Marty Chilberg's  Instablog

Responding to some questions from followers, here is my look at TSYS revenues,  Let me say up front that I sold my position back in July based upon several factors including this analysis.  However, I've started rebuilding my position on the recent weakness and intend to complete my investment once the overall market becomes more stable.  I believe the pullback of around 40% from my exit point is overdone and coming as the company appears to be poised for more positive results going forward.
 

Commercial Segment

	CY08		CY09		CY10		SepYTD
Service (1)	$64.4	63%	$ 89.7	70%	$169.0	84%	$130.4	91%
Systems (2)	$37.5	37%	$ 37.6	30%	$  32.7	16%	$ 12.5	9%
Total	$101.9		$127.3		$201.7		$142.9
share	46%		42%		52%		47%
core (3)			25%		18%		4%

Note 1) C10 included approximately $72m from Networks in Motion (NIM) per company.  None in C09

Note 2) SMS licenses impact per company: C08 $24m, C09 $28m, C10 $13m, C11 none.

Note 3) Core growth rate adjusted to exclude impact of NIM in C10 and SMS license revenues in C10-11.

Government Segment

	CY08		CY09		CY10		CY11YTD
Service (1,2)	$ 36.9	31%	$ 62.2	36%	$ 93.3	50%	$   94.6	59%
Systems (3)	$ 81.4	69%	$110.6	64%	$ 93.8	50%	$   66.1	41%
Total	$118.3		$172.8		$187.1		$ 160.7
share	54%		58%		48%		53%
core (4)			46%		(6)%		(3)%

Note 1)  Nov-09 purchased Solvern Cyber security bus.  C09 combined revenue $18m (most not incl).  Estimated C10 at $28m (guidance $7m per quarter).

Note 2)  Nov-09 purchased Sidereal SatCom business.  C09 revenue reported approx $3m.  C10 estimated at $24m (guidance $6m per quarter).

Note 3)  Feb-11 closed Trident space, defense, SatCom business.  No C10 revenues included.  C11 guidance $40m for 11 months.  Used 8/11 YTD.

Note 4)  Core growth after backing out impact of acq'd revenues shows declines in C10 and C11 consensus forecast.

Total Revenues

	CY08		CY09		CY10		CY11	CY12
Service	$101.4	47%	$151.9	51%	$262.3	67%
Systems	$118,7	53%	$148.2	49%	$126.5	33%	street	street
Total	$220.1		$300.1		$388.8		$424.4	$475.8
core (1)			39%		2%		2%	12%

Note 1)  Core growth excludes impact of SMS licenses and acquisitions per notes above.

Quarterly Performance

	Sep-11	Jun-11	Mar-11	Dec-10
Consensus	$ 113.5	$  102.6	$ 103.6	$110.9
Reported	$ 112.6	$  100.7	$  90.4	$102.3
Surprise	$  (.9)	$   (1.9)	$  (13.2)	$  (8.6)
%	(1%	(2)%	(13)%	(8)%

Summary of the above tables:
Core growth  The growth that is commonly attributed to TSYS in press releases or company presentations is misleading, driven by purchased revenues rather than organic growth.

Transition to Service  The company has dramatically shifted the mix of service and systems revenues.  Service in 2008 was 46% and has grown to 67% in 2010. The current year-to-date service share has grown to 74%.  Service revenues are recurring and more predictable going forward.

Revenue guidance has been terrible  The poor performance in share price should come as no surprise to anyone following this company.  They have consistently missed the street on the top line.   The company doesn't provide quarterly guidance focusing rather on calendar year.  It clearly isn't working.  The company has stated that they see 25% organic growth for CY11-13 based upon a recent bottoms up analysis.  I do not believe they will come anywhere close to achieving this.  The street consensus for C12 is currently indicating 11% growth which will be challenging given the deficit issues and overall economic slowdown. 

Government slowdown is real  Government spending caused by deficit concerns has clearly had a significant impact once you eliminate the impact of acquired companies.  Acquiring Trident, Solvern and Sidereal has exacerbated this issue, minimizing the shift toward a higher commercial revenue mix.

Commercial segment growth is anemic  Commercial revenue growth is weak even after eliminating the impact of SMS licensing which has commonly been mentioned by management as the underlying issue.

Despite the trends depicted above I'll now go into the reasons why I'm building a position in the stock.

