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Easy Link Services International [ESIC]

F4Q08 Earnings Call

October 21, 2008 8:00 am ET

Executives

Rachel Colgate - Investor Relations Group

Thomas J. Stallings - Chief Executive Officer

Glen Shipley - Chief Financial Officer

Analysts

Tom Horn - Acorn Capital

Warren Duffy – Private Investor

Sam Heely

Brian Morgan - Reely & Bennett

Operator

Good day everyone and welcome to the Easy Link Services International Corporation financial results for fiscal fourth quarter 2008 conference call. Today’s conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to Rachel Colgate of the Investor Relations Group. Please go ahead, ma'am.

Rachel Colgate

Thank you, operator. Good morning everyone and thank you for joining us. With us today from management are Thomas J. Stallings, CEO and Glen Shipley, CFO of Easy Link Services International Corporation. Before we get started, I would like to remind listeners of some key points.

First, during this conference call, including the question and answer session, management may make forward-looking statements regarding future events and/or future financial performance of Easy Link Services International Corporation.

You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and that actual results may differ materially from those contemplated by such forward-looking statements.

I refer you to the documents that Easy Link Services International Corporation files from time to time with the Securities and Exchange Commission, particularly the company’s annual report on form 10K for the fiscal year ended July 31, 2008, filed with the SEC on October 21, 2008, including the risk factor discussion in item 1A of that report.

These documents contain and identify important factors that could cause actual results to differ materially from those contained in our projections. Easy Link Services International Corporation undertakes no obligation to update or revise forward-looking statements to reflect change assumptions, the occurrence of unanticipated events or changes in future operating results.

Second, if you do not have a copy of the earnings release, you may access it through the company’s website, www.easylink.com, under the "About Easy Link" and "Investor Information" tab.

At this time, I’d like to turn the call over to Thomas J. Stallings. Tom, please go ahead.

Thomas J. Stallings

Thank you, Rachel. Good morning everyone and thank you for joining us for our fiscal fourth quarter in year 2008 conference call. We are pleased to report that the financial results of the fourth quarter continue to confirm the value of our Easy Link acquisition and the success of our integration of the two businesses.

As you have undoubtedly seen from the details of our year-end results, the company produced record revenues and earnings, which we will discuss in a moment. However, before we review 2008, I’d like to address what possible effects the current worldwide economic situation might have on our future plans and potentially, our business volumes.

As you may recall, we previously announced an aggressive growth strategy that would result in the company reaching $250 million in revenue by the end of our fiscal 2010. When we established that goal, we felt confident that it was achievable through a combination of reasonable organic growth and acquisitions.

However, as we all know, the events of the last month have greatly changed the overall economic outlook and the stability of the financial markets worldwide. Back when we set that goal for ourselves, we planned to use a portion of the cash on our balance sheet and access the credit markets to finance our expansion plans. Unfortunately, the credit markets have all but disappeared, at least temporarily, which has set back the acquisition plans that we have been diligently working on throughout the previous fiscal year.

Although we continue to evaluate acquisition opportunities, until the financial markets begin to stabilize and over the past couple of days there have been positive signs that it is beginning to do so, we will be limited in the scope of possible transactions. We are still very much committed to reaching our goal by the end of fiscal 2010 and will remain aggressive in that pursuit.

In addition, the current turmoil in the financial sector, which represents about 19% of our worldwide revenue, has been unprecedented in modern times. We remain uncertain, at this time, as to what this means for our company’s business.

For example, the collapse of the Lehman Brothers Worldwide has eroded our future expectations for that account, particularly in the U.K., where they were one of our customers. Also, the pending acquisition of Wachovia, who is a current domestic customer, by Wells Fargo, also a customer of ours, presents a somewhat cloudy outlook for the future revenue potential of that account.

On the other hand, the acquisition of Washington Mutual, a company that is not a customer of ours, by J.P. Morgan, one of our most significant current customers should bring potential new revenue opportunities. It’s easy to see that fiscal 2009 brings with it new and unexpected challenges for the company.

However, aside from the unique set of challenges and opportunities mentioned with our financial services customers, our core business remains solid and we want to assure you that we will continue to do all that is possible to create new value for our share holders within the limitations of the current financial and economic realities.

As we have done throughout 2008, we’d like to reiterate that the metrics we believe best illustrate our performance are revenue, gross margin, operating income and adjusted EBITDA.

