PLATO Learning F1Q08 (Qtr End 01/31/08) Earnings Call Transcript

PLATO Learning (TUTR)

F1Q08 Earnings Call

March 4, 2008 4:45 pm ET

Executives

Michael A. Morache - President and CEO

Robert J. Rueckl - Vice President and CFO

Vin Riera - Senior Vice President, Sales and Services

Analysts

Rob Brown - Craig Hallum

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the first quarter 2008 financial results conference call for PLATO Learning, Incorporated. (Operator Instructions) PLATO Learning reminds you that statements made in their press release and on this call that are not related to historical information are considered forward-looking statements within the meaning of the private securities litigation reformats of 1995. These statements are based on the company’s current expectations about future events. While the company believes that the assumptions made in connection with the forward-looking statements are reasonable, they can provide no assurance that these assumptions and expectations will prove to us incorrect and actual results may materially differ from these expectations. The company’s forward-looking statements are subject to risk and uncertainties such as those described in the company’s most recent filings with the Securities and Exchange Commission, including those on forms 10-K and 10-Q.

The content of this call contains time sensitive information that is accurate only as of today, March 4^th, 2008. PLATO Learning undertakes no obligation to publicly update or revise any forward-looking statements, whether it is a result of new information, future events, or otherwise. I will now turn the call over to your host, Mr. Michael A. Morache, President and CEO of PLATO Learning. Please go ahead, sr.

Michael A. Morache

Thank you, Kathy. Good afternoon, everyone. Thank you for joining us. On the call with me today is Rob Rueckl, our Vice President and CFO, and Vin Riera, Senior Vice President, Sales and Services. I will begin the call with opening remarks. Rob will comment on financial results for the quarter and then I’ll make some concluding comments. We’ll wrap up the call by taking your questions.

As reported in our press release today, we continue to experience rapid growth in orders for our online subscription-based courseware products, which increased 39% in the quarter, our ninth consecutive quarter of double digit, year-over-year growth in this metric. Orders for courseware products delivered on our PLE platform nearly doubled to $4 million. Subscription revenues grew 55% in the quarter or $2.8 million exceeding the decline in license fee revenues from perpetual products. This is a significant inflexion point in our transition from perpetual license model to a subscription model resulting in a moderation of the quarterly declines in total revenue and improvements in subscription margins and profitability since the transition to a software as a service model began in late 2005.

Total orders in the quarter were $10.6 million compared to $12.8 million in the first quarter of last year. The decline in total orders included a $2.8 million decrease in orders for Legacy perpetual products as we continue to focus sales efforts on our new subscription products. Total orders in the quarter were also affected by approximately $2.6 million of subscription orders that were expected to close in Q1, but pushed into the second and third quarters.

Next, Rob will review our first quarter financial performance in more detail and I will follow his comments with key metrics we use to monitor our strategic progress. Rob?

Robert J. Rueckl

Thank you, Mike, and good afternoon everyone. Total orders for the quarter were $10.6 million dollars down from $12.8 million in the first quarter of last year. Subscription orders increased $1.4 million or 32% to $5.6 million, but were exceeded by $2.8 million decline in orders for Legacy perpetual products. Services orders declined $800,000 dollars. As Mike mentioned, subscription orders were affected by approximately $2.6 million in orders that pushed out of Q1 into Q2 or Q3 and the latest deprived decline reflects the focus of our sales organization on selling our new subscription products. The decline in services orders reflects the lower volume of product orders and decline in orders for software maintenance on our perpetual products.

The deals that pushed out of Q1 also affecting number of orders over $100,000 in the quarter, there were 12 orders in the quarter over $100,000 with an average order value of $163,000 compared to 17 orders over $100,000 in the first quarter of last year with an average order value of $177,000. Of the $2.6 million orders that pushed out of Q1, ten deals were over $100,000.

