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SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
[X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarter ended June 30, 2004 | ||
OR | ||
[ ] | THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File No. 0-30821
TELECOMMUNICATION SYSTEMS, INC.
MARYLAND (State or Other Jurisdiction of Incorporation or Organization) | 52-1526369 (I.R.S. Employer Identification No.) | |
275 West Street, Annapolis, MD (Address of principal executive offices) | 21401 (Zip Code) |
(410) 263-7616
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act): Yes [ ] No [ X ]
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Shares outstanding | ||||
as of June 30, | ||||
Title of Each Class | 2004 | |||
Class A Common Stock, par value $0.01 per share | 24,575,405 | |||
Class B Common Stock, par value $0.01 per share | 8,845,001 | |||
Total Common Stock Outstanding | 33,420,406 | |||
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INDEX
TELECOMMUNICATION SYSTEMS, INC.
Page | ||||||||
PART I. FINANCIAL INFORMATION | ||||||||
Item 1. | Financial Statements (Unaudited) | |||||||
Consolidated Statements of Operations for the three- and six-months ended June 30, 2004 and 2003 | 3 | |||||||
Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003 | 4 | |||||||
Consolidated Statement of Stockholders’ Equity for the six-months ended June 30, 2004 | 5 | |||||||
Consolidated Statements of Cash Flows for the six-months ended June 30, 2004 and 2003 | 6 | |||||||
Notes to Consolidated Financial Statements | 7 | |||||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 15 | ||||||
Item 3. | Qualitative and Quantitative Disclosures about Market Risk | 30 | ||||||
Item 4. | Controls and Procedures | 30 | ||||||
PART II. OTHER INFORMATION | ||||||||
Item 1. | Legal Proceedings | 31 | ||||||
Item 2. | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities | 31 | ||||||
Item 3. | Defaults Upon Senior Securities | 31 | ||||||
Item 4. | Submission of Matters to a Vote of Security Holders | 31 | ||||||
Item 5. | Other Information | 31 | ||||||
Item 6. | Exhibits and Reports on Form 8-K | 32 | ||||||
SIGNATURES | 33 |
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TeleCommunication Systems, Inc.
Consolidated Statements of Operations
Three months | Six months | ||||||||||||||||||
ended June 30, | ended June 30, | ||||||||||||||||||
2004 | 2003 | 2004 | 2003 | ||||||||||||||||
Revenue: | |||||||||||||||||||
Service bureau and subscriber | $ | 20,103 | $ | 8,310 | $ | 40,839 | $ | 15,865 | |||||||||||
Software systems: | |||||||||||||||||||
Software licenses | 5,808 | 788 | 7,504 | 3,255 | |||||||||||||||
Software systems and services | 3,257 | 1,492 | 6,098 | 2,633 | |||||||||||||||
Software systems total | 9,065 | 2,280 | 13,602 | 5,888 | |||||||||||||||
Network solutions | 11,279 | 9,490 | 18,763 | 17,619 | |||||||||||||||
Total revenue | 40,447 | 20,080 | 73,204 | 39,372 | |||||||||||||||
Operating costs and expenses: | |||||||||||||||||||
Direct cost of service bureau and subscriber revenue | 12,718 | 3,961 | 25,985 | 7,967 | |||||||||||||||
Direct cost of software systems revenue | 3,203 | 1,352 | 5,607 | 3,037 | |||||||||||||||
Direct cost of network solutions revenue | 7,046 | 6,492 | 11,245 | 11,852 | |||||||||||||||
Research and development expense | 4,555 | 4,664 | 9,601 | 8,579 | |||||||||||||||
Sales and marketing expense | 3,323 | 2,213 | 6,513 | 4,606 | |||||||||||||||
General and administrative expense | 4,766 | 2,707 | 9,253 | 5,610 | |||||||||||||||
Non-cash stock compensation expense | 346 | 389 | 703 | 762 | |||||||||||||||
Depreciation and amortization of property and equipment | 1,912 | 1,690 | 3,644 | 3,235 | |||||||||||||||
Amortization of acquired intangible assets | 532 | 139 | 1,064 | 277 | |||||||||||||||
Amortization of software development costs | 239 | 7,774 | 326 | 8,804 | |||||||||||||||
Total operating costs and expenses | 38,640 | 31,381 | 73,941 | 54,729 | |||||||||||||||
Income/(loss) from operations | 1,807 | (11,301 | ) | (737 | ) | (15,357 | ) | ||||||||||||
Interest expense | (857 | ) | (216 | ) | (1,664 | ) | (492 | ) | |||||||||||
Other (expense)/income, net | (87 | ) | 125 | (182 | ) | 409 | |||||||||||||
Net income/(loss) | $ | 863 | $ | (11,392 | ) | $ | (2,583 | ) | $ | (15,440 | ) | ||||||||
Earnings/(loss) per share — basic | $ | 0.03 | $ | (0.38 | ) | $ | (0.08 | ) | $ | (0.52 | ) | ||||||||
Earnings/(loss) per share — diluted | $ | 0.02 | $ | (0.38 | ) | $ | (0.08 | ) | $ | (0.52 | ) | ||||||||
Weighted average shares outstanding — basic | 32,566 | 29,610 | 32,225 | 29,589 | |||||||||||||||
Weighted average shares outstanding — diluted | 36,591 | 29,610 | 32,225 | 29,589 | |||||||||||||||
See accompanying Notes to Consolidated Financial Statements
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TeleCommunication Systems, Inc.
Consolidated Balance Sheets
June 30, | December 31, | ||||||||||
2004 | 2003 | ||||||||||
(unaudited) | |||||||||||
Assets | |||||||||||
Current assets: | |||||||||||
Cash and cash equivalents | $ | 15,763 | $ | 18,785 | |||||||
Accounts receivable, net of allowance of $1,679 in 2004 and $393 in 2003 | 27,431 | 20,208 | |||||||||
Unbilled receivables | 13,559 | 8,862 | |||||||||
Inventory | 2,836 | 451 | |||||||||
Other current assets | 3,085 | 1,915 | |||||||||
Total current assets | 62,674 | 50,221 | |||||||||
Property and equipment, net of accumulated depreciation and amortization of $24,569 in 2004 and $20,925 in 2003 | 15,080 | 11,449 | |||||||||
Software development costs, net of accumulated amortization of $1,080 in 2004 and $754 in 2003 | 480 | 518 | |||||||||
Acquired intangible assets, net of accumulated amortization of $1,064 in 2004 | 5,755 | — | |||||||||
Goodwill | 13,802 | — | |||||||||
Other assets | 3,987 | 3,092 | |||||||||
Total assets | $ | 101,778 | $ | 65,280 | |||||||
Liabilities and stockholders’ equity | |||||||||||
Current liabilities: | |||||||||||
Accounts payable and accrued expenses | $ | 17,579 | $ | 8,817 | |||||||
Accrued payroll and related liabilities | 3,936 | 3,331 | |||||||||
Deferred revenue | 4,458 | 1,683 | |||||||||
Current portion of notes payable | 10,313 | 5,698 | |||||||||
Current portion of capital lease obligations | 1,474 | 2,154 | |||||||||
Total current liabilities | 37,760 | 21,683 | |||||||||
Capital lease obligations and notes payable, less current portion | 5,553 | 6,746 | |||||||||
Convertible subordinated debentures, net of discount of $6,027 in 2004 | 8,973 | — | |||||||||
Stockholders’ equity: | |||||||||||
Class A Common Stock; $0.01 par value: | |||||||||||
Authorized shares — 225,000,000; issued and outstanding shares of 24,575,405 in 2004 and 22,062,974 in 2003 | 246 | 221 | |||||||||
Class B Common Stock; $0.01 par value: | |||||||||||
Authorized shares — 75,000,000; issued and outstanding shares of 8,845,001 in 2004 and 9,363,688 in 2003 | 88 | 94 | |||||||||
Deferred compensation | (1,077 | ) | (1,399 | ) | |||||||
Additional paid-in capital | 184,149 | 169,256 | |||||||||
Accumulated other comprehensive loss: | |||||||||||
Cumulative foreign currency translation adjustment | (10 | ) | — | ||||||||
Accumulated deficit | (133,904 | ) | (131,321 | ) | |||||||
Total stockholders’ equity | 49,492 | 36,851 | |||||||||
Total liabilities and stockholders’ equity | $ | 101,778 | $ | 65,280 | |||||||
See accompanying Notes to Consolidated Financial Statements
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TeleCommunication Systems, Inc.
Accumulated | ||||||||||||||||||||||||||||
Class A | Class B | Additional | Other | |||||||||||||||||||||||||
Common | Common | Deferred | Paid-in | Comprehensive | Accumulated | |||||||||||||||||||||||
Stock | Stock | Compensation | Capital | Loss | Deficit | Total | ||||||||||||||||||||||
Balance at January 1, 2004 | $ | 221 | $ | 94 | $ | (1,399 | ) | $ | 169,256 | $ | — | $ | (131,321 | ) | $ | 36,851 | ||||||||||||
Options exercised for the purchase of 432,981 shares of Class A Common Stock | 4 | — | — | 901 | — | — | 905 | |||||||||||||||||||||
Issuance of 37,860 shares of Class A Common Stock under Employee Stock Purchase Plan | — | — | — | 179 | — | — | 179 | |||||||||||||||||||||
Issuance of 1,568,308 shares of Class A Common Stock in connection with the Enterprise acquisition and related financing, net of issuance costs | 16 | — | — | 8,366 | — | — | 8,382 | |||||||||||||||||||||
Fair value of beneficial conversion feature of convertible subordinated debentures | — | — | — | 3,662 | — | — | 3,662 | |||||||||||||||||||||
Issuance of warrants to purchase 341,072 shares of Class A Common Stock | — | — | — | 1,395 | — | — | 1,395 | |||||||||||||||||||||
Conversion of 518,687 shares of Class B Common Stock to Class A Common Stock | 5 | (5 | ) | — | — | — | — | — | ||||||||||||||||||||
Stock compensation expense for issuance of Class A Common Stock options at below fair market value | — | — | — | 381 | — | — | 381 | |||||||||||||||||||||
Amortization of deferred compensation expense | — | — | 322 | — | — | — | 322 | |||||||||||||||||||||
Stock compensation expense for options issued to non- employees for service | — | — | — | 8 | — | — | 8 | |||||||||||||||||||||
Foreign currency translation adjustment | — | — | — | — | (10 | ) | — | (10 | ) | |||||||||||||||||||
Net loss for the six months ended June 30, 2004 | — | — | — | — | — | (2,583 | ) | (2,583 | ) | |||||||||||||||||||
Balance at June 30, 2004 | $ | 246 | $ | 88 | $ | (1,077 | ) | $ | 184,149 | $ | (10 | ) | $ | (133,904 | ) | $ | 49,492 | |||||||||||
See accompanying Notes to Consolidated Financial Statements
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TeleCommunication Systems, Inc.