In each of these categories, our current results are consistent with the strong numbers we had previously reported. Glen will discuss our financial results in greater detail, but I’d like to highlight those results for you.

Total revenue in the fourth quarter was $23.9 million and $92.9 million for the year-end period, making this a record year for the company and exceeding our previous revenue guidance of $90 million. Our combined gross profit margins remain solid at 71.5% for the fourth quarter and 71.2% for the fiscal year.

Operating income was $3.5 million for the fourth quarter, and $15.9 million for the year-end period. Adjusted EBITDA for the fourth quarter was $6.1 million and $25.8 million for the year-end period, exceeding our previously announced guidance of $22 to $24 million.

On the business development front, we continue to make new additions to the EasyLink Sales and Marketing team. We appointed Brenda Morris as head of EMEA sales. Brenda brings more than 20 years experience in the information technology industry and we are pleased to have her join our team as part of our continued effort toward expanding our international footprint.

In the fourth quarter we expanded two customer relationships and added many new accounts to our client base. I would like to highlight the account expansions and mention just a few of the accounts. EasyLink continues to leverage its long-term relationship into new areas with JP Morgan.

The recent acquisition of Bear Stearns has brought new opportunity. We have integrated its inbound production fax messaging services into Bear Stearns Investment Banking business, saving costs for them by eliminating the need for a number of fax servers.

EasyLink Desktop Fax services have expanded into JP Morgan's treasury services, enabling them to automate the process of remittances to JP Morgan National Account Services application. JP Morgan's administrative organization has benefited from expanding EasyLink's Desktop Fax services throughout that operation. Now administration documents are being handled electronically, eliminating the need to handle large volumes of paper.

These three new application areas have generated new revenues to EasyLink, and continue to solidify the relationship between JP Morgan and the Company. As a result of our outstanding relationship with Citigroup, our global reach and our proven customer service track record, we recently expanded our existing business arrangement with them to include their Asia-Pacific region.

This was accomplished by winning the opportunity to provide them with outbound messaging solutions for fax and telex delivery of foreign currency exchanges and other financial documents. EasyLink now supports application-based messaging solutions for Citi around the globe.

During the process of upgrading our CRM system to an application from salesforce.com, we met with a number of their executives and had the opportunity to present our desktop messaging services to them.

As it turns out, our solution mirrors their own computing direction for their products, and eliminates the infrastructure costs associated with other solutions. Salesforce decided to implement our applications, thus providing all of their employees EasyLink Desktop Messaging capabilities.

Over the last quarter our team developed, implemented and began maintaining a critical messaging application for Quintiles Transnational Corporation. Patients who are participating with their physicians in clinical drug trials in 35 countries around the globe can now provide immediate updates on drug testing results to Quintiles' data consolidation facility at their headquarters in Raleigh, North Carolina through EasyLink On-Demand Messaging system. Also, Quintiles' 20,000 worldwide employees now use the EasyLink Desktop Messaging system to help improve productivity and reduce infrastructure costs.

Also during the fourth quarter the EasyLink sales team was asked by Prudential Financial Services to respond to a request for proposal to provide them with band services. The criteria for their decision were to be based on price, reliability, functionality and customer support.

We were competing with all of our major competitors and were able to demonstrate the superiority of the EasyLink offering and therefore we were rewarded a multiyear contract. In aggregate, the above new business represents approximately $1.2 million of annual recurring revenue.

We intend to continue to expand our customer base both domestically and internationally and are confident in our abilities to continue to achieve strong results as we have demonstrated with our fourth quarter and year-end results for 2008.

At this point I'm going to hand the call over to Glen Shipley, who will review our financial results in detail. After that I will return to review the company strategy and vision and then we'll take calls from investors.

Glen Shipley

Thank you, Tom. Good morning, all. I will now review the fourth quarter and fiscal year-end 2008 results. As Tom has previously mentioned, total revenue for the fourth quarter was $23.9 million and for the year-end period was approximately $9.2 million.

We have noted throughout this year we believe the comparison to prior years' fourth quarter and year-end periods do not provide meaningful information to our shareholders as a result of the EasyLink acquisition.

However, for disclosure purposes, revenue for the fourth quarter of fiscal 2007 was $5.4 million, and for the year-end 2007 revenue was $21.9 million. The operations that generated these 2007 revenues are now part of our supply chain messaging segment.

