Telanetix, Inc. Q3 2008 Earnings Call Transcript

Nov.12.08 | About: Telanetix, Inc. (TNIX)

Telanetix, Inc. (TNXI) Q3 2008 Earnings Call November 12, 2008 1:00 PM ET

Executives

Kirsten Chapman – Investor Relations, Lippert/Heilshorn & Associates

Doug Johnson – Chairman and Chief Executive Officer

Paul Quinn – Chief Financial Officer

Analysts

Manuel Recarey - Kaufman Bros., LP

Len Goldberg - Goldberg Capital Management

[Jack Morback] - First Washington Corporation

Operator

Ladies and gentlemen, welcome to the Telanetix third quarter 2008 conference call. My name is [Tanya] and I will be your coordinator for today. (Operator Instructions)

I would now like to turn the presentation over to your host for today's call, Kirsten Chapman. Ms. Chapman, please proceed.

Kirsten Chapman

Thank you, Tanya. I would like to thank everyone again for joining us today on the third quarter 2008 conference call for Telanetix, Inc. With us on the call today from management are Doug Johnson, Chairman and CEO, and Paul Quinn, CFO. Before I turn the call over to management I will read a short safe harbor statement:

Current statements contained in this call that are forward-looking statements within the meaning of applicable federal securities laws including, without limitation, anything relating to or referring to future results and plans for future business development are thus prospective. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified based on current expectations. Such risks and uncertainties include, without limitation, the risks and uncertainties set forth from time to time in reports filed by the company with the Securities and Exchange Commission.

Although the company believes expectations reflected in the forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Consequently, future events and actual results could differ materially from those set forth in and compensated by or underlying in the following forward-looking statements contained herein. The company undertakes no obligation to publicly release statements made to reflect events or circumstances after November 12, 2008.

Before the company reviews the financials, I will define some metrics which are not in accordance with generally accepted accounting principals, commonly known as GAAP. Management believes certain non-GAAP measures may provide relevant and meaningful measures to evaluate the business. EBITDA is defined as earnings or loss before interest, income tax, depreciation and amortization, and the company defines adjusted EBITDA as EBITDA adjusted for non-cash items, including share-based and warrant compensation, severance costs, charges related to Series A preferred stock, and changes in fair market value of warrants and beneficial conversion feature liabilities.

Also, the company reviews voice revenue in two categories - Core Voice business and a legacy product that is a product we refer to as Enterprise Smart Number, for large enterprise markets. While Enterprise Smart Number has a profitable stable business, its sales cycles are very long and the model is not leveragable. Therefore, Telanetix no longer markets this product and does not have associated sales and marketing expenses and expects the product's revenue contribution to decrease over the extended term. While the legacy product is expected to moderately temper overall sales, it is important to note it is profitable.

On today's call, Doug Johnson, Chairman and CEO, will review the company' s accomplishments and Paul Quinn, CFO, will review the financial results. Then Doug will deliver closing remarks and open the call for questions.

It is now my pleasure to introduce to you Doug Johnson. Please go ahead, Doug.

Doug Johnson

Thank you, Kirsten, and thank you all for joining us today.

I'd like to begin my remarks by reminding everyone that we have set as our overarching goal to achieve sustainable profitable revenue growth. During the third quarter our Video products improved and our voice sales continued to perform well. Revenue grew 6.2% to $8.5 million over last quarter. Core Voice services revenue grew 8.6% in the quarter, while Video revenue grew 6.4%. Also, total gross margins grew 660 basis points to 53.4% from 46.8% just a quarter ago.

Even as the economic environment has become challenging, our Core Voice line count has grown sequentially quarter-over-quarter by 7%. In addition, we generated another strong quarter in low customer churn of 1.9%. We are proud of our voice team and its commitment to customer sales and customer service.

With respect to our capital structure we were very pleased to have accomplished a major transformation as highlighted on our last call in August. We increased our new debt facility by $2 million and radically altered the terms of the debentures, specifically lowering debt service requirements, extending the debenture term, fixing the interest rate, and removing the ratchet provision. As a result, we materially reduced the cash use for debt service and created more flexibility in our near-term working capital.

