Cartesian's (CRTN) CEO Donald Klumb on Q2 2014 Results - Earnings Call Transcript

Aug.12.14 | About: Cartesian, Inc. (CRTN)

Cartesian, Inc. (NASDAQ:CRTN)

Q2 2014 Earnings Conference Call

August 7, 2014 5:00 PM ET

Executives

Corey Kinger – Associate Managing Director, Brainerd Communicators, Inc.

Donald Klumb – President, CEO, CFO and Director

Analysts

Orin Hirschman – AIGH Investment Partners

Operator

Good evening, and welcome to the Cartesian Second Quarter 2014 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference call over to Ms. Corey Kinger. Ms. Kinger, the floor is yours, ma'am.

Corey Kinger

Thank you, Mike. Good afternoon, everyone. Thank you for joining us for Cartesian's conference call to discuss the company's financial results for the second quarter of 2014. On today's call will be Donald Klumb, Chief Executive Officer of Cartesian. The second quarter earnings release is available for your reference on Cartesian's website at www.cartesian.com.

Before turning the call over to Don a couple of quick reminders. A live version, as well as a replay of the call, will be broadcast on the Investor Relations portion of Cartesian's website for 90 days. Also, a short Q&A session will follow the prepared remarks.

I would like to caution all participants that our call may contain forward-looking statements reflecting management's beliefs and assumptions regarding future events based on the best available information. Listeners are therefore cautioned not to put undue reliance on forward-looking statements as they are not a guarantee of future performance and remain subject to a number of uncertainties and other factors that could cause actual results to differ materially from forecasts.

A more detailed description of these uncertainties and risk factors are provided in today's earnings release and in our filings with the Securities and Exchange Commission, which I encourage each of you to review.

With that, I will now turn the call over to Don Klumb, CEO of Cartesian. Don?

Donald Klumb

Thanks, Corey, and hello, everyone, and thanks for joining us today. So the second quarter really extended the trend from our first quarter as we continue to implement our reorganization, execute on our vision and make this a break-out year for the firm. We drove 24% revenue growth year-over-year in the quarter and improved profitability while significantly investing in technology offerings and our newer solutions – our newer Elutions alliance. So, I'd like to focus on really three topics on today's call.

I'd like to first update all of you on the progress to-date in the execution of our strategic plan involving our reorganization and the transformation of the firm. I'd then like to summarize some key financial highlights from the second quarter and then finally, and very important, close with some key next steps as we move through the second-half of 2014.

Okay. So to start it off, I'd like to emphasize the progress we're making on executing our strategic plan beginning with the first of our three-pillar initiative. It's what I always refer to as doing what we do better.

Our reorganization was designed to yield several specific benefits. First, from a sales and delivery standpoint it has enabled us to further elevate and deepen our relationships with our large clients. In complement, we are adding new key clients and have a healthy pipeline of activity and new logos. In short, by doing business better we're creating an environment that allows us to better pursue and exploit new opportunities as they arise and as I will further discuss the growth from pillar-I really drives an increase in our operating margin further enabling us to enhance investment in our technology and our alliances.

So, it's important to note that we're achieving growth in our core business during a period of significant industry consolidation, which remains both an opportunity and a challenge for us. We are well-positioned with clients undergoing M&A, but such changes add an element of risk that we must manage.

Further, the labor markets in both the U.S. and the UK arena in particular are tighter these days. Demand is high for top talent and it adds urgency to our need to improve, how we execute our core business to maintain profitability.

Again, this is an area where the reorganization can and will be effective, and we're confident we have the right strategy tools and people to succeed. So success in pillar-I feels [ph] pillars-II and pillars-III, which involve expanding our managed solutions offerings and developing alliances with strategic partners. Managed solutions like our managed analytics offerings and strategic alliances are the real keys for achieving transformative growth for our company.

So let me take a minute to talk about our Ascertain platform, which enables rapid, cost-effective and repeatable deployments of industry-specific solutions. It is a key component of our initiative to increase the mix of technology enabled managed solutions with our clients. As we go to market with an aim to increase our technology mix our objective is to achieve greater penetration and stickiness with offerings that have scalability, recurring revenue and better operating margins.