On a segment reporting basis results for the fourth quarter and year-end are as follows. Revenue for the fourth quarter for the supply chain messaging, which includes electronic data interchange, products and services and telex was 12.3 million, which represented 51% of the total consolidated revenue and had a gross margin of 74.2%.

Revenue for the fourth quarter on On Demand messaging, which includes all fax and production messaging, Document Capture and Management and e-mail services is 11.6 million and represented 49% of total consolidated revenue and produced a 68.7% gross margin. As Tom mentioned previously, our gross profit margin for the quarter held strong at 71.5%.

Turning to the year-end results, revenue for the Supply Chain messaging segment totaled 48.5 million or approximately 53% in total revenue and ended the year with a gross margin of 74.2%. Revenue for the year-end period on the On Demand messaging segment was 43.6 million or 47% of total revenue and had a year-end gross margin of 67.8%. Total gross margin for the year on a combined basis was 71.2%.

Turning to a comparison of the fourth quarter to the third quarter results of fiscal 2008, revenue for the third quarter was 23.6 million as compared to 23.9 million in the fourth. The difference of approximately 300,000 is primarily the result of volume increases in production messaging. Gross margin for the fourth quarter was 71.5% as compared to 71.6% for the third quarter.

Operating income for the fourth quarter was 3.5 million as compared to 4.5 million for the third quarter. The approximate 1 million difference stems from certain increase expenses recorded in Q4. These include increased head count in sales and additional marketing spend totaling approximately $527,000 as well as certain one time adjustments to G&A for year-end purposes with approximately $508,000.

Again as Tom mentioned in the past, and we have all said, we are not emphasizing GAAP net income as a metric by which shareholders should measure our success. However, reported GAAP net income in the third quarter was 6.9 million, with this number including 4.4 million of a tax benefit in the release of a portion of our tax loss carried forward and other tax reserves.

GAAP revenue for the fourth quarter was 8.1 million, include an additional 6.8 million in tax benefit release on a portion of EasyLink’s tax benefit reserve to offset estimated future taxable income. We anticipate that these tax assets will be used to offset much of our U.S. federal tax burden in future years.

We again encourage shareholders to consider adjusted EBITDA as a better measure of performance as this figure filters many of our non-cash adjustments. Adjusted EBITDA for the third quarter was 7.1 million and adjusted EBITDA for the fourth quarter was 6.1 million. The approximate difference of 1.2 million was primarily a result of the previously mentioned expense increases in Q4.

For the year-end, the adjusted EBITDA was 25.8 million and as Tom noted before, exceeded our guidance by approximately 3 million at the low end.

Turning to the balance sheet, we ended the year with 32.1 million in cash, total current assets of 49.7 million and total current liabilities of 22.42 million.

Before we open the floor for questions, I’d like to turn to Tom for some final comments. Tom?

Thomas J. Stallings

Thank you, Glen. To reiterate what I mentioned earlier in a call, I like everyone else in business today, we expect the remainder of 2009 to be a most challenging year. But we are confident that the EasyLink team will rise to the occasion and continue to grow and succeed in spite of the challenges presented.

At EasyLink we are very fortunate that our company has a broad array of products and services that support mission critical business communications for a very impressive and diverse customer base. We have a very manageable debt structure and over $32 million in cash.

In spite of the challenges we face in 2009, we will stay committed to our strategy of creating organic growth through increased investments in sales and marketing worldwide. It is vitally important for us to continue to add new customer revenue to our existing $90 plus million in recurring revenue.

We strongly believe that we exited 2008 having made a number of critical hires in this area and having developed a sales team and sales strategy that will produce results needed to insure revenue growth now and into the future.

As mentioned previously, we will pursue our goals becoming a $250 million revenue business through aggressive investment in organic growth coupled with a continued focus on acquisition opportunities. As we have during 2008, we will also continue to streamline our business processes and enhance our service execution making even more progress on our ultimate goal of operational excellence.

Thank you for you attention and interest. At this point, Shawn, we would like to take some questions.

Question-and-Answer Session

Operator

(Operator instructions) We'll go first to Tom Horn of Acorn Capital.

Tom Horn - Acorn Capital

Hey you guys. How are you doing?

Thomas J. Stallings

Good. How are you, Tom?

