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Executives

Bill Tamblyn – CFO and EVP

Todd Simpson – President and CEO

Ditech Networks, Inc. (DITC) F4Q10 (Qtr End 04/30/10) Earnings Call Transcript May 27, 2010 4:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Ditech Networks' fourth quarter fiscal year 2010 conference call. At this time, all participants are in a listen-only mode. (Operator instructions) And as a reminder, this conference is being recorded.

I would now like to turn the conference over to Bill Tamblyn, Chief Financial Officer. Please go ahead.

Bill Tamblyn

Thank you very much. Good afternoon, everyone. This is Bill Tamblyn, the Chief Financial Officer of Ditech Networks. Thank you for joining us on this conference call today, and we will cover Ditech’s announcement of the results for its fiscal 2010 fourth quarter ended April 30th, 2010.

Today’s conference call will cover our financial results for the quarter and we will also provide our outlook for the first half of fiscal 2011. Todd Simpson, Ditech’s President and CEO, will provide the business and strategic analysis and I will provide a more detailed analysis on the financials. Before we begin, let me state that this conference call is being held on May 27th, 2010. Any sound recording or republishing of the contents of this conference call is expressly forbidden without the written approval of Ditech Networks.

Also, we must point out that there are as with similar presentations, the following discussion contains forward-looking statements and in particular, the financial projections of our first half of fiscal 2011 that involve risks and uncertainties. Our actual results may differ materially from those discussed here. We will attempt to identify such forward-looking statements with qualifying words such as we intend, plan, believe, estimate or predict, or we may, could, should 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 10-Q for the third fiscal quarter ended January 31st, 2010 filed March 16th, 2010 with the Securities and Exchange Commission.

We assume no obligation to update these projections or other forward-looking statements. Additionally, let me comment on our approach to governance and the SEC compliance. Please allow me to mention that we comply with all effective SEC and NASDAQ requirements related to audit committee compliance and independence. 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 Website at www.ditechnetworks.com.

Non-GAAP financial measures will be discussed on the call and a reconciliation of the GAAP and non-GAAP financial measures is disclosed in our press release of today as well as in our press release of February 25, 2010 with respect to our Q3 numbers, both of which are located on the Ditech Networks’ Website, www.ditechnetworks.com.

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

Todd Simpson

Thanks, Bill. Good afternoon everyone. For Q4 of our 2010 fiscal year, we had $7.3 million in revenue, and we ended the quarter with a little bit more cash than when we started, namely $34.5 million. Because we had some revenue carryover from our Q3 to Q4, we believe that may be more relevant to look at the last six months where we had $11.6 million in revenue.

The last fiscal year was a time of investment for us, investment in both product and business model diversification. We strove to extend our product lines and to add recurring revenues, both of which we made headway on. In undertaking this investment, we did use some of our cash, in line with what we had indicated in our investor calls over the last year.

We also used some inventory throughout the year, which helped our bottom line. We still have significant inventory, although our product mix is such that we will need to bring in some inventory as we move through fiscal year 2011. With the investments we have made, we believe we have a more diversified product portfolio and better potential for growth. Therefore for the current fiscal year, we have a clear goal of pushing towards cash breakeven and a return to profitability.

As our investors know however, our underlying VQA business is still difficult to project on a quarter-by-quarter basis and will probably show some ups and downs. As the recurring revenue from our new initiatives grow, we believe we can smooth out and then better predict our quarters. As a case in point, the current quarter, we have several opportunities that we believe are time to close to the quarter-end, which makes it difficult to provide projections.

Thus, instead we are looking at a six-month window and are projecting that our revenues for the first half of fiscal 2011 will be in the $13 million to $14 million range. As our cash collections can trail orders by several months, we expect to use cash in Q1, but then regain ground in Q2 and later. Bill will as always be discussing our financials in greater detail later on the call.

So, let me now touch on each of our product lines and their status. Our VQA platforms are maturing robust and outside of continually improving the core algorithms, they don’t require a significant platform investment. We have focused our efforts on TDM applications for VQA in developing markets, which have high wireless growth rates, and we concentrated on Voice-over-IP applications in the mature markets.

