TeleCommunication Systems, Inc. Q2 2008 Earnings Call Transcript

TeleCommunication Systems, Inc. (NASDAQ:TSYS)

Q2 2008 Earnings Call

July 31, 2008 5:00 pm ET

Executives

Maurice B. Tose’ – President, Chairman and CEO

Bruce White – General Counsel

Thomas M. Brandt, Jr. – Chief Financial Officer and Senior Vice President

Analysts

[Baroon Shadof] – Raymond James & Associates, Inc.

Scott P. Sutherland – Wedbush Morgan Securities Inc.

James G. Kennedy – Marathon Capital Management

[Jason Stankowski] – Castle

[Jeffrey Myers] – Cobia Capital

Greg Weaver – Invicta Capital

Shane Kim – Camden Partners

Operator

Welcome to today’s TeleCommunication Systems second quarter 2008 teleconference. (Operator Instructions) I would now like to turn the call over to Maurice Tose’.

Maurice B. Tose’

With me today is Tom Brandt, our Chief Financial Officer and Bruce White, our general counsel. Before we present our formal comments, I will ask Bruce to advise listeners to the cautions that they should consider during this call. And following our presentation we’ll open the lines for Q&A. Bruce.

Bruce White

Some statements you will 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 beliefs, expects or anticipates and you should listen to these statements with the knowledge that actual results may differ materially from these forward-looking statements. The risk factors that could cause the results to differ may be found in our SEC filings including Forms 10-K and 10-Q. We encourage all investors to read these documents.

Also during this 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 B. Tose’

Today our second quarter earnings release crossed the wire service at about 4:15 today and a full text copy of our press release has been distributed via email and is also available on our website. We have also updated the financial model that puts the company’s financial information into perspective and is available for download from the investor information section of our website.

As indicated in our news release, net income for the second quarter was $12 million on $44 million of revenue and $15 million of EBITDA, all representing record operating results for the company. It was the ninth GAAP profitable quarter of our past ten.

Our second quarter benefited from the sale of a wireless email patent yielding more than $8 million, illustrating the value of our large and growing portfolio of wireless communications technology patents. Even without the sale, our second quarter was the second most profitable quarter in the company’s history, second only to this year’s first quarter leading to increased confidence in the company’s prospects for continuing profitable growth.

First, the continuing explosive growth in text messaging usage in the U.S. is driving sales of software licenses, maintenance and customization. Second, our recurring hosted location based services for cellular E9-1-1 is serving better margins while we continue to invest for growth in the emerging Voice over IP or VoIP market and location based applications beyond public safety. And third, our government business, in addition to delivering improving margins was recently awarded a contract valued at up to $246 million over the next 39 months.

Also I’m pleased to note that TCS was added to the Russell 2000 Index when Russell Investments reconstituted its comprehensive set of U.S. and global equity indexes last month. Now some highlights from this quarter’s operations.

Second quarter commercial segment revenue was $25.6 million yielding gross profit of $14.9 million or 58% of revenue, which is more than double the gross profit in the second quarter last year. The improved results reflect strong and continuing growth in our text messaging business through sales of licenses for increased capacity to new and existing customers and continuing growth in software maintenance revenue. In 2007 TCS software delivered approximately 80,000,000,000 text messages, which was more than double the year before. We are currently on track to double in 2008 the volume of messages handled last year.

During the second quarter we continued to expand our market penetration in North American operators with capacity growth sales to two existing customers as well as the sales of both SMS Express and the Wireless Intelligent Gateway to a third U.S. CDMA carrier customer. Looking at market indicators for text messaging, in the U.S. market Frost and Sullivan reported in June that SMS traffic is expected to increase 73% in 2009 and grow at an average compound annual growth rate of over 45% over the next five years. Further, they specifically forecast that in order to handle this volume growth North American carrier spending on short message service inner platforms and maintenance will increase from about $175 million per year in 2007 to more than $275 million in 2012.

Webbush Morgan analysts reported an aggregate of 160% year-over-year growth in text messaging at Verizon, AT&T and T-Mobile during the first quarter of 2008. Their report goes on to say that they believe that there are at least two to three more years of solid growth ahead in the U.S. market for SMS. And in a recent report from Amplitude Research, buyers of new cell phones say that the most important feature on their phones was in fact text messaging, cited by 73% of respondents.

Under our company’s business model, licenses for the cumulative growth produced sustained and growing maintenance revenue on the growing base. The continued popularity of text messaging creates new opportunities to protect the privacy and experience of the subscriber. Industry reports indicate that some carriers receive as much as 200,000,000 unsolicited messages each month. In our most recent SMSC software release, TCS developed a parental control feature.

This feature allows carriers to offer their subscribers the ability to establish text messaging usage limits for members of a family plan based on volume as well as hour of the day. We’ve also seen the number of users on TCS deployed messaging portals increase to over 40,000,000 provision subscribers. There’s an emerging TCS opportunity in the FCC Commercial Mobile Alert System or CMAS. CMAS is a federally sponsored technology for enabling emergency text alerts to wireless subscribers when risks of weather, earthquake or military dangers are high. TCS continues to participate in the standards bodies working group activities for CMAS.

