SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the quarter ended September 30, 2015

OR

Commission File No. 0-30821

 

TELECOMMUNICATION SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

 

(410) 263-7616

(Registrant’s telephone number, including area code)

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  þ    No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨    No   þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

 

 

 

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INDEX

TELECOMMUNICATION SYSTEMS, INC.

 

 

 

 

 

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TeleCommunication Systems, Inc.

Consolidated Balance Sheets

(amounts in thousands, except share data)

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

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TeleCommunication Systems, Inc.

Consolidated Statements of Operations

(amounts in thousands, except per share data)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

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TeleCommunication Systems, Inc.

Consolidated Statements of Comprehensive Income (Loss)

(amounts in thousands)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

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TeleCommunication Systems, Inc.

Consolidated Statements of Cash Flows

(amounts in thousands)

(unaudited)

   

 

See accompanying Notes to Consolidated Financial Statements.

 

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TeleCommunication Systems, Inc.

Notes to Consolidated Financial Statements

September 30, 2015

(amounts in thousands, except per share amounts)

(unaudited)

 

 

1. Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation. 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 nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. There were no significant changes to our accounting policies as described in Note 1 of our consolidated financial statements included in Item 15(a)(1) of our 2014 Annual Report on Form 10-K. These unaudited consolidated financial statements should be read in conjunction with our audited financial statements and related notes included in our 2014 Annual Report on Form 10-K. The terms “TCS,” “Company,” “we,” “us,” and “our” as used in this Form 10-Q refer to TeleCommunication Systems, Inc. and its subsidiaries as a combined entity, except where it is made clear that such terms mean only TeleCommunication Systems, Inc.

Use of Estimates. The preparation of these financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts and related disclosures. Significant estimates and assumptions in these consolidated financial statements include estimates used in revenue recognition, fair value of business combinations, fair value associated with goodwill, intangible assets and long-lived asset impairment tests, estimated values of software development costs, income taxes and deferred valuation allowances, the fair value of marketable securities and stock-based compensation, and legal and contingency fees. Actual results could differ from those estimates.

 

Reclassifications. Certain amounts previously presented for prior periods have been reclassified to conform to the current presentation.  These immaterial reclassifications had no effect on net income, working capital, or equity previously reported.

 

Recent Accounting Pronouncements. In September 2015, the Financial Accounting Standards Board ("FASB") issued new guidance on business combinations to simplifying the accounting for measurement-period adjustments. The new guidance requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. Prior to the issuance of the standard, entities were required to retrospectively apply adjustments made to provisional amounts recognized in a business combination. The guidance is effective for annual periods beginning after December 15, 2015, and interim periods within those years. Early adoption is permitted. The amended guidance is not expected to have a material impact on our consolidated financial statements.

 

In July 2015, the FASB issued new guidance to simplify the subsequent measurement of inventory to be measured at the lower of cost or net realizable value. Prior to the issuance of this standard, inventory was measured at the lower of cost or market. The guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those years. Early adoption is permitted. The amended guidance is not expected to have a material impact on our consolidated financial statements.

 

In April 2015, the FASB issued new guidance to simplify the presentation of debt issuance costs by requiring debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying value of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the update. The guidance is effective for annual periods beginning after December 15, 2015, including interim periods within those periods. Early adoption is permitted. The amended guidance is not expected to have a material impact on our consolidated financial statements.

 

In August 2014, the FASB issued new guidance for presentation of financial statements for going-concern, which addresses when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year after the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. The new guidance applies to all entities and is effective for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. The amended guidance is not expected to have a material impact on our consolidated financial statements.

 

 

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In May 2014, the FASB issued new guidance for revenue recognition. The new guidance provides a five-step revenue recognition model which replaces the prior revenue recognition guidance in its entirety. The core principle of the new standard is that an entity will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. The standard also requires more detailed disclosures to enable users of the financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The guidance provides alternative methods of initial adoption; retrospectively applied to each prior reporting period or a modified retrospective approach, in which the cumulative effect of initially applying this new guidance is recognized at the date of initial application with additional disclosures. In July 2015, the FASB deferred the effective date to January 1, 2018 and is allowing early adoption beginning January 1, 2017. We are currently evaluating the alternative transition methods and the impact that this standard will have on our consolidated financial statements.

 

2. Earnings per share

Basic net income per common share is based upon the average number of shares of common stock outstanding during the period.

For the three and nine months ended September 30, 2015 and 2014, respectively, 4,832 shares issuable upon conversion of our 7.75% Convertible Notes were excluded from the computation of diluted net income per share because their inclusion would have been anti-dilutive.

For the three and nine months ended September 30, 2014, shares issuable upon conversion of our 4.5% Convertible Senior Notes were excluded from the computation of diluted net loss per share because their inclusion would have been anti-dilutive.

Concurrent with the issuance of the 4.5% Convertible Notes, we entered into convertible note hedge and warrant transactions. Because the Company would have exercised a call option if the market price of our stock exceeded the warrant exercise price of $12.74 per share, the effect of the convertible note hedge, which expired pro rata as the 2014 Notes were repurchased, was excluded from the calculation of diluted earnings per share for the three and nine months ended September 30, 2014, as the impact was always considered anti-dilutive. The warrants expired in the second quarter of 2015.  

The following table summarizes the computations of basic and diluted earnings per share:

 

Our two classes of common stock (Class A and B) share equally in dividends declared or accumulated and have equal participation rights in undistributed earnings. In addition, our unvested restricted stock does not contain non-forfeitable rights to dividends and dividend equivalents. As such, unvested shares of restricted stock are not participating securities and our basic and diluted earnings per share are not impacted by the two-class method of computing earnings per share.

 

 

 

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3. Stock-Based Compensation

Restricted Stock

We had 1,674 and 2,190 restricted stock units outstanding at a weighted-average grant date fair value per share of $2.75 and $2.42 as of September 30, 2015 and 2014, respectively. Total unrecognized share-based compensation expense is approximately $3,000 and $3,300 as of September 30, 2015 and 2014, respectively, which is expected to be recognized over a weighted-average period of approximately two years.