We see several more years of good market potential on TDM and growing requirements for Voice-over-IP quality management and transcoding solutions. We believe the growth prospects for our Voice-over-IP solutions should increase as Voice-over-WiFi, Voice-over-WiMAX, and LTE networks gain traction. Our PVP Voice-over-IP platform was recently deployed in another large carrier to mitigate some specific voice quality issues. We believe this is indicative of issues that will face Voice-over-IP solutions as they are deployed more widely.

mStage, our newest platform, represents the evolution and diversification of our VQA platforms. It is a software-centric product as opposed to being hardware-centric. The software approach allows mStage to not only support VQA, but also a whole host of other voice processing algorithms from mixing to keyword spotting and whisper messaging. As previously disclosed, mStage is in testing at carriers and we believe that has good opportunities for revenue in the next quarter or two. This revenue will most likely be slow and steady indicative of early market traction.

On voice applications, we are highly focused on realizing the potential of our voice-to-text application family, PhoneTag. Other applications such as toktok and PoketyPoke continue to be used to drive interest in our solutions, but are not significant investment areas for us right now. PhoneTag is actually a spectrum of products applicable to multiple markets. We have fully automated transcription, human transcription and a mix of the two which we term hybrid. Our automated voice mail-to-text product continues to test as one of the best in the industry. Many large carriers are looking at the mix of fully automated and hybrid solutions, and we see continued momentum towards deployment in the second half of this calendar year with growth in calendar year 2011.

While we continue to work with large carriers on PhoneTag, we are also signing up smaller players. We signed about 10 in the last quarter. These smaller players have the potential to provide incremental growth, although obviously not to the same scale as a Tier 1 would. In the last quarter, we also refined our agreement with SimulScribe to take over the retail base, namely those consumers who sign up at PhoneTag.com.

There is a high overlap in operations between the wholesale and retail businesses, and we believe this will allow us to run the entire operation more efficiently. So, we now have retail enterprise and carrier solutions. Our focus is clearly on the carriers, but as PhoneTag as a cloud service with open ATIs, we can also effectively offer to the other markets. With the addition of the retail component, our voice-to-text revenue was over 700k for the last quarter. While voice mail-to-text is the lead application for the voice-to-text technology today, there are also growth opportunities in other applications. Applications such as conference call transcription, voice-to-SMS, and enterprise integration.

While there is always some customization for these applications, the core voice-to-text technology is shared across them. We are also looking at extending the languages we support under PhoneTag based on market demand. The synergies between our voice quality and voice recognition technologies are also starting to be realized. There are good operational overlaps in terms of both R&D and sales which we intend to further develop through fiscal year ’11.

We also believe there are application synergies, where the combination of mStage and our applications will have value. As part of our evolution in applications and voice services, we will be positioning all of our technologies on a new Website called Grid.com. Grid.com will host our APIs and software, including versions of VQA for enterprise and smaller carriers, and the full suite of PhoneTag offerings. It represents a low friction way for consumers to get started with our technologies. We will be saying more about Grid.com over the coming quarters.

With that overview, I will hand the phone back to Bill Tamblyn, our CFO, to give more details on our numbers and to give some important updates on our NOL stats. Bill?

Bill Tamblyn

Thanks, Todd. I would like to now share with you the financial results for the fourth quarter fiscal 2010 as well as our outlook for the first half of 2011. Please allow me to mention that in our discussion today, our operating results will be provided on a non-GAAP basis. Our press release posted on our Website includes the summary information from GAAP and related reconciliation for Q4. The primary change is the elimination of $360,000 related to stock compensation.

The key points of the fourth quarter results as noted in our press release are as follows

revenue, $7.3 million; non-GAAP gross margin, 56.1%; non-GAAP loss from operations, $1.9 million; non-GAAP net loss of $1.8 million; non-GAAP diluted loss per share from continuing operations was $0.07 per share; cash at the end of Q4 was greater than the Q3 level at $34.5 million versus $34.4 million with operating cash flow being a positive $600,000 in the quarter.

