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WebEx Communications, Inc. (WEBX)

Q1 2007 Earnings Call

April 24, 2007 5:00 pm ET

Executives

David Farrington - Vice President, General Counsel, Secretary

Subrah S. Iyar – Co-Founder, Chairman of the Board, President, Chief Executive Officer

Michael Everett - Chief Financial Officer

Gary Griffiths – President, Products and Operations

Analysts

Bradley Whitt - RBC Capital Markets

Karthick Butt (NYSE:PH) - Goldman Sachs

Presentation

Operator

Good day Ladies and Gentlemen and welcome to the WebEx Communications first quarter 2007 earnings conference call. My name is Rachel and I'll be your conference coordinator for today. At this time all participants are in a listen-only mode, and we will conduct a question-and-answer session towards the end of today's conference. (Operator Instructions). As a reminder ladies and gentlemen, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. David Farrington VP and general counsel, please proceed sir.

David Farrington - Vice President, General Counsel, Secretary

Thanks very much and welcome to WebEx Communications Inc. Q1 2007 earnings call. We will not be providing today any information regarding Cisco's pending tender offer for WebEx. Information regarding the status of the tender offer has been and will be made available via press releases such as that issued this morning by Cisco and public filings with the Securities and Exchange Commission.

The presentation today contains forward-looking statements based on WebEx's current expectations, assumptions, estimates and projections regarding WebEx including statements about our future plans, strategies, business, and financial results, and other metrics relating to our business. These statements maybe identified by the use of words such as expect, anticipate, intend, believe, and plan.

WebEx's actual results could differ materially from those projected in such forward-looking statements. Additional information concerning factors that could cause our actual results to differ materially from those contained in the forward-looking statements can be found in WebEx's filings with the Securities and Exchange Commission.

The presentation today in our earnings release provide financial measures for net income and earnings per share, both in accordance with Generally Accepted Accounting Principles or GAAP and in accordance with measurement which are differ than GAAP. These differ from GAAP in that exclude expenses and the impact on our tax rate associated with the new accounting rules on equity compensation, certain expenses from WebEx's acquisition of internets.com, and certain expenses incurred in connection with the pending acquisition of WebEx by Cisco.

We use these measures to help us evaluate our operational financial performance and believe that providing these non-GAAP measurements is helpful to management and investors in comparing our quarterly results in the manner which is not influenced by nonoperational expenses and changes in accounting rules relating to equity compensation.

The presentation of this additional information is not meant to be considered in isolation or as a substitute for net income or earnings per share calculated in accordance with GAAP. An audio file of this call, together with slides being presented today and today's press release announcing our financial results including a reconciliation of GAAP and non-GAAP financial measures will be made available on the Investor Relations section of our website at webex.com.

Presenting on the call today will be Subrah Iyar, WebEx's Co-Founder, Chairman, and CEO; and Michael Everett, our CFO. Also available during the Q&A will be Gary Griffiths, President of Products and Operations for WebEx. And now, I would like to turn the call over to Subrah.

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Subrah S. Iyar – Co-Founder, Chairman of the Board, President, Chief Executive Officer

Thank you David and hello everyone. Q1 2007 was another excellent quarter for WebEx. We had a great start to 2007 with revenues climbing 21% to reach $107 million. In Q1, we experienced strength across the board in our business. This momentum continued from 2006. We hit a new high in bookings with strong international growth. We accelerated net customer addition, and we increased gross margins. These results were driven by strong leadership across the board in the WebEx organization.

In this quarter, we also added 127,000 new registered users. This grows our customer base to 2.3 million subscribers with the largest subscriber base on demand application. We are clearly seeing growing adoption of our services as more businesses collaborate with partners, suppliers, and customers over the internet.

In earlier quarters, I had indicated that our growth strategy had been focused on two dimensions, going deep and going wide. Going deep into customer organizations with our expanding collaboration suite, going wide to third party services through the WebEx connect platform.

The results in Q1 in our core web collaboration business indicate that our strategy for going deeper continues to gather momentum in the quarter. Now with respect to going wide, I am glad to report that our WebEx connect strategy continued to gather significant momentum in the quarter as well.

Specifically, we signed 65 new customer deals for connect applications in the quarter. This compares to the dozen transactions we signed last quarter. Thus, I am pleased with the execution of our strategy of going wide and going deep in Q1. Looking forward, the most important news in the quarter was our acquisition by Cisco.

Over the past ten years, I am proud to have led WebEx through numerous opportunities and challenges. During this time, we have built a leadership position in our chosen category. We are now positioned to accelerate and broaden the execution of our strategy. The Cisco merger gives us the opportunity to do that quickly and move to the next phase of growth.

