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TSYS > SEC Filings for TSYS > Form 10-Q on 5-Aug-2013All Recent SEC Filings

Show all filings for TELECOMMUNICATION SYSTEMS INC /FA/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for TELECOMMUNICATION SYSTEMS INC /FA/


5-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the financial condition and results of operations should be read in conjunction with the consolidated financial statements, related notes, and other detailed information included elsewhere in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 (this "Form 10-Q"). This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are statements other than historical information or statements of current condition. We generally identify forward-looking statements by the use of terms such as "believe", "intend", "expect", "may", "should", "plan", "project", "contemplate", "anticipate", or other similar statements. Examples of forward looking statements in this Quarterly Report on Form 10-Q include, but are not limited to statements: (a) regarding our belief that our technology does not infringe the patents related to customer indemnification requests and that indemnification claims should not have a material effect on our results of operations; (b) regarding our expectations with regard our senior credit facility, notes and notes hedge transactions; (c) that we believe we have sufficient capital resources to fund our operations for the next twelve months;
(d) relating to our backlog; (e) that we believe that capitalized software development costs will be recoverable from future gross profits; (f) regarding our belief that we were in compliance with our loan covenants and that we believe that we will continue to comply with these covenants; (g) regarding our expectations with regard to income tax assumptions and future stock based compensation expenses; (h) regarding our assumptions related to goodwill;
(i) that a significant underperformance relative to historical or projected future operating results, significant change in the manner of our use of acquired assets, and significant negative industry or economic trends could cause us to conclude that impairment indicators exist and that our acquired intangible assets might be impaired; (j) relating to our R&D spending; and
(k) regarding our reliance on funding by the U.S. government and any decrease in expenditures, the elimination or curtailment of a material program in which we are involved, or changes in payment patterns of our customers as a result of changes in U.S. government spending, could have a material adverse effect on our operating results, financial condition, and/or cash flows.

These forward-looking statements relate to our plans, objectives and expectations for future operations. We base these statements on our beliefs as well as assumptions made using information currently available to us. In light of the risks and uncertainties inherent in all such projected operational matters, the inclusion of forward-looking statements in this report should not be regarded as a representation by us or any other person that our objectives or plans will be achieved or that any of our operating expectations will be realized. Revenues, results of operations, and other matters are difficult to forecast and our actual financial results realized could differ materially from the statements made herein, as a result of the risks and uncertainties described in our filings with the Securities and Exchange Commission. These include without limitation risks and uncertainties relating to our financial results and our ability to (i) continue to rely on our customers and other third parties to provide additional products and services that create a demand for our products and services, (ii) conduct our business in foreign countries, (iii) adapt and integrate new technologies into our products, (iv) develop software without any errors or defects, (v) protect our intellectual property rights, (vi) implement our business strategy, (vii) realize backlog, (viii) compete with small business competitors, (ix) effectively manage our counterparty risks, (x) achieve continued revenue growth in the foreseeable future in certain of our business lines, (xi) have sufficient capital resources to


fund the Company's operations, and (xii) successfully integrate the assets and personnel obtained in our acquisitions. These factors should not be considered exhaustive; we undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. We caution you not to put undue reliance on these forward-looking statements.

The information in this "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" discusses our unaudited consolidated financial statements, which have been prepared in accordance with GAAP for interim financial information.

Critical Accounting Policies and Estimates

Management's Discussion and Analysis of Financial Condition and Results of Operations addresses our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We have identified our most critical accounting policies and estimates to be those related to the following:

- Revenue recognition,

- Business combinations,

- Acquired intangible assets,

- Goodwill,

- Software development costs,

- Marketable securities,

- Stock compensation expense,

- Income taxes, and

- Legal and other contingencies

This discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included in our 2012 Form 10-K.