Carriers are currently expected to formally notify the FCC of their plans to support CMAS by September of 2008. It is expected that most carriers will support the CMAS initiative. During the second quarter FEMA, the Federal Emergency Management Agency, was designated as the lead federal alerts aggregator. With our company’s strength as a leader in E9-1-1 combined with our experience in secure government communications solutions and delivering billions of text messaging daily, we believe that TCS is uniquely qualified to work with the government and wireless operators to make CMAS a success.

Moving on to the location based services arena, during the second quarter Tier 2 carrier PCS selected TCS to provide E9-1-1 service to its new major northeastern U.S. markets which include Boston, New York City and Philadelphia. We also signed two new Tier 3 wireless carriers to five year 9-1-1 contracts. Six existing Tier 3 wireless carriers extended contracts and discussions are progressing on schedule for the renewal of one of our Tier 1 wireless carrier 9-1-1 contracts.

Also, TCS began a service for a Tier 1 cable operator employing TCS’s [Match a Street Address Guide] validation service in support of their VoIP customers. This service received a product of the year award from Technology Marketing Corporation, our third award to date for this offer. TCS also deployed 9-1-1 services for provider of enterprise VoIP automatic location detection systems in a multi-campus environment. Several states now require such location capability for

enterprise communication systems and as a result TCS has enhanced our VoIP 9-1-1 service to address this requirement.

TCS also has joined the European Emergency Number Association (EENA) new advisory board which will reinforce the advocacy organization’s leading role as the voice of 1-1-2 in the European Union or EU. TCS is the only EENA 9-1-1 service provider among an elite group of major political association and industry leaders invited to join the EENA advisory board.

Last week, the president signed into law the New and Emerging Technologies 9-1-1 Improvement Act of 2008. This bill will now provide the much awaited liability protection for VoIP service providers and their vendors. Beyond public safety based location services, we recently announced the completion of an agreement through our Qualcomm partner to provide hosted location services to Tata in India. This exciting development allows us to expand into the huge India market opportunity. We are expecting deployment to be completed by the end of this year.

Including the Tata deal, TCS has signed five new carrier customers using our Xypoint Location Platform during the first half of 2008, bringing our non-public safety customer count to 14. And we have four pending deals that we expect to close in 2008 to reach our stated goal of eight to ten new LBS customers this year.

A recent study by ABI Research reports that TCS is the second largest vendor of LBS infrastructure in the world and that the total LBS infrastructure market will grow to $2.2 billion in 2013. ABI also forecasted that more than 550,000,000 GPS enabled handsets will be shipped by 2012. Nokia, the world’s largest handset manufacturer currently has 12 handset models with built-in GPS and plans to ship 35,000,000 this year.

During the second quarter TCS’s connected navigation product gained traction in the telematics industry. Connected navigation means evolution beyond early in-vehicle systems which rely on digital disks of map data which are prone to becoming obsolete to systems which take advantage of wireless connectivity either via cellular or WiFi technology. We continue to expand our scope of work in deliverables, especially within [Binso], as a result of our unique combination of connected navigation technology, public safety E9-1-1 solutions and experience with electronic map data for the telematics market.

We also renewed and expanded relationships with dynamic content suppliers including Inirix, Traffic.com from NAVTEQ and Traffic Cast. The integration of these content feeds continues to improve the coverage and quality of data available to both our traffic and navigation application customers.

TCS launched a precise location enabled version of Rand McNally StreetFinder on Alltel’s network during the quarter. This application automatically locates the subscriber using the TCS LBS server that was deployed in Alltel’s network last year. This illustrates how our company can benefit from our unique ability to offer a complete LBS solution including applications. While Rand McNally StreetFinder is a subscription based product, meaning that consumers pay a monthly fee to use the product we see advertising revenue playing a larger role in LBS applications moving forward.

TCS is aggressively pursuing both subscription base and advertising base revenue models. We launched an ad supported traffic application on Verizon Wireless during the quarter and expect to follow this with other ad supported launches in the coming quarter.

Moving on to review of our patent activity, during the second quarter we sold a mobile email patent that was involved in the infringement lawsuit we filed against REM in December, 2007. As a result of the patent sale the lawsuit has been dropped. Net proceeds to TCS after legal fees and expenses were $8.1 million.

TCS was issued two new patents in the second quarter, bringing the total number of our patents to 58 with 194 applications pending. The first patent awarded this quarter was a system patent for an open architecture development program with centralized synchronization. The second patent received this quarter describes a method for mobile to web communications. This invention allows a wireless user to send a short message to a pre-defined address and to receive a return message.

This patent provides the basis for wireless users to participate in text message marketing and voting campaigns such as those utilized by popular television contest shows, and to search for local information through text messages, such as SMS 4-1-1 services, on demand poll services and popular mobile local search services. TCS continues with our efforts to enforce and license our patents. Post trial motions remain pending in the inter carrier messaging patent lawsuit against Sybase, which led to a May, 2007 jury award of more than $10 million.