Six months ended | ||||||||||
June 30, | ||||||||||
2004 | 2003 | |||||||||
Operating activities: | ||||||||||
Net loss | $ | (2,583 | ) | $ | (15,440 | ) | ||||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||
Depreciation and amortization of property and equipment | 3,644 | 3,371 | ||||||||
Amortization of acquired intangible assets | 1,064 | 277 | ||||||||
Non-cash employee compensation expense | 703 | 762 | ||||||||
Amortization of software development costs | 326 | 8,804 | ||||||||
Amortization of debt discount | 669 | — | ||||||||
Amortization of deferred financing fees included in interest expense | 224 | 56 | ||||||||
Other non-cash expenses | 359 | (50 | ) | |||||||
State of Maryland loan forgiveness | (100 | ) | (100 | ) | ||||||
Changes in operating assets and liabilities: | ||||||||||
Accounts receivable, net | (161 | ) | 5,486 | |||||||
Unbilled receivables | (4,697 | ) | (2,164 | ) | ||||||
Inventory | (1,778 | ) | — | |||||||
Other current assets | (442 | ) | (84 | ) | ||||||
Accounts payable and accrued expenses | (168 | ) | (8,730 | ) | ||||||
Accrued payroll and related liabilities | (434 | ) | 171 | |||||||
Deferred revenue | 442 | (326 | ) | |||||||
Net cash used in operating activities | (2,932 | ) | (7,967 | ) | ||||||
Investing activities: | ||||||||||
Acquisition of Enterprise assets, net of cash acquired | (17,800 | ) | — | |||||||
Purchases of property and equipment | (4,859 | ) | (2,391 | ) | ||||||
Change in other assets | 477 | 62 | ||||||||
Capitalized software development costs | — | (1,865 | ) | |||||||
Net cash used in investing activities | (22,182 | ) | (4,194 | ) | ||||||
Financing activities: | ||||||||||
Payments on long-term debt and capital lease obligations | (3,928 | ) | (2,447 | ) | ||||||
Proceeds from issuance of Class A Common Stock and Convertible subordinated debentures | 21,000 | — | ||||||||
Financing fees related to issuance of Class A Common Stock and Convertible subordinated debentures | (1,100 | ) | — | |||||||
Proceeds from issuance of long-term debt | 5,000 | 2,624 | ||||||||
Proceeds from exercise of employee stock options and sale of stock | 1,085 | 112 | ||||||||
Net cash provided by financing activities | 22,057 | 289 | ||||||||
Net decrease in cash | (3,057 | ) | (11,872 | ) | ||||||
Effect of exchange rates on cash and cash equivalents | 35 | — | ||||||||
Cash and cash equivalents at the beginning of the period | 18,785 | 27,402 | ||||||||
Cash and cash equivalents at the end of the period | $ | 15,763 | $ | 15,530 | ||||||
See accompanying Notes to Consolidated Financial Statements
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TeleCommunication Systems, Inc.
1. | Basis of Presentation and Summary of Significant Accounting Policies |
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three- and six-month periods ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. These unaudited consolidated financial statements should be read in conjunction with our audited financial statements and related notes included in our 2003 Annual Report on Form 10-K, as amended.
Effective January 1, 2004, we acquired 100% of the Enterprise Mobility Solutions division of Aether Systems, Inc. (the “Enterprise segment”) in accordance with a Purchase Agreement dated as of December 18, 2003 (the “Enterprise Acquisition”). The operations for this newly acquired segment have been included in the consolidated financial statements as of January 1, 2004. All intercompany balances and transactions have been eliminated.
Use of Estimates.The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and related disclosures. Actual results could differ from those estimates.
Allowances for Doubtful Accounts Receivable.We use estimates to determine the amount of the allowance for doubtful accounts necessary to reduce accounts receivable to their expected net realizable value. We estimate the amount of the required allowance by reviewing the status of significant past-due receivables and by establishing general provisions for estimated losses by analyzing current and historical bad debt trends. Actual collection experience has not varied significantly from our estimates, due primarily to credit and collection policies and the financial strength of our customers. Receivables that are ultimately deemed uncollectible are charged-off as a reduction of receivables and the allowance for doubtful accounts.
Inventory.We maintain inventory of component parts and finished product for certain SwiftLink® units. Additionally, we maintain inventory in conjunction with the Enterprise segment. The Enterprise inventory consists of finished goods such as handheld computers, pagers, wireless modems, and accessories. Inventory is stated at the lower of cost or market. Cost is determined using the first-in, first-out method.
Goodwill.Goodwill represents the excess of cost over the fair value of assets of businesses acquired. Goodwill acquired in a purchase business combination is not amortized, but instead tested at least annually for impairment in accordance with the provisions of Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets. See below for a description of our accounting policies regarding testing long-lived assets for impairment.
Acquired Intangible Assets.In conjunction with the Enterprise Acquisition, we acquired customer contracts, a customer list, developed technology, and trademarks that will be amortized over their respective estimated useful lives of 3 – 5 years, with a weighted-average useful life of 4.1 years, based on the ratio of the estimated cash flows generated in each period to the estimated total cash flows to be contributed from each asset.
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Notes to Consolidated Financial Statements — (Continued)
Impairment of Long-Lived Assets.Long-lived assets, including intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable. If an impairment indicator is present, we evaluate recoverability by a comparison of the carrying amount of the assets to future undiscounted net cash flows that we expect to generate from these assets. If the assets are impaired, we recognize an impairment charge equal to the amount by which the carrying amount exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of carrying values or fair values, less estimated costs of disposal.
Other Comprehensive Income/loss.Comprehensive income, as defined, includes changes in the equity of a business during a period from transactions and other events and circumstances from non-owner sources. Other comprehensive income/loss refers to revenue, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income, but excluded from net income. For operations outside the U.S. that prepare financial statements in currencies other than the U.S. dollar, results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at end-of-period exchange rates. Translation adjustments for our international subsidiaries are included as a separate component of accumulated other comprehensive loss in stockholders’ equity.
Stock-Based Compensation.We have two stock-based employee compensation plans, which are described more fully in Note 7. We record compensation expense for all stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees(APB No. 25) and related interpretations. Under APB No. 25, compensation expense is recorded over the vesting period to the extent that the fair value of the underlying stock on the date of grant exceeds the exercise or acquisition price of the stock or stock-based award.
Reclassifications.Certain prior period amounts have been reclassified to conform to the current year presentation.
2. | Acquisition and Related Financing |
Effective January 1, 2004, we acquired the Enterprise segment in accordance with a Purchase Agreement dated as of December 18, 2003.
The Enterprise segment provides wireless data solutions, uniting messaging, synchronization and web technologies. These solutions include package and vehicle tracking, productivity tools, and the ability to capture digital signatures for proof of delivery to a growing installed base of logistics customers. The Enterprise segment is a leading reseller of BlackberryTM devices and provides real-time financial market data to wireless device users under annual subscriber contracts in the U.S. and Europe. As a result of the acquisition of the Enterprise segment, the Company believes that it will be able to expand its product offerings to both new and existing customers, expand its international sales, and provide broader technology and expertise to its customers, opening new markets to the Company.
The aggregate purchase price was approximately $22,406, consisting of cash payments of $18,150, a note payable in the amount of $1,000, bearing interest at the prime interest rate, and 204,020 shares of our Class A Common Stock, valued at $1,056, based on the average closing price for the five days immediately preceding the closing of the acquisition. In addition, management expects to incur approximately $2,200 of costs directly related to the acquisition. The total purchase price has been allocated based on independent third-party valuation procedures performed on the acquired assets and assumed liabilities, with the excess of the purchase price
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Notes to Consolidated Financial Statements — (Continued)
over the assets acquired and liabilities assumed being allocated to goodwill. The valuation has resulted in the recognition of $13,802 of goodwill. This goodwill has been allocated to the Enterprise segment, and we expect it to be deductible for tax purposes.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition:
Assets: | |||||
Cash | $ | 1,882 | |||
Accounts receivable, net | 7,047 | ||||
Inventory | 606 | ||||
Other current assets | 718 | ||||
Property and equipment | 750 | ||||
Acquired software development costs | 287 | ||||
Acquired intangible assets | 6,819 | ||||
Goodwill | 13,802 | ||||
Other assets | 30 | ||||
Total assets | 31,941 | ||||
Liabilities: | |||||
Accounts payable and accrued expenses | 6,188 | ||||
Accrued payroll and related liabilities | 1,032 | ||||
Deferred revenue | 2,315 | ||||
Total liabilities | 9,535 | ||||
Net assets acquired | $ | 22,406 | |||
The following unaudited consolidated pro forma results of operations of the Company for the three-and six- month periods ended June 30, 2003, gives effect to the January 1, 2004 acquisition as though it had occurred on January 1, 2003:
Three months | Six months | ||||||||
Ended | Ended | ||||||||
June 30, 2003 | June 30, 2003 | ||||||||
Revenue | $ | 33,373 | $ | 67,047 | |||||
Loss from operations | (11,607 | ) | (16,856 | ) | |||||
Net loss | (12,195 | ) | (17,915 | ) | |||||
Loss per common share: | |||||||||
Basic and diluted | $ | (0.39 | ) | $ | (0.58 | ) | |||
The pro forma results include the estimated amortization of intangibles, estimated depreciation of the fair value of the property, plant and equipment acquired, and the recognition of interest expense related to financing the acquisition. The pro forma results are not necessarily indicative of the results that would have occurred if the acquisition had actually been completed on January 1, 2003 and do not reflect the reduction in recurring costs during the latter part of 2003, nor are they necessarily indicative of future consolidated results.
