Executives
Claire Long - CFO
Jim MacIntyre - CEO
Analysts
Richard Baldry - Canaccord Adams
Atul Bagga - ThinkEquity
David Hilal - FBR
Brent Thill - Citi
Visual Sciences, Inc. (VSCN) Q3 2007 Earnings Call November 7, 2007 5:00 PM ET
Operator
Good day, ladies and gentlemen, and welcome to the ThirdQuarter 2007 Visual Sciences Earnings Call. My name is Tina, and I will be yourcoordinator for today. At this time, all participants are in a listen-onlymode. We will be facilitating a question-and-answer session towards the end of today'sconference. (Operator Instructions). As a reminder, this conference is beingrecorded for replay purposes.
I would now like to turn today's presentation over to yourhost Claire Long, Chief Financial Officer. You may proceed.
Claire Long
Good afternoon, everyone, and thanks for joining us today todiscuss Visual Sciences third quarter results. Following the live call, an audioarchive of this call will be available on the company's website.
Today's call contains forward-looking statements that arenot a description of historical facts. For example, statements about ourprojected future results, growth opportunities, business strategies, marketobservations and future product plans are forward-looking statements.
In addition, statements regarding Visual Sciences' abilityto complete the proposed merger with Omniture, the ability to satisfyconditions to closing the merger, including obtaining stockholder andregulatory approvals, and the benefits of the merger to stockholders, are alsoforward-looking statements. You should not regard any forward-looking statementas a representation by Visual Sciences that any of its plans will be achieved.
Actual results may differ materially from those discussed duringthis conference call due to the risks and uncertainties inherent in VisualSciences' business, as well as the potential impacts on Visual Sciences'business, results of operations and common stock price resulting from theproposed merger with Omniture including, but not limited, to risks ofdisruption to our business development and sales efforts and disruption anddistraction of our management and employees from day-to-day operations as aresult of the merger, risks associated with obtaining stockholder or regulatoryapprovals related to the proposed merger, risks that the expected financial effectof the merger may not be realized, risks associated with contractuallimitations on our ability to take certain actions prior to the closing of the merger,risks associated with costs to be incurred in connection with the merger, and risksassociated with Visual Sciences' failure to complete the merger.
These statements are based solely on information availableto Visual Sciences as of the date of this call. Our current expectations,forecasts, and assumptions are subject to a number of risks and uncertaintiesthat can cause actual results to differ materially from those anticipated bythese forward-looking statements. We refer you to our SEC filings, includingthe company's Annual Report on Form 10-K for the year ended December 31, 2006and other reports the company filed with the SEC for more information aboutthese risks and uncertainties.
You should also be aware that Omniture intends to file withthe SEC a Registration Statement on Form S-4, which will include a joint proxy ajoint proxy statement/prospectus of Omniture and Visual Sciences and otherrelevant materials in connection with the proposed merger transaction.
The joint proxy statement/prospectus will be mailed to thestockholders of Omniture and Visual Sciences. Investors and security holdersare urged to read the joint proxy statement/prospectus and the other relevantmaterials when they become available because they will contain importantinformation about Omniture, Visual Sciences and the proposed transaction.
The joint proxy statement/prospectus and other relevantmaterials, when they become available, and any other documents filed byOmniture or Visual Sciences with the SEC, may be obtained free of charge at theSEC's website.
The statements we will make in this conference call arebased on information we know as of today, and we assume no obligation to updateany of those statements.
I'd also like to point out that we will present certainnon-GAAP information on this call. The reconciliation of GAAP to non-GAAPfinancial measures is included with today's press release, and is alsoavailable on our website.
With that, I'd like to turn the call over to Jim MacIntyre,CEO.
Jim Macintyre
Thanks, Claire, and thank you, everyone, for joining ustoday for Visual Sciences third quarter earnings call. The third quarter wasvery busy for Visual Sciences on a number of fronts.
On the operational front, we had a solid quarter, resultingin revenue that came in at the high end of our guidance range, and non-GAAPearnings that came in well above our guidance range.
To summarize our quarterly financial results for the thirdquarter; total revenues were $20.4 million, representing 8% year-over-yeargrowth on a non-GAAP basis, and 17% growth on a GAAP basis.
Non-GAAP net income came in at $3.1 million, or $0.15 perdiluted share. The third quarter also marked our 16th consecutive quarter ofpositive cash generation. In Q3, we continue to see strong demand for ourreal-time analytics products.