The fourth quarter details are as follows. Total revenue for the quarter was $7.3 million, a 69% increase from the prior quarter of $4.3 million and a 43% increase from the prior year of $5.1 million. Q4 revenues were in line with our projections. More on our first half of FY11 revenues later in this discussion. International revenues were approximately 25% of total revenues. We had two greater-than-10% customers in Q4 and they approximated 69% of revenues compared with three greater-than-10% customers in Q3 that approximated 69% of revenues.

Non-GAAP gross profit for the quarter was $4.1 million or approximately 56.1% of revenues, this was in our expected range. The mix of customers and products contributed to this gross margin level. Non-GAAP operating expenses were approximately $6 million for the quarter, higher than our projections of $5.3 million to $5.5 million. The higher level was due partially to voice-to-text, increased cost for retail sales, legal and headcount costs that should decline in our coming quarters. The details of the operating expenses for each area as follows. Non-GAAP sales and marketing expense was $2.7 million. This was an increase of $500,000 from the prior quarter due primarily to increased sales levels, the addition of the PhoneTag retail and the trade show cost such as Mobile World Congress.

Non-GAAP R&D expense was $2.2 million, supporting our legacy business and new mStage toktok initiatives. This was a $100,000 decrease from the prior quarter. We are rolling out cost as appropriate and investing in new areas as prudently as we can. Non-GAAP G&A was $1.1 million, up $100,000 from the prior quarter and in line with our expectations based on audit fee expenses in the period as expected.

Other income expense netted to an expense of approximately $30,000, due to general low returns on short-term investments and the interest accrual on our convertible notes. Non-GAAP pretax operating loss approximated $1.9 million versus a non-GAAP loss of $3.3 million last quarter. Non-GAAP income taxes is tied to A&T and foreign taxes Our non-GAAP net loss was $1.8 million, which is $0.07 per share compared to $33.4 million or $0.13 per share in the prior quarter.

To reiterate, all of the operating results that I have just given you other than revenue and net interest expense are on a non-GAAP basis. Please refer to our press releases for the third and fourth quarter of fiscal 2010 for comparative GAAP results as well as reconciliations of the non-GAAP results to our GAAP results.

Moving on to the balance sheet and cash flows, both of which are on a GAAP basis, cash equivalent short-term and long-term investments at quarter-end totaled $34.5 million, up nominally from the prior quarter. This was $500,000 higher than our projections for the quarter. We have provided cash projections in our November call on a six-month basis and updated it in our last call as a $2 million to $4 million decrease in cash equivalent short-term and long-term investments from the end of Q2, believing that Q3 would be a tougher quarter for cash burn with our reduction in force and timing of shipments and it was.

While for the six-month period, we were less than $4 million for use of cash from operations of $2.93 million, our total cash change from Q2 to Q4 was a $3.4 million decrease, as October cash was $37.9 million versus the $34.5 million at April 30th. This was approximately $1.7 million use of cash per quarter. Cash flows from operations was approximately a positive $600,000 for the quarter. This was a level better than we believed we would achieve based on working capital trends and overall business level.

At quarter-end, accounts receivable were approximately $2.4 million. This was a $400,000 from the prior quarter. DSOs in Q4 were better than expectations at approximately 30 days and were lower than our prior quarter of 59 days. We expect our long-term target to be between 45 and 60 days based on international revenues. Let me remind you that the DSO numbers are subject to change as the timing of sales and shipments in any given quarter is always subject to fluctuation.

Net inventory was $6 million at quarter-end, down $1.1 million from the prior quarter of $7.1 million. This decrease in inventory is solely based on using existing inventories for customers adding to reserves and bringing in nominal inventory during the period. At quarter-end, we believe the remaining inventory is still usable based on forecast. We still have significant gross inventories that are reserved.

