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Executives

Maurice Tose - Chairman, President and CEO

Tom Brandt - SVP and CFO

Bruce White - General Counsel

Analysts

Suhail Chandy - Wedbush Morgan

Tim Quillin - Stevens Incorporated

Mark Jordan - Noble Financial Group

Barry Sine - Capstone Investments

Mike Latimore - Northland Securities

Jim Kennedy - Marathon Capital

Jon Gruber - Gruber & McBaine Capital Management

TeleCommunication Systems Inc. (TSYS) Q2 2009 Earnings Call July 30, 2009 5:00 PM ET

Operator

Welcome to the TeleCommunication Systems Inc., second quarter 2009 Earnings Call. At this time all participants are in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. (Operator Instructions).

And it is now my pleasure to turn the call over to Mr. Maurice Tose. Please go ahead sir.

Maurice Tose

Thank you and good evening. We thank you for joining us to discuss Telecommunication Systems second quarter 2009 results. With me today is Tom Brandt, our CFO, and Bruce White, our General Counsel. Before we present our formal comments, I will ask Bruce to advise listeners of the cautions that they should consider during this call. And following our presentation, we'll open the lines for Q&A. Bruce?

Bruce White

Thank you, Maurice. Some of the statements you would hear during this call are forward-looking within the meaning of federal securities laws. Some but not all of these statements include language such as believe, expects or anticipates and you should listen to those statements with the knowledge that actual results may differ materially from these forward-looking statements.

The risk factors that could cause results to differ maybe found in our SEC filings, including Forms 10-K and 10-Q. We encourage all investors to read these documents. Also, during the call, we may refer to measures of income that are not computed in accordance with generally accepted accounting principles. To the extent that we refer to non-GAAP data, we have provided a reconciliation in our press release and on our website. Maurice?

Maurice Tose

Thank you, Bruce. While our second quarter earnings release crossed the wire services at about 4:15 pm today and a full text copy of our press release has been distributed via email and is also available in fact on our website. We've also updated the financial model that puts the company's financial information into perspective and this is available for download from the investor information section of our website.

As indicated in our news release, revenue for the second quarter was $67.1 million, up 53% year-over-year, and our EBITDA $14.5 million or $0.28 per diluted share, compares to second quarter 2008 EBITDA of $7.2 million to which was added $8.1 million from a patent sale for a total of $15.2 million.

After a normal income tax provision in the quarter just ended, we are reporting net income of $6.6 million or $0.13 per diluted share. Investors are reminded that prior to 2009, a normal tax provision was not made for determination of net income. So the last year's second quarter $0.26 per share is not comparable to this year's reported results.

Results for the quarter include a month and half contribution from the operations of LocationLogic the former Autodesk division that TCS purchased in mid-May along with the acquisition transaction expenses.

For both business segments we are reporting substantial increases over Q2 '08 revenue and gross profit over second quarter 2008 amounts, with growth from both the services and system sales buy each segment.

Second quarter Commercial segment revenue was a record $33.1 million, yielding record gross profit of $22.3 million or 67% of revenue, up 44% from $15.5 million of gross profit in Q1 '09. Growth included higher contributions from messaging licenses and maintenance, as well as $2 million of locations services revenue from a month and a half of LocationLogic business.

In the second quarter 2009, TCS Messaging Software systems processed over 165 billion messages, up 31% from the previous quarter and 250% the volume of a year ago. TCS Messaging Software and Career Customers has handled more volume in the first half of 2009 than the total number of messages handled in all of last year, and we now expect this trend to continue.

According to Frost & Sullivan, industry research report just released on July 24, mobile messaging, particularly SMS, continues to increase at a rapid pace with no slowdown in sight. They see a compound annual growth rate of 35% from 2008 through 2014, driven not just from person-to-person SMS traffic, but also from application-to-person messaging in the form of social networking, alerts, promotion, and enterprise messages.

With about 61% or 168 million US mobile subscribers using SMS, Frost & Sullivan expects the penetration of messaging use to grow to about 83% or 238 million US subscribers in 2014. Average messages per active messaging subscribers should grow as well.

In its tally of global short message service center market share, the Frost & Sullivan report ranks TCS tied for third, noting their decision is the globally leader while TCS is a leader in the North American market.

During the second quarter TCS delivered to a Tier-1 carrier our next generation SMS Express over mobile broadband solution that supports SMS over Internet protocol enabling the use of multiple transport networks for sending and receiving text messages.

Our Short Message Service inter application software is capable of supporting both new premium messaging applications that will be enabled by the increased capacity available in the next generation networks, as well as the rapidly growing mobile social networking and marketing, advertising tools such as Twitter and Facebook that are driving text messaging volume.

As operators rollout fourth generation access networks, the TCS solution will ensure that the text messages will be delivered with a seamless user experience as Legacy and next generation mobile broadband networks must co-exist.

During the second quarter TCS secured a multi-million dollar carrier order for our Mobile Value-added-service Platform. A solution which allows a carrier to bypass content aggregators for enterprise to phone business services.

The solution connects directly to the wireless operator's data network enabling enterprises to send text messages directly to mobile handsets. Wireless operators can facilitate enterprise messaging internally to employees, externally to customers and even support campus alerts via secured mass delivery.

As I said last quarter, we know that our largest customer has two SMS vendors in his network and we will not always get a 100% of the business from growth in customer usage of SMS. But the overall demand drivers that I have just described and the progress in customer and channel communications during the quarter have encouraged us to raise our sites as to our license and maintenance sales.

This continued growth in demand for text messaging service creates opportunities to supply of SMSC solutions to other wireless networks in addition to incremental license sales to incumbent customers networks. We are continuing to make progress with our messaging channel partner on initiatives to penetrate new carrier customers with messaging technology solutions.

We believe that our largest SMS customer will continue to purchase incremental licenses to accommodate growth and traffic volume on their network. And we are working on a large volume multiple quarter capacity purchase that will support them through 2010.

Our total messaging software maintenance and license revenue in the first half of 2009 was about $28 million. We currently expect messaging revenue in the balance of 2009 through the end of 2010 to total $80 million to $90 million absent significant new customers.

