Phoenix Technologies F1Q08 (Qtr End 12/31/07) Earnings Call Transcript

Phoenix Technologies, Ltd. (PTEC)

F1Q08 Earnings Call

January 22, 2008 8:30 am ET

Executives

Erica Mannion – Sapphire Investor Relations

Woodson M. Hobbs – President & Chief Executive Officer & Director

Richard W. Arnold – Chief Financial Officer & Chief Operating Officer

Analysts

Eric Martinuzzi – Craig-Hallum Capital Group LLC

Richard Kugele – Needham & Company

[Siegmar Schmidt – Siegmar Digital Lab]

Analyst - D&D Securities

Randolph Guggenheimer, Jr. – Burnham Financial Group

Presentation

Operator

Good day and welcome to Phoenix Technologies Q1 2008 conference call. Today’s conference is being recorded. At this time I’d like to turn the conference over to Erica Mannion, Investor Relations, please go ahead.

Erica Mannion

Good morning and thank you for joining us to discuss Phoenix Technologies financial and operating results. With me today are Woody Hobbs, President and Chief Executive Officer and Richard Arnold, Chief Operating Officer and Chief Financial Officer. For the convenience of participants on today’s call management has posted slides on the company’s website at www.Phoenix.com. These slides contain many of the financial metrics that will be provided during today’s call. The slides can be found in the investor relations section of Phoenix’s website on the webcast page under the events page titled Phoenix Technologies first quarter 2008 financial results call.

On the call today you will hear various forward-looking statements including those relating to our products, strategy in business and financial goals. Actual outcomes and results may differ materially from the expectations contained in these statements due to a number of risks and uncertainties. Please refer to the company’s recent SEC filings at the SEC’s website at www.SEC.gov or at www.Phoenix.com and to the Safe Harbor located in our press release distributed today for detailed discussions of these relevant risks and uncertainties.

The company undertakes no responsibility to update any forward-looking statements made on this call. The press release distributed today that announced the company’s results is available on our website www.Phoenix.com in the investor relation section under financial press releases. The current report on Form 8K furnished with respect to our press release is available on our website in the investor relation section under SEC filings.

Before I turn the call over to Rich Arnold I would like to mention that during calendar Q1 the company will be speaking at the following conferences: Southwest Securities Small CAP Growth Conference in Dallas, Texas on January 31 and at the Ross 20^th Annual OC Growth Stock Conference in Dana Point, California [break in audio].

Richard W. Arnold

[Break in audio] call for fiscal year 2008. Woody and I are thrilled that were are able to report profitable results in the first quarter of our second year at Phoenix and that we therefore met one of our most important objectives that we announced at the time of our appointment. As indicated in this morning’s press release, our net revenues during the three months ending December 31, 2007 was $17.4 million, this represents a 79% increase from the $9.7 million of net revenues in the December quarter of 2006, and an 11% increase from the quarter ended September 30, 2007. These results are actually above the range we described in the pre-announcement we made only two weeks ago, and that reflects the fact that certain of the royalty reports we’ve received from OEM customers since that announcement exceeded our expectations.

On a GAAP basis we achieved net income for the first quarter of fiscal year 2008 of $2.2 million or $0.08 a share which is a $10.2 million or $0.39 a share improvement over the net loss of $8 million or $0.31 a share that we report for the first fiscal quarter of last year. It’s also a $2.9 million of $0.10 a share improvement over the net loss of $0.7 million or $0.02 a share that we reported for the quarter ended September 30^th. On a non-GAAP basis in the first quarter of fiscal year 2008, Phoenix reported a net profit of $3.3 million or $0.12 a share which is a 24 % improvement from the non-GAAP net profit of $2.7 million or $0.10 a share that the company had reported for the fourth quarter of fiscal year 2007. In the first quarter of last year we reported a non-GAAP net loss of $4.7 million or $0.18 a share. Total non-GAAP adjustments in the first quarter of fiscal year 2008 were $1.1 million, consisting of $1 million of 123R non-cash stock compensation expense and $0.1 million in charges related to previous restructuring initiatives. The non-GAAP adjustments are more fully described in the reconciliation between GAAP net earnings and non-GAAP net earnings provided in the financial statements that accompanied the earnings press release.