And now we turn to the government solutions group performance. The gross profit earned from government customers in the second quarter of 2008 was $4.3 million, which is an impressive 23% increase over the second quarter of 2007. While revenue for the quarter of $18.3 million was down 6% from the same year ago quarter, the average gross margin percent was 23 which is an improvement of 18% last year.

The margins on the most recent quarter’s system shipments were higher due to an improved revenue mix and progress in obtaining lower average system component and assembly integration costs. With a healthy backlog of funded orders and a robust pipeline of high probability opportunities, we are confident of the government’s group’s contribution to 2008 and 2009 results.

Customers have confirmed that significant funding is in place for near term SwiftLink systems orders and additional wireless point-to-point link systems. Further, in early July we were awarded a three year contract to provide up to 1,500 SwiftLink systems and their related support equipment, maintenance and support staff with a ceiling value or $246 million. We have visibility of near term fund it requirements of nearly 120 systems and associated services.

Our government systems business has never been busier than it is today and has a brighter outlook than ever before. In Q2 we delivered over $7.3 million in systems under 17 different contracts from our new state of the art integration facility in Tampa. We added critical engineering assets and workforce in response to new customer requirements and were able to make all deliveries on or ahead of schedule. The new levels of efficiency gained from assembling and testing in our new facility combined with cost savings measures and buying power achieved by increased volume were the main contributors to improved gross margins.

In parallel, with our production improvement efforts our engineers developed three new SwiftLink products and designed a wide array of VSAT Terminals and base band equipment in support of the Army. One of the most notable achievements is the [SwiftLink Stingray], a platform that will provide higher data throughputs in our smallest form factor to date. We are excited about the markets that this new technology opens up for our government systems business.

Our latest SwiftLink offering of three basic Satcom terminals, coupled with three base band kit variance and three upgrade kits permitting use of KU, KA and X-band frequencies provides 34 variations of communications packages that are completely interchangeable and plug-n-play for the user. We believe that this level of tailoring to accommodate challenging communications missions is unparalleled in the industry today.

Our government systems business is having a banner year as well. In this quarter we received a sizable long term contract to provide band widths services in support of morale, welfare and health activities for deployed war fighters. This service allows these war fighters to have broadband internet access for personal use, such as sending email to their friends and family, making Voice-over-Internet phone calls back home and even viewing their wives and children via video teleconferencing. We are proud to have been selected to provide this service to our forces overseas.

The proliferation of SwiftLink’s systems throughout DOD has fueled demand for a growing number of TCS field service representatives deployed side by side with our customers to provide training, support and field repair of our equipment. For our professional services group, we received ceiling increases and contract extensions of nearly $9 million to accommodate increases of TCS staff for two of our long term key DOD accounts. A new engagement at the Office of the Secretary of the Army has allowed us to staff 13 highly skilled consultants in support of our continuity of operations planning service.

We also began staffing TCS engineers and management consultants for IT governance work and to the Department of Homeland Security Chief Information Office as part of a five year contract to provide program management services to DHS IT operations. Overall we now expect revenue from professional government services to grow from the $5 million a quarter over the last two years to more than $8 million a quarter beginning with the current quarter. This is in addition to third quarter growth in services revenue from Teleport and SwiftLink maintenance services.

We expect to carry a significant backlog of services work into 2009. The worldwide satellite services contract vehicle is nearing the end of the second of its five years. Today, TCS has won more taskings than any of the other five awardees. Total contract dollars awarded to TCS are now $360 million, second only to General Dynamics. The $246 million award for SwiftLink B Sat equipment for the Army insures that TCS is now a major player in the DOD space for this kind of communications technology and positions us as a credentialed competitor for large scale communications technology awards.

In summary, we have great momentum in our government business unit. This year will produce record revenue and margin and based on backlog and expected pipeline, this momentum will carry into the next several years.

Thomas M. Brandt, Jr.

For the second quarter record revenue of 443.9 million was up 24% from last year. Gross profit was $19.2 million for the quarter or 44% of revenue. We had record EBITDA of $15.2 million or $0.33 per diluted share and record GAAP net income of $12 million or $0.26 per diluted share. The overall company revenue split for the quarter was 55% services and 45% systems and was about 58% commercial and 42% government.

In the commercial segment the second quarter services gross profit was up $1.5 million to $8.6 million from $7.1 million a year ago on a 12% increase in revenue. Higher maintenance revenue and an increased number of service connections for VoIP and E9-1-1 services contributed to higher profitability.

Commercial systems gross profit was $6.3 million for the second quarter, an increase of $6.2 million from $0.1 million a year ago. This was on $9.1 million of revenue up from $1.3 million a year ago. The second quarter of 2007 was the last period before our leading SMS customer made a multi-quarter arrangement for purchases of incremental license text messaging capacity. The capacity offered under the initial such arrangement has now been fully purchased, a quarter earlier than initially expected and we expect to enter into a new such arrangement during the current quarter.

