Ditech Networks, Inc. F3Q09 (Qtr End 01/31/09) Earnings Call Transcript

Ditech Networks, Inc. (DITC)

F3Q09 Earnings Call

February 19, 2009 4:30 pm ET

Executives

Bill Tamblyn – Chief Financial Officer, Executive Vice President

Todd Simpson – President and Chief Executive Officer

Analysts

None

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ditech Networks third quarter fiscal year 2009 earnings release conference call. (Operator Instructions) I would now like to introduce your opening speaker for today, Chief Financial Officer Bill Tamblyn.

Bill Tamblyn

Thank you very much. Good afternoon everyone. Thank you for joining us for this conference call, which will cover Ditech Networks' announcement of results for its fiscal 2009 third quarter. Today's conference call will cover our financial results for the quarter and our outlook for the fourth quarter of fiscal 2009. Todd Simpson, Ditech's President and CEO, will provide the business and strategic analysis; and I will provide a more detailed analysis of the financials. Following the update, we will open up the call for Q and A.

Before we begin, let me state that this conference call is being held on February 19, 2009; and any sound recording or republishing of the content of this conference call is expressly forbidden without the written approval of Ditech Networks.

Also, we must point out that as with similar presentations, the following discussion contains forwardlooking statements, in particular the financial projections of our fourth quarter 2009 and the development of our mStage product that involve risks and uncertainties. Our actual results may differ materially from those discussed here.

We will attempt to identify such forwardlooking statements with qualifying words such as we intend, plan, believe, estimate, or predict or we may, could, or will or other comparable language. Factors that could cause results to differ include factors discussed today in this conference call and in our press release today, as well as those detailed in the section entitled "Future Growth and Operating Results Subject to Risk" in Ditech's Form 10Q for the quarter ended October 31, 2008, filed December 8, 2008, with the Securities and Exchange Commission.

We assume no obligation to update these projections or other forwardlooking statements. Additionally, let me comment on our approach to governance and the SEC compliance. Please allow me to mention that we have no offbalancesheet entities or associations. We believe we have to the best of our knowledge disclosed all other obligations and related party transactions as required.

Our auditors do not perform consulting services for us, such as system reviews, IT reviews, or other forms of consulting services. We comply with all effective SEC and NASDAQ requirements related to audit committee compliance and independence. We continue to adhere to SarbanesOxley compliance requirements.

Our discussion today of our operating results will be on a nonGAAP basis. Our press release posted on our website includes a summary reconciliation between our nonGAAP and GAAP results for Q3. The primary adjustments in Q3 2009 are the elimination of approximately $135,000 related to stock compensation and approximately $485,000 of restructuring charges.

Today's announcement was released over the wire this afternoon in a press release, and you may also read it on Ditech's website by going to the investors section of the site at www.ditechnetworks.com. NonGAAP financial measures will be discussed on the call, and a reconciliation again to the GAAP and nonGAAP financial measures is disclosed in our press release of today as well as in our press release of November 20, 2008, with respect to our fiscal Q2 numbers for 2009, which is also located in the Ditech Networks website.

With that, I would like to turn the call over to Todd to comment on our announcement and our strategy going forward. Todd.

Todd Simpson

Thanks, Bill. Good afternoon everyone, and welcome. So if you have been watching our recent news, you have seen that we formally announced the next generation of solutions we are developed, namely mStage. We did this in anticipation of the Mobile World Congress trade show, the largest such show for the mobile industry.

MStage positions Ditech as an enabler of revenue generating voice applications to complement our existing voice quality and transcoding solutions. The response to mStage, both before and during Mobile World Congress, has been excellent. Our release has been covered by dozens of news outlets, industry analysts, and industry blogs.

Further, our direction has received support from many large players in the industry, including some of our existing customers as well as prospective customers. The renowned mobile industry analyst Andrew Seybold commented that, and I quote, "with mStage, Ditech is taking the logical step of handing voice applications over to the experts, the carriers. By combining a networkbased solution with an open API, carriers will be able to offer a seamless, always on, voice application to the subscriber."

With mStage, Ditech can help to enable the convergence of voice communications with web and enterprise services. It will allow carriers and application developers to manage, manipulate, and enhance voice conversations with a great deal of flexibility and control. MStage will create a bridge between voice and webbased applications, including both enterprise and social networking. In short, mStage allows application developers to break down the barriers to social interactions that currently exist when we use the phone.