The third quarter is typically a slower quarter in theanalytics market; however, our bookings actually increased by greater than 50%over the comparable quarter of 2006 due to a significant increase in our up-sellactivity.
In Q3, we closed 307 sales booking transactions, with bothnew and current customers. These included bookings with 49 new customers suchas National Trust, C&H Distributors, Gaylord Hotels, and [TaxSlayer] aswell as one new major domestic airline and two major financial servicescorporation, adding to our already strong penetration in these two verticalmarkets.
During Q3, we also saw our relationships expand with anumber of our clients, including Debenhams, FX Networks, Guess, Crackle, [Dig],Trip Advisor, City Search, Yamaha Motor Corporation, Whitbread Group and [BART]to name a few. Visual Sciences trend towards larger deal sites has alsocontinued with our average deal sites for new customers increasing 17% over Q2after increasing over 40% from Q1 to Q2.
We received a number of accolades on our products during thequarter, two of our products Visual Site and HBX Analytics were featured theForrester Wave Web Analytics Q3 2007 independent research report.
According to the report, Visual Site and the underlying Platform5 technology provide the most powerful data architecture and real-time analysistools in the industry. Additionally, Visual Sciences' HBX Analytics wasacknowledged for its easy-to-use tools, with the highest score in the usabilitysection of the current offering category of Forrester's report.
Separately, Knowledge Management World selected the VisualSciences' Technology Platform 5 as a trend setting product of the year for2007. It was selected from over 650 products reviewed. We are extremely pleasedto have received this recognition.
In terms of new products, during the quarter, we announcedthe availability of Visual Sciences Search 5.0, the latest version of thecompany's award-winning website search solution. This release improved customerease-of-use through cleaner task-based work flows, and site user experience ,throughnew search results presentation templates.
We began offering Search 5.0, the fast-track deploymentoption, ensuring that online retailers and e-commerce websites had the opportunityto fully implement the product in advance of the busy holiday shopping season.
In other events, I am also happy to report that during thequarter we settled the patent litigation with NetRatings and we were able toput that issue behind us.
And lastly, as you know, on October 25th, we signed adefinitive agreement to be acquired by Omniture through a combination of stockand cash, ending the formal evaluation of our strategic alternative that weannounced in July which was managed by Goldman Sachs. Importantly, thiscombination is the first public-to-public acquisition of two Software-as-a-Servicecompany.
With the tremendous growth that we see in the analytics andonline optimization market, we believe that this strategic combination willdrive increased value for our shareholders, customers and partners. We thinkthat this combination position us to better innovate and build the solutionsthat so many organization in our markets are interested in.
While both Visual Sciences and Omniture have independentlygrowing businesses, a combined entity will accelerate scale so that we can moreaggressively reinvest in the product functionality and support services thatour high growth market deserves.
Now, let me turn the call over to Claire to provide you adetailed overview of our Q3 financial results.
Claire Long
Thanks Jim. The following commentary will be on a non-GAAPbasis, which will exclude amortization of intangibles, stock-based compensationexpenses, the one-time NetRatings legal settlement expense, expenses related tothe merger transaction, and include purchase accounting adjustments to revenueand other non-cash adjustments.
A GAAP to non-GAAP reconciliation is included in the pressrelease we issued earlier today.
For the third quarter of 2007, we recorded revenues of $20.4million. Total revenue increased 8% organically year-over-year. Revenues fromsubscription, hosting, and support were $16.6 million, representing 81% oftotal revenue for the quarter. We had a strong quarter for license revenues,which came in at $1.9 million and represented 9% of revenues. Revenues fromoutside the United Statesaccounted for 14% of total revenues in Q3 2007. Our gross margin for Q3 was 74%,essentially in line with the 75% we reported in Q2.
Turning to the P&L. On a non-GAAP basis, total costs andoperating expenses represented 58% of revenues, which is an improvement from63% reported in both the third quarter 2006 and last quarter. Included in ouroperating expenses this quarter was $663,000 of legal expenses attributable tothe NetRatings settlement, as compared to $530,000 in Q3 of 2006, and $697,000last quarter. There is a legal fees associated with the actual lawsuit--not thesettlement of the lawsuit.
As we previously announced on August 20th, we entered into asettlement and patent cross-license agreement with NetRatings during thequarter. The accounting for that settlement resulted in us recording a one-timesettlement expense of $889,000, and a patent asset of $7 million. The patentasset will amortize over a 9.5 years, based on the pattern in which theeconomic benefit is consumed, which is approximately a $150,000 per quarterthrough the end of 2008, at which point it begins to increase.
