Intraware F3Q08 (Qtr End 11/30/07) Earnings Call Transcript

Intraware Inc. (ITRA)

F3Q08 Earnings Call

January 10, 2008 5:00 pm ET

Executives

Wendy A. Nieto - Chief Financial Officer, Principal Accounting Officer, Exec. VP and Controller

Peter H. Jackson - Co-founder, Chairman, Chief Exec. Officer and Pres

Analysts

Kelly Cardwell - Central Square Capital

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Intraware third quarter of fiscal year 2008 earnings conference call. The company’s release made earlier today is available from its website at www.intraware.com. During the presentation, all participants will be in a listen only mode. Afterwards security analysts and institutional portfolio managers will be invited to participate in a question and answer session. (Operator Instructions)

As a reminder, this call is being recorded Thursday, January 10, 2008. A replay of the call will be accessible by dialing 888-203-1112 and entering conference ID number 9234976. International callers should dial 719-457-0820. An archive of this call will also be available on the Intraware website at www.intraware.com.

I would now like to turn the conference call over to Wendy Nieto, Chief Financial Officer of Intraware. Please go ahead, ma’am.

Wendy A. Nieto

Thank you. Good afternoon and thank you for attending Intraware’s conference call to discuss financial and operating results for the third quarter ended November 30, 2007. With me today is Peter H. Jackson, Chairman, Chief Executive Officer, and President of Intraware. By now you should have seen a copy of today’s earnings release that was distributed atthe close of regular trading. You may access the release on our website at www.intraware.com.

The format of the call will be as follows: Peter will discuss operating highlights of our third quarter and I will provide details of our third quarter financial results and guidance for the fourth quarter of fiscal 2008. We will then open the call for questions and also address questions we received by e-mail.

Before continuing I’d like to remind you that during this call, in addition to discussing the actual results of this quarter, we will be making some forward-looking statements pursuant to theSafe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on our current expectations and beliefs and are subject to a number of factors and uncertainties that could cause our actual results to differ materially from those described in these forward-looking statements.

These include without limitation statements regarding our expectations for the company’s performance inthe fourth quarter of fiscal year 2008 and in future quarters, new product introductions, developments with our partners, and our expectations as to future trends and events inthe market generally. Actual results could differ materially from those anticipated inthe forward-looking statements.

For a detailed discussion of the factors and uncertainties that could cause our actual results to differ materially from those described in these forward-looking statements, please refer to the prospectus described in our form 10-Q that we plan to file with the Securities and Exchange Commission tomorrow and any updates to those risk factors contained in other documents that we file from time to time with SEC. Those documents and reports can be viewed on the Investor page of our website. We undertake no obligation to update or revise any of our forward-looking statements whether as a result of new information, future events, or otherwise.

Let me also mention that the company meets regularly with current and prospective investors to discuss historic and non-material aspects of our business. If you are interested in scheduling such a meeting or require other information, please call us using the phone number on today’s release.

I’ll now turn the call over to Peter Jackson.

Peter H. Jackson

Thank you, Wendy. Good afternoon, everyone. We are pleased with our third quarter results where we demonstrated our ability to grow our customer base, achieve record positive cash flow, and once again achieve profitability for the quarter. In addition, we achieved $1.3 million in contract renewals, new customers, professional service engagements, and variable billings.

Highlights for the quarter include: we achieved a record $582,000 in cash flow from operations, we signed SubscribeNet service agreements with three leading technology providers. These customers bought SubscribeNet for compliance and cost savings, plus a hosted service we could get them live faster than any other alternatives. We signed two pilot customers for SubscribeNet service, one of which has already converted to a two year agreement in the fourth quarter. We also renewed or extended seven of our existing SubscribeNet contracts with companies such as QAD Critical Path and entered into five professional services statements of work.

We increased the total annual contract value of our SubscribeNet customers by approximately $280,000 to a total of $10.9 million. This is the fifth consecutive quarter that the metrics have increased and we added over $240,000 end users to the SubscribeNet service, a metric that has consistently improved quarter over quarter, pushing the total end user adoption to the $2.15 million end user mark. We reached record high variable billings, a 60% increase over the prior quarter, which has also become a record high. Variable billings has increased for five straight quarters. Not only was the dollar value of the variable billings at anall time high, but also the number of customers incurring the variable billings and the average value of the variable billings.

Variable billings are triggered when customers exceed certain thresholds established inthe services agreements. Once a customer has exceeded those thresholds, we are generally able to negotiate a higher fixed fee for these customers as they are deriving increasingly greater value by having a higher number of customers utilizing the SubscribeNet service, so variable billings is the leading indicator of incremental contract growth potential. Variable billings are not included in our total annual contract value calculation, although they do contribute to the revenue in the period in which they are recorded.