Stock Options

We had 15,966 and 16,142 stock options outstanding as of September 30, 2015 and 2014, respectively, of which 7,598 were “in-the-money” at September 30, 2015. During the first nine months of 2015, we granted 3,021 options and 1,262 shares were exercised. Total unrecognized share-based compensation expense was approximately $5,500 and $4,600 as of September 30, 2015 and 2014, respectively, which is expected to be recognized over a weighted-average period of approximately three years, respectively.

Total Stock-Based Compensation

We recognized total share-based compensation expense of $1,231 and $1,361 in in the third quarters of 2015 and 2014, respectively, and $3,759 and $4,561 in the nine months ended September 30, 2015 and 2014, respectively.

 

 

4. Supplemental Disclosure of Cash Flow Information

 

 

 

 

5. Marketable Securities

Available-for-sale marketable securities at September 30, 2015:

 

 

The following table summarizes the estimated fair value of available-for-sale marketable securities by contractual maturity at September 30, 2015:

 

 

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Available-for-sale marketable securities at December 31, 2014:

 

The following table summarizes the estimated fair value of available-for-sale marketable securities by contractual maturity at December 31, 2014:

 

6. Fair Value Measurements

Our assets and liabilities subject to fair value measurements on a recurring basis and the required disclosures:

 

 

 

 

 

 

 

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The carrying values of financial instruments, including accounts receivable, unbilled receivables, and accounts payable approximate their fair values due to their short-term maturities.

We hold marketable securities that are investment grade and are classified as available-for-sale. The securities include corporate bonds, agency bonds, and mortgage and asset-backed securities that are carried at fair market value based on quoted market prices.

We hold trading securities as part of a rabbi trust to fund supplemental executive retirement plans and deferred income plans. The funds held are all managed by a third party and include fixed income funds, equity securities, and money market accounts, or other investments for which there is an active quoted market. The related deferred compensation liabilities are valued based on the underlying investment selections in each participant’s account.

The interest rate swap was valued based on forward curves observable in the market, using Level 2 inputs; see Note 12. The effectiveness of the interest rate swap is computed by comparing the present value of the cumulative change in the expected future cash flows of the variable leg of the swap and the present value of the cumulative change in the expected future variable interest payments designated in the hedging relationship.

Assets and liabilities that are measured at fair value on a non-recurring basis include long-lived assets, intangible assets, and goodwill. These items are recognized at fair value when they are considered to be other than temporarily impaired using significant unobservable inputs and are classified as Level 3.

The long-term debt, excluding leases, is reported at the borrowed amounts outstanding. The estimated fair value is based on a market approach using quoted market prices or current market rates for similar debt with approximately the same remaining maturities, where possible, and are classified as Level 2. Our long-term debt, excluding leases, consisted of borrowings under our Senior Credit Facilities and 7.75% convertible senior notes; see Note 12. At September 30, 2015, the estimated fair value of our long-term debt, excluding leases, was approximately $133,000 versus a carrying value of $134,575. At December 31, 2014, the estimated fair value of the long-term debt, excluding leases, was approximately $123,000 versus a carrying value of $124,567.

There were no transfers in or out of Level 1, 2, or 3 during the three and nine months ended September 30, 2015.

 

 

7. Segment Information

We report operating results in two business segments:

Commercial Segment: We are one of two leading companies that enable 9-1-1 call delivery via cellular, VoIP, and next generation technology. Other TCS hosted and managed services include cellular network and device platforms and applications for text messaging and location-based services. We are also engaged in patent monetization activity which is included in this segment. Commercial Segment customers include wireless network operators, VoIP service providers, wireless device manufacturers, automotive industry suppliers, and state and local governments.

Government Segment: For U.S. Department of Defense agencies, we provide cybersecurity training and consulting, support, and “C4ISR” (command, control, communications, computers, intelligence surveillance and reconnaissance) resources, wireless ground terminals and related support, management and resale of satellite bandwidth, and information technology outsource services. TCS engineers furnish and support ground terminals used for secure satellite-based and other line-of-sight and beyond-line-of-sight

 

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communications, as well as related components incorporating government-approved cryptologic devices and other hardened components for aerospace and defense.

Management evaluates segment performance based on gross profit, and all revenues reported below are from external customers. We do not maintain information regarding segment assets. Accordingly, asset information by reportable segment is not presented.

The following tables set forth the results of our reportable segments and a reconciliation of segment gross profit to net income:

 

 

 

 

 

 

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8. Inventory

Inventory consisted of:

 

 

 

9. Acquired Intangible Assets, Capitalized Software Development Costs, and Goodwill

Our acquired intangible assets and capitalized software development costs consisted of:

 

 

Estimated future amortization expense:

 

 

 

Software development costs:

For the three and nine months ended September 30, 2015, we capitalized $184 and $1,090, respectively, of software development costs after the point of technological feasibility had been reached but before the software was available for general release. For the three and nine months ended September 30, 2014, we capitalized $65 and $1,066, respectively, of software development costs. These costs are being amortized over their estimated useful lives beginning when the products are available for general release. We routinely update our estimates of the recoverability of the capitalized software product costs. Management uses these estimates as the basis for evaluating the carrying values and remaining useful lives of the respective assets.

Goodwill:

The carrying amount of goodwill is:

 

 

 

 

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10. Concentrations of Credit Risk and Major Customers

The financial instruments that potentially subject us to concentrations of credit risk are accounts receivable and unbilled receivables. Those customers that comprised 10% or more of our total revenue or receivables (billed and unbilled) are summarized in the following tables:

 

 

Percentage of receivables (billed and unbilled) as of September 30:

 

 

11. Line of Credit

We have maintained a line of credit arrangement with Silicon Valley Bank (“SVB”) since 2003. On June 25, 2013, we closed on a new senior secured credit facility, as amended on April 30, 2015 (the “Senior Credit Facility” or “Credit Agreement”), with the SVB and three other lenders. The Credit Agreement includes a revolving loan facility (“Revolving Loan Facility”) for up to $30,000 and matures on March 31, 2018. The principal amount outstanding under the Revolving Loan Facility is payable prior to or on the maturity date. Interest on the Revolving Loan Facility accrues at Eurodollar/LIBOR (beginning at LIBOR+3.75%) or Alternate Base Rate (“ABR”) (beginning at ABR +2.75%), which may be adjusted as provided in the Credit Agreement, and is payable monthly.