Both the one-time settlement expense and the amortizationexpense are excluded from our non-GAAP results. In addition, during the quarter,we made the initial $2 million cash payment pursuant to this agreement.
Our sales and marketing costs decreased by 480 basis pointsas a percentage of revenue from the prior quarter. The prior quarter includedcosts related to our U.S.and European user forum and marketing costs related to our re-branding. Therewere no similar costs in the third quarter.
Product development decreased by 170 basis points due tofurther streamlining of our product development team.
G&A increased by 190 basis points due to costs related toour SOX work, which typically gears up in Q3 of each year as well as legalexpenses. Our non-GAAP net income for the quarter was $3.1 million or $0.15 perdiluted share. Overall, we were pleased with our financial results this quarter.
Turning to the balance sheet, we ended the quarter withapproximately $14.5 million in cash and short-term investments. In Q3, we generated$2.2 million of positive cash flow from operations. We also incurred $2.3million in capital expenditures for the quarter, resulting in neutral free cashflow.
The outstanding balance on our revolving credit facility was$4 million as of September 30th. Net accounts receivable was $19.1 million atthe end of Q3, up approximately $2 million from the prior quarter. DSO for thethird quarter was 85 days, up from 79 days in Q2. The increase was due to thetiming of collections with larger customers. Larger customers have more complexdealing requirements that also result in the increased time to collections.
Deferred revenue at the end of Q3 was $20.4 million, up from$20.2 million at the end of Q2.
As we've said on prior earnings calls, most of our subscriptioncontracts are typically built quarterly, but our maintenance and hostingcontracts are typically built annually, with the majority of the renewal dateson maintenance contracts in the first and the fourth quarters of the yearresulting in lower deferred revenue balances in the second and third quarters.
As a reminder, fluctuations in deferred revenue are impactedby the timing of our invoicing and payments, as well as the mix of subscriptionand license billing.
Our retention rate for HBX and Visual Sciences and ouroverall contract lengths remained in line with historical averages.
Turning to financial guidance; as noted in our press releaseearlier today, we will no longer be providing forward-looking guidance andinvestor should no longer rely upon the guidance made in Visual Sciences' pressrelease issued on August 2, 2007.
Due to potential changes in customer buying behaviorresulting from the pending transaction with Omniture and uncertainty regardingthe timing of the closing of the deal, we anticipate less predictability thanusual. Although we are encouraged by the initial reactions we have seen fromour customer base., it is too early to determine the impact on up-sell and newbooking activity.
With that, I'll turn the call back over to Jim to discussthe market trends and operational highlights for the quarter.
Jim MacIntyre
Thanks Claire. As I mentioned in my opening remarks, thethird quarter of 2007 was a very busy and productive time for Visual Sciences. Thoughwe were running the now-concluded process to evaluate our strategic alternativesduring the quarter, the Visual Sciences team still managed to perform aboveexpectations.
Visual Sciences is addressing a huge and growing marketingopportunity defined by the rapid growth of online advertising, new forms of digitallyconnected customer interaction and the expansion of online business, ingeneral. We are well positioned to capitalize on those opportunities, and willbe in an even better position to do so as a part of Omniture.
Organizations today are drowning in customer interaction data,and the potential for business optimization that's hidden in it. Collecting thedata is easy part. The hard part is discovering profitable insight within thedata and then acting on those insights quickly to gain competitive advantage.
This customer interaction data comes from a wide range ofdigitally connected systems including websites, point-of-sale systems, e-mailsystems, call centers, case management systems, kiosk and ATMs amongst others.
Analysts estimate that less than one quarter of organizationhave implemented any type of technology that allows them to effectively analyzeand optimize their businesses, using the value buried in all of their customer interactiondata, leaving a large opportunity in the market.
The good news is, that many organizations who have thatopportunity, are recognizing the value of real-time data analysis andoptimization technology, in increasing revenue, improving customer experience,driving down cost and informing better competitive business decisions.
Other large companies see this market opportunity, too. Its sizeand importance is shown by the investments of large players includingMicrosoft, Google, Yahoo and others. This is one of the reasons why we view thecombination with Omniture as a strategic combination that makes sense for bothcompanies at this time.