Government segment services revenue was $7.8 million compared to $8 million a year ago, and gross profit was $1.5 million compared to $1.9 million a year ago. As Maurice just said, a number of new business initiatives bore fruit during the quarter just ended so that we expect significant improvement in the contribution from government services beginning in the third quarter of this year.

Sales of government systems for the quarter were $10.5 million compared to $11.4 million a year ago and gross profit of $2.8 million was up from $1.6 million in Q2 ‘07, mainly due to improved revenue mix and progress in obtaining lower average system component and assembly costs. Company wide operating expenses excluding depreciation increased 13% over last year’s second quarter. As a percentage of revenue they were down from the same period last year.

Total R&D sales and marketing and G&A expenses were $13.5 million or 31% of total revenue compared to $11.9 million last year or 34% of total revenue. The increase was due primarily to increased provision for legal expenses in G&A and increased accrual for variable compensation expense.

Research and Development expense was $3.9 million in Q2 ‘08 versus $3.3 million a year previous. Sales and marketing expenses totaled $3.6 million for the second quarter versus $3.2 million a year ago. JAR administrative expenses were $6 million versus $5.5 million in the second quarter of ‘07.

EBITDA from continuing operations was a record $15.2 million, which includes $8.1 million from the sale of a patent. Excluding the gain from the patent sale EBITDA for the quarter was $7.2 million which is up from $0.3 million in last year’s second quarter.

Non-cash charges totaled $3 million for the quarter versus $3.1 million in last year’s second quarter. Depreciation of fixed assets was $1.5 million down from $1.6 million last year and non-cash stock base compensation expense was $0.9 million compared to $1.1 million last year.

The bottom line we reported GAAP net income for the quarter of $12 million on record sales of $43.9 million. At the end of the second quarter funded backlog was $115 million down from $123 million at the end of Q2 ‘07. As of June 30 ‘08 our total backlog was $206 million up from $159 million a year ago.

We enter Q3 2008 expecting to realize $76 million of our funded backlog over the next 12 months. Beyond this funded backlog our licensing arrangements and unfunded government contract orders give us substantially improved visibility overall. Subsequent to the quarter end TCS was selected by the U.S. Army as the sole awardee for up to $246 million of deliverables for a full range of deployable satellite solutions based on the company’s highly reliable SwiftLink deployable communications product line.

This brings total backlog to about $450 million. Funded contract backlog represents contracts for which fiscal year funding has been appropriated by our customers, mainly federal agencies and for our hosted services contracts, multiplying the most recent month’s recurring revenue times the remaining months under existing long term agreements. Total backlog as is typically measured by government contracts includes borders covering optional periods of service and/or deliverables which have not yet been incrementally funded by the customer.

The company’s liquidity position improved considerably in the second quarter of 2008. Quarter end cash totaled about $28.2 million up from $18.5 million at the beginning of the quarter. And debt was reduced by $1.1 million to $12.3 million. The company’s second quarter EBITDA generated $15.2 million of cash including $8.1 million from a patent sale proceeds and $0.9 million was generated from stock option exercised. Funds were used for $1.1 million of debt reduction, $1.4 million for capital expenditures including capitalized software development, net cash interest of $1 million and working capital of $3.8 million.

Unused availability under our lines of credit totals about $22 million at quarter end. We are continuing our practice of providing longer term but not quarterly guidance as to future P&L performance by the company. Following top line gross of 22% in 2006 and 15% in 2007 we now expect overall revenue for 2008 to be in the $188 to $195 million range, representing year-over-year gross of 28 to 35%.

Based on our first quarter experience with the higher margin mix of revenue, we now expect EBITDA for 2008 to grow from 2007’s $15.6 million to the range of $25 to $27 million or $0.55 to $0.59 a share excluding the second quarter patent sale, which represents about $0.18 a share. All in we now expect 2008 EBITDA of $33 to $35 million or $0.73 to $0.77 a share. We estimate that shares for diluted EPS for 2008 will be $45.5 million.

We foresee non-cash charges for 2008 to be about the same as 2007’s $12 million and interest and taxes for the year should total about $1.5 million so the GAAP net income should be about $19.5 to $21.5 million or between $0.42 and $0.46 a diluted share. These expectations for 2008 profitability don’t include any additional potential net proceeds from the company’s patent litigation. Once again our 2008 guidance data may be 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 the call back to Maurice’.

Maurice B. Tose’

Our company’s text messaging, deployable Satcom and public safety technology all contributed to solid second quarter profits, along with the fruits of our intellectual property management efforts leading to the sale of a valuable patent. Sales of patents and systems are nonlinear quarter-to-quarter but by having developed multiple business models from monetizing our technology the long term value that is accumulated in TCS continues to improve the company’s year-over-year performance trend.

TCS’s messaging business continues to benefit from record setting text message usage in the U.S. and as discussed on this call leading analysts predict that the strong growth of text messaging will continue for at least another three to five years as our early market leadership and location based services gains further traction.