The Revolving Loan Facility includes two sub-facilities: (i) a $10,000 letter of credit sub-facility under which the bank may issue letters of credit, and (ii) a $5,000 swingline sub-facility.

As of September 30, 2015, there were no borrowings under our Revolving Loan Facility and we had $30,000 of unused borrowing availability. As of December 31, 2014, we had $5,000 of borrowings outstanding under the Revolving Loan Facility and had $25,000 of unused borrowing availability.

 

12. Long-Term Debt

Long-term debt consisted of:  

 

Aggregate maturities of long-term debt at September 30, 2015 are:

 

 

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Senior credit facilities

Our senior credit facilities under a June 25, 2013 agreement, as amended on April 30, 2015 (the “Senior Credit Facilities” or “Credit Agreement”) include (i) a $56,500 term loan A facility (“Term Loan A Facility”), and (ii) a $43,500 delayed draw term loan facility (“Delayed Draw Term Loan Facility”). The Senior Credit Facilities also include a $25,000 incremental loan arrangement subject to the Company’s future needs and bank approval, although no assurances can be given that this incremental loan amount will be available to us when and if needed. In 2013 and 2014, we borrowed $10,000 and $14,562, respectively, under our Delayed Draw Term Loan Facility and the proceeds were used towards the retirement of our 4.5% convertible notes. The remaining $18,938 of the Delayed Draw Term Loan Facility was fully drawn on April 30, 2015 and the proceeds were used for general corporate purposes. The Credit Agreement provides that the banks hold at least $35,000 of the Company’s cash and marketable securities until December 31, 2015.

Interest rate hedging activities

In August 2014, we entered into an interest rate swap agreement with our principal bank. Its $32,094 initial notional amount represents about half of the outstanding balances of the floating rate Term Loan A Facility and the Delayed Term Loan Facility to reduce the variability of interest expense due to changes in interest rates. The interest rate swap results in us paying a fixed rate of 5.17% on the notional amount of the swap until its June 25, 2018 maturity. The notional amount of the swap will change over time to reflect approximately 50% of the outstanding expected Term Loan A Facility and Delayed Draw Term Loan Facility balances. Interest rate reset and interest rate payment dates mirror those of the underlying Term Loan A Facility and Delayed Draw Term Loan Facility. The swap is expected to exactly offset changes in expected cash flows due to fluctuations in the one month LIBOR rate over the term of the hedge. The interest rate swap fair value as of September 30, 2015 and December 31, 2014 was a $498 and $240 liability, respectively. For the three and nine months ended September 30, 2015 and 2014 the hedge was highly effective and no gains or losses were recognized in earnings.

 

13. Capital Leases

We lease certain equipment under capital leases which are collateralized by the leased assets. Amortization of leased assets is included in depreciation and amortization expense.

Future minimum payments under capital lease obligations consisted of the following at September 30, 2015:

 

 

 

14. Income Taxes

We reported income tax expense of $1,413 and $2,180 for the three and nine months ended September 30, 2015, respectively, compared to $2,607 and $2,200 of income tax expense for the three and nine months ended September 30, 2014, respectively. As of September 30, 2015, we continued to provide a valuation allowance for all federal and some state deferred tax assets. The Company continually evaluates facts representing both positive and negative evidence in the determination of its ability to realize the deferred tax assets reported in the notes included in our 2014 Annual Report on Form 10-K.

We do not anticipate a significant change to the total amount of unrecognized tax benefits within the next twelve months.

 

15. Commitments and Contingencies

Some customers seek indemnification under their contractual arrangements with the Company for claims and other costs associated with defending lawsuits alleging infringement of patents through their use of our products and services, and the use of our products and services in combination with products and services of other vendors. In some cases we have agreed to assume the defense of the case. In others, the Company will negotiate with these customers in good faith because the Company believes its technology does not infringe the cited patents and due to specific clauses within the customer contractual arrangements that may or

 

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may not give rise to an indemnification obligation. The Company cannot predict the outcome of such matters and the resolutions could have a material effect on our consolidated results of operations, financial position, or cash flows. Due to the inherent difficulty of predicting the outcome of litigation and other legal proceedings and uncertainties regarding the Company’s existing litigation and other legal proceedings, the Company is unable to estimate the amount or range of reasonably possible loss in excess of amounts accrued. The Company’s assessments are based on estimates and assumptions that have been deemed reasonable by management, but that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause the Company to change those estimates and assumptions. Therefore, it is possible that an unfavorable resolution of one or more pending litigation or other contingencies could have a material adverse effect on the Company’s consolidated financial statements in a future fiscal period.

The application and interpretation of applicable state and local sales and other tax laws to certain of our service and system offerings in certain jurisdictions is uncertain. In accordance with generally accepted accounting principles, the Company makes a provision for a liability for taxes when it is both probable that the liability has been incurred and the amount of the liability or range of liability can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted if necessary. At September 30, 2015, the Company is subject to an ongoing state and local tax audit by the Washington State Department of Revenue. During the quarter, the state’s administrative law judge issued a report which led us to reduce our overall accrual for state and local tax settlements by about $1,000. As this and other tax audits progress in the normal course of business, the Company will review and adjust a provision for loss as appropriate.

Other than the items discussed immediately above, 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. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the financial condition and results of operations should be read in conjunction with the consolidated financial statements, related notes, and other detailed information included elsewhere in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2015 (this “Form 10-Q”). This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are statements other than historical information or statements of current condition. We generally identify forward-looking statements by the use of terms such as “believe,” “intend,” “expect,” “may,” “should,” “plan,” “project,” “contemplate,” “anticipate,” or other similar statements. Examples of forward looking statements in this Quarterly Report on Form 10-Q include but are not limited to statements: (a) regarding our belief that our technology does not infringe the patents related to customer indemnification requests and that indemnification claims should not have a material effect on our results of operations; (b) regarding our expectations with regard to our Senior credit facility, notes, notes hedge transactions and interest rate hedging activity; (c) that we believe we have sufficient capital resources to fund our operations for the next twelve months; (d) relating to our backlog; (e) that we believe that capitalized software development costs will be recoverable from future gross profits; (f) regarding our expectations with regard to income tax assumptions and future stock-based compensation expenses; (g) regarding our assumptions related to goodwill; (h) that a significant underperformance relative to historical or projected future operating results, significant change in the manner of our use of acquired assets, and significant negative industry or economic trends could cause us to conclude that impairment indicators exist and that our acquired intangible assets might be impaired; (i) relating to our research and development spending; and (j) that we believe the unusual accounting and legal fees incurred related to the investigation work under the direction of the board in response to questions raised by an employee in the first quarter of 2015 are nonrecurring and complete.