This recent quarter showed strong market validation of our technology and offerings as well as our pricing and market positionings. We had wins with technology providers of all sizes, from company with $100 million to nearly $2 billion in sales, with average software selling prices ranging up to tens of thousands of dollars. The interest in our channel offering, which I mentioned in our last quarterly call, continued to be strong this quarter with several of our new customers as well as some of our existing ones committing to use our technology to support sales and distribution through their sales channels. We have recently been successful in several rigorous competitive purchasing processes. These wins give us confidence that we are offering the technology and services most valued b y our customers and prospects and that we are providing services at a price that is both competitive inthe market and profitable for us.

Another positive sign of market acceptance for our offering was the signing of a new top five customer shortly after the end of our third quarter. We believe there were many drivers behind the project including offering a positive customer experience, cost of goods saving, and to provide customers with a green fulfillment option. This SubscribeNet agreement is a two year agreement and we look forward to announcing more information as soon as we are able.

In the broader picture, acquisitions continue to bea major factor in our vertical that creates risk and opportunities. This quarter we have seen growth in our install base as customers acquired new companies and add new acquired company’s products and customers to the SubscribeNet service. On the other side of the coin, as our existing customers themselves are acquired, we see the opportunity to grow the value of those relationships by telling into the acquired company. Traction with our partners continued to be fruitful. The ability to add e-commerce and/or payment capabilities continued to influence customer’s buying decisions in Intraware’s favor. Inthe third quarter, Digital River also completed a sale to one of our existing customers allowing for that customer to move ahead with an integrated e-commerce and electronic software delivery solution. We also added new customers utilizing Aspera as our premium download service.

Now I’d like to discuss some of Intraware’s marketing highlights for the quarter. We held our largest and most successful SubscribeNet user conference that was attended by 51 customers and prospects, and 10 people representing 6 Intraware partners. Not only did our partners once again financially sponsor and participate in presentations and partner trade show events at our SubscribeNet user group, but one of the most well-received and interactive sessions of this two day event was an expert panel of our license management partners and customers. Customers and prospect feedback has been positive and 100% of the questionnaire respondents said they would attend the SubscribeNet user conference in 2008.

Let me know turn to an update on new developments in our infrastructure which is the backbone of our offerings. During the third quarter of fiscal 2008, we continued to invest inthe ongoing improvement of our SubscribeNet service. Several significant customers’ specific initiatives were completed, including Channel Manager and Evaluation Manager implementations. In addition to this customer-specific development, core system enhancements were completed. These enhancements included updates to remain current with export compliance regulations, new data center improvements to better support disaster recovery, and the rollout of download manager to work in conjunction with our Akamai integration.

Another development we are proud of is zAthlete, which can be accessed at www.zAthlete.com, an online network for athletes and teams, allowing them to communicate with teammates, friends, fans, and coaches, and to share game videos, photos, documents, and external links. zAthlete is an example of how we are able to leverage our entitlement management into a social networking site to control content. Most social networking sites are publicly available and have few restrictions on who can create or view content. Entitlement management allows members to control who accesses their private data and ensures all interactions are secure. Originally introduced in October of 2007, zAthlete has undergone rapid evolution.

In December of 2007, the following features were added: teams, clubs, leagues, alumni, and similar groups can create zAthlete profile ages and members and fans of the group. Administrators of the teams can grant permission to additional individuals to add photos and videos to the team site. In addition to photos, videos, and links, members can now upload documents, spreadsheets, and presentations such as schedules, standings, or rules. Large or high definition videos are now uploaded and encoded for playback over the internet faster and more reliably. Finally, more secure email verification and individual system-wide communication preferences.

Another site of ours which shows the benefit of entitlement-based API is Digital Fastball, a free general service digital delivery service. It is used by individuals, consultants, and small professional firms to securely deliver large files to customers or friends. Digital Fastball has been adding users over the past year. We view Digital Fastball as complementary for SubscribeNet and zAthlete and we will continue to incorporate into them over the next year.

Intraware continues to bea leader in software as a service application. Leveraging our experience in hosting on demand implementations along with adding requirements of securely delivered large files in order to improve scalability and performance, we’re consistently evaluating technology and services that we can leverage within our platform. Recently we incorporated or extended the use of the following technologies: on demand computing for processing large file uploads such as video, low cost, unlimited persistent network storage, content delivery networks enhanced with Intraware’s entitlement control.

This has been a very exciting quarter for us. Not only do we make significant financial progress, but we saw wide market acceptance of our technology through the new customers we gained and contracts with existing customers we renewed our extended. We are proud of our new developments and I am confident that we will continue to bea leader in software as a service.

