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SuperCom Limited (NASDAQ:SPCB)

Q1 2014 Earnings Conference Call

June 10, 2014 10:00 AM ET

Executives

Kenny Green - GK Investor & Public Relations

Arie Trabelsi - President and CEO

Doron Ilan - CFO

Ordan Trabelsi - President of U.S. Operations

Analysts

George Melas - MKH Management

Operator

Ladies and gentlemen thank you for standing by. Welcome to SuperCom’s First Quarter 2014 Results Conference Call. All participants are present in listen-only mode. Following management’s formal presentation instructions will be given for the question-and-answer session. As a reminder this conference is being recorded. You should have all received by now the Company’s press release. If you have not received it, please contact SuperCom’s Investor Relations team at GK Investor Relations or review it in the news section of the Company’s Web site www.supercom.com.

I would now like to hand the call over the call to Mr. Kenny Green of GK Investor Relations. Mr. Green, would you like to begin please?

Kenny Green

Thank you, Operator. Welcome everyone to SuperCom’s conference call to discuss its first quarter 2014 results.

I would like to welcome all of you to the conference call and I’d like to thank SuperCom’s management for hosting this call. You should have all received by now the Company’s press release. If you have not received it you can find it on SuperCom’s Web site. In addition, if you would like to be added to SuperCom’s mailing list, please contact us.

With us on the line today are Mr. Arie Trabelsi, President and CEO; Doron Ilan, CFO; and Ordan Trabelsi, President, North America.

Ordan will first provide a brief discussion of the performance of the business in the quarter followed by Doron who will discuss the results. We will then open the call for the question-and-answer session, where Arie, Doron and Ordan will be available to answer your questions. Before we start, I’d like to point out that this conference call may contain projections or other forward-looking statements regarding future events or the future performance of the Company.

These statements are only predictions and SuperCom cannot guarantee that they will in fact occur. SuperCom does not assume any obligation to update that information. Actual events or results may differ materially from those projected, including as a result of changing market trends, reduced demand and the competitive nature of the security systems industry, as well as other risks identified in the documents filed by the Company with the Securities and Exchange Commission.

In addition following the Company’s disclosure of certain non-GAAP financial measures in yesterday’s earnings release, such non-GAAP financial measures will be discussed during this call. Such non-GAAP measures are used by management to make strategic decisions, forecast future results and evaluate the Company’s current performance. Management believes that the presentation of these non-GAAP financial measures are useful for investor’s understanding and assessment of the Company’s ongoing core operations and prospects for the future. Unless otherwise stated it should be assumed that the financials discussed in this conference call will be on a non-GAAP basis.

A full reconciliation of non-GAAP to GAAP financial measures were included in yesterday’s earnings release.

And with that, I would now like to hand the call over to Ordan Trabelsi. Ordan please go ahead.

Ordan Trabelsi

Thank you, Kenny. I would like to welcome all of you and thank you for joining us today. We’re very excited with the results of the first quarter of 2014, our first as a combined company with our recently acquired Smart ID division. For some time now we have felt really good with this acquisition as we saw both teams merge and work together seamlessly to achieve fast and effective results, with our technologies, operations, existing customers and new projects.

Now we’re happy to be able to demonstrate this with numbers, which has surpassed our expectations. And this happened very fast. Within only one quarter operating as a joint entity, we not only strengthened our relationships with current and new customers represented by several new orders, but also started realizing significant synergies with very high growth and operating margins. We achieved an EBITDA margin of 33%, higher than we expected to achieve so early on, our EBITDA number of $1.8 million is at a rate faster than the 2013 pro forma half year numbers, which was $3.1 million EBITDA for the first two quarters of 2013.

This also means that already in the first quarter of operating as a unified company, we have successfully been able to bring the Smart ID division’s profitability up to SuperCom’s level, a level which took us several years to reach since the launch of our corporate restructuring in 2010. It very much demonstrated the significant cost synergies of our recent acquisitions and our capability to quickly turn a loss making business in 2013 at OTI into a profitable one at SuperCom. This is a significant and important capability of our team.

We expect to be able to maintain an average strong margin profile throughout this year, but keep in mind that as new contracts come into play there will be temporary shifts in growth and operating margin. With regard to the revenues, we do know that looking at SuperCom historically our first quarter is seasonally the weakest of the year. We do not expect 2014 to be any different and we look forward to strong growth in revenue from this point during the remainder of the year.