These forward-looking statements relate to our plans, objectives and expectations for future operations. We base these statements on our beliefs as well as assumptions made using information currently available to us. In light of the risks and uncertainties inherent in all such projected operational matters, the inclusion of forward-looking statements in this report should not be regarded as a representation by us or any other person that our objectives or plans will be achieved or that any of our operating expectations will be realized. Revenues, results of operations, and other matters are difficult to forecast and our actual financial results realized could differ materially from the statements made herein as a result of the risks and uncertainties described in our filings with the Securities and Exchange Commission. These include without limitation risks and uncertainties relating to our financial results and our ability to (i) continue to rely on our customers and other third parties to provide additional products and services that create a demand for our products and services, (ii) conduct our business in foreign countries, (iii) adapt and integrate new technologies into our products, (iv) develop software without any errors or defects, (v) protect our intellectual property rights, (vi) implement our business strategy, (vii) realize backlog, (viii) compete with small business competitors, (ix) effectively manage our counterparty risks, (x) achieve continued revenue growth in the foreseeable future in certain of our business lines, (xi) have sufficient capital resources to fund the Company’s operations, and (xii) successfully integrate the assets and personnel obtained in our acquisitions. These factors should not be considered exhaustive; we undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. We caution you not to put undue reliance on these forward-looking statements.

 

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The information in 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 generally accepted accounting principles for interim financial information.

 

Critical Accounting Policies and Estimates

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

This discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included in our 2014 Form 10-K.

 

Overview

TeleCommunication Systems, Inc. develops and delivers highly reliable and secure wireless communication technology. TCS provides solutions in 9-1-1 infrastructure, cybersecurity, deployable wireless terminals, space components, and applications for mobile location-based services and messaging. Principal customers are wireless network operators, defense and public safety government agencies, and Fortune 150 enterprises requiring high reliability and security. While we manage and have historically reported two business segments, Commercial and Government, digital wireless voice and data communication technology is converging, so engineers from both segments are collaborating to address solution needs for customers of both segments.

Commercial Segment: We are one of two leading companies that enable 9-1-1 call delivery via cellular, VoIP, and next generation technology. Other TCS hosted and managed services include cellular network and device platforms and applications for text messaging and location-based services. We are also engaged in patent monetization activity which is included in this segment. Commercial Segment customers include wireless network operators, VoIP service providers, wireless device manufacturers, automotive industry suppliers, and state and local governments.

Government Segment: For U.S. Department of Defense agencies and other customers, we provide cybersecurity training, support and services, and “C4ISR” (command, control, communications, computers, intelligence surveillance and reconnaissance) resources, wireless ground terminals and related support, management and resale of satellite bandwidth, and information technology outsource services. TCS engineers furnishes and supports ground terminals used for secure satellite-based and other line-of-sight and beyond-line-of-sight communications, as well as related components incorporating government-approved cryptologic devices and other hardened components for aerospace and defense.

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. It should be read together with Item 1A Risk Factors and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2014 Form 10-K as well as the unaudited interim consolidated financial statements and the notes thereto located elsewhere in this Form 10-Q.

 

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Indicators of Our Financial and Operating Performance

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

 

Results of Operations

 

Revenue and Cost of Revenue by Segment

Commercial Segment  

 

 

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

Our commercial services revenue is generated from hosting and maintaining software and networks for 9-1-1 service for wireless and VoIP service providers and operators of next generation (internet protocol) 9-1-1 (“NextGen911”) infrastructure (mainly state and local governments), as well as hosting and maintaining applications and infrastructure software for Location-Based Services (“LBS”) and text messaging platform software. This revenue primarily consists of monthly recurring service fees recognized in the month earned. Hosted LBS and E9-1-1 fees are generally priced based on units served during the period, such as the number of customer cell sites, the number of connections to Public Safety Answering Points (“PSAPs”), or the number of customer subscribers

 

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or sessions using our technology. Subscriber service revenue is generated by hosted client software applications for wireless subscribers, generally on a per-subscriber per-month basis. We also earn services revenue through nonrecurring engineering (“NRE”) custom software development contracts. Maintenance fees on our systems and software licenses are usually collected in advance and recognized ratably over the contractual maintenance period, and unrecognized maintenance fees are included in deferred revenue. Services also include custom software development, implementation, and related service projects under time and materials or fixed-fee contracts, which are reported using percentage-of-completion accounting.

 

Third quarter 2015 commercial services revenue was $35.8 million, down from $42.5 million third quarter 2014 revenue due mainly to a 2014 one-time favorable $4.7 million adjustment to location applications subscriber-based revenue. Our NextGen 9-1-1 related services revenue increased 47% in the third quarter 2015 which was offset by a 10% decrease in wireless and VoiP services. Nine months ending September 30, 2015 commercial services revenue was $3.4 million lower compared to the nine months ending September 30, 2014 primarily due to the 2014 one-time favorable adjustment to applications subscriber-based revenue and an 8% decrease in mobility solutions revenue, offset by a 54% increase in NextGen 9-1-1 related services in 2015.

The direct cost of our commercial services revenue consists primarily of compensation and benefits, licensed location-based application content, network access, data feed and circuit costs for network operation centers and co-location facilities, and equipment and software maintenance.

For the three and nine months ending September 30, 2015 direct cost of commercial services revenue was $0.1 million (1%) and $2.2 million (5%) higher, respectively, than for the same periods in 2014, reflecting additional costs related to custom development efforts incurred in 2015.

