major contract award via the DISA vehicle. The other being our $58 million Marine Corp global KU network award.

We are seeing an increase in demand for satellite managed services and anticipate additional awards over the remainder of this year. The drawdown of our field support staff outside the U.S continues as part of the Afghanistan exit, partly offset by growth in our Continental U.S Field Support Staff through our recently awarded Battle Command and Sustainment Support System or BCS3 contract work.

As a Sole Awardee on a two-year $20 million contract to manage City of Baltimore IT services with options to extend for an additional three years at $10 million per year in various agencies. TCS expanded its presence during the quarter in the Department of Public Works, the Health Department, and the Department of Transportation.

We expect additional work scope as we move into the second year of the contract. TCS has been selected as one of six band with reseller partners for O3b Networks, which is building a new fiber quality satellite based global internet backbone for telecommunications operators or telcos and internet service providers are ISPs in emerging markets.

Their satellites offer game changing technology as they’re able to deliver higher capacity, lower latency, and better prices compared to legacy geosynchronous satellite. With O3b, we offer affordable satellite bandwidth to both government and commercial customers that need connectivity.

Government systems revenue was $10 million in the second quarter. Average government systems margins were 27% of revenue, up from 19% in the fourth quarter of 2014, on a better mix of business.

The print agencies has been finding the upgrade and VSAT of TCS NAP systems, which are being proven and battle tested for nearly a decade. We’ve handled orders for VSATs of more than 100 of a committed 360 of the over 800 deployed systems, and the expected value of the 360 VSATs is in the $30 million to $40 million range. SNAP VSATs are the armies’ technology gap filler for their heavy variant Transportable Tactical Command Communications or T2C2 terminal.

Budget issues led the Army to delay the T2C2 rollout. Our SNAP VSATs include our TCS replacement for a Cisco End of Life Router which is also embedded in many other DoD communication systems. The TSR not only replaces the older router, it includes an embedded server and switch in the same footprint.

TCS has sold over 270 TSRs in its first six months and has a pipeline for 2,500 more. We have received a multi-million dollar order for foreign purchase of our new XY terminals designed to address the expanded tracking needs of low, medium earth orbiting satellites or LEO/MEO’s. Several defense agencies are now in discussions with TCS for both fixed and transportable variants of our XY terminals as we believe DoD will begin adopting LEO/MEO solution to be deployed in remote locations throughout the world.

Progress towards Tropo and low cost protective comms programs continues, which we expect to substantially enhance predictable government segment revenue as programs of records. A growing military concern is that a satellite denied battlefield is increasingly likely, so that alternative solutions like Tropo and protective comms will be implemented.

TCS’s Tactical Transportable Tropo or 3T solution which enables beyond line of site communication by bouncing signals off the bottom of the atmosphere was recently evaluated at the Army’s Network Interoperability Evaluation or NIE event in support of its signal monetization program. We are in the process of transitioning our Tropo business from the WWSS contract vehicle to the GTACS contract vehicle and anticipate that Tropo scatter systems will be procured for U.S. Army Air Defense units for data links among air defense Patriot batteries.

We expect major Tropo scatter sales over the next three years as the DOD replaces legacy systems. In components Mitsubishi Heavy industries placed a $3 million contract with TCS during the quarter for products in support of the Japanese HTV Space Transport Vehicle and Mitsubishi Electric placed a $2.5 million contract in support of other Japanese satellite programs with a follow-on order for $6 million expected later this summer. These would generate 2014 revenue and 2015 backlog. Mitsubishi Electric remains our largest customer for our electronic, electrical and electromechanical or EEE components.

During the second quarter, we were notified that we were selected as a prime contractor on the Department of Defense Homeland Security Eagle II five year contract vehicle with a two year option period and an estimated contract sealing of $22 billion. We are currently tracking 27 major capture opportunity over the next five years with a pipeline sealing value of $197 billion.

TCS is planning to submit prime bids on six near term RFP solicitations in the balance of 2014. As we move towards the governments September 30, fiscal year-end, we are seeing increased procurement activity and are confident that our diverse customer base will play second half orders for our deployable communications product and associated services. Year-end spending activities appear to be more robust than in the past several years.

Now, Tom will provide some updated color on the company’s financial position and outlook.

Tom Brandt

Thank you, Maurice. The details of the second quarter results are included in the press release, and maybe viewed in context via the spreadsheet model posted on our company’s website.

As set forth in the press release, at quarter end, the company had about $63 million of cash and securities. $30 million of unused bank credit line availability and $15 million of available un-drawn delayed draw term loan.

Net debt declined during the quarter from $81 million to $73 million, and is down from $116 million at the end of 2012. Our company’s practice is to maintain at least $50 million of liquid balance sheet assets as reassurance to our target customers and partners around the world.

