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RMG Networks Holding Corporation (NASDAQ:RMGN)

Q2 2014 Earnings Conference Call

August 7, 2014 9:00 am ET

Executives

David Roberts - SVP, General Counsel

Bob Michelson - Interim President, CEO

Loren Buck - EVP, COO

Bill Cole - EVP, CFO

Analysts

Operator

Good day ladies and gentlemen, and welcome to the Second Quarter 2014 RMG Networks Earnings Conference Call. My name is Jeanette and I will be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I'd now like to turn the conference over to Mr. David Roberts, RMG’s General Counsel. Please proceed.

David Roberts

Thank you, Operator. Good morning everyone. And thank you all for joining RMG Networks second quarter earnings call. Joining me on the call today are Bob Michelson, RMG Networks, Chief Executive Officer, Loren Buck, Chief Operating Officer and Bill Cole, Chief Financial Officer.

RMG Networks issued its second quarter 2014 press release today, which can be found on the company's Investor Relations pages at ir.rmgnetworks.com along with the slides that will accompany the remarks during this call. These slides can also be found by registering through the webcast link. A PDF of these slides has also been made available.

Before we start, I would like to remind everyone of the Safe Harbor statement included in the earnings press release issued today. The Private Securities Legislation Reform Act of 1995 provides a Safe Harbor for certain forward-looking statements. Including statements made during the course of this call. These forward-looking statements are based on the company's current expectations and beliefs concerning the future developments and their potential effects on the company.

A number of these factors could cause actual results or outcomes to differ materially from those indicated by such forward-looking statements. These forward-looking statements involve significant risks and uncertainties some of which are beyond the control of the company and are subject to the changes based upon various factors. For more detailed discussion of some of the ongoing risks and uncertainties of the company's business, I refer you to the company's filings with the Securities and Exchange Commission including our Form 10-Q for the first quarter of 2014 and our Form 2000-Q (sic) 10-Q for the second quarter of 2014 being filed within the next few business days.

During this conference call, we will also disclose non-GAAP financial measures as defined by SEC Regulation G including adjusted revenue, pro forma combined adjusted financial results and adjusted EBITDA which we define as net income before interest, taxes, depreciation and amortization adjusted for acquisition related and integration terms. Asset impairment charges, purchase price accounting items recorded as part of our acquisitions and certain other items that we believe do not reflect our core operating performance.

The comparable GAAP financial information including operating income, the GAAP measurement most directly comparable to adjusted EBITDA and reconciliations are provided in the financial tables at the end of the second quarter 2014 earnings press release which I previously referenced and which is available on the Investor Relations section of our Web site at www.rmgnetworks.com.

At this time, I would like to turn over the call to Bob Michelson, our Chief Executive Officer.

Bob Michelson

Thank you, David, and good morning everyone. Thank you for joining RMG Networks second quarterly earnings.

I'm excited to be speaking to you for the first time as RMG Networks CEO. I will start giving you some background and what attracted me to join RMG Networks as well as the opportunities that I see before us. Loren will then review our performance in the quarter. Bill will review the financials and I will come back to review our priorities and outlook for the remainder of the year. We will then open the call for your questions.

Two weeks ago, I joined RMG Networks from a background and growing technology and service companies. Most of my career has been spent in an operating role as either CEO or President across five companies and most recently, I was an operating partner for a private equity firm. In both situations profitable growth driven by excellence in execution and adherence in designing and delivering long-term strategies had been my guiding principles.

I joined RMG because it has built a great foundation for growth in two large expanding industries Digital Media and Visual Communications. The company is a recognized leader and innovator in these industries and successfully serves some of the largest enterprises globally including 70 of the fortune 100 companies. Businesses are building digital communications into every aspect of how they operate and communicate both internally with employees and externally with customers. And RMG occupies a position at the forefront of this change.

RMG's strength in Business Data Visualization particularly in contact centers and employee communications affords the company a solid high-margin platform for growth. Our Media Networks are also well-positioned aimed at a highly sort after audiences, business decision makers and affluent consumers.