Our revenues in the quarter were primarily recurring revenues from our EID activities. Beyond these recurring revenues, we expect to see revenue growth this year coming from some recent contracts that we have won. Since the beginning of 2014, we announced three contract wins. In February we announced a $4 million order from existing customers, deliverable in the first half of 2014. In March we announced a $25 million in contracts with new government customers. With the majority of this revenue to be recognized in the second quarter, third and fourth quarter of 2014. I will add some more color at this point.

This represents twp applications with a new government customer who has a demand to deploy a whole array of new applications for their government many of which will rely on the same infrastructure from these two first applications. We are adding optimal point given our initial and hence expect more projects from the same customer in the near future. Furthermore as with any typical new EID project around 20 of the 30% of the initial bid is recurring and generate revenues from 5 to 10 even more years to come.

In April, we announced two further contracts from the existing customers amounting $3.6 million, which is deliverable in second half of the year. Putting this all together combined with a term base of $5.3 million of mostly recurring revenue, we expect strong revenues in 2014 with strong growth in the next three quarters. We believe our recent momentum has started to demonstrate the potential of our fast and growing pipeline of EID bids in many countries around the world. We have seen in the past that one these bids turned into contract that it leads to continued and ongoing revenue as well as further orders from the same customer. They’re deploying new bids almost every month and are continuing to actively pursue a rich and extensive pipeline of bids, proposals and leads, and we expect to receive new orders in 2014 more of them. I’ll note that all these contracts are in the multimillion dollar per year range, so even the win of one contract will have significant impact on our results.

In summary, the merger with OTI Smart ID division is going great, pushing SuperCom even further as a strong successful and growing business with significant potential, much of which is still yet to be unleashed. We are well on the road to becoming a key player in our target EID and M2M markets where we can leverage our rich and broad range of technologies and solutions. We have a vast breadth of EID capabilities globally, outstanding market and technology experts, and strong customer relationships, and looks forward to continuing our performance throughout 2014 and beyond.

I would now like to hand the call over to Doron Ilan, our CFO, for a financial summary, Doron?

Doron Ilan

Thank you, Ordan. I will now walk you through our financial results for the first quarter of 2014, compared year-over-year with the third quarter of 2013, and after that we will be happy to take your questions.

Revenues for the first quarter of 2014 were $5.3 million way ahead of the 2 million reported in the first quarter of 2013. I will be presenting the reset of the financial results on a non-GAAP basis which exclude the non-cash income tax benefit we had in 2013 as well as amortization of software and IP and customer contracts to intangible assets, which were created the result of the acquisition of the Smart ID division in December 2013.

For the full consideration from GAAP to non-GAAP numbers, you can refer to the press release we issued yesterday. Our gross margin in the third quarter of 2014 was 84% similar to the 85% we had in the third quarter of last year. Operating income in the first quarter of 2014 was $1.8 million or 33% of revenues compared to $653,000 or 32% last year. During the coming quarter, we did not recognize an addition of tax asset. However, we still have remaining NOLs and June the coming quarter we will be reevaluating our profitability expectations and we do expect that during the course of 2014 we will be adding to realize further tax benefit.

Net income was $1.7 million compared with $0.6 million year. Earnings per share were $0.13 versus $0.07 last year. EBITDA for the quarter was $1.8 million compared to $0.7 million last year, and compared with 2013 pro forma our current EBITDA run rate is ahead of that of last year. And on the balance side, working capital at the end of the first quarter of 2014 was $5.5 million versus $4 million at the end of 2013. Shareholders’ equity increased to $20.7 million at the end of the first quarter up from the $19.4 million at the end of last year.

With that I conclude my remarks, and we would now be happy to take your questions, operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question Jim Brian [indiscernible]. Please go ahead.

Unidentified Analyst

Yes. Congratulations on the first quarter of combined entity after the acquisition. I wanted to ask a little bit about the pipeline obviously you’ve released some big contracts already this year. I know you mentioned you’ve got a strong pipeline in the works, can you give any additional color or context as to the number of potential contracts in that pipeline the size of those potential contracts how smaller how big they can get?

Doron Ilan

Okay. Thank you, Brian. And in general we cannot give you too much detail here, but we have, actually we have 10 different proposals and the size that I think going from I don’t know $3 million to $15 million in different stages. What we see is that out of the bid in a position that we will confirm for Smart ID division together with [indiscernible] with SuperCom we are right now sound contract with some proposals, that was very close to point forward, we hope we’d be awarded. And but we feel very good because the number of our proposals will increase, a number of proposals we have been putting out there is increasing every month.

