iPass CEO Discusses Q3 2011 Results - Earnings Call Transcript

Executives

Steven Gatoff - SVP and CFO

Evan Kaplan - President and CEO

Analysts

Fred Ziegel - Blue Water Capital Markets

Kevin Hanrahan - KMH Investment Advisors

iPass, Inc. (IPAS) Q3 2011 Earnings Call November 7, 2011 5:00 PM ET

Operator

Good day and welcome to the iPass Third Quarter 2011 Earnings Conference Call. Today’s conference is being recorded. At this time I’d like to turn the conference over to the company.

Steven Gatoff

Thank you, operator. Good afternoon, thank you for joining us to discuss our financial and operating results for the third quarter of 2011. I’m Steven Gatoff, Chief Financial Officer of iPass, and I’m here today with Evan Kaplan, President and CEO.

I’d like to bring the following to your attention. The date of this call is November 7, 2011. Our discussion today contains forward-looking statements about events and circumstances that have not yet occurred, statements regarding our projected financial results for the fourth quarter of 2011, the full-year 2011 and 2012. Statements containing words, such as will, expect, anticipate, believe, plan, intend and should, and other statements in the future tense are forward-looking statements.

Actual outcomes and results may differ materially from the expectations contained in these statements due to a number of risks and uncertainties including those set forth in today’s press release, our quarterly reports on Form 10-Q and Annual Report on 10-K that are filed with the Securities and Exchange Commission. These reports are available on our website and at www.sec.gov.

Please note that iPass undertakes no responsibility to update information in this conference call. On this call, we will provide and talk about our results using non-GAAP financial measures. The press release on our website includes text and tables that explain how we define and calculate the various non-GAAP metrics and the reconciliation of non-GAAP results to GAAP results.

The press release and Form 8-K announcing our financial results are available on our website. This earnings call is being recorded for replay. It is being webcast and will also be available on our website for one quarter until the next earnings call. Please note that this webcast is a property of iPass and any copying or rebroadcast without the expressed prior written consent of iPass is prohibited.

Before I turn the call over to Evan, we would like to note for you that Evan will be in San Diego tomorrow Tuesday, presenting at the Tech America Conference, and that Even and I both will be New York City, Chicago and Minneapolis next week. If you are interested in connecting with us, please feel free to shoot us an email at ir@ipass.com.

With that I’d like to turn the call over to Evan.

Evan Kaplan

Thanks Steven. Good afternoon everyone and thanks for joining us. I’d like to start this call with a bit more of a preamble than I usually provide. Its approaching three year's now since I took the home at iPass, during that time weather recession, large write-offs from previous acquisitions, a very significant decline in revenue from our legacy product and real challenges around profitability. All this resort to transform the company.

As we head into year-end, we are closing out a year that’s seen tremendous amount of change for the company and I believe a compelling amount of value creation for our shareholders. We started with such a nation product and really a singular focus and here we are well positioned in front of a rapidly expanding market with a tremendous level of excitement across a number of fronts, including product, people, customers and business models.

I think it's appropriate to take a moment to talk about this market. When I started here in mid-November 2008, we had about 100,000 commercial hot spots in our footprint and I’d estimate that covered a significant portion of the world’s commercial Wi-Fi footprint. As we talk today, we provide our enterprise customers and carrier partners with a worldwide footprint of more than 650,000 commercial Wi-Fi hotspots that are integrated to our global billing and authentication platform. It's not hard to see how we exit the year with more than 750,000 hotspots with a view to looking at multi-millions in the next few years.

