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TSYS Q4-10 Conference call update

|Includes: TeleCommunication Systems, Inc. (TSYS)

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.

- 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.