Lattice's (LTTC) CEO Paul Burgess on Q1 2016 Results - Earnings Call Transcript

| About: Lattice, Inc. (LTTC)

Lattice Incorporated (OTCQB:LTTC) Q1 2016 Earnings Conference Call May 17, 2016 2:00 PM ET

Executives

Jon Cunningham - VP, RedChip Companies

Paul Burgess - CEO

Joe Noto - CFO

Analysts

Thomas Pfister - RedChip Companies

Harold Scattergood - Boenning & Scattergood

Operator

Please standby, we're about to begin. Good day, and welcome to the Lattice Incorporated First Quarter 2016 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jon Cunningham, Vice President, RedChip Companies. Please go ahead, sir.

Jon Cunningham

Thank you, Tracy. Good afternoon everyone and welcome to Lattice Incorporated's First Quarter 2016 Earnings Conference Call. With me today is Lattice's CEO, Mr. Paul Burgess; and Chief Financial Officer, Mr. Joe Noto.

Before I turn the call over to Mr. Burgess, may I remind all listeners that in this call, management's prepared remarks contain forward-looking statements which are subject to risks and uncertainties and management may make additional forward-looking statements in response to your questions. Information regarding forward-looking statements except for the historical information contained herein are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties which may cause our actual results in future periods to differ materially from forecasted results. Actual results may differ from those discussed today, May 17, 2016 and therefore we refer you to a more detailed discussion of the risks and the uncertainties in the Company's filings with the Securities and Exchange Commission.

Now, it's my pleasure to turn the call over to Lattice's Chief Executive Officer, Paul Burgess. Paul, please go ahead.

Paul Burgess

Thanks, Jon, and welcome to everyone joining us in the call today. I'll make a few opening remarks and then pass the call over to our Chief Financial Officer, Joe Noto, for a more in-depth discussion of our financials.

In the first quarter of 2016, we continued to expand our product portfolio and our direct services revenue base. We also continued to enhance our product offering including our vide arraignment solution and our wireless handheld technology. We signed a new teaming agreement with Global Tel Link, also known as GTL. That gives us access to products and services that will further enhance our solutions.

Before I give a more detailed review of our operations and an update on our new product launch and the progress we have made against some of our strategic objectives, I'll pass the call over to Joe Noto for a more in-depth discussion of our financials. Joe?

Joe Noto

Thanks, Paul. I'll start by running down the P&L compared to the prior year quarter and turning to revenues. Our total revenue increased approximately $2.5 million from $1.5 million in the prior year quarter. Breaking down total revenue into our two components; technology sales and direct services.

Technology sales increased to approximately $1 million from $300,000 in the prior year period. The current quarter included a large sale to a key wholesale partner. Technology sales are chopped quarter-to-quarter and should be viewed on an annual performance basis. For 2016, we expected the add of the $2.6 million result in 2015.

Total direct service revenue strategically focused, increased by 25% to approximately $1.5 million from $1.2 million. Included in the overall increase was an 18% increase in coal provisioning revenue. The rate of growth in coal provision revenue is a key operating metric of Lattice's growth strategy. The direct call provisioning increase was mainly attributable to increasing the number of venues for collecting prepaid deposits at existing sites, combined with adding new sites. We expect double digit organic growth to continue at direct services.

Turning to gross margin. Our gross margin as a percentage of revenue increased 50% from 35%. Increase was mainly due to revenue mix as a higher component of total revenue was attributable to tech sales relative to the year ago period. Tech sales as a percent of total revenue accounted for 39% this quarter versus 22% a year ago. For any effects of large wholesale order during the quarter, margins and both revenue strings, tech sales and direct services tracked with historical levels at approximately 60% and 30%, respectively.

Turning to adjusted operating income. The company's adjusted operating income or cash earnings for the quarter was $180,000 versus a loss of $694,000 in the prior year. Adjusted operating income is a non-GAAP measure which essentially adds back non-cash items to the reported operating income or loss. Reconciliation of that measure can be found in our 10Q filing. The performance in the quarter was mainly impacted by the gross profit contribution from the strong technology sales and the accretive burst in direct services.

It should be noted that the company's quarter profitability is highly sensitive to the level of high margin tech revenue in the quarter. We expect to move away from that sensitivity as we continue to ramp growth in recurring direct services. We're also factoring into the improved result with a decrease in operating expenses mainly due to reductions in sales force and engineering staffing compared to prior levels to more efficiently align with sales territories and revenue levels.