Importantly the industry itself is projecting 350% growth in hotspots by 2015. He now broad based bullishness on the role of Wi-Fi and the mobile ecosystem is in direct contrast to the stated thing when I arrived here in iPass. At that time most of the industry predicted that commercial Wi-Fi would die a slow death as 3G and 4G networks appear to be positioned to dominate everything, but the dynamics are now very clear and very different. Connectivity demands have grown exponentially with unyielding growth in devices and traffic. Consequently, commercial Wi-Fi has become a critical part of almost every operators plan. To get a sense of this urgency and scale, last week Brazil’s Lloyd telecom announced they would have 1 million commercial hotspots deployed by the end of 2012. This follows a similar announcement of similar scale by China Mobile, China Telecom and other carriers around the globe. Big numbers for sure, and importantly iPass is a part of most of these discussions. As you can see for example in our recent China Mobile announcement. And so the core question you should be asking is, okay, how did iPass business and investment align t take advantage of this growth?

The answer is that on the strength of our technology platform and the expulsive growth in Wi-Fi, we expect to see the Open Mobile value proposition continue to play out well and continue to gain more traction. I’ll go through the details in a bit, but suffice to say, we saw almost a two fold increase in a number of enterprise customers that side onto the platform and now have more than 235 large enterprises committed to Open Mobile. In addition, the number of monetized usage of Open Mobile has grown rapidly, granted it started from a small number, but now it's already at a very respectable aggregate levels and has been doubling sequentially quarter-to-quarter.

Another really important point is that the drive is a value for our stockholders now spans across several markets and businesses, as we rolled out our OMX carrier offering and have a new found view toward revenue growth and profitability for our managed network services business. All in all it's been a quarter of solid results, accentuated by strong strategic value growth and thoughtful and tactical planning for 2012.

As I organized everything for today’s call, I wanted to cover with you, I come to realize that I like the cadence we have established providing a lot of transparency and what we are seeing with the business, our customers, the product, our financial results and of course, what we see going forward. And so I’d like to launch right into that.

As you have heard us talk about the past few months, we are seeing some compelling and tangible data points on our execution of Open Mobile and candidly the excitement here continues to grow. From a really strong Open Mobile product that’s now in its two old lifecycle has broad enterprise scalability for early success in leveraging our unique technology and carrier integrations into an entirely new Open Mobile exchange business. I believe the long-term iPass vision look strong and financially rewarded.

And so like you heard from me earlier, with a good mix of both conviction and evidence of traction around the long-term goal, I like to go through the following three topics with you. First, I will give you an update on the good progress we are making in the enterprise business with our Open Mobile platform. Second, I will provide some color on some nice recent wins we have seen on our new Open Mobile Exchange or OMX as we call it. And third, I will provide a view into what we are looking to achieve through the end of the year and into 2012 as we continue to execute and create shareholder value.

Let me start with our Open Mobile Enterprise business or OME as we refer to it. As a brief reminder Open Mobile is our technology platform that encompasses our cloud based mobility management portal, our various client agents for Mac, Windows, iPhone, iPad and Android devices and our worldwide transaction and settlement infrastructure that securely authenticates, bills and clears Wi-Fi transactions for enterprise customers and carrier partners.

In Q3 we continue to see good traction with enterprise customers committing to the platform, we are pleased to see another group of household names in leading Fortune 1000 companies signed Open Mobile agreements. Also we are encouraged just we are starting to see real progress on the carrier front, as both Deutsche Telekom and Telstra finally in market with the product and adding users and building pipeline at the nice cliff. And importantly we are pleased to have recently added T-Mobile USA to our listed carriers with OEM to our platform.

As I mentioned earlier we now have more than 235 customers signed on, including recent additions of Accenture, Austin Consulting, Cap Gemini, Ferrari, Hitachi America, Nokia Siemens, Procter & Gamble, Sony Computer Entertainment and Stott Oil among others. And while deployment of active users have been slower than we originally expected, we now seem to have real traction hit a nice growth pace with our total monetized users. Additional, good news is that we are seeing very healthy gains in paying OMCs under contract as we continue to grow our platform revenue. Steven will talk a bit more about some additional user metrics that we look at and that we are now providing for you to see how we are monetizing Open Mobile. Suffice to say the number of paying seats is growing nicely.