Therefore, we continue to invest in our sales, engineering and delivery teams in this area and those investments are focused and aligned in really four areas: one, maintaining and evolving the Ascertain business we currently have around business assurance for our clients; and secondly, incorporating next-gen technology like our partner company DataStax to augment our platform to perform at carrier-grade levels and in real-time; thirdly, to finalize and deployment of our managed solution hosting platform to the cloud, enabling a cost effective and timely way to deploy our core offerings and on board new customers; and then, fourth, aggressively investing in launching of our managed analytics offerings, including the addition of six new modules, making it easier than ever for our clients to tackle common industry challenges through the use of predictive and advanced analytics, kind of what we define as evolving our Smarts into a SaaS model.

So as we move forward with these initiatives, we are also focused on greater standardization and productization of our technology offerings. In the first-half of 2014, we almost doubled North America sales of managed solutions from the second-half of last year. Specifically, we successfully deployed our smart exchange platform with another Tier 2 service provider and extended a key managed analytics offering with a Tier 1 service provider.

We are driving momentum and anticipate more wins in the second-half. It is a strategic imperative for us to take these offerings to our incumbent clients under new target clients. We're clearly making progress in the development of our managed solution offerings and in leveraging Ascertain. The inherent flexibility of the platform allows for multiple deployment models ranging from point solutions that complement existing infrastructure to end-to-end big data deployments, an open and modular architecture that provides greater agility and delivers immediate results for the clients.

Additionally, utilizing new tools and technology partners, as I mentioned like DataStax allows us to scale quickly while maintaining the nimbleness necessary to quickly respond to our client's rapidly changing needs.

Okay, I'll turn now to our alliances. I'd like to highlight our recent announcement of our first client win with our partner Elutions and that's consolidated communications, where we are deploying and managing Elutions Maestro, smart buildings and smart asset solution at consolidated key operating facilities.

As a reminder, for those of you who are new to following us Maestro is an operational business intelligence platform that performs advanced analytics of real-time operational data and creates environmental changes that deliver material, energy and operational cost savings through an automated control of assets and process. To demonstrate the potential client return on investment on implementing these types of solutions, our analysis projects that the solution can provide more than 16% savings in energy and consumption for consolidated on a seven-year managed service relationship.

And with the data that we generate, as importantly, we predict we'll be able to deliver other significant operational benefits that will materially impact the cost of delivering consolidated services.

Elutions partnership is really a key component of the evolution of our business and yet another indicator that we're delivering against our transformation agenda. Our teams are actively engaged with prospects globally. Some are in later stages of dialog. Although these pursuits, as we mentioned in the past are longer in nature, we firmly believe our partnership delivers a unique and differentiated solution into the TMT market and with an anchor client the Elutions relationship is starting off exceptionally well.

We will be recognizing revenue from the Elutions alliance for the first time in the second-half of 2014. In general, our contracts may vary by client and the contract structure may include fully financed models of both installation combined with a seven-year managed service or our CapEx model where our clients acquire the software and hardware and contract with us under seven-year managed service.

Ultimately, under either of those models where you will manage and construct a contract in a way to drive appropriate operating margin and return for the firm.

So in summary, we're making solid progress on all three pillars of the plan and this gives us the right foundations as we move forward. So if I turn now to our financial results. So as I mentioned we drove 24% year-over-year growth in the second quarter, and 7% sequential or quarter-over-quarter to $17.4 million.

Note that the growth is all organic with no revenue benefit from Elutions alliance in Q2 as the newer consolidated communications contract launches in the second-half of 2014. Our UK and European group continue its trend of delivering strong growth with our team, having done a stellar job in improving the business over the past two years. In fact, over the past two past years, we've driven over a 110% revenue growth in our international business with consolidation in the sector, concentration is always an area of focus, and we work regularly to diversify within the accounts, as well as to add new client logos.

As you may recall, within North America, our business had been shrinking for some time, but I'm pleased to announce that we regain traction during the second quarter and returning to a growth trajectory with a 10% to 15% sequential growth expected in the third quarter. The reorganization along with enhancement of talent in our North American Group is really beginning to show results.

If we look at matrix, our consultant utilization in the quarter was solid, approaching 80% and our billable rates – run rates are up. However, as I will discuss in a minute, although we're making progress, we must further improve on project pricing margins and overall marketplace valuation of our capability.