The new Army contract worth up to $246 million of deployable Satcom revenue over the next three years is further evidence that our company has graduated from serving niche government customers to executing as a prime on large scale contracts. Our public safety business is continuing to sign new VoIP customers as well as renew continuing customers’ multi-year contracts.

TCS investments in communications technologies have resulted in a valuable body of protected intellectual property. Our patent sale of this quarter is our third and largest success to date in monetizing non-strategic patents. A patent litigation case is still pending that we believe will result in a successful outcome and have a growing number of other patents that we intend to enforce.

TCS has also demonstrated that the company can consistently grow year-over-year profits. We have again raised our 2008 guidance today and continue to track additional orders for closure in the third quarter that could further improve our outlook for the year. We thank you for your time and support and will now open the call to any questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from [Baroon Shadof] – Raymond James & Associates, Inc.

[Baroon Shadof] – Raymond James & Associates, Inc.

Regarding your EBITDA guidance it looks like you’re expecting the second half EBITDA to be less than the first half so what are your assumptions behind the new guidance? And are you trying to be conservative? How should we read into this?

Maurice B. Tose’

Well we would like to think we’re continuing to be conservative. We have tried to make it clear that the system sales are not linear and we’ve, in the first quarter in particular, had catch up purchases by an important customer where licenses were sold. So you can’t draw a straight line through our quarters and the company has never been that way. But the year-over-year trends are very robust.

[Baroon Shadof] – Raymond James & Associates, Inc.

Could you just talk about [evating] carriers are in terms of their messaging capacity versus the actual demand? Are they ahead or behind? How should we think of the opportunity there?

Maurice B. Tose’

Well it’s kind of a rolling number and you know typically they are behind. I mean they fall behind. The growth compounds month to month, quarter-to-quarter.

Operator

Your next question comes from Scott Sutherland – Wedbush Morgan Securities Inc.

Scott P. Sutherland – Wedbush Morgan Securities Inc.

On this government deal looks like you have about 10% committed or 120 systems so should we think about $20 to $25 million over the next few quarters from this new deal and how do you think the rest of the deal kind of rolls out over the next 39 months?

Maurice B. Tose’

You’re trying to lay that in there. We’ve incorporated what our best guesses for the deal are in the overall guidance, Scott. And out into 2009 you know it’s kind of speculative although I think we’re going to be shipping as fast as we can produce.

Scott P. Sutherland – Wedbush Morgan Securities Inc.

I guess my question is you have commitments in the near term for 120 systems or about 8% of the total systems under contract. Is that something that’s over the next four quarters or over the next two quarters? And is there any potential for more than that over the next kind of three to four quarters?

Maurice B. Tose’

Yes. And one thing there Scott is there will be a certain degree of difficulty there because there are a number of sizes of systems that comprise that 1,500. So you’ve got some very significant, some very large ones and it also goes down to some smaller man packs. But we expect that 120 is kind of going to burn over the next two quarters. And maybe a little bit into Q3. But there is additional visibility that is beginning on subsequent orders.

This vehicle, although it’s less than the WWSS in the Army vehicle can be used federal government-wide. So it was getting it in place and then the efforts that now ensue of getting further commitments from customers is in fact working.

Scott P. Sutherland – Wedbush Morgan Securities Inc.

You seem pretty confident at the margins. As the old government deals – as you’ve gotten new government deals, the margins usually started low and then you scaled up and they got more profitable. It seems like you’re more positive on margins now even with this new large deal. Is there some nicer margin profile this? It doesn’t look like you discounted it if you’re pretty bullish on the margins.

Thomas M. Brandt, Jr.

Scott, I think the best thing to assume is that for the year we’re going to have about a 20% average gross margin for the government segment. And we had a real good first half. And it’d be nice to see if that’s higher but I think that’s the way I’m looking at things.

Maurice B. Tose’

And actually, Scott, let me step back a second because I may have misspoke a little bit. We’re going to begin to deliver some of those systems in Q3 but they are more so Q4, Q4 will be a very robust quarter and then into Q1 of 2009. So there is somewhat of a ramp in some and beyond that, you know, the WPPL Wireless Point-to-Point Link there is an increasing capacity demand of there as well with committed dollars. So between WPPL and this new vehicle you’re going to see the systems numbers increasing more so again Q4, Q1 although some uptick in Q3.

Scott P. Sutherland – Wedbush Morgan Securities Inc.

On the messaging side of you business, I mean you’ve had some new wins, sounds like you have a third essentially large CDMA operator and you’re working on a new Verizon contract. I know in the past you’ve had some volatility. Do you think that volatility still exists or do you think, you know, every quarter you have some good business because you sign up more carriers?

Thomas M. Brandt, Jr.

Well, I mean, that’s obviously our hope and that’s what we believe, by increasing the base we can expand the capacity as all of them won’t be at the same place at the same time. You know, we’re going to work hard to get this next multi-quarter capacity deal in with one of our vendors and that will obviously help, but the continuance of adding the additional carrier customer’s help. But you know none are of the order of magnitude or the size that affect our largest carrier there is.