Turning to location products. We are building on our wireless E9-1-1 application revenue base by powering quite label and branded commercial location applications, one about a dozen wireless operators reaching 300 million subscribers.

With the launch of Tata last quarter TCS Navigator and Maps are now commercially available on RIM BlackBerry devices. Additionally, TCS Navigator supports touch screens with our launch on Samsung's Finesse and with the release of our traffic application on Horizon. TCS now supports four mobile advertising networks; Microsoft, Google, Nokia Interactive Ad Server, and Third Screen Media.

Earlier this month AT&T launched the next generation mobile web portal powered by TCS's mapping and traffic infrastructure.

During the second quarter we announced the completion of the acquisition of LocationLogic LLC with run rate of about $18 million of annual revenue and $5 million of EBITDA. We expect to release upgrades of LocationLogic applications during this balance of this year, which will feature improved functionality that we expect will drive future subscriber growth.

This acquisition has also expanded our hosted customer base for location platforms to include Sprint and Verizon Wireless in North America; as well as Vodafone, Spain. In addition, we are deploying services for another hosted carrier customer in Latin America later in the third quarter. The combination with LocationLogic access provides TCS with a strong as LBS technology portfolio in the industry.

Prior of the acquisition, ABI and a former research ranked TCS as a number two LBS infrastructure company in the world market. LocationLogic adds recurring application and hosted infrastructure revenue and the market share. This comes at a time, when LBS subscribers are expected to double and revenue more than double from 2008 to 2009 according to Gartner.

Assisted GPS capable handsets are the catalyst film for LBS solutions. And [Bergian's Eye] has projected that more than 20% of mobile phones sold in 2009 in Europe will be GPS capable. As with messaging, our location products are 4G capable. And our Xypoint location platform received a YMax distinction award from Internet Telephony Magazine in recognition of this focus on the future. We signed a letter of intent during the quarter to develop a next-generation telematic service for a leading North American telematics service provider. We expect these services to launch over the next 18 months.

Additionally, TCS has partnered with TUNIX to support all four navigations on TUNIX's car application platform providing OEM developers with access to TCS navigation services and solutions during design and proof-of-concept development phases. For Voice over IP carriers, and area of public safety, TCS is now finalizing a contract with Comcast for their digital voice subscribers supported by our LivewirE911 emergency services offering.

TCS also extended the term of its T mobile contract, under which we provide wireless and Voice over IP automated location indicator data connectivity. And to use our award winning Real-Time Address Validation Service, or RAVE911 for their @ home offering. TCS continues to make progress with strategic relationships for Next-Generation 9-1-1 service and is beginning to make progress with our internet protocol enabled selective routing offering.

TCS innovation engine continues to produce cutting edge solutions to market needs. During the second quarter, this inventiveness was recognized by the issuance of five U.S. patents and one International patent. Our most recent U.S. patent allows any public service, agency; for example, the military, federal, and civilian public safety answering points to provide emergency alert information to specific First Responders.

This is critical functionality for making E911 and other emergency services as effective as possible. With the acquisition of LocationLogic, TCS added 11 patents and 11 patent applications.

These patents applications provide additional depth and breadth to our location-based services patent portfolio and to the total portfolio, which now stands at 87 issue patents and 252 patent applications pending.

TCS intends to enforce its intellectual property rights where infringement is found. We continue to pursue resolution of our patent infringement suite against Sybase. Having had a final judgment of firming the validity of our patent and awarding $12 million in damages and a 12% royalty going forward, we are currently preparing to respond to Sybases' – to Sybase 365's appeal.

Should if the Court of Appeals affirm the District Court's decision upholding our 748 patent, post verdict damages could exceed a another $16 million bringing the total award to $28 million or more. And in injunction, now stayed pending appeal could also go into a place, effectively shutting down Sybase's relevant business.

New and in fact today, new lawsuits were filed against Sybase in Richmond and Alexandria on two patent matters. One, TCS's patent on inter-carrier text messaging systems and equipment of the general type as was at the issue in the earlier case. And two, elements of TCS's SMS, mobile originated to Internet patent portfolio on technology for permitting two way communication of short messages between an SMS or wireless handset and in Internet device.

Our licensing effort regarding our SMS mobile originated to Internet patent portfolio or in MO to HTTP for short, is gaining momentum. As mentioned earlier, this patent portfolio describes a method that enables handsets to interact with web applications using SMS messages. Such messages are used currently by many companies using SMS short codes for commotions, alerts, and other marketing campaigns, like audience voting for broadcast TV competitions.

We have successfully closed IP rights agreements with three companies and expect to close several more licenses in the coming quarter, including agreements with the major financial services company, and a major provider of Internet infrastructure. In support of this effort, TCS recently launched a campaign aimed at encouraging notified infringers to take advantage of our very affordable MO to HTTP license program.

During the quarter, Mark Ramberg joined us as Director of Intellectual Asset Management. Previous to joining TCS, Mark spent the last five years with Microsoft as Director of Intellectual Property, Technical Strategy. He is a Certified Licensing Professional, a U.S Patent and Trademark Office registered Patent Agent, and a degreed Electrical Engineer with over 25 years of professional experience. Besides coordinating everyday intellectual property management tasks, Mark is currently focused on moving our IP monetizations efforts to the next level.

Developing new licensing programs for existing patents, mining and enhancing the portfolio for protection of our leading-edge technologies, as well as for market advantages and cross-licensing potential; implementing enhanced internal processes for strategic invention identification and capture; and executing our strategy for near and long-term intellectual asset management.

Our government business segment revenue in Q2 '09 was $34 million, up 86% over Q2 '08, $18.3 million. Q2 '09 government gross profit was 23% of revenue for a total of $7.8 million, an increase of 3.5 million or 80% more than the gross profit generated in the same year-ago quarter.

In the first six months of FY '09, we generated 79 million in revenues, an increase of 143% over the 32.5 million revenue generated in the first half of FY '08. The corresponding gross profit numbers in first half FY '09 was $17.5 million versus $7.7 million in the first half of FY '08, an increase of 127%. We are pleased to report that this growth is a across a broad front coming from both services and systems.