In addition, we implemented organizational changes to drive profitable growth. The steps include headcount reductions, product-based P&L accountability, consolidated health plans, and the integration of offices. As a result, SG&A improved to $4.4 million in the quarter, including $715,000 in share-based compensation from $6.0 million last quarter, which included $1.6 million in share-based compensation.

I am proud of our progress. We've reduced costs while simultaneously growing the top line. Combined with our debt restructuring, we improved our adjusted EBITDA to a loss of $138,000 from a loss of $1.3 million last quarter, an improvement of more than $1 million over one quarter. As such, we believe our cash requirements to fund growth going forward will be manageable.

I would now like to address the impact of the broader economic environment on the state of our business. First, we understand the current market challenges increase the need for companies to operate even more efficiently, and we meet this need with our products and offers. Telanetix delivers low-cost IP-based communication services via broadband that can easily be integrated into existing customer's businesses, instantly creating cost savings for our customers. Therefore, demand for our products can be countercyclical to the current economic environment.

With respect to the impact of this environment on our existing customer base, we continue to maintain close relationships with our customers and offer best in class, affordable communication solutions, so we are hopeful. However, it's frankly too early to estimate the length and depth of the economic woes and to early for us to estimate the impact on our customers' business.

Now I will review the businesses by product segment.

First, in our Voice business in the third quarter we successfully launched a key channel component to our digital phone service, which is also known as DPS, which is targeted at the small business market. We partnered with Costco Wholesale, where we were proud to be named as Costco's Service Provider of the Month in July. We are in a precedent-setting position with this product and are excited about the growth prospects. In 2009, we plan to aggressively increase the related channels for DPS and continue to ramp DPS sales.

Also in our Voice business, we've made continued strong progress in improving our gross margins. We have reached a point of critical mass that has enabled us to review custom profitability and pricing. During the quarter we made changes implementing selective price increases and discontinuing marginal relationships. Additionally, our network engineering team put forth an outstanding effort to further tailor our network to capitalize on lower cost of service delivery options.

As a result of these actions, combined with DPS and ongoing customer wins, we drove Core Voice revenue growth 8.6% and we improved our Voice gross margins by 590 basis points from 53.4% in the second quarter to 59.3% in the third quarter.

While we do not anticipate this rate of change to continue, we will continually be focused on improvements of our gross margins to contribute to the profitable growth of Telanetix.

Now for a Video business update. Right before our last conference call in August, to improve our Video go to market distribution strategy, we hired J.D. Vaughn as our Vice President of Worldwide Telepresence Sales. As a part of his Video sales expansion plan, in October we augmented our team with three veteran Telepresence sales leaders who earned their stripes at RADVision, Polycom and CoreNetworks, to name just a few. Their aim will be to further develop Telanetix Video distribution channels, and we believe that these changes will have a meaningful impact on our Video sales in 2009.

As a result of our improved revenue mix between Video software and Video installation services, our Video gross margins increased 910 basis points to 29.9% from 20.8% in the second quarter.

In September we launched the Telanetix Video Represence Program. This new upgrade program layers our full Telepresence functionality into existing videoconference rooms regardless of their existing hardware. We can extend the life expectancy and in essence reduce the overall expense for a company wishing to deploy full Telepresence solutions.

There are today approximately 7,000 of these media rooms in existence among the Fortune 2000. Using Telanetix Represence allows companies to extend and upgrade those rooms with a cost savings of more than 80%. A typical upgrade to Telepresence can cost a potential customer more than $300,000. Comparatively, the MSRP for the Represence programs begins at $29,900. Further, our competitors have limitations on the way their Telepresence rooms are set up, severely limiting their ability to offer an upgrade program like Represence.

Further expanding on our low cost, IP-based communication services, last week we launched a new product for training facilities and large group Telepresence sessions called ICE, which stands for Immersive Collaboration Environment. ICE supports an unlimited number of conference participants per site with a flexible room design and brings a fundamental change to the cost effectiveness of virtual training. To achieve a similar installation, competitors require complex construction that takes months and requires building permits and actual on-site construction.

The ICE product is assembled in three to four days at less than half the price of the competitors' Telepresence room construction. Competitors' Telepresence rooms and equipment are priced at approximately $400,000 to $600,000 with annual maintenance fees adding another $150,000 per year. ICE is offered at a price point less than $300,000 with maintenance fees of less than $20,000, representing a savings of 30% to 50% and a much more rapid deployment timeframe. Customers will save initially on purchase and installation and on travel-related training expenses such as airfare and so on on an ongoing basis.

