SuperCom Ltd Q2 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by. Good morning and welcome to the SuperCom Q2 2021 Financial Results and Corporate Update Conference Call. At this time, all participants are in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Participants of this call are advised that the audio of this conference call is being broadcast live over the internet and is also being recorded for playback purposes. A webcast replay of the call will be available approximately one hour after the end of the call through August 27, 2021. I would now like to turn the call over to Scott Gordon, President of Core IR, the Company’s Investor Relations firm. Please, go ahead, sir.

Thank you, Paul. Good morning and thank you for participating in today’s conference call. Joining me from SuperCom’s leadership team is Ordan Trabelsi, Chief Executive Officer. During this call, management will be making forward-looking statements, including statements that address SuperCom’s expectations for future performance or operational results. Forward-looking statements involve risks and other factors that may cause actual results to differ materially from those statements. For more information about these risks, please refer to the risk factors described in SuperCom’s most recently filed periodic reports on Form-20F and Form-6K and SuperCom’s press release that accompanies this call, particularly the cautionary statements in it. Today’s conference call includes EBITDA, a non-GAAP financial measure that SuperCom believes can be useful in evaluating its performance. You should not consider this additional information in isolation or as a substitute for results prepared in accordance with GAAP. For reconciliation of these non-GAAP financial measures to net loss, its most directly comparable GAAP financial measure, please see the reconciliation table located in SuperCom earnings press release. The content of this call contains time-sensitive information that is accurate only as of today, August 10, 2021. Except as required by law, SuperCom disclaims any obligation to publicly update or revise any information to reflect events or circumstances that occur after this call. It is now my pleasure to turn the call over to Ordan Trabelsi. Ordan, please go ahead.