The growth in subscription orders continues to drive growth in deferred revenue. At the end of the quarter, total deferred revenue was $44.4 million, an increase of 17% from the end of the first quarter of last year and seasonally down from $49.1 million at the end of last fiscal year. Deferred subscription revenues at the end of the quarter were $30.7 million, a 55% increase compared to the same time last year, and down slightly from $32.9 million at the end of last year.

Total revenue in the quarter was $16.1 million, compared to $17 million last year, down only 5% compared to the 20 to 25% quarterly declines we experienced throughout 2007. Subscription revenues grew $2.8 million dollars, exceeding the $2.4 million decline in license fees on our perpetual products. As a result, combined subscription and perpetual product revenues increase 4%.

Services revenues declined $1.3 million on lower professional services fees and lower software maintenance revenue. Total quarterly subscription revenues have now reached $8 million dollars, resulting in year-over-year quarterly growth of 55% and consecutive quarterly growth of 11%. Courseware subscription revenues grew at an even faster pace, increasing almost 90% over the first quarter of last year and more than 15% on a consecutive quarterly basis.

Total cost of revenue for the first quarter remained flat at $8.7 million dollars. Lower cost of services and license fees on lower revenues were offset by a $1.5 million dollar increase in subscription cost of revenue. The increase in subscription costs included a $900,000 increase in subscription product amortization, reflecting the investments made in new products and enhancements with the first quarter of 2007.

The total gross margin percentage in the first quarter was 46% compared to 49% last year, due to lower revenues and margins on perpetual license products, which have low variable costs. License fee margins declined from 51% in the first quarter of last year to 37% in the first quarter of 2008. Service margins in the quarter remain unchanged at 56%. Subscription margins in the quarter improved to 42%, up from 38% in the first quarter of last year. This improvement reflects the strong $2.8 million dollar growth in subscription revenues, which are now growing faster than subscription costs, which increased only $1.5 million. This increase in subscription costs consisted of the $900,000 increase in amortization I mentioned earlier and smaller increases in royalty costs on third party products that are bundled in our subscription solutions and the cost of additional customer support resources to serve our growing subscription customer base.

Operating expenses in the quarter were down 13% to $11.4 million as we continue to achieve the efficiency gained of the softwares and service business model. These efficiencies include greater leverage of lower cost in site sales resources, which contributed to a 10% improvement in sales and marketing costs. Few delivery platforms and growing maturity of our PLE platform resulting in a 39% decline in product maintenance costs and less complex business processes, which contributed to an 8% decline in G&A costs. Going forward, we’ll continue to drive these and other efficiencies into our cost structure.

So wrapping up our PLE results for the quarter, strong growth in subscription revenues is beginning to exceed the decline in revenues from Legacy perpetual products. Moderating the overall decline in total revenues and improving subscription margins. At the same time, we continue to drive cost efficiencies into the support areas of our business. As a result, our net loss in the quarter improved to $3.9 million dollars or 16 cents per share compared to $4.5 million or 19 cents per share in the first quarter of last year.

Our cash balance at the end of the first quarter was $19.1 million, down seasonally from $24.3 million going into the quarter and down from $24.6 million at this time last year.

First quarter operating cash flow improved almost 50% to negative $2 million from negative $3.8 million in the first quarter of last year. This improvement reflects a combination of the smaller net loss and better management of our working capital.

Free cash flow in the quarter also improved. First quarter of free cash flow increased $3.2 million to negative $5.3 million. In addition to the $1.8 million dollar improvement in operating cash flow, lower product development cost and capital expenditures contributed an additional $1.5 million to the improvement in free cash flow.

This concludes my formal remarks. I’ll now turn the call back over to Mike for his further comments. Mike?

Michael A. Morache

As we’ve done on prior calls, I’d like to discuss some of the key metrics we use to monitor strategic progress. Total order growth is our broadest measure of progress and we were dissatisfied in our results this quarter after achieving modest growth in the fourth quarter of last year. Total orders declined $2.2 million from the first quarter of last year. As I mentioned earlier, two factors contributed to this decline. Our sales efforts are focused on new subscription products. Orders for our Legacy perpetual products, which now consist chiefly of incremental licenses to existing perpetual customers declined $2.8 million in the quarter. This decline is an expected consequence of our software as a service strategy.