To summarize the terms of the transaction with Omniture thatwe announced on October 25th, each Visual Sciences' shareholder will receive0.49 shares of Omniture common stock, plus $2.39 per share in cash for eachshare of Visual Sciences they own. This transaction is subject to a number ofclosing conditions, including shareholder approval of both Visual Sciences andOmniture, as well as the usual and customary regulatory approvals. Thetransaction is expected to close in early to mid 2008.
Current Visual Sciences customers will benefit near- andmid-term with continued support for our products, including HBX, Visual Site,Visual Call, Platform 5, Search, Publish and Bid, and longer-term, from abroader set of products that we will be able to offer as a combinedorganization. With the greater scale that will result from the combination, ourcustomers will also benefit from our faster pace of innovation than we would beable to provide had we remained independent.
We are 100% committed to the continued success of ourcustomers. And we will work closely with all of them to ensure smoothtransition as we become part of Omniture. I can attest to Omniture's strongcommitment to their customers, and I have been given every assurance by Joshand the rest of Omniture's management team, that this same commitment willextend to all Visual Sciences customers.
I am very pleased that Visual Sciences is becoming part ofthe Omniture family, and believe that our customers will be equally pleased, asthe combination enables a whole new level of investment and innovation to theirbenefit.
There are three key reasons the acquisition of VisualSciences by Omniture is important at this time, and I want to make sure that Ireiterate them. The first, is increased market opportunity. This combinationresults in a broader customer base over 4000 customers, and as Visual Sciencesand Omniture continue to increase the functionality available in their suite ofproducts that functionality can be more readily delivered to that broader baseof customers.
The second, is increased efficiency. As a combined company,certain parts of our cost structures are duplicative, and over time thatduplication can be eliminated allowing us to focus our investment in newdirections.
The third, is increased scale. We will be able to use therevenue efficiency we gain to invest more aggressively on our products tobenefit our entire customer base. This is investment will result in greaterresearch and development, sales, marketing, overseas expansion, and the abilityto broadcast our message more loudly in the marketplace.
In conclusion, Q3 was a very busy and productive quarter forthe entire Visual Sciences team. I am excited about what the future holds for thecombined Visual Sciences-Omniture organization, and look forward to continuingto work with our customers to ensure their success and continuing to deliverthe innovation that they have come to expect from Visual Sciences.
And with that, I would like to open the call for questions.Operator?
Question-and-AnswerSession
Operator
(Operator Instructions). And your first question comes fromthe line of Richard Baldry with Canaccord Adams. You may proceed.
Richard Baldry -Canaccord Adams
Thanks. I am wondering if you could talk a little aboutearly feedback from sort of your API partners, when you look at Omniture'sGenesis network, how you see those two fitting together? Thanks.
Jim MacIntyre
Sure, Richard. Sure, I think the early feedback and generalfeeling we have is that the both programs we had built and the program Omniturebuilt in Genesis are very similar in a lot of ways.
Partners were looking to both of us before to provide accessto the analytics data through such APIs, and I think the ability, much like therest of the transaction, will enable to have the greater investment around thecommon set of APIs, ultimately, in the future will benefit all of ourcustomers.
Richard Baldry -Canaccord Adams
And you mentioned briefly the streamlining in R&Dcontinuing to lower [some of those] costs. Could you talk about how thatchanges potentially going forward?
Jim MacIntyre
The product development costs were lower by just a hair, andI think that as we put our teams together over the last period of time, we wereable to share some resources and infrastructure across our organization,resulting in the cost.
But, there wasn't any systematic attempt to decrease costsin product development. In fact, we were able to continue to invest in thethings that we wanted to through the period.
Richard Baldry -Canaccord Adams
Great, thanks a lot. Congratulations.
Jim MacIntyre
Thank you.
Operator
Your next question comes from the line of Atul Bagga withThinkEquity. Please proceed.
Atul Bagga -ThinkEquity
Hi, Jim, good afternoon.
Jim MacIntyre
Hey, Atul, how are you?
Atul Bagga -ThinkEquity
I am well. Thank you.
Jim MacIntyre
Good.
Atul Bagga -ThinkEquity
Great quarter. Just wanted to see if you can give somecommentary on what you are seeing out there after the announcement ofacquisition by Omniture. Is it affecting your sales cycle in any way youperform?
Jim MacIntyre
Still, it's a little early for us to have a good indication.But as Omniture has publicly stated, they will make sure that the best featuresof HBX and SiteCatalyst are brought together into a combined platform thatoffers the best of both worlds for our combined customer base in the futuretime.