And turning to cash flows. Our operating cash flow in the quarter was negative $404,000 which consisted of cash earnings of $180,000 positive, offset by cash interest paid of approximately $104,000 and cash used for a net increase in operating assets of approximately $480,000. The negative OCF is financed by a $375,000 loan collateralized by accounts receivable and available cash on hand. We ended the quarter with approximately $100,000 in cash from $186,000 at December 31, 2015.

Also should be noted that at the end of April we executed the settlement agreement with GTL. Thereby restructuring current liabilities of approximately $2.7 million to a longer term note payable. Effective which would have request approximately $1.7 million as current liabilities to a long term liability classification at March 31.

We continue to face liquidity challenges as discussed in our filings and accordingly we were actively involved with securing the additional capital needed to fund operations, working capital to clients and debt repayments coming deal in the next 12 months. Towards that effort we partially closed during April approximately $383,000 of the $600,000 common stock offering to address short term liquidity.

And with that I will turn the call back to Paul.

Paul Burgess

Thanks, Joe. As I mentioned in my opening remarks, we continue to expand our product portfolio. Our new video technology completed testing in the second quarter of 2015, and we currently have it operating in some of our facilities. The new technology enables arraignment hearings to be conducted remotely with high definition quality video if required. This enabled the judge to arraign an inmate without having to move the inmate from the correctional facility to a courthouse reducing the security risk and the cost of transporting inmates.

The new system enables remote visitation with friends and family, increasing accessibility to the inmate and reducing the need for friends and family. In some cases, having to travel long distances for visit. There is a secure consultation module that provides a secure consultation between an attorney and an inmate. This provides the inmate with more readily available legal assistance and reduces the need for face to face consultation with inmates and their attorney.

The remote visitation module is also capable of having interacting with smartphone enabling the inmate to have a video visitation session with a commercial smartphone or a tablet such as an iPhone or Android device. We also anticipate upgrade in our video visitation security to include facial recognition that will identify the individual on the call to insure only those people with scheduled visitation sessions are actually on the call.

We will continue to roll out new enhancements to our video-based technology throughout the year. We have seen an increase in demand for video products in the industry and we anticipate this to continue throughout the year.

Our new CellMate, initial product testing was completed in 2015 and we announced the product release in April of this year. Although there are other tablet-based technologies being introduced to the market, Lattice has the only completely wireless handheld technology in the market that has the capability to become a fully functioning smartphone upon the inmate's release.

While in the correctional facility, CellMate provides the inmate with the same experience as a commercially available smartphone in a completely secure environment. Capabilities of the CellMate mobile include phone and voice mail, secure access to account information, access to family connect, which is a low rate communications plan, managing commissary and phone accounts, e-mail and keyword search, text messaging with keyword search, entertainment including music, books, and various games, access to the Lattice library that provides free public domain books, educational services, broadcast, legal library and services.

Based on the initial market feedback, we believe this technology to be industry leading and provides inmates with a technology at fair price points and provides inmates and friends and family with access to services currently not available. In addition, the device enables facilities to provide services that ease the cost burden on their operations. We will continue to provide updates as we roll out new applications for the CellMate mobile platform.

We are also currently evaluating different sales and distribution models to accelerate our market penetration of the CellMate product. They include rental programs for inmates, third party distribution with other suppliers servicing the corrections market and value added resellers. We believe utilizing companies with complimentary services and establish sales and distribution infrastructure will enable us to serve a large market more efficiently.

As noticed in our previous filings, on June 26 of last year, Global Tel Link filed an arbitration claim against the company. On April 29 of this year, Lattice and GTL entered into a settlement agreement that included a teaming agreement that will enable Lattice to utilize GTL products and services to enhance our product our portfolio.

Even though the companies have some competing products and services, Lattice and GTL tend to focus on subsidence of the market. This agreement will give Lattice access to cash management and trust accounting products we currently are unable to provide.