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Notes to Consolidated Financial Statements — (Continued)
3. | Supplemental Disclosure of Cash Flow Information |
Property and equipment acquired under capital leases totaled $176 and $179 during the three months ended June 30, 2004 and 2003, respectively, and $1,664 and $179 during the six months ended June 30, 2004 and 2003, respectively.
Interest paid totaled $298 and $204 during the three months ended June 30, 2004 and 2003, respectively, and $561 and $436 during the six months ended June 30, 2004 and 2003, respectively.
4. | Segment Information |
Beginning with our acquisition of the Enterprise segment in January 2004, we manage our business across three market segments: (i) our Wireless Carrier segment, which consists principally of our products and services marketed directly to wireless carriers consisting of monthly recurring E9-1-1 and hosted software application offerings as well as software license and service fees, (ii) our Government segment, which includes the design, development and deployment of information processing and communication systems and related services to government agencies, and (iii) our Enterprise segment, which comprises the operations we acquired from Aether Systems, Inc., which offers subscriber-based services as well as software licenses and services to Enterprise customers.
Management evaluates performance based on gross profit. Gross profit is defined as revenue less direct cost of revenue, excluding the amortization of software development costs, which under accounting principles generally accepted in the United States, is considered in determining gross profit from software license revenues. We have restated prior period segment information for comparative purposes.
Three months ended June 30, 2004 | Six months ended June 30, 2004 | |||||||||||||||||||||||||||||||||
Wireless | Wireless | |||||||||||||||||||||||||||||||||
Carrier | Government | Enterprise | Total | Carrier | Government | Enterprise | Total | |||||||||||||||||||||||||||
Revenue: | ||||||||||||||||||||||||||||||||||
Service bureau and subscriber | $ | 9,577 | $ | — | $ | 10,526 | $ | 20,103 | $ | 18,695 | $ | — | $ | 22,144 | $ | 40,839 | ||||||||||||||||||
Software systems: | ||||||||||||||||||||||||||||||||||
Software licenses | 5,779 | — | 29 | 5,808 | 7,443 | — | 61 | 7,504 | ||||||||||||||||||||||||||
Software systems and services | 2,465 | — | 792 | 3,257 | 4,324 | — | 1,774 | 6,098 | ||||||||||||||||||||||||||
Software systems total | 8,244 | — | 821 | 9,065 | 11,767 | 1,835 | 13,602 | |||||||||||||||||||||||||||
Network solutions | — | 11,279 | — | 11,279 | — | 18,763 | — | 18,763 | ||||||||||||||||||||||||||
Total revenue | $ | 17,821 | $ | 11,279 | $ | 11,347 | $ | 40,447 | $ | 30,462 | $ | 18,763 | $ | 23,979 | $ | 73,204 | ||||||||||||||||||
Segment gross profit: | ||||||||||||||||||||||||||||||||||
Service bureau and subscriber | $ | 4,755 | $ | — | $ | 2,630 | $ | 7,385 | $ | 9,545 | $ | — | $ | 5,309 | $ | 14,854 | ||||||||||||||||||
Software systems | 5,580 | — | 282 | 5,862 | 7,552 | — | 443 | 7,995 | ||||||||||||||||||||||||||
Network solutions | — | 4,233 | — | 4,233 | — | 7,518 | — | 7,518 | ||||||||||||||||||||||||||
Total segment gross profit | $ | 10,335 | $ | 4,233 | $ | 2,912 | $ | 17,480 | $ | 17,097 | $ | 7,518 | $ | 5,752 | $ | 30,367 | ||||||||||||||||||
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Notes to Consolidated Financial Statements — (Continued)
Three months ended June 30, 2003 | Six months ended June 30, 2003 | |||||||||||||||||||||||||||||||||
Wireless | Wireless | |||||||||||||||||||||||||||||||||
Carrier | Government | Enterprise | Total | Carrier | Government | Enterprise | Total | |||||||||||||||||||||||||||
Revenue: | ||||||||||||||||||||||||||||||||||
Service bureau and subscriber | $ | 8,310 | $ | — | $ | — | $ | 8,310 | $ | 15,865 | $ | — | $ | — | $ | 15,865 | ||||||||||||||||||
Software systems: | ||||||||||||||||||||||||||||||||||
Software licenses | 788 | — | — | 788 | 3,255 | — | — | 3,255 | ||||||||||||||||||||||||||
Software systems and services | 1,492 | — | — | 1,492 | 2,633 | — | — | 2,633 | ||||||||||||||||||||||||||
Software systems total | 2,280 | — | — | 2,280 | 5,888 | — | — | 5,888 | ||||||||||||||||||||||||||
Network solutions | — | 9,490 | — | 9,490 | — | 17,619 | — | 17,619 | ||||||||||||||||||||||||||
Total revenue | $ | 10,590 | $ | 9,490 | $ | — | $ | 20,080 | $ | 21,753 | $ | 17,619 | $ | — | $ | 39,372 | ||||||||||||||||||
Segment gross profit: | ||||||||||||||||||||||||||||||||||
Service bureau and subscriber | $ | 4,349 | $ | — | $ | — | $ | 4,349 | $ | 7,898 | $ | — | $ | — | $ | 7,898 | ||||||||||||||||||
Software systems | 928 | — | — | 928 | 2,851 | — | — | 2,851 | ||||||||||||||||||||||||||
Network solutions | — | 2,998 | — | 2,998 | — | 5,767 | — | 5,767 | ||||||||||||||||||||||||||
Total segment gross profit | $ | 5,277 | $ | 2,998 | $ | — | $ | 8,275 | $ | 10,749 | $ | 5,767 | $ | — | $ | 16,516 | ||||||||||||||||||
A reconciliation of segment gross profit to net income/(loss) for the respective periods is as follows:
Three months ended | Six months ended | ||||||||||||||||
June 30, | June 30, | ||||||||||||||||
2004 | 2003 | 2004 | 2003 | ||||||||||||||
Total segment gross profit | $ | 17,480 | $ | 8,275 | $ | 30,367 | $ | 16,516 | |||||||||
Research and development expense | (4,555 | ) | (4,664 | ) | (9,601 | ) | (8,579 | ) | |||||||||
Sales and marketing expense | (3,323 | ) | (2,213 | ) | (6,513 | ) | (4,606 | ) | |||||||||
General and administrative expense | (4,766 | ) | (2,707 | ) | (9,253 | ) | (5,610 | ) | |||||||||
Non-cash stock compensation expense | (346 | ) | (389 | ) | (703 | ) | (762 | ) | |||||||||
Depreciation and amortization of property and equipment | (1,912 | ) | (1,690 | ) | (3,644 | ) | (3,235 | ) | |||||||||
Amortization of acquired intangible assets | (532 | ) | (139 | ) | (1,064 | ) | (277 | ) | |||||||||
Amortization of software development costs | (239 | ) | (7,774 | ) | (326 | ) | (8,804 | ) | |||||||||
Interest expense | (857 | ) | (216 | ) | (1,664 | ) | (492 | ) | |||||||||
Other (expense)/income | (87 | ) | 125 | (182 | ) | 409 | |||||||||||
Net income/(loss) | $ | 863 | $ | (11,392 | ) | $ | (2,583 | ) | $ | (15,440 | ) | ||||||
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Notes to Consolidated Financial Statements — (Continued)
5. | Acquired Intangible Assets and Capitalized Software Development Costs |
Our acquired intangible assets and capitalized software development costs consisted of the following:
June 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||
Gross | Gross | |||||||||||||||||||||||||
Carrying | Accumulated | Carrying | Accumulated | |||||||||||||||||||||||
Amount | Amortization | Net | Amount | Amortization | Net | |||||||||||||||||||||
Acquired intangible assets: | ||||||||||||||||||||||||||
Customer Contracts | $ | 4,208 | $ | 690 | $ | 3,518 | $ | — | $ | — | $ | — | ||||||||||||||
Customer List | 1,942 | 319 | 1,623 | — | — | — | ||||||||||||||||||||
Trademarks | 669 | 55 | 614 | — | — | — | ||||||||||||||||||||
Software development costs, including acquired technology | 1,559 | 1,080 | 480 | 1,272 | 754 | 518 | ||||||||||||||||||||
Total | $ | 8,378 | $ | 2,144 | $ | 6,235 | $ | 1,272 | $ | 754 | $ | 518 | ||||||||||||||
Estimated future amortization expense: | ||||||||||||||||||||||||||
Six months ending December 31, 2004 | $ | 1,242 | ||||||||||||||||||||||||
Year ending December 31, 2005 | $ | 2,460 | ||||||||||||||||||||||||
Year ending December 31, 2006 | $ | 1,807 | ||||||||||||||||||||||||
Year ending December 31, 2007 | $ | 566 | ||||||||||||||||||||||||
Year ending December 31, 2008 | $ | 160 |
We routinely update our estimates of both the recoverability of the software products that have been capitalized and the fair value of the acquired intangible assets recognized as a result of the acquisition of the Enterprise segment. Management uses these estimates as the basis for evaluating the carrying values of the respective assets.
6. | Concentrations of Credit Risk and Major Customers |
Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of accounts receivable and unbilled receivables. Accounts receivable are generally due within thirty days and no collateral is required. We maintain allowances for potential credit losses and historically such losses have been insignificant and within our expectations.
