TeleCommunication Systems' CEO Discusses Q3 2012 Results - Earnings Call Transcript

TeleCommunication Systems, Inc. (NASDAQ:TSYS)

Q3 2012 Earnings Call

October 25, 2012 5:00 pm ET


Maurice Tosé - Chief Executive Officer and President

Thomas Brandt - Senior Vice President and Chief Financial Officer

Bruce White - Senior Vice President, General Counsel and Corporate Secretary


Mark Jordan - Noble Financial

Shyam Patil - Raymond James & Associates


Welcome to the TeleCommunication Systems, Inc Third Quarter 2012 Earnings Conference Call. (Operator Instructions) I would now like to turn the conference over to Maurice Tosé.

Maurice Tosé

Well, good evening, and thank you for joining us to discuss TeleCommunication Systems' third quarter 2012 results. With me are Tom Brandt, our CFO; and Bruce White, our General Counsel.

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 these 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 are statements about 2012 outlook, visibility and specific revenue projections, our growth opportunities, market opportunities and the timing of possible contracts and anticipated demand for our products and services are all forward-looking. The 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 a reconciliation in our press release and on our website.

Maurice Tosé

Thank you, Bruce. Our third quarter 2012 earnings release was issued about 4:15 today, and the full text copy of our press release has been distributed via email and is also available on our website.

The quarter started the strong second half from operations that we have expected and forecasts as TotalCom cyber solutions and 9-1-1 services for network operators and state and local governments produced year-over-year and quarter-over-quarter growth in revenue and operating profits.

Our government pipeline improved in Q3, as we were named one of eight awardees to the custom SATCOM solutions or CS2 contract. CS2 is a $2.6 billion, five year, indefinite delivery, indefinite quantity or IDIQ contract that enables the Department of Defense and federal civilian agencies to purchase TCS end-to-end turnkey solutions, which incorporate commercial satellite communication services through both, the General Services Administration or GSA and the Defense Information Systems Agency or DISA.

This is work for which the whole or the entirety of TCS is well suited to fulfill. For two additional IDIQ contracts, Homeland Security's Eagle II and the Army's GTACS, we believe that one award is imminent and the customers indicate that the other is expected before the end of the year. With wins at the Navy and the states of Tennessee, Iowa and Connecticut, the combination of TCS's the legacy expertise and our July acquisition of microDATA positions us to lead the next generation 9-1-1 market.

While we continue to report and discuss the company, based on two business segments, because of variety of business models for monetizing our technology, we are seeing more cases where end markets and our proficiency in secure and reliable wireless technology are converging.

One of our major NextGen 9-1-1 deployments is for the Navy, where both technical and federal contracts expertise intersect to enhance prospects for success. In addition, the growing body of in-building wireless deployment contracts incorporate cellular network expertise and demand for appropriate reliability and security.

And we are investing in tools that span the company exploiting our scale and enabling access to the right technical talent, with real-time project management visibility and supply chain management tools to enable TCS to meet or exceed customer expectations. We have prepared our infrastructure for the large scale contract vehicle opportunities that we have been managing through that pipeline.

TCS's 25 years of experience with state-of-the-art, secure and highly reliable communications ensures we're well able to succeed as one enterprise with multiple products, customer and channels. TCS's unique team of skilled wireless technology professionals, cyber security specialist, C4ISR contract vehicles, wireless carrier relationships and proprietary intellectual property will engender success in a market for managing, converging wireless technology.

So now moving on to business highlights from the quarter. Government segment revenue was up 38% to $92 million and gross profit was up 18% to $18 million compared to the third quarter of 2011.

There has been some seasonality to government business over the last few years, as a federal September 30 fiscal year end contributes to higher second half volume in Q3 '12 revenue included $20 million of pass-through business up from $5 million in last years third quarter.

Services revenue from the government segment was $38 million, up 19% from the same quarter of last year. Gross profit was flat with the year ago quarter at about $10 million. Our professional service In-Building Wireless campaign is an example of how we are extending our customers’ networks into areas previously unavailable to wireless systems and mobile devices.