A large part of our government segment growth since the second half of 2006 has come from the Worldwide Satellite Systems or WWSS contract. Our largest award from that contract vehicle have been from two major Army and Marine Corp programs; SNAP or SIPR/NIPR Access Point, and WPPL, our Wireless Point to Point Link.

So far we have derived about $49 million in SNAP-related revenues since August 2008 and $40 million in WPPL revenues since October 2007. The U.S. Army awarded us its 10th SNAP task order in Q2, valued at $3.4 million; bringing fundings to 42.9 million of the 232 million potential value. To-date TCS has shipped nearly 250 SNAP terminals and about 290 WPPL systems, which are deployed mainly in Iraq and Afghanistan where they are functioning in critical roles and in harsh conditions.

Our company has been informed by multiple sources that the Army and Marine Corps longer term plans include perusing program of record status for SNAP and WPPL respectively. As a program of record, the SNAP and WPPL programs will qualify for a congressionally stipulated funding and oversight, allowing the military to deploy systems to all units. Not just the ones that have been deployed in Iraq and Afghanistan.

Our customers have made it known that both SNAP and WPPL systems are field tested, reliable, and now an inaugural part of military satellite and tactical terrestrial communications, which supports the recommendation that they become programs of record. If the Army follows through with these actions, we can see orders for dozens of SNAP systems for each of their 45 brigade combat teams of which we have provisioned three to-date. It is also likely that each one of the seven Marine Expeditionary Units or MUEs will be supplied with Foothold Systems or with a long-term, thus keeping our revenue stream from these key programs flowing for multiple years.

During Q2, our engineers continued development investment in Ku and expand versions of the Stingray series of man-packable VSAT Terminals. The SwiftLink microsat 0.5 meter terminal is a lightweight modular ultra small aperture terminal solution, designed to specifically meet the needs for sensitive military communications. It contains a user friendly GUI and single front indicators to assist in satellite acquisition. It is easily pointed manually and satellite acquisitions can be obtained in the matter of minutes.

TCS engineers conducted a live demo for the US Army at our Tampa facility for interoperable land mobile radio application using our new 2.4 meter quad band C, Ku, Ka, and X satellite terminal. And we launched the SwiftLink SABR, Satellite Access Baseband Remote, multi-band, multi-aperture terminals.

These SABR VSAT terminals support plug and play interoperability with any standard space L-band modem. Each modem equipped VSAT terminal may be further combined with any one of four different SwiftLink SABR baseband kits for a uniquely customized solution.

Our systems revenue each quarter consists of a blend of high volume and lower volume deliverables assembled in our Tampa plant, together with what we call pass through system sales that involve little or no physical value add to systems sold, that yield low risk profit to the company, through customer use of our procurement vehicles.

Through a combination of efficient manufacturing processes, improved supply chain management, and better vendor pricing, our Tampa operation has delivered higher gross margins than expected for the first half of 2009. Overall, our Tampa facility continues to deliver hardware solutions at improved gross margins over the original bid rates. We expect second half, 2009 government system sales to include a higher proportion of pass through business than in the first half.

Moving onto Government services, revenue was $13.9 million, which is up 79% over the same year ago quarter and gross profit more than doubled to $3.5 million from the year earlier quarter. Growth occurred during the quarter in all three subsets of this revenue category. IT and filed support professional services, teleport services and system maintenance.

In the IT professional services domain, we recently received an extension of one of our largest IT professional service contracts that will continue TCS's service into 2010 pending award for renewal of our services for seven more years through 2016.

We have grown our SwiftLink field service staff to a total of 33 in Iraq and Afghanistan, with two integrated logistic support facilities in Iraq and shared government facilities in Afghanistan.

Our satellite managed bandwidth services provide the communications connectivity between our deployed SwiftLink systems in remote parts of the world back to our teleports and eventually onto the desktops and cell phones of our customers. Much of our recent growth has been with Federal non-DoD customers.

We continue to make investments in our teleport and customer service infrastructure. Our 24/7 SwiftLink operations center allows us to provide global around the clock customer service and increase the operational availability of our customer network. Having this capability as an adjunct to our deployable systems is a significant discriminator against our SwiftLink competitors and allows TCS to provide true end-to-end solutions.

In summary, our Government business segment had a solid first half and we expect solid performance to continue to the second half. We expect to enter 2010 with a very healthy backlog and expect to continue to grow at a double digit year-over-year rate based on the company's market position in satellite and tactical terrestrial communications and professional services. Tom?

Tom Brandt

Thanks, Maurice. Overall company revenue for the quarter was 52% services and 48% systems and was about 49% Commercial and 51% Government segment. Second quarter Commercial segment services revenue of $28.7 million was up from $16.5 million a year ago, reflecting the LocationLogic acquisition, as well as growth in overall E9-1-1 revenue and software maintenance.

Gross profit on services at $12.3 million or 59% of revenue was up from $8.6 million or 52% of revenue in Q2, '08. Improvement in gross margin is expected to continue as the mix of future business includes more location application and software maintenance revenue.

Commercial systems second quarter revenue of $12.4 million was up from $9.1 million a year ago reflecting higher license sale for increased text messaging volume in Q2 '09. The quarter's gross profit was $10 million up from $6.3 million a year ago due mainly to the higher messaging license sales.

Government segment services revenue was $13.9 million compared to $7.8 million a year ago. And Gross profit from it was $3.5 million compared to $1.5 million a year ago. As Maurice reported these increases are as a result of new and expand scope contract for all three of our professional services, satellite and airtime services, and maintenance and fuel support subsets associated with our SwiftLink and WPPL systems.

Sales of government systems for the quarter were $20.1 million, up more than $9 million from $10.5 million a year ago. On which gross profit of $4.3 million was up from $2.8 million in Q2 '08 mainly due to the increased volume of sales of SNAP and Wireless Point-to-Point Link systems under the WWSS contract vehicle. With lower pass through system sales in the period.

Second quarter company-wide operating expenses excluding depreciation and amortization totaled $17.5 million up from last year's $13.5 million. But as a percentage of revenue the sum of R&D sales and marketing and G&A expenses was down from 31% last year to 26% of revenue for the quarter just ended.