My first step as CEO is to get to know the organization from the very top to the bottom in order to make decisions on how to best optimize the allocation of efforts and resources so that RMG can achieve profitable growth. My philosophy is that the profile of a great business is one that persist as a critical component of its customers businesses. And RMG status and opportunities in this regard are quite apparent to me thus far in my first two weeks.

We want to maintain our leading position in our industries, reaping returns on investments already made while expanding our presence globally. Our leadership and innovation, wheeled it correctly gives us an opportunity to provide increasingly differentiated solutions to customers that offer them true proprietary value propositions and drive ROI in their businesses. With proper execution, RMG is uniquely positioned to intensify its status as a valued partner that is integral to our customers operations.

I will come back after review of the numbers but for now, I will ask Loren Buck, our Chief Operating Officer to give us the highlights of the second quarter. Loren?

Loren Buck

Thanks Bob and good morning everyone. I would like to take you through an overview of several key accomplishments we completed in the company's second quarter. First, we drove significant financial momentum over our first quarter results. Total adjusted revenue during the quarter was up 30% sequentially with strong gross margin improvement.

We improved our sales execution overall with the enterprise unit winning the largest software sale in company history, which comprised over 27,000 software licenses to a Tier-1 telecom provider. This is a big win that highlights the value of our customers place on our proprietary products.

Our Media unit also saw positive momentum in Q2 with a 91% sequential rebound in revenue over the first quarter. Improving revenue generation, better gross margins and reduced operating expenses allowed us to nearly cut in half our first quarter adjusted EBITDA loss.

During the second quarter, we also reallocated internal resources that made changes in certain areas of the organization to refocus our efforts on our most promising growth initiatives to streamline our operations and to better manage our operating expenses going forward. These efforts do not represent the material change in strategy, but rather a review of the early returns of the significant investments made during 2013.

We made these adjustments in order to enable us to better harvest the market opportunities we see before us, drive growth and increase profitability. As part of our efforts to enhance revenue generation, we also added Scott Pawloski as EVP and Chief Revenue Officer of our Media unit to oversee advertising sales for our Media Networks. This is a position that has remained vacant since the departure of Scott's predecessor late last year.

Scott was formerly a Senior Digital Sales Executive with Microsoft as an advertising General Manager overseeing sales and operations teams in the Central U.S. He managed the portfolio of owned and operated properties in third party sites including Xbox, Windows, MSN, Bing, Outlook, FOX Sports and MSNBC. Scott is an experienced senior sales leader and we are excited to have him on Board.

Lastly, as we previously announced that in July the company successfully completed the third amendment to its senior credit facility to a lending group headed RMG's Executive Chairman. The amended term loan facility increased from $8 million to $12 million which added approximately $3.4 million in net cash proceeds to our balance sheet. The amendment also eliminated financial covenants until at least June 2015. The amended credit facility offers us attractive and accommodative terms and provides us with additional liquidity and substantial operating flexibility.

While we appreciate there is still work to be done to put RMG firmly on the growth footing we believe is possible. We feel these developments indicate very positive momentum toward RMG Networks fulfilling its long-term potential.

And with that, I will now turn the call over to Bill Cole, our Chief Financial Officer for a detailed review of the numbers.

Bill Cole

Thank you, Loren, and good morning everyone. As a reminder, we are presenting 2013 pro forma combined adjusted results for ease of comparison. As if the two companies which were both acquired in April 2013 had existed as a combined entity in both 2014 and 2013. Further, the 2014 adjusted results and the 2013 pro forma combined adjusted results we are discussing today have been adjusted to eliminate the effects of purchase accounting, certain transaction related expenses and certain other items that we believe do not reflect the underlying operating performance of our business.

These adjustments are shown in the pro forma combined statements of operations contained in the press release that we issued this morning. You can find our as reported results in earnings release we filed this morning and in the 10-Q that we would be filing within the next few business days.

One of the adjustments we have made relates to a payment we made from our Media business to an advertising partner. The related transaction also involves a sale of equipment by our Enterprise business unit because the payments made to-date from our Media business or less than the revenue we had generated in advertising sales from the new partnership and because of the related equipment sale by our Enterprise unit.

