Interphase's (INPH) CEO Gregory Kalush on Q2 2014 Results - Earnings Call Transcript

Aug. 8.14 | About: Interphase Corporation (INPH)

Interphase Corporation (NASDAQ:INPH)

Q2 2014 Earnings Conference Call

August 07, 2014, 05:30 PM ET


Gregory Kalush - Chairman, President and Chief Executive Officer

Thomas Tipton - Chief Financial Officer, Vice President, Finance and Treasurer

Yoram Solomon - Vice President, Corporate Strategy and Business Development


William Jones - Morgan Stanley

Don McKiernan - Landolt Securities

Orin Hirschman - AIGH Investment Partners

Chris McCampbell - Southwest Securities


Welcome to the Interphase second quarter 2014 earnings call. (Operator Instructions) I would now like to turn the conference over to Greg Kalush, CEO and Chairman. Please go ahead.

Gregory Kalush

Thank you, Kevin, and good afternoon, everyone. This is Greg Kalush. I'd like to welcome you to our second quarter 2014 earnings conference call.

With me is Tom Tipton, our Chief Financial Officer, who will begin our discussion with an overview of our financial performance for the second quarter and the first half of 2014. Then I'll provide some updates on recent business activity; followed by Dr. Yoram Solomon, who will discuss penveu. We'll conclude with a brief Q&A. Tom?

Thomas Tipton

Thanks, Greg. I'd like to thank everybody for participating today and for your interest in Interphase.

Before we begin, I'd like to remind you that we do not make financial projections to the public. However, this call may contain forward-looking statements about the business, financial condition and prospects of the company. These statements are made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

The actual results of the company could differ materially from those indicated by the forward-looking statements, because of various risks and uncertainties including, without limitation, effects of the ongoing issues in global credit and financial markets, and adverse global economic conditions, our reliance on a limited number of customers, the lack of spending improvements in the communications and computer networking industries, significant changes in product demand, the development and introduction of new products and services, changes in competition, various inventory risks due to changes in market conditions and other risks and uncertainties indicated in Item 1A of the company's Annual Report on Form 10-K and in the company's other filings and reports with the Securities and Exchange Commission.

All of the foregoing risks and uncertainties are beyond the ability of the company to control and in many cases the company cannot predict the risks and uncertainties that could cause its actual results to differ materially from those indicated by the forward-looking statements. So when used in this call, the words believes, plans, expects, will, intends and anticipates and other similar expressions as they relate to the company or its management are intended to identify forward-looking statements.

I'll now provide a brief overview of our financial results for the second quarter and first half of 2014. Revenues for the second quarter of 2014 decreased approximately 15% to $3.3 million, down from $3.8 million for the second quarter of 2013. The decrease was due to our communications networking revenue decreasing to $1.8 million in the second quarter of 2014, a decrease of 35% when compared to $2.8 million for the second quarter of 2013.

About half of this decrease is due to a general slowdown in orders from several customers in the second quarter of 2014. However, I should note, that we are beginning to see that revenues from these customers are improving in the third quarter of 2014.

The remaining portion of this decrease in communication networking product revenues was due to unusually high order volume from one customer in the second quarter of 2013, due to an installation in China. Looking ahead, we are expecting revenue from our communications networking products to increase in the third quarter by more than 40%, based on order volumes we are currently receiving.

Our services revenues increased 39% to $1.4 for the second quarter of 2014, up from $1 million for the second quarter of 2013. This increase was primarily driven by growth in contract manufacturing services revenues and to a lesser extent increased engineering design services revenues. On a sequential basis, revenues decreased approximately 5% from $3.4 million in the first quarter of 2014.

Revenues for the first six months of 2014 decreased approximately 6% to $6.7 million compared to $7.1 million for the first six months of 2013. Our communications networking product revenues decreased 33% to $3.5 million for the six months ended June 30, 2014, compared to $5.3 million in the comparable period in the prior year.

About 65% of this decrease is due to the general slowdown in orders from several customers in the first half of 2014. However, as I mentioned before, we are expecting that these revenues will improve in the second half of 2014. The remaining portion of this decrease is due to unusually high order volume from one customer in the first half of 2013, due to the installation in China.