The overall absolute expense increase was due primarily to accruals for variable compensation and increased sales and marketing programs for both the government and commercial business segments and higher R&D.

Research and development expense was $4.9 million in the second quarter up from $3.9 million last year, as we continue to invest in technology for wireless messaging, platforms and applications for location based service, next-generation 911 and deployable SATCOM.

Sales and marketing expenses totaled $4.2 million for Q2 '09 versus $3.6 million in Q2 '08, reflecting initiatives in support of growth in both segments.

General and administrative expenses for the quarter were $8.4 million versus $6 million in the second quarter of 2008, as we've increased investments in legal and related costs around intellectual property, internal control infrastructure to support higher overall company business volume, accruals for variable compensation, and administrative expenses including transaction costs associated with acquiring the assets of LocationLogic.

EBITDA from continuing operations was $14.5, which is more than double the $7.2 million in last year's second quarter excluding the $8.1 million gain from patent sale. Non-cash charges totaled $3.5 million for the quarter versus $3 million in last year's second quarter. Depreciation of fixed assets was about the same at $1.4 million.

Non-cash stock-based compensation expense was $1.2 million compared to $0.9 million in Q2 '08, and amortization of software development costs and other intangibles was $0.9 million compared to $0.6 million last year, reflecting amortization of intangibles acquired with LocationLogic.

In the second quarter of 2009, we recorded a $4.2 million provision for income taxes against pre-tax income of $10.8. This represents an effective tax rate of about 39%. Prior to our year-end 2008 reversal of the deferred tax asset, we recorded a tax provision of only $152,000 for alternative minimum taxes in Q2 '08. We currently expect the average effective tax rate for 2009 to be about 38%; so bottom line, we've reported net income of $6.6 million for the quarter on sales of $67.1 million.

At the end of the second quarter, funded backlog was $165 million up from a $157 million at the end of Q1 '09. At quarter-end, our total backlog was $406 million up from $206 million, a year ago. We entered Q3 '09, expecting to realize a $124 million of our funded backlog over the next 12 months. Beyond this funded backlog, our long-term services contracts, licensing arrangements, and our unfunded government contract orders give us improving visibility overall relative to earlier year.

The company's liquidity position remains very strong in the second quarter. Quarter-end cash totaled about $59 million, up from $35 million at the beginning of the quarter. The company's second quarter EBITDA generated $14.5 million of cash. In addition, $15.2 million was generated from new term debt and lease financing of fixed assets, and $1.3 million was generated from stock option exercise.

The uses of cash included $15 million towards the acquisition of the LocationLogic access, $3.6 million for capital expenditures including a $0.5 million of capitalized software development; and a $12.4 million decrease in working capital, due mainly to collection of accounts receivable.

At quarter-end, our day's revenue in receivables, billed and unbilled, totaled 92 days down from a 101 days in March. Unused availability under our lines of credit totaled $29 million at quarter-end. Substantially, all of our cash equivalents are in federally back stopped mutual, money market funds and certificates of deposits held for us by three institutions. We are continuing our practice of providing annual, but not quarterly guidance as to future P&L performance.

We now expect overall revenue for 2009 to be in the $275 million to $290 million range, representing year-over-year growth of 25% to [33%]. We continue to expect more top line growth during 2009 in the government segment then in the commercial segment, with both segments growing 20% or more year-over-year.

With a higher margin mix of revenue, we now expect of EBITDA for 2009 to grow from 2008 to $29 million or $0.62 per diluted share excluding the $0.18 patent sale income to the range of $44 million to $46 million, or $0.85 to $0.88 per diluted share.

We now estimate that shares for diluted EPS for 2009 will be about 52 million versus the 46.6 million average for 2008. Number of shares outstanding has grown mainly due to the issuance of 1.4 million share, as consideration – partial consideration for LocationLogic acquisition from a warrant orders exercised during Q4 '08 of some rights to purchase about a million common shares. And from a higher number of in-the-money options than before the stock prices 2008 improvement.

We foresee non-cash charges for 2009 of about $14.5 million to $15.5 million and net interest expense from nil to $0.7 million for the year. As mentioned earlier, pre-tax income will be subject to a tax provision at about 38%, so we currently anticipate GAAP net income for 2009 of about $18 million to $19 million or $0.35 to $0.36 per diluted share. The 2009 environment presents opportunities for a well-capitalized growth company like TCS.

To consider accretive acquisitions that will result in some consolidation of the communication technology spaces where we are strong, we will update guidance data if we're added to the company through acquisitions. Our guidance data maybe viewed in the context of historical trends by referring to the financial model portion of our website's Investor Relations page.

At this time, I'll turn this call back to Maurice.

Maurice Tose

The marketing issues where our company is focused; continue to yield growth and profitability, text messaging, deployable SATCOM, tactical terrestrial communications, and public safety technology are recession-resistant needs; and we are now showing traction in wireless location-based services.

The company is increasingly recognized as number two or three in many of its markets. TCS's commercial business continues to benefit from record text message usage in the U.S., an analyst predicted that the strong growth in text messaging will continue for at least another five years. The early opportunities arising from the LocationLogic deal are exciting.

In our early market leadership and location-based services, positions the company for global leadership in the LBS base. We believe that as wireless carriers around the world, proceed to invest in educating subscribers on the value of LBS services, our company will grow revenues from licenses, maintenance, customization and hosting of location-based technology as has been the case for messaging technology. TCS's investment and communications technologies have resulted in a valuable body of protected intellectual property.

We are making progress in generating royalty revenue from licensing our patents, and have staff prudently to build a meaningful program. Where litigation is necessary to assert the company's IP rights on behalf of our investors we will do so.

We generated nearly as much cash during the quarter from EBITDA without a patent sale, as we did a year ago with $8.1 million patent sale. With our updated bank arrangement, we've ended the quarter with $59 million of cash, and $29 million of an unused credit line availability; positioning us to take advantage of strategic opportunities and reassuring customers that in difficult times ours is a solid company.

We thank you for your time and support and we'd now like to open the call to any questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). And our first question will comes from side of Scott Sutherland from Wedbush Morgan. Your line is now open.