The following table summarizes revenue concentrations from our significant customers:
% of Total Revenue | % of Total Revenue | |||||||||||||||||
For the three | For the three | For the six | For the six | |||||||||||||||
months ended | months ended | months ended | months ended | |||||||||||||||
Customer | Segment | June 30, 2004 | June 30, 2003 | June 30, 2004 | June 30, 2003 | |||||||||||||
Federal Agencies | Government | 22% | 26% | 22% | 27% | |||||||||||||
Customer A | Wireless Carrier | 10% | 13% | 10% | 14% | |||||||||||||
Customer B | Wireless Carrier | Less than 10% | 10% | Less than 10% | 10% |
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Notes to Consolidated Financial Statements — (Continued)
As of June 30, 2004 | ||||||||||
Accounts | Unbilled | |||||||||
Customer | Segment | Receivable | Receivables | |||||||
Federal Agencies | Government | 10% | 53% | |||||||
Customer A | Wireless Carrier | 23% | Less than 10% | |||||||
Customer B | Wireless Carrier | Less than 10% | 11% |
7. | Stock-Based Compensation |
We have two stock-based employee compensation plans: our Third Amended and Restated 1997 Stock Incentive Plan (the “Stock Incentive Plan”) and our Employee Stock Purchase Plan. We record compensation expense for all stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees(APB No. 25) and related Interpretations. Under APB 25, compensation expense is recorded over the vesting period to the extent that the fair value of the underlying stock on the date of grant exceeds the exercise or acquisition price of the stock or stock-based award. The following table illustrates the effect on net loss and loss per common share if we had applied the fair value recognition provisions of Financial Accounting Standards Board Statement No. 123,Accounting for Stock-Based Compensation,to stock-based employee compensation.
Three months ended | Six months ended | ||||||||||||||||
June 30, | June 30, | ||||||||||||||||
2004 | 2003 | 2004 | 2003 | ||||||||||||||
Net income/(loss), as reported | $ | 863 | $ | (11,392 | ) | $ | (2,583 | ) | $ | (15,440 | ) | ||||||
Add: Stock-based employee compensation expense included in reported net loss | 346 | 389 | 703 | 762 | |||||||||||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards | (2,436 | ) | (1,348 | ) | (4,218 | ) | (2,686 | ) | |||||||||
Pro forma net loss | $ | (1,227 | ) | $ | (12,351 | ) | $ | (6,098 | ) | $ | (17,364 | ) | |||||
Earnings/(loss) per common share: | |||||||||||||||||
Basic — as reported | $ | 0.03 | $ | (0.38 | ) | $ | (0.08 | ) | $ | (0.52 | ) | ||||||
Diluted — as reported | $ | 0.02 | $ | (0.38 | ) | $ | (0.08 | ) | $ | (0.52 | ) | ||||||
Basic and diluted — pro forma | $ | (0.04 | ) | $ | (0.42 | ) | $ | (0.19 | ) | $ | (0.59 | ) | |||||
In calculating the fair value of our stock options using Black-Scholes, we assumed that the expected life was five years for options granted to employees and three years for options granted to non-employees, that the risk free interest rate was 3%, and that there was no dividend yield. We also assumed that the expected volatility of our stock was 119%.
Prior to our initial public offering in 2000, we granted incentive stock options to employees and directors to purchase 885,983 shares of Class A Common Stock. The options were granted at an exercise price less than the estimated market value of Class A Common Stock at the date of grant. Net income/(loss), as reported, includes $188 and $222 of non-cash stock compensation expense related to these grants for the three-months ended June 30, 2004 and 2003, respectively, and $381 and $595 of expense for the six-months then ended. We expect to record future stock compensation expense of $398 as a result of these option grants that will be recognized over the remaining vesting period of two years.
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Notes to Consolidated Financial Statements — (Continued)
In the second quarter of 2003, we issued restricted stock to directors and certain key executives. The restrictions expire at the end of one year for directors and in annual increments over three years for executives and are based on continued employment. Net income/(loss), as reported, includes $158 and $167 of non-cash stock compensation expense related to these grants for the three-months ended June 30, 2004 and 2003, respectively, and $322 and $167 of expense for the six-months then ended. We expect to record future stock compensation expense of $1,077 as a result of these restricted stock grants that will be recognized over the remaining vesting period for executives.
8. | Long-Term Debt |
To fund the acquisition of the Enterprise assets, on January 13, 2004 the Company raised $21,000 in cash from third-parties through the issuance of (i) convertible subordinated debentures with a face value of $15,000, bearing interest at a stated rate of 3% per annum and due in lump sum on January 13, 2009 in cash or shares of the Company Class A Common Stock at the option of the Company (ii) warrants to purchase 341,072 shares of Class A Common Stock at an exercise price of $6.50 per share and expiring in January 2007, and (iii) 1,364,288 shares of Class A Common Stock. We determined that the value of the Class A Common Stock issued was $7,640 based on the quoted closing price of the Company’s Class A Common Stock on the issue date of $5.60. The difference between the proceeds from the issuance of these shares and their fair value was recognized as a debt discount. The value of the warrants was estimated to be $1,395, determined using the Black-Scholes option-pricing model and was recorded as a debt discount and additional paid-in capital. The convertible subordinated debentures provide for a contractual conversion price of $5.38 per share, and were estimated to have an issuance date beneficial conversion value of $3,662, which was recorded as a debt discount and additional paid-in capital. The resulting carrying value of the debt at issuance was $8,303, net of $6,697 of original issue discount that will be amortized over its five-year term using the effective interest method, which will yield an effective interest rate of 12.6%. As of June 30, 2004, the subordinated convertible debentures had a carrying value of $8,973.
Additionally, during the three and six months ended June 30, 2004, we borrowed approximately $2,500 and $5,106, respectively, primarily to fund equipment purchases. Approximately $2,606 of the debt, which was borrowed under the terms of a note payable, bears interest at 7.75%, is payable monthly through October 2005, and is secured by the accounts receivable owed to us by certain customers. The remaining $2,500, which was borrowed against our line of credit, bears interest at prime plus 1.0% (minimum prime rate of 4.25%, interest rate of 5.25% as of June 30, 2004), and is payable upon the collection of the receivables collateralizing the loan.
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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. This report 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. Some forward-looking statements may be identified by the use of such terms as “believes”, “anticipates”, “intends”, or “expects”. For example, the statements (a) regarding our belief as to the sufficiency of our capital resources to meet our anticipated working capital and capital expenditures for at least the next twelve months, (b) regarding our belief that general and administrative expenses will remain higher than 2003 levels and (c) that we expect to realize approximately $34.2 million of backlog during this year and $51.9 million in the next 12 months are forward-looking statements. These forward-looking statements relate to our plans, objectives and expectations for future operations. 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. Our actual financial results realized could differ materially from the statements made herein, depending in particular upon 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) reach and maintain profitability as early as anticipated or at all, (ii) 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, (iii) conduct our business in foreign countries, (iv) adapt and integrate new technologies into our products, (v) develop software and deliver products and services without any errors or defects, (vi) protect our intellectual property rights, (vii) implement our business strategy (viii) realize backlog, and (vix) achieve continued revenue growth in the foreseeable future for our E9-1-1 business. 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.
Critical Accounting Policies and Estimates
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 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, including those related to intangible assets and contingencies and litigation. 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 identified our most critical accounting policies to be those related to revenue recognition for our software contracts with multiple elements, contracts accounted for using the percentage of completion method, the relevant accounting related to valuation allowances, capitalized software development costs, and other acquired intangible assets. We describe these accounting policies in relevant sections of this discussion and analysis. This discussion and analysis should be read in
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Overview
On January 13, 2004, we consummated the purchase of the Enterprise Mobility Solutions division of Aether Systems, Inc. This unit brings to us a substantial base of 1,200 enterprise customers, more than 60,000 wireless data subscribers, applications for logistics, financial services and the mobile office, and 112 employees.
Prior to the January 2004 acquisition of the Enterprise Mobility Solutions division of Aether Systems, Inc., we managed our business in three operating segments: Network Software, Service Bureau and Network Solutions. Subsequent to the acquisition, we realigned our segments to better manage the business we operate. Our operating segments include (i) our Wireless Carrier segment, which consists principally of the previous Network Software and Service Bureau segments, and which principally includes our products and services marketed directly to wireless carriers consisting of monthly recurring E9-1-1 and hosted software application offerings as well as software license and service fees (ii) our Government segment, which consists principally of the previous Network Solutions segment, and which includes the design, development, and deployment of information processing and communication systems and related services, and (iii) our Enterprise segment, which comprises the operations we acquired from Aether Systems, Inc. and which offers subscriber-based services as well as software licenses and services for Enterprise customers. The information in this section is presented based on the operating segments through which we manage our business.
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.
Our management monitors and analyzes a number of key performance indicators in order to manage our business and evaluate our financial and operating performance. Those indicators include:
• | Revenue.We derive revenue from products and services including service bureau and subscriber-based services, software license fees and related service fees relating to our developed software products, and network solutions revenue related to our communication systems delivered to governmental agencies. | |
• | Cost of revenue.The major items impacting our cost of revenue are compensation and benefits as well as third-party hardware and software, airtime costs of subscriber-based revenue and overhead expenses. Hardware and third-party software costs are primarily associated with the delivery of product within our Government segment while also, to a lesser extent, may be attributed to the delivery of software licenses and services in both our Wireless Carrier and Enterprise segments. These costs tend to fluctuate as a result of the relative volume, mix of projects, level of service support required and the complexity of customized products and services delivered in a period. Airtime costs relate to the volume of monthly subscriber-based revenue experiences in our Enterprise segment. | |
• | Operating expenses.Operating expenses are substantially driven by compensation and benefits, travel costs, professional fees, facility costs, specific marketing and sales-related expenses as well as certain non-cash expenses such as non-cash stock compensation expenses, depreciation and amortization of property and equipment, of software development costs, and of acquired intangible assets. Operating expenses are incurred in connection with the development and marketing of new software applications as well as general corporate overhead expenses. |
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• | Liquidity and cash flows.The primary driver of our cash flows is our results of operations. Important sources of our liquidity have been cash raised at the time of our initial public offering in 2000, our January 2004 private investment in public equity financing (as described below under “Liquidity and Capital Resources”), and borrowing and lease financings secured for the purchase of equipment. | |
• | Balance sheet.We view cash, working capital, accounts receivable balances and days revenues outstanding as important indicators of our financial health. |
Swiftlink®, XYPOINT® and Wireless Internet GatewayTM are trademarks or service marks of TeleCommunication Systems, Inc. or our subsidiaries. This Quarterly Report on Form 10-Q also contains trademarks, trade names and services marks of other companies that are the property of their respective owners.