Our services revenues increased 76% to $3 million for the first six months of 2014 compared to $1.7 million for the same period in the previous year. This decrease was primarily related to increased contract manufacturing services revenue and to a lesser extent increased engineering design services revenue. We continue to see strong interest in our engineering design and manufacturing services and we expect to enjoy significant year-over-year revenue growth in 2014, in this area of our business.

Gross margin was 28% for the second quarter of 2014 compared to 37% in the second quarter of 2013. The decrease was due to a revenue mix shift toward lower margin products, an increase in revenue from services, which typically produces lower margins than our product revenue and decreased utilization of our manufacturing facility, partially offset by a decrease of $64,000 in excess and obsolete inventory charges.

Gross margin was 30% for the first six months of 2014 compared to 38% for the first six months of 2013. The decrease in gross margin on year-to-date basis was due to revenue mix shift toward services revenue, which as I mentioned before, typically produces lower margin from our product revenue. This was partially offset by increased utilization of our manufacturing facility and a decrease of $66,000 in excess and obsolete inventory charges.

Total operating expenses were $2 million for the second quarter of 2014 compared to $2.3 million for the second quarter of 2013. The details of our operating expense trends are as follows.

Research and development expenses were $649,000 for the second quarter of 2014, down from $857,000 in the second quarter of 2013. Approximately 46% of this decrease was due to the decrease in personnel and related expenses. The remaining portion of the decrease was primarily due to an increase in professional services activities, which resulted in an increase in services revenues.

Engineering cost associated with these activities generate revenue, therefore the related expenses are recorded as cost of sales rather than research and development operating expenses, resulting in a decrease in R&D expenses in the second quarter of 2014 compared to the same period in the prior year.

Sales and marketing expenses decreased slightly to $713,000 for the second quarter of 2014 from $732,000 for the second quarter of 2013. General and administrative expenses decreased slightly to $671,000 for the second quarter of 2014 from $691,000 for the second quarter of 2013.

On a year-to-date basis, total operating expenses were $4.1 million for the first six months of 2014 compared to $4.6 million for the first six months of 2013. Operating expense trends on a year-to-date basis are as follows.

Research and development expenses decreased to $1.3 million for the first half of 2014 compared to $1.7 million for the first half of 2013. Approximately 52% of this decrease in R&D expense was due to an increase in professional services activities, which resulted in an increase in services revenues. The remaining portion of the decrease was due to a decrease in personnel and related expenses.

Sales and marketing expense decreased slightly to $1.3 million for the first half of 2014 compared to $1.4 million for the same period in 2013. The decrease was primarily due to a reduction in personnel-related expenses.

General and administrative expenses decreased slightly to $1.5 million for the first half of 2014, down from $1.6 million for the same period in 2013. During the first half of 2013, we reduced our restructuring charge by $67,000 related to reduce future cash expenditure for severance and benefits. There were no similar benefit in the first half of 2014.

Our net loss was $1.1 million or $0.16 per share in the second quarter of 2014 compared to a net loss of $895,000 or $0.13 per share in the second quarter of 2013. For the six months ended June 30, 2014, our net loss was $2.1 million, resulting in a loss per share of $0.31 compared to a net loss of $2.3 million, resulting in a loss per share of $0.33 for the same period in 2013.

Turning to the balance sheet. Our working capital position decreased approximately $1 million during the quarter to $7.8 million. Our cash and securities position decreased $701,000 during the quarter to $4.5 million at June 30, 2014. As always, we will continue to carefully manage our balance sheet and working capital position as we seek to enable us for take full advantage of future growth and investment opportunities for our business.

As a result, we are actively pursuing several scenarios, whereby we will seek to raise additional funds that would be used in large part to expedite and expand marketing, sales and product launch activities associated with the introduction of penveu, and to continue to support the growth in our services business.

I'll now turn it back over to Greg, who will add some perspective to the significant events and accomplishments within our business. Greg?