Perhaps the most important benefit iPass for the OEM platform how much more usage the new software drive versus our legacy platform, but the sample size is still relatively small, the increase in network usage with the new Open Mobile platform is dramatically better than we expected, and that’s still with very little contribution from our efforts in tablets and smartphones and our new tool platform release which is just hitting the market.

On the strength of this new platform release and our steady state of IOS an Android release in our rapidly expanding network footprint creating value not just on the enterprise side of our business but also on the service provider side. In the light, I’d like to talk about the Open Mobile Exchange or OMX business that we launched relatively recently. Our OMX business is developing well, while it's too early in the world of carrier, Wi-Fi integration, the whole ecosystem is exploding and we are very excited about the meaningful discussions we are having with most operators. And we are bullish about the strategic and financial value of this business to our shareholders.

As an example, this project in strategic value creation, we recently announced an agreement with China Mobile, it makes iPass one of only two providers that can offer China Mobile’s rapidly expanding Wi-Fi footprint to other carriers and service providers. This was an important win for us, that complements our technology and distribution relationship with Deutsche Telekom and importantly we expect to drive the majority of roam-in Wi-Fi traffic for China Mobile for some time to come.

The Deutsche Telekom and China Mobile were the early proof points in our long-term PMX strategy that has iPass at the intersection of mobile operators and global Wi-Fi, a compelling spot to be in. Stay tuned as we look to make additional amount spend in this space through the end of the year.

Moving on to another topic, I wanted to spend a brief moment on our managed network service business. Many of you probably have paid a whole of attention to this business, and candidly we haven’t spent much time discussing it with you either. To recap the MNS business focuses on managing connectivity deployment and broadband services for large retail and financial branch office customers using publicly available cable, DSL and cellular infrastructure.

Over the last few years our team has managed to transform and grow this business nicely, and as we headed to 2012, we now expect that business to continue to grow revenue and turn the corner on profitability.

Happily, the MNS business is writing its own set of disruptive market trends, tied to the increasing capability of these cable and DSL networks. Interesting why we have previously run this business almost completely separately. We believe now there could be some nice synergy opportunities particularly in the role Wi-Fi plays at these branch office and retail locations at these managed networks. More on that to come as we go.

With that let’s take a look ahead. Consistent with my goal trying to have you see what I see, and laying it out in plain English, it's been a year of investment amidst significant revenue declines from a struggling legacy business. While there are few quarters left to smallest net train on our revenue, based on guidance going forward, it's clear now that we should handily beat our bottom-line estimates for 2011. Going forward as we continue the inflection to a more compelling model, we see iPass has been in a very good place, and positions solidly on our path to return to revenue growth and profitability.

Looking ahead to Q4, and importantly to the transition to 2012, I’m focused on continuing the acceleration of our OME, OMX and our MNS business. On the Open Mobile Enterprise side, we are focused on growing our active user base, accelerating customer deployments, signing new logos. As has been the case for the past few quarters in terms of gauging our progress in this business, you should look for continued enterprise customer wins, higher customer utilization, continued growth in platform revenue and some important technology and distribution relationships as we head into 2012.

On the Open Mobile Exchange side or OMX side of the business, we will look to continue to build on a now very strategically valuable technology platform to gauge our progress in this business look for us to continue develop important strategic relationships with new Wi-Fi distribution and technology ecosystem partners and look for continued carrier partner wins as we exit the year and enter 2012.

On a broader note, we continue to be committed to the theme of managing our investments closely and turning now losses into a growth story again over the next few quarters. Steven will talk a little bit more about this in a few minutes.

With that I’d like to wrap up with our view that we started down this path three years ago with an idea and a lot of work in front of us and while it may seem like a long road to some and feels like a relatively short road to others. And we are proud of the asset value we have build since we arrived and particularly the way we have been able to leverage more recently into entirely new business and revenue streams.

We have seen customer numbers and user number starts low and begin to grow nicely and important we have seen the (inaudible) effective deeper penetration and greater usage of Open Mobile across our new user base. All in all just the things you should be looking for.