Thank you, Scott. Good morning, everyone, and thank you for joining us today. Earlier, we issued a press release and our financial results for the second quarter of 2021, a copy of which will be available in the Investor Relations section of our website. Q2 was another successful quarter as we continue to execute on our business plan. As mentioned last quarter, our primary focus is investing in sales and marketing to drive future revenue goals and then in turn, leveraging higher sales to improve profitability over time. During the second quarter, we continued to make progress with our sales and marketing efforts, particularly in the IoT segment. It's important to remember that the sales cycles and processes with government customers, such as ours, are long. Our customers are discerning, but once you bring on a new customer, they tend to be very sticky and stay with us for 5, 10, or even 20 years on occasion. Although we did start making moves and progress with our sales efforts. In Europe, we've seen increased RFP activity as COVID-related restrictions have started to ease. We have been more active than last year and won a competitive tender for the Finland EM program of $3.6 million. In the USA as well, we've seen increased interest from different customers and RFPs for potential new ones. We won a competitive RFP for a $4 million project which launched on July 1, 2021, in California. During the second quarter, we opened up a small office in Kentucky, USA to help support our growing sales activity in the US with new sales, sales support, and tech support resources tailored to our unique offerings for the USA market. We believe we can scale our offerings and grow our footprint. We’ve already begun to see increases in customer interest. Since the beginning of the second quarter, we have received requests to demo and evaluate our proprietary technology from over 15 new USA potential customers. While not yet resulting in increased revenues, increases in evaluation and video activity can lead to higher revenues over time. It will take some time to see our efforts translate into revenues. However, we are confident that these investments will pay off, driving revenue growth and improving profitability over time. In our fourth quarter call last year, I highlighted a significant change in our reporting, transitioning from semi-annual reporting into a normalized quarterly reporting cycle. This quarter is the second period of reporting quarterly earnings. During this transition, we have made various enhancements to our processes that have enabled us to improve the quality and timeliness of our reporting. These improvements have not only enabled us to report our earnings on a quarterly basis, but also to have better understanding of our business operations and improve our cash allocation strategy. Our primary focus has been our IoT tracking segment, which provides products and services enabling remote monitoring. This segment has applications in both monitoring criminal offenders and quarantine compliance to reduce the spread of COVID-19. We see a large opportunity in this market, driven by various trends that are taking place. In recent years, there has been a trend towards correctional institutions increasingly using home confinement as a tool to manage incarcerated populations. Home confinement provides several benefits as correctional facilities drive these trends. First and most importantly, it is effective. By being able to monitor and manage the location of inmates, the facilities can effectively control these offenders' movement to ensure they stay within the restricted areas. Secondly, using remote monitoring with offenders has been found to reduce recidivism and measure the percentage of former prisoners who are rearrested for similar offenses. This is driving many correctional institutions to rethink their objectives in dealing with offenders, as it relates to rehabilitation versus punishment. Current trends increasingly emphasize the need to rehabilitate and enable these offenders to reintegrate into society. Additionally, it addresses the problem that many facilities have with overcrowded prisons. The overall growth in inmates has been exceeding the growth in prison facilities, causing facilities to become congested and overpopulated, creating issues in managing them. Finally, it provides dramatic cost savings to these institutions. The cost of housing a prisoner averages between $100 and $140 a day for each state and federal prisoner, whereas it only costs $10 to $35 a day to keep someone on house arrest. By providing an alternative method of confinement at the inmate's residence, it eliminates many of the costs associated with the housing and maintenance of these prisoners. This is a significant benefit driving increased interest in IoT tracking solutions. In addition to these benefits, recent demand has been magnified by COVID-19, as many overcrowded facilities have experienced severe outbreaks during the pandemic, causing authorities to rethink how they should manage this population. The demand for IoT tracking capabilities also increases as governments look for solutions that will provide viable options to verify quarantine compliance of individuals in an effort to reduce the spread of COVID-19. Our PureCare solution provides governments with the ability to effectively manage travel into their countries while minimizing the risk of spreading contagious diseases. These solutions are much more effective and less invasive for individuals who have to quarantine compared to reliance on hotels or with technology solutions attempted by companies that are not experts in tracking and monitoring. Our PureCare solution enables individuals to quarantine comfortably at their personal residences while being monitored to ensure compliance. I want to share an update on the PureCare Quarantine Compliance project in Israel. Since being awarded in March of 2021, we have continuously worked on our integrations with the Israeli Ministry of Police and the Israeli Ministry of Health. Although the projects have not gone fully live yet, we are in communication with the individuals at Ben Gurion International Airport. Since we were initially awarded the project, elections took place in Israel, resulting in a new government body and Prime Minister being elected. While we're still working on educating the new government on the effectiveness of our solution, which has been field-proven and selected by the officials in the previous government, there is currently uncertainty with the new government around the timing and scope of the project. If for some reason, the project does not launch in the originally expected scope, we believe we will be able to recoup our costs and investment into this project. That being said, the current COVID-19 environment in Israel is alarming due to the rapid increase in the reported daily new infections over the past few weeks. The number of new daily COVID cases in Israel grew from less than 50 a day in mid-June to over 6,000 a day as of yesterday, August 9— a very large number for the country. We continue to strongly believe that our PureCare solution, which has been piloted, tested, and chosen by the previous Israeli Government, would be an effective tool in mitigating the spread of the virus. Our progress and footprint within the IoT tracking segment has continued along with strong underlying market trends. On June 28, we were awarded a $3.6 million National Electronic Monitoring Project in Finland, where our PureSecurity Electronic Monitoring Suite is being deployed by the government with the objective of improving the country's public safety and efficacy, reducing prison overcrowding and lowering recidivism. This is a full-year project, which has the potential for extensions beyond the initial award. Additionally, in early May, we boarded a project in California valued at $4 million with an initial term of two years, extendable by up to three additional years. This project focuses on providing Juvenile Programming and Rehabilitative Services with the objective of supporting those offenders reentering the community and reducing recidivism. This project in California has already been launched as of July 1, 2021. This project will highlight the success of our marketing efforts in addition to validating our technology as very competitive in the market. While the original COVID outbreak highlighted the overcrowding challenges many prisons face and drove increased interest in the technology, we believe we are in the early stages of a secular trend towards using more home providing solutions to address overpopulated facilities, as well as reduce costs. As cases of the Delta variant of COVID continue to expand, we're seeing increased interest as of late in the PureCare solution, which we believe can play an important role in mitigating the spread. Our win rate for project bids in recent years for IoT tracking of offenders in Europe has been high—over 65%—which validates our secure technology and our highly regarded reputation in the industry. We will continue to invest in our technology to offer the best solutions on the market. On June 30th, we announced the closing of a financing with gross proceeds of $5 million to the company. This capital supports the company's growth initiatives, as we focus our efforts on the IoT business to take advantage of positive trends in the marketplace. This financing comprised a two-year unsecured subordinated promissory note that was completed directly with an institutional investor. The note consists of a 5% annual coupon, which is paid with the principal and a lump sum payment at maturity. There's also an option at SuperCom’s discretion, only at any time after 12 months to pay down all or a portion of the note using its ordinary shares, subject to certain conditions being met. For a quick Q2 financial overview, in the second quarter, we generated revenue of approximately $3.1 million, which was up 2% from the first quarter of 2021. Gross margins in Q2 were 57.5%, up sequentially from 55.3% in Q1. R&D was $589,000 in Q2 versus $657,000 in operating expenses in Q1. Selling and marketing operating expenses were $377,000 in Q2 versus $370,000 in Q1. General and administrative expenses were $976,000 in Q2, up from $830,000 in the prior quarter. Our operating income in the second quarter was negative $160,000, with operating margins of negative 5.2% versus an operating loss of $180,000 in the first quarter, where our operating margins were negative 6%. Financial expenses were $797,000 in Q2 versus $1.1 million in Q1. Net income for Q2 was negative $964,000, an improvement from negative $1.3 million in Q1. As of June 30, the total cash and equivalents and restricted cash stood at $10.9 million, $1.5 million of which was restricted. This compares to $4 million as of December 31, 2020, of which $815,000 were restricted. Total debt at June 30 was $30.5 million, of which $1.9 million was short-term. This compares to total debt as of December 31, 2020, of $22.2 million, $7.2 million of which was short-term, an increase that was partially due to recent financing in June. Our working capital also increased to $24.5 million at the end of Q2 from $12.7 million at the end of Q1 2021. And with that, I'll turn the call over to the operator to open the call for questions.