We again we believe that years in or thereabouts we’ll be in the 50% range of CDMA&A market share in North America.

Operator

Your next question comes from James G. Kennedy – Marathon Capital Management.

James G. Kennedy – Marathon Capital Management

Maurice, two questions for you. Number one, can you put into perspective this new overall I’ll call it SwiftLink order for lack of a better term relative to what you’ve done in the past? I mean this sounds like a very large order potentially with everything all in. Has something changed either with the system itself or the need or, I mean, how does this compare with what you’ve delivered over the years?

Maurice B. Tose’

Again it’s huge. And in part it’s what we had always been striving for since we began to sell individual units, onesies, twosies, you know, tens and twenties through various vehicles. And as we indicated, we delivered $7.3 million in systems through the 12 or 15 different vehicles – I’m sorry, I think it was 17 different customers or 17 different vehicles. You know, we’re going to continue to be doing that but what this does, this looks at the bigger Army and bigger other entities that need to buy systems in large numbers, that there will be in place a vehicle to which those users or needs can be fulfilled.

James G. Kennedy – Marathon Capital Management

Maurice are you actually displacing some current technology or is there just kind of an awakening that this is a level of sophistication needed across the board?

Maurice B. Tose’

Well, you know, it’s probably to some degree some displacing because just as we sell through those 17 different deliverable mechanisms that we did the $7.3 million there are a lot of different sizes out there that we probably are displacing some there. But it goes to irrespective of who enters the White House, either Democrat or Republican they’re both stated objective that as far as the military goes our future is about rapid deployment, deployable entities and the communications and the best and the fattest pipes that are available to give the war fighter all the technological advantages that the United States can bring to bear at any effort any place on the planet.

So this is where our military’s going to be. Again, I think Barack Obama if he’s elected is that he wants to grow the Marine Corps for its expeditionary capabilities. Both have stated Special Ops needs to grow. But this goes to the basic Army units as well because they are going to be deploying and they need the type of communications technologies that we provide.

James G. Kennedy – Marathon Capital Management

So in my follow up question related back to, and I didn’t quite catch the acronym for the newer emergency types of services that you’re a part of planning or at least you’re on some fact finding committees, etc., has that gotten to the point yet where it’s been discussed as to how those would be paid for? Would it be a part of the normal 9-1-1 fee? Would it be a separate fee? Would it be a government check being written out of some budget? I mean, have you gotten that far yet?

Maurice B. Tose’

You know I have to admit I’m not 1,000% on top of that and I don’t think that’s fully been flushed out as yet. I mean the first thing is in September for the carriers to say whether they’re going to voluntarily participate or not. You know we expect that’s going to be a resounding yes because in the end this will become a discriminator whether or not you provide it or not, because it becomes almost like core 9-1-1. But this is – this brings to bear again the strengths from our geo location and mapping and 9-1-1 and SMS in spades so, you know, there are no guarantees, you know, that we’ll win all of this business or various facets of it. But we believe we are well positioned and we are using you know our access and our exposure to folks to obviously increase our probability of getting parts of this business.

Operator

Your next question comes from [Jason Stankowski] – Castle.

[Jason Stankowski] - Castle

The question on the $246 million opportunity based on the questions that have been asked, so is approximately 8% of that you have awards for or have been asked to produce? Is that correct?

Maurice B. Tose’

Note quite. We have a smaller piece under contract and we have visibility of funds transferred and working its way through the system to get to us for a task order for the additional 120 units.

[Jason Stankowski] - Castle

Is that all the capacity you would have out until, you know, sounds like two to three quarters out it will take you to deliver that or the funds to be procured? One, I guess what’s your capacity to produce those systems in terms of time and then you know when would you expect to get more visibility? Will it be on sort of a quarterly basis that you – or is there some event that would give you more visibility into the balance of that dollar spend?

Maurice B. Tose’

I’ll start with the last one first. That’s the easiest one which is the visibility it changes hourly. You know, it’s hourly or daily as we’re tracking the funds in the system. The dollars that go with the 120 systems, it’s all there so once that award or that task [or] gets to us we’ll be off to the races in fact with that. And we do a, you know, a little bit of risk authorization as we look at the probability of things happening and jump start some activities to in fact try to level out some of the quarters so they aren’t in fact huge.

Our capacity with the expanded facility that we’re in Tampa, you know, it gives us a great capacity capability. You know the difficulty in giving you – to giving you a empirical number is because the differing sizes again of systems. They go from two liter dishes to one point two liter dishes to X-band terminals to BGan to kits. It is a, you know, part of what we try to speak to there is that we have 32 or 34 different variants now that are part of this mix.

So it’ll be different for one size system or kit than it is for another. Some of them have longer lead times for components than others. But right now, and we believe that this is where we’ll be and where we hope to be is that we’ve got, you know, visibility in producing and delivering two to three quarters out.

[Jason Stankowski] - Castle

Maybe another way to ask the question is if you were to get the whole order today and be asked to deliver say over the next 36 months, do you have to build new facilities to deliver on that or add a lot of Capex or is that sort of within your operating capacity right now?

