Visual Sciences Q3 2007 Earnings Call Transcript

Visual Sciences, Inc. (VSCN)

Q3 2007 Earnings Call

November 7, 2007 5:00 pm ET

Executives

Claire Long - CFO

Jim MacIntyre - CEO

Analysts

Richard Baldry - Canaccord Adams

Atul Bagga - ThinkEquity

David Hilal - FBR

Brent Thill - Citi

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2007 Visual Sciences Earnings Call. My name is Tina, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn today's presentation over to your host Claire Long, Chief Financial Officer. You may proceed.

Claire Long

Good afternoon, everyone, and thanks for joining us today to discuss Visual Sciences third quarter results. Following the live call, an audio archive of this call will be available on the company's website.

Today's call contains forward-looking statements that are not a description of historical facts. For example, statements about our projected future results, growth opportunities, business strategies, market observations and future product plans are forward-looking statements.

In addition, statements regarding Visual Sciences' ability to complete the proposed merger with Omniture, the ability to satisfy conditions to closing the merger, including obtaining stockholder and regulatory approvals, and the benefits of the merger to stockholders, are also forward-looking statements. You should not regard any forward-looking statement as a representation by Visual Sciences that any of its plans will be achieved.

Actual results may differ materially from those discussed during this conference call due to the risks and uncertainties inherent in Visual Sciences' business, as well as the potential impacts on Visual Sciences' business, results of operations and common stock price resulting from the proposed merger with Omniture including, but not limited, to risks of disruption to our business development and sales efforts and disruption and distraction of our management and employees from day-to-day operations as a result of the merger, risks associated with obtaining stockholder or regulatory approvals related to the proposed merger, risks that the expected financial effect of the merger may not be realized, risks associated with contractual limitations 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 risks associated with Visual Sciences' failure to complete the merger.

These statements are based solely on information available to Visual Sciences as of the date of this call. Our current expectations, forecasts, and assumptions are subject to a number of risks and uncertainties that can cause actual results to differ materially from those anticipated by these forward-looking statements. We refer you to our SEC filings, including the company's Annual Report on Form 10-K for the year ended December 31, 2006 and other reports the company filed with the SEC for more information about these risks and uncertainties.

You should also be aware that Omniture intends to file with the SEC a Registration Statement on Form S-4, which will include a joint proxy a joint proxy statement/prospectus of Omniture and Visual Sciences and other relevant materials in connection with the proposed merger transaction.

The joint proxy statement/prospectus will be mailed to the stockholders of Omniture and Visual Sciences. Investors and security holders are urged to read the joint proxy statement/prospectus and the other relevant materials when they become available because they will contain important information about Omniture, Visual Sciences and the proposed transaction.

The joint proxy statement/prospectus and other relevant materials, when they become available, and any other documents filed by Omniture or Visual Sciences with the SEC, may be obtained free of charge at the SEC's website.

The statements we will make in this conference call are based on information we know as of today, and we assume no obligation to update any of those statements.

I'd also like to point out that we will present certain non-GAAP information on this call. The reconciliation of GAAP to non-GAAP financial measures is included with today's press release, and is also available 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 us today for Visual Sciences third quarter earnings call. The third quarter was very busy for Visual Sciences on a number of fronts.

On the operational front, we had a solid quarter, resulting in revenue that came in at the high end of our guidance range, and non-GAAP earnings that came in well above our guidance range.

To summarize our quarterly financial results for the third quarter; total revenues were $20.4 million, representing 8% year-over-year growth 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 per diluted share. The third quarter also marked our 16th consecutive quarter of positive cash generation. In Q3, we continue to see strong demand for our real-time analytics products.

The third quarter is typically a slower quarter in the analytics market; however, our bookings actually increased by greater than 50% over the comparable quarter of 2006 due to a significant increase in our up-sell activity.

In Q3, we closed 307 sales booking transactions, with both new and current customers. These included bookings with 49 new customers such as National Trust, C&H Distributors, Gaylord Hotels, and [TaxSlayer] as well as one new major domestic airline and two major financial services corporation, adding to our already strong penetration in these two vertical markets.

During Q3, we also saw our relationships expand with a number 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 also continued with our average deal sites for new customers increasing 17% over Q2 after increasing over 40% from Q1 to Q2.