Commercial services gross profit for the three and nine months ended September 30, 2015 was down $6.8 million (26%) and $5.6 million (8%) from the three and nine months ended September 30, 2014, respectively, due to the decrease in revenue and margin on the 2014 revenue adjustment.

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

Commercial systems revenue results from sales to wireless carriers and state and local governments of systems incorporating our licensed software for enablement of 9-1-1 call routing and computer-aided call handling, and location-based wireless services infrastructure. It also includes revenue from the sale of patents and licensing of our intellectual property including payments for past patent infringement liabilities, upfront and non-refundable license fees, and royalty fees. In all cases, revenue from the licensing of our intellectual property is recognized when all four of the revenue recognition criteria are met. Some revenue from our larger NextGen9-1-1 deployments incorporating our software and third party components is recognized as long term contracts using percentage of completion accounting. License prices for our carrier software are generally a function of its volume of usage in our customers’ networks during the relevant period.

Third quarter 2015 commercial systems revenue increased $7.9 million compared to the third quarter of 2014. Our location platforms and 9-1-1 systems deployments each contributed about $2 million of higher revenue, and we recognized an additional $4 million of revenue from our intellectual property monetization during the third quarter of 2015. Commercial systems revenue for the nine months ending September 30, 2015 was $6.8 million, or 36% higher than the nine months ending September 30, 2014, reflecting $2.7 million higher revenue from intellectual property transactions, 40% increase in sales of our location platforms and a 15% increase in NextGen 9-1-1 system deployments.

The direct cost of commercial systems revenue consists primarily of compensation and benefits, third-party hardware and software purchased for integration and resale, travel expenses, and consulting fees as well as the amortization of acquired and capitalized software development costs. For the three and nine months ending September 30, 2015 direct cost of systems revenue was $2.2 million (71%) and $4.3 million (46%) higher, respectively, than the same periods in 2014, reflecting higher labor and direct costs for custom development work. Software development cost amortization was about $0.1 million and $0.3 million higher, respectively, in the three and nine months ended September 30, 2015 compared to the same periods in 2014.

For the three and nine months ending September 30, 2015 commercial systems gross profit was $5.7 million and $2.5 million higher, respectively, from the same 2014 periods, reflecting the higher revenue.

 

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Government Segment

 

The primary Government Segment customers are U.S. government agencies including the Departments of Defense and Homeland Security, domestic and foreign space programs, and the contractors that supply products and services to these government customers.

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

Government services revenue is generated from cybersecurity training and consulting, professional communications engineering and field support, program management, help desk outsource, and network design, deployment and management for government agencies, and operation, including resale of satellite airtime of fixed satellite ground terminal facilities for data connectivity. Systems maintenance fees are usually collected in advance and recognized ratably over the contractual maintenance periods.

Third quarter 2015 government services revenue was $1.4 million, or 6%, lower than the 2014 third quarter due mainly to 25% lower professional services revenue resulting mainly from the 2014 draw-down of Afghanistan field support personnel, and a 4% decrease in cybersecurity services revenue. For the nine months ended September 30, 2015, government services revenue was $9.9 million, or 12% lower than in the same period in 2014, reflecting 36% lower professional services revenue resulting from the draw-down of field support personnel, offset by $3.4 million higher global satellite and ground station support services revenue and 2% higher cybersecurity training revenue.

Direct cost of government services revenue consists of compensation, benefits, and travel expenses incurred in delivering these services, as well as satellite space segment purchased for resale. These costs were lower in the three and nine months ended September 30, 2015 than the same periods in 2014, which is correlated with the lower revenue and lower average margins on field support work.

Our gross profit from government services was $0.8 million (17%) and $6 million (31%) lower, respectively, in the three and nine month ended September 30, 2015 versus the same periods in 2014 due mainly to lower volume and margins from wartime field support work in 2015.

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

We generate government systems revenue from the sale of secure wireless communication systems, and the integration of these systems into customer networks. Our government systems revenue also includes electronic components sold mainly to domestic and foreign space programs.

Third quarter 2015 government systems revenue was up $6 million, or 25% compared to the third quarter 2014 due to higher deployable communication system sales and higher revenue from electronic components sales. For the nine months ended September 30, 2015 , government systems sales were $10.8 million higher than the nine months ended September 30, 2014 due to 25% higher sales of our deployable communication systems and by 11% higher electronic components revenue.

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

 

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Our government systems gross profit was $2.3 million, or 53% and $4.1 million, or 40% higher in the in the three and nine months ended September 30, 2015, than for the corresponding 2014 periods due mainly to higher volume. Government systems gross profit as a percentage of revenue was 22% and 23% for the three and nine months ended September 30, 2015, and was 18% and 20% for the three and nine months ended September 30, 2014, respectively, reflecting higher average margins on the mix of sales for the nine months of 2015.

Revenue Backlog

We had unfilled orders, or funded contract backlog at September 30:  

 

Funded contract backlog represents contracts for which fiscal year funding has been appropriated by our customers (mainly federal agencies), and for hosted services (mainly for wireless and other network operators). Backlog is computed by multiplying the most recent month’s contract or subscription revenue by the months remaining under the existing long-term agreements, which is considered to be the best available information for anticipating revenue under those agreements. Total backlog, as is typically measured by government contractors, includes orders covering optional periods of service and/or deliverables, but for which budgetary funding may not yet have been approved, and could expire unused.

Our backlog at any given time may be affected by factors including the availability of funding, contracts being renewed, or new contracts being signed before existing contracts are completed and the other factors described in the Company’s Risk Factors as filed with the Securities and Exchange Commission from time to time. The timing and amounts of government contract funding may be adversely affected by federal budget policy decisions, like handling of sequestration and continuing resolutions, and can lead to delays in procurement of our products and services due to lack of funding. 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:

Our research and development (“R&D”) expense consists of compensation, benefits, and a proportionate share of facilities and corporate overhead, as well as costs associated with using third-party laboratory and testing resources. We expense such costs as they are incurred until technological feasibility has been reached and we believe that capitalized costs will be recoverable, upon which we capitalize and amortize them over the product’s expected life. Technological feasibility is established for our software when a detailed program design is completed. Capitalized costs of software developed for internal use are included in fixed assets and depreciated over expected useful lives. We incur R&D costs to enhance existing software products as well as to create new products, including software hosted in network operation centers.