Suhail Chandy - Wedbush Morgan

Thank you. This is Suhail sitting in for Scott. Congrats on the quarter. A quick question really on the pipeline, you know, what are typically in average size of deals you're seeing especially in commercial systems, and also government systems?

Tom Brandt

Well, the range of deal side for this company is very wide, you know, where we closed in commercial; a Comcast deal that's very, very, large over a very long period of time, where we sell a contract to modify our Internet gateway application technology in a carrier, that's a whole different order of magnitude. We are not a company that lends itself to average deal sizes. We've got a wide range of customers and deliverables that helped balance sheets, [other] and produced a soother and smoother set of revenue and profit flows over the course of time, but it's not something that's easily averaged into a particular deal profile.

Maurice Tose

As we said on the call, we had several multi-million dollar deals, but we have a large number of multi-million dollar and we have several hundred thousand dollar deals, and it covers the gamete in both the government and in the commercial sales.

Suhail Chandy - Wedbush Morgan

One quick question on LocationLogic, any other kind of incremental opportunities or synergies that you see apart from the ones that you kind of mentioned?

Maurice Tose

Yes. We are working them, and we are seeing a number of opportunities that we would not have seen otherwise, which as we said we are very excited about the acquisition and its integration into the company and what it means to us on a going-forward basis.

Operator

Your next question will come from the side of Tim Quillin from Stevens Incorporated. Your line is now open.

Tim Quillin - Stevens Incorporated

Maurice, you said something important in passing and I just wanted to make sure I got it straight, but the $80 million to $90 million that you expected from your text messaging customer, what were the details on that. And my understanding you haven't signed a deal yet, you're still in negotiation. So what gives you the comfort that that's going to be the number?

Maurice Tose

Well, a couple of things, and that number doesn't represent just text messaging. It's our messaging revenue base, which is, as we said, its maintenance, its platform sales, its software, and it includes our wireless internet gateway as well as our text messaging software.

Tom Brandt

Multiple customers.

Maurice Tose

Multiple customers. So part of that's all backstopped Tim by, as we said where we are in negotiations gives us a certain degree of comfort. And what just came out yesterday in the Frost & Sullivan report echoes what we've been saying although mixed in the acceptance of folks believing what we were saying I guess and as a interested party. You go further, 169 billion text messages in one quarter, that's huge. That's almost as much as we did in the entirety of last year. So all those things and the dialogue we've had with our customers and with our channel partners give us the confidence that we are exuding in the script.

Tim Quillin - Stevens Incorporated

Was the $80 million to $90 million are you referring to messaging revenue that falls across both commercial services and commercial systems and what timeframe was that over, was it 2009 and 2010 or just the back half of '09 and 2010?

Maurice Tose

No, no. It is

Tom Brandt

The back half.

Maurice Tose

It is all the above what you just said, which is both services and systems and it's the back half of '09 and the entirety of 2010.

Tim Quillin - Stevens Incorporated

Okay. So it's hard to extrapolate that into your projections in terms of the systems revenue, but I guess not to put words into your mouth, but you expect growth in the commercial systems business in 2010 I presume. But are you looking for a back half drop off there? A back half of '09 drop-off I should say.

Tom Brandt

Tim what we found is predicting the cut-off in December between what business falls in one year or the other is dangerous for us to get real specific on, because as you know it's a software order and we've got to watch our documentary Ps and Qs. So the reason we chose to communicate what we did is that in the aggregate under the terms the arrangement we're working out, we think we're safe in sharing that much information with investors in the company. Like as to modeling what's going hit '09 versus 2010 we're all just going to have to take our best shots.

Maurice Tose

As we wanted to give some more granularity because of the, you know the (inaudible) had been there so what's going on here. And you can look at historical and say we'll be in some standard deviation of it. But we can't give you the granularity down to the quarter, but we thought the number was an important number to have people chew on.

Tim Quillin - Stevens Incorporated

Actually we're happy to have the number. I am just trying to figure out how it compares, maybe how it compares to 2Q numbers, if you extrapolate that forward is it comparable?

Tom Brandt

We said the first half, the best part number Tim is the first half counterpart was 28 million.

Tim Quillin - Stevens Incorporated

Right. Okay.

Tom Brandt

And last year in the IR deck you got an indication that the corresponding total number for 2008 was near about 40 million.

Tim Quillin - Stevens Incorporated

Okay. Well it will make me sharpen up the pencil and try and figure out exactly what that means in the model. And this happened last quarter as well but your guidance now presumes lower earnings in 3Q and 4Q then you've seen 1Q and 2Q and what should we attribute that too.

Maurice Tose

It's the timing of the systems business on both commercial and government. And while they are, as the year progresses its consumable there could be more than what we are predicting as we sit here on July 30th this is our best judgment.

Tom Brandt

Yes, but Tim if you look at the EBITDA line, it says the second, it says, I think it was the, first half was roughly 55% and the second half will pretend to be 45%. So it's not at the EBITDA line, it's not an appreciable delta.

Tim Quillin - Stevens Incorporated

Great. Not a big drop off. And 2Q came in I think a lot better than you expected when you had the conference call around the LocationLogic acquisition at that time I think you are saying the 2Q EBITDA would be similar to 1Q. What happened since then?

Tom Brandt

I think it was in particular, you were asking a question saying that the first quarter would represent a high order mark. And I was trying to get across a point that it was necessarily so. It was I think what I said.

Tim Quillin - Stevens Incorporated

That was the quarterly conference call but I think Tom made some comments on May, I think it was May 19th on the LocationLogic conference call.

Tom Brandt

Where were saying that as we looked at the balance of 2009 relative to the first quarter, my objective at the time Tim was to make it clear we didn't think Q2 was going down. And therefore I used Q1 as a benchmark for it. But the fact is that the system volume for both, commercial and government was particularly strong in the second quarter and that's the aspect of the business. The orders when they come and we book them when we book them. So I hope that's as helpful as we can be.

Tim Quillin - Stevens Incorporated

That's fair. In the government systems business, what does the pipeline look like right now? How are you expecting 3Q and 4Q government systems revenue to compare to 2Q. Presumably I think you said its going to be lower margin, but what's the revenue line going to look like?