Gregory Kalush

Thank you, Tom. And again, welcome everyone. Our second quarter 2014 results continue to reveal weakness in our communication networking business driven by our major telecom customers in Europe. Comparing the second quarter of 2014 with the second quarter of 2013, almost all of our major European telecom equipment providers reduced purchases significantly, leading to a decline, as Tom mentioned, of approximately 35% in our communications networking business.

As you may recall, on the last few conference calls, I mentioned that we expected the stall in telecom revenues in large part, because one of our customers was consolidating manufacturing locations, and thus working off excess inventories.

This customer was expected to resume their purchases of our telecom products in the second quarter, and in fact they did so. Revenues from this customer were still down from their second quarter of 2013 levels. We have orders already in the third quarter, as Tom mentioned from this customer, and it appears they are reestablishing their run rate of purchases.

Another of our large telecom equipment customers in Europe has dramatically reduced their purchasing in the second quarter of 2014 as compared with the second quarter of 2013 by nearly 40%. And on a year-to-date basis they're down nearly 30%.

During the third quarter to date, however, communications networking orders have shown a nearly 40% increase over the second quarter purchase levels and the majority of those quarters are already on the books. It remains clear that the uncertainty of revenues for legacy communication networking products will continue to keep pressure on this revenue stream during 2014.

Growth in engineering design services and electronic manufacturing services have offset some of this decline of the communication networking revenues, but at gross margins that are substantially lower than those in telecom leading to a gross margin decline of 9 points from that second quarter of 2014, compared with the same period of 2013.

Our services revenue, however, increased by 39% over the second quarter of 2013. During the second quarter of 2014, we worked on a significant engineering design services project to produce a very compact alcohol level testing device, which our customer believes will significantly improve their competitiveness in their industry.

It partnered with Interphase to design this exciting new device because of our knowledge and depth of experience, as well as our deep knowledge in telecommunications and in networking. We almost finalized this design in the second quarter of 2014, at which point our ADS revenues from this project will begin to decline and the program will migrate to manufacturing where it will begin to drive EMS revenue growth.

Our electronic manufacturing services business continues to expand and we grew this business by 55% over the second quarter of 2013. These new projects are direct results of our strategic push to win customers with more complex higher volumes products and it is clear that they value of our full set of service offerings.

I'd now like to turn the call over and ask Dr. Yoram Solomon to update you on the penveu program so far. Yoram?

Yoram Solomon

Thank you, Greg, and good afternoon everyone. In the last call I told you that we expect to begin shipping penveu to customers, partners, resellers and make it available for purchase in May. Well, after such a long development time, we began shipping penveu in May.

First of all, I would like to again, thank and recognize the hard work by the development, testing and manufacturing team in tirelessly and continuously improving this product. Word simply cannot capture the level of appreciation I feel towards this exceptional team, everybody pulled together to get the product ready to ship on time.

Some orders have already existed, which we began supplying on the first day of shipping, and more orders arrived later and continue to arrive through all channels, whether through direct sales, through our website,, through Amazon or through our different resellers, and that's an amazing feeling we've been waiting for a for a long time.

During the second quarter, we presented penveu at the largest education technology conference ISTE 2014 at the end of June, in Atlanta, Georgia. We had three separate demonstrations representing a wide variety of different used cases of penveu, including a large screen auditorium setting, as well as multiple projectors, large screen TV monitors and more.

The traffic at this show was amazing. From the time we setup on the show floor until our flights' home, we were overwhelmed with interest in penveu. The team amending the booth worked straight through the day, every day of the show. We didn't even have time to sit down for lunch. We had more than 1,500 show participants, who stop by and registered at our booth, which is an outstanding response.

One of the reasons, we are so excited, is that we had the right kind of traffic at ISTE, including many IT professionals within the different school districts in the U.S. and internationally, higher education, as well as key decision makers. And again, the feedback was overwhelmingly positive as prospective buyers were able to actually handle the product and use it for the first time. Some placed orders during the show itself.

So positive, in fact, that we took home the coveted ISTE 2014 Best of Show Awards Tech & Learning award. This is the third award penveu has won since was announced in 2012 and the product has only been available for 60 days now.

The penveu team is also the finalist in the Tech Titans Technology Inventor Award, which will be issued later this month, profiling some of the most innovative engineering endeavors over the past year. Again, we're very proud of the team, which works so tirelessly to earn us such a prestigious acclaim.

