Santeon's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Nov.14.13 | About: Santeon Group, (SANT)

Santeon Group, Inc. (OTCPK:SANT) Q3 2013 Results Earnings Call November 14, 2013 9:00 AM ET

Executives

Jeffrey Goldberger - KCSA Strategic Communications, IR

Ash Rofail - Chief Executive Officer

Mark Guirgis - Chief Financial Officer

Analysts

None

Operator

Good morning and welcome to the Santeon Group Inc. third quarter earnings conference call. All participants are in a listen-only mode. After today’s formal remarks, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I’d now like to turn the call over to Jeffrey Goldberger. Please go ahead.

Jeffrey Goldberger - KCSA Strategic Communications, IR

Thank you Maria, good morning and welcome to the Santeon third quarter 2013 earnings conference call. Again, my name is Jeffrey Goldberger and I am with KCSA Strategic Communications, investor relations counsel to Santeon. We hope you've had an opportunity to review the earnings release we issued earlier today.

As a reminder, some of the matters we will discuss on this call are forward-looking. You should keep in mind that these forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements and that such statements are not a guarantee of our future performance. Such risks and uncertainties include, but are not limited to, general economic conditions and those factors set forth in today's earnings release and discussed under the Risk Factors sections of our annual report on Form 10-K and quarterly reports on Form 10-Q and other SEC filings.

During our call today, we will reference certain non-GAAP financial measures, which we believe provide useful information for investors. We include reconciliations of those measures, where appropriate, to GAAP in our earnings release or on the Investor Relations section of our website at www.santeon.com.

Representing Santeon today are Dr. Ash Rofail, Chief Executive Officer, and Mark Guirgis, Chief Financial Officer.

Let me quickly outline the agenda for today's call. Ash will begin with a brief introduction to Santeon and an overview of our operating results. Mark will then take you through the financial details, including the income statement and balance sheet, along with key operational metrics for the three and nine months ended September 30, 2013. Following Mark’s comments, we’ll open the call for questions.

With those comments complete, allow me to turn the call over to Ash. The floor is all yours..

Ash Rofail - Chief Executive Officer

Thanks, Jeffrey, and thank you everyone for joining us on today’s call.

The past few months have been a busy and exciting time for everyone here at Santeon. We’ve made incredible strides in growing our business, and continue to add employees to keep up with customer demand. We’ve also taken definitive action to advance our long-term growth strategy. To that end, on October 31st we sold eBenefits Network to a group of investors, of which I am a member, for approximately $500,000 in cash. In return, the investment group will receive all of eBN’s assets, including its intellectual property and assume the significant investment responsibility to upgrade the platform. As part of the transaction, Santeon will provide personnel, accounting, IT, HR and other support services to eBN for at least six months under a Master Services Agreement. This agreement will provide incremental revenue to Santeon through the first half of 2014 and possibly even longer.

I want to explain the rationale behind this transaction. As part of long-term planning, we completed a top-to-bottom review of our operations. Based on our findings and further analysis, our management team and the Board of Directors concluded that although eBN holds great potential, it also requires significant investments, including the addition of a dedicated business development team and expansion of its infrastructure. Without these investments, continued growth would not be achievable. Since the business only contributes approximately 11% of our total revenues and an even smaller amount to the bottom line, and since any investment would likely take more than two years before it was accretive, we concluded that it made sense to review our options.

In August, shortly after reporting the second quarter results, we conducted a non-deal roadshow in New York, meeting with a significant number of institutional investors and financial advisory firms. During these meetings, we repeatedly fielded questions about our growth opportunities and the relationship between our Agile services and eBN businesses. The takeaway from those meetings confirmed some of the issues that were being discussed at the Board level, which also supported feedback we had previously received from existing investors on how the Company could unlock shareholder value, and that’s really key. As an emerging IT company with limited resources, we were having a difficult time meeting the increasing capital requirements of the eBN business as well as fund adequately the Agile and software development businesses. We found it especially challenging after determining that our Agile and outsourced software development businesses presented the most compelling and near-term growth opportunities to Santeon.

Divesting eBN to an investor group that has the necessary access to capital, investment experience and time horizon to help eBN meet its full potential will provide Santeon with a number of advantages. In the short term, Santeon will continue to benefit from eBN’s growth through the master services agreement, that in turn will allow Santeon to invest more heavily in Agile and software development areas. Perhaps more importantly, we believe deploying capital to these growth areas will allow investors to see a better return on invested capital and improved financial results, which should ultimately unlock value for shareholders.