Access to mobile wireless everywhere is becoming a must have. We have booked about $12 million of this business including contract supporting multiple DoD medical facilities. Medical is becoming an important In-Building Wireless market vertical where highly reliable system availability, data integrity and privacy are critical parameters.

TCS understands the unique challenges of installing and operating these wireless systems in areas where electromagnetic interference considerations must be addressed. Our track record includes successful implementations at Walter Reed Medical Center and at Fort Belvoir.

Our cyber professionals are taking an active role in the CTIA Wireless Industries Associations cyber security working group. It is comprised of senior representatives from leading wireless industry companies. Our participation in the working group, positions TCS to be a leader establishing standards and best practices for delivering advance wireless communication security for all users.

During the quarter TCS was awarded $11 million under WWSS in additional funding to provide communications infrastructure field support for the Marine Corps. Government systems revenue for the quarter was up 56% to $54 millions, generating $8 million gross profit which was up 52% from the third quarter of 2011.

About 18 months ago, based on our VSAT solutions success, Lockheed Martin and Northrop Grumman who built and integrated the Milstar and follow-on AEHF satellite constellation, invited TCS to join their team and integrate their technology into our SNAP solution. The two largest defense contractors in the world recognized four years ago that a more affordable solution was required to defend against future adversaries’ ability to jam and perform other denial of service against today's solutions. Together we completed the design of a protected low cost satellite-based communications terminal.

TCS is now the exclusive marketing and sales agent for this solution, with the sole right to manufacture and sell the low-cost terminal in its current two variants, on the move and at the quick-halt. Additional variants may be developed for airborne, maritime or other mission specific requirements.

Significant third quarter orders included $19 million in WPPL systems for the Marines and $32 million in orders for SNAP VSAT systems, accessories, field service support, system resets and maintenance. Our pipeline has also grown from numerous TROPO and VSAT opportunities. And our experience with the manufacturing of these advance products has allowed us to steadily improve our gross margins from non-pass-through business, while maintaining highly competitive prices.

TCS's Tactical Transportable TROPO or 3T solution received the prestigious Frost & Sullivan 2012 Global Product Innovation Award based on independent competitive analysis of the worldwide satellite communications market. 3T reflects a radio signal off the Earth's troposphere rather than using a satellite transponder, eliminating cost and significant terrain challenges relevant to complex battlefields conditions.

We expect growing aerospace component revenue streams in 2013 and beyond through the U.S. Orion and other programs. Revenue from Japanese space program was strong in Q3 and continued growth is expected in China, South Korea, Brazil and Russia.

We shipped a record number of Solid State Drives in Q3, with a solid backlog and follow-on orders expected to be placed on several existing programs. Six years ago TCS won a prime position on the World-Wide Satellite Systems contract. So far TCS has been awarded $636 million in funded orders, and another $733 million in unfunded options.

This contract vehicle with our successful performance on awarded work has put TCS on the map as a reliable systems integrator for large scale government C4ISR requirements. We have taken work from incumbents and compete with industry giants, the likes of General Dynamics, Rockwell Collins, and Boeing on the strength of our technical innovation and agility, track record of follow-through support with field support, cost efficiency and range of solutions scope capability.

We began a significant investment about three years ago to systematically capture additional large well-funded IDIQ contracts. It takes years to win these contracts. We chased WWSS for almost three years before receiving our award. We are currently tracking 31 major contract opportunities over the next five years with a combined extended [selling] [ph] value of approximately $146 billion.

Of these 31 opportunities, we have submitted 10 proposals which are under final evaluations by our customers. Notable pending proposals are DHS Enterprise Acquisition Gateway for Leading Edge Solutions II or Eagle II and Global Tactical Advance Communication systems and support services or GTACs. Pending the GTACs award, TCS has agreed to a WWSS period of performance completion date extension to March 31, 2014.