That concludes my formal remarks on the third quarter highlights and I now turn the call over to Wendy to take you through the financials for the third quarter and our guidance for the fourth quarter of fiscal year 2008.

Wendy A. Nieto

Thank you, Peter. Intraware achieved the top end of previously provided revenue and earnings per share guidance for the quarter. Revenues for the third quarter of fiscal 2008 were $3.1 million compared to $2.8 million for the third quarter of 2007, an increase of approximately 11%. These increases resulted from both variable billings and new customer implementations during the third quarter. Total revenues for the third quarter of fiscal 2008 decreased 2% from the second quarter, partially due to the $270,000 Intraware revenue recognized inthe second quarter upon a Q2 customer termination. The customer had substantially paid for all contracted services over the course of the agreement which we were unable to recognize until its ultimate termination.

Gross profit margins for the third quarter were 65%, up from 51% from the third quarter of 2007. However, they were down slightly from the second quarter gross profit margins of 67%. This was due to both slightly lower revenues and higher cost of revenues during the quarter. We anticipate gross profit margins for fiscal year 2008 to be approximately 65% which reflects a 10% improvement over the prior year. Although we may experience slight fluctuations, we expect to be able to leverage Intraware’s highly scalable infrastructure to provide additional gross profit margin improvements as revenues increase.

As Peter mentioned, the company achieved profitability, reporting net income for the third quarter of fiscal 2008 of $78,000 or $0.01 per basic undiluted share. This reflects a significant improvement over the prior year. As you may be aware also, the SEC previously agreed to provide non-accelerated filers, those with a market capitalization below $75 million, with a one year extension to comply with section 404 internal control requirement as we are internal controls are to be audited by external auditors. It is currently expected that an additional extension would be granted changing the current compliance date for internal controls to be audited by the external auditors and thereby extending this requirement for Intraware until fiscal year 2010. However, under the current rule, Intraware is required to provide management’s report on internal controls over financial reporting for fiscal year ended February 29^th,, 2008. Accordingly, Intraware expects to incur year end compliance fees in addition to professional service fees as it adopts this new requirement and finalizes its management report for the current fiscal year.

I am pleased to report the company was cash flow positive in total and on an operating basis inthe third quarter. We ended the quarter with $12.3 million in cash and provided $582,000 in cash from operating and activities. We continue to see our balance sheet strengthen and expect to be cash flow positive inthe fourth fiscal quarter as well.

Turning now to the company’s business outlook for the fourth quarter of fiscal 2008, Intraware expects revenues for the fourth quarter of fiscal year 2008 to be between $3.0 million and $3.1 million. The expects GAAP net income loss per basic undiluted share inthe fourth quarter of fiscal 2008 to range between $0.03 and $0.05 per share. Although we have experienced strong new customer signings since our last conference call, we do not expect to be able to realize the benefits of those new customer agreements until the next fiscal year. The company remains committed to sustained profitability and believes this is a near term reality based on the existing customer base, market transaction, and our scalable cost structure.

However, we do expect modest operating expense increases inthe fourth quarter. Sales and marketing expenses will increase in the fourth quarter as the result of higher commissions related to the addition of a SubscribeNet customer and to a much smaller extent additional expenses related to corporate compliance costs for year end activities.

We are pleased overall with the financial improvements we have been able to deliver year to date and we are focused on building on those accomplishments inthe coming fiscal year.

I would now like to open up the call for questions.

Question-and-Answer Session

Operator

Thank you, ladies and gentlemen. (Operator Instructions) Our first question comes from Kelly Cardwell of Central Square Capital.

Kelly Cardwell - Central Square Capital

Just a quick question. The contracts that were signed at Q4, was that included inthe total annual contracts value that you reported or would that be reported in the February quarter?

Peter H. Jackson

We signed it roughly a couple weeks ago so when our quarter ended atthe end of November so you will see the contract value increase on that in our next earnings call.

Kelly Cardwell - Central Square Capital

Can you give us any kind of ballpark on size and how it compares to other customers that you have?

Peter H. Jackson

I would if I didn’t have an attorney and a CFO looking at me with a couple of bazookas.

Kelly Cardwell - Central Square Capital

Okay, great. Thanks and congratulations on a good quarter.

Operator

There are no further questions at this time. Mr. Jackson, I’ll turn the call back to you for email questions.

Peter H. Jackson

I’ll just finish with Kelly, that customer will drop into our top five immediately so that’s not going to give you any numbers but you can do your back of the envelope, I know you’re good at that.

We have some questions that came online, Wendy, is that right?