We develop software for systems and services used mainly by network operators, state and local public safety organizations, federal agencies, and device manufacturers. In 2015 and 2014, we invested in R&D for 9-1-1 software and updates to location-based products, including our toolkits and application program interfaces for markets beyond network operators. We also invested in updating and expanding our secure wireless communication technology products for government customers and applications for network operators, telematics supply chain, and network security. We continue to obtain patents for some of our developers’ innovations. The total of capitalized and expensed R&D spending for the 2015 third quarter and nine months ending September 30 was about $1.9 million and $4.9 million lower than the same periods in 2014.

 

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In addition to company deliverables, our research and development expenditures and acquisitions have yielded a portfolio of 439 patents as of September 30, 2015 and more than 300 patent applications pending, primarily for wireless location-based technology.

 

R&D expense was $3.3 million and $7.5 million lower for the three and nine months ended September 30,  2015 compared to the same periods of 2014, reflecting efficiency improvements, and assignment of more software developers to customer projects classified as cost of revenue.

 

Sales and marketing expense:

Our sales and marketing expenses include fixed and variable 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 industry conferences. We sell our solutions through our direct sales force and we leverage relationships with original equipment manufacturers and large network operators as channels for our technology. We sell our products and services to agencies and departments of the U.S. government primarily through direct sales professionals, and to foreign customers through agency and subcontractor arrangements.

Sales and marketing expenses were $0.2 million and $0.9 million lower in the three and nine months ended September 30, 2015 than for the corresponding periods in 2014, respectively, due to decreases in personnel and travel expenses.

General and administrative expense:

 

General and administrative (“G&A”) expense primarily represents management, finance, legal (including intellectual property management), human resources, and internal information system functions. These costs include compensation, benefits, professional fees, travel, and a proportionate share of rent, utilities, and other facilities costs which are expensed as incurred. G&A expense was $0.8 million higher in the three months ended September 30, 2015 than the same period in 2014 mainly due to about $0.6 million of nonrecurring costs of the strategic evaluation process and higher accruals for variable compensation associated with improved operating results partly offset by about $1 million of lower overall accrual for state and local tax settlements. G&A expense was $0.4 million higher in the nine months ended September 30, 2015 than the nine months ended September 30, 2014. Higher expenses included $1.1 million of unplanned, nonrecurring first quarter accounting and legal fees resulting mainly from obligatory investigation work under the direction of the audit committee of the board in response to questions raised by an employee. No changes to the Company’s financial statements were required as a result. The effect of these expenses, and about $1 million of nonrecurring year-to-date expenses for the strategic evaluation process, and higher accruals for variable compensation associated, were partly offset by the benefits of continuing cost reductions from efficiency improvements and the third quarter reduction of our overall accrual for state and local tax settlements.

Depreciation and amortization of property and equipment:

 

Depreciation and amortization of property and equipment represents the period costs associated with our investment in information technology and telecommunications equipment, software, furniture and fixtures, and leasehold improvements, as well as amortization of capitalized software developed for internal use, including hosted applications. We compute depreciation and amortization using the straight-line method over the estimated useful lives of the assets, generally five years for furniture, fixtures, and leasehold improvements, and three to seven years for other types of assets including, computers, software, and telephone equipment.

 

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Depreciation expense decreased year-over-year, as lower capital spending, including lower spending on capitalized software for internal use, over the past two years has generated less new depreciation.

Amortization of acquired intangible assets:

Acquired intangible assets are amortized over their estimated useful lives of six to ten years.

Interest expense:

Interest expense is incurred under bank and other notes payable, convertible note financing, and capital lease obligations. Financing expense amortization results from deferral of costs incurred at the time of contracting for financing facilities, which are then amortized over the terms of the facilities.

Interest on our bank and other notes payable was higher in the nine months ended September 30, 2015 as compared to the same periods in 2014 due to a higher average borrowing balance on our Senior Credit Facility, offset by lower interest on seller notes as these were fully paid in 2014. Interest on our convertible note financing was slightly lower in the nine months ended September 30, 2015 as compared to the same periods in 2014 due to a lower average borrowing balance, as our 4.5% convertible notes were fully paid in 2014, offset by a higher interest rate in 2015. Further financing details are in the Liquidity and Capital Resources section below.

Other income (expenses), net:

Other income (expenses), net, includes interest income earned, a gain on the sale of land associated with our Manassas, VA facility, realized gains on investment accounts, and foreign currency transaction gain or loss, which is dependent on fluctuation in exchange rates. Other income (expenses), net also includes the effects of foreign currency revaluation on our cash, receivables, and deferred revenues that are stated in currencies other than U.S dollars.

Income taxes:

As of September 30, 2015, the Company continued to provide a valuation allowance for all federal and some state deferred tax assets as management’s evaluation that the Company’s ability to realize such deferred tax assets did not meet the “more likely than not” criteria. The Company continually evaluates facts representing both positive and negative evidence in the determination of its ability to realize the deferred tax assets reported in footnotes to the annual financial statements. For the three and nine months ended September 30, 2015, we have recorded income tax expense of $1.4 million and $2.2 million, respectively.

Net income:

Net income was $5 million and $5.4 million higher in the three and nine months ended September 30, 2015 than for the same periods in 2014, mainly due to higher revenue and other factors discussed above.

    

 

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Liquidity and Capital Resources

 

Capital resources: We have funded our operations, acquisitions, and capital expenditures primarily using cash generated by our operations, debt and capital leases, and issuance of public equity.

Sources and uses of cash: At September 30, 2015, our cash and marketable securities balance was $51.6 million, down from $56.1 million at September 30, 2014 and $53.7 million at the beginning of the quarter. At September 30, 2015, our liquidity also included $30 million of unused borrowing availability under our Revolving Loan Facility.

Operating activities: Cash generated from operating activities was $6.9 million for the nine months ended September 30, 2015 compared to cash of $1.6 million used for operations for the nine months ended September 30, 2014. Changes in working capital were due to the timing of billings, collections, vendor payments, payroll related liabilities, and deferred revenue due to timing of percentage of completion projects.