By focusing on higher value services, more sustainable managed solutions, and greater – and a greater mix of fixed price offerings to enable us to manage consultant mix, we are driving stronger forward margins on our newer engagements. A good example of this and more specifically in North America, our cumulative margin on all 2014 sales, have been substantially higher than the backlog that we carried in – from 2013.

Again, important to note, we're enhancing investment that offsets current operating margin dollar improvement. Investment, we believe, can most significantly move the needle for us and for the benefit of shareholders in the long run. And these include the selective adding of talent in both the sales and delivery side for our new and growing managed solutions, and specifically for the Elutions partnership, and as we build our core technical offerings, investing further in R&D, in our managed services, hosting platform for managed an analytics, as well as other key practice areas.

Of note and unfortunate, our SG&A expense for the second quarter includes $1.4 million related to an increase in litigation reserves for our previously disclosed arbitration matter with the firm's prior CEO. Excluding this expense, SG&A is up about $0.5 million compared to the prior year. As discussed, we have – we've elevated our investment in our transformations around, what we've defined as pillars two and three, and to accelerate our value proposition through solutions and alliances, in order for us on the long run to drive a more sustainable and profitable growth.

During the second quarter, we had two additional significant adjustments to net income. The first is a very positive one. We reversed the reserves for our international tax assets with a net tax benefit during the quarter of approximately $1.5 million with the remainder of pro forma earnings being primarily income from operations. The reversal of our international tax assets reserve is a terrific accomplishment and is really supports – supported by the fact that, we've driven sustained positive operating performance internationally and project future taxable income.

One thing to be clear, the tax reserve reversal only applies to the international positions at this time. The larger portion of our deferred tax asset, which is in the U.S. currently still remains fully reserved, and we will be revisiting those reserves as domestic results continue to improve. The second adjustment as I mentioned two adjustments previously discussed – was previously discussed on our first quarter call and involves the accounting around the Elutions warrants.

As you may recall in Q1, we recorded the value of the warrants as the liability versus equity. There was a subsequent amendment to our Investment Agreement with our Elutions partner. In the Investment Agreement, the liability that was unintentionally created was then reclassified during Q2 to equity. Really to simplify from a P&L perspective, we drove about on a pro forma basis, net income of about $1.8 million, which does exclude the reserve for arbitration costs versus about break-even in the second quarter of 2013 with approximately $1.5 million of that coming from the reversal of our income tax reserves internationally and the remainder being tied to operating income.

Lastly, from a financial perspective, looking at our balance sheet, we remained in a very healthy position. Cash flow was up quarter-over-quarter to $18.6 million from $16.1 million, and stockholders' equity grew to $27.9 million. So moving on – the third topic I want to discuss and that is the key next steps as we move through the back half of 2014, that executive management is focused on.

So as previously discussed, we will continue to elevate our project margins every – with the size of the firm we are now, every percent improvement, and our margins drives about 700,000 to our bottom line. We'll do this through continued selling of solutions versus consultants evolving our team composition and leveraging and adding technology to our offerings.

Secondly, we will continue to shift the mix with more solution and alliance revenue in the mix. This will further enhance operating profits and more importantly evolve our business model. Third, we're going to begin – we believe, we're going to begin to see the further benefits of our investment by Elutions and the partnership, and our investment in our managed analytics platform.

We also continue to invest in these offerings and further defining our software and solution stack. We must further enhance our bottom line results with the combination of these first three initiatives just discussed along with some select non-core cost reductions.

Internally critical for us to further enhance our technology tools, our CRM tools, leveraging of share-point for our internet, and others to enable our teams to collaborate, capture IP and product types better.

And lastly, and I'm sure U.S. our investment community will really appreciate this. We're increasing the pace of our investor and public relations activity with plans to increase attendance at key conferences and greater communication of the firm and its activities. So we expect to see more of us from – from us on this front.

Also, for informational purposes in June, we launched our quarterly newsletter, we call it Coordinates, which is available on our website. And while this newsletter is really geared towards clients and employees, it does provide good color on what's going on within Cartesian and, hopefully, as investors – as you review, you will find it helpful to you.