They have also stated that they are not going to forcecustomers to migrate rather they intend to create a compelling offering bytaking the best of both platforms to help the customers really have a positiveupgrade option in the future. So because of that strong messaging that we'vebeen able to make, we haven't seen as yet any particular impact and we continuefunctioning in the normal course.
Atul Bagga -ThinkEquity
Perfect. Thank you.
Operator
Your next question comes from the line of David Hilal with FBR.Please proceed.
David Hilal - FBR
Great, thank you. On the revenue, Jim, total revenueobviously looked pretty good with the breakdown. Subscription was actually downsequentially, which is a bit odd for a recurring subscription model. And so,can you comment as to what would cause subscription revenue to be down on asequential basis?
Jim MacIntyre
Sure, David, Claire is going to answer for you.
Claire Long
Sure, it was down just a hair, and that has to do with whenwe can start recognizing our new customer revenue and when attrition hits us.So some of that also has to do with our SES customers, where we can find dealsand there is a period of time before we can actually recognize the revenue,based on the functionality we unlocked.
So it's a combination of a number of items: I mean, overall,we were happy with the value of our new customer adds, happy with our bookings;it actually was the second highest booking quarter we've had and a lot of thatwould up sell activity into our existing customer base. So that was the reallygood positive sign as well.
David Hilal - FBR
Okay. And Jim in terms of the business, this is kind oftwofold question. One: are you addressing the cost structure? Obviously, Joshmade it clear, the major goal was the financial transaction part of the mergerwhich obviously suggests material cost cutting. Have you started to addressthat, or will you wait until the deal is consummated, number one? And kind ofrelated to that: what are you doing to ensure that the business can thrive, iffor some reason the merger does not go through?
Jim MacIntyre
Sure, David, first, in terms of the present -- the secondpart of your question, first. We are focused on maintaining our business in thenormal course through the period that we are going through in terms of HSR andshareholder votes. So, we continue to drive the business the same way that wehave been. We are working hard with the Omniture team in regard to theintegration plans and looking at what we will do in the future to optimize thebusiness as we put it together.
But the answer to your second question is really the same,in the sense that we continue to drive the business forward in the same waythat we have. We are continuing our R&D expenditure. We are continuing restof our work as was. So, that will have to go on in that way until we completedour integration planning and close the transaction.
David Hilal - FBR
Okay. And then my final question: can you just walk throughthe milestone? Does it relate to the merger for Hart-Scott-Rodino? What are thenext steps that we should be looking for? And, roughly, the timeframe for whenwe should look for like an HSR to go through? Thanks.
Claire Long
It's a little early to tell what's going to happen with HSR.We are actually just filing our application today, I am really completing that.So we don't have any initial feedback. We obviously have to pass that.
We have to file then our S-4, which we will be filing, notwhen Hart-Scott-Rodino is complete, but when we are done with our S-4. Once wepass HSR, we will have to have our shareholder vote. So a lot of it iscontingent about how long the review takes, and we just don't have any idea yetuntil we file our application and get our feedback.
David Hilal - FBR
Okay, thank you.
Jim MacIntyre
Sure
Operator
(Operator Instructions) And your next question comes fromthe line of Brent Thill with Citi. You may proceed.
Brent Thill - Citi
Thanks. Good afternoon. I was wondering if you could justaddress the deferred revenue. It's down a little last nine months. Youmentioned retention was good and your bookings are strong. So what are the keydrivers behind that decline?
Claire Long
Our deferred revenue is actually up from last quarter. Whatwe normally look for in deferred revenue is to have approximately one quarter'sworth of revenue, and that can vary for some billings that might not bequarterly, such as our maintenance billing.
It can also vary, if there is a large license deal sittingin deferred revenue and there was one quarter and I did a Q3 or Q4 and that'sprobably where you are talking about the decline where we did have a largelicense deal in deferred revenue. But we are happy with the deferred revenuebalance that have at the end of this quarter. It is up, it is approximatelythree months' worth of revenues, so it is pretty much right in line.
Brent Thill - Citi
Okay, great thanks.
Jim MacIntyre
Sure
Operator
Ladies and gentlemen, I would like to turn the call backover to Jim MacIntyre, CEO.
Jim MacIntyre
Terrific. Well, thank you all for joining us today. We lookforward to speaking with you again soon. Take care.
Claire Long
Thank You.
Operator
Thank you for your participation in today's conference. Thisconcludes the presentation. You may now disconnect. Have a great day.
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