Tom Brandt

It's running within a standard deviation to the run rates of the most recent quarter. But as you picked up on there's more pass through stuff in there, which brings the system's average margins down.

Maurice Tose

But the pipeline is good and very good. As we try to articulate, it's a solid first half and a solid second half for government both on a systems and a services' perspective. And Q3, our expectation and our budgeted forecast for government its pretty much bank. We can improve on what our internal forecast would be but we can already see what our projections and what our forecasts and what our budget was.

And as well Q4 is shaping up very nicely. As we maintained SNAP and WPPL and the program of record movement or sentiment speaks to one aspect of it but we also have our non-WWSS activities ongoing that do well by us as well. And particularly on the services side, which is the WWSS contract is limited in its ability on a services side.

We have great movement and great things going on the bandwidth side of business, as well as IT services, as we said all three areas and maintenance, all the vectors are going into right direction for us. And we believe we are going to have a solid second half and begin to bank activity that starts Q1.

Operator

Our next question will come from side of Mark Jordan from Noble Financial. Your line is now open.

Mark Jordan - Noble Financial Group

Maurice, you said that your government systems product lines would be moving towards line item status you believe that that will be achieved in the 2010 budget or 2011?

Maurice Tose

That's good question. I mean we are obviously going to be trying to have it be 2010. There will probably be some activity in 2010, but it's probably a 2011or maybe even 2012 – no, no, but it becoming a program of record is probably in the 2011 budget at the earliest, but it could the 2012, but there is activity going on right now that moves that ball forward.

Mark Jordan - Noble Financial Group

You mentioned in the G&A that obviously that had a spike up in the quarter. How much of the 8.4 million G&A was the LocationLogic deal expense?

Tom Brandt

It's in the 0.5 million to 0.75 million range, Mark.

Mark Jordan - Noble Financial Group

We should assume that absent that, we would look at a run rate dropping down 0.5 million sequentially?

Tom Brandt

Yes, that's right.

Mark Jordan - Noble Financial Group

Government services, gross profit margin had a nice pop out to 25.2 in the quarter, obviously, benefiting from volume and growth in all other pieces of business. Is that gross margin sustainable for that government services piece?

Tom Brandt

We had a really good mix again this quarter. I was caveating Q1, that all stars in the line then we had got the vendor rebate. I was trying to signal how unusually that was, and then in this it's higher. You got to consider the source when I answer here, but the outlook mix for the second half of the year is that there is higher proportion of pass through business. As you model our company, if you want to come out like it did, you've got a good but a lower average for now looking at that subset of our revenue stream in the second half.

Mark Jordan - Noble Financial Group

Just a question on the compensation expense. Are there any threshold points that would trigger a demonstratively higher compensation? Obviously, you've had some upsides surprises, with regard to favorable ones with the level of profitability. Are you accruing on a basis so that you won't face a potential patch up period in the fourth quarter if you get a fourth quarter surprise?

Tom Brandt

I liked your question Mark, and actually the short answer to your question is no, there aren't any. There aren't any accelerator triggers that really moved the overall pool a lot. I believe we've accrued in the first half in a way that there definitely shouldn't be any spikes in the second half.

Mark Jordan - Noble Financial Group

It's a kind of a final question, I'll give another shot at the trying to elicit some comments on the commercial licensing side. Obviously, given the guidance you have, you have a down tech from a very, very strong second quarter here in the third and fourth. Is there any sense as to will the licensing business be more level loaded next year, once you get into the new contract, or will it as in prior years bounce around a lot?

Maurice Tose

Mark, I would first go again back to what I've said with, I think it was, Tim, which is our first half, if you go to EBITDA line, our first half versus our second half we're within 5%. It's trickling down to the bottom line, there is a little bit more appreciable delta. If you look at the first half year-to-date at the EBITDA line, it's $25.5 million. We guided to 44 to 46. It's a drop, but I wouldn't say it's a significant drop.

Mark Jordan - Noble Financial Group

Just any comments you'd be willing to share relative to next year is to how lumpy the licensing business might be?

Maurice Tose

It goes what we said with, Tim. We can't force the hand. We have triggers in our contract that say when they get to certain capacity level that they have buy, and that can happen fast, it can happen slow, it happens when it happens, and we can't force them

Tom Brandt

But I think we probably said, it's losing out by itself. It's not that we can force it by terms of our contract. The customer and to a lesser extend the [channel can] have agendas that are outside our control that might lead them [if anything front-end load their buys] sometimes. What we're generally seeing is, even when they do that, the market is using this technology so much that what may have looked like a front-end load, ends up being a level-load because there is a need to have the licensed technology for the greatly increased volume.

Maurice Tose

If you go back IRR deck, I'm trying to remember now that it's either been 9, 10 or 11 of the past quarters only one of them did not have a license by and that was I think two years ago.

Operator

Our next question will come from Barry Sine of Capstone Investments. Your line is now open.

Barry Sine - Capstone Investments

I wanted to go back to the same question you have been getting on the additional color you gave on the SMS business. Next 18 months or so, I think you said 80 million or 90 million in revenue. You're not changing the overall guidance from the prior guidance, so that, I guess that implies that was always in your thinking for the second half of this year. Is that an improvement for what you were thinking of for 2010?

Maurice Tose

Like you said, we are not improving the overall guidance. We upped our guidance on the EBITDA, 6 million at the low end, and 5 million at the high end. We upped EPS in the 2 to 3 million range; so I'm not sure why you say we didn't or maybe I misunderstand your question.

Tom Brandt

Are you sating the raise is about equal to the beep. [Wrong]

Barry Sine - Capstone Investments

Yes. Let me rephrase the question. Or is that a change in your thinking or is that more visibility or more color?

Tom Brandt

I guess, the best way to answer is, the change is that we see more in '09 than we saw three months ago. The last time we communicated formally to investor community, and that's because of the progress in the communication process among our company people, the channel partner, and the customer, as well as other customers.

Maurice Tose

As well as the growth that we saw of 169 billion messages in Q2.