Arie Trabelsi

I want to just talk, I want to thanks the Swedish [indiscernible] on a daily basis, a total bid size can reach up to $200 million in the terms that we’re interested in looking like in our target markets.

Unidentified Analyst

Great. That’s very helpful. And I know you -- that hopes with the OTI acquisition that it would strengthen your positioning in these bids are you finding that starting to happen?

Arie Trabelsi

Yes. I think that were cases that OTI is only be doing [indiscernible] so because of the past OTI was the tougher competitor in these kind of deals, I think both seems together work from experienced [indiscernible] and as the platform filling our position, we feel that our, for bids assuming, bids right now increased almost by 200%, if we compare it to SuperCom as a fellow company.

Unidentified Analyst

Great. You also mentioned that you’re beginning to realize the synergies of the deal faster than expected. I think you also mentioned that the margins into this contract improved overtime. Can you give us any additional contest on how you expect margins to change, improve or otherwise in the coming quarters and use that?

Arie Trabelsi

I think that we’re just seeing this quarter we came very close to the gross profit, if you take the non-GAAP number for gross profit we are now 85%, 84% which is very close. In this case, it was easier because we took the context as with the people and it’s easy for us just to implement [indiscernible]. In the sales and marketing, we believe that we have some more, close to user like we optimize our network of sales and marketing. And our G&A as well, we note that a lot, of course, or expense into G&A factors will be in so we believe that some of certain margin the number we deferred like them, we lead that 36%, is that we -- it’s fairly very high. We knew that we’d be able to [indiscernible] with the increase to even 35% that they made this quarter especially in quarters we have a large quarter to come in. As a set up that it’s going to be, go down to around 50%. So we believe that the margin that we expected in our plan to reach in the third quarter, we are reaching first quarter. So it was very accurate because of the synergies can fast flow and we will continue to and we announced on the first quarter as well.

Unidentified Analyst

Great. Thank you. We’ll step back in the queue.

Kenny Green

Thanks, Brian.

Operator

The next question from Debra Fiakas of Crystal. Please go ahead.

Unidentified Analyst

Yes. This is [indiscernible] with Crystal Equity Research. Thank you for taking my questions. Could you, if you mentioned this during your opening remarks, I apologize I did not hear what your cash flow from operations was, if you could repeat that please?

Arie Trabelsi

Actually, we did not mention cash flow calculations for this quarter.

Unidentified Analyst

Were you be reporting that ultimately or?

Arie Trabelsi

No, we did not report this on -- the next quarter we will report it.

Unidentified Analyst

Okay. Just for the half?

Arie Trabelsi

Yes.

Unidentified Analyst

Okay. And then also the amortization of your intangibles that you listed in your EBITDA calculation, are those spread out across both up cost and sales as well as operating cost or they are exclusively considered among operating costs?

Arie Trabelsi

No $150,000 of in corporate revenue and the other $240,000 barrels under selling and marketing expenses.

Unidentified Analyst

Alright, very good, from your opening remark, as well as the answers to your previous questions, it sounds like you’re well, on your way to integrating the OTI operation into the parent, do you anticipate any additional costs related to bringing OTI into the full so to speak?

Arie Trabelsi

We did not expect any additional for this there are some shift, of course, that went into the second quarter that we believe that by today we are almost there, we don’t expect any additional cost from the OTI position.

Unidentified Analyst

Okay, and then my last question is in just in regard to your sales and marketing efforts, do you anticipate adding new people or are you satisfied with the your current staffing and strategy for promoting and selling your product.

Arie Trabelsi

And as a organization we always try to have the best people in our organization so we’re trying to have better people and also sales and marketing and all the other divisions but if we look at the emerge organization I frankly believe that we have almost an optimal mix of people both sales and marketing in reality and in the other division, we are [indiscernible] and the number of employees are representing some other countries that we don’t have the right presence right now but in general the way that our cost of structure is built when we get the new contract we just add more people that associate with the contract. You’ll see more changes in cost of goods but we do not expect any additional expenses for cost of G&A, sales and marketing in general will be increased in accordance to the revenue especially where people are getting commission out of sales.

Unidentified Analyst

I see okay, thank you, that was very helpful thank you.

Arie Trabelsi

Thank you.

Operator

The next question to [indiscernible] with [indiscernible] Capital. Please go ahead.