Results of Operations
Revenue and Cost of Revenue
The following discussion addresses the relative revenue and direct cost for each segment of our business:
Wireless Carrier Segment:
The following table sets forth, for the three- and six-months ended June 30, 2004 and 2003, respectively, a period-over-period comparison of the key components of the revenue and cost of revenue of our Wireless Carrier segment:
Three Months Ended June 30 | Six Months Ended June 30 | ||||||||||||||||||||||||||||||||
2004 vs. 2003 | 2004 vs. 2003 | ||||||||||||||||||||||||||||||||
($ in millions) | 2004 | 2003 | $ | % | 2004 | 2003 | $ | % | |||||||||||||||||||||||||
Service bureau and subscriber revenue | $ | 9.6 | $ | 8.3 | $ | 1.3 | 15 | % | $ | 18.7 | $ | 15.9 | $ | 2.8 | 18 | % | |||||||||||||||||
Software systems revenue: | |||||||||||||||||||||||||||||||||
Software licenses | 5.8 | 0.8 | 5.0 | N/M | 7.4 | 3.3 | 4.2 | N/M | |||||||||||||||||||||||||
Software systems and services | 2.5 | 1.5 | 1.0 | 65 | % | 4.3 | 2.6 | 1.7 | 64 | % | |||||||||||||||||||||||
Software systems total | 8.2 | 2.3 | 6.0 | N/M | 11.8 | 5.9 | 5.9 | 100 | % | ||||||||||||||||||||||||
Segment revenue | 17.8 | 10.6 | 7.2 | 68 | % | 30.5 | 21.8 | 8.7 | 40 | % | |||||||||||||||||||||||
Direct cost of service bureau and subscriber | 4.8 | 4.0 | 0.9 | 22 | % | 9.2 | 8.0 | 1.2 | 15 | % | |||||||||||||||||||||||
Direct cost of software systems | 2.7 | 1.4 | 1.3 | 97 | % | 4.2 | 3.0 | 1.2 | 39 | % | |||||||||||||||||||||||
Segment gross profit* | $ | 10.3 | $ | 5.3 | $ | 5.1 | 96 | % | $ | 17.1 | $ | 10.7 | $ | 6.3 | 59 | % | |||||||||||||||||
Percent of revenue | 58 | % | 50 | % | 56 | % | 49 | % |
* | See discussion of segment reporting in Note 4 to the accompanying unaudited financial statements. |
Service bureau revenue and cost of revenue:
We market our service bureau and software offerings to wireless carriers. Our service bureau offerings include our E9-1-1, hosted Position Determining Entity (PDE) and Text Message Distribution Center (MDC) applications. Revenue from our service bureau offerings primarily consists of monthly recurring service fees and is recognized in the month earned. E9-1-1 and PDE service fees are primarily dependent on the number of subscribers the carrier covers, Public Service Answering Points (PSAPs) served or carrier cell sites. As the carrier’s number of subscribers, PSAPs, or cell sites increases, the monthly recurring service fees increase. MDC revenue is priced
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The direct cost of our service bureau revenue consists primarily of compensation, benefits, travel expenses, and consulting fees incurred when providing our services, as well as the equipment maintenance and circuit costs of our network operations centers circuits utilized for connectivity to carrier customers and local governments’ PSAPs. In both the three-month period as well as the six-month period of 2004, we increased headcount as well as circuit costs required to support this business, resulting in an increase in costs.
Software systems revenue and cost of revenue:
We market our software systems products and services by responding to requests for proposals, through our direct sales force and through channel partners. We generate software systems revenue from licensing of our software products, and providing related maintenance and deployment services. We also sell custom software applications. The Short Message Service Center (SMSC), TCS Xypoint® Location Platform products, Wireless Messaging Gateway (WMG), as well as alerting and message notification applications are the principal generators of software license fees.
We sell our software products directly to wireless carriers. Initial licensing fees are a function of the number of subscribers or other measure of usage of our software in the network where our software is deployed. As a carrier’s subscriber base or usage increases, the carrier must purchase additional capacity under its license agreement and we receive additional revenue. Generally, we recognize license fee revenue when each of the following has occurred: (1) evidence of an arrangement is in place; (2) we have delivered software; (3) the fee is fixed or determinable; and (4) collection of the fee is probable. Software projects that require significant customization are accounted for under the percentage-of-completion method. We typically measure progress to completion using costs incurred compared to estimated total costs. We recognize estimated losses under long-term contracts in their entirety upon discovery.
If we did not accurately estimate total costs to complete a contract or do not manage our contracts within the planned budget, then future margins may be negatively affected or losses on existing contracts may need to be recognized. Software license fees billed and not recognized as revenue are included in deferred revenue.
We have also historically sold some of our network software products through channel relationships. This sales process typically includes participation of our engineers along with original equipment manufacturers in presenting our products to prospective customers. In the three-months ended June 30, 2004, software license revenue increased to $5.8 million from $0.8 million in the comparable period last year and in the six-month period ended June 30, 2004 software license revenue increased to $7.4 million from $3.3 million primarily due to a large order for an upgrade of license fees as required based on usage increases. Software license revenue was positively impacted in the three-month and the six-month periods due to revenue that was recognized in 2004 related to a large contract to deliver our location platforms for a new customer in Europe, the revenue from which was higher than a similar project in the prior year comparable periods.
Our software systems and services revenue arises from annual maintenance fees for our packaged and custom software products and fees from custom development and implementation of software products. Maintenance fees on packaged software are collected in advance and recognized ratably over the maintenance period. Unrecognized maintenance fees are included in deferred revenue. Custom software development, implementation and maintenance services may be provided under time and materials or fixed-fee contracts. We also occasionally sell computer equipment as part of our packaged software sales.
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In the three-month period ended June 30, 2004, 64% of software service revenues related to maintenance fees, while 32% related to custom development and implementation fees associated with the delivery of related software applications and the remaining 4% related to third-party hardware and software delivered as part of our packaged software sales. In the comparable period in 2003, 55% of service revenue is related to maintenance fees, while 45% of service revenue was associated with custom development and implementation fees associated with the delivery of related software applications. In the six-month period of 2004, 64% of software service revenues related to maintenance fees, while 33% related to custom development and implementation fees associated with the delivery of related software applications and the remaining 3% related to third-party hardware and software delivered as part of our packaged software sales. In the comparable period in 2003, 62% of service revenue is related to maintenance fees, while 38% of service revenue was associated with custom development and implementation fees associated with the delivery of related software applications.
The direct cost of our software systems revenue consists primarily of compensation, benefits, purchased equipment, third-party software, travel expenses and consulting fees incurred when providing our services. In the three-month periods ended June 30, 2004 and 2003, 15% and 9%, respectively of total direct costs related to the cost of purchased equipment and third-party software delivered as part of our packaged software sales. In the six-month period of 2004 and in 2003, 13% and 9%, respectively, of the total direct costs related to the cost of purchased equipment and third-party software delivered as part of our packaged software sales.
Gross profit for the Wireless Carrier segment increased to 58% of revenue from 50% of revenue for the three-month periods ended June 30, 2004 and 2003, respectively, and increased to 56% of revenue from 49% of revenue for the six-month periods ended June 30, 2004 and 2003, respectively. The increase for both the three- and six-month periods is primarily attributable to increased sales of high margin software license capacity in 2004.
Government Segment:
The following table sets forth, for the three- and six-months ended June 30, 2004 and 2003, respectively, a period-over-period comparison of the key components of our Government segment revenue and cost of revenue:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||||||||||
2004 vs. | 2004 vs. | |||||||||||||||||||||||||||||||
2003 | 2003 | |||||||||||||||||||||||||||||||
($ in millions) | 2004 | 2003 | $ | % | 2004 | 2003 | $ | % | ||||||||||||||||||||||||
Network solutions revenue | $ | 11.3 | $ | 9.5 | $ | 1.8 | 19 | % | $ | 18.8 | $ | 17.6 | $ | 1.1 | 7 | % | ||||||||||||||||
Direct cost of network solutions | 7.1 | 6.5 | 0.6 | 9 | % | 11.2 | 11.9 | (0.6 | ) | (5 | %) | |||||||||||||||||||||
Segment gross profit* | $ | 4.2 | $ | 3.0 | $ | 1.2 | 41 | % | $ | 7.5 | $ | 5.8 | $ | 1.8 | 30 | % | ||||||||||||||||
Percent of revenues | 38 | % | 32 | % | 40 | % | 33 | % |
* | See discussion of segment reporting in Note 4 to the accompanying unaudited financial statements. |
We generate Government segment revenue from the design, development, assembly and deployment of information processing and communication systems, primarily for government enterprises. Representative examples of recent network solutions projects include delivery of our SwiftLink® product, a lightweight, secure, deployable communications system, to the U.S. Departments of State, Justice, and Defense, and information services systems to local government agencies. SwiftLink® provides secure voice, video and data communications, supports a worldwide network during trips abroad and throughout the United States and provides full network functionality and Internet Protocol telephony capability using landlines and satellite-based technologies. Our Government segment also operates teleport facilities in Baltimore, MD and Manassas, VA, which
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In the three-and six- month periods ended June 30, 2004, approximately 65% and 57%, respectively, of network solutions revenue resulted from the sale of SwiftLink® and related deployable communications systems. In 2004, we also designed, tested and delivered products to government customers related to other satellite-based communication systems and information processing systems for local government agencies as well as for the country of Bahrain. In the three-and six- month periods ended June 30, 2003, approximately 55% and 48%, respectively, of our revenue for this segment resulted from the sale of SwiftLink® and related deployable communication systems, while the remaining amount related to the design, development and operation of other communication systems, as well as the design, testing and delivery of products for several government agencies.
The direct cost of our network solutions revenue consists of compensation, benefits, travel, satellite “space segment” and airtime. In the three-and six-month periods ended June 30, 2004, approximately 68% and 60%, respectively, of costs were related to purchased equipment components, which we purchase as needed for customer contracts or release from inventory, and the costs of third-party contractors that we engage. Such costs represented 59% and 57% of direct cost of network solutions revenue in the three-month and six-month periods ended June 30, 2003, respectively.
Gross profit for the Government segment increased to 38% of revenue from 32% of revenue for the three-month periods ended June 30, 2004 and 2003, respectively, and increased to 40% of revenue from 33% of revenue for the six-month periods ended June 30, 2004 and 2003, respectively. The increase for both the three- and six-month periods is primarily attributable to an increased proportion of sales of our SwiftLink® products and related deployable communications systems, which yield higher margins than various other types of projects.