Funds were generated in the quarter by $9 million of adjusted EBITDA, $15 million received in connection with the arrangement we announced last quarter to take over a foreign LBS operation while gaining access to its customer and $1 million from capital lease borrowings and proceeds from exercises and employee stock options.

Cash was used for $10 million of debt principal payments and $11 million increase in working capital, $2.6 million for capital expenditures and about $3 million for cash interest taxes and other items.

During 2013, we substantially completed the refinancing of the $103 million of 2009 convertible notes due later this year so that at quarter end less than $15 million of these notes remained outstanding for payment upon maturity.

Funded backlog at June 30th, was down slightly to $287 million from $291 million in the quarter of which we expect to recognize about $170 million during the next 12 months. Our methodology for computing backlog is described in our press release in SEC filings.

Our investor relations practice is to provide an update annual guidance and show it on the model on our website. At this time we’re updating 2014 guidance in some areas. For revenue there is no change to the range of $365 million to $375 million that we projected at the beginning of the year. For adjusted EBITDA we see a narrow range of $35 million to $38 million for the year.

We expect full year capital expenditures of $14 million to $16 million. Non-cash charges of about $26 million and cash interest net of other income and expense of about $8.5 million.

We ended 2014 with significant net operating loss in R&D credit carry-forwards. So we do not expect to pay material cash taxes in 2014. And while in 2013, we fully reserved our deferred tax asset. In 2014 we recorded some minor favorable non-cash adjustments.

Expected 2014 adjusted net income remains in the $10 million to $14 million range or $0.17 to $0.23 per diluted share using 60 million shares. Our expected GAAP net income range for the year is now $1 million to $3 million or $0.01 to $0.06 a share up from previous guidance of minus $0.02 to plus $0.03 a share.

So at this time, I’ll turn the call back to Maurice.

Maurice Tose

Thank you, Tom. Our company’s commercial customer base continues to expand well beyond wireless carriers at state, local and international customers, Voice Over IP network operators and wireless device producers increasingly use our technology. Our government business continues to invest in securing contract vehicles with state of the art products and a world class service organization.

Investments in TSR, Tropo and XY are beginning to pay dividends and combine with a well earned reputation and documented sterling qualifications. TCS is positioned to grow and take market share from government contract competitors. We remain optimistic about the second half of 2014 a momentum going into 2015 as we update operating plans and targets. Our 2013 results are the floor of a cycle our third as a public company and I believe that the guidance Tom reiterated is conservative.

We thank you for your time and support. And we now like to open the call to any questions. Operator?

Question-and-Answer-Session

Operator

(Operator Instructions) We’ll hear first from Michael Latimore with Northland Capital.

Michael Latimore - Northland Capital Markets

Thanks. Hi, Maurice and Tom.

Maurice Tose

Hi, Mike.

Tom Brandt

Hi, Mike.

Michael Latimore - Northland Capital Markets

The commercial systems revenue was strong I think you noted I think there was an LBS deal matter, but I guess, how much of that was related to the NextGen 9-1-1 activity?

Tom Brandt

Well, that’s the biggest growth area in the commercial systems arena as the non-recurring spend that the FCC graphic predicted rolls out. So, Maurice mentioned that we did have some LBS license sales as well, but that’s -- the larger piece is the NextGen 9-1-1.

Michael Latimore - Northland Capital Markets

And does that relate to the primarily one opportunity or is it sort of a multiple of opportunities there that is generating the revenue?

Tom Brandt

It’s very well spread out. There are a lot of projects going on simultaneously. So, this is a diverse customer base, lot of state and local projects, geographically widely dispersed.

Michael Latimore - Northland Capital Markets

Okay. And then both in the commercial services and government services (indiscernible) through, it looks like that (indiscernible) sequentially. Should we think about that as kind of a new baseline or was there any kind of onetime items particularly on the commercial side.

Maurice Tose

No real big onetime stuff. The wide down is still the kind of counter-cyclical or counter-growth element on the government side. But I think we’re going to still see some growth in the balance of the year. Commercial we’ve got two offsetting trends there as the 9-1-1 grows and we readjust our business mix in platforms and apps.

Tom Brandt

So I think the way you’re seeing now is a reasonable way to expect overall in the remaining quarters of ’14.

Michael Latimore - Northland Capital Markets

And slightly, the inventory grew sequentially in the second quarter. Is that sort of a preparation for more government spending in the second half here?

Maurice Tose

That’s exactly right.

Michael Latimore - Northland Capital Markets

Okay. Thank you.

Maurice Tose

Thank you, Michael.

Tom Brandt

Thanks.

Operator

(Operator Instructions) And gentlemen it appears we have no further questions at this time. I’ll turn the conference back to you all for closing remarks.

Maurice Tose

Thank you very much. This concludes our 2014 second quarter investor call, and we look forward to speaking with you again to discuss third quarter 2014 results.

Operator

And again that will conclude today's conference. Thank you all for joining us.

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