I will talk some more about the details of mStage, but let me first review our last quarter and our VQA business. We executed the last quarter very much in line with what we indicated in our previous call. Revenue was up from the previous two quarters to $4.9 million and cash used in operations was on target, including the onetime restructuring and severance costs. We expect revenue in the current quarter to be flat to up about 15%. Bill will give more details on this later.

To reiterate the shortterm philosophy outlined in the last call, we are focused on running VQA optimally, controlling costs, and investing in our mStage initiative. Specifically on the VQA business, international TDM sales were a significant contributor to our revenue in the last two quarters. We announced a significant provider, Qtel, in the quarter and delivered additional equipment to several previous customers as they build out their VQA deployments. The activities with our PVP for the IP networks are increasing in the mature telephony environments including both the U.S. and Europe. We anticipate the potential for an increase in PVP revenue this calendar year.

We have also seen and expect to see repeat purchases from our existing customers. Last quarter, we announced a smaller version of the PVP and expect to sign up our first customer for that product soon. More of our TDM customers are looking at our IP offerings as they start to transition their networks.

Our VQA business is the leverage point for launching the mStage initiative. Not only will we be using our existing relationships and channels to sell mStage, but we also leveraged a great deal of software technology, including our voice quality algorithms and high availability infrastructure from our PVP in creating the mStage platform.

The name mStage is a shortened form of media stage, the location where new and innovative media applications can be played out. MStage is being designed to support revenue-generating applications whereas our existing products provide savings in capital and operating expense. Thus, mStage is a fundamentally different value proposition to our carrier customers and one that they have encouraged us to offer.

Unique to our mStage approach is its alwayson capabilities, which will allow for innovative and cost effective voice applications to be evoked at any time, before a call, during a call, or after a call. This more closely represents natural human interaction in facetoface environments, a clear goal of communication systems within both the business and social networking domains.

We believe the market for voice applications is expanding as witnessed by an array of innovative offerings now in the market and through increased traction by signaling vendors offering data and web integration. Analysts project the convergence of web 2.0 voice applications and more traditional unified communications to grow into a multibillion-dollar industry. Further, we believe large telecom providers have an excellent opportunity to capitalize on incremental voice revenue as these new and innovative solutions come to market. MStage is specifically designed to enhance, enable, and accelerate those opportunities.

Other players in this space have focused on extending signaling capabilities to allow for innovations. We believe there is as much room for innovation in the media path as there is within signaling and that the combination of the two will be very compelling.

Our mStage platform is designed to meet three market needs: First, to allow for the widespread deployment of innovative voice applications within a carrier on a cost effective basis; second, to allow for flexible business models, spanning the spectrum from software as a service through revenue sharing, through traditional platform sales; and third, to allow for rapid innovation within voice services. We expect to see a wide variety of applications that appeal to different market segments. MStage will allow enterprises and web developers to rapidly develop and deploy customized voice applications.

The idea behind mStage evolved from conversations with our customers, with thought leaders, and with industry analysts. Many constituents feel that voice has not yet realized its full potential and, far from being a commodity, voice can be used to differentiate within a competitive market. As voice starts to tie together rich data and video services, its universality has the potential to pay large dividends. Voice works well in smart phones, but also on the lowest end handsets, making its market potential as large as the distributed base of phones worldwide.

Examples of possible mStage applications abound from business centric to end user focused. For business applications, an increased focus is being put on extending the reach of existing applications, such as [GSM] or sales force management or customized enterprise applications.

MStage allows for intelligent conferencing, voice dialing, calendar and email functions while in a call. Have you ever wanted to whisper a reminder or a suggestion to a colleague while on a conference call? Have you ever wanted to conference in another party without touching a keypad? Have you ever wanted to capture an important action item while you were driving? With mStage, you will be able to do so.

For end users, mStage will bring many web applications to life. Integrating locationbased services and social networking with mStage can extend the reach of social networks even to areas with no data connectivity. You want to see when your friends are on a call then asked to be included? You want to have background music, based on your personalized play list, to your phone calls? You want to hear updates to your face book wall or twitter stream when they occur, even if you are on the phone? With mStage, you will be able to do so.

The response to this new direction from potential customers and industry analysts has been positive and supportive. As well as providing for leading edge applications, mStage will give a carrier the ability to differentiate, add value to, and upsell voice applications to their existing consumer base.

MStage capabilities will allow carriers to easily brand an array of services, giving users unprecedented ease of access to advanced voice capabilities. Instead of using multiple points of entry to a vast and confusing array of voice services, you will be able to use mStage to create a ubiquitous voice portal, making it easy and valuable to end users.