During the third quarter, we continued to make significant progress towards our goal of becoming a leader in the Agile space. We added several new revenue generating employees to meet increasing demand as well as hired dedicated business development executives for both the commercial and government sectors. The business development folks bring a broad network of contacts and experience managing the RFP process that will be essential in helping us grow our pipeline of opportunities and secure more engagements. We think that those contacts and experience will be especially useful in the public sector, where the RFP process is more specialized. Our new head of government business development is a very seasoned business development executive with over 25 years of experience in this direct area. He began in mid-October and we expect him to lay the groundwork for some material contributions to the business in 2014.

Meanwhile, we continue to benefit from increasing demand for Agile services in the public sector. During the quarter, we began a high profile engagement with a government-sponsored enterprise and added revenue-generating consultants to our engagement with the US Customs and Immigration Services of the Department of Homeland Security and we continue to see an increasing number of opportunities in the commercial sector.

Overall, we’re very excited about the development of our business and we look forward to continuing to communicate with the investment community about our value proposition.

With that, I’ll turn the call over to Mark to discuss the financial highlights.

Mark Guirgis - Chief Financial Officer

Thank you, Ash, and good morning everyone and thanks for listening in today.

First, I’d like to speak about highlights of the profit and loss statement:

In the third quarter 2013, Santeon recorded revenue of $1.5 million, up 24% from the same quarter a year ago, and up 9.3% from the second quarter 2013. Third quarter 2013 revenue was comprised of the following: 57% Agile, 29% software development and 14% eBN revenues as compared to 68% Agile, 23% software development and 9% eBN in the year ago quarter.

Excluding eBN revenue, third quarter 2013 revenue mix was 66% Agile and 34% software development as compared to 74% Agile and 26% software development in the year ago quarter.

During the quarter, we continued to see strong demand from the federal and state government sectors for our services. The commercial vs. government mix of revenues for the third quarter 2013 was roughly 50% commercial and 50% government as compared to 73% commercial and 27% government in the year ago quarter. This shift in mix of commercial vs. government revenue is in line with the strategy we have been speaking to since our presentation at the MARCUM conference in New York City in late May. We see a significant opportunity for growth in the public sector and are dedicating significant resources to pursue that.

Our gross margin for the second quarter was 47.0% of revenue, a year-over-year decrease of 380 basis points from 50.8% of revenue last year. The decrease in gross margin is due to investments in revenue generating personnel that have yet to generate their full revenue potential. This is a temporary timing issue that we expect to reverse in the coming quarters.

SG&A expense increased 59% year-over-year but decreased 5% sequentially. The year-over-year increase is due to investments in support headcount, higher public company compliance and board expenses, stock option expense and administrative rent and associated expenses stemming from the new office lease that commenced April 1 of this year. Most significantly, we hired two full-time, experienced business development personnel to accelerate revenue growth in the commercial and government sectors. While these two persons do have experience in business development, we expect there to be a ramp up before we see material new revenue generation from them.

We measure the operational profitability of our company through Adjusted EBITDA. We have a table in the press release that reconciles reported Net Income to Adjusted EBITDA for the comparative three months and nine months ended September 30, 2013 and 2012. In the third quarter 2013, we reported approximately $20 thousand of Adjusted EBITDA, a decrease of 22%, as compared to approximately $184 thousand of Adjusted EBITDA in the third quarter 2012.

In the third quarter 2013, we reported net income of approximately $23 thousand as compared to net income of approximately $151 thousand in the year ago quarter.

Now, I’ll turn to some cash flow and balance sheet highlights:

For the nine months ended September 30, 2013, we generated approximately $110 thousand of cash from operations and used approximately $50 thousand of that in the purchase of property, plant and equipment and investments in capitalized software assets.

In addition, we used approximately $53 thousand to reduce debt and to purchase treasury stock. The net increase in cash for the nine months was approximately $7 thousand.

Our working capital position as of September 30, 2013 was a positive $135 thousand; said a different way, our current assets exceeded our current liabilities at a rate of 1.2 times. This is yet one more example of the improving and strengthening financial profile of the Company. Over the last two years, the Company has been very focused on funding its operations and growth needs through internally generated cash, while simultaneously reducing debt and strengthening the Company’s financial profile. We are proud to say that, while not done yet, we have been successful thus far in executing on this strategy.

With respect to the eBN transaction, on October 31st, we received $400,000 in cash with $100,000 held in escrow pending the legal assignment of all customer contracts that convey with the business. We expect that process to be complete in the next 3 – 4 weeks and the $100,000 to be remitted to us before December 31st. The total net cash from the transaction will be reflected on our balance sheet as of December 31, 2013.