GAAP required an offset that against revenue recognized by the Enterprise business unit. Therefore, adjusted second quarter 2014 results include a reclassification of that charge from Enterprise revenue to Media cost of sales. We feel that this reclassification results in a better presentation of gross margin of our Enterprise and Advertising businesses. These adjustments do not, however, affect EBITDA.

We report revenue in four categories and these breakouts are shown in our earnings release and in our filings. I will discuss our revenue in terms of our business units. Total company adjusted revenues for the second quarter of 2014 decreased to $16.4 million from total pro forma combined revenues of $18.9 million in the second quarter of 2013 a decrease of 13.3% year-over-year.

On a sequential basis, however, second quarter 2014 adjusted revenues increased 29.9%. Adjusted Enterprise revenues, which were primarily comprised of software and hardware product sales revenue from maintenance and content services and professional services were $11.5 million in the second quarter of 2014 versus $12 million of pro forma combined revenues in the second quarter of 2013, a decrease of 3.8% on a year-over-year basis.

Adjusted gross margin in the Enterprise unit was 58.9% in the second quarter of 2014, which represents an increase from 54.2% in the second quarter of 2013. This increased gross margin is primarily due to a more favorable sales mix resulting from the large software sale in the second quarter of 2014 that Loren discussed earlier.

On a sequential basis adjusted Enterprise revenue increased 14.4% due to an increase in product sales and professional services revenues. Adjusted gross margin also improved primarily from the more favorable sales mix. Media revenue comprised primarily of sales of advertising on our location based networks was $4.9 million in the second quarter of 2014, a decrease from $6.9 million in the second quarter of 2013. This represents a 29.6% decrease year-over-year. Adjusted gross margin for the Media unit was 13.8% in the second quarter of 2014, a decrease from 38.6% in the second quarter of 2013. The decrease in Media gross margin resulted primarily from certain fixed costs that were not covered due to the significant revenue decline.

On a sequential basis, however, Media revenue increased 91.3% in the second quarter of 2014 due to a rebound in advertising demand and better sales execution. Gross margin improved due to increased revenue generation.

In summary, revenue and gross margins were down year-over-year, however, on a sequential basis they both improved. Gross margins improved in both business units due to higher revenue and a more favorable sales mix. The second quarter adjusted operating loss of $19.4 million compares to a pro forma combined adjusted operating loss of $4.5 million in the second quarter of 2013, included in the second quarter 2014 adjusted operating loss are approximately $14 million a non-recurring charges comprised with the following items.

And impairment charges $7.2 million related to goodwill and intangible assets within the Media unit, a $6.2 million loss recognized on a long-term contract. Approximately $600,000 in cost related to the reorganization of our business operations. Please note as we discussed earlier, these non-recurring charges were added back in our calculation of adjusted EBITDA.

If you exclude these non-recurring charges, the increase in second quarter 2014 adjusted operating loss as compared to the second quarter of 2013 is attributable to the following. A decrease in revenue across both business units as well as a decrease in Media adjusted gross margin during the second quarter of 2014 which I previously described.

An increase in run rate operating expenses resulting from the continued execution of our strategic growth initiatives, these expenses include compensation to additional sales, marketing and corporate personnel, an incremental rent and expenses related to the opening of new sales offices.

And our calculation of cash operating expenses and adjusted EBITDA, we exclude deprecation and amortization, stock-based compensation expense and other non-recurring charges. The current period included approximately $1.3 million of additional depreciation and amortization and stock-based compensation versus the prior year.

On a sequential basis, our adjusted operating loss increased to $19.4 million in the second quarter from $8.3 million in the first quarter of 2014. However, if you exclude the $14 million of non-recurring charges I previously discussed, the adjusted operating loss in the second quarter of 2014 is less than in the first quarter of 2014.