The previously mentioned $2.6 billion CS2 contract was established by the GSA and DISA to consolidate procurements of satellite transponder capacity, subscriptions services including terminal and bandwidth combinations, and end-to-end solutions into one contracting vehicle from a select group of qualified contractors. Like WWSS, we plan to demonstrate our commitment to monetizing this contract once the government starts releasing task orders which is projected to occur in late 2012.

Turning to the commercial segment. Third quarter revenue was $48 million, up 4% and of which services revenue was the lion’s share at $41 million. Overall, this was about equal to last year's third quarter, but reflecting a change in mix towards the public safety market. Commercial systems revenue was $7 million, up from $4 million in the third quarter of 2011, reflecting the growing sales of NextGen 9-1-1 systems to state and local governments.

Commercial segment gross profit was $26 million for the quarter or 55% of revenue, up 19% from $22 million or 48% of revenue last year. During the quarter, we made progress in redirecting business development resources towards new kind of customers and geographic markets. The benefits from our actions to improve productivity and reduce cost together with the contribution from the acquisition of microDATA enabled us to improve margins. Our safety and security group provides wireless voice-over-IP and Next Generation 9-1-1 solutions to network operators and state and local public safety entities across North America.

We're evolving our wireless E 9-1-1 technology to deliver at 9-1-1 Voice over LTE or VoLTE, and we are now negotiating two new VoLTE contracts, which we expect to conclude in fourth quarter of '12. Next Generation 9-1-1 systems enable delivery of data such as photos, videos and opt-in data access such as health records, in addition to location to public safety first response dispatchers.

The FCC has predicted that spending on Next Generation 9-1-1 will grow to $1.2 billion of non-recurring investment and $300 million of annual recurring spending over the next 10 years and TCS is a leader.

Early in the quarter, we acquired privately held microDATA, a leader in Next Generation 9-1-1 network management and customer premise software and solutions. We also delivered our first office application, under a nationwide SMS 9-1-1 contract.

Our combined teams are now working on a trial to deliver text to 9-1-1 services through Tennessee's emergency services Internet protocol or IP network. Tennessee has been a leader, a 9-1-1 leader, and the trial will demonstrate some advance NextGen 9-1-1 capabilities, enabling text into the NextGen 9-1-1 system is only the beginning of innovations that TCS and microDATA now expect to bring to public safety in the years to come.

The TCS microDATA channel alliances enhance distribution for our public safety solutions. In addition to AT&T relationship, we have a CenturyLink contract, under which we have completed the phase one of a four-phase program to deploy TCS microDATA solutions throughout their public safety network.

The CenturyLink channel also enables access to broader geographic territories. New NextGen orders during the quarter include Indianapolis, Little Rock, Arkansas; York County, Virginia; and seven other smaller five year deals. We also received notice of award by the State of Connecticut, subject to negotiation of a final contract.

Execution under existing contract with a state of Tennessee, state of Iowa and then North Central Texas Council of Governments have progressed as scheduled. By the end of the year, we expect the TCS deployment in Iowa to be the first statewide NextGen 9-1-1 implementation in the nation.

Now, an update on our mobile applications and infrastructure business. As we reported last quarter, we have entered into a multi million, multi-year contract with a top brand global handset provider to incorporate our navigation solution in their next wave of smartphones, slated to be released in the coming months. The details of this contract will be communicated by our customer in accordance with their products announcement time table. We expect at least one additional significant navigation contract to be awarded to TCS before year end.

We are continuing to adjust our resource deployments and spending recognizing the trend of navigation and location applications becoming a part of the device platform, while enabling continued innovation in core location technology and greater scalability and ubiquity.

We are working with carrier customers to adjust pricing and promotions resulting in three times the number of new subscribers per day compared to second quarter. We will continue to pursue pricing and promotions to enhance revenue from our carrier partners. We launched Gokivo version 5 on the iPhone platform during the third quarter, which is sold through the iPhone app store. The new features in this release include the integration of 3D models and landmarks during navigation routes.

Search enhancements including voice support, satellite view and Spanish language support. Our navigation solution continues to be adapted to markets in Latin America and has been soft launch by Telefónica in Argentina and Mexico, and most recently in the third quarter by Claro in Argentina.