Our sales performance this quarter again, reflects revenue growth both from existing contracts and from major customers who have previously had the benefit of fully paid up licenses. Before I discuss our order backlog, let me remind you that we previously explained to investors that we expect strong cyclicality in these numbers with backlogs peaking at the end of the December quarter as the results of calendar year contracts, and then declining over the subsequent quarters of our fiscal year. At the end of December, 2007 our backlog of volume purchase agreements that have not yet been recorded as either revenue or deferred revenue, was approximately $40 million. This reflects a net increase of $32.7 million from the backlog as of September 30, 2007. The reason that this backlog is substantially greater than might have been anticipated based solely on normal seasonality, is that during this quarter we undertook a broad initiative to accelerate our recovery from the effects of fully paid off licenses and to limit our exposure to competitive threats.

As part of this initiative we entered into several volume purchase agreements that have durations greater than one year and that generally included a clause that specify a date for the termination of any prior fully paid up license. We also entered the first quarter with deferred revenues of $12 million, an increase of $.02 million from the balance at September 30. Combining the deferred revenue balance with the VPA agreement backlog, our customer agreements as of December 31^st reflects a total of $52 million of anticipated future revenues. Approximately half of this amount is expected to be reflected as revenue for the company during the balance of fiscal year 2008, while the remainder constitutes anticipated revenue in subsequent periods.

Since revenue for the December quarter was $17.4 million and anticipated future revenue from executed agreements increased by $32.9 million. Our sales bookings for the quarter were $50.3 million. I like that graph. Since I commenced reporting backlog in our January call a year ago, we now have a full year of historical data and are therefore able to calculate and discuss the trailing 12 months book-to-build ratio which removes the effective seasonality. This was our original objective when we began providing this information last year. For the 12 months ended December 31, 2007 our book-to-build ratio was 1.55 to 1.

Net license revenues for the first quarter of fiscal year 2008 were $15.4 million this is a 13% increase from the $13.6 million of license revenue from the previous quarter and a 94% increase over license revenue in the year earlier period, which was $7.9 million. These increases generally reflect not only the recover we’d anticipated as we reinstated fully paid up licensees to revenue generating status, but also reflect a somewhat greater than anticipated growth in our customers reported shipments, particularly of mobile computers. As services revenues for the first quarter of fiscal year 2008 was $2 million which represent a 6% or $0.1 million decrease from the fourth quarter of 2007 but a 9% of $0.2 million increase from the first quarter last year.

Gross margins increased sequentially by 15% to $15.3 million. This current period result represents 114% increase over the gross margins of $7.2 million reported for the quarter ended one year earlier. Our gross margin percentage increased from 74% in the December 2006 quarter and 85% in the September 2007 quarter to 88% in the quarter just ended. This increase resulted mainly from the increases in the license revenue which had higher gross margins than services and from our reductions in services cost.

Total operating expenses decreased by $1.1 million or 9% from $13.1 million in the September 2007 quarter to $12 million in the December quarter. Most of this change was due to the effects of reduced restructuring costs and 123R charges. During the September quarter we have taken a total of $1 million in restructuring charges associated with the closure of our Norwood facility and the shrinkage of our Milpitas occupancy. Our 123R charges had been $2.3 million, which had included the value of option grants to two new board members. This quarter, restructuring charges were less than $0.1 million and 123R charges were only $1 million. We expect these 123R charges to increase in future periods as we begin accounting for the new executive performance options, approved by the shareholders at our recent annual meeting.

R&D expenses were relatively flat quarter-to-quarter. Sales and marketing expenses increased approximately 11% mainly associated with our annual customer strategy conference and the two major product launches we completed during the quarter. G&A expenses were reduced by approximately 10% mainly as a result of the reduction in 123R charges. Including both operating expense and cost of goods, our total spending for the December 2007 quarter was $14 million, this was down 9% from the $15.4 million spent in the September quarter and down 21% from the $17.7 million spend in the quarter ended December 30, 2006.