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Enterprise Segment:
The following table sets forth, for the three and six-month periods ended June 30, 2004, the key components of subscriber and software systems revenue and related cost of revenue for the Enterprise segment:
Three months ended | Six months ended | ||||||||
($ in millions) | June 30, 2004 | June 30, 2004 | |||||||
Service bureau and subscriber revenue | $ | 10.5 | $ | 22.1 | |||||
Software systems revenue: | |||||||||
Software systems licenses | — | 0.1 | |||||||
Software systems and services | 0.8 | 1.8 | |||||||
Software systems total | 0.8 | 1.8 | |||||||
Total revenue | 11.3 | 24.0 | |||||||
Direct cost of service bureau and subscriber | 7.9 | 16.8 | |||||||
Direct cost of software systems | 0.5 | 1.4 | |||||||
Segment gross profit* | $ | 2.9 | $ | 5.8 | |||||
Percent of revenue | 26 | % | 24 | % |
* | See discussion of segment reporting in Note 4 to the accompanying unaudited financial statements. |
No period-over-period comparison between 2003 and 2004 is presented for our Enterprise segment because the Enterprise Mobility Solutions division of Aether Systems, Inc, which makes up the Enterprise segment, was acquired in January 2004.
Subscriber revenue and cost of revenue:
Our Enterprise segment sells mobile office, mobile finance, and mobile asset services and products to Enterprise customers. Subscriber-based revenue is generated from all three segments. The table below summarizes subscriber-based revenue categorized by type of subscriber:
Three months ended | Six months ended | |||||||
Subscriber Type | June 30, 2004 | June 30, 2004 | ||||||
Mobile office subscribers | 62 | % | 62 | % | ||||
Mobile finance subscribers | 25 | % | 24 | % | ||||
Mobile asset subscribers | 13 | % | 14 | % |
Subscriber-based revenue is billed to customers on a monthly basis and is generally cancelable with 30-days notice. Most corporate customers have retained their service for three years or more.
The direct cost of our subscriber revenue consists primarily of compensation, benefits, travel expenses, airtime charges and consulting fees incurred when providing our services, as well as the equipment maintenance and circuit costs of our network operations centers circuits utilized for connectivity to customer devices.
Major Customers
For the three and six months ended June 30, 2004, customers that accounted for 10% or more of total revenue were Verizon Wireless and various U.S. Government agencies. The loss of either of these customers would have a material adverse impact on our business. For the six months ended June 30, 2003 customers that accounted for 10% or more of total revenue were Verizon Wireless, United States Cellular Corporation, and various U.S. Government agencies. Verizon Wireless and United States Cellular Corporation are primarily customers of our Wireless
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Revenue Backlog
As of June 30, 2004, we had unfilled orders, or backlog, of approximately $83 million, of which $63 million related to our Wireless Carrier segment, $12 million related to our Government segment and $8 million related to our Enterprise segment. We expect to realize approximately $34 million of this backlog in the balance of this year and $52 million of this backlog in the next twelve months. The remaining backlog primarily represents the balance of multi-year contracts for our service bureau business. Total company backlog at June 30, 2003 was $81 million, of which $72 million related to our Wireless Carrier segment, $9 million related to our Government segment.
Management utilizes backlog to evaluate financial position as an indicator of committed future revenues. Our backlog at any given time may be affected by a number of factors, including contracts being renewed or new contracts being signed before existing contracts are completed. Some of our backlog could be canceled for causes such as late delivery, poor performance, and other factors. Accordingly, a comparison of backlog from period to period is not necessarily meaningful and may not be indicative of eventual actual revenue.
Operating Expenses
Research and development expense:
The following table sets forth, for the three- and six-months ended June 30, 2004 and 2003, respectively, a period-over-period comparison of our research and development expense:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||||||||||
2004 vs. | 2004 vs. | |||||||||||||||||||||||||||||||
2003 | 2003 | |||||||||||||||||||||||||||||||
($ in millions) | 2004 | 2003 | $ | % | 2004 | 2003 | $ | % | ||||||||||||||||||||||||
Research and development expense | $ | 4.6 | $ | 4.7 | $ | (0.1 | ) | (2 | )% | $ | 9.6 | $ | 8.6 | $ | 1.0 | 12 | % | |||||||||||||||
Percent of revenue | 11 | % | 23 | % | 13 | % | 22 | % |
We incur research and development costs to enhance existing packaged software products as well as to create new software products, including software hosted in our service bureau network operations center. These costs primarily include compensation and benefits, as well as costs associated with using third-party laboratory and testing resources. We expense research and development costs as they are incurred unless technological feasibility has been reached and marketability is certain. For new products, technological feasibility is established when an operative version of the computer software product is completed in the same software language as the product to be ultimately marketed, performs all the major functions planned for the product, and has successfully completed initial customer testing. Technological feasibility for enhancements to an existing product is established when a detail program design is completed.
In 2004, we incurred research and development expenses related to Wireless Carrier and Enterprise software applications, which are being marketed to new and existing customers on a global basis, with emphasis on expanded functionality of our location platform software and E9-1-1 application. In 2003, the research and development expenditures were primarily incurred in the development of our Wireless Carrier software and E9-1-1 application. Research and development expenditures remained relatively constant between 2004 and 2003 while these expenses as a percentage of revenue decreased in 2004. The decrease as a percentage of revenue is primarily the result of increased revenues in 2004 due to the Enterprise acquisition and the significant increase of software license revenue in 2004. Management continually assesses our spending on research and development to ensure resources are focused on products that are expected to achieve the highest level of success.
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Sales and marketing expense:
The following table sets forth, for the three- and six-months ended June 30, 2004 and 2003, respectively, a period-over-period comparison of our sales and marketing expenses:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||||||||||
2004 vs. | 2004 vs. | |||||||||||||||||||||||||||||||
2003 | 2003 | |||||||||||||||||||||||||||||||
($ in millions) | 2004 | 2003 | $ | % | 2004 | 2003 | $ | % | ||||||||||||||||||||||||
Sales and marketing expense | $ | 3.3 | $ | 2.2 | $ | 1.1 | 50 | % | $ | 6.5 | $ | 4.6 | $ | 1.9 | 41 | % | ||||||||||||||||
Percent of total revenue | 8 | % | 11 | % | 9 | % | 12 | % |
Our sales and marketing expenses include compensation and benefits, trade show expenses, travel costs, advertising and public relations costs as well as a proportionate share of facility-related costs which are expensed as incurred. Our marketing efforts also include speaking engagements and attending and sponsoring industry conferences. We sell our software products and services through our direct sales force and through indirect channels. We have also historically leveraged our relationship with original equipment manufacturers to market our software products to wireless carrier customers. We sell our network solutions primarily through direct sales professionals. Costs incurred for sales and marketing increased in 2004 from 2003 due to increased costs associated with addressing the Enterprise market. We expect our sales and marketing expense to increase in 2004 as a result of our acquisition of the Enterprise segment. Such costs may fluctuate quarter-to-quarter depending on spending on tradeshows and variable compensation based on levels of revenue.
General and administrative expense:
The following table sets forth, for the three- and six-months ended June 30, 2004 and 2003, respectively, a period-over-period comparison of our general and administrative expense:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||||||||||
2004 vs. | 2004 vs. | |||||||||||||||||||||||||||||||
2003 | 2003 | |||||||||||||||||||||||||||||||
($ in millions) | 2004 | 2003 | $ | % | 2004 | 2003 | $ | % | ||||||||||||||||||||||||
General and administrative expense | $ | 4.8 | $ | 2.7 | $ | 2.1 | 76 | % | $ | 9.3 | $ | 5.6 | $ | 3.6 | 65 | % | ||||||||||||||||
Percent of total revenue | 12 | % | 14 | % | 13 | % | 14 | % |
General and administrative expense consists primarily of compensation costs and other costs associated with management, finance, human resources and internal information systems. These costs include compensation and benefits, travel, and a proportionate share of rent, utilities and other facilities costs which are expensed as incurred. In 2004 such costs increased over 2003 largely due to costs incurred to support the Enterprise segment. We expect general and administrative expense to remain at a higher level than in 2003 for the remainder of 2004, as a result of our acquisition of the Enterprise segment.
Non-cash stock compensation expense:
The following table sets forth, for the three- and six-months ended June 30, 2004 and 2003, respectively, a period-over-period comparison of our non-cash stock compensation expense:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||||||||||
2004 vs. | 2004 vs. | |||||||||||||||||||||||||||||||
2003 | 2003 | |||||||||||||||||||||||||||||||
($ in millions) | 2004 | 2003 | $ | % | 2004 | 2003 | $ | % | ||||||||||||||||||||||||
Non-cash stock compensation expense | $ | 0.3 | $ | 0.4 | $ | 0.0 | (11 | %) | $ | 0.7 | $ | 0.8 | $ | 0.1 | (8 | %) |
Prior to our initial public offering in 2000, we granted incentive stock options to employees and directors to purchase 885,983 shares of Class A Common Stock. The options were granted at an
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In the second quarter of 2003, we issued restricted stock to directors and certain key executives. The restrictions expire at the end of one year for directors and in annual increments over three years for executives and are based on continued employment. Net income/(loss), as reported, includes $158 and $167 of non-cash stock compensation expense related to these grants for the three month periods ended June 30, 2004 and 2003, respectively, and $322 and $167 of expense for the six month periods then ended. We expect to record future stock compensation expense of $1,077 as a result of these restricted stock grants that will be recognized over the remaining vesting period for executives.