Last week Telefónica began full commercial launch under the [Rudder] [ph] and Movistar brand name with an SMS campaign and prominent placement on their websites and app store fronts. In Q3, 2012 TCS Family Locator signed our first Latin American carrier with the deployment schedule for Q1 2013.

TCS continues to benefit from the market consolidations in the LBS platform business in 2012.

This past quarter, we transitioned two additional operators to our turnkey hosted location services and we anticipate deploying at least two others before year-end as part a competitor replacement strategy. These opportunities leverage existing location platform capabilities and create opportunities for future scalability as the carriers look to deploy 4G in coming years.

We shifted more sales resources toward international in 2012. And thus far in 2012, we've closed platform sales including LTE in South Africa, Laos and Oman, and anticipate additional sales in Q4.

We've been managing SMSC maintenance revenue to a fixed fee structure. Our white-label enterprise messaging gateway hosted by the largest Tier I carrier in U.S. has been enhanced to manage machine-to-machine service, and to take advantage of the growth in the use of SMS for Telematics and other applications.

We now have 12 customers for our CMAS platform that was launched earlier this year, and multiple emergency alerts are available to the public through our carrier customers. The latest is the national weather service, which has broadcast about 2000 alerts since July. These alerts notify the general public of geo-targeted threats from tornadoes, flash floods and other potentially dangerous weather conditions.

TCS secure mobile communications solutions, including Secure the Edge, authentication and secure location are being enhanced to address the needs of our government customers as well as enterprise customers, who are specifically looking for secured communications that include either messaging or voice. Our multilayer secure architecture uses our Security Broker for authentication and can be deployed as an over the top application compatible with 3G, LTE and Wi-Fi based on customer needs.

In Q3, the company filed 15 U.S. patent applications and was issued 12 new U.S. and three foreign patents, bringing the total now to 249 issued patents worldwide with more than 350 worldwide applications pending. Our several simultaneous patent monetization activities are beginning to bear fruit.

One arrangement has already been negotiated and announced and we are actively negotiating four more transactions involving specific wireless data and location base services patents and we expect that too will be announced before the end of this quarter. These arrangements involve about 10% of our issued patents. Transactions involving mapping, GIS and other technology portfolios as well as [all with] [ph] focus of balancing monetization partner, enforcement strategy and cost containment.

Now, Tom will provide some updated color on our financial position and outlook.

Thomas Brandt

The details of the third quarter results are included in the press release that maybe viewed in context by the model posted on our company's website. At quarter end the company had about $98 million of total liquidity, including $33 million of our new borrowing availability under our bank credit line, and $64 million of cash equivalents and marketable securities.

Funds were generated in the third quarter of 2012, from $15 million in EBITDA and $25 million of net borrowings under our bank facility. While we use cash for $21 million to acquire microDATA, $11 million for an increase in working capital, $4 million for capital expenditures including software development, and $1 million of cash interest, cash taxes and other items.

At quarter end, funded backlog was $367 million as we ended the quarter with $708 million of unfunded customer options. We expect to recognize about $245 million of the $367 million funded backlog during the next 12 months. Our methodology for computing backlog for our subscriber and other businesses is set forth in the press release and in SEC filings.

As the guidance for this year, we have narrowed the expected range of 2012 company revenue to the $480 million to $490 million range. Some lower margin government pass through volume will flow through the fourth quarter and we expect a mid single-digit decline in year-over-year Commercial segment revenue.

We have no other changes to our previously issued 2012 guidance for EBITDA, GAAP and adjusted net income at this time. As Maurice mentioned, several transactions to monetize the patent portfolio are in progress, which could favorably affect income in the coming quarters.

We continue to expect full year 2012 investment and company-wide capital expenditures including capitalized software development of between $27 million and $30 million. TCS is also continuing to invest in R&D for NextGen 9-1-1, new secure applications and updates to commercial apps sold on a revenue share basis, as well as other initiatives to enhance company deliverables for high growth market opportunities. We are actively engaged in preparing our 2013 budget and we'll provide 2013 full year guidance via our fourth quarter investment call.