In summary, I am proud of our progress in the third quarter and, more importantly, our Voice and Video business exhibited sequential revenue growth amidst a difficult economic environment. Also, our Video business, now with the right resources and talent in place, is in a great position to capitalize on the opportunity of this emerging market.

Now before I turn the call over to Paul, I would invite you to take a look at our new website at www.Telanetix.com, where we have created a new brand for our company and our products and also where we describe how our communications software that we've built from the ground up delivers cutting-edge services in Video and in Voice.

And now I will turn the call over to Paul, who will provide you with great financial detail.

Paul Quinn

Thank you, Doug. Now to our financial results for the third quarter of 2008. I'll provide comparisons to the second quarter of 2008 as they are more relevant due to acquisitions made in 2007.

Third quarter 2008 revenues were $8.5 million, up 6.2% sequentially compared to $8 million, reflecting strong Core Voice growth. Video accounted for 20% of revenues or $1.7 million, slightly better than $1.6 million last quarter.

Voice accounted for 80% of revenues at $6.8 million, up from $6.4 million in the second quarter. We discuss our Voice revenue in two categories - Core Voice business and legacy product we refer to Enterprise Smart Number.

In the third quarter, Core Voice products grew 8.6%, which offset the more modest non-Core 1.6% increase in revenue from the Enterprise Smart Number product. In addition, the overwhelming majority of our Voice revenue is recurring revenue.

Operating metrics for the period are as follows:

The number of lines for our Core Voice business during the quarter was approximately 81,200, up 7% from approximately 75,700 last quarter.

The churn for our Core Voice products during the quarter was 1.9%, down from the 2.2% last quarter. The low churn indicates we continue to have a best in class quality of voice service level. And while we are very pleased with our best in class low churn numbers, as we look at the current macroeconomic conditions, it's certainly possible those conditions can impact our churn numbers negatively in the fourth quarter.

Gross profit was $4.5 million or 53.4% of revenues compared to the second quarter 2008 results of $3.7 million or 46.8% of revenues due to Core Voice growth, selective Voice price increases, and margin improvements in both Voice and Video.

Voice and Network Services gross profit was $4 million or 59.3% of revenues compared to 53.4% in the second quarter. We continue to make major progress in reducing the cost of delivering our Voice services. This is both in terms of negotiating with our network providers to lower their costs and as we continue to grow, we better leverage the costs of our fixed infrastructure.

Video gross profit improved to 29.9% of revenues compared to 20.8% in the second quarter. The increase reflects a more normalized mix of Video software and installation revenue and better-managed installation process.

On to expenses. As noted last quarter, we integrated offices to increase synergies and reduce costs during the quarter. SG&A was $4.4 million, including $715,000 in share-based compensation, and that was a decrease from $6 million last quarter, which included $1.6 million in share-based compensation. Our lower SG&A reflects the benefit of many cost saving initiatives; of note, consolidated health plans, reducing our vendors and lowering headcount.

For our plan to increase advertising during the quarter, our advertising expense was $457,000 compared to $367,000 in the second quarter. We expect advertising expense to decrease slightly in the fourth quarter as we pare back during the holiday season.

Research and development costs were $1.3 million compared to $1.8 million last quarter, which included $500,000 in severance.

Depreciation and amortization of intangible expense was $816,000 compared to $797,000 last quarter.

Total operating expense was $6.5 million, which included $775,000 of share-based compensation compared to second quarter total operating expense of $8.5 million, which included $2.4 million of share-based and warrant compensation and also included the $1.8 million in severance in that $2.4 million number.

Non-operating income related to the change in fair market valuation of derivative liabilities was $2.8 million compared to a non-operating income of $10.9 million last quarter.

Interest expense was $1.5 million compared to $1.7 million last quarter. And with the restructured debt during the quarter, we eliminated our principal payments and reduced our monthly obligations. We restructured our debt and no longer have preferred stock, which eliminated that cost compared to the $0.6 million last quarter.

