Double-Take Software, Inc. Q1 2010 Earnings Call Transcript

Executives

Erica Mannion – IR

Dean Goodermote – Chairman, President and CEO

Craig Huke – CFO

Analysts

Rich Kugele – Needham & Company

Shaul Eyal – Oppenheimer & Company

Kevin Shea – MKM Partners

Tim Klasell – Thomas Weisel Partners

Double-Take Software, Inc. (DBTK) Q1 2010 Earnings Call Transcript May 4, 2010 4:30 PM ET

Operator

Good day. And welcome to Double-Take Software's earnings conference call for the first quarter of 2010. The date of this call is May 4th, 2010. This call is the property of Double-Take Software and any recording, reproduction or transmission of this conference without the expressed written consent of Double-Take Software is strictly prohibited. This call is being webcast and recorded and you may access both live and replay webcasts of this call by going to the Investor Relations section of the Double-Take web site on the events and presentation page. You may also listen to an audio replay of this call by dialing 888-203-1112 from within the U.S., or dialing 719-457-0820 from outside the U.S. and entering replay pass-code 371-7147.

I will now turn the call over to Erica Mannion, Investor Relations for Double-Take Software.

Erica Mannion

Good afternoon and thank you for joining us to discuss Double-Take financial and operating results. With me today are Dean Goodermote, President and CEO and Chairman of the Board of Directors, Craig Huke, Chief Financial Officer. On the call today, you will hear forward-looking statements about events and circumstances that have not yet occurred, statements regarding projected financial results, statements containing words such as will, expect, believe and should and other states in the future tense are forward-looking statements. Actual outcomes and results may differ materially from the expectations contained due to a number of risks and uncertainties. Please refer to the company's recent SEC filings at the SEC's web site at www.SEC.gov for detailed discussions of the relevant risks and uncertainties.

The company undertakes no responsibility to update this information in this conference call and under any circumstance. The press release distributed today that announced the company's results is available on our website at www.doubletake.com in the investor relation section under financial press releases. The current report on form 8-K, furnished with respect to press release, is available on our website in the investor relations section under SEC filings. In addition, in this conference call we will provide non-GAAP financial results. The reconciliation of these measures to GAAP measures is set forth in the tables that reconcile our non-GAAP results to GAAP results from the press release located on our website as I just described.

Now I will turn the call over to Dean Goodermote, Chairman, CEO and President. Dean.

Dean Goodermote

Thanks, Erika. As previously announced, our Q1 revenue missed our expectations and I will discuss some of the reason for that shortfall. I'd like to give you some highlights first.

First and foremost, as is characteristic of Double-Take, we did produce earnings within the range of our earnings guidance. I believe we've always performed within our guidance range on earnings and sometimes exceeded it, even when topline performance was less than expected. Expenses this quarter were less than anticipated because we were unable to hire all the positions that we planned to early in the quarter and then we held back on offers late in the quarter as we sensed a revenue shortfall.

Going forward, we plan to manage headcount conservatively and not spend as far ahead of the revenue growth curve as we earlier communicated we would. Also note, with our renewals which were strong for us across all regions, renewal rates were approximately 85%, which is about 20 percentage points above the slump we saw a year ago.

We feel the strong trend will continue and believe it is a sign that a customer base is stabilizing and become more confident about spending for IT infrastructure. It also signals that our customer base continues to value our products and support. We saw license growth of about 7% globally over Q1 last year and this was led by the U.S. which grew by about 13%.

Hewlett-Packard, which always presents challenges, but we regard as a great opportunity, produced about 107% more software sales for us than it did last year. Lennox was strong too and while it maybe, not be up every quarter going forward, we do feel as if overall trend is up. Its product sales were more than 10 fold above sales over the same period last year.

Our Double-Take Move product, released last year has been a great entree into accounts that use it for migrations such as begin IT projects and thus helps insert us early in to the sales process as of up sell to Double-Take availability or sometimes into a project that we had never been a part of.

As an anecdote, we held a webinar featuring this product in the first quarter and attracted about 3100 registrants, 1500 live attendees who logged 600 questions. These stats are astounding even when compared to the largest of technology companies within the hottest of products and we believe show the growing interest and move in our flagship product Double-Take availability which incorporates it.