Tom Brandt

To put it in another way, we know all the variables that we have to factor into these outlooks the range from overall volume, market share, and price. Those all get to still down when the targets erode, and we're cutting a deal; and we are progressing as we said during the [script to protocol] towards, a deal that would take us through the end of 2010. All of that is a very, very healthy development for us and the customer in the channel and that has given us a lot more clarity than we had three or four months ago.

Maurice Tose

Three or four months ago, it was on the radar screen, it had not approach to arrived a point that it has now.

Barry Sine - Capstone Investments

In terms of the competitive environment in that business, I think this is close to doing enough duopoly there, is there any relative change in the competitive environment that's causing your new comments?

Maurice Tose

Well, it's a duopoly in the sense that there are two vendors, but the relative share there is not balanced.

Barry Sine - Capstone Investments

I think in the past you were always you know wondering whether it might rebalance a little bit, but it sounds like you're getting a little more optimistic vis-à-vis your competitor, is that fair?

Tom Brandt

Yes, it is fair. Yes.

Operator

Our next question will come from the Mike Latimore of Northland Securities. Your line is now open.

Mike Latimore - Northland Securities

Just on SMS, a little bit more. Did you say the 89, 90 million includes the multiple customers, Tom.

Tom Brandt

I did. Multiple customers, multiple products and services.

Mike Latimore - Northland Securities

Got it. And did it assume, another Tier-1 customer win over that timeframe?

Tom Brandt

No. It's only a incumbent customers.

Mike Latimore - Northland Securities

It's only incumbent. Got it. Just I guess along those lines what's the prospects for another estimate sort of Tier-1 customer went next 12 months or so?

Maurice Tose

We're working it.

Mike Latimore - Northland Securities

Okay.

Tom Brandt

You think everybody has a stake in that, be it a success is very interested in getting there.

Mike Latimore - Northland Securities

Okay.

Tom Brandt

Well, it's a slow process but it's moving we think in a good healthy way.

Mike Latimore - Northland Securities

All right. And you said your guidance for the rest of the year includes the fair amount of pass through revenue on the government business. Are you assuming there is higher concentration of that revenue than say last time given guidance?

Maurice Tose

Yes I understand the question. With regard to the second half, the mix that we see in our outlook is considerably higher proportion of pass through in the second half than we had in the first half. First half we had really good average margins.

Mike Latimore - Northland Securities

Yes.

Tom Brandt

That among other things reflects a near absence of pass through business.

Mike Latimore - Northland Securities

Okay. And then I think in the last quarter you've talked about some opportunities in Canada 911. Can you give a update on, you know if you still want any deal there?

Maurice Tose

Well, it's still working. But the early prognosis is we are going to get some but not what we had hoped. I guess it's offset with the size of the Canada market, it's only about 36 million subscribers.

Operator

Our next question will come from Shyam Patil from Raymond James. Your line is now open.

Unidentified Analyst

Hey, guys this is David calling in for Shyam. You talked about your end of quarter cash balance in your credit line. I was just kind of wondering if you could tell us, if you can talk about a little bit about potential M&A areas?

Maurice Tose

Well I think we said on the last call, we are open across the company. All of the areas in which we play and that's, you know there are opportunities in the massaging arena, there are opportunities in location, there are opportunities in public safety, there is opportunities in the government SATCOM, opportunities in [syber]. And we are looking across the spectrum.

Unidentified Analyst

Okay thanks. And then may be just you could also talk a little bit about how you view the penetration for SwiftLink. And then how do you view the kind of the addressable market for that product?

Tom Brandt

I think the best way to think about that is the implications of achieving the program or record status that we mentioned that Maurice, described in the body of today's message. If you just look at SNAP and hitting three brigades out of a potential 35.

Maurice Tose

45

Tom Brandt

45, I am sorry.

Unidentified Analyst

And what was [hitting the] numbers?

Tom Brandt

That's one way of looking at the upside for that technology.

Maurice Tose

Just to give a little color. I mean, those numbers and the numbers of field in systems we have, they are a pretty good size number. We've not I guess done the extensive level of market share analysis there. But we look at the addressable market spaces there and potential new areas that open up for us. I mean the quad band. The air force requires that you have quad-band, do not pass go, do not collect $200 unless you have quad-band.

So in part, our efforts in quad-band have been to increase our penetration across DoD into areas that we've not done a lot here to-date. Our focus has been with the Marine Corps and with the army to a smaller extent DHS, and some federal non-DoD agencies. And now we're looking back in the DoD at the air force and what that portends.

The amount of SNAPS that we have fielded for brigade combat team again speaks to and the number of brigade combat teams that we've not addressed yet, speak to the potential that in fact is there. We're getting great kudos, we have one service to say across the service that they are number one priority across the entire service was bandwidth, and second place was WPPL. Oops, I guess that [contests with the service lessons].

But that's what we're hearing and seeing again, that we're in a good position with good contractual vehicles, good performance, a great end-to-end performance. Great end-to-end performance as we said from the systems, to the airtime, to 24/7, support with field service, reps on the ground, and continuing to improve the technology to meet currency as to what is going on in the industry have bode us well.

As well as what we've always done prior to our cell phone when we started the company and supporting special ops is a six employee company, has been we understand the mission and the demands of our customers. And fact that we just get it done. We can be relied upon to meet critical schedules. They may seem impossible to us leaning out over our tips when the government dollars aren't all the way to being on a PO to us but we see where it is in the system and we have comfort and where it is to go at risk. I mean, we just feel real good.

Operator

Our next question will come from side of Jim Kennedy from Marathon Capital. Your line is now open.

Jim Kennedy - Marathon Capital

Couple of questions kind of outside the 2009 and model timeframe. I want to look at 10, 11 and 12. And Maurice if my numbers are correct in ballpark terms you all probably collected or should collect somewhere in the neighborhood of $25 million to $30 million of your [passed] state. Once the Sybase thing is resolved and assuming it's resolved in your favor.

Can one assume that you would not be bringing in a full time person particularly with the pedigree this person has, you didn't think the opportunity going forward was larger than the ones that you have already dealt with?

Maurice Tose

Well, what we have done is we brought in a recognized name in the industry with a great depth and breadth of experience and we use outside assistance as is needed as bandwidth extenders. And we structure those relationships in a way that they minimize the cost outlay to the company. And where we are now is, we think we've got the right focus, which is a daily focus versus in the past it was a collateral duty shared across a number of people. It had been where we had planed to get to because we saw the value and see the value of our intellectual property. So right now we think we are probably going to be right sized and for the foreseeable future.