Unidentified Analyst

Hi, congratulations on all your success. The question I had for you was during your prepared remarks I think it was Ordan that was speaking. You were talking about follow on orders that you expected from the $25 million acquisition, $25 million contract you start talking about something over five to ten years and you tried a 20%-30% figure, could you just slowly explain that again?

Arie Trabelsi

Sure, basically with this we brought on a new government customer that have demands for several EID projects that could come into, it could be ID cards, voter systems, or ticketing, many different applications for an EID platform, most of them rely on the same infrastructure that database and registration and we’ve already been selected for the first two projects, I mean that our database, that our technology will be there at the platform. That’s why it’s a natural assumption that the government will continue to work with us for many of the other applications if not all of them. Many of these applications rely on the same infrastructure and hence we hope to win the besides that 25 million announced more projects from the specific customer.

Now regarding five, 10 and more years we’re just in a typical EID bid, the first duration of the bid could be around four to five years and out of the bid size that is announced run 20%-30% of that is the referred element which usually continues throughout all those first five years, that will proceed to 10 and even 19 years as we have seen with some of our other contracts.

Unidentified Analyst

Okay, as you were saying, so of the 25 million you’re saying that there is a recurrent 20%-30%, there’ll be an additional recurrent element of 20%-30% from the 25 million over say five years and in addition you’re expecting additional contract rewards as a result of the initial 25 million am I understanding that correctly?

Arie Trabelsi

Yes, just to clarify, out of the 25 million there’s 20%-30% of that which will be recurrent and continue to recur annually for the next years, and that beyond the fact of actually deploying more systems which can be of larger size and have both recurrent and non-recurrent elements to them.

Unidentified Analyst

Okay, and if you work for an additional sizeable contract after the $25 million award, typically how soon thereafter would you expect to win such a contract. The term contracts is the wrong word, but get an award?

Arie Trabelsi

[Indiscernible] I am if you are asking when we expect to renew, we don’t really know but it can be in the next week of in the next month we are expecting some decision from government of Israel as a stage of last decision so it can be as I said next month or in a week or two months, it depend on fast the government makes their decision. The revenue from that will be in most cases will be recognized almost immediately because we are prepared to work on this contract [indiscernible] like there were.

Unidentified Analyst

Got it. Okay, thank you very much.

Arie Trabelsi

Thank you.

Operator

The next question from David [indiscernible] Capital Partners, please go ahead.

Unidentified Analyst

Hi, thanks for taking the question and congrats on a good quarter and good to hear the integration is going well I just had three quick questions. So just to get back to the recurrent portion of the 25 or the potential recurring portion of the 25 million order, so if the 20% to 30% of that will be 5 million to 7 million recurring, would you expect the margins on that revenue to be in line with your company average, or would you expect it to be lower or higher, that’s number one, number two was your R&D?

Ordan Trabelsi

Do you mind if we answer them per question?

Unidentified Analyst

No that’s fine.

Ordan Trabelsi

To answer the question, our current margins represent a mix, naturally the recurring elements of the contract are higher margins and some elements of the recurring revenues are higher and some are lower, but in general the recurring elements are higher than new projects which many times include installations and resetting of machinery and other hardware, but the mix right now as you see, our margins consist a big part the majority of was recurring revenues and some was non-recurring. So to answer your question, yes the recurring revenue should be a bit higher in margin than the average that you see for the company.

Unidentified Analyst

Okay, terrific. And then the second question was the research and development expense in this quarter looks like it was a lot higher than in previous quarters. I wanted to know is this the right level going forward or is it associated with specific projects that you could talk about?

Arie Trabelsi

As we said this is associated with certain projects, actually a large portion of the expenses that you see in the first quarter are expenses that were capitalized last year, we expect certain projects to be won and since these projects were won during the first quarter, we expense them during this quarter. So this will not represent the regular level that you should be looking forward.

Ordan Trabelsi

The regular level should be around 0.5 million a quarter.

Unidentified Analyst

I am sorry, I didn’t hear that. What was the number?

Ordan Trabelsi

The number should be 0.5 million third quarter.

Unidentified Analyst

Okay, perfect. The last question was on the ongoing capital expenditures for the business, what do you think an appropriate level of CapEx is to maintain your Houston business?

Ordan Trabelsi

We continue to be very low for a minimal nothing material that affects the balance sheet or the cash flow.

Unidentified Analyst

Okay, terrific. That was all I had. Thank you very much and congratulations.

Operator

(Operator Instructions) Next question is from George Melas from MKH Management. Please go ahead.