We also announced our cloud offering in Q1 and it received considerable coverage amongst the trade press. Sales to date are few and contributed a non-meaningful amount to revenue. But I believe this is the logical future for backup and recovery and we are ahead of the curves here, offering the rare possibility of running from the cloud when systems fail locally. We still plan to spend on development and marketing in this area disproportionately to its near term revenue potential. On the down side, sales cycle are longer than we would have anticipated but perhaps has to be expected given the newness of the cloud concept but on the upside we are finding the prospects to vary widely from firms and less than 10 servers to protect with those with hundreds.

With all the highlights, why did we not meet our expectations? Simply put, we failed to grow licenses sufficiently. We are probably too optimistic about the rebound from last year. Though the Americas region was up, it did not show the year-over-year increase that we expected. We thought we might see 20% to 30% increase from last year. We still think there is weakness if the S&P area and confusion between simple back up and disaster recovery which we specialize in.

The latter we hope to address through improved marketing. Also, the U.K. continues to be plagued by country specific macroeconomic issues and company specific execution issues. In addition, our newer products such as the cloud did not contribute sufficiently to growth though our expectations were modest, Double-Take Flex which can compete in DEI space, generated $25,000 in revenue and Double-Take Backup generated about $800,000 both of which were below our expectation. We believe more marketing and channel training are necessary to produce stronger results with our newer products.

Longer term, we think there's several key drivers to our business. These are growth in the S&P market, especially among service oriented businesses such as law firms, increasingly heterogeneous market for virtualization, particularly the Microsoft and VMware, emerging of back up and availability of markets into a rapid recovery market and movement of cloud based recovery. We think we are positioned well to capitalize on these trends.

Finally, I know many of you are interested in the indication of interest you received for the possible acquisition with Double-Take. In our press release, we said all that we can say I will repeat it here. That is, we previously announced that we had received unsolicited, did nonbinding, written conditional indications of interest to acquire the company our Board of Directors and consultation with financial advisors and legal advisors continues to review of this indications of interest, as well as evaluating other possible strategic transactions. With that said, there can be no assurance that any transaction will occur.

I would now like to turn it over to Craig, who can give you more detail and color. Craig?

Craig Huke

Thanks, Dean. We announced on April 12th, that revenue for the quarter had come in below our original guidance. However, non-GAAP operating income and non-GAAP diluted EPS did come within our guidance as our headcount related costs were much lower than originally anticipated.

And even though we used $8.4 million in cash to repurchase a million shares of our common stock, our March 31 cash position remains strong at $88.7 million on hand and we generated $2 million of cash from operations during the quarter. So looking at details within the quarter, total revenue for the first quarter was $18.9 million, an increase of 4% from the $18.2 million in the first quarter of 2009.

Software license revenue was $8.2 million, an increase of 7% from Q1 to 2009. We saw license revenue growth in North America, which grew by 13% and in Asia, which grew 10%. We continued to struggle with license revenue, however, in Europe especially in the U.K. License revenue declined in Europe overall by 3% year-over-year.

Maintenance and services revenue totaled $10.6 million during the quarter for an increase of 2% over Q1 2009. Maintenance revenue, excluding professional services, increased 2% and totaled $9.9 million in the quarter. Maintenance renewal as Dean said earlier continued to rebound from the levels experienced in the first half of 2009 and the renewal rate was about 85% in the quarter.

Professional services revenue increased 3% to $700,000 in the quarter. During Q1, our resellers generated 61% of our total sales, distributors generated 24% and OEMs, primarily HP, generated 7%. Overall, our indirect channel generated 92% of the sales in the quarter compared to 90% in Q4 and 90% in Q1 of 2009.

Sales by Dell, our largest reseller totaled 14% of total sales, which is down from the 17% in Q4 2009 and 16% in Q1 of last year. Tech Data, our largest distributor continued to be strong for us and accounted for 14% of sales in Q1 2010 compared to 15% in Q4 of last year, but only 3% in Q1 of 2009.

The increase is due in part to a decision in Q4 of 2009 to fulfill most CDW business through Tech Data. Sunbelt was a 10% plus partner again in Q1 2010, after falling below that level in the second half of 2009. HP, results swung back a year-over-year growth in the quarter, performing very well and amounting to 7% of total sales.

The average median order sizes were approximately $7700 and $3600 respectively. Both numbers are down from last year's levels of $8000 and $4000 slightly lower than levels in Q4 2009. The mix of sales between new and existing customers came in at 52% from new customers and 48% from existing ones. That mix is largely the same that we've seen over the past several quarters. Sales by geography in Q1 were largely the same as we saw in Q1 of 2009 with 62% coming from North America, 30% coming from EMEA and 8% from Asia.