So to wrap it up, our first-half revenue growth of approximately 20% improving profitability to $2.2 million and pro forma net income from approximately break-even in the first-half of 2013 are clear – clearly definitive positive steps. Also important, we project continued revenue growth in the third quarter from second quarter levels. Our strategy is designed to transform Cartesian and accelerate revenue growth and market capitalization. We're focused on executing on our three pillar plan, and we are building momentum on that front.

We are started with the focus of top line growth and now it’s – that it’s generating results. We're adding an operating margin focus as we evolve the teams and leverage technology. It is important that this model be self-supportive, so we remain committed to keeping costs out of the model that don’t drive the business, but want to be clear that growth will require investment.

So, from my perspective over the last two years, we successfully implemented a new company culture, a culture with passion at its core, and it is the key element that's driving our results. And now we need to take it to another and a next level, and we're committed to doing so. Our focus remains on both improving business performance near-term, whilst driving to build our longer-term vision and shareholder value.

So with that, I'll close and thanks for your time and open up for questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) The first question we have comes from Orin Hirschman of AIGH Investment Partners.

Orin Hirschman – AIGH Investment Partners

Congratulations on the progress on the – particularly on the revenue growth.

Donald Klumb

Thanks, Orin, I appreciate it.

Orin Hirschman – AIGH Investment Partners

Can you just figure us through again, because there were a handful of adjustments, what was the actual operating income for the quarter not including the tax benefit, but pulling – also not including the potential legal settlement reserve?

Donald Klumb

Sure. If we adjust those items on our operating earnings about 350,000, Orin.

Orin Hirschman – AIGH Investment Partners

Okay. You'd mentioned, North America coming back to life, what is doing that and how does the recent events in the last two days in terms of that merger being called off by T-Mobile and Sprint, how does that affect you, if anything?

Donald Klumb

Yes, yes, good question. So I truly believe that the reorganization that we really started informally in 2013, and then executed and formalized at the beginning of 2014, is having greater impact on North America than it is in the UK, EU, because I think a lot of the components of the reorganization were really leveraging off of a poster-child of the UK.

And so the collapsing, right, of multiple business units in the States and then bringing forth a North American combined sales team led by our top sales individuals, complemented by one delivery where we can best allocate resources and really elevate our thought process as we drive relationship with clients and our thought leadership in the clients, really has made a difference in enabling us to outflank the larger firms, the Lloyds, McKinseys et cetera.

I think that's a real big piece of it. As I mentioned, so second-half of your question, consolidation is a tough thing, lot of unknowns, SoftBank, Sprint, T-Mobile, I assume that's what you're referring to, on that front. I think my professional opinion Sprint stepping away from BrightStar and T-Mobile is probably a good answer.

Marcelo, I know Marcelo personally, BrightStar is a partner company of ours and very hardworking intelligent individual. I think he'll bring a real element of excitement into the Sprint account.

Orin Hirschman – AIGH Investment Partners

Okay. And just one follow-up question, just in terms of how you're selling the new products together – is there cross-sell at this point, because I would have originally thought when you made the agreement, that there wasn't going cross-sell, it's just going to be its own separate SaaS business, but it sounds like you're merging it into a cross-sell in some way, can you expand on that?

Donald Klumb

Let me – just to confirm – are you talking about the Elutions alliance product set or our own core platform?

Orin Hirschman – AIGH Investment Partners

Yes, I mean, Elutions' also. Is that remaining as a separate thing or you sell them away for clients?

Donald Klumb

It is separate, so one of the things you will see as we move forward and you'll see in our SEC filing, as we simplified we simplified the organization really into three components, right, from many business units. Our international unit, our domestic unit, and then we carve out a global alliances unit.

And so the Elutions really falls into the global alliance unit is headed by individuals disciplined on that relationship et cetera. Now, that said, as you can imagine as we sell into incumbent [ph] and regular accounts, we pull from very senior relationships and if they're right we'll leverage the sales forces in North America and Europe to open doors et cetera, and then bring in the expertise of that alliance group as well as the Elutions' team to ultimately drive and close the deal.

Orin Hirschman – AIGH Investment Partners

Okay. Neat, thank you.

Donald Klumb

You're welcome.