Earnings performance has been much better  Despite missing the revenue expectations over the past few quarters, earnings has been a different story.  The consensus expectation for adjusted eps for Jun-11 quarter was $.08 per share. which the company beat reporting $.12 per share.  Mar-11 was similar with the consensus expectation at $.02 per share compared to the reported $.12 per share.  It appears they have made significant progress controlling pricing and spending and have build a fair cushion into the guidance provided.


Signs that revenue guidance is more accurate 

Backlog/Deferred Revenue

	Sep-11		Jun-11		Mar-11		Dec-10
NTM Rev/consensus	$468,670		$453,345		$442,447		$432,665
Trident adj'd NTM revenue (1)	$468,670		$453,345		$442,447		$392,665
Recognizable BL per 10Q	$316,400		$277,500		$177,500		$179,000
% of NTM revenue (2)	68%		61%		40%		46%
Total backlog	$485,700		$433,800		$308,100		$322,300
Deferred revenue per BS	$  17,279		$  22,786		$ 21,666		$ ,18,063
Total	$502,979		$456,586		$329,766		$340,363
% of NTM revenue (3)	107%		100%		87%		95%

Note 1) Trident acquisition closed around 2/1/11.  Their backlog was not included until 3/31//11 so NTM revenue contribution is also excluded.

Note 2) The amount of backlog disclosed as recognizable over next 12 months per 10Q has jumped to 61% at 6/30/11 indicating a much higher probability of achieving consensus.

Note 3) The combination of total backlog and deferred revenues per the balance sheet as a pct of future revenues has also significantly increased at 6/30/11.


Order activity in September quarter was outstanding The company issues a press release disclosing government business awarded.  During the September quarter a total of $137.7m in new funding and $146.9m in new orders has been reported. The majority of this incremental funding is for delivery through Aug-12.  Comparing this performance to the $36.3m in new funding and $60.3m in new orders in the year ago Sep-10 quarter indicates a much stronger order flow.  Even more impressive is that this $135m when added to the govt backlog at 6/30 of $156m brings the total to $300m for government business.  This compares to trailing 6 months government revenues of $95m. 

Acquisitions should be fully integrated  Most significant acquisitions take 6-12 months to fully integrate.  Having 3 virtually simultaneous acquisitions in the Dec-09 quarter had to take a huge toll on the company.  These should now be fully integrated.  Also, the Trident acquisition was effective at end of Jan-11 with the disruptive impact now mostly gone.

Market cap looks cheap  The company has disappointed investors enough that they are now a "show me" stock.  The current market cap is approx $185m.   This compares to end of quarter market caps ranging from $208m (Sep-10) to $508m (Dec-09). The stock is currently selling at a 20% discount to book value.  The forward PE is around 6.4x compared to a consensus secular growth rate of  10.8%.  If it turns out that the company has indeed bottomed out operationally this could turn out to be a nice value investment. 

Before I close this blog post, there are a couple of issues worth addressing per requests I've heard.

Ownership control by Maurice Tose  Numerous references have been made to the ownership control of CEO Maurice Tose.  It is true that Mr Tose has a significant ownership position.  At August 31st the Form 4 filing reports that Mr Tose controls 5.492m shares of Class B stock and 442k shares of Class A.  That equates to an ownership position of 10.4% of the o/s shares reported per the Jun-11 10Q.  The Class B stock has 3x voting rights which brings his voting control to 24.7%.  While this position is substantial, providing minimal ability for individual shareholders to exert any control over the company, suggesting this is a primary driver for the recent drop in share price is unfounded.  This ownership control has been the structure since the company went public.  As an example on 12/31/08 Mr Tose had 15.7% ownership resulting in 35.3% voting control.  So in effect the last 3 years has seen a continual reduction in control.

Recent insider selling is a bearish signal  Like many investors I watch insider transactions as a potential "tell".  However TSYS has it's management team under a 10b5-1 plan that takes away the requisite intent to sell needed to consider this a bearish signal.  As an example, Mr Tose has sold 100k shares of his stock every August for the past 3 years.  I've seen no indication that there is anything to be learned from insider selling at TSYS.  It's also interesting to note that many of the same people that claim Mr Tose has too much stock also claim it's a bearish sign every time he sells any.

Please be aware that while I try to review my analysis for errors, it's always possible that some still exist.  Please do your own due diligence and review all information provided before making any investment decisions.

My reaction to the Q4 conference call for TSYS was mixed.  The results were also mixed with revenue missing the low end guidance and consensus by around $7m while beating the street by a penny per share.  After evaluating the results as well as the guidance for C11, I trimmed my position but decided to hold the remainder.  Following is a recap of the reasons.