Thank you. And we do have a question coming from Ken Wiener. Ken, your line is live. Please note your affiliation and pose your question.

Yes, hi, good morning. I was wondering, there seems to be a problem with revenue growth in the company; it's kind of minuscule and you keep saying that COVID and the prison environment, et cetera, et cetera, but it doesn't seem to show up in the numbers. I was wondering how you view the revenue going forward?

That's a good question, and thanks for asking. There are actually a few trends that are going on underneath the surface. If you look at them in 2015, revenues were roughly $30 million; almost all of that was from our identification segment, and the revenues from our IoT tracking solutions were close to zero. Now in 2021, revenue from the identification segment has declined to $2 million. That's our traditional business mainly in Africa and South America. We have shifted over the years to more recurring revenue businesses in developed economies, such as the US and Europe. While the declines from $30 million down to the identification business have occurred in parallel, we have seen growth in the IoT business, but this growth is being masked by the decline of the other business, so altogether it reached revenues around $11.8 million last year. Our new focus over the past few quarters is to invest in growth in the long-term, which includes our investment in sales and marketing teams, and continuing to invest in R&D. We have won over the past few years, even though our cash balances are very low; we've been able to win consistently in new projects with governments around the world. Those projects were won because of our technology. We scored very high on technology, had a very small sales and marketing team, and were able to bid almost blindly on many of these tenders. After we've proven our effective strategy and success with our technology, now that we have more cash on hand, we can start deploying larger projects and invest in our sales and marketing. As we mentioned in the past, a lot of our cash outlays are required for new projects because in the first six to 12 months there’s a cash requirement, as you're manufacturing the equipment, and only later next year's you're covering that expense.

The next question is coming from Kevin Dede from HCW. Kevin, your line is live.

Thanks, Ordan, for taking my question, congrats on getting your numbers out. Can you dive in a little bit on the COVID tracking project in Israel? How is it that you're comfortable knowing that you'll recoup your costs there while not knowing how the government may proceed, given the change in government?

It's a great question. With the help of the analysis from our legal department throughout the whole process of the project, we have maintained step by step according to the formal guidance from the government. So we won a formal RFP, formal award for giving formal indications and writing to start manufacturing, production, and integration with the government bodies. The things that we've done were based on their requests and demand, so we believe that for whatever reason this doesn't launch in the initial scope, we have substantial support to cover all our costs and investments. We hope, and we think it's very necessary, because of the situation in Israel that the government will immediately deploy a quarantine compliance solution. Ours is the only one that's proven and tested here in Israel to help mitigate the virus because the numbers are growing at a very rapid pace in the Israeli economy and country.

Given the changing government, what's your read on how they might evaluate what you've done and proven to them? And if they—what do you think the timeline is for some sort of feedback either, yes or no?

So the question is, a lot of the government or a lot of the new politicians in government, and that's called the expert technical people are brand new. Some of them have heard of our solutions, and they understand them; however, they are not completely up-to-date on how it works and what it does and doesn't do. As for pro forma updates, I have not received an exact understanding. We continue to be ready to deploy the solution. Our legal counsel continues to advise us on every step of the way and our interactions with the government.

Okay. Ordan, if I remember correctly, you had pilots in other countries for similar solutions, and I'm wondering if you can speak to those.