Investing activities: In the nine months ending September 30, 2015, we invested $3.1 million of cash from the sale and maturity of our investment grade marketable securities classified as available-for-sale and sold the land and equipment associated with our Manassas, VA facility for $1.6 million of proceeds and a gain of $0.4 million. For the nine months ended September 30, 2015 and 2014, fixed asset additions, excluding assets funded by leasing, were $7.6 million and $3.4 million, respectively, and investments in development of software for resale which had reached the stage of development calling for capitalization were the about same at $1.1 million and $1 million, respectively.

Financing activities: In April 2015, the remaining $18.9 million of Delayed Draw Term Loan Facility was fully drawn. In the nine months ending September 30, 2015, we made $23.4 million in principal payments on bank and capital lease borrowings. We funded $2.9 million and $1.9 million, respectively, of fixed asset additions under capital leases during the nine months ended September 30, 2015 and 2014.

Senior debt: The Company has borrowing capacity under our $130 million Senior Credit Facilities (the “Senior Credit Facilities” or “Credit Agreement”) in accordance with a June 25, 2013 agreement, as amended April 30, 2015. The Senior Credit Facilities include (i) a $56.5 million term loan A facility (“Term Loan A Facility”), (ii) a $43.5 million delayed draw term loan facility (“Delayed Draw Term Loan Facility”), and (iii) a $30 million revolving loan facility (“Revolving Loan Facility”). The Senior Credit

 

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Facilities also include a $25 million incremental loan arrangement subject to the Company’s future needs and bank approval, although no assurance can be given that this incremental loan amount will be available to us when and if needed.

On June 25, 2013, we borrowed $56.5 million under the Term Loan A Facility and used proceeds for (i) repayment of the remaining balance under our 2012 Term Loan, (ii) approximately $16 million for working capital and general corporate purposes, and (iii) fees and expenses associated with the new facility. In 2013 and 2014, we borrowed $10 million and $14.6 million, respectively, under the Delayed Draw Term Loan Facility which was used towards the purchase of the remaining outstanding 4.5% convertible notes. Under the agreement, $18.9 million of the remaining Delayed Draw Term Loan Facility was fully drawn in the second quarter of 2015 and was used for general corporate purposes. The Credit Agreement provides that the banks hold at least $35 million of the Company’s cash and marketable securities until December 31, 2015.

Additional liquidity is available through the undrawn $30 million Revolving Loan Facility at September 30, 2015, to be used for our ongoing working capital and other general corporate purposes.

The Term Loan A Facility, the Delayed Draw Term Loan Facility, and the Revolving Loan Facility have a maturity date of March 31, 2018, unless extended as provided in the Credit Agreement. The Term Loan A and Delayed Draw facility are payable in quarterly installments on the first fiscal day of each quarter beginning October 1, 2013. We made $0.4 million of scheduled payments on the Term Loan A and Delayed Draw facilities in 2013, $2 million in 2014, and $3 million in the nine months ending September 30, 2015. $1.1 million is payable in the fourth quarter of 2015 increasing to $1.7 million in the quarter ending December 31, 2016 and to $2.3 million in the quarter ending December 31, 2017, with the remaining principal due at maturity. The Senior Credit Facilities are also subject to mandatory repayments from excess cash flow and other sources, such as net cash proceeds of debt or equity issuances, asset sales, casualty insurance claims and other recovery events, as described in the Credit Agreement. In 2014, mandatory repayments of $3.9 million for excess cash flow and $0.2 million for other sources were made by the Company based on 2013 results. Based on 2014 excess cash flow as defined, the Company made a mandatory repayment of $5.9 million in the first quarter of 2015.

The Senior Credit Facilities are secured by substantially all of the Company’s tangible and intangible assets, including intellectual property. The Credit Agreement contains customary representations and warranties of the Company and customary covenants and events of default. Availability under the Revolving Loan Facility and the Delayed Draw Term Loan Facility is subject to certain conditions, including the continued accuracy of the Company’s representations and warranties and compliance with covenants. The Senior Credit Facilities are also subject to possible mandatory repayments from excess cash flow and other sources, such as net cash proceeds of debt or equity issuances, asset sales, casualty insurance claims and other recovery events, as described in the Credit Agreement. During the continuance of an event of default, at the request of the required lenders, all outstanding loans shall bear interest at a rate per annum equal to the rate that would otherwise be applicable thereto plus 2%, and shall be payable from time to time on demand.

Interest rate hedging activities: In August 2014, we entered into an interest rate swap agreement with our principal bank to reduce the variability of interest expense due to fluctuations in market interest rates. Its $32.1 million initial notional amount represents about half of the outstanding balances of the floating rate Loan Facilities. The interest rate swap results in a fixed rate of 5.17% on the notional amount of the swap until its September 25, 2018 maturity. The notional amount of the swap will change over time to reflect approximately 50% of the outstanding expected Senior Credit Facility balances; interest rate re-set and interest rate payment dates mirror those of the underlying Senior Credit Facilities. The swap is expected to offset changes in expected cash flows due to fluctuations in the one month LIBOR rate over the term of the hedge. The interest rate swap fair value as of September 30, 2015 was a $0.5 million liability. For the nine months ended September 30, 2015, the hedge was highly effective and no gains or losses were recognized in earnings.

On May 8, 2013, we completed privately-negotiated exchange agreements with note holders and retired $50 million of our 4.5% Convertible Senior Notes due 2014 issued in 2009 (“2014 Notes”) in exchange for $50 million of new 7.75% Convertible Senior Notes due 2018 (“2018 Notes”).

The 2018 Notes were issued pursuant to an indenture, dated as of May 8, 2013 (the “Indenture”), between the Company and The Bank of New York Mellon Trust Company, N.A., as trustee (the “Trustee”). We offered the 2018 Notes to certain holders of the 2014 Notes in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. The 2018 Notes bear interest at 7.75% per year, payable semiannually in arrears in cash on September 30 and December 30 of each year, beginning on December 30, 2013. The 2018 Notes are TCS’s senior unsecured obligations and rank equally with all of its present and future senior unsecured debt and senior to any future subordinated debts and will be effectively subordinate to all of TCS’s present and future secured debt to the extent of the collateral securing that debt.