George Melas - MKH Management

Thank you very much, congratulations on a great first quarter. Can you give us a little bit more color on the revenue the 5.3, what portion of that was revenue and maybe if there were different segments of the business that you can highlight?

Ordan Trabelsi

At this point we have not broken down exact revenues of the quarter but it’s similar to our general business 68% of it seems to be recurring and some elements are not. We haven’t given a specific breakdown, but it is currently in the typical business that we were and now 95% of which is usually EID and 5% in the M2M division.

George Melas - MKH Management

Okay, great. And quick question on the 25 million project that you -- there were several questions. Would that be the largest project and the largest potential project with additional applications that you or OTI has ever handled? And are you well structured and staffed to deliver on that?

Ordan Trabelsi

First of all I think that OTI is not a division as contract we decided $50 million, we believe the discount of course or can increase or extend to over $50 million in the future if we get more application. And we have some other proposal that is slight higher than that, and we don’t have a capacity problem to service this certain project. It’s very much in line with the things that we have done in the past and our track record shows, and as it grows more and more we still have a lot of capacity to handle without growing our cost structure.

George Melas - MKH Management

Okay great thank you very much, and congratulations again.

Ordan Trabelsi

Thank you.

Operator

The next question is from Brian Evans of Rogers. Please go ahead.

Unidentified Analyst

One last question Ordan you mentioned the M2M division. I am wondering if you can just elaborate a little bit on the initiatives there and your outlook for that side of the business going forward?

Ordan Trabelsi

Sure, on this specific earnings call we have spoken less on M2M division, because lot of -- what we want to show is the performance of the merger with the Smart ID division, which is part of our EID division of the company. In the M2M space we have generally had a bit of transformative business strategies, we went from component to actual solutions and this has happened over the past year to 1.5 years and now our competitive propitiatory technology in the M2M space is being united together with our capability to offer amazing solutions to customers. We have already served over 3,500 customers in the past with the technology alone and now we’re able to offer new capabilities which haven’t been seen before by just a software or a hardware providers on its own by some of who does both in together and that includes chips which can last a very long time, in terms of battery life has very long range and at a lower cost. It still has unique capability such as communicating with mobile phones and people identities to offer a whole variety of different applications and offerings in the general a lot of things and space.

We have already started launching pilots of these new solutions with large customers in the United States and other countries around the world. And soon we actually hope to announce and show our capabilities and conferences in the upcoming remainder of the year. This general division the M2M space has potential for very high growth in general market might 2019 even with the same project to be able to $300 billion for these types of services. We hope to address the certain part of that and on different presentations you could see more or less but we’re excited about that as well and hope to see that take a big part of our general revenue base within the next year.

Unidentified Analyst

Great, congratulations again on the quarter. Thanks.

Ordan Trabelsi

Thanks.

Operator

The next question comes from [indiscernible] from HS. Please go ahead.

Unidentified Analyst

Good morning or afternoon, you talked about a number 200 million. I didn’t hear here what that number was, how was that meant could you explain that again?

Ordan Trabelsi

Yes, I will elaborate. Just in the past [indiscernible] elaborate that the general EID market could be around $12 billion a year in revenues. We look at a segment which is a bit smaller it’s around 10% of the general market and that’s with developing countries and bid up to $200 million. So most of the bids that we bid on are between $10 million and $200 million usually totaled over the course of four to five years coming to a number up around $50 billion a year in the largest all type of bids that we look at in revenues.

Unidentified Analyst

Do you have an average time period of starting a bit to awarding of contract?

Ordan Trabelsi

In general, it can be 6 to 18 months. It depends on the type of process. As we said, it can be up to 18 months in some cases also longer.

Arie Trabelsi

It is that we have already an existing customer [indiscernible] additional applications, it can be an immediate thing because in charge the regular kind of process.

Unidentified Analyst

Okay thank you.

Arie Trabelsi

Thanks.

Operator

There are no further questions at this time. Before I ask Mr. Trabelsi to go ahead with this closing statement, I would like to remind participants that a replay of this call will be available on three hours on SuperCom’s Web site www.supercom.com. Mr. Trabelsi would like to make your concluding statement.

Arie Trabelsi

Thank you. On behalf of the management of SuperCom, I would like thank you all for joining us today. I look forward to seeing you on the next when we discuss our second quarter results in about two months time. Have a good day.

Operator

Thank you. This concludes the SuperCom Limited first quarter 2014 results conference call. Thank you for your participation. You may go ahead and disconnect.

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