Thus, I see this as a great win for all of our customers, partners, shareholders, and employees. Let me close by thanking our customers, the over 29,000 businesses and 2.3 million users worldwide who use our services and help guide our product vision and strategy. Their selection of WebEx as the best solution in the market made us a success.

I would like to thank the employees of WebEx around the world for their tremendous hard work and commitment over the last ten years. The dedication of our over 2,000 employees ensures that we consistently deliver on our commitments to our customers, and finally, I would like to express my appreciation to our investors and industry analysts for their support and encouragement over the past seven years as a public company.

We thank you for your faith in us and for giving us the opportunity to prove ourselves. Now to discuss Q1 in more detail, I have with me Mike Everett, our CFO, then Gary, Mike, and I will take your questions. With that, I turn it over to Mike.

Michael Everett - Chief Financial Officer

Thank you, as Subrah said we began 2007 with another strong quarter, the 27th quarter of sequential revenue growth since our IPO in August of 2000. We are proud to report record bookings in what is likely our last quarter as an independent public company.

First quarter revenue increased to $107.2 million, 21% higher then the $88.5 million in the same quarter a year ago. This was in the upper half of our guidance range of $105 to $108 million. Revenue continued the recent trend of diversification on several dimensions.

We continued to expand geographically and international revenue now represents 17% of the total, two points higher than the first quarter last year. We saw excellent growth in Europe, India, and Latin America. Indirect channels also contributed 17% of revenue in Q1, two points higher then a year ago.

Key channel partners, such as Verizon, AT&T, British Telecom, Premier, and Interpol (PH) are contributing substantially to this growth. The breadth of service offerings remains diverse as well.

Stand alone meeting center represents 35% of revenue down ten points from as recently as two years ago. Subscription revenue was 73% of the total in the first quarter, a point higher then last year. 70% of all direct subscription customers now enjoy the named host pricing model. During the quarter, as Subrah said, we closed 65 customer transactions incorporating WebEx connect partner applications. While the revenue impact from partner application was small, this quick start bodes well for the formal release of the Connect market place this summer.

Earnings; fully diluted first quarter GAAP EPS of $0.31 was 63% higher than the $0.19 we earned in the same quarter a year ago. First quarter pro forma EPS of $0.40 were 29% higher than the $0.31 we earned a year ago and in the middle of our guidance range of 39 to $0.41. The difference of $0.9 between GAAP and pro forma EPS is comprised of $0.6 of expense under the new FAS 123R option accounting rules, partially offset by a $0.1 tax benefit from those rules. $0.3 for legal and other transaction expenses relating to our pending acquisition by Cisco systems and one set from intranet noncash amortization.

On this pro forma basis, gross margin increased to 85.3%, almost a point higher than last quarter. Our attractive gross margin is based on strong realized pricing, a highly scalable infrastructure, and relentless execution. Pro forma operating margin was 28.8% this quarter, a point and a half lower then last quarter and right in line with our guidance. We are investing aggressively in sales and marketing to accelerate revenue growth in the U.S. and abroad.

Taxes, our GAAP tax rate for the quarter was 37.8%, seven points lower then the 44.9% rate we reported last year. Many of the options exercised during the first quarter were granted after the adoption of FAS 123R, and were therefore deductible for both book and tax purposes.

The pro forma tax rate, excluding the impact of FAS 123R, was 38.7% for the first quarter, slightly lower than our 2006 rate. Fully diluted shares increased by $974,000 to $52.2 million during the quarter. The increase was largely due to the effect of a higher stock price on the treasury stock calculation, coupled with substantial employee option exercises.

Cash flow from operations was $30.6 million in the first quarter, and capital expenditures were only $2 million. This resulted in strong Q1 free cash flow of $28.6 million. We have $396 million of cash and no debt on the balance sheet. In addition to strong free cash flow, we received about $18 million from employee stock option exercises and did not repurchase any shares this quarter.

Net receivables were $56.2 million with DSOs improving by one day to 47 days for the quarter. Receivable reserves increased by $300,000 to a total of $7.8 million or 12.2% of gross receivables. Reserve details are laid out in the roll forward slide being shown now.

Metrics. net subscription customers or companies increased in the quarter by a record 1,700 to 29,700. This metric does not include the now individual professional subscribers or most of our channel accounts which have usage based pricing models. Registered users or individuals grew by approximate 127,000 to over 2.3 million the quarter.

This metric does include all paying users or hosts of all WebEx services on all of our direct and indirect pricing models. Today, we have roughly 2.3 million users at an average of slightly over $15 per month. Subscription turn increased by 3/10th to 1.9% per month on an MRR loss basis, presented in the graph being shown now as a retention rate of 98.1%. Two thirds of this reported increase came from the inclusion of the now individual professional services in the turn metric for the first time. This was done to provide a more comprehensive view of our entire business.