Operator

The next question we have comes from Neil Fagans [ph], investor.

Unidentified Analyst

Hi, Don. Thanks for taking my call.

Donald Klumb

Hi, Neil. Good to hear from you.

Unidentified Analyst

I have a couple of questions, kind of unrelated. I was wondering on the joint-venture win that you announced regarding consolidated communications. It's a seven-year term. On this particular contract is the revenue recognition by Cartesian is going to be more or less linear kind of equal over the seven years, and if so is that going to be typical of what we're going to see with joint venture wins?

Donald Klumb

Yes, good question. This particular relationship is a straight-line, more of a straight-line, Neil, for your question, where the installation of the software equipment et cetera along with the managed service are bundled and then the revenue is recognized on a quarterly basis on a more straight-line over seven-year relationship, you're correct.

I think the model, it continues to evolve. We are finding in a number of global client conversations that there's actually interest, excuse me, in acquiring the hardware, software. So I can envision as many, maybe more where the transaction will be two elements. The first element being a purchase, Neil, because of a cheaper weighted average cost of capital, mostly likely with our clients.

A purchase of the front-end of the equipment and the software installation et cetera, which will then be more upfront, recognized along with margin with that followed by us in our expertise running the managed service over. We don't really try to negotiate a sever-year's and that's what most of the conversations have been on that. So to answer your question – there's a little bit of my gut, so I think it's going to be a little bit more of a split of some first year elevation followed by managed services.

Unidentified Analyst

And for Elutions to meet the revenue targets to earn their incentive warrants am I correct that the revenue have to actually be booked, not just put into backlog?

Donald Klumb

Yes, that's true. If it – the way the Investment Agreement structures is, if it's backlog, right, and it's non-cancellable backlog they can lock in on their pricing for the warrants but then the actual vesting et cetera is tied to the revenue recognition on our financial statements.

Unidentified Analyst

Okay. And is there a revenue percentage share with Elutions or are you booking the full value of the contract as Cartesian?

Donald Klumb

Yes, so again, that could be either for a number of the engagements where we – it's our clients, our incumbents et cetera and it will be our contract and we'll have the growth contract be involved in the program of the installation managed service et cetera, along with subbing to their product, their software and some of the – what I call tool-build guys to do the installation.

So, but others they bring us into the deal and we may be involved more in managed services, PMO or other in the involvement and may not have, so could really be either way, Neil.

Unidentified Analyst

And on – but on this particular one, is there a revenue share with Elutions?

Donald Klumb

The one that we closed the consolidated…

Unidentified Analyst

Yes, consolidated.

Donald Klumb

That's right, we are the prime on that and then there will be a component that obviously they're delivering the hardware, software and certain components of it, so we'll sub elements of it down to them.

Unidentified Analyst

Okay. And then, just a couple of quick questions specific to the joint-venture. Don, I understand if you don't want to, but I'm curious if you're willing to put kind of a range-bound dollar value on your pipeline of opportunities with Elutions. And yes or no, either way, how does that pipeline of opportunities with Elution compare now to the beginning of the relationship back in – let's just call it the beginning of the year?

Donald Klumb

Sure. Yes, I probably won't quantify it, Neil, but fair question. I will tell you that we have met with quite a number of Tier 1 organizations on both sides of the pond. I can tell you, I've been involved directly in some, more as an observer or participant while our teams come together in alliance. And it’s quite impressive, I've directly absorbed CTOs and others very impressed with it, various stages in the pipeline.

The pipeline has grown significantly from where we have started with certain elements of it now, kind of the show me where perspective clients are actually going out and absorbing where it’s and talking to clients to get that comfort level, but find if very compelling.

Unidentified Analyst

Okay. And then final question, Don, I'll get back in the queue. In the last call, you talked about the pipeline having kind of a level one through six, one being qualified, but early and level six being down to negotiating contract value terms. You mentioned that you had several opportunities at a level five and six. I was just curious the opportunities you were referring to three months ago, were those still viable or have they just slipped timing wise off the table completely, I'm just curious, how those particular opportunities that were advanced three months or ago are staking up now?

Donald Klumb

Yes, the exact portfolio a little bit tweak in the mix that were more advanced, remain very advanced. None of them have fallen off the table, take a little bit longer, but very positive.