Last month, we conducted the training for some of our channel, resellers, sales and support staff with continued training planned for the rest of them in the third and fourth quarters. Some of those sales people showed a very keen interest in seeing the product, they already started selling. Some of them have already brought up orders from their customers.

No matter where we show penveu, the feedback remains the same. The product is much better than interactive whiteboards and not less important, it is much more affordable. For the same price, the school can put an interactive whiteboard in a single classroom. It can put penveu units in six classrooms without sacrificing anything, and actually gaining performance and functionality.

On challenge that has troubled me last quarter was that we were not able to get penveu released to the market before May 30. While our team worked nearly around the clock to make this a reality, most decision makers at the school districts around the country were just beginning their summer break, which made our task of creating awareness particularly challenging.

Despite this challenge, we were able to grow awareness through social media campaigns and targeted advertising, resulting in a large leads in contacts database and a followership, which has grown dramatically in some cases even bi-fold in only a short period of time. Due to the increased traffic to our website, we made changes, and earlier today, released our new website with capabilities of supporting the increased traffic to it.

We have also hired specialized sales personnel who have already been successful in opening many strategically important doors and demonstrating penveu's capabilities within the different regional technology centers, which helped to direct school districts on technology selections for their classrooms.

These demonstrations have been exciting. And even though, we are just getting started, we have already visited key decision makers with both Texas and Florida, yielding a very high degree of interest in schools and enterprises, totaling more than 49,000 possible penveu placements. We are just scratching the surface of the terrific market opportunity that penveu addresses.

These efforts will continue to gain momentum throughout the rest of the year and in 2015. Of the nearly 31 million classrooms in K through 12 worldwide, the U.S. represents about 4.5 million classrooms in that K through 12 alone, so our journey has really just begun.

One thing that consistently comes through in the engagements, we have had to date, each demonstration results into same feedback, penveu is so cool, easy to use and trouble-free and it is a game changer for the classroom.

Not that we only focus on the classroom or only K through 12, we have also showed a showcase penveu in corporate training centers, higher education and full-profit schools over the past month and their reaction is the same as I just mentioned. This is significant, because the power of interactivity has not been as widely sold in these markets like they have been in the school environment.

But as a presentation tool, it is just so far advanced from any other product available on the market that these customers immediately see many uses for penveu. Some of which we ourselves did not even think of. I know that this has been a long process, and really the most exciting part is just beginning. I thank you for your patience you have shown us, as we work through the many complexities of this program.

I remain very excited about the financial prospects of the product. And for a good reason, we simply have not seen a competitive alternative to penveu or anything that promises the value proposition that this product offers.

With this, I will have you over back to Greg.

Gregory Kalush

Thank you, Yoram. And we now have a few minutes reserved for questions. I would like to open the floor. Kevin?

Question-and-Answer Session


(Operator Instructions) Our first question comes from the line of William Jones with Morgan Stanley.

William Jones - Morgan Stanley

So where the balance sheet is today, it's these 49,000 units turned into sales. Do you have the balance sheet to fulfill those orders in the shot-term period of time?

Gregory Kalush

We believe we do, with the actions that we'll be taking over the course of the next 90 days.

William Jones - Morgan Stanley

So you mean you'd do bank line or some thing like that or you can't say?

Gregory Kalush

I really can't say. But there's a couple of interesting things about the penveu program that's far different from the programs we have till date though. One is that the payment terms on this program are typically far shorter than anything we've experienced in telecommunications. And so we're able to take advantage of in fact terms on our supply line that actually favor us when we go and sell-through the product. So while there will be some cash usage with growth it will not be anywhere near as significant as it has been in our trends in the past.

William Jones - Morgan Stanley

And as far as turning the profit, we'll just have to wait and see how the orders come in?

Gregory Kalush


William Jones - Morgan Stanley

And you have mentioned that there were even some different uses that even you folks didn't think of, can you give us some example?