Employment increased by 133 to 2,322 people at quarter end. Most of the new hires were in the U.S., India, and China. We exited March at an MRR or monthly revenue rate of $37.3 million comprised of $27.3 million in subscriptions and $10 million in average monthly usage revenue. Subscription MRR increased by $1.3 million due to excellent bookings and solid customer retention.

Usage MRR grew by $800,000 based largely on strong channel resells. MRR is an important forecasting tool, but it does exclude some revenue elements, such as customer credits, setup fees, managed events, and professional services.

Looking forward, we are discontinuing the practice of providing management guidance due to our pending acquisition by Cisco. With that, Subrah, Gary, and I would be happy to take your questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And our first question comes from the line of Brad Whitt with RBC Capital Markets.

Bradley Whitt - RBC Capital Markets

Hey, you guys. Congratulations on everything; great quarter and everything moving forward.

Subrah S. Iyar – Co-Founder, Chairman of the Board, President, Chief Executive Officer

Thank you.

Bradley Whitt - RBC Capital Markets

Subrah, I just have one question just kind of in parting. If you could just kind of give us, to the best of your ability, kind of compare and contrast your strategy with WebEx Connect compared to sales force.com strategy with, I forgot what they call it but you know what I am talking about, AP (PH) exchange. As you see it just comparing, not saying which one is better or worse, but just compare and contrast your strategy and how you think it's different to what they're doing.

Subrah S. Iyar – Co-Founder, Chairman of the Board, President, Chief Executive Officer

Well, our strategy again is, we talked about going deep in web collaboration and going wide through WebEx Connect, and essentially, so our platform is focused around collaboration. It is communications and commitment collaborations; now with Cisco it will be even, with the pending acquisition we see even more depth in the communication and collaboration area.

And what we want to do is enable broad match-ups (PH) of other business applications. So the emphasis is on enabling collaboration, particularly across organizations across firewalls, etc., etc. If you look at AP (PH) exchange, their focus and again from a distance, they can talk about it better, is around first we starts with acentrics (PH) but again goes towards more a data base application hosting model primarily, as that being the platform. So that being said, so that’s from a technology and product centric approach.

Now from a distribution approach if you were to think both platforms are viable opportunities for developers in reaching customers, so if you are a developer, from a technology perspective, WebEx will offer collaboration whereas sales force will offer a master application on CRM with all of the data structures developed. And you would think firstly which application is more suitable in some cases it will be only one, in some cases it will be both. And essentially, it is who are the customers you want to get to, and again, it will be in some cases you want to get to the sales force customers only because your solution is an actual add-on to CRM but it could be a natural add on to collaboration or it could be a natural add on to both. So from a distribution platform approach, you would say that these offer two alternatives in a platform, but, again, they could be complimentary.

Bradley Whitt - RBC Capital Markets

Okay. So that's very helpful. I'm going to pass it on. Again, congratulations, particularly you Subrah, for everything you did, building the company up and getting to the point where you are today.

Subrah S. Iyar – Co-Founder, Chairman of the Board, President, Chief Executive Officer

Thank you very much, Brad. Thank you for your support by the way.

Operator

Thank you, sir. (Operator Instructions). Our next question does come from the line of the Karthick Butt (PH) from Goldman Sachs.

Karthick Butt (PH) - Goldman Sachs

Hi, this is Karthick Butt (PH) on behalf of Sarah Friar. Do you expect to see any changes in the go-to market strategy once you're a part of Cisco, and how quickly do you think the product could be put into Cisco's channel? Thank you.

Subrah S. Iyar – Co-Founder, Chairman of the Board, President, Chief Executive Officer

We see enhancements in our go-to market strategy. The fundamental strategy we don't see a change per se, but it obviously, Cisco offers a lot of complementary channel capabilities for WebEx, so from our perspective we are sort of salivating (PH) to get access to the Cisco large enterprise channels, to their partner channels, to their global access, international presence, etc. From their perspective, I would say that we bring in a new web touch model for accessing the small-medium business channels as well. And then from a product perspective, they have a whole fleet (PH) of products from the Unified communication area and we very nicely complement that. So the answer to your question, absolutely we do see enhancement to the go-to market approach, both from a product and distribution perspective. But this will take until the merge is incomplete; once it's complete we will get into the actual act of figuring out which are the initiatives that's make sense from a prioritization perspective.

Karthick Butt (PH) - Goldman Sachs

Great, thanks.

Operator

Thank you, sir. (Operator Instructions). And gentlemen, at this time there are no further questions.

Subrah S. Iyar – Co-Founder, Chairman of the Board, President, Chief Executive Officer

Thank you all again. From my side, I really appreciate all of the attention you've given us over the past couple of years and given us the opportunity to build a great company and it feels really good. I think it's a great closure for all of our customers, partners, employees, and hope to see all in a different world, sometime thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your presentation and you may now disconnect. Have a wonderful day.

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