We received a number of accolades on our products during the quarter, two of our products Visual Site and HBX Analytics were featured the Forrester Wave Web Analytics Q3 2007 independent research report.

According to the report, Visual Site and the underlying Platform 5 technology provide the most powerful data architecture and real-time analysis tools in the industry. Additionally, Visual Sciences' HBX Analytics was acknowledged for its easy-to-use tools, with the highest score in the usability section of the current offering category of Forrester's report.

Separately, Knowledge Management World selected the Visual Sciences' Technology Platform 5 as a trend setting product of the year for 2007. It was selected from over 650 products reviewed. We are extremely pleased to have received this recognition.

In terms of new products, during the quarter, we announced the availability of Visual Sciences Search 5.0, the latest version of the company's award-winning website search solution. This release improved customer ease-of-use through cleaner task-based work flows, and site user experience ,through new search results presentation templates.

We began offering Search 5.0, the fast-track deployment option, ensuring that online retailers and e-commerce websites had the opportunity to fully implement the product in advance of the busy holiday shopping season.

In other events, I am also happy to report that during the quarter we settled the patent litigation with NetRatings and we were able to put that issue behind us.

And lastly, as you know, on October 25th, we signed a definitive agreement to be acquired by Omniture through a combination of stock and cash, ending the formal evaluation of our strategic alternative that we announced in July which was managed by Goldman Sachs. Importantly, this combination is the first public-to-public acquisition of two Software-as-a-Service company.

With the tremendous growth that we see in the analytics and online optimization market, we believe that this strategic combination will drive increased value for our shareholders, customers and partners. We think that this combination position us to better innovate and build the solutions that so many organization in our markets are interested in.

While both Visual Sciences and Omniture have independently growing businesses, a combined entity will accelerate scale so that we can more aggressively reinvest in the product functionality and support services that our high growth market deserves.

Now, let me turn the call over to Claire to provide you a detailed overview of our Q3 financial results.

Claire Long

Thanks Jim. The following commentary will be on a non-GAAP basis, which will exclude amortization of intangibles, stock-based compensation expenses, the one-time NetRatings legal settlement expense, expenses related to the merger transaction, and include purchase accounting adjustments to revenue and other non-cash adjustments.

A GAAP to non-GAAP reconciliation is included in the press release we issued earlier today.

For the third quarter of 2007, we recorded revenues of $20.4 million. Total revenue increased 8% organically year-over-year. Revenues from subscription, hosting, and support were $16.6 million, representing 81% of total 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 from outside the United States accounted 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 and operating expenses represented 58% of revenues, which is an improvement from 63% reported in both the third quarter 2006 and last quarter. Included in our operating expenses this quarter was $663,000 of legal expenses attributable to the NetRatings settlement, as compared to $530,000 in Q3 of 2006, and $697,000 last quarter. There is a legal fees associated with the actual lawsuit--not the settlement of the lawsuit.

As we previously announced on August 20th, we entered into a settlement and patent cross-license agreement with NetRatings during the quarter. The accounting for that settlement resulted in us recording a one-time settlement expense of $889,000, and a patent asset of $7 million. The patent asset will amortize over a 9.5 years, based on the pattern in which the economic benefit is consumed, which is approximately a $150,000 per quarter through the end of 2008, at which point it begins to increase.

Both the one-time settlement expense and the amortization expense 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 points as a percentage of revenue from the prior quarter. The prior quarter included costs related to our U.S. and European user forum and marketing costs related to our re-branding. There were no similar costs in the third quarter.

Product development decreased by 170 basis points due to further streamlining of our product development team.

G&A increased by 190 basis points due to costs related to our SOX work, which typically gears up in Q3 of each year as well as legal expenses. Our non-GAAP net income for the quarter was $3.1 million or $0.15 per diluted share. Overall, we were pleased with our financial results this quarter.

Turning to the balance sheet, we ended the quarter with approximately $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 $2.3 million in capital expenditures for the quarter, resulting in neutral free cash flow.

The outstanding balance on our revolving credit facility was $4 million as of September 30th. Net accounts receivable was $19.1 million at the end of Q3, up approximately $2 million from the prior quarter. DSO for the third quarter was 85 days, up from 79 days in Q2. The increase was due to the timing of collections with larger customers. Larger customers have more complex dealing 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 subscription contracts are typically built quarterly, but our maintenance and hosting contracts are typically built annually, with the majority of the renewal dates on maintenance contracts in the first and the fourth quarters of the year resulting in lower deferred revenue balances in the second and third quarters.