Overall, we’re very pleased with our financial results for the quarter. The influx of cash from the eBN divestiture, which will show up on our balance sheet in the fourth quarter, will strengthen what is already a solid financial profile and give us the flexibility to pursue growth opportunities.

And now operator, please open up the call for questions…

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Robert Gorski, a private investor. Please go ahead.

Robert Gorski, Private Investor

Hey, Mark and Ash. Good morning.

Ash Rofail - Chief Executive Officer

Good morning.

Robert Gorski, Private Investor

Good morning. In the press release to sell eBN, you said that you saw Agile and outsourced software is the most compelling growth opportunities even though eBN has the most growth by far in Q3? eBN increased 98.4% and then Agile training, coaching and consulting revenue only increased 4%, while software development and revenue increased 53%?

Mark Guirgis - Chief Financial Officer

Yeah.

Ash Rofail - Chief Executive Officer

Okay.

Mark Guirgis - Chief Financial Officer

Yeah. Sorry. I thought you were going to continue. So this is Mark. How are you Robert? Hello?

Robert Gorski, Private Investor

Mark. Yeah. I am here.

Mark Guirgis - Chief Financial Officer

Yeah. Hi. Sorry. I wasn’t sure you heard me. So your point are valid Rob, I am not sure about the percentage growth that you are quoting. But, remember one thing, the eBN business is growing from a much smaller base of revenue than the software development or the Agile business. So in percentage terms, yes, it does seem dramatic, but you also have to remember the absolute numbers that you are dealing with.

So we do expect the eBN business to grow. We have been saying that all along. However, that growth comes at a pretty significant cost and that is one of the reasons why the company undertook this transaction. So I don’t disagree with your figures. I am just saying, keep in mind the absolute numbers that you are dealing with.

Robert Gorski, Private Investor

Okay. Fair enough. Let me ask this though, in the past year, you guys have been consistently spending more than you have been receiving in revenue growth, how come that is?

Mark Guirgis - Chief Financial Officer

Let me, sorry, when you say spending more, you are saying that our rate of expenses is growing faster than the rate of revenue growth?

Robert Gorski, Private Investor

Yes. SG&A was up 58.8% from the first three quarters in 2013 versus the first three quarters in 2012?

Mark Guirgis - Chief Financial Officer

Yeah. That’s a great question and it’s a good observation, Rob. And that is -- there are two answers to that. The first one is, we are a growth company. We are going to need to invest in revenue generating personnel, the infrastructure to support them and then also back office support personnel as we grow.

So the basic things like adding client service managers that are not billable, as well as revenue generating personnel. And while we would love to add half a person, you really can’t do that. So you are adding personnel ahead of revenue growth some time. But we are seeing revenue growth.

Robert Gorski, Private Investor

And…

Mark Guirgis - Chief Financial Officer

So the first thing I’d say.

Robert Gorski, Private Investor

And just…

Mark Guirgis - Chief Financial Officer

The first answer to your question, yes, we are a growth company. We are going to accelerate the expenses because we found that our incremental and very fiscally prudent approach of adding personnel at the very last second was in fact hurting revenue growth.

So that’s the first answer. The second answer is, a lot of that expense increase really was on the eBN side. So the eBN business as you pointed out has been growing rather dramatically, but the expense side of it was also growing dramatically, almost on a dollar for dollar basis year-over-year.

Robert Gorski, Private Investor

Okay. Okay. Fair enough. Ash, let me ask you a question. After the Q2 results, you said looking ahead, we are poised to continue our growth trajectory as more organizations look to drive operational efficiencies, but we’ve been nowhere near that 80% revenue growth per year like we were in 2011 and 2012, why is that?

Ash Rofail - Chief Executive Officer

Well, the demand is there. We did missed the first half of the year, not having invested in business development resources. We have lost 1 person that had the responsibility for driving the revenue and business development and so that did not materialize, and we are now really catching up to that and we are still growing and I am not happy at the rate that we are growing.

I definitely expected a much rapid and faster growth. I think we are catching up. We are making up that lost time. And governments, we expected also some proposal to and responses from some of the several bids that we submitted with the government furlough and shutdown that pushed the decision-making process towards the end of the year. So, I believe we will make up some of those losses because we know that the market is there and we are seeing that demand, it’s reflected in our pipeline.

Robert Gorski, Private Investor

Okay. I appreciate the answer, guys. The one thing I will say is I’m seeing this as a 4.5% shareholder. I don't think you guys have any revenue problem, I feel like you have a spending problem. I just feel like everyone is waiting and waiting and waiting for this revenue to start showing up to account for all the spending, that's just what I am seeing as a 4.5% shareholder.