We currently expect the mStage platform to be available for customer trials in the summer time frame. The platform leverages Ditech's experience in both voice and tier 1 platforms. Our experience building the PVP has been highly leveraged in the mStage software developed and design. We have a long history of deploying voice platforms at the edge of large networks.

To make the applications I have noted above inexpensive, ubiquitous, and high quality, we believe you need an edgebased media processing platform fine-tuned to the task. The tradeoffs between quality of service, bandwidth, latency, and ultimately usability, can be managed with mStage. Further, mStage has standard space interfaces, allowing for deployment in both existing as well as future network architectures.

To showcase the capabilities of mStage, we will also be announcing a service built on top of the platform. This service will be launched at the eComm conference in a couple of weeks. The approach of showcasing platform capabilities with an application is well validated in our industry. The application has several goals. It will prove the capabilities of the mStage platform and the web services API. It can be used to seed demand for some of the advanced applications I have outlined above. Finally, it provides a faster time to market for early adoption and use. The hosted software to service proposition is intended to expand Ditech's business model from being purely platform centric today towards recurring revenue streams in the future.

Several of our existing customers have already expressed interest in mStage and several are considering being early users of the hosted application. Thus, we are not only leveraging our intellectual property in building mStage, but also our customer contacts and existing relationships.

In summary, we are firmly on the strategic path that we have outlined over the last few quarters; and we are executing according to that plan. We are managing our VQA platform business at approximately cash break-even and we are investing judiciously in the future. I will hand the phone back over to Bill to discuss our financials.

Bill Tamblyn

Thank you, Todd. I would like to now share with you the final results for our third quarter of fiscal 2009 as well as our outlook for the fourth quarter of fiscal 2009. The key points of the third quarter results are on a nonGAAP basis as noted in our press release and are as follows.

Revenues were $4.9 million. The nonGAAP gross margin was 51%. The nonGAAP loss from operations was $3.6 million. The nonGAAP loss was $3.1 million. NonGAAP loss per share from continuing operations was $0.12 per share.

The third quarter nonGAAP details are as follows. Total revenue for the quarter was $4.9 million, up 19% from the prior quarter of $4.1 million and down from the $6.7 million for the same quarter of fiscal 2008. International revenues were $3.4 million or 70% of total revenues. We had three greater than 10% customers in Q3, and they approximated 72% of revenues.

NonGAAP gross profit for the quarter was $2.5 million or approximately 51% of revenues, up from the $2.1 million in the prior quarter. Gross profit is affected by our geographic mix and absorption of overheads based on smaller revenues. NonGAAP operating expenses were approximately $6.1 million for the quarter at the low end of our projections from the November conference call and down from $7.1 million in the prior quarter.

The details of the operating expenses for each area are as follows. NonGAAP sales and marketing expense was $2.2 million. This was a decrease of $350,000 from the prior quarter due to reduced trade show activities internationally, lower commissions, and lower head counts and marketing activities.

NonGAAP R&D expense was $2.7 million supporting our sustaining and new activities. This was down from our Q2 levels by approximately $300,000.

NonGAAP G&A was $1.1 million, down from the prior quarter of $1.4 million and approximated the levels expected based primarily on lower legal and accounting costs and head count.

Other income expense approximated income of $346,000 and is primarily due to interest income.

NonGAAP pretax operating loss was $3.2 million versus the nonGAAP loss of $5.2 million last quarter. The nonGAAP income taxes, the expense is primarily tied to the alternative minimum tax and foreign taxes. Our nonGAAP net loss was $3.1 million, which is $0.12 per share, compared to the $5.2 million or $0.20 per share in the prior quarter.

To reiterate, all the operating results that I have given you are on a nonGAAP basis. Please refer to our press release for the second quarter fiscal 2009 and third quarter of fiscal 2008 comparative GAAP results as well as the reconciliations of the nonGAAP results to our GAAP results.

Moving on to the balance sheet and cash flows, which are on a GAAP basis, cash equivalents, shortterm and longterm investments at quarterend totaled $49.2 million, a $7.2 million reduction from the prior quarter. This was approximately $700,000 less than our prior projections of $50 million and was primarily related to changes in working capital.

Cash used in operations before working capital adjustments was approximately $2.8 million for the quarter. This approximated our expectations. With the working capital adjustments, the use of cash was approximately $7.2 million. The majority of working capital adjustments were accounts receivable, inventories, and deferred revenues.