Head count at the end of December was 346, up slightly from the 334 we had on board at the start of the quarter. We’re encouraged by the industries reaction to our new product, so we expect to continue staffing growth, particularly in the R&D area over current and future quarters. I should discuss our tax accruals briefly particularly since this is the first quarter for which Phoenix is reporting in accordance with the new FIN 48, which governs accounting for uncertain tax position. Under this new accounting policy we’ve made a small adjustment to the beginning balance in our retained earnings as of October 1, 2007. The aggregate difference between our liabilities as calculated under FIN 48 and the liabilities we previously reported under FAS5, the previously applicable standard. Those of you who are interested will find the details of our FIN 48 entries in the notes in our financial statements which will be published shortly in the 10Q for this quarter.

Our income tax expense was $1.8 million this quarter, which is almost 45% or our pre-taxed income and slightly above 10% of our total revenue. This tax expense is principally the accrual of liabilities for foreign income taxes related to our operations in Taiwan. We continue to invest significant resources in our efforts to find a solution to our long running dispute with the tax authorities in that country.

We move on now to the balance sheet and cash flow statements. Our cash and short term investment balances were again well ahead of our expectations ending at $70.3 million on December 31, 2007. This is further substantial increase from the $62.7 million balance on September 30, and reflects the fact that we managed to again achieve significant positive cash flow. We continue to receive proceeds from stock options exercises which were $2.2 million this quarter, and we also achieved approximately $6 million in positive cash flow from operations which we’re pleased to report were greater than our own internal forecast.

Now for a short comment on the seasonality of our business, as most of you know, our industry’s peak production periods fall late in the calendar year, and the March quarter is generally the slowest quarter of the year for them. Our VPA sales structure insulates us substantially from the seasonality, but when our customers exceed their VPA commitments any additional revenue we receive is typically recognized during our September and December quarters. Partly as a result of this, we’ve had an exceptionally strong December quarter, which if annualized would bring us very close to our recently raised guidance of $70 million total revenue for fiscal year 2008. We therefore currently expect our March quarter revenue to be similar to the revenue we’ve just announced.

I guess I should finish by apologizing for taking up so much of your time this quarter I promise to leave a little more time for business discussion on future calls. So that completes my comments on the financial results. I would now like to hand over to Woody Hobson our President and CEO.

Woodson M. Hobbs

Good morning everyone and happy New Year. What an extraordinary calendar year in 2007 was for Phoenix, we accomplished a lot. This time a year ago I was excited about what we already accomplished in one quarter and outlined what remained to be done in order to restore health to the company and create value for our shareholders. At that time we said that it was our plan to achieve breakeven run rates for both cash flow and non-GAAP earnings by September 30^th and to end the year with over $45 million in cash. We met and substantially exceeded each of these goals showing positive cash flow in the June quarter and positive non-GAAP earnings for the September quarter. Now, we have not only reported GAAP profits for the first time in many quarters here at Phoenix, but we’ve also ended the calendar year with $70 million in cash and equivalence. Internally we set a very aggressive agenda with targets, like reporting our financial results earlier each quarter, filing our 10Qs and 10Ks 15 days early, reducing our audit costs by over 50% and bringing our ISS corporate governance core well up to above benchmark standards. We met and exceeded each of these goals.

We said that we would share exciting new technologies initiatives aimed at improving the usability, serviceability, and securing personal computers. We met and exceeded this goal by not only sharing the ideas but by launching during the December quarter our two new products FailSafe and HyperSpace. The launch for HyperSpace took place in early November at Half Moon Bay California, at Phoenix’s Annual Strategy Conference. This event provides a good example of the extraordinary position in which Phoenix holds in the personal computer industry. We hosted the event and were joined by senior executives from the big silicon and software providers and major manufacturers in the personal computer industry, representing well over $100 billion in purchasing power. Keynote speakers from Dell, HP, Lenovo, Intel, and Microsoft took to the podium and shared their viewpoints about market directions. Leading industry analysts also spoke and all were highly supportive of our PC 3.0 initiative and of our new product announcements.