Maurice B. Tose’

Well one, the supply chain that has to produce and, you know, the components it’s physics that can’t happen. It just isn’t there. The capacity of the individual pieces, you know, aren’t going to be there. I mean we are pushing and poking and prodding our supplier partners to in fact increase their capacity to be able to do more. But you know getting all of the order at one time is you know not a probable event. And we believe that for now with a great degree of certainty we can satisfy the needs of this contract under our existing – in our existing integration facility.

Now, that said if there is a desire by the government for us to accelerate we have abilities to surge and we would look at that.

Operator

Your next question comes from [Jeffrey Myers] – Cobia Capital.

[Jeffrey Myers] – Cobia Capital

I just had a quick one on the new CDMA provider you signed up. Do you know how many text messages they are currently, you know, transmitting versus, you know, your two other providers? Just trying to get a sense of the penetration, you know, when you finally get penetrated there how big the opportunity could be.

Maurice B. Tose’

And I probably should have corrected Scott when he said earlier, you know, another large CDMA customer. I mean large is a relative term after you get past the ones at the head of the class. This latest win is not a large but it’s got a nice size of message capacity and ability that we’re going to, in fact, be providing them. But even speaks greater to us, you know, part of what our strategy has been for a number of years is to get a beachhead in the carrier and then cross that carrier – I’m sorry is get a beachhead and then go horizontal.

So what this does this is an existing carrier customer for 9-1-1 and some other things that what it does now, it expands the number of products and/or services that we are providing to that customer. So more and more that’s what our game plan is and that’s what we’ll have here. You know one of the metrics that I gave is with the addition of this customer that by year’s end we look to be at near 50% of the CDMA market share in North America or I should say North America meaning in the U.S.

[Jeffrey Myers] – Cobia Capital

Right and you guys are at 25%.

Maurice B. Tose’

No we’re at 25% total SMS share in the U.S.

[Jeffrey Myers] – Cobia Capital

But where are you as a percent of CDMA share today?

Maurice B. Tose’

It’s probably pretty close. I mean, it is the beside the two GSM providers, the two big GSM meaning AT&T and T-Mobile the balance with the exception of Sprint’s iDEN is CDMA.

[Jeffrey Myers] – Cobia Capital

To get to that figure by the end of the year are you assuming any additional penetration into your existing CDMA accounts?

Maurice B. Tose’

No. I think that accounts for the orders that we have in hand.

Operator

Your next question comes from Greg Weaver – Invicta Capital.

Greg Weaver – Invicta Capital

Just a follow on to that last question. So just to be clear your current CDMA market share in messaging is what?

Maurice B. Tose’

Our current overall messaging percentage in the U.S. based upon last year’s messages to deliver was about 25%. And it’s probably you know roughly that same number for CDMA because of the way the numbers bear themselves out of total usage and what carriers within there on CDMA or GSM what messaging plans they have and the amount of capacity they have within their networks. So the 25% number of overall roughly equates to the existing 25% of CDMA that as we implement the orders that we have in hand will take us up to that near 50% CDMA.

And it’s probably going to be a little bit of a variance on that number versus total U.S. subscribers. And even as I say 25, it could be that 25 is 18, that 25 is 28. I don’t have those numbers in front of me to give you that metric but we’ll look at clarifying those numbers going forward.

Greg Weaver – Invicta Capital

Yes I was just trying to get an order of magnitude here. So you’re in essence doubling your current position? And yet some of this has already been sold?

Maurice B. Tose’

Most of it is under order of installing new systems, bringing them up, transferring capacity from one provider to us, so it’s not that a carrier has to go out and get new capacity. In most instances the carriers already have the capacity. It’s a matter of the process that it takes for us to get our systems into their networks and transfer that traffic to our systems.

Greg Weaver – Invicta Capital

So of the $20 million recognized in commercial systems so far this year, how far does that get you to the 50%?

Maurice B. Tose’

The $20 million recognized in commercial systems is more than just SMS.

Greg Weaver – Invicta Capital

Right. Well whatever segment of that is SMS. You know what I’m saying? You’ve already recognized some revenue but yet it hasn’t shown up some how in the messaging volume? You know what I mean? Or am I to assume then that there’s got to be some huge additional business between now and the end of the year in order for you to double your current messaging share?

Thomas M. Brandt, Jr.

I think there’s confusion here between the metric of 25% of the total U.S. text messaging market and 50% of the CDMA market. They’re both measures of the same numerator, they’re just different denominators. And as of right now with the CDMA market penetration that we have, we’re handling about half the messaging in the U.S. among CDMA carriers which are Verizon, Sprint, U.S. Cellular, Alltel.

Greg Weaver – Invicta Capital

So you’re already there.

Thomas M. Brandt, Jr.

We’re close, but we’re inching up on both measures. But it’s when we say 25% of one thing and 50% of the other thing so close to each other, you think we’re saying we’re growing so fast, we’re going from 25 to 50 and that’s not the case.