As a reminder, fluctuations in deferred revenue are impacted by the timing of our invoicing and payments, as well as the mix of subscription and license billing.

Our retention rate for HBX and Visual Sciences and our overall contract lengths remained in line with historical averages.

Turning to financial guidance; as noted in our press release earlier today, we will no longer be providing forward-looking guidance and investor should no longer rely upon the guidance made in Visual Sciences' press release issued on August 2, 2007.

Due to potential changes in customer buying behavior resulting from the pending transaction with Omniture and uncertainty regarding the timing of the closing of the deal, we anticipate less predictability than usual. Although we are encouraged by the initial reactions we have seen from our customer base., it is too early to determine the impact on up-sell and new booking activity.

With that, I'll turn the call back over to Jim to discuss the market trends and operational highlights for the quarter.

Jim MacIntyre

Thanks Claire. As I mentioned in my opening remarks, the third quarter of 2007 was a very busy and productive time for Visual Sciences. Though we were running the now-concluded process to evaluate our strategic alternatives during the quarter, the Visual Sciences team still managed to perform above expectations.

Visual Sciences is addressing a huge and growing marketing opportunity defined by the rapid growth of online advertising, new forms of digitally connected customer interaction and the expansion of online business, in general. We are well positioned to capitalize on those opportunities, and will be 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 the data is easy part. The hard part is discovering profitable insight within the data and then acting on those insights quickly to gain competitive advantage.

This customer interaction data comes from a wide range of digitally connected systems including websites, point-of-sale systems, e-mail systems, call centers, case management systems, kiosk and ATMs amongst others.

Analysts estimate that less than one quarter of organization have implemented any type of technology that allows them to effectively analyze and optimize their businesses, using the value buried in all of their customer interaction data, leaving a large opportunity in the market.

The good news is, that many organizations who have that opportunity, are recognizing the value of real-time data analysis and optimization 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 size and importance is shown by the investments of large players including Microsoft, Google, Yahoo and others. This is one of the reasons why we view the combination with Omniture as a strategic combination that makes sense for both companies at this time.

To summarize the terms of the transaction with Omniture that we announced on October 25th, each Visual Sciences' shareholder will receive 0.49 shares of Omniture common stock, plus $2.39 per share in cash for each share of Visual Sciences they own. This transaction is subject to a number of closing conditions, including shareholder approval of both Visual Sciences and Omniture, as well as the usual and customary regulatory approvals. The transaction is expected to close in early to mid 2008.

Current Visual Sciences customers will benefit near- and mid-term with continued support for our products, including HBX, Visual Site, Visual Call, Platform 5, Search, Publish and Bid, and longer-term, from a broader set of products that we will be able to offer as a combined organization. With the greater scale that will result from the combination, our customers will also benefit from our faster pace of innovation than we would be able to provide had we remained independent.

We are 100% committed to the continued success of our customers. And we will work closely with all of them to ensure smooth transition as we become part of Omniture. I can attest to Omniture's strong commitment to their customers, and I have been given every assurance by Josh and the rest of Omniture's management team, that this same commitment will extend to all Visual Sciences customers.

I am very pleased that Visual Sciences is becoming part of the Omniture family, and believe that our customers will be equally pleased, as the combination enables a whole new level of investment and innovation to their benefit.

There are three key reasons the acquisition of Visual Sciences by Omniture is important at this time, and I want to make sure that I reiterate them. The first, is increased market opportunity. This combination results in a broader customer base over 4000 customers, and as Visual Sciences and Omniture continue to increase the functionality available in their suite of products that functionality can be more readily delivered to that broader base of customers.

The second, is increased efficiency. As a combined company, certain parts of our cost structures are duplicative, and over time that duplication can be eliminated allowing us to focus our investment in new directions.

The third, is increased scale. We will be able to use the revenue efficiency we gain to invest more aggressively on our products to benefit our entire customer base. This is investment will result in greater research and development, sales, marketing, overseas expansion, and the ability to broadcast our message more loudly in the marketplace.