Tom Brandt

I think his question though is how much of a payoff we would expect. I mean, I'm trying to, I would be avoiding that, I know since you assigned it to me I think that that opportunity is very big. So, and the reaction of the guy we brought on board to what he has to work with is likewise very encouraging that.

Jim Kennedy - Marathon Capital

I have never known Maurice to avoid a question. So I mean …

Maurice Tose

Jim, I probably misunderstood it because …

Jim Kennedy - Marathon Capital

That's okay. I had known you to avoid a answer, but never a question.

Maurice Tose

I guess, yes, Tom is right. What I am saying here is that whatever the number happens to be today be it 20 million, 30 million or whatever, I am assuming that going forward and again, this is not '09 or 10 necessarily, but we view the opportunity as largely going forward than that which has passed to-date given the number of patents you have, the number of new wireless, I mean, new location, et cetera.

Maurice Tose

Yes. It is, yes, assuming that technology continues to accelerate as it has in the past. As again, as we currently say, [patents and a lesser property] are like fine wine, they got to mature, and that's where things are, but again our depth and breadth of intellectual property is very good.

Jim Kennedy - Marathon Capital

Lastly, your second question, but lastly, you made what I considered to be a pretty important announcement, it doesn't much discussion and that was a couple three months ago whatever you announced the new relationship, it was a very large Indian telecommunications company.

Tom Brandt

Carrier.

Jim Kennedy - Marathon Capital

It appeared to me that, that announcement framed up a relationship where they were almost relying on you, going forward, to provide many different services, potential platforms, applications, et cetera. Can you talk a little bit about that or are we still too early in that game? Because it appeared to me that that looked like a good way to view the future of what a total location-based services client might look like.

Maurice Tose

It's yes, but it's not just for India. I mean, part of what we've attempted to do by amassing the various parts of the ecosystem in location-based services with our platforms and services and offerings is to be able to provide a carrier a one-stop shop; if they so desire. It's not that they have to do the one-stop shop, but we can make life very easy for them with one throw to choke with a full mill deal. Not just in India, but in all of our addressable markets, that's what my mantra internally is to the Senior Execs responsible that I want to see. I want to see sooner rather than later that we use our full quiver to the benefit of the customers and to us.

Jim Kennedy - Marathon Capital

At this point is that relationship one that we should be watching to see how well indeed you can introduce and develop services?

Maurice Tose

Well, I'll say that one is early, and the things to takeaway from that is; one, we're in the Indian market, which is a huge market. We're there with a good carrier. We look to expand that with a number of other carriers. Likewise as we said, the number of Assisted GPS handsets in the market is what's going to drive the adoption. The handsets as it has always been is the long pole or the last pole in the tent.

Operator

It looks like our last question will come from the side of Jon Gruber from Gruber & McBaine Capital Management. Your line is open

Jon Gruber - Gruber & McBaine Capital Management

A question on the SMS number, the 80 million to 90 million which is over three halves, yet you said if I heard you correctly, the first half was 28 million, three times 28 million is the range, so that means there is no growth in this business or am I reading it wrong?

Tom Brandt

What you are reading is that from the encumbered customers as we sit here in July '09, we don't expect to go down.

Maurice Tose

There is pricing pressure. It's mature.

Tom Brandt

The nature of the [beast here] is that we're selling technology to wireless carriers who are, whose businesses lay in license to be an 800 pound Gorilla, so that it's deliverable, it's successful, they expect price concessions. We didn't know a few months ago was our pricing would come out to the extent to which another, their alternative vendor in the network might potentially or adversely impact our outlook as we speak today. We are relatively bullish with regard to that and then we don't expect a backsliding. There is upside those with regard to the encumbered customers and new customers with regard to that product line, that's the message we're trying to share.

Maurice Tose

It's a product line with products and services that continue to grow. As we speak to the usage is increasing. Again, is this is all technology, as technology continues to mature there are pricing pressures that are imparted. For us, it's a nice thing for us to be able to speak to and to put out there what it is that we are in fact seeing. It could be that the message volume growth is going to continue to increase, which is what it is going to do, I mean, that's what we have been projecting, but there is price pressure that you would have in a marketplace. Now the carriers are doing great by SMS. I mean, it's probably, it's joined the number one data service or most probable data service that they have, so they look for it quite often to cure other ills.

Jon Gruber - Gruber & McBaine Capital Management

This is the base of your current guys, and then you're going to layer on hopefully new customers and new services, and is that right?

Tom Brandt

That's right. From this dimension of our business which is very important and that it reflects the maturation of technology investments made a decade ago. We are telling you, what we see is that we're not going to go backwards between now and the end of 2010. We've got lot of growth from the other aspects of the company. We've made investments around LBS at their earlier stage then that SMS as far as market adoption, not too much in the public safety and the government [allowance] of the company. As a foundation for our view towards profitability and revenue, what we're trying to share is that we don't see more backwards with regard to the part of the company that generate a lot of profit in the first half of 2000.

Maurice Tose

Beyond broadening it, is that you know most companies look to be one, two or three in their market. What we've been speaking to or sharing today is the fact that if you look across our market segments, most of them, we are there. I guess, we were the one that probably not as government IT, there is huge government IT companies out there, but if you look at SATCOM and or VSAT; SATCOM, you know we're probably there right along with our SMS and our location-based services positioning, which is generally where you want to be. More macro-wise, I mean, we are growing during a global recession. We are growing not only top line, but we are growing EBITDA as bottom line. Ex-one-time non-cash events or tax events, so the future looks very good here, and we're are trying to sway as on the call, driven by the number of questions we've had regarding SMS, try to give you as much insight into it as well as rest of the business that we can.

Operator

It appears we have no further questions at this time.

Maurice Tose

Well, thank you and this concludes our Second Quarter Investor Call and we look forward to speaking with you again to discuss our Q3 results.

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Source: TeleCommunication Systems Inc. Q2 2009 Earnings Call Transcript
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