Greg Weaver – Invicta Capital

Right. That’s why I was initially starting to question what percentage of your share is CDMA and Maurice answered it in an odd way to confuse me. Okay. I’m also lost on what appears to be this extremely large order, that there’s no PR, there’s nothing on this $246 million?

Maurice B. Tose’

It’s a large contract ceiling that has the ability for the government to obligate resources or dollars against.

Greg Weaver – Invicta Capital

Is this WWSS? What’s the initial vehicle for this?

Thomas M. Brandt, Jr.

Yes that’s the overall vehicle and this is a contract awarded under WWSS. And as we’re speaking to you tonight we haven’t been – our press release has not been approved by the customer yet. So we will do one, but we think it’s appropriate to share the information on this call in our earnings release to the extent we have.

Greg Weaver – Invicta Capital

So you’re taking a prime position on this? And I guess how much does that involve in terms of passing through other people’s equipment and kind of what’s that do in terms of the gross margin profile for some of this business?

Maurice B. Tose’

We are fundamentally engineers and integrators when it comes to this kind of technology, so there’s a lot of other people’s equipment that goes into these solutions. We provide personnel there to do training and maintenance and deployment, but the big dollars are and have been in our government systems business. Other direct costs from purchases from vendors like Cisco and antenna companies and router companies so, you know, this isn’t new it’s just bigger.

Greg Weaver – Invicta Capital

So obviously you’ve made some improvements on your government systems gross margin which is nice to see. So if potentially we start to see some business flow from this contract, that shouldn’t impact your trajectory there?

Maurice B. Tose’

You know, I said earlier in the Q&A, you know, as I look ahead and model the company I look at a 20% overall gross margin for the government segment. We had a good first half. We had some relatively mature relationships pay relatively well during the first half. And we expect to see a lot of shipments under this new agreement in the second half and on for the next couple of years. And the overall margins are going to be, you know, going to bring the full year in the neighborhood of 20%.

Greg Weaver – Invicta Capital

So it’s a similar queue that you’ve been selling, however, it’s under a potentially new pricing scheme under this new contract?

Thomas M. Brandt, Jr.

Yes that’s right. It’s very similar to what we’ve sold. Now we’re doing much bigger volume than we’ve done in the past.

Greg Weaver – Invicta Capital

So we’ve got to see the efficiencies kick in again where as you ramp up. Right? Okay.

Operator

Your next question comes from Shane Kim – Camden Partners.

Shane Kim – Camden Partners

Can you just give me a little bit more color on this Qualcomm partnership and I think this is the first time you’re sort of – is this a pilot for the Xypoint location platform? And can you just give me some color as to what your strategy there is? And what to expect?

Maurice B. Tose’

We’ve got a number of different partnerships with Qualcomm. We’ve had one partnership with Qualcomm for, I want to say maybe eight years, where we provide their [worn] or their Y area reference network in the continental United States and I think Alaska and Hawaii, which, essentially, when you turn on a device it tells the device which three or which satellites to look at, as opposed as trying to look at the entire constellation of GPS satellites. Hence the time the first fix is enhanced and the consumption of the battery is not as bad. We’ve been doing that for a long time.

Currently, what this Tata link is under, we are Qualcomm’s global partner for hosted location for what’s called their BREW locate, which is a part of Qualcomm’s efforts to sell its intellectual property and its products on a global basis. And so this is one of several that we are working with Qualcomm, and obviously we hope to take several to many.

Operator

Your next question comes from Scott Sutherland – Wedbush Morgan Securities Inc.

Scott Sutherland – Wedbush Morgan Securities Inc.

This was a follow up actually to the last question on Tata. Looks like it’s a hosted solution. You spent some Capex this quarter. Is that Capex to ramp up the host solution for a large carrier like Tata in a growing market or was Capex somewhere else? And how do you expect kind of the Tata relationship to rollout? Is it per sub or capacity type model?

Thomas M. Brandt, Jr.

There isn’t much Capex involved. This is a capital investment on the part of the customer that’s going to deploy our solution and on a hosted basis – or rather in network –

Maurice B. Tose’

No. What it is, is we’re taking our hosting ability and we’re going to put it in place in India. So from India we will monitor the U.S. but we’ll host, or provide the XY coordinate extraction to be handed off to applications in India. So it’s not a big investment on our part Capex-wise. But it’s establishing a local presence in India.

Scott Sutherland – Wedbush Morgan Securities Inc.

And how is it expected to ramp up? Is it a capacity or per sub deal? And do these subscribers need to get GPS in their phones first to really start using these applications?

Maurice B. Tose’

It’s a purse of and it’s Qualcomm, so if it’s a Qualcomm handset the phone’s going to have it or most CDMA phones are going to have the GPS in fact already resident in [silicon].

Operator

And it appears that we have no further questions.

Thomas M. Brandt, Jr.

I really meant to turn the call over to Maurice, but we thank you all very much for joining us on this evening’s call and we’ll look forward to getting back together at the end of next quarter.

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