At this time, I'll turn the call back to Maurice

Maurice Tosé

Thank you, Tom. TCS continues to execute towards our vision of enabling secure and highly reliable solutions to the converging communication networks that are increasingly interconnected. We are leveraging our success with C4ISR systems and services. And growing in-building wireless to expand our market share of federal network solutions and take them to civilian networks.

Our leading public safety technology bridges carrier and government networks. The company's cyber security specialists are on the cutting edge of advance persistent threats and similar risk knowledge of which differentiates TCS solutions. We foresee many secure communication challenges being addressed through apps, and our experts in location based and messaging applications are valuable contributors to those solutions.

In the near term, our cellular engineers are now increasingly deployed in applying our technology for customers in addition to wireless network operators. Our intellectual property monetization efforts are bearing fruit, with announcements expected soon. We are carefully managing cost across the company without [eating the sea-corn] [ph]. And assuming the current capital market conditions persist, we are confident in our ability to address the 2014 maturity of our convertible bonds in a timely fashion.

So management believes that our company's unique synergistic technical expertise, intellectual property, products, services and customer relationships constitute a unique business, well suited to the needs of our times. And deals like to one with Lockheed Martin, Northrop Grumman and the CS2 award indicate that our scale has brought us the seat at the table.

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

Question-and-Answer Session


(Operator Instructions) Our first question comes from the line of Mark Jordan with Noble Financial.

Mark Jordan - Noble Financial

A question relative to the pass-through revenues that you referenced, I believe you've said in the press release that the $26 million went through the government systems this quarter versus $5 million last. I noticed that the - the gross margin was $15 million in either case. With that high level of pass-through one assume that's basically zero margin that would imply that the other half of the revenues that the governments systems faced had gross margins well in the middle 20% range. I wondered if you could explain was there a mix shift here or new product generation profile, whatever that is improving the margins on the government systems space ex pass-through?

Thomas Brandt

Without getting too granular, Mark, we have difference in mix every quarter. Some stuff and notably the SNAP has tended to be low and when the mix includes other than SNAP, the average margins are better. We have the TROPO and wireless point-to-point link as well as other smaller volume deliverables that flow through that line as you pointed out along with the pass-through stuff. So I think your interpretation is sound but the mix was more favorable, and we hope that continues.

Maurice Tosé

And it was $20 million of pass-through not $26 million.

Thomas Brandt

It’s 26 in the press release, Maurice, we – we put the wrong number in this script.

Mark Jordan - Noble Financial

Second question relative to microDATA, is all of microDATA's revenue in the commercial systems space?

Thomas Brandt

Most of it, but not all. That business is attractive and that there are going to be projects to deploy the software and execute the systems integration at the various customers over time. But then there is a continuing services revenue stream from maintenance and network operations monitoring. So it's not a 100% in systems.

Mark Jordan - Noble Financial

So could we say that at least in the first quarter the microDATA revenues were around $3 million sort of a delta between sort of the $4 million of you legacy and 7.1 you reported?

Thomas Brandt

In the $3 million to $4 million range, I'd say.

Mark Jordan - Noble Financial

And anything you can share in terms of what you think the growth rate of that business might be over the next 12 months?

Thomas Brandt

We're really [we’re fine with] [ph] that. We expected it based on what the FCC has indicated to be a healthy double-digit growth rate. We actually expect to participate beyond the average in the market, because of the strength of the technology that's resident in our company now. So the best proxy I would offer for that would be the FCC data that embedded in the IR deck.

Mark Jordan - Noble Financial

Final question, relative to any additional M&A plans you might have, you stated that you're comfortable with being able to handle maturity of your debts. In that planning have you assumed any more acquisitions or are you pretty satisfied and pleased with the technology and business space you have in house right now?

Thomas Brandt

There's no M&A on the table right now. If circumstances evolve, we'll figure out what kind of capital arrangements fit the cash flows of our target. But for now, we think we've got a good mix of businesses to run.


And our next question comes from the line of Shyam Patil with Raymond James & Associates.