Net loss was $619,000 or $0.02 per diluted share compared to net income in the second quarter which you'll recall included that recognition of the $10.9 million for the change in fair market value of derivative liabilities and that led to the $4.4 million of income in that quarter or $0.15 per share.

Third quarter 2008 adjusted EBITDA was a loss of $138,000 compared to a loss of $1.3 million last quarter. And as you can see, this is substantial improvement in EBITDA and it reflects the combination of strong revenue growth, improved gross margins, and the impact of our cost cutting programs.

The nine months ended September 30, 2008 revenue was $24.2 million. Net loss was $2.8 million.

Our cash and cash equivalents position was at September 30 a balance of $1.4 million.

Headcount at the end of the period was 141 compared to 145 at June 30.

And as we look to the fourth quarter, we don't expect the same rate of sequential improvement for two reasons. First, our fourth quarter is a seasonally lower revenue quarter on the Voice side of our business as part of our revenue model is based on customers' usage of their phones. As there are two major holidays in the quarter and businesses have slow weeks around those holidays, our usage - what we call true business days - are less than any other quarter of the year.

Second, while containing operating expenditures will continue to be a focus, we improved adjusted EBITDA by over $1 million from the second to the third quarter by in part implementing cost reductions in the beginning of July and we don't plan reductions of that same magnitude at this time.

I look forward to reporting our progress on our next call and, with that, I turn the call back to Doug.

Doug Johnson

Thank you, Paul.

So in closing, we are very excited about our progress in the third quarter and I'm pleased with the Telanetix management team's quick execution on improvements across the board. We accomplished some remarkable achievements, as we've mentioned. We've raised capital in tough times, we grew revenue, we increased gross margins, we reduced costs of operations and improved EBITDA materially, all in an obviously turbulent market.

We believe our strong foundation in Core Voice services, combined with the intelligent investments that we're making to improve distribution in our Video division, position us well to serve the business market in this difficult economic environment.

Today, although we are not giving specific guidance, we will say that we are confident that we'll continue to drive revenue growth and EBITDA progress and improve the health of our company.

With that, I'll turn the call over to the operator and facilitate the Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Manuel Recarey - Kaufman Bros., LP.

Manuel Recarey - Kaufman Bros., LP

You mentioned that on the EBITDA, you don't expect the same cost reductions that you implemented at the beginning of July. Are you still looking to reduce costs further or is that kind of behind us now?

Doug Johnson

There are some programs that we have in place - the material portion of the cost reductions are behind us. There are some programs that are still continuing to improve, most noteworthy is on the network side, the software that we have built can articulate through different providers and create kind of a low cost profile. The benefit of that is yet to be completely achieved, but the majority of it has been accomplished. From the headcount standpoint in the other parts of our business, I think the majority of it is done. Paul, any other?

Paul Quinn

Right, I think that's right. And I think, Manny, when we look at EBITDA improvement, thinking about how much we improved on in terms of strong revenue growth and strong margin growth, we're thinking that that's the driver for us going forward is to try to continue to improve in those areas as we demonstrated in Q3.

Manuel Recarey - Kaufman Bros., LP

Do you think you can be EBITDA positive in the fourth quarter? Is that a goal? Is that possible?

Doug Johnson

Well, what we've said, Manny, is that we are absolutely singularly focused on profitable growth in this business, and we believe that we can achieve that in the short term. And that's what we've said, so I haven't given any specific times to it because, you know, frankly, in this economic market, it's kind of hard to predict what the heck is going on with our customers.

So at this point in time, as we just reported, we have better churn than we've had. We seem like possibly we're countercyclical. But it's just too early to tell, so I think it's tough to predict.

Paul Quinn

But you can tell, Manny, from how much we improved in Q3 over Q2 that when Doug says it's a priority and it's a big focus for us. I think that's the key really for you and for our listeners is to say hey, you know, when these guys say it's a priority, it really means something. And that's what you see in our Q3 results and our focus is to deliver on that.

Manuel Recarey - Kaufman Bros., LP

Yes, the improvement was quite substantial and you guys should be commended for that. One last question on the Video side. I know you added a lot of senior management on the sales side there. Are there any metrics that you can give us as far as, like, resellers? You know, any color you can give us as far as expanding your distribution channel, maybe talk anything about the pipeline that you have on the Video side?