Unidentified Analyst

Okay. Thank you.

Donald Klumb

You're welcome.

Operator

Next we have Orin Hirschman, AIGH Investment Partners.

Orin Hirschman – AIGH Investment Partners

Hi, thank you. Again, just wanted to follow-up, just on the first Elutions deal for you, have you ever stated what kind of size it is, and can you indicate when the revenues began and what time of the year contract it is?

Donald Klumb

Yes, I have not, Orin, discussed the size of the contract, you imagine it’s relatively sizeable. The installation process that we're managing the program on right now is often running. I'm not sure if the installation be completed and because it’s a managed service, you recognize once you're operating, whether we'll kick the revenues in, in the third quarter or the fourth, but it will be in the second-half of the year.

Orin Hirschman – AIGH Investment Partners

Do you think there will be any other deals in this year's revenue or it’s getting late for that?

Donald Klumb

We're pushing every day, hope to have good news for the shareholders at some point in the second-half of the year.

Orin Hirschman - AIGH Investment Partners

Okay, that sounds good. Okay. Thank you very much.

Donald Klumb

You're welcome.

Operator

Next we have Neil Fagans, investor.

Unidentified Analyst

Hey, Don. Well, I'm going to take advantage of you here if nobody else will.

Donald Klumb

Okay.

Unidentified Analyst

I think two quick questions, you gave a statistic very quickly that I couldn’t jot down, it was something regarding improving margins, where I think you stated that a certain dollar value of top line generated a certain dollar value of bottom line margin, can you give me that again?

Donald Klumb

Yes, sure. What I was basically saying, when we launch the year right from last year, we're about $55 million company and now we're approaching $70 million company, so that’s all great. And one of the things that real important to us in that is that, the value we bring to the table, which is – it’s our value for what we do for our clients. We got to continue to be smart and push and elevate it in a number of ways mixing our teams with different mix of people bringing technology to leverage margins et cetera, because the way I pitch it to our team, Neil, is that $70 million company, every 1% margin improvement, right, on our portfolio represents $700,000 to the bottom line. And so, we're going to push for basis point improvements on that.

Unidentified Analyst

Okay, great. And also our – any of your offerings now being offered in a SaaS model or cloud-based model, is all – or is all of that yet to come?

Donald Klumb

It’s all yet to come, another good question. So just last week, we've put some announcements on our managed analytics. It’s gaining good traction from an organic perspective, and we had our first success, I think, I discussed in the script with a large Tier 1 in the states. And a number of our – of these Tier 1 clients have been trying to get their arms on big data, from a platform perspective, from a business intelligence perspective.

And what we really do is, we can leverage other platforms, as well as our own, and then elevate that into true predictive analytics, and really using the Smarts of the firm and the understanding of the data within the carrier, the MSO environment, because we worked with it all the time, it’s all we do right, and elevating and driving it.

So we've been attacking it early on with a number of small pilots, $50,000 to $100,000 to demonstrate something different than they’ve seen from the Lloyd, McKinsey or the other big firms, and we're finding that they are liking it. Some of those now are driving towards commercial state, all of those, Neil, thus far have been just getting data, putting it on a dead server of our own, or looking off their servers.

In that – while that’s all going on when I talk about investment, we're identifying what this looks like and developing the right platform in the cloud to make it easier. So part of our service will be here is what we do around predictive analytics, and here's how you work with us. We work in this cloud environment; you provide your data feeds in a secured element, yadi yadi yada, that’s all in the works. We hope to launch that in the fourth quarter.

Unidentified Analyst

Okay. Thanks again, Don.

Donald Klumb

You bet.

Operator

This will conclude our question-and-answer session. I would now like to turn the conference back over to Mr. Donald Klumb for closing remarks. Sir?

Donald Klumb

Yes, thanks a lot, Mike, really no closing remarks. Thanks everybody for participating, and we've got a lot to do, but terrific team, very passionate, and accomplishing a great deal as hopefully you guys can begin to see some. Thanks a lot.

Operator

And we thank you sir for your time today. The conference call is now concluded. We thank you all again for attending today's presentation. At this time you may disconnect your lines. Thank you and have a great day to, everyone.

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