Notes:
- The guidance for C11 excluded any SMS licensing revenues.  The C10 contribution was $13m which is likely also the GM contribution.  These are concurrent usage type licenses so the cost is likely virtually zero.  The company seemed quite upbeat about a resurgence occuring in C12 as other forms of text messaging from appliances etc ramps.  Note that maintenance revenues are still growing for SMS and is expected to for the forseeable future.  

 - Trident revenues are running about $40m per annum and are included in government systems.  The deal closed at end of January so the contribution in C11 will be for 11 months only.

-  TomB mentioned during call that they had completed the 3 yr planning process for C11-13 and that they were pleased to say that excluding the SMS business, they were seeing 25+% organic growth for all three years.  However the numbers do not fulfill that statement.  C10 revenue was $389 of which $13m was SMS licensing.  Applying his statement would yield a minimum of $470m from organic growth plus the trident business of around $38m or between $500-508m in C11 revenues.  The company guidance was only $450-475m or well short of this level.  I emailed Tom to clarify and it appears he intended his statement of organic growth to be for C12-13 only.

-  Gross margins dropped from 38% in C09 to 35% in C10.  My forecast shows this dropping again in C11 to around 33%.  This is decline has been driven by the SMS licensing business which as I mentioned has very high margins.  With this now completely out of the C11 forecast, it would appear that we should start seeing margins improve in C12.

- Capx for C11 will again be at elevated levels.  Tom had previously guided expectations to around $20-25m level for C11.  Now he is upping that to around $35-40m next year.  This is likely a continuation of capital for the acquired businesses.

- Operating expenses look to be up pretty substantially next year.  I'm forecasting around $134m or an increase of $28m.  Part of this in Trident, some is depreciation for all the capx in C10-11 and part is an expectation that the company bonus plan will be fully paid out as opposed to the C10 yr which the company stated was substantially lower due to performance.

-  Company guidance for operating income was $20-25m vs C10 at $32.4m and net income guidance of $7-10m vs C10 of $15.9m.

So all in all the outlook is not particularly good for C11.  However, my take is that the company has finally understood how damaging it is for the stock to set the bar high and continually bring down expectations throughout the year.  This looks far more conservative and seems to leave room for upside beats and raises looking out.  The market seemed to like what they heard.  While analysts were dropping their forecasts for C11 by upwards of 60% on eps, the stock was quite stable and seemed to want to rally.  It appears that the analysts/MM's either agreed with the conservative approach or that they had already anticipated the drop in guidance. 

TSYS still appears to be well-positioned with respect to LBS and cyber security offerings.  The continued progress in services that are recurring is also a big plus as we now see 2/3 of the revenue in C10 from services which has the effect of smoothing revenues and being more transparent.  Government systems will continue to be a dampening component absent new awards.  The can easily be attributed to the increased attention on the Federal deficit. 

All in all a pretty wild quarter. Here's a quick recap:

- Started the quarter with a share price of $3.91
- Met expectations for Q3 and dropped guidance for Q4 on conference call.
- Received new govt funding of $58m
- Received new govt new orders of $101m
- Received govt orders with lifetime ceiling value of $671m
- Bought another defense contractor Trident for about $26m. Trident projected to deliver $40m in revenues and $6m in EBITDA in C11.
- Share price ran up above $6 briefly before steadily dropping to its' current level of $4.71 up 20% on quarter to date.
- Analysts (8) continue to rate TSYS a buy with a $7 price target.
- Analysts dropped Q4 and Q1-11 estimates which contributed to the stock price drop.


My reaction to Trident acquisition is modestly positive as follows:
Price point was good. Buying $40m of revenues with 15% EBITDA for around $26m is a pretty inexpensive.

More govt is a negative. The commercial side of the business (aside from cyber security which will cross over) is much more valuable so anything that focuses on govt isn't positive in my view.

Growth rate is a negative. The first look RBS report stated that Trident's revenues at $40m were flattish. So TSYS gets a add-on bump for C11 but makes it all the more challenging to show 15-25% growth in C12 and beyond.

Intl focus is postive. Trident's revenues were international which could provide opportunities that allow more growth cross-selling expertise but ways.

BS in a negative. Even though the price point wasn't bad, the use of around $10m of cash in an environment where we need to improve the BS and pay off debt isn't positive.

C11 EPS is a positive.  Company stated in press release that deal was accretive.