Doug Johnson

I'll say this, Manny. On the Video side, first off - I said this a quarter ago and I'm going to say it again - I think we have a heck of a great product. We do have a low-cost advantage; we do have a disruptive advantage. On the distribution side, we're in the process of rebuilding it as I've reported before and reported again. And as a consequence, it yields a real lumpiness in the short term.

We believe that we'll be making some good announcements in this fourth quarter that will begin to post some of the milestones that you'll be looking for, so I'll give you that, that we're definitely making progress. And [when I] inspect the details of this - but I just don't want to over promise and I frankly believe that the team that we have in place is really executing on the right game plan.

So I think inside the fourth quarter you're going to begin to see some of the milestones that you're looking for in terms of how our redistribution plan gets put in place.

Operator

(Operator Instructions) Your next question comes from Len Goldberg - Goldberg Capital Management.

Len Goldberg - Goldberg Capital Management

Could you give us a sense of the level of activity occurring out there on the Video side currently?

Doug Johnson

The level of activity?

Len Goldberg - Goldberg Capital Management

Yes, quotes you're getting, requests for quotes?

Doug Johnson

Len, I don't have - that's a particular metric that I can't quantify. I mean, I can quantify but I don't have it at my fingertips, but I'll give you some anecdotal information. The Represence press release that we dropped and product that we launched has been very well received. And I'll tell you that the sales cycle on Video, it's not measured in days or, unfortunately, even weeks. It takes some time to get a sale through the process.

So we have been pleased with the response to the Telepresence - excuse me, to the Represence  product launch and we know that the way the distribution model works in Video that the relationship that we have with resellers is going to drive the volume of transactions into our business. So one of the fundamental things that we need to do, as I've mentioned in the past, is rebuild that distribution strategy to take our product, which really has a disruptive advantage to it, and get it to market.

So what I watch and where I've got my finger on the pulse is how are we doing in rebuilding that distribution and when we do have the opportunity to get in front of a customer and make our pitch, like we did with St. Vincent this last quarter and win in a real competitive situation, that's a great signal and point of validation for us that this emerging market in Video, that we have a great opportunity.

So hopefully that gives you a little color around how I look at the activity management in this space.

Operator

Your next question comes from [Jack Morback] - First Washington Corporation.

Jack Morback - First Washington Corporation

Yes, sorry. I came into the call late and I just had one question and you might have answered, what the cash level is and what your current burn rate is?

Paul Quinn

Our cash level's $1.4 million and we're not projecting a burn rate. I guess what I'd say is Doug said our cash position is manageable and when you look at our greatly improved EBITDA position, I think you see that our cash position is manageable at the $1.4 million balance and our Q3 results indicate that we're driving towards that positive cash flow number.

Operator

Your next question comes from Manuel Recarey - Kaufman Bros., LP.

Manuel Recarey - Kaufman Bros., LP

Just to stay on the distribution side again, could you give any update on how you're cross-selling the video with the voice? Is that happening at all yet?

Doug Johnson

I tell you where it really is going, Manny, where it's really going, I think, to have impact is at the reseller level. I think that there are resellers that we are meeting with now, strategic potential partners that we're meeting with now that have relationships with customers where these two products, voice and video, which are such natural cousins because clearly everybody uses voice and has a voice need and we save people money and provide a lot of great and differentiation in terms of service levels on voice, and this new product, video, which is also an IP-based product.

What we are finding is that our channel partners are the strategic place where we're going to see that marriage of those two products become real. And I'll say hopefully, Manny, you'll be seeing something to that effect in this fourth quarter announced.

Operator

Ladies and gentlemen, we are at the end of our question-and-answer session. I would now like to turn the call over to Doug Johnson.

Doug Johnson

All right. Well, thank you for joining us today. As I mentioned before, the third quarter was a quarter of execution. We executed on a plan of delivering improvements across the board and we are very excited about it. We're very excited about our video and voice opportunities and we're confident that we'll continue to drive revenue growth and EBITDA progress and improve the health of this company.

So thank you all for joining and, on behalf of Paul and myself and the employees of Telanetix, who are working very, very hard to create a great company, we appreciate your support and we look forward to our fourth quarter update. Thank you very much.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.

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