On a non-GAAP basis gross margin was 88.6% in Q1 2010 compared to 88.8% in Q1 2009. Non-GAAP gross margin on software was 99.1% in the quarter compared to 98.9% in Q1 2009. Non-GAAP gross margin on services decreased to 80.4% in the quarter compared 81.3% in Q1 2009.

The decrease is due primarily to headcount cost in our technical support group that occurred in Q1 2010 compared to 2009. Non-GAAP gross margin does exclude stock based compensation charges as is disclosed in our reconciliation slide located on our website or accompanying our press release.

Total operating expenses for the quarter were $17.1 million, an increase of 5.4% from first quarter of 2009. Excluding stock based compensation, non-GAAP operating expenses increased 5.5% to 16 million for the quarter, when compared to the first quarter of 2009.

Now I'll turn to the detail of the operating expenses. Please note that the following discussion related to sales and marketing R&D and G&A expenses exclude the effect of stock based compensation and is therefore all non-GAAP. Sales and marketing expense increased 5.8% to $8.4 million in the first quarter of 2010 from the first quarter of 2009. The increase primarily resulted from increased compensation expense as a result of annual increases given to employees in the first quarter of 2010.

We also increased marketing program expenditures in the quarter in an effort to increase our sales or leads and ultimately sales. Additionally, travel expense increased as a direct result of increased sales and marketing efforts. Sales and marketing expense increased to 44.7% of revenue in the quarter, compared to 43.9% in the first quarter of 2009.

Research and Development expenses increased 8.2% to $3.9 million in the first quarter of 2010 and compared to the first quarter of 2009. The increase relates to increased expense for compensation and also for third party contractors.

As previously mentioned, we increased our development spending in order to develop our cloud product and to continue to update our existing products. The increase in expenses is also partially offset by decrease in headcount in Q1 2009 to Q1 2010. R&D expense as a percent of revenue was 20.7% of revenue in the first quarter compared to 19.9% in the first quarter of 2009.

General and Administrative expenses increased 3.4% to $2.7 million in the first quarter. The increase as a result of increased compensation expense which was partially offset by decreased rent and insurance and legal and accounting expenses. G&A was 14.4% of revenue in the first compared to 14.5% in the first quarter of 2009.

Depreciation and Amortization expense decreased 2% to $970,000 in the first quarter. The decrease relates to lower depreciation due to lower capital expenditures in 2009 and the first quarter of 2010 when compared to previous years. Of the $970,000, $400,000 was amortization of intangible assets associated with our acquisitions.

So related to operating income, in the first quarter of 2010 we experienced a GAAP operating loss of $500,000 compared to an operating loss to $200,000 in the first quarter of 2009.

GAAP operating margin was a negative 2.5% in the first quarter compared to a negative 0.9% in the first quarter of 2009. On an adjusted non-GAAP basis, operating income was $700,000 in the first quarter, compared to $900,000 in the first quarter of 2009. Adjusted non-GAAP operating margin was 3.7% in Q1 2010 compared to 5.1% in the first quarter of 2009.

Other income netted a loss of $60,000 in the first quarter of 2010 compared to a gain of $66,000 in Q1 2009. The change relates primarily to a decrease of $88,000 of investment income resulting from lower yields received on our invested cash and a $42,000 increase in foreign currency losses in the quarter.

During the first quarter of 2010 on a GAAP basis, the company recorded an income tax benefit of $300,000 compared to a benefit of $51,000 in the first quarter of 2009. The affective tax rate in Q1 2010 was approximately 57%, compared to 53% in Q1 2009. The effective tax rate increase for the quarter, substantially due to the increase in stock based compensation expense and proportion of stock based compensation expense as a percentage of income before taxes in 2010 when compared to 2009.

We recorded a GAAP net loss of $227,000 or a penny per share loss for the quarter of 2010 compared to a loss of $45,000 or $0.0 a share for the same period a year ago. The increase in net loss and loss per share substantially result of our increase expenses in Q1 2010, as compared to 2009 was more than offset the increase we had in revenue for the quarter.