Overview

Our business is reported using two business segments: (i) the Government Segment: We provide professional services including field support of deployable wireless systems and cybersecurity training to the U.S. Department of Defense and other government and foreign customers. We own and operate secure satellite teleport facilities, resell access to satellite airtime (known as space segment), and design, furnish, install and operate wireless communication systems and components, including our SwiftLink® deployable communication systems which integrate high speed, satellite, and, internet protocol technology with secure, federal government-approved cryptologic devices. (ii) the Commercial Segment: We are one of two leading companies that enable 9-1-1 call routing via cellular, Voice Over Internet Protocol ("VoIP"), and next generation technology. Other TCS hosted and managed services include cellular carrier infrastructure for text messaging and location-based platforms and applications, including turn-by-turn navigation and E9-1-1 call routing. Commercial segment customers include wireless carrier network operators, VoIP service providers, wireless device manufacturers, automotive industry suppliers, and state and local governments.

This "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" provides information that our management believes to be necessary to achieve a clear understanding of our financial statements and results of operations. You should read this "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" together with Item 1A "Risk Factors" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"


in our 2012 Form 10-K as well as the unaudited interim consolidated financial statements and the notes thereto located elsewhere in this Form 10-Q.

Indicators of Our Financial and Operating Performance

Our management monitors and analyzes a number of performance indicators in order to manage our business and evaluate our financial and operating performance. Those indicators include:

· Revenue. We derive revenue from the sales of systems and services including recurring monthly service and subscriber fees, maintenance fees, software licenses and related service fees for the design, development, and deployment of software and communication systems, and products and services derived from the delivery of information processing, communication systems and components for governmental agencies.

· Gross profit (revenue minus direct cost of revenue, including certain non-cash expenses). The major items comprising our cost of revenue are compensation and benefits, third-party hardware and software, network operation center and co-location facility operating expenses, amortization of capitalized software development costs, stock-based compensation, and overhead expenses. The costs of hardware and third-party software are primarily associated with the delivery of systems, and fluctuate from period to period as a result of the relative volume, mix of projects, level of service support required and the complexity of customized products and services delivered. Amortization of capitalized software development costs, including acquired technology, is associated with the recognition of revenue from our Commercial Segment.

· Operating expenses. Our operating expenses are primarily compensation and benefits, professional fees, facility costs, marketing and sales-related expenses, and travel costs as well as certain non-cash expenses such as stock based compensation expense, depreciation and amortization of property and equipment, and amortization of acquired intangible assets.

· Liquidity and cash flows. The primary driver of our cash flows is the results of our operations. Other important sources of our liquidity are our capacity to borrow, through our bank credit and term loan facility and other markets; lease financing for the purchase of equipment; and access to the public equity market.

· Balance sheet. We view cash, working capital, and accounts receivable balances and days revenue outstanding as important indicators of our financial health.

Results of Operations

We develop and deliver highly reliable and secure wireless communication technology. Our mobile cloud computing services provide wireless applications and operator infrastructure for 9-1-1 call routing, navigation, asset and social applications, telematics, and text messaging. Our engineered satellite-based solutions incorporate cybersecurity expertise, and include base station management, deployable solutions for mission-critical communications with expert field support, and professional services including training.

The comparability of our operating results in the first half of 2013 to the first half of 2012 is affected by our 2012 acquisition of microDATA, GSI, Inc. which occurred on July 6, 2012. Where changes in our results of operations from the first half of 2013 compared to the first half of 2012 are clearly related to this acquisition, such as revenue and increases in amortization of intangibles, we quantify the effects. The acquisition did not result in our entry into a new line of business or product category since it added products and services similar to those provided by our Commercial Segment.


Revenue and Cost of Revenue

The following discussion addresses the revenue, direct cost of revenue, and gross profit for our two business segments.