Shyam Patil - Raymond James & Associates

Maurice, on the debt commentary you made at the end of the script, how should we think about the company handling the maturity? What are your plans there?

Maurice Tosé

Our plans are to handle in advance of it coming due.

Shyam Patil - Raymond James & Associates

How do you plan to handle it though, I mean can you give any specifics? It seems to be a concern for our shareholders.

Maurice Tosé

I mean we've got a series of options that are before us that we are analyzing as to when and which we would execute on. But we believe that we are in a good position to in fact retire the debt well in advance of its maturity.

Shyam Patil - Raymond James & Associates

And Tom, I know you gave some metrics in your script, but could you remind us again what the operating cash flow was in the quarter? What the impact was from the net impact from working capital changes and then just the free cash flow number for the quarter?

Thomas Brandt

The roll-forward of cash is in the press release in a paragraph, and I rattled through it in my script. We generated $15 million from EBITDA. We had $25 million of net borrowings mainly due to the microDATA deal. And we applied the cash $21 million to microDATA, $11 million to an increase in working capital, $4 million for CapEx, and $1 million for cash interest and taxes.

Shyam Patil - Raymond James & Associates

Should we think of the operating cash flow as being $4 million, the $15 million minus the $11 million for the working capital?

Thomas Brandt

When you look at the temporary change of working capital, you get [a net] [ph] from operations.

Shyam Patil - Raymond James & Associates

So the free cash flow was about breakeven, the same as this quarter?

Thomas Brandt

For this particular quarter, yeah, without regard to the borrowing that’s right.

Shyam Patil - Raymond James & Associates

In terms of the NIM asset, I think there's been some talk of a potential sale of that asset. How should we think about that or just any other asset sales you may have that you may be contemplating?

Maurice Tosé

Well, Shyam, I don't recall this claim we contemplated a sale of those assets, I don't know where that came from.

Shyam Patil - Raymond James & Associates

I didn't imply you guys had, I said there have been talks of that, but I didn't mean that you guys were saying it. But I'm just curious, what are your thoughts around potential sale of that asset or any other assets you may have?

Maurice Tosé

As Tom said, we're pretty happy with the mix of the businesses that now comprise TCS, and we are winning new business with those NIM asset, so there is again, wherever that rumor was started, it's not the one that we are exploring.

Shyam Patil - Raymond James & Associates

And just my last question, this is not necessarily on 2013, but just in general, how do you think about the aggregate organic growth profile for the top line business and the right kind of margin expansion potential over time.

Thomas Brandt

Well, we always look at the two segments first. And the government business particularly with the big contract vehicles, we see capable of double-digit, top-line organic growth, given the space, the C4ISR space that we're in. And the NextGen 9-1-1 business on top of the solid cellular 9-1-1 business, we see that growth in the context of what I mentioned a moment ago about the Federal Communications Commission outlook for the NextGen world.

The other piece is the harder one to predict right now. But as Maurice pointed out we're finding the new kinds of customers in addition to carriers for monetizing that technology and take an advantage of talent pool. So we're not really targeting topline number by itself. It's really looking at for now the ingredients that are increasingly cross pollinated but which for now are best managed in those groups.

Maurice Tosé

As I mentioned Shyam, one of the other attribute or aspects is our intellectual property portfolio which we've announced one relationship as I've said in the remarks, we have four additional relationships working or transactions working, which we expect two of those to be announced in this current quarter.

The velocity around the number of transactions, that a transaction can be a monetization partner, it can us enforcing or could be a sale of patents individually. We now again are getting to a point of where in '13 we expect be able to get a little more clarity in that part of the business on an ongoing basis to turn it really into a profit center as we've envisioned for some time.


Thank you. And I'm no showing further questions. I would like to turn the call back to management for closing remarks.

Maurice Tosé

This concludes our third quarter 2012 investor call, and we look forward to speaking with you again to discuss our fourth quarter 2012 results.


Ladies and gentlemen, this concludes our conference for today. We thank you for your participation. You may now disconnect.

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