Depreciation and amortization of property and equipment:
The following table sets forth, for the three- and six-months ended June 30, 2004 and 2003, respectively, a period-over-period comparison of our depreciation and amortization of property and equipment:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||||||||||
2004 vs. | 2004 vs. | |||||||||||||||||||||||||||||||
2003 | 2003 | |||||||||||||||||||||||||||||||
($ in millions) | 2004 | 2003 | $ | % | 2004 | 2003 | $ | % | ||||||||||||||||||||||||
Depreciation and amortization of property and equipment | $ | 1.9 | $ | 1.7 | $ | 0.2 | 13 | % | $ | 3.6 | $ | 3.2 | $ | 0.4 | 13 | % | ||||||||||||||||
Gross cost of property and equipment at period-end | $ | 39.6 | $ | 28.4 | $ | 11.3 | 40 | % | $ | 39.6 | $ | 28.4 | $ | 11.3 | 40 | % |
Depreciation and amortization expense (other than amortization of software development costs and acquired intangible assets, discussed below) represents the period costs associated with our investment in computers, telephony equipment, software, furniture and fixtures, and leasehold improvements. We compute depreciation and amortization using the straight-line method over the estimated useful lives of the assets. In 2004, depreciation and amortization expense was slightly higher than 2003 reflecting the level of capital expenditures made primarily to support our network operations centers and our development efforts.
Amortization of software development costs:
The following table sets forth, for the three- and six-months ended June 30, 2004 and 2003, respectively, a period-over-period comparison of our amortization of software development costs:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||||||||||
2004 vs. | 2004 vs. | |||||||||||||||||||||||||||||||
2003 | 2003 | |||||||||||||||||||||||||||||||
($ in millions) | 2004 | 2003 | $ | % | 2004 | 2003 | $ | % | ||||||||||||||||||||||||
Amortization of software development costs | $ | 0.2 | $ | 7.8 | $ | (7.6 | ) | (97 | %) | $ | 0.3 | $ | 8.8 | $ | (8.5 | ) | (96 | %) | ||||||||||||||
Percent of network software license revenue | 4 | % | N/M | 4 | % | N/M |
We capitalize software development costs after we establish technological feasibility, and amortize those costs over the estimated useful lives of the software beginning on the date when the software is first installed and used. We calculate amortization of software development costs on a product-by-product basis using the straight-line method over the remaining estimated economic life of the product, which is never greater than three years. We also compute amortization of software development costs using the ratio that current revenue for the product bears to the total
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Amortization of acquired intangible assets:The acquired intangible assets associated with our acquisition of the Enterprise segment are being amortized over their useful lives of between 3 and 5 years. The expense recognized in 2004 relates to the intangible assets acquired in the acquisition. The expense in 2003 related to the amortization of the Xypoint trade name that was amortized based on its estimated useful life of three years using the straight-line method and was fully amortized by December 31, 2003.
Interest expense:
The following table sets forth, for the three- and six-months ended June 30, 2004 and 2003, respectively, a period-over-period comparison of our components of interest expense:
Three Months Ended June 30 | Six Months Ended June 30 | |||||||||||||||||||||||||||||||
2004 vs. | 2004 vs. | |||||||||||||||||||||||||||||||
2003 | 2003 | |||||||||||||||||||||||||||||||
($ in millions) | 2004 | 2003 | $ | % | 2004 | 2003 | $ | % | ||||||||||||||||||||||||
Interest expense incurred on notes payable | $ | 0.2 | $ | 0.1 | $ | 0.1 | 100 | % | $ | 0.5 | $ | 0.2 | $ | 0.3 | 150 | % | ||||||||||||||||
Interest expense incurred on capital lease obligations | 0.1 | 0.1 | — | — | 0.1 | 0.3 | (0.1 | ) | 100 | % | ||||||||||||||||||||||
Interest expense incurred on convertible subordinated debentures | 0.1 | — | 0.1 | N/M | 0.2 | — | 0.2 | N/M | ||||||||||||||||||||||||
Amortization of deferred commitment fees | 0.1 | — | 0.1 | 100 | % | 0.2 | 0.1 | 0.1 | 100 | % | ||||||||||||||||||||||
Amortization of debt discount | 0.4 | — | 0.4 | N/M | 0.7 | — | 0.7 | N/M | ||||||||||||||||||||||||
Total interest expense | $ | 0.9 | $ | 0.2 | $ | 0.7 | N/M | $ | 1.7 | $ | 0.5 | $ | 1.2 | N/M |
Interest expense is incurred under notes payable, a line of credit, and capital lease obligations. Interest, under the terms of our notes payable, is primarily at stated interest rates of 7.75% while the portions related to the line of credit and an equipment loan are at variable rates equal to 5.25% and 5.5%, respectively, as of July 30, 2004. We made a draw of $2.5 million on our line of credit in June 2004. Because the balance of notes payable has increased versus the prior period, the related interest expense has also increased. Our capital lease obligations include interest at various amounts depending on the lease arrangement and are generally at slightly higher rates than those incurred under notes payable. The balance of our total capital lease obligations has decreased since 2003. Therefore, the related interest expense was also lower. Interest expense incurred on the convertible subordinated debentures issued in connection with our recent acquisition of the Enterprise segment accrues at the rate of 3% of the face value of the note but may be payable in cash or stock. Debt discount relates to the amount of discount computed as part of that private placement. Such discount is recorded as a reduction of debt and is being amortized over the life of the convertible subordinated debenture of 5 years. The deferred commitment fees relate to the up-front payment of fees that were incurred to secure our notes payable and our revolving line of credit facility and are being amortized over the term of the note or, in the case of the line of credit, the life of the facility, which expires in April 2006.
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Other (expense)/income, net:
Other (expense)/income consists primarily of foreign currency translation/transaction gain or loss. We record the effects of foreign currency translation on our receivables that are stated in currencies other than our functional currency. Investment income earned on cash equivalents, income related to a loan-to-grant program provided by the State of Maryland, and miscellaneous other gains or losses are also recorded as a component of other (expense)/income. The other components of other (expense)/income typically remain comparable between periods, and changes in other (expense)/income are primarily attributable to changes in the foreign currency translation/transaction gain or loss recorded for the period.
Income taxes:
Because we have generated significant net operating losses since 1999, no provision for federal or state income taxes has been made for the three or six month periods ended June 30, 2004 or any portion of 2003. We have recorded a full valuation allowance for deferred tax assets as a result of our inability to determine the realizability of our net operating loss carry-forwards.
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Liquidity and Capital Resources
The following table sets forth, for the six-months ended June 30, 2004 and 2003, respectively, a period-over-period comparison of key components of our liquidity and capital resources:
2004 vs. 2003 | ||||||||||||||||||
($ in millions) | 2004 | 2003 | $ | % | ||||||||||||||
Net cash provided by (used in): | ||||||||||||||||||
Operating activities | $ | (2.9 | ) | $ | (8.0 | ) | $ | 5.0 | (63 | %) | ||||||||
Investing activities | (22.2 | ) | (4.2 | ) | 18.0 | N/M | ||||||||||||
Financing activities | 22.1 | 0.3 | 21.8 | N/M | ||||||||||||||
Adjusted operating income/(loss), excluding non-cash charges (see reconciliation below) | 4.5 | (1.4 | ) | 5.8 | N/M | |||||||||||||
Purchases of property and equipment | (4.9 | ) | (2.4 | ) | (2.5 | ) | N/M | |||||||||||
Capitalized software development costs | — | (1.9 | ) | 1.9 | 100 | % | ||||||||||||
Payments under long-term debt and lease obligations | (3.9 | ) | (2.4 | ) | (1.5 | ) | (61 | %) | ||||||||||
Proceeds from issuance of Class A Common Stock and Convertible subordinated debentures | 21.0 | — | 21.0 | N/M | ||||||||||||||
Proceeds from long-term debt | 5.0 | 2.6 | 2.4 | 91 | % | |||||||||||||
Proceeds from exercise of employee stock options | 1.1 | 0.1 | 1.0 | N/M | ||||||||||||||
Financing fees paid related to debenture and stock issued to fund the acquisition of the Enterprise segment | (1.1 | ) | — | (1.1 | ) | N/M | ||||||||||||
Effect of change in foreign currency exchange rates on cash | — | — | — | N/M | ||||||||||||||
Cash and cash equivalents | 15.8 | 15.5 | 0.2 | 2 | % | |||||||||||||
Changes in: | ||||||||||||||||||
Accounts receivable, net | (0.2 | ) | 5.5 | (5.7 | ) | |||||||||||||
Unbilled receivables | (4.7 | ) | (2.2 | ) | (2.5 | ) | ||||||||||||
Inventory | (1.8 | ) | — | (1.8 | ) | |||||||||||||
Other current assets | (0.4 | ) | (0.1 | ) | (0.4 | ) | ||||||||||||
Accounts payable and accrued expenses | (0.2 | ) | (8.7 | ) | 8.6 | |||||||||||||
Accrued payroll and related liabilities | (0.4 | ) | 0.2 | (0.6 | ) | |||||||||||||
Deferred revenue | 0.4 | (0.3 | ) | 0.8 | ||||||||||||||
Days revenues outstanding in accounts receivable including unbilled receivables | 91 | 117 |
We have funded our operations and capital expenditures primarily using revenue from our operations as well as the net proceeds from our initial public offering in August 2000, which generated cash of approximately $83.2 million, leasing activities, issuance of long-term debt, and the private placement of our securities in connection with our recent acquisition (as described below).
We currently believe that we have sufficient capital resources to meet our anticipated working capital and capital expenditures needs for the next twelve months. We may consider raising capital in the public markets as a means to meet our debt obligations or repay the amount of debt secured under the terms of the convertible subordinated debentures. While unanticipated events and opportunities may make it necessary for us to return to the capital markets, establish new credit facilities or raise capital in private transactions in order to meet our capital requirements, we can offer no assurances that we will be able to access these potential sources of funds on terms acceptable to us or at all.