At quarterend, accounts receivable was approximately $4.2 million. This was a $2.3 million increase from the prior quarter. DSOs in Q3 exceeded our longterm expectations at approximately 77 days, compared to 42 days in the last quarter. As we have referred to many times, we would expect our longterm target to be approximately 45 to 55 days. Let me emphasize that our DSO numbers are subject to change. The timing of sales and shipments in any given quarter is always subject to fluctuations.

Net inventory was $14.3 million at quarterend, up $600,000 from the prior quarter of $13.7 million. With reduced revenues, we did not utilize greater amounts of inventory. At quarterend, we believe the remaining inventory is still usable based on our forecasts.

Gross deferred revenue at January 31, approximated $3.5 million, up approximately $450,000 from our prior quarter. Capital spending was approximately $200,000 in the quarter. Depreciation and amortization approximated $585,000. We ended the quarter with 106 employees, down from 118 in the last quarter and 143 in the July 2008 quarter. We continue to look at head count and operating expense efficiencies as we move forward.

I will now review our GAAP projections for the fourth quarter of fiscal 2009. In this regard, please note this cautionary statements regarding these forwardlooking statements that we gave at the beginning of the call. Our Q4 revenue outlook is derived from existing backlog, deferred revenues, and our bookings forecast. Therefore, we project them to be flat to up approximately 15% from the $4.9 million at the Q3 level.

We believe gross margins could be better than Q3 levels by 5% to 8% before any reserve is needed. This approximates 54% to 58%. This may vary based on product, customer mix, and revenue levels. Regarding operating expenses, we are continuing to maintain our TDM and platform businesses at a targeted cash breakeven basis. Therefore, we are moving staff to new initiatives as appropriate.

Operating expense in the fourth quarter will be tied to customer and channel mix as well as supporting our new initiatives that Todd spoke of earlier. Overall, we would expect our GAAP operating expenses, including an estimated $300,000 of stockbased compensation to approximate $6.3 million to $6.6 million. This would be approximately flat to down $300,000 below the third quarter level.

Our tax rate should approximate a range of 2% to 3% due to our loss situation. Deferred revenues at the end of Q4 are approximated to be $2 million to $3 million within the range of the past couple of quarters.

Additionally, a couple of other data points for you. Weighted average shares should continue to be calculated on a basic basis due to our losses and therefore approximate 26 million shares.

Based on projected revenues and operating expenses, we believe that operations will consume approximately $2 million in cash, including anticipated working capital changes.

Auction rate securities, since the end of Q2, we have reduced our auction rate exposure by approximately $4.8 million all redeemed at par. As a result, we would continue to have one auction rate at $4 million par which is valued at 92% of par on our balance sheet and one auction rate at $10 million par which is valued at 44% of par on our balance sheet and which is the only auction rate with a write down in value that ran through our income statement.

We will continue to monitor and work with our banks to monetize these remaining auction rates as quickly as we can and best case and par as we have down with all our other auction rates to date. However, we could experience further declines in the value of these auction rates due to the continually changing financial markets. At January 31, we have a net $8.2 million of auction rates, down from over $50 million for the same quarter last year.

Looking at Q3 as a whole, small steps forward on revenue growth while we are watching our operating expenses and cash flows, addressing opportunities and investing judiciously in our future product offering.

As discussed last quarter, we have commenced speaking on mStage and we look to commence hosting our new applications in the next couple of months.

In looking at Q4, we still have shortterm concerns on transaction timing, but we do see opportunity improvement to provide potential growth in revenues. We will continue to focus on our cash flows. With those comments, back to you, Todd.

Todd Simpson

Thanks, Bill. We are now ready to take questions.

Operator

(Operator Instructions) We have no questions in the queue, please continue.

Todd Simpson

If there are no questions, we will sum up. Thanks everyone for joining us on the call today. I did just get back from Barcelona and the Mobile World Congress, and feedback on our mStage initiative was extremely encouraging. We look forward to updating you on our progress with regards to mStage and the core business in the next call. If you want to call either Bill or I after this, please feel free to do so.

Operator

Thank you, gentlemen. Ladies and gentlemen, today's conference call is being made available for replay starting today at 3:30 p.m. in the Pacific time zone running for three months until May 19, 2009. You can access our service by dialing (800)4756701 or internationally (320)3653844 and at the voice prompt enter today's conference access code 984504. That does conclude our conference for this afternoon, thank you for your participation. You may now disconnect.

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