On a non-GAAP basis for the quarter, adjusted non-GAAP net income was $410,000 or $0.02 per diluted share, compared to a $1,000,000 or $0.05 per diluted share in the first quarter of 2009. The effective tax rate in Q1on non-GAAP pretax income was approximately 36% which we expect to be the affective rate for the full-year.

One thing to note is that we did make an adjustment in non-GAAP net income this quarter so that the non-GAAP affective tax rate would be equal to expected full year rate in each quarter of the year.

So, assuming our estimate at the full year tax rate is accurate the full year impact of these adjustments will net to zero. We did not make that adjustment in previous years. We ended the quarter with cash and short-term investments of $88.7 million, compared to $96.2 million at December 31, 2009 and $79.1 million at March 31, 2009.

Cash from operations during the quarter provided $2 million. We used $200,000 for capital expenditures from the first quarter. As I mentioned before, we used $8.4 million, to repurchase approximately a $1 of our own stock and we used an additional $200,000 to remit taxes relating to the vesting of employees restricted stock units during the quarter.

Accounts receivable March 31, 2010 was $13.9 million, which is a decrease from 16.7 million at December 31, 2009. Accounts receivable DSO was 66 days at March 31, 2010. Which is the same as it was on December 31, 2009. And up 2 days from 64 at March 31, 2009.

Headcount was 387 at the end of the first quarter of 2010 compared to 389 as of December 31, 2009. We did hire new employees during the quarter, but those increases were offset by attrition both voluntary and involuntary. Based on the results of Q1 2010, we'll be cautious regarding further hiring until we see sustainable and predictable growth, but we will hire for positions deemed necessary to continue to improve the business.

Now turning to guidance, as we said in our press release we are providing guidance for the full year 2010 only. As we continue to see uncertainty in the timing of deal closing and the affects from our possible acquisition, potentially impacting the deal. We are currently expecting total revenue for 2010 to be in the range of $84 to $88 million, which implies year-over-year growth of approximately 1 to 6%.

Non-GAAP operating income, excluding the impact of stock based compensation will be in the range of $9.6 to $12.6 million and does include affect of the amortization of intangible assets. Non-GAAP income per share for 2010 is expected to be in the range of $0.27 to $0.36 per share using a tax rate of approximately 36%.

Our cash tax rate for the year should continue to be zero as it has in the past several years. Weighted average diluted shares for the year is estimated to be $22.8 million. With that, I will open the call for questions. Amy.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Rich Kugele with Needham & Company.

Rich Kugele – Needham & Company

Thank you. Good afternoon. Just a couple of questions. I guess first when it comes to the push out, maybe you can remind me historically. Have there been many instances of deals actually being pushed? I would think that given the ASP and the ease of installation that people either going to buy or not. And then I've got a follow-up.

Dean Goodermote

Yeah. I think by push, I just mean they didn't come in when expected. Though it's more of a, I would say a forecasting planning issue on our part that I think we have to watch more carefully. We have in the past said that in 2008 first time we ever had a performance that didn't meet our expectations particularly we actually specifically said there were 14 larger deals that pushed out.

And we tracked them and over time about 12 came in by the time I stopped tracking it. I believe total only one didn't. So it does happen, it's just that this time was unusual relative to what we thought would happen in February when I first – when we gave guidance.

Rich Kugele – Needham & Company

Okay. Then secondly, when it comes to EMEA, can you just talk about what you are seeing there from a demand perspective and if there has been any fallout from some of the concerns and some of the country's, I mean I know you don't play directly in some of those countries. But is there any effect that spilling over to the U.K.?

Dean Goodermote

Well, we sell a little in that almost ever place there ever little bit helps. So few sales in the grease wouldn't hurt us then it probably helped us in the past. I think what we usually seen is we sort of can pick up on economic prices or issues maybe little belatedly in fact we realize, it would be hard to say that we are not impacted by the continent itself was flat and expected to be.

So although Craig in the script mentioned that it went down overall. Our expectations were probably met on the continent the true expecting them to be flat but they were met, it was the U.K. that brought it down a bit. So in a way mainland Europe has performed as we expected I would say.

I might add, it does seem as if there was an impact and I've read this in other places from other companies from the Icelandic issues that was in April where it seemed as if a lot of people were traveling and then stuck on vacation and that might have some impact although I think that should catch up again.

Rich Kugele – Needham & Company

Okay. Thank you very much.

Dean Goodermote

Thank you.

Operator

Next question comes from Shaul Eyal with Oppenheimer & Company.