As we previously discussed for the past two years, the SEC has been reviewing the inmate communication service industry and specifically was looking at regulating the rates that could be charged to inmates for telephone calls. On October 22 of last year, the SEC passed a new order, capping rates and eliminating almost all ancillary fees. The order passed with a three to two vote in favor. However there was a stay granted delaying the implementation of the new rate caps. The stay did not include ancillary charges and these caps will be implemented on schedule. The rate caps are as follows: $0.11 per minute for debit prepaid calls in state or federal prison; $0.14 per minute for debit and prepaid calls in jails with 1,000 or more inmates; $0.16 per minute for debit prepaid calls in jails with 350 to 999 inmates; and $0.22 per minute for debit prepaid calls in jails of up to 349 inmates, which is the majority of Lattice based facilities.

Ancillary charges would be prohibited except for the following; automated payment by phone or website would be capped at $3; payment through a live agent capped at $5.95; paper bill fee capped at $2; third party financial transaction fees such as fees charged by MoneyGram or Western Union maybe pass-through but no mark up. Mandatory taxes and regulatory fees may also be pass-through with no mark up. The net effect to Lattice based on our initial analysis and similar rates in some of our existing facilities, we anticipate very little impact on revenue and gross margin. The reduced call rates will cause an increase in volume and the increased volume will enable better economies of scale to offset any cost increases.

In addition, the new order creates a new opportunity for Lattice. Unlike other competitors in the industry, Lattice never used ancillary fees, which are now banned to offset extraordinarily high commission rates. Other competitors in our industry will be bound to current contracts that require them to pay high commission rates that they will no longer be able to offset with ancillary fees. These contracts will have to be cancelled, renegotiated or continue to operate at a loss. This gives Lattice an opportunity to compete for these contracts, which would otherwise not be available on a level playing field. We believe based on our business model and new technology platform, Lattice is one of the best positioned companies to compete in this new environment.

Although the SEC order was stayed, we believe that the rate caps that they plan on implementing will eventually be put in place, and Lattice is prepared to compete in that environment.

With that I'll open the call to questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we'll go first to Thomas Pfister with RedChip Companies.

Thomas Pfister

Hi, Paul. Hi, Joe. How are you both doing today?

Paul Burgess

I'm doing well. How about yourself?

Thomas Pfister

It's been very good. Just my first question here. So I think I saw in your 10Q that Lattice has been redirecting some of its staff to take advantage of some of the opportunities in some of the new regions that you were going into. So can you just maybe get some color on how long this redirecting would take to complete? And then just a follow-up to that question, so how long do you estimate a particular sales and how does it take to make contact with a facility and then eventually deliver a signed contract along this?

Paul Burgess

Yes, just to answer the first part of the question. The redirect we were talking about was really moving from technology sales which is really more of a corporate sale. That's really done by senior management in the company. So rather than focusing the sales and marketing efforts which we're spending quite a bit of money on in that area, we move that into our direct sales worth that focus on selling directly to the correctional facility. So there was a cut back in there. You'll probably see an increase in sales and marketing expenses in the latter half of the year as we redirect some of those expenses back into the field and in the market that we're going into.

As far as the sales cycle, as far as how long it takes someone to make contact, it really depends on the reps that you bring in, whether they're seasoned reps that already selling into the corrections market or they're law enforcement and corrections as something new. We tend to focus on bringing in people that have had direct contact in the corrections market, so they're usually coming in with roller deck already, anyway. So as far as initial contact that's usually fairly immediate. As far as how quickly we start to see contracts be awarded or be able to implement new technology into some of these correctional facilities, it's usually about a six-month ramp for us to start to see sales come in the door from higher in the new rep. But quite often it's dependent on the background of the wrap and the roller deck the rep brings in.

However, we do have a sales program that is already in contact with a lot of facilities directly in new markets that we're just starting to staff up, so we do have a readymade pipeline for a lot of these reps when we bring them in. So it's not as if we're bringing them in and they're starting from ground zero. We actually do have a sales and marketing plan that already has initial contact with a lot of the facilities that they'll be going after.

Thomas Pfister

Great, thanks for the color there. My next question relates to the recent CellMate mobile. Can you maybe give us some color on what the initial mark reaction into this product? And then another question on CellMate; as sales of the CellMate kind of ramp up, how do you expect this to affect your revenue figures?