Yes. We have requested in the past to send our technology out for pilots in the Middle East, South America, and other regions. A lot of that was at the start of the pandemic in 2020, where things were moving extremely fast, and it was very hard for a government to get a hold of the whole situation. We have received requests, or at least theoretical requests, that if they wanted a solution, they wanted 100,000 units immediately, which is a very high number of units to manufacture within a timeline that is not feasible for any company in the field. While we were not able to move at that pace, now in the third or fourth wave, as they saw it earlier this year, things are moving slower; governments understand things better now. They are less stressed and are considering how to properly deploy a solution such as our Tracking Solution. So, we continue to receive interest from governments around the world. These COVID projects are very volatile in terms of the political environment, as all things change very quickly. We've all seen the changes in requirements, restrictions, and regulations around COVID behavior, and similar changes are happening in Israel as well. So it's important for us to stay close to it.

Have you seen, or can you speak to any support, whether it's funding for pilots or initial deployments outside of Israel?

Yes. Just to clarify, at this point, we haven't received significant financing support from customers. The way these projects usually work is that you manufacture the equipment and then lease it out to the customer. At the end of the project, you maintain ownership of the equipment to use it in other locations. The typical model in IoT tracking allows us to maintain recurring revenue streams, which gives us comfort and predictability in our future revenues.

Okay, can we talk about Kentucky just a little bit, please? My understanding was that LCA was based in California. You also—if I remember correctly—hired an executive to help run your business in the States but I don't think he was based in Kentucky; I'm just wondering why you chose Kentucky, whether or not there have been changes in executive leadership in the US, and how you think we should think about that business growing, given that you've gotten the 15 new trials.

Right, so a lot of our experience in electronic monitoring extends to the US, with some companies around the area and universities nearby. We have opened this office for new talent. In comparison to Southern California, where we had some of our tech monitoring centers in the past, we can get great talent at better rates here. We have already had people in the area for the past five or six years in the sales department, and we've expanded that team with additional personnel and a small office location to help with the synergies among all the different roles.

Okay. Any changes in leadership there? Because I know you were proud to have hired an individual with a lot of experience in this business, but I don't know if that was maybe two years ago. Is that person still there or have there been changes in leadership?

Right. So, you're speaking more on the treatment side in California. A few years ago, we brought in some personnel there, and most of the team is still there. Maybe one or two people in senior management have since moved, and we have new people in those roles. However, in the treatment business, just like the project we had in Northern California, the electronic monitoring side of the business, where we provide our technology and services across the US, has the same people that manage the electronic monitoring programs in various regions in the US. Our VP of sales, Jason Gilbert, has been with us for five or six years, along with other personnel. So far, this has been very effective. You can see we have a high number of new demos and evaluations in a short period of time, and this is just the beginning of our estimates; we expect those numbers to continue to grow and our technology has already been scoring very high. A lot of it is just about operating effectively on the sales and marketing channel.

Okay. Your prepared remarks mentioned that the 15 new deals are not yet consummated at this point. Can you speak to where they stand and what your expectation is on getting feedback for them? How might that be reflected moving forward?

In the past few years, our investment has been in the offender tracking field in Europe, where we have won large national projects in Sweden, Denmark, the Czech Republic, and Bulgaria. We just announced a win of a tender in Finland in the second quarter. The technology there is more tailored to house arrest in Europe, meanwhile in the US it's more tailored to GPS tracking. The use of our smartphone solution is much more prevalent; we can also track people and facilitate video calls. The traditional incumbent technology, the ankle bracelet seen on TV, is very heavy and has to be charged every day by connecting it to a wall for up to 24 hours of battery life. In contrast, we have a new technology product developed at SuperCom; our battery can last for one to two years without needing a charge. It’s lightweight, communicates seamlessly with smartphones, and offers additional tracking capabilities. Many locations in the US have shown interest in trying out our technology. The customers that evaluate our technology are interested in its valuable capabilities. As we are now investing more into those operations for sales and sales support, we are able to handle more demos and more evaluations, which we believe will yield more positive results. In the US, I've mentioned in the past that this business is more fragmented. It’s not just the country of Sweden running programs, but many state programs, with numerous programs at the county level that are managed by small local providers.

Thanks for taking my questions, Ordan. I appreciate it. I'll turn the floor over.

Thank you. I want to thank all of you for participating in today's call and for your interest in SuperCom. We look forward to sharing our progress in the next conference call. Thank you and have a good day.

Thank you, ladies and gentlemen. That does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.