Since the announcement of FailSafe and HyperSpace our sales and engineering personnel has engaged actively with all of the world’s leading OEMs and with many of the leading providers of personal computer software. We are now quite confident that one or more major OEMs will launch products, incorporating our technology later this year. Our objective is to make the personal computer user experience as positive as the experience we have when we use many of the other appliances in our life from a television set to the smart phone. We want it to be manageable as soon as it is purchased, usable as soon as it is turned on, fixable as soon as it acts up, lockable as soon as it is out of our possession and findable as soon as it is lost. PC 3.0 is a completely new architecture for personal computers developed by Phoenix. It is our vision for the future and it is a reality for 2008. Virtualization of the personal computer is here and we are at the very core of this next generation of technology. Throughout 2008 you will hear more and more about this initiative and we expect enough significant players in our industry to make announcements that are intimately connected with our work on this front.

We are particularly pleased by yesterday’s news that Microsoft has adjusted its end user license agreements to authorize the installation of Vista on Virtualized PC’s. In years to come we are confident that PC 3.0 will make all of you much happier users of your own personal computers.

As always thanks for your interest and support we’ll continue to work hard to create value for each of you. I will now turn the call over to the Operator to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Eric Martinuzzi with Craig-Hallum.

Eric Martinuzzi – Craig-Hallum Capital Group LLC

The guidance you talked about in the press release on the 7^th but, I just wanted to capture here in one sentence. For your fiscal year 08 guidance, is revenue of $70 million and is it 10% adjusted net income? Does that still stand as well?

Richard W. Arnold

Yes.

Eric Martinuzzi – Craig-Hallum Capital Group LLC

You talked about some catch up revenue in September and December and by that I mean, where OEMs exceeded volume purchase agreements. You captured additional revenues there. What percent of the revenues in the December quarter is related to those catch up payments?

Richard W. Arnold

I couldn’t answer that, small, quite small.

Eric Martinuzzi – Craig-Hallum Capital Group LLC

And then, as far as the new products coming down the pike, you talked about a number of significant players are going to be making announcements. Is that announcement saying that they have selected Phoenix as the technology by which they will roll out some of these PC 3.0 initiatives?

Woodson M. Hobbs

That’s part of it, it kind of a combination of silicon and software providers, as well as we hope ultimately when they’re ready to announce OEMs and ODMs who are using our products as well. It was meant to be a combination of partners and customers.

Eric Martinuzzi – Craig-Hallum Capital Group LLC

Some of the contracts that you negotiated in the December quarter, your January 7^th announcement gave some of the names of the OEM’s, but you talked about two reasons for doing that: number one, was getting out from underneath the fully paid up license agreements and then the other was a competitive move. Could you speak to the competitive side of that initiative? Who are you seeing? And, what is the pressure?

Richard W. Arnold

I think the competitive factor we’re talking about is more just the overall industry competition; there are a great number of providers. Although, there is some consolidation started. So we’re just talking about the general industry competitiveness that’s going on with the PC.

Eric Martinuzzi – Craig-Hallum Capital Group LLC

So you don’t want to name anybody in particular?

Richard W. Arnold

No.

Operator

We go next to Rich Kugele with Needham & Company

Richard Kugele – Needham & Company

Three quick questions, first can you give us a sense of what the longest duration within your VPAs that you have in backlog today are post your accelerated efforts to get rid of the fully paid up licenses?

Richard W. Arnold

[Inaudible] 2009.

Richard Kugele – Needham & Company

From a cash perspective you’ve got about $70 million today, do you have a rough estimation of what you think that might look like at the end of the fiscal year?

Richard W. Arnold

Not that I’ve shared publicly, Rich. Frankly, it all depends on how successful we are at hiring the folks that we want to hire in our engineering and R&D areas. Our earnings guidance suggests that we’re going be lifting our spending in R&D and the constraints is probably not how much we’re willing to spend; it’s how good the talent out there is that we can find to do this work. The more of that talent we find the more of our projected spend we’ll actually spend and the lower our ending cash problems will be.