Capital spending only approximated $28,000 in the quarter. Depreciation and amortization approximated $800,000. We ended the quarter with approximately 130 full-time equivalents around the world, down from approximately 135 at the end of the prior quarter. More than 35 of these full-time equivalents are outside of the United States. We did a reduction in our work force in early November by approximately 10% and addressed expenditures based on the stages we are in at development with the legacy, newer products and other operating areas.

I will now review our GAAP projections for the first half of fiscal 2011. In this regard, please note the cautionary statements regarding these forward-looking statements that we gave at the beginning of the call. Our Q1 and Q2 or the first half of fiscal 2011 outlook is derived from shipments, existing backlog, deferred revenues, and our bookings forecast. We project that revenue will increase over the last six months of fiscal 2010 to $13 million to $14 million. The last half of fiscal 2010 was $11.6 million. So, this would be a 12% to 21% increase.

Regarding operating expense, we are attempting to manage our TDM and packet platform businesses as sustainable breakeven or better businesses and are therefore moving resources and related dollars to the initiatives of PhoneTag, mStage, and new apps. Gross margins should approximate 53% to 55% depending on product and customer mix. Operating expense in the first half will be tied to customer and channel mix and the investment in PhoneTag.

Overall, we would expect our GAAP operating expenses for the first six months of fiscal 2011 including an estimated $700,000 of stock-based compensation to approximate $11.1 million to $11.5 million. Our tax rate once again should be in the range of 1% to 3% due to our loss situation.

Additionally, a couple of other data points for you to consider. Net operating losses or NOLs are a topic with many of our investors. We have performed a Section 32 assessment on change of control related to our NOLs. We are currently over 40 plus percent and addressing certain investors for more information. Adding new greater-than-5% shareholders may trigger the change control and thereby limiting the NOLs as an asset. We ask that any current greater-than-5% holders or potential 5% holders work with the company to preserve the NOL benefit. If there are any questions about this, please contact us.

Cash burn remains a major focus item for us. On our last call, we stated that we believe we will be cash flow positive from operations in Q4 and we accomplished this. Going forward, we will continue to be challenged as a result of working capital trends and product revenue mix. Therefore, we expect a use of cash in the first quarter.

Looking at Q4, it was a positive quarter, positive with the revenues, opportunities and cash positive from operations. The SimulScribe PhoneTag relationship has created many leads. We look to more applications and desire to ramp these to revenues faster than the traditional telecom sales cycle. That said, we remain focused on legacy business revenue maintenance and growth. We wish to continue to advance our product offerings, while attempting to minimize our cash burn.

Lastly, moving into fiscal 2011, the voice-to-text services are becoming greater than 10% of our overall revenues, and from a revenue and gross margin point of view, we will start to break them out separately on a go-forward basis.

With that, I will turn it back over to Todd.

Todd Simpson

Thanks, Bill. So, to reiterate, we feel we now have a more valuable and more diversified product portfolio with good upside potential. Our revenues may continue to fluctuate with the VQA business quarter-over-quarter, however with our focus on growing the recurring revenue base, we believe we can become more precise and more predictable in the future. As we continue to make progress, we will also start to more actively discuss the company with the investor community. Until that time, we feel that the Q&A portion of these quarterly updates have limited value, and that we will discontinue Q&A for now.

Let me echo Bill’s communication on our NOLs quickly. We would appreciate that existing 5% shareholders or those looking to become 5% shareholders contact the company so that we can manage this asset. We appreciate everyone listening in today and look forward to following up with you offline and again in three months.

Lynda, this concludes our call for today.

Operator

Ladies and gentlemen, this conference will be made available for replay after 3.30 PM Pacific today through November 27th at midnight. You may access AT&T Executive Playback service at any time by dialing 1-800-475-6701 and entering the access code 156496. International participants may dial 1-320-365-3844. Again, those numbers are 1-800-475-6701 and 1-320-365-3844. The access code is 156496. And that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: Ditech Networks, Inc. F4Q10 (Qtr End 04/30/10) Earnings Call Transcript
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