Gregory Kalush

Well, there have been a number of cases where we've taken the product and then demonstrated it at the Superintendent, CIO and the Curriculum Director level. And they started to remark about how they would use the product in the classroom. But frankly it kind of surprised us even, in terms of what they valued it, in terms of its value proposition.

Things that we thought were extremely important, to them were somewhat less important. The things that frankly we thought were much easier for us to accomplish. They saw as a very high value creators. And one of the things in particular is being able to use it from across the room.

I suppose one of the things that surprised us is the number of classrooms, where the teachers like to walk around, not only through the classroom, but toward the back, sometimes probably when there is quite a distance from the board. And so being able to use an interactive product that doesn't require touch was a big value creator. And quite honestly, we didn't know just how important that was going to be.

Yoram Solomon

And another example is even today demonstrating the product, somebody asked about the availability of all the captured screens anywhere, and we showed them that with a simple mouse click, all the files, all the image captures in penveu, are actually available to anybody in that institution through their own network. And they thought that was amazing. We didn't even think that was important to anyone, but that was a function that was already available. Those are just a few examples.


And our next question comes from the line of Don McKiernan with Landolt Securities.

Don McKiernan - Landolt Securities

So can you give us an idea of how much capital do you think you need to raise and how that might be structured?

Thomas Tipton

We're looking at raising between $3 million and $6 million. And we're actually actively pursuing a couple of different options with that at the moment that I can't go into too much detail about at this point.

Don McKiernan - Landolt Securities

So penveu has been basically been shipping for about 40 days or so. Can you give us an idea, if hundreds are shipped or thousands or any sort of metric like that?

Yoram Solomon

Well, we did begin shipping it on May 30, so we shipped only a nominal number of units during the second quarter. We do not report right now product unit shipment. But to be clear, we are not recording penveu revenue until a definite returns and warranty history is been established for us, and those trends take several months. So once we've reached at the certain bar, that's when we are going to start breaking it out. We haven't been doing that in the past.

Don McKiernan - Landolt Securities

And to provide a number of 49,000 units is in my opinion a very substantial number, of course -- how do I put this? There is some percentage of that you're likely to get, any thoughts on what percentage of that you're likely to get?

Yoram Solomon

Well, obviously that would be highly speculative. What I can tell you is that when we use this number, when we say 49,000, we have made progress. So these are entities that we met, and we went through the first meetings. Those meetings that I referred to were at the highest level, so whether it's with school superintendent, community college presidents and people like that.

And in every one of those were now going to go to the next stage, and the next stage, and next stage, where what we are talking about, if we aggregate what they have what the potential is at 49,000. Do we make a 100% of it, less than a 100% of it, what percentage is going to be highly speculative, and we are very encouraged. And this is just as I mentioned before, this is just scratching the surface. These are just the ones we reached out to.

Don McKiernan - Landolt Securities

So I guess a better question is, in your discussions with these co-districts, do they tell you, yes, if we like it, we could use a hundred of these things or 30 of them or whatever. Is that kind of how it goes? Is that how you come up with 49,000? Or do you just count up the number of classrooms and figure it out on your own?

Yoram Solomon

It's a combination. In some cases, it is to what they tell us. And they say, you know, we want to put it in every classroom. In some cases they are going to evaluate and not talking about how many classrooms, what percentage of their classrooms. So it was our back of the envelope assessment of what the potential is and what they are telling us.

Don McKiernan - Landolt Securities

And then last question, how many different distributors or resellers do you have right now or if you can even say I'm not even sure?

Yoram Solomon

Well, I am trying to think, on our website we have six that are listed. There are a few more that are not listed that are in different stages, some major ones. Six resellers are listed on our website. But there are more people promoting this for us.

Gregory Kalush

And as you know, Don, there is a lot of local regional resellers that have approached us, and were qualifying those. Some of them actually have been reaching out to us, and who are working through the whole channel, harmony issues associated with that. But it seems like the regional guys have very close direct access to the school districts in their region. And as a result of that we're kind of increasing our presence, but those guys aren't listed on our website yet.

Yoram Solomon

And I'll add one more thing. This is a two-pronged approach, on one hand you heard us using social media, email, blogs, general awareness creation campaigns and that is to create awareness. Those people in some cases come to our website, in some cases they go to Amazon, in come cases they to the reseller.