Government Segment





                                   Three Months                                                     Six Months
                                  Ended June 30,                    2013 vs. 2012                 Ended June 30,                    2013 vs. 2012
($ in millions)                2013            2012               $                %           2013            2012               $                %
Services revenue             $   33.5        $   32.7        $    0.8                2 %     $   69.6        $   66.0        $    3.6                5 %
Systems revenue                  17.0            40.8           (23.8 )            (58 %)        33.7            64.3           (30.6 )            (48 %)
Total Government Segment
revenue                          50.5            73.5           (23.0 )            (31 %)       103.3           130.3           (27.0 )            (21 %)

Direct cost of services          24.6            24.3             0.3                1 %         50.0            49.5             0.5                1 %
Direct cost of systems           13.1            36.7           (23.6 )            (64 %)        27.0            55.0           (28.0 )            (51 %)
Total Government Segment
cost of revenue                  37.7            61.0           (23.3 )            (38 %)        77.0           104.5           (27.5 )            (26 %)

Services gross profit             8.9             8.4             0.5                6 %         19.6            16.5             3.1               19 %
Systems gross profit              3.9             4.1            (0.2 )             (5 %)         6.7             9.3            (2.6 )            (28 %)
Total Government Segment
gross profit1                $   12.8        $   12.5        $    0.3                2 %     $   26.3        $   25.8        $    0.5                2 %
Segment gross profit as a
percentage of revenue              25 %            17 %                                            25 %            20 %

1 See discussion of segment reporting in Note 7 to the accompanying unaudited consolidated financial statements

The primary customers of this segment are U.S. government agencies including Department of Defense ("DoD") and Homeland Security, domestic and foreign space programs, and the contractors that supply products and services to these government customers. TCS is a prime contractor on several multi-year, multi-billion dollar contracts, some of which are indefinite-delivery, indefinite quantity or IDIQ contracts, through which this segment generates much of its revenue. As a result, we rely on funding by the U.S. government for the programs in which we are involved. These funding levels follow the cycle of general public policy and political support for this type of spending. Moreover, although our contracts often contemplate that our services will be performed over a period of several years, the Executive Branch must propose and Congress must approve funds for a given program each government fiscal year and may significantly change - increase, reduce or eliminate - funding for a program. A decrease in expenditures, the elimination or curtailment of a material program in which we are involved, or changes in payment patterns of our customers as a result of changes in U.S. government spending, could have a material adverse effect on our operating results, financial condition, and/or cash flows.

Government Services Revenue, Cost of Revenue, and Gross Profit:

Government services revenue is generated from professional communications engineering and field support, cyber security training, program management, help desk outsource, network design and management for government agencies, as well as operation of teleport (fixed satellite ground terminal) facilities for data connectivity via satellite, including resale of satellite airtime. Systems maintenance fees are usually collected in advance and recognized ratably over the contractual maintenance periods. Government services revenue increased $0.8 million, or 2% for the three months ended June 30, 2013 compared to 2012, as a result of about 30% higher field support and maintenance and in-building wireless business volume, partially offset by about 40% lower professional services revenue. Government services revenue increased $3.6 million or 5% for the six months ended June 30, 2013 compared to 2012 as a result of about 40% more field support and maintenance and in-building wireless, and higher cyber security training business volume.

Direct cost of government services revenue consists of compensation, benefits and travel expenses incurred in delivering these services, as well as satellite space segment purchased for resale. These costs were higher in the three and six months ended June 30, 2013 compared to the same periods in 2012 as a result of the increased volume of services.

Our gross profit from government services increased $0.5 million, or 6% and $3.1 million, or 19% in the three and six months ended June 30, 2013, compared to the same periods in 2012 reflecting the higher volume of services noted above.