Richard Kugele – Needham & Company

Ok, but it’s fair to say that the restructuring is effectively over?

Richard W. Arnold

Definitely over, it’s closed now.

Richard Kugele – Needham & Company

Lastly, on the competitive front, specifically on the anti-theft since that seems to be most likely to generate revenue first, correct?

Richard W. Arnold

Yes.

Richard Kugele – Needham & Company

When you look at the customer base of the primary competitor there, how much of the market do you think they’ve secured in multiyear agreements today leaving you available to access those in the near term? They’ve got multiyear agreements of their own two, three years out right?

Woodson M. Hobbs

Well, I’d be very suspicious of any exclusionary contracts; I doubt that they’re that way. So there’s always an entrée for us to go in and sell in addition to them or replace them so I’m not sure those contracts are exclusive. I just don’t know. But, as you know we have relationships with every OEMs out there manufacturing PCs and we’re contacting them all one-by-one and showing them out new technology. So I don’t know that we’re prevented. Certainly, it’s at work for people to convert from one vendor to another, so I think that’s more of the deterrent than contracts.

Operator

(Operator Instructions) We’ll go next to [Siegmar Schmidt] with [Siegmar] Digital Lab

[Siegmar Schmidt – Siegmar Digital Lab]

I just have a question; you mention that the new products will ramp up slowly because of all the different people involved. What is kind of, in your estimation, projection when that will kick in on the revenue side for you?

Woodson M. Hobbs

Certainly, even when we announced the products, we said there wasn’t likely to be any revenues in fiscal year 2008 but, we expect to have measurable amount of revenues in 2009 and we can’t be more precise than that.

Operator

I will go next with Ed [inaudible] with D&D Securities.

Analyst - D&D Securities

Good morning and congratulations, could you give me some kind of view as to what kind of milestones we can expect on the rollout of FailSafe?

Woodson M. Hobbs

Well, I’m afraid you may see some sort of collaborative type announcements that we’re working with somebody to rollout FailSafe. But, you’re probably not going to see much of any proof until the vendors actually start to ship. When they announce their products then we’ll be able to announce ours. The only thing that can be an exception to that, and I doubt it, is sometimes if a contract is so material to our revenues as to cause us to file it, then that can happen. But, it’s unlikely, it’s just much more likely it’s gonna be later in this calendar year.

Operator

(Operator Instructions) We’ll go next to Randy Guggenheimer with Burnham.

Randolph Guggenheimer, Jr. – Burnham Financial Group

It’s quite an amazing turnaround that you’ve generated, very impressive. But, I wondered if you could talk a little bit about what the Microsoft announcement means to you or could mean to you.

Woodson M. Hobbs

Well we had customers actually that brought this problem to our attention last year which is that Microsoft had provisions in their contract that aren’t perfectly clear but at least bothered our potential customers in terms of believing that it might be a problem to virtualize Windows or virtualize the computer with Windows in that environment. So, we have been complaining to Microsoft that either that was not their intention, but it was still confusing our customers and asking them to remove that clause from their end user license. They announced yesterday what they were going to do that in the press, now we haven’t actually seen the contract yet, but we’re pretty confident from our discussions with them that any kind of restrictions to virtualization in their contracts that effect us, meaning the desktop, which is where we care about the desktop and laptop, have been removed and we don’t need to worry about those any more.

Randolph Guggenheimer, Jr. – Burnham Financial Group

Has anybody complained that that was one of the reasons they’re not making commitment yet?

Woodson M. Hobbs

No, it was more of a specter that that could be a problem in the future. Everybody has been excited about it but it’s a big commitment to move in this direction and they didn’t want to find out that Microsoft is gonna cut them off in the future. I think we all suspected that Microsoft would fix this problem, but it’s still a big relief to see it fixed. And as you know, they’re doing a big virtualization conference today too, so there kind of jumping into the pool with the rest of us who are doing virtualization.

Operator

And with no further question in our queue I would like to go ahead and conclude our conference by thanking everyone for joining today’s Phoenix Technologies’ conference call. That concludes our call for today we thank you for your participation, you may disconnect at this time.

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