Tom Horn- Acorn Capital

I'm great. I just wanted to see, I saw on your K. whatever, which I just got a chance to look at a little bit, that most of your leases that you sublet -- did the sublet when you made acquisitions in the last couple of years that are expiring in 2009 and 2010, do you know how much cost savings you expect? Is that going to be a negligible amount? How much are you losing the fact that those are sublet rather than expired and how much would you gain with that?

Glen Shipley

This is Glen, Tom. There's one primary lease that by far represents the most material amount, which was the lease on 5th Avenue from the MEC acquisition, that has been subleased or expires in 2010. It will not result in any additional revenue as a result of the accounting done in the acquisition.

However, it will result in additional cash flow, currently leased for about 60% of the face value of the lease, so we will be receiving it approximately 20,000 to 30,000 in additional cash monthly once that lease expires.

Tom Horn- Acorn Capital

Alright. And then one other question. I was just doing a publicly-traded comparison with J2 (inaudible). If I look at how much they're spending on sales and marketing, net P&A and research and development off the vine, I don't know whether that's an exact comparison of your (inaudible) business or whether there's some differences that change the gross margins at G&A, but it seems like you guys are leaner on sales and marketing, which (inaudible), but you're a little higher by a margin on R&D. The part that you classify as R&D is about $8 million on 92 million in revenue.

Could you speak a little about where that comes from and based on what businesses you're acquiring with EasyLink, are there still cost subsidies that are going to be made in the next year or do you think they've all been made? Are you running as lean as you planed to be in that area or do you plan on making additional cuts in that area going forward?

Glen Shipley

A couple of things, Tom. First of all, I can't speak specifically to the inner workings of J2, but from what I know about the company, their model is considerably different than ours. They do most of their business, as you probably know, over the internet, they have acquired most of the technology that they use in the business, as you may recall, they acquired a business from us, they don't typically use an outbound sales force to the same extent we do, and their business model is to be a leader in the small and home faxing business, which is very different from the enterprise level business that we support. So the models are slightly different and probably would result in a different set of metrics.

From the synergy point of view, we took advantage certainly of the low hanging fruit in the synergies when we made the acquisition of EasyLink. We absolutely believe that we can become more operationally efficient, which should result in additional savings on our operational costs.

Our development expense is primarily related to work that is done to both maintain the performance of our networks as well as do customized work for clients that are looking for specific workflow management applications for their faxing services or looking for some specific arrangements on their EDI platform.

So that's where we make those investments and I don't anticipate a tremendous reduction in that area. In fact, I would hope that as our business continues to grow, we will continue to be challenged to do those things.

Tom Horn- Acorn Capital

Thank you.

Operator

Our next question from comes from Warren Duffy, private investor.

Warren Duffy – Private Investor

Hi, certainly I'm thrilled with the overall results and future projections and I know that there's some questions about what will happen. The stock price is down so low and I can understand the market conditions, margin call, risk erosion but how low does the stock have to go before the two of you would be willing to buy shares on the open market?

Glen Shipley

Well we would be more than willing and would have been more than willing other than the past few weeks to make acquisitions, but as it turns out, we have a pretty tight insider purchasing arrangement and the window of opportunity is pretty small for us actually and that is further complicated by the fact that because of our strategy and our aggressive implementation of our acquisition strategy, it seems that we hardly ever get out of the situation of having an insider knowledge that we can't trade on but just on the side, not directly related to your question, but the company is executing on its buyback program and we have been relatively active in the market for the last couple of weeks using that avenue.

Warren Duffy – Private Investor

Okay.

Operator

We'll go next to Sam Heely (ph) of (inaudible) Capital.

Sam Heely

Hi guys. I just have a quick question regarding the acquisition strategy. There's no doubt that the EasyLink acquisition was terrific for top line and for EBITDA and for going forward, but the way it was structured clearly the arrangement with York has placed an overhang on the equity price.

So my question is sort of seeing how with your projected hopes of 250 million in revenues, one can assume that you're looking at either several or a large or whatever type of acquisition going forward.

What have you learned or what would you do differently or what's your plan in terms of financing so that we don't increase the overhang or don't do a great top line spending and then have another headwind that we have to tackle.

Thomas J. Stallings

Good question Sam. I think a couple of things. In order to get to 250 million by 2010, certainly we'll have to make very significant, at least a very significant transaction and I think that we actually spent a good deal of time in 2008 working towards that end only to get caught in the financial crunch toward the end of that work.