So it's important for us to enable the resellers. So I can tell you even though I can't talk about quantities, I can tell you that is there relatively even split between how many of the orders that we have received in ship, we received through resellers versus ones that we have received directly.

Don McKiernan - Landolt Securities

And then no production issues, right? You're making these things without any glitches or issues or delays?

Gregory Kalush

Yes, so far so good. We have not heard any problem.


Our next question comes from the line of Orin Hirschman with AIGH Investment Partners.

Orin Hirschman - AIGH Investment Partners

Based on the change in flow on the telecom orders and knowing what the engineering services business and the contract manufacturing business, what we would say in terms of revenues, let's say, to this coming quarter in terms of beginning to take back off from the existing business?

Gregory Kalush

Well, I think we said earlier that we have seen a fairly sizeable uptick in telecom, which is always good, because it helps the margin mix and helps to restabilize the company's financial profile. We are seeing fairly solid performance in both EMS and EDS. Although, I expect EDS to trail-off a little bit in the third quarter simply because a very significant program that we've been working on has been transitioning from design into manufacturing. But we feel as though the prospects for the third quarter in terms of margin and revenue performance will be a stronger profile of revenue for us than we've seen through the first half so far.

Orin Hirschman - AIGH Investment Partners

Are there enough orders layered in, so they will give you visibility beyond Q3 at this point?

Gregory Kalush

No, typically not. It's funny, because I wish I could say that telecom will reach steady state, but it just seems like, no matter what thing I think is going to happen, I am not surprised, because of consolidations and activities on the part of our customer. But I would tell you that the programs that we see that are providing the stability for the second quarter don't appear to be flashing the pen like deals in China that we've seen in the past, they seem to be now hitting their strides in more of a steady state from everything we can tell.

Orin Hirschman - AIGH Investment Partners

Do you think those programs are enough to take the base business without penveu to a cash-neutral yet?

Gregory Kalush

I don't know if they can get to cash-neutral, it will improve it. I don't think it will get to cash-neutral. But I also think that there is enough early potential for penveu that we can get to cash-neutral, just not perhaps without penveu.


And we do have a question from the line of Chris McCampbell with Southwest Securities.

Chris McCampbell - Southwest Securities

This is the first time, you all discussed the need for additional funds, what changed and why now?

Gregory Kalush

Well, Chris, I think it's pretty straightforward in our financial statements that we're getting a little lean, and if we want to promote penveu the way we think we need to promote penveu, we need to have a little more powder in the cake and that's really it, nothing more than that.

Chris McCampbell - Southwest Securities

In relationship to promotion, what does that look like in terms of the cash spend? What is it that you think would be majority of the cash spend in terms of promotion? What can you do with the new funds that you can't do now?

Gregory Kalush

First and foremost, it will be a direct coverage in the market; second, advertising and promotional awareness. The thing that I think we've all been surprised by, and perhaps Yoram can shed in some color around this is when we made the calls that we have made that showed us the vast opportunity with just seriously a relatively small number of calls.

The awareness level of the product really is not there, no matter what we've tried to so far. That's improving. But when they see it, when they feel it, when they actually start using it in their own classrooms, they're amazed by it. And we need to get that coverage and we need get it, get it fast, if want to turn and grow the way we think we can. And so it's really direct sales, its advertising and awareness campaigns that will promote penveu's visibility in the marketplace.

Chris McCampbell - Southwest Securities

Tom, you mentioned $3 million to $6 million, is that range based on a sensitivity to the cost of capital in relationship to dilution of shareholders or what's the range based on?

Thomas Tipton

It's based on several factors. I mean that, of course, is one. And the other factor is projected working capital needs at various levels of performance of the business, so both, high growth, medium growth, and if we have a little bit of whitewater ahead of us. So we've tried to build models that can deal with all circumstances and that we can be successful, come what may, with cost of capital analysis associated with that.


And we have no further questions at this time. We'll turn the call back to you.

Gregory Kalush

Thank you, Kevin. As always, everyone thank you for interest and your support at Interphase. This concludes our call. Have a great evening.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!