Holders may convert the 2018 Notes at their option on any day prior to the close of business on the second “scheduled trading day” (as defined in the Indenture) immediately preceding September 30, 2018. The conversion rate will initially be 96.637 shares of Class A common stock per $1 (one thousand) principal amount of 2018 Notes, equivalent to an initial conversion price of $10.35 per share of Class A common stock, which is the same conversion price as the 2014 Notes. Shares of the Company’s Class A common

 

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stock into which the 2018 Notes are convertible have been reserved for issuance by the Company. We may redeem some or all of the 2018 Notes at any time on or after September 30, 2014 at the redemption prices set forth in the Indenture plus accrued and unpaid interest to the redemption date. In addition, subject to certain exceptions, holders may require us to repurchase, for cash, all or part of their 2018 Notes upon a “fundamental change” (as defined in the Indenture) at a price equal to the purchase prices set forth in the Indenture, plus accrued and unpaid interest to, but excluding, the fundamental change purchase date. The Indenture contains customary terms and covenants, including that upon certain events of default occurring and continuing, either the Trustee or the holders of not less than 25% in aggregate principal amount of the 2018 Notes then outstanding may declare the entire principal amount of all the 2018 Notes plus accrued interest, if any, to be immediately due and payable.

4.5% Convertible notes: In 2009, we sold $103.5 million aggregate principal amount of 4.5% Convertible Senior Notes, which have now been fully retired. In the fourth quarter of 2012, we repurchased $10 million of the outstanding 2014 Notes, plus accrued and unpaid interest and recorded a gain on the early retirement of $0.4 million. On May 8, 2013, we retired $50 million of the 4.5% Convertible Senior Notes by exchanging them for $50 million of 2018 Notes. In the second half of 2013, we repurchased $28.9 million of the outstanding 2014 Notes, plus accrued and unpaid interested and recorded a loss of $0.2 million. In 2014, we repurchased the remaining $14.6 million balance of the 2014 Notes.

Concurrent with the issuance of the 2014 Notes, we entered into convertible note hedge transactions and warrant transactions, that reduced the potential dilution associated with the conversion of the 2014 Notes. The note hedge transaction expired pro rata as the 2014 Notes were repurchased. The warrants expired in the second quarter of 2015.

Seller notes: In July, 2012, we issued $14.3 million in 6% promissory notes as part of the consideration for our acquisition of microDATA, full payment of which was completed in accordance with the note terms on September 30, 2014.

We currently believe that we have sufficient capital resources with cash generated from operations as well as cash on hand to meet our anticipated cash operating expenses, working capital, and capital expenditure and debt service needs for the next twelve months. We have a Revolving Loan Facility through March 2018 of which $30 million was undrawn at September 30, 2015. We also have borrowing capacity under a capital lease facility. We may also consider raising capital in the public markets to meet capital needs and to invest in our business. Although we may need to return to the capital markets, establish new credit facilities, 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.

 

Contractual Commitments

As of September 30, 2015, our most significant commitments are term debt, non-cancelable operating leases, purchase obligations, and obligations under capital leases. We lease certain furniture and computer equipment under capital leases. We lease office space and equipment under non-cancelable operating leases. Purchase obligations represent contracts for parts and services in connection with our government satellite services and systems offerings. Our commitments consisted of the following:

 

 

¹The cash payments due for our Senior credit facility include estimated interest payments based on LIBOR plus a fixed spread that were effective at the balance sheet date.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

There have not been any material changes to our interest rate or our foreign currency risk as described in Item 7A of our 2014 Annual Report on Form 10-K.

 

Item 4. Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, and summarized and

 

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reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Rule 13a-15(b), 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 the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2015.

There have been no changes in the Company’s internal control over financial reporting during the latest fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. — OTHER INFORMATION

Item 1. Legal Proceedings

Some customers seek indemnification under their contractual arrangements with the Company for claims and other costs associated with defending lawsuits alleging infringement of patents through their use of our products and services, and the use of our products and services in combination with products and services of other vendors. In some cases we have agreed to assume the defense of the case. In others, the Company will negotiate with these customers in good faith because the Company believes its technology does not infringe the cited patents and due to specific clauses within the customer contractual arrangements that may or may not give rise to an indemnification obligation. The Company cannot predict the outcome of such matters and the resolutions could have a material effect on our consolidated results of operations, financial position, or cash flows. Due to the inherent difficulty of predicting the outcome of litigation and other legal proceedings and uncertainties regarding the Company’s existing litigation and other legal proceedings, the Company is unable to estimate the amount or range of reasonably possible loss in excess of amounts accrued. The Company’s assessments are based on estimates and assumptions that have been deemed reasonable by management, but that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause the Company to change those estimates and assumptions. Therefore, it is possible that an unfavorable resolution of one or more pending litigation or other contingencies could have a material adverse effect on the Company’s consolidated financial statements in a future fiscal period.

The application and interpretation of applicable state and local sales and other tax laws to certain of our service and system offerings in certain jurisdictions is uncertain. In accordance with generally accepted accounting principles, the Company makes a provision for a liability for taxes when it is both probable that the liability has been incurred and the amount of the liability or range of liability can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted if necessary. At September 30, 2015, the Company is subject to an ongoing state and local tax audit by the Washington State Department of Revenue. During the quarter, the state’s administrative law judge issued a report which led us to reduce our overall accrual for state and local tax settlements by about $1 million. As this and other tax audits progress in the normal course of business, the Company will review and adjust a provision for loss as appropriate

Other than the items discussed immediately above, 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 1A. Risk Factors

There have not been any material changes to the information previously disclosed in Item 1A. Risk Factors in our 2014 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

 

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Item 4. Mine and Safety Disclosures

None.

Item 5. Other Information

Item 5.02.   Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers

 

On October 28, 2015, TCS provided written notice of termination to Mr. Drew A. Morin, Senior Vice President and Chief Technology Officer the Company.

 

 

(b) None.

Item 6. Exhibits

 

 

 

 

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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 30th day of October 2015.

 

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.

 

 

 

 

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