What we have learned is that York Capital is a very supportive financial partner and through the exercises that we've been through looking at possible acquisitions, they have been very forthcoming in suggesting that they're willing to come forward and restructure their position with the company.

And we believe that when the debt market straightens out a little bit that, and hopefully it will soon, that the next structure would be a more traditional debt structure that wouldn't create the overhang.

Sam Heely

And just a quick follow-up on that line, given the difficulty for financing and also the increased value of liquidity these days, are the prices on some of the targets coming down?

Thomas J. Stallings

Well you would think they would have to of course, but there appears to be, based on the work that we continue to do, there appears to be two approaches that people are taking. One is just to hunker down and hold on to what they have, continue to operate their business and try to manage through the storm here.

The other is to be more open minded toward acquisitions and of course, we believe that we can continue to look at smaller acquisitions with our existing cash and we have engaged in a number of conversations with some smaller businesses that would be open to such a transaction and those that are interested in the second strategy, that of making a transaction happen, are pretty open minded about the current price.

Sam Heely

Okay. Thank you guys. Good luck.

Thomas J. Stallings

Thank you.

Operator

(Operator Instructions) We'll go next to Brian Morgan (ph) from Reely & Bennett (ph).

Brian Morgan - Reely & Bennett

Hi, thanks for taking my question. Can you just review for us the maturities on your debt and just maybe talk in broad terms about what constraints you see, if any, from the capital structure and whether you're comfortable with the way things are currently structured and whether you see that impinging on your ability to do acquisitions at all at this point.

Glen Shipley

Hi, this is Glen. The structure of the debt is such that beginning in March, we will begin to make principle payments over the following 30 months, in approximately $2 million a year, excuse me, $2 million a month, correct.

Those payments can be taken at the option of the York entities in stock. However, given today's share price, it would be not very likely in that their conversion price is $3.04. We're clearly under that number. They also are limited to holding only 9.9% of the current structure in any one time. So we anticipate actually beginning to make those payments at that time.

York, again, as Tom has indicated, is quite flexible in terms of wanting the company to grow. So should the opportunities occur, that might change or call for a change in the current structure. We feel like there certainly is an opportunity to discuss that with them.

Thomas J. Stallings

We also ran out a model of the business assuming a flat business going forward assuming no growth and current expense levels just to create comfort for ourselves that we would be in a position at that level of business to support the debt if we had to pay the monthly payments in cash and there was no problem in servicing the debt assuming the payments ran out through the remaining 30 months starting in March.

Brian Morgan - Reely & Bennett

Okay. And are there any interest coverage covenants or total debt to equity crisis coming?

Glen Shipley

Yes. Yes. There are. Our models indicate we stay well above it. Obviously even as we make payments, those ratios even increase much faster.

Thomas J. Stallings

We've exceeded the revenue and even the target significantly and would again assuming a flat business going forward.

Brian Morgan - Reely & Bennett

Okay. So are you at a point where you think that if you had access to more capital, there are deals to do today or are people just kind of sufficiently frozen by the uncertainty out there that kind of the M&A is generally off the table for the time being.

Thomas J. Stallings

Oh I don't think so at all. I think we had access to capital that there are a number of transactions we could do very quickly.

Brian Morgan - Reely & Bennett

Okay. Thank you.

Operator

(Operator Instructions). We'll go back to Tom Horn from Acorn Capital.

Tom Horn – Acorn Capital Group

I just had one follow up question. I was just looking at the proforma you put together on each (inaudible) of the 10K and is that the numbers that you put together for a fully diluted net income and net income versus not (inaudible), is the net income fully diluted without having backed out interest. Is that correct?

Glen Shipley

No. You've got to remember that proforma is done to high prescribed processes on every rule and regulations of the SEC. It is an attempt to say what would it look like if these companies, if they combine beginning in fiscal 2006 through the end of 2008, the assumptions underlying that do not include many of the standard adjustments you would make in a proforma.

Tom Horn – Acorn Capital Group

Okay.

Operator

It appears that we have no further questions on the phone at this time.

Glen Shipley

Thank you. Well as always, thank you for your continued interest and support of the company. It's greatly appreciated. We look forward to sharing the positive results of our efforts and your investments EasyLink during 2009. Thanks and have a great day.

Operator

And again ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may disconnect at this time.

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