Government Systems Revenue, Cost of Revenue, and Gross Profit:

We generate government systems revenue from selling secure wireless communication systems, primarily deployable satellite-based and line-of-sight deployable systems, and integration of these systems into customer networks. These are largely variations on lightweight, secure, deployable communication kits, sold mainly to units of the U.S. Department of Defense and other federal agencies. Our government systems revenue also includes electronic components, sold mainly to domestic and foreign space programs. Government systems sales decreased $23.8 million, or 58%, in the three months ended June 30, 2013 compared to 2012 due to more than 90% lower "pass through" (low-margin, low-value-add) sales as the 2012 quarter included revenue from large pass-through orders delivered in the second and third quarters of 2012. Sales of our highly reliable electronic parts were also about 30% lower due to delays in expected new funded orders. For the first six month in 2013, government systems sales were $30.6 million, or 48% lower compared to the first six months of 2012 due to about 80% less "pass through" revenue and about 40% lower sales of our highly reliable-electronic components for foreign space programs. Government systems shipments have been heavier around the Government's September 30 fiscal year end, and timing of electronic component sales to our many customers of long standing varies due to multiple factors.

The cost of our government systems revenue consists of purchased system components, compensation and benefits, the costs of third-party contractors, and travel. These costs have varied over the periods as a direct result of changes in volume. These equipment and third-party costs are variable for our different products, so that margins fluctuate between periods based on pricing and product mix.

Our government systems gross profit decreased $0.2 million, or 5% in the second quarter, and $2.6 million, or 28% for the six months ended June 30, 2013, compared to the same periods in 2012 due to the lower sales volume. Government systems gross profit as a percentage of revenue was 23% and 20% for both the three and six month ended June 30, 2013, and was 10% and 14% for the three and six months ended June 30, 2012, respectively. The increases in gross margin as a percentage of revenue reflect less lower-margin pass-through revenue in the mix, in the current period.

Commercial Segment





                                  Three Months                                                      Six Months
                                 Ended June 30,             2013 vs. 2012                         Ended June 30,             2013 vs. 2012
($ in millions)               2013            2012               $                %            2013            2012               $                %
Services revenue            $   38.1        $   37.8        $    0.3                1 %      $   75.5        $   76.8        $   (1.3 )             (2 %)
Systems revenue                  4.2             3.3             0.9               27 %           8.8             7.5             1.3               17 %
Total Commercial Segment
revenue                         42.3            41.1             1.2                3 %          84.3            84.3              -                -

Direct cost of services         15.1            16.3            (1.2 )             (7 %)         31.5            35.3            (3.8 )            (11 %)
Direct cost of systems           4.1             2.8             1.3               46 %           7.7             5.9             1.8               31 %
Total Commercial Segment
cost of revenue                 19.2            19.1             0.1                1 %          39.2            41.2            (2.0 )             (5 %)

Services gross profit           23.0            21.5             1.5                7 %          44.0            41.5             2.5                6 %
Systems gross profit             0.1             0.5            (0.4 )            (80 %)          1.1             1.6            (0.5 )            (31 %)
Total Commercial Segment
gross profit1               $   23.1        $   22.0        $    1.1                5 %      $   45.1        $   43.1        $    2.0                5 %
Segment gross profit as a
percentage of revenue             55 %            54 %                                             53 %            51 %

1 See discussion of segment reporting in Note 7 to the accompanying unaudited consolidated financial statements.

Commercial Services Revenue, Cost of Revenue, and Gross Profit:

Our commercial services revenue is generated from hosting and maintaining software and networks for public safety 9-1-1 service for wireless, VoIP service providers, and operators of next generation 9-1-1 infrastructure (mainly state and local governments), as well as applications and infrastructure software for Location-Based Services ("LBS") including turn-by-turn navigation and locator applications, and maintenance of text messaging platform software. This revenue primarily consists of monthly recurring service fees recognized in the month earned. Hosted LBS service and E9-1-1 fees are generally priced based on units served during the period, such as the number of customer cell sites, the number of connections to Public Service Answering Points ("PSAPs"), or the number of customer subscribers or sessions using our technology. Subscriber service revenue is generated by client software applications for wireless subscribers, generally on a per-subscriber per month basis. Maintenance fees on our systems and software licenses are usually collected in advance and recognized ratably over the contractual maintenance period. Unrecognized


maintenance fees are included in deferred revenue. Services also include custom software development, implementation and related service projects under time and materials or fixed-fee contracts, which are reported using percentage-of-completion accounting.