On that note thanks for your time, we look forward to taking your questions at the end of the call. And with I will turn it over to Stevens.

Steven Gatoff

Thanks Evan. I like to cover three topics today, first provide some color on the financial highlights of the third quarter, second, talk with you about what we think are some helpful additional user monetization metrics that we started sharing with you; and third provide our guidance for Q4 and reflect a bit on 2011 overall as we head into year-end.

In looking at our Q3 results, there are two consistent themes that we’ve experienced over the past several quarters and they have continued to be the overriding message about our current results. First, on the top line, we continued to grow the ever important and core engine of platform revenue in Q3 both sequentially over Q2 and year-over-year. We saw a greater than 30% annualized growth rate this quarter in platform revenue, primarily driven by solid monetization of the Open Mobile platform with our enterprise customers and some nice increases in OM platform uptake with our carrier partners. Second, on the bottom line, our discipline and strength in managing risk, costs and our balance sheet yielded another solid quarter in which both adjusted EBITDA and ending cash balances came in better than anticipated.

Starting with the revenue, even with a seasonally quiet summer quarter in which usage and revenues are typically lower, we continued to grow platform revenue. We ended Q3 with more than $5 million in total platform revenue, a high mark in the company’s history and an increase of $350,000 or 8% from the prior quarter. The total platform revenue increase was the net of a $740,000 increase in Open Mobile platform revenues, partially offset by about $390,000 in lower legacy IPC platform revenues which as we communicated last quarter was anticipated to decline on both the summer seasonal slowdown and customer migration off the legacy IPC product.

Importantly, the growth in platform revenue continues to be driven by the enterprise migration and increased traction by our carrier partners with our Open Mobile platform. And we are starting to see an early but nice amount of activity from a newfound focus on signing new enterprise logos. Specifically, in Q3 we signed 19 new direct enterprise logos and added about 30 new enterprise accounts through our carrier OEM channel.

Christophe Culine, our new Head of Global Sales who joined iPass only four months ago is already making a meaningful impact in driving our value proposition forward with enterprise customers and translating that into closed deals.

Our carrier channel partners are also driving platform revenue growth. Our carrier OEM or white label relationships in which Deutsche Telekom, Telstra, and Orange Business Services are selling their branded versions of Open Mobile to their enterprise customer base are delivering good early traction and results both in terms of new enterprise customer additions as noted a moment ago and platform revenue generation. As these carrier partners build steam with their offerings in market, we would look to see this leverage from our OEM distribution model continue with increasing scale as we move into 2012.

Overall, as we discussed a bit last quarter, we are continuing to realize better economics and greater value creation from enterprise customers who deploy the Open Mobile platform. First, in seeing a greater number of deployments across a given employee base; second, in experiencing greater platform usage across the deployed base; and third, in realizing a larger amount of network services that get used by Open Mobile platform users versus a legacy IPC users, all in a continued encouraging outcome.

While we are talking about revenue, let me spend a moment on the network side of the business. Network revenue was down about $1.9 million from Q2 with approximately two-thirds of this from the seasonally lower summer Wi-Fi usage and the remaining driver being the anticipated decline in legacy dial-up and 3G network revenue.

For the final point on revenue, I’d like to provide some brief insights on our Managed Network Services or MNS business. As Evan mentioned, through no sudden feet but rather some solid execution on turning this business around, our team running the MNS business generated a very respectable 10% or $700,000 in revenue growth in Q3 year-over-year. The MNS team is driving growth as a reflection of a successful transition from the legacy teleworker or a home office centric business to a more compelling model now built around a fully managed branch office and retail focused enterprise customer. Stay tuned for more color on the MNS business, as we enter 2012 and complete some thoughtful planning going on around scaling this business to further drive revenue and increase profitability. That’s probably a good spot to pivot over to the expense side of the house where we remain keenly focused on effectively managing our operational expenses and our balance sheet. These efforts continue to bear fruit with our Q3 adjusted EBITDA loss of about $270,000 coming in well ahead of guidance of a loss of 500,000 to $2 million.