We use adjusted EBITDA as a key non-GAAP earnings measure of the underlying operations of our core business. Adjusted EBITDA for the second quarter of 2014 was a negative $2.8 million compared to a positive adjusted EBITDA of $839,000 in the second quarter of 2013. On a sequential basis, adjusted EBITDA improved from the $5.3 million loss in the first quarter of 2014. Adjusted EBITDA decreased on a year-over-year basis as a result of the revenue gross margin and operating expenses I just described.

Let's look at Slide 5, and I will talk about our balance sheet and capital structure. RMG Networks ended the second quarter of 2014 with $3.1 million in cash. Debt at quarter end stood at $8 million comprised of borrowings from our senior credit facility. The company's book value at the end of the quarter was $40.2 million.

As Loren discussed earlier subsequent to quarter end, RMG's Board of Directors formed a special committee to undertake a new financing with related parties. Our prior senior lender sold its interest in our credit facility to a new lender group that includes RMG's Executive Chairman, Gregory H. Sachs. We then completed our third amendment to the senior credit facility increasing the facility from $8 million to $12 million and having approximately $3.4 million in net cash proceeds to our balance sheet. We also eliminated financial covenants until at least June 2015, which increased our operating flexibility.

The amended three year facility matures in July 2017 and bears interest at a fixed rate of 12%. Principal payments are deferred until maturity. The new funding was provided by our new lender group.

On a pro forma basis, after amending the credit facility, our cash balance was $6.5 million at the end of the quarter and our debt stands at $12 million. As of June 30, 2014, we have approximately 12.4 million shares outstanding and 9.6 million outstanding warrants each warrant entitles the holder to purchase one share of our common stock at a price of $11.50.

Bob, I will now turn the call back over to you.

Bob Michelson

Thanks Bill. As I discussed in the beginning of this call, I see tremendous opportunity to RMG. The goal of the management team is to drive profitable growth and we are fine tuning our execution to achieve this objective. While we are just at the beginning of this refining exercise, our approach is clear in four areas.

First, we are refocusing our efforts on a limited number of strategic initiatives in key industries, products and solutions, where our greatest opportunities lie, especially in key high-margin business data visualization solutions and our existing core Media Networks.

So we don't spread ourselves too thin and dilute our ability to achieve results. Second, we continue to support the investments that have been successful for us and are no longer pursuing those investments that have underperformed. Any new investments will be made in a measured manner with ROI requirements being paramount.

Third, in order to effectively manage the business, we will be adjusting the metric set we use internally and executing against the new benchmark metrics. The new metrics set will clearly communicate goals and create alignment and accountability throughout the organization ultimately within our effort to better achieve our potential and drive profitability in the business.

And fourth, finally, I'm a big believer in establishing relationships with employees, with customers, with vendors and with investors. So far I have met with or talked to about 90% of our RMG's employees. And these interactions have been open and candid and everyone appears to be energized about achieving our shared goals.

Going forward, we will provide clarity in our communications to all of our audiences through consistency and transparency. We want to ensure our results match our words. With respect to our financial outlook, we expect to continue the momentum we created during the second quarter. We expect to achieve revenue increases on a sequential basis in each of the third and fourth quarters. In addition, as we have previously discussed in this call, we will continue to strictly manage quarterly cash operating expenses resulting in sequential quarterly adjusted EBITDA increases. Both of these efforts will continue to drive revenue growth and put us on a path to profitability.

We improved our liquidity with the addition of $3.4 million in net cash proceeds from the amendment of our senior credit facility in July. And our objective remains to manage our cash flows, to maintain sufficient liquidities so we can move towards self-funding our growth. Again, as we are at the outset of this, we can't guarantee that our potential will be realized in an entirely linear manner. But, we can promise that we will move diligently to bring RMG to profitable growth and that we will keep you informed as we proceed along that path.

With that, I will now like to turn the call over to the operator for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And at this time, we have no questions.

I'd now like to turn the call back over to Mr. Bob Michelson for any closing remarks.

Bob Michelson

Thanks operator. Thanks everyone for participating. I look forward to [meeting] (ph) many of you in the months ahead and to give you an update on RMG's progress in our third quarter call. Have a great day.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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