In conclusion, Q3 was a very busy and productive quarter for the entire Visual Sciences team. I am excited about what the future holds for the combined Visual Sciences-Omniture organization, and look forward to continuing to work with our customers to ensure their success and continuing to deliver the 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-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Richard Baldry with Canaccord Adams. You may proceed.

Richard Baldry - Canaccord Adams

Thanks. I am wondering if you could talk a little about early feedback from sort of your API partners, when you look at Omniture's Genesis network, how you see those two fitting together? Thanks.

Jim MacIntyre

Sure, Richard. Sure, I think the early feedback and general feeling we have is that the both programs we had built and the program Omniture built in Genesis are very similar in a lot of ways.

Partners were looking to both of us before to provide access to the analytics data through such APIs, and I think the ability, much like the rest of the transaction, will enable to have the greater investment around the common set of APIs, ultimately, in the future will benefit all of our customers.

Richard Baldry - Canaccord Adams

And you mentioned briefly the streamlining in R&D continuing to lower [some of those] costs. Could you talk about how that changes potentially going forward?

Jim MacIntyre

The product development costs were lower by just a hair, and I think that as we put our teams together over the last period of time, we were able to share some resources and infrastructure across our organization, resulting in the cost.

But, there wasn't any systematic attempt to decrease costs in product development. In fact, we were able to continue to invest in the things 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 with ThinkEquity. 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 some commentary on what you are seeing out there after the announcement of acquisition by Omniture. Is it affecting your sales cycle in any way you perform?

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 features of HBX and SiteCatalyst are brought together into a combined platform that offers the best of both worlds for our combined customer base in the future time.

They have also stated that they are not going to force customers to migrate rather they intend to create a compelling offering by taking the best of both platforms to help the customers really have a positive upgrade option in the future. So because of that strong messaging that we've been able to make, we haven't seen as yet any particular impact and we continue functioning 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 revenue obviously looked pretty good with the breakdown. Subscription was actually down sequentially, 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 a sequential 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 when we 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 deals and 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 that would up sell activity into our existing customer base. So that was the really good positive sign as well.

David Hilal - FBR

Okay. And Jim in terms of the business, this is kind of twofold question. One: are you addressing the cost structure? Obviously, Josh made it clear, the major goal was the financial transaction part of the merger which obviously suggests material cost cutting. Have you started to address that, or will you wait until the deal is consummated, number one? And kind of related to that: what are you doing to ensure that the business can thrive, if for some reason the merger does not go through?

Jim MacIntyre

Sure, David, first, in terms of the present -- the second part of your question, first. We are focused on maintaining our business in the normal course through the period that we are going through in terms of HSR and shareholder votes. So, we continue to drive the business the same way that we have been. We are working hard with the Omniture team in regard to the integration plans and looking at what we will do in the future to optimize the business 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 way that we have. We are continuing our R&D expenditure. We are continuing rest of our work as was. So, that will have to go on in that way until we completed our integration planning and close the transaction.

David Hilal - FBR

Okay. And then my final question: can you just walk through the milestone? Does it relate to the merger for Hart-Scott-Rodino? What are the next steps that we should be looking for? And, roughly, the timeframe for when we 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, not when Hart-Scott-Rodino is complete, but when we are done with our S-4. Once we pass HSR, we will have to have our shareholder vote. So a lot of it is contingent about how long the review takes, and we just don't have any idea yet until 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 from the line of Brent Thill with Citi. You may proceed.

Brent Thill - Citi

Thanks. Good afternoon. I was wondering if you could just address the deferred revenue. It's down a little last nine months. You mentioned retention was good and your bookings are strong. So what are the key drivers behind that decline?

Claire Long

Our deferred revenue is actually up from last quarter. What we normally look for in deferred revenue is to have approximately one quarter's worth of revenue, and that can vary for some billings that might not be quarterly, such as our maintenance billing.

It can also vary, if there is a large license deal sitting in deferred revenue and there was one quarter and I did a Q3 or Q4 and that's probably where you are talking about the decline where we did have a large license deal in deferred revenue. But we are happy with the deferred revenue balance that have at the end of this quarter. It is up, it is approximately three 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 back over to Jim MacIntyre, CEO.

Jim MacIntyre

Terrific. Well, thank you all for joining us today. We look forward to speaking with you again soon. Take care.

Claire Long

Thank You.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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: [e-mail]. Thank you!