Paul Burgess

Yes, as far as the first part of the question. The initial feedback was good. We actually did a lot of test marketing with the product in the latter part of 2015, so we anticipated some of the feedback and some of the questions that would arise from bringing in a new wireless product. And a lot of the questions came around security. So we really spent the last part of 2015 and the early parts of 2016 making sure we were really tightening that area up, and really had all those obstacles removed for a facility so that they were very comfortable bringing in this new product. So the initial feedback's been very good. We've got it up and running in a few facilities. We actually have one of our partners that testing a rental program which is something I also mentioned today one thing we're looking at because we are primarily in county facilities, and those typically are inmates that are there for a year or less. A lot of these people may be in there for 30 days. So we're looking at rental programs for example where they can rent a CellMate for a day, 30 days, six months, whatever it may be, rather than having to purchase the product outright. So we believe that will actually increase sales as well.

As far as the revenue streams, the revenue streams that we historically obviously understand very well or really around all the telecommunications components of it. With CellMate add, there are a couple of new features that will be charged for it. A lot of the content will be charged for, as well as things such as texting and e-mail messaging. Now depending on what state you're in and the facility, those will be charged different rates. So we don't really have a strong understanding of how much that will increase revenue because we do anticipate it will cannibalize some of the highly regulated telecom revenue as well. So we're not really sure how that will balance out. We do obviously understand that it will be an increase per inmate, we're just not sure what that will be. We just don't have a big enough sample size yet.

Thomas Pfister

Okay, great, full color there. And then just my last question. Can you just discuss some of the progress you are making in your international compliance [ph]?

Paul Burgess

Yes, for the international, our biggest market is still the Canadian market. I'm working closely with their three primary customers in Canada, Bell Canada, which is the largest telecommunications company, Telus, which we've done a lot of work with BC Corrections with Telus, and Waymark [ph] which tends to focus on some of the smaller facilities in the Canadian market. So we're still very active in the Canadian market. As far as foreign market, we do expect to see potentially some additional revenue coming out of the Singapore market where we've got a test facility up and operational, but as far as any other big things coming down the pipe from international, it's primarily just those two for now. Although we do still have a presence in the U.K., Japan and Bermuda, so anyone of those could percolate at any time, but I don't have anything in the immediate forecast for those areas.

Thomas Pfister

Okay, thanks so much for the color there. Again, guys, congratulations on the great progress there. It's great to see some ramping up here and it looks like there's some exciting things going on over there at once.

Paul Burgess

All right, thanks so much.

Operator

[Operator Instructions] And we'll go next to Harold Scattergood with Boenning & Scattergood.

Harold Scattergood

Paul, can you talk a little bit about what the additional overhead to support your sales, additional personnel and the associated cost that you will be having to take on over the next 12 months as this program ramps, please?

Paul Burgess

Yes, what we expect to see is as I mentioned earlier in the call, we actually originally are starting to offset some of our large technology sales back to direct sales. So a typical rep, what we tend to do is the pay tends to ramp, but what we expect is probably per territory. It's probably going to be about a couple of a hundred thousand dollars in initial sales and marketing expense for each new state that we enter into. We've entered into the two primary states that you're going to start to see contracts coming in for Q2 and starting in Q3 will be Georgia and South Carolina. We also anticipate Pennsylvania to start to open up as well. So those are going to be the three additional markets that we're going to be going after. The marketing expenses are fairly generic across the board. There is a slight ramp per territory but our marketing programs aren't really what I call state-sensitive. So it's really focused on bringing in the new sales and sales support staff for each new territory.

Harold Scattergood

And is there a number that you anticipate per territory that you will have to hire or they're already in place? And if you have to hire them, how many would you think that would cost?

Paul Burgess

Yes, we're looking at bringing on over the next, about nine-month period two to four new reps which would open up two to four new territories. And that will approximately be anywhere from $500,000 to $1 million investment for those territories.

Harold Scattergood

Okay, thank you, Paul.

Paul Burgess

Thanks, Harold.

Operator

[Operator Instructions] It appears that there are no further questions at this time. Mr. Burgess, I'd like to return the conference back to you for any additional or closing remarks.

Paul Burgess

All right, thank you, operator. On behalf of Lattice, I want to thank everyone for their interest and participation on the call. If you have any interest in visiting the Company, let myself or Jon Cunningham from RedChip know and we'll make sure it gets arranged. Again, thank you for joining us on the call. We look forward to speaking with you again in the near future. Operator?

Operator

This does conclude today's conference. We thank you for your participation. You may now disconnect.

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 www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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