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Operating cash flows improved in 2004 primarily as a result of improvements in gross profit from higher revenue. Management believes that an important measure of cash flow from operating results is a measure of adjusted operating income/(loss), excluding non-cash charges. Management considers adjusted operating income/(loss), excluding non-cash charges in addition to, but not as a substitute for, earnings measured in accordance with generally accepted accounting principles, because it is indicative of the availability of discretionary funds and the capacity to service debt. Adjusted operating income/(loss), excluding non-cash charges is a non-GAAP financial measure, which indicates the amount of cash generated from/(used in) the operations of the business, before the impact of changes in working capital. The following table sets forth the calculation of adjusted operating income/(loss), excluding non-cash charges from our Consolidated Statements of Operations for the three-and six-months ended June 30, 2004 and 2003, respectively:
Three Months | Six Months Ended | ||||||||||||||||
Ended June 30 | June 30 | ||||||||||||||||
($ in millions) | 2004 | 2003 | 2004 | 2003 | |||||||||||||
Net income/(loss) | $ | 0.9 | $ | (11.4 | ) | $ | (2.6 | ) | $ | (15.4 | ) | ||||||
Non-cash charges included in net loss: | |||||||||||||||||
Depreciation and amortization of property and equipment | 1.9 | 1.7 | 3.6 | 3.2 | |||||||||||||
Non-cash stock compensation expense | 0.3 | 0.4 | 0.7 | 0.8 | |||||||||||||
Amortization of acquired intangible assets | 0.5 | 0.1 | 1.1 | 0.3 | |||||||||||||
Amortization of software development costs | 0.2 | 7.8 | 0.3 | 8.8 | |||||||||||||
Amortization of deferred debt discount, financing fees and commitment fees | 0.6 | — | 1.1 | 0.1 | |||||||||||||
Adjusted operating income/(loss), excluding non-cash charges | $ | 4.5 | $ | (1.4 | ) | $ | 4.3 | $ | (2.3 | ) | |||||||
The favorable change in adjusted operating income/(loss) for the three months and six months ended June 30, 2004 was $5.9 and $6.6 million, respectively, lowering the need for external financing.
Net cash used in investing activities increased in 2004 from 2003 primarily related to the acquisition of the Enterprise segment that was consummated in January 2004. In 2004, the total cash used for the purchase of property and equipment and development of our software products was $4.9 million while they were $4.3 million in 2003. The increase in 2004 is primarily related to an increase in the purchase of property and equipment required for our network operations center including the cost of leasehold improvements related to the move into new office space, our software development efforts, and our corporate administrative support. This increase is offset by a reduction in capitalized software development costs due to completion of certain software development projects that were under development in prior years.
Net cash provided by financing activities increased in 2004 from previous year levels as we secured $21.0 million in financing to fund our acquisition of the Enterprise segment. This amount was somewhat offset by financing fees of $1.1 million paid to secure such funding. Additionally, we received $2.5 million under the terms of a note payable and $2.5 million borrowed against our bank line of credit, principally to fund capital expenditure needs while meeting our commitment to repay lease and long-term debt obligations.
Under our bank credit agreement, we can borrow an amount equal to up to 80% of receivables less than 90 days old. The line of credit is secured by accounts receivable and bears interest at the prime rate plus 1.25% for equipment loans and at the prime rate plus 1.0% for all other loans, with a minimum prime rate of 4.25% (borrowing rates of 5.5% and 5.25%, respectively, at June 30, 2004). As part of this agreement, we have borrowed $2.5 million as an equipment loan, secured by purchased equipment, for a term of three years. The equipment loan
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Effective January 1, 2004, we acquired the Enterprise Mobility Solutions division of Aether Systems, Inc. Consideration for the acquisition was valued at approximately $20 million, consisting of $18.1 million in cash, $1 million in the form of a note payable and 204,020 newly issued shares of Class A Common Stock. Concurrent with the acquisition, we closed on $21.0 million of financing with two accredited institutional investors, which included a subordinated convertible debenture with stated principal of $15 million, bearing interest at a stated rate of 3% per annum and due in lump sum on January 13, 2009 in cash or shares of our Class A Common Stock at the option of the Company, approximately 1.4 million newly issued shares of our Class A Common Stock and warrants to purchase 341,072 shares of our Class A Common Stock at an exercise price of $6.50 per share, expiring in January 2007. The majority of the proceeds from this financing transaction were used to fund the purchase of the acquired assets.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet financing arrangements.
Commitments
As of June 30, 2004, our most significant commitments consisted of long-term debt, including convertible subordinated debentures, obligations under capital leases and non-cancelable operating leases. We lease certain furniture and computer equipment under capital leases. We lease office space and equipment under non-cancelable operating leases. As of June 30, 2004 our commitments consisted of the following:
Within | ||||||||||||||||||||
12 | 1-3 | 3-5 | More than | |||||||||||||||||
($ in millions) | Months | years | years | 5 years | Total | |||||||||||||||
Notes payable | $ | 10.3 | $ | 4.4 | $ | — | $ | — | $ | 14.7 | ||||||||||
Convertible subordinated debenture | — | — | 15.0 | — | 15.0 | |||||||||||||||
Capital lease obligations | 1.5 | 1.1 | — | — | 2.6 | |||||||||||||||
Operating leases | 3.3 | 3.4 | 3.1 | 1.7 | 11.5 | |||||||||||||||
$ | 15.1 | $ | 8.9 | $ | 18.1 | $ | 1.7 | $ | 43.8 | |||||||||||
Related Party Transactions
The leases for substantially all of our Annapolis, Maryland office facilities, including our principal executive office, will expire in early 2005. We have begun planning for facilities needs thereafter, including entering an agreement with Annapolis Partners LLC to explore the opportunity of relocating our Annapolis offices to a planned new real estate development. Our President and Chief Executive Officer owns a controlling voting and economic interest in Annapolis Partners LLC and he also serves as a member. The financial and many other terms of the lease have not yet been established. The lease is subject to several contingencies and rights of termination. For example, the lease can be terminated at the sole discretion of our Board of Directors if the terms and conditions of the development are unacceptable to us, including without limitation the circumstances that market conditions make the lease not favorable to us or the overall cost is not in the best interest of us or our shareholders, or any legal or regulatory restrictions apply. Our Board of Directors will evaluate this opportunity along with alternatives that are or may become available in the relevant time periods and there is no assurance that we will enter into a definitive lease at this new development site.
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Interest Rate Risk
As of June 30, 2004, we had $6.9 million available and unused under the line of credit. As of July 15, 2004, $2.0 million was outstanding under the terms of an equipment loan that was secured by purchased equipment, bearing interest at 5.5% and payable monthly through December 2006. As of the same date, $2.5 million was drawn against the line of credit and secured by accounts receivable, bearing interest at 5.25% and payable upon the collection of the receivables collateralizing the loan. A hypothetical 100 basis point adverse movement (increase) in the prime rate would have increased our interest expense for the three- and six-month periods ended June 30, 2004 by approximately $11,000 and $22,000, respectively, resulting in no significant impact on our consolidated financial position, results of operations or cash flows.
At June 30, 2004, we had cash and cash equivalents of $15.8 million. Cash and cash equivalents consisted of demand deposits and money market accounts that are interest rate sensitive. However, these investments have short maturities mitigating their sensitivity to interest rates. A hypothetical 100 basis point adverse movement (decrease) in interest rates would have decreased our interest income for the three- and six-month periods ended June 30, 2004 by approximately $45,000 and $86,000, respectively, resulting in no significant impact on our consolidated financial position, results of operations or cash flows.
There have not been any material changes to our interest rate risk as described in Item 7A of our 2003 Annual Report on Form 10-K.
Foreign Currency Risk
As of June 30, 2004, we had approximately $1.3 million in accounts receivable and $1.5 million in unbilled receivables that are exposed to foreign currency exchange risk. We record transaction gains or losses as a component of other (expense)/ income in our Consolidated Statements of Operations. There have not been any material changes to our foreign currency risk as described in Item 7A of our 2003 Annual Report on Form 10-K.
Item 4. | Controls and Procedures |
As of the end of the period ending June 30, 2004, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company required to be included in the Company’s periodic SEC filings. There have been no significant changes in the Company’s internal controls or in other factors which could significantly affect internal controls subsequent to the date the Company carried out its evaluation.
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PART II. — OTHER INFORMATION
Item 1. Legal Proceedings
In November 2001, a shareholder class action lawsuit was filed against us, certain of our current officers and a director, and several investment banks that were the underwriters of our initial public offering (the “Underwriters”): Highstein v. Telecommunication Systems, Inc., et al., United States District Court for the Southern District of New York, Civil Action No.01-CV-9500. The plaintiffs seek an unspecified amount of damages. The lawsuit purports to be a class action suit filed on behalf of purchasers of our common stock during the period August 8, 2000 through December 6, 2000. The plaintiffs allege that the Underwriters agreed to allocate common stock offered for sale in our initial public offering to certain purchasers in exchange for excessive and undisclosed commissions and agreements by those purchasers to make additional purchases of common stock in the aftermarket at pre-determined prices. The plaintiffs allege that all of the defendants violated Sections 11,12 and 15 of the Securities Act of 1933, as amended, and that the underwriters violated Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder. The claims against us of violation of Rule 10b-5 have been dismissed with the plaintiffs having the right to re-plead. We intend to vigorously defend the lawsuit. We believe that more than 300 other companies have been named in nearly identical lawsuits that have been filed by some of the same law firms that represent the plaintiffs in the lawsuit against us.
We are not currently subject to any other material legal proceedings. However, we may from time to time become a party to various legal proceedings arising in the ordinary course of our business.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
(a) None
(b) None.
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit | ||||
Numbers | Description | |||
3(i).1 | Amended and Restated Articles of Incorporation | |||
3(i).2 | Second Amended and Restated By-Laws | |||
31.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
31.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
32.1 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |||
32.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
(b) Reports on Form 8-K.
On April 28, 2004, we filed a Form 8-K attaching a press release announcing the Registrant’s financial information for the fiscal quarter ended March 31, 2004. This Current Report on Form 8-K was furnished, not filed, to the Commission in accordance with General Instruction B.6. of the General Instructions to Form 8-K.
On June 30, 2004, we filed a Form 8-K attaching a press release announcing information concerning its revenue and earnings expectations for the periods ending June 30, 2004. This Current Report on Form 8-K was furnished, not filed, to the Commission in accordance with General Instruction B.6. of the General Instructions to Form 8-K.
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Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on the 3rd day of August 2004.
TELECOMMUNICATION SYSTEMS, INC. |
By: | /s/ MAURICE B. TOSÉ |
Maurice B. Tosé | |
Chairman, President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
/s/ MAURICE B. TOSÉ Maurice B. Tosé August 3, 2004 | Chairman, President and Chief Executive Officer (Principal Executive Officer) | |
/s/ THOMAS M. BRANDT, JR. Thomas M. Brandt, Jr. August 3, 2004 | Senior Vice President and Chief Financial Officer (Principal Financial Officer) |
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