Subscription orders continue to show significant growth and our sales organization is making excellent progress on selling our solutions to larger customers; however, the timing of these larger implementations tends to occur during the peak buying season in our third and fourth quarters. During the quarter, approximately $2.6 million in orders, primarily for larger implementations that were expected to close in Q1, pushed into Q2 or Q3. In fact, our second quarter order rate through the end of February is more than 80% ahead of last year, giving us confidence that the Q1 order decline was largely a matter of timing. While we do not expect this level of growth to continue for all of Q2, we do expect to achieve modest order growth as we did in the fourth quarter of 2007.

As I mentioned earlier, orders for Internet-based courseware products continue to experience strong growth, increasing 39% over the quarter of last year. This growth will continue to drive significant growth in subscription revenues going forward. During the quarter, we added 116 school districts and community colleges to our PLE customer base, 55 of which were all new PLATO Learning customers. We are pleased with the growth in customers using our PLE platform and are especially pleased that the 55 all new PLE customers is comparable to the number added in the fourth quarter of 2007, despite the normal seasonality of lower sales that occurred in the first quarter.

The number of PLE registered users crossed the half million mark during the first quarter. At the end of the quarter, 613,000 individual users, mainly students and teachers, and 840 school districts, community colleges, and other educational institutions across the U.S. were registered to use PLE. This represents an increase of 25% during the quarter. As of the end of last week, the number of registered PLE users was up another 8% to 663,000.

The length of subscription periods is a key factor in determining order size and a measure of customer’s commitment to our solutions. The average length of new subscriptions sold in the first quarter was 15.3 months, down from 22.4 months in the fourth quarter. Our experience is that subscription periods tend to be shorter during the seasonally slow quarters as customers increase their licenses for the balance of an existing subscription period or purchase shorter-term solutions through the end of the current school year or summer programs.

Subscription margins are now improving after declining to the mid-30% range in 2007, when increases and product amortization were outpacing subscription revenue increases. Subscription margins increased to 42% and are expected to consistently improve going forward.

We continue to lay the foundation for achieving significant operating leverage by streamlining, simplifying, and improving most of our internal business processes. We took $19.1 million out of our cost structure in 2007, compared to 2006, and another $1.7 million in the first quarter of 2008. Our Internet delivery infrastructure continues to perform above our expectations in terms of both up-time and the number of simultaneous users it is serving allowing us to delay some of the planned incremental capital equipment and support cost as the user base grows.

The third revenue is a key forward-looking indicator of revenue and our deferred revenue balance of $44.4 million at the end of the quarter is projected to contribute approximately $31 million in revenue to the balance of fiscal year 2008.

As Rob mentioned in his remarks, operating cash flow in the first quarter improved by $1.8 million or nearly 50% and we believe operating cash flow is an important measure of operating results, because unlike net earnings in [unclear], operating cash flow is unaffected by subscription accounting.

These are some of the metrics we use to measure progress and to improve the execution of our strategy. We will continue to refine these and other important measures of progress and share them with you. In addition to these quantitative measures of progress, here are a few other indications of progress. Yesterday we announced the availability of our Achieve Now elementary reading and math courseware on Sony Play Station portable or PFP, making PLATO Learning the first educational, technology provider in North America to market educational gaming software on this popular hand-held devise. Originally developed for Sony’s Play Station consoles, Achieve Now has been a popular solution generating more than $40 million in orders from 2004 through 2007. We believe educational gaming can help students master key reading and math skills, because the current generation of young learners is accustomed to and indeed prefers digital technology for everyday activity.

During the first quarter, we invested $3.2 million in the development of new products and features. In December, we released a number of significant PLE enhancements that have been made available to all PLE subscribers. These new features include online assessments, an industry exclusive automated grade reporting capabilities, including the ability for schools to enter their own grading rubrics.