Further, there are two important data points around this better than expected result. First, this improved result will still achieve in the context of having invested in our OME and OMX product and platform development around smartphones and the additional feature functionality that’s seen in our new 2.0 release. And second, this quarter’s adjusted EBITDA result includes a severance expense charge that we took in Q3 of about $600,000 as we continue to engineer costs out of the business and look ahead to turning the corner in 2012. This realignment and one-time P&L charge that is not labeled a restructuring and is, therefore, included in the adjusted EBITDA number is anticipated to drive quarterly OpEx savings of about $400,000 per quarter going forward and starting immediately in Q4.

The final point on our financial results is that we continue to deliver a solid balance sheet, generating modest positive free cash flow in Q3 and ending the quarter with $26.3 million in cash and of course, we continue to have zero debt.

With that, I’d like to talk a bit about some additional Open Mobile monetized user metrics that we have begun sharing. In Q4 2009, we introduced the average monthly monetized users metric that provides visibility and that represents active users. This metric continues to be indicative of the adoption and use of our services. As we continue to drive forward with our Open Mobile platform, our approach to contracting and pricing models with our enterprise customers and carrier partners continue to evolve and now includes, for example, deployed pricing models in addition to our historical active user based pricing.

As such, iPass management has found it helpful to also track the monetized users of our Open Mobile Enterprise customers for whom we are being paid but who have not yet been fully deployed by their enterprises. This metric is known as paying undeployed monetized users. Beginning this quarter, we are reporting all the elements of the enterprise Open Mobile monetized user base along with a historic active user based metrics for the overall company and accordingly we are reporting three Open Mobile monetized user metrics.

First, Open Mobile monetized users active. This is the number of Open Mobile users who are billed Open Mobile platform fees and who have used or have Open Mobile fully deployed. Note that above and beyond the addition of the word active to this label, this metric is the same definition of our AMMU metric that we have been using. Second, Open Mobile monetized users paying, undeployed. This metric represents those users who are billed Open Mobile platform fees, but whose users have yet to use the Open Mobile client or fully deploy the Open Mobile client on a device. And third, Open Mobile monetized users gross. This metric is simply the sum of one, active monetized Open Mobile users; and two, the paying, undeployed Open Mobile monetized users. It represents the total users of Open Mobile for which iPass is being paid and in fact, it’s the highest-level metric that demonstrates our overall success in monetizing the Open Mobile platform with enterprise customers.

In this regard, we finished Q3 with more than 137,000 gross monetized Open Mobile users, an increase of about 90,000 users or almost 3x the Q2 Open Mobile number. We are pleased with the significant addition as we obviously see it as an arbiter for driving meaningful long-term value.

With that, I’d like to talk about Q4 and reflect a bit on 2011 overall. As both Evan and I have discussed, we continue to feel good about where we are with the progress we have made on Open Mobile customer contracts, the increasing platform revenue in aggregate and from our Open Mobile offering specifically, and the good early momentum that we are seeing from carriers on our new OMX Wi-Fi authentication and settlements business. It’s a good mix of near-term P&L impact and strong strategic value creation. We continue to watch enterprise Open Mobile deployments and are actively engaged to drive those forward to the best extent we can.

Given these dynamics and the nature of the continued decline in the legacy dial-up, 3G, and minimum commitment network revenue. For Q4 2011, we anticipate total revenue to be in the range of approximately 33 to $35 million. And we anticipate adjusted EBITDA for Q4 to be in the range of a loss of $1.25 million to income of $0.25 million.