Ash Rofail - Chief Executive Officer

Yeah. And, Rob, let me say, that’s kind of a -- is more a long-term strategic question, because the way the business is right now, it’s pretty heavy on the consulting and that's a very high cost. And it granted and put us in a very strong position because we are becoming the go-to when it comes to kind of the Agile consulting in the transformation and we see these large projects but the cost associated with that is very high.

We want to shift that where we are balancing some of these high cost resources with growth in the software development outsourcing, which is higher revenue, lower margins, cost are very low as well as platform and products where licensing and subscription based.

So, I think you will start to see some of that shift. But initially where the opportunities are and how we get into the door in order to build and continue to grow on add-on services. Yes, the cost is high. We are very actually sensitive to that. And part of the investment that the cash infusion that eBN brings is really to try to solve that formula of how do we lower our consulting cost and grow that margin, so that you are not really seeing that picture. We see it, we are very sensitive to it and we are kind of trying to transition from that into the model of outsourcing and the model of products and platforms.

Robert Gorski, Private Investor

Okay. Fair enough. And then last thing I promise -- as far as KCSA, I am sure it’s a great firm. I’m sure they have a lot to offer. It’s just the timing is wrong, right. You guys made $24,000 in the last quarter. You guys paid them $30,000. I know you know where I am coming from from, but at the same time I mean, I can proofread a press release and get you in front of you investors, that aren’t going to invest, I mean that’s not a problem.

The thing is that and I mentioned this in my last conference call, but you are getting in front of the investors which is fantastic, but it’s a very small float and no one that you are getting in front of is looking to buy this thing, that’s what makes it so frustrating to the current shareholders. $30,000 a month, I mean I was ...

Ash Rofail - Chief Executive Officer

Hello? Hello?

Operator

It appears his line has disconnected. (Operator Instructions) We do have a question from Teresa Reese.

Teresa Reese, Private Investor

Hi. This is Teresa Reese. I have a question, I guess for Mark or Ash, one question but there are two parts to it. What actions of plan to generate revenue from uBroadcast asset, the company acquires exactly (inaudible)?

Ash Rofail - Chief Executive Officer

We can --we heard -- sorry to interrupt you, we've heard just -- the voice is very faded. We understand, we heard the first part of that question as what is our plan to generate revenue from uBroadcast asset?

Teresa Reese, Private Investor

Yes. Okay. You did hear that correctly.

Ash Rofail - Chief Executive Officer

Now, I can hear you better, right.

Teresa Reese, Private Investor

Okay.

Ash Rofail - Chief Executive Officer

The second part of that question.

Teresa Reese, Private Investor

So as I said the company acquired this asset in 2010 through the uBroadcast reverse merger and over the 3 years, eBN’s traffic appears very well and the product is not well developed and working. What assurance can you give the shareholders that uBroadcast can compete with other media asset and generate revenue?

Ash Rofail - Chief Executive Officer

Yes. Okay, very good question, very valid question. In the -- it’s no different story than eBN. It is an asset. I think there is a market for it but the amount of investment that is needed to make that asset, a revenue generating and producing asset is quite significant. We have been managing the business and like we said growth and cash generation has been organic, fully organic. We want it to be profitable every quarter. We’ve been working hard towards that. We are addressing kind of the high profile and the high demand areas that are quite visible around us like Agile services and outsourcing and products.

And we could not stretch our revenue to really capitalize all the different assets in the company. uBroadcast is one that is being evaluated right now, there are a couple of what I will call blue birds out there that could breathe some life into that, that will kind of, without costing the company or stretching other areas of the business that are critical that could push that asset forward and realize revenue. But the board and management is looking at what reasonable investment without robbing other part of the business that will be needed. Right now it’s self sufficient and it’s generating very little revenue without any cost.

So we’re looking at one of these blue birds coming in and being able to revive that or you would have to think just as we did with eBN is what would be the synergy with uBroadcast and whether it’s within the general strategy of the company direction or we need to invest or not?

Teresa Reese, Private Investor

Okay, thank you.

Ash Rofail - Chief Executive Officer

Thank you.

Operator

At this time, I would like to turn the floor back over to Jeffrey Goldberger, for any closing remarks.

Jeffrey Goldberger - KCSA Strategic Communications, IR

Thank you, Maria and again we appreciate everybody’s time on this morning’s call. Management will make themselves available post call. As a reminder, there will be a replay of this call in our archive of the audio webcast available. Please refer to company’s investor relations website for details. Thank you again and look forward to speaking to you next quarter.

Operator

Thank you. This concludes today’s Santeon Group’s third quarter 2013 earnings conference call. You may now disconnect.

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