We are continuing to expand our courses offerings above the 40 courses in our original development plan and already available on PLE. We also continued to invest in classroom assessment solutions, which we have been releasing in phases. When all phases are released later in Q3, we will have a complete assessment solution on PLE to replace the functionality of our Legacy subscription assessment products, which have been experiencing declining sales for the last few years.

New capabilities for classroom assessment already released are driving demand for our courseware products, because they work together to prescribe real time, personalized, student learning programs correlated to all state test blue prints, a PLATO exclusive. PLATO uniquely is able to help school districts use technology to reduce dropout rate and improve student learning based on their actual needs.

By the middle of this summer, we expect to have largely completed the three year product road map we created in late 2005 for our transition to a software as a service company. As a result, we now have the flexibility to moderate our aggressive product investment later this year and into 2009.

We target and monitor PLE growth by four categories of sales. Conversions of Legacy customers to subscriptions, new customers, expansions by existing customers, and renewals. Since launching PLE less than two years ago, we have converted 676 of our 4,000 customers to PLE, despite not having until Q3 last year a complete set of products to replace PLATO Legacy products.

In addition, we’ve added a total of 218 all new PLATO customers on PLE. Our PLE customer base is an excellent source for expansion sales. Approximately 15% of our PLE customer base placed an expansion order in the first quarter of 2008 alone.

And finally, since the introduction of PLE, we have renewed 79% of the value of all PLE subscriptions eligible for renewal. With a full and robust set of PLE products now in the market, we expect to accelerate the rate of sales in all of these categories.

These accomplishments and progress our team metric confirmed to us that we are making progress towards our strategic objectives and the goal generating revenue and cash flow growth in the future that will reward our shareholders.

The conversion to a subscription business has presented many challenges during the transition, but we are making significant progress in our confidence and our ability to execute for shareholders remains high.

That concludes our formal remarks. We will now take any questions you may have. Back to you, Kathy.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Rob Brown with Craig Helen. Please go ahead.

Rob Brown - Craig Hallum

Good afternoon. You talked about your subscription margins starting to increase sequentially every year. Could you give us a sense of where those could go as you kind of get more ramped in the system. Is there a target margin you’re kind of looking at?

Robert J. Rueckl

Well, we’ve always said that our subscription margins get into the mid-60’s and probably higher than that. So we still have that as the target. We won’t get there this year, but we’ll continue to see those increase this year up to around the 50% range. In the fourth quarter, I don’t know that we’ll get there on average for the year, but we’ll continue to see those increase.

Rob Brown - Craig Hallum

Okay, great, and then also your license revenue level has declined to a relatively small level. Do you see this declining down or do you see it stabilizing in this area?

Robert J. Rueckl

We continue to see it declining down. I’m not sure, I think within 2008 we’ll continue to see the seasonality, so I think it will go up in Q3 and Q4 relative to Q1, but I think we’ve said in the past that ’08 looks like the same level or percentage decline that we saw from ’06 to ’07. That’s in the 50% range, but I’m going to qualify that now by the PSG. The PSG is a perpetual product and we aren’t prepared to talk about the levels of PSG sales this year, but that was not in our original plans and Mike can talk a little bit more about that, but that wasn’t in our original plan for 2008. Something that came up earlier in the year. So that may actually moderate the decline, perpetual revenue year over year.

Rob Brown - Craig Hallum

Okay, good, and then lastly, in our cash burn, are you still expecting to be a modest cash burn for the year or no cash burn for the year?

Michael A. Morache

We’ll still have a goal of being a little bit cash flow positive for the year. So yeah, modest burn or no burn.

Rob Brown - Craig Hallum

Good. Thank you.

Operator

Thank you. For any further questions or comments, please press star 1 now. Mr. Morache, we have no further questions.

Michael A. Morache

Very good. Well thank you again for joining us today. We appreciate your continued support and look forward to updating you at the end of our second quarter. Thank you and good-bye.

Operator

Thank you and, ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.

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