Not surprisingly, this is a clear implication on our overall performance for the full-year 2011. Recall that we came into the year focused on making investments on supporting our new OME and OMX platforms and we guided to an anticipated adjusted EBITDA loss in the range of 4 to $6 million. With our Q4 guidance, you can now see that due to some strong platform revenue results and our own good cost management, we are coming in at a far lower adjusted EBITDA loss. And importantly, like our Q3 adjusted EBITDA results this full-year 2011 result also has a non-recurring severance expense of about $600,000 in it.

So, you can see the glide path is continuing to improve, as we have signaled and as we have executed along the way these past several quarters. Further, while we are working diligently on our 2012 planning process right now, one outcome that Evan and I are fully committed to is making sure that 2012 is a profitable year on an adjusted EBITDA basis. Stay tuned for more on that as we finalize our plans and post you on our outlook for the full-year 2012 on our call in late January, early February.

I’d like to wrap up with two brief but important messages. First, we like the underlying business results that we are generating. Metrics are continuing to improve and we are seeing this across our enterprise customer base, carrier OMX partners, platform revenue, and the important long-term value indicator of Open Mobile monetized users. Second, we continue to manage the risk, the legacy business and our cost structure very well and in a way that’s delivering improved results. It’s always been important to Evan and to me that as we grow and as we invest, we do it responsibly and with a view toward ensuring stockholder value and you should expect that to continue.

With that we appreciate your time and support and will be glad to open the call for any questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We will take our first question from Fred Ziegel with Blue Water Capital Markets.

Fred Ziegel - Blue Water Capital Markets

Okay. Evan, could you talk to the China Mobile agreement because when I read the press releases and a few other articles, it looks like it’s a little different in that, unless I’m missing something, we have got kind of OMX is the platform hub for carrier customers coming into China and then we have going the other way the use of your infrastructure by China Mobile’s customers who are going from China to someplace else. Am I reading that right?

Evan Kaplan

Not completely, Fred. So, let me sort of clarify. So, as of today we cannot report that China Mobile customers going outbound are using iPass technology and platform as of today. What this announcement really covers is what’s called the roam in. And China Mobile ran a competitive process, it ended about three months ago to choose two providers to put dual gateway into China for any other carrier or service provider who wants to roam into China to use their expanding Wi-Fi network. We won one of those slots. And we are as of today, on the strength of our enterprise foundation driving most of the traffic on that’s going into China Mobile. And so the thing we like about this is one is, it guarantees us routes into China. It also makes attractive for other partners to carry for us into China and use our OMX platform to roam into China into China Mobile. So, we are pretty pleased with that. We have been doing a bunch of work in China and Brazil and other places where Wi-Fi has been growing strongly and so it’s an affirmation of sort of what we communicated really two earnings calls ago.

Fred Ziegel - Blue Water Capital Markets

Okay. On the MNS business, I hesitate to ask this question, if we are transitioning from the teleworkers kind of the revenue stream to the more branch office, where along the timeline are we in that shift do you think?

Evan Kaplan

So, we are pretty far along. I view the teleworker space is declining pretty rapidly and the risk there pretty high. But we are pretty far along in that process of moving almost all of that business to branch office and retail locations. So, that’s one of the reasons why we are talking about on this call, because we can see the turn, we can see at least as best our visibility of de-risking the customer base and finally, we can see I think for the first time in that business, hopefully this coming year profitability.

Fred Ziegel - Blue Water Capital Markets

And what resources additionally are you putting in MNS now that it looks like you think there are some growth opportunities versus say six months ago when it was just kind of on cruise control?

Evan Kaplan

I think it has to do so, we have got a pretty entrepreneurial team down in Irvine and they have managed to do most of this work without very little additional capital infused and so we are not thinking about putting a lot of additional resource forward to in order to achieve that.

Fred Ziegel - Blue Water Capital Markets

Last question from me for Steven, the 600,000 in severance where does that end up in the P&L mostly?

Steven Gatoff

It’s across the three or four different operating expense buckets. The bulk of it was in sales and marketing.

Operator

Thank you. We will take our next question from Kevin Hanrahan with KMH Investment Advisors.