Wendy A. Nieto

Yes. At this time we’ll quickly go over the questions that came from our individual investors via email. The first one being, “We have not seen an announcement for the renewal of the Digital River contract and am inquiring on the status of the contract.”

Peter H. Jackson

It is a contract that now expires at the end of March and we don’t anticipate a problem going forward. It’s a good relationship.

Wendy A. Nieto

The second question was in regards to the pipeline and prospective customers and sort of how we characterize that and could they clarify our statement with regards to our pipeline?

Peter H. Jackson

The pipeline has grew even further beyond I think that was our earnings call we talked a little bit on the call on the script and part of the call about three wins and two pilots. We had one of those pilots convert. So that’s four new wins there. We’re just involved in a lot of projects because there’s a lot of push towards green and certainly by June by organizations and we’re involved in many projects from software to hardware to semiconductors and the timing of those things closing are just things we can’t control but right now we’re ahead of what I think our internal expectations were in terms of contract value by a measurable amount right now so those deal flows are running nicely and continue to grow.

Wendy A. Nieto

And then the last email question we have today is, “You’ve mentioned that the greatest revenue potential of the company rests with zAthlete. Does this mean that SubscribeNet is mature in terms of future growth progress?

Peter H. Jackson

I wouldn’t say revenues to maturity on SubscribeNet. I think SubscribeNet for us there’s $100 million number out there for us and I sort of antiquate that based on when we look out atthe number of companies that are out there doing work physically using warehouses, using CDs, DVD to deliver. It’s still a significant number. It may not seem like a large market for us to get $100 million for InchWare but the way we price and the way we do subscription based selling, it’s a re-occurring number so we charge annually as most of you know for how many customers you have on the service and as you can see by adding nearly $250,000 last quarter, that should add to more billing and show up in the variable and we’re going to see some pretty good sites over the next fiscal year just based on our customer base and the expansions that are going on.

All our metrics are finally kicking in and which is nice because we don’t have the one customer that’s over 10%, it’s coming from a lot of different areas, new customers coming in, so SubscribeNet is growing nicely. zAthlete, if you follow the social networking space at all, there’s a huge movement in this area. It’s not as big as people moving to email inthe early 90s but there’s a lot of things we can get accomplished inside the environment in Web 2.0.

I think Chambers sort of touched on that a little bit this morning saying that the biggest movement in technology, I forget the quote exactly, was around video and social networking and we’re certainly experiencing far better growth than we had anticipated within the zAthlete page and in terms of revenue, there is a report that just came out that showed that the amount of dollars that are going to flow into the social networking space just over the next four years and I think it’s because it can get specific based on the content that they can extract from these people and these profiles and the discussions that we’ve had with a couple dozen different types of manufacturers from protein bars to power drinks to caffeine drinks to apparel to athletic equipment. There’s a good opportunity for us to do that within our profiles.

I think there’s a critical mass component within zAthlete and a lot of people say, “Hey, I’d like to invest in your company because I really like the zAthlete, I like the way it works and I’m using it” and really it’s hard to quantify at this point and say, “Hey, that’s a really good decision.” It is a venture related or stealth related product that we’re able to leverage off allthe work we did in SubscribeNet and the upside is that if you doget to 10,000 users, you pretty quickly get to 100,000, if you get to 100,000, you pretty quickly get to a million, and you can start to do the math in terms of what you can get per active profile after that, so I think in the coming quarters we’ll see how we are going relative to that growth.

There is an enormous amount of revenue that can come down if we’re as successful as we’ve been in terms of the growth rate of this particular product and coming out of its beta, hopefully by this summer with allthe features we’ve added and the additional features we intend to add, there’s a really nice roadmap for this product and there’s a lot of customer satisfaction around it, so we see big revenues that can come from zAthlete but it’s really going to bea function of us succeeding on becoming and getting to critical mass. We’re excited about it, we’re motivated by it, we’re not distracted by it. There’s a lot of work to be done on S net, the customers are asking for a lot. We have the resources in place to meet those. We’re going to meet our objectives, but atthe same time, I think this is a great way for us to leverage our infrastructure and give ourselves an opportunity to be a much larger organization over the next year.

Wendy A. Nieto

With that being the last email question, I’ll turn the call back over to the operator in the event there were any additional calls.

Operator

At this point there are no further questions today. There will bean audio as well as the internet rebroadcast of today’s conference. The audio rebroadcast will be available for one year through the end of business, January 10, 2009 by dialing 719-457-0820 with a passcode of 9234976. To access the internet rebroadcast, please log into www.interware.com.

I thank everyone for joining us today. That does conclude the presentation. Have a great afternoon.

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