Commercial services revenue was $0.3 million, or 1% higher, in the three months ended June 30, 2013 compared to the same period in 2012 reflecting 7% higher revenue from 9-1-1 related services offset by 4% lower application and platform services revenue, including navigation. Commercial services revenue was $1.3 million, or 2% lower, in the six months ended June 30, 2013 compared to the same period in 2012 due to about 8% less application and platform services revenue, mainly due to a wireless carrier navigation application contract change reported in the second quarter of 2012, partially offset by higher 9-1-1 related network monitoring, and other professional services revenue, including about $2 million from the acquired microDATA business.

The direct cost of our commercial services revenue consists primarily of compensation and benefits, licensed location-based application content, network access, data feed and circuit costs for network operation centers and co-location facilities, and equipment and software maintenance. The direct cost of services also includes amortization of acquired and capitalized software development costs of $0.6 million and $0.3 million for the three months ended June 30, 2013 and for June 30, 2012, respectively. For the three months ended June 30, 2013, the direct cost of services revenue decreased $1.2 million, or 7%, from 2012, due mainly to lower direct labor and other direct costs. Amortization of capitalized software development costs was $1.3 million and $2 million, respectively, for the six months ended June 30, 2013 and 2012. The decrease in amortization of capitalized software development costs for the six months ended June 30, 2013 reflects the write-down of amortizable intangibles during the second quarter of 2012. The direct cost of services revenue decreased $3.8 million, or 11%, for the six months ended June 30, 2013 compared to the same period in 2012, reflecting a decrease in labor and direct costs related to custom development efforts responding to customer requests, and deployment requirements for wireless and VoIP E-9-1-1.

Commercial services gross profit for the three and six months ended June 30, 2013 increased $1.5 million, or 7%, and $2.5 million, or 6%, respectively, compared to the same periods in 2012 due to mainly to cost savings.

Commercial Systems Revenue, Cost of Revenue, and Gross Profit:

We sell communications systems to wireless carriers and state and local governments incorporating our licensed software for enablement of 9-1-1- call routing and computer-aided responder dispatch, including Next Generation 9-1-1 technology and location-based wireless services and text messaging. In July 2012, we acquired microDATA, which expanded our share of the market for Next Generation 9-1-1 technology. Revenue from our larger deployments of Next Generation 9-1-1 technology, incorporating our software and third party components, are long term contracts reported using percentage of completion accounting. We recognize revenue from the sale of patents and licensing of our intellectual property including payments for past patent infringement liabilities, upfront and non-refundable license fees, and royalty fees. Licensing fees for our carrier software are generally a function of its volume of usage in our customers' networks during the relevant period. In all cases, revenue from the licensing of our intellectual property is recognized when all of four of the revenue recognition criteria are met.

Commercial systems revenue for the three months ended June 30, 2013 increased $0.9 million compared to 2012 as a result of higher Next Generation 9-1-1 and mobility-solution license sales. Commercial systems revenue for the six months ended June 30, 2013 was $1.3 million higher compared to 2012 from higher Next Generation 9-1-1 technology revenue, mainly associated with the acquisition of microDATA in the third quarter of 2012.

The direct cost of our commercial systems revenue consists primarily of compensation and benefits, third-party hardware and software purchased for integration and resale, travel expenses, consulting fees as well as the amortization of acquired and capitalized software development. The direct costs of systems revenue for the three and six months ended June 30, 2013 increased $1.3 million, or 46% and $1.8 million, or 31%, respectively, compared to the same periods in 2012, reflecting an increase in labor and direct costs for customer-related custom messaging and location-based system development . . .

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